July 2017 Municipal Market Update Ranking the States by Fiscal Condition:
The municipal market continues to live in a world of perfect technicals. Supply did start picking up again in July, but not enough to satisfy demand and once again, munis outperformed taxables. We continue to be cautious with any new investments, especially at the short-end of the yield curve. This does not include 7-day variable rate demand notes, which are earning roughly 80 bps.
I recently came across a very comprehensive analysis put out by the Mercatus Center at George Mason University. It does a very good job looking at various levels of solvency by state. Although there are not any concerns at this time, the research shows that most states have a challenge ahead to keep pace with fast growing healthcare costs. We review this analysis and give you our thoughts in this month’s credit review.
Muni Market Review:
Once again, the municipal market continued to enjoy strong fundamentals to outperform the taxable market. Taxable rates were mainly unchanged, but muni yields declined, as slightly higher new issuance supply was not enough to satisfy seasonal demand technicals. More specifically:
- Muni rates changed from -14 to 5 bps, with an 11 bps curve steepening.
- Taxable rates changed -5 to 0 bps, with a 4 bps curve steepening.
- To date, 2017 issuance is lagging 2016’s record levels by 13% but it was higher in July 2017 then in 2016. We feel there is a good chance this pick-up in issuance will continue through the third quarter.
- The short-end of the muni curve remains rich in our eyes.
- 5-year AA rated bonds are priced to a 1.30% yield.
- We would prefer 7 day VRDNs at a .80.
Credit default spreads have been stable this year with the national index tightening slightly by 5%. Yet recently, and the biggest factor to the lower national average, has been a 15% tightening in New Jersey spreads. We are unaware of any good news from the state, and in fact the recent state fiscal rankings just released has New Jersey dead last.
Market News & Credit Update:
- S&P downgraded Alaska for the second time in two years as the downturn in the energy-industry is adversely impacting the state’s fiscal condition. It is now rated AA. This S&P downgrade comes one week after Moody’s did the same thing and shows the State to be rated Aa3. Of note, in this month’s credit review section, Alaska gets high marks for its cash solvency. In fact, the cash levels are so high, it makes one wonder if they are managing it inefficiently.
- In a recent survey, people were asked about their level of respect for various professionals. The results were quite revealing:
- Only 32% of respondents respected financial advisors
- Only 29% respected politicians
- Only 26% respected insurance agents
Please note, they did not ask about municipal financial advisors. We would expect that one to be a whole lot higher!
- State unemployment rates recently released by the Bureau of Labor Statistics shows the following:
|
5 Lowest |
|
5 Highest |
|
|
|
Colorado |
2.30% |
|
Alaska |
6.80% |
|
North Dakota |
2.30% |
|
New Mexico |
6.40% |
|
Hawaii |
2.70% |
|
District of Columbia |
6.20% |
|
Nebraska |
2.90% |
|
Louisiana |
5.50% |
|
New Hampshire |
2.90% |
|
Kentucky |
5.10% |
Ranking the States by Fiscal Condition: Mercatus Center – George Mason University
Introduction:
The Mercatus Research Center recently released its “Ranking the States by Fiscal Condition”. At a recent CFA Institute Conference, this study was cited in a public policy discussion, and was highly recommended as a good quantitative approach to analyzing the credit solvency of the states. We here at MainLine are very positive on municipal credit quality, but the results of this study reminds us of the fiscal challenges that lay ahead for the states.
Background:
This study uses 14 metrics that assess the extent to which the states can meet short-term bills and longer term debt obligations. The data used is from each state’s 2015 comprehensive annual financial report. State finances were analyzed using the following five dimensions of solvency:
- Cash Solvency – the comparison of cash available versus current liabilities to be paid.
- Budget Solvency – the comparison of long-term ability to meet all estimated liabilities.
- Long-Run Solvency –the comparisons of all assets owned by the state, this includes land, buildings, and all of the estimated future liabilities.
- Service-Level Solvency – The ability of the state to increase fees or taxes to meet future liabilities.
- Trust Fund Solvency– This includes all of the previous measures but adds the ability of the state to meet future pension and debt service obligations.
At this time revenue growth remains moderate while expenditure growth is increasing led by Medicaid and healthcare related costs. A natural fiscal gap of 5% per year is projected over the next 50 years. This means cuts in programs or additional revenues are needed to help keep fiscal balance.
Cash Solvency Index:
The use of several ratios that measure each state’s ability to pay its bills over the next 30 to 60 days from its current assets. It can also highlight any fiscal imbalance between revenues and expenses at the state’s operating budget level. The results range from 10.57 to -2.91 times with 2.68 times being the average.
|
TOP FIVE |
|
BOTTOM FIVE |
||||
|
Rank |
State |
Index |
|
Rank |
State |
Index |
|
1 |
Alaska |
10.57 |
|
46 |
Maryland |
-2.60 |
|
2 |
Florida |
8.01 |
|
47 |
Pennsylvania |
-2.66 |
|
3 |
Utah |
5.88 |
|
48 |
Illinois |
-2.81 |
|
4 |
South Dakota |
5.75 |
|
49 |
Massachusetts |
-2.88 |
|
5 |
Wyoming |
4.77 |
|
50 |
Connecticut |
-2.91 |
These results are quite interesting and raise several questions. The negative index is concerning as if those states are unable to access additional funds, a delay in payment or no payment may occur. On the other hand, states keeping too much cash raises the question of inefficient managing of assets. Why are these funds not invested in longer assets?
Budget Solvency Index:
This is a lot like the cash solvency but is a measure for longer-term fiscal imbalance and ability to pay liabilities owed. It highlights the state’s need to make fiscal reform for longer tern budget balance. The average is 1.04 with the range being from 5.88 to -11.05.
|
TOP FIVE |
|
BOTTOM FIVE |
||||
|
Rank |
State |
Index |
|
Rank |
State |
Index |
|
1 |
North Dakota |
5.88 |
|
46 |
Illinois |
-1.26 |
|
2 |
Wyoming |
1.76 |
|
47 |
Louisiana |
-1.41 |
|
3 |
Connecticut |
1.61 |
|
48 |
Massachusetts |
-1.47 |
|
4 |
Utah |
1.59 |
|
49 |
New Jersey |
-2.55 |
|
5 |
North Carolina |
1.43 |
|
50 |
Alaska |
-11.05 |
These results are a bit concerning as only the top six states have an index over 1 times. This highlights one of the big conclusions of the study, that expenditure growth is growing much faster than revenue for most states and, therefore, there is a need for cost control or revenue enhancements. Roughly 88% of the states, if nothing changes from current budget practices will have fiscal problems in the future.
Long-Run Solvency Index:
An extension of budget solvency as it includes the assets owned by the state such as land, and government buildings. This is a way to help identify, if things got bad, what the state could sell or lease to help pay its liabilities. The average is -.17 with the scores ranging from 9.88 to -5.54.
|
TOP FIVE |
|
BOTTOM FIVE |
||||
|
Rank |
State |
Index |
|
Rank |
State |
Index |
|
1 |
Nebraska |
9.88 |
|
46 |
Kentucky |
-2.90 |
|
2 |
Oklahoma |
4.85 |
|
47 |
Connecticut |
-3.81 |
|
3 |
Tennessee |
4.70 |
|
48 |
Massachusetts |
-3.95 |
|
4 |
South Dakota |
4.19 |
|
49 |
Illinois |
-5.28 |
|
5 |
Idaho |
2.82 |
|
50 |
New Jersey |
-5.54 |
Of concern with these results is the fact that only ten states, if they liquidated everything they owned, could meet future liabilities. Where is the money going to come from to meet future obligations? It also highlights, once again the higher level of state expenditure growth expected in the coming years.
Service Level Solvency Index:
This measures the state’s ability to raise taxes or increase spending with revenues growth. Depending on the source of income, can the state raise rates without economic harm or collection problems? This analysis will highlight those states with financial flexibility to make changes needed to meet future obligations. The average is -.07 with the scores ranging from 5.23 to -4.77.
|
TOP FIVE |
|
BOTTOM FIVE |
||||
|
Rank |
State |
Index |
|
Rank |
State |
Index |
|
1 |
New Hampshire |
5.23 |
|
46 |
West Virginia |
-3.11 |
|
2 |
Nevada |
5.14 |
|
47 |
Delaware |
-3.60 |
|
3 |
Florida |
3.79 |
|
48 |
Vermont |
-3.93 |
|
4 |
Virginia |
3.70 |
|
49 |
New Mexico |
-4.61 |
|
5 |
South Dakota |
3.04 |
|
50 |
North Dakota |
-4.77 |
Results shows that on average, the ability to raise revenues is 50/50 and actually realize an increase in revenue. Depending on the state and the type of revenue, an increase in fees or taxes could or could not result in long-term revenue gain. It appears to be a case-by-case decision.
Trust Fund Solvency Index:
Here comes the bogeyman! This analysis captures the pension and OPEB obligations of the states. It includes the ability to meet future pension obligations the state as promised along with everything else included in the previous index measures. This index also includes the increased debt service levels the state will need to meet and its capacity to actual increase it.
|
TOP FIVE |
|
BOTTOM FIVE |
||||
|
Rank |
State |
Index |
|
Rank |
State |
Index |
|
1 |
Oklahoma |
6.91 |
|
46 |
Illinois |
-1.46 |
|
2 |
Tennessee |
2.54 |
|
47 |
Mississippi |
-1.53 |
|
3 |
Nebraska |
2.16 |
|
48 |
Ohio |
-1.65 |
|
4 |
North Dakota |
2.11 |
|
49 |
New Mexico |
-1.71 |
|
5 |
Wisconsin |
1.92 |
|
50 |
Alaska |
-1.88 |
Results show an average of .04 with a range of 6.91 to -1.88. Once again this is not positive for the states, as only seven states are able to pay all future obligations including their pension liability.
Overall Results:
Time to add up the results and see which states are considered strong from the analysis, and which ones are not.
|
TOP FIVE |
|
BOTTOM FIVE |
||||
|
Rank |
State |
Index |
|
Rank |
State |
Index |
|
1 |
Florida |
3.52 |
|
46 |
Maryland |
-1.09 |
|
2 |
North Dakota |
3.48 |
|
47 |
Kentucky |
-1.38 |
|
3 |
South Dakota |
3.02 |
|
48 |
Massachusetts |
-2.00 |
|
4 |
Utah |
2.86 |
|
49 |
Illinois |
-2.05 |
|
5 |
Wyoming |
2.25 |
|
50 |
New Jersey |
-2.18 |
Ok. There you have it. Some surprises in the top and in the bottom. Noteworthy results:
- Anyone shocked to see New Jersey and Illinois in the bottom five? The analysis included Puerto Rico last year. I guess the Institute decided that was no longer a “solvent” situation.
- What is with North/South Dakota and Wyoming that makes them so fiscally sound? Oh yes, nobody lives there.
- That being said, Florida has disproved that a big state cannot be fiscally responsible. Last year ranked #6, it is now the state in the best fiscal condition. This is even more impressive knowing the high amount of retirees and the concerns with health care costs usually associated with them.
- Maryland #46? For the most part, the highest credit rated states are in the top third of the rankings except Georgia and Maryland. AAA rated Georgia is ranked 22nd as long run solvency was ranked poorly. Maryland is ranked 46th due to low cash index solvency and long run solvency. Could this study be an early indicator of possible downgrades in the future?
- The battle between New York and California goes to New York, which is ranked 39, with California at 43.
- I was surprised to see Connecticut ranked as high as 37, and Colorado as low as 30. I guess the marijuana tax revenue in Colorado is not leading to fiscal soundness (LOL).
Conclusions:
Oh my! Roughly 95% of the states have tough budget decisions to make in the future. We do believe there are natural forces that will help these states as they go forward. For example:
- Population and economic growth to grow out of fiscal constraints.
- Ability to increase taxes and fees or create new ones to increase income
- Ability to make policy changes, cuts in service to control expenditure growth
- Ability to refinance debt and structure repayment to ease anticipated debt service expenditures.
This study highlights that for some states, fiscal management struggles have yet to begin. Those struggling now are in bigger trouble as we move forward. This study has done a great job of highlighting these concerns. As always, we here at MainLine West will remain on alert. We are big believers in the purity of municipal finance and its strong credit quality, but we are not blind to potential challenges on the horizon. We also know the history of municipal finance, and that we believe in the end the SWAN will continue to swim in calm waters.
We encourage you to look at the full report:
https://www.mercatus.org/system/files/norcross-fiscalrankings-2017-mercatus-v1.pdf