Issuers paid less to borrow in the tax-exempt market in 2010, with a more pronounced decline in underwriting fees on bond issues authorized as part of the American Recovery and Reinvestment Act compared to the decline of combined tax-exempt and stimulus debt.
Not only did issuers see a larger drop in borrowing costs for stimulus debt versus all bonds combined last year, but underwriting fees in general were lower for both stimulus-only and tax-exempt and stimulus debt combined when compared to 2009 fees, according to new data from Thomson Reuters.
In 2010, issuers paid underwriters an average of $6.44 per $1,000 face value to bring stimulus-only bonds to market — a decline of $1.01 from the $7.45 they paid in 2009.
When stimulus bonds were factored into the overall fees, however, it cost issuers an average of $5.94 — just 27 cents less than the average $6.21 they paid in the year before. Underwriting spreads include managers’ fees, underwriting fees, average take-downs and expenses.
“The spreads on stimulus bonds were converging to be more in line with the traditional tax-exempt spreads as the novelty factor wore off,” according to Peter Delahunt, national institutional sales manager at Raymond James & Associates Inc. in New York City.
Despite the modest decline last year for all bonds — which includes stimulus financings — the 2010 level ranks as the third highest in the past decade, behind both stimulus-driven 2009 and 2001, when fees climbed to $6.48, a spread that hasn’t been equaled since.
Additionally, excluding 2009, last year’s spread remains the highest overall since 2002, when fees averaged $6.17.
Municipal sources say the decrease in fees was much more pronounced for stimulus-only bonds because of the market’s growing acceptance for taxable Build America Bonds, a large chunk of the debt that came to market as a result of the ARRA, which was signed into law in February 2009.
Since the legislation passed, issuers flooded the long end of the municipal market with a total of $181.5 billion of BAB debt prior to the program’s expiration on Dec. 31, 2010.
Chris Mier, managing director and chief strategist at Loop Capital Markets LLC in Chicago, said there is not a significant enough of a difference in the underwriting spreads to indicate exactly what might have caused the fees on all bonds to drop so slightly. For instance, over the last 10 years, fees have averaged 5.736%, with a high of 6.48% in 2001 and a low of 4.89% in 2008, he noted.
“At $5.94 relative to the average, the difference of 27 cents is about half of the standard deviation of 48 cents,” Mier said. “Based on the standard deviation, the change is not terribly significant. It could be a systematic decline in spreads because of competition, but it’s more likely a random fluctuation.”
Underwriting fees on negotiated and competitive bond issues dropped last year to $6.03 from $6.22, and to $5.23 from $6.16, respectively, compared to 2009.
Mier says issuers’ rush to market with BABs could have helped curtail fees. “You had a significant uptick in volume based on issuers trying to get in the market,” he said. But given the standard deviation, “you’d suspect in any given year that’s within 25 cents plus or minus the average — you’d have to regard that as a random event.”
However, George Friedlander, senior municipal strategist at Citigroup Inc., said underwriting spreads were likely to drop from their earlier highs, “as they always do as a new market matures” following an initial “burn-in” period, as was the case in 2010 with BABs.
“From January until April [2009], we were just beginning to come out of the worst market environment in history, and firms were unwilling to underwrite at the spreads that [prevailed] before the crisis,” he said. “By 2010, until mid-November, BABs sapped much of the volatility out of the market, and firms were willing to compete more aggressively on spread.”
Friedlander called 2009 an “outlier” and said the decrease in fees was not random.
“I think it was predictable,” he said.
Of the $432.98 billion in total volume that came to market in 2010, fees on new-money and refunding deals both fell from 2009 levels: new money to $6.05 from $6.39, and refundings to $5.59 from $5.84.
Likewise, fees declined in most municipal bond sectors, except for development, which skyrocketed to $5.07 from $3.65, and health care, which jumped to $8.56 from $7.78 — its highest spread in a decade. Fees in the housing sector also rose, climbing to $6.40 from $5.66, the highest level since it hit $6.63 in 2002.
On the other hand, underwriting spreads in the environmental sector were among those with the sharpest decline, dropping to $4.31 from $5.20 last year, according to data.
Some analysts, like Richard Ciccarone, chief research offer and managing director at McDonnell Investment Management in Oakbrook, Ill., linked the lower overall fees to the increased competition among both large and small dealers in 2010.
“Every time a big company closed it seems like a smaller company opened,” he said. At the same time, Ciccarone said, the existing large firms increased their public finance efforts at a time when the volume of BABs was growing rapidly, he noted.
