1. LOCAL GOVERNMENT CREDIT OUTLOOK— VIRGINIA AND THE US -- with an update on GASB 54 Virginia GFOA June 9, 2011 SUSAN KENDALL, VICE PRESIDENT/SENIOR ANALYST

2. VIRGINIA GFOA JUNE 9, 2011 Today’s Agenda »Fiscal 2012 National Perspective—Toughest Year Yet –Local Governments Facing Unprecedented Challenges –Downgrades Outpace Upgrades –Defaults are low but are expected to increase –Debt is not the problem –What are we watching? What could change? »Virginia Outlook –Virginia is recovering slightly ahead of the nation –Local governments remain pressured –Unemployment has dropped and credit quality remains high –Management is the key »GASB 54 Fund Balance Restatement –No significant ratings impact expected 2

3. VIRGINIA GFOA JUNE 9, 2011 FY12--Toughest Year Yet

4. VIRGINIA GFOA JUNE 9, 2011 Unprecedented financial stress across municipal sectors Recession is over, but economic recovery is tepid State and local governments are lagging in recovery End of federal stimulus will make 2011 an even more stressful year for state and local governments Moody’s has had negative outlooks on state and local governments for 2 years Downgrades have outpaced upgrades for 9 consecutive quarters Source: Moody’s

5. VIRGINIA GFOA JUNE 9, 2011 Default Counts by Purpose Purpose Ratings Outstanding Defaults Housing1,04121 Health Care65021 Electric, Water or Sewer Enterprise1,6453 Higher Education8431 Recreation931 City, Town, County – Non-General Obligation2,3424 General Obligation8,6103 Total15,22454 Very few rated municipal bonds have defaulted »From 1970 to 2009, 54 Moody’s rated municipal issuers defaulted »78% were in non-profit hospital or housing project sectors »Average recovery on defaulted municipal bonds has been 59% of par, compared to 37% for defaulted corporate bonds

6. VIRGINIA GFOA JUNE 9, 2011 Defaults are higher among unrated bonds

7. VIRGINIA GFOA JUNE 9, 2011 Rated defaults expected to increase in 2011 Could be 2-3x 2008 levels Consistent with defaults implied by our rating distribution Depends on willingness to make tough choices

8. VIRGINIA GFOA JUNE 9, 2011 Municipal spreads remain wider, post credit crisis Source: Moody’s

9. VIRGINIA GFOA JUNE 9, 2011 Local governments face a revenue and spending crisis, not a debt crisis Source: Bureau of Census State and local government quarterly tax revenue performance

10. VIRGINIA GFOA JUNE 9, 2011 Low revenue growth + fragile recovery = challenges

11. VIRGINIA GFOA JUNE 9, 2011 FROM MOODY’S ECONOMY.COM Local governments will underperform states Sources: Census Bureau, Moody’s Analytics Tax revenues, fiscal yr, % change

12. VIRGINIA GFOA JUNE 9, 2011 FROM MOODY’S ECONOMY.COM Recession has finally hit property taxes Source: Census Bureau, Moody’s Analytics

13. VIRGINIA GFOA JUNE 9, 2011 State and local debt growing, but slower than other sectors

14. VIRGINIA GFOA JUNE 9, 2011 Total US public debt lower than other major economies

15. VIRGINIA GFOA JUNE 9, 2011 Reduced state and local spending could threaten growth

16. VIRGINIA GFOA JUNE 9, 2011 What are we watching? What could change? »Local Governments: Small, weaker issuers will be most stressed, some distressed –Risks: » Further state aid cuts » Some have exposure to enterprise risk with outsized debt levels » Exposure to financial institutions, liquidity and credit facilities expiring » Breakdown in political process that results in failure to pay debt, bankruptcy filing »States: Revenues remain weak, but most will manage through spending cuts, use of reserves and federal stimulus money –Risks: » Expiration of federal stimulus funds in June 2011 creates large gaps » Entitlement spending for pension, OPEBs, Medicaid continues to grow » Material shift in market confidence

17. VIRGINIA GFOA JUNE 9, 2011 Virginia Outlook

18. VIRGINIA GFOA JUNE 9, 2011 Virginia is Recovering Slightly Ahead of the Nation »Unemployment rates remain well below national levels »Recession was mild »Job growth is average »Construction employment expected to grow faster than average as demand for housing resumes »Virginia remains a desirable place to do business –Low cost of doing business –Favorable regulatory environment »Downside risks persist: –Failure to investment in transportation improvements –Job losses in manufacturing accelerate –Federal spending cuts are deeper than expected

19. VIRGINIA GFOA JUNE 9, 2011 Virginia Local Governments Remain Under Pressure »Declining Assessed Valuations reduce Property Taxes »Commonwealth of Virginia FY12 Budget » State finances are under control but cuts will not be reversed » Structural balance remains elusive » What’s the future for state and federal aid? »Local Revenues Recovering? »Expenditure Management » Layoffs, salary freezes and service reductions are still the norm »Impact of Defense and Other Federal Spending Cuts » Local economy and revenues could be affected

20. VIRGINIA GFOA JUNE 9, 2011 FROM MOODY’S ECONOMY.COM Public Sector Dragging on National Employment Source: BLS Total nonfarm (R) State and local government (L) Employment, ths

21. VIRGINIA GFOA JUNE 9, 2011 Virginia Unemployment is Dropping but Still Elevated 21 Source: Commonwealth of Virginia Employment Commission

22. VIRGINIA GFOA JUNE 9, 2011 High Credit Quality Reflected in Moody’s Local Government Ratings Distribution 22 US VIRGINIA

23. VIRGINIA GFOA JUNE 9, 2011 Management is the Key »Strong management will be critical to maintaining long-term credit strength – Adherence to management policies – Prudent use of reserves along with plan to replenish – Conservative long-range forecasting and monitoring of economically sensitive revenues – Structural balance – Maintenance of financial flexibility – Thoughtful debt management and capital planning 23

24. VIRGINIA GFOA JUNE 9, 2011 GASB 54 Fund Balance Restatement

25. VIRGINIA GFOA JUNE 9, 2011 What does GASB 54 do? –New fund balance classifications affect accounting presentation » Effective beginning fiscal year 2011 audit cycle –Clarification of definitions for special revenue funds A greater number of fund balance categories is intended to promote transparency GASB 54 Implementation

26. VIRGINIA GFOA JUNE 9, 2011 Previous fund balance categories –Reserved - not available for appropriation, cannot be spent due to constraints –Unreserved - available for appropriation, may be categorized as designated or undesignated –Designated - available for appropriation, only internally-imposed limitations –Undesignated - available for appropriation, no limitations New fund balance categories –Non-spendable - not in spendable form (ex. prepaid item, long-term receivable) –Restricted - externally-imposed constraints (ex. unspent bond proceeds, state dedicated funds) –Committed - internally-imposed constraints (ex. contract commitments) –Assigned - intended use expressed (ex. budget carryover for specific item) –Unassigned - no constraints in any way Reclassifications

27. VIRGINIA GFOA JUNE 9, 2011 An example… Traditional Fund Balance Reporting Requirements – General Fund 2008 2007 2006 Reserved for encumbrances 9,196 15,309 15,196 Unreserved, designated expenditures 45,373 63,742 71,474 Unreserved, undesignated 9,991 28,912 32,126 Total 64,560 107,963 118,796 Restated GASB 54 Fund Balance Reporting Requirements – General Fund 2008 2007 2006 Committed 10,410 11,449 14,227 Assigned 1,551 18,985 19,246 Unassigned 52,599 77,529 85,323 Total 64,560 107,963 118,796 GASB 54 Restatement

28. VIRGINIA GFOA JUNE 9, 2011 What does it mean for Moody’s analysis? –Principles of credit analysis will remain unchanged » Still emphasize trends of fund balance as percentage of revenues, operating flexibility, budget practices –No significant ratings impact expected » Rating possibly affected if material operating issues not previously disclosed are somehow surfaced »Some expect benefits post-implementation –Improved transparency in composition of fund balances –More standardization in presentation of fund balances »But, trend analysis more difficult in the short-term –Not all issuers will be able to complete an historic restatement of fund balances » Some fund balances may “spike” from FY2010 to FY2011 due to GASB 54 reclassifications » We will look at annual changes to discern a consistent operating trend GASB 54 and Moody’s Analysis

29. VIRGINIA GFOA JUNE 9, 2011 Susan Kendall Vice President/Senior Analyst Lead Analyst, Virginia Regional Ratings 617-204-5634 susan.kendall@moodys.com Julie Beglin Vice President/Senior Analyst Team Lead, Eastern Regional Ratings 212-553-4648 julie.beglin@moodys.com 29 Dora Lee Associate Analyst Eastern Regional Ratings 212-553-1477 dora.lee@moodys.com Jennifer Rinaca Associate Analyst Eastern Regional Ratings 212-553-4346 jennifer.rinaca@moodys.com

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