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LOCAL GOVERNMENT CREDIT OUTLOOK—VIRGINIA AND THE US --with an update on GASB 54
Virginia GFOA June 9, 2011SUSAN 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
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VIRGINIA GFOA JUNE 9, 2011
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
-250
-200
-150
-100
-50
0
50
100
150
200
Upgrades Downgrades
Rating Changes by Number
Source: Moody’s
VIRGINIA GFOA JUNE 9, 2011
Default Counts by Purpose
Purpose Ratings Outstanding Defaults
Housing 1,041 21
Health Care 650 21
Electric, Water or Sewer Enterprise 1,645 3
Higher Education 843 1
Recreation 93 1
City, Town, County – Non-General Obligation 2,342 4
General Obligation 8,610 3
Total 15,224 54
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
VIRGINIA GFOA JUNE 9, 2011
Defaults are higher among unrated bonds
Recent US Municipal Defaults2008 2009 2010 2011 YTD
Issuers (#)Rated by Moody's 5 1 2 0Unrated and Rated by Moody's 167 207 82 14
Volume ($millions)Rated by Moody's 3,678$ 24$ 40$ -$ Unrated and Rated by Moody's 8,518$ 1,688$ 3,233$ 605$
Source: Moody's and Income Securities Advisor, Inc.
VIRGINIA GFOA JUNE 9, 2011
Rated defaults expected to increase in 2011
Aaa
Aa1
Aa2
Aa3 A1 A2 A3
Baa1
Baa2
Baa3 Ba1
Ba2
Ba3 B1 B2 B3
Caa1
Caa2
Caa3
Ca-C
0%
5%
10%
15%
20%
25%
30%
35%
40%
Municipal vs. Global Corporate Ratings
Public Finance All Global Corporates
• 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
VIRGINIA GFOA JUNE 9, 2011
Municipal spreads remain wider, post credit crisis
Source: Moody’s
0
50
100
150
200
250Baa - Aaa Spreads
VIRGINIA GFOA JUNE 9, 2011
Local governments face a revenue and spending crisis, not a debt crisis
2008Q1 2008Q2 2008Q3 2008Q4 2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3
-30.00%
-20.00%
-10.00%
0.00%
10.00%
20.00%
Total Personal Income Sales Property
Source: Bureau of Census
State and local government quarterly tax revenue performance
VIRGINIA GFOA JUNE 9, 2011
Low revenue growth + fragile recovery = challenges
U.S. Nonfarm Employment (000s)
Source: Bureau of Labor Statistics
124,000
126,000
128,000
130,000
132,000
134,000
136,000
138,000
140,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Baseline Economic Growth 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%
Per Capita Personal Income $42,052 $44,187 $47,154 $49,405 $51,293
Source: Moody's Investors Service
VIRGINIA GFOA JUNE 9, 2011
FROM MOODY’S ECONOMY.COM
11F 12F 13F-2
0
2
4
6
8
10Local government State
Local governments will underperform states
Sources: Census Bureau, Moody’s Analytics
Tax revenues, fiscal yr, % change
VIRGINIA GFOA JUNE 9, 2011
FROM MOODY’S ECONOMY.COM
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10E
11F
-4
-2
0
2
4
6
8
10
Recession has finally hit property taxes
Source: Census Bureau, Moody’s Analytics
VIRGINIA GFOA JUNE 9, 2011
State and local debt growing, but slower than other sectors
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Q3 20
10 -
2
4
6
8
10
12
14
16
18
20
(trillions of dollars)
Households Business State & Local Govt Federal Govt Financial & Foreign
VIRGINIA GFOA JUNE 9, 2011
Total US public debt lower than other major economies
Japan* Italy France Germany US Spain Canada* Australia0
20
40
60
80
100
120
140
160
180
200
(% of GDP, 2009)
Central Regional and Local*Data as of 2008
VIRGINIA GFOA JUNE 9, 2011
Reduced state and local spending could threaten growth
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Q3 2010-3
-2
-1
0
1
2
3
4
5
(Percentage Point Contribution to Change in GDP)
GDP Federal 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
FROM MOODY’S ECONOMY.COM
Public Sector Dragging on National Employment
Source: BLS
Total nonfarm (R)
State and local government (L)
Employment, ths
VIRGINIA GFOA JUNE 9, 2011
Virginia Unemployment is Dropping but Still Elevated
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Source: Commonwealth of Virginia Employment Commission
Blacks
burg
Bristo
l
Charlo
ttesv
ille
Culpep
er
Danvil
le
Harris
onbu
rg
Lync
hbur
g
Mar
tinsv
ille
Richm
ond
Roano
ke
Staun
ton
Virgini
a Bea
ch
Was
hingt
on D
C
Winc
hest
er
VIRGIN
IAUSA
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
18.0
March-08
March-09
March-10
April-11
VIRGINIA GFOA JUNE 9, 2011
High Credit Quality Reflected in Moody’s Local Government Ratings Distribution
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US
Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa30%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Counties
Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa30%
5%
10%
15%
20%
25%
30%
35%
Cities
VIRGINIA
VIRGINIA GFOA JUNE 9, 2011
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
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
GASB 54 Implementation
VIRGINIA GFOA JUNE 9, 2011
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
Reclassifications
VIRGINIA GFOA JUNE 9, 2011
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
GASB 54 Restatement
VIRGINIA GFOA JUNE 9, 2011
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
GASB 54 and Moody’s Analysis
VIRGINIA GFOA JUNE 9, 2011
Susan KendallVice President/Senior AnalystLead Analyst, Virginia Regional [email protected]
Julie BeglinVice President/Senior AnalystTeam Lead, Eastern Regional [email protected]
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Dora LeeAssociate AnalystEastern Regional [email protected]
Jennifer RinacaAssociate AnalystEastern Regional [email protected]
VIRGINIA GFOA JUNE 9, 2011
© 2009 Moody’s Investors Service, Inc. and/or its licensors and affiliates (collectively, “MOODY’S”). All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY COPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY’S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY’S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided “AS IS” without warranty of any kind. Under no circumstances shall MOODY’S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY’S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY’S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The ratings, financial reporting analysis, projections, and other observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. 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. Each rating or other opinion must be weighed solely as one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding or selling.
Moody’s Investors Service, Inc. (“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.”
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