TRENDS IN STATE AND LOCAL
GOVERNMENT FINANCE
Presented by
Jeff Pantages, CFA
Chief Investment Officer
Alaska Permanent Capital Management
900 W 5th Avenue Suite 601
Anchorage, AK 99501
www.apcm.net
Presented to
Alaska Government Finance Officers Association
November 19, 2013
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907-272-7575
[email protected]
Agenda
 An Update on the U.S. Economy
 Trends in State and Local Government Finance
 The Municipal Bond Market
1
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Expect Growth at Moderate Pace
Source: Federal Reserve Bank of San Francisco. Shaded areas indicate U.S recession.
2
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Unemployment Rate Gradually Declining
Source: Federal Reserve Bank of San Francisco
3
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Employment Is Now 0.8% Above The Prerecession Level
1990
1980
2001
2007
Source: The Nelson A. Rockefeller Institute of Government State Revenue Report November 2014
4
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Percent of Americans Employed in Troubling
Source: CBPP.org, BLS, and NBER
5
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Inflation Tame For Now – Partly Due to Lower Oil Prices
Source: Federal Reserve Bank of St. Louis. Shaded areas indicate U.S recession.
6
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Bond Yields Still Near Historic Lows!
10 Year Treasury
2.34%
as of October 31, 2014
Source: Federal Reserve Bank of St. Louis. Shaded areas indicate U.S recession.
7
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Federal Reserve Policy: There Be Dragons!
Source: J.P. Morgan Asset Management. Data as of September 30, 2014.
8
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The Market is Failing to Price in Fed Movements
ZIRP
Source: J.P. Morgan Asset Management. Data as of October 30, 2014.
9
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Budget Deficits – Improving, but Still Adding to Debt
10
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Kicking the Can Down the Road…Again.
11
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Republican’s & Democrat’s Spirit of Bipartisanship
Don’t expect them to share a turkey!
12
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State & Local Governments Viewed Favorably
as Federal Rating Hits New Low
13
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Less Partisan Views of State and Local Gov’t
14
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Trends in State and
Local Government Finance
15
Sustainable Investment Thinking
Recent Studies on State and Local Economic and Fiscal
Issues (all 2014)
 National Association of State Budget Officers: Fiscal Survey of States
 The Nelson Rockefeller Institute of Government: State Revenue Report
 Center on Budget and Policy Priorities: When and How States Should
Strengthen Their Rainy Day Funds
 Pew: Recovering from Volatile Times: The ongoing struggles of
America’s big cities
 National League of Cities: City Fiscal Conditions 2014
 Center for Retirement Research at Boston College: The Funding of State
and Local Pensions: 2013-2017
16
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Trends in State and Local Government Finance
 Revenues Generally Improving
 Property and sales taxes ticking up, offsetting temporary weakness
in income tax
 State and Local Payrolls Still Pinched
 S&L employment at 19 million or 14% of total
 Federal Austerity Remains a Challenge
 Dependency on Federal Government is at 11%, but great variation
across the states
 Pension and Healthcare Funding Issues Remain
 Pensions 73% funded using generous assumptions
 Healthcare…Fugetaboutit!
 Implications of new GASB standards
17
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Private Job Market is Improving, While
Government Employment Had Been Declining
Private
Government
Source: Federal Reserve Bank of St. Louis. Shaded areas indicate U.S recession.
18
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Cumulative Change in Employment Since
Start of Recession
19
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Growth in Major State Taxes Ticks Downward
Local Taxes
State Taxes
Source: The Nelson A. Rockefeller Institute of Government State Revenue Report November 2014
20
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Personal Income Taxes Show Declines in Q2
Income Tax
Sales Tax
Property Tax
Source: The Nelson A. Rockefeller Institute of Government State Revenue Report November 2014
21
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State Budget Shortfalls Declining
Source: BlackRock. Data: Center on Budget and Policy Priorities.
Years represented are fiscal years. * Reported to date.
22
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States Rebuilding Reserves
23
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Local Property Taxes Improving Along with
Housing Prices
Local
Property
Taxes
Housing Price Index
Source: The Nelson A. Rockefeller Institute of Government State Revenue Report November 2014
24
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Most Cities Had Not Recovered to Prerecession
Revenue Peaks
Note: Recession officially ended in 2009.
25
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Property Tax Declines in Most Cities Began After
the Great Recession and Continued in 2012
26
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Intergovernmental Revenue Helped Cities in 2009 and
2010 but Fell as Austerity Measures Took Hold
27
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Some Cities Rolled Back Spending Cuts in Major
Categories in 2012
Source: The Pew Charitable Trusts Recovering from Volatile Times: The ongoing struggles of America’s big cities
28
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Percent of Cities “Better Able/Less Able”
to Meet Financial Needs (2014)
Source: National League of Cities City Fiscal Conditions 2014
29
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Percent of Finance Officers Indicating Factor had
a Positive or Negative Impact on FY 2014 Budgets
Source: National League of Cities City Fiscal Conditions 2014
30
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State and Local Pension Funding Ratios
Source: Center for Retirement Research at Boston College. Note: 2012 is authors’ estimate.
Data: Various 2012 actuarial valuations; Public Plans Database (2001-2011); and Zorn (1990-2000).
31
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Distribution of Funding Ratios for Public Plans
Source: Center for Retirement Research at Boston College
Data: Authors’ calculations and various 2012 actuarial valuations.
32
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Financial Crisis = Higher Unfunded Liabilities =
Higher ARC
Source: Center for Retirement Research at Boston College The Funding of State and Local Pensions: 2013-2017
Note: The ARC equals normal cost – the present value of the benefits accrued in a given year – plus a payment
to amortize the unfunded liability, generally over a 30-year period.
33
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Gov’t Not Meeting Required Contributions
Source: Center for Retirement Research at Boston College The Funding of State and Local Pensions: 2013-2017
34
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Aggregate State and Local Pension Liability under
Alternative Discount Rates
Source: Center for Retirement Research at Boston College. Note: 2012 data in trillions of dollars.
The $3.8 trillion figure is the value for the liabilities of plans in our sample, which – on average – are calculated
using a discount rate of about 8 percent. Data: Authors’ calculations and various 2012 actuarial valuations.
35
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Aggregate Funded Ratios for State and Local
Plans: Currently Reported versus GASB Proposals
Source: Center for Retirement Research at Boston College
Data: Authors’ calculations from various actuarial valuation reports (2012) and the PPD (2009-11).
36
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New GASB Standards Will Raise or Lower Funding
Ratios!
 Assets will be reported at current market value rather than being
actuarially smoothed over five years
 This will result in a sharp increase in actuarial assets
 Projected benefit payments will be discounted by a combined
rate that reflects the expected return for the portion of liabilities
that are to be covered by plan assets and the return on highgrade municipal bonds for the portion that are to be covered by
other resources.
 But, there is a lot of discretion
 CRR at Boston College asks if the old state and local pension
funding ratio in 2014 is 75.2%, is the new funding ratio 69.5% or
80.6%?
37
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Solution: Throw the Hail Mary Pass?
Source: The Nelson A. Rockefeller Institute of Government The Blinken Report January 2014
38
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Wikipedia: Hail Mary Pass
A very long forward pass in American football,
made in desperation with only a small chance of
success, especially at or near the end of a half.
39
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Headwinds: As the Population Ages, Retirement Systems
Are Maturing, With Fewer Workers Per Beneficiary
Source: The Nelson A. Rockefeller Institute of Government The Blinken Report January 2014
40
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Alaska Funding Ratios
Ratio of Assets to Liabilities
110%
U.S. Composite* 2013: 72.0%
100%
90%
80%
70%
60%
50%
AK TRS
AK PERS
2013: 48.1%
2013: 54.5%
40%
2001
2003
2005
2007
2009
2011
Data: Center for Retirement Research at Boston College; The Funding of State and Local Pensions: 2012 – 2016; July 2013
* U.S. Composite is a sampling of 126 plans which represent approximately 90% of the assets in state-administered
plans and 30% of assets in plans administered at the local level.
41
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2013
State Assistance: A Cash Infusion Solution?
Source: State of Alaska ARM Board
42
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The Municipal Bond Market
43
Sustainable Investment Thinking
Municipal Bonds: The Comeback Kid!
44
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Moody’s Outlook for State and Local Governments
 Moody’s has had negative outlooks on state & local government
sectors for 6 years (recently upgraded states to stable)
 Downgrades have outpaced upgrades for 17 consecutive quarters
Rating Changes by Number
300
250
Upgrades
Downgrades
200
150
100
50
0
1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13
Source: Moody’s Investors Service
45
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Current Yield Curves vs. Last Year
Municipals
AAA Rated
U.S. Treasuries
Source: Bloomberg
46
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Issuance in Falling
47
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Voters Skeptical of New Bond Proposals
48
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Municipal Bond Market Challenges
 Generally an illiquid market, and now no AAA bond
insurance!
 Unfunded liabilities along with the costs of employee
compensation packages increase risks
 Detroit and others looking for bondholders to pay “their fair
share” so ability and willingness to pay is questioned
 Tax exemption of municipals is questioned by federal
government in search for new revenues
 This, despite a near pristine track record and very few actual
defaults through history!
49
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Historical Bond Defaults 1970 – 2011
Rating
Municipals
Corporates
AAA
0.00%
0.48%
AA
0.01%
0.86%
A
0.04%
2.22%
All Ratings
0.13%
11.17%
Data: Moody’s
50
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Average Bond Default Recovery
30 Days Post Default
Ultimate Recovery
Municipal
Bonds
59.9%
67.0%
Corporate
Bonds
31.0%
41.0%
Data: Bloomberg News: Munis Default Less, Pay Back More Than Corporates, Moody’s Says 2/11/2010
51
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Municipalities in The Headlines
52
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Detroit Chapter 9 Bankruptcy – a Precedent?
53
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Moody’s: Detroit and Stockton Bankruptcy
Rulings Credit Negative for Bondholders
 Pensions fare better than government debt
 Pensions are not fully protected; giving cities leverage
to cut them
 Debt issued by some enterprises is effectively secured
 Retirees’ healthcare benefits are an important part of
the bankruptcy process
54
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Wither Puerto Rico?
Source: The Economist, Moody’s Investors Service. * State/territory debt only.
55
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Price: Puerto Rico 5.00% 7/1/2034
Par
$0.67
Source: Bloomberg
56
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In Summary
 U.S economy expanding with modest growth and low inflation
 Global multi-speed expansion underpinned by easy money
 Long-term entitlements problematic for federal, state, and
local governments
 States in better shape than localities due to diversity of
revenue and ability to shift costs to local governments
 Municipal bond market improving as supply shrinks, but tax
uncertainty and “headline risk” remain.
57
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