After a torrid first half, long-term municipal bond issuance in 2015 is currently on pace to eclipse $400 billion for the first time since 2010.
The muni market saw $222.51 billion of issuance during the first half of the year, up 43.6% from the first half of 2014 which saw $154.93 billion. During the same period of time, the number of issues also increased to 7,191 from 5,372.
Refundings accounted for much of the uptick, with issuers taking advantage of the current low-rate environment. There was nearly twice as much refunding activity in the first half of 2015 as there was in the same period a year ago, as refunding volume reached $100.02 billion over 3,200 issues after $51.71 billion in 1,952 issues in the first half of 2014.
Muni volume showed year-over-year increases in every month, though the pace of those increases slowed as the year progressed. The first quarter saw a robust 66.2% increase to $107.32 billion, while the second quarter climbed 27.5% year-over-year with $115.18 billion of issuance.
"The story, of course, for volume in the first half of this year has been refundings," said Tom Kozlik, managing director and municipal strategist at PNC Capital Markets. "If this pace of issuance keeps up, we could very well break through the annual record issuance level."
That record was set in 2010, when $433.3 billion of long-term debt came to market over 13,828 issues.
Threatening the pace of issuance, however, many economists and municipal analysts believe an interest rate hike from the Federal Reserve will be coming soon, most likely in September.
"Rates aren't going down," said Chris Mauro, director of municipal bond research at RBC Capital Markets. "Even if we stay at this level, it's going to have a dampening effect on refundings. The best case is that we will finish the year with $240 billion or less in everything else and $160 billion of refundings. We are on pace currently for a $410- to $415-billion pace, but I think it will come below $400 billion because the pace of refundings has slowed."
Mauro also said that for the first four months of the year, we had issuance far in excess of the five-year and 10-year averages but since May, long-term issuance has been much closer to the respective monthly averages.
"If we stay on this pace as rates tick up, issuance will become lighter in the second half of the year," said Mauro.
Kozlik believes that it is possible for refunding activity to be strong going forward, if interest rates cooperate.
"That is because a yield curve flattening from a Fed-driven increase in shorter term rates could further improve refunding savings. This of course is assuming that long-term rates remain rather stable in the process. This dynamic could further boost refundings for the last half of the year," he said.
New-money issuance for the first half of the year is up slightly year-over-year, having increased 1.1% to $74.78 billion in 3,363 issues from $73.94 billion in 3,038 issues a year ago.
"On the new-money side, I am still expecting issuance to remain challenged," said Kozlik. "This is directly related to falling credit quality of municipal issuers. Issuers are hesitant to add fixed costs, and new bond debt service is one cost that is often easy to put off. There are still many issuers, especially local governments, who have not come to terms with the new fiscal reality they are facing in the post-2008 world."
Stephen Winterstein, managing director of research and chief strategist at Wilmington Trust Investment, is optimistic that new money can get to the point that Mauro mentioned above.
"New-money is practically flat for the first half of 2015, reflecting issuers' cautionary approach to new projects and substantial infrastructure improvements. As the economy continues to pick up steam, we would expect new-money supply to follow suit and increase," he said.
Moody's Investors Service said that downgrades outnumbered upgrades in the second quarter, the first time in three quarters more ratings were cut than raised.
"One more important factor to note for municipal bond market investors is that downgrades are still at 2008 recession-like levels and the U.S. economy has experienced several years of an economic recovery. Many local governments are not adjusting their budgets to reflect this new reality," said Kozlik.
