A near default by Brevard County, Fla., jolted municipal bond insurers in October, triggering a close examination of lease exposure and a rehashing of underwriting criteria.
Brevard County came close to backing out of its $24 million lease obligation when commissioners almost approved a referendum giving voters the option, effectively, of defaulting on the bonds. Although only Municipal Bond Investors Assurance Corp. stood to lose, the entire marketplace closed ranks and decried the referendum proposals as "irresponsible."
Leases are a protifable market sector for bond insurers, carrying better premium rates than most other bonds. And the industry is on track to insure $5.5 billion of new-issue leases and certificates of participation in 1991, a 46% increase over the $3.75 billion insured in 1990, according to Securities Data Co./Bond Buyer.
The enormous leap in insured volume is mostly a function of leases fast becoming the financing of choice for states whose property tax collections are crimped by voter-initiated state laws. California currently uses lease financings due to such a law, and Massachusetts is expected to step up lease issuance for similar reasons, according to market participants.
The situation in Brevard County did not threaten the market sector, but it did trigger a soul-searching. "Leases have always been a very highly scrutinized area," said Neil G. Budnick, senior vice president of research at MBIA. "The market had a heightened awareness of lease risks, and it's only heightened further still since Brevard."
Other issurance companies also kept a closed watch as MBIA attempted to sway the vote against a referendum. "Any one of us would have insured that deal," said Christopher H. Richman, managing director of public finance at Financial Guaranty Insurance Co. "It certainly makes you nervous."
The episode was like a three-alarm fire at MBIA. Surveillance officers departed for Florida, and a steady stream of phone calls were poured onto Brevard politicians, businessmen, and media leaders. The gist of MBIA's message: Approve this referendum, trigger a default, and you'll never borrow again.
The wider marketplace also sat up and took notice. Rating agency officials issued a series of reports warning of "shock waves" throughout the municipal community, and Moody's Investors Service threatened a negative review of Brevard's general obligation rating. A national analysts' group said, "To void this commitment ... would be a strong signal to the bond market that Brevard County obligations are unreliable."
MBIA quickly discovered that a few politicians considered the lease-financed office building a sore jurisdictional point. County Commissioners Truman Scarborough, Karen Andreass, and Sue Schmitt were displeased with the relocation. Certain county employees, facing a 30-mile drive to work instead of a few blocks, joined the cause.
Sources emphasized that there was no popular discontent with the building itself. The three commissioners "generated" voter unease, but local press reports indicated more confusion than animosity. It took only three people to put the bonds on the brink.
MBIA, which assumed the Brevard County exposure as part of the Bond Investors Guaranty portfolio purchased in late 1989, found itself at the tip of an informational iceberg. The company needed to learn exactly what was going on, and it needed to educate the entire county about what was at stake.
"You don't want to overreact to the situation," said Richard L. Weill, general counsel at MBIA. "You have to educate yourself, to understand how emotional an issue this is."
Unlike most problematic municipal deals, Brevard County was not experiencing any cash shortages or indenture-related confusion, Mr. Weill explained. Two issues were at hand: The location and the quality of the new building.
MBIA could only affect the latter issue since the building was nearly complete. "We made sure the [quality] objections being raisedd were addressed," Mr. Weill said, "and it turned out that all that was wrong were a bunch of littled things."
Specific actions included consulting on the selection of a committee investigating the workmanship and following through with local officials, he said. In the end, MBIA convinced Ms. Schmitt to vote against the referendum, and she became the swing vote in the three-to-two decision.
"If the market hadn't explained the consequences of her act, she would have voted to have a referendum," Mr. Weill said. "We didn't do anything special. All we kept doing was explain what the ramifications of the act were."
MBIA is the largest insurer of lease bonds. In 1990, the firm backed $1.71 billion of tax-exempt lease issues for a 46% share of the insured lease market, which totaled $3.75 billion. So far in 1991, MBIA is still the leader with a 37% share, or $1.91 billion of the $5.17 billion insured, according to Securities Data Co./Bond Buyer.
AMBAC Indemnity Corp. was the second-busiest lease insurer in the past two years, backing 35% in 1990 and 28% in 1991, or $1.32 billion and $1.47 billion respectively. Financial Guaranty Insurance Co. was less active, insuring 11% in 1990 and 24% so far this year. Other insurers backed 6% or less of the market.
Bond insurance executives said that, after penetrating the political issues, the Brevard County deal boiled down to the predominant issue with all lease -- the "essentiality" of the project being financed. Although in this instance the building was clearly in need, its site perhaps was not.
"There's always appropriation risk in these leases, and there's always political risk in every municipal credit," Mr. Budnick of MBIA said. "But the essentiality should offset political considerations. Once you get into dicier projects, that leaves the door open for people to fight them."
Mr. Budnick said Brevard was a necessary lesson with a silver lining. If the marketplace, public officials, and voters now better understand both the risks and the stakes of lease obligations, it will be easier to handle similar circumstances the next time around, he said.
"I'd like to pick a less bumpy road," Mr. Budnick said. "But this is how you do it. And I anticipate there will be more local politicians who question leases."
Mr. Richman of FGIC said the Brevard deal brought a mixed package to the market. "There's good news and bad news here," he said. "The bad news was that it got as far as it did. The good news was the market reaction; the media reports and experts' involvement had the desired impact.
"We know now that substantial issuers are not ultimately going to screw up their market access," he added. "That was proven out in Brevard County."
All sources agreed that lease volume will continue increasing as voters become less willing to approve everything from schools to prisons. Gayle Robinson, senior vice president at AMBAC Indemnity Corp., said that as the market grows, insurers cannot relax their guard.
"We walk carefully among" the California leases, for example, Ms. Robinson said. "We do earthquake testing, essentially testing, rental interruption testing.
"We would not want to do a golf course," she continued, "because if the budget gets tight and it comes to keeping the schools open, the golf course will suffer."
And Ms. Robinson stressed that,d in the end, leases are different animals. "Fundamentally, the legal construction is different," she said. "Whenever you allow a will or a will-not appropriate option, it's more risky than putting a line item in a budget."
