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Taxation

NAST to Congress, White House: Don't Mess with Tax Exemption

FEB 14, 2013 1:37pm ET

Three state treasurers are leading an effort in the nation's capital this week by meeting with policy makers and the White House to say that curtailing or eliminating tax exemption is not an abstract issue but rather it would have significant adverse impacts at the state and local level.

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Comments (3)
The wake up call will be too late if governement doesn't realize that the people that lend money to State and Municipalities because of the Tax Free advantage will probably not lend it when and if it becomes taxable. At that point people will just shop around for the best places to park their funds, for the greatest returns. Len B
Posted by Lennyb98@yahoo.com | Thursday, February 14 2013 at 3:36PM ET
It is tempting, no doubt for sincere people in Washington to look at tax-exemption as a form of interest subsidy for states and municipalities and leave it at that. But, in reality it is an on-off switch, not only for projects like water and sewer improvements that will be more difficult to pencil out but for many issuers, who can be expected to lose access to funding from the bond market altogether. Or clients tend to be rather small compared to places like Chicago or New York, but they are just as important a part of America as the larger communities that we are all familiar with. Absent tax-exemption, who would be interested in a $1.4 million 30-year water and sewer revenue bonds issued by a BBB rated town with a Census population of 446? Maybe a bank. However the bank would not only want a higher interest rate but a shorter amortization-and therein lies the rub. Annual principal and interest payments on a $1.4 million 30-year 4% tax exempt revenue bond come to $80,962. Annual P&I on a 10-year taxable bank loan at 5.25% comes to $183,514. The bulk of the 12No7% increase in annual debt burden doesn't come from the higher rate - it comes from the pressure of accelerated principal payments. Not only banks, but investors in taxable bonds prefer shorter maturities. Corporations deal with that by issuing short and intermediate-term bonds with large balloon payments, which introduces market risk to their balance sheets that they deal with by paying to keep bank lines open and executing complicated derivative contracts. Our municipal clients cannot do these things. In many cases his is because of state laws and their own policies that are designed to keep derivative risks at bay. But the real killer for corporate-style balloon deals is the almost universal presence of tests based on maximum annual debt service (MADS) in resolutions and ordinances that were enacted in connection with outstanding municipal debt. Haw does our little town of 446, whose bond covenants require that net revenues of its combined water and sewer system generate 120% of maximum annual debt service and whose current customer rates and volumes generate net revenues at a healthy 196% of MADS deal with an $875,000 balloon (what would be left to pay on a 5.25% balloon bond with a 20-year amortization and a 10-year maturity)? The Town just goes to the State and to Washington to beg for money to fix its pipes pumps and valves to meet customer needs and environmental regulations. Raising customer rates by 1,000%, which would come close to meeting the town's debt service coverage covenants, is not an option worthy of serious discussion.
Posted by t3240m353 | Thursday, February 14 2013 at 9:50PM ET
It is tempting, no doubt for sincere people in Washington who are not municipal market participants, to look at tax-exemption as a form of interest subsidy for states and municipalities and leave it at that. But, in reality it is an on-off switch, not only for projects like water and sewer improvements that will be more difficult to pencil out but for many issuers, who can be expected to lose access to funding from the bond market altogether. Our clients tend to be rather small compared to places like Chicago or New York, but they are just as important a part of America as the larger communities that we are all familiar with. Absent tax-exemption, who would be interested in a $1.4 million 30-year water and sewer revenue bonds issued by a BBB rated town with a Census population of 446? Maybe a bank. However the bank would not only want a higher interest rate but a shorter amortization-and therein lies the rub. Annual principal and interest payments on a $1.4 million 30-year 4% tax exempt revenue bond come to $80,962. Annual P&I on a 10-year taxable bank loan at 5.25% comes to $183,514. The bulk of the 12% increase in annual debt burden doesn't come from the higher rate - it comes from the pressure of accelerated principal payments. Not only banks, but investors in taxable bonds prefer shorter maturities. Corporations deal with that by issuing short and intermediate-term bonds with large balloon payments, which introduces market risk to their balance sheets that they deal with by paying to keep bank lines open and executing complicated derivative contracts. Our municipal clients cannot do these things. In many cases his is because of state laws and their own policies that are designed to keep derivative risks at bay. But the real killer for corporate-style balloon deals is the almost universal presence of tests based on maximum annual debt service in resolutions and ordinances that were enacted in connection with outstanding municipal debt. How does our little town of 446, whose bond covenants require that net revenues of its combined water and sewer system generate 120% of maximum annual debt service and whose current customer rates and volumes generate net revenues at a healthy 196% of MADS deal with an $875,000 balloon (what would be left to pay on a 5.25% balloon bond with a 20-year amortization and a 10-year maturity)? The town just goes to the State and to Washington to beg for money that these larger political entities do not have to fix its pipes pumps and valves to meet customer needs and environmental requirements. Raising customer rates by 1,000%, which would come close to meeting the town's debt service coverage covenants, is not an option worthy of serious discussion.
Posted by t3240m353 | Thursday, February 14 2013 at 9:58PM ET
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A recent phenomenon is the emergence of bonds with shorter call protection as funding alternatives for municipalities. However, the shorter call protection also dampens the potential upside for investors, which in turn reduces the price they are willing to pay.

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