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Week of 03/15/2021
Landmark America Rescue Plan
Credit Positive For Municipal Bonds…
Credit positive for the municipal bond sector, the $1.9 trillion America Rescue Plan was enacted into law on March 11, 2021. The third wave of federal aid brings substantial direct aid to states, local governments and other municipal bond sectors. Direct federal aid will help offset government revenue gaps caused by the COVID health crisis, stabilize government budgets and avoid spending cuts. Direct aid and economic stimulus measures boost near-term revenues for states and locals, transit systems, schools, colleges and hospitals and help bridge near-term fiscal gaps. COVID-19 hit bond sectors such as transit, airlines, higher education bore the brunt of ratings downgrades. The credit quality for any government will be impacted by the entity’s plans for using its federal aid allocation and level of fiscal stress.
States are slated to receive $195 billion of direct aid which equates to 16% of states’ own source revenue. California’s federal aid allocation, $26 billion, is the highest amongst U.S. states. Lowest rated U.S. states, Illinois and New Jersey will receive $7.5 billion and $6.4 billion respectively. Tourism dependent Hawaii will receive more than a fifth of its operating revenue from the federal aid. New York State which saw its rating cut as the pandemic raged, could receive significant federal aid as much as 18% of operating revenue. The new aid is substantial, ranging between 10% and nearly 30% of some states’ Fiscal 2020 operating revenue.
State revenues are set to trend higher. Illinois’ revenue is expected to be 8% and 5% higher in Fiscal 2021 and Fiscal 2022 than prior year, after dipping 3% in Fiscal 2020 per Moody’s. Echoing the trend, California is likely to see 19% revenue growth in Fiscal 2021, 5% growth in Fiscal 2022 reversing a 12% dip in Fiscal 2020 compared to prior year. Illinois’ federal aid will chip away at its legacy bill backlog and pay off its COVID-19 related borrowing from the Federal Reserve. New Jersey plans to use its federal aid to make a full pension contribution, a year ahead of schedule.
Dire COVID-19 related predictions did not come true. State and locals governments’ tax revenue losses are much lower than predicted last Spring. Most states are awash in revenue outperformance brought by prior rounds of federal Covid-19 relief aid. Puerto Rico’s sales and use tax revenue is 32% higher than estimated for the first half of Fiscal 2021. New York and California are outperforming expectations with projected surpluses in Fiscal 2021. The trend of revenue outperformance is echoed in Illinois and New Jersey. New Jersey, which issued $4 billion in deficit financing COVID emergency bonds, has plenty of unused emergency bond proceeds. Only two municipal bond issuers, Illinois and New York’s Metropolitan Transportation Authority, tapped the Federal Reserve’s backstop lending program set up post-COVID for states and local governments.
Local governments will receive $130 billion of direct aid to replace revenue lost to COVID-19 and cover related expenses. Home prices raged higher during the pandemic, anchoring strong property tax collections for local governments. Property taxes on commercial property including office, hotel, retail and multifamily housing are witnessing declines and could recover slowly. Direct stimulus payments to individual and extended unemployment benefits will support local government tax revenue growth. Lower rental income from urban apartments and offices is likely to pressure property values. New York City could recover $6 billion from the new federal aid, while California cities and counties stand to receive $16 billion direct federal aid.
The federal aid will bolster airlines’ liquidity at a time when signs of improving travel demand are emerging. During the pandemic, air travel passenger volume saw an unprecedented decline of 95%. Current air travel volume is near 60% while break even thresholds are about 80%. Pre-pandemic travel could rebound by 2024. U.S. airlines could burn cash through much of 2021 if not into 2022 but liquidity balances and remaining funding sources should be sufficient until traffic rebounds. Nearly all U.S. airports maintained pre-pandemic ratings. Most airports still have strong fee setting flexibility and liquidity but parking and car rental revenue face pressures. On the heels of significant CARES Act funding, $10 billion to airports and $25 billion to airlines and December 2020 federal aid, $2 billion to airports and $15 billion for airline payrolls, America Rescue Plan brings additional federal support of $8 billion for airports and $14 billion for airlines.
“This funding is crucial as we work to bring back ridership and recover from the pandemic. Critically, it will also further offset COVID’s impact and help protect against devastating service cuts and layoffs in the years ahead where we still face deficits,” stated MTA Chairman. Despite two aid packages passed last year that delivered an estimated $8 billion to the MTA, leadership discussed service cuts between 40-50% across the board and in February approved a toll increase on bridges and tunnels of 7%. Mass transit agencies will receive $30 billion of federal aid from the America Rescue Plan to offset decline in ridership and operating revenue. Metropolitan Transportation Authority (MTA) will receive $6 billion in federal funding from the third round of federal aid. The transportation sector, which accounted for more than a quarter of post-COVID ratings downgrades, has received multiple rounds of federal aid.
Hard hit by COVID-19, colleges and universities will receive $40 billion in direct aid from the latest federal package. CARES Act allocated $30 billion to schools and colleges and another $82 billion came from December federal Covid relief package. Generous federal aid from all three Covid relief packages buoyed credit trends for public schools facing higher remote learning and COVID-19 costs.
Positive for hospitals, expanded public health insurance coverage is part of the America Rescue Plan. Generous tax credits favoring more people to obtain or maintain health insurance, made possible by America Rescue Plan, have reversed the Trump administration’s curbs on public health insurance. Fewer uninsured puts a lid on uncompensated care provided by safety net hospitals and boosts reimbursements. Rural health care hospitals will receive $8.5 billion to reimburse healthcare related expenses and COVID-19 related lost revenue. Skilled nursing facilities, where the crisis traces its beginnings in the U.S., will receive $200 million for COVID-19 infection control.
In the wake of the America Rescue Plan, positive credit ratings actions for states and local government debt have begun. Last week, Moody’s upgraded Chicago Public Schools’ credit rating to “Ba3” from “B1”. The nation’s third largest school district is set to receive $1.8 billion in funding from the America Rescue Act, on the heels of more than $1 billion federal aid awarded since the pandemic began. S&P lifted its outlook on Illinois general obligation bonds to stable from negative. Moody’s upgraded its outlook on the U.S. states and local government sector to stable from negative. COVID- 19 cost three U.S. states ratings downgrades. Detroit’s strong financial management and proactive pandemic management led Moody’s to maintain a positive outlook despite the pandemic and last month S&P changed its outlook to stable on Motor city debt.
Compared to prior COVID relief federal aid, governments have more latitude in the use of America Rescue Plan aid funds. America Rescue Plan aid can be used to cover costs or replace revenue lost due to the pandemic, and use of funds would not be subject to an expiration date. Federal aid will continue to be available to states as needed through 2024. Timely federal aid from the $2.2 trillion the Coronavirus Aid, Relief and Economic Security Act (CARES Act) enacted a year ago, and $910 billion Coronavirus Response and Relief Supplemental Appropriations Act helped governments cope with COVID-19 emergency care costs. The $350 billion in direct aid to states and locals more than doubles the $150 billion in COVID-19 relief aid provided in the $2.2 trillion CARES Act.
Since the global financial sell-off of March 2020, municipal bond benchmarks have returned over 13% and high yield muni bond index returns are 26%. Recent new issues from high yield municipal bond issuers have been heavily oversubscribed. Detroit’s junk rated new bonds were twenty times oversubscribed. Strong investor demand for higher tax-free yields brought narrower credit spreads for lower rated new municipal bond issues. Last month, Chicago Public Schools issued new bonds which offered investors 117 basis points of extra yield relative to top rated municipal bonds, down from a 560 basis point peak yield penalty five years ago. At present, returns on municipal bonds are outperforming Treasury and corporate bonds. Last Spring, when the earliest round of Covid-19 federal aid was announced, municipal bond returns lagged treasury and corporate bond returns because direct aid to states and local governments was missing. Year-long efforts by lawmakers nationwide paid off, as sizeable direct aid for municipal issuers, more discretion in use of funds and extended funding timeframe has arrived with the America Rescue Plan. Muni bonds have posted significant gains since the March 2020 worldwide financial meltdown and generous federal aid from the America Rescue Plan carries a powerful tailwind for the $3.9 trillion municipal bond market.
Compare 30-Year taxable U.S. Treasury yield 2.38% to 30-Year tax-exempt muni bond yield “AAA” 1.72%; “AA” 1.91%; “A” 2.19%; “BBB” 3.14%. For investors in the 35% tax-bracket, a 3% tax-exempt yield is equivalent to a 4.62% taxable yield. Top rated tax-free bonds yield 72% of comparable taxable U.S. Treasuries.
Information obtained from sources deemed reliable; GMS does not purport Review/Preview contains all available information.