Outlook 2010: Build America Bonds to continue popularity; $450.5 billion in tax-exempts expected

By Sheri Kasprzak

New York, Dec. 31 - Build America Bonds sparked some buzz in 2009 in the municipal bond market, and that activity is expected to continue into 2010, according to market insiders.

BABs accounted for roughly 15% of all municipal issuance in 2009. That number is expected to increase during 2010, according to Tom Kozlik, vice president and municipal credit analyst at Janney Montgomery Scott LLC.

There was $56 billion in Build America Bonds sold during 2009. Kozlik said he believes around 20% to 30% of all municipals sold in 2010 will be Build America Bonds. He expects that there will be between $115 billion and $175 billion in Build America Bonds sold during 2010.

The Securities Industry and Financial Markets Association estimates about $85 billion of BABs will be issued in 2010 based upon a survey of large and regional municipal bond underwriters and dealers. Kozlik, who participated in the survey, said he feels this number is very low.

Anthony Shields, a vice president with Grigsby & Associates, said he agrees; but, he feels BABs will be successful to the detriment of pure tax-exempt bonds.

"BABs will continue to become a more and more dominant force in the muni market, squeezing our true tax-exempts, which the government has always wanted to do anyway," Shields told Prospect News.

Sifma estimated, also based on its survey, that $450.5 billion in tax-exempt municipals will come to market in 2010, a 7.9% increase from the estimated $418 billion sold in 2009. Kozlik said he feels this number is fairly accurate.

Rounding out Sifma's forecast, long-term bond issuance is expected to be $347.5 billion for 2010 and short-term issuance is forecast to be $68 billion. Variable-rate demand obligations volume is expected to be about $35 billion.

Market retains appetite for munis

The expected increases in muni volume for 2010, according to Sifma, signals continued appetite for municipals.

"Despite fiscal difficulties at the state and local levels, the strong issuance forecast underscores the market's appetite for municipal bonds and the ability of state and local government to make use of different financing vehicles available to them, including Build America Bonds," said Randy Snook, executive vice president of business policy and practices for Sifma, in a statement.

"Having a stable and efficient municipal bond market that helps states and local communities finance important initiatives is a critical component of the financial services industry's efforts to help grow the U.S. economy."

The majority of issuers in the U.S. public finance market will be state and local governments issuing general obligation, revenue and sales tax bonds, said Kozlik. Sifma agreed, noting in a statement that "the largest issuing use-of-proceeds sector would be general purpose bonds in both 2009 and 2010, with a very small minority expecting transportation or education to be the largest sectors."

Tough times for housing

One sector that might issue fewer bonds in 2010 is housing authorities, according to Kozlik, with single-family housing bonds down specifically.

Housing agencies will likely have a hard time offering competitive interest rates, Kozlik noted.

"It's important that they get issuance up, but I don't know that that will happen until rates stabilize," he added.

What's ahead for 2010? According to Kozlik, the picture may not be perfect, but he does not expect a "municipal meltdown." Kozlik said he has heard buzz about defaults, but he does not feel there will be major defaults during the year.

Additionally, Kozlik said he feels insurance will still have some value to some issuers in 2010. But not everyone agrees with this.

"I'm not so sure I agree entirely," one sellside source countered.

"Insurance might have some value, but mostly for lower-rated issuers. Some new [bond insurance] names may come up in the new year, but the market is always wary of newcomers, quite frankly."

First BABs were most interesting

Among the specific offerings of 2009, several market insiders said they felt the first Build America Bonds issued in April and May were among the most interesting.

"I think the [New Jersey] Turnpike Build America Bonds were the first BABs," said one sellsider.

"That would be my pick for the most interesting, just because they were kind of groundbreaking."

The New Jersey Turnpike Authority sold $1.75 billion in series 2009 revenue bonds on April 20.

The bonds (//A) were sold on a negotiated basis with Morgan Stanley & Co. as the lead manager.

The offering included $1.375 billion in 7.414% taxable bonds due 2040, which priced at 370 basis points over Treasuries. The sale also included $300 million in series 2009 tax-exempt bonds, which are due 2039. Those 5.25% bonds were priced to yield 5.35%. The authority also sold to retail investors $75 million in 5% tax-exempt bonds due 2028, which were priced to yield 5.03%.

Kozlik said he feels the BABs were the most interesting in part because of their wild popularity and because of the tightening spreads. The U.S. Treasury, Kozlik said, expected the BABs program would cost about $53 million in subsidy payments. He estimates that the program has actually cost $1.4 billion for 2009. In 2010, the Treasury has estimated that BABs will cost $323 million, but Kozlik anticipates that the Treasury will pay out $2.6 billion in subsidy payments.

Additionally, spreads have been tightening on BABs, Kozlik said, and that makes them, on a broad level, some of the most interesting bonds issued during 2009.

"I really wish I had been one of the people buying the early Build America Bonds," he said.

The average spreads on BABs issued in April and May ranged from 180 to 200 bps, and now those spreads are between 150 to 165 bps, Kozlik noted.

California bonds draw interest

In addition to Build America Bonds, market insiders reported that California's bonds were of interest during 2009 as well.

"I think the real interest in California bonds this year was just watching to see how cheap they were going to go," said one sellside source when asked about his thoughts on the most interesting offering of 2009.

"As the economy there has crumbled, it's been interesting to look at how yields have risen. I don't have the pricing sheets for every California deal here, but I recall some of the BABs had yields near 6%, even after the subsidy."

Another sellsider said he felt California was an interesting place to watch during 2009, simply because of the economic issues.

"I can't really think of one deal that stands out for me, but California in general seemed to be where everyone was watching," he said.

"It might have more to do with the budget problems there than anything else. Honestly, I'm not sure what's going to happen next year [in 2010]. It would be nice if they [California] can fix some of the mess, but it might be beyond repair without government help. Looks like California might be this year's AIG."

Looking at a specific offering, one market insider pointed to the state's $4.138 billion sale of series 2009 tax-exempt G.O. bonds and Build America Bonds.

The bonds (Baa1//BBB) were sold through lead manager Goldman Sachs & Co.

The sale included $2.82 billion in taxable bonds and $1.75 billion in Build America Bonds, said Joe DeAnda, spokesman for the state treasurer's office.

Yields on the taxable bonds range from 3.75% to 7.23%, and yields for the tax-exempt bonds range from 2.95% to 5%. The net yield on the BABs was 4.7% after factoring in the 35% federal subsidy.

Retail investors bought $505.2 million of the bonds, including $427.7 million in tax-exempt bonds and $77.5 million in taxable bonds. Retail investors bought up 33% of the tax-exempt bonds offered them, and 31% of the taxable bonds offered them. Institutional investors bought the rest.

Proceeds from the deal will fund capital expenditures.

California Statewide deal stands out

Another market insider said he felt one of the more successful sales of the year was a $1.9 billion sale of revenue bonds from the California Statewide Development Authority.

"In terms of things I worked on during the year, the California Statewide Development deal was probably one of the true success stories," he said.

"You know, it's a California issuer, which to some investors has been a big drawback, but they went in with an A [rating from Standard & Poor's], and I think that made a difference. We were pretty proud of that."

Moody's Investors Service rates the authority Baa1, and Fitch Ratings rates it BBB.

The offering, which priced in November, included $395 million in bonds and $1.5 billion in bonds. Both bonds are due June 15, 2013. The $395 million in bonds have a 4% coupon, priced at par, and the $1.5 billion in bonds have a 5% coupon, priced at 103.295.

Goldman Sachs was the senior manager.

Proceeds will be used to repay borrowings from local property taxes.

Secondary may falter in 2010

In the year ahead, traders reported that the secondary market may not see the pull it did in 2009.

"Build America Bonds are basically pulling [buyers] away from secondary," noted one trader.

"I'm thinking in 2010, we'll still see investors really looking more toward primary, particularly those BAB deals. Maybe toward the end of the year [2010], things will pick up. There's a December cutoff for BABs, and that might actually help secondary volume somewhat."

In terms of what traded during 2009, the trader said that there was a lot of interest in secondary for health care bonds, including bonds from Catholic Health Care West.

"They're a frequent issuer, at least for the health care sector," said the trader.

"It's not that shocking that they get traded pretty frequently."

Not long after pricing, Catholic Health Care's 5.125% 2034 bonds sold in early November through the Colorado Health Facilities Authority were seen at 4.75%. And the bonds were recently seen trading at 4.426%.

"Health care is one sector we expect to see [in 2010]," said the trader.

"Other things we'll probably see is the typical universities, housing, straight G.O.s, things like that. I don't think there will be any particularly new trends for what trades next year."

In other trading news, California's 5% 2017 economic recovery bonds, which were priced in late October, were trading near 4.17% after pricing. The same bonds were seen recently at 3.65%. The 5% 2022s were trading at 4.85% right after pricing, and were seen recently at 4.416%. The 4% 2016s traded near 3.93% shortly after pricing. Those bonds were seen recently at 3.736%.

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