The Week in Public Finance: Hot Munis, Cooling Off Creditors and Warming Up to Facebook

A roundup of money (and other) news governments can use.
by | July 22, 2016

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It’s July and Muni Bonds Are Hot

The municipal bond market could be off to its best start since 2010, when federal policies helped fuel new issuance. During the first six months of this year, a total of $221 billion in bonds have been brought to market by state and local governments, according to data from the Securities Industry and Financial Markets Association (SIFMA). The total includes new bonds and refinanced ones.

Most of that activity has come from the second quarter of the year, specifically in May and June when the volume of new bonds in each month was the highest since 2008, according to an analysis by RBC Capital Markets’ Chris Mauro. Even Puerto Rico’s recent default on a $2 billion debt payment has not appeared to phase investors or hurt interest rates.

The market is currently on pace to finish the year with over $430 billion in issuance. But with more than five months to go before the end of the year, anything could happen -- particularly with a volatile presidential contest underway. Last year, the pace cooled in the second half of the year, with the value of total bonds issued finishing just shy of $400 billion. Still, Mauro said he is increasing his original prediction of new bond volume to somewhere between $400 billion and $425 billion.

The Takeaway: There are a few things that are really favoring the muni market this year. For one, the tax exemption on the income investors earn on their muni bonds now “carries more value for top [tax] bracket investors than at any time since the Reagan years,” said Alan Schankel, an analyst with the firm Janney Montgomery Scott. That's mainly thanks to an overall low interest rate climate and top earners paying a higher tax rate today.

Situations abroad have also worked in the muni market’s favor: The financial disturbance last month caused by Britain’s decision to leave the European Union steered investors away from stocks and toward bonds. The demand drove interest rates even lower. In addition, negative interest rates abroad have made the low bond rates in the U.S. look good by comparison.

No Budget, No Problem

Despite not being able to agree on a budget, states have no problem taking care of bondholders. In Illinois, legislators have approved a stop-gap budget that allocates spending for certain programs, the largest being public education.But even without a budget, state bonds carry "little long-term default risk,” according to Municipal Market Analytics’ Matt Fabian. Under Illinois law, bondholders are guaranteed payment.

That's now true in West Virginia as well. While legislators agreed at the 11th hour on cuts to balance the state budget, they first shored up how bondholders would get paid should the state start a fiscal year without a budget. The bill gives the governor the authority through executive order to pay all outstanding debt absent a budget by the first of the fiscal year. Not surprisingly, the move was applauded by credit ratings agency Standard & Poor’s, which said in an analysis this week that the law “untangles debt service from politics ... as we've observed in other states.”

The Takeaway: At least in Illinois, bondholders can only be placated for so long. Despite the legal protections, Fabian in his analysis notes that Illinois faces a record $7.8 billion deficit a year from now if its current spending plan does not change. That's because the state isn’t increasing any revenue streams to counteract spending. Illinois is also plagued by massive pension liabilities and is approaching a $10 billion backlog of unpaid bills. Although state leaders have portrayed the new agreement as a “positive step” forward, Fabian wrote that he “has a hard time viewing a budget this bad as anything but an admission of the governor’s and legislature’s failure.”

How to Quietly Lure Facebook

Utah Gov. Gary Herbert signed a package of bills this week, including one intended to attract Facebook to build in his state. The bill provides a sales tax exemption to companies that build sprawling data centers, which Facebook is considering doing in either Utah or New Mexico.

The bill was actually debated once before the current special session. It passed the full Senate and a House committee during the regular 2016 session, but died on the House floor because House members were upset they were not clued into the Facebook connection. Mention of Facebook was deliberately kept out of the public debate so as not to jeopardize the company’s purchase or lease of land for the data center. Facebook was concerned a leak would drive up the price, according to UtahPolicy.com.

The Takeaway: Utah House members aren't the only ones with hurt feelings. If the company does reach a deal with the state, Utah will have to report the forgone sales tax revenue as lost income on its next financial report, thanks to new accounting rules that kicked in this year. The savings for Facebook could strain Utah’s relationship with existing tech companies who have already committed to the state in its quest to attract the industry.

“By passing this, you are opening the doors to large behemoths to come in and compete with one of Utah’s own,” writes the CEO of C7 Data Centers in the comments section of the Utah Policy story. “We go all these years of paying sales tax, property tax, and a municipal tax on power, building a business, and then a behemoth comes in, and they get all the advantages that we would have loved while we were struggling against the big guys. We could have used the help.”

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