Tennessee Comptroller Weighs Curbs On Variable-Rate Debt, Derivatives

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BRADENTON, Fla. - After hearing from more than a dozen professionals and local elected officials about the future use of variable-rate debt and derivatives in Tennessee, the state's comptroller has decided to take comments from the public before finalizing recommendations to the State Funding Board.

In a series of proposed changes to the state's existing regulations, Comptroller Justin Wilson has recommended numerous restrictions on the use of variable-rate debt and derivatives, including provisions that would effectively prevent most small cities and counties from engaging in such transactions.

Wilson first unveiled his proposed new guidelines May 1 in response to difficulties experienced by some of Tennessee's smaller issuers whose transactions went awry in the current financial crisis.

He also is considering other sweeping changes limiting the use of variable-rate debt for municipal financing, such as allowing swaps only on deals valued at $50 million or more, and restricting forward purchase agreements to deals valued at $25 million or more.

The comptroller's proposed new guidelines, including a "red line" version that delineates the proposed changes, can be found at www.tn.gov/comptroller/lf/lfsfundbd.htm.

Ultimately, it will be up to the State Funding Board, consisting of the governor and other state officials, to decide what changes will be made. But no decision is expected until Wilson finalizes his recommendations.

Since releasing the proposed changes in May, the comptroller's office has been taking comments, most of which have come from investment banks, financial advisers, law firms, and county officials. The comptroller's office this week posted their comments at www.tn.gov/comptroller/lf/lfsfundbd_comments.htm.

Wilson also released a statement on Tuesday announcing that he wants more public comments before making his final recommendation to the Funding Board.

"Variable-rate bonds may seem like a great idea when the market conditions are favorable," Wilson said. "As interest rates rise, so can the cost to the taxpayer. Other circumstances outside the control of the borrower also can drive up the cost of borrowing dramatically.

"The state hasn't historically had a lot of oversight over the use of variable-rate debt by cities and counties," he added. "Perhaps that should change. That's why I invite those interested in this topic to offer suggestions on what safeguards are appropriate."

No deadline was announced with respect to when public comments should be submitted.

Some of the professionals who have already reviewed Wilson's proposal welcomed the changes, while others seemed concerned about their strict nature, the additional costs they would impose, and the lack of flexibility they would afford local governments going forward.

Peter Shapiro, managing director at SWAP Financial Group LLC, said yesterday that his firm has spoken extensively with the comptroller's office and also has sent written comments about the draft regulations that have been proposed.

"We've advised them they should retain additional flexibility for the fact that the market is one that changes a lot over time," Shapiro said. "They may very well find circumstances that these regulations are too inflexible to fit."

Shapiro said he believed Tennessee officials are concerned about "the potential for the well-connected to push though things that might be inappropriate." However, he also commended the effort by the state to improve regulations and said they are "clearly intended to be helpful."

"The hard thing is creating hard and fast rules," he said. "You find that despite the best-intentioned effort to foresee all future circumstances there will inevitably be a future circumstance that does not fit. Our concern is that future events look differently than what they expect and transactions which are prudent and conservative, and are needed by a Tennessee government, may not be able to occur."

Shapiro said one of the greatest lessons of the current financial crisis has been that unexpected things happen, and issuers must be prepared. A perfect example, he said, is that everyone assumed banks would always be available to provide liquidity facilities for floating-rate bonds. But today that is not the case, and most issuers that do find liquidity facilities are paying higher costs for them.

In addition to the draft regulations that the comptroller's office has already prepared, Wilson said Tuesday that his office also is developing disclosure documents regarding the fees and other costs local governments pay in debt financing and derivative transactions.

The comptroller said his office is talking to the Municipal Securities Rulemaking Board about making the information available on the Internet.

"Local government officials and the taxpayers ought to understand clearly all of the costs involved," Wilson said. "And they can't understand the costs unless they're able to find out what they are."

The comptroller said he and his staff are currently reviewing all comments before making final recommendations to the State Funding Board.

"We have to be very careful about what we're doing here," Wilson said. "Developing a comprehensive debt-management policy for local governments is a priority for this office. It's not the type of work that can be rushed."

The comprehensive review of debt practices in Tennessee came about after a New York Times article in April raised questions about industry professionals who taught state-required derivatives courses geared to local government officials and later advised Tennessee communities on the use of them, often serving in various roles in a single transaction.

The state first enacted a law requiring cities and counties to take an educational course about using derivatives in 1999. The comptroller's office is required to issue a letter of compliance with the law when cities and counties want to enter into derivatives contracts.

Wilson has said that the guidelines for the course and those that issuers must follow have not been changed or updated since 2002, but much has changed in the credit markets since then.

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