Battered Market to Face Heavy Supply Pressure

The municipal bond market faces a potential glut of new supply in the coming week, with  more than $10 billion scheduled to be priced, after a selloff  that pushed yields almost 50 basis points higher over the past five days and forced issuers to delay deals.

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The primary market was the biggest casualty after  Federal Reserve Chairman Ben Bernanke’s hinted Wednesday that the Fed may start tapering its $85 billion-a-month bond purchasing program. Many of the week’s prominent deals were rescheduled due to market volatility. Retail investors also withdrew $2.2 billion in municipal bond mutual funds.

“Even though summer has arrived, the bond market is experiencing a big chill as a result of Chairman Bernanke’s comments and how the market is interpreting his comments,” said Rick Calhoun, first vice president at Crews & Associates. “As a result, cash is coming out of bond funds and bids have evaporated.”

“Next week’s large supply will define the market for the near term,” he said. “Some of the larger issuers, such as Illinois, Michigan Building Authority, and Louisiana Tobacco, already trade a little wider. Therefore, yields may have to be much higher to get the deals done.”

The secondary market was also hit this week. “I was trying to sell bonds earlier this week but bids were so outrageous that I looked to buy Friday,” a North Carolina trader said. “Going into quarter-end some of the big desks just said they aren’t willing to bid anything at all. The bids that they did have were so bad you can drive a truck between bid-ask spread. There is no liquidity in the market.”

The primary market is about to get hit with more than  two-and-a-half times the volume that  priced in the past week with $10.23 billion expected to be issued, up from the pastweek’s revised $3.79 billion. In the negotiated market, $8.83 billion should be priced, up from $2.9 billion. In competitive sales, $1.40 billion are set to be auctioned, up from arevised $891.5 million in the past week.

“Issuers have lost the advantage they have enjoyed for nearly two years,” said Tom Doe, chief executive officer of Municipal Market Advisors. “Fortunately, interest rates are still historically attractive to fund important infrastructure. Spreads to MMA are only relevant when spreads are compared for issues underwritten in a comparable context.”

The market now faces a “unique” challenge,  a New York underwriter at a large Wall Street firm on said Friday afternoon. “The market has a horrible tone to it right now, and we have no sense yet” whether large deals will continue to be sidelined, or how investors will receive those that do end up pricing. This underwriter added, “We have calls with issuers lined up all afternoon.”

The volatility put some issuers and underwriters for the week’s mammoth deals in a quandary.

The largest deal of the week is expected to come from Illinois with $1.3 billion of GOs scheduled for pricing Wednesday by Wells Fargo Securities. The deal will go to market as planned, state debt manager John Sinsheimer told The Bond Buyer late Friday. “We are going forward regardless of market conditions,” he said, noting that the financing is funding some critical capital needs, including more than $250 million for roadways.

“The long-term dividends will far exceed any rate the market might throw at us,” he said. The deal is structured with serial bonds maturing from 2014 to 2038.

Similarly, the $1.3 billion Los Angeles County, Calif., tax and revenue anticipation note deal will also remain on track as expected, given that the Municipal Market Data yield in 2014 remained unchanged at 0.18% as of Friday, according to an underwriter at book-runner De La Rosa & Co.

While there was a feeling of disbelief in the market Friday, he said,  he was unaware of any large, long-term deals postponed due to market conditions. He assumed, though, that any planned refundings “could be in deep trouble with this backup.”

Late Friday, a source at Citi said the firm’s three large deals, including the $505 million Michigan Building Authority sale structured as serials from 2014 to 2033 with terms in 2043 and 2047, the $650 million Louisiana Tobacco deal slated for Monday with three series, ranging from 2016 to 2033, as well as a $375 million of state revolving fund bonds from the Environmental Facilities Corporation for New York City Municipal Water Finance Authority, will price as scheduled.

The selloff prompted issuers to begin postponing some of the past week’s large deals, including $763 million of California Health Facilities Financing Authority, which was postponed due to market conditions. New York’s Metropolitan Transportation Authority also put its $350 million deal on day-to-day status.

California’s City of Hope postponed a $250 million taxable general obligation note sale. Philadelphia was expected to issue $400 million of GOs next week and delayed the sale to an undetermined date due to market volatility.

Volatility showed no signs of slowing Friday.

“There are buyers and some of it is being bid for,” said Rick Cahill, managing director at Herbert J. Sims & Co. While liquidity hasn’t completely dried up, “Bonds are all over the place.” he said. “Wherever there is a bid and a customer needs cash they are hitting the bid. They don’t have the liquidity.”

A $10 million block of North Texas Tollway Authority 5s of 2042 traded at 5.16% on Friday morning. “That makes another 20 basis point cut Friday reasonable,” Cahill said. The last trade of any significance was earlier in June at 4.36%.

Also Friday, New York Liberty Development Corp. 5.75s of 2035 traded at 5.25%. Later on Friday the bonds retraded at 5.17. On Thursday, the bonds traded at 5.05%.

Bids-wanted also spiked on Friday, Cahill said. As of noon, there were $620 million bids wanted listed on Bloomberg, compared with $921 million on June 14. On June 7 there were $420 million and $390 million on May 31.

“It seems like on Fridays over the past month and a half it’s been in the $350 million to $400 million range, except for this Friday and last Friday,” Cahill said. “So it’s indicative that when retail start seeking redemptions, mutual funds have to sell.”

And the market won’t hit bottom until retail stops panicking, Cahill said. “When people stop redeeming mutual funds they will realize they don’t have a lot of options. Stock and commodities are volatile and then they will realize maybe they should go back into funds and reset at higher yield levels. That’s what we need” Cahill said.

“People are just puking bonds,” a Boston trader said. “It’s not pretty. It’s worse than in 2010 both on a percentage basis and the speed of which the selloff has occurred.”

In 2010, a selloff in the muni market was a combination of the expiration of the Build America Bond program, softer Treasuries, and banking analyst Meredith Whitney’s doomsday comments. “It was a multitude of things and it started the end of October 2010 and stabilized in January 2011. This is happening in a much shorter time and we started at much lower yields so the percentage increase is that much more dramatic,” he said. “This is typical panic behavior by retail.” After another 20 basis point raise in yields Friday, cross over buyers may start to emerge, the Boston trader said. “There are bonds trading. You have taxable bonds and people sniffing around putting their toes in the water. You can’t call a bottom but you can recognize value if you have cash available.”

The mutual fund redemptions show retail investors are  trading on fear, he said. “The bottom occurs when retail stops acting irrationally,” he said. “The same people who bought a fund six months ago and told their advisor they were a long-term investors have suddenly decided six months is too long. It’s difficult because everything is down including equities, oil, gold, and commodities. So people in that fear trade are moving into money markets.”

Through Friday, the 10-year Municipal Market Data yield ended 40 basis points higher at 2.63% and the 30-year yield jumped 46 basis points to 3.96%. The two-year yield increased 12 basis points for the week to 0.43%.

Yields on the 10-year Municipal Market Advisors 5% jumped 45 basis points for the week to 2.78% and the 30-year yield spiked up 46 basis points to 4.08%. The two-year yield rose 12 basis points to 0.50%.



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