Transcription:
Mike Scarchilli (00:05):
Hi everyone and welcome to The Bond Buyer Podcast, your essential resource for insights into all things public finance. I'm Mike Scarchilli, editor-in-chief of The Bond Buyer, and today's episode features portions of a critical and timely conversation from the bomb buyers Texas Public Finance Conference earlier this month titled The View from Washington Shifting Policy Wins moderated by Ajay Thomas from FHN Financial. The discussion features Emily Brock from the Government Finance Officers Association, Nicole Kracum of Oppenheimer and Co and Nick Samuels of Moody's ratings. Together they dive into the growing risks facing municipal issuers from heightened uncertainty over the federal tax exemption to the financial ripple effects of tariffs and potential cuts to federal support programs. Their conversation explores what these developments could mean for credit quality, borrowing costs, and the long-term resilience of state and local governments, especially as federal funding becomes less certain and local entities are forced to shoulder more responsibility. Let's get into it.
Ajay Thomas, FHN Financial (01:11):
Well, good afternoon everybody. Welcome to the Texas Bond Buyer Conference. It's really nice to see a lot of friendly faces and friends and colleagues and industry participants here this afternoon. Well, this is a really exciting panel from the standpoint of substance and a lot of theater, both because there's just so much uncertainty that's been in the marketplace that surrounds everything from tax policy to tariffs, which we all got a real good taste of this last several days and what's been being contemplated both at the federal level and certainly at the state and local level in reaction to what's happening with the Trump administration and some of the proposals that are going around the halls of Congress. So with that, I want to really start off our discussion really there and what is happening at the federal level with some of these policies that range a whole series of different topics.
(02:06):
While there's a lot of fixation on taxes and tariffs, we do have other things that are happening with government efficiency, with immigration, things that are going to affect healthcare delivery, and there's just a whole series of issues that I think are going to be very pertinent and interesting to what happens in our industry. So with that Emily Brock, you're right at the forefront of what's going on and being an advocate for the industry and for every participant that cares about public finance, you're probably going to be the most popular person at this conference for what the latest views are, more than you already are at most of these events. But with that, maybe you could give us an update from your seat as to in your work of what's happening in Congress and in the White House and in some of the threats facing the market as we sit here today.
Emily Brock, GFOA (03:02):
Never thought as a little girl that my popularity would hinge on being the biggest nerd on Capitol Hill, but I'll ask. I do want to say and credit where credit's due. It really has not been me advocating this time around, and I say that I've been doing this for 10 years now, so I have seen three different comprehensive tax reforms, five government shutdowns, 17 continuing resolution, so a fair amount of activity happening and threats to the municipal bond tax exemption. But this time around there has been so much vigilance on behalf of the entire market, both the issuers, the bankers, the lawyers and everyone in between who participate and advocate on our behalf. I just want to say thank you, especially for those in Texas and the work that you are doing, but to give you a status update, I did ask a friend in the corner if she could just hold up news reels because that's as current as they get these days.
(04:07):
What is current and what's incredibly important to us is this status of the federal activity that is working toward tax reform. As we all know, the 2017 tax cuts in Jobs Act are set to expire this year because we are a two year congressional budget cycle. So much of them would have expired in 10 years. So now what happens is, of course, the House and the Senate have to agree on a lot of things. The largest of which is how much is it actually going to cost us to extend these Tax Cuts and Jobs act? Right now we have two different reconciliation bills, one's in the house which says it's going to cost 4.5 trillion and one in the Senate, which is says it's going to cost us 1.5 trillion as usual, the math is not math thing. So what we need to do is we need to understand our vulnerability or our threat, and what we do is we look at, well, what are the methods by which Congress can use to pay for that, either 1.5 or $4.5 trillion?
(05:13):
Well, they can mess around with the taxes, right? And if you raise tax rates, you raise revenue for the federal government. If you lower tax rates, you'll lower taxes for the federal government, but then they can also look at mandatory and discretionary spending. The difference between the two is discretionary is like your operating budget. That's where Doge comes in. So to the extent that there are actually jobs lost and there isn't necessarily operating funds that are needed for the agencies, that's cost savings. But really what the house is looking toward is that mandatory spending side, and that's where we talk about Medicare, Medicaid, social security, veterans benefits, student loans, all of those things fall underneath that. It's like your YouTube TV subscription and your HBO subscription that you signed a long time ago, and they kept having those rates go up, but you love them too much to let 'em go, so you keep on paying for it.
(06:12):
The house is very interested in looking at those mandatory spending parts of the federal government to try to see where they can actually shore up those funds. So alas, that comes back to us was our vulnerability level, the municipal bond tax exemption. When that first category, the tax exemption is actually one of the top 10 tax expenditures of the federal government and who's above us. Well, beloved, things like the child tax credit, like estate tax, like salt, all of those things are above us, and so when they start crossing off, things above the list are vulnerability goes up and up and up. So our advocacy is at a heightened pace right now. It is more important than ever, especially for Texans to reach out to members of Congress to let them know that the municipal bond tax exemption is vulnerable and we need their support. And no, I am not gaslighting you. It is go time. It's time to reach out.
Ajay Thomas, FHN Financial (07:21):
Thanks. That's a great start. Emily. Let's discuss dollars and cents, and I think this will be pertinent to all three of you that are on the panel. You talk about the vulnerability and some of the other options that are immediately ahead of the municipal tax exemption and how we become increasingly vulnerable as those are accounted for. Do you sense from the conversations happening now in Washington that they've come to some consensus about what the value of the exemption is, and is that enough as a pay for to really make it vulnerable as people are so concerned about it?
Emily Brock, GFOA (07:58):
Yeah, I mean, 4.5 trillion is a lot, and the Joint Commission on Taxation has scored the entire municipal bond tax exemption at 300 billion over the course of 10 years. Now, what that means is it's not only future issuance, it's current outstanding holders of debt and their tax exemption. Now, I don't know about you, but if they take away the tax exemption for grandma's and grandpas, my mom, my dad, I will go after them. This is certainly a non-negotiable tactic to go ahead and take away a tax exemption on currently hold debt, but that's the value that they've been given. That's a substantial amount, 300 billion, but does it go toward paying 1.5 trillion or 4.5 trillion? That I think is the next question at hand.
Ajay Thomas, FHN Financial (08:49):
Nicole, in your role, you have a unique vantage point. You've been a banker, you're a credit currently, and you work with a lot of the bankers at your firm as to in their clients and their issuers over what some of these type of issues ultimately mean for them from a credit perspective. Where do you see the, let's say either the muni tax exemption is eliminated completely, partially certain sectors, how does that affect credit spreads and investors and issuers and how they might interact with one another going forward?
Nicole Kracum, Oppenheimer (09:24):
Thanks, and thanks for having me speak on the panel today. Excited to be here. So repealing or limiting the tax exemption would raise borrowing costs, taxable bonds yield more than tax exempt bonds and sometimes in many cases by more than 50%. So doing a simple analysis from a spread perspective, that could look like 150 to 250 basis points. And if you're increasing your interest costs, well that makes your debt service a larger part of your annual budgets. And so with that, you have the crowding out of other spending priorities, you may have to increase taxes, or in other cases, issuers may pull back on capital spending or reevaluate their capital programs. So it would make a major impact to put another dollar amount on it. Reports estimate that governments saved 714 billion in borrowing costs, and that was from 2000 and to 2014 due to the tax exemption.
(10:33):
Other estimates looking forward, borrowing cost savings of 824 billion is estimated for the next decade due to that tax exemption. I think an earlier panel, some people talked about some of the other possible implications of losing the tax exemption. We think about limited or non-existent market access for the smaller or less frequent borrowers. So that's going to cause a major impact for our market. And again, to put some numbers on it, roughly 25,000 muni borrowers have outstanding debt under 25 million, and that's compared to a thousand corporate entities. A couple other implications of losing the tax exemption, issuers would have less ability to call that for savings and then refinancing risk would enter the picture as well.
Ajay Thomas, FHN Financial (11:31):
Nick, let's continue on a little bit with that as the structure of how a municipal issuer may have to access the marketplace and costs necessarily with that, I think there's some consensus that will automatically go up for them. From your vantage point, how has that recalibrate maybe make you rethink from a rating agency standpoint, the credit quality and viability for some of these issuers going forward, especially as you look at different parts of the country, maybe regionalize it, and here we've got fast growth areas here like Texas and in the south, Southeast versus maybe somewhere like the Northeast where you see some population flight and some declining ability to support tax bases and revenue streams.
Nick Samuels, Moody's Ratings (12:20):
Yeah, I mean bigger issuers who issue frequently may be able to adapt better. Some of those issue taxable debt now because of the purposes that they issue for are very diverse. But like Nicole said, smaller issuers or small issuers who issue every few years or not very often will have a harder time getting into the market and need to find different ways to finance their capital needs. We talked about even bigger issuers, but who have big capital plans and big capital needs, who would see their borrowing costs go up? Maybe they have to adjust their capital plans, but that doesn't mean that their capital needs are diminished, especially for certain types of purposes. So it creates new challenges.
Emily Brock, GFOA (13:08):
I would also say this access to capital is really salient in a member of Congress's office. For those of you who don't know, GFOA supports a website called built by bonds.com, channeling our inner fels, as you know in a high tech way, but built by bonds.com is a repository for issuers to go in and tell their story what has been built by bonds, but also there's a number of other resources on that website, one of which University of Chicago generated over the last couple of weeks. All that we asked was who is issuing in each congressional district? And you go into this website and you can poke on your congressional district and you've got a laundry list of the last 10 years of issuers, and we walk right into the member of Congress's office and we draw, we take a marker out, we draw a line right above that $30 million mark and we say, everybody below this is going to have a hard time finding access to capital. That is a compelling point. They're looking at that and they're saying, but my kid went to that middle school. I've drove across that bridge today. But as you're looking at it, it sinks in that access to capital will be much harder for those essential public service providers in their community.
Nicole Kracum, Oppenheimer (14:34):
Uncle. Yeah. One thing to maybe add there is people talk about the fact that states may have to intervene if we get to this dire scenario where the tax exemption is taken away, that states would have to intervene and maybe with numerous avenues, bond banks or guarantee programs or state intercepts, et cetera. But in a lot of cases that would require state law changes, political will to get that done, and then resources to actually build out that program. So it's not easy and it's costly, so it's not a good solution.
Ajay Thomas, FHN Financial (15:16):
The other issue for some of the smaller issuers and ones we see most frequently all across Texas and other parts of the country is just going to be the shift in how you have to access capital if you can get access. Because I think going to a fully taxable market, while the municipal market is now more increasingly familiar, I would say not totally educated in the taxable market of how a municipal issuer works from a credit perspective, and Nicole, you probably have a lot of knowledge about that, the anticipation that you could move theoretically into a more of a corporate style market with big term bond bullet maturity type structure as opposed to the serial bonds that our municipal brochures are used to not only drives a cost up, but also limits access to the marketplace for a whole range of issuers because they're not able to issue bonds that way.
(16:12):
And there's certainly the winners and losers of being a bigger size deal in a corporate market versus less one. And also the weekly competition for airtime with investors and to get their focus because now instead of a 10 billion heavy week in Munis that we talk about for issuance, you could be in a week of 45 and 50 billion with a whole range of corporate issuers competing for investor attention. So there are a lot of different issues that result out of that. I know Emily, in your efforts and in your discussions, the conversation certainly is to play defense and hold off any adjustment to the muni tax exemption at all at this point. But we are all hearing about members of Congress and staffs thinking about in the White House, thinking about sector specific maybe type cuts, taking more of the scalpel approach to the muni tax exemption, as they say, for sectors such as housing and higher education, healthcare, the use of private activity bonds in different segments, how does that ultimately resonate with members of Congress to say, we really don't want to go even there. We think that the Muni tax exemption needs to stay intact as a whole for the municipal issuer? Well,
Emily Brock, GFOA (17:33):
I mean, it's actually a pretty legendary story from 2017 when a certain member of Congress who was chairman of the Ways and Means committee had written into the 2017 Tax Act, the complete elimination of private bonds, and boy, oh boy, that was a lot. It's still a lot, but here we are again, and I'm thinking back to that 2017 circumstance where Chairman Brady came back and he was talking with an airport and an airport said, if you get rid of private activity bonds, that new gate is gone. Is toast talking with a 5 0 1 C3 college? And they're saying, yeah, if you eliminate private activity bonds, that student housing is dead. So I don't know if it's actually true or not, but five days later, private activity bonds were out of the bill. So telling the story of what private activity bonds do in your community seems to be an essential element of making sure they stay out.
(18:45):
But I'd also like to say GFOA has a policy. Bonds build community, all types of bonds build community, and the way that we operate on Capitol Hill with the public finance network is together with the A HA with nacubo, with all of the private activity bond issuers along with geo and revenue bonds, we don't really see a distinction, but they do. You are hearing sentiment on certain members of Congress's staff and certainly those that were there in 2017 who had opinions back then. They still have those opinions now and education needs to take place. That is the projects need to be articulated to them that will have a much more difficult time, become much more expensive in their districts. Those are the most compelling stories that help for them to understand elimination or taking a scalpel approach. Not only does it not raise enough revenue to be compelling to pay for either 1.5 or $4.5 trillion, but it also makes costs for hospital beds much higher.
Ajay Thomas, FHN Financial (19:57):
Nick, maybe you can speak to this and then Nicole, as we think about different sectors and the importance of having access to tax exemption for them, I think higher ed comes to mind, right? Where we have a whole range of different institutions facing real headwinds with, we've even heard on the previous panel with K through 12 about their challenges with enrollment. That certainly is bubbling up to the higher ed sector where you have an enrollment cliff coming. When you think that is just as an example, but you look at other sectors like housing and healthcare where we are seeing some discussion about maybe the tax exemptions not needed for them. How do you view that from your lens as severe for that sector versus is that a winner and loser scenario between geo issuers and higher ed? I mean, how does that impact the marketplace from your view?
Nick Samuels, Moody's Ratings (20:52):
Well, let me answer it in several different ways because you've picked out a sector that is facing a whole set of unique headwinds now, and it would be very interesting whoever introduces the controller tomorrow who's moving on to a new job in higher ed to hear what his thoughts about that are. But look, I mean, let's talk about just the credit challenges for the higher ed sector, right? They already are facing enrollment challenges. They're facing enrollment. That's just because of changing demographics in the US because of changes in views of the value of higher ed of a higher education degree. They're facing challenges to the extent that international students can't as easily come to the US now. Those tend to be students that pay more US students, and they're now facing this very challenging environment of research grants and other types of grants being withheld from them with not a lot of sense of what sort of the process or warning of when those grants might be withheld.
(21:59):
So really big challenges. And of course, higher education institutions also, depending on where they are and what they do in the context of research, can be economic drivers for the local governments that they are within. And that has real potential to the extent that those types of things are withheld or slowed down to really slow economic growth in their areas. Also would be a good question for the controller tomorrow, because Texas a and m has a lot of very important research institutions related to transportation and some other things that really are drivers here and important sources of data that we use in all of our transportation research.
Ajay Thomas, FHN Financial (22:41):
Nicole, maybe if you can answer it from this perspective, from your credit strategist point of view and the intermediary link you play between bankers, yours and investors themselves. How do you possibly see the investor base as a whole being impacted by all the discussion going on in Washington about the threat to tax exemption to possibly, yes, there's chance that it will be eliminated outright to certain sectors. Taking all that into consideration, do you see a thinning of the investor base happening? Do you think that No, they'll just course correct. They'll adjust, they'll be expansive, and there'll be enough buyers out there.
Nicole Kracum, Oppenheimer (23:24):
That's a tough question because, so you're saying in going to the taxable market,
(23:31):
So presumably that would bring in some new investor types where the tax exemption didn't benefit them, so presumably it would bring in some of those new types of buyers. But municipal credit in a lot of cases is very, can be esoteric, can be particularly for some of the issuers that we were talking about earlier. They're smaller or issue less frequently. An investor, an international investor may not have the time or wherewithal to want to understand those smaller credits. So those types of buyers may not automatically shift into our market beyond that. It gets complicated. Yeah, I'll stop
Ajay Thomas, FHN Financial (24:24):
There. Yeah, I know something I'll worry about is we've seen over the last 12 to 18 months, certainly the proliferation of activity from SMA that are participating in a lot of transactions and helping to clear the market in a lot of cases. And we're not seeing wild over subscriptions on deals anymore as we used to in certain times of the market. So when you do get into these periods of time where there's competition for investors and certain investors are making market decisions and either stepping to the sidelines out of the marketplace for various reasons or getting, taking a more cautious approach in where they make investment decisions based on alternative investments that are available at any given point in time, the tax exemption being either eliminated or capped in some way, I think is starting, if not already, already, creating anxiety among insurers that need and have active capital programs that fight for investors every single transaction, every single day trying to get as many eyes on their deals as possible out in the marketplace.
Emily Brock, GFOA (25:35):
Yeah, I think there's no love lost for investors in Congress despite popular belief. I think what Congress is looking at is you really have to extract yourself from an analytical viewpoint from the municipal market, and you really have to talk about use when you're talking to a member of Congress. There is no other private activity bond more beloved than affordable housing right now. You talk to any member of Congress and they will say, I don't love private activity bonds, but I love affordable housing. In fact, I did talk with a member of Congress and they were saying, we just love Litech and we throw our full support behind Litech, but we do not support private activity bonds. And I said, well, that's going to be a hard one to take apart there. You need one to have the other. And so really educating them to say, private activity bonds by use is articulated in the tax code and it is able to be scalpel out by use. But then you kind of throw in the most recent discussion, of course about stadium bonds. Popular belief on the hill is that stadium bonds are private activity bonds. They're not always private activity bonds. So articulating that use and really having a conversation about what it is that you're the tool, the tax tool that you're looking at and what it means to the citizens in your community is a conversation that is a real conversation that happens very frequently with us, between us and folks on the hilt lately,
Ajay Thomas, FHN Financial (27:19):
Nick, it seems like what all we're talking about, whether it's the threat to tax, exemption to implementation and the aftermath of tariffs, some of these other issues that are related to that in terms of what the federal government is looking to maybe push down on states and local communities, it sort of screams to me that issuers are going to be having to increasingly think strategically about resiliency whether whatever level of government issuer you are, and I know we've talked a little bit about, and there's been focus on disaster recovery and climate and what's going on with different communities and how they're addressing it from your vantage point, and as you look at credit, strength and resiliency, do you think that any of these issues stand out to you as an issuer, really needs to start focusing on how they manage through certain funding mechanisms that they're maybe exposed to the federal government or how resilient they need to be if they can't issue tax exempt bonds, for instance, anymore?
Nick Samuels, Moody's Ratings (28:26):
Well, the strongest rated entities are doing that anyway because they have very strong fiscal governance, and so they're sort of scenario analysis, analyzing those things all of the time anyway. But you used the word resiliency, and we can think about that in a lot of different ways, right? Fiscal resiliency. I think we want to talk a little bit about disaster relief, but I think also if you've listened, as we've listened to the three of us talk, and we've probably said the word uncertainty at this point, like 25 times in the last 25 minutes, and that is the thing that is creating the greatest credit challenge right now is there are really new levels of uncertainty just coming from many different directions for municipal issuers right now. But I want to talk about the real resiliency for a second because you mentioned disaster relief, right? And the same with Medicaid.
(29:20):
That's a 60-year-old program where there's a known status quo in the context of disaster relief funding. There also has been a really known status quotes. So you have an event, a natural disaster event, there's a presidential declaration. You very much know you're going to get reimbursed for your first responder cost and your debris cleanup and all of these kinds of things at a specific level if you go through certain exercise of keeping your receipts and submitting your reimbursements. And I don't think that that has been questioned per se, but there is a lot of uncertainty about political rhetoric of will those funds flow in a timely way so far, yes. But in the context of other kinds of resiliency, there is a program created in the Infrastructure Act called Brick, and I'm not going to get the acronym right, building Resiliency into Communities or something like that, which is just canceled either earlier this week or at the end of last week, Texas local governments lost more than $500 million from that of resiliency programs, which would make them more resilient to future disasters and maybe cost less than going forward. Those grants are gone and as part of this overall budget cutting. So it really means that if you had thought that certain types of capital improvements or other types of resiliency programs or adaptation programs would be paid for by the federal government or that they would have a share in it, that's not the case anymore. So now you have to reevaluate your capital spending and where the money's going to come from and what's the thing that you can't do if you really think that you have to do this other thing.
Ajay Thomas, FHN Financial (31:08):
We've all been involved in conversations in Washington, what's been going on, and we talked about several of some of the high level more public issues. Emily, maybe start with you. Is there anything that, from an issue perspective, that is viewed as, wow, this is important to issuers in the industry to really wrap their mind around they do this, this is in threat in what's being discussed from a policy perspective in Washington? Is there something that we don't hear about maybe often as frequently enough that you're hearing that, oh, well, that's actually under consideration.
Emily Brock, GFOA (31:43):
Oh, well, the tax exempt municipal bond, right? But you keep, that's like every other word out of my mouth, but I think that, as I mentioned before, there's a lot of sort of false ties that are existing like, oh, well, what if we take this little bit of the tax exemption away, but we give you this? And the reality is sort of separating those conversations, whether it is the state and local tax deduction or the fallacy that tariffs will actually raise enough revenue for the exemption or for the tax bill itself. It's incredibly, the math is not mapping, and so we continue to try to drive home the point of what individual decisions of individual tax code policies are going to have and the implications of local governments moving forward.
Ajay Thomas, FHN Financial (32:39):
I'll end with this. I think we collectively feel issuers are the absolutely the best advocates for what's going on right now, especially with the threat to muni tax exemption and bringing to life how valuable a tool that is for your local communities. And to the degree you can reach out to your congressional delegation, your state representatives in your area and jurisdiction, and impart to them how important these issues are. And as Emily put it, making tangible connections to this is what tax exempt bonds build in these communities and how they make them affordable not only in real time and for future, but how you manage your tax rates and the strength and the future of your institutions in the community that make your community what it is. So great discussion. Thank you so much for that.
Mike Scarchilli (33:35):
We hope you found this episode of the Bomb Buyer Podcast, both informative and illuminating. A big thank you to Emily, Nicole, Nick, and AJ for offering their deep insights into the evolving challenges coming out of Washington. Here are three key takeaways from today's discussion. One, municipal issuers face increasing uncertainty, not just from the ongoing debate over the federal tax exemption, but from broader shifts in federal fiscal policy that could push more financial burdens onto states and local governments. Two, borrowing costs could rise sharply if the tax exemption is curtailed, disproportionately impacting smaller issuers and making access to capital more difficult for essential infrastructure projects. And three, in this environment, proactive financial management, strategic resiliency planning, and strong advocacy with policy makers are more critical than ever from municipal issuers to protect their fiscal health and funding flexibility. Thanks again for listening to the Bond Buyer Podcast. This episode was produced by the Bond buyer. If you liked what you heard, please subscribe on your favorite podcast platform. Leave us a review and check out our ongoing coverage@www.bombbuyer.com. Until next time, I'm Mike Scarchilli signing off.