'Build America Bonds' A Big Win For Wall Street

(Dow Jones) Wall Street firms have received fees exceeding $1 billion in less than a year selling "Build America Bonds" meant to spur jobs in struggling cities, often charging municipalities higher costs than for traditional bond deals.

These new bonds were rolled out in April 2009 under President Obama's economic stimulus plan to create jobs building roads, schools and hospitals. Unlike conventional municipal debt, the new bonds are taxable and generally carry higher interest rates.

The U.S. pays 35% of the interest, so the bonds have enabled local governments to borrow during a credit crunch and save money at the same time, making the higher costs a wash for them.

The Wall Street fees are "surprisingly high," says Edward Prescott, a Nobel-winning economist at the Federal Reserve Bank of Minneapolis and a professor at Arizona State University.

The banks confirm charging higher Build America fees, but say the costs are coming down as the bonds become more popular. Bank officials say the higher fees are justified because they are working harder to sell the bonds to investors who wouldn't traditionally buy municipal debt, such as pension funds, insurance companies and foreign investors.

Goldman Sachs Group Inc. (GS) is the top seller of Build America Bonds, with $9.79 billion in sales, according to research firm Thomson Reuters, followed closely by J.P. Morgan Chase & Co. (JPM), Citigroup Inc. (C), Barclays PLC (BCS, BARC.LN), Bank of America Corp.'s (BAC) Bank of America Merrill Lynch and Morgan Stanley (MS).

On average, the underwriting fees for Build America Bonds are $8.20 per $1,000, according to Thomson Reuters. By comparison, the standard fee for tax-exempt issues is $5 to $6 per $1,000, according to Wall Street banks. Thomson Reuters says 984 deals have been done since April. Underwriting fees were disclosed in just two-thirds of those, totaling nearly $1 billion.

Spokesmen for all the banks declined to comment.

One of the biggest deals was a $1.3-billion Build America Bond issued in October to rebuild the San Francisco-Oakland Bay Bridge and make it earthquake-resistant. The Bay Area Toll Authority, the agency handling the project, paid $11.37 in fees per $1,000 in bonds to a syndicate led by Citigroup and Merrill Lynch, or more than $14 million.

That was about twice what it would have paid banks to underwrite traditional tax-exempt municipal bonds, says Brian Mayhew, chief financial officer of the agency. And the interest rates paid to investors are higher. Since Washington pays 35% of the interest, the amount that the Bay Area Toll Authority pays is just 4.07% over 40 years compared with 5.5% it would have paid with tax-exempt bonds, Mr. Mayhew says.

Mr. Mayhew says he believes the underwriting fees were justified because they also included management fees and structuring the deal, which involved calculating toll collections and income streams. A piece of the bridge broke the day before the issuance, making it an even tougher sell.

"These bankers had a lot of work to do," Mr. Mayhew says.

He says it is difficult to measure the direct jobs stimulus. The bridge project began in 2000 and employs hundreds. "This may look like more Wall Street greed," he says, "but for my transaction, we felt pretty good."

For Wall Street, Build America Bonds are a fast-growing and significant business. Since the program began in April 2009, $78 billion worth of these bonds have been sold, according to Thomson Reuters.

By the end of this year, bankers estimate that as much as $150 billion more of the bonds will be sold--more than one-third of the municipal bond market. Sales could increase in the wake of the jobs bill passed by the Senate last week and under consideration now by the House.

Many municipalities are racing to issue the bonds this year to qualify for the 35% subsidy. The Obama administration has proposed making the program, due to expire at the end of 2010, permanent and scaling back the subsidy to 28%.

"Expanding and making this program permanent, as the president proposed in the budget, will further improve the long-term functioning of the municipal-bond market," says Alan B. Krueger, Assistant Secretary for Economic Policy at the Treasury Department.

Meanwhile, some lawmakers are seeking to abolish the program altogether. "This money is going directly from American taxpayers to Wall Street investment banks," says Jim Lyons, a tax lawyer for Sen. Charles Grassley (R., Iowa), who voted against the stimulus package that established the bonds.

Sen. Grassley began grilling Goldman last week about its profits from Build America Bonds after the financial giant--a lightning rod for criticism of Wall Street excess--ran an ad promoting the bonds in Politico, a political news outlet.

"Build America Bonds are funding vital infrastructure projects from California to New York," the ad said. "Goldman Sachs is proud to play a role in rebuilding our nation's infrastructure--and in bringing much-needed jobs to our communities." Goldman declined to comment.

Among major Build America Bond deals, the Metropolitan Washington Airports Authority in August paid $11.20 per $1,000 to a syndicate led by Citigroup and Morgan Stanley. This was for the first-ever issuance of a bond for the Dulles Toll Road, says Lynn Hampton, the chief financial officer, and was the standard fee at the time. It will be used to build a 25-mile extension to the Washington metro that will loop in the airport.

She said the banks worked with the agency for nearly a year before the bond issue. The deal included about $400 million in Build America Bonds, as part of a broader $963 million package. She said the Build America portion, despite the higher fees, were the lowest-cost part of the deal. The agency will pay 4.85% in interest after the subsidy.

Ms. Hampton says the financing helped create 59 jobs and retain 824 employees.

"We are able to move forward faster so the jobs are expedited," she says. "Otherwise, the jobs would eventually be there, but the project would have cost more and been delayed some."

As investors are growing more familiar with the bonds, fees are falling a bit. For less-complicated issues, such as general obligation bonds for states, the prices are lower.

Citigroup, for example, underwrote Build America Bonds for Maryland last month for $4.77 per $1,000. Citi declined to comment.

Washington Airports Authority's Ms. Hampton says she intends to float another Build America Bond deal in May, and expects the fees to be lower.

"Investors are really starting to like these things," she says.