CHICAGO — The market for tax-credit bonds created by the federal stimulus is expected to take off despite a sluggish start and remaining questions surrounding the so-called tax-stripping option, said participants at The Bond Buyer’s Municipal Finance in the Stimulus Era conference here yesterday.
“We haven’t had a market in tax credits to date in this country but we’re in the midst of creating one — there’s too much volume and the subsidies are too deep,” said Kemp Lewis, managing director at Morgan Keegan & Co. “There will be more than $30 billion in bonds with tax credits attached.”
The new law allows for several new types of tax-credit bonds, where the federal government provides the investor with a tax credit instead of the issuer paying interest. The programs include school construction bonds, qualified energy conservation bonds, qualified zone academy bonds, and Build America Bonds that feature tax credits instead of a 35% direct subsidy for the issuer.
The qualified school construction bond program is the largest and most generous, with a 100% tax credit compared to different levels of credits on the other bonds. The $22 billion QSCB program — 40% of which is allocated to the 100 largest school districts in the U.S. — includes $11 billion in allocation this year and $11 billion in 2010. With about 60 transactions completed, roughly $900 million of QSCBs have been sold to date.
Many school districts are accelerating their capital plans in order to issue their bonds before the end of the year, and at least two large Midwestern districts are expected to sell their full QSCB allocation before Dec. 31, said Melanie Shaker, an analyst with Fitch Ratings. The Dormitory Authority of the State of New York and Virginia also have large deals coming.
Issuance is expected to increase even as issuers and investors wait for final Treasury Department guidance on whether the tax credits can be stripped from the principal repayment and sold to separate investors. The question has attracted a lot of attention but so far has not proved to be a real obstacle to issuers, said Arthur Miller, a vice president at Goldman, Sachs & Co.
“I tend to view this as a tempest in a teapot,” said Miller. “Issuers ask 'Will it make a difference in terms of pricing?’ And thus far I can’t say it would. If we start to see more investors interested in buying the bonds in stripped form, we might see a difference — but now I can’t see one, and it’s not a compelling reason not to issue.”
For school districts that received individual allocations to issue the bonds, the threat of ceding their bond allocation to their state if they fail to issue this calendar year outweighs the risk of waiting for tax-stripping guidance, according to James Pass, a managing director at Guggenheim Partners LLC.
“Issuers know they can get 100% of their allocation now,” he said. “It’s one of the best deals in town. It does come down to the question, do you want to borrow money at 2% or less or do you want to wait for the stripping regulations? Most school districts want to move.”
Buyers like Guggenheim — the largest buyer of tax-credit bonds so far — find the new market attractive for several reasons, Pass said.
“It’s a prudent investment based on the duration limited by the federal act — 14 to 16 years is a great duration for us,” he said. “When you compare a general obligation AA-rated school district to corporate-rated AA bonds, there’s tremendous values in these tax-credit bonds. And we like to be an early leader, when the spreads are usually a bit wider in the beginning, and then tighter, like we saw in the Build America Bond market.”
Large institutional buyers are likely to remain the chief buyers of the new debt, as the new market is too complex for the retail market, Miller said. Goldman acted as underwriter on the San Diego Unified School District’s $38.8 million transaction, the first large QSCB deal. When the deal was being crafted, “the question was do we include retail or not, and the answer was definitively no,” Miller said.
“The reasoning is, as a new market it’s not clear to us that we have the necessary infrastructure of support in terms of credit analysis, accounting, reporting,” he said. “My analogy is my mother-in-law: Would she be able to understand this? Yes, but only after a two-day seminar like this. Maybe as time goes by, and all $22 billion is issued [the retail market will build], but at least for right now I don’t see it being anything other than an institutional market.”
