Note volume was 17% lower than it was last year as state and local governments continued a period of austerity, supported by a stronger United States economy that helped strengthen finances and curtail the need for short-term cash flow.
Rising tax collections in the fourth quarter of 2014 minimized the need for cash-flow borrowing to fulfill state and local governments' operating needs, said David Litvack, head of tax-exempt fixed-income research at U.S. Trust. Besides rising taxes, state finances were also buoyed by increasing revenues, both of which helped decrease note volume to $44.4 billion among 2,597 issues in 2014, from $53.5 billion across 2,679 issues in 2013, according to data provided by Thomson Reuters.
"This is an across-the-board decline, but it's concentrated at the state level," and is consistent with an improving economy, noted Phil Fischer, municipal research strategist at Bank of America Merrill Lynch. Fischer referenced the decreasing issuance by state governments to $13.3 billion over 17 issues last year from $21.95 billion among 25 offerings in 2013 as a primary source of the trend.
"It's a reflection of the improving economic scenario at the state level," Fischer said. He said outstanding short-term debt is a typical barometer of fiscal stress, but there was less stress in 2014 because states needed less short-term borrowing than in the past.
Outstanding short-term debt has shrunk to $37 billion from $106 billion back in early 2000s, Fischer said. "We're back at the levels we haven't seen since 1995," he said, noting that the federal government has been aiding economic recovery since following the 2007 and 2008 recession.
"As states improved, they didn't need short-term borrowing," Fischer said.
That was also evidenced in the absence of new-money issuance, which fell by 16.6% to $46.62 billion in 461 issues, versus $52.27 billion among 2,631 issues the previous year. Refunding volume, meanwhile, fell 27.6% to $779.3 million amid 32 issues, compared with $1.07 billion among 41 issues in 2013.
Despite the shrinking note volume, the product is in heavy demand among short-term municipal fund managers, but issuance may remain limited until economic weakness returns, Fischer added.
Since note issuance is seasonal, with less supply sold in January and more in June and July during heavy spring note season, Fischer said the overall trend is expected to stay. "The amount of the decline is limited, but the direction is undoubtedly down," he said.
"Given what we are seeing regarding state taxes, it looks as though the trend for note issuance is expected to be down," he added.
Joe Lynagh, portfolio manager and vice president of T. Rowe Price Group in Baltimore, said lower note issuance in the municipal market in 2014 was part of a larger cyclical trend related to the interest-rate cycle, as well as the rise in bank financing.
"All issuers are looking at the extremely low cost of long-term financing relative to short term financing," Lynagh said. "A lot of muni issuers have refinanced their short-term debt in favor of long-term debt."
Besides the general diminished need for short-term debt financing, banks in recent years have become an alternative to issuers tapping the capital markets amid growing assets and a lack of attractive lending opportunities, Lynagh added. "Short-term debt has come out of the capital markets and, in turn, been financed through banks," he said.
Experts said some of the seasonal issuance last year was linked to the arrival of a pair of large note sales in August and September.
August volume fell to $7.22 billion last year, from $15.88 billion in 2013, and Fischer said that had a lot to do with the trimmed down, $5.4 billion state of Texas tax and revenue anticipation note sale that month, which was about $1.8 billion less than the $7.2 billion the state issued the prior year.
The 2014 sale was more than three times oversubscribed, picking up $19.6 billion in orders, and was priced at its lowest borrowing cost — 0.1326% — since it began issuing TRANs in 1987. The notes were rated triple-A by all three major rating agencies.
Yields were driven down even further in the secondary, getting as low as 0.119% on Aug. 26. Meanwhile, California issued $2.8 billion of revenue anticipation notes in September. Although the deal was down from the $5.5 billion issuance of RANs in 2013 and was the state's smallest in eight years, according to the state treasurer's office, note issuance in September more than doubled to $6.41 billion among 236 deals, from $3.11 billion among 220 issues.
The California deal matured in June 2015 and priced aggressively at a net interest cost of 0.107% on a 1.5% coupon in 2015, after being oversubscribed five times, with 16 broker-dealers submitting 76 bids for $16.935 billion of RANs. The smaller size of the RAN deal reflects the state's improved budget and liquidity condition, the state treasurer's office said at the time of the 2014 sale.
California sells RANs each year to cover seasonal cash-flow imbalances that occur during the fiscal year.
The smallest amount of cash-flow notes the state has had to borrow was $1.5 billion for fiscal 2006-2007. The notes are rated MIG-1 by Moody's Investors Service, SP-1-plus by Standard & Poor's and F1 by Fitch Ratings.
While the big note issuers may have slightly "skewed" the results, the reason municipalities generally issued less is because of their strengthening revenues, Litvack said.
Lynagh agreed, adding that "state and local governments are only now coming out of the economic downturn and will be a little reticent in ramping up budgets until the crisis is clearly behind them."
Besides lower issuance in August, February issuance experienced a 63.9% decline to $1.31 billion among 145 issues, down from $3.63 billion among 168 issues, while November issuance fell by 63.3% to $1.91 billion among 185 issues, after totaling $5.23 billion among 174 issues in 2013.
Few sectors saw growth in note volume last year, including the development sector which catapulted to $290.8 million among 14 deals, versus $84.4 million among 15 issues in 2013.
