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LOCAL GOVERNMENT CREDIT OUTLOOK—
VIRGINIA AND THE US
--with an update on GASB 54
SUSAN KENDALL, VICE PRESIDENT/SENIOR ANALYST
Virginia GFOA June 9, 2011
Today’s Agenda
» Fiscal 2012 National Perspective—Toughest Year Yet
– Local Governments Facing Unprecedented Challenges
– Downgrades Outpace Upgrades
– Defaults are low but are expected to increase
– Debt is not the problem
– What are we watching? What could change?
» Virginia Outlook
– Virginia is recovering slightly ahead of the nation
– Local governments remain pressured
– Unemployment has dropped and credit quality remains high
– Management is the key
» GASB 54 Fund Balance Restatement
– No significant ratings impact expected
VIRGINIA GFOA
JUNE 9, 2011
2
FY12--Toughest Year Yet
VIRGINIA GFOA
JUNE 9, 2011
Unprecedented financial stress across municipal
sectors
•
•
•
•
•
Recession is over, but economic recovery is tepid
State and local governments are lagging in recovery
End of federal stimulus will make 2011 an even more stressful year for state and local governments
Moody’s has had negative outlooks on state and local governments for 2 years
Downgrades have outpaced upgrades for 9 consecutive quarters
Rating Changes by Number
Upgrades
Downgrades
200
150
100
50
0
-50
-100
-150
-200
-250
Source: Moody’s
VIRGINIA GFOA
JUNE 9, 2011
Very few rated municipal bonds have defaulted
» From 1970 to 2009, 54 Moody’s rated municipal issuers defaulted
» 78% were in non-profit hospital or housing project sectors
» Average recovery on defaulted municipal bonds has been 59% of par, compared to 37% for
defaulted corporate bonds
Default Counts by Purpose
Purpose
Housing
Ratings
Outstanding
Defaults
1,041
21
650
21
1,645
3
843
1
93
1
City, Town, County – Non-General Obligation
2,342
4
General Obligation
8,610
3
15,224
54
Health Care
Electric, Water or Sewer Enterprise
Higher Education
Recreation
Total
VIRGINIA GFOA
JUNE 9, 2011
Defaults are higher among unrated bonds
Recent US Municipal Defaults
Issuers (#)
Rated by Moody's
Unrated and Rated by Moody's
Volume ($millions)
Rated by Moody's
Unrated and Rated by Moody's
$
$
2008
2009
2010
2011 YTD
5
167
1
207
2
82
0
14
3,678 $
8,518 $
24 $
1,688 $
40 $
3,233 $
605
Source: Moody's and Income Securities Advisor, Inc.
VIRGINIA GFOA
JUNE 9, 2011
Rated defaults expected to increase in 2011
Municipal vs. Global Corporate Ratings
40%
35%
30%
• Rated defaults expected to increase in
2011
• Could be 2-3x 2008 levels
• Consistent with defaults implied by
our rating distribution
• Depends on willingness to make
tough choices
25%
20%
15%
10%
5%
0%
Public Finance
All Global Corporates
VIRGINIA GFOA
JUNE 9, 2011
Municipal spreads remain wider, post credit crisis
Baa - Aaa Spreads
250
200
150
100
50
0
Source: Moody’s
VIRGINIA GFOA
JUNE 9, 2011
Local governments face a revenue and spending crisis,
not a debt crisis
State and local government quarterly tax revenue performance
20.00%
10.00%
0.00%
-10.00%
-20.00%
-30.00%
2008Q1
2008Q2
2008Q3
2008Q4
Total
2009Q1
2009Q2
Personal Income
2009Q3
Sales
2009Q4
Property
2010Q1
2010Q2
2010Q3
Source: Bureau of Census
VIRGINIA GFOA
JUNE 9, 2011
Low revenue growth + fragile recovery = challenges
U.S. Nonfarm Employment (000s)
140,000
138,000
136,000
134,000
132,000
130,000
128,000
126,000
124,000
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Source: Bureau of Labor Statistics
Baseline Economic Growt h Assumptions, 2011-2015
2011
2012
2013
2014
2015
Real GDP Growth
3.2%
3.2%
3.3%
3.1%
2.8%
Non-farm Employment Growth
1.3%
1.6%
2.0%
2.6%
1.8%
Unemployment Rate
9.4%
8.3%
7.4%
6.3%
6.0%
Personal Income Growth
5.1%
6.1%
7.7%
5.8%
4.8%
$42,052
$44,187
$47,154
$49,405
$51,293
Per Capita Personal Income
Source: Moody's Investors Service
VIRGINIA GFOA
JUNE 9, 2011
Local governments will underperform states
Tax revenues, fiscal yr, % change
10
Local government
State
8
6
4
2
0
-2
11F
Sources: Census Bureau, Moody’s Analytics
12F
13F
FROM MOODY’S ECONOMY.COM
VIRGINIA GFOA
JUNE 9, 2011
Recession has finally hit property taxes
10
8
6
4
2
0
-2
-4
78
81
84
87
Source: Census Bureau, Moody’s Analytics
90
93
96
99
02
05
08
11F
FROM MOODY’S ECONOMY.COM
VIRGINIA GFOA
JUNE 9, 2011
State and local debt growing, but slower than other
sectors
(trillions of dollars)
20
18
16
14
12
10
8
6
4
2
-
Households
Business
State & Local Govt
Federal Govt
Financial & Foreign
VIRGINIA GFOA
JUNE 9, 2011
Total US public debt lower than other major economies
(% of GDP, 2009)
200
180
160
140
120
100
80
60
40
20
0
Japan*
*Data as of 2008
Italy
France
Germany
Central
US
Spain
Canada*
Australia
VIRGINIA GFOA
JUNE 9, 2011
Regional and Local
Reduced state and local spending could threaten growth
(Percentage Point Contribution to Change in GDP)
5
4
3
2
1
0
-1
-2
-3
2000
2001
2002
2003
2004
GDP
2005
Federal
2006
2007
2008
2009
Q3 2010
State and local
VIRGINIA GFOA
JUNE 9, 2011
What are we watching? What could change?
» Local Governments: Small, weaker issuers will be most stressed, some distressed
– Risks:
» Further state aid cuts
» Some have exposure to enterprise risk with outsized debt levels
» Exposure to financial institutions, liquidity and credit facilities expiring
» Breakdown in political process that results in failure to pay debt, bankruptcy filing
» States: Revenues remain weak, but most will manage through spending cuts, use of reserves
and federal stimulus money
– Risks:
» Expiration of federal stimulus funds in June 2011 creates large gaps
» Entitlement spending for pension, OPEBs, Medicaid continues to grow
» Material shift in market confidence
VIRGINIA GFOA
JUNE 9, 2011
Virginia Outlook
VIRGINIA GFOA
JUNE 9, 2011
Virginia is Recovering Slightly Ahead of the Nation
» Unemployment rates remain well below national levels
» Recession was mild
» Job growth is average
» Construction employment expected to grow faster than average as demand for
housing resumes
» Virginia remains a desirable place to do business
– Low cost of doing business
– Favorable regulatory environment
» Downside risks persist:
– Failure to investment in transportation improvements
– Job losses in manufacturing accelerate
– Federal spending cuts are deeper than expected
VIRGINIA GFOA
JUNE 9, 2011
Virginia Local Governments Remain Under Pressure
» Declining Assessed Valuations reduce Property Taxes
» Commonwealth of Virginia FY12 Budget
» State finances are under control but cuts will not be reversed
» Structural balance remains elusive
» What’s the future for state and federal aid?
» Local Revenues Recovering?
» Expenditure Management
» Layoffs, salary freezes and service reductions are still the norm
» Impact of Defense and Other Federal Spending Cuts
» Local economy and revenues could be affected
VIRGINIA GFOA
JUNE 9, 2011
Public Sector Dragging on National Employment
Employment, ths
Total nonfarm (R)
State and local government (L)
Source: BLS
FROM MOODY’S ECONOMY.COM
VIRGINIA GFOA
JUNE 9, 2011
Virginia Unemployment is Dropping but Still Elevated
18.0
16.0
14.0
12.0
10.0
8.0
March-08
March-09
6.0
March-10
April-11
4.0
2.0
0.0
Source: Commonwealth of Virginia Employment Commission
VIRGINIA GFOA
JUNE 9, 2011
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High Credit Quality Reflected in
Moody’s Local Government Ratings Distribution
Counties
Cities
45%
35%
40%
30%
35%
25%
30%
25%
20%
20%
15%
15%
10%
10%
5%
5%
0%
0%
Aaa Aa1 Aa2 Aa3
A1
A2
A3 Baa1 Baa2 Baa3
VIRGINIA
Aaa Aa1 Aa2 Aa3
A1
A2
A3 Baa1 Baa2 Baa3
US
VIRGINIA GFOA
JUNE 9, 2011
22
Management is the Key
» Strong management will be critical to maintaining long-term credit strength
– Adherence to management policies
– Prudent use of reserves along with plan to replenish
– Conservative long-range forecasting and monitoring of economically sensitive revenues
– Structural balance
– Maintenance of financial flexibility
– Thoughtful debt management and capital planning
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VIRGINIA GFOA
JUNE 9, 2011
GASB 54 Fund Balance Restatement
VIRGINIA GFOA
JUNE 9, 2011
GASB 54 Implementation
What does GASB 54 do?
– New fund balance classifications affect accounting presentation
»
Effective beginning fiscal year 2011 audit cycle
– Clarification of definitions for special revenue funds
A greater number of fund balance categories is intended to promote transparency
VIRGINIA GFOA
JUNE 9, 2011
Reclassifications
Previous fund balance categories
– Reserved - not available for appropriation, cannot be spent due to constraints
– Unreserved - available for appropriation, may be categorized as designated or undesignated
– Designated - available for appropriation, only internally-imposed limitations
– Undesignated - available for appropriation, no limitations
New fund balance categories
– Non-spendable - not in spendable form (ex. prepaid item, long-term receivable)
– Restricted - externally-imposed constraints (ex. unspent bond proceeds, state dedicated funds)
– Committed - internally-imposed constraints (ex. contract commitments)
– Assigned - intended use expressed (ex. budget carryover for specific item)
– Unassigned - no constraints in any way
VIRGINIA GFOA
JUNE 9, 2011
GASB 54 Restatement
An example…
Traditional Fund Balance Reporting Requirements – General Fund
2008
2007
2006
Reserved for encumbrances
9,196
15,309
15,196
Unreserved, designated expenditures
45,373
63,742
71,474
Unreserved, undesignated
9,991
28,912
32,126
Total
64,560
107,963
118,796
Restated GASB 54 Fund Balance Reporting Requirements – General Fund
2008
2007
2006
Committed
10,410
11,449
14,227
Assigned
1,551
18,985
19,246
Unassigned
52,599
77,529
85,323
Total
64,560
107,963
118,796
VIRGINIA GFOA
JUNE 9, 2011
GASB 54 and Moody’s Analysis
What does it mean for Moody’s analysis?
– Principles of credit analysis will remain unchanged
»
Still emphasize trends of fund balance as percentage of revenues, operating flexibility, budget practices
– No significant ratings impact expected
»
Rating possibly affected if material operating issues not previously disclosed are somehow surfaced
» Some expect benefits post-implementation
– Improved transparency in composition of fund balances
– More standardization in presentation of fund balances
» But, trend analysis more difficult in the short-term
– Not all issuers will be able to complete an historic restatement of fund balances
»
Some fund balances may “spike” from FY2010 to FY2011 due to GASB 54 reclassifications
»
We will look at annual changes to discern a consistent operating trend
VIRGINIA GFOA
JUNE 9, 2011
Susan Kendall
Vice President/Senior Analyst
Lead Analyst, Virginia Regional Ratings
617-204-5634
susan.kendall@moodys.com
Dora Lee
Associate Analyst
Eastern Regional Ratings
212-553-1477
dora.lee@moodys.com
Julie Beglin
Vice President/Senior Analyst
Team Lead, Eastern Regional Ratings
212-553-4648
julie.beglin@moodys.com
Jennifer Rinaca
Associate Analyst
Eastern Regional Ratings
212-553-4346
jennifer.rinaca@moodys.com
VIRGINIA GFOA
JUNE 9, 2011
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VIRGINIA GFOA
JUNE 9, 2011
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