Increasing fuel efficiency has led to declining revenues from the 18.4 cent tax per gallon that feeds the transportation trust fund and that economic picture is only slated to get worse: new federal fuel efficiency standards have mandated that auto makers increase average fuel economy to 54.5 miles per gallon by 2025. According to the Congressional Budget Office, the trust fund will become insolvent as early as 2015 as expenditures continue to outpace revenue growth.
But two more wrinkles have been added: since 2009, highway funding has been authorized in short term funding extensions as opposed to multi-year renewals by Congress. The bursts have created uncertainty about the fund’s long term future with the latest authorization set to expire in the fall of 2014. And more recently, several ratings agencies downgraded or revised outlooks of Grant Anticipation Revenue Vehicle (GARVEE) bonds that are repaid with money issued from the trust to states.
“The sequestration issue put a fly in the ointment,” says Wells Fargo Senior Analyst Randall Gerardes. “The general fund is subject to that even though the trust fund is not. So, if funds are sequestered and not transferred, then you have commitments out there based on expectations in revenue from the trust fund. Then you have [more than] $18 billion up in the air. What they’ll do is unclear.”
Gerardes suggests that investors would be wise to favor indirect GARVEE bonds, which also tap local transportation funding in addition to federal support, over direct bonds which solely rely on money from the trust fund to repay investors.
But Tom Kozlik, an analyst with Janney Montgomery Scott, believes the strength of both kinds of bonds hasn’t reached that point of uncertainty – yet. Although observers would feel happier with a long term funding plan, the fact that the most recent reauthorization explicitly included a general fund transfer for the first time is seen as a vote of confidence.
“I think that the federal government has done a very job in showing support for transportation and that has been recognized by the capital markets,” Kozlik says. “From an analyst’s point of view, I think that if there was something more set in stone, I think I would look at it more favorably. But I think D.C. lawmakers recognize that transportation in most areas is the backbone of our country.”
In his January report, U.S. Fiscal Uncertainty Affects Transportation Funding, Gerardes suggests three ways the trust could be funded in the long term: 1) increasing the federal per gallon gas tax, 2) reducing Highway Trust Fund grants to states or 3) increasing support from the U.S. general fund. But analysts agree the federal government is unlikely to take any action about the deficit until the situation becomes urgent.
In the meantime, states could bolster local funding such as increasing the gas tax or upping fees associated with vehicles as way to create more financial stability behind indirect GARVEE bonds, Gerardes says.
“I think those agencies are going to be the ones investors flock to, he says. “They will be proactive in management and really showing they’re taking this into their own hands.”
But states have had their own problems with depleting transportation revenues and raising fees or taxes while consumers are still recovering from the recession has been politically unpopular. An attempt in Maryland to raise the gas tax failed last year after the cost of fuel ticked up last spring. Gov. Martin O’Malley, a democrat, is making another attempt this year, proposing either a 1 percentage point sales tax increase or adding a sales tax to gasoline. Across the river, Virginia’s Republican Governor Bob McDonnell is proposing nixing the gas tax altogether in favor of a higher state sales tax. Both proposals are expected to face heavy opposition.
Nicol Malas, managing director of Siebert Brandford Shank & Co., notes that recent trends have shown states spending less on transportation projects as budgets are constrained. Meanwhile construction bids are also coming in lower than anticipated. Therefore, states’ funding programs may not match levels needed in the past.
“So if there is going to be a shortfall in federal funds, the question isn’t what’s the extent of those funds, it’s what the need is,” Malas says. “If the needs are more manageable [after reduced budgets], it sort of neutralizes the effect of what’s coming in on the federal side.”
