Infrastructure Investor (CPE Eligible)

As the country looks to address the vast infrastructure needs, how do investors view the opportunities – and the risks – of investing in US infrastructure? How could the muni market start to incorporate the climate-related risks and why hasn't it done that already? What do investors want to see more of in the coming months/years?

Transcription:

Lynne Funk (00:08):

Good afternoon. I'm Lynne Funk, Executive Editor at the Bond Buyer. I am delighted to introduce our panel of esteemed experts today to discuss the investor perspective, Infrastructure Investment. Can you hear me Okay? So with me today, I have Tom Doe, who CEO, and Founder of Municipal Market Analytics, Inc. David Narefsky, who's Partner at Mayer Brown, Hector Negroni, who's Founder and CEO of Foundation Credit, and Adam Stern, who's Co-Head of Research at Breckinridge Capital Advisors. I'm definitely excited to talk to this panel because each of them have really a unique seat in the market, and each of them have very strong opinions in the market, and I think they're important for everyone to hear. But particularly today, I think this conversation's going to be of interest to some of the issuers in the room. I hope it is. At least we will talk about the makeup of the Muni investor landscape, the shifts there issuance, the willingness to issue climate change, private and alternative investment capital opportunities, and a little on policy in DC. But first I will say when two o'clock hits and the Fed makes the announcement, someone please shout out what it is we would like to know.



(01:25):

But with that, I'll kick us off here. We've seen some shifts in the Muni buy side with investors kind of fleeing, not kind of fleeing mutual funds. In 22 and 23, the dramatic shift into SMAs ETFs, JP Morgan actually estimates that more than half of household ownership is currently held in SMAs, and that's been something that's pretty remarkable. But liquidity challenges remain, and we all know that particularly in times of volatility, as the dealer community holds fewer bonds, crossover buyers, including insurers, banks, hold fewer munis because of the tax policy and regulatory changes. And with all of this leading to really the story that munis are ever more reliant on retail investors. So Tom, I'd love to have you kick us off here with some of your thoughts on sort of the current demand components in the media market, and we'll go from there.



Thomas Doe (02:13):

Well, so as everybody now knows, it's the SMA world. We call it the dominant demand component. And I think what I wanted to just share with you is how we got here, because we've really traveled back in time because prior to 1976, before there were municipal bond funds, it was the individuals that dominated the ownership of Munis. And back in that, prior to 1976, is that the average yield on a 30 year bond on municipals was around three 50. Well, since April of the second quarter of 2022 when we all went to SMAs, is that the average yield has been around three 70. So a little bit better value here in this era of dominant municipals, but of dominant sma. The other thing that the SM a involvement has, or retail involvement has been evolving since really 2010. And there've been four instances where we saw retail get very engaged.



(03:27):

And it was when we saw the 10 year AAA level get to two 50, which gets to be, or two 53%, which now takes you over to 5% taxable equivalent yield. Well, that happened in the wake of Meredith Whitney, if you all remember that back in 2010. And the accompanying mutual fund redemptions, then it occurred again in right after the Trump election in 2016. We had that spike again, retail again became engaged. And then it occurred during covid when again, we had that incredible historic movement in yields and retail embraced again. Then finally, we're in this era of the last two years, when that 5% taxable equivalent benchmark was reached, retail became engaged, and the Fed's policy being prolonged for two years kept the SMAs involved. I think that the municipal bond fund and the ETF product, let's just say the fund product is going to have a time to rise again.



(04:39):

And Hector, you've launched A ETF just recently. And what was interesting is that in the first 15 ETF growth in Munis, and its first 15 years, so up until second quarter of 2022 grew at the same rate that municipal bond funds did in their first 15 years. So a new product, new idea, the new shiny thing gets attention and draws assets. Now since we've then got that higher yield level than the tenure that ETF inflows have waned and they've slowed down, and we'll talk a little bit more about it, but I think what we're going to see is that with what I believe will be the systemic credit event in the municipal market, which will be associated with climate, is that investors will, as they did in the wake of the New York City crisis, seek a broader portfolio for protection rather than the, and Adam can speak to this in terms of maybe the 10 to 30 bond position that might be in an SMA portfolio.



(05:51):

And so we'll shift again, and that's how the market works with cycles. The important thing about liquidity in my last point here is that what the municipal market, when they underwrite bonds, you need to place bonds as fast as possible, get 'em off the books, and you find the easiest. You find who that dominant demand component is in order to structure your deal. So it'll move quickly. And what is important about that is that when you're structuring those, getting that feedback in terms of flow is that it's just really important to understand who that component is, will they be there, and how fast you can reach them. And I think that we will see that, again, evolve. Everything's been structured toward the SMA, I think we'll see it then pivot again towards something that's maybe a little bit more performance oriented. And if rates do continue to move, if we do get a Fed to cut rates and we're back in this lowering cycle, the funds will also have an opportunity to sell performance because this high yield won't be there any longer.



(07:02):

But one last point, I'm sorry, and I don't, is that the one big change I think that we're seeing is in the United States, we have about 250,000 individuals who have a high net worth of $30 million or more. And I think that this era of wealth wants the service and attention that the SMA brings to the table. And again, I always say, well, it's kind of like the trust department back in the 1920s of JP Morgan catering to those individuals and with the appropriate services and high touch that those ultra high net worth clients want. So it's kind of interesting to me that our industry is really in the hands of 250,000 individuals here in the us.



Lynne Funk (07:51):

Thanks, Tom. And I'll just tell the rest of the group, of course, we were going to try to keep this conversational, so if you have anything to add, feel free, let me know.



David Narefsky (07:59):

I actually did have one thing to add please, if that's okay.



Lynne Funk (08:02):

Thanks, Dave.



David Narefsky (08:02):

You sort of touched on this, Tom, but I was thinking of the relationship or if there is a relationship between the SMA investors and the muni issuers. You were talking about their high maintenance investors. So have you seen anything that's relevant to how it's important for the SMA investors to have a particular, or for issuers, I should say, to think about how they would relate to this category of investors that maybe they hadn't had to think about before?



Thomas Doe (08:35):

I'm going to pass this to Adam because he's dealing with it every day.



Adam Stern (08:39):

This is what we do. So Breckenridge is a Muni SMA provider, and we have well over 10,000 of these accounts. Some of them with the ultra high net worth folks that Tom's talking about. Most of them just ordinary high net worth investors. So the typical account is kind of 20 positions to 50 positions kind of deal. Yeah, I mean, what does an SMA investor want from the issuer? Disclosure and transparency are probably the two main items generally now with the rise of SMAs coming through intermediaries, so a company like Breckenridge or whoever is your asset manager, is going to be providing you quarterly updates. And if there's a credit event, hopefully explaining that to you. But the benefit to an SMA in particular for these retail investors is when the tide goes out and you have a covid, you have a GFC, maybe Tom's right, we have some climate risk event. And the ordinary rules of really low defaults, low ratings transition risk in the market go away. This is the sleep at night portion of these investors' portfolios. So they like to kick the tires, look, touch, feel, and to be able to go through bond by bond by bond. Here's why you own this. Here's why you own that is enormously reassuring. And that's one of the key value adds of an SMA portfolio.



Hector Negroni (10:15):

But there's no free lunch and



Adam Stern (10:18):

No, correct.



Hector Negroni (10:18):

You should be aware of the fact that the more the concentration of participation as marketplace falls in the SMAs community's hands, the more it's less flexible and the more it's less solutions oriented. It works wonders and it should work wonders when issuance increases, which I think we all kind of believe and we'll talk about. I think the need for financing has to grow. We haven't borrowed more. We're largely very under levered as an industry. The issuer community is very under levered relative to GDP growth relative to needs and demands relative to risks. And that solution can't uniquely be solved by the most passive expression of investment, which is largely the SMA audience. So it has a lot of great qualities to it, a lot of depth, a lot of insatiability, but it's more for a narrow channel of interest. And if you fall outside that channel, things have not gotten easier for you.



Thomas Doe (11:16):

Well, the other important point too is that when, since the underwriters want to move the bonds quickly, when they do the primary deal is that when that demand component shifts, and we saw it with the mutual funds to the SMAs, is there's about a six month lag in terms because the distribution arms atrophy of investor side who's not the dominant demand component because everyone's trying to structure deals for the one who's going to buy the bonds most easily. So as you're pointing out, Hector, things get more difficult when you get off the mainstream.



Adam Stern (11:50):

Yeah, correct.



Lynne Funk (11:51):

Meaning particularly that chunk of 22 where things were pretty hairy out there for the market.



Hector Negroni (11:57):

And I think historically we've thought about in getting off the fairway as having to do with technical factors of a lot of volume or a headline risk. And I think as we're going to discuss getting off the fairway going forward, is that the needs to be financed are different and changing and evolving, especially when you think about them in the wake of climate risk adaptation.



Lynne Funk (12:21):

Okay, so let's move into an issuance because right now, as of this month, we're about 33 or 34% over year over year, potentially beating 2020s record of 480 billion. Tom, actually, your firm's projecting pretty major growth in issuance particular over the next decade. And a lot of that's led by your thoughts on climate related changes in severe weather events that are going to force issuers hands. I think perhaps, sorry, 50. Alright. 50 basis points fed. Cut. Interesting. Okay. Alright, well I'm wondering if fishers are going to borrow even more now I rates are going to fall, so I'll speed this up. So I guess the question though is different people have different thoughts on issuance projections and maybe Tom, why don't you kick us off why you think it's going to grow and then we can get a little bit more into the climate aspect of it as well.



Thomas Doe (13:26):

So we've had, in the municipal industry's history, there have been four decades where the decade over decade growth has been a hundred percent. And that was in the 1920s when revenue bonds really started to evolve. We were also just reminding me that municipal bonds were used for soldiers bonuses, veterans, of course, roads and highways were involved 1950s. Again, revenue bonds again are dominant and for electricity, utilities, and again for turnpikes, we saw growth go from in that decade from 23 billion to 67 billion, right? So pretty large growth. 1970s, we saw it again occur over the 1960s and the 1980s we saw that as well.



(14:22):

Refundings of course is going to fuel. Now with lower rates, we may see more refundings next year, but the big driver of all of it is in the 2030s we believe is that we'll see a trillion dollars issued by the municipal bond industry on an annual basis. And that's going to be fueled by, and Ben Watkins alluded to it earlier during his panel on adaptation needs, and that's the municipal market's bread and butter, right? It's brick and mortar. Mayor Benjamin was talking yesterday about the floods in the Carolinas and we saw it in North Carolina, just had a huge rainstorm. So going to be storm water, it's going to be heat, it's going to be all aspects of flooding. So I believe is that the climate is going to drive and raise the priorities around climate oriented projects. So adaptation projects, the federal government will not be there.



(15:22):

The IRA money, which we've heard talked a lot about 90% of that went toward mitigation as someone said, save the planet, cool the planet and only a hundred billion of it went to adaptation. So again, trying to deal with the consequences of climate, not trying to solve the warming planet. So in my discussions with different sustainability officers, resilience officers, this is the big opportunity for municipals in the capital markets because they don't know about the capital markets and there just needs to be that discussion because all they're looking for is federal funding. They're looking for grants which are pennies, and the projects that are going to be needed are going to be massive. And then on top of that, we're going to see migration issues that'll eventually occur. We've already saw them during covid that where people went to lower income state taxes and people are going to be migrating from areas of climate risk to areas of climate safety.



(16:28):

And with that infrastructure will need to be expanded to accommodate the shifts in population. There's going to be needs, of course, to stabilize in those areas where it's not, so it's not going to happen overnight. We think it's probably 10 years away. And with that, it's going to come the credit risks that I alluded to earlier. And that's going to be the challenge of how to monitor those credits, how information is disclosed about the risks. But to me, I think it's just the absolute opportune time. If I were 30 years old and coming into this industry, the intersection of public policy infrastructure needs the necessity to deal with climate's. Consequences would be, I think it's going to be one of the most challenging, exciting times and eras that we're going to do. And I think the municipal industry is going to make a ton of money.



Lynne Funk (17:26):

So let me throw this out real quick. I know what you're going to talk about. I want to make sure we get it there though. What's the willingness of the issuers to come through with this?



Hector Negroni (17:31):

That's where I was going to go. I think this is,



Lynne Funk (17:33):

Thank you.



Hector Negroni (17:33):

What you're supposed to tease out from what Tom's saying and from the spectacular depth and breadth of the capacity of the SMA money is why aren't I levering myself up more? Why am I holding to the sacrosanct, pick your rating, my AA minus my A plus, take it down a notch, borrow more. You're not going getting over your skis. You have extraordinary capacity as issuers, multiple sources of operating leverage and monopolistic capacity, and there's a massive pool of demand for what you want and you're not being charged for it. The time is now



Adam Stern (18:14):

Waiting



Hector Negroni (18:15):

Yeah I am Waiting For the bonds.



Adam Stern (18:15):

Yeah, I got it. But yeah, we are definitely waiting for the bonds. We'd love to see the bonds. As Tom said, the SMA buyer is, it's a retail yield based buyer, so there's going to be demand if you come with a 6% coupon, that's a double A in some future state, people will buy the heck out of that. It's not going to come at a 6% yield, it's going to be still range bound in that three point a half to 4% range, whatever. It's, I guess I have a bunch of comments. I could talk about that. So Tom and I have done a couple of these now, so I'm not totally sold. We'll be quite as big a market as Tom thinks I am sold. The market's going to be bigger. There's a great economic historian, I think he was at the University of Maryland, Joseph Wallace, who has this kind of theory of how state local federal governments borrow when they borrow.



(19:00):

And I do agree a hundred percent. The federal government's a big problem here. When I came in, Ben Watkins was doing a spiel on the federal government. I couldn't agree more. The federal government, it's an unsustainable situation. They're not going to be there. What this historian talks about is that when the political and fiscal cost, interest cost, but not just interest, tax costs, et cetera of financing yourself becomes prohibitive, what you tend to see is a rotation into another level of government to finance needs. So in the depression, you saw this for the local governments got out over their skis, what happened? It collapsed. And you see the state governments pick up the slack. It's happened in different periods of time for our 250 year history. And we're approaching a period, not necessarily in part for climate change, but not wholly for climate change, but in part just because of the federal government's fiscal condition must be financed either through cuts or higher taxes.



(19:55):

And when that happens, the flow down to the state and local governments will not be there. And as Hector's saying, they're under leveraged. If you look at debt to GDP ratios, we're down from, depending on how you measure it, excluding slugs excluding funding 18 to 20% of U-S-G-D-P almost to 10, again, depending on how you measure it. But that is a significant amount. We've been at 4 trillion now since 2010, something like that. So there's much more capacity, especially at the state level where you have climate risks. The issuers are reasonably healthy. So Florida is the epicenter. If any sort of climate data you look at, Florida is the epicenter of climate risk. They're going to have to do adaptation projects, they're going to have to recapitalize cat fund citizens. Property insurance can continue to have issues they're going to be dealt with. It is affordable, it is manageable, but somebody's going to have to pay for it.



(20:57):

When I do the math on the issuance, if you look back to 1980s, for example, the largest 20 year period that you see in terms of new money issuance on a year over year compound annual growth rates, it's usually around five to 6%. If you look at maturities in the market, we would have to grow if it was over the next 10, we would've to grow at about eight to eight and a half to kind of double the market. But if you're looking further out, I mean I do agree that's when the impacts climate change are going to be more acute. You're going to have more public willingness to borrow. So the market's going to grow, whether it's a doubling, whether it's up 25%, whether there's some privatization in there that goes on, we talk about p threes today and getting stuff off the books so that issuers don't have the risks, especially in perhaps some of the revenue bond sectors.



(21:46):

One question you'd sent along Lynne, or kind of a piece of this is why haven't we seen climate risk priced? There's a ton of reasons why I haven't seen climate risk. So the first is, is we're still dealing with the best municipal credit environment in 40 or 50 years. I mean, we're getting towards the tail end of it, but if you look at the amount of federal money before the IAJA that was spent during covid, depending on how you measure that, it's at least equivalent to the post-war period and the new deal in terms of flow down to state and local governments or possibly more. Again, that's before the IHJ. So that's there. We've had good economy except for a couple months of covid for 12 years. That's generally good for credit. The rise of the SMA buyer, the SMA buyer doesn't like to buy very long.



(22:37):

They like to buy within 10 years. So we've had our first inversion of the yield curve inside 10 years for the first time ever in the market, just in the last couple years. And that's because retail investors like to buy five-year bonds in these sma and they're just going to look for that five-year bond and pressure it down. We haven't had the supply. So the ratios are coming down, the spreads are down, and so there's just too much of a technical support. And then in terms of the climate disclosure, it's immature. So it's gotten much better. If we have a thing where we'll strip down all the official statements in the market and look at them over time, mentions of climate change have gone from about under 3%, call it 10 years ago to upwards of 30% some months in official statements. So it's getting better, the standardization, the quality of the information, again, incrementally better but not remotely close to what you would want.



(23:35):

And so all of that is about to change. And when, I don't know, someone once told me when I started doing this, never give a date or an amount when you're making a prediction. So I'm not going to give either, but it is going to change. And the reason it's going to change is the data's better. You have spatial finance companies, other companies showing you where the risk is. So as an analyst, you can go and query like, okay, I see they have high risk. Are they doing adaptation programs? You have more examples, concrete examples of, I dunno if I would call them climate defaults or climate super downgrades, but they are climate adjacent credit events. So the most recent one is Clyde, Texas. But we've had Southwest Public Power Agency in Arizona a couple months ago. Obviously the Hawaii electric stuff, I mean there's probably 10 to 20 in the last five years depending on how you want to think about it. So this is coming and an issuer should be prepared. So I mean, I agree. If you are an issuer and you have a long-term project and you're thinking through some of these issues, do it sooner than later, especially if you just have aging infrastructure, which is an overlapping related problem, but it seems to make sense.



Hector Negroni (24:57):

I don't want to lose sight of the competition for financing that comes from other needs that are also resource constrained. We obviously have an extraordinary delayed CapEx Opex issue. We've had enormous demographic shifts in this country post covid that are about people who left an area to go to somewhere else and now work remote. And that put enormous pressure. I know when the last time I was in Austin, I was there, not just recently, like traffic's awful. Sorry if anybody's from there. It's a lovely town, but there's too many people and not enough space on the road necessarily. To oversimplify, there's anecdote upon anecdote of how demographic shifts have played heavily into places. You also have a reindustrialization. People are either looking for either tax jurisdictions or particular workforces to do fairly large projects, fairly large footprints, whether it's assembly of particular products because they want to do more make and main American vehicles, electrons in the United States or whether it's dealing with the demand and growth for data centers to feed ai. There's an extraordinary range of competing demands for financing and climate risk is just one of them, and it's a big one. And that means you should be, issuers should be moving quicker and frankly levering themselves up a little more because the demand's here now,



David Narefsky (26:19):

So I think you mentioned this earlier, Hector, I was curious to follow up about issuer reluctance to sell more debt. And I'm assuming, but maybe part of what you were surmising is I'm nervous I need the money, but what I don't want to happen is I want to have a downgrade because I'm going to look bad. Someone's going to criticize me. I'm going to get an editorial in the local paper that I can't manage the cities or state or whatever the issuer's finances is. And so it takes some vision and courage to overcome kind of those normal kind of local issues. Yes.



Hector Negroni (27:01):

The extreme end users of the public finance process are individual investors and local governments, and both of them are reasonably risk averse, not really entertaining reputational risk. I always say when I used to run an underwriting business when I went back at Goldman, I'd used to say like they're in the operations business, they're just not in the finance business. And so it's incumbent on us to comfort them, to show them the path, to tell them why that makes sense. And I think that there's an unnamed legion of people who just don't want to, things see things change and they need to grow up and realize they're losing squandering opportunity.



Thomas Doe (27:39):

But I think the rating agencies, and there are some representatives here in the room, but I think they're going to start to change because they recognize that there's a need, a different way of communicating the risk that's conveyed by the singular alpha, the letter that all the individual investors look at on their portfolios that Adam manages for 'em, right? They're not looking at the credit review. They're looking at is it aa, is it a bay plus, whatever it may be. And I think what's going to happen is there's going to be better communication of that risk going forward. All the rating agencies have invested in climate data companies and analytics in order to put that information together as Adam, me, there are plenty of providers now that are providing the climate analysis to the CUSIP level. ICE is one of 'em. First Street Foundation is another one. And so the information is readily available. What's going to be, I think the rating agencies will recognize that doing a project that's looking 10 years out to solve a problem 10 years out, taking on that risk leveraging today for tomorrow can be well documented that it's a good financing to undertake because the risk is going to be so well quantified.



Hector Negroni (29:04):

I think we're going to see, and David and I have talked about this in the past, I think we're going to see a discussion about the unfunded liability, not about pensions. What's the unfunded infrastructure liability? What's the unfunded climate risk liability? When you take that into account, the rating isn't as important as the understanding how that has a consequence. Those are pretty meaningful contingent liabilities.



Lynne Funk (29:29):

Great. So actually I think we've now talked about the traditional uni market growing.



Hector Negroni (29:35):

Go out of order.



Lynne Funk (29:35):

What's that?



Hector Negroni (29:36):

Did we go out of order?



Lynne Funk (29:37):

Did I go out of order?



Hector Negroni (29:38):

No, go ahead.



Lynne Funk (29:39):

Did you guys go out of order? Of course you went out of order. I knew that was going to happen, but I'd like to pivot to the alternative investments at this point because I think there's the muni market, but we also know as this conference is highlighted, there's public private partnerships. So maybe we start though. Actually, let's start with P threes. David, maybe you could kick us off with this one. They've grown in the space, several folks in the room have done them. Why do you think they would work and why do you think that they haven't been utilized as much?



David Narefsky (30:11):

So it's interesting to look at the last 25 years. I mean, it's true that there probably were transactions that we would today call public-private partnerships done sort of episodically before that. But it wasn't really until the beginning of the 21st century that we had kind of a concentration first of a few highly visible long-term leases, asset monetization transactions, which were followed by a small number of very successful, accomplished new construction public-private partnerships in the transit space in particular. And I think that maybe as happens with many situations like this, people started to think that this was a solution for more problems and maybe rationally made sense. So maybe there was a little undue expectation of how much a public private partnerships could accomplish. But also I think it's worth noting that if you depends on how you measure them, are you going to measure them by the number of transactions that are done or by the asset value associated with the transactions?



(31:26):

Because legitimately public private partnerships tend to, there's lots of upfront costs, there's lots of transaction costs, there's advisor costs, and so there's only a portion of infrastructure in America and only a portion of issuers in America for which I think public-private partnerships make sense. And those are the ones that they get a lot of visibility. They're also, whether they were public private partnerships or not, they tend to be very complicated projects. They have lots of permitting requirements, they've got a lot of public input, so they take a long time to get done. When you put all that together, I'm not sure that a number of transactions that we've actually seen in the market and are in the market today isn't necessarily an inaccurate sense of how much there should be in the market. Now, Morteza was talking earlier today about one thing that the Build America Bureau courtesy of Congressional Authorization is trying to do, and that's to provide some of this upfront diligence cost to smaller issuers to smaller units of government, which may produce more activity beyond the large cities and states and special purpose governments where they all can't be 6 billion airport terminals.



(32:52):

So I'm not sure that, well, there's probably a place for it. And it may be that in the climate and resiliency area, there may be some particular areas where the marketplace can be especially helpful just as it's now been an energy kind work that people were talking about earlier. I think that that's sort of my initial perspective.



Lynne Funk (33:12):

Hector, what about you? You were kind of unique in this space in particular. Talk about what you do. Talk more about theirs.



Hector Negroni (33:19):

I mean, listen, public-private partnerships are a subset of the toolbox, and that's how they have to be thought of in my view generally. They usually are a valuable application for when the asset or the business if you will, really doesn't belong in the portfolio of the issuer. I've always contended, airports are a great example. I get it that they're in the physical footprint, but they're largely so regulated by the feds and so unprofitable in some ways that they should be more privatized. And I think we've all traveled enough outside the united to realize, wow, they're really nice. So when the asset or the business or parking garages or whatever else you think is the relevant business activity or asset that should be privatized, government's got to decide what business they're in. And the other thing is where there's a particular expertise in maybe technology, for example, at a very smaller size, we see a lot of renewable gas projects on landfills.



(34:15):

And so that's an interesting place for us to middle. That's not a natural place for the government to be involved. They have the asset, which is the landfill that can benefit from the financing of it, but they only don't want to operate it. So P three should be part of the toolkit in its entirety. And frankly, one of the people who is in an unsurprising lack of leadership, the federal government once again falls down in showing the way this single most successful public private partnership in the United States history is military housing privatization approaching 25 or 30 billion. It worked perfectly fine. I think there were maybe one or two very minor credit issues, and it was an asset that the government really didn't manager very well. We all know the federal government administers projects rather poorly. And so as a result, they should be leading by example. They've extraordinary of assets that they should be finding partnership capital with. And then that would make it easier to move downstream to people who are far more reputationally at risk at the local government rather to pursue those initiatives.



Lynne Funk (35:23):

I would say. What about national infrastructure bank? But that term's been, or that has been thrown around so many times now. I mean you just kind of laid it out there that perhaps maybe, maybe no,



Hector Negroni (35:35):

Sorry, breathe advocate, just get out. What a terrible idea. But yeah,



David Narefsky (35:39):

I'm not a fan either. But



(35:42):

We could take a poll. But it's interesting. This got a lot of attention. I think starting around 2008, both in the wake of the financial crisis during the early part of the Obama administration, and I think it is periodically, there's still every year it seems that some group of people and congress, senators and congressmen are introducing a bill of some kind under the view that this is going to solve a large part of our infrastructure of financing needs. So one, I can't imagine there's enough political banks are like a dirty word. So having an infrastructure bank is not something that Congress is ever going to approve right now. Second, I think in some ways we have a national infrastructure bank. Now it's to build America Bureau that it's doing TIA loans, it's doing RIF loans now it's going to do TIA and RTOD loans. It's issuing, allocating private activity bonds, that Congress of surface transportation.



(36:49):

It's doing a variety of things in that space. That's a really helpful function. And I think with people like Morteza running, I dunno if Mort is still here, I'm going to give him a big shout out because for the last five years, I think he's done a very good job with his team in using those tools and making them more available as a supplement traditional municipal finance. So I think that's great that when people talk about national infrastructure bank, my sense is we have one, maybe we could improve on the one we have now, but actually trying to create one out of whole cloth as it's made people do in some other countries is not going to happen.



Thomas Doe (37:27):

I can remember when Ed Rendell testified before Congress in 2010, I think it was about the infrastructure bank and champions and how great it'll be to have all that capital from China to come in and build our US infrastructure. So I just kind of think about that now. Great idea. I'm sorry, that's a Philadelphia icon right here. Well,



Hector Negroni (37:53):

The concept's just a little lazy because what's missing? The thing I think you wanted to go a little bit about alternative capital a little bit was listen, the vast majority of needs can be well-served by traditional tax exempt capital. And the opportunity is really now because it's this vast growing pool that's demand that has lots of capacity. By definition though, it doesn't solve everything. And at the margins, there are deals that don't either fit the exemption, don't come with a rating or too small to get really big investors in it. And so I think what we need to be thinking more about as we think about infrastructure writ large is as the demands grow, we need to begin to embrace the idea of the term out there. Blended capital stack gets used a lot. Listen, it's about making the parts of the financing that are available to you. Maybe there's equity capital to be had or equity like capital to be had from the feds. Maybe there's philanthropic capital that can be had equity capital. Then there's a stable senior capital base that comes from the traditional marketplace. And then at the fringes, I like to play.



Thomas Doe (39:00):

So Hector, we talked about this before on one of our prep calls, and I think one of the, and I was asking the question, I don't want you to follow through in the way you said on the phone. So when Adam passes on a deal and now it comes into your world, what's the credit review that you do in order to deploy your capital for whether it's an alternative structure, whether it's a traditional deal because you're getting calls with deals that have problems, they're problem troubles, and you step up and you've built some good relationships with firms to help a source of capital.



Hector Negroni (39:41):

We usually get the call because it doesn't fit their interest channel. And as soon as it falls out of that channel, it's not investment grade, it's taxable, it's off the run. It requires some flexibility, patient capital, some element to it. It usually comes to a little half baked because for most of the universe there isn't a natural capital execution for non-traditional or off the run financings. And so we take the mindset of being a solutions provider. So people come and say, Hey, listen, we want to do this really long, a hundred percent levered, no equity taxable deal against this project that hasn't even been built yet. And say, okay, why don't we do something we'll lend against, which is maybe shorter dated financing. It's a little more expensive. You're going to put up equity and you'll get some traction on the ground and then you'll take our risk out and you'll go replace it with much longer term stable lower cost capital.



(40:37):

And I think that idea of that, what we tend to do, Tom, is we tend to see things that come in are like the cake isn't assembled exactly right. They got a lot of the ingredients there, but it was in the oven too long or too little or whatever. We got to kind of fix that a little bit and we address that with a lot of solution structuring and I think that's because the demands just go back to my point. I mean this whole strategy that I've set up in our infrastructure debt fund, for those of you who don't see Andy back there in the corner, please bring 'em all your deals.



(41:07):

It's arising because the demand for financing for infrastructure is percolating beyond the capacity of the traditional markets. Regional banks are increasingly more challenged to provide capital. They have deep, deep demand within a narrower channel. And if a deal isn't big enough, you really can't call the insurance companies. And so we want to fill that gap. We think there's a big void in there, and I think that that's frank. I think we're going to have a lot of competition. I think we're early. I think in five years there's going to be a whole bunch of 10 years ago when I left my old job to start a hedge fund, somebody said There's no billion municipal hedge funds. There's now 10. I think in the same way we're early here, I think a flexible patient capital, kind of a private credit style approach to infrastructure at the local level is going to only grow in terms of opportunity. And we're going to have competition probably from people in this room in the next five years.



Thomas Doe (42:02):

I have to think too that some of these, I was mentioning these ultra high net worth clients who have exorbitant amount of capital, who are looking for opportunities in the space, looking for some tax efficiency are going to seek out.



Adam Stern (42:18):

I think that's going to happen,



Thomas Doe (42:19):

That growth.



Adam Stern (42:20):

So I mean even this year, if you look at the supply numbers, I think it's like 14% of the market's private placement. I don't remember ever being that high. And the reason is you have whatever it is, 70, 80 trillion wealth transfer happening now every week. I think it's like 10,000 baby boomers are retiring. I mean supply demand, I mean, we can use more supply, but as Hector's pointed out, the market can absorb this. We've got households in aging Americans who are under allocated to bonds and they're going to want to buy more tax-free bonds. And so I think there's plenty of stuff there. If I may, the infrastructure bank idea, I couldn't agree more. I think mean if what we're talking about is the Build America Bureau, which I don't view that as an infrastructure bank. I view that as a kind of federal facilitator with a limited budget that does a lot of good things.



(43:12):

Like a true infrastructure bank, I don't think makes any sense for the United States. I mean, we have no shortage of capital if we wanted to. I mean certain people in this room would hate this idea, but you could bring back Babs and restructure it and access trillions of dollars of global capital for the most mature infrastructure market in the world. And so we don't have an issue there at all. You'd have all sorts of federal local control issues and it's just a mismatch. If you look at the market, there's 127,000 bond series in the muni market. 50% of them are less than $12 million. I mean, the last infrastructure bank proposal I saw was to capitalize an infrastructure bank for $5 trillion, which is 25% larger than the 4 trillion muni market. What are they going to do? Lend money out in little 5 million pieces to Iowa school districts? That's never going to happen. So it's poorly thought out. It addresses the wrong problem. The federal government candidly probably can't afford it. It's got an enormous amount of political challenges. The reason other countries do it is generally to kind of seed in extra capital for infrastructure projects that they actually need because they're small open economies. They're not like the United States. It's just totally misplaced. I would just advocate anybody in this room who hears about it think



Hector Negroni (44:34):

Hard about it. It doesn't make any sense. It's just upside down As it relates to procurement, funding, financing and generally ownership of infrastructure assets is largely, I intensely local at the United States.



(44:48):

We're the only developed western country where that's the case.



Adam Stern (44:51):

In other countries they're trying to replicate more to some extent.



(44:55):

We'll see if they get there. Yeah, we have



Hector Negroni (44:56):

200 years of doing it effectively. We have a little bit of a runway. But they're looking to expand their domestic bond markets. That's correct. I mean it doesn't, but they tend to do it at the federal level. If you want to build a highway development program in Portugal, it happens in Lisbon, and the decisions are all made there. Whereas by contrast here, I like to joke all the time when I'm talking to 'em, a lot of our clients are non-US, most of 'em foreign investors. I like them. I have to explain to you, every school district in Texas thinks they're a separate country,



David Narefsky (45:26):

Right? The glory and the challenge of federalism. By the way, Adam, just to be clear, I only call the Build America Bureau or National Infrastructure Bank to people who think a national infrastructure bank is a good idea. And I tell them, well, we have something that's working in that direction



Hector Negroni (45:40):

Already. There



Adam Stern (45:41):

You go. Every time I hear it, I just, well,



Hector Negroni (45:43):

I'd love to post some and see how Tom racks it, because I mean, nobody's suffered the slings and arrows of testimony in Congress more than Tom. Thank you. Never doing that myself. When I think about what the government could do better, that's an interesting question.



Thomas Doe (46:02):

Well, and this is the big takeaway. I mean, I had the opportunity in this past January to address the Senate budget Committee and one of the exchanges I had with Senator Braun who's going to be the next governor of Indiana, and he says to me, we're talking about municipal bonds and funding climate, and I talk about the size of my, what we just talked about, the growth of the market, and Senator Broco. So Tom, you're not here looking for funding from the government. You're telling me that state and local governments can finance these needs. And I said, yes. He goes, that's great. Now, the other aspect of that experience down there with the other senators, and now that committee is that there has been, from the staffers that I've been in contact with who have been in discussions around 2025 potential change in tax policy is that munis aren't in part of the discussion.



(47:11):

So there's a lot of hand wring about everything's on the table, everything's the exemptions at risk, and various trade associations are getting all fired up about it. But I'm not hearing that. I am just one guy. And I think the other thing, and Hector and I talk about this a fair amount, is that with this growth of the industry is that the municipal industry has a rare opportunity in its history, in its interface with DC to champion its role and how positive and important it is to funding infrastructure. And once again, we talk about this all the time, every conference about how much 75% of US infrastructure is funded by municipal bonds, and we go on about this, but we just don't engage Congress appropriately. We don't talk to Senate and the house and educate them and have them aware of it. They really don't know.



(48:13):

That being said, again, it's not coming up, but I think with the growth we've got, and this is why I get excited about the climate issue because it's going to touch every aspect of our market. It's going to take touch every state and local government. It's going to be the issue of this generation, and Congress is going to be paying attention. They know they don't have the money. We all know that. We've all saw the graph in the Wall Street Journal about the deficit and all that, and they're going to be looking for the state and local governments to finance these critical needs that their constituents are going to want solutions to, and the industry is poised for that role. It just has to season.



Adam Stern (48:53):

So a couple of points on that. I think one kind of concept trickling through everything we're saying here is we don't have a financing problem. We have a funding problem. So we're talking about willing issuers be willing to do this, right? There's about 10 states that don't have any debt, right? I mean, South Dakota, I don't know the last time South Dakota issued a bond. So it's ingrained whether because of state local debt limits and the history of the psychosis associated with credit events from 50, 70 years ago or whatever it is. So that has to change a bit. And then real wages, real incomes have been down the last few years starting to come back now, but people are not feeling in a mood unless they're in a fast growing place, the Texas of the world, et cetera. But certainly in New England, like where I'm from, people aren't always in the mood to be raising taxes anymore than they're already taxed.



(49:49):

And so this is one reason why I'm a little less sanguine about the market growing as much as it's going to grow because it has to grow. I don't think it's going to grow because of public willingness. People will fund the projects they absolutely need to fund, but this is the problem. Everybody's dancing around when you're hearing about infrastructure banks and going into the federal government for money, Tom's right, it's a pittance. It's not enough money, but it's, it's really people trying to solve, Hey, I can get an extra couple million in a grant here from Department of Transportation. That's nothing. That's not going to solve a lot of problems. That's not a reliable source of funding and what the market could use even before we get to a place where we're issuing a lot more bonds and it's on the taxpayer dollar, the rate payer dollar, at least as it relates to the feds, is just get some certainty there.



(50:41):

I'm a little less, I do agree the likelihood the tax exemption goes away or is meaningfully changed is a low. But I also think based on the last 15 years, 20 years of history and the proposals that have come out of Congress in the haphazard nature of lawmaking and the fact that if you're a house member, you may get presented with, tomorrow, we breach the debt limit. Here's the deal, yes or no, and that's your choice from leadership. And it happens to have eliminate private activity bonds from some Yahoo who put that in there. It could happen. I don't think it's a high likelihood, but I think it's in the back of my mind, maybe a little bit more than these guys. But short of that, the highway trust fund is probably the main thing the federal government could be doing. Come to an agreement and authorize that for as long as you conceivably have, even if it's not as much money, if you can get a longer authorization window, there's some certainty there. You can do p threes to help. You can do some other stuff. What we have now is craziness, which is two six year authorization now comes due 26. Is that right? I think it is.



Thomas Doe (51:51):

The industry needs to talk in a bigger way about what its role is and articulating that to DC



(52:01):

And not go in on a tactical basis, oh, it's private activity bonds or it's bank qualified. It needs to be kind of put its chest out a little bit and say, look, this is what we've done as an industry. This is what we are capable of doing. This is what we're interested in doing, and here's our toolbox of solutions. And then saying, this is the discussion we should be having and having it now before it gets to a point where, oh, where's the cut going to come? And then we're responding again. We tend to be a fearful and responding industry as opposed to initiating an offensive. And I think there needs to be a change in that mindset of everybody here in the room. Okay,



David Narefsky (52:43):

So this would be going beyond worrying about advanced for fundings, correct, yes. The other thing, this is maybe just the bond lawyers, wishful thinking, but one thing that probably would be helpful in a small way is to sort of rationalize the rules. Every time an exemption was passed, there's a different rule. So airports have one rules to follow. Highways now and mass transit have a different rule to follow. It makes no sense. And also it probably stifles some of the, Hector was very legitimately talking about airports make really good sense to have more public private partnerships. Well, the tax exempt bond rules don't exactly make that easy. They make it a much easier for transit projects and highway projects. So that would be a small but helpful thing to do.



Hector Negroni (53:28):

That's why you need to unleash public pension dollars to be equity for those and let them borrow tax exempt.



Lynne Funk (53:34):

Big ideas. Big ideas, big issues and big ideas. Unfortunately, we're out of time, so if anybody has questions for our panel, you're going to have to grab them after. But I do think we can come up and we can say we want fiscal federalism. There are investors, issuers sells more bonds, and I think that's about it. Right. Thank you very much to our panel. Thank you all for being here and we'll talk soon.