SLGS window would reopen, BABs cuts continue until 2029

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The Treasury trading window for State and Local Government Securities will reopen within the next two weeks under a budget agreement between the Trump administration and congressional leaders.

The two-year budget agreement, reached Monday and expected to be signed by the president following approval by the House and Senate in the coming days, would also maintain sequestration cuts to direct-pay bond subsidies for 10 more years.

Those are two of the impacts on the municipal bond market under the budget deal, which also provides state and local governments with federal funding certainty for the 2020 and 2021 fiscal years, once the House and Senate finish work on annual appropriations.

The House has approved 10 of the 12 annual spending bills for 2020, while the Senate has held back on floor votes awaiting a larger deal on spending caps.

The pending deal provides certainty for the Senate to vote on 2020 spending in September, though it leaves little time for the two chambers to work out their differences in a conference committee prior to the Oct. 1 start of the 2020 fiscal year.

The spending bills already approved by the House are $15 billion above the $632 billion cap on domestic spending agreed to under the deal and will need to be trimmed in conference, but it does represent an increase over fiscal 2019.

The two-year agreement is expected to be voted on in the House this week while the Senate may wait until next week.

Both chambers will be in recess during August and neither will reconvene until early September, when there is a possibility of a federal debt default if there is no action taken to raise the debt limit.

Speaker Nancy Pelosi, D-Calif., sent a letter to House Democrats urging them to support the deal.

“We must never let the full faith and credit of the United States come under threat, and therefore are proud to have lifted the debt limit until July 31, 2021,” Pelosi wrote.

The SLGS window has been closed since March 1, when Treasury began taking extraordinary measures to avoid breaching the debt limit.

SLGS are typically used by state and local governments and other entities that issue tax-exempt municipal bonds because of yield restrictions and arbitrage rebate requirements under the Internal Revenue Code.

The role of SLGS has been significantly diminished by the termination of advance refundings under the Tax Cuts and Jobs Act, with the amount of SLGS outstanding declining more than 49%.

There were 13,147 SLGS bonds and notes with a combined value of $47.9 billion at the end of June compared to 21,015 SLGS bonds and notes valued at $94.4 billion at the end of 2017, according to the Treasury.

There still are three uses for SLGS.

First, they are sometimes used for escrows in current refundings. They are also sometimes used for equity defeasance escrows which are yield restricted. The third use is for longstanding advance refunding escrows.

Senate Republican Majority Leader Mitch McConnell said Tuesday he will be “proud” to support the deal “when the Senate votes on the agreement before we adjourn at the end of the month.”

The deal includes $75 billion in spending cuts, including an extension of the mandatory sequester through 2029.

Federal subsidy payments made to issuers of Build America Bonds and other direct-pay bonds have been cut by 6. 2% in fiscal 2019 under sequestration, shaving 2.17 percentage points off the 35% federal subsidy. The subsidy for the current fiscal year, as a result, is 32.83%.

The sequestration rate cuts are not cumulative and reset at a new percentage annually.

Sequestration was enacted as part of the Budget Control Act of 2011 for spending beginning in March 2013. The cuts are automatic, annual, across-the-board reductions to defense and non-defense discretionary and mandatory spending programs which stem from Congress's failure to reach an agreement over how to significantly cut the deficit.

Richard Moore, president-elect of the National Association of Bond Lawyers, said he was “not surprised” the sequestration cuts to the BABs subsidy has been extended.

“I’ve come to accept that reality,” Moore said. “More than anything I think it’s another reminder that unless there’s protection from sequestration I don’t see a reinstatement of Build America Bonds as a valuable tool for building infrastructure.”

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