Municipal Market Update
May 19, 2015
Table of Contents
1. Market Conditions
2. Green Bonds
3. Pension Funding
1
RBC Capital Markets
Market Conditions
SECTION 1
Macro Market Overview
 Global equity markets came under pressure recently, as concerns over Greece and European peripherals resurfaced
 Greece and its creditors remain at an impasse over austerity measures/fiscal targets as time runs out ahead of debt service payments
 China’s central bank cut reserve-ratio requirements after growth hit the slowest pace in six years
 10yr German Bund closed at a record low yield of 0.077% on Friday; UST10 rallied 8bp last week to close at 1.87%
 Primary supply in municipal market remains elevated, with $9 – 10 billion pricing weekly
 This will mark the seventh week of the year with volume north of $9 billion, and supply is up 81% year over year
 The sheer number of deals pricing in a given week is overwhelming investors; reception for smaller deals has become challenging
 Credit spread widening over the past several weeks has contributed to a neutral tone in the intermediate/long end of the curve
 Investors in the first five years of the curve continue to demand wider spreads, leading to a flatter credit curve
 Lighter economic calendar includes existing/new home sales, durable goods, KC/Dallas Fed indices, and jobless claims
 RBC’s forecast for fed funds liftoff has shifted to September
Ratios Last Week:
Interest Rates Last Week:
UST 5
UST 10
UST 30
MMD 5
MMD 10
MMD 30
3
10-Apr
1.4
1.95
2.58
1.22
1.97
2.84
17-Apr Change (bp)
1.31
-9
1.87
-8
2.52
-6
1.22
0
1.94
-3
2.83
-1
5yr Ratio
10yr Ratio
30yr Ratio
10-Apr
87%
101%
110%
17-Apr Change (bp)
93%
+6 Ratios
104%
+3 Ratios
112%
+2 Ratios
Supply YTD:
$130.2bn vs. $71.7bn last year at this time (+81.4% yoy)
Supply Last Week:
$9.7bn ($7.1bn negotiated + $2.6bn competitive)
Supply This Week:
$9.6bn ($7.0bn negotiated + $2.6bn competitive)
Avg. Weekly Long-Term Supply:
$8.7bn in 2015; $6.0bn in 2014
Visible Supply:
$11.9bn as of this morning
Avg. of past 30 days: $11.7bn
Avg. of past 60 days: $11.0bn
RBC Capital Markets
Increased Volatility is Impacting All Global Markets and Issuers
Most Market Participants Expect Volatility to Remain High over the Near to Intermediate Term
 A number of factors have combined to create increased volatility in all major financial markets:
 Regulatory changes – including increased capital requirements and lower leverage ratios have lowered risk profiles for market participants
 Conflicting central bank strategies – ex. US Federal Reserve and the European Central Bank
 Geopolitical issues impacting exchange rates and the pricing of major commodities such as oil and gas
 The limited ability of central banks to impact intermediate and long-term interest rates without coordinated global action
 Uncertainty regarding the timing of a new US rate increase
 The “MOVE Index” measures volatility in U.S. Treasury Bonds (and by extension the overall fixed income market). The Index is a weighted
average of 1 month treasury options. Increases indicate heightened volatility
 The “Corporate Bond Sector Spreads” chart at right illustrates volatility in corporate bond spreads in March 2015
“MOVE Index” of Treasury Volatility
Corporate Bond Sector Spreads
March 2015
140
120
MBS
100
bps
MTD
Level
80
60
YTD
2014
Change (bps)
20
+1
-8
-7
Financials
118
+ 10
+2
-5
Utilities
122
+ 13
+3
- 10
Covered
40
+ 13
+4
- 30
High Yield
500
+ 24
- 16
+ 105
EM External
410
+7
+5
+ 77
40
20
0
04/12/13
08/12/13
Source: Bloomberg
4
12/12/13
04/12/14
08/12/14
12/12/14
04/12/15
Source: Bloomberg / PIMCO
RBC Capital Markets
Long-Term Market
Market Overview
 Equity markets in U.S. continued moving higher last week, with some
indices, including S&P 500 Index, ending Friday at all-time highs
 S&P 500 Index gained 2% last week, and is up 5% over last two weeks
Municipal GO “AAA” MMD Yield Curve Changes
4.50%
 Market catalysts last week seemed to include cease fire in Ukraine,
decent earnings reports from U.S. companies, and negotiations between
Greece and its creditors
4.00%
 Oil prices gained during the week, a sign some believe that global oil
demand, and by extension global economic growth, is not falling off a cliff
like some believed a few short weeks ago
2.50%
 Concern over oil prices caused Treasury yields to increase dramatically in
previous two week period
3.50%
3.00%
2.00%
1.50%
1.00%
0.50%
0.00%
 On January 30th, yield on 10-year Treasury was 1.67% and 30-year
Treasury was 2.24%
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29
Year
02/13/2015
02/13/2014
 By Friday’s close, yields had increased by nearly 40 basis points on both,
to 2.03% on 10-year Treasury and 2.63% on 30-year Treasury
 Last week of January saw recent lows in price of barrel of oil, with many
claiming that the low price was a function of declining demand
 Since that time, both oil prices and Treasury yields have increased sharply
U.S. Treasury Yield Curve Changes
4.00%
3.50%
 Municipal yields jumped higher again during past week, with municipals
underperforming Treasuries by increasing in yield more
3.00%
 This might have been a catch up to Treasuries, as municipals did not
increase as much in yield as Treasuries the previous week
2.00%
 Municipal yields on Municipal Market Data (MMD) AAA General Obligation
curve increased over 10 basis points for maturities 10 years and longer
1.00%
 This followed a week in which yields were up by more than 20bps for
maturities of 10-years and longer, creating a sharp two-week increase in
yields
0.00%
2.50%
1.50%
0.50%
3 mo
6 mo
1 yr
2 yr
3 yr
02/13/2015
5 yr
7 yr
10 yr
15 yr
20 yr
30 yr
02/13/2014
 Municipal bond mutual funds continued to see strong inflows last week,
although less than previous week
5
Source:
Bloomberg and Thomson Municipal Market Data
RBC Capital Markets
Source:
6
SIFMA vs ICE LIBOR
04/15/2015
01/15/2015
10/15/2014
07/15/2014
04/15/2014
01/15/2014
10/15/2013
07/15/2013
04/15/2013
01/15/2013
10/15/2012
07/15/2012
04/15/2012
01/15/2012
10/15/2011
07/15/2011
04/15/2011
01/15/2011
10/15/2010
07/15/2010
04/15/2010
01/15/2010
10/15/2009
07/15/2009
04/15/2009
%
Short-Term Market
Market Overview
 Short term interest rates remain extremely low
SIFMA vs. ICE LIBOR
300%
250%
200%
150%
100%
50%
0%
Average
Bloomberg
RBC Capital Markets
Tax-Exempt Market Dynamics
Muni Bonds: 2015 Issuance versus Redemptions
$50
Actual Supply
RBC Forecast Supply
Redemptions
Par Amount ($BN)
$40
$30
$20
$10
$0
2013 – 2015 Municipal Weekly Volume
250
4,000
2,000
Oct-14
Dec-14
Sep-14
Aug-14
Jul-14
Jun-14
Apr-14
May-14
Jan-14
Mar-14
Dec-13
Nov-13
Oct-13
Sep-13
Jun-13
Aug-13
Apr-13
May-13
Mar-13
Feb-13
Jan-13
0
100
50
0
Jan-15
6,000
150
Jan-14
8,000
BBB Spread
Jan-13
10,000
A Spread
200
Jan-12
$ millions
12,000
AA Spread
Jan-11
14,000
Basis Point Spread to AAA MMD
Competitive
Negotiated
Average
Jan-10
16,000
Credit Spreads Remain Tight for Highly Rated Issuers
Source: Bloomberg, Lipper and Thomson Municipal Market Data
7
RBC Capital Markets
The Municipal Market Evidences the Current High Level of Volatility
Assessment of Secondary Market Liquidity is an Increasing Investor Focus in Primary Market Purchase Decisions
Macro Municipal Market Factors
Movement in 5 and 20-Year AAA MMD
 In addition to macro-factors causing increased volatility in global
markets, US municipal market has number of additional specific
factors that have increased volatility:
1.50%
5-Year MMD
1.40%
-20 bps
 Consolidation has reduced number of active major and regional
market makers
1.30%
+17 bps
+9 bps
+47 bps
1.20%
 Regulatory changes have reduced liquidity from remaining dealers
-28 bps
1.10%
 Ineffectiveness of hedging strategies as municipal and UST rates
do not move in lockstep
-17 bps
+5 bps
+16 bps
1.00%
-6 bps
 Many typical new issue market participants do not have capital to
deploy in primary or secondary market
 Certain buying classes such as TOBs and rotational accounts have
been negatively impacted by regulatory changes and tighter lending
practices
 Market indexes are not well geared to gauge/consider current
market liquidity level and investor sentiment
0.90%
09/02/14 10/02/14
3.20%
01/02/15
02/02/15 03/02/15
04/02/15
20-Year MMD
3.10%
3.00%
+15 bps
2.90%
 Supply is uneven and periods of heavy supply often create greater
investor leverage in pricing process
2.80%
 Larger dealer positions may negatively impact credit spreads as
they are worked down
2.60%
 Given these factors, volatility in municipal market recently includes
significant credit spread shifts in addition to movement in MMD
2.40%
8
11/02/14 12/02/14
2.70%
-14 bps
-21 bps
-50 bps
2.50%
2.30%
09/02/14 10/02/14
+38 bps
+50 bps
-33 bps
+12 bps
-12 bps
11/02/14 12/02/14
01/02/15
02/02/15 03/02/15
04/02/15
RBC Capital Markets
Current Investor Preferences
Current Volatility Levels Require Strong Pre-Sale Investor Dialogue on Issues
 Insurance companies and bank portfolios have been primary drivers of demand in 15-30 year range
 In many instances, banks and insurers have been willing to purchase sub-5% coupons, reducing an issuer’s TIC
 Bond funds have experienced positive fund flows and remain active throughout yield curve
 Professional retail investors have been reaching further out on yield curve, buying out to 15 years
Buyer Category
1
2
3
4
5
6
7
8
Term / Maturity (Year)
Commentary
9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
Money Market Funds
Active 13 months and in. Main buyers of sealed-bid maturities.
Corporate Cash Managers
Target is 2 years and in; sometimes out to 5 years. Need high-quality paper with
higher yield than agency debt.
Short-Duration Bond
Funds
Target is 5 years and in. Can buy 3-5% coupons.
Are less constrained by deal size than long-end funds.
Municipalities
Inside of 5 years. Need high quality credits.
Can buy 2-5% coupons depending on maturity.
Professional Retail
Target 2-15 years. Need the income and coupon protection of a 5% structure.
Individual Retail
Out to 15 years and select maturities in 20, 25, & 30 years. Not sizable on their own
but will accept lower coupons.
Intermediate Bond Funds
Target 5-20 years. Often need 5% coupons. Can play in middle-market deals when
new-issue volume is light.
Bank Trust Departments
Target out to 8-10 years, where bonds are typically non-callable. Prefer par-ish
bonds.
Insurance Companies
12 to 25 years; Are more dollar price sensitive than bond funds. Often will accept 4handle coupons.
Long-Term Bond Funds
Max yield buyers, focusing on 20-30+ years. More focused on liquidity and deal size
than short/intermediate funds. Minimum 5% coupon.
Relative-Value Buyers
Target 15-20 years. Can buy 4% or 5% coupons.
Most focused on yield and retail arbitrage opportunities.
Bank Portfolios
Target high quality GO or essential service credits. Sweet spot is 20-30 years. Can
buy sub-5% coupons depending on portfolio needs and credit quality.
9
RBC Capital Markets
Municipal Market Fund Flows
Until Fund Flows stabilize, trading in municipal market will remain volatile
According to data from Lipper, for week ended April 15, 2015, weekly municipal bond funds reported $486 million in outflows,
down from previous week’s $33 million of outflows
 Long-term muni bond funds saw inflows, gaining $238 million in the latest week, after experiencing inflows of $227 million in the
previous week
 Four week moving average is currently $(60) million, down from last week’s number of $95 million
Fund Flow ($ millions)
Lipper Municipal Fund Flows
$2,000
$2,000
$1,000
$1,000
$0
$0
($1,000)
($1,000)
($2,000)
($2,000)
($3,000)
($3,000)
Flow Change
($4,000)
($5,000)
Dec-10 Mar-11
($4,000)
4-Wk Moving Avg
($5,000)
Jul-11
Oct-11 Feb-12 May-12 Aug-12 Dec-12 Mar-13
Jul-13
Oct-13 Feb-14 May-14 Sep-14 Dec-14 Apr-15
3/11 3/18 3/25 4/1
4/8 4/15
Period ended April 15, 2015
10
RBC Capital Markets
Comparison of Minimum vs. Current vs. Maximum AAA MMD
2014 & 2015 Comparison
Historical Ten Year Comparison
7.00
7.00
Min
Min
04/17/2015
Max
04/17/2015
Max
6.00
5.00
5.00
4.00
4.00
%
%
6.00
3.00
3.00
2.00
2.00
1.00
1.00
0.00
0.00
5
10
15
20
25
30
5
10
15
20
25
30
Source:
11
Current 2014 & 2015
04/17/2015
Min Max
1.22 0.94 1.34
1.94 1.72 2.79
2.45 2.12 3.50
2.68 2.35 3.89
2.78 2.45 4.11
2.83 2.50 4.20
5
10
15
20
25
30
10 Year
Min Max
0.62 3.97
1.47 4.86
1.80 5.47
2.10 5.74
2.42 5.88
2.47 5.94
Thomson Municipal Market Data
RBC Capital Markets
Current Municipal Market Conditions: “AAA” MMD
After closing at 2.84% previous week, 30-year “AAA” MMD decreased by 1 bp from April 10 – April 17 to 2.83%
Shift in “AAA” MMD Since April 2014
“AAA” MMD January 1, 2007 to Present
4.000%
6.000%
3.500%
5.000%
3.000%
4.000%
2.500%
3.000%
2.000%
2.000%
1.000%
Jan-07
1.500%
Jan-08
Jan-09
Jan-10
Jan-11
10 Yr
Jan-12
20 Yr
Jan-13
Jan-14
Jan-15
Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr
30 Yr
April 3, 2014 to Present
January 1, 2007 to Present
10 Year
20 Year
30 Year
Maximum
4.860%
5.740%
5.940%
Minimum
1.470%
2.100%
2.470%
Current
1.940%
2.680%
2.830%
Maximum
Minimum
Average
10 Year
2.470%
1.720%
2.120%
20 Year
3.330%
2.350%
2.837%
30 Year
3.610%
2.500%
3.072%
Shift in 30-year "AAA" MMD
2008
2009
2010
2011
2012
2013
2014
0.790%
-0.900%
0.520%
-1.130%
-0.740%
1.330%
-1.340%
Source: TM3, Thomson Reuters
10, 20, and 30 year “AAA” MMD shown to represent different average lives of municipal transactions
Rates as of April 17, 2015
12
RBC Capital Markets
Bond Buyer 20 General Obligation Bond Index
54 Year Historical Perspective
% of Time in Each Range Since 1961
Bond Buyer 20 GO Index since January 1961
14.0%
Bond Buyer 20 GO Bond Index
Today's Rate at 3.45%
12.0%
10.0%
8.0%
6.0%
Yield Range
Less than 3.50%
3.50% - 4.00%
4.01% - 4.50%
4.51% - 5.00%
5.01% - 5.50%
5.51% - 6.00%
6.01% - 6.50%
6.51% - 7.00%
7.01% - 7.50%
7.51% - 8.00%
Greater than 8.00%
Total
8.93%
7.02%
11.33%
10.66%
14.86%
10.34%
8.01%
7.31%
6.60%
3.88%
11.05%
100.00%
4.0%
2.0%
0.0%
Source: Bloomberg as of April 16, 2015
Weekly yields and indexes released by the Bond Buyer. Updated every Thursday at approximately 6:00pm EST. 20 Bond General Obligation
Yield with 20 year maturity, rated AA2 by Moody's Arithmetic Average of 20 bonds' yield to maturity.
Today’s 3.45% level is lower than 91.74% of historical rates since January 1961
13
RBC Capital Markets
Bond Buyer Revenue Bond Index
36 Year Historical Perspective
% of Time in Each Range Since 1979
Bond Buyer Revenue Index since September 1979
15.5%
Bond Buyer Revenue Bond Index
Today's Rate at 4.18%
13.5%
11.5%
9.5%
7.5%
Yield Range
Less than 3.50%
3.50% - 4.00%
4.01% - 4.50%
4.51% - 5.00%
5.01% - 5.50%
5.51% - 6.00%
6.01% - 6.50%
6.51% - 7.00%
7.01% - 7.50%
7.51% - 8.00%
Greater than 8.00%
Total
0.00%
0.00%
4.31%
13.52%
21.98%
13.47%
9.11%
3.83%
6.73%
5.39%
21.66%
100.00%
5.5%
3.5%
Source: Bloomberg as of April 16, 2015
Weekly yields and indexes released by the Bond Buyer. Updated every Thursday at approximately 6:00pm EST. 25 Revenue Bond
Yield with 30 year maturity, rated A1 by Moody's and A+ by S&P Arithmetic Average of 25 bonds' yield to maturity.
Today’s 4.18% level is lower than 99.46% of historical rates since September 1979
14
RBC Capital Markets
Green Bonds
SECTION 2
Municipal Green Bond Issuance
Overview, Proceeds, Principles and Certification
Green Bonds: Definition
 Green Bonds are standard bonds dedicated to financing projects with clearly identified environmental and climate benefits
Green Bond Use of Proceeds
 Green Bond Principles (GBP) recognize broad categories of Green Projects:
– Renewable Energy
– Energy Efficiency (including efficient buildings)
– Sustainable waste management
– Sustainable land use
– Biodiversity conservation
– Clean transportation
– Clean water and/or drinking water
Green Bond Principles and Certifications
 GBP recommend that all designated Green Project categories provide clear environmental benefits that can be described,
assessed, and quantified
 For buildings, LEED (Leadership in Energy and Environmental Design) Certification generally achieves Green Bond criteria of
being in top 15% of energy efficient buildings
– Must be approved by U.S. Green Building Council, which assigns points to projects based on levels (Silver, Gold, and
Platinum) of achievement in improved environmental performance
16
RBC Capital Markets
Municipal Green Bond Issuance
Green Bonds Have Risen to Prominence in Municipal Sector
 15 Series of Green Bonds have been issued since June 2013 by:
– Water and Sewer issuers such as City of Venice, FL, District of Columbia Water and Sewer Authority, East
Central Regional Wastewater Treatment Facilities Operations Board (Palm Beach County), The
Metropolitan District, Hartford County, Metropolitan Water Reclamation District of Greater Chicago
– Higher education institutions such as MIT, University of Cincinnati, and Indiana University
– State-level issuers such as California, Indiana Finance Authority (SRF), NY Environmental Facilities Corp and
Massachusetts
 Total par amount of $2.3 billion
 In corporate bond market, Green Bond issuance was $36 billion in 2014, $14 billion in 2013 and $2 billion in 2012
Green Bonds Designation Implies Commitment to Environmental Standards
 Use of Green Bond proceeds have clearly stated environmental benefits
 Green Bond issuers may have reporting requirements on use of proceeds
17
RBC Capital Markets
The Bond Buyer: Green Bond Funds Take Interest in Municipals
 On September 16, 2014, The Bond Buyer published article titled “A Flood of Green Debt Stands Out”
 According to article, muni managers are turning to Green Bonds to meet rising demand from investors
 Municipal green bonds account for 1.83% of Standard & Poor’s Green Bond Index
 Fund managers have found that interest in green funds is generally result of investors motivated by desire to promote
conservation or help offset global warming, not just prospect of earning a return
 No green bond funds have yet been devoted entirely to municipal debt – the ones in existence include corporate and assetbacked bonds
 Municipal issuers recently issuing green bonds have been able to attract new investors to their credit, and in some cases,
municipal bonds as a whole
 Bond funds have also been able to increase and diversify the type of investors in their funds by going green
 Green Bond funds have attracted new investors without outperforming benchmark municipal or corporate bond funds with
similar maturities
18
RBC Capital Markets
Pension Funding
SECTION 3
Rating Downgrades and Outlook Changes Increasingly Driven by Underfunded Pension Levels
Issuer
City of
Chicago
Rating Agency
Moody's
Fitch
S&P
Date
Rating Action
02/27/2015 Aa3 before 7/17/13,
downgr to Baa2 by
2/27/15
11/08/2013 AA- to A- (neg)
09/13/2013 A+ (outlook revised
to neg)
Rating Commentary
Baa2 GO rating incorporates expected growth in already highly elevated unfunded pension liabilities and continued growth in
costs to service liabilities, even if recent pension reforms proceed and are not overturned in legal appeal.
Pension concerns overshadow recent improvement in other aspects of city's credit profile.
Outlook change reflects view of risks involved in how city will address upcoming, large pension payments.
Wayne
County (MI)
Moody's
02/06/2015 Baa3 to Ba3 (neg)
Pennsylvania
Moody's
Fitch
Expectation that large and growing pension liabilities coupled with modest economic growth will limit ability to regain
07/21/2014 Aa2 to Aa3 (stable) structural balance in near term
09/23/2014 AA to AA- (stable)
Funding levels of pension systems have materially weakened as result of annual contribution levels well below actuarially
determined annual required contribution (ARC) levels
New Jersey
Moody's
S&P
05/13/2014 Aa3 to A1
04/09/2014 AA- to A+
Combined with sluggish economic recovery and ongoing pressure of statutorily scheduled pension contribution increases,
state will be challenged to restore its weak liquidity position.
Future pressures include growing debt, pension, and other post-employment benefit (OPEB). Debt and Liability profile is 3.8
on scale of 1 to 4 (4 being weakest).
Kansas
Moody's
04/30/2014 Aa1 to Aa2
Pension under-funding remains a significant challenge for state.
A- (outlook revised
to neg)
Ba3 rating also incorporates weakened economic environment that we expect will continue to limit prospects for revenue
growth, as well as above average exposure to unfunded pension liabilities.
Pension funding levels overall are weak, with firefighter plan severely underfunded. City has contributed less than required
amount to fire plan in recent years due to litigation and concerns about plan administration, but has been ordered to resume
full contributions.
New Orleans
Fitch
09/30/2013
Omaha (NE)
S&P
09/13/2013 AAA to AA+ (stable)
Jacksonville
Fitch
08/27/2013
AA (outlook revised Negative Outlook reflects uncertainty as to how city will resolve large unfunded pension liability and rapidly rising pension
to neg)
contributions.
Cook County
(IL)
Fitch
07/24/2013
AA- (outlook revised Overall debt burden is moderate; however, unfunded pension liabilities are concerning, and statutory framework of annual
to neg)
funding remains significantly lower than actuarial funding requirements.
Tucson (AZ)
Moody's
05/29/2013 Aa2 to Aa3 (stable)
Outlook takes into account that city will continue to be challenged to improve overall financial position given trend of growing
pension and OPEB costs and increased mass transit subsidies.
Fulton County
(GA)
Fitch
04/19/2013 AA+ to AA (negative)
Partially influenced by annual pension contributions which have increased $11 million or 33% since 2008. This will likely
continue to consume higher proportion of resources given retirement system's weak funded ratio.
Kentucky
S&P
01/31/2013
Outlook revision reflects our concern over pension funded levels, which have declined and are likely to continue declining due
AA- (outlook revised
to lower-than-actuarially required funding of pension liabilities and budgetary pressures associated with funding postto neg)
employment.
Kansas City
(MO)
Fitch
03/01/2012
AA (outlook revised Included among key drivers for outlook revision is that in aggregate, city has not made full annual pension cost (APC) to
to neg)
pension plans for at least past six years.
Overall, S&P does not view city's pension reforms to date as sufficient to address weak funded position of pension plans,
particularly given management's expectation that plans will not be fully funded for another 45 years.
Rating agencies have increased emphasis on pension liabilities when rating an entities’ credit
20
RBC Capital Markets
Recent Pension Reform Efforts
California and Illinois continue to try to alter pension systems
California
Illinois
 Governor Jerry Brown signed pension reform bill on
September 12, 2012
 Pension overhaul delivered December 3, 2013 estimated to trim
$160 billion off state payments owed to system, with goal of
reaching fully funded status in 30 years
 The California legislature previously passed pension reform
measure, Bill AB340, on August 31, 2012 with strong
bipartisan support
 California’s pension reform includes:
 Retirement age: Raises retirement age to 67 from 55 for
most new employees to get full benefits, and 57 from 50
for new public safety employees
 New formula: Changes benefit calculation formulas for
new employees
21
 Changes will reduce $21 billion of state's unfunded liability and
$1.5 billion from upcoming annual payments
 Illinois’ pension reform includes:
 COLA: Reduces annual cost-of-living increases for retirees
 Retirement Age: Raises retirement age for workers 45 and
under
 Salary Based: Limit on pensions for highest-paid workers
 401(k): Employees will contribute 1% less out of paychecks,
while some will have option to contribute to 401(k)-style plan
 Pension caps: Caps benefits for new public employees
who make more than $110,100; or those who make more
than $132,120 but don’t get Social Security
 Benefit Calculation: Caps salary level for pension calcuation
and raises retirement age for younger workers, in some cases
by five years
 Spiking: Eliminates pension “spiking,” or inflating salary in
years before retirement to increase pension
 State Involvement: Increase state payments into system by
$60-$70 billion
 Double dipping: Eliminates most double dipping, or
drawing pension while working another government job
 On December 10, 2013, S&P improved outlook on A- Illinois GO
bond rating to “developing” from “negative”
 Felons: Forbids felons from collecting pensions
 Illinois short term bonds traded 10-15 basis points lower during
week after overhaul (December 9-13, 2013)
RBC Capital Markets
Rhode Island Example
Renegotiated Reform could preserve most of $4 billion UAAL reduction over next 20 years
Pre-reform Situation
Initial Reform
Renegotiated Reform
 UAAL of $7.3 billion
 All accruals through July 1, 2012 preserved
(including accumulated benefit multiplier)
 Settlement announced on Feb. 14, 2014,
scales back some provisions of Rhode
Island Retirement Security Act, a 2011 law
that reduced benefits for active employees
by shifting to hybrid system combining DB
and DC plans and limiting COLA for
retirees
 Funded ratio of 47%
 Exponential increase in ARC
 Projected insolvency of plan
 Pressure on General Fund and
Taxpayers
 Economic and tax revenues lagging
region and US
 COLAs suspended until solvency reaches
80%, then subject to excess 5-year
annualized return over 5.5%, with cap of 4%
and only apply to first $25K of benefit
 Retirement age increased proportionately (but
accruals preserved through July 1, 2012)
 New State Treasurer, New Governor
 Reduced definition of salary and averaging
period (3-5 years) but preserved minimum as
calculated on July 1st
 Required education and public
relations campaign on crisis at hand
 Reduced benefit multiplier accruals beginning
July 1 (to 1% in most cases)
 Reality check with Legislature about
effect on current and future budgets
 Mandatory conversion to hybrid plan for new
and existing employees, reduced version of
existing defined benefit with new defined
contribution with employer matching
 Employee contributions remain constant, but
now broken down among plans
 Reduced UAAL to $4.3 billion (funded ratio
now 60%) and amortized from existing 19 to
25 years
 Current employer contribution reduced from
$689 to $384 million to DB and $30 million to
DC for FY13, with lower future trajectory
 Pension benefits to be calculated based on
both inflation (CPI) and pension fund’s
investment returns
 On April 2, 2015 settlement was reached
resolving 6 out of 9 lawsuits against
reform and locking in 90% of reform’s
savings
 Settlement must be implemented by May
18, 2015
 Proposed agreement favors veteran
employees: reduce retirement age for
many current workers to 65 from 67,
increase frequency of COLA, and restore
traditional DB plan for workers with 20
years or more
 Would give employees 2% COLA after
legislation passed and then one every four
years until system 80% funded
 Increases tied to mix of fund
performance and CPI
 Expected savings of $4 billion over long term
22
RBC Capital Markets
Kentucky Example
Multistep reform geared toward ensuring predictability and sustainability
Pre-reform Situation
Key Aspects of Reform
 UAAL of $26.2 billion in 2012, approximately double
annual tax revenue
 New pension plan for anyone hired after January 1, 2014
 Funded ratio of 50%
 Exponential increase in ARC
 Skipping pension payments while local governments
struggling to keep up with their required contributions
 Cities in Kentucky Retirement Systems—such as
Louisville and Lexington—had been making required
pension contributions in full each year
 However, their funding gap continued to grow because
each year state-mandated COLAs were not paid for,
and cost was added to unfunded liability
 From 2006-2011, unfunded COLAs added $1.8 billion
to Kentucky's state and local government pension debt
 2008 pension reform legislation supposed to remedy
system’s gaping funding deficiency, but only after long
ramp-up
 State not required to make full payments until 2024
 Future COLAs have to be paid for before given (instead of occurring
automatically)
 Accompanying legislation passed to raise additional $100 million
annually to help pay estimated $131 million a year to make up gap in
pension contribution
 Commitment to immediately begin paying full amount owed
 New cash-balance retirement plan where new workers accumulate
retirement savings from employer and employee contributions, receive
guaranteed minimum 4% investment return, and retire with lifetime
benefit based on account balance
 New plan also more equitable to short- and medium-term workers by
providing more portable benefit
 New hybrid approach provides more predictable cost structure than
current plan by reducing number of assumptions to accurately project
costs
 Assumptions about employee turnover and salary growth not required
in cash balance plan, because employee benefits accrue smoothly
and are not based on formula
 Similar reform failed to pass with Teachers’ Retirement System this year
Source:
23
The Pew Charitable Trusts, Kentucky’s Successful Public Pension Reform, September 27 2013.
RBC Capital Markets
Pension Funding Bond Issues
PFB Issuances
Issuer
24
Sale Date
Par Issued
Objective
Illinois
Jun 2003
$10.0 bn
Reduce large UAAL; achieve budgetary savings
Oregon
Oct 2003
$2.1 bn
Reduce large UAAL
Wisconsin
Dec 2003
$850 mm
Puerto Rico
Jan 2008
$1.6 bn
Increase funding of closed pension systems with few assets
Connecticut
Apr 2008
$2.3 bn
Reduce large UAAL; implement reforms for COLA calculation
Denver Public Schools
Apr 2008
$450 mm
Chicago Transit Authority
Jul 2008
$1.9 bn
Milwaukee County
Mar 2009
$400 mm
Fund large UAAL and create pension stabilization reserve to absorb
volatility from future UAAL as result of sub-par investment returns
Kentucky
Aug 2010
$468 mm
Refinance Commonwealth loans to Retirement Systems at lower rate
Fort Lauderdale
Sep 2012
$338 mm
Reduce large UAAL; establish ordinance requiring full funding of
benefit enhancements at time benefits granted
Baltimore County
Nov 2012
$256 mm
Fund UAAL created as result of reduced investment return
assumption
Fund UAAL of pension and accrued sick leave (OPEB) plans;
achieve budgetary savings
Reduce UAAL to enable merger into statewide system
Secure reforms negotiated with unions to significantly reduce benefits
and increase employee contributions; also OPEB bond issue to
remove employer obligation to fund retiree healthcare
RBC Capital Markets
State Pension Funding Bond Issuances
8%
10 Year UST
30 Year UST
7%
Kansas
$500 mm
Feb 2004
Illinois
$10.0 bn
June 2003
Kentucky
$270 mm
Feb 2011
Connecticut
$2.3 bn
April 2008
6%
Puerto Rico
$1.1 bn
May 2008
5%
4%
3%
Puerto Rico
$1.6 bn
Jan 2008
Oregon
$2.1bn
Oct 2003
2%
Wisconsin
$800 mm
March 2008
Wisconsin
$1.8 bn
Dec 2003
Puerto Rico
$300 mm
June 2008
Indiana
$184 mm
Dec 2003
1%
Kentucky
$468 mm
Aug 2010
Kentucky
$153 mm
Feb 2013
Jan-15
Sep-14
May-14
Jan-14
Sep-13
Jan-13
May-13
Sep-12
Jan-12
May-12
Sep-11
May-11
Jan-11
Sep-10
May-10
Jan-10
Sep-09
May-09
Jan-09
Sep-08
May-08
Jan-08
Sep-07
May-07
Jan-07
Sep-06
Jan-06
May-06
Sep-05
Jan-05
May-05
Sep-04
May-04
Jan-04
Sep-03
May-03
Jan-03
Sep-02
May-02
Jan-02
Sep-01
May-01
Jan-01
Sep-00
May-00
Jan-00
0%
8 states have issued pension bonds totaling $21 billion since 2000. Several other municipal authorities and cities have also
executed similar transactions totaling over $30 billion during that period.
25
RBC Capital Markets
Issuers Currently Considering Pension Funding Bonds
Other states and cities such as Kansas, Kentucky, Colorado, Jacksonville and Riviera Beach are considering PFBs
Kansas
Colorado
 Kansas lawmakers approved $1 billion pension
funding bond issue to close funding gap in Kansas
Public Employees Retirement System (KPERS)
 State Treasurer issued FA RFP to securitize revenues and issue $4
billion in bonds to reduce unfunded liability for State’s Public
Employees Retirement Association (PERA)
 State has successfully issued pension obligation
bonds in past (2004: $500 million issuance)
 State also considering issuing $8 billion of pension bonds to fund
unfunded liability associated with School Division of PERA
 Bonds expected to be issued in series of $350 $450 million
Kentucky
 KPERS estimates issuance will improve funded
ratio to 66% from 60%
 Kentucky lawmakers considered bill to issue $3.3 billion in pension
funding notes for underfunded teachers' pension plan
 Proposal is attempt to maximize investment
returns and reduce cost cutting pressure on other
programs in State
 The proposal is also backed by State Treasurer
Ron Estes who says “There are pros and cons
to it..[but] it’s a reasonable burden”
 Vice President of Kansas’ Senate states “Pensionobligation bonds, given near historically low
interest rates, are an increasingly good option to
manage debt.”
Source:
26
 Legislation currently being drafted for 2015 session to authorize bonds
 However, bill did not pass and talks on hold
 Bill proposed bonds issued by Kentucky Asset Liability Commission
(ALCO), which has split ratings notched lower than state in part
because notes subject to payments through lease financing
agreements and biennial appropriation by General Assembly
 Moody’s and S&P currently rate ALCO’s appropriation ratings as
Aa2/AA with S&P providing a Negative outlook
 S&P states, “…the negative outlook reflects our view of Kentucky’s
substantially underfunded pension liabilities and the long-term
pressures the state faces unless these are managed.”
Bond Buyer’s “Kentucky Eyes POBs to Fix Teachers' Pension Fund” dated February 18, 2015; Bond Buyer’s “Kansas Lawmakers Approve Pension Bonds” dated April 6, 2015; Wall Street Journal’s “Risky Pension-bond
Strategy Considered in Kansas” dated February 5, 2015
RBC Capital Markets
Points of View When Considering Pension Funding Bonds (PFB)
Economic
 A Pension Funding Bond (PFB) introduces external leverage into funding source for pension plan
Introducing External
Leverage into System
 Bond proceeds are transferred to pension plan for investment
− Bond interest and principal are required obligations of plan sponsor
 PFB proceeds are co-mingled with all other assets of pension fund
Investment
Expectations Based on
Overall Pension Fund
Stronger Funding
Levels Outperform
During Periods When
Investment Returns are
Less than Actuarial Rate
 Investment expectations should be consistent with overall pension fund
 Caution should be taken as to when to invest bond proceeds given potential size of deposit
− Professional investment advisors will likely “feather” in long term investments to minimize
market risks and/or use bond proceeds to pay current expenses without liquidating existing
positions
 Improving funding ratios gives best opportunity for plan to maintain required levels going forward,
reducing volatility and required investment risk
 The more dollars held by plan and invested, the easier to keep funded ratios high, regardless of
investment return
− Even with exceptional returns, it is difficult to shrink unfunded ratios as liabilities grow
− Further action must be taken outside of achieving solid returns
 Plans that meet or exceed their actuarial rate of return can still lose ground
27
RBC Capital Markets
Points of View When Considering Pension Funding Bonds (PFB)
Actuarial
Actuarial Rate Defines
Unfunded Liability
 PFB proceeds are managed similar to all other funds within pension, and assumed rate of return is
actuarial rate for pension
PFB Rate Relative to
Plan’s Actuarial Rate
Creates Value
 As long as bond rate is less than actuarial rate, issuer's net payments to fund pension obligations
(ARC, if any, plus bond principal and interest) will be reduced
PFB Proceeds Have Net
Positive Impact on ARC
and Funded Ratio
 Actual investment results for entire fund over time are important, but impact of introducing PFB
proceeds to reduce or eliminate an Unfunded Liability has net positive impact on funded ratios and
Annual Required Contribution, even if investment returns are below bond rate going forward
28
RBC Capital Markets
Points of View When Considering Pension Funding Bonds (PFB)
Balance Sheet
GASB 68 Potentially
Creates New Blended
Discounting Rate
 If projected contributions are not sufficient to fully fund UAAL over expected term, GASB 68
calculation will cause increase to reported UAAL
 GASB 68 requires discounting future pension liabilities in out years after assumed fund balance falls
below zero at lower of actuarial rate or issuer's long term cost of capital (tax- exempt, high quality
municipal bond rate)
Unfunded Liabilities
May Increase
Significantly With GASB
68
 GASB 68 may impact size of unfunded liability that will be required to be disclosed on sponsor’s
balance sheet
PFB Now Has Greater
Impact on Unfunded
Liabilities
 Issuing PFB will greatly reduce amount of unfunded pension liability required to be disclosed on
balance sheet by immediately improving plan’s funded ratio
29
RBC Capital Markets
Disclaimer
30
RBC Capital Markets