Sell Side

July Sees Lighter Volume

Municipalities sold an unusually light slate of bonds last month as the bond market continued to cope with the fallout from the financial crisis.

Municipal issuers floated $23.6 billion of debt in July, a decline of 36.4% from July 2008, according to Thomson Reuters.

Even considering seasonal lethargy, this represents a paucity of issuance. Bond sales in July have averaged $29.72 billion over the last 10 years.

The month's bond sales once again reflected the migration of the municipal market toward fixed rates and away from variable rates.

Issuers sold just $1.47 billion of short-put variable-rate debt in July, a decline of 80.9% from July 2008.

The tax-exempt money market industry, which according to the Investment Company Institute at the end of last year comprised 248 funds managing $491.5 billion, is the primary buyer of short-term instruments like variable-rate munis. Variable-rate bonds typically need letter-of-credit backing from a bank to achieve a credit rating eligible for purchase by money market funds, which by regulation must meet high standards.

Because the financial crisis has decimated banks' credit ratings, finding letters of credit from banks with ratings high enough to satisfy money market funds has become more difficult and expensive.

Issuance of paper backed by letters of credit tumbled 82.9% in July, to $1.03 billion, as compared to the year earlier.

In its Monetary Policy Report to the Congress, the Federal Reserve last month noted "substantial strains" in short-term public finance in the first half of 2009.

Though the variable-term market is working well for high-quality issuers, the Fed said, "many lower-rated issuers appeared to be either unwilling or unable to issue this type of debt at the prices that would be demanded of them."

The restriction in variable-rate issuance has reshaped the landscape of state and local government borrowing.

Last year, 29.7% of municipal borrowing was short-put variable-rate. At 8% so far this year, short-put variable-rate bonds are on pace for their smallest market share since 1993.

Inversely, sales of bonds with fixed interest rates have declined at a far less drastic pace. Municipalities sold $21.5 billion of fixed-rate bonds in July, down 25.4% from the year before.

So far this year, fixed-rate debt accounted for 88% of bonds sold by municipalities. If it persists for the rest of the year, it would be the highest percentage of fixed-rate bonds since 1993.

Another bifurcation in municipals is investors' growing preference for bonds backed by general obligation, full faith and credit, pledges as opposed to revenue streams.

With 60% of issuance so far in 2009, revenue bonds are on pace to command their smallest share of the new-issue market since at least 1982.

James Colby, senior municipal strategist at Van Eck Global, said he does not expect to see a resurgence in revenue bond issuance until the economy recovers.

"Our marketplace has been reintroduced to the notion of risk," Colby said. Investors will remain reluctant to risk money on government projects until a stronger economy lends more credence to revenue projections, he said.

A number of sectors associated with revenue bonds posted significant declines in issuance.

The transportation, housing, electric power, and environmental facilities sectors all reported at least 30% lower issuance than July of last year.

Richard Ciccarone, director of research at McDonnell Investment Management LLC, said what surprised him most was that Build America Bonds did not lift taxable issuance more.

Since their introduction in April, 215 municipal issuers have sold $18.9 billion of BABs, according to Thomson Reuters. BABs constituted 76% of taxable issuance in July and 62% of taxable issuance in June.

Ciccarone had anticipated the taxable sector would command a greater share of overall issuance, given BABs' popularity.

Taxable bonds were 18.6% of total issuance in July, which while far higher than anything before 2009, does not exactly redraw the map.

"It felt like they were a bigger factor," Ciccarone said. "The number is not dramatically up."

BABs themselves commanded a 14.1% share of the new-issue market in July, compared with 11.4% in June. About 14% of municipal bonds sold since April have been BABs.


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