Municipal Bond News 7/15/24

Muni Bonds Hit A Sweet Spot…Lower Inflation Fuels Muni Bond Rally…Assured Guaranty Combines Two U.S. Financial Guaranty Insurers…Chicago Public School Budget Plan… Judge Swain Orders Mediation…Illinois Finances Stronger… IRS Hauls $1 Billion From Tax Evaders…

Muni Bonds Hit A Sweet Spot… “That’s a whole lot of yield for not a lot of risk,” Barron’s wrote this weekend “These days, the tax-equivalent yields for many muni bonds across the maturity spectrum are pushing 6%. That’s better than investors can do not only in equivalent Treasury bonds, but in corporates and money-market funds as well.” Years of government stimulus have helped improve state and local finances, making all munis less risky. “Like chocolate and peanut butter, a dovish Fed and narrower credit spreads are two great tastes that go great together in high-quality municipal bonds, where investors in the highest tax brackets can earn impressive income without sweating credit risk,” Barron’s said. Regardless of which party wins the 2024 elections, it might not be easy to keep tax rates static amid soaring deficits. If the Trump-era tax cuts are not extended by the end of 2025, Americans would see a $1.8 trillion tax increase on January 1, 2026. “Higher federal taxes would make muni bonds more attractive than they already are.” An expected turn towards lower policy rates, the potential for higher federal taxes, and strong credit quality of states and local governments boost the case for municipal bonds.

Lower Inflation Fuels Muni Bond Rally…Long term muni bond yields dropped about 7 basis points last week. The decline in bond yields comes as consumer prices fell in June, the first month of disinflation, and unemployment rose to the highest since 2021. Welcome news of lower inflation and softer labor markets was termed a “game changer for munis” by a leading financial publication. “The latest data show that labor-market conditions have now cooled considerably from where they were two years ago,” Fed Chair Jerome Powell said on Capitol Hill last week. Bond markets assign near-certain odds of a September rate cut. Although the Fed has penciled in one 25 basis point rate cut this year, bond markets are anticipating two rate cuts in 2024.

Assured Guaranty Combines Two U.S. Financial Guaranty Insurers… Assured Guaranty Municipal Corp. (‘AGM’) will merge into Assured Guaranty Inc., (‘AG’, known as Assured Guaranty Corp. until May 2024), expected to be effective August 1, 2024. The two companies have identical credit ratings. “By aggregating AGM and AG into a single insurance company, the merger enlarges the pool of capital available to support each insurance policy and results in a further diversification of the insured portfolio’s credit profile,” Assured Guaranty said. Moody’s, S&P and Fitch have said that the combined unit’s financial strength will be unchanged post-merger. Moody’s stated that it believes the merger “results in a moderate strengthening of the combined entity’s credit profile relative to the current overall credit profiles of AGM and AG.”

Chicago Public School Proposes Budget Amid Teacher Contract Talks…Chicago Public School (‘CPS’) unveiled a $9.9 billion budget proposal for Fiscal 25 amid talks on a new contract for teachers. The budget aims to close a $500 million dollar budget deficit, which is higher than 400 million forecast earlier due to rising healthcare costs. For the past four years, CPS has benefited from $2.8 billion in federal COVID aid. It plans to spend the remaining $233 million in the upcoming fiscal year. Much of the spending growth relative to prior year is due to higher capital investment. Cuts to central office operations, debt restructuring and federal grants are part of the budget. CPS anticipates the budget will be amended to reflect added personnel costs after it reaches contract deals with the teacher’s union and a recently formed principals union, as done in the past. Public hearings on the spending plan are upcoming.

Judge Swain Orders Mediation…PREPA bond parties must continue mediation talks for 60 days, during which time litigation will be stayed, Judge Swain ordered at last week’s court hearing. Mediation talks have been not fruitful so far. “I must tell you the mediation team does not see a prospect for meaningful, serious negotiations between the parties,” Chief Mediator Judge Shelley Chapman said. If substantial progress is not reported within 60 days, Judge Swain will consider restarting the bankruptcy’s litigation on various legal and possibly evidentiary issues. Judge Swain also said that without a consensual plan of adjustment she may consider dismissing the bankruptcy and leaving it to “multi-front litigation outside of this forum … in which every interest, including Puerto Rico’s, fends for itself.” The board’s valuation and data are unlikely to hold up in the face of the First Circuit’s ruling that favors bondholders, Judge Swain opined. She added that bondholders are being “expansively aggressive in their attack” on PREPA’s debt plan.

Illinois Finances Stronger…Illinois’ reserves and liquidity grew substantially in Fiscal 2024. The lowest-rated U.S. state’s general revenue fund balance rose 55% to $1.7 billion/June-24 from $1.1 billion a year ago, a level the state hadn’t seen since 1999. Illinois has paid its bills on time and in full for the last three years. That starkly contrasts to 2017 when Illinois faced a $16.7 billion backlog of unpaid bills. By 2025, Illinois rainy day fund is expected to grow to $2.3 billion, up from $1.9 billion. Moody’s has a positive outlook on Illinois general obligation bonds, while S&P and Fitch carry a stable outlook on Illinois general obligation bonds rated Moody’s ‘A3’ S&P ‘A-’ Fitch ‘A-’. The state pension systems remain underfunded. A new law permits pre-payment of the required monthly state contribution to pensions, which could bring more flexibility for investing pension assets.

IRS Hauls $1 Billion From Tax Evaders…The IRS has collected more than $1 billion since last Fall from millionaire’s who were delinquent on income taxes. The IRS focused on 600 individuals with incomes of more than $1 million per year who each owed more than $250,000 in federal taxes. Concurrent with higher enforcement on million dollar plus incomes, the IRS has recently shifted its target to those making more than $400,000. In particular, those who failed to file federal income tax returns since 2017 could be prone to higher scrutiny. The IRS said, “The collection results achieved in less than a year reveal the magnitude of what can be achieved over the long run as our Inflation Reduction Act enforcement continues to ramp up in the months ahead.”

Compare 30-Year taxable U.S. Treasury yield 4.46% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.74% “AA” 3.99%; “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 83% of comparable taxable U.S.  Treasuries.