As I wrote on my post on August 6, 2013 questions forced me to learn a little more about how the municipal bonds work. Although I am definitely a neophyte when it comes to the bond market, some would say on everything, I nonetheless wanted to share a little of what I learned. One of the answers I looked for is what would happen if the city is unable to pay the bond holders with the HOT tax.
I realize the city has inundated us with tome after tome about how the stadium debacle is not going to cost the property tax owners anything. I’m sure many Detroit debt holders were assured that Detroit would meet its financial obligations.
So what happens if the HOT taxes aren’t enough to pay the bonds?
In my research I found out that one of the reasons affiliated companies are setup by corporations is because of what is known as “bankruptcy remote”. Overly simplified, a company forms another company for the specific purpose of holding and managing a specific asset. This way, the parent company’s assets are protected from bankruptcy.
I have no doubt that the ballpark ownership has structured their companies in this manner.
However as I read more, I asked myself is it possible that the city is prudently shielding itself from bond holders should it not be able to pay for the bonds?
Remember that the city created the City of El Paso Downtown Development Corporation as a public, nonprofit corporation on December 18, 2012. Is it possible that this company is part of a “bankruptcy remote” strategy?
That led me to ask myself, how do cities file for bankruptcy.
I learned that cities do not file traditional bankruptcy as companies, or individuals; rather they file under what is known as a Chapter 9 of the US Bankruptcy Code. As with the other well-known bankruptcy options (Chapter 7; liquidation and Chapter 11; reorganization), a municipality filing for bankruptcy achieves an immediate benefit by giving itself some time to negotiate with its creditors while keeping the creditors from activating their collection options.
Texas is one of 22 states that allow municipalities access to Chapter 9 bankruptcy proceedings. In the case of Detroit, unlike Texas, it had to ask a judge for permission to file for bankruptcy because Michigan has conditions that require a judge to review the filing before it can be used. El Paso does not have to ask a judge before filing a Chapter 9 action.
In a Chapter 9 filing, and generally from a non-lawyer’s perspective, the filing treats General Obligation bonds as unsecured debt. Revenue bonds, on the other hand are treated as secured debt thereby giving the bonds being levied by the city for the ballpark a higher placement, above its GO’s should the city face insolvency because of its high debt.
In other words, the debt for the ballpark now takes precedence over the general obligation bonds of the city of approximately $564 million. But it is important to note that, unlike a general obligation bond (GO) where the repayment is backed by the taxpayers because the issuer commits to raising taxes or other revenues to make the payments, revenue bonds are issued based on a defined revenue stream, in this case the hotel taxes, better known as the HOT taxes.
Though this does not mean that the city taxpayers’ are not liable for the ballpark because any default by the city would create an avalanche of consequences, both political and economic, that filing for Chapter 9 is usually the very last result should the city not be able to meet its ballpark obligations with the HOT taxes.
The city is allowed to get away with the notion that property taxes would not be raised to cover shortfalls because, technically it is not required to do so. But the reality is that monies are likely to be shifted in order to make up any shortfalls from the HOT taxes. And just like today’s city council relies on the notion that they have to make unpopular decisions because of the potential liability of millions in litigations fees, so will future city councils be required to make up the difference with property taxes should the need arise.
There are also numerous examples of how the city shifts monies from one account to another because necessities change. This is the reason why Cortney Niland is so hot on tolling the free bridge to bring in millions. Not only is it popular to “tax” none residents, especially Mexicans among the votes but it also makes the general fund pot larger from where to pay for the extravagant flights-of-fancy that Niland and cohorts salivate over.
The Bloomberg report on November 23, 2010, titled; “Muni-Bond Issuers May Face Default ‘Crunch’ as Stimulus Ebbs, Lehmann Says”, clearly lays out that ballparks have a high incidence of defaulting on loans.
So how could the city default?
As with any credit transaction the documents for the credit agreement points us in the right direction. There are many instances of default, ranging from being unable to make the principal plus interest payments to “technical defaults”. For the purposes of this blog post I’m going to oversimplify the discussion on a potential default.
In the case of the ballpark bonds I referred to the publicly available “Preliminary Official Statement Dated June 27, 2013”. All 220 pages of the documents is one of the most boring things I have ever endured but it is also full of useful nuggets of information.
According to the document, Fitch has rated this debt as “A+” while Standard & Poor’s rated it “AA-“. The document also states that two types of bonds will be issued; Special Revenue Bonds, Series 2013A for $40,980,000 and Special Revenue Bonds, Taxable Series 2013B for $19,820,000. I already discussed in my previous post why I think the city is issuing two versions of the bonds.
The first payment on the bonds is expected to be February 15, 2014 with payments expected on February 15 and August 15 of each year.
As you might remember from my previous post, the city has created a company to float the bonds using collateral that the city owns and is leasing to MountainStar Sports Group, LLC. One of the arguments used by the opponents to the ballpark is the notion that should the ownership team fail to make the required payments, or the HOT tax is insufficient to meet the debt service on the bonds then the property owners of the city would make up the difference.
According to the bond document, the bonds are “payable solely from lease payments to be made by the city; provided however, that the team payments may only be used to pay debt service on the taxable parity bonds”. In other words, those who buy the Series B bonds will be paid back directly from monies received from the ownership group.
For the rest of the bonds, the Preliminary Official Statement adds that the “obligations of the city to make lease payments is a current expense of the city, payable solely from funds annually appropriated by the city for such use from lawfully available funds”. Remember that the city has entered into a lease agreement with its own corporation and it stipulates that the city will be making lease payments to the corporation. “Lawfully available funds” are those funds the city gets from its revenue sources, including property taxes, among others.
The bond document further spells out that the funds used to make the payments will come from “funds Appropriated by the City from any money that has not been encumbered to secure the payment of any indebtedness of the City and that may lawfully be used with respect to any payment obligated or permitted under the Lease Agreement, including but not limited to unencumbered and lawfully available revenues derived by the City from the Additional Tax, the Team Payments with respect to the Taxable Series 2013B Bonds only, the 1% general sales and use tax levied by the City, bridge revenues and transfers from City-owned utility systems”.
In other words the money to pay the bonds can come from the city’s other revenue generating sources. This means that if the city is faced with a shortfall it can take money from the general fund account and make the payment. The resulting shortfall would then have to be made up with higher fees or raised taxes, or without completion of the project the money was originally budgeted for. More importantly, when looking to balance the annual budget, the city can look to cut services, increase fees or taxes but not cut the bond payments.
In regards to the Hotel Occupancy Tax (HOT) Rate, the document states that the “Lease Payments largely depend on the occupancy and average daily rates (‘ADRs’) at hotels located within the City”. The document adds that the “aggregate hotel occupancy tax rate of 17.5%” is “one of the highest in the nation”.
All though the city goes to great lengths to spell out that it is not assuming the debt directly its actions are such that the city’s future largely depends on it meeting its financial obligations, including those of the ballpark.
More importantly, though the city has the option to file for bankruptcy it is very unlikely to do so before forcing the taxpayers’ to pony up for the baseball debacle. There are just too many issues that would arise if the city were to exercise a Chapter 9 proceeding. These issues are not only political but also are detrimental to the citizens of the community.