CHICAGO — Lured by record low interest rates, Midwestern borrowers rushed refundings to market during the first six months of the year while issuers in a region known for its conservative leanings treaded more cautiously in adding new debt.
Issuance by the region’s local and state governments, nonprofits, health care providers, schools and other tax-exempt borrowers jumped by 72% for the first half of the year to $37.6 billion in 2,380 transactions, compared to $21.9 billion in 1,702 deals for the first half of 2011.
Like its neighbors, Midwestern borrowers sought to take advantage of falling interest rates to trade in higher rates on existing debt, data from Thomson Reuters indicates. Refunding bonds more than tripled to $16.7 billion from $4.8 billion a year earlier, representing a 246% jump.
“New issues were actually down while refundings soared,” said Richard Ciccarone chief research officer at McDonnell Investment Management. “Deleveraging and reducing debt costs through lower interest rates probably reflects the conservative character of the Midwest during the period.” New money dipped slightly by 1.4% to $13.2 billion from $13.4 billion.
The bigger leap in issuance came in the second quarter when borrowing doubled to $24.7 billion from $11.9 billion, compared to an increase to $13 billion from $10 billion in the first quarter.
All states lumped into the Midwestern category with the exception of Indiana recorded gains in issuance. Illinois issuers led the pack with $8.7 billion of bonding in 321 issues for an 18% increase. Michigan saw a steep 270% spike in borrowing with $7.3 billion sold in 217 deals, compared to $2 billion for the same period last year. Wisconsin borrowers issued 77% more in 358 deals valued at $4 billion, while Ohio issuers sold 156 % more bonds totalling $6.6 billion in 214 transactions from $2.6 billion in 175 transactions.
For a conservative region that is seeing a slow economic recovery and still relies heavily on the manufacturing sector for jobs, refundings that save taxpayer dollars make the most political sense even though rates are attractive for building projects.
That’s the case especially for local governments, which may link their capital spending to their operating budgets.
“There’s an aversion to appearing to be a spendthrift,” said Shawn O’Leary, senior research analyst at Nuveen Asset Management, which makes it hard to justify building new police and fire stations while cutting services at the same time. “The political optics are probably trumping the economics of the situation.”
This year marks the first time since 2007 that the state of Ohio has borrowed to finance K-12 and higher education projects, noted assistant state debt manager Larry Scurlock.
“The state in late 2007 completed a [$5.5 billion] tobacco bond securitization, and used those proceeds to fund K-12 and higher education capital projects,” Scurlock said. “Those proceeds have all been expended, so the state is back to issuing GO bonds for those projects.”
The Ohio Public Facilities Commission sold $580 million of bonds for education capital projects during the first six months of the year, according to Scurlock. The issuance of education bonds by all issuers across the state rose 492%, to $2.4 billion for the first six months.
The rise in Buckeye State issuance also is due to a rise in refundings, Scurlock said. All of the deals were done for net present-value savings.
“Low rates have been good to the state for both new money and for our economic refundings,” he said.
Looking ahead, Ohio will start to issue bonds under a new $1.35 billion capital budget approved by lawmakers in March. The state expects to issue the debt, backed by general fund revenues, over the next several years, Scurlock said.
Borrowing by Indiana-based issuers tumbled by 10%, to $1.8 billion from $2 billion over the same period last year. The number of transactions, however, rose in 2012 to 137 from 116 for the first half of 2011.
Revenue bonds made up the bulk of the issuance, and fell by 19% compared to last year, while general obligation bonds rose by 56%, to $362 million from $232 million. The triple-A rated state does not issue GO debt.
Tax-exempt borrowing accounted for $34 billion of total volume in the Midwest with revenue-backed issuance at $19.5 billion, topping general obligation borrowing at $18.1 billion, a reversal from the same period last year.
General purpose borrowing accounted for $12 billion of the bonding, while the education sector saw $10.5 billion, health care $4.8 billion,and utilities $3.9 billion. While all of those sectors ended the first half of the year in positive territory, transportation issuance fell by 14% to $1.4 billion, according to the data.
Issuance among types of borrower rose across the board with state agencies leading the group and accounting for $9.3 billion of borrowing, followed by cities and towns with $7.8 billion, districts at $7 billion and state governments at $6 billion.
The Michigan Finance Authority topped the list of single largest deals for the first half with its sale of $2.9 billion of unemployment bonds, which refunded a short-term loan. Citi and Bank of America Merrill Lynch were the senior book-running managers on the June sale.
The state used the proceeds to defease $3 billion of short-term debt the state rushed to market in late December 2011 to pay off its federal unemployment liability insurance without incurring new penalties by rolling it over into the new year.
Michigan was only the third state, behind Texas and Idaho, to issue bonds to cover the federal liability. Officials estimated they saved $250 million by paying municipal market interest rates instead of the rate charged by the federal government.
Illinois’ $1.8 billion GO refunding in May marked the second largest borrowing of the first half and a separate $800 million new-money sale in January marked the fourth largest. Jefferies & Co., BMO Capital Markets and Duncan-Williams Inc. / Rice Financial Products Co. were co-book-runners on the refunding and the new money that included a mix of taxable and tax-exempt bonds sold competitively. Illinois’ five deals totaling $3.6 billion put it at the top among largest issuers in the region followed by the Michigan Finance Authority with two deals totaling $3.5 billion.
The third largest sale came from Illinois’ Metropolitan Pier and Exposition Authority, which in June sold of $855 million of revenue bonds to raise new money for projects, generate double-digit refunding savings, and accomplish the second leg of an ongoing restructuring of its debt service schedule. Morgan Stanley and Jefferies were co-book-runners.
The fifth largest deal came from Detroit, which sold $660 million of water and sewer bonds in June, one of several deals that the troubled city has brought to market so far this year.
The Detroit Water and Sewerage Department priced the deal after delaying it a week as a fiscal crisis threatened to engulf the city when officials warned they might not have enough money to make a scheduled debt payment due to a dispute with the state. Goldman, Sachs & Co. was senior manager.
In looking ahead at the remainder of the year, several large deals have already priced since the close of the first half of the year including Chicago’s $1.5 billion O’Hare International Airport refunding bonds and Illinois’ $1.5 billion unemployment sale.
Nuveen’s O’Leary and other market participants said there appears to be a solid pipeline of issuance for the remainder of the year, with volume possibly being affeccted by the results of both the presidential and local elections in the fall.
“Some may be taking a watch and see approach” given the potential for looming federal cuts, O’Leary said, especially local governments that have less revenue flexibility than states in managing federal cuts.
JPMorgan took the top seat among senior managers with 39 deals valued at $4.1 billion, followed by Bank of America Merrill with 40 deals totaling $3.9 billion, Citi with 22 deals valued at $3 billion, Morgan Stanley with 20 deals valued at $2.3 billion, and Robert W. Baird & Co. with 240 transactions totaling $1.8 billion.
Public Financial Management Inc. led among advisory firms working on 179 deals totaling $6 billion, followed by Baird with 82 deals totaling $2.809 billion, and Acacia Financial Group with 22 deals for $2.802 billion.
Bond counsel rankings were led by Miller Canfield Paddock and Stone, followed by Peck Shaffer & Williams LLP and Quarles & Brady LLP.
