Taxables, climate will push the needle for munis in 2020

The public finance industry is in a particularly positive position to start 2020, with low rates and supply, aggressive demand here and abroad, an increased focus on climate and taxable issuance, and geopolitical uncertainty leading to a continued flight to quality.

There is a general consensus that municipals are poised to perform well in 2020, even if they underperform relative to 2019. But larger than simply price performance should be an increased focus on how this new climate can help the industry evolve into the new decade.

Participants should be prepared to harness opportunities and innovations, anticipate the risks that come along with them, and be ready to show investors, as well as policymakers and regulators in Washington, why this industry is so vital to the growth of the country as a whole. The changes that are occurring should not be looked at as passing trends but as the new normal for munis.

While it’s quite clear that buyers of municipal bonds, specifically retail investors, look to them for income, there are newcomers with different mandates to diversify their holdings, whether through ESG, impact or green, or a genuine intrigue and education in the municipal market. There is an opportunity to expand the buyer base in a meaningful way here.

What 2019 has shown is that it’s not just cost savings for issuers and intrigue from new investors that is leading the changes. The tenor of the municipal market is evolving and various participants are exploring ways to drive the discussion broader than how the municipal market has typically functioned.

The story of 2019 was taxable issuance, and the industry at large expects that trend will continue in 2020 and beyond. And the influx of taxable bonds dovetails nicely with climate, green and ESG investing as it opens doors to those investors seeking income along with “impact,” particularly international investors.

In 2019 many participants focused mostly on the advanced refunding component as the catalyst for the burst of taxables, but the picture is bigger than simply low rates and tax law changes. To ignore what some have called unexpected in the taxable space is to really say we were unprepared. One cannot ignore the rapid international education that has occurred from this surge in taxable issuance and that interest overseas makes the industry ripe for aggressive pursuit of expansion of its buyer base, as we first reported in the fall.

The municipal market should be viewed as a much larger investment ocean beyond the U.S. pond for the reasons above. It’s attracting investors from overseas at a faster clip, likely to eclipse the Build America Bonds era. International investors see states, such as California (the fifth largest economy in the world), as a worthy alternative sovereign debt investment to diversify their portfolios.

Importantly, it should be noted that the big difference between the BABs market and purely taxable munis is that investors know that, unlike BABs, there is no sunsetting the taxable market — it’s permanent. So the international education that has occurred and will continue to occur for our market is especially crucial that we tell the right story. We will explore the international investment component further in the coming weeks.

As this market attracts diverse buyers, participants said they will focus more on new data sets, such as taxable indices and potential benchmarks, and forward-looking participants are seeking additional data and technology to help with their business in this space.

Issuers, bankers, and asset managers alike have focused the lens on taxables by pitching international investors, doing international roadshows.

Point blank, first-time issuers in taxables have emerged over the past few months and even quite small, infrequent issuers are joining the taxable trend as bankers and other participants show the dollar sign savings it can provide. Taxable deals have a much larger share of the new-issue calendar so far this year, with this week Chicago issuers joining the likes of New Jersey, Massachusetts and Pennsylvania issuers as taxable bond issuing entities in 2020. This week, there are 14 deals over $100 million, four of which are taxable or partially so.

Some market participants disagree with the notion that taxables are here to stay for the long run as a major component of the market. It is known that the entire bond universe — corporates, sovereigns, the Apples of the world — are all priced off UST. Perhaps it would be great for price discovery to have more muni curves, but at the end of the day, investors know what Apple trades to the UST market and the same will be expected from munis. No one expects taxable municipals to be priced off anything other than U.S. Treasuries.

But if the past few months say anything about how some market participants are viewing taxable munis, it’s taken on a different tone. International investors are salivating over the prospect of uniform disclosures — whether for climate, green, ESG-related factors — to help guide their muni investments.

For example, ICE Data Services and IHS Markit are exploring the taxable space, including the potential for new taxable yield curves. MMD has taxable curves and Refinitiv TM3/MMD analysts generate taxable muni benchmark curves for new issue, secondary trading, news, risk models, evaluated prices and more.

This market is changing and the appetite for that change is real. There will be a massive transfer of wealth in the coming years to a younger, more tech-savvy and international investor class with mandates for new environment, political, social designations for their investments.

The municipal market is ripe for driving these investors to help build public infrastructure in the next decade, and frankly, the muni market has always been the natural fit. The surge in the taxable market and the rapidly growing green market will paint a revamped picture of what munis have to offer. The industry should be prepared to paint that picture.

While tax-exempts are still the center of the municipal universe, we can’t gloss over the intrigue that taxables and emerging climate concerns have in selling the muni story at home and abroad and what it means for all industry participants over the next decade.