Note volume declines in the midst of pandemic

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The total volume of short-term notes dropped by 12.5% in the first half of 2020 with the COVID-19 pandemic to blame for the overall decrease as heightened uncertainty caused the postponement of many deals.

The volume of one-year securities decreased to $17.9 billion among 1,037 issues, down from $20.45 billion issues in 1,093 deals in the first half of 2019, according to new data from Refinitiv.

When the pandemic hit in March, many deals were postponed or pulled altogether, which resulted in less volume than the prior first half, municipal analysts noted.

“I think that thematically we know volume was down considerably and these declines are atypical because of COVID and the economic suspension,” Jeffrey Lipton, head of municipal credit and market strategy and municipal capital markets at Oppenheimer & Co. said.

He said the global pandemic threw the municipal market a curveball in the first half, but after a few ailing months, the market prevailed and ended up outperforming before the second half.

“Coming into 2020, muni issuers were poised to craft their note schedules more around conventional cash-flow borrowing needs with less of a focus on Fed action and the interest rate outlook given expectations of stable monetary policy throughout 2020,” he said.

Following the infusion of heavy doses of liquidity from the global Central banking community in 2019, Lipton said the market was inclined to believe that 2020 would reveal more muted accommodation without a return to zero interest rates.

“In fact, we were thinking that if we saw a bottoming in the global economy with a less-synchronized slowdown, then there may have been room for bond yields to touch higher levels,” Lipton added.

However, the COVID-19 pandemic began to impact note sales as early as the first quarter when issuers started to get more concerned over COVID and its transmission rates, he said.

January note issuance fell 42% to $1.92 billion in 138 deals, from $3.31 billion among 140 deals in the first half of 2019, according to the data.

“The steep decline in January volume year over year supports our premise of a more stable rate environment as well as the presence of stronger municipal budgetary operations against a backdrop of fiscal austerity and a firm national economic profile during a late cycle recovery, despite slower growth performance,” Lipton said.

That was followed by a 12.2% increase in note issuance in February as the market prepared for the impacts of COVID-19, he said.

“February’s year-over-year increase was likely attributable to specific short-term funding needs and growing issuer concern over emerging COVID-19 infection rates and an uncertain economic impact, with a desire to improve liquidity should the markets seize up in a worst case scenario,” Lipton said.

February’s issuance grew to $1.77 billion in 119 deals, versus $1.58 billion among 122 over the first six months of the prior year, the data showed.

In March — when the global pandemic grew to epic proportions — issuance dropped 12.1% to $1.33 billion among 98, down from $1.51 billion in 113 deals in the prior first half.

However, while note issuance was dropping, investors were finding value in the short end of the yield curve, Lipton noted.

“As note issuance dropped heavily with the March sell-off when mutual fund complexes were struggling to meet redemption needs, giving rise to outsized bid lists and virtually no price discovery, market participants focused on outstanding short tenors at attractive levels in April,” Lipton said.

He said this was due to the Federal Reserve’s newly crafted liquidity facilities and swelling credit concerns, which resulted in outperformance along the short end of the curve.

Back to issuance, the largest monthly decrease came in April — a month after COVID paused life around the world and the global economy — as volume fell to $1.82 billion in 160 deals, compared with $3.26 billion among 152 deals in the first six months of 2019.

Issuance continued to fall in May as note deals dropped by 8.6% to $1.94 billion among 189 deals, versus $2.12 billion in 198 deals the prior first half.

“March through May note volume declines reflect the effects of extreme market disruption, growing credit concerns across virtually all sectors of the muni asset class, and interventionist moves by the Fed and Congress,” Lipton said.

Following more than three months of declines, note issuance began to inch up in June, when issuance grew 5.2% to $9.11 billion in 333 deals, compared with $8.66 billion of issuance in 368 deals in the prior first half.

“Overall new-issue supply initially narrowed considerably with the economic suspension, yet with the swift implementation of monetary and fiscal measures, reinvestment demand grew strong, fund flows turned positive, weekly calendars became elevated, and munis outperformed,” Lipton said.

Despite the overall decline in note volume, some individual sectors thrived during the pandemic, as cash-flow needs became crucial during the economic disruption, analysts said.

Some of the sector increases were likely due to municipalities’ budgets being under pressure and the need for cash in light of the economic impact of the pandemic, according to Anthony Valeri, director of investment management at Zions Bancorp.

“I think many states passed budgets with the anticipation of receiving additional federal aid, so the note funding was simply tiding them over until the next round of stimulus is passed and ultimately delivered,” Valeri said.

That was most likely the case with sectors, like healthcare, which boasted a significant increase in note issuance over the period as the nation battled the impacts of the COVID-19 pandemic.

Though the amount of deals dropped to just two, issuance in the healthcare sector grew by 444% to $167 million, up from just $30.7 million in four deals in the prior first half of 2019.

Other sectors saw noticeable increases as well, such as development, which rose 77.6%. However issuance peaked at just $146 million among 12 deals, from $82.2% among 13 deals in the previous first half.

Public facilities also increased to $101.8 million in 34 deals, from $70.1 million among 27 deals the prior period.

But, Lipton pointed out that even though note volume going forward in the remainder of 2020 is likely to rise among larger states, like New York, New Jersey, Massachusetts, and Connecticut, that might not necessarily mean a larger number of issuers.

“For a number of issuers, there may be less motivation to convert to long-term fixed-rate structures given relative comfort that borrowing costs may be lower upon note retirement/renewal, while others may continue the current trend and pursue the long-term deals out of concern over potential extension risk,” he said.

“While the vast majority of the note sector is comprised of bond anticipation notes, we anticipate that cash flow structures, as opposed to BANs, will see higher issuance volumes,” Lipton said.

“The dynamics of note issuance may also be impacted by the utilization of the Fed’s Municipal Liquidity facility — which is scheduled to terminate in December — particularly since we do not know how active it will be,” Lipton added.

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