FACT CHECK: Borrowing Will Raise Taxes, Water Bills

By GEORGE SOUTHERN
Cape Charles Wave

(EDITOR’S NOTE: The writer was an international economist for the U.S. Department of State in Washington, DC. Earlier as a newspaper reporter he and his wife were privileged to spend an afternoon with Nobel economist Milton Friedman and his wife Rose at their Vermont mountain home, where Friedman taught them about the “tooth fairy.”)

December 5, 2013

Our neighbor Wren lost his first tooth the other day and the tooth fairy gave him five dollars. But his mother says that’s a one-time thing; future teeth will get only 25 cents. So Wren is destined to learn that the tooth fairy is a variable and capricious spirit.

Meanwhile, Cape Charles Town Council has been told it can refinance current debt, borrow an additional million dollars, and save money in the bargain. Taxpayers have an opportunity to address Council tonight (Thursday, December 5) at a 6 p.m. public hearing at Town Hall.

Town Manager Heather Arcos advises that “the projected total debt service for both the refinanced loans and the new projects will be less than the Town currently pays.” She got that from financial advisor David Rose of Davenport & Company.

The Town is thinking like the customer for a new car who says, “I don’t need to know how much it costs – just how much the monthly payments are.”

At last Tuesday’s work session, Council member Mike Sullivan said he wants no tax increase and no utility rate increase. But he’s OK with borrowing more — “if we can finance improvements under the existing debt service.”

Council member Steve Bennett said, “Maybe we could have a tax decrease next year.”

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Here’s the math: The Town has a 5% bond with a balance of $1.1 million (all figures are rounded) with 19 years left to pay. The total interest the Town would pay during the next 19 years is $606,000.

Town Council plans to refinance that loan with one at 2.65% for 10 years, followed by another 10 years at whatever the rate might be in 2024. Advisor Rose has produced amortization schedules that “assume” the interest rate will simply remain the same. Assuming that to be the case, the interest savings over 20 years would be $288,000.

But what if the interest rate in 2024 is a lot higher? No problem: Council member Chris Bannon says he was told that even if the rate goes to 12%, “we’d still be saving.” Here’s the math:

Total Interest

If Town does nothing:        $606,000
If rate stays at 2.65%:       $318,000
If rate adjusts to 12%:       $689,500
If rate adjusts to 11%:       $646,000
If rate adjusts to 10%:       $603,500

So assuming a worst case future interest rate of 10%, refinancing appears to make sense. But it would make even more sense if the Town secured a low rate for the entire period of the loan.

If the story stopped here, it would mean relatively lower taxes and lower water bills for the next 10 years (and probably higher taxes and water bills after that). But at this point the tooth fairy makes her appearance with the promise of “free money”:

“The projected total debt service for both the refinanced loans and the new projects will be less than the Town currently pays for the two water and wastewater loans.”
— Town Manager Arcos

Here’s the math:

Annual interest on $1.1 million (First Year)

If rate is 5%:       $54,000
If rate is 2.65%:  $29,000
Savings:             $25,000

Saving $25,000 a year is not enough – not nearly enough – to service a new $1 million loan. Why, then, does Davenport’s Rose claim that it is? The answer is that Rose has “structured” (to use his word) the new loan with an artificially low debt service in the beginning. For the first three years, at least, the Town will indeed enjoy “free money.” But that low debt service in early years comes at the cost of higher than normal debt service later. Here’s the math:

Annual Debt Service on $1 million over 20 years at 2.65%

.                 “Structured”   Straight Line

Year 1:         $6,000      $64,500
Year 2:          6,100        64,500
Year 3:         45,000        64,500
Year 4:         61,500       64,500
Year 5:         55,600        64,500
Year 6:         34,800        64,500
Year 7:         61,000        64,500
Year 8:         60,900        64,500
Year 9:         60,800        64,500
Year 10:        60,600        64,500
Year 11:        60,500        64,500
Year 12:        63,400        64,500
Year 13:        63,200        64,500
Year 14:        64,900        64,500
Year 15:        62,800        64,500
Year 16:       107,300        64,500
Year 17:       106,900        64,500
Year 18:       106,500        64,500
Year 19:         70,700        64,500
Year 20:        70,700        64,500

The Davenport “structured” debt service balloons in later years, when current Council and staff will be gone. These are also the years when the interest rate is sure to be much higher. (The above calculations are based on the fiction that the rate will remain at 2.65%.)

Bottom line: Yes, refinancing will save money, at least for the first 10 years. But no, it will not save enough to finance an additional $1 million in borrowing – except if “creative structuring” is employed to artificially hold down the debt service over the first few years.  After that, expect higher taxes and higher water bills.