It has been a rough year thus far in 2022 for bonds, and municipal bonds have been no exception. Municipal bond prices have fallen as a response to inflation fears and the Federal Reserve’s interest rate increases (removal of the proverbial punch bowl). Our crystal ball regarding the timing of the market volatility remains cloudy, so instead this blog will focus on a couple of recent attention-grabbing topics in the municipal bond market.
Mr. Toad’s Wild Ride
Disney World recently worked its way into the municipal bond market headlines. In March, The Walt Disney Company issued a statement criticizing a recent bill passed by the Florida legislature. In response, Florida’s governor asked the legislature to terminate a “privilege” Disney enjoys- a special improvement district known as the Reedy Creek Improvement District (RCID), established in 1967. Within hours, bills were filed to terminate all special districts enacted “prior to 1968”, which specifically refers to RCID without naming it. As with rapidly drafted legislation, the ramifications for the RCID and the surrounding counties, cities, and potentially the state of Florida, are profound.
Disney originally purchased 25,000 acres of swampland overlapping Osceola and Orange counties in 1960. At that time, the nearest power and water lines were ten miles away. It would have been exorbitantly expensive for the counties or state to run utility lines out to what was to become Disney World. The state of Florida and Disney worked together to create the Reedy Creek Improvement District, which acts as its own local municipality and provides power, water, road maintenance, and fire protection. It allows Disney a fair amount of autonomy over building permits and fee collection. RCID is also allowed to issue municipal debt, which it has, to the tune of about $1 billion. Special improvement districts are not unusual. Tens of thousands exist around the United States and Florida has more than 1,800 of them. What is unique about the RCID is that it is almost entirely comprised of Disney-owned land and the state allows the district to tax Disney (itself) at three times the rate normally imposed by local and state governments on property owners.
The impromptu dissolution of the RCID creates a host of complicated issues. The legislature did not identify what governmental entity would take over the operations, ownership, fee collection, or bond indebtedness of the district. This responsibility could be forced upon one or more of the surrounding cities (Lake Buena Vista and Bay Lake) and counties (Osceola and Orange). These municipalities are not legally allowed to tax property owners at the high tax rate that the RCID taxed Disney, raising the question of how will the significant debt be serviced? Speaking of debt, when the state created the RCID, it created a covenant to not limit or alter the right of the district to carry out its services, and levy and collect taxes, unless all debt was paid off. These would seem to fall under the category of “limit and alter.” While Becker Capital does not manage any of the RCID debt for our clients, this hasty action by the state could alter bond investors’ views of Florida’s commitment to preserve bond holder’s rights-which would be a negative for all Florida municipal debt.
Pandemic Relief and the State of the Muni Market
Are you over the pandemic? You may be done thinking about it, but states and local governments are happily anticipating the second of two rounds of pandemic aid from the American Rescue Plan. The U.S. Treasury Department has begun the transfer of the second half of the $350 billion slated for states, counties, cities, tribal government, and territories. The federal government gave the recipients wide parameters on the use of the funds, believing local legislators were better positioned to decide which projects would best stimulate their local economies. I’ve found it interesting to look at the budgets of local cities and counties to see the creative ways they are spending these additional funds (perhaps I need a better hobby?) This money has been used to help create transitional and low-income housing, provide hazard pay for teachers and first responders, pay overdue utility bills, shore up small businesses and non-profit organizations, public and mental health services, and even solar arrays.
The extra fund flow from the federal government to state and local government has helped ease the financial stresses of the pandemic. Many states struggled at the beginning of the pandemic and had to rely on rainy day funds to balance their budgets. But strict spending measures, federal fund inflows, and better than expected tax collections have greatly improved their fiscal situations. In fact, the Pew Charitable Trusts reports that state’s total balances (rainy day funds plus ending balances) hit a record high of $217.1 billion, which is almost $100 billion higher than the previous high of $121 billion in 2019. A few states are even proposing lowering their tax rates.
Municipal bond market losses have been painful so far this year, but market dislocations often present interesting opportunities. Last summer, a ten-year tax-exempt AAA muni bond was yielding about 0.93%, which was expensive at 57% of the equivalent treasury yield. Today, a ten-year AAA muni yields 2.80%, which is much more appealing at 100% of the treasury yield. It’s been a wild ride, but this sell off may provide a silver lining for investors willing to step into the municipal market: municipal yields are higher and relatively attractive as financial metrics are improving for many municipalities.
The opinions expressed represent those of the author, and is not intended to be a forecast of future events, a guarantee of future results, nor investment advice. This commentary does not provide information reasonably sufficient upon which to base an investment decision. The information discussed herein, including specific securities, is solely intended for illustration purposes and do not represent all of the securities purchased or sold in client accounts. Furthermore, this should not be considered an offer or recommendation to buy or sell any security. All performance referenced is historical and is no guarantee of future results. Investing involves risks including possible loss of principal.