Week of 8/2/2021

High Yield Muni Bonds Rally… Upside in Puerto Rico Bonds… Bond Insurers Run Strong… Chicago Outlook Boosted… Nation’s Largest School Board… States Closer to Opioid Settlement… Taxable Muni Bonds Favored… Fed Stands Pat…

High Yield Muni Bonds Rally… High yield bond index return, 7.3%, is near four times overall muni market return. The riskiest municipal bonds are fetching record low yields. Non-rated and junk rated municipal bond index yields dipped to 2.91%, an all-time low. Yield penalty, or the extra compensation investors seek for riskier state and local governments has narrowed to 2.2%, the least since 2007. Student housing, private colleges, hospitals, senior living and state tobacco agencies often issue speculative municipal bonds. Riskier muni bonds account for about a fifth of this year’s bond sales. In August, Puerto Rico’s water and sewer utility will issue $1.7 billion unrated tax-free bonds. The Island water utility’s long term bonds fetched around 2.56% yield last month, significantly down from 4.15% from a December 2020 bond sale. Record low yields are a favorable backdrop for non-rated and speculative rated issuers’ borrowing plans. With direct federal aid funds to municipal bond issuers being spent over the next 18 months, credit improvement could be in store.

Upside in Puerto Rico Bonds… Improved recovery prospects and a high yield bond rally are a tailwind for Puerto Rico bond returns. Moody’s estimates prospective recovery to be between 80% and 85% on pre-2011 general obligation (GO) bonds and 83% to 88% on pre-2011 Puerto Rico Public Building Authority (PBA) bonds based upon new bonds, cash, consummation fees and the present value of a contingent value instrument linked to future sales tax receipts, if the Title III court confirms debt plans. Barclays calculated 91 cents on the dollar fair value estimate for Puerto Rico’s 8% GO bonds maturing in 2035 which traded around 85 cents recently, up from 69 cents at the start of 2021. Puerto Rico bond prices rebounded strongly during 2018 after plunging in Q4 2017 on fears related to Hurricane Maria. Since then, the trend has been up, with some sharp pullbacks along the way. The high yield bond rally could boost returns on Puerto Rico bonds. “Puerto Rico GOs/PBAs have already performed great this year, rallying 10-15 points in 2021, Barclays analysts said last week “However, after analyzing recent trading levels of the more liquid GO and PBA bonds, we find that there could still be more upside across the complex.” Court hearings on the Island’s central government debt adjustment plan will commence in November.

Bond Insurers Run Strong… Credit positive for insured municipal bonds, nearly all of bond insurers’ Puerto Rico exposure is covered by a settlement in place. Better than expected recoveries and higher certainty on Puerto Rico exposure add to bond insurers’ credit strengths. Since mid-2016, bond insurers have paid claims on Puerto Rico exposures in full and on time, reflecting the resilience of bond insurance. About 8.4% of new municipal bonds are insured, the highest since 2009. Growth in insured muni bond volume, up 31% from last year, surpasses 15% growth in municipal bond market. On the heels of COVID-19, bond insurers are on a strong run fueled by higher insured bond volumes and Puerto Rico debt settlements.

Chicago Outlook Boosted… Moody’s, the only rating agency to rate Chicago at junk, assigned a stable outlook to Chicago bonds, while affirming its “Ba1” rating. The action reverses a prior negative outlook assigned post-COVID-19. Federal relief $1.9 billion from the America Rescue Plan, robust property tax collections, and rebounding taxes after the city and state lifted all COVID-19 capacity restraints last month brought the outlook boost. Both S&P and Fitch carry negative outlooks, and a higher investment grade rating. S&P rates Chicago “BBB+” and Fitch has the city at “BBB-”. “The pandemic did delay the city’s timeframe to reach structural balance, moving it to 2023 from 2022, indicating the city’s vulnerability to changing economic conditions,” S&P analysts explained their June decision to keep the outlook at negative despite easing fiscal pressures. Moody’s has rated the city speculative grade “Ba1” since court rulings in 2015 reinforced a state constitutional ban on pension benefit cuts. Moody’s said it could lift the city back into investment grade territory through a “demonstrated ability to match ongoing revenues with ongoing expenses including the accommodation of statutorily required increases in pension contributions” and/or a “moderation of the city’s pension burden arising from robust economic and revenue growth or strong pension asset performance.” Strategic use of federal relief and outperforming revenues offers a window of opportunity for favorable structural changes in Chicago that require political will.

Nation’s Largest School Board… Chicago Public Schools’ board is set to become the largest elected school board in the country. For the first time in history, Chicago voters will elect their full school board beginning in 2026 per a new law enacted by Governor Pritzker last week. The elected school board will have 21 elected members, up from seven mayor- appointed members at present. City Hall’s grip on school operations will soften, as more power is handed to unions and parents. The move has long term governance implications.

States Closer to Opioid Settlement… States and locals stand to receive $26 billion from a proposed settlement agreement with opioid distributors. More than 40 states including California, New York, Pennsylvania, Connecticut and Delaware could drop litigation against Johnson & Johnson, AmerisourceBergen Corp and other drug companies, while a few states such as Washington could seek more compensation. The opioid epidemic’s economic cost is over $630 billion between 2015 and 2018 from lost labor force, lower productivity and higher public health and safety costs. The landmark settlement is a major step forward in resolving over 4,000 lawsuits filed by state and local governments seeking compensation for billions spent battling the opioid crisis.

Taxable Muni Bonds Favored… Taxable municipal bond could return 5% by the end of the year. Bank of America forecasts. “We continue to favor taxable munis over corporates,” Bank of America analysts noted. Barclays analysts echoed that while corporate spreads have widened somewhat on growth concerns, taxable municipal bonds outperformed yet again, “We still see this muni sub-sector as well supported, despite rather rich valuations. “ ‘AAAs’ and ‘AAs’ will see strong demand from life insurers, incentivized by changes in the NAIC’s risk weightings and some ‘BBB’ credits are still attractive enough versus similarly rated corporates with relatively few credit concerns on the horizon.” Investors favor taxable municipals over corporate bonds, noting that state and local government bonds are much safer and tend to benefit during stock market routs that often impact company debt unfavorably. Taxable municipal bonds have gained 1.6% since the start of the year, beating investment grade corporate bonds, which have lost about 0.3% over the same period per Barclays indices.

Fed Stands Pat… “It’s not something that is on our radar screen right now,” Fed Chair Powell said that the central bank is nowhere near considering plans to raise rates. Some Fed officials want to see more hiring before pulling back on the Federal Reserve’s bond buying. “There’s a range of views on what timing will be appropriate,” Powell said. During a prior bond purchase program that ended in 2014, the Federal Reserve shrank its bond purchases in modest, equal amounts over the course of 10 months. It then waited another 14 months before raising interest rates. On recent inflation surge, Powell stuck to his long standing view, “My best estimate is that this is something that will pass.” U.S. economy grew at a 6.5% annualized rate in the second quarter, below expectations of 7.6% growth, pointing towards a peak of the economic cycle.

Compare 30-Year taxable U.S. Treasury yield 1.89% to 30-Year tax-exempt muni bond yield “AAA” 1.43%; “AA” 1.58%; “A” 1.70%; “BBB” 2.18%. For investors in the 35% tax-bracket, a 2.15% tax-exempt yield is equivalent to a 3.3% taxable yield. Top rated tax-free bonds yield 77% of comparable taxable U.S. Treasuries.

If you have any questions or desire updated information contact your GMS Account Executive.