MuniLand – Preview of the State of the States in Fiscal Year 2014: Déjà Vu

SNWAM Research’s annual State of the States report is ready. We covered 27 states’ audited Comprehensive Annual Financial Reports (CAFRs) for fiscal year 2014. Our conclusions are based on each CAFRs Statement of Net Position and Statement of Activities; footnotes detailing bonded indebtedness, liabilities for pensions and OPEBs, and inter-fund transfers; and, when necessary, separate CAFRs published for large pension and OPEB plans. This methodology includes closely governed component units within the CAFRs, the operations of which can fairly be treated as part of the operations of the states themselves. This methodology allows us to compare state finances in a consistent manner and adds to our confidence in the accuracy of our findings.

As was the case in FY 2013, state operations were generally sound in FY 2014 due to the continued mild economic expansion, which improved sales and income tax revenue. Operating margins were positive for 24 of the 27 credits. The states of Connecticut, Massachusetts, and New Jersey were significant exceptions, as each incurred operating deficits of $1 billion or more, measured on a total funds basis. Our basic conclusion is that most, but certainly not all, of the states that we follow reported very solid operating performance in FY 2014.

Now comes the more somber news. Last year, our comment on FY 2013 was that the states did well operationally, but frittered away an opportunity to use their improved liquidity and generally stronger financial positions to begin to address, and to gain control of, their bonded indebtedness and their unfunded liabilities for pensions and OPEBs. In FY 2014, our take is almost exactly the same, only with a greater degree of concern because unfunded pension liabilities increased by a surprisingly large amount. For our group of 27 states, the problem generally does not lie with bonded debt outstanding, which rose by only 1.7% to $800.2 billion; and neither does it lie with OPEBs, which rose by 2.2% to $502.9 billion. The problem lies with unfunded pension liabilities, which grew by 14.2%, to $754.2 billion. That is a huge increase, and is particularly disappointing given that we are 5-6 years into economic recovery and also riding a huge rally in the equity markets, a staple of pension fund investing.

These warning signals have been apparent for some time now, and it is deeply disappointing, morale-breaking really, that the states keep ignoring them. And so, SNW’s opinion about FY 2014 comes down to a retake of FY 2013 – a good year operationally, not a good year in terms of managing “longer-term” liabilities. The great danger is that for several of the 27 states the long-term has now become short-term; and for the rest, too, the long-term is shorter than it used to be. Our conclusion is that for a number of years now, the municipal bond market has become increasingly but perhaps imperceptibly more risky. Be on the lookout for our in-depth Minute in the Market report on the States, and, for our impact investment clients, the integration of HIP Scores into our analysis.

Source: SNWAM Research, State CAFRs