WASHINGTON — Maryland has become the first state to disclose that a portion of its Build America Bond subsidy payment was reduced so that it could pay the federal government outstanding payroll taxes, state officials said this week. The offset could affect BAB issuance in the future, they said.

Meanwhile, Ben Watkins, director of Florida’s Division of Bond Finance, said the state has stopped issuing BABs after reviewing the potential liabilities of such offsets.

“We have determined that it is not prudent to continue using the BABs program because of the potential for having the subsidy payments withheld,” Watkins said.

The Internal Revenue Service notified Maryland in a one-page letter that $6,869.54 of the state’s May subsidy payment was withheld because of funds the state owed the federal government under Form 941 on employment taxes. The offset represents less than 2% of the BAB payment the state had expected to receive by May 31. The payment is the second the state received on BABs issued in October. The first payment was received in full, state officials said.

The BABs are rated triple-A by Moody’s Investors Service, Standard & Poor’s and Fitch Ratings. They were sold competitively to Barclays Capital.

The reduced payment will not adversely affect the state because the payments are not pledged to the bonds and are, instead, added to the state’s general revenues, according to state officials and the bonds’ offering documents.

Patti Konrad, the director of debt management in the state treasurer’s office, said she is preparing a report about the offset issue for Maryland’s Capital Debt Affordability Committee, which includes the state’s comptroller, treasurer and other state officials and oversees the state’s debt issuance. The committee will meet on June 9, she said. If the committee has “issues” with the offset risk, then that could determine whether the state issues BABs in its next debt sale, scheduled for July, she said.

“I want make sure [the committee] understands the whole spectrum of the good and the risks with BABs,” Konrad said.

She noted that the offset was incurred for the state’s Sept. 30, 2009, payroll tax payment. “It was a very small amount for a very recent quarter,” she said.

The offset problem contributes to the concerns that issuers have had about their BAB subsidy payments. The continued success of the stimulus-created BABs, along with other bonds for which issuers receive federal payments, could be in danger if the issuers reject them because of concerns about federal interference, market participants have said.

The offset problem may be a larger concern for smaller municipalities, especially those that have issued qualified school construction bonds, said Matt Fabian, managing director at Municipal Market Advisors in Concord, Mass.

“The more common thinking was the offsets would occur at the state level” because of their interaction with the federal government’s health and welfare programs, he said. MMA discovered recently that Austin’s BAB payment was reduced because it owed payroll taxes.

With offsets occurring because of payroll taxes, this “means that offsets in general could be more frequent,” he said, adding, “With the QSCBs, [issuers] are a little more sensitive because the [subsidy] money may be more essential to the issuer.”

Treasury and IRS officials have said subsidy payments can be offset if an issuer has failed to fully pay payroll taxes or make grant payments or health care payments to the federal government.

As the offset problem is increasing as a concern, issuers and underwriters may call on Congress to fix it.

“If issuers begin to back away from the BABs program specifically because of [offsets] it would only encourage bankers a bit more to lobby for a congressional resolution,” Fabian said.

Watkins said he would like to see Congress “fix the problem so that I don’t have any risk of my subsidy going away.”

For now, there is no securities law requirement for issuers to disclose offsets of BAB payments. But the Securities and Exchange Commission could consider requiring issuers to disclose offsets, Fabian said. “If not necessarily for the investors’ benefit … Other issuers would benefit from knowing how frequent offsets have been occurring,” he said.

Other states besides Florida are avoiding BABs because of potential federal interference in the subsidy payment. In March, South Carolina’s treasurer, Converse A. Chellis, shunned BABs in a $660 million deal in part because of concerns the IRS may block subsidies if an issuer owes the federal government money.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.