Muni Credit News July 19, 2016

Joseph Krist

Municipal Credit Consultant

ALASKA BUDGET CRISIS REVISTED

Two years ago I had the good fortune to spend time in interior Alaska. The trip gave me an appreciation for its vast scale, unique attributes, and the role of nature and the State in the creation of a unique role for its State government. These are some of the reasons that back in the first quarter of this year we commented on the looming budget crisis facing the State of Alaska in the face of consistently lower oil prices. The state is facing huge ongoing deficits as oil prices remain stubbornly low. This is forcing the State to consider – given its history – radical approaches to manage the state fiscal position going forward in an era of diminished oil revenues.

The State Office of Management and Budget has just issued a report suggesting two potential remedies for consideration by the Legislature. One remedy proposed is the “No Action Plan” and requires a state budget of $1.5 billion revenue. This revenue level assumes an optimistic $55/bbl price of oil, increasing over time to offset production declines.  The other is the “SB128 but No Tax Plan” and assumes a budget of $3.4 billion, $1.5 billion current revenue at $55/bbl plus $1.9 billion, the amount expected if SB128 passes the legislature, but no other revenue measures. State budget reserves will be completely depleted in FY18 without new revenue measures. In FY19, Alaska could be facing these scenarios. 

The budget would be one-third of the current FY17 budget and only one-quarter of the FY15 budget. Most government agency operating budgets would be 10 to 20% of current levels, a level similar to state spending experienced in the late 1960’s. School funding would be reduced to 32% of the current $1.25 billion, dropping to $400 million. Local education employment would fall from the current 24,400 to an estimated 10,000 statewide. The Alaska Performance Scholarship and Power Cost Assistance would end in FY19.

Medicaid and other health formula funding would be reduced by 25% to maintain as much federal coverage as possible. All other health programs would be shut down, privatized, or significantly reduced. These include senior benefits, child care benefits, homeless assistance, victim’s assistance, housing programs, pioneer homes, health clinics, public health labs, etc. Fish and Game, Environmental Conservation, and Natural Resources combined would have $18 million in operating revenue compared to $134 million total in FY17. This represents less than 10% of the FY15 funding level.

Transportation’s operating budget would be less than $40 million compared to the $218 million. Road maintenance and ferry service would end for some segments and be significantly curtailed on others. Many of the 240 state maintained airports would be closed, and the rest would have reduced operations. The legislature would have a budget of $11.6 million compared to the current $64 million 15% of FY15. The current budget is just over $1M per legislator, it would drop to $193,000 per legislator. There would be no ‘on behalf’ retirement payments, no school debt reimbursement, and no community revenue sharing, shifting all those costs to local governments. There would be no rural school construction funding or rural school maintenance.

Most prisons would be closed, and prisoners either released early or send to out of state facilities as a result of funding at 25% of current level. Public safety would be 25% of current level, leaving most areas without trooper presence. The capital budget would be less than $20 million costing the state federal highway match funding. AVTEC and most University campuses would lose all state funding. Any remaining campuses would receive one-third or less of current revenue. Up to 50% of state and university facilities would need to be sold or shuttered. State Library and Museum facilities would operate only at the level that could be sustained by earned revenue and fund raising.

State employment would drop by an estimated 12,000 employees (25,000 total, ~13,000 UGF funded, cut 70% of UGF employees, and cut 25% of state employees on other fund sources due to lack of matching funds). The drop in state and education employment plus the reduction in Medicaid would precipitate significant reduction in health care spending compounding overall state job losses. The amount spent for the Permanent Fund Dividend would nearly match the total state budget.

If the Senate Bill 128 (the Permanent Fund Protection Act) is passed in its current form, state revenue will increase by ~$1.9 billion and provide total Unrestricted General Fund revenues of $3.4 billion. The budget would be 78% of the current FY17 budget and just over half, 56%, of the FY15 budget. Most government agency operating budgets would be cut an additional 25% from the current levels and operate at 40-60% of the FY15 level. School funding would be reduced to 80% of the current $1.25 billion, dropping to $1.0 billion. Local education employment would see 3,000 to 5,000 fewer employees from the current 24,400.

 Medicaid and other health formula funding would be reduced by 10% to protect federal coverage. All other health programs would see an additional 25% reduction, impacting senior benefits, child care benefits, homeless assistance, victim’s assistance, housing programs, pioneer homes, health clinics, public health labs, etc. Fish and Game, Environmental Conservation, and Natural Resources combined would have $100 million in operating revenue compared to $134 million total in FY17. This represents about 59% of the FY15 funding level. Higher fees for permitting and inspections would be expected.

The transportation operating budget would be $163 million compared to $218 million. Road maintenance and ferry service would be curtailed. Many of the 240 state maintained airports would be closed or have reduced operations. The legislature would have a budget of $48.5 million compared to the current $64 million over 60% of FY15. The current budget is just over $1 million per legislator, it would drop to $800,000 per legislator. There would be no ‘on behalf’ retirement payments, no school debt reimbursement, and no community revenue sharing shifting those costs to local governments.

The Alaska Performance Scholarship and Power Cost Assistance would be reduced and eliminated within 5 years. There would be no rural school construction funding and minimal rural school maintenance. Corrections would be reduced an additional 10%. Two or possibly three prisons would be closed and some prisoners would be housed out of state. Public safety would be reduced an additional 10% from the current level, leaving some areas without trooper presence. The capital budget will remain at the minimal level to meet federal highway and other match requirements at $100 million. University funding would be reduced another $80 million likely forcing campus closures and possible divestitures to communities. Some state and university facilities would need to be sold or shuttered. State employment would drop by another 2,000 employees on top of the 2,100 fewer expected by the end of FY17.

Clearly these are worst case scenarios designed to stimulate thought and debate. Many of the contemplated spending cuts would be self-defeating for the State and its economy. We do note that the document does not make any reference  to the State seeking to address its problems on the backs of its bondholders. Perhaps the harsh if beautiful environment and self-sufficient spirit of most Alaskans serve to better focus the mind on solutions in a way that warm tropical winds do not.

CHICAGO RELEASES FY 15 FINANCIAL REPORT

The City of Chicago released its Comprehensive Annual Financial Report for calendar 2015. It includes a huge reported increase($17 billion) in liabilities consisting almost entirely of unfunded liability in the city’s four employee pension funds, covering police, firefighters, laborers and white-collar workers. The increased figure reflects two changes in how the liability is reported. First, it had to report the true shortfall in assets for its pension funds, using real actuarial figures. And it had to reduce the assumed rate of return on pension assets from 7.5 percent to 5 percent, an action that pushed up the unfunded liability.

The number also reflects the impact of the recent Illinois Supreme Court decision overruling, on constitutional grounds, a prior city pension rescue plan that relied on a combination of tax hikes and benefit cuts. The court ruled out those cuts, saying full benefits amount to a contractual promise that cannot be infringed.

There is some good news in that the shortfall between what the city is now contributing and what it actuarially should be contributing is down to the lowest level since between 2006 and 2011, depending on which fund is examined. But the city still isn’t meeting its actuarially required contribution or ARC and won’t fully begin to do so until 2020-22, under the current plans. The funds now have just 20.3 percent to 33.6 percent of the assets needed to pay promised benefits.

On the positive side, the amount of unrestricted cash in the city’s operating fund has roughly doubled in the past year, to $93 million, and that the city spent $106 million less than budgeted in its operating fund. Also, the city has removed all variable-rate and swap debt, but total outstanding general obligation debt rose about $1 billion during the year, to $23 billion.

On balance, there are positive things that stand out. The adoption of more realistic earnings assumptions for the pension funds, the improved ARC shortfall ratio, the reduction of exposure to variable rate risk, and the restraint on City spending relative to budget must be noted. While Chicago has a plethora of problems, lack of understanding on the part of the mayor is not one of them.

PROPOSED TRADING TAX WOULD INCLUDE MUNICIPALS

Municipal bond investors always have to be on the lookout for innocent sounding legislative proposals that target something else but hurt municipal bonds. The latest example is from Rep. Peter DeFazio (D-OR). Last week, he introduced legislation that would levy a 0.03 percent tax on transactions of stocks, bonds and derivatives to discourage speculative financial trading. “The ‘Putting Main Street First Act’ is designed to stop the sorts of high-speed trading that adds volatility to the markets.

According to supporters, a “Wall Street speculation tax” would not only help move our financial markets away from dangerous high-frequency trading, but also raise significant revenue to address unmet needs.” Oh by the way, according to the Joint Committee for Taxation, the tax would raise $417 billion over ten years.

While well intentioned, the tax would, by including munis, be effectively throwing out the baby with the bathwater. “This tax is a great way to raise money for the federal government by making the financial sector more efficient,” said Dean Baker, Co-Director of the Center for Economic and Policy Research. “The cost of the tax will be fully covered by the savings from reduced trading. This means that the ordinary investor will be left unharmed by this tax. The only people who feel the impact will be the short-term traders and the financial intermediaries.” We could not disagree more as it pertains to municipal bonds. Fortunately, DeFazio admits that there is no chance of passage in the current Congress.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

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