WASHINGTON - The National Association of State Treasurers' priorities include maintaining the tax- exempt status of municipal bonds, preventing local government investment pools from being hurt by money market mutual fund reforms, and helping to develop criteria under which munis could be considered high-quality liquid assets, said its incoming president, David Lillard. Lillard, Tennessee's treasurer, was elected NAST's 2015 president on Monday at the group's conference in Mackinac Island, Mich. He is currently NAST's senior vice president and will take over as president in January.
He told The Bond Buyer about NAST's goals in a lengthy interview prior to the conference.
NAST will amplify its efforts to highlight the importance of tax-exempt bonds for state and local governments as the new year and the start of the next Congress approach, Lillard said. Tax reform could be a topic that Congress takes up in the next session, which begins in January, he added.
In order to achieve certain goals of tax reform, such as lowering marginal tax rates and simplifying the code, Congress will have to alter or eliminate many tax preferences known as tax expenditures.
The muni exemption is one of those expenditures and could be at risk. Some members of Congress and President Obama have already released proposals that would hurt the muni exemption. President Obama's budgets for the past few years have included proposals to cap the value of the exemption at 28%. House Ways and Means Committee chairman Dave Camp, R-Mich., released a tax-reform proposal in February that would both cap the value of the exemption at 25% and prevent private-activity bonds issued after 2014 from being tax exempt.
During the process of working on tax-reform legislation, Congress will have to prioritize expenditures and look at what best serves the public. Tax-exempt munis are an important source of financing for infrastructure, Lillard said.
"Municipal bonds serve an integral role in infrastructure finance in America, and for that reason among others, NAST believes they're vitally important," he said.
The treasurer also warned that issuers' borrowing costs would be higher if the muni exemption was curbed. State and local governments' borrowing costs would have increased by about $173 billion from 2003 to 2012 if the 28% cap had been in place during that time period, according to a 2013 report from several state and local groups that used estimates from the Securities Industry and Financial Markets Association.
"Limited resources in government, particularly state government and local government, are an issue at all times," Lillard said, so higher borrowing costs "would have to be borne either through reduction in the amount of infrastructure constructed, or by increasing taxes at the state and local levels, which I think would be counterproductive."
Another priority for NAST is to work with the Governmental Accounting Standards Board in hopes that it will clarify its rules in a way that allows local government investment pools to continue to use accounting principles consistent with a fixed share value in the wake of the Securities and Exchange Commission's money market mutual fund reforms. NAST and the National Association of State Auditors Comptrollers and Treasurers have created a working group to develop proposals that they hope the GASB consider.
The MMF reforms, which the SEC adopted in July, require institutional funds to adopt a floating net asset value and this would indirectly affect LGIPs because they are similar to MMFs and GASB requires money market-like funds to be governed by MMF rules in order to use accounting methods consistent with a fixed share price. NAST has previously said the reforms would damage LGIPs. Many states, including Tennessee, prohibit local governments from investing in vehicles with a variable share price.
"[LGIPs] are the places where local governments invest their short-term money, and in Tennessee, it's a very integral part of our system of assisting in local government finance in the state, and that's true in many states as well," Lillard said.
Last week, the Federal Reserve adopted a rule that would require large banks to maintain a certain ratio of high-quality liquid assets to total net cash outflows. Under the rule, which will go into effect on Jan. 1, munis do not qualify as HQLA. But the Fed's staff is working on another proposal to consider some munis as HQLAs.
"We hope to work with the staffs of the fed and other agencies to develop criteria under which at least some of the municipal bond issuances would be considered for liquidity status," Lillard said. The agencies have not said what criteria they plan to prioritize specifically for munis, but NAST contends that many of the criteria for HQLA mentioned in previous announcements would apply to some munis. These include low risk of default, limited price volatility and sufficient volume.
Issue Price, Infrastructure and BABs
Lillard previously was chair of the State Debt Management Network, an affiliate of NAST. The SDMN was one of the many groups that told the Treasury Department and the Internal Revenue Service last year that its proposed issue price rules are problematic.
Under the current rules, the issue price for each maturity of bonds publicly offered is the first price at which a substantial amount of the bonds is reasonably expected to be sold to the public, with substantial defined as 10%.
However, the proposed rules would eliminate the reasonable expectations standard and instead base the determination of issue price on actual sales of the bonds. They include a safe harbor under which the issue price would be the price at which the first 25% of the bonds are actually sold to the public. Market groups have said that a move to an actual sales approach would be unworkable.
"I think it's good that [Treasury and the IRS are] taking time to look at the substantive issues involved and the points that have been raised, and hopefully engaging in a consultative process going forward about that issue," he said.
State treasurers are also concerned about transportation. In July, Congress passed legislation to keep the federal Highway Trust Fund, which reimburses states for transportation spending, solvent through May 2015.
Lillard said he thinks the short-term extension was helpful, but that NAST wants Congress to start working now on a solution that will sustain the HTF for the long term. Congress should do their research and consult with market players to find a solution that is workable, he said.
Senate Finance Committee Chairman Ron Wyden, D-Ore., has suggested that he wants to revive the Build America Bond program to stimulate infrastructure investment. The BAB program allowed state and local governments in 2009 and 2010 to issue taxable bonds and receive federal subsidy payments equal to 35% of interest costs. But while the program was very popular during those two years, issuers have concerns about reviving the program because the subsidy payments have been reduced since 2013, stemming from federal spending cuts known as sequestration.
While there are many people, including some state treasurers, who continue to support BABs, "the sequestration of the BAB subsidy payment did put something of a chill on people's view of them," Lillard said, and Congress should address that issue if they decide to reauthorize the program.
"For any financing program to work properly, one thing that all parties -- the issuer, the borrower, and market players involved in it need -- is certainty concerning the result," he said. "And if you have a situation where, through sequester or through possible legislative action in the future, key elements of the financing can in effect change, the net borrower costs can change, then that's an issue to be addressed."
Challenges for state and local governments
Lillard, a Republican, was first elected Tennessee state treasurer in 2009 by the state's general assembly.
According to The Bond Buyer's2013 annual review, about $3.56 billion of long-term bonds were issued in Tennessee last year, a figure that includes state and local government issues. A Fitch Ratings study from 2013 found that Tennessee's ratio of debt and pension liabilities to personal income was the lowest of any state.
Lillard became Tennessee treasurer with a background as an attorney and a local government official.
The incoming NAST president holds bachelor's and law degrees from the University of Memphis and a Master of Laws in Taxation from the University of Florida. He practiced law for more than two decades at a regional firm in Memphis called Burch, Porter & Johnson PLLC. During that time worked on mergers and acquisitions, municipal finance, health care finance and related areas.
"Work in programs involving finance is nothing new to me, and being treasurer is something of a natural extension of what I did all those years," he said.
From 2002 to 2009, Lillard served on the Shelby County Board of Commissioners, and was chairman of the board from 2007 to 2008, according to the Tennessee treasurer's office website.
Because of his experience in local government, Lillard came to the state treasurer's job understanding how hard it is to put "the square peg of expenses in the round hole of revenues," he said.
"That's the issue you have at the local government level, is trying to make your revenues and your expenses balance and also supply meaningful programs to citizens," he said.
Dealing with limited resources is also one of the biggest challenges for state treasurers, Lillard said.
"Resources are always in short supply, so it's a matter of being innovative and using ingenuity in terms of designing and also implementing programs that address the needs of the citizens in each state," Lillard said. He thinks NAST should take a greater role in working with treasurers to figure out how to implement programs.
He also wants NAST to work with other groups to educate citizens on retirement readiness and financial literacy. Lillard is chair of NAST's Business Model Working Group, which has proposed financial education partnerships with business entities.
"I think treasurers have an integral and vital role to play in assisting Americans in educating them about retirement readiness and the crisis that faces this country in that area," he said.
Tennessee is in the process of building an approach to retirement readiness education for participants in its pension and deferred compensation plans. The state developed and implemented a financial literacy commission in 2010.
Pension costs are an issue for many states and Lillard said that states are being proactive about managing their plans. "The funded status of defined benefit pension plans has been improving because of the market but also because I think because decision-makers are placing much more management emphasis on them," he said.
Tennessee's consolidated retirement system is 93.6% funded, and the state has funded 11% of its annual required contribution since at least 1972. Still, the Tennessee legislature has enacted pension reforms in the last couple of years.
In 2013, the legislature enacted a new defined-benefit/defined-contribution hybrid plan. Even though the DB pension plan was well-funded, "we felt it was necessary because of various financial issues to change the plan," Lillard said. And earlier this year, the state legislature enacted legislation requiring local governments to fund 100% of their ARCs.
Tennessee officials also are helping to educate local government officials about the new GASB pension standards, which for most governments take effect this fiscal year. The guidance will require state and local governments that offer defined benefit pensions, for the first time, to report a net pension liability in their financial statements.
"[Local governments] don't have the level or sources of information available to them, I think, that a lot of state officials do on how to apply the standards and how to implement them," Lillard said. "From that standpoint, their challenge is higher, and we are attempting in Tennessee to make sure that our local government officials are aware, and that they have information at their fingertips to help them make decisions as they go forward."
