November 19, 2020
With a Biden administration on the way, what impacts might it have on the US$4trn+ municipal bond market? Here, Mellon senior portfolio manager Jeffrey Burger assesses the prospects.
In a year dominated by Covid-19 headlines, municipal bond investors and issuers have not been immune from the market rollercoaster wrought by the pandemic. Lockdown impacts, periods of limited liquidity and rising unemployment are just three factors that have taken their toll on the sector.
May and June alone saw defaults from a combined tally of 20 US municipal borrowers amid growing strain triggered by reaction to the pandemic across US states.1
Yet Mellon senior portfolio manager Jeffrey Burger points out that, for all this, the sector has since shown significant signs of recovery and municipal bond markets remain largely resilient despite the pressures some issuers faced at the height of the pandemic.
“Despite the recent challenges, most municipals have enjoyed robust post-recession revenue growth and improved cash reserves. We believe states and local governments will likely want to maintain some level of reserves for future emergencies and are incentivized to manage a portion of their budget deficit via expenditure reductions. Also, potential federal aid could temper the magnitude of draws from reserve funds. Regardless, we do not expect the possibility of depleted reserves to have an impact on the ability of states to meet their debt obligations,” he says.
What next under Biden?
With some degree of normality returning to markets - despite concerns about a second wave of Covid-19 infection - attention is now on the changing administration, following the election success of Presidentelect Joe Biden. Many investors are weighing what he and his administration’s plans might mean for sectors such as the municipal bond market.
Burger is optimistic the win may deliver positive news for investors in municipal bonds, since Biden has expressed he is committed to boosting US infrastructure.
“Infrastructure is a very important area and a key political focus. I believe that under a Biden presidency, there will finally be some push for infrastructure build in a meaningful way. This would likely benefit the municipal bond asset class, but it's really a question of policy in terms of how that infrastructure program would be directed to reflect the values of the parties in control,” he says.
Under a Democrat-controlled presidency, and possibly Senate, Burger adds, the likelihood of government implementing more “green” and environmentally friendly projects to provide economic stimulus would be higher than under a Republican Party administration.
Under the incoming administration, Burger points to US airports as a key area for likely infrastructure spend. Despite the lockdown having a devastating short-term impact on commercial flights, he predicts air travel will eventually recover. With this in mind, Burger believes America’s crumbling airport infrastructure could benefit from a long-deferred upgrade.
Roads and hospitals, he adds, could be other beneficiaries of new infrastructure spend. However, he adds that a balance will need to be struck to make sure any public money is spent wisely.
“If infrastructure renewal is done correctly, we would argue it can be highly stimulative to the economy. The danger is that if it is not done correctly, it could be sunk cost and end up wasting public money,” he adds.
Beyond infrastructure build, another potential advantage of a Democratic US election win could be the party’s position on tax, adds Burger. While the likelihood of material tax changes has been dramatically reduced since the Democrats did not receive a mandate via the so-called “Blue Wave”, control of the Senate remains in question due to two runoff elections in the State of Georgia. If the Democrats win those elections, he believes the Democrats will be more likely to raise corporate tax – which could make tax efficient municipal bonds more attractive.
“We believe there's a higher likelihood a Democratic controlled presidency, House, and possibly Senate, would raise corporate tax rates. From a municipal bond perspective that could make the asset class more appealing to corporations and banks. One of the reasons investors like municipal bonds in the United States is their tax-free nature,” he says.
While he acknowledges the Covid-19 pandemic may yet cause further problems, Burger remains optimistic for prospects in the municipal bond sector.
“We are of the opinion that while there might be some increase in defaults, particularly in the highest risk arenas of the market. Whether that's in continuing care and retirement communities, nursing homes or other related areas, the lion's share of this asset class will continue to service its debt on time and when due. The biggest risk we see from a credit perspective are more downgrades and spread widening.
“At a regional level, US states are required to have balanced budgets and have many tools at their disposal to achieve this obligation, including the ability to cut expenditures and/or raise taxes. On a relative basis, we believe US state and local governments with diversified revenue streams and solid pension systems should prove robust in this environment. It is also worth pointing out that, throughout its history, municipal credit has been remarkably resilient under various economic scenarios,” he concludes.
1 The Wall Street Journal. Coronavirus Surge Strains Municipal Bond Market, but Investors Still Pile In. 02 July 2020.
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