Articles

Build American Bonds

Alan Remedios, PM Fixed Income Investments

February 19, 2010

With 2010 at our footstep, a look back to the municipal fixed income markets in 2009 provides interesting perspective on what's to come this year. Indeed, the past year began with great consternation about the fallout from the 2008 fiscal and credit crisis - culminating in wide credit yield spreads. Also, there was great debate about the political willingness and effectiveness of governmental support for states - thus placing pressure on the entire municipal sector.

With the benefit from hindsight, we now know that 2009 ended with a bang for the municipal bond market. Indeed, those wide credit spreads narrowed throughout the year providing for stunning performance for the municipal sector, especially for lower quality issuers. Additionally, we also know that the federal stimulus (the American Recovery and Reinvestment Act of 2009 - ARRA) created the Build America Bond program (BAB) which was very effective and popular with both issuers and investors.

While the state of municipal credits will remain challenging this year, the markets are suggesting that municipalities are coming to grips with realities of balancing budgets. At First Foundation Advisors, we find the outlook for the BAB program appealing as it is changing the landscape for the overall marketplace and will provide more interesting investment opportunities for our clients.

We have analyzed the program and outlook for the new-year. Below is a recap of our analysis.

The program

• The program (starting in April 2008) is designed to allow states to fund infrastructure projects such as roads, schools and sewers at preferential rates
• The program will likely be extended into 2011 or 2012 (currently scheduled to expire at the end of 2010)
• The California BAB issues are taxable for Federal income purposes but remain state tax-exempt for California domiciled investors (issuers receive a federal subsidy, currently 35% of the interest paid)
• Issuance in 2010 is likely to swell to $130 billion ($64 billion sold in 2009) as states take advantage of the federal program - this would amount to 30% of overall municipal issuance
• Maturities typically are long-term - between 10-30 years

The market

• The investing audience for these issues is large and diverse - pensions, endowments, foundations and individuals (not to mention the global marketplace)
• Yields have been relatively attractive versus taxable alternatives such as Government and corporate issuers (and to municipal yields depending on tax bracket)
• The long-term nature of the maturities is acting to reduce the supply of traditional long-term tax-exempt municipals - creating a flatter yield curve

Opportunities

• Liquidity improving as larger states access the marketplace i.e. California, Pennsylvania, New York and Texas
• Demand likely to remain strong
• Attractive relative yields versus alternatives
• Given the finite nature, scarcity of issues and increasing acceptance of the structure may provide solid performance

We are excited out the outlook for the overall municipal marketplace given the above analysis and feel that 2010 will be a constructive one for investors. We look forward to working closely with you this year in helping you reach your goals and objectives.

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