Issuers, investors should prepare today for tomorrow’s infrastructure boom

Congress will likely approve a federal infrastructure plan that in turn eventually will set off a new era of projects for states and municipalities. However, local governments and agencies still will need to raise substantial additional funds themselves to achieve their goals.

This will require smart public financing strategies that factor in how interest rates, inflation, employment, wages and the relevant tax base may evolve while these projects take shape over the next several years. Issuers and investors alike must start thinking about both those national trends and the unique characteristics of specific locations — whether these are the conditions of municipal utilities or the personalities on a school board.

Reality check
Before doing so, it is worth providing a reality check on the obvious obstacle. Tribalism in Washington is notorious for derailing otherwise sensible policies. This definitely has transpired with long-debated infrastructure proposals that gained national attention under President Donald Trump and have persisted under President Joe Biden.

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What is different this time? The deep human and economic toll of the COVID-19 pandemic.

It has prompted rare bipartisan consensus that the U.S. needs a job creation program focusing on the middle class and acknowledging rural communities while upgrading everything from transportation, water and internet systems to schools and power facilities.

Moreover, several national polls indicate that voters support an infrastructure plan, even if it requires raising taxes. On June 24, the White House announced support for a Bipartisan Infrastructure Framework that listed an array of potential financing sources to cover $1.2 trillion of spending over eight years.

On August 1, a bipartisan group of senators released the Infrastructure Investment and Jobs Act bill, and on August 10 the Senate passed a version of the bill with bipartisan approval. The plan entails repurposing unused COVID-19 emergency relief funds, as well as several measures that issuers — and investors — may want to explore.

These include public-private partnerships, private activity bonds, direct loans and asset recycling for infrastructure investment.

Depending on how these are implemented, they could result in starkly different outcomes such as an increase in tax-exempt municipal bonds, taxable munis overtaking tax-exempt bonds, or even both tax-exempt and taxable munis experiencing sustained increases in issuances.

Financing needs
U.S. municipal bond issuances increased 8.5% during the year through June compared with the same six months of 2020, rising from $210.4 billion to $228.2 billion, according to the Securities Industry and Financial Markets Association (SIFMA).

During the previous decade, municipal issuances increased 64.2%, rising from $295.1 billion to $484.5 billion. Since 2018, issuances of new capital bonds have far outpaced refunding issuances. Between 2004 and 2020, individuals were the largest holders of munis, outpacing mutual funds, banks and insurance companies.

There is $13 trillion worth of infrastructure improvements that could be made across the U.S. between 2021 and 2039, according to the American Society of Civil Engineers (ASCE). The ASCE also provides a state-by-state breakdown of potential construction-ready projects that could benefit from a federal infrastructure investment package. This recently included $3.4 billion of water-related projects in North Carolina alone.

Issuers tend to prioritize strategies that allow them to raise just enough funding to achieve their infrastructure goals at the lowest cost of capital.

Officials who are subject to public scrutiny have incentive to strive for transparency with their communities about not only the purpose and feasibility of projects, but also the timing and repayment terms of the financing. Investors have good reason to care about this as well, since the number of muni defaults increased from 44 in 2018, to 55 in 2019, to 82 in 2020, according to Municipal Market Analytics.

Yet investor appetite appears poised to remain strong for well-crafted projects throughout the country. To illustrate this point, in May, Texas voters approved bonds totaling slightly in excess of $6.5 billion to go toward school facilities in 57 independent school districts.

In Arkansas, voters in the city of Bentonville recently approved a bond financing plan of approximately $289 million to accomplish a major multi-year infrastructure program, and in August voters in the city of Cabot approved a bond issue of about $100 million also for infrastructure projects.

Economic factors
As the global pandemic has proven, unexpected disruptions can emerge at any time. This means we must continually assess the economy for signs of shifts in the terrain. July’s Federal Open Market Committee (FOMC) meeting kept target interest rates in the zero to 0.25% range, with the Fed suggesting that inflation and employment would need to improve further before the central bank raises rates.

The consumer price index rose 5.4% during the 12 months through July and the personal consumption expenditures price index rose 4.0% during the 12 months through June. The July unemployment rate was 5.7%, far below the 10.5% of July 2020 but well above the February 2020 pre-pandemic level of 3.5%. However, the July unemployment rate was 6.1% for the construction industry.

Although the Fed will remain accommodative for a while longer, given that interest rates cannot go lower without risking other macroeconomic problems, it is possible that rates will begin rising modestly over the next year. But states and municipalities still will be able to benefit from relatively low rates and federal infrastructure spending. This should create much needed construction jobs, as well as opportunities for patient investors.

That is, if politics doesn’t derail public financing for the public good.

Dennis Hunt is executive vice president and head of public finance at Stephens Inc.