Low yields, high demand prompt uptick in short-term notes

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The phenomenon of low yields and a flatter yield curve persists, yet a voracious appetite for municipal bonds was responsible for a nearly 18% increase in short-term note volume in the first half of 2019.

Strong demand from both issuers and investors led to a 17.9% increase, which occurred between January 1 and June 30, compared to the same period in 2018, according to new data as of July 2 from Thomson Reuters.

Issuers sold $20.25 billion among 1,075 note issues in the first six months of the year, compared to $17.17 billion over 1,045 issues last year, the data showed.

“With yields being so low, notes become an attractive tool for issuers to utilize to access capital markets,” Shaun Burgess, portfolio manager and fixed income analyst at Cumberland Advisors said.

Meanwhile, the significant municipal mutual fund inflows in the first half of the year prompted a rise in note demand on the buy side — especially among rated paper, according to Burgess.

“Notes generally offer a more attractive yield than short-term bonds in a serial issue, so for an investor they are an attractive short-term option,” he said.

This year’s trend is in contrast to recent years when rate volatility — namely the potential for rising rates and ongoing austerity among state and local municipalities resulted in a steady decline in short-term note volume.

While sources say austerity is a reality for municipalities, current market technicals prompted the noticeable uptick in 2019’s first half, sources said.

General issuer psychology and short-term structural mechanics have elevated note issuance throughout the first six months of 2019, according to Jeffrey Lipton, managing director and head of municipal research and strategy and municipal capital markets at Oppenheimer & Co.

“Our sense is that borrowing activity is moving in lock-step with Fed policy where concerns over higher interest rates have abated — for now,” he said.

The data proves that to be true as tax-exempt note issuance jumped by 20.7% to $19.88 billion among 1,014 deal, versus $16.47 billion in 981 deals in the prior first half.

Taxable note sales dropped, however, by 48.7% to $359.4 million among 60 deals, down from $700.2 among 63 deals.

A flatter yield curve relative to the same period last year also helped to lift note issuance year-to-date, according to Lipton, who said a number of issuers were recognizing value on the short-end of the curve.

In fact, issuers accessed the market most in April when they sold $3.19 billion among 136 deals, up from $1.04 billion in 125 deals in the prior first half.

“Although we believe that austerity measures still apply and that the overall national economic profile remains firm during this late-cycle recovery — albeit with slower growth performance — issuers are now more comfortable marketing short-term notes for specific purposes,” Lipton explained.

A 19.1% increase in new-money notes in the first half help reinforce his point, as volume grew to $20.16 million in 1,066 deals, versus $16.92 million in 1,030 financings.

State agencies also demonstrated a significant boost in note issuance, with $3.37 billion sold among 17 deals, up from just $519.5 million among 12 deals the prior first half.

Elsewhere, meanwhile, note issuance surged in the electric power sector where the number of deals remained unchanged at nine — but the volume rose substantially to $276.8 million from just $23.4 million in 2018.

The healthcare sector also grew to $30.7 million among four issues, up from $100,000 in one deal the prior year. At the same time, issuance in the transportation sector drove up to $2.89 billion among 32 issues, compared with $482.1 million among 41 deals in 2018.

Lipton noted that certain issuers are less motivated now to convert to long-term, fixed-rate structures than they have in the past given the relative comfort that borrowing costs will be lower when notes retire or renew.

“For others, it is a matter of having a need to fund a backlog of projects while keeping in notes during construction periods so as to accommodate timing irregularities of state aid payments,” he said.

Lipton suggested that some issuers are also making up for a drop in note issuance in 2018 and cash flow needs may have increased for some — particularly those issuers experiencing declines in state aid payments.

“Generally, now with stronger revenue growth, improved expenditure controls, and consistent allocations to rainy day funds already made, issuers have more capacity to cover their note borrowings,” he explained.

Growth in other segments of the note market supported that concept.

Notes backed by revenue debt rose by 20.1% to $1.57 million among 37 issues, versus $1.31 million among 30 deals.

General obligation notes, on the other hand, rose 17.8% to $18.67 million among 1,038 issuance, versus $15.85 million in 1,015 deals, the data showed.

Back at Cumberland, managers have been more active in new-issue notes this year, according to Burgess, who said the firm is taking advantage of the opportunity to park some funds short-term while still receiving better rates than money market instruments.

“We believe we will continue to see notes come to market until longer yields rise and we see more than 125 basis points between one year and 30-year paper,” Burgess added.

“Given our view that rates are likely to trend lower through year-end, a stable economic profile, and similar issuer psychology, we would expect note issuance for the second half of the year to be up from the same period of last year,” Lipton added.

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