Skip to content
Laird Norton Wealth Management
  • Services
          • Wealth Planning
            • Business Owner
            • Equity Compensation
            • Estate Strategies
            • Philanthropic Giving
            • Tax Strategies
          • Investment Management
            • Tax-Aware Investing
            • Risk Management
            • Alternatives & Private Market
            • Impact Investing
          • Trust Services
            • Beneficiary Services
            • Family Legacy
            • Trust Administration
            • Trust Benefits
            • Understanding Trusts
          • NonProfit Clients
            • Request RFP Participation
  • About
          • About LNWM
            • Fiduciary Financial Advisor
            • How We Help
            • Our Team
            • Corporate Social Responsibility
            • Careers
            • Community
            • Board of Directors
            • FAQs
        • two people in a kayak on water
  • Insights
        • Blog

          Top-of-mind at LNWM and elsewhere.

          Papers

          Expert insights and analysis.

          Videos

          See what we're up to.

          Media

          Our published work and media coverage.

  • Contact
Search Icon
Client Login
mobile-login

Home » Insights » Investment Management » Why We’re Holding on to High-Quality Municipal Bonds

Why We’re Holding on to High-Quality Municipal Bonds

David Baker | Investment Management | April 17, 2020 (April 20, 2020)

Covid-19 containment efforts are chipping away at state and local tax revenue, while spending on public services is rising. Because (unlike the federal government) states cannot borrow on an unconstrained basis, there is concern state and local entities across the US will be squeezed financially and have difficulty making payments on municipal bonds. These worries, and a market environment marked by scant liquidity, have driven muni bond yields to historically high levels relative to Treasuries. At one point, 10-year munis yields hit 3% vs. just 0.8% for Treasuries. Although the yield spread has since narrowed, it is still substantial :

Recent Yields:
10-year, AAA-rated General Obligation municipal bonds: 1.14%
10-Year US Treasury bonds: 0.64%

While the muni bond market faces major challenges, I don’t think it is in dire straits. There are multiple levels of support being provided to municipalities by the Federal Reserve as well as the federal government.

Fed Support

Last week, the Federal Reserve said it would provide $500 billion in short-term lending to state and local governments to help fund budget gaps caused by Covid-19. While all states can access the program, some concerns have been voiced. That’s because of restrictions on the size of counties that can qualify for support — only 10 cities and 16 counties are technically eligible. This may not seem like broad-based support, but it actually is.

The level of municipal bond issuance is generally correlated to population. California and New York, for example, have issued about 33% of all the US municipal bonds on the market. Those 16 counties that are eligible for Fed support? My math says they account for about 30% of reported Covid-19 cases. So, the Fed has focused on the areas likely to have the greatest need for these loans. And of course, states can participate and pass that support down to local municipalities at the city and county level, as needed.

I think the role of the Fed here isn’t to provide a bailout and choose winners/losers, but to provide liquidity to keep the muni bond market functioning. Providing added liquidity the way the Fed has is clever on a couple of fronts. In scope, $500 billion is roughly 15% of muni bond new issuance, which has averaged about $400 billion a year in gross issuance. Interestingly, net new issuance has been negative for years – if you subtract bonds maturing or paid off early. In fact, the size of the muni bond market has been shrinking over the past decade.

The Fed is also using a second mechanism to support the muni market: it is allowing existing short-term muni debt and VRDNs (Variable Rate Demand Notes) to be used as collateral for muni money market new issuance, creating another backstop. I think new muni issuance will be able to be rolled over with the support of this Fed program. I also expect that the Fed will begin to buy longer-dated muni bonds if market liquidity starts to dry up again, most likely starting with purchases of muni bond ETFs.

Still, at the end of the day, Fed liquidity facilities can only do so much, and I don’t think that’s what really will solve the problem. Direct federal government aid or grants have a clear role to play, and fortunately we have this type of fiscal support coming from Congress.

Fiscal Support

State and local governments are receiving $150 billion of the $2 trillion in new fiscal spending via the CARES Act. This is direct funding to combat the impact of Covid-19 (excluding additional hospital support), which is what really moves the needle. States and municipalities are also receiving an additional $200 billion in emergency appropriations to support ongoing operations. 

Do municipalities have enough overall support via the CARES Act? Consensus seems to be no, even if muni markets have been recovering. I’ve seen numbers that say anywhere from $100 billion to $600 billion in additional aid is needed. The willingness seems to be there in Congress to provide this level of extra aid. Reports are that CARES Act II is planned to include another $250 billion for state and local governments.

I think the Federal Reserve is looking for states to handle their operations with support from the federal government. Again, the Fed is providing liquidity to the muni bond markets via loans to some of the most important issuers, while allowing states to diagnose local problems and appeal for more direct aid from the legislature.

The Outlook

My view is that the federal government will do whatever it takes to prevent the chaos of widespread municipal bond defaults. Municipal tax collections are actually historically quite stable, with personal income taxes being the most volatile component (that’s a problem for states, not local governments). The chart below shows historical municipal tax collection from state and local sources to give context to how well municipalities have made it through prior crises.  

Washington State and Local Revenue

My sense is that some municipal bond issuers will face near-term problems with funding, budgeting,  and liquidity constraints – but not long-term problems (pension funding shortfalls can be addressed post-crisis). There will certainly be pain points on a case-by-case-basis, such as for hospitals and airports. And some municipalities will have liquidity issues because of deferred tax collection. I anticipate we will see some state and local government employees furloughed if not now, then post-crisis.

However, based on history and federal government actions to date, I don’t expect many municipal bond defaults, despite the unique challenges that Covid-19 presents. For context, the historical rate of default on municipal bonds initially A-rated or higher has been less than 1/10th of 1 percent. The greater risk is of credit downgrades from rating agencies, which will likely affect lower-rated muni bonds the most and cause renewed liquidity concerns.

As far as LNWM portfolios go, we are comfortable with our muni bond positions, even if we may yet face additional volatility. As we move past Covid-19, the yield advantage of muni bonds relative to Treasuries will likely prove transitory and reward patient investors.

We are invested in high-quality munis, rated AA on average, issued by larger entities with reliable financial statements. We’ve never invested heavily in the high-yield muni bond arena, a fragile, small corner of the market that is the most likely to see defaults. Nevertheless, the municipal bond fund managers we invest with have been stress-testing the bonds they own under various scenarios of falling municipal revenue over the next 12 months; so far, they are confident that the muni bonds they hold will continue to make payments during that timeframe.

  • Share:
  • Tagged:
  • Coronavirus
  • municipal bonds

David Baker

David is Senior Director, Investment Strategy and Communications. at Laird Norton Wealth Management. While his focus is mainly on the numbers, David also writes the firm’s monthly Flash report, and he is a key contributor to LNWM’s quarterly investment outlooks.

Sign Up For Monthly Economic Flash

Find out how all major financial markets are performing and why.

Site Logo in footer footer logo
facebook Twitter Opens a news tab Linkedin Opens a news tab Youtube Opens a news tab

About

  • Board of Directors
  • Careers
  • Community
  • Contact
  • FAQs
  • Our Team
  • Sign up for Navigator

Services

  • Investment Management
  • Sustainable Investing
  • Tax Strategies
  • Trust Services
  • Understanding Trusts
  • Wealth Planning

Address

  • Laird Norton Wealth Management 801 Second Avenue, Suite 1600
    Seattle, WA 98104
    United States
  • 206.464.5100
  • 800.426.5105
© 2023 Laird Norton Wealth Management. All rights reserved.
Form CRSOpen PDF in a new tab Legal Terms and Conditions Privacy Policy
We use cookies on our website to give you the most relevant experience by remembering your preferences and repeat visits. By clicking “Accept All”, you consent to the use of ALL the cookies. However, you may visit "Cookie Settings" to customize your settings.
Cookie SettingsAccept All
Manage consent

Privacy Overview

This website uses cookies to improve your experience while you navigate through the website. Out of these, the cookies that are categorized as necessary are stored on your browser as they are essential for the working of basic functionalities of the website. We also use third-party cookies that help us analyze and understand how you use this website. These cookies will be stored in your browser only with your consent. You also have the option to opt-out of these cookies. But opting out of some of these cookies may affect your browsing experience.
Necessary
Always Enabled
Necessary cookies are absolutely essential for the website to function properly. These cookies ensure basic functionalities and security features of the website, anonymously.
CookieDurationDescription
cookielawinfo-checkbox-advertisement1 yearSet by the GDPR Cookie Consent plugin, this cookie is used to record the user consent for the cookies in the "Advertisement" category .
cookielawinfo-checkbox-analytics11 monthsThis cookie is set by GDPR Cookie Consent plugin. The cookie is used to store the user consent for the cookies in the category "Analytics".
cookielawinfo-checkbox-functional11 monthsThe cookie is set by GDPR cookie consent to record the user consent for the cookies in the category "Functional".
cookielawinfo-checkbox-necessary11 monthsThis cookie is set by GDPR Cookie Consent plugin. The cookies is used to store the user consent for the cookies in the category "Necessary".
cookielawinfo-checkbox-others11 monthsThis cookie is set by GDPR Cookie Consent plugin. The cookie is used to store the user consent for the cookies in the category "Other.
cookielawinfo-checkbox-performance11 monthsThis cookie is set by GDPR Cookie Consent plugin. The cookie is used to store the user consent for the cookies in the category "Performance".
viewed_cookie_policy11 monthsThe cookie is set by the GDPR Cookie Consent plugin and is used to store whether or not user has consented to the use of cookies. It does not store any personal data.
Functional
Functional cookies help to perform certain functionalities like sharing the content of the website on social media platforms, collect feedbacks, and other third-party features.
CookieDurationDescription
__cf_bm30 minutesThis cookie, set by Cloudflare, is used to support Cloudflare Bot Management.
bcookie2 yearsLinkedIn sets this cookie from LinkedIn share buttons and ad tags to recognize browser ID.
bscookie2 yearsLinkedIn sets this cookie to store performed actions on the website.
langsessionLinkedIn sets this cookie to remember a user's language setting.
lidc1 dayLinkedIn sets the lidc cookie to facilitate data center selection.
UserMatchHistory1 monthLinkedIn sets this cookie for LinkedIn Ads ID syncing.
Performance
Performance cookies are used to understand and analyze the key performance indexes of the website which helps in delivering a better user experience for the visitors.
CookieDurationDescription
_uetsid1 dayBing Ads sets this cookie to engage with a user that has previously visited the website.
_uetvid1 year 24 daysBing Ads sets this cookie to engage with a user that has previously visited the website.
Analytics
Analytical cookies are used to understand how visitors interact with the website. These cookies help provide information on metrics the number of visitors, bounce rate, traffic source, etc.
CookieDurationDescription
_ga2 yearsThe _ga cookie, installed by Google Analytics, calculates visitor, session and campaign data and also keeps track of site usage for the site's analytics report. The cookie stores information anonymously and assigns a randomly generated number to recognize unique visitors.
_gcl_au3 monthsProvided by Google Tag Manager to experiment advertisement efficiency of websites using their services.
_gid1 dayInstalled by Google Analytics, _gid cookie stores information on how visitors use a website, while also creating an analytics report of the website's performance. Some of the data that are collected include the number of visitors, their source, and the pages they visit anonymously.
_hjAbsoluteSessionInProgress30 minutesHotjar sets this cookie to detect the first pageview session of a user. This is a True/False flag set by the cookie.
_hjFirstSeen30 minutesHotjar sets this cookie to identify a new user’s first session. It stores a true/false value, indicating whether it was the first time Hotjar saw this user.
_hjIncludedInPageviewSample2 minutesHotjar sets this cookie to know whether a user is included in the data sampling defined by the site's pageview limit.
_hjIncludedInSessionSample2 minutesHotjar sets this cookie to know whether a user is included in the data sampling defined by the site's daily session limit.
_hjTLDTestsessionTo determine the most generic cookie path that has to be used instead of the page hostname, Hotjar sets the _hjTLDTest cookie to store different URL substring alternatives until it fails.
_omappvp11 yearsThe _omappvp cookie is set to distinguish new and returning users and is used in conjunction with _omappvs cookie.
_omappvs20 minutesThe _omappvs cookie, used in conjunction with the _omappvp cookies, is used to determine if the visitor has visited the website before, or if it is a new visitor.
calltrk_session_id1 yearThis cookie is set by the Provider CallRail. This cookie is used for storing an unique identifier for a user browser session. It is used for tracking the number of phone calls generate from the website.
vuid2 yearsVimeo installs this cookie to collect tracking information by setting a unique ID to embed videos to the website.
Advertisement
Advertisement cookies are used to provide visitors with relevant ads and marketing campaigns. These cookies track visitors across websites and collect information to provide customized ads.
CookieDurationDescription
_fbp3 monthsThis cookie is set by Facebook to display advertisements when either on Facebook or on a digital platform powered by Facebook advertising, after visiting the website.
_mkto_trk2 yearsThis cookie, provided by Marketo, has information (such as a unique user ID) that is used to track the user's site usage. The cookies set by Marketo are readable only by Marketo.
fr3 monthsFacebook sets this cookie to show relevant advertisements to users by tracking user behaviour across the web, on sites that have Facebook pixel or Facebook social plugin.
MUID1 year 24 daysBing sets this cookie to recognize unique web browsers visiting Microsoft sites. This cookie is used for advertising, site analytics, and other operations.
test_cookie15 minutesThe test_cookie is set by doubleclick.net and is used to determine if the user's browser supports cookies.
Others
Other uncategorized cookies are those that are being analyzed and have not been classified into a category as yet.
CookieDurationDescription
_ce.gtldsessionNo description
_dc_gtm_UA-41670453-11 minuteNo description
_hjSession_275188330 minutesNo description
_hjSessionUser_27518831 yearNo description
AnalyticsSyncHistory1 monthNo description
BIGipServerab10web-nginx-app_httpssessionNo description
BIGipServerab47web-nginx-app_httpssessionNo description
calltrk_landing1 yearThis is a functionality cookie set by the CallRail. This cookie is used to store the landing page URL. It helps to accurately attribute the visitor source when displaying a tracking phone number.
calltrk_nearest_tld9 years 10 months 8 daysNo description
calltrk_referrer1 yearThis is a functionality cookie set by the CallRail. This cookie is used to store the referring URL. It helps to accurately attribute the visitor source when displaying a tracking phone number.
CookieLawInfoConsent1 yearNo description
li_gc2 yearsNo description
SAVE & ACCEPT
Powered by CookieYes Logo