Let's get the bad news out of the way first: Despite continued low borrowing costs, the first quarter of 2014 saw 26 percent lower issuance in the municipal bond market than last year. Moreover, there's not much optimism that things will improve. Market experts predict that 2014 activity overall will be down by 8 percent to 12 percent.
Still with me? Good, because there are two reasons to be positive. The first is bond insurance, which is making a comeback.
A little context: When the $2.5 trillion bond insurance market collapsed in 2008 in the wake of the mortgage security debacle, the big-name insurers -- Ambac, MBIA Corp. and Financial Guaranty Insurance Co. -- saw their triple-A ratings take a nose dive. Without an insurer's triple-A rating, many smaller issuers who don't carry the name recognition of, say, a Los Angeles, Chicago or Dallas, were finding it difficult to access the market and attract investor interest. (Where bond insurers had guaranteed more than half of the muni bonds issued before 2008, they insured just over 3 percent in 2012.)
Fortunately, that's changing. Today, ratings for insurers are finally on the rise. They're not back to triple-A yet, but they are high enough to do business. In March, Standard & Poor's upgraded National Public Finance Guarantee Corp. to AA-minus and Assured Guaranty to AA. According to Municipal Market Advisors (MMA), an independent authority on public finance, the upgrades imply that bond insurance ratings may have hit their bottom. With time, insurers could eventually re-attain the triple-A ratings of their pre-crisis days. "This could mean that issuers can insure their bond deals more often, and in theory, at a lower cost," a March report from MMA noted. The group projects that the percent of bonds covered by insurance will grow to 5 percent this year.
The second reason to be positive is that Build America Bonds (BAB) may be back. For those of you who loved BABs, Massachusetts Sen. Edward Markey is your hero-to-be. He has introduced a bill to revive BABs, a program that allowed issuers in 2009 and 2010 to issue taxable bonds and receive subsidy payments from the U.S. Treasury equal to 35 percent of the interest costs. Under Markey's bill, the subsidy rate would be 31 percent for BABs issued in calendar year 2014 and lowered by 1 percent each successive year, remaining at 28 percent for BABs issued in 2017 and thereafter.
Originally authorized as part of the American Recovery and Reinvestment Act, BABs were an effort to pique the interest of a new range of investors -- such as foreign ones and pension plans -- who were attracted to municipal credits but had no particular use for the tax exemption. The experiment was a great success; BABs pumped a lot of money into the muni market. From April 2009 through the expiration of the program at the end of 2010, more than $181 billion of BABs were issued to provide financing for infrastructure projects.
But with sequestration, Congress cut subsidy payments to issuers by 8.7 percent in fiscal 2013 and by 7.2 percent in fiscal 2014. Markey's bill would prevent that from happening again; issuers would not be hurt by sequestration cuts for any federal subsidy payments made after the date of enactment. The legislation also would allow qualified BABs to be refunded. The bill has been referred to the Senate Finance Committee.
Markey is not the only one with an eye on BABs. In his fiscal 2015 budget, President Obama proposed an America Fast Forward (AFF) bond program, which would build on the Build America Bond program. AFF bonds would be direct-pay bonds with a 28 percent subsidy rate that could be used for the same kinds of projects financed by BABs but also for projects that could be financed with qualified private activity bonds.
Meanwhile, without relief from the sequestration cuts, some jurisdictions are trying to reconfigure their BABs. Two school districts in Ohio, for instance, report they intend to redeem some or all of their Build America Bonds because subsidy payments were reduced.
I would be remiss if I didn't mention that constant lingering threat to muni bonds -- that is, the threat of Congress taking action to remove or limit the muni bond tax exemption. President Obama's fiscal 2015 budget includes a proposal to cap the value of the tax exemption for municipal bond interest at 28 percent. What makes that proposal, which he has offered in previous budgets, so dangerous this time around is that it is similar to the 25 percent cap on the value of the muni exemption in draft tax reform legislation released earlier this year by Rep. Dave Camp, the Republican congressman who chairs the House Ways and Means Committee. The worry is that, if both Republicans and Democrats agree on curtailing the exemption, does that mean this is something that could happen? The muni tax exemption is, as Utah Treasurer Richard Ellis, president of the National Association of State Treasurers, put it, "out there as a target."