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Build America Bonds: An Overview
05/07/2009
Background
The Texas Department of Transportation's (TxDOT) main funding comes from traditional sources such as gas tax revenues, vehicle registration fee revenues and federal reimbursements. This enables TxDOT to pay for the construction and maintenance of nearly 80,000 centerline miles of roadway for which it is responsible. Due to the large expense of funding infrastructure, TxDOT also has a variety of debt programs available to help pay for and advance projects, including the Texas Mobility Fund, Proposition 14 Bonds, Comprehensive Development Agreements and Pass-Through Financing. Borrowed money has helped the department continue growth in contracting.
SituationTraditionally, the bonds TxDOT uses to fund transportation projects are sold in the tax-exempt market. This accounts for state and local governments being able to issue $2.7 trillion in the U.S. debt capital markets. By solely seeking investors from this sector, TxDOT's ability to secure cost effective financing for future infrastructure projects is limited, given the recent disruption in the capital markets.
One tool to help gain additional investors could be in issuing taxable bonds, such as Build America Bonds, or BABs. The total debt issuance for all taxable bonds accounts for $11.7 trillion in the U.S. debt capital markets.
BABs provide TxDOT another option to access a broader investor base, as well as reduce borrowing costs. Since there are a lot more taxable investors than tax-exempt investors, TxDOT's utilization of BABs would give us access to these investors.
BABs are part of the American Recovery and Reinvestment Act federal stimulus plan. It allows governmental issuers to sell taxable debt until 2011 and receive a cash rebate from the U.S. Treasury equal to 35 percent of all interest paid for the term of the debt. While a BAB could draw a higher taxable financing cost to the issuer than a tax-exempt bond, the 35 percent federal government giveback may turn it into a lower overall borrowing rate.
In the current market, the Build America program would provide TxDOT with interest cost savings over the life of the issue. Expanding TxDOT's universe of tax-exempt investors means larger size bond denominations can be potentially be completed at a lower cost. These desirable characteristics can be structured into the Texas Mobility Fund financing program, hopefully resulting in a favorable response from investors.
The best candidates for BABs are medium to large, highly-rated (strong credit rating of ‘A' or higher) issuers, like TxDOT. Major targeted investors in BABs include mostly domestic corporate investors, such as bond funds, insurance companies and asset management companies.
BABs criteriaFor "qualified bonds" issued before 2011, TxDOT can claim the 35 percent tax credit directly, receiving a cash payment from the U.S. Treasury Department. The credit is payable by the Treasury on each interest payment date and can go to the entity actually making the payment on the debt, whether it's TxDOT or another entity. There is also no aggregate cap amount on these bonds; however, the "qualified bonds" must meet the following criteria:
- All available project proceeds must be spent on capital expenditures, as defined by the IRS.
- A spend-down requirement is met, which means bond proceeds have to be expended within time periods prescribed by law.
- The issuer must make an irrevocable election to have this provision apply, which means the issuer (in this case TxDOT) has to select an option - either the interest rate subsidy or a tax credit - and once the ‘election' is made, it can't be changed.
