Few, if any, municipal finance professionals were predicting at the beginning of last year that 2009 would be one of the strongest years ever for municipal debt issuance.
The credit markets were essentially frozen and cash-strapped cities and states were facing rapidly rising unemployment and plunging tax receipts. Remarkably, though, municipal bond issuance in 2009 exceeded $409 billion, making it the second-largest year of issuance on record. Further, the market is off to another strong start this year.
The Build America Bonds program rightfully gets a lot of the credit. Since its inception in 2009, issuers have raised nearly $75 billion through the program, according to The Bond Buyer.
The Regional Bond Dealers Association is fully supportive of the Obama administration’s proposal to permanently extend and expand the program. At the same time, however, it is important to note that municipal issuers raised $325.2 billion last year selling traditional tax-exempt debt. Indeed, tax-exempt securities accounted for almost 80% of total issuance in 2009.
The combination of BABs and traditional tax-exempt securities has given issuers a powerful new package of tools to raise money efficiently and cost-effectively by expanding issuance options and the investor base. Issuers can choose to use taxable or tax-exempt bonds or both together, depending on the circumstances.
For example, Fresno, Calif., recently raised $131.5 million of new-money bonds for the city water system. The issue was split with $91.3 million of BABs and $40.2 million of tax-exempt securities. The split followed the yield curve and favored BABs when they were more beneficial to the issuer.
Tax-exempt issues and BABs complement each other because they appeal to different classes of investors. Traditional tax-free bonds appeal to the market’s long-time investors, including retail customers, mutual funds, banks, and insurance companies. Taxable BABs, on the other hand, appeal to a whole new set of investors, such as pension funds and foreign investors, that have traditionally avoided the market because they cannot take advantage of tax exemptions.
A key part of the logic for creating the BAB program was specifically to expand the traditional municipal bond market to include new types of investors. Proponents rightly believed attracting new investors would increase demand in the market, ultimately lowering borrowing costs for issuers.
Some in Congress have questioned the efficiencies of tax-exempt bonds versus taxable bonds, especially when referencing the BAB program. The Regional Bond Dealers Association strongly believes it would be a serious mistake to significantly curtail the ability of municipalities to raise money by issuing tax-exempt bonds.
The tax-exempt municipal bond market has existed since the 1920s and is deep and liquid with ready investors who are fully accustomed to and comfortable with the products. This level of liquidity and certainty has in turn created a strong secondary market in which investors can easily sell their holdings. This confidence also directly benefits issuers because investors will pay higher prices and accept lower yields to participate in such a liquid market.
Municipal issuers have much to gain by having the ability to issue both BABs and tax-exempt bonds and, conversely, a lot to lose if either goes away. The two programs work together to make each more efficient and cost-effective. They appeal to different investor classes, and they lower costs by offering unique benefits and creating greater demand.
Virtually every state, city, and municipality is under enormous pressure to invest in vital infrastructure projects, such as new schools, roads, and hospitals. These projects also create badly needed new jobs. Municipal issuers, struggling with their own economic problems, cannot afford to overpay to finance projects.
Working together, the BAB program and traditional tax-exempt securities can help municipalities raise money efficiently and less expensively, allowing cities and states to build our roads, bridges, and tunnels, while also providing an economic boost through job creation.
Mike Nicholas is chief executive officer of the Regional Bond Dealers Association.
