Author: Thomas J. Hastie, Esq., Public Finance Chair, Malamut & Associates, LLC
After years of attractive interest rates, the great interest rate reckoning may have finally arrived. Or not. The truth is we really do not know. Since the end of 2021, many financial and economic experts have documented a rise in the municipal market data index, with a resulting rise in actual interest rates for municipal bonds and short-term notes. And while the expectation is that rates will continue to rise in the short term, there is little consensus on when rates will stabilize and what the new normal will look like.
When I began my practice almost 25 years ago, the expectation was that notes would pay roughly 4% interest and bonds would average around 6%. These expectations were based on history, which is not always the best guide. In fact, for most of the years I have practiced, rates have been below these benchmarks, sometimes spectacularly so. I remember the first time I sold a short-term note for below 1% and I remember my jaw hitting the floor when a one-year note was rolled over at 0.19%. Similarly, I recall with some excitement when longer term bond averages fell below 4%, then 3% and for a period, rates averaged below 2%!
These were great times for municipal Chief Financial Officers, municipal advisors, auditors and bond counsels. Governing bodies were shown conservative debt service projections which were routinely exceeded by the actual results. Governing bodies which voted to proceed with long term financings with expected debt service of X where shown actual results that were $10,000 to $15,000 below those projections on an annual basis. It was obvious that Municipality A had assembled an above average team of financial employees and professionals which produced superior results! To quote early Billy Joel, “I loved these days”!
But as Dylan forecasted: “The times are a-changin”.
So how do we, as municipal finance professionals, approach the new new? Here are five suggestions that may help.
- Define expectations and face reality. Interest rates move and they tend to trend in a certain direction. Sometimes they are stable. Sometimes they are rising. Sometimes they are falling. As a professional, you do not control these trends, but you must be ready to discuss them within the context of a financial transaction. If a Town is contemplating a bond sale, do not pull out the interest rates for bonds sold in 2019 and use those to make projections. Instead talk to your municipal advisor and bond counsel and prepare your governing body for what is coming. “When we sold bonds in 2019, debt service on a million dollars for 20 years averaged $86,000 a year. But in 2022, interest rates are 70 basis points higher so that same million dollars will cost $96,250.” These types of discussions will preserve credibility for the financial professionals and lead to a sigh of disgruntled relief on sales day; rather than a wave of nausea when the sale bids are revealed.
- Plan and adapt. When there is market volatility, discussions among a municipality’s financial team should be earlier, more frequent and more in-depth. If a note is maturing in July or August, planning should start when the budget is being put together.
Should the municipality remain in notes? How much are the mandatory paydowns? It might be better for the tight 2022 budget if the municipality can sell bonds and skip those paydowns. But if it does go to bonds, how much are the initial principal paydowns in 2023 and what are the budget issues going to be in 2023? And if interest rates are higher, maybe it is beneficial to keep the newer ordinances in notes while bonding the ordinances that require the paydowns even if that means a return to the bond market in two years rather than four. These are all valid considerations and potential strategies. And in-depth discussions can only help bring a level of clarity for you. Everything is harder in 2022, so plan ahead.
- By historical standards …We should get out in front of this. Last year, your town’s notes sold for 0.65%. This year, they will sell for 2.00%. That is no fun, especially when the debt service line item needs to remain flat next year and your surplus is down just in time to benefit from that 0.5% on your investments.
For the last two years, your budgets have dealt with lots of uncertainty and projections based, not on history, but on your gut and nerve-wracking prognostication gleaned from experience (except for the court fees, you nailed that one!) Now you are emerging into a time that may be returning to something that looks like normal, but everything is more expensive. How is this fair? Well it is not, but neither is life. And it is beyond your control.
The truth is no one wants to hear that rates remain historically low. Last year they were lower. All you can do is collect the best information and data available and use it to guide the discussion and offer sound advice to your elected officials going forward. If the municipality put off bonding and now needs to permanently finance its notes into bonds, that is what it will do. Getting angry or upset because in hindsight a better result could have been achieved by acting earlier will not help anyone, especially you. Let’s be honest; we all should have bought Apple for $4.00[1] when Steve Jobs came back to the company in 1996. We did not. So we are still working. That is life. And you have a hard job. And you must continue working … because Apple[2].
- And speaking of Apple2. We have all been there. It is a Council Meeting. There is a resolution authorizing the sale of bonds. Someone poses the question “What will interest rates be when we sell?”. My response usually follows the theme of: The rates in the projections are conservative and based on the recent market. Those rates could change. If I knew with certainty where interest rates would be five weeks from now, I would not be in a council chamber at 8:12 PM; I would be drinking [insert drink of choice] in [insert your version of paradise].
The truth is that based on experience and professional obligations, municipal fiscal professionals may have more awareness about the state and direction of general financial trends than most average people. But your job is to spend public money responsively, strive for stability in budgeting and help manage a stable municipal tax rate. It is not to play the markets or to beat the markets. If you have some flexibility, by all means use it. Sell a note a month early because everyone “knows” the Fed is raising rates in two weeks (hint – if everyone knows it, it is already priced into the market’s expectations.) Use updated interest rate projections to size your bond sale to keep the impact on the tax rate minimal. In crafting the budget, stow a little extra in the salary accounts so you can transfer it to the debt service line if note rates are higher than anticipated (just don’t hide it in the fuel line item).
The volatility in interest rates creates uncertainty and tension. Today looks different than what you expected. But that does not mean you know what tomorrow will look like. If the long-term plan was to sell bonds; think about the most responsible way to sell bonds. Don’t just kick the can down the road by staying in notes. Size and sell the bonds in a way that can be managed in the 2023 budget and beyond. It may feel like you are “locking in” higher rates; until it turns out that 2022 was in fact the “good old days.” So stay with your plan and preserve as much flexibility as possible.
- Come gather ‘round people. As mentioned earlier, volatility creates uncertainty and tension. Not just for you, but for your elected officials and your taxpayers. They too are dealing with uncertainty while gazing into the future, both near and far. And their uncertainty may create additional pressure on you. Just remember, they can’t demand that you will be right; only that you will be honest; so clear communication is paramount.
From budgeting to long range planning, factor this volatility into your projections. Create different scenarios to explain the level of risk inherent in a volatile market. Instead of one debt service projection for a future bond sale, develop three with interest rates stable; up 20 basis points; or 50 basis points. Be prepared with metrics to explain the volatility: “For every ten-basis point increase, the actual increase in interest costs will be $40,000 per year given the size of our bond sale”. Explain options for the future: “While our notes mature in October, I would like to be able to enter the markets as early as August so if interest rates continue to rise, we can act as soon as possible”. In situations like today’s volatility, the trick is not to sound confident; it is to be honest about the uncertainty and keep communicating clearly as you move forward.
Thanks for taking the time to read this. Good luck and remember that tomorrow will be different. For better or for worse.
[1] My memory is that Apple stock was around $4.00 a share when Steve Jobs returned to Apple. I researched it and was surprised to find that it may have been $16.00 a share at that time, but with an analysis that said that if you purchased $1,000 in shares at that time and held all shares through future splits and reinvested all dividends in new shares, the resulting shares spread over the original $1,000 invested would yield a share price of $0.22 a share. So, good choice to pass on that one. I mean even if in December of 1996, you were four months into a marriage where you paid for the wedding and was saving for the down payment on your first home and planning to start a family; it was a time when it would have been madness to peel off $1,000 and invest it on a gut feeling. In that case, no regrets are warranted.
P.S. I assure you this is purely a hypothetical and in no way semi-biographical and a source of daily regret.
P.P.S. For those laughing at the notion that you would be in the market in 1996 because you were 10 years old at the time, simply substitute (i) Bitcoin for Apple, (ii) 2011 for 1996 and (iii) $1 for $4. And welcome to the pain.
[2] Or Bitcoin.
