Are we missing a golden opportunity in the municipal bond market to finance fixes to crumbling bridges, dams, roads and schools?
A veteran research analyst thinks so.
Richard Ciccarone, president of Merritt Research Services, said a combination of factors line up ideally right now that enable issuers to cost-efficiently address the country’s critical infrastructure needs.
Certainly, the public is focused on the issue, as high-level negotiations between Congress and the president proceed on a major infrastructure bill. At the same time, issuers are well positioned to take advantage of historically low borrowing rates.
“Municipal bond borrowers have not taken full advantage of opportunities to borrow at low rates to fund infrastructure,” Ciccarone said in a report issued earlier this year, “but the window of opportunity remains open – with or without federal assistance.”
“Issuers must act now before higher rates and inflation return.”
Urgent need meets favorable borrowing conditions
The country’s need to upgrade its aging infrastructure has been well documented for decades. The American Society of Civil Engineers, for example, issues an assessment every four years. Its latest report analyzed 17 different facets of infrastructure, from energy, levees and ports to transit, rail and aviation.
While the group said the United States showed progress over the past four years, there’s still considerable work to be done, and it will require funding – $2.59 trillion over the next 10 years.
Despite the need and a favorable environment to finance repairs, issuers have largely missed the mark, Ciccarone said.
“Ironically, over the past 10 years, low interest rates in the tax-exempt municipal bond market provided a significant opportunity tackle the infrastructure gap through traditional borrowing. Instead, most governments in need of infrastructure repair failed to take sufficient advantage of low rates to restore and modernize their capital assets.”
He noted that in seven of the last 11 years, the benchmark Refinitiv MMD AAA 30-year tax-exempt municipal bond averaged a daily yield of less than 3%.
“These levels contrast favorably to annual long-term tax-exempt rates averaging more than 4% since 1968,” he said.
While low rates have led to more issues, a substantial proportion of the bond proceeds have been used to pay down debt, not tackle new projects. In fact, since 2010, in the aftermath of the Great Recession, about 40% of bond proceeds were used to refund or refinance outstanding debt.
Opportunity in the municipal bond market as debt loads decline
As entities refinance their existing debt, municipal bond sectors across the board have seen the cost of outstanding debt loads decline. “This, in turn, creates some budgetary breathing room for infrastructure improvements without increasing the burden on taxpayers, ratepayers and other stakeholders,” Ciccarone said.
Low rates, stabilized credit quality and strong demand by investors has narrowed the yield difference between higher and lower quality borrowers.
“This means that lower rated bonds and credit sectors are also able to reap the benefits of borrowing at a lower cost than would be the case in more traditional interest rate environments,” he said.
Low rates can yield substantial savings.
For example, the median aggregate outstanding borrowing cost of the general obligation group, including states, cities, counties and school districts, fell by 1%. The result? Borrowers save about $1 million a year on outstanding debt amounts of $100 million.
“Those savings can be leveraged and applied to a new 30-year bond issue to address a wider base of necessary infrastructure improvements,” he said.
Advantages of public investment
Investing in infrastructure has many advantages. It has a high rate of return, it creates jobs and it addresses critical public needs. Yet U.S. investment in infrastructure is at its lowest percentage of GDP in about 70 years.
While fiscal prudence is important, avoiding public works projects is dangerous. It can impact public safety, adversely affect the economy and add costs later.
As we’ve noted, state finances, for the most part, fared better than expected in the wake of the pandemic (“State and Local Finances Closer to a Boost”) and today there is a unique opportunity in the municipal bond market to finance much-needed upgrades.
We urge lawmakers in Washington and across the country to embark on important infrastructure projects and invest in our future.