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Build America Bonds -- A Credit Perspective --

This presentation provides a credit perspective on Build America Bonds and discusses the different types of bonds, credit risks, and implications for revenue bonds. It covers topics such as the background, tax credit, direct payment, risks related to maturity and call provisions, reliability of the interest rate subsidy, management assessment, timing of interest rate subsidy receipts, and implications for debt service coverage ratio.

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Build America Bonds -- A Credit Perspective --

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  1. Build America Bonds-- A Credit Perspective -- Boston Municipal Analysts Forum June 17, 2009

  2. Topics • Background • Different Types of Build America Bonds • Credit Risks

  3. Background • Created by the American Recovery and Reinvestment Act of 2009 • Must be designated and issued before 1/1/11 • Authorizes state and local governments to issue two general types of taxable governmental bonds with federal subsidies for a portion of their borrowing cost • Tax Credit • Direct Payment • “Recovery Zone Economic Development Bonds”

  4. Background, continued • Authorized to expand the market for state and local government bonds • Pension funds and money managers have been the primary purchasers along with insurance companies and retail • May not have more than de minimis amount of premium

  5. Tax Credit • Offers tax credits to investors in the bonds in an amount equal to 35% of interest payable by the issuer on taxable governmental bonds • May be issued to finance any governmental purpose for which tax-exempt governmental bonds (excluding private activity bonds could be issued under § 103 of the IRS code • May be issued to finance capital expenditures and working capital expenditures • May be used for new money, current refundings, and one advance refunding

  6. Direct Pay • Treasury shall pay issuer 35% of interest (45% for Recovery Zone Economic Development Bonds) • Subsidy can be paid either in advance or as reimbursement • Proceeds may be used to finance only capital expenditures • They may not be used for: • Refundings, or • Working capital • May have a reasonably required reserve fund

  7. Risks Related to Maturity & Call Provisions • First BABs structured like corporate bonds • long-term bullet maturities • either no call provisions or “make whole” call provisions • Now, some of the smaller Build America Bond transactions are structured with • serial maturities • 10-year call provisions

  8. Risks Related to Maturity & Call Provisions, continued • If a small issuer with little to no other debt chooses to structure a BAB like a typical taxable bond, lack of flexibility could be a credit issue • Even with a large issuer, it’s possible that traditional corporate structure might be used as an excuse to push debt out longer than the norm

  9. Reliability of the Interest Rate Subsidy • U.S. government has a long history of following through with its financial commitments • Confident that the federal government will make subsidy payments in keeping with guidance that they have published • Do not think that there is risk of nonpayment for financings issued as Build America Bonds prior to January 1, 2011

  10. Management Assessment • Strong management • Written procedures • Deep bench • Management is less important when issuer • is not dependent on the federal interest rate subsidy to make debt service payments • has a comfortable liquidity position as it relates to debt service demands

  11. Timing of Interest Rate Subsidy Receipts • Application for subsidy • Fixed rate bonds • not more than 90 days • not less than 45 days prior to interest payment dates • Variable rate bonds • within 45 days of the last debt service payment within a quarter

  12. Timing of Interest Rate Subsidy Receipts, continued • Issuers should expect to receive requested payments within 45 days of the date that a processible Form 8038-CP is filed with the IRS • No assurance that the interest rate subsidy will be received by the issuer prior to the date on which debt service is due to be paid to investors

  13. Gross Funded BABs Deals • The simplest of these programs will not rely on receipt of subsidy payments in order to make debt service payments in whole and on time.

  14. Net Debt Service Model • Net debt service models will require a back-stop.

  15. Implications for Revenue Bonds • Debt Service Coverage Ratio, Rate Covenant & ABT • Based on ratio of revenues to debt service • Depending on how federal interest subsidy is reflected, may weaken ratios

  16. Let’s Do the Math • Two ways of looking at revenues • Operating revenues = $2 million (A) • Operating revenues + subsidy = $2,050,000 (B) • Two ways of looking at debt service • Debt service without incremental taxable interest = $1 million (C) • Incremental debt service & subsidy = $50,000 (D) • A/C = 2.00x (before BABs) • B/(C+D) = 1.95x (subsidy in numerator & denominator) • B/C = 2.05x (subsidy in numerator only) • A/(C+D) = 1.90x (subsidy in denominator only)

  17. www.moodys.com

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