DALLAS - More than 10 Texas municipalities have used or rare considering using a new type of anticipation note that could become a prevalent debt in instrument in Texas.
"Potentially, every city and county we have could use it," said Dan Wegmiller, an associate with First Southwest Co.'s office in Austin. "You are probably looking at hundreds of deals."
Tim Merriweather, a vice president in the Austin office of Masterson Moreland Sauer Whisman, agreed. "There is a lot of talk about it. I think it will become a fairly common financing vehicle," he said.
The new financing began last fall after the Texas legislature approved Senate Bill 63, which allowed cities and counties to issue tax-exempt revenue, tax, or bond anticipation notes for up to seven-year terms without getting voter approval. In addition, the bill removed the prohibition of pledging ad valorem taxes to support the short-term securities for issuers with a population of more than 80,000.
The intent of the legislation was to give municipalities the ability to issue commercial paper quickly and spend the proceeds quickly to avoid paying high amounts of arbitrage rebate to the federal government.
"It was passed to help counties get around the arbitrage law," said Dallas County Treasurer Bill Melton, who was a primary advocate of the bill. "But it has not been utilized for the exact purpose that it was passed."
Instead, cities and counties are using the anticipation notes to accelerate the timetable for smaller projects from under $500,000 to $2 million that require short-and intermediate-term financing. The deals are being handled by at least two investment banking firms, First Southwest Co. and Masterson Moreland.
"We saw a unique financing opportunity that would be beneficial to our clients whether or not it was expected when the legislation was approved," said Jim Sabonis, a vice president at First Southwest, which has handled most of the deals so far.
Sabonis and others said the primary advantage of the financing is the speed with which it can be done and its streamlined process as well as the savings on interest rates on alternative financing vehicles.
Generally, the anticipation notes, which carry a pledge of either a future sale of voter-approved bonds, a revenue fund, or ad valorem taxes, could in some cases replace certificates of obligation, capital leases, or shorterm bank loans.
Note issuance can be accomplished in about 30 to 45 days, less than half the time required by other vehicles such as certificates of obligation, which require a notice of intent and a two-week waiting period for voter petitions. In addition, the anticipation notes carry better interest rates than short-term bank loans and can have a longer maturity.
"You have a real good short-term bond program and not much hassle," said Tom Pollan, a bond attorney with Bickerstaff, Heath & Smiley in Austin. "The issuer doesn't have to go through the hoops of an election" or a voter petition.
While some could argue that the process bypasses voters, industry sources said many municipalities have to move quickly to finance projects or face penalties.
For example, the anticipation note financing was used in:
* San Patricio County to expand a jail. Under the program, Masterson Moreland was the underwriter for a $700,000, seven-year anticipation note deal issued earlier this year to provide funds for the jail. The notes were issued as a general contractor was finishing up the jail and county officials realized it was too small because of higher demand. To keep the general contractor on site for prison expansion, the county had to move rapidly.
* The city of Hutchins to finance water and sewer improvement to attract a 1,000-bed state jail. The city had no cash reserves to fund the project, but needed to make infrastructure improvements immediately to win the bid for the jail. First Southwest implemented the competitive sale of the anticipation notes within 30 days, issuing $520,000 in debt with five-year maturities in March.
* Hays County to purchase a building for courts and records. The $1.4 million issue was sold last month to allow the county to take advantage of a real estate bargain that could have fallen through if it had been delayed. Although a bank loan might have been obtained, using an anticipation note sale saved the county money even with the additional cost of issuance factored in, said Wegmiller, who handled the deal for First Southwest. The anticipation notes were sold at a rate of 4.59%, while a local bank loan would have carried a prime rate of 6.6%. Total savings were more than $75,000, subtracting the $20,000 in debt issuance cost.
Industry sources said the anticipation notes are particularly beneficial for equipment and small building purchases with issue sizes ranging from $500,000 to $1.5 million.
"We will see a lot of it," Pollan said. "But they are not big, high-ticket items, so I don't think people are going to get rich off of it."
The anticipation notes are also helpful for cities and counties that do not have an enterprise revenue system and need to pledge ad valorem taxes. For example, investment bankers said the notes were used in Walker County and the city of Watauga for just that reason.
"In Texas, it looks like it could become the tool of choice for small issues," said Amelia Alvarez, a Standard & Poor's Corp. analyst who wrote about the innovative program for the May 2 edition of CreditWeek Municipal.
Asked whether the tool could be abused because it allows debt issuance without voter approval, Alvarez said she thought the legislation included some important safeguards.
"First, like certificates of obligation, anticipation notes must be approved by the Texas state attorney general before issuance. Second, while no legal limit is imposed on the par amount of an anticipation note, the required rapid debt amortization schedule is expected to keep the size of issuances small," she wrote in CreditWeek.
Because of the safeguards and the necessary tax, revenue, and bond pledges, rating agency officials said the anticipation notes often would carry the same rating as the municipalities' general obligation bonds.
Although the notes could become an important financing tool in Texas, Standard & Poor's officials said they do not expect them to catch hold in many states.
"I don't think it will catch on in a widespread way in other states unless we see some constitutional and legislative changes," said Bob Durante, an associate director at Standard & Poor's. "A lot of state constitutions prohibit issuing general obligation debt without voter approval."
Durante said Texas municipalities have been able to issue such debt, including certificates of obligation, without voter approval. Now, the structure simply is different.
Texas investment bankers, bond attorneys, and public officials said the law creating the anticipation notes program sailed through the state legislature with little opposition.
