WASHINGTON — The 7.2% reduction in federal subsidy payments to Build America Bond issuers for fiscal year 2014 is a credit negative for issuers that rely on the subsidy to make debt service payments on the bonds, said Moody’s Investors Service.
The credit negative declaration does not imply a rating or outlook change but is indicative of the impact of a development as one of many factors affecting an issuer.
The BAB program was created under the American Recovery and Reinvestment Act and allowed state and local governments in 2009 and 2010 to issue of almost $182 billion of direct-pay bonds for which they would receive subsidy payments from the Treasury equal to 35% of the interest costs.
But the federally-mandated sequestration has resulted in cuts to BAB subsidy payments. From March through the end of fiscal 2013 on Sept. 30, the subsidy payments were generally cut 8.7%. The 7.2% payment reduction rate for fiscal 2014, which began Oct. 1, replaces the 8.7%. Moody’s said that cutting the subsidy effectively reduces BAB issuers’ revenue.
Some issuers depend on the subsidies to make debt service payments. To account for the reduced subsidy, they may have to make budget adjustments or draw on debt service reserve funds, Moody’s said.
However, most general obligation bond issuers do not rely on the subsidies to make debt service payments. Instead, they budget to pay debt service on the BABs without the subsidies. While some issuers have a large volume of outstanding BABs, “the credit impact on most issuers is small and manageable,” Moody’s said.
The rating agency noted that New York City, the second largest BAB issuer, and the New York City Transitional Finance Authority, the sixth largest BAB issuer, combined had roughly $15 million in subsidy reductions in fiscal 2013. That amount was only about 0.2% of New York City’s combined debt service expenditures, though.
Additionally, many issuers have some protection from significant BAB subsidy reductions, because their official statements have extraordinary redemption provisions that can be triggered by the cuts. These include “make-whole-call” provisions that give issuers the option of redeeming their bonds at a specified yield spread above Treasury yields, the rating agency said. But the make-whole-call provisions can make it too expensive for an issuer to redeem the BABs.
The subsidy reduction has nothing to do with the federal government shutdown that began Oct. 1. However, Congress could change the subsidy reduction rate or revert to the original subsidy level in any agreement on a budget for fiscal 2014, Moody’s said.