Game Changer: How the American Rescue Plan Improved the Outlook for Munis
In a complete reversal from what was expected roughly a year ago, the outlook for muni issuers is much brighter.
In a complete reversal from what was expected roughly a year ago, the outlook for muni issuers is much brighter. Shortly after the onset of the COVID-19 crisis, there were concerns that issuers would face a tsunami of downgrades and potentially defaults. That didn’t happen. It didn’t happen because the crisis had a disproportionate impact on different parts of the economy, and due to the swift and substantial fiscal support.
Since March 2020, there have been six separate bills totaling about $5.3 trillion. The most recent one, the American Rescue Plan (ARP), is a game changer for the muni market. The bill provides a large amount of direct aid for many different types of municipal issuers, as well as several provisions that should support economic growth and indirectly support many muni issuers. It's not all rosy for the muni market, though. Although the risk for a wave of downgrades has waned, yields are low relative to comparable alternatives. As a result, we suggest investors moderately add some lower rated investment grade muni exposure as they provide more attractive yields than the higher rated part of the investment grade muni market.
The effect on muni issuers wasn’t as bad as originally expected
The economic fallout from the COVID-19 crisis hurt many workers and businesses. However, it wasn’t nearly as bad as expected for the muni market, partly because of the disproportionate effect it had economically on lower- vs. higher-income earners. According to the Pew Research Center, 47% of lower-income households reported they had been “laid off/lost a job” or “had to take a cut in pay.” This compares to 32% for high-income earners. This matters for state governments because the largest source of revenues for many states are income taxes. Many states also have a progressive tax structure, in which higher-income earners are taxed at a higher rate.
Since March 2020 (the start of the COVID-19 crisis) through December 2020, revenues were higher in 21 states relative to the same period in 2019. The states that saw larger declines either don’t have a state income tax, like Washington, Texas, and Florida, or are largely dependent on the travel and tourism industry, like Nevada and Hawaii. The travel and tourism industry has been one of the hardest-hit industries.