Note issuance followed rest of market down in 2018

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The impacts of tax reform, economic recovery, rate volatility, and ongoing state and local austerity prompted a 12.4% decline in municipal note issuance in 2018, municipal experts said.

“The tax law played a role by ruling out advance refundings,” said Anthony Valeri, director of investment management at Zions Wealth Management in San Diego.

The absence of the municipal provision contributed to total annual note volume declining to $42.23 billion among 2,219 deals, versus $48.23 billion among 2,337 issues in 2017.

The elimination of advance refundings occurred under the Trump Administration’s historic tax reform legislation signed into law Dec. 21, 2018.

Much of the short-term note issuance declined last year because the promise of higher rates spooked issuers, others said.

“I would suspect that the decline in note issuance is partially related to sentiment last year that rates were on the rise,” said Richard A. Ciccarone, president and chief executive officer at Merritt Research Services, LLC. “Issuers felt compelled to reduce short-term instruments in favor of longer- term financing in anticipation of higher borrowing rates later when the notes retire,” Ciccarone explained.

Dan Heckman, senior fixed income strategist at U.S. Bank Wealth Management, said some municipalities decided to convert short-term debt to longer-term debt, which factored into the decline.

“The fear of the Fed raising rates further has some entities thinking now may be the time to do a conversion to fixed-rate structures,” Heckman added.

Note issuance declined in every month of the year, except for February and August, when issuers sold 18.3% and 20.1% more of the one-year note vehicles, respectively, compared the prior year, according to the new annual data provided by Refinitiv.

The boost in issuance in those months could have resulted in some issuers starting off early 2018 with increased cash flow needs, as well as rushing some last-minute note deals to market in late summer, ahead of the potential tax reform in the fourth quarter, municipal sources said.

A rush to market in late summer, they said, also caused a slight pop of 4% additional note issuance in the third quarter overall to $17.871 billion in total volume up from $17.184 billion the prior year -- even though the deal count fell to 677 from 701.

Otherwise, issuance decline in all three other quarters -- by 9.7% in the first, 21.7% in the second, and 29% in the fourth -- as rate volatility and state and local austerity aided the declining note issuance overall last year. In those quarters, issuance fell to $5.953 billion from $6.589 billion; $11.219 billion from $14.337 billion; and $7.186 billion from $10.115 billion, respectively.

“Regarding state and local budget austerity, it was a reflection of two relatively modest years of revenue growth -- in fiscal year 2017 and fiscal year 2016,” Valeri of Zions said.

The growth prompted states to take a modest approach for fiscal year 2018, he noted.

For instance, municipalities sold 86.1% less note volume for electric power projects in 2018, issuing $183.3 million among 13, down from $1.318 billion among 12 the prior year.

Short-term transportation note issuance also fell by 67% to $1.105 billion in 64 deals, compared with $3.347 billion in 70 deals, according to the data.

Additionally, healthcare issuance dropped by 66.8% to $225.8 million in nine deals, versus $679.8 million in 12 deals.

“While there is evidence of underperformance in certain areas of the economy, the data throughout last year supported the late-cycle recovery,” said Jeffrey Lipton, managing director and head of municipal research and strategy at Oppenheimer & Co. Inc.

“We would suspect that improving allocations to state ‘rainy day’ funds helped to mitigate the need for cash-flow borrowings as a way to bridge the gap between revenues and expenditures,” Lipton said.

“States have done a credible job of growing these resources in subsequent years following the 2008-2009 financial crisis,” he noted. “In 2018, many issuers experienced improved revenue collections and were able to effectively control expenditures, and thus were able to redirect a portion of surplus monies into their rainy day funds as a sign of prudent fiscal management.”

However, others said state expenses have matched modest revenue gains and that overlap limited note issuance.

“Expenses are rising on a variety of fronts and not any one single source,” Valeri explained. “There isn’t much capacity to take on additional debt.”

That was reflected in the volume of short-term notes for mortgages and other enhancements, whose issuance both fell to zero from $28.9 million in two deals and $29.5 million in one deal, respectively, in 2017.

Housing is one sector that did experience an 89% increase in short-term note issuance to $68.8 million from $36.4 million the prior year. However, deal size declined to four from five.

The growing population of school aged children -- and school construction needs -- around the country most likely led to the 12.2% increase in short-term notes in the education sector last year to $11.10 billion in 681 deals, up from $9.89 billion in 740 deals in 2017.

“The noted rise in short-term note issuance for higher education credits in 2018 can be attributed to ongoing budgetary pressure experienced within this sector,” Lipton said.

Aside from these individual sectors nuances, Valeri predicted that any increase in note supply is likely to be limited going forward.

Meanwhile, other market and political forces factored into the decrease of the one-year instruments.

“A relatively steeper yield curve and the absence of new tax reform concerns also contributed to the 2018 drop in note issuance,” Lipton said.

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TRANs State tax revenues Interest rates Refunding bonds Tax reform