With the issuance of U.S. Treasury securities a hair’s breathe away from a trillion and a half dollars for 2009 and the prospect for next year’s flood of Federal paper easily topping that level, Uncle Sam has “depended on the kindness of strangers” to finance his profligate ways for some time now.
To the extent we learn best by example, or put another way, monkey see, monkey do, the states - not as in the United States but the individual states - are now looking to far off horizons to sell their debt. Illinois will be the first of the “50” having registered bonds for sale in Europe as part of its $3.5BN debt offering scheduled for sale this week and New York and California, the nation’s largest municipal bond issuer are both seriously considering the move. “I’m sure all of the states are willing to tap into foreign demand,” Breckinridge Capital Advisor president, Peter Coffin said.
With rates on the U.S. 10-year moving from 2% in January to about 3.79% last night, buyers both foreign and domestic are demanding more compensation to take on Uncle Sam’s debt. The collapsing of credit spreads in 2009 was the only thing that saved the corporate and municipal debt markets as yields on the underlying Treasuries did not rise as fast as the prospect of financial Armageddon receded netting an approximate 9.08% gain for investment grade corporates (NYSEARCA:LQD), 37.33% for high yield (NYSEARCA:JNK) and 7.25% for municipals (NYSEARCA:MUB) vs. a -21.38% loss for long dated Treasuries (NYSEARCA:TLT) and a -5.94% hit on the shorter end the curve (NYSEARCA:IEF).
One method used by states looking to raise capital from others besides those stateside is a new vehicle known as Build America Bonds which are taxable, pay a higher return to investors than regular muni’s but are actually as cheap or cheaper for the states to issue due to good ‘ol Uncle Sam chipping in for 35% of the coupon. [Editor's note: PowerShares recently launched a Build America Bonds ETF (NYSE:BAB), the first of its kind.]
Washington state issued a bond on October 15th at what Treasurer James McIntire called a “record low” effective yield of 3.52%, saving the state $63MM on a $500MM issue.
An interesting twist here is that even though the BAB’s are allowing the states to finance more cheaply, investors are actually demanding higher yields on this paper with the spread between taxable muni’s and BBB corporate paper widening from 80bps three months ago to 125bps last week. There is also a spread premium to higher rated corporate paper of 10bps, 25bps and 45bps on AAA, AA and A respectively.
Build America Bond’s produce taxable income for domestic investors but not so for foreign purchasers hence non-U.S. domiciled holders get a yield pickup; the issuing state gets access to low cost capital and Uncle Sam goes deeper in debt financing the difference. C’mon, did you really think it was going to land up any differently?
The popularity of BAB’s is growing as, starting in April, $64.3BN were issued in 2009 and about $130BN are scheduled for next year which will be approximately 30% of total expected municipal issuance in 2010.
Another reason for the increase issuance in 2010 is a change looming in Congress as to whether the 35% subsidy should be continued beyond its 2010 expiration and if so whether all BAB’s should carry the same subsidy.
Ron Wyden (D, OR) who proposed the bonds as an experiment six years ago said, “there will inevitably be a debate about cost.” Hopefully there is enough blue in that dog to make the debate a healthy one.
Enjoy the Holiday shortened week.