DALLAS — The average offering of Build America Bonds fell in the first half of 2010 as smaller issuers became more familiar with the hybrid product that mimics corporate bonds and targets the municipal market.
An increasing number of smaller issuers, such as school districts and local authorities, took advantage of the federally subsidized bonds in the $1 million to $5 million range even as major issuers continued to offer large deals. California’s $2.5 billion general obligation bond issue in March topped those major issues.
The mean size of BAB deals fell to about $72 million in the first six months of this year from about $76 million in the second half of 2009. Year-over-year comparisons are not possible because BABs were not introduced until April of last year.
With 721 issuers, BAB volume climbed to $51.9 billion, a 7% rise over the second half of 2009 when 641 issues sold.
The stimulus sector continued to diversify in March when President Obama signed the Hiring Incentives to Restore Employment Act, or HIRE, that provides direct-subsidy payments to qualified school construction bonds, qualified zone academy bonds, new clean renewable energy bonds, and qualified energy conservation bonds. Issuers and their underwriters also found ways to overcome one early limitation of BABs — the lack of call provisions.
“The first of these Build America Bonds transactions were structured along the lines of corporate bonds with long-term bullet maturities and either no-call provisions or 'make whole’ call provisions,” Moody’s Investors Service analyst Edith Behr said. “Now, however, some of the smaller BAB transactions are being structured with serial maturities and 10-year call provisions that mirror traditional tax-exempt call provisions.”
The original BAB deals were negotiated, but issuers and their advisers learned they could offer the bonds competitively as the market matured. In the first half of this year, 237 deals worth $10.5 billion sold competitively versus 205 deals valued at $6 billion in the second half of 2009 — a 75% increase.
“Some issuers are required to sell bonds competitively,” noted Daniel Kozloff, managing director at Public Financial Management, the top financial adviser for BAB deals from Jan. 1 to June 30. “As the BAB market has evolved, we have seen this sale type become more prevalent. We’re seeing those issuers who have to sell bonds competitively able to access this market and receive aggressive bids on their BABs.”
The increasing versatility of BABs marks the rapid evolution of the taxable muni bond that made its first appearance in a pair of issues on April 15, 2009, about two months after enactment of the American Recovery and Reinvestment Act.
Last month, the University of Virginia — which, along with the University of Minnesota broke the 2009 BABs barrier — took a second helping with a $190 million competitive deal. The university’s first issue of $250 million sold through negotiation with JPMorgan.
The growth of BABs is reflected in the fact that taxable municipals comprised 33% of the issuance in the first half of this year, versus 13% in the final six months of 2009. Volume of $26.7 billion in the first quarter of 2010 was slightly larger than the second quarter’s $25.1 billion.
Citi, the top underwriter for BABs in the first half, managed 40 issues worth $7.6 billion, giving the company a 14.7% market share, slightly ahead of Bank of America Merrill Lynch at 14.5%. Goldman, Sachs & Co. ranked third with 17 deals valued at $5.8 billion, followed by Barclays Capital at $5.6 billion and JPMorgan with $5.3 billion.
Citi, which served as senior manager on California’s $2.5 billion deal, moved to the top spot from the No. 3 position in the second half of 2009.
Among financial advisers, PFM dominated the field with 23% of the market and 64 issues worth $10.3 billion. Public Resources Advisory Group ranked second with $5.9 billion and a 17% market share, followed by First Southwest Co.’s $3.3 billion and 7.4% share.
Underwriters, brokers and analysts recognized the need to educate investors about the hybrid characteristics of the new product.
“Due to the success of the BAB program, nontraditional buyers of municipal bonds have entered the market at an accelerating pace,” analysts at Fitch Ratings wrote in a special report. “These new investors include life insurance companies, individual retirement accounts, public pension funds, and non-U.S. investors.”
Fitch in April devoted a section of its website to deal specifically with BABs.
One group of investors which entered the BAB market more slowly than expected were the international funds.
“The international buyers were a little slow to warm to BABs, not only because it’s a new credit but because the GO is sort of a new animal for them,” said one industry expert. “How does someone in Asia or the Middle East understand the credit of a U.S. state or local entity?”
The three biggest issues of BABs in the first half came from California. The second largest deal was the Bay Area Toll Authority’s $1.5 billion issuance of BABs, which was followed by the Los Angeles Unified School District with $1.25 billion.
Hanging over the BAB market is lingering uncertainty about whether the subsidized debt will exist beyond this year. Municipal market participants are urging lawmakers to extend the program, but election-year politics have bred delays.
“There’s a lot of fear out there that BABs are going to be dead on the vine,” said one industry executive. “Investors don’t want to buy something that’s not going to go on. The further and further you get into the year without an extension, the more you’re going to see that fear.”