CHICAGO - Stevens Point, Wis., next week will close on the sale of $3.65 million of taxable general obligation promissory notes - possibly the first such deal under the new Build America Bonds program that was included in the federal stimulus package.
Taking advantage of the new program, which some market participants have said could generate $1.5 billion in issuance, the Stevens Point Common Council approved the deal last week, with the closing set for Tuesday.
The city will apply for a direct-pay interest subsidy from the federal government rather than use an investor tax-credit option available under the BAB program.
The eight-year notes are structured much like a bank loan and resemble a private placement.
Wells Fargo Brokerage Services LLC provided the lowest rate under proposals sought by the city and will purchase the bonds at a taxable rate of 5.12%, said Stevens Point comptroller and treasurer John Schlice.
Foley & Lardner LLP is bond counsel. It was the law firm's Arthur W. Jorgensen, based in Madison, who first suggested the program as an option the city might consider for the planned bond issue.
Under the BAB program, municipalities can sell taxable bonds and receive a 35% direct subsidy in the form of payments from the federal government to pay interest on the bonds or allow investors in the bonds to claim tax credits worth 35% of interest paid.
Once the direct subsidy is factored into this taxable deal, the effective interest rate is lowered to the equivalent of a tax-exempt rate of 3.328%. That results in a savings of about $146,300 over the lowest tax-exempt rates submitted to the city under proposals received from three banks for issuing either tax-exempt or taxable debt.
"The program works for us because with the direct rebate it's providing the lowest cost of borrowing," Schlice, the city's top finance officer for the last 23 years, said in an interview this week.
Although Stevens Point's finances remain in strong shape with a $14 million reserve in place to help buffer the city's $24 million budget through any downturn in revenues, Schlice said: "We are also looking at ways we can benefit the taxpayer, and this seemed pretty straightforward."
The city's $24 million of general obligation debt is rated Aa3 by Moody's Investors Service.
Stevens Point earlier this year was looking at how best to finance a series of projects that included the purchase of several fire trucks, street maintenance, phone system upgrades, and the installation of a fiber optic network between municipal buildings. Schlice was looking at a direct bank loan to avoid higher bond issuance costs when Jorgensen raised the BAB program as an option.
Schlice asked the 10 banks Stevens Point does business with for proposals that included tax-exempt and taxable rates. JPMorgan, Citizens Bank, and Wells Fargo submitted proposals.
JPMorgan offered a tax-exempt rate of 4.23% and a taxable rate of 6.43%. Citizens offered a tax-exempt rate of 4% and a taxable rate of 5.75%. Wells Fargo offered a tax-exempt rate of 4.02% and a taxable rate of 5.12% that proved the lowest rate of borrowing when the BAB subsidy was factored into the costs.
Schlice said he was comfortable moving quickly to take advantage of the program based on a recent opinion paper authored by Foley & Lardner's Michael Bailey, and given the deal's simple structure. No public offering and pricing will be held. Wells Fargo will purchase the debt and place it with investors through its own certificates of participation program.
Wells Fargo's lead banker on the deal, Victor Chang, said his firm is very interested in the product and he has presented it as an option to his clients, recommending that municipal issuers "take a hard look at it as an option based on the current yield curve ... The bottom line is it can be a much lower cost of borrowing for some. The taxable market is much broader."
The program allows municipal issuers this year and next to offer an unlimited amount of taxable debt and elect to apply for the subsidies if the proceeds are being used for qualified tax-exempt purposes. The purpose is to expand the tools available to municipalities to finance projects at the most affordable rate. In creating the program, Congress is aiming to introduce new types of investors to municipal debt that carries significantly lower default rates than corporate debt.
Potential buyers include foreign investors, pension funds, defined-contribution investors, some trust accounts, and others looking for fixed-income holdings like tax-deferred portfolios. The program also is expected to prove attractive to other investors who don't stand to benefit from a tax-exemption, such as U.S. banks that are still writing off losses and don't need the tax-exemption but are in search of higher yields from strong credits.
"The program is doing here what it is intended to do, open up a market for municipal debt that lowers the cost of borrowing," Jorgensen said.
While many issuers are closely examining the benefits of using the BAB program, many are awaiting guidance from the Treasury on a range of issues. Stevens Point was able to move forward quickly due to its use of a loan-like, private-placement structure that did not require the resolution of issues involving publicly offered debt.
The city is awaiting direction on how and when issuers would receive their direct-pay subsidies from the government. The Treasury Department has said it hopes to release very preliminary guidance on direct-pay BABs late this month or early next month that will address that issue.
Stevens Point does not have an interest payment until well after Treasury is expected to release that guidance, Jorgensen said. He added that other issues municipalities are awaiting guidance on include the level to which issuance costs can be financed, a factor that did not come into play for Stevens Point because it has just limited costs associated with the loan-like structure.
While the participants in the Stevens Point transaction believe the unprecedented program is successfully serving its purpose, market participants across the country are still digesting its details, pondering and even bracing for the sweeping impact it stands to have on the tax-exempt market.
Analysts from Barclays Capital have estimated issuance of $150 billion under the program. However, Loop Capital Markets LLP analysts in a recent report predict that most of the BAB volume will not represent new issuance but rather a transfer of issuance of traditional tax-exempt bonds to the taxable market.
"We think that a $75 billion reduction in volume in the traditional tax-exempt market per year is sufficient to move rates in the tax-exempt market lower, providing a partial offset to the loss in demand from issuers migrating to the taxable market," said Loop's Chris Meir.
House Ways and Means Committee chief tax counsel John Buckley has attempted to assure bond lawyers that the stimulus' bonding programs are not meant to undercut the traditional tax-exempt bond market but to provide state and local governments with one more financing mechanism to borrow money.
While the program may prove beneficial for a wide swath of municipal borrowers, another concern is that it may add to the costs facing some already financially struggling states. New York calculates average interest rates paid by all school districts - excluding the state's five largest cities - in the year the state approves the project and sets that as the rate for which reimbursement is based. That figure might not reflect the incorporation of the subsidy.
Bond lawyers have said the program will alter the relationship of issuers and the Internal Revenue Service. In audits of tax-exempt debt, bondholders typically are at risk because the interest payments they receive could be declared taxable by the IRS if the bonds violate the tax laws.
Under the direct-pay option, the bonds are already taxable, and it is the issuers receiving the payments from the Treasury Department rather than the bondholders that are directly at risk in an audit. It is unclear exactly how the IRS will handle enforcement actions. Most attorneys suspect the IRS will stop payments when they suspect or find violations, and perhaps even seek a refund.
Enforcement action aside, Chang said some issuers he's talked to about the BAB program are concerned over whether they can rely on the interest subsidy over the life of their bond issues especially on issues that go out 30 years.
"I'm seeing a lot of interest in the program but some issuers are concerned about whether Treasury or Congress could change their mind down the road on the subsidy," he said.
John J. Cross 3d, associate legislative tax counsel for the Treasury's office of tax policy, has tried to quell concerns that Congress could halt the payments, saying that the law treats the payments like a tax refund, and that they should be seen as "an ongoing, kind of permanent appropriation."
