Bonds

Texas school debt deluge will have triple-A wrap as PSF limit is raised

Texas school districts, flush with new bond authorizations over the last year, are breathing a sigh of relief now that a cost-saving state guarantee program for their debt is fully back in business after the Internal Revenue Service increased its capacity for the first time since 2009. 

In a notice of intent last week, the federal agency said it will change a formula that had limited the amount of public and charter school bonds guaranteed by the Texas Permanent School Fund to $117.3 billion.

The PSF wrap gives school district bonds a triple-A rating.

The IRS move means the program’s capacity will grow by nearly 86% to about $218 billion, making it widely available again after a period in which many districts were turned away, according to the State Board of Education.

“News of this change by the IRS is a welcome victory for Texas students and taxpayers,” Board Chairman Keven Ellis said in a statement. “Instead of paying millions in higher interest costs, school districts can instead use that money for much-needed facility improvements.” 

Austin Independent School District will save about $25 million in borrowing costs over the life of its record-$2.44 billion bond program approved by voters in November, according to Eduardo Ramos, the district’s chief financial officer.

“Now that we are able to minimize financing costs as a result of this decision, we will be able to use these much-needed funds instead to renovate our older campuses and instructional facilities,” he said in an email.  

The PSF program saw huge demand for the triple-A-rated enhancement from Texas public school districts that received voter approval for about $23 billion of bonds in last year’s May and November elections. 

As a result, the program’s projected available capacity fell as low as $26.6 million at the end of 2022, but rebounded after the State Board of Education lowered the program’s reserves to 0.25% from 5% effective March 1. As of March 31, capacity stood at $5.18 billion.

The fund’s dwindling capacity forced many districts to sell debt based on their own underlying ratings or to pay for bond insurance as the Texas Education Agency prioritized the guarantee for school systems with the lowest property wealth per average daily attendance.

Applications for $8.4 billion of debt from 56 districts were denied the guarantee between November 2022 and January 2023 due to capacity constraints, according to the State Board of Education.

Austin, which has triple-A ratings from Moody’s Investors Service and Kroll Bond Rating Agency, got a taste of selling bonds without the guarantee in January.

The $542 million bond deal’s true interest cost of 3.67% was 10 basis points higher than a $551 million Dallas ISD bond issue with the PSF guarantee that priced the same day, even though the Dallas district carried underlying ratings a notch lower at AA-plus or equivalent. 

Ramos said Austin ISD anticipates returning to the muni market in January 2024 with guaranteed bonds.

School districts were not deterred from seeking voter approval for bonds this month even with the prospect of not obtaining a PSF guarantee, according to John Martin, senior managing director at Hilltop Securities in Dallas.

“They’re having bond elections because of their need,” he said. “They’re not going to wait on the Permanent School Fund to come back into play to be able to sell bonds, particularly in an inflationary environment where the cost of these facilities continues to skyrocket.”

School districts placed $24.7 billion of bonds on May 6 ballots, with voters approving about $16.8 billion, according to Texas Bond Review Board data.

The Houston area’s Fort Bend ISD, where voters approved all three parts of a $1.2 billion bond package to fund school construction, safety improvements, technology upgrades and a natatorium, welcomed the IRS action.

“This will mean that (district) taxpayers will pay less on interest costs when the district issues debt, which is a direct savings to taxpayers,” said Chief Financial Officer Bryan Guinn.

The district, which relies on a $150 million commercial paper program to fund construction at the outset, is eying the first bond issue from the package next May to refund some CP notes, he said, adding each fiscal year on average could see about $200 million of bond issuance based on current timelines and cash flows.

Northwest Independent School District, the fastest growing school system in North Texas, had the most bonds on the ballot at nearly $2 billion in three proposals, which were all passed by voters.

The bulk of the request — a $1.67 billion measure — will fund eight new or replacement schools and four early childhood centers to accommodate an additional 8,400 students. The district’s enrollment has climbed to 29,248 this year from 17,752 in 2013.

The district, which has underlying ratings of Aa2 from Moody’s and AA from Fitch Ratings, will sell an initial tranche of bonds this summer or early fall, according to spokesman Anthony Tosie.

Garland ISD in the Dallas area won approval for nearly $1.28 billion of bonds in three propositions to address more than $3 billion in needed repairs and upgrades and to update technology. 

Debbie Cabrera, co-interim CFO, said she expects there will be four or five bond sales over the course of several years with an initial issuance in July estimated in the $300 million range. 

Major Parkhurst, a Fitch analyst, said the increase in the federal limit for the program has no near-term credit impact on the PSF’s AAA rating, which is a function of modeling analyses that consider the credit quality of participating school districts, the program’s current leverage, and the value of the PSF’s investment corpus. 

“If leverage were to increase over time and begin to show pressure under our ‘AAA’ model scenarios, our view could then change,” he said in an email.

The PSF bond guarantee program dates back to 1983 when it was approved by Texas voters as a way to lower school financing costs.

The fund itself, which was established in the 1845 state constitution, became an investment fund with a $2 million appropriation by the Texas Legislature in 1854 to benefit schools. It had a total balance of $56.8 billion as of Aug. 31, 2022.

The IRS last lifted the limit in December 2009 after the program shut down when it ran out of capacity. That limit was based on the PSF’s 2009 value, which was about half of its current value.

The new IRS formula “essentially aligns the federal limit with the state statutory limit at five times the cost value of the Texas Permanent School Fund, or approximately $218 billion at current levels,” according to the board of education’s statement.

U.S. Rep. Lloyd Doggett, a Democrat who represents Austin, had fought unsuccessfully for a bill to increase the cap, and he declared victory after the IRS acted.

“My pending bipartisan legislation and appeals to the administration have finally produced the solution we have long sought — effectively a permanent exemption for the PSF,” he said in a news release last week.

The IRS notice on its proposed regulation, which “may be relied upon for bonds sold on or after May 10, 2023,” acknowledged “certain perpetual trust funds that otherwise could provide credit enhancement under the special exception to the arbitrage restrictions for eligible pledged funds … will soon be limited in their capacity to provide guarantees for tax-exempt bonds at a time when there is a significant need for such guarantees.”

A July 31 deadline was set by the IRS for comments on any questions related to Notice 2023-39.

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