Sell Side

Low Yields No Help In August

Record low yields failed to spur issuers to action in August, as total municipal volume fell 25.1% from a year ago, with issuance in nearly every sector declining in the taxable and tax-exempt markets.

Long-Term Bond Sales: January-August

Total volume fell to a six-month low of $27.2 billion, according to preliminary data from Thomson Reuters. Summers are typically a slow time for muni activity, but that tally represents the lightest August since 2003.

Tax-exempt product accounted for more than two-thirds of new issuance with 815 deals worth $19.5 billion, but was down 24.4% from August 2009. The decline partly reflects the attraction of taxable Build America Bonds, which have constricted the supply of traditional muni bonds.

Taxable volume was also down. Only 270 deals totaling $7.3 billion were issued last month, reflecting a 31.4% reduction in taxable issuance from August 2009.

The taxable volume in August included $4.7 billion of BABs — less than half the issuance of a year ago — the lowest monthly BAB volume in 13 months.

Tom Kozlik, municipal credit analyst at Janney Capital Markets, said the decline in muni market volume isn’t too surprising given how light the forward-looking calendar has been since May. The period between Independence Day and Labor Day is historically light on volume as people take time off.

“Issuers are human, too,” Kozlik said.

Capital needs in some sectors may also be light because federal stimulus funds have helped fill some budgetary voids, according to Richard Ryffel, managing director of investment banking at Edward Jones.

He said much of the needed borrowing has already been completed, and fewer infrastructure projects are being initiated due to the slowing economy.

Still, the broad tumble in volume is curious given that borrowing costs for municipalities have never been lower. Tax-exempt yields have been falling rapidly since a calendar year peak on April 7.

The Municipal Market Data 10-Year triple-A yield fell as much as 99 basis points from the April peak to a nadir of 2.17% on Aug. 25.

The two-year triple-A yield shed 52 basis points in the same period to 0.31%, while the 30-year triple-A yield lost 50 basis points to 3.67%.

Much of that strengthening occurred last month. The yield on the MMD 10-year triple-A yield, for instance, has shed as much as 41 basis points the last four weeks.

While current rates are clearly attractive to issuers, most are unable to jump into the market simply for that reason, Kozlik said.

“When issuers are going to do a $300 million bond deal, that’s not just decided a month ahead of time,” he said. “There’s got to be a capital plan. It’s not easy to just say, 'Oh look, the bond market is low, let’s do an issue.’ ”

Falling yields indicate continued demand, but much of the appetite stems from institutional investors looking for safe haven assets. Retail buyers, by contrast, have been looking elsewhere in the past three months, said Ryffel.

“Retail demand is down from last year or even from a few months ago,” he said. “For the most part you have people sitting on the sidelines waiting for yields to go up.”

However, investors seeking tax-exempt interest have few alternatives, according to Ryffel, and those seeking to maintain a diverse portfolio will continue to buy munis directly or via bond funds.

Among sectors, volume tumbled across the board save for issuance of general purpose bonds, which rose 3.2% to $9.1 billion from the prior August.

Education bonds, the second-largest sector after general-purpose debt, fell 26% to $5.2 billion. Transportation bonds, the third-largest sector, fell 22% to $4.5 ­billion.

Other declines were even more precipitous. Health care sank 67% to $1.7 billion, housing issuance tumbled 54% to $531 million, and environmental facilities issuance plummeted 70% to $275 million.

The decline in refunding deals also continues to be a factor. They have become less attractive, given the low interest-rate environment in the broader fixed-income market.

Refunding volume decreased 42% to $5.3 billion, while new-money issuance fell 21% to $18.3 billion.

In an advance refunding, bond proceeds are placed in an escrow account to pay principal and interest on the refunded bonds until they can be called. Refunding bonds are typically invested in an escrow of Treasury securities, but the transaction is less economical when Treasury yields are this low because the escrow earns less.

“The advance refunding would have to include an issue with fairly high coupons in order to result in refunding savings high enough to make up for the negative arbitrage the refunding would experience in the escrow investment,” Kozlik said.

Competitive deals, helped by the continued issuance of plain-vanilla general purpose bonds, jumped 13.3% to $6.2 billion last month. But negotiated deals declined 32% to $21 billion.

Meanwhile, bond insurance continued to play a minor role. Just 144 deals worth $2 billion were insured in the month, or 7.4% of all new volume.

Insurance year-to-date fell 34.6% compared to the same eight months last year, to $18.3 billion.

While the market struggles with just one active private insurer — Assured Guaranty Ltd. — other state-supported guarantees continue to play a more significant role wrapping new bonds.

These guarantors — called “Other Guarantees” by Thomson Reuters — insured 163 deals last month worth $1.8 billion. That’s a 258% increase from August 2009, and year-to-date such guarantees were up 126% to $11.6 billion.

Despite the dearth of overall issuance recently, the muni market remains on track to float more than $400 billion in 2010. Issuance in the first eight months was $260.7 billion, or 0.7% more than the same period in 2009, a year which eventually saw $410 billion of long-term notes issued.

Borrowing looks likely to remain light over the next month: The Bond Buyer’s 30-day visible supply index on Tuesday was a modest $5.96 billion.

However, beyond September many participants are expecting a flood of taxable issuance as borrowers take advantage of the full 35% BAB subsidy before it potentially expires or is reduced at the end of the year.


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