Transcription:
Mike Scarchilli (00:05):
Hi everyone and welcome to the Bond Buyer Podcast, your trusted source for insights on all things public finance. I'm Mike Scarchilli, editor-in-chief of The Bond Buyer, and in this episode, our 1st of 2026, Bondbuyer Senior Reporter and buy-size specialist, Jessica Lerner, is joined by Giles Nicholson, Senior Managing Director and Head of the Public Finance Quantitative Solutions Group at Sibert Williams Shank. Their wide-ranging conversation was recorded in December prior to the conclusion of what turned out to be a record setting year for municipal issuance with $580 billion in volume. All facts and figures quoted in this episode reflect the market conditions at the time of recording and remain directionally accurate as the year officially closed out. Together, Jessica and Giles unpacked the biggest story alliance from 2025 from early fears about the elimination of the tax exemption to the April tariff induced selloff to record setting issuance trends across sectors like education and higher ed.
(01:06):
They also look ahead to what may drive volume and volatility in 2026 and explore how technology is transforming the investor and issuer experience in real time. Let's get into it.
Jessica Lerner (01:17):
Hi, Giles. It's great to see you again. The meaty market has been anything but predictable this year. Tariff induced volatility, a deluge of supply and fears of the tax exemption are just a few key events that we saw this year. And speaking of tax exemption, a big worry coming into 2025 was the fear that it would be eliminated. That didn't come to pass, but how did it affect the market?
Giles Nicholson (01:44):
Well, thanks so much, first of all, for having me on the podcast, Jessica. It's great to be here with the bond buyer. I would say that even as early as December of 2024, before the administration took office, we saw a congressional budget office document that put a specific savings number on eliminating the tax exemption for private activity bonds, which included 501. It was a total of $43 billion from 25 to 34, so over those 10 years. But because of the phase in of that, three quarters of the benefit came from 2030 to 2034 in the out years and only 10 billion prior to that because the idea from that document was that it would gradually take effect and wouldn't have any retroactive effect on existing outstanding bonds. So there wasn't much of a benefit from that relative to the need in that document. This was, by the way, an option that was on the table in 2017 in conjunction with the tax legislation that year, but it was dropped from the final bill that ended up eliminating the tax-exempt advance for fundings.
(02:43):
Later documents, even in January, also referenced potential savings from eliminating the tax exemption, but they more broadly also mentioned general government issues with potential savings of up to 250 billion. So that's when market participants, that really caught their attention to see that as potentially on the table. However, these were staff level documents designed to provide information to lawmakers on a variety of policy options rather than top-down political wishlists. And that was just a responsible thing for any kind of planning entity to do on behalf of politicians, just so they know the broadest range of options and what the cost or benefit would be of them. Most market participants discounted the political viability of complete elimination of the exemption, given bipartisan support for it. There were just too many key players against the idea. The bigger concern, which was with us for the first half of the year, was about preserving the exemption for private activities, including 501 since that was initially on the table, and that remained up in the air for quite a some time.
(03:50):
However, because retroactive application to already outstanding bond issues was never serious on the table, given legal and other impediments, this highly limited the potential revenues over any medium term planning timeframe. So it basically ended up not being worth the effort versus other tweaks in the tax system away from the municipal bonds. We didn't see major moves in interest rates directly that were directly related to tax discussions. As I said, retroactivity was never on the table. So primary and secondary markets never priced it in. We did see, however, month by month, issuance go up versus 2024 in the first half of the year, which really wasn't the case in the second half when issuance was lower generally, with the exception of July where there was an overhang from the first half. You will recall that the tax bill was finalized right around the 4th of July.
Jessica Lerner (04:41):
Heading into the year, we knew the tax exemption was going to be an issue, but a big surprise in April was the massive tariffs on nearly all imported goods from other countries. That created huge volatility in the muni market as yields sold off hard 90 basis points over a three-day period before rallying and clawing back gains over the next few days. How did this affect the market?
Giles Nicholson (05:06):
Well, as you said, tariff enhancements did move rates significantly in both directions in an exceptionally short period of time. Typically, geopolitical and unexpected economic news moves the treasury market much more than the municipal market. And you see that on single days, especially when there's an unexpected piece of information or potential war scare. But in this case, municipal rates move much more in the 10-year range by over 90 basis points, as you said, versus less than 50 basis points for US treasuries. Now, some of this was market participants attempting to put a price on something where the primary market had effectively paused and information was limited. So pricing services needed to adjust benchmarks in a good faith effort to value bonds in real time, but there are some limitations to this because even hour to hour, some of the rates are changing and you have ... And so underwriters, issuers, investors didn't really know what bonds were worth.
(05:59):
And so putting a price at the end of the day was very difficult.
(06:04):
Some of this was also real. Outflows in just two weeks total, four and a half billion dollars. And interestingly, when you dig deeper into the data, and this is what I thought was sort of interesting, there were some smaller outflows during the month of March. So when we entered April and all that volatility we end up having in that selloff and the climb back down in rates, we entered the month of April with a lack of tone that made it vulnerable to the dislocation that ensued during April. But at the end of the day, when I think about the whole thing with tariffs and especially the April dislocations, I think what's exciting and reassuring for us as a market is how inflows snap back in the following weeks as the market quickly stabilized. Tariff uncertainty is still with us, but I think municipal markets and investors are showing real resilience in the face of potential policy changes.
(06:58):
Industry participants, both issuers and investors are used to times of volatility. And after all, we all have a time horizon that's much longer than most fixed income markets.
Jessica Lerner (07:09):
Well, the thing about April was that you saw certain deals pulled or shelved or moved to the day-to-day calendar, but that month was still able to eke out gains year over year. And so that's really emblematic of the surge of issuance. Right now, issuance is approaching 550 billion having already top 2024's 500 plus billion figure. This is a new record. Why the surge this year?
Giles Nicholson (07:36):
Well, I think to answer this question thoroughly, we need to look at the detailed composition of issuance, which the bond buyer pretty nicely lays out in your statistical tables. Education grew more than any other sector in relative terms and is up 29% year to date or by $32 billion. We think some of that is an acceleration of bonding, as I referenced before. More broadly, the breakdown of new money and refundings across the market is quite instructive. New money is up 66 billion or 20%. This alone is a big driver, and some of it's attributable to construction inflation being baked into project costs. Refunding volume has actually been down. Rates were higher by 40 basis points in 10 years and closer to 60 basis points in 30 years. So that was part of it, but it's also partly a reflection of something more subtle. The population of 5% bonds that could have been refunded.
(08:27):
MMD in 2015 and 2016, 10 years earlier, was generally lower than it was in 2014. So many three and 4% bonds were issued that hit their 10-year call mark, not all of which provided savings in the current market. So those bonds are generally still out there at this point.
Jessica Lerner (08:48):
So higher education was also an area where you saw surging issuance. That's been happening throughout the year, but the sector has been under strain given the uncertainty around funding, endowment taxes, and enrollment of foreign students. What has been the impact of the sector and where do you see this going?
Giles Nicholson (09:09):
Well, I think a little historical perspective is quite useful here. In the 1986 Tax Act, which now is almost hitting the 40-year anniversary, which is really the big construct we've been living under with tweaks over the years. Many large private higher education issuers actually lost access to the tax exemption altogether for new money and only regained it 11 years later in 1997 because during that time, there was a $150 million cap on 501 debt outstanding with the exception of critical care hospitals and that affected the universities. So this is not the first time that federal policy has had a significant impact on the sector. Endowment taxes in particular have been a policy consideration for quite some time now and have been floated across the political spectrum. The 2017 Act imposed a 1.4% tax on endowments above 500,000 per student, so they did it on a per student basis in relative terms.
(10:05):
And then the 2025 reconciliation bill introduced a graduated scale starting at that same 1.4% for 500,000 endowments that were 500,000 per student, and going up to 8% as a top rate where the endowment per student talks $2 million. Now, this top rate really only applies to a small number of institutions and doesn't significantly impair the credit quality of the sectors as a whole. Now, it's not clear what behavioral changes we're going to see long-term from this change, if any. Sandy Baum of the Brookings Institute actually had a deep dive into this topic, and I'd recommend her piece to anyone interested in some of the policy nuances and considerations on that. Moving to research funding, it's been interrupted, but we are seeing a series of workouts in real time on this as well. So while the short-term disruption has certainly been significant to some its researchers as individuals, we don't see a long-term impact to the sector's bottom line if research money is made whole in the intermediate term.
(11:07):
On the issue of foreign students, there was a temporary pause to the processing of student visas for a few weeks in May and June, but most of the backlog was worked through by the time the fall term started with some exceptions. So it did not for the most part profoundly affect enrollment and therefore tuition revenue. The process for certain applicants is now more cumbersome, especially for certain countries, requiring earlier action on the part of applicants themselves. Again though, as is the case with researchers, it's disruptive for the individual, but ultimately the visa is typically ultimately approved on a longer timeframe than traditionally with some exceptions for certain countries. But overall, we don't see it having a profound impact on the credit quality of the sector.
Jessica Lerner (11:59):
So supply was obviously a big topic this year, and it's going to be a big topic next year. On the heels of surging issuance this year, most strategists expect 2026 to be another record year with at least 600 billion. What factors are contributing to this? And one impact will the Federal Reserve interest rate policy have in the new year that might make volume either higher or lower than expected?
Giles Nicholson (12:26):
We think volume will stay strong in 2026. David Hammer in your September podcast articulated the outlook well. Tax bases, including property taxes, have recovered on a multi-year lag basis from their lows following the 2008 financial crisis and can support added issuance, albeit at a higher construction cost, which is I think a point that David made. In many parts of the country, the need for basic infrastructure to support a growing population and economy requires bond issuance. There's just no way around it. Interestingly, the assets being financed are not necessarily more valuable in real terms than they would've been five years ago or 10 years ago before the pandemic. They just cost more to build than nominal terms. So the 500 billion is more likely a new normal and not a temporary spike. There is some concern out there that the rolling off of various federal funding streams that were elevated during the pandemic and its aftermath could have a budgetary impact, especially at the state level, but that generally affects the operating side of budgets rather than capital spending, which is where the borrowing hits since it is financed over multiple years through bond deals or even decades, and there's necessarily a much longer time horizon to that.
(13:40):
So we don't see some of the limits in the federal operating aid, either limiting or for that matter, increasing bond issuance. The refunding side is harder to know with certainty, though we already do see some outlines of it. We're almost 15 months into a loosening process. It slowed down this year as the Fed has taken stock. We don't know if it has come to an end. I think the chair level transition has been well telegraphed to the market, so much of the impact of that on the long end of the curve is likely already priced in. But we still have a persistent slight MMD inversion in the first five years or so on the tax exempt side, which we're used to by now, but by historical standards is quite unusual and even anomalous. I expect that with additional loosening, if that happens, we would return to an upward sloping curve in the early maturities.
(14:32):
This could make put bonds in variable rate debt more attractive vehicles for bond issuance. One of the wild card, and I kind of touched on this before, is the composition of potential refunding candidates by coupons, since that does affect volume. Depending on how you measure it, about 200 billion or so in bonds will first be currently callable in 2026, but we have to remember that 2016, the year most of these bonds were issued was a lower interest rate environment. So only about half of these bonds bear a 5% or greater coupon. Borrowing a big selloff, we can expect those 5% bonds to be refunded. The other half of the population is mostly lower coupon bonds split between the 4% and 3% range. In addition, and I mentioned this earlier, we also have an overhang of currently callable sub 5% bonds that were not refunded this year.
(15:21):
This is a new pattern. Earlier this decade when rates were exceptionally low up and down the yield curve, almost every bond at every coupon could be refunded for savings when you hit the first call date. If additional, which meant that the refunding, whatever was callable, basically got called with some exceptions. If additional loosening and/or economic softness leads to lower rates in the 10 year and longer range of maturities, then some of those bonds became currently callable in 25, and even some of the overhang from 2024, as well as additional sub-five bonds that were issued in 2016 that are about to be currently callable this coming year, might provide present value savings. Relatively modest reductions in yields in key maturity years, and these are basically bonds that mature up to 20 years, from one year out to 20 years, could have a meaningful impact on refunding volume, spiking it well above the 100 billion conservative baseline.
(16:14):
We could see 150 billion or more. A quick comment on the yield curve, because that really does affect this. Even though rates in general in 2025 were higher than they were in 2024, five and 10 year MMD are on track to end the year 30 to 40 basis points lower in yield. So that's the shorter maturities, five and 10 year lower. With the 30 year, however, up about 25 basis points or so. The fulcrum where rates are unchanged is at the 15 year point. So we enter a new year where rates are actually lower in the first 14 maturities. So what's the upshot of all that? More and more lower coupon bonds are hitting their call date and not being refunded. If we have a lower rate environment, especially in those first 20 year, 20 years of maturities, you could see a flood of those refundings coming in.
(17:02):
It'll move the refunding volume more than we're used to because we've had stability. Basically, since advanced refundings were eliminated, we've had some stable view into what the refunding volume will be year by year, whatever's currently called, gets called. Yes, there are tenders as well, but that's basically what the refunding population is. Now we're going to see a little bit more variability again, akin to what we had back when advanced refundables were available.
Jessica Lerner (17:25):
So anecdotally, money has been moving out of mutual funds into SMAs and ETFs. We've heard this for years. What's the reason for this and will this growth continue in 2026?
Giles Nicholson (17:38):
Well, I think we can break this into two parts. ETFs are well suited to smaller investors who still need the tax exemption. You generally get more flexibility and transparency than with a mutual fund. The pricing and holdings information can be accessed in real time and expenses are generally low. I would say the MSRB under Mark Kim's leadership has been looking at this and publishing some valuable research pieces. As you referenced, and this is in their research, the ETFs have grown from 0.7% of muni assets in the first quarter of 17 up to 3.5% in the second quarter of this year. They're generally more liquid than the underlying munis, but don't impair the liquidity of the underlying munies according to MSRB data. At this point, we're getting up to about 200 billion outstanding and there is more growth expected. SMAs are more suited to high income individuals who want a portfolio they can control.
(18:28):
It allows them to plan around potential tax events and manage credit and duration exposure in a simple way. And they have grown hugely in percent and absolute terms. They're up 30% in 2018 while mutual funds are basically flat. But I think to answer your question more fundamentally, I think the reason we have these products available with low transaction costs is essentially technology. When information is readily available and brokerage firms can tailor the creation and transaction processing of products dynamically and in real time, investors benefit from cheaper and more tailored options. They don't pay as much for them because the overhead is lower and issuers benefit from a broader investor base for their issue. So I think that's one of the exciting things going on in the technology space right now is just that the whole ability of investors get the product cheaper and then issuers have access to that whole new universe or growing universe is just going to get better and better.
Jessica Lerner (19:27):
You're right. Part of the reason SMAs have been able to see this explosive growth is because of technology. It's becoming more of a presence in the muni market. As the industry moves toward increased automation and reliance on machine learning and artificial intelligence, what's next?
Giles Nicholson (19:46):
Well, we're seeing change at a faster rate than ever. It's almost a cliche at this point, right? I mean, the transition from bearer bonds to registered bonds, and then finally the book entry took years and was like a large logistical effort on the part of this industry. At breakdown technology impact into three different groups of players. Investors we just talked about. Buying and selling ETFs and individual bonds via computer without human intervention is happening. This is another thing the MSRB is looking at in detail. And so getting access to the tax exemption as an individual will not have the transaction and shoe leather costs we've lived with for so very long in this industry. And that I think is going to make a difference too for some of the smaller issuers that are out there. We have tens of thousands of issuers. Some of them will be able to get at market access and market information and audience through some of the information available in, and it'll just give a much broader ability for them to ultimately place their bonds.
(20:53):
We're not quite there yet, but I think it will be happening. At the bank's end, I can tell you, all of our processes are getting simpler. You can literally just ask your browser with an AI hook in to pull issuers financials or even an official statement for you. The whole process of getting information on the banking side is much easier. Building a debt database is basically a thing of the past. It's something we used to do very manually. External vendors will provide you with a debt summary and a computer file that you can use to model debt within seconds. The contrast to the days when you had to build everything by hand using a microfiche machine and in- house software is enormous. Several days of building debt has become an hour or two of checking it, which is still an essential task. Finally, issuers can gather the information they need directly and efficiently to make informed financial decisions, turning to the financial community for higher level strategic advice rather than just for basic information.
(21:49):
What's next? Of course, all of these trends will continue, and there may be things that'll happen sooner than we think. However, I think more profoundly is that we are switching the way we think about work in real time, and this of course goes beyond municipals. The Wall Street Journal had a piece recently where, just a few days ago, actually, where they said that for certain client assignments, this was away from the whole muni industry, this is generally the way their chargebacks work internally and to clients as well. Future legal compensation would not be based so much on billable hours of associates, but more on the outcomes overall. So the broader point coming out of that that I would make is that white collar pay and rewards are now going to be more and more detached from the pure clerical effort involved as clerical effort can now be outsourced to a computer.
(22:41):
So all of us in this industry need to rethink and are rethinking in real time how we work. We now have research and execution staff basically inside our keyboard, and maybe it'll be voice activated before we know it. And our contribution as individuals in all aspects of this industry is going to be based on thought and strategy going forward rather than on raw effort. And we've really, and especially, we've had so many hardworking analysts and associates in the industry who are very smart with great qualifications having to do a lot of grunt work. They will be able to progress to the next level as they learn their craft faster because they'll be able to gather the basic information more easily. And then all of us will be upping our game and be able to contribute in a more meaningful way. So I think that's all quite exciting.
(23:27):
It's different. It's going to require us to be pretty open-minded, but I find it quite exciting and liberating.
Jessica Lerner (23:34):
And lastly, looking into 2026, are there any lessons from this year that we should take with us?
Giles Nicholson (23:40):
Well, I think overall, looking back to 2025 and forward into 2026, I think we can be heartened by our market's persistent resilience. And that is a word I would just like to tack on to 2025. Investors stayed engaged except for brief periods like that volatility in April. Issuers continue to finance their programs deliberately with an eye to the long term rather than simply to the latest news. And other market players from banks to insurance companies to rating agencies stayed focused on pulling everything together for the clients they serve. So I think this gives us all the confidence to whether whatever surprises may lie and wait for 2026.
(24:22):
I'd like to make one final shout out to the bond buyer for the role that it plays through conferences, events, and news coverage. You really do bring a whole variety of people together in ways that deepen our sense of community and purpose outside the context of individual transactions, and that is of great value in helping us collaborate. I mean, anytime we go to these conferences, we see people, we make connections. It doesn't necessarily lead to a bond deal in and of itself, but especially as we work through so many changes in this world today, having that broader sense of community in this industry, I think gives a psychic value and a sense of purpose to all of us. And I think the bond buyers played such a great role in that. And so I'm very grateful to you and to your Inspire staff and management for the essential role you play in bringing that all together.
(25:07):
In general, I appreciate the opportunity to speak today, so thank you so much for this, Jessica.
Jessica Lerner (25:13):
So thanks, Jiles, for joining us. I look forward to chatting with you in the future.
Giles Nicholson (25:18):
Thank you.
Mike Scarchilli (25:20):
That's a wrap for this episode of The Bond Buyer Podcast. A big thank you to Giles Nicholson for his insights and to Jessica Lerner for leading the conversation. Here are three key takeaways from today's episode. One, tax exemption fears were real, but ultimately didn't derail issuance. Although early 2025 brought anxiety around potential changes to the tax treatment of municipal bonds, the market ultimately absorbed the policy noise with bipartisan support helping to preserve the exemption. Two, despite severe April volatility tied to sweeping tariff announcements, the muni market proved remarkably resilient. Rates snapped back quickly, inflows returned, and issuance rebounded strongly, even allowing April to post a year over year gain. And three, technology and efficiency gains are flattening the playing field across the muni ecosystem. As Giles explained, the tools now available to smaller firms and issuers from AI-driven data analysis to platform-based banking workflows are narrowing the gap between large institutions and more agile players.
(26:33):
This democratization of access is reshaping competition across the board. Thanks again for listening to the Bond Buyer Podcast. This episode was produced by the BombBuyer. If you liked what you heard, please subscribe on your favorite podcast platform, leave us a review and visit us at www.bondbuyer.com for more of our award-winning coverage. Until next time, I'm Mike Scarchilli signing off.