CHICAGO — Columbus, Ohio, has set a May 29 sale date for a $368.7 million general obligation refunding that will mark the largest redemption to date of Build America Bonds due to federal subsidy cuts under sequestration.
Long-time Columbus Auditor Hugh Dorrian said the decision to redeem the bonds has upset a few holders, but most investors he's talked to understand the decision.
"As a public official I can't sit here and pass up this kind of opportunity," Dorrian said, referring to the savings the city expects to achieve by refunding the bonds into traditional tax-exempt GO fixed-rate bonds, despite the loss of the federal subsidy. "I'm solely motivated by saving money for the good taxpayers of Columbus."
Dorrian anticipates the city will achieve "several million dollars" of net present value savings with the refunding. The city generally targets at least 5% savings on any refundings and expects to achieve at least that with the BAB transaction.
BABs were created in 2009 as part of the American Recovery and Reinvestment Act. The program, which expired at the end of 2010, gave issuers the option to issue the BABs as tax-credit bonds or direct-pay bonds, where issuers receive subsidy payments from the federal government equal to 35% of their interest costs on the BAB. Recovery zone economic development bonds, known as "super BABs" offered a 45% subsidy. The vast majority of borrowers opted for the direct-pay bonds.
The federal government has moved to reduce the subsidy amid the federal budget deficit debate. An 8.7% subsidy cut took effect March 1 as part of the sequestration budget cuts.
Triple-A rated Columbus was one of the few issuers that took a conservative route and included in original bond indentures a traditional 10-year call feature and provisions for an extraordinary optional redemption at par in the event of a reduction of the subsidy. The city built in additional flexibility by allowing redemption if the federal government simply announced its intention to cease making full payment of the subsidy.
The city's decision to feature an at-par redemption as is typical in muni deals, as opposed to the make-whole provision favored by taxable market buyers, makes the refunding affordable. The make-whole provision, pushed at the time by many investment banks doing BAB deals, makes refundings less affordable by requiring issuers to redeem the bonds at a price determined by a formula that reflects market value. Bankers argued at the time that forgoing the make-whole call would result in higher interest rate penalties.
The finance team on the Columbus BAB deals batted back and forth whether to feature the flexible redemption provisions, debating greater flexibility versus a borrowing penalty. "Some said do it and some said don't," Dorrian recalled. "The final decision came to me, and I said, 'Do it.'"
The city did not see a borrowing penalty for the decision when it issued its first series of BABs in 2009, but it did in 2010, Dorrian said, estimating the penalty in the range of 10 to 20 basis points.
"These were very, very good issues at the time, but what has obviously occurred is that Congress and the [Obama] administration has made a step backwards on its promises," Dorrian said. He predicted that more subsidy reductions could be coming. "The patient may be getting sicker at a slower pace but it's still sick," Dorrian said of the federal deficit. "I think there's a good chance of the risk of more reduction."
Dorrian said he's received many calls from holders of the bonds that have heard about the city's decision to redeem. "The vast majority have been understanding, though a couple have been upset, though they have also understood," the auditor said. "I reminded them, first of all, that this was all very, very amply disclosed in the documents from the outset," he said, noting that the city has since put out a press release on the possible redemption and disclosed the plans on the Municipal Securities Rulemaking Board web site.
Columbus first began considering the move late last year when threat of the reduction first surfaced as part of the deficit talks, but Dorrian said he wanted to wait until it received actual reduced subsidies to go forward.
"I've taken a very conservative approach," Dorrian said. "Bond counsel was satisfied long before I was."
The May 29 deal is tentatively sized at $368.7 million, which includes all the city's BABs as well as $83 million of economic recovery zone bonds. Because the economic recovery bonds have a 45% subsidy payment, refunding savings will be smaller and the city will decide closer to pricing whether it will redeem all or any of the debt.
Bank of America Merrill Lynch is senior manager and JP Morgan and Stifel, Nicolaus & Co., Inc. are co-seniors. PNC Capital Markets LLC, Fifth Third Securities Inc., Keybanc, and The Huntington Investment Company round out the team. Bricker & Eckler LLP, the city's long-time bond counsel, is also on the team. Prism Municipal Advisors LLC is financial advisor.
The city is set to meet Monday with rating agencies on the deal.
