By Chris H. Sieroty
With credit markets cautious about backing new municipal debt in the midst of a severe economic downturn, Inland Southern California cities and counties have been blocked from issuing municipal bonds to pay for a wide range of basic needs from new highways to school construction and new sewer systems.
But with the passage of the American Recovery and Reinvestment Act, President Barack Obama’s $787 billion stimulus package, cities and counties have the opportunity to go to market with a new type of debt, known as Build America Bonds. The bonds give issuers a 35 percent federal rebate on interest costs for taxable bond issuances.
Paul Sundeen, assistant city manager and chief financial officer with Riverside, said he was considering issuing Build America Bonds when the city goes to market in July with $260 million in Sewer Fund notes. The proceeds from the sale will be used to maintain and upgrade Riverside’s sewer system.
He said the federal rebate could save the city approximately $5 million over the life of the bonds. The Sewer Fund bonds were expected to have a 30-year maturity.
In 2007, the city issued $119 million in non-taxable certificates of participation, and $153 million in tax allocation revenue bonds was issued by the city’s redevelopment agency through a joint powers authority, the Riverside Public Financing Authority. Sundeen said the interest rate on the certificate-of- participation notes was 3.3 percent, while the total interest in the tax allocation revenue bonds, which are partially non-taxable, ranged from 4.56 percent to 5.58 percent. They all mature in 30 years.
He said what makes these new bonds so appealing is “the projected interest savings on the longer-term maturities” compared with the costs associated with the city’s 2007 issuance.
Emil Marzullo, interim executive director of the economic development agency in San Bernardino, said he was studying how much Build America Bonds would save the city if they go to market next year with an issuance to pay for infrastructure projects. Build America Bonds, or BABs, give state and local governments the opportunity to attract corporate debt investors while offering subsidies that reduce costs, particularly for longer maturities, to less than what issuers might obtain in the tax-exempt market.
The securities are also exempt from state and local taxes if purchased within the state that sells them. The legislation created a two-year program that allows state and local governments to issue taxable bonds to fund infrastructure projects and have the U.S. Treasury Department pick up 35 percent of the annual interest cost of the debt.
On April 22, California sold $5.23 billion in the federally subsidized bonds that carry a rate of 4.83 percent. All are in 25-year and 30-year maturities.
“The funding will help secure thousands of jobs for workers and millions of dollars in revenues for businesses which depend on infrastructure projects,” state Treasurer Bill Lockyer said in a statement. “And with the Build America Bonds, we’re providing this much-needed economic stimulus at a substantial savings for taxpayers.”
The yield of the Build America Bonds will save taxpayers about $1.15 billion over the life of the bonds, the treasurer said.
The sale provided a further boost to some 5,000 state projects affected by an infrastructure financing freeze imposed in December 2008 by the state’s Pooled Money Investment Account (PMIA).
Normally, the PMIA lends money to infrastructure projects, then gets reimbursed when the state sells bonds. But in the last half of 2007, California could not sell bonds because of the state’s prolonged budget stalemate and the nationwide credit crunch. At the same time, the fiscal crisis required the PMIA to conserve as much cash as possible to ensure it could help the state pay for education and other high-priority services. So, the PMIA was forced to stop making infrastructure loans.
The freeze delayed or stopped projects across the state. Some got relief from the proceeds of the $6.5 billion bond sale completed on March 24.
BAB proceeds will fund road, school, flood control, water, environmental and other projects eligible to be financed with voter-approved tax-exempt bonds.
So far $7.4 billion in BABs have been sold. Analysts expect $100 billion to $150 billion may hit the market over the next 18 months.
“With all of the sales being successful, I expect others to take advantage of issuing these bonds,” said John Cummings, executive vice president and head of the municipal bond desk at PIMCO in Newport Beach. “The benefit is that the issuer saves on interest costs. If you are California it’s a 50 to 60 basis point savings on their recent bond issuance. That’s a lot of money.”
The funds are good news for state and local governments, whose economies account for almost 13 percent of gross domestic product. Local officials can use the proceeds to build bridges, fix roads and remodel schools, the kind of projects President Barack Obama is counting on to jump-start the U.S. economy and create jobs.
Cummings said BABs can also attract new buyers of municipal debt and help large issuers find a broader investor base for their bonds. He said he expected the bonds to become more popular with cities throughout San Bernardino and Riverside counties that need to pay for infrastructure projects but have had access to the markets denied because of the credit crunch and recession.
Pension funds, university endowments, insurers and other big investors can’t get enough of the debt, which hit the market in late April. The New Jersey Turnpike Authority, the agency that oversees the 148-mile highway, planned to offer roughly $250 million of Build America Bonds. But investor demand was so great that the agency actually sold $1.4 billion, and it plans to use the proceeds for road work.
The Rector and Visitors of the University of Virginia sold $250 million of triple-A-rated BABs in a single 30-year bullet maturity with the bonds priced to yield 6.222 percent. With the federal subsidy, the net yield fell to 4.04 percent, according to a university official. The New York Metropolitan Transit Authority, which runs the city’s subway system, issued $250 million more in bonds than expected.
On April 23, the agency sold $750 million of the federally subsidized notes. Yield for the bonds Series was 7.336 percent for the 2039 maturity, which is the equivalent tax-exempt yield of 4.768 percent.
“Further, by upsizing the issuance, the MTA was able to lock in these favorable yields for most, if not all, of its borrowing for the remainder of the year,” said Gary Dellaverson, MTA chief financial officer. “This is important because it will take away much of the uncertainty of the MTA’s debt service budget and also provide cost savings.”