The Massachusetts ALM Program Reducing Risk from a Global Balance Sheet Perspective June 2014
This presentation has been prepared by the Commonwealth of Massachusetts to provide summary information relative to the general obligation credit of the Commonwealth. The presentation is incomplete. The presentation is not part of the Commonwealth’s Information Statement (Information Statement) and is qualified in all respects by reference to the most recently updated Information Statement that has been filed with the Municipal Securities Rulemaking Board through its Electronic Municipal Market Access (EMMA) system. Investment decisions relating to Commonwealth general obligation bonds and notes should be based only upon the most recently updated Information Statement and the Official Statement of the Commonwealth relating to such bonds or notes. The provision of access to this presentation does not constitute an offer to sell or the solicitation of an offer to buy any bonds or notes that may be described or mentioned in the presentation. Commonwealth bonds and notes are sold only by means of an Official Statement and through registered broker-dealers. The information set forth herein includes information obtained from non-Commonwealth sources that are believed to be reliable, but such information is not guaranteed as to accuracy or completeness and is not to be construed as a representation by the Commonwealth. All information and expressions of opinion herein are subject to change without notice. The Commonwealth undertakes no obligation to provide any additional information or to update any of the information or the conclusions contained herein or to correct any inaccuracies that may become apparent. This presentation contains certain forward-looking statements that are subject to a variety of risks and uncertainties that could cause actual results to differ from the projected results, including without limitation general economic and business conditions, conditions in the financial markets, the financial condition of the Commonwealth and various state agencies and authorities, receipt of federal grants, litigation, arbitration, force majeure events and various other factors that are beyond the control of the Commonwealth and its various agencies and authorities. Because of the inability to predict all factors that may affect future decisions, actions, events or financial circumstances, what actually happens may be different from what is set forth in such forward- looking statements. Forward-looking statements are indicated by use of such words as “may,” “will,” “should,” “intends,” “expects,” “believes,” “anticipates,” “estimates” and others.
Table of Contents 1) Executive Summary 2) Balance Sheet Risk 3) Asset/Liability Management 4) The Pro Forma Massachusetts Five-Year ALM Program 5) Program Risk 6) Series 2014 C Financing 7) Conclusion
Executive Summary
Executive Summary • Like every state, the Commonwealth of Massachusetts (the “Commonwealth” or the “state”) has significant assets and liabilities that are exposed to changes in market interest rates • To proactively reduce interest rate risk, the Commonwealth has adopted Asset/Liability Management (or “ALM”) as its long-term strategy for debt financing and balance sheet management • ALM is a bedrock interest rate risk management framework utilized by insurance companies, banks, and other large financial institutions for the last three decades • Massachusetts’ goal is to reduce interest rate risk proactively, like its private sector peers, by following ALM and creating a natural hedge between assets and liabilities to reduce interest rate risk and significantly reduce cash flow volatility with respect to the state’s operating budget 5
Executive Summary • To create a naturally hedged balance sheet, the Commonwealth will prudently add variable-rate bonds – instead of 100% fixed-rate bonds – to its debt portfolio over the next five years to offset the interest rate risk of its floating-rate assets • While risk reduction is the purpose and outcome of implementing the ALM program, the act of reducing interest rate risk does not inherently mean that the state is accepting reduced revenues/income/returns • In fact, the Commonwealth expects the implementation of the ALM program to provide a number of long-term credit positives: Reduce cash flow volatility significantly, improving budget performance through all business cycles Reduce interest costs due to the use of additional variable-rate debt in an upwardly sloping yield curve environment Return control of the balance sheet to Commonwealth managers Instill an enhanced level of interest rate risk measurement, monitoring and reporting by Commonwealth managers 6
Balance Sheet Risk
Introduction • The Commonwealth of Massachusetts’ goal is to be proactive in managing and strengthening its balance sheet so that its ability to provide services to its citizens, and its ability to maintain its strong credit, is sustained over the long-term • Like other large governments, Massachusetts has billions of dollars in assets and liabilities that are exposed to changes in interest rates that can ultimately impact the state’s operating budget Assets include operating cash and the reserve fund’s short-term investments Liabilities include debt obligations used to fund the capital budget • One widely understood lesson of the recent financial crisis has been that governments and financial institutions should avoid explicit bets on the direction of interest rates which could magnify the interest rate exposure to their balance sheets • Equally important, though not as obvious, is the need to avoid implicit bets on interest rates caused by the structure of their asset and liability portfolios • Over the next five years, Massachusetts is taking steps to ensure that its balance sheet is not explicitly or implicitly “betting” on the direction of interest rates 8
Global Balance Sheet Risk: Assets • On the asset side of the state’s balance sheet, interest rate risk is the risk to the operating budget arising from a decline in interest rates • Should interest rates decline, investment income would also decline, affecting the amount of revenues available to support the budget • With annual revenues of nearly $35 billion, the Commonwealth maintains a significant portfolio of cash and short-term investments that provides liquidity to the operation of state government • Average monthly operating cash balances in FY 2014 are projected to be nearly $1.5 bn • Over the last ten years, the state’s annual year-end balance of cash and short-term investments has averaged more than $3.2 billion* Invested Cash Balance Invested Cash Balance ($’s 4.5 FY in Billions) 4.0 2004 $3.546 2005 3.748 3.5 2006 4.324 3.0 ($'s in Billions) 2007 3.612 2.5 2008 3.847 2.0 2009 2.242 1.5 2010 1.662 2011 3.143 1.0 2012 3.265 0.5 2013 2.953 0.0 2014 (Proj.) 3.169 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 (Proj.) Average $3.228 Fiscal Year * Source: Government Fund Balance Sheet in the Comprehensive Annual Financial Report FY2004-2013 representing core operating cash and investments; totals do not include assets of the MSBA; the balance for FY2014 is projected 9
Global Balance Sheet Risk: Assets • In addition to operating funds, the state maintains a Budget Stabilization Fund that currently has one of the highest balances in the country Since its creation in 1986, the average annual balance of the Budget Stabilization Fund is nearly $1 bn Over the last ten years, the average balance is close to $1.6 bn • The fund is a long-term reserve with asset balances that will remain exposed to interest rate risk Stabilization Fund Balance (at FY End) 2.5 2.3 2.2 2.1 2.0 1.7 1.7 1.7 1.6 1.6 ($'s in Billions) 1.5 1.4 1.4 1.4 1.2 1.1 1.0 0.9 0.8 0.8 0.7 0.6 0.5 0.4 0.5 0.4 0.3 0.2 0.1 0.1 0.1 --- --- --- 0.0 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 (Proj.) Fiscal Year 10
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