Municipal Bond News 5/23/23

Rates ‘May Not Need to Rise as Much’, Says Powell…Muni Bond Issuers’ Federal Exposure Varies…California Outlook Lower, Moody’s…New Jersey Tax Revenue Dips…Illinois Rainy Day Funds Boosted…Chicago Fiscal Progress…Transit Systems’ Fiscal Cliff…Sports Betting Grows…

Rates ‘May Not Need to Rise as Much’, Says Powell…Chances of a credit crunch as the Fed fights inflation is likely to keep future rate hikes at bay. “While financial stability tools help to calm conditions in the banking sector, developments there, on the other hand, are contributing to tighter credit conditions and are likely to weigh on economic growth, hiring and inflation,” Fed Chair Powell added “As a result, our policy rate may not need to rise as much as it would have otherwise to achieve our goals.” Central bankers are divided on future rate hikes. Some Fed officials including Governor Michele Bowman and Cleveland Fed president Loretta Mester have suggested that the Fed should continue hiking rates. Minneapolis Fed president Neel Kashkari is open to ‘move a little bit more slowly from here’ but objects to any declaration that the Fed is done raising rates. Traders assign eight in ten odds of a rate pause at the Fed’s June meeting.

Muni Bond Issuers’ Federal Exposure Varies…Federal debt ceiling impasse indirectly affects municipal bond issuers, some more than others. When explicit or implicit federal government support is a credit factor for a municipal bond credit, a standoff at Capitol Hill elevates rating risk. The vast majority of state and local governments would likely be resilient to any potential change in the U.S. rating. U.S. states are sovereign and have broad fiscal autonomy. Local governments also have a highly stable revenue base. Infrastructure-related municipal bonds, such as airports and toll roads, are rated based on their standalone credit quality rather than U.S. government linkages. Large universities, with sizeable endowments and vast autonomy, are more resilient than smaller ones. Federal grants to utilities face uncertainty. Hospitals with outsized reliance on federal Medicare and Medicaid revenues could be exposed to a prolonged disruption at the federal level, based on their liquidity positions. Public Housing Authority bonds, and Section 8 projects, reliant on federal appropriations, could tap debt reserves for any temporary disruption. In 2011, a debt ceiling stand-off led to forced spending cuts. Should that recur, non-defense discretionary and entitlement programs become vulnerable. The nature and extent of federal exposure could have rating implications for municipal bond issuers. The impact on individual credits would depend on how long the federal debt impasse continues, and any offsetting credit strengths.

California Outlook Lower, Moody’s…California’s rating outlook was revised to negative from stable by Moody’s, as it affirmed the Golden State’s ‘Aa2’ rating. Revenue uncertainty and the state’s capacity to balance near-term budget gaps without substantial use of reserves are factors. The outlook shift comes a week after Governor Gavin Newsom warned that Fiscal 24 budget shortfall could be larger than earlier estimated. Moody’s stated, “The negative outlook reflects a weakened and uncertain revenue environment in California that raises the possibility of extended pressure on the state’s budget.”

New Jersey Tax Revenue Dips…April tax collections dropped 27%, more than double originally forecast. The drop comes a year after record high state revenues. New Jersey has lowered its revenue forecast for the current fiscal year and Fiscal 24. The Garden State is ‘well-prepared to handle this April surprise’, noted the State Treasurer. The state’s $7.9 billion surplus amounts to 15% of appropriations.

Illinois Rainy Day Funds Boosted…The lowest-rated U.S. state boasts a rainy-day fund of $1.7 billion. State reserves had been decimated during the 2015 to 2017 budget impasse. In recent times, Illinois socked away outperforming revenue to rebuild reserves. The policy has been rewarded by several credit upgrades. Since 2021, Illinois has earned eight credit upgrades from rating agencies, the first in more than two decades.

Chicago Mayor Seeks New Taxes…A slew of new tax hikes on the wealthy and large corporations could raise Chicago revenue by $7 billion. New city administration headed by Mayor Brandon Johnson has outlined a plan that reinstates a big business head tax, that was eliminated by former Mayor Rahm Emanuel. Higher jet fuel tax, real estate transaction tax, financial transactions tax, a local wealth tax and digital ad tax are also sought. State approval would be needed for a local wealth tax and city income tax for high earners. The mayor’s office estimates that a 3.5% tax on households earning more than $100,000 would bring about $2.1 billion of recurring revenue. Some large cities, such as New York and Philadelphia, levy municipal income taxes. In recent years, Chicago’s budget gaps have narrowed. The city has made progress towards balancing revenue and expense growth, and increased pension contributions to its four underfunded pension plans. Chicago’s GO, sales tax secured, airport and utility bonds have collectively received three credit upgrades and three positive outlooks from ratings agencies over the last eight months. “We are starting to see investors come in our bond sales that are normally investors who invest mostly in high grade credits, Chicago’s outgoing administration noted that the city is in the midst of a financial turnaround. Chicago issues between $1 billion-$2 billion of new bonds each year, that are much sought for higher tax-exempt yield.

Transit Systems’ Fiscal Cliff…Raising rating downgrade risks, the largest transit systems in the nation facing a $6.6 billion shortage through Fiscal 2026. Federal aid is close to running out, and ridership is still well below pandemic levels. Before the pandemic, 7.8 million people used public transit, over half came from New York metro area and San Franscisco Bay area. MTA expects ridership to reach 80% of pre- COVID-19 levels by 2026. Ridership is already at 80% to 90% of pre-COVID-19 levels for New Jersey Transit. “This is a national problem,” MTA CEO noted. Bay Area Rapid Transit, Los Angeles Metro, Chicago Transit Authority, and Washington Metro also face funding shortfalls.

Sports Betting Grows…In 2022, U.S. sports betting revenue grew 75% over prior year. The launch of online sports betting in several states has driven the growth. New York ranks as the largest sports betting market in the nation, followed by Illinois. New Jersey, a pioneer in sports betting, has been pushed down to the third spot. 32 U.S. states have legalized sports betting, since the U.S. Supreme Court allowed U.S. states to regulate sports betting in 2018.

Compare 30-Year taxable U.S. Treasury yield 3.94% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.57% “AA” 4.03%; “A” 4.38%. 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 91% of comparable taxable U.S. Treasuries.