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Tax-Exempt Bond Market Gains Traction

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Corporate & Finance Alert

October 28, 2008

The tax-exempt bond market experienced its first reprieve last week from the ongoing credit crunch and dearth of tax-exempt bond buyers, which had driven up tax-exempt bond yields and effectively shut down the tax-exempt bond market over a month ago for all but a few tax-exempt bond issuers. The Bond Buyer’s 20-Bond Index, a weekly yield index comprised of a composite of twenty general obligation bonds that mature in twenty years and have an average rating roughly equivalent to Moody’s Investors Service’s Aa2 and Standard and Poor’s Rating Service’s AA, declined sixty-nine basis points last week to 5.32% from a high of 6.01%. According to The Bond Buyer, a nationally recognized bond marketing publication, this sixty-nine basis point decline represents the largest one-week drop for the 20-Bond Index since October 7, 1982, and brings the index to its lowest level since September 25, 2008 when it was 5.23%. Increased demand for tax-exempt bonds can be largely credited with the precipitous drop in yields and is indicative that, at least in the short-term, tax-exempt bond investors have returned to the table.

As long-term tax-exempt bond yields rose to the 6% level a couple of weeks ago, the relative cheapness of tax-exempt bonds as compared to U.S. Treasuries widened to a point which proved too attractive for many investors, particularly the retail investor. Due to increased demand, The Bond Buyer noted that on October 22, 2008 M.R. Beal & Co. re-priced $536 million of bonds for the New York City Municipal Water Authority. As a result, yields were reduced by thirteen basis points in 2017, fifteen basis points from 2019 through 2022 and in 2024, and by forty-five basis points in 2040. Yields in final pricing ranged from 4.87% in 2017 to 5.90% in 2040. Furthermore, $336 million of bonds was purchased by retail investors with the remaining $200 million of bonds being purchased by institutional investors. On the same day, Siebert, Brandford Shank & Co. priced $500 million of general obligation bonds for the State of Connecticut. Due to increased demand by tax-exempt bond investors, yields were selectively lowered by five to twenty-three basis points. The bonds mature from 2009 through 2028, with yields ranging from 2.10% in 2009 to 5.23% in 2028.

Whether tax-exempt bond yields continue trending downward depends on many factors and will be determined in large measure by the effect of the coming to market of numerous postponed tax-exempt bond issues in the coming weeks and the breadth of investor demand. Another factor which would have a positive effect on tax-exempt bond yields would be the entry into the market of new triple-A rated bond insurers, such as triple-A rated Berkshire Hathaway Assurance Corp. which has already guaranteed a number of tax-exempt bond issues across the country. Additionally, certain letter of credit banks are beginning to resume the issuance of their letters of credit on tax-exempt bond financings. Each of the preceding factors will have the effect of creating a lower cost of capital for tax-exempt bond issuers. While long-term tax-exempt bond yields normalized to a degree last week, long-term tax-exempt bond yields remain inordinately high. Tax-exempt bond issuers and conduit borrowers utilizing tax-exempt bond proceeds, that are contemplating financing projects on a tax-exempt basis in the near term, may want to consider a wait-and-see approach until some additional volatility is washed out of the market.