Sell Side

Munis See 3d Busiest November on Record

The municipal bond industry is barreling toward its third $400 billion year.

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Municipalities floated $37.76 billion in debt in November, according to preliminary data from Thomson Reuters — the third most active November in the market’s history. Last month’s total represents a 46.7% increase from November 2008, in which supply was constrained by illiquidity and panic in credit markets.

Bolstered by a recovery in the bond market and support from federal government programs, municipalities have sold $373 billion in debt this year.

That means with a reasonable supply in December, municipal borrowing in the bond market could top $400 billion in a year for just the third time. The first time was in 2005, when municipalities floated $408.28 billion of debt. The second was in 2007, with $429.9 billion in issuance.

Assuming municipalities would have to issue $27 billion this month to reach the $400 billion plateau again, a typical December would do it. Each December in the five years ending 2007 saw issuance exceeding $27 billion.

Further, issuers likely do not even need to sell that much debt because November’s total is probably higher than these figures ­indicate. Thomson Reuters almost always revises the monthly volume numbers upward in the ensuing weeks as it discovers deals not included in the original figures.

Advisors Asset Management municipal strategist Phil Villaluz said volume is proceeding at a “torrid pace,” which he expects to persist for the rest of the year.

“It has to do with issuers needing to sell and access capital,” Villaluz said ­yesterday.

With tax revenue continuing to decline, municipalities need to find ways to finance their budgets, he said.

Tax receipts by state and local governments shriveled 8.9% in the first half of the year, according to the Census Bureau.

Because governments are reluctant to raise taxes with unemployment north of 10%, filling budget gaps in many cases entails borrowing.

“They’re going to wind up debt-financing their way through these problems,” Villaluz said.

Hearty borrowing in 2009 extends a trend of state and local government indebtedness. Municipal debt has nearly doubled in the past 10 years to $2.93 trillion, according to the Federal Reserve. In the past decade, state and local government debt has grown at nearly twice the rate of the economy.

Further, state and local governments’ liabilities — which include bonds, loans, and payables — at the end of the second quarter exceeded their assets by $319.26 billion, the biggest gap in history, according to the Fed.

Richard Ciccarone, head of research at McDonnell Investment Management, said figuring out whether municipalities are borrowing too much pivots in part on determining whether they have become overly reliant on debt in a recession or whether they are reasonably taking advantage of an attractive subsidy under the stimulus program.

The American Recovery and Reinvestment Act in February established the Build America Bond program that enables state and local governments to forego the traditional tax exemption on their debt and instead sell taxable bonds and receive a federal subsidy equal to 35% of their interest costs.

By tapping the taxable credit market, issuers have gained access to new types of investors such as foreign buyers and pension funds. The result has been an onslaught of bond sales by state and local governments in the taxable bond market.

State and local governments have sold $73.94 billion in taxable bonds this year, including $55.54 billion in Build America Bonds — the primary type of taxable debt created under ARRA.

November marked something of a comeback month for tax-exempt issuance, which had receded from the foreground earlier in the year as taxable municipal bonds became the dominant story of 2009.

Nearly 20% of municipal borrowing this year has been in the taxable market, compared with 7% over the previous 10 years.

Tax-exempt bonds fought back in November with issuance that represented 76.6% of volume compared with 63% in October.

Meanwhile, most of the biggest deals in October were taxable as issuers sold $12.95 billion of BABs. Last month, the two biggest deals — the $1.9 billion California Statewide Communities Development Authority revenue bond offering secured by payments from the state and the $1.8 billion California general obligation deal — were tax-exempt.

BAB issuance in November slipped to $7.06 billion.

Much of the jump in tax-exempt issuance came from municipalities borrowing money to buy back their outstanding bonds.

Issuers sold $9.68 billion in refunding bonds in November as a drop in interest rates made it more economical to raise money to repay outstanding debt. The refunding bonds are tax-exempt; federal law does not allow the use of BABs for refundings.

Throughout November, the yield on the 10-year spot of Municipal Market Data’s double-A yield curve averaged 3.1%. That means double-A rated municipal governments that floated bonds at almost any point over the last decade enjoy dramatically lower costs now than when they had previously borrowed. The average double-A 10-year yield since the beginning of the decade is more than 4%.

Also, Treasury rates lower than municipal rates earlier in the year made refinancing impractical because municipalities typically invest proceeds from a refunding in Treasury bonds and use the coupon payments from that to repay the refunded debt. If a Treasury rate is too low, it cannot cover that payment. Now that muni rates are back below Treasury rates, that “negative arbitrage” has vanished for many issuers.

Refunding bonds replace outstanding debt and do not contribute to growth in outstanding bonds. Still, the volume of bonds sold to raise new money spiked almost 70% to $23.54 billion in November.

With Assured Guaranty’s subsidiaries the only companies writing bond insurance, just 4.4% of new bonds coming to market in November were insured.

In the heyday of bond insurance, insured bonds routinely commanded a market share more than 50%.


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