CHICAGO Securities and Exchange Commission officials downplayed the potential for the so-called budget "sequestration" Thursday, but said dealers selling Build America Bonds should inform investors of any potentially risky call provisions.
"I think it's been overblown," John Cross, director of the SEC's office of municipal securities, said of the likelihood that $1.2 trillion in automatic, across-the-board federal budget cuts over 10 years will be triggered on Jan. 2.
The cuts were legislatively mandated after Congress failed to reduce the federal budget deficit last year and they will occur unless Congress fails to take action to stop them.
"The [sequestration] provision is intended to be so ugly and scary that it would prompt Congress to do something different," Cross said.
Cross made his comments during a panel discussion at the National Association of Bond Lawyers' Bond Attorney's Workshop here.
Another panelist, Dave Sanchez, an attorney in the SEC's muni office, said dealers should tell potential investors if BABs contain "extraordinary call provisions" that might allow issuers to call the bonds under certain circumstances, such as when federal subsidy payments are cancelled or reduced.
The federal government pays issuers of BABs, which are taxable bonds created by the American Recovery and Reinvestment Act, subsidy payments equal to 35% of their interest costs. Over $181 billion of BABs were issued in 2009, when the program was created, through 2010 when it expired.
Earlier this month, a report from the Office of Management and Budget said 7.6%, or $255 million, of federal subsidies for BABs could be cut in the first year if Congress does not avert sequestration.
Total cuts for all direct-pay bonds, including BABs, Qualified Zone Academy Bonds, Qualified School Construction Bonds and Qualified Energy Conservation Bonds, could be $322 million, according to OMB.
With the cuts, an issuer's subsidy would shrink from 35% to 32.4%, or 2.6% of total interest costs, according to a report issued by Sterne Agee.
Panelists said a survey of BAB redemption provisions found "an incredible difference" in the language of different bond documents and that different bonds have different triggers for calls.
The Securities Industry and Financial Markets Association issued a notice in late September in which it also urged dealers to disclose sequestration-related risks to investors. Members of Congress have said they intend to address budget problems after the November elections.