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Week of 9/6/2021
Ida Recovery From Aid, Insurance… California Outlook Boosted… Illinois’ Deficit Shrinks… Chicago Revenue Outperforms… New Pension Law Credit Positive For Chicago Park District… Taxable Munis Sought… Muni Supply Tumbles… The Rich Rush to Muni Bonds, WSJ…
Ida Recovery From Aid, Insurance… Disaster declaration by President Biden brings substantial FEMA reimbursements to local governments for recovery costs from Hurricane Ida, a category 4 storm. Insurance reimbursements, along with supplemental state aid could cover yet unknown tax base declines and financial losses to local governments, utilities, hospitals and schools that stood in Hurricane Ida’s path. Although local governments came out resilient with massive rebuilding, ratings downgrades came in tow with Hurricanes Sandy (2012) and Katrina (2005). When Hurricane Maria made landfall in 2017, Puerto Rico came to a standstill. Its economy grew leaps and bounds in the wake of the natural disaster, and the Island restored its electric grid with historic federal aid. Six hurricanes made landfall on the U.S. Atlantic or Gulf Coast in 2020, the highest number in over 15 years. The number of hurricanes could reach double digits in 2021 Fitch estimates. Some cities have learnt important lessons from natural disaster. Critical infrastructure upgrades, such as New Orleans’ Hurricane Storm Damage Risk Reduction System costing $15 billion installed in 2011, helped cities brace with winter storm Uri (2021) and Hurricane Laura (2020). Compared to Hurricane Katrina, the largest hurricane in U.S. history, recovery from Ida could cost a tenth at about $10 billion per insurance industry analysts. Fitch Ratings estimates Ida’s insured losses $15 billion to $25 billion, which would fall below the record $65 billion in insured losses from Katrina. Risks from rising sea levels and wildfires have forced state and local governments across the nation to tackle stressors to energy grids from climate change. More fuel for President Biden’s climate change agenda comes with the latest storm. Mitigating long-term credit impact, government liquidity cushions, insurance reimbursements along with bridge loans pending FEMA disbursements are likely. For those able and willing to bear risk, the disruption could unearth attractive investment opportunities.
California Outlook Boosted… S&P raised its outlook on California to positive from stable. “The outlook change reflects California’s projection of near long-term structural balance and high reserves, even assuming that currently high capital gains tax and federal aid revert to historically lower levels in later years,” S&P noted. Highly progressive income taxes tie state revenue to economic cycles. California, which received the most direct federal aid from the America Rescue Plan, has detailed a plan to spend $27 billion aid, with only about $330 million unallocated. Close to half of the federal aid will offset COVID-19 related impacts. Governor Gavin Newsom (D) is likely to win the September 14 election, the Golden State’s second recall election in history. In 2003, Californians ousted Democrat Gray Davis from the top office and elected Republican Arnold Schwarzenegger. 53% of voters approve of Newsom’s first term performance, while 39% want a change per a recent Public Policy Institute poll. Unfazed by the rare election, investors seek as little as 6 basis points over top- rated muni bonds to own California bonds, down from 11 basis points in January. Wealthy Californians face the steepest income taxes in the nation and are driving up demand for Golden State bonds. To be issued on election day, $2.1 billion California tax-exempt bonds should see strong demand.
Illinois’ Deficit Shrinks… Marking the biggest improvement in many years, Illinois trimmed its general fund deficit by $1.1 billion in Fiscal 2021. A general fund deficit, defined as bills on hand exceeding available cash, has persisted in Illinois for over two decades. Compared to other U.S. states, Illinois’ general fund balances are the weakest at negative 13% of revenues. Illinois’ general fund deficit peaked at $14.6 billion in 2017 and is down to $6.4 billion per the latest audit recently released 13 months after Fiscal 2021 closed. Chiding the lowest-rated U.S. state for tardy financial reporting, auditors opined “The State of Illinois’ current financial reporting process does not allow the state to prepare a complete and accurate Comprehensive Annual Financial Report in a timely manner” which limits effective oversight. Ongoing multi-year implementation of an enterprise resource planning system for financial accounting could improve financial reporting time. Governor Pritzker agreed to address issues within agencies for better reporting timelines.
Chicago Revenue Outperforms… Chicago’s revenue collections in the first half of this year reached $1.47 billion, exceeding the budgeted $1.38 billion and prior years’ $1.26 billion revenue. The gains came from sales, utility, income and personal- property replacement taxes. The opportune outperformance comes as Chicago seeks to plug a $733 million gap in the 2022 budget. Options include using $782 million American Rescue Plan funds, reforms and potential new revenue.
New Pension Law Credit Positive for Chicago Park District… Pensions are a significant challenge for several local governments that overlap the City of Chicago tax base. Chicago Park District’s pension system faces a high risk of asset depletion as current assets roughly cover only 4.4 years of benefit payments. In August, a new law enacted by Governor Pritzker seeks to address Chicago Park District’s under funded pension plan. A significantly higher near-term pension contribution of $80 million in Fiscal 2021, compared to just $13 million under the prior formula, is required per the recent statute. The law also puts new hires in a lower tier for pension benefits. The changes are credit positive for the Chicago Park District, an issuer of $820 million lower rated tax-free municipal bonds.
Taxable Munis Sought… In August, taxable bond supply was down 40% down a year ago. The sharp fall suggests that states and local government could issue fewer taxable bonds 2021. In 2020, one in three municipal bonds was taxable. That could change, as one fifth of new municipal bonds could be taxable in 2021 analysts estimate. Higher U.S. bond yields and a dollar rally have led foreigners to seek taxable municipal bond investments. Bank of America forecasts that taxable municipal bond returns could grow from 2% so far to 5% in 2021.
Muni Supply Tumbles… Municipal bond supply fell sharply in August. A 8.4% dip in primary market volume comes amid multi-year direct federal aid allocations to state and local governments and upcoming federal infrastructure funding. This years’ biggest muni issuers are California, Texas and New York. Texas’ new muni bond volume is 11.2% lower than last year, while New York’s new muni issuances have dipped 1.2% and California has issued 3.6% more bonds than a year ago. 2021 municipal bond supply could come close to a record $484 billion municipal bonds issued by states and locals last year.
The Rich Rush to Muni Bonds, WSJ…“The biggest winners of the 2020 election have turned out to be state and local governments,” WSJ September 2 editorial wrote, “The tax bill for wealthy Americans in many states could soon exceed 50% on stock sales, dividends and interest income. Despite the paltry yields on munis, Americans may still net more than they would buying corporate bonds or Treasury’s. Tax-exempt munis are a port in this tax storm.”
Compare 30-Year taxable U.S. Treasury yield 1.98% to 30-Year tax-exempt muni bond yield “AAA” 1.56%; “AA” 1.79%; “A” 2.00%; “BBB” 2.20%. For investors in the 35% tax bracket, a 2.1% tax-exempt yield is equivalent to a 3.3% taxable yield. Top rated tax-free bonds yield 79% of comparable taxable U.S. Treasuries.
If you have any questions or desire updated information contact your GMS Account Executive