WASHINGTON — The National Association of Bond Lawyers issued an alert Friday to its members about the potential impact the $1.2 trillion in across-the-board federal budget cuts would have on Build America Bonds and other direct-pay bonds.
“NABL members whose clients have issued, underwritten or purchased such “direct-pay” bonds should be aware the effect the so-called “sequester” may have on them,” the two-page release said. “In addition to a reduction in the subsidy payments, depending on the documents under which the bonds were issued, certain extraordinary call provisions, may be triggered.”
BABs, which were created under the American Recovery and Reinvestment Act in 2009 and expired in 2010, are taxable bonds for which the federal government makes payments to issuers equal to 35% of their interest costs.
Last week the Office of Management and Budget released a report that detailed the impact sequestration would have on government agencies and state and local governments. The report showed that payments authorized for direct-pay bonds would be cut 7.6% — totaling $255 million for BABS, $62 million for qualified school construction bonds, $3 million for qualified zone academy bonds and $2 million for qualified energy conservation bonds.
If Congress doesn’t stop the sequester, it will take effect on Jan. 2, 2013 under a resolution by the Federal Budget Control Act of 2011 because the joint congressional “Super Committee” failed to reduce the deficit by $1.2 trillion over the next 10 years.
As a result, next year alone there would be $110 billion in federal budget cuts and the cuts would total $1.2 trillion over 10 years.
NABL said it is too soon to predict what percentage, if any, cuts would be made to BABs and other direct-pay subsidies in 2014 and after.
BABs, like most municipal bonds, permit early redemption prior to their maturity. But BABs also contain extraordinary call provisions that upon an “extraordinary event”— including a reduction or elimination in federal subsidy payments — the issuer is given the option to call the BABs often at a price that is lower than a make whole call.
A MWC is typically the greater of the present value of future debt service payments remaining on the bond or the initial offering price of the bond.
NABL urged its members who have issued, underwritten or purchased BABs to review potential ramifications of the sequestration with their clients including call provisions.