City council's approval of the tax lien sale depended onbalancing the city's financial needs with sa...

1. Philadelphia's tax lien sale and securitization.
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

2. 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

3. 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 the portfolio to give it a
rating. In the end, the rating agency gave Philadelphia a 29 percent
discount, which translated into a lien portfolio of $106 million
supporting $75,485,000 in bonds. After establishing a $2.6 million
interest reserve and paying issuance costs, available funds for the city
and school district totaled $69,843,000. As stated, $42,527,000 of this
amount was held in reserve to protect future years' budgets. The
remaining $27.5 million (the new money) was divided between the city and
school district in accordance with their tax authority.

4. The difference between the portfolio value, $106 million, and the
amount of bonds issued, $75.5 million, was paid to the city and school
district as a subordinated note. The $30.8 million subordinated note
becomes the source of payment for both the bond holders and the
servicers. The bond holders are paid quarterly from the collections on
the liens. The servicers also are paid from the collections. Only after
all the bonds are paid off, does the city and school district derive
some revenue from the over-collateralized portion of the portfolio, the
subordinated note of $30.8 million. While it is assumed that some
revenue will come from the subordinated note, the city and school
district have not projected any revenue from this portion of the deal.
Exhibit 1 displays the details of the sale and securitization.
In choosing the servicers, the city through its financial advisor,
Public Financial Management, sent a request for qualifications (RFQ) to
23 companies known to have interest in this line of collections work.
The RFQs sought information regarding the servicers' experience in
real estate tax lien collection and their approval or rating from any of
the three rating agencies. Five servicing companies qualified after the
RFQs were evaluated. The subsequent request for proposals basically
sought the servicers' proposed fee structure. The most competitive
aspects of the fees proposed by the servicers were blended into a single
fee structure. Because of the relatively large number of parcels in the
Philadelphia portfolio, it was decided to obtain three servicers. The
contract between the PAID and the servicers allows for the shifting of
liens from those servicers who are underperforming specific benchmarks

5. to those who are achieving or exceeding the contracted benchmarks.
Exhibit 1
CALCULATION OF PHILADELPHIA TAX LIE SALE AND SECURITIZATION
Total Value of Liens $106,319,079 (A)
School's Portion $58,475,493 (B)
City's Portion $47,843,586 (C)
$106,319,079
Bonds/Issuable = (A) x 71% $75,485,000
Less Issuance Cost Reserve $5,353,146
Total Amount Bonds $70,131,855 (D)
Total Amt. Subordinated Note = (A) x 29% $30,832,533 (E)
Proceeds to School Dist. = (D) x 55% $38,572,520 (F)
Proceeds to City = (D) x 45% $31,559,335 (G)
City's Senior Note = (C) x 40% $19,137,434 (H)
City's "New" Money = (G) - (H) $12,421,900 (I)
City's Subordinated Note = (E) x 45% $13,874,640 (J)
Sch. Dist. Senior Note = (B) x 40% $23,390,197 (K)
Sch. Dist. "New" Money = (F) - (K) $15,182,323 (L)

6. Sch. Dist. Subordinated Note = (E) x 55% $16,957,893 (M)
(Because of different millage rates, the city's interest in the
real estate
tax lien portfolio is 45 percent while the school district's is 55
percent.)
Termination Fee. The fee structure is in three parts. First, there is
a termination fee. In the event that a servicer is terminated without
cause, it is entitled to a fee based on 2 percent of the principal value
of its portfolio, if termination takes place in the first year. This fee
declines until the third year when a 1/2 percent termination fee would
be paid by the issuer.
Administrative Fee. Second, there is an .8 percent administrative fee
based on the size of the principal amount of the portfolio held by each
servicer. As the portfolio is worked and liens converted into cash, the
value of the administrative fee will decline.
Incentive Fee. Of greatest importance is the incentive fee, which is
designed to encourage servicers to collect on even the most difficult
liens. Accordingly, the first 10 percent of the portfolio each servicer
collects will earn the servicer .25 percent of the funds brought in. The
incentive fee increases with each 10 percent of the portfolio collected
until the final 10 percent of the portfolio allows the servicer to earn
6 percent on the monies brought in.
The Rush to Pay

7. Publicity about the sale of the liens and the fear that the servicers
would somehow be more draconian in their collection methods moved many
long-standing delinquents to either pay their delinquencies or enter
into 12- to 24-month payment plans.
The City of Philadelphia increased the pressure on delinquents by
securing authority from the state legislature and city council to charge
up to 18 percent in attorneys fees for the collection of delinquent real
estate taxes. This 18 percent goes to the city and school district, not
the servicer, but it increases the value of portions of the portfolio
with liens filed after December 1990. Prior to the engagement of the
servicers, Philadelphia's delinquents flocked to make restitution on their back taxes. This rush to pay
before the terms of settlement got
tougher was also reported by other cities that used securitizations,
sold their liens directly to servicers, or simply hired private
servicers.
The initial legislation for the sale and securitization was submitted
to city council in November 1996, and final passage took place in June
1997. During the month of April, a series of public hearings was held by
City Council that generated significant publicity. The misinformation that is the stock in trade of
radio talk shows had a positive effect and
motivated people to pay their back taxes. Between May 1 and June 16, the
city and school district collected a combined $36,550,519 in cash. In
addition, 30,230 payment plans worth $68,816,768 were obtained.
Balancing Financial Interests

8. The biggest obstacle in selling the liens, hiring servicers, and
going forward with the securitization was obtaining city council
approval. Philadelphia, like many cities, has large concentrations of
lower-income people. City council members, particularly those who
represent low-income districts, were concerned about protecting
delinquent taxpayers from unfair collection methods. Even though
servicers are required to use the same methods, payment plans, and
techniques employed by the city revenue and law departments, many
council members feared that low-income people would be forced to make
payments they could not afford and also were concerned about adverse
voter reaction from a large segment of the population. More than 30
percent of Philadelphia's 600,000 households live on an income of
less than $15,000 a year. Almost 20 percent, one out of every five
properties, had a real estate delinquency and at least one lien.
In the end, getting this tax lien sale to market required balancing
the financial interests, as represented by the rating agencies, with the
safeguards for citizens required by city council. Every measure to
protect the interests of the delinquent citizen could result to one
degree or another in a greater discount and less money in the deal.
Without the provisions for protecting individuals, however, city council
approval would not have been provided. Because the school district
needed the money by the end of its fiscal year (June 30), finance staff
were able to provide a solid reason to do the securitization and a real
deadline for city council action.

9. The most significant protection provided to lower-income people was
to structure the servicing agreement to allow unlimited lien
substitution for either economic development purposes or because of the
economic hardship of the property owner. If a property whose lien is
being worked by a servicer is thought to be important for an economic
development project where the tax delinquency might assist a public
agency or a community development corporation in obtaining the parcel,
or if the property owner is clearly destitute, the lien can be
substituted with a lien of equal value and quality. Since the portfolio
did not include all the tax liens held by the City of Philadelphia and
because the city files up to $50 million of delinquent tax liens a year,
there is no difficulty in finding suitable substitutes. This feature
gave council members comfort that they could remove the truly destitute
from the servicers' embrace.
The experience of other cities that have utilized servicers is that
there has not been any increase in foreclosures, and the principal
servicers themselves report that while owner-occupied properties may be
threatened with tax sales, it is not in the servicers' financial
interests to foreclose on these properties.
The portfolio Philadelphia provided to the servicers was constructed
so that senior citizens and other taxpayers on special payment plans
were not included. People who entered into payment agreements with the
city before June 17, 1997, were assured that their liens would not be
placed in the portfolio nor would their liens be used for substitution

10. and put in the portfolio at some later date - even if they broke the
payment agreement. City council members were assured that people who
enter into payment agreements with the servicer and then break the
agreement will have at least 60 days before the property goes to tax
sale. District council members are to be notified two weeks before any
tax sale of properties within their district.
At the last minute, three recalcitrant council members agreed to
support the tax lien sale and securitization if the city would designate a million dollars of the new
money gained from the sale to set up a loan
program so that working people faced with tax foreclosure can get the
necessary down payment to enter into a payment agreement. Since the
city's housing funds come from community development block grants,
current loan programs are income restricted. Use of the tax lien
proceeds removes the income barrier. Under the new Homeowner Protection
Program, loans will be repaid with the tax delinquency as part of the
monthly payment plan. In addition, participants will be required to
undergo household finance and budget counseling to insure that taxes are
paid appropriately in the future.
As municipalities seek to turn uncollected taxes, fines, and fees
into cash, the sale and securitization of these receivables may be an
increasingly important tool. The Government Finance Officers Association
adopted a recommended practice, "Sale and Securitization of
Property Tax Liens," in June 1997, which is displayed in the
accompanying sidebar.

11. RELATED ARTICLE: GFOA RECOMMENDED PRACTICE Sale and Securitization
of Property Tax Liens (1997)
Background. Governments sell or securitize property tax liens to
eliminate backlogs of accumulated delinquent tax receivables and convert
those receivables into cash. Tax liens, which are attached to properties
for nonpayment of property taxes or those assessments, may be bundled
and sold directly to investors through a bulk-sale process. They also
may be sold to a trust, where the payment stream is securitized. Bonds
backed by the delinquent taxes are then sold to investors and the
proceeds of the issue are paid to the government that sold the tax
liens.
Recommendation. The Government Finance Officers Association (GFOA)
recommends that governments contemplating the sale or securitization of
property tax liens undertake a careful analysis of benefits and risks
both in the current fiscal year and over the long-term. When evaluating
the sale or securitization of tax liens, governments should:
1. Ensure they have legal authorization to enter into these types of
transactions and understand any conditions or limitations imposed by
state or local law.
2. Be clear about the public policy objectives to be achieved, such
as improving collections or avoiding costs associated with the ownership
of the property on which taxes are owed.

12. 3. Evaluate whether changes in the collection process could reduce
the occurrence of delinquencies.
4. Use sale proceeds for non-recurring purposes, particularly if the
amount of the sale or securitization is large. Governments using a tax
lien sale or securitization as a one-time mechanism to address a current
year budget gap should assess the short- and long-term implications for
the government's credit quality. They also should consider how gaps
will be closed in later years and whether structural budgetary balance
is able to be achieved without future tax lien sales or securitizations.
5. Determine that the net return after taking account of transaction
costs is acceptable in terms of alternative approaches, including
retaining ownership of uncollected receivables.
Once a decision has ben made to sell or securitize tax liens,
governments should:
1. Examine the lien pool carefully to ensure properties will be
acceptable to investors. Lien-to-value ratios of various classes of
property, the age of the liens, historical redemption rates in the
community, property types, and the number of environmentally impacted
properties are among the factors that should be considered.
2. Review statutory cure periods established to permit owners to pay
delinquent revenues to ensure that an appropriate balance is struck

13. between government policy objectives and acceptability to investors.
3. Select legal and financial advisors and other service providers
with demonstrated experience with these transactions.
4. Select a servicer with a proven track record if such a firm is
being used to collect delinquent taxes. Rating agency approval of the
servicer is typically required, and will be based, in part, on the
record of the servicer. Among the qualifications that should be
evaluated are:
* knowledge of state and local law;
* due diligence capabilities in the lien selection process;
* adequacy of the servicing system, including recording, auditing,
and financial reporting procedures; and
* historical performance in serving liens, including procedures for
workouts and foreclosures.
5. Recognize the community relations impact of establishing a private
collection mechanism. Governments should take steps to maintain good
relations among all affected parties, such as designating an ombudsman or instituting a formal
complaint process through which problems that
may arise are addressed.

14. References
* "Tax Lien Securitization: Putting Non-Performing Assets to
Work," Government Finance Review, GFOA, June 1996.
* "Municipalities Turn to Property Tax Lien Sales,"
Standard Poor's CreditWeek Municipal, March 25, 1996.
weight loss philadelphia
Approved by the GFOA Executive Board October 17, 1997
BEN HAYLLAR, Ph.D., is the City of Philadelphia Director of Finance
and a member of the GFOA's Committee on Debt and Fiscal Policy. He
joined the administration of Ed Rendell in 1993 after serving as
Pittsburgh's director of finance.