Limited Municipal Credit Impacts Expected from Trump Administration Effort to Curtail Sanctuary Cities

President Trump signed an executive order five days after his inauguration providing for the withholding of federal funds to sanctuary jurisdictions (state and local governments commonly known as sanctuary cities). The order, “Enhancing Public Safety in the Interior of the United States,” keeps one of the President’s campaign promises and is intended to curtail policies of sanctuary jurisdictions that could impede enforcement of federal immigration laws (for more details on sanctuary city policies, see SNW's Impact Insight prepared by Glen Yelton, Head of SNW Impact Research). While there are questions regarding the legality and the applicability of the executive order, we expect that any potential impacts of the order on the credit quality of state and local debt would most likely be felt by jurisdictions with limited fiscal flexibility and/or debt with weak bondholder protections.

On January 30, Fitch ratings indicated that it expects that the credit ratings of sanctuary cities will not change if federal cuts are implemented. Fitch notes that the impact of such cuts would be limited, as most federal funds are restricted to specified programs, which a jurisdiction could cut if the funding is withheld. Property taxes are typically the largest source of direct funding for local government operations and debt programs, and the executive order would not impact the flow of those revenues or most other state or local revenue sources.

Fitch also noted that constitutional challenges to the order could dilute its impact. San Francisco has already filed a suit in federal courts, the first city to challenge the legality of the order. While case law seems to allow the federal government to withhold funds from state and local governments, Morgan Stanley noted in its analysis of the order last week that the courts have limited that power to compliance related to the intended use of federal funds, but have ruled that the federal government cannot punish a state for refusing to adopt a policy.

There seems to be more concern over the impact to state and local governments from other potential changes to federal policies such as the funding of health care and trade. Despite those concerns, Fitch has maintained a stable outlook for local government credits. While SNW also maintains a stable outlook on the Local General Obligation bond sector, our analysis may be a bit more nuanced than Fitch’s. Like Fitch, we like local G.O. bonds because of growing tax bases and bondholder protections, but we believe local appropriation debt, particularly for weaker credits, could be more susceptible to fiscal pressures from changes to federal policies, including the order related to sanctuary jurisdictions.

Source: Bloomberg, Bond Buyer, Fitch Ratings, Morgan Stanley, SNW Impact Research, Whitehouse.gov