Investor demand is high and borrowing costs are relatively low, yet municipal bond issuance remains flat.
In this attractive environment, why aren’t there more muni bonds on the market?
It can’t be for lack of need.
Infrastructure’s cry for funding
A widely cited “report card” issued by the American Society of Civil Engineers scores the nation’s infrastructure at a C-minus. In its analysis of 17 categories of infrastructure, the group cited deficiencies in a variety of areas, including wastewater treatment, levees, transit, roads and hazardous waste.
The engineers, for example, said the U.S. loses about 6 billion gallons of water each day due to water main breaks, while the location and condition of 10,000 miles of levees are unknown. Almost 20% of transit vehicles and 6% of “fixed guideway elements,” such as tracks and tunnels, are in poor condition, according to the group.
And the list goes on.
Municipal bonds have served as a key funding mechanism for public works projects for more than 100 years. Why aren’t they being deployed on a greater scale to address these serious shortfalls?
Strong appetite from investors
It’s not for lack of interest.
So far this year, investors have poured more than $88 billion into muni bonds. Reports say we will see record municipal inflows in 2021, while demand could exceed supply by almost $100 billion.
Legislation signed by President Biden will likely lead to some increase in issuance, as we’ve pointed out (“New Infrastructure Law’s Impact on Municipal Bond Market”).
The new law stipulates only partial funding for some projects, so we expect an uptick in local bonds, and the law expanded the use of private activity bonds.
Despite the law, however, we don’t expect an immense growth in the market.
Other factors behind municipal bond issuance
Perhaps, a new report in The Bond Buyer suggests, the lack of muni bond issuance is a result of outdated thinking.
Currently, laws restrain the interest costs and debt loads municipal issuers can assume.
While prudently managing costs is critical to state and local governments, limits were imposed when rates were significantly higher and should be reconsidered. Interest rates have declined over the past 40 years, financing costs remain relatively inexpensive and municipal finances, for the most part, are on the upswing.
Another reason for issuer reticence may be city leaders’ sensitivity over risking their city’s investment rating and the potential political fallout.
While understandable, it may be time to take a more nuanced approach to debt issuance and give appropriate weight to the risks of neglecting infrastructure.
“Ratings themselves are more about management, economies and budget discipline, as well as debt levels and interest coverage ratios,” the report notes.
Analysts don’t expect a tidal wave of bonds
For more than a decade, the municipal bond market has hovered around $3.7 trillion to $4 trillion. Analysts said this year’s issuance should be about $460 billion and may rise slightly in 2022 to $475 billion – $500 billion. Savvy investors continue to find value in the tax-free bond market and keep their interest clock ticking.
But it’s time we take a hard look at municipal bond issuance. Infrastructure plays a fundamental role in our economy, health and daily lives. It’s imperative we address crumbling roads, insufficient water treatment facilities, energy and communications capabilities.
We support a robust dialogue on these needs and allowing municipal bonds to do their job.