Refunding volume increased 22.8% to $47.8 billion in the first six months of 2010, despite the year-long decline in long-term non-stimulus program bond issuance, reflecting a shift in the yield curve and improved market conditions. Refunding volume was $38.9 billion in the same period of 2009.
Yield levels experienced their most precipitous drop in the 7-to-12 year portion in the first half of this year as they declined anywhere from 10 to 22 basis points, according to the Municipal Market Data’s triple-A scale. The long end of the curve also rallied, with yields dropping from 8 to 13 basis points between 25 and 30 years.
“The belly of the curve is rallying,” said Evan Rourke, portfolio manager at Eaton Vance. “That’s probably a function of people getting more comfortable with the fact that the economy has been slow, that inflation hasn’t picked up, and that rates are likely to stay low for longer than people thought.”
Rates still managed to post gains in the intermediate part of the curve in the first half of 2010, with yields climbing between three and five basis points between 15 and 22 years out.
Rourke said those gains are indicative of an “absence of real strong buying interest.”
The MMD triple-A scale yielded 3.00% in 10 years and 3.70% in 20 years on Dec. 31, 2009, along with 4.15% in 30 years. On June 30 of this year, the scale dipped 21 basis points to 2.79% in 10 years and 13 basis points to 4.02% in 30 years, but increased five basis points to 3.75% in 20 years.
“The market seems to be slowly adjusting to current market yields,” Rourke said. “Every time you’ve dropped a handle historically, with individual investors being the dominant buyer of munis, there’s been a degree of hesitation.”
People have slowly adjusted their expectations as yields have fallen and inflation has remained low, and are more comfortable now with the idea that a 2.5% return is OK in a 1% environment, he said.
“Now you’re talking about 10-year munis through a 3%, 20-year munis — you’re below a 4%, and the long end is also below a 4%,” Rourke said.
Daniel Berger, senior market strategist at Thomson Reuters, said “investor preference has been to stay short given the historically low yields” the past few months. Overall long-term issuance in the municipal market in the first half of 2010 climbed 3.9% to $204.2 billion, up from $196.5 billion during the same period last year.
With Build America Bonds and other stimulus debt now exceeding a quarter of long-term issuance in the first half, non-stimulus long-term issuance declined 18.2% to $147.9 billion from $180.7 billion during the same period in 2009.
Nearly all non-stimulus categories showed a drop from first-half 2009 levels, with the exception of refundings. Berger said the uptick in refundings figures to continue in the second half of the year.
“Anecdotally, we are hearing a lot of refundings popping up in the calendar,” he said. “We are seeing quite a few names and the calendar is getting very crowded.”
Rourke also noted that the difficulties issuers face in doing refundings is “the issue of relative value to munis and the ability to construct an escrow — the arbitrage issues.” He said that refundings will continue to get done if issuers can do escrows.
“You always see a lot of those shorter call bonds getting done — bonds with a 2017 call and a 2024 maturity,” Rourke said. “Those bonds are getting refunded — I think you’ll see that continue.”
Tax-exempts cheapened to Treasuries considerably over the first half of the year, helping to make munis more attractive. On Dec. 31, 2009, the triple-A municipal scale in 10 years was 77.5% of comparable Treasuries and 30-year munis were at 88.9%, according to MMD. On June 30 of this year, they were 94.9% and 103.1% of comparable Treasuries, respectively.
Howard Mackey, president of the broker-dealer division of Rice Financial Products, said the dynamics of the first six months of 2009 were quite a bit stronger than they are now.
“We have had a fairly strong market this year and we’ve seen a good amount of refundings, but we had a good run during the first half of last year because we were coming off the heels of a financial calamity,” Mackey said. “Now, I think we are just getting the benefits of a low yield. But it will be very hard to duplicate [2009] even with the absolute low yields that we are seeing in the markets.”
Accounting for stimulus program issuance, first-half 2010 volume increased over the same period in 2009 in every month except April and June, and by at least 14% in each. Only January and May saw gains among non-stimulus issuance, with May gaining by just 0.3%.
In April and June, non-stimulus issuance dropped by 31.1% and 38.8%, respectively, to $19.9 billion and $23.7 billion from $28.9 billion and $38.7 billion. All long-term bonds dropped 25.8% to $27.4 billion from $36.8 billion in April and 21.0% to $34.6 billion from $43.9 billion in June.
Rourke found the April and June dips surprising, particularly the June decline.
“You’d think there’d be some reinvestment flows and there’d be more deals in that month,” he said. “It may be, however, that last year was exceedingly heavier issuance in that time frame.”
June was “exceptionally heavy,” according to Rourke.
The largest refunding in the first half of 2010 was a $1.1 billion issuance from the Massachusetts Department of Transportation, which was priced by Citi and JPMorgan in May. The high yield was 4.81% with a 5% in 2037.
MassDOT also had the second-largest refunding of the first half, a $853.6 million offering in April.
Other sizeable first-half refundings included a $713 million sale for the New Jersey Higher Education Student Assistance Authority in January, $694.3 million of debt for the District of Columbia in March, and $650 million of bonds for the New York Liberty Development Corp. in June.
