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Push to Expand ARRA

DEC 21, 2009 6:53pm ET
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WASHINGTON — Municipal market participants want Congress to provide more assistance for muni bonds next year by extending or expanding many of the bond-related provisions in the American Recovery and Reinvestment Act, especially those authorizing the Build America Bond program.

"Obviously, I think there's a lot of hope that the temporary provisions, some of them at least, will be extended," said Thomas Vander Molen, a partner with Dorsey & Whitney LLP in Minneapolis.

"We'll be paying close attention to the work that needs to be done on the expiring bond provisions from ARRA," added Susan Gaffney, director of the Government Finance Officers Association's federal liaison center.

The House started on this course last Wednesday by approving a jobs bill that would expand two tax-credit bond programs for schools to allow state and local issuers to receive direct BAB-style payments from the Treasury Department instead of investors receiving tax credits.

The provisions, which would apply to qualified school construction bonds and qualified zone academy bonds, could be the beginning of a major change in the muni market, with Congress modifying the tax-credit bond programs, which have never really taken off, to reflect the more popular BABs.

"In light of the success of the BAB program, this is a sensible step forward and could jump-start the QSCB and QZAB programs next year," said Jeremy Spector, a partner at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo PC and chair of the American Bar Association's committee on tax-exempt financing. "If successful, the next step would be to extend the direct subsidy payment to other categories of [tax-credit bonds]."

Vander Molen also suggested the subsidy mechanism for direct payments to issuers be made an option for existing tax-credit bond programs.

"I think there's some significant support for doing that," he said. "I think that would make a lot of sense, because there's still a lot of marketing difficulties with the bondholder credit bonds, and you don't really have nearly that degree of difficulty with the direct-subsidy bonds."

As of Dec. 11, state and local governments had issued more than $63 billion of direct-pay BABs, which provide them with federal payments equaling 35% of their interest expense. That compared to a paltry $2.46 billion of tax-credit bonds that were issued during the same period, according to Thomson Reuters.

The QSCB program accounted for most of that tax-credit bond issuance — 144 deals totaling $2.4 billion — but still fell far short of the $11 billion Congress authorized for the program for 2009. An additional $11 billion of QSCBs have been authorized for next year.

QZABs have not fared nearly as well. Despite receiving $1.4 billion in authority as part of the ARRA enacted in February, just 16 issues totaling $43.1 million of QZABs were sold in 2009, according to Thomson Reuters.

As far as extending the BAB program beyond its Dec. 31, 2010, expiration date, it appears the discussion already has moved beyond "if it will happen" and instead has advanced to "when it will happen" and "for how long," as well as, "who else will be allowed to participate" in the program.

The top tax lawyer in the House, John Buckley, suggested in November that the direct-pay BAB program could even be made permanent, although probably at a lower subsidy rate than the current 35% of interest expenses. Buckley, the majority chief counsel for the House Ways and Means Committee, said at a conference co-hosted by the National Association of Bond Lawyers and American University's Washington College of Law: "I do believe that there will be an extension of BABs, and the only question is when that happens and for what duration .... There is a good case to be made for the sooner the better, and the longer, if not permanent."

Many market participants have urged Congress to approve a BAB extension as soon as possible because it would give the still-developing market some stability and show investors that the bonds will not be orphaned in just 12 months.

A recent survey conducted by The Bond Buyer and the Securities Industry and Financial Markets Association showed that 45% of market participants queried wanted the BAB program extended in its current form, while 30% wanted the program extended at a lower subsidy rate and 26% wanted the program to expire.

EXPANDING BABS

Market participants are beginning to consider how the program could be expanded to other sectors of the muni market. Currently, BABs are limited to new-money issue by governmental bodies to finance capital expenditures, with the idea that they be used for projects that stimulate the economy. Some market participants have suggested Congress permit BABs to be used for working capital purposes such as refundings.

A Bank of America Merrill Lynch global research report published earlier this month projected that if the 35% subsidy rate were retained for BABs and the program was expanded to include refundings, issuers would sell roughly $75 billion of new-issue BABS and between $200 billion and $300 billion of refunding BABs next year.

Charles Samuels, a lawyer with Mintz Levin and counsel to the National Association of Health and Educational Facilities Finance Authorities, said charitable organizations are beginning to discuss whether they could take advantage of the bonds.

"How exactly would that work? We're just beginning that discussion," he said. "I think the jury is still out on them, but there's absolutely no controversy that they've become very, very popular."

NAHEFFA will be taking a look at some public universities and hospitals that have used BABs for insight on how the financing tool could benefit private nonprofit schools and hospitals, he added.

Tax-credit bonds have existed in one form or another for over a decade, now spanning seven programs and currently authorized at a total of nearly $30 billion. But even though these bonds got a big boost in the ARRA, a robust tax-credit bond market still has failed to develop, with some market participants wondering whether one ever will.

"They're easier to market, they've become more attractive to the marketplace, ... even if they give sufficient guidance for tax-credit stripping, I still think you're going to see more acceptance in the marketplace of more direct-subsidy bonds," Vander Molen said.

However, a major question about the future of BABs is what might happen to the 35% subsidy rate, which Treasury officials have repeatedly pointed out was intended to be rich to encourage issuance and economic development. While attracting issuers, the high subsidy rate has resulted in costs to the Treasury that were well beyond estimates originally made when BABs were proposed.

The congressional Joint Tax Committee in February estimated the federal government would spend $51 million in fiscal 2009 and $292 million in fiscal 2010 on the BAB program, but some market analysts have predicted the program could end up costing the federal government billions a year over the life of the bonds.

Most market participants agree the program is not likely to be made permanent without a lower, more revenue-neutral subsidy, sources said. Lawmakers likely would look at how much federal revenue they forgo for tax-exempt bonds, and then scale the subsidy level for BABs to a similar level, perhaps one slightly higher so BABs still provide some distinct appeal to issuers, sources said.

Varying revenue-neutral subsidy levels have been estimated by market participants, with a general consensus emerging that it would likely fall somewhere between 22% and 27%.

However, BABs are not the only ARRA provision garnering attention as expiration dates begin to loom.

When the ARRA was signed into law in February, it contained a number of provisions that eased tax law restrictions or expanded the market for muni bonds through the end of 2010. All munis were exempted from the individual and corporate alternative minimum tax. Banks were permitted to purchase and hold more tax-exempt debt without losing tax deductions. Market participants are turning their attention and energy towards keeping those provisions beyond their Dec. 31, 2010, expiration dates.

Both Samuels and Gaffney said that they would like to see extended, or made permanent, the provision that enables banks to purchase more tax-exempt bonds. Under the ARRA, the so-called bank deductibility limit was expanded so that banks now can deduct 80% of the cost of buying and carrying the tax-exempt bonds sold by issuers whose annual bond issuance is less than $30 million, as opposed to the previous $10 million limit. Furthermore, that limit can be applied to borrowers rather than issuers in conduit financings.

Gaffney highlighted the provision as one of GFOA's top priorities, with the hope of making it permanent in forthcoming legislation.

"Many of our members have greatly benefited from this provision, and ... [it] has helped small communities all across the US," she said.

"Bank deductibility is now being used by many, many small projects across the country," said Samuels, who added that his group is also pushing Congress to make permanent a provision in the Housing and Economic Recovery Act of 2008 set to expire at the end of 2010 that allows the federal home loan banks to provide letters of credit for all tax-exempt bonds.

"We want to get it made permanent or at least extended, but probably made permanent," he said. NAHEFFA currently is gathering information it wants to present to Congress about how helpful both of those provisions have been, he added.

REGULATION

On the regulatory front, market participants are hoping the coming year includes additional guidance on some ARRA provisions, but also a return to regulatory needs that existed before the stimulus package monopolized much of the Treasury's lawyers' attention in 2009.

The Treasury and the Internal Revenue Service recently identified 10 muni bond projects they hope to release under their 2009-2010 priority guidance plan.

At the top of their list is stripping guidance on tax-credit bonds and how issuers or investors can strip the credit from the bond and sell it separately. Some market participants hope stripping will broaden the tax-credit bond market, but Treasury officials have warned that stripping should not be seen as a cure-all and that there are a number of complicated issues that they must work through before proposing guidance.

In addition, three pieces of proposed guidance seem primed for becoming final sometime in the next 12 months — rules for bond-financed solid-waste disposal facilities, public approval requirements for private-activity bond-financed projects, and allocation and accounting rules used to apportion private payments and private use in tax-exempt bond transactions.

The solid-waste disposal facility and PAB public approval guidance were both released to generally positive reviews from market participants. Given that the main criticism of those regulations were that they could not be utilized right away, Treasury officials hope to finalize them quickly. A public hearing on the public approval regulations was held last January, while a hearing on the solid-waste disposal facility regulations is slated for Jan. 5.

The allocation and accounting rules have lingered in the proposed state since 2006, and Vander Molen said he is looking forward to final regulations.

"I'm not quite sure how they're going to come out," he said. "That's kind of up in the air."

In addition, the Treasury probably will provide further guidance on some ARRA provisions in 2010. Members of the American Bar Association's taxation section recently highlighted 25 BABs issues for which they are seeking clarification, including whether or not BAB proceeds can be used to provide grants for projects and whether BABs and tax-exempt bonds that are issued at the same time would be considered part of the same issue.

The lawyers said other bond-related ARRA programs also are in need of further regulatory clarity, such as whether an issuer can designate its entire jurisdiction as a "recovery zone," which is eligible for special tax breaks and recovery zone economic development bonds as well as recovery zone facility bonds.

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