Municipal Bond News 10/23/23

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Muni Bonds Oversubscribed Amid Treasury Rout… Bellwether Yields Rise…Chicago Earns Rating Upgrade…Bond Insurance Grows…Student Housing Recovers…U.S. Cities Revenue Forecast Dims…SALT Cap a Bargaining Chip…Fed Officials Mull Rate Pause…

Muni Bonds Oversubscribed Amid Treasury Rout…Benchmark muni bond indices rose 25 to 30 basis points last week, following a similar yield surge in comparable U.S. Treasuries. New muni bonds issued last week featured several $1 billion plus offerings. 2.3 times worth of orders sought New York City Transitional Finance Authority’s $1 billion tax-exempt bonds, which offered a top yield of 4.96%. A $1.2 billion State of Connecticut bond offering for transportation projects received strong bids and a top yield of 4.75%. “Investors continue to see opportunity in Connecticut and recognize our improved financial standing as a symbol of sustainable strength. The impact of our collaborative, bipartisan work to stabilize state finances in recent years is reflected in both the credit rating increase our transportation bonds received prior to this offering and the affordable borrowing costs we were able to secure at a time of high national interest rates, directly saving money for taxpayers,” Connecticut’s bond office stated. A bond expert told Financial Times “I think what is happening in the bond market is net positive for the next decade. We’re actually going to have income in the coming decade.” Municipal bonds currently offer a significant yield advantage over comparable taxable U.S. Treasury bonds.

Bellwether Yields Rise…Treasury yields rose to the highest in 16 years, extending a multi-week bond rout. Benchmark U.S. Treasury yields are at or near 5% for all maturities, the highest level since 2007. 30-year Treasury yields climbed to 5.14%, and the bellwether 10-year closed the week at 4.98%. The Middle East war fuels haven bond demand while a swelling U.S. deficit boosts the supply of Treasury securities. Fed’s higher-for-longer narrative, and stronger-than-expected jobs, inflation and retail sales data and concerns over federal borrowing plans drove bellwether yields higher. Treasury yields pulled back after Fed Chair Powell signaled that the Fed may pause on raising rates in November. 10-year U.S. Treasury bond yields have risen about 1% since the Fed last raised rates at the end of July.

Chicago Earns Rating Upgrade…Fitch boosted the rating of the third-largest U.S. city to ‘BBB+’ from ‘BBB’ and assigned a stable outlook. The upgrade was “driven by a decline in the city’s long-term liability burden stemming from steady growth in the economic resource base and improved debt management practices, Fitch said. The upgrade comes on the heels of a $16.6 Fy24 spending plan unveiled last week by first-time Mayor Brandon Johnson. The proposed budget is counting on billions of dollars of additional revenue from tourism and recreation to help plug a budget deficit. “Fitch expects continued solid revenue growth driven by the strength and resilience of the city’s economy, excluding the effect of new or raised taxes and fees,” Fitch noted. Mayor Johnson said, “These additional upgrades reaffirm the fiscal stability of Chicago,” Johnson said in a statement. “The ratings not only prove the excellence of our city’s operational and financial management, but also confirm that we have the ability to attract additional investment, boost economic vitality, and further strengthen our city’s finances.”

Demand For Insured Muni Bonds Grows…Demand for insured municipal bonds has grown this year. Faced with high interest rates and volatile market conditions, states and local governments achieve lower borrowing costs by wrapping insurance on bond offerings. Bond insurance mitigates credit risk and investors value bond insurers’ guarantee of full and timely debt service payments if unforeseen events unfold, a peace of mind to investors. Since COVID-19, investor demand for insured muni bonds has risen. Generally, revenue-secured bonds issued by airports, schools, student housing, utilities, and lower-rated local governments tend to issue insured muni bonds. About 8.5% of new muni bonds issued this year carried bond insurance. Fewer insured muni bonds were issued this year, echoing a slowdown in borrowing by state and local governments.

Student Housing Recovers…Privatized student housing projects have largely rebounded from COVID-19-related challenges. Median occupancy hit 98% last year, up from 71% in 2020 for Moody’s rated student housing projects. Median debt service coverage has improved to 1.45x in Fiscal 22, just a little short of 1.51x pre-pandemic. Rental rate hikes are not keeping up with inflation-driven cost surges. During the pandemic, university support, debt service reserve funds and other project funds helped offset census losses. A Municipal Bond Specialist can guide investors in assessing credit factors affecting individual student housing projects. The student housing bond sector generally offers higher tax-free yields.

U.S. Cities Revenue Forecast Dims…A potential economic slowdown has led U.S. cities to lower revenue forecasts. City officials expect sales and income tax receipts to decrease by 3.1% and 5.9%, respectively in Fiscal 23. Meanwhile, property tax revenue is expected to increase marginally by 0.9% since it lags the overall economy and reflects the value of properties one to three years in the past. Roughly half of 820 U.S. cities surveyed by the National League of Cities were optimistic about their ability to balance their budgets in fiscal 2024, a decline from the prior year. Cities received about $65 billion of federal direct aid for COVID-19 relief. Many have already spent COVID-19 relief funds, which are set to expire by 2026. City officials cite inflation, infrastructure needs and rising labor costs as budget constraints.

SALT Cap a Bargaining Chip…Lawmakers are weighing a proposal to raise the cap on SALT deductions. Efforts to double the SALT cap or do away with it come as the U.S. House wrangles to appoint a speaker. The cap on SALT deduction has implications for high-tax U.S. states. A Tax Foundation expert reckoned, “The SALT issue “is likely to continue being an issue between now and the end of 2025, when the cap expires.”

Fed Officials Mull Rate Pause…The policy debate is shifting from how high rates need to rise to how long they need to be at the current levels, the highest in 22 years. Philadelphia Fed President Patrick Harker said he thinks the Fed can likely wait until early next year to decide whether rapid rate hikes of the past 20 months have done enough to keep inflation heading lower. The recent surge in bellwether yields has tightened monetary conditions. “Given the uncertainties and risks, and how far we have come, the committee is proceeding carefully,” Fed Chair Powell added “Incoming data over recent months show ongoing progress toward both” of the Fed’s goals, stable inflation and strong employment.

Compare 30-Year taxable U.S. Treasury yield 5.14% to 30-Year tax-exempt Municipal Bond yield “AAA” 4.62%; “AA” 4.94%; %; “A” 5.32%. For investors in the 35% tax bracket, a 5% tax-exempt yield is equivalent to a 7.69% taxable yield. Top-rated long-term tax-free bonds yield 90% of comparable taxable U.S. Treasuries.