Wednesday, April 27, 2011

The Municipal Bond Market and its Discontents: California's High-Speed Rail Funding Problem

We've offered this interview with State Treasurer Bill Lockyer in a previous blog.

Below is an update on Moody's ratings for the municipal bond market picture in the US, and therefore, certainly, in California. Due to the economy in general, and California's economic trials and tribulations for decades, the state's huge debts and deficits have contributed to the ratings of this state's bonds to nearly junk status.  

As you know, the voters, by a narrow margin, supported a $9.95 billion bond issue for high-speed rail in 2008.  Very few of those bonds have been sold.  Lockyer paints a grim picture of the near future for these bonds.

What's critical for California's high-speed rail ambitions is the liquidity of these bonds since these funds are to be matched on a one to one basis with any other HSR earmarked funds.  That first step will take the federal ARRA awarded funds, match them with no more than the same amount of bond money, giving the rail authority around $5 billion to spend on the first construction steps in the Central Valley.

That first step only scratches the surface of the massive funding required to proceed beyond laying some rail where it won't be used.  The costs for California and the US will be staggering.  But, the state taxpayers will be in the hole for $10 billion, plus interest over the life of the bonds as they are sold. Consider every bond dollar to cost the state another dollar; that is to say, this, as far as we're concerned, is a $20 billion expense burden on the state taxpayers.  And, that's in in a state with a $26+ billion deficit right now!

The availability of future bond fund money -- IF there is future federal funding -- is in question.  Just one more thing to pay attention to in California.

Moody's Sees Worse To Come
More Downs Than Ups Seen in 2011
Wednesday, April 27, 2011
By Dennis Moore

WASHINGTON — This year will be the “toughest year so far” for state and local governments since the economic plunge began in 2008, with rating downgrades expected to outnumber upgrades, according to Moody’s Investors Service.

“With all of the financial problems facing the municipal bond sector, we do expect more defaults in 2011,” said Naomi Richman, managing director of Moody’s public finance team, as the agency released its first-quarter ratings report. “We do see some very stressed credits.” 

Two of the issuers and borrowers that Moody’s rates defaulted on their municipal debt in 2010, Richman said.

Besides more defaults, Moody’s also expects several “near misses,” where defaults are avoided only at the last minute.

That applies especially for those local governments that have drained their reserves, already turned to one-shots like asset sales, have exposure to enterprise risk, face rollover risk for their debt, or face a political impasse, according to the rating agency.

Downgrades ran ahead of upgrades 3.9 to 1 in the first quarter of the year, the ninth consecutive quarter with more downgrades, Moody’s said.

There were 66 downgrades and 17 upgrades across the public finance sector among the issuers and borrowers rated by Moody’s.

 Only the last quarter of 2010 was worse for munis, with a ratio of 4.6 to 1 for downgrades compared to upgrades.

Downgrades of $23 billion par value of bonds in the first quarter were way higher than upgrades of $2.8 billion.

“We expect downgrades to continue to exceed upgrades throughout 2011 for states and local governments and school districts,” said Conor McEachern, Moody’s assistant vice president and the report’s author.

State ratings will continue to show credit stress as governments have lost not only tax revenue associated with the recession, but also federal stimulus money from the American Recovery and Reinvestment Act, which expired Dec. 31.

Many of the jobs that the Obama administration contended would be saved or created by the ARRA may now be lost because of state budget cutbacks.

A number of states have depleted their reserves but still face significant spending obligations. Moody’s said two states were downgraded during the first quarter: Kentucky and Nevada. Both were downgraded because of the recession and narrow economic bases, according to the rating agency.

About 37 cities and towns made up almost half of the first-quarter downgrades, Moody’s found. “States are pushing down their cuts” to the local level, Richman said.

The other major problem, she said, is the lag between falling home prices and the resulting drop in real estate tax revenue.

Home prices have been declining steadily for several years, but lower assessed valuations are only now catching up. That means localities are only now seeing the resulting declines in property taxes.

Moody’s reported six downgrades and no upgrades among infrastructure ratings in the last quarter. Highway, airports, and power projects all lost income from lower usage.

The rating agency also downgraded six not-for-profit hospitals.

Revenue problems will continue as reimbursement pressures from insurers mount, patient volume flattens or declines, and the recession produces higher levels of uncompensated care.

Ratings of higher education and other nonprofit issuers ratings fell because of nondiversified sources of revenue, including state budget cutbacks.

Moody’s analysts expect colleges and universities will not be able to continue to increase tuition and will be forced to make more budget cuts.

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