Sell Side

BABs Help Pump Up Volume

The amount of debt floated by state and local governments jumped last month as the burgeoning Build America Bonds program provided an alternate forum for issuers to borrow money.

Municipalities sold $33.21 billion of bonds in August, a 2.2% uptick from August last year and a sizeable bump over July.

The biggest boost was taxable debt. Governments sold $10.23 billion of taxable bonds in August, representing 30.8% of municipal debt sold. That marked the biggest percentage in history, according to Thomson Reuters, topping the record set in April.

The five biggest municipal deals last month - floated by the University of California, the Dormitory Authority of the State of New York, the North Texas Tollway Authority, the Texas Transportation Commission, and the Metropolitan Washington Airports Authority - all were either taxable or had taxable components.

More than 92% of the taxable issuance in August was through the BAB program.

Created through the American Recovery and Reinvestment Act in February, the BAB program enables municipalities to sell taxable bonds and receive a federal subsidy equal to 35% of the interest costs.

Taxable municipal bonds theoretically appeal to investors such as pension funds and European investors, who do not pay U.S. federal taxes and therefore do not benefit from the traditional tax exemption on municipals.

Issuers have sold $28.42 billion of BABs since April, representing almost 17% of the municipal borrowing during that time.

"The investor appetite has been very strong," said Peter Hill, head of public finance at Wells Fargo Securities. "I would say that the program has been very successful and it has clearly accrued to the benefit of our municipal clients."

Aside from investors that do not pay taxes in the U.S., Wells Fargo - which has been involved in roughly $11 billion of BABs offerings - markets BABs to investors in Europe and Asia, Hill said.

Tax-exempt sales in August shrank 23.3%, to $22.91 billion. For the year, tax-exempt sales are down 17.7%.

The surge in taxable bonds has partially offset the collapse in certain other sectors that has dragged issuance all year.

Volume is down 15.1% from this point last year, mainly because of the shriveling of issuance in variable-rate debt obligations.

VRDOs normally need letter-of-credit backing from a bank to achieve ratings strong enough to be eligible for purchase by a money market fund.

The tax-free money market fund industry, which comprises 518 funds managing $440.74 billion, is the primary buyer of VRDOs.

Since the credit crisis decimated banks' credit ratings, letters of credit with sufficiently strong ratings are more expensive and difficult to find. As a result, sales of VRDOs are down 76.5% this year.

The trend continued in August.

Issuers sold just $3.18 billion of VRDOs with short puts in August, down from $8.52 billion in August 2008. LOCs were down more than 70%.

In the first eight months of the year, issuers sold almost $70 billion less in VRDOs than the first eight months of last year, which more than explains the decline in overall issuance to $255.6 billion at the end of last month versus $301.1 billion at the end of August 2008.

Insurance penetration in August was 7.7%. This was likely all Assured Guaranty Ltd., which essentially commands a 100% market share in the bond insurance industry since buying Financial Security Assurance in July.

FSA had wound down its business under its former parent company, and Assured planned to ramp up business again after closing the merger.

Bank-qualified issuance continued to grow in the wake of the federal government's expansion of municipal debt eligible to be held by banks.

Normally, banks have to pay taxes on the interest on municipal bonds unless the bonds are bank-qualified, which used to mean sold by an issuer that floats $10 million or less of debt a year.

The stimulus package raised the ceiling for bank qualification to $30 million, resulting in an upswing in bank-qualified bonds.

Bank-qualified issuance jumped almost 80% in August, to $2.06 billion. Bank-qualified issuance for the year has almost doubled.


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