Joseph Krist

Municipal Credit Consultant

PR HURDLES TOWARDS DEFAULT THIS MONDAY

Puerto Rico’s government still has not set a delivery date for Puerto Rico’s audited financial statements for fiscal year 2014, Public Affairs Secretary Jesús Manuel Ortiz said Wednesday.  “Certainly, we don’t have a delivery date,” said Ortiz, while adding that meetings between KPMG and government officials are still underway. The government of Gov. Alejandro García Padilla was expected to release the financial statements early this month. However, uncertainty over the  Government Development Bank (GDB) has again delayed the delivery of the statements, which were due almost a year ago.

At the GDB,  there remains uncertainty in figuring out the government bank’s loan loss reserves. If the government can restructure its debt, then there would be more money on hand; if the government isn’t able to restructure, then there is less money. Many assumptions tied to the central government are difficult to value.

Ironically the administration is currently evaluating a proposal from KPMG to perform the audited financial reports for fiscal year 2015, which are due May 1. KPMG also produced the audit for fiscal 2013, which was delivered two months past its deadline. During the past three years, KPMG has been paid roughly $20 million in professional-services contracts, according to government records.

Congress heading out of Washington on Friday, missing deadlines on the budget and on helping Puerto Rico with its financial crisis. Having failed to enact a bill by the May 1 deadline to help the territory, lawmakers are now focusing on a July 1 deadline, when around $2 billion in principle and interest payments come due.

The government is expected to keep operating as usual, but economists warn that its access to capital markets will shut down and that eventually this will curtail public services if a debt-restructuring mechanism isn’t approved. Puerto Rico expects multiple lawsuits to be filed shortly after Monday’s anticipated default. A House bill would create a control board to help manage the island’s $70 billion debt and oversee debt restructuring. But the legislation has stalled in the Natural Resources Committee, as some conservatives and Democrats have objected to the approach.

Speaker Paul Ryan, R-Wis., has pushed the bill, saying the U.S. may eventually have to bail out the territory if Congress doesn’t act soon. Utah Rep. Rob Bishop, the Republican chairman of the Natural Resources panel, says he hopes the island’s impending default will create more urgency among his colleagues. The Senate is expected to wait to see what happens in the House first.

The Puerto Rico government is expected to keep operating as usual, but economists warn that its access to capital markets will shut down and that eventually this will curtail public services if a debt-restructuring mechanism isn’t approved. Puerto Rico expects multiple lawsuits to be filed shortly after Monday’s anticipated default.

Democrats called upon House leaders to modify this spring’s three-weeks on, one-week off legislative schedule to keep working, as Puerto Rico moves toward its default on Sunday. “It’s very, very hard to get anything done if you are a drive-by Congress,” said House Minority Leader Nancy Pelosi, D-Calif. “We’re barely here. And these deadlines are coming.” Hours later, however, Democrats joined Republicans in adjournment.

It is clear that Congress has yet to figure out which outcome generates political upside. With national attention focused on the presidential nomination process, it has been hard  for Puerto Rico to generate a sufficient level of political traction and attention in order to drive a resolution of its situation. In the meantime, it appears that the coalition of political leaders who initially supported tax increases earlier this year is falling apart. With the island’s gubernatorial election process beginning to take shape, Sen. President Eduardo Bhatia Gautier, Sen. José Nadal Power, House President Jaime Perelló Borrás, Rep. Rafael Hernández Montañez, and PDP gubernatorial candidate David Bernier all announced their opposition to the planned tax changes. A scheduled increase in VAT has been delayed due to this opposition.

Meanwhile it has been about seven months since the initial announcement of a PREPA restructuring agreement and it has still to be implemented. PREPA  is seeking to prolong a bond-purchase agreement with its creditors to May 2, averting a potential termination of a larger debt-restructuring deal. The agreement  would have bondholders and insurance companies agree to buy $111 million of three-year bonds from PREPA. The contract expired late Wednesday and is part of PREPA’s plan to restructure $9 billion of debt. The larger restructuring pact will end if the bond-purchase agreement fails to continue.

MEANWHILE IN ATLANTIC CITY

Assembly Speaker Vincent Prieto will post his Atlantic City rescue bill for a vote next Thursday. Prieto released a schedule for the Assembly on that includes a voting session on Thursday. Prieto’s bill gives the city two years to meet benchmarks in order to solve its financial crisis. If the city fails to do that, it will be taken over by the state.

Senate President Steve Sweeney is reported to have tried to compromise with Prieto by offering a bill that gives the city 130 days to meet benchmarks, but Prieto is said to have been unwilling to accept it. Atlantic City Mayor Don Guardian and Council President Marty Small have repeatedly said they support Prieto’s bill.

May 15 is the deadline date for action by the State that would enable Atlantic City to avoid a default. Much of this has been lost in the fog of the market’s attention on Puerto Rico and its woes.

We believe that while much smaller in terms of dollars, the failure of the State of New Jersey to help Atlantic City avoid a default would have implications for the market, especially for the ability of not only New jersey’s municipalities but also for the State itself.

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

FL ADOPTS P3 LEGISLATION

Recent legislation created The Florida Department of Transportation Financing  Corporation as a nonprofit corporation for the  purpose of financing or refinancing projects for the department.  It permits the Department to finance P3 projects through the issuance of tax-exempt bonds. It shall be governed by a board of directors consisting  of the director of the Office of Policy and Budget within the Executive Office of the Governor, the director of the Division of Bond Finance, and the Secretary of Transportation. The  director of the Division of Bond Finance will be the chief executive officer of the corporation and shall direct and supervise the administrative affairs of the corporation and  control, direct, and supervise the operation of the corporation.

The legislation authorizes the department to adopt relevant federal  environmental standards as the standards for a program. Sovereign immunity from civil suit in federal court is waived. The Legislature found that there is a public need for the rapid construction of safe and efficient transportation facilities for the purpose of traveling within the state, and  that it is in the public’s interest to provide for the construction of additional safe, convenient, and economical  transportation facilities. The law requires that in connection with a proposal to finance or refinance a transportation facility pursuant to this section, the department consult with the Division of Bond Finance of the State Board of Administration. The department must provide the division with the information necessary to provide timely  consultation and recommendations. The Division of Bond Finance may make an independent recommendation to the Executive Office  of the Governor.

Specifically, The Department of  Transportation may request the Division of Bond Finance to issue bonds secured by toll revenues collected on the Alligator Alley , the Sunshine Skyway Bridge, the Beeline-East Expressway, the Navarre Bridge, and the Pinellas Bayway to fund  transportation projects located within the county or counties in  which the project is located. The law provides that the department’s Pinellas Bayway System may be  transferred by the department and become part of the turnpike  system under the Florida Turnpike Enterprise Law. Upon transfer of the Pinellas Bayway  System to the turnpike system, the department shall also  transfer to the Florida Turnpike Enterprise the funds deposited  in the reserve account established shall be used by the Florida Turnpike Enterprise solely to help fund the costs of repair or  replacement of the transferred facilities.

The  department may enter into a service contract for a project  may enter into one or more such service contracts with the corporation and provide for  payments under such contracts, subject to annual appropriation  by the Legislature. Each service contract may  have a term of up to 35 years. The obligations of the department  under such service contracts do not constitute a general  obligation of the state or a pledge of the full faith and credit  or taxing power of the state, and such obligations are not an  obligation of the State Board of Administration or entities, but are payable solely from amounts available in  the State Transportation Trust Fund, subject to annual  appropriation. The Florida Department of Transportation Financing Corporation may issue and incur notes, bonds, certificates of  indebtedness, and other obligations payable from and secured by amounts payable to the corporation  by the department under a service contract. The duration of  any such note, bond, certificate of indebtedness, or other  obligation or evidence of indebtedness may not exceed 30 annual maturities. Debt may be sold through competitive bidding or negotiated  contracts, whichever is most cost-effective.

Such obligations are exempt from taxation; however, such exemption does not apply to any tax imposed under chapter 220 on  the interest, income, or profits on debt obligations owned by  corporations.

KANSAS – THE SONG REMAINS THE SAME

Last year at this time, Kansas legislators were facing  a $400 million hole in the FY 2016 budget. This year the gap is $290 million after increases in sales and cigarette taxes. Governor Sam Brownback would fill the gap by taking $185 million from the state highway fund, delaying more than two dozen projects, and he would cut spending to state universities by 3 percent, about $17 million, for the fiscal year beginning July 1. That would continue a 3 percent cut he ordered earlier this month.

More than $1.5 billion has been shifted from the highway fund to the state’s general fund and other state agencies since 2011. Until now, Brownback made assurances that all highway projects would go forward. But his budget message last week led the state Department of Transportation to announce the delay of 25 projects slated to begin over the next two to three years, including a Kansas 68 widening project in Miami County. Projects currently underway aren’t affected.

Other moves would require approval by the Legislature, which returns from a spring recess on Wednesday. Three options have been offered by the Governor.

One option would sell off a portion of the state’s future tobacco settlement money for quick cash. The first option was to sell a portion of the state’s future payments from a national tobacco settlement, which Kansas dedicates to early childhood education programs, to bondholders for a one-time infusion of $158 million. It’s a contentious idea. Kansas along with most other states receives a payment each year of some $58 million, although the annual payment is expected to decline in the future as smoking declines.

A second option would delay a $99 million state payment to the Kansas Public Employees Retirement System until fiscal year 2018. Current retirees’ benefits wouldn’t be affected by the delay, he said. A third option would make 3 to 5 percent cuts to most state agencies, including funding to K-12 public schools and state universities. A 3 percent reduction to K-12 schools would be about $57 million.

The options offered by the Governor are either one-shots (the tobacco bonds), irresponsible pension funding deferrals (Kansas has one of the lowest pension funding ratios). None of them are positive for the State’s credit and would continue a pattern of offloading the results of the failed tax cut experiment on to the credits of underlying entities to the detriment of their ratings. We see Kansas as an environment to avoid for credit conscious investors so long as Governor Brownback clings to his failed tax cut program. S&P would seem to agree keeping the State’s credit on negative outlook this week.

HIGH YIELD DOWNGRADE

Iowa Fertilizer Company LLC has been downgraded by Fitch to B+. The project generating revenues for the company’s controversial $1.2 billion tax-exempt deal has experienced a substantial delay in start-up is expected to necessitate a draw on the cash-funded debt service reserve for mandatory 2016 payments. These payments and construction cost shortfalls are expected to be funded by a $150 million letter of credit-backed (LOC) subordinated loan facility from sponsor OCI N.V.

The project fully exhausted its contingency and issued an additional $100 million of combined senior debt and sponsor equity in June 2015, and additional funding will be required to complete the facility. Further change orders and contractor claims are still being negotiated, indicating that final costs could rise further.

The project will utilize commercially proven technologies with relatively low maintenance risk. At the same time, it’s main products have historically exhibited considerable price volatility. Fitch estimates that a shift in the supply-demand balance could negatively impact prices, as a 10% change in nitrogen product prices will result in a 0.40x-0.50x change in debt service coverage ratios.  Management’s latest expectation is that ammonia production will begin in the September/October 2016. These obligations total an estimated $168.3 million. Construction progress, the status of OEC’s claims, and market fertilizer prices over the next few months will determine the likelihood that IFCo can meet its obligations relying only on projected sources of funds available to the project company.
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

KENTUCKY BUDGET MAKES SOME EFFORT AT PENSION FUNDING

The Kentucky General Assembly has passed a $21 billion Executive Branch budget for the next two fiscal years that will pour $1.28 billion into the state pension systems and make no cuts to K-12 education while authorizing the governor’s plan to cut most state agency funding by nine percent over the biennium. Most new money in HB 303 will go for state pension in the Kentucky Employees Retirement System and the Kentucky Teachers’ Retirement System. Funding in FY 2017 will be $933.1 mn and in FY 2018 will be $888.8 mn. That is 5.7% of enacted spending for the upcoming biennium.

Funding for K-12 education will not be cut under HB 303, which protects funding to schools and gives the Department of Education up to $20 million in additional funds over the biennium as a necessary governmental expense if there are not enough per-pupil SEEK funds available. Public preschool will be made available to families with incomes below 200 percent of the poverty level as part of a pilot program, and $15 million in preschool funding will be set aside for grants to help develop full-day programs for children eligible for state child care assistance.

In the area of higher education, HB 303 authorizes lesser cuts of 4.5 percent over the biennium for state colleges and universities that faced the possibility of 9 percent cuts under the governor’s original proposal. A performance-based funding formula for state universities is also found in the bill that will require 5 percent of state university base funding to be gauged on an institution’s performance. Kentucky State University would be exempt from the performance-based model.

LOUISIANA

On April 12, 2016, Louisiana Governor John Bel Edwards released his proposal for the state’s fiscal year 2017 budget. Citing shortfalls in the state budget, Edwards said that deep cuts to many state services were necessary to close gaps for the overall improvement of the state’s financial health. The proposal included cuts to the state’s primary college scholarship program (TOPS), cuts to “safety net hospitals” for low-income families, and cuts to education at both the K-12 and college levels. The funding for the TOPS program, in particular, would be reduced by about two-thirds of its current level, leaving the total funds at about $110 million. The state legislature went on to debate several bills that would alter how  cuts.

The cuts followed up a series of tax increases adopted during a special session of the legislature in late winter. These included a rise in the State sales tax rate of 1%, an expansion in the taxable base for the existing 4% sales tax through FY 2018, and the stabilization fund and appropriated $200 million of monies from funds received under the BP settlement agreement.

According to the U.S. Census, Louisiana had 14 state pension plans as of April 2015. Between fiscal years 2008 and 2012, the funded ratio of Louisiana’s state-administered pension plans decreased from 69.2 percent to 55.5 percent. The state paid 96 percent of its annual required contribution, and for fiscal year 2012 the pension system’s unfunded accrued liability totaled $18.4 billion. This amounted to $4,161 in unfunded   liabilities per capita.

The State continues to be negatively impacted by low oil prices. These have had a negative impact of revenues and employment and increased pressure on the expenditure side of the budget. So long as oil prices remain in a relatively depressed state, the negative pressure on the State’s credit ratings will persist. These are exacerbated by the State’s weak pension funding position reflecting years of underfunding now creating annual budget gaps.

RHODE ISLAND PENSION DEVELOPMENTS

So far this year’s budget process has not continued positive momentum which the State and the Governor had hoped to carry forward in regard to the State’s longstanding pension funding issues. In 2007, legislation was enacted which provided for surplus General Fund monies to be transferred to the State Retirement Fund. Pressures on the General Fund diminished support for this plan as it was felt that the funds were needed elsewhere and last year the Legislature effectively repealed these provisions keeping those surpluses within the General Fund.

Most prominent among those pressures were the need for additional state aid to struggling municipalities. Those struggles are based in changes in the local economies but also fiscal pressures resulting from increasing pension demands. Some 20 of the 36 municipal pension plans have funding ratios below 60%. These pressures resulted in the Chapter 9 bankruptcy of the City of Central Falls in 2011.

Now nearly five years later, several municipalities are considered to be distressed. For FY 2017, eight are determined to be eligible for funding from Rhode Island’s Distressed Communities Relief Fund. Pension requirements are but one of several criteria used to determine qualification for Fund monies. It is hoped that at least one community will be able to drop out of the program in FY 2017.

These factors are among many that weigh negatively on Rhode Island’s credit outlook as it continues to deal with the long-term decline of its major manufacturing industries. Its efforts to do so have been stymied by competition from the larger neighboring states in the region and larger and more established entities in those states in the commercial and service sectors that Rhode Island seeks to expand.

Our view is that those pressures will continue and will be sufficient to outweigh the impact of the positive steps which the State is undertaking. We would view that State’s debt as one to underweight versus other comparably rated state bonds.

PR CREDITOR AGREEMENT

According to press reports, the Government Development Bank (GDB) and a group of its creditors have struck a tentative deal, providing the bank with some relief ahead of its $422 million debt payment due May 2. The group of GDB creditors, which hold about a fourth of the bank’s roughly $4 billion debt, would agree to a forbearance agreement that covers only $120 million of the May payment. The government could still be pressed to declare a partial moratorium on the remainder of the payment, as there is not enough money to meet the payment in full. The tentative plan reportedly would also include a debt-exchange process whereby GDB creditors would get new with a haircut estimated at 50%. Creditors would have to accept that they would receive no principal payments in the next few years. The rest of the bank’s creditors would still need to join the agreement if the exchange is to take place.

Meanwhile in Washington, the Puerto Rico debt restructuring bill was still short of votes. The bill is still being rewritten, and as of yet the vote has not been rescheduled. The U.S. House Natural Resources Committee issued a statement Tuesday seeking support for its bill. “Congress cannot pass legislation to erase the decades of fiscal mismanagement and socialist policies that brought the territory to its knees. But a growing number of Members understand we must act on a responsible solution to prevent U.S. taxpayers from footing the bill,” the panel statement said.

Meanwhile, the situation on Puerto Rico remains “fluid”. The Puerto Rico House of Representatives passed a bill that would exclude general obligation (GO) and Sales Tax Financing Corp. (Cofina) bonds from the law that allows the governor to declare a debt moratorium. The leader of the PDP in the Senate said in an interview that he agrees that the government should not include general obligation debt or debt that is sustainable such as Cofina debt, which is guaranteed by the sales and use tax,  in the moratorium. He also said he believes the debt that was recently restructured at the Puerto Rico Electric Power Authority should not be part of the debt moratorium.
I don’t support including the general obligation bonds in the negotiation to restructure debt because it would be in violation of the constitution.”

However, Gov. Alejandro García Padilla immediately advised lawmakers in a statement that he plans to veto the bill if it reaches his desk. These maneuverings are why it is a fool’s errand for analysts to try to predict the outcome of this process. Those with the means and capacity to deal with these day to day machinations are most appropriately equipped to play in these bonds. Rare is the individual investor who is.

In the meantime, the Government Development Bank has filed with regulators to sell taxable debt that would mature May 2017 as officials negotiate with creditors about a $422 million payment owed at the start of May. And no, the Puerto Rican government has not released audited financial statements for FY 2014. They are requesting proposals from auditors for FY 2015 financial statements. And yes, it is FY 2017 that begins this July 1.

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

SEC STEPS UP MUNI FRAUD EFFORT

It will perhaps be of more interest locally in the NY metro area than nationally but the recent actions of the SEC enforcement staff in the municipal bond market should be encouraging to investors. The SEC alleges that Ramapo officials resorted to fraud to hide the strain in the town’s finances caused by the approximately $60 million cost to build a baseball stadium as well as the town’s declining sales and property tax revenues.  It is alleged that they cooked the books of the town’s primary operating fund to falsely depict positive balances between $1.4 million and $4.2 million during a six-year period when the town had actually accumulated balance deficits as high as nearly $14 million.  And because the stadium bonds issued by the Ramapo Local Development Corp. (RLDC) were guaranteed by the town, certain officials also masked an operating revenue shortfall at the RLDC and investors were unaware the town would likely need to subsidize those bond payments and further deplete its general fund.

According to the SEC’s complaint, inflated general fund balances were used in offering materials for 16 municipal bond offerings by Ramapo or the RLDC to investors, who consider the condition of a municipality’s general fund when making investment decisions.  After town supervisor Christopher P. St. Lawrence purposely misled a credit rating agency about the town’s general fund balance before certain bonds were rated, he told other town officials to refinance the short-term debt as fast as possible because “we’re going to all have to be magicians” to realize the purported financial results.

Christopher P. St. Lawrence, who served as RLDC’s president in addition to being town supervisor, masterminded the scheme to artificially inflate the balance of the general fund in financial statements for fiscal years 2009 to 2014. St. Lawrence and Aaron Troodler, a former RLDC executive director and assistant town attorney, concealed from investors that RLDC’s operating revenues were insufficient to cover debt service on bonds to finance the stadium. Troodler helped conceal the fictitious sale and boost the account balance of the town’s general fund by approving RLDC financial statements reflecting a purchase of property that never actually occurred.  Troodler also signed offering documents that contained an additional fabricated receivable totaling $3.66 million for another transfer of land from the town to the RLDC.  The only land transferred from the town to the RLDC during the time of the purported transaction was property donated for the baseball stadium, which St. Lawrence and Troodler knew did not impose any payment obligation on the RLDC.

Town attorney Michael Klein helped conceal outstanding liabilities related to the $3.08 million receivable recorded in the town’s general fund for the sale of a 13.7-acre parcel of land to the RLDC.  But because the title of the property was never transferred from the town to the RLDC, Klein also made misleading statements about the receivable’s source. Troodler helped conceal the fictitious sale and boost the account balance of the town’s general fund by approving RLDC financial statements reflecting a purchase of property that never actually occurred.  Troodler also signed offering documents that contained an additional fabricated receivable totaling $3.66 million for another transfer of land from the town to the RLDC.  The only land transferred from the town to the baseball stadium, which St. Lawrence and Troodler knew did not impose any payment obligation on the RLDC. The town’s deputy finance director Nathan Oberman participated in activities to inflate the town’s general fund by arranging $12.4 million in improper transfers from an ambulance fund to bolster the troubled general fund during a six-year period.

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against St. Lawrence and Troodler.

CONNECTICUT BUDGET WOES CONTINUE

Although by various measures, Connecticut is a wealthy state it’s budget is not immune from the pressures of declining revenues and accelerating expenses.   In part because  the state’s legislators are forced to rely heavily on its highest earners to fill the state’s coffers. Nearly 61% of tax revenues is from the income tax. They are  fearful of alienating more of the highest-earning residents after a tax increase last year. Since an initial budget was accepted in February, revenues have

To counter this trend, the Governor released a revised budget for FY 2017 that reflects a 4.89% decline in revenues from the February estimate. It employs layoffs of state employees to reduce expenses by 8.1%. This does result in a small surplus if nothing else changes. Connecticut is in a tough spot as it wealth is highly concentrated and much of it is mobile. On the expense side, flexibility is limited by the need to fund pensions after a long period of underfunding. Spending for those costs account for 5.6% of spending. In addition, debt service eats up a very high 12.8% of expenses.

So the outlook for Connecticut remains negative. This reflects the poor revenue trend and the maintenance of expenditure pressures going forward in an atmosphere of limited management  flexibility.

PUERTO RICO

Puerto Rico Secretary of State Víctor Suárez disclosed that discussions with a group of GDB creditors could involve a request for a forbearance agreement that would cover roughly $120 million of the May 2 payment due from GDB. “If we strike a forbearance agreement, there is still the possibility of declaring a partial moratorium,” said Suárez.  Suárez said it is not currently being contemplated that the creditor group would be asked for additional cash flow lending. He did acknowledge that “the cash flow situation of the government continues to be delicate. The government needs to follow up every week on its cash flow to make the calls with respect to the July 1 payments. It is very hard, very hard that the government can make any payment in July 1.

YOUTH SMOKING TRENDS

It’s the time of year when the states receive their annual payments from the tobacco companies under the Tobacco Settlement Agreement (TSA). As consumption of cigarettes (not other tobacco products) is one of the prime variables impacting the level of these payments  tobacco securitization bonds, annual trends in consumption are closely followed.

The Centers for Disease Control(CDC) and the U.S. Food and Drug Administration’s (FDA) Center for Tobacco Products in its Morbidity and Mortality Weekly Report (MMWR) showed that overall tobacco use by middle and high school students has not changed since 2011. Data from the 2015 National Youth Tobacco Survey show that 4.7 million middle and high school students were current users (at least once in the past 30 days) of a tobacco product in 2015, and more than 2.3 million of those students were current users of two or more tobacco products. Three million middle and high school students were current users of e-cigarettes in 2015, up from 2.46 million in 2014. Sixteen percent of high school and 5.3 percent of middle school students were current users of e-cigarettes in 2015, making e-cigarettes the most commonly used tobacco product among youth for the second consecutive year. During 2011 through 2015, e-cigarette use rose from 1.5 percent to 16.0 percent among high school students and from 0.6 percent to 5.3 percent among middle school students.

From 2011 through 2015, significant decreases in current cigarette smoking occurred among youth, but there was no significant change in the prevalence of current cigarette smoking among this group during 2014 – 2015. In 2015, 9.3 percent of high school students and 2.3 percent of middle school students reported current cigarette use, making cigarettes the second-most-used tobacco product among both middle and high school students. The importance of this particular data trend is that levels of youth smoking have a direct correlation to levels of adult smoking over the long term. Any change in this direction of this trend is noteworthy. This one, should it continue could slow or stabilize the overall decline in cigarette consumption which has negatively impacted levels of available revenues for the repayment of tobacco bonds in recent years.

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 BILL INTRODUCED

Rep. Sean Duffy, R-Wis., introduced a bill H.R. 4900, the “Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA).” late Tuesday to address Puerto Rico’s debt crisis. It was the subject of a Natural Resources Committee hearing on Wednesday and is expected to be voted on by the committee on Thursday. We outlined the expected basic provisions in our special edition of Tuesday April 12. The main changes in the bill since it was initially discussed are in the board’s makeup, its power to unilaterally impose regulations on the commonwealth, and the required steps for an entity to undergo restructuring. The board would still only be able to file restructuring petitions on behalf of the commonwealth and its public authorities after the debtors tried to reach an agreement with their creditors through voluntary debt restructuring proposals and have provided the board with up-to-date financial statements. The bill also eliminates a provision from the earlier version that gave the oversight board power to unilaterally implement recommendations and binding regulations.

Reaction from Puerto Rican politicians was mixed. Rep. Nydia Velazquez (D-NY) was unenthused. “Given that four Board members will be appointed by Republicans, there is significant reason to believe that restructuring authority will never be granted,” Velazquez said. “This concern is compounded by section 601, a new provision, which adds a collective action clause to the bill. This clause requires two-thirds of creditors to voluntarily agree to restructure their debt, a hurdle that is not realistically achievable.” In a conference call with journalists on Tuesday, Puerto Rico’s governor, Alejandro García Padilla, said he believed that Congress had taken Puerto Rico’s complaints of federal overreach seriously and acted in good faith to tailor the oversight board to Puerto Rico’s situation.

A hearing before the House Natural Resources Committee was held this week. The Obama administration expressed concerns that undermining the minimum wage and overtime rules in Puerto Rico, thereby increasing the disparities in pay between Puerto Rico and the mainland, is not a recipe for economic growth. Rather, it believes a locally administered Earned Income Tax Credit is a more powerful and effective way to stimulate the economy and encourage work. The one time mayor of Washington D.C., Anthony Williams commented on the issue of an oversight board. “The lessons drawn from other notable places that were subject to oversight does instruct that if done with due respect for those in public office, and with keen awareness of both community leadership and an eye on business interests, good and sustainable solutions can and have occurred.”

After the hearing, the Committee chairman said that the planned schedule for consideration of legislation needed to be extended. “The Administration is still negotiating on provisions of the legislation, creating uncertainty in both parties. This legislation needs bipartisan support, but Members need time to understand the complexity of the issue and the ramifications of any proposed changes. It is unfair to all Members to force a vote with provisions still being negotiated.”  In addition, As of Thursday, the PR government still did not know when the long-awaited Commonwealth Annual Financial Report (CAFR) for the year ended June 30, 2014, would be released.

The fiscal 2014 CAFR was due nearly a year ago, in May 2015. KPMG, the independent auditors tasked with the process, said it would take the firm another eight to nine weeks to complete the audit once they receive all pending information. Since early this year, administration officials have stated the government has handed in everything on their end. But they have also acknowledged that some commonwealth components have yet to finish certain processes related to the external audit, including the cash-strapped Government Development Bank (GDB) and two of the commonwealth’s retirement systems.

P3 UPDATE

The  I-69 Section 5 project is a part of an Indiana highway that is being expanded to handle expected increased truck traffic resulting from NAFTA. The I-69 Section 5 project involves rehabilitating and upgrading 21 miles of the existing four lane State Road 37 in Morgan and Monroe counties to interstate standards from Bloomington to just south of Martinsville, Indiana. As part of the conversion, the existing partially-controlled limited access facility will be upgraded to have fully controlled access and will include the addition of travel lanes in the north and southbound lanes.

Bonds have been issued secured by a pledge of future payments from the private entity which is constructing and will operate the road. Availability payment P3s transfer cost, schedule and quality risks away from taxpayers during such time that the private sector is responsible for construction, operations and maintenance. If the road isn’t made “available” to the public in compliance with performance standards in the contract, the recurring, inflation-adjusted payments are reduced accordingly. Under terms of the contract, the state would make an $80 million “down payment” to the private partner, Isolux Infrastructure, which would pay the $325 million estimated for construction. Once that section of highway is complete, the state starts paying the partner $21.8 million a year for 35 years and the company maintains the highway.

Fitch Ratings last week downgraded the Indiana Finance Authority’s private activity bonds (PABs) issued on behalf of I-69 Development Partners LLC (I-69 DP) for the I-69 Section 5 project to ‘BBB-‘ and placed the bonds on Rating Watch Negative. The downgrade reflects the deteriorating credit quality of Isolux Corsan SA (Isolux), parent of the construction contractor, Corsan-Corviam Construccion SA, whose rating was revised to ‘B-‘/Rating Watch Negative on Feb. 12, 2016. This followed an earlier downgrade of Isolux on Dec. 7, 2015 to ‘B’/Rating Watch Negative.

The downgrade further reflects a projected eight month delay to substantial completion, initially expected in October 2016, which was disclosed in the most recent construction update published in March 2016. The revised substantial completion date is now June 28, 2017. Now the bondholder is exposed not only to project risk but financial risk of the private construction contractor. There is a Debt Service Reserve Account sized at modest a six-month’s debt service.

P3 project s have not been quite the godsend that politicians and investors have hoped for in many cases. While the private entities are often better at project execution than government, they also have brought an element of financial risk to transactions often unrelated to the project at the center of an individual bond issue. The result has been a greater shift of risk to investors than they anticipated resulting a shift in the risk balance away from the issuers onto those investors.

BOND MARKET GETS SOME REGULATORY RELIEF

U.S. cities and states won a partial victory Friday as the Federal Reserve gave final approval to a rule that will allow banks to include some municipal bonds in allocations of easy-to-sell assets meant to serve as protection against a financial crisis. A multiagency rule adopted in 2014, called for the biggest banks to hold enough high-quality liquid assets to survive a 30-day period of financial stress. The central bank revisited the idea of including munis after local governments waged a lobbying campaign for the change.

Bank regulators adopted the minimum-liquidity demand as a response to deficiencies highlighted during the 2008 credit crisis, when financial firms were stuck with assets they couldn’t sell. The Fed, which announced completion of its revised rule in a statement, said it relied on an analysis that suggested certain munis should qualify because they have liquidity characteristics similar to assets such as corporate debt securities. The victory is only a partial one for issuers in that a substantial portion of muni activity occurs in the bank units overseen by the Office of the Comptroller of the Currency. So far, neither the OCC nor the Federal Deposit Insurance Corp. has matched the Fed’s confidence in the liquidity of the muni market.

The Fed’s change, which takes effect July 1, applies to Fed-supervised lenders subject to the liquidity coverage ratio requirement. Those bank holding companies will be able to include a limited slice of munis among the Treasuries, highly-rated corporate bonds and foreign-government debt they already count against their liquidity demands. The Fed will allow munis that “have a proven record as a reliable source of liquidity in repurchase or sales markets during a period of significant stress,” according to the text of the rule. Such munis can be part of a second tier of liquid assets, which can total no more than 40 percent of the overall liquidity buffer.

The phase-in period for the liquidity rule started in 2015 and it is set to go into full effect on Jan. 1. It’s also expected to be joined this year by a separate but related liquidity demand — known as the net stable funding ratio — that considers a longer stress horizon. Even under the pressure of rules and warnings from municipal lobbyists, banks have increased their muni holdings, which rose to almost $500 billion by the end of 2015, more than twice the levels the industry held at the end of the financial crisis.

SAN BERNARDINO PENSION BOND SETTLEMENT

Pension bonds have come in for lots of criticism as to whether or not they are a good tool for governments to use to deal with ballooning pension costs. Now there is another example of how they may not be such a good idea for investors either. Moody’s Investor Service said Monday  that San Bernardino’s bankruptcy settlement agreement with two pension obligation bondholders reached last week is a “significant loss and credit negative” for the bondholders and other investors in local government debt.

San Bernardino declared bankruptcy in 2012. The settlement includes a 60 percent haircut for the creditors, cutting the city’s payments to pension bondholders by $45 million. The California city agreed to pay a total of $51 million over 30 years, beginning one year after the bankruptcy court approves the city’s plan of adjustment. Although up significantly from the city’s original 1 percent proposal, Moody’s said its own calculations determined the public obligation bondholders would actually recover less than 30 percent of their investment, not the 40 percent stated in the settlement. Commerzbank Finance & Covered Bond S.A. and Ambac Assurance Corporation are the creditors of the city’s roughly $100 million in pension obligation bonds.

STADIUM BONDS NOT JUST A MAJOR LEAGUE ISSUE

The New York Yankees and the Tampa Sports Authority announced plans Monday for a $40 million improvement project at Steinbrenner Field, the Yankees spring training facility.  It would be financed equally among the State of Florida, Hillsborough County and the Yankees. The funding includes construction of new outfield concourses and gathering spots, improved access into the ballpark and additional improvements at the team’s minor league training complex nearby. The construction is expected to be complete by March 2017.

The Yankees will pay their portion of the construction through lease payments, which will run through 2046. Six teams have left Florida since 2003 to establish spring training homes in Arizona, making the Cactus League equal in size to the Grapefruit League. In response, the state passed a hotel tax that goes to fund new or renovated facilities. Exhibition games draw a greater percentage of out-of-town visitors than regular-season games in major league cities. So this may make more sense in support of the argument over whether these projects generate economic growth. The tax is paid by visitors, and that money is used to get a commitment from teams. The Yankees have already completed more than $6 million worth of renovations on the minor league and major league training facilities, including new batting cages.

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

NEW PLAN FROM PR

On Monday, Puerto Rico said it had found a way to make debt payments of $1.85 billion a year, compared with the $1.7 billion a year it had offered before. The new restructuring plan covers $49.3 billion of Puerto Rico’s total debt, most of which is in the form of municipal bonds. The larger margin is a result of using projected government revenue for fiscal year 2021, instead of fiscal 2016, as the basis for the restructuring team’s 15% debt-service target as a percentage of annual revenue.

It calls for creditors to exchange existing bonds for two new classes of bonds. The offer is up from a previous offer of $26.5 billion. Puerto Rico has taken the position that all types of creditors must sacrifice, however. The new offer announced on Monday reflects that position. General obligation bonds held by investors who do not live on the island would get a recovery rate of 74 percent under the new proposal. Holders of sales-tax-backed bonds would get 57 percent; and holders of bonds issued by the Government Development Bank would get just 36 percent.

The first type would be a “base bond” with a total face value ranging from $32.6 billion to $37.4 billion, depending on whether bondholders in Puerto Rico opted in or took advantage of the special offer available to them alone. The new base bonds would start out paying 1.1 percent interest for the coming fiscal year. (Under Puerto Rico’s previous offer, interest payments would not have started until a year later.) The interest rate would then rise gradually to 5 percent in 2021, the same year principal repayments would start. Bondholders living in Puerto Rico would, however, have the chance to recover more of their initial investment if they were willing to wait. Instead of trading in their holdings for the regular base bonds, they could opt for “local holder base bonds,” which would have a value equal to the face amount of the bonds being handed over. The local holder base bonds would pay a fixed, 2 percent rate of interest over a longer period of time.

For investors not living in Puerto Rico, there would be only a chance of getting a full recovery. In addition to their base bonds, they would get a second type, called “capital appreciation bonds,” which would not offer any cash payments until after the base bonds had been fully repaid and it was clear how much of a loss each type of bondholder had suffered. The CABs would be repaid in full upon maturity as they accrete value — at 5% annually over a 49-year period under the commonwealth’s most recent offer. CABs would ensure creditors fully recover initial losses, only if they hold onto these until maturity.

The higher recovery rates and a debt instrument tailored for local bondholders are the  major changes in the government’s revised debt-restructuring proposal, which was presented to creditors on March 23 before it was released publicly Monday. Negotiations between the commonwealth and its creditors are slated to continue this week. The commonwealth first proposed to creditors in January an exchange offer with two types of instruments: a mandatorily payable base bond; and a growth bond to be paid only if the island achieved economic recovery. Cuts to principal, or haircuts, hovered around 45%, and only $1.75 billion of government revenue would be available each year for debt service. This amount now increases to $1.85 billion, allowing the U.S. territory to offer more base bonds — and higher recovery rates — under the revised proposal. The larger margin is a result of using projected government revenue for fiscal year 2021, instead of  fiscal 2016, as the basis for the restructuring  team’s 15% debt-service target as a percentage of annual revenue.

Growth bonds would be replaced with capital appreciation bonds (CABs), which are repaid in full upon maturity as they accrete value — at 5% annually over a 49-year period under the commonwealth’s most recent offer. CABs would ensure creditors fully recover initial losses, only if they hold onto these until maturity. The commonwealth’s advisers believe this instrument will eventually become highly tradable as the island recovers its creditworthiness along the way.

Puerto Rico residents, who happen to mostly own the island’s less-secured debt, could now choose a par-for-par exchange, instead of taking discounted base bonds. These par bonds would mean a longer maturity for local bondholders, while receiving 2% interest payments for more than 50 years beginning in January 2017. Under the new offer, the amount of base bonds could reach as much as $27.8 billion, depending on the participation of Puerto Rico residents on the local instrument, while roughly $1.75 billion in CABs  and up to $8 billion in local holder bonds would also be issued. While seeking a leveled debt-service schedule, the commonwealth’s most recent offer would translate into a longer debt-repayment calendar. No principal payments until fiscal 2021 are still contemplated, but interest payments would now be paid current, scaling up until reaching 5% annually by fiscal 2021. The local bond option would always be paid a 2% annual interest during its life.

Proposed haircuts include about 16% for commonwealth-guaranteed debt, including general obligations (GOs), and 43% for Sales Tax Financing Corp. (Cofina) bonds. Less-secured paper, such as the Highways & Transportation Authority and the GDB’s, could see cuts to principal of 44% and 64%, respectively, while other credits end up in the 50% range. If the commonwealth fails to obtain a legal mechanism by which to bind holdouts or if the federal government significantly reduces financial support to the island, the terms of the exchange offer would have to be revised, which could mean larger haircuts for creditors.

At least three different creditor groups have countered with their own offers. These include constitutionally guaranteed GOs; sales tax-backed, lockbox-structured Cofina; and a group of local cooperatives and credit unions that mostly own less-secured paper.

For the administration, the creditors’ proposed fixes fell short, often solving only part of the problem and placing an unfair burden on less-protected credits. None of the counteroffers would deal with the government bank’s debt woes. None would contemplate cuts to principal.

So far, creditors have sought more government revenue dedicated to debt service, less impairment and higher recoveries. Commonwealth advisers recognize there is a tug of war over the administration’s 15% target of annual government revenues destined to debt service, and has said the idea is to make it the least painful possible to creditors.

PREPA

The passage of the debt moratorium legislation has created much uncertainty as to its impact on the existing agreement framework for a restructuring of Puerto Rico electric Power Authority’s outstanding debt. In a report issued late Friday, Moody’s weighed in with its opinion. “The moratorium law could also create complications for negotiations between the Puerto Rico Electric Power Authority (PREPA – Caa3/negative) and its lenders, which have been underway for 18 months and appear to be approaching a resolution. The law encompasses the commonwealth’s numerous debt-issuing entities including PREPA and gives Puerto Rico’s governor the power to invoke a state of emergency with respect to PREPA (or any other government agency), thereby beginning a moratorium. However, the law does not include the PREPA Revitalization Corp., the special purpose vehicle that is expected to issue securitization bonds to complete the restructuring of PREPA’s $9 billion of debt. We continue to believe that PREPA and its creditors are working constructively toward a consensual agreement.”

The next turn in the PREPA restructuring process will come when the utility will obtain a ruling on its securitization charges within the next 87 days, followed by a validation process. In parallel, PREPA’s restructuring team will be making its case before the credit rating agencies, which will ultimately decide if the new securitization bonds are worthy of investment grade.

AND IN CONGRESS

The House Natural Resources Committee had been expected to release a revised version of its Puerto Rico bill early this week, including a modification designed to avoid a constitutional challenge if the legislation is enacted. Some have warned the bill would violate the Uniformity Clause of the U.S. Constitution. That clause, in Article 1, Section 8, says, “Congress shall have power … to establish … uniform laws on the subject of bankruptcies throughout the United States.”

The bill would be revised to permit the other four U.S. territories, should their financial situations plummet, to opt into its provisions. The territory’s Governors would have to sign them. As a result, Guam, the U.S. Virgin Islands, America Samoa, and the Northern Mariana Islands could opt for the creation of an oversight board that would have the sole ability to file a petition for debt restructuring.

Under the bill, debtors could not have a proposed financial control board file a petition for restructuring on their behalf until they have released their most recent audited financial report and engaged in voluntary debt restructuring discussions with creditors. The bill borrows from Chapter 9 of the U.S. Bankruptcy Code but explicitly avoids amending that statute and instead uses the Territorial Clause of the Constitution as the basis for its debt restructuring provisions. The other territories don’t want to be in the measure.

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 GDB UNDER PRESSURE FROM CREDITORS

A group of hedge funds asked a federal court in San Juan on Monday to freeze the assets of Puerto Rico’s Government Development Bank, claiming it was insolvent and appeared to be spending what cash it had left to prop up other parts of the island’s troubled government. The bank had failed to provide financial information that creditors were entitled to under federal law, the hedge funds said in a lawsuit. They asked the United States District Court in San Juan to bar further cash transfers by the bank, other than those essential to the safety and well-being of the island’s residents.

“Once G.D.B. spends its last remaining funds — and it is only a matter of time — many essential services in Puerto Rico may come to a halt,” the hedge funds said in their complaint. By then, they said, there would be nothing left for the bank’s creditors, who “will suffer substantial losses.” The Government Development Bank has a debt payment of about $422 million due on May 1. It is doubtful as to whether the bank has enough cash to make it.

The president of the bank, Melba Acosta Febo, responded that the lawsuit’s accusations were “erroneous” and that the bank was acting within the bounds of the relevant laws. “The central claim of G.D.B.’s creditors, that G.D.B. has knowingly withheld financial information in order to prefer certain depositors over its bondholders, is wholly false and without basis in fact,” she said, adding that the bank “will respond to the complaint in full through proper legal means.”

PR THROWS A TANTRUM

The Governor signed the Puerto Rico Emergency Moratorium & Financial Rehabilitation Act. It empowers the governor to order the Government Development Bank (GDB) to restrict the outflow of cash in a bid to stabilize its dwindling liquidity levels, which stood at roughly $560 million as of April 1, according to the bill. Initial plans called for having García Padilla signing an executive order to this effect immediately following the enactment of the moratorium legislation. The House passed, without alterations, the version the Senate approved the night before. Representatives passed the bill after House Treasury Committee Chairman Rep. Rafael Hernández gave up on attempts to take out the general obligation (GOs) debt from the governor’s moratorium.

The sudden moves seemed likely to make more difficult the effort in Washington to enact a rescue package for Puerto Rico. The House Natural Resources Committee, which has been drafting the rescue in consultation with Democrats in Congress and the Treasury Department, released a statement as we went to press. House Committee on Natural Resources Chairman Rob Bishop said “efforts to refine the Committee’s discussion draft continue. All parties are working in good faith as we finalize responsible legislation that helps solve the crisis and protects American taxpayers. “I thank Speaker Ryan for allowing an open process with input from all stakeholders. The input we have received has been wonderful and positive; it will make a better bill. I thank all Members and stakeholders for their engagement in this process.”

The drafters have been trying to strike a balance between Democratic and Republican Party priorities as well as numerous constitutional hurdles. So far, the lawmakers in Congress have called for sending a federal oversight board to Puerto Rico, auditing all major branches of government there, promoting fiscal reforms and eventually providing certain restructuring tools that are normally available only in bankruptcy. But the oversight board, which may have seemed a reasonable requirement in Washington, is still seen on the island as an intolerable vestige of colonial rule.

ATLANTIC CITY APPROACHES THE EDGE

Gov. Chris Christie announced Monday that the state is suing Atlantic City to make sure the local government pays $34 million it owes to the city’s school district over the next few months, once again escalating a bitter battle over the ailing finances of the gambling resort. In a Statehouse news conference on Atlantic City, Christie accused city officials of using the money to stay afloat and “fund rich union contracts they’ve been unwilling to change.” At issue is state law that requires municipalities across New Jersey to collect property tax payments on behalf of their school districts and give that money to them in scheduled payments.

Christie said Atlantic City’s municipal government has about $10 million left and is neglecting the next payment to make a city payroll of $3.2 million Friday. Today he called the mayor a liar who has “zero idea” what he’s doing. The lawsuit seeks to compel the city to make the payments owed from now until June, beginning with an $8.4 million installment on April 15. In his own news conference at the Statehouse on Monday, Atlantic City Mayor Don Guardian said the city is on a payment schedule set by a state monitor and that the city always intended to make the upcoming payments. Mayor Guardian also announced that Atlantic City’s nine public-worker unions have agreed to a plan to stretch payroll payments from 14 to 28 days to avoid a city shutdown that was set to begin Friday. The city council was expected to finalize the plan as we go to press.

The lawsuit could put added pressure on state Assembly Speaker Vincent Prieto (D-Hudson) to break an ongoing standoff with the Governor and allow a vote on legislation that would authorize a state takeover of Atlantic City’s local government. Christie has said he will sign a state aid package for the city only if state lawmakers pass legislation approving the takeover. He will only sign the aid package and the takeover if they are passed together, without any changes. Prieto has said that the bill has no chance of passage in its current form.

There are a myriad of ways in which the political structure in Atlantic City can be criticized for decades of corruption and failure. In no way does it provide the Governor for a basis to act in ways which are so counterproductive and which bring into question the State’s long standing willingness to protect holders of local debt issued by the State’s municipalities. The Governor’s rants do not provide a basis for a positive resolution.

STADIUM FINANCING A TARGET AGAIN

In a time when the simplest of issues can be made extremely complex, it is nice to see a piece of legislation introduced that makes no effort to disguise its purpose. Rep. Steve Russell, R-Okla., has introduced a bill in the House that would prohibit the use of tax-exempt bonds to build or subsidize professional sports stadiums and for-profit entertainment arenas. It is simply titled the “No Tax Subsidies for Stadiums Act”. Under current law, a stadium can be built with tax-exempt bonds as long as no more than 10% percent of the debt service is paid or secured by private parties and no more than 10% of it is privately used. Since 2006, 263 tax-exempt bond issues totaling $16.9 billion have been sold to finance stadiums and sports arenas, according to figures compiled by Thomson Reuters (TRI). That includes the five bond issues totaling $82.2 million have been reported thus far for 2016.

The bill states in plain English that “Section 103(a) shall not apply to any bond issued as part of an issue any proceeds of which are to be used to provide a professional entertainment facility. For purposes of this subsection, the term ‘professional entertainment facility’ means any facility (and appurtenant real property) which, during at least 5 days during any calendar year, is used as a stadium or arena for professional sports exhibitions, games, or training, or as a venue for any entertainment event the live audience for which exceeds 100 individuals, and any net earnings from which inure to the benefit of an individual or any entity other than the United States, any State or political subdivision thereof, any possession of the United States, or any agency or instrumentality of any of the foregoing, or an organization which is described in paragraph (3), (4), (5), (6), (7), (10), (19), or (23) of section 501(c) and exempt from tax under section 501(a) or is a political organization (as defined in section 527(e)(1)).”.

The amendment shall apply to obligations issued after the date of the enactment of the Act. In a statement, Russell said the Office of Management and Budget has estimated that repealing tax-exempt bond financing for stadiums would lower the budget deficit by a total of $542 million over the next decade. Russell, who serves on the House Armed Services Committee and is a retired career military man, said that money could be used to fund the armed services. He is a first term Congressman who is a disciple of former Senator Tom Coburn who espoused strict limits on federal spending which he was often unsuccessful in achieving.

We think that the impact on investors would be minimal. The more likely aggrieved parties would be the teams that use the facilities and the bankers who structure and underwrite the deals.

CHICAGO PUBLIC SCHOOL DEBT – INVESTMENT OR WAGER?

The impact a Chapter 9 bankruptcy would have on Chicago Public Schools and its investors is uncertain at best. The district in its most recent bond sale declared that one of its pledged repayment streams under the state’s alternate revenue bond structure would meet the bankruptcy code’s designation of “special revenues” that are largely shielded in Chapter 9.

CPS’ most recent bond issue was accompanied by a special opinion that provides the legal reasoning behind CPS’ position that the bonds’ structure provides a security which preserves the statutory lien on pledged revenues and offers relief from the automatic stay provisions of the bankruptcy code. Whether it would hold up in bankruptcy court given the limited litigated precedent, it would be a contested issue with no guaranteed outcome.

The bonds are full faith and credit obligations supported by a pledge of property tax revenues of the CPS. The pledged tax revenues are levied as part of the bond resolution but are abated by the district because it uses pledged state aid to cover debt service. Abatement comes only after CPS makes its annual February deposit into the debt service account to cover June and December payments with state aid or some other revenue, if necessary. The tax levy for debt service has never been triggered.

The structure allows non-home rule governments like CPS to get around voter approval requirements. The backdoor referendum model requires a public vote only if sufficient signatures are raised after CPS publishes its intent to issue the bonds. No opinion has been offered as to how pledged state aid would be treated because those funds are comingled with other revenues and so would not meet bankruptcy code’s definition of special, segregated revenues. The board acknowledges there is no binding legal precedent for its position and doesn’t guarantee the debt would avoid a cram down where the pledged tax revenue could be stayed and terms adjusted in a plan of adjustment deemed “fair and equitable” by the court.

There is limited precedent in Illinois on which investors can rely. Some feel that an Illinois appellate court that upheld an alternate revenue structure and tax pledge in a 2002 case involving a hospital that had closed provides guidance. A Chapter 9 filing is currently not possible under Illinois law, and CPS is exempt from some state oversight rules.

The school board is authorized to direct the county to deposit pledged property taxes with the trustee but that direction can be revoked. If CPS is correct about the way its bonds would be treated in a bankruptcy, such a Chapter 9 outcome would leave pensions and contracts to take the hit. That runs in the face of the fact that public pension benefits enjoy strong protections under the state constitution – a status that was reinforced by the Illinois Supreme Court’s ruling last week that benefit cuts in Chicago’s 2014 pension reforms violate state law giving contractual status to membership in governmental pension funds.

In the end, the bonds provide enough uncertainty in our view as to place them in the category of a wager, albeit one supported by an annual 8.75% interest payment pledge.

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.