Low-Rate BABs Bill On Tap

WASHINGTON — Rep. John Tierney, D-Mass., plans to soon introduce a bill that would require all new munis to be taxable direct-pay bonds with a 25% federal subsidy rate — a proposal drawing a frosty reception from issuers and underwriters.

Tierney announced his plan on Monday as part of a broad tax-reform bill — the Tax Equity and Middle Class Fairness Act of 2011 — designed to save $60 billion by eliminating tax expenditures or preferences. The congressman hopes to garner Republican support for his bill, which could be introduced when Congress reconvenes in May, a staffer said.

Tierney would save an estimated $92 million in one year with the direct-pay bond provision. The 25% subsidy rate is lower than the 28% rate in President Obama’s fiscal 2012 budget request.

Obama proposed making the expired Build America Bond program permanent at a rate he said would be revenue neutral.

The reinstatement of the BAB program has been coveted by issuers and underwriters since Congress failed to extend it last year. However, several market participants said Tierney’s proposal would be ineffective with a 25% subsidy rate and the elimination of tax-exempt bonds would rattle an already fragile muni market.

Tierney’s bond plan “is not the model that we would prefer,” said Michael Nicholas, chief executive officer of the Bond Dealers of America. The ideal muni market needs tax-exempt bonds and some form of a direct-pay, federal subsidy bond, he said.

“Every dealer I talk to, one of the first questions is: 'Is there any chance we’re going to get some BAB-type product brought back this year?’” Nicholas said. Underwriters are skeptical the muni market will reach $250 billion of issuance this year without a BAB-like product, he said.

Chris Mier, chief investment strategist at Loop Capital Markets LLC, said Tierney’s proposal is “a good idea,” but the market still needs tax-exempt bonds.

“Almost as a precautionary measure, I think it is a good idea to have BABs, at a minimum, waiting in the wings” with the 25% subsidy rate, Mier said. “Down the road,” once the market tumult still lingering from the recession clears, “then if Congress wants to make the muni market 100% BABs, I think that is a workable outcome,” he said

Some issuers said Tierney’s subsidy rate would be too low to attract issuers.

The BAB subsidy rate “has got to be at least 30% to make financial sense for us,” said Tom Dresslar, spokeman for California Treasurer Bill Lockyer. Dresslar expressed doubt that Tierney’s proposal “would be a program we would make much use of.”

Tierney’s plan to eliminate all new tax-exempts in favor of the direct-pay bond with a 25% federal subsidy model “is obviously a bad tradeoff,” Dresslar said.

California was by far the largest BAB issuer with $13.4 billion sold over the life of the program, according to Thomson Reuters. New York City was second with $4.4 billion.

Tax-exempt bonds are “the critical financing tool for state and local governments and thereby our national infrastructure,” the Securities Industry and Financial Markets Association said in a release. “We strongly urge Congress to maintain it. At the same time, a program based on direct-pay taxable bonds, with an appropriate reimbursement rate, could be helpful to supplement the demand side of the tax-exempt market.”

At least four other bills have been introduced in the House to renew BABs, all sponsored by Democrats and all with subsidy rates of between 28% and 32% in the first year. None of the bills contain rates as low as Tierney’s and none would wipe out the market for new tax-exempt munis.

A version of BABs to be used exclusively for transportation projects might be included in a six-year transportation reauthorization bill being drafted by Rep. John Mica, R-Fla.

In the Senate, Ron Wyden, D-Ore., has introduced tax-reform legislation that would require new munis to be tax-credit bonds instead of tax-exempts. Wyden also is considering tax credit bonds for transportation projects.

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