Week of 8/19/2019

Based on U.S. Treasury Yields-Record Low Muni Yields Represent Value… Year-To-Date Long-Term Muni Bond Returns Exceed 10%… California Earns Rating Upgrade… NJ Bonds In Demand… Teachers Contract, Budget On Chicago Public Schools Agenda… Chicago Casino Needs State To Lift Constraints… Bondholders And IL Governor Curb Hedge Fund’s Profit Ploy… U.S. State Revenue Outperforms…

Based On U.S. Treasury Yields-Record Low Muni Yields Represent Value…It might seem strange to call 30-year municipal bonds at record low yields of around 2% a bargain. But it’s all relative. State and local debt is at its cheapest level versus U.S. Treasuries since March, with 30-year municipal bonds offering around the same yield of similarly dated Treasuries. Thanks to new tax laws, munis became increasingly attractive earlier this year during tax season, offering a safe-haven for high net worth retail investors which created a frenzy for tax-free municipal bonds. While municipal bonds have rallied alongside other fixed income assets due to the current global economic slowdown, they haven’t kept up with Treasuries, which are more liquid. This month municipals have returned 1.58%, while Treasuries have returned over 2.29%. Even though the Muni-Treasury gauge may signal that 30-year municipals are attractive, the low yields may not excite all buyers. During this cycle of low rates GMS recommends investors consider premium bonds as a defensive strategy for lower rates.

Year-To-Date Long-Term Muni Bond Returns Exceed 10%…Drop in U.S. Treasury yields and higher demand for a tax-shelter has boosted the returns on the long-term muni bond index to exceed 10% this year. Second in safety to U.S. Treasuries, 30-year top-rated tax-free state and local government bond yields slid to 2%, the lowest since 2011. 10-year tax-free yields hit a new low of 1.26%. Tax-free bonds currently yield 95% of taxable U.S. Treasuries, attractive pricing for the much sought tax-free securities. For 32 straight weeks, investors have bought more municipal bonds with the majority invested in long term taxfree bonds. Bank of America Corp. strategists foresee yields on the long-dated municipals to drop even lower to 1.85% by year-end.

California Earns Rating Upgrade…Fitch upgraded California’s General Obligation (GO) bond rating to “AA”, restoring the Golden State’s earlier rating from 2002. It was less than a decade ago that media headlines stated “California is bankrupt”. Beating estimates by 7%, California raked in higher July revenues of $8.3 billion. A big contributor was corporation tax, which is 33% more than expected. California’s Fiscal 2020 budget is viewed favorably by major credit rating agencies. “For now, a decade into record national expansion, good times prevail,” S&P noted. GO bonds rated “AA-” by S&P, “Aa3” by Moody’s and “AA” by Fitch yield 2.1% for 30 years or 11 basis points more than top-rated muni yield. The yield gap or spread has narrowed from 35 basis points a year ago bringing gains to bondholders. California’s GO bond index shows returns of 7.8% this year.

New Jersey Bonds In Demand…New Jersey GO bonds returned 9.10% this year outperforming all U.S. state bond index returns. Tax-free bonds issued in New Jersey are much sought. Garden State per capita income is 126% of U.S. median income level, and highest earners pay the thirdhighest income tax rate in the nation. New Jersey is making incremental progress towards funding neglected pensions and replenishing reserves. New Jersey, the second-lowest rated U.S. state, is off to a strong Fiscal 2020 start with July tax revenue 12% higher than a year ago.

Teachers Contract, Budget On Chicago Public Schools (CPS) Agenda…“There’s no reason why we shouldn’t get a deal done”, Mayor Lightfoot referred to talks on a teachers’ contract that ended in June. The teachers’ union balks at Lightfoot’s offer of a 14% pay raise over five years, asking for 5% annual raises instead. The Mayor wants a five-year contract, and the union is leaning towards a 3-year contract. A neutral fact-finding report recommends a 5-year contract with 16% cost-of-living adjustments which is closer to the Mayor’s offer. The 25,000-member strong Chicago Teachers Union (CTU) has taken tough stands with prior city administrations. The neutral fact-finding report states, “Due to wage increases, pension payments, debt service increases for capital improvements in CPS facilities, programmatic investments and school funding, CPS is still determining how to fill its projected $141M shortfall for FY20. It will be able to do so, but the Board cannot sustain greater salary costs than it has proposed.” In its Fiscal 2020 proposed budget, CPS notes the “district’s improved financial situation” as budget pressures have eased. CPS $7.7 billion Fiscal 2020 budget is $117 million over last year. It includes more than $700 million in debt service and $619 million in capital improvements. The Fiscal 2020 budget will be presented to the Board of Ed on August 28 after hearings this week. Holders of junk-rated CPS bonds are keen to see a stable and reasonable contract with teachers.

Chicago Casino Needs State To Lift Constraints…Experts reckon that shedding a 33% privilege tax on casino sales could boost the case for a Chicago casino. Onerous taxes could constrain a Chicago casino which has the potential to become the highest grossing casino in Illinois; a feasibility study confirms Mayor Lightfoot’s assertions. The Mayor will use the report to convince lawmakers for ‘a bill that gets it right’. The Pritzker administration will be “working with stakeholders, including the mayor and General Assembly, to refine this approach and ensure that we maximize the opportunities for jobs for residents and revenue to address our financial obligations.” Windy City was not counting on casino revenues until 2021, which allows more time to find solutions.

Bondholders And IL Governor Curb Hedge Fund’s Profit Ploy…Bondholders, Nuveen Asset Management and AllianceBernstein joined forces with Governor Pritzker to ward off a profit-motivated activist hedge fund allegedly seeking to interfere in capital markets. In a short bet, the hedge fund bought insurance or protection against default for certain Illinois general obligations. After that, the hedge fund along with a right-leaning Illinois Policy Institute challenged the validity of $14 billion GO bonds issued in 2003 and 2017. The litigation was premised on hedge funds’ expectations for gains on the short bet or default protection. “Permitting activist investors to litigate against the validity of widely held municipal bonds based on their credit default swap bets could introduce a significant destabilizing force into the municipal markets,” bondholders briefed the court. Governor J.B. Pritzker has called the lawsuit a tactic to interfere in capital markets. An Illinois Circuit Court will decide if the complaint should be nixed. The bond market recognizes that debt service on widely-held full-faith-and-credit Illinois GO bonds must not fall prey to a hedge fund’s profit ploy.

U.S. State Revenue Outperforms…For the second straight year, U.S. state Fiscal 2019 revenues beat estimates and outpaced prior year. State sales tax collections accelerated after 43 states expanded sales taxes to online sales following favorable U.S. Supreme Court decision. Outperforming Fiscal 2019 revenues, amid record-long expansion, led many states to build higher reserves and direct funds towards pensions. In 2019, California, Connecticut, and Texas improved pension sustainability. An increasing number of states have enacted higher gas taxes to fund transportation needs. Although federal tax changes factored into states’ revenue forecasting, 46 U.S. states enacted timely Fiscal 2020 budgets. Overall, U.S. state budgets have remained conservative in Fiscal 2020.

Compare 30-Year taxable U.S. Treasury yield 2.10% to 30-Year tax-exempt muni bond yield “AAA” 2.00%; “AA” 2.25%; “A” 2.48%; “BBB” 2.73%. For investors in the 35% tax-bracket, a 2.7% tax-exempt yield is equivalent to a 4.15% taxable yield. Top rated tax-free bonds yield 95% of comparable taxable U.S. Treasuries.