Municipalities will continue their hiatus from borrowing money this week as they are once again slated to sell a meager amount of new debt.
State and local governments are scheduled to sell just $723.6 million of bonds this week, according to The Bond Buyer and Ipreo data, an uncommonly small amount of debt.
This comes on the heels of a final week of 2010 in which a solitary issuer was scheduled to sell a measly $525,000 bond issue.
This is the supply lull municipal market participants were looking forward to during the paroxysm of bond sales in the fourth quarter. A $131.2 billion flurry of debt issuance in the fourth quarter helped propel the municipal bond market to a record $431 billion of issuance in 2010.
This barrage of new bonds put the skids on the municipal rally that brought yields to all-time lows late in the summer.
As the municipal bond market was stuffed with week after week of $10 billion-plus in new issuance in the fourth quarter, trading desks eyeing rising Treasury yields were wary of taking on bonds. The market had trouble finding buyers for all the new debt without offering higher rates.
Now that supply has all but vanished, the market isn't exactly falling over itself to buy bonds. Yields have eased down nine basis points from their near-term peak of 3.25% on Dec. 16, according to the Municipal Market Advisors 10-year triple-A scale, but remain about 50 basis points above where they were at the end of the third quarter.
This may simply be because buyers are on vacation, but it likely reflects, at least in some part, selling from mutual funds. Municipal bond mutual funds became a more critical buyer in the past two years as they were awash in $69 billion of new money from investors in 2009 and an additional $32.2 billion of inflows the first 10 months of last year.
Investors suddenly began taking money out in November, and mutual funds have contended with more than $17 billion in outflows the past two months, according to the Investment Company Institute. Redemptions typically force mutual funds to sell bonds to raise the cash to return to investors.
Outflows or not, most analysts expect the market to grapple with significantly less supply this year than last year, for a number of reasons.
Principally, barring an astonishing turn of events, the Build America Bonds program will have expired on Jan. 1.
The BAB program, which enabled municipalities to sell taxable bonds with a federal subsidy, increased 2010 volume in two ways. One, it coaxed more issuers into the market by offering lower borrowing costs. Two, many issuers hurried to issue debt before the expiration at the end of last year, pulling into 2010 some issuance that otherwise would have taken place in 2011.
Loop Capital in a report last month estimated $20 billion of BABs and other stimulus bonds dragged 2011 borrowing into 2010.
But analysts expect lighter issuance for other reasons, too.
Last month, Loop projected issuance of $375 billion this year, which would mark a decline of 13%. Loop's annual prognostication is divined from a linear regression model that tracks how the magnitude of borrowed money by municipalities responds to factors like interest rates, state and local government revenue, and the slope of the yield curve.
The majority of the variance in municipal bond issuance every year is explained by changes in interest rates, according to Loop's regression analysis. Since rates have risen, Loop expects higher borrowing costs to depress volume.
Another way interest rates affect volume is the force they exert on refunding bonds.
Refunding bonds can comprise anywhere from less than 10% of issuance, a low reached in 2000, to more than half of issuance, which was reached in 1992. Much depends on the slope of the Treasury and municipal yield curves, which determine how feasible it is for municipalities to use cash flows from Treasury bonds to meet their own debt service before the debt becomes callable.
When intermediate Treasury yields are significantly lower than longer-term municipal yields — as they are now — municipalities do not find it economical to advance refund their bonds.
The "negative arbitrage" on five-year Treasury bonds versus 20-year double-A rated municipal bonds is more than 250 basis points, according to Municipal Market Data, compared with an average of 110 basis points since the beginning of 2006.
Loop anticipates negative arbitrage will shrink advanced refunding issuance by $20 billion this year. Municipalities issued $98 billion of refunding bonds in 2010, a figure that does not include deals that were partially new-money and partially refunding.
Negative arbitrage does not, however, affect current refundings of bonds that are already callable. According to a JPMorgan estimate, $170 billion of municipal bonds will become callable this year, compared with $148 billion last year. Assuming no increase in interest rates, JPMorgan expects current refundings to jump by $20 billion because of the bigger stock of callable bonds.
The biggest deal on the calendar this week is a $420.1 million health care revenue bond from the Massachusetts Development Finance Agency on behalf of Partners HealthCare System, a health care not-for-profit that operates about a dozen hospitals in the state. The lead underwriter is JPMorgan.
This complicated deal comes in six series, some of which have numerous subseries. Two series with $100 million of par value will be variable-rate notes with a bank guarantor and a remarketing agent. Two series with roughly $140 million of par value will be puttable variable-rate notes, but with no bank guarantor.
Another $48.9 million will be floating-rate notes with interest rates resetting based on a spread to the Securities Industry and Financial Markets Association index, which measures yields on tax-free variable rate demand obligations.
Finally, $130.8 million will be term bonds maturing from 2014 to 2021, plus a bullet maturity in 2041.