Are Build America Bonds making a comeback?

Two Senate bills hope to permanently revive the taxable bonds, which were originally created in 2009 as part of Washington’s efforts to stimulate the economy.

Under a bill proposed recently by Sen. Ed Markey, the federal government would rebate to state and local issuers 31% of interest costs on bonds issued under the program. The rate would apply to bonds issued this year but would be gradually reduced to 28% by 2017, where it would be set permanently.

Markey’s bill, known as the Bolstering Our Nation’s Deficient Structures (BONDS) Act, is modeled after the Build America Bonds Act of 2013 introduced by Rep. Richard Neal. Neal’s bill is still in committee.

Original BABs were a success

The original program, established under the American Recovery and Reinvestment Act, was highly successful. Although in existence for only 20 months, state and federal governments issued more than $181 billion in BABs for new public works projects, with the federal government reimbursing 35% of interest costs.

However, because of Washington’s budget battles and the ensuing mandated cuts known as sequestration, subsidy payments to states were reduced. Under Markey’s bill, subsidy payments would be free of sequestration cuts for bonds issued after enactment of the law.

Geoffrey Beckwith, executive director of the Massachusetts Municipal Association, said his group supports the legislation.

“In addition to protecting and safeguarding traditional tax-exempt municipal bonds, which will always be the centerpiece of local government financing, Senator Markey is offering communities an attractive and innovative financing tool to build and invest in schools, police and fire stations, roads, bridges, parks and other critical public infrastructure.”

As we noted soon after the original program kicked off, (Popularity of BABs Bodes Well For Tax-free Bonds), the program is a winner for everyone.

Municipalities benefit because they can borrow at a lower net interest cost and the projects financed through BABs spur local job growth.

Taxable investors can diversify into high-quality securities in a sector of the credit markets that has recently been unavailable to them.

What’s more, with tax-burdened investors already flocking to munis, new BABs would put further pressure on the supply of tax-exempt bonds, providing a boost to the market values of existing municipal bond portfolios.

Looking down the road amid today’s higher tax rates, tax-exempt yields look particularly inviting.

James A. Klotz is the President of FMSbonds, Inc. Email the Author04/16/2014