Pension Funding & State Finances


The relationship between municipal credit ratings and pensions is simple, and pension health has become a critical factor in determining states’ credit ratings. The funding rate of pension plans is indicative of a state’s long-term ability to manage general finances responsibly. For municipal issuers, credit rating is arguably the most important element when determining financing costs. Since the Great Recession, rating agencies have used pension funding as a dominant factor in their rating methodology.

Borrowing costs are typically higher for issuers with a history of financial stress related to debt repayment and revenue streams. Of course, state and local governments have varying pension funding levels and liabilities, some healthier than others. A portion of payroll taxes primarily funds the liabilities. The higher the liabilities, the more likely they will affect credit evaluations. Furthermore, pensions affect state and local government budgets because many states redirect general fund revenue receipts to the programs.

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Understanding Interest Rate Risk in Bond Funds


Since March of 2020, The Federal Reserve has kept the Fed Funds target rate at the 0-0.25% range to stimulate the economy, and elected to maintain that level at the most recent Federal Open Market Committee meeting. With the country beginning to reopen and return to normal, the idea of rising interest rates has resurfaced.

While the Fed continues to watch economic data to determine the target rate, long-term rates are still controlled by investor demand. Yields on the 10-year Treasury bond have inched up this year evoking an important aspect of investing in bond funds, understanding interest rate risk.

A common misconception of investing in bonds is that when interest rates rise, bonds fall out of favor as their prices drop. While the inverse relationship between interest rates and bond prices exists, there are many factors to consider when planning current and future bond holdings – whether to hold individual bonds or invest in a bond mutual fund.


A bond fund’s duration, specifically modified duration, is an indicator of how sensitive the net asset value is to a change in interest rates. Duration provides investors with another aspect of comparison between bonds with different maturities and coupon rates. Simply stated, for every 1% change in interest rates, positive or negative, the price of a bond fund will inversely decline or increase by its modified duration. For example, if a fund’s modified duration is 5 years, the net asset value could be expected to rise 5% for every 1% decline in interest rates and fall by 5% for every 1% increase in interest rates. Bond funds with longer average maturities and lower average coupons have a longer duration, and therefore generally experience a higher degree of price fluctuation, while bond funds with shorter average maturities and higher average coupons have a shorter duration and generally experience a lesser degree of price fluctuation.

Price Returns and Total Returns

The good news is that performance of bond funds is not solely tied to the incremental changes in interest rates. Bond fund total returns are generated from two sources; interest payments on bonds (paid as fund distributions) and changes in bond prices. While interest rates rise, active portfolio managers have opportunities to purchase bonds at higher yields, and over time, a portfolio’s income may offset a decline in the value of individual bonds, mitigating the impact of that decline on a Fund’s total return.

Since its inception in 1980, approximately 98.6% of the Bloomberg Barclays Municipal Bond Index total return has been generated by income.



Active Bond Fund Management

Periods of rising rates can be challenging for investors who purchase individual bonds or funds aligned with a bond index. Active bond fund managers have the ability to take strategic steps to mitigate, to some degree, the impact of market volatility. With the ability to actively manage fund holdings over time, these managers may implement a number of strategies to adjust fund holdings based on market expectations. Fund holdings may be altered by quality rating in an effort to manage credit risk – a risk that may increase along with rising rates. Holdings may also be altered by maturity date and coupon, thereby adjusting portfolio duration or the sensitivity of the portfolio to movements in rates. Reducing portfolio duration would reduce sensitivity to a change in rates.

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Bourbon Boom Creates Revenue for Kentucky


Whether you enjoy a glass occasionally or have sworn off brown liquor since college, there is no denying that bourbon distilling has once again become a big business for the state of Kentucky. Horses and coal put the state on the map, but bourbon is what is drawing the largest crowds, leading distillers to undergo capital improvements of over $2.3 billion collectively along the bourbon trail.

Distilleries in Kentucky employ just over 20,000 people with an annual payroll of close to $1 billion. Recent estimates show 9.2 million barrels of bourbon currently aging in rickhouses, a little over two barrels per Kentuckian, generating property tax revenues of approximately $29 million annually. While this is good news for the State’s finances, it is causing issues for distilleries big and small. Kentucky is the only state with a barrelage tax, which may ultimately be accountable for the sudden growth of distilleries outside of Kentucky. In 2014, the Kentucky legislature passed a corporate income tax credit to help offset the taxation, however, the rapid increase in aging barrels has greatly reduced the benefit of the tax credit. The value of aging barrels was around $3.8 billion in 2020, an increase of $400 million since 2019 and twice the assessed value of barrels in 2010.

Booms and busts

Before 2019, the previous peak of barrels in rickhouses was in 1968 when the state had 8.7 million barrels aging. Bourbon started losing its luster in the 1970s and was out of favor through the 1980s when rum and vodka took over the top spots nationally. During that time, much of the bourbon produced in Kentucky was exported overseas. However, prominent bourbon distillers saw an opening for another domestic bourbon boom in the late 1990s, when the Beverage Testing Institute in Chicago obtained a bottle of Pappy Van Winkle in 1997 and gave it a score of 99 out of 100 – the highest rating ever given to a whiskey. Anticipating the resurgence of bourbon enthusiasts, the Kentucky Distillers Association started the Bourbon Trail in 1999 with ten distillers. Today there are 38 distilleries only 20 minutes from each other, and the total barrelage has increased 164% since 2000.
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Kentucky Experiences Substantial Growth in Logistics


Kentucky revenue has held up well during the COVID-19 pandemic. General fund revenue for the current fiscal year was up 5.6% through the end of 2020, increasing 16.1% in December after a slight downturn in November. One notable business sector contributing to revenue growth in the state is logistics.

The business of logistics is a critical component of supply chains and is growing at a rapid pace in Kentucky, employing close to 83,000 people. Kentucky’s central location in the Ohio Valley makes it a prime spot for distribution across the United States for many suppliers and shippers. Leaders in the sector are pushing Kentucky legislators to provide funding and subsidies to help build out the State’s infrastructure in areas surrounding warehouses and airports. To date, lawmakers have provided resources to help with traffic problems around Shepardsville, where a third cloverleaf highway interchange has been completed to help alleviate tractor-trailer congestion.

To further ease major traffic problems related to the sector’s rapid expansion, a new warehouse area has been established slightly further south near the Bardstown exit off of Interstate 65. McKesson Corporation, the oldest and largest healthcare company in the nation, recently signed a lease in the Shepardsville area for a one-million-square-foot warehouse that is currently being used to distribute COVID-19 vaccines. Five weeks prior to the first vaccine shipping date in mid-December, the CDC along with project Warp Speed, was involved in helping build out refrigeration units to store vaccine doses for Pfizer and Moderna. With the world watching, the first shipment of Prizer-BioNTech vaccines departed the Louisville UPS Worldport Hub on December 13, 2020. The UPS Worldport Hub is the second-largest freight enplanement airport in the U.S. and fourth-largest worldwide.
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Taxable Municipals – Myths and Misperceptions


Anthony Tanner, CFA®

Taxable Municipal Bonds grabbed the attention of not only municipal bond market participants in 2020, but also of investors and financial professionals globally across the asset class landscape.

Nationally, new issue volume growth was confined to the burgeoning taxable municipal bond sector, where issuance doubled from $72.2 billion in 2019 to $145.2 billion in 2020. By comparison, tax-exempt issuance in the municipal bond market declined slightly from $354 billion to $328 billion.

The eye-popping issuance figures for taxable municipal securities made headlines throughout the year. The $145 billion of new taxable municipal bonds were issued as fully Federally taxable, but in most cases, retained the applicable state tax exemption. This accounted for almost one third of all municipal bonds issued and ultimately accounted for the entire increase in total issuance in 2020. The prominent rise of this mechanism in the municipal market occurred as a consequence of the component of the 2017 Tax Cuts and Jobs Act which eliminated tax-exempt advance refunding of tax-exempt issues.

Questioning The Tax Exemption – Again

With taxable municipals accounting for such a prominent slice of state and local government borrowing there has been growing speculation in the financial press, and among market participants, about what this means for traditional tax-exempt financing. Common viewpoints gaining traction have called into question the need for traditional tax-exemption in municipal finance and even suggested the success of taxable issuance in 2020 proves municipal bonds can exist without the tax-exemption.

This speculation has been fueled by a number of misperceptions about the municipal bond market and the nature of public finance. The explosion in taxable issuance ultimately resulted from the confluence of two watershed developments:

• The arbitrary prohibition of the advance refunding mechanism that had been a staple of municipal finance for 100 years.

• Generational lows in benchmark U.S. Treasury yields off of which the yields of other taxable securities are “spread” by a variety of taxable investors.

What these developments ultimately point to is the simple continuation of the old fashioned resourcefulness of the nation’s municipal finance officials: optimizing the borrowing costs of their taxpayers and constituents, rather than a long-run steady state “transformation” of the municipal bond market.

Tax Cuts and Jobs Act – Where It All Began

The 2017 Tax Cuts and Jobs Act (TCJA) was signed into law on December 22, 2017. It was hailed as significant tax reform, primarily for its reduction in marginal individual income tax rates, although its “significance” seems muted compared to the 1986 Reagan-style tax reform that dropped top rates from 50% to 28%. Of greater impact to the municipal market was its provision that prohibited the advance refunding of tax-exempt securities with proceeds from tax-exempt issues.
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Chris Johns Covered Munis on CNBC’s The Exchange


Aquila’s municipal bond fund portfolio manager, Chris Johns, was a recent guest on CNBC’s The Exchange with Brian Sullivan. Chris and Brian discussed the growing size of outstanding municipal bond debt and the importance of in-depth credit research in an environment where demand is high and credit spreads are narrow. Chris also shared his thoughts on current credit trends and the risk profile of municipals.

You can watch Chris’ segment on CNBC’s website, under The Exchange’s Muni Money section, or listen to the segment on The Exchange’s January 29th podcast; available on all podcast platforms.

Chris has managed Aquila Tax-Free Fund of Colorado for over 30 years and Aquila Tax-Free Trust of Oregon, which he co-manages with Tim Iltz, since 2011.

Shares of the Funds may only be sold by offering the Funds’ Prospectus. Before investing in a Fund, carefully read about and consider the investment objectives, risks, charges, expenses, and other information found in the Fund prospectus. The prospectus is available on this site, from your financial adviser, and when you call 800-437-1020.


Tony Tanner, CFA® on Money Life with Chuck Jaffe


Tony Tanner

Tony Tanner

Tony Tanner, CFA®, Municipal Bond Fund Portfolio Manager with Aquila Group of Funds, was recently interviewed on Money Life with Chuck Jaffe.

During their conversation, Tony discussed how the troubled economy and lower interest rates will impact the bond market and may lead investors to diversify their fixed-income holdings. He notes that while he doesn’t anticipate a big wave of municipal defaults, credit-quality will be challenged.

Chuck Jaffe is a veteran financial journalist and nationally syndicated financial columnist whose work appears in newspapers from coast to coast. He started the Money Life podcast in 2012, and previously hosted Your Money and various podcasts for MarketWatch, where he was a senior columnist.

We hope you enjoy the interview.

Before investing in a Fund, carefully read about and consider the investment objectives, risks, charges, expenses, and other information found in the Fund prospectus. All prospectuses are available on this site, from your financial advisor, and when you call 800-437-1020.


S&P Considers Kentucky Adequately Positioned for COVID-19 Pressures


Standard and Poor’s Global Ratings recently announced they consider the state of Kentucky “adequately positioned” to handle economic pressures brought on by the COVID-19 pandemic.

In an effort to effectively address the state’s rapidly changing needs, the Kentucky Legislature, which normally releases a biennial budget, passed House Bill 352 on April 15th, adopting an $11.4 billion one-year executive branch budget. The fiscal 2021 budget reduced the revenue forecast by $130 million, but S&P cited that they firmly believe Kentucky has sufficient near term liquidity to manage pressures brought on by economic hardships related to the pandemic. The bill also fully funds the teachers and state employees’ pension plans. Fiscal year 2021 will mark the second year in a row that Kentucky has made full contributions to those plans.

If excessive pressure does weigh on the state’s finances due to the current crisis, Kentucky also has the ability to issue Tax and Revenue Anticipation Notes (TRANs) amounting to 75% of estimated revenues anticipated throughout the year.

The recently passed Coronavirus Aid, Relief and Economic Security Act (CARES) created a Coronavirus Relief Fund for state and local governments which is expected to allocate $1.732 billion to Kentucky. Of that amount, $1.6 billion will go to the state, and $134 million will go to the city of Louisville and Jefferson County, the only local government under the law to quality for relief based on the number of residents. Kentucky will also receive approximately $410 million through CARES’ Education Stabilization Fund, which will fund K – 12 education and colleges and universities.

At Aquila Group of Funds, we have been monitoring Kentucky’s economic and credit strength since 1987. We have been pleasantly surprised recently by the resilience of sectors feeling the most stress. For example, the Louisville Jefferson County Airports have over $105 million of unencumbered investments in government agencies, and their annual budget is $75 million. We expect they will be able to withstand a fairly long reduction in revenue. We are also watching private colleges, and believe that they can handle the financial pressure due to their healthy endowments. We believe, through our ongoing analysis, that the state is well positioned to weather this storm with the recently passed budget and emergency government funding.

Before investing in one of the Aquila Group of Funds, carefully read about and consider the investment objectives, risks, charges, expenses, and other information found in the Fund prospectus. The prospectus is available on this site, from your financial advisor, or by calling 800-437-1020.


New Podcast: Recent Muni Market Volatility


We sat down with Portfolio Manager, Tony Tanner, CFA®, on March 17th to get his insight on the ongoing volatility in the municipal bond market and how the current conditions compare to prior periods of instability. Tony began his buy-side career managing two flag-ship single-state municipal bond funds in the early 1990s, and he has managed through a variety of volatile municipal bond markets, including the bond bear markets of 1994, 1999, 2008 & 2016. The podcast is linked below, and the full transcript is available here.

Manager Commentary

Aquila Funds Podcast

Length 20:25

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Aquila Funds

Tony Tanner

Portfolio Manager
Aquila Tax-Free Trust of Arizona