Tollroads Show Strongest Growth in Total Revenue Growth
Tollroads Edge Hospitals for the Municipal Bond Credit Sector Revenue Honors
Tollroad and Hospital Sectors easily led all other municipal bond credit sectors when it came to annual total revenue growth over the recent five year period spanning 2012 through 2017.
Tollroads saw a median increase of 30.4%, barely edging out hospitals (systems and independent obligors), which grew by 29.8%.
The slowest growing sector belonged to the wholesale electric sector, which only saw a five year bump of 4.3%. The wholesale electric group, also frequently referred to as public power authority joint action agencies, has been showing positive margins as their missions are often limited to the large generating power plants that they financed.
The credit sector summary analysis comparing the growth in total revenues to total expenses from 2012 to 2017 was compiled by Merritt Research Services, LLC using audited reports from approximately 10,000 municipal bond borrowers.
The Tollroad sector was the clear leader among the major municipal credit sectors. Its total revenue pace was about double that of its total expenses during the period from 2012 to 2017. The strong revenue growth experienced by the sector doesn’t mean that every municipal bond tollroad borrower raised more than it took in every year; but, the vast majority has been doing that lately. For Fiscal Year 2017, 75% of all tollroads reporting a five year trend showed positive net income.
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.
Risk Perception of State and Local Government Debt May Stress Taxes and Leverage Without a Certainty of Payment – Use of Statutory Liens, Special Revenues and Other Means of Assurance
By James E. Spiotto
Fiscal distress of or perception of risk of nonpayment by government begets higher cost of borrowing and even loss of access to the market
The perception of fiscal distress leads to higher interest rates (cost of borrowing) in the global markets:
- On March 2, 2012, Greece had a ten year bond annual yield of 37.1% and in July, 2015, after the third attempted bailout and austerity package being implemented, Greece’s annual yield is still over 10.5% with a 52 week range of 5.5% and 19.5%.
- Since 1826, Greece has defaulted on its sovereign debt since 1826 at least five times prior to its recent financial crisis (1826, 1843, 1860, 1894 and 1932).
- Brazil, a large developing economy which defaulted or restructured its sovereign debt eleven times since 1826, the last time in 1990, had an average ten year bond annual yield between 2006 and 2015 of approximately 12.3% with all time high of 17.91% in October, 2008.
- Puerto Rico, given its recent financial distress experience, had yields on its ten year G.O. bonds exceeding 10% in February, 2014.
- At the same time, other sovereigns experienced unusually low bond annual yields of 2.27% for U.S.A., 1.52% for Canada and 1.03% France.
- A review of the adverse effect of state and local governments trying to balance the budget by defaulting or devaluing the currency has been met with harsh consequences, and the inability to pay due to financial distress, which is understood by the market, raises borrowing costs and could even deny market access.
The 200-300 basis point spread between strong and weak credits. Traditionally, the spread in the municipal market between strong credits (top investment grade) and significantly weak credits (lower non-investment grade) was 200-300 basis points. (See e.g., approximate 200 basis point trading spread between Detroit sewer and water with and without Chapter 9 threat and Chicago sale tax securitization approximate 275 basis point lower than similar Chicago maturities.)
Cincinnati — Taking a Look at One City’s Approach to Alleviating the Burden of Pension Legacy Costs
Legacy costs, especially for mature cities, can carry a long lasting burden on the finances of municipalities challenged by massive unfunded pension liabilities and retiree health care costs. Those cities most affected by these burdens also typically experience high levels of fixed costs required for debt service and OPEB payments in addition to their pension contribution requirements. Measured against their total spending (i.e. governmental activities expenditures), high fixed costs place a squeeze on current tax dollars to cover operations, provide for public safety and the costs to repair and replace infrastructure.
Once they are in place, trying to lower legacy costs by restructuring public pensions can be like moving a mountain whenever benefits and expectations are already locked into the mindset of active and retired employees. The city of Cincinnati serves as a good example of a city that in recent years has tried to tackle the problem. In its case, it took nearly seven years of confrontation and negotiation to make the effort happen.
Cincinnati’s Collaborative Agreement
Out of the city’s four pension plans, the City of Cincinnati maintains one single employer plan, the Cincinnati Retirement System (CRS), which has been in place for the benefit of its employees since 1931. The CRS is the largest of all its plans and the source of the city’s highest unfunded pension liability. The city’s other three plans are smaller liability cost sharing multi-employer plans.
In the aftermath of the credit crisis, subsequent to 2007, it became evident that the CRS pension plan was headed on a serious negative path that threatened to spiral downward. Taking the initiative to stem a potential fiscal crisis, the city initiated negotiations with its unions, which led to a contentious standoff. After nearly five years of litigation to reach a Collaborative Agreement, it took another 15 Months of negotiations to reach a final deal. On October 5, 2015, U.S. District Court Judge Michael R. Barrett granted final approval. Coming to terms was no easy task but the issue gained traction as a recognized crisis when the Governmental Accounting Standards Board’s new accounting rules went into effect in 2015, which required the plan to automatically reduce its discount rate from 7.5% to a blended discount rate of 5.59%. Under GASB’s new pension rules, a reduction in the discount rate is required and triggered whenever the plan’s assets were deemed insufficient to cover all of the plan’s retirement benefits. The net impact of the discount rate change on Cincinnati’s Retirement System plan reduced the overall funding rate to only 57.5% as reported in the 2015 CAFR from 64% in the previous year, a trend that threatened to go even lower in future years.
The agreement that went effective immediately was designed to “share the pain” across all parities with the city making major new contributions and the retirees receiving reduced benefits.
Key actions taken as a result of the negotiation to resolve the $862 million unfunded pension liability were:
- Transferring $200 million from the healthcare trust into the pension system by reducing health care benefits to employees;
- Make a $39.1 million city cash infusion into the pension system;
- Guarantee an employer contribution for 30 years (The City is to contribute 16.25% of payroll into the pension system annually. Historically the contribution rate had been under ten percent within the last 20 years);
- Reduce COLA spending from 3% compound to 3% simple;
- Suspend COLAs for all employees for three years: three years and current retirees did not receive a COLA in fiscal years 2016, 2017, and 2018. All future retirees will not receive a COLA during their first three years of retirement;
- Extend the retirement age and years of service requirement for some current employees
The primary goals of these actions were to: Stabilize the overall financial position of the CRS so that both current and future retirees can expect to receive meaningful and competitive benefits in the future, specifically pension and healthcare benefits. The pension trust fund will be funded at actuarially appropriate levels, with the goal of establishing a projected 100 percent funding ratio in 30 years and remain funded for the balance of the Collaborative Service Agreement (CSA).
The impact of the changes enacted in 2015 were spread out over time and not visibly reflected in the short term. In the city’s most recent FY 2017 audit, the fixed cost percentage share of the city’s ratio of current debt service, contributions to pensions & OPEB to governmental activities expenses, increased from 17.1 % in FY2016 to 36.6% in FY2017. However, the relatively big jump in the fixed cost ratio was distorted by the downward impact on total expenses associated with the Collaborative Settlement Agreement, which effectively cut total expenses by reducing annual contribution requirements related to lower pension and healthcare expenses. The city’s business enterprises also saw their total expenses adjusted to reflect the reduced pension costs as a result of the CSA pension reduction requirements. The net impact of these 2015 changes produced substantial improvement in the plan’s total pension liability as evident in the most recent city audit in which the problematic Cincinnati Retirement System Plan funding ratio took a significant upturn to 74% in FY 2017 from 52% in 2016.
It remains premature to say that Cincinnati has cured its problem with legacy liabilities. What can be said is that it has made major headway to secure a more manageable outlook and a dose of optimism for both its pensioners and its taxpayers.
Michael J. Ross
State General Fund Financial Conditions
The growing recognition of economic cycles and the need for state and local governments to prepare for downturns as well as plan for progress going forward require officials, citizens and investors to remain keenly focused on municipal finance. MuniNet Guide provides commentary on and analysis of the municipal bond markets and trends, public pensions, and the rarely used Chapter 9 Municipal Bankruptcy experience related to extreme cases of fiscal distress.
Municipal Finance – State Financial Conditions: General Fund Median Total Fund Balance as Percentage of Expenditures – FY 2009 to FY 2016 // Median Assigned and Unassigned Fund Balance to Revenues Percentage – 2011 to 2016 (Source: Merritt Research Services)
Most State General Fund Balances For FT 2016 Continue Positive Path
As measured on a median basis, state total general fund balances in relation to expenditures recorded their best end of year operating position since the 2008 credit crisis. The total fund balance includes designated and restricted monies for special reserves and purposes as well as unreserved monies available for any purpose.
The state median for total general fund balance as a percent of expenditures reached 12.2% for Fiscal Year 2016, the highest level in eight years. In comparison, the low point occurred in 2010 after state reserves were tapped to offset lower tax revenue collections.
Merritt Research Services: Benchmark Central
Merritt Research Services provides benchmark median values for municipal credit analysis across 13 different sectors. Freely available and updated regularly.
National Assoc. of State Budget Officers (NASBO)
Professional membership organization for state budget and finance officers that advances state budget practices via research, policy analysis, and education.
Government Finance Officers Association (GFOA)
Mission is to promote the professional management of governmental financial resources by advancing fiscal strategies, policies, and practices.
California Local Government Finance Almanac
Online resource of data, analyses, articles, and issue briefs on California municipal finance, revenues, spending, and governance topics.
Nelson A. Rockefeller Institute of Government, The
Mission to enhance the capacities of state governments and the federal system to deal effectively with the nation’s domestic challenges.