WASHINGTON — Issuance of private-activity bonds subject to state volume caps declined in 2013 for the third straight year, as PABs face competition from other financing tools, according to an annual survey and market participants.
At least $8.82 billion of PABs subject to state volume caps were issued in 2013 — $2.26 billion or 20.42% less than the $11.09 billion issued in 2012. Issuance has been declining since it hit the recent peak of about $14.5 billion in 2010, according to the results of a survey of the states and District of Columbia by the Council of Development Finance Agencies.
The continued decline in issuance is "not surprising," CDFA officials said in their report on the survey. "To a certain extent, competition from alternative bond tools, including both special allocations of tax-exempt bonds and tax credit bonds, are driving the decline in issuance," they wrote. "As each of these vehicles takes a small slice of the private-activity bond market, each piece adds up to a significant decline."
While interest rates are low, issuers may choose to finance projects by issuing taxable bonds or receiving capital from private lenders such as banks, rather than by issuing PABs. As market-level interest rates rise, as expected over the next few years, demand for tax-exempt bonds is also likely to grow, CDFA said.
The survey is based on data reported each year by officials of the state and DC authorities that allocate PABs based on the state caps. CDFA released data for both 2012 and 2013 because it did not collect the 2012 data last year and there was no survey released in 2013.
Not every state provides data in every year, so some variation in the data can be attributed to their differing participation. Additionally, some of the numbers states report may not be accurate.
Issuance also declined in the muni market as a whole in 2013. Long-term muni volume dropped 12.5% during the year, in part because issuance of refunding bonds slowed substantially, according to Thomson Reuters.
Private-activity bonds are issued by public entities to provide low-cost financing for the projects of nonprofit organizations or companies that serve a public purpose.
Issuance of most types of PABs are subject to state volume caps based on a formula published by the Internal Revenue Service. In 2013, state volume caps for PAB issuance were the greater of $95 per capita or $291.88 million. Unused cap can be carried forward for up to three years but must be abandoned after that.
The types of bonds subject to the volume caps include certain types of exempt-facility bonds such as multifamily housing bonds, water and sewer bonds and bonds for hazardous waste facilities, as well as mortgage-revenue bonds, industrial development bonds and student-loan bonds.
PABs that are not subject to the state volume caps include such exempt-facility bonds as those for airports, docks and wharves, veterans' mortgage revenue bonds and 501(c)(3) bonds. Data on the issuance of these types of bonds was not included in CDFA's report.
The issuance of cap-subject exempt facility bonds, mortgage revenue bonds and student-loan bonds all declined in 2013. IDB issuance rose, as did issuance of redevelopment bonds and agricultural and other special categories of cap-subject PABs.
California was the state in which there was the most cap-subject PAB issuance in 2012 and the second most in 2013. But $732.9 million fewer PABs were issued in the state in 2013 than in 2012, representing about one third of the decline in overall PAB issuance during that period.
In 2013, the 50 states and D.C. received $32.75 billion of new volume cap allocation and carried forward at least $56.45 billion from 2010 to 2012. In total, states could issue about $90 billion of cap-subject PABs, according to CDFA.
But issuance in 2013 was only about 10% of the total volume cap. CDFA officials said the cap usage rate has declined significantly for several years. The highest PAB issuance recorded was in 2007, when states used 58% of their total cap, the group said.
Housing Bonds
Issuance of tax-exempt, single-family mortgage-revenue bonds declined 31.13% in 2013 and 52.65% in 2012. These bonds allow housing finance agencies to provide mortgages to first-time home buyers who meet certain income restrictions and who are buying homes that have purchase prices of no greater than 90% of the average area purchase prices.
John Murphy, executive director of the National Association of Local Housing Finance Agencies, said tax-exempt MRB issuance has been down since the height of the housing crisis. MRB proceeds are invested before they are used to assist home buyers, and because market interest rates are low right now, the proceeds would have to be invested at interest rates below the bond rates. This would create "negative arbitrage," or losses, for an issuer.
Greg Zagorski, legislative and policy associate at the National Council of State Housing Agencies, said that housing finance agencies are instead using other tools, such as selling loans to Fannie Mae, to finance single-family mortgages and lower their borrowing costs. He expects MRB issuance will pick up when interest rates rise and the bonds regain some of their competitive advantage compared to other financing tools.
When market interest rates rise, mortgage rates will rise, and HFAs will be able to issue MRBs with interest rates lower than conventional mortgage rates. Because mortgage rates are so low right now, mortgages financed by MRBs are less competitive, Murphy and Zagorski said.
Issuance of multifamily housing bonds, a type of exempt facility bond used to finance affordable rental housing projects, fell slightly in 2013 after rising the year before. Murphy said he was surprised that issuance declined in 2013 because borrowing costs for these types of projects should be low now, meaning that an issuer can issue more bonds have less of their project financed with other funds.
Student Loan Bonds/IDBs
Student-loan bond issuance continued declining in 2013. There was a 37.8% drop in issuance in 2013, following a 23.06% drop the previous year.
The decline in issuance was due to the elimination in 2010 of the Federal Family Education Loan Program, said Samantha DeZur, vice president of communications and industry relations for the Education Finance Council.
Under the FFEL program, private lenders could provide loans to students that were guaranteed by the federal government. Agencies would issue PABs to finance these loans. But after the program was eliminated, 100% of new federal loans have to be issued directly by the federal government. Therefore, new student-loan bonds are now only being issued to refund outstanding bonds and finance private student loans, DeZur said.
"Private loan issuance has been pretty steady and actually growing," DeZur said, but most student loans are direct federal loans.
Issuance of IDBs, which provide financing for small manufacturers, rose to $355.8 million in 2013 from $240.4 million the previous year. The 2013 figure is close to the total $373.9 million of IDBs issued in 2011.
Some states, including Massachusetts, Minnesota and New Hampshire, did not provide CDFA with 2012 data but reported IDB issuances in 2013.
The total issuance last year was far less than the nearly $1 billion of IDBs states issued in 2009, according to CDFA.
"Figures for 2014 and 2015 will be necessary to determine whether the 2013 total represents a leveling off of the IDB market, or a true rebound of tax-exempt bond use by small manufacturers," the group said.
Actions Could Be Taken
State and local government officials could take a number of actions to boost PAB issuance, CDFA said. Some officials could do a better job making potential borrowers of proceeds aware of PAB options. They also could standardize issuing documents and implement regular pooling programs to help borrowers save costs, CDFA said.
Authorities could create their own credit-enhancement programs, particularly as it has been harder to get letters of credit from banks since the Great Recession — something that has hurt IDB issuance, said Jason Rittenberg, CDFA director of research and advisory services.
Congress could also take action to bolster PAB issuance. Currently, exempt-facility bonds can be used for a variety of energy projects but not explicitly those for solar and wind power. Congress could add renewable energy facilities to exempt facilities category, CDFA officials said.
Additionally, Congress could make changes to the rules for IDBs, such as raising the limit on the size of projects that could be financed with them to $20 million from $10 million, increasing from the current $20 million limit the amount of capital expenditures borrowers can have over a certain period of time to be eligible to issue IDBs, and expanding the definition of manufacturing to include the production of intangible products such as software, according to the report.
President Obama and lawmakers have offered some proposals to loosen restrictions on PABs. One proposal in Obama's fiscal 2015 budget request, which has also become the basis for legislation introduced in Congress, would take PABs for water infrastructure out from under state volume caps so that more of these bonds could be issued.
But there have also been proposals to curb or eliminate tax-exempt PABs, and that will likely continue to be the case with lawmakers looking to raise revenues to offset lower tax rates. House Ways and Means Committee chairman Dave Camp, R-Mich., proposed in his tax reform discussion draft to eliminate the tax-exemption for PABs issued after 2014.
