Transcription:
Lynne Funk (
Hello everyone. Can you hear us tonight? Hi, everyone welcome. Welcome to the last panel of the first day of the bond buyers California public finance conference. It's so nice to see everyone.
John Stanley (
Do you want me to shout to try to get everyone to quiet down?
Lynne Funk (
You could yell if you'd like.
John Stanley (
We're gonna try to finish up this panel so that we can move on to the happy hour afterwards.
Lynne Funk (
But if you leave you can't get a cocktail. Just FYI. Just kidding, So Hi everybody. Welcome, Thank you for being here. It's so nice to see you all in person I'm Lynne funk. I'm the executive editor at the bond buyer. This panel today is we are covering the recently passed inflation reduction act and what it means for muni's. I'd like to welcome our speakers. First we have Shawn Dralle, She's the Executive Director at UBS Financial Services. Shawn joined UBS in early 2018. She began her career in the public finance industry nearly 30 years ago working for the predecessor firm to RBC capital markets. And after that JP Morgan she is a board member for the women in public finance Los Angeles chapter and has served on other non-profit boards and various capacities. So welcome Sean.
Shawn Dralle (
Thank you.
Lynne Funk (
And then we have John Stanley. John is a partner at Orrick who focuses his practice on the tax aspects of muni finance and on tax Controversy matters which often happens in muni's for sure. in his muni finance practice John has served as bond council special tax council and underwriter underwriters council for a variety of transactions including particularly governmental airport and public power financings. So, briefly the in inflation reduction act that was passed in mid-August features definitely a lengthy list of incentives for public and private entities to help push the country toward Joe Biden's goal of reducing gas house emissions by 50% by 2030. So, I'll note to start that while this new law may have other implications for public finance for our purposes today we're just gonna touch on a few. One of them is the law's central revenue generator which is a 15% minimum tax applied to adjusted financial statement income as opposed to adjustable taxable income of corporations with three year average incomes of more than 1 billion that is expected to generate about 220 billion over 10 years now Munis typically exempt from taxable income are not exempted from BA book income. So big corporations that have relied on tax exempt muni bonds to bring down income may find the paper less valuable. Some say this. So we'll we'll touch on that. but one of the sweeteners is a provision that's long long sought by the public power sector which is direct pay credits for clean energy projects. John would you you wanna to kick us off here with some of the the tax credit provisions and the sweeteners as we call them? Perhaps the good.
John Stanley (
Yeah. So the inflation reduction act provides a number of tax credits for taxable entities to fund things like renewable energy projects clean vehicles a number of other projects intended to reduce greenhouse gas emissions and it provides that any tax exempt entity in the United States including political subdivisions cities counties school districts 501 C three organizations with respect to 12 of these credits can get a direct payment from the federal government. So, you can think of this as a federal grant program administered through the tax code. So, things like I I think the big one that will impact maybe everyone here is if you personally go out and you buy an electric car you can get a tax credit. Now if your city or county is going out and buying an electric car they can get a tax credit. It'll be a direct payment back since it's not an offset to your taxable income but just a cash payment relating to that. The dollar amounts for the cars are not all that big. The dollar amounts are larger when you're talking about buses and vehicles over 14000 pounds but that's something that's gonna affect everyone. There's also focusing on the minor ones direct pay tax credits for building electric vehicle charging stations a number of other ones and then the big ticket ones that are getting get a lot of interest from this community are the investment tax credit and production tax credit for renewable energy projects. So if you're building a solar plant or if you're putting solar panels on your rooftop on the top of city hall or in your school district parking lot you're gonna be able to apply for a direct payment equal to some percentage of those costs. That's the investment tax credit the production tax credit gives you a dollar amount per megawatt of energy that is actually generated that's has to be sold to an unrelated person. So, the production tax credit is probably gonna be more relevant to public power entities rather than a city that's planning to use the solar power for its own load. so maybe I'll pause there.
Lynne Funk (
Sure. I was gonna ask then maybe specifically if you could talk about do you think that direct pay these direct pay credits for public power agencies and other muni borrowers that may wanna finance their own renewables as opposed to perhaps?
John Stanley (
Sure. So, I mean over the last however many years most large renewable projects in the country have been privately owned and municipal entities enter into power purchase agreements to buy the power from that. And that's in part because they had to be privately owned in order to get these tax credits. And when the tax credit is 30% of the cost it's hard to beat that. Now there's the potential for public power entities to go out and build their own projects claim the tax credits and one I know somebody who ran the numbers and looked at a 25 year comparison and as came to the conclusion that owning and getting the tax credits would be about 5% cheaper than an equivalent PPA. There's a lot of assumptions that went into that. I don't know what they were. I also wanna say that the choice between owning a project or doing a PPA from a project is not a apples to apples comparison. There's a lot of different elements that go into that. I've heard lots of people say that municipal entities prefer to own and if they can they will. I've heard other people say no it's just a lot simpler to stick with the PPA approach setting aside taking a step back and looking at the big picture for all of this. Right now we have private entities going out and building a large solar project. They're entering into a PPA with an MOU. A lot of their funding is coming from tax equity which is a lot of the big banks and tax equity charges a pretty high rate of return. So, that's driving up the cost a little bit meaning the power purchase agreement has a higher cost. Having this direct pay option perhaps puts some leverage on the table for municipal entities to say well instead of doing that I might build it myself and maybe I'll get a cheaper cost. The other thing that the act added is an ability for private entities to directly sell the tax credits. So, if you're a solar developer entity your your role is going out and building and operating these solar projects instead of needing to bring in that tax equity money. Maybe now you can just sell the tax credit. And both of these could have the effect of driving down the rates that tax equity is requiring lowering the costs for everyone. so we'll see how this all plays out.
Lynne Funk (
Okay. We'll get to some more of the technicals on tax credits but let's pivot to the we started with maybe the good but now let's go to the presumably potentially bad which is this new 15% tax minimum tax on corporate income. What Sean would you wanna start? what do you think the impact perhaps on demand might be with this?
Shawn Dralle (
Yeah sure. And I'll talk about as Kelly said we were we're as Lynn said we were talking about kind of the good the bad and the ugly and I suppose I get to talk about the bad and the ugly a little bit shockingly but it one of the bigger provisions of of the inflation reduction act which is a really odd name for this given all of the provisions within it. And it is a little bit of a Christmas tree with all of the ornaments on it. But on the surface it's like oh the this new 15% corporate minimum tax is really going to dampen or or damp down demand on the muni side. It is when when you drill down into it a little bit further the impact at least at first blush probably shouldn't be very impactful to the buy side or to the man side. If anybody has looked at the legislation or looked at some of the analysis for it about 150 corporations it's as Lynn mentioned in her remarks it's a an additional 15% on corporations that earn over a billion dollars over a three year period. And, based on accounting specific accounting roles that's about 150 corporations and of that amount. There's been some analysis done that shows that about 50% of those have some type of municipal holdings within their portfolios. And, so that's a relatively small number of companies that fit into that category. And there are other categories some large insurance companies some banks may get sucked into that billion and over category. But again of the amount of holdings that they have of municipals that's a very small percentage. And really in at least in the near term shouldn't really impact demand on the corporate sector the one thing I said I would add a couple of things actually since I get to talk about the bad and I'm also the oldest person up here is that impactful from a buy side perspective not so bad. And we'll talk about ESG in a second because frankly that's perhaps one of the good is that this opens up more demand on the ESG side. But the fact of the matter is that's how the income limits right now are set right now obviously is as corporate growth as corporate earnings grow over time. The amount of people that are sucked into the billion dollars is gonna grow over time as well. And so as we sit here right now you can say well maybe there there really isn't demand but if these provisions remain and remain over the next decade or so more and more corporations will be hit by the 15% minimum tax and that could then follow through and suppress demand for Munis. What I would say about that is that it's now we're now at year four of the 2017 let's take away tax exempt advance refunds and these provisions while relatively small and certainly no one stood up and said well how is this gonna how is this 15% tax gonna impact Munis? These types of provisions particularly when they're embedded in the tax code are very hard to reverse. And again continue this is a longer conversation for a different day and a different topic but continue to erode tax exemption generally. And I think that is something that as a community in the municipal finance area that sometimes we are reactive and rather than proactive on that not that everybody's not trying to do all of the right stuff but I view this as a in a larger lens of while yes on the surface corporate taxation companies over a billion is huge. That's great a great tax generator. there are obviously unintended consequences particularly on our side and particularly in demand if you look at it over a longer period than just in the immediate future.
Lynne Funk (
So, this kind of leads to the ugly which we didn't even really mention yet but I think it's that it's a good way to a good segue. When you talk about sequestration and when you go back to build America bonds so these new tax credit bonds and John maybe we can we both can talk about this actually. I think the question I have is how will these tax credit payments work mechanically and treasuries as treasuries sending the payments the first question and then could these same could these payments be subject to sequestration like build America bonds were yeah. A decade ago.
John Stanley (
I think we're gonna wait and see how the payments are actually gonna be mechanically administered. The require to claim one of these payments. It has to be claimed on the first tax return the tax return filed for the year in which the project is placed in service. If your entity does not file a tax return then treasury is supposed to put out guidance as to how to claim the tax credit nothing applies until next year. So, the payments are not available until 2023. The payments are not available largely for projects placed in service in 2023 or things acquired in 2023. So there is some time to see how this this is gonna work play out. I think one key takeaway is if you're planning to buy a new bus fleet for your transit agency maybe consider waiting until next year just to see if you can get tax credits for a large portion of it. I would expect that it will be a payment from treasury much like how Babs were handled. There's gonna be a form to file maybe some backup documentation and then you'll receive the payment hopefully better than the paper checks that they started out making Bab subsidies with hopefully they can move quickly to electronic transfers. And then there's the question of sequestration. The language in the Bab subsidy was that the issuer shall be entitled to a credit. The language here is a little bit different. It says shall be treated as making a payment that can then be credited. I think the hope was that that would be different enough to change the sequestration result. I was told earlier this week by people who spend a lot more time on this stuff and have talked with OMB that this language probably isn't good enough. Maybe that conclusion has already been made and some sort of note or something will be coming out but that means let's assume that it is subject to sequestration. I think the impact then is gonna be okay if you're deciding whether or not to build your own solar plant or do a PPA you're gonna have to take a haircut on what your likely tax direct pay tax credit is gonna be. If you're a school district in California and you're already putting solar panels on your parking lot because of the your own accounting benefits of how much that that helps the school district's bottom line you're gonna apply for a tax credit and get that. And you whatever you get is something more that you weren't gonna get before. If you're a buying an new electric fleet you're probably gonna you were probably gonna do that anyway. And so now here's something that'll make the cost cheaper. I think it raises a lot more was on a discussion this morning with these production tax credits where you get a dollar amount per megawatt that is generated over the first 10 years and people were asking well could we pledge that to debt service? Could we issue bonds secured just by those production tax credits setting aside all of the timing and other issues. the fact that those are subject to sequestration creates a very big risk that the dollar amount may not be you don't know what the dollar amount is gonna be which makes it really hard to treat that as a really stable revenue source.
Shawn Dralle (
To that end John I know this panel came together at the last minute but so I have some questions but there are other reductions embedded in the legislation as well in the act. as far as materials use of materials Davis bacon other types of things that to your point it's not just sequestration but there are other reductions proof of proof of project if you will that could potentially reduce the subsidy as well.
John Stanley (
Yes. Although, I might phrase it it's instead of reductions if anyone has spent any time with these tax credit legislation it gets changed every three to five years. And so there's all this tortured history of this kind of project qualifies and then it doesn't and then the rate was this and then it stepped down. They tried to sort of take a clean slate and be like okay here's what it's gonna be going forward. And it's a fairly small credit for any project. And then if you meet these federal prevailing wage and certain apprenticeship standards then you get what has historically been the full credit. So, for the investment tax credit you get 6% for anything. If you meet prevailing wage and apprenticeship you get 30% then on top of it if you meet certain domestic content requirements using us produced steel iron and a certain percentage of manufactured components you can get another 10%. And, if you're placing it in certain low income areas the meat qualifications you can get another 10%. So, potentially there's a lot of ability to really max out some of these credits. Yes all of it may be subject to sequestration. and then for the direct payment there's actually they sort of built in a a takeaway which is starting in 2024 unless you meet these domestic content requirements the direct payment starts to take a haircut. So, and in 2025 if you don't meet the domestic content requirements or meet in an exception you can't get the direct payment from talking with people who do tax credit work. Now, they've said that it's basically impossible currently to meet the domestic content requirements because there just isn't enough of the components built in the us. But that actually means that some of these exceptions which are written into the code as treasury will provide exceptions along these lines. And one of them is if there's not enough material being produced in the United States or if the cost of the us produced material would increase the cost of your project by 25%. So, it may be that those credits those exceptions end up swallowing that rule and make it so that everyone can still get the direct payment at least until some point in time when enough us manufacturing has ramped up. And that's another thing is there's another tax credit for us manufacturing of these components which is also strangely something that tax exempt entities are eligible to receive. So, if anyone's thinking about starting a governmental entity to build solar panels or wind turbines there's direct pay tax credits available.
Lynne Funk (
So, I didn't know that on our prep call. But what we all that said is there I wanna ask you both maybe Sean you can start with that history of potentially here is this great product for you a great tool for you to use but then it's gonna be sequestered. So, Is there any might there be some hesitation on traditional muni issuers to participate in such a program with not knowing that in a couple years a new Congress comes in and says well sorry haircut this.
Shawn Dralle (
Yeah, I think the short answer is I don't know. I think there is some Bab hangover if you will when people use the word sequestration whether this is different or not as to whether an issuer would be willing to go on but to John's point earlier it's not just about the sequestration. It's also about the power purchase agreement is using someone else's balance sheet for example and there are other other factors administration other costs that come into play when you're deciding whether you wanna own something and take that back on yourself rather than partnering with the private sector.
Lynne Funk (
So, Then John would you kind of alluded to that are we gonna start seeing a lot taking all that aside? Are we gonna start seeing more clean energy projects come to market with tax exempt Munis as a use by using these credits as well? Like could it could it bolster traditional tax exempt muni issuance as well?
Shawn Dralle (
Yeah. And so just to I perhaps skimmed over this earlier it is the way that these tax credits work is you could 100% bond finance tax exemp bond finance one of these projects and you only take a 15% haircut in the tax credit. So, it's the lesser of the amount of bond financing that goes into it or 15%. So for muni entities that allows them to borrow at a lower cost than the private sector can and get most of the tax credits. I think there will be some projects that happen. I don't really have a sense as to how many is it a huge growth sector? Someone else commented that we haven't seen a whole lot of public power financing as a market as a whole over the last few years there's kind of been a decline in that. So, maybe this will help contribute to a a growth in that area. But I don't really know.
Lynne Funk (
Okay. What about everyone's favorite or least favorite topic which is ESG? How does perhaps this new act bolster perhaps ESG issuance or does it does it not?
John Stanley (
I mean I think it starts from a couple of different perspectives. I think so from a supply perspective I I think there are certainly anything these all of these projects are inherently ESG related. So when we talk about well there might be diminished demand because of the corporate minimum tax. On the flip side there's probably increased demand from ESG and ESG funds is particularly it's the previous panel I assuming was talking about. It's become more common and it's not it's simply not going to be there are more and more funds because there are more and more buyers and investors who care about the ESG side. So, clearly this fits within all of that that so perhaps any any demand that is diminished from the tax raising side is replaced by the ESG demand from a credit perspective just to take that just slightly wider Moody's and S and P were immediately issuing reports that the implications of the IRA I guess is what we're calling it. I don't know. It's a terrible name is that this is a credit positive for local governments for state governments because of not only of the additional tax credits or the potential for financing other renewable projects simply because it is bolstering in some cases and these are things we haven't talked about but embedded within this act is 4 billion for the west for mostly in Western states for drought mitigation. So, all of that drought mitigation for hydrogen for green hydrogen production which is always I think interesting to think about green hydrogen production as that relates to electric vehicle charging stations and which one's going to if you're doing a bunch of electric kind of coming back to who wants to own who wants to be the municipal entity that owns the first electric vehicle charging station and this act kind of aggressively increases the speed in which green hydrogen can be produced that then replaces the batteries they're being charged at the electric vehicle station. So, kinda have to think two and three and five steps ahead as to which projects you wanna invest in. But I think from an ES all of this is ESG related from a buyer base expansion from a credit perspective all of that is positive.
Lynne Funk (
Could I ask and and and go back to the buy side on that for a second you had said we had mentioned in prepping for this panel that what build America bonds did as a taxable product really introduced muni's per se to a broader investor base.
Shawn Dralle (
Yeah I think it's kind of the same concept here is that we had crossover buyers in Babs and so taxable muni buyer that had never bought municipal bonds before but because of this new influx of taxable had to be come familiar with taxable bonds and taxable issuance and those buyers have stayed over the last 12 years and and are now much more commonplace than we had. I think that's the same in this ESG space as well that they will become more familiar with municipal credits and municipal projects. And, that's another expansion of the buyer base which is of course always good for our local borrowers.
Lynne Funk (
I think I've heard anecdotally too that when you go back to this 15% new tax that property and casualty insurance companies the banks that a lot of 'em more actually buying taxable bonds before this
Shawn Dralle (
Yeah, I think there was other panels but in really that's a a ratios game as to how taxables and tax expenses are trading at any given point in time. And so more familiarity just generally speaking with municipal bonds and and ESG type projects is going to increase the base regardless.
Lynne Funk (
Okay, I have one quick question for me and then we'll see if anybody from the audience has questions. This is actually from a colleague of mine but I thought it was fun. we've heard that some say that the bulking up of the IRS budget which is a big part of the new law will be bullish for demand because wealthy taxpayers will want to plow more money into Munis. Do you have any thoughts on that?
John Stanley (
Certainly interesting hypothesis. I mean I don't there was an article that went around fairly recently about some pretty aggressive offshore stuff where the IRS should have caught it but they just didn't have the manpower staff power to do that. so we'll see. I mean it it's interesting.
Lynne Funk (
Good stretch.
John Stanley (
It's probably a stretch but it could be I mean they do score muni bonds as something like for budgeting purposes that primarily affects higher income taxpayers. So, maybe it would be something that would drive more demand.
Lynne Funk (
Okay, Thank you for indulging. Is there anything else that we we had talked about? We missed we're getting close on time already. Did we cover it all? See if there's any questions, any questions from the audience going once? Okay. Well thank you to our our speakers. Thank you to John. Thank you to Sean. Really appreciate it. Enjoy the rest of the conference.