Infrastructure spending gaps may pose a greater risk than pension shortfalls

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With infrastructure on the front burner in Washington, municipal analysts are increasingly pointing to the credit implications of the infrastructure spending shortfall for cities and states.

The median age of U.S. city infrastructure increased to 15.4 years in 2016 from 11.5 years in 2006, according to Richard Ciccarone’s article, “Aging Infrastructure is a Problem, From Any Point of View,” published on Nov. 29, in Ciccarone, who focused on city government audits for his piece, told The Bond Buyer that he has found a similar trend for non-city governments.

Ciccarone’s preliminary estimates for the median spending amount that state governments would have needed to spend to replace depleted infrastructure grew to $4.35 billion in 2016 from $3.1 billion in 2009.

In October Moody’s Investors Service released a report that showed state and local government spending on infrastructure as a percent of U.S. gross domestic product had declined to 1.7% in the second quarter of 2017 from 2.6% in second quarter of 2009. The shift “suggests an ongoing buildup of deferred infrastructure maintenance that will eventually prove expensive and credit negative for the sector,” said Moody’s senior analyst Dan Seymour in the report, “State and Local Government Delays in Capital Expenditures Push Costs into the Future.”

In inflation-adjusted terms, state and local government infrastructure spending fell 20.6% from the second quarter of 2009 to 2017, according to the Bureau of Economic Analysis. Though the second quarter of 2009 was a peak due to the Build America Bonds program, spending was also down 15.3% to 2017 from the first quarter of 2007.

In response to U.S. infrastructure deterioration, President Trump has introduced an infrastructure plan that places more of the funding burden on state and local governments and the private sector. Some have criticized the plan for inadequate federal funding.

Chris Hamel, former Head of RBC Capital Markets’ Municipal Finance Group, said the Ciccarone and Seymour reports, “are a precise statement of why our country faces an infrastructure-underfunding crisis.”

Unfunded infrastructure repair and replacement are a fourth liability that municipal issuers have, along with debts, pensions, and other post-employment benefits, Ciccarone said. Cities’ unfunded infrastructure needs are even greater than their unfunded pension liabilities, he said.

Seymour reported that the ratio of infrastructure spending to infrastructure depreciation steadily declined to about 1.35 in 2016 from about 2 in 2004. This is another indicator that governments are falling behind in repairing and replacing infrastructure.

Local and state governments’ postponement of infrastructure spending doesn’t just mean that that they have simply deferred the spending, two analysts said. Some of the delayed spending was to be used to make both infrastructure and the city around them more resistant to major storms and other occasional natural disasters. The delay will mean the ultimate cost could be much higher and not merely deferred.

The flooding of New Orleans after Hurricane Katarina was due to the prior failure to improve and maintain the cities’ levies, said Mark Hallenbeck, director of the Washington State Transportation Center.

The failure to adequately fund infrastructure meant that after Hurricane Harvey in Texas and Superstorm Sandy in New York City there was much more damage than there would have been, said Cherian George, head of the Americas in Fitch Ratings’ global infrastructure and project finance group. The resilience of U.S. infrastructure is going down, making areas ripe for more expensive “natural” disasters.

Addressing the aftermath of these storms in areas without adequate infrastructure preparation is much more expensive than if the work had been done before the storms, George said. Sandy’s cost is now estimated at $100 billion to $120 billion.

The cost of aging infrastructure that hasn’t been properly maintained can also be seen in actual failures. In 2015 a bridge on Interstate 10, the main road between Los Angeles and Phoenix, collapsed in California. While a flood triggered the collapse, University of California Engineering Professor Abolhassan Astaneh-Asi did a study that attributed the collapse to poor engineering of the bridge built in 1967.

Since the 2015 collapse, the bridge has been replaced but the new one has many of the previous bridge’s problems, Astaneh-Asi said, according to the Desert Sun news web site.

In February 2017 major cracks were found on the Pfeiffer Canyon Bridge on California Route 1 in Big Sur. The bridge had to be shut down, demolished, and replaced. The bridge didn’t open until October 2017, shutting down a very popular tourist route along the Pacific Ocean for eight months and isolating the communities along the highway.

New York City subway system has seen increasing delays and problems in recent years, something many observers have attributed to its aging signaling system and subway cars.

As an example of failing infrastructure, George mentioned problems with the Oroville Dam and its spillways in February 2017. These led to an evacuation of more than 180,000 who lived downstream.

The California dam and its spillways were “found to have original design issues but more importantly weren’t maintained as they should have when the original design flaws could have been corrected,” George said. “It all comes down to poor maintenance.”

Municipal analysts said there were both cross-sector and sector-specific factors contributing to under-funding of infrastructure.

“In my view, our political institutions and culture are not set up to manage long-term issues very well,” said Natalie Cohen, managing director for Wells Fargo Securities. “These include infrastructure as well as saving to fund retirement and investing in education so there will continue to be a new crop of well-trained talent to fill jobs. Deficiencies in these investments take a long time to show up (and a long time to remedy) which is why they get neglected.”

Columbia University Adjunct Professor and infrastructure investor Joel Moser saw things similarly. “The country needs more repairs and replacements a lot sooner than it needs big greenfield projects but repairs aren’t sexy and since they usually can’t be financed, they often go unfunded for political gain.”

“There is a ‘New Fiscal Reality’ that all municipal bond issuers are experiencing,” PNC managing director Tom Kozlik wrote in an email. “This is characterized by revenues that are not rising as fast as they have in the past, if they are rising at all. And expenditure demand that is rising faster than revenues. Over the last few years and currently infrastructure spending has been crowded out by this ‘New Fiscal Reality.’”

Frank Shafroth, director of the Center for State and Local Leadership at George Mason University, said, "as Americans are growing older and living longer, meeting public pension obligations -- in many cases constitutionally obligated -- means less is available for public investment in capital budgets and expenditures, such as public infrastructure." Kozlik agreed pension funding pressures would be a factor in coming years.

Other analysts pointed to factors specific to the road and bridge sectors. Hallenbeck and Kurt Forsgren, S&P Global Ratings sector leader for U.S public finance sector ratings, said the failure to increase motor fuel tax failure since 1983 has cut revenue available for the federal Highway Trust Fund. The failure to increase effectively pushed down the tax 61% after inflation. Hallenbeck talked about the highway fund in an email and Forsgren wrote this in a report, “Transportation Grant Programs Continue to Fill Gaps in the U.S. Infrastructure Deficit, For Now.”

“Absent a new funding source, we expect states and regional transportation authorities will struggle to fill potential long-term declines in federal transportation funding, and will look to expand tolling,” Forsgren wrote in his August 2017 report.

Another problem for the Highway Trust Fund is that cars have been getting more fuel efficient over the last three decades. So the ratio between the number of vehicle traveled miles and the number of gallons of gas consumed by vehicles has steadily gone up, reducing the revenue flow for the fund.

Several municipal market participants said government disclosure of their infrastructure needs should be improved.

While Government Accounting Standards Board statement 34, issued in 1999, covered this issue a little bit, much more needs to be done, Ciccarone told The Bond Buyer.

Many governments have five year capital improvement plans but these cover what work plans to be done but not what work should be done. Investors need to know about the latter and need to be able to look beyond five years, Ciccarone said.

There should be some way of governments stating the recommended levels of annual infrastructure spending and how that relates to their current levels of spending, Hamel said.

In March 2017 California State Treasurer John Chiang proposed a state-wide infrastructure assessment. In “Building California’s Future Begins Today,” Chiang wrote, “Currently, there is no central inventory of existing infrastructure assets that provides the data necessary to systematically and consistently assess and quantify what work must be done.”

As of early February there has been a pilot for this assessment but it is still a work in progress, said California Treasurer spokesman Marc Lifsher.

Referring to the California proposal, Hamel said, “I think this is prudent business practice as well as smart public education practice.”

The District of Columbia is further along in assessing its infrastructure spending needs. In October 2017 the Office of the Chief Financial Officer put out a report stating that the district had $6.7 billion in capital needs through fiscal 2023. The report, “District of Columbia Long-Range Capital Financial Plan Report,” said that about $4.2 billion of that will go unfunded. Both numbers exclude funding for Metro and P3 projects. Beyond fiscal 2023 the report anticipates further funding shortfalls.

Yet the report also notes that the district’s financial plan anticipates increasing its funding for capital projects each year through fiscal 2026, when the funding should roughly equal annual depreciation.

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