Week of 7/23/2019

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Puerto Rico Governor Impeachment Or Resignation Is Being Demanded…Airport Bonds Outperform…Chicago General Fund Balance Trends Higher Pensions Still a Burden… Growing Connecticut Pensions Loom Large…Various Opinions on Public Pensions… As Insured Bonds Outperform Demand Grows… Traders Bet Fed Rate Cut 100% Certain… Longer Term Munis Remain Attractive…

Puerto Rico Governor Impeachment Or Resignation Is Being Demanded…Governor Rosselló could face impeachment as he stopped short of resigning as Governor. The Governor has lost the confidence of his own New Progressive Party, U.S. President Trump and many Democrats. Governor Rosselló (D) will resign as president of the ruling New Progressive Party and will not contest next year’s gubernatorial election. “This is the first step,” the Governor’s 2016 running mate, Puerto Rico Resident Commissioner Jennifer Gonzalez has asked the Governor to step aside along with former Governor Luis Fortuño who stated, “It is necessary to finalize this chapter to redirect the Country towards the recovery of its economy, the essential services affected and effective and reliable governance.” Speaker Carlos “Johnny” Méndez has set up an exploratory committee to evaluate an impeachment process. The Bar Association of Puerto Rico said that there is sufficient legal basis for the House of Representatives to initiate an impeachment process. “I must be respectful of the constitutional order and I welcome the process started by the legislative assembly,” Governor Rosselló stated that were an impeachment process to take place, the executive branch will continue working to guarantee the continuity of government operations. The Island’s leadership crisis has led Congress to consider tighter restrictions on federal funding. “I know the people of Puerto Rico well, and they are great. But much of their leadership is corrupt, & robbing the US Government blind!” President Trump remarked. Meanwhile, the Federal Oversight Board plans to file a debt adjustment plan for the Commonwealth “in the next few weeks,” per Natalie Jaresko, board executive director. The Oversight Board’s appointment is pending Senate approval. It is too early to know who will step in. Triggered by 900-pages of profane online chats by the Governor, millions of Puerto Ricans from all walks of life faced up to failures of their elected leaders and decisively demand a change. Bondholders are keen to see a change. Recent events could catalyze much needed positive changes for the Island’s future capital access.

Airport Bonds Outperform…Fueled by robust air traffic and low fuel costs, U.S. airports have seized the opportunity to scale up and modernize. Muni investors rushed to tax-free bonds issued by Chicago O’Hare, San Francisco, Los Angeles and Denver international airports to finance upgrades within the last year. Next week Austin International Airport plans to sell $320 million bonds rated Moody’s “A1” S&P “A”. Looking ahead, Miami International Airport’s’ $5 billion capital plan is on the radar. In the supply-starved muni market, bonds secured by airport revenues are a welcome source of higher supply this year. Airport bonds, a niche tax-free investment, are much sought for the exposure to the economic activity of regional hub cities: valued for a diversified tax-free portfolio. Muni bonds issued by airports, toll roads and ports have gained over 7% in a year outperforming the muni market S&P index 6.4% gain.

Chicago General Fund Balance Trends Higher Pension Still a Burden…Chicago’s General Fund balance has steadily grown ten-fold to $332 million in 2018 from $33 million in 2012. “General Fund balance is what a lot of rating agencies look at,” however Chicago CFO stated concerns about a large budget gap due to pensions. Despite higher pension contributions in recent years, low returns have led Chicago’s net pension liabilities to grow by $2 billion or 7% in 2018. Chicago public pension funds recorded negative investment returns in fiscal 2018 after double-digit returns in prior year. Meanwhile, plans for a city casino slated to help with police and firefighter pensions are shaping up. Financial feasibility studies for five sites selected by Mayor Lightfoot for a 4,000-seat Chicago casino are expected soon. Mayor Lightfoot has invited bondholders for an annual investor conference on September 20 to discuss 2018 finances, 2020 budget and a three-year outlook.

Growing Connecticut Pensions Loom Large…To fund its bloated pension tab, CT has boosted revenue contributions to historically high levels and found accord with teachers in recent years. Much more needs to be done. Relative to its GDP, Connecticut’s combined debt and pension burden is the highest among U.S. states: teacher pensions make up a third of Connecticut’s leverage. Connecticut’s pension problems began decades ago when the state lowered pension contributions. The Great Recession’s investment losses added to pension woes. Recent labor agreements have increased employer contributions and lowered cost-of-living-adjustments known as COLAs. The Connecticut Pension Sustainability Commission recommends transferring eligible state assets into a legacy obligation trust for pensions and using state lottery proceeds to boost pension funding. Other governments have explored similar avenues: New Jersey’s 2017 transfer of its lottery to the state pension fund, capital city Hartford’s transfer of a city park to the local pension fund and Detroit’s bankruptcy settlement come to mind. Connecticut rated Moody’s “A1” S&P “A” Fitch “A+” is a frequent muni bond issuer that received two upward changes to a ‘positive outlook’ this year. CT bonds have gained 6.17% this year outperforming general muni market Barclay’s index return 5.6%.

Various Opinions on Public Pensions…Twenty states have pension plans that are less than two-thirds funded, and five states have pension plans that are less than 50% funded, per Tax Foundation. “We find that in the aggregate pensions can be stabilized with moderate fiscal adjustments,” a Brookings Institution analyst shared research findings that many pension plans have made changes for long-term viability, by shifting to hybrid 401K type defined contribution plans, reducing benefits for new hires, delaying full retirement age, reducing COLA and increasing contribution rates. Long term sustainability rather than underfunding is rooted in the history of public pensions as pension plans were not required to be fully funded decades ago. However, the scale of unfunded pension liabilities has become one of the factors for credit ratings. A Moody’s analyst stated, “We look at pensions as a must pay obligation.” Experts reckon that reform now may be less costly and less painful than coping with a larger crisis later.

As Insured Bonds Outperform Demand Grows…This year $9.5 billion insured bonds have been issued which is 5% more than prior year. 58% of insured bonds issued this year carry Assured Guaranty bond insurance followed by Build America Mutual which had a 40% market share. Insured bonds outperformed the overall muni bond market. Traders Bet Fed Rate Cut 100% Certain…Traders bet that July rate cuts are 100% certain has been priced in most financial tools ranging from bank deposit and home mortgage rates. Retail sales, the labor market and industrial production over the past few weeks have been unexpectedly strong adding to odds of a 25-basis rate cut instead of 50- basis points. Federal Reserve Bank leaders have pushed for the Fed to “take out some insurance against the possibility of a sharper-than-expected slowdown” and to do what it takes for a “sustained expansion”.

Longer Term Munis Remain Attractive…Short term bond yields closely follow the Fed funds rate change while longer dated munis align with inflation outlooks. Accordingly the gap in yield between short-term and longer duration tax-free munis has widened. “AAA” Tax-free munis yield 1.157% for 2 years, 1.56% for 10 years and 2.37% for 30 years. 30-year Tax-free munis yield 93% of comparable taxable U.S. Treasury yield. In the 28th straight week of inflows, investments in muni bonds accelerated over prior week. Muni bond investors have taken the cue from the Fed and plied more investments towards fixed income tax-free bonds.

Compare 30-Year taxable U.S. Treasury yield 2.55% to 30-Year tax-exempt muni bond yield “AAA” 2.37%; “AA” 2.51%; “A” 2.78%; “BBB” 3.11%.