Tax-Exempts Beat BABs In After-Tax Yields
September 6, 2010
WASHINGTON - A National Bureau of Economic Research study has concluded that while Build AmericaBonds have succeeded in their mission to lower financing costs for state and local governments, traditional tax-exempt bonds still offer more enticing after-tax yields to individual investors.
On average, state and local governments saved 54 basis points per year by issuing BABs instead of tax-exempts, according to the new study. It analyzed 6,177 different BAB transactions totaling $63.4 billion that were issued from April through December 2009 and compared them to the 95,233 tax-exempt deals totaling $332.2 billion that were issued during the same period.
"To our knowledge, our paper is the first formal analysis of the BAB market not produced by the federal government," the study's authors wrote.
The National Bureau of Economic Research is a 90-year- old private, nonprofit, nonpartisan research organization that specializes in economic issues and is based in Cambridge, Mass., with a branch office in New York City.
The study is dated May 2010 but was not released until late last month.
It follows several BAB studies that the Treasury Department has released, touting the significant savings it can offer issuers. In fact, the Obama administration has proposed making the program permanent at a reduced subsidy level.
BABs offered issuers an unsubsidized yield of 3.69%, which dropped to an effective yield of 2.32% on average after including the federal subsidy payments equal to 35% of interest costs. By comparison, tax-exempt bonds on average offered issuers an after-tax yield of 2.86% during that same time period.
But those savings might be understated, since the study notes that regular tax-exempt yields also have been lowered by the existence of the BAB market, which has made room on the supply side of the tax-exempt market by moving more deals to BABs.
"The Obama stimulus package has succeeded in reducing the financing costs of local and state governments in funding infrastructure projects," the study stated.
While the BAB program does not offer a more appealing investment opportunity to individuals, the program is attractive to new types of muni investors - those with no U.S. tax liabilities.
"In this light, the BAB program can be interpreted as a wealth transfer from the natural holders of municipal bonds, who are individual U.S. taxpayers, to corporations, pension funds, and foreign investors not subject to individual U.S. income taxes," the study said.
Build America Bonds also are more attractive to institutions because they generally are sold in larger amounts than tax-exempt bonds. The study stated that the average issue size of BAB transactions in 2009 was $10.2 million, whereas the average tax-exempt deal was $3.5 million.
It also found that BABs tend to have longer maturities - 54% of them issued in 2009 had maturities longer than 10 years, while only 36% of tax-exempt bonds had maturities of the same length. Ratings for BABs generally were comparable to tax-exempt offerings.
The study did not analyze BAB underwriting fees. The major Wall Street firms underwriting the bonds have been subject to some criticism, most notably from Senate Finance Committee ranking minority member Sen. Charles Grassley (R-Iowa) for charging higher underwriting fees for BABs than for tax-exempt bonds. Data cited by the Treasury and market groups indicate the fees have come down enough that they now are more in line with tax-exempt transactions as the novelty of BABs has worn off.
The study was done by Andrew Ang, a business professor at Columbia Business School, Yunhang Xing, an associate professor of finance at Jones School of Management at Rice University, and Vineer Bhansali, a managing director at PIMCO.
Price Guidance Sought
Meanwhile, four major municipal market groups are urging Treasury to issue guidance confirming that the existing regulatory framework on issue price for tax-exempt bonds also applies to Build America Bonds and stating that if issuers follow certain long-standing practices, they can be confident they are complying with the rules in this area.
The groups stressed there is an "urgent need" for such guidance in a letter to John Cross III, the Treasury's associate tax legislative counsel.
The groups also provided Treasury with an analysis of market data they said confirms "trading up" of bonds occurs in all markets, especially in the corporate market, but not so much in the Build America Bonds market.
Uncertainty surrounding issue price has gripped the BAB market in recent months, since the Internal Revenue Service began asking BAB issuers if they were following the pricing of their bonds - something issuers traditionally have not done.MME
-This article originally appeared in The Bond Buyer.