The municipal market got a whole lot more interesting in 2009, thanks to the introduction of new types of taxable municipal debt by the Treasury Department as part of the American Recovery and Reinvestment Act of 2009. This gave fans of municipal bonds more types of municipal debt to invest in, while enabling states and local municipalities to put people to work on infrastructure projects subsidized by the federal government.
Because some of these new types of munis are taxable, they can be purchased by a wider variety of investors–including those who might not have benefited from the tax-exempt nature of typical munis. Municipalities and states benefit too, effectively issuing debt at low rates, and taking advantage of the federal subsidies.
While tax-free municipal debt issuance won’t match 2008 levels, it will be higher, and taxable muni issuance will sharply rise in 2010, according to a forecast from The Securities Industry and Financial Markets Association (SIFMA). The “SIFMA 2010 Municipal Issuance Survey” projects a healthier outlook for municipal debt issuance overall, with higher interest rates starting in mid-2010.
More than half of the firms participating in the survey believe rates will rise based on “inflation” concerns, while others indicated that they believe rates will rise based on “the size of the federal deficit and expected borrowing needs.” The forecast projects that the 10-year Treasury yield will rise to 4.38% by the end of 2010, and that the 2-year Treasury note will yield 2.0% by then. They also expect that the ratio between AAA-rated general obligation muni yields and Treasury yields will normalize “to where they were before the credit crisis,” falling to 80% of the 10-year Treasury by the end of 2010. Spreads had widened considerably during the crisis, as so many investors jumped into Treasury securities. In December 2008, the ratio was around 170%.
The forecast projects aggregate taxable and tax-free municipal issuance to rise 7.9% to $450.5 billion for 2010, from an estimated $418 billion in 2009. Taxable munis–though proportionally a much smaller fraction of the overall muni market–account for the largest overall increase in issuance–45%–from $76 billion in 2009, to $110 billion in 2010. This includes “direct pay” Build America Bonds (BABs), taxable municipal debt issued to finance state and municipal capital improvement and infrastructure projects under the American Recovery and Reinvestment Act of 2009. Issuance of this type of BAB is expected to leap 46.6%, to $85 billion in 2010, from an estimated $58 billion in ’09. In addition to direct pay BABs, the survey projects the largest percentage gain will be for issuance of “tax credit” debt, soaring 400% from $1 billion in 2009 to $5 billion in 2010. These include tax credit BABs, plus “qualified school construction bonds (QSCBs), clean renewable energy bonds (CREBs), and qualified zone academy bonds (QZABs),” according to the report.
Build America Bonds have become popular enough that, in November, Invesco PowerShares launched a Build America Bond Portfolio ETF, (symbol BAB), based on the BofA Merrill Lynch Build America Bond Index.
A note on these new taxable munis: Direct pay bonds have yields that compare with other taxable debt, so investors receive a taxable yield that’s higher than that of tax-free munis. State and local governments receive “direct subsidy payments…for a portion of their borrowing costs,” according to a May 21, 2009 statement before the House Subcommittee on Select Revenue Measures of the Committee on Ways and Means by Alan B. Krueger, Assistant Secretary for Economic Policy and Chief Economist, at the Department of the Treasury.
Tax credit municipal bonds, on the other hand, provide investors with “a Federal tax credit equal to a set percent of interest received. The tax credit provides investors with a subsidy just sufficient to make them indifferent between the tax credit bond and an otherwise similar taxed bond,” according to the Krueger statement.
Tax credit bonds can also be “stripped” into separate securities in which the bond’s cash flow and tax credits are parted, packaged and sold to different investors.
In tax exempts, the report says issuance of variable rate demand obligations (VRDOs), should increase 16.7%, from $30 billion estimated for 2009 to $35 billion in 2010. Long-term tax-exempts (for this survey described as one year or more to maturity) are expected to grow by 7.8%, from the $323 billion estimate for 2009 to $347.5 billion in 2010. Short-term note (one year or less) tax-exempt issuance should rise by 5%, from $65 billion in 2009 to $68 billion in 2010.
Comments? Please send them to email@example.com. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.