The article below is reprinted with permission from The Capital Issue, a quarterly newsletter published by Lancaster Pollard.
For healthcare providers issuing debt, 2012 was a banner year. Despite increased municipal bond issuance, rates remained at historically low levels as demand exceeded supply for much of the year.
What were the drivers of the robust 2012 market for issuers? Can these factors continue in 2013 keeping interest rates low while increasing bond volume?
The 2012 municipal bond market rebounded from the previous year's total bond sales, which were at the lowest levels in a decade. According to The Bond Buyer's annual offering data, total U.S. bond sales were up 30.1 percent in 2012.
This year-over-year annual increase was the largest since 2001 when volume was up 43.3 percent compared to 2000. Last year's total bond sales of $374 billion were only slightly less than the 10-year average of $386 billion, meaning the market has begun to return to normal issuance levels as the U.S. economy continues to recover.
Despite the increased volume, rates steadily declined throughout the year as intermediate and long-term rates fell to 2012 lows in November, which were the lowest levels since 1965. A December sell-off followed as concerns with the impending fiscal cliff came to the forefront. These worries combined with additional year-end supply entering the market, investors taking year-end profit and mounting apprehension regarding the future of tax exemption for municipal securities has driven interest rates slightly higher.
As a result of the low interest rates, there was a surge in volume as borrowers sought to refund existing indebtedness and lock-in debt service savings. The sharp increase in refunding volume drove overall volume higher, as the volume of refunding offerings was the highest seen in the past 10 years both in terms of total volume ($156 billion) and percentage of total sales (38 percent).
Lastly, given that municipal bonds are typically issued with 10-year call provisions, annual bonds sales generally follow 10-year cycles as issues that become callable are refinanced. Therefore, refunding volume was further driven higher in 2012 as 2002 issues, a high volume year for the bond market, first became callable.
According to Thomas Woolsey, senior vice president and director of trading at Lancaster Pollard, it was the combination of low interest rates, the plethora of cash held by institutional fund investors and the increase in refunding activity that caused what many deemed to be a "positive perfect storm." This unusual mixture of circumstances significantly increased investor appetite resulting in a scarcity of available bond product. Due to this chain of events, many senior living and healthcare providers were able to close on financings at rate levels previously unimaginable.
"Most deals brought to market in 2012 were well received," said Mr. Woolsey. "One specific example is a Baa2-rated hospital brought to market in the fall of 2012. Due to high levels of interest from investors and the compressed credit spreads, the hospital’s bonds were multiple times oversubscribed. And as a result, marketing interest yield levels were driven even lower, culminating in remarkable rate execution for a medium-grade-credit hospital."
Conversely, there are also several factors that could push rates lower:
Most analysts predict a slight increase in municipal bond interest rates during 2013. Volume predictions are mixed, but the majority expects volume to remain close to 2012 levels. According to Wells Fargo's 2013 Municipal Market Outlook, 2013 volume will mirror 2012 levels, but could be slightly smaller ─ around $340 billion ─ given the political uncertainty around the tax exempt status of municipal bonds and the potential for a recession.
An expected decrease in refundings would also hamper 2013 overall volume potential. Looking at volume levels 10 years previously as an indication, 2003 also was a high-volume year. This is an indication that there will be lots of new callable debt in 2013. However, any increase in interest rates will negatively impact the financial viability of a refunding offering.
That being said, volume levels could quickly increase should there be any impactful legislative changes. As has been demonstrated with past legislative changes, market volume often increases in advance of implementation of law changes. A change in tax-exempt status of municipal debt is just one example of a legislative change that could drastically impact bond volume in 2013.
Kevin Laidlaw is an assistant vice president at Lancaster Pollard in Columbus. He may be reached at klaidlaw@lancasterpollard.com.
For healthcare providers issuing debt, 2012 was a banner year. Despite increased municipal bond issuance, rates remained at historically low levels as demand exceeded supply for much of the year.
What were the drivers of the robust 2012 market for issuers? Can these factors continue in 2013 keeping interest rates low while increasing bond volume?
Where we've been
"The past is never dead. It's not even past." ─William FaulknerThe 2012 municipal bond market rebounded from the previous year's total bond sales, which were at the lowest levels in a decade. According to The Bond Buyer's annual offering data, total U.S. bond sales were up 30.1 percent in 2012.
This year-over-year annual increase was the largest since 2001 when volume was up 43.3 percent compared to 2000. Last year's total bond sales of $374 billion were only slightly less than the 10-year average of $386 billion, meaning the market has begun to return to normal issuance levels as the U.S. economy continues to recover.
Despite the increased volume, rates steadily declined throughout the year as intermediate and long-term rates fell to 2012 lows in November, which were the lowest levels since 1965. A December sell-off followed as concerns with the impending fiscal cliff came to the forefront. These worries combined with additional year-end supply entering the market, investors taking year-end profit and mounting apprehension regarding the future of tax exemption for municipal securities has driven interest rates slightly higher.
Why we went there
The first major factor in the increased bonds sales during 2012 was the historically low interest rates. The Federal Reserve Board's ongoing quantitative easing and investors seeking safe, income-driven assets in amidst of uncertainty resulted in yields reaching new lows as short-term rates remained near zero.As a result of the low interest rates, there was a surge in volume as borrowers sought to refund existing indebtedness and lock-in debt service savings. The sharp increase in refunding volume drove overall volume higher, as the volume of refunding offerings was the highest seen in the past 10 years both in terms of total volume ($156 billion) and percentage of total sales (38 percent).
Lastly, given that municipal bonds are typically issued with 10-year call provisions, annual bonds sales generally follow 10-year cycles as issues that become callable are refinanced. Therefore, refunding volume was further driven higher in 2012 as 2002 issues, a high volume year for the bond market, first became callable.
According to Thomas Woolsey, senior vice president and director of trading at Lancaster Pollard, it was the combination of low interest rates, the plethora of cash held by institutional fund investors and the increase in refunding activity that caused what many deemed to be a "positive perfect storm." This unusual mixture of circumstances significantly increased investor appetite resulting in a scarcity of available bond product. Due to this chain of events, many senior living and healthcare providers were able to close on financings at rate levels previously unimaginable.
"Most deals brought to market in 2012 were well received," said Mr. Woolsey. "One specific example is a Baa2-rated hospital brought to market in the fall of 2012. Due to high levels of interest from investors and the compressed credit spreads, the hospital’s bonds were multiple times oversubscribed. And as a result, marketing interest yield levels were driven even lower, culminating in remarkable rate execution for a medium-grade-credit hospital."
Investor viewpoint
Issuers were not the only ones to have a positive take on the 2012 municipal bond market. The continued drop in rates was also beneficial to investors already owning bonds as the decreasing yields resulted in increased prices. Therefore, the Standard & Poor's National AMT-Free Municipal Bond Index returned 18.4 percent for bond investors in 2012.Factors in play in 2013
Looking to 2013, many analysts expect another year of low muni yields as the Federal Reserve Board continues its bond buying program. However, there are several items to monitor in 2013, both economic and political, which could have a large impact on the bond market. Factors that could push municipal bond interest rates higher include:- Recovering economy and inflation fears ─ Bloomberg's quarterly investor poll from late November 2012 showed the most optimistic view of the global economy in nearly two years.
- Tax reform ─ Currently, there are several proposals that would affect municipal bonds, including the elimination of the tax exemption, replacing the tax exemption with a federal subsidy and capping deductions based on a dollar amount or percentage. Implementation of any of these proposals or even the continued threat of any of these proposals could decrease the demand for tax-exempt bonds and drive interest rates higher.
- Medicaid and Medicare reimbursement cuts ─ Reimbursement uncertainty would increase the perceived risk of bonds issued by healthcare and senior living providers, pushing interest rates higher. For example, Moody's Investors Service has issued a negative financial outlook for the nation’s nonprofit hospitals citing the lasting impact of the recession on patient volumes and a challenging reimbursement environment.
Conversely, there are also several factors that could push rates lower:
- Threat of sequestration ─ Signs of political uncertainty could push investors to again seek safety in the form of U.S. Treasuries, dragging other bond rates lower.
- The Fed’s commitment to buy long-term Treasuries ─ The Fed has committed to keeping rates low until 6.5 percent unemployment rate is achieved.
- The European debt crisis ─ Perceived weakness in Europe would lead to an inflow of cash into the U.S. market, resulting in increased demand and lower interest rates.
What's the verdict?
"The best thing about the future is that it comes one day at a time." ─ Abraham LincolnMost analysts predict a slight increase in municipal bond interest rates during 2013. Volume predictions are mixed, but the majority expects volume to remain close to 2012 levels. According to Wells Fargo's 2013 Municipal Market Outlook, 2013 volume will mirror 2012 levels, but could be slightly smaller ─ around $340 billion ─ given the political uncertainty around the tax exempt status of municipal bonds and the potential for a recession.
An expected decrease in refundings would also hamper 2013 overall volume potential. Looking at volume levels 10 years previously as an indication, 2003 also was a high-volume year. This is an indication that there will be lots of new callable debt in 2013. However, any increase in interest rates will negatively impact the financial viability of a refunding offering.
That being said, volume levels could quickly increase should there be any impactful legislative changes. As has been demonstrated with past legislative changes, market volume often increases in advance of implementation of law changes. A change in tax-exempt status of municipal debt is just one example of a legislative change that could drastically impact bond volume in 2013.
Kevin Laidlaw is an assistant vice president at Lancaster Pollard in Columbus. He may be reached at klaidlaw@lancasterpollard.com.
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