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Volume Is Back in The Dumps

Summer doldrums seem to have taken hold of the municipal market, as volume in July and year-to-date is off significantly, and the scenario does not look likely to change soon, with issuance not expected to pick up until fall.

July issuance declined 16.8% to $24.3 billion from last year and volume for the first seven months of the year declined 39.5% to $141.7 billion from the same period in 2010.

“June was the biggest month so far this year, and when we look back at the 10-year monthly average, issuance always peaks in June, goes down in the summer, and spikes up in the fall,” said Peter Hayes, head of municipals at BlackRock. “So it’s not surprising that July was lower.”

As the grueling federal debt-ceiling negotiations failed to reach resolution in the last few weeks of July, the municipal market became increasingly wary of what might take place in early August. Some analysts say that while issuers may not have rushed to the market to beat the Aug. 2 debt-ceiling deadline, borrowers that were already scheduled to come to market shrank their offerings significantly.

“The state of Maryland downsized its deal slightly with regards to the refunding portion,” Hayes said, adding that uncertainty may have contributed to the state holding back from the refunding portion of the deal, issuing only new bonds instead.

Other market participants say the impressive $8.4 billion sold in the week of July 18 was a sign that issuers may have come to market earlier than expected.

“The debt ceiling debate has created some uncertainty for issuers recently, and we saw a larger calendar of $8 billion two weeks ago,” said Jamie Iselin, head of municipal fixed income at Neuberger Berman. “Part of that was issuers trying to be cautious and get deals done with the uncertainty looming about the Aug. 2 deadline. And that accelerated issuance.”

And even though the third week of July saw the highest weekly issuance for the year, “the market handled it very well,” Hayes said. “Demand was good, especially with deals that have yield. That is what investors have been gravitating towards and demand for those remains strong.”

But record issuance in one week of the month did not make up for an otherwise lackluster month of low volume.

Negotiated and competitive issuance for July were both off about 20% from last year. Roughly $17.4 billion in negotiated bonds came to market in July, down from $22.6 billion a year ago. About $5.1 billion in competitive deals came to market for the month, down from $6.5 billion last July.

Keeping with the traditional order, borrowers in California, New York, Texas, and Illinois grabbed the top spots for most issues. Even though the Golden State itself has yet to come to market this year, issuers within the state came to market 467 times from January to July, with a par amount of $18 billion, followed by Empire State issuers coming to market 341 times with a par value of $17.5 billion.

Both states were down 46.7% and 15.5% from January through July 2010, respectively.

Texas and Illinois followed, with borrowers in those states issuing $12.8 billion and $7.9 billion, respectively, while volume for both states is off 29.5% and 53.7% from the same time period last year.

This month the Pennsylvania Higher Education Assistance Agency led the way with a $1.7 billion issue and the University of California Regents followed with a $1.2 billion taxable deal. The New York State Dormitory Authority and New York City followed with taxable and tax-exempt $909.4 million and $800 million issues, respectively.

Despite the fairly large deals, new money continued to suffer, with $14.2 billion coming to market in July, down 20.4% from last year. Refunding bonds were down only 1.3%, with $5.9 billion being sold compared to $6 billion last July.

Surprisingly, two of the largest sectors, education and health care, issued more bonds in July this year than a year ago. About $8.6 billion in education bonds were issued, up 35.3% from last July’s $6.4 billion. About $1.4 billion in health care bonds were offered, up 83.1% from $742.5 million a year ago.

“The outlook for the health care sector is less certain, but I think that hospitals have been anxious to come to market to take advantage of market-attractive borrowing levels,” Hayes said. “Market appetite is strong and the yields on a relative basis for health care lower-rated credits are still attractive with rates between 6.5% and 7% for longer maturities.”

Others agree that health care sector yields are attractive. “As we get closer to implementing the health care bill, the sector will experience some additional pressure points,” Neuberger’s Iselin said. “But it is also a large sector of the market that has yield, so in a low absolute-yield environment, it is a large source of paper for investors that are looking for additional yield in a yield-starved environment.”

Transportation and general purpose debt did not fare as well, as both sectors saw muni volume drop 60% and 31.3%, respectively. Issuance for transportation was down to $2.5 billion for July, compared to over $6 billion in July 2010, and general purpose bonds were down to $7.1 billion from $10.3 billion.

Education, the largest sector by issuance, was down 20% year-to-date, followed by a 45% slide in general purpose bonds, a 53% plummet in transportation, and a 41% drop in health care bonds.

Going forward, Iselin said he expects demand for new issuance to be strong in the short end of the yield curve.

“With money market fund yields so low, some investors have migrated to short-duration bond funds focused on one-to-three-year or three-to-five-year maturities,” he said. “Demand there is really high.”

Meanwhile, demand remains strong for “tried and true high-quality high-grade names,” Iselin said. Investors are flocking to well known triple-A or high double-A issuers, he added, and “those are the types of names that draw investors in.”

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