Higher education, healthcare expect tough conditions ahead

The Bond Buyer's 2026 Predictions Report

Funding crises are the storms on the horizon for muni finance

Key takeaway: Funding crises in higher education and healthcare, as well as heightened defaults, are likely in the eyes of respondents.

The uncertain economic environment has municipal finance professionals forecasting heightened defaults and funding crises in various market sectors for the year ahead.

Roughly 72% of respondents were fairly confident that there would be a funding crisis in healthcare in the coming year. A similar share of municipal finance professionals (71%) were also confident that there will be a funding crisis in higher education across the same period. More than half of respondents (62%) said increased defaults and impairments were a high likelihood in 2026.

These trends could bring significant levels of risk not just to individual businesses, but to the municipal finance industry as a whole. 

Federal funding cuts stemming from the One Big Beautiful Bill Act have left state lawmakers with few options to combat the gap, save for raising revenue or cutting spending. With some legislators approaching an election year, few are likely to propose raising taxes as a means of increasing revenue.

Brian Sigritz, director of state fiscal studies for the National Association of State Budget Officers, told The Bond Buyer that as states begin approaching budget negotiations for fiscal 2027, more discussions around "how states are going to handle the changes on a federal level" will appear.

"There are a number of states where spending demands are exceeding revenue growth so that's creating some long-term challenges," Sigritz said. "So states will have to balance all these competing things going on at the same time."

Bond demand could mostly remain the same for 2026

Key takeaway: Bond demand is predicted to stay the same year-over-year.

The majority of respondents are expecting bond demand in 2026 will keep roughly the same pace as in 2025.

The largest share of respondents predicting increased demand were for overall demand (44%), followed by tax-exempt bonds (39%), general obligation bonds (36%) and revenue bonds (31%). Short-term notes (27%), taxable bonds (22%) and green bonds (12%) also saw some support for increased demand predictions.

Market demand for most categories of bonds is expected to remain the same year-over-year, with ESG bonds garnering the largest share of respondents (43%) that predict demand will taper off in 2026.

ESG bonds have continued to fall out of market favor over the last few years, as state legislators in Oklahoma, Louisiana, Wyoming and others propose anti-ESG policies that restrict contract eligibility.

Otherwise, demand is expected to largely stay the course or increase in some cases.

Jeff Lipton, municipal market intelligence analyst for The Bond Buyer, said given existing forecasts for volume, "the results for bond demand seem to be in alignment." 

"I suspect that a greater supply of bonds can provide diversification opportunities for multiple buyer classes, particularly for SMAs," Lipton said.

How might institutional investment in the bond market change in 2026?

Key takeaway: ETFs and SMAs will increase in popularity with those investing in the bond market.

Investment activity in the bond market is predicted to largely remain unchanged, but some entities are increasing their activity.

ETFs were the top institutional category (57%) that reported increases in investment activity in the bond market when comparing 2026 to 2025. SMAs (45%) were close behind, followed by mutual funds (23%), banks (14%) and insurance companies (14%).

ETFs were the only institutional group that saw a greater share of "increase" responses than "stay the same" responses. 

The changes in the retail landscape have led to a rise in popularity for ETFs and SMAs among retail investors, with J.P. Morgan reporting that muni SMAs hold an estimated $1.3 trillion in assets under management. Separately, ETF muni holdings are up 22.4% year-over-year to $163.1 billion as of the third quarter of 2025, according to the latest Federal Reserve data.

Dan Solender, partner and director at Lord, Abbett & Co., said at The Bond Buyer's recent National Outlook conference that the SMA "business is booming" in part because of how customizable the vehicles are.

Currently, there's political discontent nationwide. Investors "want us to be able to customize and exclude certain cities or states or sectors. You have to be able to do all this," he said.

Challenging times for municipal finance

Key takeaway: The higher education and healthcare sectors of the municipal finance market are poised for tough times ahead.

Municipal finance, like most areas of the financial system, is subject to the ebbs and flows of the broader economic environment. Some areas could get hit much harder than others.

Higher education (80%) and healthcare (76%) were identified as the top sectors expected to face the greatest challenges over the next five years. The next two closest sectors were affordable housing (39%) and senior living (39%).

Project finance (18%), ports (11%) and airports (3%) had the lowest share of respondents predicting trouble.

The changing demographics of college students in addition to funding cuts at the federal and state levels put higher education issuers in a challenging spot to close funding gaps.

In November, Moody's announced it would maintain its negative outlook on the higher education sector into 2026 as expectations for revenue growth are outpaced by expenses, according to Moody's analyst Patrick Ronk.

Revenue growth is projected to slow to 3.5% from 3.8% as demographics and competition limit pricing power, Ronk wrote in the report. Meanwhile, the sector is projected to see expense growth of 4.4%.

Credit quality could largely be balanced, with notable downgrades

Key takeaway: Credit quality could largely stay the course in 2026, with notable downgrades.

While the majority of respondents expect credit quality to remain balanced between downgrades and upgrades, more than one-third (36%) of municipal finance professionals expect downgrades will outpace upgrades. Only 9% predict upgrades will outpace downgrades.

One example of a downgrade occurred earlier this month, when Brightline Trains Florida LLC was the subject of another credit quality downgrade from S&P Global Ratings. The agency dropped its already junk-level rating on $2.2 billion of senior, so-called Opco, debt one notch to CCC-minus.

Are issuers addressing climate and severe weather-related events?

Key takeaway: Issuers are doing a fairly good job when it concerns addressing climate and severe weather-related events in credit disclosures.

The impacts of climate risk and severe weather events on bond portfolios have been often discussed, but some muni pros feel that issuers are getting better about addressing these market factors.

More than half of respondents (54%) said climate and severe weather-related events are being well addressed in issuer credit disclosures, versus 42% who said they were not being adequately addressed. Roughly 4% said they were unsure.

Changing climate conditions have pushed lawmakers to consider new legal frontiers, such as allowing local governments to sue fossil fuel companies at the state level for climate damages. These cases, albeit in differing stages, heighten the importance of addressing climate risks in credit disclosures.

Last month, Fitch Ratings announced a proposed methodology for implementing a screening tool that would identity climate-focused risk in public finance. The proposal drew cautious approval from Municipal Market Analytics, which while positive about increased transparency, said it "could be better with enhanced disclosure."

Details from the draft explain that climate vulnerability signals, or climate.VS, reflect an issuer's exposure to climate risk but would not be among the key rating drivers in Fitch's criteria. However, they could impact key rating drivers, and the 0-100 climate.VS score for five-year intervals is intended to act as a forward-looking screening tool.

"Our proposal was to publish only the scores that are 50 or above, because that is the threshold at which we're saying there could be potential credit implications in the future," Arlene Bohner, head of U.S. public finance at Fitch told The Bond Buyer.