Transcription:
Michael Scarchilli (00:06):
Hi everyone, and welcome to The Bond Buyer Podcast, your essential resource for insights into everything municipal finance. I'm Mike Scarchilli, editor-in-chief of The Bond Buyer, and today we're delving into the critical role that bond banks play in helping communities navigate the challenges of climate change and severe weather events. Joining us is Michael Gaughan, executive director of the Vermont Bond Bank. As Vermont faces increasing climate related challenges, Michael shares how the bond bank is stepping up to support local governments, especially in small vulnerable communities hit hard by recent storms. He also discusses the broader implications for bond banks nationwide and the innovative ways they can be used to address both immediate disaster recovery and long-term infrastructure resilience. In this episode, you'll hear how bond banks like Vermont's are crucial in providing low-cost capital, ensuring market access and supporting equitable recovery efforts. We'll explore how these institutions can serve as a model for other states facing similar climate related challenges, and we'll also touch on potential federal policy shifts that could enhance their impact. So with that, let's get started and dive into this discussion.
Lynne Funk (01:17):
So hi. Yes, and thanks to Mike Scarchilli for our kind introduction here. Michael, as we record this podcast Tropical Storm, Debbie is making her way up the East coast causing flooding, tornadoes and deaths while Park Fire continues to burn in Northern California. You particularly are not unfamiliar with the effects of severe weather events and climate change in the state of Vermont. Let's just get into this. Can you talk about how the Vermont Bond Bank has helped your cities and towns in Vermont, manage climate related needs, especially after last summer's massive flooding, now you're experiencing even more rain, so talk about that.
Michael Gaughan (02:07):
Yeah, sure. And so thank you for having me, Lynne. It's a real honor to be on The Bond Buyer podcast. Yesterday I was driving home from a hiking trip actually and stopped through a town called Plainfield, which is near Montpelier in Vermont. And they had experienced really some severe destruction related to some rain events and flooding. We had a year to the day from our flooding last year. And in touring that it became obvious that there's some really significant infrastructure needs that are going to stem from that. There's a bridge that was sort of washed away and there's a temporary bridge up now. There is water and sewer infrastructure that was attached to that bridge that will have to be reconstructed. And then there are a number of homes and multifamily structures that are no longer habitable. And all of these have public financing implications, and that's one of the interesting ways in which a bond bank, and we're likely going to talk about the power of a bond bank, but the way in which we can help towns like Plainfield, which have less than a thousand people in them, so massive infrastructure needs in the multimillion dollars worth of damage.
(03:27):
And at the same time, they only have an operating budget in hundreds of thousands of dollars, just to give you a sense of the scale. And so in a rural state or even in a place where you have underserved or historically underinvested in cities, a bond bank can be really important in helping communities at their most vulnerable time. And so what are we doing? Number one, we're going to be there for Plainfield or whomever in the state when they choose to rebuild after the dust is sort of settled on any potential FEMA reimbursements or other infrastructure needs. And we, given our structure and given the state credit enhancement we have, we're going to be able to offer them the low cost of capital that we offer our most successful and sort of best credit community to rebuild. But in the interim, we have been doing a lot of work and thinking about how we can help these communities most at risk.
(04:30):
And what it kind of all boils down to is liquidity and access to funding to bridge FEMA in the event that it's there. In this most recent storm, FEMA's been on site, the governor has applied for a disaster declaration, but we still don't have that. It still hasn't been declared, but that doesn't mean they can just sit tight while they wait. They've got to get the bridge rebuilt and they've got to get this community working again. And so that's one of the ways we can be really helpful and I can talk about the various programs we have going on.
Lynne Funk (05:06):
Yeah, I think that would be very helpful here for our listeners maybe who aren't familiar with what a bond bank actually does, tell us how do your programs work and perhaps how could they offer a model for other states that are facing similar challenges? You talk about a thousand people community, so often we think about, we hear headlines on big places and big major structural damages, but we forget that there are these smaller communities that face similar challenges. So that was a lot of question to throw at you there.
Michael Gaughan (05:41):
Yeah, those small communities are most vulnerable. They don't have, maybe they just have one or two staff, maybe they're open five days a week, maybe they're not. And certainly they struggle with the same workforce challenges that even the larger communities struggle with. But back your original question, a bond bank is Vermont is actually very proud to be the first bond bank in the country. The essential nature of it is that it facilitates financing for facilities and infrastructure projects all over the state. The primary means by which it does this is to pull those small loans together, use those as collateral and a repayment source for larger bonds that we issue under our name to the capital markets, the muni market. And then there's a number of varieties in the way in which credit enhancement occurs. But the sort of original model that was put forward in the bond bank, Vermont Bond bank, that is to have a state intercept on all of the loans.
(06:48):
So not school districts as some states have, but both municipalities and school districts. And then it sort of double barreled in a way. We also benefit from the state's moral obligation on our bonds. And so that gives us a double A plus S and P rating, AA two rating Moody's. And that same cost to capital is passed along to communities of a couple hundred people or communities of tens of thousands of people within Vermont. And so that bond bank idea that started here in 19 69, 19 70 has since spread. The varieties that are in the Northeast look very similar to us, but there are other varieties that have sort of made their way. West and South Virginia Resource Authority, New Mexico Finance Authority and others. Indiana Bond Bank, there's a number of them. There's about 14 or so bond banks, maybe missing one or two, but of various levels of activity around the country.
Lynne Funk (07:57):
Well, this is a good segue here. I want to ask, I guess first I'd like to ask you what, if anything, does the bond bank, do bond banks in general need in terms of perhaps more federal state support, particularly as climate related needs become more pressing and maybe even start to play a dominant role in the bank's financing programs?
Michael Gaughan (08:22):
Yeah, that's a really interesting question. And one of the reasons I've been very, I guess, tried to promote the idea of a bond bank nationally is because the concept is plastic in a way to meet the diverse needs of individual states. And I think there's some really interesting applications of this as it relates to climate. So if we were to design a climate program from scratch at the federal level to finance climate improvements, you'd obviously think about things like stormwater management or you'd think about things like elevating buildings or pumps or things of that nature. But one of the more interesting climate related investments that we helped facilitate in one of our towns was they Hardwick, who has unfortunately been hit twice by the 2023 storms and the 2024 storms recently purchased a gravel pit. And you might think a gravel pit. Okay, well, they're vertically integrating their operations that might make sense.
(09:30):
They can sort of control one of the primary sources of inputs into their road maintenance program. But during flood events, the majority of the damage in Vermont has occurred with road washouts and road destruction. And so they have a ready source of material to rebuild. I don't think you could design a federal program that met that need. And the same goes for other infrastructure types. Notably absent from programs like the infrastructure Investment and Jobs Act was a significant amount of money for school rebuilding. We alongside many states, have a school facility infrastructure that is deteriorating and needs significant investment. And bond banks can help facilitate that reinvestment at a very low cost and can expand beyond the confines of federal programs, which are federal infrastructure programs, which are primarily contained to water and sewer and transportation. So they have a lot of unique applications to meet people in their communities where they can self determine what those needs are and then be assured that they have market access and low cost capital.
Lynne Funk (10:51):
That's very helpful. I think it's interesting, and I'm not the first one to say this, I can't remember who actually said it to me, but it's just sort of like what the muni market broadly and a bond bank particularly really is the definition of fiscal federalism, right? Really putting the work into your hand to the local state, local level. So you wrote kind of piggybacking on this idea, right? You wrote a Brookings paper, a Kins Institute research paper on bond banks. Well, first, I guess, can you tell us a little bit about it for those who haven't read it? And number two, have you gotten any responses from federal state partners?
Michael Gaughan (11:37):
Yeah, as I mentioned, I've really been trying to champion the idea of a bond bank. About a year and a half ago, I started to realize that they just really meet the moment for so many reasons as we sort of saw the national infrastructure programs be signed into law and observe what they did and what they did not fund. And I was fortunate enough to meet Addie Tor my co-author on this paper for Brookings Metro. And the paper sort of describes what bond banks are, how they work, very common, hopefully a common understanding for listeners that are already invested in the muni market, but then lays out a number of points, I think in terms of why they meet the market that are most relevant. And that model that I described at the beginning here about how bond banks can pool loans together, sell bonds, and sort of handle the sort of more complicated aspects of accessing the muni market because the playing fields of the world, or even some of our medium sized communities here in Vermont are not accessing capital on the regular.
(12:51):
They're not going to market every six months. Maybe they're talking to their local bank. And so we can bring that expertise to bear on their issuance, minimize costs, transaction costs or opportunity costs and provide a lot of efficiency there. Well, that same idea can be applied to new programs. So one of the things we're spending a lot of time looking at, that is one of the reasons Bond banks I think meet the moment and is subscribing the article, is accessing federal resources faster. So we've been spending a good deal of time looking through the IRA thinking through potential ways in which we could take those programs and make them plug and play for our local communities coming up with financing mechanisms that bridge the elective pay credit as it pertains to either electric vehicles or things like rooftop solar or even ground Mount solar to some degree.
(13:51):
And then in particular, there's a program within the IRA called the Greenhouse Gas Reduction Fund, and we've been very active in thinking through how we could apply sort of a conventional pool loan muni pool loan structure to that source of funding to bring down the cost of capital for energy retrofits of schools. Here in Vermont, we have literally millions of square feet that are on heating oil. And so that's a huge climate win, but takes a sophisticated intermediary to get from the federal funding that's available to the local school district. That's one reason bond banks meet the moment. The other is this idea that I spoke of a little bit before where even in a small town, or even I should say even a large city, they still struggle with workforce issues. And GFOA has been very prominent in describing the workforce issues that are present in government finance.
(14:49):
And those are only going to become, I think, more challenging layer on top of that, a really kind of bespoke unique market that is the municipal market. And bond banks can sort of cut through that noise, reduce the knowledge barriers for participants in the market and help communities continue to access capital efficiently despite the workforce and unique circumstances of the muni market. Closely related to that are the emerging and present disclosure requirements. So again, bond bank can help facilitate that under a bond bank structure. We're doing our own portfolio review annually and then looking for major updates or material events within our communities on an ongoing basis.
(15:50):
And then within our portfolio, you have to be over 15% of the total pool until you have to report to Emma. So that's a big advantage because the communities know the bond bank well, they know what we're going to ask for and when they're just literally trying to figure out someone that is a person that can run payroll, that's knowledgeable, having to have that understanding of municipal disclosure is a big ask. And so particularly as things get more sophisticated with FDTA and others, bond makes can help cut through that. And equity hopefully, as you've seen, is a big part of this throughout. So we're not just offering this service for the best, most credit worthy borrower. We're offering this service for everyone in the state. And that includes, and this sort of gets into climate, is that that includes the most hard, the most significantly impacted community and helping them rebuild or the community that faces the largest challenges.
(17:01):
They don't bear a market premium as they come to try and rebuild or take on their next big infrastructure project. Same goes with historically disadvantaged communities that are trying to approach both equity within their community as well as receive equity in terms of their financing. So that's a huge component of it. And then just to sort of tie out climate, our portfolio itself is diversified. So when the muni market looks at the bond bank, they're not just looking at central Vermont that's been hit two years now in a row. They're looking at the entirety of our portfolio, which includes places like Chiney County, where Burlington is that have had some impacts, but not newly to the extent of central Vermont. And then finally, we're looking at the state as a whole, and so then we can think through where gaps in the existing structure lie and how we might bring resources to bear on that. And so that gets into our municipal climate recovery fund that I can talk about more that we're very proud of and sort of relates to some of this climate thing.
Lynne Funk (18:15):
That's awesome. Actually, I was just going to ping you on that. As I understand it, it's one of only three other similar statewide programs nationally, is that correct?
Michael Gaughan (18:26):
Yeah, I think we were the fourth from a research indicates now the level of activity in those other programs. I don't know.
Lynne Funk (18:35):
Okay. Well, I guess from your seat, from perspective, what's been the response from our local governments on this? Well first explain it in a bit, and then do you see expanding to other climate related events beyond just the floods?
Michael Gaughan (18:47):
Yeah, so this is I think a really important program that we launched. We have observed because this annual monitoring of our portfolio in terms of the financial statements, obviously we're looking for material events and other things on in between, but as late as 2021, even 2022, we were still seeing balance sheet impacts of the 2011 flooding that hit Vermont from Tropical Storm Irene. And that was a real lesson and that the disaster recovery framework that we have in this country has a lot of gaps. And given it's over subscription and the possibility of adding heat events to it, that only promises to be more significant. But what that taught us was that disaster recovery is not just an immediate liquidity need, it's also sort of a medium term liquidity need. And so as so many communities were hit by last summer's flood events and were hit in an interest rate environment that was much different than it was in 2011 and through the teens, we felt we needed a fast moving, low cost, highly flexible source of capital that could be structured in a medium term so that they could be able to wait out the FEMA reimbursement process, this communities as well as make the right decision in the event FEMA was forcing them down a path that was not the right path in terms of resilience.
(20:24):
And then the bond bank always stands on the back end of that. If it's an infrastructure project that makes sense, that is a long useful life. Our conventional programs could always be the takeout for that if FEMA isn't there. So we work closely, we have a really forward thinking smart treasurer here, Mike Pek, and worked with him closely to get a loan through a program called the 10% in Vermont program where 10% of the cash balances the state holds, which a lot of states are fairly significant right now, can be lent out to economic development and climate related projects. And this clearly was sort of both because you can't have much economic development if you don't have streets that connect to each other. And so we then offered the program, we were two times oversubscribed and are looking into ways we might be able to expand that given this summer's events, both the storm we spoke about we've had, and then we've had some sort of random, there's a lot of moisture in the air and in the ground.
(21:32):
And so we've had some other unique events over the course of the past two months that might be applicable. But I think it, we're really proud of that program and I think it's really making a difference. And when we talk with the League of Cities and Towns, we ask them what can we do? And they say, get our towns money so they can continue to operate and they can pay their bills and they can wait for whatever recovery funding is coming. And so this program as well as the equity aspects and big part of bond banks that I didn't speak about before is just market access. We've got scale, the market is increasingly biased towards larger deals, and so we can offer all these things. And so that sort of helped to set the stage for why we thought that article was important. And to your original question, the reception has been very good, particularly with industry participants who say, well, yeah, this is obvious, maybe it's against my interest because I find ways to, exploit is probably a strong word, but find opportunities for returns in the inefficiencies of the market. But this ultimately worse on the issuer side, we're solving for public good here. And so it's on us to find the most efficient way to deliver infrastructure in this country given our decentralized system. And we're obviously kind of in a bit of a lame duck period politically. So there's some folks that have expressed interest, but it will be educating them. And then obviously not much is going to happen until we get through November.
Lynne Funk (23:27):
Okay. So you bring up a very interesting point, and of course that is right, you're taking some potentially smaller lower grade deals out of the market by going through the bond bank. Can you talk a little bit about how does Bond bank issued paper benefit investors? And maybe, I guess on the one hand you could look at how does it benefit the muni market in general? And I mean, I would say just as you just mentioned, it's lowest cost of capital. We've got so many pricing needs, that's obviously an area. But from an investor's perspective, why invest in the bond bank's paper?
Michael Gaughan (24:08):
Yeah, and I'm glad you asked that question. I really do think it's a win-win, and this is a great time for my ads. So BT bond bank.org/investors, we just closed the deal. And in that OS, we described the fact that we will be going to market with a refunding deal later this month and you can sign up for updates on that deal on our website. But we're recording this on August 8th. So what we offer, I think is it's not just there's a reason, there's a premium or there is bonds that are smaller in scale price cheaper, and it's because of that liquidity, that trading size. And so you might have demand from a specialty state like Vermont, but it might be hard to find bonds and it may not know where to look. And then ultimately you want more liquidity. So we can offer that by pulling these loans together and offering and giving a bigger block size to the market.
(25:17):
We also consolidate the monitoring function for the buy side as well. So you're reviewing the financial statements of the bond bank and our obligated persons, which are again, our 15% or more of our portfolio. And then we're very transparent in terms of the work we do to monitor our own portfolio. We annually post our portfolio meetings on our website and things of that nature. I think there's a real advantages to the market, particularly as we've seen some participants leave the market. I think those trends only, I'd expect the demand for larger block sizes to only increase over time, particularly if we get back into a low rate interest environment and some of the retail participation starts to fall out a little bit. So I think those are real advantages for us. And then the other thing, and this is perhaps more theoretical, is that there's a number of thinkers out there.
(26:22):
Tom Doe is one that we've spoken with recently that sort of describe the fact that we aren't pricing in physical climate risk right now into the market. And so now's the time to make those improvements. Well, not everyone, there's still these market access issues, there's still the prioritization still in terms of bringing federal dollars to a community. There's still the sort of complexity of that and the matching dollars. And so bond banks can help facilitate that, can help facilitate climate resiliency and improve the quality of portfolios, given that not everyone is currently pricing in that risk. Or they might realize their risk, but they're not necessarily going to adjust the value of their portfolio with that at this point in time. So existing portfolios become more resilient if a bond bank is there, particularly given its focus on equity and helping out those credits within a portfolio that are perhaps weakest or most in need of help and make them stronger.
(27:28):
And with Donna, our portfolio, a great example of this is the city of Winooski. It's right next to Burlington, Vermont. It's a city of about 8,000 people. One square mile historically has been a place of immigrant activity going back to the mill era where parts of it called little Canada because of the French Canadians coming down. And that immigrant community has continued, has had lower levels of community wealth than some others, but has really undertaken an ambitious capital improvement program. And the bond bank has been a partner in that for a long time to the point where just recently associated with a USDA loan, they needed to get a bond anticipation note, and they went out and got a public rating, they got a Aa3 rating, and we couldn't be more proud to have been part of that progression of that community who has worked through a lot and sort of shows the power in which to bring up communities within a service area of a bond bank.
Lynne Funk (28:36):
That's excellent. And just so for our listeners purposes, you mentioned Tom Doe from Municipal Market Analytics, also, that firm also is projecting much more issuance in general as a result of climate effects. I mean, what are your thoughts on that? It would seem obvious, but there's also a level of hesitation on state and local governments from taking on more debt perhaps. But
Michael Gaughan (29:04):
Yeah, we've been thinking a lot about this, and I think a lot hinges on FEMA and what the future looks like. We really need to reconceive the way that model works. FEMA is really built on a premise that these climate events are acts of God, and I think increasingly they're really acts of man because of human cause climate change. And if that's the case, we don't know exactly when the events are going to happen, but we know they're going to happen. And so the fact that the most significant, and I know that obviously there's been work around this, there's been changes, but the most significant amount of funding to get ahead of this stuff comes after a disaster through hazard mitigation funds. And that's obviously backwards from what we'd really want. And so there's a perverse incentive for communities to not get ahead of these costs because they are just avoided costs.
(29:59):
They aren't really revenue producers. And so I worry that we're in, there's probably a scheme theory or something. I don't know. We're in a position where there are great incentives to get ahead of these things because you sort of have this moral hazard of FEMA potentially being there to solve the problem. Maybe. And we have an example of this from last summer. We had a wastewater treatment plant in one of our communities. It was heavily depreciated and will likely be rebuilt, and it was in a floodplain and will likely be rebuilt after the disaster. And that's great for that community, but I don't think that's a good model nationally and definitely not cost effective. So I think we have to shape our incentives for communities to get ahead of this because even if FEMA is there on the backend, they're still suffering that goes on in that community that no one residents really shouldn't have to bear. So it's definitely a thought of mine. And I think one way in which, again, bond banks can be helpful is to think through risk mitigation frameworks and investments that might help those communities lower the cost of getting ahead of these improvements.
Lynne Funk (31:18):
Excellent. Michael, we could keep going and going. This is such a ripe topic and we will actually keep going. Not right now, but you, I'm going to do a special plug on my end. You are speaking at The Bond Buyer's Infrastructure Conference in September in Philadelphia, which we're really looking forward to having you there. Yeah.
Lynne Funk (31:38):
Yeah. But in the meantime, while we still have some time here, is there anything that I didn't ask you that you think you want to leave our audience with today?
Michael Gaughan (31:47):
Yeah, well thanks, Lynne. I mean, I think the thing I kind of missed in my excitement to talk about bond banks was the actual policy proposal of the Brookings Metro Paper. And that was a one-time, $25 billion appropriation for Congress to help expand the work of existing bond banks and to create new bond banks around the country. And that would really be to, since this is a sophisticated crowd that would help to provide incentive to structure these bond banks with high ratings without having to necessarily tap into either state appropriations or moral obligation pledges that were kind of version one of bond banks. So really to grease the skids on getting these going for all the reasons we've talked about, all the diversity of needs that states have, including school facilities and other types of physical and social infrastructure that weren't covered by the recent legislation over the past couple of years.
Lynne Funk (32:45):
Excellent. Thank you so much for your time. This has been a really great conversation, and I know it's going to be one that we're just going to continue to have and happy to be the platform to make sure that it is had. So Michael, thank you for your time.
Michael Gaughan (32:59):
It was so wonderful to speak with you. And thank you.
Michael Scarchilli (33:02):
We hope you enjoyed this episode. A big thank you to Michael Gaughan for joining us and sharing his valuable insights into the work of bond banks and their importance in climate resilience and infrastructure financing.
Let's review some key takeaways from this conversation.
One, bond banks are vital in providing financial support to small and vulnerable communities, ensuring they have access to the capital needed for recovery and rebuilding after severe weather events.
Two, the flexibility of bond banks allows them to adapt to the unique needs of different states and regions, making them a crucial tool in addressing the diverse challenges posed by climate change. And three, there's a growing recognition that more robust federal support and policy innovation could significantly enhance the role of bond banks in financing critical infrastructure and improving community resilience.
Thanks again for listening to this Bond Buyer podcast. This episode was produced by the Bond Buyer. If you enjoyed this episode, please hit like and subscribe on your favorite podcast player. And please rate us, review us and subscribe to our content at www.bondbuyer.com/subscribe. Until next time, I'm Mike Scarchilli signing off.