February 2016 Update on Federal Budget Sequestration that Affects Build America Bonds and Other Direct Pay Subsidy Bonds

Under current law, direct pay bond subsidy payments are subject to federal budgetary sequestration through fiscal year 2025. On February 9, 2016, the Office of Management and Budget released the nondefense mandatory sequester percentage for fiscal year 2017. According to the OMB release, the percentage reduction that will be applied to payments to issuers of direct pay subsidy bonds for fiscal year 2017 (which begins on October 1, 2016) will be 6.9 percent. The percentage reduction for the current fiscal year is 6.8 percent. The sequestration rate for federal fiscal years 2018 through 2025 will be set from time to time in the future, unless Congress takes action to change or eliminate the sequestration percentage.

The Office of Tax Exempt Bonds within the Internal Revenue Service (IRS-TEB) has previously advised that issuers of direct pay subsidy bonds should complete IRS Form 8038-CP as directed in the instructions for the form, claiming the full amount of the direct pay subsidy to which they would be entitled absent sequestration. IRS-TEB has also advised that issuers will receive correspondence concerning their subsidy payment reduction after they file Form 8038-CP.

The types of direct pay subsidy bonds affected by federal budgetary sequestration include build America bonds, recovery zone economic development bonds, qualified zone academy bonds, qualified school construction bonds, qualified energy conservation bonds and clean renewable energy bonds.

As has been noted previously, in light of the ongoing federal budgetary sequestration process, issuers of direct pay subsidy bonds may wish to consider whether and to what extent they are currently in a position to exercise a special, extraordinary or other optional call right (if any) provided under the terms
governing their direct pay subsidy bonds. The answer to this question will turn in part on the specific provisions establishing the call right in the relevant bond document or statutory authorization, and on the economics of refinancing the direct pay subsidy bonds from other sources (such as an issue of tax-exempt bonds), including the cost of any redemption premium associated with calls of such direct pay subsidy bonds.

Please contact Antonio Martini directly at 617-378-4136, or any other member of Hinckley Allen’s Public Finance Practice Group for more information about the ongoing federal budgetary sequestration process, or if you have any other bond compliance matter you would like to discuss.