A Thumbs Down From Sell Side
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.