The Federal Reserve’s decision to keep interest rates low is providing stimulus to a once contracting Wall Street business: underwriting municipal bonds.
State and local government debt sales may surge to a record in 2020, extending this year’s boom, as borrowing costs hold near the lowest in over half a century, according to forecasts from some of the market’s biggest underwriters.
That marks a welcome shift for banks that saw bond work dry up in 2018 after President Donald Trump signed legislation that blocked new tax-exempt debt sales for a major type of refinancing known as an advance refunding.
But with rates now so low, local governments can even refinance their debts by selling taxable bonds and still come out ahead, causing a surge in issuance that’s expected to continue. Every analyst surveyed by Bloomberg expects municipal-bond sales to rise next year even after the 24% jump so far in 2019.
Loop Capital and Hilltop Securities are the most optimistic underwriters in the $3.8 trillion municipal market, expecting sales to reach $450 billion. Bank of America Corp., the biggest underwriter, anticipates about $430 billion of debt will be issued. That would exceed the record $425 billion sold in 2016, according to data compiled by Bloomberg.
“Nobody was really expecting all these taxable advance refundings -- and here they come, in large numbers,” Chris Mier, chief strategist at Loop Capital, said in an interview.
Along with the supply surge, most analysts surveyed by Bloomberg see muted returns in 2020, given the strong performance this year as the Fed cut interest rates and mutual funds received a record influx of cash. Overall, state and local debt returned 7.6% in 2019, the biggest gain in five years, while the riskiest securities delivered 11% gains.
- Citigroup Inc. analysts led by Vikram Rai estimate that $95 billion of the new debt sales will be taxable securities, with a “meager” $345 billion of tax-exempt sales, well below the trend from 2015 to 2017
- Thomas McLoughlin, UBS’s head of municipal bonds, said voter approval of most of the largest bond issues on ballots in the November 2019 election bolsters his 2020 supply outlook. “Barring an abrupt increase in Treasury yields,” refinancing transactions can continue, he said
- Tom Kozlik, head of municipals at Hilltop Securities, anticipates a “record amount” of municipal debt in 2020, with $297 billion in new money sales for infrastructure improvements and $153 billion of refinancings
- Jeffrey Lipton, head of municipal research at Oppenheimer & Co., said his forecast of $420 billion to $440 billion in supply could be “tempered by issuer concerns over economic growth expectations and election-year rhetoric.” He maintains that munis should have a positive performance, forecasting “modest single digit returns” in the range of 3% to 5%
- Municipal Market Analytics doesn’t see annual issuance dropping below $400 billion in any of the next five years. Unless there’s an unexpected material rise in interest rates, “there is more upside than down to these numbers, particularly in the out years as more state and local issuers sell bonds for water and transportation projects and to address local economic vulnerabilities from climate change,” said Matt Fabian, a partner at the firm
- Barclays Plc analysts led by Mikhail Foux advised clients that “the best days are behind us, and municipal returns in 2020 will be much more subdued.” Investment-grade securities will return about 2% to 2.5% and high-yield bonds 3% to 3.5%, he wrote
- Bloomberg Intelligence’s Eric Kazatsky estimates that the supply of new debt will be easily absorbed, projecting that it would take about $460 billion to meet current demand, given the amount of cash flowing into mutual funds and the approximately $371 billion of interest and principal payments that investors will receive
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