The American Recovery and Reinvestment Act (ARRA) of 2009 authorized $25 billion in “Recovery Zone Bonds” to stimulate economic recovery in “recovery zones.”  A recovery zone is designated as such because of any of the following:

• Significant poverty, unemployment, rate of home foreclosures or general distress
• Economically distressed because of military base closure or realignment
• Any area where a designation as an “empowerment zone” or “renewal community” is already in effect

George K. Baum & Company believes that these bonds can be used as a source of funding for certain qualifying renewable energy projects.

The Federal government will allocate the bonds to the states according to each state’s decrease in employment as compared to the national decrease in employment.  The bonds must be issued by December 31, 2010.

There are two types of recovery zone bonds, Recovery Zone Economic Development Bonds (RZEDBs) and Recovery Zone Facility Bonds (RZFBs) and both could potentially be used to finance renewable energy projects.  ARRA authorized $10 billion in RZEDBs and $15 billion in RZFBs.

RZEDBs
Recovery Zone Economic Development Bonds are bonds in which a qualified issuer issues taxable bonds and the U.S. Treasury provides either:

1. Direct subsidy to the issuer
   
   • 45% subsidy of interest paid for RZEDBs from the Treasury to the issuer
   • Only for new money financings
   • Not subject to future appropriation risk
2. Tax credit to bondholders
• 45% tax credit for RZEDBs
• Tax Credit can be stripped and sold

RZEDBs Example:
Direct Subsidy Example

• Bondholder receives taxable interest payment from the issuer of $1,000
- Interest payment is higher because the bondholder does not receive the benefit of a tax credit…total taxable income = $1,000

• The issuer is responsible for paying principal + $1,000 to the bondholder
• The U.S. Treasury would pay the issuer $350 ($1,000 x 35%), leaving the issuer with a net interest payment cost of $650

Tax Credit Example

• Congress estimates to sell a tax credit bond at par a tax credit bond should provide coupons at 74.1% of a comparable taxable bond’s coupon
• Bondholder receives an annual (taxable) interest payment from the issuer of $741
- Claims a tax credit of $259 ($741 x 35%)…total taxable income = $1,000

• Issuer is responsible for paying principal + $741 to the bondholder

Publicly placed RZEDBs will most likely be sold to investors at competitive rates if the issue is larger enough to attract taxable buyers (over $50 million) and has a credit rating of “AA” or higher, or in some cases a private placement may be an option.

The benefits of issuing RZEDBs could include as much as a 50 basis point (0.50%) net interest cost savings and more structuring flexibility when compared to tax credit bonds.

Some considerations of issuing RZEDBs include:

• Taxable investors insist on “make whole call” provisions thus limiting refunding and pre-payment possibilities
• Treasury has not disclosed direct subsidy spending restrictions (aside from securing bonds)
• Direct subsidy presents the most economically advantageous structure in the current form
• Greater interest cost savings on the long end of the RZEDBs yield curve and potential to structure short tax-exempt bonds and long RZEDBs

RZFBs
Recovery Zone Facility Bonds provide tax-exempt financing for projects that traditionally have not been allowed to issue tax-exempt bonds.  RZFBs provide tax-exempt financing to the private sector.  RZFBs must be issued by December 31, 2010 and 95% of the net proceeds must be used for recovery zone property.  A recovery zone property must meet the following criteria:

• The property was constructed, reconstructed, renovated or acquired after the date when the property was designated as a recovery zone
• All or almost all of the use of the property is not used for “bad projects”

Bad projects consist of gambling facilities, golf courses, liquor stores, racetracks, etc.