By Joe Feuerherd
NCR Washington Correspondent
Goldman Sachs, the global investment banking firm, and O'Meara, Ferguson and Kearns (OFK), a small advisory company headed by a former seminarian, have targeted the financial power of a potentially huge new player in the securities markets - the nation's 195 Catholic dioceses.
It's an ambitious plan aimed at nothing less than "creating a new financial paradigm for the church in the United States," Goldman vice president Kerry Rudy told Bishop Carl Mengeling of Lansing, Mich., in a July 2004 letter.
With combined budgets of $100 billion, a revenue base of 19,000 parishes, and incalculable real estate assets (because churches pay no taxes, the value of their land is not publicly recorded), many U.S. dioceses have long relied on outside experts to manage assets and maximize returns. But Goldman and OFK have a new approach. Under their plan, U.S. dioceses would raise money through the $400 billion tax-exempt municipal bond market.
The "revenue bonds" touted as key to diocesan financing do not, generally speaking, put taxpayers at risk, though they must be issued by local governments. Instead, the diocese itself (and the banks that support a particular bond issue) will bear the brunt of investor wrath should the church default. The interest on the bonds is exempt from federal and some state income taxes, which makes them attractive to investors.
In early April, when the Austin, Texas, diocese borrowed the proceeds of a $79.8 million government-sponsored bond issue, the approach got its first significant test. Goldman and OFK worked for more than a year on the transaction, which they believe will save the rapidly expanding central Texas church millions over the next three decades.
"We see no risk beyond what we would have incurred with any other lender, and the interest rate is the lowest available," Austin diocesan spokesperson Helen Osman said in an e-mail response to NCR questions. "The bottom line is that we are being better stewards of the gifts being given by Catholics in the pew."
It's a stewardship model Goldman and OFK would like to see gain widespread acceptance.
For decades, nonprofit Catholic hospitals and universities have used government-issued bonds to fund construction projects. But only two dioceses - Arlington, Va., and Indianapolis - previously secured the credit ratings needed to benefit from the deeply discounted interest rates that make such borrowing so attractive. And in Arlington and Indianapolis cases, bond proceeds were used for school construction, noted Msgr. Daniel Maher, former chairman of the Arlington diocese finance council and president of the Diocesan Fiscal Management Conference, the association of church financial officers. By contrast, $32 million of the Austin bond proceeds will be used to reduce the diocese's existing debt (which is directly tied to previous construction projects eligible for tax-exempt financing), while $46.1 million will be used to renovate or construct parish halls, community rooms and parochial schools. Further, the $79.8 million Austin deal dwarfs previous diocesan efforts and, according to Goldman Sachs, marks a new day in diocesan finance. Church finance professionals are looking at the Austin transaction as a potential model, said Maher.
In a new light
"We believe that the Catholic church has tremendous resources that, if presented appropriately, will enable dioceses across the country to access capital at the lowest cost with significantly more attractive terms than current funding vehicles can provide," said Goldman's Rudy.
Goldman's Rudy, in his midsummer pitch to Mengeling, laid out the background of the Austin deal and its potential implications for dioceses across the country.
A Goldman-Sachs presentation to credit agencies interested in backing the Austin deal pointed the way. "The … presentation was a unique and compelling story that we believe will cause the credit markets and lenders to look at the church in a new light."
The bond market, said Rudy, should treat dioceses - whose congregants are akin to taxpayers - less like nonprofit entities and more like a government, which typically get the most favorable interest rates and repayment terms on their bonds. "Goldman Sachs and OFK have been making the case that while the Catholic church does not have unlimited taxing authority like a state or municipal government, the church should be viewed as closer to that end of the spectrum," wrote Rudy.
To Goldman, the ability of a bishop to tax any Catholic entity within a diocese "demands [that bond rating agencies give] more credit … to a diocese's ability to make timely payments on its debt obligations."
Further, because dioceses have a "moral obligation" under church law to assist financially troubled dioceses, and would likely provide assistance in the event of a bond default, the church should benefit from lower interest rates on their bond-funded loans. Said Rudy, "The fact that it is a norm of the Holy See that dioceses have an obligation to aide a diocese in financial distress when able … enhances the financial credit of all dioceses."
Two other factors make diocesan participation in the bond market attractive, said Rudy. Dioceses are typically land-rich and cash-poor, so Goldman Sachs worked "with the rating agencies to identify [Austin diocesan] property that is not essential to the operations of the church that can be readily sold (if necessary) to provide liquidity."
And money begets money. The church, continued Rudy, "should be able to earn more income from its cash and investments than it pays in interest cost on its bonds generating positive 'arbitrage' or income."
Growth fueled Austin deal
It's no surprise that the rapidly expanding Austin diocese plans to raise more than $145 million for parish and parochial school construction projects over the next three years. The regional population explosion that increased the number of area Catholics by 90 percent between 1990-2003 also strained the central Texas church's ability to meet the needs of its 450,000 faithful. There simply aren't enough modern meeting rooms, parish halls, and parochial school classrooms to serve Austin Catholics, whose numbers are expected to nearly double again over the next 20 years.
"Our parishes and schools are straining at the doors," said diocesan communications director Osman. "Parishes that were built on empty prairie land just a few years ago now have five and six Masses a weekend, almost all standing-room only."
It's that same population boom, and the increases in Sunday collections that came with it, that allowed Bishop Gregory Aymond and his finance team to pursue the unconventional financing plan designed by OFK and Goldman.
Soon after coming to Austin in 2000, Aymond, formerly an auxiliary bishop in New Orleans, realized "that pastors and parish finance councils were not adequately planning for future growth in services, facilities and the resource capital to fund them," according to Osman. In early 2002, the bishop hired former Ernst & Young senior manager Mary Beth Koenig as the diocese's chief financial officer.
Which is when OFK, the financial advisory firm, entered the picture (see story on Page 7).
OFK representatives made three trips to Austin prior to the summer of 2003 to meet with Koenig and diocesan finance officials. "We were introduced to the CFO by the bishop as a resource for her," OFK said in a mid-2003 report on the firm's activities. In April 2004, Goldman Sachs was hired to underwrite the bond issue.
There were obstacles to getting the transaction completed. Securing a rating from Moody's and Standard & Poor's - whose endorsement can mean millions in saved interest costs - was a cumbersome process. Extensive details on diocesan structures, canon law, cash flow and anticipated growth had to be provided to the rating agencies.
That all-important rating, however, was worth the effort. It led North Carolina-based Wachovia Bank to issue a "letter of credit," which means the bank and not the church will deal with creditors should the diocese default.
Meanwhile, the clergy sex abuse related bankruptcies of the Tucson, Ariz., Portland, Ore., and Spokane, Wash., dioceses threatened to spook the market, potentially frightening the institutional bond-buyers who would typically jump at the chance to place highly rated Wachovia-backed bonds in their tax-exempt portfolios.
"When Portland declared bankruptcy [on July 6, 2004], that was a big deal," OFK principal Pat O'Meara told NCR. "And nobody knew what was going on for about four weeks and everybody was trying to understand … the story. We didn't expect it to happen in the middle of this, but it did, and we weathered it."
More disclosure required
Dioceses have traditionally resisted using government-issued tax-exempt bonds to fund capital needs for two reasons. First, church and state concerns (see story on Page 9) limited the practice. Next, churches, unlike other tax-exempt charitable organizations or public corporations, don't have to report on their finances. No audits are required, no disclosure mandated.
That combination of secrecy and lack of accountability will be tested should additional dioceses look to tap the bond markets.
Every government-sponsored bond issue includes an "Official Statement," called an "OS" - a lengthy jargon-laden document that, if carefully read, describes the bona fides of the issuer, the borrower, and the financial team that analyzed and underwrote the deal. The bond buying public uses the OS to evaluate the potential risks and benefits of a purchase.
In Austin's case, the OS reveals that:
- The diocese did not, until late 2004, report a $65 million bank line-of-credit on its books, of which it had used $52.5 million. "The diocese's independent auditors have historically not shown the $65-million line of credit with Bank of America … under the rationale that the assets financed were at the parish level and the parishes have actually paid the debt service to the lenders directly out of their revenues."
- Parish financial statements are accepted at face value by the diocese. "This practice is largely the result of the historically strong credit history of the church, the consistency of significant revenues generated from parishes, and the vast amount of church real estate holdings financed by parishes, generally with cash and very little debt. It is also the result of the high cost of conducting large numbers of individual audits at the local parish level."
- The diocese's $1.9 million reserve for "contingent liabilities," combined with its insurance coverage, "will be sufficient to cover any potential liability arising from threatened [clergy sex abuse] claims."
- There is ambiguity over who actually owns diocesan assets. In bold print, the OS states that "there can be no assurance" that the bishop's control "over assets held in the name of one or more parishes will not be challenged under civil law or canon law by a parish, pastor, or a parishioner, creditor, court or others."
- Though not legally obliged to do so (as the OS notes in bold print) other dioceses have a "moral obligation" to help another diocese experiencing financial difficulty.
And, with considerable specificity, the OS describes the parameters and purposes of the bond financing.
The deal
On one level, the Austin plan is simple, like going to a new credit card company that pays off your old credit card debt and gives you additional cash at a lower rate of interest.
In Austin's case, the "old credit card" is a $65 million line-of-credit the diocese had from Bank of America; and the new debt from the bond issue is to be paid off with the revenue the diocese anticipates from weekly donations from the faithful and a planned $65 million diocesan-wide capital campaign.
"The Catholic church does not tithe its members," notes the OS, "but Catholics are under a moral obligation to attend Mass every Sunday (and on certain Holy Days) and to support the church financially, at the risk of committing sin."
Investors - largely money market funds and other institutions - like the Austin bonds because they are backed by Wachovia Bank, underwritten by Wall Street powerhouse Goldman Sachs, get high marks from rating agencies, and are exempt from federal (and some state) income taxes. The diocese likes the plan because it will reduce interest payments on $32 million in existing debt, free up cash for day-to-day operations, and provide parishes with the resources they need to expand.
The state of Texas, meanwhile, says it is permissible to use government mechanisms to fund church construction projects because the facilities can be used for such "nonsectarian" purposes as Boy Scout gatherings, English-as-a-second-language classes, and Alcoholic's Anonymous meetings. "High-level conversations were held with the state attorney general and his deputy to gain acceptance of our strategy at a policy level," according to Goldman's Rudy.
OFK and Goldman Sachs, meanwhile, profited handsomely from the Austin transaction. As lead underwriter, Goldman shared its $501,036 fee with Calyon Securities, which assisted in marketing the bonds. The other parties to the deal - numerous attorneys, rating agencies (Moody's and Standard & Poor's), and Wachovia all got a piece of the more than $1.2 million left after the underwriters took their share. And it's likely, say industry experts, that additional fees were paid to some of the participants outside the "cost of issuance."
Even the Vatican got a piece of the action - a $100 administrative fee ("taxa") to process the approval required under canon law for a diocese taking on significant debt.
There was one additional obstacle. The diocese needed a local government entity to actually issue the bonds, to be a conduit between the church and the bond-buying public.
So, sometime in 2004, the Austin church went shopping.
Creedmoor meets Wall Street
"Forum-shopping" is the term municipal finance professionals use to describe the process of identifying a local government entity needed to act as a "forum" or "conduit" for tax-exempt bonds. Nonprofits seeking to access the tax-exempt debt markets need a governmental sponsor for their bonds. The factors are the same anyone would consider when purchasing a service: cost, quality and flexibility.
The diocese approached one Texas village, Rollingwood, which turned them down, uncomfortable with the idea of issuing debt on behalf of a church.
Ultimately, aided by a local business owner who knew the diocese's needs, the church discovered Creedmoor, home to San Francisco Parish, a post office, 300 people, and little else. "There's not much to the city of Creedmoor other than a sign that says 'Creedmoor,' " Travis County Commissioner Karen Sonleitner told her colleagues at a February public hearing held to approve the bond issue.
Nevertheless, Creedmoor's Capital Area Cultural Education Facilities Finance Corporation was created in January 2005 for the specific purpose of issuing the diocesan bonds. ("There'd be no other reason to do it," said Harvey Davis, the Travis County manager who handles bond issues for the local government there.) In return, Creedmoor gets a $50,000 fee - money village administrator and the Creedmoor Finance Corporation "registered agent" Robert Crandal says will be used to build a community center.
Creedmoor's Finance Corporation is a bureaucratic necessity, an administrative convenience. The bonds are not backed by Creedmoor's 300 citizens. They are at virtually no risk should the diocese default. Instead, the bonds are a "general obligation" debt of the diocese.
Village administrator Crandal told NCR that the seven-member cultural facilities corporation board includes "two representatives from the Catholic diocese." The diocese, however, denies that it has any control over the corporation. "None of the members represent the interests of the Austin diocese," said diocesan spokesperson Osman. "Some of the members may be Catholic, but diocesan officials are not aware of their religious status. Diocesan officials had no role in recruiting members for the corporation."
Creedmoor, said Osman, was a natural choice. "A smaller entity would be easier to work with than a larger one. Creedmoor was attractive because its community would benefit from the partnership in a very tangible and real way."
Still, some question the practice.
Travis County's Sonleitner voted for the bond issue, but only after raising questions about small jurisdictions "that all of a sudden decided to … form a corporation simply for the purposes of racking up fees for their jurisdiction." Such opportunism, said Sonleitner, "undercut a lot of serious work, taking away business for other communities."
Travis County (population 857,000) is a jurisdiction with considerable experience in bond financing and is where more than one-third of the church buildings to be modernized or built are located. The county would have been interested in issuing the bonds, Sonleitner said at a public hearing. But diocesan officials never approached them.
Some mild concerns
On the record, some church and financial professionals express mild concerns about the Austin transaction.
"If I was a lawyer representing the diocese I would put the paper [describing the transaction] under a microscope to see whether this is the camel's nose under the tent" regarding possible government strings attached to use of tax-exempt bond proceeds, said John Hartigan, a retired vice president and general counsel of Salomon Brothers, a large investment banking firm.
Previously, some Catholic universities have faced restrictions on how they use facilities built with bond money, but Austin diocesan officials anticipate no problem in this regard.
Further, said Frank Butler, president of FADICA, the association of Catholic family foundations, it is problematic if the Catholic institutions (including Austin parishes, other dioceses, and such groups as the Knights of Columbus) mentioned in the Official Statement as potential sources of revenue in the event of a default have not been briefed on the terms of the bond issue. Asked by NCR how pastors, parish finance councils and parishioners had been made aware of the bond financing and how they reacted, Austin spokesman Osman said, "The response from parishioners has been extremely positive." Diocesan officials briefed parish finance councils on the transaction, said Osman.
Still, agreed Butler and Hartigan, from a purely financial perspective, the transaction appears to make a lot of sense.
"If Goldman Sachs and Wachovia have invented a way for churches, and not just Catholic churches, to finance their needs more efficiently, I don't see why anybody should be unhappy about it," said Hartigan.
"It seems to be an inexpensive way to finance the needs of the diocese," said Butler.
Off the record, others with experience in municipal finance and knowledge of the church - and fearful of alienating Goldman or Wachovia or the rating agencies by going on the record - question whether the church should be in a business that requires both political sharp elbows at the local level and enough financial sophistication to keep up with Wall Street. But even those skeptics acknowledge that a transaction involving some of Wall Street's biggest and most formidable players - Goldman Sachs, Wachovia, Moody's and Standard & Poor's - is worthy of respect.
Still, there's obvious unease among the major players in the transaction. Repeated requests for face-to-face or telephone interviews with Austin Bishop Gregory Aymond and diocesan chief financial officer Mary Beth Koenig were rebuffed. Instead, diocesan communications director Helen Osman provided partial answers to questions posed by e-mail and referred queries to O'Meara.
Msgr. Ronny E. Jenkins, the Catholic University of America canonist who signed off on the transaction, did not return phone calls asking for comment.
An April 8 story on church finances in the Austin Business Journal, which included interviews with Aymond and Koenig, made no mention of the bond issue. No stories related to the bond issue appeared in the diocesan newspaper, nor were any news releases touting the success of the financing effort released.
The Goldman Sachs municipal credit committee, which reviewed the firm's participation in the transaction, is headed by Francis Ingrassia. As managing director of Goldman's municipal finance division, Ingrassia played a key role in moving the Austin deal forward. Last summer, Ingrassia participated in a two-day forum conducted by the forerunner to a new organization, the National Leadership Roundtable on Church Management, for Catholic business leaders who want to make church management practices more transparent.
Through a spokesperson, Ingrassia and other Goldman officials declined repeated requests to comment on the Austin transaction or the "new financial paradigm for the church in the United States" they are promoting.
Joe Feuerherd is NCR Washington correspondent. His e-mail address is jfeuerherd@ncronline.org
This story appears in the June 17, 2005, issue of National Catholic Reporter
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