The content on this website is intended for investment professionals and institutional asset owners. Individual retail investors should consult with their financial advisers before using any of the content contained on this website. Breckinridge uses cookies to improve user experience. By using our website, you consent to our cookies in accordance with our cookie policy. By clicking “I Agree” and accessing this website, you represent and warrant that you are agreeing to the above statements. In addition, you have read, understood and agree to the terms and conditions of this website.

Municipal Perspective published on February 8, 2017

2017 Municipal Bond Credit Outlook


  • Credit fundamentals remain stable heading into 2017. Default rates remain low and debt levels have fallen. Most financial metrics suggest revenue issuers are also in stable condition.
  • Several credit weaknesses lurk. Despite largely stable conditions, pension and infrastructure stress remain issues. In addition, some states continue to show signs of fiscal imbalance.
  • The federal policy environment is the most significant risk for the market. Proposed changes to the federal tax code, including the municipal tax exemption, plus plans to repeal and replace the Affordable Care Act (ACA) and revamp infrastructure policy, would have material credit impacts on municipal issuers.
  • We expect higher volatility in 2017. As a consequence, there may be more buying opportunities in the A-rated space.

2017 Credit Fundamentals

Broadly Stable, but Downside Risks Remain

For the third consecutive year, municipal credit fundamentals entered January in stable condition. The economy continues to grow at a modest pace and revenue, transportation and local government credits are benefiting. Overall, state and local debt levels continue to fall as a percentage of U.S. GDP, and the municipal default rate remains low. In 2017, the pace of infrastructure decay may even slow a bit after a protracted period of neglect.

Still, a meaningful degree of credit turbulence persists under today’s calm credit waters, including:

  • Pension stress
  • Issue-specific headwinds to certain revenue sectors
  • Fiscal imbalance at the state level
  • Weak credits, including Puerto Rico
  • Weakening legal covenants
  • Significant federal policy risk

In our view, federal policy uncertainty may be the most important credit factor in 2017. Republican control of the presidency, Congress and Senate portends policy change in several areas, including tax reform, infrastructure policy and repeal of the ACA. The federal government’s trade and immigration posture may also change. Federal policy could prove a major driver of credit fundamentals over the next few years.

We continue to favor very high-grade bonds given the tight levels of current A-rated credit spreads. However, policy uncertainty is likely to drive spreads wider from time to time during 2017. During these periods of volatility, adding A-rated exposure may make sense.

Municipal Market Strengths

The economy. Entering 2017, economic fundamentals look reasonably good. The national unemployment rate reached 4.6 percent in November, its lowest level in 99 months. Wages increased by 2.9 percent on a year-over-year basis in December. Home prices are up 6 percent compared to the same time last year, and annual retail sales growth remains steady at nearly 4 percent.[i] The S&P 500 ended 2016 up 11 percent, and the Federal Reserve has telegraphed three rate hikes over the next 12 months. As Figure 1 illustrates, growth – excluding a few outliers – has been modest to strong across states for the past several years.

Revenue credits. Employment growth should drive traffic at airports and toll roads and help other transportation-related credits.[ii] Essential service revenue bonds such as those for Water-Sewer, Electric Utilities and Higher Education issuers should also benefit. Notably, these issuers start from a solid financial base. Median debt service coverage was 1.7x for Water-Sewer credits and 1.5x for Electric Revenue credits at the end of FY16.[iii] Liquidity in the private higher education space has generally been good.[iv]

Local governments. Local governments also seem poised for a strong 2017. Many are in better fiscal health than is commonly thought. While pension, retiree healthcare and infrastructure stress certainly afflicts the local government sector, it is also true that 81 percent of city finance officers describe their cities as “better able to meet their financial needs” compared to last year.[v] On average, cities and counties reported holding roughly 150 days of cash on hand in FY15, up 20 percent from FY10.[vi]

As Figure 2 shows, property tax growth should continue next year. Property taxes generally lag home-price growth by 1-3 years, depending on the jurisdiction, and any slowdown in real estate price appreciation should prove manageable given current home-price highs. We note that rising interest rates might crimp the pace of home-price growth in 2017, especially in “hot” markets such as San Francisco, Denver, Boston and the District of Columbia. Also, recent closings of big-box retailers could impact the tax base of certain small communities.[vii]

State and local debt levels also continue to fall. Since 2009, state and local debt has declined from 20 percent of U.S. GDP to just under 16 percent (Figure 3). The decline in debt reflects, in part, the unwillingness to fund infrastructure needs and the voter aversion to public debt in general. However, it underscores the fact that bonded debt levels remain manageable in most places.

Low default rate. The municipal default rate also remains extraordinarily low. The number of defaults in 2016 was on top of the number in 2015 (Figure 4). This figure includes seven defaults out of Puerto Rico.

Slower infrastructure decay. There remains a significant backlog of infrastructure needs across the country (see our November 2016 white paper, Infrastructure Accounting: A Blind Spot Facing Investors). However, the pace of infrastructure decay may slow a bit next year. Interest rates are set to rise over the next several months, which may incent issuers to fund projects now while rates remain low.

In addition, there is increasing evidence that taxpayers are willing to fund new projects. Monthly state and local construction spending picked up in the second half of 2016 and a record number of transportation initiatives passed on November ballots.[viii] Notably, voters in New Jersey approved a constitutional amendment to dedicate the state’s gas tax revenue to transportation projects.[ix] In Illinois, residents approved an amendment that prohibits the state from using transportation funds for non-transportation purposes.[x] In Atlanta, voters approved sales tax increases to fund a variety of mobility initiatives.[xi] Just a few years ago, Atlanta-area residents rejected a similar ballot initiative.

Municipal Market Challenges

Ongoing pension stress. An uptick in interest rates in 2017 coupled with solid 2016 stock market returns should support pension fund performance over the near term. However, pension debt is likely to continue to challenge issuers over the next several years.

Pension funds’ return assumptions are likely to fall further. In December, the California Public Employees’ Retirement System (CalPERS), the nation’s largest public pension system, announced that it would reduce its return assumption to 7 percent from 7.5 percent. California issuers can expect annual pension contributions to rise by 30-40 percent over the next three years.[xii] Other pension funds are likely to follow CalPERS’ lead. Actuaries expected long-term returns of only 6.2 percent in 2015.[xiii]

Also, recent reform efforts have failed to stem rising pension debts in the places where reform is most needed. Since 2009, 74 percent of state-administered public plans and 57 percent of locally administered plans have reduced benefits,[xiv] and in 2017 reformers may win key legal battles in California and Puerto Rico.[xv] Still, pension debt has increased meaningfully in several states where it was already elevated (Figure 5).


Issue-specific headwinds for certain revenue sectors. While economic and financial fundamentals for most revenue sectors appear solid, there are growing secular risks that require monitoring in certain sectors. These include:

  • Driverless cars. Investors increasingly take seriously the competitive threat of driverless cars to mass transit credits. Auto companies such as Ford, Audi, Volkswagen and Nissan expect to deploy autonomous vehicles on the road by 2021.[xvi] Competition from driverless cars could reduce farebox revenue for mass transit issuers or compete with airlines for short-flight routes. Over time, competition from driverless vehicles could depress taxpayer support for certain transit systems that become “white elephants.” It’s also quite possible that driverless technology will complement existing transportation options. For now, however, the technology raises more questions than answers: When offered a choice between a driverless Uber or a commuter rail, which will consumers choose? Which markets will adopt the technology first? What new infrastructure might be required to support these vehicles? What is a realistic timeline for mass adoption of driverless car technology?
  • Rate Fatigue. Evidence is increasing that water and sewer ratepayers are tiring of chronic rate hikes, especially in California’s drought-stricken areas. In affluent Yorba Linda, California, voters recalled local water district board members after a court upheld unpopular rate hikes.[xvii] In Oxnard, California, residents overwhelmingly approved a ballot measure to nullify sewer-system rate increases. A judge has placed the latter result on hold, but without the rate increases city officials have warned that the wastewater fund could run out of cash in February.[xviii] The assumption that ratepayers will always be willing to fund revenue issuers’ operating, maintenance and debt service costs through higher rates appears strained, at least for issuers in areas under water duress.
  • Falling Demand and Lingering Clean Power Regulations. The operating environment for electric utilities remains constrained. Many utilities continue to confront declining energy demand. And despite the incoming administration’s distaste for the Clean Power Plan, most state and federal carbon regulations are likely to remain intact for the time being.

State budget shortfalls remain common. Currently, 14 states have a negative rating outlook from either Moody’s or S&P. In FY16, state general fund revenues were below forecast in 25 states, and through the first several months of FY17 the numbers are no better.[xix] State fiscal erosion reflects a variety of factors, some broadly shared and others state-specific. Certain states, such as Alaska and Louisiana, remain overly reliant on oil-related revenues to balance their budgets. These states are still adjusting to the 2014 oil price shock.

In other states, such as Illinois and Pennsylvania, political gridlock threatens long-term credit fundamentals. Tax aversion has led to a weaker fiscal balance in Kansas. Pension stress is pressuring Connecticut, New Jersey and Kentucky. Over-reliance on highly progressive and volatile income taxes creates challenges for California. Finally, slow economic growth is an issue for several states with otherwise low debt and solid credit profiles. State budget stress presages cuts to education and municipal aid as well as more ratings downgrades for both states and downstream local governments.

Weak credits. As in prior years, a handful of flawed credits could sap investor confidence in the market and, in conjunction with other negative market news, cause spreads to widen. Among places to watch: Atlantic City, where the state seeks to avoid default, at least for the next year;[xx] Chicago Public Schools, which is borrowing at penalty levels;[xxi] and Dallas, Texas, where unusual provisions in a deferred retirement option plan for state workers have triggered a run on the city’s pension fund.[xxii]

Puerto Rico. In 2017, at least three risks will emanate from Puerto Rico that are material to the broader market.

First, the Commonwealth’s extraordinarily weak fiscal integrity may influence the debate over federal tax reform. The municipal tax exemption has contributed to Puerto Rico’s distress by enabling its borrowing at below-market rates. Federal lawmakers may cite Puerto Rico when considering whether to repeal or curtail the exemption.

Second, in 2017, a federal court may rule on the relative priority between Puerto Rico’s sales tax-backed bonds and constitutionally protected GO bonds.[xxiii] A ruling in favor of the sales tax-secured holders may imply that state constitutional protections are weaker than the market currently perceives. In contrast, a ruling in favor of Puerto Rico’s GO holders might have the opposite effect. 

Third, Puerto Rico’s new governor plans to push for statehood during his term. Puerto Rican statehood is a low-probability event, for now, but if Puerto Rico eventually becomes a state the success or failure of its debt restructuring would have greater meaning for the municipal market. Unlike federal territories, financially overwhelmed states have broad authority to restructure and prioritize debts.[xxiv] If Puerto Rico becomes a state prior to resolving its debt crisis, the precedent it establishes will plainly apply to its 50 neighbors.

Weaker security features and reduced use of bond trustees. The length of the economic expansion has led to more-permissive underwriting standards over the past few years.[xxv] For example, many mid-A rated Hospital credits now lack a mortgage lien in property.[xxvi] Earlier in the decade, mid-A Hospital credits were routinely secured with such liens.

In addition, fewer issuers are using bond trustees. Bond trustees are generally required to act as a fiduciary for thousands of different bondholders upon default, and they may be only partly able to contact, organize and ask investors to vote on settlement terms. Their assistance in default situations may prove important in coming years given lower bond insurance penetration rates. However, as Figure 6 illustrates, bond trustee penetration rates appear to be falling.[xxvii]

A variety of factors are likely contributing to the less-frequent use of bond trustees. First, reduced issuance of variable rate demand bonds and auction rate securities since 2007 has probably depressed demand for trustees. These deals often involved puts, letters of credit and swaps that created a need for third-party fiduciaries. Second, strong demand for municipal bonds (reflected in today’s low yields) reduces the incentive for issuers to offer strong security features or to pay for the use of a trustee. Third, bond trustees may not be as useful as some perceive. In some recent defaults, bond trustees have been slow to act or ineffectual.[xxviii] Finally, the presence or absence of a bond trustee generally has no impact on bond ratings. A trustee’s value becomes apparent only when a default occurs, and from a ratings perspective, it may be only marginally important relative to other credit factors.

Impact of Federal Policy

Federal policy and election-related risks are the most relevant for municipal credit fundamentals entering 2017. Republican priorities, including tax reform, repealing (and replacing) the ACA and passing an infrastructure bill could significantly impact bond prices, volatility and credit fundamentals. President Trump’s trade and immigration policy preferences also create risks for certain regions and credits.

Tax reform. Changes to the federal tax code are likely in 2017. President Trump and Congressional Republicans have prioritized tax reform, and their tax plans are very similar (Figure 7). Both plans include lower marginal rates, limits on deductions and lower rates for corporations and non-corporate businesses.[xxix] Both plans would also be stimulative, as each increases annual deficits.[xxx]

Tax reform is a meaningful risk for municipal investors because it may involve altering the exclusion for municipal interest, adjusting other tax preferences that have a credit impact or changing the federal corporate tax structure.

To begin with, tax reform could impact the value of the municipal tax exemption in several ways. Results could include:

  • Cutting marginal income tax rates without altering the exemption. This outcome seems quite possible. It would likely lead to an increase in borrowing costs for issuers and higher municipal-to-Treasury ratios.

    Why it could happen: The tax reform plans proposed by President Trump and House Republicans include lower rates for all taxpayers. The president has said he wants to “keep” the tax exemption, and both plans lack specifics on it. [xxxi] In addition, the proposed plans are generally stimulative (which suggests that policymakers are less keen on deficit reduction than commonly understood). Finally, the Joint Committee on Taxation (JCT) will employ dynamic scoring when it measures the budget impact of any tax changes.[xxxii] Dynamic scoring should make it easier to keep the exemption in place, as some portion of any cuts in taxes will be assumed to pay for themselves.
  • Cap the value of the exemption. This outcome is also possible, but probably less likely than leaving the exemption alone. It would also likely lead to an increase in borrowing costs for municipal issuers and higher municipal-to-Treasury ratios.

    Why it could happen. Trump’s and House Republicans’ plans include reducing or eliminating exemptions and deductions and/or limiting the number of deductions that a taxpayer can claim. To the extent that municipal interest is included in these deductions and exemptions, the value of the tax preference for municipal interest should diminish. Also, former Republican House Ways and Means Committee Chairman Dave Camp proposed an effective 10-percent surtax on municipal interest for top earners in his Tax Reform Act of 2014. That surtax would have been brought about by placing a cap on the value of the exemption.[xxxiii]
  • Tax certain kinds of municipal bonds. Quite possibly, policymakers will curtail the size of the municipal market by making certain kinds of municipal bonds, such as private activity bonds, ineligible. Reducing the market’s size would place downward pressure on yields and reduce municipal-to-Treasury ratios.

    Why it could happen. Private activity bonds include those issued by tax-advantaged nonprofits such as private universities and hospitals. In recent years, Congress has expressed skepticism about tax preferences for private university endowments,[xxxiv] and at the state and local level there is growing interest in taxing large, tax-exempt nonprofits in general. In the next few months, the Illinois Supreme Court will decide whether nonprofit hospitals should remain exempt from paying property tax.[xxxv] Several towns in New Jersey are challenging hospitals’ nonprofit status, as well.[xxxvi] In addition, the Tax Reform Act of 2014 eliminated the exemption for private activity bonds.
  • Eliminate the exemption for newly issued bonds. Complete elimination of the exemption, even if the change was solely prospective, seems unlikely. Elimination would increase municipal yields and ratios going forward, but a premium would exist on legacy bonds.

    Why it could happen. The National Commission on Fiscal Responsibility and Reform proposed eliminating the exclusion for municipal interest in 2010. A more recent proposal from Sen. Ron Wyden and ex-Sen. Dan Coats also included prospective repeal.[xxxvii] Neither proposal proved lasting or popular.
  • Eliminate the exemption for newly issued and outstanding bonds. To our knowledge, this has not been proposed and seems very unlikely.

    Why it could happen. Not applicable; it probably won’t occur.

Other tax preferences with credit impact. Away from the tax exemption, other tax preferences have the potential to alter municipal credit dynamics (Figure 8). Changes to the state and local tax deduction or adjustments to the exclusion for employer-provided health insurance would be meaningful, in our view.


  • The state and local tax deduction. The state and local tax deduction is the third-largest tax expenditure in the federal tax code. If reform includes eliminating or reducing this deduction, the change would have positive near-term, and negative long-term, credit implications for state and local issuers.

In the near term, reducing the value of the state and local tax deduction would likely increase adjusted gross income (AGI) in several states. Some states use the federal tax code’s definition for adjusted gross income to set their income tax base. Reducing the value of the deduction would increase AGI and, likely, tax collections.[xxxviii] While lawmakers would probably act to cut state tax rates in response, this might take a few budget cycles.

Over the long term, reducing the state and local tax deduction would increase the marginal cost of providing state and local services. For example, under current rules, every 1 percent increase in a state’s income tax rate costs that state’s taxpayers less than 1 percent because they can deduct state income taxes on their federal return. Removing or reducing the state deduction forces taxpayers to bear the full burden of a state income tax hike. Over time, this may make it more difficult to raise revenue and could lessen some governments’ ability to fund essential services.

Exclusion for employer-provided health insurance. The federal code’s largest individual income tax break is the exclusion for employer-subsidized health insurance. The U.S. Treasury estimates that, at current rates, the exclusion will cost the federal government $2.7 trillion over 10 years.[xxxix] As part of ACA reform and tax reform, House Republicans have proposed eliminating this exclusion.

Ending the tax break for employer-provided health insurance could significantly alter existing compensation norms for state and local government workers. Health insurance benefits in the state and local sector are a substantial portion of pay (Figure 9). Taxing these benefits should incent employees to bargain for higher wages relative to existing benefits. Some workers might leave public employment as a result, because many state and local workers are attracted to public sector work precisely because it offers exceptional health benefits.

To the extent that taxing health benefits results in lower-cost health insurance plans, it might also reduce retiree healthcare (OPEB) costs. This would be a credit positive for certain issuers. Under certain plans, retirees’ OPEB benefits change whenever health benefits change for current employees.[xl]

  • Corporate taxes. Reducing corporate income tax rates should dampen demand for municipal bonds from corporate buyers.

    Nonetheless, in our view, corporate tax reform is unlikely to have a significant direct impact on the municipal market. Corporate investors hold 28 percent of municipal bonds and mostly consist of banks and insurance companies.[xli] These holders invest in the market mostly on a buy-and-hold basis. They are unlikely to sell their holdings hastily simply because tax rates change. Reduced bank demand could increase borrowing cost for small issuers who sometimes rely on bank lending to fund local infrastructure projects. However, over time, state bond bank structures and/or new state intercept programs might fill the void to assist these issuers.

    If corporate tax reform includes so-called “border adjustments,” it could have an indirect credit impact for some local governments in certain regions of the country. Under the House Republicans’ “destination-based cash flow plan,” the corporate income tax code would include border adjustments that would convert the corporate income tax into a value-added-like tax.[xlii] Export sales would go untaxed and foreign production costs would be nondeductible. On paper, these changes should favor exporters and harm companies whose input costs are imported. However, economists are confident that foreign exchange markets would quickly adjust to wash out any expected impacts.[xliii] If economists are wrong, or foreign exchange markets take time to adjust, states where exports comprise a high percentage of gross state product, such as Washington (where Boeing Co. is located) or Michigan (where auto manufacturers produce), might benefit.

ACA Repeal and Replace. Congressional Republicans and President Trump have made repealing and replacing the ACA a top priority in the 115th Congress. Repeal-and replace-efforts are likely to include substituting the ACA’s existing exchange subsidies with a refundable tax credit and revamping the Medicaid program.[xliv] These proposals are likely to negatively impact nonprofit hospitals and states, although the timing of any changes is unclear.

  • Nonprofit hospitals. Hospital systems have generally benefited from the ACA. Exchange subsidies and the Medicaid expansion have helped increase the number of insured patients, reduce hospitals’ bad debt expense and improve hospitals’ operating performance.

    Replacing today’s exchange subsidies and scaling back the Medicaid program would likely reverse these trends. The replacement proposals are not as generous as current law. In the case of individual subsidies, they include refundable tax credits that would grow at a rate slower than actual healthcare costs.[xlv] With respect to Medicaid, they envision converting the program into a block grant or per capita grant structure. This would likely shift more costs toward providers and hospitals.[xlvi]
  • States. Reforming the Medicaid program would also likely shift more costs to the states. On average, Medicaid makes up 26 percent of state spending (Figure 10). Under the block grant and per capita grant proposals, the federal portion of these costs would decline over time.

In addition, Medicaid reform is likely to increase the states’ marginal cost of providing healthcare services. Under the current matching grant structure, Medicaid provides at least a $1 match for every $1 spent by a state.[xlvii] Converting Medicaid into a block grant or per capita grant program would reduce the amount of benefits a state “buys” when it spends an extra dollar on Medicaid eligible services.

Infrastructure. A centerpiece of President Trump’s economic policy agenda is an increase in infrastructure funding. The president proposes to accomplish this in part by offering $137 billion in federal tax credits to leverage an additional $863 billion in private investment.[xlviii]

More federal infrastructure funding would be a credit positive for the municipal market. Figure 11 shows the extent to which infrastructure spending has not kept pace with economic growth over the past several decades.

But it is unclear whether President Trump’s proposal would achieve that end. The tax credit proposal is far too limited in scope, and there are few projects to which the credits could be directed. Private investors are interested in larger projects that produce reliable income from user fees. In contrast, most municipal borrowing is for smaller issuers whose bonds are backed by taxes or appropriations. This includes bonds issued for schools, locally maintained roads and police stations.

In addition, Trump’s proposal could inject more credit risk into the municipal market. To begin with, the premise of Trump’s tax credit plan is an increased role for large pools of private capital in the municipal market, including pension funds, endowments and private equity. Investors such as these are more likely to favor opaque private placements or unorthodox one-off lending structures that may complicate issuers’ debt portfolios. In addition, the plan would dovetail with efforts at the state and local level to increase public-private partnerships (P3s) in infrastructure funding. P3s can be complex and sometimes involve disguising debt as leases on municipal balance sheets. This, in turn, enables issuers to understate their debt for purposes of calculating debt limits.

Trade and Immigration. President Trump’s trade and immigration policies may also be important for credit quality. Trump has consistently advocated trade protectionism in varying degrees. His immigration policies could dampen demand for higher education issuers and increase costs for U.S. cities.

Federal trade law gives the U.S. president broad leeway to renegotiate or alter existing trade agreements. Specifically, the Trade Expansion Act permits the president to raise tariffs to protect national security. Provisions of the Trade Act of 1974 permit tariff increases for up to five months without Congressional approval.[xlix] If President Trump uses these laws or others on the books, it would likely impact specific regions and industries – although predicting which ones is difficult. To the extent that incidental changes in tariffs lead to a significant reduction in global trade, four of the 10 counties in the U.S. that might see the most-negative impact are in California (Figure 12).  

Immigration policy might modestly impact the higher education and local government sectors. Attorney general nominee Jeff Sessions has been a vocal critic of the H1-B visa program, and during the campaign Trump discouraged companies from hiring employees on H1-B visas. U.S. private and public universities benefit from H1-B visas insofar as they attract international students. Loss of tuition revenue from international students would be a credit negative for these issuers.[l]

City leaders remain concerned that Congressional Republicans and President Trump will withhold federal aid from “sanctuary cities.” This seems unlikely given that the Constitution forbids the federal government from commandeering local law enforcement officers or arbitrarily cutting federal aid to states.[li] Still, the risk is material enough that many cities have set aside funds to defend immigrants who might be detained under new federal policies.[lii]

Volatility Likely, Opportunities in A-rated Bonds

Given the significant degree of uncertainty associated with federal policy change, we expect an uptick in volatility over the next year. This may present buying opportunities in A-rated bonds at certain times. The credit environment looks generally stable away from federal policy risk, but a confluence of risks may cause spreads to widen now and again. These risks could include higher-than-anticipated inflation, more-aggressive rate hikes by the federal reserve or idiosyncratic credit stories that spook the market temporarily. As Figure 13 illustrates, A-rated credit spreads have widened since the election.


Entering 2017, municipal credit fundamentals are largely stable. The economy is growing at a reasonable clip, and key financial metrics suggest that most revenue sectors are in good health. These strengths largely offset ongoing risks associated with pension costs and delayed maintenance as well as budget imbalances in certain states. Federal policy conditions present the most imminent threat to fundamental credit quality. In just a few months, the tax exemption and state and local tax deduction may be altered. The Medicaid program could be changed to the detriment of hospitals and states, and trade and immigration policy could develop in largely unpredictable ways. We expect volatility to characterize the market in 2017, and we advocate strategic buying in the A-rated space when opportunities present themselves.


[i] These are December 2016-over-December 2015 figures for both retail sales and home prices. Data from the Federal Housing Finance Agency and U.S. Census.

[ii] Note that Moody’s Investors Service anticipates that enplanements will increase by 2.5% in 2017 and that toll road revenue will jump by 5-6%. See Moody’s airport and toll road outlooks, December 2016.

[iii] Breckinridge analysis based on Merritt Research Services data, January 2017.

[iv] Ibid.

[v] “City Fiscal Conditions 2016,” National League of Cities, October 2016.

[vi] Breckinridge calculations based on Merritt Research data and sample size of 900+ cities and 800+ counties for fiscal years 2010-2015.

[vii] Hayley Peterson, “A giant wave of store closures is about to hit the U.S.,” Business Insider, December 31, 2016.

[viii] State and local construction spending is available from the U.S. Census. For ballot data: Over 70% of transportation-related ballot measures passed in November 2016 per the Eno Center for Transportation, and there was a record number of initiatives on the ballot per the Center for Transportation Excellence, November 2016. See: Transportation Ballot Measures Recap, Eno Center for Transportation, December 12, 2016.

[ix] Assembly Concurrent Resolution #2, introduced in December 2015. The amendment was approved, 54.51% to 45.49%.

[x] Illinois General Assembly, House Joint Resolution Constitutional Amendment 36, adopted 5/5/2016. The amendment was approved, 78.91% to 21.09%.

[xi] City of Atlanta, as of November 8, 2016.

[xii] “CalPERS Reduction in Assumed Investment Returns is Credit Positive for Governments,” Moody’s Investors Service, January 4, 2017.

[xiii] Per Breckinridge conversations with Milliman actuaries.

[xiv] Jean-Pierre Aubry and Caroline V. Crawford, “State and Local Pension Reform Since the Financial Crisis,” Center for Retirement Research at Boston College, January 2017. The authors classify a “benefit reduction” as a change that (a) reduces benefits for retirees, (b) reduces benefits for new or current employees or (c) requires employees to contribute more out of salary for the same benefit.

[xv] In California, the state Supreme Court will hear an appeal of the ruling in Marin Association of Public Employees v. Marin County Employees’ Retirement Association, 2 Cal. App. 5th 674, Cal Ap. LEXIS 693 (August 17, 2016). That case establishes that local public employers in California, under certain conditions, can alter pension benefits prospectively, even for current employees. If upheld, Marin would likely reverse longstanding precedent in California. It would also create vulnerabilities for pension-related precedents in other states. The “California rule” that Marin appears to reverse has been applied in several other states to establish the scope of protections for public pension benefits. If the ruling is upheld, it may have meaning for future pension reform litigation in other states. In Puerto Rico, the Oversight Board will likely announce its treatment for pension obligations and bonds. Market participants will be watching closely.

[xvi] Brian Connery, Morgan Stanley presentation, September 2016.

[xvii] Denisse Salazar, “Recall successful in Yorba Linda water board; City Council adding two new faces,” The Orange County Register, November 9, 2016. Available at:

[xviii] Wendy Leung, “Fallout from Measure M seen as “bitter pill to swallow,” Ventura County Star, November 17, 2016. Available at:

[xix] “Fiscal Survey of the States,” National Association of State Budget Officers, Fall 2016. Year-to-date in FY 17, only four states are experiencing revenue growth in excess of budget.

[xx] See Moody’s Investors Service issuer comment on Atlantic City, November 28, 2016.

[xxi] In 2016, Chicago Public Schools issued GO bonds with a high yield of 8.5% in February and special tax bonds with a high yield of 6.25% in December. Both rates are hundreds of basis points above market norms. See:

[xxii] Tristan Hallman, “Appeals court sides with Dallas Police and Fire Pension System in 2014 DROP case,” Dallas Morning News, December 13, 2016.

[xxiii] GO and Cofina bondholders have been suing to lift PROMESA’s automatic stay for various reasons (ex: Lex Claims, LLC, et al. v. Garcia-Padilla, et al.). The stay is subject to extension but it is set to expire in mid-February 2017. Lawsuits against the Commonwealth for nonpayment of debt or redirection of pledged revenue might ensue after that date. GO holders may eventually be compelled to argue that Cofina bonds represent illegal debt or, alternatively, that the sales taxes that support Cofina payments are subordinate to constitutionally mandated first lien GO payments.

[xxiv] Testimony of James E. Spiotto, “Hearing on the Role of Public Employee Pensions in Contributing to State’s Insolvency and the Possibility of a State Bankruptcy Chapter, House Judiciary Subcommittee on Courts, Commercial and Administrative Law, February 2011.

[xxv] Municipal Market Advisors “Default Trends” report, December 8, 2016.

[xxvi] Conclusion based on anecdotal evidence from Breckinridge analysts.

[xxvii] GO bonds are often issued without the use of a bond trustee, but it is generally assumed that revenue deals include one. The data here includes GO, non-GO and revenue debt. Internal analyses show that the trend is the same for the revenue debt only.

[xxviii] Kyle Glazier, “Bond Trustee Blue in Michigan Deal Gone Bad,” The Bond Buyer, August 26, 2016.

[xxix] Trump’s latest proposal would reduce the number of individual income tax brackets from the current seven to only three. The top rate would be 33% instead of 39.6% (exclusive of the 3.8% Medicare tax on certain net investment income for high-income taxpayers).  See “An Analysis of Donald Trump’s Revised Tax Plan,” Tax Policy Center, October 18, 2016. The House Republicans’ “Better Way” plan would also trim the number of federal income tax brackets to three from seven, and it would use the same three rates (12%, 25% and 33%). The plan would provide a preferential top rate for capital gains, dividends and interest income of 16.5%. The Trump plan would also provide a preferential rate for dividends and capital gains. See “An Analysis of the House GOP Tax Plan,” Tax Policy Center, September 16, 2016

[xxx] See the Tax Policy Center’s Trump and House Republican analyses, cited above.

[xxxi] Evan Fallor, “With Trump’s Support, Muni Exemption Advocates Take Battle to Congress,” The Bond Buyer, December 16, 2016.

[xxxii] In early January 2015, the House approved a rule change that requires the Congressional Budget Office and Joint Committee on Taxation to include the macroeconomic effects of any legislation that causes a gross budgetary effect of at least 0.25% of U.S. GDP. Incorporation of such macroeconomic effects is known as “dynamic scoring.” As a practical matter, only changes to tax law or mandatory spending items (e.g., Medicaid, Social Security and Medicare) create “gross budgetary effects” exceeding 0.25% of GDP. So, this rule change very likely means that any tax reform legislation submitted in 2017 is likely to use dynamic scoring to estimate its impact on the long-term deficit. See: “The House’s New Rule on Dynamic Scoring,” Committee for a Responsible Federal Budget, January 8, 2015. Available at:

[xxxiii] See Tax Reform Act of 2014, Secs. 1001-1003. Among other changes, the proposal would allow certain tax preferences, including tax-exempt interest, to be taken against the 25% tax bracket. But the top income tax rate under the plan would be 35%.

[xxxiv] Janet Lorin, “Congress Asks Colleges How Endowments Help Reduce Tuition,”, September 13, 2016. Available at: Trump has expressed similar concerns:

[xxxv] Lisa Schencker, “Should Illinois hospitals have to pay property taxes? Court will weight question,” Chicago Tribune, January 12, 2017.

[xxxvi] Susan K. Livio, “These towns are now challenging hospitals’ tax-free status,”, February 24, 2016. Available at:

[xxxvii] The Bipartisan Tax Fairness and Simplification Act of 2011.

[xxxviii] “Tax Code Connections: How Changes to Federal Policy Affect State Revenue,” Pew Charitable Trusts, February 2016, p. 11. Pew notes that at least six states use federal taxable income to set their income tax base. Federal taxable income would include the deduction for state and local income taxes.

[xxxix] Analytical Perspectives Budget of the United States Government (FY 17), Table 14-3.

[xl] John Sanchez, “The Vesting, Modification, and Financing of Public Retiree Health Benefits in Light of New Accounting Rules, The John Marshall Law Review, Summer 2008.

[xli] Federal Reserve Flow of Funds, Table Z. 212, December 2016.

[xlii] “An Analysis of the House GOP Tax Plan,” Tax Policy Center, September 16, 2016.

[xliii] Alan Auerbach, “A Modern Corporate Tax,” Center for American Progress, December 2010 and “The House GOP’s Destination-based Cash Flow Tax, Explained,” Tax Foundation, June 30, 2016.

[xliv] House Republicans’ “A Better Way” proposal, June 22, 2016.

[xlv] House Republicans’ “A Better Way” proposal, June 22, 2016.

[xlvi] John Hollahan and Matthew Buettgens, “Block Grants and per Capita Caps, The Problem of Funding Disparities among States,” Urban Institute, September 8, 2016.

[xlvii] “Medicaid and the Uninsured,” Kaiser Family Foundation, September 2012.

[xlviii] Wilbur Ross and Peter Navarro, “Trump Versus Clinton on Infrastructure,”  Available at:

[xlix] Marcus Noland, Gary Clyde Hufbauer, Sherman Robinson and Tyler Moran, “Assessing Trade Agendas in the U.S. Presidential Campaign,” Peterson Institute for International Economics, September 2016.

[l] “Trump’s Election victory to Shift Ground on Trade, Financial Regulation, Healthcare,” Moody’s Investors Service, November 9, 2016.

[li] Printz v. U.S., 521 U.S. 898 (1997) and South Dakota v. Dole, 483 U.S. 203 (1987).

[lii] “LA, other municipalities plan immigrant legal aid after Trump’s win,” Southern California Public Radio, December 19, 2016. Available at:


DISCLAIMER: The material in this document is prepared for our clients and other interested parties and contains the opinions of Breckinridge Capital Advisors. Nothing in this document should be construed or relied upon as legal or financial advice. Any specific securities or portfolio characteristics listed above are for illustrative purposes and example only. They may not reflect actual investments in a client portfolio. All investments involve risk – including loss of principal. An investor should consult with an investment professional before making any investment decisions. This document may contain material directly taken from unaffiliated third party sources, including but not limited to federal and various state & local government documents, official financial reports, academic articles, and other public materials. If third party material is included, it is believed to be accurate, and reliable. However, none of the third party information should be relied upon without independent verification. All information contained in this document is current as of the date(s) indicated, and is subject to change without notice. No assurance can be given that any forward looking statements or estimates will prove accurate or profitable.