DORAL, Fla. — An Obama administration official last week said the underwriting fees for Build America Bonds are coming down, and the expectation is that if the subsidized taxable borrowing program was made permanent, they would come down further.
Alan B. Krueger, assistant secretary for economic policy at the Treasury, told the audience at the National Municipal Bond Summit here that “new products typically require upfront investments and involve greater uncertainty, so they are likely to have higher underwriting spreads as a result.”
Krueger spoke just hours after President Obama Thursday signed legislation making more stimulus bonds eligible for BAB-type interest-rate subsidies. He noted that from last April to February, the average underwriting fee per $1,000 was $6.19 for tax-exempts versus $7.29 for BABs, a difference of $1.10 per bond, according to issuance-weighted data from Thomson Reuters.
However, as BABs have gained greater traction in the market, and as more deals are being structured by municipal underwriting desks rather than by corporate desks, fees have been coming down. Last July, for instance, the underwriting fee approached $8.50 per $1,000, whereas from October onwards the average cost has been below $7.00.
He suggested that making the program permanent — as the president’s budget proposed — would remove uncertainty, which Krueger said would bring costs down even further.
Fees should be structured to minimize the borrowing costs of municipal governments, he said, but determining that cost can be tricky. It must take into account “the complexity of the deal, the size of the deal, the risk and difficulty of placement, the amount of work and investor education involved, and other factors,” Krueger said.
Concerns that underwriting fees are unjustly high for Build America Bonds, which Republican Sen. Charles Grassley has argued as he opposed the expansion of BAB-type subsidies, were largely dismissed by conference participants.
While no one disputed that underwriting fees on the taxable asset on which issuers receive a 35% interest-cost subsidy are indeed higher, bankers and issuers alike said the fees were a valid reflection of the costs associated with a new financial tool coming to market.
Kemp Lewis, managing director at Morgan Keegan & Co., explained that the pool of buyers in the taxable market is much deeper than for tax-exempts, and as a result underwriters face more competition in selling their product.
“It takes a dollar or so more takedown to sell those taxable bonds than to sell the comparable maturity, comparable risk tax-exempt bonds, because it is a new asset class, and because we’re now competing against all the other asset classes for the investor interest,” he said.
Iowa’s Grassley, the senior Republican on the Senate Finance Committee, recently said Wall Street was “cheering the expansion” of BABs because banks could “skim the cream” off municipal issuers. He suggested that issuers may not be too concerned about paying the lowest fee given the subsidy already offers a great deal of savings.
Some participants at the summit, however, questioned that logic.
“I want to meet some of these issuers who no longer care if they’re paying the lowest fee because their borrowings are cheap, because they seem not to be the ones I’m dealing with,” Mitchell Rapaport, partner at Nixon Peabody LLP, joked.
Meanwhile, Ben Watkins, director of Florida’s Division of Bond Finance, said the BABs program has been a win-win situation for everyone involved.
“Usually when somebody says, 'Oh, it’s a win-win situation,’ I’m looking for the guy whose getting hosed,” he said. “But in this case it truly is because they [investors] are getting another asset class with great value, and it is the lowest alternative financing available to me.”
Despite his enthusiasm, Watkins last week said he recently suspended issuance of BABs due to concerns that the federal government could offset subsidy payments if an issuer has other obligations to the federal government.
On Wednesday, the House Ways and Means Committee approved a bill to extend the BABs program and reduce the current 35% direct-pay subsidy rate to 33% in 2011, 31% in 2012, and 30% in the first three months of 2013.
“BABs were intentionally generous because the federal government wanted to stimulate economic activity,” Krueger said. “In the longer run, obviously, we have an interest in reducing our large budget deficits.”
