Week of 1/24/2022

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Institutional Investors Favor Munis in 2022… PR Govt Debt Plan Wins Court Approval… California Budget Surplus… Connecticut Revenue Outperform… Illinois, New Jersey Pensions Boosted… MTA Wins Largest Transit Aid… Transportation Munis Credit Positive…

Institutional Investors Favor Munis in 2022… Investors favor long term and high yield municipal bond funds. Last week brought inflows for both long term and high yield municipal bond funds while short-term and intermediate term municipal bonds were shunned by investors triggering a net outflow after 45 consecutive weeks of cash inflows to municipal bonds. “In most cases muni fund outflow cycles were triggered by rate spikes, although the length of the current outflow cycle might be shorter compared with previous cases, in our view,” a Barclays strategist noted. “Treasuries are really in the driver’s seat,” a Vanguard Group strategist added, “While fundamentals are really good, we expect munis to move alongside Treasuries.” Wells Fargo analysts stated, “We expect broad demand for munis to continue, based on the anticipation for higher taxes, but also, rising rate cycles by the Fed have historically been positive for munis”. BlackRock analysts echoed, “While broader bond markets tend to struggle during periods of rising rates, munis have proven relatively resilient to interest rate increases” predicting that low single digit returns for investment grade munis and ‘notable contributions’ from the high yield sector in both income generation and outperformance. High yield muni bonds will outperform with positive returns and investment grade munis could see negative returns, CreditSights forecasts. In January, 10-year top rated municipal bond yields increased by 20 basis points, lower in relation to a 30 basis point yield increase for comparable U.S. Treasuries. The bulk of negative performance is expected in the first quarter, which would lend itself to ‘provide a more attractive entry point for stronger performance later in the year’. Volatility is a central theme in 2022. Positive momentum for municipal bonds is expected to continue in 2022. Investors look at the tax-exempt status of municipal bonds as a hedge against any future tax increases and believe municipal bonds can offer better protection from rising interest rates relative to other assets.

Puerto Rico Govt Debt Plan Wins Court Approval… Judge Swain approved Puerto Rico’s central government debt plan, ending a four-year bankruptcy proceeding. During this time, the Island saw three different governors. Its economy rebounded with massive federal aid and its finances are steered by a federally appointed Oversight Board appointed by former President Obama and President Trump. To do away with the board, Puerto Rico must balance budgets for four consecutive years and meet other requirements, such as obtaining access to the credit market at reasonable rates. “So at the very least, the board will be around for at least three more years,” board President David Skeel said. “It may be a bit longer than that.” Governor Pierluisi stated, “We still have a lot of work ahead of us.” The debt plan is likely to become effective before March 15, 2022, per Natalie A. Jaresko, the executive director of the Oversight Board who stated “This period of financial crisis is coming to an end.” The Title III Court approved the COFINA debt plan in 2019 and will take up restructuring the Island’s electric utility debt next.

California Budget Surplus… A $45 billion surplus and robust reserves of $34 billion are part of Governor Newsom’s Fiscal 2023 spending blueprint. Golden state’s surplus budget is driven by incredible growth in tax collections during the pandemic. California will halt a gas tax increase and invest over $9 billion in transportation improvements such as transit and rail projects, high speed rail and ports. More funds for schools are planned. California taxes the wealthy more than people with lower incomes to the point that, in 2019, the top 1% of earners paid nearly 45% of all the state’s income tax collections. Home to the fifth largest economy in the world, CA population declined for the first time in 2020. Newsom’s proposal now heads to the state Legislature, where a Democratic majority will ease passage of the spending plan.

Connecticut Revenue Outperform… “This is incredibly positive news,” Connecticut State Speaker said as higher sales and personal income taxes and a resurgent real estate market have erased Connecticut’s feared $854 million deficit for this fiscal year and turned it into a projected surplus. Five percent growth in sales and income tax-revenue hasn’t occurred in more than 10 years. A hot real estate market has helped turn a projected deficit into a modest $70 million surplus for the budget year that ends June 30. Connecticut is poised to collect over $1 billion more than anticipated in taxes over the next two years. The revenue uptick brings Connecticut finances closer to a structural balance. State officials have warned of ‘sizable’ projected deficits of more than a billion dollars in each of the next two fiscal years. Connecticut will make a supplemental pension contribution towards its $41 billion pension liability for the second straight year. Rainy day funds have grown and it received $2.8 billion from the America Rescue Plan. Connecticut ranks among high grade bond issuers with ratings upgrades earned last year. Its long term tax-free bonds fetch 45 basis points additional yield relative to top rated muni benchmarks.

Illinois, New Jersey Pensions Boosted… Near-term benchmarks that measure pension funding have improved with stellar investment returns. For the first time, New Jersey pension contributions will exceed a ‘tread water’ indicator in Fiscal 2022, meaning unfunded liabilities will not grow further in Fiscal 2022. Garden State’s landmark comes after accelerated pension contributions by the second lowest rated U.S. state, and stellar investment returns, 29% in Fiscal 2021. In Illinois, strong investment returns of 22% have boosted the asset/benefit coverage ratio to almost 8 years and its net pension liability fell 8% to $133 billion in Fiscal 2021. New Jersey pension assets could cover promised benefits for about 8 years by 2030 up from 6 years at present, as the Garden State moved to suspend cost of living adjustments to stem liability growth. While higher pension contributions are likely for both Illinois and New Jersey, investment returns are volatile by nature. If future investment returns drop sharply, pension funding gains could be at risk.

MTA Wins Largest Transit Aid… A $6.2 billion infusion to MTA marks the largest ever grant from the Federal Transit Agency. The latest federal funding comes after MTA received $4 billion under the April 2020 CARES Act and $4.1 billion from the Coronavirus Response and Relief Supplemental Appropriations Act of December 2020. The Infrastructure Investment and Jobs Act will provide another $10 billion to the MTA. “This $6 billion gives them deep, deep liquidity,” Senator Chuck Schumer (D) said. MTA had estimated that prior federal aid would last until 2025. MTA’s acting CEO affirmed that the latest federal aid would also continue its capital program, adding, “In the near term, it has allowed us to maintain a balanced budget.” Along with the federal windfall, higher state funding is planned for Fiscal 2023 is a liquidity boost.

Transportation Munis Credit Positive… The Department of Transportation and Federal Highway Administration is handing out $27 billion to states and territories to rebuild thousands of bridges over the next six years. Of this, $5.5 billion will be sent out in 2022. Illinois is in line to receive nearly $1.4 billion in federal funding over five years to help upgrade the state’s deteriorating bridges and New Jersey could receive as much as $1.14 billion. In Illinois, Governor J.B. Pritzker’s ‘Rebuild Illinois’ construction program, a six-year, $45 billion capital plan, is ongoing. The funding comes from the $1 trillion bipartisan infrastructure plan President Joe Biden signed into law in November 2021. The historic capital infusion is the largest federal funding since interstate highways were built. The funding boosts capital and collateral for transportation related municipal bonds.

Compare 30-Year taxable U.S. Treasury yield 2.04% to 30-Year tax-exempt muni bond yield “AAA” 1.77%; “AA” 2.01%; “A” 2.11%; “BBB” 2.80%. For investors in the 35% tax-bracket, a 2.8% tax-exempt yield is equivalent to a 4.3% taxable yield. Top rated tax-free bonds yield 87% of comparable taxable U.S. Treasuries