Ratings, Teachers’ Strikes, Pensions, Higher Education

During the quarter, Moody’s and S&P reported that upgrades of municipal bonds continued to dominate downgrades in 2017. For S&P it was the sixth year in a row, with California leading the way in the number of upgraded issuers, followed by Florida and Texas. For Moody’s it was the third year in a row that upgrades surpassed downgrades. Moody’s noted, however, that the dollar amount of downgrades did exceed that for upgrades. The downgrades of New Jersey, Illinois, Connecticut, Puerto Rico, and related issuers accounted for almost 70% of downgraded debt. As our readers know, we have avoided the mentioned issuers’ bonds – except for selected insured bonds of Puerto Rico. Overall, the positive ratings environment is expected to continue with projected economic growth, although S&P notes that the tax reform limits on the deduction of interest for mortgages larger than $700,000 could constrain home prices in high-cost places like California (limiting the flexibility to raise property taxes); and the cap on federal deductions for state and local taxes could also produce stress in high-tax states, thus limiting upside ratings movements and potentially resulting in downgrades. Notwithstanding the positive growth, outlooks show that pockets of weakness are expected to remain in healthcare and higher education.

State Ratings

We noted in our last quarterly municipal credit commentary that state rating activity had waned; and now the first quarter of 2018 is the first quarter in at least seven when there was no rating action on any state by Moody’s, S&P, Fitch, or Kroll; and that includes trend changes.

There was plenty of state news, however, focused on teachers’ strikes.

The West Virginia teacher’s strike closed all schools in the state for nine weekdays ending March 6th. The teachers prevailed and secured a 5% pay increase for public employees and a pledge to review healthcare coverage. The raises will likely come from reductions in other services. Oklahoma teachers have a strike planned for April 2nd, and although the state did grant a pay raise to public employees on March 26th, as of this writing the strike has yet to be called off. The pay increase will be funded by increasing taxes on oil and gas production, hotels, tobacco, diesel fuel, and gasoline. Arizona teachers are looking for pay raises, too, and a strike could be on the horizon after teachers’ success in West Virginia. There are also rumblings from teachers in Kentucky, who are worried about potential changes to their health and pension benefits. K–12 education is one of the largest spending items for states, second only to Medicaid, though it declined from 22% of states’ spending in 2008 to 19.4% in 2017, according to a report by the National Association of State Budget Officers. Overall spending on education increased 3.9% in 2017; however, the growth in Medicaid spending was 6.1%.