COZEN O'CONNOR PUBLIC FINANCE ALERT

Qualified School Construction Bonds (QSCBs):  Some Thoughts    

Qualified School Construction Bonds (QSCBs) are a new type of tax credit bond created under the Recovery Act.  All of the proceeds (exclusive of costs of issuance up to 2%) must must be used for the construction, rehabilitation or repair of a public school facility or the acquisition of land on which such a facility will be constructed.  The Recovery Act authorizes $11 billion per year of QSCBs for 2009 and 2010, 40% of which is designated for specific large school districts, and the remaining 60% of which has been allocated to the states which in turn will make allocations within the state. The allocations to the states and to the specific large school districts are set forth in IRS Notice 2009-35: http://www.irs.gov/pub/irs-drop/n-09-35.pdf.

The issuer pays no interest on the QSCBs. Instead, the holders receive a quarterly federal tax credit computed at the "credit rate" described below. 

The Treasury Department establishes the maximum maturity and the credit rate for QSCBs each business day and posts them at the following site: http://www.treasurydirect.gov/govt/rates/irs/rates_qtcb.htm.  These two factors are locked in on the sale date for an issue of QSCBs.

  1. The maximum maturity of the QSCBs is set by the Treasury Department; it is the term that will result in the present value of the obligation to repay the principal on the bonds being equal to 50% of the face amount of the bonds.  The maximum maturity as of April 16, 2009 is 14 years.
  2. The Treasury Department also sets the "credit rate" which is used to calculate the amount of the tax credit.  The credit rate is based on the Department's estimate of the yield on outstanding bonds from market sectors selected by the Department that have an investment grade rating of between A and BBB for bonds of a similar maturity.   For example, the credit rate for April 16, 2009 is 7.83%.  Once the credit rate has been established for the issue on the sale date, each quarterly credit is equal to the principal amount of the bonds times the credit rate divided by 4.  See IRS Notice 2009-15:  http://www.irs.treas.gov/pub/irs-drop/n-09-15.pdf.

The San Diego Unified School District has released a Preliminary Official Statement for an issue of $39 million of QSCBs: http://www.bondbuyer.com/attachments/200904094P0L9B64-1-SanDiegoPOS.pdf.  As described in the POS, this issue would allow the tax credit associated with a bond to be stripped and sold separately from the principal component of the bond.  The stripped tax credit would be evidenced by a separate tax credit certificate.  All the bonds are stated to mature in 14 years.  The bonds are not subject to optional or sinking fund redemption.  However, because the QSCBs rules generally require the proceeds to be spent within 3 years of issuance, there is an extraordinary mandatory redemption (with an unspecified premium) to the extent of any unspent proceeds.  The school district has covenanted to make annual deposits into a sinking fund in years 7 through 14 (but those amounts will not be applied to pay principal until the maturity date in year 14).   

It will be interesting to see what sort of market there is for QSCBs and whether the stripped tax credits will increase investor interest.

Pennsylvania:  The PA allocations for QSCBs for 2009 are:

  1. $146,897,000 directly to the Philadelphia School District, and
  2. $315,737,000 to be allocated to other districts by the PA Department of Education (PDE). 

PDE has not yet announced its method for making the allocations; an announcement may be made in about a month.