The municipal bond market continues to deal with possible federal funding changes and the elimination of the tax exemption at a time when it faces other persistent challenges to fund infrastructure and contends with greater uncertainty and more volatility.
As such, bond banks have been
"The services that bond banks provide — with a reliable and consistent process and widely available access to the financing — proves to be important because the opportunity cost for the small communities of learning the process and availability of capital is quite a lot, and that has only become more important in recent years," said Michael Gaughan, executive director of the Vermont Bond Bank, in an interview.
Furthermore, bond banks — which tend to be most successful in smaller rural areas, and communities that are in the market every five to 10 years — "often carry stronger credit ratings than the small to mid-sized municipalities they serve. This allows local governments to access lower borrowing costs and better market reception than they would on their own," said Alice Cheng, director of municipal credit and investor strategy at Janney.
Currently a dozen or so states have bond banks, the oldest hailing from the New England states. Arizona recently reactivated the Greater Arizona Development Authority with a new round of financial assistance in August after being dormant for 10 years. Not every state has been successful, as
Bond banks provide small municipalities, schools and other local institutions the ability to enter the market in a cost-effective and scalable way, as one pooled issue allows bond banks to lend the proceeds to the underlying borrowers. And their usage will only increase if some of these issues, or others, come to fruition.
For example, the Alaska Municipal Bond Bank (A1/AA-//AA/) came to market Tuesday with a $58.34 million deal — $44.82 million of non-AMT general obligation and refunding bonds, 2025 Series One, and $13.52 million of AMT GO and refunding bonds, 2025 Series Two.
The deal consisted of three new-money loans — stemming from three separate applications — to fund community projects: school improvement projects for Petersburg Borough, airport terminal improvements for the city of Whittier and a harbor replacement project for Ketchikan Gateway Borough, according to the preliminary official statement.
The remainder of the funds will be used to refund outstanding bonds issued by the bond bank, the proceeds of which were used to make loans, and pay a portion of the costs of issuance, the statement said.
The bond bank usually comes to market two to three times a year because "there is a need at the local level for funding of capital projects," said Ryan S. Williams, executive director of the Alaska Municipal Bond Bank.
"It is an advantage for communities to utilize the bond bank because they receive lower rates," he said.
Bond banks may prove an even more attractive option if the tax exemption is eliminated, market strategists said.
The tax exemption is at greater threat of being eliminated than ever before, some market strategists believe, compounded by Stephen Moore, an economic advisor to President Donald Trump during his 2016 campaign, who last week called for some form of taxation on muni bonds.
Moore's comments did not move the needle for all strategists, including those from J.P. Morgan, who "continue to believe that comprehensive reduction in the tax-exempt status within the municipal market is both unlikely and unwise."
The potential elimination would most likely see a shift toward greater utilization of bond banks, following a more "European model," said Wesly Pate, senior portfolio manager at Income Research + Management.
For example, in the United States if a small town needs to build a fire station, they can issue the bonds themselves to fund the project, he noted. However, in other parts of the world, it tends to be either bank financing or several entities come together, and an issue gets underwritten by a large bond bank, according to Pate.
If retail is no longer the main buyer, insurers would probably step in as would entities that otherwise buy corporates, he said.
In that case the muni market would compete one-on-one with securitized and corporate markets, which would force market participants to either keep these really small deals or "wind up paying a very large liquidity penalty, so investors will reap the benefit of that, or to get the scale, you wind up financing everything in large bond banks, and that keeps the liquidity side of it a little bit more at bay and that's what ultimately will attract institutional buyers," Pate said.
However, it's still "far too early" for bond banks to see increased use or creation to address a potential loss of the tax exemption when issuing bonds, said Ajay Thomas, head of public finance at FHN Financial.
"Eliminating tax-exemption for municipal issuers would, in my view, ultimately force a change in the way state and local issuers would have to issue bonds that would be a steep hill for issuers (and taxpayers/ratepayers) to get used to," he said.
And utilization and creation of bond banks is "possibly one way (and a necessary way) states would have to assist many smaller issuers in their state to have the 'access' to an all-taxable market," Thomas said, noting smaller-sized, less frequent issuers may face challenges with the taxable market accommodating smaller par size transactions.
Bond banks would also provide a more attractive financing option if there are increased borrowing needs from municipalities, Cheng said.
"With stimulus funds depleted and economic uncertainties ahead, local governments face growing capital needs," she said, noting potential federal spending cuts could limit alternative funding sources and bond banks may be a solution.
The possible loss of federal funding — which should be viewed as "highly disruptive" — would not lead to a direct increase in bond banks, but it may be an option issuers explore, especially in the long term, said Matt Fabian, a partner at Municipal Market Analytics.
The loss of federal funding makes credit quality worse, and states will, in turn, explore options to alleviate local credit pressure, he said. This includes bond banks, along with "state aid intercepts or guarantees, or the direct replacement of local governments by states and infrastructure funding or government consolidation," he said.
Bond banks can also step up and use "innovative ways to address both immediate disaster recovery and long-term infrastructure resilience,"
These banks could provide climate risk applications, offering financial assistance to small and at-risk communities, guaranteeing these communities have the necessary funding for recovery and rebuilding following severe weather incidents, he said.
Bond banks can also address climate change challenges, adapting to meet specific needs of various states and regions, Gaughan noted.
Moreover, there is growing acknowledgment that enhanced federal support and innovative policies could improve bond banks' abilities to finance necessary infrastructure and strengthen community resilience, he said.
But even without any possible changes or challenges, there remains a "great opening" for bond banks, Gaughan said in an interview.
"The impact of the work they do goes further with the tax exemption, as that is just a precondition of lower cost infrastructure, but in either scenario, there are important features of bond banks that make them relevant at this moment in time," including the reduction of information barriers and lowering the opportunity cost for accessing capital, he noted.
And as market dynamics change — "in terms of who's participating and the amount of liquidity they're providing" — navigating this complex landscape, and then layering on the reporting requirements, bond banks have become helpful in dealing with the challenges that local communities face, Gaughan said.
