Moody’s Warns About Effect of Funding Freeze on Distressed Municipalities

John Reitmeyer | July 22, 2019 | Budget
Rating agency alerts investors to potential trouble if Gov. Phil Murphy’s suspension of $105 million in ‘transitional aid’ remains in place

Credit: NJTV News
Gov. Phil Murphy’s decision to impound funds earmarked for New Jersey’s neediest municipalities over concerns about the state budget has drawn the attention of Wall Street.

A recent notice from Moody’s Investors Service called Murphy’s sequestering of nearly $105 million in so-called “transitional aid” for fiscally distressed municipalities a “credit negative” for the communities since they use the aid to balance their own spending plans.

Recent recipients of the state’s transitional aid have included Atlantic City, Camden, Nutley, Paterson, Penns Grove, Salem, Seaside Heights, Trenton and Union City.

Murphy said earlier this month that he was suspending the transitional-aid appropriations and dozens of other spending items until concerns about the state budget are resolved. The subsequent notice from Moody’s, a major Wall Street credit-rating firm, isn’t a formal downgrade of any of the municipalities’ credit ratings, but instead warns investors of a potential for trouble as long as the state funding is held back.

“Given the frequently razor-thin margins of error in distressed municipal budgets, a suspension can lead to the need for draconian cost-cutting or large tax increases,” Moody’s said.

Calls for funding to be released

The firm’s warning led advocates for municipal governments to renew calls for the Murphy administration to immediately release the funding to the municipalities. But state Department of Treasury officials responded by saying they are keeping close tabs on the fiscal condition of both the state and the municipalities, and suggested action could be taken quickly, if necessary, to prevent major hardships for municipalities.

Murphy, a Democrat, removed nearly $50 million in spending from the final version of the $38.7 billion budget for fiscal year 2020 that he signed June 30. He deleted the appropriations using line-item veto powers authorized by the state constitution after he and the Democratic-controlled Legislature failed to resolve disagreements over several key budget issues, including lawmakers’ refusal to enact a millionaires tax sought by the governor.

Murphy also put $235 million in FY2020 appropriations in reserve in response to the fiscal concerns. The largest single item on that list of suspended appropriations was $104.8 million in funding for transitional aid. The aid is supposed to help municipalities “transition” from periods of fiscal distress to long-term stability. Such aid can only equal 85 percent of a prior year’s transitional aid, and the funding can only be used to cover municipal operating costs.

The governor has said he will hold back the reserved appropriations until Treasury is confident that some of the riskier savings initiatives that lawmakers included in the legislative spending bill have actually resulted in lower spending. He said he is not willing to put any more strain on the state’s already thin budget reserves amid the uncertainty.

The notice Moody’s issued last week noted there is still $10 million in funding for transitional aid that remains untouched by Murphy’s budget actions. But Moody’s also noted that would cover only a fraction of the $92 million in such aid that was distributed in FY2019. And while transitional aid typically goes out to municipalities later in the fiscal year, which began July 1, Moody’s cited several reasons why an ongoing suspension of the appropriations should be a concern for investors.

Cap on local property-tax increases

Among those concerns is a state law that restricts annual revenue collections for municipalities by requiring them to limit local property-tax levy increases to no more than 2 percent year-over-year. Pressure on the spending side of the ledger is also a problem in many of the distressed municipalities that are expecting to receive transitional aid, Moody’s said.

“Cutting spending is, at best, a temporary solution because many of the municipalities struggle with legacy cost issues, including deferred infrastructure expenses,” the notice said.

It advised that complete loss of transitional aid for some municipalities, including Paterson, would wipe out local budget reserves if they are forced by the state to go without transitional aid.

“Few of the municipalities in question have substantial reserves, so covering the transitional aid gap in this way could leave them with little to no buffer,” the notice said.

The New Jersey League of Municipalities, a group that lobbies in Trenton on behalf of local governments, raised concerns about the suspension of the transitional aid by underlining that the funding goes only to communities facing “serious fiscal distress.” Michael Cerra, the organization’s deputy executive director, repeated that point on Friday as he observed the impacted communities are already running on very narrow margins.

Confirming ‘greatest fear’

“Moody’s confirmed our greatest fear about the sequestration of funding,” Cerra said. He also said some of the municipalities operate under a calendar-year spending plan, meaning their budget years are already half over.

“(The) Moody’s analysis underscores that immediate action is needed to protect the taxpayers of these communities,” he said.

Similar impoundments have occurred before, most recently in 2016, when then-Gov. Chris Christie temporarily held back $100 million in transitional aid amid a dispute with lawmakers over public-worker health-benefits savings. That funding was eventually released without causing any major hiccups for municipalities. But this year, it could take some time before the Murphy administration develops enough confidence in the Legislature’s revenue projections to release the impounded appropriations.

Treasurer Elizabeth Maher Muoio suggested in her response to the Moody’s notice that her department still has the option of putting other spending items in reserve instead of the transitional aid if a municipality is facing an “imminent hardship” due to the impounding of the aid.

“We are constantly monitoring the state’s fiscal situation and have asked every state agency to keep us informed of any imminent needs or hardships that might arise in relation to spending items under their purview that have been placed in reserve,” she said.