Sequestration: Federal Subsidy Payments for BABS and Other Direct-Pay Subsidy Bonds will be Reduced 8.7%

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Pursuant to the Balanced Budget and Emergency Deficit Control Act, on March 1, 2013, the President issued the sequestration order which requires automatic spending cuts ("sequestration") as the result of Congress' failure to enact legislation to reduce the budget deficit. Among the federal expenditures affected by these cuts are subsidies due to state and local governments which issued bonds pursuant to several bond programs authorized by Congress during the depths of the economic downturn. Those programs provided for the issuance of taxable bonds and the payment of a subsidy from the federal government to the issuer to approximate the benefits of issuing tax-exempt bonds. These direct-pay subsidy bond programs included Build America Bonds, Qualified Zone Academy Bonds, Qualified School Construction Bonds, Qualified Energy Conservation Bonds, and New Clean Renewable Energy Bonds. Although the order has been issued, it will not be implemented until March 27, 2013.

The Office of Management and Budget ("OMB") originally released a report in 2012 which showed that the federal subsidy payments for the federal fiscal year ending September 30, 2013 ("FY 2013"), may be cut by 7.6%. OMB has now indicated in a report to Congress dated March 1, 2013, that the current percentage reduction will be 5.1%. The 5.1% is the overall reduction in the program's total FY 2013 level. Since the beginning of FY 2013 last October 1 some issuers have received payments that were not reduced. In order to achieve the overall annual savings of 5.1%, the remaining payments will have to be cut by a larger percentage. The Tax Exempt Bond office ("TEB") of the Internal Revenue Service has now advised that subsidy payments to issuers through September 30, 2013, will be reduced 8.7%. Issuers should continue to complete Form 8038-CP in the normal manner. Issuers will then be advised by correspondence of the amount by which the payment will be reduced. Click here to see the full TEB announcement. This reduction could change if Congress and the President can agree on an alternative to sequestration. This reduction is also only applicable to FY 2013.

Nonetheless, issuers of any of the direct-subsidy bonds should consider how these cuts will impact their budgets and compliance with bond covenants. In some cases, issuers account for the subsidy in their general fund. In other cases, issuers pledge the subsidy to bondholders. When the subsidy is pledged to bondholders, issuers will want to consider how these cuts affect the ability to pay debt service. Also, these cuts may impact compliance with rate maintenance covenants or additional bonds tests. Finally, issuers will want to consult the redemption provisions for their bonds to determine whether these cuts may implicate an extraordinary redemption provision.

Topics:  Bonds, OMB, Sequestration, Spending Cuts, Tax-Exempt Bonds

Published In: Education Updates, Energy & Utilities Updates, Finance & Banking Updates, Tax Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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