Wow, it’s been an amazing week in Municipal Finance! It was really hard to choose which items to write about…there were so many interesting and relevant events! So, let’s dive right in to this week’s Monday Muni Minutes….
CURRENT EVENTS
What’s New at the IRS…
Got Forensic Audit??
ABAG planning Forensic Audit after Apparent Embezzlement
The Association of Bay Area Governments – ABAG for short, quickly took steps to replace $1.3 million which is missing from the 
city’s development fund after an alleged embezzlement.
The Finance Authority for Nonprofit Corporations or FAN for short, appears to be the victim of embezzlement from its long-time Director Clarke Howatt, who has worked for ABAG since 1995.
Charles Lomeli, chair of FANs Executive Committee stated “we are deeply shocked that FANs long-time director Clarke Howatt, appears to have embezzled $1.3 million from funds designated for public improvements in San Francisco.”
Additionally, a forensic audit is being scheduled although a firm has yet to be selected to conduct the audit.
The facts in the case are as follows:
- Howatt created a fake LLC using a legitimate developers name
- He opened an account in the name of the fake LLC at Citibank
- He misled underwriting counsel Jones Hall by directing the creation of numerous documents, including a second indenture staff report and a FAN resolution
- Howatt went to the board for immediate action:
- claiming the time to expend the bond proceeds was about to expire
- submitted an eligible list of public improvements
- obtained the ABAG finance director’s approval using the FANs board resolution
- claiming the time to expend the bond proceeds was about to expire
Then…the coup de gras…
Using ABAGs approval, Howatt convinced Union Bank trustees to wire 1.3 million dollars to the fake LLC.
To step back, ABAG is a regional planning agency and was the conduit issuer for the city on the original $5.7 million bond issue that was to pay for infrastructure improvements via the Mello Roos community facilities district bond. Since 1990, ABAG has issued, on a conduit basis, more than $6.7 billion of bonds in 273 issues.
At 22.8%, the $1.3 million dollar theft was a significant portion of the $5.7 million dollar bond deal.
ABAG is also working with the FBI as well as San Francisco City Attorney’s Office to investigate any and all missing funds.
Howatt, who is the only person named in the suspected theft, resigned by email on Thursday.
[Editor’s Note: As my Grandma used to say…one bad apple can quickly spoil the whole bag. So true grandma! This is another fascinating article which highlights the risks, obligations and possible reasons why the SEC and IRS are pledging to pay closer attention to special districts going forward. Unfortunately, the vast, overwhelming majority of issuers who are doing it right could face extra scrutiny thanks to a few people like Mr Howatt – thanks a lot, hmmm?]
However…on the brighter side…..Two Audits get “No Change”
In another interesting Bond Buyer article, the IRS just closed the audit of two series of bonds issued in Colorado with a “no change” in tax-exempt status.
As shared in earlier editions of the Monday Muni Minutes, these two audits were from the Colorado Housing and Finance Authority (CHFA) on their $53.07 million 2002 Bonds and the Colorado Health Facilities Authority’s $42.82 million 2007 Bonds.
The CHFA bonds were the combination refunding and new money bonds as were the Colorado Health Facilities bonds.
In the September letter from the IRS, these bonds were both audited as part of a project involving arbitrage compliance in 
connection with the filing of a Form 8038-T. As we’ve shared in the past, the 8038-T deals strictly with arbitrage rebate. Additionally, the IDR requests specifically asked for “focused advanced refunding bond information”.
As discussed in the IRS TEB Director’s 2015 Update webinar last week, the IRS cited both advance refunding and arbitrage rebate as two areas where TEB agents will continue to focus their attention.
One other interesting point to note: In the “no change” letter from the IRS, it said that an information return was incorrectly filed…as it had the wrong employer identification number.
Ooops….
[Editor’s Note: This is just another tiny heads up that we need to be VERY careful and make sure that we use the correct numbers on all of our forms. Some sage advice my tax counsel told me early on…check twice…file once.]
IRS Notice 2015-12: New Applications Being Accepted for CREBs Volume Cap
In what is being seen as “good news” by the American Public Power Association and power lobbyists, nearly $1.4 billion of unused New CREBs (Clean Renewable Energy Bonds) is available for eligible projects by public power providers, government providers, clean renewable energy bond lenders and electric co-ops.
Key points to note:
- New Allocation method. Before it was allocated from smallest to largest, now it is 1st come, first served
- Allocations up to amount requested for Govts and Co-ops, beginning March 5th
- Applications from Public Power projects up to amount requested as long as total requests do not exceed the cap – must be submitted by June 3rd
- Application must list what projects the CREBs will be used for as a “qualified renewable energy facility”, along with details
on construction, cost, location and completion - An independent, licensed engineer will need to certify CREBs requirements will be met
- Attestations as to appropriate ownership of the project and that proper government and financing approvals have or will be obtained
- The issuer will also need to attest that the proposed use of the bonds meets federal tax law requirements
- IRS will send letters informing applicants of their allocation – issuers have 180 days to issue the bonds
[Editor’s Note: The allocation of unused New CREBs will help provide financing for a variety of power infrastructure projects. Providers have experienced some unexpected cuts in subsidies due to sequestration, which led to a focus on extraordinary redemption provisions in bond documents. You can click the link for the full text Notice 2015-12, or in Resources under Out & About below. ]
Resignations, Takeovers and Armageddon….oh My!
Both Pennsylvania and Michigan made the Bond Buyer’s muni news last week…and it wasn’t for playing nice in the office or for budget surpluses.
Pennsylvania Treasurer Rob McCord resigned, effectively immediately, on January 30th, admitting he “stepped over the line” and may plead guilty to charges of threatening would-be campaign contributors with loss of state business.
Christopher Craig was appointed to serve in the role on an interim basis. The FBI is also investigating.
Although McCord was given credit for diligent service in saving the state over $1 billion in the last six years, his departure comes on the heels of the January 21st grand jury recommendation that Attorney General Kathleen Kane face perjury and abuse of office charges for her office leaking grand jury information.
A couple of states away, Warren Evans, Wayne County Michigan’s newly elected executive, had the dubious honor of painting their county’s fiscal portrait…and it was really ugly…with a ton of red ink.
Wayne, the home county to Detroit, has already seen its share of news, but at the city level. Per Evans, Financial Armageddon could come as early as August 2016. State takeover and bankruptcy are options.
“Even with all of the funds pooled together, we’re going to get to the area where we just don’t have enough to pay the bills”. 
Evans said as he presented the Ernst & Young report on Wayne’s financial outlook. “It’s a bad picture. One of the big requirements for bankruptcy, and that’s an ugly word, is your cash position; if you don’t have cash it’s one of the triggers.”
To put it in perspective, the county has an accumulated deficit of $161 million and pension funding has decreased to 45% today – down from 95% ten years ago.
The E&Y Report paints a “significant cash burn absent drastic budget cuts or significant changes in legacy liabilities”. Those include pensions, healthcare costs and budgets in the sheriff’s and prosecutor’s offices. Annually through 2019, debt service is $20 million per year, with pensions at $42 million and retiree health benefits at $33 million.
Wayne is barely holding on to its S&P investment grade status at BBB- and Moody’s Baa3. Fitch has them rated BB- speculative. Wayne has $730 million of LTGO Bonds and $340 million of LTGO Notes outstanding.
The county needs to come up with $70 million per year to cover the shortfall and address the pension liability. Evans said, “The bottom line is everything is on the table, there’s no sacred cows.”
[Editor’s Note: Wayne is, unfortunately, facing the same woes as so many other government entities. We keep seeing the double-edged sword impact of downward spiraling revenues, coupled with double-digit healthcare cost increases and promises to pay 4, 6 and even 8% interest on pensions that are and have been earning less than 1% in many instances – due to state restrictions on investment holdings.]
OUT & ABOUT
Conferences in early 2015:
The Bond Buyer’s Texas Public Finance Conference, February 9-11, 2015
Omni Barton Creek Resort & Spa, Austin, TX
The Bond Buyer and BDA’s National Municipal Bond Summit March 1-3, 2015
The Westin Beach Resort & Spa, Fort Lauderdale, FL
Resource:
IRS Notice 2015-12 (CREBs)
Editor Commentary: Issuer Recap & Muni Perspectives…MCDC, Continuing Disclosure & IRS Focus in 2015
For the last few weeks, I shared links to both Orrick’s MCDC Webinar hosted by the Bond Buyer, as well as the IRS – TEB Director’s 2015 Update – both of which aired last Thursday. I hope you had a chance to watch them!
As expected, Orrick’s presentation was thoughtful with an impressive team of experts on deck. Although somewhat technical in their presentation, here are some key highlights in layman’s terms:
- Overview of MCDC: 5 year look back (10 really)
- Focus on OS and disclosure non-compliance
- Carrot & Stick Approach
- Huge Task – both Underwriters and Issuers
- SEC already asking for More Info
- Enforcement likely in “3 Waves”
- The Question: Entity focus or Individuals?
- In drafting your future CDAs, think about the following:
- Disclosure Approaches – All or Nothing, positive affirmation or silence
- Disclosure Tips like “Date Certain” vs “X” number of days
- Look Long and Be Flexible – 30 years is a long time
- Only issuer data is required, not third party
- Reporting changes in 2010 – some items are reportable in all instances
- Tools, Training and Support
Later that morning, The IRS TEB Director, Rebecca Harrigal conducted a short, clear and to-the-point presentation.
Right at 27 minutes in length, Ms Harrigal covered
- Focus SHIFT – From Big Issuers to Smaller Issuers & Conduit Borrowers
- Post issuance compliance will remain a significant emphasis
- Use of Templates – Standardize Enforceability
- VCAP and Examinations
- First 4 months of FY15, closed as many cases as all FY14
- Two new Notices
- 2015-2: VCAP for 501(c)(3)s who lost exempt status
- 2015-12: CREB’s Vol Cap Allocation
- Creative System Solutions
- Coordinating with SEC & Treasury
- Compliance Checks are back
- Market Segment Focus
- Arb, Non-Hospital 501(c)(3)s
- Direct Pay Bonds
- More Education and Outreach to come
- QSCBs – June 2015
- VCAP – Sept 2015
So…what does all this mean to us…as issuers?
Well, that depends on who you talk to. For some of my bond & tax counsel friends, the question arises regarding issuer time constraints, prioritizing compliance needs and understanding. These are true and insightful points, given the lingering economic crunch which typically leads to finance departments losing staff AND training budget.
Unfortunately, that won’t get us off the hook though.
Underwriters, still reeling from their own “MCDC Wake-Up Call”, know up close and personal what the “stick end” of the MCDC could entail for them that Orrick so eloquently shared. This will likely mean a “new normal” in disclosure due diligence for any bond deals.
They are really not trying to be adversarial – but their ongoing ability to practice in the muni arena will depend on them doing their own independent due diligence…to a “reasonable certainty”. That is their reality…and will be going forward.
Now, as an issuer, while I know this means more work and headache for us, I can also clearly understand why.
Let’s face it. Under 15c2-12, the underwriter is squarely in the line of fire under the Securities Laws and the bondholders. Just go back and re-read the last several months of Monday Muni Minutes…I would just bet that you can expect a much more robust continuing disclosure due diligence process during any bond deal.
And remember, it will be a five year OS look back each time.
Now, what do many issuers think? Based on the surveys from our PIC Essentials course and the polls taken during the Orrick webinar, more education – particularly focused on the operational side of issuer accounting and processes is sorely needed. Practical, understandable training is hard, if not impossible to find… and generally focuses on the legal side of the equation.
I understand and can relate completely. Been there – done that. Need a new T-Shirt…
What should also be clear to issuers, underwriters and bond counsel is that the IRS, SEC and Treasury are coordinating efforts and looking to system solutions to boost compliance, consistency and enforceability.
In closing, So, my fellow issuer friends, let’s keep the conversation going…re-read the highlights from the Orrick and the IRS 
presentations above. What areas in your post issuance compliance program need help?
Issuer 2 Issuer team is already developing three new programs which will solve these problem areas for you…quickly, economically and practically. The PIC Essentials members have already suggested two more mini-series courses: 1) Policies and Procedures, and 2) Bond Accounting Boot Camp – both from the Issuer’s perspective.
There seems to be a tremendous interest…plus over 20% of the participants on the Orrick webinar indicated they did not have current policies in place.
That last sentence scares me just a little bit… Why? Because there just may have been someone from the IRS on that Orrick webinar too.
The third course is a more robust offering, covering Issuer compliance & accounting needs and solutions from A to Z. 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, that is what drives what you, as the issuer, have to comply with, right?
More on that to come later…
So, as you can see, the webinars and resulting conversations are hugely beneficial. They keep our attention focused on our post issuance compliance…and hopefully with a mindset that is geared to being proactive and strategic.
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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