June is usually a busy period for municipal sales, but issuers floated only $30.5 billion of debt overall last month. That amount represents a 30.4% decline from the $43.9 billion issued in June 2009, according to preliminary data from Thomson Reuters.
Analysts said increased uncertainty in the municipal market, in combination with broader market volatility relating to the sovereign debt crises in Europe, was to blame for the light supply. Chris Mier, managing director at Loop Capital Markets, said risk aversion is on the rise in the municipal bond market.
“Uncertainty is the enemy of smooth, well-functioning markets, and there’s a lot of uncertainty going on right now,” Mier said. “Whether it was BABs or tax-exempts, it didn’t really matter. It was more related to the credit quality of the issuer itself. And clearly, your lower-rated states — California, Illinois, and two or three others of the lowest-rated states — are facing a less receptive market.”
Not a single sector issued more debt last month relative to June 2009. General purpose bonds declined the least with a 15.6% decrease to $11.1 billion, while declines in excess of 40% were seen in six sectors. Among them were development (-86.7%), environmental facilities (-73.8%), health care (-42.2%), housing (-66.1%), public facilities (-64.5%), and transportation (41.8%).
“Usually you don’t see that,” Mier said. “There’s no natural reason why issuers would be looking to issue less this June than in other June’s, so I think you have to assume that most of the weight relates from demand-side problems.”
Some of the shortfall in June volume may also be due to the low yields offered by municipal debt.
The yield on the triple-A general obligation 10-year muni bond was 2.79% early in the month, its lowest of the calendar year. As of Tuesday, the yield was little changed at 2.81%.
Phil Villaluz, municipal strategist at Advisors Asset Management, said investors balked at those yields, creating a tough environment for new issues.
At least two deals were postponed this week because of such problems. Illinois, which was scheduled to offer a $900 million BAB issuance yesterday, moved the issue to July 14. The Delaware River Port Authority also postponed a $320 million BAB issuance.
Conversely, a global flight to quality pushed the benchmark 10-year Treasury to less than 3% earlier this week. Despite the low yields among munis, by Treasury standards they’re actually at their most expensive in more than a year.
“As anyone pricing an issue lately has painfully seen, the municipal market has been extremely volatile,” Mier said, adding that weaker credits have seen rates gapping substantially.
The supply of traditional munis has been limited by a general trend among larger issuers to use Build America Bonds rather than tax-exempt debt.
Just $19.5 billion of tax-exempt debt entered the market last month, reflecting a 44.7% decrease compared to June 2009. From January to June, tax-exempt supply was reduced by 21.7%.
Taxable issuance, by contrast, increased by 26.2% to $10.6 billion in the month, while in the first half of the year it leapt by 152.4% to $63.3 billion.
However, Villaluz said comparisons to last year can be misleading because BABs were not sold until April 2009 and it was many months before the market became comfortable with them.
“This June you see a shift in the break-down between tax-exempts and BABs,” he said. “You’re seeing more acceptance in the market not only from the issuer side but from the investor side.”
Market participants said BAB volume could have been greater if it was clearer that the product would be extended beyond its current 2010 expiration date.
The issue of “offsets” — whereby the federal government may intercept subsidy payments if issuers have payments due under other federal programs — has dampened enthusiasm for the taxable product.
“Some issuers have chosen to forgo the benefits of BABs, if the savings versus a tax-exempt deal are modest, in order to avoid the uncertainty,” Mier said.
Still, market participants said the June figures do not alter their outlook for the remainder of the year.
If anything, the opposite may be true, according to Tom Kozlik, municipal strategist at Janney Capital Markets. He said the dearth of tax-exempt issuance in June could help increase appetite for those products the rest of this year, as might the popularity of BABs for the last nine to 12 months.
A broader look at market volume does not suggest major problems. In the first two quarters, new issuance totaled just over than $200 billion, a 1.8% advance over the first half of 2009.
“I think the muni market is still on track to be where most folks were expecting it to be — at or over that $400 billion mark by the end of the year,” said Kozlik.
Meanwhile, the bond insurance industry may be benefiting from the same market turmoil.
Assured Guaranty Ltd. — the only guarantor still writing new policies — backed 9.7% of new issuance in June, versus a year-to-date market share of 6.6% and a 2009 market share of 8.7%.
“There’s been a little bit of retail appetite for insurance and in certain cases the pricing is such that it can work for an A-rated issuer,” Mier said.
Bond insurance continues to be valuable, particularly in a climate where retail investors want to be sure they are holding quality assets, according to Kozlik.
“One of the big things that the insurance means is that there is another organization that has its skin in the game, that has reviewed the credit and gone into detail about what the risks are,” Kozlik said.
However, Villaluz said the recent decision to move municipal ratings to a global scale may dim the industry outlook. That move by Moody’s Investors Service and Fitch Ratings gave thousands of issuers a higher rating.
“You’ve had 90% or so of investment- grade ratings get shifted to double-A or better,” Villaluz said. “It makes for a tougher case for muni bond insurance.”