The failure of Platte County, Missouri to appropriate funds to pay debt service on the Zona Rosa Retail Project raised questions as to the enforceability of the security pledge of appropriation bonds in general in the municipal bond market.
Municipal borrowers’ issue annual appropriation-secured debt to fund various projects for numerous reasons. The central reason is that annual appropriation debt is not general obligation debt. It doesn’t count against the general obligation debt caps, constitutional, or statutory limits most municipalities have. Not being directly secured by property taxes, there is no immediate economic consequence to residents.
Equally, there may be other revenues pledged to pay debt service. In Platte County, it was expected the sales taxes from the Zona Rosa shopping area would cover debt service. The appropriation was viewed as a back-stop security.
Paying The Price For Not Paying
Platte County’s failure to pay got the immediate attention of the municipal bond market’s standard setters, the bond rating agencies Moody’s and Standard & Poor’s. They were swift to act. Moody’s dropped Platte County’s general obligation bond rating to Ba3, Standard & Poor’s went further, lowering it to B-. No matter that the bonds were issued by a separate entity of the county (bonds were issued through its Industrial Development District in 2007). The downgrades on the general obligation of the county by the rating agencies pointed directly at willingness to pay—or in this case, unwillingness. It is a clear and unambiguous message that payments secured by annual appropriations are not optional. Treating them as such has serious consequences.
The swift and encompassing rating agency actions play another role other than enforcer. Putting the town’s entire credit rating at risk (and therefor its access to the capital markets) is a big red flashing beacon to be prudent and cautious before pledging public revenues to private projects. If an economic development project is anticipated to be that successful, the margins should attract private investment capital. It shouldn’t need the tax-exempt funding subsidy.
But Wait, There’s More.
This is not the first appropriation-secured bond issue to run into the failure-to-appropriate issue. For example, Lombard, Illinois failed to fund an appropriation for debt issued through its Public Facilities Corporation for a hotel and conference center. In that case as well, the rating agencies were swift to act. Moody’s withdrew its rating; Standard & Poor’s dropped Lombard’s rating down to a speculative grade B.
But wait. There’s more. Moberly, Missouri failed to pay on appropriation bonds for an economic development project. The sugar-substitute manufacturing plant never was completed and the city did not fulfill what was viewed as its obligation to pay. Standard & Poor’s dropped the city’s general obligation bond rating to below-investment-grade BB-. Although the matter was resolved a few years ago, it wasn’t until 2018 that the rating was upgraded to BBB.
Essential Public Purpose vs. Economic Development
Observing these events, one might conclude that since these projects were not for the traditional essential-public purposes that municipal bonds generally fund, such as schools, hospitals, or infrastructure, they were inherently less secure than appropriation-secured bonds issued for essential government services.
It is true municipal bond investors do look to that essentiality of municipal purpose as a critical stabilizing credit and security influence. This stems from the fact that municipal bonds generally fund projects designed to have long life-spans because the borrowers also tend to be long-term. Towns, cities, counties, or states don’t just roll up the sidewalks or get sold off for parts in the event of financial problems. Problems are usually temporary, get resolved, and the government entity continues on. It has to. The residents still need the services.
(For a more detailed examination of funding public services during a municipal bankruptcy, please read “What ‘Adult Entertainment,’ Puerto Rico and Chapter 9 Bankruptcy Have In Common” Forbes.com 9/6/2018)
However, bonds for economic development projects don’t fall under the essentiality umbrella. Initially municipalities may enthusiastically embrace issuing bonds seen as creating jobs in their community. But if the project stumbles, the municipality is often less enthusiastic about spending public dollars to support a failing private enterprise.
Investors taking comfort that the rating agencies will act swiftly to enforce the standard must balance that view with the consequences of what happens in the interim. The bondholder gets subjected to a below-investment grade bond, a decline in valuation, and likely loss of liquidity—to say nothing of potentially losing interest payments (and likely principal as well) for an indeterminate period of time. No fun there.