Market participants were already making funeral arrangements for Build America Bonds one day after federal lawmakers failed to extend the program in a compromise tax bill released late Thursday.
The BAB program expires Dec. 31. Issuers sold $174 billion of the bonds since the program began in April 2009.
Traders said the omission of the popular taxable bond program was not a surprise for them.
Its expected demise was priced into the market Tuesday and Wednesday, when Treasury-led routs widened 30-year yields a combined 20 basis points.
Tax-exempt yields barely responded to the news of its omission Thursday and Friday.
“The death vigil is very much underway,” said Fred Yosca, head of trading at Bank of New York.
California Treasurer Bill Lockyer, in a statement Friday morning, said expiration of the BAB program will increase borrowing costs for the nation’s taxpayers by about $15 billion to $29.6 billion in 2011.
“The BABs program has been a great success story,” said Lockyer, whose state is the nation’s top BAB issuer with sales of $37.8 billion. “It has helped finance critical infrastructure investment across the country, [created] thousands of jobs and saved taxpayers’ billions of dollars.”
Additionally, New York City Comptroller John Liu said BABs have been very beneficial to the Big Apple. However, he said the city didn’t expect any difficulties without them.
“BABs have been very helpful to New York City and the municipal market at as whole, restoring stability and lowering interest costs by broadening the bond investor base,” Liu said.
Yosca said the supply of BABs will dwindle post-expiration and the wild card is the demand outstanding bonds will receive.
This is “something they may not want to hold 20 or 30 years to maturity,” Yosca said of BABs. “Will they get the liquidity on the way out on a product that is extinct? There should be some positive effect by cutting off the supply, but I don’t know how much of a boost in demand.”
Taxable investors never really embraced the taxable muni bond. BABs trade at wider spreads than comparable corporate bonds.
Yosca said that disparity indicates buyers of those corporates have not jumped on the BAB bandwagon.
He is not sure they will once the product expires.
“There are two competing factors,” said Matthew Posner, director of Latin American operations at Municipal Market Advisors. “Scarcity versus those who do not want to own an orphan product.”
Although tax-exempt yields were flat to higher by one or two basis points on Friday, BABs were trading tighter in the secondary market, including bonds from this week’s $1.8 billion New Jersey Turnpike Authority offering, which traded five to 10 basis points tighter from original levels.
Posner predicted BABs will trade a bit better before they cease being traded altogether.
Despite this, the end of the BAB program will not necessarily be a negative for the muni market, Yosca said.
“Clearly the firms who underwrite them will be disappointed, but BAB yields widened out so dramatically from April through July, people lost a lot of money on them,” he said. “There was a good amount of money made and lost. But if they were the most profitable product we had all year, that would be a different story.”
Yosca also said whether or not he was disappointed by the end of the program depended on if he’s answering as a taxpayer or as a bond trader.
“From a taxpayer’s perspective, no. It was subsidizing borrowers who didn’t really need it, so from that perspective, it’s good,” Yosca said. “But from a bond market participant’s point of view, they were a fun thing to trade.”
