WASHINGTON – Municipal issuers may have to forget about buying state and local government series securities for the escrows of all those advance refunding deals they are rushing to market ahead of a final tax bill.
The bills in both the House and Senate would terminate advance refundings after the end of the year. State and local governments have reacted to the threat of the halt by advance refunding as many bonds as they can before the end of the year.
But the debt limit is looming and if Congress doesn’t suspend it or increase it by Dec. 8, then the Treasury Department will have to take extraordinary measures and the first action it usually takes is to halt sales of SLGS.
SLGS are specially tailored, non-marketable securities from Treasury that can only be purchased by state and local governments or other muni issuers subject to yield restriction and arbitrage rebate restrictions under the Internal Revenue Code. They are most often bought by issuers for advance refunding escrows, which are subject to yield restriction requirements. Issuers want to make sure their investment yields don’t exceed their bond yields. But issuers can also invest in SLGS with bond proceeds to avoid generating arbitrage.
“Because of the pending tax bills, issuers all across the country are rushing to do advance refundings before New Year’s,” said Sam Gruer, managing director at Blue Rose Capital Advisors. “The market is expecting a significant amount of advance refundings and the SLGS window is going to be shut down in the middle of it.”
Gruer said issuers may instead have to buy open market Treasuries for their advance refunding escrows.
“Given the potential for a large amount of transactions, issuers should start planning for this now,” he said.
Market sources said they are especially worried that smaller state and local governments with smaller transactions will be unable to advance refund their bonds.
Federal tax rules contain a safe harbor under which tax regulators won’t question the yield on an advance refunding escrow if the issuer obtains at least three bids for the securities to be put into the escrow. But what if smaller issuers don’t get three bids or any bids at all for escrow securities?
Underwriters and investment advisors may be swamped with advance refundings and not want to spend the holiday season trying to find bids for small deals, some sources said.
The Congressional Budget Office said in a report issued Thursday that if the debt limit is not suspended or raised after Dec. 8, the Treasury will have to take extraordinary measures.
But those measures would keep the federal government from running out of cash until late March or early April, CBO said.
Currently there is no statutory limit on the issuance of new federal debt because Congress the limit of federal debt through Dec. 8 in the Continuing Appropriations Act, 2018, and the Supplemental Appropriations for Disaster Relief Requirements Act, 2017, enacted in September.
That means that on Dec. 9, absent any action by Congress to extend the suspension or increase the ceiling, the debt limit will be reset to reflect the cumulative borrowing through the period of suspension.
As of Nov. 17, an additional $700 billion was borrowed, bringing the amount of outstanding federal debt subject to the limit up to $20.5 trillion, the CBO report said. On Dec. 9 the new debt limit will be that amount plus whatever is additionally borrowed through Dec. 8, the report said.
“Under current law, on Dec, 9, federal debt will be at the statutory limit and the Treasury will need to use “extraordinary measures” to continue to raise cash,” the CBO said. “Those measures would probably be exhausted in late March or early April.