A debt-financing deal worth a half-billion dollars a year appears to cost Idaho hundreds of thousands more in interest and fees than similar offerings by other states, and a governor-appointed investment adviser wants a state oversight board to review it.
The adviser, Cameron Arial, is the latest financial expert to question how the Idaho Treasurer’s Office conducts business and manages state investments and public funds. The office, led since 1998 by Ron Crane, oversees $4.5 billion in cash and other holdings, including separate pools of investments from localities and state agencies, as well as public endowment funds and unclaimed assets.
Prior critical assessments, including those by legislative auditors, lawmakers and former employees, have questioned spending and investment decisions by the office, often pointing out where the state could save money through practices such as competitive bidding, streamlined transactions and other industry best practices. Allegations of shoddy investment management were part of a 2016 wrongful-termination claim by an employee who said he was fired for trying to stop them. The claim remains unresolved.
But Crane, whose office oversees the annual borrowing in question, said Arial’s criticism was based on financial data that did not take into account market fluctuations or unique aspects of the Idaho borrowing. He called Arial’s concerns “erroneous” and said he has no plans to bring them to the oversight board, which he chairs.
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Comparing Idaho, Colorado borrowings
Idaho issues a tax anticipation note, or TAN, which is short-term security with a one-year maturity. It’s a way governments borrow to balance out revenues that fluctuate over the course of a fiscal year, providing a source of capital early on before most tax revenues are collected. The debt is repaid from tax receipts when the note matures after a year.
Arial is one of five outside financial experts appointed by Gov. Butch Otter to a board formed in 2014 to help the treasurer’s office strengthen investment practices following a $10 million market loss. He sent his concerns to the board in mid-May and later to a second board that monitors the state’s credit rating.
Arial looked at underwriting and financing costs of the comparable state borrowings last year by Idaho and Colorado.
Idaho has sold the notes since 1982 in amounts that, over the past decade, have ranged between $475 million and $600 million annually. The state is now completing its 2017 sale. That $500 million offering, the same amount as last year, is set to be sold this coming week.
“Given this information and my understanding of how the current year’s process is proceeding, it is in the state’s interest that we meet as soon as possible to address these concerns,” Arial wrote to fellow board members, adding that past transactions should also be reviewed “to gain further insight into improving the issuance process.”
Fees, interest higher
Arial, in his analysis, questioned why Idaho paid $279,000 in fees to underwriter Piper Jaffray for last year’s TAN, nearly eight times Colorado’s $33,000 outlay to a syndicate of underwriters contracted through competitive bidding. Idaho also paid a higher yield on the borrowing — 72 basis points, compared to 60 basis points in Colorado’s case. That difference in rates is equivalent to $600,000 in additional interest charges for Idaho.
Many factors influence yields, including market timing. Idaho sold last year’s $500 million offering on June 7, six weeks before Colorado, at a time when the benchmark yield for similarly rated securities was 67 basis points. Still, Idaho’s borrowing priced five basis points above that benchmark. When Colorado’s $600 million offering went out on July 19, the benchmark yield was 60 basis points. Colorado obtained that rate.
Responding to that part of Arial’s analysis, Crane said in an interview Thursday that the 2016 note’s interest cost was affected by market uncertainty over interest rates, as well as by pending market reforms that made the state’s notes harder to sell.
Crane said that last year the Federal Reserve, which sets a benchmark interest rate, was expected to raise that rate at its meeting in mid-June. It did not, but rates nudged up ahead of time anyway on the expectation. The state priced its offering the week before the Fed met.
“Hindsight is always 20-20,” Crane said. “As it turned out, they didn’t raise rates so the market settled back down.”
Arial, a former investment banker with Zions Bank and now with Athlos Academies, a Boise charter school company, said other differences between the two deals likely contributed to lower costs for Colorado.
Colorado sold its notes through competitive bidding, where underwriters submit bids to an issuer to purchase some or all of the securities on offer. Idaho has consistently done a negotiated sale of its notes through a single underwriter, who purchases them at a discount and then resells them to investors. The latter arrangement results in higher underwriting fees and is typically employed under special borrowing circumstances, such as when the borrower has poor credit, amid high market volatility, for new issues, or for an unusually large or complex issue.
Idaho’s borrowing, by municipal investing standards, is none of these and a fairly routine transaction. But Idaho has stayed with a negotiated sale in large part because it borrows less money, and less often, than other states. With less business to offer to underwriters, it is potentially less likely to benefit from a competitive bid arrangement, where underwriters might bid low in the hope of obtaining other state business.
Crane was joined at Thursday’s interview by his chief deputy, Laura Steffler, and Eric Heringer, whose investment firm Piper Jaffray moved this year from being underwriter to financial adviser, an intermediary role that serves the state’s interest to obtain the best possible financing. Crane said Arial’s analysis was an unequal comparison between two different deals.
Through a spokesman, Crane later said that his office might consider competitive bidding next year if market conditions warrant.
Practices questioned before
The state treasurer’s practices related to the annual note have been called into question before. Crane and as many as 10 people — state finance officials, outside advisers, and typically two state legislators (along with some spouses, who pay their own way) — annually travel to New York City for several days to meet with ratings agencies that assign an investment grade to the state’s debt offering. Both the travel cost and the multiple ratings — Idaho seeks ratings from all three major ratings firms at a cost of up to $60,000 each — have been criticized as excessive, even unnecessary. Other issuers, including Colorado, often handle such ratings discussions by phone.
Arial questioned the added cost of obtaining multiple ratings, but Crane defended the practice Thursday, saying that the Idaho note rating served as a benchmark for borrowing by other state entities, such as the Idaho Housing and Finance Association and Idaho Building Authority, which also justified traveling to New York to meet with rating agency officials in person.
“I think he’s erroneous in his analysis,” Crane said of Arial’s questions. “I think it’s apples to oranges and I don’t think it’s a fair analysis.”
Board review uncertain
The Investment Advisory Board on which Arial serves was created by the Legislature in 2014 after a legislative audit unearthed questionable investment practices by the treasurer. The board, as its name suggests, is advisory only and has no oversight authority. It is chaired by Crane and by statute meets quarterly.
Arial also sent his letter to the state Credit Enhancement Review Committee, formed in 2005 to monitor the state’s credit rating. Also chaired by Crane, it issues annual reports but has not met in years. Arial is not a member of that committee.
Crane said he saw no reason to convene either board to address Arial’s concerns. The CREC’s role, he said, “is to enhance and protect the credit rating of the state. It has nothing to do with overseeing the TAN issue.”
“Unless there was an outcry from the board ... I don’t have any intention of calling a CREC meeting at this time.”
But one CREC member, Rep. Rick Youngblood, R-Nampa, said Arial’s concerns “make perfect sense to me.” Youngblood, a vice president for corporate deposits with Sunwest Bank, has for years pressed via legislation to have the treasurer regularly seek competitive bids for the state’s banking deposit business to obtain lower costs.
Youngblood said those same cost concerns applied to the state’s TAN issuance.
“You would question whether you’re getting the best possible financial advice if you’re not checking the market and seeing who’s competitive and who’s not,” Youngblood said. “When you’re saving potentially hundreds of thousands of dollars, wouldn’t you think that might be worthwhile? Wouldn’t you think that might be your job?”
Crane, in the third year of his fifth four-year term, announced last year that he would not seek re-election in 2018. Neither Youngblood nor Arial has any interest in running for the post, they said.
Responding to Crane, Arial said the borrowing costs were “a legitimate concern that needs to be addressed.”
“From a taxpayer’s perspective, if there’s taxpayer dollars that are being spent on things that don’t necessarily provide benefit to the state, fees and interest costs that could be either reduced or eliminated, then I would want to know about that,” Arial said. “At the end of the day, the intent of the letter is to improve the state’s process.”