by Ryan Bolger and Seth Brumby. Additional reporting by Alex Plough.

The municipal bond market finances American civilization. From court houses to school houses, city pipes to street lights, if it’s for the public good, a municipal bond will pay for its construction.

Despite municipal finance largely remaining a staid, conservative segment of the capital markets, the definition of public purpose – and the federal tax exemption awarded for it – has evolved over time to include everything from stadiums to retirement communities to underperforming charter schools.

It’s that evolution that has reignited criticism surrounding the Public Finance Authority (PFA) – an at-times controversial political subdivision of the State of Wisconsin used to finance higher risk projects.

In the face of a chorus of naysayers about the quality of PFA-related bonds, it is worth noting that a majority of the paper is performing. The issuer also closed out a record year in 2016 with USD 1.79bn in issuance for 2016, according to Bloomberg data.

Most recently the PFA landed in the spotlight last spring when it opened the door to the completion of a megamall – complete with an indoor ski slope, theme parks and high-end retailers – that has been under construction for more than a decade in New Jersey’s swampy Meadowlands. Canadian developer Triple Five Group bought the rights to the American Dream mall in the Borough of East Rutherford in 2012 with the goal of raising USD 1.15bn in tax-exempt bonds to finally make the complex a reality after two other developers tried and failed.

However, initial concern that the municipality could be on the hook for the retail complex’s debt in the event of a default sunk the project at the local level when the governing body declined to move forward with the necessary financing, said East Rutherford Mayor James Cassella.

American Dream Meadowlands

Construction of the American Dream

Fears expressed by Rutherford’s Borough Council, which governs the town along with the mayor, were amplified when the developers announced plans to issue tax-exempt bonds, which don’t require investors to pay federal taxes on interest income, Cassella said, adding that the type of financing was essential for the economic health of the project. To Cassella, those fears were unfounded, because the bonds have been structured as non-recourse obligations. That means creditors would not be allowed to go after East Rutherford to collect on the debt, he said. Still, a solution was needed.

“The only way you could issue [the tax-exempt bonds] is if you could get approval from the Local Finance Board and that begins with the council,” Cassella explained. “All the parties realized it would be difficult to go back to tax-exempt bonds which is what they wanted to do. I don’t think there was an appetite.”

With the deal stopped in its tracks, backers were forced to look outside of New Jersey. Triple Five ultimately punted the bonding to the government entity owning the land under the mall, leaving the New Jersey Sports and Exposition Authority with the ability to tap the PFA.

The PFA is one of no more than a dozen so-called conduits, or third-party issuers that can issue bonds to finance projects in other states. The authority, however, is uniquely lax in its filing requirements and has shown a tendency to issue bonds for projects outside its state when conduits there will not, according to four sources involved in the municipal market.

“Part of what holds the muni market together is states ultimately shepherding their issuers into the straight and narrow,” said Matt Fabian, a partner at Municipal Market Analytics. “How each state effectively provides capital market access to its entities is a process that is a culmination of years of policy and precedent.”

While the PFA once only raised the ire of those who accuse the organization of being too willing to issue deals deemed too risky by local regulators, some prospective investors have also begun to approach PFA-sponsored deals with caution, the sources said.

High yield municipal bond funds make up the core of the PFA investor base. Click here for a list of mutual funds invested in PFA bonds.

“There’s an investor perception issue that if you have to go outside of your state for the conduit there’s a problem with your credit,” said a banker who sells the PFA’s bonds to investors. “If a deal is being issued by the PFA then investors want to know why.”

Still, PFA program manager Mike LaPierre said in an emailed statement that standards for issuance via PFA are no less stringent than those of the Colorado Health Facilities Authority or the Industry Development Authority of Pima, both of which also finance projects across state borders.

For its part, the PFA has issued 455 bonds totaling USD 3.94bn in principal tied to 108 projects in public offerings since its first deal in 2010, Bloomberg data shows. The American Dream mall project is the largest deal of the bunch, with most of the conduit’s projects brought by nonprofit and private-sector borrowers to finance multi-family residential real estate projects, assisted living homes, student housing facilities and charter schools.

Click here for a listing of outstanding PFA bonds and summaries of the projects financed by them.

Deciding which groups could use tax-exempt bonds to finance their projects used to be solely up to the state governments where the projects were located. As it went, state governments created their own conduit issuers, set the rules for them, and did not have to worry about borrowers finding a conduit to use in another state. That all changed when the PFA started issuing bonds in 2010, Fabian said.

“Often, if an issuer doesn’t have access to the markets themselves because they are too small or not well-known enough, or for whatever reason, they will go through a state-level conduit, or a local conduit, but it is regulated by state law,” Fabian said. “There may be conditions, like credit conditions, like a loan-to-value ratio or some kind of paperwork or documentation or disclosures that have to be made to get access to that conduit [within the state], so the PFA can provide an alternate entry into the market for [borrowers] who find the state’s conditions onerous or perhaps want to pay a lower fee versus a local conduit.”

The PFA also helps borrowers work around state policies on tax-free bonds, said a lawyer who works on PFA deals. Developers go to the PFA when they cannot get the financing they want in their own states, the lawyer said.


PFA project locations by state, weighted by number of project facilities (e.g. charter schools, nursing homes, apartment complexes, etc.) Green = 1 to 5, Yellow = 5 to 10, Orange = 10 to 30, Red = 30+. Source: Bloomberg

Outside State Lines

PFA-issued bonds have performed well so far, although some of the underlying projects have been engulfed by more than their fair share of controversy.

When Vertex LLC, a charter school leasing company, in June 2015 wanted to build two charter school facilities in North Carolina, it avoided using the North Carolina Capital Facilities Finance Agency, the in-state conduit for charter school bond sales, to issue the debt. Vertex instead sold bonds through the PFA to finance both facilities, one of which was leased to the underperforming Thunderbird Preparatory Academy.

Fast-forward less than a year after the Thunderbird bonds were issued and the school nearly lost its charter. The North Carolina Charter School Advisory Board voted unanimously in June to recommend closing the school following complaints of mold, a rat infestation and concerns over its ability to service its debt, according to reports by The Charlotte Observer. But the Board ultimately backed off of its decision in favor of demanding more intense scrutiny.

Vertex financed two other charter school projects through the PFA, offering investors bonds with yields as high as 12%. A yield that high, “is a warning flag as far as credit quality,” Fabian said. “There’s an implication of risk there.”

Elsewhere in education, the University of Kansas offers one of the clearest examples of borrowers circumventing state conduits. The university issued USD 327m in bonds in the summer of 2016 through the PFA instead of the Kansas Development Finance Authority when the KDFA determined the school could not legally issue the bonds without approval to build a new research facility from the state’s legislature. The university instead found a friend in the PFA to issue the bonds before the legislature had the chance to weigh in.

“I do not believe it occurred to the legislature that a [Kansas Board of] Regents institution could finance a research facility without legislative approval by going to a finance authority other than the KDFA,” said KDFA general counsel Rebecca Floyd.

Perhaps ironically, Wisconsin has found itself in a similar situation. Its legislature overwhelmingly supported the PFA’s creation – voting unanimously in favor of the bill that defined its powers – but the state government has no oversight over the PFA’s ongoing business.

In fact, the state had no role in financing a controversial luxury hotel project in Madison, Wisconsin that took advantage of federal disaster relief funding to issue USD 66m bonds through the PFA in 2012. That deal, brought by the developer of the Edgewater Hotel, headed to the authority after it appeared the city would not approve the facility under its tax incremental financing program, according to a Wisconsin public official.

The project’s developer, Robert Dunn, was criticized in a Wisconsin arbitration ruling for hiring his own company to manage the Edgewater facility, construction of which was delayed after the filing of sixteen separate liens against the hotel, as reported by the Wisconsin State Journal.

“The Public Finance Authority was authorized in Wisconsin statutes, however the state does not have any representation on the PFA board, does not review any of their financings, and there is no direct or indirect security from the State of Wisconsin,” David Erdman, capital finance director for the state, said in a written statement to Debtwire. “There is no administrative or financial connection between the state’s various borrowing credits and the financings completed through the PFA.”

“The State of Wisconsin’s Capital Finance Office is diligent in protecting the state’s bond rating and seeks to limit any confusion in the marketplace by distinguishing between our offerings and those of any unaffiliated authority in Wisconsin,” Erdman wrote.

PFA program manager LaPierre, however, said the ability to pass legislation means the State of Wisconsin has some control. “The PFA’s enabling legislation is quite specific in terms of how PFA is authorized to operate and the controls to which it is subject,” LaPierre wrote.

In 2010, two national advocacy groups called the National Association of Counties (NACo) and the National League of Cities (NLC) partnered with their local divisions in Wisconsin to create the PFA as an independent entity. The bill authorizing the PFA was passed with unanimous support in both houses of the Wisconsin state legislature – a vote of 98-0 – after a “lobbying blitz” from both groups, said a source familiar with the effort.

The authority’s backers likely chose Wisconsin because the state already had a legal framework in place for creating intergovernmental organizations consisting of different municipal types, Erdman said.

California was actually the first state considered for creation of a new issuing authority but elected representatives seemed unlikely at the time to vote for the legislation following the creation of a similar entity almost thirty years earlier in 1988, according to a second lawyer who has worked on PFA bond deals.


PFA bond issuance by year

‘Pushing the envelope’

Looking ahead to the future for conduits, a rule proposed in February 2016 by the Treasury Department and the Internal Revenue Service could impact the ability to issue tax-exempt debt as easily.

The rule sought to reign in the excessive use of tax-exempt bond financing for private projects by redefining the “political subdivision” status granted to the likes of the PFA. The proposal received more than 100 comments, mostly against implementation.

As envisioned, the plan outlines a three-pronged test for determining whether government authorities can issue tax-exempt bonds. The first test is whether an organization has the right to exercise a substantial amount of sovereign power in the form of eminent domain, taxation or policing. Political subdivisions would also have to serve a governmental purpose, and finally, be controlled by a state or local government. The governmental purpose component also requires that the organization “operate in a manner that provides a significant public benefit with no more than incidental benefit to private persons.”

The PFA plan to finance the American Dream mall is a good example of how governments use political subdivisions to stretch the limits of the US tax code, according to Marc Pfeiffer, a Rutgers University professor and a former NJ government oversight official.

“We’re probably pushing the envelope too far in how we’re supporting the tax exemption for private sector bonds, and [the American Dream mall] is probably an example of the most extreme case of using the IRS tax code for something it wasn’t really meant to do,” Pfeiffer said.

Not all are in agreement with the attempt to clamp down on the practice at hand.

The proposed rule places the entire universe of government authorities at risk of not falling within the definition of political subdivision when there have only been a few bad actors who have abused the use of tax-exempt bond sales, said Emily Brock, a director at the Government Finance Officers Association (GFOA), a lobbying group that represents public finance officials. The GFOA filed a joint comment letter against the rule along with the NLC, NACo and six other groups.

“The [legal] authority comes from the state to establish the [municipal] authority and its ability to provide public services is defined by the state,” Brock said. “We were just kind of baffled why the federal government needed to impose another layer of rules on that or restrictions on that when in fact the authority would come from the state.”

“We’re willing to work with the Treasury to help them specifically to address those nefarious activities if indeed that is something they would like to do with this rule,” Brock concluded.

Whether the PFA would fall within the new proposed federal definition of political subdivision is unclear. Brock said she thought it would qualify, but Pfeiffer of Rutgers said the PFA’s tendency to finance projects in other states could undercut its qualification.

LaPierre claims the PFA would not have any problem meeting the public benefit component of the rule. As evidence he points to a report the PFA commissioned from consulting firm Chamness Group. According to the report, the PFA has created 23,628.03 jobs by funding 101 new construction projects since its creation in 2010.

Familiar faces

The PFA was modeled after a similar conduit in California called the California Statewide Communities Development Authority (CSCDA) and contracted with the same municipal advisor to carry out its operations and administration, according to reports from California’s state auditor, the Public Finance Authority’s website, business registrations and SEC filings.

Both conduits were run at inception by HB Capital Resources. However the firm, co-headed by principals Steve Hamill and Jerry Burke, was eventually replaced as CSCDA’s advisor following an August 2012 California state audit that criticized how the authority was paying the issuer.

The audit found that the practice of paying HB Capital a percentage of fees associated with the amount of bonds it issued created a financial incentive for the advisor to recommend the approval of those bonds. It also criticized the CSCDA for not periodically bidding out the role of municipal advisor.

For its part, the PFA eventually replaced HB Capital with a company called GPM Municipal Advisors. GPM is also controlled by Hamill and Burke, SEC filings show. Further, the advisors report the same address, in Walnut Creek, California, according to Wisconsin and California business registrations.

While HB Capital no longer advises the CSCDA, Bridge Strategic Partners – a company co-founded by Hamill’s nephew, James Hamill – does, according to the CSCDA’s website and SEC filings.

“The results of the audit were favorable to CSCDA and did not stipulate any change in program manager,” LaPierre wrote. “It is our understanding that [Bridge Strategic Partners’] selection to advise the California Statewide [Communities] Development Authority came about through a competitive bidding process.”

Catherine Bando, executive director at the CSCDA, declined to comment.

Regarding the PFA’s advisors in California, they offer the market an issuer “known for willingness to underwrite anything,” one restructuring lawyer said. “If you need to issue, they will charge you for it, but they will do your deal,” the lawyer said.

Editor’s Note: Debtwire Investigations is an editorial initiative brought to you by a hand-picked group of some of our best and brightest investigative journalists. A rotating team of five beat reporters has taken countless hours away from its already expert coverage to go far beyond specific credits and market segments to focus on long-form pieces, deep data dives and impactful investigative analysis.

Background image credit: Paul Frederickson