DALLAS — Texas plans to sell $155 million of general obligation bonds for its water development program as the Internal Revenue Service conducts a routine audit of a 2002 deal.
Piper Montemayor, director of debt and portfolio management, said she does not expect the audit to affect pricing. “It’s a standard audit,” she said.
The Texas Water Development Board bonds are expected to be priced through negotiation on Sept. 11 with a closing on Oct. 2. Barclays is senior manager with Frost Bank, M.R. Beal & Co., Jefferies and Siebert Brandford Shank & Co. as co-managers. First Southwest Co. is the TWDB’s financial advisor, with McCall Parkhurst & Horton as bond counsel.
The Series 2012G bonds will mature serially through 2041 and carry ratings of AA-plus from Standard & Poor’s and triple-A from Moody’s Investors Service and Fitch Ratings. All three outlooks are stable.
Moody’s anticipates that Texas “will continue to recover at a pace faster than the nation both in the near term and in the long term. Risks include the need to structurally balance the budget while continuing to keep pace with demand for education and other spending in the fast-growing state.”
Earlier this month, the board issued $29.4 million of Series 2012F bonds for water projects in economically distressed areas of the state. Those bonds, with a final maturity in 2032, achieved a true interest cost of 2.638%, Montemayor said.
Disclosure of the IRS audit was included in the preliminary official statement for the upcoming deal and was posted last week on the Municipal Securities Rulemaking Board’s online EMMA system.
The IRS notified the TWDB that the Series 2002B bonds were randomly selected for an audit, according to the notice.
The IRS has conducted audits of municipal bond issues since 1993 as part of its Tax-Exempt Bond Compliance Program to ensure that issuers and bond counsel comply with the increased number of technical rules that have been enacted since 1986.
A targeted audit examines transactions that have potential problems based on information received from various sources. A random audit is designed to gather data from which the IRS can develop profiles for future audits, according to the IRS.
A 2002 study by the Bond Market Association, now part the Securities Industry and Financial Markets Association, showed that issuers were concerned about the effects of an IRS audit, particularly in the secondary market.
“Given the size and diversity of the municipal market, it is simply not necessary for a fund manager to buy a bond that is under the ‘black cloud’ of an audit,” according to the report, titled Secondary Market Effects of Municipal Bond Tax Audit Disclosure. “So, bonds under audit are not likely to attract new investors. On the other hand, if a fund already owned a bond that came under audit, the fund manager would typically hold rather than sell the bond with the hope that the matter will be resolved, rather than sell at a depressed price. Clearly, this behavior results in a decline in market liquidity.”
The likelihood of TWDB bonds to be ruled taxable is considered remote. The bonds are issued on behalf of water utilities whose requests for loans are pooled to achieve lower interest rates than the utilities could achieve on their own.
The largest borrower in the upcoming issue is the San Jacinto River Authority, which is in the midst of a $1 billion project. The agency scaled back its original request to $155 million from the original $250 million. The first phase of funding for the River Authority project came last year with $67.5 million of TWDB bonds.
Last November, Texas voters approved Proposition 2, which authorizes the board to carry up to $6 billion in outstanding debt. As of Nov. 30, it had about $1.06 billion of authorized but unissued GO bonds, according to Standard & Poor’s.
While the Texas economy continues to outperform the nation, analysts have cautioned that the state’s fiscal condition bears scrutiny amid pressures on education spending. For the first time, Texas legislators lowered education spending ratios in the 2011 session while dipping into the state’s rainy-day fund to soften the impact of falling revenues.
In preparation for the 2013 legislative session, a panel of 22 lawmakers is reviewing the state’s school finance system after five recent lawsuits challenged the funding of school districts. The study group was authorized in SB 1, the appropriations budget bill that was passed at the end of 2011’s special legislative session.
The TWDB issues financial assistance bonds under a 1997 constitutional amendment that consolidated the agency’s various authorizations, with debt proceeds supporting water conservation and related infrastructure projects.
While the program generally pays for itself, certain programs — including ones for economically distressed areas, a state participation program, and the water infrastructure fund — received support from the general fund.
Since creation of the TWDB in 1957, the Legislature and state voters have approved constitutional amendments authorizing it to issue up to $4.23 billion of bonds to finance water-related projects.
Created in response to the severe drought of the 1950s, the agency has played a major role in keeping the fast-growing state supplied with water.
With severe drought again gripping Texas in 2011, the importance of maintaining adequate water supplies became a high priority. The Texas AgriLife Extension Service estimated 2011 drought-related production losses at $5.2 billion.
The TWDB’s 2012 state water plan predicts water demand in Texas will rise by 22% by 2060. In the near term, analysts expect Texas to continue to outpace the nation’s economic recovery.
The state sales tax, which accounts for 56% of all general revenue collections in Texas, is up by 12.0% for 11 months of fiscal 2012 compared to the year before. That surpasses the previous projections of 5.4% growth in sales tax revenue. Texas has no personal income tax.
Overall general fund revenues are 13.4% greater than the same period in fiscal 2011 through July and are 12.9% greater than forecast. Fiscal 2013 sales tax growth is expected to be 0.4%. At the same time, year-to-date cash outflows are 6.8% greater than forecast, driven by public assistance payments that are 11.5% greater than forecast, according to Moody’s.
“The pressures from those costs demonstrate the downside to the growth in Texas’ economy and population growth that totaled 1.7% in 2011: as its population increases, demand for social services also grows,” according to Moody’s.