While the demand for government bonds are shaky due to governmental finance uncertainties, you can find a good level of comfort in the safety of the aloha state's bond market. The State of Hawaii and the four counties - Hawaii County, City & County of Honolulu, County of Kauai, and the County of Maui - sells general obligation bonds to finance infrastructure improvement projects.
Despite municipal bond downgrades and defaults, bonds by the State and Counties have maintained stellar bond ratings by Moody's of at least an A rating, signifying a high ability to repay short-term debt and serve as an upper-medium grade of bonds with low credit risk in the long-term.
What I'd like to do is present my bull case of bonds issued by the State and County levels of government - one entity at a time. This article will discuss the State level. I feel that it illustrates the safety of these governmental bonds, it would be best to also discuss certain fundamentals of the Counties and the State. Please bear in mind that I may not be able to provide some of the up-to-the-minute figures because the State and Counties are currently in the budget preparation process and may not have enacted budget bills for another month or so - at the earliest.
The Political Staging
The State of Hawaii has undergone significant changes in the political climate since the elections in the fall of 2012. For starters, out of four congressional delegates - two Representatives and two Senators - three of those seats have new incumbents. Second, due to the untimely passing of one of the two U.S. Senators, our former Lieutenant Governor has been appointed to fill the Senate seat, resulting in the then-State Senate President becoming the new Lieutenant Governor. Third, several incumbents in the State Legislature lost their seats due to either stiff competition from new challengers or due to a State reapportionment.
The late former U.S. Senator Daniel Inouye (D-HI) was a heavy-hitter in securing federal funding for the State of Hawaii. The State of Hawaii economy relies on two industries - tourism, and the military. Since tourism is predicated on various other market factors, the only real controllable element was the military funding, which Senator Inouye was able to secure to the benefit of Hawaii. Of course, Senator Inouye did also work to secure additional federal infrastructure improvement program funding for certain projects happening in Hawaii.
Operating vs. CIP Budgets
For as long as the budget process has been in effect in Hawaii, there are essentially two State budgets: the operating budget - which covers the day-to-day operations of the State - and the Capital Improvement Programs (CIP) budget - which finances all infrastructure improvement and construction activities to State properties. The operating budget is comprised only of cash received from tax revenues, while the CIP budget issues general obligation bonds to finance their projects. As part of the operating budget, some of the funds are allocated to pay for bonds repayments.
The Council on Revenues
As a result of the 1978 State Constitutional Convention, the Council on Revenues was created. The Council is made up of seven economists and business executives who provide short and long-term forecasts of the State's economy with data that has been provided by the State Department of Taxation. The Council prepares quarterly and annual estimates of tax revenue collected and governmental expenditures and report projections and actual data every June 1st, September 10th, January 10th, and March 15th to the Governor and State Legislature.
The estimates that the Council comes up with must be taken into consideration by the Governor and the Legislature in creating any revenue-related legislation as well as the State budget.
Because the current biennial budget hasn't been finalized or approved yet, I will cite numbers from the State Department of Budget and Finance's version of The FB 2013-2015 Executive Biennium Budget Budget in Brief.
Means of Financing
Other Federal Funds
Federal Stimulus Funds
The base columns reflect operating base budget amounts given to all State agencies equivalent to their FY13 budget appropriation. A significant portion of the requested general funds are for non-discretionary costs. Approximately sixty-three percent ($278.5M) are for non-discretionary cost increases. $76.7M in FY14 and $81.9M in FY15 will be dedicated to debt service for CIP for the Department of Education, University of Hawaii and other State programs.
Means of Financing
General Obligation Bonds
General Obligation Reimbursable
Other Federal Funds
General Fund Debt Ceiling
Section 9, Article VII of the Hawaii State Constitution requires that the legislature establish a general fund expenditure ceiling which limits the rate of growth of general fund appropriations, not including federal funds, to the estimated rate of growth of the State economy.
The FY14 operating budget requests $11,757.9M with CIP requests at $1,707.4M. That comes out to approximately 12.7% in debt. The FY15 operating budget requests $12,080.7 with CIP requests at $906.2M. That totals approximately 7% in debt. The figure is indeed scary.
Why Hawaii Bonds Gives Aloha
Despite a high level of debt service and available State bonds issued to the open market, I see a few reasons why you can depend on these bonds providing your portfolio and pocket with some aloha:
Chapter 37 of the Hawaii Revised Statutes requires the State to only pass a balanced budget.
None of the administrations in the State - State level or County level - is willing to lose their superior bond rating, therefore if they must cut funding from other State operations to pay for debt service, they will.
The State administration has emphasized plans to restore the rainy day fund to 2011 levels, when the fund had $60M on-hand. To underscore the point, Hawaii had changed an administrative rule that previously required that any general fund ending balance exceeding five percent of the budget be used to provide a tax refund. Under the new change, the legislature can choose between providing a tax refund or deposit the balance into the State's rainy day fund.
State bonds hold an Aa2 bond rating from Moody's.
- The various State bonds have coupon rates ranging from 3.25% to 5.65%.
Reasons of Concern
Like any investment vehicle, there are always reasons of concern attached to them and periodically red flags. In this case, please be aware of the following reasons of concern:
- Bond yields do provide a lower yield than the preferable high-yielding stocks.
- The Hawaii economy is driven by two industries: tourism and military. Senator Inouye's passing put Hawaii near the bottom of the priority list for financial appropriations, therefore ensuring that less money would go into Hawaii's economy from the Federal Government. In previous instances where terrorism scared the market, tourism took a hit in Hawaii.
- Due to the debt load taken over the years with the current debt load plus other operating liabilities, Hawaii's total debt per capita is approximately $29,061 - exceeding any other state in the country. This debt could scare any investor.
- The high level of debt could require more payments in the future. Combined with any future CIP expenditures needed, at some point the State hypothetically could overextend their financial resources, leading to an inability to pay and therefore a downgrade in bond ratings.
I believe that by buying Hawaii State bonds, you'd be giving your portfolio and wallet a little bit of aloha by providing a steady stream of income for your money. You can choose to buy these bonds individually through your broker. The State of Hawaii's Aa2 bond rating and the legal provisions of Section 9, Chapter VII and Section 37-92 of the Hawaii Revised Statutes provide statutory safeguards to ensure some peace of mind. Keep in mind that there are still risks associated with this investment. Specifically, the risk of increasing debt loads. Ultimately, the decision to invest or not to invest would be up to you - hopefully after doing your own independent research on this.
In future articles I will discuss the individual counties' fundamentals and why I believe that the bonds of either Honolulu, Hawaii, Kauai, or Maui County are a safe investment as well.