Midwest's fourth-quarter surge not enough to erase early volume decline

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A surge in fourth-quarter issuance led by Illinois' $6 billion bill-backlog borrowing couldn't stave off an overall drop in 2017 Midwest municipal debt sales after double-digit declines earlier in the year.

Total borrowing in the region slipped by 5% from 2016 to $82.98 billion, according to data from Thomson Reuters. The number of deals was down to 3,850 from 4,463.

First-quarter volume was down 24.8% year-over-year, followed by a 17.6% slide in the second quarter and a 37.4% decline in the third. Fourth-quarter issuance surged 62.8% with $34.97 billion issued in 1,125 deals.

The rush to market to beat the threats posed in pending tax reform legislation prevented a much steeper overall decline.

Private activity bonds were on the chopping block in early versions of the tax bill that finally passed with PABs intact but tax-exempt advance refundings eliminated.

“Just the suggestion of eliminating the tax exemption for private activity bonds put them on steroids, displaying how indispensable they are to so many key sectors of the economy,” said Illinois Finance Authority Executive Director Chris Meister.

“What we saw in the last month of 2017 in Illinois was a dramatic acceleration of activity -- the authority’s largest agenda in its history,” he said.

“This alone should demonstrate to Congress how popular and effective this tool can be in accomplishing their policy goals. It’s a low-cost, high-return, market-driven financing option that has so many more applications that can help in developing infrastructure in the years to come,” Meister added.

Given the December crush it’s difficult to say how 2018 will land.

“A lot of issuers who were looking for more efficient refundings or to get all of their ducks in a row suddenly had a very hard deadline in which they needed to complete an advance refunding,” said Samuel Adams, a Columbus, Ohio-based vice president at KeyBanc Capital Markets.

Adams said that 2018 is likely to be a down year, but “the potential of infrastructure reform at a federal level could incentivize borrowing and easily move the needle,” he said.

Pat McGow, co-lead of Miller Canfield’s Public Finance Group, said issuers are already moving to adjust to the post-tax reform environment with alternative structures to replace tax-exempt refundings that include both taxable advance refundings and forward deliveries.

“We are also seeing some other market changes such as shorter redemption periods that may impact refunding volumes,” McGow said. “The market is still trying to figure out how to deal with the loss of tax-exempt advance refundings and there are lots of different ways that market participants are going about doing that.”

Refundings were down 22.7% year-over-year region-wide despite the fourth quarter flood, though new money issuance was a bright spot, increasing 8.6% to $40.29 billion.

Illinois, Missouri, Ohio, Wisconsin, North Dakota and South Dakota recorded volume gains last year while Indiana, Michigan, Minnesota, Iowa and Wisconsin experienced declines.

Illinois-based borrowers topped the crowd accounting for $21.66 billion of the region's volume in 610 transactions for a 7.3% increase, followed by Ohio with $13.9 billion over 348 deals for a gain of 21.6% and Wisconsin with $12.57 billion of debt issued in 610 deals for 21.4% gain.

Michigan saw a 43.5% drop in issuance to $7.44 billion.

The state’s issuers couldn’t keep up with 2016’s record pace, which was largely due to an unusually high number of refunding transactions, PFM Financial Advisors LLC managing director Kari Blanchett said in an email. “Additionally, 2016 issuance included some larger transactions, including the inaugural issuances of Great Lakes Water Authority,” she said, which topped $1 billion.

Blanchett said she is “hopeful the loss in volume will be offset by an increase in new money issuance, as Michigan recovers and begins to address deferred capital needs,” but noted that tax reform and rising interest rates are likely to keep volumes down again in the state.

“New money issuance should be steady or increase due to improved economic conditions, but not high enough to hit volume numbers seen in 2015 and 2016,” said Umbaugh’s Lansing, Michigan-based partner Jesse Nelson.

Indiana saw a 38.5% drop in bond volume but market players say that the $4.8 billion issued over the year is a more normalized volume relative to the $7.9 billion the state’s issuers sold in 2016. Diana Hamilton, president of Sycamore Advisors, said Indiana market watchers anticipate that the numbers in 2018 will look similar to 2017, “but they think there is a lot of capacity in universities and K-12.”

Illinois volume is expected to drop this year, as the $6 billion backlog borrowing was a one-time measure, and new money issuance is expected to lag given the expiration of the state’s $31 billion capital program with lawmakers and Gov. Bruce Rauner focused on the November election.

Education represented the largest sector in the region, with $23.73 billion of debt sold, a decrease of 10.1%. General purpose followed at $20.23 billion for a 17.9% increase, and then healthcare with $14.89 billion for a modest 2.4% increase.

The uptick in healthcare issuance slightly lagged the national 5.2% increase, but both in the Midwest and nationally the sector would have seen a double-digit drop if the pending tax bill hadn't spurred year-end action.

“Because of the tax reform initiatives in November that included the threat against PABs and advance refundings there was a rush to market,” said George Huang, a director in municipal securities research at Wells Fargo Securities LLC. “The rush was limited to issuers that already had deals in the pipeline scheduled for the first and maybe the second quarter that they could push up.”

Healthcare borrowers must go through conduit issuers such as authorities or local governments, and a tax-exempt legal review which makes a quick execution difficult. Huang said some borrowers who couldn’t move swiftly enough turned to taxable deals.

The lack of issuance ahead of the fourth quarter rush was driven by a mix of factors including a desire to hold back on borrowing due to uncertainty over federal efforts to repeal and replace the Affordable Care Act and a lack of need with many systems already taking care of borrowing needs due to the low rates in recent years.

The market “could see some refundings related to the wave of consolidation” among not-for-profit health systems but that remains to be seen as systems don’t need to rush on that front, Huang said.

Throughout the region, tax-exempt issuance declined 5.8% to $73.45 billion while taxable slipped 1.2% to $7.49 billion. The division between tax-exempts and taxable could narrow in this year as some issuers turn to taxable transactions to refund debt that's not yet callable given the elimination of advance refunding in the tax package, several market participants said.

Floating-rate products grew in popularity but volume remained modest with short and long put products accounting for less than $4 billion.

Private placements gained in favor rising by 39.2% to $8.94 billion. Bonds wrapped with insurance coverage saw a 3% gain to $4.08 billion of debt.

The Illinois state government was the region’s top issuer, credited with $6.25 billion largely through its bill-backlog deals. It was followed by Wisconsin and Chicago.

Illinois has the two largest deals, with the $6 billion backlog transaction that was composed of a $4.5 billion negotiated deal and a $1.5 billion competitive transaction won by JPMorgan. Both offered 12 year bonds to pay down the state's record $15 billion bill backlog that skyrocketed during the state's record two-year budget impasse.

Chicago's $1.16 billion general obligation new money and refunding deal sale in January 2017 that included a mix of tax-exempt and taxable paper followed in the third spot, and the Chicago Board of Education had the fourth-biggest deal with a $1.025 billion transaction in November.

Chicago doesn't expect a GO borrowing this year but plans additional borrowing under its Sales Tax Securitization Corp. credit as well as a big O'Hare International Airport deal as the city embarks on a terminal renovation and expansion program.

Bank of America Merrill Lynch led the table of senior managers, credited by Thomson Reuters with 86 deals valued at $10.39 billion, followed by JPMorgan with 82 deals valued at $8.79 billion and Citi with 59 deals valued at $5.19 billion.

PFM Financial Advisors led among advisory firms on 328 deals valued at $13.18 billion, followed by Acacia Financial Group with 40 deals valued at $4.97 billion, and Public Resources Advisory Group with eight deals valued at $3.61 billion.

Chapman and Cutler LLP topped the bond counsel league tables, credited with 358 deals valued at $9.09 billion, followed by Quarles & Brady LLP with 387 deals valued at $5.52 billion, and Kutak Rock LLP with $4.34 billion.

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