The public finance industry got a resounding “resilient” rating from market participants from a Bond Buyer survey of the post- or near-post COVID-19 state of the industry.
While the municipal bond market still faces rising global interest rate challenges, legislative loggerheads in Washington and the omnipresent effects of COVID-19, the muni industry scored a strong B in terms of getting through it all, according to nearly 83% of municipal industry participants.
More than 80% of the 121 respondents to the Bond Buyer Municipal Industry Survey, sponsored by Assured Guaranty, rated the industry’s resiliency an eight (36%), nine (36%) or 10 (12%) out of 10.
Industry professionals see more challenges in the working conditions created by the pandemic than the economic conditions.
The top three expected challenges for 2021 among all respondents: lack of face-to-face communication (48%); travel restrictions/interruptions (43%); and rising interest rates (31%).
Their assessments, gathered from late February until March 10, are backed up by market, credit and anecdotal data from the previous year.
The market rebounded in ways that were hard to imagine during one of the worst sell-offs in municipal market history as COVID-19 began its rampage in March 2020, when short-term rates reached record levels, 11% of the market was pulled from mutual funds in the span of two weeks, and the yield curve inverted as the globe began shutting down.
The market ended 2020 with an all-time issuance record — $483 billion —a number that rises to more than $550 billion if corporate CUSIPs, direct bank loans and other nontraditional “muni” investments are included.
“Muni bonds are the core of U.S. infrastructure and strong market dynamics together with federal support will enable state and local governments to continue to make these critical investments,” an issuer wrote in comments to the survey.
How issuers, in a year marked with the worst public health crisis in a century, brought to market the amount of bonds they did with the help of underwriters, legal teams and advisors, bankers, insurers, among others, is a testament to the market’s resiliency and its centrality to the state and local governments it serves.
When asked about the most significant impact on business created by COVID-19, municipal finance pros most often cited the lack of face-to-face communication made necessary by social distancing mandates to protect public health.
Travel restrictions and workflow disruptions were also mentioned by one third or more of those The Bond Buyer asked.
These results were as unsurprising as the quintupling of the stock price of Zoom Video Communications Inc. between April and October 2020. Virtual meetings are now as commonplace as handwashing and mask-wearing.
On the flip side, only a minority of those surveyed noted a loss of confidence in financial markets, a decrease in revenue, or challenges with technology as entire workforces moved remotely.
“The lingering impact on transportation, entertainment, and higher-ed sectors is real, but the opportunity for investing in technology and utilities for a more sustainable future exists,” an institutional asset manager said. Something in particular, the person noted, was a “reshuffling of population, creating opportunities.”
Local governments finding the proper balance with their constituents on the timing of when to open back up to pre-COVID operating conditions is another concern.
“Additionally some businesses will be lost due to COVID, and local governments will be looking for ways to get back to pre-COVID economic levels as quickly as possible, which may require local government economic stimulus policies,” the asset manager said.
Biggest risks, according to a lawyer: “COVID continuing to be a major problem; reduced revenues due to unemployment and travel industry slowdown; increased expenses due to open borders policies.”
“Biggest opportunities: large increase in federal funding for local use; climate change infrastructure needs,” the lawyer wrote.
“Rising interest rates will reduce refunding volume in 2021,” a broker-dealer said. Already in the first quarter, analysts have noted a drop in refundings.
“The biggest risk is how the full reopening of the economy will impact interest rates,” one respondent said. “As a municipal advisor, I am becoming adjusted to this new world of low interest rates and would love to see my clients take advantage of them. However, a rise in rates in response to a fully open economy would eliminate much of the opportunities that could be available this year.”
There has also been global demand growth for munis in the pandemic via taxable issuance.
On the heels of strong growth in 2019 and 2020, most municipal finance pros expect the taxable boom in issuance to continue, with 55% saying ‘yes, probably’, 15% answering ‘yes, definitely’, and 18% said ‘no,’ while 12% were unsure.
Taxable bonds represented more than 30% of 2020 issuance, helped to stabilize the muni market by introducing investors to the asset class in a meaningful way.
Environmental, social and governance issues, as well as impact and/or green investing is of high importance and value to nearly half of muni pros. Asked about the prioritization of ESG, impact, green investing for the next one to three years, 7% said critical, 40% said high, but not critical priority, 32% said moderate priority, 19% said a low priority and 6% said not a priority.
One underwriter noted that opportunities in ESG and better technology for fuel efficiency and data insights into those technologies will be key for the industry.
“Biggest risk: yields increasing. Biggest opportunity: ESG,” another respondent said.
“Risks — muni credit, climate challenges in coastal areas, rising interest rates,” a rating agency analyst said. “Opportunities — green and social bonds.”
Infrastructure
As the survey was being conducted, negotiations were underway for the stimulus package President Biden signed March 11 and talk was afoot of a national U.S. infrastructure proposal, which the Biden administration laid out on Wednesday.
For municipal participants, even before the news, these issues were high on their minds.
“There is an appetite and opportunity, if Congress can work in a bipartisan manner, for a stimulus program that encourages shovel-ready type projects to be funded with a combination of federal and local funding sources,” a municipal advisor said. “State and local governments still have ample borrowing capacity available, but it would take a bargain sale type event to motivate and encourage their spending and overcome the temptation to sit on the sideline.”
About the importance of a federal infrastructure package being enacted in 2021, 53% assigned an 8, 9, 10 rating where 10 indicates critical.
“Risks: Extreme weather events, partisan gridlock, another COVID wave disrupting the economic recovery,” an analyst wrote. “Opportunities: Infrastructure bill.”
On the importance of the role of federal government in providing stimulus to state and local governments, 51% assigned an 8, 9 or 10 rating where 10 indicates critical.
“Risks: permanent loss of retail businesses,” a broker-dealer wrote. “Opportunities: funding of infrastructure projects in partnership with the Federal Government.”
On the importance of the Federal Reserve reinstating a program similar to 2020’s Municipal Finance Liquidity Facility, only 16%, assigned an 8, 9 or 10 rating..
“Municipal liquidity is still episodic, and could be disrupted by unexpected shocks,” a bond insurer representative said. “The Fed should be providing more backstop liquidity.”
On the importance of restoration of tax-exempt advanced refundings, 50% assigned an 8, 9 or 10 rating where 10 indicates critical.
“If Congress fails to reinstate advance refundings, the supply of investment grade tax-exempts may continue to compress,” a registered investment advisor representative wrote. High-net worth investors in high-tax states (NY, CT, CA) “may find it increasingly challenging to redeploy cash. Reinvestment risk may continue to rise within retirement planning. Those financial professionals as myself who specialize in managing income generating alternatives will look to firms such as BlackRock, Goldman Sachs, PGIM, etc to get creative.”
On the importance of issuer creditworthiness, 81% gave an 8, 9 or 10 rating, and several respondents were not so quick to embrace a rosier outlook on credit.
“The credit issues due to the uneven economic recovery and poor demographic and social factors are real,” a municipal advisor said.
Bond insurers grew their business in 2020 to $34.167 billion from $23.927 billion in 2019 as more investors demanded and issuers purchased insurance for their deals in very uncertain times. On the question of how important is bond insurance and will it grow or decrease or stay the same, 91% of those surveyed, or nine out of 10 municipal finance pros, expect usage of bond insurance to increase or stay the same.
The typical factors that issuers face have been compounded by the pandemic — a slow economic recovery, empty buildings in downtown areas, the loss of small businesses — “we’re still a ways away from fully understanding the implications of such things,” one respondent said.
“Credit issues due to uneven economic recovery and poor demographic and social factors,” a ratings analyst ticked off, “still not fully recognized.”
“I feel that reduced revenues is going to have a devastating impact on issuers and recovery is going to take many years,” a lawyer said. “I think the market is riding a wave of short-term solutions and has yet to start showing long-term impact.”