Continued credit and fiscal strength, as well as attractive long-term interest rates for much of 2016 bolstered state and local governments and sparked a decline in many segments of the short-term note market, according to annual data from Thomson Reuters.
Municipal issuers' ability to lock into long-term rates ahead of a Federal Reserve Board tightening sequence also contributed to a decline of 1.5% in short-term note issuance in the 12-months from January to December. As long-term volume surged 11.2%, short term note volume fell to $36.67 billion in 2,391 issues from $37.21 billion in 2,437 issues in all of 2015.
The biggest drop occurred in the second quarter, when note volume plunged 16.3% to $11.49 billion in 703 deals, from $13.72 billion in 766 issues. Combined new money and refunding note volume fell to $47.5 million in 10 deals for the year, a decrease of 50.8% from $96.9 million in seven deals in 2015.
"More conservative budgetary assumptions are being incorporated into issuers' financial profiles and meaningful effort is being made to bolster reserve balances," Jeffrey Lipton, managing director and head of municipal research at Oppenheimer & Co., said in an interview explaining the decrease in note sales last year.
He said note issuance is typically cash-flow driven, and during periods of greater financial stress, short-term cash flow borrowings tend to rise as budgetary flexibility and the ability to manage interim shortfalls become limited.
Last year, however, continued austerity at state and local governments stunted the growth of short-term notes.
"It clearly reduced the amount of notes being sold," said Phil Fischer, head of municipal bond research at Bank of America Merrill Lynch. "On the one hand, having fewer notes outstanding is a reflection of generally enhanced credit quality." On the other hand it limits investors' availability, he said.
The biggest drop in the supply of notes from a year earlier was in September, when volume fell by 38.8% to $2.87 billion in 225 deals, from $4.70 billion in 251 deals in the same month in 2015.
July's decline of 32.8% to $4.70 billion among 250 offerings, from $7 billion in the previous year in 305 deals, was a direct result of the reduction or absence of many big note deals by large states, which enjoyed better fiscal health as a result of austerity measures since the financial crisis, experts said.
"Coming out of the great recession, the volume of notes needed decreased" to approximately half of the $60 billion the short-term note market issued in 2007 and 2008, Fischer said.
"We used to have big issues from California and Texas, but they have been scaled way back because the states didn't need the money," he said.
After issuing tax and revenue anticipation notes, TRANs, annually for nearly three decades, Texas' strong fiscal management, conservative budgeting, diverse economy, and fund balances have allowed the state to forgo issuing short-term note obligations in both fiscal 2016 and fiscal 2017, which begin on Sept. 1, according to the comptroller's office.
"A number of issuers that perhaps needed to access the note market over the past two years are in better credit shape and are not necessarily pressed to pursue cash flow financing," Lipton added.
In addition, overall note volume declined while long-term rates remained relatively low ahead of the Federal Reserve Board's decision on Dec. 14 to begin its tightening cycle and raise the fed funds rate by 25 basis points to between 0.50% and 0.75%.
Public facilities fell by 64.9% to $124.8 million in 74 issues, from $355.1 million in 64 deals, Environmental facilities' issuance dropped 52.1% to $3.5 million in just two deals, from $7.3 million in three deals the previous year.
Electric power note issuance fizzled by 44.7%, decreasing to $412.4 million in 15 deals, from $746.2 million in 16 deals.
Fischer said note issuance is most frequently used by cities and school districts for education and general purpose financing.
Despite the market's overall credit strength and austerity, the education sector's issuance still grew by 17.7% to $11.3 billion in 732 deals, from $9.62 billion in 725 deals in all of 2015. Colleges and universities' sales increased 136.9% to $1.56 billion in 13 deals, up from $662.2 million in six deals.
"We kind of reached homeostasis with note issuance," Fischer said. "The wild card is simply the degree of the shift in money market funds, which occurred because of the new federal rules" that became effective in late 2016, and how that will affect the ability of the states and local issuers to finance notes going forward.
The impact of a further reduction in note volume could be seen as early as the spring note season, according to Fischer. "If we see a big drop in June, that would suggest state and local governments' migration to private placements with banks" as opposed to issuing the traditional one-year note instruments in the municipal market, he said.
Lipton said both changing financial market and political climates could spark some growth in the note sector.
"As interest rates rise and the uncertainty of a national fiscal policy agenda could possibly weigh on state and local credit, we could see an increase in short-term, cash-flow borrowings," Lipton said.
