Alert November 29, 2010

BABs Hanging On

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.