CHICAGO – At least 12 small Wisconsin cities that approached the federal government’s Build America Bond program with a skeptical eye and stuck with flexible redemption provisions may act on those options due to federal subsidy cuts that took effect in March.
As some smaller Wisconsin cities weighed tapping the federal government’s BAB or other direct-pay bond programs in 2009 and 2010, they did so with concern, a local financial advisor recalls.
The municipalities embraced the program only after incorporating features that afforded them the opportunity to redeem the bonds at par in the event the government altered the subsidy – a situation that has come to pass in the form of sequestration.
“We are not Missouri, but we are still the ‘Show-Me’ state,” said Brookfield, Wis.-based financial advisor Michael Harrigan, of advisory firm Ehlers Inc. “It reflects the prudent nature” of municipalities in the state.
At least 11 clients of Ehlers who sold BABs or recovery zone economic development bonds competitively over the course of the programs have joined the trickle of issuers considering whether a redemption -- at par plus accrued interest – makes sense after the subsidy cuts included in the $85 billion of federal sequestration budget cuts that took effect March 1.
Subsidies on direct-pay municipal bonds due from the federal government between March and September are impacted by sequestration. The bonds were issued on a taxable basis, with issuers receiving 35% subsidies for BAB interest and 45% on RZEDBs.
As previously reported by The Bond Buyer, the Central Texas Regional Mobility Authority will redeem $45 million of BABs on June 5 and Monona, Wis. earlier this month redeemed $7.7 million of BABs due to the 8.7% subsidy reduction from sequestration.
Ehlers’ list of clients that have filed notices alerting investors that the federal government cuts have triggered the redemption provision includes Beloit, Belleville, Columbus, Cudahy, Egg Harbor, Greenfield, Horicon, Mount Pleasant, Sheboygan, Stevens Point, and West Allis. Horicon came to market this week with a $2.2 million refunding to redeem its April 2010 BABs. Not all have decided to act.
Market participants said the number is striking given the small, single-digit percentage of issuers who included an at par redemption provision instead of the make-whole call preferred in the taxable market.
The 11 issuers Ehlers advised embraced language in their bond documents that permitted a redemption under extraordinary events that included changes in certain provisions of the tax code in a way that modified the subsidy or if the U.S. Treasury failed “to make a cash subsidy payment to which the issuer is entitled and such failure is not caused by any action or inaction by the issuer.”
“Clients had a lot of questions about what would happen if the federal government changed the subsidy and whether it was a risk they should be taking and how could they protect themselves,” Harrigan said.
“No one really thought this would happen, but the risk and uncertainty was definitely on the minds of many local elected officials and with the redemption at par language many elected bodies felt protected,” he added.
“Clients had a lot of questions about what would happen if the federal government changed the subsidy and whether it was a risk they should be taking and how could they protect themselves,” Harrigan said. Quarles & Brady LLP served as bond counsel on the original transactions.
For municipalities with the ability to refund at par, the decision becomes purely economic, Harrigan said. Current rates offer some issuers savings – even compared to the full BAB subsidy. Refunding also sheds the future risk of cuts. For smaller issuers, the cuts are tougher to swallow than for larger ones.
Investment bankers pushed make-whole call provisions especially on larger transactions undertaken early in the BAB program, warning that borrowing penalties could result in their absence. 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.
Harrigan said Ehlers did not notice a penalty imposed on issuers that adopted the flexible provision.
Beloit filed a notice on April 10 that it is considering redeeming $4.2 million of general obligation-backed RZEDBs from an April 2010 issue due to the 8.7% subsidy reduction. “The reduction was not due to any action or inaction by the Issuer,” the notice reads. The city used other funds to pay the interest due April 1 and no interest payment delinquency is reported. The city council will consider on May 6 whether to approve a refunding if savings targets are met.
In a commentary on BAB redemptions in its weekly research report, Bank of America Merrill Lynch said it estimates “that many of these BAB issuers with ERPs at par could realize debt service savings with par calls at current rates while eliminating the risk of future cuts to the subsidy.”
ERPs at par represent a small chunk of the BAB market with only 1.5% of the BABs examined which pay coupons in May containing an ERP at par, and 1.9% containing an ERP at a premium of 103, according to BofAML. The remaining 96.6% of BABs either contained no provision or an ERP at a make-whole call of the equivalent Treasury rate plus 100 basis points. “One could say they stuck by principles,” in going with ERPs, said BofAML’s head of municipal research John Hallacy said of the Wisconsin cities, “and it’s worked out well for them.”
Nearly $188 billion of BABs were issued in 2009 and 2010 after they were created in 2009 as part of the American Recovery and Reinvestment Act to jump-start municipal issuance following the 2008 financial crisis by luring taxable buyers into the municipal debt market.
The program expired at the end of 2010 as Congress did not enact an extension.
Belleville will consider next month whether to approve the redemption of $2.4 million and $1.5 million of GO community development bonds on July 9. Columbus is considering redeeming $1.85 million of taxable GO notes from a February 2010 issue. Cudahy has approved an initial resolution to redeem its $7.3 million 2009 BAB issue in June. Egg Harbor will refund $3.6 million of GO harbor improvement bonds if economical. Greenfield may consider redeeming $3.5 million of GO BABs. Mount Pleasant may consider redeeming $4.1 million of GO BABs from a 2010 issue. Sheboygan may redeem $2 million of GO notes from a June 2010 issue. Stevens Point is considering but has not taken further steps to redeem $3 million of GO notes from a June 2010 issue. West Allis is advancing plans to redeem $7 million of GO bonds from an April 2010 issue in July.