SEC’s Sanchez raises questions around prepay energy deals

Donna Alberico

Prepay energy bond deals are among the types of municipal financings that the Securities and Exchange Commission is monitoring to gauge whether bond-issuing governments are aware of the potential for unrealized or smaller-than-expected savings.

Processing Content

“On prepays, we are looking at it from the perspective of looking at the overall economics” of large borrowings that can total $1.2 billion or $1.5 billion but “where the net benefit to the [municipal] entity is a very small fraction of that,” Dave Sanchez, director of the SEC’s Office of Municipal Securities, said in remarks to the Government Finance Officers Association’s debt committee, which met Saturday ahead of the GFOA’s 120th conference, held this year in Chicago.

Prepay energy bonds are one example of the types of transactions — other examples include bond refundings, tender offers, or taxable forward delivery deals — that promise savings that may not materialize, Sanchez said.

The regulator for the “past couple of years has been really focused on what information your financial professionals are giving you as issuers in order for you to make the best decision that you can,” Sanchez said.

“I’ve consistently said that we’re not trying to second-guess your financial decisions, but it’s interesting when you see things happen in the market and you think, ‘Why would someone make this decision?'” he said. “My first presumption is that you’re not getting the information you should be getting,” he said. “On the flipside, maybe you’re just making really bad decisions.”

His comments come as prepay energy financings becoming a larger part of the municipal market. In early June, a nearly $1.2 billion prepaid energy deal connected with Alphabet, Google’s parent company, marked the first time a hyperscaler tapped the muni market and a sign that other tech companies may follow.

Prepays are structured credit financings that typically involve multiple counterparties, including corporations that receive the bond proceeds.

“The benefits to ratepayers can be very small,” Sanchez said. That’s “not an SEC issue, but it’s interesting,” he said.

“The question is, is the municipal advisor explaining that?” he said. “You guys did all this work on the tax exemption,” Sanchez added, referring to the GFOA’s successful lobbying efforts to save the tax exemption last year. “I don’t think that’s a positive story about the tax exemption when you’re lending the tax exemption to private entities and they are reaping a giant benefit from it and there’s almost no benefit to the municipal entities.”

On other deals that may not fall under direct SEC oversight but can create market “murkiness,” Sanchez reiterated concerns regarding quasi-governmental entities and districts that are controlled by private parties, such as joint powers associations and special districts. For the first time, Sanchez mentioned public improvement districts as potentially problematic, especially if controlled by private entities.

The questionable tactics employed by some of these special districts may fall outside regulators’ purview, but the SEC is still monitoring the activity, Sanchez said.

“I would think [a government entity] would be concerned when an entire JPA is run by two private people who have a financial incentive to issue as many deals as possible,” he said, noting the “very low level” of accountability and transparency of some boards.

“Why would an otherwise very sophisticated municipal issuer participate?” he asked. “There must be some knowledge gap that’s allowing this to continue,” he said.

“It’s something that creates murkiness in our market,” he added. “I’m not asserting that this is something the SEC has the authority to change but I do think it’s important for us to recognize what’s happening in the market and look for a solution.”

On the “bread and butter” municipal market debate over comparing negotiated versus competitive deals, Sanchez repeated previous comments that the regulator is keeping its eye on post-primary market pricing to track when bonds trade up in the secondary market immediately following a primary market pricing.

When bonds increase in price immediately after a sale, it signals the issuer may not have received the lowest yield possible. It’s important to regulators because “inefficient pricing” means issuers, and therefore taxpayers and ratepayers, are not getting the best price. The pricing information is increasingly easy to track, he said.

“We’re seeing a lot of trading in immediate post-secondary market that goes against the issuer, and that’s where we’re going to look at the regulated entities involved and ask why is that happening on your watch,” he said.

“It’s very easy to track that price movement and flag movement that was bigger than it should be, so it’s going to be a consistent part of life going forward,” Sanchez said. “Your financial professionals should be paying more attention to it, which means you [as issuers] should be, which means you should start getting better pricing.”