The Inability or Unwillingness of an Educated Population to Understand Risk
Even Though Those Risks Are a Direct Threat to Home Values and Classroom Instruction
Council Has Simply Not Been Entirely Forthright or Candid With the Citizens
Nor Have the Citizens Demanded that Council Do So
By Ira Kaylin
Kaylin is a Former Member of the City Council and Co-Chair of the Budget and Finance Committee. He is a Retired International Financial Professional
January 6, 2018
The City’s Financial Advisor’s Memorandum regarding identification of risks and risk mitigation is workman like and covers most, but not all, of what one would expect in this type of analysis. A further review of the Davenport information reveals pernicious aspects to the so called risk mitigation techniques the Company proposes.
It is important that Falls Church citizens be made aware of the risks before the first bond is offered for sale.
In that regard, except for the recommendation to increase the City’s Fund Balance, the other risk mitigation recommendations by Davenport are actively harmful to the City. The report does not factor in all the components that would affect the “probability of [debt] payment interruption,” which is the basis for setting the risk margin for interest rates.
After the 2007-2009 Great Recession, rating agencies were under heavy criticism for the lack of a comprehensive view of all of the risks to bond repayment and not going beyond solely measuring reserves. Specifically what is missing from the risk assessment and what is required is a review of a City’s overall financial track record and prospects for future repayment of debt.
The Fear of Sunlight and Transparency
As has been mentioned in prior articles, the City Council and City Manager treat operating costs with the same fear that Dracula has for sunlight.
Therefore it is not surprising that Davenport does not even mention operating costs could have an impact on our rating. Rating agencies, since the sub-prime crisis, have been under pressure to include these types of issues in their analyses.
This is especially pertinent because the city’s operating costs are projected to exceed debt service costs in five years.
Davenport’s Mitigation Repayment Stress Relief Alternatives Are Flawed
Davenport includes one recommendation that is simply wrong: The “principal wrap around” technique is a legitimate financial vehicle. However, it is purchased by the issuer of the debt not the City.
Other “poison pills” are to have the City consider an interest only loan and to capitalize interest charges.
The interest only approach has been fully discredited since the sub-prime collapse. Its purpose was for people to secure mortgages because they were unable to meet normal mortgage payment requirements. Needless to say interest only debt instruments add millions of dollars to overall costs–which are great for financial institutions but financial poison for the debtor.
Capitalizing interest, as the name suggests, adds delayed interest payments to the principal amount of the bond, increasing the required funding to repay the bond.
It is appalling that such a toxic debt structures would even be considered.
Also, Davenport’s suggestion that the City “ladder” its bond proceeds in order to yield a higher return is theoretically correct, but to the best of this author’s knowledge it is not permitted by the State of Virginia. This regulation was promulgated in order to prevent misuse of fund and is limited to 1 or 3 year investments.
The Bottom Line
If we can’t fund the bond on conventional terms then we should NOT commence the borrowing.
To do so risks insufficient funding in the coming years for teacher salaries unless the Council resorts to draconian real estate tax increases which will have an adverse impact on your home values.