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Act 37 Covid-19 Debt Cost Reduction Review

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Act 37 Covid-19 Debt Cost Reduction Review ACT 37 COVID-19 DEBT COST REDUCTION REVIEW OCTOBER 2020 October 31, 2020 Dear Honorable Governor Wolf and Members of the Pennsylvania General Assembly: I am pleased to present Pennsylvania Treasury’s COVID-19 Debt Cost Reduction Review for your review and consideration. The report was produced pursuant to Act 37 of 2020, which directed Treasury with the task of providing an analysis of the debt obligations of Commonwealth authorities and related entities and identifying refinancing opportunities that may provide savings. The attached report includes a thorough overview of the recent history of debt utilization in the Commonwealth, an entity-by-entity analysis that both summarizes current debt holdings and identifies refinancing recommendations where appropriate, and a general assessment of Pennsylvania’s fiscal condition – taking into consideration both best practices for state financial management and our performance relative to peer states and 50-state medians. To start, I wish to thank the General Assembly and the Governor for entrusting Treasury with the preparation of this report. Concerns regarding debt management are always prudent, even under ordinary economic conditions. Additionally, I would like to acknowledge Phoenix Capital Partners for their invaluable work on the debt analysis portions of the report, as well as Pew and Mercatus for their insights on how the Commonwealth can both improve its credit rating and position itself to better withstand future economic shocks. The cooperation and insight provided by the Governor’s Budget Office and the Department of General Services was particularly helpful in analyzing the Commonwealth’s use of General Obligation debt. Treasury reviewed over 30 different Commonwealth authorities and related entities that either issue or hold debt, in the process identifying possible opportunities for some of those entities to refinance their debt obligations. Included in this report is a total of seven separate refinancing opportunities to refund approximately $2.4 billion in outstanding bonds which, if pursued under favorable market conditions, could potentially reduce costs by as much as $179.5 million in present value savings. In addition to identification of cost-saving opportunities, Treasury has also included recommendations the General Assembly could consider to both improve our ability to manage debt and increase the likelihood of a credit rating enhancement. Regular debt refinancing is an important action and can yield significant reductions in debt service costs. However, credit rating improvements offer more sustainable and predictable, year-over-year reductions in borrowing costs. While it is clear that this report was written against the backdrop of the COVID-19 economic crisis and the fiscal challenges presented by COVID-19 are themselves unique, it is my hope that this report can be used as an opportunity to begin a more general discussion aimed at addressing the underlying financial challenges facing the Commonwealth. I commend the General Assembly’s search for innovative solutions. Your willingness to thoughtfully review the state’s financial obligations, as well as your openness to suggestions for possible improvement, bode well for our ability to use this current economic crisis as a springboard to a more stable economic and fiscal future for Pennsylvania. These times necessitate a productive discussion on debt management, debt affordability and the overall fiscal health of our Commonwealth. As always, I look forward to being a committed participant in those conversations. Sincerely, Joseph M. Torsella State Treasurer TABLE OF CONTENTS Chapter 1 – Introduction I. Introduction Page 01 II. Scope Page 03 III. Current Credit Outlook Page 03 Chapter 2 – Background I. Legislative Mandate Page 07 II. Identification Process Page 08 III. List of Entities Page 09 Chapter 3 – Overview of General Obligation Bond Debt in the Commonwealth I. Commonwealth Debt Page 13 II. Capital Project Debt Page 14 Chapter 4 – Overview of Short Term Tax Anticipation Debt in the Commonwealth I. Tax Anticipation Note Page 17 II. Short Term Investment Pool (STIP) Page 19 III. STIP Line of Credit Page 19 IV. Recent History of the STIP Line of Credit Page 21 V. Note on the Realignment of Federal Payments Page 23 Chapter 5 – Annual Short and Long Term Debt Supported by State Revenues Page 27 Chapter 6 – Obligation Profiles Page 31 Chapter 7 – Total Debt Obligations I. Debt Outstanding: Measuring Pennsylvania’s Total Debt Burden Page 111 II. Metrics Page 112 Chapter 8 – Debt Affordability I. Pennsylvania Debt Limit/Constraints Page 119 II. Factors Affecting State General Obligation Bond Ratings from Ratings Agencies Page 120 III. Ratings Agency Assessments of Pennsylvania Page 121 IV. Pennsylvania’s Fiscal Strengths and Challenges Page 122 TABLE OF CONTENTS (CONTINUED) Chapter 9 – Fiscal Flexibility I. What is Fiscal Flexibility, and Why Does It Matter? Page 127 II. Pennsylvania’s Fixed Costs Page 127 III. Pensions Page 128 IV. Rainy Day Fund Page 129 V. Consolidated State and Local Debt Metrics Page 130 Chapter 10 – Policy Recommendations Page 133 Chapter 11 – Glossary Page 137 Appendix Page 141 ACT 37 COVID-19 DEBT COST REDUCTION REVIEW Chapter 1 – Introduction Joseph M. Torsella, Pennsylvania State Treasurer I. Introduction The ability to borrow, to access needed capital to fund immediate priorities, is an essential financial tool of any governmental body. Since its early colonial history, Pennsylvania has issued debt to fund such things as frontier outposts, needed militia supplies, early road construction and new public buildings. As a state, the Commonwealth’s practice of issuing tax 1841 PA Revenue Anticipation Note anticipation notes and other forms of general obligation debt continues and has been the preferred means to provide new schools, highways, airports, water and sewer facilities, prisons, court houses and most all other public improvements. Debt is neither a new nor novel practice for Pennsylvania; rather, it is a well-established method by which immediate public needs are funded through short- or long- term borrowing. Throughout the past several legislative sessions, a growing proportion of Pennsylvania General Assembly members have shown interest in measuring the total breadth of debt holdings of the Commonwealth and Commonwealth-related entities. Institutionally, Pennsylvania Treasury’s view has long been that debt is neither inherently positive nor negative, but neutral: when deployed with care and for the right purposes, debt can provide returns for the Commonwealth over the long-run that would otherwise be left on the table, and when deployed badly and for the wrong ends, can worsen fiscal challenges. However, in all cases we acknowledge the benefit of taking stock of the Commonwealth’s entire debt load and presenting it in a clear and objective manner. The primary aim of this report is to provide an unbiased depiction of the total level of debt in the Commonwealth and identify possible opportunities for debt refinance. While the debt burden of the Commonwealth is subject to routine calculation and recalculation, to our knowledge, this report marks the first modern comprehensive analysis that attempts to capture the full scope of debt issuing Commonwealth entities. Each fiscal year, Treasury receives an appropriation to pay debt service on all anticipated outstanding Commonwealth debt. Statistics on the level of General Obligation (GO) Bond debt have been publicly available on the Treasury website since the Treasury Transparency Portal was launched in 2017 (https://patreasury.gov/transparency/index.php), and the level of detail provided and user functionality has increased in subsequent upgrades. Other types of debt information necessary for analysis in this report were not readily available to Treasury prior to the passage of Act 37. 1 The Pennsylvania Treasury, Act 37 COVID-19 Debt Cost Reduction Review: Chapter 1 - Introduction This report should be considered in the context provided by the COVID-19 pandemic and resulting economic recession. Indeed, the formal title for this report is the “COVID-19 Debt Cost Reduction Review.” At the time of writing, Pennsylvania, like many states, is struggling to recover from a downturn similar in scale to the 2008-2009 Global Financial Crisis. The current statewide unemployment rate is slightly above 8%.1 Declines in revenue have been severe, particularly towards the end of the 2019-2020 fiscal year, with April, May, and June revenues below projections by 49.7 percent,2 17.3 percent,3 and 17.8 percent,4 respectively. Decreased revenue collections have caused S&P Global Ratings, in their recent evaluation of Pennsylvania, to estimate that the Commonwealth may need to borrow $4.5 billion of additional liquidity between internal and external sources to cover gaps in revenue during fiscal year 2020-2021 – a figure representing 13.2% of General Fund expenditures.5 At the time that this report is released, Treasury – in coordination with the Office of the Budget and the Office of the Auditor General – will have just days prior executed an agreement to access a private bank line of credit in conjunction with the Treasury Short Term Investment Pool (STIP) Line of Credit to help maintain expenditures of the Commonwealth through the end of the fiscal year. In Pennsylvania, as around the country, the COVID-19 pandemic has created historically unique pressures on state finances that require creative approaches, including new borrowing, to avoid
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