In Praise of BABs and Their Potential

WASHINGTON — Lauding the success of the Build America Bonds, market participants here yesterday turned their attention toward the potential for the program to be extended beyond its current Dec. 31, 2010, expiration.

The BAB program, created under the federal stimulus law, offers issuers a 35% subsidy on taxable municipal debt that they can sell for new-money general governmental bond purposes.

Justin Hoogendorn, managing director at BMO Capital Markets, said that if the program is extended but the subsidy level is reduced to 25% in an effort to reduce the cost to the federal government, BAB issuance could fall, leading to more volume returning to the tax-­exempt market.

He and others also suggested that the market for tax-exempt debt might also get a boost if federal tax rates were to increase in the future as the federal government grapples with an expanding deficit.

If Congress opts not to extend the program, Jeffrey Scruggs, managing director at Goldman, Sachs & Co., said he would anticipate a busy active end of 2010 as issuers race to get BABs issued while it is still an option.

Scruggs also said the BAB program came along at the perfect time, as credit markets began to loosen, and thus far has proven to be a boon to both the taxable muni and and traditional tax-exempt bond markets. Increased BAB issuance has opened the door for traditional issues to find a home in the tax-exempt market, he said.

“The BABs have actually raised both boats,” he said.

Scruggs also said some initial concerns that BABs were intended to ultimately replace the tax-exempt market have been unfounded.

He said there has been nothing to indicate that BABs are intended to usurp traditional munis, and the program is simply meant to serve as “a very useful additional tool.”

“Is this something that is designed to eventually take the place of tax-exempt bonds? The answer to that is no,” he said.

Scruggs and others made their comments at a conference on municipal finance and the stimulus law hosted by The Bond Buyer and Bank of New York Mellon.

With the general consensus that the more than $33 billion in BABs sold since inception show it has been a resounding success, market participants discussed the chance that the program could be extended beyond its original two-year lifespan — and if it were, what could happen to the subsidy level.

Scruggs noted that many in the muni market and in Congress have been happy with the performance of BABs, but “the best form of advertising” would likely come from issuers discussing the advantages of the program with their representatives.

Market participants also expressed enthusiasm for the variety of stimulus act-created tax-credit bond programs available to the muni market, particularly the qualified school construction bond program, but noted that the relatively new financing tool still carries with it some challenges.

Kris Kolluri, the chief executive officer of the New Jersey School Development Authority, said his state has been allocated $443 million of QSCB authority for 2009 and 2010. He said they hope to issue some of the bonds in the next few months, and that the potential savings the financing tool offers makes it very attractive to the states.

“When we issue, this has the potential for saving over $300 million, and that savings goes directly at what the governor and legislature would have to pay every year in debt service,” he said. “You can just imagine how powerful ... an instrument like this is.”

The panelists said some local issuers were worried about a provision in the American Recovery and Reinvestment Act stating that localities receiving QSCB allocations would lose that bond authority to the state if they do not issue the bonds by Dec. 31, 2009. But Marvin Markus, managing director at Goldman, said Treasury officials told market participants at a meeting held earlier this month by the Municipal Forum of New York that they were looking into whether they could provide some relief on that deadline.

Doug Lamb, a partner at McGuireWoods LLP, raised the question of whether or not the tax credits from tax-credit bonds could be “stripped” and sold to separate investors now, even though the Treasury Department has not yet released regulations detailing how it would be done.

Although a number of questions remain about the complexities of stripping, Lamb said it may be possible to see some straightforward credit strips being done. Treasury officials are working on the rules currently, but the large number of technical issues are slowing progress.

“It really would ultimately depend on the scenario and the appetite of the purchaser for dealing with that uncertainty,” he said.

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