BABs Crimp Tax-Exempts, But Munis Set New Record

State and local governments borrowed more money in 2010 than any other year on record, but traditional muni investors often found it difficult to buy tax-exempt paper thanks to the onslaught of Build America Bonds.

Total long-term issuance expanded 5.8% to $433.3 billion in 2010, beating the previous record from 2007 when volume totaled $429.9 billion.

The figures are based on competitive, negotiated, and privately placed sales of municipal bonds maturing in at least 13 months.

Taxable issuance accounted for 35% of the total, thanks largely to the $117.4 billion of BABs issued to a broader market of fixed-income investors.

Combined with other stimulus debt programs, taxable issuance reached $134.2 billion in 2010, nearly double the 2009 figure.

Those sectors helped most by BABs saw issuance soar.

Bonds in the education sector jumped 10% to $101 billion, while transportation bonds climbed 37% to $66.9 billion, and electric power bonds leaped 83% to $29.5 billion.

But with issuers floating the largest deals via the BAB program, traditional tax-exempt issuance fell nearly 15% from 2009 levels to $275.5 billion — the lowest in nine years.

The scarcity of tax-exempt paper helped yields fall to historic lows as investors fought to own new tax-exempt debt. For instance, the 10-year and 30-year yields fell in late August to all-time lows of 2.17% and 4.06%, respectively.

“Low interest rates, strong buyer demand, and the Build America Bond program meant that the new-issue markets were open for the vast majority of issuers,” according to Guy LeBas, the chief fixed-income strategist at Janney Capital Markets.

Investors, seeking extra yield amid the low interest rate environment, moved down the credit scale and extended market access to lower-rated borrowers.

Issuers rated A-minus sold 108% more debt in 2010 versus the prior year, according to Standard & Poor’s. The equivalent figures from Moody’s Investors Service and Fitch Ratings show advances of 61% and 143%, respectively.

Low yields also incentivized issuers to refund debt at lower rates. While new-money issuance jumped 7.2% to $280.1 billion in 2010, refunding bond issuance climbed 13.7% to $98.3 billion and ­represented nearly 23% of all volume in the year.

General obligation debt, contrary to trend, fell 4.7% to $148 billion, while revenue-backed bond issuance moved up 12.1% to $285.5 billion.

Justin Hoogendoorn, managing director at BMO Capital Markets, believes the decline of GO debt issuance and the expansion of revenue bonds reflects some investor anxiety as the media zoomed in on budget shortfalls across sectors.

“Investors have found comfort in knowing specific revenues are backing deals, as the bankruptcy topic has eroded some confidence around the typically higher-credit perceived GO bond,” Hoogendoorn said.

New debt issuance from state governments and agencies accounted for nearly 42% of total volume, but it was among smaller types of issuers that big increases were found.

Issuance from cities and towns jumped 12.5% to $54.4 billion, while district borrowing moved up 5.5% to $63.2 billion and local authority issuance increased 18.1% to $84.1 billion.

“In preparation for future credit challenges, it appears that local governments stepped up bond issuance in 2010 to create a cushion against future revenue shortfalls,” LeBas said.

He explained state governments are the first to deal with credit challenges in the muni credit cycle, while local governments will be faced with those challenges in the coming years.

The climate of low rates quickly changed in the fourth quarter as issuers rushed to beat the expiration of the BAB program, which offered qualified ­borrowers a 35% federal subsidy to issue taxable debt.

BABs accounted for 24% of the $757.6 billion of state and local debt issued from April 2009 — when they first hit the market — through the end of 2010.

When it became clear in mid-November the program wouldn’t be extended, BAB issuance flooded the market.

“Rates were pretty level all the way until you got to November, and then the world changed,” said John Hallacy, municipal research strategist at Bank of America Merrill Lynch. “We were just cranking away there.”

More than $44 billion of BABs were issued from October to December, helping make the fourth quarter the second-most voluminous ever at $133.8 billion.

The surge in supply, coinciding with a massive Treasury sell-off that kicked the benchmark 10-year note up 79 basis points, contributed to municipal prices experiencing their worst quarterly performance in 16 years.

Thirty-year tax-exempt yields jumped 98 basis points and 10-year yields climbed 78 basis points, placing munis at one of the cheapest yield levels in the past two years.

Bond insurers, represented by two platforms run by Assured Guaranty Ltd. for the entire year, were unable to take advantage of the low-rate or tumultuous environments.

Less than $27 billion of bonds carried an insurance wrap in 2010, a decline of 24% from the previous year and a far cry from the pre-financial crisis days when more than half of all issuance was ­guaranteed.

For reprint and licensing requests for this article, click here.
MORE FROM BOND BUYER