A Verdict on the Undercard

The U.S. Supreme Court last week ruled unanimously that railroads have the right to challenge the way states calculate their property taxes, in a challenge to Georgia's valuation of the CSX Railway's lines in the state.  The dollars at stake are not tiny, but they won't make or break any Georgia government's finances, either.  Rather, the case is remarkable to the muni market mainly because it was the first case heard on Nov. 5th, when the justices also heard arguments in Kentucky v. Davis, which challenges the near-universal practice of states exempting interest on bonds from issuers within their borders from their own state income taxes.

The Davis ruling is still expected early next year.  The justices seemed sympathetic to the status quo during the oral arguments last month, but it ain't over until the ink is dry...

Affirming Davis Would Be Long-Term Gain for Investors; Near-term Boon for Brokers?

Many in the muni bond industry seem to think that preservation of the status quo, i.e. the Supremes overturning Davis, would be in the best interest of the market. I can see where issuers might feel that way but it seems that upholding Davis could be a boon to bond brokers.

Assuming that states would likely exempt all bonds from taxation in order to preserve tax exemption for themselves, this would open up the investment options for buyers. Investors in high-tax states now are forced to buy in-state. As the attorney for the Davises, G. Eric Brunsted Jr., put it to Chief Justice Roberts: “One cardinal principle of investment is diversification. These discriminatory tax laws basically compel people to hold only the bonds within their particular State.”

If investors were no longer compelled to buy in-state only they would indeed be able to achieve much greater diversity in their portfolios. That development would be an opportunity for enterprising bond brokers to do some business helping their clients restructure portfolios that are, naturally, heavily concentrated in all single-state issues. The ability to buy bonds from pretty much any state might even attract more investment to the muni market. Wouldn’t that be a net positive for all parties?

Gavin Murphy

National Editor

The Bond Buyer

gavin.murphy-AT-sourcemedia-DOT-com

Roberts Risk

Add a new category of risk to the checklist municipal issuers need to assess before entering into interest-rate swaps:  Roberts Risk.

For the next year, swap counterparties on both sides of municipal transactions will have to try and read the Supreme Court tea leaves to figure out whether the nearly-universal system of state income tax exemptions will be thrown out.  The issue is most acute in high-tax, wealthy states like California and New York, where the state tax exemption makes a material impact on a bond's taxable-equivalent yield, and thus allows those states' bonds to trade at a premium.  In The Bond Buyer today, Municipal Market Data pegs the market yield for one-year paper in California at 3.58%.  The next-lowest yield in the region is 3.65%.

Today's BB: Choosing Congestion?

The Bond Buyer this morning reports yesterday's apparently veto-proof vote by the Texas House for a two-year moratorium on private toll-road projects -- which takes particular aim at Gov. Rick Perry's Trans-Texas Corridor project and its initial contract with Cintra-Zachry.  If the definition of "news" is its ability to surprise the reader, then this qualifies as a big story.

It shouldn't, necessarily:  The anti-toll backlash had been brewing for a while, and Musician Kinky Friedman drew more than 500,000 votes on essentially a one-issue, anti-toll platform in last year's gubernatorial race.  But given the state's massive transportation needs and aversion to taxes, tolls seemed like an awfully reasonable answer, and given the amount of time and effort investment bankers and others have invested in Texas over the last few years, it seems safe to conclude that this vote was unexpected.

Ultimately, fast-growing communities and economies have a choice between the 3 Ts -- Tolls, Taxes, or Traffic.  Texas is already providing a fair amount off tax revenue for the transportation program, and it's not clear how much more they can add.  No one's actively arguing in favor of more traffic, but if tolls are really off the table, it seems inevitable.  So, Texas readers, let's put the ball in your court:  Is this the end of the story, or can Perry craft a compromise, either broadly or on technical grounds, to block the ban?

Elsewhere in the paper, our industry coverage swings away from layoffs and back to good news:  Belying its name, First Southwest is adding a trading desk in Boston, and just when you thought a Democratic Congressional majority would quash talk of tax-reform, Sen. Arlen Specter, R-PA, has introduced a new flat-tax bill (don't worry -- it's not going anywhere soon).