The New Build America Bonds (from Reuters)

Treasury unveils Build America Bonds
Thu Apr 9, 2009 3:35pm EDT
By Lisa Lambert and David Lawder

WASHINGTON (Reuters) - The U.S. Treasury said on Friday that states and municipalities using new "Build America Bonds" created under the economic stimulus law face limits on their use, with the deepest subsidies reserved for capital projects.

The bonds, a new type of debt aimed at overcoming obstacles presented by stressed municipal bond markets, pay interest that can be taxed, but offer a tax credit for the buyer, according to Treasury guidelines released Friday.

In place of the tax credit, issuers may opt to receive a direct payment from the federal government equivalent to 35 percent of the interest costs. Issuers who elect to take the subsidy are limited in how they can use the debt.

While the tax credit bonds can be used to finance the same kinds of expenditures as tax-exempt governmental bonds, those with the direct subsidy "generally may not be issued to refinance capital expenditures in 'refunding issues,'" the Treasury said.

Treasury is breaking with other federal programs that authorize states to issue debt, such as the one for mortgage bonds, by not setting constraints on how many bonds can be sold. In the same light, it is not capping the amount it will pay in subsidies. Time seems to be the major limit, as the bonds must be sold within the next two years.

The subsidy was included to entice buyers, such as foreign investors, who may not need the credit, Treasury said.

"As a result of this federal subsidy payment, state and local governments will have lower net borrowing costs and be able to reach more sources of borrowing than with more traditional tax-exempt and tax credit bonds," it said.If a state issued a bond at a 10 percent taxable interest rate, it would receive a subsidy equal to 3.5 percent of that interest and then would only pay 6.5 percent on the bond.

"What this does is provide the market with enough specificity for issuers to go forward, especially in direct pay Build America bonds," said Philip Fischer, municipal strategist at Bank of America Merrill Lynch.

The tax credit bonds would most likely be taken up by larger issuers, he added, and some mutual funds have already expressed interest in buying Build America Bonds.

"They did a good job," said Carol Lew, a Newport Beach, California, bond attorney, although questions remain about what happens to the bonds post-issuance. "This is a new animal, we're going to have to get used to it."

Lew, a former head of the National Association of Bond Lawyers, said the Treasury will need to explain if the bonds can be refunded or refinanced in the future, and whether issuers can make changes in their use.

"Are issuers at more of a risk of an IRS audit because they're now dealing directly with the IRS?" she said about the Internal Revenue Service.

"These bonds give state and local governments a new, direct injection of capital to jump-start infrastructure projects that will create jobs and improve our cities and towns," said House Ways and Means Committee Chairman Charles Rangel, the New York Democrat who helped draft the stimulus plan, in a statement.

Rangel also lauded the Treasury Department for quickly setting up the program. The IRS will begin making payments on the tax credits on July 1, Treasury said.

Treasury also announced the allocations of the $11 billion school construction bonds and the $1.4 billion Qualified Zone Academy Bonds, which can be used to retrofit school facilities, included in the stimulus law.

The bonds, which grant investors tax credits in lieu of interest payments, are allocated according to certain formulas and the construction bonds are granted to states and the 100 largest school districts based on current levels of federal school funding. California will receive the largest allotment, of $773.53 million, followed by Texas, which will be able to issue up to $53.59 million bonds.

Guidance on the stimulus law's Recovery Zone Economic Development Bonds will be released soon.

(Additional reporting by Michael Connor in Miami; Editing by Leslie Adler)


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