Download - Kelly McGary
Continued Focus on Managementand
Credit Analysis in the Current Economic Climate
Florida Government Finance Officers AssociationKelly McGary, Senior Director
May 31, 2009
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Table of Contents
> 12 Habits of Highly Successful Finance Officers
– Management’s Impact on Municipal Credit Ratings
> Credit Market Discussion
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12 Habits of Highly Successful Finance Officers
Management’s Impact of Municipal Credit Ratings
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Topics for Discussion
> Credit factors beyond/within a government’s control
> 12 positive management practices
> ‘Worst’ management practices
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Factors Beyond Governments’ Control
> Location
– Positives: climate, natural resources, access to transportation, proximity to metropolitan employment centers.
– Negatives: climate, natural resources, access to transportation, proximity to metropolitan employment centers.
> Economy
– Regional/national events.
– Economic development efforts can have an impact, but usually over a long period of time.
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Factors Beyond Governments’ Control (Cont’d)
> History
– Why do people live here?
– Political climate of past administrations.
> Other Levels of Government
– State and federal mandates.
– Changes in revenue sharing.
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Management as a Credit Factor
> Unlike some other credit factors, management practices are within a government’s control.
> Good financial management helps to offset other credit risks, while poor financial practices keep some ratings below their “natural” level.
> Management practices are often a leading factor in a rating change - up or down.
> Institutionalized policies should be evaluated by objective standards.
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The 12 Habits of Highly Successful Finance Officers
> Fund balance reserve policy/Working Capital reserves Very Significant
> Debt affordability reviews and policies Very Significant
> Superior debt disclosure practices Very Significant
> Multi-year financial forecasting Significant
> Interim financial reporting & monitoring Significant
> Pay-as-you-go capital funding policies Significant
> Rapid debt retirement policies Significant
> 5 year CIP integrating operating costs Influential
> Contingency planning policies Influential
> Policies regarding non-recurring revenue Influential
> Financial reporting and budgeting awards Influential
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Fund Balance PoliciesVery Significant
> Operating reserves, revenue stabilization or rainy day fund.
> Insulation against unanticipated revenue shortfalls or expenditure increases.
> Working capital in cases of seasonal cash flow.
> Sized according to issuers needs: revenue volatility, seasonality of receipts.
> Fitch looks most positively on policies that are adopted into local law, specify method/level of funding and outline withdrawal and replenishment procedures.
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Debt Affordability PoliciesVery Significant
> Indication of management’s focus on long-term financial health.
> Provides necessary inputs to derive realistic capital plan.
> Compliance with state-imposed debt limit is a given.
> Fitch looks for policies that address the debt burden on the tax base, the population, and the budget.
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Superior Debt Disclosure PracticesVery Significant
> Revenue bond covenants & coverage.> Details on pledged tax or revenue stream trends.> Internet accessibility to financial statements, budgets, and capital
improvement plans.> Operating fund cash flow.> VRDO’s, swaps & derivatives.> Statistics for enterprises on fees, customer trends, and service
volume trends.
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Multiyear Financial ForecastingSignificant
> Provide planning framework for managers and elected officials.
> Anticipate future imbalances between revenues and spending.
> 3-5 years is the norm.
> Specific enough to be the basis for discussion and decisions.
> General enough to accommodate inevitable changes in fiscal/economic/political climate.
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Interim Financial ReportingSignificant
> Early warning system.
> Means of communicating with management and elected officials.
> Format for analysis of variances from budget and prior year.
> Details within major revenue and spending categories aid in variance analysis.
> Clearly defined assumptions are important.
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Pay-As-You Go Capital PoliciesSignificant
> Reduces fixed debt service costs.
> Can improve financial flexibility.
– Operating funds earmarked for capital projects can be redirected if a budget shortfall occurs.
> GASB 34 may prompt more issuers to adopt pay-go policies to reduce debt.
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Debt Amortization PoliciesSignificant
> Life of debt should be less than or equal to useful life of assets financed.
> Rapid amortization reduces duration of fixed cost commitment and frees up capacity for future projects.
> Fitch’s rules of thumb for G.O. debt amortization rate:
– >65% in 10 years considered rapid
– <40% in 10 years considered weak
> Best policies govern structure of debt and are linked to capital improvement program.
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Long-Range Capital PlanInfluential
> Widely accepted; absence is notable.
> Five years is the most common time frame - some longer.
> Includes needed projects funded and sources of funding.
> Best plans integrate operating budget impacts and are limited by debt affordability policies.
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Contingency PlanningInfluential
> Identify risks inherent in adopted budget and take steps to offset them.
– Economic assumptions
– Internal/external approvals
– Natural disasters
– Voter initiatives on taxes/spending
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Policies Regarding Use of One-Time Revenue SourcesInfluential
> Asset sales, debt restructuring, court settlements, tax collection windfalls.
> Use of non-recurring revenues for ongoing expenditures can create budgetary stress.
> From a credit perspective, one-time revenues should be matched with one-time or discretionary spending pressures.
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Putting It All Together
> In Fitch’s experience, issuers using financial best practices have fared better.
> Policies that are adopted into local law or are otherwise institutionalized are best.
> Policies can change, but once adopted, fiscal discipline tends to stay.
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Worst Practices - Don’t Try These At Home
> Cash basis accounting
> Qualified audit opinion for material weakness
> Deficit financing for 2 of last five years
> Slow debt retirement (< 35% in 10 years)
> Unfunded accrued pension liability (funding ratio < 60%)
> TRANS/RANS growing significantly faster than annual spending
> Debt restructuring that defers > 35% of current debt service
> Over-reliance on non-recurring revenue > 15%
> Aggressive investment policy for operating funds
> Pension contribution deferral in the current budget year
> Budgetary impasse beyond legal completion date
> Lack of Capital Improvement Plan (CIP)
> Excess interfund borrowing, with no capacity to repay in near future
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Part II. Credit Market Discussion
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Current Credit Concerns for Local Governments
> Broad-based, deep and potential prolonged recession, affecting most regions and economic sectors
– Housing market
– Employment levels
– Retail sales
– Personal income (lagged)
> State aid reductions
> Credit markets
– Debt composition (i.e. auction rate securities, variable rate demand obligations)
– Need to issue/redeem short-term borrowing
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Housing Market Metrics
> Price income ratio (PIR) – measures the ratio of median single-family home price to average household income
> Price equalization factor – calculates the amount by which median single-family home price would have to fall to equal the average of the 1990s PIR
> Home price forecasts – five-year forecast provided quarterly by University Financial Associates (UFA) for the 50 states, District of Columbia, and 100 MSAs
> LoanPerformance – Mortgage Bankers Association data on mortgage delinquency and foreclosure trends for states, MSAs, counties, cities, and towns
– Provides detail on subprime ARMs and negative amortization mortgages (“Option ARMs”)
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Housing Market Data by MSA (p. 1 of 3)
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Housing Market Data by MSA (p. 2 of 3)
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Housing Market Data by MSA (p. 3 of 3)
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Mortgage Loan Delinquency Data
0
2
4
6
8
10
12
Delin
quen
t 90+
Day
s or F
orec
losu
re (%
)
0
50
100
150
200
250
% Ch
ange
3Q08 % Change
Appendix 2: All Loans Seriously Delinquent
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So What?> Tax base declines in many Florida counties – fiscal year 2008, 2009, expected
for 2010 and uncertain for future years.
> Property tax collection rates
> Save Our Homes often perceived as a hindrance during the boom but provided some taxing margin, or at least a time lag to prepare
> Statutory authority to adjust the millage rate, affording the ability to offset AV declines with rate increases – politically challenging –
> Economically sensitive revenue streams struggling
– Sales taxes
– Tourist development taxes
– Fuel taxes
– Building and Permitting Fees
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Credit Market Disruptions> Late 2007-2008: Downgrades of bond insurers and banks> Spring 2008: Auction rate securities
– Failed auctions– Penalty rates– Conversions to VRDOs
> Fall 2008–Present: Variable rate demand obligations– Failed remarketings and bank bonds– Maximum interest rates– Accelerated amortization– Swap termination triggers
> Ongoing: market access issues– Premium rates for all but treasuries– Impaired ability to sell bonds (for new money or to redeem bond anticipation
notes), cash flow notes – Availability of liquidity/LOC’s: Fitch’s 2009 rating outlook for U.S. financial
institutions is Negative
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Local Government Response to Economic Downturn> Reduction in capital projects, particularly those funded on a pay-as-you-go basis
> Increases in fine and fee revenue
> Very few cases of tax increases, but base expansion considered
> Hiring/wage freezes
> Elimination of non-essential non-personnel spending
> Use of accumulated reserves in excess of policy floor and other non-recurring funding sources
> Reserve reductions to levels below policy floor
> Furloughs, lay-offs, labor contract renegotiations, core service reductions
> Asset sales
> Increased cash flow borrowing, when available and economical
> Vendor payment deferrals
> Deferrals in pension and OPEB funding
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Retaining Strong Credit Quality
> Budget realistically to conservatively
> Formulate “what-if” scenarios and identify contingencies
> Monitor revenues and spending frequently
> Continue long-range financial planning
> Create a rationale for using non-recurring funds for operating expenditures
> Stay within financial policies where possible
> Maximize structural solutions
> Develop a framework for use and replenishment of reserves
> Keep rating agencies informed of significant changes in circumstances
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