By setting up municipal sales desks in foreign offices 10 years ago, top-ranked underwriter Citi had a head start in selling taxable munis to foreign investors, which turned out to be a major boon once Build America Bonds were introduced last year.
Issuance of BABs, the taxable asset that offers issuers a 35% direct interest payment from the federal government, is on track to reach $100 billion in the coming weeks, according to Thomson Reuters.
Since BABs hit the market in April 2009, Citi has senior managed $12 billion of the bonds in 66 deals, or 12.4% of the market. Citi estimated that about 15% of their BAB totals were sold internationally.
But despite the BAB program’s broad usage and the subsidy’s effectiveness at reducing borrowing costs for state and local governments, coupon rates remain high relative to their corporate and sovereign peers, in part because foreign appetite has been minimal.
Underwriters have been hoping to change that by marketing municipal bonds in general, and BABs in particular, to an international audience not so familiar with the market.
“Muni credits don’t sell themselves abroad,” said Patrick Brett, a director of Citi’s municipal securities division in New York who in the 2000s spent a year in London and a year in Hong Kong setting up muni desks for a then-small taxable municipal market. “Even though some of these issuers have been coming to market for 200 years, they’re basically all new to our foreign clients.”
With a team of senior bankers over the past several months, Brett met with investors in 14 different countries and sent marketing materials to potential buyers in an additional 15 countries.
“To the extent you can get those 800 or 1,000 buyers who are on the fence right now off the fence, that will only help to tighten in spreads relative to corporates and sovereigns,” Brett said of the foreign buyer base. “It’s really to everyone’s benefit — not just the issuers, but also to the federal government, given the 35% subsidy.”
Relative to corporate and sovereign debt, Citi data indicates that BABs yield 30 to 100 basis points higher on average, and the biggest reason for that is the narrower buyer base, Brett said.
In recent months BAB spreads versus corporate debt has been steadily tightening.
According to data from JPMorgan, the spread between single-A-rated BABs and Treasuries fell to around 180 basis points at the end of April from around 225 basis in November.
The spread of single-A-rated BABs to comparable corporates, based on the JPMorgan US Liquid Index, has also fallen to less than 60 this week from 90 basis points at the turn of the year.
When BABs were first introduced, each deal had 50 to 100 buyers in them, while more recent deals have garnered appetite from 150 to 200 buyers, Citi said about the deals with which it is familiar
Some of those buyers include domestic and international pension funds and life insurance funds, and Brett said sovereign funds and central banks were also becoming involved.
Still, corporate issuances typically have 1,000 to 2,000 buyers, so there should be plenty of room to induce appetite.
General obligation BABs from California were considered a natural target for investor interest on Citi’s international tour, because of the state’s size and its status as a relatively recognizable name abroad.
“One of the points we were making was, 'Look, California is trading cheap relative to the Philippines and Indonesia, and it’s trading even cheaper relative to Brazil and Mexico,’” Brett said.
Also, the state has consistently issued billions of dollars of debt, so investors with liquidity concerns could be assured to have a relatively fluid market.
“If you were to stack them up against investment-grade corporates, they actually issue more debt than all these investment-grade corporates who have the 1,000 or 2,000 buyers, globally,” Brett said.
The results of the tour paid off quickly.
Last November, a foreign client who the bank would not name indicated it was interested in purchasing up to $1 billion of California GO debt.
Citi contacted the state treasurer’s office, and though the bank had just been senior underwriter for the state a month before — meaning it was not their turn in the underwriter’s rotation cycle any more — it was awarded the position to underwrite a deal for $908 million.
The bonds, sold on Nov. 3, were priced to yield at 7.35% on a 20-year maturity, a spread of 323 basis points over the comparable-maturity Treasury rate.
In the earlier deal led by Citi, the same spread had been 353 basis points. Once that closed, Citi realized its foreign distribution capabilities would continue to help California issue debt to a broader market.
When California next came to market in late March, Citi convinced the state to let it handle international distribution as co-senior manager of a taxable deal worth $3.4 billion.
“We went to Sacramento, sat down with the Treasurer and said, ‘We’d like to help you do something that no one else has done yet,’" said Ward Marsh, Citi’s head of municipal securities. “‘Your BABs have mainly been placed domestically. At some point that won’t be broad enough to get the pricing you want. We’d like, on the next deal, to take it and market it globally.’”
The treasurer’s office said $730 million of the deal was mopped up by foreign buyers, reflecting 21.5% of the issue. The deal had a 16-year maturity priced to yield at 6.65%, a spread of 210 basis points over Treasuries.
“The BABs program promised to expand the investor base for our bonds,” Treasurer Bill Lockyer said in an e-mail. “The March sale marked the first significant realization of that promise. Hopefully, the trend will continue in future BABs transactions, because higher demand should equal lower borrowing costs for our taxpayers.”
Brett refers to the March California BAB sale as “the first truly, globally distributed BABs deal.”
He added, “California made a big splash in the markets and caught some people by surprise.”
Before that transaction, it had not always been clear that foreign buyers could be big players in the muni market.
Marsh said sub-sovereign debt was a difficult sell, particularly while Greece, hour by hour, was creating headlines — and headaches — across the globe. Much of the media, including financial publications Barron’s and the Wall Street Journal, began comparing California to Greece.
But the comparisons proved to be “a very beneficial backdrop” to spotlight the differences with a few key metrics, Marsh said.
According to Roubini Global Economics LLC, for instance, the GDP-to-debt ratios of the high deficit states — New York, Illinois, New Jersey, and California — did not exceed 3.0% of gross domestic product in 2008-09. By contrast, the GDP-to-debt ratios for Portugal, Italy, Ireland, Greece, and Spain were well above 60%.
The states were also paying less than 1% of GDP on interest payments, whereas the countries were paying more than 6%, according to RGE.
Brett added that foreign investors didn’t often know municipal bondholders have a certain priority among creditors. In California, for instance, revenue flows to the education system first, and then to bondholders.
With more investors now familiar with the asset, Citi expects the spread differential to corporate and sovereign bonds to continue narrowing.
“It’s really meaningful, if you think of it in present-value terms,” Brett said. “The savings for an issuer, typically, in a BABs deal are 50 or 60 basis points, so if they broaden out their buyer base they could double their savings.”
Other underwriters have also been selling the product to international buyers. Third-ranked BAB underwriter JPMorgan, for instance, displayed its success in finding international buyers in mid-March when it placed a private deal of below-investment-grade bonds, worth $45 million, to an Australian pension fund.
The placement was part of a larger $140 million issuance by the Central Texas Regional Mobility Authority, which said that “millions of dollars over the life of the bond” would be saved because of the diversifying demand.
“It certainly behooves issuers to think about broadening out their buyer base and to think about trying to reach this global audience of investors,” Brett said. “You can’t just think about the investor base being bordered by the 50 U.S. states.”