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Build America Bonds |
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Background The Economic Recovery and Reinvestment Act (the "Act") created a new form of bonds known as Build America Bonds ("BABs"). Build America Bonds are taxable and, through Federal subsidies or tax credits, are intended to reduce municipal borrowing costs. Description of Build America Bonds The Act created two types of BABs. The first type of BABs provide a Federal subsidy to investors equal to 35% of the interest payable by the issuer ("Tax Credit BABs"). The second type of BABs provide a direct Federal subsidy that will be paid to state and local governments in an amount equal to 35% of the interest ("Direct Payment BABs"). Both types of BABs must be issued before January 1, 2011. Tax Credit BABs provide a 35% interest subsidy (net of the tax credit) to investors that results in a Federal subsidy to the issuer equal to approximately 25% of the total return to the investor (interest and the tax credit). Tax Credit BABs may be issued to finance any governmental purpose for which tax-exempt government bonds (excluding private activity bonds) could be issued including current refundings and one advance refunding. The bonds must comply with all requirements applicable to the issuance of tax-exempt governmental bonds. Direct Payment BABs offer a larger Federal subsidy than Tax Credit BABs; however, they are subject to more restrictions. In general, Direct Payment BABs may be issued to finance capital expenditures for any governmental purpose for which tax-exempt government bonds may be issued, excluding private activity bonds and excluding refunding bonds. Costs of issuance paid from Direct Payment BAB proceeds are limited to 2%. In order to receive a Federal subsidy, issuers will be required to submit a payment request form no earlier than 90 days, and no later than 45 days, before each interest payment date. Issuers will receive the requested payment within 45 days of the date the form is filed with the Internal Revenue Service. In the future, the payment procedures may be changed to an electronic platform. Financing for a project may be subdivided into two issues; one comprised of traditional tax-exempt municipal bonds and one comprised of BABs. Further technical details regarding BABs is available in the IRS guidelines. Market for Direct Payment Build America Bonds Build America Bonds are intended to expand the market for municipal bonds by attracting buyers that normally would not buy tax-exempt bonds. Potential investors of BABs include investors in low income tax brackets, individual retirement accounts, public pension funds and foreign investors. Taxable municipal bonds are not new; however, the amount issued each year has been very small (6.6% of total municipal bond volume in 2008). Taxable municipal bonds have traditionally been issued when tax-exemption is precluded by the Internal Revenue Code (e.g. when the proceeds are used for private activities or multiple advance refundings). Due to the absence of a significant existing market for taxable municipal bonds, the demand and market for BABs in not fully clear at this time. The initial sales of BAB issues; however, have been well received with yields below traditional tax-exempt bonds after taking into account the Federal subsidy. The specific terms that are required to market the bonds are still evolving. These terms include maturity limitations, redemption limitations, and additional disclosure that is more typical of corporate bonds. Feasibility of Direct Payment Build America Bonds Historically, taxable municipal bonds rated double-A or better had yields ranging from .50% to 1.50% over Treasury bonds. Presently, the spread between tax-exempt municipal bonds and treasury bonds is at record high levels. Consequently, the spread between treasury bonds and taxable municipal bonds is much higher than the historical spreads. In spite of the potentially large spreads, BABs may provide significant savings to municipal issuers. Consider the following. If the yield on a taxable municipal bond issue is 6.5% the Federal subsidy would equal 2.275% and the yield paid by the municipal issuer would equal 4.225%. As noted above, the terms of the bonds may be different than traditional municipal bonds. For example, buyers may be reluctant to buy callable BABs. Corporate bonds, and some of the first BABs coming to market, include "make-whole redemption" features. A make-whole redemption feature allows the bonds to be redeemed; however, the present value of all remaining scheduled payments of principal and interest are paid upon redemption. Consequently, the opportunity to achieve a refunding savings in the future is eliminated. Unacceptable financing terms may be overcome by subdividing the issue into traditional tax-exempt bonds and taxable components. Another option, may be to include a redemption feature more acceptable to municipal issuers and pay a somewhat higher rate. First Issues Come to Market From April 13 to April 17, 2009, the first issues of Build America Bonds were priced. The issues included $250 million for the University of Virginia and $37.3 million for the University of Minnesota. The University of Virginia's issue has a 30-year bullet maturity and was rated triple-A by all three major rating agencies. The University of Virginia issue had a taxable rate of 6.22%, which was 154 basis points higher than the triple-A Municipal Market Data index and 255 basis points higher than the 30-year Treasury yield. After taking into account the Federal subsidy the yield equates to approximately 4.03%. The University of Minnesota's financing, rated Aa2 by Moody's and AA by Standard & Poor's, included both a tax-exempt and Build American Bond component. The BABs mature in 2028 and were priced with a rate of 6.30% and 6.38% yield. Due to the high demand for BABs, issuers coming to market from April 20 to April 23, 2009 increased the size of their issues. The New Jersey Turnpike Authority come to market with a $1.375 billion issue. The issue was rated A3 by Moody's, A+ by Standard & Poor's and A by Fitch. The portion of the issue which matures in 2040 was price to yield 7.41%. The New York Metropolitan Transportation Authority came to market with $750 million of BABs. The bonds are rated AA by Standard & Poor's and A+ by Fitch. The 2039 term bonds were priced to yield 7.34%. California, rated A2 by Moody's and A by Standard & Poor's and Fitch, sold $5.23 billion of BABs. The BABs which mature in 2039 were priced to yield 7.43%. While the initial issues suggest that there will be considerable savings from BABs, as issuers shift to BABs and the volume of tax-exempt issues declines, it is possible that the yields on tax-exempt bonds will decline. In spite of initial results, careful scrutiny will be required over time to determine how supply changes impact both the municipal tax-exempt and taxable bond markets. Services Provided by WM Financial Strategies With new financing options available to municipal issuers, now is the time to consider engaging WM Financial Strategies for your bond or lease transaction. Through a competitive proposal process, WM Financial Strategies will be able to determine whether traditional tax-exempt bonds or BABs result in the lowest cost of financing for your transaction as well as providing favorable financing terms.
As an independent
financial advisor, WM Financial Strategies
does not underwrite bonds or sell securities; accordingly
objectivity of its findings and recommendations are guaranteed. By
employing competitive bidding or a highly competitive proposal process, WM Financial
Strategies insures transparency and accountability in the selection
of the underwriter as well as securing the lowest financing cost.
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WM Financial
Strategies |
