Last summer, about two dozen muni bond professionals gathered in a New York City apartment to celebrate the end of the alternative minimum tax on new housing bonds.
"I am such a bond nerd - yes, it's true - I had a non-AMT party," said Marian Zucker, the New York State Housing Finance Agency's executive vice president for housing programs and policy. "I was so excited."
The fete came after the Housing and Economic Reform Act removed the AMT for housing bonds, making them attractive to a wider range of investors and providing lower interest costs for borrowers. Then, this year's federal stimulus package opened a two-year window that allows issuers to refund billions of dollars of previously issued AMT bonds with non-AMT debt.
The stage seemed set for a stampede of new non-AMT housing bonds and for refundings of AMT bonds. But expensive issuance costs and higher fees for credit enhancement have set up barriers to such transactions, and early redemption restrictions also have created impediments for the refunding deals.
Most municipal bonds are not subject to the AMT - out of $40.05 billion sold in New York last year, according to Thomson Reuters, only $1.56 billion were subject to the tax, most of which were private-activity bonds sold for housing developments and airports.
Under the American Recovery and Reinvestment Act, new-money bonds and certain refunding bonds sold in 2009 and 2010 are not subject to the AMT. AMT bonds that were sold from 2004 through 2008 are eligible for refunding with non-AMT debt.
AMT bonds are not as liquid or attractive to most investors as non-AMT bonds, and with more individuals being snared by the tax, fewer people want them.
"The alternative minimum tax has been hitting a greater number of taxpayers, even with the federal government trying to adjust for it," said Evan Rourke, portfolio manager at Eaton Vance. "Because there's less people who can buy them, we've seen AMT spreads widen over the last few years ... The ability to refund with a non-AMT bond should help [borrowers] with their financing costs."
Next month, the state HFA plans to bring to market one of the first deals to refund AMT debt with non-AMT bonds. The agency hopes to refinance $126 million sold in 2006 to finance the Caledonia, a mixed-use development with 288 rental units in Manhattan's Chelsea neighborhood that includes 59 units reserved for low-income tenants. The debt was sold as variable-rate demand bonds on behalf of the Related Cos.
But even though this deal takes advantage of the AMT refunding window, it would have been coming to market anyway because the project is converting to long-term financing from construction financing. The HFA tenders the bonds when the construction period is finished and substitutes the construction credit enhancement with long-term credit enhancement and remarkets the bonds. In this case, a letter of credit from Landesbank Baden-Wurttemberg will be replaced with credit enhancement from Fannie Mae.
"Because we're otherwise going in to restructure the bonds because of the credit substitution, it makes sense to roll the non-AMT refunding into that transaction," Zucker said.
Barclays Capital will underwrite the bonds, which will be remarketed as variable rate.
The HFA has nearly $990 million of bonds outstanding that financed 14 projects and are eligible for refunding to non-AMT bonds, said spokesman Philip Lentz. All of those borrowers have been notified that this is an option, he said.
Lentz pointed to a project called 80 DeKalb Avenue in Brooklyn for which the HFA issued $60.35 million of AMT bonds in 2008 and a second tranche of $43.8 million of non-AMT bonds this year as an apples-to-apples comparison of non-AMT savings. The AMT tranche is now trading 21 basis points higher in yield than the non-AMT bonds, he said.
At a board meeting earlier this month, HFA president Priscilla Almodovar said they expect to see refundings come before the board because the savings may make sense for borrowers over the long run.
"It's something we're encouraging our developers to do even though the savings to them today are relatively small," she said.
Today's high cost of credit enhancement, coupled with relatively narrow spreads between variable rates for AMT and non-AMT bonds, is causing some borrowers to take a wait-and-see attitude. Some deals may just be too small, considering the costs of issuance, to make a refunding cost-effective, market sources said.
As a proxy for variable rates, the Securities Industry and Financial Markets Association municipal swap index shows that such rates are low by historical standards, especially compared to just a few months ago. At 0.53% in mid-April, the index has come up a bit from mid-January, when it got down to 0.46%, the lowest rate in the 30 years of history listed on SIFMA's Web site. But that is dramatically lower than the 7.96% rate seen at the peak of the financial crisis in September.
"The problem with VRDO is there aren't significant savings," said Richard Froehlich, general counsel and executive vice president for capital markets at the New York City Housing Development Corp. "Obviously if rates go higher, the differential may increase, and that's part of the incentive."
The HDC is looking at doing more than $1 billion of pooled refundings to remove the AMT liability. The corporation's president, Marc Jahr, said the agency is currently "sorting through deals and making decisions about which ones are ripe to refund and which ones perhaps should wait on the sidelines."
They have also been speaking with their major credit enhancers - Fannie Mae, Freddie Mac, and Citi - about refunding both variable-rate demand bonds and fixed-rate bonds.
"Even though there are a lot of different deals, we talked about doing them as a package so that it would be simplified - so we would go back into the market with multiple refundings all in one official statement," Froehlich said. "The idea behind a pool would be to make it cheaper and more efficient - that's the goal there - to sort of open up the window and say come on in, and then if they're not interested, then we just move forward with whoever is."
If $1 billion of refunding sounds like a lot, it's less than half of the $2.46 billion of AMT-subject bonds issued by the HDC from 2004 through 2008, according to Thomson Reuters.
Jahr said that the HDC has fixed-rate deals that are eligible under the window but are protected from early redemption by call date restrictions and by law can't be advance refunded.
"VRDOs are callable at any time while the fixed rate are not - the fixed rate don't necessarily have optional redemption, so the only way to do them is a tender," Froehlich said.
Roughly half of the Port Authority of New York and New Jersey's bonds issued during the eligible period are subject to the AMT because they finance capital projects at its air and sea ports. During that time, the authority sold $4.05 billion of AMT bonds, including $750 million last year, but those are going to stay that way.
Refinancing that debt and getting rid of the AMT liability would offer "significant interest rate savings," Port Authority spokesman Steve Coleman said in an e-mail. "However, because our bonds have 10-year call protection, we do not have any candidates for refunding AMT debt issued in 2004-08 with current non-AMT bonds in 2009-10."
For a different reason, the opportunity has been a non-starter for the Albany County Airport Authority as well.
The authority sold $83.2 million of variable-rate bonds in January 2008. Locking in a letter of credit from Bank of America NA at 38 basis points just before the collapse of the auction-rate security market and the liquidity drought seemed like a stroke of good fortune, said chief financial officer William O'Reilly. But when taking off the AMT liability became an option, he quickly found out the LOC provider wasn't going to give the authority a break if it tried to do so using a new LOC for a refunding, he said.
"I knew a refunding would result in me having to get a new letter of credit but I was hoping maybe they would entertain a reissuance," O'Reilly said. "They said no, that if I were to try to touch that bond they would require me to terminate the existing letter of credit and get a new one, and the price would be four times the current 38 basis points."
Refunding now would result in a net loss, and with bond insurance nearly impossible to get, converting the bonds to fixed rate would be even more costly for the airport, which Moody's Investors Service rates A3, O'Reilly said. Seemingly adding insult to injury, the LOC expires on Jan. 30, 2011, just 30 days after the window closes on such refundings.
"As I move closer to the expiration date of the letter of credit ... does it behoove me at that time to move into the market to try to refund or reissue these bonds?" he said. "Let's hope in a year and a half from now the market's better."
