Issuu

Global Interdependence Center Focus on American Cities

Robert Kurtter, Managing Director US Public Finance Hamilton, Bermuda

October 11, 2013

State Update 2013

Global Interdependence Center, October 11, 2013

Distribution of State G.O. & Issuer Ratings

State Ratings 16

» 40 stable outlooks » 6 negative outlooks

» 2 positive outlooks

8 6

4 2

Baa3*

0 Aaa

Aa1

Aa2

Aa3

* Puerto Rico

Global Interdependence Center, October 11, 2013

Distribution of State G.O. & Issuer Ratings

Global Interdependence Center, October 11, 2013

State Sector Outlook Revised to Stable

Rationale for stable outlook includes: Continued economic stability

»  –

Federal cuts are more predictable and measurable; less likely to undermine economy

Aggregate revenue growth continues, faster than expected and surpassing prerecession levels in 4th quarter 2012

»  –

Personal Income Tax leads growth, may be one-time

–

State revenues are highly economically sensitive

Highly rated states rebuilding reserves to levels consistent with long-term median

Areas of caution remain and some states will continue to see credit pressure –

Employment levels still weak

–

Federal deficit reduction

–

Pensions squeeze budgets

Global Interdependence Center, October 11, 2013

Rating Actions Reflect Improved Stability 2013

2012 »

Downgrades – 4: ˗

Connecticut to Aa3

˗  ˗

Illinois to A2 Pennsylvania to Aa2

Puerto Rico to Baa3

Negative Outlooks Assigned – 3: ˗  Illinois, Maine, Washington

Positive Outlooks Assigned – None

US government rating outlook negative

Downgrades - 1:

Stable Outlooks Assigned – 6: ˗

Minnesota, Washington

Maryland, Missouri, New Mexico, Virginia

Positive Outlooks Assigned – 2: ˗  ˗

Illinois to A3

Michigan New York

US government rating outlook revised to stable

Global Interdependence Center, October 11, 2013

Key Economic Indicators Have Stabilized Total

YOY % Change in Monthly Employment

6.00%

Private

Government

4.00% 2.00% 0.00% -2.00% -4.00% -6.00% -8.00% 2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: US Bureau of Labor Statistics

Payroll employment increased by 169,000 in August and 7.3% unemployment rate is lowest since 2008

Residential construction permits up 26% since July 2012 (Moody s Analytics); existing home sales up 13.2% since August 2012 (National Association of Realtors)

Consumer confidence rising despite federal tax increases –

Vehicle sales, a key indicator of consumer confidence, increased to almost 16 million annually in June 2013, near the pre-recession long-term trend

Global Interdependence Center, October 11, 2013

Quarterly Tax Revenues Surpass Peak Year-Over-Year Quarterly Percentage Change in State Tax Revenue

30 20 10 0 2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

-10 -20 -30

Source: Rockefeller Institute of Government Total Tax Collections

Personal Income Tax

Sales Tax

In the first quarter of 2013, state tax revenues exceeded the same quarter in 2008 by 4.4% when adjusted for inflation, according to Rockefeller Institute

Early in 2013, states’ estimates for total tax revenues increased 1.5% over earlier predictions, and 40 states reported that collections would meet or exceed budget (NASBO)

Anticipation of tax law changes in 2013 led to one-time revenues in the fourth quarter of 2012 Global Interdependence Center, October 11, 2013

Slow but Steady Reserve Replenishment GAAP Reserves Reach 10-Yr Median 20.0 10.0 0.0 -10.0 -20.0 -30.0 -40.0 2003

2004

2005 Aaa

2006

2007 Aa

2008 A

2009

2010

2011

2012

10-Yr Median

Source: Moody’s Investors Service; State CAFRs

States have worked to balance budgets through tight budgeting and fiscal restraint

Median estimated FY13 budget reserves increased to 2.6% of expenditures from 1.3% in 2010, but remains below the 8.3% fiscal 2008 median (NASBO)

However, reserves close to10-year median of 4.5% of revenues, GAAP basis

Seven states report that budgetary reserves will be below 1%, down from 12 in 2010 (NASBO) Global Interdependence Center, October 11, 2013

Local Governments

Global Interdependence Center, October 11, 2013

US Local Government Outlook Remains Negative »

Despite overall economic rebound, local government credit remains strained

Local governments benefit less directly from factors driving state credit conditions

Although housing markets in some regions are rebounding, gains have not resulted in property tax revenue growth yet

Fixed costs remain high and are increasing

Downgrades continue to outpace upgrades at relatively high levels Rate of Downgrades in 2013 Remains Consistent with 2012 400

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

350 300 250 200 150 100 50 0

1Q07

3Q07

1Q08

3Q08

Upgrades

1Q09

3Q09

Downgrades

1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

1Q13

Downgrades as % of Ratings Revisions

Source: Moody’s Investors Service

Global Interdependence Center, October 11, 2013

Pace of Economic Recovery Varies Widely by Region »

West and South leading in recovery, although gap may be closing somewhat

Unemployment rates are converging among the regions, although disparities remain within regions

Home price gains concentrated in areas with most declines during downturn

Housing Market Growth Strongest in West Top Metro-Area Increases in Case-Shiller Home Price Index, % annual change, June 2013 20-metro composite Portland Seattle Miami Detroit Atlanta San Diego Phoenix Los Angeles San Francisco Las Vegas 0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

Source: Standard & Poor’s Case-Shiller

Global Interdependence Center, October 11, 2013

Top Local Government Revenues are Still Constrained Local Government Revenues by Source

Property Taxes 29%

State Aid 34%

Sales Taxes, Income Taxes, Other Taxes 10%

Charges for Service 16%

Federal Aid 4%

Miscellaneous 7%

Source: US Census Bureau

Global Interdependence Center, October 11, 2013

Top Local Government Revenues are Still Constrained »

Sales and income taxes are recovering, but comprise a relatively small portion of the sector’s overall operating revenue base

In many states, aid to local governments remains below pre-recession levels »

e.g., Kansas, California, Michigan

The housing market recovery will have a delayed and/or limited impact on property tax revenues for many local governments Property Taxes

Sales Taxes

Income Taxes

35% 30%

29%

25% 20% 15% 10% 7%

0% -‐5%

1Q 2 010 2Q 2 010 3Q 2 010 4Q 2 010 1Q 2 011 2Q 2 011 3Q 2 011 4Q 2 011 1Q 2 012 2Q 2 012 3Q 2 012 4Q 2 012 1Q 2 013 Source: US Census Bureau

(4 Q uarters Ending)

Global Interdependence Center, October 11, 2013

Local Governments Have Made Difficult Decisions, More to Come »

Local governments have made deep cuts, mainly by reducing staff sizes and freezing salaries and wages

Fixed costs continue to rise steeply, outpacing revenue growth

Some local government management teams find it difficult to identify new areas of cost containment without adversely impacting services Pace of Local Government Job Cuts is Slowing Annual Change in Average Local Government Employment

5.0% 4.0% 3.0% 2.0%

United States

1.0%

New York MSA

0.0%

Los Angeles MSA Dallas MSA

-1.0%

Chicago MSA

-2.0% -3.0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013*

*Forecast

Source: US Bureau of Labor Statistics, Moody’s Analytics

Global Interdependence Center, October 11, 2013

Speculative Grade GO Ratings Continue to Grow »

Indicates level of distress within the local government sectors

Still a small number relative to total rated universe (37)

State oversight of local governments integral to management of distress General Obligation Non-Investment Grade Ratings Growth

Ba Source: Moody’s Investors Service

B 2011

2012

Caa 2013

Global Interdependence Center, October 11, 2013

Despite Pressures, Most Local Governments are Highly Rated and Will Likely Remain So 35%

30%

25%

20%

15%

10%

0% Aaa

Aa1

Aa2

Aa3

A2 City

County

Baa1

Baa2

Baa3

Ba1

Ba2

Ba3

School District

Global Interdependence Center, October 11, 2013

Municipal Bankruptcy & Default

Global Interdependence Center, October 11, 2013

Implications of Recent Municipal Bankruptcies and Defaults »

Default and bankruptcy are not the same

Bankruptcy treatment is an explicit part of credit evaluation for distressed credits

Some severely distressed local governments may be facing “service insolvency”

Revenue bondholders not necessarily in much stronger position than distressed GO

Ranking of pension vs. debt obligations to be tested in CA and MI cases

Recent default recoveries are lower than in the past

Global Interdependence Center, October 11, 2013

‘Service Insolvency’ Heightens Risk to Bondholders »  Costs of funding health and public safety starts to compete fiercely with debt service –  Detroit, Stockton and San Bernardino cited “service insolvency” as rationale for bankruptcy filings –  San Jose and Chicago have alluded to insolvency as leverage in bargaining

»  Corporate, project finance and health care entities in distress undergo ‘straight-line’ decline –  Cash, reserves, and revenues dwindle until sale or merger, or closure; bondholders divide remaining assets

»  General governments may decline until ‘service insolvency’ diverts all resources to operations –  Bondholders may be put on hold until crisis is resolved

Global Interdependence Center, October 11, 2013

Debt Obligations vs. Pension Obligations to be Tested »  Priority of claim for bonds versus pensions is not clear –  Security for pensions and ranking vs. other obligations is generally untested by courts –  Priority outlined in bond documents or state statute may not necessarily hold up in Chapter 9 bankruptcy

»  Treatment of debt versus pensions may prove to be most significant and far-reaching result of the Detroit and California bankruptcies –  Only in Rhode Island, so far, does debt come before pensions in a stressed situation –  California distressed cities assert that pension are paid ahead of debt –  In Detroit EM’s plan, tax-supported debt is treated on parity with unfunded pensions (up-sized to reflect more conservative assumptions) and OPEBs

»  Depending on Detroit outcome, additional stressed local governments may turn to bankruptcy as a tool to reduce or restructure their debt and pension obligations

. Global Interdependence Center, October 11, 2013

Recoveries for Recent Government Defaults are Lower »  Local government recoveries have historically been high - 80% vs. 50% for corporate recoveries »  Prior to recession, most local government defaults reflected liquidity problems that interrupted debt service but were fully recovered –  e.g. Orange County, Polk County, Baldwin County had 100% recovery

»  Recent defaults have resulted from insolvency and may result in lower recoveries –  Detroit, Stockton, Harrisburg, Jefferson County –  In insolvency scenario, assets diminish while services must continue to be provided

»  Treatment of bondholders in bankruptcy or default is uncertain –  Central Falls paid bonds, cut pensions; Vallejo paid pensions, haircut debt –  Detroit’s proposal to creditors treats GO bonds as “unsecured” next to pensions and OPEBs

»  Bondholders may accept losses to avoid a protracted legal battle

Global Interdependence Center, October 11, 2013

Appendix

Global Interdependence Center, October 11, 2013

Illinois: State Faces Daunting Pension Challenges »

Illinois has been downgraded five times in the past four years, largely because of state’s failure to address unfunded pension and backlog of unpaid bills

Its current GO rating (A3/ negative) is well below the Aa1 average for US states and two notches below the next lowest-rated state, California

Rationale for downgrades of related credits is explained in recent special comment (“Illinois-Linked Credits Capped at State GO Rating”)

General Assembly (state legislature) has repeatedly failed to reach consensus on pension reforms, but may do so in time for “veto session” starting October 22

–

Legislative leaders seeking accord on reforms that will be both meaningful and able to survive litigation

–

Implementation of a credible, comprehensive pension funding program would improve the state’s credit quality

–

Current rating and outlook assume inability to enact substantial reforms

Other challenges include impending expiration of 2011 tax increases –

Revenue loss from tax phase-out (starting in 2015) appears likely to exacerbate backlog of unpaid bills

Global Interdependence Center, October 11, 2013

Commonwealth of Puerto Rico (Baa3 Negative) What are we watching?

What are we seeing/ expecting?

Private sector employment and other trends

Private sector job loss in 2013 of 2-3%; continued decline in pharmaceutical operations; continued population decline

Prospects for widening structural budget gap and greater need for deficit financing

Possible decline in base revenues (vs. modest growth in budget) and likely shortfalls against new tax estimates, which will widen deficit financing need from budgeted $820 million

GDB net liquidity position (net of restricted funds and short term external debt of GDB, Commonwealth, and Authorities)

Pension Liabilities

GDB net liquidity position of $1.5 billion (unaudited 6/30) looks sufficient to cover 1 additional year of moderate stress-case budget deficit - without new market access and before any new loans to authorities & municipalities

TRS Reforms

Global Interdependence Center, October 11, 2013

Puerto Rico’s Bond Spread Over BBB Rated Bonds »

PR 30y GO v. BBB 30y GO Spread 700

40,000

35,000

600

JulyEAI released 30,000

500

400 Basis Points

Detroit Bankruptcy Filing

Negative PR Mainstream Press

300

20,000

15,000

in Millions

25,000

Sharp increase in PR spreads versus the rest of the municipal market and a pivot to short term cash flow borrowing by the commonwealth to wait out volatility ˗  $1-1.2 billion of GO TRANS expected by end of 2013 ˗  $400 million of PRHTA BANS - paid off $400 million of $2.2 billion in GDB LOCs ˗  Cost of funds relatively unchanged, but refinancing risks increased

200 10,000

100

5,000

0 6/3

6/10

6/17

6/24

7/1

7/8

7/15

BBB Spread (left)

7/22

7/29

PR Spread (left)

8/5

8/12

8/19

8/26

9/2

9/9

Volume (right)

Global Interdependence Center, October 11, 2013

Pension Obligations

Global Interdependence Center, October 11, 2013

Bond index discount rate provides a balance sheet measure of pension liability »  Our approach is similar to private sector standard set by FASB »  Discounts the promised benefit payments using current market interest rate –  Treats pension benefits as bond-like obligations –  Liabilities are measured independently of asset mix or performance –  Liabilities of identical pension plans (government, hospital, or manufacturer) measured on the same day should be identical

»  Contrasts with public sector approach focused on funding –  Discounts using assumed investment rate of return based on asset mix –  Estimates the PV of employer contributions, if assumptions are met –  Market risk in this approach increases as the return assumption increases

Global Interdependence Center, October 11, 2013

Statesâ€™ Adjusted Net Pension Liabilities Vary Widely Nine states had 2011 ratio of ANPL to revenues exceeding 100% A3 to A1

Aa3 to Aa1

Aaa

unrated/no GO debt

18 16

Number of States

14 12 10 8 6 4 2 0 <25%

25-50%

50-100%

100-200%

200-300%

ANPL/Revenue grouped by range

Source: Audited financial reports for states and various pension plans and Moodyâ€™s calculations Ratings include state general obligation ratings and issuer ratings

Global Interdependence Center, October 11, 2013

30 Out of 50 Largest Local Governments Had Moodyâ€™s ANPL Greater than 100% of Revenues in Fiscal 2011

Number of "Top 50" Local Governments

15 Speculative A 10

Aa Aaa

0 < 0.5x

0.5x - 1.0x

1.0x - 3.0x

3.0x - 5.0x

> 5.0x

ANPL / Revenue Grouped by Range

Global Interdependence Center, October 11, 2013

Pace of legislative reforms is a positive factor »  Unprecedented pace of reform activity, with legislation passed in most states in recent years –  Expect to continue, with some passing second or third rounds (as in VA)

»  Most reforms geared toward new employees and/or existing employees on a going-forward basis (e.g. IL, CA, FL, NY) –  Reduces normal cost (NC) rather than prior service liability –  NC reduction is positive for budget, especially if existing employees included (FL and VA)

»  Some have enacted COLA reductions/ suspensions affecting retirees –  Meaningful reductions in UAAL, but subject to ability to withstand legal challenges (MN and CO upheld, RI, NJ, NM ongoing, OH not challenged) –  Providence (RI) COLA suspension based on negotiation with employees & retirees to avoid litigation –  Ballot measures another route, but also subject to legal challenges

Global Interdependence Center, October 11, 2013

Overlapping Debt and Pension Liabilities Far Higher in Detroit Than Other Large Cities $ in billions – ﬁnancial repor0ng year 2011 GO Ra>ng

New York

Los Angeles

Chicago

Houston

Philadelphia

Detroit

Aa2

Caa3

Net Direct Debt

$70.3

$3.5

$8.9

$3.3

$4.3

$2.2

ANPL

$69.0

$14.6

$28.5

$6.1

$7.3

$2.0

Direct Debt and Pension Sub-‐total

$139.3

$18.1

$37.3

$9.4

$11.6

$4.3

2011 Full Value

$793.7

$401.3

$225.6

$141.8

$63.0

$18.9

Direct Debt and Pensions as % of Full Value

18%

17%

18%

23%

Overlapping Debt

$0.0

$14.1

$9.9

$6.4

$2.9

$1.9

Overlapping ANPL

$0.0

$16.9

$17.4

$1.9

$1.7

$2.5

Overlapping Sub-‐Total

$0.0

$31.0

$27.3

$8.4

$4.6

$4.4

$139.3

$49.1

$64.6

$17.8

$16.2

$8.6

18%

12%

29%

13%

26%

46%

Total Direct and Overlapping Debt and Pensions

Total Direct and Overlapping Debt and Pension as % of Full Value

Global Interdependence Center, October 11, 2013

Bob Kurtter Managing Director Robert.Kurtter@moodys.com

Global Interdependence Center, October 11, 2013

© 2013 Moody’s Investors Service, Inc. and/or its licensors and affiliates (collectively, “MOODY’S”). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. (“MIS”) AND ITS AFFILIATES ARE MOODY’S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY’S (“MOODY’S PUBLICATIONS”) MAY INCLUDE MOODY’S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY’S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY’S OPINIONS INCLUDED IN MOODY’S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. CREDIT RATINGS AND MOODY’S PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODY’S PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODY’S PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY’S ISSUES ITS CREDIT RATINGS AND PUBLISHES MOODY’S PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY’S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY’S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided “AS IS” without warranty of any kind. MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, MOODY’S is not an auditor and cannot in every instance independently verify or validate information received in the rating process. Under no circumstances shall MOODY’S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY’S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY’S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The ratings, financial reporting analysis, projections, and other observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. Each user of the information contained herein must make its own study and evaluation of each security it may consider purchasing, holding or selling. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY’S IN ANY FORM OR MANNER WHATSOEVER. MIS, a wholly-owned credit rating agency subsidiary of Moody’s Corporation (“MCO”), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MIS have, prior to assignment of any rating, agreed to pay to MIS for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,500,000. MCO and MIS also maintain policies and procedures to address the independence of MIS’s ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at www.moodys.com under the heading “Shareholder Relations — Corporate Governance — Director and Shareholder Affiliation Policy.” For Australia only: Any publication into Australia of this document is pursuant to the Australian Financial Services License of MOODY’S affiliate, Moody’s Investors Service Pty Limited ABN 61 003 399 657AFSL 336969 and/or Moody’s Analytics Australia Pty Ltd ABN 94 105 136 972 AFSL 383569 (as applicable). This document is intended to be provided only to “wholesale clients” within the meaning of section 761G of the Corporations Act 2001. By continuing to access this document from within Australia, you represent to MOODY’S that you are, or are accessing the document as a representative of, a “wholesale client” and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to “retail clients” within the meaning of section 761G of the Corporations Act 2001. MOODY’S credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail clients. It would be dangerous for retail clients to make any investment decision based on MOODY’S credit rating. If in doubt you should contact your financial or other professional adviser.

Global Interdependence Center, October 11, 2013