Players in public finance have been shaken by proposed tax reform legislation that, if enacted, would eliminate tax-exempt advance refunding bonds, tax-exempt private activity bonds, tax-exempt financings of professional stadiums, and qualified tax credit bonds. These changes would alter many fundamental characteristics of debt that finances public infrastructure projects.
Many coaches preach that “the best defense is a good offense.” This adage can ring as true in politics as it does in sports. Public finance teams have launched vigorous efforts to inform elected representatives about how the public finance aspects of the proposed tax reform legislation threaten many important public infrastructure projects that are incentivized and made possible by tax-advantaged finance. Continuing this offensive game plan is vital.
In a best-case scenario, Congress will ultimately acknowledge the important public benefits provided by tax-advantaged financing and leave intact provisions of the Internal Revenue Code that incentivize public infrastructure investment. However, teams with a good offense must be prepared to play good defense as well. Thus, as the political gears churn, issuers and borrowers should huddle with legal counsel and financial advisors to consider the possibility of worst-case scenarios in which some or all of the proposed tax reform legislation is enacted.
Some issuers and borrowers are employing a “hurry-up offense” to close potential transactions before year end. While this strategy can avoid many consequences of the potential “worst case” scenario, it will not avoid some new disclosure considerations. For example, issuers and their counsel will want to consider whether the typically short general disclaimers regarding future changes in tax law should now address potential changes to income tax rates and the elimination of the alternative minimum tax, how eliminating state and local tax deductibility could affect an issuer’s coffers, and the recently discussed possibility that tax reform could trigger future federal sequestration of amounts owed to state and local governments. Additionally, deal teams should review mechanisms such as call provisions to ensure that issuers and borrowers have the nimbleness needed to respond to the potential effects of tax reform.
For some issuers, there simply isn’t enough time to issue “at-risk” bonds before the proposed effective dates of the legislation. And, at the end of the day, if all or part of the proposed legislation passes, everyone will have to readjust their strategy to some extent. While enacting an offensive game plan and hoping for the best, what should defensive coordinators be thinking about should the worst come to pass?
Because the proposed elimination of tax-exempt advance refundings appears in both the House and Senate proposals, these financings seem to be most at risk for elimination. Thus, issuers and borrowers should discuss with financial advisors potential adjustments to their debt profile for future offerings—e.g., among other things, whether a portion of future long-term fixed rate debt should be replaced with multi-modal variable rate demand bonds; whether the typical 10-year call protection for long-term fixed rate debt should be replaced with something different (such as “make-whole” calls); and whether it makes sense to re-enter the derivatives market as a means of interest rate management - a potentially scary proposition for many once-burned issuers.
Issuers, borrowers and their advisors also should consider how a repeal of tax exemption for all future private activity and stadium bonds could affect any outstanding bonds issued prior to the effective date of any such legislation and, in particular, how subsequent events could result in an unintended loss of the tax-exempt status of these bonds.
Legislative precedent over the last four decades reveals that significant new legislative restrictions on tax-exempt bonds of a type contained in the pending legislation are almost always accompanied by exceptions to those new restrictions for current refunding bonds (there being no plausible policy reason not to include exceptions of that type). However, for some reason (be it an oversight or intentional) the House-passed bill’s elimination of tax-exempt private activity and stadium bonds has no such exceptions. In the almost unthinkable event that those provisions are enacted without current refunding exceptions, reissuances of outstanding debt will take on a new level of importance due to their treatment as a current refunding for tax purposes.
Parties contemplating modifications to bond documents that would cause a reissuance of the bonds may want to err on the side of caution and make those modifications prior to year-end. Cautious issuers and borrowers of variable rate debt may wish to review outstanding bond documents to determine anything that needs to be done to ensure that any future conversions between interest rate modes and mandatory tenders fit within the prescribed rules that would prevent such actions from triggering a reissuance. Issuers and borrowers with PABs or stadium bonds involving commercial paper programs and drawdown bonds may be wise to consider defensive actions that need to be taken prior to year-end.
These are just examples of some of the defensive measures that issuers, borrowers and their advisors should begin to ponder as the offense continues to press Congress to drop those restrictive public finance proposals altogether. Yogi Berra once said “it ain’t over ‘til it’s over,” but he would undoubtedly agree that one should also cover all the bases when preparing for the game. Here’s hoping for those who were around in 1986, that this won’t be “like déjà vu all over again.”