The municipal bond market remained comatose in February, with state and local governments reluctant to try and raise money in the face of unreliable demand and volatile borrowing costs.
Municipalities floated just $16.16 billion of debt in February, according to Thomson Reuters, a 40.6% plunge from the same month last year and the lightest February issuance since 2000.
After a historically meager slate in January, municipalities have sold $28.91 billion of bonds so far in 2011, a 52% drop from the first two months of 2010 and the paltriest issuance for this time of year in a decade.
Most people expected volume to drop this year because of the blitz of issuance in December, which likely pulled forward into 2010 some deals that would have otherwise come this year.
The median forecast for 2011 issuance coming into the year was $395 billion, after a record $433 billion slate last year, according to a Securities Industry and Financial Markets Association survey of analysts who expected the Build America Bond program to expire, as it did on Dec. 31.
But with investors withdrawing more than $39 billion from municipal bond mutual funds in the past 15 weeks and 30-year triple-A rated muni bonds exhibiting 30-day yield volatility as high as 20% this year, issuance has fallen even more than expected.
Issuers are choosing not to test a turbulent market.
“Now, with the elimination of BABs, at least for the time being issuers are faced with issuing what would be higher-costing debt in the form of tax-exempt issuance,” said Howard Mackey, president of Rice Financial. “A lot of them are taking a look at what they can afford to issue. … There are probably some limitations that are being addressed, in terms of debt issuance.”
With municipal governments and investors each sticking mostly to their own side of the dance floor, some researchers are revising their outlook for volume in 2011. John Hallacy, head of municipal research at Bank of America Merrill Lynch, last week cut his prediction for 2011 issuance to $350 billion, from $385 billion.
Hallacy’s predictions for January and February were both too high by $10 billion.
“The reality has been even harsher than what we considered to be cautious estimates going into the year,” he wrote in a research note.
JPMorgan analysts Chris Holmes and Alex Roever sliced their outlook — which at $345 billion was already well shy of the median — to a measly $300 billion.
That would represent a plummet of more than 30%, and if accurate would be the lightest annual issuance since 2001, without adjusting for inflation. Adjusting for the rate of inflation for state and local governments estimated by the Bureau of Economic Analysis, January was the lightest month of issuance since 1986, and excluding that February the lightest since 1989.
Among the numerous factors Holmes and Roever cited influencing volume, one major consideration was the big wave of financing in advance of projects municipalities conducted in the BAB craze late last year.
The BAB program, which enabled state and local governments to sell federally subsidized taxable bonds, expired at the end of December. Municipalities sold $44.1 billion of BABs in the fourth quarter to get in ahead of the deadline.
Some of these deals raised cash for future projects, which Holmes and Roever called “tactical prefunding.”
Municipal governments in some cases have therefore already obtained the money for their capital projects this year, eliminating the need to borrow.
“Many issuers had advanced forward their calendars,” said Phil Villaluz, head of municipal research and strategy at Sterne Agee.
The sharp drop in issuance relative to expectations, though, proves there is more to it than that.
Holmes and Roever also claimed market volatility, a substantial increase in yields since early in the fourth quarter, and wariness about sparse demand have depressed the number of deals coming to market.
“Higher funding costs are discouraging issuance,” the two analysts wrote. “[Some] borrowers are simply delaying new-money issuance in hopes that yields will decline closer to last year’s levels.”
Issuance in virtually every category declined sharply. Tax-exempt sales cascaded 41.5%, to $11.1 billion. Taxable bond sales slipped 38.8% to $5 billion, as the expiration of the BAB program was offset in part by Illinois’ taxable $3.7 billion pension bond deal — far and away the biggest sale of the month.
That offering represented 23% of issuance for the month and was larger than the next five-biggest deals combined.
Refinancings continued to play a smaller role in the market, with sales of refunding bonds dropping by more than half, to $3.9 billion.
The 20-year double-A rated municipal bond yield exceeds the five-year Treasury yield by more than 200 basis points, rendering advanced refundings uneconomical in most situations. Sales of variable-rate demand obligations are all but moribund. Municipalities sold $253.5 million of VRDOs in February.
With almost $200 billion of bank facilities on existing VRDOs scheduled to expire this year and next, according to SIFMA, many municipalities consider the bank guarantees that typically accompany VRDOs too expensive.
The contraction in VRDO issuance coincides with an increase in other types of deals seen as alternatives to puttable VRDO financing, such as floating-rate notes and non-puttable VRDOs. The slowdown in bond issuance is not being accompanied by a slowdown in needs to finance municipal capital projects.
Holmes and Roever expect governments to have to come to market eventually. Both municipalities and investors might feel better about completing deals when the exodus of cash from municipal bond mutual funds fully dies down, they wrote in a report last week.
“When the smoke clears, there will likely be an influx of pent-up supply,” they said.
Bond insurance penetration for the quarter was 4.5%.