CHICAGO - Even the Midwestern embrace of the federal government's taxable Build America Bond program couldn't stave off a drop in the region's bond issuance for the first half of the year as refunding activity faded, health care borrowers struggled to access the market, and governments tightened their belts.
Midwest issuers sold a total of $29.95 billion of bonds in 2,072 transactions, down 21.3% over the same period in 2008 when governments and other borrowers sold $38.07 billion in 2,177 deals. The drop-off marked the lowest level of borrowing in the first half of the year since 2001, when issuers sold $28.66 billion of debt in 2,311 issues, according to Thomson Reuters.
Issuance in the first quarter actually rose by nearly 15% but that increase couldn't offset the nearly 42% drop in second-quarter bond sales. The decline was seen across the Midwest in all but two states. Iowa and Wisconsin stood out, posting 16.4% and 11.4% gains in volume, respectively.
Wisconsin's numbers were bolstered by its $1.5 billion tobacco restructuring in March. Iowa's levels should remain strong in year-end results as the state in July sold $600 million of bonds for its new capital program to promote job creation.
Illinois led the pack among states but issuance there dropped by 24.8% to $7.26 billion from $9.65 billion during the same period last year. Ohio issuance fell 32.9% to $4.16 billion from $6.21 billion. Michigan - the epicenter of the domestic auto industry's struggles - saw a 41.8% drop in issuance to $3.82 billion from $6.56 billion.
New-money issuance showed a slight gain of 5.4% to $16.71 billion, while refunding bond issues dropped 35.3% to $8.62 billion. Issuers turned heavily towards fixed-rate structures over floating-rate ones as the number of liquidity providers shrank and the costs for standby bond purchase agreements and letters of credit rose.
Variable-rate issuance with short put features fell by 68.1% to $4.5 billion from $14.11 billion.
Borrowers opted for insurance coverage on only $3.25 billion of their debt compared to $12.81 billion for the same period last year, representing a 74.6% drop.
State agencies, cities, counties and universities all issued less, with the notable exception of state governments, who doubled their issuance levels to $3.74 billion.
While the region's drop exceeded the national decline of 15% in overall issuance, the region saw a 75.3% spike in taxable volume compared to a 57.6% national increase.
Issuers flooding the market in the second quarter with taxable bonds under the Build America Bond program that was established in the federal government's economic stimulus package drove the Midwest's taxable issuance to $5.24 billion from $2.99 billion for the same period last year. Tax-exempt issuance dropped 26.3 % to $24.33 billion from $33.01 billion.
"The Midwest really figured very prominently in the use of the BAB program," said Richard Ciccarone, chief research officer at McDonnell Investment Management LLC. "Use of the stimulus program and a notable decline in refunding and a reticence of conservative Midwestern governments to issue debt due their weakened economies really led to a scarcity of tax-free municipal paper."
The region's third largest deal - a $500 million new-money sale in May by the Illinois State Toll Highway Authority to raise funds for its massive overhaul of the tollway system - was among the top BAB deals for the region. Goldman, Sachs & Co. was lead manager.
Cook County, Ill., completed one of the largest also in June with its $427.4 million new-money and refunding general obligation bond issue. The transaction included roughly half refunding bonds for savings and half new money that was sold as Build America Bonds. Loop Capital Markets LLC was senior manager on the deal and Samuel R. Ramirez & Co. was co-senior.
Wisconsin's $1.5 billion tobacco bond restructuring in March that shifted the bonds' security to a state appropriation pledge topped the charts of individual deals. Barclays Capital served as the lead underwriter.
Chicago's $611 million new money and refunding general obligation sale in January followed. William Blair & Co. was senior manager.
In one of the largest health care transactions of the first half, Michigan's Royal Oak Hospital Finance Authority priced $393 million of revenue bonds Jan. 16. The sale was on behalf of William Beaumont Hospital, one of Michigan's largest health care systems.
Some sectors - like public facilities, environmental facilities and general purpose - posted increases, but other key areas like transportation and health care faltered. With $5.01 billion issued during the first half, health care issuance saw a 47.7% decline in volume compared to the $9.58 billion during the first half of 2008.
The decline stems from a slow first quarter, but the roots of the cause are partly due to last year's market conditions, according to Kenneth Kaufman of the Illinois-based financial advisory firm Kaufman, Hall & Associates Inc.
"It's an outlier number," Kaufman said of the nearly 50% drop from 2008 to 2009. "A lot of issuance in 2008 was refinancing of auction-rate debt, which died in February of 2008. Hospitals had probably as much auction-rate debt as any sector, and they had no choice - it was trading at 12% and 13% - they just had to restructure. It was a once-in-a-lifetime experience."
The credit crunch in late 2008 also kept some health care borrowers from entering the market early in 2009 as hospitals were unwilling to pay the higher yields demanded at the time by investors weary of any credit risk.
The collapse of the auction-rate securities market continued to reverberate in 2009 in other ways as well. Last year, many hospitals scrambled to restructure their failed ARS into variable-rate debt supported by bank credit, which was suddenly more scarce and expensive.
This year, many of those same issuers are refinancing that debt again, shifting it into a fixed-rate mode, in part to shed the expensive credit enhancement.
"Last year the situation was so overwhelming that people did what they had to do," Kaufman said. "A number of transactions were only a bridge, so now we're certainly seeing some level of transactions [that are putting issuers in] a more comfortable spot."
An increase in traditional fixed-rate debt issued this year also comes as credit analysts have started to warn health care issuers that too much variable-rate debt could affect their credit profile.
The preference for fixed-rate debt and the pace of issuance is likely to continue throughout the rest of the year, Kaufman predicted. Health are issuance already began rebounding in the second quarter.
"The first quarter was pretty slow, but the third and the fourth will be more like the second," he said, noting that several large health care deals are entering the market this week. "It's such an atypical year."
The Illinois Finance Authority, which serves as the main conduit for nonprofits in the state to access the tax-exempt market, held on to its top spot among Midwest issuers with $2.26 billion of issuance in 19 deals. Wisconsin followed with $1.63 billion of issuance and then the Indiana Finance Authority with $1 billion.
Michigan more than tripled the amount of debt it issued during the first half over last year, making it one of the five largest issuers in the Midwest. The financially struggling state issued $819.8 million in debt during the first half compared to $233.8 in 2008.
The state's largest transaction was a $301.9 million general obligation bond issue sold in early April. It came as the state continued to struggle with one of the worst economies in the nation, driven in large part by a failing U.S. auto industry. Refunding bonds accounted for roughly
half of the issue in a restructuring done in part to push off debt service to free up money in the next budget cycle. Merrill Lynch & Co. was the remarketing agent on the transaction.
The combined forces of Merrill Lynch and Banc of America Securities helped that firm capture the number one spot among senior managers in the region, leading $3.68 billion worth of issuance in 41 deals - up from a fourth-place ranking for the first half of 2008. JPMorgan finished second, Morgan Stanley third and Barclays fourth. The previous first place finisher - Citi - dropped to fifth place.
Public Financial Management Inc. led among financial advisers, followed by Chicago-based Scott Balice Strategies and then Kaufman Hall. Chapman and Cutler LLP led among bond counsel, followed by health care specialist Jones Day and Miller Canfield Paddock and Stone.
