Joseph Krist

Municipal Credit Consultant

ALL GOING WRONG FOR PUERTO RICO

If it had not already, PR’s financial crisis has reached critical mass for sure. The GDB was a source of loads of negative news. First, it announced that the Commonwealth would be unable to meet its required annual financial disclosure by May 1. Then the Bank released a letter to the Legislature which suggested that the Commonwealth would be unable to meet its liquidity requirements at the start of the fiscal year on July 1.

The bank made the warning in a letter made public a day after it was sent to Gov. Alejandro Garcia Padilla and the presidents of the island’s Senate and House of Representatives. “The island’s financial state is extremely uncertain,” the letter said. “A government shutdown would have a devastating impact on the economy, with salary and public service cuts, and a long and painful recovery.”

The letter urged legislators to immediately implement measures to cut costs and balance the budget and that  the government needs to approve a five-year plan to help reduce a $73 billion public debt as well as approve sweeping changes to the island’s  tax system.

In a number of interviews, David Chafey, president of the bank’s board of directors said once the government does that and presents a balanced budget, then it can be in a better position to issue bonds. “Time is passing, and it’s passing quickly,” he told The Associated Press. “We need to provide investors with some kind of comfort.”

Typically one agency of the government will not write to the rest of the government so openly but the letter was issued amidst negotiations between  Gov. Garcia and members of his party who oppose legislation that would impose a 16% value-added tax that he says is needed to help generate more revenue. In the House of Representatives a group of legislators reached a tentative agreement to impose a 14% value-added tax. If passed, the measure would then go to the Senate.

Stunningly, the GDB letter and the Governor’s efforts appear to have been for naught. Earlier in the morning of the the Governor’ s speech the House convened to consider the Governor’s plan to impose a value added tax of VAT as part of his financial reform package. In the session which ran past 3 a.m., the House of Representatives voted down the tax reform bill after failing to secure enough votes from the Popular Democratic Party (PDP) majority. Along with the New Progressive Party minority delegation, six PDP members voted against the measure. The final vote count was 22 in favor and 28 against.

The governor characterized their vote as “irresponsible” and “disloyal,” and the House speaker said that the PDP caucus will seek disciplinary sanctions for the six legislators.

After the vote, Puerto Rico Gov. Alejandro Garcia Padilla unveiled a $9.8 billion operating budget Thursday night in which he pledged to reduce crime, create jobs, boost school attendance and expand the U.S. territory’s tourism sector during a state of the commonwealth address. Padilla said he plans to reduce the island government’s $2.2 billion deficit to $775 million in one year, in part by taxing those who earn $200,000 or more a year or who buy homes valued at $1 million or more. He did not provide details about those taxes. On the sales tax front, Padilla also said that by Dec. 1, he will reduce the 7 percent sales tax to 6.5 percent and continue to exempt items including prescription medicine, books and non-processed foods. Those looking for an austere budget will be disappointed that Padilla promised that overall, more than 40,000 public employees in 28 agencies will see pay increases by next February. Padilla’s proposal is $750 million higher than the current budget, which legislators of the opposition party questioned.

According to recent reports by Bloomberg and Reuters, PREPA bondholders will be granting the utility a 30-day extension on its forbearance agreement, which had been set to expire today. This would be the third extension conceded to the troubled utility after the original March 31 deadline.

 PRISON DEBT BACK IN THE SPOTLIGHT

It has always been one of the riskier areas of the high yield market so the news of at least two facilities having debt problems in Texas is not a surprise. One is the now empty  Willacy County Correctional Center in Raymondville. One morning late last month, the prisoners rioted. Guards put down the uprising in about five hours, but the destruction was so extensive as to force the closure of the facility leading to all 2,800 inmates being transferred. “Worst scenario, we’ll lose about $2.3 million annually, which is about 23 percent of our income,” said one Willacy County commissioner.

The County counts on the prison as a business generating revenue. The prison’s water and sewer bill is $50,000 a month. Once insurance pays for extensive repairs to the prison, the county needs to fill those beds again as the facility is looked as a way to generate revenue and create jobs. Willacy County built three of them. The Correctional Center was the largest, with a staff of nearly 400. They’re now unemployed.

The County sold bonds, built the prison and hired an operator — Management & Training Corporation (MTC). MTC contracted with the U.S. Bureau of Prisons to incarcerate low-security male immigrants who are serving out sentences for illegal border crossings and aggravated felonies. Many if not most of the private prisons in the Southwest were built to service this “market”. For that service, the federal agency paid MTC to manage the prison. Then MTC paid the county $2.50 per prisoner, per day. But ultimately, it’s the county that’s on the hook for its $63 million debt on the nine-year-old prison.

When the U.S. Bureau of Prisons canceled its contract with Willacy County last week, it explained that the federal inmate population was down, and it didn’t need additional beds. The prison will be in competition with several other facilities for a more scarce “commodity”.  Like many private facilities, inmates have complained of bad living conditions and substandard medical care. MTC emphatically disputes this criticism. The company has hired a third party to investigate why the inmates mutinied. Meanwhile, Willacy County plans to cut all non-essentials in its budget — such as plans for a courthouse renovation and a new hurricane shelter.

Elsewhere in Texas, on February 2, 2015, the Trustee, UMB Bank, N.A., for the $42 Million Bondholders has notified the Maverick County Public Facility Corporation that Maverick County failed to make a scheduled $1,415,000 principal payment on Bonds on February 1, 2015, but did make the February 1, 2015 interest payment. Consequently, the Trustee had advised the Maverick County Public Facility Corporation that there are “several events of default have occurred and are continuing under the Indenture.

As is usually the case, all Project Revenues are pledged as security for the Bonds and the County is obligated to cause all Project Revenues to be delivered directly to the Trustee. The County continues to intercept Project Revenues, which constitutes a violation of the County’s obligations under the Lease.The County has then remits funds that it requisitions back for payment of operating expenses. Under the terms of the Lease, all Project Revenues must be delivered directly to the Trustee and are to be used to pay Rental Payment Deposits first, prior to using such revenues to pay Project operating costs and expenses. The County’s failure to deliver intercepted funds to the Trustee for application towards the Rental Payment Deposit caused an Event of Default.

A further complication is the fact that the Corporation had its non-profit corporate charter forfeited in August 28, 2009. The Maverick County Public Facility Corporation continued to enter into many legal agreements regarding the operation, management, and detention of federal prisoners at its Maverick County Detention Center as well as with the $42 Million Bondholders and Trustee, the U.S. Marshal’s Service, financial advisors, legal counsel, and other third party contractors. All of these actions potentially expose Maverick County to significant financial risks and liabilities.

The Maverick County Public Facility Corporation is in negotiations with the $42 Million Bondholders and Trustee in either restructuring the principal and interest payments owed on the debt and/or the forbearance of these payments and recently terminated its long standing financial advisor, Southwestern Capital Markets, Inc., while retaining a new one in First Southwest Capital.

The potential workout is additionally complicated by events associated with ongoing federal corruption investigations of the County. A Maverick County commissioner and former justice of the peace were arrested last week as part of an ongoing bribery investigation in the border city of Eagle Pass that has resulted in arrests bringing the total number of people charged in the ongoing investigation into a bid-rigging and kick-back scheme in Maverick County to 22. Among the others charged are three former county commissioners all of whom have pled guilty.

In Burnet County, a private jail deal will produce significant principal losses for bond holders after the facility is sold to the County. The 587 bed jail has been privately operated until 2014 when the County took it over. The County will pay $14.85 million for the facility while there are some $32,770,000 of bonds outstanding. The jail had been consistently underutilized and had proven to be a less than secure facility after several escapes. County inmates are sufficient to occupy only about 30% of the beds.

WAYNE COUNTY FINANCIAL UPDATE

Earlier this year we reported on the financial woes facing Wayne County which includes the City of Detroit within its borders. This week County  Executive Warren Evans unveiled a recovery plan with deep cuts – including wiping out retiree health care – in an effort to avoid bankruptcy. According to Evans, “this plan will prevent bankruptcy even though in some areas we are worse off [than when] Detroit was pre-bankruptcy.”  Wayne has just under $700 million of limited-tax general obligation bonds and $302 million of LTGO notes outstanding.

The plan eliminates the county’s $52 million structural deficit but the pension system that’s only 45% funded with a $910 million shortfall and a $200 million, bond-funded jail project in downtown Detroit that the county abandoned half built due to lack of money are not dealt with. Since 2008, the county’s has plugged general fund shortfalls by shifting money from its pooled cash fund. According to the County Executive, the county will not be liquid enough to rely on fund transfers anymore and will be entirely out of money by next summer.

The plan would eliminate health care for future retirees. It would move most employees and some retirees to high-deductible insurance plans and provide retirees with fixed and limited subsidies for the purchase of supplemental insurance, likely under the new federal health care law. That’s similar to what Detroit did in its bankruptcy, shifting retirees to the national exchange. These cuts would save $28.4 million in 2015, with annually increasing savings rising to $49.8 million by 2020.

It raises the retirement age to 62 and reduces future pension benefits by changing the pension multiplier. It increases the number of years used to determine compensation to 10 years from the current three- to five-year equation. All county employees would see 5% salary cuts. The total impact of these cuts would mean $60.3 million in savings for the county, including $53.4 million in the general fund.

In February, Evans blamed the county’s problems on a loss of property tax revenue and “fiscal and managerial mismanagement.” The county receives 60% of its general fund revenue from property taxes, which fell to $289 million by fiscal 2013 from $408 million in fiscal 2008. The plan assumes no increase in property tax revenue until 2018, and then only a $4 million boost.

The problems on the capital side are based in the county issue of $200 million of bonds in 2010 for a new jail, which is supposed to replace the current aging criminal justice facilities. But the county was forced to abandon the project in 2013 when it became too costly, and the county cannot return to the markets for additional financing in its current fiscal condition.

The county lost its last investment-grade ratings shortly after initial comments about the county’s finances in February.

 

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

TOBACCO USE DATA RELEASED

This is the time of year when tobacco securitization investors refocus attention on sales figures and funds available for distribution at mid-month under the terms of the Master Settlement Agreement. As the states and their subdivisions calculate exactly how much is available to them from the April distribution, other data becomes available regarding smoking trends which are central to the analysis of these bonds.

The most recent Morbidity and Mortality Weekly Report (MMWR) from the Centers for Disease Control and Prevention and the U.S. Food and Drug Administration’s Center for Tobacco Products (CTP) showed that Current e-cigarette use among middle and high school students tripled from 2013 to 2014, according to the data. Findings from the 2014 National Youth Tobacco Survey show that current e-cigarette use (use on at least 1 day in the past 30 days) among high school students rose from 4.5 percent in 2013 to 13.4 percent in 2014, or from approximately 660,000 to 2 million students. Among middle school students, current e-cigarette use more than tripled from 1.1 percent in 2013 to 3.9 percent in 2014—a rise from approximately 120,000 to 450,000 students.

This is the first instance since the survey started collecting data on e-cigarettes in 2011 that current e-cigarette use has surpassed current use of every other tobacco product overall, including conventional cigarettes. Hookah smoking roughly doubled for middle and high school students, while cigarette use declined among high school students and remained unchanged for middle school students. Among high school students, current hookah use rose from 5.2 percent in 2013 (about 770,000 students) to 9.4 percent in 2014 (about 1.3 million students). Among middle school students, current hookah use rose from 1.1 percent in 2013 (120,000 students) to 2.5 percent in 2014 (280,000 students).
There was no decline in overall tobacco use between 2011 and 2014. Overall rates of any tobacco product use were 24.6 percent for high school students and 7.7 percent for middle school students in 2014.

What is problematic for investors is that In 2014, the products most commonly used by high school students were e-cigarettes (13.4 percent), hookah (9.4 percent), cigarettes (9.2 percent), cigars (8.2 percent), smokeless tobacco (5.5 percent), snus (1.9 percent) and pipes (1.5 percent). The products most commonly used by middle school students were e-cigarettes (3.9 percent), hookah (2.5 percent), cigarettes (2.5 percent), cigars (1.9 percent), smokeless tobacco (1.6 percent), and pipes (0.6 percent).

The results are problematic as MSA revenues are based on sales of actual cigarettes or “sticks” rather than sales of all tobacco products such as roll-your-own tobacco and smokeless tobacco e-cigarettes, hookahs and some or all cigars. Should this trend continue, expected rates of cigarette shipment declines should be anticipated with negative impacts on securitization cash flows.

KANSAS REVENUE WOES CONTINUE

A new forecast issued Monday projects that the state will collect $187 million less in taxes through June 2016 than anticipated. This may force Gov. Sam Brownback and the Legislature to consider larger tax increases than they had expected to balance the state budget. Before the new forecast, they had been working on budget proposals requiring about $150 million a year in tax increases. Revising a forecast made in November, state officials and university economists reduced the estimate for total tax collections for the current fiscal year by nearly $88 million, to about $5.7 billion. They also cut the tax collection estimate for the fiscal year beginning in July by nearly $100 million.

MORE NEGATIVE NEWS FOR PREPA

OFG Bancorp announced that its Oriental Bank subsidiary (“Oriental”) will place its $200 million participation in a fuel purchase line of credit with the Puerto Rico Electric Power Authority (PREPA) on non-accrual status and will take a $24.0 million provision. The move reflects Oriental’s view that PREPA, despite its oil price related increasing ability to meet contractual obligations with creditors, has signaled an unwillingness do so.

Oriental, said, “Our credit analysis, based principally on data provided by PREPA and its advisors, shows the utility has the financial capability to pay its creditors. However, in the recent negotiation for extending the more than 8-month forbearance period previously granted by its creditors, PREPA clearly demonstrated a reluctance to commit to do so, despite the utility’s improved cash flows.”

Oriental’s $200 million PREPA exposure was acquired through the late 2012 purchase of BBVA’s Puerto Rico operations, and is part of a syndicated $550 million fuel purchase line of credit.

NEW JERSEY DOWNGRADE

Moody’s downgraded New Jersey’s general obligation bonds to A2 from A1. The outlook is negative. Ratings on the state’s appropriation-backed, other GO-related debt, and intercept programs were also lowered one notch. The downgrade to A2 was driven by the continuation of the state’s weak financial position and large structural imbalance, reflecting continued pension contribution shortfalls. Liquidity and structural balance are projected to remain very weak through fiscal 2016 – a longer period than contemplated. While some stabilization in budget performance, economy, and liquidity was noted, Moody’s is concerned that beyond fiscal 2016, the state’s plan to restore long-term structural balance relies on economic growth and further pension reforms, which have uncertain timing and impact.

The negative outlook reflects anticipated further decline in the state’s financial and pension position before pension reform, if successful, is implemented. Without meaningful structural changes to the state’s budget, such as pension reform that dramatically improves pension affordability, the state’s structural imbalance will continue to grow, and the state’s rating will continue to fall.

ATLANTIC CITY

The City of Atlantic City was granted a 60-day extension on a $40 million state loan that was due on March 31. The extension comes as a lawsuit was filed by the Borgata Hotel Casino that could challenge future bond sales. The city’s emergency manager Kevin Lavin released a report on March 24 recommending cutting expenses by $10 million this year as well as negotiating with key stakeholders to help create “fiscal stability.” Atlantic City is facing a projected $101 million budget gap in 2015.

Recent economic news includes a grand-opening for a new 85,450-square-foot Bass Pro Shops Outpost store with 200 employees on April 15. A new 16,000-square-foot development from BET Investments featuring upscale stores is also scheduled to open this year next to the Boardwalk Hall sports arena. One day after Polo North, a Wellington, Fla.-based developer received court approval to buy the Revel casino for $82 million, Polo North Inc. and Stockton University in Galloway Township, N.J. announced plans on April 3 to invest more than $500 million in the city.

Stockton, a public college, is slated to open its new Island Campus at the former Showboat Casino Hotel site in Atlantic City this fall. Polo North deposited $26 million in escrow for Stockton, which covers the $18 million purchase price the university paid for the former casino property as well as other costs incurred such as maintenance, utilities, employees and insurance.

Stockton has an 18-month first right to purchase or lease the property for educational purposes. A contingency in the deal allows the university a 90-day period to terminate the contract as it evaluates potential legal challenges from the neighboring Trump Taj Mahal, which has tried to block the bid because it doesn’t want college students living next to its casino.

CA WATER RATE DECISION

A California state appeals court on Monday ruled that a tiered water rate structure used by the city of San Juan Capistrano to encourage conservation was unconstitutional. The Orange County city used a rate structure that charged customers who used small amounts of water a lower rate than customers who used larger amounts.

The 4th District Court of Appeal struck down San Juan Capistrano’s fee plan, saying it violated voter-approved Proposition 218, which prohibits government agencies from charging more for a service than it costs to provide it. “We do hold that above-cost-of-service pricing for tiers of water service is not allowed by Proposition 218 and in this case, [the city] did not carry its burden of proving its higher tiers reflected its costs of service,” the court said in its ruling.

The court opinion means that tiered prices are legal as long as the government agency can show that each rate is tied to the cost of providing the water. A group of San Juan Capistrano residents sued that city, alleging that its tiered rate structure resulted in arbitrarily high fees. The city’s 2010 rate schedule charged customers $2.47 per unit — 748 gallons — of water in the first tier and up to $9.05 per unit in the fourth. The city, which has since changed its rate structure, was charging customers who used the most water more than the actual cost to deliver it, plaintiffs said. The law, they argued, prohibits suppliers from charging more than it costs to deliver water.

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

STADIUM FINANCE BACK IN THE SPOTLIGHT

The upcoming NFL draft has focused most attention and interest on who will be playing where next season. Based on recent performance, fans of the St. Louis Rams should be focused on player personnel issues but instead the primary issue is how long will they have a team to root for. Last month, NFL Commissioner Roger Goodell announced that the league was accelerating its efforts to move a team to Los Angeles. St. Louis Rams owner Stan Kroenke, with land in Los Angeles and a fully developed construction proposal, is a frontrunner in the race.

It has been pretty well established that the financing of professional sports facilities with public funds has generated questionable returns on that investment to the taxpayers of the entities backing those projects. Nonetheless, Missouri Gov. Jay Nixon’s two-man stadium task force has been working for months to solidify financing and sidestep project-killing delays before presenting plans for a $985 million riverfront stadium to a National Football League owners committee this spring.

The plans have been controversial and it is unclear that local residents would support such investment, especially in the City of St. Louis. There has been significant pressure to submit the question to a public referendum. In response, the public body that owns and operates the Edward Jones Dome filed suit Friday against the city of St. Louis, seeking to avoid a civic vote on the use of taxpayer money for a new downtown football stadium. Filed in state court, the suit claims that a 2002 city ordinance requiring a public vote is “overly broad, vague and ambiguous.” The suit seeks a ruling that the ordinance either does not apply, conflicts with state statute or is unconstitutional.

The suit is complicated by the fact that the City and State political establishments have been working together to build a new stadium. At the same time, the city counselor has a responsibility to vigorously defend all the laws of the city. City of St. Louis residents voted in favor the ordinance in 2002 by nearly 10 percentage points — 55 percent to 45 percent. St. Louis County voters approved a similar measure two years later, 72 percent to 28 percent. Approved as a municipal ordinance in the city and a charter amendment in the county — the two laws prohibit any “financial assistance” from the city and county to a professional sports facility without voter approval. They define “financial assistance” to include tax reduction, tax-increment financing, land preparation, loans, donations, payment of obligations, and the issuance, authorization, or guarantee of bonds.

The initial plans for the stadium included up to $450 million from the NFL and team, $130 million in personal seat licenses, some tax incentives and as much as $350 million through a “bond extension.” To support debt issued for the current stadium, the state sends $12 million a year to the authority which operates the existing Edward Jones Dome. Those funds amortize construction bonds and cover upkeep on the stadium. The city and county each send $6 million.

Now the political winds may be changing. St. Louis County Executive Steve Stenger has said that the Governor is no longer looking to funding from the County.  The lawsuit spells out the city’s now-expanded role in a new facility. According to the new filing the city will issue new bonds, which will pay off the city’s debt on the existing stadium as well as provide funding for construction of the new stadium. Debt service, the suit says, will not exceed the $6 million a year in current payments. The city also will donate land to the project, and provide tax-increment financing or creation of a transportation development district or community improvement district.

The Governor and Jim Shrewsbury, the Nixon-appointed Dome authority chairman and former city aldermanic president said that they didn’t think “another public vote” was required. Dome authority attorneys agree. Ten of the authority’s 11 board members at a meeting in January unanimously passed a resolution that allowed the authority chair to hire contractors and file suit on behalf of the board. The Mayor of St. Louis has not taken a public position on the financing but has written to city aldermen, promising to “vigorously defend the validity of our ordinance” and, whatever the outcome, follow the law. Confusing many, the  letter went on to describe plans to continue the City’s $6 million annual payments beyond the current debt expiration in 2021.

We are of the view that the stadium backers should follow the route taken by MLB’s San Francisco Giants and the owners of the NFL’s Jets and Giants and privately finance a new stadium. That is not to say that provision of land is out of the question. But the use of limited tax revenues and borrowing capacity for a private benefit facility like this is not the way to go.

SMUD COMPLETES LONG CREDIT ROAD BACK

The recent announcement by Moody’s that it has upgraded the rating on the Sacramento Municipal Utility District’s (SMUD) outstanding $1,873,105,000 electric revenue bonds to Aa3 from A1 and the rating on the $347,850,000 subordinate lien revenue bonds to A1 from A2 with a stable outlook completes a long journey on the road to credit recovery.

June 7 will mark the 16th anniversary of the vote to close the Rancho Seco Nuclear plant after a failure of power supply for the plant’s non-nuclear instrumentation system led to steam generator dryout which the NRC called the third most serious safety-related occurrence in the United States at a nuclear generating plant.

In supporting the upgrade Moody’s cited timely rate-setting as an unregulated utility with no revenue transfer requirement to city or regional governments; effective risk management program; improved financial metrics; the strong competitive position against regional peers; the improvement in the diverse local area economy; and the sourcing of 26% of renewable energy for retail load while maintaining competitive prices. Ironically, the forced closing of Rancho Seco may have been a long-term blessing in disguise for SMUD given California’s aggressive stance towards renewable energy. For example, California contemplates ramping up the renewable power standard to 50% by 2030.

SMUD may need to incur incremental capital expenses for a potential major pumped storage facility that would be used to help manage intermittent power flows owing to the state’s increased reliance on renewable energy. SMUD’s leverage ratios reflect a much more favorable debt profile, Any new capital spending is expected to be funded significantly from internal sources and the cost of construction of a pumped storage facility could be shared with area utilities.

LATEST PUERTO RICO REVENUE DATA…

Treasury Secretary Juan Zaragoza Gómez announced that General Fund revenues totaled $838.6 million in March, up by $53.5 million from March 2014. The 6.8% year-over-year increase is the highest increase registered during the past eight months. corporate income tax revenues were $104.8 million; this figure was up $36.2 million from March 2014 and $22.4 million above estimates. In addition, the Treasury Secretary pointed out that corporate revenues have not exceeded $100 million for a month of March since 2007. Individual income tax collections exceeded March 2014 collections by $22.0 million, a 13.2% increase.

Foreign corporation excise tax (Act 154) revenues were up by $57.9 million, or 40.5%, year-over-year. Alcoholic beverages and tobacco products collections increased by $1.3 and $1.4 million, respectively. In March, Motor vehicle excise tax collections, which have registered consecutive double digit percentage reductions throughout the fiscal year-to-date, registered the smallest reduction ($1.7 million, or 5.6%) in the last 9 months. The Treasury Secretary announced that fiscal year-to-date revenues total $6.0 billion, which is $153.2 million, or 2.5%, below estimates.

WHILE DEBT REMAINS THE FOCUS

Efforts continue to work out PREPA’s debt troubles as bondholders have offered to extend their forbearance agreement with the utility for another 30 days. The offer includes a mutual commitment to continue working together on the refinement of a capital investment and rate plan, a timeline for PREPA agreeing to a work production plan and outside review of the work plan and information exchanges between the parties with provisions for public review. The news came as the PR legislature held hearings with the lead witness being the Authority’s Chief Restructuring Officer. Increasing frustration is being expressed by all sides at the slow pace of negotiations and the market impact of such a significant cloud of uncertainty. The authority’s chief restructuring officer, Lisa Donahue, told the commission she will present a first draft of a restructuring plan by June 1.

Those concerns are reflected in an increasing and more frequent Federal presence on that part of various U.S. Treasury officials who have been seen in more frequent meetings with Commonwealth financial officials. This reflects potential roadblocks emerging in the effort to reliquify the GDB with one report indicating that A group of hedge funds is demanding that as one condition of lending $2.2 billion to Puerto Rico, lawmakers must balance its budget for the long haul or agree to be found in default if a gap emerges. This would be a heretofore unseen requirement in the municipal market. During a local radio interview early Wednesday, GDB President Melba Acosta admitted it will be difficult to go to the market in the near future as tax reform, the fiscal year 2016 budget proposal and the situation at the Puerto Rico Electric Power Authority, among others, converge.

CA DROUGHT UPDATE

The Metropolitan Water District, which sells imported water to more than two dozen local agencies serving 19 million people in Southern California, voted Tuesday to reduce regional deliveries by 15 percent as the state grapples with a fourth year of drought. The board will revisit the issue in December. Cities that want to buy more water will have to pay penalties of up to four times the normal price for extra deliveries.

Moody’s has weighed in with its view that the governor’s executive order imposing water use restrictions to achieve 25% statewide reductions is overall credit negative for the state’s water utilities. It is their view that the utilities have little time to increase rates and fees to promote conservation, and the mandated conservation will reduce operating revenue. The fiscal impact will be to reduce the sector’s debt service coverage and reserves.

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

RHODE ISLAND PENSION SETTLEMENT PROPOSED

Rhode Island and most of its public employee unions reached a tentative settlement last week to the comprehensive challenge to the state’s 2011 overhaul of its beleaguered pension system. The settlement, which affects 59,000 current and past state employees, provides for adjustments to the minimum retirement age, the chance for more frequent cost-of-living increases and an increase in the defined-benefit pensions available to longtime public employees. If approved by the court and the General Assembly, the proposal would end litigation from six challenges arising from changes made to the pension system in 2009, 2010 and 2011. The court will set a schedule for the parties to implement the settlement, and the remaining three lawsuits will be addressed by the Court. The April trial date will be vacated for the purpose of implementing the settlement. It still must be approved by the General Assembly.

Six of the nine unions that sued the state agreed to the settlement. The three unions that have not settled represent about 800 employees; their challenge will be addressed by the court after the settlement is implemented. But a trial scheduled to begin this month has been averted. The settlement also relieves the new governor, Gina Raimondo of a major headache as she seeks to address Rhode Island’s struggling economy. In her prior role as the state’s general treasurer, she was the chief architect of the pension overhaul under challenge.

“The state had a very strong case, but Ms. Raimondo said that “to take the litigation risk off of the table is the right thing to do.” The settlement gives financial certainty to employees and retirees, she said, and is affordable for taxpayers. “All of the structural elements of the original pension legislation remain intact,” she said, adding that those elements provide “a fundamental restructuring of the system and fundamentally puts the system in a much healthier position.”

The $14.8 billion pension system was overhauled by the legislature when it created a hybrid plan that split direct contributions between the state and employees. It also suspended cost-of-living adjustments and raised the retirement age by five years, measures intended to save $4 billion over 20 years. Those changes angered public employee unions, which then sued to  challenge the plan as unconstitutional. The unions actively opposed Ms. Raimondo’s candidacy last year for governor.

The proposed settlement has received generally favorable reviews from outside observers. Frank Shafroth, the director of the Center for State and Local Government Leadership at George Mason University, said the settlement appeared to be good for Rhode Island, “because not agreeing to it means the long-term problem gets worse.” Part of the problem for pension systems across the country is that employees are living longer than in previous generations, Mr. Shafroth said, so settlements like this are going to become more necessary. He added that he regarded the Rhode Island settlement “as a very constructive development.” Roger Boudreau, who leads the Rhode Island Public Employees’ Retiree Coalition, told The Associated Press that retirees would not be happy with the settlement because they were getting “a fraction” of what they were promised. But, he added, they knew their chances of prevailing at trial were “very slim at best.”

The perception of continuing progress of pension reform in Rhode Island removes a significant drag on its credit standing. The state still needs to renew its economy after long term declines in its old manufacturing base but the pension issue is a major building block in the establishment of structural balance for the state’s finances.

ILLINOIS LEGISLATURE LOOKS AT CHAPTER 9 FOR CITIES

Illinois statutes don’t currently grant general legal authority allowing for a Chapter 9 filing by municipal entities with the one exemption being for the Illinois Power Agency. A recent hearing was held by the House Judiciary-Civil Law Committee on House Bill 298, sponsored by Rep. Ron Sandack, R-Downers Grove, which would permit local governments to file for Chapter 9 bankruptcy. Conditions allowing for such a filing such as state approval and potential alternatives were also discussed at the March 20 hearing.

The committee heard from representatives of the public finance community and civic organizations who pressed to make new options available for struggling communities and offered an alternative in the form of a new authority to assist local governments solve fiscal problems without bankruptcy. While a bankruptcy provision has not gained much traction with Democrats who control the General Assembly, discussions over whether Illinois should add such a law has received heightened attention since the new Republican governor, Bruce Rauner, proposed the option. Police and fire unions urged against permitting Chapter 9.

Sandack said his bill would require municipalities to first show they truly are insolvent and have made a good faith effort to restructure their debts with creditors. “By sponsoring this bill I am not encouraging municipalities to abandon efforts to regain financial stability on their own. The bill would simply provide municipalities with an additional tool to help them get their financial affairs in order,” he said.

Local governments face big increases in their public safety pension contributions next year due to a prior state mandate to shift to an actuarially required contribution level. There is a school of thought that says that the Governor and others want to give local governments more leverage in negotiating pension reforms. There is also the fact that Rauner has proposed to halve the amount of income tax revenue distributed to municipalities.

The well-regarded Chicago Civic Federation, is supporting a measure to create an authority designed to intervene before a government’s fiscal strains reach crisis stage. The quasi-judicial authority would help local governments deal with pension-related and other fiscal burdens threatening their solvency. The goal would be to avoid defaults and bankruptcy while putting a government on a sustainable path.

Existing law in the form of The Fiscally Distressed City Act is for cities with a population under 25,000. Under its terms, a local government must ask the General Assembly for the appointment of a special commission to consider whether the municipality meets the act’s criteria and if approved it can qualify for state financing assistance.

We would favor a mechanism for more robust intervention and oversight vs. the bankruptcy option. The Detroit experience showed the vulnerability of debt holders under that process and we think that any trend in that direction should be opposed.

CHICAGO ELECTION

A brief word about the Chicago election results which saw Rahm Emanuel elected to a second term. Viewed through the prism of a bondholder, the result has to be viewed positively. While significant financial issues remain for the City, many of the actions for which the mayor was criticized politically – school reform, higher taxes and utility rates, and pension change proposals – were all positive for bondholders. That is not to say that we expect rating stability or improvement but the uncertainty over the direction of city policies over the next four years were a significant drag on the City’s credit which has now been somewhat mitigated.

KANSAS GOES THE PENSION BOND ROUTE

The Kansas legislature approved an authorization for pension bonds as part of its overall budget process. Kansas is now expected to issue $1 billion in bonds to bolster its pension system for teachers and government employees. The Kansas Public Employees Retirement System would receive an infusion of cash, immediately narrowing a long-term gap in funding for retirement benefits. The pension system would invest the money and expects its investments to earn significantly more than the state would pay on the 30-year bonds.

The bill limits the state to paying 5 percent or less in interest to bond investors, and the pension system expects to earn 8 percent annually on its investments the long-term. The state issued $500 million in pension bonds in 2004, paying almost 5.4 percent in interest. The pension system’s investment earnings have averaged 7.7 percent annually since then.

Whether or not the plan is a good budget or credit move is subject to debate because the move also is designed to help with the state budget by decreasing state contributions to public pensions by $64 million over the next two years. The pension system already was on track to close a projected $9.8 billion gap between revenues and benefit costs from now until 2033 under laws enacted in recent years that require increasing state contributions to pensions.

The state must close a budget shortfall projected at nearly $600 million for the fiscal year beginning July 1. The gap arose after lawmakers, at Brownback’s urging, slashed personal income taxes in 2012 and 2013 to stimulate the economy. This would appear to be yet another iteration of borrowing for operating expenses regardless of the academic arguments supporting such debt. The borrowing would not be necessary if sound financial practices were not overruled by ideological zeal.

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

PR REMAINS TURBULENT

The Puerto Rico Electric Power Authority (PREPA) announced Monday that it agreed with its creditors to extend their previously negotiated forbearance agreements for 15 days. Creditors agreed not to take any enforcement actions against the utility while the forbearance agreements remain in effect. The creditors, who hold more than$9 billion of its debt, have the right to accelerate their claims, potentially forcing the utility into insolvency. PREPA previously missed a deadline  March 2 when it was supposed to present bondholders with a comprehensive restructuring plan. PREPA had previously told creditors restructuring would likely take 10 years instead of an expected five years. The creditors did not take action when the March 2 milestone was missed.

Some of the creditors are said to have offered additional financing to overhaul operations in return for concessions such as using the current drop in oil prices to pay off debt. Other measures needed to secure additional financing could include collecting unpaid electricity bills from the government and taking stronger action against electricity theft.  The savings to PREPA from the recent drop in oil prices is estimated by some at around $1 billion.

The negotiating creditor group represents over 60 percent of PREPA’s bondholders and includes large hedge funds such as Blue Mountain Capital and Appaloosa Management, mutual funds Oppenheimer and Franklin Templeton, bond insurers, as well as Citibank and Scotiabank.

On the general obligation front, the Commonwealth seeks to move forward on its proposed $2.95 billion refinancing to reliquify the GDB. After four rounds of legislative amendments, the bonds are projected to come at an original-issue discount lower than 93 cents on the dollar. When the bond issue finally comes (with an interest-rate cap of 8.5%), it could end up yielding as much as 10% when the original-issue discount is factored in.

A little more than a week has gone by since the passing of new taxes to support the bond issue (la crudita). There have already been increases at the gasoline pump of 4 cents a liter, which will cost the average consumer about $277 annually in additional transportation costs alone, according to estimates by some economists. The cost to large corporations is estimated by these same economists as the equivalent of a 2.4% tax rate. No formal economic-impact study was conducted before la crudita was approved. Government statistics already indicate a decline in the volume of gasoline sold in PR during the past five years. Some of the reasons for the decline include the use of more fuel-efficient vehicles, including hybrids, and a population decrease due to migration and a lower birth rate.

At the same time, longer term tax reform continues to be considered in the legislature. Intense and widespread opposition to the initial tax reform proposed by the administration of Gov. Alejandro García Padilla is forcing major changes to that plan, which is expected to substantially cut down on the size of the proposed increase in the consumption tax, and as a result, the amount of revenue it will raise. House Speaker Jaime Perelló is proposing a 12% VAT, which would still provide space for substantial income-tax relief. That plan would raise an estimated $500 million, rather than the $1.2 billion originally proposed by the administration, according to House Finance Committee Chairman Rafael “Tatito” Hernández.

Top administration officials, including the governor, have said that lowering the proposed tax to that level would require cutting back on the income-tax relief proposed under the tax-reform plan. Senate Finance Committee Chairman José R. Nadal Power said budget discussions would also be a guide to determining the final outlines of the proposed reform, but added that keeping the VAT to 12% would be a “great achievement.”

PA. P3 FINANCING

PennDOT has begun to use its authority to issue up to $1.2 billion in Private Activity Bonds (PABs) as granted by the U.S. Department of Transportation. These tax-exempt bonds, which are less expensive than traditional financing options available to private firms, will account for the majority of the total capital costs of the Pennsylvania Rapid Bridge Replacement Project at a low borrowing cost. This is consistent with other P3 projects in other states.

The first tranche of debt for the  Pennsylvania Rapid Bridge Replacement Project recently closed. The consortium successfully priced $721,485,000 of tax-exempt Private Activity Bonds (PABs) on February 24th. The BBB rated bonds, priced at a premium, were oversubscribed, and were purchased by over 40 different investors. J.P. Morgan and Wells Fargo acted as the underwriters.

The project is the first public-private partnership (P3) to bundle multiple bridges in a single procurement in the U.S. Granite Construction Company anticipates booking a 40 percent share of the contract. Plenary Group is the project sponsor, financial arranger and primary investor for the Plenary Walsh Keystone Partners consortium, which has been contracted by the Pennsylvania Department of Transportation (PennDOT) to deliver the project. The Plenary Walsh Keystone Partners consortium includes The Walsh Group, Granite and HDR. Construction is expected to begin in May 2015, with a projected completion date of December 2017.

Under the contract, Plenary Walsh Keystone Partners will finance and manage the design, accelerated construction, financing, maintenance and rehabilitation of 558 geographically dispersed, structurally deficient bridges across the state over a 28-year contract term. PennDOT will be responsible for routine maintenance such as snow plowing and debris removal. To ensure PennDOT’s construction program is met, Plenary Walsh Keystone Partners is utilizing 18 different Pennsylvania-based subcontractors to leverage local knowledge and existing sub-contractor networks

PennDOT will continue to own all of the bridges included in the project. The department is contracting the design, construction and lifecycle maintenance responsibilities for 25 years. The Plenary Walsh Keystone Partners team will be responsible for any failures or defects that might occur during the term of the contract in addition to expected maintenance, similar to an extended warranty. If properly designed and constructed a bridge should not require significant maintenance during the first 25-35 years, but the contract serves as a warranty to ensure the bridges are constructed to achieve the lowest lifecycle cost of ownership.

This project includes 558 of the roughly 4,000 structurally deficient bridges in Pennsylvania that are in need of replacement or repair. A majority of those projects will be procured as traditional design, bid, build projects contractors are accustomed to. The bridges selected as eligible for the project have similar characteristics; most importantly they are relatively small and can be designed and constructed to standard sizes. The similarity of the bridges allows for streamlined design, prefabrication (mass production) of standardized components such as beams, and the replacements can be done relatively quickly. All of these factors make bundling the projects as one P3 contract the most efficient and cost effective way to deliver these bridge projects according to the Commonwealth.

THIS COULD BE THE PEAK

It seems that the end of every positive interest rate cycle in the municipal bond market is signaled by attempts to finance unlikely amusement deals in the high yield space. It appeared that a proposed tourist facility based on a reproduction of Noah’s Ark in Kentucky in 2014 might have been that signal but that deal failed in the traditional market. Another amusement facility may be poised to assume that role, this time in Arizona. A property developer, the Granger Group, has primarily been a developer of  health care and senior living complexes. Granger is now in the process of completing development plans for a $500million theme park and resort development in Williams, Arizona.

Williams is a town of some 3000 which is the self-proclaimed Gateway to the Grand Canyon. Millions annually pass through on the way to the Grand Canyon National Park and the developers are predicating their plans on the attraction of four million of those visitors each year. The attraction would include a selection of rides, an adventure course, a wilderness area, an amphitheatre, hotel and spa and themed restaurants.

The sponsors are seeking approval for state legislation allowing for an Arizona theme park district board to issue as much as $1billion in bonds to pay for any number of theme parks inside a certain land space approved in December by the Williams City Council, the Phoenix City Council and the Coconino County Board of Supervisors.

If the proposal from the Granger Group is accepted, 9 per cent of revenue generated would be used to pay off the initial capital investment. The proposal predicts such a park would generate around $125million annually of gross revenue. Initial plans for the theme park include Route 66, wild west, mining and Navajo Nation themed areas. The group also promises rides, interactive exhibits, animal encounters, stunt shows, gold panning, archery, rock climbing, kayaking, ziplining, mountain biking, and hot air balloon rides.

The Granger Group is currently conducting a feasibility study for the project, which is due in later this month. The developer is yet to finalize an operator for the project and in May will focus on refining the plans. It is fair to say that this deal has to potential to join a large list of failed recreation projects that have been visited upon the tax exempt market at times of overvaluation of high yield credits. We urge investors direct and indirect (as owners of high yield mutual fund shares) to approach this type of credit with a high degree of skepticism and caution as it moves closer to market.

In the interim, overall first quarter issuance was the highest since 2010 – and third highest since 2006. Muni issuance is up 58.8% to $102.551 billion in 3,071 issues from $64.568 billion in 2,132 issues for the first quarter in 2014, Thomson Reuters data show. Refundings doubled in volume to $18.65 billion in 590 issues in March from $9.26 billion in 307 issues a year earlier. Combined refunding and new money deals increased 33.1% to $12.01 billion from $9.02 billion, while new-money issues were up 0.9% to $10.33 billion. Taxable and tax-exempt deals increased almost the same percentage, with taxables increasing 45.1% to $3.39 billion and tax-exempts increasing 45.9% to $37 billion.  Education more than tripled to $17.47 billion from $5.28 billion. Health care almost quadrupled to $2.72 billion from $720 million. The declining general perception of the creditworthiness of these two sectors coupled with increased issuance also suggests that our thesis has merit.

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.