Week of 12/13/2021

Investors Seek High Yield Bonds… Chicago Bonds Oversubscribed… Illinois Pension Funding Boost… Migration, Home Price and Property Tax… Hospital Margins Shrink… SIFMA on 2022 Forecasts… Vanguard Predicts Sharp Supply Drop… Buy Long Term Munis, BoFA…

Investors Seek High Yield Bonds… Investors are willing to accept a lower yield premium for lower rated municipal bonds than a year ago. For “BBB” rated municipal bonds, the lowest tier of investment grade, the premium over top rated debt is near the lowest since 2007, at around 58 basis points, less than half the level of a year ago. Last week, Golden State Tobacco sold $4.2 billion “BBB+” rated bonds with long term taxable bonds issued at a 4.2% yield and tax-exempt capital appreciation bonds maturing in 2066 trading at a 3.5% yield spreads or about 215 basis points above top rated municipal benchmarks. Golden State bonds are trading at premium prices in the secondary market. Assured Guaranty insured California toll road bonds fetched taxable yields of 3.4% or about 195 basis points above U.S. Treasuries. Grand Canyon University sold speculative rated taxable bonds close to a 5% yield. Massive federal aid has boosted the credit prospects of riskier tax-free bond sectors. The debate on steep income tax levies amid low market yields has caused a record influx of cash to high yield muni bonds. “People are looking for yield and willing to go down the credit curve,” a municipal portfolio manager added “it helps that the lower rated credits are stronger than they used to be due to the extra cash they’re sitting on.” “BBB” rated muni bonds have earned 4.8% in 2021, while high yield municipal bonds have earned 7.5% index returns.

Chicago Bonds Oversubscribed… Orders worth double the Chicago bonds offered last week led to lower yield spreads. The extra yield investors seek for Chicago general obligation bonds is the lowest in a decade. Newly issued 10-year Chicago general obligation bonds rated “BBB+”/“BBB-” yield about 62 basis points above top rated muni benchmarks, compared to a 109 basis point yield penalty in 2020 and 169 basis point yield spread in 2019. The city’s sales tax secured subordinate bonds rated “AA-” yield about 3.1% taxable for 15 years or about 144 basis points more than similar dated U.S Treasury bonds while sales tax secured tax-free bonds fetched 1.78% tax-free for 13 years. Chicago increased its planned borrowing by about $1 billion taking advantage of a lower yield penalty. The $2.2 billion bond refinancing and exchange of tendered bonds will bring savings of $250 million to help balance the city budget. Bondholders tendered more bonds than anticipated by the city. Chicago CFO stressed that all maturities achieve savings and no debt is being extended out and the average life of the new bonds is shorter than the existing average life. The CFO noted, “Our buyers by and large want to hold onto” the city’s bonds so the exchange offered the opportunity to continue holding bonds with added duration from a longer call date in an “offering we were able to make that generated some benefit for us as well as investors.”

Illinois Pension Funding Boost… Stellar investment returns of more than 22% are way ahead of Illinois pension plans’ 6.5% to 7% target. The outperformance has cut Illinois’ unfunded pension liability to $130 billion, a 10% drop from a year ago. Illinois pensions’ aggregate funded ratio reached 46.5%, the highest since 2008. Even with the booming return on investment, the state still contributes roughly $2 billion a year less than the amount it is actuarially required to reach its eventual full funding. Illinois aims to reach a 90% funded ratio by 2045.

Migration, Home Price and Property Tax… Nationwide home prices have surged almost 20% since the onset of COVID-19. The gains have been uneven across various regions and the pandemic has hastened migration trends. The long standing net out-migration that increased with the pandemic shows no signs of abating in California and Illinois. New York loses residents at about a 50% clip more than pre-COVID-19. The flight to New Jersey and Connecticut has eased, while southern states such as Texas and Florida still see an influx of residents. Idaho, the fastest growing state in population, saw home price gains above 30%. Higher home prices do not always translate into government revenue. Property tax formulas, rate limits and appraisal practices vary across state and local governments. It could take up to two years to reflect home prices into property taxes. Property taxes are the single largest revenue source for local governments. Local governments in Hawaii, Connecticut and Florida are poised to see higher property taxes from the surge in home prices.

Hospital Margins Shrink… Higher labor costs from staffing shortages, and higher supply costs will dampen hospital margins in 2022. Many hospitals defer profitable procedures, not due to low bed capacity but staffing shortages. State provided temporary nursing staff, military and National Guard are coming to aid hospitals’ staffing shortages. Federal aid received in 2020 and 2021 to help offset COVID-19 related revenue losses is unlikely to continue in 2022. A trend of mergers and acquisitions, which has provided a lifeline to struggling hospitals while strengthening larger ones, is likely to continue.

SIFMA on 2022 Forecasts… Insights from economists surveyed by SIFMA, a capital markets trade association: 81% expect the long term U.S. GDP growth rate of 1.5-2%, with 53% state this is lower compared with pre-COVID estimates. 47% expect a resolution to the supply chain constraints by mid-2022. 67% of respondents believe current inflation pressures are transitory. 64% of respondents believe the recently passed $1 trillion infra package pose no risk to inflation. 80% see stagflation as a long term risk to the economy. 100% expect the proposed human infrastructure plan will be passed; all believe the final package will be $1-2 trillion. Roundtable economists remain divided on when the Fed will begin to lift its target range for the federal funds rate with 29% each responding 2Q22, 3Q22, and 4Q22.

Vanguard Predicts Sharp Supply Drop… 11% fewer new municipal bonds, about $400 billion, could be sold in 2022, per a Vanguard forecast that is lower than what Wall Street has projected so far. The sharp drop comes as state and local governments have “a lot of cash” and “are really in good shape” amid strong revenue outperformance. Vanguard forecast that the Muni-Treasury yield ratio could range between 70% to 75% for 10-year top rated municipals and about 80% for 30-year tax-free bonds.

Buy Long Term Munis, BoFA… Longer dated municipal bonds could deliver total returns of 5.5% next year, forecasts Bank of America Merrill Lynch, and high yield municipal returns could be 5% in 2022. The largest underwriter of state and local government debt projects that top rated 30-year tax-free bond yields could fall as low as 1.1%. 2022 demand for muni bonds will remain ‘resilient’ with $540 billion of principal redemptions and coupon payments to bondholders and rising domestic and foreign demand. In 2022, high yield municipal bonds’ outperformance could continue.

Compare 30-Year taxable U.S. Treasury yield 1.84% to 30-Year tax-exempt muni bond yield “AAA” 1.54%; “AA” 1.73%; “A” 1.91%; “BBB” 2.40%. For investors in the 35% tax-bracket, a 2.4% tax-exempt yield is equivalent to a 3.69% taxable yield. Top rated tax-free bonds yield 84% of comparable taxable U.S. Treasuries.