WASHINGTON — One year after the American Recovery and Reinvestment Act fundamentally altered the municipal landscape, market participants are pressing lawmakers to extend and expand its provisions.
There has been a flurry of activity on Capitol Hill in recent weeks as bills were proposed or enacted that would extend, expand, or tweak some of the ARRA’s bond-related provisions.
The biggest item on the agenda is the Build America Bonds program, which ARRA created to give issuers of the taxable tax-credit bonds the option of receiving direct payments from the federal government equal to 35% of their interest costs. Under the stimulus law, BABs can only be issued through the end of the year, and only to finance new capital expenditures.
Though issuers initially viewed BABs with suspicion as a potential replacement for tax-exempt bonds, the program’s popularity has led market participants to push for more BABs in more places, and several legislators are taking up the call.
“I was, frankly, a little skeptical when the program was being discussed conceptually that there would be a strong appetite in the taxable market for municipal debt securities, but the success of the program has certainly exceeded my expectations,” said Michael Decker, managing director and co-head of the muni division of the Securities Industry and Financial Markets Association. “What’s become apparent is that there’s a long-term need for this kind of a product … it’s been a terrific success.”
“I think it’s exceeded everybody’s expectations,” said Mike Nicholas, chief executive officer of the Regional Bond Dealers Association. “It’s a great tool that has room to expand.”
BABs hit their first growth spurt earlier this month, when President Obama signed the Hiring Incentives to Restore Employment Act, or HIRE, that expands BAB-style direct subsidy payments to four fledgling tax-credit bond programs: qualified school construction bonds, qualified zone academy bonds, new clean renewable energy bonds, and qualified energy conservation bonds.
Issuers can opt to receive a direct subsidy payment from the federal government instead of providing investors with a tax credit.
For the school bonds, the subsidies would be equal to the lesser of the actual interest rate of the bonds or the daily tax-credit rate set by the Treasury Department. The energy bonds would receive 70% of that amount — the same subsidy level offered under the tax-credit mode.
Market participants expect issuers to take full advantage of the new direct-pay options.
“I think, overwhelmingly, you’ll see [issuers] go over to the direct-subsidy mode,” said Kathleen McKinney, president of the National Bond Lawyers Association and a shareholder at Haynsworth Sinkler Boyd PA in Greenville, S.C. “It’s just so much easier to understand.”
But not everyone is a BAB-lover. Sen. Charles Grassley, R-Iowa, the ranking minority member of the Senate Finance Committee, claims they are a spending program disguised as a tax cut that mostly benefits big Wall Street underwriting firms and issuers with lower credit ratings. Other Republican members of Congress, like Arizona Sen. Jon Kyl, agree.
Nevertheless, the potential for a wholesale shift from tax-credit bonds to direct-pay bonds appears to lessen the importance of guidance the Treasury released March 23 on how to “strip” the tax credits from tax-credit bonds and sell them separately.
President Obama’s fiscal 2011 budget request proposed the BAB program be made permanent at a 28% subsidy level, which budget documents maintained would be revenue-neutral. The White House also proposed that nonprofit hospitals and universities be able to sell BABs and that issuers be allowed to use BABs to finance refundings and working capital needs.
But thus far, federal lawmakers have opted for a slightly less dramatic approach, due in part to the fact that they are restricted by statutory pay-as-you-go budgeting rules.
Although the administration claimed in its budget documents that expanding BABs and making them permanent would add just $24 million to the federal deficit over the next 10 years, the Joint Tax Committee recently estimated the proposal would cost a bit more — $8.4 billion, to be exact.
A second jobs bill, the Small Business and Infrastructure Jobs Tax Act of 2010, was approved by the House on March 24. It takes a different approach. Under the bill, BABs would be extended until April 1, 2013, but the subsidy rate would be reduced to 33% in 2011, 31% in 2012, and 30% in the first three months of 2013. The program also would allow new BABs to refund previously issued BABs.
Decker said he supports the bill and that the reduced subsidy level seems about right.
“I think that you can make an argument that a reimbursement rate somewhere in the 30s is justifiable” compared to the benefits offered by traditional tax-exempt bonds, he said.
“Going from 35 gradually to 30 makes it much more attractive,” Nicholas said. “It’s definitely the smarter approach.”
Levin’s bill also contains a couple of other bond-related provisions but fails to extend two ARRA provisions that encourage banks to buy municipal debt that market participants say are vital.
They currently are slated to expire at the end of the year. The first ARRA provision increases to $30 million from $10 million the small-issuer limit for bank-qualified bonds, and allows the limit to be applied to individual borrowers participating in conduit deals, rather than the conduit issuer.
The second modifies the 2% de minimis rule for financial institutions to include banks. Under that provision, financial institutions that invest in tax-exempt bonds can deduct 80% of the cost of buying and carrying them, to the extent that their tax-exempt holdings do not exceed 2% of their assets.
Earlier this month, 12 muni market groups sent a three-page letter urging leaders of the tax-writing and banking committees to make the provisions permanent. But so far no extensions have found a home in pending legislation.
“It’s proven to be probably even more successful than we imagined,” said Charles Samuels, a lawyer with Mintz Levin Cohn Ferris Glovsky & Popeo PC and counsel to the National Association of Health and Educational Facilities Finance Authorities, which signed the letter. “It’s put a lot of small nonprofits into the marketplace that couldn’t have afforded to go.”
McKinney said the provisions have been “a savior, really, for a lot of smaller … colleges, health care [facilities], YMCAs, and cultural arts facilities.”
They were “a great success story but it just hasn’t gotten the same level of publicity” as other success stories, namely BABs, she added. “I’m hoping that that will get a second look.”
Market participants speculated the cost of the provisions could be causing the delay. The JTC estimated extending both provisions by another year would cost $2.96 billion over 10 years. But the two provisions were not scored separately, leading some to speculate that the de minimis provision could be driving up the price tag of the package.
“If you had to choose which one you would like, I think [it’s] the $30 million one ... that’s gotten much more utility.” McKinney said.
