The elimination of the alternative-minimum tax for housing bonds is expected to attract corporate investors to the municipal housing bond market for the first time and lower borrowing costs for issuers, market participants said yesterday.
President Bush is expected today to sign the housing legislation containing the AMT provision, as well as a provision providing an extra $11 billion of capacity for housing bonds under the private-activity bond volume cap. State and local housing agencies will be able to begin issuing housing debt that is not subject to the AMT as soon the bill is enacted.
State and local housing issuers probably will be able to lower their coupon rates by as much as 60 to 65 basis points because of the AMT exemption, according to John Murphy, executive director of the National Association of Local Housing Finance Agencies.
Because more corporations are subject to the AMT, retail and institutional investors have been the primary buyers of housing bonds. Now corporations will be able to play a greater role in the market, several market participants said.
John Craford, executive vice president of finance and administration for the Connecticut Housing Finance Authority, said he expects high demand for the these bonds but that, initially "the market is going to take a while to figure out how much this little added exemption is worth."
The AMT exemption may bolster demand for long-term serial bonds, Craford said. Previously, retail investors lost interest in longer maturity serial bonds, but corporations may be more interested in holding such bonds, he said.
Under current law, interest on private-activity bonds are subject to the AMT, making the paper much less appealing to traders, market participants said. About 71% of the housing bonds sold in 2007 were AMT, according to Thomson Reuters.
However, there still will be demand in the secondary market for bonds that are subject to the AMT for companies and individuals that are not subject to the tax. Corporations, insurance companies, and individuals who are able to avoid the AMT will be able to benefit from the higher yields AMT bonds offer to be competitive in the market.
"It could actually increase demand for them," said Kurt van Kuller, a housing expert and assistant portfolio manager with 1861 Capital Management LLC, a hedge fund in New York. Bonds subject to the AMT offer exempt investors an "opportunity to scoop up that extra yield which constituted the AMT penalty," he said. "Why not take the extra yield if you're not subject to AMT?"
NALHFA's Murphy said that even though the new AMT exemption will be appealing to issuers, current market conditions are still slowing issuance in the single-family housing sector.
While he expects increased issuance on the multifamily housing side, which usually involves large rental apartment complexes, most single-family issuers are facing negative arbitrage, or bond yields that are higher than yields from their invested bond proceeds. Issuance in the single-family housing bond sector will only improve as the market improves and issuers can earn higher rates on their investments, according to Murphy.
"I think it's going to be contingent upon increased interest rates," he said.
Since the tax code prohibits housing and other private-activity bonds from being advance refunded, issuers will not be able to prematurely redeem them in an attempt to take advantage of the new AMT exemption.
Anthony Freedman, a tax attorney with Holland & Knight LLP here, said that issuers and investors alike are highly anticipating the new AMT-exempt housing debt.
"People are already in the market pricing non-AMT housing bonds, based on the expectation that the president will sign the bill any day now," he said.
Puerto Rico even announced yesterday that it was postponing selling $490 million of housing bonds until the bill is enacted, in order to take advantage of the AMT exemption. Officials estimated issuing non-AMT bonds would save as much as $16 million, or 40 basis points.
Freedman agreed that, due to the large amount of housing bonds subject to the AMT that are already in the market, it is unlikely that the new, AMT-free bonds will make the old bonds noncompetitive.
"It's a big market, and I don't think ... the number of bonds outstanding is so much larger than new issues ... It's hard to see a significant impact," he said. "Housing bonds have taken enough of a hit in the past year that I don't know if the small increment of new non-AMT housing bonds affects the existing market for AMT bonds."
Meanwhile, Merrill Lynch & Co. released a report Monday stating that while housing issuance has lagged below expectations this year, the pending enactment of the legislation is expected to increase issuance, perhaps beyond original expectations. As a result, the firm raised its projections for housing issuance for 2008 to between $470 billion and $500 billion from between $415 billion and $470 billion.
Separately, the Treasury Department released its plan to initiate a covered bond market in the U.S. Covered bonds, which make up a $3 trillion market in Europe, are debt issued by commercial banks and backed by a pool of mortgages held on the banks' balance sheets. The market barely existed in the U.S. because of strict rules imposed on commercial banks by the Federal Deposit Insurance Corp. Also Fannie Mae and Freddie Mac, which typically buy mortgages from the banks and securitize them for investors, do not have European counterparts.
The new covered bond market is not likely to compete with state and local issuers because the interest earnings from covered bonds will be taxable.
"I don't see any significant competition between the two," van Kuller said. "They are generally designed to serve different segments of the mortgage market."