Sell Side

November Volume Down 22% From '07

New-issue par value volume in November fell 22% from last year, as the municipal market continued to grapple with the fallout from the credit crisis that has left it relying on retail investors to scoop up bonds.

The month's volume of 554 represents the smallest number of deals for a November since 1983, when 478 issues came to market. It represents the smallest number of deals for any month since January 1990.

The 554 issues that came to the market in November represented a par value $23.5 billion, according to Thomson Reuters. A total of 1,057 issues with a par value of $30.1 billion entered the market last November.

"We got hit with the Lehman [Brothers] issue and problems with [American International Group Inc.] and that put the market in a different kind of regime in September, October, and November," Merrill Lynch & Co. municipal strategist Philip Fischer said. "And that's where we are now. We're in a situation in which the market is demand constrained."

Despite a slow start to the year, the market began to catch up to last year's record pace, when refundings of auction-rate securities helped push up the volume totals. But the market has slowed down dramatically since September, when Lehman Brothers Holdings Inc. declared bankruptcy and troubles in the credit market erupted. For September through November, volume by par value has fallen 31.2% from last year.

"November numbers reflected a continuation of the shell-shock slide in the market which has affected both underwriters and issuers alike," Richard Ciccarone, managing director and chief research officer at McDonnell Investment Management LLC, wrote in an e-mail. "While issuance was still down 22% there was a feeling that the October frozen market was thawing in November."

The market has relied on retail buyers to support the primary market with institutional buyers like "mutual funds facing continued net redemptions, non-financial corporations needing less tax-exempt income as the recession deepens, and arbitrage programs either shut down or sidelined," Municipal Market Advisors managing director Matt Fabian wrote in his weekly report. Institutional demand is "quite low," said Bruce Floberg, lead senior municipal strategist at RBC Capital Markets.

Secondary supply is also building, putting pressure on the market, Fischer said. Casualty and property as well as monoline insurers have all been willing but not forced sellers into the market, according to Fischer.

For instance, between June 30 and Sept. 30, MBIA Inc. reduced the municipal holdings in its insurance portfolio by $573 million as it repositioned its holdings to increase liquidity, it said in a third-quarter earnings presentation earlier this month.

The demand constraints have pushed all but the highest quality, most liquid credits from entering the market, Fischer said. He noted that the average size of a deal in November increased to $42.4 million from $28.5 million last year.

"The highest credit-type things are getting bit done a little bit easier, but it's still harder to get done things in the single-A category," Floberg said. "You still have a lot issues waiting to come to market, that are ready to come to market, waiting to be sold."

Par value of refundings jumped 112.6% in September to $6.6 billion, as other new-money issuers "were either waiting and hopeful for lower rates or reconsidering plans to take on debt," Ciccarone said. Six of 10 of the largest deals of the month included at least a portion of refunding debt, including the Empire State Development Corp.'s $672.1 million issue on Nov. 5 and Massachusetts' $544.3 million issue on Nov. 19.

The decline in competitive sales also reflected the stress in the market. The par value of competitive issues fell nearly 80% from last November to $1.2 billion in the month this year. Negotiated sales made up almost all of the market in November and fell just 5% from last year.

The competitive deals that have come to the market have tended to be smaller. Since the Lehman Brothers bankruptcy on Sept. 15, just five competitive bond offerings of more than $100 million have come to market; three came to market in the previous week.

The average size of the competitive deal in November fell to $7.6 million from $18.8 million.

Moving forward, it could be months before these issues are resolved. The backlog of new issues means there will be plenty of supply - the question is who will buy it. Fischer estimates that a retail-centered market can support between $20 million to $25 million in new issues per month.

"In order to clear the backlog of issuance, we're going to have to develop the demand side and that means we're going to have to place more paper with retail and cross-over buyers," Fischer said.

Later he added: "What we have is the numbers telling us that, at least for the near term, we've had a change in the micro-market structure of the municipal market both in terms of supply and demand."


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