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November Boosted By BABs

NOV 30, 2010 9:00pm ET
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A record amount of Build America Bond issuance helped municipal market volume gush to $41.7 billion in November, or 8.9% more than in the same month last year.

Long-Term Bond Sales: January-November

Issuers are scrambling to use the BAB program and its 35% subsidy before its Dec. 31 expiration. The program’s future remains uncertain, though federal lawmakers have discussed the possibility of extending the 20-month-old program another year at a lower subsidy level.

BAB issuance totaled $14.2 billion in November, reflecting a 34% share of new borrowing, according to preliminary data from Thomson Reuters. That amount represents the largest monthly BAB issuance since the program’s inception in April 2009 and an 87% increase from November 2009.

The deluge in BABs helped make November the third most active month this year for issuance, behind October’s $45.6 billion and March’s $44.4 billion.

Tax-exempt issuance was headed in the opposite direction in November with a $24 billion tally that is the lowest for that month since 2004.

Total market issuance for the first 11 months of 2010 was up 3.3% to $385.8 billion from the same period of last year — the second most voluminous year on record. The most active year ever was 2007, with issuance of $429.9 billion.

BABs have accounted for $100.1 billion of all market issuance so far this year — a 26% market share.

George Friedlander, municipal bond strategist at Citi, believes there is a 60% chance BABs will be reauthorized. He said the legislative process could take two or three weeks, so issuers have every reason to rush into BABs while they can.

“Issuers who fear the implications of non-extension of the BABs provisions … have a strong incentive to keep their deals moving forward toward issuance over the next three weeks,” he wrote on Nov. 29.

November’s heavy issuance has contributed to recent market volatility. Triple-A rated, 30-year tax-exempts jumped as much as 74 basis points between Nov. 1 and Nov. 18, while 10-year bonds leapt 50 basis points, before each strengthened in the second half of the month.

Between Nov. 1 and Nov. 29, BAB prices fell 3.74%, according to a Wells Fargo index. Meanwhile, tax-exempt bonds shed 2.43%, according to the S&P National AMT-Free Municipal Bond Index. November was the worst month of the year for BAB and tax-exempt prices.

Troy Willis, portfolio manager at Oppenheimer Rochester Funds, attributed the early sell-off to market fears about the BAB program’s expiration, but said those fears have subsided now.

“In the summer, they priced in a 100% chance BABs would be extended,” he said of market perceptions. “Then in November, after the mid-term elections, they determined there was closer to a zero-percent chance they would be extended. Now we’re back to a 90% chance BABs get extended.”

Willis said he doesn’t think the prospects of an extension have actually changed that much as the perception of market participants, which he blames for the market volatility.

By sector, the most notable changes last month versus the previous November were in transportation and health care. Transportation issuance jumped 112% to $7.18 billion, likely as a result of the surge in BAB issuance. But health care volume fell 66% to $1.6 billion as shifting political fortunes cast new doubt on recent health care reform.

“Health care reform has a lot of hospitals and hospital groups scratching their heads,” Friedlander said. “There is pent-up demand, but it is going to take a while.”

Borrowings for general purpose and education, the two largest sectors, were relatively steady. General purpose issuance fell 5.5% last month to $14 billion, and education issuance declined 2.6% to $6.7 billion.

Issuance from state governments and state agencies fell 12% and 19.4%, respectively, from a year ago. Borrowings from cities and towns went up 29.3%, district issuance climbed 56.2%, and local authority borrowing moved up 45.3%.

Friedlander said there were 37 governors up for re-election in November, which probably caused certain projects to be delayed as they avoided focusing on new projects during an election.

“Whatever need for projects there is at the state level either got done early or is going to be deferred until the new governor gets their hand around stuff,” Friedlander said. “It just so happened that this year there was a massive number of governors all coming up for re-election at once.”

Looking ahead, December should see at least $11 billion to $15 billion in BAB volume, said Domenic Vonella, a market analyst at Municipal Market Data. He noted that December 2009 issuance was $36.1 billion, which should be a base estimate for this month’s volume.

“Even if the extension bill is passed, you’re going to see an influx of BAB supply as issuers take advantage of the 35% rebate,” he said. “It could be more if you start getting a nervous rush to the ­market.”

Other stimulus bonds set to expire at the end of the year also saw record issuance.

Recovery zone facility bonds, the tax-exempt private-activity bonds, were used in 16 issues totaling $579 million last month, which accounts for 36% of that program’s borrowing.

Recovery zone economic development bonds, the taxable bonds often dubbed “super-BABs” because of the 45% interest cost subsidy, were used in 58 issues worth $692 million. The 58 issues was a record.

Among credit enhancements, bond insurance continued to be an insignificant player.

Assured Guaranty Ltd., the only guarantor wrapping new debt, insured 115 issues totaling $1.4 billion last month for a total penetration rate of 3.4%. Assured’s share from January to November was 6.4%, constituting 1,570 deals worth $24.9 billion.

BABs can be wrapped too, but Assured has found it difficult to do so for reasons that include the high ratings typical of BABs, their different buyer base, and structural issues related to how the federal subsidy payment is given to issuers.

Dominic Frederico, Assured’s chief executive, told investors in early November that insurance could be a difficult sell amid a flood of BAB issuance, but he expected penetration to be higher next year if BABs expire.

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A recent phenomenon is the emergence of bonds with shorter call protection as funding alternatives for municipalities. However, the shorter call protection also dampens the potential upside for investors, which in turn reduces the price they are willing to pay.

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