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Summer Doldrums in Full Force

The wave of fiscal conservatism sweeping the nation continues to cap issuance of state and local government debt at the lowest levels of the past decade.

Long-Term Bond Sales: January-August

New borrowings in August stumbled into the data sheets at just $21 billion, a 29% trim from the $29.7 billion issued in August 2010 and a 42% cut from the $36.4 billion floated in 2009.

Thomson Reuters figures show year-to-date issuance accumulating to just $163.3 billion, or 38% less than a year ago.

The August and year-to-date numbers are each the lowest since 2000.

“We’re in a new era of austerity,” said Rob Williams, director of fixed income at Charles Schwab. “There’s less appetite for infrastructure investments, given the belt-tightening.”

The volatile month began with Standard & Poor’s downgrading the United States and concluded with Hurricane Irene sweeping up the East Coast. Only in the middle did issuers feel secure enough to borrow a decent chunk of debt.

The month’s biggest week of issuance began Aug. 15 when $6.5 billion was issued, including two deals worth more than $950 million apiece, the largest of the month. The other three weeks were capped at $5 billion.

“August was a month of uncertainty,” said Peter Hayes, head of municipals at BlackRock. “For half the month, issuance was pretty light. We had some issuance in the middle of August and though it was handled fairly well, demand was not as strong as past months.”

The lack of issuance draws a curious juxtaposition for issuers, as borrowing costs have never been so low for new debt. Ever.

Benchmark yields fell to all-time or multi-decade lows in indexes maintained by Municipal Market Data, Municipal Market Advisors, and The Bond Buyer.

But Williams said politicians are riding the fiscal wave, and that’s trumping any consideration of low yields.

In part this is because the phenomenon isn’t limited to munis. The whole economy is caught in a deleveraging cycle, including at the federal and consumer level, he added.

Retail participation has been generally quiet since the debt-ceiling debate spooked the fixed-income markets, Williams said. But heightened stress in broader bond markets hasn’t hit tax-exempt buyers too hard, with buyers seeing no reason to rush the exits.

“Munis followed Treasuries and we haven’t seen retail panic,” he said. “So there’s more confidence in high-quality muni bonds as compared to other asset classes.”

While the 10-year Treasury yield swung between 1.97% and 3.20% last month, MMD’s 10-year muni yield only wagged between 2.15% from 2.63%. Strength has been most pronounced in high-grade debt, while demand for lower-quality credits hasn’t been robust.

As a result, MMD’s single-A spread on 30-year debt widened from 69 basis points in early August to 91 basis points on Tuesday.

“Most retail investors are taking a wait-and-see approach instead of seeking to invest opportunistically in lower rated issuers with lower liquidity,” Williams said, adding the same trend is apparent in the corporate world.

The biggest sector at play in August was education, where borrowers floated $5.6 billion of debt, just 5% less than in 2010. And utility issuance actually rose 2.4% from last year to $4 billion.

But the market’s biggest sector, general purpose, saw issuance drop 47% to $4.7 billion, while transportation issuance fell 56% to $2.2 billion and health care issuance crashed 63% to $787 million.

The January-to-August data shows the most significant cuts to issuance have been for general purpose, which fell 47%, transportation, which dropped 54%, and health care, which was down 41%. The decline in education bonds was 17%.

Among credit enhancements, Assured Guaranty’s two insurer platforms wrapped $1.3 billion of new issues for a volume share of 6.1%. Year to date, their penetration rate is one percentage point lower.

Public guarantee programs, called “other guarantees” by Thomson Reuters, continue to increase their presence. They wrapped $3 billion of new product in August, or 14% of new volume. Year to date, these programs — dominated by the Texas Permanent School Fund — have insured 7.6% of all issues.

The big question is whether issuance will pick up after Labor Day.

Hayes said issuance typically rebounds after a light summer, but this year has been too atypical to depend on historical norms. The market is still waiting on economic data and President Obama’s plans to create jobs. Such events will set the tone for rates, which in turn will impact the muni market.

Williams, emphasizing the political climate, said, “Many market watchers are expecting volume to remain fairly low as muni governments continue to reduce the amount of new projects that requires debt.”

A big factor could be California. Issuers in the state have so far borrowed $21.8 billion, more debt than any of their 49 siblings, but the state itself hasn’t issued any general obligation bonds. If it does, that would pour some needed liquidity into an increasingly barren market.

Buyers could certainly use new issuance. While the risk-off trade prompted by Standard & Poor’s downgrade of the United States didn’t quite hit municipal bonds, Hayes said liquidity dried up near the end of month, partly because of slow issuance and the need for price discovery.

Overall, new-money issuance is down 46% at just $88 billion this year, and more bonds are likely to mature or be called than are issued, meaning the overall size of the muniverse could shrink in 2011, according to John Hallacy, head of muni research at Bank of America Merrill Lynch, who estimates that $186 billion will roll over in the calendar year. He also noted the Federal Reserve’s data on outstanding munis did shrink in the first quarter.

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