Week of 9/4/2019

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The Case For High Yield Munis… Judge Upholds Illinois GO Bondholder Security… Illinois Cuts Deficit… Ratings Upgrades For Chicago Bd of Ed Bonds… Mayor Looks at Options to Fix Chicago Budget Deficit… Supreme Court to Rule on Oversight Board Constitutionality… Market Expects Rate Cuts…

The Case For High Yield Munis…While overseas investors are grappling with negative bond yields, U.S. investors have more options for investment income based upon risk and reward. Investment-grade “BBB” rated munis yield 2.83% tax-free or a 4.35% taxable equivalent for 30 years. Tax-free top-rated munis yield more than comparable taxable U.S. Treasuries. Surging overseas demand caused the 30-year Treasury bond yield to fall to all-time low of 1.9%. The tax-free municipal bond market comprising U.S. state and local debt is still mostly sheltered from cross-currents in the global financial markets. Therefore, Treasury bond gains have outpaced tax-exempt municipal bond gains. Unlike the U.S. Treasury bond market, the tax-free muni market offers a variety of 4% or 5% coupon bearing muni bonds. Such bonds carry premium prices and provide investors tax-free coupon income until bond maturity. A tax-free high yield muni bond index shows returns near 10% this year. Commensurate with risk-return, high yield munis carry higher risks. In a diversified portfolio, investments in high yield tax-free bonds benefit from the expertise of a Municipal Bond Specialist.

Judge Upholds Illinois G.O. Bondholder Security…The Court upheld the constitutional security of full-faith-and-credit Illinois general obligation (GO) bonds by blocking a profitmotivated hedge funds’ complaint. Sangamon County Circuit Court Judge Jack D. Davis II concluded that the complaint on certain Illinois GO bonds filed was an improper interference with the application of public funds. Illinois Attorney General stated “We are pleased with the court’s decision to deny the plaintiffs leave to file a taxpayer action that, according to the court, resembles far more of a political stump speech than it does a legal pleading that would result in an unjustified interference with the application of public funds.” Governor Pritzker’s office echoed, “The administration is pleased that the judge repudiated this sham lawsuit brought on by the same far-right actors whose pathological desire to bankrupt the state brought us four years of devastation under Bruce Rauner.” The complaint targeted specific Illinois GO bonds which rallied upon the courts’ rejection of the ‘frivolous’ complaint filed for ‘a malicious ulterior purpose’. A Moody’s analyst stated, “The judge’s ruling today denying a lawsuit that sought to invalidate some of Illinois’ GO debt is positive for the state and in line with our view that the plaintiffs’ argument lacked merit. The ruling is reassuring to GO bondholders. Illinois GO bonds have returned 9.18% this year outpacing overall muni market index 7.61% return.

Illinois Cuts Deficit…Illinois cut its general funds deficit by $6.849 billion from a deficit of $14.612 billion in Fiscal 2017 to a deficit of $7.763 billion in Fiscal 2018. “That is largely because of a refinancing of state debt from high-interest to low-interest repayment,” State Comptroller informed. The deficit is the smallest since 2015. To help address Illinois’ fiscal challenges, Governor Pritzker (D) has his hopes pinned on a state constitutional amendment on the November 2020 ballot. Governor Pritzker has plans to sell state-owned Chicago real estate, including the marquee 17- story Thompson Center in the Loop, to produce a long-term revenue stream for paying down Illinois’ $134 billion unfunded pension liabilities. Talks with Mayor Lightfoot on state-owned Chicago real estate are gaining momentum.

Ratings Upgrades For Chicago Bd of Ed Bonds…Upgrades from both S&P and Fitch have boosted prospects for junk-rated Chicago Bd of Ed (CPS) bonds ahead of a $369 million bond sale this week. With a positive outlook, S&P upgraded CPS credit from “B+” to “BB-”. Fitch upgraded from “BB-” to “BB” with a stable outlook. Moody’s upgraded the Bonds from “B3” to “B2” in July 2018. Fiscal 2018 brought a small surplus for CPS reversing negative fund balances in two prior years. In Fiscal 2019, CPS is outperforming its budget and expects a surplus. In Fiscal 2020, CPS expects to close a $56 million budget gap. “The upgrade reflects the Board returning to a positive fund balance in Fiscal 2018 that we view as sustainable, Fiscal 2019 estimates indicating an addition to reserves, and adopting a balanced budget for Fiscal 2020, albeit with one-time revenues,” S&P stated. Chicago Board of Ed approved a $7.7 billion budget for the coming year and authorized the sale of $1.9 billion. Chicago Teachers Union struck down contract terms proposed by the Mayor and a neutral fact-finder and asked the Board to delay a budget. The teachers union is set to strike on September 25. CPS ability to control spending and manage its cash flow will be critical, although the finances of the nation’s third-largest school district have improved.

Mayor Looks at Options to Fix Chicago Budget Deficit…New revenues, state help and savings from lower cost debt could help Chicago’s $838 million Fiscal 2020 budget gap, the largest in recent history. A traffic congestion tax aimed at ride-sharing services and a progressive real estate transfer taxes if state-approved are amongst options hinted by the Mayor. After putting a hiring freeze, the Mayor is tackling overtime pay and getting resident inputs on service cuts. A 3% cost-of-living-adjustment promised to city workers and retirees is ‘unsustainable’ the Mayor stated that pensions and labor costs make up two-thirds of the budget gap. A chronic budget deficit and a big unfunded pension liability have led to low credit ratings. State help for sustainable pensions and for a viable Chicago casino are high on the Mayor’s agenda. Lightfoot is looking at a robust cannabis industry to boost state revenues. The Mayor may call for elimination of short term borrowing and is exploring some form of debt refinancing to save $100 million. The Mayor’s budget proposal is expected in October. Lightfoot informed “I cannot in good faith promise you that I will take any option off the table to tackle this crisis, whether it’s through budget reductions or by raising revenue.”

Supreme Court to Rule on Oversight Board Constitutionality…A Supreme Court ruling on the constitutionality of the current Oversight Board is expected by January 2020. While Senate confirmation is pending, a new cycle of Oversight Board nominations has clocked in. The Oversight Board’s term ended on August 30. On October 15, 2019, the U.S. Supreme Court will hear arguments on the First Circuit’s ruling against the Oversight Board. The Oversight Board appealed to the Supreme Court to overturn the First Circuit’s decision. The U.S. Court of Appeals for the First Circuit has ruled that members of the Oversight Board were unconstitutionally appointed. The First Circuit did not dismiss the Oversight Board’s actions to date or Puerto Rico’s Title III cases. President Trump nominated the Oversight Board’s current members to allow them to complete their current terms. At the upcoming Supreme Court hearing, the top court could unfold the Oversight Board’s actions during the past three years. Market Expects Rate Cuts…“We aren’t so sure that the US economy is ‘in a good place’ and view recession risks as sufficiently worrisome to warrant further Fed easing,” a PIMCO economist stated. U.S. GDP, the broadest measure of the nation’s output of goods and service, rose at a lower than estimated annual rate of 2.0% in the second quarter. The bond market expects three more rate cuts in the next six months suggesting yields could drop further after hitting an all-time low last week.

Compare 30-Year taxable U.S. Treasury yield 1.95% to 30-Year tax-exempt muni bond yield “AAA” 1.97%; “AA” 2.19%; “A” 2.38%; “BBB” 2.83%. For investors in the 35% tax-bracket, a 2.8% tax-exempt yield is equivalent to a 4.35% taxable yield. Top rated tax-free bonds yield 101% of comparable taxable U.S. Treasuries.