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As Rates Rise, Florida's Refunding 'Run' May End

BRADENTON, Fla. – Florida will find it more difficult to refund debt now that an uncharacteristically long period of low interest rates in the muni market appears to be ending, according to the state's top finance official.

A convergence of factors is now pushing rates up, Ben Watkins, director of the Division of Bond Finance, told Gov. Rick Scott and members of the state's Cabinet Tuesday.

"I have to say this has been a long run," he said. "It's been extraordinary and it's been abnormal relative to historic market cycles that we had a very low interest rate environment and very favorable market conditions for a six-year period.

"This may be coming to an end."

Over the last few months, Watkins said interest rates have risen about 100 basis points due to several factors, including an improving economy and rising inflation that likely will lead the Fed to raise interest rates at its Dec. 13-14 meeting.

Another factor helping to drive up interest rates, he said, is the potential impact of tax reform that could reduce the benefits that tax-exempt bonds offer, which has affected investors' appetites for tax exempt paper.

"We see money for the first time in four or five years flowing out of the muni space and money being redeemed, which puts upward pressure on rates," Watkins said.

The Division of Bond Finance executed 82 refunding transactions over the last six and a half fiscal years totaling $12.6 billion that generated gross debt service savings of nearly $2.5 billion or $1.9 billion on a present value basis, according to the 2016 Debt Affordability Study that Watkins presented to the Cabinet.

Half of all state debt was refinanced at lower interest rates during that period.

Florida still has some refundings that are "in the money" relative to benchmark savings requirements, he said, but there will probably be fewer transactions in the months ahead as opposed to those done over the last 6-1/2 years.

The recent election of president-elect Donald Trump has also affected rates and sparked muni outflows, according to Ramirez & Co.'s Municipal Market Weekly report on Monday.

"Municipals significantly underperformed the flagging Treasury market last week in response to continued mutual fund outflows and a burst of new issue supply, as investors continue to embrace risk-on trades amidst a perceived pro-growth Trump administration," Ramirez said.

Major market influences included OPEC's decision to cut production, Trump's Treasury nominee who wants to issue 50-year and 100-year bonds, and an improving employment rate, the report said.

"New issue supply last week of $10.5 billion was digested, but with some concessions and unsold balances, Ramirez said. "Tax-exempt mutual funds experienced an outflow of over $2 billion in the week ending November 30, continuing the post-election muni selloff."

Florida has taken advantage of low rates by refinancing more debt than it has borrowed for new capital needs.

Watkins said the state has now seen a "watershed event" by reversing a decade of new-money borrowing.

Between 2000 and 2010, under former Republican governors Jeb Bush and Charlie Crist, state debt grew from $18 billion to a peak of $28.2 billion.

Since Scott took office in January 2011, the amount of outstanding state debt has decreased by about $4.1 billion to $24.1 billion in 2016.

Scott, a Republican who is averse to borrowing, said after Tuesday's Cabinet meeting that the state has done a "nice job" continuing to pay down debt - a trend that he hopes will continue in the coming year.

That could spell trouble for Florida's incoming state Senate president, who wants to use his powerful position to back an environmental program financed with the largest state bond program in 15 years.

Sen. Joe Negron, R-Stuart, has said he will sponsor the $2.4 billion program – of which $1.2 billion would be financed with state-issued bonds.

The other half of the program's cost would be paid by the federal government.

Negron said the program would finance the purchase of land and the construction of massive reservoirs to store polluted water to prevent toxic algae blooms like those that blighted Florida's southeast coast this summer.

He plans to file the legislation for next year's session, which begins March 7.

Conservative Republicans control both houses of the Legislature and like Scott have been reluctant to issue debt except for school construction and transportation projects.

Lawmakers have also resisted purchasing land for environmental purposes.

But Negron said when he announced his program in August that it offered a solution to years of caustic blue-green algae blooms that have choked marine life and threatened human health due to the release of bacteria-laden water from central Florida's 730-square-mile Lake Okeechobee.

The releases, controlled by the U.S. Army Corps of Engineers, caused fish-killing, malodorous blooms this summer along the coast in Indian River, St. Lucie, and Martin counties.

"For too long, our community has been plagued by tremendous environmental and economic impacts as hundreds of millions of gallons of water are released from Lake Okeechobee each year," said Negron, whose district encompasses St. Lucie and Martin counties, and a portion of Palm Beach County. "Permanent storage south of Lake Okeechobee is unquestionably needed as part of the overall plan to solve this catastrophic problem."

Negron did not release details about how the funding from the federal government would be requested or how long it would take to get.

The program he has proposed would be financed with 20-year bonds secured by revenues from the state's documentary stamp tax on real estate transactions, which have surged since the end of the 2008 recession as Florida's real estate market rebounded.

Watkins has said that documentary taxes could support Negron's program.

Negron said he will call for the debt to be issued under the Florida Forever bond program, an existing environmental land-buying effort for which $3 billion of debt was authorized in 2001.

About $1.02 billion of outstanding Florida Forever bonds are secured by documentary stamp tax revenues, and another $246.7 million of parity debt is outstanding under the Everglades Restoration Bond Program.

The bonds are rated Aa3 by Moody's Investors Service, and AA-minus by Fitch Ratings and S&P Global Ratings.

Scott, who would ultimately have to sign off on Negron's proposal, has not said if he will support it.

The governor is expected to release his budget recommendation for fiscal 2018 soon, and has said that he will include 5% pay raise for state law enforcement officers that would cost $11.7 million.

The budget will also include plans that Scott will support for issuing debt.

There is capacity for the state to issue new money bonds, according to Watkins' debt study.

The state's ratio of debt service costs to available revenue fell to 5.46% in 2016, compared to 5.58% in 2015, a factor that supports maintenance of the state's triple-A implied general obligation bond ratings from Fitch Ratings and Standard & Poor's, and the Aa1 rating from Moody's Investors Service.

The ratio is below the 6% "target" that lawmakers prefer to maintain for planning purposes, although their policy is to cap borrowing at 7%.

At the rate Florida has been issuing debt, the ratio is projected to remain well under 6% for the next decade but the percentage is "dependent upon continued revenue growth and restrained issuance of new money debt," Watkins' study said.

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