Two extraordinary events this past week point to the strength of the municipal market. The positive developments came from New York City and California and had me reading the news twice over.
Moody’s upgraded New York City to Aa1 with the primary rationale that the economic base has become more diverse and the growth has taken place away from financial services. This diversification was taking place well before Amazon decided to depart the scene. In addition, the financials have been well managed despite all of the continuous pressures on the budget.
The other item was the favorable financial overview that is emerging out of California. Having read the California official statements since 1978, it is challenging to recall a time when the financials have looked so good. The Budget Stabilization Account, a.k.a. Rainy Day Fund, is forecasted at $13.535 billion at the end of Fiscal Year 2019 and is forecasted in the Governor’s Budget to increase to $15.302 billion by the end of FY2020. The Multi-year forecast is inclusive of an array of assumptions, forecasts a BSA of $19.371 billion by the end of FY2023.
The latter is subject to all kinds of forces; however, these are impressive numbers to display with reasonable assumptions. In addition, the Safety Net Reserve is forecasted at $900 million and the Special Fund for Economic Uncertainties is forecasted at $3.38 billion at the end of FY2019, which is just months away. The multiple reserves are at a high compared with $144 billion General Fund Expenditures. Net Borrowable Resources are also relatively high at $42 billion, although the amount does fluctuate over the course of the year. Given the strength of the cash position, doing a revenue anticipation note borrowing is something of the past. Even more impressive is the paying down of borrowing from other funds that was done in more challenging times. One has to conclude that the trajectory for ratings in the near term is in an upward position.
Does this mean that there are no factors that may detract from such impressive performance? Of course, there are multiple considerations in this regard. One only has to look to the considerations of Pensions and other post-employment benefits, OPEBs. Even as contributions have been increased of late, increasing the funding ratio is a long-term goal. The funding ratio for the PERF in California stands at 67.4% in the latest reading. This level is acceptable but can stand to improve over time.
But we know that governments do not achieve only according to their financial stability and strength.
Many policy issues continue to be quite challenging, even at a time when the economy is performing so well. Providing for housing and the homeless have been policy goals in both jurisdictions for quite some time. The housing supply and demand imbalance has been particularly distressing in California. Even with attempts to max out on all available housing programs, more units need to be built. The fact that the economy is so strong exacerbates the problem. There are regional differences across the state especially in land costs, but, on average, units are relatively expensive to deliver.
We can add to the list of needed improvements a whole array of differing project areas. Among them are cybersecurity, climate change, transportation, and the list goes on.
We thought by now that we would have more to analyze on infrastructure funding. We remain hopeful but in the absence of any federal changes, states and localities are contemplating in a very deliberate fashion in engaging in more P3 projects. The recent Kansas City airport project is just one example.
Returning to the financial strength theme, I have been cogitating on how close are we to the peak in financial performance.
There is no evidence that we are there yet but we are starting to receive some indications. Quite a few jurisdictions are reporting the underperformance of income tax collections. The root cause has been blamed to a large extent on the Tax Reform. There is no question that taxpayers who could take various actions to shift income and to time the recognition of capital gains on an optimal basis have done so. Whether this phenomenon is a one-time factor or will be ongoing remains to be seen.
The economy continues to perform well with unemployment at or near record lows and income growth accelerating at a somewhat better pace than the last few years. Both of these factors bode well for state and local governments. However, the Federal Reserve shifted to a pause from its tightening path out of concern to not tip the balance.
It would appear that if the equilibrium is to be disturbed, it will probably emanate from global events and forces and not from domestic factors at this time. The calls for recession in 2020 or 2021 are ringing a bit hollow. Perhaps, the economy can keep expanding without a sharp economic event. Nevertheless, I applaud the governments that they are discussing recession in their risk sections and they are taking steps to prepare. Building reserves and balances to record levels is a great first step.
We should enjoy the benefit of the current financial prowess where it exists and value the same. Spreads may be driven even tighter in our low-interest environment.
We are just girding ourselves because we appreciate that the current peak in financial strength that we are presently benefiting from has some probability for change in the intermediate range.
