Build America Bonds Proving Gift That Keeps Giving: Muni Credit

Build America Bonds, orphaned after Congress failed to extend the program in 2010, are on a pace to beat Treasuries and tax-exempt municipal debt for a third straight year.

Created by President Barack Obama’s 2009 economic stimulus, the taxable local-government bonds have earned 8.3 percent this year through Sept. 12, compared with 1.7 percent for federal debt and 5.8 percent for tax-free munis, Bank of America Merrill Lynch data show.

Issuers from California to Maine sold $188 billion of Build Americas in the program’s 21 months, data compiled by Bloomberg show. Congress has resisted renewing it amid Republican opposition to the program, which subsidizes 35 percent of issuers’ interest costs. At a time when local-government interest rates are close to 45-year lows, Build Americas offer a yield boost that has also lured international buyers who don’t benefit from traditional munis’ tax exemption.

“It’s really been hard to find” the securities, said Justin Hoogendoorn, a fixed-income strategist at BMO Capital Markets in Chicago. “It’s kind of a food fight.”

Concern that European leaders may fail to contain their debt crisis has fueled a U.S. fixed-income rally that has depressed interest rates in the $3.7 trillion muni market.

Yields on tax-frees due in 20 years fell to 3.61 percent in July, close to a 45-year low, according to a Bond Buyer index.

Yield Quest

Build Americas yield about 4.5 percent on average, or 1.5 percentage points more than 30-year Treasuries, according to a Wells Fargo index with a 27-year maturity. Corporate bonds due in 2042 yield about 0.80 percentage point more than Treasuries, according to Moody’s data.

“The additional spread that you see on BABs sets them up to continue to have pretty favorable return characteristics,” said Jamie Iselin, who helps oversee $10.5 billion as head of muni fixed-income at New York-based Neuberger Berman Group LLC.

A Build America bond that California issued in 2009 and that is due in 2039 traded yesterday with an average yield of 5.3 percent, or about 2.35 percentage points above 30-year Treasuries, data compiled by Bloomberg show.

The most-populous state sold about $14 billion of the bonds, according to the treasurer’s office.

Reinstatement Proposal

The fiscal 2013 budget offered by Obama, a Democrat, included a proposal to permanently reinstate the program with lower subsidies of 30 percent through 2013 and 28 percent beginning in 2014, Michael Zezas, head of muni strategy at Morgan Stanley in New York, wrote in a Sept. 4 report.

The securities were intended to lower borrowing costs for localities and boost job-creating infrastructure spending, from clean-water projects in Ohio to a bridge across the San Francisco Bay.

Demand for Build America debt has been fueled by the lower default rate on munis relative to corporate bonds.

From 1970 to 2011, an average of 0.08 percent of investment-grade munis that were sold a decade or more earlier defaulted, compared with 2.61 percent for investment-grade company bonds, according to Moody’s Investors Service.

“As much as people like to buy corporates, the historical default rates are much, much lower in municipals,” Hoogendoorn said. “If you can get that same quality in a taxable municipal bond, it’s a really attractive item for investors.”

In trading yesterday, yields on 10-year tax-exempts with a AAA rating rose about 0.02 percentage point to 1.77 percent, data compiled by Bloomberg show. The yield touched 1.63 percent in July, the lowest for a Bloomberg Valuation index starting in January 2009.

Following are pending sales:

METROPOLITAN TRANSPORTATION AUTHORITY in New York City is set to sell $1 billion of revenue bonds as soon as next week to refund debt, data compiled by Bloomberg show. (Added Sept. 14)

BAY AREA TOLL AUTHORITY, California, plans to offer $716.5 million of revenue bonds as soon as next week, data compiled by Bloomberg show. Proceeds will refund debt sold in 2006, according to Fitch Ratings. (Added Sept. 14)

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

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net

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