Municipal borrowing rates have declined significantly over the past several weeks as all debt markets have traded higher, driven by increased uncertainty about future domestic and global economic growth. Domestically, many market observers are starting to wonder if the longest expansion in U.S. history is losing steam and what will be the long-term economic effects of certain policy measures, such as the ongoing trade conflict with China. Internationally, uncertainty surrounding Brexit negotiations, as well as stagnating growth in European and Asian markets, is adding to economic worries.
Accordingly, the Federal Reserve Board (Fed) lowered its target benchmark rate another 25 basis points recently, further marking the end of a multiyear tightening cycle and reversing previous predictions for multiple rate increases in 2019.
Ongoing economic concerns have been reflected by significant declines in long-term borrowing rates, as investors scale back their outlook for long-term growth. We see this in the U.S. Treasury yield curve, which is now partially inverted. Additionally,
The charts below present the recent movement of tax-exempt and taxable rates at different parts of the curve, as well as the evolution of the MMD/Treasury ratio over the same time period.
If the 2017 Tax Cuts and Jobs Act had not eliminated advanced refundings, today’s rate environment would stimulate a significant boost in advance refunding transaction volume, with issuers taking action to refinance outstanding debt at lower rates. However, since advance refundings are no longer available, underwriters are aggressively pursuing alternative refunding structures, including:
As you evaluate refunding proposals, we urge careful consideration of the pros and cons of each refunding approach. By definition, the first three approaches are more costly than traditional tax-exempt debt. It is helpful to keep the following questions in mind:
As mentioned earlier, all alternative refunding structures, with the exception of cash defeasance, are more costly than tax-exempt borrowing. So the key rationale for undertaking one of these refunding approaches should be either the need to secure debt service savings prior to the call date of the bonds, or a strong belief that the current rate environment will soon deteriorate.
We recognize many local governments are working through tough budgets and welcome cost saving measures. That said, given the current economic outlook and reasonable likelihood of further Fed loosening action, we urge abundant caution and forward thinking when evaluating the breakeven analytics between undertaking an alternative refunding today versus waiting to refinance debt through a current refunding.
Baker Tilly Municipal Advisors welcomes the opportunity to discuss your refunding alternatives to determine the true viability of a refunding for interest cost savings or other related objectives from debt restructuring.
For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.