Municipal bond issuers will continue to face several credit challenges in 2026, but MTAM expects that the vast majority of municipalities will successfully manage through most difficulties with a combination of spending cuts and revenue enhancement plans.
MTAM has always been, and will continue to be, a conservative asset manager. We are very selective in the municipal sectors and top tier bonds we decide to purchase and hold. Notwithstanding the challenges facing municipal bond issuers, there are always good opportunities, even for the very conservative investor. We still expect defensive credits like water and sewer bonds, special tax bonds, and public power bonds to perform better from a fundamental perspective. These types of bonds tend to have revenue streams that are less subject to economic volatility, have strong covenants, or are tied to an “essential service”, making debt service payment more certain. In addition, there is legal precedence that bonds backed by a dedicated revenue stream may be protected in the case of a municipal bankruptcy. We prefer bonds that have a clean flow of funds, broad revenue streams, and high debt service coverage tests.State and Local Governments
MTAM’s overall credit outlook for U.S. state and local governments in 2026 is expected to remain stable, primarily supported by steady, albeit slower, revenue growth and generally strong fiscal management. This stable outlook is balanced against challenges such as growing expenses and policy uncertainty. The vast majority of state and local government rating outlooks are stable in 2026, consistent with the prior year.Local governments are expected to see continued revenue growth, which helps maintain satisfactory finances. This is supported by overall U.S. economic resilience, even as momentum is anticipated to slow somewhat. A history of prudent financial management and strong governance practices are central factors in maintaining stable ratings for many individual local government entities.
The stable revenue picture is challenged by rising expenditures. These can include infrastructure needs, social spending, and adapting to climate risks. Another key material risk for local governments remains the uncertainty surrounding federal and state policies and funding, which can impact local budgets significantly.
While no recession is expected, the environment presents a mixed picture. Challenges include:
- Political polarization: This theme is seen as a headline structural factor straining credit worldwide, making long-term planning difficult due to potential policy shifts and short-term fixes.
- Higher interest rates/debt affordability: Although global rates are expected to ease slightly, higher debt levels and refinancing costs are a persistent pressure for many governments.
- Demographics and Housing: Weakening demographic indicators and housing affordability issues open up opportunities for adaptation, but also present underlying economic risks.
Credit risks may emerge from a slower labor market, tariff-driven inflation, and changes in federal responsibilities. Even so, most governments should be able to absorb these pressures due to strong financial resilience.
Macro risks to revenue include the potential for escalating tariff pass-throughs, which may raise the Consumer Price Index (CPI) and curb consumption; softening payroll growth and potential layoffs; and a slowdown in IT-related capex that could weigh on equity markets and income tax collection in market-sensitive states like California and New York. In addition, housing indicators are weakening, and we expect the residential housing sector to slow in 2026. This could pressure local sales and transaction taxes, as well as assessed property values over time.
Spending pressures persist. States face uncertainty around changes to Medicaid and the Supplemental Nutrition Assistance Program (SNAP) implemented under H.R. 1. Wage growth for public employees remains high, increasing strain on budgets, particularly for local governments. The shift of federal costs to states and local governments could be negative for credit where financial resilience is thinner.
Operating trajectories are broadly stable. Most state and local governments used prior surpluses to build reserves, pay down debt, and invest in one-time capital needs, though some with pre-existing challenges still face fiscal constraints. Ongoing implementation of state tax policy changes and softer economic growth could drive volatility in revenue and budgets. For local governments, lags in property tax assessments and tax collection trends allow time to adjust to changing conditions, while an economic downturn would create more immediate strain on governments that rely on sales and income taxes.
We believe that most states will be able to balance slowing revenue growth against the rising expenditure needs, while maintaining ample reserve balances, pointing to the fact that states have some time to adjust to federal policy changes on tariffs, tax structure, immigration, federal spending and natural disaster recovery support.Not-for-Profit Hospitals
MTAM continues to have a negative outlook on the not-for-profit healthcare and hospital sector for 2026, although U.S. not-for-profit hospitals have made some meaningful strides over the past year.
While some large hospital systems perform well (volumes, labor), risks are higher for some smaller or specific healthcare services (like certain physical therapy firms). We expect continued strong performance for some larger, diversified systems that benefit from improved patient volumes, better labor markets, and strategic adaptation. Reduced contract labor and lower turnover and better staffing have driven margin gains since 2024, though improvement has been uneven and some credits remain pressured. Health systems are accelerating efficiencies to get ahead of post-2026 H.R. 1 Medicaid cuts. Strong balance sheets provide flexibility to manage volatility.
Capex will continue, with shifts toward outpatient, increased access points and IT, and some large patient tower projects continue. Credit trifurcation will continue as well-capitalized systems reinvest, leverage technology (including Al) and pursue partnerships/M&A, while weaker providers face strain, especially in challenged markets.
The following are key areas to watch:
- Executives are intensifying cost control and revenue growth to bolster cash flow ahead of H.R. 1 cuts and other headwinds.
- H.R. 1 will weigh on margins, but most Medicaid reductions begin after 2026, providing a runway for preparation.
- Persistent macro pressures could depress profitable volumes and weaken payer mix.
- M&A activity may pick up as stronger systems consolidate core markets and push into other geographies.
- Capex is set to rise to meet demand, with spending prioritizing access points and technology.
Nonprofit hospitals and health systems are expected to continue their modest margin improvements through the end of 2025 and into 2026, though systemwide operating margins may never recover to pre-pandemic levels amid macroeconomic pressures and the longer-term threat of the One Big Beautiful Bill Act’s (OBBBA’s) changes to reimbursement and coverage.
MTAM forecasts a median operating margin between 1% and 2% while noting largely healthy volume trends and strong balance sheets. A key factor in next year’s expected operating margins is the OBBBA. Though the law’s full hits to hospitals do not begin to kick in until after 2026, expense savings and top-line revenue opportunities are being accelerated by management teams to get ahead of the legislated reimbursement cuts. Cash flow implications will also vary between different states, markets and levels of Medicaid exposure, meaning OBBBA operating challenges will not hit all hospitals quite the same way.
In the meantime, solid volume trends, particularly in population growth areas, have many systems increasing their capital spending to improve access and capacity. This is being led by investments in outpatient services and access-focused technology, including artificial intelligence.Transportation
Growth should remain largely undeterred for U.S. airports, toll roads, and ports in 2026. MTAM’s sector outlook for 2026 remains stable, with expectations for overall satisfactory credit conditions and continued momentum in volume activities for airports, toll roads, and ports.
Most transportation credits are expected to operate in a slow-but-steady economy that gently lifts already high volumes. Balance sheets remain robust after strong federal funding and greater cash retention post-pandemic, though politicized federal grants pose risks — particularly for airports that rely more on grants and may need to delay or resize capex to preserve credit profiles. Ports are the key outlier, with a less stable outlook amid tariff-driven trade headwinds and shifting shipping patterns.
For U.S. airports, mild volume growth is expected as uneven travel spending and airline route rationalization cool recent gains. Rising project costs and potential grant shortfalls could pressure leverage, though flexible capex timing and alternative funding help mitigate these risks. Capacity risks persist as airlines manage fleets and service levels, potentially constraining demand in some regions.
For U.S. toll roads, modest traffic growth and toll increases broadly in line with inflation are expected. Authorities remain willing to adjust rates, with public resistance likely easing as inflation moderates. Commercial traffic may be tempered by weaker imports.
For U.S. ports, tariffs and trade policy shifts are expected to lower cargo volumes in 2026, while capital input costs rise on imported materials, potentially pressuring financial profiles if borrowing needs climb. Cruise activity remains a bright spot with robust demand and capacity expansion, remaining mindful of the tourism and spending cycle.
The expected steady macro backdrop should provide a modest boost to transportation volumes and revenues in 2026, even as agencies contend with tariff-related disruptions and growing politicization of federal grants.Water and Sewer
MTAM is maintaining a stable outlook on the U.S. water and sewer sector for 2026. The sector’s strong fundamentals are underpinned by the essential service provided to users, monopolistic business nature, and high barriers to entry. Additional positive features are low price sensitivity, strong liquidity, and independent local rate-setting authority. These factors insulate the sector to some extent from economic cycles. However, persistent droughts and overregulation could reduce financial flexibility for certain issuers.
The stable outlook for the water and sewer sector reflects an operating environment for the upcoming year that is generally stable relative to 12 months prior. Most utilities fared well and absorbed the inflationary shocks of the prior years and have now adapted to the “new normal” operating environment that includes higher costs for supplies, personnel, and contractors relative to pre-pandemic years. Utilities’ budgets reflect more normalized rates of increase for operating expenses, but capital budgets have continued to rise, which will likely be sustained into 2026.
U.S. water utilities will ease into a “new normal” operating environment for 2026 that includes more manageable costs while protecting against increasing environmental and cyber risks.
Capital programs remain robust as rebids and updated estimates flow into plans. Leverage has edged down over the past two years as rate support bolstered margins. However, margins could narrow in 2026 as issuers advance larger programs and add debt. Interest rate pressures should continue to ease, with policy rates expected to decline, sustaining refunding economics and stabilizing borrowing costs.
Other key sector considerations include potential federal cuts to State Revolving Fund allocations that were proposed at approximately 90% in the fiscal 2026 budget. These cuts could push borrowers toward higher-cost financing.
Inflation-driven rebids and labor-related challenges pushed capital budgets higher in recent years, and although those pressures have largely eased, utilities are now managing to a higher effective tariff rate. Many projects are not regulatory-driven and postponing or scrapping work due to above-expected costs risks deepening already significant deferred maintenance.
Another ongoing threat for water utilities is their susceptibility to cyberattacks, which likely means certain cybersecurity practices that water utilities will eventually have to comply with. Shorter term spending would likely focus on conducting cybersecurity assessments, but any identified vulnerabilities or successful breaches at a utility could result in unforeseen capital expenditures.Public Power
MTAM’s 2026 sector outlook for U.S. public power electric utilities is stable, reflecting strong sector characteristics and a conservative business model that provide issuers with stability and strength, even during periods of uncertainty. The fundamental strengths of the sector include: autonomous rate-making authority, the essential nature of electric service, mandates to serve well-defined areas with monopolistic characteristics, and reliable cash flow.
While operating performance should remain resilient, affordability pressures and capacity needs are key considerations that may impact the sector.Affordability is expected to weaken modestly as residential electric costs rise and real median household income growth lags. Near-term operating cost pressures have stabilized but remain elevated, requiring timely cost recovery to preserve margins. Natural gas prices are expected to remain stable through 2026, with limited impact on utilities’ financial performance and credit quality. We also expect interest rates to decline through 2026, improving refunding economics and moderating revenue requirements for capital programs.
Key watch items include the potential imbalance between capacity and demand amid accelerating data center/Al load and plant retirements; intensifying capital input costs due to supply chain and labor constraints; unexpected emissions restrictions that could pressure costs and affordability; and increased stranded-asset risk if demand underperforms. A sharp deterioration in affordability or accelerated capacity shortfalls could drive a negative outlook.
The public power sector’s backdrop looks broadly steady in 2026, with utilities prepared to handle rising demand and move forward on new generation investments; while inflation and interest rates could firm around midyear, utilities are expected to adjust rates to sustain financial metrics, though a pronounced rise in capital costs or a return of supply-chain bottlenecks could weigh on performance.Colleges and Universities
MTAM is maintaining our negative outlook on the higher education sector for 2026 based on the increasing headwinds from federal policy, enrollment, and other macroeconomic conditions that will affect revenue growth prospects and operating margins in the coming year.
Tuition revenue, which is often the largest revenue source for colleges and universities, remains constrained as demographic trends and financial aid policy changes reshape domestic student decisions and as prospective international students face numerous hurdles. While state funding improved for the 12th straight year, slowing revenue growth and shifting federal cost burdens beyond 2026 are risks.
Despite these headwinds, two-year programs are driving sector growth, and institutions are pursuing partnerships, asset monetization, and alliances to manage costs. We expect consolidation to accelerate, especially for schools in regions with economic and demographic stress. Capital spending will likely rise in 2026 to address deferred maintenance and housing needs, but additional debt may otherwise hamper overall operating cost flexibility.
Revenue growth is projected to slow to 3.5% from 3.8% as demographics and competition limit pricing power. Meanwhile, the sector is projected to see expense growth of 4.4%.
The federal government has added new obstacles, even to schools that have easily weathered prior challenges for the sector. The Trump administration has cut funding for research, reduced staff at the Department of Education, and launched formal civil rights investigations over schools’ diversity policies.
In 2026, policies from the July 2025 budget reconciliation bill will take effect. The bill capped how much students can borrow from federal student loan programs, including the Parent PLUS program for undergraduates and the Grad Plus and Professional PLUS programs for graduate students.
Graduate degrees have been some of the only sources of growth for some universities. Prospective students who reach the cap on federal borrowing will likely turn to private loans, but there is a chance that private lenders will not lend for programs where graduates are less likely to have high earnings, like Master of Fine Arts degrees. The reconciliation bill also expanded the endowment tax, although it only applies to schools which can easily cope with the hit.
In 2026, the enrollment outlook is uncertain. The demographic cliff will continue to shrink the pool of potential students. Declines in international enrollment spurred by the Trump-administration’s anti-immigrant policies have been particularly painful, as international students typically bring high net tuition revenue.
We expect modest growth in community college enrollment, particularly in nondegree vocational programs that have expanded to meet workforce needs. Large comprehensive universities, both public and private, will continue to have the largest share of revenue gains given their growing enrollment, with 3.4% growth at comprehensive publics and 4% for privates.
Issuers in the higher education sector have very different circumstances. For large universities with strong brands, factors like the demographic cliff have been less challenging. Smaller universities have struggled to compete for a declining student pool.
Other credit concerns for the higher education sector include weakened fundraising, and investment market volatility. We are also noting the quickening turnover of college presidents, and more frequent and sophisticated cyber attacks.Housing
MTAM views the tax-exempt housing sector as having a stable outlook in 2026. This outlook anticipates that strong management and solid financial footings will help housing finance agencies (HFAs) withstand potential federal policy shifts and general economic pressures.
HFAs have demonstrated resilience in navigating higher interest rates in 2024 and 2025, maintaining strong financial health. MTAM expects this stability to continue, supported by effective management of expenses and healthy net incomes.
While overall credit quality is stable, affordability remains a concern for new homebuyers. We forecast a potential decrease in the 30-year fixed mortgage rate to around 5.75% by the end of 2026, which should improve the situation, but affordability will still be under pressure compared with historical levels.
The sector is closely monitoring potential changes to federal funding for HUD programs as part of the fiscal 2026 budget. While proposed changes could create pressure, the credit implications will only become clear after the final legislation is approved by Congress.
MTAM expects a generally stable environment for Housing Finance Agencies in 2026, buoyed by lower rates, but requiring proactive management of affordability pressures and evolving market competition. The rise of private credit is reshaping lending, increasing competition for assets, and potentially leading to looser covenants, requiring careful monitoring by HFAs.Default Outlook
In August 2025, Moody’s Investors Service released its annual municipal bond market snapshot, U.S. municipal bond defaults, and recoveries, 1970-2024. In addition to noting that the municipal sector remained resilient and strongly liquid in 2024, the report continued to affirm two hallmark benefits municipal bonds offer. First, defaults and bankruptcies remain rare overall: just one in 2024. Second, municipal credits continue to be highly rated compared with corporates.
There was one municipal default in 2024, and most of the municipal sector remained highly rated and stable. A small hospital system’s severe cash flow and liquidity challenges led to missed rental payments and ultimately the acceleration of the debt which it was unable to pay.
Municipal defaults remain rare and concentrated in competitive enterprises. The average five-year cumulative default rate (CDR) has been stable or fallen for the municipal sector overall and for each subsector over the past five years. The average five-year CDR since 2015 for the municipal sector overall is 0.05%, broadly consistent with the entire study since 1970. The competitive enterprises subset of the municipal sector has the highest five-year CDR, at 0.20% since 2015 and 0.35% for the entire study. However, this is still very low compared with the average five-year global corporate CDRs of 8.3% since 2015 and 7.1% since 1970.
Municipal ratings continued to drift up and at a higher rate than corporates. In 2024, the one-year rating drift was 4.2 notches per 100 credits for municipals as upgrades again outpaced downgrades, higher than the rating drift for global corporates of 1.1 notches per 100 credits. General governments and municipal utilities led the way for the municipal sector as rating drift remained negative for competitive enterprises in 2024.
Municipal ratings have successfully differentiated defaulters from non-defaulters. Since mid-2020, the three-year average defaulter position for municipals has exceeded 99%, while the corporate three-year average defaulter position has ranged between 82% and 84%.
Municipal credits remain highly rated. The divergence in default rates underpins the predominantly higher ratings of the municipal sector, reflecting its greater resilience. The median rating for municipal issuers is Aa3, compared with Baa3 for global corporates. As of the end of 2024, 98.5% of the municipal sector was rated investment grade compared with only 54.7% of corporates.
As Moody’s states, while the U.S. public finance sector remains remarkably stable and experiences infrequent rated defaults, there remain caveats, especially as a result of how it has evolved. In the first instance:”There is a growing evidence that legal security, while important in recovery, is a weak shield against default when credit fundamentals are poor.” In the second, as noted last year, the challenges associated with demographic shifts (aging and relocating populations—affecting tax receipts), substantial increases in pension and retirement healthcare leverage, and “the associated heightened exposures to equity markets.”
According to Standard & Poor’s, the U.S. public finance (USPF) default tally rose to eight in 2024, up from four in 2023. For historical context, from 2014 to 2024 average defaults per year were 9.4. This compares with 2004 to 2014 where average defaults per year were 6.7. The overall default rate in 2024 was 0.03%, up very slightly from 0.02% in 2023.
Overall credit quality remained positive, but upgrades and downgrades were relatively more balanced across USPF in 2024. S&P Global Ratings raised 743 USPF ratings and lowered 491, compared with 1,157 upgrades and 257 downgrades in 2023. The transportation sector continues to have dramatic improvements in credit quality, with 42 upgrades and no downgrades.
Historically, among investment-grade ratings (‘BBB-‘ or higher), defaults are rare. The highest annual number of non-housing investment-grade defaults was in 2012, with four. For housing, only one year in the past six has had any investment-grade defaults, and that was 2020, when there were seven. The annual average number of investment-grade defaults are 0.4 for non-housing and 0.5 for housing.
In U.S. Public Finance, according to S&P, large numbers of defaults tend to stem from specific crises. From 2012 to 2017, there were 66 non-housing defaults. Almost half (31) of these were related to Puerto Rico (five in 2015, 13 in 2016, and 14 in 2017).
Although defaults are infrequent among rated USPF bonds, certain triggers can lead to multiple defaults. Typically, defaults are telegraphed by a series of downgrades. Detroit; Stockton, Calif.; and Puerto Rico all experienced multiple downgrades before defaulting on a total of 44 ratings from 2012 to 2023.
In 2024, defaults in Fitch Ratings’ U.S. public finance (USPF) group increased to four, compared with zero defaults in 2023. All four defaults came from speculative-grade (SG) ratings. This increased the annual default rate to 0.1% for all Fitch-rated USPF securities. Investment-grade (IG) securities registered no defaults for the third consecutive year, with only four defaults recorded since the portfolio’s inception in 1999. Among SG securities, the annual default rate increased to 4.5%. For historical context, USPF experienced its highest one-year default count in 2017, with six securities defaulting, resulting in a 0.2% default rate for the entire portfolio. Among IG securities, the highest one-year default count was in 2020, with two securities defaulting, representing 0.1% of the portfolio. Among SG securities, in 2017 the six defaults represented a 6.2% default rate. Examining medium-term trends, the five-year moving average default rate for all USPF securities remained at 0.1% for the eighth consecutive year. Among IG securities, the five-year moving average default rate was effectively 0.0%. Among SG securities, the five-year moving average default rate marginally decreased to 1.8%. From a long-term perspective, considering the entire USPF rating portfolio history since 1999, the average annual default rate for all USPF securities remained effectively at 0.0% in 2024, as has been the case since the portfolio’s inception. The same is true for IG securities. For SG securities, the long-term average default rate marginally increased to 1.6% from 1.4%.Conclusion
MTAM continues to recommend that investors select high-quality municipal issuers that understand the new economic and financial reality, and have made or are making budget adjustments. Essential service revenue bonds without the budgetary concerns of state and local governments and limited payrolls can be attractive, but we stress that an essential service issuer cannot flourish if the underlying governmental entity is in dire economic circumstances. A healthy outlook holds for most infrastructure issuers due to fundamental strengths reflected in the provision of essential public services, adequate balance sheets, and generally sound governance and fiscal management practices. In the case of the enterprise sectors comprised of higher education, health, and housing, credit quality will be maintained primarily as a function of their ability to increase fees, control costs, and improve overall operating margins. Sound debt and fiscal management practices, preservation of adequate liquidity, and strong governance oversight will be significant determinants of credit quality for issuers during the coming period of financial adjustment.