Municipal Borrowing: Municipalities go Solo or through Bond Bank

(from Maine Townsman, January 2005)
By Alan Elliott, Freelance Writer

In addition to the hundreds of workers laid off when the Lincoln Pulp and Paper mill closed last January, an early casualty was a $1.3 million bond issue scheduled for the Lincoln Sanitary District.

Scheduled through the spring issue of the Maine Municipal Bond Bank (MMBB), the funding would have paid to replace aged and ailing equipment at the town’s wastewater treatment facility. The mill’s bankruptcy had, however, left a gaping hole in the district’s income. As LP&P’s unpaid water and sewer bills rose to more than $100,000, the district fell out of compliance with Bond Bank guidelines. MMBB had to pull the funds.

“I kind of saw it coming,” said Lincoln Water District Superintendent Darold Woolsey. “And, quite frankly, there was so much uncertainty that my board would have been reluctant to start the project. They were actually somewhat relieved that the money was yanked away.”

Events in Lincoln reflected a year of mixed results elsewhere on the state’s municipal bond landscape. New York debt rating agency Standard & Poor’s (one of three major ratings firms) upgraded five Maine towns during 2004. The agency downgraded only one entity — the state itself — dropping its rate a notch to AA. Jeff Buswick, an associate director for Standard & Poor’s public finance division in Boston, said the demotion was due to three consecutive years of negative fund balances, thin cash reserves and uncertainty imposed on future revenue streams by “tax referendum activity in the state.”

But the Maine Municipal Bond Bank, a quasi-state institution, came away smelling like a very healthy rose. Two rating agencies, Standard & Poor’s and Fitch, boosted MMBB’s status, giving it the first AAA rating in the state. Executive Director Robert Lenna said the change eliminated the Bond Bank’s need to purchase bond insurance, a costly means of backing bonds with an AAA grade. Lenna said those savings should amount to somewhat more than $100,000 per issue, lowering the interest rates bond issuers pay by a couple of basis points (one basis point equals .01 percent).

Those savings could alter the equation for communities considering issuing bonds on their own, an often daunting question for many small municipalities, school and water districts across the state.

But development pressure and changing demographics are pushing more towns to consider the costs. Wells, with fewer than 10,000 residents, was among the communities to seek and earn a first time rating from Standard & Poor’s in 2004. Bucksport, Casco and Bar Harbor, all with fewer than 5,000 residents, were among those to receive upgrades.

Richard Ranaghan, a former finance director for the city of Portland who is now a municipal financial advisor for Banknorth, estimates there are 30 to 40 municipal entities in Maine that periodically opt for independent bond issues. He has chaperoned many through the process, including smaller issuers such as the Auburn Water District and the towns of Oxford and Paris.

Managing independent bond issues isn’t for everyone, Ranaghan explains, and the first qualifying question is, will the size of the funding goal justify the additional costs?

“A bond issue typically needs to be at least $750,000 or so before it makes sense to issue on their own,” Ranaghan said, “because there are issuance costs that they have to pay.”

The cost of an independent issue can be an additional 2 to 3 basis points, approximately $30,000 to $50,000 on a $1.5 million, 20-year bond. A piece of that goes to the rating agencies — Standard & Poor’s, Fitch and Moody’s Investors Service. They typically charge upwards from $5,000 to $10,000 to review a municipality’s finances, management, demographics and development trends and issue a credit rating. Those ratings have direct impact on the interest rate — the town’s cost of borrowing capital.

Next in line for a paycheck are the financial advisors, like Ranaghan. They review municipal accounting and management practices, arrange a syndicate of underwriters and manage the bond sale. Fees can run another $3,000 to $10,000. After that comes a list of lesser charges, like the $2,500 to $3,000 cost to print the official issue statement.

There is no way to generalize and say the cost to borrow is more or less through the Bond Bank or an independent issue. As with home mortgages, much depends on timing, on credit ratings and on the amount being borrowed. The final cost of an issue can be teased out only on a case by case basis.

Larger municipalities which issue debt are the most able to outdo the Bond Bank’s rates (and tend to prefer having the more hands-on control over their finances). But for the Wells, Kennebunk and Bucksport scale contingent, Ranaghan says, parsing the relative advantages of the Bond Bank versus independently issued debt is a more complex equation.

“It’s kind of like what municipalities are going through now with local control,” he said. “Do they give up and go regional — i.e., do you go to the Bond Bank — or do you do it on your own, pay the same, but retain more say over how it’s done?”

State legislators created the Bond Bank in 1971 to assure Maine’s towns, counties and districts access to national municipal debt markets. It goes to market twice a year, in the spring and fall, acting as an independent bond issuer. Its issues are actually bundles of agreements involving, on average, about 25 municipalities and districts. The Bond Bank assumes the ultimate risk while the communities become, in effect, sub-issuers — paying interest and borrowed capital to the Bond Bank rather than to the actual holders of the bonds.

MMBB’s beginnings were similar to those of bond banks formed for similar purposes in many other states. Over the years, the Maine Bond Bank has broadened its mission.

Lenna, a former deputy director of the Maine State Housing Authority, arrived as executive director in 1988. Just about that time the federal government created the first state revolving loan fund for wastewater treatment facilities under the Clean Water Act.

The feds appropriated funds for use by states; requiring states to provide a 20% match. Maine had the option to loan those funds, or to use them to leverage additional capital through the sale of bonds.

That task was assigned to the Bond Bank, relegating approval of borrowers and projects and management of engineering and policy to the Department of Environmental Protection. The arrangement was successful enough to be applied to several other state agencies. First was the Department of Education’s school renovation revolving loan fund. Then another revolving fund was created in 1996 through the Safe Drinking Water Act and managed through the Department of Human Services. Most recently, in 2004, the Legislature’s Transportation Committee authorized the Bond Bank to issue up to $50 million in Grant Anticipation Revenue Vehicle bonds for construction of the new Waldo-Hancock County bridge.

In the process, the Bond Bank evolved into a de facto professional financial services organization providing support for DHS, DEP, DOE and DOT.

“All four of those entities probably have about $2.5 billion of debt outstanding,” Lenna said. “And we have 12 people here taking care of all that money.”

It’s important to mention: the Bond Bank is self-funding and requires no state funds to operate. Also worth noting is that Lenna’s duties have expanded in proportion to the bank’s role. He is now executive director of the Maine Health & Higher Educational Facilities Authority, the Maine Governmental Facilities Authority and the Maine Public Utility Financing Bank, as well as the Bond Bank.

Lenna admits there is some competitive verve between the Bond Bank and the Dick Ranaghans of the world. Last year’s rating change has a direct impact on that competition.

Ratings provide bond buyers a means to gauge the level of risk tied to a particular bond. Whether it’s a school district or a city, Moody’s, S & P and Fitch take a close look at finances and the actual managers. They chart out development and demographic trends and assess prospects and threats to the entity’s incoming revenue.

An increase in ratings often indicates improvement in one or more of those areas. In the case of the Bond Bank’s upgrade, the change stemmed from an alternative method of modeling risk. The method, S & P’s Buswick said, was originally developed to rate large casinos in Monte Carlo. The agency had formerly gauged the Bond Bank’s risk by determining its ability to weather a total loss of revenue.

The Monte Carlo model gauges the statistical probability of such an absolute default. In casino terms, what is the chance of every player and machine topping the house in a single night?

S & P figured that probability into the Bond Bank’s overall profile, then ran every conceivable scenario through its models. Buswick said they couldn’t get the Bond Bank to break.

“They have the coverage and the cash set aside to manage through any real worst case scenario we could come up with,” he said.

In terms of ratings, the Bond Bank still has room for improvement. Moody’s Investors Service remains the hold out, assigning an AA rating. Lenna said mature, rational discussions with Moody’s continue as to the error of their ways.

Brunswick Finance Director John Eldridge has faced the question of Bond Bank versus independent issue several times. The town last issued debt through the bank in the 1980s. A decade ago it compared rates (both the town and the bank were rated AA) and found independent issues more cost-effective. That may have changed, Eldridge said, with the bank’s recent upgraded rating.

As Brunswick prepares to issue $700,000 on a bond anticipation note, a number of factors could affect the relative costs.

Issuers who hold to below $10 million in new debt per year receive Bank Qualified status. The label increases demand for the bond and potentially lowers interest costs. Another factor is that large bond buyers, like most investors, aim for a diverse portfolio. That diversity includes both pooled funds like the Bond Bank and independent municipal issues. Towns like Brunswick, AA rated, with only $15 million in debt, well-manicured balance sheets and the tax advantage of coastal property, constitute an attractive independent buy.

All things considered, Eldridge said direct cost comparisons are hard to come by.

“You think a double A and a double A are going to trade the same on the same day, but that’s not necessarily true,” he said.

Lenna contends that the factors can generally be sifted down to a reasonably clear read on comparative costs.

“We’re really comfortable with the numbers we can show people and say it is your choice,” Lenna said. “If Dick (Ranaghan) or anybody else can provide the least expensive credit of borrowing to a community then I believe it is our statutory responsibility to tell people that.”

Then there are cases like Lincoln, which continues to fall through the bond market cracks. Ineligible for either a Bond Bank or independent issue, Woolsey said the town tapped every politician and shook every bush it could, finally managing to piece together the necessary funds through a combination of USDA Rural Development loans and grants.

“So that project is on track,” the superintendent said. “And we expect to have our pre-construction meeting here this month.”