NEW THIS WEEK, December 10, 2018:
Municipal Bond Yield Curve — (December 12, 2018)
Fiscal Year 2017 Municipal Bond Audit Times Are Still Too Slow
Municipal Bond Audit Times Show Slight Improvement Since 2015 But Most Still Late to the Table — The County, State and City Sectors are the Least Timely
By Richard A. Ciccarone
Municipal bond analysts and investors are accustomed to waiting a lot longer for municipal bond financial audits to be completed after the close of the fiscal year than they would on a corporate bond. While public corporations are required to file an annual audit within 60 to 90 days after the close of the year, municipal bond borrowers often finish their audited annual reports in close to twice that time and a large number take even much longer.
While investors need the audit documents for credit evaluation and securities pricing purposes, they are not the only stakeholders that have a need to see timely audited financial reports. Governing boards associated with public bodies and not-for-profit organizations need to review the audits in order to fulfill their duty for proper oversight. Like municipal bond analysts and investors, they are better able to respond to issues disclosed in an audit if the documents are timelier. Although this issue has been lingering for decades, the time it takes to complete and sign an audit after the fiscal year has been completed hasn’t changed much over the last ten years.
Merritt Research Services, LLC, an independent municipal bond credit data and research company based in Hiawatha, Iowa and Chicago, Illinois, has been tracking the time it takes municipal bond borrowers to complete their audits after the close of the their fiscal years since Merritt Research released its first report in 2010. Its latest findings looked at over 10,500 Fiscal Year 2017 audits by credit sector and over 110,000 audits since 2008.
The Latest Results
The latest analysis focused on 2017 audits found a modicum of good news in that there was a modest improvement in completion time rates over the past two years as governmental audits have made the adjustments to more detailed pension reporting in line with changes in GASB rules 67 and 68 that occurred mostly in the 2015 audits. Audits form non-governmental municipal bond borrowers, such as power agencies, hospitals and private universities, finished much faster than those for governments.
As has been the case in other years, the median completion time for the governmental reports still hovers between 170 and 180 days. That’s still a long way from the target reporting times in the corporate bond market and well below what the municipal bond industry considers to be a muni guideline of 120 days.
Merritt Research’s latest report continues to show that certain types of municipal bond borrowers, mostly associated with corporate like enterprise entities and not-for–profit organizations (issued under the IRS 501c-3 code), are consistently faster to finish their audits than the governmental state and local governmental sectors. These non-governmental issuer sectors have median times which range from 99 days to 161 days.
Consistently placing fastest on the list of all municipal bond credit sectors are (1) public power wholesale electric agencies (also known as joint action agencies and quasi-government enterprises), (2) hospitals, (3) private higher education institutions and (4) Tollroads. Each of these sectors show a median audit completion time of 120 days or less, passing the unofficial municipal bond guideline most frequently cited as best practice.
A WAKE-UP CALL FOR OTHERS – THE LESSONS LEARNED AND TO BE REMEMBERED FROM PUERTO RICO’S DISTRESS AND PROMESA
By James E. Spiotto
The Treaty of Paris ending the Spanish-American War of 1898 resulted in control of Cuba, Puerto Rico, Guam and The Philippine Islands being given to the United States. Cuba in 1902 and The Philippines in 1946 were given independence. Puerto Rico and Guam remain territories of the United State. In recent years, Puerto Rico as a Commonwealth flirted with independence or statehood with no clear decision.
In 1996, Congress repealed (effective 2006) Section 936 of the Internal Revenue Code (previously Section 931) that existed since the 1920’s to encourage U.S. corporations to invest in Puerto Rico by providing an exemption from federal taxes. This measure promoted two-thirds of Puerto Rico’s GDP, namely, in finance, insurance, real estate (19.6%), and manufacturing mainly in pharmaceuticals and electronics (46.4%).
By 2006, Puerto Rico was in financial distress due to at least in part to the effect of the Jones Act that purportedly added 10-15% to the costs of many goods due to the duty on non-U.S. ships, combined with repeal of Section 936 of the Internal Revenue Code without any replacement, as well as, Puerto Rico’s claimed inequity of federal government funding compared to states costing Puerto Rico billions annually for decades relating to Medicaid, Medicare, Supplemental Security Income (“SSI”), earned income tax credit (“EITC”), child tax credit (“CTC”), etc. All of this culminated in finance distress. In 2006, Puerto Rico had $40 billion of public debt and public debt per capita of $10,666.66, double the average for state and local governments in the U.S. Also in 2006, Puerto Rico’s public debt as a percentage of GDP was 45.82%.
Historians may well debate the causes and impact of Puerto Rico’s financial and operational distress, but it should be clear public debt was not the cause of financial distress of the government. It is a symptom of a systemic problem. As noted, the Merchant Marine Act of 1920 adding 10-15% to the price of many goods carried by foreign vessels, the repeal of Section 936 of the IRS Code (previously Section 931) encouraged U.S. corporation to invest in Puerto Rico and Puerto Rico’s claimed inequities in its funding and treatment compare to states purportedly costing Puerto Rico billions annually for decades are a fertile ground for blame.
Puerto Rico was founded on the principles that public debt has a first priority of payment upon default (along with expense of insular government) embodied in Section 34 of the 1917 Jones Act, which governed Puerto Rico prior the Commonwealth’s Constitution in 1952. The inclusion of Article VI, § 8 in the 1952 Puerto Rico Constitution continued this policy providing constitutional public debt, upon insufficient funds to pay expenses, were first to receive payment from “available resources.” When faced with the 2006 financial crisis, Puerto Rico, with $40 billion of public debt outstanding, chose to borrow more rather than restructure its debt. Puerto Rico used the COFINA securitization structure to add another $17 billion of public debt by 2015 that purportedly was not limited by the constitutional debt limit, resulting in public debt of Puerto Rico totaling over $72 billion.
Put another way, by 2006, Puerto Rico with $40 billion in public debt choose to literally double down on debt rather than face the then need for financial restructuring or federal government assistance such as oversight and refinancing of debt in 2006 rather than 2016 the ultimate result. Between 2006 and 2015, $40 billion of public debt became $72 billion, the percent of debt to GDP rose from 45.82% to 69.83%, and per capita public debt more than doubled from $10,666.66 to $20,727.38 (the average for state and local government debt in the U.S.A. in 2015 was $5,633.88, one quarter of Puerto Rico’s).
Growth in Public Higher Education Debt Outstanding Outpaces All Other Major Municipal Bond Sectors
Public Higher Education Debt Outstanding Has Grown by Over 80% Since 2007 Leading All Other Major Municipal Bond Credit Sectors
by Richard A. Ciccarone
Municipal Bond Credit Sectors — Ten Year Outstanding Debt Trend
Based on municipal bond credit sector medians, Public Higher Education and Community Colleges registered the biggest increases in long term debt outstanding than any other credit sectors that borrow in the municipal bond market during the period 2007- 2017. Universities and colleges saw a ten year growth of 85.2%, the most of all major municipal bond sectors tracked by Merritt Research Services LLC, an independent municipal data and research company that tracks financial conditions on over 10,000 municipal bond borrowers. Long term debt attributed to Community colleges followed close behind with an 80.7% growth rate. The ten year time span used in the comparison included the Great Recession as well as the subsequent recovery years.
Higher education institutions, in general, have incurred higher debt loads for capital improvement programs over the past two decades, triggered by a “keeping up with Jones'” mentality that swept the board rooms of college administrations. The wave of more expansive and luxurious campus facilities at competing colleges and universities was motivated in part on the grounds that the shrinking pool of eligible college age potential students required them to provide state of the art facilities. Private higher education institutions, many of which started their capital programs earlier than public institutions, ranked fifth in their median debt expansion with a smaller but still robust 39.6% growth rate.
In the case of community colleges, expansion programs heated up as public officials responded to the demand for lower cost institutions available for families seeking a lower cost option to either reduce the cost leading to a four year degree or a path providing more specific job preparation and training..
On the other side of the debt trend scale, wholesale electric agencies, also called joint action agencies, whose primary purpose is to generate or jointly purchase power on behalf of or to resell to mostly local municipal utilities, saw their outstanding debt loads fall by 23.8% over the past ten years, the biggest percent drop among all the major credit sectors tracked Merritt database. Public power borrowers, which also include retail electric utilities, have seen their debt loads and new capital outlay requirements shrink in line with greater reliance on smaller, less expensive generating plants, more purchased power from surplus suppliers and conservation efforts. Since 2007, retail municipal electric utilities lowered their median long term debt outstanding by 5.4%.
Featured Chart: State Taxes Per Capita
- Key Statistical Takeaways from Per Capita State Tax Revenue Median Trends
– The state (excluding territories) median for total governmental activities tax revenue per capita reached its highest level in FY 2017, more than any year since 2003.
- The per capita level of $2,655 is higher than it would be if you apply the inflation rate from the end of 2003’s per capita level of $1,708, in which case the expected inflation adjusted level would be $2,344 for October 2018.
- In 2017, the top five states governments with the highest governmental activities per capita tax revenue were Vermont at $4,917, Hawaii at $4,658, Delaware at $4,561 and Connecticut at $4,499 and Minnesota at$4,430.
- Alaska had the lowest governmental activities taxes per capita level at $916 and New Hampshire was next at $1,667.
- Data provided by Merritt Research Services, LLC as of November 19, 2018.
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