Andy Richards

Background

The American Recovery and Reinvestment Act of 2009 (ARRA) created BABs. The intention is to reduce the cost of municipal borrowing in order to help stimulate economic activity during the recession by encouraging building projects that in turn would create jobs. Borrowing costs are lowered either through a direct subsidy to the issuer or tax credits available to the investors at the rate of 35 percent of the interest payable by the issuer. This 35 percent subsidy is intended to be deeper than the subsidy implicit in traditional tax-exempt bonds. Because BABs are taxable and provide investors with a higher interest rate of return, they generally appeal to a broader market (U.S. federal tax-exempt entities, foreign investors, pension funds, etc.) than traditional tax-exempt securities. ARRA created two types of BABs:

• Tax Credit BABs (under Internal Revenue Code (IRC) §54AA)—Tax Credit BABs provide a federal subsidy to investors equal to 35 percent of the net interest payable (net of the tax credit) by the issuer, which is equal to approximately 25 percent of the total return to the investor. Tax Credit BABs may be issued to finance any governmental purpose (excluding private activity bonds) for which tax-exempt government bonds could be issued, including current refundings and one advance refunding.
• Direct Payment BABs (under IRC §6431)—Direct Payment BABs provide a direct federal subsidy that will be paid to state and local governments in an amount equal to 35 percent of the gross interest due. Direct Payment BABs offer a larger federal subsidy (gross versus net) than Tax Credit BABs; however, they are subject to more restrictions. In general, Direct Payment BABs may be issued to finance only capital expenditures for any governmental purpose and excludes private activity bonds and refunding bonds.

Treasury’s Analysis

The report issued by the Treasury Department analyzed the underwriting fees associated with issuing BABs. Critics have said BABs’ underwriting fees are typically higher than traditional tax-exempt bond underwriting fees. The treasury report concluded that initially the weighted-average BABs' underwriting fee was higher than the average for tax-exempt bonds ($7.29 per $1,000 issued compared to $6.19 per $1,000 issued); however, BABs’ underwriting fees have declined significantly, i.e., $6.64 per $1,000 issued during the first two months of 2010. Also, the treasury report noted the underwriting fees paid by BABs issuers have been small relative to their savings on interest costs.

Program Requirements

In general, to take advantage of the program, issuers must make an irrevocable election to treat an issuance under the program on or before its issue date. Issuers under the Direct Payment program are required to submit a payment request form (new IRS Form 8038-CP, Return for Credit Payments to Issuers of Qualified Bonds) generally no earlier than 90 days, and no later than 45 days, before each interest payment date. Issuers will receive the requested payment within 45 days of the date the form is filed with the IRS. For purposes of applying arbitrage restrictions under IRC §103, the yield on BABs is to be determined based upon the interest paid net of the amount of subsidy received pursuant to the program. Additional guidance from the IRS pertaining to BABs is included in IRS Notice 2009-26, Build America Bonds and Direct Payment Subsidy Implementation.

Subsidy Excluded from the Provisions of OMB Circular A-133

The U.S. Office of Management and Budget (OMB) determined the BABs program is excluded from the provisions of OMB Circular A-133, Audits of States, Local Governments, and Non-Profit Organizations. Therefore, the federal subsidy received under the BABs program should not be presented by auditees on the schedule of expenditures of federal awards and should not be included in the scope of the single audit.

Proposed Extension of BABs Program

The program began in April 2009 and is to expire January 1, 2011. However, President Obama’s $3.8 trillion fiscal 2011 budget proposed to permanently extend the BABs program at a reduced subsidy rate of 28 percent. His proposal also would expand the use of BABs to include refundings and working capital, as well as allow 501(c)(3) organizations to issue the taxable bonds.

Also, the Small Business and Infrastructure Jobs Tax Act of 2010, passed by the House of Representatives, proposes to extend the BABs program through March 13, 2013. The proposed subsidy in the bill would decline annually from an initial rebate of 35 percent for 2009-10, to 33 percent, 31 percent and 30 percent in 2011, 2012 and 2013, respectively.

Contact your BKD advisor for more information or assistance with the requirements of the Build America Bond program.