Sell Side

A Mixed Month for Volume

The bifurcation in the municipal market continued in February as tax-exempt debt issuance slumped compared to last year, but total issuance moved higher as a result of taxable Build America Bonds.

Under the BABs program, enacted under the American Recovery and Reinvestment Act in February 2009, municipal issuers can issue taxable bonds and receive a 35% subsidy on the interest cost. As a result, issuers since last March have had access to a wider investor audience including foreign investors and pension funds. The new choice for issuers has caused tax-exempt issuance to become scarcer.

Last month tax-exempt issuance fell almost 26% to $17.1 billion, compared with $23.0 billion in February 2009, according to Thomson Reuters.  However, because the taxable market issued $7.6 billion of debt in the month — including $7.0 billion of BABs — total issuance was driven 7.3% higher to $25.1 billion, the largest amount since 2007, which was a record February.

“We continue to see issuance grow — obviously the big story continues to be Build America Bonds,” said Justin Hoogendoorn, managing director of strategic analytics at BMO Capital Markets. “Taxables are taking a continuously growing portion of supply.”

BABs accounted for roughly 28% of the market last month, compared with about 22% in January.

Hoogendoorn said the 30% mark is probably the equilibrium share of the market, but a new threshold could be set if market conditions warrant it.

“Most of the people that can issue BABs at this point are coming with BABs,” he said. “But if there’s any doubt on the extension of the program or a dropping of the subsidy, as we go forward in the year we’ll see an even larger percentage of BABs coming to the market.”

The impact of BABs has been positive for issuers as diminished supply in the tax-exempt market has pushed yields lower.

Since late November credit spreads have been tightening, according to Municipal Market Data. The single-A versus triple-A spread averaged 80 basis points last month, a few points down from January and 25 basis points narrower than in November. In February 2009 the spread was 130 points.

“What that’s telling me is that with tax rates likely to go up, we continue to have more and more people saying, 'I want this shelter from taxable income,’ ” Hoogendoorn said. “But on the flip side, there’s just not enough supply coming to market.”

Breaking down the month’s issuance by sector, general purpose bonds climbed 44% compared to the previous February and accounted for nearly one-third of all issuance. Education bonds also contributed more than a quarter of all issuance, yet they fell 13% from the prior year.

Comparisons to the last two years could be misleading though, given how volatile conditions were.

“[Last year] market participants were still dealing with the wake of the Lehman bankruptcy and the beginning of the global economic crisis,” said Tom Kozlik, municipal analyst at Janney Capital Markets. “January and February 2008 auctions were failing and many participants were focusing on the effects of auction-rate security products and a lack of liquidity.”

State governments and agencies made up 41% of all debt issuance, leaving the rest to counties and parishes, cities and towns, districts, local authorities, and higher education facilities.

For bond insurance, the first two months of the year failed to point to any rebound. Only $4.6 billion of new issuance, or 7.9%, was insured in the primary market, a lower percentage than the 8.7% market share seen last year.

The largest borrowers in the month, by state, were Illinois with 121 issues worth $8.2 billion, California with 98 issues totaling $6.2 billion, and New York with 68 issues worth $4.0 billion. In February 2009 they were ranked 119th, 72nd, and 67th.

Noting that some of the largest borrowers are experiencing credit troubles, Hoogendoorn said the issuers may be getting a pass because the market’s focus has been on the broader sovereign -ebt concerns in Europe.

“The spotlight will eventually turn back,” he said. “So I think it’s good that these municipalities are coming to the market now.”

Looking towards March, Kozlik said the first months of the year tend to be slower while issuance then jumps in March. But it’s hard to say if that trend will hold up this year — The Bond Buyer’s 30-day visible supply was just $5.4 billion on Feb. 25.


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