Debt Management An issuer’s and an investor’s point of view Stifel NicolausJones HallFranklin TempletonCity of San José Sara Brown Managing Director Steve Melikian Partner Jennifer Johnston Analyst, Municipal Bonds Peter Detlefs Debt Administrator
General Fund Financings in a Bankruptcy World
A Word About Lease Financings COPs / Lease Revenue Bonds were created to circumvent statutory limitations on debt issuance ▫Not considered “debt” because of judicially recognized exception to debt limit for leases Obligation to budget and appropriate the lease payment so long as city has use/possession of an identified asset ▫Because the lease payments must be appropriated annually, they are not binding on future councils ▫Market perceives a difference among city-owned assets: essentiality
Credit Market Concerns Reflect the Inherent Structure of this “Debt” No clear prioritization of debt repayment vs. other general fund expenditures Possible unwillingness to repossess the leased asset Possible inability to re-let the leased asset
Rating Agencies React Moody’s recently increased its differential between a city’s GO bonds and its general fund obligations, because leases: ▫are highly exposed to city’s general finances ▫compete with other city funding priorities ▫For most cities, the result is a 2-notch differential S&P has traditionally concluded on a 1-notch differential
Best of Times // Worst of Times Best of Times: 1.Interest rates in general are extremely low Worst of Times: 1.Relative to the general market, interest rates for general fund leases are higher Wider spreads to MMD 2.Concerns about future downgrades
Investor Reaction Several large institutional funds will no longer purchase lease-backed obligations ▫Insurance provides no value For the most part, individual retail investors will not purchase lease transactions ▫Just too much risk ▫Maybe insurance will resurrect interest
Concerns Lead to Bifurcated Market Issuance w/ Relative Ease ▫Large transactions > $50 million ▫Well-known municipality ▫Frequent participant in market → more secondary market liquidity Issuance w/ Market Challenges ▫Small transactions <$30 million ▫Less-known municipality ▫Infrequent issuer → less secondary market liquidity
Bond Counsel “Clarifies” Bankruptcy Law
POTENTIAL AREAS OF SAVINGS IN BANKRUPTCY Labor Contracts Pensions (?) Retiree Health Care Bond Debt Service Constitutional Limitation on Debt Prevents Other Long-term General Fund Liabilities
Labor Contracts Cut Pay Cut Benefits Cut Employees
Pensions (?) Are Pensions protected in Bankruptcy? Two arguments against changing: ▫Pensions are contracts and have special statutory protection under State law that cannot be impaired ▫California courts have continually upheld the primacy of pensions, which should be honored by a Federal bankruptcy judge “Impairment” requires: ▫a legitimate fiscal crisis or emergency; ▫that the proposed solution is reasonable and necessary to address the fiscal crisis or emergency; and ▫That there is not a less intrusive way to accomplish the same result
Retiree Health Care Appears to have no similar (to Pensions) protection under California Law Stockton has reduced its payments for Retiree Health Care
Bond Debt Service Revenue Bonds with statutory liens are protected in a Chapter 9 Proceeding Sentiment is that G.O. Bonds are similarly protected since tax overrides can only be used for G.O. Bond Debt Service General Fund Obligations –COPs, Lease Revenue Bonds & POBs– are at risk Asset Essentiality becomes important as the bankrupt entity seeks to “walk away” from the lease
An Investor Explains It’s Decision Tree
Decision-Making Process Bond Security Issuer Credit Quality ▫Legal/structural framework ▫Financial position ▫Debt & pension burden Disclosure Market ▫Supply of alternative bonds ▫Retail Buy – Sell - Hold Bond Security Issuer Credit Quality ▫Demographics, economy & wealth indicators ▫Discussion with management Disclosure Market ▫Rates ▫Daily pricing of the funds Buy – Sell - Hold
How Have Things Changed? Insurance Ratings Media / Headline Risk Disclosure
Challenges Decision-making in a political environment Pensions, unions, long-term liabilities Bankruptcy Appropriation risk Essentiality Headlines/Media Partnerships between issuers and buyers
An Issuer Explains It’s Debt Management Procedures
Primary Disclosure Development of an Official Statement Appendix A – general City information prepared and updated by City staff Actively engage more staff in disclosure process ▫Budget Office ▫Retirement Staff ▫Public Works ▫City Attorney’s Office
Evolving Pension Disclosure Growth in sheer volume of pension disclosure ▫Between 2003 and 2013, increased from 2 pages to 40 pages Extensive review, each and every time enter the capital markets by: ▫Plan Actuary ▫Retirement Staff ▫City Attorney’s Office ▫Disclosure Counsel
Secondary Market Disclosure Annual Report pursuant to requirements of Continuing Disclosure Agreement Rating Agencies’ Periodic Review Comprehensive Annual Financial Report Material Event Notices
Reporting Publically available reporting and periodic education with City Council on matters related to disclosure and finances ▫Quarterly investment and debt reports ▫Comprehensive annual debt report ▫Monthly financial reports ▫Comprehensive staff reports highlighting key disclosure issues ▫City Council study sessions CAFR presented to City Council within 5 months after end of Fiscal Year
Key Points We ALWAYS Remember Disclosure is the CITY’S responsibility Cannot solely rely on consultants ▫Be active and INVOLVED in the process Disclosure is hard work and is NEVER done Disclosure is CRITICAL to the city’s success in the marketplace