Municipal Bond News 5/13/24

Illinois Bonds Oversubscribed…Muni Bond Rating Upgrades Outweigh Downgrades…Jumbo Muni Bond Sales Hit Record…California Cuts Spending…Tobacco Bonds Shrink…PREPA Revenue Discovery…U.S. States Pick Up College Tuition Tab…“Too Early” For Rate Cuts…

Illinois Bonds Oversubscribed…Over six times worth of orders came to buy $1.8 billion Illinois general obligation bonds issued last week. Illinois received “tremendous feedback from the bond market, and especially from retail investors,” Illinois bond director said. The state has received nine rating upgrades in the last three years. Governor Prtizker noted “The market has recognized that Illinois is no longer a mismanaged, unreliable state to do business with. We are now seen as a constantly growing and expanding economy benefitting from saving, investing, and shepherding taxpayer dollars responsibly.” Illinois bonds repriced to lower yields in secondary trading. Long term general obligation bonds offered a top yield of 4.27%. Strong demand led to some of the tightest credit spreads the state has received in recent history.

Rating Upgrades Outweigh Downgrades…Muni bond rating upgrades surpassed downgrades in the first quarter of 2024. S&P upgrades doubled the number of downgrades. The most common rating action is a rating affirmation. However, when a rating does change, upgrades outweigh downgrades by a ratio of 4:1, a Fitch analyst noted. This trend is visible in nearly all muni sectors. In the transportation sector, upgrades surpass downgrades by forty times, a S&P analyst echoed. Healthcare and higher education sectors carry higher ratings risk. The overall strength of the economy led to the uptrend in credit quality. About two-in-three new muni bonds issued in the first quarter was rated.

Jumbo Muni Bond Sales Hit Record…The number of billion dollar plus muni bond offerings in the primary market has risen sharply. 22 muni bond offerings have exceeded $1 billion deal size so far this year. The volume of jumbo-sized transactions this year is poised overtake the prior record. In 2020, the primary market saw 26 billion dollar plus muni bond sales, the highest annual record for mega muni deal issuances. Large scale capital programs, inflation and favorable borrowing costs led states and local governments to bring larger tax-free financings to the market. Larger-sized bond offerings tend to gain more investor attention in the secondary market and enjoy a broader investor pool. This year’s largest muni bond offerings are $3.2 billion Brightline train bonds and $2.3 billion Jefferson County, Alabama bonds.

California Cuts Spending…Governor Newsom proposed an updated $288 billion spending plan on Friday for the fiscal year that starts July 1. That is well below the nearly $311 billion he signed into law last year. The latest plan projects a $26.7 billion deficit. In March, lawmakers agreed to spending cuts and deferrals worth $17.3 billion. California faces additional spending cuts and will also dip into reserves. California enjoyed a surplus of more than $100 billion just three years ago. This is the second year in a row the nation’s most populous state faces a multibillion-dollar shortfall. California’s annual spending is the largest of any state in the country.

PREPA Revenue Discovery…Bondholders claim that Puerto Rico’s electric utility (‘PREPA’) has illegally and improperly diverted $3 billion in revenue since 2017 that should have been deposited to trustee-held bond accounts for debt service. Syncora Guarantee and GoldenTree Asset Management want PREPA’s monthly financial activity reports that show PREPA’s calculation and disposition of net revenue. In February, holders and insurers of 40% of PREPA bonds requested the court to allow bondholders to appoint a receiver to take over PREPA. Last month, bondholders showed a new electric revenue forecast to the Title III court that could boost bondholder recoveries. The Title III court is currently reviewing the updated revenue forecast.

Tobacco Bonds Shrink…Tobacco bond issuance has come to near standstill. No new tobacco bonds have been issued in almost two years. The outstanding volume of tobacco bonds has shrunk as bonds have matured. Some U.S. states such as Illinois retired tobacco bonds recently. Majority of tobacco bonds were refinanced when policy rates were at generational lows. Refinanced tobacco bond issues were structured around latest cigarette smoking trends. Last month, U.S. states received $5.8 billion from tobacco manufacturers in annual settlement payments. That’s almost 10% lower than last year’s payment, and the smallest since tobacco settlement payments began 25 years ago. The decline in annual payments is linked with fewer smokers in the United States. After outperforming returns last year, tobacco bonds have posted a small negative return this year. Speculative-rated tobacco bonds yield 6.2%, about 70 basis points higher than high yield muni bond index.

U.S. States Pick Up College Tuition Tab…Overall revenue for public colleges climbed by 0.8% to a record high of $18,301 per full-time student. However, tuition revenue per student fell 3.3% in 2023, the largest decrease in over forty years. Public colleges have seen state and local funding rise, while tuition revenue has fallen. State support increased for the 11th consecutive year. Appropriations for public institutions grew by an inflation-adjusted 3.7% per student in 2023. Amid falling enrollment and rising costs, public universities’ reliance on state aid has grown. U.S. states are investing in higher education.

“Too Early” For Rate Cuts…“I, at this point, have not written in any cuts” for 2024, Federal Reserve Governor Michelle Bowman said she expects a number of months and Fed meetings before rate cuts begin. “It’s just too early to think about cutting rates,” Dallas Fed President Lorie Logan said. Boston Fed President Susan Collins said it will take “more time than previously thought” to bring inflation sustainably down to the central bank’s 2% target. “I am optimistic that today’s restrictive level of rates can take the edge off demand in order to bring inflation back to our target,” Richmond Fed president Thomas Barkin added “The full impact of higher rates is yet to come.” Bond markets are betting on two or fewer rate cuts for this year.

Compare 30-Year taxable U.S. Treasury yield 4.62% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.84%; “AA” 4.03%; “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 83% of comparable taxable U.S. Treasuries.