The fourth quarter was dominated by tax reform and its effects on the supply and pricing of municipal bonds. The prospect that one of President Trump’s major initiatives would finally be passed by year-end buoyed the stock market. For a recap of the tax law changes and effects on the municipal market, please see John Mousseau’s commentary “The Muni Take on the Tax Bill (Round Two)”.

As we move on from tax reform, many are hopeful that an infrastructure plan will be addressed this year. The ability of municipalities to continue to issue private activity bonds had been threatened in the tax reform process. These bonds help fund traditional infrastructure projects from hospitals to airports and are expected to be instrumental in furthering an infrastructure initiative. Improvement of our infrastructure is important to our nation’s continued growth, as the country depends on the preparedness of our electric, water, and wastewater utilities and it depends on safe roads and bridges to provide for efficient transport of goods and services.As we have noted in past commentaries, the American Society of Civil Engineers, while noting some improvement, still gives US infrastructure a D+ rating, similar to the last major assessment in 2013.

The quarter also experienced significant natural disasters, which we commented on in our Dec 22nd commentary, “Wildfires Abound”, and in our October 10th Q3 commentary “Whirlwind Is an Understatement”.

State ratings activity waned a bit in Q4, compared to past quarters. State ratings volatility may continue to decline, as the downgrades of the past few years have targeted attention to the growing liabilities and some states’ overreliance on narrow revenues. Some states and other municipalities are making inroads at reducing large and mounting unfunded pension and other postemployment benefits (OPEB), such as promised healthcare liabilities. These actions include reducing earnings assumptions on invested assets to realistic levels that reflect market conditions, fully funding annual contributions, and gaining concessions from employees. States such as Alaska and Oklahoma, which are overly reliant on oil and gas business or royalties and which have not yet addressed long-term fixes, have already been downgraded.

High-tax states will have to manage the implications of tax law changes that may affect their citizens disproportionately – and in some cases substantially – by reducing the tax deduction for state and local taxes and mortgage interest. These changes effectively raise federal taxes and reduce the flexibility of states and localities to raise taxes. Connecticut is an example of a high tax state that has already lost population in response to high taxes and a difficult operating environment. High-growth states such as Texas and Florida will be watched to see if there is pressure on their budgets for infrastructure and social services. Many municipalities, having learned a lesson from the financial crisis, have made an effort to keep reserves or rainy day funds at healthy levels.