A Thumbs Down From Sell Side

The Bond Buyer - - Front Page - By aaron Weitz­man ChiP Bar­nett and

Mu­nic­i­pal bond is­suers and un­der­writ­ers re­coiled this month at a House GOP tax re­form bill that they said would shrink the mar­ket by more than a third.

The pro­posal was “like a light­ning bolt com­ing from a clear blue sky,” said Ben Watkins, di­rec­tor of Florida’s Di­vi­sion of Bond Fi­nance. “You would think that there would be some thought process in­volved in the mak­ing of this bill but clearly there wasn’t. We have to pre­pare for the worst and hope for the best.”

Kevin Dun­phy, manag­ing di­rec­tor and head of pub­lic fi­nance for Mit­subishi UFJ Fi­nan­cial Group, said the bill’s

spon­sors were tak­ing heat from the muni in­dus­try for fail­ing to con­sider the long-term im­pact.

The blow­back from mu­nic­i­pal pros came be­fore the House Ways and Means Com­mit­tee passsd a tax re­form bill that would boost rev­enue

by elim­i­nat­ing tax free pri­vate ac­tiv­ity bonds and ban­ning ad­vanced re­fund­ings. On Wed­nes­day Sen­ate sources said Fi­nance Com­mit­tee chair­man Or­rin Hatch would pro­pose a tax re­form pack­age that would

pre­serve PABs and re­fund­ings, while rais­ing rev­enue by elim­i­nat­ing – rather than merely re­duc­ing – the de­duc­tion for state and lo­cal taxes.

“Rec­og­niz­ing that the bill will be heav­ily ne­go­ti­ated as it goes through the leg­isla­tive process, I was really sur­prised by the ini­tial pro­posal” said Dun­phy. “The Ad­min­is­tra­tion has been say­ing it is pro- in­fra­struc­ture and pub­lic spend­ing up to $1 tril­lion, and then this comes out and it con­tra­dicts its pub­lic po­si­tion. This pro­posed bill dra­mat­i­cally in­creases the fi­nanc­ing ex­pense for in­fra­struc­ture spend­ing, not-for-prof­its, af­ford­able hous­ing and other gov­ern­ment projects.”

Watkins has sent let­ters to the en­tire Florida con­gres­sional del­e­ga­tion with some num­bers on what the state of Florida has been able to ac­com­plish re­cently us­ing the tools the House bill would elim­i­nate.

“Over the past 10 years, we have had 104 ad­vance re­fund­ing trans­ac­tions to­tal­ing $16.1 bil­lion that gen­er­ated $3 bil­lion of sav­ings as we were able to take ad­van­tage of his­tor­i­cally low in­ter­est rates and we re­funded over half of our en­tire debt port­fo­lio,” Watkins said. “We want to show with num­bers to try and com­mu­ni­cate the ad­verse con­se­quences and raise the aware­ness.”

Jami­son Fe­he­ley, JPMor­gan’s head of pub­lic fi­nance bank­ing, said the pro­posed elim­i­na­tion of pri­vate ac­tiv­ity bonds would hurt a wide va­ri­ety of is­suer sec­tors in­clud­ing not-for-profit health­care, pri­vate higher ed­u­ca­tion in­sti­tu­tions, sur­face trans­porta­tion, air­ports, sin­gle and multi-fam­ily hous­ing, among oth­ers.

“Tax­able debt of­fer­ings or tax­able bank lend­ing would be­come their only op­tion,” he said.

“I think it’s fair to say cer­tain pro­vi­sions in the pro­posed tax re­form bill took the mar­ket by sur­prise and the po­ten­tial mar­ket im­pli­ca­tions go­ing for­ward are still be­ing as­sessed,” Fe­he­ley said. “In any given year, ad­vance re­fund­ings make up roughly one-third of to­tal is­suance so the pro­hi­bi­tion on ad­vance re­fund­ings could clearly im­pact sup­ply go­ing for­ward. Whether that sup­ply gap gets ab­sorbed with new money re­mains to be seen.”

Although the tax­able mar­ket is ac­ces­si­ble and healthy, those is­suers would have to pay a lit­tle bit more but would be left with no choice since there are still projects and work to be done, he said.

Un­der­writ­ers said is­suers would have less flex­i­bil­ity when it comes to op­tion­al­ity and struc­tur­ing of deals, since tax-ex­empts tra­di­tion­ally come with a 10-year par call and tax­ables usu­ally fea­ture make whole calls. As a re­sult, some tax-ex­empt deals may not be fea­si­ble in the tax­able mar­ket.

“There could be a sev­eral hun­dred-ba­sis-point dif­fer­en­tial” in fi­nanc­ing costs, Dun­phy said “The op­tions may be to shrink or de­cline the deal. 501(c)(3) en­ti­tles have been deemed to de­liver a pub­lic ben­e­fit. With this bill, the gov­ern­ment is not sup­port­ing that mis­sion. Non-prof­its will have greater dif­fi­culty in the fu­ture be­cause this bill may in­crease their fi­nanc­ing costs by 30%.”

Fe­he­ley also said that some Is­suers po­ten­tially af­fected by the pro­posed tax re­form bill are now as­sess­ing all avail­able op­tions, “in­clud­ing ac­cel­er­at­ing trans­ac­tions into the mar­ket be­fore the end of the year, as well as other in­terim so­lu­tions de­signed to pre­serve the cur­rent tax sta­tus,” said Fe­he­ley. “We ex­pect mar­ket vol­ume to in­crease sig­nif­i­cantly fol­low­ing the Thanks­giv­ing hol­i­day pe­riod.”

Dun­phy said the muni mar­ket could shrink by one-third un­der the House bill, and that the tem­po­rary in­crease in is­suance to beat the dead­line would just be steal­ing vol­ume from next year.

How­ever not all is­suers can ac­cel­er­ate a deal fast enough to com­plete them be­fore the clock runs out.

Ken­ton Tsoo­dle, as­sis­tant fi­nance di­rec­tor with Ok­la­homa City and a mem­ber of GFOA’s debt com­mit­tee, said that process of speed­ing up deals isn’t easy with all the state man­dated ap­provals needed.

“Maybe most con­cern­ing, is the speed at which they want to move on this,” he said. “Over­all, we are very con­cerned, with the big­gest im­pact be­ing with our air­port. We have a cur­rent project to ex­pand the ter­mi­nal and pro­vide more gates for our air­lines as our city keeps grow­ing. It’s a roughly $90 mil­lion project and if we were to do the deal in the tax­able mar­ket as op­posed to tax-ex­empt, it could cost over $6 mil­lion of ad­di­tional in­ter­est cost, present value that is about $3 mil­lion.”

He also that the city has three up­com­ing ad­vance re­fund­ing op­por­tu­ni­ties and if those went away, it would lose about $6 mil­lion of sav­ings.

The limit or elim­i­na­tion of state and lo­cal tax de­duc­tion would hurt ev­ery­where, Tsoo­dle said, but it would hit es­pe­cially hard in his state.

“Here in Ok­la­homa, the cities don’t get prop­erty tax, we op­er­ate pri­mar­ily on sales tax and tak­ing that away could lead to them hav­ing less dis­pos­able in­come to spend on tax­able goods and ser­vices, di­rectly im­pact­ing the cities.”

Wil­liam Sims, manag­ing prin­ci­pal at HJSims said that he has no doubt about which area the House bill would af­fect the most.

“It will really hurt non­profit or­ga­ni­za­tions,” he said. “To the ex­tent that non­prof­its ful­fill their mis­sions to help the less for­tu­nate, the higher cap­i­tal costs with tax­able bonds will di­min­ish non­prof­its’ reach and cause more re­liance on gov­ern­ment so­lu­tions.”

While tax-ex­empt is­suance would shrink un­der the House bill, the sup­ply of tax­able bonds would rise, Sims said.

“Tax­able mu­nis would def­i­nitely in­crease,” Sims said. “How­ever, the loan to value, debt ser­vice cov­er­age and liq­uid­ity ra­tio re­quire­ments tend to be stricter in the tax­able mar­ket. The ra­tios will also be neg­a­tively af­fected by the higher in­ter­est rates of tax­able se­cu­ri­ties.”

He said the ef­fects of this change would be felt at his firm.

“I can­not speak for oth­ers, but it will cer­tainly af­fect us. We al­ready are ac­tive in the tax­able mar­ket, but this event would make us a lot more ac­tive,” Sims said. “The bill really hurts non-profit or­ga­ni­za­tions and the com­mu­ni­ties they sup­port. It would seem that there would be more ob­vi­ous tar­gets for tax re­form.”

Dun­phy said his big­gest worry is the pres­sure on the Ad­min­is­tra­tion to get some­thing done, af­ter ef­forts to re­peal the Af­ford­able Care Act failed.

“The Ad­min­is­tra­tion wants to get it done quickly so they claim a vic­tory,” he said. “I hope that in its haste some­thing detri­men­tal to new is­suance doesn’t sneak through.”

Ac­cord­ing to Florida’s Watkins, “This bill dis­re­spects the part­ner­ship that we have had be­tween state and lo­cal and fed­eral gov­ern­ment in terms of fund­ing and fi­nanc­ing for in­fra­struc­ture in the coun­try and it di­min­ishes the re­sources avail­able for in­fra­struc­ture. They aren’t sav­ing any­one any­more ex­cept for them­selves, I am hope­ful cooler heads pre­vail in the end, con­sid­er­ing this is in­con­sis­tent with ev­ery­thing they ad­vo­cated be­fore.”

The bill also poses a threat to un­der­writ­ers, Dun­phy said.

“This bill would ex­ac­er­bate the trend of small firms ex­it­ing the busi­ness. By re­duc­ing the amount of new is­suance, the bank­ing rev­enue pie will shrink,” he said. “With de­clin­ing rev­enues and in­creas­ing reg­u­la­tory and com­pli­ance costs, the busi­ness propo­si­tion is less at­trac­tive. How­ever, the re­main­ing muni bonds will be­came more at­trac­tive.” ◽

“It will really hurt non­profit or­ga­ni­za­tions,” said Wil­liam Sims of HJSims. His firm would be more ac­tive in tax­able deals, he said.

Florida’s Ben Watkins sent let­ters to his state’s en­tire con­gres­sional del­e­ga­tion.

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