NFMA Urges a Hard Look at Appraisals

WASHINGTON — The National Federation of Municipal Analysts is urging market participants to take a critical look at the feasibility studies or appraisals that issuers use and cite in bond documents to support the viability of bond-financed projects.

The NFMA on Tuesday released a draft white paper on expert work products, or EWPs, that recommends the disclosure of key information about the work products, including the standards that were adhered to in their development and whether their "significant" assumptions are reasonable.

While many market participants assume that EWPs "inherently represent the confidence" of underwriters and borrowers, "this may or may not be true and should be specifically addressed" in the disclosure documents, the white paper warns.

The NFMA is soliciting comments on the draft white paper through Feb. 28. It was principally authored by Robert Doty, president of American Governmental Financial Services in Sacramento, and Peter Bianchini, managing director and senior municipal strategist at Mesirow Financial Inc. in San Francisco.

In an interview, Bianchini said that many work products are well done and performed by well-known firms, but that's not universally the case. As a result, analysts would like every report to include the qualifications of the experts that create them, as well as any potential conflicts of interest they may have with any member of the financing team.

Some work products do not go into detail about the industry standards behind the reports, he said.

Experts also may offer an explanation for their methodology but not say if it's the industry standard.

"To the extend that they're following an industry standard, it would be helpful for that to be disclosed in the report," Bianchini said.

Greg Clark, vice chairman of the NFMA and the co-chairman of its disclosure committee, said the analyst group is generally trying to prompt consultants and their financial teams to be more transparent.

Doty contends the white paper may decrease the number of muni defaults by helping issuers and analysts to ask important questions and ensure that EWPs are prepared in a more professional manner.

A large volume of munis that have defaulted in recent years have incorporated EWPs, but the experts often do not voice an opinion about whether their assumptions are reasonable even though their studies are central to investor decisions, he said.

"Sometimes market participants don't pay attention to how they're prepared and often issuers lack experience as to what questions to ask," Doty said. "But these are key representations in an offering document."

Doty added that in some cases of bond defaults from land-secured transactions with appraisals, such as with Florida community development districts, there were no expert work products. A professional review of land values and potential values would have been helpful, he said.

Among several recommendations, the white paper urges that EWPs include an affirmation by the expert that "in its professional opinion all significant assumptions used in the work products are reasonable."

"If this statement cannot be made, the expert should state which assumption(s) are not reasonable and why they are not reasonable," the NFMA wrote.

An expert's sources of information, particularly sources for significant assumptions, should be disclosed in the study, and assumptions provided to an expert by other parties should be identified, along with any interest of those parties in the project or bond issue.

In addition, experts should identify key items of "sensitivity" and provide a range of results by using multiple inputs for the sensitive items, such as "base," "best," and "worst" cases, the NFMA recommended.

EWPs also should include the expert's qualifications, expertise and history, including any licenses and professional certifications.

In the main body of the disclosure document, the NFMA recommends that the underwriter and borrower include a statement that they have reviewed the EWP and have a reasonable basis to believe that the assumptions are reasonable.

Further, they should make a statement regarding the ability of investors and similar parties to rely upon the expert and the EWP when assessing the transaction, along with descriptions of both the EWP and the expert.

Though the NFMA white paper does not point to specific transactions, market participants noted the importance of EWPs is underscored by the fact that some of the most recent larger muni defaults involve ambitious bond transactions with faulty underlying feasibility studies.

A case in point is the $650 million Las Vegas Monorail bond transaction underwritten in 2000, which tanked due to the combination of a protracted recession, a credit guarantee from an now-insolvent bond insurer and dramatically over-optimistic ridership projections.

The bonds were secured only by the revenue created from the monorail, so the key to the creditworthiness of the debt was how many people would ride it and how much they would pay.

The consultant, URS Greiner, estimated that by 2009, the system would be shuttling 21.2 million people a year between Las Vegas hotels, generating $63.7 million in annual fare revenue.

However, the forecasts were way off, and the monorail generated only approximately $27 million in fare revenue last year — shy of the forecast by almost $37 million.

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