Municipal budgets continue to exhibit severe stress, and public officials are being pressed to come up with solutions that create savings from both traditional and non-traditional sources. The low-hanging fruit has generally been exhausted, and incremental silver-bullet solutions are hard to find.
Against this backdrop, there are valuable dollars being left on the table by municipal issuers around country who are too busy, too disinterested, too scared, or just too uninformed to sensibly invest bond proceeds as if they were part of the rest of their investment portfolio.
Investment of bond proceeds is one of the basic blocking and tackling functions of the municipal market. It’s the flip side of borrowing.
Too often in the current environment, issuers leave these proceeds invested at near-zero money market rates due to a concern about the future direction of interest rates, becoming paralyzed, or simply moving on to other pressing priorities after a bond sale has closed.
Meanwhile, the virtually zero investment return on proceeds substantially increases the cost of financing, and require a greater contribution of current budget resources to pay debt service costs.
An onslaught of negative press and alleged prior bad behavior by market professionals have made this area uncomfortable for many issuers and market professionals alike. Nonetheless, the approach of sticking one’s head in the sand is an expensive, damaging alternative during lean times.
We recently met with an issuer that had a new debt-service reserve fund of approximately $20 million. The bonds had closed and the issuer was keeping the funds in a money fund earning 0.30%. No real attempt was being made to explore alternatives, and inertia was beginning to set in.
Assuming a continuation of that strategy, and current rates, the issuer would earn about $60,000 in income over the next year. We discussed several alternatives for investments that would have increased their current yield tenfold or more to 2.50 to 3.00 percentage points above their current rate.
Many of these would have required locking up funds for an extended period of time, a decision issuers are often unwilling to make in the hopes that something better is on the horizon. In the meantime, they would forego $500,000 to $600,000 of additional income to offset current-period debt service costs or provide funding for the salaries of half a dozen municipal employees.
We discussed the pros and cons of various structures and vehicles, all within the parameters of their safety and liquidity needs. We explained that for each year that they keep the money short, it becomes that much harder to recoup lost earnings in the future if or when higher yields re-emerge.
And, in fact, the dollars may have more utility during times of crisis than in more normal periods. We also discussed the possibility of setting specific targets for investment rates so that they could monitor the market and pull the trigger once that target had been met. The issuer gained a greater appreciation for the implications of their near-term investment decisions, and the potential for solutions that balanced near-term and long-term objectives.
While they may not change their current investment decision, they at least understood the cost of the dollars left on the table and the options that are available. The cycle of inertia was broken.
In this environment, active decision-making that encourages idea-generation and exploration of all relevant options is the best path for finding budgetary solutions.
While no new product twist or creative new approach may be applicable, or comfortable, there are an array of time-worn approaches that might work reasonably. Allowing inertia to persist is simply not an acceptable strategy.
Matthew Roggenburg is a managing director at Cityview Capital Solutions LLC