Week of 10/11/20201

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Yield Volatility Unlocks Value… Fewer High Yield Muni Bonds… Weak Hiring Clouds Outlook… Airports Modernize Amid Travel Recovery… PREPA Operations Probed… Federal Board Urges Island Lawmakers…

Yield Volatility Unlocks Value… Municipal bond yields are the highest in six months. “This is something everybody was looking for,” an institutional investor told Bloomberg, while another portfolio manager added “There’s a ton of cash on the sidelines” that will likely pounce on the higher tax-free yields. The breakout in tax-free yields is fueled by market bets about rate hikes next year. Ten-year muni yields are up about 4 basis points in the past week, compared to 14 basis points for similar dated taxable Treasury bonds. The yield movement is a spark to secondary market trading, which went into a lull over the summer. Investors have bought tax-free bonds for 30 straight weeks, though the pace of inflows dropped recently. Driven by a Treasuries led selloff, high yield muni bond funds saw outflows in the past two weeks, after investors had been piling cash into higher yielding bonds. “We saw outflows mainly due to the rate volatility and an uncertain outlook,” a Barclays strategist clarified. The amount of cash flowing back to investors from principal and interest repayments hits a seasonal low in the Fall. With Washington set on tax hikes, higher tax-free yields could prove to be opportune for investors. Many see the selloff as an opportunity to buy tax-free bonds and unlock value in municipal bonds.

Fewer High Yield Muni Bonds... Supply of higher yielding tax-free bonds retreated this year after hitting decade highs last year. This year, $80 billion new high yield muni bonds have been issued, compared to $126 billion in 2020. Many lower rated issuers such as hospitals and schools found attractive rates and more flexibility in the taxable bond market. Project-based high yield issuers have issued more bonds in 2021. Local multifamily housing agencies have issued over $5 billion of new tax-free bonds this year surpassing highs hit in 2020. Charter school issuance also hit a record high and the retirement sector is borrowing at a pace above pre-pandemic levels. Unrated and lower rated issues carry higher risks and yields. For example, a tax-increment district consisting of a Connecticut waterfront community sold $50 million unrated long term bonds last week that fetched a top yield of 3.75% tax-free. In contrast, high grade housing bonds backed by a Colorado town’s tax appropriation were issued at a top yield of 2.6%. Narrow revenue or tax pledges, cost-sensitive development and project marketability are common risks of higher yielding project-specific municipal bonds. The riskiest munis have benefited from a reopening economy, federal stimulus and demand for junk offerings amid near record low yields. Outpacing negative returns on taxable corporate bonds, high yield municipal bonds show index returns of 6.21% year-to-date.

Weak Hiring Clouds Outlook… U.S. jobs growth fell to the slowest pace this year. The economy created 194,000 jobs in September, far below the 479,000 predicted by economists. Dismal jobs in September show the smallest gain since December 2020. Many workers gave up a job search and exited the labor force last month. Slower hiring amid a smaller labor pool caused the unemployment rate to fall to 4.8% in September from 5.2% prior. Latest economic data led Moody’s to lower its estimate of third-quarter GDP growth to 2.6% annualized rate from 3.9% prior. Missed jobs numbers, a worrying indicator of the spread of the Delta variant, come at a time when most enhanced benefits for COVID-19 related unemployment have already lapsed. Investors are watching out for the Fed’s stance on weak hiring.

Airports Modernize Amid Travel Recovery… U.S. airports have seen 32 million travelers pass through security in September, compared to 42 million pre-COVID. A year ago, airports security checkpoints saw under 14 million passengers per TSA data. As passengers gradually return, many airports are zealously taking on capital upgrades. Dallas Fort Worth International Airport is renovating terminals and expanding gate capacity as part of its $5.4 billion capital plan. Pittsburgh airport is set to modernize with a new $1.4 billion terminal financed by tax-exempt bonds sold in August. Atlanta Airport sold $360 million high grade bonds last month, as did Los Angeles airport which sold about $1 billion bonds at recently. With airlines seeing a recovery in leisure travelers, the return of lucrative business travelers appears more distant amid another wave of COVID-19 infections. Substantial federal aid was allocated to airports and airlines reeling under sharp COVID-19 related drop in air travel. Some airports may see 100% recovery to pre-COVID levels by 2024 and growth thereafter. S&P Municipal bond airport index has returned 4.7% over the last year. Airports are busy advancing capital plans amid steady recovery from COVID-19 fallouts.

PREPA Operations Probed… “Many of your answers were incomplete. You refused to answer others,” U.S. House Natural Resources Committee questioned Luma Energy and PREPA officials at a hearing last week. Luma Energy has landed in controversy. Puerto Rico’s House of Representatives sued Luma, and the Island’s Supreme Court has ordered it to turn over data, which Luma contends is confidential. Last week, the sole electric utility’s governing board called for a state of emergency at PREPA to speed up contracts and equipment purchases. Poorly maintained capital ravaged by hurricanes, retirement of experienced employees, and an obsolete generation system has been blamed for a spike in power outages. Luma Energy took over charge of PREPA’s transmission and distribution system in June 2021. FEMA allocated $9.4 billion to restore PREPA, but the funds have not been disbursed so far. House Natural Resources Committee intends to investigate the current condition of the power grid, the transition to renewable energy and the contract with Luma Energy. Since the middle of 2017 PREPA has been in bankruptcy. In 2019, PREPA gained the support of over 90% of its bondholders for a debt pact. That pact continues to exist amid opposition from fuel lenders, retirees and an unsolved lien challenge posed by the Island administration in PREPA’s Title III court proceeding. Resolution of PREPA’s Title III bankruptcy is not expected until next year. Meanwhile, new leaders at the helm of PREPA’s board follow forced resignations of the utility board president and executive director. “It is essential that we make changes that allow us to advance the transformation that our people need,” Governor Pierluisi added that the PREPA’s transformation and reconstruction is at the highest priority.

Federal Board Urges Island Lawmakers… “We are almost there. Let’s get to the finish line with the legislation necessary to restructure the debt so we can go into confirmation hearings in November with all of the necessary pieces in place to lift the burden of bankruptcy from the people of Puerto Rico.” Puerto Rico Oversight Board’s Chairman David Skeel urged. After years of tough negotiations, a diverse group of creditors including retirees, unions, bondholders and bond insurers and others agreed to a Plan of Adjustment to reduce the Island’s central government debt load. Puerto Rico’s House and Senate have each passed versions of the debt restructuring bill. While both are contingent on keeping public pensions intact, the Senate version also earmarks additional funds for municipalities and the University of Puerto Rico, some of which the federal board opposes. The bills will have to be reconciled before they can go to the governor’s desk. Puerto Rico’s lawmakers, the Oversight Board and Governor Pedro Pierluisi are expected to meet October 16 to discuss the legislation that provides a path for the Island’s Title III bankruptcy to end.

Compare 30-Year taxable U.S. Treasury yield 2.16% to 30-Year tax-exempt muni bond yield “AAA” 1.74%; “AA” 2.03%; “A” 2.29%; “BBB” 2.41%. For investors in the 35% tax-bracket, a 2.4% tax-exempt yield is equivalent to a 3.7% taxable yield. Top rated tax-free bonds yield 81% of comparable taxable U.S. Treasuries.