An empty New York City subway car.
Preston Rescigno | Getty Images
The $3.8 trillion market for funding state and local governments, airports, schools and hospitals faces a test next month as New York City’s transit agency offers bonds to the market for the first time since the coronavirus emptied its subways, trains and buses.
Investing in the roughly $900 million offering from the Metropolitan Transportation Authority will be a leap of faith on the part of investors who will will have to imagine a healthier, post-shutdown New York economy, where commuters return to work, students go back to school and tourists come to see Broadway shows again.
The deal was originally expected to price this week, but was shifted to next month.
“When the MTA does come to market it will represent a test case for one of the more severely impacted revenue bond issues,” said Jeff Lipton, Oppenheimer head of municipal research and strategy.
Many issuers face uncertainty, as states and cities grapple with how to fill a sudden budget hole and move forward, in an environment of uncertainty about what the economic rebound will look like and how it will impact future revenues.
The issuers of state and local debt are facing a crisis unlike any other, with the sudden loss of revenues nationally from income taxes, sales taxes, parking, and even hotel room taxes. Collectively these governments are seeking another $750 billion from the federal government, a request that is expected to pit Republicans against Democrats and red states against blue states.
“This is not going to be just a federal bailout of the states. On the other hand, this will be an ongoing discussion,” said Treasury Secretary Steven Mnuchin on CNBC Tuesday. But he said it makes sense to help states with high expenses from the coronavirus, like New York and New Jersey, but not to help states just because they’ve mismanaged their finances.
Congress is going to consider another round of funding for states as part of the next phase of spending for the coronavirus. “Sen. McConnell and other Republicans in the Senate are concerned that Blue States are gearing up to offload their chronic budget shortfalls and yawning public pension program deficits, which have nothing to do with the virus, on the federal government,” notes Stephen Stanley, chief economist at Amherst Pierpont, “This is going to be a massive food fight …when Congress returns to D.C.”
Mnuchin also told CNBC that he expects the debate over whether the federal government funds will be used to pay for coronavirus-related expenses, or to fund other expenses, which states are struggling to cover. “The issue of lost revenues is something that is to be debated in the House and Senate. Everyone of these bills has had overwhelming bipartisan support,” he said.
New Jersey’s Gov. Phil Murphy told CNBC this week that the state’s problem has been made worse because revenues have “fallen off a table” and that it will run out of cash in four to six weeks. At that point, it will be hard to pay police and teachers, he said.
Lifeblood for states, cities
The municipal bond market is the lifeblood for state and local finances and is tapped by governments, school districts, and entities like New York’s MTA. It has been a haven for retirees and other investors seeking the benefit of tax exempt investments and the relative safety of local government debt.
States were fiscally stronger ahead of the virus shutdowns than they had been in the past.
“Heading into this economic suspension, states as a whole were in very food shape. They did a good job of rebuilding their rainy day funds,” said Lipton. “On average, about 7.5% of spending of their budget goes into reserves…The economy was growing rather strongly; sales tax receipts, income tax receipts were rising so they were able to set aside meaningful dollars in the reserve funds, and now the question is how much of those reserve funds are going to be drawn down.”
When credit markets started to seize up in March, the muni market was hit by massive outflows and it shutdown to new issues. But the Fed’s actions revived it, including a new liquidity facility for state and local governments. It expanded that facility Monday by lowering the population limits for loans from two million for counties to 500,000 and from one million for cities to 250,000.
“We’ve seen the liquidity impact to financial markets, and now you’re going to see the economic impact. In munis, it takes awhile to play out,” said Curtis Erickson, head of capital markets at Preston Hollow Capital. “Stuff we see now is going to start to hit municipal budgets three months from now…It’s going to be a difficult process to get states and locals back to square on their finances. What happens if real estate starts to go down? That will be another hit to locals. It’s very difficult to invest in this market because of the uncertainty.”
Moody’s says the states alone will lose out on $160 billion in revenues from 2019 to fiscal year 2021, which for many states begins on July 1. Moody’s said there is a $200 billion shortfall in what the states expected to receive.
“Even with an assumed revenue upturn beginning for most states in fiscal 2022, our base scenario does not result in a recovery to fiscal 2019 levels by fiscal 2024,” according to Moody’s.
Strategists expect to see a wave of credit downgrades, some defaults and also political headwinds as they try to adjust spending or raise taxes to make up their shortfalls.
McConnell has already thrown out the suggestion that states should go bankrupt, and his office issued statements calling the request for relief “blue state bailouts.” His comment drew protest from governors, including a sharply worded reaction from the Democratic governors of New York and New Jersey. His comment was also criticized by Maryland’s Republican governor, and is seen as unlikely to gain traction in Congress, which would have to change existing law to allow for bankruptcies. Unlike local governments, states are prohibited from filing for bankruptcy.
McConnell’s comment added some jitters to a market that had become more stable, since reaching its high yields March 22. The Fed’s liquidity program and facility for municipal bonds helped bring in yields and calm the market though the secondary market is still soft. The market sold off just before McConnel’s comment last week, but it continued to selloff.
The yield on the 30-year top rated MMD muni index was at about 2.13% Monday, well off its March 22 high of 3.37% but up from the 1.90% it was at on April 20 before McConnell’s comment. On Tuesday, the yield was moving higher again. Yields move opposite price.
“It could be a negotiating tactic. States and local governments have asked for $750 billion in aggregate,” said Ian Rogow, co-head of municipals research at Bank of America Securities. “It could be Sen. McConnell and others looking at that figure and saying its too large.”
Rogow said the states alone are looking for $500 billion. “Fiscal 2019 tax revenues at the state level were on the order of just over a trillion dollars, and they’re asking for $500 billion, 45% of fiscal 2019 revenues,” he said.
President Donald Trump weighed in on the state of Illinios. Illinois State Senator Don Harmon sent a letter to members of Congress earlier this month, asking for $40 billion, including $10 million to shore up the state’s underfunded pension fund. In a tweet Monday, Trump questioned why tax payers should bail out poorly run states, like Illinios, when most states do not need help.
Other states having difficulty meeting pension obligations include Kentucky, New Jersey, Connecticut and Colorado. Fitch recently downgraded Illinois to BBB-, the lowest rung of investment grade, and last week it downgraded its rating on New Jersey to A minus from A, citing limits on the state’s economic activity due to the virus shutdown.
Strategists say ratings agencies may not catch up with some issues until later on, and they point out that some cities and states are more reliant on sales taxes than others. Some are dependent on tourism and revenues from hotels. In the case of Las Vegas, it relies on hotels and casinos. Bank of America strategists say overweight cities that are tech-heavy. It also suggests overweighting the 8-to-20-year part of the market, and it has an underweight on small private colleges and the high yield part of the market.
Some favor the steady nature of water and sewer authorities over entities like airports that are now hampered by a lack of revenues and have an uncertain outlook.
“The market is holding up, but I’m not sure what it is. It’s being supported by the technicals, by the fact fund flows have not continued to go out,” said Peter Bianchini, Preston Hollow executive director. “It’s not backed by analysis. We can kind of go sector-by-sector and credit-by-credit and talk about all the uncertainties. These are governments that provide essential services. They generally collect revenue streams that people are obligated to pay.. I expect most will fulfill expectations, Most governments will pay and not have a problem…There’s just a higher probability of having more problems now.”
Mass transit bonds
Lipton said the MTA should be able to place this deal. “But finding sufficient buyers at a yield level that would clear the market may be challenging.” he said.
“The MTA is operational…Ridership is critically down across the various MTA assets. I think it’s going to take quite awhile before the MTA attains pre-crisis ridership levels, if they do at all,” he said. ” At least in the short-term that’s not expected to happen.”
The MTA’s subways, buses and trains, like Metro North are critical to transportation in New York, New Jersey and Connecticut.
“The MTA represents a significant contribution not only to the New York economy, but the northeast corridor region,” said Lipton.
The MTA received $3.8 billion in emergency funding under the CARES Act, to help get it through a period of extremely low ridership.
“The management of the MTA has been very out and front vocalizing the MTA’s need for additional federal funding to get them through this crisis,” said Lipton. “I think it’s a test case because it’s a bulge bracket recurring issuer. It will be interesting to see what the institutional reception looks like. It will be interesting to see what the pricing looks like. For the institutional buyer, it’s about how much they already have on their books.”
It is now seeking about $900 million in the market when it re-markets $250 million in debt and offers roughly $675 million in transportation revenue bonds, expected to mature in 2045, 2050 and 2055.
“My view is the MTA absolutely believes with the liquidity on hand, monies received from the federal government, as well as other state and federal support likely to be made available, the MTA should see its way through to the other side of this because at some point, in the not too distant future, the New York economy will reopen,” said Lipton. “Nevertheless, investors must understand that funding issues for the MTA will be at the heart of credit analysis.”
The MTA is among the largest U.S.issuers with about $44 billion in total debt outstanding. It was downgraded because of impact of the virus on its revenues.
“The rating agencies have taken the position that if we actually thought there would be a default the rating would not be in the single A category,” said Rogow. “I would expect they’ll be the beneficiary of more funding. Do I think there is downward rating pressure on the MTA? Yes. Is there downward pressure on other issuers as well? The answer is yes. Does this translate into default? I think the answer is no.”