Loading the player...

DEFINITION of 'Build America Bonds - BABs'

Build America Bonds (BAB) were taxable municipal bonds that featured tax credits and/or federal subsidies for bondholders and state and local government bond issuers. Build America Bonds (BABs) were introduced in 2009 as part of President Obama's American Recovery and Reinvestment Act (ARRA) to create jobs and stimulate the economy.

The Build America Bond program expired in 2010.

BREAKING DOWN 'Build America Bonds - BABs'

During the economic recession in 2009, investors were saving their money and staying away from investments, including municipal bonds. To ensure that local municipalities and counties were able to raise the much-needed capital needed to revitalize their local economies, the federal government introduced Build America Bonds (BABs).

BABs were introduced to encourage investment in the local sector. BABs, like municipal bonds, are debt securities issued by a state, municipality, or county to finance capital expenditures. The interest rate on these bonds were subsidized by the federal government, making the cost of borrowing for infrastructure projects cheaper for state and local governments looking to borrow funds to finance new projects. In general, there are two distinct types of BABs: tax credit BABs and direct payment BABs.

Tax credit BABs offered bondholders and lenders a 35% federal subsidy of the interest paid through refundable tax credits, reducing the bondholder’s tax liability. If the bondholder's tax liability was insufficient to use the entire credit, it could be carried forward to future years.

The direct payment BABs offered a similar subsidy that was paid to the bond issuer. The U.S. Treasury made a direct payment to Build America Bond issuers in the form of a 35% subsidy of the interest they owed to investors. Since the effective cost of borrowing was reduced for issuers, they were able to offer the bonds to investors at competitive rates in the markets. California's $5.2 billion BAB issue in early 2009, for example, offered an interest rate of 7.4% to investors. The state had to pay only 4.8% of that interest, with the federal government picking up the tab for the rest. In addition, investors were more likely to opt for a bond issued by a government body since they will be less exposed to default risk prevalent in holding corporate bonds.

The difference between Build America Bonds and traditional municipal bonds is that income generated from the latter is exempt from federal and some state taxes while with BABs, the interest income was subject to tax at the federal level. Some traditionally tax-exempt issuers, such as private party issuers and 501(c)(3) organizations, were not eligible to use the Build America Bond program. Also, the program was only open to new issue capital expenditure bonds issued before January 1, 2011; BABs could not be issued for refinancing transactions.

RELATED TERMS
  1. Municipal Bond

    A municipal bond is a debt security issued by a state, municipality ...
  2. Taxable Bond

    A taxable bond is a debt security whose return to the investor ...
  3. Double Barreled

    A double barreled bond is a municipal bond in which the interest ...
  4. Authority Bond

    An authority bond is a security issued by a corporate or government ...
  5. Bondholder

    A bondholder is the owner of a government or corporate bond.
  6. Special Assessment Bond

    A special assessment bond is a type of municipal bond used to ...
Related Articles
  1. Investing

    The Basics Of Municipal Bonds

    Investing in municipal bonds may offer a tax-free income stream, but such bonds are not without risks. Check out types of bonds and the risk factors of muni-bond.
  2. Investing

    What's Going On With Muni Bonds?

    Should investors worry about the turbulence in the muni market?
  3. Investing

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
  4. Investing

    Foreign Investors Flock to U.S. Municipal Bonds

    Interest in U.S. municipal bonds by foreign investors is on the rise. Here's why.
  5. Investing

    Municipal bond tips for the Series 7 exam

    Learn to distinguish between general obligation and revenue bonds to ace the municipal bonds portion of the Series 7 exam.
  6. Investing

    The Best Bet for Retirement Income: Bonds or Bond Funds?

    Retirees seeking income from their investments typically look into bonds. Here's a look at the types of bonds, bond funds and their pros and cons.
  7. Financial Advisor

    Why You Should Invest In Municipal Bond ETFs

    These versatile instruments have become popular with investors in higher tax brackets and fill a specific niche in the wide selection of fixed-income offerings.
  8. Investing

    Corporate Bonds for Retirement Accounts

    Corporate bonds are usually the preferred choice in retirement accounts. Here are some of the benefits of corporate bonds, and strategies for a portfolio.
  9. Investing

    Six biggest bond risks

    Bonds can be a great tool to generate income, but investors need to be aware of the pitfalls and risks of holding corporate and/or government securities.
RELATED FAQS
  1. Where can I buy government bonds?

    The type of bond dictates its purchase. Federal bonds are issued by the federal government, while municipal bonds are issued ... Read Answer >>
  2. Which factors most influence fixed income securities?

    Learn about the main factors that impact the price of fixed income securities, and understand the various types of risk associated ... Read Answer >>
  3. What Is a Triple Tax-Free Municipal Bond?

    Learn how a triple tax-free municipal bond is like any corporate bond, but provides an additional incentive for investors ... Read Answer >>
Trading Center