Build America Bonds, or BABs, are municipal bonds issued from April, 2009 through December, 2010 as part of the American Recovery and Reinvestment Act. Like traditional municipal bonds, Build America Bonds are issued by states, counties, and municipalities. However, unlike traditional munis, the income is fully taxable to investors.
With a Build America Bond, the federal government provided issuers with a subsidy that enabled them to attract buyers by offering higher rates that they otherwise may not have been able to afford. This subsidy takes the form of the federal government paying 35% of the interest on BABs. For example, if the interest on a BAB is 6%, the cost to the issuer is 3.9% The investor receives the full 6%. Keep in mind, this was a subsidy and not a guarantee against default made by the federal government.
While their taxable nature means that BABs aren’t a particularly attractive option for typical municipal bond investors – those in high tax brackets seeking to avoid taxation on their investment income – they nonetheless proved popular with institutional investors seeking to improve portfolio diversification and gain the higher yields that were typically available in BABs. At issuance, yields typically fell in a range between traditional municipal bonds and corporate bonds.
Characteristics and Risks of Build America Bonds
The vast majority of Build America Bonds have high credit ratings of AA and AAA. Many of the issues are general obligation bonds, which are backed by the municipalities’ taxing power, or essential services bonds, which are backed by revenues sources such as water and sewer projects. Most Build America Bonds were issued with maturities of 20 years or more.
Since the credit risk of Build America Bonds isn’t particularly high, the primary factor investors need to worry about is interest rate risk. If prevailing rates rise, BABs prices can be expected to fall. Since rates have been falling for the majority of the time since the BAB program began, the asset class has provided strong total returns through the first four years of the program.
The Purpose of Build America Bonds
The money raised through BAB issuance was required to be used to fund public construction projects, thereby fulfilling the objective of creating jobs. As a result, only government entities could issues BABs. The political motivation behind the program is expressed in this quote by Treasury Secretary Tim Geithner from April 3, 2009: “Increasing state and local funding for capital projects doesn't just help rebuild our aging infrastructure. It gets American's back to work. Build America Bonds is an innovative approach to augment the ailing tax-exempt bond market and shows the Administration's commitment to economic recovery for Main Street.”
Issuance of Build America Bonds
The raw data, sourced from the U.S. Treasury website, is as follows:
- 2009: 746 BAB bond issues, for a total value of $63.8 billion, representing 19% of total municipal bond issuance
- 2010: 1,529, $117.4 billion, 26.1%
- Total: 2275 issues, $181.3 billion, 23.1%
The largest amount of issuance occurred in the final three months of 2010, as issuers rushed to the market ahead of the program’s expiration. While no new bonds are being issued, the bonds sold during 2009 and 2010 will trade on the secondary market until they mature, which in some cases will not be until 2040.
How to Buy Build America Bonds
Individual Build American Bonds can be purchased through a broker, but most investors would likely opt for one of the various mutual funds or exchange-traded funds (ETFs) that invest in the asset class. The first mutual fund dedicated to BABs was the Eaton Vance Build America Bond (ticker:EBABX), while three ETFs invest in the asset class: PowerShares Build America Bond (BAB), SPDR Nuveen Barclays Capital Build America Bond ETF (BABS), PIMCO Build America Bond Strategy Fund (BABZ). These funds continue to offer yields higher than that which is available in funds that invest in corporate bonds of similar credit quality.
Disclaimer: The information on this site is provided for discussion purposes only, and should not be construed as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities. Be sure to consult investment and tax professionals before you invest.