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Municipal Bond News 6/5/23
Municipal Bonds Rally…Rate Hike Odds…State HFA Multifamily Bonds Strong…Tobacco Muni Bonds Hit Hard…Colleges Face Challenges…Chicago Seeks Pension Fix…Federal Debt Deal Spares State and Local Aid… Fewer Municipal Bonds…
Municipal Bonds Rally…A day after the U.S. House and Senate approved a bipartisan federal debt pact, tax-free bond yields fell. The accord ends a weeks- long standoff that brought volatility in financial markets. State and local government bond yields fell about 10 to 15 basis points, echoing a rally in comparable United States Treasury bonds. June is a large coupon repayment month for bondholders. High reinvestment demand boosts municipal bond prices. This year, mutual fund investors have sold almost $8 billion of municipal bonds, significantly lower than last year. Investors pulled out four times as much in the first five months of 2022, driven by steep policy rate hikes. Meanwhile, wealthy investors have purchased municipal bonds to lock in high tax-free income. The Federal Reserve has slowed the pace of rate hikes. Volatile market conditions present an opportunity for wealthy long-term investors to add to tax-free bond portfolios.
Rate Hike Odds…One-in-three odds of a 25-basis point rate hike at the Fed’s June meeting and 70% odds of a similar rate hike in July come from a mixed jobs report. In May, wage growth slowed to a 4.3% annual pace. Unemployment rose to 3.7%, higher than expected. However, May’s job growth came in well above consensus estimates. Amid a resilient U.S. economy, signs of labor market weakening make the case for central bankers to take more time to assess the evolving outlook before raising rates again. Some central bankers including Governor Philip Jefferson, nominated to be Fed Vice Chair, said last week skipping an increase would give policymakers time to assess data but not preclude future tightening.
State HFA Multifamily Bonds Strong…Extraordinary demand for affordable housing nationwide has boosted the prospects of state housing finance agency (‘HFA’) multifamily bonds. About 50% of HFA loans for multifamily projects receive federal subsidies, such as Section 8 housing assistance payments. Typically, rental housing projects are well positioned to withstand rising expenses and benefit from generally strong asset-to-debt ratios. Operating performance is stable. State HFA multifamily bond programs will continue to deliver strong financial and loan portfolio results sectorwide despite high inflation, Moody’s said. As construction costs for affordable rental housing rise, the pipeline of new projects may slow in 2024. The volume of outstanding multifamily housing bonds likely will continue to drop, a boost to bond prices.
Tobacco Muni Bonds Hit Hard…High-yield tobacco bonds performed the worst among municipal bond sectors last month. Tobacco bond prices declined 2.9% in May, while high-yield muni bonds were down about 1% last month. Investors have pulled out $550 billion from high-yield municipal bond funds in the last quarter. Higher recession odds have weighed on high yield muni bond prices. Tobacco bonds trade frequently, making them prone to market volatility. Cigarette shipment volumes declined 9.7% last year, the largest drop on record. Many tobacco bond issues were restructured in recent years to reflect lower smoking trends. Longer maturities of tobacco bonds relative to most other muni bond sectors leads to larger price moves when rates rise. Ohio Buckeye Tobacco 5% coupon tax-free bonds currently offer tax- free yields close to 5.5%.
Colleges Face Challenges…Lower-rated private colleges face a complex operating environment. With federal COVID-19 aid of $76 billion set to expire, the higher education sectors’ finances face a downtrend. College revenues face the threat of tuition cuts in a recessionary environment. High school graduation rates are declining, as is college attendance. Amid enrollment pressures, inflation and high interest rates have driven up costs. From a decade ago, the number of distressed colleges and universities is up 70% per a Bain report. Investment returns tumbled with an 8% loss in Fiscal 22, from an average gain of 30% a year earlier. Endowments still boosted overall college spending per a study by the National Association of College and Business Officers. Endowments help colleges navigate fiscal challenges.
Chicago Seeks Pension Fix…New tax revenue, pension obligation bonds, and asset consolidation are among funding solutions sought to shore up Chicago pensions. The city’s four public pension funds carry low funded ratios ranging between 21% to 46%, and its $33.7 billion pension liability is a financial burden. To find sustainable funding sources, new city administration has launched a working group that includes state lawmakers, city finance team and labor representatives. Previous state and local attempts to reform pensions were overturned by the Illinois Supreme Court. State Constitution bars impairing benefits. Over the last decade, higher property taxes, phone and water surcharges helped. Revenues from the city’s first casino will go towards pensions. Budget surpluses from 2022 and 2023 are slated for supplemental pension funding. The new working group will look not just at the current budget, but the city’s long-term financial picture, and all constitutional options will be on the table.
Federal Debt Deal Spares State and Local Aid…Unused funds from $350 billion America Rescue Plan, the largest direct federal aid to states and local governments, will not be rescinded under a federal debt ceiling pact. Since the U.S. Treasury already sent out state and local fiscal recovery funds, those funds are considered obligated for federal budgeting purposes, even if they are yet to be spent by the recipient. States and local governments are required to obligate pandemic funds by the end of 2024 and to spend the money by the end of 2026. A National League of Cities clarified, “Local leaders do not have to rush to obligate funds. Any state and local fiscal recovery funds, even if they have not been spent, are safe.”
Fewer Municipal Bonds…In May, 29% fewer municipal bonds were issued compared to a year ago. A few planned muni bond offerings were canceled to avoid volatile market conditions. Uncertainty on federal debt ceiling talks and future rate hikes amid concerns about tighter credit conditions heightened market volatility, leading borrowers to wait for better borrowing conditions. States and local governments can still bank on unused federal aid. High liquidity allows muni bond issuers to defer new borrowing. A trend of fewer primary market muni bond issuances has taken hold.
Compare 30-Year taxable U.S. Treasury yield 3.92% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.59% “AA” 3.89%; “A” 4.19%. 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 92% of comparable taxable U.S. Treasuries.