The new 'Bilk America Bonds' : Investment banks get taxpayer subsidies for BABs, then charge even higher fees to Govt. Agencies issuing the debt.
By Jeremy R. Cooke
States and municipalities paid an average 37 percent more to investment banks for underwriting Build America Bonds than for handling tax-exempt sales since offerings of the subsidized taxable debt began in April.
Municipal issuers compensated underwriters at an average $7.39 per $1,000 for sales involving Build America Bonds and $5.40 for tax-exempt deals, based on data compiled by Bloomberg from a sampling of $40 billion of each type. Across the $55 billion in so-called BABs sold so far, the difference translates to more than $100 million in added costs. Both fee rates exceed this year’s $4.91 corporate average.
Local government officials accepted higher fees from banks marketing the new product, which provides a 35 percent federal interest subsidy under President Barack Obama administration’s stimulus initiative. Issuers obtained lower net borrowing costs than from traditional tax-exempt financing, and the program’s advent helped reduce yields in the broader municipal market.
“The large subsidy gives them leeway to charge more because the issuer probably cares less about the underwriting fee,” said Matt Fabian, managing director and senior analyst at Concord, Massachusetts-based independent research firm Municipal Market Advisors. “They shouldn’t care because federal taxpayers will cover the difference. As a federal taxpayer, I’m highly concerned.”
Nine Football Fields
The $100 million in added fees would be enough to build about 500,000 square feet (46,451 square meters) of high school space, based on average construction costs for New York City cited by Reed Construction Data in September. The area equals almost nine football fields.
The American Recovery and Reinvestment Act, enacted in February, allows state and local governments to raise money for infrastructure projects that would otherwise be deemed tax- exempt by selling an unlimited amount of federally subsidized, taxable bonds through 2010. Refinancing existing long-term, tax- exempt bonds with Build America deals isn’t allowed.
This year’s record flows of cash into tax-exempt bond mutual funds at a time when public agencies have an incentive to instead sell taxable debt helped drive down yields on benchmark 20-year general obligation securities to 4.33 percent on Nov. 24 from 4.92 percent April 9, a Bond Buyer index shows.
The price of tax-exempt state and local government bonds rose more than their higher-yielding taxable counterparts from May 1 through Nov. 24, pushing the BofA Merrill Lynch Municipal Master Index to a 6.2 percent return, while the firm’s Build America Bond Index gained 6.04 percent in the same period.
Build America Bond yields averaged almost 20 basis points, or 0.2 percentage point, more than similarly rated corporate debt, JPMorgan Chase & Co. analysts said in a research note Nov. 25.
To sell the new type of taxable bonds, governments and banks sought out investors who typically hold corporate debt, including pension funds and overseas buyers, and who may need to be educated about credit profiles of municipalities.
“The way they’ve defended it to us is there’s a huge amount of international travel because the marketing is heavily toward international investors that drives up the price,” Fabian said. “Our argument has been it doesn’t matter even if the banker is making less on the bond, net-net, it’s still a higher fee to the issuer.”
Michael DuVally, a spokesman for Goldman Sachs Group Inc., declined to comment. Brian Marchiony of JPMorgan, Kerrie McHugh from Bank of America Corp. and Jeanette Volpi of Citigroup Inc. also didn’t comment. Bank of America, which bought Merrill Lynch & Co., is based in Charlotte, North Carolina. The rest are based in New York.
Before this year, municipal issuers didn’t sell taxable obligations unless the law dictated it for the intended use, usually a project benefiting private interests. Sales of fixed- rate taxable municipal bonds rose more than fivefold this year through Nov. 20 to $70.3 billion compared with the comparable 2008 period, Bloomberg data show.
Bond dealers have made arrangements to handle the increased flow of taxable munis, which are typically quoted based on the spread, or amount of yield, above Treasuries, unlike tax- exempts.
The Pennsylvania Turnpike Commission, operator of the toll- road system that stretches across the sixth most-populous U.S. state, sold tax-exempt debt and Build America Bonds this year.
“The 35 percent subsidy is the primary thing that we’re looking at versus financing with traditional tax-exempts,” said Nikolaus Grieshaber, chief financial officer of the commission. “That’s a significant benefit.”
The commission’s all-in borrowing cost for the $275 million, 30-year Build America Bond sale in June was less than 4 percent, after accounting for the interest rebate from the U.S. Treasury, Grieshaber said.
Tax-exempt transportation revenue bonds with similar maturities and ratings were yielding 5.12 percent at the time, according to a Bloomberg Fair Value index. The advantage is less than the gap indicates because the turnpike’s Build America Bonds can’t be called at par, or bought back at face value, in 10 years as issuers can on most municipal debt with longer maturities.
Fees on the tax-exempt issues were $6 per $1,000 of bonds backed by a senior lien on turnpike revenue sold in July and $6.24 on an October issue of subordinate-lien debt. In deals including Build America Bonds, the turnpike agency paid $8.30 for a June issue under the senior revenue credit and $7.78 in October for securities backed by wholesale gasoline taxes.
“We would’ve done BABs even with higher underwriting fees,” Grieshaber said. “To the extent the program remains out there through 2010, we would look to do some more.”
Underwriters’ discounts, which are disclosed in the official statements that outline details of each bond sale, equal the initial prices offered to the investing public minus what the underwriters pay to the issuer for the bonds. In some cases when Build America and tax-exempt bonds are sold at the same time, there is only one overall discount listed.
The median tax-exempt bond sale in those surveyed by Bloomberg News was $313.7 million, and the median Build America deal was $298.2 million.
Municipal issuers selling both types of debt have been paying more to underwriting firms on average than U.S. companies did this year. The average fee on $1.23 trillion of corporate issues was 0.491 percent, or $4.91 per $1,000 of bonds, according to data compiled by Bloomberg. Sales of fixed-rate municipal bonds totaled $342 billion through Nov. 20, Bloomberg figures show.
“Any time you have a niche industry, people are going to pay more,” Fabian said.
U.S. bond markets will close early today at 2 p.m. New York time, according to recommendations from the Securities Industry and Financial Markets Association.
To contact the reporter on this story: Jeremy R. Cooke in New York at firstname.lastname@example.org.
Last Updated: November 27, 2009 00:00 EST
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