Week of 11/04/2019

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High Yield Long Term Tax-Free Bonds Rally… Third Federal Rate Cut Amid Slow Growth Low Inflation… State and Local Gov’t Credit Remains Strong… Chicago Teacher Strike Ends… Chicago Park District Eyes Pension Reform… PREPA Debt Plan Court Hearing in January… California Tobacco Bonds Oversubscribed…

High Yield Long Term Tax-Free Bonds Rally…Speculative grade or non-rated tax-free bonds maturing long term have delivered 11.5% index returns this year surpassing overall muni market 6.9% index return. Surging investor demand for higher risk muni bonds has driven down yields on the riskiest tax-free bonds down to about 4%, the lowest since at least 2003. Investors demand about 2.2% additional yield or spread to own high yield muni bonds relative to top-rated taxfree bonds. Fewer high yield tax-free bonds are available for retail buyers. An increasing number of high yield muni bonds are restricted for institutions only. With large mutual funds being dominant buyers of non-rated muni bonds, retail investors seeking higher tax-free yield benefit from the expertise of a Municipal Bond Specialist to select suitable high yield bonds and understand risks. Over $18 billion of cash has flowed to high yield bonds this year, amid a surge of $72 billion inflows to tax-free bonds. In October, muni bond issuance rose 48% from prior month to $53 billion; $16 billion new muni bonds are expected to be issued next month per Bloomberg. A low inflation outlook favors long term bonds’ tax-free fixed income stream. In the 43rd straight week of cash inflows to muni bonds, investors favored long term muni bonds which received $1.34 billion or 84% of the new investments. Yields on top-rated long term muni bonds fell sharply after the Fed cut short term rates by a quarter-percentage point for the third time this year and signaled it won’t consider raising them until inflation picks up.

Third Federal Rate Cut Amid Slow Growth Low Inflation…It came as no surprise that the Fed lowered the benchmark federal-funds target rate by 25 basis points for the third time in a year. U.S. inflation remained soft in September. The Federal Reserve’s preferred inflation gauge, the personal-consumption expenditures price index, fell to its weakest monthly reading since January. From a year ago, the inflation index was up 1.33%, well below the Fed’s 2% target. The U.S. economy expanded during the third quarter at a 1.9% annual rate down from 3.5% growth rate a year ago.

State and Local Gov’t Credit Remains Strong…Despite some indications of slowness in the national economy, credit quality of states and local government remains on a solid footing. States and locals are poised to end 2019 on track. 2020 revenue projections for U.S. states and local government appear strong. A sign of improving credit quality, ratings upgrades of state and local government bond issuers outpaced downgrades in the second quarter of 2019. The trend has continued for eight quarters in a row. California, Texas and New York led in upgrades, with school districts accounting for the bulk of local government upgrades. The municipal-debt market remains one of the world’s safest, with only 0.16% of those rated by Moody’s Investors Service defaulting between 2009 and 2018, compared with 6% of corporate bonds.

Chicago Teacher Strike Ends…Chicago teachers’ longest strike since 1987 is over. The union has reached a tentative agreement with Chicago Public Schools, The Chicago Teachers Union (CTU) House of Delegates voted to approve the deal on Oct. 30. Union members still need to ratify the contract. The new five-year contract includes a 16 % pay raise for teachers over five years, a 40% raise for lower-paid workers, and a social worker and nurse will be in every school by 2023. Mayor Lori Lightfoot promised to focus on affordable housing, but not as part of contract negotiations with teachers. The compromise included an extra $30 million in spending on education and five days have been added to the school year to make up for 11 strike days. The exact price of the deal is unknown. Some sources estimate the deal to cost about $500 million, while others put a $1.5 billion price tag. Mayor Lightfoot said that fiscal limits had been carefully weighed throughout weeks of negotiation adding “We were very, very conscious of making sure that we only agreed to things on an individualized basis but also in the aggregate that were sustainable and financially responsible, and that’s part of the reason we weren’t able to reach an agreement any sooner.”

Chicago Park District Eyes Pension Reform…A new plan to raise Chicago Park District’s pension contributions is in the works. Higher contributions to pensions could come from debt service savings, a moderate property tax increase and user fee hikes. A 2014 plan that lowered pension benefits was voided by the court. A multi-year contribution ramp-up could bring Chicago Park District pensions to be at actuarial funding from current 32% funding. The District which has $800 million muni bonds outstanding is working to get full union support before presenting legislation. A new labor contract struck last month raised salaries and hiked employee healthcare contributions. The labor contract, estimated to cost $14 million, averted a strike. Chicago Parks’ bonds carry a split rating with a junk or speculative grade rating from Moody’s and ‘AA+’ from S&P and ‘AA-’ from Fitch.

PREPA Debt Plan Court Hearing in January…January will bring two significant court hearings on Puerto Rico debt. The Title III Court has postponed the hearing on PREPA’s debt restructuring to January 14, 2020 from December 11, 2019. The U.S. Supreme Court will hear arguments on the constitutionality of the Oversight Board appointment in January. PREPA’s debt plan or RSA has the support of at least 89% of bondholders. PREPA’s debt plan faces opposition from the utility’s fuel lenders, pensioners and unions. Puerto Rico’s legislature is said to be under pressure to reject the pact. The Island’s industry groups and some members of U.S. Congress have spoken against the debt plan. Meanwhile, concerns over unchecked and undisclosed professional fees are building as consultants and lawyers have racked up $530 million in fees during the Island’s Title III process.

California Tobacco Bonds Oversubscribed…Robust demand for a California Tobacco bond new issue saw lower bond yields allowing for more than anticipated new bonds to be issued this week. Higher yielding bonds from high-tax states are actively sought by a broad group of investors including retail, separately managed accounts and insurance companies. The FDA on Oct. 4 warned the public to stop using vaping products fueling expectations that restrictions on e-cigarettes could boost shipments of traditional cigarettes. Tobacco bonds have returned 8.6% this year.

Compare 30-Year taxable U.S. Treasury yield 2.23% to 30-Year tax-exempt muni bond yield “AAA” 2.13%; “AA” 2.38%; “A” 2.55%; “BBB” 2.99%. For investors in the 35% tax-bracket, a 3.1% tax-exempt yield is equivalent to a 4.6% taxable yield. Top rated taxfree bonds yield 96% of comparable taxable U.S. Treasuries.