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What’s Going on With Muni Credits?
The trend of local governments only seeking out one credit rating for bonds is growing. Now, one in five bonds issued in the municipal market has just a single credit rating assigned to it, according to data from Municipal Market Analytics (MMA).
This can be attributed to several factors. For one, fewer individual investors -- the biggest users of credit ratings information -- are directly purchasing muni bonds, so the demand for multiple ratings has lessened. Also, agencies are increasingly giving different ratings to the same bond, which “undermines the notch-by-notch value of individual rating assignments," said MMA analyst Matt Fabian.
Along with this trend is another one: A significant portion of municipal issuers are worse off than they were at the end of the Great Recession. By the measure of PNC Capital Markets analyst Tom Kozlik, 20 percent of state and local governments have seen their underlying credit quality decline -- some significantly so.
Kozlik blames this on one key fact: governments' inability to balance their revenue and spending to live within their means. “Also,” Kozlik adds, “some state and local governments still have not grasped the scale, costs and risk that pension liabilities and other post-employment benefits still pose to credit quality and fiscal balance.”
The Takeaway: These two trends contribute to the mysterious reputation the municipal market has with outsiders. When even the credit rating experts can’t agree (note Chicago’s three different ratings from four agencies), it’s tougher than ever to generalize about the overall health of state and local governments. But if more of them continue to falter, it will undoubtedly invite assumptions about unsustainable governments everywhere.
Paul Ryan Meets With Cities to Talk Taxes
During a meeting with the National League of Cities, Speaker Paul Ryan said this week that the U.S. House will take up tax reform next year.
Among the considerations is nixing the provision that allows taxpayers to deduct state and local taxes from the income they declare to the federal government. Ryan said he favors that over the more common proposal of eliminating the tax exemption for municipal bond investment income because it would bring in twice as much revenue for the federal government ($1.1 trillion over 10 years).
Next year may also bring long-awaited movement on taxing online sales. Ryan said he's asked the chairman of the House Judiciary Committee -- where a Senate-approved bill allowing states to levy online sales taxes has languished -- to get the House’s version of that bill to the floor. If that's accomplished, the two bills would have to be reconciled because they differ on whether a sales tax would be applied in the state of the buyer or seller.
The Takeaway: This could mean more battles for state and local governments on Capitol Hill. The news about the Internet sales tax bill is encouraging, but it's coming a little late. States have grown tired of waiting for Congress to act and have taken the issue to the courts. A test case could be heard by the U.S. Supreme Court as early as late 2017, when the House may still be debating the issue
Meanwhile, Ryan has added a new tax concern for state and local government interests on top of the perennial fight about keeping the muni bond tax exemption. “While saving [the muni bond] exemption is our top priority in efforts to reform the tax code,” wrote NLC’s Carolyn Coleman, “I let the Speaker know that preserving [the state/local tax] deduction is a close second.”
The unpredictable stock market over the past nine months has taken a bite out of California’s revenue. The state's income tax revenue tends to be among the most volatile in the country because it's so closely tied to the stock market. Income tax collections in April, states' biggest month for the tax, were $1 billion less than California had budgeted. The flagging revenues impact what the state can deposit in its budget reserve accounts. That means a year from now, California expects to have somewhere between 5 and 7 percent of its annual expenditures in reserve -- far below the 10 percent originally envisioned.
Adding to the volatility is a temporary tax hike on millionaires that was approved by voters in 2012. “To date, a mostly appreciating stock market throughout the Proposition 30-era has helped boost California's revenue trend,” said Standard & Poor’s analyst Gabriel Petek in his report this week. “But in a sustained market correction -- which is inherently unpredictable -- the dynamic would work in reverse, making state tax revenues susceptible to a steeper drop-off.”
The Takeaway: California has tried to mitigate its volatile income tax revenue by putting excess revenue in its reserves. But despite all the state has done to protect itself from another revenue crash like the one it experienced during the Great Recession, it may not be enough to fully absorb the shock if and when the next downturn comes. That doesn’t bode well for other states that have only recently begun planning for the next downturn. For example, Kansas, which has been plagued with revenue shortfalls largely thanks to an income tax cut, created a budget reserve fund just this month.