Municipal Bond News 7/3/23

Muni Bonds Most Popular for Retail Buyers, Barron’s… Municipal Bonds Outperform… “Two or More Rate Hikes,” Powell Says…Bondholders to Appeal PREPA Court Ruling…California Budget Pact Boosts Reserves… Illinois Pension Risks…Illinois’ Record High Reserves… Federal Approval for MTA Congestion Pricing…

Muni Bonds Most Popular for Retail Buyer, Barron’s… “The combination of tax-free income and relative safety has made munis the most popular investment for retail buyers,” Barron’s wrote this weekend, “Long-term munis look better. Their yields roughly equal equivalent Treasuries, meaning a big after-tax yield advantage.” Tax-free state and local government bonds with double-A ratings yield close to 4% tax-free, as do other high-quality long-term munis from essential- service entities. That is equivalent to a 6.15% taxable yield. Municipal bonds currently offer about 60% higher long-term yield relative to comparable U.S. Treasury bonds.

Municipal Bonds Outperform…In June, tax-free municipal bonds’ 1% gain outperformed losses for taxable U.S. Treasury and corporate bonds. Municipal bonds’ June outperformance relative to comparable U.S. Treasuries is the highest in two years. Scarce issuance of new municipal bonds and a surge in tax-free reinvestment demand led to the outperformance. This year, states and local governments have issued 15% fewer municipal bonds. Steep rate hikes, along with liquidity from unused federal aid and record high reserves has led to fewer muni bond sales in the primary market. Most Wall Street firms have slashed their forecasts for 2023 muni bond supply. Tight supply compared to demand is favorable for municipal bond returns. A portfolio manager told Bloomberg, “Munis are in good standing to outperform Treasuries through the second half of the year.”

“Two or More Rate Hikes,” Powell Says…“A strong majority of committee participants expect that it will be appropriate to raise interest rates two or more times by the end of the year,” Powell said last week at Madrid. Stating that the outlook is “particularly uncertain,” the Fed Chair clarified that the “Fed’s commitment isn’t to a particular number of rate hikes”, and “the timing and extent of any further rate increases will depend on the course of the economy.” The U.S. economy grew at an annual pace of 2% in the first quarter, well above the 1.3% pace reported earlier. Faced with higher odds of additional rate hikes in July and September, bellwether U.S. Treasury bond yields surged to the highest in three months. However, municipal bond yields remained relatively steady, buoyed by high investor demand.

Bondholders To Appeal PREPA Court Ruling…A bondholder group, which includes BlackRock, Nuveen, Franklin, GoldenTree and Invesco, plan to appeal Judge Swain’s recent ruling that limits Puerto Rico electric utility (‘PREPA’) bondholder claim to $2.38 billion. That is well below what PREPA earlier said it expected to pay bondholders. A December 2022 debt plan filed in the Title III Court envisioned PREPA could pay $5.8 billion to bondholders. On June 23, 2023, the oversight board certified a Fiscal 24 fiscal plan, which foresees “substantially lower” electric demand and “substantially higher” costs in coming years. The guiding principle for all debt restructurings is sustainability,” said Board Chairman David Skeel. “The Oversight Board has been analyzing carefully and dispassionately how much debt PREPA can pay and made that determination strictly based on the most recent available data.” When PREPA entered Title III bankruptcy in 2017, it owed $8.3 billion to bondholders. Judge Swain has called off a planned July 17 confirmation hearing. The board plans to file its third amended debt plan by July 14, and Judge Swain has delayed debt plan court hearings to November or later. Judge Swain has rejected bondholders’ request for her to certify their appeal of the Title III court decision that substantially lowers bondholder recovery. While bondholders could continue their appeal, without Judge Swain’s certification it carries a lower probability of being taken up by the First Circuit Court of Appeals. Bondholders are asking for a lift in the stay on litigation in the bankruptcy, which could allow bondholders to appoint a receiver to control PREPA’s finances.

California Budget Pact Boosts Reserves, Cuts Spending…Lawmakers have agreed upon a $311 billion Fiscal 24 budget deal that covers a $32 billion shortfall without dipping into reserves. California began Fiscal 23 which ended on June 30, with a $100 billion surplus. However, Golden State revenue has slowed this year amid high inflation, volatile investment performance and a downturn in the technology sector. Unlike the boom years, when lawmakers expanded government spending this year’s budget forced difficult trade-offs. Lawmakers cut about $8 billion in spending and delayed some expenses. Notably, the budget carries a $5 billion state funding boost to public transit. The plan aims to borrow $6.1 billion and would set aside $37.8 billion in reserves. Governor Newsom said, “In the face of continued global economic uncertainty, this budget increases our fiscal discipline by growing our budget reserves to a record $38 billion, while preserving historic investments in public education, health care, climate and public safety.”

Illinois Pension Risks…A pension stabilization fund has helped Illinois make supplemental pension contributions in Fiscal 22, Fiscal 23 and budget Fiscal 24. “However, contributions are still short of an amount we consider indicates funding progress,” S&P noted recently. To cut pension administration costs, Illinois is pushing to consolidate hundreds of small police and fire pension funds and pool assets. So far, the vast majority of police pension funds are on board with pooling pension assets, but a dozen or so are asking the state supreme court to overturn a four-year-old law requiring smaller pension funds to pool assets, arguing it is unconstitutional as it erodes benefits. Illinois’ unfunded liability hovers near $140 billion while Chicago owes nearly $34 billion. State of Illinois and city of Chicago are seeking solutions to improve pension funding.

Illinois’ Record High Reserves…Illinois has built up its rainy-day fund to a record high of almost $2 billion. The state plans to boost reserves in Fiscal 24 which began on July 1. Illinois’ rainy-day fund was set up in 2001, grew to about $276 million by 2014, and was near depleted by 2019. Political discord over state budgets between 2015 and 2017 weighed on state reserves, and led to multiple ratings downgrades. With its reserve close to 4% of state spending, Illinois rainy day fund lags U.S. states. On average, U.S. states’ reserve levels are about 11% of spending.

Federal Approval for MTA Congestion Pricing…MTA’s congestion pricing tolling plan has received approval from the Federal Highway Administration last week. Motorists will pay a hefty toll for driving in the central business district, determined by a six-member traffic board. Congestion pricing could cut Manhattan traffic by 20%, a win for public transit. MTA stands to gain $1 billion in new revenue from congestion pricing, the first in the United States. Los Angeles is also looking for congestion pricing.

Compare 30-Year taxable U.S. Treasury yield 3.86% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.56% “AA” 3.88%; “A” 4.16%. 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.