The Bond Buyer - - Front Page - By John hal­lacy

and af­ford­able-hous­ing devel­op­ers will be more chal­lenged in dis­tribut­ing their bonds un­der pro­posed tax re­forms.

When you walk into an emer­gency room to­day clutch­ing your in­sur­ance card, you of­ten pass a wall of donors to that fa­cil­ity. You know that the phys­i­cal plant you are en­ter­ing would not be the same with­out those donors. Char­i­ta­ble con­tri­bu­tions will be pre­served in the tax bill pend­ing in Congress, so, per­haps, there will be no change in giv­ing pat­terns.

How­ever, the debt ser­vice be­ing paid fig­ures to be much greater than it would have been in a tax ex­empt mar­ket. This means that in the plan of fi­nance, cer­tain pa­tient rooms or op­er­at­ing room fea­tures may have to be fore­gone given the de­mands of the cap­i­tal bud­get. Or the im­prove­ments might have to be phased in over time as the bud­get al­lows.

A po­ten­tial 50 ba­sis point or more move in in­ter­est costs may make a great dif­fer­ence in the abil­ity to ser­vice the debt in go­ing from tax ex­empt to tax­able debt for all of the needs of the in­sti­tu­tion. In­sti­tu­tions of to­day may have a mix of tax ex­empt and tax­able debt. Con­sid­er­ing the lat­ter, tax­able debt is usu­ally con­sid­ered only when con­di­tions are op­ti­mal.

In the last cal­en­dar year, just over $51 bil­lion of health­care pa­per was is­sued for all kinds of fa­cil­i­ties. This amount rep­re­sented 11.3% of to­tal is­suance for the year. The num­ber was clearly driven to this level , in part by the amount of re­fund­ing ac­tiv­ity in the sec­tor.

If Tax Re­form goes through as drafted, the prac­tice of hos­pi­tal fi­nance would stand to change con­sid­er­ably. The in­ter­est cost con­sid­er­a­tion is just one of the many as­pects that are likely to change. For­tu­nately, health­care in­sti­tu­tions al­ready use full ac­crual ac­count­ing. How­ever, even for health­care there is a much greater level of trans­parency in a tax­able world.

The House ver­sion of the tax bill dis­con­tin­ues the de­duc­tion for ex­tra­or­di­nary med­i­cal ex­penses. Re­ports are sur­fac­ing that the Sen­ate may be more in­clined to pre­serve this de­duc­tion and may off­set the ex­pense with other ad­just­ments at the mar­gin.

An­other 501(c)3 sec­tor about to be changed if tax re­form is adopted as con­tem­plated is the Higher Ed­u­ca­tion sec­tor. Last year, Higher Ed­u­ca­tion ac­counted for $18.5 B or 4.1% of the to­tal mu­nic­i­pal is­suance for the year. I have al­ready dis­cussed the un­prece­dented rec­om­men­da­tion to tax en­dow­ments of a cer­tain size.

The con­cern here go­ing for­ward is that the en­tire sec­tor will be treated as tax­able. In much the same man­ner as is the case in health­care, tax­able fi­nanc­ing has been pur­sued from time to time when con­di­tions have been op­por­tune.


How­ever, the vast ma­jor­ity of fi­nanc­ing for higher ed­u­ca­tion has been ac­com­plished on a tax ex­empt ba­sis. Av­er­age credit qual­ity in this sec­tor is gen­er­ally very high. Yet many smaller in­sti­tu­tions with Baa/BBB type cred­it­wor­thi­ness have also fared well in this mar­ket with rel­a­tively low in­ter­est costs.

Mov­ing to a tax­able en­vi­ron­ment will have a pro­nounced ef­fect on in­ter­est costs. Col­lege af­ford­abil­ity has been a grow­ing con­cern for a num­ber of years. Un­less there is a sep­a­rate rev­enue stream, the costs of cap­i­tal are em­bed­ded in tu­ition. Higher in­ter­est costs are likely to ag­gra­vate al­ready climb­ing tu­ition costs.

An ad­di­tional fac­tor is the elim­i­na­tion of the de­duc­tion for stu­dent loan in­ter­est. This change may force some stu­dents into think­ing more about how many stu­dent loans they may be able to af­ford and it may have an im­pact on col­lege se­lec­tion. It will be in­ter­est­ing to see if the “free” col­lege op­tion is sus­tained in this en­vi­ron­ment.


Hous­ing is an­other sec­tor that has ben­e­fited from the mu­nic­i­pal ex­emp­tion and a va­ri­ety of fed­eral pro­grams for pro­vid­ing low in­come hous­ing. These as­pects have been most in­flu­en­tial when mort­gage rates are high and qual­i­fy­ing for a mort­gage is rather re­stric­tive. In the cur­rent low rate en­vi­ron­ment, the tax ex­empt hous­ing sec­tor has not been quite as ro­bust. Yet hous­ing is­suance in 2016 to­taled $19.9 bil­lion or ap­prox­i­mately 4.4% of to­tal is­suance. Hous­ing sup­ply is at a crit­i­cal stage in many lo­cales.

In Cal­i­for­nia, the prob­lem is acute. In re­cent dis­cus­sions in the San Diego mar­ket, I have been in­formed that a sin­gle “low” in­come unit may cost as much as $450,000 to con­struct. Tax ex­empt pro­grams can­not solve that dilemma, but the pro­grams do serve to pro­vide more units at the mar­gin.

As some­one who has worked in the tax­able world at var­i­ous points in my ex­pe­ri­ence, I fully ap­pre­ci­ate that the mar­kets are very dif­fer­ent in char­ac­ter and prac­tice. The tax­able mar­ket has great de­mand for large trans­ac­tions. Many in­sti­tu­tional in­vestors in the tax­able world seek out and want to hold in port­fo­lio bench­mark bonds. A bench­mark bond is usu­ally much greater in size than a mu­nic­i­pal term bond. An or­der of mag­ni­tude of 10 times would not be an ex­ag­ger­a­tion.

Small par size is not de­sir­able in the tax­able mar­ket. In mu­nic­i­pals, the av­er­age size trans­ac­tion last year was about $33 mil­lion. This amount does not ap­proach the level of a bench­mark bond.

I do fully ap­pre­ci­ate that the tax­able mar­ket is able to evolve and adapt to chang­ing needs. The base line con­cern is that smaller is­suers with lower cred­it­wor­thi­ness are likely to pay a great deal more in in­ter­est costs. Larger struc­tured trans­ac­tions such as pub­lic pri­vate part­ner­ships will find an even more re­cep­tive mar­ket.

The small col­lege with an en­roll­ment of 1,500 or the small com­mu­nity hos­pi­tal with a hun­dred beds is go­ing to be more chal­lenged in dis­tribut­ing their bonds.

We are await­ing more de­tails from the markup ses­sions of H.R. 1. We know that a va­ri­ety of in­ter­est groups in the af­fected sec­tors have been at a fever pitch of ac­tiv­ity since the re­lease. In the end, the vote tally is of more im­me­di­ate im­por­tance that the pol­icy nu­ances. Ev­ery­one would ap­pre­ci­ate a tax cut and would en­joy ap­ply­ing the re­leased funds as they see fit.

We just want to cau­tion that some of these freed up funds may need to be ap­plied to pur­poses that have pre­vi­ously been bol­stered by the power of the tax ex­emp­tion.

John Hal­lacy is a con­tribut­ing ed­i­tor at The Bond Buyer fol­low­ing a long ten­ure in the mu­nic­i­pal busi­ness, pre­dom­i­nantly as head of mu­nic­i­pal re­search for Bank of Amer­ica Mer­rill Lynch. John has also spent time as an an­a­lyst and man­ager at S&P Global, un­der­writer and mar­keter at four bond in­sur­ance com­pa­nies, and has served as the head of MAGNY and pres­i­dent of the So­ci­ety of Mu­nic­i­pal An­a­lysts.

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