Municipal Bond News 2/5/24

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Muni Investors Position Portfolios For Appreciation… FOMO Boosts Muni Demand…First Rate Cut Timing… Appeals Court Weighs PREPA Revenue Lien…Airport Fly High…Large Cities’ Office Woes…Federal Climate Bounty

Muni Investors Position Portfolios For Appreciation…“History points to a comeback narrative for municipal bonds,” U.S. News & World Report wrote last week. Since 1994, municipal bonds have often experienced double-digit returns in the subsequent 12 months after five of the last seven drawdowns. For example, muni bonds bounced back with double-digit returns a year after redemptions or outflows from bond funds in the 2008 Great Financial Crisis and the 2020 pandemic. Over the last thirty years, the 12-month period following the last rate hike has produced attractive returns, experts noted. America’s aging demographic and the 2025 phase-out of personal income tax rate reductions from the Tax Cuts and Jobs Act of 2018 are trends that favor muni bond returns over the long term. “Munis have two return levers, whereas cash has one—you’re only getting the current short-term yield,” a portfolio manager added “With municipals, you get yield pickup as well as the potential for price appreciation. And that’s exactly where you want to be and how we are positioning our portfolios for the end of the Fed hiking cycle that we appear to be in.”

Fear of Missing Out Boosts Muni Bond Demand…Capital is pouring in to buy municipal bonds this year. Institutional investors are back in droves to purchasing state and local government bonds. The turnabout comes after large institutions sold over $120 billion of muni bonds over the last two years to meet fund redemptions. Bank of America, the largest muni bond underwriter estimates that institutional demand for muni bonds will grow in 2024. Investors are looking to invest their cash hoards after bond yields dropped since November. Better days ahead for muni bonds, amid strong credit conditions, a bevy of investment experts reckon. It is important not to overlook the opportunity to lock in higher tax-exempt yields on municipal credits with fundamentals ranging from stable to improving, a portfolio manager added, “Investing is an unpredictable art.”

First Rate Cut Timing…A March rate cut is unlikely, “We’ve made a lot of progress on inflation. We just want to make sure that we do get the job done in a sustainable way,” Fed Chair Powell added “This year is going to be a highly consequential year for the Fed and for monetary policy.” The Federal Reserve, which is not influenced by politics or Wall Street, is getting plenty of advice. Senate Banking Committee Chair has urged Powell to cut rates soon to ease home affordability. The Fed’s ‘higher-for- longer’ rate strategy poses a risk for the banking sector, bond expert Jeffrey Gundlach said. The central bank should lower interest rates over the next six to twelve months, veteran investor Bill Gross said. The Fed will weigh the pace of rate cuts based on inflation and labor markets. The Fed last raised rates in July 2023. Major Wall Street banks extended their forecast of the first rate cut to May or June. On CBS 60 Minutes yesterday, Powell reiterated that the Fed is “trying to pick the right time” to begin rate cuts.

Appeals Court Weighs PREPA Revenue Lien...The U.S. Court of Appeals Judge Julie Rikelman asked Puerto Rico’s fiscal agency lawyer if he knew of any examples of bankruptcy cases where the creditors’ “claim” was limited to less than the total face value of what had been promised to them before the bankruptcy. At an Appeals Court hearing last week, PREPA Ad Hoc Group attorney challenged oversight board attorney’s argument that bondholders cannot legally have a lien on future revenue, as this could upend the entire field of secured financings, including revenue bonds. PREPA’s trust agreement is a “vanilla agreement” like hundreds of others, and, it doesn’t make sense for the court to make a “one-off” interpretation of it, bondholders’ attorney told the Appeals Court. Bond insurers, major bondholders, 14 state attorney generals and the Securities Industry and Financial Markets Association (‘SIFMA’) are opposed to a lower court’s March 2023 ruling that limits PREPA bondholder claims on the electric utility’s revenue.

Airport Fly High…New record highs for air travel and bond issuance are in the cards for airports. Air travel has exceeded pre-pandemic levels since last year. New York City-area airports recorded all-time high passenger traffic recently. The surge in air traffic has accelerated construction. Capital projects and refinancing are driving up bond sales. Airports are expected to issue about $21 billion of new muni bonds this year, up 34% from a year ago. “Though there are still some future challenges to navigate, the sector’s days of playing defense are effectively over,” a Fitch analyst stated. Many large airports earned ratings upgrades last year. The resurgence reflects the resilience of airports. With the upbeat outlook, airport bond spread, or the extra yield over top-rated benchmarks has narrowed.

Large Cities’ Office Woes…Office demand shows no signs of returning to pre-pandemic levels. All-time high office vacancy is a challenge for the largest U.S. cities and transit agencies. Nationwide office vacancy rate could rise to 15.7% in 2024 and 16.6% in 2025, per Fitch. The national office vacancy rate was 13.5% last year, up from 9.5% pre-pandemic. San Francisco, Houston, Dallas/Ft. Worth, Chicago, Washington DC, Los Angeles and New York have the most vacant offices. Commercial real estate prices have trailed, a hit on property tax collections. New York’s MTA collected $636 million less through state real estate taxes in 2023 compared to 2022. Commercial real-estate woes are raising risks for lenders and forcing large U.S. cities to reconfigure their tax base.

Federal Climate Bounty…States and local governments have seen a windfall in federal support for climate initiatives, totaling $556 billion from HUD and FEMA over the past two decades, relative to $26 billion in local matching funds. That’s a 20:1 federal support level to states and cities hit by extreme weather. However, climate-related spending by the U.S. federal government dropped 80% in 2023. The winding down of several funding programs comes as stimulus packages are moderating. Meanwhile, private insurer spending rose slightly. Many states including New York, Texas, Florida, New Jersey and U.S. territory Puerto Rico have received more in federal climate-related funding than their total outstanding general obligation debt.

Compare 30-Year taxable U.S. Treasury yield 4.28% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.52%; “AA” 3.80%%; “A” 4.03%%. 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 82% of comparable taxable U.S. Treasuries.