Build America Bonds: Legal issues, canceled refundings and other updates

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As some state and local governments and their agencies look to redeem or refund their Build America Bonds (BABs), some questions have come up regarding the legality of doing so, especially as current interest rates may likely lead to an increase in Build America Bonds being called by issuers this year, according to market professionals.

BABs, authorized in 2009 and 2010 as part of a stimulus program during the Obama administration, allowed issuers to sell taxable bonds and receive a subsidy on the interest rates they paid to investors from the federal government. Federal budget “sequestration” has resulted in lower-than-promised subsidies to issuers since 2013.

Issuers have moved to call outstanding BABs following a recent U.S. Supreme Court ruling that, according to a February publication from law firm Orrick, supports the conclusion that sequestration “resulted in a materially adverse change to the cash subsidy payment obligation.”

J.P. Morgan has identified 14 “unique” issuers that have either called BABs, posted conditional calls or announced that they are considering financing plans. The six in California have outstanding BABs totaling $6 billion, according to J.P. Morgan.

The Regents of the University of California closed its deal that redeemed outstanding BABs via an extraordinary redemption provision, despite the threat of an investor lawsuit.

This debate centers on whether issuers are legally authorized to trigger the extraordinary redemption provision following cuts to BABs’ 35% subsidy under the government sequestration process, starting in 2013. The current sequestration level is 5.7%. BABs refundings through the extraordinary redemption provision only recently entered the conversation in a prominent manner, following a 2023 court opinion stemming from Indiana Municipal Power Agency v. United States.

After the ruling, Orrick partners Charles C. Cardall and Barbara Jane League said in a report posted on the firm’s website that the decision provides “favorable guidance” for issuers wondering if sequestration “constituted an ‘extraordinary event’ that would trigger their right to seek extraordinary optional redemption.”

Washington state refunded some of its outstanding BABs, despite pushback due to these debates.

James Pruskowski, chief investment officer at 16Rock Asset Management and a market participant who holds no BABs, told the Bond Buyer these extraordinary redemption provisions are mostly concentrated in “these big sophisticated issuers with densely populated areas and mostly on the coastal regions, such as New York, California and Washington.”

Bondholders have enjoyed several years of strong income and stable prices, so it can be “painful to lose that premium to an ERP being exercised,” Pruskowski said.

Norfolk, Virginia, became the first issuer to cancel its BABs refunding. Norfolk gave no reason for the cancellation of its redemption plans or bond issuance. However, the city said it reserved the right to call the 2010B BABs for redemption in the future.

Read more of the latest Build America Bonds news in our coverage below.