A 10-year low of new municipal bond issuance is what was on everyone’s mind in 2011.
Last year, only $295 billion of tax-exempt bonds were issued, down almost 32% from 2010 when $433 billion was issued. It was the lowest amount of issuance since 2001.
“It looks like we may be in a new age of austerity for state and local governments in terms of taking on new debt and funding new projects,” said Rob Williams, director of fixed income and income planning at Charles Schwab. “We saw the impact of that in 2011 driving volume issuance down.”
“The returns in munis have beaten just about every other fixed-income sector other than Treasuries, and that’s counter to what many would have expected going into the year,” Williams said. “Lower defaults and falling Treasury yields played a part, but the supply equation has been a factor also.”
And supply was down in each quarter. In the first quarter of 2011, only $47.9 billion of bonds were issued, down over 54% from the first quarter of 2010, when $104.4 billion was issued. In the second quarter, $70.8 billion was issued, down 30% from the second quarter of 2010, when $100 billion was issued.
In the second half, the numbers looked a little better. In the third quarter, issuance was down only 19.3% to $76.3 billion from the $94.5 billion that was issued in the third quarter of 2010. And in the fourth quarter, issuance was down only 25.3% to $100 billion, down from the $133.9 billion issued in the fourth quarter of 2010.
“There were almost two different markets this year,” Williams said. “The first half was concern and stress and munis got attention for potential defaults. The first and second quarter also saw a sharp drop in issuance because many issuers came to market at the end of 2010 to take advantage of the last few months of the Build America Bonds program.”
“By the third quarter, things started to turn,” he said. “Treasuries improved as the economy looked weaker and those who had waited in 2010 to start activity came in the third quarter. And by the end of the year, muni returns ended up quite strong.”
Others agree. “It was really a gift in the first part of 2011 that everything was so cheap,” said Patrick Smith, chief executive of Granite Springs Asset Management. “When the primary is cheap, we participate. And when it is priced to perfection, we look for something in the secondary.” The lack of new issuance helped the secondary stay supported through the rest of the year, he said.
Negotiated issuance suffered the most, with $227.6 billion coming to market in 2011, down more than 36% from 2010’s $357.3 billion. Competitive issuance was only down 18.5%, to $39.6 billion from $73.2 billion issued in 2010.
New York, California, and Texas maintained their positions from last year as the three states that had the most issuance.
Borrowers in New York issued $39.3 billion in 2011, down only 3.2% from more than $40 billion that was issued last year. Issuers in California came to market with $37.4 billion, down only 39% from last year’s $61 billion. Issuance in Texas was down more than 37%, to $23.2 billion from $37 billion.
In December, three of the biggest deals were over $1 billion, and the top five were over $650 million.
The largest issue was a $3.3 billion general purpose deal from the Michigan Finance Authority.
Puerto Rico snagged the next two spots for largest issuers in December, with $1.8 billion coming from the Puerto Rico Government Development Bank and $1 billion coming from the Puerto Rico Sales Tax Finance Corp.
Rounding out the top five was a $702 million deal from New York’s Empire State Development Corp. and $672.5 million issue from the New York Liberty Development Corp.
Partly due to the Federal Reserve’s Operation Twist, which pushed yields to record lows, half of the deals in December were refundings. As a result, refunding issuance for the year was down only 7.4% from 2010, while new-money issuance was down more than 36% from last year.
“Volume for refundings was relatively stable,” Williams said. “A lot of the 2011 issuance has been refunding activity, which has led investors to go back out and reinvest in new bonds. That has been a theme in 2011, with less issuance for new projects.”
Issuance for the biggest sectors of borrowers was down between 20% and 50% for 2011 when compared to 2010.
General-purpose debt, the largest sector, was down 29%, to $85.2 billion from $119.4 billion last year. Education, the second-largest sector, saw volume decline 25.3%, to $75.3 billion. Transportation, the third-biggest sector, was down 51% to $32.8 billion in 2011, down from $67 billion in 2010. Utilities and health care were down 29% and 20%, respectively.
“There is the same belt-tightening across the board,” Williams said. “No one is immune. They are all recovering from a pretty deep recession and no one is eager to go out and put pressure on revenue streams when the pace of recovery is not what many expected it would be at this point after a recession.”
Williams expects the attitude of fiscal austerity to continue into 2012. “There is enough uncertainty that most governments will be cautious,” he said.
“GO and revenue debt is getting more expensive because demand on the retail side for higher-quality debt has been strong,” he said. “So we see more money moving into the single-A category instead of the triple-A space looking for yield.” Williams said he is also pointing towards the middle part of the curve in the five-year to 15-year range.
From the buy-side perspective, Smith of Granite Springs said that in the secondary market, “no one was giving anything away,” and the only way to add value is to “go off the beaten path and look at credits that actually require you to do some research.”
Smith expects that trend to continue in 2012. “Most of my clients are high-net-worth and they are suffering from financial repression,” he said. “The bonds that I bought in the span of the last decade are rolling off and I can’t replace that 5% coupon they have gotten used to. We will strike a balance between duration risk and credit risk and evaluate credits on a case-by-case basis.”
For extra yield, Smith said he will look down the credit scale a little — though still staying in the investment-grade range — and will look out to the seven- to 10-year range.
“Issuance is going to remain below the prior year’s average because there is so much fiscal distress,” he said. “No one is starting new projects if they really don’t need to. And that means another year of below-average new issuance in muni bonds.”
Taylor Riggs writes for The Bond Buyer.
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