The New York State comptroller's office will probably speak out against a sale and leaseback transaction in Troy, N.Y., but it will not have anything to say about the deal's legality, sources close to the comptroller's office say.
The deal, which closed April 1, featured the sale of $35 million of lease revenue bonds by the City of Troy Industrial Development Authority. Investment bankers sold the deal as an unrated private placement with maturities ranging from four years to 30 years.
One point that has drawn the comptroller's attention is that city officials plan to use proceeds from the deal to close a $4 million gap projected in the city's fiscal 1992 budget. New York law requires state legislative approval before municipalities can do deficit bonding.
But because the Troy deal would be a lease transaction done through a conduit financing, it could escape the need for that approval and the oversight that comes with it: state review of the municipality's financial condition for the duration of the bond's maturity, including verification of the municipality's budget deficit and scrutiny of its budget each quarter.
Troy officials say they deliberately avoided the need to seek approval because they could not risk seeing the Legislature block the bonding and doom their financial recovery plan.
Sources with knowledge of the inquiry by the comptroller's office say the department's Division of Municipal Affairs will issue an official opinion or some kind of policy statement on the deal in an attempt to discourage other municipalities from using the lease bond proceeds to close budget gaps.
The comptroller's office declined to comment on the inquiry or the response the office is preparing.
At the moment, the division is stockpiling documents concerning the Troy bond deal, a source close to the inquiry said. The source described the division's efforts as in its "early fact-gathering stage."
The source said the issuance of an opinion or policy statement could be "months away." The comptroller's statement, when it is issued, "will point out the deficiencies in the deal," said the source.
Comptroller Authority
Over Legal Matter Is Limited
Besides the use of bond proceeds for deficit-reduction purposes, the comptroller's office is investigating if an industrial development authority has the legal authority to address budget problems of a municipality. But this policy response will not explicitly state that the deal as completed illegally, sources said. The comptroller's office "will let someone else conclude its legality," the source said.
The office will "document what they [in Troy] did, and if what they did was in accordance to the authority they had in doing it," a source close to the inquiry said.
As part of its duty as chief auditor in the state, the comptroller's office can provide opinions on financial matters. But the office cannot determine if a municipality broke the law, said Kenneth W. Bond, a partner at Sullivan, Donovan, Bond & Bonner.
Although the inquiry is far from complete, officials in the municipal affairs division have already discouraged other municipal officials from using the sale and leaseback techniques to help address budget shortfalls. The comptroller's office doesn't "want to encourage anyone to do this type of deal," the source aid.
The Comptroller's office is worried by the number of municipalities trying to do deficit bonding as a stiff regional recession drags on.
This year, for example, 10 municipalities are seeking such approval, a level Comptroller Edward V. Regan termed "unprecedented" in a public letter arguing for greater state oversight of troubled localities.
One of the major issues in the Troy case is the comptroller's interpretation of section 109-B of the state's general municipal law. This section, which was added in July 1991, gave municipalities for the first time the ability to finance capital improvement projects on a lease-purchase basis using lease revenue securities or certificates of participation.
The amendment, however, did not specifically allow municipalities to issue these forms of debt to cover budget deficits. Instead, the law stipulates that these financings must be used for "capital improvements," which include the "acquisition, erection, construction" of property.
Without this specific instruction, many lawyers who deal with state municipal finance consider the Troy deal illegal, or at the least, irresponsible.
The legal concept, known as Dillon's Rule, named after the legal scholar John F. Dillon, holds that municipal corporations only have those powers that are "expressly conferred by the constitution, statutes, or charter" or "fairly implied in, or incident to, the powers expressly granted."
Officials in Troy as well as their bond counsel, Joel H. Moser, partner in the law firm of Moser & Moser, have steadfastly defended the legality of the deal, as well as their motives for selling lease revenue bonds instead of more traditional forms of bonding.
Mr. Moser structured the deal for the city and has acted as Troy's adviser in its dealings with the comptroller's office and the municipal bond community.
The deal, Mr. Moser said, was structured after city officials determined they would need a combination of capital improvements and budget relief due to a sharp reduction in state aid and the devastating effect the recession has had on state municipalities like Troy.
The deal involved the simultaneous selling of property from the city to a previously established local development corporation, and then to the Troy Industrial Development Authority, which sold the bonds to pay for the transaction.
Officials in the comptroller's office have said that Troy could have issued general obligation bonds, instead of lease revenue bonds, at lower costs. General obligation bonds are usually sold at a lower interest rate. The Bond Buyer 20-Bond Index for the week the Troy deal was sold was calculated at 6.73%.
The 30-year portion of the Troy deal sold at an interest rate of 8% on its closing date.
Despite the high interest costs, Troy officials say the deal is part of an overall financial recovery plan, which includes a property tax increase and budget cuts in reaction to a sharp reduction in state aid payments.
Mr. Moser said a $10.5 million portion of the sale would be dedicated to needs other than the improvements of city facilities, including what is now projected as $2.8 million that is needed to plug the city's budget deficit and $3.7 million to roll over existing debt. The balance will be used to pay down the $35 million issue.
State's Doubts
Are Not Shared by All
Troy officials and Mr. Moser said the city will use the lion's share of the development authority's 30-year term bond sale - $24.6 million - to make improvements to the police and fire stations, a garage, and other city facilities. The deal. Mr. Moser said, will take care of all the city's capital projects for two years.
At the moment, Moody's Investors Service is reviewing how the industrial development authority transaction and the city's overall financial plan will affect its general obligation bond of Baal, said Michael L. Johnston, a vice president and a manager of Mid-Atlantic ratings at the firm. The city is not rated by either Fitch Investors Service or Standard & Poor's Corp.
Despite the comptroller's opposition to the deficit financing portion of the plan, Mr. Johnston said the rating agency views that aspect as "not fundamentally different" from a credit standpoint than other municipalities that have requested state legislation to issue deficit bonds.
Mr. Moser, in recent telephone interview, also brushed aside complaints that the deal does not rely on legal precedent and the state's municipal finance statutes. "The whole legal argument is a paper tiger," he said.
Mr. Moser said an industrial development authority has the "expressed authority to issue bonds." And as far as the city is concerned, "it can use the money for any city purposes," Mr. Moser said, adding that the deal is no different than the state of New York issuing bonds through the Local Government Assistance Corp.
Although the corporation, known as LGAC, was designed to reduce and eventually eliminate the state's spring borrowing for municipalities, the state, like Troy, also uses some of the proceeds for working capital needs, Mr. Moser said.
Despite Mr. Moser's defense, denunciations from the comptroller's office and many bond counsel have had a chilling effect on other potential leaseback deals in New York designed to address budget problems.
For example, sources say word from the comptroller's office prevented Suffolk County from continuing with a planned sale and leaseback of the H. Lee Dennison County office building to help close the county's $46 million 1992 fiscal year budget gap. The sale and leaseback proposal would have generated $25 million the county planned to use for improvements to the building and to help address its budget problems.
Cynthia Munk, a spokeswoman for Comptroller Regan, confirmed that department officials had spoken with Suffolk County officials about the portion of the municipal law that pertains to sale and leaseback financing, but refused to elaborate. Charles K. Stein, deputy Suffolk County executive for finance, would neither confirm nor deny that conversations with the comptroller's officer persuaded the county to drop the Dennison sale and leaseback plan.
In Monroe County, officials considered the sale and leaseback of a county office building to help plug a $42 million budget gap for the 1990 to 1992 fiscal years.
Gerald J. Mecca, Monroe's director of finance, said the county had contemplated the deal, but drafted no formal plans. Although aware of the comptroller's opposition to such a move, Monroe County resisted the deal largely because it was "a one-shot of cash" the county did not see as addressing its structural budget problems, he added.
With interest in sale leaseback transactions growing as New York municipalities struggle to balance their budgets during a stiff economic downturn, many municipal market professionals are hoping the comptroller's office soon codifies its position on these deals.
Ms. Munk said the comptroller's office will soon issue new regulations on certificates of participation, securities issued as a result of the sale and leaseback of property. She said these regulations would not refer to the Troy transaction.
For Ronald H. Fielding, president of the Rochester Funds, a municipal bond mutual fund company, these regulations as well as the comptroller's response to the Troy deal could not come any sooner.
Mr. Fielding, one of a handful of investors who purchased the Troy lease revenue bond deal, said the comptroller's office has created uncertainty in the municipal market by not immediately publishing an official ruling on the deal.
"I would strongly prefer that the comptroller codify what's legitimate and what's not," Mr. Fielding said. "No one wants a gray area."
