The Build America Bond program was launched by the U.S. government last winter as one way to help cash-strapped cities and towns move forward with vital infrastructure projects while at the same time putting Americans back to work. By any measure, the program has achieved these goals and more.
According to The Bond Buyer, municipal governments have issued more than $47 billion of BABs since the program was launched. It may be overstating the case to say the program re-ignited the municipal bond market this year, but it was clearly a catalyst, creating significant additional liquidity by attracting billions of dollars from new nontraditional municipal investors.
The program has enabled hundreds of issuers to come to market on better terms, thus encouraging them to go forward with badly needed facilities, such as new schools, hospitals, environmental projects, and water and sewer projects.
Issuers of all sizes have taken advantage of BABs, ranging from California and the New Jersey Turnpike Authority to suburban De Pere, Wis., which was one of the first to tap into the program in April, issuing $2.7 million of BABs.
In another example, Brea, Calif., located in northern Orange County, issued $12.9 million of BABs in May, along with $12.9 million of tax-exempt bonds. The BABs were issued to fund capital improvements for the city's water system. The tax-exempt bonds were issued to refinance prior obligations.
The city's decision to incorporate BABs into its financing program resulted in effective savings of approximately $100,000 per year or $3 million over the life of the bonds. The effective true interest cost or yield for the financing program was 4.42%, a savings of approximately 58 basis points over a financing program that did not incorporate BABs.
If the city had been able to issue BABs for the entire program, the effective savings would have been closer to 100 basis points compared to a straight tax-exempt issue. Under the rules of the program, however, the city was only able to issue BABs for the new-money portion of its financing, since BABs cannot be used for refunding purposes.
Noting the savings, Brea financial services director Bill Gallardo says: "We were able to quickly adapt to take advantage of market conditions, which helped the city benefit from the Build America Bonds program. We were able to capture attractive borrowing rates relative to a traditional tax-exempt issue."
Brea, like hundreds of other issuers, was able to save significantly through the program as a result of the federal government's subsidy of 35% of the interest payments due on the bonds.
At the same time, however, the program has also helped keep funding costs down by attracting new classes of investors to the municipal bond market, such as pension funds and foreign investors that generally do not invest in tax-exempt securities.
The Treasury Department anticipated this development and stated in a press release announcing the program: "The interest rate feature will make Build America Bonds attractive to a broader group of investors and therefore create a larger market than typically invest in more traditional state and local tax-exempt bonds, where interest rates, due to the federal tax exemption, have historically been about 20% lower than taxable rates."
This broadening of the market for municipal bonds can and should be one of the lasting legacies of the BAB program. The Regional Bond Dealers Association strongly believes the program should be continued for several reasons.
BABs directly help financially burdened local governments realize cost savings for badly needed infrastructure projects. These projects in turn create both construction jobs and long-term employment opportunities.
Finally, the BAB program has significantly expanded the market for municipal securities. New investors mean higher demand, greater liquidity, tighter spreads and, ultimately, lower costs for all municipal issuers. Long after the recent economic crisis has faded into memory, cities and states will still be able to arrange financing at a lower cost because the Build America Bond program expanded the market and attracted new liquidity.
America needs the infrastructure projects undertaken by local government. Workers need the jobs created by those projects and taxpayers need the BAB program to hold down costs.
