Economic Development

A Bond Market In Flux

Muni bond borrowing costs may rise, as well as state and local credit ratings.
by | February 2006

Municipal bond issuance will be down this year: State and local governments will borrow only $396 billion in 2006, down from $457 billion last year, according to a forecast by the Bond Market Association.

Still, a year of nearly $400 billion in issuance is a signficant one for the muni bond market, and the heart of it will be new money--debt taken on for new projects that states and localities finance this year. With interest rates on the rise, refunding--bonds in order to retire higher-interest-rate debt--is likely to decline by as much as 50 percent over last year's totals.

Given the relatively low interest rates of the past few years, states had been rushing to refund their bonded debt, but "those opportunities have mostly been exhausted," says Michael Decker, senior vice president for research and policy analysis for the Bond Market Association.

Experts have been expecting higher long-term interest rates for months as a result of a strengthening economy and actions by the Federal Reserve, which started raising short-term interest rates in the middle of 2004. For a variety of reasons, among them a low rate of inflation, rates remained persistently stable. Rates should start creeping up this year, directly affecting refunding activity.

For state and local issuers looking for new capital, a counterweight to rising interest rates will be improved credit ratings, which tame the interest rates they pay when they come to market. A number of states have seen their ratings improve in recent months. Thanks to healthy revenue increases, many states and localities are running surpluses for the first time in years. Although the revenue trend is projected to continue this year, it may moderate, given the slower rate of economic expansion expected later in the year, as well as the anticipated cooling of the housing market--and with it reduced property tax revenue.

But maintaining strong ratings will face other challenges, namely budget pressures from pension and retiree health care obligations as well as Medicaid costs. "Over the short term, it's not likely to result in a significant change in rating trends," says Steven Davidson, the bond association's research director. "It's more of longer-term concern."

Josh Goodman
Josh Goodman  |  Former Staff Writer

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