Alternative muni borrowings have spiked since March
Municipal borrowers have increased their use of private placements, bank loans, and direct lines of credit since mid-March in response to the difficulty of accessing the note and bond market.
The Dormitory Authority of the State of New York is about to execute one of the largest of these, a $1 billion private placement scheduled for Friday.
Municipal borrowers’ moves to alternate forms of borrowing had its origins in mid-March when the market was hit with the seriousness of the COVID-19 spread, its consequences for government policy, and the impending shutting down of the broader economy. In response, investors were asking for significantly higher yields for new issues and secondary trading went haywire, and nearly all issuers planning bond sales put them on hold.
As alternatives to the traditional market, municipal entities have turned to other solutions for their short-term and long-term borrowing needs.
According to the Electronic Municipal Marketplace Access website, the number of municipal private placements increased from 206 in January and 195 in February to 247 in March and 365 in April.
When the federal government postponed the deadline for submitting income tax forms to July 15 from April 15, many states followed suit. This led to a delay in states collecting a large amount of taxes. And that has put short-term financial pressure on them.
Citi Head of Municipal Debt Capital Markets Patrick Brett said to address short-term needs municipal entities turned to lines of credit from financial institutions and the Municipal Liquidity Facility from the federal government.
There’s been tens of billions of dollars of municipal lines of credit set up since March, Brett said. Issuers didn’t always draw upon the lines. Some were set up “out of an abundance of caution.”
“Bank loans and lines of credit have generally been shorter in tenor, with private placements extending further out the curve,” Brett said. About $5 billion to $10 billion of long-term private placements have been made since mid-March.
According to Refinitiv, from Jan. 1 to May 18 there were $7.3 billion of private placements this year compared to $5.4 billion last year in the same period. Refinitiv and the MSRB do not track bank loans and lines of credit.
D.A. Davidson Managing Director Scott Stevenson thinks the turn to bank borrowing was largely confined to the mid-March to mid-April period. “In my general opinion, when MMD was cutting 50 basis points daily, banks did very little to adjust pricing and even tightened pricing following the Fed action to lower the bank cost of funds rates. I would say banks were/are more selective on credit but filled a much-needed void in terms of liquidity and price for A+ or better rated borrowers (high grade).
“The market has largely normalized now and that credit space is generally better in the capital markets, but there were a few weeks from mid-March to mid-April where high grade issuers were 50 to 100 basis points better off to borrow from banks directly rather than capital markets, depending on maturity, weighted average life and credit,” he said.
Erin Ortiz, managing director, municipal research at Janney Montgomery Scott, said: "I’ve seen reports of issuers across various municipal sectors, especially in healthcare and higher education, either increasing or adding lines of credit to help address any potential or current short-term cash-flow disruptions stemming from additional expenses, reduced revenues or both, attributable to COVID-19.
"For many states and locals, rainy day balances or other reserves are at all-time highs, but there are limits to what has been built up over the years, and the financial stresses from COVID are unprecedented. Metaphorically, it is raining, so tapping rainy day funds is expected, but most issuers who rely on revenues that have been disrupted don’t have balance sheets to handle the magnitude of the revenue delays. If short-term or cash-flow borrowing options are available, particularly if filling the gap for a delayed revenue source, there may be an increasing trend of issuers getting lines in place or issuing notes."
Of the last 60 days, a banker at a major investment bank said in an email, “Many entities, particularly non-profits, rushed to secure revolvers and lines of credit as their business models have been adversely affected. We have seen some of this in government space but not as much (yet).”
Mikhail Foux, Barclays Head of Municipal Strategy and Research, saw disclosure requirements as contributing to the trend toward alternate borrowing vehicles. “I think it is extremely hard for municipalities go give guidance in the current environment, when the economic situation is so uncertain — that's partially why continuing disclosures are down; and I would expect them to improve with time, when issuers get a better handle on their finances … So we see increased usage of these alternative tools.”
In 2019, there were 974 private placements valued at $19.3 billion. The entire new-issue market saw more than $400 billion of new-issue supply price during 2019. Going back to 2015, there has been an average of $23.8 billion of private placement deals per year. The high during the span occurred in 2017 when there was $40.2 billion over the course of 1,473 deals.
After tax reform was enacted in 2017, banks had less incentive to own munis, generally, so private placements fell off.
Voluntary disclosure of bank loans and private placements have increased over the years, as investors and rating agencies noted more than five years ago when their use by issuers was beginning to grow. Participants noted then that the interests of bond investors could be at risk if bank loans and private placements of debt draw on government resources also used to back securities.
New York State plans the DASNY private placement as part of its short-term borrowing plans to combat revenue losses tied to the COVID-19 pandemic.
New York is facing a near-term liquidity crunch because of a three-month postponement of the tax-filing deadline to July 15 from April 15.
Moody's Investors Service has assigned a MIG 1 rating to New York State's $1 billion State Personal Income Tax Subordinate Revenue Anticipation Notes, Series 2020A, The notes mature December 15, 2020 and are scheduled to close in the private placement.
"The MIG 1 rating reflects the long-term credit quality of the state of New York (Aa1 negative) and its pledge of subordinated indebtedness financing agreement payments backed by dedicated personal income tax receipts," Moody's said.
Andrew Coen contributed to this report.