Week of 5/21/2019

COFINA Exchange Offer…More Rainy Day Funds For New Jersey…PREPA RSA Not A Done Deal… More Nuances To Special Revenue Bonds… A Decade Of Economic Growth Firms Muni Credit… Slower Retail Signals Lower Growth… Higher Chances of Rate Cuts…Muni Bonds Gain…

COFINA Exchange Offer…All new COFINA bonds issued in February in a debt exchange could be tax-exempt. The IRS notified COFINA that the $3.59 billion of Series 2019 A2 taxable bonds and the $45.57 million of Series 2019 taxable B2 bonds can be exempt from federal taxes. COFINA will offer holders of 2019 A-2 B-2 taxable bonds the opportunity to exchange such 2019 A-2 B-2 bonds for COFINA Tax-exempt bonds. Bondholders will have 20 days from the launch date of the exchange. To take advantage of the exchange offer, which will give investors new securities with yields 0.25 percentage points lower than when they were first offered in February. COFINA expects to launch the offer on or prior to May 31 and the exchange bonds could be issued by July 1, 2019. In February, COFINA restructured $17.6 billion of sales tax bonds by selling $12 billion of new COFINA bonds in a debt swap. Since issuance, new COFINA bonds have gained in price.

More Rainy Day Funds For New Jersey…For the first time in a decade, New Jersey’s rainy day fund will see inflows. Record high income tax collections allow New Jersey to shore up its surplus revenue fund, created by state statute in 1990 for emergencies. April tax collections were 57% higher than a year ago or $377 million more than projected mainly because tax reform altered state and local tax prepayment patterns. “It is absolutely critical that these funds remain in a ‘lock-box’. We have to prepare for forces both inside and outside our control,” New Jersey State Treasurer said as New Jersey’s rainy day fund ran out during the Great Recession. The improved revenue outlook could help New Jersey (Moodys “A3” S&P “A-” Fitch “A”) to achieve a billion dollar budget surplus in fiscal 2019 and 2020. New Jersey’s budget surplus has improved significantly under Governor Phil Murphy’s administration after the Garden State saw 11 bond rating downgrades between 2011 and 2017. New Jersey’s pension system, amongst the worst funded in the nation, is a factor in its ranking as the second lowest rated U.S. state. While Governor Murphy wants a ‘millionaire’s tax’ to raise $447 million annually, state lawmakers want to reform state pension and health benefits. An improved revenue outlook could allow more breathing room for long term fiscal solutions to emerge.

PREPA RSA Not A Done Deal…Only 47% of bondholders support PREPA’s May 2019 restructuring support agreement or RSA and some bond insurers prefer a court appointed receiver. None the less, the latest RSA is a significant development because it has been approved by the Fed Board and a previous holdout, Assured Guaranty. “As always with matters involving PREPA, there remains a high degree of uncertainty about whether this restructuring plan can or will be implemented, including execution risk,” Moodys stated. There Muni Week 5/21/2019 Review / Preview COFINA Exchange Offer…More Rainy Day Funds For New Jersey…PREPA RSA Not A Done Deal… More Nuances To Special Revenue Bonds… A Decade Of Economic Growth Firms Muni Credit… Slower Retail Signals Lower Growth… Higher Chances of Rate Cuts…Muni Bonds Gain… is still uncertainty if the 67% bondholder support threshold will be met amid affordability issues. If court approved, the PREPA debt exchange could be the third settlement of Puerto Rico’s legacy debt.

More Nuances To Special Revenue Bonds…In the wake of a court ruling on Puerto Rico debt, investors looking at special revenue bonds are likely to pay more attention to the credit quality of the parent government. A recent United States Court of Appeals decision that Puerto Rico Highway and Transportation Authority need not pay debt service on special revenue pledges during bankruptcy has brought into focus the linkage between a government’s enterprise systems and its general operations. Often, there are distinctions between the credit quality of an enterprise and its parent government. However, a shared economic base, governance, financial and legal linkages create an inter-related credit profile. Moodys placed on review for downgrade debt $20 billion of debt: affected enterprise issuers’ credit rating was significantly higher than parent governments’ rating. Fitch believes that the Puerto Rico ruling does not bear upon state-related special revenue debt as U.S. states do not have the ability to file for bankruptcy. Although special revenue pledges may not be immune from default, special revenue bonds still provide investors with significant protections and higher recoveries.

A Decade Of Economic Growth Firms Muni Credit…A decade of economic expansion has led property values to grow nationwide. Cities, counties and school districts see added reserves, healthy liquidity and tax base growth. In 2017, median tax base grew by almost 5% for cities, counties and schools while debt levels remain largely unchanged. Historically, local governments’ debt levels have remained low with the median debt level between 0.5% to 1.6% of value. Mounting pension liabilities remain a challenge for local governments. Rising pension costs will continue to strain operating budgets for local governments with large unfunded liabilities. Most U.S. states forecast improved fiscal 2019 fund balances and are building or maintaining reserves in fiscal 2020. In the midst of the fiscal 2020 budget season, half of all U.S. states are projecting revenue growth of over 3%. Some states including California and Connecticut have mandated higher reserve levels through constitutional provisions or bond covenants for higher credit discipline.

Slower Retail Signals Lower Growth…Retail sales, which unexpectedly declined in April for the second time in three months, could be impacted as the U.S.- China tariff retaliations take hold. Auto sales dropped to the lowest since 2017 as seven of 13 major retail categories saw declines from a month ago. In dollar terms, retail spending growth excluding gasoline remains weaker than at any point since the 2007-09 recession. Since December, overall industrial output excluding energy has dropped 1.7% and durable goods production is down 2.3%. Morgan Stanley cut its second-quarter GDP growth estimate to 1.2% from 1.5%.

Higher Chances of Rate Cuts…Traders see a 75% chance of a rate cut this year with nearly even odds of a rate cut as early as September this year. Probability of a second rate cut this year is over 30% per futures markets. U.S. Treasury bond yields have priced in future rate cuts. The two-year Treasury note yields 2.17%, which is below the Fed funds rate target of 2.25%-2.50%. Yields on treasuries fell to the lowest in a year.

Muni Bonds Gain…Muni bond yields dropped further from a week ago amid low new issue supply. $5 billion of new issue bonds are expected this week, lower than earlier estimates. Last week’s notable bond issuer was Allen Park, Michigan which returned to the bond market successfully after exiting state oversight two years ago. “A1” rated University of Pittsburgh Medical Center new issue was ten times oversubscribed. In the 19th straight week of inflows to muni bonds, over half of the investments favored long term munis. Marking the longest inflow streak since 2016, investors added about $1.3 billion to municipal-bond funds this week.

Compare 30-Year taxable U.S. Treasury yield 2.8% to 30-Year tax-exempt muni bond yield “AAA” 2.46%; “AA” 2.66%; “A” 2.79%; “BBB” 3.22%.