California Communities STAR Bond Program Offers Cities a Cost-Effective Financing Tool
by James Hamill and Mark Curran
James Hamill is program manager with California Communities and can be reached at firstname.lastname@example.org. Mark Curran is a managing director with Piper Jaffray and can be reached at email@example.com.
Through the American Recovery and Reinvestment Act (ARRA), the federal government is providing a way for cities to issue taxable Build America Bonds (BABs) and Recovery Zone Economic Development Bonds (RZEDs). These bonds can be used for capital projects that cities may be currently undertaking or planning to break ground for in the near future.
Both BABs and RZEDs offer some attractive financial advantages, including a federal government direct subsidy of the bond interest costs: 35 percent for BABs and 45 percent for RZEDs. Municipalities can lower borrowing costs by 10 to 25 percent or more if they take full advantage of the most favorable taxable municipal bond rates.
A Closer Look at RZEDs
As part of the ARRA, the U.S. Treasury has allocated $10 billion nationally for RZEDs, which are issued in the taxable markets at taxable interest rates, offset by the 45 percent interest rate subsidy. The resulting net interest rate for RZEDs dramatically lowers the cost of borrowing for new projects. Furthermore, RZEDs can be combined with BABs or tax-exempt financings.
In terms of municipal public projects, RZEDs can finance a very broad range of new construction and rehabilitation efforts. The focus is on “shovel-ready” projects that will enhance the economic stimulus, and the RZEDs must be sold by the end of 2010. Any community interested in utilizing RZEDs must establish a recovery zone, and the project(s) being financed must be within or clearly of benefit to the new zone. Municipalities with allocations are considering:
• Public facilities, such as police and fire stations;
• Other public infrastructure projects, such as street paving and major street repair;
• City hall upgrades or improvements;
• Parks and recreation facilities; and
• Libraries and community centers.
More About BABs
BABs can finance all of the municipal public projects that qualify for standard tax-exempt municipal bonds. Sold in the taxable market at taxable interest rates, BABs receive a 35 percent interest subsidy from the U.S. Treasury in the form of a direct payment to the city, in accordance with the ARRA. In contrast to RZEDs, BABs do not require allocation and therefore have no size or geographic limitation. As a result, the market for BABs has developed rapidly over the past few months and offers cities significantly lower net-interest costs than comparable tax-exempt financings. BABs complement and can be combined with any RZED or tax-exempt financing to achieve the lowest overall borrowing cost.
Questions of Size
While BABs can be issued in all sizes and by most types of municipal credits, RZEDs are strictly limited based on the federal allocations to each community. In California, these allocations range from less than $1 million to more than $175 million (City of Los Angeles) with a median allocation of $4.8 million for the 49 larger cities (with a population greater than 100,000). Smaller cities looking to work with their counties to share in the remaining county allocations can expect allocations in the $1 million to $5 million range. While many of these RZED allocations may be combined with BABs or traditional tax-exempt bonds to create larger financings, it is likely that many federal economic recovery-based taxable bond financings are going to be less than $20 million.
STAR Bond Program Helps Cities Move Forward
To provide the lowest possible financing costs for cities wishing to use the ARRA financing tools, California Communities — a joint powers authority sponsored by the California State Association of Counties and the League of California Cities — is working with private-sector partners to implement a pooled issuance platform called Statewide Taxable American Recovery (STAR) Bonds. The STAR Bond Program is open to California public agencies issuing RZEDs and BABs. Designed to provide issuers with a bond pooling vehicle that benefits each individual issuer, the bond program’s features include:
• Standardized documents that help lower the costs of issuance;
• Structuring intended to produce high taxable-market acceptance;
• Pooling with similar credits to present a larger issue size; and
• The 10-year “par call” traditionally used for municipal bonds.
The STAR Bond Program’s goals are to establish a strong and continued market presence for California taxable municipal bonds and enable California cities and counties to quickly move forward with economic recovery-based projects.
California Communities and its private-sector partners have structured this new program to provide California cities with an efficient and flexible method of securing the benefits of the taxable bond market. The STAR Bond Program does not require any shared credit risks or cross-collateralization. Furthermore, the program is designed so that each community can retain its own local financial advisor and bond counsel to structure its local financing program.
For more information on the STAR Bond Program, contact James Hamill at (925) 933-9229, ext. 216, or Mark Curran at (415) 984-5139. To learn more about California Communities, visit www.cacommunities.org.