Tax reform causes drop in 2018 first half volume

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Municipal bond volume is running 18.1% lower than last year’s historic level, in line with analyst expectations given the enormous impact the new tax legislation has had on the market.

Halfway through the year, total volume stands at $164.676 billion over 4,749 deals, compared with $200.992 billion in 5,871 transactions, according to data from Thomson Reuters. The monthly volume was down 40.3% in January, 23.6% lower in February, dropped 20.9% in March, climbed 2.2% in April, fell 9.7% in May, and was 16.1% lower in June.

Volume did, for the most part, continue to pick up and normalize with more distance from the commencement of the new tax laws. Issuance in January totaled $21.50 billion, then fell to $17.86 billion, rose to $26.02 billion, rising again to $31.37 billion, higher to $35.95 billion, dipping to $32.98 billion and ending with $25.31 billion.

Volume for the first half of this year dropped to $164.68 billion, compared to $200.99 billion the year before. First quarter volume was down to $65.38 billion from $92.27 billion and second quarter issuance was lower to $99.29 billion from $108.72 billion.

“The Tax Cut legislation has directed issuance for the first half of 2018 and it is likely to influence bond activity for the second half of 2018 as well,” said Tom Kozlik, managing director and municipal strategist at PNC Capital Markets. “But I think questions about the economy, policy uncertainty and deteriorating credit quality are likely to keep issuance from jumping significantly for the rest of the year.”

At the end of 2017, he forecast total issuance for 2018 at $295 billion, a “significant departure from $436 billion in 2017 and $444 billion in 2016, but there are some significant factors that are influencing it.”

Tax reform aside, Kozlik said that he has been “pleasantly surprised” with the level of new money that has come in 2018 versus not only his initial forecast, but relatively to what we have seen over the last several years.

“This activity to be indicating to us that some issuers in the municipal bond market are ready to utilize interested rates that, although are rising, are still near generational lows,” he said. “It could also be indicating that the credit landscape may better improving for at least some of the market.”

New-money is up 4.2% to $6.09 billion in 460 deals, compared to $5.84 billion in 505 issues.

Peter Block, managing director or credit and market strategy at Ramirez and Co., said that total fixed-rate gross supply of $180 billion in 2018 is “only” 15-17% behind 2017, which is surprising to the upside due primarily to the higher than projected new money component of $107 billion as of July 27 at 60% of total year to date.

“The new money in 2018 is also 62% of 2017’s total new money of $172 billon,” he said. “New money is likely higher versus original projections due to the total gross number and still negative net supply amidst high demand, particularly in still high-tax states such as Calif., New York, Illinois, etc.”

He added that this very strong demand for tax-exempt income has had the effect of compressing spreads, thereby helping borrowers offset year to date muni yield scale rate increases, making borrowing costs overall similar to 2017 levels.

“While we are still calling for full year gross at negative 27% year-over-year or roughly $317 billion, which implies a $22 billion monthly average, it is probable that we make an adjustment towards end of summer provided the phenomenon just discussed persists.”

Kozlik agreed, saying that If we took an average of second half issuance from 2009 to 2016 (not including 2017) and reduce that by 20%, we get a total of $152 billion.

“That means issuance would come in at a total of $317 billion ($165 billion plus $152 billion) for the year,” he said. “But even if we annualize first half 2018 numbers we still only get to about $330 billion.”

Kozlik said that although interest rates remain relatively low (but are on the rise), if anything there is more economic uncertainty now because of the questions about the negative impact the Tax Cut and tariffs could have.

“Some state and local governments are battling the crowding out impact from pensions, or are just generally seeing their credit deteriorate and do not want to add more liabilities to their balance sheet,” he said.

Kozlik said the big take-way is that issuance is still significantly down from last year.

“The total for 2018 could be the lowest since Build America Bonds accelerated issuance into the end of 2010 and cut 2011 issuance to only $288 billion,” he said. “I am not one that is seeing anything that leads me to think that there is swarm of municipal issuance waiting for the second half.”

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