Municipal Bond News 5/6/24

High Yield Muni Bond Demand Soars…Hospital M&A Spree “Generally Credit Positive” … Unrated COFINA Bonds Prized…Bellwether Yields Fall…Rate Cut Odds Boosted… Bondholders Seek Additional PREPA Hearing…Warren Buffett Expects Tax Hikes…Bond Insurance Grows…

High Yield Tax-Free Bond Demand Soars…High yield muni bonds account for less than 4% of $144 billion muni bonds sold this year. Only $5.5 billion tax-exempt high yield muni bonds have been issued this year. Due to a shortage of high yield bonds, investors are eager to buy high yield muni bonds. High yield bond funds have received plenty of cash inflows since last year. “The high yield muni index is really compelling because of the 6%+ and 9%+ tax-equivalent yields,” an expert told Bloomberg. Large high yield bond issues such as $3 billion Brightline bonds recently in the primary market saw strong investor demand. Bond prices rose in secondary market trading, and risk premium or the spread over top-rated muni bonds narrowed. Billion-dollar plus high yield muni bond issues are rare in the muni market. Such bonds are highly sought for their higher visibility in the bond market.

Hospital M&A Spree “Generally Credit Positive” …Hospital mergers and acquisitions climbed to the highest since 2020. Of the 20 announced transactions, four were “mega mergers”. Academic health systems acted as the acquirer in six transactions this year. Last week, North Carolina’s Novant Health issued $1.9 billion tax-free muni bonds at a top yield of 4.68% to fund acquisitions. This week, California’s Adventis Health is set to issue ‘BBB+’-rated muni bonds to fund several acquisitions. Hospitals halted expansions during the pandemic. Large health systems find it lucrative to acquire to increase capacity. Cost pressures have lowered the margin of error for smaller hospitals. New construction costs have risen 40% since the pandemic and land is rarely available. Hospital sector muni bond sales have tripled from a year ago. Moody’s terms consolidation in the hospital sector as ‘generally credit positive.’

Unrated COFINA Bonds Prized…Puerto Rico’s unrated COFINA Bonds are highly valued in the municipal bond market. Sales tax collections cover COFINA bond annual debt service by 2.59x. It only takes four months of sales tax collections to cover annual debt service. The remainder is available for the Island’s general fund. An expert told Barron’s last week that if Puerto Rico wants to access the muni market, it could apply for a credit rating for these bonds, “and we think that will work out pretty well.”

Bellwether Yields Fall…U.S. Treasury yields fell to the lowest in three weeks. Bellwether 10- year U.S. Treasury yield fell 14 basis points. The two-year Treasury note’s yield fell as much as 20 basis points after peaking at 5.04% this week. Municipal bond yields fell five to eight basis points from a week ago. Fewer-than-expected job growth and higher unemployment in April suggest a downshift in labor markets. “Our restrictive stance of monetary policy has been putting downward pressure on economic activity,” Fed Chair Powell comments led bond markets to rally. U.S. state and local government bonds recorded the highest volume of daily trades as investors anticipate lower rates likely this year.

Rate Cut Odds Boosted…Bond markets assign three-in-four odds of a September rate cut. This is a notable increase from the 57% chance predicted just a week ago. “It’s unlikely that the next policy rate move will be a hike,” Fed Chair Powell said that the Fed would leave rates at current levels for “as long as needed” if inflation proved more stubborn. He also said the Fed would be prepared to cut rates if the economy slowed sharply. The Fed has held rates at a 23- year high since last July. Powell dialed back rate hike fears at the Fed’s meeting last week.

Bondholders Seek Additional PREPA Hearing… “Important and probative” new evidence that Puerto Rico’s electric utility (‘PREPA’) could generate more revenue in coming years than estimated in the debt plan has surfaced. Revised electric demand forecasts have been presented by LUMA Energy, the private operator of electric transmission and distribution, to the Puerto Rico Energy Board. The new forecast increases revenues available to pay bondholders to $4.1 billion from $2.6 billion. Bondholders are asking the Title III court to “reopen the record” of the confirmation hearing and to “grant a supplemental hearing on the evidence on the PREPA’s greater revenue potential.” Confirmation hearings on the debt plan ended on March 18, and Judge Swain’s ruling is pending. The U.S. Court of Appeals is also yet to rule on the revenue lien. Bondholders claim that PREPA would be able to pay 58% more bond debt based on LUMA Energy’s latest forecast. “Omitting the revised load forecasts from evidence would result in the court potentially issuing a ruling based on an outdated and incomplete record,” bondholders wrote to the Title III court that the evidence provide shows that PREPA can afford to pay its creditors more than is proposed under the plan.”

Warren Buffett Expects Tax Hikes…Federal taxes are likely to rise, veteran investor Warren Buffett opined last week. “With present fiscal policies, I think that something has to give,” Buffett added that “higher taxes are quite likely.” Tax cuts of the 2017 Tax Cuts and Jobs Act are set to expire in 2025. U.S. fiscal deficit has grown sharply in recent years. Based on which party wins the White House and Congress next year, changes to the tax code are imminent.

Bond Insurance Grows…Municipal bond insurance grew 24.4% in the first quarter of the 2024 year-over-year. The growth reflects a surge in overall muni bond issuance. Assured Guaranty has a 53% market share of bond insurance written this year, followed by Build America Mutual at 47%. Assured benefits from “institutional investor demand for Assured Guaranty’s insurance on larger transactions. “It was a very successful start to the year,” BAM noted that its insured par amount has surged 44.4% year-over-year, faster than the pace of the overall market.

Compare 30-Year taxable U.S. Treasury yield 4.64% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.98%; “AA” 4.05%; “A” 4.34%. 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 86% of comparable taxable U.S. Treasuries.