With muni primary in limbo, issuers turn to private placements

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Private placements, bank loans and lines of credit have ticked up in the last two weeks as issuers seek an alternative to a primary market that has all but shut down as markets reel from the COVID-19 pandemic.

New York’s Empire State Development Corporation privately placed $381 million of tax-exempt and taxable refunding state sales tax bonds with Bank of America Securities last week, the state comptroller’s office said.

Sources said more are to follow.

These developments make the case for the federal government to take action to enact a stimulus bill that will likely help to stabilize the secondary markets and also revive the municipal primary market, sources said.

On Monday afternoon, a stimulus bill remained stalled in the Senate.

Even with the Federal Reserve’s essentially limitless line of purchases of various securities, including variable rate demand obligations and short-term municipal debt — adding to a list of assets eligible to be used as collateral by financial institutions — sources said the municipal new-issue market won't reopen until there is good news from Washington on the legislative side.

Otherwise, the industry may see more issuers privately placing their debt.

"Issuers at this point are looking to save money, so if private placements eliminate professional fees they would otherwise incur from accessing market from the traditional route, they may opt for that. The fact that so many deals are on hold or day-to-day shows that they don't like rates where they are at right now or are concerned with where buyer appetite is. Many issuers have been riding it out with the hope that we have a reversal," said Eric Kazatsky, muni strategist for Bloomberg Intelligence. "However, unless we get more concrete news out of Washington — endez billthe [Robert] Mendendez bill, the stimulus legislation broadly — issuers may very well increase private placements to alleviate the immediate-term financial stresses of needing to sell bonds."

There were two legs to the New York transaction: refunding and new money. The $381 million refunding proceeded last week through a private placement with Bank of America, and is scheduled to close on March 26.

The new money — roughly $1.7 billion — is not a private placement, and timing is to be determined, according to New York State Comptroller Thomas DiNapoli’s office.

While $381 million is not that large of a deal for an issuer the size of New York, the placement still says that deals need to get done. With the primary mostly closed, more issuers may look to private placements as an alternative to selling debt and banks will oblige if the issuer’s credit quality meets their regulatory requirements.

"High-grade GOs will lead the way," a New York banker said, adding that initial offerings would be conservative in size, probably between $100 million and $200 million.

“If it’s a bank, they tend to buy high-quality credits. They don’t typically speculate with their municipal allocation,” said Matt Fabian, partner at Municipal Market Analytics. “If the primary market doesn’t come back, or even if demand restarts, private placements will now be a direct competitor to the market. The two-year muni-UST ratios are at over 800%. At levels like these, you can’t deny that banks will purchase directly from high-quality issuers."

In 2019, there were 974 private placements valued at $19.3 billion. The entire new-issue market saw more than $400 billion of new-issue supply price during 2019. Going back to 2015, there has been an average of $23.8 billion of private placement deals per year. The high during the span occurred in 2017 when there was $40.2 billion over the course of 1,473 deals.

After tax reform was enacted, banks had less incentive to own munis, generally, so private placements fell off.

So far in 2020, there have been 81 private placement deals totaling $1.449 billion. Sources expect that number to grow as the industry copes with the virus and issuers just need to sell bonds.

Voluntary disclosure of bank loans and private placements have increased over the years, as investors and rating agencies noted more than five years ago when their use by issuers was beginning to grow. Participants noted then that the interests of bond investors could be at risk if bank loans and private placements of debt draw on government resources also used to back securities.

“Over the past two weeks of market disruption we have noticed a number of scheduled bond issues move to a direct bank purchase,” said Geoffrey Buswick, managing director and sector leader at Standard & Poor’s Global Ratings. “As we have said before, we see the use of bank loans as a meaningful and efficient way to access capital. We do include these loans in our debt metrics and expect full disclosure of the credit details of these transactions.”

A case in point is that S&P on March 19 downgraded to A from A-plus the University of Pittsburgh Medical Center. UPMC had a 2020 issuance planned to secure $1 billion of additional debt for capital projects, $550 million for various refinancings, and $210 million to repay a bridge loan used to defease debt after the acquisition of Western Maryland Healthcare System.

“In light of the COVID-19 pandemic and unpredictable health system needs over the next several months, management has obtained, or is in the process of obtaining, a line of credit and several bank loans totaling $2 billion and plans to place all proceeds on the balance sheet for potential working capital and other needs during this time. Ultimately, management has committed to keeping debt outstanding at $5.5 billion, or approximately $1.2 billion above debt levels at December 31, 2019. This review and rating action assume that once the health care environment around COVID-19 stabilizes, UPMC will be able to accomplish the refinancing, return debt levels to $5.5 billion, and begin to finance the capital project contemplated under the originally proposed $1 billion new debt issuance,” S&P analysts wrote.

“Our calculation of debt coverage does not include payments on the incremental $1 billion line of credit and bank loan, as we assume those funds will not be part of UPMC's long-term debt structure,” S&P said. “If the situation changes, we will reassess debt levels and debt service coverage ratios."

Kyle Glazier, Aaron Weitzman and Gary Siegel contributed to this report.

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