Muni Credit News March 21, 2017

Joseph Krist

joseph krist,











Those looking for clues about how Trump budget policies would support campaign rhetoric supporting infrastructure spending, got some last week. Trump would slash programs that invest in rural infrastructure. The “skinny plan” proposes to eliminates the “duplicative” Water and Wastewater loan and grant program, a savings of $498 million from the 2017 annualized continuing resolution (CR) level. Rural communities can be served by private sector financing or other Federal investments in rural water infrastructure, such as the Environmental Protection Agency’s State Revolving Funds according to the document. It eliminates the Economic Development Administration, which provides small grants with, in the view of this administration provides limited measurable impacts and duplicates other Federal programs, such as Rural Utilities Service grants at the U.S. Department of Agriculture and formula grants to States from the Department of Transportation. By terminating this agency, the Budget saves $221 million from the 2017 annualized CR level.

It increases DOD’s budget authority by $52 billion above the current 2017 level of $587 billion. This increase alone exceeds the entire defense budget of most countries, and would be one of the largest one-year DOD increases in American history. It is exceeded only by the peak increases of the Reagan Administration and a few of the largest defense increases during the World Wars and the conflicts in Korea, Vietnam, Iraq, and Afghanistan (in constant dollars, based on GDP chained price index). Unlike spending increases for war, which mostly consume resources in combat, the increases in the President’s Budget primarily invest in a stronger military.

As for specific sectors supporting municipal bonds, the budget proposes an additional $1.5 billion above the 2017 annualized CR level for expanded detention, transportation, and removal of illegal immigrants. This bolsters the private and contract prison sector. At airports, the budget proposes to raise the Passenger Security Fee to recover 75 percent of the cost of TSA aviation security operations. This will make it harder to raise other PFCs for capital needs. The Federal Aviation Administration’s funding for commercial service to rural airports takes a major cut.

Mass transportation would be seriously impacted. The American Public Transit Association has identified 23 projects around the nation which would face viability threatening funding shortfalls if the Trump budget proposals are adopted. Among those projects are some which we have previously discussed in the Muni Credit News. They include Chicago’s proposed Red and Purple Line Modernization Project; Maryland’s Purple Line; New York and New Jersey’s Hudson Tunnel Project; and New York’s Second Avenue Subway Phase 2.

States will be pressured by the proposal to eliminate or reduce State and local grant funding by $667 million for programs administered by the Federal Emergency Management Agency (FEMA) that are either unauthorized by the Congress, such as FEMA’s Pre-Disaster Mitigation Grant Program, or that must provide more measurable results and ensure the Federal Government is not supplanting other stakeholders’ responsibilities, such as the Homeland Security Grant Program. For that reason, the Budget also proposes establishing a 25 percent non-Federal cost match for FEMA preparedness grant awards that currently require no cost match. This is the same cost-sharing approach as FEMA’s disaster recovery grants. The activities and acquisitions funded through these grant programs are viewed in this budget as primarily State and local functions. $210 million is eliminated for the State Criminal Alien Assistance Program, in which two-thirds of the funding primarily reimburses four States for the cost of incarcerating certain illegal criminal aliens.

An additional pressure on states is the proposal to decrease Federal support for job training and employment service formula grants, shifting more responsibility for funding these services to States, localities, and employers. It eliminates funding for specific regional efforts such as the Great Lakes Restoration Initiative, the Chesapeake Bay, and other environmental programs. These program eliminations produce spending $427 million lower than the 2017 annualized CR levels. The Budget returns the responsibility for funding local environmental efforts and programs to State and local entities. It eliminates infrastructure assistance to Alaska Native Villages and the Mexico border.

Cuts to HUD’s Community Development Block Grant program, which since the 1970s has devoted billions to helping improve housing and living conditions in cities, would be eliminated. How great an impact would that be? For example,Michigan communities could lose some $111 million compared to the current year — including $31 million for Detroit. The rest would be spread around the state, including $5 million for Wayne County, $4 million for Oakland County and nearly $2 million for Macomb County. In Detroit, CDBG funds have helped pay for homeless shelters and transportation for seniors as well as defraying costs for rehabilitation projects for housing and some acquisition and demolition costs in the city’s fight against blight. The loss of another HUD program would cost state communities $29 million total.

What is missing may be the most important consideration to the municipal market and that is tax policy. There is nothing to indicate what the Trump administration policy is towards municipal bonds and the tax exemption for them. So from the point of view, the document is fairly useless. As a policy document, the “skinny budget” comes up quite short but this is to be expected given the White House-centric nature of this administration’s policy apparatus. Effectively, it is a political document that provides few directional surprises so it does not provide much of use to those who are trying to make current investment decisions.


In 2015 to boost funding for the state’s public roadways and bridges, which have strained under a growing population, Proposition 7 amended the Texas Constitution to route some taxes collected on car sales to the State Highway Fund.  Some 83 percent of voters supported Proposition 7.

Nonetheless, the Texas House’s chief budget writer filed legislation last week that would pave the way for lawmakers to claw back billions of dollars that voters approved for state highways, freeing them up for other budget needs. House Appropriations Chairman John Zerwas  filed a resolution that would cut that initial cash infusion, aiming to free up money at a time when cash is tight. House Concurrent Resolution 108 could cut the first transfer under Proposition 7 of nearly $5 billion in half, but only if two-thirds of lawmakers in both the House and Senate support such a move.  It is possible because of  a “safety valve” in Senate Joint Resolution 5, the legislation that the Legislature approved in 2015  to send Proposition 7 to voters later that year.

At the Texas Department of Transportation, agency officials have  plans for all of the Prop 7 money. Gov. Greg Abbott also released a proposed budget in January that called for directing all of the Prop 7 funds to TxDOT as voters intended. Tax cuts in 2015 cut available state revenues by about $4 billion, and a slowdown in the oil patch also shrunk the budgetary pie. The voter-approved transfer of funds to the highway fund would leave even fewer dollars available to put toward areas such as health care, education and the state’s collapsed foster care system.

It is ironic that highway funding, often the subject of specific voter actions in support of infrastructure spending, is the source of budget bailouts for states experiencing general revenue shortfalls whether because of lower overall economic activity or as the result of poorly thought through tax cuts. Kansas is the most obvious example. The moves to use these funds merely provide temporary budget relief but then diminish the credits supported by transportation related revenues. So in the end neither credit experiences long term benefit.


We have recently commented on our view of the highly negative anticipated impacts of the AHCA in its present form on state credits. Recent statistics show that Employment in health care also continued to trend up in January (+18,000), following a gain of 41,000 in December. The industry has added 374,000 jobs over the past 12 months. While many focus on the higher end jobs in the healthcare sector, the reality is that healthcare has largely stepped into the role which manufacturing used to serve as a source of jobs for the less skilled, less educated, and immigrant populations in the workforce. The loss of these jobs would have serious implications for state budgets on both the tax and expense sides of the ledger. Recent academic work has supported our concerns. One example is a study from the Milken Institute School of Public Health at George Washington University. That study indicates that consequences of repealing both premium tax credits and Medicaid expansions include: About 2.6 million jobs could be lost nationwide in 2019, rising to almost 3 million by 2021. Every state would experience major job losses. Almost all of the jobs lost are in the private sector. Almost  a  million (912,000) are in health care, while the remaining two-thirds are in other industries, including construction, real estate, retail trade, finance and insurance. States with the highest job losses in 2019 include: California (334,000 jobs), Florida (181,000), Texas (175,000), Pennsylvania (137,000), New York (131,000), Ohio (126,000), Illinois (114,000), Michigan (102,000), New Jersey (86,000), and North Carolina (76,000).  The states with the highest percentage of healthcare employment versus total employment in excess of 10% are West Virginia, Rhode island, Ohio, Maine, Massachusetts, Mississippi, Pennsylvania, North Carolina, and New York. All of them are states in which manufacturing used to serve as a source of jobs for the less skilled, less educated, and immigrant populations in the workforce. They also will see the impact in their major cities. Estimates of the share of employment in represented by healthcare in cities ravaged by a declined manufacturing bases include Cleveland -11.2%, Pittsburgh-10.4%, Detroit-10.3%, Philadelphia-10.5%, Youngstown-10.7%, Providence-11%, Charlestown WV- 11.4%. Louisville, Gary IN, Cincinnati are all above the national average of 9%.

15 Republican governors have raised concerns about the House GOP’s health care bill amid the fiery debate surrounding the long-promised repeal of Obamacare. And no governors have publicly expressed strong support for the American Health Care Act. Arkansas Gov. Asa Hutchinson said “There needs to be some adjustments to relieve some of that cost-shift to the states and to make sure we don’t go back to where we were before, which was that we just had our emergency rooms filled with those who did not have coverage.” “Phasing out Medicaid coverage without a viable alternative is counterproductive and unnecessarily puts at risk our ability to treat the drug-addicted, mentally ill and working poor who now have access to a stable source of care,” Ohio Gov. John Kasich said.

Recent research by the Urban Institute and Dobson, DaVanzo & Associates estimated a $400 billion loss in total hospital revenue from 2018 to 2026 and $166 billion loss in net income would rise by $1.1 trillion from 2019 to 2028. This would lead to significant pressure to include higher uncompensated care funding from already strained state budgets. Those states would also experience declines in revenues from lower sales and income taxes resulting from lower employment and lower purchasing by hospitals and care providers. There is almost nothing favorable for the states in this legislation.


The CalPERS’ board voted on December 21, 2016, to lower the discount rate to 7.375% from 7.5% in the upcoming actuarial valuation for June 30, 2016; 7.25% in the 2017 valuation; and 7.0% in the 2018 valuation. Six weeks later, on February 1, 2017, the CalSTRS board decided to move slightly faster, reducing its discount rate to 7.25% in the 2016 valuation and 7.0% in 2017 from 7.5%. The two largest public pension systems in the U.S. both have committed to lowering their discount rates without changing their funds’ asset allocations.

S&P explains that CalPERS’ discount rate had an inflation assumption of 2.75% and a real rate of return of 4.75%. The real rate of return is scheduled to decrease 0.5% over the next three years while the inflation assumption is stable and will be looked at in 2018 in the experience study, which CalPERS conducts every four years. The impact on the cost of earning a year of service (the normal cost) will add 1% to 3% of pay for non-safety groups and 2% to 5% for most safety groups. S&P expects most unfunded liability payments to increase 30% to 40% over the next seven years as the costs are realized. For the state alone, that will ultimately mean contributing $2 billion a year more toward pension costs.

Reducing the discount rate will accelerate the slope of cost increases, intensifying the pressure that state and municipalities will face as growing pension contributions account for larger portions of their budget, especially in this slow revenue growth environment. Reducing the inflation assumption softens the discount rate reduction’s impact. Pension benefits are calculated based on years of service and salary, so a lower inflation assumption implies that salaries are growing more slowly than before, lowering projected benefits and total liability.  Reducing the inflation assumption softens the discount rate reduction’s impact. Pension benefits are calculated based on years of service and salary, so a lower inflation assumption implies that salaries are growing more slowly than before, lowering projected benefits and total liability.  State legislation AB 1469 sets the contribution rate for schools through fiscal year 2021. This schedule more than doubles their contribution rates from fiscal years 2015 to 2021, so S&P anticipates significant strain on schools’ budgets over the next several years. However, while their contributions will continue to increase due to the phase-in of AB 1469, the effect of the discount rate change has no impact on school contribution rates until fiscal 2022. Even after that window opens, school yearly contribution changes are capped at 1% and in total can only grow by 1.15% more than the bill’s current schedule. So absent further statutory changes, the resulting contribution burden to schools is both delayed and limited to a minimal 1.15% of their payroll. The result is to raise the near term cost of pensions for both the state and its localities and school districts. Ultimately, the total obligation for pensions will see slower growth thereby reducing the total liability. This then improves the liability side of the balance sheet resulting in a more favorable credit profile. As a result, S&P takes a more positive view of California’s credit profile.


The initial market reaction to Puerto Rico’s plans for limited debt service payments was negative based on limited trading. The fiscal plan certified for the administration of Ricardo Rosselló, for the next 10 years, allocates $800 million for the payment of debt starting in 2019. The government’s debt obligations range from $3.8 billion to $5 billion a year over the next decade. It is the government’s position that $800 million is the amount available and that  this should serve as a base assumption for a restructuring.

One of the disappointing aspects of the situation is contained in comments from the fiscal board. The board’s interim executive director said that its approach over the past few months was to certify a fiscal plan and ensure that by the end of this year the government can achieve enough savings to continue to meet pension obligations to retirees and the ability to manage the healthcare system when Affordable Care Act funds are exhausted.

The fiscal plan certified for the next 10 years included Cofina and funds subject to clawbacks as part of the general fund revenue. The assumption in the fiscal plan assumes that in a debt restructuring these funds are available for the payment of general expenses. The board’s emphasis now is on reaching consensual agreements that restructure the debt at a level that is sustainable for Puerto Rico.

That language builds in a bias in favor of public services and more importantly, pensioners. This would continue a pattern of pensioners being treated much more favorably than bondholders. The difference here between this and other municipal bankruptcy situations is the existence of the constitutional provisions in favor of bondholders. We understand the practical and political realities of the Commonwealth’s financial and debt situation. We remain troubled by the precedent which would be set if a restructuring deal  were ultimately forced upon bondholders that resulted in less than full payment for the general obligation debt.


In January, we discussed the economic impact of foreign students in the U.S. We highlighted the growing importance of these full tuition consumers of education to an increasing number of institutions, especially state institutions who have suffered declining state support. Now there is news which may expose the vulnerabilities inherent  in relying on that demand cohort.

A survey undertaken by a a coalition of six higher education associations in February 2017 produced the following findings from more than 250 U.S. institutions which responded to the short survey, with representation of all sizes, types and geographic diversity of higher education in the United States. 39% of responding institutions reported a decline in international applications, 35% reported an increase, and 26% reported no change in applicant numbers. There are more than 100,000 students studying in the U.S. from the Middle East, making up just under 10% of our international student enrollment nationwide. 39% of institutions have reported declines in undergraduate applications for Fall 2017 from the Middle East. 31% of Institutions have reported declines in graduate applications for Fall 2017 from the Middle East.

Almost half a million Indian and Chinese students study in the U.S. 26% of institutions have reported undergraduate application declines from India and 25% reported application declines from China. o 32% of institutions have reported graduate application declines from China, and 15% have reported application declines from India.

The most frequently noted concerns of international students and their families, as reported by institution-based professionals, include a perception of a rise in student visa denials at U.S. embassies and consulates in China, India and Nepal; a perception that the climate in the U.S. is now less welcoming to individuals from other countries; concerns that benefits and restrictions around visas could change, especially around the ability to travel, re-entry after travel, and employment opportunities; and concerns that the Executive Order travel ban might expand to include additional countries.

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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