PUBLIC
FINANCE
TEXAS YEAR IN REVIEW MUNICIPAL FIN ANCE
SM
ADVANCING PURPOSE IN
PUBLIC FINANCE HilltopSecurities helps communities meet their boldest financing needs.
TA BLE OF CONTENTS
How? By putting 70 years of
1 Foreword
experience to work. By distilling the
2
Market Insights
shared knowledge of a top-ranking
3
Texas Legislative Update
municipal advisory practice. And by
4
2018 at a Glance
leveraging the insight of a national
8
Texas Cities
network of financial professionals
10
Texas Schools
to give you timely market solutions.
12
Arbitrage Rebate
13
Structured Finance
14
Continuing Disclosure
15
Government Investment Pools
16
Municipal Cash Management
We like to think of ourselves as facilitators of bold visions. And we’re honored to work with those who move our society forward.
SM
A M E S S A G E F R O M D AV I D M E D A N I C H , H E A D O F P U B L I C F I N A N C E
Two themes dominated financial headlines in 2018: economic growth and interest rates. What’s interesting is how context and time can change the conversation around these themes. As we roll into 2019, both economic growth and interest rates are at a turning point. Economic growth was substantial in 2018 with one of the most robust expansionary periods in recent U.S. history, though sentiment around the general economy seems to have turned quickly. Will this year see the end of this expansionary period? Will it see the start of a recession? 2019 interest rate expectations changed dramatically in the last months of 2018. Experts predicted additional increases in the federal funds rate, but now forecast none. Some experts think we may even see rates decline in 2019. In 2018, the municipal market saw the lowest issuance volume since 2013. The dominant cause of this drop was the elimination of advance refundings, which have not been this low since 2002, and we expect 2019’s volume to follow suit. However, 2020 and beyond should see growth as a significant number of deals become refundable. Last year was a solid year for bond elections once again, and with long-term interest rates still very low, new money issuance should be strong. This year is stacking up to be full of possibilities and challenges for municipal issuers, and we take great pride in being able to help advance communities across Texas. Yet, to understand the year ahead of us, it’s important to look at the one that came before. We have compiled this Municipal Finance Year in Review to help you do just that, and we hope you find it useful.
MARKET
INSIGHTS Since June 2009, the U.S. has enjoyed the second longest
Below is a chart showing daily treasury rates in December
period of expansion on record, benefitting from steady
2018. The latter half of the month shows an inversion of
growth in a bull market. Despite the good times, experts
the yield curve as the five-year yield drops below the six
warn a recession is imminent. Although headlining economic
month- and one-year yields.
numbers like unemployment, GDP growth and stock market
DA I LY T R E A S U RY Y I E L D S
returns have been relatively strong, several factors signal the
12/1/18 - 12/31/18
risk of contraction in the near future.
3.00
THE 2018 YIELD CURV E 2.90
The yield curve is essentially the difference between longand short-term interest rates on U.S. government bonds.
2.80 Yield (%)
Historically, an inverted yield curve (when short-term yields move higher than long-term yields) has been a very
2.70
2.60
reliable predictor of recessions and is closely monitored by policymakers. The yield curve is a leading indicator
2.50
of the business cycle, and the delay between an inversion
2.40
of the curve and the beginning of a recession has ranged from six to 24 months. The inversion of the yield curve
6 Month Yield
has correctly signaled all nine recessions since 1955 and
1 Year Yield
5 Year Yield
7 Year Yield
10 Yr Yield
Source: www.treasury.gov & Thomson Reuters
has had only one false positive in the mid-1960s, when an
There are plenty of reasons to be confident in the current
inversion of the curve preceded an economic slowdown
U.S. economy: unemployment is low, inflation is under
but not an official recession.
control and growth is strong. However, there is also a key
While historical circumstances differed for each recession,
indicator signaling that we’re nearing an end-of-cycle
the patterns of past yield curve inversions are remarkably
environment. Along with the yield curve flattening and
similar. A pronounced increase in short-term interest rates
inverting in places, trade wars, geopolitical issues and
(which are essentially controlled by the Federal Reserve,
government debt threaten to shock the system and could
or “the Fed�) generally drives the tightening of the curve.
lead to an economic downturn.
Long-term rates typically move much more gradually whether they increase or decrease. Long-term rates also reflect expectations of future economic conditions. While they increase with short-term rates in the early part of an expansion phase, they tend to stop when investors become pessimistic or fearful that a recession is nearing.
page 2
TEXAS L EG I S L AT I V E
UPDATE On January 8, 2019, Texas Legislature convened the 86th
Legislators are currently working on proposals to address
legislative session. State Representative Dennis Bonnen of
this imbalance. Possible solutions proposed include
Angleton was elected to serve as the session’s house speaker.
finding new revenue streams (rather than relying on the
Upon kickoff, Bonnen, Governor Greg Abbot and Lt. Governor
rainy day fund), ending the $59.8 million in current tax
Dan Patrick were in alignment on the session’s highest
breaks1, enacting property appraisal reform and/or raising
priorities: school finance and property tax reform.
existing taxes.
However, the question looming in the minds of lawmakers is
PROPERTY TA X R EFOR M
how will the state pay for these priorities? Governor Abbott
Another high priority for the 86th Legislature is property
has placed the onus on Texas legislators to find funding
tax reform. According to the Tax Foundation, Texas still has
strategies that work for everyone.
one of the lowest state and local tax burdens in the country.
We’ve expanded upon these priorities and how they affect
Currently, local governments are only allowed to collect
municipal finance in Texas.
property taxes, while the State is largely funded by sales taxes. Further, Texas is among seven states that do not have
SCHOOL FINANCE
a state income tax.
Funding strategies for Texas schools haven’t seen major
One plan for property tax reform comes from Governor
reform since 1993. Currently, local property taxpayers
Abbott. Abbott’s proposal seeks to limit annual local
contribute more than half of the funding, the State
governments’ property tax revenue growth to 2.5%. To
contributes a third and the federal government contributes
increase revenue beyond that, governments would need
about a dime of every dollar schools cost.
approval from two-thirds of voters. In addition to his
According to the Texas Legislative Budget Board’s article,
plan, Abbott will prevent the state from passing unfunded
“Fiscal Size-Up: 2018-19 Biennium,” the State spends
mandates down to local governments. Another provision
approximately 6.3% less per student than it was spending
to this proposal would require a supermajority of voters to
in 2010, and its share of public education spending has
approve additional debt.
dropped from 37.6% to 35% of the total projected for the
While this proposal would slow increases in how much
fiscal 2019 budget. The federal share has also dropped
revenue local governments collect, it wouldn’t necessarily
from 16.4% to 9.5% of the total in 2019. The local share
lower individual property tax bills. Under the current law,
funded by property taxes has risen from 46.1% to 55.5%. To
cities, counties and special purpose districts can only
rebalance the State and local shares of public education, it
increase property tax rates if that revenue stream increases
would take an estimated $5.7 billion increase in annual
by 8% or more.
State spending.
Hegar, Glenn. “Tax Exemptions and Tax Incidence: A Report to the Governor and the 85th Texas Legislature.” https://comptroller.texas.gov/ transparency/reports/tax-exemptions-and-incidence/2018/96-463.pdf (accessed January 3, 2019). 1
page 3
2018 AT A GLANCE
T E X A S M U N I C I PA L BOND MARKET DEA L VOLUME BY METHOD OF SA LE
T O TA L PA R A M OU N T I S S U E D 2018
Competitive
2018
$38,563,743,934
2017
$46,251,653,082
2016
$50,311,597,423
2015
$45,104,319,996
2014
$45,248,826,862
576
2017
610
2016
593
2015
615
872
889
430
Source: Ipreo MuniAnalytics
728
Competitive
Negotiated
Source: Ipreo MuniAnalytics.
Source: IpreoMuniAnalytics MuniAnalytics. Source: Ipreo 2018
2018 ELECTION DATA ELECTIONS
Cities
29
Counties + Road Dist + Tollway Auth
3
Hospital Districts
1
Jr/Community Colleges
1
Other
3
Schools
384
516
2014
ISSUER TYPE
Negotiated
101
Water and Special Districts
34
Total
172
576
TOTAL 610 PROPOSITIONS
2017
384
AMOUNT CARRIED
PERCENTAGE CARRIED
615
$ 2,447,680,000
$ 2,289,055,000
817,300,000
817,300,000
800,000,000
800,000,000
162,500,000
162,500,000
100%
2,695,000,000 430
2,695,000,000 728
100%
11,009,331,959
9,971,437,659
91%
4,919,274,688
4,606,019,688
94%
$22,851,086,647
$21,341,312,347
93%
2016
2015
2014
593
516
Source: Ipreo MuniAnalytics
94%
872
100% 100%
889
ISSUA NCE BY TY PE OF DEBT ISSUER TYPE
PAR AMOUNT
PERCENTAGE
$ 1,984,025,000
31%
School District
8,779,051,934
23%
City
7,830,207,920
20%
Other
4,760,650,000
12%
County
3,359,339,000
9%
Special District - Ad Valorem Tax Districts
1,560,470,000
4%
Colleges/Universities
184,485,000
0%
Special District - Incremental Tax Districts
166,765,000
0%
State
Total
$38,624,993,854
Source: Ipreo MuniAnalytics.
page 4
100%
N AT I O N A L BOND MARKET F I V E Y E A R S O F M U N IC I PA L B ON D F I N A N C E 2014 Total
2015
2016
2017
2018
$339,049.8
$397,707.9
$444,799.6
$436,345.4
$338,933.1
11,126
12,989
13,274
11,668
9,402
Development
12,195.6
12,631.1
11,768.2
17,199.1
7,602.2
Education
86,113.4
124,833.3
128,997.1
120,317.1
82,122.8
Electric Power
12,176.8
17,346.5
14,210.0
9,637.7
6,554.3
2,223.1
1,688.4
2,455.7
2,476.4
1,944.1
Health Care
25,604.3
32,975.5
49,592.0
48,890.8
30,965.4
Housing
13,124.9
15,578.0
19,186.5
20,883.6
21,109.3
Public Facilities
10,917.9
11,465.2
9,949.4
9,568.2
11,574.8
Transportation
53,800.6
47,848.7
50,895.2
63,135.0
51,587.9
Utilities
38,350.4
40,311.7
51,146.2
40,286.4
38,627.1
General Purpose
84,542.9
93,029.3
106,599.1
103,951.1
86,845.1
New Money
145,303.5
150,498.0
173,429.5
202,463.5
235,300.8
Refunding
127,914.7
163,768.5
178,110.3
145,034.6
59,419.5
Combined
65,831.6
83,441.3
93,259.8
88,847.3
44,212.7
242,994.7
290,375.5
325,202.5
311,783.5
238,169.1
Competitive
71,824.7
87,199.5
98,670.4
98,247.6
81,965.1
Private Placements
24,230.4
20,132.7
20,926.6
26,314.3
18,798.8
Number of Issues Purpose
Environmental Facilities
Use of Proceeds
Method of Sale Negotiated
Source: Thomson Reuters ( based on data available on December 31, 2018). All dollar amounts are in millions of dollars. Figures are based on issues maturing in 1.09 years or longer. Private placements and municipal forward sales are included, but short-term notes maturing in less than 1.088 years and remarketings of variable-rate bonds are excluded. Taxable bonds issued directly by electric cooperative utilities are included. Insurance figures represent only the insured portion of issues. Other Enhancements include certificates of deposit, collateralization, guaranteed investment contracts, private mortgage insurance and surety bonds. The purpose categories are defined as follows: Development: industrial development, economic development, non-government office buildings. Electric Power: public power utilities. Environmental Facilities: solid waste disposal, resource recovery, pollution control, recycling. Health Care: hospitals, nursing homes, continuing-care communities, assisted living, general medical. Housing: single-family housing, multifamily housing. Public Facilities: government buildings, fire and police stations, jails and prisons, civic and convention centers, museums and libraries, stadiums and sports complexes, theaters, parks, zoos and beaches, other recreation. Transportation: airports, seaports and marine terminals, toll roads, highways and streets, bridges, tunnels, parking facilities, mass transit. Utilities: water and sewer, gas, flood control, sanitation, combined utilities, miscellaneous utilities. General Purpose: general purpose, veterans (other than housing), agriculture, churches, temples and mosques, unknown.
page 5
2018 AT A GLANCE
TA X - E X E M P T I N T E R E S T R AT E S
A A A R ATED MMD W ITH M A R KET EV ENTS TIMELINE
3.50 3.30 3.10 2.90
Yield (%)
2.70 2.50 2.30 2.10 1.90 1.70 1.50
MMD Source: Thomson Reuters Source: Ipreo MuniAnalytics.
2YRMMD
10YRMMD
DATE
30YRMMD
EVENT
February 6, 2018
The DJIA falls 1,600 points
March 22, 2018
Fed rate hike of .25% moves the fed funds target rate to a range of 1.5% to 1.75%
May 31, 2018
U.S. announces that it will extend its tariffs on imported steel (25%) and aluminium (10%)
June 14, 2018
Fed rate hike of .25% moves the fed funds target rate to a range of 1.75% to 2.00%
July 6, 2018
President Trump announces U.S. Tariffs on $34 billion worth of chinese goods
September 14, 2018
Hurricane Florence makes landfall
September 27, 2018
Fed rate hike of .25% moves the fed funds target rate to a range of 2.00% to 2.25%
October 10, 2018
Hurricane Michael makes landfall
November 8, 2018
Three California wildfires displace thousands
December 3, 2018
Yield curve began to invert
December 20, 2018
Fed rate hike of .25% moves the fed funds target rate to a range of 2.25% to 2.50%
December 21, 2018
The DJIA closes at 22,445 after its worst week since 2008
page 6
G ENER A L I N T E R E S T R AT E S MUNI/TR E A SURY YIELD R ATIO 110
10 Year Maturity Ra�o (Muni/Treasury)
10 Year Ra�o - 10 Year Average
30 Year Maturity Ra�o (Muni/Treasury)
30 Year Ra�o - 10 Year Average
105
100
Ra�o (%)
95
90
85
80
75
70
65 1/1/2018
2/1/2018
3/1/2018
4/1/2018
5/1/2018
US T R E A S U RY S L OPE A N A LY S I S
6/1/2018
7/1/2018
8/1/2018
9/1/2018
10/1/2018
US Treasury Slope Analysis
2 10 Year minus 2 Year Spreads 1.8
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
page 7
30 Year minus 2 Year Spreads
11/1/2018
12/1/2018
TEXAS CITIES
Municipalities in Texas experienced a tumultuous year in 2017.
According to the Fed’s February 2018 report:
Lawmakers approved significant legislation,
The Texas economy is benefiting from oil prices above
Congress passed the federal tax law (which barred tax-
$60 per barrel, rising exports, business optimism
exempt advance refundings) and Hurricane Harvey
stemming from the new federal tax law and strength
slammed into the Gulf Coast.
in the U.S. economy.
In comparison, 2018 was a quieter year for Texas cities
The report also identified Texas as being fourth in the
and towns. The State’s population continued to grow
nation in job creation in 2017. However, the Fed’s November
significantly and its economy continued to perform as one
2018 report reflects the previously mentioned slowing:
of the nation’s strongest, a fact most evident at the year’s
Texas economic growth remains robust but is
start. Yet, a review of the Dallas Federal Reserve Bank’s
showing signs of moderating. While many major
Texas Economic Update titles reflects a softening in the
Texas metros saw employment gains in the third
State’s economy as the year progressed: MONTH February 2018
quarter, state job growth was slower compared with the first half of the year. On the whole, the Texas labor
TITLE
market continues to tighten. The unemployment rate
“Thriving Texas Economy Expands
hit a record low in September, and reports of wage
Broadly”
pressures persist. Housing indicators suggest supply
“Texas Economic Expansion March 2018
and demand constraints, with a drop in home sales
Continues; Tight Labor Market Could
and affordability coinciding with low inventories.
Limit Stronger Growth” May 2018 June 2018 August 2018
A number of factors led Texas cities to put forth general
“Texas Economic Growth Continues at
obligation bond packages in 2018, including aging
Healthy Pace”
infrastructure, population growth, increased economic
“Texas Economy Continues to
activity and desires for higher quality of life.
Advance”
According to the Municipal Advisory Council of Texas’
“Red-Hot Texas Economic Growth
website, Texas cities put forth 29 bond elections in 2018 for
Likely to Cool”
a total of $2,447,680,000 in general obligation bonds, with
“Texas Economy Keeps Growing but October 2018
$2,289,055,000 passing (93.5%). While still significant, the
Signs of Supply-Side Constraints
amount of authorization Texas cities were requesting from
Emerge” November 2018
their citizens was down sharply from previous year totals
“Texas Economy Continues Expansion
($4,187,235,000 or 98%).
but Shows Signs of Cooling”
page 8
CI T Y A N N UA L E L E CT ION R E S U LT S
among its top priorities are providing property tax reform and tackling school finance reform. Property tax relief will
YEAR
AMOUNT CARRIED
% CARRIED
2018
$2,289,055,000
94%
2017
$4,187,235,000
98%
the event of a rollback situation. Finally, in past sessions,
2016
$1,777,420,000
88%
legislators considered limiting municipalities’ rights to
2015
$1,211,424,500
93%
2014
$1,014,204,000
60%
likely focus on a cap on tax revenues. In conjunction with a cap, legislators have also put forth automatic elections in
incur debt; however, it remains uncertain if this will gain traction in 2019.
Bond issuance volume among Texas cities also trended downward, but with significantly less movement, falling from a total of $8.820 billion in 2017 to $7.830 billion in 2018. C I T Y PA R A M OU N T I S S U E D B Y Y E A R
2018 WAS A QUIETER YE AR FOR
2018
TE X AS CITIES AND TOWNS.THE
2017
2016
2015
2014
$7,830,207,920
STATE’S POPUL ATION CONTINUED
$8,820,571,043
TO GROW SIGNIFICANTLY AND IT’S
$9,775,010,000
ECONOMY CONTINUED TO PERFORM
$9,135,415,000
AS ONE OF THE NATION’S STRONGEST.
$8,969,770,000
Source: Ipreo MuniAnalytics
Source: Ipreo MuniAnalytics.
Texas cities will focus on a number of items in 2019—none more daunting than what will happen in Austin. The 86th legislative session commenced on January 8, 2019, and
page 9
TEXAS PUBLIC
SCHOOLS I SD A N N UA L E L E CT ION R E S U LT S
In 2018, Texas independent school districts focused their efforts on managing overall enrollment increases, planning facility needs
YEAR
AMOUNT CARRIED
% CARRIED
2018
$ 9,971,437,659
91%
remained the primary source for funding capital projects. The
2017
$11,780,001,500
84%
voted dollar amount carried in 2018 was down from the record-
2016
$ 6,989,719,038
92%
2015
$ 9,644,338,498
88%
2014
$ 9,412,480,175
91%
and mobilizing for the much-anticipated 2019 legislative session. As expected, voted bonds supported by ad valorem taxes
setting amount carried in 2017. However, with over 90% carried in 2018, local support for Texas schools remains high. ISSUA NCE TR ENDS FOR ISDs
PA R A M OU N T I S S U E D B Y Y E A R
Coming off record-setting issuances in 2015 and 2016, issuance volume for 2018 was down by 28% from the 2017
2018
level due to a substantial reduction in refunding issuances. The amount of new issuances—tied to two years of above
$8,779,051,934
2017
$12,517,377,153
average voted authorization—has and is projected to offset the decline in advance refunding issuance tied to federal
2016
$17,433,204,926
tax legislation changes. The large number of refundings 2015
completed between 2014 and 2017 left ISDs with very few tax-exempt refunding opportunities in the near term.
$16,411,434,541
2014
Opportunities to refund for savings are expected to pick up
$11,812,146,126
Source: Ipreo MuniAnalytics Source: Ipreo MuniAnalytics.
in the coming years as call dates move closer and if market conditions allow.
NEW MONEY VS R EFUNDING ISSUA NCE
PERMANENT SCHOOL FUND
$18B
As expected, investor demand for Permanent School Fund
$16B
(PSF) guaranteed bonds remained robust.
With their
$14B
AAA rating and adequate capacity, PSF guaranteed bonds
$12B $10B
continue to be the premier credit throughout the State.
$8B
Based on U.S. Census Bureau data, Texas continues to the lead
$6B
the nation in annual population growth. Across the State, ISDs
$4B
generally continue to experience property value increases, but
$2B $-
not all schools are realizing the benefit.
page 10
60%
51% 34%
48%
52%
11%
40%
2015 2014 New Debt Issuance
49%
2016
66%
89%
2017 2018 Refunding Issuance
1 0 -Y E A R “A A” U N D E R LY I N G
Because of Texas’ current funding formulas, as property
PSF SPOT SPREADS TO MMD
values rise, the overall amount of State funding per student has decreased. With the reduction of the State’s funding percentage
0.50
by as much as 8% over the last 10 years, schools are continually working to stretch local dollars. Many schools have held, or are
Yield (%)
0.40
considering, tax ratification elections (TREs) to offset State
0.30
funding reductions.
0.20
As Texas’ education system and infrastructure needs remain a challenge and student populations continue to
0.10
drive the need for capacity, these trends are expected to continue throughout the next biennium unless legislative
0.00
changes are made to the funding system. MMD Source: Thomson Reuters
Source: Ipreo MuniAnalytics.
TA X R AT I F IC AT ION E L E C T ION PA S S AG E R AT E B Y Y E A R YEAR
NUMBER OF TREs
PASSED
FAILED
% PASSED
% FAILED
2009
47
29
18
62%
38%
2010
77
60
17
78%
22%
2011
44
32
12
73%
27%
2012
44
36
8
82%
18%
2013
42
39
3
93%
7%
2014
29
24
5
83%
17%
2015
41
38
3
93%
7%
2016
51
42
9
82%
18%
2017
59
55
4
93%
7%
2018
58
52
6
90%
10%
TOTAL
492
407
85
83%
17%
p a g e 11
ARBITRAGE R E B AT E
R EBATE
As 2019 commences, a subtle shift is taking place. The cause? Short-term interest rates. With the Fed anticipating
From a Rebate standpoint, the IRS allows issuers to earn and
additional short-term rate hikes this year and predictions
retain a profit on investing new money project proceeds if
of an inverted yield curve, 2019 could catch issuers by
they are spent quickly enough to meet a spending exception.
surprise. Unless prepared, issuers may see something on
The spending exception time periods are 6, 18 and 24 months.
their balance sheets they haven’t seen in 10 to 15 years:
The 18- and 24-month exceptions have semiannual interim
arbitrage liabilities.
spending benchmarks that must be met. If an issuer misses
This year appears to be kicking a short-term investment
a benchmark, their spending exception is permanently lost.
cycle very similar to the 2003-2007 period when issuers
PREVENTATIVE ACTION: Monitor your investment
generated liabilities by simply investing in money
rates and bond yields by issue. Focus on spending
market/pool accounts. The period can be broken into two
the new money proceeds and monitor the benchmarks
types of liabilities: Yield Restriction (2003-2004 series)
for compliance.
and Rebate (2005-2007 series).
The past 10-15 years have lulled issuers into a state of comfort
YIELD R ESTRICTION
when it comes to worrying about Yield Restriction and
The IRS requires a calculation to be performed called
Rebate liabilities. However, short-term rates are increasing
Yield Restriction. This calculation encourages issuers
and unless issuers are proactively monitoring and spending
of new money project issues to spend their proceeds
project proceeds, they may be sending a portion of their
within three years of the date of issuance. If there are
investment earnings to the U.S. Treasury.
unspent proceeds at the end of the three-year period, the Yield Restriction calculation kicks in and starts with a beginning zero balance (regardless of any negative Rebate or Yield Restriction generated during the first three years).
UNLESS PREPARED, ISSUERS MAY
In a rising investment rate environment, if an issuer has unspent proceeds at the end of the three-year period and
SEE SOMETHING ON THEIR BAL ANCE
the investment rates are above the issue’s bond yield, a Yield Restriction liability may be generated and a payment
SHEETS THEY HAVEN’T SEEN IN 10
may need to be made. P R E V E N T A T I V E A C T I O N : Monitor and focus on
TO 15 YE ARS: ARBITR AGE LIABILITIES.
spending new money proceeds within three years of the date of issuance.
p a g e 12
STRUCTURED FINANCE
In 2018, we saw increased interest in managing interest rate
2017. Natural gas average prices dropped only $0.02/mcf to
risk through a variety of interest rate derivative products.
$10.84 in 2018.
Long-term rate increases continued last year from their
Large governmental purchasers of liquid fuels and natural gas
absolute historical lows seen in mid-2016. The 10-year LIBOR
continued to use commodity futures, options and derivatives
(taxable) swap rate reached a peak of 3.29% and municipal
(swaps, caps and collars) as part of their fiscal policy tools.
swap rates moved similarly, with the 10-year SIFMA swap
For these entities, commodity-hedging strategies are part of
rate reaching a 5-year relative high of 2.48% in November
a risk management program to mitigate unexpected spikes in
2018. Increases like these presented opportunities for
energy prices. Hedges also provide a level of price certainty
some issuers with pre-crisis swaps to finally unwind these
that makes budgeting easier.
transactions as part of a fixed rate refunding.
For 2019, the EIA projects decreases in annual average
Municipal issuers and borrowers also showed renewed
gasoline and diesel prices to $2.50 and $2.95/gal, respectively.
interest in executing new swaps and caps for synthetically
Conversely, the EIA expects natural gas to rise an average of
fixing-out new money deals and establishing rate lock
$11.24/mcf in 2019, compared to $10.84 in 2018.
strategies for anticipated debt issuance. Moreover, interest
BOND PROCEEDS IN VESTMENT
rate derivatives continued to be a cost effective way to
As short- to medium-term interest rates increased
mitigate future interest rate risk.
throughout 2018, opportunities to invest project or
As of December 12, 2018, the mid-market cost of hedging a 10-
construction funds grew. Many banks and dealers are
year bullet maturity for 12 months with a SIFMA swap was
reentering the REPO and GIC (unsecured) market as broader
approximately 1 basis point or .01% (excluding transaction
interest rates increase and credit conditions improve.
expenses). The long-term historical average has been 1-2
The 2- and 3-year U.S. Treasury rates increased from
basis points per month, while a forward bond delivery
a low of 1.88% and 1.97% to a high of 2.97% and 3.04%,
averaged approximately 5-6 basis points per month. We
respectively. At the beginning of December, the U.S.
expect this opportunity to last if the shape of the yield curve
Treasury curve began to invert between the 3- and 5-year
is unchanged, continues to flatten or inverts on the short end.
maturities causing many issuers to keep their investments
COMMODITY HEDGING
short-term (1-3 years) until further steepening occurs.
Liquid fuel prices increased in 2018 compared to 2017
The U.S. 2-10 year spread diminished throughout the year,
averages, while natural gas prices remained effectively
so typically longer-term investments were invested in
the same. According to the U.S. Energy Information
shorter maturities.
Administration (EIA), retail gasoline prices per gallon
With the Tax Cuts and Jobs Act and the elimination of
rose to an average of $2.73 in 2018 from $2.42 in 2017.
tax-exempt advance refundings, most escrow open market
Retail diesel prices rose to $3.17 in 2018 from $2.65 in
securities investments were limited to within 90 days.
pa g e 13
CONTINUING DISCLOSURE
In August 2018, the SEC announced amendments to its Rule
entails reviewing each of an issuer’s outstanding bonds,
15c2-12, increasing the number of event notices that issuers
determining their reporting requirements and verifying
must monitor for and file on EMMA to 16. These two new
that the filings were complete and timely for each of the
events, if material to the issuer, are:
prior five years.
1. A material financial obligation, an agreement to covenants, events of default, remedies, priority rights
W H AT IS CONTIN UING DISCLOSU R E?
or other similar terms of a financial obligation; and
SEC’s Rule 15c2-12 requires dealers, when underwriting
2. Default, event of acceleration, termination event,
public finance securities, to ensure the issuer enters
modification of terms or other similar events under
into an agreement to provide financial and operating
the terms of a financial obligation, any of which reflect
information to the MSRB on an ongoing basis, including
financial difficulties.
financial information and/or operating data reports and
Compliance date for the Rule change is February 27, 2019.
audits. Some issuers may have more frequent filings due
After this date, the Rule change is applicable when an
to the commitments made in their bond documents. The
issuer has a primary offering of municipal securities with
Rule also applies to material event notices, including
a new continuing disclosure undertaking agreement that
issuer- and bond-insurer rating changes and bond call
includes the two new event notices.
and defeasance notices, which must be filed on EMMA within 10 business days of occurrence.
W H AT DOES THIS ME A N FOR ISSU ER S? The new rule changes mean that issuers with new
W H AT’S N EXT?
financial obligations must be reported on EMMA within 10 business days of execution. The new obligations
While the industry saw less focus on disclosure
include private placements, direct loans, direct purchase
enforcement throughout 2018, questions remain about
of municipal securities by an investor, swaps, options and
the level of SEC enforcement in the future for issuers
other derivative instruments and municipal leases that
and individuals alike. Issuers are looking to the guidance
operate as a financing instrument to borrow money.
provided by industry membership organizations, such as
This SEC Rule 15c2-12 change also requires issuers to
the Government Finance Officers Association, to focus
have policies and procedures in place to monitor for
on implementing post-issuance compliance policies and
incurrence of a debt obligation that, prior to February 27,
procedures and educating those responsible for their
2019, would not have been subject to reporting on EMMA.
execution. This is an important process, whether it’s performed in-house or handled by a third-party provider
Prior to the issuance of debt, the industry standard has
such as HilltopSecurities.
become a five-year look-back to determine compliance with previously required EMMA filings. The look-back
page 14
GOVERNMENT INVESTMENT
POOLS In 2018, government investment pools continued to provide
feel the Fed may be approaching the end of their tightening
competitive investment options for market participants.
period as interest rates near a desired neutral rate that is
Throughout the year, pools continued to see fund balances
neither stimulating nor repressive for growth. The Federal
grow driven by the rise in short-term interest rates. In this
Open Market Committee’s December 2018 projections
increasing interest rate environment, portfolio managers have
show two rate hikes in 2019 instead of the three that we’re
been consistently reinvesting at even higher rates, thereby
projected at its September 2018 meeting.
attracting assets and boosting demand for these high-quality,
However, the data-dependent Fed may further consider the
low-duration investments.
market’s view due to the lack of inflation pressure despite an
It was also an eventful year for the Fed, one marked by
unemployment rate near a 50-year low. Though we’ll wait
a significant change in leadership and unprecedented
to see what actually transpires, all signs point to a new year
scrutiny. The Fed raised their interest rate benchmark in
that will continue to benefit our government entity clients
March, June, September and December in 2018, closing
as they look to achieve their investment goals and enhance
three consecutive years of rate hikes (nine in total) since
their cash management programs through prudent and
they began rate normalization in 2015. These hikes have
conservative investment choices.
had an immediate impact on pools due to their short-term maturity of 60 days or less. LOGIC, which primarily invests in commercial paper,
A BOUT TEX STA R A N D LOGIC
started 2018 at 1.44% and reached 2.44% at December 2018. TexSTAR started the year at 1.29% and reached 2.24% at
HilltopSecurities,
in
conjunction
mid-December. Invested balances in the pools have also
Investment
responded strongly to the increased rates, which reached
TexSTAR and LOGIC government investment pools.
record levels for combined assets under management in
These government investment pools offer Texas
2018—TexSTAR at $7.7 billion and LOGIC at $7.8 billion for a
cities, counties, school districts and other public
combined level of assets under management of $15.5 billion.
entities investment options for their cash management
Management,
Inc.,
with
JPMorgan
administers
the
programs that provide preservation of principal, daily
2018 also saw pool participants move funds from local banks
liquidity, portfolio diversification and competitive yield,
that have been slow to respond to increased rates due two
combined with an uncompromising commitment to
factors: the cost of additional collateral required to hold
service. This simplicity and convenience distinguishes
government funds and the impact of regulatory reform on
these programs among other investment services for
money market funds, which charge higher management fees
Texas local governments.
than pools, resulting in lower returns. As the year came to a close, uncertainty grew regarding the amount of rate hikes the Fed would implement in 2019. Many
pag e 15
MUNICIPAL CASH
MANAGEMENT In 2018, a strong labor market and tax cut-fueled business
year drew to a close and it became apparent economic growth
investment drove GDP to its strongest back-to-back quarterly
was slowing, extension trades made sense.
performance since 2014. Fed officials, witnessing the surge
Significantly higher yields translated into higher earnings
in growth, seized the opportunity to continue “normalizing”
for clients, and like the previous year, interest in external
monetary policy.
management increased. In the first quarter of 2018 (the
After raising the overnight target rate by a total of 75 basis
highpoint for most local government clients) assets under
points in 2017, the Fed was even more aggressive in 2018,
management topped $13 billion, a two-fold increase over a
hiking short-term interest rates four times in quarter-point
five-year period.
increments. At year end, the overnight fed funds rate stood at a range of 2.25% to 2.50%.
A B OU T H I L LT OP SE C U R I T I E S
The run-up in bond market yields was significant. In a
ASSET M A NAGEMENT
12-month period beginning in early September 2017, the
Hilltop Securities Asset Management, LLC, is an
two-year Treasury-note yield more than doubled from a low
SEC-registered investment advisor focusing on local
of 1.26% to 2.71%. The two-year yield peaked at 2.97% in
government operating funds, bond proceeds, debt service
early November 2018, the highest in over a decade. Unlike
and reserve funds. Our philosophy is conservative with
the previous year, the anticipated Fed hikes were mostly
an emphasis on safety and liquidity. The investments
priced into the market, which meant investors had been
are restricted to highly rated fixed income securities,
compensated up front for those increases.
predominantly including Treasuries, agencies, municipal
As the fourth quarter began, the trade war with China
bonds and prime commercial paper.
worsened and the threat that an agreement would not be reached began to drag on both confidence and spending. Volatility was reintroduced to the equity markets and the year’s gains began to evaporate. The broad market S&P 500 index, which reached a fresh record high of 2,930 in mid-
THE FED WAS EVEN MORE
September, had surrendered all of its gains three months later. As investors took refuge in the bond market, bond yields
AGGRESSIVE IN 2018, HIKING
retreated in the fourth quarter.
SHORT-TERM INTEREST R ATES FOUR
In 2018, the most frequently applied management strategy for cash management clients was to gradually extend short
TIMES IN QUARTER-POINT INCREMENTS.
durations when the yield curve was favorable, mitigating market exposure and accruing as much advantage as possible from the Fed’s rate tightening moves during the year. As the
page 16
SM
214.953.4000 800.678.3792 1201 Elm Street, Suite 3500 Dallas, Texas 75270
Hilltop Securities Inc. delivers the forthright advice and tailored solutions necessary for municipal issuers, institutions, broker-dealers and individuals to thrive. We are a financial services firm and registered investment adviser headquartered in Dallas, Texas, with offices across the United States. Our areas of focus include public finance, municipal and taxable fixed income underwriting, sales and trading; equity and portfolio trading; retail brokerage services; securities clearing; structured finance; and securities lending. A wholly owned subsidiary of Hilltop Holdings Inc. (NYSE: HTH), HilltopSecurities’ affiliates include Hilltop Securities Independent Network Inc., PlainsCapital Bank, PrimeLending and National Lloyds Corporation.
CONTACT US HilltopSecurities is ready to help your organization advance the community it serves. To learn more, call or visit us online today. 8 0 0. 678 . 3792 | H I L LT OP SE C U R I T I E S .C OM
Š2019 HilltopSecurities Inc. | All rights reserved MEMBER: NYSE/FINRA/SIPC | HTS303113148
SM