Sustainable Debt Growth Trend Emerges Amid Pandemic

Market segment growth ahead

S&P Global Ratings expects U.S. municipal green-labeled debt to continue grabbing a larger share of the municipal market in 2021, estimating green-labeled issuance of about $18 billion, or 4.1% of total municipal issuance, as projected by S&P Global Ratings Research. For the total sustainable debt market, we believe it is possible that issuance could surpass $30 billion for 2021, bringing cumulative issuances to more than $100 billion since the first municipal green bond was issued by the Commonwealth of Massachusetts in 2013. The extraordinary pace of growth in social and sustainability bonds, combined with the role of the pandemic in driving social bonds forward in 2020, adds complexity to the forecast.

Chart 1 depicts the growth in green bonds as a percentage of total municipal market issuance. The green bond market share has increased to 3.4% in 2020 from 0.03% in 2013. Including all sustainable debt, the market share expanded to 5.8% in 2020, from 3.2% in 2019 and it has never been higher than 2.5% in all prior years. On average, sustainable debt's share of total municipal market issuances increased 51% per year from 2014 through 2020.

Chart 1

Pandemic's repercussions help push municipal sustainable debt to new heights

Amid the COVID-19 pandemic, the municipal bond market saw a record $474 billion in issuances during 2020. Sustainable debt followed suit, soaring to a new peak with municipal issuers adding $27.6 billion in debt with green, social, or sustainability labels, more than double 2019's level. It was an extraordinary 2020 for this market segment, and S&P Global Ratings has seen a clear growth trend emerge since the first municipal green bond was issued in 2013.

Although this market sector was growing prior to 2020, the pandemic and its related risks were clear factors driving 2020's extraordinary growth in all three types of labeled sustainable debt, particularly social bonds. As the pandemic curtailed tax revenue and drove health and safety expenditures upward, for example, state and local governments increasingly turned to the municipal market to fund capital projects and to create or preserve budgetary flexibility. The U.S. Federal Reserve System's actions to lower interest rates and steady bond markets made borrowing even more appealing for many municipal entities. Some entities that issued labeled bonds cited the pandemic and its drain on government and nonprofit finances as the driving factors bringing them to market. The pandemic's influence was clearly a factor driving market segment growth last year, but we believe the overall growth trend will likely continue. The rapid growth of sustainable debt issuances, by both par amount and number of issues, is illustrated in chart 2.

Chart 2

While we believe sustainable debt is poised for growth in 2021, we believe the segment will face ongoing volatility due to the influence of very large, or mega-issues, on total volume. In addition, S&P Global Ratings Research expects total municipal issues to decline 5% in 2021 (see "Global Financing Conditions: Bond Issuance Could Decline 3% To $8 Trillion In 2021" published Jan. 28, 2021, on RatingsDirect).

Since 2013, only one year (2018) saw sustainable debt decline in both absolute terms and as a percentage of the municipal market. Total municipal issues declined 24% in 2018, while green-labeled bonds fell 54%. We attributed the disproportionate decline in green bond issuances largely to an absence of the mega-issues by entities that have become established green bond issuers. For 2021, we believe that the relatively newer social and sustainability labels will comprise a significant amount of debt issues beyond the green label. We believe these labels, along with the market's increasing focus on environmental, social, and governance (ESG), will likely offset the projected decline in overall municipal issues, driving overall labeled debt higher. Longer term, we believe the prospects for sustainable debt growth will at least partly depend on the extent to which a pricing advantage emerges for labeled issues, a subject of ongoing debate in the market.

Meanwhile, the new administration in Washington has made climate change a theme of its early executive actions, which is likely to accelerate the broad trend toward climate-friendly, resilient investments. With the new administration also comes the potential for policy changes that could prop up overall issuance levels, including the potential return of tax-exempt advance refundings and Build America Bonds (taxable municipal bonds with investor tax credits or interest payment subsides issued under a federal government program that expired in 2010).

Sustainable Debt Market Characteristics

Green bonds still comprise the majority of issuance, but social and sustainability labels are booming

Green bonds comprise a majority of the municipal sustainable debt market (chart 3). However, municipal issuers' surging interest in touting their social and sustainability bona fides has led to extraordinary growth in social and sustainability-labeled bonds over the past two years. Given market trends, we anticipate near-term growth in all sustainable debt categories relative to the municipal market, and we anticipate social and sustainability bonds combined will increase their share of the pie.

Chart 3

Rapid growth in social bonds propelled by the pandemic

In 2020, social bond issuance rose from a barely significant component of the market to 26% of total sustainable debt issuance with $7.1 billion issued, 9.1x the amount issued in 2019. The market saw 43 series of social bonds issued, up from just four issues in 2019 and a single issuance in 2018.

The pandemic and its related consequences clearly amplified the longer-term growth trend and even generated new sources of sustainable debt issuance in the municipal market. For example, 2020 saw the first labeled municipal bonds issued by national nonprofit foundations. Starting with the Ford Foundation's $1.0 billion social bond issuance in June, major philanthropic foundations turned to the social bond market to amplify grant-making efforts and provide financial support to nonprofit organizations whose finances and operations were strained by the pandemic and its effects. While 2020's growth in social bonds--to 26% of labeled sustainable debt from 5% in each of 2018 and 2019--was clearly influenced by the pandemic, we expect social bonds' market share to grow on average given the natural alignment of many public finance issuers with social goals.

More players enter the field, but established issuers retain the spotlight

The municipal green bond market remains concentrated, with the top 10 issuers accounting for 65% of green labeled debt issued in 2020 (table 1).

Table 1

This concentration persisted even as more issuers labeled bonds as green. For 2020, we identified 176 unique issuers of green bonds, 109 were first-time issuers using the label. The 62% of total first-time issuers was the highest percentage since 2015, when the market was less than one-fourth the size of 2020 (chart 4).

Though diversifying by number of participants, the market remains heavily influenced by its largest issuers, none more so than the New York Metropolitan Transportation Authority (NYMTA), which in 2020 alone accounted for 25% of total green-labeled issuances via six issuances totaling nearly $4 billion. Furthermore, a single mega-issue is still enough to catapult an issuer into the list of top issuers in any given year. For example, the Los Angeles County Metropolitan Transportation Authority's (LACMTA) $1.4 billion Measure R series 2020-A green bonds made LACMTA the second-largest municipal green bond issuer, and fifth-largest issuer of all municipal sustainable debt in 2020 (tables 1 and 3).

Chart 4

Transportation sector issuers who are committed to the green label and issue substantial amounts of debt have been key to driving the growing market (table 2). Since 2013, transportation entities have comprised five of the top 10 green bond issuers by total par. Despite only having three and two issuances to their name, respectively, LACMTA and the Greater Orlando Aviation Authority, Fla., sit among the top five green bond issuers. Some issuers like NYMTA, the Indiana Finance Authority, and the San Francisco Bay Area Rapid Transit District (BART) appear committed to the label, with more than a dozen green-labeled issues under their belts.

Table 2

With a broader pool of issuers, total sustainable debt issuances by U.S. municipal borrowers shows slightly greater diversity than the green bond market alone. The top 10 issuers across all three labels accounted for 56% of total 2020 issuances (table 3). Including social and sustainability bonds in addition to green bonds, the top 10 issuers accounted for 44% of total issues from 2013-2020 (table 4).

Table 3

Table 4

In our 2019 report, we identified 31 states with at least one green bond issuer from 2013 to 2018. With the strong growth in green bond issues in 2019 and 2020, along with the beginnings of a social and sustainability municipal bond market, we now identify 41 different states with at least one issuer of sustainable debt (chart 5)--but issues remain concentrated on the coasts, particularly in California and New York. Issuers in California have accounted for 30% of total municipal sustainable debt issued, with issuers in New York accounting for 25%. Third in the ranking is Massachusetts with 9% of the total, followed by Florida (5%) and Washington (4%).

Sustainable debt issuances trend much larger than the municipal market average

For the total market, the average par amount issued hovered around $100 million for all sustainable debt in each of 2018 through 2020 (chart 6). This far exceeds the average annual U.S. municipal issuance of about $36 million over that span. In prior years, we've questioned whether the entry of more issuers into the market would drive the average par amount down, somewhat offsetting the role of the mega-issues. This does not yet appear to be the case, and the market remains defined by relatively large issuances, with the average total sustainable debt issuance at $103.6 million in 2020, 2.8x the average U.S. municipal debt issuance.

Chart 5

Chart 6

External reviews are on the rise as the market seeks greater transparency

As the sustainable debt market grows, we believe investor demand for greater transparency of use of proceeds will only increase. Last year, we noted that 2019 was the first year in which most green bonds were issued with some form of external review. The trend continued in 2020, with nearly three-quarters of all green bond issues externally verified (chart 7).

Chart 7

External verifiers generally review issues and opine on whether the use of proceeds align with the relevant ICMA standards. External verifiers use their own methodologies or methodologies approved by another organization, such as the Climate Bonds Initiative. Many bonds issued with an external review include a report in the offering document describing how the use of proceeds aligns with the relevant standards. In other cases, the offering document does not contain a separate report, but contains language indicating that the verifier has reviewed the transaction and considers the use of proceeds as aligning with the relevant standard. In addition to market interest in use of proceeds verification, the entry of BAM GreenStar in 2019 significantly contributed to the emerging trend of external reviews, particularly among relatively smaller issues.

Including all sustainable debt, 2020 was the first year in which most issues carried an external review, with 60% verified (chart 8). Though slightly less than half of social bonds (47%) had an external review in 2020, and just 25% of sustainability bonds did, the high percentage for green bonds with an external review elevated the total market figure.

Chart 8

A change in 2020 is that smaller issues, those under $10 million in par, are now more likely to carry an external review than not. Prior to 2020, only one-third of issues under $10 million in par carried an external use of proceeds review. With the addition of 2020, two-thirds of issues in that size category were externally reviewed over the entire span of 2013-2020. The largest issuances remain the most likely to carry an external review, with 86% of issues greater than $500 million in par having an external review (chart 9).

Chart 9

Transportation and water top green bond use of proceeds

Green bond issuance in 2020 was dominated by the public transportation sector (chart 10) led by NYMTA, which issued green bonds to fund capital projects as well as refinancing debt amid the global pandemic that forced immense budgetary pressure on the operator as ridership plummeted and tax revenue fell.

Green bonds issued for water projects showed remarkable stability over the past five years, with the exception of 2018 when total issuance in the green and overall municipal market was down substantially. In 2020, green energy projects supplanted green buildings as the third-largest sector by use of proceeds, propelled by major issues by the New York Power Authority (NYPA) and Southern California Public Power Authority (SCPPA), with both utilities funding projects deemed to further green the power grid. NYPA's issuances focused on transmission projects, while SCPPA's green bonds refunded prior bonds issued to finance hydroelectric and wind generation, as well as transmission projects.

Moving forward, we expect to see transportation remain a primary sector for green bond issuance, given the natural linkage between public transit and green priorities, such as reducing carbon emissions. Public transit entities, though facing substantial headwinds, operate in a highly capital-intensive line of business and, in many parts of the country, maintain significant expansion plans (see "Outlook For U.S. Not-For-Profit Transportation Infrastructure: Light At Tunnel's End--But How Long Is The Tunnel", published Jan. 13, 2021). So long as some of the large, frequently issuing public transit agencies continue to label their bonds green, the transportation sector will remain a key part of the labeled market.

For green energy projects, we expect transmission projects to remain a source of green bond issuance, with some generation related to solar, wind, and hydroelectric projects. Though intuitively large-scale power generation projects appear well poised to drive the green bond market, most large-scale generation assets are built and financed by private sector entities. Therefore, though there will likely be some growth, we do not anticipate generation projects of public power utilities to become a leading component of broader municipal green bond use of proceeds in the near term.

Chart 10

Social bonds take off, funding education and affordable housing projects

The largest social bond issuers went to market to finance capital projects related to access for essential services, primarily education (table 5).

Table 5

Education--primarily capital projects for public school and higher education facilities--and affordable housing projects represent the vast majority of total social bond issuance, at 45% and 33% of total issuance, respectively (chart 11). The five issues comprising the $1.6 billion we've identified with a mixed use of proceeds consist of debt issued by foundations in 2020. In addition to the Ford Foundation's $1.0 billion, the John D. and Catherine T. MacArthur Foundation, Doris Duke Charitable Foundation, The Andrew W. Mellon Foundation, and the Bush Foundation each issued debt in 2020 to support grant-making activities. In each case, the foundations cited the COVID-19 pandemic's influence on the foundation's nonprofit grantees as contributing to the purpose for the social bond issuance.

Moving forward, we believe social bonds are likely to grow in the municipal market, possibly by orders of magnitude over the next several years. We expect the growth to be propelled by factors including persistent wealth and income inequality and the natural overlap between social purposes and the operations and purpose of many municipal entities.

Chart 11

Sustainability bonds grow, primarily supporting affordable housing projects

The rise in bonds carrying the sustainability label does not reflect a market move away from bonds issued to finance projects with an environmental or a social benefit. Instead, sustainability bond growth simply reflects the emergence of a new label for bonds issued with a green and/or social purpose, as well as the existence of overlap between some projects that accrue benefits in one of these areas with the other. It also reflects the reality that many municipal issuers' capital plans include projects intended to address environmental and social challenges. Though use of proceeds is often mixed for a sustainability bond, we've classified bonds by primary purpose, based on our reading of offering documents.

Nearly all sustainability bonds issued in the U.S. municipal market have been issued for affordable housing projects, and typically include green building elements (chart 12).

Chart 12

New York affordable housing projects dominate, with two issuers--New York City Housing Development Corp. and New York State Housing Finance Agency--accounting for 69% of total sustainability bond issuance in 2020, and 69% of the total over the past four years (table 6).

Table 6

Sustainable debt is more likely to be issued for new money than the municipal market as a whole--the additionality question

For the municipal sustainable debt market, new money made up 75% of total par, and 70% of the total number of issues (chart 13--in cases where a single series was used for refunding as well as new money, we categorized it based on the majority of proceeds). These figures are remarkably similar to our findings from 2019, where we identified 76% of issuance and 72% of total issues as new money. For the total municipal market, new money fell to 56% of total issuance in 2020, from 62% in 2019. Refunding increased to 31%, while mixed-use issuance was 12% in each of the past two years, according to Bond Buyer data.

The question of additionality remains intriguing for sustainable debt--how much does issuance in this market segment indicate net environmental or social benefits that would not otherwise accrue without the issuance and specific use of proceeds? For refundings, positive outcomes may have been accrued through the funded projects, but not as a result of the refunding bond issuance, since those projects were already funded through other means. We believe the greater prevalence of new money versus refunding for sustainable debt is one indicator pointing to the additionality represented by this corner of the municipal market.

Chart 13

Sustainable Debt Is Here to Stay, For Now

In 2021, S&P Global Ratings expects U.S. municipal sustainable debt will likely accumulate a larger share of the municipal market. Although we also believe the segment will face ongoing volatility related to the outsized impact of mega-issues and certain frequent issuers, we believe this volatility could abate over time to the extent that more issuers enter the market issuing green, social, or sustainability-labeled bonds. In the near-term, we expect external review of bond use of proceeds to continue increasing, as investor demand for information to support ESG investing goals increases. We expect transportation, education, and affordable housing to remain key sectors driving growth in labeled bonds. Longer term, we believe the prospects for sustainable debt issuance growth will likely depend on the extent that a pricing advantage emerges for labeled issues.

A Note On The Sample

Our sample includes those financings registered as green bonds by the Climate Bonds Initiative, municipal bonds that received Green Evaluations by S&P Global Ratings, and other self-labeled green, social, and sustainability bonds identified by S&P Global Ratings based on our review of offering statements. We've also included certain issues carrying certification by an external verifier that bond use of proceeds align with the green bond principles, even when those issues have not been labeled green on the offering document's cover page. Finally, we've included notes, loans, and private placements carrying one of the sustainable debt labels, where we've identified them.

Related Research

• 2021 Credit Outlook For U.S. Public Finance: Back On Track?, Jan. 29, 2021
• Sustainable Debt Markets Surge As Social And Transition Financing Take Root, Jan. 27, 2021
• Global Financing Conditions: Bond Issuance Could Decline 3% To $8 Trillion In 2021, Jan. 28, 2021
• Sustainability in 2021: A Bird’s-Eye View Of The Top Five ESG Topics, Jan 28, 2021
• Outlook For U.S. Not-For-Profit Transportation Infrastructure: Light At Tunnel’s End – But How Long Is The Tunnel, Jan. 13, 2021
• Outlook For U.S. Public Power And Electric Cooperative Utilities: Ratings Should Remain Resilient, Jan. 14, 2021
• Outlook For U.S. Water And Sewer Utilities: 2021 Provides 2020 Hindsight, Jan. 19, 2021