TELLURIDE – Telluride made the national news recently, but this time having nothing to do with skiing or film festivals.
Instead, Bloomberg News columnist Joe Mysak gave Telluride a bit of financial world notoriety last month when he used the strategy the town has employed to refinance part of its remaining $19.2 million Valley Floor debt as an example of how investors can earn more than the going interest rate in the municipal bond market.
The part that raised a few eyebrows around here, however, was that Mysak included Telluride’s creative financing strategy, ranked A1 by Moody’s Investors Services to indicate an upper-medium-grade obligation subject to low credit risk, among a group of other investment opportunities at the bottom of the investment-grade scale, or worse.
“You can find tax-exempt yields of 5 percent and more in the municipal bond market, if you are willing to confront risks such as typhoons, earthquakes, angry voters and a record of failure,” Mysak wrote in his Sept. 14 editorial.
“What passes for high yield in municipals these days is accompanied by unconventional risk.”
With the letter of credit that secured the 2007 Valley Floor bonds set to expire this past September, the Telluride Town Council in July authorized a refinance of the debt in July through two separate financing arrangements.
The first financing arrangement authorized the issuance of $10 million in excise tax revenue bonds secured by the town’s Open Space Fund. By ordinance, 20 percent of all the town’s unencumbered revenues go directly into that fund.
The second, which Mysak called out in his column, allowed an agreement whereby the town leases Rebekah Hall, Town Hall, its Public Works maintenance shop and three vacant parcels it owns near the Telluride Middle/High School to a trustee – in this case Wells Fargo Bank – in return for rental payments worth $9.2 million.
The town then leases the properties back from the trustee, making rental payments while retaining the use of its assets, in a financing strategy known as a Certificate of Participation. In it an investor buys a share of lease revenues rather than a bond that is secured by those revenues.
Because that lease arrangement is appropriated in the town’s annual budget it is not considered a multi-year obligation and does not require voter authorization.
“It’s basically a financing vehicle we’ve been using since TABOR,” said Steve Jeffers, a managing director at Stifel Nicolaus, the town’s underwriter, referring to the 1992 Taxpayer Bill of Rights under which Colorado state and local governments cannot raise tax rates without voter approval, and cannot spend revenues collected under existing tax rates if revenues grow faster than the rate of inflation and population growth, without voter approval.
“If you seek 5 percent, Telluride, Colo., wants to lease you its town hall,” Mysak wrote of the deal, going on to note: “The town isn’t obligated to make any payments other than those ‘which may be appropriated’ every year.”
“This gossamer security may sound unusual to untrained ears, yet it is a common structure in the municipal market: bonds are backed by taxes or certain revenue streams; COPs are backed by nothing but promises.”
True, the COP does not have a pledged revenue stream like the Valley Floor bonds, but Jeffers didn’t see this fact as the negative Mysak seemed to suggest.
Rather than being limited to a specific revenue stream like the excise tax revenue bonds, the COP is payable from all legally available revenue, he explained.
“It basically gives the town maximum flexibility to use the Capital Fund as well as General Fund,” Jeffers continued, describing the potential revenue stream as “broader and maybe better than a straight revenue bond.”
Jeffers noted that the town’s COP deal and the excise bonds received equal ratings of A+ from Standard and Poor’s.
“It doesn’t rely just solely on Real Estate Transfer Tax or sales tax,” he said of the COP. “And the fact that we can access it all is the reason the COP got such a high rating.”
In his column Mysak went on to describe how investors could get a 6 percent return by helping finance train service between downtown Denver and the city’s airport.
“Moody’s rates these Baa3, which is the bottom of the investment-grade scale,” he wrote.
Investing in some of the $66 million COP offered to build a high school in super typhoon- and earthquake-prone Guam, where “investors are betting that the lawmakers will appropriate the money to pay debt service,” although lawmakers are under no obligation to do so, he added, would yield 7 percent on the Standard and Poor’s B-rated instruments.
“Yes, that’s a junk rating,” he wrote.
“We’re a long way from B,” said Jeffers of Telluride’s COP rating.
“We’re light years away from Guam and we’re also light years away from the yield that they’re paying on Guam,” he continued, noting that only a portion of the Telluride COP maturing in 2036 yields over 5 percent.
“The overall interest rate on an average basis is closer to 4.5 percent,” he said.
Finally, investing in $117.6 million in unrated revenue bonds to build a retirement community in Illinois yields over 8 percent, but comes with some significant unknowns.
“Investors have to worry about getting the facility built and about maintaining a certain level of occupancy. They have to think about health-care reform and regulation, Medicare and Medicaid, and nursing shortages, among other things,” Mysak wrote.
In response to an email from The Watch, Mysak said he was not intimating that investors should avoid the Telluride instruments, as some who saw the column inferred, nor any of the others.
“I wasn't suggesting investors avoid any of them, just know what they're buying,” he wrote.
“So many investors seem to think that there is such a thing as a generic municipal bond; or that all municipal bonds are alike, and entirely risk-free,” he wrote. “That's a big mistake.”
“I still stand behind the fact that it was a well-structured transaction,” said Jeffers.
“It was well received by investors, it delivered an attractive interest rate to the town and was well-secured for the investor,” he said.