Municipal Bond News 12/26/23

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2023 Muni Bond Winners…State Attorney Generals, SIFMA Support PREPA Bondholder Appeal…U.S. State Revenue Dip Ahead…New York City Budget Gaps…Chicago Eyes TIF Wind-Down…Muni Bond Supply Forecast…

2023 Muni Bond Winners…The $4 trillion municipal bond market is ending 2023 on a strong note. Positive returns are at hand for every muni bond sector and credit conditions are robust. Among U.S. states, Illinois bond prices gained the most, up 7.5% this year. Hospital bonds posted over 7% index returns. The biggest winners are longer-dated high-yield municipal bonds, with index returns above 10%. Puerto Rico’s high-yield long-term bonds have posted close to 16% index returns this year. Tax advantage led muni bonds 6.4% annual return to outperform U.S. Treasury bonds 3.2% return. The gains follow losses in 2022. 2023 marked a return to pre-COVID-19 operating conditions for several tax-free bond sectors. Credit upgrades outpaced downgrades for most municipal bond sectors. In 2023, muni bonds were a popular investment. Municipal bond trading surged as retail investors boosted their holdings of municipal bonds, while mutual funds saw redemptions. Volatile market conditions presented opportunities to lock in muni bonds’ attractive taxable equivalent yields, as high as 10% at times for top earners of high tax states. Longer-dated muni bonds are reasonably priced, with tax-free yields offering 87% of taxable Treasury yields. For the first time since April 2020, price levels fell in November from a month ago. The annual pace of inflation is within striking distance of the Fed’s target, favoring longer-dated municipal bonds.

State Attorney Generals, SIFMA Support PREPA Bondholder Appeal… Municipal bond market enforcement agency, SIFMA, and more than a dozen U.S. state attorney generals are opposed to Judge Swain’s decision that undermines the Puerto Rico electric utility revenue lien granted to bondholders. Bondholders and bond insurers have appealed Judge Swain’s decision that sharply limits bondholders’ revenue claims. “Doing so would harm the market and its participants — including the states, municipalities and investors — and threaten the continued viability of the primary revenue stream for vast swaths of municipal public works projects, such as water systems, health care facilities, power plants, waste disposal facilities, or low- and moderate-income housing programs,” Attorney Generals of 14 U.S. states, jointly filed a brief in the U.S. Court of Appeals for the First Circuit that supports the bondholder appeal. Title III court’s lien estimation is ‘wrong as matter of law and bad as a matter of policy.” SIFMA added, “This conclusion grossly misreads the underlying bond documents—and grossly misunderstands the function of the municipal bond market and the expectations of its participants. In doing so, the District Court has contravened decades, if not centuries, of market precedent and thrust confusion upon the $4 trillion revenue bond market.” On Jan 29, the U.S. Court of Appeals will hear oral arguments. Judge Swain plans to hold a plan confirmation hearing in March.

U.S. States Revenue Dip Ahead…Ahead of 2024 legislative sessions, most U.S. states have begun preparing governor’s budget plans for Fiscal 25. U.S. states expect to collect almost 2% lower general fund revenue in Fiscal 24. Despite the decline, aggregate state revenue is 34% above pre- pandemic levels, National Association of State Budget Officers reported. In Fiscal 23, U.S. state revenue increased barely 1% from a very high baseline after two straight years of double-digit growth in Fiscal 21. The exhaustion of pandemic funds and a lower revenue outlook will slow spending plans in the upcoming state budget cycle, marking a return to more ‘normal’ fiscal conditions in 2024 and more credit differentiation. A mix of tax structures, industries, demographics, tax policies across U.S. states and local governments allows investors to differentiate between bond credits.

New York City Budget Gaps…Growing migrant care costs are weighing on New York City budget gaps. Budget gaps could grow to $8.7 billion in Fiscal 2025 and over $13 billion in Fiscal 26, which are higher than earlier city projections. Mayor Eric Adams has called for spending cuts. Favorably, NYC revenue collections have outperformed. “Given many of the fiscal challenges facing the city are not under its direct control, preparation and transparency about choices and decision-making are crucial to navigate the uncertainty ahead.” New York State Comptroller stated. New York State has called for more federal funding to cover the Big Apple’s outsized spending on migrants, projected to hit over $6 billion in Fiscal 25.

Chicago Eyes TIF Wind-Down… Mayor Brandon Johnson wants to generate cash flow for the Windy City by winding down tax-increment financing districts (TIFs). An influx of property tax revenue is expected to revert to entities like Chicago Public Schools, the Chicago Park District, with many TIFs on the brink of expiration. TIFs were created to spur real estate development by creating some subsidies for developers. Chicago has 127 tax-increment financing districts. Chicago TIFs raked in $1.3 billion in property taxes last year. The bulk of the property taxes collected in the TIF is pledged for TIF-related debt service, and a sizeable remainder goes for city purposes. “There was always going to come a time where we were going to have to think past TIF, and in a way I’m grateful that this mass expiration of TIFs is kind of forcing our hand,” a lawmaker stated. Mayor Brandon Johnson wants to borrow over $1 billion to wind down tax-increment financing districts (TIFs) and generate cash flow for the Windy City. The proposal envisions $1.25 billion muni bonds, issued over five years, to potentially wind down Chicago’s TIFs and generate an annual influx of $250 million for city coffers.

Muni Bond Supply Forecast…States and local governments are forecast to issue between $330 billion to $450 billion bonds in 2024. Actual muni bond issuance has fallen short of Wall Street estimates in recent years. In 2023, $375 billion muni bonds were issued, lower than $390 billion issued in 2022 and $483 billion in 2021. State and local government borrowing plans could pick as federal aid funds are nearly spent. As inflation eases, stability in policy rates could lower borrowing costs. The 2024 presidential election could also impact government borrowing plans. In 2024, Muni bondholders will receive about $416 billion from principal redemptions. New muni bond supply will likely fall short of reinvestment needs.

Compare 30-Year taxable U.S. Treasury yield 4.05% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.42%; “AA” 3.79%%; “A”4.09%. For investors in the 35% tax bracket, a 3.5% tax-exempt yield is equivalent to a 5.4% taxable yield. Top-rated long- term tax-free bonds yield 84% of comparable taxable U.S. Treasuries.