Summary: Although Texas officials have been working with the IRS to address the need for more capacity, it may not happen fast enough with current pipeline exceeding the limits.
Due to its popularity, and Texas rapid population growth in suburban districts, the Permanent School Fund (PSF) is fast approaching its $117.3 billion limit with $100.2 billion exhausted, approximately 85% of full capacity through the end of June, according to the Texas Education Agency (TEA), which oversees the program.
The Texas Permanent School Fund pledges to back debt sales sold by Texas school districts through an insurance-like program that has certain federal capacity limits. Because of this, school districts are able to borrow at lower interest rates. With a closure to this program, school districts would need to rely on their underlying credit ratings, which could increase their costs to borrow, possibly halting construction due to heavy costs. The PSF program is rated AAA by S&P, Fitch, and Moody’s, their highest ratings.
While a closure may seem extreme, this isn’t the first time the program has exhausted its guarantee capacity. In 2009, investment losses in the financial crisis combined with an increase in bond guarantees caused the program to hit its then limit – 2.5x the cost value of the fund – and shut down in March of that year. To address the capacity constraint, the IRS in December issued a ruling in 2009 that increased the cap to 5x, and the Texas State Board of Education (SBOE) later approved a lower cap of 3x. The Texas Education Authority (TEA) began accepting new applications in December 2009, and the program reopened in February 2010.
If the program is forced to close, we have little concern for existing bondholders. Here are the reasons:
- We believe that this could be a positive for existing bondholders and should not impact credit quality of the existing instruments.
- The IRS limit is 5x the value of the fund based on valuations from 2009, not current levels.
- TEA currently has a more conservative limit of 3.5X cap based on the current cost value of the fund.
- TEA won’t change their cap without assurances from Ratings agencies that the AAA rating will be maintained.
If the cap is reached there is the potential for spread compression on existing PSF-GTD paper due to demand for it. Also, Texas PSF paper tends to widen out in July and Aug due to the volume of issuance that comes during these months.
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