Demand, low cost boosted notes in 2017

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Responding to the strong investor demand for short-term paper and their own need for low-cost financing against a backdrop of heavy market volatility and uncertainty last year, municipalities issued 30.3% more short-term note debt in 2017 than the prior year, according to annual figures from Thomson Reuters.

Short-term note issuance increased to $48.05 billion among 2,332 deals, versus $36.89 billion among 2,415 deals the prior year.

Although there were slightly fewer deals in all of 2017, the year-over-year volume indicated a strong need on both the buy-side and sell side of the municipal market, sources said.

“Overall last year we saw quite a pick up in the last quarter in overall issuance -- and perhaps there was a feeling among municipalities when looking at issuing longer-term structures versus shorter-term structures they felt there was a very good opportunity to enter the market before any dynamic changes occurred and the Fed got more aggressive with raising rates,” Dan Heckman, senior fixed income strategist at U.S. Bank Wealth Management, said in an interview.

In addition, he noted the strong investor appetite for variable-rate demand notes and other short-term paper throughout the year.

Others agreed that overall market conditions and municipalities’ financial issues led to the boost in note issuance in 2017.

“The year-over-year 30% rise in municipal note issuance was most likely influenced by Central Bank monetary policy -- and to a lesser extent more active cash flow needs brought about by a greater presence of budgetary stress,” said Jeffrey Lipton, head of municipal research and strategy at Oppenheimer & Co.

“Through much of the first half of the year, short-term rate expectations impacted note issuance patterns as issuers tried to incorporate potential rate hikes into their short-term debt strategy,” Lipton explained.

From January to June, the largest increase in note issuance occurred in May when $4 billion came to market in 174 financings, which was a 91.7% jump from the prior year which saw $2.09 billion of volume in 189 deals, according to the data.

“The almost doubling of May volume year over year took account of consensus expectations for another rate increase at the June FOMC meeting,” Lipton noted.

“Heavier second half year over year note issuance was also likely influenced by a more noticeable flattening of the muni yield curve, as well as by the uncertainties of looming tax reform,” he added.

In the second half, note issuance spiked by 143.8% in August to $9.55 billion in 248 deals, over 2016’s $3.91 billion in 232 deals. October also rose by a significant 136.5% to $5.07 billion in 207 deals, versus $2.14 billion in 168 deals previously.

“A similar pattern evolved throughout the second half of 2017 with well over 100% year over year note volume growth in August and October ahead of rate decisions in September and early November respectively,” Lipton explained. “Strong year over year November note issuance came ahead of the widely anticipated December rate hike,” he said.

November note issuance rose by 84.4% to $2.22 billion in 160 deals, compared with $1.20 billion in 180 deals in all of 2016.

Among the larger issuers, state governments saw the biggest increase, widening their issuance by 133.7% to $10.72 billion among 21 deals, compared to the prior $4.58 billion among 14 deals. They were followed by state agencies, which grew by 68.5% to $5.58 billion in 46 deals, over $3.31 billion in 34 deals previously.

Some of the growth by the issuers was a result of budgetary shortfalls, or other financial inefficiencies, experts said.

“State aid to many local governments has been cut back and a number of issuers are finding it more and more challenging to prioritize their expenditure needs, particularly in the areas of pension funding, public safety and social services,” Lipton said.

Meanwhile, sector issuance of notes more than doubled in some areas, like healthcare, electric power, and utilities.

Healthcare, for instance, rose by 339.7% to $679.8 million among 12 deals, after just nine deals the prior year totaling $154.6 million, while electric power increased by 219.6% to $1.31 billion among 12 deals, compared with $412.5 million among 15 deals the prior year.

Utilities also saw a noticeable increase with $5.17 billion among 131 deals, up from $2.02 billion in 122 deals -- an increase of 155% year over year.

Entities like utilities are sensitive to cost, while healthcare is under a lot of pressure due to declining reimbursements and the uncertainty surrounding Obamacare.

“They probably looked at [the note market] as a mechanism to do financing and do it at a low cost and low interest rate,” Heckman said.

“A lot of these entities are looking to bring costs down as much as possible,” he added.

Alternatively, some sectors did see a decrease in note issuance throughout the year, such as colleges and universities, housing, and direct issuers, but Heckman said that decline points to factors beyond the municipal market or monetary policy.

“I think there’s some trends with colleges where student population overall is flat to slightly declining, but that is more economic and demographic in nature,” he explained. For instance, job opportunities could be stealing enrollment numbers from colleges.

“If there is an opportunity to enter the workforce when jobs are plentiful, there could be a slight drop off in enrollment, and there is not as much need [for short-term issuance] from a growth standpoint in those sectors,” Heckman said.

Direct issuers also fell by 75% to $15.1 million among seven deals, down for $60.3 million in 16 deals in 2016, while the housing sector issued 47.4% less notes in all of 2017 with $36.4 million in five deals, down from $69.2 million in three deals the previous year.

However, despite a few outliers, overall, note issuance showed some of the most noticeable expansion in recent years last year, according to Heckman, who said there was consistently strong demand to meet that growing supply.

“We don’t see that subsiding in 2018,” he said. “We think demand for that type of structure is going to be in more demand.”

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