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Municipal Bond News 3/20/23
Should Municipal Bond Investors Fret Over First Republic Bank… Hospital Bonds Recovering…Bargain in Obscure Corner of Municipal Bond Market…Odds Favor 25 Basis Point Rate Hike…Summers Warns Against Financial Dominance…Illinois Rating Upgraded… Lawmakers Seek Affordable Housing Boost…Many U.S. States’ Revenue Outperforms…White House Proposes Tax Hike on Wealthy…
Should Municipal Bond Investors Fret Over First Republic Bank…First Republic holds over $19 billion municipal bonds. If they are forced to liquidate, they should do so in orderly manner. However, if other banks follow suit, a large amount of debt may get dumped into the municipal bond market, dragging prices down. At this time, municipal bondholders should be concerned, but not be panicked.
Hospital Bonds Recovering…Investment-grade hospital municipal bonds are up 2.6% this year. Bond price gains come as labor costs have eased and patient volumes are stabilizing. Last year, operating pressures on hospitals escalated amid continued surges in labor costs, delayed treatment by patients and the winding down of pandemic federal. funds. Today, staffing costs are much lower. For example, travel nurse pay has dropped to about $3,000 per week, down sharply from $10,000 a week during the pandemic. The shift puts hospitals in a stronger position to negotiate higher reimbursement rates with private insurers, who push for lower costs industrywide. Although hospitals’ operating expenses are still higher than pre-COVID-19 levels, hospitals are recovering from the pandemic.
Bargain In Obscure Corner of Municipal Bond Market…Prepaid gas bonds may trade at wider spreads amid headlines on banking system concerns. Investor concerns on the banking industry are bleeding into a corner of the $4 trillion municipal-bond market where major investment banks guarantee energy for public utilities. Government agencies issue pre-pay gas bonds to purchase long-term supplies of natural gas. Large institutional banks act as facilitators of the transactions, guaranteeing the supply and providing investors tax-exempt exposure to bank credit. Now, with global markets on edge, and the collapse of some US regional banks, those bonds have cheapened.
Odds Favor 25 Basis Point March Rate Hike…The Federal Reserve is expected to raise policy rates by 25 basis points on March 22, 2023. Futures markets assign about two-in-three odds of such a move. In February, the Fed hiked policy rates by 25 basis points, marking a slower pace of rate hikes that began one year ago. Traders are betting that the upcoming rate hike could be the last, with broad expectations of a pause in May and rate cuts as early as June.
Summers Warns Against Financial Dominance…Former Treasury Secretary Lawrence Summers said the Federal Reserve shouldn’t be spooked into easing its rate hikes to contain inflation in the wake of the recent banking turmoil. “It would be very unfortunate if, out of solicitude for the banking system, the Fed were to slow down its rate of interest-rate increase beyond what was appropriate given the credit contraction,” Summers favors a 25- basis point rate hike.
Illinois Rating Upgraded…Moody’s has raised the credit rating of Illinois to ‘A3’ up from ‘Baa1’, marking the eighth credit upgrade the state has received in less than two years. The upgrade follows S&P’s recent action that lifted Illinois rating to ‘A-’. “The state is on track to close fiscal 2023, which ends June 30, with further growth in reserves that are already at their strongest level in over a decade. The state is also increasing payments to its pension plans,” Moodys gave high marks to Illinois’ improved governance. Illinois’ “rainy day” fund is slated to reach its highest-ever balance of more than $1.9 billion by the end of the fiscal year. Moody’s stable outlook on Illinois “balances the financial progress being made by the state with the uncertainty of the present economic climate.” Illinois general obligation bonds haven’t carried a Moody’s rating in the ‘A’ category since being cut to ‘Baa1’ from ‘A3’ in October 2015. The rating went on to sink to a low of ‘Baa3’, one notch above junk, in June 2017 during the state’s two-year budget impasse when then Gov. Rauner (R) and the legislature’s Democratic majority could not come to terms. The trajectory shifted with Moody’s upgrades in 2021 and 2022. “This credit upgrade, our second one this year, is the result of the steps we’ve taken in Illinois to put ourselves on firm fiscal footing,” Gov. JB Pritzker added “We have balanced our budget, paid our bills on time, cleared out decades of debt, made extra pension payments, and saved billions for a rainy day. There’s more work to be done.”
Lawmakers Seek Affordable Housing Boost…More tax-free housing bonds could be in store if recent legislation, ‘Affordable Housing Credit Improvement Act’ is enacted. The bill seeks to provide additional tax incentives to affordable housing projects financed with tax-free private activity bonds. If enacted, the measure could add two million affordable homes over the next decade. Amid a divided Congress, a broader tax bill may be needed to boost tax incentives for affordable housing. There is a shortage of affordable housing nationwide. Existing programs limit the use of tax-free bonds to develop affordable housing. Not likely to shy from high interest rates, bond issuers are looking to issue more tax-free bonds for housing projects, a public good. A National Council of State Housing Agencies spokesperson said, “Enactment of these provisions would allow for increased housing production and bond issuance.”
Many U.S. States’ Revenue Outperforms…States’ solid revenue growth generally favorable compared to forecasts set nearly a year ago. More than halfway through Fiscal 23, the 18 largest U.S. states’ aggregate tax collections are almost 6% higher than a year ago, outperforming budget expectations which forecast Fiscal 23 aggregate tax revenue to be 3.1% lower than prior year per Fitch and National Association of State Budget Officers. Strong sales tax revenue, driven by high consumer spending and inflation, led to the outperformance. Notably, sharp declines in stock-based compensation have led California, New York, and Massachusetts tax revenue to decline in the first seven months of Fiscal 23 from a year ago. Revenue outperformance, relative to budget, creates a cushion of reserves. For many U.S. states, reserves are poised to grow this year.
White House Proposes Tax Hike on Wealthy…President Biden seeks to hike taxes on those earning more than $400,000. A higher Medicare Tax of 5%, up from 3.8% now, is sought to bolster the Medicare Trust fund. The tax hike plan is part of the White House federal budget unveiled last week. Biden said, “Let’s ask the wealthiest to pay just a little bit more of their fair share, to strengthen Medicare for everyone over the long term.” Tax hikes face stiff opposition from Republicans, who have control of the House since November. The tax hike plan is a pivot for lawmaker’s battle on the nation’s debt limit and spending priorities.
Compare 30-Year taxable U.S. Treasury yield 3.57% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.45%; “AA” 3.89%; “A” 4.26%. 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 97% of comparable taxable U.S. Treasuries.