A new rule is going into effect next month that many believe will shed light on a controversial spending area for state and local governments: how much they owe banks for private loans.

The rule, issued by the Governmental Accounting Standards Board (GASB), lays out standards for reporting these loans in government financial reports. Unlike public debt -- which is issued through the municipal bond market and subject to regular disclosure requirements -- disclosures about direct loans from banks are not regulated. So, up until now, governments revealed as much -- or as little -- as they wanted about their private debt.

The lack of continuity has been a source of growing frustration, particularly as governments’ private debt rolls have ballooned. Since 2009, banks have more than doubled their municipal holdings to $536 billion in securities and loans.

Governments like the loans from banks because they come with lower costs and can be more convenient than going through the cumbersome public debt process. But observers worry that the terms of these loans aren't transparent enough, obscuring an important part of a government's financial health.

The new rule requires governments to include in their annual reports a statement called GASB 88 that will include not just the amount of money borrowed directly from banks but any unused lines of credit, any public assets pledged as collateral and any terms laid out in the lending agreement that could trigger early payment or financial penalties.

The rule goes into effect for government fiscal years that start after June 15, meaning most governments will begin including the information in their fiscal 2019 annual reports. It could apply -- by one estimate -- to as much as $50 billion to $60 billion in bank deals a year. That's significant considering that last year $448 billion in total debt was issued publicly in the municipal bond market.

Bank loans have been a point of contention, particularly with bondholders and ratings agencies, because some contain language that, in the event of a bankruptcy or default, makes private debt a priority for paying back over public debt.

What's more, the terms are so broad in some cases that the bank can recall the loan more easily. A Stanford University study of these types of loans in California concluded that more than half of the municipalities there that have borrowed from banks have put themselves at “financial risk” thanks to stringent terms in the loan. That, the paper concluded, makes direct loans riskier than bonds.

A credit rating downgrade could trigger a financial penalty or even a requirement from the bank to immediately pay off the remainder of the loan -- and ironically, such an event could strain finances so much that it could put a government at further risk for a downgrade. For example, in 2015, a downgrade by Moody’s Investors Services on Chicago triggered a $58 million penalty for the already fiscally beleaguered city. (The city ended up negotiating a new deal to avoid the full penalty.)

The rule is supported by many industry trade groups, such as the Government Finance Officers Association (GFOA) and the National Federation of Municipal Analysts, as well as regulators like the Municipal Securities Rulemaking Board.

The change for governments, says Michele Mark Levine, GFOA’s technical services director, shouldn’t be too onerous because most places have been reporting some part of their bank deal information in some fashion.

However, she warns, a federal proposal regarding bank loan disclosures could be far more cumbersome. Last year, the Securities and Exchange Commission proposed a rule that, among other things, would require governments to disclose direct loans from banks within 10 days of closing. The proposal has yet to move forward. 

In other public finance news this week:

Dodd-Frank Rolled Back

 

President Trump on Thursday signed into law the first major banking bill since the Dodd-Frank financial overhaul in 2010.

The measure, supporters say, will provide regulatory relief for small banks. But critics warn that it loosens important consumer protection requirements for lending.

For munis, the bill contains a big plus: It expands a federal rule outlining the kind of liquid assets that banks must hold in case of an emergency to include all investment-grade -- that is, anything above junk status -- municipal bonds. Up until now, banks have been limited in the kinds of municipal bonds that qualify as “highly liquid.”

Many were concerned that the limitation for munis would make it more expensive for states and localities to issue debt during the next economic downturn because demand for them would be lower from banks. Now, says National Association of State Treasurers President Beth Pearce, many hope the reclassification will strengthen the municipal bond market, “which will lead to lower borrowing costs for public infrastructure projects and result in savings for state and local governments and taxpayers.”

IRS Wants to Block SALT Workarounds

 

The Internal Revenue Service announced it would issue proposed regulations that address attempts by states to help residents avoid a new limit on the deductibility of state and local taxes.

So far, California, New Jersey and New York have passed laws that allow residents who owe more than $10,000 in state and local taxes to pay the remainder into a state charitable trust. More states have said they would follow.

Because charitable contributions are still tax-deductible under federal law, the state trust contribution offers residents a workaround to the $10,000 state and local tax deduction cap imposed by the GOP tax reform.

While high-tax blue states have complained the most about the new cap, some studies show that taxpayers across many states could be hamstrung by it.

According to a recent report by the Pew Charitable Trusts, the average taxpayer in 19 states and the District of Columbia deducted more than $10,000 in state and local taxes. For example, the average deduction in Minnesota was around $13,000, while Wisconsin residents who deducted state and local taxes averaged more than $11,600.

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