State Street Launches Build America Bond ETF (BABS)

by on May 14, 2010 | ETFs Mentioned:

State Street has partnered with Nuveen Investments to launch the SPDR Nuveen Barclays Capital Build America Bond ETF (BABS), the second ETF offering exposure to a corner of the bond market created as a result of the recent recession. BABS will track the performance of the Barclays Capital Build America Bond Index, a benchmark that includes all direct pay Build America Bonds in the Barclays Capital Taxable Municipal Index.

Build America Bonds were introduced in April 2009 as part of the American Recovery and Reinvestment Act, providing state and local governments a way to raise capital at competitive rates. Unlike most municipal bonds, Build America Bonds are taxable securities, eliminating one of the advantages that has traditionally allowed municipalities to issue debt at lower rates than otherwise comparable corporate debt. Here’s the unique element of Build America Bonds: the U.S. Treasury makes a payment to the issuers of direct-payment Build America Bonds equal to 35% of the total interest payable to investors. So if a municipality issues a $100 million Build America Bond with a taxable coupon of 10%, the issuer would make an annual interest payment to investors of $10 million and would receive a $3.5 million payment from the Treasury, resulting in an effective interest rate of 6.5%.

Popular (And Controversial)

Since being rolled out just over a year ago, Build America Bonds have been embraced by governments looking to fund utility projects, public buildings, courthouses, roads, and schools. According to a recent study, state and local governments have issued approximately $100 billion in Build America Bonds, saving them about $12 billion compared to what they would have paid if they issued tax-exempt bonds. A mild controversy arose over the program earlier this year when the Wall Street Journal reported that big banks were charging “surprisingly high” underwriting fees to issue Build America Bonds.

Build America Bonds have also been popular among investors, perhaps because of studies showing low default rates relative to similarly-rated corporate bonds (see this study for a closer look). PowerShares introduced its Build America Bond Portfolio (BAB) in November 2009, and assets have already surged to nearly $300 million. BAB tracks the BofA Merrill Lynch Build America Bond Index, a benchmark comprised of similar securities (see a breakdown of BAB’s holdings). Both BAB and BABS charge expense ratios of 0.35%.

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Disclosure: No positions at time of writing.