NEW YORK – Congressional cuts to U.S. spending, following a negative outlook on federal debt by Standard & Poor’s, may adversely affect state credit ratings, according to Janney Montgomery Scott LLC.
The ratings company put the U.S. government on notice that it risks losing its AAA investment grade unless politicians agree on a plan by 2013 to reduce budget deficits and the national debt. S&P said this week there’s a 1-in-3 chance the ranking may be lowered within two years and that its “baseline assumption” is that Congress and President Barack Obama will agree on a plan to contain deficits before then.
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There’s a “clear connection” between the federal government’s credit and states, so the “trajectory of states’ ratings is more likely to be negative than positive” as Congress cuts spending, said Guy LeBas, chief fixed-income strategist at Philadelphia-based Janney, which oversees $13 billion in bonds.
“The problem with the degree of government cutbacks being discussed is that they’re so large that in one way federal government cutbacks are going to affect every sector of the muni market,” LeBas said. “It’s now a matter of how much.”
Investors have pulled about $31.6 billion from U.S. municipal-bond mutual funds since Nov. 10, 22 straight weeks of net withdrawals, Lipper US Fund Flows said April 14. Investors withdrew a record $4 billion in the week ended Jan. 19, according to the Denver-based research company. The funds included in the weekly number hold at least 75 percent in municipal bonds, said Devin McCune, head of U.S. flows and marketplace at Lipper.
Whitney Effect
The withdrawals were sparked in part by Meredith Whitney, the banking analyst and head of Meredith Whitney Advisory Group LLC in New York after she predicted “hundreds of billions” of dollars of defaults may occur this year as state and local governments grapple with budget deficits and tax collections that haven’t returned to pre-recession levels.
Yields on top-rated tax-exempt securities due in 10 years have jumped 21 basis points, or 0.21 percentage point, since March 1, according to a Bloomberg Valuation index. Ten-year U.S. Treasury yields have fallen about 3 basis points in the same period.
While federal aid cuts will probably be felt by states, they will affect local governments as well, LeBas said in a telephone interview.
“In our experience with spending cuts, the bad stuff rolls downhill,” he said. “When the federal government needs to save money, they do it at states’ expense. When states need to save money, they do so at” the expense of local municipalities.
Tax Revenue
State tax revenue increased by 7.8 percent in the last three months of 2010, compared with the same period in 2009, the fourth consecutive quarter that states reported growth in collections on a year-over-year basis, according to a report from the Rockefeller Institute of Government. Municipal receipts fell 2.3 percent in the quarter.
Reductions in federal aid will force states and cities to re-evaluate revenue projections, said Jim Colby, a senior municipal strategist for New York-based fund manager Van Eck Associates.
“It’s one thing if there’d been no revenue-sharing, but there has been,” Colby said. “So states and municipalities are going to have to reinvent how they anticipate revenue flows.”
Credit Default Swaps
The cost to protect $10 million in California debt against default for five years rose to $241,110 annually on April 18, from $210,980 on March 31, according to CMA, a data provider owned by CME Group Inc. that compiles credit-swap prices from hedge funds and other clients.
U.S. cities and local governments will lose at least $3 billion in funds for housing, community redevelopment projects, public transportation and police and fire departments as part of the budget agreement that averted a federal government shutdown last week.
The agreement struck between President Obama and Congressional leaders will reduce money for the Department of Housing and Urban Development’s community development fund by $942 million to $3.5 billion, according to a breakdown of spending reductions released by the House Appropriations Committee today.
It would also eliminate $680 million from public transportation grants, more than $700 million from low-income housing, and $786 million from grants for local agencies that respond to emergencies.
Standoff Averted
The cuts affecting cities are among those needed to produce the $38 billion in savings that Obama and congressional leaders agreed to for the remainder of the 2011 budget year. The agreement resolved a standoff between the White House and Republican leaders that last week threatened to force the first federal government shutdown in 15 years.
States are “trying to do as much with less and if not, do less with less,” Colby said.
Following are descriptions of pending sales of U.S. municipal debt:
MAYO CLINIC, whose Rochester, Minnesota, campus is the oldest and largest multi-specialty physician practice in the U.S., plans to sell $290 million in tax-exempt bonds today to refinance existing debt. The revenue bonds, which are being issued by the city, are rated Aa2 by Moody’s Investors Service and AA by Standard & Poor’s, both third-highest. Bank of America Merrill Lynch and Wells Fargo & Co. will underwrite the securities. (Updated April 20)
MUNICIPAL ELECTRIC AUTHORITY OF GEORGIA, which sold securities last year to help build two of the first new U.S. atomic generators in 30 years, plans to sell $175 million in tax-exempt debt and $3 million in taxable subordinated bonds as soon as next week to finance capital improvements and refinance debt. Moody’s and S&P rate them at the fifth-lowest investment grade while Fitch Ratings ranks them one level higher at A+. Banks led by Morgan Stanley will underwrite the debt. (Updated April 19)
NEW YORK LIBERTY DEVELOPMENT CORP., a state arm created to finance rebuilding the World Trade Center site, plans to sell about $2.6 billion in debt tomorrow, a remaking of its 2009 bonds for the site in lower Manhattan, according to preliminary offering documents. Proceeds from the issue will be placed in escrow and invested in U.S. Treasuries, rather than being used directly for construction, documents show. The debt may be awarded AAA by Fitch Ratings on April 28. (Updated April 20)
