Long-term municipal bond issuance was down eight percent for the first ten months of the year, according to Thomson Reuters data, which appeared in The Bond Buyer. October 2008 was a particularly bleak period for new issuance, which declined by 57 percent from the same month just one year ago.
But the tides may be turning … Over the past few weeks, activity is once again picking up, as many issuers are willing to “test the waters,” says Jacob Sorensen, a municipal bond underwriter with Raymond James.
Just-released November data shows a 22 percent decline in new issue volume compared to 2007 – certainly an improvement compared to October’s percentage loss.
The slowdown in new offerings began earlier in the year, with the collapse of the bond insurance companies, and became more pronounced with the troubles plaguing the larger investment firms and overall deterioration of the economy, he explains.
Because of uncertainty in the markets, many deals were put on the shelf. Now, however, more issuers appear to be willing to see if they can complete their offerings at decent levels.
The municipal bond calendar has shown a significant shift to an increase in the number of negotiated versus competitive deals – not surprising in the face of today’s challenging market conditions.
Michael Ross, CFA, Senior Municipal Desk Analyst with Morgan Keegan & Co., notes that this shift has been relatively recent, prompted by liquidity problems that arose as a result of increased selling pressures in the marketplace.
The liquidity crisis spurred a flight to quality; as Treasury rates moved lower and spreads grew wider, investors pulled back from the municipal market. Even though municipal bonds are tax-exempt investments, when they began trading at higher yields than Treasuries, it forced their value down.
In The Fundamentals of Municipal Bonds (published by The Bond Market Association, which has since become part of the Securities Industry and Financial Markets Association), Judy Wesalo Temel explains that a negotiated sale provides “greater flexibility in structuring bonds and in reacting to the most current market conditions” than a competitive sale.
We are apt to see fewer competitive deals in this type of market environment, as Ross further clarifies, because they cannot be managed at the same level of detail as a negotiated deal. While there was a time when it was more cost-effective to complete an offering through a competitive underwriting, negotiated deals make more sense in today’s marketplace. The broker/dealer managing a negotiated sale can market the bonds and measure demand before the deal is priced, helping the issuer decide when the timing is right to bring the deal to market.
Overall, what conditions drive issuance? Timing, competition, and market conditions are all factors that issuers consider when bringing a deal to market, according to Sorensen. If the market environment takes a turn for the positive, evidenced by strong institutional investment activity, we will likely see more issuers wanting to get their deals placed and completed.
Certain deals are required to close by a specific date, often year-end. While the market typically sees a slowdown after Thanksgiving, this year could be different, as issuers attempt to complete deals that were put on hold – before the December 31 deadline arrives.
There is, of course, the risk that too many deals could overflow the market. “At some point, the market may be unable to take in any more deals,” Sorensen says. That could force issuers to price deals at higher coupon/yield levels in order to move them.