Bond Bonanza?

REVIEW SUMMARY
What. Build America Bonds.
Issue. Do bonds hurt taxpayers and should Congress extend the program?
Impact. Taxpayers subsidize Gulf Coast governments issuing nearly $500 million in Build America Bonds in 18 months.
By the numbers. The Gulf Coast has issued $478 million in Build America Bonds.

A 19-month-old federal program so popular on the Gulf Coast that government agencies have issued nearly $500 million in bonds through it, could be in trouble because of its costs to taxpayers.

In addition to the “Build America Bond” program's $36 billion cost in the face of a $1.3 trillion federal deficit, a new study finds that the program is benefiting pension funds and foreign investors at further cost to taxpayers.

But eliminating the program could have serious ramifications for what's become nearly one-fourth of the U.S. municipal bond market — $160 billion in just 18 months. In that time, according to data assembled by the Business Review, roughly 1,900 Build America Bonds have been issued.

Data from Reuters published by the Securities Industry Financial Markets Association, shows there's been 1,011 deals this year through the third quarter, totaling $72.5 billion. Florida's share year-to-date exceeds $2.5 billion. The volume for the rest of the long-term municipal bond market is $224.7 billion.

Buried in the Feb. 2009 federal stimulus bill is language allowing local and state governments, public hospitals, school boards and universities to issue taxable municipal bonds to fund capital improvements they could otherwise finance with tax exempt municipal bonds.

One version of the bonds — the most popular with state and local governments — provides a direct federal subsidy of 35% of the bond's total coupon interest. A Treasury Department study of the first 12 months of the program through March claims the bonds saved state and local governments roughly $12 billion in interest costs.

But a recently released Columbia University Business School study calculates that the bonds are, on average, a bad deal for individual U.S. taxpayers, the typical buyers of municipal bonds, known as munis.

“If you are a retail investor, you decide between a Build America Bond and a regular muni, and you're better off with a muni,” says Columbia finance professor Andrew Ang. That's because traditional tax-exempt municipal bonds provide a higher after-tax yield to individual investors.

A bond finance expert, Ang led a three-man research team that prepared the working paper for the Cambridge, Mass.-based National Bureau of Economic Research, a private, nonprofit, nonpartisan research organization.

Ang says it's the first and only formal analysis of the Build America Bonds market not authored by the U.S. government. The study looked at $63.4 billion in Build America Bonds issued from April through Dec. 2009 and compared those to $332.2 billion in tax-exempt deals issued during the same timeframe.

Because Build America Bonds are taxable, the average unsubsidized yield of 3.69% drops to an effective after-tax yield of 2.32% on average. Tax-exempt municipal bonds, in comparison, yield 2.86% making them typically a better deal for individual investors.

Also, because the bonds are generally sold in larger amounts than tax-exempt bonds, and typically have longer maturities, the Build America Bonds are relatively more attractive to institutional buyers.

That's one of the reasons the program came to be.

'Cool thing'?

The municipal bond market was in dire straits in late 2008 and early 2009 when President Obama signed the American Recovery and Reinvestment Act, the stimulus bill. The program, it was thought, would open the municipal bond market to more institutional investors.

And that it did, but at the cost of individual U.S. taxpayers in Ang's view. That those are the same people footing the bill for the subsidies, while giving a bonus to foreign investors and others not paying income taxes, raises big policy questions for politicians to consider, especially given the budget deficit.

Pension funds, for example, have long-term horizons, so longer maturities match up well with those funds' objectives. For 2009, the average size of a Build America Bond was $10.2 million, according to the study. The average size for a tax-exempt bond was $3.5 million. For Build America Bonds, 54% had maturities greater than 10 years, while only 36% of tax-exempt bonds were longer than a decade.

The analysis shows that on average, local and state governments have been getting financing at 54 basis points cheaper than issuing bonds in the regular tax-exempt municipal bond market. A basis point is 1/100 of a percent.

Government agencies up and down the Gulf Coast have been taking full advantage of the federal government's largesse by issuing nearly $500 million in Build America Bonds since its inception.

More deals are on the immediate horizon as government agencies race to beat the Dec. 31 deadline. According to Fell Stubbs, treasurer for the University of South Florida, the USF Financing Corporation plans to piggyback on its existing $10 million Build America Bond with a $13.5 million deal this fall to fund new athletic facilities.

Stubbs, who doubles as the corporation's executive director, says two more projects are moving ahead too, including an $18 million mixed-use residence and student center project for the St. Pete campus.

The Build America Bond financing, Stubbs says, saves USF 60 basis points versus tax-exempt bonds, meaning a savings of $2.3 million over the 20- to 30-year life of the bonds. Says Stubbs, “It's a very cool thing.”

The city of Sarasota was the first in Florida, issuing a $21.1 million bond in May 2009. Those funds are paying for the Robert L. Taylor community complex in Newtown, the controversial downtown city parking garage project on Palm Avenue, and the purchase of lands on U.S. 301 to complete a deal with Sarasota County that removed three businesses from the tax rolls.

In September, the city issued another Build America Bond to pay for citywide water and sewer improvements. And now, with a recent Florida Supreme Court decision, Sarasota County plans to move ahead to use the bond program to fund part of its contribution to the reconstruction of Ed Smith Stadium.

The city and the county will also take advantage of another version of the bond program. Two “recovery zone” bond programs provide a 45% subsidy for projects meeting unemployment criteria in economic recovery zones. County officials estimate a $4 million savings over the life of those bonds.

Local governments across the state are allocated $538 million for recovery zone economic development bonds and $808 million for recovery zone facility bonds. Unlike the Build America Bonds direct subsidy program, these programs have caps.

Lee County is allotted $93.5 million from recovery zone bond programs, but is also using Build America Bond bucks to build its new spring training stadium for the Boston Red Sox. The $42.5 million bond, issued in September, is backed by tourist development tax revenue.

Lee Memorial Health System issued its own $42 million Build America Bond last April to finance renovations to the original Gulf Coast hospital building. A spokesman says the effective interest rate for the hospital would have been 7.28% without the 35% subsidy, instead of 4.73%.

The Peace River Manasota Water Supply Authority has issued a $29.6 million bond to fund pipeline extensions. The authority saves 51 basis points compared to a tax-exempt issue. Break-even, Yates says, is at 40 points.

One deal, though legal, may give federal officials another reason to bury the bond program by letting it expire.

Ultimate payers

Hillsborough County issued a $48.125 million Build America Bond to finance the purchase of environmentally sensitive lands. So, U.S. taxpayers with their own $1.3 trillion budget deficit to rein in, are subsidizing the purchase of county land that removes property from county tax rolls, and a time when the county is dealing with record budget deficits.

The bottom line in this case is that the county saves on the coupon interest costs only to lose it on the back end with the perennial loss of property tax revenue.

How much building can occur on environmentally sensitive land with Build America Bonds? And how many jobs can be created with this kind of “stimulus” spending?

Taxpayers are getting hit at the local level, and also with the bond program's part of the stimulus' $800 billion price tag, Professor Ang's chief concern.

“The issuers don't give a damn,” observes Columbia's Ang. “But who should give a damn is the people ultimately paying for this and that's the taxpayer.”

Professor Ang and his colleagues raise some other issues in their study of the bond program. One is that there's a real risk for the Build America Bond market that the IRS could rescind some of the tax benefits should Congress lower the 35% subsidy.

That idea is already on the table in a broad House bill (H.R. 4849) that calls for extending the program to June 2013, but gradually lowering the subsidy to below 30%. It passed in March. A Senate bill (S. 3793) lowers it to 32% and extends it for a year, but has failed to reach the Senate floor.

U.S. Rep. Vern Buchanan, R-Longboat Key, voted against the House bill.

In an email from a spokesman, Buchanan opposed the measure “primarily because it increased taxes on employers, which is the last thing we should do as we try to get the economy moving. ... We have to stop deficit spending on government programs that haven't created jobs.”