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Don't Forget the Financing! - Community Broadband Bits Podcast 307
When municipalities and other local governments are planning for publicly owned Internet infrastructure, they must coordinate many moving pieces to get the project going and to keep it on a successful track. In this interview, Christopher and Tom Coverick, Managing Director at KeyBanc Capital Markets, discuss one of the most important components of community network planning: finance.
Christopher and Tom met up at the May 2018 Broadband Communities Summit in Austin, Texas.
In addition to some of the types of bonding and other mechanisms communities use to fund their projects, Christopher and Tom discuss the politics and ancillary issues that affect local leaders’ decisions to take the step to finance for a project. Risk is a consideration and it affects the cost of financing. Tom advocates that financing should be part of the equation early in the planning process and he explains why his experience has led him to this conclusion. Christopher and Tom also talk about some creative funding techniques that local communities have used to make borrowing more palatable and suitable for their unique situations.
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Tom Coverick: Just as quickly as you're putting your team together to plan your network and to engineer that network, you need to be having all of the parties involved in all of the sign off involving the financial structure, at least on a parallel path with your network plan.
Lisa Gonzalez: This is episode 307 of the Community Broadband Bits podcast from the institute for Local Self Reliance. I'm Lisa Gonzalez. When a community decides that it needs to invest in broadband infrastructure, they need to consider matters such as design, business model, and management. A critical piece of bringing the vision to reality is how to finance the project. In this interview, Christopher speaks with Tom Coverick from KeyBanc Capital Markets. The two caught up at the Austin, Texas, Broadband Communities Summit in May. Who better to get candid advice, lessons learned, and special insights into what goes on into financing community broadband network projects than someone like Tom. He works with communities looking to improve local connectivity by investing in these types of projects. In addition to the role of politics, risk, and bonding, Tom and Chris talk about a few different municipalities and their chosen paths. Now, here's Christopher with Tom Coverick from KeyBanc Capital Markets.
Christopher Mitchell: Welcome to another edition of the Community Broadband Bits podcast. I'm Chris Mitchell with the Institute for Local Self-Reliance down for one final interview from the Broadband Communities Summit in Austin, Texas. Welcome to the show, Tom Coverick.
Tom Coverick: Thank you. Glad to be here.
Christopher Mitchell: You're the managing director for KeyBanc Capital Markets and how-- you've been a frequent sponsor of Next Century Cities' events and a player in a lot of municipal, and lots of other kinds of broadband, investments.
Tom Coverick: That's fair to say. Yes, we have been. We're proud sponsor. We believe in the effort.
Christopher Mitchell: You arranged for one of the first special assessment districts which we'll be getting to for, for broadband in Brigham City. So I just learned that. I'm really excited to talk a little bit about those experiences.
Tom Coverick: Great.
Christopher Mitchell: Um, so, a good start: What is -- what is KeyBanc? And in particular the Capital Markets part of KeyBanc?
Tom Coverick: So KeyBanc Capital Markets is a wholly owned subsidiary of Key Corp. Key Corp has one of the largest banking presences in the Pacific Northwest as well as in the northeast. We're headquartered in Cleveland, Ohio. We have over 18,000 employees and KeyBanc Capital Markets, which is the corporate part of the corporate bank, uh, also domiciles our investment banking in public finance practices and that's where I am headquartered in Chicago.
Christopher Mitchell: And for the purposes of this interview, you understand municipal finance?
Tom Coverick: Yes, I do. I've been a public finance banker my entire career. So my experiences range from working with large issuers, issuing several hundred million dollar deals to smaller transactions like Brigham City, like we'll talk about in a few minutes, which was just about $3.6 million.
Christopher Mitchell: I went through grad school focused on science and technology policy for a public policy degree. And in that time I had an opportunity to take simple course on public finance, and I thought, "Boring, I'm never going to use this." And then I spent three years teaching myself stuff I could've learned in a few hours from someone who is qualified to teach it to me. So, um, I think this stuff -- just a shout out for other people, advice I give to all grad students that are going to work in public policy -- learn how finance works. It's essential
Tom Coverick: And learn how politics plays a vital role in shaping financial decisions in municipal government because it is -- sometimes that is a wild card.
Christopher Mitchell: Right. So if, if I'm a city and I'm thinking about building a network, what role does KeyBanc play in that?
Tom Coverick: KeyBanc can play several roles. The role that I would play as a professional would be to work to bring a bond issue through the capital markets and distribute bonds to investors, public investors. But one of the key elements of our firm is that we can have several touch points, whether it's direct lending or whether it's a private placements with some more difficult credits or perhaps even CRA credits and things of that nature. So one stop shopping.
Christopher Mitchell: CRA is the Community Revitalization Act.
Tom Coverick: Yes,
Christopher Mitchell: It's important for communities in overcoming past lacks of -- lack of investment.
Tom Coverick: Right? And it really does -- does have the initiative or the opportunity to eliminate or reduce the digital divide. And that's part of the corporate responsibility that banks like KeyBanc have in the communities where we do business.
Christopher Mitchell: And I think it's worth noting that this is the kind of conversation that I think will be useful for a number of folks to get a better appreciation of how banking works in in relation to this. But Jordana Barton with the Dallas Federal Reserve Bank has done a wonderful paper on broadband, the digital divide, banks and the CRA. Tim Herwig, who's with the Office of the Comptroller of the Currency, is-- has done incredible work to try and make it clear that banks can invest in these sorts of projects. So there are resources out there where if you think you have a bank locally, you know, or if you want to find a way of taking care of this sort of thing in your communities, those are the kinds of things to be looking at. I think you have more options now because of their work.
Tom Coverick: Right. It's absolutely right.
Christopher Mitchell: So that's exciting. Um, well, so I wanted to get into a little bit about what cities are looking at when you're thinking about having to borrow millions of dollars or for larger cities, tens or hundreds of millions of dollars. What options are there for cities?
Tom Coverick: So cities are presently challenged, as we all know, with aging infrastructure. So deploying new infrastructure is not necessarily the highest thing on their priority list. Oftentimes as we've discussed individually, Chris, those new initiatives such as municipal broadband and fiber deployment simply fall to the bottom because of aging infrastructure, whether it's water and sewer lines or roads or other types of infrastructure. And so when cities are looking at their priorities, they pay for those things that need to get down to first done. And unfortunately most of the time, broadband isn't something that is understood by a large number of municipal officials. They hear from their constituents, from their economic development folks and from all types of other members and stakeholders in their community, even some of their own politicians, that this is something that's desperately needed to grow and to make sure that the city remained competitive going forward.
Christopher Mitchell: And priorities are important because cities have limitations in how they can fund these sorts of things, right?
Tom Coverick: Right. And so, you know, when you look at what's available to pay for this. Um, it's -- it is still considered from many perspectives an infancy type of credit. When you look at credit markets, a water and sewer credit has been around for 100 to 125 years. So those types of credits are deemed an essential service. Simply put, people need water. People need sewer. And so those essential services are typically very strong credits. Uh, and so when you start to look at, you know, introducing a new utility, many of the investors and creditors, including banks, are very squeamish about the future, given the competition that municipalities face.
Christopher Mitchell: And I would add onto one thing, agreeing entirely with what you said, is that a water is typically, not universally, but typically a monopoly product. So as an investor, you know that, um, you're going to have customers. Whereas with a broadband network, you have to trust the competence of the network to get enough customers to pay back the debt.
Tom Coverick: That's exactly right. and so, um, when you have such a reliable revenue stream, like a water and sewer credit or even electric credit, those are utilities that have been proven over time and have strong ratings and strong essentiality in the community. And so those types of credits are extremely well received by investors. On the other side, something as new as broadband, even though it's been around for the last 15 years. It's a relative newcomer to the market place.
Christopher Mitchell: So we often hear the city is offering bonds. Um, what, what are different options? -- Bonds are kind of many different flavors and, and the options available with them. Can you walk us through the common ones?
Tom Coverick: The most simple type of bond is a general obligation bond. That bond is backed, secured by property taxes that are paid throughout the local jurisdiction, the issuing body, those tend to be very strong credits. Those credits tend to be the most well received, but there are other very strong credits that an issuer can rely on, a municipality can rely on, and those are things like motor fuel tax bonds or sales tax bonds or franchise fees bonds, those are bonds that are secured by energy taxes. So in the simplest form, uh, you have to really take a look at what's available to an issuer and what is the best credit and quite frankly, what the capacity is. Investors will ultimately look to see what the repayment cycle looks like and what the reliability of that revenue stream is going forward.
Christopher Mitchell: There's also tax increment finance bonds, which I think many of us view as a double edged sword for the challenges that presents to the rest of the tax base. Um, my impression is we're seeing more instruments available and that cities are using multiple instruments often to figure out how to finance a project.
Tom Coverick: You know, with the aging infrastructure and the demands that are being placed on municipalities for revitalizing those, there needs to be more creativity. There's only so many arrows in the quiver that municipalities have, so they have to be open to more and more types of structures quite frankly, and as those structures evolve, the market will continue. You know, the folks that we sell bonds to will continue to have a growing appetite for them. Albeit some of those opportunities are at a higher interest rate than something as reliable as a general obligation bond.
Christopher Mitchell: Right. And I wanna -- I wanna come back to that in a second, but the thing I just wanted to note was that cities do have a limit in how much they can bond for. That -- I'm sure there's complicated calculations to figure out how that works, but I think it strikes me that there's a couple of key things. One is there's a riskiness as a city engaged in riskier borrowing in the past or been less able to pay back its debt and then sort of size of the city amount of physical infrastructure and things. What are the sorts of things I'm missing that when into that calculation?
Tom Coverick: Well at the end of the day, what you have to consider is market access and market access is determined in large part by the municipality's ability to repay those bonds. The repayment of those bonds is stemmed from what is the tax base, what is the revenue source, how large is the city, to your point. And so as we look at those types of factors, we also have to remember that an issuer's rating is on the line as well. Access to the capital markets at efficient levels in preserving rating strength is very important to many, many political subdivisions. And for that reason, even though as a matter of practicality, they could certainly borrow a lot more. It may impact their rating. The more they borrow -- just like our own personal credit ratings. The more, the more everybody, you know, burdens themselves with debt -- the more stress there is on a credit rating. And so, you know, there's a lot of different reasons beyond just the ability to borrow. It has to do with many other optics, uh, in terms of preserving your rating. No politicians really want a downgrade on their ratings -- a ratings downgrade on their watch. And so that has another potential impact to it.
Christopher Mitchell: And, and cities don't want to go right up to that limit. They want to have some headroom in case something goes wrong. There's a natural disaster or something?
Tom Coverick: Correct? That's correct. That's a fair statement.
Christopher Mitchell: So with the -- and the interest rate, this is something that, again, in grad school I spent a lot of time in macroeconomics talking about different things and um, it seems to me it can be simplified that if you have a project that looks like it has greater risk, you will pay more to borrow. And um, that is an entirely reasonable supposition.
Tom Coverick: Yes, the more risky the -- it's like anything else in life -- the more risky, the more you pay.
Christopher Mitchell: And some cities have offered debt that was not backed by a general obligation. For instance, Monticello, Minnesota is known for having issued this kind of debt. They had a higher interest rate and they ultimately had to get their bond holders of significant haircut. In a market like this, as you noted, was newer, it kind of spooked investors and anyone else that wanted to use that found that the interest rate was unacceptably high at that point. That's a dynamic that I'm guessing you've seen in these markets regularly.
Tom Coverick: Yes, absolutely. Uh, if -- if, if an investor needs to be educated on a credit, the issuer will pay a premium typically.
Christopher Mitchell: To have a successful project, we're often telling folks need to get involved in engineering earlier than they might think. And one of the things that you and I have discussed, I've discussed with multiple people down here at Broadband CommunIties [Summit in Austin, Texas], is that financing remains a challenge. What do you want to be doing to make sure that, that you're going to achieve success with your project? Particularly from a financing point of view?
Tom Coverick: I think many of us have witnessed, uh, some really great plans by municipalities, uh, some great designs and some great engineering and some tremendous local support for the project. And then you get to a point where the question is, how are we gonna pay for this and that project suddenly goes dormant, uh, because there's really no financial plan in place. So I, I would argue and throw out for debate and I think I'm right, that just as quickly as you're putting your team together to plan your network and to engineer that network, you need to be having all of the parties involved and all of the sign off involving the financial structure at least on a parallel path with your network plan.
Christopher Mitchell: So you have experience with a special assessment areas, In some states they call it different things, local improvement districts or all kinds of different names, because states have to call things differently or else they wouldn't have an excuse to have a dividing line between them, I guess. Um, let's just talk a little bit about Brigham City and how that worked. Because I -- I -- When I learned about Brigham City in Utah, I thought it was a terrific idea. Brigham City is in the Utah Utopia footprint, the network that's a massive open access network connecting many different cities -- more than 10 cities. It has really struggled. They made some bad decisions and they really were the recipient of some malice from the incumbents. Not asking you to comment on any of that, but I just wanted to note, I just came from a panel with a person from Utopia who -- she was discussing how things have really turned around and they're really looking good. Um, they are the most well rated network in Utah. Like people love Utopia more than even Google Fiber. So as we're talking about Utopia is worth noting for people who are used to hearing it being discussed as a failure. It has done remarkably well in recent years. Part of that success is that Brigham City took it upon themselves to fund the infrastructure to finish the build out of Brigham City. And you can tell us how that happened.
Tom Coverick: So this goes back to 2009. So this is not necessarily a new concept. A Brigham City is a Utopia city that wanted to build the network faster than Utopia would be able to build it. And quite frankly, Utopia wasn't able to finance it at that point in time given its current structure. So what Brigham City did was establish a voluntary assessment district, which is -- allowed it under Utah state law. Uh, as you mentioned, jurisdictions dictate what issuers can do, what municipalities can do, in regard to these types of districts. But with regard to Brigham City, it was a voluntary, uh, district, uh, we bonded $3.6 million for those individuals and businesses that chose to have an assessment on their, I believe it was their water bill -- I'd have to look back it's been some time -- but they were assessed directly on, on one of their utility bills. And as a result of that, they make a monthly payment or a periodic payment. A portion of that payment goes directly towards paying this debt service. And so it was a unique way for them to, to do that. I will tell you that the smaller the district the more difficult, you know, we have as underwriters and, and folks that place these types of bonds to put them into the marketplace because the more finite the district, uh, the less there is for an investor to claw back on, in terms of if the district in fact failed, which is obviously not the case here. They paid on their bonds very, very well and effectively. That was one way that we access to the capital markets was, was achieved.
Christopher Mitchell: And so to, to spell it out, I like to try and repeat some of these things for people that may not be as familiar with it. Their people went door to door and they explained to people what it was and you borrowed an amount that was related to the number of people that opted in and in the event that there was a, a default or some kind of event, um, the value of the bonds was not backed by taxpayers, but by the value of the homes of the individual people that were involved.
Tom Coverick: That's a good point. In Utah, the statutes for borrowing with regard to special assessment districts are actually very generous and so there are several remedies an investor has in Utah that may not be available in other jurisdictions. In Utah, there would be a property tax -- a tax lien placed on the home by the municipality. If in fact that went unpaid for a period of time, there could be a foreclosure or quite frankly, the City of Brigham City would have the ability to pay for the debt portion of debt service from any legally available funds so it could even have paid for the debt from its general fund. The statutes there really strengthen and bolster that credit, but that's not available in every jurisdiction.
Christopher Mitchell: Sure. One of the things that I also heard was that, you know, I think cities are not likely to sort of ride in if you miss a payment and try to take your house from you. I think it's worth noting. Cities are often look for other remedies, try to work with you, and that sort of thing. In the event that there, there is something, it's always worth knowing what the law says and what the options are available, but I also don't want to scare people too much on this because I think it's an incredibly exciting option. It's being used in Idaho where they call it local improvement districts. It's being used in the state of Washington where they call it local utility districts. I believe the state of Colorado just allowed the creation of these kinds of districts so we may see that happening, uh, there as well. Um, I, I, you know, I'm, I'm very excited about it. One of the things that I was curious about is how that interfaces with other kinds of debt. So if Brigham City borrowed $3.6 million from these assessment areas, which again to state were voluntary, um, if they had just put out a GO [general obligation] bond for $3.6 million, would that have had the same impact on their, um, amount of borrowing? Or the way that, the way that investors view their indebtedness?
Tom Coverick: With regard to debt capacity, that's what we refer to that in the industry is: What is debt capacity. Debt capacity is defined in different places, um, by dIfferent ways and it looks at overlapping debt, the debt of school districts, park districts, library districts, what have you along with the issuer itself.
Christopher Mitchell: Let me just reinforce that because it's worth noting a city might be very well run, but if you're in a county that's really struggling, you have to take that into account.
Tom Coverick: Yes, you have to hit to con -- that is one of the factors you have to consider because at the end of the day, the rating agencies, when they look at how to rate these individual and respective credits, are going to consider the debt burden, the overall debt burden on, on a certain area and not just the particular issuer. And so, you know, what the industry has done is when we look at how these credits are structured, we try to get them as strong as we can, given the guidelines that we have from cities. And those guidelines vary tremendously, based on political wherewithal and based on the individual stressors or strengths of a community. There could be a community that has a AAA rating and they will just be so debt averse even though they have the capacity because they never want to ding their AAA rating and so even though the capacity is there, the unwillingness to use it may override any decision that's made. But to answer your question, typically special assessment districts are limited in nature, and so they don't have an overwhelming effect on the overall borrowing capacity or the rating for an individual jurisdiction.
Christopher Mitchell: As we wrap this up, I'm curious if you have any advice for cities that are trying to figure this stuff out and and how to think about it when they're approaching a financial institution such as yourself. What should they know when they're trying to figure out who to work with?
Tom Coverick: To answer that question effectively, Chris, I think I go back to what we talked about a few minutes ago and that is the plan of finance should be running parallel to the network plan. That's the first thing. Get your finance team together early, talk about what your options are, talk to your attorneys, talk to your bond counsel, your local bond counsel, those firms that provide the tax opinions because obviously we want to access the capital markets as effectively as you can and find out all of the different options that are available to pay for, for the network. Because there are many out there and it may not be financed solely by a bond issue. It may be financed by a few, a few different pieces. Um, the second piece of advice I think I would provide is to understand that accessing debt financing in any form will require that a political subdivision, whether it's a municipality, that's a city or a county or a town or what have you, will require to have some type of security other than just the system revenues. As we all know, these are expensive projects. The first few years of the project, they don't cash flow that well because there's such a huge capital outlay in those years. And so from our perspective, we, we, we would strongly advise that cities really look for ways to bolster their credit because they will have limited market access and limited access to capital financing without having some, what I refer to as skin in the game. And that's very difficult for many municipal jurisdictions to get their hands around is they either they don't want to do that or they're just limited.
Christopher Mitchell: And I, I think skin in the game is a, is a great phrase because, uh, I would support that just from an incentive point of view to make sure that they are doing everything that is possible to make sure that the network is a success. If risk is apportioned in the wrong way, um, we could see more projects that are not as successful. So I, uh, I think skin in the game is a very smart thing to be thinking about.
Tom Coverick: Right. And I think if you look at it from a potential creditors perspective, whether their creditor's an investor or a large financial institution or a venture capital type of investor, it's great that everybody has buy-in on the project. It's great that you know it's going to be transformational for community, but unless the community is willing to assume some risk itself, you shouldn't be expecting anyone else to assume risk in your project with you.
Christopher Mitchell: Thank you so much, Tom Coverick.
Tom Coverick: Thank you.
Lisa Gonzalez: That was Christopher with Tom Coverick from KeyBanc Capital Markets. We have transcripts for this and other podcasts available at Muninetworks.org/BroadbandBits. Email us at podcast@MuniNetworks.org with your ideas for the show, you can follow Chris on Twitter. His handle is @CommunityNets. You can also follow MuniNetworks.org stories on Twitter. The handle is @MuniNetworks. Subscribe to this podcast and the other ILSR podcasts, Building Local Power and the Local Energy Rules Podcast. Access them on Apple Podcast, Stitcher, or wherever else you get your podcasts. Never miss out on our original research, subscribe to our monthly newsletter at ILSR.org. Thanks to Arnie Huseby for the song "Warm Duck Shuffle" licensed through Creative Commons, and thanks for listening to episode 307 of the Community Broadband Bits podcast.