The Muni Opportunity

The Muni Opportunity

Anu Rajakumar: As the tax and policy initiatives of the Trump Administration come into greater focus, investors have been watching closely for their impacts on tax-exempt investing and the municipal bond market. At the same time, we're seeing an unusual dynamic. Municipal bond supply is significantly outpacing demand, creating both complexity and opportunity for market participants. Nevertheless, the muni market is showing remarkable resilience with elevated yield, attractive income, and generally low default rates. With policy shifts potentially on the horizon, what are the implications for investors seeking tax advantaged income? How might these changes reshape the muni landscape?

My name is Anu Rajakumar, and today I'm joined by Jamie Iselin, Head of Municipal Fixed Income, to dig beneath the headlines and challenge some of the assumptions shaping the muni market today. Jamie, welcome to the show.

Jamie Iselin:Thank you for having me.

Anu: Jamie, let's start talking about policy, a big focus in the muni market. It's been a major influence on municipal bonds this year. Of course, the administration recently passed its One Big Beautiful Bill Act, which had many significant tax proposals that may impact investors. Why don't we do a quick summary of what that bill meant for muni investors, and what elements of the bill do you think are most impactful for the investors that you work with?

Jamie:I think the big thing is how well the muni market came through the OBBBA relative to expectations. If you think back into the spring, there was a lot of hand-wringing in the marketplace that the muni tax exemption would get eliminated, and then in the worst-case scenario, maybe even completely removed. I think that made investors somewhat skittish.

Anu: I'm sure you had a lot of phone calls in the last few months. [laughs]

Jamie: We had a lot of phone calls from clients saying, "What's going to happen to my muni bonds?" We were never in the doomsday camp, as it relates to that. We also believed if there were restrictions placed on the tax exemption, that previously existing bonds would be grandfathered, but there was a lot of concern. It's hard to quantify, but I think it was causing investors to hold back. The good news is, when you looked at the house version, and then what was ultimately passed, the tax exemption was completely preserved in the bill. I think the market breathed a huge sigh of relief.

You started to see, as that became more clear in the spring and then early summer, the muni market started to rally. We actually got parts of the market. When you think about housing bonds and private activity bonds, where the bill actually potentially expands the universe of issuance, which is, again, the opposite of what most people felt would happen there. Now, the SALT cap is a very interesting topic. When we think back to 2017 when the Tax Cuts and Jobs Act was passed, that cap at $10,000, that effectively raised most investors' effective state tax rate, made demand for munis in those higher tax states even higher.

Now we do have a slight increase in the cap, but I think when you look at states with high tax rates like New York, California, and New Jersey, even with a slightly higher cap, tax rates are very, very high in those states. I don't think you're going to see a material change in the demand for muni bonds. I think especially in higher tax states, it's going to remain very elevated.

Anu: Excellent. Thank you very much. I'm sure in a few months, as you work through potential implications of the bill, some sectors garnered a lot of attention this year. I was wondering if you can tell us a little bit about some of those. The hot sectors that you, and issuers, and clients were really watching as a result of the potential bill's passage.

Jamie: I think the healthcare sector is one that is very interesting. Obviously, we got Medicaid reform. Those changes and potential cuts don't go into effect for a little while. I think when looking at the healthcare sector, you have to pay attention to what the potential impacts of a reduction in revenue streams that cover the patients that got to those hospitals that are on Medicaid. I think you have to be very flexible about that.

One of the beliefs that we've always had about the healthcare sector is generally, bigger is better. The big multi-state systems, or larger standalone hospitals, that have the balance sheets to withstand those types of changes, are the kind of credits that are going to come through these changes in much better shape, and they have the resources and the financial flexibility to do so. I think that's one area that we've definitely been focusing on a lot, and will continue to focus on in the days and years ahead.

Anu: Sure. You mentioned credit quality. I think there was likely just, there's been this heightened focus on both the fiscal health of the state and local governments, just as these policy issues have arisen. How do you think some of the dynamics that you've been observing have impacted credit quality of the muni market, both in terms of the default risk as well as the investor demand?

Jamie: The credit quality is actually at a very high place. We are most likely past peak credit quality, given where we are in the economic cycle. When you look at state and local governments, they have very high reserve levels. They got a lot of aid during COVID. Then as the economy bounced back, they really filled up their reserve accounts. While the reserve levels are not quite at the peak that we experienced two years ago, they are at very, very high levels.

What does that mean? That means that if we have an unexpected bump in the economic environment, they have the resources to get them through that period without having to make more painful decisions. I think muni credit quality is in a pretty good spot right now. The other thing that is important to remember for state and local governments is, unlike the federal government, they don't have a printing press.

Most of them are required to balance their budgets year in and year out. That leads to a much more prudent fiscal place for those issuers. Again, they pay close attention to reserve levels and financial flexibility. I think when you look at all of those factors combined, we feel that muni credit quality is actually in a very, very good place right now. We're not bearish on the economy by any stretch of the imagination, but if the unexpected happens, we think muni credit quality is flexible and can get through that environment quite well.

Anu: Sure. Like you said, you have a focus on that credit quality as well, just to make sure that you have a buffer yourselves. The other big story, I think, of the year has been on the supply side, especially with the surge in new issuance earlier this year. What's driving that and what has that meant for market dynamics and opportunities for investors?

Jamie: We have had an incredible year of supply. We had an incredible year of supply in 2024, and it's continued. We are on track to have north of $500 billion in supply, and to hit an all-time record. I think it's almost a perfect storm for supply. In the municipal bond market, many bond deals are approved by voters. When we go and vote in the fall, you'll oftentimes see a ballot initiative. Voters have generally-- they don't approve all of them, but they've generally been approving a lot of them. I think it's a recognition that there is a real need for newer buildings, better schools, better roads, better airports. The voters are approving these deals and they're coming to market.

We're also in an environment where just doing a big construction project is more expensive. A school construction deal today is more expensive, all things being equal, than it was a couple of years ago. That's increasing the size of deals. The COVID money that all these state and local governments got is starting to dry up. Again, accessing the market to raise funds to do these infrastructure projects continues to be incredibly important. I think when you put all of those factors together, it's leading to a supply level that I do think there's a high likelihood we're going to hit an all-time record in 2025.

Anu: Maybe if you happen to know-- you said on track for $500 billion for 2025. Before 2024, on average, what was the size of the market? Was it a couple of hundred billion or smaller? Has it really just been an immense growth year over year, would you say?

Jamie: I'd say an average year is in the $400 to $450 billion. Last year, we ended up above $500 billion. This year, I think we're going to eclipse last year. It's a great thing. A few years ago, one of the biggest problems or challenges in the muni market was the belief that there isn't enough supply for the overall demand. We have an aging demographic in our country.

As more and more people retire and shift to a fixed income, that municipal demand just increases. I think there was some healthy concern, are we going to have enough supply to meet that demand? I think we're in an environment right now where not only we have a record this year, but these higher levels of supply are probably here to stay because there's a lot of infrastructure in this country that needs to be fixed.

Anu: Absolutely. Speaking of infrastructure, I understand that public-private partnerships have become a bigger part of the muni landscape. Can you share some examples of those and tell us how those kind of deals are reshaping infrastructure in the United States?

Jamie: It's an incredible development in the muni market where a public entity, a municipality sees a need for infrastructure and partners with a private entity to make that project a reality. It's a mutually beneficial relationship. The public entity sees what needs to be done but they bring in the expertise of the private entity, their ability to build a project, their ability to attract private capital. They come together, they share in the risks and rewards of the project. The goal is to deliver a cost-efficient, hopefully on time, or ahead-of-schedule project that benefits the public good.

We've really seen a significant uptake in these types of deals. I'll give you a couple examples that I think are important to point out. LaGuardia Airport. I'm a native New Yorker. I've flown through the airports around here my whole life. You think back 10, 15 years ago, LaGuardia Airport was viewed as an embarrassment in terms of the condition that it was in. A P3 or public-private partnership helped do this fabulous renovation that we have of this airport, kept it opened and functioning at the same level of usage while this complicated project was being done. Now anybody that's gone to that airport, I think by many people, it's rated as the nicest or one of the nicest airports in America.

Anu: I was going to say, I was like, a moment of respect for what LaGuardia did, which was truly transformational. What a pleasure it is to fly out of LaGuardia once again. I am totally in agreement. It is really a spectacular airport now. The fact they did that while it was running is really incredible.

Jamie: On a very, very tight piece of land. It's not like--

Anu: Yes, absolutely.

Jamie: They kept the volumes up. There were a few days where folks had to get out of taxis a mile from the airport and walk.

Anu: Walk half a mile. [laughs]

Jamie: Another interesting one that was just in the market last week was one of the largest BBB rated deals of all time. It was a public-private partnership to build an express lane toll road in the State of Georgia. Again, the public entity saw how bad the traffic was and said, "If we could have additional arteries for drivers, if they so choose to use and accelerate the pace of traffic, that's what this project aims to do." It was an over $3 billion deal that was very, very well received by investors. I think this is a trend that is here to stay. They're coming together and they're really getting some important infrastructure deals done for the American public.

Anu: Now, in those bonds, how are the bonds actually structured? Is it all municipal bonds or is it a mixture of privately issued bonds and muni bonds?

Jamie: It could be both. What we see on our side is the municipal side, there may be loans involved, these TIFIA loans from the federal government. There's a range of capital sources plus equity that the private side would put in. The funding structures are diverse. You bring all the different expertise together to deliver these projects. It's a very exciting time, because they're in an earlier stage, they can tend to be lower investment-grade-rated credits, so they have some additional yield to start with, which can be very attractive for the right municipal investor.

Anu: Absolutely. We mentioned being New Yorkers, and so I figured I would ask, we've recently gone through the primary mayoral race for New York City, what are your thoughts on what may happen next and what it might mean for New York City bonds?

Jamie: The Democratic primary was a surprise, I think, particularly for folks who weren't following the election that closely. If you actually were looking at it more closely, Mamdani was surging in the polls and picking up pace week after week, but he was not expected to win in most people's eyes. I think that was the initial surprise that some folks have. I think what I've talked to clients about is that you have to take a step back and think about what we see in primaries and what we see on the campaign trail can oftentimes be very different from what it means to ultimately sit in the executive position, whether you're a mayor or a governor, and actually govern.

One of the things that we've tried to point out to clients is that New York City, and it goes back to the financial crisis that happened to the city in the 1970s, there's a lot of structure around their finances. There are a lot of sets of eyes and ears looking at that process and how it's done. There's a lot of controls. Even some of the tax increases that have been proposed, rental freezes, those things can't be done unilaterally. They need approval from the governor, from the state legislature.

Again, I think there is a potential change coming. We still have the general election coming up. We'll have to see how that ultimately plays out in who the voters decide to pick. I think investors need to take a step back and recognize that there's a lot of controls around the finances of New York City, and saying one thing on the campaign trail and what it means to govern are two, oftentimes, very different things. We're watching it closely. We're going to follow the races closely, and we'll see how it plays out and watch what happens, and adjust it.

Anu: More to come in the space in a few months' time.

Jamie: Definitely.

Anu: TThat's good point. Jamie, the US muni market is increasingly attracting global investors, especially with the growth in taxable munis. Could you talk about why non-US investors might find this market appealing and what makes it unique compared to other regions?

Jamie: The muni market as a whole is over $4 trillion in size, and people think about it just as the tax-exempt market that would appeal to US-based high-tax-paying investors. As you point out, Anu, about 15% to 20% of the market gets issued as more traditional taxable bonds, same exact issuers that you see in the tax-exempt markets. State of California is an example. They issue lots of general obligation tax-exempt bonds. They also issue general obligation taxable bonds, same credit. You're in the same part of the capital structure.

What's exciting about the taxable muni market is they trade just like corporate bonds, a spread over treasuries. Taxable munis produce yields when you compare ratings that are very much in the ballpark of what you see on the corporate bonds side. The muni market is a very, very highly rated asset class. I think the appeal to foreign investors is you can find yields that are similar to what you see in the investment-grade corporate side, you can get a higher rating, and then the last thing that the taxable muni market offers is a lot of longer duration exposure.

For those foreign investors or insurance company investors that want to match an asset to a liability that they have, that market adds up really, really well for them. We've seen very, very strong demand from overseas investors because it's not costing them a lot from a yield carry standpoint relative to other taxable alternatives to be involved in it, and they love the quality.

Anu: Absolutely. That makes total sense. Wrapping up here, Jamie, looking ahead, what are the most important risks or opportunities that you're watching in the muni market for the rest of 2025?

Jamie: I'm pretty fired up as a muni person. I'm like, I guess I'm supposed to be a glass-half-empty, that kind of person. I love the supply theme that we are talking about. The muni market has 50,000-plus unique issuers. When supply is coming at this pace, it's very hard for the market to follow all of the deals. As a bond picker, that creates enormous opportunity. It just increases the likelihood that an investment is going to be mispriced. I think this above-level supply is a great, great thing for muni bond investors.

The other thing that I believe is, whatever your view is on the Fed and what they ultimately do, it is very unlikely that they're going back to zero-interest-rate policy anytime soon. These higher yields are going to be with us for a long time. That is a really, really good thing for fixed-income investors in the muni space. I think the last thing is we have policy proposals that are coming out at a dizzying pace.

It is our job and other market participants' job to follow that, figure out what is likely, and then to analyze potential knock-on effects, what is the second and third derivative of these policy proposals. This is a time, in my opinion, where active research is really, really important because we're in a very, very fast-paced policy environment. Again, I think, based on some of the examples that we already talked about, that will create some really unique opportunities for investors if you can figure that out.

Anu: Absolutely. No, I think those are some great summary points. Thank you very much for those comments, Jamie. I can't let you go without a quick bonus question. I had the pleasure of getting to know you many, many years ago when you and I were partnered up for a Neuberger Berman service project way back in the day. I know you've been a board member of the Neuberger Berman Foundation, and I understand that you're currently on the board of Friends of the Children New York.

I'd love for you to share a bit more about that organization, and also tell us about how your many years of involvement in philanthropy has shaped your approach to what you do as a muni portfolio manager.

Jamie: That's a great question. That was such an exciting time because through NB's volunteerism experts, I'm able to meet so many great people at the firm. I remember when we first met, I got involved with Friends of the Children New York through a lunch-and-learn at Neuberger Berman, where a previous executive director of the organization spoke. I immediately fell in love with the organization. It's one of the only professional mentoring organizations that exists in the country.

Friends of the Children starts to work with kids when they're in kindergarten all the way through 12th grade to make sure that every kid, we call them achievers, has a responsible adult in their lives who can offer advice and counsel when you need it the most. It delivers. As a finance person, I love numbers, just the outcomes that it delivers relative to that mentor or responsible adult not being in the child's life is truly extraordinary. I got involved. I met them. They kindly, a little over 10 years ago, asked me to join the board.

I was the board chair for three years. It's been one of the most extraordinary things that I've been involved with. I think it's one of the most rewarding things that I've been involved with. I think, as an investor, you have to understand the whole world that you're investing in, and being involved in that organization has really given me some really unique insights into challenges that people are having in New York City. I think it's made me a more well-rounded person and really helped me in so many ways, personally and professionally.

Anu: That's awesome. Thank you so much for sharing that and for your many years of service and community work that you've done through Neuberger Berman and outside of the firm. Thank you for that. Jamie, it's been great speaking to you today about your insights on the muni market. You mentioned it's a $4 trillion market with 50,000 unique issuers. It's been a very busy year for you, as we discussed, between the Big Beautiful Bill and the supply surge in 2025.

We also spoke about the increase of public-private partnerships, which have been transformative, particularly even in places like LaGuardia Airport, down to the New York City race, and the interest from non-US investors in the US muni market. For all of those thoughts, we really appreciate you being here. Thank you for being on the show today.

Jamie: Thank you for having me.

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