Monday, March 19, 2007

Reserve Funds and Arbitrage

So Supervisor Reed expects to put $2 million in reserves any time now according to his Standard & Poor’s letter. I’m assuming that we don’t have that kind of money sitting on a shelf, so where else would it come from. Bonding?

So what are reserve funds anyway? Reserve funds provide a means for raising money today, investing it and spending the money and earnings in the future. Many towns, as part of their normal budgeting process, may earmark a certain number of dollars to put in their reserve fund perhaps because they foresee they will need some capital expenditures in the future be it a new town building or equipment. Rather than bonding, which costs money, they put “X” amount of money in Reserve to pay for their future needs. If a town sets up a "specific" reserve fund say for capital expenditures it is required that it is done by permissive referendum--in other words, the residents have a chance to put it up for a vote just like we are doing for the bond resolutions that were passed in October 2006.

Another way to add to the Reserve Fund would be to move “surplus monies” at year end into the reserve. Surplus is money that is budgeted and not used by year end. You will notice that sometimes surplus money is used at budget time to keep the tax rate down.

Then there is the moving of bond monies into a reserve fund like the Town of New Hartford plans to do. Perfectly legal; however, we feel that perhaps the Town should be telling residents "the plan" and just what bond monies they can expect to see sitting in a fund hopefully collecting more interest than we are paying and what bond monies would be expended now. Are we buying all the trucks in Proposition 6 or are some of them to be purchased in the future? We know that we are buying the Gradall, we have been paying $5,000 a month to lease it. Is the $150,000 for sidewalks going into a reserve fund and that is why they have yet to even bother to get written approval from the State & County to build sidewalks on the State and County roads Phase I of the sidewalk plan—Tibbitts Road, Oxford Road, Kellogg Road & Oneida Street? Are they truly going to pay off the Bond Anticipation Notes (BAN)in Proposition 1 & 2 like they say or are we going to continue paying interest only on the BANs for the next couple of years and put the bond money in Reserve? How much of the $2 million in stormwater will we see spent this year? When we asked Roger Cleveland how soon the stormwater money would be all spent, he just said they would spend it as fast as they can. How about the $92,000 for lighting at the Recreation Center and the Highway Garage. Will we see those lights installed soon?

Reserve funds are generally “earmarked” and cannot be used for other than the intended purpose. So suppose the town decided to put the $45,000 for the garage renovations into a reserve fund maybe waiting for those grants and member items that they have been talking about to materialize. It could sit there and earn interest, the interest would become part of the reserve fund, but it could never be used for anything other than highway renovations, at least not legally. The only time the money could be used for other than the intended purpose is when the bond principal and interest is completely paid off. There are also restrictions on the amount of time that the town can hold the bond money in reserve. The school district, I am sure, does this all the time. That is why you just saw in the paper that they finally spent the 2001 bond money for laptops in December 2006. They were earning interest on their bond money.

According to an October 24, 2006 editorial in the Observer Dispatch, the town wants to add to its fund balance in order to upgrade their bond rating. So I guess that has been the plan all along; however, perhaps Supervisor Reed should have told Standard & Poor's that they were actually bonding for $4.6 million with up to $2 million going to reserves—that would be $2 million of restricted funds—not money that can be spent anyway the town wants or needs to. According to our sources, the town actually has very little reserve money that can be spent. The majority of the reserve fund is earmarked for specific purposes. The reason Supervisor Reed probably didn’t tell Standard & Poor's about the additional $1.6 million is because if he told them he was bonding for $45,000, $92,000 and $150,000, it might have sent up red flags to the people at Standard & Poor's.

So what is arbitrage? Arbitrage is the difference between the interest paid on bonds and the interest earned by investing the proceeds of the bonds in higher-yielding securities. We specifically asked John Shehadi, CEO of Fiscal Advisors, the financial planners that the town is using for this bonding, if these would be “arbitrage bonds”. He confirmed that they are indeed. Bonds where you plan on investing the money to earn interest have to be declared “arbitrage bonds” before they are sold.

What part of the $4.6 million of bond money is actually going to be spent right away and what part is going to be put into Reserves—what bonded items will be put on hold while the town tries to make arbitrage money? Residents have a right to know. Does the town even know is another good question--plans certainly seem to be lacking from all accounts that we have witnessed.

The October 24, 2006 editorial in the Observer Dispatch says that “they want to add to the fund balance and that is why they chose to bond for smaller-ticket items it normally might pay out of its regular budget.” At the March 14, 2007 Town Board Meeting, Village of New Hartford Mayor said that the town was bonding for small items in order to get a better rate on the bonds. We contend that they decided to bond for everything they could to reach that magic $5 million mark—the point at which they would still be considered a "small issuer" and not be subject to as many Federal regulations as they would if they were bonding for over $5 million. In order to bond for an item, it has to have a useful life and be subject to depreciation. Are they bonding for "unneeded" items just to have as much money as possible to play the arbitrage game with? We also contend that they bonded for everything they could in order to keep the tax rate increase at $.04 over the 2006 rate. Supervisor Reed didn’t want an “uproar” just before the school bond issue was up for a vote. Had he put some of these items in his 2007 budget, the tax rate would have been much higher.

Ironically, the tax rate for New York Mills residents who live in the Town of New Hartford has more than tripled this year, going from $.07 in 2006 to $.24 in 2007. We still haven't figured out how they did that! If you live in New York Mills/Town of New Hartford, this bonding will add another $.18 per thousand of assessed value to your tax bill-almost doubling your 2007 tax rate--that is if their current figures are correct. How many of the benefits of this bonding do you think you will see in New York Mills?

By the way, in the October 24, 2006 editorial, the town board said the bonding would only add $.05 per thousand in 2010, now it is up to $.18 per thousand with no date of when we will first see the increase. Another instance where they keep changing the facts. It is difficult to know what to believe at this point!

The Federal Government has very strict rules set up for municipalities putting bond money into reserves with the expectation of getting more interest on the money than they would pay out on the bonds.

B. Limiting Arbitrage Profits (excerpt from article Municipal Bond Tax Issues Explained

Tax-exempt bonds bear interest at a lower rate than comparable taxable securities. This enables a local government unit (in normal market conditions) to issue tax-exempt bonds, take the bond proceeds, and invest them in higher yielding taxable securities. Of course, local governments do not pay income taxes, so the spread between the interest payments on the bonds and the interest earnings on the investments is profit to the local government. This profit is called "arbitrage."

As you can imagine, the Feds are not thrilled with local governments taking advantage of the tax exemption to earn arbitrage. The Feds want to see the bond proceeds spent as soon as possible on the project being financed.

The Feds use two primary mechanisms to limit arbitrage: "temporary periods" and "rebate." A local government is permitted to earn arbitrage only during a "temporary period"; once the temporary period ends, bond proceeds may not be invested at a rate in excess of the bond yield. The most common temporary period rule states that a local government must spend at least 85% of its bond proceeds within three years (subject to certain exceptions, of course).

Basically, arbitrage can only be for up to 3 years (although there are exceptions, such as a workers’ strike that delays capital projects) and you have to spend up to 85% of the bonds within the 3 years. So based on the Standard & Poor’s letter, the town is planning on putting almost half of the money into reserves. We are sure that is why Mr. Timpano is working with the town and that is why Supervisor Reed thinks he “needs” a comptroller. Arbitrage is a tricky game and without someone who knows what they are doing, the town can get burned. There are very strict IRS regulations that must be followed. While this type of financing may work very well for the County, and school district who have more money to “play” with than the town, but we do not believe that it is a wise decision for our town. We don’t have the kind of budget where we can make up shortfalls without increasing the tax rate. They make an investment mistake and we will pay for it. We all know how the County handles their money. We don’t have a town sales tax that we can impose on shoppers or a tobacco settlement to offset mistakes—therefore, mistakes will be covered by property taxes.

The main problem of this administration is that they work on a “need to know” basis and they don’t think that taxpayers have a need to know anything. They should outline just what they plan to do with the money—that should be part of the plan. Obviously, they don’t have a plan and that is why they cannot answer the questions that have been asked at the “informational” meetings. Are they planning on bonding every year--they can't answer that question. To date, we have seen nothing to convince us that this administration has the skills needed to play this "arbitrage" game; they are still trying to get a handle on Town Law!

I will leave you with a quote from the NYS Local Government Handbook:
“When local government takes expenditures that have been traditionally financed from current appropriations and begin to issue debt to finance such expenditures, it may be an indication that current revenues are not keeping pace with expenditures.”

To view more on this subject, I have a pdf file with some pages from the NYS Local Government Handbook published by the State of New York. I have boxed some of the key points in red.

Next, we will tell you what has given us a reason to be concerned about the town budget.

1 comment:

Edmund J. Wiatr, Jr. said...

It certainly looks like the Town of New Hartford's elected officials have lied to the residents of New Hartford?