(Bloomberg Opinion) -- When the coronavirus finally fizzles out as a public-health threat, state and local governments will struggle to start picking up the economic pieces. Starved of tax revenue for months, they’ll need to find other ways to raise money as they wait for businesses to regain their footing.
Washington is working on ways to help. President Donald Trump belatedly abandoned his dismissive bystander stance when he declared a national emergency on Friday the 13th last week, committing $50 billion to these beleaguered stewards at the center of the health crisis. Democrats in the House of Representatives won his support for another relief package that’s now before the Senate.
But much of the rebuilding will eventually have to rely on borrowing at the state and local level, where recent history provides more than a glimmer of hope in the form of a decades-long decline in the cost of municipal debt.
Now two responses to the coronavirus turmoil are giving governors, mayors and bondholders reason to expect that a rebound, when it arrives, will allow even the least creditworthy cities and states to obtain record-low borrowing costs in the months ahead.
First, the Federal Reserve has pushed interest rates almost to zero. Second, investors looking for safety are fleeing stocks for bonds, which almost always pushes yields down as prices rise — though for an abnormal period last week, some $3.8 trillion of municipal bonds defied the gravity of plunging U.S. government interest rates and suffered a daily loss like no other in recorded history. As recently as March 9, the yield on municipal debt sold by almost 2,000 state and local governments with more than 55,000 outstanding securities, hovered at 1.14%, the lowest cost since at least 1979 when the Bloomberg Barclays U.S. Municipal Index began compiling data.
Interest rates were much higher then, so the benchmark bond yield this month already was unprecedented in modern times, having declined from 1.78% at the end of 2019, 2.11% at the end of 2015 and 3.80% at the end of 2010, according to data compiled by Bloomberg. Now with the Fed guaranteeing the easiest monetary policy since the last recession as Covid-19 threatens another contraction, state and local governments also will benefit.
“When a market is priced to perfection, an unforeseen event like the virus can knock it off kilter,” said Eric Kazatsky, a Bloomberg Intelligence analyst. “The worse equities do, the more likelihood there is that liquid assets like munis get sold to bail out stock positions.”
Because Trump makes the stock market the measure of his leadership, he never tires of badgering the Fed to keep lowering interest rates, a boon to state and local governments and their bondholders. That's especially true for the most troubled borrowers. Among the states whose bond yields declined the most since Jan. 1, 2019, Illinois saw rates fall more than any other state, to 1.52% on March 9 from 3.36%. That’s a shrinkage of 184 basis points when the benchmark national municipal yield declined 155 basis points to 1.14%, according to data compiled by Bloomberg.
The relative borrowing cost for Illinois, which has among the worst unfunded pension liabilities in the nation, narrowed to 29 basis points earlier this month, the smallest spread since 2013, before rising to 52 basis points on Tuesday, still an historically low yield. These numbers show that the state this year was poised to borrow at a record-low rate as well as its most favorable rate compared to the rest of the U.S., according to data compiled by Bloomberg. Even amid the market turmoil of recent days, Illinois remains in a far better position than in 2008, when it was forced to pay 4.78% on its debt. From Jan. 1, 2019 through March 9, 2020, securities sold by Illinois municipalities returned (income plus appreciation) 20.1%, more than any other state, before plummeting this week along with the rest of the municipal bond market.
Unlike the S&P 500 stock index, which has lost 2.5% since the beginning of 2019, the benchmark municipal bond index gained 8.5%. The market's biggest borrowers, California and New York, returned 8.2% and 7.8% during the same period as their borrowing costs declined about 45 basis points to 2.1%. Bond yields for South Carolina, West Virginia, Connecticut and Kentucky (all of which are, like Illinois, among the worst states in terms of unfunded pensions) declined as much as 92, 86, 82 and 39 basis points, respectively, to 2.2%, 2.2%, 2.0% and 2.6%. Los Angeles sold debt earlier this year at a yield of 0.4%, or 120 basis points less than what it had to pay in 2018, according to data compiled by Bloomberg.
Now the municipal market is poised to have one of its biggest borrowing bonanzas. Illinois has more than 17,000 bonds issued by its municipalities totaling $82 billion with an average coupon rate of 4.3% that can be called, or refinanced, at a lower rate in the months ahead. If this week’s rate bump recedes as expected, and the state is able to refinance these debts at last week’s yield of 1.5%, or 2.8% less than what it paid originally, it would save about $2.3 billion. New Jersey, similarly, has more than 13,000 callable bonds totaling $61 billion with an average coupon rate of 3.8%. If the state's municipalities can refinance these debts at last week’s average borrowing cost of 1.5%, the 2.3% savings would amount to $1.4 billion, according to data compiled by Bloomberg.
To be sure, refinancings can't happen without investors. Until the market retreated before Trump's emergency declaration, the iShares National Muni Bond Exchange Traded Fund, the largest such ETF, experienced a record inflow of funds during the past 12 months as 33,000 additional shares were created, the most since its creation in 2007. After suffering its biggest daily loss of 4.8% last week, the ETF now trades at the biggest discount in seven years to its underlying portfolio of bonds.
All of which means that the outlook still is for the best rates yet.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Matthew A. Winkler is Co-founder of Bloomberg News (1990) and Editor-in-Chief Emeritus; Bloomberg Opinion Columnist since 2015; Co-founder of Bloomberg Business Journalism Diversity Program in 2017. During his 25 years as Editor-in-Chief, Bloomberg News was a three-time finalist and winner of the Pulitzer Prize for Explanatory Reporting and received numerous George Polk, Gerald Loeb, Overseas Press Club and Society of Professional Journalists and Editors (Sabew) awards.
©2020 Bloomberg L.P.