The first month of the post-BAB era saw just $12.2 billion of new debt, according to preliminary data from Thomson Reuters. That’s nearly 63% less than in January 2010 and the slimmest volume of any month since January 2000.
“The muni market is dependent on a precariously thin base of demand in the aftermath of the demise of Build America Bonds,” Citi’s George Friedlander wrote.
Issuers rushed to market in the fourth quarter of 2010, ahead of the Dec. 31 expiration of the BAB program, which offered qualified borrowers a 35% federal subsidy to issue taxable debt. BABs accounted for 24% of the $757.6 billion of state and local debt issued from April 2009 through last month.
BAB issuance spiked as the program neared its end, with borrowers moving debt sales up to beat the clock. Fourth-quarter issuance totaled $133.8 billion, the second-highest quarterly volume on record.
But with so much borrowing front-loaded into 2010 at subsidized levels, few issuers were prepared to sell much debt in January.
The yield environment in the new year also is not as friendly to borrowers of long-term debt.
For example, the triple-A rated, 10-year bond reached a 24-month high of 3.46% in mid-month and had a median yield of 3.32% in January. By contrast, its highest yield was 3.27% in 2010 and the median was 2.76%, according to Municipal Market Data.
“Many issuers are still choosing to wait it out until a more favorable rate environment appears,” said Tom Kozlik, credit analyst at Janney Capital Markets, who noted the recent triple-A rated 10-year yield was 80 basis points higher than on Nov. 1.
The yield on the gilt-edged 30-year bond also peaked at 5.08%, the highest since late December 2008.
These jumps in yield, attributed to headline risk causing 11 straight weeks of outflows from muni mutual funds, are all the more worrisome to market participants given the light supply.
Evan Rourke, a portfolio manager at Eaton Vance, said the market is still in a “discovery” process. It’s finding out what yields will tempt retail investors into tax-exempt bonds, he said, noting that a heavier batch of supply would probably offer more information.
“We haven’t hit a very large surge in supply,” Rourke said. “That might be something that would impact our market.”
Amid this climate, refundings fell 55% from last January to $3 billion, while new-money issuance dropped 68% to $7.3 billion.
Declines in volume were seen in all sizes of borrowers. Issuance from state governments dropped 86% to $936 million, borrowing from state agencies fell nearly 60% to $4.0 billion, and new debt from counties and parishes fell 77% to $555 million.
General purpose bonds, the most common form of issuance, fell by two-thirds to $4.3 billion in January from the same period a year earlier.
Most sectors also saw a major decrease. Issuance in the biggest — education — was more than halved as it tumbled 55% to $3.2 billion. Issuance of health care bonds fell 31% to $2.1 billion, while new debt for the utilities sector declined 73% to $1.1 billion.
Just three states accounted for 46% of all new debt in the month.
New York led the way with $2.4 billion of borrowing, while California issuers floated $1.8 billion of munis and New Jersey peddled $1.3 billion.
Most of New Jersey’s debt was from a single deal issued by the New Jersey Economic Development Authority. It borrowed $1.1 billion in the month’s biggest deal, on Jan. 13.
Bond insurers, represented by two platforms run by Assured Guaranty Ltd., insured just 40 deals with a par value of $308 million, or 2.5% of the month’s volume.
State-backed guarantee programs, such as the Texas Permanent School Fund, wrapped more than double that volume, with 47 deals worth $607 million.
BABs had siphoned borrowing from the tax-exempt market, where Assured is strongest. The company hopes to find more of a footing this year after guaranteeing less than 7% of all borrowing in 2010. It wrapped about 1% of BABs.
Yields have risen and credit spreads have widened since late November, when it became clear that federal lawmakers would not be extending the BAB program. Its demise represents a window of opportunity for Assured and potential new entrants.
However, Standard & Poor’s warns that investment-grade insurers may be downgraded by a full category later this year, pending a new ratings methodology that would take into account a series of business risks and a new leverage test.
Chris Holmes and Alex Roever, analysts from JPMorgan, estimate that under the proposed criteria, Assured would have to raise $2 billion of fresh capital to maintain its AA-plus rating.
“If AGO were unable to raise this amount of capital, it would eventually be downgraded to A or possibly A-minus,” they wrote, noting that implementation of the proposed changes could easily take until the end of the year.
Meanwhile, letters of credit fell 91% to $30.6 million.
Rich Raffetto, head of government banking at U.S. Bank, said issuers continue to issue longer-term fixed-rate debt rather than go through the hassle of selling short-term, variable-rate demand notes, or VRDNs, which require bank guarantees and interest rate swaps.
“Frankly, it’s simpler to not have to deal with liquidity and credit enhancement for VRDN structures in an environment where supply of those [facilities] remains depressed,” he said “You continue to have reduced supply of interested players in the market.”