Regional News

Far West Issuance Falls 14%

SAN FRANCISCO - Far West municipal bond issuance fell 14% in the first half of 2008, as issuers delayed new-money deals and rushed to refinance auction-rate securities with variable-rate demand obligations.

Volume dropped to $48.5 billion in the first six months of the year from $56.3 billion in the same period a year ago, according to Thomson Reuters data.

New-money sales dropped 34% to $21.6 billion, while refundings rose 31% to $17.7 billion. As in other regions, the statistics diverged by time period - issuance rose 8.4% in the second quarter after a 36% drop in the first.

"What we're seeing is not normal. In fact, it's unprecedented and unlikely to be replicated," said Roger L. Davis, chair of the public finance department at Orrick, Herrington & Sutcliffe LLP, the region's top-ranked bond counsel. After the credit crisis repelled issuers of the first quarter, Davis has seen "intense activity across a broad range of issuers to convert, refund or otherwise restructure their auction-rate securities" in the months that followed.

The ARS crisis "has crowded out - by dint of focus and attention - other regular financings."

Wider credit spreads and the lack of available bond insurance also weighed on issuance by lower-rated credits.

"Some of those are not saleable or are waiting for better market conditions," Davis said. "But that's not by any means a majority of the market."

The use of bond insurance dropped by almost two-thirds, in the wake of downgrades to many formerly triple-A level bond insurers. The plight of the insurers weakened both the ARS and the VRDO markets, where deals had typically been structured with bond insurance.

The ARS market collapsed in February after dealers ceased supporting the securities by bidding in the regular auctions. That led to many failed auctions, forcing many issuers to pay much higher interest rates, encouraging them to refinance their debt out of auction-rate mode. The woes in the auction-rate market materialized later, as insurer after insurer suffered downgrades.

The credit crunch and its closely related economic downturn also helped determine which issuers would dominate the market in the first half. Volume was down in eight of the region's nine states, the only exception being Nevada.

California was the region's top issuer, selling more than $8 billion of debt in six issues. And California saw the largest five single bond issues in the region. The biggest was directly related to the economic slowdown - a $3.2 billion deficit bond deal sold in February as the state struggled to stay ahead of a widening general fund deficit.

The region's fifth-largest deal came from an arm of the state government, the California Department of Water Resources, a $1 billion March issue that largely refunded auction-rate electricity revenue bonds.

The two most active local government issuers - Clark County, Nev., and San Francisco International Airport - spent much of the first half restructuring variable-rate debt. San Francisco's airport jumped to sixth place among the region's issuers with $1.3 billion of bond issues.

California issuers in total sold $36 billion of bonds in the first half, a decline of roughly 13%.

Nevada volume increased 21% in the first half to $3.5 billion. Clark County's $1.7 billion accounted for about half of the state's total. The county, which owns Las Vegas McCarran International Airport, had a significant amount of impaired floating-rate airport revenue bonds to refinance.

The region's smaller, more conservative states - where simple, fixed-rate deals dominate - saw sharp declines in activity. In Alaska and Montana, volume fell by more than 60%.

The drastic dip in new-money issues is unlikely to last for long, said Anthony J. Taddey, a managing director at RBC Capital Markets in Los Angeles. While a few big issuers have commercial paper programs that allow them to wait out rough markets, the "vast majority" of issuers don't have that option.

"If they have spent years getting this public consensus, getting environmental impact statements, getting it though city council, going through the public hearing process, going through the drawings, going through the applications process, the construction bidding process, all of the politics associated with that and on and on and on - frankly, they want to get the thing done," Taddey said. "As long as you can show them that they're paying a reasonable market rate of interest, they are generally going to go forward."

"Have you seen one headline that says, 'This library is not being financed for another six months because of the ARS crisis?' No, because the long-term fixed rates are still pretty favorable," he said.

"Our issues are timed to meet to meet the demand for our mortgage originations," agreed John Sager, chief financial officer for the Idaho Housing and Finance Association, the state's busiest issuer in the first half with 10 deals worth $325.8 million.

"We've seen pretty steady demand for our product over the past couple of years as a lot of the subprime and more exotic things that were popular in the market a couple of years ago have fallen apart," he said.

That doesn't mean the association was insulated from the aftershocks of the credit crunch. Sager said he's been forced to change the way he does business to keep capital flowing to his programs.

"Our principal impediment this year has been the lack of standby liquidity to support our variable-rate program," he said. "We are rationing the liquidity we have very carefully to get us through until the liquidity market opens up to us - hopefully soon."

Sager said IHFA has sold more bonds to Fannie Mae this year to save liquidity for deals where it really needs to go with variable-rate bonds. The association didn't have any impaired debt to fix in the first half because it only sells its double-A and triple-A rated tranches as floaters, has no insured, variable-rate bonds, and has no auction-rate program.

Recent federal legislation that will exempt housing revenue bonds from the alternative minimum tax should also help the association adopt an even more conservative profile.

"As we get more favorable pricing due to the non-AMT provisions of HR 3221, we will definitely shift more toward fixed-rate debt," Sager said. "If we can achieve a competitive mortgage rate using a plain-vanilla structure, we won't have to use more exotic structures."

Citi retained the top spot in the region's underwriting chart and finished at the top of the league tables in four of the region's nine states. It was senior manager on 79 deals worth $11.3 billion, up from 76 deals worth $10.3 billion a year ago. Citi underwrote almost twice as much as regional runner-up Morgan Stanley, which boosted its volume 20% from the first half of 2007, when it finished fourth.

Merrill Lynch & Co. was the region's biggest loser in the first six months of the year. Its volume dropped by more than half, and it fell to fifth place in the table from second, though the number of deals it was credited with was down only slightly, to 34 from 39.

The league tables are sure to change even more next quarter. UBS Securities LLC ranked ninth among lead underwriters in the first half, but it shuttered its municipal bond department in June. The firm's wealth management arm has continues to bid on some smaller competitive muni deals.

Public Financial Management Inc. led Public Resources Advisory Group to head the list of the region's top financial advisers, switching places from a year earlier.

Orrick finished in its accustomed place atop the bond counsel table. The firm's market share fell to 32% from 39%, but it still did four times as much business as runner-up K&L Gates.



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