Why municipalities need to create long-term financial plans
Market signals are showing that anyone invested in municipal bonds should be looking at this market very carefully. The Bloomberg Barclays Municipal Bond Index dropped 1.1% in the first three months of 2018. While the decrease may seem small, this is the biggest first-quarter decline in 15 years. Additionally, investors pulled about $830 million out of state and local government bond mutual funds during the week ended April 11, the biggest outflow since January 2017, and the second straight week of investors pulling cash from mutual funds.
Also, because many municipalities rushed to issue debt last year, this year, bond issuance has decreased substantially and is expected to remain at lower levels the rest of the year.
The new federal tax law signed into effect at the end of 2017 has left municipalities scrambling to figure out how much they will have in tax receipts. Moreover, any municipality that did not borrow last year is now confronting issuing debt in a rising interest rate environment. This means that municipalities’ cost of borrowing will be going up, precisely when they may struggle to get more taxes from residents, whose property values may decrease due to the new federal tax law’s limitation on state and local tax deductions.
Local elected officials and municipality personnel increasingly are being asked to do more with less. Unfortunately, most municipalities are used to producing financials and a budget annually, which by the time they are produced and available to residents and investors, the information is already old and not particularly useful. Now, more than ever municipalities should create long-term financial models and plans that are updated frequently with relevant economic and market data. Municipalities are challenged by uncertainties caused by the new federal tax law, rising medical costs and pervasive underfunded pension problems. Additionally, having to operate in a rising interest rate environment and with a potential trade war looming, municipalities need to factor how potential economic, market, or operational risks, such as natural disasters or cyberattacks, could impact their financial stability.
Based on my professional experience working with different kinds of private and public sector entities, having a long-term plan provides a dynamic tool to help organizations preserve assets, identify where they may be funding gaps, and to identify potential income shortfalls. For municipalities specifically, elected officials and municipal personnel should quantitatively determine the priorities of their constituents to help them determine funding needs for infrastructure development or other community priorities, and to identify potential income shortfalls from residential or retail tax payors.
Sharing my view are also international standard setters and state comptrollers. For example, the Government Finance Officers Association of the U.S. and Canada, an important best practices standard-setter for public finance officials, advocates for “long-term financial planning as a highly collaborative process that considers future scenarios and helps governments navigate challenges.” Moreover, the GFOA believes that “long-term financial planning works best as part of an overall strategic plan.” State comptrollers and treasurers also advocate the creation and implementation of long-term financial plans. The Office of the New York State Comptroller, for example, not only recommends that municipalities create a long-term plan to cope with “future stresses,” but also includes on its website a useful manual on how to create a long-term plan.
If you have made it this far dear reader, you can be forgiven for thinking that the above is common sense advice. Unfortunately, very few municipalities in the U.S. have long-term financial models and plans. This is sometimes because of lack of personnel who have the skills to create a long-term financial model and plan. In the U.S., however, often only municipalities that are in trouble are required by state authorities to create long-term financial plan, as was the case with New York City and Stockton, California. Having learned its lesson, Stockton now has a 30-year plan that it uses for budgeting and planning purposes; New York City’s plan has a five-year forecast.
GOVERNING, the U.S.’s leading media platform covering politics, policy and management for state and local government leaders, just published its annual survey "Equipt to Innovate." This survey focuses on seven areas necessary for “having a high-performing government: being dynamically planned, broadly partnered, resident-involved, race-informed, smartly resourced, employee-engaged and data-driven.” Of the 74 top municipalities participating in the survey, only 32% had long-term plans that look ahead by three to five years. I also spoke to a number of municipal ratings analysts who, off the record, told me that in their experience very few municipalities have long-term financial plans in place. Unfortunately, a lack of long-term planning leaves municipalities vulnerable to being more reactive than proactive.
Municipalities may take long term planning seriously if more global ratings analysts speak about the issue publicly. For example, in speaking to Bloomberg Government recently, Standard and Poor’s analyst Kurt Forsgren said: “What bond-rating agencies are hoping to learn and are increasingly asking cities is how cities are approaching long-term planning, both from an asset and revenue-stream perspective.” This is the type of statement that municipal leaders should take note of.
Moreover, I would strongly encourage any investor in municipal bonds to be asking those issuers what their long-term plan for their financial stability is.