The looming battle between President Barack Obama and Congress over raising the $16.4 trillion U.S. debt ceiling threatens to slow the biggest wave of municipal refunding since 1993.
As the U.S. reached its statutory borrowing limit last month, the Treasury Department stopped issuing special securities that usually make it easier and cheaper for localities to refinance higher-cost debt. With municipal yields falling to 47-year lows, cities and towns bought $138 billion of these State and Local Government Series securities last year, the most since 2005, data from Municipal Market Advisors show.
The disruption can raise refunding costs, and may persuade some issuers to postpone deals, said Brett Johnson, Colorado’s deputy treasurer. Without the so-called SLGS, an issuer may pay an extra $40,000 to refund higher-cost bonds, he said. He plans a $31.5 million deal in February for Colorado’s Transportation Department, for which $40,000 is enough to plow about 3,500 miles (5,631 kilometers) of roads during winter storms.
“This particular transaction will produce enough savings that we probably will go through with it either way,” Johnson said from Denver. “But the savings would be a little bit less possibly than they otherwise would be with SLGS.”
It’s the eighth time in 20 years that the Treasury has suspended the program. It was established in 1972 as part of an effort to restrict localities from earning arbitrage profits by investing refunding proceeds in higher-yielding securities. The longest halt, from October 1995 through March 1996, lasted 162 days. The securities count against the government’s debt limit.
The debt ceiling wasn’t part of negotiations between the president and Republicans at the end of 2012, as lawmakers focused instead on averting more than $600 billion of spending cuts and tax increases that were set to take effect this month.
Sometime between Feb. 15 and March 1, the Treasury will no longer have sufficient funds to pay all its bills, the Washington-based Bipartisan Policy Center said last week.
If the SLGS suspension extends into February, it may slow refunding, said Matt Fabian, a managing director at Concord, Massachusetts-based research firm Municipal Market Advisors. Bondholders would stand to gain as they may get to hold higher- yielding debt longer, he said.
Refundings made up about 62 percent of the $373 billion of local issuance in 2012, the biggest percentage since 1993, according to John Hallacy, head of muni research at Bank of America Merrill Lynch in New York. In 2013, he forecasts the ratio will fall to 47 percent as localities sell more bonds to finance new projects.
SLGS are sold only to local governments, for terms fixed by the buyers, to help meet Internal Revenue Service restrictions. Their interest is set daily at 0.01 percentage point below the government’s estimated borrowing cost for each maturity. In certain refundings, a city or town sells debt and parks the proceeds in securities such as SLGS, funds from which go to pay the older bonds.
Treasury closed the issuance window Dec. 28 and won’t reopen it until Congress passes, and the president signs, legislation boosting the debt limit, the department said.
The securities can be bought through the Internet and don’t require help from investment bankers, according to Johnson. Transaction costs related to open-market purchases can eat into refunding proceeds and may make some issuers put off deals, he said.
In trading last week in the $3.7 trillion muni market, benchmark 10-year yields fell to 1.74 percent, the lowest since Dec. 31, data compiled by Bloomberg show.
With interest rates on similar-maturity Treasuries at about 1.87 percent, the ratio of the two yields was about 93 percent, and touched the lowest in almost a month. The lower the ratio, the more attractive Treasuries are relative to munis.
Cary, North Carolina, a suburb of the state capital of Raleigh, managed a refunding deal last week without SLGS and wound up saving $9,000 because of the level of Treasuries, said Karen Mills, the town finance director.
“The yields that we were able to purchase in the open market were higher than what the SLGS yield would have been,” she said.
That’s not always the case, she said before the deal. Sometimes revenue can get lost if the open-market bonds don’t match the maturity of securities being refunded, she said.
SLGS are “really easy” to use, said Johnson in Colorado. “You essentially go online and you make a couple of clicks” based on maturity dates, he said. “You get your rate pretty quick.”
Following is a pending sale:
New York’s METROPOLITAN TRANSPORTATION AUTHORITY plans to sell $500 million of revenue bonds as soon as this week. The proceeds will be used to finance transit and commuter projects. (Updated Jan. 14)
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