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Private-Activity Bond Volume Sees 13% Slippage in 2011

WASHINGTON — Private-activity bond issuance declined in 2011, mirroring the overall municipal market as state and local governments stepped up offerings during the last half of 2010 to take advantage of favorable stimulus law provisions before they expired, according to an annual survey and market participants.

Volume Cap Allocations and Issuance of Private-Activity Bonds in 2011

Fifty-one states and the District of Columbia issued $12.8 billion of PABs in 2011, a drop of 13% or $1.8 billion from the $14.6 billion in 2010, according to the results of a survey by the Council of Development Finance Agencies.

The PAB volume represented 4.43% of the $287.7 billion total municipal bond issuance last year, with overall issuance at a 10-year low. PAB issuance rose for the first time in three years in 2010, by 22.2%, after it slumped 12.7% in 2009 and 51% in 2008. 

The dollar amount of 2011 issuance is more in line with the 2008 and 2009 figures. The surge in 2010 appears to be more of an outlier, CDFA officials said in a release.

While the decrease in PAB issuance is “disappointing,” it “actually fared somewhat better in comparison” to overall muni bond issuance, according to CDFA officials.

The substantial drop in PAB issuance relative to the previous year is due to a handful of programs from the American Recovery and Reinvestment Act of 2009 that provided incentives for issuers to accelerate their borrowing in 2010, said Michael Decker, managing director and co-head of munis at the Securities Industry and Financial Markets Association. 

The Build America Bond program, for example, was created in 2009 by ARRA but expired at the end of 2010. BAB issuers receive subsidy payments from the federal government equal to 35% of their interest costs.

Another popular ARRA provision was for bank-qualified bonds. It allowed banks for one year to deduct 80% of the cost of buying and carrying tax-exempt bonds sold by issuers whose annual issuance was $30 million or less, up from $10 million.

The exemption of water and sewer bonds from the alternative minimum tax was a third ARRA provision that boosted borrowing in 2010.

Private-activity bonds are issued by state and local issuers to provide low-cost financing for the projects of nonprofit organizations or companies that serve a public purpose.

They include housing, manufacturing, student loan, airport, solid waste, highway, high-speed rail and other tax-exempt bonds.

PAB issuance is limited and subject to state volume caps based on a formula published by the Internal Revenue Service.

In 2011, state volume caps were $95 per capita or $277.82 million, which ever is greater. Unused cap can be carried forward for up to three years but must be abandoned after that.

For 2012, the Internal Revenue Service increased that amount to $284.56 million from $277.82 million, based on population gains published by the Census Bureau late last year.

The per capita rate for 2012 did not change, but the volume cap of private-activity bonds that state and local governments will be able to issue rose by 1.2% to $32.821 billion.

The $12.8 billion of PAB issuance in 2011 represents 41% of the volume cap allocated for that year and just 15% of states’ total available capacity, which includes previous years’ carryforward.

That usage rate is the lowest seen in recent years, according to the CDFA. It compares with 2010, where states utilized 48% of the amount allocated and 21% of their total capacity.

Several years of limited issuance have built states’ total capacity significantly so that there was $32.1 billion more in initial capacity in 2011 than in 2008.

Apart from the surge in housing and exempt facilities, most other categories of private-activity bonds were down, the survey showed.

Small-issue industrial development bonds, mortgage credit certificates and other bond offerings all fell by double-digit percentages.

“Other” bond issuances, which includes bonds that are not part of the six specific categories, plunged 88% to $147.8 million, down from $1.2 billion n 2010.

Small-issue industrial development bond issuance plummeted 43.9% for the fourth consecutive year to $373.9 million, down from $665.9 million in 2010. IDB issuance has dropped by $300 million each year for the past four years, after reaching its peak of $3.1 billion in 2007.

“The overall trend for IDB issuance continues to conceal a great deal of variability at the state level,” CDFA officials noted.

A number of traditionally active states dropped their issuance by half or more in 2011, compared to 2010. Pennsylvania had the largest drop-off in volume of IDBs with $40.4 million, followed by California with $13.7 million and Massachusetts with $9.9 million.

Despite the overall sector drop, about one-third of states saw a rise in IDB issuance in 2011, suggesting that several states likely issued bonds for one or more additional projects in 2011 than in 2010.

Arizona had the largest increase in volume of IDBs with $100.6 million, followed by Indiana with $18.5 million and Texas with $13.3 million.

CDFA officials said the IDB declines can be attributed to two primary factors: limited interest rate spreads between tax-exempt bonds and other financing options, and relatively low caps on project size that place too many restrictions on potential projects.

Under current tax law, small-issue IDBs can be up to $10 million in size. The $10 million limit has not been raised since 1979 and has never been adjusted for inflation.

Small-issue IDBs are sold through conduit transactions, with issuers lending the proceed to corporate borrowers. But under existing tax-law provisions, borrowers can only have up to $20 million of pending capital expenditures over a six-year period — three years before and three years after issuance of the bonds. The limit includes not only the capital expenditures to be financed with the small-issue IDBs, but other capital expenditures as well.

Issuance for student loan bonds dropped 9.7% to $1 billion, the third straight year of decline as a result of stricter underwriter rules.

Student loan issuance fell 18.9% in 2010 as a result of legislative changes from provisions in President Obama’s health care reform law.

The law requires all federal guaranteed student loans to be originated by the federal government. As a result, state and local higher-education agencies are restricted to issuing private, non-guaranteed loans, even though the bulk of the market had been for guaranteed loans.

In 2009, student loan issuance fell 11.6% from the previous year to $1.4 billion. That drop came after $1.5 billion of bonds were issued in 2008, a 65% decrease from 2007.

“Issuance of PABs for alternative student loans mirrors the contraction of the student loan market, driven in part by the underwriting criteria these loans carry and the inability in some cases of borrowers to meet the credit standards,” said Vince Sampson, president of the Education Finance Council.

Sampson said he was not surprised to see the drop in PAB issuance, as the entire student loan market has seen a significant decrease in activity.

At its peak in 2007, total private student-loan market issuance was more than $20 billion, according to the EFC. By comparison, there will only be about $7 billion in total private student loan originations for 2012.

Meanwhile, multifamily housing soared 90.8% to $4.5 billion, up from $2.4 billion in 2010. However, this was the first year since CDFA began conducting the survey in 2007 that New York officials provided their information, which may have skewed some of the multifamily numbers, CDFA officials said. The Empire State issued $1.3 billion in multifamily bonds, the second largest issuer in that category after California, which issued $2.1 billion.

Housing bond activity in 2010 and 2011 was primarily due to the successful New Issue Bond Purchase program, according to John Murphy, executive director of the National Association of Local Housing Finance Agencies.

The NIBP was created in late 2009 by the Treasury Department to revitalize bond issuance among state and local housing agencies.

Under the program, the Treasury agreed to buy $15.3 billion of securities from Fannie Mae and Freddie Mac that were backed by new mortgage revenue bonds or multifamily housing bonds issued by the housing finance agencies.

Garth Rieman, director of housing advocacy and strategic initiatives at the National Council of State Housing Agencies, agreed with Murphy. He said the NIBP program was extremely successful.

“The housing finance authorities attribute much of their ability to issue bonds and make their housing programs available to the New Issue Bond Program,” he said.

As a result of the NIBP, issuance of single-family housing bonds, the largest category of PABs under the cap, increased 23% to $5.6 billion in 2011 from $4.5 billion in 2010.

Exempt facilities — which include high-speed rail, highways, airports, solid waste and green buildings — skyrocketed 212.3% to $5.6 billion, up from $1.8 billion in 2010.

Jack Basso, director of program finance and management at the American Association of State Highway and Transportation Officials, said a portion of the increase could be attributed to the jump in creation of toll roads across the country.

While the percentage increase is significant, Decker warned that the total exempt facilities issuance is still small and likely represents just one or two large deals that took place in 2011.

Private-activity bond issuers are allowed to “carry forward” their capacity allowance for up to three years.

The survey showed states were carrying forward $54.2 billion of allocation from the past two years into this year, up 25.3% from the $43.5 billion carried forward into 2011.

As a result, states will have about $85 billion in total PAB volume cap capacity for 2012, which will be a 2% increase over the capacity for 2011.

Volume cap is primarily abandoned when an allocation remains unused at the end of the three-year eligibility window. States had to abandon a significant amount of their allocations — $6.6 billion — due to expiring 2008 allocations. That compares to $4.3 billion of abandoned PAB allocations reported for 2010.

“This number will likely continue to rise for the foreseeable future, as states’ issuance of PABs is not keeping pace with capacity,” CDFA officials said.

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