Philadelphia's tax lien sale and securitization.

• Author: Hayllar, Ben

City council's approval of the tax lien sale depended on balancing the city's financial needs with safeguards for low-income homeowners.

On June 30, 1997, the City and School District of Philadelphia closed their first securitization of tax liens. More than $106 million of real estate tax liens were sold to the Philadelphia Authority for Industrial Development (PAID). PAID used the liens to collateralize the issuance of seven-year bonds totaling $75,485,000. This sale marked the seventh securitization to take place since Jersey City's first effort in 1993. It also marked the first time the bonds were sold in a public offering and the first time a major rating agency insured the issue. Finally, there are many features in the transaction, such as the power to substitute liens during the life of the collection process, that make the Philadelphia tax lien sale and securitization a model for other cities interested in turning uncollectible liens into cash.

The tax lien sale and securitization process is possible because the rating agencies recognize that certain private-sector collection firms, known as servicers, can collect on real estate liens that governments with limited technical, financial, and personnel resources cannot. In fact, the rating agencies rate both the quality of the portfolio of liens and the tax lien servicer.

Because of the age of the liens, their high lien-to-value ratios, and other features of the lien portfolio, Philadelphia's independently elected city controller concluded that the revenue and law departments would collect only 40 percent of the proposed lien portfolio over the next five years. It should be noted that this is not the same as the city's real estate tax collection rate. It predicts only what the city would be able to do with a specific portfolio of old liens with high lien-to-value ratios. The difference between what the city would collect on its own and what the servicer is expected to achieve is new or found money for the taxing bodies. Securitizing the portfolio to collateralize bonds allows this found money to be available immediately. Because of the complexity of the transactions, the securitizations that have taken place have required cost of issuances that are greater than 3 percent of the bonds issued. In Philadelphia's case, costs of issuance were approximately $3 million or 3.8 percent of the bonds issued. This cost is justified since the sale and securitization provided $27 million in new money that would not have been available to the City and School District of Philadelphia otherwise.

Since 40 percent of the entire portfolio, or $42.5 million, would have been collected by the city with existing resources, this amount was removed from the proceeds of the sale and placed in a senior note that will be paid to the city and school district over the next five years. This so-called "hold harmless" money is separate from the new or found money achieved by the securitization.

Because the city will use the proceeds for economic development, the interest on the bonds is taxable. Typically, such taxable issues are priced at 50 to 75 basis points above the two-year Treasury bond.

The Portfolio and Servicers

Philadelphia's portfolio consisted of real estate tax liens on 33,591 properties of which 21,896 are residential. The city does not know how many of these residential properties are owner occupied and how many are rentals. More than 6,000 other properties are commercial or industrial and 5,908 are vacant lots. One third of the properties in the portfolio have liens that are at least 10 years old.

The rating agencies examined the portfolio from the time of its initial creation until four days before the bonds were sold. Because the portfolio was constantly changing, due to liens being deleted because payments had been arranged or errors in the liens had been identified, the rating agencies were asked to examine a moving target. However, once the portfolio was frozen and the agencies were asked to make a final rating, they had sufficient experience with...