Refundings propel Midwest volume bump as borrowers spurn new debt

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Midwest-based municipal bond issuers borrowed $40.4 billion during the first half of the year as record low rates more than tripled refunding activity.

Issuance in the region compared to the first six months of last year rose an overall 24% over 1,837 deals from $32.6 billion in 1,580 transactions, according to data from Refinitiv.

While refundings took center stage, new money tapered off, down 16% to $20.3 billion.

The education sector saw a big increase as did the use of taxable structures to do advance refundings banned under 2017 tax code revisions, and bond insurance rose was used more as the credit worries over the COVID-19 pandemic’s financial wounds grew more amplified.

Taxable borrowing more than tripled to $10.5 billion, which market participants attributed to the combination of low taxable rates and strong investor interest that allows issuers to bypass the tax code ban on advance refundings.

“Taxable municipals are here to stay for some time assuming that rates will stay at these incredibly low levels,” said John Hallacy, president of John Hallacy Consulting LLC.

Tax-exempt issuance was up 7.6% to $29.8 billion.

First quarter issuance swelled to $21.2 billion from $14.2 billion for a nearly 50% increase even as the market froze in the latter half of March when lockdowns began and investors sought to preserve liquidity and pulled investments as worries grew over the pandemic’s economic threats. The second quarter saw a 4.3% gain accounting for $19.2 billion of borrowing up from $18.4 billion.

The percentage growth put the Midwest behind the Southwest which jumped by 42% but ahead of the Northeast rise of 21% and the Far West increase of 8.8%. The Southeast shrunk by 7%.

Illinois, Michigan, Minnesota, Nebraska, North Dakota, South Dakota, Ohio, and Wisconsin contributed to the increase while Iowa, Indiana, and Missouri ended the first half with a decline in borrowing compared to the first six months of 2019.

The Ohio Buckeye Tobacco Settlement Authority refunding of $5.35 billion of debt in February propelled the state to the top. Jefferies and Citi led the sale.

Ohio-based issuers sold $12.5 billion in total, up 151%.

The Buckeye deal was the largest in the municipal market in the first six months of 2020.

Michigan followed with $5.8 billion, up 12.7%, Illinois with $5.5 billion, up 11.2%, Wisconsin at $4.5 billion, up 17.8%, and Minnesota $3.1 billion up 7.1%.

The jump in refundings as the Bond Buyer indexes continued to fall to new lows along with the drop in new money say much about the Midwest, said Richard Ciccarone, president of Merritt Research Services.

“Midwest issuers were more motivated to reduce their debt service” than to issue new money and some may have used as a means to offset revenue cuts or declines in the second quarter, Ciccarone said.

As the pandemic’s economic shutdown and ensuing recession’s impact on revenue became clearer, some fiscal managers may have seen the low rate environment and ability to issue taxable debt to reduce costs as a preferred option to defer or in lieu of spending cuts.

The education and general purpose sectors showed big gains while utilities, development, electric power also rose with healthcare, housing, transportation and public facilities falling off. Education borrowing accounted for $15.9 billion of volume, up 38.5% followed by general purpose at $12.7 billion, up 155%. Utilities was the third highest sector at $3.6 billion, up 9.1% followed by healthcare at $3.1 billion, down 34% while housing came in at $2 billion, down 18.5%.

Negotiated transactions remained the preferred sale type accounting for $30.7 billion of volume, up 31%, and competitive sales accounted for $7.7 billion, up 5.1%, with private placements making up the remaining $2 billion, a 12.1% increase.

A fixed-rate structure was used on nearly all of the region's volume, $39.2 billion.

Bond insurance doubled to $3.3 billion on 237 deals.

“Bond insurance may be finding a place here in as the Midwest is seeing more strain,” so the appeal for investors grows, Ciccarone said.

State government borrowing ballooned by 265.5% to $3.4 billion. District borrowing was the highest at $10.8 billion, a 32% increase, followed by local authorities at $8.4 billion for a 133% gain and then state agencies at $7.4 billion, down 36.6%. Cities and towns borrowed $4.7 billion, down 7.5%, and higher education issuers sold $3.8 billion, up 178.7%.

Second half
Since the second half of the year began on July 1, a handful of healthy sized deals have already sold or are in the works including an $800 million Michigan deal and $800 million Chicago Transit Authority sale. Chicago is planning a refunding and airport deal while Illinois may borrow up to $5 billion through the Federal Reserve’s Municipal Liquidity Facility if a new federal relief package that compensates governments for lost revenue is not enacted in the coming months.

Refundings may keep up the same pace as long as low rates enable them, but the outlook for new money is uncertain as it will depend on the outcome of the presidential election and local referendums, whether the federal government enacts more relief and an infrastructure package, and the course of the pandemic with issuers and the buy side watching for rising caseloads and the status of treatments and a vaccine.

“It’s typical to see a deferral of spending on capital while the economy is in a slowdown when taxpayers are less enthusiastic about funding new projects,” Ciccarone said.

Health and safety borrowing to upgrade ventilation systems is one area where issuers would feel more comfortable using debt.

“The remainder of the year greatly depends on whether we have a second wave of the virus” and also “whether there is any more assistance for municipal credits at all from the federal level,” Hallacy said, as negotiations on a stimulus/relief deal remain stalled. “The election outcome is likely to have some effect on the municipal market especially if taxes will be on the increase.”

Airports, mass transit, higher education and hospitals will all be stressed for some time and that all will impact borrowing plans.

“The so-called back to normal will not be for some time and it remains to be seen if all of the credits have the wherewithal to weather the turbulence,” Hallacy said.

The massive Ohio Buckeye tobacco deal restructured debt that would otherwise have begun to default within four years. It also brought the bonds back to an investment grade rating. The sale refunded most of the authority’s 2007 bonds.

Chicago’s Sales Tax Securitization Corp.’s $1 billion refunding of outstanding city debt in January was the Midwest's second-largest long-term debt transaction.
The city that week also sold $467 million of GO refunding bonds in the region's ninth-largest transaction in the first half.

Savings from the two deals helped the city wipe out its budget deficit and is providing $100 million to help deal with a new COVID-19 revenue hole. Goldman Sachs and JPMorgan led the issue.

The University of Michigan’s $988 million June sale, led by BofA Securities and Goldman, ranked number three. The region’s three largest deals all had taxable components.

Illinois’s $800 million competitive sale in May won by BofA Securities followed and the Ohio Public Facilities Commission $780 million June sale with Loop Capital Markets in the lead was fifth. Two deals from the Great Lakes Water Authority, and deals from the state of Wisconsin and University of Missouri rounded out the top 10.

The tobacco sale gave the Buckeye authority the top spot among issuers, followed by Wisconsin at $1.5 billion, the GLWA with $1.15 billion, the Chicago Sales Tax Securitization Corp and University of Michigan.

Citi took the top senior manager spot, credited by Refinitiv with $6.1 billion of deals, followed by Jefferies with $3.6 billion, JPMorgan with $3.2 billion, BofA with $2.9 billion, and Stifel Nicolaus with nearly $2.9 billion. Robert W. Baird & Co., Goldman Sachs, RBC Capital Markets, Morgan Stanley, and Wells Fargo Securities rounded out the top 10.

PFM Financial Advisors led among advisory firms, credited with $11.5 billion. Acacia Financial Group followed with $3.1 billion, Baker Tilly Municipal Advisors with $2.5 billion, Ehlers with $1.7 billion, and Piper Sandler with $1.1 billion. Yuba Group, Ponder & Co., Janney Montgomery Scott, Columbia Capital Management and CSG Advisors Inc. rounded out the top 10.

Squire Patton Boggs took the top bond counsel spot, credited with more than $4.9 billion, followed by Orrick Herrington with $2.7 billion, Chapman and Cutler with nearly $2.7 billion, Dinsmore & Shohl with $2.4 billion, and Miller Canfield with $2.3 billion. Quarles & Brady, Kutak Rock, Thrun Law Firm, Gilmore & Bell, and Dorsey & Whitney rounded out the top 10.

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