Unlocking Value: Trading Private Credit’s High Fees, Impaired Liquidity, and Declining Floating Rates for the Tax-Free Certainty and Security of Municipal Bonds
The municipal bond market navigated a turbulent first quarter in 2026, characterized by a “tale of two halves.” While the year began with robust demand and falling yields, a sharp reversal in March, driven by reignited inflation fears and the outbreak of the conflict in the Middle East, erased early gains. Despite this volatility, the fundamental case for municipal bonds has strengthened, particularly as a transparent and liquid alternative to the increasingly opaque private credit market.
Q1 2026 Market Performance and Yield Dynamics
The first two months of 2026 saw municipal bonds off to one of their strongest starts since 2020, with the Bloomberg Municipal Bond Index gaining over 2% through February. However, March brought a significant repricing due to geopolitical strife, with the 10-year tax-exempt benchmark yields, which had bottomed at 2.52% in late February, rising to end the quarter at 3.12% — a 59-basis point jump in a single month, according to the Municipal Market Data AAA muni curve.
Key drivers of the Q1 performance included1:
- Technical Conditions: Record issuance in 2025 continued into Q1 2026, with total volume reaching $129.6 billion, up 7% year-over-year.
- Resilient Inflows: Despite March’s volatility, tax-exempt mutual funds and ETFs saw nearly $26 billion in net inflows for the quarter, comfortably absorbing supply, illustrating strong retail appetite.
- Yield Curve Shifts: The long end of the curve (30-year) became particularly attractive as the Muni/Treasury ratio rose to 91%, the highest level in nearly two years.
The Rising Tide of Local Taxes
In our recent Clinton Investment Jan Commentary, we highlighted a critical and growing risk: the increasing frequency of state and local tax increases across the country. We note that, while state-level credit fundamentals remain generally stable, local municipalities are increasingly choosing to raise income taxes on the wealthy to balance budgets as pandemic-era federal aid is fully exhausted and to address growing unfunded mandates.
We see this trend accelerating, evidenced by tax increase proposals in CA, VA, RI, and ME, together with passage of a 9.9% income tax increase in the state of Washington on those making more than $1 million, effective in 2028. Recently, the state of Illinois began considering a 3% “millionaire’s tax” on high earners.
Munis vs. Private Credit: The Safety and Yield Advantage
As the Federal Reserve continues to cut short-term rates, the landscape for income-seeking investors appears to be shifting away from floating rates, preferred savings, money market funds, and private credit, toward municipal bonds.
The Decline of Private Credit
Private credit, once the darling of the “yield at any cost” era, is facing significant headwinds in 2026.
- Fee and Liquidity Burdens: Private credit funds often charge high management and performance fees (e.g., 2% and 20%) and frequently utilize “lock-ups” and “gates” that prevent investors from freely accessing their capital during market stress, as is occurring with increasing frequency in the current environment, evidenced by the plethora of news articles referencing funds implementing these tactics.
- Floating Rate Risk: Most private credit loans are floating rate. As the Fed cuts rates, the yields on these loans will naturally decline, potentially eroding the income profile that attracted investors initially.
- Default Concerns: A recent quote from Fitch Ratings highlights the rising fragility in this sector, estimating a private credit default rate of roughly 6%.2 By contrast, municipal bond default rates remain historically below 1%, according to Moody’s.3
The Taxable Equivalent Yield (TEY) Calculation
Municipal bonds currently offer a compelling alternative to private credit and other taxable fixed income instruments. with TEY’s of 8% to 9% for those in the highest tax bracket, seeking protection from federal, state, and local taxes. For example, if a long-term muni bond offers a 5.00% tax-free yield (as seen recently in the 20-30 year area of the curve for NY), the TEY is approximately 8.45%.4
The visualization above illustrates how a base tax-free yield of 5.00% scales as the investor’s tax burden increases. In high-tax states like New York or California, the TEY can easily surpass 9.5% when accounting for both federal and state exemptions.
Conclusion
The first quarter of 2026 reaffirmed that while municipal bonds are not immune to interest rate volatility, they have historically been, and we believe will remain, among the most resilient and sound investments for high-income investors. When one considers the rising pressure to raise state and local taxes, especially on high-income earners, together with the rising default concerns, high fees, and declining floating rate yields in private credit, municipal bonds remain a compelling alternative given their return profile, credit stability and higher level of liquidity they offer investors.
This material has been provided for informational purposes only and is not intended by Clinton Investment Management to provide and should not be relied on for tax, legal or accounting advice. If such advice is required, please consult with your own tax, legal and accounting advisors.
Please remember that past performance may not be indicative of future results. Net-of-fee performance returns are calculated by deducting the actual Clinton Investment Management, LLC investment management fee from the gross returns. Performance returns include the reinvestment of income and capital gains. Actual results may differ from the composite results depending upon the size of the account, investment objectives, guidelines and restrictions, inception of the account and other factors. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product, made reference to directly or indirectly in this newsletter (article), will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter (article) serves as the receipt of, or as a substitute for, personalized investment advice from Clinton Investment Management, LLC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Please consult with an investment professional before making any investment using content or implied content from any investment manager. A copy of our current written disclosure statement discussing our advisory services and fees is available upon request.
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1Source: Municipal Securities Rule Making Board
2Fitch: U.S. Private Credit Default Rate Continues Upward March to 5.8% in January 2026
3Moody’s: US municipal bond default and recovery rates, 1970-2024 | Default Report | Moody’s
4The taxable equivalent yield is calculated by dividing the tax-exempt yield by 1- the maximum federal income tax rate of 40.8% (37% federal + 3.8% NII tax).
