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Reduction of Credit Payments for Direct Payment Obligations

Public Finance Law Update

Our records indicate you issued one or more of the following types of bonds for which you expect to receive a credit payment from the Internal Revenue Service (the "IRS") on all or a portion of the interest payments due on the bonds: Build America Bonds ("BABs"), Recovery Zone Economic Development Bonds ("RZEDBs"), Qualified School Construction Bonds ("QSCBs"), Qualified Zone Academy Bonds ("QZABs"), New Clean Renewable Energy Bonds ("CREBs") and Qualified Energy Conservation Bonds ("QECBs") (collectively, "Direct Pay Obligations"). As you may be aware, the subsidy payments to be made by the IRS with respect to Direct Pay Obligations are among the payments subject to the effect of the Balanced Budget and Emergency Deficit Control Act of 1985, as amended (commonly referred to as the "Sequester"). Credit payments on your Direct Pay Obligations may have already been reduced or could be subject to reduction in the future. You should be aware of the implications of this reduction in subsidy payments, as described below.

Reduction in Credit Payment from the IRS

As of March 1, 2013, the IRS began reducing all credit payments requested by issuers in connection with Direct Pay Obligations pursuant to the requirements of the Sequester. According to the IRS, credit payments will be reduced until the end of the federal government's fiscal year (September 30, 2013) or intervening Congressional action, at which time the reduction of credit payments is subject to change. After you or your fiscal agent file a form 8038-CP requesting the credit payment, you will receive notice from the IRS with the amount of the reduced credit payment you or your fiscal agent will receive. Payments have been reduced by approximately 8.7%.

The reduction of the credit payment is significant for at least two reasons:

  1. issuers will have to find other funds to make up the shortfall so that the full interest payment can be made when due on the Direct Pay Obligations, and

  2. the reduction may trigger an extraordinary redemption provision of the Direct Pay Obligations (described further below), which would allow the issuer to currently redeem the Direct Pay Obligations. If that is the case, it is advisable for the issuer to file a material event notice within 10 business days, as described further below.

Extraordinary Redemption Provision

Some Direct Pay Obligations have extraordinary redemption provisions allowing the issuer to redeem them early if a full credit payment is not received from the federal government through no fault of the issuer. These Direct Pay Obligations would have language similar to the following:

the Bonds are subject to redemption prior to maturity, in whole or in part, at the option of the Issuer, on any day, at a redemption price equal to 100% of the principal amount redeemed plus accrued interest to the date of redemption, in the event that either (a) Section [54AA or] 6431 of the Internal Revenue Code of 1986, as amended, is repealed, amended or modified in a manner which results in a reduction or elimination of the Issuer's credit payment from the United States Treasury or (b) the United States Treasury fails to make a credit payment to which the Issuer is entitled and such failure is not caused by any action or inaction by the Issuer.

You should consult with your financial professionals as soon as possible to determine if your Direct Pay Obligations have this or a similar extraordinary redemption provision. If so, it is advisable to file a material event notice or notices alerting investors to the reduction in the credit payment and the extraordinary redemption provision within 10 business days after the provision is triggered. You may determine that additional material event notices are necessary or desirable as well.

Material Event Notice

No material event notice is required if your Direct Pay Obligations do not have the extraordinary redemption provision. If they do, it is advisable to file a material event notice or notices to alert investors of the receipt of the reduced credit payment and the triggering of that provision within 10 business days, whether or not you have decided to act on the provision. Issuers should consult with their financial professionals for guidance with regard to the content and timing of the material event notice(s) in light of their situation.

Unless engaged to do so, we cannot give specific advice as to how to proceed with respect to material event notice(s). However, we have prepared a sample form of a material event notice with several options that we can share with you and your financial professionals.

We appreciate the opportunity to work with you in the past and look forward to working with you in the future. If you have any questions, please don't hesitate to contact any of the attorneys in the Quarles & Brady Public Finance Group.

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