Sell Side

March Shows Pick-Up in Volume

New-issue volume in the municipal market for March was the third-busiest on record, giving a glimpse of a market starting to thaw from the deep freeze seen earlier this year.

With 791 issues totaling $39 billion last month, volume fell just 12% from last year's $44.3 billion, according to preliminary data from Thomson Financial. Though the volume was still down from last year's total, it was an improvement over February, when $21.5 billion of deals represented a 33% decline from February 2007.

For the first quarter of 2008, volume of $80.3 billion on 2,259 deals fell 25.3% below the first three months of 2007, according to Thomson. When comparing the month to the quarter, it is clear that new-issue volume is picking up.

"We can see for the month that we are much closer to last year's volume than we are year to date," said Merrill Lynch & Co.'s municipal strategist, Phil Fischer. "That's a clue in a certain sense that things are happening now which were not happening earlier in the year."

Over the first two months of 2008, market dislocations in the bond insurance industry and then the auction-rate security market drove issuers to the sidelines. As issuers look to enter the market for needed capital, they are choosing the types of bonds most able to help them work around the current turbulence.

For example, problems in the auction-rate market are leading issuers to choose to sell variable-rate paper, with a short put. In March, the 120 issues with a total volume of $9.4 billion represents a 250.1% increase in the sale of that kind of debt over the same month last year. In the quarter, variable-rate issuance rose 148.2%, on 290 issues for volume of $15.9 billion, as compared to the first quarter of 2007, according to preliminary Thomson data.

Variable-rate paper with the short put was 24% of the total March issuance this year, compared to 6% last year. For the quarter, variable-rate short-put paper is 19.8% of the total issuance, compared to 5.9% in the first quarter last year. So while variable-rate paper has become a greater percentage of total issuance in the shadow of illiquid auction-rate securities, the trend is even more pronounced in March.

Some of this issuance is new money but the pace of refundings is also picking up. For the month, preliminary data shows 249 refunding issues with a volume of $11.4 billion, a 9.7% decrease over the total last March. For the quarter, refundings are down 46% over last year's first quarter, on 571 issues for volume of $17.3 billion.

Of the $8.3 billion of refundings that Thomson is able to classify, $8.09 billion in 156 deals last month was current refundings, while $272 million in 16 deals was advanced refundings. The current refundings, up from $7.6 billion in 81 deals in March 2007, could begin to capture the ARS refinancing activity.

"We are much higher variable-rate issuance and much higher refundings, and as a result the volume is larger," Fischer said.

The movement away from bond insurance also continued, as only 225 issues with a volume of $9.8 billion had insurance, a drop of 50.3% from the total last March of 550 issues and volume of $19.7 billion. In the quarter, 748 issues with a volume of $21.4 billion used bond insurance, a drop of 61.2% over the first quarter of 2007.

In its place, issuers got credit enhancement in the form of liquidity facilities for use with variable-rate paper. In doing so, they rushed into letters of credit and standby bond purchase agreements.

In March, 62 issues totaling $3 billion employed letters of credit, a 137.9% increase over last year's totals for the month. Thirty-seven issues for volume of $4.4 billion used a standby bond purchase agreement, a 505.6% increase over March 2007. In the quarter, letters of credit increased 176.4%, on 184 issues for volume of $6.2 billion, while standby bond purchase agreements increased 182.5%, on 68 issues for total volume of $7.2 billion.

Among the states with the largest issuance in the month, the top four remained in the same order as last year, with California leading the way, followed by Texas, New York, and Florida. Issuers in Puerto Rico combined to make the commonwealth the fifth most active in March.

While the primary market gives a good indication of the supply of bonds in the market, it also serves as the driver for pricing in the secondary market. In comparing the fairly robust issuance in March with the conditions in the secondary market, Fischer said it is clear that a lot still needs to happen before the market returns to more normal conditions.

Typically with levels of new issuance like last month the market should trade far richer to Treasuries than it is currently, he said. The deleveraging of hedge funds and other arbitrage accounts that continues to occur has kept demand from driving the ratios to Treasuries down to historical levels, according to Fischer.

"We are a long, long way from equilibrium," he said. "The general confusion within the market needs to clear so we can get effective arbitrage into the market. The loss of the arb fund [as a class of investors] is a significant detriment to the liquidity in the market."

Regardless, Fischer said he expects volume to continue on an upward slope.

"I think we should generally expect that the numbers will grow as we head into the spring and summer," he said.



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