Market participant floats limiting amount that can be issued per year
As the Obama administration continues its relentless pursuit of the tax exemption of municipal bonds, at least one muni market participant is proposing an alternative that could introduce the kind of “fairness” that the president seeks.
Instead of capping the exemption at 28%, as President Barack Obama supports, why not put some limits on the amount of tax-exempt bonds that municipalities can issue in a given year?
Peter Coffin, president of Breckenridge Capital Advisors Inc., thinks that limiting every muni bond issuer in the country to $100 million worth of tax-exempt issuance per year would go a long way toward solving many of challenges and criticisms that the $4 trillion muni bond market faces.
“Part of the reason the administration is proposing limiting the exemption on tax-free bonds is because tax-free yields, when compared to corporate bonds, are too good of a deal for investors,” he said. “The market can't absorb all the tax-free debt, so the yields on those tax-free municipal bonds rise relative to taxable bonds.”
Limiting annual muni bond issuance at $100 million per issuer would affect only about the 100 largest muni bond issuers, and it would cut annual tax-exempt issuance roughly in half, Mr. Coffin said.
For the vast majority of local municipalities, the result would be lower borrowing costs because reducing the overall issuance would force yields lower. And that, in turn, would reduce or eliminate the advantage that muni bond investors have been enjoying since the financial crisis.
“The municipal bond market consists of a lot of small issuers and a few large issuers,” Mr. Coffin said. “The small issuers, that issue debt occasionally, need the tax exemption because they would get lost in the taxable-bond market, because institutional investors are not going to invest in debt from small, occasional issuers.”
The minority of large muni bond issuers, by contrast, “can and should come to the taxable-bond market, because the institutional market is ready and willing to finance them very efficiently,” Mr. Coffin said.
Naturally, not everyone is on board with his proposal.
“I think the bigger bond issuers have some pretty big projects, and switching over to taxable bonds would raise their cost of borrowing,” said Tom Dalpiaz, senior vice president at Advisors Asset Management Inc.
He cited the taxable Build America Bonds program, which is supported by a federal subsidy, as proof that the muni market can and will support both taxable and tax-exempt bonds.
“The BABs program allowed municipalities to reach a different audience, but I think they liked having both of those options,” Mr. Dalpiaz said. “But I'm not sure they would like being forced to go the taxable route.”
Mr. Coffin's proposal would force the taxable route only after the municipality already had issued $100 million worth of muni bond in a year.
Both Mr. Dalpiaz and Mr. Coffin recognize that without placing limits on issuance, the muni market might have become overly dependent on debt to pay bills, finance projects and balance state and local budgets.
“There are some people who think the exemption encourages municipalities to issue debt and encourages over-borrowing,” Mr. Dalpiaz said.
