By Ryan Velez
The wave of Republican tax cuts at the end of last year made bankers across the country very happy, and now, according to Bloomberg, they are looking to double dip on the profits by raising interest rates on their loans to local governments. This is allowed due to clauses in contracts when they lend to states and cities giving them the right to trigger the increases if legal changes lower the returns on their investments.
How did the tax cuts accomplish this? Slashing the corporate rate made the tax-exempt loans less valuable than before compared with other assets, once federal taxes are taken into account. This led to banks like Wells Fargo & Co., U.S. Bancorp and SunTrust Banks demanding higher interest to right the ship, so to speak.
Municipal Market Analytics estimates that there are about $180 billion of such loans outstanding. That could translate into tens of millions of dollars in extra costs each year for local agencies. At the same time, Trump is calling for these agencies to spend even more on infrastructures like roads and airports.
“It takes away from money that would help the state’s reserve, or it takes away from money the state may appropriate for other statewide public purposes,” said David Erdman, the capital finance director for Wisconsin, whose payments on a $279 million loan will jump by about $750,000 next year. He declined to name the lender.
While regulations mean that many of these cities and states don’t get to know automatically if their rates are going up, some banks are giving heads up. Tennessee, the Metropolitan Atlanta Rapid Transit Authority, and Portland, Oregon, are among those whose payments are set to rise, according to public officials.
“We’ve heard underwriters are dealing with it in different ways,” said Emily Brock, federal liaison for the Government Finance Officers Association, which represents local government officials. “One thing’s for sure, not all issuers understand clearly how that gross-up provision is going to impact them.”
Wells Fargo has informed its clients the rate increase is automatic, but borrowers can try to negotiate new terms, said Adam Joseph, the head of Public Finance Capital Strategies at the San Francisco-based bank. He said the increases haven’t come as a surprise.
“The existence of the factor was very much known to the client at the time of the deal,” he said. Some are getting some luck. For example, First Republic Bank told California non-profits that they would not trigger said clause for their loans, said Cathy Martin, treasurer and chief financial officer of Guide Dogs for the Blind, in San Rafael, California. “I can’t tell you how grateful I am because it would have been fairly significant money for us,” said Martin.