In March 2023, the House of Representatives introduced the Investing in our Communities Act, H.R. 1837, which would reverse a component of the 2017 Trump Tax Reforms that affected Municipal Bonds. A similar bill was introduced in the Senate, the LOCAL Infrastructure Act, S. 1453, in May 2023. So, what's the fuss about pre-refunded bonds, and why should you care?
For the Legislation:
The 2017 Tax Cuts and Jobs Act limited municipalities’ ability to advance refund debt by prohibiting them from issuing tax-exempt bonds for advance refinancing. Instead, they had to use taxable debt, which meant paying higher interest rates. This made it more challenging for state and local governments to manage their borrowing costs and invest in infrastructure projects. In short, it weighed down on taxpayers with higher costs or delayed local development.
The tax-exempt status given by the federal government to municipal bonds is a stimulus to encourage demand for these bonds, ultimately reducing the cost of borrowing for local governments. Bill H.R. 1837 & S. 1453 backers and Muni market advocates argue that advance refunding is a practical way to fuel growth and fiscal stability in local governments that should be supported in the tax code.
Understanding Pre-Refunded Bonds:
Pre-refunded bonds are born when municipalities refinance their existing debt prior to the next call date. Similar to homeowners refinancing mortgages to snag better interest rates, municipalities issue new bonds. They use the proceeds to escrow their old bonds, removing them from their financial books. This is done by fully hedging the old bonds with US Government debt, ensuring they'll be paid off at the next call date. These bonds, now fully backed by Uncle Sam, are known as "pre-refunded bonds."
What to Expect:
The big question is how this legislation could impact activity in the refunding market. From 2008-2017, refunding transactions made up 52% of municipal market issuances, while that figure dropped to 36% from 2018-2021.
No progress has been reported since the Spring, and while it is likely the last thing on their minds while the House is electing a new speaker, we will stay tuned to see how H.R. 1837 & S. 1453 develop.
Sources:
US Municipal Bonds Statistics; SIFMA, 2023
H.R. 1837 (IH) – 118th Congress: Investing in Our Communities Act; GovInfo.gov, 2023
S. 1453 – 118th Congress: LOCAL Infrastructure Act; govtrack.us, 2023
Support Legislation to Restore Tax-Exempt Status of Advance Refunding Bonds; National Association of Counties (NACo), 2023
Disclosures:
This content has been prepared for informational purposes only and should not be considered as investment, tax, or legal advice. Opinions and forward-looking statements expressed are subject to change without notice. We recommend all investors to consult with a financial and/or tax advisor regarding their individual circumstances before taking investment decisions.
Investing in bonds exposes the investor to the risk of loss of principal. Lower and non-rated securities are more volatile and less liquid than investment grade bonds. Liquidity risk relates to the timing of converting a security into cash without affecting the market price. Municipal bonds and preferred stocks tend to be less liquid than government or corporate bonds. Higher-yielding, longer-maturity, lower-rated, non-rated, or certain bond restrictions (minimum denomination requirements) limit or reduce the liquidity of bond holdings.
Please visit our website for a complete list of disclosures and risks: www.maustininvestments.com.
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