As most readers of The Bond Buyer are probably aware, in early February President Obama signed into law a temporary suspension of the federal debt ceiling. Consequently, the Bureau of Public Debt re-opened the so-called SLGS window, which had previously been closed, and issuers were able once again to order State and Local Government Series for refunding escrows.
The nature of this law differs from the way Congress has historically handled approaches to the debt ceiling.
Typically, Congress approved a specific dollar increase in the debt ceiling level and the increase was sufficient for the Treasury to manage its borrowing for an extended period of time. In February there was no increase in the debt ceiling. Instead, the limit was temporarily suspended. Absent any further action by Congress, on May 19 the debt ceiling will automatically reset to the nation’s debt level. This has important implications for municipal issuers selling refunding debt near this date.
Since the debt ceiling will be automatically set to the actual debt balance on May 19, the Bureau of Public Debt will be legally unable to deliver SLGS securities to municipal issuers with a settlement date after that date. As most municipal bond sales are priced several weeks ahead of the closing date, this can affect issuer bond sales as early as late April and early May, with closings scheduled for after May 19th. To date, we have not seen any notification from Treasury regarding this concern, and it is possible that they have already accepted SLGS subscriptions for settlement past May 19.
As we have written in the past, the Federal government uses the SLGS program as a debt management tool, and is under no obligation to provide market participants with significant advance notice of any temporary cessation in their acceptance of applications for the purchase of SLGS, a SLGS window closure. Further, although historically the Bureau of Public Debt has honored all SLGS applications that were received prior to any window closings, a review of the SLGS regulations makes it clear that they are not legally required to do so. And in this case, they may be legally prohibited from doing so.
As a means to mitigate transaction execution risk, issuers should begin evaluating alternative means for purchasing escrow securities in the secondary market (“Open Markets”) through competitive bidding. Fortunately, the effectiveness of this approach was recently reaffirmed during the SLGS window closure a few months prior and issuers found the process, when managed professionally, to be efficient and effective with ample supply of dealers to compete.
Typically, only 48 to 72 hours are required for proper preparation for a bid. Even after the SLGS window reopened, many issuers reaped the benefit of being able to compare the cost of purchasing a refunding escrow with Open Markets versus the SLGS as long as there was sufficient preparation within the team.
While under normal market conditions some issuers and bond counsel firms prefer the ease and simplicity of the SLGS application process over a competitive bidding process, the looming extraordinary closure of the SLGS window introduces new transaction risks that must be properly and prudently managed.
In the very near future SLGS subscriptions may not be available through, or honored by, the Bureau of Public Debt, and bond sales may be delayed or bond closings may be jeopardized.
Because it can take 48-72 hours to properly structure and complete a bid process, in a situation where SLGS are suddenly unavailable for subscription, there may not be sufficient time to structure and complete a tax-compliant bid process if advance planning has not occurred. This might necessitate a delay of several days, putting the economics of the refunding at risk as markets can move adversely during this period and targeted savings levels may no longer be achievable.
For refunding transactions scheduled to be sold during this period of uncertainty, it is imperative that Open Market securities be seriously considered as a risk reducing strategy even if it provides little, or even no, demonstrable economic benefit to SLGS. Although Open Market securities generally may not be purchased for an advance refunding escrow if they provide no economic benefit to SLGS, this is not a factor if SLGS sales have been halted. Furthermore, as a matter of prudence, it is advisable to dual track both Open Markets and SLGS up until the day of pricing.
