I’m not a muni analyst. I just look at numbers and make observations. I took a look at Onondaga County, NY. The home of Syracuse.

The county has a Aa1/AAA rating from Moody’s/Fitch. I have no idea what a AAA means today. The “top shelf” should be something that is more certain than the economic winds of up-state NY in my mind. That said, my look at Onondaga says they are a good credit. The outstanding bonds are money good. If you own them, sleep tight. They will pay interest and principal on time. If that’s the definition of a AAA, they meet it. O does a very good job of presenting its numbers. There were a few things that I thought were worth noting. I use some of the information in the broader context of the muni market:

According to the census there are 455,000 residents . 14% of the population is over 65; 23% are under 18. 74,700 have disabilities. The healthy adult workforce is about 270,000. I’d be surprise if 70% had full time jobs.

Syracuse University has a total of 31,000 students. The faculty is 1,500. The budget for SU is $1 billion. A decent chunk of that stays in O.


-The Onondaga 2010 budget:

A net deficit of only $2mm. Not bad on a $1b expense base. But look at the sources of revenue. The State kicks in $119mm (12%) and the Feds $88mm (9%). The state of NY has its own problems. Not just this year. It will be every year for the next ten. Along the way Onondaga is going to get squeezed. The Federal side is no different. Those numbers are going down. They will go down for nearly every county in the country.


To make a point, the following is a listing of outstanding muni bonds:

My impression is that this is a fairly complex financial position for a community of 455k people. O pays $45,000 a year to agents just to distribute the interest. Think of the legal fees for all those bond indentures. The underwriting spreads for Wall Street are a daily source of revenue for the folks with white spats. Secondary market trading of this paper is a flow traders dream; you can drive a truck through the bid offer spreads. No wonder everyone loves it. With this much debt everyone makes money. Right?

It’s important to note that there is gross and net bond debt outstanding. O has defeased some older high coupon bonds. In my view they have done a very good job of taking advantage of both lower interest rates and their strong credit rating. They “arbed” Ben Bernanke with his QE and ZIRP. Along the way bondholders (aka Savers) get less for their money. So O wins, savers lose and Ben is the broker for this.

The current principal outstanding is 441mm, but $244mm has been pre-refunded. So net debt is only $197mm.

When you look at O you have to focus on the net number. But I am troubled by this phenomenon. What you see with O you will see with almost all munis. They have much more debt outstanding than the net debt they are rated on. Yes it is true that the PreRe stuff is now secured with solid assets (government guaranteed bonds. They are called SLUGS (State and local Gteed. Securities)).  But heaven forbid there was a call on the SLUGS during a government shut down. Something like that could never happen, could it?

This feels a bit like ponzi land to me. There is much more muni debt outstanding than there is debt reported on the balance sheets of munis. The problem becomes if/when this paper starts rumbling around. (like it did with Agency bonds).

As of 1/31 the Treasury SLUG account had $187b of paper out. Is this 187b of extra funding for Treasury a big deal? No, not really. What’s another $200b amongst friends? It is only 13% of the 11’ deficit. Well, actually, that is a fairly big deal.

 

So why does O deserve a AAA? Easy answer: They have a solid tax base. That income stream is (technically) committed to the bondholders. Some values/tax numbers:

Note that the tax revenue declined YoY by 16%. They lowered the mil rates. They could have kept the mil rates the same and lowered the assessed values. The result would have been the same. I don’t believe the value of real estate in Syracuse has appreciated over the last four years. I suspect it has gone down quite a bit. The value of the RE is not the issue. It is the property tax that is generated that counts. The 2011 revenue is lower than it was in 2003. Given that the assessed values seem too high, further drops in property tax revenue is likely.

The revenue from this property is $154mm in 2011. That comes to 78% of Net Debt. A favorable ratio. More importantly is the revenue to current year debt service ratio. Principal ($15mm) and Interest ($9mm) for 2011 is $24mm. O covers their debt nut 6Xs. That justifies my view they are ‘money good’. It is the basis for that lofty AAA.

Based on the property values being assessed a formula is used to establish the maximum amount of debt that O can have:

NY State law sets the formula for the maximum debt level a community can have. (7% of the average of the “Full Value” of the property base) From this comes the conclusion that O can have up to $1.4b of debt. Given that they are well below that level ($200mm/12%) they are considered a AAA. Just the idea that O has nearly unlimited capacity to borrow money bothers me. (another 1.2b or 6X increase)

This a flawed concept. I can accept that the lower this ratio is the better the credit of the borrower. But what is the value of that real estate? What counts (to me) is the taxes that come from the property. Setting a debt limit based on inflated property values is not a concern with O. But other communities are kidding their bondholders on what this key ratio is.

The business of defeasance I previously touched on has created significant benefits for O over the past decade. I think the window for defeasance has closed. As the cost of new debt rises the opportunity to ReFi goes away. Consider this BABs bond O issued last year. A 5 1/8% coupon bond is now yielding 5.80% (trading at 93). This is a proxy for what it would cost O to issue new debt. The ReFi window is closed for O, (and most other munis across the country). This increase in borrowing costs is not a reflection of O; the entire muni yield curve has gone up. The ten year is has moved a very significant 75BPs

The following is a discussion of the historical savings from defeasance activity:

Taking advantage of the lowest interest-rate environment in forty years(thanks to Ben B) , the County refunded $18.5 million of 10-year old bonds in 2003, saving $1.8 million through 2014. In 2005, the County participated in a second pooled tobacco bond sale, which enabled the County to defease $19.9 million, beneficially affecting the years 2007 - 2025 for total debt service relief of $27.3 million. In late 2009, the County issued $33.3 million of refunding bonds, enabling savings of $3.3 million in 2010 – 2023.

It is the County’s goal to annually review its outstanding debt for refunding opportunities. In 2010, The County maximized its interest savings by issuing a mix of tax-exempt, Build America and Recovery Zone bonds.(Sorry O, this benefit has left the barn, and it's not coming back.)

Syracuse University is a power force in the local economy. I have no doubt that this fine school will be contributing to economic activity (and taxes) for a long time to come. But, once again, I see chinks in this armor. The tuition at SU this year is $50,791, up 6.2% YoY. This is a big nut. In years past tuition cost was supported by Pell grants, donations, investment returns from endowments. The money also came from tapping 401Ks or a ReFi of the family home. A ton of it came from student loans. Most of that has gone away. I wonder if SU will be the driver of growth that it has been in the past.


O has a large capital budget. They need to make repairs to old “stuff’ and build new “stuff”. It’s a long list. A significant portion of this has to be financed with new debt.

The capital plan:

Source of funds for capital spending:

Note that only 12% of the budget comes from reserves. The balance is either borrowed or is grant money from the State or Feds. This is the model that has been in place for years. I don’t think that model is going to work so well for the next decade.

I don’t see a credit problem with O in the foreseeable future. I would put the odds of a default or a restructuring around “0”. But I see signs of weakness. Both in the micro-economics of O and the broader macro dynamics of the muni market.

For what it is worth I have trouble accepting the Aa1/AAA rating, NY State GO bonds are rated Aa2/AA. What happens in Albany will flow down to O. Wanna bet on at NYS downgrade in the next year?

If you don’t own O’s bonds yet and are looking for a chance to buy in, I would hold off. Yes, the bonds have gotten cheap of late. I think they will be cheaper still in the next few years.