County Finance

I was struck by this in the Recorder article (here):

The first step, according to Arnold, was to defease the outstanding MOSA debt, or set up a restricted bank account under the control of a trustee to pay off the red ink, which currently stands at just over $9.4 million.

The key word is ‘defease’ which is explained here as:

A defeasance is a financing tool by which outstanding bonds may be retired without a bond redemption or implementing an open market buy-back. Cash is used to purchase government securities. The principal of and interest earned on the securities are sufficient to meet all payments of principal and interest on the outstanding bonds as they become due.

Essentially, defeasance allows an issuer to collateralize outstanding debt with a portfolio of “risk-free government securities”, thereby instantly removing the debt from the issuer’s balance sheet. This occurs because the government securities generate the cash flow needed to pay all interest and principal on the outstanding bonds when due. Under generally accepted accounting principles, if the portfolio of securities includes only high quality securities such as direct obligations of the United States Government, the bonds are treated as “defeased” or legally retired.  (See FASB Statement No. 76 Advance Refunding and Defeasance Policy and GASB Statement No. 7).

The takeway from the above is that MOSA’s balance sheet would be restructured as essentially debt-free with the defeasance. That leaves two key questions:
1) What happens to the county balance sheets and credit ratings given the MOSA defeasance?
2) How does a structural change in the balance sheets of MOSA impact their operating and financial incentives vis-a-vis risks and returns?

I’m not arguing that defeasance is good or bad — I have no idea so far– I’m just curious.

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