DALLAS — Refunding opportunities abound amid low interest rates, but the loss of State and Local Government Series Treasury securities has made escrows more challenging, according to those involved in some recent deals.
State and Local Government Series securities (SLGS, also known as "slugs") are commonly used to establish an escrow account for advance refunding of outstanding debt.
The securities allow issuers to avoid investment yields that significantly exceed that of their refunding bonds, allowing them to comply with arbitrage rebate and yield restriction requirements.
SLGSs are nonmarketable securities that, by design, comply with Internal Revenue Service rules.
With the federal debt limit issue back in play, the Treasury Department closed its SLGS window March 13. That forced issuers to seek escrow agents who could buy Treasuries on the open market or equivalent investments. As a last resort, the escrow account could be held in cash.
Some school districts in Texas have found that getting bids for open-market escrowed securities is becoming more difficult. The issuers are competing for the same Treasuries, sidelining some of the smaller issuers.
Humberto Aguilera, bond counsel with the firm Escamilla & Poneck in San Antonio, said that safe harbor provisions require an issuer to choose from at least three bids in awarding a contract to a provider of open market escrowed securities. However, out of five refundings he has been involved in since the SLGS window closed, none received three bids.
"So many people are going after these same types of securities, we're not getting three bids to meet that safe harbor requirement," Aguilera said.
By showing a good faith effort to obtain more than three bids, the issuer should be able to legally satisfy the safe harbor requirement, Aguilera said.
"It's a new wrinkle in our practice that we're dealing with," Aguilera said. "We're rolling with the punches until the SLGS window opens."
Lisa Pepi, director of cash and treasury management at the San Antonio Independent School District, said the issue came up as the district planned a $307 million refunding May 13.
The district, one of the largest in the state, had to undertake additional planning to minimize transaction risk and assure that an escrow agent would be found.
"We as issuers just need to understand the ramifications associated with the current conditions of the SLGS window being closed, the scarcity of eligible securities and the reluctance of banks to pledge collateral on bank deposits so that we can plan accordingly in a timely manner before the bond pricing," Pepi said. "Part of the challenge is getting people to understand why this is even a concern because this has never been an issue before with the availability of SLGS."
The SLGS window is closed for the 11th time in 20 years. However, this closing is expected to last longer than the typical two months or so.
The Congressional Budget Office estimated in March that Treasury is likely to have sufficient cash to make its regular payments through October or November without a debt limit increase. SLGS issuance counts as debt toward the debt limit, so Treasury closes the SLGS window as the limit nears.
If Congressional brinksmanship of recent years prevails, the debt limit would not be raised until the threat of default is near.
A financial advisor who worked on a recent refunding for a school district in North Texas said the escrow issue has not caused any of his clients to forego deals. However, he said banks are reluctant to hold an issuer's cash if Treasuries cannot be found.
"It actually costs the bank to collateralize a cash deposit," he said. "It becomes a little problematic."
Keeping bond proceeds in cash is also costly because the issuer will not receive any return and the IRS could still impute a yield on the escrow, according to Sam Gruer, Managing Director at Cityview Capital Solutions in Roseland, N.J.
In hopes of broadening the pool of assets that could be held in escrow, issuers sought the Texas Attorney General's guidance on whether agency discount notes from Fannie Mae or Freddie Mac would qualify. The AG's office has answered in the negative, though not through a formal letter, Aguilera said.
"It really limits the pool that you can put in your escrow," Aguilera said. "We're now seeing banks say 'We can't collateralize your escrow.'"
Spurred by refundings, Texas school district bond issuance has been robust in 2015, more than doubling the volume issued in 2014 for the year to date through April, according to data from Thomson Reuters.
In 2014, Texas districts issued $2.94 billion for the first four months of the year, including $1.93 billion for new money alone. Over the first four months of 2015, more than $7 billion has been issued, with only $1.23 billion for new money.
Districts have enjoyed record savings in a flood of deals so far this year.
San Antonio ISD achieved net present value savings of $34.8 million on its deal that priced through hometown underwriter Frost Bank.
Neighboring Northeast ISD closed on a $345 million refunding April 23 that provided nearly $50 million, or 14%, net present value savings, according to Brian H. Moy, senior director of budgets and financial analysis for NEISD. Since July 2012, NEISD has refunded $689.5 million of previously issued debt.
In the Fort Worth area, Birdville ISD issued $190 million in two series, including $98.3 million of refunding bonds. The issue came to market March 5, before the SLGS window closed. The present value savings equaled $11.2 million or 9.68%.
In the Houston area, Cypress-Fairbanks ISD saved 10.6% or $34 million in net present value on a $308 million refunding, according to Stuart Snow, chief financial officer. As muni rates have fallen to historic lows over the past five years, the district has had to pay closer attention to negative arbitrage issues, Snow said.
Another Houston area district, Clear Creek ISD, combined $67 million of new money bonds with $126 million of refunding. The deal saved CCISD $16.4 million in interest cost, according to school officials.
In the Austin area, Bastrop ISD's $53 million refunding of a 2007 series lowered its interest costs by 220 basis points, officials said. The lower rate provided savings of $12 million and reduced annual debt service costs by $400,000.
Over recent years, the district has obtained more than $20 million in savings, according to Sandra Callahan, BISD chief financial officer.
