Municipal issuance is poised to reach the largest total annual volume on record, breaking past the $448.61 billion record set in 2017, driven largely by taxable and refunding issuance.
Amid a global pandemic that has shaken the world, the municipal market will absorb the most aggregate debt in its history in a most volatile year. The primary market was held to a halt in March after the reality of COVID hit, seizing up access for issuers to price bonds.
While the issuance figure is high — currently at $443 billion with at least $11 billion yet to be priced — the caveat that cannot be overlooked in 2020 is that taxables and taxable refundings make up a large portion, 30% of the volume. Meaning, it’s not pure tax-exempt new-money which typically makes up 90% of the municipal market in years past. Taxable issuance so far is $135 billion, a 123% increase over 2019.
“Although it’s a record year, it was unusually easy to place for two reasons — refundings and taxables,” Matt Fabian, partner at Municipal Market Analytics, said. “The relative relationship of exempts to taxables is super advantageous.”
Taxable issuance, a relative afterthought for many traditional muni trading and banking desks before 2017, alone has surpassed $135 billion in 2020, far larger than 2019's $72.3 billion, when in the second half taxable
Taxable figures in 2019 and 2020 also easily beat out 2009 and 2010, the direct-pay Build America Bond era when issuers sold $182 billion over the two years of the program’s existence.
Many participants point to taxables as helping the market get through 2020 by making it easier for the overall market to digest exempt issuance by broadening the investor base to nontraditional muni buyers such as international investors and insurance companies.
Another consideration is that private placements, corporate CUSIPs, and direct bank lines of credit took some of the tax-exempt paper out of the market, thereby freeing up the exempt market to be competitive with its traditional buyer base.
These transactions are not factored into consensus figures of total outstanding “muni” debts. If that paper were incorporated, the market for municipal issues would skew higher.
How issuers, in a year that has been marked with the worst public health crisis in over 100 years, brought to market the amount of bonds they have, is a testament to its resiliency and its necessity for the state and local government it serves.
“If I hear someone say the muni market is a backwater market ... the market has responded in an amazing way,” said Michael Decker, senior vice president of policy and research at the Bond Dealers of America. “It really demonstrates the resiliency of the muni market.”
Even with the increase in overall volume, investors are clamoring for more municipal bonds because new-money paper is scarce relative to other years and cannot meet demand from redemptions, not to mention the infrastructure needs across the country being left unaddressed.
“With so much of the volume being refundings, that doesn’t really change net supply; they just increase reinvestment pressure,” Fabian said. “The market itself became a credit tool in 2020,” noting “where so much of issuance was aimed at or indirectly aimed at providing budget relief.”
That creates a different dynamic in that now lenders are also credit providers, creating an unfamiliar role for investors, Fabian said.
“A lot of the activity this year was helping issuers get through the pandemic and that’s just not normally what the market does,” Fabian said. “We don’t think of market access as a primary credit factor for long-term bonds. Issuers typically do not need market access on a long-term basis but this year, a lot of them did.”
In a "normal" market, 95% of issuance is for capital while 5% is for budget relief, “and most of that has been for Puerto Rico,” Fabian said. “The market stepped up in a major way to help our issuers to get through the crisis. It’s subtle, but real.”
Budget aid aside, the fundamental purpose of the municipal bond market remains.
“There is still a significant need for investment in infrastructure across the country,” said Leslie Norwood, managing director, associate general counsel, and head of municipals at the Securities Industry and Financial Markets Association, noting the American Society of Civil Engineers’ assessment that trillions of dollars is needed for new projects and a backlog of repairs.
Municipal triple-A rates are at near-historic lows, though, and ratios to U.S. Treasuries have fallen over the course of the year, even more dramatically so in the past month to range from as low as 70% to the current 85% on 10-years.
“The market performance is interest-rate driven. Short-term interest rates right now are lower than they were before the crisis,” Norwood said. “This market has certainly exhibited its resiliency.”
Inflows into municipal bond mutual funds have rebounded from a massive sell-off in March/April when outflows were $46.128 billion in March alone, according to Refinitiv Lipper. Billions have flowed back into the funds since, at $27.135 billion as of the end of October.
All of these factors have positioned issuers to place their debt with relative ease, though credit concerns remain and uncertainty about the pandemic clouds any assurance that 2021 and 2022 will be an easy recovery for states and localities and their conduit borrowers.
Decker said one of the concerns with regard to credit is how revenues and expenses for issuers will play out in the years to come.
“There’s a question I’m hearing: ‘Is risk being adequately compensated?’ he said. "Even if it’s a low risk, a long-shot risk, there is a dark cloud, an unknown shadow hanging over the market” because of COVID-19.
Decker said with such low yields, participants are asking how they can find value in a market “where you’re getting so little return.”
The 10-year AAA muni for example was at 1.44% in January. It shot up to 2.86% on March 23. As of publication, it hovers around 0.70%.
Market shocks of the magnitude caused by COVID-19 had not been felt since the Great Recession. In fact, the SIFMA Swap Index, a 7-day high-grade market index made up of tax-exempt variable rate demand obligations (VRDOs), began 2020 at 1.06%. On March 18 it skyrocketed to 5.20%, and then dramatically fell to 0.74% on April 8 then to 0.19% on May 6. A low of 0.08% was hit on September 2. It now sits at 0.10%.
By comparison, the week Lehman Brothers filed for bankruptcy on September 15, 2008, the SIFMA index was at 1.79%. The reset on September 17 jumped to 5.15%. The index then jumped to 7.96% on September 24, 2008.
Credit concerns, looming overhead, are still less severe than in the post-Great Recession time frame, source said.
Fabian said that perhaps because the pandemic is relatively finite from an investor’s viewpoint, they can provide bridge capital because they see the end of the bridge.
That view has the largest banks and market participants expecting 2021 issuance to be as robust or more so than 2020. Issuance estimates for 2021 range from $550 billion on the high end from Citigroup Global Markets to just $375 billion from Hilltop Securities.
Jeff Lipton, managing director, head of municipal credit and market strategy at Oppenheimer & Co., said Oppenheimer expects $420 billion to $440 billion in 2021, the same projection it had for 2020. MMA projected $500 billion this year and it expects $500 billion for 2021, and likely in 2022.
Lipton said the market needs to hang its hat on technicals that have been strong most of 2020 and will continue to be through the remainder of the year and into 2021.
One of the reasons he said the market had fared so well on the backend of the year is the market sold off “so much and so fast in the March-April timeframe, there is still a lot of cash to be put to work.
“The new-issue market has done very well. We’ve had some notable upsizing to deals as of late. We expect that to continue. Technicals will certainly drive market performance” into year-end and 2021, Lipton said.
He noted that while municipals will underperform U.S. Treasuries on the whole in 2020, muni returns in November alone were 150 basis points while UST returned 35 basis points.
“As of late, the last few months, munis have definitely outperformed and a lot of that has to do with the supply-demand aspect of this market,” he said. “I think we want to be sure we are not getting lulled into a false sense of security. We’ve really rallied” in 2020.
Another support for issuers in 2020 was the Fed’s Municipal Liquidity Facility, created as a backstop, a psychological benefit for both issuers and investors.
The Federal Reserve acted quickly, Norwood noted, and not only the MLF assisted in the recovery of the market, but also the commercial paper facility and the Money Market Liquidity Facility.
Decker and many others said the MLF did its job, and is likely not needed going forward.
“Part of the decision for the MLF to expire, if you look at issuance booming, rates so low, liquidity ample — it’s hard to point to a market failure in 2020,” Decker said, adding that it would still be a welcomed backstop, albeit one that might not be used.
"We do not believe the conclusion of the Municipal Liquidity Facility at year end will have a meaningful impact on the overall market given its seldom use and likely revival should issuers come under additional stress," said BlackRock's Peter Hayes, Head of the Municipal Bonds Group, James Schwartz, head of Municipal Credit Research and Sean Carney, head of Municipal Strategy in market report.
Yet memories of austerity measures put into place post-Great Recession loom high above state and local governments and the infrastructure and mere day-to-day cash needs issuers in the United States face — to fund health-related costs, police, transit, schools and public pensions — are also elevated more than before.
Recessions historically lag for state and local governments. The hit on the national economy is quicker to rebound while the effects stay around longer and more intensely for state and local issuers as the reverberations take more time to set in because of the inability for states and localities to run deficits as the Federal government can.
“They certainly did in the post-Financial Crisis,” Decker said. Typically, there is a lag in reinstating spending and rehiring at the state and local levels.
According to the National Association of State Budget Officers, nationwide economic lockdowns led to the first drop in tax revenues at -0.8% since the Great Recession. At the same time, spending increased well above forecasts (+7.8%) due to the need for expanded social services amid the pandemic.
"Balancing budgets for fiscal 2021 will be a greater challenge absent additional federal assistance if more severe lockdowns are mandated," BlackRock said.
However, there are reasons for optimism, they wrote.
Tax receipts have been resilient in the new fiscal year, especially in states that rely on progressive income taxes, as high earners adjusted to the work-from-home environment. Also, higher equity markets should alleviate some pressure on state pension plans, BlackRock noted.
“I would say one of the issues that is sort of buoying the market is the fact that financial fallout from COVID-19 hasn’t been as severe as some states predicted back in March and April,” Decker said.
