Prices retreated in the face of new issuance yesterday as the recent heavy tone turned into tangible losses.
Municipals closed down 1/4 to 1/2 point on average, but more in spots amid steady bid-wanted flow, traders said.
Lesser high-grade yields rose five basis points, while gilt-edge high-grade yields were up only three basis points, thanks to aggressively bid triple-A new issues.
About $1.5 billion of debt was sold yesterday, with New York City offering the largest, a $775 million offering sold through negotiated sale. In addition to traditional plain vanilia general obligation debt, the city offering included $115 million of derivative products, $300 million of variable rate debt, and $70 of zero coupon bonds.
In the debt futures market, the September municipal contract settled down 18/32 to 101.13, pushing the MOB to another record low. The MOB spread widened to negative 461 from negative 450 Monday.
Traders said the market felt like it could achieve even lower prices, suffering from what many say is an annual July sell-off.
"It's the sequel to last summer's disaster when a flood of deals buried a fully invested market," said one trader.
True to former patterns, dealers stocked up on a massive amount of bonds in June in the belief that billions in July 1 bond calls and payments would give funds cash to fuel a big July rally. As a result, prices rose in June amid widespread bullishness.
But, to the Street's dismay, the follow-through cash failed to materialize after July 1 at the same time as issuers swamped the market with deals, eager to tap the low interest rates achieved in June.
The end result was a tortuous waiting period in early July as dealers clung to the hope that buyers would appear with full coffers, and then a sharp, painful downdraft in late July when the Street gave up hope amid a flood of deals and a dearth of buyers.
Looking ahead, buyers will likely be left with the upper hand, able to demand even more price concessions from the Street before participating in any new issues.
"It's greed, then fear," another trader said. "In June we ran it up and now everybody is afraid they'll lose everything they made this year."
Away from trading floors, many analysts and portfolio managers say investors are just suffering from sticker shock and call for a positive outlook for bonds in the long-term.
They said that strong Treasuries are buoying tax-exempts, inflation is low, and the economy is sputtering. All of this is bullish for bond prices, the analysts and portfolio managers noted.
But on the front lines, the tone was jittery and nervous yesterday anyway. The markets were suddenly forced to worry about things it had previously considered resolved in its favor.
Treasuries have recently been jumpy over bouncing commodities prices, thanks to massive flooding in the Midwest. New problems arose yesterday after Federal Reserve Board Chairman Alan Greenspan hinted at higher inflation and worried over the fate of the deficit reduction plan.
Government bonds dipped and later recovered on the news.
Municipal futures tried to recover, but were thrown back, while cash continued lower without looking back.
"We've seen weakness develop into some serious malaise," said one trader. "We've got some real deals here and people are very nervous about buying them at these levels. The buyers now have the upper hand and are going to let us hang out to dry."
The sour market conditions have resulted in the cancellation or postponement of some deals, easing supply pressure, but only by a minimal amount.
The Bond Buyer calculated 30-day visible supply at a still hefty $8.49 billion yesterday and secondary supply was also on the increase. The Blue List of secondary dealer inventory rose $80.3 million, to $1.87 billion, the highest since $1.93 billion on June 17.
N.Y.C. Offering
Topping the negotiated sector, a 29-member syndicate also led by First Boston Corp. as senior manager priced, restructured, and repriced $775 million New York City general obligation bonds.
A First Boston underwriter said the offering received a fair amount of institutional business, but demand was not robust. The maximum yield on the current coupon portion of the offering was 5.90%.
Some institutional investors said they shunned the deal because yields were rich compared to secondary market levels for outstanding New York City debt. Buyside sources said city long bonds recently traded at a 6% yield.
But other market players noted that the aggressive price was achieved because there were so many derivative products that fixed-rate bonds were in short supply.
At the repricing, the amount was boosted from $675 million originally scheduled for sale, in part to make room for additional derivative products and variable rate debt.
About $21 million of current interest bonds were added in a 2007 maturity, while yields were lowered by 10 basis points in 1995 and by five basis points in 1996.
Bonds were added to the shortend of the curve and cut from the longer end in order to meet state requirements concerning the 50% rule affecting how local issuers repay their debt.
Meanwhile, Prudential Securities was in the process of setting rates on about $70 million of zero coupon bonds, known as NYC BONDs, or mini-bonds, but details were unavailable late in the day. The bonds are tailored for retail investors.
The final reoffering of serial bonds included $258 million fixed-rate current interest bonds priced to yield from 3.75% in 1995 to 5.85% in 2010. A 2013 term was priced as 5.80s to yield 5.90%.
The bonds are rated Baal by Moody's Investors Service and A-minus by Standard & Poor's Corp. and Fitch Investors Service.
Also included in the city offering were $115 million of derivative securities.
First Boston structured $55 million of inverse-floating rate securities in the 2011, 2012 and 2014 maturities. The city entered an interest rate swap with Credit Suisse Financial Products, an affiliate of Credit Suisse carrying Aa2/AAA ratings, to lock in synthetic fixed-rates of 5.75% to 5.80%.
The derivatives were priced 10 to 15 basis points below the rates the city would have received on similar fixed-rate bonds, a First Boston official said.
For the first time, city officials allowed First Boston to customize terms of derivatives, the official said. The inverse floaters in the 2012 and 2014 maturities were leveraged to pay investors 1.5% more interest for every 1% drop in market rates. Investors would also receive 1.5% less interest for every 1% rise in market rates.
Lehman Brothers, a co-senior manager in the city syndicate, structured $60 million in the 2008, 2009, 2010, 2013 and 2015 maturities as RIBs/SAVRS, comprised of auction-set floating rate securities and inverse floating rate securities. The securities were 1 0 basis points below the rate the city would have paid on fixed-rate bonds, a Lehman official said.
City officials said the final pricing of the transaction demonstrated the virtues of the negotiated bond sale, as opposed to a competitive sale of debt.
The deal, for example, was restructured late Monday, to reflect addition demand for derivative products and to allow the city to increase the amount of variable rate debt for sale.
The city, for example, increased the amount of derivatives to $115 million from $100 million.
In addition, city officials say that because of investor demand they increased the amount of variable rate debt yesterday to $300 million from their initial proposal of $200 million.
All told, seven banks provided letters of credit for the deal's $305 million variable rate portion. These securities will be priced next wednesday or thursday, and delivered on Aug. 2. The variable rate bonds will be reset on a daily basis.
City officials say Chemical provided an LOC on $100 million of the securities: Morgan Guaranty Trust Company of New York for $50 million; Sumitomo Trust & Banking Co. for $50 million; Landes Bank for $30 million; Credit Bank for $25 million; The Sanwa Bank for $25 million; and the Industrial Bank of Japan for about $24.6 million.
Michael Geffrard, director of the city's Office of Public Finance, said the restructuring of the offering and its effect on the final pricing of the deal, could only be accomplished through a negotiated sale.
"The negotiated synergy allows us to squeeze all the different pieces of an issue together," Geffrard said.
Elsewhere in the negotiated sector, Merrill Lynch priced $98 million taxable Houston, Tex., Airport System subordinate lien refunding revenue bonds.
The firm said it received the verbal award at the original price levels.
Non-callable serial bonds were priced to yield from 3.85% in 1994 to 6.10% in 2001. Those yields were from 40 basis points over comparable Treasuries in 1994 to 60 basis points over in 2001.
The deal is FGIC-insured and rated triple-A by Moody's, Standard & Poor's, and Fitch.
