The Shield – Key Public Finance Themes for 2021

Key Public Finance Themes for 2021

It is just one month into calendar year 2021 and we are already seeing themes of the coming year emerge. Highlighted below are three themes to which our team is paying particularly close attention.

LIBOR Transition

The anticipated LIBOR transition is undoubtedly one of the most important topics in public finance in 2021, and perhaps in all of the financial markets. In mid-January, our team had the opportunity to present at the Wisconsin Health & Educational Facilities Authority virtual annual meeting on the topic of the LIBOR transition, and we are advising clients every week about considerations to make and actions to take in preparation for the LIBOR cessation. We re-present here a summary of the critical do’s and don’ts for issuers and borrowers at this stage of the LIBOR transition process.

Do’s

Recognize the LIBOR will away…eventually!
Inventory your institution’s LIBOR exposure.
Understand that various market participants are impacted differently as a result of the LIBOR transition.
Recognize there are different implications for financial instruments with a market valuation (derivatives) versus those without (variable rate loans / bonds).
Rely on your financial and legal advisors to ensure proper transition occurs for your institution.

Dont’s

Assume that LIBOR transition will occur at the same time for all financial instruments.
Assume that SOFR as a replacement index for LIBOR, even with a spread adjustment will make your institution whole as value transfer risk remains a legitimate concern.
Assume that adopting “standard” LIBOR replacement language or ISDA fallback protocols is automatically the best approach.
Assume the LIBOR transition process is solved as many market and regulatory developments are expected during 2021.

Credit Ratings

The COVID-19 health pandemic has created business disruptions in just about every U.S. public sector. Few are unscathed, and many face daunting challenges in the year ahead. These challenges have been highlighted as each of the three major rating agencies have published their credit outlooks for 2021. Not surprisingly, most U.S. public finance sectors are on negative outlook. Key credit themes for these outlooks include the persistence of weakened revenue streams, rising expenses, weak economic conditions, and the ongoing operational challenges resulting from the health pandemic. There are pockets of optimism and certainly hope for a more robust economic environment as the COVID-19 vaccines roll out, but the rating agencies have signaled the credit challenges may persist longer than desired.

2021 Sector Outlooks

Rating Agency*	Higher Education	Healthcare	Non-Profits	State & Local Governments
Moody's (1)	Negative	Negative	Negative	Negative
S&P (2)	Negative	Negative	N/A	Negative
Fitch Ratings (3)	Negative	Stable	N/A	Stable

* None of Moody’s, S&P, or Fitch Ratings have any U.S. public finance sectors on positive outlook

(1) Within Moody’s rated U.S. public finance sectors, only state housing finance agencies and municipal water and sewer utility sectors are on stable outlook.

(2) For S&P, six of 10 public finance sectors are on negative outlook.

(3) For Fitch Ratings, three of eight public finance sectors (higher education, housing and transportation sectors) have negative rating outlooks in 2021.

Potential Tax-Exempt Market Changes & Volatility

While every year brings new possibilities for the markets as a whole and the tax-exempt markets in particular, there could be meaningful changes that come about in 2021. Of course, we are kicking off the year with interest rates up off their all-time historical lows, but not by much. Borrowing costs remain extraordinarily favorable, with the 30-year tax-exempt MMD benchmark rate at 1.38% and long-term taxable rates remaining below 2% at the end of January. Besides favorable borrowing costs, what more could 2021 bring?

Will market interest rate volatility persist?

Likely, yes. While the Federal Reserve continues to hold the federal funds rate near zero and expects to do so for some time due in part to its revamped inflation framework, longer-term rates will be impacted by many more factors including supply and demand.

Will we continue to see tightening of credit spreads in the new year?

Early indications suggest yes, and perhaps meaningfully, especially for lower-rated credits that experienced significant credit spread increases in 2020.

Will we see the return of tax-exempt advance refundings?

It’s too early to know for certain, but either tax reform or economic stimulus packages could bring back an important financing mechanism for the public sector.

Will we see a rise in corporate tax rates and, therefore, an increase in the value of tax-exemption?

Major tax law changes take time, but a Democratic pursuit of this legislative action should not come as a surprise.

Conclusion

While 2020 brought many unexpected challenges, we are hopeful for a brighter 2021. We trust that as the new year begins to unfold for you and your organization, your preparation and resiliency will lead to favorable outcomes in the year ahead. We look forward to assisting you along the way.

About the Author

Erik Kelly | President | [email protected]

Erik Kelly serves as President of Blue Rose, providing leadership, coordination, and oversight of the firm’s advisory services since 2011. He also serves as the lead advisor to many of the firm’s clients, including advising higher education, non-profit, and other borrowing entities on the planning for and execution of all types of debt and debt-related derivative transactions. In managing the firm’s various advisory service areas, Mr. Kelly oversees both compliance with the changing regulatory environment and the delivery of professional advice to the firm’s clients.

Mr. Kelly holds a bachelor’s degree in economics from Amherst College and a master’s degree in theological studies from Bethel University. Mr. Kelly passed the MSRB Series 50 Examination to become a qualified municipal advisor representative and the MSRB Series 54 Examination to become a qualified municipal advisor principal.

Blue Rose Announcement: Blue Rose’s Max Wilkinson promoted to Assistant Vice President

Mr. Wilkinson provides in-depth modeling, research, and analytics in support of the delivery of capital planning, debt and derivatives advisory, and reinvestment services to our clients. He is responsible for preparing analyses considering various bond structuring options, comparable issue pricings, institutional debt capacity constraints, credit rating models, and break-even refinancing rates. Mr. Wilkinson is involved in every step of the financing process for various clients, from initial development of the plan of finance to rating agency presentations to bond and derivative pricing and bidding of reinvestment products. In his new role, he will be tasked with growing client management responsibilities, in particular ensuring that our clients’ transactions run smoothly through closing.

“Max continues to go above and beyond for our clients. He understands the market and our clients’ needs, is proactive, and delivers valuable advice with clarity and confidence. We couldn’t be more pleased with Max’s performance and congratulate him on a well-deserved promotion,” says Scott Talcott, Senior Vice President.

Please join us in celebrating Mr. Wilkinson’s accomplishments!

Max Wilkinson, Associate

Office: 952-746-6048

Email: [email protected]

Comparable Issues Commentary

Shown below are the results of two negotiated, tax-exempt public higher education issues that sold in the month of January. Western Michigan University (“WMU”) and the University of Idaho (“UIdaho”) priced tax-exempt bond issues on January 21st and January 26th, respectively. WMU’s Series 2021A bonds were issued as a purely new money transaction, with proceeds financing a new student center and dining facility, a new roadway, and redevelopment of the southern portion of the University’s main campus. However, WMU also issued simultaneously priced two refunding bond series (the Taxable Series 2021B bonds and the Tax-Exempt Forward Delivery Series 2021C Bonds), which were issued to refinance portions of the University’s Series 2013 and Series 2011 Bonds, respectively. Meanwhile, the University of Idaho’s 2021A bond issue was issued solely to defease the University’s outstanding Series 2011 bonds, which are subject to mandatory tender on April 1, 2021. Rather than convert the 2011 bonds to a new interest rate period, UIdaho opted to issue the 2021A bonds to effectively refinance the existing issue by defeasing the outstanding bonds.

Both borrowers opted to utilize bond insurance from Assured Guaranty Municipal to augment their credit profiles as they entered the market. Western Michigan’s bonds carried underlying ratings of Aa3/A from Moody’s and S&P, respectively, and UIdaho’s bonds were rated A1 by Moody’s – with the use of insurance, both bond issues carried an enhanced rating of AA from S&P as well. Structurally, the deals were quite similar as well, with both bond issues serialized through 2041 and utilizing standard 10-year par call features with exclusively 5%-coupon structures. However, Western Michigan’s 2021A bonds had a meaningfully longer final maturity, with additional term bonds all the way through 2053 in contrast to the 2041 final maturity of UIdaho’s 2021A bond issue.

The two universities priced into a stable tax-exempt market, with tax-exempt interest rates remaining near all-time lows entering 2021. Both institutions saw MMD yields decrease further on the dates their bonds priced, with the index falling by 1-2 bps across the yield curve for WMU on January 21st and by 2-4 bps across all maturities for UIdaho on January 26th. Perhaps unsurprisingly given the highly comparable credit profiles of the two transactions, credit spreads for Western Michigan and Idaho were also quite similar, with an average differential of less than 2 bps on their comparable serial maturities (2023 – 2041).