SIFMA Member Notice
September 28, 2012
Dealers Should Consider Advising Customers Purchasing Direct-Pay Bonds of the Risk that Sequestration
of Federal Funds Could Allow the Issuer to Call Some of those Direct-Pay Bonds pursuant to Extraordinary
Optional Redemption Provisions.
The United States Office of Management and Budget recently released a report1 (the “OMB Report”)
identifying various federal programs that would be subject to formula-based, across-the-board funding
reductions beginning on January 2, 2013 as a result of the potential sequestration of federal funds.
Congress may still act to eliminate or modify sequestration before it becomes effective. Further, if
sequestration occurs, the actual amount and timing of funding reductions may vary from that set forth
in the OMB Report and could vary by direct-pay bond type depending on when interest subsidy
payments are receivable by issuers.
Among the categories of funding reductions are direct-payment interest subsidies required to be made
to issuers of Build America Bonds (BABs), Qualified Zone Academy Bonds (QZABs), Qualified School
Construction Bonds (QSCBs) and Qualified Energy Conservation Bonds (QECBs). BABs, QZABs, QSCBs and
QECBs are all referred to as “direct-pay bonds”. According to the OMB Report, 7.6% of the interest
subsidy payments for direct-pay bonds may be subject to sequestration beginning in 2013.
Some direct-pay bonds have extraordinary optional redemption provisions that allow the issuer to
redeem the bonds if certain events take place that cause a reduction or termination of federal subsidy
payments. These redemption provisions may be triggered by specific changes in law, by actions taken
by federal agencies, by a reduction in payments for any reason, or by other factors. While some bonds
provide for a “make-whole” call in such circumstances, which may or may not be economic for the issuer
to exercise under current market conditions, others permit the bonds to be called at par or upon
payment of a stated redemption premium. In those instances, the extraordinary redemption price may
make it economic for issuers to redeem or refund the direct-pay bonds. The decision by an issuer as to
whether and when to redeem direct-pay bonds could be affected by multiple factors such as market
conditions at the time of the redemption, the redemption price, the issuer’s expectation of future
subsidy payments, and any timing requirements related to when a redemption becomes optional,
among others.
Dealers should review the extraordinary optional redemption provisions of direct-pay bonds being
offered to customers to determine the circumstances under which the bonds may be subject to
1
Executive Office of the President of the United States, “OMB Report Pursuant to the Sequestration Transparency
Act of 2012 (P. L. 112–155),” September 2012.
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SIFMA Member Notice
Page 2
extraordinary optional redemption and the applicable redemption price. Dealers may wish to consult
with counsel in that regard. Further, dealers should consider whether it is appropriate to advise
customers who purchase direct-pay bonds of the risk that, in the event of sequestration, some of those
bonds may be subject to extraordinary optional redemption by the issuer at a price that may be less
than the price paid by the customer to purchase the direct-pay bonds or less than recent trade prices.