In Today’s Monday Muni Minutes…The New SEC “Kid in Town”, VCAP Request over PABs, Hospital Issuances are UP…despite Risk, and our NEW Muni Market Minute Segment!
CURRENT EVENTS
There’s a “New SEC Kid in Town”… 
Office of the Investor Advocate… Focusing on Disclosure in the 21st Century
At Friday’s Practicing Law Institute’s SEC Speaks 2015 conference we, again, get a strong sense of where muni compliance is headed. Buckle up friends…
But first…how many of you were aware of this new office at the SEC?
In this meeting, which included members from virtually every arm of the agency, Commissioner Luis Aguilar called for stronger enforcement…including industry bars for financial professionals who commit fraudulent conduct.
He had strong words to share…“These bars, not only serve to punish the wrong doer, but also protect investors from future misconduct by such person”.
Aguilar further stated “these bars send a clear message to the next potential fraudster”.
So…I don’t think the focus on increased compliance and transparency will end…any time soon.
We also heard from the first head of the Office of the Investor Advocate Rick Fleming who, while only in his position for a year, has clearly hit the ground running.
Fleming reports directly to SEC chair Mary Jo White and has pledged to be active in improving disclosure
in the municipal market.
Fleming also said that continuing disclosure needs to be “brought into the 21st century” and that the information being presented needs to be “engaging and digestible”.
Simply put, the old fashioned method of providing investor information will not cut it going forward.
Let me repeat that…engaging and digestible disclosure in a 21st century format…
Fleming recently submitted a comment letter to the MSRB, supporting the joint MSRB/FINRA proposal requiring additional disclosures for municipal securities dealers acting as principals to disclose “reference prices” to customers for same-day trades.
Ultimately, his office’s job is to promote the investor interest, analyze impacts of SEC proposals and find ways to help improve investor protection.
The “new kid” in town has a powerful mission…and we ALL better pay attention.
[Editor’s Note: We have known, since before the MCDC deadlines, that the SEC is serious about tightening municipal disclosure, making it more transparent and diligently pursuing wrongdoers…even at the individual level…like Allen Park and Harvey. When new protection offices are created and Commissioners use terms like “industry bars” and “egregious fraudulent conduct”, that “the winds of change” are blowing…and in our direction.]
Texas Issuer Requests VCAP for Excess Private Use
The infamous 10% private activity bond rules led the Texas Conroe Industrial Development Corporation to request a VCAP settlement from the IRS – for two separate series of their bonds…issued in 2008 and 2012 respectively.
The CIDC issued $15 million in revenue bonds in 2008 in $25.39 million in bonds in 2012 to refund the 2008 Bonds, plus provide for expansion of one of its industrial parks.
The CIDC purchases and develops land by providing public roads and utilities and then sells the land to industrial users for manufacturing and other such facilities.
In this case, the sale of the property financed by the bonds, even though they were backed by sales and use tax revenues appeared to run afoul of both the 10% private use and the private payments tests…making them private activity bonds.
Conroe city attorney Marcus Winberry said. “When sale proceeds from a financed project exceed a threshold established under IRS regulations, the tax advantaged status of the bonds can be jeopardized unless the bonds are either redeemed or the excess sales proceeds are promptly devoted to an alternative qualified use,”
He further explained, “Late last year during an internal post bond issuance review, the CIDC determined that land sales to private users had exceeded the maximum threshold without appropriate remediation.”
CIDC cautioned in their EMMA notice that they cannot be sure of the VCAP outcome.
[Editor’s Note: Although not specifically stated, the “late last year” review may have been a direct result of the MCDC review process. CIDC, or their underwriters, discovered the violation and have taken quick and decisive steps to remedy the situation, in hopes of preserving the tax-exempt status of their bonds.]
Non-Profit Hospital Bond Issuances Up…But Risk still Exists
Although bond issuances for not-for-profit hospitals are already up significantly in 2015, the rate of return investors are getting does not appear to match the risks this sector still faces.
S&P, Fitch and Moody’s still maintain negative outlooks on the entire non-profit hospital sector, which is fighting significant challenges from the Affordable Care Act. Combine this with continued downward pressures on revenues and reimbursement, coupled with increasing volumes…and it’s little wonder struggles exist.
A few statistics:
- In 2009, hospitals issued $40 billion
- In 2014, it was down over 60% percent to just over $15 billion
- In 2015 YTD, issuances are already at 25 percent of the 2014 total
- More than 50% of the 2015 issuances are refinancing deals
Municipal Market Analytics, a municipal research firm, shared news that the default trends for the non-profit hospitals are such that it could be among the most significant sectors in terms of the number of defaults. The ACA is being blamed for this ongoing risk.
That does not give me the financial warm and fuzzies…at all.
However, on the upside the MMM cited increasing concerns over municipal market bankruptcies like Detroit and Puerto Rico as why demand for hospital bonds is increasing.
They also said that bondholder treatment for hospitals is seen as more predictable then what can happen in a Chapter 9 scenario for a municipality.
[Editor’s Note: So what is a bondholder to do? Coming from the hospital sector, I understand, first-hand, what the recession, the ACA and other increasing regulations (HIPAA and electronic records are just another small example) are doing to this sector. There are so many moving pieces, it’s no wonder the bondholder, the SEC and IRS are all paying very close attention….]
OUT & ABOUT
Conferences in Q1 – 2015:
The Bond Buyer and BDA’s National Municipal Bond Summit March 1-3, 2015
The Westin Beach Resort & Spa, Fort Lauderdale, FL
Resource: On Demand Replay of Continuing Disclosure after MCDC
Slides: Final Slide Deck for Continuing Disclosure after MCDC
NEW: A Couple of Muni Market Minute Updates
(My tiny new idea hint from last week – quick bits on ongoing topics…let me know what you think!)
Favorable PLR on Water Bonds from IRS
An un-named issuer, only shared as a “political subdivision and governmental agency of the state”, has received a favorable Private Letter Ruling for issuing governmental and private activity bonds to finance water facility improvements.
Water and wastewater bonds generally get tight scrutiny regarding their uses, particularly as many of these projects involve large sums of money, “take or pay” or output contracts and can benefit both industrial as well as municipal users.
[Editor Note: This is great news for the issuer…while we wait to see the outcome of recent legislation to exempt water bonds from state volume caps as well as QPIBs.]
Wayne County Bankruptcy Talks…Premature or Not?
Even after Standard & Poor’s toppled Wayne County’s last bond from investment grade status, it urged caution, citing that Michigan Law makes a “rush to bankruptcy” difficult for Wayne County.
They did note that Detroit moved very quickly to Chapter 9 after an emergency manager was hired so the rating agency could change their view and bring further actions.
[Editor Note: Wayne has some nearly vertical cliffs to climb – mainly establishing their ability to severely reduce their legacy obligations. We will watch this closely and keep you posted.]
Editor Commentary: The Tale of Two Schools…and Why We Should Be Concerned…
Last week’s Bond Buyer featured two very different school districts…one in Detroit, which has struggled financially and academically for years…
…and another, which proudly boasts some of the highest test scores in Indiana and a lucrative tax base – yet defaulted on two debt service payments last month.
Let’s take a quick look at these two schools, what happened…and ponder a couple of questions.
The default happened at Munster School District, an Indiana Blue Ribbon rated school district of five schools with 4,100 students…about 30 miles from Chicago, Illinois.
While we have covered the woes of the Detroit Public Schools (DPS) in earlier editions, the state of Michigan is working hard to come up with a turnaround plan to remove $55 million in debt from the school, stopping short of calling it a “restructuring”.
Let’s step back and review some details:
Detroit Public Schools (DPS)
- $2.1 billion in debt
- Fixed costs, including debt service and retirement are 35% of total revenues
- Fiscal Deficit in 2015 is $170 million
- Junk ratings on Bonds
- Under Emergency State Management for six years
(School Town of) Munster School District
- $97 million in debt and leases (2011)
- 4,100 students and 400 employees
- Voter-Approved 2013 Property Tax hike provides $3.4 million annually
- BBB Bond Rating – Investment Grade
- Long-Term Executive Management
So what happened to these seemingly night – and – day schools?
In DPS’s case, we are all aware of the challenges that city faced as a result of the auto industry collapse, Detroit’s recent high profile bankruptcy and now Wayne County’s dire financial woes.
Governor Rick Snyder is working hard to alleviate not only DPS’s debt, but to put a mechanism in place, namely legislatively approving a $75 million distressed schools fund – which will also help other struggling districts in Michigan.
In Munster, it is simply a case of the school district being caught off guard when a $2.2 million lag in expected property tax collections from December collided with an already weakening cash flow position.
Even though the voters approved a tax-hike to fund the Munster schools, the payments simply did not materialize. As we all know, you can’t pay debt service with your accounts receivable.
This brings me to the first question: Why, after a default, is the rating still investment grade?
Although the school’s officials made-up the debt service payments within just a matter of days, it took emergency local bank loans and City Council action to make that happen.
The second question: If a double-default can happen to a Blue Ribbon school in one of the most lucrative tax based counties, should we all be paying a little closer attention to other dominoes which may be ready to topple over in our K-12 Systems?
Warning bells are going off in my compliance brain right now.
Now back to DPS: The Detroit School, which has been under emergency state management for six years, is only one of many districts which continue to decline. While clearly downplaying the bad “bankruptcy” word, it’s going to take some serious changes to tackle the academic and financial issues facing these schools.
Michigan’s solutions range from the $75 million distressed school fund to working hand-in-hand with citizen groups to develop preventative measures to stop schools from getting into these positions in the future.
That is a tall order when you think about a school’s life-blood reliance on property tax revenues and state funding (both of which are struggling and lagging) combined with higher student loads (many also disadvantaged) and legacy liabilities in healthcare and retiree/pension costs for both the schools and the municipalities that support them.
Three points which bear highlighting:
- Investors: Do independent credit quality research – bond ratings alone are not enough
- Schools and Municipalities: Long-term funding solutions and oversight is clearly needed
- Issuers: Expect to see more eyes on your bonds, your financial strategy and your cash flow
Unfortunately, these two examples really go way beyond the surface of financial administration in our schools. This hits to the heart of the often-overlooked financial inter-relationship and interdependence that leads to the “domino effect” of failing municipal cash flows.
If the homeowner is laid off and gets behind on taxes, the county and schools don’t get funded. It also 
typically means less sales or income tax revenue to the state.
Add increased demand on services for struggling citizens. Repeat.
All the while, we have students who need top-notch educations – likely well beyond K-12…to be able to compete in the increasingly global marketplace. Our economy depends on them.
But wait…that takes money…and the cycle starts again. That’s why we should be concerned.
This will not be an easy solution, but it’s one we have to address…for us and for our kids.
What do you think?
In closing, we continue to work on the next sets of trainings
- Policies and Procedures (over 20% of Issuers still need policies)
- Bond Accounting Boot Camp – the Issuer’s perspective
- PIC Essentials Blue Print – Building a Comprehensive Post Issuance Compliance Program
Now, this will be approached from the Issuer perspective, not as an underwriter or bond counsel. However, it will cover the Regs and key aspects of your Bond Documents as well. After all, these documents drive what you, as the issuer, have to comply with.
More on that to come later…
We are also working on a plan to re-offer PIC Essentials – the 10-Step Compliance Framework in an on-
demand video series format – within a secure membership site.
We will send more details on all of these “next steps” via e-mail in the next week or two…
While you continue to watch what comes out of California with the ABAG case and MCDC, we will continue to build and deliver quality, issuer-focused post issuance compliance training that is convenient, relevant and reasonably priced to meet YOUR needs. That remains our priority commitment to YOU.
After all, time is money, right?
We hope you found this week’s edition of the Monday Muni Minutes valuable and informative.
As always, your comments are welcome…
To your compliance success,
Debbie
The greatest compliment you can pay us is to share this newsletter with your issuer friends….
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