Is the recent failure by Congress to reach a long-term solution for funding highway transportation projects creating new risks for municipal bonds backed by these revenues? While finding new revenue sources for highway improvements is indeed a thorny political issue, we feel that the credit quality of the existing bonds remains sound.
In fact, the ongoing debate may create opportunities to add bonds of selected issuers.
The Highway Revenue Act of 1956 authorized the creation of the Federal Highway Trust Fund as a method to fund highway improvements. The Federal Highway Trust Fund has been historically financed through flat gas and diesel fuel taxes - currently 18.4 cents per gallon tax on gasoline and 24.4 cents per gallon tax on diesel fuel. These taxes are collected by the states and remitted to the federal government. The states, in turn, apply for grants from the Fund to finance transportation projects. The interstate highway system has largely been financed and maintained by the states from this revenue source.
The Fund has been running operational deficits for a number of years due to declining gasoline sales and unchanged tax rates since 1993. At the same time, there are continued spending pressures to upgrade the interstate highway system.
As shown in the accompanying chart, vehicle miles driven have been virtually flat in recent years, while new passenger vehicle fuel efficiency has markedly improved. The end result has been declining fuel tax revenues, which will likely continue as more efficient vehicles replace older cars on the road.
For the fiscal year ending on Sept. 30, Conning expects federal gas tax revenues to reach $34 billion. This amount would be less than the $35.1 billion collected during fiscal 2012, although more than the $31.8 billon that was collected during fiscal 2013. The congressional Budget Office has estimated that outlays from fund will be $54 billion for fiscal 2014. Spending needs above gas tax receipts have been met by Fund drawdowns and transfers from federal general funds for the better part of a decade. During fiscal 2014, approximately $18 billion was transferred to the Fund from federal general funds. Since 2008, Congress has diverted $54 billion from the general fund of the Treasury to the Highway Trust Fund, according to the Heritage Foundation.
Under the specter of possible insolvency of the highway trust fund, Congress approved the transfer of $10.8 billion from the general fund to the Fund in July 2014, extending federal transportation spending through May 2015. The transfer maintains the flow of transportation grants for the short term. The existing highway bill MAP-21 expired on Sept. 30, 2014. Over the summer, Congress was unable to reach a multi-year solution for highway funding that addresses the structural imbalance in the Fund, despite extended discussion.
The high essentiality of the program's operations has never been in question, but the flat-fee per gallon gas tax is no longer generating enough revenue as economic activity and fuel consumption have decoupled.
There have been discussions, although no actual action taken, toward raising federal excise taxes on gasoline. Former Pennsylvania Governor and current co-chairman of Building America's Future (an infrastructure advocacy group) Ed Rendell has suggested a 15 cent per gallon supplementary tax, indexed to inflation, for the next ten years, before allowing to sunset and replaced with a per-mile tax structure. There is no current political consensus to raise gasoline taxes.
Municipal bonds are issued by the states based on expected monies to be received from the Federal Highway Trust Fund to finance highway construction projects Securitizing the future revenue stream allows states to generate up-front cash necessary to finance highway projects today. The bonds are known as Grant Anticipation Revenue Vehicles, or GARVEES. According to Moody's, there is $12 billion of outstanding debt backed by federal highway grants. To the extent the Fund is not fully funded, there is a potential for debt service shortfalls.
This remains a very unlikely scenario as only a portion of the monies is needed to pay debt service on existing bonds. This is because GARVEE bond debt service coverage is set high, often 5-time, to provide a comfortable margin of safety against declining Fund revenues. Thus, even with a 30% cut in highway funding from existing levels, debt-service coverage would remain robust for most credits. Furthermore, until a long-term solution is reached on federal highway funding, no new GARVEES are likely to be issued, which protects bond holders against dilution. Despite the decline in federal gas tax revenues, we feel that the outstanding bonds remain well secured by pledged federal payments. Without long-term clarity regarding the fate of the Fund, GARVEES will face elevated credit risk any time the program faces renewal. While it seems unlikely that Congress would ever allow the full expiration of the federal highway program, it is getting increasingly creative on sources for the transfers.
The most recent extension was funded using money shifted from pension smoothing, customs users fees, and a fund that had been set up to manage leaking underground storage tanks.
We have made no internal credit rating changes as a result of the failure to secure a long-term solution for highway funding. We feel that existing high debt service coverage and GARVEE security features offer bondholders strong protection from potentially lower federal grant revenue. The recent short-term solution, although not optimal, illustrates the importance of finding revenues for the Fund so needed highway projects can continue unabated with important benefits for the entire economy.
Our investment theme is to identify GARVEE credits with high debt service coverage from federal highway grant monies. We feel that the margin of safety provided by existing debt service coverage adequately covers the risk of reduced future federal grants. We believe that solutions for adequately funding the federal highway trust fund will be found given its essential purpose. In summary, we feel the gas tax shortfalls are more of a public policy issue than a credit issue. We are looking to add additional exposure for selective credits in this sector.
Paul Mansour is a managing director and head of municipal credit research at Conning. Sharif Soussi, CFA, is an assistant vice president and research analyst.
