WASHINGTON — Issuers of Build America Bonds and other direct-pay bonds will have their subsidy payments processed in fiscal 2015 reduced by 7.3% because of sequestration.
The 7.3% cut, which took effect Oct. 1, was confirmed Thursday by the Internal Revenue Service and calculated by the Office of Management and Budget earlier this year.
The fiscal 2015 reduction rate replaces the slightly lower 7.2% cut for subsidy payments processed in fiscal 2014. In addition to BABs, the cuts in subsidy payments will also apply for qualified school construction bonds, qualified zone academy bonds, new clean renewable energy bonds and qualified energy conservation bonds.
Richard Kogan, senior fellow at the Center of Budget and Policy Priorities, said that one of the reasons this year's sequester rate for direct-pay bonds and certain other programs may be higher than last year's is because federal extended unemployment insurance expired last December and therefore is not included in the pool of programs to receive cuts in fiscal 2015. Kogan and Bill Hoagland, senior vice president at the Bipartisan Policy Center, also said the fiscal 2015 rate may be higher because of slowed growth in Medicare spending.
The cuts in federal nondiscretionary spending known as sequestration began in March 2013 and were triggered by Congress' failure to reach agreement over how to significantly cut the deficit. Sequestration for direct-pay bonds and other mandatory programs was originally supposed to last through fiscal 2021. However, Congress extended the cuts for those programs through fiscal 2023 under a budget agreement passed in December, and through fiscal 2024 under legislation passed in February.
Direct-pay bonds are taxable bonds that state and local governments can issue and receive subsidy payments from the Treasury Department equal to a portion of their interest costs. Issuers of BABs, which could only be issued in 2009 and 2010 received subsidy payments from the Treasury equal to 35% of their interest costs before sequestration. The sequestration cuts to subsidy payments have triggered extraordinary redemption provisions in bond documents for some BABs and allowed issuers to either redeem them or announce that they can redeem them any time in the future.
Dustin McDonald, director of the Government Finance Officers Association's federal liaison center, said the cuts have "done a lot to erode support from state and local governments for Build America Bonds."
Bill Daly, director of governmental affairs for the National Association of Bond Lawyers, said the reduction rate is "a reminder of that uphill climb that any direct-pay bond bill would face in reestablishing the confidence of the issuer community."
President Obama's fiscal 2015 budget proposes creating America Fast Forward bonds, which would be similar to BABs, but have a 28% subsidy rate that would be precluded from being cut under sequestration.
Daly said that even if a direct-pay bond bill protects the subsidy payments from sequestration, many issuers would still be skeptical, given that they were once told that BAB subsidy payments wouldn't be reduced.
McDonald noted that, in addition to creating the AFF bond program, Obama's budget would also cap the value of the tax exemption for municipal bonds at 28%. A permanent BAB program, coupled with a 28% cap, "would not sufficiently replace the financing tool of the tax exemption," he said.
Matthias Edrich, a partner at Greenberg Traurig LLP, said that the 7.3% cut is important for disclosure and reporting purposes.
Issuers have to report revenues in financial statements, and if they have direct-pay bonds, they may need to explain the reduced subsidy payments in those statements. Also, if an issuer gets revenues from subsidy payments and issues new bonds that are paid for by general revenues, "issuers in offering documents may need to provide additional explanation of revenue reductions resulting from the sequester," he said.
Additionally, some types of bonds can still be issued as direct-pay bonds, Edrich said. For example, Oregon issued $2.08 million of QECBs in June, and Georgia issued $13.75 million of QSCBs in July, according to information and documents available on the Municipal Securities Rulemaking Board's EMMA system.
The fiscal 2015 reduction rate applies to payments processed during the year, regardless of when the amounts claimed on issuers' 8038-CP forms were filed with the IRS. In May, Rebecca Harrigal, director of the IRS tax-exempt bond office, said that sequestration kicks in at a point that is in between when the issuer files the forms and when the interest is due to bondholders.
