The Advantage of Crossover Refunding of Build America Bonds
Many governmental entities considering an advance refunding of their Build America Bonds (“BABs”) can achieve a better economic result by using a crossover refunding. While an advance “net” refunding typically results in a loss of federal subsidy payments as soon as the BABs are defeased, a crossover refunding may allow an issuer to remain eligible for these payments until the BABs are actually discharged.
In an advance refunding that is not a crossover refunding, proceeds of the refunding bonds are held in escrow to pay debt service on the refunded bonds, and holders of the refunded bonds typically are entitled to look only to the escrow for payment and security. Under the debt modification tax rules, a legal defeasance is generally treated as a significant modification of the bonds (a “reissuance”) and therefore a deemed exchange of the original bonds for newly issued bonds. Although an exception exists for the defeasance of tax-exempt bonds, BABs are taxable bonds subject to the general debt modification rules.
As a result, the original BABs would be considered discharged for federal income tax purposes at the time they are defeased, and the reissued bonds would not qualify as BABs. An issuer which advance refunds BABs would become ineligible for the subsidy payments from the time of defeasance, even though the original BABs remain outstanding for non-tax purposes.
In a crossover refunding, however, the escrow secures the refunding bonds, and the issuer remains liable for the prior bonds. There is no legal defeasance and therefore no resulting reissuance of the refunded bonds. Because the original BABs remain outstanding for tax purposes, the issuer is still eligible for the federal subsidy payments until the BABs are redeemed at a later time.
Issuers of BABs should consider whether a crossover refunding may help them to more efficiently restructure their obligations.