Standard & Poor's said in a report Friday that if issuers of direct-pay Build America Bonds pledge or plan to use the federal payments for debt service, then it will evaluate their ability to cover the debt service in case they are left waiting by the mailbox for checks the federal government promised to send.
For direct-pay BAB issuers who have no plan to use the federal payments for debt service, the rating agency said it would assign ratings based on the security for the bonds, such as the full faith and credit of the issuer or pledged revenues.
The rating agency made the statements in a report on the municipal bond provisions of the American Recovery and Reinvestment Act of 2009, warning that the federal government's payment mechanisms for direct-pay BABs "raise questions as to the likelihood of timely payment - at least in the near term."
The BAB program lets muni issuers sell taxable bonds and either receive a direct payment from the federal government or have the government give investors a tax credit. The payments and tax credits would equal 35% of the interest paid on the bonds. Direct-pay BABs have become popular with issuers.
The Internal Revenue Service plans to mail federal subsidies to BAB issuers. But any delay could leave the issuers forced to make the full interest payment or face default, Standard & Poor's pointed out.
Standard & Poor's said in the report that, though it is worried about the direct payments' timeliness, it will consider in determining ratings whether issuers have reserve accounts or other sources of funding that could be relied on in case of late Treasury payments - or if the Treasury moves to an electronic payment system to ensure timely payments to issuers.
Federal officials have said that their top priority is to get subsidies to issuers on time. Clifford J. Gannett, the director of the IRS' bond branch, told a May 9 meeting of the American Bar Association's tax-exempt financing committee that the "mandate has really been to get these payments out contemporaneously with the interest payment dates - that's been our plan."
The Treasury and IRS said in initial guidance in April outlining BABs that they plan to "actively pursue refining" how the direct payments are made and are studying the feasibility of allowing them to be made electronically, similar to the system used by the Bureau of Public Debt for payments on state and local government series securities.
Alan Krueger, the assistant secretary for economic policy and chief economist at the Treasury Department, told lawmakers two weeks ago that a "major challenge" for the IRS will be to develop an electronic payment system to eliminate the concern about delays.
To date, all of Standard & Poor's BAB ratings have been the same as the issuer's rating of the underlying security for the bonds, said James Wiemken, the primary author of the report.
The report also ruled out credit concerns that the federal subsidies could be cut or stopped with future legislation. "We view the obligation of the Treasury to make a subsidy payment to be a permanent, continuing appropriation analogous to the continuing authority of the IRS to make tax refund payments," the report said.
Any BAB payment or investor tax credit subsidy could be offset by a tax liability such as the issuer failing to comply with the requirements for issuing the bonds, the report noted, adding that this is not a credit concern.
