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SANCTUARY CITIES AND MUNICIPAL CREDIT: SEPARATING POLITICAL NARRATIVE FROM FISCAL REALITY

Matthew Riggle and Kyle Gerberding
Jan 29
3 min read

Recent proclamations by the Federal Government signaling intent to cut or withhold funding to “sanctuary” cities and states add a new layer of complexity to municipal credit analysis. However, it’s important to emphasize that not all affected jurisdictions are alike. The implications of potential funding reductions will vary significantly depending on each municipality’s tax base, revenue diversity, budget structure, legal protections, and the share of operations funded by federal aid.

These threats to historically blue localities are not new from President Trump. Yet, following the recent freeze of social safety-net funds to five states—highlighted by the Minnesota fraud investigation—this issue underscores the need for ongoing credit surveillance across client portfolios. Looking under the hood of underlying credits and evaluating potential impacts in an evolving federal funding landscape has never been more critical.

Background:

The Trump Administration recently announced that federal payments to sanctuary cities would be suspended starting February 1, 2026. Specific funding streams have not been fully detailed, but the directives appear targeted at localities not complying with federal immigration enforcement. Courts have previously blocked similar efforts dating back to President Trump’s first term, including a federal injunction as recently as August 2025, which found such orders “unconstitutionally coercive.” While presidents often threaten funding based on policy priorities, the breadth of these recent proclamations makes legal clarity challenging.

Municipal Implications:

Regardless of how the situation unfolds in the near term, this adds another headwind to state and local government budgets, alongside OBBBA policies taking effect this year. Many cities rely on federal funds funneled through states via transportation and infrastructure grants, housing and community development programs, and DOJ/DHS law enforcement grants. According to a June 2025 Pew Research report, federal dollars represented 36% of total state revenue in FY 2023, making them the second-largest revenue source after tax collections.

While federal funding exposure varies across municipalities, complete elimination of these funds could negatively impact the bottom line, potentially pressuring cities to cut services, raise taxes, or run wider deficits. These pressures may lead mayors and governors to reassess fixed costs, potentially affecting third-party credit ratings. As seen with the market reaction to the election of NYC Mayor Mamdani, political threats alone can temporarily increase borrowing costs. Throughout the past year, our credit research has reinforced a core theme: not all credits are equally exposed, and many municipalities remain fully capable of “standing on their own two feet.”

Our Analysis:

Many cities at risk of federal funding cuts are large, economically diverse jurisdictions with substantial local revenues from income, property and sales taxes, as well as service fees. This revenue diversity provides resilience against federal volatility. While some states receive up to 50% of their budgets from federal funds via grants for programs and services, many cities maintain sufficient cash reserves and flexibility to protect debt service.

Our client holdings prioritize strong legal covenants and revenue streams insulated from swings in operating funds. While federal funds tied to immigration enforcement may be withheld from noncompliant jurisdictions, withholding funds for unrelated purposes—such as community development, health, education, or transportation—would likely face constitutional challenges. Anticipated court battles do not alter the fundamental research behind our holdings. In fact, this environment encourages issuers to strengthen disclosures, acknowledge risk, and reinforce already resilient balance sheets, ultimately improving transparency and efficiency.

Bottom-Up Research Focus:

During periods of uncertainty, our analysis emphasizes:

• Local revenue strength and diversification	• Economic diversity
• Management and governance quality	• Revenue structure and stability
• Litigation monitoring and federal policy tracking	• Legal resilience
• Issuer-specific fundamentals	• Reserves adequacy

Noncomprehensive List of Sanctuary Cities

Source: APA 2025, Merritt Research Services

Closing:

While federal threats from the Trump Administration capture headlines, treating all sanctuary cities as equally vulnerable or weaker than their peers is misleading. In the midst of the changing municipal credit landscape, we remain focused on nuance and issuer-specific credit fundamentals, sifting through the haves and have-nots, seeking long-term opportunities for clients through active portfolio management.

APA-2601-55