Build America Bonds (BABs) have been experiencing significantly widened spreads in recent months due to a surge in refinancing activity. Despite a debate over the legal ability of issuers to call the debt, municipal bond strategists have observed a cheapening trend in the BABs index option-adjust spread compared to the ICE Broad Taxable Municipal Bond Index OAS. This has been primarily attributed to the ERP refunding, which has prompted issuers to bring $4 billion of BABs to the market for refinancing this year.
The pace of BABs refundings has accelerated, especially after a court decision deemed repeated budget sequestration cuts as an “extraordinary” event that allows issuers to call the debt. However, this move has sparked controversy among investors who question the qualification of sequestration as an extraordinary event. Some investors have even threatened legal action against issuers who opt for refinancing, challenging the validity of the transactions.
Amidst the debate and controversy surrounding BABs refinancing, some strategists recommend considering various types of direct-pay bonds that offer low risk of being called even in the current market scenario. Bonds with ERP calls at T+100bps and low-coupon BABs trading below par are identified as attractive investment options by experts. However, investors are advised to be cautious of potential price fluctuations and call risks associated with these bonds, especially in the event of a market rally.
The Bloomberg BABs Index has witnessed spreads widening to over 100bps from below 90bps, marking a significant shift in market dynamics. While the Bloomberg Taxable Municipal Index has outperformed the investment-grade corporate market, BABs have emerged as notable laggards within the taxable muni index. This trend has raised concerns among investors and prompted discussions on the future outlook for BABs in the market.
Despite the challenges and controversies surrounding BABs refinancing, some experts still see value in investing in these bonds. Opportunities to capitalize on attractive tax-exempt valuations, especially within the AAA group, are noted as potential benefits for investors. However, issuance costs and call risks remain key considerations that could impact the overall attractiveness of BABs as an investment avenue.
Overall, the impact of refinancing on Build America Bonds has led to a significant shift in market dynamics, with widened spreads and increased scrutiny from investors. While there are opportunities for value and potential savings for issuers, the debate over the legal aspects of calling debt and the risks associated with refinancing continue to be key factors shaping the future of BABs in the municipal bond market. Investors are advised to carefully assess the market trends, investment strategies, and potential risks associated with BABs before making investment decisions.