WASHINGTON — This year, the volume of municipal debt issuance is expected to increase from the suppressed levels in 2011 caused by curtailed federal spending, federal cuts to Medicaid and Medicare, and pent-up capital requirements and borrowing needs, according to a report Moody’s Investors Service released Monday.
“The backlog will translate into more issuance in some sectors, such as infrastructure and water and sewer utilities,” said Chris Holmes, public finance research director at Moody’s. “Higher education and other issuers will continue to hold back on capital expansion plans and associated borrowing.”
However, the report, “Debt Drivers 2012,” found that debt issuance is unlikely to reach the same level as in 2010, which was abnormally high due to the pending expiration of the Build America Bonds program.
Muni borrowing plunged 31.5% in 2011 to the lowest level in 10 years despite rock-bottom state and local government borrowing costs. Outstanding municipal debt has only marginally increased in the last three years, indicating that reduced revenue and budget cuts unrelated to debt service will be the principal drivers of credit stress, the report said.
Moody’s said that while one would expect state and local governments to borrow more when interest rates are low, this is not the case.
“Our analysis of the historical relationship between municipal borrowing costs and borrowing volume concludes that interest rates are usually only a modest factor driving new-money issuance,” the agency said. “Rather, state and local governments base their new-money borrowing plans primarily on capital needs, voter sentiment, political viability, and the relative health of operating budgets, with interest rates representing only a secondary consideration except during periods of extreme volatility.”
Prevailing low interest rates are expected to buoy refunding volume, though refunding opportunities will be exhausted the longer yields stay low, Moody’s said.
Looming federal cuts to Medicaid and Medicare will indirectly support issuance by health care institutions to fund consolidations needed to accelerate cost reductions and to optimize operations, according to the report. Similarly, state governments will continue to cut aid to local governments, leaving some localities little choice but to minimize borrowing in order to restrict additional debt-service expenditures.
Political aversion to higher debt issuance — such as the growing anti-debt sentiment fueled by the skyrocketing debt burden of the federal government and the European debt crisis — has subdued issuance volume, the report noted. States’ recession-induced fiscal shortfalls, coupled with mounting off-balance sheet liabilities in the form of pensions and other post-employment benefit liabilities, such as health care, have put state debt liabilities under scrutiny. As a result, some states have restricted their debt issuance in recent years and will likely do the same over the next year. Moody’s said.
For example, in New Jersey, Republican Gov. Chris Christie has been outspoken about scaling back debt issuance. The state has increased its pay-as-you-go financing as a way to reduce debt issuance and plans to reduce issuance to $626 million in 2016 from $1.1 billion in 2012.
Issuance of short-term notes by states is likely to decline from last year, Moody’s said. States use short-term borrowing as a tool to manage the cash flow between revenues and expenditures. During periods of budgetary stress, short-term borrowing increases. Budget deficits have narrowed over the past three years on the back of federal fiscal stimulus and stabilizing revenues. States closed combined budget gaps of $191 and $130 billion in fiscal 2010 and 2011, respectively.
Moody’s expects local governments will reduce financings over the next year due to substantial revenue and expenditure pressures. Capital expenditures of cities, counties and school districts will remain depressed as municipalities delay new projects in an effort to manage their expenses, the report said.
Some municipalities will entertain issuing more dedicated tax-backed bonds instead of general obligation bonds, while others will increase issuance with identified revenue streams like voter-approved sales tax, according to Moody’s.