Muni bond market: No, the sky is NOT falling (but there are alternatives)

Mon, 2015-09-21 16:23 -- Liz Enbysk

Financing panelists included, left to right, David Swindell, Georgia Levenson-Keohane and Joshua Franzel.

With bankruptcy and loan defaults putting struggling cities in headlines, a "sky is falling" mentality has some cautious about the municipal bond market.

Yet Joshua Franzel, Director of Policy Research with the International City/County Management Association (ICMA), suggested otherwise during a session on financing trends that took place at Smart Cities Week® in Washington, D.C. last week.

Between 1970 and 2014 there were 92 municipal bond defaults, Franzel said. That's a relatively small number compared to the 11,000 municipal issuances completed on average each year.

"You are talking about a very secure and robust market for issuing debt," Franzel said, which may explain why today 90% of all state and local infrastructure is financed with municipal bonds.

But whether it’s the political cost of issuing debt, outstanding debt balances or other challenges, cities may look at other ways to pay for infrastructure needs.

Tapping other sources
Franzel and other experts on the panel highlighted other financing trends gaining steam. Among them:

  • Pension funds and other institutional investors, Franzel noted, are looking at ways to diversify their portfolios and generate excess returns. He said today some $3.7 trillion in assets are under management of state and local pension funds. Of that, about 2% is invested in infrastructure – hospitals, rail networks, etc. "So it's not a sea change," he suggested, but something to keep an eye on going forward.
  • Catastrophe bonds were mentioned by Georgia Levenson-Keohane, Senior Fellow and Director of the Program on Profits and Purpose at the New America Foundation. Noting that cat bonds aren't entirely new, she said today there is new thinking about how they apply. She gave the example of New York City knowing in 2012 that Hurricane Sandy was coming, but not understanding the enormity, including the storm surges that caused so much havoc. The New York Metropolitan Transportation Authority emerged from Sandy uninsurable, Levenson-Keohane said, and turned to the cat bond market. Investors that bought the bonds were betting there wouldn't be another Sandy-like storm in the next three years. Often investors use them as a diversification tool – and the higher yields they can generate. Catastrophe bonds are on a growth trajectory, Levenson-Keohane said, with $25 billion or so in issuances this year.
  • Social impact bonds, explained Patrick Lester, Director of the Social Innovation Research Center, are at the simplest level performance-based contracts often used in human services where there is opportunity to do prevention work to move high-cost populations into lower-cost services. Nonprofits, he suggested, don't have the ability to work completely for free, so outcome-based social impact bonds provide bridge financing. Few projects are actually up and running, Lester said, although more are planned. And there have been failures, he said. Because they are both high risk and low return, social impact bonds won't typically attract private dollars, but foundations are supportive and bigger funding streams are starting to happen.
  • Property-assessed clean energy (PACE) loans illustrate how infrastructure improvements don't have to be bond based, said David Swindell, Director of the Center for Urban Innovation and an associate professor in the School of Public Affairs at Arizona State University. PACE programs are a way to finance energy efficiency and renewable energy improvements, for example, allowing people to upgrade the energy infrastructure in their homes without upfront capital. They get a loan from their local government and pay it back through property taxes, although Swindell says the energy savings are generally enough to repay the loan.

Smart Cities Financing Guide
Swindell is a co-author of the Smart Cities Financing Guide, which he and colleagues developed for the Council. It features 28 different financing tools available to cities, with details on the pros and cons of each.

The Guide, available as a free download for registered members of the Council, is a first step for cities looking beyond traditional municipal bonds, he said.