Municipal Bond News 8/28/23

Treasury Rout Lures Muni Buyers…PREPA Pact… Powell Commits to Fight Inflation…Fewer Insured Muni Bonds…Muni Bond Supply Declines…Top Muni Bond Issuers…Sports Betting Grows…

Treasury Rout Lures Muni Buyers…The summer selloff in the U.S. Treasury market is providing an opportunity to invest in muni bonds for higher tax-free income investments. In August, muni bond yields surged to 2023 highs. Long- term top-rated muni benchmarks currently yield around 3.93%, about 70 basis points higher than this year’s low hit in April. August long-term muni yields are about 30 to 40 basis points higher than a month ago. Higher muni bond yields follow a surge in comparable U.S. Treasury yield. In August, the 30- year Treasury yield hit its highest level since 2011 at 4.37% before declining to 4.26% last week. 10-year U.S. Treasury yield touched 4.32%, before declining to 4.23% by the close of the week. Sensitive to policy rate outlook, the two- year U.S. Treasury yield surged to 5.07% last week, the highest since 2008. Central bankers are unified that policy rates will stay higher for longer to prevent a resilient economy from reigniting inflation. Some investors reckon that yields may be near highs in the current interest rate cycle. Since March 2022, eleven fed-funds rate hikes have brought volatile market conditions. It is hard to know, when, and by how much, restrictive policy rates will trigger a slowdown. Amid volatility, investors are betting if rewards from a bond rally could be larger than any hit from additional rate hikes.

PREPA Pact…Puerto Rico’s electric utility (‘PREPA’) reached an agreement with 43% of creditors. The oversight board offers 12.5% of original par to BlackRock Financial Management, Nuveen Asset Management, Franklin Advisers, Whitebox Advisors, and Taconic Capital Advisors who have agreed to support a third amended debt plan and not file an appeal of the plan of adjustment should the Title III Court approve it. Hold-outs, which include Assured Guaranty, Syncora Guaranty, and GoldenTree Asset Management, would receive recovery of about 3.5% of the original claim. National Guaranty stands to get new bonds equal to 19.3% of their original par. The new plan keeps in-tact a December 2022 settlement pact with uninsured bondholders, that offered 50% of par plus contingent value securities to settling bondholders. Holders of only $75 million of PREPA bonds opted for the December 2022 offer. Non-settling bondholders have the option to join the 12.5% deal for the time being, the board said. The restructured bonds would carry an average interest rate of 7%, paid by a flat connection fee and a volumetric charge on customer bills, subject to Puerto Rico Energy Bureau approval. Two contingent value instruments (‘CVI’) are slated for bondholders that support the latest plan. Hold-outs are not eligible for the CVIs. CVI payouts are linked to electric demand and fuel generation cost savings. Assured Guaranty intends to file an appeal in the First Circuit Court of Appeals if the latest debt pact is court approved. Assured stated that it remains “committed to negotiating a fair and reasonable settlement, but creditors’ rights must be respected, and this process brought to a fair and just conclusion.” If the latest debt pact is court approved, Assured intends to file an appeal in the First Circuit Court of Appeals. The oversight board plans to file a new Disclosure Statement for the latest plan which seeks to cut PREPA’s debt burden from $10 billion to $2.5 billion.

Powell Commits to Fight Inflation…At Jackson Hole last week, Fed Chair Powell committed to bringing down inflation to its 2% target. Powell noted that headline inflation has declined from a year ago. However, “there is substantial further ground to cover to get back to price stability’ as core inflation, which excludes volatile food and energy, is still elevated. To get inflation down to 2% target, a period of below-trend economic growth, a softer labor market and tight monetary conditions may be required. Given resilience of the U.S. economy, additional evidence of above-trend growth could warrant further tightening of monetary policy. Focused on the evolving outlook and risks, Powell said, “We are navigating by the stars under cloudy skies.”

Fewer Insured Muni Bonds…Echoing a trend of declining muni bond issuance in the primary market, the volume of newly issued insured municipal bonds has dropped. Roughly $15 billion insured muni bonds were issued in the first half of 2023, 12% lower than a year ago. Demand for bond insurance from both bond issuers and investors has grown. Reflecting higher demand for bond insurance, about 9% of new muni bonds carried bond insurance, up from 6% pre-pandemic. Assured Guaranty and Build America Mutual are the only bond insurers that write new bond insurance policies. Assured Guaranty’s market share grew to 63% from 56% a year ago. Build America Mutual stated it had “a solid first half of 2023, supported by strong demand for BAM’s guaranty from institutional municipal bond investors who were looking to maximize liquidity and manage rating volatility in their portfolios.”

Muni Bond Supply Declines…Primary market supply of muni bonds fell 17% in the first half of 2023 compared to a year ago. Tax-exempt bond issuance fell almost 11%, while taxable bond issuance plummeted 40%. General obligation bond volume was about the same as last year. The volume of bonds secured by pledged revenue streams declined 26%. Uncertainty on policy rates and economic conditions, as well as volatile market conditions contributed to the lower muni bond supply. This week, only $2.3 billion muni bonds are on the new issue calendar, about the lowest this year.

Top Muni Bond Issuers…Texas issued the most muni bonds in the first half of 2023, followed closely by California, New York and Illinois. Florida ranked fifth in new issue volume. Other top ten states in primary market bond volume are Georgia, Wisconsin, Massachusetts, New Jersey and Michigan. Sectors that saw higher new muni bond supply included environmental facilities and electric power. The healthcare sector and senior living facilities had fewer muni bond offerings this year, mostly due to operating margin pressures. Transportation bond issuance is also lower than a year ago.

Sports Betting Grows…2023 could be a stellar year for sports betting. U.S. sports betting revenue is 65% higher in the first half of 2023 compared to a year ago. Legalization of sports betting in Kansas, Massachusetts and Ohio has driven the growth. More than 30 states and Washington, D.C., have legalized sports wagering. In 2018, the U.S. Supreme Court allowed states to regulate sports betting. More than 30 states and Washington, D.C., have legalized sports wagering. Most states set taxes between 10% and 15%, and few such as New York, collect as much as 51% from sportsbooks. States and local governments have collected $3.6 billion of gaming taxes in the recent quarter, up almost 10% from a year ago.

Compare 30-Year taxable U.S. Treasury yield 4.27% to 30-Year tax-exempt Municipal Bond yield “AAA” 3.92%; “AA” 4.28%; %; “A” 4.53%. 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 91% of comparable taxable U.S. Treasuries.