Groups Urge Immediate Guidance on BAB Pricing

Four major municipal market groups yesterday urged the Treasury Department to immediately issue interim guidance on how to determine issue price for Build America Bonds, warning that confusion surrounding the topic is having a “chilling effect” on the still-developing market.

Meanwhile, the Treasury released guidance stating that issuers can apply tax-exempt bond rules to BABs for purposes of determining issue price. That is  something the Government Finance Officers Association, the National Association of Bond Lawyers, the Regional Bond Dealers Association, and the Securities Industry and Financial Markets Association had asked for in their two-page letter

But not all of the groups’ concerns were addressed by the interim guidance.

Uncertainty in the municipal market about how to determine BAB issue price — coupled with heightened scrutiny from the Internal Revenue Service on the topic and the potential for issuers to completely lose their 35% subsidy payments — have led to widespread concern from market participants, the muni groups wrote yesterday.

“This uncertainty is having a chilling effect on the issuance of BABs as issuers and their advisers struggle to ensure compliance with the applicable rules,” the letter said. “The uncertainty could be removed if the service would issue guidance on the determination of the issue price, even if that guidance is just interim guidance pending a further review of the issue.”

This month, only 92 BAB issues totaling $5.4 billion were sold, compared to 142 issues totaling $12.6 billion the previous month, according to data from Thomson Reuters.

Specifically, the tax-exempt bond rules state that issue price is determined based on the first price at which at least 10% of the bonds are sold to the public and that the issue price does not change based on subsequent sales of the bonds.

Furthermore, issue price can be determined for tax-exempt bonds based on the reasonably expected sale price of the bonds to the public on the sale date, provided a bona fide offering of the bonds is made to the public. However, questions have arisen as to whether issue price can be determined if the bonds are sold to dealers or institutional investors who immediately sell or flip them to retail customers at higher prices.

Another source of the uncertainty surrounding BABs is a controversial complianc- check questionnaire the IRS is sending to every BAB issuer, asking if they are tracking the secondary market trading of their bonds after the sale date.

Concerns have arisen that the IRS may determine after the fact that the issue price the issuer determined is incorrect based on secondary market trading and could decide to block the subsidy.

The groups pointed out in the letter that issuers have no control over secondary market trades of their bonds and that the BAB market “cannot function properly with this type of risk being imposed on investors or issuers.”

The chilling effect this uncertainty has had on BABs is most evident in the competitive market, the groups said in their letter. In competitive deals, aggressive bids from underwriters can lower interest rates on BABs, but at the same time lengthen the time it takes to get 10% of the bonds sold and issue price determined.

Despite potentially causing more difficulty in determining issue price, the aggressive bids benefit the federal government as well as issuers because they lower the subsidy payments, the groups pointed out in their letter.

The Treasury notice released yesterday did not weigh in on the role secondary market trading might play in determining issue price.

Alan Anders, deputy director of finance for New York City’s Office of Management and ­Budget, said last week that the issue-price controversy could be discouraging issuers from competitive offerings.

“This confusion could actually be deterring some deals. Some issuers may be holding off or even considering going to negotiated deals,” he said. “This is something the Treasury should very much want to fix.”

Issue price also is significant because of a statutory requirement that BABs not be sold at more than a de minimis amount of premium.

The premium limit was put in place to ensure that issuers do not artificially inflate the interest rates of their BABs to obtain larger subsidy payments, and currently if issuers violate that limit, they stand to lose their entire subsidy.

The muni groups said the complete loss of a subsidy payment would be “an excessive and disproportionate penalty” for an issuer and recommended the Treasury come up with alternative remedies.

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