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

SPONSOR Sanchez, M.

ORIGINAL DATE

LAST UPDATED

2/24/07

2/28/07 HB

SHORT TITLE

Economic Development and Loan Guarantees

SB 1119/aSPAC

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)

Relates to SB1130 and HB1190

SOURCES OF INFORMATION

LFC Files

Responses Received From

NM Finance Authority

State Investment Council (SIC)

Economic Development Department (EDD)

SUMMARY

Synopsis of SPAC Amendment

The Senate Public Affairs Committee amended Senate Bill 1119 to guarantee payments to other

creditors invested in project revenue bonds rather than just NMFA. NMFA reports that the

amendment removes the requirement for NMFA to issue the bond as well.

Synopsis of Original Bill

Senate Bill 1119 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

Senate Bill 1119/aSPAC – Page

2

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.

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

There is no effective date so it will be effective June 15, 2007 by default.

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.

Senate Bill 1119/aSPAC – Page

3

Currently, NMFA relies on appropriations from the legislature to guarantee the EDRF program.

In 2005, the legislature appropriated $10 million to NMFA to start this program and guarantee

projects. This is referred to as the Smart Money program and NMFA is seeking $30 million this

year of funding. It is not clear if this will legislation will mean that NMFA will no longer need

appropriations.

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 (from their analysis of HB1190, a similar bill):

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

dollars out of the STPF, which represents approximately 2.3% of the STPF balance of

$4,383,867,930. As a “differential rate" investment, though not specified by the

legislation, it is assumed that the interest rate earned on such bonds would be below a

“market rate" investment. Expected returns (IRR) for investments with this risk profile

are in the 20-25% range. If you assume that the bonds will pay a couple of 1%, the

shortfall or lost opportunity cost given the level of risk from making these investments

could easily approach 20% or $20,000,000 a year, assuming all $100,000,000 is invested.

That figure does not include any potential defaults by the companies receiving the benefit

of these bonds.

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.

SIC:

As this legislation would create a new category of differential rate investment, the SIC

notes that there is a growing presence of these types of below market rate investments in

the Severance Tax Permanent Fund. To date, here are the following investments allowed

under their various investment programs:

7-27-5.3 Conventional mortgage pass-through securities: $100MM/yr

7-27-5.4 New Mexico business investments (SBA/FHA) 20% of STPF (FHA/SBA)

10% of STPF (BBB or better)

7-27-5.5 Educational loan notes $10MM/yr

7-27-5.13 Educ. Inst. R&D facilities revenue bonds 10% of STPF

7-27-5.15 NM Private Equity funds & Business investments 6% STPF (Private Equity)

0.75% of STPF (SBIC)

7-27-5.17 Employers mutual company revenue bonds $10MM

7-27-5.22 obligations under 33-1-19 correction facilities SIC approval

7-27-5.24 Investment in obligations for state capitol buildings $10,155,000

7-27-5.26 Investment in films produced in NM 5% of STPF

While ultimately the total amount of investments allowed as differential rate investments

is up to the State Investment Officer & Council, the amounts available for investment

Senate Bill 1119/aSPAC – Page

4

under a below market rate are more than half the fund. In addition, there are current

legislative proposals to expand the amount available for investments in film (+1%),

private equity (+3%) and SBIC (+0.25%).

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 reports many concerns regarding its role in this legislation. They are primarily concerned

with recovering funds from NMFA should one of the bonds default. NMFA also has concerns

which are reported below. These concerns may be exacerbated by the amendment allowing

the EDRF bonds to guarantee bonds issued by parties other than NMFA.

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

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).

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.

The question of legal remedies surrounding this legislation is complex, as among other

things, it raises the question of who ultimately has recourse against the borrower. Would

it be NMFA, as they issue the bonds through SWEDFA to the project, or would it be the

SIC. If it was NMFA, is it proper or even possible for the SIC, as the injured party, to

assign legal rights for remedy to the NMFA. It is not clear whether this could be done in

a legal manner, which may take us back to the SIC suing NMFA should recovery be

difficult.

Senate Bill 1119/aSPAC – Page

5

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 (from analysis of HB1190):

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.

ADMINISTRATIVE IMPLICATIONS

NMFA (from analysis of HB1190):

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 and HB1190 are identical except that they both include a temporary provision for $30

Senate Bill 1119/aSPAC – Page

6

million in loan guarantees to a tilapia hatchery in Hidalgo County.

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.

NMFA provides specific recommended amendments:

a. In A(2) add the word “state" between specific" and project" in line 21 on page 3

b. provide that the EDRF Bonds could be paid down to the extent that the full amount of

the guarantee was no longer needed, section (A9) and (10)

c. Clarify whether or not the guarantee bonds can be issued in an original amount less

than the principal amount of the project revenue bonds (partial guarantee)

d. In Section A(5), at line 7, add the word “maximum" before the word “amount"

e. In Section A(10), at line 5, delete the word “contemporaneous" and insert “consistent"

NF/nt