BUILD AMERICA BONDS

` BAB’S VERSUS MUNI’S

Now that you have an overview on the newest debt instrument, the Build America Bonds, https://www.bestcashcow.com/bond_resources/build-america-bonds.html, let’s see if we can determine which is better for your portfolio, the standard tax fee municipal bond, or the new Build America Bonds with their government subsidy.

There is some question as to which is the better, or most appropriate investment, BAB’s with the tax credit, or tax free munis. Loop Capital Markets set out to answer that question by studying BAB’s that were sold alongside tax exempt muni’s between April 20^th and August 10^th. The study analyzed 134 BAB issues and 596 tax free municipal issues.

Before we answer the question regarding which is the better of the two products, let’s take a look at what the study discovered. One of the first things the study found is that the yield spread between the BAB’s and Treasuries has narrowed significantly from what they were when first issued. What used to be a difference of over 300 basis points, (3 percent), is now under 200 basis points (2 percent).

That would suggest that BAB’s had to offer a higher yield in order to attract investors because of their newness, and because of investor’s unfamiliarity. As borrowers got used to the new bonds, understood how they worked, and watched price action, more came into the market and pricing settled down to around 200 basis points over Treasuries. They do not have to offer as high a yield anymore to lure buyer s in.

Further tests are being run to try to determine how much of the spread narrowing is specific to BAB’s, and how much is due to a narrowing in the market in general. Additional tests are underway to determine why non institutional or smaller investors prefer high profile issues over lesser known names. As you can see, clearly more work is ahead of us as we grow to understand the new bonds.

Some of the, flock to bigger names, may have to do with investor perception of the secondary market and a belief that a bigger name issuer will be more liquid and will retain its price more than a small school bond for example.

There is also quite a difference when it comes to call provisions. With taxable bonds the yield difference between callable and non callable bonds is around 6 basis points, whereas on the BAB’s the difference is around 44 basis points, or almost a half a percent.

Research also showed that issue size made little difference in price as opposed to municipal issues. Underwriters urged municipalities to offer larger blocks thinking investors would be more comfortable with the liquidity that the larger issues offer in the secondary market, but that has not changed the pricing much.

State tax exemptions-which should help BAB pricing in the states that do not tax interest- did little to affect the bonds pricing. The biggest benefit of the BAB’s goes to the investor that is a foreign investor and not subject to US taxes, or to institutional investors who buy for pension plans.

You have to look at which bonds, the BAB’s or tax free munis, are going to offer you the best net yield. If you are an investor in the highest tax bracket and are subject 41% federal and 9% state taxes, after you crunch the numbers you may, want to go with the tax free munis as opposed to BAB’s that offer a 35% credit.

That’s what it has always been about, individuals crunching the numbers to see what is right for themselves, not what the masses may tell you. If you are in the lowest bracket you may find that BAB’s offering the credit will give you the best return. Do the math.

Good luck and Happy Investing.