CHICAGO - A flood of refundings by Midwestern issuers looking to shed auction-rate securities and variable-rate bonds backed by downgraded insurers in the second quarter of 2008 couldn't compensate for a steep fourth-quarter drop-off in borrowing amid the economic and market turmoil of last fall.
Midwestern borrowers issued $67.1 billion of debt in 3,838 transactions last year, a 9.5% drop over the 2007 issuance levels of $74.1 billion in 4,325 deals, according to Thomson Reuters. The number is slightly worse than the 8.8% drop nationally.
Volume fell by 18.6% to $13.8 billion in the first quarter, then surged by 38.4% to $24.3 billion in the second quarter and again fell in the third by 13.7% to $15.2 billion. Fourth-quarter issuance fell by 37.5% to $13.8 billion.
Issuance fell in Midwestern states with the exception of Minnesota and South Dakota, which saw modest increases of 2% to 3%, and Wisconsin, which experienced a 21.8 % increase. Volume fell across most sectors with a few exceptions, most notably being health care, which increased by 79% to $18.1 billion. Transportation and utility borrowing also recorded increases over the previous year.
Fixed-rate issuance accounted for $41.7 billion of volume, representing a 26% drop over levels the previous year, while floating-rate debt totaled $23 billion, up 150% over 2007 as issuers sought to capitalize on lower variable-rate rates even as liquidity and letter of credit costs grew.
Issuance of auction-rate securities fell to zero from $6.4 billion a year earlier following that market's collapse in late 2007 and early 2008 due to the credit crunch. The use of letters of credit skyrocketed by 216% on $12.3 billion of debt, while deals using bond insurance fell 55.7% to $15.3 billion of debt amid downgrades of monoline bond insurers.
New-money bonding totaled $32.4 billion, down 31% from a year earlier, while refundings grew by 46.5% to $21.5 billion. Nationally, new money was down 23.3% and refundings up 43.5%. Some of the decline can be attributed to the market turmoil that ensued last September following Lehman Brothers' bankruptcy that froze the market, but issuers also remained on the sidelines for economic reasons, said several analysts.
"The important story is the steep decline in new money. It tells you governmental entities are reluctant to start new projects in this economic climate," said Richard Ciccarone, chief municipal research analyst at Illinois-based McDonnell Investment Management LLC. "They don't want to have to pass on the costs to taxpayers and ratepayers during a difficult economic time."
The picture for the rest of 2009 remains mixed for prospective volume, he said. As the House and Senate now move to reconcile differences in the economic stimulus package each passed, states are watching for whether they will need to provide matching funds for infrastructure grants. If not, Ciccarone doesn't expect significant borrowing gains on that front.
With pent-up demand for projects and deferred maintenance and a need to stimulate their economies, some states are poised to take on significantly more debt.
Iowa Gov. Chet Culver has proposed a $700 million bonding program for infrastructure while Illinois lawmakers hope this spring to adopt a long-delayed capital program. Ohio plans to continue borrowing throughout the year to finance Gov. Ted Strickland's $1.5 billion job stimulus plan, which relies on $800 million in new-money debt.
Health care financings led sector issuance with $18.1 billion of bonds issued, a spike of nearly 80% from 2007, driven largely by refundings stemming from the collapse of the auction-rate market, which was long favored by health care borrowers. Health care bond sales made up nine of the top 25 largest bond sales in the Midwest last year, and most states saw double- and even triple-digit increases.
St. Louis-based Ascension Health completed one of the year's largest deals with its staggered conversion of $1.4 billion in auction-rate securities through a number of different conduit issuers. Citi and Morgan Stanley were co-senior managers on the deal.
The spike in health care deals kept Illinois-based financial adviser Kaufman Hall & Associates Inc. busy for the year, as it ranked as the top financial adviser in the Midwest. Kenneth Kaufman said much of the sector's issuance was driven by the collapse of the ARS market, and then further restructurings prompted by other market events such as the monoline insurer downgrades.
"It was really more of a waterfall; it wasn't one isolated event," Kaufman downgrades. "It just kept happening. There were certain organizations - not just in the Midwest but across the country - that had two or three restructurings in the year, constantly trying to get to a safer place."
Health care issuance for the remainder of 2009 could be mixed with some struggling providers putting big projects on hold. In the early months of the year interest rates have generally been too elevated for some issuers to enter the market, and obtaining bank-supported credit remains costly and difficult to secure, according to Kaufman.
"Interest rates have been coming down fairly steadily over the last six, several weeks, and if that continues to happen then people will feel that they can get in and rebalance their capital structure between fixed and variable rate," he said. Health care credits rated below single-A have had a particularly tough time in the market given investor demand for top credit quality, Kaufman added.
The Illinois Finance Authority, which serves as the conduit for health care and higher education borrowers, led among Midwestern issuers with $4.6 billion sold in 76 deals. The Indiana Finance Authority followed with $2.6 billion issued in 37 deals, and Chicago was third with $2.6 billion in 13 transactions.
The Chicago Transit Authority issued the largest single deal, with Morgan Stanley in the senior manager position on its $1.9 billion July taxable sale that provided funding for pensions and other post-employment benefits.
Wisconsin refunded auction-rate debt in an $800 million deal led by Citi in March and Chicago came to market in January with its $780 million O'Hare International Airport new-money and refunding deal that had been put on hold in late 2007 with the former Lehman Brothers in the top spot. The Illinois State Toll Highway Authority restructured insured variable-rate debt in a $766 million deal in February with Goldman, Sachs & Co. in the lead spot.
The Michigan Municipal Bond Authority moved to restructure $500 million of ARS issued to finance the state's relatively new School Loan Revolving Fund. The 2007 ARS sale was the state's first to finance the school fund, and last March, after the market began to fail, the state restructured the debt into four series of variable-rate and term-rate bonds, all of which are taxable. Merrill Lynch & Co. was the senior book-running manager on the transaction.
American Municipal Power-Ohio's sale of $761 million of revenue bonds marked one of the region's largest deals of the year and provided the final piece of financing for the $3.7 billion Prairie State Energy Campus Project. In addition, AMP-Ohio is developing two additional generation plants as part of a $4.3 billion capital plan. The utility is expected to start issuing debt this year to finance the plan.
The top senior manager rankings for last year don't necessarily reflect the dramatic reshaping of the broker-dealer landscape as names like Bear, Stearns & Co. and Lehman Brothers disappeared while investment banks struggled to cope with losses stemming from the collapse of the subprime mortgage market.
Citi took the top spot, managing $7.7 billion of debt in 79 issues, followed by JPMorgan with $6.6 billion of issuance in 90 deals. Their positions were reversed a year earlier. Morgan Stanley followed in the third spot and Merrill Lynch came in fourth followed by Goldman Sachs and Barclays Capital, which acquired Lehman's broker-dealer.
Where the changes could be seen was in the elevation of regional firms in the Midwest rankings. Robert W. Baird & Co. rose to eighth place from 14th while RBC Capital Markets rose to ninth from 12th and BMO Capital Markets GKST Inc. rose to 12th from 18th.
Kaufman Hall uprooted Public Financial Management Inc. from its top spot among advisers. PFM followed in second place and Ponder & Co., which specializes in the health care sector, took the third spot, up from 16th the previous year.
Chapman and Cutler LLP took the top slot among bond counsel, followed by Squire Sanders & Dempsey LLP and then Peck Shaffer & Williams LLP.
