Asset Management recently completed a comparative credit review of 29 states plus the Commonwealth of Puerto Rico. Our sample includes (1) states such as California, Idaho, Oregon, and Washington, where many of our clients reside and invest; (2) nearby states, such as Colorado, Arizona and Utah, with strong economies and favorable credit characteristics; (3) states such as Florida and Texas, which have no personal income tax (and, therefore, no tax shelter inflating the prices of their debt) and issue large volumes of debt; (4) various other states that offer good economic performance along with conservative debt management practices; and (5) “headline” jurisdictions, including Connecticut, Illinois, New Jersey, and Puerto Rico, in which we have no investment interest but that demonstrate many of the fiscal and debt issues resulting from weak or inattentive management. Overall, we are seeing stable trends in operating performance, but looming challenges continue to manifest in the form of pension costs and OPEB liabilities, which are still growing at a worrisome pace.
Our methodology for conducting this analysis involved the use of
government-wide accounting statements which include various component units as
well as the states proper; this methodology enabled us to compare
“apples-to-apples” results for the states and associated entities. We
used FY 2012 data for 26 states. Illinois, New Mexico, Puerto Rico, and
South Carolina have not yet released 2012 accounting statements, so we used
2011 data for those jurisdictions.
We collected two broad types of data: (1) measures of fiscal performance (chief among them operating data and measures of liquidity), and (2) debt statistics, consisting of outstanding bonded indebtedness, unfunded pension liabilities, and unfunded liabilities for post-retirement employee benefits (“OPEBs”). Here are the highlights of our findings:
In general, the states in our sample performed satisfactorily in FY 2012, much like they did in FY 2011, though perhaps not as well as we would have hoped given the slow but steady improvement of the nation’s economy. Aggregate government-wide expenditures in our sample states dropped by 1.1% in FY 2012 versus FY 2011, but the overall ratio of revenues to expenditures was also lower – 101.1% in 2012 versus 102.4% in 2011. The states managed to cut expenditures, but revenue growth was anything but robust. The result was a minor squeeze on liquidity, as cash and investment balances dropped from an average 28.0% of government-wide expenditures in 2011 to a still-comfortable 24.8% in 2012. Nevertheless, the best one can say is that, on the fiscal side, the states did no better than okay in 2012, and it is probable that state finances will not improve materially in the future, absent a pick-up in the pace of the economic recovery nationwide.
Some states did not do okay in 2012. California, Connecticut, Hawaii, Illinois, Maryland, Massachusetts, New Jersey, New York, and Puerto Rico ran government-wide deficits. Seven of these eight jurisdictions also ran deficits in 2011 (Massachusetts being the exception). Four of them – Connecticut, Illinois, New Jersey, and Puerto Rico – continue to report large negative net worth numbers. On a more positive note, those states in which SNWAM’s clients, and bond-buying, is concentrated, did well. For example, among the states of most interest to us and to our clients, Florida ranked second best for liquidity, Idaho fourth, Utah sixth, Oregon eighth, and Washington twelfth.
By now most investors understand very well that the line-up of potential claims on the future financial resources of the states includes exposure to pension and OPEB liabilities as well as to bonded indebtedness. Accordingly, our study includes aggregate totals for all three types of potential obligations, ranked by per capita amounts and by percentage of personal income. In the aggregate, the states in our sample borrowed freely in 2012, increasing bonded debt outstanding by 8.7% to a total of $831.8 billion. Unfunded pension liabilities rose even faster, by 10.4% to $667.8 billion, which indicates that states must act much more decisively – and soon – to address the growth of these liabilities. In contrast, aggregate liabilities for OPEBs were stable at $520 billion, reflecting better control of employee/retiree health care costs and enhanced funding of annual required contributions. But much more must be done; average pension funding is running at 73%, and average OPEB funding is an abysmal 5.6%. Considered in their entirety, potential debt/pension/OPEB obligations are huge, totaling $2.020 trillion, or $8,091 per capita and 19.1% of personal income across the sample. Separately, bonded debt is $3,333 per capita and 7.9% of personal income; unfunded pension liabilities are $2,675 and 6.3%; and unfunded OPEBs are $2,083 and 4.9%.
The entities in worst shape are Puerto Rico (total unfunded liabilities $97.6 billion, $26,268 per capita and 161.7% of personal income), Illinois ($167.6 billion, $13,053, 31.0%), New Jersey ($146.6 billion, $16,058, 30.2%), and Connecticut ($68.5 billion, $19,095, 32.3%). By way of comparison, the respective numbers for California are $304.3 billion, $8,099, and 18.5% -- not great, but clearly more manageable than those of the worst-ranking four. On a less somber note, the states on which SNWAM focuses for our clientele rank much better: looking at debt plus unfunded pensions plus unfunded OPEB liabilities as a percentage of personal income, Washington ranks third best among the states in our sample, Arizona fourth, Florida fifth, Idaho sixth, Texas eighth, Utah ninth, Colorado tenth, and Oregon thirteenth – all in the better half of the sample. California ranks nineteenth.
While the FY 2012 fiscal performance of the states in our sample was okay at best, the continued rapid rate of growth in bonded debt outstanding and unfunded pension liabilities is cause for increasing concern. We feel that these issues, which the municipal market has long regarded as a longer-term problem, will fall upon us sooner than many expect. Bonded debt and unfunded pension liabilities, which grew at 8.7% and 10.4%, respectively, in FY 2012, are very “hard” liabilities involving contractual and vested rights that can be modified only with great difficulty, if at all. OPEB liabilities may perhaps be “softer” legally, but they are likely to be nearly as thorny politically. State and local governments need to direct serious attention to these liabilities sooner rather than later. At SNWAM, we have for a long time been factoring these liabilities – and bond issuers’ attention both to controlling them and to funding them – into our appraisals of the credits we buy for our clients. We will continue to do so, and with ever-increasing rigor, in the months and years ahead.