posted by Mike Madison at 8:26 AM /
I suspect that many Mt. Lebanon residents skipped right over this story in the recent Almanac:
USC finds bank to remarket bonds
It doesn't have anything to do with Mt. Lebanon, and even for USC, the topic is interest rates swaps and bond insurance for the bonds that paid for the new USC recreation center.
Bond insurance? That's where Mt. Lebanon taxpayers should start paying attention. I've been educated on this topic by my Pittsblog and Pitt colleague Chris Briem (check out his blog at Null Space), and I parked a note about it in a post last month. The basics are these: Any municipal entity that floats a bond may need to buy bond insurance. Bond insurance, like any kind of insurance, covers the risk that the issuer will default on the bond. For those entities, no insurance, no borrowing. Some financial institutions will underwrite a muni bond without insurance (for especially creditworthy issuers that borrow frequently, and for especially risky issuers). Historically, however, for creditworthy borrowers (Mt. Lebanon, for example) insurance premiums have been a minor issue. The insurance is available, the insurance inexpensive, and the insurance is useful in marketing the bonds.
However.
As my friend Chris B. has been writing for some time, bond insurers are financial institutions (they take premiums and invest them, just like most insurance companies do), and as financial institutions they've been performing pretty poorly. Even creditworthy bond issuers are having trouble borrowing money -- because their carriers are in trouble. Bond insurers have been hoping for a federal bailout, but so far, their pleas have been rejected.
Down in Upper St. Clair, The Almanac reports on bonds used to finance the new recreation center:
What does this mean for Mt. Lebanon and the high school renovation proposal? Whether the School Board wants to borrow $150 million or $100 million or something else, it's going to have to borrow a cruise-ship-load of money. Lots of people have noted that interest rates appear to be so low right now that the cost of the money is low. Borrow lots, they suggest; it's cheap and will only get more expensive.
Bond insurance, however, is the Achilles' heel of this argument. (Will Mt. Lebanon School District buy bond insurance? It appears that the answer is yes - see slide 2 in this recent presentation.) Even if bond insurance is available now, it may be expensive. More important, even if the insurance is cheap today, the original carrier may go under. In today's market, that's a meaningful risk. If the carrier goes under, thenthe bonds go into default. In the comments, John correctly points out that the bonds don't go into default. But if the insurance carrier fails, there is a consequence: depending on the terms of the indenture, a new carrier would have to be found, or the bonds would have to be refinanced. That means that the issuer (that is, us) would have to refinance on short notice and on potentially terrible -- expensive -- terms. (The following point is added in response to John's comment:) The collapse in the bond insurance market that many people see coming -- including bond insurers themselves -- means this: Mt. Lebanon SD's relatively placid history issuing bonds is not a reliable guide to its future.
In other words, purely in financial terms, renovating the high school may not be the bargain that it appears to be to some people. When thinking about the costs of the project, think about all of the costs.
USC finds bank to remarket bonds
It doesn't have anything to do with Mt. Lebanon, and even for USC, the topic is interest rates swaps and bond insurance for the bonds that paid for the new USC recreation center.
Bond insurance? That's where Mt. Lebanon taxpayers should start paying attention. I've been educated on this topic by my Pittsblog and Pitt colleague Chris Briem (check out his blog at Null Space), and I parked a note about it in a post last month. The basics are these: Any municipal entity that floats a bond may need to buy bond insurance. Bond insurance, like any kind of insurance, covers the risk that the issuer will default on the bond. For those entities, no insurance, no borrowing. Some financial institutions will underwrite a muni bond without insurance (for especially creditworthy issuers that borrow frequently, and for especially risky issuers). Historically, however, for creditworthy borrowers (Mt. Lebanon, for example) insurance premiums have been a minor issue. The insurance is available, the insurance inexpensive, and the insurance is useful in marketing the bonds.
However.
As my friend Chris B. has been writing for some time, bond insurers are financial institutions (they take premiums and invest them, just like most insurance companies do), and as financial institutions they've been performing pretty poorly. Even creditworthy bond issuers are having trouble borrowing money -- because their carriers are in trouble. Bond insurers have been hoping for a federal bailout, but so far, their pleas have been rejected.
Down in Upper St. Clair, The Almanac reports on bonds used to finance the new recreation center:
The original insurer of the bonds, Financial Security Assurance (FSA), was downgraded by Moody's and is on "negative credit watch." If FSA is downgraded below Aa3, the Bank of New York won't be able to continue as remarketing agent.
The Bank of New York proposal will remarket the bonds at SIFMA, plus 10-20 basis points, with FSA insurance and PNC as the liquidity provider. Township Finance Director August Stache said that had the Bank of New York not agreed to remarket the bonds, the only remaining option would have been to get a one-year note to buy time to find a permanent solution for the bond financing problem.
What does this mean for Mt. Lebanon and the high school renovation proposal? Whether the School Board wants to borrow $150 million or $100 million or something else, it's going to have to borrow a cruise-ship-load of money. Lots of people have noted that interest rates appear to be so low right now that the cost of the money is low. Borrow lots, they suggest; it's cheap and will only get more expensive.
Bond insurance, however, is the Achilles' heel of this argument. (Will Mt. Lebanon School District buy bond insurance? It appears that the answer is yes - see slide 2 in this recent presentation.) Even if bond insurance is available now, it may be expensive. More important, even if the insurance is cheap today, the original carrier may go under. In today's market, that's a meaningful risk. If the carrier goes under, then
In other words, purely in financial terms, renovating the high school may not be the bargain that it appears to be to some people. When thinking about the costs of the project, think about all of the costs.
Labels: bond insurance, high school renovation
5 Comments:
I think about the costs, attend board meetings, and tell my elected officials how I feel.
"... think about all the costs." You bet! Careful examination and analysis of the J.M.S. report will also show that the 2nd. and 3rd. traunches or issuances of bonds..$37 million & $10 million respectively... are wrapped, therefore resulting in increased interest costs of close to $10million over interest costs for conventional, equal annual debt service amortization issuances. The oral explanation given by the financial advisor for this wrapping approach was that "...almost all school boards want to minimize the initial millage increase and this is how it can be accomplished...". And the public will be none the wiser one presumes. The $50 million bond issue for the elementary school renovation project was in fact wrapped by the previous board, and this is resulting in about $10 million in extra or excess interest costs over the life of the bond issue to we taxpayers.
Hopefully current and future board members will not succumb to this temptation.
Avoiding the $10,000,000 interest expense of bond wrapping could have been avoided for +/- one latte a month on a $200,000 (assessed value) home on the earlier bond issue. The same is true for the new HS bonds, although we probably need to sprinkle in a little Board courage for good measure.
This and the other hidden costs are things that BA (Before Allison) would not have been discussed very much in public. Mr. Allison has had a significantly more mature approach to open leadership.
As the new administration and possibly new Board (depending on timing) approaches the HS project, let's stay on the Allison trajectory of Openness, Community Education and Community Engagement.
In the past the Mt. Lebanon School District has given the winning bidder on our bonds the option to buy bond insurance if they could get a better net cost for the school district than they could without insurance. In other words the district did not pay the bond insurance cost and a high rate.
If the bonds are insured and the insurance company defaults the bonds don’t default unless the school district defaults also. Mt Lebanon has issued insured and uninsured bonds in the past - see www.moodys.com for the history.
If the school district defaults also the State’s Act 150 Intercept Program protects bondholders because the State of Pennsylvania intercepts the State subsidy payment and gives it to the bank trustee to pay the bondholders. Because of the Act 150 Intercept program Moody’s rates Pennsylvania school districts A-1 at the lowest as long as the debt service payments co-ordinate with the State subsidy payment timeline. The Intercept Program in effect puts the States credit rating behind school bonds. Thus, the District can issue debt at A-1 bond rates at a minimum compared to the AA2 rating we hold today; this interest rate difference should be minimal.
Assuming the school bonds are General Obligation bonds only, the first $69,000,000 of bonds would be unlimited tax bonds and additional bonds would be limited tax bonds under Act 1. Statements have been made at meetings that the first $69,000,000 of bonds may not be issued but this statement was not supported by the financial advisor’s Plan given at the February meeting of the Board’s Audit and Finance Committee. The interest costs on the Plan were a great deal higher than they needed to be.
A long and interesting comment came in from someone who claims to be an investment banker and Mt. Lebanon native.
Unfortunately, this soul did not leave a name or contact information, so I rejected the comment. Whoever you are -- please feel free to re-submit the comment under your own name.
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