As lawmakers prepare to shelve the Build America Bonds program, investors should strongly consider purchasing the government paper, according to Peter Coffin, president of Breckinridge Capital Advisors Inc. But he also warns that the program's end will trigger uncertainty — and some near-term volatility — in the municipal bond market.
“If the BAB program is allowed to expire, it will not be healthy for the muni market,” said Mr. Coffin, whose firm manages $13.5 billion in muni bond portfolios.
While he is mystified as to why lawmakers would want to end the federal program, he plans to take advantage of the market conditions that will be created if and when BAB issuance ceases.
“If the program expires, demand for BABs will certainly decline, but supply will decline down to zero, so I would expect prices to do better,” Mr. Coffin said. “If they don't extend the program, it's an investment no-brainer.”
The BAB program, which was introduced in April 2009 as a way to attract institutional investors to municipal bond debt investments, is expected to expire on schedule at the end of the year — despite efforts from the Obama administration to extend the program.
Unlike traditional tax-free muni bonds, the taxable BAB program provides state and local municipalities with a 35% federal subsidy to help pay the interest rates on the bonds, which are sold primarily to the kinds of tax-exempt institutional investors that don't otherwise invest in muni debt.
Total BAB issuance from inception through the end of November was more than $170 billion.
Mr. Coffin, who purchased $600 million worth of BABs for his clients, said ending the program will rattle the muni bond market because retail investors, as the primary muni bond buyers, are not equipped to absorb the total flow of muni bond issuance.
“The financing needs of the nation's states and localities outgrew retail investors long ago, but that was masked by the practice of converting long-term debt into short-term floating-rate debt,” he said. “Prior to the BAB program, that was a huge part of how the muni market functioned, but that strategy won't work anymore, because the auction-rate-securities market seized up and died in 2008.”
Mr. Coffin, who believes the BAB program might be reintroduced at some point, issued a press release today designed to “debunk the biggest myths surrounding the BAB market.”
For example, he disputes the argument that disbanding the program will save taxpayer money by eliminating the federal subsidy.
“Municipal borrowing will continue to be subsidized with tax exemption as it has been for 100 years,” he said. “BABs are a different form of subsidy and widely acknowledged to be more efficient, so there is greater public benefit relative to the cost to the federal government.”
On the argument that extending the program would add to the federal deficit, Mr. Coffin explained that the extension proposals include a reduction in the federal subsidy to around 28%, “which the Treasury Department has determined is no more costly than the [traditional muni bond] tax exemption.”
Critics of the program have also charged that the BAB program led to increased borrowing by municipalities.
But Mr. Coffin said that that has not been the case.
“Typically, when a municipality issues debt, they have to go to the voters first,” he said. “And I think the muni market works well in that way.”
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