Week Of 8/22/2022

IRA Boost To Municipal Bond Market…New Jersey Outlook Boosted…“Chicago Turnaround is Now,” CFO… Airports See More Travel, More Federal Dollars… PREPA Talks Extended Amid Power Outage Fued… Slower Pace of Rate Hikes?…

IRA Boost To Municipal Bond Market… A broad swathe of tax-free bond sectors are poised to benefit from the Inflation Reduction Act (‘IRA’) signed by President Biden. States and locals will reap additional income tax dollars from more stringent tax enforcement, an outcome of an $80 billion federal investment in the IRS. Affordable housing would get a boost as the Inflation Reduction Act would create a $1 billion incentive program for energy-efficient affordable housing. Hospitals stand to benefit from a three-year extension of enhanced subsidies to purchase health insurance on the individual marketplaces created by the Affordable Care Act. The IRA law brings $485 million in spending for energy, climate change and healthcare, to be paid from new tax revenue and prescription drug savings. New grants will help states and local governments address pollution, public health challenges and climate-related initiatives. It is debatable if the law’s 15% minimum corporate tax on the largest corporations has any meaningful impact on the tax-free bond purchases by large banks and insurance companies. High Net Worth demand for municipal bonds as a tax shelter is set to grow. The IRS will hire thousands of additional staff to clear its backlog of tax audits. Treasury Secretary Janet Yellen said the IRS funding boost “will allow the I.R.S. to work to end the two-tiered tax system, where most Americans pay what they owe, but those at the top of the distribution often do not.”

New Jersey Outlook Boosted… “New Jersey’s finances have shown a remarkable turnaround,” S&P raised its outlook on New Jersey general obligation bonds to positive from stable. The higher outlook comes after two consecutive years of fulfilling pension contributions based upon actuarial requirements. “The state’s recently adopted fiscal 2023 budget now appears to show structural balance between ongoing revenues and expenditures,” S&P noted that New Jersey’s unreserved fund balance could be about 13% of appropriations by next year, a change from past minimal fund balances. Substantial one-time federal pandemic grant revenue and high capital gains tax receipts that are volatile by nature have contributed to the current strength in Garden State finances. New Jersey still faces headwinds, as its long-term liabilities remain among the highest in the nation. Commenting on the outlook boost, Governor Phil Murphy said, “Not only have we gotten our fiscal house in order, we’ve fortified it.”

“Chicago Turnaround is Now,” CFO… An upswing in Chicago’s fiscal trajectory appears to have cheered its bondholders. A pension funding milestone was achieved with Chicago’s recent $2.28 billion pension contribution that meets actuarial requirements. On the horizon, recurring $200 million from casino tax revenue could be a boon for the city’s underfunded pensions. Last week, investors questioned city administration on how the city’s finances would fare after the federal aid funds are exhausted, were critical of crime in the city, and took note of Chicago’s high pension liabilities. City CFO responded, “The city has a plan for long-term stability.” Mayor Lightfoot has stressed that growing real estate developments and social investments will stand the Windy City in good stead. “We do believe the city’s message here is accurate,” a Chicago-based portfolio manager said. Chicago expects a surplus this year, and future projected budget gaps ‘modest and manageable’. Chicago CFO told bondholders, “The Chicago financial turnaround is now and we have the numbers to prove it.” Chicago’s investment grade general obligation bonds yield offer higher yields relative to local government general obligation bonds. This Fall, the Windy City will issue its first ‘ESG’ labelled tax-free bonds.

Airports See More Travel, More Federal Dollars… Air travel has picked up. Domestic traffic is near 87% of pre-COVID-19 levels, whereas international travel volume lags at around 65%. Terminal expansion is a priority, particularly because 85 airports have begun to receive federal grant funding from the $25 billion Bipartisan Infrastructure Law signed last November. The funding follows over $20 billion of federal pandemic funds. Reflecting on the resilience of the airport municipal bond sector, certain airports such as Chicago O’Hare airport and Minneapolis-St. Paul airport have received recent credit ratings upgrades. Airports bear the brunt of high fuel prices, elevated air fares, and a slowing global economy. Airports with strong domestic demand are more insulated from global turbulence caused by China’s zero-COVID policy or the war in Ukraine. As airports gear up capital plans, airports bond sales are up 53% relative to last year. The airport sector’s higher bond issuance comes in a supply-starved municipal bond market. Relative to top-rated municipal bond benchmarks, airport bonds offer higher tax-free yields to long-term bond investors.

PREPA Talks Extended Amid Power Outage Fued… Just as mediation talks began to make headway, power outages have triggered a rift related to the operation of the Island’s sole electric utility. Both Governor Pierluisi and Resident Commissioner Gonzales, who at one time were supportive of PREPA’s private operator, are now critical of the private operator Luma Energy. Resident Commissioner Gonzales has called to ‘evaluate the Luma contract and rescind’ the landmark privatization contract.’ Against this backdrop, mediation team talks on PREPA debt restructuring have been extended to September 9, 2022. Last week, the mediation team reported that “negotiations are continuing to make progress” and “it is beneficial to continue the mediation process and extend the mediation termination.” The oversight board explained recently that the negotiations have been delayed due to ‘starkly different legal positions leading to starkly different economics involving bond claims.’

Slower Pace of Rate Hikes?… Mixed signals from Fed Minutes released last week divided the bond market’s September rate hike expectations. “As the stance of monetary policy tightened further, it likely would become appropriate at some point to slow the pace of policy rate increases while assessing the effects of cumulative policy adjustments on economic activity and inflation,” the minutes of the Federal Open Market Committee’s July 26-27 meeting released last week read. Traders assigned 60% odds for a 50 basis point rate hike, with a lower 40% for a 75 basis point rate hike in September. Is a slower pace of rate hikes in the offing, will be question for Fed Chair Jerome Powell at Jackson Hole this week.

Compare 30-Year taxable U.S. Treasury yield 3.21% to 30-Year tax-exempt muni bond yield “AAA” 3.14%; “AA” 3.71%; “A” 3.98%; “BBB” 4.03%. For investors in the 35% tax-bracket, a 4% tax-exempt yield is equivalent to a 6.15% taxable yield. Top rated long-term tax-free bonds yield 98% of comparable taxable U.S. Treasuries.