It is not often one hears someone nicknamed “Wild” Bill exhorting patience.
“Wild” Bill Veronda, though, knows that sometimes big ideas can take time.
Build America Bonds are one such idea.
Veronda, who joined the broker Carolina Capital Markets last month as a taxable municipal bond analyst, sees BABs as a product with lasting appeal to a range of investors, particularly pension funds.
Assuming the program is extended — which appears increasingly likely — Veronda believes pension funds and certain other types of investors will gradually embrace BABs, leading eventually to tighter spreads.
Enacted under the American Recovery and Reinvestment Act last year, the Build America Bond program authorized municipalities to scrap the tax exemption on their debt and instead float taxable bonds and collect a federal subsidy equal to 35% of the interest costs.
The program thrust borrowers like the state of Wisconsin and the New Jersey Turnpike Authority — which previously sold debt mainly to wealthy people who could benefit from the tax exemption — into the same taxable credit market as Peru and Wal-Mart Stores.
Veronda said it is understandable the bond market would be slow to warm to BABs.
Building relationships takes time, he said.
The dealers that sell bonds to accounts that have not traditionally purchased state and local government debt don’t know municipals credits.
The dealers that know muni credits don’t have relationships with the crossover buyers BABs were meant to lure into the market.
“A lot of people don’t have any expertise in evaluating municipals,” Veronda said. “They’re used to corporate credits.”
Plus, he said, the BAB market, aside from being statutorily temporary, is not yet big enough to grab the taxable market’s attention.
As of yesterday, issuers have sold $97.44 billion in BABs since the program’s inception, according to Thomson Reuters.
Considering the taxable market includes a corporate sector with $11.55 trillion in outstanding debt, a Treasury bond sector with $7.78 trillion outstanding, and a government agency sector with $8.1 trillion outstanding, the current batch of outstanding BABs is too tiny to send ripples through the market, Veronda said.
As the market grows and firms commit more resources to selling BABs, he expects them to gain more acceptance.
For now, investors have the opportunity to buy BABs at what Veronda considers attractive spreads.
Last August, BABs were selling at a spread of more than 200 basis points over Treasury bonds with comparable maturities, according to a Wells Fargo index that adjusts BAB yields for the values of their call options.
Today the spread is fewer than 170 basis points, and the trajectory has clearly been downward.
Veronda said over time spreads could tighten an additional 20 basis points. That might take a year or more, he said.
Veronda, who used to run a high-yield taxable fund for Invesco, sees several factors working in BABs’ favor.
Municipalities continue to demonstrate negligible default rates compared with corporate bonds or mortgage-backed securities.
The “recalibrations” Moody’s Investors Service and Fitch Ratings have undertaken will help to highlight that, Veronda said.
“I don’t think the municipal market in general is well-understood, let alone some of the familiarity with ratings,” he said.
Just as important, Veronda added, recovery rates for defaulted municipal bonds are far superior to recoveries in corporate defaults.
That means even in the event of default, municipal bond investors have a lot less to worry about than corporate bond investors, who often see their debt slide to cents on the dollar if the borrower runs into trouble, Veronda said.
Even Harrisburg, Pa., which is publicly contemplating filing for bankruptcy protection, had general obligation debt maturing in two years trade at a yield of 2.6% last month, according to the Municipal Securities Rulemaking Board.
Pension consultants are notoriously slow to incorporate new ideas, Veronda said, but over time he expects they will have no choice but to devote greater allocations to BABs.
Ultimately, he predicted, half of state and local government borrowing could come through the taxable sector.