The muni market: How two big changes could impact government borrowing
This week’s newsletter is dedicated to muni bonds. The municipal market finances 75% of our nation’s infrastructure and with the passage of the Infrastructure Investment and Jobs Act—plus the pending Build Back Better legislation—it’s time to take a look at some of the latest developments in this vital state and local financing tool.
A new tool for expanding broadband
The Infrastructure Investment and Jobs Act (IIJA) expands the use of Private Activity Bonds (PABs) to cover the expansion of broadband to underserved areas. Roughly 30 million Americans (9% of the population) don’t have high speed internet access in their homes according to the Federal Communications Commission. The gap widens to one in three residents in rural areas.
Related: How the pandemic put a spotlight on the digital divide.
The IIJA helps private companies and local governments bridge the digital divide by allowing certain broadband projects to be financed with tax-exempt municipal bonds. Qualified projects:
Provide broadband service to census block areas where fewer than half of households don’t have “terrestrial broadband service” at a speed of at least 25 megabits per second (mbps) for downloads and at least 3 mbps for uploads. (See more on internet speeds below.)
Upgrade the service speed for residential, commercial, or a combination of residential and commercial locations to at least 100 mbps for downloads and 20 mbps for uploads.
What this does: PABs are tax-exempt municipal bonds issued by a local or state government, but on behalf of a private company. Tax-exempt bonds fetch lower interest rates in the municipal market and therefore lower the overall cost of financing. PABs are limited to use for projects in the public interest, such as affordable housing or hospitals. Broadband is arguably in the public’s interest as well—and the IIJA has now created a cheaper way for private companies to finance broadband expansion. This savings will be even more critical as interest rates rise.
Why this matters: Governments can theoretically pay for expanding broadband along existing utility lines in the public right-of-way. But ultimately, internet providers are responsible for building the “fiber to the home,” or FTTH. And in rural areas, where homes can be a half-mile or more off the main road, this is no small issue.
“There have been a lot of questions about how governments could do that themselves…but providers play such an integral role, it just makes a lot more sense for them to be a serious government partner in all this,” the Government Finance Officers Association’s Emily Brock told me this week. “This formalizes the relationship between [providers] and governments to get that fiber into the home.”
Hat tip to subscriber Tony King for bringing this PAB development to my attention. If you have questions or tips to share, let me know by replying to this email!
PABs can also now be used to build qualified carbon dioxide capture facilities.
The current limit on transit- and transportation-related PABs (toll roads, hot lanes, etc.) is now doubled to $30 billion.
PAB issuance slowed in 2020, reports the Council of Development Finance Agencies.
A comeback for bond insurance?
More issuers are using bond insurance these days and the pandemic has been a big factor. Worries about climate change could cement the industry’s comeback.
The pandemic created a lot of uncertainty around state and local government revenues for much of 2020. That was a big reason for the dramatic boost in the rate of bonds issued with insurance that year: In total, $34.45 billion in new bonds carried insurance -- the highest since the Great Recession ended in 2009. Even with the economic stabilization this year, insurance is still going strong. Through October 2021, wrapped municipal bond issuance totaled $31.5 billion, according to RBC Capital Markets.
Looking ahead, the chatter about municipal climate risk has been increasing in recent years. Extreme weather events linked to climate change have called into question the preparedness and resiliency of utilities and other government issuers, while studies point to the potential long-term economic effect. One BlackRock Investment Institute report estimated that some vulnerable cities could see economic losses of up to 10% of GDP without decisive action.
The bottom line: Insurance provided safety for muni market investors during the pandemic and its continued use indicates that investors and issuers are both finding it attractive in situations where there might be a little more long-term uncertainty. Climate risk plays right into this notion. While no one expects bond insurance to dominate the market as it once did, it’s likely that the pandemic spike in usage is here to stay.
For a refresher: Here’s my explainer on what the Great Recession did to bond insurance and credit ratings.
A busy market in 2022
Largely thanks to the aggressive federal policymaking over the past 21 months and with Build Back Better expected to pass in some form in early 2022, some market watchers say next year will be the busiest yet for the municipal market. Hilltop Securities analyst Tom Kozlik predicts a record $495 billion in total issuance in 2022.
“A long-standing aversion to funding infrastructure and other key projects with municipal bonds will begin to abate in areas where financial constraints, especially worrisome after the Great Recession, have been reduced (not entirely eliminated) in the Golden Age of U.S. Public Finance,” he wrote. While it’s “possible” rising interest rates could limit refinancing of debt, Kozlik said he doesn’t anticipate any significant impact.
The takeaway: The municipal market in the pandemic era is worlds away from what happened after the Great Recession. That’s almost entirely because of the difference in immediate and longer-term federal support this time around (worth more than $7 trillion and counting since March 2020). Federal stimulus to governments during the last recession ended in 2009 and state and local governments were still making dramatic budget cuts years after that. Those cuts contributed to a stalled economic recovery, which directly affected governments’ willingness to borrow in the municipal market.
A personal note on being a “last mile” household
I hadn’t even heard of satellite internet until my family and I moved to our forever home in a rural area of Maryland. But it’s the only option for us and our immediate neighbors. About a mile up and down the road, households are wired. In fact, when our home was built in 1994, the builders included cable outlets because I suppose they figured service providers would eventually string cable up here. That turned out to be optimistic.
Cable internet providers can offer speeds up to 200 mbps and data caps at 1 terabits for an average price of $50 per month. By comparison, satellite providers offer speeds “up to” 25 mbps/download and 3 mbps/upload. That optimum speed is subject to data caps of 50 or 100 gigabytes, and service can go out entirely in stormy weather.
For us, that means paying twice as much as we used to for internet service that can be unreliable in a Zoom-dominant world. Anyone reading this who’s done a video call with me has probably seen the end result of this. More than once during virtual schooling in 2020 and early 2021, I packed up my son, his tablet and my computer and we drove to the nearest hotspot in order to tune in to class while sitting in my car. On a few other rough days, we just gave up and asked his teacher to email us her presentation for the day.
And we are the lucky ones. We can afford the “premium” satellite internet service. My son has a parent who could shuttle him around if need be. A lot of kids in our area don’t have either.
What I’m working on
Please join me and former big-city mayors Mike Nutter and Mark Funkhouser on Dec. 15 as we discuss the outlook for local governments in 2022. We’ll cover the IIJA, how its provisions intersect with today’s biggest challenges, and how local officials can maximize value in their communities. We hope to provide lots of good information in this one-hour webinar for folks in the private and public sector.
Cyberattacks keep targeting colleges. How can they protect themselves? See my latest story for HigherEd Dive.
That’s it for this week and if you’ve made it this far, I’d love your feedback. Was this too long? Too short? What did you like and what could you have done without? Please don’t hesitate to reply to this message with your thoughts.
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