Why short-term notes fell in the first half

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The decreasing need for temporary cash flow among state and local municipalities prompted a 23.7% decline in the volume of short term notes in the first half, according to municipal analysts.

Total volume between January and June fell to $15.95 billion among 1,029 issues down from $20.92 billion among 1,112 deals in 2017, according to new data provided by Thomson Reuters.

“One can correlate short-term financing with general economic behavior,” Phil Fischer, head of municipal research at Bank of America Merrill Lynch said. “Positive economic growth should induce lower short-term financing.”

Municipal notes are short-term, fixed-rate, tax-exempt debt securities that typically mature in 12 months, and are issued to raise capital in anticipation of tax receipts, revenue, or proceeds from a bond issue. Three types of municipal notes are bond anticipation notes, tax anticipation notes, and revenue anticipation notes.

“There is a fundamental economic reason for short-term notes,” Fischer explained, noting that the securities allow municipalities to smooth out cash flows before tax revenues are received at certain times of the year.

However, municipalities had less need for borrowing to bridge any gaps in cash flow during the first half of 2018 -- and therefore curtailed their issuance of short-term notes, Fischer and Yingchen Li, senior municipal analyst at BAML said in an interview.

For example, revenue issuance -- which was already under $1 billion -- fell by 76.8% to $750.2 million in 23 issues, compared with $3.23 billion among 28 issues in the prior first half, the data showed.

General obligation bonds declined by 14% to $15.20 billion among 1,006 deals, versus $17.68 billion among 1,084 issues.

Some individual sectors experienced severe declines in issuance, the data showed.

For example, issuance of short term notes by colleges and universities fell to zero in the first half, compared with $80 million in two issues previously.

Meanwhile, there was a 92.3% decline among state agencies to $219.5 million in 10 issues, down from $2.862 billion among 24 issues.

The utilities sector experienced the largest decrease in short-term note issuance as it fell 89.2% to $377.9 million in 44 issues, compared with $3.5 billion among 65 issues in 2017’s first half.

Transportation, meanwhile, fell 79.8% to $481.9 million among 40 issues, down from $2.389 billion in 40 issues the prior year.

Issuance also fell among local authorities, which issued 67.6% less at $719.9 million in 35 issues, from $2.223 billion among 42 deals.

From January to June, municipalities issued the least amount of notes in May, when issuance dropped by 46.6% to $2.142 billion among 193 issues, compared with $4.009 billion in 174 issues in the first half of 2017.

By contrast, February saw a modest 18.3% increase in issuance as notes grew to $2.196 billion among 110 issues, versus $1.857 billion among 137 issues in 2017’s first quarter.

Issuance fell 30.2% to $10.01 billion among 666 issues in the second quarter, and only 9.7% in the first half to $14.337 billion among 700 issues.

Only few sectors saw growth of short-term note issues in the first half.

Electric power and environmental facilities increased 58.1% and 25.7%, respectively. Electric power grew to $23.4 million among nine issues, up from $14.8 million among six issues, while environmental facilities grew to $4.4 million in a single deal, up from $3.5 million in three issues.

State governments grew by 99.2% to $2.199 billion among eight issues, compared with $1.104 billion in six issues.

Fischer said decreasing short-term issuance has two impacts for the market.

On one hand, he said, fewer short-term instruments increases the demand for synthetic paper, such as variable-rate demand notes, but, on the other hand, it demonstrates continued credit strength on the part of the municipalities.

Meanwhile, although tax reform didn’t have a direct impact on the short-term note market, the presence of it caused some residual effects, the analysts noted.

“Last year the economy was not very different from the past few years,” Li said. “But, this year fiscal policy kicked in following tax reform.”

“While the change in tax rates after tax reform has not affected the demand for short-term notes, the quantity fell as the macro effects of the tax reform act accelerated borrowers’ economic activity and caused states to be less dependent on borrowing to smooth out cash flows,” Fischer said.

Fischer noted that this year’s $15.9 billion is a far cry from nearly a decade ago when the note volume hovered between $50 billion and $60 billion in an era of increased borrowing needs and times of less economic buoyancy.

By contrast, the analysts said short-term note issuance has been trending down in recent years amid continued austerity, as well as an improving economic outlook and better revenue expectations among municipalities.

“Our economists are looking for strong economic activity this year and we are anticipating a continuation of this trend,” Fischer said, noting expectations of increased cash at the federal and state level supported by gross domestic product of 3%.

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