Texas Ratings and Changing Markets GTOT 2016 Winter Seminar Steve Murray Senior Director December 5, 2016 Session Objectives 1. Texas muni bond volume for 2016 2. Recent election results 3. Where is the yield curve heading? 4. New Fitch criteria and Texas rating results 5. Fitch state and local government update 6. Fitch state pension update 7. Dallas pension challenges 8. U.S. infrastructure needs and funding 1 1
Texas Muni Bond Volume History 60,000.00 Annual TX Muni Bond Volume ($B) 1979-2016 50,000.00 40,000.00 30,000.00 20,000.00 10,000.00 0.00 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 2 2016 Texas Muni Bond Activity 1,767 Transactions YTD $51.9 billion total volume on track for a record Refundings and new money transactions running about even Schools are largest component at 32, followed by cities (20) and authorities and corporations (10) Texas ranks 2 nd to California YTD in muni bond volume ($48.4B thru end of October vs. $57.4B in CA) TX and CA have combined for 27 of 2016 U.S. total muni volume 3 2
Low Borrowing Costs Have Spurred Activity Bond Buyer 20-Bond GO Index 4 3.75 3.5 3.25 3 2.75 2.5 2.25 2 4/28/2016 5/28/2016 6/28/2016 7/28/2016 8/28/2016 9/28/2016 10/28/2016 4 Texas 2016 Bond Election Results Summary of elections held on 11/08/2016 Issuer Type Elections Total Propositions Cities 8 $1,767,480,00 0 Counties + Road Dist + Tollway Auth Bonds Carried $1,537,405,0 00 Carried 86.98 8 $445,700,000 $445,700,000 100.00 Jr/Community Colleges Schools 24 $2,861,910,57 7 Water and Special Districts 2 $149,000,000 $149,000,000 100.00 $2,694,310,5 77 94.14 2 $9,220,000 $9,220,000 100.00 Total 44 $5,233,310,57 7 $4,835,635,5 77 92.40 5 3
History of Texas Bond Elections (Amounts Approved--$B) 2007-2016 40,000.00 35,000.00 30,000.00 25,000.00 20,000.00 15,000.00 10,000.00 5,000.00 0.00 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 6 Fitch Tax-Backed Criteria and Texas Ratings Fitch in April, 2016 introduced revised tax-backed rating criteria with the following goals: 1.Communicate Fitch s opinions more clearly 2.Introduce forward-looking tools 3.Continue to apply the analytical judgment that only comes from experience 7 4
Key Criteria Changes Assign issuer default ratings (IDRs). Re-focus four traditional areas of analytical consideration. Publish category specific key rating factor assessments. Recognize more explicitly the strong operating environment for US governments. Consider more consistently a government s independent legal ability to raise revenues and areas of spending flexibility. Evaluate issuer-specific reserve fund adequacy in the context of an individual government s revenue volatility and financial flexibility. Introduce scenario analysis. 8 Assignment of Issuer Default Ratings Assign public IDRs to all state and local general purpose governments IDR represents general credit quality assessment IDR = unlimited tax general obligation (ULTGO) rating No longer a rating distinction between ULTGO and limited tax general obligation (LTGO) ratings IDR facilitates comparison of credit quality among issuers within the sector and across different sectors 9 5
Re-Focus Four Traditional Areas of Analytical Consideration Current Criteria - Attributes Economy Debt and Other Liabilities Finances Management & Administration New Criteria - Key Rating Factors Revenue Framework Expenditure Framework Long Term Liability Burden Operating Performance Fitch will publish rating category assessments for new Key Rating Factors 10 Strong Operating Environment for US Governments Recognition of the core features that credits in the state and local government sector share by virtue of their operation within the U.S. context Most economies within the U.S. are notably strong and supportive of high ratings when considered in a global context Benchmarking highlighted sample credits where we undervalue/overvalue the economy 11 6
Introduce Forward Looking Tools Revenue Sensitivity Tool Generates the cyclical revenue change (expressed as a change in revenues) based on a standard three-year GDP assumption that Fitch will use in scenario analysis. Scenario Analysis Considers issuer specific fundamentals and potential performance under a standard economic stress highlighting how cycles affect individual issuers differently. Revenue Sensitivity Tool & Scenario Analysis Tool work together to highlight how an issuer s financial position can change through an economic cycle and the level of change considered consistent with the existing rating 11/29/2016 12 New Criteria--Six Month Update Thru Oct. 30, U.S. Tax Supported Group has reviewed nearly 600 issuers/ratings: Roughly 80 of rating actions have been affirmations. Upgrades accounted for 15 Downgrades accounted for 5 Texas rating action over the same period has shown similar results: 111 total rating actions 95 affirmations 85 of the total 15 upgrades 14 of the total 1 downgrade 1 of the total 13 7
Fitch State and Local Government Special Report November 2016 Ratings for state and local governments generally remained strong through the Great Recession and ensuing recovery Resilience reflects budgetary flexibility Defaults remain extremely rare for U.S. subnational governments between 1999-2015 just 0.02 Average general government rating in the AA category Since the Great Recession the only Fitch-rated general government defaults were Detroit and Puerto Rico 14 Fitch State and Local Government Special Report November 2016 cont d. Persistent challenges remain: Rapid fixed cost growth Rising healthcare spending Weakening demographic trends Basic infrastructure needs Some state and local governments still struggle to maintain structural balance pensions are acute pressures for some entities Most governments have a strong ability to address budgetary challenges 15 8
Fitch 2016 State Pension Update November 2016 The median combined burden of states debt and pensions measured 5.1 of personal income ID of depletion dates and use of consistent valuation methods are increasing NPL of some systems, while reporting assets at fair market value (vs. smoothed value) is lowering NPL for others State pension metrics will be more volatile based on yearly market value changes; no rating changes expected from new accounting Funded ratios are improving 73.1 in 2015 vs. 70.7 in 2014; actuarial contributions are climbing Low returns and weakening demographics will pressure pension systems over time 16 Dallas Police and Fire Pension System Fitch, S&P and Moody s all recently downgraded the City of Dallas, citing increasing pension pressures. Fitch currently rates the city IDR AA, Negative Outlook. Pension issues exist with both the employee plan and police and fire plan: ERF experienced sizable investment losses, increasing NPL DPFP also experienced investment losses DROP role in DPFP emerged as a significant risk to the plan - No time limit on DROP participation - Generous guaranteed investment return to DROP accounts - DROP accounts represent more than one-half of plan assets - Withdrawal of DROP accounts could result in a run on the bank City voters recently approved ERF plan changes DPFP plan election on hold due to legal challenge 17 9
U.S. Infrastructure Needs and Financing President-elect Trump has sketched out a broad plan for infrastructure project financing $137 billion of tax credits to private investors would leverage $1 trillion of infrastructure investments over 10 years One-time tax of offshore business income at an attractive rate being discussed to help finance National infrastructure bank also being discussed Opinions pro and con surfacing over recent days--final package far from completion 4/3/14 18 People in pursuit of answers 4/3/14 19 10
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