* Payments suspended as part of IRS plan
* Build America Bonds rebate already cut by sequestration
* Larger issuers likely to weather suspension
By Lisa Lambert and Patrick Temple-West
WASHINGTON, Oct 4 (Reuters) - The inability of the U.S.Treasury to send Build America Bond payments to state and localgovernments during the federal government shutdown is the latestblow to hopes these securities might grow into an alternative totax-exempt municipal bonds.
Taxable Build America Bonds, created in the 2009 economicstimulus plan, pay issuers federal rebates equal to 35 percentof the bonds' interest costs. The rebates were so attractivethat state and local governments rushed to sell $181 billionBABs in the 20 months of the program's existence.
When the BABs program expired with the end of the stimulusplan, issuers pushed to bring it back or create a similar formof taxable debt with rebates, often also called"direct-subsidy."
Since the government shutdown began on Oct. 1 because of abudget impasse in Congress, all tax refunds have been halted,including BABs rebates.
It is the latest complication to make issuers skeptical ofproposals for new direct-subsidy bonds because many say thebonds entangle state and local governments in federal budgetfights that jeopardize their funds.
The across-the-board spending cuts known as sequestrationthat started this spring sliced into all BABs rebates. Issuershad believed rebate amounts were guaranteed and were dismayed tofind they could shrink. On Monday, the day before the shutdownbegan, the Internal Revenue Service said that year-twosequestration cuts would trim BABs payments by 7.2 percent.
"We've already gone through this drill with sequestration,"said Chris Mier, managing director of analytical services forLoop Capital Markets, about the suspension of rebates.
The Government Finance Officers Association, the largestorganization representing issuers, could not say how manyissuers were expecting rebates during the shutdown. There is nocentral calendar of BABs interest payments or rebates. RecentIRS statistics show that in 2010, the last year data isavailable, issuers received $1.78 billion total in BAB rebates.
About 90 days before an interest payment is due, an issuerformally requests the rebate and then receives it typically 30days before the payment date, according to Utah TreasurerRichard Ellis.
Like many issuers, Utah does not use the rebates to coverits interest payments due in January and July. It has set asideenough funds for interest costs and then treats the rebates asadditional revenues, said Ellis.
Most at risk from the suspension would be to small issuerssuch as remote school districts that also apply the rebates tothe interest payments and have payments due soon, Loop Capital'sMier said.
President Barack Obama has pushed for an alternative totraditional tax-exempt municipal bonds, arguing they cost thefederal government more than they benefit local governments.Obama has suggested creating more direct-subsidy debt programsand also capping the tax exemption on municipal bonds, whichwould drive down the demand for them.
Richard Ciccarone, a managing director at McDonnellInvestment Management, said the current payment suspension showsdirect-subsidy bonds make states and cities too dependent on thefederal government.
Issuers should see "they have a strong interest inpreserving the current tax-exemption structure," he said.
Asked if he would ever push for Utah to issue direct-subsidybonds should they reappear, Ellis, the state treasurer, said: "Iwouldn't."
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