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State of the States: An Opportunity Foregone

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Each year, as part of our credit process, SNW Asset Management examines a sample of the most investable and relevant 29 states, plus the Commonwealth of Puerto Rico. We do this to assess the states’ fiscal performance and exposure to bonded indebtedness, as well as other liabilities including unfunded pension obligations and “other post-employment benefits” (OPEBs). In fiscal year 2013, our sample states continued to rebound from the recession of 2008-09. Aggregate revenues exceeded aggregate expenditures by greater amounts than in fiscal years 2012 and 2011, and liquidity also continued to improve. The states’ capitalization metrics also recovered. Unfortunately, these states’ fiscal successes did not extend to their debt metrics. Bonded indebtedness was well controlled, but unfunded pension liabilities rose faster than in previous years, even with large gains in the equity markets that are favored by pension managers.

Outstanding bonded indebtedness and unfunded pension liabilities averaged more than 14.8% of aggregate personal income (the annual personal income of each state’s citizenry) in FY 2013, ranging from 3.9% in Tennessee to a staggering 39.9% in Alaska. These are “hard” liabilities that state and local courts are unlikely to allow to be reduced in any substantial way – short of a federal bankruptcy decree. Adding in unfunded OPEBs – which are “softer” liabilities, but liabilities that the states must nonetheless ultimately make good – the sample average rises to more than 19.5% of aggregate personal income. The chart below displays the total of bonded debt plus unfunded pension and OPEB liabilities versus aggregate personal income for each of the states in our sample.

Outstanding bonded indebtedness plus unfunded pension and OPEB liabilities exceed $100 billion in each of 6 states – Ohio ($112 billion), Texas ($137 billion), New Jersey ($175 billion), New York ($231 billion), and California ($324 billion) – and account for 55% of the sample’s total. These are big numbers. Ranked against one another, 18 states do better than the sample average of percent personal income (debt + pension + OPEB), meaning that the states that do worse than the sample average do very much worse. The states that fare worst when liabilities are measured as a percentage of aggregate personal income are, in descending order: New York, South Carolina, Massachusetts, Ohio, New Jersey, Connecticut, Illinois, Hawaii, and Alaska. 

Our bottom line for the states’ debt metrics is that they are accelerating faster than growth in all revenue sources.  As a result, debt metrics are structurally out of balance with the underlying state revenue outlook. What is most discouraging to us is that so many of our sample states – virtually all of them, in fact – did not use the generally benign financial environment in FY 2013 to begin the process of controlling and ultimately reversing the relentless growth of their non-bond liabilities. Ultimately, FY 2013 presented a foregone opportunity to reduce the pace of long-term off-balance sheet liabilities growth and to better align future obligations with a sustainable rate of revenue growth. The strong municipal bond market has masked these problems throughout 2014. If and when market volatility increases, it is likely that investors will discern the strong from the weak, and punish the credits struggling to keep their fiscal house in order. 

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