Tag Archives: economies of scale

Cluck, Cluck, AB 394 comes home to roost?

Chickens Roosting

A quick review:  Nine Republican members* of the Nevada Assembly introduced AB 394 in the last session, the bill would create a process for breaking up the Clark County School District into smaller, separate, districts because – “…Reconfiguring the structure of the Clark County School District into local school precincts will offer an educational system that is responsive to the needs and concerns of the residents of that school district;..”   (*Gardner, Fiore, Jones, Silberkraus, Hickey, Dickman, O’Neill, Seaman, and Trowbridge)

The bill passed in the Assembly on a 35-5 vote, and the Senate on a 13 to 7 vote, with one excused.  It was signed into law by Governor Sandoval on June 11, 2015.

The Numbers Game

For a party, the members of  which take umbrage at any suggestion they aren’t the party of fiscal responsibility, fiduciary trust, and conservative financial values, AB 394 demonstrates a level of financial naïveté that could easily be categorized as sophomoric. 

There is a inkling in AB 394, during its preliminary discussion of rural district consolidation in which there’s a hint that the Assembled Wisdom understood the principle of Economies of Scale.  However, the venerated Assemblage turned right around in the same bill and pretended these didn’t exist for the one district in the state actually large enough to benefit from those economies of scale.  For the uninitiated, here are some of the babes pitched out with the bath water in the interest of creating “responsive” little districts:

(1) The larger the operation (business) the more individual employees are able to specialize in various tasks creating technical expertise which in turn creates greater efficiency.  For example, a larger school district might be able to finance a specific office that focuses on testing and the administration of examinations.  In a smaller district these tasks might be assigned to a ‘curriculum director’ whose office is also responsible for the development of course content, the in-service training of teachers in that content, and the mapping of the curricular content throughout the district.  In the business domain, larger firms can separate tasks in the offices or on the shop floors that allows specialists to develop proficiencies in technical or production tasks.  

(2) Bulk purchasing.  Think of the difference in pricing between supermarket chain stores and the local corner bodega.  Volume, plus reduction in packaging and transportation costs, mean lower per unit expenses. There are approximately 24,286 first graders in the Clark County School District.  There are approximately 4,869 first graders  in the Washoe County School District.  [CCSD and Washoe SD]  Which has the better capacity to buy in bulk?  Which can negotiate for more discounts?

(3) Spreading overhead expenses.   Republicans, often supportive of mergers and acquisitions, note that the mergers of private sector firms allow for the rationalization of operation centers. or to put in more simply – it’s better (more efficient) to have one main office than two.   Again, the schizoid nature of AB 394 says that the rationalization of overhead expenses is fine for the rural districts, but CCSD is “just too big?”  By this logic, Goldman Sachs, Chevron, and JP Morgan Chase would have been broken up long ago.

(4) Let’s get to one economies of scale factors that’s extremely important for a large metropolitan population, the concept of Risk Bearing Capacity.  Again, the larger the enterprise the higher its risk bearing capacity.  The most common example of this factor is in the pharmaceutical industry wherein large corporate firms are able to finance (borrow for) research because profit lines in popular products provide investors with the assurance that the debts incurred can be paid off at the agreed interest rate.  Now, take a look at the Debt Service reported in the CCSD financials:

CCSD debt service

What we’re looking at above are all the bonds issued by the Clark County School District on which the district is paying off principal and interest.  Nor it is too difficult in a rapidly expanding population to have to issue bonds for school construction or renovation.  Schools aren’t  cheap to build and equip.  Constructing an elementary school for about 600 youngsters, at $190 per square foot will cost about $14,800,000.  A middle school for just over 900 students costs $215.14 per square foot, with a total cost of approximately $30,000,000.  High schools are even more expensive.  The total cost: $54,900,000 (1600 students) [NCEFAt this point one of the largest AB 394 egg layers  comes back to her nest.

“Moody’s Investors Services hasn’t downgraded the Clark County School District’s construction bond rating — yet.

But the credit rating firm late Monday issued a report warning a bill Nevada Gov. Brian Sandoval recently signed that could lead to the breakup of the nation’s fifth-largest public school system “poses uncertainty” and “a credit negative” to the district’s ability to repay debt.”  [LVRJ]

Investors who buy bonds (lend public & private institutions money) want their money back + interest.  The greater the risk the higher the interest rate on the bonds.   The ratings agencies, no saints themselves as we witnessed during the financial sector collapse of 2007-2008, are in the business of telling investors how much risk is involved – the lower the rating the higher the risk, therefore the higher the interest rate demanded for the loan.

The Clark County School District currently has an A1 rating from Moody’s.  The outlook was “stable” as of February 17, 2015.   What has “de-stabilized” this projection is – AB 394 – which creates “uncertainty.” Without spending the usual $150 Moody’s charges for smaller reports, let’s guess the nature of that “uncertainty.”   The Clark County School District’s report on its financials assures bond holders:

“Maintenance of the current property tax rate will be sufficient through fiscal 2015 to retire the existing bonded debt since the District issued previous bonds based upon the factors of growth in assessed valuation in addition to increases in student population. The Capital Improvement Program provided authority to issue general obligation bonds until June 2008 and will be repaid from a fixed tax rate of 55.34 cents per $100 of net taxable property. [CCSD pdf

Translation: The Clark County School District – as it is currently functioning – has the financial capacity to retire (pay off) existing debt, and the ability to repay Capital Improvement bonds from its property tax base. A property tax base of the present 8,012 square miles comprising Clark County, which according to the Nevada Department of Taxation has a final assessed value (property) of $69,258,468,466.  A number large enough to assure investors in CCSD bonds that they’ll get their money plus interest, since the ad valorem revenue is calculated at $495,059,633 for the county.   We can use the old reliable Red Book to determine what the Clark County School district can expect from its share of the property tax revenue: $819,903, 015 from a total 2014-15 assessed valuation of $62,904,942,089.

By now it should be getting obvious why Moody’s is getting nervous.  Under the terms of AB 394, there must be a plan in place to chop up the school district by the 2018-2019 school year.  Thus, we’d have an advisory committee and a technical advisory committee contracting with a consultant for the grand purpose of carving up the district – but how?

If the notion is to create “neighborhood schools” then would we amalgamate current high school attendance zones? [map]  However, a quick look at the obvious north/south or east/west divisions compared to the assessed valuations of the areas involved quickly demonstrates that not all school districts would be “created equally.”

Perhaps the “Performance Zones” could be used as a basis?  Where do we put the rural schools, from Moapa Valley to Laughlin?  Again, how does the dissolution of the district help any of these financially?  

Unfortunately for those who would be new map makers, Clark County, like so many other major metropolitan areas is comprised of various zones – residential, industrial, and commercial.  As long as the financial foundation of a school district is based on property taxation, then we have to live with the fact that while upscale residential property comes with high tax bills, there isn’t all that much of it.    A district carved out of a major commercial zone with a rather smaller number of residential properties in that zone might have resources in abundance compared to an area of high residential properties – and therefore higher numbers of students, but a lower total assessed valuation.  Geography can often be a real pain in the derrière and in this instance it’s going to be.

At the risk of petulantly pounding the dais – there appear to be only 12 members of the Assembled Wisdom in the last session who understood the gravity of separating school districts within a diversified metropolitan area, one with an overall assessed valuation currently capable of keeping investors optimistic about bonding capacity and bond retirement.  The remaining 48 – not so much – maybe one more round of Econ. 101 is in order?

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Filed under Economy, education, Nevada economy, nevada education, Nevada legislature, Nevada politics, nevada taxation, Politics, Rural Nevada, Sandoval

Bubble Bubble Here Comes Trouble? REO to Rental Securitization

Three WitchesBubble: The real estate experts in Las Vegas, NV were happy to report the Shadow Inventory of foreclosed homes in the region wasn’t as high as expected as of January 20, 2013. [LVRJ]  Nevada’s anti-robo-signing law (AB 284) is part of the reason, and some homes are still on the market because they aren’t in salable condition.  Before we get entirely too pleased with ourselves…

There are homes that will be included in the Shadow Inventory in the next two years; homes which will be in default and Nevada may be able to circumvent the foreclosure statistics  increases by using short sales.

Bubble:  There are several motivations for purchasing real estate, one of which is to transform unsold residences into rental properties, as in the following example from last December:

“Home prices fell 62 percent from 2006 to early 2012—the steepest drop in any U.S. metropolitan area—yet Vegas is again enticing buyers. The number of homes listed for sale has dropped to a 1.5-month supply, down from the four-month stock that’s typical in the area, says Jeremy Aguero, principal at Applied Analysis, a Las Vegas research and advisory firm. One reason for the inventory squeeze: Investors such as Blackstone Group (BX), GTIS Partners, and Haven Realty Capital are buying deeply discounted homes in bulk to rent out at a profit.”  [BusinessWeek]

The good news is that (a) more rental properties are available, (b) some of the excess inventory is off the market, so that (c) home prices could rebound and those “under-water” on their mortgages might see a bit of relief.   Again, before we become too cheerful, there’s another reason to invest in foreclosed properties which if not carefully monitored could lead to another Bubble.

Toil: There’s more to the story than Blackstone’s interest in getting into the rental business in Nevada.    Blackstone’s also been active in southern California:

“In all, major investors have raised between $6 billion and $9 billion to buy single-family homes, according to a recent analysis by investment bank Keefe, Bruyette & Woods. The goal is to bring corporate scale and efficiency to what has historically been a mom-and-pop, single-family-home rental business.” [LATimes]

What we have here is Wall Street moving in on Main Street.  Renting residences used to be primarily a Mom & Pop operation.  But, Mom & Pop don’t have between $6 and $9 billion to buy up residential real estate.  Now we tread into “market efficiency” territory.  There are some variant perspectives on what “efficiency” really means.

When we speak of efficiency as a component of Economies of Scale, the Black Rock venture looks like the application of operational efficiency to the old Main Street individual homeowner model of residential rental markets.  There are Internal economies of scale (the company is so big that it can buy in bulk usually at a discount not available to smaller concerns) and External economies in which the company is so big it can get preferential treatment from governments or outside sources to reduce taxation, get roads and utilities provided, etc. in an environment in which a small business or individual cannot successfully compete.

The initial view is that Blackstone is taking advantage of its capacity to be operationally efficient — it can buy up residential real estate in Nevada and southern California at prices heavily discounted by foreclosure processes or perhaps even short sales.

Trouble: What we don’t need is a real estate market which is “operationally efficient” to such an extent that we create yet another Bubble.  So, let’s read further into the Los Angeles Time’s article:

“These firms are also exploring ways of packaging rental income streams into securities, similar to the way mortgages were bundled during the boom years. Those mortgage bonds — often packed with risky home loans that produced mass defaults — turned into the toxic assets that helped bring down major banks during the financial crisis.”  (emphasis added)

There are some breaches in this model.  Real estate is a labor intensive business, if we think in terms of home maintenance, home marketing, and all the associated jobs which must be performed to rent and receive income from a block of home purchases.  Profit margins depend on rental income, and will the rental income stream support acceptable levels of profitability given the labor intensive nature of the housing market?   What happens to the business model if high competition for properties drives prices up beyond the  original cost estimates?  What happens if the profitability margin in the “revenue stream” doesn’t meet expectations?

Now we have to consider the other “Efficiency.”  The rental income will be securitized.  Packaged into bonds. The bonds will be sold in financial markets, and the efficient capital market theory tells us “the price of an asset reflects all relevant information that is available about the intrinsic value of the asset.” [EconLibrary]  What determines the value of the bonds?

What’s “relevant information?”  Do we include the rating assigned to the bonds by the rating companies?  We’ve seen this movie before and it didn’t end well.  In fact, the ratings companies seem to have gotten a bit of religion on the subject of slapping high grade investment ratings on questionable products:

“Ratings companies began commenting last year on how they would approach assessing potential securities backed by rental homes, a market fueled by the foreclosure crisis they helped create by granting inflated grades to mortgage bonds.

Moody’s said in August that items including a dearth of historical data on the business could make it difficult for issuers to obtain the grades they seek.

In its report today, Moody’s said it wouldn’t offer its “highest ratings” to deals backed by “equity” structures, rather than individual mortgages, also because they would offer less protection against “unauthorized sales” of homes and new liens. [Bloomberg, Jan. 2013]

Do we include the timeline in our calculation of the bond value?  Last November Blackstone opined that it had a two year window in which to buy up financially fragile properties, [Bloomberg] so are properties purchased in the 3rd year likely to be less profitable, and thus have a lower return for investors than properties purchased in the first two?  If the bonds are manufactured as they were during the Housing Bubble (mixtures of good and bad loans which blew up when housing demand and prices collapsed) then what is the “intrinsic value” of the assets (bonds)?  Will the bond packages include combinations of rental income from markets in which prices are going up, and from regions where the market is still depressed?   If so, then what is the actual “value” of the bond? How many markets have to see increased home prices before the admixture of cheaper and more expensive rentals in securitized assets gets “top heavy?”

Enter all the usual suspects.  Blackstone got an increased loan from Deutsche Bank this month to “underpin” its long term financing of the new REO to Rental securities.  What we know so far about this:

The new Deutsche Bank loan, upsized to US$2.1bn, includes an
original US$600m warehouse facility in addition to investments
from eight other banks and securities investors.

At least 20 banks and investors looked at participating in
the loan, and some passed because their charters would only
allow them to participate in bond deals and not bank loans.

Securitization specialists with knowledge of the deal said
Deutsche Bank expanded the size of the facility in order to
accommodate Blackstone’s increased commitment to purchasing
distressed single-family homes with the goal of renting them
out.  [ChiTrib]

Think of that warehouse as a paper storage facility in which all those rental agreement are stack up, only to be divided up, restacked, and used to back bonds issued by Blackstone.   We’ve seen this movie before too — it didn’t end well in its last incarnation.

Not to put too fine a point to it — but, are we about to get into the same “valuation” debacle about the actual value of sliced, diced, tranched, and securitized assets we witnessed in 2007-2008?

Double, double toil and trouble;
    Fire burn, and caldron bubble.

If we get ourselves into this mess again it’s going to take more than newt’s eyes, fillets of fenny snakes, frog toes, bat’s wool, and dog tongues to extricate ourselves.

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Filed under Economy, housing, Nevada economy