WASHINGTON — Members of the Government Finance Officers Association’s governmental debt management committee on Friday unanimously agreed to propose a revised policy on direct-subsidy and tax-credit bonds that acknowledges Build America Bonds have emerged as a significant sector of the municipal market.
The move marks a departure from its earlier policy on direct-subsidy bonds, also called taxable bond options, which dated back to President Jimmy Carter’s administration and staunchly opposed them. The committee also unanimously signed off on an advisory document outlining things issuers should consider if issuing BABs. The votes came during a meeting the committee held here.
Both documents now advance to GFOA’s executive board, which will consider them at their next meeting in March. If approved by the board, the policy would have to be signed off by GFOA members during the group’s annual meeting in June but the advisory document would become effective.
The proposed policy stops short of endorsing BABs, but instead acknowledges their existence, along with a menu of tax-credit bond options.
“As Congress looks to create, enhance, extend, or revise tax-credit bond programs and as regulations are promulgated, GFOA will work with Congress and the Treasury Department to maximize the cost reductions of these programs and minimize their administrative burdens,” the document said.
GFOA’s previous policy simply stated that the organization “does not support the taxable bond option.” Members had aired concerns in the past that BABs could potentially replace tax-exempt bonds and make state and local governments reliant on the federal government.
The proposed revised policy explicitly states that GFOA’s overall stance remains that tax-exempt bonds should be the primary vehicle for municipal financing. It also states that GFOA opposes anything that would “cause harm to, substitute for, or crowd out the tax-exempt bond market.”
The advisory document highlights topics issuers should consider on BABs, when preparing to issue them, when actually issuing them, and after they are sold. For example, it recommends issuers determine exactly how much in subsidy payments they are due to receive over the life of the bonds so they can be aware of how much monetary risk would exist if Congress were to retroactively modify the program. Furthermore, issuers should create a process ensuring that paperwork requesting subsidy payments is regularly sent in on time as well as verifying those payments were received.
BAB issuers also should familiarize themselves with the terminology and conventions of the taxable market. For example, the advisory notes that make-whole calls that are typical in the taxable market can make bonds effectively noncallable because the costs of redemption would be prohibitive.
Separately, the debt committee approved changes to a revised advisory on the use of debt-related derivatives products and the development of a derivatives policy, and also said it plans to make changes to a companion checklist. The advisory, developed in 2005, warns state and local governments to use caution when determining if derivatives contracts are an effective financing tool, as recent market experience has shown that derivatives, when used to hedge a particular bond issue, can limit an issuer’s flexibility with respect to the bond issue.
Language also was added to recommend that swap termination and collateral requirements should reflect the relative, comparable credit risks of the issuer and counterparty based on a corporate equivalent, or global ratings scale. The change reflects the opinion by several committee members that collateral posting requirements should, in most cases, be the sole responsibility of issuers’ counterparties because their ratings do not fully reflect their credit risk. Likewise, termination events should be structured “asymmetrically,” to generally favor issuers, they contend.
The panel also approved a revised best practices document on using variable rate-debt instruments, with additional background information warning that variable-rate debt should be used only by issuers with expertise in these instruments that have adequate financial capacity to accommodate rapid and potentially large changes in borrowing costs. In addition, language was added to the document to warn that variable-rate demand obligations should not comprise more than 20% to 30% of an issuers’ portfolio, based on rating agency recommendations.
Another document it approved, a new best practices document on secondary market disclosure responsibilities of issuers, recommends that issuers submit event notices within 30 days after they learn of an event. Proposed Securities and Exchange Commission changes to its Rule 15c2-12 on disclosure would require filings to be made within 10 days of an event’s occurrence.
The committee also revised a best practices document on the payment of the expense component of an underwriters’ discount. It notes that issuers are not responsible for, and should not pay, fees due to the Securities Industry and Financial Markets Association or the Municipal Securities Rulemaking Board.
