The use of taxable bonds provided for under the federal stimulus package could drive up costs for New York if school districts decide to issue them, due to the state's reimbursement formula.

While the American Recovery and Reinvestment Act of 2009 has two provisions dealing specifically with school construction bonds, school districts could also choose to issue taxable Build America bonds to finance their capital projects.

The state's formula for reimbursing school districts for some of their capital construction costs includes interest costs. Rather than using actual interest rates on debt, New York calculates average interest rates paid by all school districts - excluding the state's five largest cities - in the year the state approves the project and sets that as the rate for which reimbursement is based. In fiscal 2008, for example, the average rate was 3.625%.

Add some higher-yielding taxable debt into that mix and the average interest rate would increase. The stimulus package allows issuers to sell taxable Build America bonds through Jan. 1, 2011. The bonds come with a federal subsidy that the issuer can receive or tax credits that can go to the bondholders. The subsidies and tax credit would be equal to 35% of the interest paid on the bonds.

As issuers sift through the details of the stimulus package and wait for guidance from the U.S. Treasury, it is still unclear whether there will be a market for taxable deals or whether school districts would use them.

"Right now the spreads - taxable and municipals - over treasuries are probably in the 250 basis point range, depending on credit quality; if you tag onto that the potential 35% rebate to an issuer or tax credit to the purchaser, it's very attractive," said Richard Tortora, president of Capital Markets Advisors LLC, a financial advisory firm that has school districts as clients.

"When the state put together this formula, I don't think anyone envisioned that because of this strange market anomaly that school districts might issue taxable debt, and I'm sure no one envisioned that there could be this 35% subsidy," he said. "It could really wreak mayhem with the state's funding formulas."

Amending the reimbursement formula would have to be taken up by the Legislature, said bond counsel Martin Geiger of Hawkins Delafield & Wood LLP.

"To what extent is the state going to take into account any offsetting 35% grants in determining reimbursement to school districts? That's a policy matter and a decision to be taken up by folks in Albany," Geiger said. "One would think the state would deduct 35% of the interest rate."

"We are aware of this situation and we are reviewing it," state Division of Budget spokesman Jeffrey Gordon said in an e-mail.

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