I had the opportunity to go down to UTOPIA’s office today to get updated on what’s going on down there. I walked away with a much better feel of what’s going on and a better understanding of what has caused the situation with the bonds. They also comitted to do a better job of keeping me up to speed on what’s happening. Here’s the lowdown on why the bonds are being called.
The bond situation they are in is complex, ugly, and not at all their fault. UTOPIA was required by the financing bank to use variable rate bonds instead of fixed rate bonds. Variable rate bonds obviously create a lot of issues with financial planning since you can end up with drastic and sudden rate changes. As a hedge against this, UTOPIA opted to create sort of a hedge against this volatility using a second type of bond. (If I screw up this explanation, someone send Kirt Sudweeks in to fix my explanation.)
The gist of it is that UTOPIA makes payments on a bond at a fixed 5.65% in exchange for receiving revenues on a type of variable-rate bond that has, historically, been withing 14 basis points (0.14%) of the type of bond they are using for financing. Because the bonds paid to them have historically been about the same as the bonds they are paying, it should, in theory, ensure that they pay no more than 5.65% on the outstanding debt.
The problem, though, is that the short-term bond market has gone completely haywire in a way without precedent. Instead of these two bonds being very close to each other in interest rate, they have instead created a delta as big as 6%. UTOPIA’s capitalized interest for making bond payments was burned very quickly as a result and the bond rates still haven’t normalized again. Another complication is that the bank that underwrote UTOPIA’s bonds had its rating downgraded and the interest rate was driven even higher.
While I couldn’t get confirmation as to what the total shortfall will be and what it would have been had bond rates not flipped out, I’m confident that this is a temporary situation. I can’t really discuss specifics, but suffice to say that after being let in as to what they are doing and what’s being worked on, they are on an upward trend that should resolve itself in a few years and they will only need to call a very small portion of the pledges. As it stands right now, they gave the cities a year’s advance notice of their intent to call and will draw from monies that have already been set aside. In effect, pledging cities have up to two years of breathing room before new money must be made available and it will be nowhere remotely close to the full pledge amount. Another positive effect is that when they go cash-positive, they can bond against subscriber revenue instead of the cities’ tax pledges, thus absolving the cities of any liability.
So here’s the take-away in a nutshell:
- Nobody saw what was coming in the bond market because it had never happened before.
- UTOPIA is covering operating expenses and a significant amount of the bond and will only need a fraction of the pledges for a limited period of time.
- There’s a strong upward trend in revenues that will bring UTOPIA cash-positive within a few years and remove substantive risk from the cities when the bond is no longer secured with sales tax pledges.
What this proves is that the “free lunch” financing model requiring little-to-no upfront capital is not tenable and will not result in ubiquitous coverage. It also proves that the artificial financing limits in place by the legislature are causing a lot more harm than good. So yes, there is short-term pain, but there is light at the end of the tunnel.