Even as policymakers and tax experts engaged in headline-making and thus far fruitless debate about the future of the friendless alternative minimum tax, issuers in 2005 came to market with plenty of deals subject to the AMT, easily surpassing 2004's volume.
AMT financings in 2005 totaled $30.48 billion, a 30.7% increase over the $23.32 billion in 2004, according to Thomson Financial.
This spike in volume occurred as President Bush's Advisory Panel on Federal Tax Reform considered and then recommended the elimination of the AMT, which originally was intended to prevent the wealthy from exploiting tax loopholes but increasingly has ensnared the middle class.
Unlike fully tax-exempt bonds, the interest on AMT bonds is taxed if the investors who hold them are subject to the AMT. Eliminating the tax would cause outstanding bonds to outperform and give AMT issuers access to cheaper financing. Allowing more taxpayers to be impacted by the AMT would have the opposite effect. This effectively happened in 2005 when Congress failed to extend exemptions to the tax, though leaders pledged a retroactive legislative fix.
Municipal analysts expect Congress to deliver on that promise and say few investors or issuers are building finance plans or trading strategies around the tax panel's recommendations.
"People were not trading it," said Phil Fischer, head of municipal and index research at Merrill Lynch & Co. "We did not expect that the tax panel's recommendations would be realized in law in the short-term at all."
Rather than being caused by policy factors, the increase in overall AMT volume followed the trend of the issuance frenzy that was 2005, a record-setting year that saw $407.7 billion in new deals.
However, unlike the municipal market as a whole, the increase in AMT borrowing was driven more by new-money issuance than by financings that took advantage of low rates and a flat yield curve to refund existing debt.
New-money borrowing in the AMT sector jumped to $21.28 billion in 2005 from $17.64 billion in 2004, an increase of 20.6%. Refunding volume climbed to $5.15 billion from $4.10 billion. By contrast, new-money issuance in the overall tax-exempt market declined slightly in 2005 to $224.38 billion from $229.48 in 2004, while refundings surged by 47.6% to $130.26 billion from $88.23 the year before.
Matt Fabian, lead municipal analyst at UBS Financial Services Inc., attributed the increase in new-money volume in the AMT sector to the sale of airport and housing bonds.
"There's been an awful lot of airport issuance because investors were so cautious previously about how airport bonds would perform," he said. "And single-family housing issuance in general rises when interest rates rise."
In 2005, AMT transportation issuance soared 73.3% to $6.94 billion from $4.00 billion in 2004, as investors differentiated between the struggling airlines and relatively secure airport bonds.
"People are finally realizing that airport bonds are not airline bonds," Fabian said. "They have a much more diverse and stable revenue source."
Meanwhile, borrowing for housing - the largest sub-sector of the AMT market - increased by 14.4% to $14.19 billion from $12.41 billion in 2004.
AMT housing bonds finance subsidized loans for applicants who meet income levels and other requirements. Issuance of such debt increases when mortgage rates are rising - as they did, albeit modestly, during 2005 - because higher rates eliminate other options for lower-income borrowers.
"When rates are really low, there are tons of mortgages and many exotic products available," Fabian said. "Now that rates are rising, the affordable lenders have a better product, so their volume is rising."
Among other sub-sectors that saw an increase in issuance in 2005, education borrowing climbed to $3.69 billion from $2.05 billion.
The only AMT bonds to decline in volume in 2005 were those issued for environmental facilities and general purposes.
Not surprisingly in a year of swelling volume, issuance of both fixed- and variable-rate AMT debt increased in 2005, though growth was more dramatic in variable-rate structures.
Volume of variable-rate debt with short puts increased 66.7% to $10.14 billion from $6.08 billion in 2004, and auction-rate debt volume increased 39.5% to $5.09 billion from $3.65 billion the previous year. Fixed-rate issuance rose 18% to $14.74 billion from $12.48 billion.
Just as in the fully tax-exempt market, AMT borrowers increasingly sold variable-rate debt and then swapped it to fixed-rate obligations, giving many a lower cost of capital than they could have achieved by directly selling fixed-rate bonds, according to Fischer of Merrill Lynch.
"We saw an increased use of synthetic refundings and an increased use of synthetic fixed," he said. "We just have a growing use in the market as issuers get greater authorization to use derivative structures."
As issuance rose in 2005, so reportedly did demand, as investors embraced the higher yields and lower ratings often offered by the borrowers whose debt is subject to the AMT.
"Our retail is insatiable for the product," said Edward Merrigan, director of research at Ziegler Capital Markets Group. "I think people have gotten stock fatigue."
