Yield Beating Risk Buoys First Revenue-Bond Issuer: Muni Credit
The city that sold the first U.S. revenue bonds more than a century ago is the latest issuer in the $3.7 trillion municipal market to gain from investor appetite for riskier debt.
Wheeling, West Virginia, a city of 28,355 residents 60 miles (97 kilometers) southwest of Pittsburgh, sold about $38 million of water- and sewer-revenue bonds this week, its biggest offer since at least 1990, data compiled by Bloomberg show. The city’s relative borrowing costs were 45 percent less than in 2010. The locality in 1885 was the first to issue bonds backed only by a project’s earnings, according to a study by Paul Maco, a partner at law firm Bracewell & Giuliani LLP in Washington.
Water and sewer bonds are the worst-performing revenue debt this year, returning 0.7 percent, compared with 1.1 percent for the entire municipal market, Barclays Plc data show. Yet Wheeling’s securities, with a Standard & Poor’s credit grade five steps below AAA, benefited from a rally that has pushed the yield penalty for similarly rated bonds to a five-year low.
“The sweet spot in the municipal market is between A and BBB rated municipal bonds,” said Robert DiMella, co-head of MacKay Municipal Managers, which oversees $7.6 billion of local debt in Princeton, New Jersey. “Spreads are going to continue coming down.”
With the Federal Reserve keeping its benchmark overnight lending rate near zero and extending a program of monthly bond purchases, yields on local debt are near generational lows. As a result, investors are buying lower-rated credits for the higher yields, helping localities recover from the recession that ended in 2009.
The extra yield investors demand to hold A rated utility bonds rather than top-rated issuers in that industry is 0.32 percentage point, the lowest since March 2008, Bloomberg data show.
“With rates where they are, we’re barely looking at AA and AAA names,” said Craig Pernick, a senior managing director at Bethesda, Maryland-based Chevy Chase Trust Co., which oversees about $1.3 billion in munis. “The high BBBs and the low single-As are where we’ve found a lot of value.”
The rally in lower-rated securities proved a boon to Wheeling in its sale. The offering, rated A by S&P, included six-year bonds that were priced to yield 1.63 percent, or about 0.56 percentage point more than benchmark munis.
Wheeling last sold bonds for its water system in April 2010, with six-year debt priced to yield 3.19 percent, or about 1.02 percentage points more than benchmark securities. The debt was specially qualified for bank buyers and was insured by Assured Guaranty Municipal Corp.
The city will use proceeds of this week’s sale to build a water-treatment plant, said city manager Robert Herron. Some of the city’s clay pipes, which also deliver water to surrounding cities, have stamps from 1889, he said. Herron said he’s been told the city was the first to issue municipal revenue bonds.
“This may be in today’s dollars the single largest public works this city has ever undertaken,” said Mayor Andy McKenzie. “Our existing water plant is about 85 years old and it has simply outlived its purposeful life.”
It wasn’t until 1950 that most states had legislation authorizing revenue-bond financing, according to Maco’s report.
“No financing structure has been of greater importance to growth of the U.S. municipal market than the revenue bond,” Maco wrote in his report, titled “Building a Strong Subnational Debt Market,” which was published in the Winter/Spring 2001 issue of the Richmond Journal of Global Law & Business.
Wheeling issued “the first ‘pure’ revenue bond” without general-obligation backing, he said.
Revenue debt accounts for the brunt of municipal issuance. Localities and their agencies sold about $273 billion of such bonds last year, compared with $155 billion of general obligations, Bloomberg data show.
Wheeling’s water system needs about $200 million of upgrades, McKenzie said.
The city isn’t alone in needing such work. Investment planned through 2020 in the U.S. on projects such as roads, bridges and schools will fall $1.6 trillion short of what’s sufficient to maintain the facilities, the American Society of Civil Engineers said in a March report. The group gave wastewater systems a “D” grade.
Wheeling sold before a drop in municipal issuance. The Los Angeles Department of Water & Power plans to sell $480 million next week in the slowest period for supply in about seven weeks. States and cities are set to issue just $4.6 billion of debt.
The ratio of the two interest rates, a gauge of relative value, is about 97 percent. It has risen from a two-month low reached this week. The higher the figure, the cheaper local bonds are when compared with federal securities. The ratio has averaged 92 percent since 2001.
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