Tax rewrite took a big bite out of Texas bond issuance


DALLAS — Todd Brewer, partner for Orrick, Herrington & Sutcliffe’s public finance practice in Houston, began his career as a bond lawyer in the financially eventful year of 1987.

That was the first year after the 1986 tax bill roiled the municipal bond market. It also coincided with an oil price collapse that devastated real estate in Texas, creating a wave of bond defaults by municipal utility districts that had sprung up in the Houston area during the preceding boom.

“I learned how to be a bond lawyer as things were collapsing,” Brewer said.

From 1980 through 1989, more than 400 Texas commercial banks failed, including nine of the state’s 10 largest bank holding companies. In 1988, the federal banking system counted 175 failed Texas banks with assets of $47.3 billion. That represented 25% of the state’s 1987 year-end banking assets, according to the Federal Reserve.

Thus it’s worth noting when Brewer calls 2018 one of the three most significant years of his career, joining 1987 and 2009, the year after the global financial collapse.

“It was a very difficult year,” Brewer said of 2018, citing the loss of advance refunding in the 2017 tax legislation that sharply curtailed bond issuance. “It could have been much worse if private activity bonds for nonprofit institutions had also been eliminated.”

The House version of the 2017 tax bill would have killed private activity bonds, but the final legislation preserved them.

With total bond issuance in Texas at $31.4 billion in 2018 per Thomson Reuters, volume fell 23% over the previous year and 38% from the record year of 2016. The statewide volume was the lowest since 2011 when the recession’s maximum impact was felt in municipal finance. While new money was down in 2018, the bulk of the downturn came from refunding.

“It represents a significant monetary loss to issuers in the Texas market due to an inability to refund at interest rates available in 2018,” Brewer said. “For most of the issuers, interest rates remained attractive.”

Nationally, volume of $338 billion was down nearly 25% compared to 2017, which was not a strong year, either. Volume in Texas was down 20% compared to 2016. Texas ranked third in volume behind California and New York.

For Texas’ 2018 fiscal year, which began Sept. 1, 2017, and ended Aug. 31, debt issued by state agencies, colleges and universities dropped by 18.2% to $7.07 billion compared to $8.65 billion issued in fiscal year 2017, according to the Texas Bond Review Board’s recent report.

Fiscal year 2018 issues included $4.77 billion in new-money and $2.3 billion in refunding bonds. Other debt issued included $1.63 billion of commercial paper.

State issuance is expected to continue to fall in the current fiscal year, according to the board. Texas state agencies plan to issue about $4.4 billion in bonds, commercial paper and variable-rate notes during fiscal year 2019, a projected decrease of $1.31 billion or 22.9% year over year.

Local debt issuance in fiscal year 2018 dropped $6.77 billion or 17.2% from the record issuance in fiscal year 2016.

Local refunding fell nearly 49% to $11.8 billion, according to the BRB.

“Over the past five fiscal years, 93.8% of local governmental refundings achieved both a cash and net present value savings,” the 2018 report said.

"It's a once in a generational shift," said Orrick public finance vice chair Todd Brewer of the firm's hiring of 20 public finance lawyers.

“I learned how to be a bond lawyer as things were collapsing,” says Orrick partner Todd Brewer.

Texas local governments, not counting conduit issuers, had $230 billion in outstanding debt at the end of fiscal year 2018, an increase of $34.6 billion or 17.7% since fiscal year 2014, the BRB reported. Of the 2018 total, 65.3% or $150.22 billion was general obligation debt to be repaid from local ad valorem tax collections while the remaining 34.7% or $79.77 billion will be repaid from revenues.

Texas issuance of local debt has varied over the past decade from a low of $21.68 billion in fiscal year 2010 to a high of $39.41 billion in fiscal year 2016.

Over the past five fiscal years, new-money debt issuance totaled $83.94 billion and refunding debt totaled $79.76 billion. During that time the top three issuers of both new-money and refunding money were school districts, cities and water districts that together made up 88% of the new-money volume of $73.96 billion and 79.4% of the refunding transaction volume of $63.3 billion.

In the last fiscal year, weighted average of issuance costs for state bond issuers was $4.69 per $1,000 compared to $5.26 per $1,000 for fiscal year 2017, according to the BRB. The deals ranged in size from $4.1 million to $1.05 billion.

The average issue size for Texas’ state issuers in fiscal ’18 increased to $266.5 million from $256.1 million in fiscal year 2017. Fourteen of the 20 transactions completed in fiscal year 2018 were $100 million or greater in size compared to 22 in 2017.

Underwriters’ spreads began to increase after the financial downturn in fiscal year 2008 due to higher underwriting risk in the municipal bond market and higher issuance costs associated with the introduction of Build America Bonds.

The BABs program expired on Dec. 31, 2010. Since 2009 underwriting spreads have declined to levels seen prior to the financial downturn, according to the BRB.

In fiscal year 2018, the weighted average underwriting spread accounted for about 72% of all issuance costs. As a result of a decrease in other underwriter’s spread costs in fiscal year 2018, the weighted average underwriting spread per $1,000 of bonds issued decreased to $3.37 from $3.68 in fiscal year 2017.

During fiscal year 2018 fees per bond decreased overall compared to fiscal year 2017. Other issuance costs, including bond counsel, financial advisor, rating agency, printing and other costs per $1,000, decreased to an average of $1.32 compared to $1.58 in fiscal year 2017.

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