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Chicago, San Antonio Offering Build Americas Bonds: Muni Credit

Chicago and San Antonio, the third and seventh most-populous U.S. cities, are selling a total of $750 million in Build America Bonds amid an Internal Revenue Service audit of previous sales of the taxable securities.

The IRS is probing San Antonio’s sale of $375 million in federally subsidized debt for its municipal utility, CPS Energy, in June 2009. The agency is also looking into the Metropolitan Water Reclamation District of Greater Chicago’s sale of $600 million of the securities in August 2009. The agency is independent of the city. This week’s sales come as Build America issuance reaches $3.9 billion, a 10-month high, according to data compiled by Bloomberg.

While the audits may have no discernible effect on the latest sales, both may be forced to price aggressively given the numbers of Build Americas available, said Mike Pietronico, chief executive officer of New York-based Miller Tabak Asset Management.

“The bigger issue is the gigantic amount of BABs supply coming into the market through the end of the year,” said Pietronico, who oversees $315 million in municipal debt. “The audit is a nuisance.”

San Antonio Bonds

San Antonio’s debt from the previous sale, maturing in February 2039, traded yesterday at an average yield of 5.17 percent, or 126 basis points above a comparable U.S. Treasury. The so-called spread was 106 basis points on Oct. 21. Build Americas from the Metropolitan Water Reclamation District of Greater Chicago, which serves an area of 883 square miles, including the City of Chicago and 125 suburban communities, traded at a spread of 127 basis points on Oct. 22, up from 119 basis points on Sept. 28. A basis point is 0.01 percentage point.

Chicago’s offering this week, secured by a subordinate pledge on the city’s sewer-system revenue, is ranked AA by Fitch Ratings, third-highest; Aa3 by Moody’s Investors Service, fourth-highest; and A+ by Standard & Poor’s, fifth-highest.

Pete Scales, a spokesman for Chicago’s budget office and Chief Financial Officer Gene Saffold, didn’t immediately return calls seeking comment on the debt sale.

Jonathan Baum, director of investment banking for Kansas City-based George K. Baum & Co., the deal’s underwriter, didn’t return calls seeking comment.

San Antonio’s $500 million Build America sale, backed by electric- and gas-system revenue, is rated Aa2 and AA by Moody’s and S&P, third-highest, and AA+ by Fitch, one level higher.

Being ‘Prudent’

It’s unlikely that the audit will affect the deal’s pricing, said Paula Gold-Williams, the chief financial officer of CPS Energy, in a telephone interview yesterday.

“This program has been very, very successful,” she said. “It’s just prudent on the part of the IRS to ensure the program has been administered responsibly.”

Justin Perras, spokesman for JPMorgan Chase & Co., an underwriter on the sale, declined to comment.

Investors are comfortable with San Antonio’s credit, so the audit may not have an impact on pricing, said Jeffery Elswick, director of fixed income at Frost Investment Advisors LLC in the city. The firm oversees $6.6 billion in assets.

“It’s not what folks will focus negatively on,” said Elswick, who said he plans to buy the bonds. “The market right now is receptive to new deals, so it might not affect the market.”

Shifted Attention

The IRS, which monitors abuses by borrowers in the subsidized municipal-bond market, has shifted attention to Build America Bonds since they were created last year. The market has since swelled to more than $148 billion.

The agency is auditing 15 to 20 Build America Bond deals, said Clifford Gannett, the director of the tax-exempt bond division of the IRS.

Among other issues, he said, the IRS is examining initial trading in the securities to see whether jumps in price soon after they are sold run afoul of regulations meant to keep issuers from selling the securities at above-market interest rates. That would boost the cost of the subsidy payments by the Treasury.

In tax-exempt bonds, audits can pose a risk to investors because the IRS can revoke that exemption, exposing holders to tax bills. In the case of Build Americas, investors aren’t exposed to that risk.

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