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F I S C A L I M P A C T R E P O R T

SPONSOR Herrera

ORIGINAL DATE

LAST UPDATED

2/15/07

HB 1190

SHORT TITLE

Economic Development and Loan Guarantees

SB

ANALYST Francis

REVENUE (dollars in thousands)

Estimated Revenue

Recurring

or Non-Rec

Fund

Affected

FY07

FY08

FY09

(0.1)

Recurring General Fund

(0.1)

Recurring Severance Tax

Permanent Fund

* See Narrative for possible fiscal impacts

(Parenthesis ( ) Indicate Revenue Decreases)

Duplicates SB1130.

SOURCES OF INFORMATION

LFC Files

Responses Received From

NM Finance Authority

State Investment Council (SIC)

Economic Development Department (EDD)

SUMMARY

Synopsis of Bill

House Bill 1190 amends the Statewide Economic Development Finance Act (SWEDFA) to

allow the New Mexico Finance Administration (NMFA) to issue bonds to guarantee project

revenue bonds issued for economic development. These loan guarantee bonds can only be sold

to the State Investment Council (SIC), which will purchase them as part of their severance tax

permanent fund investments. The maximum amount of outstanding bonds is capped at $100

million.

The economic development revolving fund bonds (“EDRF bonds") would need to be authorized

by law and approved by the state Board of Finance (BOF) as well as reviewed by the Legislative

Finance Committee and the NMFA Oversight Committee. The duration of the bonds will be the

same as the project revenue bond they are guaranteeing.

House Bill 1190 – Page

2

The EDRF bonds will be paid off from an account within the Economic Development Revolving

Fund (EDRF) that consists of payments on the underlying project revenue bonds that come from

the project or other sources and a distribution from net gross receipt tax collections. If the

project payments are insufficient to cover the EDRF bond payments owed to EDRF bond holders

(i.e. SIC) than a distribution from net gross receipts taxes (GRT) will be made to the EDRF. The

GRT distributions will be made along with any other distributions required for debt service

payments and prior to any other distributions.

NMFA has provided a flow chart of how the EDRF bonds would work:

Interest only pa yments for life of

guarante e: State GRT pa ys

differential between interest earned

on bond proceeds and interest due on

bonds

SIC (purchased as severance tax

permanent fund investment)

Bond Proceeds deposited into

Economic Development Revolving

Fund in a segregated account for

benefit of New Mexico Tilapia

bondholders in the event of default

NMFA – (Statewide Economic

Development Finance Act)

Unknown Bond Purchasers

Interest only pa yments for life of

guarante e: State GRT pa ys

differential between interest earned

on bond proceeds and interest due on

bonds

SIC (purchased as severance tax

permanent fund investment)

Bond Proceeds deposited into

Economic Development Revolving

Fund in a segregated account for

benefit of New Mexico Tilapia

bondholders in the event of default

NMFA – (Statewide Economic

Development Finance Act)

Unknown Bond Purchasers

Source: NMFA

A temporary provision of HB 1190 allows NMFA to immediately guarantee a loan for tilapia

aquaculture and hydroponic vegetable production project developed by the NM Tilapia

Corporation. The bond for this project cannot exceed $30 million.

EDD:

This project is an expansion of a New Mexico based company that will be a full scale

tilapia food processing facility. The proceeds would be used for buildings, land and

infrastructure for the tilapia processing facility. The project would still have to approved

by the NMFA board under the SWEDFA act. NMFA would provide the due diligence to

the NMFA board and the economic development department would provide the cost-

benefit analysis and determine the economic development benefits as required under

SWEDFA.

There is an emergency clause so this legislation will take effect upon signing by the Governor.

House Bill 1190 – Page

3

FISCAL IMPLICATIONS

The fiscal impact on the general fund, where gross receipts tax revenue flows, cannot be

determined as the calculation relies on (1) the interest rate of project loans guaranteed, (2) the

duration of the project loans and (3) the level of defaults. If, for example, all of the bonds were

10 year maturity issued at 5 percent and they all defaulted, the fiscal impact would be

approximately $12 million.

There are also implications for SIC’s investment return. These investments are likely to be at

rates at or below fair market rates and so the impact will be the differential between the average

rate of return earned on SIC investments and this lower rate. If the economic development

revolving loan bonds paid 4.5 percent that would be 400 basis points below the long term

average for SIC. The investment of $100 million would cost SIC $4 million per annum by not

being able to invest that amount in other asset classes.

SIC:

The bill caps the amount allowable to be invested under this amendment at $100 million

dollars out of the STPF, which as of 12/31/06 was $4,383,867,930. $100MM is

approximately 2.3% of that STPF balance. As a “differential rate" investment, though

not specified by the legislation, it is assumed that the interest rate earned on such bonds

would be far below a “market rate" investment. Current rates on US Treasury notes are

about 5%. For the calendar year ending 12/31/06 the STPF earned 13.3% overall, 40

basis points (or 0.4%) above its benchmark. It is assumed these investments would return

less than T-bills, and considerably less than the STPF historical investment-return

average of 8.5%.

SIC reports that this would be considered a “differential rate" investment or an “economically

targeted investment" which means that the primary goal of these investments is not necessarily

highest return. These investments have an economic development component. Currently, they

have allocation targets of 5 percent for film, 6 percent for NM private equity and 0.75 percent for

the Small Business Investment Corporation (there is legislation pending to increase all of these

targets). Adding $100 million to this allocation will increase the overall target allocation to

almost 15 percent. Any changes in allocation will come from other asset classes that may yield

higher returns.

SIGNIFICANT ISSUES

The mechanism proposed here is highly irregular. The distribution of GRT would be unknown

each month. There is no indication as to whether these distributions would be monthly,

semiannually or annually which makes a difference in the processing of tax revenues.

Presumably the use of GRT is because it is a revenue stream of sufficient size and regularity that

it can be and has been successfully used for bonding purposes. The state, through the building

revolving loan fund, and local government are able to issue high quality bonds by dedicating

gross receipts tax revenues.

SIC:

On page 4, Section 2A, item (7) reads: “the principal paid to the holders of the economic

development revolving fund bonds and the corresponding interest shall be reduced by

any unrecouped amounts paid to the holders of the project revenue bonds;" Assuming

House Bill 1190 – Page

4

the holders are the SIC, the SIC is unclear on what this is trying to say. Does that

somehow allow the issuer to lower the amount of repayment, thereby reducing the

amount of principal due to the bond holders (SIC).

On page 8, Section 6B, indicates authorization for the SIC invoking the guarantee on a

defaulted bond, “…shall be released only upon the order of a court or upon certification

of the New Mexico finance authority that revenue from the project is insufficient to make

the bond payments and that, without the bond payments, the project would be in default

on the project revenue bonds." The SIC interprets this as saying its only form of recourse

should the bond issuer default, and the NMFA for whatever reason not acknowledge that

default, would be a legal action in the civil courts. Such action is costly in time,

resources and investment. Furthermore, the legislation is unclear on who would be held

accountable – the project that defaulted on the bonds, or the state itself through NMFA,

or a combination of the two; potentially creating a situation where one state agency sues

another to recoup monies. If NMFA agrees that a project has defaulted, the related costs

and financial losses would still fall upon the state, and not whatever company or project

received the funding from the original bond issuance & investment.

SIC is concerned about default and how they would exercise their fiduciary responsibility to

recover the assets when the issuing agency is NMFA. While the language refers to the GRT

paying the debt service if there is not enough in the special account, there is a lack of clarity

regarding what specifically happens in case of default.

NMFA:

The state investment council is able to receive a “market rate" or “differential rate" on its

investments. The distribution of gross receipt tax used to pay of debt service is pledged to

pay the differential interest only. This could be a 2 to 3 point spread because of the

discrepancy between the interest earnings of the special account and the interest rate that

would be required by the prudent investor act governing the Severance Tax Permanent

Fund. If there is a call on the guarantee, the money held in the segregated account of the

Economic Development Revolving Fund would be used to pay bondholders. In that

instance, the State GRT will be required to make the entire interest payment due on the

bonds during the life of the bonds. At bond maturity, the fund held in the segregated

account will be used to pay principal on the bonds. It is unclear how bonds will be paid if

there is a call on the guarantee and which fund bears the burden of the default in that

instance.

PERFORMANCE IMPLICATIONS

NMFA:

The finance authority is supportive of the implementation of loan and bond guarantee

mechanisms described in this bill. Several of New Mexico’s neighboring states offer

multiple finance incentives to promote economic development and New Mexico will

continue to be at a disadvantage in the economic development arena without tools such as

guarantees. Amendments made to the Statewide Economic Development Finance Act in

2005 expressly authorized the implementation of bond and loan guarantees.

House Bill 1190 – Page

5

ADMINISTRATIVE IMPLICATIONS

NMFA:

The Statewide Economic Development Finance Act (the “Act") partners NMFA and

NMEDD and empowers the partnership to implement four “programs:" loan

participations, direct loans, guarantees and conduit bonding. Through amendments made

the Act in 2005, the NMFA and NMEDD have the statutory power to support the

proposed bond issuance and corresponding guarantee, but neither has yet developed the

policies nor adopted the rules necessary to adequately safeguard the public’s interest.

In order to issue bonds, the NMFA and NMEDD would each have to promulgate rules to

implement the authority to issue conduit bonds. For NMEDD this involves the public

rulemaking process and for NMFA, this requires both NMFA Board and NMFA

Legislative Oversight Committee approval of the rules. Additionally, the NMFA would

have to develop policies to ensure proper monitoring and due diligence are in place prior

to the rule adoption. Similarly, the NMFA and NMEDD would have to adopt policies

and rules through the respective processes to implement a guarantee program. Lastly,

since this is the first of the projects to receive such a guarantee, it is likely that the

Attorney General’s Office and Legislative Finance Committee will want to review the

proposed terms of the guarantee to ensure adequate safeguards are in place to protect the

State’s interest.

CONFLICT, DUPLICATION, COMPANIONSHIP, RELATIONSHIP

SB1130 is a duplicate.

TECHNICAL ISSUES

SIC:

On page 5, Section 2A, item (9) states: “the economic development revolving fund bonds

shall be issued under terms that provide that no principal shall be payable to the bond

holders until the term of the loan guarantee has expired." As written, that would make

the payment due to the SIC only *after* the loan guarantee has already expired. The

point of having a guarantee is to ensure that it remains in effect fully until *after*

payment of principal is finalized. There are mechanics involved in this kind of

transaction that would make any kind of simultaneous expiration of the guarantee and

transfer of repayment difficult, as well as unnecessary. Bottom line, the guarantee should

be good until the bond holder (SIC) is repaid in full.

ALTERNATIVES

To address concerns about default, specific language regarding the default of the EDRF bonds

and how SIC is protected would be an appropriate amendment.

SIC has a valid concern about its fiduciary responsibility protecting their investment (i.e. the

EDRF bonds) and the NMFA ability to select and approve projects. Additional clarification

about the roles may be prudent.

NF/mt