Many state and local governments are currently facing a legal battle regarding the redemption or refunding of their Build America Bonds (BABs). These bonds, which were authorized as part of a stimulus program during the Obama administration, allowed issuers to sell taxable bonds and receive a subsidy from the federal government on the interest rates paid to investors. However, due to federal budget “sequestration” since 2013, issuers have seen lower-than-promised subsidies, leading to questions about the legality of redeeming outstanding BABs.
The recent U.S. Supreme Court ruling has sparked a debate over whether sequestration constitutes an “extraordinary event” that would trigger issuers’ right to seek an extraordinary optional redemption of their BABs. This ruling has prompted issuers, such as the Regents of the University of California, to move forward with redeeming their outstanding BABs, despite potential legal challenges from investors. J.P. Morgan has identified 14 unique issuers, with six in California alone, that have either called BABs, announced conditional calls, or are considering financing plans in light of the current interest rate environment.
Bondholders, who have enjoyed stable income and prices in recent years, are now facing the prospect of losing their premium if issuers decide to exercise the extraordinary redemption provision. Market participants, such as James Pruskowski from 16Rock Asset Management, have pointed out that these redemption provisions are more prevalent among sophisticated issuers in densely populated areas, particularly on the coasts. This trend is evident in states like New York, California, and Washington, where issuers are grappling with the decision to refund their BABs.
Despite the legal uncertainties and pushback from investors, some states have proceeded with refunding their outstanding BABs. Washington state, for example, has chosen to redeem some of its BABs, while Virginia’s Norfolk city became the first issuer to cancel its refunding plans without providing a specific reason. The ongoing legal disputes surrounding these redemptions highlight the complexities of the current regulatory environment and the challenges faced by both issuers and bondholders.
The legal debate surrounding the redemption of Build America Bonds continues to evolve as issuers navigate the implications of sequestration and seek clarity on their rights under the extraordinary redemption provision. While some states have moved forward with refunding their BABs, others are facing legal challenges and uncertainties regarding the legality of such actions. As market professionals and legal experts weigh in on the issue, the fate of outstanding BABs remains uncertain, leaving both issuers and bondholders in a state of flux.