Legal issues, canceled refundings and other Build America Bonds news to watch

Build America Bonds: Legal issues, canceled refundings and other updates

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As some state and local governments and their agencies look to redeem or refund their Build America Bonds (BABs), some questions have come up regarding the legality of doing so, especially as current interest rates may likely lead to an increase in Build America Bonds being called by issuers this year, according to market professionals.

BABs, authorized in 2009 and 2010 as part of a stimulus program during the Obama administration, allowed issuers to sell taxable bonds and receive a subsidy on the interest rates they paid to investors from the federal government. Federal budget "sequestration" has resulted in lower-than-promised subsidies to issuers since 2013.

Issuers have moved to call outstanding BABs following a recent U.S. Supreme Court ruling that, according to a February publication from law firm Orrick, supports the conclusion that sequestration "resulted in a materially adverse change to the cash subsidy payment obligation."

In 2024 alone, J.P. Morgan has identified 22 unique issuers that have either called BABs (13 issuers, affecting $7.5 billion of debt), posted conditional calls (four issuers, set to impact $2.2 billion of debt), or announced that they are considering financing plans in this regard (seven issuers, potentially impacting $490 million of debt). Totaling YTD calls and notices of potential redemptions, BABs ERP activity would total $10.2 billion for the year, according the J.P. Morgan.

The Regents of the University of California closed its deal that redeemed outstanding BABs via an extraordinary redemption provision, despite the threat of an investor lawsuit.

This debate centers on whether issuers are legally authorized to trigger the extraordinary redemption provision following cuts to BABs' 35% subsidy under the government sequestration process, starting in 2013. The current sequestration level is 5.7%. BABs refundings through the extraordinary redemption provision only recently entered the conversation in a prominent manner, following a 2023 court opinion stemming from Indiana Municipal Power Agency v. United States.

After the ruling, Orrick partners Charles C. Cardall and Barbara Jane League said in a report posted on the firm's website that the decision provides "favorable guidance" for issuers wondering if sequestration "constituted an 'extraordinary event' that would trigger their right to seek extraordinary optional redemption."

Washington state refunded some of its outstanding BABs, despite pushback due to these debates.

James Pruskowski, chief investment officer at 16Rock Asset Management and a market participant who holds no BABs, told the Bond Buyer these extraordinary redemption provisions are mostly concentrated in "these big sophisticated issuers with densely populated areas and mostly on the coastal regions, such as New York, California and Washington."

Bondholders have enjoyed several years of strong income and stable prices, so it can be "painful to lose that premium to an ERP being exercised," Pruskowski said.

Norfolk, Virginia, became the first issuer to cancel its BABs refunding. Norfolk gave no reason for the cancellation of its redemption plans or bond issuance. However, the city said it reserved the right to call the 2010B BABs for redemption in the future.

Read more of the latest Build America Bonds news in our coverage below.

Norfolk, Virginia will not proceed with BABs redemption

The city of Norfolk, Virginia canceled its plans to call some of its outstanding Build America Bonds. In March, the city said in a conditional notice that it was considering a redemption of $56 million of its direct-pay taxable 2010B capital improvement BABs under an extraordinary optional redemption before the due date of April 25, according to a notice from the paying agent, Wilmington Trust N.A.

"The city has now determined it will not proceed to redeem the 2010B bonds on the redemption date or to issue the above-described refunding bonds," Wilmington Trust said in its notice. "Consequently, the paying agent will not receive moneys sufficient to redeem the 2010B bonds [and] the 2010B bonds will not be redeemed on the redemption date."

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Norfolk, Virginia, becomes first issuer to cancel BABs redemption plan

UC Regents BAB redemption plans leads to legal questions

The Regents of the University of California said in a supplement to its official offering statement they plan to proceed with the issuance of 2024 Series BV bonds, which was part of a $1.1 billion deal of general purpose bonds the Regents priced in early March, and the redemption of the refunded BABs, closing the books on the deal at the end of March.

The UC Regents noted in the document that investors have threatened to sue if the university system fails to either cancel the redemption or pay the make-whole price.

Regardless of how these matters play out, the Regents said it does not believe they will have a material adverse impact on its financial position nor its ability to pay the debt service on all of its outstanding debt, according to the supplement.

Read more:

UC Regents proceeds with BABs redemption despite threatened lawsuit

Washington state makes deal to refund BAB

Wells Fargo Securities, leading a seven-bank syndicate, priced $1.08 billion of Washington state motor fuel tax and vehicle related fees refunding revenue bonds in a deal to refund outstanding Build America Bonds issued in 2009 and 2010.

The deal comes after a group of investors sent a letter challenging the legality of the Regents of the University of California's ability to trigger an extraordinary optional redemption provision to refund their outstanding BABs ahead of a March 5 deal. A second letter was sent, this time from the law firm Kramer Levin, threatening a lawsuit if the Regents of the University of California "fail to cancel the redemption or pay the make-whole redemption amount."

Washington state proceeded with its bond pricing, said Aaron Sherman, an Office of the State Treasurer spokesman. The state's finance team includes Piper Sandler and Montague DeRose as co-municipal advisors and Foster Garvey as bond counsel.

Read more:

Washington state's massive deal latest to test BAB redemption

Chas Cardall, a tax partner at Orrick, said he doesn't know whether the action by the bondholders against the Regents of the University of California will change issuers' minds.

Gittings Photography

BAB refunds now have legal backing

Chas Cardall, a tax partner at Orrick, the bond counsel that worked on the recent Regents of the University of California deal that sparked an investor rebuke of the legality of the BABs refunding portion of it, said he "suspected most issuers would realize or would have had parties that they're working with in their transactions advise them that there was a possibility that investors were going to be unhappy."

A group of bondholders told the bond trustee in March that they believe "unequivocally" the Regents of the University of California "has no legal basis to redeem any of the above securities pursuant to exercising the Extraordinary Optional Redemption provisions."

Bank of New York Mellon, the trustee on the deal, "is prohibited from executing the redemption of any of the prior bonds, as such action would constitute a violation of bondholder rights, and a violation of contractual agreements established in the official statements," they wrote in a letter.

Read more:

Despite investor challenge, issuers may have legal backing in BAB refundings

Bloomberg News

Dramatic BABs increase expected this year by market participants

Market participants say the combination of an early 2024 court ruling and current interest rates will likely lead to a dramatic increase in Build America Bonds being called by issuers this year.

While only a small amount of BABs have been called using an "extraordinary redemption provision" since sequestration of BABs subsidies began in 2013, that should change as more issuers look to take advantage of using sequestration as a reason to exercise it, with analysts expecting the largest year of BABs called by the ERP to date.

For over a decade, as the subsidy for direct-pay BABs "has been less than originally promised due to sequestration, issuers have wondered if sequestration constituted an 'extraordinary event' that would trigger their right to seek extraordinary optional redemption," said Orrick partners Charles C. Cardall and Barbara Jane League in a report posted on the firm's website.

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Issuers expected to call $20B to $30B of BABs this year