Tax Policy News: New York, California

Muni update

Tax Policy News: New York, California

Proposals in two key states would change the landscape for the largest issuers and their investors.


Municipals Outperformed During the Week

AAA municipal yields moved 7-10 basis points lower during the week, outperforming Treasuries and leading the Municipal/Treasury ratios lower to 69%-103% across the yield curve. The Bloomberg Barclays Municipal Index returned 0.47%, while the HY Muni Index returned 0.75%.

Technicals: Strong Fund Flows Continue

Fund Flows: During the week ending August 5, municipal mutual funds reported a 13th consecutive week of inflows at $1.6 billion, according to Lipper. Long-term funds recorded $610 million of inflows, high-yield funds recorded $103 million of inflows and intermediate funds recorded $14 million of inflows. Municipal fund net inflows YTD now total $6.0 billion.

Supply: The muni market recorded $8.8 billion of new-issue volume last week, up 18% from the prior week. Issuance of $256 billion YTD is 30% above last year’s pace, primarily driven by taxable issuance, which is approximately 4.5x last year’s levels and comprises 30% of YTD issuance. We anticipate approximately $10 billion in new issuance this week (+17% week-over-week), led by $1.4 billion LA MTA and $561 million taxable Michigan State Building Authority transactions.

This Week in Munis: Tax Policy Makes Headlines in New York and California

More tax policy rhetoric came into focus in California and New York last week, which would have direct implications for the municipal market’s largest issuers and investors.

A proposal in California detailed a retroactive income tax hike that would raise the top rate to 16.8% from 13.3%. Proponents forecast that the proposed tax increase could raise close to $7 billion and help close an estimated $55 billion state budget deficit. Opponents argue that passage would cause wealthy taxpayers to flee California and detract from long-term growth prospects. The most recent tax-increase legislation that raised California’s top rate to 13.3% passed by a margin of 55% to 45% in 2012 and was extended in 2016.

Last Tuesday, New York Governor Andrew Cuomo pleaded with New York City’s wealthiest residents to return to the city, highlighting the top one percent of the city’s population pays 50% of the tax revenues. New York City faces a $30 billion budget deficit due to the pandemic and it will be exacerbated if those who have left the city do not return in a post-COVID world.

This week’s rhetoric highlights the sizeable budgetary challenges faced by the municipal market’s largest issuers, as well as the demand for federal aid to help cure budgetary shortfalls. Absent significant federal aid, we anticipate austerity measures that would result in downgrades across the municipal market. At the same time, the prospect of higher taxes is a tailwind for tax-exempt municipal valuations and demand prospects. For California residents, considering a 16.8% top tax rate, we anticipate the taxable-equivalent yield of a 30-year state general obligation security would increase 24 bps from 2.94% to 3.18%.

 

Exhibit 1: California Bonds—Nominal vs. Taxable Equivalent Yields

Source: Bloomberg. California 30-year representative yield is the 30-year California BVAL yield. As of 07 Aug 20.  Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

Exhibit 2: Municipal Bond Yields and Index Returns

Sources: (A) Muni yields: Thomson Reuters Money Market Directory; Treasury Yields: Bloomberg. As of 07 Aug 20. (B) Bloomberg. Taxable-equivalent yield assumes a top marginal tax rate of 40.8%. As of 07 Aug 20. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

Exhibit 3: Tax-Exempt and Taxable Municipal Valuations

Source: (A) Bloomberg, Western Asset. AAA, AA, A, BBB Corporate Indices. After-tax yield assumes a top effective tax rate of 40.8%. As of 07 Aug 20. (B) Bloomberg, Western Asset; Taxable Muni Index Corporate comparable used is the long corporate (ex. BBB) to better align credit quality and duration. As of 07 Aug 20.  Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


Definitions:

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

credit rating is a measure of an issuer’s ability to repay interest and principal in a timely manner. The credit ratings provided by Standard and Poor’s, Moody’s Investors Service and/or Fitch Ratings, Ltd. typically range from AAA (highest) to D (lowest). Please see www.standardandpoors.com, www.moodys.com, or www.fitchratings.com for details.

The Bloomberg Valuation Service (BVAL) provides transparent evaluated price information for a variety of financial instruments, including GSAC sector bonds (Government, Supranational, Agency, and Corporate), mortgage backed securities, municipal bonds, and over-the-counter derivatives.

Investment-grade bonds are those rated Aaa, Aa, A and Baa by Moody’s Investors Service and AAA, AA, A and BBB by Standard & Poor’s Ratings Service, or that have an equivalent rating by a nationally recognized statistical rating organization or are determined by the manager to be of equivalent quality.

High yield (HY) bonds, also called junk bonds, are bonds with below investment-grade ratings (BB, B, CCC for example) and are considered low credit quality and have a higher risk of default.

The Bloomberg Barclays Municipal Bond Index is a rules-based, market value-weighted index engineered for the long-term tax-exempt bond market.

The Bloomberg Barclays Municipal High Yield (HY) Index is market value-weighted and designed to measure the performance of U.S. dollar-denominated high-yield municipal bonds issued by U.S. states, the District of Columbia, U.S. territories and local governments or agencies.

The Bloomberg Barclays Investment Grade Municipal Bond Index is a rules-based, market value-weighted index engineered for the investment-grade long-term tax-exempt bond market.

One basis point (bps) is one one-hundredth of one percentage point.

Revenue bonds are supported by the revenue from a specific project, such as a toll bridge, highway, or local stadium.

General obligation (GO) bonds are issued directly by state or local governments or their agencies to meet essential government functions such as schools and highway construction. These bonds are backed by the issuer’s pledge and its full faith, credit and taxing power to meet interest and principal payments.

Yield-to-Worst (YTW) is the yield generated assuming a bond is redeemed by the issuer on the least desirable date for the investor. Yield-to-Worst for the asset class is calculated as the weighted average yield to worst of the individual constituent bonds.

spread is the difference in yield between two different types of fixed income securities with similar maturities; usually between a Treasury or sovereign security and a non-Treasury or non-sovereign security.

The Municipal/Treasury Ratio (M/T ratio or muni-Treasury ratio) is a comparison of the current yield of municipal bonds to U.S. Treasuries. If the yield on AAA munis is 1.5% and the yield on the 10-year Treasury is 2.0%, the ratio is 0.75. The higher the muni-Treasury ratio, the more attractive munis are relative to Treasuries.

Top

Important Information

 

All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. 

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.  Unless otherwise noted the “$” (dollar sign) represents U.S. Dollars.

This material is approved for distribution in those countries and to those recipients listed below. Note: this material may not be available in all regions listed.

All investors and eligible counterparties in Europe, the UK, Switzerland:

In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office 6th Floor, Building Three, Number One Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4, D04 EP27. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

All Qualified Investors in Switzerland:
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH. Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All investors in the UK:
In the UK this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People's Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC's commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC's commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (109) Jin Guan Tou Gu Xin Zi Di 016; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC.

All Investors in Australia and New Zealand:

This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827).  The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

The aforementioned Legg Mason entities are wholly owned subsidiaries of Franklin Resources, Inc.