Thursday, May 2, 2013

SEC Charges Victorville, CA and Airport Authority with Securities Fraud

By Tim Dulaney, PhD and Tim Husson, PhD

Earlier this week, the SEC charged the City of Victorville, California and several other entities with municipal bond fraud. The charges relate to a $13.3 million 2008 bond offering by the Southern California Logistics Airport (SCLA) Authority, which was intended to refinance an "ill-conceived" redevelopment project for airplane hangers at the former George Air Force Base, which closed in 1992.

Municipal bonds are sometimes considered among the safest investments available. Municipal bond markets have been tested in recent years by increasing public debt burdens in many cities as well as the high profile default by Stockton, California. The alleged fraud in Victorville reveals some of the difficulties in municipal finance, which in this case may have led city officials and others to mislead investors and the public about the financial condition of certain assets.

According to the complaint (PDF), the city sold three tax increment bonds:
each underwritten by Kinsell, Newcomb & DeDios (KND), "a broad-based, enterprising investment banking firm". The SCLA borrowed an additional $35 million in short-term funding in February 2008 through a private placement with an unnamed bank. The authority issued $13.3 million Subordinate Tax Allocation Revenue Bonds in April 2008. The bonds were issued to repay part of the debt in the private placement as a result of the exercise of an option by the bank that bought the February 2008 bonds (paragraph 62 of the complaint).

This April 2008 financing was based upon a $65 million valuation of four airport hangars. This valuation was in spite of the fact that the county assessor had previously valued two of the four hangars at a little less than $9 million a piece. Prior to the April bond offering and after the February private placement, the county assessor provided a valuation of less than $10 million for the third hangar and estimated the fourth hangar would be similar since it was "identical". As a result, the county assessor valued the four airplane hangers at $27.7 million; however, in the April bond offering documents, the value of the hangers was reported to be $65 million.

The valuation of the hangars is of paramount importance for the bond investors since the value of the bonds is based upon incremental tax revenue. In other words, payment is based upon the "increase in property tax revenues resulting from an increase in the aggregate assessed value of the property within the relevant redevelopment area."

According to the SEC, the reason for the misstatement was that as credit markets were tightening in 2007-2008, investors were requiring higher debt service ratios than before. Debt service ratios, in the context of tax increment bonds, compare the amount of incremental property tax revenue that is available to pay off a bond with the total payments required on that bond. For example, a ratio of 1.5 would mean that the available tax revenue was 1.5 times the amount required to service the debt. According to the SEC, "nearly all of the tax increment available to the Authority had been used to secure its prior bond issuances," and the debt service ratios required by investors increased from 1.10 to 1.25.

The SEC alleges that the mis-statement of the value of the hangers was false and misleading, and have charged the City, the SCLA Authority, KND, and several related individuals with securities fraud.

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