Bank-qualified bond issuance nearly doubled in the first half compared to the same period last year, after provisions in the federal stimulus law raised the limit for the debt and extended it to borrowers in conduit deals as well as issuers for 2009 and 2010.
As of July 10, $16.55 billion of bank-qualified bonds had been sold this year, compared to $8.41 billion over the same period last year — a 96.7% increase, according to Thomson Reuters.
The boost in issuance is due to provisions in the American Recovery and Reinvestment Act designed to encourage banks to purchase more tax-exempt bonds.
One ARRA provision modified the 2% de minimis rule for financial institutions to include banks so they are able to deduct 80% of the cost of buying and carrying tax-exempt bonds, to the extent that their tax-exempt holdings do not exceed 2% of their assets. Another provision expanded to $30 million from $10 million the small-issuer limit for bank-deductible bonds. Banks can now deduct 80% of the cost of buying and carrying the tax-exempt bonds sold by issuers whose annual bond issuance is less than $30 million.
The law applied that $30 million limit to borrowers in conduit deals so that a single issuer can issue bonds for several borrowers and the bonds will all be bank-qualified as long as each borrower does not receive proceeds from more than $30 million of them.
The expansion of the current law have “produced a substantial expansion of the BQ market,” Banc of America Securities-Merrill Lynch said in a recently released research report. Bank-qualified debt has increased so substantially since the ARRA was enacted in mid-February that more than half of all muni issues so far this year have been bank-qualified, the report said.
Of the 10 categories of bank-qualified bonds tracked by Thomson Reuters, issuance rose this year in eight of them, with just the electric power and environmental facilities categories lagging behind last year’s numbers.
Education has been the largest sector for bank-qualified issuance so far this year, with 1,459 issues totaling $8.47 billion sold. That compares with 1,136 issues totaling $4.35 billion sold during the same period last year.
The second-largest category of BQ debt is general purpose bonds: 984 deals worth $5.11 billion have been sold so far this year, compared to 703 issues worth $2.25 billion during the first half of last year.
Those two categories account for the majority of bank-qualified bonds issued this year. Utilities were the third-largest category with 318 issues worth $1.58 billion, up from 267 issues totaling $865 million last year.
But even if these temporary changes in the law are making it easier for banks to buy munis, the overall economic decline still is slowing activity, market participants said.
“It seems to be working, but it’s definitely hampered by the external environment .... There’s no question about it,” said Charles Samuels, a lawyer with Mintz Levin Cohn Ferris Glovsky & Popeo PC who is counsel to the National Association of Health and Educational Facilities Finance Authorities, which lobbied strongly for the provisions. “It’s not like you can say because of this or any other provision it’s a happy world, that’s not the case ... but this is definitely helping.”
Michael Decker, co-chief executive officer of the Regional Bond Dealers Association, said even though the dismal economy may be hampering bank-qualified bond issuance somewhat, the provisions are having their intended impact.
“I think demand for debt assets among commercial banks isn’t as robust as it might have been if we weren’t in the throes of a banking crisis,” he said. “But even with that in mind, the provisions are having a very measurable, beneficial effect for small issuers, they’ve had a very positive outcome .... The provisions are having exactly the effect the drafters intended.”
The provisions work together to allow both small and large issuers to sell their bonds to commercial banks, Decker added.
The expansion of the small-issuer provision for bank-qualified bonds provides more small deals that are more attractive to small banks, while the de minimis provision gives larger banks an appealing reason for buying larger tax-exempt debt issues, he said.
Another stimulus provision that is boosting banks’ purchases of bonds exempts all tax-exempt debt issued in 2009 and 2010 from the alternative minimum tax, as well as bonds refunding debt that was issued during the last five years, Decker said.
“That’s really been a positive factor in enhancing the desirability of municipals for commercial banks,” he said, adding that he has heard of some banks exchanging previously purchased munis for those issued this year under the ARRA to take advantage of the AMT break.
Leslie Norwood, managing director and associate general counsel for the Securities Industry and Financial Markets Association, said the provisions have provided a boost mainly to larger “small” issues.
“What we’re seeing in the market generally is a lot of issuance up to that $30 million limit,” she said. “Investors are looking for larger issues — an investor would typically rather have a $30 million piece rather than a $10 million piece.”
When the stimulus law was enacted in February, the bank-qualified bond provisions largely flew under the radar compared to the major expansions of the tax-credit bond programs and the new direct-pay Build America Bonds program.
However, the bank-qualified provisions were able to make a mark on the muni market as soon as the stimulus was signed into law.
While the muni market had to wait months for regulatory guidance outlining how to proceed with the tax-credit bond and BAB programs, the framework was already in place for bank-qualified debt, allowing issuers and investors to immediately take advantage of the liberalized rules.
“They don’t need to have regulations — they know how to do these,” Samuels said.
