Even as the market for Build America Bonds has evolved over the past 12 months, underwriters, bankers, and analysts are still schooling investors and issuers about the taxable securities using various approaches.
BABs were part of the American Recovery and Reinvestment Act, signed into law by President Obama in February 2009.
Education runs the gamut from firms that rely on the Internet as a means of teaching their clients about BABs to those that rely on in-house analysts to field questions and conduct meetings and presentations with issuers and investors.
Whether they dedicate little or extensive marketing and education to BABs, participants from several firms of varying sizes agree that with the market’s changing needs, education will remain a key component in making the BAB sector grow and thrive.
Large or small, participants say the three main classes of buyers of the economic stimulus credit — domestic taxable investors; non-traditional domestic taxable buyers, such as hedge funds; and overseas investors — are still doing their homework when it comes to the one-year-old security class.
James Lansing, managing director and head of syndicate and debt capital markets at JPMorgan, said the benefits of heavy BAB education are two-fold: investors learn more about the taxable municipal securities, while issuers benefit from investor feedback.
“Both the underwriters and the issuers are working to build a market,” said Bob Muller, who heads JPMorgan’s investor marketing.
Large domestic and international buyers of taxables prefer large benchmark deals, large Cusips over smaller-sized serial bonds, and want to avoid callable bonds, according to Lansing.
“The callable nature is problematic for total-return driven buyers because they have duration constraints,” he said. “They are fine with sinking funds and amortization, but they have a problem with callability because the negative convexity is very difficult to hedge.”
Over the past year, the firm has doubled its full-time municipal marketing staff to six with BAB deals constituting up to 50% of the department’s workload.
Muller said JPMorgan ramped up its education efforts since last year because “the taxable world is very credit-focused. Investors like analysis and education, and there is a value placed on knowing the story.”
As the BAB market matures, Muller has seen an improvement in the learning curve among a wider group of investors. For instance, domestic buying has now expanded from mostly asset managers to life insurance companies and managers of pension funds — two investor classes with very little focus on the municipal market historically.
JPMorgan itself has been a major player in the growing market since leading the underwriting syndicate on one of the first big BAB deals — a triple-A $250 million sale from the University of Virginia on April 15, 2009.
Since the inception of the program, the firm has senior managed 52 deals totaling $10.79 billion through March 23, out of total BAB issuance of $86.35 billion among 1,096 issues, according to Thomson Reuters.
Lansing and Muller said besides their own staff instructing investors on the ABC’s of BABs, many investors gain a certain comfort level from speaking directly with issuers.
“If an investor is spending three hours understanding a BAB deal, a half-hour conference call with the issuer is extremely helpful,” Lansing added.
While JPMorgan is primarily focused on the sale of BABs domestically, it has also stepped up its international marketing among central banks, insurance companies, and pension funds overseas, Muller said. He and Lansing just returned from Europe and Asia two weeks ago, and will visit China, Singapore, and Australia in another week.
Muller noted that unlike domestic taxable investors, who participate in a single U.S. market, international investors can face policies from their own governments that present barriers to buying BABs.
Some international investors have to gain governmental approval before buying the securities. For instance, in Taiwan, the insurance industry cannot buy any debt without first gaining approval from the country’s insurance regulator, he said.
“The potential for a global market is great, but the reality is short of what we would like,” Muller said.
In general, the overseas effort is a work in progress, they said. “We get some substantial orders and some smaller interest, but by no means are international buyers driving this market,” Lansing said.
International investors are warming up to BABs, and see an extension providing strength, stability, and liquidity, Muller said.
Meanwhile, other firms are turning to the Internet, creating internal educational literature, and beefing up sell-side research.
Howard Mackey, president of the broker-dealer division of Rice Financial Co. in New York City, said his firm has sights on growing its share of the BAB market. “BABs have tended to displace a number of tax-exempt issues in terms of volume in the past year, and our firm has made the adjustment to service that growing market,” he said.
It currently markets BABs mostly to institutional accounts, like insurers, money managers, mutual funds, and pension funds, but there are still lessons for newcomers. Rice has compiled its own manual to facilitate increased education for investors and issuers.
Titled “BAB Market Update,” the publication is a comprehensive review of the market from April 15, 2009, to March 19, 2010, and includes a summary on issuance and trends; a list of major investors; deals by rating category, issuer type, and sector; and BAB spreads versus the U.S. corporate bond index.
Mackey has observed a more diverse buyer base, and said it has been easy to school existing tax-exempt and taxable muni investors on BABs. “It is not much of a stretch for them to understand,” he said, since they share concerns about liquidity, credit quality, spreads, coverage ratios, and sustainable cash flows.
BABs have also gained popularity among issuers as an alternative to municipals. “They have learned that the tax credit it is a comparatively inexpensive source of financing versus tax-exempts,” Mackey said.
Rice, which has a small number of international clients, is forecasting future growth abroad as international banks and financial institutions work to regain profitability, Mackey said. “To the extent they do, international financial institutions will become fairly significant buyers of BABs,” he said.
Mike Pietronico, chief executive officer of Miller Tabak Asset Management in New York City, said his firm uses the Internet to educate its sales, research, and trading staff. He agrees that firms have targeted education efforts toward institutional accounts.
“We would expect retail to move somewhat slower due to the still-illiquid nature of the product, and the uncertainty of what this program might look like should the composition of the U.S. Congress become radically altered in the future,” Pietronico said.
In the meantime, his firm is remaining defensive. “We are currently watching this mostly long-duration product from the sidelines until interest rates are more normalized by the Federal Reserve,” he said. “We are interested in seeing how this market performs when liquidity is removed by our central bank.”
