CHICAGO – Issuers in the Midwest sold $32.5 billion of municipal bonds in the first half of 2017, a 21.6% drop compared to the same period last year as refundings sunk and new money borrowing fell short of reaching positive territory.
Local and state governments and not-for-profits in the Midwest sold the debt in 1,877 deals, according to Thomson Reuters data. In the first six months of 2016 they sold $41.4 billion in 2,413 transactions.
The first and second quarters both saw a double digit percentage drops with about $14.5 billion of bonds sold in the first quarter and about $17.9 billion in the second. The region's volume slippage was second only to the Southeast which saw a 31% falloff, and exceeded the national 12% decline.
Refundings slid by 48.5% landing at $7.9 billion, while new money declined 5.4% to finish the first half at $16.8 billion with the remainder of volume selling in combined transactions. Negotiated deals remained the favored form of borrowing accounting for $22.4 billion of issuance. Private placements were up 2.7% to nearly $3 billion.
Market participants see a range of local and national issues at play.
Diana Hamilton, president of Indiana-based Sycamore Advisors, said two factors contributed to the big drop in refundings.
“After two big years of refunding transactions in 2015 and 2016, most of those opportunities are exhausted – except for ones with longer call dates where negative arbitrage made the refunding not as attractive,” she said.
The second factor, one which Hamilton believes will have a growing influence on the market through 2020, is that starting in 2008 there were a large number of transactions under the federal government’s taxable Build America Bonds program and most of those have make-whole call provisions that cut into the value of refunding savings.
“The BABs overhang will continue to cloud the refunding market for the next couple of years,” she said.
While rates jumped after the presidential election, they have settled and the Federal Reserve’s hikes in benchmark rates have had limited impact on municipal rates, “so there’s no sense of urgency to rush into the market because of worries over rates going up,” said Richard Ciccarone, president of Merritt Research Services LLC.
Others say the landscape exists for refundings to pick up steam.
“Clearly refunding opportunities have been dramatically affected in the first half, year over year,” said Ryan Kozak, a managing director at Huntington Bank. But low rates and increases in short term investment rates create a more favorable environment for issuers to realize savings in the second half of 2017, he said.
A 22.9% surge in Wisconsin gave it the leading spot among states, with its issuers selling $6.9 billion, followed by Illinois where $5.7 billion was borrowed, a 33.2% drop. Ohio accounted for $5.2 billion of the region’s bonding, an 11.5% drop. Michigan accounted for $3.5 billion of volume, a 43.2% drop.
Minnesota issuers borrowed $2.5 billion, a 40.5% decline, and Indiana issuers borrowed $1.85 billion, a 45.1% decline.
“If I were to compare the two years we had a lot more refunding especially current refunding in 2016,” said Patrick McGow, a principal and public finance group leader at Miller Canfield.
McGow said that what is driving issuance now are more new money projects and “surprisingly more" advance refundings in 2017.
“As the yields on escrows have gone up so that we’ve been able to do more advance refundings with longer escrow periods than we were doing last year,” said McGow. “It’s a trend that we have seen over the last several months.”
Aside from the big falloff in refundings, Ciccarone thinks Illinois’ political dysfunction is part of the story as uncertainty over the state’s budget could have interfered with borrowing plans. The state ended a two-year-old budget impasse in July when Democrats with the help of some Republicans pushed through a $36 billion budget package and then overrode Gov. Bruce Rauner’s vetoes.
Local governments, public universities and transit agencies all took a funding hit in the budget but say the benefit is that adoption of budget provides funding certainty. School aid funding remains hung up in a political dispute.
“The Midwest certainly showed a lack of interest in borrowing despite relatively low interest rates,” Ciccarone said. “The region’s conservative profile is part of it; concerns over credit quality” might have played a role.
Borrowing across sectors weakened with only transportation and development-related bonding experiencing growth. Education bonds accounted for $11.7 billion of volume, a 26% decline, while general purpose issuance followed at $6.1 billion, an 18.8% decline. Healthcare borrowers, struck with worries over Republican attempts to remake the Affordable Care Act, slid 33.1% to $4.4 billion.
Bond insurance volume gained 21.2% but still wrapped a minimal level of $2.3 billion. Across issuer types, only counties and parishes and cities and towns ended the first half with volume growth. District borrowing accounted for $8 billion of the region’s volume; cities and towns accounted for $7.7 billion; and state agencies $7.5 billion.
Chicago led the pack among issuers selling almost $2.6 billion of long-term debt. That included a nearly $1.2 billion new money and refunding general obligation sale in January that was the largest Midwest deal of the first half. Chicago also priced an $812 million O’Hare International Airport financing in June, the region's third largest deal.
The state of Wisconsin followed Chicago among issuers with $2.1 billion, and the Wisconsin-based Public Finance Authority – a national conduit agency – was third with nearly $1.7 billion.
Cuyahoga County, Ohio was fourth on the issuer ranking with $946 million of borrowing for MetroHealth System which is a public hospital system that serves the county. That deal marked the region’s second largest transaction.
The transaction refunded some debt and added $800 million to MetroHealth’s balance sheet to fund a $950 million transformation of its main campus following a sweeping overhaul of its operations. The transaction also prompted Fitch Ratings, Moody’s Investors Service, and S&P Global Ratings to drop the system’s ratings by three notches leaving it at the lowest investment grade rating over concerns about its heavy debt load. Outlooks are stable at the triple-B-minus level.
Some big deals are on tap for the remainder of the year and others have been talked about but are uncertain for the second half.
The Illinois Finance Authority will sell $560 million of state revolving fund bonds next week. Chicago officials have said they plan to begin taking advantage of a new bond structure this year to refund existing sales tax and general obligation bonds. Illinois is authorized to sell up to $6 billion GO paper to pay down bills by the end of the year. It’s unclear whether the Rauner administration will act on the authorization or not.
Bank of America Merrill Lynch led the senior manager rankings, credited by Thomson Reuters with running the books on $3.3 billion in the Midwest, followed by Goldman Sachs with $2.8 billion and Stifel Nicolaus with $2.5 billion. Robert W. Baird, JPMorgan, Citi, Piper Jaffray, Wells Fargo, RBC Capital Markets, and Loop Capital Markets rounded out the top 10.
PFM Financial Advisors took the top spot among advisors, credited with working on $4.2 billion of financings, followed by the healthcare advisory firm Kaufman Hall with $1.8 billion, and Acacia Financial Group with $1.7 billion.
Quarles & Brady finished the first half in the lead among bond counsel, credited with working on $3.1 billion, followed by Chapman and Cutler with $2.3 billion, and Gilmore & Bell with $1.8 billion.