CARLSBAD, Calif. — As economists debate whether the federal stimulus package has created the jobs and economic growth promised, municipal bond market professionals have little doubt that the American Recovery and Reinvestment Act has revived their market.
A wide range of market participants who spoke at The Bond Buyer’s California Public Finance Conference and a pre-conference hosted by the California Debt and Investment Advisory Commission this week described the ways the stimulus package has eased the financial crisis in their corners of the market.
The ARRA was passed in February to boost the U.S. economy out of the deepest downturn since the Great Depression. It included a series of bond provisions that offered subsidies for some types of issuance, opened new markets to municipal issuers, and offered an alternative-minimum tax holiday for interest on private-activity bonds.
The creation of the Build America Bonds program — which allows muni issuers to sell taxable debt and collect a direct 35% subsidy from the Treasury Department in place of the traditional indirect subsidy of tax exemption — has opened vast new markets for local government bonds and helped heal the traditional tax-exempt market by reducing the supply of tax-free bonds coming to market.
“Build America Bonds are for the municipal finance market what the 'Cash For Clunkers’ was for the automotive industry,” said Cadmus Hicks, a managing director at Nuveen Investments, referring to the new car sales subsidies that emptied out auto dealer inventories last month.
Hicks didn’t necessarily mean that as a compliment. He said the 35% subsidy may be too generous to be sustained. But the result is that municipal issuers have embraced the new product.
“I think they’re going to find Build America Bonds are much more popular than they expected them to be and therefore much more expensive than they expected to the federal government,” he said.
Muni issuers have sold about $32.3 billion of BABs this year, according to Thomson Reuters. That’s about 12% of market volume for 2009. All told, 17% of volume this year has been taxable, up from 7% in the same period of 2008.
One result has been a steep drop in yields since the stimulus package was passed in February, a rally that has broadened across the credit curve and deepened in recent months. Yields on the Municipal Market Data 30-year triple-A general obligation bond index have fallen to 4.1% Wednesday from 4.5% just before the first BABs were issued in April.
The yield for 30-year tax-exempt GOs had soared to 125% to 135% of the yield for Treasuries in the weeks before BAB issuance but had fallen back to 96% as of midweek, according to MMD.
BABs can’t take all the credit. The Federal Reserve has pumped trillions of dollars into bank reserves, mortgage bonds, corporate commercial paper, and Treasuries, forcing fixed-income investors to look elsewhere for yield and moving financial markets toward a broader recovery.
Indeed, muni yields were already well below their post-Lehman Brothers bankruptcy highs when BABs began to hit the market. Still, BABs get most of the credit from muni pros.
“Even for those that aren’t using Build America Bonds, there has been a benefit,” said Eileen Gallagher, a managing director at Stone & Youngberg LLC. “Moving 17% of the volume out of the tax-exempt market helps the supply-demand relationship.”
The ARRA’s exemption of private-activity bond interest from the alternative minimum tax has also significantly freed up the market for bonds for airports and seaports.
During the worst of the credit crisis, the market for AMT bonds essentially dried up. Officials from the Port of Los Angeles and San Francisco International Airport say they have reaped big benefits in terms of lower rates and market access by getting access to fully tax-exempt debt.
“We certainly think that the ARRA has presented us with some pretty good opportunities to get savings,” said Chloe Weil, debt manager at San Francisco International. “Our strategy is really to not leave any pennies on the table.”
The airport converted $267 million of AMT bonds to tax-exempt status in June and refunded $175 million of AMT debt with tax-exempt notes in September. The transactions will save about $1.6 million a year in debt service.
Market-wide, the volume of AMT debt fell to $1 billion, or 0.4% of municipal issuance, so far this year, down from $20.1 billion, or 6.3% of issuance, in the same period a year ago, according to Thomson Reuters.
That is not to say the massive stimulus bill didn’t include a few flops. ARRA created a range of so-far little-used tax-credit bonds, such as qualified school construction bonds and BABs that are tax-credit bonds rather than the direct-subsidy BABs that issuers are selling.
Investment bankers, financial advisers, and bond lawyers on the ground in California are finding that tax-credit bonds are much harder to take advantage of than the direct-subsidy BABs.
The qualified school construction bond program offers an especially generous tax credit. The Treasury sets the rate for deals at its estimate of the going market rate for similar credits. Theoretically, a school district will be able to sell the bonds at par, and the tax credit will serve as an adequate coupon payment for investors.
Only two California school systems, the Oakland Unified School District and the San Diego Unified School District, have used the QSCBs, said Russell Goings, a managing director at Cabrera Capital Markets LLC.
In highly rated San Diego, the program worked as advertised, but the lower-rated Oakland school system had to supplement the tax credits by offering a 2.8% supplemental yield to find a buyer.
That’s a very low rate, but the combination of the federal tax credit and the local rate pushes the yield to about 10%. That means the program actually boosted the combined cost borne by local and federal taxpayers well above market yields.
Goings said the problem is that there is no market for tax credits. He said there is only one investor buying the credits and he can set the price he wants.
“If he doesn’t buy your deal, you can’t do your deal,” he said.
Hicks said tax-credit bonds don’t work for tax-exempt municipal bond funds because they can’t be counted as income under Securities and Exchange Commission rules.
Tax-exempt fund funds can only use tax-exempt income for the yield statistics that are key to marketing mutual funds.
“From our perspective, if we try to put tax-credit bonds into a tax-exempt fund, we’d get no credit for the actual taxable income,” he said. “From a marketing standpoint, that does not work.”
Hicks also faulted lawmakers for writing the tax-credit bond legislation in ways that make them both too complex and uneconomical for individual investors.
The legislation gives investors tax credits that offset interest costs. But the legislation made both the interest and the tax credits taxable. That doesn’t work when investors compare the yields to other investing options, such as taxable bonds purchased for a tax-deferred retirement account, he said.
“The way they structured it just doesn’t make sense,” Hicks said.
