Tax Credit Bond Issuers’ Payments May Increase Under Sequestration

By Colette J. Irwin-Knott, CIPFA, Partner, October 24, 2012
Articles: Schools Related, Latest News

If your school district or local governmental unit issued direct payment Build America Bonds (BAB’s), including Qualified School Construction Bonds (QSCB’s), Qualified Zone Academy Bonds (QZAB’s), Clean Renewable Energy Bonds (CREB’s) or Qualified Energy Credit Bonds (collectively the “Tax Credit Bonds”), you are about to learn the meaning of a new term: sequestration.

Build America Bonds and some of the other financing tools described above were part of the American Recovery and Reinvestment Act of 2009, commonly known as stimulus funding, which were issued in 2009 and 2010.  Rather than being tax-exempt, these bonds offered tax credits as an incentive for bond purchasers.  A direct subsidy from the federal government often funded 35% of the issuers’ interest costs.  These Tax Credit Bonds were an excellent option at that time and saved millions of dollars for your taxpayers, because construction projects were able to take advantage of not only low interest rates, but low construction costs as well.

However, one of the risk considerations was that it was always possible the government’s subsidy could change over the life of the bonds. Generally, Umbaugh advised its Tax Credit Bond clients to hold onto sufficient funding to have a cushion for higher debt repayment amounts if the subsidy was ever adjusted.  Specifically, having a Debt Service Fund working balance that could provide payment if the tax credits were late was recommended.

Sequestration

Sequestration may possibly increase your interest payment amount beginning in early 2013.

Congress adapted the legal term sequestration in recent years to describe a fiscal procedure.  It’s related to the term for sequestering a jury – or literally holding something away for safekeeping. 

The authority for sequestration of federal appropriations originates in the Gramm-Rudman-Hollings Deficit Reduction Act of 1985. That legislation recognized Congress sometimes doesn’t realize until all the various appropriations bills pass that the total appropriations exceed the spending limit Congress has set in its annual Budget Resolution. If that happens and Congress cannot agree on cuts to stay within the limit, sequestration is an automatic spending cut that goes into effect. 

The U.S. Treasury “sequesters” the difference between the Budget Resolution spending limit and the amount appropriated, so the excess funds are not distributed to the agencies for which it was appropriated. 

In theory the percentage held back is the same for every agency, but Congress has historically chosen to exempt certain programs, knowing these cuts could be very painful in Social Security and defense budgets, for example.  But if some agencies are exempt, others must make up the difference.  Congress can opt to raise the spending cap for a given year – but that doesn’t meet the original intent of reducing the budget deficit.

Because the joint Congressional “Super Committee” failed to agree on a plan to reduce the deficit by $1.2 trillion over the next 10 years, a resolution by the federal Budget Control Act of 2011 will trigger a broader automatic sequestration for 2013 to take effect January 2 unless some action is taken to prevent it.  It’s difficult to predict what budget cuts Congress or the President might make between now and the end of 2012, or to know if Congress will act to stop this broader sequestration. 

A report issued by the Office of Management and Budget projected sequestration will reduce the subsidy for Tax Credit Bonds by 7.6%, or an estimated $255 million. 

What does this mean for you?

If you have outstanding Tax Credit Bonds, begin planning now for the possibility your interest payments may increase. 

1. First determine the potential increase in your bond payments. 
2. Although you initially may have set aside money for a payment increase, the Indiana Department of Local Government Finance has encouraged local governmental entities to reduce their cash balances.  Check to make sure what you set aside for a potential payment increase is still available. 
3. If you don’t have sufficient resources to meet your obligation, consider the available alternatives to fund your debt payments. 
4. Debt payments get first priority, so you also need to project the effect larger payments will have on your other funds.   

Many clients have an upcoming January 15, 2013 payment which may be impacted. Therefore, it’s important to plan for this potential now, rather than when the payment is due.

If you have questions or need help with understanding what sequestration may do to your Tax Credit Bond obligations, contact us at footnotes@umbaugh.com.

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Information in this article was believed current as of the date of publication. As you know, changes occur frequently. The information presented is of a general educational nature. Before applying to your specific circumstances, please contact us at footnotes@umbaugh.com.