Three Cash-Crunch Approaches Proving Useful to Municipalities During the Pandemic
For municipalities facing short-term cash squeezes related to the pandemic, three main approaches have proven most relevant. CFOs and finance directors have become quite familiar with one—direct aid via governmental fiscal measures—but may be less familiar with the other two: cash-defeasance/new-money and 12-month interest restructuring. Also included below is a breakdown of the most relevant governmental relief programs.
With the tax reform act in 2017 prohibiting tax-exempt advance refundings, municipalities have had to look to different methods to refinance their existing debt to provide for debt service savings. One such method that has gained popularity is the cash-defeasance/new-money bond program. This approach involves taking pay-as-you-go funds that are allocated to a new-money project and redirecting those funds to cash-defease existing debt with high coupons up to that debt’s first optional redemption date. Then, on or around the same time, the issuer would issue tax-exempt new money bonds for the project.
It’s important to note that the pay-as-you-go funds must have the flexibility to be redirected as described above. If these funds are in fact earmarked for a particular project, then it becomes difficult to execute this program. Unrestricted cash and cash equivalents may be used to cash-defease high-coupon outstanding debt, should proposed capital improvement projects be financed with a tax-exempt bond issue.
As always, any municipality considering this program should consult with their financial advisor, bond counsel, and particularly their rating agencies to ensure the using this program would not result in a negative rating event.
12-Month Interest Restructuring Program
Under this federal program, the municipality is allowed to restructure up to 12 months of interest accruing from the date of the restructuring bonds. Note this applies only to interest that accrues after the date of issuance of the restructuring bonds.
As an example, if the municipality has a 06/01/2021 interest payment and issues the restructuring bonds on 04/01/2021, then only two months of the 06/01/2021 interest payment can be funded with the restructuring bonds. In this example the municipality could also fund the six months interest payable on 12/01/2021 as well as four months of interest payable on 06/01/2022.
Under this program, principal refinancing or restructuring is precluded, which allows this program to not be considered a “refunding” under tax law and so not an “advance refunding.”
To the extent other bond issues are being considered at the time of the restructuring bond issue, these will need to be treated as separate issuances with at least 15 days’ separation from the other tax-exempt issues. The 15-day period is based on bond purchase agreement dates. However, both bond issues can close on the same day if so desired. No 15-day separation is needed if other issues are taxable bond issues.
The restructuring bond issue can be issued as capital appreciation bonds to help deferring debt service payments.
As with cash-defeasance/new-money programs, issuers considering a 12-month interest restructuring program should consult with their financial advisor, bond counsel, and rating agencies. Also, municipalities should review and confirm authority under state law to issue bonds to restructure interest payments.
For the applicable federal code, see Title 26 of the Code of Federal Regulations – Chapter 1.150-1(d)(1)(i)): Definition of Refunding Issue and related definitions – Exceptions and special rules – Payment of certain interest.
Fiscal Responses to Pandemic
In closing, here is a quick rundown of stimulus and relief programs, several of which have been lifelines for municipalities facing short-term cash crunches. (Source: Investopedia‡)
- Stimulus and Relief Package One (March 6, 2020). Coronavirus Preparedness and Response Supplemental Appropriations Act, 2020 – $8.3 billion to fund research for a vaccine, give funds to state and local governments to fight the spread of the virus, and to mitigate the spread of the virus overseas
- Stimulus and Relief Package 2 – Families First Coronavirus Response Act (March 18, 2020). Allocated $3.4 billion for free school lunch support, paid sick leave and tax credits for employers, unemployment insurance support, and cost waivers for COVID-19 testing.
- Stimulus and Relief Package 3 – The CARES Act (March 27, 2020). Appropriated $2.3 Trillion for such things as $500 billion in government lending to companies affected by the pandemic, $367 billion in loans and grants to small businesses through Paycheck Protection Program (PPP) and expanded Economic Injury Disaster Loan (EIDL) Program, $150 billion in grants to state and local governments, and approximately $60 billion for schools and universities.
- Stimulus and Relief Package 3.5 – PPP and EIDL (April 24, 2020). Appropriated $484 billion mostly to replenish the PPP and EIDL Program.
- Stimulus and Relief Package 4 – $900 Billion (December 21, 2020). This package appropriated $900 billion to such items as $325 billion in small business loans, $45 billion for transportation funding including $15 billion in airline payroll support, $14 billion for transit, and $10 billion for state highways. Additionally, this package provided $82 billion in funding for K-12 Emergency Relief Fund and $22.7 billion Higher Education Relief Fund
- Stimulus and Relief Package 5 – The American Rescue Plan (March 11, 2021). This $1.9 trillion package included funding for such items as $130 billion for K-12 schools, $39 billion for Higher Education, $30 billion for Public Transit, and $15 billion for Airline Industry workers.
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