Co-Authored by Phil Weisshaar is a Vice President in the Public Finance Department of Stifel
The number of school districts that could benefit from refinancing just dropped due to fast-rising interest rates. The AAA GO MMD – a benchmark for the tax-exempt municipal bond market (similar to the S&P 500, Dow Jones, or NASDAQ for the stock market or U.S. Treasury yields for the bond market) – has jumped up more than 100 basis points (1.00%) since the start of the year (Source: Thomson Reuters).
The impact on lending volume is significant. The weekly average supply of municipal securities throughout the United States so far in 2022 is approximately 15% less than in 2021 (Source: Bloomberg). In Ohio, only a small number of school districts have refinanced bonds so far in 2022 (Source: Thomson Reuters).
Given that interest rates have been so low for so long throughout the pandemic, we have experienced borrowers moving at a slower pace, not feeling the need to rush into a refinancing. Now, as interest rates are back on the rise, your questions might be: what options do I still have for a refinancing, and which of those options make the most sense with rising interest rates?
The goal of a refinancing is oftentimes to produce savings, and the difference in payments before and after the refinancing are – by definition – savings. The amount of savings (or lack thereof) is driven by interest rates and the calculus is case by case for each school district because of its unique characteristics. Although some refinancings may not currently meet saving goals, it is possible that interest rates are more favorable in the future. That being said, school districts can make savings in the following three generalized options.
- Equal Savings – For example, if $1,000,000 are your annual payments before the refinancing and $800,000 after the refinancing, your resulting savings are “equal” at $200,000 per year. For the sake of the example, say your last payment is in 20 years. $200,000 times 20 equals $4,000,000, which is your total savings. This is considered a “proportional” refinancing because payments after are proportional to payments before.
- Deferred Savings – For example, if $1,000,000 are your annual payments before the refinancing and your last payment is 20 years in the future, it is possible to shorten that last payment to say, for example, 15 years while keeping annual payments from years 1 through 15 the same. In this example, you have zero savings in years 1 through 15 but $1,000,000 in savings from years 16 through 20 totaling $5,000,000. From the perspective of payments, this is considered a “front-loaded” refinancing because payments after the refinancing are made more quickly than expected. From the perspective of savings, this is considered “deferred” because savings are produced at the end.
This example option – all other things being equal – produces the most savings. Intuitively, that makes sense because you are making payments more quickly than you otherwise would have. In a rising interest rate environment, you might be inclined to pursue this sort of option because it generates the most savings.
- Up-Front Savings – For example, if $1,000,000 are your annual payments before the refinancing and your last payment is 20 years in the future, it is possible to produce zero or near-zero payments in say the first 3 years while keeping annual payments from years 4 through 20 the same. In this example, you produce $1,000,000 or near $1,000,000 in savings in year 1, year 2, and year 3 (totaling $3,000,000) but zero savings in years 4 through 20. From the perspective of payments, this is considered a “back-loaded” refinancing because payments after the refinancing are made less quickly than expected. From the perspective of savings, this is considered “up-front” because savings are produced at the beginning.
This example option – all other things being equal – produces the least savings. However, counterintuitively, in a rising interest rate environment, you might be inclined to pursue this sort of option because Ohio Revised Code Section 5705.14 enables, under certain conditions and with certain approvals, a school district to transfer savings from the bond retirement fund to the permanent improvement fund. Those savings can then be used for certain capital expenditures. A complete description of the conditions and approvals for this process would take another article. Please consult your legal, underwriting, and advisory team regarding if this option or any of the aforementioned options are appropriate for your circumstance.
With those three generalized options in mind, please note that any particular refinancing should also take into account the payments on your other outstanding financings as well as future financing needs. Your strategy, which might include some option of the three aforementioned options, can then be appropriately communicated to your board of education, taxpayers, and voters ahead of a request for a new operating levy, permanent improvement levy, or another bond issue. Again, please consult your legal, underwriting, and advisory team regarding which options, if any, are appropriate for your circumstance. The choice to finance or refinance is made more difficult by rising interest rates, but professionals are here to help.
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Steven Mahr is a Vice President in the Public Finance Department of Stifel. He can be contacted at mahrs@stifel.com or 614.453.9541.
Phil Weisshaar is a Vice President in the Public Finance Department of Stifel. He can be contacted at pweisshaar@stifel.com or 216.592.6840.