Transcript Capital Markets and Financing Options Update – Increased Importance of Obtaining and Maintaining Underlying Credit Ratings FGFOA Executive Boot Camp John Incorvaia, SVP –

Capital Markets and Financing Options Update –
Increased Importance of Obtaining and Maintaining
Underlying Credit Ratings
FGFOA Executive Boot Camp
John Incorvaia, SVP – Moody’s
Investors Service
November 13, 2012
Outline
1. Themes in Municipal Finance
2. Outlook on Municipal Issuers Remains Negative
3. The National Economy
4. The Florida Economy
5. Ratings – Importance and Process
Increased Importance of Obtaining and Maintaining Underlying Credit Ratings
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Themes in Municipal Finance
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What is the greatest challenge facing state and local
governments?
1. Public Pensions
2. Healthcare Expenses
3. Fiscal Cliff/Risk of Another Recession
4. Local Government Bankruptcy Filings
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What is most likely to occur?
1. US Fiscal Cliff
2. The Magic and not the Heat make it to the NBA finals
3. The President will be able to dictate policy to both the
House and Senate
4. Hurricanes become a thing of the past
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Themes in Municipal Finance
State and Local Government – Overview
Overview
Spotlight shifted from state credit stress – and to a lesser extent enterprise risk – to local
government credit stress.
Primary driver of this shift is a longer than expected recession with a very weak housing
and jobs recovery.
For those local governments with especially weak housing markets and stressed
finances, the traditional view of willingness to pay on debt is being challenged – as
evidenced in r
Difference between states that actively intervene to assist local governments that are
fiscally stressed and those that take a “hands off” approach.
We see risk to investors rising in those states where as a matter of state policy or
practice the state does not intervene financially or in exercising state control over financially
distressed localities.
We expect LG credit stress to continue at least through 2013, and until we see a
sustained recovery.
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Themes in Municipal Finance
Local Governments rely primarily on property taxes, sales taxes and state aid for their
revenue
o Property taxes have been weak due to stagnant housing markets and lag in property
valuations
o Sales taxes weak due to weak job market
o State aid weak due to stressed state finances and school aid cuts
High labor costs also drive weak governments to fiscal brink:
o Costly labor settlements granted during the peak of the boom
o High pension costs driven by the weak performance of assets portfolio
Tax limitations and other extraordinary requirements that limit the ability of LGs to access
their tax bases also increase credit risk
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Outlook on Municipal Issuers
Remains Negative
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Local Government Outlook Remains Negative
More Cases of Severe Stress, but Vast Majority are Coping
»Negative outlook for the 4th consecutive year
»Primary drivers for the negative outlook
– Pace of economic recovery is tepid and uneven across regions
– Major revenue sources are stagnant
– Budget options are growing more limited
– Rising pension and benefit costs
– More instances of failing enterprises and tightening liquidity
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Continued Weak Economic Recovery
Slowing Total Nonfarm Employment Growth Due Largely to Manufacturing
Midwest
Annualized
Growth
in Total
Nonfarm
Employment
Northeast
South
West
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
-0.5%
2011Q1
2011Q2
2011Q3
2011Q4
2012Q1
2012Q2
2012Q3
Source: Moody's Analytics Aggregation of U.S. Bureau of Labor Statistics Data
Source: U.S. Bureau of Labor Statistics
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Major Revenue Sources are Stagnant
Property Taxes
30%
State Aid
33%
Charges for Service
17%
Sales Taxes, Income,
Other Taxes
10%
Federal Aid
5%
Miscellaneous
5%
Source: U.S. Census Bureau
» Property tax revenues will lag any improvements in property valuations
» State aid to local governments remains under pressure
» Sales tax and other revenue pace of recovery has been uneven
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Balancing Budgets by Cutting Jobs
Local Government Employment Has Not Rebounded, Seeing Declines for
16 Consecutive Quarters
Total Nonfarm Employment
Percent
Change
From
Previous
Quarter
1.0%
0.5%
0.0%
-0.5%
-1.0%
-1.5%
-2.0%
2007 Q1
2008 Q1
2009 Q1
2010 Q1
2011 Q2
2012 Q1
Source: U.S. Bureau of Labor Statistics (2012 Q3 is average of July and
August)
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And Tapping Reserves
General Fund Balance Declines Between 2007 and 2010 Were Widespread
% of Rated Issuers with Declines in General Fund Balance of < 10%
% of Rated Issuers with Declines in General Fund Balance of ≥ 10%
Percent
of Sector's
Rated Issuers
Experiencing
Declines in
General Fund
Balance
Between 2007
and 2010
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Cities
Counties
School Districts
Source: Moody's Data - Total Rated Issuers: Cities = 2,703, Counties = 888, School Districts =
3,530
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Rising Pension Pressures Spur More Reforms
»Multi-Employer plans imposing higher costs on local governments
– Pennsylvania’s Public School Employees Retirement System contributions
– Maryland’s shift in annual teacher pensions cost
»Pension reforms becoming more common
– CA Public Employers Retirement System and CA State Teachers Retirement System
– Providence, RI, a standalone plan, cut benefits to current and future retirees
»Pension reforms are alleviating some of the pressures on local governments
– Study by Boston College Center for Retirement Research
»Some local governments turning to pension bonds
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More Instances of Severe Credit Stress Due to Failing
Enterprises and Tightening Liquidity
»Enterprise projects can add sudden/unanticipated strain to local governments
˗ Due to prior guarantees, debts of stressed competitive enterprises are falling on local
government budgets and balance sheets
˗ Examples include sports facilities, convention centers, healthcare facilities
»Dwindling cash spurs short term borrowing
– Non-seasonal borrowing indicative of liquidity stress and raises market access risk
»Severe stress testing some local governments’ willingness to pay
– Expect local government bankruptcy and defaults to increase but remain rare among
approximately 8,500 rated entities
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While we believe that there will be a modest increase in
municipal bankruptcies and defaults, we expect these to
continue to be rare events
» The overwhelming majority of local governments that Moody’s rates are sound
investment grade credits, and their risk of bankruptcy or default is remote, but in some
cases the willingness to pay bondholders before other creditors has eroded.
» There has been a recent increase in municipal bankruptcies, but the number is still
very small relative to the number of municipal issuers.
» The majority of municipal bankruptcies are special-purpose districts, redevelopment
authorities and are frequently unrated.
» Two thirds of municipalities in the U.S. are unrated or do not issue debt
» Rating Implications: Bankruptcy is an explicit part of credit evaluation for distressed
credits
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Bankruptcy and default are not the same thing
» Bankruptcy and default are not synonymous for local governments.
» Bankruptcy can occur without default.
» Default can occur without bankruptcy.
» The ability of a municipality to file for bankruptcy does not necessarily have negative
rating implications.
» Ratings are based on default and loss, not bankruptcy per se
» Jefferson County and Harrisburg are examples of municipalities that defaulted well
before they declared bankruptcy. Central Falls has not defaulted on its GO debt, but
declared bankruptcy.
» Rating Implications: Ratings are based on default and loss, not bankruptcy. In Sierra
Kings, even though the district was still in bankruptcy, we upgraded the bonds to Baa3
from Ba2, after the court accepted an agreement to allow pledged special revenues to
pay debt service on the district’s bonds.
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National Economy
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U.S. Economy Lags Past Recoveries…
% change 3 yrs after recession trough
40
GDP
Employment
35
30
25
20
15
10
5
0
61Q1
70Q4
75Q1
82Q4
91Q1
Recession troughs
01Q4
09Q2
Sources: BEA, BLS, Moody’s Analytics
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…Largely Because of Housing
Post-recession contribution to GDP gain, %
35
30
25
20
Residential investment
cumulative contribution to
increase in GDP, 3 yrs
after recession trough
Housing wealth effect
Total
15
10
5
0
-5
Year recession ended
49
54
58
61
70
75
80
82
91
01
09
Sources: BLS, Moody's Analytics
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Balanced Housing Markets…
60
3,000
% over-, under-valued (L)
50
2,500
40
2,000
30
1,500
20
1,000
Excess supply of housing, ths (R)
10
500
0
0
-10
-500
-20
-1,000
90
92
94
96
98
00
02
04
06
08
10
12
Sources: Census, Fiserv, Property Portfolio Research, Moody’s Analytics
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…Stronger Job Growth and High Affordability…
600
200
Monthly job gains,
ths (R)
400
195
200
190
0
185
-200
180
-400
175
Affordability index (L)
-600
100 means a family earning the
median income can afford a
median priced home
-800
-1000
09
10
11
170
165
160
12
Sources: BLS, NAR, Moody’s Analytics
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…Will Turn Housing from Weight to Driver
Contribution to real GDP growth, annualized % change, ppt
1.5
1.0
0.5
0.0
-0.5
-1.0
Housing wealth effect
Residential investment
Total
-1.5
-2.0
-2.5
05
06
07
08
09
10
11
12
13
14
15
Source: Moody’s Analytics
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House Price Growth Will Return…
Case-Shiller Index, % change, 2012Q1-2015Q1
U.S. = 10.6
12.8 to - 24.0
9.2 to 12.7
7.6 to 9.1
< 7.6
Sources: Fiserv, FHFA, Moody’s Analytics
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But Locals Will Continue to Struggle
Tax revenue, fiscal yr-to-yr % change
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
States
Local
governments
10
11
12
13
Sources: Census Bureau, Moody’s Analytics
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Florida’s Economy
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Florida Economy
- Florida Economy Weakens In July, Reports Comerica Bank's Florida Economic
Activity - "Following a moderate dip in June, the Florida economy weakened further in July, by 0.6
points, according to our Florida Economic Activity Index," said Robert Dye, Chief Economist at Comerica
Bank. "
- Florida economy faces long road to recovery, report says - University of Central Florida's
latest economic forecast tries hard to find something nice to say about the state's condition.
- Florida’s economy lags behind nation; low wages contribute - Florida workers were hit
hard by the Great Recession and the economic recovery is coming to them more slowly than their
counterparts in other states across the nation, according to a new report, the State of Working Florida.
- UCF economist: Florida’s economy will finally build steam in 2013 - University of
Central Florida economist Sean Snaith is predicting Florida’s economic growth will accelerate into 2013
and 2014, saying the national economy is in neutral and Florida is about to hit the gas pedal — and hit it
hard
- Moody’s Economy.com (July 2012) - Florida’s recovery will proceed modestly until house
prices bottom, business confidence improves, and accelerating in-migration galvanizes service-sector
expansion. This will not happen until mid-2013. In the long term, robust population growth and strong
economic fundamentals will enable FL to outperform the nation.
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Florida Economy
Source: FL Office of Economic and Demographic Research
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Florida Economy
Source: FL Office of Economic and Demographic Research
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Florida Economy
Source: FL Office of Economic and Demographic Research
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Florida Economy
Source: FL Office of Economic and Demographic Research
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Ratings – Importance and Process
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Ratings and Investors
Why Do Investors Want Underlying Ratings?
- Uncertainty and confusion surrounding local, national and global economies
- Uptick in municipal bankruptcies or “near misses”
- Growing number of local anti-tax and fee measures
- Shortened list of liquidity providers and monoline insurers
- Heightened risks associated with spiraling pension, health care and OPEB obligations
- Pressures on U.S. rating due to impending “fiscal cliff”
- Better understand issuer’s credit strengths absent credit substitution
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What IS a Rating?
- Independent and unbiased assessment of an issuer’s ability and willingness to pay its
obligations on time and in full
- Forward looking assessment that is monitored annually for accuracy
- Varying degrees of credit strength reflected in alpha-numeric designation (e.g., Aa2)
- Serves as a “go between” issuer and investor, facilitating the market
- Considers four general areas: Economy/Tax Base, Debt, Finances and Management
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What a Rating is NOT
- Recommendation to purchase, sell or hold particular securities
- Predictors of non-credit-related market price movements
- Audits, and do not guarantee authenticity of information from issuers
- Public policy report cards, although politicians have used them as such
- A measure of quality of life
- Not fixed, can change over time
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Moody’s Long-Term Debt Rating Scale
Lowest
Risk
Highest
Risk
Aaa
Obligations rated Aaa are judged to be of the highest quality, with minimal
credit risk.
Aa
Obligations rated Aa are judged to be of high quality and are subject to very
low credit risk.
A
Obligations rated A are considered upper-medium grade and are subject to
low credit risk.
Baa
Obligations rated Baa are subject to moderate credit risk. They are
considered medium grade and as such may possess certain speculative
characteristics.
Ba
Obligations rated Ba are judged to have speculative and are subject to high
credit risk.
B
Obligations rated B are considered speculative and are subject to high credit
risk.
Caa
Obligations rated Caa are judged to be of poor standing and are subject to
very high credit risk.
Ca
Obligations rated Ca are highly speculative and are likely in, or very near,
default, with some prospect of recovery of principal and interest.
C
Obligations rated C are the lowest rated class and are typically in default, with
little prospect for recovery of principal or interest.
Investment
Grade
Speculative
Grade
Note: Moody’s appends numerical modifiers 1,2, and 3 to each generic rating category from Aa through Caa. The
modifier 1 indicates that the issuer or obligation ranks in the higher end of its generic rating category; the modifier 2
indicates a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of that generic rating category.
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The Rating Process
» In the course of the rating process, a Moody’s analyst:
– Gathers information sufficient to evaluate risk to investors who might own or buy a given security
– Develops a conclusion in committee on the appropriate rating
– Monitors the security on an ongoing basis to determine whether the rating should be changed
– Informs the marketplace of any rating actions via press release, including detailed rating rationale
» Process involves an active, ongoing dialogue between the issuer and analyst
– Conduct introductory discussions to explain Moody’s rating methodology and process
– Hold meetings with management to gain insight into:
»
The entity and its operations, strategic goals, governance structure, & financial condition
»
Relevant sector trends and operating environment
– Issuers encouraged to raise any concerns and present all materials pertinent to the analysis
» Ratings determined by Committee
– Based on evaluation of key rating factors outlined in published methodologies
– Various viewpoints bring objectivity into the process
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Rating Methodologies
» Published methodologies describe analytical
framework for determining ratings
» Specific risk factors vary considerably by sector
» Rating approach includes an analysis of key
factors and sub-factors
– Each factor is evaluated individually
– Some factors are easily quantifiable, while others
involve qualitative assessment
– Factors are assigned different weightings according
to their predictive value
» Example: U.S. Local Government G.O.
Methodology involves four key rating factors:
– Economic Strength (40%)
– Financial Strength (30%)
– Management and Governance (20%)
– Debt Profile (10%)
» Benefits:
– Uphold rating consistency
– Enhance transparency, recognizing that rating
outcomes ultimately involve judgment
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1) Economic Strength
Tax Base Growth and Trend
» Relative size
» Has it been growing?
» Tax rate pledge
» Industry concentration
Type of Economy
» Tax base make-up: residential, industrial, or agricultural
» Presence of high growth or poorly performing industries
» Amount of land available for (re)development
Wealth, Demographics, and Workforce
» Full value per capita
» Per Capita income
» Unemployment (critical for cities that have income tax)
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2) Financial Strength
Balance Sheet and Liquidity
» General Fund Balance = Assets – liabilities
» General fund balance relative to operating revenues
» Size of general fund balance depends on revenue sources
» Cash is king
» Quality of receivables
Operating Flexibility / Budgetary Operations
» Statutory ability of local government to raise revenues
» Accuracy of forecasts
» Surplus good, deficit bad.
» Two ways to end a deficit – raise revenues or cut expenses
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3) Debt Profile
Leveraging
» Most defaults involve over-leveraging
» High debt burdens make it difficult for municipalities to deal with economic downturns
» Direct Debt As a % of Full Value
» Direct Debt Per Capita
» Remaining Debt Capacity (How Close to Debt Limit?)
» Amount of Operating Budget Dedicated to Debt Service
Amortization
» Repayment vs. Useful Life of the Asset?
» Amount of Total Principal Outstanding Repaid in 10 Years
» Balloon Payments
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4) Management & Governance
Fund Balance Policies
» Adoption of fiscal plan which includes fund balance target, and instances in which
reserves may be used
Debt Planning
» Debt Plan which includes target and maximum debt levels targeting pay as you go
funding of capital work as part of a multi year CIP
» Don’t assume high rates of growth in tax base
Succession and Contingency Planning
» Formalized succession/contingency plan identifying organizational structures,
succession plans should key personnel change
Timely Disclosure
» Timely audited financial documents which are attested to by an outside firm, and the
direct disclosure of any material events as soon as possible
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Confluence of Negative Factors in Florida
Severity of Housing
Market Correction
State Cuts and
Uneven
Performance of
Non-Ad Valorem
Revenues
Ongoing Property
Tax Reform
Measures
Strain on Credit
Quality
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Managing to Maintain Credit Quality
We recognize challenges faced by local government managers in current
environment
» Uncertainty surrounding rebound of economically sensitive revenues
– Added and omitted taxes, construction code fees, interest income
» Levy limitation to raising taxes
» Desire to maintain service levels
» High degree of fixed or mandated expenditures
– Contractual salary increases, pension contributions and debt service
Higher rated entities typically manage these demands successfully while
maintaining financial flexibility.
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Managing to Maintain Credit Quality
Management’s response to economic pressures is key to
maintaining credit quality.
Practices we’ve seen include:
A. Plans and policies to ensure financial flexibility is maintained
B. Ability and willingness to make mid-year adjustments
C. Use of multi-year budgets and projections
D. Conservatively structured budgets
E. Limited exposure to enterprise risk through guaranteed debt
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Ability and Willingness to Make Adjustments
» Identification and quantification of cushion in budget early on
»
Appropriation reserves to cancel or lapse
»
Discretionary spending, pay-go capital, vacant funded positions
» Implementation of difficult mid-year budget decisions
»
Service cuts, hiring freezes, retirement incentives and furlough days
»
Decisions consider and quantify hidden costs (increased overtime expenses, upfront costs related to incentives)
» Utilization of one-time fixes with plan to regain structural balance
»
»
Watch for trend of increasing reliance on non-recurring revenues or expenditure avoidance
–
Asset sales
–
Use of reserves
Develop plan for restoration of structural balance, replenishment of reserves
–
Increase recurring revenues
–
Decrease expenditures
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Active Monitoring of Revenues and Expenditures
Active monitoring of financial operations can lower odds that even
conservative budget estimates will miss the mark
» Revenues
– Monthly and/or quarterly monitoring to anticipate shortfalls
– Frequent reporting to governing body
» Expenditures
– Overtime, severance costs
– Tax appeal settlements
– Weather-related expenditure spikes
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Conservatively Structured Budgets
» Structural balance
»
Are recurring operating revenues sufficient to fund recurring expenditures?
»
When relying on fund balance or “one shots” to balance the budget, is it a trend or just one year?
»
If fund balance drawn does the budget indicate structural improvement?
» Balance surplus appropriation against cushion built into the budget
»
Appropriate surplus with strategy to regenerate
–
Conservative budgeting of current tax collections, interest income and state aid below actual expectation
–
Conservative estimates for added and omitted taxes
–
Limited reliance on increases in deferred school tax levy
» Additional flexibility
»
Room to raise property taxes
»
Budgeting/reserving for tax collection shortfalls
»
Budgeting /reserving for union settlements
» Red flags of aggressive budgeting:
»
History of deferred charges
»
Increased cash-flow borrowing
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Local Governments Will Face Tough Choices as Weak
Economy Continues to Pressure Revenues
Municipal market is broad and has diverse credit risks
Moody’s has had negative outlooks on state and local governments for 4 years
Downgrades have outpaced upgrades for 11 consecutive quarters
Key Operating Environment Challenges:
» Slow national economic growth showing signs of weakness
» Property taxes and state aid remain under pressure
» More difficult budgetary tradeoff decisions
» Enterprise and debt structure risks cause financial strain
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Despite credit pressures, local governments have
inherent strengths
Governments exist in perpetuity
Federal monetary policies benefit state and local economies
Economies of some large cities are broad-based and diverse
Local governments have strong incentives to pay bond debt
Debt service, even when combined with unfunded pension liabilities, is a small share of
expenses
Local governments have a variety of powerful fiscal management tools at their disposal
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Q&A
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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.”
Any publication into Australia of this document is by MOODY’S affiliate, Moody’s Investors Service Pty Limited ABN 61 003 399 657, which holds Australian Financial Services License no. 336969. 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.
Notwithstanding the foregoing, credit ratings assigned on and after October 1, 2010 by Moody’s Japan K.K. (“MJKK”) are MJKK’s current opinions of the relative future credit risk of entities, credit commitments,
or debt or debt-like securities. In such a case, “MIS” in the foregoing statements shall be deemed to be replaced with “MJKK”. MJKK is a wholly-owned credit rating agency subsidiary of Moody's Group Japan
G.K., which is wholly owned by Moody’s Overseas Holdings Inc., a wholly-owned subsidiary of MCO.
This 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 investors. It would be
dangerous for retail investors to make any investment decision based on this credit rating. If in doubt you should contact your financial or other professional adviser.
Increased Importance of Obtaining and Maintaining Underlying Credit Ratings
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