Public Finance Update - November 2010

Build America Bonds (“BABs”) represent one of the more successful programs created by the American Recovery and Reinvestment Act of 2009 (“ARRA”). The BABs program provides tax credits and interest subsidies that enable state and local governments to finance capital projects with taxable bonds that appeal to a wider universe of buyers. Over $160 billion in BABs have been issued since the inception of the program.

Before the recent mid-term elections, investors generally believed the BABs program would be extended in some form past its 2010 sunset. Given the post-election influx of Republican legislators, however, the program’s future has become less assured. Opponents of BABs argue that the program should not be extended because, among other things, it has cost the federal government more than expected, and because the projects financed with BABs do not create the types of jobs that foster economic recovery.

Nevertheless, congressional observers recently indicated that “tax extenders” bills are expected to be passed by Congress sometime after Thanksgiving. The legislation will likely include an extension of the BABs program, albeit with a slightly lower subsidy rate (between 30% and 32%, rather than 35%). The tax extenders legislation is also expected to include extensions of Bush-era tax cuts, which is why observers believe that Republicans will accept the extension of certain ARRA programs such as BABs.

Meanwhile, state and local governments are scrambling to issue BABs in order to take advantage of the 35% federal tax credit/interest subsidy before December 31. If Congress fails to extend the program and the authority to issue BABs expires, issuers will again be faced with the perennial problem of how best to finance their infrastructure obligations. Solutions will likely include both tried-and-true tax-exempt bonds, as well as a patchwork of previously successful and re-emerging financing methodologies, including public-private partnerships, privatization, variable rate instruments, letters of credit and bond insurance, tax sharing arrangements, and special district financing.

The California School Finance Authority (“CSFA”) recently issued $12 million in Qualified School Construction Bonds (“QSCBs”) to finance K-8 school facilities in Chula Vista, California, for the High Tech High charter school. The High Tech High bonds represent the first issuance of QSCBs in California for a charter school and have been recognized as the “Far West Deal of the Year” for small issuers by The Bond Buyer.

QSCBs are authorized as part of the Build America Bond program under the American Recovery and Reinvestment Act of 2009 (“ARRA”) to help finance school construction, rehabilitation and repair. The QSCBs provide either a federal tax credit for bond holders or interest subsidy payments to issuers, each designed to significantly reduce the issuer’s cost of borrowing for public school construction.

For the High Tech High bonds, the CSFA will receive direct interest subsidy payments from the U.S. Department of Treasury. City National Bank, represented by Goodwin Procter, provided a direct-pay letter of credit that will pay the interest and principal with respect to the bonds. The federal subsidy payments will be used to reimburse City National Bank for interest drawings under its letter of credit. The High Tech High bonds mature on July 1, 2020, and bear interest at the rate of 5.041% per year. The transaction received an “AAA” rating from Standard & Poor’s, primarily based on a standby letter of credit issued by the Federal Home Loan Bank of San Francisco.

U.S. Transportation Secretary Ray LaHood recently announced that the federal government will reallocate any high-speed rail grant moneys rejected by states that have already received allocations. Many recently elected Republican governors ran on platforms that included opposition to high-speed rail. These critics maintain that high-speed rail will not attract sufficient ridership to justify the billions of dollars necessary to create a viable infrastructure, especially during a severe recession.

Many governors, including California Governor Arnold Schwarzenegger, remain committed to the future of high-speed rail. In a recent letter to LaHood, Governor Schwarzenegger expressed “astonishment” at the other governors’ rejection of their respective high-speed rail programs and stated “[i]f other states refuse your support, we would certainly welcome their shares – particularly as we continue to demonstrate how well those dollars will be spent in our great State.”

Since 2009, the federal government has announced over $10 billion in grant moneys for high-speed rail, of which California has been awarded $3 billion. California’s high-speed rail is expected to initially run from San Francisco to Los Angeles, and later to Sacramento and San Diego. The trains are expected to travel at speeds of up to 220 mph, and the trip from Los Angeles to San Francisco is expected to take less than 2 hours and 40 minutes.

This month, spreads reversed their downward course. The November 2010 yield on AAA-rated municipal bonds increased from 4.19% to 4.55% for 30-year bonds and from 2.59% to 3.14% for 10-year bonds. Yields on treasuries also increased from 3.91% to 4.20% for 30-year bonds and from 2.56% to 2.80% on 10-year notes, yet continued to remain below muni yields in each case.  Recent Federal Reserve announcements on the state of the U.S. economy, international tensions in Korea and financial uncertainty in Ireland are working their way through the debt markets, creating a choppy trading pattern.

 

Source: Bloomberg (www.bloomberg.com)