Municipal Bond News 10/21/24

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Advantages of Muni Bond Investments…Demand Fuels Mega Muni Bond Sales…Bond Insurance Grows…Muni Bond Repurchase Offers Grow…Chicago Seeks Budget Deficit Fix…CPS Faces Credit Pressures…HBCU Enrollment Grows…Muni Market Weighs Economy

Advantages of Muni Bond Investments…“Munis are considered a safe investment, in which you pay no federal taxes and sometimes no state taxes, and they provide you with a steady income stream and have a relatively low rate of default,” Forbes wrote last week. Even though taxable corporate bond yields may be higher than muni bond yields, high earners realize a higher income from tax-free muni bonds after accounting for federal and state income taxes. Current top-rated long-term municipal bonds yield 3.6% tax-free relative to a 4.9% taxable yield on similar-rated corporate bonds. A bondholder in the 35% federal income tax bracket would effectively realize a 5.54% yield from muni bonds on an after-tax basis. Additionally, the default rate for investment grade muni bonds is just 0.09%, significantly lower than the 2.25% default rate for similar-rated corporate bonds, based on Moody’s data spanning half a century. Muni bonds are most comparable in credit quality to U.S. Treasuries. Over the last thirty-plus years, muni bonds have delivered a positive annual return in five of the last seven rate-cutting cycles.

Demand Fuels Mega Muni Bond Sales…Amid a surge in demand for muni bonds, three billion dollars plus muni bond deals are front and center in the primary market. A $3.2 billion New Jersey transportation agency bond issue rated S&P ‘A- ‘/Fitch ‘A’ was upsized. Chicago O’Hare airport bonds received strong demand. $1.6 billion high grade Pennsylvania general obligation bonds offered a top yield of 3.9% for twenty years. Last week, muni bond funds reported the highest weekly inflows of cash since January. Demand for muni bonds is currently the strongest it has been since the start of the year.

Bond Insurance Grows…The volume of insured muni bonds has grown close to 27% this year. Assured Guaranty insured 57% of the newly insured muni bonds. Build America Mutual’s market share has grown to over 43% this year, up from 37% a year ago. According to its CEO, Assured Guaranty’s insurance offers “meaningful financing cost savings for issuers and additional protection for investors during a time of geopolitical uncertainty and increasingly unpredictable environmental conditions.” Build America Mutual noted that strong interest from institutional investors continues to drive the use of insurance on larger and higher-rated deals. AMBAC, which is not currently issuing new insurance, plans to sell off its legacy bond insurance business to Oaktree Capital by early next year. Sophisticated investors favor purchasing insured muni bonds.

Muni Bond Repurchase Offers Grow…States and local governments are on track to repurchase about $30 billion in outstanding muni bonds this year. Tender offers, or issuers’ seeking to repurchase debt, are a way to refinance costly existing debt. Tender offers gained in popularity as aggressive rate hikes made traditional refinancing more expensive. Flush with ample cash reserves, Florida seeks to buy back about $500 million of its debt, marking the Sunshine State’s first ever tender offer. An investors’ decision to tender depends upon the offered purchase price relative to the current market price as well as the reinvestment opportunities. However, it’s worth noting that less than half of recent tender offers have been accepted by investors.

Chicago Seeks Budget Deficit Fix… “The City of Chicago faces serious financial challenges that will only be rectified through innovative solutions and long-term planning,” the Civic Federation said. The non-partisan watchdog suggests raising garbage collection levies, broadening sales taxes, cutting staffing costs and suspending a supplemental pension payment introduced in recent years. A planned $1.5 billion Chicago bond sale has also become controversial. City officials have deferred their vote on the bond sale so that the city cannot use bond proceeds for operating expenses. Chicago faces a nearly $1 billion deficit next year, the most since the pandemic, as well as an unexpected gap this year after the school system refused to pay a pension bill. Despite challenges with office occupancy, Chicago’s real estate valuation has climbed 30% since 2021 per the latest tax assessment.

CPS Faces Credit Pressures…Amid cost pressures, Chicago Public Schools (‘CPS’) would need to find new revenue to maintain structural balance. Unbudgeted cost increases for a new teachers’ contract, currently under negotiation, and the end of federal pandemic aid in fiscal 2026 have created budgetary pressures. An increase in revenue will require action by the City of Chicago, or the State of Illinois. It is unclear whether the city will release cash resources from tax increment financing districts, and, if the state will raise school state aid. Moody’s is monitoring CPS’ ability to achieve structural balance amid changes in board composition.

HBCU Enrollment Grows…Credit positive for Historically Black Colleges and Universities (‘HBCUs’), enrollment has grown between 6% and 29% between Fall 2020 and Fall 2023. In contrast, median enrollment for the higher education sector has declined. HBCU’s have also secured substantial new funding from wealthy benefactors and federal government. Early in 2024, billionaire Ronda Stryker contributed $100 million to Spelman College, the largest single donation ever made to an HBCU. Better student retention, higher market share and improved infrastructure is needed for sustained credit improvement.

Muni Market Weighs Economy Versus Election… Presidential election outcomes, and economic conditions, will determine credit conditions for $4 trillion state and local government bonds. The extent of tax reform, federal spending, tariff regulations and new laws amid widening federal budget deficits will depend on the balance of power in Congress. However, it is likely that economic conditions will have a more significant impact on credit conditions for infrastructure-related municipal bond sectors than the presidential election results. The credit quality of toll roads, airports, electric utilities and ports is tied to the strength of the economy. Along with demand, rate-setting tied to cost recovery is key. Inflation and interest rate levels impact margins and capital spending. A complete policy U-turn on major federal spending laws such as the Infrastructure Investment and Jobs Act and Inflation Reduction Act is unlikely. However, Republican leadership could slow the agency- level implementation of these laws. Generally, bridges, toll roads and airports tend to receive more bipartisan support while clean energy and climate programs face political pressures. A likely divided U.S. government will require bipartisan compromises.

Compare 30-Year taxable U.S. Treasury yield 4.37% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.64% “AA” 3.94%; “A” 4.09%. For investors in the 35% tax bracket, a 3.7% tax-exempt yield is equivalent to a 5.7% taxable yield. Top-rated long-term tax-free bonds yield 84% of comparable taxable U.S. Treasuries.