Major challenges for the public finance industry abound but rising interest rates is the largest concern for business in 2022, market participants said in a Bond Buyer/Arizent Research survey.
Nearly 60% of respondents said rising interest rates are their biggest worry, followed by regulatory requirements or changes at 45% and a lack of face-to-face communication and market volatility at 37% and 36%, respectively.
Ongoing threats from the coronavirus, inflation and legislative inertia on muni issues in Washington, among other factors, also led a majority of those in municipal finance to believe a full economic recovery won’t be reached until at least July.
Thirty-five percent of respondents said they believe a full economic recovery will happen in the second half of 2022, while 40% said they don’t believe it will happen until 2023. Fifteen percent believe it will occur during the first half of this year, and 10% believe the economy has already recovered.
While the municipal credit picture is dramatically better than right after COVID-19 hit in 2020, two-thirds of survey respondents think municipal credit will be negatively affected moving forward.
“Recovery is different depending on who you’re talking to. We’re looking at kind of 2019 as the starting point in the anticipated recovery efforts, and we had expected it to occur this year — 2022,” said Guadalupe Gutierrez-Vasquez, managing director of capital funding for the city and county of Denver. “But like everybody else, we’re struggling to see how things will continue to evolve with the coronavirus.”
Rising rates
“We’ve had an unprecedented era of low rates,” said Stephen Akin, founder of Akin Investment, a registered investment advisor. “Inflation really could get away from the Federal Reserve; it’s not out of the realm of possibility.”
The Federal Reserve has begun reducing its asset purchase program and it expects to zero out those buys by June. At least three rate hikes are expected in 2022, with some analysts anticipating a fourth.
“That’s going to cause people to look at their analysis and go, ‘OK, where are we sitting?’ Hopefully, they will come to the realization that even if rates rise a little bit, by any rational, historic comparison, they’re still going to be very low,” said Barry Fink, executive director of the Minnesota Higher Education Facilities Authority.
Infrastructure
In terms of municipal bond volume in 2022, 90% of respondents believe it will match or exceed 2021 levels.
“Overall, in terms of issuance, we’ll probably see a roughly similar year [to 2021] in terms of innovative procurements and other things like that, with most of that new activity happening in the back half of the year,” said Jim Ziglar, a principal at Rebel, an infrastructure advisory firm.
President Joe Biden signed the $1 trillion Infrastructure and Investment and Jobs Act into law in November and three-quarters of the respondents see the IIJA as having a positive impact on the public finance landscape.
But provisions the muni industry was seeking, such as the restoration of tax-exempt advanced refundings and a reboot of a direct-pay bond program, were left out of the package.
Their exclusion was felt as a setback for many in the industry. Reviving advanced refundings was the main legislative objective for nearly half of market participants, or 47%, who responded to the survey.
The next legislative vehicle for that and other provisions to be considered is through the Build Back Better negotiations, which are contentious and fluid.
“It’s possible that we could see an increase in issuance and volume this year, but that’s contingent on what happens with the Build Back Better bill,” Ziglar said.
Lawmakers are unlikely to include the “kind of municipal bond provisions that the industry wanted,” according to Joseph Krist, founder of Muni Credit News LLC.
“There’s not going to be quite as much flexibility as there might have been, and that will slow some kinds of projects.”
“With the muni provisions failing to get any love from the infrastructure bill, we may see a lot more taxable [debt]. That might happen,” said Rudy Salo, a partner at Nixon Peabody LLP, although it will depend upon interest rates and how far they go up.
Taxable refundings may increase due to a lighter year in 2021 when issuers were holding back in the hopes for the return of exempt refundings. Candidates for refundings that were not done may be pushed into the early part of 2022.
ESG and munis
One of the fastest-growing focus areas in the municipal market is environmental, social and governance factors. Half of survey respondents expect the growing focus on ESG factors to accelerate growth, though one-in-eight believe it will reduce growth. Two-thirds of respondents would change their businesses if regulators focus on environment, social and governance issues.
While the industry lacks uniformity on ESG standards, many believe 2022 could be the year to spark further discussions on standardization as investors demand more information on ESG factors and regulators begin to delve into assessing them. The Municipal Securities Rulemaking Board’s priorities for 2022 include responding to its recently released request for information on ESG.
“Investors are looking for that more, so it’s something that issuers are going to have to respond to,” Fink said.
“The industry has to come to grips with how they’re going to treat the concept of ESG, and how it’s going to be understood and valued,” Krist said. “Because that could wind up being one of the great hooks for nontraditional money — overseas investors, sovereign wealth funds — into the municipal market.”
Additionally, nearly 9-in-10 see electronic trading and artificial intelligence/machine learning having a larger role in the municipal market in the next five-plus years.
The report was conducted online during October among 137 participants, including qualified issuers, analysts, asset managers and others.