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Market Reacts to Obama's AFF Proposal

FEB 20, 2013 12:52pm ET
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Municipal market participants are encouraged but cautious about President Obama’s proposal for a new type of taxable, direct-pay bond called America Fast Forward bonds to finance the nation’s infrastructure.

AFF bonds, modeled after the Build America Bond program, would include private-activity bonds and relax certain limitations on how the bonds could be used, according to a White House release issued Wednesday.

BABs, which were created in 2009 under the American Recovery and Reinvestment Act but could no longer be issued after 2010, could only be used for capital expenditures and governmental purposes.

Direct-pay bonds are taxable. For BABs, the Treasury Department sends issuers subsidy payments equal to 35% of the bonds’ interest costs, although that subsidy amount could be lower for AFF bonds. The White House did not specify a subsidy rate for AFF bonds, but the president in the past has proposed reinstating BABs at a 28% subsidy rate. Rep. Gerry Connolly, D-Va., recently introduced legislation to make BABs permanent at a 25% subsidy rate.

The House Ways and Means Committee’s ranking minority member, Rep. Sandy Levin, D-Mich., who proposed reinstating BABs last year, encouraged Republicans to embrace the president’s infrastructure plan as a place to start for job creation.

“The Build America Bonds program was highly successful and we should build off that success,” Levin said Wednesday. “The real obstacle is the House GOP’s insistence on doing nothing.”

But even if AFF bonds are proposed with a lower subsidy rate, it’s unlikely they will gain much momentum in Congress before lawmakers hash out a comprehensive deficit reduction plan.

Bill Daly, director of governmental affairs for the National Association of Bond Lawyers, said it is encouraging the White House recognizes the importance of state and local governments, but he isn’t optimistic the proposal will move forward until the federal deficit reduction is resolved. “This would have to be taken up in a tax bill and that seems unlikely,” he said.

Within the next few months, Congress must decide whether to stop the $85 billion in automatic, across-the-board budget cuts set to go into effect on March 1, agree to a continuing resolution to keep the government funded past March 27, and decide whether to raise the nation’s debt ceiling again, which has been suspended until May 19.

In addition, Republicans have little appetite to reinstate BABs, claiming they provide lucrative fees for underwriters and encourage issuers with lower credits to borrower more. In an environment where Republicans stress that government spending is the problem to the deficit, Obama’s proposal can almost be considered dead on arrival, sources said.

“The summary is very vague, but this appears to be just a rehash of BABs, but making them even broader,” said a Republican aide. “Considering that Congress refused to extend the BABs program back in 2010, it’s unclear how this initiative would proceed.”  

In its release, the White House said, “AFF bonds would attract new sources of capital for infrastructure investment — including from public pension funds and foreign investors that do not receive a tax benefit from traditional tax-exempt debt.”

Municipal Market Advisors’ chief executive officer Tom Doe said the AFF program sounds like a good idea but would encourage more borrowing to build projects, which is not fiscally prudent for cash-strapped governments.

The primary concern among a handful of market participants was that this proposal would act as a substitute for traditional tax-exempt financing, which Obama has threatened to curtail as a way to raise revenue.

“That’s wrong and the administration’s neglect, disinterest and treatment of tax-exempt financing as exemplified in the 28% cap proposal is very unfortunate,” Chuck Samuels, a lawyer at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo PC, said referring to Obama’s proposal to cap the value of tax exemption at 28% for the wealthy.

Michael Decker, managing director and co-head of the municipal securities division at the Securities Industry and Financial Markets Association, echoed Samuels, saying it would be inconsistent to revive direct-pay bonds while at the same time increasing the costs of traditional tax-exempt financing. “We would like to see direct-pay bonds or BABs come back but not at the expense of full tax exemption for infrastructure finance,” he said.

Council of Development Finance Agencies president Toby Rittner commended the President for the plan but said “any proposal to increase infrastructure investment must come with reciprocal and complimentary tax-exempt bond reform.”

If the AFF bonds “represent another arrow in the quiver for state and local governments to access private capital markets, state treasurers would generally look upon it favorably,” said National Association of Treasurers president and Virginia Treasurer Manju Ganeriwala. She added, however, that the group’s top priority is to maintain the current status of muni bonds because it is the most efficient financing mechanism.

Government Finance Officers Association representatives said an additional tool in their toolbox would be helpful but that they prefer that muni bonds remain the primary mechanism to provide infrastructure so that state and local governments’ ability to access capital markets is not harmed.

The AFF bond program is part of the president’s larger goal to invest in infrastructure as outlined in his state of the union address last week. Obama also called for a Fix-It-First program to invest $50 billion immediately into the nation’s transportation infrastructure. He re-proposed creating a National Infrastructure Bank that would have the ability to leverage, through loans and loan guarantees, private and public capital to support national and regional infrastructure projects.

The National League of Cities said they remain “very concerned” about the proposed national infrastructure bank because a poorly funded bank would be no substitute for muni bonds. “If infrastructure investments are to encourage job creation, there must be a robust municipal bond market,” NLC executive director Clarence Anthony said, warning curbs to tax-exempt bonds would raise issuers’ borrowing costs.

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