The legislation passed by Congress last year to raise the federal debt ceiling included a provision referred to as sequestration. This clause basically provides that if Congress is unable to agree on additional budget cuts by January 2, 2013 that will reduce the federal deficit over the next ten years, then a series of automatic cuts will go into effect. The Office of Management and Budget (OMB) issued a report in September 2012 outlining the impacts of these automatic cuts, should they go into effect, which noted that the subsidy payments to issuers of Build America Bonds (BABs) would be reduced by 7.6%.
What does this mean to communities that issued taxable BABs in prior years? It is difficult to say. At this time, we do not know for sure if sequestration will go into effect. Several organizations, including the Government Finance Officers Association (GFOA), the National League of Cities, National Association of Counties, Securities Industry and Financial Markets Association (among others), have filed a request with OMB and the administration asking that BAB subsidies be exempted from sequestration. In addition, if Congress can come to an agreement on an alternative budget cut plan prior to January 2, then sequestration will not be triggered.
That said, it is prudent for those who have outstanding BABs to consider the potential impacts if sequestration were to become a reality. Here are some key items to consider:
- The 7.6% reduction would reduce the subsidy on the BABs from 35% of the interest payments to 32.3%. This equates to an increase in net expenses of 2.7% of the interest on these bonds. What impact does this have on the overall future budgets, fund balances/net assets, and cash flows?
- If the BABs are revenue bonds, will the decreased subsidy result in the enterprise fund being unable to meet the debt coverage requirement?
- Is there language in the bond resolution which would allow the BABs to be called or refinanced if certain extraordinary events take place? If so, would there be a premium required? Would the costs associated with a refinancing outweigh the additional interest costs from the reduced subsidy?
At this time, communities that issued BABs should consider the impact this reduction could have, and the available options. Management may wish to contact us to discuss the specific situation. Without a doubt, management should continue to monitor the situation in Washington for potential changes over the next two months, which may prevent sequestration from taking place.