The “Build America Bonds” were created by Bill S.238 called "The Build America Bonds Act of 2009 which provides $50 billion of federal taxpayer funds to subsidize state and local government tax free bonds in support of 'shovel ready' infrastructure projects.
The U.S. Government gives the issuing municipality or state a 35% rebate on the interest that the issuer pays to the bond holders. This is a huge benefit for local governments.
We have not yet found out why, but it is apparently giving a big benefit to the buyers of the bonds who are getting an income stream at well below market prices for comparable issues. In some cases the BAB bonds are pricing at 149 basis points over comparably rated corporate bonds.
Where is the inefficiency coming from in this bond offering? Who is taking the differential, the vigorish, being granted to the state and cities? Who are the underwriters and the market makers? Who are the big market makers besides Pimco? What are the fee structures being charged compared to the overall bond market?
Meredith Whitney, star analyst that she is, was the closest with her $4.65 prediction. She thinks the stock has lots of room to run, notes Fortune. Goldman, in her mind, will surf the economic woes now roiling the country. Goldman is a top underwriter of municipal bonds and the No. 1 underwriter of Build America Bonds. "These are a new type of municipal bond, part of the Obama administration's $787 billion stimulus plan. Cities, states, universities and government entities use BABs, as they're known, to finance infrastructure projects. This is a potential $50 billion annual market, Whitney says, and Goldman currently holds a 25 percent share," reports a Fortune article.Oh now it all makes sense. Droit de Seigneur.
Bloomberg
Taxpayers Inferior to Shareholders With Obama Bonds
By Michael McDonald and Bryan Keogh
July 22 (Bloomberg) -- State and local governments, forced to close budget gaps by firing workers and shutting schools, may pay at least $4.2 billion more in interest than companies with similar credit ratings on Barack Obama’s Build America Bonds.
The $17.4 billion of Build America Bonds sold since April pay an average yield that’s 0.96 percentage point more than corporate securities with the same ratings, according to data compiled by Bloomberg and based on the 25 largest deals.
“Taxpayers are taking it on the chin,” said G. Joseph McLiney, president of Kansas City, Missouri-based McLiney & Co., a firm that specializes in selling municipal bonds that qualify for federal tax credits. “There should be no spread.”
While Build America Bonds opened credit markets to municipalities after the collapse of Lehman Brothers Holdings Inc., states and cities are being penalized compared with corporations, which are 90 times more likely to default than local governments, according to Moody’s Investors Service....
‘Disserving Their Constituents’
The difference in borrowing costs shows elected and appointed officials are failing taxpayers, said Stanley Langbein, a banking and tax law professor at the University of Miami and former counsel at the U.S. Treasury in Washington.
Issuers are “supposed to get the best rate available,” Langbein said. “To me they’re disserving their constituents. Their responsibility is to get the lowest rate available, which is the corporate rate.”
Congress included the Build America Bonds program in the $787 billion stimulus President Obama signed into law in February, after sales of fixed-rate municipal bonds fell 17 percent last year to $281.1 billion, according to Bloomberg data. Most of the drop followed Lehman’s bankruptcy in September.
The initiative, which expires at the end of next year, provides a federal subsidy for 35 percent of the interest costs on taxable bonds sold by states, local governments and universities to finance capital projects that create jobs. Borrowers say they save money compared with tax-exempt debt because the interest after the federal payments is lower than tax-exempt benchmarks.
‘Priced it Right’
“We feel like we priced it right,” Jennifer Alvey, Indiana’s public finance director, said of the June bond sale. Indiana is paying a rate of 4.28 percent after the subsidy, lower than on tax-exempt bonds, she said. “That’s the difference I care about.”
Investors demand higher rates from municipal borrowers because Build America Bonds are 91 percent smaller than company offerings on average, according to data compiled by Bloomberg.
While California sold $5.23 billion in April, the largest issue so far, Avondale, Arizona, offered $29.8 million on July 6 for sewer and other public improvements. The average par amount for Build America Bonds is $102.5 million, compared with $1.16 billion for the 611 U.S. investment-grade corporate bond offerings this year, according to Bloomberg data.
‘Pricing Power’
Investors also require higher yields because they say the securities may become difficult to trade if the program isn’t extended past 2010, said Natalie Trevithick, a senior vice president at Pacific Investment Management Co. The Newport Beach, California-based firm runs the world’s biggest bond fund, the $161 billion Total Return Fund.
“We do have much more pricing power in these deals,” Trevithick said.
Endowments, foundations and pension funds are overlooking the securities because unlike Pimco, they don’t have expertise to analyze municipalities, said Peter Coffin, president of Boston-based Breckinridge Capital Advisors, which oversees $10 billion in bonds.
“You have a lot of big buyers so there’s less price competitiveness,” said Scott Minerd, the chief investment officer at Santa Monica, California-based Guggenheim Partners, which manages $100 billion.
Alan Krueger, the Treasury’s chief economist in Washington, said Build America Bonds succeeded in reviving the municipal market by lowering debt costs. He said municipal and corporate securities are different, so they are difficult to compare.
‘Good Start’
“Build America Bonds are doing what they were designed to do, which is lower the cost of capital for municipalities and increase access to capital markets,” Krueger said in a July 15 telephone interview. “That’s what Build America Bonds are intended to do, and they’re off to a good start doing that.”
State tax collections fell 11.7 percent to $160 billion in the first quarter compared with the same period in 2008, the largest drop in at least 46 years, the Rockefeller Institute of Government in Albany, said in a July 17 report.
Congress’s Joint Tax Committee estimated in February that the Treasury would spend $9.8 billion through 2019 subsidizing the bonds. Matt Fabian, a managing director at Municipal Market Advisors in Westport, Connecticut, said in a June 22 report that the program’s price tag may reach $27.3 billion by the time all such securities mature in 2044...
The spread is even wider when considering more of the smaller Build America Bond deals, according to Philip Fischer, a strategist in New York at Merrill Lynch & Co., a unit of Charlotte, North Carolina-based Bank of America. He found that on July 15 the average yield on bonds of more than $100 million compared with an index of AA corporate rates was 1.49 percentage point.
“Munis and corporates are apples and oranges in terms of the credit, but does that justify that kind of spread? Not for me,” said Ben Watkins, the director of Florida’s state bond division. Investors in the corporate bond market are “taking advantage of an opportunity.”
