Janney Fixed Income Strategy
The Macroeconomy, Monetary Policy and the Fed, and Municipal Challenges
SEPTEMBER 19, 2014
Municipal Challenges Current Status of Municipal Credit, September 2014 Edition Moody’s Public Finance Ratings Distribution as of Jan. 1, 2014
60%
40%
20%
0% Aaa
Aa
A
Baa
Ba
Source Moody’s and Janney FIS.
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Municipal Challenges Ratings Distributions: Municipal vs. Corporate Issuers, Year End 2013 (Moody’s)
Source Moody’s report, May 2014, US Municipal Bond Defaults and Recoveries, 1970-2013 and Janney FIS.
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Municipal Challenges
Confusion as to the current status of municipal market credit conditions
Much attention to outliers, not representative of credit conditions
Fear driven by headline risk, mis-information & outliers
$15 million account Moody’s headline(s):
“Positive Trend of Upgrades Continues” 1Q14 Revisions “Stabilizing Credit Tends Across Most US Sectors” 2Q14 Revisions
What does municipal p credit look like now? 4
Municipal Challenges Municipal Credit Quality Remains High, but has Fallen Slightly Recently Comparison of Moody’s Public Finance Ratings Distribution as of Jan. 1, 2014
60%
2011
2014
40%
20%
0% A Aaa
A Aa
A
B Baa
B Ba
Source Moody’s and Janney FIS.
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Municipal Challenges
Turns out the municipal prediction “heard heard around the world” world was way off
Report titled: “Tragedy of the Commons”- Launched ratings of 15 states 60 Minutes on Dec 19, 2010
“There is not a doubt in my mind that you will see a spate of municipal bond defaults…you could see 50 sizeable i bl defaults, d f lt 50 to t 100 sizeable i bl defaults d f lt –more. This will amount to hundreds of billions of dollars worth of defaults.” Meredith Whitney Source: 60 Minutes, and Janney FIS.
“When individual investors look to people who are supposed to know better, they’re told, they’re patted on the head and told told, ‘It It is not something you need to worry about. When it will be something to worry about within the next 12 months.” Meredith Whitney
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Municipal Challenges Defaults (Moody’s Rated) have Remained Very Low
30 public finance defaults since beginning of 2008
Source Moody’s report, May 2014, US Municipal Bond Defaults and Recoveries, 1970-2013 and Janney FIS.
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Municipal Challenges Most Defaults (Moody’s Rated) have Been Housing and Healthcare Related
Source Moody’s report, May 2014, US Municipal Bond Defaults and Recoveries, 1970-2013 and Janney FIS.
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Municipal Challenges Eight Municipal Bankruptcies on Average a Year Going Back to 1980
# of M Municipal Baankruptcies
20 15
13 11
10 7
5 1
0 1980
1988
1996
2004
2012
Source Chapman and Cutler, Municipal Market Advisors and Janney Fixed Income Strategy. Through March 2014.
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Municipal Challenges
We still do not expect a municipal market meltdown
Investors, observers and analysts themselves need to refocus
Perception of municipal credit Much (too much) attention has been on outliers
Be aware of underlying credit quality, factors causing deterioration in some sectors
Credit selection is very important
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Municipal Challenges US State Rating Distribution – Still Mostly in the Higher Categories
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Moody's
S&P
15 12 9 6 3 0 Aaa/AAA Aa1/AA+ Aa2/AA Aa3/AA-
A1/A+
A2/A
A3/A-
Source: Moody’s, S&P and Janney FIS.
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Municipal Challenges Declines in State Tax Revenues 20
15
Nominal Change in State Tax Revenues (%)
15
10
10
5
5 0 0 -5 -5 State tax revenues declined in 1Q14 (-0.3%), prelim shows lower in 2Q14 (-0 ( 0.8%) 8%) too
-10 -15 -20
-10 -15 -20
01Q1
02Q4
04Q3
06Q2
08Q1
09Q4
11Q3
13Q2
Source: Rockefeller Institute, U.S. Census Bureau and Janney FIS.
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Municipal Challenges Total Year End U.S. State Balances, Fiscal 1979 to Fiscal 2014 TX and AK make up $25 of $57 billion.
$80 $60 $40 $20 $0
79 82 85 88 91 94 97 00 03 06 09 12 Source Fiscal Survey of States, Fall 2013, NASBO and Janney FIS. $ in billions.
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Municipal Challenges U.S. State Budget Strategies – Tax Increases – A Lever of Last Resort
States Relied Mainly on Spending Cuts to Close FY12 Budget Gaps
Strategies (Non-Tax) States Used to Reduce or Eliminate Budget Gaps
Source Center on Budget and Policy Priorities and Janney FIS.
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Municipal Challenges U.S. State Credit Quality is High, Sector Outlook is Stable, Downgrades Lurk for Some Positive Recent State Rating/Outlook Actions State
Action
Notes
Date
Agency
South Dakota
Outlook raised to Positive from Stable
Improved budget planning and results
8/1/2014
S&P
New York
Upgraded to AA+ from AA
Improved budgetary management
7/23/2014
S&P
C lif i California
U Upgraded d d to Aa3 A 3 from f A1
I Improved d governance andd better b finances fi
6/25/2014
M d' Moody's
New York
Upgraded to AA+ from AA
Improved fiscal management practices
6/20/2014
Fitch
Rhode Island
Outlook raised to Stable from Neg
On budgetary approval for 38 Studios debt
6/18/2014
S&P
New York
Upgraded to Aa1 from Aa2
Improved governance and spending restraint
6/16/2014
Moody's
Maine
Outlook raised to Stable from Negg
Stable economyy and revenues drive outlook
6/4/2014
Moody's y
Kentucky
Outlook raised to Stable from Neg
Fiscal discipline & auto sector recovery
6/2/2014
Moody's
Negative Recent State Rating/Outlook Actions State
Action
Notes
Date
Agency
Kansas
Downgraded to AA from AA+, Neg Out
Structural imbalance and tax cuts
8/6/2014
S&P
Pennsylvania
Downgraded to Aa3 from Aa2
Structural budget imbalance & pensions
7/21/2014
Moody's
Illinois
Lowered outlook to Neg from Developing
Structurally imbalanced FY15 budget
6/23/2014
S&P
Michigan
Lowered outlook to Stable from Positive
Lower in response to softening revenues
6/17/2014
S&P
New Jersey
Outlook to Watch Neg from Stable
Continuing structural imbalance
6/2/2014
S&P
New Jersey
Downgraded to A1 from Aa3
Budget imbalance, rev shortfalls, pensions
5/13/2014
Moody's
New Jersey
Downgraded to A+ from AA-
Ongoing budget strain, still neg outlook
5/1/2014
Fitch
Kansas
Downgraded to Aa2 from Aa1
Slow economic pace, structural imbalance
4/30/2014
Moody's
Source Moody’s, S&P, Fitch and Janney FIS.
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Municipal Challenges U.S. Local Government Ratings Distribution (Moody’s Rated)
Source Moody’s (Jan. 2014), Rating Methodology Presentation and Janney FIS.
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Municipal Challenges Number of Public Finance Upgrades & Downgrades (Moody’s Rated) 300
Moody's Upgrades (#)
Moody's Downgrades (#) 50% of Moody's upgrades were due to a new rating methodology (or new criteria) it i ) iin 1Q & 2Q 2014
200
100
0
-100
-200 200 Only 20%of downgrades were...
-300 1Q02
4Q03
3Q05
Source Moody’s and Janney FIS.
2Q07
1Q09
4Q10
3Q12
2Q14 17
Municipal Challenges Focus in on Local Government Downgrades (Moody’s Rated) Why Were Local Governments Downgrades in 2Q14? (Moody’s)
Narrowing Reserves (Just a) New Rating Criteria
Structural Imbalances Weak Credit Profile
6% 25%
14%
The Total # of Local Government Downgrades is Building % of Local Year G t Govt. (8,300) 2008 81 0.98% 2009 279 3.36% 2010 259 3.12% 2011 296 3 57% 3.57% 2012 344 4.14% 2013 437 5.27% 20141H 198 2.39% Total 1,894 22.82% Source: Moody Moody'ss and Janney FIS. FIS Moody's Tax Backed Downgrades (#)
55%
Source Moody’s and Janney FIS.
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Municipal Challenges U.S. Local Government Revenues Not Trending Even Close to Pre-2010 Levels
$900
$700
Actual U.S. Local Government Tax Revenues The yellow line shows how revenues were trending before the Great Recession, when U.S. growth was much higher
This difference is a reason why some local govt. issuers are susceptible to rating downgrades
$500 The green line is a revenue trend based on local govt revenues from just post 2010 results
$300 2004
2007
2010
2013
Notice the trend of local govt tax revenues since i 2010 iis bbarely l higher, this is not a positive for local government credit quality
2016
2019
Source: U.S. Census Bureau and Janney FIS.
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Municipal Challenges
What is the current status of…
U.S. State Government credit quality- “Stable”
Ratings are generally high – only some falling Indicators to watch Some significant g credit deterioration driven byy structural imbalances
Local government credit quality- “Cautious”
R ti Ratings generally ll high hi h – 20% falling f lli Downgrades have massively outpaced upgrades
Structural imbalances Narrowing of reserves
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Municipal Challenges Tom Kozlik | Municipal Credit Analyst | tkozlik@janney.com | 215.665.4422 Tom Kozlik Kozlik, Director and Municipal Credit Analyst Analyst, joined Janney Montgomery Scott in 2008 after time at UBS and Bear, Bear Stearns. Stearns In his current role Mr. Kozlik advises Janney’s retail and institutional clients about the strengths and weaknesses of municipal market credit profiles and offers guidance about how other trends might affect issuer credit profiles. He has been voted to Smith’s Research and Gradings Municipal All-Star Team in the Housing category. Mr. Kozlik graduated from the Schreyer’s Honors College at the Pennsylvania State University with a degree in Political Science with Honors and earned a Masters of Governmental Administration from the Fels Institute of Government at the University of Pennsylvania. He co-taught a ggraduate level class at the Universityy of Pennsylvania y titled the Business of Public Finance Investment Bankingg which is offered to students at the Fels Institute of Government and Wharton Business School.
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Certification & Disclaimers This report is the intellectual property of Janney Montgomery Scott LLC (Janney) and may not be reproduced, reproduced distributed, distributed or published by any person for any purpose without Janney Janney’ss express prior written consent. This presentation has been prepared by Janney FISR (FIS) and is to be used for informational purposes only. In no event should it be construed as a solicitation or offer to purchase or sell a security. The information presented herein is taken from sources believed to be reliable, but is not guaranteed by Janney as to accuracy or completeness. Any issue named or rates mentioned are used for illustrative purposes only, and may not represent the specific features or securities available at a given time. Preliminary Official Statements, Final Official Statements, or Prospectuses for any new issues mentioned herein are available upon request. The value of and income from investments may vary because of changes in interest rates, foreign exchange rates, securities prices, market Indices, as well as operational or financial conditions of issuers or other factors. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. We have no obligation to tell you when opinions or information contained in Janney FIS presentations or publications change. Definition of Ratings Overweight: Janney FIS expects the target asset class or sector to outperform the comparable benchmark (below) in its asset class in terms of total return Marketweight: Janney FIS expects the target asset class or sector to perform in line with the comparable benchmark (below) in its asset class in terms of total return Underweight: Janney FIS expects the target asset class or sector to underperform the comparable benchmark (below) in its asset class in terms of total return Benchmarks Asset Classes: Janney FIS ratings for domestic fixed income asset classes including Treasuries, Agencies, Mortgages, Investment Grade Credit, High Yield Credit, and Municipals employ the “Barclay’s U.S. Aggregate Bond Market Index” as a benchmark. Treasuries: Janneyy FIS ratings g employ p y the “Barclay’s y U.S. Treasuryy Index” as a benchmark. Agencies: Janney FIS ratings employ the “Barclay’s U.S. Agency Index” as a benchmark. Mortgages: Janney FIS ratings employ the “Barclay’s U.S. MBS Index” as a benchmark. Investment Grade Credit: Janney FIS ratings employ the “Barclay’s U.S. Credit Index” as a benchmark. High Yield Credit: Janney FIS ratings for employ “Barclay’s U.S. Corporate High Yield Index” as a benchmark. Municipals: Janney FIS ratings employ the “Barclay’s Municipal Bond Index” as a benchmark. Analyst Certification Tom Kozlik the Primarily Responsible Analyst for this report, hereby certify that all views expressed in this report accurately reflect our personal views about any and all of the subject sectors, industries, securities, and issuers. No part of our compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.
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