Friday, December 20, 2013

Richmond's Eminent Domain Program: It Could Really Happen

Richmond, California’s plan to use eminent domain to free city homeowners from underwater mortgages took a number of steps forward recently. Until this month, I would have given very long odds against Richmond actually going ahead with the plan, but now I would place the chances at close to 50/50.

The first development occurred last week in Washington with the Senate’s confirmation of Melvin Watt as Director of the Federal Home Finance Agency – which regulates Freddie Mac and Fannie Mae.  Under Acting Director Ed DeMarco, the agency had suggested it might prevent GSE financing in Richmond if the city moved forward with its plan to seize properties under the guise of eminent domain. The threat of not being able to get a Fannie or Freddie insured mortgage would have inflamed local opposition to the program. But, given Watt’s more progressive orientation, I doubt that he will continue DeMarco’s resistance. I suspect Watt is much more likely to look at the situation through the “little people vs. big banks” lens than his predecessor – whose career was devoted to the health of the home financing market.

The other developments occurred Tuesday night at the City Council meeting, the video of which is available here (most of the relevant discussion can be found between the 3 hour and 6 hour marks).  Mayor Gayle McLaughlin proposed and won passage of a motion that fine-tuned the program in a couple of important ways.

First, her measure imposed guidelines limiting the eminent domain program to mortgages below the conforming loan limit (now $729,750) and in struggling neighborhoods. This change addresses a revelation first made here at ExpectedLoss and later picked up in a WSJ blog and by the San Francisco Chronicle: that the program would have benefitted owners of some very expensive properties in affluent neighborhoods.

Second, the McLaughlin proposal calls for the eminent domain power to be exercised by a “Joint Powers Authority” rather than by the city itself. As reported by the Chronicle’s Carolyn Said, this change allows the eminent domain action to be approved by only a simple majority vote – rather than a super-majority as previously required. There appear to now be three solid “no” votes out of the seven officials who vote on the Council, so the need for a super majority appeared to be a deal breaker.  McLaughlin should be able to hold onto the four votes necessary to create the JPA and implement the eminent domain program. 

But the JPA device imposes a new challenge: another city would have to agree to participate in the JPA. Although McLaughlin and her supporters listed a number of potential partners in California and elsewhere, none of these cities have gone as far down the eminent domain path as has Richmond. Indeed, it is possible that none of these cities will ever get beyond the talking stage. This assessment applies especially to San Francisco – a city whose skyrocketing home prices have left few mortgages underwater.

A more likely candidate, El Monte, will need to be careful. The city declared a fiscal emergency in 2012 and some of its bonds carry non-investment grade ratings. Richmond has already been punished by the municipal bond market despite its superior fundamentals; it’s hard to see how a lesser credit like El Monte will attract investors if it goes ahead with eminent domain.

So the need to get a partner is a significant barrier – but not an insurmountable one. Undoubtedly, the ambitious folks at Mortgage Resolution Partners are very hard at work finding Richmond a mate. Of course, the path to finally condemning mortgages leads through the courthouse. Whether Richmond can prevail, with a very unusual interpretation of the takings clause, against a battalion of well-financed Wall Street lawyers is another bet entirely.

Thursday, December 19, 2013

Good Intentions are Not Enough: The Problem of SEC Mandated XBRL Reporting

Public companies have been required to supply financial reports since the Depression, but gathering and analyzing this disclosure has had its challenges. In the 1990s, the SEC began uploading 10-K’s and 10-Q’s to the internet, greatly simplifying the data collection task. These electronic reports were not standardized, creating the need for downstream users to write complex parsing algorithms and/or use manual processes to harvest the financial statements.

In the late 1990s, accounting and technology firms devised a standard called XBRL – eXtensible Business Reporting Language – to streamline the data acquisition process. XBRL disclosures rely on a common system of tags that consistently identify financial statement elements. The universe of elements differ amongst accounting standards, such as US Generally Accepted Accounting Principles (US-GAAP) and International Financial Reporting Standard (IFRS). An XBRL taxonomy lists all the acceptable financial statement elements for a given accounting standards.

Beginning in 2009, the SEC started requiring public companies to file 10-K and 10-Q disclosures in XBRL using a US-GAAP taxonomy – maintained by the accounting community and approved each year by the SEC.

Recently, I worked with UK-based OpenCorporates to gather SEC XBRL disclosures and harvest data from them. The goal was fairly simple: walk through all the XBRL documents and gather some basic parent company data points (like total assets, total liabilities, total revenue and net income) for the latest fiscal year from these disclosures.

This task proved surprisingly difficult because of a lack of standardization between XBRL documents from different companies. For example, many companies did not report a value for Total Liabilities. One might “back into” this value by subtracting Shareholders’ Equity from Total Assets, but this doesn’t always work. A small percentage of XBRL reports even lacked a Total Assets field. On the income statement side, the dispersion was even greater, with Total Revenue, Operating Income and Net Income often unavailable.

Finding data for the latest period also proved challenging. XBRL files can contain numerous contexts. Each context refers to a reporting period (e.g., a particular quarter or year) and a scope – which may be the parent company or a particular segment of the corporation (e.g., a subsidiary). Contexts contain period elements and an optional segment element indicating which timeframe and what scope the context covers. To find the latest year’s parent company data, it is necessary to develop a program to walk through each context.

These examples suggest that processing SEC mandated XBRL disclosures is less than straightforward. Indeed, the industry group XBRL.US reports finding 1.4 million errors in the universe of XBRL documents filed thus far.

A recent letter from Darrel Issa (R-CA) to the SEC notes that the agency itself is not using the XBRL files it requires corporations to file. Instead, it continues to rely on commercial data aggregators. Electronic disclosure won’t improve unless numerous eyes are scrutinizing it and reporting issues. Data sets need to be exercised; otherwise they remain unfit.

The lack of XBRL utilization represents a major threat for transparency advocates. If we ask for more accessible disclosures and then don’t use them, filers can be expected to push back. In the case of SEC XBRL, the filings are sufficiently complex to require the use of third party XBRL submission firms. In other words, it is too difficult for most companies to prepare XBRL submissions themselves – they need to use an independent preparer, just as individuals often need to hire professionals to file their annual tax returns. Corporations would undoubtedly like to economize on this cost, and can be expected to resist the XBRL reporting requirement if the filings are not used.

From my perspective, a big problem with the XBRL rollout is that it started with large public companies. By 2009, many data aggregators already had mature processes for assimilating the traditional SEC disclosure. As a result, fielded public company financial data has become a commodity; individuals can access these data for free at Yahoo Finance and many other portals. The incentive for aggregators to use XBRL is thus limited because the problem has already been solved at some level, and because the data are widely available, there is little benefit to potential new entrants.

XBRL can provide much greater benefits for data sets that have not received as much attention. I became interested in XBRL back in 2001 because I was hoping to get a standard source of private company data at my bank. The idea was to provide unlisted corporate borrowers with an XBRL template to provide quarterly disclosure.

Another high impact application for XBRL is state and local government financial reporting. When XBRL was growing up in the 1990s and 2000s, US municipal bonds were generally perceived to be safe. That perception started to change in 2008 with Vallejo’s bankruptcy filing and the collapse of the municipal bond insurance industry. Subsequent municipal bankruptcies culminating with that of Detroit in 2013, have reinforced the perception that municipal securities are risky. Government financial statements, which may have been ignored previously, now have significance as investors search for the next bankruptcy candidates.

However, the rollout of XBRL to other areas – such as local government – may now depend on its successful implementation in existing areas: especially the high profile SEC US public company application. If the SEC is unwilling or unable to engage, the community would be well served by collaborating to implement its own improvements. Although XBRL filing companies compete with one another, they all have an interest in the success of the XBRL standard. Thus, as an industry group, these companies can propose and implement improvements to SEC XBRL filings that will make them easier to use. For example, they can develop an enhanced XML Schema Definition which provides additional checks over and above those legally mandated. Such a schema should ensure that filers always include common financial statements such as Total Assets and Total Liabilities. It should also ensure that, within any given XBRL file, the latest period’s parent company filing is easily identified.

XBRL was and remains a good idea. Transparency advocates need to ensure that it does not become an idea whose time has come and gone. To keep XBRL on track, its public company instance needs to be refined so that implementation costs are reduced. Further, it needs to be applied to other areas – such as US local governments – which stand to gain greater benefits from its adoption.

Tuesday, December 3, 2013

For Puerto Rico, Low Transparency ==> High Yields

Puerto Rico 10-year bonds have been yielding around 8% in recent weeks. That’s a 400bp premium over bonds over AAA munis and 500bp over Treasuries – for instruments that are triple tax free throughout the US.

Muni market headlines focus on the Commonwealth’s large debt (over 100% by some measures), underfunded pensions and weak economic performance. Yet revenues are rising, the largest pension system has been reformed and the Commonwealth has enough cash on hand to avoid issuing any new GO debt for the remainder of Fiscal 2014.

Perhaps Puerto Rico’s risk is not as great as the 8% bond yields suggest. I say perhaps, because gaps in the Commonwealth’s disclosure make risk assessment and monitoring challenging.

Earlier this year, I built a fiscal model for Illinois that suggested the state’s absolute credit risk was limited. The model estimated the probability that interest and pension costs – two large uncontrollable, senior obligations – would claim 30% of state revenues – a level associated with previous defaults in US states and comparable jurisdictions. The state of Illinois supports modeling of this sort by providing a comprehensive annual financial report, interim financial reporting, a multi-year budget forecast and pension system actuarial reports that forecast contributions, benefit levels and other indicators over the next thirty years.


Puerto Rico provides some of these elements, but many aspects of the Commonwealth’s fiscal disclosure are missing, delayed or incomplete.

For example, the Commonwealth’s 2012 CAFR appeared on September 16, 2013 – more than 14 months after the end of the fiscal year. This is later than every US state, and substantially later than most.

Although it takes time to produce audited financials, unaudited cash statements should be easy to generate shortly after the fiscal year end. Yet, as of early December, a statement of fiscal 2013 full year revenues and expenditures by category was still unavailable (see for where the report is supposed to appear). Since the fiscal year ended on June 30, prospective investors have now been waiting over five months for this statement. The Puerto Rico Treasury Department likely has this data: components have appeared in press releases and Treasury has already published comparable numbers for the first quarter of fiscal 2014.

Another shortcoming is the lack of a multi-year revenue and expenditure forecast. Illinois provides a three year general fund revenue forecast as part of its budget package. I have found no comparable report for Puerto Rico.

Finally, the Commonwealth’s pension reporting is relatively skimpy and has been rendered obsolete by the 2013 reform. There is no document that provides up-to-date forecasts of annual employer contributions, employee contributions, benefit levels, administrative expenses or asset valuations.

Thus, Puerto Rico asks investors to lend it money on a long-term basis but fails to provide them the tools necessary to readily forecast the Commonwealth’s ability to service these debts. The resulting uncertainty may well be feeding the frenzied selling that has recently taken Puerto Rico spreads to astronomical levels.

The current administration has been trying to step up its investor relations. There are investor calls, slide presentations and even a voluminous Commonwealth report. But the volume of interaction is a poor substitute for quality, consistency, and predictability – at least for those in the bond markets.

Rather than providing reams of assertions and stale data, the Commonwealth would do well to provide investors and other stakeholders, concise, timely and complete financial statements and projections. It’s the provision of the expected, necessary, transparency that could yield lower yields.