The role of munis in the future of cities

During this 30-minute presentation, Arizent's research team will present their findings on the topic of the future of cities and how munis will help shape it. 

Transcription:

Michael Moeser (00:10):

Okay, I think we're ready.

(00:13)

Hello. Welcome everyone. I'm your moderator Michael Moeser. I'm a Research Analyst at Arizent, Parent Company of Bond Buyer. Thank you. We're gonna be talking about highlights of a new report that was released on Monday, the role of munies in the future of cities. And I'm joined by two gentlemen here on my right hand side we have Ben Watkins. For those of you who don't know Ben, you can easily read page two of the magazine and later tonight at the Hall of Fame induction process. And then also Chris Jumper Director at Assured Guaranty as well. So, We conducted a research study back in August and September among the Muni marketplace, the stakeholders. We surveyed about 150 people, 152 to be exact. And we asked participants in the market what they thought about infrastructure issues and policies facing US, cities and towns. And we really dove into get a handle on the sentiment about the various impacts of macroeconomic events, policy decisions, and the ability to solve those challenges. And we're going to the first section here. We're gonna talk about concerns, priorities, and confidence. And I heard this a few times this afternoon. What keeps you up at night? And in terms of the challenges in 2023, you could almost say what are the things that keep you up at night? And by and large, the recession was in about a quarter of people's minds. And if you look at the top four, it's about 65% of the respondents said it was something along the lines of the rising interest rate environment, inflation confidence in financial markets. And so I guess I'd start off my first question maybe to Chris, what does this mean? Are we gonna see lower bond issuances? Are there gonna be rising spreads? What's your thought on that?

Chris Jumper (02:18):

Yeah, so first of all, thank you very much. Great opportunity to speak here and thanks to the Bond Buyer for allowing me to participate on this wonderful panel with famous Ben Watkins. So thank you very much. As far as recession rising, interest rates, inflation, I mean volatility, they're all kind of linked and it remains there's a lot of widespread concern about recession whether or not it's an official recession, it's kind of semantics. Prices are still going up. You've got Americans and municipalities are still struggling. I think there's been a little bit of signaling that inflation is moderating a bit or cooling a little bit. So you know, might see maybe the Fed start to back off the really aggressive interest rates. But again, prices are still going up and I think it's a challenge. I think you have a lot of costs that are associated with it. And we heard before also that entrance costs are significant and they make it a more expensive, you've got rising material and labor costs, which is gonna impact decisions on financing, decisions on the size of projects. So I think you could see some contraction if it continues.

Michael Moeser (03:45):

Ben earlier an earlier session, there was a gentleman from Moody's and he gave his projection that I think it was like 6 or 7% growth next year. And every year thereafter it seemed to be going down. I guess with what Chris is saying, rising costs are projects gonna be put on hold in 23.

Ben Watkins (04:06):

Well, so as I look at those factors and think about, inflation is numer number one there absolutely no doubt about it. And I think it's probably understated in some respects from where I sit, inflation, what the Fed did in federal monetary policy combined what they did in fiscal policy with R, the combined impact of those two things was like pouring gas on a fire that was already raging out of control. And the way we're having to pay for that is through inflation. And we are talking percentages and naturally the rate's gonna decline. But we've got projects coming in 20, 30 and 40% above estimates. And so that's significant.

Michael Moeser (04:52):

Well, that probably limits how much a municipality can do.

Ben Watkins (04:56):

Absolutely.

Michael Moeser (04:58):

So, let's talk about priorities coz that was another area that we looked at. And this is a little complicated chart, but if you bear with me at the bottom side, we asked survey respondents, what are the areas that you think are the most critical over the next five years? When we heard a lot about roads and bridges, particularly the last session from the ODOT folks. And then on the left hand side you have the investments and what you see in the box the highly prioritized, clearly roads, bridges, water, sewers, some basic infrastructure. But on the left hand side, we've circled the under prioritized areas. And I guess my question to you, Ben, maybe to start off with, are schools under prioritized?

Ben Watkins (05:43):

Well, so all I can do really is speak to Florida and what our experience is, and we may well be the outlier on all of this just in terms of what we've dealt with. So, constitutional amendment limiting class size eight years ago. And so we've already been through the process of financing all of that at the state level and pushing it down to the local school districts. So really the priority of the current administration has been teacher pay and getting the minimums up 47,500 is what was the goal. And several hundred million invested in on a recurring basis in getting teacher salaries up. So that's been the focus and the emphasis in Florida because our infrastructure is, it's all new everything. So we don't struggle with some of the same issues that other governments do across the country.

Michael Moeser (06:38):

Chris, is this more of a I guess a here and now in terms of is this prioritization a function of the current forecast or is this something systemic?

Chris Jumper (06:48):

Well, I think it's a little systemic and I agree with Ben you know, did have the build back better school action plan. I believe it was like 8 billion dollars that they assigned for it. But the American Society of Civil Engineers identified about 380 billion of school related projects that need to be undertaken over the next 10 years. So, it's like throwing a minuscule compared to the demand that needs to be undertaken. I do agree with the high priority of the water systems and roads and bridges I mean our economy basically is dependent upon our infrastructure, our roads, our bridges, our toll roads, our airports, our ports, our electric systems, water systems and sewer systems.

Michael Moeser (07:40):

Well let's talk about the optimism and also the concerns from a legislative perspective. What we saw, and I'll cover these two slides quickly so we can get perspectives from both Ben and Chris, when we talked to the muni stakeholders in this survey, about half said they were optimistic, either very optimistic or optimistic to get things done in the next five years. And there was a slightly higher degree of optimism over the next 10 years in terms of getting those critical infrastructure needs met. Now when we asked another question in terms of the confidence in the current legislative actions and policies, we only had about three in 10 or about half saying that they're confident in the current perspective. I guess maybe I'll turn to you, Ben being from the state of Florida, what needs to be done legislatively and does more of this fall on the state and local government shoulders?

Ben Watkins (08:37):

Well, so my perspective on all of this is I mean you think about it, some of the acronyms we use, the inflation reduction acts, it was exactly the opposite. So, people want to do things and they want to take credit for it, but where the rubber meets the road is really in how the money gets deployed. So, as I think about the inflation reduction act or the IIJA or whatever you want to call it really the devil's in the details and on a lot of that there is so much, it has so much baggage hanging on it, so many conditions on it, whether it's fair labor.

Michael Moeser (09:15):

I Just say give me an example.

Ben Watkins (09:15):

Back better, all of those things. That's not the way we roll in Florida. And so I'm very concerned. So as, see Emily Brock up here, she's the beast. I've given her a name because of the role she played and!

Michael Moeser (09:30):

I'm imagining these two people riding on a Harley, racing each other down the highway.

Ben Watkins (09:36):

But in terms of, I think about ARPA funding and I think about the rules that were necessary to implement, if not for her persistent prodding of the bureaucrats here in DC to give clarity around the rules.

Michael Moeser (09:50):

You realize we're in DC right now.

Ben Watkins (09:52):

Yeah, I get that. But that's never stopped me before. So I don't know why this should be any different. My roleplay is shortening, I don't give a shit back off the chart. So you get the unfiltered version of what it's like to live in the provinces and have to implement some of the things that the heady people here in DC think that they're contributing to. So, it reminds me of Teddy Roosevelt saying, which is have your eyes on the stars, but your feet on the ground. So, the feet on the ground part is what they don't get here in terms of how is this really gonna work? When I look at the infrastructure reduction at a lot of that funding is for things that I can't even pronounce relative to carbon sequestration and regional infrastructure for all of that. I'm going, well I don't even know what that is. So I don't see how that's going to I don't see the feasibility in deploying that. So great high minded, changing the world kind of stuff. But the practical reality is when it comes to actually deploying the resources that's where I lack the confidence that this is really gonna move the needle in a meaningful way. I agree with Chris, the water infrastructure, everybody can agree on that. But again, we've got disparities depending on where you live and who you are. We don't have lead pipes in Florida, we don't have the same issues with lead pipes in Florida, but we're all about clean water. So maybe in that space yet, yes, but on a lot of the other stuff is completely lost on me.

Michael Moeser (11:46):

Chris, what do you think?

Chris Jumper (11:47):

So again, I believe our infrastructure is way overstretched. I think the IIJA is a start. It's moving the right direction. You've seen they're addressing climate change in the form of US DOT getting 6, 7 billion for emissions control and emissions reduction. You've got waterways and levies and dams several billion dollars assigned to that electric systems. So they're at least attempting the right track. But again, I think it's a small amount for a massive problem or massive challenge. I think

Michael Moeser (12:30):

You're saying more needs to be done.

Chris Jumper (12:32):

A lot more needs, I think more needs to be done. And again, it's gonna come down to a lot of municipal financing, a lot of privatizations. I think there's just, again when you compare what is identified in the act versus what the American Society of Civil Engineers has, basically identified huge disparity.

Michael Moeser (12:58):

Well let's talk about another problem cuz there's sort of interest rates, state and local taxes. And this is a whopper and I heard about we had a few discussions yesterday about salt and it almost feels like a double whammy. So, four out of 10 of the survey respondents said the impact of rising interest rates would impact infrastructure projects, future financing of projects. And then you look on the flip side, nine out of 10 think that state and local government tax revenues have either already been negatively impacted or will be impacted for the next year or the next five years. And it's a double whammy. And maybe Ben, Chris pick who wants to start. But how do you see both of these factors weighing in on the infrastructure in the US and maybe Chris can issuers withstand a potential recession?

Chris Jumper (13:57):

I think they can, again, we've seen them come through the great recession, 2008 the pandemic and continue on our interest rates. I like the comment where it was like didn't four outta 10 thought they're worried about rising interest rates. And I'm just curious if that was before the last two that

Michael Moeser (14:25):

This, the research was conducted August 18 to September 25.

Chris Jumper (14:28):

25, Okay. It's just the last one. But yeah, it just seems like

Michael Moeser (14:35):

Notice that there's 9% that are not worried. I'm trying questioning who those people are. There are always those people in any kind of research study don't own credit cards. People busy on the Harley.

Chris Jumper (14:47):

Again, higher interest rates make projects more expensive. You've got that compounding with inflation, higher labor costs, higher material costs. It's definitely gonna impact I think projects in the future moving forward. I think it just makes it a lot more challenging. I also was curious about the optimistic five year outlook that oh this, we're gonna take care of this within five to 10 years. I mean a lot of these projects are very long term projects and are gonna take I think

Michael Moeser (15:23):

With maturities 20, 30 years or more. And so it definitely is difficult, but there's always the challenge of funding versus financing in this metric. And maybe Ben, I guess from your perspective and also thinking about the colleagues at other states that may not be as advantaged as you are, how does this sit with you in terms of it's getting more expensive and especially if we get hit with a potential recession that the tax revenues may go down and realizing what Chris said, these projects are being funded over a longer period of time than five years or 10 years.

Ben Watkins (16:03):

Right, So the way that I think about it in terms of interest rates, it's taken refunds off the table, taking volume out of the market induced an awful lot of volatility. So market conditions are challenging, money's flowing out of our space. Goldilock enjoyed the Goldilocks market for a decade and that's over. I'm old enough to remember borrowing it at north of 5% and it has been a very long time since that happened. And not only is it getting more expensive, it is more expensive. I mean there's no doubt about it in terms of the cost of construction both on the labor side and the material side is significant headwinds in terms of what can be done and add to that the additional cost of financing no doubt about it, that it's materially more expensive now to put product on the road so to speak. And it doesn't matter what the complexion of the infrastructure is, it's more expensive.

(17:03)

And so in terms of recession, you sort of deal with it as you can again may be the outlier in the sense that I think that because of the way the state was managed through the pandemic and in doing everything we could to stay open, keep schools open so people could go to work, our in migration, which is our growth business, was off the chart. So we benefited from that economically, just in terms of month over month revenues over projections remarkable 20% growth rate and then you dump the aura money on us, which we didn't really need. It was a windfall. And so we've got 20 billion in reserves.

Michael Moeser (17:51):

Sounds like it's Christmas in Tallahassee.

Ben Watkins (17:54):

So we're in a good place. But I can't say that that's uniform across the country.

Chris Jumper (18:01):

And would on this slide too, I would also mention as far as local government taxes being negatively impacted, again, I think it depends on the structure of the state taxes. Florida for example, has consumption tax, sales tax is a large component of it and that actually might do really well. There's certain states that have petroleum taxes, at least in the short term, they're probably gonna do well because fuel prices are going up but or have gone up. But again, it's hard to generalize.

Michael Moeser (18:34):

Let's switch gears here and talk a little about IIJA climate change and ESG. And I know these are some of the favorite topics here.

Chris Jumper (18:42):

Favorite subject.

Michael Moeser (18:43):

So let's start with the IIJA, So when we asked the survey, respondents three outta four said that they saw a significant positive impact or a limited positive impact higher among Democrats compared to Republicans. But when we asked the question to that it would alter the landscape in terms of public finance over the short term, the next one to five years despite industry concerns and the relative optimism, only one in three acknowledged that they had accessed it or planned to access it in the future. And then you made a comment in an earlier conversation we had that it was really accelerating infrastructure or keeping up with inflation. And I wanted to follow up on that.

Ben Watkins (19:29):

Yeah, So I'll get to that. But the first thing I want to say is I think Emily gave it the best, the beast gave it the best moniker it could possibly have Nomo FOMO. And so that is the opportunity for funding and not wanting to miss out on that. But the point is there are no rules written and with the strings, the conditions for receiving the money on a grant basis, I don't think you're gonna see the uplift that people think there will be with respect to use of the monies on the grant fund. And it's gonna take a long time, again without Emily prodding the bureaucrats in Washington to give clarity around what the criteria are, what the rules are, how those are monies are gonna be deployed, people aren't gonna sign up for it. And as I sit here thinking about it, there's also formulaic distribution to our transportation, to our department of transportation. We we're doing zero new projects, all we're doing is paying for the inflation on the projects that were originally planned up in our five year capital plan. So that's all the formulaic, the additional funding that's coming to the state formulaically, that's how it's being deployed.

Michael Moeser (20:51):

Chris, thought?

Chris Jumper (20:51):

So again, this slide very interesting because 64% of the respondents did not plan to apply for the funds. Again, owing to the, I think it's discussed a lot more in some of the other panels the complexity of applying and the fact that it's more of a reimbursement after you've done, after you've completed the project, after you've got it up and running, that's when you can get your grant monies in a lot of cases. So it's really not that seed money that can start a project. And I think it's just the complexity of applying, making sure that you meet all of the criteria is a bit of a challenge. I like with Jessica Matthew said at the lunch discussion where she described going out and helping some of these municipalities that don't have that kind of grasp on how to apply and how to get the money and how to meet all of the criteria. I think that's gonna be probably a growth industry too.

Ben Watkins (21:52):

Well and as I think about it too, the compliance the muni finance officers are a risk averse bunch and we want clear rules to be able to follow to know that we're not sailing over the age. So there's that element of it too. The more complicated it is, the post-grant compliance stuff is an issue. And as I think about it too, at least with respect to where Florida sits last Tuesday's election, may have had a put us at a disadvantage in getting the kind of positive feedback from the grant applications than we would have.

Michael Moeser (22:33):

Let's talk a little bit about climate change, cuz I think what we saw here in the research is that it's a big issue. We heard about climate change a few times today and yesterday and what we saw is that there's a significant consideration or moderate consideration being given by a majority of people around how climate change climate change action plans, things of that nature. I heard that acronym earlier. And so I guess maybe how does this affect projects going forward? And Chris, since you work with issuers guaranteeing what kind of impact and when we get into the ESG, which is on the next slide, thinking about the scorecards that are being developed, does that make it more expensive? What are the factors there?

Chris Jumper (23:22):

Yeah, so again, as a financial guarantee, we guarantee timely payment of principle and interest on bonds that we qualify and ensure. And once we provide our irrevocable policy, we're on it so long as those bonds are outstanding. So we're very, very focused on ESG and really we're focused on the E, at least I am, I shouldn't say we because is shaking his head at me. We're focused on the E in the ESG. I live and die by it. And we've always had a view on is there potential for hurricane, is there potential for flooding, is there potential for earthquake wind damage? But what we've done just looking at last year, 2021, there was 145 billion dollars worth of damage done from 20 events. Now again, you had winter storms hitting Texas, you've had hurricanes going through New Orleans. It was a busy year. But again, it just kind of highlights that this is something that is not only impacting the infrastructure that needs to be done, but it's also a lot of repair that would need to be take place. So again, as a financial guarantee, we've got a very long-term view. We are the last of the buy and hold investors.

(24:50)

So we have a high focus on it. In the past few years, what we've done we've been developing our an ESG model or actually an environmental impact model to measure climate change and potential impact on a community or a impact on their ability to repay a bond issue. And we've been working with urban footprint on it. They're a consultant that we retained. We came up with a model to help evaluate the vulnerability of environmental risk. So, this past September we just announced that we're going to actually roll that out like an ESG analysis to the market. It's called Municipal Bond Insight. And it's really designed, it's gonna be designed or it has been designed to basically help investors, help market participants sort of gauge or evaluate what does their portfolio look like in relation to climate risk and give them a sense, they can look at their whole portfolio, they could look at a territory, they could look at an individual entity that's issuing and get a sense of what is the environmental risk, how would it impact them? Again, providing some probabilities.

Michael Moeser (26:14):

So very useful!

Chris Jumper (26:15):

Yeah, probabilities of impact on population or property values that I think will be helpful. And I think from what I've heard here, there's gonna be a demand for it.

Michael Moeser (26:27):

And when I look at this chart on the left, not the right hand side or at least my right with a political bias, we're on the right coast, not the left coast. I just wanted to make I live Texas, I'm in the middle. Okay, so you got about 30% of the people saying here that I don't consider climate change or it's a minimal consideration if we were to get in that Jetson's little jet that we've seen a couple times already in five years alone, I guess would this be pretty much the 30% saying it's not, climate change is not a consideration, is that pretty much gonna go away, that almost every infrastructure project, every municipal program will need to consider it?

Ben Watkins (27:08):

Yeah, well as I think about it ESG means a lot of things to a lot of people. And the issues that the two issues that get conflated are designated bonds for specific purpose versus ESG is a risk issue. What I hear Chris describing is a risk issue. It's a fair question to ask what are you doing about the risk confronted in your jurisdiction? That's a very fair question. And we started down that road and Emily shepherded through and Nancy Feldman did a great job this morning outlining the GFOA best practices. So it's not about an answer, it's about a process, it's about risk based disclosure. I'm all in on that because it's a fair question to ask over the long term and we're doing a lot in the state to deal with that issue. The ESG thing from an investment management standpoint or designated bonds is probably a better way to say it. Unfortunately, the muni business has historically been politically agnostic and this the ESG advocates have now injected a political element into the discussion that's not constructive in my judgment. And it's degenerated into a political statement with an ideological bent. And so in terms of ESG designations as a movement I'm not into labels I'm not into verifiers because there's no value from a risk reward standpoint, it's not even close. The risk flaw outweighs the reward. So that's where I am on that.

Michael Moeser (28:56):

I just wanna make sure you're not holding anything back there though. I guess our last slide really is around ESG in terms of very, as you can see when we asked about the political affiliation very much different in terms of the impact ESG would affect public finance. And I see that we're pretty much out of time and I know we've covered this, but maybe just in a closing points Chris, do you wanna say a few closing thoughts here? Sure.

Chris Jumper (29:31):

Again just on ESG and in addition to just assessing the risk, we also look at what the adaptations have been ongoing. Again, a state like Florida where not only the local municipality is focused on it, but there's also regional efforts to manage irrigate drainage and there's also state efforts to do it. So we're digging into it and we're finding a lot of really good information on that too. And I think it's a good balance. Again, infrastructure is critical. It is way overstretched. I think there's definitely the bipartisan bill act is a good start, but there needs to be a lot more and more done.

Ben Watkins (30:25):

Yeah. Well, just to make it clear, I am not a climate denier and we are doing an awful lot in Florida to address the issue, but it's all around environmental risk. It's all about hurricanes and sea level rise and inland flooding. And that's a totally different thing in statewide. I mean, we've been doing statewide building codes for hurricane hardening the infrastructure since 1993. Hurricane Andrew statewide resiliency officer, chief science officer, developing consensus estimates on sea level rise programs, grant programs for resiliency infrastructure where you're hardening your infrastructure and the additional cost is a portion of that is picked up by the state. It's planning and zoning quite honestly, coastal setbacks, all of that. So, it all is something that we've not really even had to think about in the muni finance space until the question was asked. And it's a fairly recent vintage and there's an awful lot to say around that without getting into the whole designated bonds ESG debate.

Chris Jumper (31:29):

And it's almost like a topic esg, it should really be broken out now E should be separate from S should be separate from G. Although there is a little, I think, relation between E and G, you know how governance dictates their response to environmental.

Michael Moeser (31:45):

So if you folks want to hear more from these gentlemen, the cocktail reception is outside. If you wanna read the report, go on to Bond Buyer, it's available to subscribers. It's the role of munis in the future of cities. I want to thank these two gentlemen. Let's give them a round of applause.