U.S. School Construction Stimulus Pays Too Little, Lawyers Say

By Dunstan McNichol

Sept. 28 (Bloomberg) -- The U.S. Qualified School Construction Bond program hasn’t stimulated the economy because it pays a percentage point less interest than investors demand, according to lawyers involved in the tax-credit initiative.

Only 25 school districts have issued the bonds totaling $400 million. As much as $22.4 billion of the debt may be issued. Many districts selling the obligations supplement the Treasury-approved rate with an additional 1 percent to 2 percent payout, said Arthur E. Anderson II of McGuire Woods LLP of Richmond, Virginia, who is working with two clients on $110 million in schools bond deals.

That contrasts with Build America Bonds, another tax- incentive bond initiative included in the $787 billion economic stimulus plan Congress approved in February. Issuance of the debt, offering a 35 percent federal interest subsidy, totals $33.7 billion and accounts for about 17 percent of municipal borrowing since April when the obligations began coming to market, according to Bloomberg data.

Qualified School Construction Bonds give buyers a federal tax credit on their earnings, while the issuer was supposed to pay nothing for the money. The Treasury Department sets the value of the tax credit at an interest rate allowing districts to issue at par, or 100 cents on the dollar. On Sept. 25, that rate was 6.06 percent, Anderson said.

Higher Interest

“We are hearing the relatively small universe of buyers wants a yield between 7 and 7.25 percent,” Anderson said during a panel discussion on Qualified School bonds at the American Bar Association’s Joint Fall Continuing Legal Education Meeting in Chicago Sept. 25. “Over the last 30 days, even AA issuers are having to include a supplemental coupon to be able to sell those issues.”

A U.S. Treasury Department representative concurred with Anderson’s assessment, saying the federal government is considering changes to the program.

“Over the course of the year, corporate rates have dropped faster than state and federal rates, and I think that has had an impact on what you’re seeing now,” said John Cross III, associate tax legislative counsel for the Treasury Department’s Office of Tax Policy in Washington, referring to how companies’ taxes have declined relative to taxes. “We will continue to monitor the level of the rates and whether or not some alternative formula should be adopted or used in that area.”

The Treasury Department may make adjustments within several months, Cross said in an interview after the panel discussion.

Increase Borrowing

Build America Bonds and the Qualified School bonds were designed to spur borrowing and capital spending by public agencies in different ways in response to credit markets that froze up amid the bankruptcy of Lehman Brothers Holdings Inc. in September 2008.

The Build America program, which doesn’t cap the amount bonds that may be issued, is scheduled to expire Dec. 31, 2010. Traditionally, capital projects were funded with tax-exempt securities.

Treasury is going to review the basket of bonds it uses to compute the qualifying interest rate, Cross said.

The schools bonds are part of President Barack Obama’s economic stimulus, intended to lift the U.S. out of the deepest recession since the Great Depression.

While officials review the lack of participation in the Qualified School program, some investors doubt the federal government will always stand behind the more successful Build America Bonds effort and honor the interest subsidy pledge to maturity. The cite the mounting federal deficit, totaling $1.38 trillion during the first 11 months of the fiscal year.

To contact the reporter on this story: Dunstan McNichol in Trenton at dmcnichol@bloomberg.net.