Muni Credit News February 23, 2017

Joseph Krist

Municipal Credit Consultant











The  Governor’s Budget  for the 2018-2019 biennium implements many of the 4 percent cuts suggested by state agencies and further reduces agency expenditures, except public school funding formulas and certain other priorities, by an additional 2 percent. It purports to do so without issuing new debt, raising taxes or utilizing the Economic Stabilization Fund. The Governor’s Budget calls for a business tax reduction, property tax reforms and maintaining funding for roads. This budget also calls for a constitutional amendment that would permanently limit the state’s spending growth to the rate of growth in population and inflation. This despite the fact that the legislature passed a budget for the current biennium that limited growth in state fund expenditures within this population and inflation benchmark.

It proposes to continue down the path to franchise tax elimination by cutting the rate to achieve another $250 million in savings for Texas employers. Other policy initiatives would adopt real revenue caps that prevent local governments from endlessly raising taxes without voter approval. Second, it calls for meaningful limits on the overlay of special purpose districts.

On the revenue side, The Governor’s Budget  utilizes  a four-year look back of historical population and inflation data. This methodology creates a 5.81 percent allowable growth rate, which is significantly below the lowest personal income growth estimate provided to the Legislative Budget Board (LBB) (9.9 percent) and well below the number adopted by the LBB (8 percent).

The budget does reference the local pension difficulties plaguing the State’s major cities but makes clear that, in the Governor’s view, there is no affirmative role for the State in resolving them. This budget calls for a constitutional prohibition on using state funds to bailout local pensions. A recent Attorney General Opinion has made clear that the state has no legal obligation to finance floundering plans. At the same time, the Governor’s comments on pensions are somewhat conflicting.

He expresses the view that the state government should get out of the business of micromanaging local pension decisions while unequivocally making clear that statewide taxpayers will not be on the hook to bailout local pensions. The entities that are financially responsible to their employees, retirees and taxpayers should work with municipal leaders, pensioners and stakeholders to develop solutions — are still dependent upon state action to implement meaningful changes.

In terms of how the biennial budget deals with the uncertainties of ACA repeal and replacement, it relies on block grants. In the Governor’s view, Block grants should be used for the administration of state-managed Medicaid programs, and Congress should act to authorize this important reform. The block grants should be designed in a way that protects states from cost growth due to population growth or the economy and should be accompanied by reforms that significantly reduce or eliminate federal requirements. The reformed Texas Medicaid program would include personal responsibility requirements for certain populations. This the approach favored by the most ideological conservatives.

One small in dollars but large in policy aspect of Gov. Abbot’s budget has already been challenged in the courts. A federal judge issued a preliminary injunction against a Texas plan to cut off funding for Planned Parenthood from the state’s Medicaid program. It is only some $4 million in question but it would complete efforts to eliminate PP from participation in Texas’ Medicaid program. State health officials let it be known in December that Planned Parenthood would no longer receive funding from the program. The group had 30 days before the change took effect unless it filed an appeal.

The preliminary injunction preserves what Planned Parenthood contends are funds to provide cancer screenings, birth control access and other health services for nearly 11,000 low-income women. Similar defunding efforts have also been blocked in Arkansas, Alabama, Kansas, Mississippi and Louisiana. All of these efforts simply create greater uncertainty about the viability of proposed budgets and, for the weaker credits, expose them to more downside risk.


House Bill 1002 passed the state’s lower legislative chamber. Among a variety of increases in fuel and motor vehicle taxes and fees, it also Repeals restrictions on when a tolling project can be undertaken.  The bill also includes a provision which Requires the Indiana department of transportation (INDOT) to seek a Federal Highway Administration waiver to toll interstate highways. It also limits the first toll lanes under the waiver to certain interstate highways and provides for a public comment period and requires replies to the public comments for a toll road project by INDOT or a tollway project carried out using a public private partnership.

The bill, by requiring an outside consulting firm to perform a tolling feasibility study, could increase INDOT expenditures in FY 2017. The state of Wisconsin recently published a tolling feasibility study (December 2016) that was performed by a third-party vendor. The reported costs for this study were$700,000. INDOT reports the cost of a tolling feasibility study could be between $200,000 and $500,000. Increases in INDOT expenditures for a tolling feasibility study would come from the State Highway Fund.


# of bridges         # deficient            % deficient

Iowa 24,184 4,968 20.5%
Pennsylvania 22,791 4,506 19.8%
Oklahoma 23,053 3,460 15.0%
Missouri 24,468 3,195 13.1%
Nebraska 15,334 2,361 15.4%
Illinois 26,704 2,243 8.4%
Kansas 25,013 2,151 8.6%
Mississippi 17,068 2,098 12.3%
Ohio 28,284 1,942 6.9%
New York 17,462 1,928 11.0%


The table depicts the ten states with the largest number of structurally deficient bridges in the U.S. as reported by the American Road and Transportation Builders Association.  Historically, Pennsylvania had been the dubious annual leader in this category but in the last two years has been overtaken by Iowa.

There are some common threads which run through this list. Pennsylvania, Illinois, and Kansas have all been known for their respectively dysfunctional budgeting processes. They have each let transportation funding lag with Kansas transferring money from highway funds to cover general fund shortfalls resulting from unrelated tax cuts. Each state on the list has a substantial rural component to their transportation system which leads to a larger number of smaller yet important bridges often which are the responsibility of entities below the state level. This has complicated funding for upkeep and replacement.

From our standpoint, it reinforces our view of the importance of infrastructure maintenance as Congress debates not only funding but project priority. Maintenance clashes with the well-known administration preference for new, big, and shiny projects. The empirical evidence would seem to lean in favor of restoration over new construction, especially in rural areas where commercial activities rely on a strong local transportation system to facilitate the movement of goods to market.


Many infrastructure proponents are looking to see whether Transportation Secretary Elaine Chao reconsiders her decision as to whether or not to allow federal funding at this time for a project in northern California. Caltrain formally petitioned the administration to reverse course on its recent decision to halt $647 million worth of grant money for the transit agency until the start of the federal fiscal year in October. Caltrain commuter rail that runs between San Francisco and San Jose. The rub is that the project would also eventually benefit the state’s high-speed rail project.

The electrification project is scheduled to begin on March 1. It is probably the best example of “shovel ready” around. The existing commuter rail line has experienced significant ridership increases and few doubt the need to increase capacity on that line. The work would most likely be needed regardless of its ability to facilitate the high speed rail project.

Based on that reality, the decision not to fund at this time is seen as politically motivated. Regardless of the ultimate outcome, it illustrates the difficulty in managing the politics and execution of any large scale infrastructure plan. Just in the case of rail expansion, major projects requiring significant funding are awaiting execution and funding decisions in Democratic strongholds including RTA updates in Chicago, a new trans-Hudson rail tunnel between New York and New Jersey and, the MBTA in Boston to name a few. Should political considerations become a prime funding consideration all of these projects could be at risk. In Chicago and Boston, negative decisions would be seen as having potentially negative impacts on the underlying credits sponsoring those projects.


The plans announced this week to ramp up efforts by the Trump administration to deport larger numbers of undocumented aliens may have resulted in an unintended benefit for investors in high yield local detention facility bonds. The sector had been under pressure as the result of announcement by the DOJ under the Obama administration to significantly curtail the use of these facilities for a variety of reasons. There was also concern that policies that deemphasized deportations would reduce demand for cells by the Immigration, Customs, and Enforcement Service which used these facilities to hold potential deportees while they awaited final adjudication of their cases.

Under the plans announced this week, a much higher level of apprehension and detention of the undocumented would result. This would create a much higher level of demand for cells, thereby reducing the short-term financial risk associated with these projects. This change in policy should create – at least as long as it remains in effect – an opportunity for investors in this sector.

The whole turn of events does highlight the long term political risk of investment in this class of bonds. It renders individual project economics less relevant to investors. It also shows how quickly the outlook for these credits to change. We are always less comfortable when the foundation for a credit is not fundamental economic viability so we still believe that it is a class of bonds that individual investors should curb their enthusiasm for.


In our last issue, we outlined the Governor’s proposal for a fiscal year 2018 budget. Before the budget process was allowed to play out, Moody’s announced that it has downgraded the State of West Virginia’s general obligation debt to Aa2 from Aa1, affecting approximately $393.6 million in debt outstanding. The state’s lease appropriation and moral obligation debt has been downgraded one notch to Aa3 and A1, reflecting the ties to the general obligation rating.

Moody’s said that “the downgrade of the general obligation and related lease ratings expenditures and available resources, which is generally inconsistent with a Aa1 rating. While the state has used a mixture of revenue enhancements, expenditure reductions and reserves to close budget gaps, revenues continue to lag budgeted estimates and the structural imbalance is likely to continue at least through 2018. Additionally, while the economy has begun to stabilize some, the demographic profile remains weak. Pension liabilities remain above average and the state’s debt burden could increase under the Governor’s new infrastructure proposal.”

At the same time, Moody’s expressed its view that the economy is stabilizing and liquidity remains healthy, allowing the state financial flexibility to weather a slower rebound. Additionally, it expects the state to continue with what it called its prudent management practices, managing through what will likely be a longer term but more moderate revenue decline.


We recently discussed ongoing litigation over the rights of general obligation versus those of COFINA bondholders to revenues legislatively dedicated to outstanding COFINA debt.  Since then there have been new developments. The COFINA Senior Bondholders, the Puerto Rico Funds, and the Major COFINA Bondholders, all  own COFINA bonds in differing amounts. If no federal statute grants an unconditional right to intervene, the Court is nonetheless required to grant a party’s motion to intervene if that party has “demonstrate[d] that: (1) its motion is timely; (2) it has an interest relating to the property or transaction that forms the foundation of the ongoing action; (3) the disposition of the action threatens to impair or impede its ability to protect this interest; and (4) no existing party adequately represents its   interest”.

The Puerto Rico Funds and the Major COFINA Bondholders’ made respective motions to intervene which raise similar arguments as to why each should be permitted to intervene as of right. Specifically, both the Puerto Rico Funds and the Major COFINA Bondholders argued that they have an interest in the revenues that back the COFINA bonds which they hold.  The Puerto Rico Funds and the Major COFINA Bondholders asserted that no existing party to this action can adequately represent their respective interests.

The COFINA Senior Bondholders’ motion to intervene was denied in light of the Court’s conclusion that the PROMESA counts are not stayed. The Court is satisfied that the Puerto Rico Funds and the Major COFINA Bondholders have met their modest burden of showing that there is a possibility that no named defendant may adequately represent their interests. That rests on the somewhat technical issue that BNYM Trustee — the named defendant the GO Bondholders allege adequately represents the interests  of  the  Puerto  Rico  Funds  and  the  Major COFINA Bondholders—has moved to dismiss the second amended complaint in this case on grounds that could result in BNYM Trustee being dismissed as a defendant.  Should BNYM Trustee prevail on its motion to dismiss, no COFINA Bondholder representative would remain as a litigant in this case unless the Court permits intervention.

The Court denied the Commonwealth Defendants’ motion to stay, and the COFINA Senior Bondholders motion to intervene . The Court granted  the motions to intervene of the Oversight Board, Ambac, the Puerto Rico Funds, and the Major COFINA Bondholders. So it would seem that opposing interests have been aligned with each other making for a much more difficult process of speculating as to how this is all going to turn out. We are comfortable with saying that a final resolution is a long way off and that we are glad to be in the position of spectator rather than speculator with anything at risk.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

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