Cuts Could Push BABs Off Fiscal Cliff
WASHINGTON — The threat that federal subsidy payments for Build America Bonds could be slashed under the sequestration process after administration officials assured issuers those payments were safe could permanently sour the muni market on BABs and other direct-pay bonds, market participants said Monday.
In a report sent to Congress Friday, the Office of Management and Budget said that, of $4.241 billion of subsidy payments authorized for issuers of BABs and other direct-pay bonds in fiscal 2013, 7.6% or $322 million would be cut early next year. The cuts would come under the legally mandated process by which $1.2 trillion would be cut from federal programs across the board because Congress failed to reduce the federal deficit last year, and the “fiscal cliff” looms.
The prospect of cuts come after Treasury Department officials assured muni issuers in 2009 that they could rely on receiving their BAB subsidy payments, which equal 35% of their interest costs.
“That was something that was guaranteed would never be cut,” said Manju Ganeriwala, Virginia’s treasurer who last week was elected to become president of the National Association of State Treasurers in 2013.
“This is the poster child for what issuers have been concerned about,” said Kristin Franceschi, president of the National Association of Bond Lawyers and a partner at DLA Piper LLP. “This has been the concern that everyone’s had from Day One.”
“It’s a reminder of why direct-subsidy bonds are a poor alternative to tax-exempt bonds for issuers,” said Eric Johansen, chair of the Government Finance Officers Association’s debt management committee and a former treasurer of Portland, Ore.
About $255 million in subsidy payments would be cut for BABs. There would be $62 million in payment cuts for qualified school construction bonds, $3 million for qualified zone academy bonds and $2 million for qualified energy conservation bonds, according to the OMB’s report.
“Congressional interference with the BAB subsidy has always been a major risk to this product, but it’s unclear if issuers or their bankers fully appreciated it until now,” said Matt Fabian, a managing director at Municipal Market Advisors. “This may be a major blow to issuer support for BABs, particularly as a replacement to tax-exempts.”
Bond Dealers of America issued a statement warning: “This action undermines the trust investors and issuers have now and in the future regarding direct-pay or even tax-credit bonds that rely upon federal participation. The potential action is particularly disappointing in light of proposals by members of Congress and other policymakers to replace tax-exempt bonds with these new types of bond products in the name of tax reform.”
SIFMA declined to comment.
Lars Etzkorn, director of the National League of Cities’ center for federal relations, says long-term impacts may loom. “I think this calls into question a fundamental premise of subsidy bonds,” he said. “How guaranteed are they? This doesn’t happen to tax-exempt bonds. If we see a BABs II, they will trade at a much higher premium and they’re certainly going to lose whatever attractiveness they had.”
Chris Mier, managing director of the analytical services group at Loop Capital Markets, said the potential cuts could result in a “major muni-taxable market fiasco” because these bonds are held in portfolios of taxable instruments” and investors will start worrying whether they will get their full coupons.
While it’s a low probability, the threats of cuts could cause a bond-market liquidity crisis because of the concern that the federal government appears willing to renege on its commitments, he said.
Franceschi, Fabian and Mier said the subsidy cuts are not likely to harm larger issuers, especially issuers of general obligation bonds. But smaller issuers, particularly of revenue bonds, could be hurt, especially if they’ve used the subsidy to back their bonds.
“It’s going to depend on how the issuer used the BABs and how the BABs were structured,” said Franceschi. For revenue-backed sewer and water bonds or bonds issued by development districts, issuers would not immediately be able to raise rates or change projections and actual property assessments to make up for the reductions in payments, she said.
Ben Watkins, Florida’s director of bond finance, said, “You can’t unwind [these transactions]. You just have to eat it. But I don’t think it’s going to be a major meltdown or credit event.”
Virginia has issued about $1.5 billion of BABs and $369 million of QSCBs, officials there said. The subsidy cut would be about $735,000 for fiscal 2013, according to Ganeriwala. “These are not huge amounts, but it was still a shocker to see it in that report,” she said.
Kate Marshall, NAST’s current president and Nevada’s treasurer, said her state’s annual subsidy payment for BABs for fiscal 2013 is about $1.3 million and a 7.6% cut would be about $100,800, which would not be a huge hit. The bigger issue, she said, is that, “Sequestration doesn’t get at the problem, it just shifts costs” from the federal government to state and local governments.”
While many market participants say Congress will not let sequestration happen, others are not so sure. Susan Collet, BDA’s senior vice president for government relations, said: “We haven’t seen any evidence over the past year that Congress can come together on big fiscal solutions, so why would the lame duck [session after the election in November] provide a better opportunity?”