BABs for moms

Give Jim Ward credit for asking the best question of the night.

Davenport & Co. representatives made a surprise appearance at last night’s Town Council meeting to educate council members and the rest of us on the pros and cons of traditional tax-exempt municipal bonds compared to the Build America Bonds, a federal program that came out of the American Recovery and Relief Act that subsidizes 35 percent of the debt service the bond issuer has to pay the bond investor. As the discussion wore on, with each question posed by council members delving into yet another subtlety, Ward cut to the chase:

If you were investing your mother’s money, your inheritance, in municipal bonds, would you invest in BABs?

As the Davenport presenter hemmed and hawed a flurry of on-the-one-hands and on-the-other-hands, Ward jumped in, “So, that’s a no.”

Not exactly, said the Davenport rep before launching into an “it depends” series.

Ward pressed him again for an answer, and the Davenport rep fell back on the “I can’t really give a recommendation, it depends on what you want” response used by waiters when asked to recommend a fish.

At that point, sensing that the council was leaning toward the tax-exempt option that would give the town $2 million in cash upfront, above and beyond the $20.4 million authorized in the sale, town manager Roger Stancil interrupted.

But we have a recommendation, Stancil blurted out, including town business management director Ken Pennoyer on his side, and that is for the BABs option.

The town council had the option of voting to include BABs with the tax-exempt bonds, the option Stancil wanted because it could potentially save about $40,000 a year in debt service expense over 20 years. But it carried the risk that should an anti-Obama faction take control of Congress, something that some analysts believe could happen in the next election, the federal subsidy could be repealed. Then BABs would have to be reissued at perhaps a higher interest rate, and end up costing the town more than the tax-exempt option. The tax-exempt option would give the town an additional $2 million upfront, but could cost as much as $2 million more in additional debt service, Pennoyer said, though he didn’t explain how the extra $1.2 million materialized that had not been mentioned until it seemed the council was favoring the $2 million upfront bonus.

A third option emerged during the discussion: Go with the tax-exempt bonds and apply the $2 million toward the $20.4 million limit and sell only $18.4 million. Stancil pointed out that if any of the projects go over budget, the town might not have enough money to foot the overrun.

In the end, council members voted unanimously for BABs.

The most important question that nobody asked? Does Davenport profit more from the BABs or the tax-exempt option?
– Nancy Oates

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  1. Steve Brown

     /  September 16, 2010

    More risky financial behavior by Chapel Hill. And I thought they were done when they went ahead with the library. Soon enough they will be the “southern part of Greece”.

  2. Geoff Green

     /  September 17, 2010

    If it’s such a terrible idea, why did our business-experienced councilmembers Gene Pease, Matt Czajkowski, and Penny Rich vote to use the BABs? You guys did endorse Czajkowski for mayor on the grounds that he is “a practical man” with good “common sense.” Would you consider this a counterexample?

  3. Steve Brown

     /  September 17, 2010

    Counterexample? I’ll have to check on Wikipedia for that.

    Bad idea? No doubt.

  4. Nancy Oates

     /  September 17, 2010

    Gene Pease called in sick and missed the meeting.

  5. Due to the nature of how BABs are priced, Davenport estimates it will be at least 5 years out before someone invest in one (bidders have a choice of taxable [BABs] or tax-free municipals).

    Is it going to be a bad deal or cause the Town problems? I believe Council decided that given the 5 year horizon, approving BABs as an option didn’t carry any drawbacks (though we’ve seen with the whole Library bond issue, if there had been a bit more fiscal prudence 5 years ago we probably wouldn’t be having this discussion).

    It should be noted that Laurin Easthom still stands firm and doesn’t support selling any kind of bonds this year.

    Mark K. told me that the risk I was referencing in the earlier article was spelled out here:

    Although there is no guarantee that the Federal Government will continue the program to its end, and pay out rebates until the final maturity for all bonds issued under the program, the impact of ceasing rebates would make it extremely unlikely. In order to inoculate itself against that the remote possibility that rebates will cease, the bond documents are written so that the issuer can re-issue the balance of the BAB debt as tax-exempt debt, thereby avoiding paying taxable rates, should the Federal Government cease rebates. This increases the safety of using BABs, but still leaves the issuer open to interest rate risk at the time of re-issue.

    I maintain that this barely scratches the surface of the risk portrayed and that Council (and the citizens they serve) would have been better served if a variety of scenarios – full subsidy, partial subsidy, no subsidy – had been documented. Instead of guessing, why not present a range of scenarios?

    The same document, by the way, omits exploring the range of potential near term excess funding due to tax frees being sold (over $2M if a full slate of above par tax frees).

    Davenport’s presentation appeared (parts were tough to read from the back row) to do a much better job of outlining some of the downsides. Their presentation to Council went a long way towards educating both Council and the public (including, as those folks who watched might have noticed, filling in some gaps in Council’s knowledge of Bond 101).

    Now that the “what” of BABs has been aired, it still might be nice to know the “why” or “how” of it getting on the consent agenda in the first place came to be….

  6. One last comment on the consent agenda item.

    The accompanying fiscal note says:

    Due to interest rates being near historically low levels and the additional savings available
    through use of BABs, debt service costs should be lower than previously estimated. Based on current rates average annual debt service payments are estimated to be below $1.4 million. The attached schedule shows the impact on the debt fund through FY2019-20. Based on our projections there will be more than adequate capacity in the debt fund to cover debt services expenses for this transaction.

    I believe the subtext here is that since the damage to the bottom line wasn’t as bad as originally projected the debt fund is open for business – that we can “safely” pile on more debt. Very troubling.

    What kind of debt? Hard to say.

    Last night the consultant from Kling-Stubbins put TIF (tax incremental funding) front-n-center as a source of funding for the new transit center. Some folks might recall that I stood firm against TIF for the Lot $5 project. I remain leery of it due to the numerous examples of misuse throughout the country.

    I did expect TIFs to come back into play once we hired a new director of the Downtown Partnership who coincidentally led the charge for TIF projects in Tulsa. If Council approves using TIFs for a transit center, it seems like using them for Lot $5 will follow.

    But if that doesn’t happen, Chapel Hill taxpayers still face the fiscal unknown of how monies will be raised to pay for that pit in the ground. Building in a little breathing room – at least based on the arbitrary debt ceiling Council approved – might allow Council to make the case for more directly taking on that debt load.

  7. Nancy Oates

     /  September 17, 2010

    Didn’t the State of California invent TIF and use it heavily? That alone raises a red flag for me.

  8. Nancy, TIFs can work to a community’s advantage if the proper groundwork is laid, the economic conditions are right, the district carefully drawn and the project worth some of the risk.

    For instance, though I haven’t heard Jim speak of it, he could help make a decent argument that using TIFs to support Tulsa’s Arts District was a good move. Unfortunately, the landscape is littered with a lot of TIF related failures – including their use to build infrastructure for Walmarts.

    TIFs, at their simplest, rob Peter to pay Paul. Tax revenues that normally could be plugged back into our Downtown district, to build up necessary infrastructure or seize some economic opportunities, will, instead go to pay the underlying debt for something like the Lot $5 moneypit.

    Using TIF to build a publicly owned transit station is questionable as the underlying property won’t generate tax revenue and the commercial capacity, at least as its sketched out, won’t generate enough sales tax revenue to compensate.

    Another problem I see with TIFs for Chapel Hill is based on our fiscal track record of the last decade. Robbing tax revenue from the Downtown district to pay for a couple economically uncertain projects is putting a few too many eggs in the basket. Even the most optimistic projections don’t show a net payback on TIF for several decades. All that time, any infrastructure or other improvements Downtown will be funded through other sources, which, of course, limits our Town’s ability to respond elsewhere.

    As one observer put it at the last big Lot $5 public hearing, monies are fungible. That redirected revenue will have to be made up mostly from the residential tax base.

    Again, TIFs have been shown to work when care is taken, discipline exercised and the economics make sense. Chapel Hill is not prepared, by any length, to experiment with their use.