Constructive financing
Officials in New York City awoke to unpleasant news one morning in April: A key part of the city’s infrastructure – fabled Yankee Stadium – was crumbling. Mayor Rudolph Giuliani quickly put forth a proposal to fund construction of new stadiums for both Big Apple baseball teams.
Many New York residents, however, urged exploration of a different approach, one that cities throughout the country have successfully applied in various stadium construction projects. That strategy, increasingly being used to satisfy a range of municipal needs, is one of public-private partnerships.
Public-private development construction totaled about $25 billion in 1997, according to an estimate by New York-based KPMG Peat Marwick. Stadiums have been at the forefront of the public’s growing acceptance of public-private alliances for infrastructure and municipal development.
Applying the resources and expertise of the private sector toward solving municipal needs is becoming increasingly common. Both sectors are exploring additional ways to work together to provide public services; to develop, finance and implement infrastructure and community facilities; and to retain important corporate or industrial constituents.
New, creative alliances are resulting in more efficient use of taxpayers’ dollars. Additionally, increasing numbers of public sector entities are applying financing tools and techniques from the private sector, including creative use of financial guarantees and other financial engineering products such as interest rate swaps, commercial paper and forward investment contracts. Public-private partnerships include a wide range of opportunities.
Creative partnerships can help municipalities and public entities reduce ongoing costs without ceding control. Last year, for example, Tulare County, Calif., found a new way to stabilize health care insurance costs. The county negotiated with its two health insurance providers, structuring new agreements with established premium levels and service guarantees. The county then issued bonds, strengthened by financial guarantee insurance, to finance those insurance costs.
Annual premiums will be paid out of the bond proceeds, held in an escrow account. The transaction enabled the county to guarantee its two insurance providers three years of business with annual up front premium payments. The providers, in turn, agreed to discount premiums, strictly limit rate hikes and add new benefits in exchange for pre-payments.
In the area of stadium financing and construction, new examples of public-private cooperation are cropping up every week. For example, Miami officials recently announced a taxable financing arrangement for a proposed Miami Heat basketball arena.
Referred to as “enterprise finance,” the transaction leverages team and arena revenues to limit the amount of public taxes used to fund construction of the sports complex. Borrowing techniques and structures from the corporate financing sector, the deal is supported with financial guarantees. It taps the long-term capital markets without using shorter-term public subsidies or syndicated bank loans.
Infrastructure development beyond stadium construction also is an active area for potential partnerships. Recently, Modesto, Calif., entered into a partnership with its redevelopment agency, the Stanislaus County government and private sector developers to craft a proposal for a new municipal services building.
The Modesto revitalization project includes a public plaza, a multi-screen cinema and a parking garage scheduled for completion in March 1999; and a city/county administrative building with retail shops, to be finished in October 1999. The arrangement is probably better characterized as a public-public-private partnership, since city and county officials had to agree on the details before they could negotiate with a private sector developer.
The city gets a new police station out of the deal and expands its administrative space. The county will be able to move about 250 employees to the new city/county building, thus freeing up space in one of its suburban facilities. At the same time, the city will sell some of its existing administrative space to the county for ancillary court services such as the probation and district attorney’s offices.
“We will be co-locating similar functions (of city and county government) on the same floor, in the same building,” says Modesto City Manager Ed Tewes. “We can provide better customer service – more ‘one-stop shopping’ for many important services.” For example, residents will be able to pay utility bills and property taxes and obtain building permits, all in one location.
During weekdays, the new parking garage will be used mainly by city and county employees and constituents. Evenings and weekends, the parking will be available for customers of downtown retail and entertainment establishments. “We are proud of our relationship with Stanislaus County and our ability to craft a common project that meets multiple goals,” Tewes says.
Achieving mutual goals Attracting and/or retaining important business interests in the community is an effective way to benefit both the public and private sectors. In the past, that was accomplished through the use of extensive tax breaks and giveaways. But today, most municipalities realize that they hold a box full of tools, such as potential development sites, zoning, building codes, community involvement, environmental review and employment incentives. Public sector entities can use those strengths to structure partnerships with the private sector that will enable both sides to achieve their desired goals without compromising the community’s long-term stability.
Last year, Indianapolis successfully structured and executed a refinancing of the construction costs for a large aircraft maintenance facility. The city planned and designed the building in partnership with United Airlines, ensuring that the airline would use its airport as a major maintenance hub. The transaction created jobs and economic activity in the area, shifted the risk away from taxpayers and onto private investors, and served to enhance the airport’s maintenance facilities.
About 200 miles to the south, in Louisville, Ky., city officials recently worked closely with a major employer, United Parcel Service, to ensure the company’s continued presence in the area. UPS faced a growing shortage of employees for its labor-intensive operation, so traditional solutions such as tax incentives were not appropriate. Instead, municipal officials, UPS and state education officials created a plan that would encourage students to work with UPS part-time while taking college-level classes at a newly developed site near the UPS facility.
An art and a science Creating a solid public-private partnership is more art than science, but certain fundamentals should be in place to foster a lasting relationship. A 1992 stadium deal – the refinancing of the America West Arena in Phoenix – exemplifies the successful public-private transaction. While Phoenix provided about half of the financing for the city-owned arena, nearly 50 percent of the facility’s cost was financed through the sale of taxable municipal bonds secured by facility revenues.
“We locked in a very attractive interest rate (about 7.3 percent) for the duration of our debt,” says Paige Peterson, controller for the arena. Additionally, the bonds are now insured, so they cost less than the letter of credit obtained under the original financing.
The term of the taxable refinancing coincides with the city’s agreement with the National Basketball Association’s Phoenix Suns to remain in Phoenix for 30 more years. The strengths of the agreement rest on a firm foundation: a growing, economically diverse area able to support a team with a premium price structure; strong fan support for all events at the multi-purpose arena; a steady flow of contractual income through suites, premium seats and advertising revenues; and a proven operating history with an experienced management team.
The Suns’ owners have agreed with the city to allocate revenues from suites and fixed signage ($11 million in the most recent year) toward arena operating expenses and debt service. The Suns can keep residual funds, as much as 60 percent of the total take.
“[The Suns’ owners] are putting themselves subordinate to the arena and to debt service,” Peterson says. He notes that, in the past five years, the residual funds going back to the Suns have never amounted to 60 percent of the total.
Should the Suns falter, suite and signage revenues could tail off; however, Phoenix Arena Development, LLC, a Suns subsidiary, still would be liable for debt service and arena operating expenses. Further, in the event of a possible NBA players lockout next season, the Suns would need to refund a portion of suite and signage revenues.
In addition to the Suns, the arena is home to the Phoenix Coyotes hockey team, the Rattlers arena football team and the Mercury women’s basketball team. Naming rights to the arena paid by America West Airlines also factor into the revenue equation.
Such solid fundamentals should be the core of any public-private financing partnership. “You also need, on the private side, strong commitment from the tenants,” Peterson says. He predicts partnerships such as the one in Phoenix will become much more common.
Phoenix is an example of a city that “did its homework,” making sure that the fundamentals were in place prior to entering into a partnership. However, examples abound of municipalities that have rushed into cooperative agreements with sports franchise owners, only to find that the value of publicly subsidized financing can be distorted. The economic impact touted by stadium proponents may not materialize, leaving taxpayers disillusioned with the reality of such partnerships.
Diverse skills needed To succeed in structuring and executing a productive public-private partnership, both sides must possess, or have access to, a range of skills that may not have been necessary before. For example, public officials must be conversant in design/construction risk, intellectual property considerations, finance and taxation issues, market risk concerns, effects of potential competition and environmental liability.
Private sector partners, in turn, must apply their expertise in light of the political risk governments face every day: Will changes in legislation negatively affect the partnership? Will turnover of government officials change the nature of the relationship? Does the public at large support the initiative, and, if not, could voters be educated about the value of the partnership?
As public-private partnership opportunities develop, public officials must ensure that the intended benefits actually materialize. That is particularly vital when services are partially privatized or contracted out to private vendors and are not part of the traditional range of municipal services.
The Information Superhighway, with its multi-faceted potential, qualifies as a nontraditional municipal service. Financing its infrastructure – primarily fiber-optic cables – is one area attracting plenty of attention.
Anaheim, Calif., currently is partnering with San Diego-based SpectraNet International to create the first municipally owned, privately run fiber-optic network. The collaboration includes laying more than 50 miles of fiber-optic cable throughout the city without use of public funds.
After completing the upgrade, the company will offer voice, video, data, multimedia, and local and long- distance phone services. Five percent of the revenues generated by the network will go toward funding access for all residents, and Anaheim will use the network for its own municipal purposes.
A range of tools Municipal and government officials should remain open to considering the full range of tools at use or under development in the private sector as building blocks for potential partnerships for public sector benefit. A partnership might be as extensive as privatizing facilities or services, or it might simply involve applying financing or management techniques from the private sector.
With its focus on the bottom line, the private sector is replete with innovative money-saving tools and examples of resourceful financing. By contrast, public sector officials, with their broader focus on constituency needs, quality of life, policy issues and political realities, need to access private sector expertise to determine how those tools might be best applied to serve taxpayer concerns.
Interest rate swaps are an example of a private sector financial tool that the public sector increasingly uses. They are used to lower the long-term cost of funds or to provide more predictable financing costs. For municipalities and local government entities, intelligently using a swap or other sophisticated financing techniques requires a strong relationship – a partnership, if you will – between the public sector entity and a private sector financial expert.
The road to a successful public- private partnership is not always a smooth one, as the California state university system demonstrates. Officials there had been working with a consortium of technology companies to create a for-profit, limited-liability company known as California Education Technology Initiative (CETI). CETI would help finance technology improvements in the state’s university system by allowing companies funding CETI to sell telecommunications and computing services to the universities.
However, when students, faculty and lawmakers complained that such a deal would limit choices of technology products and providers, CSU officials restructured their proposal. Further action is expected later this year.
As public-private partnerships continue to evolve, financial guarantees and other financing tools will be needed to strengthen deals and leverage municipal involvement, thus ensuring positive results for all constituents. Such tools will continue to help taxpayers “get more bang for the buck.”
The author is managing director of New York-based Ambac Assurance Corp.
Despite ample evidence that risky investments of public funds can wreak havoc with a government’s fiscal condition, too many funds administrators continue to make them. As a result, leery taxpayers may be forgiven for sharing Will Rogers’ sentiment: “I’m far more interested in the return of my money than the return on my money.”
In Ohio, state officials have stopped talking about the problem and started doing something about it. Having learned some hard lessons, the state has begun operating an educational program for public funds managers.
Over a span of two years, Painesville, Ohio, lost some $6.4 million after a member of the county treasurer’s family secretly invested public money in securities tied to stock indexes. And in Cuyahoga County, a $1.8 billion investment pool that was organized and managed by the county treasurer lost $115 million in 1994 through risky, leveraged borrowing. In both cases and in others like them, investors were not good stewards of public funds and often proved themselves incapable of anticipating and responding to a rapidly changing market.
Seeking to prevent such mismanagement, safeguard public money and calm taxpayers’ fears, the Ohio State Treasurer’s Office set up the Center for Public Investment Management (CPIM). Following the lead of other professions such as law, medicine and accounting, the state has mandated an annual continuing education program for its 3,600 public funds managers, representing cities, counties and school, fire and library districts. Plans also are in the works for a program to provide county commissioners with training specific to their needs as advisors to county treasurers.
The CPIM will offer classes including “Writing an Investment Policy,” “Public Cash Management,” “Public Depositories,” “Use of Investment Advisors,” “Collection of Taxes,” “Investment Management” and “Understanding the Bond Market.” Additionally, the curriculum includes a mandatory instruction block on ethics.
Courses are held in a variety of locations across the state. Most of the sessions last one day, although a few, including special instruction for newly elected county treasurers, last two days.
The conference fee is $70, and participants can earn up to seven hours of continuing education units per conference. After successfully taking the minimum required course hours, each treasurer receives a certificate of completion. Each treasurer must complete seven hours of training annually or face restrictions on his or her investment authority.
In addition to establishing the CPIM and its educational program, Ohio legislators have imposed several restrictions on public funds investors. For example, the investors are prohibited from purchasing derivative-type securities, and they are required to file a written investment policy with the Auditor of State.
Since the program began last year, Ohio has trained 70 percent of its public funds managers. Several other states, including Illinois, Delaware and Nevada, have made inquiries about the educational program.
The 1998 CPIM Conference Series, entitled “Securing the Basics,” began in February and will run through August. This year, the CPIM has established its Advanced Institute, which will cater to veteran funds administrators with greater experience and expertise, offering two-and-a-half-day seminars with more intensive levels of study.
This article was written by Kenneth Blackwell, treasurer of the state of Ohio.
“Ehlers on Public Finance,” a new book by Robert Ehlers, offers real-life case studies covering scenarios that municipal finance officials are likely to encounter. The book is intended for issuers of municipal bonds as well as for the lawyers, financial advisors, insurers and accountants who advise them. A consultant with 40 years experience in public finance, the author successfully oversaw more than 700 municipal bond issues in a career dating back to the early 1950s.
The 392-page book features spreadsheets, charts and illustrations. It contains 33 chapters divided into four main sections:
* Planning a Bond Issue, which includes advice on choosing financial advisors and legal counsel, taking stock of an entity’s present fiscal condition, deciding on the amount of the issue and planning a debt service schedule;
* Authorization, which covers such issues as jurisdiction, due process, administrative procedures, wording of a ballot, compliance with state election lawsand relations with the community;
* Marketing Bonds (Getting the Money), which includes negotiated vs. competitive public sales, setting terms and details of the sale, advertising, disclosure, bond insurance and investing sale proceeds; and
* Special Issues, which discusses tax increment financing, lease purchases, bond pools, arbitrage, zero coupon bonds and deep discount bonds.
The book costs $299, plus $5 for shipping and handling. Orders may be sent to Ehlers on Public Finance, P.O. Box 580013, Minneapolis MN 55458-0013; faxed to (612) 521-0757; or processed on the Internet (www.publicfinance.org). For more information, call (612) 522-4620.
After two years of prompting by the National League of Cities, three federal agencies agreed to stop holding cities and counties accountable for bond-related wrongdoings by their brokerage firms.
Nation’s Cities Weekly reported last month that the U.S. Department of Treasury, Justice Department and Securities and Exchange Commission have agreed to halt all investigations and actions involving 102 municipal bond refinancings by 83 municipalities. The landmark settlement could set a precedent for similar impending cases.
Much of the improper actions involved yield burning, so named because it involves “burning down” the yield of bonds by artificially marking up their prices. After municipalities reaped savings from refinancings in the early 1990s, they generally deposited the proceeds into escrow accounts that were stocked with Treasury bonds. According to federal investigators, the firms administering the escrow accounts allegedly marked up the Treasury bonds before selling them to the local governments.
City and county governments are obligated to pay tax on any profits earned from a refinancing – even if the bond underwriter secretly took the profits. Until the three federal agencies reached their agreement, the Internal Revenue Service maintained that it only had authority to go after municipalities and municipal bondholders.
The local governments thus were under threat of undergoing expensive IRS investigations and penalties, and possibly losing tax-exempt status on their outstanding bonds. The local entities might also have incurred the cost of seeking redress from the actual wrongdoers.