Municipal Bond News 1/6/25

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First Circuit Upholds PREPA Revenue Lien…Muni Bonds’ Higher Reward-Lower Risk…Stellar Tax-Free Income Idea For 2025…New Year Reinvestments…Fed Must Finish Inflation Fight…Moody’s on Chicago Credit…Chicago Teachers Contract Limbo…Muni Bond Issuance Defies

First Circuit Upholds PREPA Revenue Lien…On December 31, 2024, the First Circuit Court of Appeals upheld the revenue lien granted to Puerto Rico electric utility bondholders. The Appeals Court rejected the oversight board’s petition for a rehearing of the revenue lien litigation. “This is the third time in the last six months that the bondholders have won, and the Board has lost, in the Court of Appeals, which has now repeatedly confirmed that PREPA’s over $8.2 billion face amount of revenue bonds (which, with interest accrued prior to and during the now-seven-year span of the case, could result in a claim of over $11 billion) are properly secured by a perfected, enforceable lien on PREPA’s past, present and future net revenues,” PREPA bondholders noted. The Oversight Board stated that it will proceed on its path to a responsible debt restructuring that will end PREPA’s bankruptcy and leave PREPA with the critical resources to make the necessary investments to provide Puerto Rico with reliable electricity.

Muni Bonds’ Higher Reward-Lower Risk…Municipal bonds offer an attractive balance of risk and reward for investors in higher tax brackets. Long-term top-rated muni bonds yield about 3.8% tax-free currently. That’s equivalent to roughly 7.6% for a fully taxable bond for an investor in the top federal tax bracket in a high-tax state like New York or California. The tax- adjusted or taxable equivalent yield for a broad municipal bond index is comparable to that of high-yield corporate bonds. However, state and local government bonds are considered ‘haven’ assets, ranking in quality alongside U.S. Treasuries. High-net-worth investors can achieve taxable equivalent yields from municipal bonds that are similar to those of high-yield corporate bonds but with significantly lower risk.

Stellar Tax-Free Income Idea For 2025… “Municipal bonds remain a favorite of individual investors due to tax benefits,” Barron’s wrote this weekend, noting that not all munis are created equal. With yields tight relative to Treasuries, triple-A municipal bonds with maturities of 10 years or less offer little appeal for investors in all but the highest federal tax brackets. There are better values among long-term munis, with bonds from such high- quality issuers as the Los Angeles International airport and the Port Authority of New York and New Jersey yielding 4% to 4.5%. The high-yield sector is one hot area in the $4 trillion muni market. The average yield on high yield muni bonds has fallen to about 5.5% from 6% over the past year. Some institutional investors have favored large high yield muni bonds such as Brightline trains issued last year. Individual investors have boosted their holdings of muni bonds.

New Year Reinvestments…In January, muni bond investors are poised to receive $43 billions of interest and principal repayments. Illinois, Texas and New Jersey will have the largest redemptions this month. Reinvestment demand is likely to outpace the primary market muni bond issuance. About $9 billion of new muni bonds are expected to be sold in January. Expectations of fewer rate cuts led to outflows from bond funds in the past four weeks. The outflows follow 23 straight weeks of inflows. Muni bonds have delivered positive returns in eight of the last 11 Januaries.

Fed Must Finish Inflation Fight…Despite significant progress in reducing price pressures over the past two years, inflation remains “uncomfortably above our target,” stated San Francisco Fed President Mary Daly last week. Fed Governor Adriana Kugler expressed her concerns as well, emphasizing that she wants to ensure the recent “bump” in inflation data does not prove to be persistent. “I align myself with those who prefer a prolonged period of restriction,” remarked Tom Barkin, President of the Federal Reserve Bank of Richmond. He added, “Inflation has not yet returned to target, so we still have more work to do. However, we believe we do not need to be as restrictive as we once were to achieve that goal.” Fed policymakers are widely expected to maintain steady borrowing costs when they meet later this month.

Moody’s on Chicago Credit…Chicago’s credit trajectory is materially unchanged based upon its Fiscal 2025 budget. “The city’s fiscal 2025 budget includes a mix of credit positive and credit negative elements, but on balance does not fundamentally change the city’s credit trajectory. The fiscal 2025 budget favorably continues the city’s substantially improved pension funding practices,” Moody’s noted. However, while the city has strong legal options to increase revenue, the budget suggests that the actual capacity to continually raise resources may be diminishing. Favorably, Chicago’s general fund balance is well above pre-pandemic levels, providing a buffer to address the city’s ongoing budget challenges.

Chicago Teachers Contract Limbo…Chicago Board of Education fired the CEO of Chicago Public Schools last week, but the CEO will stay on till the school year ends. Mayor Brandon Johnson has recently appointed the current board, after all board members resigned last month. The board’s composition will change again as ten elected members join in mid-January. A contract agreement between the Chicago Teachers Union and Chicago Public Schools still appears to be far off, although verbal tentative agreements appear to have been made. Chicago Public Schools’ CEO said, “The eventual agreement must be aligned with our strategic plan and must be financially sustainable, and if we overextend ourselves today, it will be our children and staff who pay the price tomorrow.”

Muni Bond Issuance Defies Forecasts…In 2024, $507 billion muni bonds were issued, up almost 32% from a year ago. Most forecasters believed 2024 issuance would exceed 2023 levels. At this time last year, none envisioned that states and local governments’ new borrowing would exceed records set in 2020 and 2021, let alone surpass $500 billion. Infrastructure needs, migration trends and the depletion of federal pandemic aid led to the surge.

Compare 30-Year taxable U.S. Treasury yield 4.80% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.85% “AA” 4.14%; “A” 4.27%. For investors in the 35% tax bracket, a 3.9% tax-exempt yield is equivalent to a 6% taxable yield. Top-rated long-term tax-free bonds yield 80% of comparable taxable U.S. Treasuries.