CHICAGO — If federal interest rate subsidies for Build America Bonds are reduced either because of sequestration or a federal deficit deal, Columbus, Ohio, is planning to respond.
Columbus Auditor Hugh J. Dorrian intends to ask the City Council next month for authority to refund up to $475 million of Build America Bonds and recovery zone economic development bonds should federal subsidies be cut under sequestration or in a deal to avoid the fiscal cliff.
The city, unlike many BAB issuers, included in the original bond indentures a traditional 10-year call feature and provisions for an extraordinary optional redemption at par in the event the federal government announces its intention to reduce or eliminate the subsidy payments.
The city would refund the taxable bonds issued under the federal stimulus programs for tax-exempt general obligation securities to achieve significant savings in the event of a change in the status of the interest rate subsidies.
"I want to be prepared. If there is any cut back in the subsidy I want to be able to move," Dorrian said in an interview Wednesday. "We are certainly not looking forward to the fiscal cliff, but we owe it to the taxpayers to explore all avenues in the event that it does occur."
The City Council next meets Jan. 14 so the city expects to know by then the fate of the subsidies. Though a final decision on refinancing the debt rests on a review of the fiscal impact, Dorrian said his office likely would move forward on refunding the city's $375 million of BABs if there's any change to the 35% interest rate subsidy. A deeper analysis would be needed on a decision to refinance the city's $100 million of RZEDBs as they receive a greater 45% federal subsidy.
The federal stimulus bond programs that provide the interest rate subsidies were aimed at jumpstarting municipal issuance following the 2008 financial crisis by expanding the municipal marketplace to include taxable buyers.
Top-rated Columbus has eight series of outstanding taxable bonds issued during 2009 and 2010 when the subsidy programs were in place. The city traditionally seeks at least 5% present value savings on any refundings and a cut in the 35% subsidy likely would allow the city to meet or exceed that threshold.
If the city moves forward with a refinancing it would likely include some additional non-BAB GO refundings in the transaction, Dorrian said. The city has not yet named an underwriting team for the possible transaction. Bricker & Ecker LLP would serve as bond counsel and PRISM Municipal Advisors, LLC is advising the city.
Dorrian is among those market participants upset over the threat posed to the subsidies after administration officials assured issuers in 2009 and 2010 that those payments were safe.
The Office of Management and Budget said in a report earlier this year that 7.6%, or $322 million, would be cut from $4.2 billion in authorized subsidy payments to issuers of BABs and other direct-pay bonds in fiscal 2013. They are part of $1.2 trillion in automatic spending cuts triggered if Congress fails to reach a deficit reduction plan. A total of $255 million of BAB subsidies would be cut. With a 7.6% BAB subsidy cut, an issuer would see a reduction from the full 35% subsidy to 32.4%, which would equal 2.6% of total interest costs.
Call provisions were debated in early BAB issues in 2009 as many investment bankers pushed issuers to adopt the make whole calls commonplace in the taxable market and more familiar to corporate buyers. A make whole call renders refundings less affordable as it requires issuers to redeem the bonds at a price determined by a formula that reflects market value.
Issuers typically paid a penalty — estimated at the time to be 35 to 40 basis points — on early sales to include more traditional municipal 10-year calls and extraordinary redemption language that allow the bonds to be called at par or at some price above face value. Optional redemption language varies with triggers that include any change in the subsidy status or other federally mandated changes.
Dorrian said bankers pushed the city to adopt the make-whole provisions, but he wanted to preserve flexibility. After reviewing the city's BAB pricings, he was unconvinced that the city ever saw more than a basis point or two penalty, if any, for including municipal call provisions.
"We wrestled with this issue at the time that we sold Build America Bonds. While I thought it was unlikely that the U.S. government would ever adjust the subsidy payment schedule, I also felt that we should prepare for it," he said.
Market participants have said that investors who bought BABs in the secondary at premium prices could take a loss should their bonds be redeemed next month.
President Obama returned early from vacation to Washington and the Senate reconvened Thursday from its holiday break while the House remains on break. While a so-called grand bargain remains elusive ahead of the Jan. 1 deadline, leaders have suggested another possible scenario is a short-term deal.