There has been a growing trend among state and local governments to redeem or refund their Build America Bonds (BABs) in light of current interest rate fluctuations. This trend has raised questions regarding the legality of such actions, particularly as issuers navigate the complex landscape of subsidy payments and budget restrictions. BABs, which were introduced in 2009 and 2010 as part of a stimulus program during the Obama administration, provided issuers with the opportunity to sell taxable bonds while receiving a subsidy on the interest rates paid to investors from the federal government.
Federal budget “sequestration” has led to lower-than-promised subsidies to issuers since 2013, prompting some to consider redeeming outstanding BABs. Recent discussions have been fueled by a U.S. Supreme Court ruling that supports the notion that sequestration resulted in a significant change to the cash subsidy payment obligation. This has sparked debates among industry professionals and legal experts regarding the legality of triggering extraordinary redemption provisions in response to subsidy cuts.
J.P. Morgan has identified a group of “unique” issuers, including those in California, that have either called BABs, posted conditional calls, or announced financing plans. The actions of entities like the Regents of the University of California, who closed a deal to redeem outstanding BABs despite potential legal challenges, have brought attention to the broader debate. The issue at hand is whether issuers have the authority to exercise extraordinary redemption provisions following subsidy reductions under the sequestration process.
The uncertainty surrounding BABs refundings and extraordinary redemption provisions has implications for bondholders and market participants. While some have enjoyed strong income and stable prices over the years, the possibility of losing premium to an exercised ERP can be daunting. Market observers like James Pruskowski have noted that issuers in densely populated and economically significant regions like New York, California, and Washington are more likely to consider BABs refundings.
One notable case is that of Norfolk, Virginia, which became the first issuer to cancel its BABs refunding plans without providing a specific reason. While the city has reserved the right to call the 2010B BABs for redemption in the future, the decision to forego immediate redemption reflects the varied approaches taken by different issuers in response to the ongoing legal and financial uncertainties surrounding BABs.
The debate surrounding the legality of redeeming Build America Bonds is complex and multifaceted. As issuers grapple with changing subsidy dynamics and market conditions, the decision to trigger extraordinary redemption provisions carries significant implications for all stakeholders. Moving forward, industry professionals, legal experts, and market participants will continue to monitor these developments closely to navigate the evolving landscape of municipal bonds.