A Retiree, a Toll Bridge, and a Feasibility Study That Missed
A 62-year-old retiree with a $500,000 portfolio, 70% in CDs and 20% in investment-grade bonds, tells her broker she wants 'safe, tax-free income' and cannot afford principal loss. The broker proposes $150,000 of 5.25% unrated senior lien bonds for a toll bridge, 30-year final, with 1.10x base-case debt service coverage from a 2022 feasibility study projecting 6% annual traffic growth. First-year actual traffic came in 22% below forecast, and the bonds have a 3-year ramp-up period before the 1.25x rate covenant is tested. The debt service reserve holds six months of payments, and there is no bond insurance.
1. Evaluate the suitability of the proposed $150,000 purchase for this customer.
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The recommendation fails on its face.
- Stated objective: safe, tax-free income, no principal loss. This is an unrated, single-asset, 30-year project finance bond with traffic risk. It does not match.
- Concentration: $150,000 is 30% of a $500,000 portfolio that is otherwise in CDs and investment-grade bonds. A single unrated credit at 30% is not a suitable allocation for a capital-preservation investor.
- No insurance, thin reserve: six months of debt service is a modest cushion for a ramp-up asset.
- Track record: first-year traffic 22% below forecast is a material adverse development, not a footnote.
Regulatory frame: the recommendation must have a reasonable basis and be suitable for the customer; the suitability analysis has to weigh the stated objective and the concentration. If the customer insists, the broker must document the discussion and the risks in the customer's own words.
Alternatives to discuss: insured or higher-rated municipals, a laddered portfolio, or a much smaller position.
2. Analyze the feasibility study and identify what the broker must disclose.
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Read the study critically:
- Traffic growth of 6% annually is aggressive for a mature toll facility; toll roads typically show ramp-up then GDP-like growth.
- A 1.10x base case is thin. Base case should not be the stress case. Look for the downside scenario; if the study does not have one, that itself is a finding.
- The rate covenant is not tested for three years. During ramp-up, coverage can fall without a technical default. The reserve only covers six months.
- First-year shortfall of 22% suggests either the study's assumptions or the model was wrong. Ask whether the study was updated after the shortfall, who prepared it, and whether the issuer has commissioned a new one.
- Call and refinancing features, toll escalation assumptions, and competing routes all need review.
Disclosure to the customer: the unrated status, the 22% traffic shortfall, the thin coverage, the ramp-up covenant holiday, the reserve size, the absence of insurance, and the illiquidity of a 30-year unrated issue. The customer should not hear about the shortfall from the newspaper.
3. The customer insists on participating. What, if anything, would make a partial allocation defensible?
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A defensible partial allocation would look like this:
- Size: a small fraction of the portfolio, not 30%. A position on the order of a few percent limits the damage if the credit deteriorates.
- Suitability documentation: the customer's stated objectives, the risks disclosed, the alternatives offered, and the customer's decision, all in the file.
- Updated information: the most recent traffic data, any revised feasibility study, and current coverage calculations before the order is entered.
- Structural mitigants: prefer an insured series, a shorter maturity, or a higher-lien tranche if one exists.
- No misleading framing: do not present 5.25% tax-free as 'safe income.' It is a high-yield project credit, and it should be described that way.
If none of these can be satisfied, the answer is no, and the file should show why.