Commonwealth of Virginia

Manju Ganeriwala Treasurer November 12, 2013

Types of Debt
Issuers of Municipal Bonds
States State Authorities or Agencies Local governments: Counties, Cities, Towns, School Districts, Special Districts (e.g. Parks or Utilities) Charitable Organizations: Hospitals and Educational Organizations

Types of Debt
General Obligation Debt: secured by the full faith, credit and taxing power of the issuer. A promise by the issuer to treat the debt obligation as payable from any legally available source. Appropriation-Supported Debt: secured by revenues received as appropriations by the legislative body form general tax revenues and/or revenues appropriated by the legislative body from other available sources of funds. Moral Obligation Debt: backed by the moral, but not legal, obligation of an issuer to appropriate funds in case of default. Revenue Bonds: bonds secured by specifically assigned sources of future income (e.g. sales tax revenues, water and sewer system revenues, toll revenues). Leases/Certificates of Participation: bonds or fractional ownership interests in lease payments made by an obligor, including administrative buildings, correctional facilities and university buildings.
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Types of Debt
Municipal bonds are issued for a variety of purposes
Transportation Environmental Utilities (Water and Sewer, Solid Waste) Power & Gas Utilities Healthcare Higher Education Public Education Housing Tourism & Economic Development

State and Local Governments

State and local governments have a number of connections State funding levels for local governments controlled by the state State legislatures can change laws on government funding, debt issuance or expenditure responsibilities States can provide oversight over the operations of local units States can assist local governments in debt issuance Pooled bond programs can provide local governments stronger credit and more cost effective method of financing projects - for example, Virginia Resources Authority and Virginia Public School Authority

Challenges to Public Finance

The National Economy Federal Fiscal Policy Risk Spotlight on Retirement Liability Financial Market Concerns over Bankruptcy and Default Financing Significant Infrastructure Needs Increasing Regulatory Environment

The National Economy

The U.S. economy has been in recovery for nearly four years
GDP growth has picked up several times only to slow again Slow pace of recovery has left unemployment high and the economy growing below its longterm potential

The slower growth has weighed down government revenue State and local government budgets have been stressed
Unemployment compensation Medicaid Affordable Care Act Sequestration Government shutdown Debt ceiling threat

There are significant risks to continued growth, with federal fiscal policy as the biggest threat

Federal Fiscal Policy Risk

Uncertainties regarding tax reform
Will tax exemption for municipal securities be retained, eliminated or reduced Tax reform discussions have included proposals to establish a 28% limit on the value of deductions and exemptions The result would be a tax on interest from tax-exempt municipal bonds for high-income investors, equal to the investor's marginal tax rate minus 28% Demand for tax-exempt municipal bonds would deteriorate and investors would demand higher yields Estimates of higher yields range from 40 to 75 bps Limited resources are constrained even further ultimately resulting in fewer projects being funded or pressure to raise taxes or make significant budget cuts

Federal Fiscal Policy Risk

Sequestration has led to reduced Federal aid
Certain states and localities could be more vulnerable to the negative effects of further impacts of sequestration

Government shutdown January 2014; Threat of US government default February 2014

States and localities do not know the full impact of the recent government shutdown Fragile recovery could be jeopardized by another round of uncertainty and another shutdown

Spotlight on Retirement Liability

Pension promises are large Investment losses following 2008 are substantial Great recession has caused governments to fall behind in required contributions Developments in Rhode Island, California, Detroit, Puerto Rico and Illinois have focused attention on pension funding Rating agencies increasingly recognize and quantify the extent of unfunded pension and Other Post Retirement Benefits (OPEB)

Financial Market Concerns over Bankruptcy - Detroit

The filing for bankruptcy by Detroit in July 2013 caused concern through the municipal market Detroit is the largest city to have filed for bankruptcy
Detroits filing is an isolated case, few cities have filed for bankruptcy Detroit's fiscal problems are not indicative of the broader municipal credit landscape

G.O. bonds are considered safest types of bonds Detroits emergency manager has classified Detroits G.O. bonds as unsecured
Bondholders could end up with as little as three percent of their face value

The outcome of the bankruptcy process will dictate whether the value of the full faith and credit pledge backing G.O. bonds will be diminished going forward

Financial Market Concerns over Bankruptcy - Detroit

Municipal Market Remains Resilient Despite dire predictions in 2010 of hundreds of billions of dollars in municipal defaults, no rush to bankruptcy Despite some localities in Michigan having to postpone their planned sales in the first weeks after Detroit declared bankruptcy, the localities have since been able to access the market History shows fallout from bankruptcy dissipates quickly
California three high-profile bankruptcies in 2012 but has since recovered with upgraded state credit rating and narrowing yield penalty

Municipals remain the safest security after Treasuries Important to keep that honor Higher yields and tax-exempt status offer more attractive option than cash But follow Detroits case for any change in bankruptcy law treatment of G.O. Bonds

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Financial Market Concerns over Default - Puerto Rico

Concerns of a default by BBB- rated Puerto Rico, which has $52 billion in debt outstanding (about 80% of the territorys GDP) Puerto Rico bonds are exempt from federal, state and local income tax
Widely held in state specific municipal bond funds and also held in many general and high yield municipal funds About 80% of Puerto Rico's debt are held by municipal bond funds At least 5% of the portfolios of 180 mutual funds are in Puerto Rican bonds. Pressure to sell Headline news Increase outflows from municipal bond funds, resulting in general underperformance and wider credit spreads for municipal bonds.

A downgrade or funding crisis could have effects across the municipal market

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Financing Significant Infrastructure Needs

All states are faced with significant infrastructure needs, Maintaining existing assets and building new facilities, Ensure the safety and economic vitality of the state, county, city and region Federal contributions have been reduced and states and localities need to fund a larger share Debt capacity and affordability in conjunction with huge infrastructure needs, forces states to prioritize projects Control debt through annual debt affordability report and debt policies

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Increasing Regulatory Environment

SECs Report on the Municipal Securities Market cited two primary areas of concern:
1. 2. Improve disclosure Improve market structure

SEC seeks to expand oversight of financial statements and disclosure materials Under its existing regulatory authority, SEC is enforcing proper disclosure In 2013, the SEC has issued four cease and desist orders SEC oversight could lead to improved transparency but review could delay transaction and increase legal fees Issuers adopt continuing disclosure policy Will change business practices in the municipal securities business Formalize communications between issuers and underwriters Goal is not to inhibit discussion of ideas and free flow of information

SEC has issued its Final Rule addressing the definition of Municipal Advisor

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Contact Information

Manju Ganeriwala Treasurer of the Commonwealth of Virginia Virginia Department of the Treasury 101 North 14th Street Richmond, VA 23219 (804) 371-6011 Manju.ganeriwala@trs.virginia.gov