Sell Side

First-Quarter Volume Close To Record

Strong investor demand allowed municipal issuers to sell near-record levels of debt at historically low yields in the first quarter of 2010.

Long-Term Bond Sales: January-March

“Away from the constant media headlines in regards to negative credit quality concerns to municipals overall, that did not seem to translate into less ability to issue debt,” said Michael Pietronico, chief executive officer at Miller ­Tabak Asset Management. “It seems the investing public is less concerned about credit quality, while the media is perhaps overly focused on it.”

From January to March, municipal issuance was 17.1% greater than the year before.

To date, $99.96 billion of long-term debt came to market compared to $85.4 billion in the first quarter 2009, according to preliminary data from Thomson Reuters. Only in 2007, a record year for volume, did the market see more than $100 billion issued in the first quarter.

Note sales totaled $5.36 billion in the first quarter, down 2% from the $5.47 billion sold in the first quarter of 2009.

Meanwhile, yields across the muni curve clearly flattened over the quarter. The spread between triple-A two-year munis and comparable Treasuries began the year at 214 basis points and flattened to 128 points, according to Municipal Market Data. In 10 years, the muni-to-Treasury spread flattened from 147 basis points to 119.

“The unrelenting pounding these credits are receiving from the news media should, all else being equal, scare away investors, depress prices, and widen credit spreads,” Chris Mauro, director of municipal bond research at RBC Capital Markets, wrote in a recent research note.

But, he added, “despite being at historically low levels already, muni-Treasury ratios continue to grind tighter into the spring.”

The low yields are largely the result of tax-exempt scarcity owing to the success of Build America Bonds, the taxable asset created by the American Recovery and Reinvestment Act of 2009.

By giving issuers the option to borrow in the taxable market with a 35% direct-payment subsidy, the stimulus program has allowed state and local governments to tap into a much wider investor base, while leaving traditional muni investors competing for less tax-exempt product.

As a consequence, tax-exempt issuance fell by 19.3% compared to the first three months of last year. There was 27.9% less tax-exempt debt sold in March than a year ago.

Meanwhile, taxable issuance accounted for one-third of all borrowing by municipalities. The quarter saw $32.71 billion of taxable muni assets hit the market, including $13.65 billion last month.

“The profile at the long end seems dominated by how much volume BABs are pulling out of the market and what that’s doing to the supply dynamics for tax-exempts on the long end,” Mauro said in an interview. “That appears to be the biggest driver of what’s going on right now.”

Going forward, the influence of BABs may be even more dramatic if the program expires as scheduled, by year-end, or if pending legislation to expand the program with a lower subsidy rate is approved by Congress.

“Don’t forget, BABs may surge if they cut back on the subsidy to the issuers,” said Kurt Van Kuller, director of institutional sales at Northeast Securities.

Projecting further into the year, Van Kuller said total volume should come in higher than last year’s $409.56 billion, but added that making firm predictions is a fool’s errand until the future of BABs is clearer.

“Issuers may accelerate issuance in that case to obtain the more favorable 2010 interest subsidy,” he said.

The increase in municipal volume to date is all the more surprising given that the primary market is operating with little influence from credit enhancement.

In the first quarter, issuers only sold $6.4 billion of bonds wrapped by insurance, which is 42% less than the first quarter of last year, according to Thomson Reuters. As a share of the market that represents just 6.4% of issuance, and the trend is downwards as less than 4.0% was insured in March.

Moreover, with Moody’s Investors Service and Fitch Ratings each confirming in recent weeks that they will move to global ratings scales later this month, insurance could become increasingly irrelevant going forward.

“The ratings adjustments that we will see over the next 30 days will make things more difficult for the bond insurers, especially the start-ups, since the lower risk category credits will be the ones that will benefit most from the recalibration,” Mauro said.

If there’s a positive angle for insurers at all, Van Kuller said it is that bond insurers could diversify the business away from essential service bonds to keep up volume.

“There’s so much rating stress in the municipal market that it might point towards a rebound in business for bond insurers,” he said. “Much of that may need to come from sectors other than essential purpose bonds, which would get the brunt of the favorable impact from the ratings scale changeover.”


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