BRADENTON, Fla. - As part of an effort to improve Tennessee's standards for local governments that use variable-rate debt and derivatives, Comptroller Justin Wilson may recommend new state regulations that would require local governments to file continuing disclosures about those transactions.
Wilson has talked to the Municipal Securities Rulemaking Board about using its Electronic Municipal Market Access system, known as EMMA, as a mechanism for filing the disclosures, he said in an interview yesterday.
"Our initial feel is that this could work well not only for cities and counties, but for the investors,"Wilson said. "My concern is not just for investors but the taxpayers here in Tennessee."
MSRB spokeswoman Jennifer Galloway acknowledged that the board has discussed the use of EMMA with the comptroller.
"Beginning on July 1, municipal bond issuers will be able to submit voluntary disclosures to EMMA and the category of derivatives information certainly is among the information issuers can submit for public access to the Web site," Galloway said.
Voluntary filings, such as those about derivatives, would be in addition to the mandatory continuing disclosures that the Securities and Exchange Commission will require issuers to file electronically through EMMA beginning July 1 under its Rule 15c2-12, Galloway noted. The mandatory disclosures will include annual financial and operating information as well as notices of material events, such as bond calls and rating changes.
The MSRB in April began operating the first phase of a short-term reporting system that includes basic reset information for VRDOs. Subsequent phases of the system will include more data on VRDO remarketing as well as program documents.
After learning about various problems some Tennessee governments encountered with their variable-rate debt earlier this year, particularly small issuers, Wilson embarked on overhauling state educational requirements and regulations for those transactions.
Wilson is now reviewing comments on an initial set of recommendations that he proposed. He plans to develop final recommendations for the State Funding Board to consider, possibly as early as next month, Wilson said yesterday.
At the same time, the comptroller said he is also broadening his efforts to include debt management practices and new disclosure requirements for local governments.
"We actually have had statutory authority for a number of years for the development of a model finance policy for all sizes of municipalities," Wilson said. "The area I'm most concerned with is the appropriate use and level of variable-rate debt."
With two-thirds of her county's debt in variable-rate mode, Blount County commissioner Wendy Pitts Reeves said she also is concerned.
"I am relieved that Mr. Wilson is taking it seriously," said Reeves, who applauded the comptroller's efforts to focus on debt management practices.
Blount County, in east-central Tennessee, covers 560 square miles and has a population of 121,511. It had five variable-rate bond issues outstanding with five associated swaps covering a total notional amount of $93 million. Ambac Financial Services LP is the counterparty on all five swaps.
When the county was unable to replace a letter of credit on two of the variable-rate issues, commissioners agreed in February to issue bonds with a two-year balloon payment due at maturity to take out $49 million of the variable-rate debt. The five swaps are still in place as well as three small variable-rate issues, according to David Bennett, the county's finance director since 1999.
"The problem, to me, is we have so much of our debt in variable rate and swaps," Reeves said. "We're paying nothing on the principal, and there are ongoing fees for back-loaded debt."
But Bennett said the county has saved millions by using variable-rate debt instead of fixed-rate debt. All of the county's variable-rate issues for which there were swaps were well under $50 million each.
Bennett said the controversy that has arisen across the state about the use of derivatives has caused confusion about the real problems associated with variable-rate debt, which is the inability to obtain liquidity facilities. He also bemoaned the fact that if the comptroller's proposed new guidelines are put in place, none of Blount County's variable-rate deals and swaps would have been allowed.
One of Wilson's principal preliminary recommendations would only allow interest rate swaps on deals valued at $50 million or more, and forward purchase agreements would only be allowed on deals valued at $25 million or more.
Under those guidelines, Bennett said Blount County would be punished and unable to use derivatives in the future.
However, he also admitted that the county has never had a debt management or swap policy approved by elected officials. He recently forwarded proposed policies for commissioners to consider next month.
"It's one of the things we've done not so much because the comptroller is looking at swap guidelines or interest rate agreements, but more because with the economic times we've gone through we wanted to make sure we're all on the same page and fully open and transparent," Bennett said.
Scott Fairclough, senior vice president of the public finance derivatives group for Sterne, Agee & Leach Inc., said he would never allow a client to execute a swap unless a swap policy is in place.
Fairclough, who has offered suggestions about how the state should revise policies regarding derivatives, applauded Tennessee officials for recognizing there are problems with derivatives practices in the state.
"I think swap guidelines for use by local municipalities is a wise practice," said Fairclough, who believes local governments should be required to use independent derivatives advisers to eliminate conflicts of interest.
The state should establish a form of derivative management policy with minimum standards to protect issuers against conflicts of interest and overuse of derivatives while at the same time incorporating flexibility so that the swap and financial adviser can tailor the management policy to an issuer's specific credit, risk tolerance, and understanding level, Fairclough said.
But he also said the preliminary guidelines proposed by Tennessee's comptroller may be too restrictive for the economics of derivatives to work.
"They way they are written makes it really difficult to take advantage of derivatives products," he said, citing the recommendation that would limit swap use to deals valued at $50 million or more.
While the comptroller's recommendations are designed to keep smaller cities and counties with limited resources and expertise from taking risks on such transactions, Fairclough said there may be better ways of defining appropriate users by the size of their population, debt portfolio, or frequency of issuance.
Wilson said he expected his recommended changes for educational requirements and standards for variable-rate use will be brought forward soon. He expressed hope that additional recommendations regarding local government debt management policies and disclosure would be considered before the end of the year.
Andrew Ackerman contributed to this story.
