Refundings and low issuance leave Florida with billions in debt capacity
Florida ended 2019 with billions in debt capacity thanks to conservative bond issuance, another year of higher state revenue collections and its continued aggressive focus on refinancings.
The Sunshine State can issue $32.4 billion of bonds over the next decade, although that debt capacity is “a scarce resource and should be used sparingly to fund critical infrastructure needs,” concludes the 2019 Debt Report the Division of Bond Finance released in December.
The 28-page document also reviews vulnerabilities that could affect the state’s triple-A ratings, such as pension liabilities and the need to maintain adequate state reserves.
“We’re really, really pleased with where we are right now from an economic standpoint,” Bond Finance Director Ben Watkins said Monday.
The state’s upward trajectory is set to improve further, he said, because of Gov. Ron DeSantis’ support for reducing investment return assumptions for the Florida Retirement System and for designating $1.4 billion in unspent general revenue for reserves in his fiscal 2021 budget proposal.
“Those are both huge from a credit perspective and a really positive reflection on what to expect from the new administration,” Watkins said.
DeSantis, a Republican, took office on Jan. 8, 2019 after a narrow win over Democrat Andrew Gillum.
From the beginning DeSantis signaled his plans to operate differently from his predecessor, Gov. Rick Scott, particularly with regard to the state’s official policy in recognizing climate change.
Scott, now a U.S. senator, forbade state agencies to utter the words climate change or use them in state agency reports.
On Aug. 1, DeSantis appointed Dr. Julia Nesheiwat as the state’s first chief resilience officer to coordinate a statewide response to prepare “Florida for the environmental, physical and economic impacts of sea level rise.”
Watkins said Nesheiwat’s appointment and the state’s recognition of the need for resiliency is of “immense importance” to the credit markets because of Florida’s susceptibility to rising seas and potentially increased hurricane activity.
“In the credit markets generally it’s a hot topic, something analysts and investors care about,” Watkins said. “If you’ve got a problem then the first step in forming a solution is acknowledging that you have one.”
Although Florida’s new focus on resiliency is important, he said it isn’t mentioned in the annual debt report because it’s a tangential issue unrelated to debt and financial management.
The report is prepared each year for the governor and lawmakers to determine bond issuance plans in accordance with the state’s policy.
The state targets the amount of debt issuance annually based on a ratio of debt service costs to available revenue. Lawmakers plan for a ratio up to 6%, with a cap at 7% that can be exceeded if a fiscal urgency is declared.
Revenues available to pay debt service in fiscal 2019 totaled $42.9 billion, an increase of $1.8 billion or a 4.4% in year-over-year growth.
Refinancings combined with growth in new revenues and future borrowing plans kept the state’s debt ratio to 4.64% in 2019, keeping the ratio below the 6% policy target for a fifth consecutive year.
The benchmark debt ratio is projected to remain consistently below 6% through 2029, according to the report.
“For near term planning purposes, there is approximately $5 billion to $7 billion of net debt capacity available within the policy target over the next three years or approximately $1.5 billion to $2 billion a year over the next three years,” the report said.
About $4 billion of debt is projected to be issued over the next decade primarily for transportation projects, although lawmakers could add to that number during the session that starts Jan. 14.
The state ended a favorable year marked by low interest rates and a “very” strong economy, Watkins said at a Dec. 3 meeting with the state Cabinet, which consists of DeSantis, Attorney General Ashley Moody, Commissioner of Agriculture and Consumer Services Nikki Fried, and Chief Financial Officer Jimmy Patronis.
“With respect to municipal market conditions we have dollars flowing into the space to be invested and we had interest rates that were very low so the combination of those factors has led to very strong demand for municipal bonds and has kept us in the game with regard to our ability to able to reduce our long term costs through refinancings,” Watkins said.
“We have a reduction in the amount of debt we have outstanding because of our limited use of debt to finance the budget and we’ve been able to reduce our cost of the debt outstanding by lowering the interest rate through refinancings and our balance sheet is very well positioned currently,” he added.
In calendar year 2019, Florida issued $1.7 billion in refundings, which saved the state $260 million in interest costs. Over the last nine years, refinancings totaled $16.2 billion, saving $3.2 billion.
From June 30, 2010 to June 30, 2019, total direct debt declined by $7.6 billion, or 27%, because few new money bonds were authorized, according to the debt report.
“So we’re well positioned with debt capacity available to fund critical infrastructure needs,” Watkins told the Cabinet, adding that the state’s ratings still face vulnerabilities because of the state’s pension system funding level and the need to maintain adequate reserves.
Florida finished fiscal 2019 with about $3.4 billion in reserves, an amount that equates to 10.4% of general fund revenues. Fiscal 2020 is expected to end with about $3 billion or 9% in reserves.
“The governor’s budget recommendation sets the right mark at a combined general fund reserve of $3.1 billion so it’s a $100 million increase” proposed for fiscal 2021, Watkins said. “At the end of the day when you look at revenues coming in and expenditures going out that is the bottom line measure that the rating agencies look to.”
Watkins said the state has been fortunate to be able to maintain good reserves to deal with unexpected financial contingencies, primarily in recent years because of hurricanes and funding recovery costs in anticipation of receiving reimbursements from the Federal Emergency Management Agency.
“If we did not maintain adequate liquidity, if we did not maintain adequate reserves, we would not have the luxury of that financial flexibility but it also serves as a cushion against the inevitable economic cycle which will occur,” he said.
“For the last 10 years since the credit crisis, it’s all been in one direction, right, it’s all been up,” Watkins continued. “I’m here to say that even a stopped clock is right twice a day and at some point [the economy] will turn and it’s important that we be well positioned to have adequate resources.”
Watkins said the state’s pension system has about a $25 billion unfunded liability.
“That’s more than the debt we have outstanding,” he added.
Florida had $20.6 billion in direct debt outstanding as of June 30, 2019, a $400 million year-over year decrease, according to the debt report.
In the statewide multi-employer pension plan, Florida’s share of the annual contribution is 20% while the rest is paid by cities, counties, public schools, colleges and universities and special districts.
“With respect to vulnerabilities and progress to be made we’ve been very direct and vocal,” Watkins said, adding that state economists who estimate annual revenues must calculate how much is necessary to adequately fund the pension system using the correct rate of return on investments or discount rate.
Over the last five years, the state has moved that discount rate to 7.4% from 7.75%. For fiscal 2021, the rate of return assumption will be lowered 20 basis points to 7.2%, a move Watkins said was supported by the governor’s office.
“So we are moving in the right direction but we still have more work to be done,” he said. “A reasonable investment return would be an extraordinarily important signal to send to the rating agencies that we understand the magnitude of the challenges and are working to address those.”
The debt report said the state’s investment consultants and actuaries believe that a 6.6% to 6.7% discount rate is more realistic. It also noted that S&P Global Ratings recently published guidance indicating 6.5% would be a sustainable return assumption.
In affirming Florida’s AAA rating on Dec. 19, S&P said the state's use of a 7.4% discount rate “could result in rising pension costs, albeit manageable, over time.” A discount rate of 6.5% would likely result in less market volatility.
“Due to gradual reductions in the discount rate, Florida's pension funded ratio increased to 84.3% in fiscal 2018 from 83.9% in fiscal 2017,” S&P said. “In October, the discount rate was further reduced to 7.2% for fiscal 2021.”
S&P also said pension reform measures instituted in 2011, including requiring employees to contribute 3% of their salaries and extending the vesting period, have contributed to lower growth in Florida’s unfunded liabilities.
Fitch Ratings and Moody's Investors Service also affirmed their triple-A ratings in 2019.