A key municipal financing tool utilized after the Great Recession was revitalized Friday as well as other large changes to the municipal market. Part of the Democrats’ $3.5 trillion economic agenda, a draft bill released by the House Ways and Means Committee would reinstate Build America Bonds (BABs), allow issuers to advance refinance debt on a tax-exempt basis, and raise higher marginal income tax rates for high-net-worth individuals.
Likely Surge in Tax-Exempt Supply
Build America Bonds were a product of the American Recovery and Reinvestment Act of 2009. BABs lower state and local government borrowing costs since the federal government covers a portion of interest costs – either directly by paying 35% of interest cost or via tax credits to bondholders worth 35% of the interest earned.
Before the program’s sunset, the market issued $187 billion of BABs during 2009 and 2010 – or nearly 25% of total issuance during this time. It’s tough to gauge how much new supply could result with BAB’s reincarnation but annual issuance could easily surpass $500 billion for the first time.
In Colorado, total BABs issuance was $4.1 billion during 2009/2010 and accounted for 30% of the Colorado market’s total supply.
Many of the state’s largest issuers took advantage of the cost savings. However, small towns and water districts also utilized the BABs program with the state’s smallest borrowing coming from Denver Public Schools at $1.5 million.
The draft proposal also provides for advanced tax-exempt refunding – a commonly used tool that was eliminated by the 2017 Tax Cuts and Jobs Act. The 2017 elimination pushed municipal issuance into the taxable side as issuers were still able to find cost savings thanks to historically low nominal yields. The chart below shows the dramatic uptick in taxable borrowing in the municipal market now consistently representing +20% of total issuance.
While a deal is far from done (two Democratic Senators have shown hesitancy in supporting the $3.5 trillion plan since Sunday) the proposal has piqued the municipal market’s interest. Heavy inflows have forced most investors to put cash to play in a limited number of deals. Upticks in supply may provide some breathing room and allow for more selectivity. Lower demand and high supply might bring some relief to overstretched valuations.
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