BABS redemption controversy vexing issuers

The troubled history of Build America Bonds is coming to a head as municipalities weigh tough choices over redeeming the bonds that have lost their appeal to issuers because of their administrative headache, reduced subsidy rate, and the current high interest rate environment.

“Every official statement is different,” said Emily Brock, director, federal liaison center for the Government Finance Officers Association. “There’s different language, different messages and different commitments that are conveyed between the issuer and the investor and that’s the discussion being had.”

The comments came during a meeting of the Debt Committee of the GFOA in Orlando Florida on Saturday. 

BABs issuance was authorized for less than two years from 2009-2010.  The taxable bonds were designed to help pull the country out of the global financial crisis. They financed about $180 billion in infrastructure projects during that time, at one time accounting for about 20% of the municipal bond market.  

Because BABs are taxable they typically carry higher interest rates.  When they were created the law provided for a 35% subsidy of the interest paid to the bondholder to be paid by Treasury directly to the issuer.  

Since 2013, federal budget sequestration has resulted in lower-than-promised subsidies leaving issuers in a financial pickle. According to the Internal Revenue Service, the subsidy rate has been reduced on a yearly basis since then. The highest rate of reduction was 8.7% in 2013 and is currently pegged at a 5.7% cut until 2030, which is the lowest it’s ever been. 

A Debt Committee member who represents a municipality with many millions of BABs outstanding expressed that they, “Would love to get out of them, but I don’t want to do it at the cost of offending or hurting my ability to issue the $11 billion of new money that I need to get done over the next 10 years and knowing that I will probably prevail in court if I get sued.” 

Some issuers are trying their luck by calling their BABS while utilizing an extraordinary redemption provision, which can result in passing losses onto investors. Some investors have threatened to sue by saying that sequestration does not qualify as an ERP. 

  “It’s not a question about whether I will win in court,” said Brock. “It’s whether I will go to court.”

About $110 billion of the $180 billion of BABS issued has an ERP clause written into the OS language, per a report from Barclays. Issuers are expected to redeem $20-30 billion in BABS this year that they believe qualify for ERPs.

The GFOA is wrestling with what to do advise members currently sitting on BABs and looking for guidance. “We don’t give advice on potential issuances,” said Brock.  “That is between an issuer, their municipal advisor, and bond counsel.”

 “We could potentially have a general advisory with different considerations for issuers that are thinking about refunding their BABs but it’s going to take a little bit of time for us to think about that, because we’re so new in it.”  

While working on how to advise its members on the current BABs problems, the GFOA has also been working on making sure the situation doesn’t happen again. “As Congress looks toward a potential direct subsidy pay bond, we know what we don’t like, and we know what we would prefer,” said Brock. 

The preference for the industry would be that any promised subsidy remain immune from an across-the-board sequestration that brings a meat clever approach to budget negotiations.

The current consensus per the GFOA is that BABS remains a hot button issue. Legal teams and municipal advisors should be consulted to fully understand the economics, financial implications and legal risk before making the move to call the bonds.