State and local governments are getting very little help from earnings on their investments at the precise time they need it most.
Municipalities’ incoming annual reports for fiscal 2009 show a severe decline in investment earnings, especially for states, according to Merritt Research Services.
The culprit is low interest rates. Most states and cities restrict the bulk of their investing to safe short-term bonds, or other products that offer security and liquidity, such as money market funds, repurchase agreements, or commercial paper.
With the Federal Reserve pinning its target for short-term interest rates to zero, these products offer minimal yield.
Commercial paper maturing in three months yields 0.16%, the three-month Treasury bill yields 0.11%, and bank certificates of deposit yield 0.3%, according to the Fed. According to iMoneyNet, the average money market fund yields a record low 0.02%.
Merritt Research Services keeps track of the investment income reported by states and localities.
Richard Ciccarone, director of research at McDonnell Investment Management and Merritt’s majority owner, said the first wave of reports is usually a good indicator for what the overall numbers will be.
With about two-thirds of states having filed their fiscal 2009 comprehensive annual financial reports, the median state’s investment income last year fell 68% to $38.1 million, down from $120.5 million in fiscal 2008 and $162.6 million in 2007.
The figures imply states are earning around 1.5% on their investments, compared with more than 5% the previous two years.
With about a fifth of cities filing their reports, the median city’s investment income halved to $876,000 in fiscal 2009 from $1.7 million in fiscal 2008, down from $2.1 million in 2007.
These numbers reflect the income from all governmental funds, not just general funds.
“Part of the challenge for the investing of unencumbered balances is they have to keep that money relatively short because it has to be liquid,” said John Hallacy, head municipal strategist at Bank of America Merrill Lynch. “Sometimes they have to keep quite a bit of it short, which could clearly reduce returns when short rates are where they are today.”
Hallacy said he has seen some municipalities move into slightly longer-term products to boost yields.
Investment income is not a major source of most states and cities’ revenue.
In fiscal 2008, investment earnings contributed about 0.8% of total state revenue and 2.6% of total city revenue, based on the numbers provided by Merritt.
“It’s mostly a very small part of revenues and, given what’s going on, it’s pretty minor,” said Amy Lasky, managing director at Fitch Ratings.
Still, Ciccarone said the decline in investment income compounds a decline in most other revenue sources and is yet one more worry for municipal credit analysts.
State and local government income-tax receipts plunged 19% last year to register their lowest total since 2004, according to the Bureau of Economic Analysis. Sales taxes shriveled 4.6%.
The investment income figures also help illustrate a clear trend, Ciccarone said — states are burning through their cash reserves to meet expenses.
The decline in investment income was far more drastic for states than it was for cities or school districts.
Ciccarone said this is because states have less to invest because they depleted their cash. That means states have smaller amounts invested, and also that they have to keep those sums in safer, lower-yielding products because they need to ensure quicker access to it.
The median state’s cash hoard is sufficient to cover general fund expenses for 28.6 days, according to Merritt — a severe decline from the 44.2-day median cash stockpile reported in fiscal 2008.
Meanwhile, school districts’ days’ cash on hand actually increased last year, while cities reported a more modest erosion.
New York, the biggest state so far to submit its annual report, earned a 1.7% yield on its investments last year, compared with a 4.5% yield in fiscal 2008.
The state wrung $256 million from its investments, a 74% drop and the lowest sum in at least six years.
Part of the reason is that its invested assets averaged $10 billion for the year, compared with $11.6 billion the previous year.
Texas posted a $2 billion loss on its investments, mainly because of a $2.4 billion loss from the Permanent School Fund.
The $22.6 billion fund is used to help back $50 billion of school district debt. It tends to invest in riskier and longer-term investments than most states do.
Pennsylvania lost $137.8 million on its investments in fiscal 2009.
“In and of itself, it would not be a major issue for our budget,” said Rick Dreher, director of the state’s Bureau of Revenue, Cash Flow and Debt. “Combined with economic losses and lower revenues from income tax, sales taxes, corporate taxes, it was another area of revenue concern.”
Dreher said the state’s investment earnings remain low because it has “significantly less idle cash for investment purposes.”
The $3.2 billion decline in revenue last year “virtually wiped out our cash balances that had been used for intermediate and longer-term investments,” he said.One of the reasons school districts are generally faring better than states is a reliance more on property taxes than income or sales taxes.
Property taxes are assessed on real estate values that are updated infrequently, so many people are paying taxes on valuations conducted before the real estate downturn.
Property tax receipts actually increased 2.7% last year, according to the BEA.
The Los Angeles Unified School District — the biggest school system in the country, with nearly 1,000 schools and 800,000 students — reported a 10% decline in investment income, to $453.6 million, a more mild decline than the ones suffered by many states.
