Trend in the Region

Midwest Has Tepid Take on Debt

CHICAGO — Political and fiscal challenges took a steep toll on Midwest municipal borrowing levels during the first half of 2011, contributing to a 47% nosedive in volume compared to the same period last year.

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Issuance fell to $21.2 billion, down from nearly $40 billion over the first half of 2010.

Issuers posted lackluster numbers for both quarters, though borrowing picked up somewhat in the second quarter. Last year at this time, the region’s volume levels had leaped by 32.5% due primarily to a surge of borrowing by Illinois to fund its capital program and provide budgetary relief.

The first quarter saw a 56.1% decrease in borrowing to $9.8 billion in 715 deals while the second quarter dropped by 35.3% to $11.4 billion in 948 deals, according to Thomson Reuters. The region provided the market with more than 1,000 deals in the first half of last year and 1,243 in the second quarter.

The continuing low interest rate environment couldn’t lure many hesitant borrowers — especially states — as issuers sought to focus on balancing budgets and avoiding the ignition of electoral anger.

“It’s the political dynamic,” said Chris Mier, managing director and lead analyst at Chicago-based Loop Capital Markets LLC. “Politically it became very difficult, especially at the state level, for governments to issue debt. It’s politically undesirable to do financings when you are battling a budget deficit and pension problems and citizens are bombarded with that news.”

New governors took office in many states, including Iowa, Michigan, Minnesota, Ohio, and Wisconsin, some pledging to rein in bonding and spending in order to deal with large budget deficits, while some incumbents followed the same track.

The notable exceptions included Illinois — which expects to issue $2 billion to $3 billion in the current fiscal year for capital projects in a $31 billion public works program — and Minnesota, where Gov. Mark Dayton won legislative support for a $500 million bonding bill as part of a budget compromise.

Issuance also saw an across-the-board dip among areas of government, with state-related borrowing falling most sharply. State agency debt issuance shrank by 64.2% to $3.3 billion, state government bonding fell by 49.8% to $4.7 billion, cities and towns declined by 26.4% to $4.7 billion, and issuance among districts dropped 38.6% to $3.9 billion.

Borrowing among Missouri issuers showed the largest drop-off, 64.6%, to $1.5 billion. Ohio issuance declined by 58.7% to $2.2 billion, Illinois dropped 53.4% to $7.3 billion, and Michigan fell by nearly 52.9% to $2 billion.

The decline hit most major sectors, with the exception of housing, electric power, and development. They saw increases but represent just a small chunk of issuance with less than $1 billion in each. General-purpose borrowing fell by 45.4% to $7.5 billion, while education dropped 48.6% to $5.7 billion, and health care sunk by 50.7% to $3.2 billion.

Health care volume came in 51 separate issues, compared to 112 for the same time last year as issuers postponed or canceled capital spending amid concerns about reimbursement rates that are expected to tighten under the federal health care law and cuts tied to the debt-ceiling deal, according to Pierre Bogacz, managing director at HFA Partners LLC.

“I think health care reform is 80% of why hospitals are putting projects on hold right now,” Bogacz said. “They don’t think it’s prudent to embark on large strategic endeavors without knowing what reform means for them.”

The drop in health care issuance also reflects alternative borrowing strategies being used, including direct loans from banks. Banks that previously issued letters of credit or standby bond purchase agreements to support publicly floated variable-rate bonds are increasingly interested in buying the debt themselves.

“These are the same banks that used to do letters of credit, and when they come up for renewal, the banks no longer want to do a LOC but they’re very enthusiastic about doing direct placements,” Bogacz said. “From a hospital’s standpoint, what’s not to like?”

Providers that directly place their bonds with a bank can often achieve 100 basis points or more in savings and avoid the put risk from a volatile public market. Bogacz said he expects the trend to continue.

“Banks are trying to deploy their capital,” he said. “I’ve heard that management is saying you cannot lose a deal on price — that’s a very telling sign that they’re hungry for business.”

Overall, new-money issuance totaled $13.3 billion, refundings added up to $4.4 billion, and combined issuance was $3.5 billion. The dip hit both new money and refundings nearly equally, with new borrowing falling by 48.8% and refunding dropping by 43.9%. 

General obligation bonds represented $11.6 billion of the sales by Midwestern issuers over the first half while revenue-backed bonds totaled $9.6 billion.

Due to the expiration last year of the taxable Build America Bond program created by the federal stimulus package, taxable bonding saw a sharper drop-off, 66.6%, than tax-exempt issuance, which declined 39.3%.

Issuers used a fixed-rate structure on $19.4 billion worth of borrowing, while opting for a variable rate on $1.1 billion.

Private placements jumped 95% in this year’s first half over 2010. Issuers privately placed a total of $554.7 million of debt in 53 separate transactions compared to $284.2 million in 31 deals for the first six months of 2010.

Insurance coverage was sought on just $600 million of bonds in 77 deals, representing a 75.2% drop. The figures underscore the difficult road back faced by bond insurers after the market’s collapse when monolines lost their triple-A ratings.

“Spreads are wide, and people are concerned about credit risk while retail is active,” Mier said. “So the lack of market penetration for insurance speaks to how difficult the crawl back is to earning the trust of investors.”

Illinois topped the charts among issuers due to its $3.7 billion sale in February to fund its fiscal 2011 pension payment. Morgan Stanley, Goldman, Sachs & Co. and Loop were senior managers.

Chicago followed with $1.4 billion sold in six issues, led by its $1 billion April sale senior managed by Citi to fund an ongoing runway makeover at O’Hare International Airport.

The Illinois Finance Authority was next with 10 issues totaling $837 million, followed by Wisconsin with two issues for $704 million and the Indiana Finance Authority with eight issues totaling $596 million.

Illinois’ pension-related sale topped the charts on deal size, followed by Chicago’s airport issue and Wisconsin’s sale of $429 million of GOs with JPMorgan in the lead spot. The University of Minnesota Regents followed with a $335 million sale led by Barclays.

Franklin County issued the fifth-largest deal, on behalf of OhioHealth. The system priced $314 million of hospital revenue bonds June 23 that were a mix of new money and refunding. Barclays was the senior manager.

Michigan’s largest issue so far this year is from the Lansing Board of Water and Light. The utility — the largest municipally owned utility in the state and a relatively rare bond issuer — priced $250 million May 25.

Proceeds financed construction of a new natural gas plant in Michigan.

Where the final numbers for the year will land remains unclear. A slate of issuance is planned, with large deals coming from Chicago, Cook County, Illinois, Minnesota, and Ohio.

Chicago is planning to sell more than $300 million of debt, while Cook expects to issue up to $425 million. Minnesota wants to sell tobacco debt in the fall and $600 million to $700 million of GOs in late summer or early fall.

Ohio plans a $300 million GO offering by the Ohio Public Facilities Commission to finance school projects. The state will take competitive bids on the issue in mid-September.

Health care issuance is expected to remain low for the rest of the year as providers wait to see how Congress’ so-called super committee tackles federal deficit cuts.

It was a tight race in first-half rankings among senior managers. Citi led the pack, with 18 deals totaling $1.8 billion. Morgan Stanley followed closely with 18 deals worth $1.7 billion and Goldman Sachs was third with five deals totaling $1.6 billion. Loop came in fourth, receiving credit on three deals worth $1.5 billion.

JPMorgan was fifth, with 22 deals worth $1.5 billion, and Bank of America Merrill Lynch was next with 19 transactions worth $1.4 billion. Barclays, Robert W. Baird & Co., Wells Fargo Securities, and Stifel Nicolaus & Co. rounded out the top 10.

Peralta Garcia took the top spot among financial advisors in the region due to its work on Illinois’ pension sale. Public Financial Management Inc. followed, advising on 111 deals. Health care specialist Kaufman Hall & Associates came in third, credited for work on 12 issues.

Kutak Rock LLP took the top spot among bond counsel, working on 28 deals worth $4.1 billion, followed by Chapman and Cutler LLP with 172 deals totaling $1.4 billion, and Dorsey & Whitney LLP with 128 deals for nearly $1.4 billion.


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