CHICAGO — The market for privately placed municipal debt came out of the shadows in 2011. While muni bond issuance in general fell, private placements surged last year, with issuance leaping 243%. But the sudden popularity might not last. The increase was driven by borrowers looking to refund letter-of-credit backed variable-rate debt, and as the number of expiring LOCs falls, so will the private placement market, according to some market participants.
Last year the overall volume of private placements rose to $9.49 billion with 396 issues compared to $2.76 billion and 239 issues in 2010, according to Thomson Reuters, which includes direct bank purchases in its data.
The firm gets its information from surveying placements agents and banks.
Private placements are transactions in which a borrower directly places a loan with investors or a bank, either with or without a placement agent.
The deals allow issuers to avoid risks associated with traditional variable-rate bonds, and with no underwriter or rating agency fees, they often cost less.
There are no disclosure requirements, an aspect that borrowers tend to like. But some have criticized such deals for their lack of transparency. Many issuers — especially larger entities with outstanding debt — are starting to voluntarily report the transactions.
Rating agencies have warned that rated issuers with outstanding bonds need to disclose the deals. At least one agency is now charging for the work of reviewing the deals’ covenants, with another reportedly considering it, though most of the issues themselves remain unrated.
Most deals are relatively short, with banks typically offering three-, five- or seven-year resets and a 10-year renewal. Maturities began to lengthen last year, however, as banks competed more for deals. Many borrowers are opting to leave long-term public debt outstanding and refund the earlier maturities with private placements.
Even with a 242% year-over-year increase, private placements remain a small piece of the overall market. The $9.5 billion placed in 2011 compares to negotiated sale volume of $225.6 billion and competitive sale volume of $59.5 billion.
Nevertheless, private placements rose across nearly all sectors while negotiated and competitive volumes fell. The development bond sector is the only one that saw a decline in transactions, with a 40% decrease in 2011 compared to 2010.
The education sector saw a 164% increase for a volume of $2.6 billion from $987 million the year before. Electric power private placements jumped 227%, general-purpose private placements rose 178%, and those for housing rose 246%.
Private placements of public facility bonds rose by 777% to $382 million in 2011 and those for transportation bonds increased by 236%. The utility sector saw a 952% increase, to $924 million in 33 deals compared to 2010.
The issuance of taxable bonds that were privately placed also grew, by 12% to $887 million inn 59 transactions, while taxable bonds sold through negotiation or competitively fell by around 80%.
The health care sector continues to see the largest volume of privately placed deals, $2.89 billion in 72 deals last year compared to $503 million in 19 deals in 2010 — a 475% jump.
Health care issuers are often more familiar with bank lenders than typical municipal issuers, in part because they typically have several bank facilities, like letters of credit, according to Pierre Bogacz, a managing director at Florida-based HFA Partners LLC, a health care financial advisory firm. “When banks really started to focus on deploying their balance sheets and started to offer these direct purchases, hospitals were higher on their calling list
than state or local governments,” he said.
Bogacz said about half his business last year was related to direct purchases, a jump that he thinks was common for many health care advisors last year.
The market became so popular in 2011 that for the first time, borrowers began asking banks about deals instead of vice versa, according to John Wooten, director and head of the municipal placements group at Wells Fargo Securities LLC.
Wells Fargo was one of the first banks to start offering direct placements as an alternative to LOC-backed variable-rate debt.
“Two years ago, we were presenting it, but no one was asking,” Wooten said. “Now it seems more people are cognizant of it.”
Despite its sudden popularity, the private placement market might not be built to last, Wooten and Bogacz agreed.
That’s because the sector last year worked through much of the low-hanging fruit — refinancings of variable-rate bonds backed by expiring letters of credit.
“The refinancing options are probably diminishing as LOCs are taken out,” Wooten said. When it comes to new-money issues, it could be too soon to tell how popular direct placements will become, he added.
Bogacz notes that in the health care sector, new-money issues have been on a slow decline since the peak of 2008, and that large projects with typical 30-year lives, like new patient centers, also remain on hold as providers grapple with fiscal uncertainty and the new federal health care law.
At the same time, banks that have aggressively gone after deals in 2010 and 2011 could start to suffer “indigestion” as their balance sheets fill up, Bogacz said.
“We view the current appetite of banks for these products to be just temporary, and a function of their inability to find other suitable borrowers and to be able to deploy their balance sheet,” Bogacz said.
“It’s still very competitive, but I think the banks are going to get indigestion and reach their exposure limits,” he said. “Six to 12 months from now, this product may be all but retired.”
© 2012 The Bond Buyer and SourceMedia Inc.
This material is intended for general information purposes only and does not constitute legal advice. For legal issues, readers should consult legal counsel. To discuss this article or municipal advisory services, email or call 888-699-4830. HFA Partners, LLC is an Independent Registered Municipal Advisor registered with the Securities and Exchange Commission (SEC) and the Municipal Securities Rulemaking Board (MSRB) under the Dodd-Frank Act of 2010.
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