Isn't there a percentage of data that if you -- I mean, you're not keeping statistics to even demonstrate the point you're trying to make and you're in control of all the data and we are just supposed to sit here and based on the experience reach a conclusion --
I think you're recommending to me that we use old data that may have passed some standard and we don't really know how that report was run to see how it -- I don't know how it was run to see how it passed the standard, but you're recommending to me that we use old archaic data that we're finding today in the street that a lot of it is incorrect.
That's anecdotal -- that's anecdotal stories you're repeating. I want to know statistically what a lot means. 197 And if you can't answer that, then it's just anecdotal.
Okay, well maybe it's -- I can't tie a percentage to it because I don't have a system that will tie a percentage to it, but I mean the best I could do is inform you of what we're finding and --
Let's just take one small example. It's a rowhouse in Northeast Philadelphia in Mayfair, let's call it, and the data in the database is going to say that it was built as a three bedroom, it's going to say that its lot size is "X," the same as all the other lots around it. It's going to tell you what, I don't know if it tells you whether or not it has a front roof, it tells you, you know, how many bathrooms it has or had when it was built, you have most of the data you need. The additional data you're going to add to that property is incremental. If they built a garage somehow in the back alley, that's an important piece of data, but my point is there aren't that many properties that have undergone that significant a change where it is not worth 198 while to just -- to take the combination of the new data -- it's all the datas and characteristics, old like the information on that rowhouse, and new, which is additional information on that rowhouse. And, so, we have a lot of data, and most of it is accurate, so --
And, sir, I think we want the same thing here, I really think we do, but my example would be what happens when half of a block or like five or six houses in a block are gone and we have them as free-standing single family homes and we don't even know that they're gone because we haven't gotten down to that part of the city yet and we're going to value them with a value of $250,000 and the public is going to see that and say, well, how can Mr. McKeithen know what he was doing when he valued all these houses on all these streets and they're vacant lots.
Well, the answer to that question is we do that today. The answer to the question is that will be such a small subset of the overall amount of data that you 199 will have gotten it 99 percent correct. That's the answer. You can't create the rule for the exception, and that's what you're suggesting. You're trying to create a rule for every exception and apply the rule in cases where it doesn't exist, and that's not how a statistical modeling works and it's now how our property appraisal system should work. You don't create rules for the exceptions. Okay. So, turning to commercial property valuation.
Can you walk me through the day in the life of a commercial industrial evaluator?
Okay. A commercial evaluator, we have several different commercial units, depending on what unit you're in, but I will start with the major office, hotel evaluators. They're going to come in, they're going to do some of the same similar things a residential one would. They'll check their emails and check their phone, calls and things like that. Then they're going to start looking 200 at some of their properties, trying to acquire the data that's needed to value those. Some of that data, the most important pieces of data are going to be like the income and expense documents. If they don't have an income and expense document for a particular piece of property, they're going to look for comparable properties in the specific building class and try to get data and comp it out to the subject property. They work mainly with pro forma sheets, which is the income and analysis, to get a final value, and then they're going to walk through each item on the pro forma and see if it's reasonable or not or supportable and then they're going to derive a final value for any particular office building or hotel. They work a lot more with professionals in the industry. We have different applications that will help us look at leases, they're going to look at all types of financial information to walk through every component of that pro forma and then they're going to move onto the next property and value 201 each of those properties more on an individual basis as opposed to in mass like the residential people do. For like the apartment unit, they will do something very similar. They look at the income and expense information for each particular parcel that they have information for. They will look at comparability for ones that they don't have it for and look at rental rates and things like that and try to, you know, gain a value for each multi-family apartment complex property. So, similar with industrial, similar with the large general commercial stuff, and so they mainly work on a more individual basis with information and then caucus up with their supervisor, or Ms. Machiz back here, who is the assistant administrator for commercial, and, you know, industry experts.
So, for commercial properties, how many properties have you received the rent roll and income information on as a percentage of the whole to allow you to evaluate that and how do you audit that? 202
We can get that for you. We did do a breakdown on what we got back off of the last mailing, so we will get that for you.
In order to set values city wide if the same -- I assume you're trying to apply the same principal to commercial and industrial that you're applying to residential?
It's a mass appraisal approach, but it's more itemized when you get down to it. Industrial is a little bit different. It can be done more in mass with rates per square foot of sales and things like that, but when you're talking large office buildings, hotels, it's much more of an individual process.
Unnecessary interest expense paid to a corporate parent, what is your process for --
Well, we have a list of things that are not applicable in real property valuation, and so when we see those listed in the income and expense report we pull them out and we only use the things that are applicable to industry standard.
Do you know what percentage of properties have been you have all the data you need?
Well, you never have all the data you need, you have a certain amount of --
I completely agree with that point. That's the point I was trying to make a minute ago. You never have all the data you need.
But for commercial 204 properties it's much easier to do because you can go to other things like Costar and you can go to brokers and things like that and get information, so.
What percentage complete are you in terms of gathering the data?
Well, we're sending out income and expense surveys in May to be returned back in June for the commercial properties, so large office building, hotel, some of the things I just told Council President Clarke, the multi-family properties.
I'm sorry, so what happens when you don't get back data in June for 90 percent of the properties in the city, how do you then go through and do what you're doing with residential properties such that by September you can set a value on all of that stuff? If you're beginning that process now, how can we reasonably expect it to be completed in three months?
Well, once you get the commercial I&Es, it's a lot less analysis than 205 you might have to do with residential. Large office buildings are not going to change in condition and things like that in between the time you first see it and when we you do that I&E report, so we're going to get back, you know, a certain percentage and it will be -- hopefully it will be healthy enough where we can make certain assumptions and, you know, plug in information on pro formas and derive values. And then we also have -- I'm sorry -- we also have appraisals that will be done on various properties out of a certain dollar value, and so we will have that information as well.
What percentage of the properties -- you're basically saying you have not begun that process today because you're sending out the --
We have begun field inspections for like our industrials and our mixed use and things like that. I was starting off with the large office building and hotels where, you know, you don't -- you live and die pretty much by the I&E reports. 206
And what happens if you don't get the I&E reports until August for a majority of the properties?
I anticipate we will get the majority of them by June, no later than July. If we don't -- we also in appeal season, so some of them it behooves us to wait until an appeal is filed and we have an appraisal report from the actual property owner, so.
Well, they're likely to win any appeal if we haven't reappraised them in this process, aren't they, because compared to the average residential property they're over valued. So, to the extent you don't complete or get that full information by September, aren't we setting ourselves up for a situation where we've set a Millage Rate based on values that are way too high for commercial and industrial?
You're going to get an opportunity, if you don't get the I&E, then you're going to get enough I&Es from comparable properties, typically you will get enough I&Es from comparable properties to make assumptions 207 about your subject that you didn't get the I&E for. So, you know, that's -- and then once again you have things like Copass and Costar and things like that to lead you along the way to help you with these assumptions in the pro forma.
So, how much of a change are you expecting in commercial and industrial?
Well, I can't say. I mean, I haven't run any numbers on them yet, so I can't say.
You can't say. If it's a significant change and you have two months to do it, doesn't that really put into question the whole process?
No, because you can, once again, you have the information, and the information is valid.
You don't have the information if they don't send it back.
Once again, you're not -- if you don't get the information for each every individual property, you're going to get 208 it for some that are comparable enough for you to make the assumptions.
What percentage are you going to have get it from in order to have a statistically significant sample enough?
I don't think that you have to -- I think you need to be able to get enough for each type of property breakdown that you have. And in addition to that, with all the information that you can obtain from outside sources, like, once again, Copass, Costar and things like that, I think you have enough information to make an estimate of value.
So, what you do is you take the information you have on property "X" and say that I can apply this to property "Y" because they're similar properties, they're the same --
Okay. So, what I don't understand is why you can't do the same thing in a residential area where you've got rowhomes built all around the same time, half the block is done, you know, you know the other half was built at the same time, it's going to be roughly the same data you can apply to it to get similar values, in other words, you compare -- you apply the values from the properties that you've looked at -- I mean, we can go back and forth on this all day -- but statistically I think you're demonstrating what you can do in commercial, you can do in residential if you choose to, or you can choose not to and then the data is not available for City Council as they consider this momentous decision. It's a choice you're making that --
I think that this is -- it will be a huge mistake to think that you could do the same thing with residential you could do with commercial. And commercial properties, once again, are not as volatile. They're not knocked down as often. They change as far as leases and things like that and 210 tenant fix up, but they don't change as far as being removed and new ones being built as often as residential, and so you have a better opportunity with collecting data and getting -- and making assumptions then you would with unseen residential properties.
I would accept your premise if there was any data to back it up.
So, what data does OPA have that demonstrates that residential properties actually change their characteristics, get knocked down more than commercial properties or industrial properties in the city, for example? I mean, you just made a statement as if it were fact, I would like to know --
Experience has taught me that you don't oftentimes see a Marriott knocked down as often as you would see a rowhouse.
No, but a lot of the industrial properties are knocked down in this city, a lot of smaller commercial 211 properties. We're talking about all of commercial and industrial.
I am more concerned about the larger ones that would be an obvious mistake. I think that they're a lot easier to deal with from that perspective then a residential rowhouse in neighborhoods you've never seen.
But once again what you're presenting is anecdotal evidence and not data, is that fair?
I don't have statistics to demonstrate that, but I think twenty-some years of experience will show.
Could you please provide us with a matrix showing the following -- we will send this to you too -- all existing property tax relief mechanisms, whether they're permitted under state law, the State Constitution, as Councilman Kenney mentioned, whatever. All proposed mechanisms. The source off authority state or local law for the mechanism. What property owners are eligible for the relief under the mechanism. 212 The average and total value of relief provided for each mechanism and projected amounts for proposed relief measures. And based on the totals, and this is the important part, the average cost to the average taxpayer of the existing and proposed relief measures?
We can get you the information we have on that. So, you'll send that to us too so we'll know exactly what you're asking for.
Yes. I think I will stop here and we'll wait for a call back so we get some data. Thank you, Mr. President.
Thank you. Councilman. We will break for 45 minutes. It's 2:45. (At this time, a short break was taken).
Good afternoon. Council is reconvened. Will the next operating department come up, I believe it is the Office of City Treasurer. Will you please approach 213 the witness table. (Witnesses approach).
Councilman Greenlee says five minutes is five minutes real time. We're going to get started. Good afternoon, everyone.
Okay, great. My name is Nancy Winkler. I am the City Treasurer and thank you, Councilman Jones, Councilmen, for having us here today. We have submitted our written testimony and I understand that you would like us to simply summarize.
You can take your time. There is not that many questions, so you might want to go ahead and do it and get it in.
Summarize, I am going to 214 summarize. So, the City's Treasurer's office is responsible for the distribution of checks and electronic payments. The investment of bond funds and operating funds not needed for daily retirements. In addition, the office is responsible for new bond issuances for fundings and the management of over $8.7 billion of outstanding debt including debt issued for the General Fund, the Water Department, the Aviation Department and the Philadelphia Gas Works. The Fiscal Year 2013 General Fund budget request is for $886,605 which represents no change from our Fiscal '12 estimated obligations, provides funding for the City Treasurer to accomplish these core responsibilities: The highlights of the fiscal '13 budget requests by proposed expenditures are as follows: $745,937 in Class 100 funds representing 84.1 percent of the Office's proposed budget which funds 14 positions. There is $118,444 in Class 200 funds 215 representing 13.4 percent of the Office's proposed budget and the combined Class 300 and 400 amount is $22,222 for supplies and equipment. In Fiscal 2012 the Treasurer's Office supervised the issuance of $173 million of Tax and Revenue Anticipation Notes, TRANs, which we call the City's TRAN. $233.8 million of Airport Revenue Refunding Bonds. $88.8 million of Gas Work Revenue Bonds, refunding bonds, and $135 million of Water and Wastewater Revenue Bonds for new construction which was sold at the same time as $49.9 million of refunding bonds. Highlighted below are some of the main accomplishments for the City Treasurer's office. We generated a total of $26 million of present value savings in three refunding transactions. I'll skip the details of that. We worked on restructuring 12 different letters of credit, which was done from April 2011 through December of 2011. That produced significant annual recurring savings, better business terms, reduced the costs and 216 the risks for the City. Longer terms, we have longer periods of time before the expiration of these facilities locking in these lower costs and reducing the costs of renewal. And we also diversified our exposure in several ways, one by bringing in more letter of credit banks, higher rated letter of credit banks, and staggering the expiration dates so we won't have as many letters of credit all expiring in such a narrow window of time. The City has ratings of A2 from Moody's Investor Service and today S&P upgraded the City's bond rating --
It's terrific. It's great. Upgraded the City's rating from BBB flat to BBB plus with a positive outlook. And Fitch has maintained the A-minus rating that 217 was in place prior to that. During the fiscal crisis, City had been downgraded by Moody's from A1 to A2 and in December of 2009 Fitch downgraded the City from BBB plus to BBB and then Moody's -- sorry, Fitch undertook a revision to its rating system which led to an increase in the rating which was related to the change in their rating system and that went up to A-minus. So, we are working as part of the team to maintain strong relationships with the rating agencies and also with investors. The City has, you know, a history of having had a financial control board and so it's very important for us to work closely to educate investors around what is going on in the City so that they can be comfortable in buying the City's bonds. We believe that the City's general fund rating effects not only the cost for general fund financed projects, but also impacts the borrowing costs for Water, PGW and Airport. So, when we get this increase it really should help all the other related borrowers, even though they're not secured with 218 the General Fund in any way. One of the other accomplishments this year was a competitive sale of the City's TRAN. That is the first time we sold the TRAN competitively in some time, at least ten years. We did it on the Internet. We received 34 separate bids totaling $1.7 billion in orders, which was ten times the size of the TRAN. The TRAN was $173 million, and that helped lower our annual borrowing costs for the TRAN. I think I will skip past the rest of the written testimony and see if there are any questions.
Well, again, congratulations. We just got the news as well that that happened. We went from BBB to BBB plus with recommended rating. And I was curious, what are the, if you had to name three factors that helped us to improve that rating, what were they as a municipality?
First of all, the very strong financial management of the City through this extended recessionary period, the severe downturn in finances which started in 2008, the City put a plan in place which required a very wide range of actions, management actions, legislative actions, City Council actions, state actions and that plan eliminated the deficit and in this year, as you know, the City ended with a fund balance of $92,000, which is basically no fund balance, but it's a slight positive fund balance on a budgetary basis, not a gap basis. So, that process that the City went through over several years and the ability of all the various stakeholders to come together to find a solution was very important, and it was important to see a trend. It was also very important that the FY12 budget and the FY12 current projections included in the FY13 budget show a continued contribution to fund balance, fund balance being one of the key financial metrics for all of the rating agencies. So, that is extremely 220 important. They will be looking to see that we actually do meet that projection.
I know our rating agencies aren't created equal, are some more equal than others. Is it better to have the A-minus versus the triple -- can you explain that to us out of the three?
Well, the investors typically want to receive an interest rate on the bonds that they own commensurate with the lowest rating that's out there. And, so, for us the gap between the Moody's A2 and the BBB flat was costly to us because --
No, that was just the refundings on other bond deals that we did last year, that has nothing to do with the potential ongoing value to the City of getting say into the A category. But it will be -- it should be millions of dollars to the City and all of its borrowers if the City could get into the A category because there is about 80 to 100 basis points, in other words, between .8 percent and 221 1 percent roughly incremental additional costs to being a BBB credit versus being a single A credit. And really this has changed very materially in the last few years. It used to not really cost the City very much to be a BBB credit because up until 2008 the City was able to buy bond insurance at fairly low cost and could just then access the markets with the bond insurance, which was AAA. And since the credit crisis, investors are drawing very major distinctions and demanding much higher rates because they don't rely on bond insurance anymore and they're really looking to the underlying rating.
I think it was roughly $372 million in bonds across three programs. I am correct apparently.
And what is the process by which the decision is made to refinance or refund?
So, the City has a bond, has a debt policy, and the debt policy 222 establishes a savings requirement so we don't do a refunding unless the bonds that we're refunding produce at least three percent savings. So, we have to be able to lower the City's cost at least three percent on a present value basis, and so that's the basic criteria we use. I think these transactions actually generated savings in excess of three percent.
Okay. So, once we started doing that, did you approach the rating agencies or did they contact you? What was the process that actually got us bumped up in those rating agencies?
So, both Moody's and Fitch have just maintained the rating in this most recent ratings action, which is associated with another refunding we are doing. We are refunding the 2002 Neighborhood Transformation Initiative Bonds for Savings. So, about a year ago we went to S&P and said look at the City's 223 plans, we appear to be able to be on track to eliminate the accumulated budgetary deficit and that's quite an accomplishment in this extremely difficult economic environment, we think you should consider upgrading us. And so they went back to Committee, this was last March, and the Committee agreed they would consider upgrading us and at that time they changed the rating from BBB flat to BBB with a positive outlook, and that enabled us to spend really the next year talking to them about what we're doing. We had a team here in December. That team came down for a full day. We spent the morning presenting the City's finances and having them meet some of the key departments. They met with the Revenue Commissioner, they met with Rich McKeithen to learn about what was going on with the re-valuation. They met with the prison's commissioner to learn about some of the cost savings and management changes that have been going on there. They met with the police commissioner and his team. Each one of these entities brought teams of people in. 224 They met with the mayor and his education officer and the pension folks, so they got a very rich understanding of the strength of the management of the City. Because, really, our pension funding and our fund balance are very, very weak, and so what our strategy was, was to argue that notwithstanding these extremely weak, you know, relative to other cities, relative to other cities with similar demographics to ours, we have various, you know, we have good management. And the other half of the day --
Say that again, I mean for the record, so we all hear that, comparable.
Relative to other cites with similar demographics, we have very weak pension funding and very weak fund balance.
Yes, certainly it's Rob 225 Dubow, and really -- but it's across departments, there is lots of strong managers that have to manage in, you know, extremely tight budgetary circumstances. And then we gave them an entire afternoon on the economy of the City.
I am going to pass this on. I have a number of questions that I'll defer until the next round, but, again, kudos because it meant real money to us to be upgraded and I think all of us, including this body, making grown up decisions in rough economic times managing our way through a recision says a lot. We have a long way to go. I don't kid myself to think that we're out of the woods at all, but I am impressed that the needle is moving slightly in the right direction and it's reflected in our bond rating. With that, I will recognize Councilman Green.
You mentioned that you gave the bond rating agencies a statement on the -- or spent a lot of time on the City's economy. What did you present to them?
We took them on a tour of Center City and then we took them down to the Navy yard. And in Center City the presentation was coordinated with the Commerce Department with Alan Greenberger and his staff, with PIDC, with the Center City District, and with the University City District, Matt Bergheiser. So, what we did is we put them on a bus and went around Center City. Then we went down to the -- we went along 95 down to the Navy yard, spent some time, went around the Navy yard, then went up to University City, went out there. Then we went over to a conference room at Comcast and had some businessmen speak about the business climate here and then Alan gave a power point presentation on the City's economy.
Could you please 227 provide the power point presentation and any of the written materials to the Chair?
Actually, the power point presentation is so large that we don't actually -- do we have a file copy of it? Okay. It's extremely large. We might need to give you a flash disk.
Thank you, Councilman. The Chair recognizes Councilman Goode.
A few questions for the record. Wells Fargo inherited our payroll deposits contract from Wachovia a year or two ago. When is that contract due to expire?
That contract has one 228 more renewal on it. The renewal should be before you this spring. They're one year contracts which we can renew up to four times, so we have one more renewal which we would be bringing to you this spring and we would need it to become effective July 1, I believe, July 1.
So, this time next year we will be anticipating a new contract?
We will be running an RFP process to seek competitive proposals from the City's nine depositaries to propose for the payroll contract and we are exploring adding other City deposits as well?
Okay. And when will the renewal ordinance be submitted to Council?
When will the renewal ordinance be submitted to Council? 229
We have initiated the process for that, but it's not prepared yet.
Okay. And, lastly, when will the next disparity study be released.
There is a draft of the disparity study which is under review. The first week of May.
Thank you, Councilman Goode. Can I ask a quick question? What is the difference between bidding our bonds out and then underwriting them, and is there a potential savings in bidding them versus underwriting them?
So, the difference is when we competitively bid, which is pretty rare for the City, we hire -- we have a financial advisor and our bond counsel and we just use them to structure the bonds, to pick the day of sale, and prepare all of the disclosure documents. We don't engage an underwriter. And we draft a notice of sale and we post that 230 in the financial -- in the places where the bond underwriters know where to go and look and see, it's the bond buyer, Thompson Municipal. We post it there and give folks a couple of weeks to read our disclosure language and we tell them that on a day and at a time we will receive bids, we receive them by the Internet, and that we will award based on the lowest true interest cost, which is a methodology of calculating the entire cost taking in all the costs associated with the bond issue.
So, maybe four or five years ago we were in a poor position to get bonds and things like that, but has that improved because of the rating? Can we be a little more competitive at this point?
So, I felt that the best way to start thinking and looking at doing a competitive sale would be to do something very straight forward, which is the TRAN. The TRAN was a six month, a seven month obligation, investors could really get their arms around that and we knew that the City's liquidity had improved significantly. 231 In several years past, there weren't that many investors who were willing to buy the TRAN because the City's financial circumstances were uncertain and because of that very few people were willing to buy, so it wouldn't have been possible to sell the TRAN competitively, or it would have been maybe it could have happened, but it would have been probably risky and expensive. So, it was clear that there was big improvement. We were now in November/December of Fiscal '12, so about halfway through Fiscal '12, and so that seemed that would be a good way to get started with that. So, we took the bids in over the internet.
Madam Commissioner, how much does the City currently have in fixed rate debt?
My name is Jim Lanham. I am Deputy City Treasurer. General obligation bonds, there are different categories of fixed rate debt that we have. General obligation bonds we have about $1.9 billion. The total General Fund debt, that includes the Municipal Authority, paid the 232 Redevelopment Authority, is about $3.7 billion, and all in, including the Airport, Water, Gas Works debt is about $8.7 billion I believe.
And then almost of the General Fund obligation, which is General Fund's supported obligation, the $3.5 billion of General Fund supported obligations, $100 million is General Funds, the General Fund debt, and then there is another $240 -- I believe it's $240 million of paid variable rate debt associated with the stadiums.
So, on the total amount of letters of credit that were replaced were -- the total dollar amount of the letters of credit that were replaced is not shown here, but I believe it was $960 million roughly. And what we did there was we ran competitive processes. We ran one process, which really was initiated before I got here on the stadium 233 bonds because those were expiring first, and got bids, substantially lowered the cost, and then we put a package together for all of the remaining facilities that were expiring, for PGW, for Water, and for GO, and the only one that we didn't include in this solicitation was the Airport because PGW, Water and GO were all expiring within, I think it was within three weeks of one another, so from a timing perspective it made sense to put that in one solicitation. Of course people bid each one separately because their credit ratings are different and their credit characteristics are different. So, we went, we took a team of people to New York, we invited all the banks in. We had about 50 people come to a conference room. We headlined up in New York and we did a three-hour credit presentation to the banks and I think that was important. When I was talking about investor outreach, that's the kind of thing we're trying to do and that I think also helped lower the cost.
What are the 234 minimum community reinvestment goals for each of these depositories that we deal with? Do you have any sense of that?
So, now these letter of credit banks are not the depositories, they're different. The depositories are the banks in which we --
I'm sure, I get that, but do we have a minimum expectation from the banks that we place our money in based on the community reinvestment act?
I think they have to participate in our disparity study, but I am not sure we have a minimum.
This is on the line of Councilman Goode. I bet you if he is pressing his button right as I -- there you go. Would you -- do you want to --
I will just elaborate on it. 235 The depository banks have to submit on an annual basis a statement of community investment goals. We cannot require them to have minimum goals because when Councilman Tasco introduced her (inaudible) or lending legislation, the state legislature barred us from passing that type of legislation. So, we are barred from passing any regulation that deals with their performance and basing our decisions based upon their performance and requiring certain things from them, but we are allowed to establish requirements for their authorization and that's what requires them to, one, submit annual community investment goals, and, two, submit a long-term strategic plan based upon an annual lending disparity study.
So, this legislative body can do nothing, but can the Treasurer through its discretion do anything to --
This legislative body decides who is authorized. The Treasurer decides where to put the money in.
Okay. All right. 236 I'm going to stop on that and recognize Councilman Green.
Thank you, Mr. Chairman. In your -- it's great news on the upgrade -- but in your testimony you noted that Philadelphia's bond rating is on the low end of the spectrum for big cities in America. Is there any city lower than Philadelphia?
The City of Detroit is rated -- I'm not sure exactly what their rating is now because they have been having their rating drop on a fairly regular basis, and the date I have may be old, but they are in a non-investment grade status.
So, there is one big city in America that has got a lower bond rating than us?
If you look at some of the smaller City's, there are some smaller cities that have some, you know, lower ratings than us.
What are the main factors that -- I'm sorry, you discussed that, it's the unfunded pension liability and lack of reserve fund. So, to improve our bond rating further, what would that -- what does that look like?
Well, I think the first step is to continue to make progress on building fund balance, and which is -- the City has very narrow liquidity now. We have really very, as you can imagine with a $92,000 fund balance, even when we -- if we, let's say, get to a 50 or 60 million dollar fund balance at the end of this fiscal year, that's still extraordinarily narrow liquidity for an entity of our size. It's only really a few days of operating cash for us, which is really very weak relative to our peers. Many of our peers carry between 10 and 20 percent of fund balances. So, I know often people talk about a minimum five percent. You know, I think it may be if we make some progress on the pension 238 side, and here I am talking about not just funding but also bending the cost curve in some way through modifications to the benefits, those would be two major steps. I also think getting through the actual value initiative exercise will be a major factor as well because it stabilizes the revenue, you know, a revenue source for the City.
Has that been mentioned in meetings with the rating agencies?
We have discussed all of these issues with the rating agencies, yes.
Yes. If you read the Fitch report, for example, they are concerned about the current situation, the risk exposure with the Steb as it stands now and the need to transition to a more reliable funding source and getting rid of that uncertainty.
Will any one of 239 those three things improve our rating or is there a --
I think it's -- at the end of the day what I think they're going to look to is a combination of things that stabilize the City and enable the City to have perhaps a little bit more financial flexibility then they have, the City has today. As you know, if we have even just a very small reduction in a revenue or an unanticipated expense, that creates immediate need to take action because there isn't any cushion to manage that.
I mentioned this during the Capital Budget hearings last week, but I think the question is probably better directed to you as the Treasurer. The Administration is proposing a commercial paid program for capital projects at the airport to borrow funds just in time and reduce interest costs. We noticed that in the capital borrowing we began last year with $200 million that we're borrowing and paying interest of five-plus percent on. We still 240 have $143 million at the end of this year that we're paying five percent on. What do you think the pros and cons are of using a commercial paper program approach for capital budget, you know, for our regular capital budget to build up enough of a commercial paper balance to make it worth while to go borrow, we already owe the money?
Well, it's a complicated thing to make a decision to implement a commercial paper program, I think, for the City because its credit rating is so low and, in fact, it has struggled a little bit at certain times with getting cost effective letters of credit, and you need a letter of credit to do a commercial paper program, that would be a prerequisite. We would want to feel confident that we were entering a period of stability for the City's finances where we would be able to maintain that program outstanding for some period of time. Typically programs are authorized for between three and five years, so certainly having that liquidity improved for the City 241 would be very important, and also having -- I think I would want to be in the A category from all three rating agencies, that's just a -- I mean, this is a very preliminary set of comments and I would want to go back and do more thinking about it. In terms of size of a commercial paper program, I don't think you would want to run a program less than about $100 million. There is a lot of work involved and expense of putting a program together, so I don't think you would want to run one for less than $100 million. And for the issuers who do use these programs, they typically are associated with entities that have large capital programs and fairly, you know, long-term plans that's pretty predictable. I think we seem to have -- I think we anticipated we were going to spend those capital dollars faster than we did, so in a way the value of the commercial paper would be that if we didn't, we weren't, you know, ready to spend as fast we wouldn't have incurred the debt until we're ready to spend.
Right, yeah, it 242 would be a savings of, you know, last year --
-- ten million dollars, which could be used for other things, right? Okay, thanks, I look forward to continue to talk about that with you.
On one of the professional services contracts -- oh, I'm sorry. Excuse me, Mr. Chair.
Councilman, you want to let -- you want to defer. Please proceed, Councilman Green.
One of the professional services contracts in the Treasurer's budget is for Swap Management Consultant Services. Swaps have been much in the news this year, so perhaps this would be a good time to provide an overview of what they are, why they are used, and just sort of your general take on Swaps.
Sure. So, the City has interest rate exchange contracts which are 243 called Swaps. And essentially the City agrees to exchange payments with a third-party, a Swap counter party, typically these are large financial institutions, highly rated financial institutions, typically they're banks, and so the City associates this with a bond issue and in all of our cases they're associated with floating rate bonds, which the City has issued. These bonds typically have an interest rate which resets once a week and so as the rate will change each week depending on the short-term municipal market, and the City sought in all cases to have more budgetary certainty and so agreed to make a fixed rate payment which was designed to be similar to a long-term fixed rate on a fixed rate bond issue that we're more familiar with, and to receive a floating rate which was in most cases equal to SIFMA, which is a short-term seven-day floating interest rate, municipal interest rate.
I am going to try to rephrase that to say essentially we enter into a contract where if interest rates went up we were protected against borrowing costs at a 244 higher rate, and if interest rates went down we had decided that the rate we entered into the contract at was a rate we were willing to pay for some time in the future, and so we said, hey, we like this rate, we can manage this rate, we're going to lock into this rate now, so if it had gone up we would have made money on the hedge, we would have protected ourselves against an increase in rates. When it goes down, we have paid the rate that we signed up to pay in the beginning. Is that an accurate description of how a Swap works?
I agree with that, and I would just say that there is one major distinction to draw between a fixed Swap rate contract which would go to the final maturity of the bonds, and a fixed rate in the cash or municipal market. And the difference is in the cash and municipal market typically the City would get, as would most municipal issuers, a ten-year par call. In other words, we would have an option that we would own, that we could exercise at any time after ten years to redeem those bonds at par, in other words, not to pay 245 a premium or any extra redemption costs, just redeem them in a par. And when these bonds that we refund, all of those had embedded in them at the time they were originally issued that optionality. And the City Swaps, while you could have put an option on the Swaps and you still could if you were to do Swaps, none of them had that option. Instead the City took a slightly lower fixed rate and did not include an option to terminate the Swap at par.
Okay. So, is there anything inherently evil about Swaps? Are they a good management tool? What is your general position on the tool that is a Swap that is used by municipalities, counties and states?
Yes, the Swap market is a very, very large global market. It's a very liquid market. And because it is large and global and liquid, it was very attractive to municipalities because they could get funding 246 rates that not just because of giving up their call option, but also just because of the way capital is accessed. It was a way to access the taxable market effectively, which is a global market, at lower costs. And because we were buying bond insurance, we could homogenize our credit, and instead of borrowing in what is really a more constrained municipal market, borrow in a global market. So, it was viewed as cost effective. The problem really with the Swaps were that the underlying variable rate bonds and the letters of credit and bond insurance associated with those bonds did not perform and that was a big problem. And, so, to do the Swaps and get the benefit you have to feel confident about that underlying variable rate market and the letters of credit market that you would need to have performed going forward.
Thank you, Councilman. The Chair recognizes Councilman Kenney. 247
Thank you, Mr. Chairman. The timeline or the description that you gave relative to the Swaps and their dynamic and their predictability is true in an economy that's performing, correct, an economy that has not gone through what the U.S. economy has gone through in the last three years?
Right. What I was, I suppose, trying to suggest is that you would need to be comfortable that the City could withstand another shock like we just experienced and that's --
In your opinion, what was the primary cause for the economy's collapse in that period of time?
Okay. And in your opinion did the banking policies of the institutions that we entered the Swaps, engaged into the Swaps with, did that in any way contribute to the economy's collapse, the way in which their credit practices, their 248 lending practices, their banking practices in general?
Sure. I mean, the mortgage -- the mortgage market became a very different market where large mortgages were securitized and became -- that became a funding source that then led people to borrow beyond their means and the banking industry was willing to package them up in certain ways that would sort of allow this credit to be advanced to folks who really couldn't afford, and that was really what drove -- a key factor in the bubble.
That key factor, how did it affect the dynamic of the Swap relationship between the City, the School District -- well, if you want to speak about the City only -- and those institutions that we entered into this arrangement with?
Well, it effected it in a number of different ways. One, the bond insurance companies and the letter of credit banks that were providing liquidity and credit to the variable rate bonds, many of those 249 entities were exposed to the credit bubble in various ways. So, they were exposed by owning the derivatives, by being a broker with the derivatives, and as a result, as their credit and liquidity collapsed, the market lost confidence that the securities that they were providing and liquidity to wouldn't perform.
So, it's nothing that the City did or the School District did to effect the negative position we were in relative to the Swap arrangement? We didn't, I mean, the City didn't --
No. No, the City performed under its contract as it agreed to perform when it entered into the contract.
And as if you were dealing with your physician or your lawyer or anyone else in a profession, you would expect the appropriate care and attention be made to the way in which they conduct their business, their medical profession or their law practice. 250 I mean --
Well, when we entered into the contracts, typically we entered into a contract with a subsidiary of these institutions which they typically would create which was a Swap entity.