Week of 04/26/2021

Biden Tax Plan Builds Investment Case For Tax-Free Bonds… Infrastructure at Forefront… Bond Insurance Soars Amid COVID-19… PREPA Privatization Challenged… Puerto Rico Gains Higher Access to Federal Funds… Puerto Rico General Obligation Debt Restructuring by Year-end… Muni Rally Underway…

Biden Tax Plan Builds Investment Case For Tax-Free Municipal Bonds…Tax-shelter offered by the $3.9 trillion municipal bond market will be prized much more as High Net Worths face a doubling of the capital gains tax. President Biden’s “American Families Act” seeks a top capital gains tax rate of 43.4% for million dollar incomes, up from 23.8% today. Biden seeks to tax capital gains for taxpayers earning more than $1 million at the top personal income tax rate, which he wants to raise to 39.6% from 37%. Add the 3.8% ObamaCare tax on investment and 43.8% tax is the federal tax rate for million dollar incomes. Adding 13.3% in California and 11.85% in New York (plus 3.88% in New York City), which also tax capital gains as regular income, top earners in high tax states are headed into the 60% rate range. All of this would add up to the highest rate on capital gains since before the Steiger capital gains tax cut of 1978. For the first time, some Americans’ capital gains could be taxed at a higher rate than ordinary income, instead of favored treatment on capital gains as it has been during most of U.S. tax history. Corporate tax hikes were in the “American Jobs Plan” rolled out last month. Biden also wants to cut estate tax exemptions and eliminate the step-up basis on capital gains that accrues on death. Biden’s tax proposal is an opening salvo for negotiations and Democrats’ efforts to tax capital the same as labor could also seek to tax dividends at the same rate as ordinary income. No doubt, the demand for tax-free municipal bonds is set to soar. Finding tax-free bonds has been harder as states and locals’ taxable bond issuances surged. In 2020, close to 40% of municipal bonds issued by high tax California were taxable bonds causing short supply of tax-exempt bonds. It is not surprising that the average over-subscription of new municipal bond issuances rose to 6.5 times in March from 4.6 times in the prior month. Secondary municipal bond trading shows that New York and California tax-free bonds are clearly benefiting from the higher taxes their wealthy residents will soon face. Some short California and New York credits were trading at “AAA” levels. Tax-shelter is more compelling than ever as an investment strategy.

Infrastructure at Forefront…The $2 trillion American Jobs Plan has sparked a couple of different infrastructure bills to resurface. A more traditional infrastructure bill in the range of $600 billion to $800 billion is sought by Republican senators. Some are touting the America’s Transportation Infrastructure Act, unanimously approved by the Senate Environment and Public Works Committee in 2019, which would have authorized $287 billion for surface transportation. Transportation Secretary Pete Buttigieg’s Move America Forward Act which would provide authorization for $226 billion in tax-exempt private activity bonds and establish a federal infrastructure tax credit to encourage public private partnerships is also gaining attention. A bipartisan group of lawmakers wants American Infrastructure Bonds, similar to federally subsidized Build America Bonds, to help states and locals fund infrastructure projects. Biden’s American Jobs Plan falls short of the $2.6 trillion 10-year funding needed to maintain America’s core infrastructure estimated by the US Army Corps of Engineers. The White House will listen to all proposals, Press Secretary Jen Psaki said, “But in terms of the ideas being put forward, we’re quite open to a range of mechanisms for agreed upon legislation moving forward,” Psaki said that the nitty-gritty of the plan is being worked out in congressional committees.

Bond Insurance Soars Amid COVID-19… The volume of newly insured municipal bonds has doubled from a year ago. Close to 8% of new issue municipal bonds are insured, the highest since 2009. Assured Guaranty’s market share has climbed as its primary market insured par in the Q1-2021 was two-and-a-half times prior year volume. “This comparison partly reflects the market disruption caused by pandemic concerns in the first quarter of 2020, but in what may be a more meaningful comparison, our first-quarter production is also 37% higher than in the fourth quarter of 2020.” Second in market share, Build America Mutual CEO echoed, “This was BAM’s strongest first quarter on record and it showed that the increased investor demand for insured bonds that started following the spread of the pandemic last Spring is continuing.”

PREPA Privatization Challenged… A union is seeking to upend PREPA’s privatization. In June 2020, former Governor Wanda Vasquez announced a deal for LUMA Energy to take over PREPA’s transmission and distribution system. Since then, LUMA and PREPA have been laying the groundwork for the actual take over. Both Puerto Rico’s Energy Bureau and the Puerto Rico Court of Appeals rejected a separate challenge to the takeover in 2020. The Oversight Board supports electric utility privatization and Governor Pierluisi has suggested amending the contract with LUMA. “I am in favor of the energy transformation and of Puerto Rico having a resilient and reliable electrical system and at the same time we have to safeguard the labor rights of our public servants and make sure that the energy service improves and its cost is fair and reasonable for all.”

Puerto Rico Gains Higher Access to Federal Funds… HUD unlocked Puerto Rico’s access to $8.2 billion federal funds granted by Congress in 2018. President Biden has eliminated restrictions requiring incremental grant obligations, a federal financial monitor to supervise the aid and additional oversight from the Island’s federally imposed Financial Oversight Board. The actions come as the Biden administration is easing Trump-era restrictions on the Island’s access to federal aid. Under Trump, HUD had previously approved a total of $20 billion for the Island’s reconstruction, a historic amount. But the agency stalled the release of the aid in 2019 and imposed additional restrictions and requirements last year. Puerto Rico Governor Pedro Pierluisi applauded Island officials “who have demonstrated their dedication to responsibly manage all these funds” adding, “Without a doubt, this is great news for Puerto Rico.”

Puerto Rico General Obligation Debt Restructuring by Year-end… Puerto Rico’s central government debt restructuring could be complete by year-end. Puerto Rico is expected to post a cumulative budget surplus of $15.2 billion through 2035 as $123.5 billion of federal disaster funds and coronavirus relief money helps boost the local economy per the Commonwealth’s latest fiscal plan. The multi-year proposal serves as a framework for Puerto Rico’s yearly operating budgets. The Oversight Board is seeking a confirmation hearing on its debt restructuring deal on or about Oct. 18.

Muni Rally Underway… The second quarter rally in municipal bond rates appears to be well underway; per Bank of America Merrill Lynch wrote, “As we stated before, low ratios should prevail for much of the year and any blip should present a good opportunity on relative values.” Last week several U.S. states issued new bonds at favorable yields and spreads. Connecticut’s $1 billion bonds fetched a 10-year yield of 1.21%, or 30 basis points over top rated benchmarks versus a May 2020 new issue that came with a 2.17% yield with a 120-basis point yield gap. New Jersey general obligation bonds priced at 1.69% yield, compared to a 2.08% yield for November bond issue. $1 billion New York payroll mobility tax bonds for MTA bridges and tunnels were many times oversubscribed and yields were as much as 17 basis points lower than anticipated. California forward delivery general obligation bonds were re-priced to lower yields while Washington State and Rhode Island sold competitively. The tax-free municipal bond market offers a diverse new issue calendar and a tax-shelter investment opportunity.

Compare 30-Year taxable U.S. Treasury yield 2.26% to 30-Year tax-exempt muni bond yield “AAA” 1.61%; “AA” 1.76%; “A” 1.99%; “BBB” 2.96%. For investors in the 35% tax-bracket, a 3% tax-exempt yield is equivalent to a 4.6% taxable yield. Top rated tax-free bonds yield 71% of comparable taxable U.S. Treasuries.

Information obtained from sources deemed reliable; GMS does not purport Review/Preview contains all available information.