Municipal Bond News 12/12/22

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Why Wealthy Investors Are Buying Municipal Bonds… Chicago Bonds Oversubscribed and Upsized… Producer Prices Mixed…MTA Yield Penalty Grows… Illinois Revenue Outlook Boosted…Hospitals’ Ratings Risks…Title III Exits Restore Island’s Market Access…

Why Wealthy Investors Are Buying Municipal Bonds… Sophisticated investors are betting that high yields offered by municipal bonds may not last. First, the outflow cycle took munis cheaper than what current economic conditions would say they should be, as Vanguard’s muni head explains. Second, a likely U.S. recession in 2023 boosts prospects for municipal bonds. Recessions drive a ‘flight-to-quality’ to government bonds as investors shun riskier assets. Goldman Sachs CEO assigns 2 out-of-3 odds of a U.S. recession in 2023, with fewer odds of a ‘soft landing. Third, inflows to municipal bond mutual funds, a gauge for demand, are likely to ‘turn around at some point next year and will be beginning what is a typical trend of a muni inflow cycle,’ Vanguard leadership estimates. Last week, municipal bond mutual funds received small inflows, only the third week investors purchased municipal bonds since August. Fourth, supply of new tax-free bonds sold in the primary market is the lowest in over three decades. Finally, states and local government finances are in good shape. “At the very highest end of the market, the family offices are very engaged in this – very engaged,” a Citigroup chief investment officer said that the wealthy are placing large orders to buy municipal bonds. Surging demand suggests that higher tax-free yields may not last. Value municipal bond prices make it an opportune time to buy municipal bonds for the long run.

Chicago Bonds Oversubscribed and Upsized… The Windy City’s general obligation bonds issued last week were well-received by investors amid a supply- starved municipal bond market. The city upsized the bond offering to make the most of favorable market conditions. In the last month, market yields have dropped. Tax-free yields of 4.8% for bonds maturing in 20 years, or about 160 basis points above top-rated benchmarks were offered by the nation’s third largest city. Recently, Chicago received an investment-grade rating from Moody’s after seven years of junk-rated status. S&P raised its outlook to positive last month, and Fitch awarded a two-notch upgrade in October. “We’ve been monitoring the market very closely and we’ve seen a lot of the strength in munis especially with the dearth of supply,” Chicago CFO added that the city’s shrinking spreads and lower interest rate costs are a testament to the impact of the rating upgrades on trading and “it’s literally investors buying the Chicago financial turnaround story.”

Producer Prices Mixed… Wholesale price gains slowed to 7.4% annual pace in November, down from 8.1% prior and a peak of 11.7% in March-22. However, price gains are higher than forecast of 7.2% year- over-year gain. Monthly price gains, 0.3% in November, are a touch above forecast, 0.2%. Most economists are leaning toward a 50-basis point rate hike on December 14, although the higher-than-forecast inflation reading has raised odds of a 75-basis point rate hike.

MTA Yield Penalty Grows… One of the largest issuers of triple-tax exempt bonds, New York’s MTA offers higher yields amid funding risks. Investors seek a steeper yield penalty ranging between 150 basis point to 177 basis points for tax-free bonds issued by the nation’s largest transit agency. New York politics will determine the level of federal, state and city aid offered to fill a $3 billion budget gap in 2025. Lawmakers’ generosity, including $15 billion COVID-19 federal and an additional $336 million of state funding this year approved by Governor Kathy Hochul, holds out optimism for future funding. With ridership hitting a plateau of about 65% of pre-COVID-19 levels, efforts to hike fares, lower service schedules and other cost measures will be front and center.

Illinois Revenue Outlook Boosted… Illinois has raised its forecast for Fiscal 23 general fund revenue collections by about 10%. State source revenue has grown sharply in the first five months of Fiscal 23. The revenue growth is ‘impressive’ especially since these tax receipts are being compared to the record- breaking levels of Fiscal 22. High personal income tax, corporate income tax, and sales tax collections have led to the revenue surge. Amid uncertainties around the national economy, the ‘brunt of the impact of a potential slowdown/recession in Illinois will fall more in Fy24.’ A government forecasting commission noted that Illinois ‘revenue outlook for Fy23 looks promising.’

Hospitals’ Ratings Risks… In 2023, hospitals will see revenue grow, however margins will remain pressured. Higher reimbursements from commercial insurers are likely given that health insurance costs grew about 20% this year. A Public Health Emergency declaration, which enhanced government reimbursement, is slated to end in 2023. However, a continued rebound in patient volume augurs well for cash flow. Labor shortages will drive operating expenses higher for some municipal bond sectors. High interest rates, inflation and supply chain issues could pressure operating margins. Favorably, subsidies for Affordable Care Act premium, which were set to expire in 2022, have been extended for an additional three years, aiding healthcare access to 2 million Americans. Strong balance sheets and governance could be crucial. A complex operating environment raises ratings risks for some hospital bond issuers.

Title III Exits Restore Island’s Market Access… Puerto Rico’s highway authority is the second Puerto Rico bond issuer to exit Title III bankruptcy in 2022. In March-22, the central government exited bankruptcy, almost three years after COFINA’s 2019 bankruptcy exit. The final resolution of Puerto Rico legacy bonds was in limbo for much of 2020. In 2021, general obligation debt talks advanced amid new Island administration and several new oversight board member appointments. In 2023, Puerto Rico’s electric utility is slated to exit bankruptcy. Puerto Rico’s fiscal agency head stated “The HTA plan’s implementation represents one more significant step in restructuring Puerto Rico’s public debt, returning to the capital markets, and laying the foundation for a stronger, vibrant, and resilient economy.” The Island’s tax collections have outperformed in recent years. The oversight board will probably remain on the Island for a few more years. Some Puerto Rico bonds, such as restructured COFINA bonds, may seek credit ratings in the next few years.

Compare 30-Year taxable U.S. Treasury yield 3.51% to 30-Year tax-exempt muni bond yield “AAA” 3.49%; “AA” 4.01%; “A” 4.57%. For investors in the 35% tax-bracket, a 4% tax-exempt yield is equivalent to a 6.15% taxable yield. Top rated long-term tax-free bonds yield 99% of comparable taxable U.S. Treasuries.