CHICAGO — After their 2010 surge, Midwestern issuers scaled back their municipal bond borrowing by 33.9% last year, in step with the national decline in bond volume.
Local and state governments, schools, and nonprofits issued a total of $55.4 billion of muni debt last year in 3,742 deals, down from $83.8 billion in 5,015 transactions in 2010. The region’s volume declined slightly more than the overall national drop of 32% to $294.7 billion, according to Thomson Reuters figures.
The steepest quarterly drop — 55.2% — came in the first quarter when $10 billion of debt was sold, followed by the second quarter when issuance dropped by 32.9% to $11.9 billion. In the third quarter, $13.4 billion was issued, with volume rising $20.1 billion in the fourth quarter.
The numbers present a sharp contrast to 2010’s 26% surge in issuance, topped by an issuer rush to market in the fourth quarter to take advantage of the expiring taxable Build America Bond program.
“The Midwest was in a bread-and-butter mode,” said Richard Ciccarone, chief research officer at McDonnell Investment Management. “There was a cultural inclination for governments to resist tax and debt in 2011.”
Several analysts said the region could see increased borrowing this year due to pent-up demand, an improving economy, and the persistent attractiveness of low interest rates, but they cautioned that several factors make it difficult to predict. Age of infrastructure could prompt more revenue-backed borrowing for enterprise systems, but governments could remain hesitant with respect to tax-supported debt, Ciccarone said.
Issuance levels could have fallen even more precipitously in 2011 if the early predictions of a rampant rise in municipal defaults and bankruptcies had come to fruition, according to trading desk analysts from Morgan Keegan & Co.
“We think headline risk will be less onerous in 2012 than in prior years, but will not fade away,” Morgan Keegan predicted.
President Obama’s $3.8 trillion fiscal 2013 federal budget proposal would reduce the value of tax-exempt interest and other tax preferences while resurrecting and expanding the BAB program that issuers tapped in droves before its expiration. While the budget may be labeled dead on arrival amid congressional gridlock, several analysts said it could affect borrowing attitudes.
“If issuers believe there’s a chance that BABs might come back, they might hold off,” said Craig Elder, senior fixed-income research analyst at Robert W. Baird & Co. On the other hand, if support appears to be growing for limits to tax-exemption on municipal bond interest, issuers could hurry to market ahead of any possible changes..
Issuers continue to eye refundings. “If low rates hold steady, the Indiana Finance Authority anticipates issuing additional refunding bonds this year,” IFA director Kendra York said in an e-mail.
The slump hit the majority of Midwestern states, including Illinois, Iowa, Minnesota, Missouri, Nebraska, Ohio, South Dakota, and Wisconsin.
Michigan posted a modest 6.9% gain in volume, Indiana issuance jumped by 18.4%, and borrowing by North Dakota issuers rose by 23.3%.
Big borrowers in 2010 — Illinois and Ohio — recorded the steepest drops. Issuance in Ohio fell by 54.6% to $7.3 billion while Illinois borrowing slid by 50.1% to $13 billion. Michigan issuers accounted for $9.2 billion of the region’s volume, while Indiana represented $6 billion.
Minnesota accounted for $5.3 billion, Wisconsin represented $4.5 billion, Missouri made up $3.9 billion, Iowa had $3.1 billion, and Nebraska was $2 billion.
Indiana’s increase comes after a few years of depressed volume due in part to the sweeping overhaul in 2009 of the state’s property tax structure and imposition of caps.
The reform, coupled with the national recession, drove down property-tax backed bond issuance, noted Diana Hamilton, president of Sycamore Advisors. The law has prompted more local governments to issue revenue bonds, she said.
“We’re seeing a migration in larger communities from property tax-backed debt to user fee-backed debt,” Hamilton said.
Michigan would have seen a significant decline if not for the Michigan Finance Authority’s December issuance of $3.3 billion of unemployment bonds.
North Dakota’s increase was driven in part by a small rush to market by local governments and school districts that wanted to issue general obligation bonds ahead of a controversial measure to abolish property taxes that voters will consider June 12. The measure would essentially eliminate GO borrowing this year because the state attorney general ruled that if passed, the measure would be retroactively effective to Jan. 1, 2012.
The overall regional decline was nearly split evenly among revenue-backed issuance and GOs. Revenue bonds accounted for $31.3 billion of bonding last year while GOs made up $24 billion, according to Thomson Reuters.
Private placements shot up dramatically by nearly 400% to $2.7 billion in 177 issues from $701 million in 87 issues.
The anemia crossed nearly all sectors among Midwestern borrowers, with the exception of bonds classified in the development category, which rose by 16.3% to $1.7 billion. General-purpose borrowing accounted for the biggest chunk of Midwestern bonding last year of $17.8 billion, down 26.2% over 2010.
Education borrowing dropped 35.9% to $14.4 billion, health care slid 27.8% to $6.5 billion, public facilities decreased 45.6% to $2.5 billion, transportation fell 54.5% to $3.3 billion, and utilities was down 23.8% to $5.8 billion.
Part of the reason behind the health care slump is the uptick in direct and private placements. Health care has been one of the most popular sectors for the relatively young movement of placing debt directly with banks. Health care providers are turning to the product as a way to replace the need for letters of credit to support variable-rate debt. Borrowers are also attracted to the lower issuance costs, as well as the lack of disclosure requirements.
The private placement market is expected to remain popular in 2012, accounting for around 18% of overall health care issuance this year, according to estimates included in a new report from Bank of American Merrill Lynch’s municipal research group.
After a slow first half of the year for both new-money and refunding issues, author John Hallacy predicted an uptick in the second half of 2012.
“We expect volume to grow in the second half of the year,” Hallacy said in the report. “The consensus is that hospitals will spend on [information technology] when they do resume capital expenditures.”
Tax-exempt borrowing and taxable issuance diverged sharply with the end of the BAB subsidy for taxables. Tax-exempt issuance accounted for $46 billion of total 2011 issuance, down 3.6%, while taxable issuance was down 75.4% to $8.6 billion.
New-money bonding accounted for $32.8 billion of borrowing, compared to $13.5 billion of refundings, and $9.2 billion in combined issues.
State agencies led borrowing, accounting for $16.5 billion of issuance, down 16.2%; followed by cities and towns, which sold $10.3 billion, down 20.5%; districts, which sold $9.2 billion for a 32.5% drop; and states, which accounted for $7.5 billion of borrowing, down by 45.8% from 2010.
The struggling bond insurance industry further fell off, with insurance used on only $1.9 billion of deals, down 54.9%, while LOC use rose by 100% to $4.7 billion in 44 issues as the market saw the entrance of new banks and an easing of credit among others.
Illinois’ $3.7 billion taxable GO sale in February to cover its fiscal 2011 pension payment topped the chart of largest deals followed by the Michigan Finance Authority’s $3.3 billion state unemployment sale, Chicago’s $1 billion O’Hare International Airport deal, the Indiana Finance Authority’s $993 million water and sewer sale, Minnesota’s $769 million of new-money and refunding GOs, and Minnesota’s $757 million tobacco securitization.
The Michigan deal made the state the third, after Texas and Idaho, to issue debt to repay federal loans for unemployment benefits. Several other states, including Illinois, are eyeing similar financings.
The Chicago deal followed the city’s settlement of a lawsuit filed by United Airlines and American Airlines seeking to halt the city’s original transaction amid the airlines’ push to slow plans for some of the projects in an ongoing $8 billion expansion. The city expects to top the sale this year with up to $1.75 billion of O’Hare refunding bonds.
The Indiana transaction financed the sale of Indianapolis’ sale of its water and sewer systems to the private, nonprofit utility Citizen’s Energy Group. Indianapolis-based Sycamore Advisors LLC was financial advisor on the deal, which helped propel the eight-year-old firm into a top-10 spot among financial advisers.
The Michigan authority led the list of top issuers overall, followed by Illinois, the Indiana Finance Authority, Chicago, Wisconsin, and the Illinois Finance Authority.
Citi, the lead manager on the Michigan unemployment deal and the O’Hare sale, took the top spot among senior managers of Midwestern debt. It managed 36 issues valued at $6.1 billion. JPMorgan followed with 73 deals valued at $5.7 billion, Morgan Stanley with 49 deals valued at $5.3 billion, Bank of America Merrill Lynch with 45 transactions valued at $3.8 billion, and Barclays Capital with 26 deals valued at $2.9 billion.
Public Financial Management led the pack of financial advisers followed by Baird, Peralta Garcia Solutions, First Southwest & Co., and Springsted Inc.
Kutak Rock took the top spot among bond counsel, followed by Dickinson Wright LLC, Chapman and Cutler LLP, Ice Miller LLP, and Dorsey & Whitney LLP.