National Association of Health and Educational Facilities Finance Authorities

Build America Bonds (BABs) and their potentialfor 501(c)(3)s and Related Considerations

March 22, 2010

Moderator: Maribeth Wright, Ph.D. Executive Director Iowa Higher Education Loan Authority (515) 282-3769

Meghan B. Burke Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. Boston (617) 348-1663

John H. Bonow Public Financial Management (PFM) Seattle (206) 264-8900

Agenda

• Nuts and bolts of direct payment BABs

• Subsidy

• Disclosure

• Potential extension, modification and expansion of BABs

• BABs market and transaction considerations

• Flipping – to what extent is this a problem?

• Conclusion

2

Nuts and Bolts of Direct Payment BABs

• Established under ARRA

• Expires end of 2010

• Governmental bonds only

• Must otherwise qualify to be issued as tax-exempt bonds

• Use of proceeds limited

Costs of issuance (2%)

DSRF

Balance 100% for new capital

No refunding or working capital

• Federally taxable bonds

• Subsidy 35% of interest payable by issuer

• Most issuers/borrowers optimize tax-exempt and BABs (more cost-effective option varies by maturity)

• Redemption provisions– Extraordinary redemption if

nonpayment of subsidy

– Make-whole, par call or non-callable

3

Nuts and Bolts of Direct Payment BABs

• Filing requirements:

At closing (new 8038-B)

Before each and every Interest Payment Date (8038-CP)

Who’s responsible for filing?

Transition to SLGs-like electronic model

Kinks being worked out

• Payment from U.S. Treasury to Issuer (or agent paying interest)

• Post issuance complianceQuestionnaires

Research/monitoring?

• Issue price controversyPotential “flipping” (bonds sold to other investors at higher prices/lower yields shortly after the primary order period)

• Excludes prevailing wage (unlike certain other ARRA programs)

4

BABs Subsidy

• Standing appropriation - same status as tax refunds• Absent a change in law, payments will be made without

further action of Congress• Political risk similar to overall tax-exemption on bonds• Potential offset against unrelated tax or other federal

liabilities of issuer

• Pledge

• Covenant considerations (DSRF, additional bonds, rate covenant, flow of funds, etc.) - whether based on gross or net debt service

• IRS audit/enforcement• Potential withholding or clawback of subsidy payments

5

Disclosure

• By and large little disclosure about subsidy

• Few, if any, changes in approach to disclosure, initial or ongoing, notwithstanding different buyer base and initial perception that taxable market would demand more

• Generally true whether revenue bonds or general obligation

• Opinion published in OS typically silent as to BABs treatment (opinion on BABs qualification delivered solely to obligor and cannot be relied on by investors)

6

Potential Extension and Expansion of BABs

• BABs or tax credit bonds favored by some policy-makers as more efficient, effective and less costly delivery of tax subsidy

Is this true?

• Will BABs and tax credit bonds eliminate tax-exempt bonds?

7

Potential Extension and Expansion of BABs

• Given perceived success of BABs, likely to be extended and/or expanded

• HIRE law signed Thursday - certain tax credit bonds (QSCBs and QZABs) may be issued with subsidy – Subsidy equal to the lesser of a published rate and the actual bond

rate (this was the more generous House version)– Eliminates December 31, 2010 sunset for these bonds– Also “BABified” CREBs and QECBs (70% subsidy)

• President Obama’s proposed budget provides permanent extension of BABs and reduction of subsidy to 28%, expansion to 501(c)(3)s and allowance for current refundings and working capital

• March 17, House Way and Means approved BABs extension to 4/1/2013 with annually reduced subsidy (33%, 31% and 30%) and allowance for current refundings

8

9

Relative BABs and Tax-Exempt Costs (“A” rating)

Net BABs Yields are Cost-Effective for Most Maturities

Treasury Auction

• All successful bidders are awarded securities at the same yield, which is the yield that corresponds to the highest rate or yield of the competitive bids

• Designed to minimize the cost of financing by promoting broad, competitive bidding and liquid secondary market trading

Market Clearing Yield

3.32%$2.5MM @3.25%

$3MM @3.26%

$5MM @3.27%

$15MM @3.28%

$15MM @3.29%

$25MM @3.30%

$40MM @3.31%

$100MM @3.32%$100MM @3.33%

$0MM

$100MM

$200MM

$300MM

$400MM

$500MM

$600MM

Agg

rega

te D

eman

d

Yield Bid

$200MM Bond Offering

10

BABs Influence on the Municipal Market

•Underwriting syndicate sales all bonds at clearing yield

•Syndicate assumes no underwriting risk

•Large investors can game order period

UnderwriterSyndicate

Instit. BuyersA. Own AccountIns. Co. Banks

Instit. BuyersB. Proxy Retail Bond FundsInstit. TrustsMoney

Managers

Offering Yield 3.32% $2.5MM

$3MM

$5MM

$15MM

$15MM

$25MM

$40MM

$100MM$100MM

11

80 bps

90 bps

100 bps

110 bps

120 bps

130 bps

140 bps

150 bps

160 bps

170 bps

180 bps

1/12/10 1/14/10 1/16/10 1/18/10 1/20/10 1/22/10 1/24/10 1/26/10 1/28/10

Spre

ad t

o M

MD

Trade Date

Miami Airport2035-5.375% Maturity

To Customer

From Customer

Inter-Dealer

Original Spread

* Bubble size indicates size of trade

12

Secondary Trading: The “Flipper” Market

• Addressing issue price certification requirements and trading activity

13

Wire Language to Limit Flipping

Issuance Size, Sale Method, and Redemption Features

• Large issues still dominate the BABs market

• More issues are being sold competitively

• Use of par call features is declining

14

Conclusion

• The market demand for BABs has expanded significantly

• With increased market demand there has also been a growing level of comfort among BABs investors with traditional 501(c)(3) tax-exempt structures and sale types. These accepted characteristics include:

– Smaller transaction sizes; various amortizations; par calls

• BABs have become a standard market security that often allows an issuer to realize savings for some maturities versus traditional tax-exempt debt

• Legislative proposals to extend BABs, possibly expand to 501(c)3s, possibly allowing refundings and working capital uses, but reducing subsidy will shape BABs issues in 2011 and beyond.

– Expect flurry of BABs issues in 2010 while the 35% subsidy persists

– Analyze the merits of preparing during 2009, if possible, for 501(c)(3) issuance in 2011 and beyond

15