Cities have issued bonds since at least the 1100s when Venice, Italy, used them to finance military operations. In the U.S., about three-quarters of core infrastructure investments have been financed through state and local government bonds. Since 2014, almost $70 billion in municipal bonds has been issued to finance public power investments, ranging from generating facilities to substations, operating centers, and more.
Despite their popularity and efficacy, these centuries-old financing tools often face scrutiny when tax reform is on the table, as it will be again in 2025. Read on to learn about some of the projects bonds have financed for public power, why they are a preferred choice for financing projects, and the potential risks municipal bonds may face in 2025.
Low-Risk Win-Win
Bonds are debt that municipalities take on to finance various projects. Municipalities use these tools to finance large infrastructure projects that will serve the community for decades, so bonds with a 30-year term are common. Investors essentially lend money by purchasing the bonds and then earn interest on the money they invest. At the end of the bond’s term, the investors get their money back.
Corporations issue bonds, too, but there’s a difference between corporate bonds and municipal ones. “On the corporate bond, the interest paid on that bond is taxable for the bondholder,” said John Godfrey, senior government relations director at the American Public Power Association. “If a corporation pays 5.1% for a bond, part of that interest will get taxed away, so the net return is lower. That’s why when a municipality issues a tax-exempt bond, it can issue it at 3%. That’s a 210 basis point difference between corporate and municipal bonds.”
Godfrey explained that while some people assume the tax benefits of municipal bonds attract only wealthy investors, research indicates otherwise. The percentage of upper- and lower-income bondholders mirrors the percentages of people in these groups in society. “One way to manage risk is to own tax-exempt debt,” he said. “There are a lot of fixed-income folks that own these bonds.”
If bonds seem like a good deal for the investor, they’re also a great deal for municipalities.
“When you’re looking at financing a project, you look at what options are available to you,” said Amber Teitt, vice president of debt management and treasury for American Municipal Power, Inc., or AMP, a wholesale power supplier and services provider for more than 130 member utilities in nine Midwestern and East Coast states. She added that bank products and taxable bonds are among the options, “but tax-exempt municipal bonds are the primary financing mechanism for public infrastructure because they typically provide the lowest cost of capital.”
Teitt noted that bonds also offer the right risk profile. “You can look at variable rate structures or other products that might require refinancing at some point in time,” she said. “Over the years, we’ve been able to use tax-exempt or tax-advantage bonds to enter into long-term financings that utilize fixed-rate debt. In addition to the lowest cost of capital, these bonds provide the added benefit of a reduced risk profile through predictable annual payments for our member communities.”
Sally Canazaro, finance director for the Borough of Middletown, Pennsylvania, recently used a general obligation, or GO, bond to finance a new substation to serve its 10,000 customers. GO bonds are backed by a government entity’s full faith and credit, and Canazaro considered them protected by that. “In the bond, it says that you can raise rates or taxes to cover them in the future. That way, you don’t default on the bond.”
Canazaro also likes that bonds let her anticipate expenses. “We plan every year what we will pay in interest and principal, just like you do with a mortgage. A bond allows you to pay over time and make big expenses more manageable,” she said.
Finally, bonds help utilities ensure the right people pay for the infrastructure. “We’ve used municipal bonds to make sure cost causation is considered,” said Jason Norlen, general manager for Heber Light & Power in Utah. “If you’re just building war chests for projects off your current rate base and you’re paying cash on projects to accommodate new growth, then all your existing customers have paid for a project new customers required you to do.”
Allowing for Growth
Heber Light & Power recently used bonds to pay for 10 miles of 138 kilovolt transmission line and a $23 million point of delivery substation to go along with it. Together, the projects came in around $30 million. “We’re a growing utility because our service territory is experiencing a lot of growth and development, about 5% a year with no end in sight,” Norlen said.
The utility is also building a new administration building. Having expanded from 13 employees in 2000 to nearly 50 today, the utility needs more space.
In addition to giving employees a little breathing room, these bond-funded investments have added reliability and safety to the system. Another plus is that much of the new distribution has been undergrounded to avoid marring the view of the lovely Heber Valley, which the utility serves.
Growth is happening in Middletown, Pennsylvania, too. A new housing development is underway and bringing enough load that the borough decided it was time for a new substation. “One substation we have was at its end of life and didn’t have the capacity we needed,” said Greg Wilsbach, public works director for Middletown. “We were able to redo the whole substation with this round of bonds.”
The benefits to the community will be faster service restoration and greater reliability. That’s because the town now has two substations that can each hold the entire territory if one substation goes down. Canazaro added that the new substation brings “the health of Middletown’s infrastructure to a higher level.”
At AMP, member utilities subscribe to generation projects based on their community needs and goals. So, for instance, if a utility seeks low-emission generation, there are options to fulfill that preference. Over the past 15 years, generation facilities financed with bonds include hydro plants along the Ohio River, a natural gas combined-cycle facility in Fremont, Ohio, a coal plant in Illinois, and solar facilities across Delaware, Michigan, Ohio, and Virginia.
All these projects were financed by tax-exempt or tax-advantage bonds, said Michael Beirne, vice president of external affairs at AMP and executive director for the Ohio Municipal Electric Association, which provides legislative liaison services for AMP and 80 Ohio public power communities.
Tax-exempt bonds, such as the GO bonds used by Middletown, deliver tax-free interest to investors. Interest on tax-advantage bonds is taxable to the bondholder, but tax-advantage bonds offer other benefits to the bond issuer.
Affordability at Risk
“About 15 years ago, in lieu of tax-exempt debt to finance projects, AMP and many other public power entities took advantage of federal initiatives at the time: the Build America Bonds (BABs) and the New Clean Renewable Energy Bonds (New CREBs) programs,” Beirne said. “Those programs used taxable debt and then the U.S. Treasury provided a credit payment to issuers of that debt to offset the difference between taxable and tax-exempt debt costs.”
The BABs and New CREBs programs were designed to support shovel-ready projects during the Great Recession. Beirne added that the programs weren’t flawless, and here’s why: They’re vulnerable to sequesters, which are automatic spending cuts triggered by a failure to meet congressional budget goals.
“The sequester takes a haircut of 5% to 6% off the credit payments we receive from the federal government on BABs and New CREBs bonds,” Beirne said. AMP or any other affected bond issuer must make up the difference in interest payments to bondholders. The result? AMP members have received more than $50 million less than what was originally promised from the federal government, costs that must be made up by customers. Those are “dollars that could have been invested in local communities or used to support electric rates and create jobs. AMP members stand to lose an additional $28 million over the life of the sequester,” noted an AMP white paper.
APPA’s Godfrey noted that the Tax Cuts and Jobs Act of 2017 has provisions that expire at the end of 2025. “The effect of extending those provisions is about $3.5 trillion over 10 years, which means a massive tax policy debate with huge budget implications is set to tee up in 2025,” he said.
The debate will focus on how to pay for that lost revenue from extending the tax cuts. During the last examination of tax cuts, tax-exempt bonds were looked at for potential reforms, recalled Godfrey, who expects some of the same project proposals to crop up again.
If the tax-exempt status of municipal bonds ends, the effect will be increased costs for public power projects, and the numbers are significant. Godfrey said that APPA is gearing up to defend municipal bonds while encouraging Congress to modernize rules around them. Among the modernization efforts is a push to recover the refinancing option on tax-exempt bonds lost in 2017. Also on the wish list are changes in tax law related to the deductibility of bank carrying costs on municipal bonds. Right now, banks can only deduct those carrying costs of bonds purchased from cities issuing less than $10 million a year, a number that hasn’t changed since 1986. APPA and others would like to see that amount increase to $30 million to incentivize more bank investment for smaller utilities.
“We need more investment across the board,” Godfrey said. “Data centers and bitcoin miners are fundamentally changing the landscape, and we’re electrifying transportation. We will absolutely need more resources, not fewer.”
APPA won’t be fighting alone. Regional associations and utility members will advocate for the continuation of tax-exempt bonds. “We continue to meet with our congressional delegation — both Republicans and Democrats — and we ask our members to do it as well,” Beirne said. “We will fight tooth and nail to ensure that public power continues to have the ability to issue tax-exempt debt.”
