Public Finance Update - January 2010

The Franklin County Convention Facilities Authority in Ohio recently issued $160 million of taxable Build America Bonds (BABs) to finance the construction of a Hilton hotel in the City of Columbus.  The Authority will own the hotel, which is being constructed next to a convention center in an effort to boost attendance at the convention center and generally benefit the city’s economy.  Debt service on the BABs will be paid from a combination of hotel revenues and the hotel’s bed tax.

To date, most issuances of BABs have been utilized to finance public purpose infrastructure rather than projects that include a private use.  The IRS has confirmed, however, that BABs can be used to finance facilities that include a private use component so long as the bonds are not “private activity bonds” within the meaning of the Section 141(a) of the Internal Revenue Code.

A bond is considered a private activity bond if, with certain exceptions, it meets the “private business use test” (i.e., if more than 10% of the bond proceeds are used for a private business use) and the “private security or payment test” (i.e., if more than 10% of the bond proceeds are secured by or payable from property used for a private business use).  A bond is also considered a private activity bond if, again with certain exceptions, the lesser of (i) $5 million or (ii) greater than 5% of the bond proceeds are used to make loans to non-governmental borrowers (the “private loan financing test”).

Contrary to practitioners’ more conservative notions, the Hilton Hotel financing in Ohio clarifies that BABs may be utilized for a wider range of projects and may be secured by a broader range of revenue sources than previously thought.  For example, BABs may be utilized to finance a sports stadium or other project benefitting a non-governmental entity, so long as the project is owned by a public entity and not more than 10% of the debt service payments are derived from private revenues.  Assuming the yields on BABs stay competitive, an increasing number of issuers and developers are likely to use the security to finance public-private projects.

In a move not expected to significantly affect the current municipal bond market, Standard & Poor’s recently downgraded California’s general obligation debt from “A” to “A-.”  California already had the lowest credit rating of any state in the union, and analysts do not believe that this latest downgrade will have a significant impact on California’s ability to sell its debt in the short run.

California faces a $20 billion budget deficit over the next 18 months.  Tom Dresslar, spokesman for State Treasurer Bill Lockyer, said that the recent S&P downgrade “highlights the critical need for the legislature and the governor to produce a swift budget resolution that is credible to the market.”  In fact, Governor Schwarzenegger recently proposed a plan to rectify the state’s impending $20 billion deficit through a combination of federal bail-out requests and steep cuts in spending for social services, health care, education, environmental programs, mass transit, and state employment.  The Governor warned that the current crisis will not only require his admittedly draconian cuts, but likely will also require another round of IOUs.  If enacted, the Governor’s proposed cuts are expected to spur additional litigation.

On February 17, 2009, in response to one of the worst economic downturns in our country’s history, President Obama signed a $787 billion economic stimulus package called the American Recovery and Reinvestment Act of 2009 (“ARRA”). Since that time, over 57,000 individual contracts, grants, or loans have been awarded nationwide, totaling over $158 billion in available funds. In California alone, over 5,600 awards have been made, totaling over $18 billion in available funds. While some critics have expressed doubts as to whether ARRA has impacted the job market as positively as originally predicted, according to www.recovery.gov, the website established by the federal government to track the ARRA disbursements, over 640,000 jobs have been created or saved through the application of ARRA funds across the country. The following table describes the 20 largest ARRA awards to date:

Recipients	State	Type of Award	Amount of Award	Use of Funds
CA Governor's Office of Planning and Research	CA	Grant	$4,387,948,882	Education
TX Governor's Office of Econ. Development & Tourism	TX	Grant	$2,177,682,329	Education
State of New York	NY	Grant	$1,653,933,720	Education
Florida Education Department	FL	Grant	$1,479,922,294	Education
Savannah River Nuclear Solutions, LLC	SC	Contract	$1,407,839,884	Nuclear Energy
CH2M Hill Plateau Remediation Company	WA	Contract	$1,359,715,229	Nuclear Energy
National Railroad Passenger Corporation	DC	Grant	$1,293,525,000	Transportation
California Department of Education	CA	Grant	$1,226,944,052	Education
State of Illinois	IL	Grant	$1,126,357,559	Education
California Department of Education	CA	Grant	$1,124,920,473	Education
CA Governor's Office of Planning and Research	CA	Grant	$1,084,768,673	Prisons
Executive Office of State of Ohio	OH	Grant	$980,685,675	Education
Solyndra, Inc.	CA	Loan	$535,000,000	Solar Energy
CH2M WG Idaho LLC	ID	Contract	$437.675.000	Nuclear Energy
UT-Battelle, LLC	TN	Contract	$338.697.231	Energy Research
SAIC-Frederick, Inc.	MD	Contract	$302,521,207	Cancer Research
Washington River Protection Solutions LLC	WA	Contract	$299,728,838	Wastewater Treatment
Babcock & Wilcox Technical Services Y-12, LLC	TN	Contract	$270,299,243	Environmental Cleanup
Brookhaven Science Associates	NY	Contract	$257,613,800	Energy Research
Washington Closure Hanford, LLC	WA	Contract	$253,614,000	Nuclear Energy

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Source: www.recovery.gov

In addition to direct awards in the form of grants, contracts, and loans, ARRA authorizes certain tax benefits to encourage the financing of public infrastructure projects, including Build America Bonds, Qualified School Construction Bonds, Qualified Energy Conservation Bonds, Qualified Zone Academy Bonds, and Clean and Renewable Energy Bonds. For instance, Build America Bonds (“BABs”), which are taxable bonds that provide either an interest subsidy to the issuer or a tax credit to investors, are the fastest growing component of the current municipal bond market. BABs can be issued to finance virtually any project that can otherwise be financed with tax-exempt bonds, including projects that include 10% private business use (see earlier article “BABs Go (Slightly) Private”). Due to the federal subsidy, an issuance of BABs yields substantially more than a traditional taxable bond, making the security attractive to a larger number of investors.

To date, more than $64 billion in BABs have been issued across the country, which accounted for approximately 16% of the total municipal bond market in 2009, and approximately 76% of the total volume of taxable municipal bonds for that period – an unqualified success by any measure. The legal authority for BABs is scheduled to expire after 2010, a fact that some believe supports the current interest in the securities. Many hope, however, that the unanticipated success of the BABs program will prompt its extension.

From December 2009 to January 2010, the yield on AAA-rated municipal bonds stayed level for 30-year bonds at 4.47% and increased slightly for 10-year bonds from 3.17% to 3.28%.  During the same period, the yield on Treasuries increased slightly from 4.43% to 4.53% on 30-year bonds and from 3.52% to 3.64% on 10-year notes, maintaining the 10-year muni-treasury yield ratio at 90.1%.

Source: Bloomberg (www.bloomberg.com)

Sources: Unemployment Rate and Consumer Price Index: U.S. Bureau of Labor Statistics (www.bls.gov)
                 Existing/New Home Sales and Housing Starts: National Association of Realtors (www.realtor.org)