DETROIT – AFTER THE FIRE…THE FIRE STILL BURNS

So now the hearings have ended and a decision will be announced on November 7 as to whether or not the City’s Plan of Remediation will be accepted. Regardless of the actual finding, it seems appropriate to consider what it is that the City actually accomplished and what the implications are for the municipal market in the long term.

Some of the conclusions are obvious and immediate while some are more subtle. Obviously, the strength of the general obligation pledge has been forever diminished. In the end, the City was effectively allowed to abdicate its responsibility to the bondholder to take all means necessary within the context of its sovereign immunity and police powers. While the immediate circumstances in Detroit may provide a stronger case for such an abdication than in some others, the fact that the City systematically failed to exercise its responsibilities over decades makes absolution a less acceptable concept.

The real triumph in this case belongs to lead bankruptcy counsel. The resolution of this case on essentially the City’s terms represents the culmination of a two decade effort on counsel’s part to weaken and permanently diminish the value of the GO pledge. 20 years and two multi-billion dollar defaults later, victory in this quest is almost within grasp. Academically and legally a success perhaps but definitely a failure for the bond market and the faith of the individual investor in it.

In the case of the City, the result is at best a very qualified win. The improvement in the City’s position is purely on the liability side of the balance sheet. The City still has overwhelming infrastructure needs, a limited economy and tax base, and a significantly weakened political base. Individually, each is a major credit negative. In combination, they create what is at best a highly speculative investing environment. Raising the revenue necessary to support the kind of capital and operating expense required over the foreseeable future remains a formidable challenge. The school system is still very poor, the jobs base for an undereducated core population remains insufficient, and the environment for raising taxes and state aid remains hostile.

So in many ways the City’s victory appears to be Pyrrhic at best given the damage done to such a significant sector of the municipal bond market. Hopefully, no one considers this to be mission accomplished.

PR BACK BY ITSELF IN THE SPOTLIGHT

The ongoing nature of the challenges facing Puerto Rico were reemphasized through the release of more negative economic data and additional cautionary commentary from Moody’s about the ongoing liquidity weaknesses of the GDB. The GDB released a  revised liquidity projection earlier this month. It projected that its quarter-ending available cash  might be as much as 22 % under previously forecast amounts unless a bond issue could be floated to refinance debt owed by the Highway & Transportation Authority (HTA).

The GBD’s forecast, an update from its last projection made in March, projected that available cash will stay close to $2 billion through the fiscal year ending June 30, 2015. This is contingent on the receipt by the bank of at least  $1 billion or more from a proposed bond financing to repay some of HTA’s outstanding $2 billion in loans made to the Authority from the GDB. If Puerto Rico fails to refinance any of the loans, GDB’s available reserves would fall to $819 million at the end of March 2015, versus some $1.05 billion using GDB’s prior forecast.

Puerto Rico is expected to announce details of the planned financing, which Moody’s speculated would involve a pledge of new petroleum products tax revenues, subject to authorizing legislation, during a GDB investor webcast on Wednesday. The plan would be for the transaction to occur before year-end 2014, according to the liquidity projection. The  GDB has maturing note principal totaling $481 million in fiscal 2015, and to $876 million in fiscal 2016.

Moody’s said, “depletion of GDB’s cash position, which serves as a proxy for that of the commonwealth, could lead the commonwealth and GDB to resort to budgetary payment deferrals and other cash management tools in order to pay debt service, which would increase the risk of default and place negative pressure on the rating of the commonwealth and its related entities. While such a scenario, with heightened default probabilities, would indicate growing credit pressure on the ratings of the commonwealth and related entities, we believe it is unlikely.”

If the proposed transaction occurs, a $1 billion infusion to GDB would result and quarter-end liquidity would rise about 72 percent above previously projected sums, reaching almost $2 billion on June 30, compared with $1.1 billion under the March forecast.

GDB reported that its net liquidity as of September 30 was $1.4 billion — $1.7 billion less than on June 30. Withdrawals of funds by the commonwealth and its corporations have reduced GDB liquidity in the intervening months. The Puerto Rico Electric Power Authority withdrew $40 million for debt service from its GDB accounts, and the commonwealth withdrew $700 million in the form of a Tax and Revenue Anticipation Note (TRAN) as well as another $700 million from its own debt service accounts for general obligation bond debt service, according to GDB’s liquidity report. An external TRAN financing subsequently allowed the commonwealth to repay $400 million to GDB.

On the economic front, The Puerto Rico Labor Department reported this week that 981,000 people were employed in September, 35,000 below the same month a year ago and 7,000 less than August. The September unemployment rate was 14.1 percent, up from 13.5 percent in August. This was however below the 14.6 percent rate in September 2013. There were 161,000 people officially unemployed in September, 12,000 less than a year ago. In August there were 154,000 people actively seeking work and collecting jobless benefits through the Labor Department.

Nearly 43 percent had been unemployed for less than five weeks; 26.7 percent for between five and 14 weeks; and 30.5 percent for at least 15 weeks. More than 51 percent of those listed as unemployed in September said they were laid off involuntarily and did not expect to be called back. In August there were 154,000 people actively seeking work and collecting jobless benefits through the Labor Department. Puerto Rico’s labor participation rate dropped back below 40 percent in September, settling at 39.6 percent, down from 40.9 percent in September 2013 and 40.1 percent in August. Agriculture employment in September dropped 2,000 jobs to 21,000 on a year-over-year basis.

PHILADELPHIA CITY COUNCIL SAYS NO TO GAS WORKS PRIVATIZATION

Philadelphia City Council President Darrell Clarke said Monady that the risksof selling Philadelphia Gas Works Co., the  largest municipally owned gas utility in the U.S., outweigh the benefits. “While Council concludes that the terms of this sale proposal are insufficiently favorable for Philadelphians and pose an unacceptable degree of risk to consumers, we readily acknowledge opportunities for the enhancement and possible expansion of PGW’s operations,” Clarke said. The deal, which was struck in March, was then estimated by Mayor Michael Nutter to enable the City to apply at least $424 million into the city’s retirement system, which is 47 percent funded. UIL Holdings, the proposed buyer had promised to fund replacement of much of the system’s aging cast-iron pipe. While the Council debated the issue internally, it never held public hearings on the proposed sale.  The Council President said that a report from its consultant, Concentric Energy Advisors, showed that losing PGW’s annual $18 million payment to the city dropped the value of the proposal and that there were no commitments to keep bill increases “at reasonably affordable levels” after three years of UIL ownership. The council didn’tpropose another solution to shore up the pension system, while cutting services and raising taxes to pay for pensions aren’t “particularly viable options,” according to Mayor Michael Nutter. In the interim, the S&P rating for outstanding PGW revenue bonds was upgraded to A- from BBB- on October 21.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Municipal Credit Consultant

DETROIT BANKRUPTCY GETS AN ‘OUT DATE’

U.S. Bankruptcy Judge Stephen Rhodes announced at this week’s Monday hearing that he expects to announce his decision as to the feasibility of The City of Detroit’s Chapter 9 during the first week in November. This will occur essentially at the same time as Michigan voters render their verdict on whether or not to re-elect Governor Rick Snyder to his post. Snyder currently leads his opponent by an average of 3.5% points in recent polls but this gap is within the margin of error. While the overall Michigan economy is the primary issue, the vote is also seen  as a referendum on the Governor’s appointment o an Emergency Manager in Detroit and the resulting Chapter 9 plan.

Investors must remember that confirmation is a determination of feasibility o the City’s Plan of Adjustment by the bankruptcy judge. Other issues such as fairness and equity have essentially been “settled away” by the City and its major creditors. The judge again urged remaining individual objectors to the plan to settle their issues by the time of his decision. The process of settlement pursued by the City effectively allowed the bankruptcy process to skirt those fairness and equity issues so his decision – especially if it affirms the Plan feasibility – will not provide clear guidance going forward to other municipalities evaluating the potential usefulness of bankruptcy as a “tool” in managing their long term liability issues especially as they pertain to pensions.

In the meantime, private economic efforts to redevelop the City core economically proceed. Mike Illitch, the owner of the Detroit Tigers and Red Wings participated in an official groundbreaking ceremony at the site of the new arena for the Red Wings designed to be the centerpiece of a large  redevelopment scheme. The construction of this facility will facilitate the demolition of the Joe Louis Arena and allow the transfer to and development by major city creditors that is a key component to the achievement of claims settlements in the current bankruptcy proceedings.

PUERTO RICO REVENUES IMPROVE BUT FALL SHORT

The Treasury Department of Puerto Rico reported a mixed bag of results for revenues through the end of September. Total General Fund (GF) revenues for the three months ending September 30 were $1.774 billion. This was $75 million more than was collected during the first quarter of FY 2014, but was short of estimates by some $36.4 million. September collections were $46 million below the Treasury’s original estimate of $755 million at $709 million. The monthly shortfall was the second consecutive monthly miss in actual versus estimated collections.

Many major categories actually increased such as income and sales taxes but collections overall were another victim of congressional inaction. Revenues connected with rum excise taxes were negatively impacted as Congress failed to pass extender legislation which had the effect of reducing the tax take rebated to the Commonwealth from $13.25 to $10.50 per gallon. While this can be addressed retroactively by Congress, it is not required and the Commonwealth is counting on those revenues for budget balance and cash flow. Motor vehicle excise taxes continued to decline for the third straight month but at a slower pace.

A more recent piece of bad news was the decision of a lower court in Puerto Rico which upheld a claim for $230 million of tax refunds from the Commonwealth of Puerto Rico by Doral Financial Corp. If upheld after all appeals are exhausted, the award could be amortized through a $45 million per year payout over five years.  Puerto Rico however, enacted its Fiscal Sustainability Act (Act 66-2014), which provides for all adverse judgments, other than those resulting from eminent domain or court-approved paymentplans, to be budgeted annually after consideration of  the financial condition of the Commonwealth. It also provides that in no event shall such appropriation exceed $3 million for a given year. Puerto Rico apparently expects  Act 66-2014 to applyin the event of a final adverse judgment in the Doral case, but one would expect this tobe contested by Doral. Puerto Rico intends to appeal the case if necessary to the Puerto Rico Court of Appeals and the Puerto Rico Supreme Court.

CHICAGO BUDGET PROPOSAL

The political morass at the state level continues to influence the efforts of the City of Chicago to address its looming pension cost crunch. Under current state law, the city will have to pay another $550 million into those funds in 2016. The initial budget proposal does not reflect that in the 2015 budget property tax levy. Instead, Mayor Emanuel hopes that he can get state legislators to restructure those funds after the upcoming legislative elections in a way that reduces that payment. The City cannot make changes in its employee pension plans without legislative action at the state level.

Away from the pension issue, the budget proposal calls for a variety of non-property tax increases totaling $62 million. These increases include a 2% rise in parking taxes at city garages, ( $10 million). Valet parking services also would have to pay that tax on their full fees to customers( $2 million). The mayor also proposes eliminating an exemption in the cable TV amusement tax, typically passed on to consumers by $12 million.

Businesses and individuals who lease office equipment and vehicles would see a 1% increase in the personal property tax on those transactions, bringing the total tax to 9 % ( $17 million). The mayor also would start applying that tax to on-the-go car rental services, like Zipcar, to raise $1 million. The plan also calls for the city to raise an extra $17 million by collecting sales taxes now evaded through rebate deals with distant suburbs — a measure expected to bring in more money from fuel purchases by airlines — and another $4.4 million by eliminating an amusement tax rebate charged on luxury skyboxes at city stadiums.

These increase are on top of previously enacted increases of $1.40 a month of the city’s 911 tax on cell phones and land lines while also raising the tax on prepaid cell phones by 2%. Those fees went fully into effect at the start of this month and are expected to increase city revenue by about $50 million by the end of the next year. These increases free up an equal amount of money to cover the city’s required additional payments into city workers’ and laborers’ pension funds next year, under a restructuring of those funds approved earlier this year by the General Assembly. In each of the four following years, the city will have to come up with another $50 million to pay into those two funds.

These increases would occur in addition to doubling sewer and water fees, increasing vehicle sticker fees, increasing weekday and higher-end garage taxes, raising hotel taxes, boosting cigarette taxes and setting up ticket-issuing speed cameras near schools and parks. And yet the police and fire pension issue still drags on the City’s credit! But is that truly a surprise? While the political outlook for the Mayor has improved in light of the illness of an expected strong opponent, the reality is that meaningful reform is likely to occur later rather than sooner. We would not be surprised to see an additional downgrade of the City prior to the enactment of meaningful reform which is likely not to occur until after the 2015 local elections in Chicago.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist
Municipal Credit Consultant

DETROIT BANKRUPTCY MOVES INTO HOME STRETCH

The City and its remaining holdout creditors used this week’s hiatus in the proceedings to reach tentative settlements of the major remaining objections to the City’s Plan of Remediation. Settlements were announced by FGIC and the City on its claims associated with pension bonds issued by City-related entities. FGIC and the bondholders will get $141 million in new notes but will also receive some nine acres of riverfront property currently occupied by the Joe Louis Arena, home of the City’s NHL Red Wings. Bond insurers and bondholders will have an option to put a hotel and retail development on the site after demolition of “the Joe” in 2017. The demolition will be financed by the State. Bondholders include funds managed by Aurelius Capital Management and BlueMountain Capital Management. FGIC said that the settlement ” provides FGIC a recovery consistent with other Class 9 creditors. FGIC has always been, and continues to be, believers in Detroit’s long-term revival prospects, and this deal gives us the opportunity to participate in and help catalyze that revival.”

The City also announced a settlement with the Macomb County Interceptor Drainage District. The District settled its claim for $22 million. The District and FGIC were essentially the last institutional objectors to the Plan. Remaining objectors to the Plan of Remediation are some individual investors, residents, and pensioners. Their objections were being heard by the bankruptcy judge as we went to press. An additional hearing is scheduled for the next week in the trial on the Plan which resumed today. A decision on the feasibility of the Plan from Judge Rhodes could be expected soon thereafter.

REFUNDING TO BOLSTER CA. TOLL ROAD CREDIT

Next week, the San Joaquin Hills Toll Corridor Agency (TCA) is scheduled to market $1.35 billion of refunding bonds to finance the restructuring of the TCA’s debt and relieve some of the pressure to raise tolls to maintain debt service coverage and stabilize the TCA’s credit ratings. The TCA’s Orange County toll facilities have consistently underperformed in terms of usage and revenue since their opening in the mid 1990’s. This has led to lower than projected coverage and concerns that revenues would be inadequate to meet sum sufficient rate covenant and coverage requirements. This reflects the TCA’s generally ascending debt service schedule which requires sustained growth in available revenues.

Last week S&P announced that it raised its rating to BBB- from BB- on the TCA’s outstanding 1993 and 1997 toll road revenue bonds and assigned the same rating with a stable outlook to the proposed senior refunding bonds. A ‘BB+’ rating was assigned to the junior lien portion of the proposed issue. The planned restructured debt service schedule increases from approximately $107 million in 2016 to an approximate peak of $210 million in 2042. Restructured maximum annual debt service (MADS) is significantly lower than the previous MADS of approximately $270 million, and the annual rate of growth in debt service from 2016 to 2026, averages approximately 2.3%. The restructuring extends the final maturity from 2042 to 2050. This is typical of many such past restructurings.

Disclaimer: The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column. The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned. Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice. Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed. Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Municipal Credit Consultant

DETROIT BANKRUPTCY MOVES INTO FINAL ROUNDS

The City of Detroit’s Chapter 9 proceedings are on hiatus until next week. The break provides a good opportunity to assess just where things are and the issues which will confront the City regardless of the outcome of the current trial. Recently concluded testimony centered on the willingness of city officials to follow through on any plan approved by the bankruptcy court. A key component of any Chapter 9 plan confirmation is a determination of feasibility by the bankruptcy judge. In reality, much of the ultimate feasibility of any such plan rests on the willingness and ability of a city’s body politic to take the actions necessary to implement the plan both in the long and short run. Given the recent extended history of the City’s politicians in terms of their ability and willingness to make hard choices in managing the City’s finances, this is clearly a source of concern to all of the various constituencies in these proceedings.

City officials have responded as expected to inquiries on these topics. The judge has however, been quite direct in his questioning of the witnesses called to support the City’s case for approval. He noted the need for sustained support for the plan by both the executive and legislative branches of City government and expressed concerns about certain reversals of previously expressed views about the need for a bankruptcy as well as individual components of the resulting Plan of Adjustment by some of the witnesses. His concerns mirror those expressed by many entities over recent months as the Chapter 9 proceedings unfolded.

The judge also continued to use his position as final arbiter in these proceedings to encourage more negotiation over issues involving the creation of the Great Lakes Water Authority. This issue remains unsettled as suburban participants still want assurances as to the future operations and maintenance of the Authority’s assets as they impact future resource needs to repair and expand the system. Those negotiations continue to occur through mediation.

The issue of whether the assets of the Detroit Institute of Art remains as part of the proceedings as FGIC continues to argue in favor of more equitable treatment of debt holders versus the City’s pensioners. The topic is of continuing interest broadly given the increasing role of pension funding as a source of long term credit pressure for so many issuers.

PENSIONS AT CENTERSTAGE IN STOCKTON

Last week’s decision regarding the status of Stockton CA’s obligation to make payments to the CA Public Retirement System (CALPERS) classified that obligation as contractual and potentially subject to adjustment under the Bankruptcy Code. The decision got wide attention as this is the first of many Chapter 9 proceedings to actually get far enough to have the issue decided judicially rather than through settlement. Franklin Resources had been challenging the City’s plan to meet obligations to CALPERS and therefore to its pensioners in full while offering general creditors like Franklin effectively minimum  payments on obligations owed to them. In a sector of bankruptcy which has a relatively small body of precedent, decisions like this receive much attention. The judge’s decision is not necessarily precedent setting as it is not binding on any other proceeding or jurisdiction. It may not even prevent the judge from determining that the City’s Plan of Adjustment is feasible or confirmable even with the proposed unequal treatment of the two creditor classes. A decision is expected at month’s end.

NEW JERSEY’S PENSION AND CREDIT BIND

Next week, MAGNY will hold a presentation on the State of New Jersey and credit issues confronting the state. First and foremost among the issues which have led to several downgrades of the State’s GO and appropriation debt ratings has been the issue of pension and OPEB benefit funding. The issue was a prime concern for Governor Christie’s first term and he used a fair amount of favorable political capital to reform and strengthen the state’s pension systems which had been chronically underfunded.

Primary among the actions taken was the enactment of legislation designed to address underfunding through scheduled annual payments from general state funds to shore up the available asset bases of the funds. The expectation was that careful fiscal planning bolstered by a recovering state economy would provide the necessary resources to fund the annual payment goals. Unfortunately, the state economy did not grow as expected due to a variety of factors and the state revenue projections overestimated the level of resources available. The impact of Hurricane Sandy exacerbated the State’s economic woes.

The revenue shortfalls could have been addressed in any number of ways including increases in certain tax rates. Political considerations kept that from happening so the State found itself in a deficit position at the end of FY 2014 and facing a projected shortfall for FY 15. One of the major ways the State decided to address this general problem and balance the budget was to effectively renege on the promises contained in the 2010 pension legislation and appropriate a smaller amount than required to the pension funds.

Now the State finds itself in the position of facing an ongoing imbalance between revenue and expense (structural imbalance) and a growing unfunded benefit liability, reversing a trend of improvement experienced in the early years of this decade. One of the primary suggestions which proponents of pension reform advance is the conversion of benefit plans to a 401(k) type model. A recent report by Stephen Herzenberg

Executive Director, Keystone Research Center – How to Dig an Even Deeper Pension Hole – raises questions about whether this would be the most effective path for New Jersey to follow.

The Herzenberg report postulates that a transition of the state’s defined benefit plans to a defined contribution model could cost the state some $42 billion. This would reflect the impact of closing the current system to new employees thereby skewing the average age of beneficiaries higher. The report cites two negative impacts from such a move. First, investment managers are assumed to shift plan assets from higher-return to

safer assets – just as individual investors approaching retirement shift savings away from risky assets to protect themselves against market drops shortly before they start to withdraw money, thereby reducing investment earnings. Second, as DB recipients

age out and retire more and more of the funds remaining in the plans need to be removed from non-liquid assets, such as private equities, and invested in liquid assets that are easy to convert to pension checks for retirees. This will also lower the

rate of return, increasing the taxpayer contributions needed to honor existing pension obligations.

While the State evaluates its options, the downgrades continue and the State finds itself scrambling to get is arms around structural balance and funding of pension liabilities. Investors will be watching presentations such as that scheduled for next week. How the State addresses these difficulties will impact the directions of its credit and the ongoing relative valuations of its outstanding debt.