Build America Bonds

Build America Bonds (BABs) were taxable municipal bonds authorized by the American Recovery and Reinvestment Act of 2009 for qualifying state and local government issuers. The program applied to bonds issued before January 1, 2011, and used federal tax-credit or direct-payment subsidy features to lower issuer borrowing costs while giving taxable-bond investors access to municipal credit exposure.

Key Takeaways

• BABs were taxable municipal bonds, not ordinary tax-exempt municipal bonds.
• The main forms were tax credit BABs for investors and direct payment BABs where the federal subsidy was paid to the issuer.
• Direct payment BABs generally used a federal subsidy equal to 35% of coupon interest, subject to program rules.
• New BAB issuance ended for bonds issued after December 31, 2010, but outstanding BABs can still matter in municipal portfolios.
• Investors should review the official statement, call provisions, subsidy risk, credit quality, tax treatment, and market price before relying on the label.

How Build America Bonds Worked

BABs shifted the municipal-bond comparison from “tax-exempt yield” to “taxable yield plus subsidy mechanics.” In a traditional tax-exempt Municipal Bond, investors may accept a lower stated yield because the interest can be exempt from federal income tax. In a BAB, interest was taxable to the investor, but a federal tax credit or issuer subsidy was designed to reduce the issuer’s net borrowing cost.

Why BABs Matter

BABs matter because they widened the investor base for municipal issuers. Taxable bond buyers, including institutions that do not benefit much from tax-exempt interest, could evaluate municipal credit without needing the tax exemption to drive the return. For issuers, the federal subsidy could make taxable issuance competitive with traditional tax-exempt financing.

BABs also remain relevant because outstanding bonds can appear in portfolios, bond funds, refunding discussions, and secondary-market analysis. A BAB should be evaluated as a real municipal security with maturity, price, credit, call, tax, and disclosure features, not just as a stimulus-era label.

Build America Bonds vs. Traditional Municipal Bonds

Practical Example

A city issued a direct payment BAB in 2010 to finance infrastructure. The investor reviewing it today should not assume it behaves like a plain tax-exempt bond. The review should check taxable yield, credit pledge, maturity, call protection, whether federal subsidy changes affect issuer economics, and whether any extraordinary redemption provision could allow the issuer to redeem the bond.

Risks And Limitations

• Taxable interest can make after-tax return very different from a tax-exempt municipal bond.
• Federal subsidy reductions or sequestration can affect issuer economics and may interact with call provisions.
• BABs are still municipal credit exposures; issuer revenue, debt service, covenants, and project risk matter.
• Outstanding BABs can have long maturities and interest-rate sensitivity.
• The label does not replace review of the official statement, continuing disclosures, price, yield, and tax position.

Common Mistakes

• Saying BABs ended in 2009. The program covered qualifying bonds issued in 2009 and 2010, before January 1, 2011.
• Treating BABs as tax-exempt municipal bonds.
• Ignoring direct-payment subsidy mechanics when analyzing issuer economics.
• Focusing on the federal subsidy while ignoring credit quality, maturity, price, liquidity, and call features.
• Assuming all BABs have identical redemption provisions.

Public Source Checks

• IRS tax credit and direct pay bonds provides current IRS context for direct pay bonds and filing rules.
• IRS Internal Revenue Bulletin 2009-16 describes BAB definitions, taxable bond status, issuance before January 1, 2011, and the 35% direct-payment credit.
• U.S. Treasury Build America Bonds guidance release explains the 35% taxable borrowing-cost subsidy and gives a basic direct-payment example.
• MSRB issue brief on possible redemption of Build America Bonds explains current municipal-market issues around BAB redemptions and subsidy-related provisions.

Related Terms

• Municipal Bond: BABs are municipal securities, but taxable.
• Taxable Bond: Broader taxable fixed-income context.
• Tax-Exempt Bond: The usual municipal-bond comparison point.
• American Recovery and Reinvestment Act (ARRA): The statute associated with the BAB program.
• Subsidy: Government support mechanism central to direct payment BABs.
• Issuer: Entity responsible for the municipal bond obligation and disclosure.

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