Junk-Rated U.S. Municipalities Shine Brighter with Record Low Rates, According to Reuters

By Hilary Russ and Karen Pierog

NEW YORK/CHICAGO – Despite record low interest rates, the $3.7 trillion U.S. municipal debt market has not experienced a surge in new borrowing, with the exception of lower-rated borrowers who are taking advantage of this opportunity to bolster their finances at manageable costs.

As of mid-July, total municipal debt issuance for the year was down 1.6 percent, totaling $227 billion compared to the same period last year. However, new borrowing excluding refinancing rose by 12.5 percent to $88.8 billion, with the most significant increase occurring among lower-rated debt, according to data from Thomson Reuters.

A closer examination of the data reveals that the issuance of municipal junk bonds rated BB-plus or below soared by 170 percent, reaching $1.2 billion compared to the same period in 2015.

Higher-rated issuers have been capitalizing on the low rates primarily through refinancing existing debt but have been hesitant to increase borrowing for new projects due to lengthy approval processes and a reluctance from many communities to take on additional financial burdens.

In contrast, financially struggling municipalities may face similar challenges but are often compelled to borrow to remain operational. Many of these entities can issue revenue bonds, which do not require voter approval.

Cash-strapped regions, such as Illinois and low-rated Chicago, have the option to issue bonds for new expenditures without needing taxpayer approval via ballot measures.

Experts note that some distressed cities and states "have to borrow to keep going," as emphasized by Matt Posner, a principal at a public finance research firm.

With municipal bond rates at historic lows, those with lower ratings are keen to seize this possibly fleeting opportunity to borrow affordably before any potential market shifts lead to increased costs.

"Lower-rated issuers are taking advantage of the very tight spreads and strong demand for bonds that offer any additional yield," said James Dearborn, head of municipal investing at a major investment firm.

For instance, Loma Linda University Medical Center in California has decided to double its outstanding debt to fund renovations required for state seismic safety compliance. Following a downgrade by Fitch Ratings, which classified the center as junk with a rating of BB-plus, it sold nearly $1 billion in debt in April. The largest tranche offered a 5.25 percent coupon and has since seen its yield fall to 3.24 percent.

Similarly, Chicago’s Board of Education sold B-plus rated bonds in February to support capital improvements and refinancing; these 28-year bonds, initially sold at a significant discount, have appreciated above par value.

The district’s CEO has indicated that additional borrowing is being considered.

Public-private ventures, such as the upgrade of LaGuardia Airport in New York, have also contributed to the increase in borrowing, with many featuring a municipal bond component rated in the triple-B range, which has also grown based on Moody’s data.

Notably, lower-rated borrowers are refinancing their old debt at a faster pace compared to investment-grade issuers. The total value of junk-rated refunding bonds surged by 248 percent to $1.9 billion, while overall refunding activity declined by 9 percent to $138 billion.

More transactions are on the horizon. Detroit, for example, is preparing to issue approximately $615.5 million in refunding bonds shortly, potentially saving around $37 million in its first general obligation offering since emerging from its municipal bankruptcy in December 2014.

In addition, Chicago, which faced a downgrade to "junk" status last year, plans to sell up to $1.25 billion in general obligation bonds this quarter, while Illinois may refund up to $2 billion in bonds.