Week of 11/25/2019

Taxable Muni Growth Spurs Bank Buying Binge… Atlantic City Wins Rating Upgrade & Positive Outlook… High Yield Revenue, GO Chicago Bonds Upcoming… Record High CT Budget Reserves… U.S. States Collect More, Spend More… U.S. Airports’ Debt Service Coverage Soars Higher… COFINA Sales & Use Tax Transfers In Good Shape…

Taxable Muni Growth Spurs Bank Buying Binge…Given low fixed-income yields, bank have found an interesting niche in taxable muni bonds, which have outperformed with a 12% index return this year. Major U.S. banks bought $1 billion of state and local government bonds in the recent quarter. Banks’ appetite for muni bonds has grown after taxable bond issuance reached a decade high. U.S. banks are the third largest buyers of muni bonds, following mutual funds; individuals or retail are the largest buyers of muni bonds. For 46 straight weeks, mutual funds have added record amounts of cash to muni bonds; banks’ muni bond buying spree will boost the demand for muni bonds. Surging issuance of taxable bonds could continue. Low interest rates allow states and local governments to refinance prior debt without worrying about tax status of the new bonds. With taxable bonds, states and local governments can tap into a broader investor market, including foreigners fleeing negative yields and U.S. pension funds seeking diversification. The growing popularity of taxable muni bonds could take a toll on the supply of tax-free bonds. When taxable Build America bond supply increased in 2010, the prices of tax-free muni bonds shot up due to the shift in supply. Resurgent taxable bond supply bodes well for muni bond returns and highlights the attractiveness of the $3.8 trillion muni market, second in safety only to U.S. Treasuries.

Atlantic City Wins Rating Upgrade & Positive Outlook…S&P raised its credit ratings two notches to ‘BB-’ from ‘B’ on Atlantic City General Obligation debt. Improved operating and financial picture comes after outstanding tax appeals and payables were settled. Liquidity concerns have eased, and consecutive current fund surpluses have been achieved. State oversight continues, and the city continues to implement state recommendations for improving its economic, budgetary and pension challenges. Liquidity covers debt service two times, which is adequate. Atlantic City’s reserve levels and liquidity could improve with likely stable finances. Political risk associated with payment of debt service, and structural reforms has diminished shaping a positive credit outlook.

High Yield Revenue, GO Chicago Bonds Upcoming…A new junior lien sales tax secured bond to be issued by Chicago will add to high yield investors’ interest in Chicago bonds. By early next year, the Windy City is all set to issue an interesting mix of high yield sales tax secured, General Obligation (GO) and taxable bonds in a much-awaited $1.5 billion bond sale. The new Chicago bonds will refinance prior debt to bring savings of $210 million to the City. With record low interest rates, states and cities have been issuing a combination of taxable and tax-exempt bonds to save interest costs. Investors demand higher yields from Chicago due to its pension burden. Chicago’s mayor is currently negotiating a contract with police and fire unions. High yield Chicago GO obligation taxable bonds are trading for 5.3%, or about 3.5 percentage points more than top rated debt, while tax-exempt debt with a 5.5% coupon due in 2035 is yielding about 2.50% to a 2025 call and a 4.21% to maturity.

Record High Connecticut Budget Reserves…Connecticut’s record high budget reserve of $2.5 billion is set to grow. In Fiscal 2021, rainy day funds could reach Connecticut’s statutory maximum of $3 billion barring a recession. Current reserves are equal to 13% of appropriation spending. Rainy day funds will cover Connecticut’s $30 million General Fund operating deficit expected in Fy20. Connecticut bonds have delivered a 7.3% index return this year.

U.S. States Collect More, Spend More…Higher spending in Fiscal 2019 is driven by strong gains in tax collections. U.S. state spending rose by 5.7 percent in Fiscal 2019, compared to 3.4 percent in Fiscal 2018. Supporting the higher spending, U.S. state tax collections grew in Fiscal 2019 and Fiscal 2018 respectively, following two years of slow growth in Fiscal 2016 and Fiscal 2017. Spending from federal funds to states also rose in Fiscal 2019, partly due to recent federal budget agreements. Spending from states’ own funds increased at the highest annual growth rate since the last recession. In Fiscal 2020, state spending is expected to slow as states promote structural balance and strengthen reserve funds. U.S. states collectively spent $2.1 trillion in Fiscal 2019 per National Association of State Budget. States’ debt service spending $53 billion in Fiscal 2019 is a modest 3.7% of state funds.

U.S. Airports’ Debt Service Coverage Soars Higher…Higher revenues and stable airline costs have taken U.S. airports’ debt service coverage to new heights. More enplanements in Fy18 compared to a year ago came as airline seats became more affordable. Ultra-low-cost and low-cost airlines have grown and more discretionary spending on travel is backed by U.S. economic growth. Lower jet fuel costs have driven airfares lower. Fees from Uber, Lyft have replaced airport parking revenues. U.S. airports’ median leverage and debt to net revenue has declined, per Moody’s. Along with record high net revenue debt service coverage ratio of 1.69x, 659 days cash on hand has hit a new peak per Moody’s FY18 medians. In 2019, strong enplanements will continue to boost debt service coverage ratio.

COFINA Sales & Use Tax Transfers In Good Order…The first post-restructuring transfer of COFINA owned sales and use tax went smoothly. COFINA received sales and use tax of $437 million for Fy20 which is COFINA’s property per the February 2019 restructuring. The same has been transferred to the bond trustee for bondholders. As mandated, systems set up for clear, quick and automatic transfer of COFINA owned sales and use tax to the bond trustee are working in good order. COFINA Executive Director said, “COFINA’s independent Board of Directors and its management are pleased that this milestone was achieved, as it evidences COFINA’s successful restructuring and the reestablishment of its access to the capital markets.”

Compare 30-Year taxable U.S. Treasury yield 2.21% to 30-Year tax-exempt muni bond yield “AAA” 2.16%; “AA” 2.40%; “A” 2.62%; “BBB” 3.01%. For investors in the 35% tax-bracket, a 3.01% tax-exempt yield is equivalent to a 4.6% taxable yield. Top rated tax-free bonds yield 98% of comparable taxable U.S. Treasuries.