by Matthew D. Jessup on March 6, 2013
The talk-of-the-town the past two weeks in Washington DC and around the country has been about sequestration. You can’t turn on the television or “open” a newspaper on your iPad without hearing about it. The federal budget cuts that took effect March 1, 2013 affect defense spending, air traffic controllers, and now even tours at the White House.
One impact not widely publicized is that on the governmental issuer of municipal bonds and, more specifically, Build America Bonds, or BABs. Sequestration has cut by 8.7%, the direct pay subsidy expected by local government issuers of BABs. That means any local government issuer of BABs should expect an 8.7% reduction in the “BAB revenue” it is likely anticipating in its 2013 budget.
BABs were created by the federal government in 2009 as part of the American Recovery and Reinvestment Act. Though many types of BABs were created, most New Jersey local governments (and governments country-wide) issued “direct pay” BABs – taxable bonds to fund tax-exempt projects at taxable interest rates, with a 35% interest rate subsidy paid back to the local government issuer by the federal government. The 35% subsidy was meant to lower the taxable debt service to comparable debt service on a tax-exempt issue. In total, $3.351 billion of direct pay BABs are affected by the sequestration cuts.
In New Jersey, issuers of BABs are required by the Division of Local Government Services to budget the full taxable debt service payment on BABs in the budget, as if the local government would not receive any subsidy. However, the local government issuer is then permitted to anticipate the 35% subsidy payments as a revenue in the same year’s budget. As a result, New Jersey local governments will feel the effect of sequestration on the revenue side of the budget and not on the “outside-the-cap” debt service side.
Many BABs were issued with special redemption features that allow the issuer to refund its BABs in the event of an adverse tax action, such as a reduction in the subsidy. As interest rates generally are lower today than they were in 2009 and 2010, issuers of BABs should consult with their professionals to determine the viability of issuing traditional tax-exempt refunding bonds to refund BABs for a debt service savings. Perhaps the State Local Finance Board might even consider approving refundings of BABs that produce less than the standard 3% present value savings, particularly if the sequestration cuts to the subsidy end up being the first in a series.
Issuers of BABs will still be required to submit to the IRS their form 8038-CP 45 days prior to the interest payment date. The IRS will, temporarily, process the reduced subsidy payments by hand, but anticipates no delay in sending them out. Perhaps an indication of whether the sequestration cuts to BABs are here to stay, the IRS expects that it will have an automated system for processing the reduced payments by mid-April.
by Christopher B. Langhart on August 3, 2012
Municipal Securities Rulemaking Board (“MSRB”) Notice 2012-25 (the “Notice”) was approved by the SEC on May 4, 2012 and took effect on August 2, 2012. The Notice sets forth the responsibility of underwriters of municipal securities to make certain disclosures to an issuer, to ensure that they have dealt fairly with that issuer.
Specifically, the Notice states that an underwriter must disclose to the issuer that:
(i) Rule G-17 requires an underwriter to deal fairly at all times with both municipal issuers and investors;
(ii) the underwriter’s primary role is to purchase securities with a view to distribution in an arm’s-length commercial transaction with the issuer and it has financial and other interests that differ from those of the issuer;
(iii) the underwriter does not have a fiduciary duty to the issuer under the federal securities laws and is therefore not required by federal law to act in the best interests of the issuer without regard to its own financial or other interests;
(iv) the underwriter has a duty to purchase securities from the issuer at a fair and reasonable price, but the underwriter must balance that duty with its duty to sell municipal securities to investors at prices that also are fair and reasonable; and
(v) the underwriter will review the official statement for the issuer’s securities in accordance with, and as part of, its responsibilities to investors under the federal securities laws, as applied to the facts and circumstances of the transaction.
The Notice also makes clear that the underwriter must not recommend that an issuer not retain a municipal advisor.
Compensation is addressed in that an underwriter must disclose to the issuer whether underwriting compensation will be contingent on the closing of a transaction. If so, the underwriter must disclose that such compensation presents a conflict of interest, because an underwriter could conceivably recommend a transaction that is unnecessary or larger than necessary. Typically an underwriter does not get paid unless a transaction is completed, so it is likely this disclosure will be necessary in almost every transaction.
The basic intent of the Notice appears to be to emphasize that the underwriter is a party to a business deal and is not always the issuer’s ally. However, the underwriter is acting no differently than in past deals, and this flurry of disclosure requirements has come about solely due to the changes in Rule G-17.
An issuer can expect to receive initial disclosure representations at the beginning of a transaction, but certain additional disclosures may be required at later times within a transaction, especially for more complex transactions. Since the Notice requires that an issuer acknowledge receipt of such disclosures, an issuer can expect to be requested to sign an acknowledgment of receipt of the disclosure representations of an underwriter. However, by acknowledging or signing for such receipt, the issuer is acknowledging only that it has received and read the representations and is not making a contract with the underwriter or in any way binding the issuer to continue the transaction.
The Notice states that all written and oral representations made by an underwriter to an issuer must be truthful and accurate and not misrepresent or omit material facts—which conduct might be expected anyway—and that an underwriter must have a reasonable basis for its statements and any prepared materials. For example, an underwriter cannot represent that it has the requisite knowledge or expertise with respect to a transaction, if the personnel who will work on the transaction don’t have such knowledge or expertise. This is important to think about during the RFP and RFQ processes.
The requirements detailed in the Notice raise potential issues that need to be thought about in every transaction going forward, especially because the Notice appears to be a harbinger of the stricter regulation of municipal securities transactions that seems all but inevitable.
by Matthew D. Jessup on July 18, 2012
The Local Finance Board (Board) has released a questionnaire for all municipal and county applicants seeking approval of the Board to:
1. Long-term finance tax appeals;
2. Long-term finance certain emergencies; and
3. Issue bonds pursuant to a non-conforming maturity schedule.
The four-page questionnaire is being used by the Board to help assess whether the applicant has made prior efforts to “prepare for a reasonably forseeable financial challenge” and whether the applicant has “made substantial efforts to control spending.” The questionnaire asks project-specific questions (“When did the applicant become aware of the underlying issue?” “What appropriation and other steps has the applicant taken to provide for the financial exposure?”) and more general operational questions (“Do elected officials receive compensation?” “Are there any shared service agreements in place?”).
The message being sent by the Board to potential applicants is clear from the questionnaire – don’t look for us, the Board, to provide financial relief unless you, the Applicant, have already made substantial efforts on your own.
This message can best be applied to an applicant seeking long-term financing of tax appeals. A municipality or county seeking to finance prior years’ tax appeals, that has not been providing funds via a reserve for tax appeals in the budgets of prior years or the current year, is not likely to be favorably reviewed by the Board.
The questionnaire should be reviewed by all municipalities and counties and used as a guidebook in managing potential financial exposures. Municipalities and counties seeking any of the approvals referenced above should be prepared to complete and file the questionnaire simultaneous with filing their application with the Board.
A complete copy of the questionnaire can be found here.
by Matthew D. Jessup on January 19, 2012
It’s no secret that municipalities have been hit hard by the ongoing recession. One source of significant financial stress is the amount of money that municipalities are required to pay to residents as a result of tax appeals. As real estate values continue to decline, successful tax appeals continue to rise, forcing municipalities to pay significant judgment amounts out of an ever-declining surplus. Municipalities currently have a few tools to finance these tax appeal judgments, including by refunding bond ordinance or by a series of emergency appropriations that are later taken out by refunding bond ordinance.
Municipalities have now been given yet another tool to assist with this ongoing struggle with tax appeal refunds. Yesterday, Governor Christie signed into law A-3971/S-3110, which states, among other things, the following:
Any municipality that has ended the previous budget year with a deficit in operations caused, whether in whole or in part, by obligations created from tax appeals, may issue notes with the approval of the Local Finance Board on such conditions as the Local Finance Board deems appropriate. The amount of notes authorized pursuant to this provision shall not exceed the cash payments or tax credits due to tax appeals and shall be authorized by a bond ordinance approved by the Local Finance Board.
I’m calling this one the “Do Over Bill”, as in “Those municipalities that didn’t finance tax appeals last year by refunding bond ordinance or pay tax appeal amounts through emergency appropriations, now get a do over.” This opportunity at a “do over” could not have come at a better time. In this economic environment, rating agencies are concerned more than ever before with the level of surplus held by municipalities. This new law gives municipalities a chance to restore surplus and stave off the probable ratings downgrade that would have otherwise followed.
Similar to the Local Finance Board’s recently announced criteria for financing tax appeal credits, to me it’s a shame that this new law allows a municipality to issue these new Tax Appeal Notes only if the municipality’s previous budget year ended with a deficit in operations. If Town A spends $3 million on tax appeals in a given year and ends up with $10,000 in surplus in operations, Town A does not qualify under the new law and cannot issue new Tax Appeal Notes to help restore surplus. But if Town B spends the same $3 million on tax appeals and ends up with a $5,000 deficit, Town B gets to recapture and rebuild all $3 million in surplus through the issuance of these new Tax Appeal Notes.
Perhaps over time, the Local Finance Board can find a way to ease the “deficit” requirement. In the meantime, if your municipality finds itself starting 2012 with a deficit created in part by tax appeals, there is now a mechanism to help right the ship.
by Matthew D. Jessup on December 15, 2011
Yesterday, the Local Finance Board (Board) took the first step in establishing a new rule that would allow municipalities and counties to issue refunding bonds and capture debt service savings on an expedited basis. This is a significant development, as timing is everything when it comes to refundings, particularly in this volatile economic market.
The Board has adopted a resolution approving a proposed rule that would allow municipal and county issuers to issue refunding bonds to refund outstanding long-term bonds without the prior approval of the Board, as long as certain conditions are met. Currently, municipalities and counties must appear before the Board for approval after introduction and before final adoption of a refunding bond ordinance. Because the Board accepts applications and meets only once per month, the current procedure can result in a 30 to 45 day delay – plenty of time for interest rates to rise and opportunities to decrease debt service to vanish.
The proposed conditions are as follows:
Upon closing on a refunding bond issue, an issuer will need to file a certification with the Board that details that the above conditions were met, with appropriate back-up and an itemized accounting of the costs of issuance of the refunding bonds.
An overwhelming majority of the refunding transactions completed by municipalities and counties meet the above conditions. Accordingly, most issuers will receive the significant benefit of being able to enter the bond market quickly without any additional burdens. Any issuer that was going through the process of authorizing a refunding bond issue at the end of 2010 knows how quickly interest rates can rise and certainly can appreciate the benefit this proposed rule provides.
The Board’s proposed rule is subject to a 60-day comment period and additional action prior to becoming final. During that time period, issuers will still need to make application to the Board for approval to issue refunding bonds.
by Matthew D. Jessup on September 30, 2011
The Division of Local Government Services indicated today that municipalities may, for the first time, finance with refunding bonds or notes the amount owed to a taxpayer as a result of a successful tax appeal and applied as a credit against future taxes to be paid by such taxpayer (taxpayer credits). Previously, municipalities were able to finance only the amount actually paid by the municipality by check back to the taxpayer.
Specifically, the Division will allow municipalities to finance 3/4 of the amount of taxpayer credits. The logic is that, even though the entire taxpayer credit is being given to the successful taxpayer in the 4th Quarter, that taxpayer credit is a product of the overpayment made by the taxpayer in Quarters 1, 2 and 3.
This, of course, presumes that the tax appeal is settled after the 3rd Quarter tax payment is made by the taxpayer. It is unclear whether a tax appeal settled after the 2nd Quarter but prior to the 3rd Quarter would result in only 2/4 of the credit being eligible for financing.
But, there’s no such thing as a free lunch.
Approval by the Local Finance Board to finance taxpayer credits comes with four conditions:
1. The municipality must show that, absent financing the taxpayer credits, the municipality would end the fiscal year with a deficit in operations (this would be a projected deficit, since the Local Finance Board’s approval of these financings must occur no later than the November Local Finance Board meeting).
This condition is unfortunate. Those municipalities that have large amounts of taxpayer credits but do not meet this condition will be forced to spend their surplus funds instead of financing the taxpayer credits over several years. In this economic environment, with rating agencies already downgrading municipal credits at alarming levels, this unnecessary use of surplus will be a “credit negative” (to use a rating agency phrase) and lead to increased costs of borrowing for municipalities.
2. The municipality may finance tax appeal credits only one time. Choose your year wisely.
3. The municipality will be required to undertake a revaluation or reassessment, as appropriate.
4. The municipal governing body must adopt a resolution acknowledging that all new hires through the end of the next succeeding fiscal year be approved by the Division.
Municipalities will be required to complete a Division-issued form asking a series of questions regarding each new hire, including who is being hired, at what compensation, whether the hire will be civil service, why the hire is taking place (someone’s retiring, new position, etc.). The Division will scrutinize each new hire thoroughly.
This is not a perfect solution, as noted above. In addition, it is troubling that each municipality may finance taxpayer credits only once. Even if a municipality immediately undertakes a revaluation or reassessment, those procedures take time, and the intended effect of eliminating or drastically reducing the number of tax appeals won’t be felt the next year. The municipality will likely have the same taxpayer credit problem in the next year, with no real, viable solution.
That said, the inability of municipalities to finance taxpayer credits over a multi-year period was putting enormous financial pressure on many municipal budgets. The Division’s solution will go a long way towards eliminating one of many financial pressures faced by municipalities.
by Matthew D. Jessup on August 8, 2011
In today’s municipal bond market, your credit rating is more important than ever. Underwriters and financial advisors say that the difference between an “A” rating and a “AA” rating can mean the difference of 30 basis points or more. Such a difference can result in interest rate savings of $315,000 on a $10,000,000 20-year general improvement bond issue. In refunding transactions, 30 basis points can mean the difference between achieving the State-required 3.00% present value savings (and capturing debt service savings) and falling short (and letting bondholders keep your money).
That said, not every municipality is blessed with a healthy general fund balance, a wealthy tax base and a full “cap bank” under the 2% Property Tax Cap Act. After recently meeting with one rating agency and participating in ratings calls with both ratings agencies week after week, it occurred to me that there are three easy ways every municipality can immediately improve its standing with the rating agencies.
First, establish written policies regarding (1) use and regeneration of General Fund balance, (2) long-term capital improvements and (3) issuance of short- and long-term debt. Your municipality likely already has “informal” or “understood” policies regarding these topics, but they’re not written down. Simply putting them to paper (and, even better, having them adopted by the governing body by resolution) shows the rating agencies that all members of the administration are in agreement and that the policies will survive departing finance officers and administrators and provide continuity.
Second, complete and update revenue and expenditure forecasting on a monthly or quarterly basis. Continuous updates to a 12- or 18-month projection will better prepare a municipality to anticipate and react to future revenue decreases or expenditure increases. Revisit prior forecasts and identify and use historic trends to help prepare future forecasts. Preparing and updating these forecasts, being prepared to discuss each item and meeting the projections consistently are all indications to the rating agencies of a strong management team.
Third, provide monthly or quarterly financial reports to the Mayor and governing body. Use the revenue and expenditure forecast discussed above to prepare a “projected versus actual.” Many municipalities already prepare similar reports but fail to share them with the Mayor and governing body. Keeping everyone informed is another characteristic of a strong management team.
Your municipality likely implements one or more of these three suggestions in an informal way. It is a short step-up to make them formal in a way that satisfies the rating agencies. The effort will be minimal and the result could be significant.
Both Moody’s Investors Service and Standard & Poor’s publish their rating methodologies. I encourage everyone to read through them for more details on what the rating agencies are looking for when assigning a rating to your municipality.
Moody’s – General Obligation Bonds Methodology
Standard & Poor’s – General Obligation Bonds Methodology
by Matthew D. Jessup on March 24, 2011
Earlier this week, the Securities and Exchange Commission (SEC) announced that additional field hearings examining the state of the municipal securities market were being suspended due to budgetary constraints. In lieu of these hearings, the SEC is asking market participants to submit comments on a wide range of municipal securities market topics, including “disclosure and transparency, financial reporting and accounting, and investor protection and education”. A complete list of topics may be found on the SEC’s website (http://www.sec.gov/spotlight/municipalsecurities.shtml).
The New Jersey Government Finance Officers Association (GFOA) recently asked Ed McManimon for his opinions on whether the GFOA should formulate a response to the SEC. Here is Ed’s response:
Our view is that the SEC is really looking for comments and suggestions from the market itself, not the Issuers. It is the SEC’s hope that the Financial Community will urge more specific procedures for municipal debt, similar to corporate debt, so that it might serve as a catalyst for more regulation of tax-exempt debt, or replacing tax-exempt debt with taxable debt or more routine disclosure, etc. I believe that any comments from the GFOA or extended government community will be a waste of effort and will at this point fall on deaf ears. However, we should be prepared to react to extreme positions that may result from their exercise.
I am also concerned that it would be difficult for us to make a strong case at this stage since, candidly, in my opinion, the lax and inconsistent compliance by many local governments with fairly benign initial and continuing disclosure and related issuing requirements has probably spurred this effort on and makes it hard to confront this exercise by the SEC in any meaningful way.
We need to get our house in order by making sure all local governments and all Finance Officers and all auditors and all bond attorneys, etc., understand the significance of continuing disclosure filing requirements, arbitrage calculations on a regular basis and the benefit of maintaining current updated financial information if you want to access the market effectively and keep regulators from proposing more stringent, costly and onerous requirements on all of us.
To further Ed’s point, note the statement made by the SEC on its website: “[P]rotecting investors in the municipal securities market is a core function of the Commission and the staff is continuing its’ [sic] efforts to gather information about the market and develop recommendations for improving the state of the municipal securities market.”
Readers that know Ed know that he is always interested in the contrarian view. Leave us a comment below and share your view. And if you decide to submit a comment to the SEC, let us know.
by Matthew D. Jessup on March 16, 2011
This is the time of year when each calendar-year municipality is finalizing its audited financial statements for the year ending December 31, 2010 and adopting its budget for 2011. The focus is generally on the finishing touches for the audit, as well as working with the Division of Local Government Services to fine-tune the revenue and expenditure numbers in the budget.
Let me add one very important step to this process that is often forgotten or overlooked, and yet is now more important than ever. Someone needs to file the completed audit and the adopted budget with the Municipal Securities Rulemaking Board (MSRB) through the MSRB’s Electronic Municipal Market Access Dataport (www.emma.msrb.org) to ensure compliance with your municipality’s secondary market disclosure requirements.
That last sentence may have made your head spin, but the filing of secondary market information needs to be a priority for any municipality that has issued municipal bonds. In order for a purchaser of municipal bonds to comply with certain Securities Exchange Commission (SEC) and MSRB requirements, the purchaser must receive a written promise from the issuer of the municipal bonds that the issuer will (1) provide annually its updated financial information, including the audit, the budget and certain demographic and other economic data originally included in the Official Statement that was used to sell the municipal bonds; and (2) provide notice of the occurrence of certain “material events” if they occur. This promise is written into every Official Statement distributed in connection with the issuance of municipal bonds. Without it, there would be no buyers of those bonds.
The SEC and the MSRB are more focused than ever on enforcing the written promise made by municipalities. In fact, the SEC Chairwoman reported to the House of Representatives yesterday that the SEC would like the ability to pursue municipal issuers directly, versus having to enforce disclosure obligations indirectly through the purchasers of municipal bonds, the way it does currently.
It has been my experience that all too often, municipalities forget to file their secondary market information with the MSRB. The municipality thinks the auditor, bond counsel or financial advisor automatically completes the filing, and the same professionals think the municipality completes the filing. The deadline for filing secondary market information varies by issuer and is contained within the form and sale resolution authorizing the bonds.
So, please allow this to serve as a reminder. Contact your auditor, bond counsel and financial advisor and make sure everyone has the same understanding of who is filing this information. Hire one of your professionals to undertake this responsibility if need be. Any fees associated with this work are well worth preserving your municipality’s access to the municipal bond market and will pale in comparison to the fines and penalties the SEC may one day have a right to collect from your municipality.
by Matthew D. Jessup on December 17, 2010
Last night, the House of Representatives followed the earlier action of the Senate and approved significant tax legislation that, among other things, failed to include an extension of the Build America Bond (BAB) Program. The BAB Program automatically expires on December 31, 2010, and tax legislation was the last chance for a stay of execution. The BAB Program allowed governmental issuers to issue taxable bonds to finance tax-exempt capital projects and receive a 35% (or in some cases 45%) interest subsidy from the Federal government.
Based on the very scientific “by show of hands” survey I conducted last month at the League of Municipalities, governmental issuers in New Jersey won’t be mourning the death of BABs for long. Very few municipalities issued BABs, and the few that did are still (a) wondering whether they saved money compared to issuing traditional tax-exempt bonds and (b) holding their breath that the Federal government makes good on its promise to pay the subsidy for the next 20 or 30 years.
What municipalities should mourn is the reversion of the “Bank Qualification” limit from $30 million back to $10 million. Originally created in 1986, the $10 million limitation had never been increased based on inflation or regionalization, until 2009 when it was increased to $30 million pursuant to the legislation creating BABs. Tax legislation was needed to prevent the decrease back to $10 million at the end of the year.
Banks buying “Bank Qualified” debt are allowed to deduct 80% of the cost of borrowing and holding such debt issued by governmental issuers that issue no more than (for now) $30 million of tax-exempt debt each year. When banks have access to less expensive capital, those savings are passed down to the municipal issuers. On any given day, bank qualification can mean as many as 50 basis points or more in savings.
Rather than issue Build America Bonds, a significant number of New Jersey issuers took advantage of the limitation increase to $30 million and issued bank qualified debt in 2009 and 2010. The increase in the limitation was long overdue and provided critical debt service relief to municipalities. It is unfortunate that Congress couldn’t separate its dislike for BABs from the benefits of a higher bank qualification limit, so that the latter could continue. Heading into the worst budget year they have ever seen, local governments needed this valuable benefit.