Just as an overview, the municipal bond market has an approximate value of $2.7 trillion. Over the last 4 years, the median municipal bond issuance has been $400 billion.
In the past, investors had the benefit of simply needing to know two things: whether the municipal bonds were AAA-insured by one of the monoline bond insurers (AMBAC, MBIA etc. ), and whether the municipal bond income was or was not subject to the Alternative Minimum Tax. Over the last 12 months, the use of AAA-insurance has been largely discredited. Investors must now rely on old-fashioned credit analysis to understand the unsecured creditor status on an opaque municipal bond. Because of recent legislation, banks can now own, up to 2% of assets, non-bank-qualified muni bonds. The recently passed Stimulus Bill offers municipalities a new tax-credit bond option, allowing a municipality to pay taxable interest and receive a direct payment from the Federal Government equal to 35% of that taxable interest, called Build America Bonds (BAB).
I have recently reviewed an investment bank’s external pitch book (paper copy) to municipalities on these BABs, which are referred to as the Tax Rebate Bond Option. The bankers are showing municipalities how to cut their costs (eg. issue taxable bonds further out and tax-exempt bonds with shorter maturities). In one example, a municipality could increase the average life of the bond, BUT lower the overall yield by 0.40%. Great trade for the municipality. The anticipation on new BAB issuance is $50 to $100 billion for 2009, which may limit the issuance of tax-exempt bonds, which was roughly $400 billion per annum.
Bottom line: The good news: additional liquidity in the muni bond market. The bad news: increased complexity, and potentially lower yields for taxable investors.
Always Asking, Never Assuming™
Christopher Holtby