Week of 10/21/2019

California Earns Second Bond Upgrade… Teachers Contract Crucial For Chicago Public Schools Ratings… U.S. Supreme Court Hearing On Puerto Rico Oversight… IMF Lowers Growth Forecast… NY, CA Munis Sought Amid High Demand… Attractive Muni Bond Prices…

California Earns Second Bond Upgrade…For the second time in the last three months, California won a credit rating upgrade. Moody’s upgraded California’s General Obligation bonds to ‘Aa2’ from ‘Aa3’ last week, following Fitch’s August upgrade to “AA’ from ‘AA-’. “California’s budget reserves and liquidity have never been stronger,” a Moody’s analyst noted. Efforts by state legislature and Governor Gavin Newsom to grow CA rainy day fund, pay down pension liabilities and “eliminate the state’s wall of debt” helped shape Moody’s decision. Growth in revenue, economic expansion and a continued disciplined approach to the state’s use of its funds supports the higher rating. California no longer has the fastest growing economy in the country, as it did a few years ago. Moody’s still expects growth to continue in the Golden State, albeit at a more moderate pace. Continued fiscal prudence “will make the state more resilient and ensure that we are better prepared to deal with whatever the global economy has in store for the future” CA State Treasurer noted. On the rating upgrade, Governor Newsom said, “California is showing that it is possible to take bold action to tackle the affordability crisis, climate change, and other challenges all while living within our means.”

Teachers Contract Crucial For Chicago Public Schools Ratings…Teacher strikes last week do not carry immediate credit impact, however, Moody’s stated that the outcome of contract talks will be crucial to credit quality. 40% of Chicago Public Schools (CPS) expenses are salaries. Staffing and salary increases sought by the union could be substantially more than fiscal 2020 budget contingencies of $330 million. CPS has a narrow surplus of $365 million in its general fund which is about 5% of general fund revenue. Union demands for more salary, staff and affordable housing comes at a price tag of $2.5 billion. Financially, CPS is better positioned now than in 2012 when the last contract was struck. Additional state aid and property tax hikes have helped CPS cut a $1 billion deficit and build reserves. Last month, CPS won two ratings upgrades: ‘BB’ from ‘BB-’ from Fitch ratings, with a stable outlook, and to ‘BB-’ from ‘B+’ from S&P, with a positive outlook. A Fitch analyst stated, “If the final resolution causes the district to materially deplete its reserves or leaves it with an unsustainable cost structure, credit quality could be affected.” Over the weekend, CPS offered a new counter-proposal for staffing but it is still not acceptable to the union, there are other issues are outstanding. The outcome of the talks could impact CPS financial trajectory. The path depends on the final price tag.

U.S. Supreme Court Hearing On Puerto Rico Oversight…In an 80-minute hearing, U.S. Supreme Court justices reviewed the constitutionality of the Oversight Board’s appointment. Chief Justice John Roberts and Supreme Court judges reflected on whether the role of the Congress-appointed Oversight Board was territorial or federal. Supreme Court questions on the complexity of overturning board appointments appeared to suggest that the President Obama’s appointments to the Oversight Board could survive General Obligation bondholder challenge. In February 2019, the First Circuit sought Senate confirmation for the Oversight Board deeming its appointment unconstitutional without overturning board actions. The Oversight Board’s plan for restructuring General Obligation bonds filed in court September 27 faces opposition. Court-ordered mediation on General Obligation bonds ends on November 30. The Supreme Court ruling on constitutional challenge is expected by early 2020.

IMF Lowers Growth Forecast…A Switzerland-sized void in the global economy is attributable to the U.S.- China trade war, IMF opined that economic uncertainty has trimmed global output by 0.8% or $700 billion this year and possibly next. Global economic growth ebbed to the lowest this year since the 2009 Great Recession. The IMF lowered its 2019 global growth forecast to 3.0% from 3.2% and its 2020 forecast to 3.4% from 3.5%. World’s three largest economies, U.S., China and Japan are likely to slow further in 2020. Cracks in U.S. domestic consumption showed up with September retail sales unexpect decline for the first time in seven months. Based on business sentiment, the Fed views the U.S. economy as growing at a ‘slight to moderate pace’ through October and lowered growth expectations for the next six to twelve months. While the Fed debates on insuring the U.S. economy against growing risks, bond investors assign higher chances that a third rate cut this year could arrive on October 30.

NY, CA Munis Sought Amid High Demand…New York and California muni issuers were center stage as investors poured cash into municipal bonds for the 41st week in a row. Investor demand for long term, New York State Thruway Authority $1.7 billion junior bonds rated ‘A2/A-’ junior bonds including Assured Guaranty insured bonds saw top yields ranging from 3.3% to 3.4% for longest dated debt and 3% for Assured Guaranty insured bonds for 34 years. California’s largest taxable competitive bond offering saw a surge of investor interest. $1.1 billion taxable California General Obligation bonds fetched low yields in competitive bidding by a dozen banks driving down interest costs for the Golden State. “While many factors impact the pricing of the state’s bonds, we believe that the rating upgrades were a positive factor in achieving two bids with true interest costs less than 2.40%,” CA State Treasurer’s Office reported.

Attractive Muni Bond Prices…Healthcare and Hospital bonds will be front and center this week. A broad range of over 30 muni bond issues including a dozen taxable bond issues are expected this week. This includes ‘AA’ and ‘A’ credit hospital systems offering taxable bonds, Miami-Dade County, Florida water and sewer system bonds and Pennsylvania transportation bonds. Investors are likely to find value in muni bond prices when looking at comparable bonds. Tax-exempt muni yields offer 93% of comparable U.S. Treasury taxable yield.

Compare 30-Year taxable U.S. Treasury yield 2.28% to 30-Year tax-exempt muni bond yield “AAA” 2.12%; “AA” 2.38%; “A” 2.53%; “BBB” 3.12%. For investors in the 35% tax-bracket, a 2.9% tax-exempt yield is equivalent to a 4.8% taxable yield. Top rated tax-free bonds yield 93% of comparable taxable U.S. Treasuries.