If 2010 was the year of Build America Bonds, what should 2011 be known as? So far the themes are simple: issuers don’t want to issue and buyers don’t want to buy.
Municipal bonds sold in the first quarter total just $46.94 billion, according to preliminary data from Thomson Reuters. That’s the slimmest sum since the first three months of 2000 and 55% less than the same period last year.
Adjusted relative to the size of the market at the start of each quarter, first-quarter issuance equalled 1.6% of outstanding debt, the smallest amount since 1986.
The dearth of issuance can’t be understood without reference to fourth quarter of 2010, when issuers sprinted to the market to beat the Dec. 31 expiration of the BAB program. With one exception, more bonds were sold in that quarter than any other on record: $133.6 billion, or roughly triple the first quarter of 2011.
“We had a big party at the end of the year, so we’ve basically had a big hangover since,” said Noe Hinojosa, chief executive at Estrada Hinojosa & Co.
Taxable issuance suffered the most. BABs accounted for $27 billion of volume from January to March in 2010, but of course none were issued this year. Taxable issuance thus fell 78% to $7.4 billion in the first quarter, as just 214 issues came to market versus 536 in the same period last year.
Tax-exempt issuance from January to March totaled $38.8 billion, a 45% falloff from last year.
Both declines can be attributed in part to the issuers front-loading debt through the BAB program last year.
Jeffrey Bosland, head of public finance at JPMorgan, estimates that up to $50 billion of issuance was pre-funded in 2010 because of the incentives to use the program.
Volume from last year was so large that issuers are still busy digesting the proceeds, according to Natalie Cohen, managing director of municipal research at Wells Fargo Securities.
“It takes time to go through the RFP process, competitively bid, and get to the point of actually spending funds,” she said.
No surprise, then, that issuance was slashed across the board. The $16.2 billion of general purpose bonds sold from January to March was 56% lower than the same period last year, while the $13.9 billion of education bonds marked a 40% drop, and the $4.5 billion of health care bonds was 57% lower.
Increases were only in small sectors: development bonds rose 57% to $1.1 billion and housing bond volume jumped 12% to $1.1 billion.
What is surprising is that nobody was predicting issuance to be this light. Estimates of 2011 volume were mostly around the $350 billion range in December, with at least one outlier above the $400 billion mark. A number of banks then revised these estimates to around $300 billion in February, and now it’s common to see predictions closer to $250 billion.
Robert Nelson, managing analyst of Municipal Market Data, told The Bond Buyer’s National Municipal Bond Summit on Thursday that it “may take a number of years” for muni volume to get back to $300 billion. Such dire predictions indicate that a lot more is going on than just a post-BAB hangover.
One factor is the change in mindset towards austerity. State and local government officials are still getting their feet wet in the budget cycle, and they are reluctant to issue new debt until their budgets are planned.
“Much of the low-hanging fruit for state budget balancing was picked in the last two years, so this year is particularly difficult for budget makers,” Cohen said.
She said much of the deficit noise has been at the state level, so many governors and legislators have reacted by agreeing not to raise taxes.
“Saving revenues for core spending rather than new debt in the face of lots of proceeds in the bank makes sense,” Cohen added. “States are among the largest issuers, so that will affect volume.”
By type of issuer, counties and parishes scaled back the most, issuing 70% less debt in the first quarter versus the same period last year. State agencies issued 60% fewer bonds, state governments borrowed 56% less, and cities and towns cut bond issuance by 48%.
Tom Kozlik, municipal credit analyst at Janney Capital Markets, said the budget uncertainty has made it difficult to predict where the market is heading this year.
“We might as well be trying to navigate one of those wooden explorer ships on a foggy evening in the 17th century,” he said.
Another factor is rising borrowing costs.
The benchmark 10-year, triple-A muni yielded an average of 3.18% over the past three months versus 2.98% in 2010’s fourth quarter.
Borrowers have been less inspired to issue in this higher-rate environment, yet that same 10-year yield averaged 3.75% over the past decade, so retail investors justifiably view current yields as too low. The result is a market in gridlock.
One muni trader called the dearth of new supply “a godsend” earlier this week, as he pointed out that new issues would test the market and potentially cause borrowing costs to soar.
But there are few signs that a surge of supply will hit the market any time soon. Volume in March was slightly up from February but is still the lightest March in 11 years. And The Bond Buyer’s 30-day visible supply was just $6.3 billion as of Thursday.
Still, Hinojosa told the Muni Summit on Wednesday he was optimistic there would be a spike in issuance later this year.
“We’re seeing issuers tapping into the water and seeing how warm it’s going to be in the next month or so,” he said.
