A federal official and market participants yesterday butted heads over whether direct-pay Build America Bond issuers should worry about Congress stopping or reducing the federal payments that are to be made to them, despite repeated statements by tax experts in Congress and the administration that such worries are baseless.
The financing tool, which was created under the stimulus law, allows municipal issuers to sell taxable debt in 2009 and 2010, and elect either to receive a direct payment from the federal government equal to 35% of their interest costs or have the government provide a tax credit to investors who buy the debt.
The direct-pay option has garnered significant attention and high levels of issuance in its few months of existence, but municipal issuers still are expressing doubts over whether they can trust Congress to maintain that same subsidy for the life of the bonds, which typically would be 30 years.
Speaking on a panel at the Securities Industries and Financial Markets Association's Municipal Bond Summit here, John J. Cross 3d, associate tax legislative counsel for the Treasury Department's office of tax policy, insisted that the subsidy is not in danger. It would be "highly, highly unlikely" that policymakers would retroactively alter payments made on existing direct pay BAB issues, he told industry officials at the conference, noting that lawmakers would have to go so far as to alter the statute to cut off the payments.
"I don't think that's a real issue," he said. "There is a permanent and definite appropriation."
Nonetheless, J. Ben Watkins 3d, director of Florida's bond division, who was also on the panel, said he wants to retain the ability to call any BABs his office issues at par "in the event the federal government changes their mind."
"I don't have any compelling reason to trust the policymakers in Washington that the level of subsidy and the check they're going to send me every six months will happen over the course of the next 30 years, so I want to protect myself," Watkins said.
Cross maintained that if a muni issuer sells direct-pay BABs in the two-year window authorized by the stimulus, "You ought to be able to sleep like a baby." Any changes to the program, he said, would happen purely on a prospective basis following its sunset at the end of 2010.
"That and an unlimited supply of Ambien would work for me," Watkins quipped.
Standard & Poor's stated in a report issued at the beginning of this month that it would not take into account any concerns about payments being stopped in the future when determining the credit quality of direct-pay BAB issuers.
"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.
Cross alluded to the potential that the BAB program, if found worthwhile by the muni community, could be revisited, extended, or even expanded in the future.
"The big question going forward for BABs is going to be, where do we go from here?" he asked. "Is it one worth keeping going forward?"
Ruth Levine, a principal and senior analyst with mutual fund company Vanguard Group Inc., who also sat on the panel, is not worried about the government stopping payments for BABs issued under the stimulus law, but rather that Congress would discontinue the program in the future if it proved too costly, leaving only a relatively small amount of issues outstanding.
"Is there a possibility that this market sometime in the future could become orphans?" she asked, noting that there have been cases where states have agreed to subsidize localities for various reasons, only to bring an end to those programs when faced with budgetary pressures.
On the regulatory front, Cross said the Treasury hopes to publish in "the very near future" guidance allocating and detailing procedures for the $25 billion in Recovery Zone bonds authorized by the stimulus bill and $2 billion of tax-exempt tribal government economic development bonds.
The Recovery Zone bond program consists of two parts: $10 billion of recovery zone economic development bonds which, like BABs, would provide a direct payment to issuers, this time equal to 45% of interest, as well as $15 billion of recovery zone exempt facility bonds, which would be private-activity bonds. The bonds will be allocated to states, counties, and large cities based on how much their unemployment increased in 2008.
