Session 2 tzitzouris

City Finances are Improving, But Beware the Hill Street Syndrome!

First, the Good News……Muni Govt Finances are Improving, Despite the Headlines Otherwise Local Property Tax Revenues & Freddie Mac Home Price Index

16%

Local Property Tax Revenues, 4 Qtr. Rolling, Y/Y Pct Chg, 3 Year Lag, LHS

14% 12%

Freddie Mac House Price Index, 4 Qtr. MA, Y/Y Pct Chg, RHS

18% 13%

10% 8%

8% 6%

3%

4%

-2%

2% -7%

0% -2%

-12% '89

'92

'95

'98

'01

'04

'07

'10

'13

Cities are Reporting Stronger Finances, with Revenues Rising Faster than Spending State & Local Spending, Ex-Federal Aid SAAR, 4QTR Avg, BEA

14% 12%

State & local spending, excluding federal aid, has averaged just 1.1 percent growth over the past four quarters‌‌

Average Since 1962 = 5.6%

10%

8% 6% 4% 2% 0% 2Q 2015 = 1.1%

-2% '62

'67

'72

'77

'82

'87

'92

'97

'02

'07

'12

Cities are Reporting Stronger Finances, with Revenues Rising Faster than Spending % of Cities Better Able/Less Able To Meet Financial Needs

Last Click: 2014 = 80%

1.0 Better Able

Source: National League of Cities

0.8 0.6 0.4 0.2

0.0 -0.2 -0.4 -0.6 Less Able

-0.8 -1.0 '90

'92

'94

'96

'98

'00

'02

'04

'06

'08

'10

'12

'14

The Not so Good News…. Pension Contributions are Crowding out Other Expenditures Total State/Local Pension Payments (FY, $BN, Census Bureau) 300 CAGR Since 1993 = 8.2%

Pension contributions are taking up an increasing amount of state government spending, as pension checks are outpacing investment returns.………

250

200

150

100

50 '93

'95

'97

'99

'01

'03

'05

'07

'09

'11

'13

The Not so Good News‌. Pension Contributions are Crowding out Other Expenditures State Government Contributions To Pensions, % of State General Fund Spending

8% 7% 6% 5% 4% 3% 2% '93

'95

'97

'99

'01

'03

'05

'07

'09

'11

'13

To Offset this, City Services Face Cuts, with Schools Usually 1 in Line ST

Mayor: Chicago School Cuts Include Layoffs, Less Maintenance

Philadelphia Schools: Another Year, Another Budget Crisis

Huffington Post, 7/2/15) -- Chicago school and city officials detailed $200 million in cuts - including layoffs, scaled-back maintenance and reduced transportation - to the nation's third-largest school district Wednesday, one day after the district paid a $634 million pension bill officials said it couldn't afford.

NPR, 11/4/14) -- Trying to figure out why Philadelphia's public schools have been teetering on insolvency the past few years is no easy task.

Mayor Rahm Emanuel said schools would still open on time in the coming school year and class sizes wouldn't be affected. He put the blame on state legislators for worsening the situation and said a property tax increase was up for consideration…………………………………………….. …………………..The district will eliminate 1,400 jobs - including 350 vacant positions to go unfilled - but few teachers will be impacted, with layoff notices going out to support and central office staff, Chicago Public Schools Interim CEO Jesse Ruiz said.

But let's start with some basic facts. The district, the eighth largest in the nation, is entirely dependent on three sources of money: Almost half of its $2.8 billion budget comes from the city. A little over a third comes from the state. Most of the rest comes from the federal government.

Matthew Stanski, the district's chief financial officer, likes to compare this money to an "allowance." He says, "We're given an allowance and we have to determine what to do with that allowance“………

The Hill Street Syndrome is the Vicious Cycle of Debt and Crime that Destroyed our Cities in the 70s & 80s Violent Crime Per 100k (2013) vs. GO Debt Per Capita (2013) 15-City Index (Plus Memphis, Minneapolis, Phoenix, New Orleans, & Nashville)

4500

Nashville

4000 3500

Wash, D.C. Chicago

3000

There comes a point where the combination of crime and debt is too high to ever overcome, and bankruptcy is the only option

G.O. Debt

2500

San Fran Boston Pittsburgh

2000 1500

Seattle

1000

Denver Dallas

Minneapolis Houston New Orleans

Memphis Philadelphia

Charlotte Phoenix

500

San Jose

Los Angeles

0 0

500

Detroit 2012 (Pre Bankruptcy) Cleveland

Atlanta Violent Crime 1000

1500

2000

The Strategas 15 City Muni Macro Index Measures Fiscal and Credit Stress in our Bellwether Cities 15-City Economic & Fiscal Health Index and City GO Debt Ratings Comparison City Charlotte Seattle Denver Boston Washington San Jose San Francisco Dallas Pittsburgh Houston Los Angeles Atlanta Cleveland Philadelphia Chicago Avg.

Overall 64.5 62.1 61.3 60.7 60.5 58.8 58.0 50.2 49.2 48.7 48.2 48.0 47.1 44.5 36.7 53.2

Economic 75.7 70.4 69.0 64.0 66.5 69.9 72.4 61.8 57.7 58.8 54.4 56.1 44.7 52.4 55.9 62.0

Reserves 41.7 43.4 49.0 58.1 23.2 63.5 35.1 26.6 36.4 22.7 29.7 52.4 36.7 10.4 9.2 35.9

Budget 49.0 50.3 47.9 60.9 59.9 42.7 53.6 43.7 42.4 56.4 48.2 49.7 39.0 39.5 38.2 48.1

Debt 69.3 67.8 64.0 53.3 80.3 36.9 41.7 45.5 43.3 36.9 47.8 17.4 72.9 59.7 5.3 49.5

Moody's Aaa Aaa Aaa Aaa Aa2 Aa1 Aa1 Aa1 A1 Aa2 Aa2 Aa2 A1 A2 Ba1

S&P AAA AAA AAA AAA AAAA+ AA+ AA+ A+ AA AAAA AA A+ BBB-

Fitch AAA AAA AAA AAA AAAA+ AA A AA AAA+ ABBB-

The Strategas 15 City Muni Macro Index is Made of these G.O. CUSIPs Strategas 15 City Muni Macro Index City CUSIP Atlanta 047772YR3 muni Boston 100853VJ6 muni Charlotte 161035FP0 muni Chicago 167486TA7 muni Cleveland 186343YS2 muni Dallas 235219KG6 muni Denver 249164MW1 muni Houston 442331E59 muni Los Angeles 544351HK8 muni Philadelphia 717813QK8 muni Pittsburgh 725209KF6 muni San Francisco 797646A48 muni San Jose 798135A58 muni Seattle 8126262U2 muni Washington 25476A8H5 muni

These 15 CUSIPs make up the Strategas 15 City Muni Macro Index, where each CUSIP is roughly 10 years in maturity, generally non-callable, and general obligation in nature. The goals of these indices are 1) to pinpoint emerging macro trends in the financial health of major U.S. cities 2) to observe changes in city borrowing costs, and 3) to pinpoint richness/cheapness in the larger urban metro markets. From the standpoint of total debt outstanding, these 15 cities had roughly $120 billion of primary government debt outstanding as of 2013 financials, or only about 3% of total muni sector debt, but the MSA of these 15 cities encompass a full 1 in 4 U.S. citizens. As a consequence, the economic and financial health of these cities can be thought of as a bellwether for a large portion of the U.S. economy, and the credit spread index should provide as close to a real time indicator of this health as is possible.

Our Muni Macro Index Has Shown Sensitivity to PR Stress Strategas 15 City Index Sprd to TSY vs PR 8% 2035 G.O. Sprd to 10 Yr TSY

0.5%

Puerto Rico G.O. (RHS)

Strategas Index (LHS)

10.3%

9.8%

0.4%

9.3% 0.3% 8.8% 0.2% 8.3% As stress has built in Puerto Rico, spreads on the Strategas 15 City Muni Macro Index have also bounced sporadically.

0.1%

0.0% Mar-15

7.8%

7.3% Apr-15

May-15

Jun-15

Jul-15

Aug-15

Sep-15

Headlines will Remain a Risk for the Broader Muni Space for Years 1. Puerto Rico’s seemingly sloppy restructuring will still pose a risk of capital flight to states and cities.

2. A second Chicago downgrade into junk would put the Windy City on the path to escalating borrowing costs and perpetual deficits.

3. State specific funding and pension concerns in NJ, PA, Il, and other smaller states will dominate political chatter in 2016, and could further weigh down risk appetite for city credits in those states.

Conclusions: 1. City fiscal health is generally improving, and should continue into the next recession (likely after 2017).

2. But headline risk from large, and still weakening credits will be a drag on risk appetite for years.

3. City (and state) fiscal competence will be an almost zero sum outcome; one city’s loss will be another’s gain, but there will be a net “dead weight” loss to all as cities like Chicago drain capital from the system.

4. Long-run, cities that learn from the mistakes of the past will thrive, both economically and financially, but not until bondholders are forced to learn a valuable lesson; that lesson is that ability to pay and willingness to pay are not one and the same in muni land!