July 12, 2018

I. FINANCING CONSIDERATIONS FOR P3 PROJECTS.

A. Public vs. Private Funds – Advantages and Disadvantages

1. Advantages to Public Funds

• Government ability to access capital markets through tax-exempt financing – lower coupon
• Availability of credit rating from national rating agencies – attract a wider number of investors
• Regular calendar of bond issuances – more established debt markets
• Taxing authority (subject to limits in state law or municipal charter)
• Financial credit not tied directly to a single developer or project

2. Disadvantages to Public Funds

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• Timeliness of process – requirement for multiple steps to achieve closing
• Public nature of process – ancillary considerations may come into play
• Structure of financing may be costly and inefficient
• Competition from other public financing needs
• Political vagaries
• Strict limits on uses of funds

3. Advantages to Private Funds

• Flexibility on types of financing depending upon source
• Multiple sources depending upon risk profile of investor
• Speed of execution
• Confidentiality of financing terms
• Less restrictions on use of funds

4. Disadvantages of Private Funds

• Impact on balance sheet / return to investor may be adversely impacted
• Difficulty in financing assets which may be owned by public entity – inability to pledge as collateral and lack of control
• Financing may be tied to progress of project and other conditions which may be outside of control of developer
• Need for “deep pocket” to secure financing    
• Higher coupon for private debt due to lack of tax exemption

B. Land Assembly and Conveyance

• Many public/private partnerships are constructed on government owned ground that may be sold or leased for private development or held by the government agency throughout the construction period and leased or sold back
• Ability to structure land swaps from public sector ownership as consideration for private participation
• Eminent domain power of governmental agencies can assist in land assembly

C. Tiered Financing Through Federal, State and Local Program

• Larger P3 projects may involve participation by federal, state and local governmental agencies and sources of funding
• Overlapping jurisdiction may require involvement, if only to cooperate in granting right of ways and access (i.e., local jurisdiction; municipal vs. county participation, etc.)
• In Maryland, each local government must contact the State on an annual basis with respect to its priority programs for transportation projects – may be a catalyst for public/private partnerships

D. Tax credits and Other Subsidies

1. Federal Income Tax Credit Programs

• Low-income housing tax credit (Sec. 42 of Internal Revenue Code) - Awarded to for-profit and non-profit sponsors of eligible housing projects on a competitive basis subject to meeting state allocation plans. Goal is to encourage the private sector to invest in the construction and rehabilitation of housing for low and moderate income families. Credits (9% or 4%) of income on annual basis are allowed for up to 70% of qualified basis for new construction, with lesser amount for other buildings. Owner of qualified low-income building must rent either 20% of units to households with incomes of 50% or less of area median income or 40% of units to households with incomes of 60% or less of area median income.  Administered by Dept. of Housing and Community Development in Maryland which allocates credits and approves development proposals.
• New markets tax credit program (Sec. 45D of the Internal Revenue Code) – Goal of program is to spur revitalization efforts in low-income and impoverished communities. Tax credit incentives for equity investment in certified “Community Development Entities” which are banks that lend funds for redevelopment  activities in impoverished areas. Credit is for 39% of the investment over a seven year period (5% in first 3 years, 6% in remaining 4 years). Credits are awarded by US Treasury Department. Program requires periodic extension (current authorization expires at the end of 2013).
• Historic preservation tax credit program (Section 47 of Internal Revenue Code) – Provides a federal income tax credit equal to 20% of the investment for the rehabilitation of income producing “certified historic structures.” Program administered through the National Park Service within the U.S. Department of the Interior. There is also Maryland’s State Sustainable Rehabilitation Communities tax credits available through the Maryland Historical trust (MHT) for certified historic structures.

2. State Tax Credit Program –

• Enterprise Zones are zones intended to promote economic development in economically distressed communities – Administered by the MD Dept. of Business and Economic Development and by the local economic development agencies of counties and other local jurisdictions.
• Specified jurisdictions in Maryland (30 separate enterprise zones as of December 31, 2012) granted the authority for property owner to claim 10-year credit against local real property taxes on a portion of real property improvements
• (commencing at 80 percent during the first 5 years then decreasing 10 percent each year thereafter to 30 percent in the tenth (10th) year).
• Further, eligible businesses in an enterprise zone may claim 1-year or 3-year credits for wages paid for new employees against state income tax liability
• Other programs include One Maryland Economic Development Program, Jobs Creation Tax Credit, and Film Production Activity Tax Exemption

3. State and Local Authority for Certain Other Subsidy Programs

• Business Improvement Districts -- Annotated Code of Maryland, Article 23A, Section 44
• Arts and Entertainment Districts - Maryland Annotated Code, Economic Development Article, Section 7-506.1
• PILOTS (Payment in Lieu of Taxes) - Maryland Annotated Code, Tax-Property Article, Section 4-701 – 4- 707
  
  

II. MUNICIPAL BOND REQUIREMENTS

A. Constitutional and Statutory Authority for Borrowings by Local Jurisdictions

1. Federal Constitution – Tenth Amendment – Powers not delegated to the United States by the Constitution nor prohibited by it to the States are reserved to the States respectively, or to the People

2. State Constitutions provide further delegation of authority to counties, municipalities and other jurisdictions or authority is provided expressly under State-enabling legislation.

• Maryland Express Powers for Charter Counties – Article 25A, Section 5 Annotated Code of Maryland

3. In Maryland, three different categories of counties:

• Commissioner Counties – power to pass local laws vested in Maryland General Assembly with no or very limited authority to adopt legislation by the County Commissioners
• Charter Counties – broad authority for counties to legislate on almost all local matters – generally more populated counties are charter counties, including Montgomery, Prince George’s, Howard, Anne Arundel and Baltimore Counties; Frederick County adopted charter last year which will take effect in 2014.
• Home Rule Code Counties – authority for County to enact legislation in the areas granted under the express powers provision of the Maryland Constitution to charter counties with authority over certain matters reserved to the State

4. Varying authority for municipalities home rule – Baltimore City effectively operates as a charter county, but authority of other municipalities may differ widely

B. General Rule for Local Governmental Political Subdivisions is that

Indebtedness May Only be Contracted for a “Public Purpose” Must be an Expenditure that Furthers the Purpose of the Local Government

1. State Constitution Debt Limits – often limit the amount of public debt to a specific percentage of assessed valuation of property, which may vary depending on level of government, types of indebtedness, etc

• Charter Counties in MD limit is 6% of real property assessed base.
• County charters may also limit ability to increase tax rates to a specified percentage of existing tax obligations in any given year
• Debt ceilings apply to general obligation debt, as opposed to revenue bonds, but there are other limitations from a credit rating perspective on issuance of bonds which are not considered to be “self-supporting.”

2. General Obligation Bonds vs. Special Revenue Bond Authority

• General Obligation Bonds – full faith and credit of the local governmental issuer is pledged to support the obligation – bonds are repaid from general taxing authority of the local governmental issuer
• Revenue Bonds – bonds repaid from a dedicated source of revenues (i.e., tolls, fees, dedicated taxes or assessments) but for which local jurisdiction has not pledged its full faith and credit; generally, there is increased risk for revenue bonds and, accordingly, the interest coupon is generally higher than general obligation Bonds

3. Examples of Maryland State Revenue Bond Authorities –

• Maryland Transportation Authority (MdTA) – acts as conduit issuer for Maryland Department of Transportation projects including toll roads, bridges and tunnels, as well as other transportation related projects including Baltimore-Washington International Airport and Port of Baltimore. Annotated Code of Maryland, Transportation Article, Section 4-201 – 4-407.
• Maryland Community Development Administration (CDA) – issues revenue bonds to support low-income housing projects. CDA is a governmental unit within State Department of Housing and Community Development.
• Maryland Industrial Development Financing Authority (MIDFA) - encourages private sector investment in priority funding areas by issuing revenue bonds and providing credit enhancement to loan transactions. Annotated Code of Maryland, Economic Development Article, Section 5-401 – 5-466.
  
  
• Maryland Economic Development Corporation (MEDCO) – broad authority to issue bonds and other debt instruments to support projects that relieve unemployment, encourage the increase of business activity and commerce, retain and attract business and promote economic activity in the State of Maryland. Annotated Code of Maryland, Economic Development Article, Section 10-101 – 10-132.
  
  
• Maryland Health and Higher Education Facilities Authority – issues bonds to support health care institutions and educational institutions located in State of Maryland. Annotated Code of Maryland, Economic Development Article, Section 10-301– 10- 356.
  
  
• Maryland Stadium Authority - issues bonds and operates sports facilities, convention centers, museums and other entertainment facilities around the State of Maryland. Annotated Code of Maryland, Economic Development Article, Section 10-601– 10-658

4.     Local Government Issuers of Municipal Debt - Subject to authorization, counties and municipalities may issue revenue bonds directly. In addition, State law may provide for authority to governmental agencies or districts to issue debt – i.e., several counties have established housing authorities that may issue debt and intercounty agencies such as in the Washington, D.C. area, the Washington Suburban Sanitary Commission

5. Specific Bonding Authority for Local Jurisdictions -

• Economic Development Revenue Bonds - Annotated Code of Maryland, Economic Development Article, Sec. 12-101-118.
• Redevelopment Bonds - Annotated Code of Maryland, EconomicDevelopment Article, Sec. 12-301 – 312.

C. Federal Income Tax Considerations for Municipal Bonds

1. While most laypersons consider municipal bonds to be equivalent of tax-exempt bonds, this is not the case. Interest on municipal bonds is only exempt if it satisfies the requirements of Section 103 of the Internal Revenue Code

• Three exceptions include (i) private activity bond which is not a qualified bond; (ii) arbitrage bonds; and (iii) bonds not in registered form (i.e., bearer bonds)
• May still be desirable to pursue municipal bond financing even if not tax-exempt where other financing advantages described above make public financing more beneficial to project; can also have series of taxable bonds issued as part of an overall issuance of non-taxable bonds to finance specific project
• Some taxable bonds allow for tax credits on holders’ tax returns – i.e., under American Recovery and Reinvestment Act adopted in 2009, Congress authorized “Build America Bonds” to finance many types of public projects which, while interest paid was considered taxable, provided for a tax credit to the holder on their federal income tax return.

2. Private Activity Bonds – Section 141 of Internal Revenue Code defines the term “private activity bonds” to be any bond issued as part of an issue which meets (A) the private business use test and the private security payment test or (B) which meets the private loan financing test

• Private business test is satisfied if more than 10 percent of the proceeds of an issue are to be used for any private business use and private security test is met if payment of principal or interest on more than 10 percent of the proceeds of the issue are directly or indirectly secured by or payable from property or payments used for a private business use
• Private loan financing test is satisfied if more than the greater of 5 percent of the proceeds or $5 million is used directly or indirectly to make or finance loans (other than certain defined exceptions such as tax assessment loans) to private business
• Term “private business use” means use by a trade or business carried on by any person other than a governmental unit
• IRS regs permit use by private business entities (i.e., developers) of bond financed infrastructure provided the improvement carries out an “essential government function” such as a road, water or sewer system or recreational facility and the issuer and developer intend to transfer ownership of the infrastructure to a governmental entity upon completion.

3. Qualified Bonds – category of private activity bonds that are nonetheless tax exempt (subject to meeting volume cap and other limitations) – narrowed the categories of what used to be called “industrial revenue bonds”:

Exempt Facility Bonds - 95% or more of proceeds used to finance specific types of quasi-public projects including airports, docks and wharves, sewage facilities, solid waste facilities, energy or gas generation facilities, hazardous waste facilities, inter-city rail, qualified educational facilities among others.

• Qualified Mortgage Bonds
• Qualified Veterans’ Mortgage Bonds
• Qualified Small Issue Bonds
• Qualified Student Loan Bonds
• Qualified Redevelopment Bonds
• Qualified 501(c)(3) Bonds

4. Arbitrage Bonds – Section 148 of Internal Revenue Code defines as an arbitrage bond as any bond having a yield materially higher than the yield on previously issued tax exempt bond – permits temporary investment of bond proceeds or investment of up to 10% in a required reserve fund at higher rate. Issuer must rebate any excess earnings to federal government.

5. Reimbursement Limitations for Tax-Exempt Bonds – IRS regulations require that subject to certain exceptions, no later than 60 days after expending bond proceeds for project costs, issuer must adopt an “official intent” resolution. Further limit of reimbursing costs made pursuant to an official intent resolution to occur not more than 18 months following later of (i) date of original expenditure or (ii) date project placed in service or abandoned, and in any event not longer than 3 years after date of original expenditure.

6. Operational Limits on Bond-financed facilities – To avoid private use of a bond-financed facility, IRS has promulgated guidelines for management agreements with private parties to operate such facilities (such as parking lots) – (i) must pay reasonable compensation and not based upon net profits of operation of the facility and (ii) method or formula for compensation falls within a number of safe harbor tests depending on the length of the contract which require primarily a fixed fee, a capitation fee or per unit fee; ability of the government unit that owns the facility to cancel the agreement.

III. TIFS AND SPECIAL TAXING DISTRICTS

A. Legislative Authority for Special Taxing Districts

1. State Enabling Authority: Annotated Code of Maryland, Article 23A, Section 44A – Financing New Infrastructure Improvements – Authority for Municipalities and Article 24, Section 9-1301. Special Districts – Authority for Selected Counties (Anne Arundel, Baltimore, Calvert, Cecil, Charles, Garrett, Harford, Howard, Prince George’s, St. Mary’s, Washington and Wicomico)

• Authorizes issuance of bonds secured by pledge of special real property taxes to construct infrastructure improvements including storm drainage systems, sewers, water systems, roads, bridges, culverts, tunnels, streets, sidewalks, lighting, parking, parks and recreational facilities, libraries, schools, transit facilities, solid waste facilities, and other infrastructure improvements
• Local variation in Prince George’s County which allows proceeds of special tax districts to be used to finance construction and maintenance of convention centers, conference centers and visitors’ centers, as well as buildings designated as workforce housing and allows special hotel rental taxes to be imposed
• In addition to foregoing, district may support payment of costs of construction, as well as operation and maintenance, of infrastructure improvements located in or supporting a transit-oriented development
• Certain counties have adopted separate enabling legislation for special taxing districts (i.e., Frederick, Montgomery Counties)
• Requirements to create special taxing district includes the following;
• Petition signed by two-thirds of owners of real property by number and by assessed value (Montgomery County – 80% plus other mandated steps including receiving approval of MNCPPC and County Executive);
• Adoption of resolution or ordinance by municipality or county defining geographic boundaries of the district, authorizing imposition of special ad valorem or other taxes, authorizing creation of special fund into which special taxes are deposited and authorizing expenditure of funds for specific acquisition or construction of specified infrastructure;
• Adoption of bond resolution to authorize issuance of bonds by local jurisdiction;
• Filing of declaration within land records to subject property to special tax (note: general authority is for special tax in addition to ad valorem real property taxes; however, certain counties, including Prince George’s and Charles Counties, have authorized special hotel rental taxes);

• Special tax methodology must be approved as part of the creation resolution to specify type of tax, rate of tax, provision for increase or prepayment of taxes and finding of public benefit; and
• Authorization for MEDCO (Maryland Economic Development Corporation) to issue bonds on behalf of infrastructure improvements located in or supporting a transit-oriented development or a State hospital redevelopment

2. Baltimore City Authority – Section 62A of Baltimore City Charter

• In addition to authorizing costs of transportation, water and sewer, and recreation-based infrastructure improvements, special tax districts can be used to fund costs of providing units of affordable housing

3. Other Authority – Montgomery County Taxing District for White Flint – Section 68C of the Montgomery County Code

• District imposed under authority of Maryland Annotated Code express powers provision giving County authority to levy special taxes for governmental purposes
• Infrastructure improvements limited to transportation infrastructure, including roads, bridges, streetscape, etc. and transit facilities
• State law adopted to exempt special taxes imposed from Montgomery County Charter requirements on yearly tax caps
• Tax district creation assisted in part due to very active participation by community alongside developer group owning parcels proposed to be redeveloped in the negotiation of the infrastructure and rate of tax to be imposed under the special tax district

B. Legislative Authority for Tax Increment Financing Districts

1. Annotated Code of Maryland, Economic Development Article, Sec. 12-201-213

• Authorizes all political subdivisions (counties and municipalities) in State, except Baltimore City, to form “development districts” whereby a portion of the tax increment of real property taxes above a base year normally paid into the General Fund of the political subdivision is instead paid into a special fund to be used to support bonds issued by the political subdivision
• Proceeds of bonds may be used to buy, lease or acquire property, conduct site removal, relocation of businesses or residents; installation of roads, installation of utilities, construction of parks and playgrounds, construction or rehabilitation of buildings for governmental purposes and related costs of issuance
• Local variation for Prince George’s County – bond proceeds may also be used for construction or maintenance of convention, conference or visitor centers
• Special authority to pledge other local taxes that are attributable to or generated within a “Transportation-Oriented Development.”

• In addition to bonds issued by local jurisdictions, MEDCO authorized to issue bonds to support TOD, “sustainable community” and state hospital redevelopments.
• Process to create tax increment financing district includes the following:
• adoption of resolution or ordinance by municipality or county defining geographic boundaries of the development district and pledging all or a portion of the tax increment into a special fund
• certification of the amount of the amount of the original assessable base of the real properties which will serve as the measuring year against which future tax increments will be calculated
• adoption of bond resolution to authorize issuance of bonds
• Oftentimes, special tax districts are created as a means of providing additional security to repayment of TIF district bonds so if tax assessments do not rise sufficiently to provide enough tax increment to repay bonds, special taxes may be imposed to cover the shortfall – may have districts that overlap

2. Baltimore City Authority – Sec. 62 of Baltimore City Charter

• In addition to authorizing cost of transportation, water and sewer, recreational and governmental purpose based infrastructure improvements, TIF districts can be used to fund costs of providing units of affordable housing and construction or rehabilitation of buildings that are abandoned property or distressed property; may also be utilized for construction of structured and surface parking facilities that are publicly owned or privately owned but serve a public purpose

C. Municipal Bond Underwriting Criteria for Special Taxing Districts

1. Debt Service Fund to cover unexpected shortfalls in collection of tax – Generally 10% of principal amount of bonds to be funded initially; can be used in later years to pay bond debt service in lieu of collection of taxes.

2. Value-to-Debt Criteria – Depending on the credit rating of the bonds, a minimum ratio of the value of the underlying real property (as determined by recent SDAT property assessment and taking into account any improvements financed by the bonds) to the outstanding principal amount of the bonds will be required – for unrated bonds a minimum value-to-debt of three-to-one is often required.

3. Debt Service Coverage – will examine over the life of the bonds and depending on credit rating and age of the project, a minimum coverage ratio will be imposed.

4. Additional Credit Support – underwriters working with credit rating agencies will determine need for bond insurance, letters of credit and other credit support. Where new developments with few property owners, may be required guaranties of minimum tax payments or other.

D. Timeline -- Bond Financing Procedures for Taxing Districts

• Developer initiates process through filing petition or lobbying local government to issue bonds; may also engage underwriter to model financial structure of bonds and to market and sell bonds on behalf of local government
• Adoption of Resolutions and Ordinances require public hearings and work sessions with local government issuer
• Local government hires bond counsel to opine on legal authorization, federal income tax exemption and municipal securities disclosure obligations relating to bond issuance.
• Preparation of tax methodology and financial projections. Local government may also hire a financial advisor or special tax consultant to advise it on the financial safety and soundness of the transaction
• Negotiation of acquisition or funding agreement between developer and local governmental to address disbursement of proceeds
• Preparation of bond indenture between issuer and independent bank trustee to administer payments to bond holders
• Negotiation of bond purchase agreement between issuer and underwriter/placement agent governing obligations of underwriter to purchase bonds, indemnifications and legal risk allocation
• Preparation of bond disclosure document for investors – official statement or limited offering memorandum with bond underwriter or placement agent to describe bond structure and project status

• Continuing disclosure agreement for local government and for developer – covenant to provide ongoing disclosure of status of project and material events affecting bonds for periods after closing
• If seeking rating from national credit rating agencies, submission of financial projections and bond financing documents to rating agency; purchase of bond credit enhancement, etc.
• Marketing of bonds, road shows, bond closing – developer/ property owner opinions and certifications of project status, authority to enter into agreements with local government; filing tax declaration for special tax district and inserting disclosures into property purchase agreements for owners of properties