Municipal Bond Market Commentary
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Municipal Bond Market Commentary
Although the COVID-19 pandemic has had many unfavorable consequences, one positive aspect has been historically low interest rates within the U.S. Municipal Bond Market. Yields for the Ten-Year U.S. Treasury Note, which serves as a benchmark for the overall municipal bond market, closed at 0.72% on August 31, 2020. This is slightly more than one-tenth (11.96%) of the average for the past 60 years of 6.02%.
For those School Districts that had successful elections on June 2, 2020 for general obligation bonds or levy increases to support new money lease financings, these low interest rates result in favorable borrowing costs. Specifically, the interest rates or reoffered yields are approximately twelve cents on the dollar for what the average yield on the Ten-Year U.S. Treasury Note has been for the past 60 years. This presents an opportunity to lock in some very attractive low rates on financings supporting new construction projects.
Another favorable outcome under these market conditions occurs when the District is concerned about the project costs coming in much higher than the budgeted estimates of the architect and/or the construction manager. By placing a higher interest rate on the bonds (e.g. 5.00%, 4.00%, or 3.00%) the reoffering premium an investor will pay until the call date (typically five years with L.J. Hart & Company) can be substantial (i.e. 117% to 118% of face value with the 5.00% interest rate). The additional funds supply a cushion to enable the District to complete the projects at a quality level closer to what the voter’s expectations might be. With the five-year call feature, it then becomes likely that the District can pursue a current tax-exempt refunding to significantly reduce future interest expense.
For those issuers with bond or lease financings that are currently callable, the very low interest rates are making it economical to complete refundings of the original issues. Thus far in 2020, L.J. Hart & Company has closed 24 bond refundings with a total par value of $87,065,000 that produced net interest savings of $6,075,615. Another eight lease financings with a total par value of $35,245,000 generated a future reduction of interest expense of $2,863,486. One client saved $302,271 by decreasing the average interest rate from 2.31% to an effective new rate of 0.98%, while another was able to refinance a lease with an average interest rate of 3.75% to 1.09% with an accompanying savings of $1,075,845 on an original issue size of $7,000,000. It took a quick response time, the willingness to schedule prompt special meetings of the Boards of Education, and the ability to understand the financial complexities taking place. The end result was considerable unexpected savings on existing bonds or leases that produced excellent public relations and an increased capability to consider larger no tax increase future financings.
Some proposals for future legislation in the U.S. Congress that can be helpful to Missouri School Districts include the repeal of advance refunding restrictions that were implemented under the Tax Reform Act and Jobs Bill that became effective on December 31, 2017. Under existing law to qualify as a tax-exempt refunding the existing (refunded) debt securities need to be called within ninety days of the issuance date; otherwise, the refunding securities need to be issued as a taxable security, which means much higher interest rates. With most of the analyses of taxable advance refundings, the net interest savings after accounting for the negative arbitrage included in the calculations, do not justify the extra expense. L.J. Hart & Company does support the removal of the advance refunding restrictions but does not expect this legislation to be approved before the November 3, 2020 election.
Other legislative proposals include the renewal of the Build-America Bonds which have taxable interest rates for the investor with subsidies from the U.S. Treasury of 45%, reduced after three years to 35%. The chief purpose of these Build-America Bonds is to jump start an extensive U.S. Infrastructure Program. Under the existing COVID-19 pandemic and the political divisiveness in the U.S. Congress, it seems unlikely that any final action is going to occur prior to the November 3, 2020 election.
L.J. Hart & Company very much appreciates this chance to communicate with the MoASBO audience. For those Districts that desire additional discussion of the U.S. Municipal Bond Market impact on Missouri School Districts, we welcome and encourage them to contact us.