MuniLand: Progress Impossible – State Budget Battles Continue

Most states’ 2016 fiscal year started July 1, but budget battles continue in Pennsylvania and Illinois. Both states have freshman Governors and legislative leaders from opposing political parties.  The lack of budget plans is straining state finances and causing credit downgrades.  Social services are being trimmed, college student financial aid is going undispersed and, worst of all, lottery winners can’t collect their prize money and quit their jobs. In all seriousness, the lack of a budget is a credit concern because it indicates management can’t deliver cost controls or revenue enhancement, which pressures liquidity levels.  These state budget impasses raise questions about local jurisdictions’ “willingness” to pay outstanding debt, because without state action, state aid distribution to local entities is in jeopardy. For example, S&P Rating Services issued a six notch downgrade to BBB+ from AA+ on Chicago Motor Vehicle Fuel Tax backed bonds because the state budget bottleneck is delaying transfer payments to the Chicago’s Motor Vehicle Fund.  At the end of September, Fitch Ratings issued a memo expressing concern about divergent ratings between state general obligation bonds and dedicated tax bonds like the Chicago Motor Vehicle Fuel Tax bonds.  Fitch argues that dedicated revenue bonds usually do not warrant ratings higher than entities’ G.O. rating.  However, considerable value can be had in dedicated tax revenue bonds where coverage ratios are strong and management displays a willingness to take action. So keep an eye out for more ratings movement and value opportunities in the dedicated tax bond sector.

Sources: Wall Street Journal, Fitch Ratings, S&P Ratings, Bloomberg News and SNWAM Research