WASHINGTON — The Obama administration’s proposal to lower the subsidy rate for Build America Bonds to 28% is creating investor uncertainty and could hinder the program, California Treasurer Bill Lockyer warned Sen. Barbara Boxer this week.

In a three-page letter sent to the California Democrat, Lockyer said the administration’s proposal to permanently extend the program at the 28% rather than then 35% subsidy rate could reduce market access and raise rates for BAB issuers, since the relative economic value of BABs versus traditional tax-exempt bonds at a lower rate would be “very uncertain.”

“Institutional investors are aware of this uncertainty and are questioning how much governments will actually utilize BABs at this subsidy level rather than turning back to tax-exempt bonds,” he wrote.

Lockyer called on Congress to extend the program at the higher subsidy rate as soon as possible to allay investor concerns that bonds issued under the program — which currently is slated to expire at the end of the year — could be “orphaned.”

“For the BABs program to assist the state in accessing the capital markets in 2010, the market needs to know now that not only will the BABs program be extended but that it will also have a sensible economic subsidy level,” he wrote. “A temporary BAB extension with an expansion of uses, for say one to two years, is better than no announced extension, but only if there is a cost-effective subsidy level of 35%.”

Lockyer also called for the Senate to follow the House’s lead and pass legislation that would allow qualified school construction bonds to be sold as direct-pay BABs. The jobs bill the House passed in December would expand the BAB direct subsidy to QSCBs and qualified zone academy bonds. A draft version of Senate jobs legislation released yesterday would expand BABs to those categories plus qualified energy conservation bonds and so-called new clean renewable energy bonds.

While the Senate draft would subsidize interest costs on tax-credit bonds at rates of 65% or 45%, depending on the size of the issuer, Lockyer called for the Senate to include the House bill’s richer subsidy rate, which would be roughly equivalent to the credit rate on the bonds. The credit rate for QSCBs are intended to cover 100% of interest costs.

“This structure would result in no additional cost as compared to what was originally scored under” the American Recovery and Reinvestment Act, Lockyer wrote.

In her response, Boxer said the Senate Democratic leadership will include a BAB extension in its jobs legislation, but did not delve into specifics regarding length of extension or possible expansion of the program to other areas of the muni market. She also threw her support behind keeping the current subsidy rate.

“Like you, I believe that the strength and efficacy of the BAB program depends on the level of economic subsidy offered to the states that issue these bonds,” she wrote. “In extending the BAB program, I will work to maintain the federal BAB subsidy at or near this level.”

She said she also would work to allow issuers of QSCBs to receive direct subsidies. A provision permitting just that was included in draft jobs legislation released by the Senate Finance Committee yesterday.

“Allowing issuers to use the proven BAB subsidy method would free up the market for school construction bonds,” she wrote.

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