Kelly McGary

Continued Focus on Managementand

Credit Analysis in the Current Economic Climate

Florida Government Finance Officers AssociationKelly McGary, Senior Director

May 31, 2009

April 1, 2009www.fitchratings.com 2

Table of Contents

> 12 Habits of Highly Successful Finance Officers

– Management’s Impact on Municipal Credit Ratings

> Credit Market Discussion


12 Habits of Highly Successful Finance Officers

Management’s Impact of Municipal Credit Ratings


Topics for Discussion

> Credit factors beyond/within a government’s control

> 12 positive management practices

> ‘Worst’ management practices


Factors Beyond Governments’ Control

> Location

– Positives: climate, natural resources, access to transportation, proximity to metropolitan employment centers.

– Negatives: climate, natural resources, access to transportation, proximity to metropolitan employment centers.

> Economy

– Regional/national events.

– Economic development efforts can have an impact, but usually over a long period of time.


Factors Beyond Governments’ Control (Cont’d)

> History

– Why do people live here?

– Political climate of past administrations.

> Other Levels of Government

– State and federal mandates.

– Changes in revenue sharing.


Management as a Credit Factor

> Unlike some other credit factors, management practices are within a government’s control.

> Good financial management helps to offset other credit risks, while poor financial practices keep some ratings below their “natural” level.

> Management practices are often a leading factor in a rating change - up or down.

> Institutionalized policies should be evaluated by objective standards.


The 12 Habits of Highly Successful Finance Officers

> Fund balance reserve policy/Working Capital reserves Very Significant

> Debt affordability reviews and policies Very Significant

> Superior debt disclosure practices Very Significant

> Multi-year financial forecasting Significant

> Interim financial reporting & monitoring Significant

> Pay-as-you-go capital funding policies Significant

> Rapid debt retirement policies Significant

> 5 year CIP integrating operating costs Influential

> Contingency planning policies Influential

> Policies regarding non-recurring revenue Influential

> Financial reporting and budgeting awards Influential


Fund Balance PoliciesVery Significant

> Operating reserves, revenue stabilization or rainy day fund.

> Insulation against unanticipated revenue shortfalls or expenditure increases.

> Working capital in cases of seasonal cash flow.

> Sized according to issuers needs: revenue volatility, seasonality of receipts.

> Fitch looks most positively on policies that are adopted into local law, specify method/level of funding and outline withdrawal and replenishment procedures.


Debt Affordability PoliciesVery Significant

> Indication of management’s focus on long-term financial health.

> Provides necessary inputs to derive realistic capital plan.

> Compliance with state-imposed debt limit is a given.

> Fitch looks for policies that address the debt burden on the tax base, the population, and the budget.


Superior Debt Disclosure PracticesVery Significant

> Revenue bond covenants & coverage.> Details on pledged tax or revenue stream trends.> Internet accessibility to financial statements, budgets, and capital

improvement plans.> Operating fund cash flow.> VRDO’s, swaps & derivatives.> Statistics for enterprises on fees, customer trends, and service

volume trends.


Multiyear Financial ForecastingSignificant

> Provide planning framework for managers and elected officials.

> Anticipate future imbalances between revenues and spending.

> 3-5 years is the norm.

> Specific enough to be the basis for discussion and decisions.

> General enough to accommodate inevitable changes in fiscal/economic/political climate.


Interim Financial ReportingSignificant

> Early warning system.

> Means of communicating with management and elected officials.

> Format for analysis of variances from budget and prior year.

> Details within major revenue and spending categories aid in variance analysis.

> Clearly defined assumptions are important.


Pay-As-You Go Capital PoliciesSignificant

> Reduces fixed debt service costs.

> Can improve financial flexibility.

– Operating funds earmarked for capital projects can be redirected if a budget shortfall occurs.

> GASB 34 may prompt more issuers to adopt pay-go policies to reduce debt.


Debt Amortization PoliciesSignificant

> Life of debt should be less than or equal to useful life of assets financed.

> Rapid amortization reduces duration of fixed cost commitment and frees up capacity for future projects.

> Fitch’s rules of thumb for G.O. debt amortization rate:

– >65% in 10 years considered rapid

– <40% in 10 years considered weak

> Best policies govern structure of debt and are linked to capital improvement program.


Long-Range Capital PlanInfluential

> Widely accepted; absence is notable.

> Five years is the most common time frame - some longer.

> Includes needed projects funded and sources of funding.

> Best plans integrate operating budget impacts and are limited by debt affordability policies.


Contingency PlanningInfluential

> Identify risks inherent in adopted budget and take steps to offset them.

– Economic assumptions

– Internal/external approvals

– Natural disasters

– Voter initiatives on taxes/spending


Policies Regarding Use of One-Time Revenue SourcesInfluential

> Asset sales, debt restructuring, court settlements, tax collection windfalls.

> Use of non-recurring revenues for ongoing expenditures can create budgetary stress.

> From a credit perspective, one-time revenues should be matched with one-time or discretionary spending pressures.


Putting It All Together

> In Fitch’s experience, issuers using financial best practices have fared better.

> Policies that are adopted into local law or are otherwise institutionalized are best.

> Policies can change, but once adopted, fiscal discipline tends to stay.


Worst Practices - Don’t Try These At Home

> Cash basis accounting

> Qualified audit opinion for material weakness

> Deficit financing for 2 of last five years

> Slow debt retirement (< 35% in 10 years)

> Unfunded accrued pension liability (funding ratio < 60%)

> TRANS/RANS growing significantly faster than annual spending

> Debt restructuring that defers > 35% of current debt service

> Over-reliance on non-recurring revenue > 15%

> Aggressive investment policy for operating funds

> Pension contribution deferral in the current budget year

> Budgetary impasse beyond legal completion date

> Lack of Capital Improvement Plan (CIP)

> Excess interfund borrowing, with no capacity to repay in near future


Part II. Credit Market Discussion


Current Credit Concerns for Local Governments

> Broad-based, deep and potential prolonged recession, affecting most regions and economic sectors

– Housing market

– Employment levels

– Retail sales

– Personal income (lagged)

> State aid reductions

> Credit markets

– Debt composition (i.e. auction rate securities, variable rate demand obligations)

– Need to issue/redeem short-term borrowing


Housing Market Metrics

> Price income ratio (PIR) – measures the ratio of median single-family home price to average household income

> Price equalization factor – calculates the amount by which median single-family home price would have to fall to equal the average of the 1990s PIR

> Home price forecasts – five-year forecast provided quarterly by University Financial Associates (UFA) for the 50 states, District of Columbia, and 100 MSAs

> LoanPerformance – Mortgage Bankers Association data on mortgage delinquency and foreclosure trends for states, MSAs, counties, cities, and towns

– Provides detail on subprime ARMs and negative amortization mortgages (“Option ARMs”)


Housing Market Data by MSA (p. 1 of 3)






Mortgage Loan Delinquency Data

0

2

4

6

8

10

12

Delin

quen

t 90+

Day

s or F

orec

losu

re (%

)

0

50

100

150

200

250

% Ch

ange

3Q08 % Change

Appendix 2: All Loans Seriously Delinquent



So What?> Tax base declines in many Florida counties – fiscal year 2008, 2009, expected

for 2010 and uncertain for future years.

> Property tax collection rates

> Save Our Homes often perceived as a hindrance during the boom but provided some taxing margin, or at least a time lag to prepare

> Statutory authority to adjust the millage rate, affording the ability to offset AV declines with rate increases – politically challenging –

> Economically sensitive revenue streams struggling

– Sales taxes

– Tourist development taxes

– Fuel taxes

– Building and Permitting Fees


Credit Market Disruptions> Late 2007-2008: Downgrades of bond insurers and banks> Spring 2008: Auction rate securities

– Failed auctions– Penalty rates– Conversions to VRDOs

> Fall 2008–Present: Variable rate demand obligations– Failed remarketings and bank bonds– Maximum interest rates– Accelerated amortization– Swap termination triggers

> Ongoing: market access issues– Premium rates for all but treasuries– Impaired ability to sell bonds (for new money or to redeem bond anticipation

notes), cash flow notes – Availability of liquidity/LOC’s: Fitch’s 2009 rating outlook for U.S. financial

institutions is Negative


Local Government Response to Economic Downturn> Reduction in capital projects, particularly those funded on a pay-as-you-go basis

> Increases in fine and fee revenue

> Very few cases of tax increases, but base expansion considered

> Hiring/wage freezes

> Elimination of non-essential non-personnel spending

> Use of accumulated reserves in excess of policy floor and other non-recurring funding sources

> Reserve reductions to levels below policy floor

> Furloughs, lay-offs, labor contract renegotiations, core service reductions

> Asset sales

> Increased cash flow borrowing, when available and economical

> Vendor payment deferrals

> Deferrals in pension and OPEB funding


Retaining Strong Credit Quality

> Budget realistically to conservatively

> Formulate “what-if” scenarios and identify contingencies

> Monitor revenues and spending frequently

> Continue long-range financial planning

> Create a rationale for using non-recurring funds for operating expenditures

> Stay within financial policies where possible

> Maximize structural solutions

> Develop a framework for use and replenishment of reserves

> Keep rating agencies informed of significant changes in circumstances

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