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Refundings Dominate Midwest in 2012; New Money Slows

FEB 12, 2013 4:07pm ET
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CHICAGO — Refunding opportunities fueled a 36.3% surge in bond issuance among Midwest municipal bond borrowers last year as the steadfastly conservative region shied away from adding new debt in favor of shoring up balance sheets.

2012 Midwest Annual Review

Issuance rose to $71 billion in 4,578 deals from $52.1 billion in 3,751 transactions in 2011, according to data from Thomson Reuters. The climb back to positive territory followed a 34% decline in borrowing in 2011, a figure fairly in step with the national decline that year of 32%.

Midwestern borrowers still grappling with the aftermath of the Great Recession and a slow recovery remained restrained on new-money issuance, which accounted for $27.7 billion of debt issued last year, a 5% decline over 2011 issuance of $29.3 billion. Refundings more than doubled to $29.5 billion.

“The story has really been refundings. Rates are low and there’s demand for paper,” said Natalie Cohen, head of municipal research at Wells Fargo Securities, noting that the market is especially ripe for current refundings as rates are down from those a decade ago. She pointed to two large 2012 refundings, of Metropolitan Pier and Exposition Authority of Illinois convention center debt and Chicago O’Hare International Airport bonds from a decade ago.

Issuers favored revenue-backed borrowing that accounted for $40.1 billion of debt, compared to general obligation bonds that made up the remaining $30.9 billion.

Buoyed by low long-term rates, more than $65 billion of issuance last year came in fixed-rate mode.

Issuance rose in the first three quarters compared to 2011 before tapering off in the fourth quarter by 15% compared to the year before. Second-quarter borrowing, totaling $25.2 billion, led the way — a figure that was up 113% over the previous year. All Midwestern states recorded higher levels of borrowing with the exception of Indiana, which saw a 10% decline. Nebraska saw the highest percentage increase of 90% to $3.7 billion. Illinois borrowers topped the volume charts by issuing $16.3 billion, up by 25%, followed by Ohio with $10.8 billion for a 48% increase and then Michigan at $9.9 billion, up 69%.

The Hoosier State government does not issue GOs, but state agencies, which are the largest issuers of bonds in the state, saw a drop as did school districts and local authorities. Indiana’s depressed local volume is in part due to a sweeping 2009 overhaul of the property tax structure and imposition of caps. That has driven down property-tax backed bond issuances, particularly among school districts.

The aversion last year in many Midwestern states toward adding new debt — even in a prolonged low-interest-rate period — stems as much from political will as it does financial conditions given governments’ improving coffers, especially at the state level.

While refundings likely will continue, low borrowing costs combined with pent-up demand and improving tax collections could coax more new-money issuance out of borrowers this year.

“The Midwest last year was not using the bond market to rebuild and expand infrastructure,” said Richard Ciccarone, chief research officer at McDonnell Investment Management. “After three years of deferring expenses or adding debt, there is pent-up demand and we could see governments open up the purse strings.”

Nationally, the average age of infrastructure is at a seven-year high of 13.6 years, Ciccarone noted.

In triple-A Missouri momentum is building among state leaders to pursue a new bond-financed state building program and raise revenue for transportation. The state is a rare issuer and most of its debt must have a voter seal of approval.

Ciccarone and Cohen said the unknown that could throw in a wrench in volume this year remains uncertainty over federal actions involving sequestration absent a budget agreement, or changes to the status of tax-exemption in a budget agreement.

Borrowing shot up across sectors with education debt accounting for $19.2 billion of overall borrowing during 2012, up 33% over the previous year. Education was followed by health care-related debt making up $10.6 billion for a 62% increase, utility issuance at $6.9 billion for a 19% increase, and then transportation borrowing at $4.5 billion for a 38% boost.

Borrowing across all issuer types also posted gains, the largest coming from the cities and towns category that rose by 52% to $15.3 billion. State agencies led issuers, selling $18.1 billion of debt for a 37.8% increase, while state governments sold $10.2 billion for a 36% hike. 

Tracking the national trend, health care volume rose as providers sought to take advantage of the low rates to refund debt and in some cases shift variable-rate bonds into a fixed-rate mode, experts said.

Refundings will likely continue this year, but new-money deals could also see a comeback, according to Allan Baumgarten, publisher of the Health Market Review publications.

“There’s a still lot of cranes out there, and lots of new construction,” Baumgarten said. “2013 is a transition year” as hospitals prepare for the full implementation of the new federal health care law in 2014.

“They’re trying to position themselves so that they become a desirable hospital for newly insured people to come through. At the same time there’s a concern they have to address their care-management practices because these new payments are still going to be less than a normal commercial patient,” he said. “Again, opportunity but also challenges for these hospitals.”

Baumgarten said he expects the pace of mergers and consolidations that has swept the sector over the last year to continue in 2013 in the Midwest.

“There’s lots of activity going on,” he said, noting that Chicago saw four mergers last year and a handful of other mergers are in the works. “There’s a whole range of hospital systems extending their presence not necessarily just through acquisitions but through other partnerships.” 

Illinois finished the year in the Midwest’s top issuer spot with its steady stream of new money and refundings that totaled $5.1 billion in seven deals. Illinois started off the year with an $800 million GO sale and followed with another $575 million of GOs in March to fund projects in the state’s ongoing $31 billion capital program. The state then refunded $1.8 billion of GO debt in April for savings. In July, Illinois sold $1.5 billion of debt to pay off its federal unemployment insurance loans.

The Michigan Finance Authority with 14 deals totaling $3.8 billion followed Illinois as the second biggest issuer by volume. Chicago with 14 deals valued at $2.7 billion took the third spot. The city’s deals included $1.3 billion in O’Hare bonds in August, a $600 million GO sale in May, and new-money and refunding water and sewer bonds. 

The Indiana Finance Authority, which offered 23 issues totaling $2 billion, came in fourth, followed by the Illinois Finance Authority with 22 deals totaling $1.8 billion. Wisconsin, with $1.7 billion sold in 11 deals, was sixth.

The Michigan Finance Authority had the Midwest’s largest deal of 2012, a $2.9 billion sale of revenue bonds featuring a new state credit to pay off the state’s federal unemployment loan. Michigan was only the third state, after Texas and Idaho, to issue bonds to repay federal loans for jobless benefits, though several states have since done so. The debt snagged triple-A ratings from the three major ratings agencies, and the deal won The Bond Buyer’s 2012 Deal of the Year.

Two state of Illinois deals followed on the largest-deal table. A $1.26 billion sale by the Indiana Finance Authority of Midwestern Disaster Area Bonds in December to finance a fertilizer project came in fourth. The IFA’s $1.19 billion MDAB issue on behalf of a subsidiary of an Egyptian company also to finance a nitrogen fertilizer plant came in fifth. The Metropolitan Pier and Exposition Authority of Illinois’ $855 million new money and refunding of convention center bonds ranked sixth among the largest issues from the region.

JPMorgan and Bank of America Merrill Lynch ran neck and neck in the race to be the region’s top senior manager. Both snared 10.1 % of market share but JPMorgan squeezed out a win with 75 deals valued at $6.94 billion compared to Bank of America with 80 deals valued at $6.9 billion.

Citi, Morgan Stanley, Wells Fargo & Co., Robert W. Baird & Co., Stifel Nicolaus & Co., Barclays Capital, RBC Capital Markets, and Piper Jaffray & Co. rounded out the top 10.

Public Financial Management Inc. held on to its top position among financial advisers working on 293 deals valued at $8.8 billion. The firm was followed by Acacia Financial Group Inc., Baird, Springsted Inc. and First Southwest Co.

Miller Canfield Paddock and Stone Plc, which worked on 128 deals valued at $4.2 billion, took the honors as top bond counsel from last year’s winner Kutak Rock. Chapman and Cutler came in second followed by Quarles & Brady, Gilmore & Bell LLP, and then Kutak.

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A recent phenomenon is the emergence of bonds with shorter call protection as funding alternatives for municipalities. However, the shorter call protection also dampens the potential upside for investors, which in turn reduces the price they are willing to pay.

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