Municipal Bond News 7/1/24

Investors Must Avoid ‘Cash Trap’…Muni Credit Spreads Narrow…Cooler Inflation Boosts Rate Cut Odds…New Jersey’s Fiscal 25 Budget…PREPA Debt Hearing Could Re-Open…Charter School Finances Gain…Stadium Muni Bonds Grow…

Investors Must Avoid ‘Cash Trap’… Investors should beware of falling into a “cash trap” as the Fed approached lower policy rates. With the potential for a federal reserve interest rate cut this year, long-term municipal bond prices are expected to rise. There is over $6 trillion invested in money market funds at present. Many investors are looking to sell money market investments after the first fed funds rate cut. Some may regret not getting out of cash sooner. Individual investors tend to linger in cash-like instruments much longer than is profitable, known as a ‘cash trap.’ Institutional investors tend to buy longer- dated bonds earlier in the rate-cutting cycle, while individual investors tend to do so a year to 18 months after the rate-cutting cycle begins. By not being as quick to reallocate portfolios towards longer-dated tax-free investments, individual investors often miss out. Falling yields could bring potential muni bond price appreciation, which is not achievable with taxable cash. Today’s muni bond market offers a robust calendar of tax-free offerings from state and local governments offering historically high tax-free yields.

Muni Credit Spreads Narrow…The extra yield investors demand to hold riskier muni bonds instead of top-rated issuers has sunk to the lowest in at least a decade. The yield penalty or credit spread has steadily declined this year. High yield muni bonds currently offer about 180 basis points of extra yield relative to top-rated tax-free bonds, down from 260 basis points at the start of the year. Investors in the highest tax bracket would have to earn more than 9% on a federally taxable bond to match the yield on a Bloomberg high yield index. That is higher than about 8% corporate junk bond index yield. High-yield muni bonds have significantly lower historical default rates and less volatility than their corporate counterparts. High yield muni bond indices have returned 4.15% so far this year. Some of the best returns in the U.S. bond market have been found in riskier muni bonds sold by hospitals, affordable housing developers and charter schools.

Cooler Inflation Boosts Rate Cut Odds…May 2024 inflation measures hit the lowest level in over three years. Headline prices remained unchanged in May and are 2.6% higher than a year ago. U.S. economic growth slowed in the first half of 2024, after above-trend growth last year. The Atlanta Fed’s GDPNow forecast now pegs second-quarter growth at 2.7%, a downward adjustment from the 3% penciled earlier. With mortgage rates near 7%, recent contracts for previously owned homes slumped to the lowest level in records back to 2001. Fed officials are hoping the moderation in economic activity will put a further damper on inflation. “The economy is slowing faster than most economists expect and faster than what the Fed expected,” an expert told Bloomberg that the Fed is at risk of keeping rates “too high for too long.” Bond markets anticipate the first rate cut in September.

New Jersey’s Fiscal 25 Budget…New Jersey enacted a $56.7 billion spending plan for Fiscal 25, which begins today, the largest in history. For the fourth straight year, New Jersey will fully pay the state contribution of over $7 billion to its pension fund. Continuing the State’s focus on lowering debt, the budget utilizes the Debt Defeasance and Prevention Fund to pay for $200 million of capital expenditures. Schools are poised to get the highest level of state funding in history. A 40% increase in state school funding will help lower property taxes. New revenue of $800 million annually comes from a corporate tax hike that sunsets in 2029. The corporate tax hike will create a dedicated funding stream, the Corporate Transit Fee, to fund New Jersey Transit. The $56.7 billion spending plan is an increase of about $728 million over the governor’s proposal from earlier this year and $2.3 billion more than the fiscal year 2024 budget. Revenue projections indicate that the state will earn about $54.5 billion in the new fiscal year, meaning the budget functions at a deficit of $2.1 billion. The budget utilizes $2 billion from its surplus account, leaving a $6.1 billion surplus.

PREPA Debt Hearing Could Re-Open…On July 10, Judge Swain will hold a status conference to discuss next steps on Puerto Rico electric utility’s debt plan in light of the Appeals court ruling on PREPA’s revenue lien. Bondholders that hold 49% of PREPA bonds, including Assured Guaranty, Syncora Guarantee, GoldenTree Asset Management, Invesco Advisers Inc. and MacKay Shields LLC, extended a cooperation agreement to oppose the bankrupt utility’s current debt plan. Mediation talks regarding alterations the current debt plan are ongoing. Meanwhile, Puerto Rico’s oversight board has three new members and two re-appointments. Additionally, the board is poised to have a new chairman.

Charter School Finances Gain…Charter school enrollment grew at the fastest pace in a decade. State funding to charter schools rose in 2023. Majority of S&P-rated charter schools saw revenue growth and higher margins. Vast majority of charter schools are rated ‘BBB-’or lower. Charter schools in Colorado, Florida, New Jersey, Texas, and Utah have relatively stronger credit quality, whereas Michigan and Minneapolis charter schools have the lowest median ratings, S&P noted. Charter schools face risks inherent to the sector such as charter contract renewal, state budget appropriations and rising costs. Larger school networks remain generally better-positioned to weather changes in funding landscapes and enrollment. Amid growing demand and sound finances, the charter school sector’s credit quality is stable. Stadium Muni Bonds Grow…The issuance of muni bonds to finance new sports stadiums has risen. Last week, Charlotte, NC approved a $650 million tourism tax bonds for upgrading the Bank of America stadium for NFL’s Carolina Panthers. State of Kansas lawmakers have proposed new sales tax and revenue muni bonds to build a new stadium for Kansas City Chiefs, who are currently located in neighboring Missouri. Earlier this year, the Tennessee Titans broke ground on a new football stadium financed by tax-free bonds issued last year. On Tuesday, the city of Jacksonville, FL, approved a $1.25 billion stadium renovation plan for the NFL’s Jaguars. Sales of muni bonds for sports facilities tripled to $1.8 billion last year, the most since 2006. With the Chicago Bears and the soon-to-be Las Vegas Athletics also in talks to build new stadiums, investors can hope to see an array of stadium-related tax-free bond offerings. Last month, Spartanburg, SC sold $64 million muni bonds for a Texas Rangers affiliate, Hub City Spartanburgers. The Moody’s ‘A1’rated long term bonds yield 5.7% currently.

Compare 30-Year taxable U.S. Treasury yield 4.57% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.79%; “AA” 4.07%; “A” 4.29%. 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.