CHICAGO - A flood of refundings by Midwest issuers looking to shed auction-rate securities and variable-rate bonds backed by downgraded insurers offset a nearly 20% drop in new-money borrowing to result in an 8.9% increase in issuance in the region for the first half of 2008.
Midwestern issuers sold a total of $13.5 billion of bonds in 871 deals in the first quarter - a 20% drop over the same period a year earlier. But volume surged to $24.1 billion in 1,222 transactions in the second quarter - a 37% increase over the same period in 2007. As a result, total volume in the Midwest in the first half was $37.5 billion, up from 34.5 billion.
New money accounted for $15.6 billion in 1,340 deals, representing a 19.8% drop, while refundings totaled $13.1 billion in 584 issues for a 40.7% increase and combined transactions totaled $8.9 billion in 169 deals for a 54.8% increase, according to figures from Thomson Reuters.
The numbers fall short of gains made in overall issuance in other regions and nationally. The Midwest also lagged the nation in 2007 issuance levels when the region managed just a 1% overall gain in issuance compared to the national hike of 10.6%.
"The economic slowdown and high unemployment in the Midwest is very clear," said Richard Ciccarone, chief municipal research analyst at Illinois-based McDonnell Investment Management LLC. "Although the cries are being heard for infrastructure investment, you are not seeing the pump priming at this time as issuers are being squeezed by the need to restructure" auction-rate and some insured variable-rate debt.
Some issuers, although in need of new money for projects and deferred maintenance, may be avoiding new-money issuance until restructurings are completed, afraid to flood the market with too much of their paper.
Ciccarone said he doesn't see significant new-money gains until at least next year as Midwestern issuers adhere to their conservative reputation and rein in new borrowing during a tight economy, at least for now. Declines in property values and increased foreclosure rates also make it more difficult for issuers to approach voters for the property tax increases sometimes needed to repay new debt, Ciccarone added.
The bulk of Midwestern debt was sold through negotiation - $32.7 billion.
About $26 billion of volume was backed by a revenue stream with $11.5 billion carrying a general obligation pledge. About $22 billion sold with a fixed-rate structure and $14 billion with a variable-rate structure and short put feature. As issuers sought to eliminate their auction-rate securities amid that market's collapse early this year, the use of letters of credit rose by 405%, attached to $6.7 billion of debt. Bond insurance was carried on $12.6 billion of debt, a 32.5% drop over the first six months of 2007.
State agencies represented the largest group of borrowers - issuing $11.9 billion of debt in 233 transactions, followed by cities and towns with $7.3 billion in 704 issues. Of the 11 Midwestern states, only Illinois, Michigan, and Ohio saw an increase in issuance, with Illinois borrowers leading the pack with $9.5 billion in 380 deals, followed by Michigan with $6.5 billion in 231 deals, and Ohio with $6.1 billion in 180 transactions.
Issuance among the sectors was mixed, with education leading by volume with $10.8 billion of debt sold in 43 issues, down 3.8% from last year. General purpose rose by 4% to $6.2 billion, while transportation-related borrowing totaled $3.3 billion for a 24% increase.
Health care borrowers increased issuance by 108% for $9.4 billion of bonds issued in 157 deals. The levels reflect the heavy use of auction-rate securities by health care providers and their flood to the market to restructure the issues along with the restructuring of floating-rate debt insured by downgraded insurers.
ARS rates began rising last year amid the overall credit crunch in the market stemming from the subprime mortgage market collapse. As the situation worsened amid ongoing insurer downgrades, broker-dealers that served as auction agents sought to retain their own liquidity and began withholding their own bids and auctions began failing. Health care issuers had long favored the auction-rate structure as it provided a means to issue long-term debt with short-term rates that did not require a liquidity facility because of the lack of a put.
"What we've seen is a lot of volume has been auction-rate remediations beginning in March that really took off," said James LeBuhn, a health care analyst at Fitch Ratings. Some systems that refinanced from the auction-rate mode into insured variable-rate demand bonds had to return to the market a second time to shed the tainted insurance.
Elevated issuance levels are expected to continue for the remainder of the year with an additional boost expected in new-money sales. "We expect volume for the balance of the year to still be very robust as we see the tail end of the remediation on the auction-rate market but also now seeing more new money," LeBuhn said.
Problems in the auction-rate and bond insurance markets "eliminated some noise out of the market," said Edward Merrigan, director of research at Chicago-based BC Ziegler & Co. "I'm actually optimistic about the next six months," Merrigan said. "Interest rates are elevated right now, but the swap market is still performing well. There's a pent-up capital demand, people that need to get their projects out of the drawing boards. I have a feeling there will be a strong second half for new-money issues."
St. Louis-based Ascension Health, the largest not-for-profit health care system in the country, came out the largest issuer in the Midwest for the first half when its repeat trips to the market are tallied as it used different issuers to convert $1.4 billion of auction-rate securities.
Ascension converted about half of its auction-rate debt into variable-rate demand bonds and half as serial mode put bonds. Citi and Morgan Stanley were the co-senior managers on the transaction. Kaufman, Hall & Associates Inc. was the financial adviser, and Orrick, Herrington & Sutcliffe LLP was bond counsel.
Wisconsin's nearly $800 million March restructuring of its ARS securities that were originally issued to fund the state's pension-related liabilities was the largest single issue in the Midwest for the first half of the year. Citi was the senior manager.
Chicago's $780 million new money and refunding of O'Hare International Airport-related revenue bonds in January was also in the list of top issues. That deal had been delayed by market conditions from late last year. Lehman Brothers was the senior manager.
A $761 million sale by American Municipal Power-Ohio in June marked the final piece of financing for the $3.7 billion Prairie State Energy Campus Project's coal-fired generation plant. Located in southwestern Illinois, the coal plant project includes two pulverized-supercritical generating units with a combined 1,582-megawatt capacity and an adjacent mine that is under construction with 200 million tons of coal reserves. JPMorgan was senior underwriter on the transaction.
Some large new-money issues have recently priced or are expected later this year to contribute to volume for the last six months. The Chicago Transit Authority in July sold nearly $2 billion of pension-related revenue bonds and Wisconsinis working on a restructuring of its $1.6 billion tobacco securitization issue.
Ohio also plans to step up bond issuance this year with two separate packages that rely heavily on borrowing. Later this year the state expects to begin to issue about $970 million of tax-exempt bonds as part of a $1.57 billion economic stimulus package signed into law this summer by Gov. Ted Strickland.
The Illinois Finance Authority topped the list of issuers in the first half, selling $3.2 billion in 50 transactions on behalf of not-for-profit borrowers in the state. Chicago followed with $2 billion of general obligation, revenue-backed, and refunding offerings in nine deals. Wisconsin was third with $1.3 billion followed by the Indiana Finance Authority with $926 million, including $750 million for the new stadium for the National Football League's Indianapolis Colts.
The dramatic shake-up among broker-dealers - with UBS Securities LLC exiting the municipal market, JPMorgan acquiring Bear Stearns & Co., and layoffs at many Wall Street firms - has not fully begun to show in the rankings.
Citi took the lead spot managing $4 billion, compared to JPMorgan in the second spot with $3.3 billion and Lehman Brothers up in the third spot from the 10th spot last year with $3.3 billion. Morgan Stanleytook fourth place, up from 19th for the same period last year. Goldman, Sachs & Co. took fifth, up from 12th, and Merrill Lynch & Co. took sixth, down from a first place finish last year. UBS dropped to eighth from fourth.
Health care refundings kept the specialty shop of Kaufman Hall busy. It took the top advisory spot with $4 billion, knocking Public Financial Management Inc. into the second spot with $2.7 billion of issuance. Another health care adviser, Ponder & Co., took the third spot with $1.4 billion of issuance.
Miller Canfield Paddock and Stone narrowly took the top spot among bond counsel away from Chapman and Cutler LLP with $3.5 billion of issuance compared to $3.3 billion for Chapman.
