Bloomberg News

Build America Bonds Closing Treasury Gap May Rally: Muni Credit

September 22, 2011

Sept. 22 (Bloomberg) -- Build America Bonds, the federally subsidized securities spawned by President Barack Obama’s economic-stimulus program, are the cheapest relative to Treasuries in nine months and may be poised to rally as investors seek higher yields.

Issuance of the Build America Bonds ended Dec. 31 when Congress declined to extend the program after almost $188 billion in sales. The taxable borrowings, part of the $814 billion stimulus, enabled states such as California and Massachusetts to win purchases from international investors.

Treasury yields have fallen faster than rates on Build America Bonds, which were 241 percent of those on government debt as of Sept. 20. That’s higher than this year’s average of 202 percent, according to a Wells Fargo index. In the fourth quarter, the gap may attract purchasers looking for relative value, said Mikhail Foux, a credit strategist at Citigroup Inc.

“Because it’s widened so much there will be more buyers,” Foux said in a telephone interview. “You could see more trading.”

Build America Bonds are already outperforming Treasuries and corporate debt this year.

The total 2011 return on Build America Bonds was 20.5 percent through yesterday, compared with 6.9 percent for corporate securities, according to Bank of America Merrill Lynch indexes, which include price changes and interest income. Treasuries gained 8.9 percent.

Higher Returns

Build America Bonds have produced higher returns because rates on those securities dropped this year after they were priced in 2010 and 2009 with yields above Treasury and corporate rates, said Peter Demirali, who manages $350 million of taxable municipals at New Jersey-based Cumberland Advisors.

Yields on Build America Bonds have fallen by 128 basis points this year to 5.06 percent yesterday, just above the two- year low of 5.04 percent on Sept. 19, Wells Fargo data show.

“When the original deals came, many of these benchmark issues came well over 300 basis points above corresponding Treasuries and to some extent almost double the spread of similar-rated corporate debt,” Demirali said in a telephone interview from Vineland, New Jersey. “They were significantly undervalued in the marketplace.”

Spreads Narrow

An A+ rated New Jersey Turnpike Authority Build America Bond sold on Dec. 8 and maturing January 2041 priced with a 7.1 percent yield, 264 basis points above that day’s 30-year Treasury rate. Intel Corp, the world’s largest computer chipmaker, Sept. 14 sold an A+ rated $1 million bond maturing October 2041 at 4.85 percent, 160 basis points above the 30-year Treasury index.

Yesterday, the yield on the Turnpike’s bond had narrowed to 242 basis points above Treasuries.

A limited supply of Build America Bonds resulting from the program’s end also helps the municipal securities produce greater returns than corporate bonds, Demirali said. Build America Bonds account for almost half of Cumberland’s $350 million taxable fund, he said.

The Obama administration created Build America Bonds to lower borrowing costs for localities with a 35 percent federal subsidy on interest. The program financed clean-water projects in Ohio, highways in Kansas, dormitories at Rutgers University in New Jersey and a bridge spanning the San Francisco Bay.

California and New York City, two of the three largest issuers of municipal debt, marketed the bonds to overseas investors, who typically invest in corporate debt and can’t take advantage of the U.S. tax exemption available on traditional municipals.

International buyers boosted their holdings of U.S. munis to $73 billion by the end of 2010 from $50.5 billion in 2008 on the strength of the taxable securities, according to Federal Reserve data.

Following is a description of a pending sale of municipal debt:

CONNECTICUT STATE HEALTH & EDUCATIONAL FACILITY AUTHORITY, which sells bonds on behalf of hospitals, colleges and universities, will sell as soon as today $260 million of revenue bonds for Hartford HealthCare. The securities are rated A, S&P’s fifth-lowest rating. Citigroup Inc. will lead a syndicate of banks on the sale. (Updated Sept. 22)

--Editors: Walid El-Gabry, Mark Schoifet

To contact the reporters on this story: Michelle Kaske in New York at mkaske@bloomberg.net

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net


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