June 17, 2010 / 7:09 PM / 9 years ago

Build America Bonds may be the new sovereign debt

WASHINGTON/CHICAGO (Reuters) - Some investors in Europe and Asia are discovering the Build America Bond program created in the U.S. economic stimulus plan last year offers attractive yields and stability, and are finding the bonds more appealing than sovereign debt, two Citigroup directors said on Thursday.

“We’re seeing some European investors diversify into U.S. states,” said Patrick Brett, director of Citigroup (C.N) U.S. municipal strategy, at the Reuters Global Real Estate and Infrastructure Summit in London.

“When you actually sit down and go through it credit point by credit point, you see investors actually voting with their wallets and investing in U.S. states,” he added.

Taxable BABs have spread through the municipal bond market like wildfire since debuting in April 2009, with more than $100 billion sold by states, cities and other municipal issuers wanting to obtain the program’s 35 percent federal rebate on interest costs. In May, BABs made up a third of new issues, according to the U.S. Treasury.

Meanwhile, investors such as U.S. pension funds that do not need tax breaks afforded by typical tax-free municipal bonds have swept up the safe debt that pays higher yields than most munis.

Over the last seven or eight months, foreign investors’ interest has grown too, Brett said. A foreign investor’s BABs inquiry jump-started a nearly $1 billion California deal last November, according to Brett.

Now investors in Europe, Asian financial centers such as Hong Kong and even the Middle East are looking into the bonds, including sovereign funds and central banks, he added.

The initial focus has been on big muni issuers such as Illinois and California, the leading BABs-sellers, mostly because deals totaling more than $250 million are the most cost-effective to sell abroad, Brett said.

Another California BABs deal of a total $3.4 billion in March saw “significant demand” from Europe and Asia, Brett said, adding that Citigroup had marketed the deal in 29 countries.

Overseas demand is ramping up despite political impasses over dealing with big budget holes in several states, including California, Illinois and New York.

“In general, investors are aware of the large states and some of the budget issues they’ve had and we generally start with a skeptical audience,” Brett said.


Still, he said, buyers find that states are more appealing than financially struggling European countries such as Greece.

“I think some press accounts unfairly lump California and Illinois with Greece and some of the other sovereigns in Europe,” Brett said.

Most states’ debt equals 3 to 5 percent of their gross domestic product, and states have a “tremendous” amount of authority over taxes, debt issuance and debt guarantees, Brett said, noting a higher proportion of BABs are issued with full faith and credit general obligation pledges versus traditional tax-exempt munis.

“(Investors) come to believe that U.S. states, despite admittedly having significant budget issues, are actually far better off than global sovereigns by many metrics,” Brett said.

Citigroup is planning on bringing several other benchmark deals to foreign markets this summer, as it expects a “significant pipeline” through the end of the year, Brett said.

The sales include a $900 million Illinois bond sale on June 30 and a $1.2 billion Los Angeles County Community College deal composed mostly of BABs that will begin pricing in late June, said David Brownstein, a Citigroup Global Markets managing director.

The buyer base has been expanding, but there is room for far more investors.

Brett said the most broadly distributed BABs deals have 150 to 200 buyers, up from 40 to 50 when they debuted. But by comparison, corporate bonds can have more than 1,100 buyers.


The BABs program is set to expire along with the stimulus plan in December. The House of Representatives recently passed a measure to extend the program through 2013, albeit at a lower subsidy. The Senate could vote this week or next on a similar extension.

Fear that the program will expire is not inspiring a rush to issuance or a buying frenzy, David Brownstein, Citigroup managing director, told the summit.

Brownstein calls BABs “the most successful component” of the stimulus act because it has broadened the investor base for municipal issuers, lowered debt costs, and has generated jobs on infrastructure projects funded with the debt.

“It’s hard not to believe there will be an extension,” Brownstein said.

In the first quarter of 2010, Citigroup was the top senior underwriter of stimulus-related debt, including BABs, according to Thomson Reuters data.

Reporting by Lisa Lambert and Karen Pierog; Additional reporting by Joan Gralla in New York and Natalie Harrison and Gregory Roumeliotis in London, editing by Matthew Lewis

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