| SEPTEMBER 23, 2016
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Nebraska Town Hit With 'Superdowngrade'
The tiny town of Ralston, Neb., was surprised by a seven-notch "superdowngrade" this week when its arena bonds were sent hurdling into junk rating territory. S&P Global Ratings said it moved the rating from A+ to BB because of the financial strain the building is placing on the city of roughly 6,000 people.
Ralston voters overwhelmingly approved $29 million in bonds to build the arena and related projects back in 2011. The city, which is surrounded by the capital Omaha, told voters that feasibility studies had suggested the arena would earn enough to pay for itself and could even boost the city’s revenue to the point where they could reduce property taxes. Instead, the building and related revenues have fallen short, leading Ralston to make up the difference by increasing property and other taxes in 2015.
The arena -- which accounts for roughly half of the city’s outstanding $49 million in debt --represents an outsized burden on a city that collects roughly $4 million annually between its general fund and its debt service fund, according to its most recent financial report. “The city's liquidity is very weak, coupled with what we view as weak management conditions,” said S&P credit analyst Blake Yocom. “Furthermore, Ralston is overleveraged. The city's high-debt burden will likely continue to pressure its finances and taxing flexibility.”
In response to the downgrade, Ralston Mayor Don Groesser told the Omaha World-Herald this week he was “disappointed” and contested many of S&P’s assertions. He also told the city council the arena is “doing a great job," and that "it’s just all going to plan,” according to the World-Herald.
The Takeaway: Stadiums and arenas in general are controversial investments. But one thing seems clear: They're a very risky investment for smaller governments. In 2012, for instance, the Minneapolis suburb of Vadnais Heights had its own credit rating downgraded to junk status when it decided not to cover a bond payment on its $25 million sports complex. City Mayor Marc Johannsen called the move “unfair.” Ramsey County eventually took the complex off the city’s hands, paying $9.8 million for it. Earlier in 2012, Wenatchee, Wash., was also downgraded to junk because it failed to support a regional sports arena that defaulted on nearly $42 million in debt.
If Ralston doesn’t continue to cover the arena’s debt or otherwise get it off its books, history has shown its own credit rating could be in jeopardy.
Banking on Munis
Banks are now the third largest holders of municipal bonds after going on a buying spree this spring, a new analysis says. Between March and June this year, banks spent more on municipal bonds -- $17 billion -- than they have in any other quarter in the past four years. That now puts a total of $526 billion in bonds and loans on their books, a 10 percent increase over the past year, said Municipal Market Analytics’ Matt Fabian.
The Takeaway: This development plays into the overall shift researchers are seeing on who buys municipal bonds. The market has long been dominated by so-called retail investors – often referred to as “mom and pop” or household investors. This detail has been important for those lobbying to keep the tax-exempt status of the municipal bond.The argument is that if taxed, it would hurt the middle class and retirees.
But new data has shown that class of investors is shrinking and being replaced by very wealthy individuals. Meanwhile, Fabian reports, the other major buyers of municipal bonds as of late have been mutual funds and exchange-traded funds. “Along with the steady decline in household assets, these data highlight the steady evolution of the municipal market to a more institutionally oriented universe,” Fabian said.
California’s Big Test
A new analysis of one of the nation’s biggest state budget bounceback stories warns that all is not sunny in California after all. It's true that California is a far cry from the $20 billion annual deficits the state faced in early 2011. Thanks to new policies and a tax revenue structure that benefits greatly when the stock market is booming, the Golden State now has budget reserves equal to about 7 percent of annual expenditures, has reversed more than $10 billion in school aid deferrals and paid off more than $7 billion in debt.
But, said S&P analyst Gabe Petek, California’s turnaround isn’t bulletproof. Perhaps the biggest vulnerability California faces is its disproportionate reliance on a narrow, wealthy segment of its taxpayer base. This reliance leads to revenue volatility and is a big reason the state faced such gaping deficits when the financial crisis hit in 2008. That volatility has actually become more acute during Gov. Jerry Brown's administration, thanks to a tax hike on the state’s wealthiest earners. Thus in tax year 2014, according to S&P, the top 1 percent of income earners paid 48 percent of the state's personal income tax.
The Takeaway: California has done an admirable job of preparing for the next downturn and staying conservative in its spending during the current economic expansions. But, Petek notes, that spending restraint is in large part due to Brown’s leadership and could change with the next administration. Additionally, the state’s budget is still more vulnerable to a financial crisis than most other states because of its reliance on investment income.
Other states that rely heavily on investment income are Connecticut, New York and Oregon. It’s not necessarily bad to have a heavier reliance on that revenue stream, but California’s experience has shown that much depends on who’s captaining the ship when times are good. Connecticut, for instance, has continued to struggle with budget deficits and credit rating downgrades, even during a time of economic expansion.
It’s also important to put things in perspective. After downgrades and upgrades, California and Connecticut now have the same credit rating from S&P.
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