Threats to tax-exemption the X factor in 2025 issuance projections

Municipal bond supply projections for 2025 are at a high of $745 billion and a low of $480 billion, with most firms anticipating issuance next year will be on pace, if not surpass, 2024's record-breaking total. While interest rates, inflation and macroeconomic policy will play a role in the total, potential tax policy changes will be the deciding factor for what governments end up borrowing next year, analysts said.

While most on the Street expect issuance to hover around $500 billion, a few think volume will be much higher, primarily because they expect some issuers to flood the market to get ahead of any changes to the tax exemption as the new Congress seeks to pay for the $4 trillion needed to replace the expiring Tax Cuts and Jobs Act.

The fluidity of both policy and macroeconomic uncertainty was already felt earlier this year as issuance began surprising to the upside, leading some firms to revise their 2024 supply projections upward. Once issuers saw more favorable market conditions, a general acceptance of rates staying higher for longer and growing uncertainty ahead of the November election, they came to market with more debt than anticipated and in much larger-sized deals.

Year-to-date, issuance is at $480.6 billion, just shy of 2020's record $484.6 billion.

On the high end for 2025 predictions is HilltopSecurities, which expects $745 billion of issuance, a 50% increase, mostly due to potential tax policy changes, said Tom Kozlik, managing director and head of public policy and municipal strategy at the firm.

"The key reason for the substantial increase in issuance, unprecedented in a year-over-year period, is my suspicion that at the end of the first quarter or beginning of the second quarter, lawmakers … will propose significant and far-reaching tax-related legislation," he said.

This will "eliminate (or significantly curtail) the municipal bond tax exemption," leading to the potential end of new-issue tax-exempt bonds after Jan. 1, 2026, Kozlik said.

Kozlik thinks governments and private activity bond issuers will accelerate as much tax-exempt issuance next year as they can.

However, if a threat to the tax exemption does not happen, Kozlik expects issuance to be at $535 billion.

Municipal Market Analytics, Inc. sees issuance in 2025 at $500 billion with some upside, said Matt Fabian, a partner at the firm.

Fabian expects there to be a lot of new-money and refunding volume, but in the event of a move earlier in the year to remove of the tax exemption or to cap the exemption's value, issuance next year could drop to $250 billion to $350 billion, he said.

Fabian said depending on the severity of the threat to the tax-exemption, record issuance numbers, such as $750 billion to $1 trillion, are not impossible.

On the lower end of the predictions, J.P. Morgan expects issuance will be at $490 billion, said Peter DeGroot, managing director and head of the municipal research and strategy team at the firm.

DeGroot noted the forecast is "heightened as we track policy developments related to the extension of TCJA, and whether certain aspects of the municipal exemption are drawn into the conversation."

If the market starts to factor in limitations to tax-exempt financing early in 2025, there could be a pull forward of supply, which introduces "upside risk" to J.P. Morgan's current issuance forecast, potentially prompting the firm to revise it.

"One of the primary drivers of expected sustained elevated levels of volume in 2025 is the broad-based nature of the surge in 2024's supply," DeGroot said.

Record tax-exempt issuance this year did not come from a "massive increase" in supply from one or two sectors, but rather a broad-based elevation across sectors and types of issuance, the firm noted.

Rising project costs and expanding demand to finance the "growing need for power along with utility maintenance and replacement given aging infrastructure" also played a role in lifting supply this year, DeGroot said.

SWBC expects next year's issuance to be even higher with between $525 billion to $550 billion of supply as infrastructure needs continue to grow, said Chris Brigati, managing director and chief investment officer of SWBC.

Brigati also believes any change in the tax exemption may lead issuance even higher as there may be a "rush" to the market.

With gross domestic product growth expected to remain "quite positive" next year, that will support new financing as stimulus funds are being spent down by muni issuers, noted BofA strategists, who forecast issuance to hit $520 billion — $375 billion of new money and at least $145 billion of refundings.

"We expect slightly higher than the trendline growth in 2025 due to multiple factors, including infrastructure needs across the country and issuance momentum, population growth, higher than pre-COVID inflation and a likely more favorable interest rates environment," they said.

Refunding issuance will rise because there will be a larger pool of candidates and a likely better interest rate environment, BofA strategists said.

They expect $450 billion of tax-exempts, $45 billion of taxables and $25 billion of AMT bonds.

"Barring any unexpected macro developments next year, taxable new money should see better issuance in 2025 as the Fed continues to cut rates, but we do not expect taxable advance refundings to recover in any meaningful way," they said.

Janney predicts supply for next year between $500 billion to $525 billion, reflecting governments' effort to address infrastructure challenges, rising social program demands and shifting economic conditions, said Alice Cheng, a credit analyst at Janney.

Cheng said next year will see a more favorable interest rate environment compared to the last two years, likely driving the higher refunding volume.

She expects a larger percentage of supply to be refundings, with about 40% of the volume a combination of new-money and refundings or only refundings.

Additionally, moderate economic growth and easing inflation could give state and local governments the market stability to issue more debt for capital projects, Cheng said.

Furthermore, rising volume could stem from supply chain disruptions and tariff-driven inflation that may require issuers to fund increasingly expensive projects, she said.

Ramirez expects issuance at $515 billion for next year, up 5% from this year's expected $490 billion, said Peter Block, managing director and head of municipal strategy at the firm.

New-money will remain elevated compared to historical and grow modestly to $406 billion, up 3% year-over-year, driven by "inflated costs, continued pressing public infrastructure needs, and dwindling to non-existent [American Rescue Plan Act] funds," he said.

Refunding issuance will increase "materially" to $109 billion, up 15% year-over-year, as "interest rates likely grind lower throughout the course of the year, producing greater targeted debt service savings," Block said.

Despite the increase in refunding issuance, reinvestment in 2025 should be down 20%, reflecting lower maturing principal maturities and dwindling pre-refunded escrow calls, he said.

"The combination of elevated supply and depressed reinvestment, at only around 70% of projected gross supply, results in approximately $150 billion of net supply," Block said.

Wells Fargo anticipates $500 billion of gross supply, with tax-exempt issuance at $435 billion and taxable volume at $65 billion, both of which will be driven by new money, said Vikram Rai, head of municipal strategy at the firm.

An "upside surprise" could see issuance surpass $550 billion due to potentially increased issuance of general obligation or general purpose sector bonds because of elevated costs and lower federal grants and funds, he said.

Other factors include persistent recession and growth fears, elevated inflation and affirmation of rates staying higher for longer, leading to issuers giving up on waiting for lower rates before funding capital projects, Rai said, though the most important factor to a possible increase is threats to the benefit of tax-exemption.

"If tax-exempt benefits are scheduled to be capped or curtailed in any way, it could change the tax-exempt vs. taxable make-up of supply in 2025 (more issuers could rush to issue tax-exempt bonds much like the advance refunding rush of 2017)," he said.

However, other factors, like yield volatility, expectations of an impending rate rally and a slow start to issuance in the first quarter of 2025 could lead to a "downward surprise," Rai said.

Barclays expects around $480 billion of supply, most of which will be tax-exempt, and net issuance will be "positive" and "sizable" once more at $165 billion, said Barclays' Head of Municipal Research & Strategy Mikhail Foux.

New-money will also remain heavy at an estimated $335 billion to $345 billion, he said.

"In November, a large portion of bonds on ballots was approved (especially from California), which is typically a good indicator of new money supply in the upcoming year," Foux said.

There will also be a "good deal" of refundings, as the Fed should keep cutting rates, making refundings, even of lower-coupon bonds, attractive enough, Foux said.

Moreover, there will also continue to see current refundings, as new-money supply 10 years ago has been "relatively robust," he said.

Foux also notes the red wave creates uncertainties about the future of tax exemption, potentially resulting in many issuers coming to market to get ahead of potential changes.

The need for infrastructure investments will remain an "ongoing theme," encouraging issuers to come to market and possibly leveraging already-allocated federal infrastructure funds, Foux said.

Regardless of the total next year, there is a growing sense that infrastructure spending needs are growing and the market could become much larger if issuers are willing to borrow.

MMA predicts issuance could rise to around $1 trillion per year as "governments protect threatened economies, invest in long-term climate adaptation, and face structurally higher inflation and budget pressures."

If lawmakers curtail the tax-exemption, Fabian said a taxable/partially-taxable market "would imply distinctly less investment, to the detriment of growth and/or recovery from natural disasters."

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