Municipal Bond News 2/26/24

Tax Hike Brings Illinois Surplus…Chicago Credit Outlook Shifts…Bond Insurance Soars…Larger California Deficit Forecast…Hospitals Amid Favorable Trend…Experts Assess 2024 Muni Market…“What’s The Rush?, Ask Fed Officials…

Tax Hike Brings Illinois Surplus…New taxes could bring a surplus for Illinois, overturning a recent deficit warning by the state administration. Hiking sports betting taxes and capping corporate loss deductions and retailers’ sales tax rebates could bring $827 billion in Fiscal 25. Tax hikes come as state revenue outperformance is slowing and expenses increasing. “I wish we had big surpluses to work with this year to take on every one of the very real challenges we face,” Governor Pritzker said upon presenting a $52.7 billion spending plan for Fiscal 25, which begins on July 1. Illinois general funds revenue for fiscal 2025 will be nearly $53 billion, up 1.5% from prior year. Expenditures are set to rise to about $52.7 billion, up 1.4% from this year. Illinois will spend about $13.4 billion on education, 3.4% higher than the current year. Pension contributions will amount to $10.1 billion. Illinois’ rainy-day fund will receive $205 million this year and another $170 million in fiscal 2025 to bring its total to $2.3 billion. The City of Chicago will receive $150 million from state budget. $500 million new bonds to expand the state’s quantum technology are also planned. Illinois has received nine ratings upgrades over the past five years, a turnaround from near-junk ratings earlier. Governor Pritzker’s sixth budget builds on the policies that led to fiscal and credit improvements for the lowest-rated U.S. state.

Chicago Credit Outlook Shifts…S&P has lowered its outlook on Chicago general obligation bonds to stable from positive. Emerging cost pressures not matched by new revenue led to the outlook shift. 2024 expenses have grown notably, although the 2024 budget is balanced. Rising migrant care costs, public safety and pension spending are weighing on Chicago’s long-term finances. S&P said, “Chicago’s economy continues to expand and provides a solid foundation for the rating.”

Bond Insurance Soars…Insured muni bond volumes are the highest since 2008. Bond insurance growth has defied a slowdown in muni bond sales. Insured bond issuance shot up about 6% last year although states and local governments issued about 3% fewer bonds. Investor confidence and enhanced credit ratings have boosted the demand for insured muni bonds. Both bond insurers saw year-over-overgrowth in insured bond volume. Market leader Assured Guaranty’s insured bond volume rose close to 15%, while Build America Mutual rose almost 4%. The largest Assured-insured muni bonds include Dormitory Authority of State of New York bonds, JFK airport, Houston airport and power bonds in New York. Assured Guaranty said, “Investors have been more sensitive to the risk of unexpected economic developments since the onset of the pandemic in 2020, and that growth in recent years reflects both investors’ appreciation of the benefits that bond insurance provides, especially during volatile economic or uncertain market conditions, and issuers’ recognition of its cost-effectiveness and capacity to increase investor demand and market access.”

Larger California Deficit Forecast…The Golden State could face a record $73 billion budget deficit in Fiscal 25. California Legislative Analyst’s office raised its deficit forecast by $15 billion or 26% last week. Governor Newsom pegged the deficit at $37.9 million last month. Weaker-than -expected tax collections are to blame for the higher deficit forecast. Corporate tax collections have dropped by more than a third in December from a year ago, and both income tax withholding and payments are ‘fairly weak.’ Newsom has called for spending cuts and deferrals. The legislative analysts said, “If the budget problem increases by 15 billion dollars, the Legislature will need to find a like amount of new budget solutions to ensure the budget is balanced for 2024 to 2025.”

Hospitals Amid Favorable Trend…By 2025-2026, hospital margins could return to pre-pandemic levels. In 2024, hospital sector operating margins are slated to increase to around 1.6%. That is an improvement from operating margins of around 0.5% to 0.7% in 2023 per Fitch estimates. 2022 was a low point for the Hospital sector, as expenses grew 70% faster than revenue. Hospitals began to see ‘better than breakeven results’ in 2023 after revenue grew and expense pressures eased. A slowdown in expense growth is driving the favorable trend. Fitch stated, “While this [operating margins] is still below pre-pandemic levels, margin improvements fueled by positive labor indicators, volume diversification and efficiency initiatives lead us to believe that margins could return to near historical trends around 2025-2026.”

Experts Assess 2024 Muni Market…The macroeconomic environment, costs, federal policy, climate events and cybersecurity will shape the credit of states and local governments in 2024, a Bond Buyer survey suggests. Inflows to bond funds this year are anticipated by a third of respondents, while a quarter say it is too early to tell. Municipal bond issuance is expected to increase moderately this year. Refunding bond issuance to refinance costly debt will rise, over half of surveyed experts said. The direction of interest rates will have the most impact on the $4 trillion muni market, while the federal elections, inflation and the regulatory environment will also be centerstage.

“What’s The Rush?, Ask Fed Officials…“I am going to need to see at least another couple more months of inflation data before I can judge whether January was a speed bump or a pothole,” Federal Reserve Governor Christopher Waller said as he delivered a speech titled “What’s The Rush?”. Most Fed officials flagged risks of cutting rates too quickly at the Fed’s January 30-31 meeting. The Fed is also discussing slowing the pace at which it shrinks its asset portfolio, a move towards easier monetary conditions. At the end of January, Fed officials judged policy rate was ‘likely at its peak.’ Since the Fed’s January meeting, the U.S. economy has been stronger-than- expected. The exact timing of the first interest-rate cut remains unclear. Bond markets assign 70% odds of a June rate cut. When asked about rate cuts last week, Federal Reserve Governor Michelle Bowman said, “Certainly not now.”

Compare 30-Year taxable U.S. Treasury yield 4.36% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.71%; “AA” 3.91%; “A” 4.18%. 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 85% of comparable taxable U.S. Treasuries.