Joseph Krist

Municipal Credit Consultant

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

DISCLOSURE STILL A PROBLEM

Regular readers of our twice weekly comments know by now that we feel strongly that the disclosure practices of municipal bond issuers are, to put it kindly, deficient. Now we see that the U.S. Securities and Exchange Commission has problems with those practices as well. We were heartened to see last week’s announcement of enforcement actions against 71 municipal issuers and other obligated persons for violations in municipal bond offerings.

The actions were brought under the Municipalities Continuing Disclosure Cooperation (MCDC) Initiative, a voluntary self-reporting program targeting material misstatements and omissions in municipal bond offering documents.  The initiative offered favorable settlement terms to municipal bond underwriters, issuers, and obligated persons that self-reported certain violations of the federal securities laws.  Obligated persons are typically nonprofit entities such as hospitals and colleges that borrow the proceeds of bond issuances and are obligated to pay principal and interest on the bonds.

The SEC found that from 2011 to 2014, the 71 issuers and obligated persons sold municipal bonds using offering documents that contained materially false statements or omissions about their compliance with continuing disclosure obligations.  Continuing disclosure provides municipal bond investors with important information, including annual financial reports, on an ongoing basis.  The SEC’s 2012 Municipal Market Report identified issuers’ failure to comply with their continuing disclosure obligations as a major challenge for investors seeking information about their municipal bond holdings.

The parties settled the actions without admitting or denying the findings and agreed to  agreed to undertake to establish appropriate policies, procedures, and training regarding continuing disclosure obligations; comply with existing continuing disclosure undertakings, including updating past delinquent filings, disclose the settlement in future offering documents, and cooperate with any subsequent investigations by the SEC.

The SEC has now filed a total of 143 actions against 144 respondents as part of the MCDC Initiative.  These actions are the first against municipal issuers since the first action under the initiative was announced in July 2014 against a California school district.  The SEC filed actions under the initiative against a total of 72 municipal underwriting firms, comprising 96 percent of the market share for municipal underwritings, in June 2015, in September 2015, and in February 2016.

There is disappointment in that the list of settling parties includes large and  sophisticated issuers. The usual arguments against stronger disclosure requirements tend to emphasize the relative small scale of many issuers and the cost of compliance relative to available resources. In this case, the 71 parties included state agencies, large cities and counties, and even two states. The list undermines the size argument as a defense against weak disclosure.

We have a relatively stark position on the question of disclosure. Our view is that issuance in the public debt markets is a privilege and that compliance with disclosure requirements is the price of participation in that market. We hope that the Commission continues to vigorously support the right of investors to full and timely disclosure and that issuers take their responsibilities more seriously.

MARIN COUNTY PENSION CHANGE UPHELD IN CA. COURT

Public employees in Marin County, California, failed to prove a state-mandated change in how their pensions are calculated unconstitutionally violated their employment contracts, an appeals court ruled. At issue in the case was a 2013 amendment to the County Employees Retirement Law that the state Legislature passed in order to curb the practice of “pension spiking.” Pension spiking occurs when “public employees use various stratagems and ploys to inflate their income and retirement benefits,” explained Justice James Richman, of the First District California Courts of Appeals, in an August 17 ruling.

Four Marin County employees, joined by five organizations that represent county employees, sued the Marin County Employees Retirement Association to stop the implementation of the new formula. They complained that they “agreed to accept employment and remain employees of their respective employers based on the promised pension benefit.” The trial court ruled in favor of the retirement association, stating that the new formula did not violate the employees’ constitutional rights.
The employees appealed, but the appeals court affirmed the decision. “While a public employee does have a ‘vested right’ to a pension, that right is only to a ‘reasonable’ pension—not an immutable entitlement to the most optimal formula of calculating the unconstitutional. “Here, the Legislature did not forbid the employer from providing the specified items to an employee as compensation, only the purely prospective inclusion of those items in the computation of the employee’s pension,” Richman added. A pension can be spiked through an increase in final compensation or the inclusion of unused vacation pay in the benefit calculation.

After the economic downturn of 2008, underfunded public pensions received national attention. California’s legislature excluded some items from the calculation of county employees’ retirement income. Since then, localities have been seeking ways to reduce their future pension and health liabilities. this decision is clearly useful and credit positive for California localities seeking to make similar changes.

HOMELAND SECURITY TO REVIEW PRIVATE PRISONS

Last week we discussed the department of Justice’s decision to eliminate the use of private prisons. At that time, we warned that the real fear for municipal bond investors would be if facilities operating under contract with Immigration and Customs  Enforcement were to reach a similar decision. That day has now come one step closer.

Department of Homeland Security Secretary Jeh Johnson announced Monday that the Department  is considering curbing private immigration detention operations. The Secretary said that he directed the Homeland Security Advisory Council, chaired by Judge William Webster, to evaluate whether the immigration detention operations conducted by Immigration and Customs Enforcement should move in the same direction.

The DHS advisory council has until Nov. 30 to determine whether to follow the Justice Department’s lead. Johnson said he asked Webster to create an advisory council subcommittee “to review current policy and practices concerning the use of private immigration detention and evaluate whether this practice should be eliminated.” The subcommittee will lead the review, while the full council will file its evaluation to Johnson in November.

Should the DHS decide to suspend its involvement with private prison operators, it would strike a huge blow to the creditworthiness of many transactions which generate the majority if not the bulk of their pledged revenues through contracts with the DHS. These deals are located throughout the country although unsurprisingly many are located proximate to the southern U.S. border.

TOBACCO

We think that it is always useful to review the cigarette consumption data that is available whenever a new tobacco securitization issue is poised to come to market. A smaller deal for a group of seven New York counties presents our latest opportunity to do so.

While we do not think that anything in the data suggests that the long-term trends in cigarette consumption will change, we would be remiss not to note that U.S. cigarette shipments did rise some 1.9% in 2015. IHS Global, the entity which projects cigarette consumption for securitizations, did not attribute the rise to any particular factor. The study also projects that the share of sales by participating manufacturers in the Tobacco Settlement Agreement will remain constant after a period of efforts by non-participants to increase sales.

What we found most interesting in this official statement, was data presented on the impact of New York State and particularly New York City’s tax policies on cigarettes. New York City has the highest taxes and retail per pack prices in the nation. It also has a thriving underground retail cigarette market. IHS data shows that less than 4 in 10 cigarettes purchased in New York are legitimately purchased and properly taxed. This is through smuggled packs sold at retail establishments or through the sale of individual cigarettes through street vendors.

While this phenomenon may not have a direct impact on the creditworthiness of tobacco securitizations, it is instructive as to the efficacy of extremely high tax policies as a deterrent to cigarette sales. Otherwise, we continue to believe that tobacco bonds serve best as a trading vehicle for larger investors and that the long-term risks to the credits don’t serve the needs of many individual investors.

NEW YORK HOTEL TAX BONDS RETURN TO THE MARKET

The New York Convention Center Development Corporation, a subsidiary of the State’s Empire State Development Corporation, is planning to market some $413 million of revenue bonds backed by the proceeds of a $1.50 per night hotel room fee collected on hotel rooms in New York City. The bonds will fund a portion of the cost of the expansion of the thirty year old Javits Convention Center on Manhattan’s west side.

The City was somewhat late to the game of using hotel tax revenue bonds to finance public facilities. After years of concerted efforts by the Bloomberg administration to develop a tourist based economy, enough confidence in the durability of the tourism boom that followed and continues to this day was generated to support the issuance of hotel tax backed bonds. The pledged revenues in 2015 generated over $45 million of available revenues.

This produces coverage of just over 1 times debt service. The plan of finance assumes consistent annual growth in revenues of at least 1% through final maturity. Given the historical trend of revenues, it is not an unreasonable assumption. The world economic meltdown wasn’t enough to halt the trend and issues like relative currency values have not seemed to dent the trend either. It comes down to the fact that the one factor which could seriously impede the maintenance of positive tourism trends would be a breakdown in security in the City.

Fifteen years after 9/11, New York continues to be the area of the most concern in terms of it being a prime terrorist target. That regardless of the fact that the most recent attacks have occurred elsewhere. Paris has shown that there is a level and number of events which will damage tourism. This summer, after a number of incidents, the City of Light has seen a decline of one million in the number of visitors relative to prior summers. So it can happen but it takes a sustained number of incidents.

LABOR DAY

According to the U.S. Department of Labor, Labor Day, the first Monday in September, is a creation of the labor movement and is dedicated to the social and economic achievements of American workers. It constitutes a yearly national tribute to the contributions workers have made to the strength, prosperity, and well-being of our country.

Through the years the nation gave increasing emphasis to Labor Day. The first governmental recognition came through municipal ordinances passed during 1885 and 1886. From these, a movement developed to secure state legislation. The first state bill was introduced into the New York legislature, but the first to become law was passed by Oregon on February 21, 1887. During the year four more states — Colorado, Massachusetts, New Jersey, and New York — created the Labor Day holiday by legislative enactment.

By the end of the decade Connecticut, Nebraska, and Pennsylvania had followed suit. By 1894, 23 other states had adopted the holiday in honor of workers, and on June 28 of that year, Congress passed an act making the first Monday in September of each year a legal holiday in the District of Columbia and the territories.

We honor Labor Day by only putting out one issue of the Muni Credit News this week. Enjoy your weekend and look for our next issue on Tuesday, September 6.

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

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

LOUISIANA

A week ago we discussed the State’s proposed cash flow borrowing. This before the full scope of the damage from flooding in the Baton Rouge area had become apparent. Now that the level of devastation is clearer, it is easy to conclude that the State fiscal condition could be in serious trouble as a result.

The picture is, as in the case of most large scale natural disasters, much more complex. Clearly, there will be real disruption to the economic life of the area and significant expense demands on government. But they may not be as harmful as one might assume. Many of the costs of recovery will be borne by the federal government. FEMA will reimburse the vast majority of government expenditures. As for the impact on the State’s fiscal position, the interruption to some revenue sources will be offset by a high level of retail sales and economic activity related to the repair and replacement of homes and businesses.

This activity will drive a large and concentrated burst of sales tax revenues. Businesses that generate these revenues will also receive taxable income. Clearly, there will be dislocation and disruption but the overall effect on the State’s credit will be less than one would imagine at first blush. It’s been proven time after time in areas impacted by natural disasters.

PENNSYLVANIA

Earlier this month, we questioned the assignment of a stable outlook to the Commonwealth of Pennsylvania’s general obligation bond rating. Our stance was reaffirmed with the announcement from Pennsylvania Treasurer Timothy A. Reese that he had extended a $2.5 billion line of credit to the Commonwealth of Pennsylvania. A draw of $400 million from the line of credit to the General Fund was immediately made to prevent the General Fund cash balance from falling into the negative this month.

This is the second time in 2016 and the third time in 23 months that the state has needed to borrow money to meet short-term cash needs illustrating the ongoing structural budget deficit facing the commonwealth. While progress has been made on reducing the structural deficit, additional revenues enacted as part of the 2016-17 budget will not be fully realized until late in the fiscal year and, as a result, the General Fund balance began this fiscal year with $500 million less than the previous fiscal year.

The Treasurer said “The General Fund’s low cash balance so early in the fiscal year is a troublesome sign and illustrates the need for Pennsylvania to adequately and decisively address its ongoing structural deficit. While Treasury will continue to work with the administration and the General Assembly to manage these continuing shortfalls, until our state’s fiscal house is in order Pennsylvania’s credit rating will continue to suffer, and taxpayers will pay more to fund our debt.”

In our view this is exactly why we questioned the assignment of the stable outlook. Just because this kind of borrowing is internal rather than public, it doesn’t make it a better situation than is the case in, for example, Louisiana which is borrowing less in public. We understand that the Commonwealth has borrowed to cover a short term General Fund shortfall 15 times over the past 24 years. The borrowing maximum under this line however, is $1 billion greater than at any time since 1991.

MTA HUDSON RAIL YARDS TRUST

One of the more prolific issuers in our market is bringing a new credit to the new issue marketplace. One of New York’s best known real estate development projects is the West Side Redevelopment project. Any visitor to the city would likely be familiar with the huge amount of commercial and residential high rise construction underway from 9th Avenue to the Hudson River. One of the more complicated and controversial aspects of the plan was the construction of platforms over a long existing railroad yard complex which serves Pennsylvania Station.

The air rights and the platform over the yards will serve as the base on which additional construction will take place. The Metropolitan Transportation Authority owns this asset and is now in a position to monetize it. Hence the creation of the MTA Hudson Rail Yards Trust.

The Trust plans to issue $1.057 billion Metropolitan Transportation Authority (MTA) Hudson Rail Yards Trust Obligations. The bonds to be issued  will be payable solely from the Trust Estate established under a Trust Agreement. The trust estate consists principally of monthly ground rent from tenants of the ERY and WRY, monthly scheduled transfers from a capitalized interest fund, payments made by the tenant upon the exercise of fee purchase options, contingent support payments made by the MTA (including interest reserve advances), and rights of the MTA to exercise remedies under the leases and rights of the Trustee to exercise remedies under the leases and the Fee Mortgage.

The trustee will have a first secured lien on the MTA’s fee simple interest in the owned property under the Eastern Rail Yard and Western Rail Yard leases which are not cross defaulted nor cross-collateralized. The mortgages will secure the MTA’s obligation to pass on payments of ground rent and fee option payments received from tenants under the ground lease. If the MTA does not exercise cure rights following a lease non-payment event of default, the trustee may exercise its remedies under the each fee mortgage. These include foreclosing MTA’s fee interest. The Trustee will have the right to step into the MTA’s position as owner of the property and act as landlord under the defaulted lease. This gives the trustee the right to terminate the lease and sell and/or re-lease the property.

At its core, the financially responsible party for the obligations is the MTA. The leases call for   escalating, fixed ground rent payments, as well as a requirement that the MTA provides for interest reserve replenishment for up to 7 years following a lease default.  Proceeds will finance transit and commuter projects of the various affiliates and subsidiaries of the MTA, to fund an interest reserve requirement of 1/6th of the greatest amount of interest in the current or future years, pay capitalized interest and fund costs of issuance.

The bonds received an A2 rating from Moody’s. While constructed to be a primarily stand alone credit, the financial health of the MTA will still be a key factor in any rating analysis. This reflects the liquidity provision requirements in the event of a lease default. Moody’s is clear that the rating on these bonds is tied to the rating for  the MTA’s Transportation Revenue Bonds.

THE REALITIES OF PENSION REFORM IN CHICAGO

The realities of the difficulties inherent in funding Chicago’s pension liabilities was highlighted when Mayor Emanuel announced that senior citizens would get a break on the water and sewer service tax, proposed in early August. Some 66,000 or so Chicago residents 65 or older who live in single-family homes would be exempt from the new tax. The proposal is meant to appease aldermen unhappy with the plan to shore up the municipal workers pension fund.

Seniors already do not pay for sewer service, which accounts for half of the bimonthly bill. Those who do not get separate water and sewer bills, as is often the case in condominiums and town homes, will continue to be eligible for a $50 annual rebate on their water and sewer bill, but they would not get a break on the new tax.

Many aldermen would prefer a number of alternative revenue sources such as a city income tax or another property tax increase. Those would be more difficult to enact. An income tax would require state authorization, posing political difficulties for legislators. The mayor opposes  another property tax increase after two property tax increases for the City and Chicago Public Schools.

The City estimates the water and sewer tax to eventually raise $239 million a year, to be used to increase contributions to the municipal pension fund. A group of 11 aldermen have asked the administration for the schedule of contributions to the city municipal worker pension system over the next 40 years. They want to be sure that the new water and sewer tax would cover the pension cost before they vote on it next month.

City officials however,  said the city has yet to run those numbers. It is still doing calculations on existing new plans to increase contributions to the city laborer’s plan with revenue from the already increased emergency communications fees on all landlines and cell phones billed to city addresses.

STUDY HIGHLIGHTS RISKS IN SAN DIEGO STADIUM PROPOSAL

At the City’s request, Public Resources Advisory Group (PRAG) reviewed portions of the San Diego Integrated Convention Center Expansion/Stadium and Tourism Initiative’s (the “Initiative”) financing approach for a combined convention center and Chargers stadium. PRAG did not independently verify is the reasonableness of the total Project Cost estimate of $1.8 billion.

The Initiative relies on increasing the City’s Transient Occupancy Tax rate by 6%. Of the new 6% levy, the first 1% would be transferred “off the top” to the Tourism Trust Fund (“TTF”). The remaining 5% would then be available for the transfer of a second 1% to the TTF (after the payment of debt service), which together with the initial 1%, would replace the current 2% Tourism and Marketing District Assessment (“TMDA”), and for the financing, planning, construction, operations and maintenance and future capital improvement costs of the Project. These TOT revenues would be used on a pay‐go basis and to pay debt service on TOT‐backed revenue bonds. In addition, they are required to be used in a certain order, with the City’s general fund having the lowest priority in the flow of funds. The ability of these TOT revenues to meet the Initiative’s requirements is the primary financial risk factor to the City.

Various aspects of the current Project Cost are still being evaluated and are subject to change over time. Goldman Sachs (GS), the Chargers’  banker, estimates a 30 year interest rate of 4.25% on the project. The GS financial model assumes a $1.8 billion total project cost: the Chargers would contribute $650 million to the Project, and 5% of the 6% TOT increase in the Initiative would be available to fund or finance $1.15 billion of Project Costs. Those Project Costs would include convention center construction costs, any allocated costs in the combined convention center/stadium, and all costs for land acquisition, environmental mitigation and ancillary infrastructure.

Currently, PRAG found that with only 1% of the 6% of the TOT levy associated with the Initiative having priority over debt service, the credit quality of the TOT‐ backed revenue bonds is much more protected from revenue shortfalls and cost overruns than Overall Coverage which includes debt service, the second 1% transfer to the TTF, O&M and CapEx, all of which have to be met prior to the City’s general fund receiving any of these TOT revenues.

PRAG states that the future TOT revenue growth assumptions, the current Project Cost estimate and a 4.25% all‐in interest rate reflected in GS’ numbers underpin the ability of the Initiative to pencil out financially. PRAG views each of these assumptions and all three of them on a combined basis as not conservative for a Project with this long of a lead time and are subject to significant risk of change.

All of this will be part of what will be an active debate leading to the vote on November 8. The study is one more piece in the complex debate over the entire phenomenon of public financing of stadiums for professional sports teams.

PR LEGAL UPDATE

A U.S. District Court Judge stayed a lawsuit filed by Ambac Assurance Corp. against the Puerto Rico Highway Authority (PRHTA) seeking to block a lease extension of two island toll roads.  The stay was granted  because Ambac did not challenge the applicability of a provision of the Puerto Rico Oversight, Management and Economic Stability Act (Promesa) that stays lawsuits against the government. Ambac was given until Friday to say whether they wish to join other parties in other cases at a September hearing to determine if cause exists to vacate the Promesa stay.

Plaintiffs in the lawsuit Lex Claims v. García Padilla until Aug. 25 to file a motion on a notice of stay filed by the government. Aurelius Capital Management, Autonomy Capital, Covalent Partners, FCO Advisors, Monarch Alternative Capital and Stone Lion Capital Partners had filed suit July 20 to stop the government from transferring funds from bondholders contending it violated Promesa.

The judge  is planning to schedule a hearing in September to determine whether to stay lawsuits filed by National Public Finance, which seeks to limit the island’s moratorium law and by Brigade Leveraged Structures, which seeks to stop the Government Development Bank from transferring funds to agencies.

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

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

CHARTER SCHOOL ABCs

With the start of the school year looming just around the corner, education facilities come to mind. The low rate environment and the steady demand for higher yielding issues has led to a steady stream of charter school financings. For investors new to the sector, here’s a little primer.

The first law allowing the establishment of charter schools was passed in Minnesota in 1991. There are approximately 6,700 charter schools now. The basic criteria for these offerings are based in demand for seats, the supply of seats in a given area, the quality of the management of the school from both a financial and educational standpoint, the nature of the assets pledged, and the security for those assets in favor of the bondholder. More subjective criteria include the sponsorship of the particular school, their level of participation and oversight, and their record of academic results both at the individual school securing the bonds and at other schools they own or sponsor.

What nearly all of these credits have in common is the reliance on state per capita aid payments which are based on statutorily established formulas. Usually, a minimum  percentage of the student enrollment must regularly attend a school and an amount of aid for each of those pupils is appropriated by the state and delivered by the state to the school. These monies are the predominant source of revenues pledged to the bondholders.

So what are the risks to this revenue stream?  There are several. The state aid payments may be diminished if a school does not maintain attendance at the proscribed levels. The aid payments may be diminished if, for a variety of reasons, the state does not make the required annual appropriation of these monies. They can be diminished by formula changes enacted by the legislature or other changes to state per capita aid payments enacted for reasons having nothing to do with an individual school. Perhaps the biggest risk for bondholders is the possibility that a school’s charter may fail to be renewed or revoked in the event of academic or financial management deficiencies.

The risk of closure due to academic non-performance is real. One example is Michigan. Michigan was an early and enthusiastic participant in the charter school movement. The program in that state has existed since 1993. Currently, there are 302 charter schools in the State. Since the inception of the program in 1993 however, the charters of 108 such schools have been revoked by the State.

Charters are issued to each school by oversight entities established under state law. They are issued for varying amounts of time usually three, five, or ten years. What is important to bondholders is the fact that the charter usually is shorter than the maturity of the bonds. This exposes the bondholder to all of the financial risk associated with a school which loses its charter or other accreditation. It is the responsibility of the sponsor of each school to meet the criteria for charter renewal and to take the necessary remedial steps to address changes in charter status.

Should a school be unable to operate or operate in a financially deficient manner, the facilities are usually pledged to the bondholders under a first mortgage in their favor. This is a remedy which comes with some practical limitations. Often the building housing the school is on land  which is not part of the pledged assets, and some facilities are limited as to what purposes the facilities may be used. There can be zoning or other restrictions which limit the use of the facilities. This often limits the marketability of pledged property in the event of a liquidation. These are important factors in determining the actual value of a pledged asset.

For all of these reasons, many of these credits are rated below investment grade and are marketed to only qualified institutional investors. Hence the presence of these credits in so many high yield mutual fund portfolios. For the individual investor, these credits do provide additional income but they require a good deal of research and monitoring to avoid the kind of workout situation for which individual investors are generally unsuited.

PENNSYLVANIA STATE INTERCEPT UPGRADE

Eight months after downgrading it to Baa1, Moody’s has upgraded Pennsylvania’s school district pre-default enhancement program to A2 from Baa1. It also raised the maximum rating on school district bonds enhanced under Pennsylvania’s post-default intercept to A3 from Baa1. The upgrades incorporate a law Pennsylvania passed on July 13 that would provide for state funds to be intercepted and diverted to bondholders in the event of a default even without appropriations due to school districts.

The law eliminates the doubts about the program’s swiftness and effectiveness that arose during the commonwealth’s fiscal 2016 budget impasse, during which school districts operated for months without any appropriations due to them, and therefore no funds available to be intercepted to prevent or cure a default. With the new law in place, funds will always be available to prevent or cure defaults, regardless of whether the commonwealth has passed a budget.

This upgrade is more justified than was the recent credit upgrade for the state. The law on which this upgrade is based is clearly an identifiable structural change. It does not reflect any perception that financially the credit is any stronger. (See the 8/9/2016 MCN for our views on the Commonwealth’s financial outlook) The move is a benefit for the school districts which depend on the program, especially a credit challenged one like Philadelphia.

PROVIDENCE HEALTH MERGER REFLECTS ACA IMPACT…

One of the expected results from the pressure to reduce costs on providers under the Affordable Care Act was a wave of consolidation in the industry. One example of that trend is the merger of two major West Coast health systems. Providence St. Joseph Heath  is a multistate, not-for-profit healthcare system formed on July 1, 2016, and comprised of Providence Health System and St. Joseph Health System. The organization is headquartered in Renton, Washington (the corporate headquarters of PHS) and has a second base of operations in Orange County (the corporate headquarters for SJHS). PSJH is co-sponsored by Providence Ministries and St. Joseph Health Ministry, and is active in Alaska, Washington, Oregon, Montana, California, and Texas. Pro forma annual revenues is approximately $21 billion. Altogether, Providence St. Joseph Health will have $6.4 billion total debt outstanding after closing on a pending bond issue.

The combination results in a  large, mostly contiguous, service area covering much of the western United States; a large consolidated pro forma revenue base of over $20 billion; a leading market share in most of its markets; an integrated care delivery platform which includes significant inpatient and outpatient services, employed physicians, and various health plan products; and an experienced, capable, management team with significant experience executing large and complicated affiliations.

For the pending bond issue, PSJH was assigned a Aa3 rating by Moody’s which is consistent with Providence’s pre-merger rating. St. Joseph was rated A1 pre-merger.

…AS DOES HACKENSACK/MERIDIAN MERGER IN NEW JERSEY

On July 1, 2016, a merger between two major providers in New Jersey closed. System are now Hackensack Meridian Health Network. HMHN is now one of the largest systems in the state. Hackensack is the largest provider in Bergen County, and Meridian Health System, is a sizable $1.9 billion integrated multi-hospital system in Monmouth and Ocean counties. The combination results in a $3.5 billion entity. The expectation is that synergies that will be realized over time will outpace the costs to capture such efficiencies.

This positions the ultimate credit –  the debt obligations of each system remain separately secured at this time – to ultimately be positioned for another upgrade. For now, Hackensack University Medical Center is upgraded to A2 from A3. This in spite of Hackensack’s historically high operating lease exposure declined following the debt-financed acquisition of a clinical plaza and parking garage which will reduce future lease expenses. While Hackensack has taken several steps to mitigate its growing pension liabilities and low investment returns, weakening the absolute measure of total debt relative to unrestricted cash.

One other major difference is that while HMHN is now bigger and more diverse, it still is exposed to potentials for change in state funding for Medicaid by having all of its facilities in the one state. The multi-state nature of Provident St. Joseph diversifies that risk.

ANOTHER SMALL COLLEGE DOWNGRADE

The issues of rising tuition and student debt were front and center during the national political conventions. Proposals for student debt forgiveness and free tuition at public colleges were bandied about. Interestingly, it was the managements of small private colleges who were the most vocal in their concern about the possible negative impact of free tuition on the demand for small private colleges. In the last two years, the closings of Sweet Briar and Dowling Colleges made news in the municipal bond market.

Last week, Bard College, a well known small private college in New York saw its rating continue its three year plunge below investment grade. Moody’s lowered the rating on Bard’s $131 million of debt from Ba3 to B1. The downgrade comes on the heels of ongoing declines in total cash and investments decreasing spendable cash and investments further and an increase in debt, including amounts outstanding under lines of credit and lender financing incurred for the purchase of an historic site adjacent to the Annandale-on-Hudson (NY) campus. Bard is increasingly dependent on operating lines of credit, even as it expects to have violated financial covenants in the bank agreements again for FY 2016.

The ongoing depletion of liquidity and increased exposure to bank agreements heightens the prospects for a liquidity crisis in the absence of extraordinary donor support. With a cash flow from operations insufficient to cover debt service, prospects for a material increase in liquidity apart from collecting pledges receivable or benefiting from additional gifts remain slim. A settlement with the US Department of Justice for $4 million in FY 2016, is likely to result in more weak operating performance. One positive element is that the Bard Graduate Center benefits from an external trust that held $111 million in investments as of June 30, 2016.

PRIVATE PRISONS UNDER THE GUN

Localities which have looked to private prisons as a source of revenues and/or jobs got a jolt last week when the U.S. Justice Department announced plans to end its use of private prisons.  A DOJ memo instructs officials to either decline to renew the contracts for private prison operators when they expire or “substantially reduce” the contracts’ scope. The goal is “reducing — and ultimately ending — our use of privately operated prisons.”

Officials concluded the facilities are both less safe and less effective at providing correctional services than those run by the government. “They simply do not provide the same level of correctional services, programs, and resources; they do not save substantially on costs; and as noted in a recent report by the Department’s Office of Inspector General, they do not maintain the same level of safety and security.”

There are 13 privately run privately run facilities in the Bureau of Prisons system, and they will not close overnight. The Justice Department will not terminate existing contracts but instead review those that come up for renewal. All the contracts would come up for renewal over the next five years.

The Justice Department’s inspector general recently released a report concluding that privately operated facilities incurred more safety and security incidents than those run by the federal Bureau of Prisons. The private facilities, for example, had higher rates of assaults — both by inmates on other inmates and by inmates on staff — and had eight times as many contraband cell phones confiscated each year on average, according to the report.

Private operators have said that comparing Bureau of Prisons facilities to privately operated ones was “comparing apples and oranges.” They generally dispute the inspector general’s report.

Three weeks ago the bureau declined to renew a contract for 1,200 beds at the Cibola County Correctional Center in New Mexico. Plans would allow the Bureau of Prisons over the next year to discontinue housing inmates in at least three private prisons, and by May 1, 2017, the total private prison population would stand at less than 14,200 inmates. According to the inspector general’s report, private prisons housed approximately 22,660 federal inmates as of December 2015. That represents about 12 percent of the Bureau of Prisons total inmate population, according to the report. By 2013, the private prison population was 32,000 but it began to decline because of efforts to adjust sentencing guidelines and to change the way low-level drug offenders are charged. DOJ said the drop in federal inmates gave officials the opportunity to reevaluate the use of private prisons.

The real threat will come if the Bureau of Immigration, Customs, and Enforcement follow the Justice Department’s lead. There are many rural jurisdictions which built facilities “on spec” to house illegal immigrants under occupancy based contracts with that agency. Many of the outstanding bonds were issued under those circumstances. Bonds secured by those payments would be immediately at risk if those contracts were not to be renewed. So, if you own bonds backed by payments from the federal government for prisons financed with local certificates of participation be very alert to any moves by ICE to follow the DOJ lead.

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

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

LOUISIANA CONSIDERS CASH FLOW BORROWING

It has never a good sign when a state undertakes short-term borrowing to fill in gaps in cash flow. In bygone times, revenue anticipation notes (RANS) were often issued to deal with timing issues between receipts and expenses. They also were used to cover gaps resulting from revenue shortfalls resulting from poor forecasting practices or unanticipated economic changes. As time has gone by, revenue estimation has become more sophisticated and better overall cash management practices have taken hold so the need for this type of borrowing at the state level has diminished significantly.

So it was disappointing to see that the State of Louisiana will consider this week a proposal to issue some $500 million of RANS to finance cash shortfalls in the first half of the fiscal year which began on July 1. The State budget process was particularly difficult and protracted this year as a new administration sought to rectify some of the questionable budget practices of the prior administration of Bobby Jindal. His program of tax and expense cuts led to a weaker financial position for the historically low rated State of Louisiana credit.

Legislative supporters of the Jindal era are attributing the need for the borrowing to naturally occurring timing differences between revenues and expenses. The more likely explanation is that In the past the state has been able to shift funding from savings accounts as needed to keep up. Those pools of money, including a Medicaid trust fund and contingency fund in the Division of Administration are now gone. those funds were applied to cover shortfalls in prior fiscal years.

Should such a borrowing be authorized and undertaken, it would be the first time since the 1980’s that Louisiana had needed such a borrowing. We view the use of such a borrowing to be a negative credit event which should place pressure on the State’s already low ratings. This despite the efforts of the new administration to address the impacts of the Jindal era budget practices.

ILLINOIS MOVING FORWARD WITH P3 TOLL PROJECT

The Illinois Department of Transportation is soliciting private partners to help develop the Interstate 55 managed lane project — new toll lanes from Bolingbrook to Chicago designed to alleviate congestion. This project is anticipated to include the addition of one lane in each direction within the existing median of I-55 between I-355 to the west and on the east at I-90/94 needed to accommodate implementation of a managed lane, which could include Express Toll Lane (ETL), High Occupancy Vehicles (HOV) lane, High Occupancy Toll (HOT) lane, Congestion Priced lane, or other feasible managed lane configurations as determined to be appropriate for a projected 2040 travel demand.

Interstate 55 experiences severe congestion for extended periods of time on a daily basis and is unable to accommodate the existing traffic demands (regional, daily commuter and local) due to limited roadway capacity, roadway design constraints at some locations, high truck volumes and numerous interchanges. In addition, commuters have limited available public transit options. This has resulted in increasingly long and unreliable travel times, decreased safety and increased costs for delivery of goods and services.

The Federal Highway Administration (FHWA) has determined that the Illinois Department of Transportation’s proposed I-55 Managed Lane Project will have no significant impact on the human environment. The FHWA issued a Finding of No Significant Impact (FONSI) based on the Environmental Assessment (EA) prepared for the study. The Illinois Department of Transportation (IDOT) has completed the voting process among property owners and occupants identified as benefited receptors regarding proposed noise mitigation along the I-55 Managed Lane Project corridor.

Thirteen noise walls totaling over 11 miles in length with 1,776 benefited receptors were found to be feasible. As established by Federal Highway Administration regulations, property owners and/or tenants identified as benefitted receptors are able to vote for or against noise walls in their area. In order for a person to be eligible to vote, the noise wall must decrease the noise level at the property by at least 5 decibels, which is a readily perceptible change in noise (typically homes within 300 feet of a noise wall). If more than 50% of the votes received are in favor of a wall, the wall is likely to be implemented with the proposed project.

Private developers would help defray the estimated $425 million cost of the project, according to IDOT. Private partners would have a hand in designing, building, operating and managing the toll lanes. Potential partners need to submit proposals by Sept. 8. IDOT needs approval from the General Assembly for the I-55 toll project. If all goes as planned, construction could start as early as next year and wrap up in 2019, officials said.

Last month, the state approved a similar project — a public/private toll bridge linking Interstate 80 to the CenterPoint intermodal facility in Joliet and Elwood. The Houbolt Road bridge will cost $170 million to $190 million, with CenterPoint building and operating the toll bridge over the Des Plaines River. IDOT is covering $21 million of that cost.

LIPA UPGRADED BY MOODY’S

Moody’s Investor Service upgraded the Long Island Power Authority’s (LIPA) credit rating one notch to A3 from Baa1 (senior debt) and to Baa1 from Baa2 (subordinate debt). Moody’s cited “enhancements” to its ability to recover costs from customers following last year’s rate-hike proceeding. It also noted improvements in LIPA’s operating performance, better customer satisfaction levels, more transparent and credit supportive regulatory relationships and an expectation for better financial performance on a sustained basis.

On January 1, 2016 a three-year rate plan was put into effect, which called for modest electric distribution rate increases and automatic recovery mechanisms that provide protection against certain external factors. Supportive automatic recovery mechanisms approved and implemented include a revenue decoupling mechanism (RDM) and a delivery service adjustment (DSA). Together, these mechanisms provide automatic cost recovery should certain external events occur, including revenue variations that result from changes in economic conditions, weather or energy efficiency programs as well as higher-than-budgeted storm costs.

LIPA’s has received grant funds from FEMA, which along with internal generated cash flow sources and incremental debt will fund a capital investment program focused on storm hardening and enhancing system reliability. Because of the existence of the FEMA funds, currently held in a restricted cash account, the debt ratio is expected to continue its declining trend even while incremental debt is incurred to fund the capital investment program.  A higher rating could occur if the fixed obligation charge coverage were to reach 1.50 times while its debt ratio declined below 100%, both on a sustained basis.

PREPA ROAD TO RECOVERY HITS MORE SNAGS

The path to recovery for PREPA appears to have run into some more problems. It appears that the time line for recovery will be extended through year end with the announcement of an extension of the contract of PREPA”s restructuring advisor through December 15. The extension, which will cost $6.713 million, has been criticized with the news that the advisor had paid Standard and Poor’s some $365,000 in consulting fees to help secure an investment grade rating for bonds to be exchanged as part of an Special Purpose Vehicle that is a cornerstone of the Restructuring Support Agreement (RSA) it has secured with 70% of its bondholders. As of yet,  all of the credit rating agencies declined to give the new bonds an investment grade. Since that did not happen, PREPA must return to the negotiating table with bondholders.

PREPA continues to believe that there is a path to obtaining an investment grade rating for the securitization bonds and intends to initiate a formal rating process with rating agencies in the near future. The investment grade, which is key to consummate the deal for an exchange of debt for new securitization notes to receive 85% of their existing claims in new securitization notes, is not yet guaranteed by credit rating agencies despite a securitization mechanism tied to a rate hike that could surpass 22%.

That rate hike is already facing potential challenges. As we go to press, it is expected that eight leading Puerto Rico business and industry organizations will announce the filing of a major lawsuit to block no-limit (“blank check”) rate increases as part of the controversial Puerto Rico Electric Power Authority (PREPA) debt restructuring scheme. U.S. groups are also joining in support of the litigation effort.

The industry groups are the  Institute for Competitiveness and Economic Sustainability of Puerto Rico, the Puerto Rico Manufacturers Association, the United Retailers or “Centro Unido de Detallistas,” the Puerto Rico Products Association,  the Chamber of Marketing, Industry and Food Distribution, Puerto Rico Hospitals Association, the Puerto Rico Hotel & Tourism Association, and the Association of Contractors and Consultants of Renewable Energy.

ALL ABOARD FLORIDA BONDS DERAILED IN COURT

Martin and Indian River Counties in Florida won a favorable decision in a U.S. District Court in their challenge to the private activity bond allocation granted to the private developer of the high speed train project, All Aboard Florida. Now known as the  Brightliner, the project would provide service between Miami and central Florida. (See the MCN, 6/16/16) The counties have sought to block the project on environmental grounds, a hurdle which we have discussed numerous times as a major investor risk in public-private (P3) projects.

Fourteen months ago, the Court denied preliminary-injunction motions filed by the two Florida counties,  which sought to invalidate the U.S. Department of Transportation’s (“DOT’s”) authorization of $1.75 billion in tax-free bonds to be issued to finance a private passenger-rail project known as All Aboard Florida. The Court found that the counties had not met their burden of demonstrating standing because they had failed to show that enjoining DOT’s authorization would significantly increase the likelihood of halting construction on Phase II of the project, the portion that runs through their borders. The Court did permit the Counties to conduct discovery designed to provide Plaintiffs an opportunity to uncover evidence to support their assertion that, without the ability to issue $1.75 billion in tax-free private activity bonds (“PABs”), AAF would be significantly less likely to proceed with the project.

Both counties allege violations of the National Environmental Policy Act (“NEPA”), the National Historic Preservation Act (“NHPA”), the Department of Transportation Act (“DTA”), and Martin County additionally alleges a violation of Section 142 of the Internal Revenue Code, as amended by the Safe Accountable Flexible Efficient Transportation Equity Act (“SAFETEA”). Because Plaintiffs have alleged facts showing that the AAF project qualifies as major federal action, the Court denied Defendants’ motions to dismiss Plaintiffs’ NEPA, NHPA, and DTA claims.

The project is divided into two phases. In Phase I, AAF intends to provide rail service linking West Palm Beach, Fort Lauderdale, and Miami. Phase I has received private funding and is in development; in fact, it is nearly complete.  Thus far, AAF and its parent company, Florida East Coast Industries (“FECI”), have spent over $612 million on development and construction and expect to commit to spending an additional $200 million.

To fund Phase II of the project, AAF applied for a $1.6 billion loan through the Railroad Rehabilitation and Improvement Financing program (“RRIF”). RRIF is both a loan and loan- guarantee program administered by the FRA for the development and improvement of railroad tracks, equipment, and facilities.  RRIF loans are subject to NEPA review of the proposed project’s environmental effects.  FRA has been acting as the lead agency in preparing an Environmental Impact Statement (“EIS”) and Record of Decision to determine the environmental effects of Phase II prior to making a final determination as to AAF’s loan application. FRA, in cooperation with the U.S. Army Corps of Engineers, U.S. Coast Guard, and Federal Aviation Administration, issued a draft EIS in September 2014 and a final EIS (“FEIS”) in August 2015. The FEIS analyzed a wide range of potential environmental and other consequences of the project and “identified and evaluated measures that would avoid, minimize, or mitigate impacts that would result from the Project.”  under the RRIF program.

The Court cannot to address the sufficiency of the allegations in the counties’ complaints unless they have standing to bring their claims. With a finding of standing, the Counties can challenge on environmental grounds. The hope to at least delay bond issuance through the current (after two extensions) January 1, 2017 deadline to issue the bonds. The counties’ burden in this phase of the case was to show that invalidating the PAB authorization would significantly increase the likelihood that AAF would abandon Phase II of the project. The Court found that they have. An appeal is expected.

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

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

 ANOTHER P3 TOLL ROAD BANKRUPTCY

On March 22,2007, a concession agreement was executed between the Texas Department of Transportation   and   SH130  providing for the financing, construction, and operation of a toll highway in Texas. Financing was provided one year later by a consortium of foreign banks and a TIFIA loan ($440 million) from the U.S. Government. If you recall, privatization of roads had been a goal of the Bush administration and then Texas Governor Rick Perry.

Texas State Highway 130 (SH 130), also known as the Pickle Parkway, is a highway from Interstate 35 in San Antonio along Interstate410(Texas) and Interstate 10 to east of Seguin, then north as a tollway from there to Interstate 35 north of Georgetown. SH 130 runs in a 131-mile (211 km) corridor east and south of Austin. The route parallels I-35 and is intended to relieve the Interstate’s traffic volume through the San Antonio-Austin corridor by serving as an alternate route.

The highway was developed in response to the tremendous surge in truck traffic on the I-35 corridor brought on by the North American Free Trade Agreement during the late 1990s, especially truck traffic originating from Laredo. The road opened for operation in November, 2012. It quickly became known for two things – it had the highest speed limit in the U.S. at 85 mph and almost no traffic.

It is difficult for toll highways which run essentially parallel to free limited access roads like 1-35, to attract sufficient numbers of users. It is often difficult to convince potential users that the savings in time and fuel are enough to offset the cost of tolls. SH 130 levied a toll for a passenger car that was nearly $20 and a heavy truck would be over  three to five times over in recent years, which made the cost/benefit analysis less favorable to potential users.

These forces combined to generate revenue yields from the road coming in well below ability to service the $1.1 billion of outstanding debt  that financed construction. The continuation of these trends and the lack of any real alternatives led  the to consortium to seek bankruptcy protection earlier this year.

Last week, the debtors proposed a plan of reorganization which effectively turns the project over to its creditors. A new corporate entity will be formed to operate the road and the outstanding debt will be refinanced with a combination of debt and Payment in Kind or PIK instruments. So effectively, it is up to the lenders to fix the problem and recover their investment.

What is of real interest to municipal investors is the role of Cintra, S.A. as one of the members of the original consortium which built and operated the project, This represents the third failed P3 project in the US in which Cintra has been a primary participant which has not achieved the desired results. It was the initial purchaser of the Chicago Skyway which benefitted the City of Chicago but which Cintra divested itself of in a year’s time and the ill-fated Indiana Tollway privatization. That deal was hailed as a huge success for Indiana and its Governor Mitch Daniels but was a financial failure for Cintra. Based on that track record we would be wary of any P3 involving Cintra.

MOODY’S GREEN BOND RATINGS

The Upper Mohawk Valley Regional Water Finance Authority received a green bond assessment of GB1 for $8.78 million of water system revenue bonds the first GBA from Moody’s Investors Service to be issued in the U.S. The assessments range from GB1 for excellent to GB5 for poor. The assessment is designed to help investors determine if green bond proceeds are being used to achieve “positive environmental outcomes,” according to Moody’s.

Beginning in July, the rating agency has assigned four GBAs, the first three of which went to European entities. There a growing number of investor classes both individual and institutional who invest specifically in projects designed to address environmental issues. There are mutual funds which are marketed as “green” investment funds. Moody’s attributed the demand for these ratings to institutional buyers primarily . The existence of an outside “objective” assessment of the “green” status of the bonds will address compliance and marketing issues for the funds.

The Upper Mohawk Valley Regional Water Finance Authority bonds are to be issued soon to help finance an increase in the water system’s resiliency and the furtherance of its mission to provide safe drinking water to users. The authority is an instrumentality of New York State that serves 130,000 residents through 38,900 service connections in the eastern portions of the eastern portions of Oneida and Herkimer counties as well as the city of Utica.

According to Moody’s calculations, global green bond issuance during the second quarter reached a new quarterly high of $20.3 billion, raising total volume for the first half of the year to $37.2 billion, an 89% increase over the same period a year ago. The U.S. accounted for about 22.8% of the second quarter issuance and 19.8% of first quarter issuance, Moody’s said. U.S. Issuers in the second quarter were from Massachusetts, New York, California, Maryland, Indiana, Cleveland, Ohio, New Jersey, Rhode Island, and St. Paul, Minn.

Determining factors would include whether bonds issued to finance a project will reduce a carbon footprint, deter climate change, or improve water quality. The GBA will be based in part on the disclosure practices of the issuer and borrower and how transparent they are. The GBA is determined according to five key factors: organization; use of proceeds; disclosure of the use of proceeds; management of proceeds; and ongoing reporting and disclosure on environmental projects financed or refinanced with the bonds.

In the example of the Upper Mohawk Valley Regional Water Finance Authority, Moody’s said the authority is effectively organized and properly staffed with qualified and experienced personnel. The bonds, are explicitly designated as green bonds in the draft official statement by the Authority. They are being issued under the authority’s capital improvement plan to improve the water system’s infrastructure through increased capacity and dependability with proceeds allocated to raw water transmission upgrades that will improve the authority’s ability to draw water from the Hinckley Reservoir during major droughts that lead to below-normal water levels in the reservoir.

A small share of proceeds will finance design of two new water storage facilities as well as improvements to a water treatment plant and pumps and regulating stations. The authority discloses information on these projects in its annual comprehensive financial reports and on its website in capital projects committee reports.

The projects are expected to be completed within 12 months and the first-year initial disclosure is supposed to indicate in detail how the proceeds were expended, the contractors performing the work and receiving payments, and the actual work that was completed. In order to maintain the designation Moody’s says that “annual reporting will also include updates on four key metrics that at the same time link up to base line disclosures that permit comparative analysis”. “These include reservoir water levels versus transmission capacity, conveyance of purified potable water during the year, trihalomethane levels and the total amount of hydroelectric power produced by the turbines within the water treatment facility.”

It is fair to ask if there should be any concern as to whether the rating agency is stepping outside of its area of expertise. Would it be more proper to consider this the realm of engineering and/or environmental consultants? On whose expertise are they relying for ongoing chemical or other water quality analysis? Will a credit like the NYC Water and Sewer Finance Authority get credit for its renowned water quality and minimal treatment requirements? We ask because historically the rating agencies have relied on their stand that their credit ratings are just opinions to protect themselves from the consequences of overrating bonds. They seem to be making the case that the GBA is a more quantitative assessment rather than just an opinion.

ILLINOIS TESTS THE MARKET

Illinois is going to see if it can take advantage of its most highly rated credit by issuing  Sales Tax Revenue Bonds during the week of August 22. Build Illinois bonds have a first and prior claim on the state share of the 6.25% unified sales tax and a first lien on revenues deposited into the Build Illinois Bond Retirement and Interest Fund (BIBRI). Debt service payments on the junior obligation bonds are subordinate to outstanding senior lien debt service; the senior lien is not closed. The security includes strong non-impairment language, and no requirement for annual appropriation.

These provisions are seen as providing a degree of insulation to the bonds from the larger credit problems plaguing the State’s GO credit. The trustee and the state’s debt manager transfer monthly 1/12th of the greater of 150% of the certified annual debt service or 3.8% of the state’s share of the sales tax up to the certified annual debt service requirement. The 3.8% of revenues has, since fiscal 2013, been greater than the debt service requirement, accelerating annual debt service funding.

Coverage of annual debt service and MADS requirements is very high for both liens. Additional security features include additional bonds tests that require debt service be no more than 5% of the state’s prior year sales tax receipts to issue senior lien bonds and 9.8% to issue junior obligation bonds; this effectively requires 20x coverage to issue senior lien bonds and 10.2x coverage to issue junior obligation bonds.

Revenue performance since the end of the recession has shown good  year-over-year growth in all years except 2013. Sales tax revenues grew 4.1% and 4.5% in fiscal years 2014 and 2015, respectively. This year has been impacted by lower gasoline prices, with just 0.7% year-over-year growth in sales tax revenues in fiscal 2016. The state taxes gasoline sales as a percentage of the per-gallon price.

This issue is coming to market with ratings from S&P (AAA negative outlook) and Fitch AA+ (stable outlook). Moody’s has a much different view of the degree of insulation the credit has from the State’s well-known problems, assigning a Baa 2 rating to the bonds. Over the years the segregation of state sales tax collections in a variety of jurisdictions and credit environments, in our view, has stood the test of time. That serves as the basis for our view that the Moody’s assessment is too harsh supporting the State’s move to come to market without soliciting a Moody’s rating.

At the same time, the fact that the senior lien is not closed precludes a AAA rating in our view. This in spite of the strong credit provisions we have described. All in all, the bonds represent a solid AA credit.

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

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

NEW JERSEY PENSION PARALYSIS

Senate President Stephen Sweeney all but declared dead a ballot question to mandate more funding for New Jersey’s troubled pension system – costing an estimated $20 billion over five years. It had been his top legislative priority. He is expected to run for governor in 2017 and spent more than a year pitching his plan as a lasting fix to New Jersey’s pension-funding crisis, one of the worst in the country.

By cutting more than $2 billion from pension payments during the budget crisis in 2014, Gov. Christie triggered a series of downgrades from Wall Street credit-rating agencies and several lawsuits from unions. The state Supreme Court upheld Christie’s pension cuts last year, even though Christie had signed a law pledging to make them in full. Democrats in response proposed a constitutional amendment – which must be approved by the voters – to overturn that court ruling.

The Assembly approved the ballot question in June. But the Senate has not done so and needed to act before the constitutional deadline on this past Monday to place the measure on November’s ballot. Sweeney said it would be “irresponsible” to proceed with the pension amendment at a time when lawmakers do not know how much a potential transportation deal will cost in future tax revenue (see the 7/28/16 MCN). Of the two leading transportation plans, one would cost $550 million and the other $1.7 billion in lost annual revenue after being phased in over several years. Sweeney ruled out raising taxes or cutting from other areas of the budget to meet pension and transportation costs.

Sweeney’s position represents a shuffle in the usually expected politics of pensions. Union leaders called the democrat ” a liar” and the state director of the Communications Workers of America union, said the amendment is needed because politicians like Christie and Sweeney keep moving the goal posts on their pension-funding promises, she added. “It’s been over two decades since any administration – Republican or Democrat – made a full pension payment,” she said. The amendment would increase pension payments over five fiscal years with some of the strongest legal language available anywhere in the country. Pension payments would have become the top priority in the state budget every year in perpetuity – impervious to any budget cuts even after the first five years. The amendment also would have required state officials to make pension payments on a quarterly basis. No state mandates quarterly pension payments through its constitution.

Spread out over five years, the amendment’s cost would have been $20 billion, according to the nonpartisan Office of Legislative Services, starting with a $2.4 billion payment in fiscal year 2018. New Jersey’s state budget this year is $34.5 billion, and Christie is proposing to make a $1.9 billion pension payment, what would be the largest in state history, but only 40 percent of what actuaries say is needed to fully fund the retirement benefits workers have earned.

Sweeney supported the amendment for months, stressing that pension costs grow exponentially for state taxpayers over the long term with each passing day that the pension system’s problems are further neglected. Christie, Republican lawmakers and business groups are all opposed to the pension amendment. Bondholders should be concerned about provisions which place pension payments ahead of debt service no matter how positive the full funding of pensions would be from a ratings perspective.

NEW HAVEN, CONNECTICUT

Recently the outlook for the State of Connecticut come under scrutiny. We note the fact that while aggregate state wealth indicators are strong, many of its cities had been hollowed out economically and faced significant financial challenges on their own. The recent release of a preliminary official statement by the City of New Haven in support of a pending GO bond sale gives us an opportunity for a case study.

The City’s role as the home of Yale University is well known. The surrounding city has not benefitted from its presence as much as one might think and the relationship between the University and the residents has been fraught for years. The local economy has struggled and the property tax base has stagnated. As a result, the City has high demands for services but its capacity to raise revenues has been strained.

In recent years, the City has been able to maintain control of expenditure growth with the budget growing less than 2% per year since 2009. Expenditures have increased from $456 million to $509 million over that period. Unfortunately, like the State, the City faces steady growth in its liabilities for pensions and other post employment benefits (OPEB). These have grown to present the greatest fiscal challenge to the City.

Pension funding contributions have been increasing regularly if at uneven rates since 2009, growing by a total 65.8% over that period. In spite of this effort,  which has increased the share of pension funding from 6% to 9% of total expenditures, the funding ratio for these liabilities has decreased from 60% to 39% for non-uniformed employees and 58% to 50% for uniformed employees. This reflects a combination of disappointing investment returns combined with a rapid rate of increase in accrued liabilities as employees age out and retire. It also reflects a nationwide policy of addressing lower salary growth through the use of increased pension benefits as a negotiating tactic with employee unions.

Scarier is the lack of asset accumulation for OPEB by the City. It essentially funds these on a pay as you go basis. These liabilities have now increased to 184% of annual payroll. At the same time, the funding ratio for these liabilities has stood at 0.1%. This because the City only began the asset funding process in 2012 and only made appropriations for this purpose in two years.

The City is rated Baa1 by Moody’s and A- by S&P and Fitch. The latter two have positive outlooks on their ratings. Our view is that such an outlook is hard to justify in the face of these liability issues along with the low return investment environment we are in. Given that the funding ratios reflect assumed annual investment returns of 8% (and that is a decrease) each additional year of investment underperformance will further pressure funding ratios. In the face of this kind of fiscal pressure, we cannot see this as a positive situation and the bonds are a triple B credit. They need to be priced accordingly.

KANSAS POLITICS COULD REVERSE FISCAL TRENDS

We normally would not give a lot of weight to primary results in state government races but this year’s primary in Kansas is a unique situation. For some time we have negatively commented on the outlook in Kansas which results from the strong ideological bent of its legislature and Governor Sam Brownback. Last week, voters went to the polls to choose candidates for the November general elections for state legislators. To say that they sent a message is an understatement.

The results cut deeply into the Senate’s conservative voting majority and may have reversed it in the House, especially if Democrats pick up a few more seats in November. Moderates and Democrats regularly teamed up to block right-wing legislation until conservative challengers purged the Senate of most of its moderates in the 2012 Republican primaries.

The moves to eliminate the income tax were designed to stimulate business growth and employment but failed to do so. The governor’s signature tax plan exempted more than 300,000 business owners from paying any income tax. What they did accomplish was to diminish state revenues and force cutbacks in expenditures in the form of lower aid to local school systems and highways. Schools and roads are among the more cherished services for Kansas voters.

In the meantime, Kansas missed revenue expectations for June by more than $33 in the 2016 fiscal year, which ended June 30, and after the state lowered revenue estimates significantly in April. The bulk of the June shortfall can be attributed to lower-than-expected income tax receipts. Corporate income tax receipts are expected to be $20 million below expectations, and individual income tax receipts are expected to be $18 million off the mark. Some other types of taxes outperformed estimates, but not enough to fully offset the loss.

SCRANTON FACES DAUNTING CHALLENGES

Scranton, PA has been a city on the decline for nearly a century. The demise of the anthracite coal industry and its role as a railroad hub have long been documented. It has led to long term declines in population and property values. This led to continuing budget imbalance and reliance on increased tax and financial gimmickry. Eventually, the City’s bag of tricks emptied and it found itself in the Commonwealth of Pennsylvania’s Act 47 Distressed Cities Program.

Under the program, the City was supposed to undertake a five year plan of fiscal renewal such that it could leave the program in 2017. Unfortunately, the City was unsuccessful in its implementation of the revenue adjustments and workforce changes required under the 2012 plan. A deficit is projected for each of the next five fiscal years with the 2020 deficit estimated at $19 million or nearly 20% of expenditures. A revised recovery plan along with an extension of the Recovery Period to 2020 has been adopted. The plan is designed to help the City to avoid a declaration of fiscal emergency in the next two years.

The plan includes an increase in the local services tax from $52 to $156 per year. Right now, earned income and local property tax revenues cover on $56 million out of $71 million of employee expenses (wages and pensions). It seeks to sell the City-owned parking system and looks to the fees charged for sewer services as a source of funding for the City’s unfunded pension obligations. It calls for asset sales and application for grants from the Commonwealth.

The City has applied to sell the Sewer System to a private operator. Estimated proceeds re $110 to $120 million, with 80% due to the City. If successful, the City will apply its proceeds to defeasance of $18 million of debt and to funding $65 million of unfunded pension liabilities. In spite of this significant cash infusion, the funding ratios for the City’s pension funds will still be only 50%.

It is the view of the Plan’s developer that without implementation of all elements of the Plan, the City will need to declare a fiscal emergency. Even if implemented, property taxes may have to be raised. The City’s $132 million of debt will need to be refinanced. The Plan suggests the use of pension bonds payable from dedicated earned income tax revenues as a part of the solution.

Of more immediate concern is the need to issue some $35 million of GO notes. These notes, maturing in 10 and 15 years, will be full faith and credit obligations of the City. Unfortunately, the problems outlined above present a very weak credit in support of that pledge. There has been a lack of public political support for raising taxes and fees and even less political will on the part of local politicians. Without those to factors and the means to pay, the City’s debt remains at best a highly speculative investment.

INDIANA P3 DOWNGRADED AGAIN

In our April 14, 2016 issue we commented on the problems facing the I-69 Section 5 project that is a part of an Indiana highway that is being expanded to handle expected increased truck traffic resulting from NAFTA. Isolux Corsan SA (Isolux) is the parent of the construction contractor, Corsan-Corviam Construccion SA, whose rating was revised to ‘B-‘/Rating Watch Negative on Feb. 12, 2016. Those problems have continued. Now, Fitch Ratings has downgraded the Indiana Finance Authority’s private activity bonds (PABs) issued on behalf of I-69 Development Partners LLC (I-69 DP or the Developer) for the I-69 Section 5 project to BB from BBB-. The bonds remain on Rating Watch Negative.

The downgrade reflects continued delays in construction and unresolved payment issues between the construction contractor and subcontractors, culminating in two Notices of Default issued by the Developer to the construction contractor, citing failure to promptly pay subcontractors and falling behind on an existing remedial plan, which have 20 and 60 day cure periods, respectively.

Delay risk is also heightened by the financial deterioration of Isolux Corsan SA (Isolux), parent of the construction contractor, Corsan-Corviam Construccion SA, whose rating was revised to ‘RD’ (Restricted Default) from ‘C’ on Aug. 3, 2016, reflecting the execution of a Distressed Debt Exchange following recent filings for forms of court protection. The company has confirmed that, to date, it has met payments but non-payments are planned under restructuring plans.

This transaction continues to be a great advertisement for the perils of P3 projects for both investors and for governments who hope to benefit from the “efficiencies” of the private sector in lieu of traditional funding for public projects.

 

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

CHICAGO LOOKS TO WATER BILLS TO FUND PENSIONS

The latest credit development in the Chicago pension saga is a proposal by Mayor Rahm Emmanuel to generate the $239 million over five years needed to save Chicago’s largest city employee pension fund. Emanuel proposed  a “utility tax” on water and sewer bills over the next four years. The plan is to start with a 7 percent tax, double it in year two, impose a 21 percent tax in year three and end at 28 percent in years four and five.

After that, the tax would rise annually to meet the “actuarially required contribution” to achieve a 90 percent funding ratio by 2057 for a Municipal Employees pension with $18.6 billion in unfunded liabilities that is due to run out of money in 2025. The average Chicago household currently pays $686.04 a year for water and sewer services that use 7,500 gallons of water.

The plan faces some clear hurdles. It rests on City Hall’s assumption that the new tax can be enacted by the City Council in September under the city’s sweeping home-rule power and does not require state legislative approval. It is expected to cost the average homeowner $4.43 more month or $53.16 a year in 2017. In the fourth year, the added tax burden will be $225.96 a year.

The plan would undoubtedly be well received by investors who view the pension situation as the primary factor weighing on the City’s credit but it will undoubtedly be just the opposite for homeowners who will see the city’s property tax levy double under Emanuel’s leadership and the aldermen who represent them. Emmanuel acknowledges this by saying “I’m not saying this is not tough. It is tough . . . But the Council has always stepped up for Chicago’s future and I’m absolutely confident they will step up and be part of that solution so that, once and for all, the bow can be tied as it relates to the pensions”.

One outsider view that carries considerable weight in analytical circles is that of the Civic Federation. Its president called it a “positive and politically reasonable step” to try to “use water fees” instead of raising property or sales taxes that would only compound the “high tax situation that already exists.” He added a caveat when he characterized the plan as “a creative and brave effort by the mayor but it will require continued monitoring. We have not seen the actuarial detail to prove” the tax will generate enough money “in the longer term,” he said.

A property tax increase based on the value of a home would have been less regressive than a tax on water and sewer bills based on water usage needed to live, a property tax hike would have had the added advantage of being deductible on federal taxes for homeowners. In spite of that, a property tax hike is considered untenable at present.

PENNSYLVANIA – STABLE OUTLOOK?

The upcoming sale of GO debt by the Commonwealth of Pennsylvania occasioned Moody’s to review its Aa3 rating and to maintain with a revised outlook, upwards to stable . Their rationale – “The revision of the commonwealth’s outlook to stable recognizes that Pennsylvania’s problems – while sure to persist – are unlikely to lead to sharp liquidity deterioration, major budget imbalances, or other pressures consistent with lower ratings for US states. Pennsylvania continues to make steady progress toward better funding of its pension liabilities, which remain large but not abnormally large by state standards. The commonwealth is likely to continue struggling to balance its budgets in future years, but the magnitude of its budget gaps will be solvable. And while legislative gridlock, depletion of its rainy day balances, and a long history of pension underfunding reflect poorly on the commonwealth’s governance practices, none of these is inconsistent with the current rating category, which is already below the median for a US state.

Whenever a rating is challenged in court by aggrieved investors, the rating agencies wriggle off the hook by citing their First Amendment right to express an “opinion”. So exercising the same right let us express our opinion that the phrases “likely to continue struggling to balance its budgets in future years, depletion of its rainy day balances, and a long history of pension underfunding” are not consistent with a double A rating. Especially in a state where so much economic activity is concentrated geographically in two areas with the rest in an extended state of deep decline.

Our advice to investors is, if they must, invest in this name at a spread to other comparably rated credits and please do not be surprised when partisan considerations hold up serious structural budget reform in the second two years of Governor Wolf’s term. Only a serious rebalancing of the legislature in November should lead to a view of credit stability.

NUCLEAR POWER – COSTLY ON THE WAY IN AND THE WAY OUT

The Omaha Public Power District in Nebraska is planning to sell $175 million of revenue bonds this month. OPPD has operated a nuclear generating facility – the Fort Calhoun generating station since 1983. The official statement updates investors about its plans to close the plant at the end of 2016 and replace the generating capacity with purchased power generated by natural gas fired facilities.

We see the details of this change as indicative of a number of factors influencing power generation decisions by both public and investor owned utilities. First, it continues a trend of closures of nuclear plants. These are occurring in spite of the perceived positive impact on global warming of these facilities due to their lack of carbon emissions. The perceived environmentally friendly status of natural gas fired plants combined with their OPPD is not making a particularly daring decision.

It is also a decision which is not without cost. The official statement estimates the cost of decommissioning the Calhoun plant at $1.256 billion. At present, the District estimates that it has accumulated some $387 million of assets in decommissioning trust funds. There are two shortfalls that exist in these funds. One is the difference between the asset values and the total estimated decommissioning costs – a long term problem. Of more concern is that the NRC requires $435 million of funding to demonstrate assurance of funding for decommissioning. So the District will have to generate at least $50 million of additional funding by year end. The District will also have to pay Exelon, the plant operator, $5 million for early termination of its operating agreement.

The plant is for accounting purposes now carried as a regulatory asset for the purpose of recovering its costs of decommissioning. A 10 year amortization period commenced in December, 2013 for cost recovery and there is a balance of $117 million on that asset. Each year the District will recognize a depreciation charge against the balance of that asset. So there is a way to recover some of the cost.

At the same time, the New York State Public Service Commission has issued an order that will allow upstate utilities to charge their customers nearly $500 million a year in subsidies aimed at keeping some upstate nuclear power plants operating. Exelon has said it may have to close its R. E. Ginna and Nine Mile Point nuclear plants unless it receives financial help from the state. Another company, Entergy, had said that it would close the James A. FitzPatrick plant, which neighbors Nine Mile Point on the shore of Lake Ontario in Oswego County, by early next year.

Starting in 2017, the subsidies would cost utility ratepayers in the state $962 million over two years. The overall cost of the clean energy program to utility customers would be less than $2 a month. Exelon has pledged to invest about $200 million in its upstate plants next spring if the program is approved.

The plants also provide economic benefits in job starved localities by maintaining employment. In some cases, they are by far the largest property tax payers in their localities. No one is arguing that this is the cheapest way forward.

SNAKE EYES FOR ATLANTIC CITY

Just after avoiding a default on its debt, the Atlantic City economy and the effort to restore it took a hit when the Taj Mahal announced that it will be closing after Labor Day. The story will get lots of publicity since it still has the Trump “brand” in its name even though Mr. Trump is no longer involved. It is actually owned by Carl Ichan. A long strike and a steady decline in business at the facility will lead to a loss of 3,000 jobs just at a time when the City does not need it.

The decision reflects the long term challenges faced by the gambling industry in Atlantic City. With continuing competition from the newly established Pennsylvania facilities draining customers, Atlantic City remains under pressure. Potential additional new competition from New England reinforces the fear that gaming is becoming a zero sum proposition in the Northeast.

PURPLE LINE P3 TAKES LEGAL HIT

The proposed mass transit project in Maryland known as the Purple Line suffered a significant legal setback when a federal judge issued an order that will force the project to submit an environmental impact study. The project, a 16.2-mile light rail transit project in Montgomery and Prince George’s Counties, Maryland is planned to be constructed through a public private partnership or P3 arrangement. The judge found that that the recent revelations regarding Washington Metropolitan Area Transit Authority’s (“WMATA”) ridership and safety concerns merit a supplemental Environmental Impact Statement (SEIS) under NEPA and reserved judgment as to the remaining issues. Accordingly, plaintiffs’ motion for summary judgment was granted in part, and federal defendants’ and defendant-interveners cross­ motions for summary judgment  were denied  in part.

The NEPA requires that federal agencies consider the environmental effects of proposed actions by requiring them to “carefully consider detailed information concerning significant  environmental  impacts.”  The plaintiffs claimed that defendants’ failure to prepare an SEIS based on recent events that raise substantial concerns about WMATA ‘s safety and in turn its possible decline in future ridership. The judge found that defendants’ failure to adequately consider WMATA’ s ridership and safety issues was arbitrary and capricious, and that these conditions create the “seriously  different picture” that warrant an SEIS.

Plaintiffs pointed to a “series of incidents that have raised questions about passenger safety”, explained that the National Transportation Safety Board had found that the “FTA and WMATA’s Tri-State Oversight Commission are incapable of restoring and ensuring the safety of WMATA’s subway system,” and emphasized how these developments directly undermined the rationale for the Purple Line. Plaintiffs stated that ridership on the  WMATA  subway  has  declined  every year  since 2009. In their view, the news of (declining Metrorail ridership) . . . casts an additional shadow over the rosy projections of ever­ increasing ridership for the Purple Line, which  is inextricably  linked to and dependent upon the use of several subway stops from beginning to end.

The Maryland Transportation Authority (MTA) offered in response only that the Purple Line is not part of the WMATA’s Metrorail  system.  The  Purple Line would be owned by MTA and operated by MTA’s contractor. Therefore, the financial or other issues currently being experienced by WMATA do not involve the Purple Line, and they  have no relationship to the environmental impacts of the Purple Line. Therefore, the WMATA-related issues cited in FCCT’s letter provide no basis for preparing  an SEIS.

This was sufficient for the relevant federal regulators but the judge found such reliance to be arbitrary and capricious given the need for access to the Purple Line through the WMATA system. He found that defendants wholly failed to evaluate the significance of the documented safety issues and decline in WMATA ridership, skirting the issue entirely on the basis that the Purple Line is not part of WMATA. While it is true that WMATA is a distinct entity from MTA, which would own and operate the Purple Line, this does not provide a rational basis for defendants’ summary conclusion that a decline in ridership thereon has no effect on the Purple Line, given that the previous projections estimated over one quarter of Purple Line riders would use the WMATA Metrorail as part of their trip.

We never fail to be amazed when projects underestimate the role of the environmental review process as a potential source of delay and/or blockage of transportation projects whether they be for road, rail, or air projects. In assessing project viability whether before or during investment, investors need to be concerned with the status of the environmental review process and satisfy themselves that they are being compensated for the associated risk.

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

MSRB DISAPPOINTS ON BANK LOAN DISCLOSURE

Participants in the municipal bond market have been fighting the glacial pace of disclosure reform for as long as I can remember. The latest development in this effort is in the realm of disclosure of credit exposure by municipal issuers through direct lending by banks. In an effort to avoid the time, cost, and financial disclosure requirements associated with a public debt offering, smaller municipalities have increasing turning to commercial banks as a source of financing. While there have been some benefits for issuers, this lending has raised a number of credit issues for analysts and investors attempting to ascertain the actual level of risk associated with investment in a given issuers bonds.

One of the big concerns associated with this kind of borrowing is the lack of disclosure available to debt investors surrounding the exact security provisions for these loans. While the loans themselves are usually secured on a subordinate basis to outstanding debt, that can change in the event of a default on a loan. Often, in the event of default, the lending bank can demand that the borrower issue actual bonds which are secured on a parity with previously issued debt. holders of those bonds can suddenly find themselves with a significantly larger amount of debt secured on a parity with theirs. This complicates the analysis of potential recovery in the event of a default and/or bankruptcy and makes valuation of the total amount of outstanding debt much more problematic.

So it was with some disappointment that we see that the Municipal Securities Rulemaking Board (MSRB) announced this week that the U.S. muni market’s self-regulating group would not pursue “at this time” a rule to facilitate disclosure of bank loans taken out by states, cities, schools and other bond issuers. The board, which regulates muni dealers, bond underwriters and financial advisors, but not state and local government issuers, has been trying to devise a way to boost disclosure of such private loans for the reasons we have discussed.

The MSRB’s decision likely means that most investors will not be able to get this information. This despite the fact that the regulator itself acknowledged in March that only a small number of issuers had disclosed the loans “The board continues to believe that disclosure of alternative financings is important for assessing a municipal entity’s creditworthiness.” She said the board would instead continue to push for voluntary c”We preserve our ability in the future to do rule-making, but we wanted to give it a little more time,” Kelly said.

Our view continues to be that the industry needs to err on the side of more rather than less disclosure. As the old saying goes “sunlight is the best disinfectant”. With more municipalities using this technique and bankruptcy becoming more prevalent, this is an increasing concern for investors.

CHICAGO MAKES ITS CASE TO INVESTORS

This week the City of Chicago held its annual investor presentation. Given the daunting challenges the city faces, the update is timely. The City’s total revenues for 2016 are projected to end on target, although certain revenues are projected to end substantially under budget due to factors unrelated to Chicago’s economy. These revenues include utility taxes and the personal property replacement tax (PPRT). Utility tax revenues are expected to come in 2.6 percent or $11 million below budgeted amounts. The decline is driven by continuing low prices for natural gas, the mild winter, and the cooler than normal spring and early summer. Electricity tax, cable television tax, and telecommunication tax revenues are projected to end even with the 2016 budgeted amounts.

In addition to the decline in utility tax revenue, the City estimates that it will receive $40 million less in PPRT revenue in 2016 than budgeted. This reduction is due primarily to a misclassification of income taxes by the State of Illinois in 2014 and 2015 that resulted in the overpayment of PPRT revenues to local governments. The State adjusted downward its PPRT payments to local government earlier this year to reflect amounts that are owed. Local governments will be required to reimburse the State beginning in 2017.

Personal property lease tax revenues are expected to end 16.8 percent, or $29.8 million, above budget due to greater than previously anticipated compliance by the technology industry. The City lowered the personal property lease tax rate and waived taxes penalties and interest for years prior to 2015 for certain cloud software and infrastructure. Transportation-related taxes, including the garage tax and ground transportation tax, are anticipated to finish 2016 near budget at $238 million.

Corporate fund expenditures are currently expected to end the year at $3,548.7 million, or 1.0 percent, below the budgeted level of $3,570.8 million. These estimates are based on year-to-date spending, incorporating payroll trends, market pricing for relevant commodities, and any known changes or events that have or are anticipated to occur during the remainder of 2016. Based on current revenue and expenditure projections, the City estimates a 2017 corporate fund gap of $137.6 million.

The $137.6 million gap for 2017 is the lowest projected gap since 2007, and is substantially smaller than was projected for 2017 in the 2014 and 2015 Annual Financial Analysis. For the first time since 2011, the gap for the coming year is put forward without separate consideration of the City’s pension funds.

Corporate fund resources are projected to decrease from 2016 year-end estimates, and 2016 budget, by 1.6 percent or $58 million to $3,513 million in 2017, largely due to further expected declines in PPRT revenue. The 2017 PPRT estimates are anticipated to decline an additional $34.6 million, making these revenues 27 percent below the 2016 year-end expectations, as the State further decreases PPRT payments to recoup overpayments in previous years.

Economically sensitive tax revenues are anticipated to increase in 2017 above the 2016 level. Sales tax revenues are expected to grow at a rate of almost 3.0 percent through 2017 as consumer confidence figures continue to improve. Compliance levels for the personal property lease tax are projected to remain high, causing revenues to grow 4.5 percent on top of the growth in 2016 revenues. Utility tax revenues are expected to return to levels consistent with the 2016 budget on the expectation 2017 will bring more typical winter weather and natural gas tax revenue will increase over 2016 revenues. Other utility taxes are projected to remain flat or experience small fluctuations. Even though real property transfer tax revenues are projected to decrease by nearly 12 percent in 2017 compared to 2016 year-end, they are expected to grow over the 2016 budget by almost 4 percent. The decline from year-end is due to one-time increases from the transfer of ownership interests in the Skyway and Millennium Park garages in 2016.

The 2017 expenditures are forecasted to grow by approximately $80 million over the 2016 budget to $3,650.6 million. The majority of the projected expense increases for 2017 are personnel costs, primarily wages. The 2017 projection for these expenses assumes the same number of employees as 2016 with wages growing based on required contractual wage and prevailing rate due to the final phase-out of retiree health care and other initiatives designed to reduce growth in the cost of the City’s health care plan.

And of course no discussion is complete without news on pensions. As of July 29, 2016, the City has identified a permanent, reoccurring source to fund three of its four pension funds. In the fall of 2015, the City adopted a four-year property tax increase that provides funding for the City’s pension contributions to the Police and Fire pension funds through 2018. A small additional payment is needed in 2019 which is incorporated in the 2019 projections. Increases in pension contributions necessary to stabilize the Municipal pension fund are not included in the 2017 budget shortfall, as any increase in contribution will be coupled with a dedicated revenue source. Prior to the adoption of the 2017 budget, the City anticipates reaching a funding plan and reform agreement with the Municipal pension fund following the same framework as was achieved with the Laborers’ pension fund.

These projections assume status quo in terms of state action regarding pension reform. They also assume a successful outcome to ongoing litigation over the City’s obligation to fund healthcare benefits for retirees. The next step in that litigation is August 11.

The City’s presentation is consistent with our view that the Emmanuel administration is trying to do the right thing within the constraints of a challenged local political environment and an unsupportive state political environment. The disparate views represented on a 50+ member City Council and a dysfunctional state government severely handcuff anyone trying to enact broad reforms in Chicago’s long term credit trajectory. To the extent that management can influence a rating, this administration has to be viewed as a net positive factor.

BRAVES STADIUM HAS A POLITICAL COST

It won’t reduce the $400 million contribution from the County’s revenue base, but the voters of Cobb County, GA have exacted some political price for the County’s funding of part of the new stadium for the Atlanta Braves under construction for the 2017 season. The project has been controversial for a number of reasons unrelated to its cost and financing. Their current facility, Turner Field in central Atlanta, is only twenty years old. Nevertheless, the publicly financed facility has been declared outmoded after less than 20 seasons of use by the Braves.

Sun Trust Park will be supported by $397 million of bonds to be issued by the Cobb-Marietta Coliseum & Exhibit Hall Authority. The stadium will supposedly be more convenient to the majority of the Braves’ fan base but for many fans the real issue may be that this will result in a less “urban” tilt to the fan base. Ironically, it has not been the cost or the public financing of that cost that has raised the ire of Cobb county’s residents.

It has been reported that the Cobb County Commission—the five-person local governing body – that approved the Braves’ plan without public debate by standing in hallways to get around open-meetings laws — has determined that if county residents want to get the $40 million in new parks they voted for way back in 2008, they’ll have to raise taxes, because that money has now been siphoned off for the new baseball facility. The park bonds were never issued, then when the property tax hike funding them was set to run out, the commission decided to renew it for the stadium instead of spending it on what voters had intended it for.

So, when it came time for the primary election for the chairmanship of the Commission Incumbent Chairman Tim Lee lost his reelection bid . Some of the voters who voted against Lee said they were in favor of the Braves’ move to Cobb, but objected to the way the deal was negotiated in secret and committed some $400 million in public money to build and maintain a new stadium without a popular referendum. One said simply, “He should have asked.”

So the takeaway is not very straightforward. Voters seemed to be more concerned about the process than the result. A lot of the local opposition seemed to be development related rather than stadium related. This instance provides little clue as to whether politician’s usual fear of stadium referenda was validated. We see no applicability of this result to any possible result in November on a referendum in San Diego for a new Chargers stadium.

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

OUT IN THE TERRITORIES

With Puerto Rico sitting in a state of limbo as events under Promesa play  out, investors are looking at debt from other U.S. territories in a new light. So the recent downgrades of the debt issued for the Virgin Islands Water and Power Authority to below investment grade merited attention. The downgrades come on the heels of a Spring decision by the Public Services Commission to deny W.A.P.A. a requested electric rate increase and instead placed the petition under a 60-day review. W.A.P.A. said it needed the increase to help stabilize its finances, and to have, at minimum, 45 days cash on hand, which equates to roughly $34 million. It also said the rate increase would bolster the market’s confidence in the authority’s bonds. Moody’s calculates that W.A.P.A. has approximately $127 million in electric system revenue bonds outstanding and approximately $100 million in subordinated electric system revenue bonds.

In a press release, W.A.P.A. Interim C.E.O., Julio Rhymer Jr., said the downgrade was expected in wake of the P.S.C.’s decision, along with W.A.P.A.’s deteriorating financial condition. “In light of last week’s decision by the Public Services Commission to delay action on a requested emergency rate increase, resulting in W.A.P.A.’s inability to amass sufficient days of cash on hand, the rating downgrade, was largely anticipated”. The Moody’s downgrade of senior bonds from Baa3 to Ba2 and subordinate bonds from Ba3 to Ba1, follows previous pronouncements by not only Moody’s but by Fitch, another rating agency, and S&P which contend that W.A.P.A. is in a precarious financial position based largely on outstanding receivables, the lack of liquidity and a multi-million dollar lawsuit recently brought by a former fuel supplier.

Despite expected modestly improving operating cash flow generation owing to recent customer gains and access to a $13 million term loan from the Rural Utility Service (RUS), W.A.P.A.’s financial flexibility will remain tight. Bond debt service over the next 12 months is secured by a debt service and fully cash funded debt service reserve fund. The authority’s unrestricted cash position of around $13.7 million has been improved by the Virgin Islands government’s efforts since the beginning of this year to reduce outstanding electric receivables to an estimated $22 million from a peak of around $41 million at June 30, 2015.

For some time, the Authority’s credit has been characterized by a short-term approach towards liquidity and financial management as well as frequent late filing of audited financial statements. The territory’s hospitals, along with some of the semi-autonomous agencies of the government, continue to owe the authority millions of dollars for past electrical and potable water service. These agencies are not current and have sizeable outstanding balances. WAPA is effectively subsidizing their operations while its finances deteriorate.

A proposal to incorporate a permanent charge that recovers street lightning costs to help support has been made W.A.P.A., and the P.S.C.’s could go either way. However, actions are uncertain and unlikely to restore W.A.P.A.’s weak financial profile to levels commensurate with a higher rating in the short term.

ATLANTIC CITY AGREES TO LOAN TERMS; AVOIDS DEFAULT

A last minute agreement with the State of New Jersey allowed Atlantic City to avoid an August 1 default. City Council approved a loan agreement with the state during an emergency meeting Thursday night. The state asked for certain assets, including the dissolution of the city’s Municipal Utilities Authority. “I want it secured by every asset they have, so that if they don’t pay it, I get to take the assets, sell them and pay you (the taxpayer) back,” Gov. Christie said Thursday.

The council is set to start the process of dissolving the authority during its September meeting. Dissolving the authority requires two readings of the ordinance, and the council can pull the ordinance after funding has been secured. City officials contend the state has no need to worry about the repayment of the loan. The city plans on repaying the state with the two years of marketing funds that would have gone to the Atlantic City Alliance — totaling $60 million — and $18 million from the Investment Alternative Tax, as part of a rescue package signed in May.

Some Council contended that the agreement was rushed. The state countered that members were notified about the emergency meeting two hours before it was scheduled to start and that all members of council were notified of the meeting at the same time. The loan is being made pursuant to legislation the governor signed in May giving the city until Nov. 3 to draft a five-year fiscal plan that includes a balanced budget in 2017. If the city fails to submit a plan or the plan is deemed insufficient, the state can sell city assets, break union contracts and assume major decision-making powers from the city’s government for five years.

The Mayor of Atlantic City said that “a five-year projection for city budgets from 2017 through 2021 is currently being prepared under the terms of the recovery plan. The city plans to have a draft of the plan completed by late fall and the final document presented to the commissioner of the Department of Community Affairs prior to the deadline.”

PENNSYLVANIA TURNPIKE

While neighboring New Jersey battles it out over gasoline taxes, the Pennsylvania Turnpike Commission looks to market some $315 million of bonds backed by oil franchise taxes. This tax is levied at a rate of 208.5 mills per gallon of fuel sold at wholesale in the Commonwealth. In 1991, the distribution of a portion of this tax was enacted into law which dedicated 14% of the 55 mills of the tax to the Commission. The security for the bonds includes a determination that these revenues are deemed to be appropriated without additional legislative action.

This matters given the budget delays which have characterized the Commonwealth’s budget process in each of the last two years. Those delays would not have prevented the timely collection and distribution of the pledged revenues. The major risk associated with the credit is the potential for reductions in demand for fuels in the face of a decline in sales related to either the economy or to increased fuel efficiency. Those risks are common to any consumption driven tax revenue stream. Consumption has been steady to slightly declining since 2007 which is not surprising given the economy over that period as well as driving trends nationally.

NEW JERSEY

A revised plan for renewing New Jersey’s Transportation Trust fund was advanced by the State Assembly. It calls for a 23 cent per gallon increase on retail sales at the pump. and reductions in other taxes, including a phase out of the estate tax and larger tax exemptions on retirement income. The New Jersey Chamber of Commerce, the New Jersey Gasoline, Convenience Store, and Automotive Association and the New Jersey Sierra Club have come out in support of raising the gas tax to replenish the trust fund, but caution the hike proposed by lawmakers might not produce the level of revenue they expect.

The revenue concerns reflect worries that there is a good amount of the volume in the state of New Jersey that comes from New York and those people will have less reason to purchase gasoline in New Jersey anymore.

The Senate Budget Committee Chairman is trying to get a measure approved that would satisfy concerns about tax fairness. The impact on employment short term is a major political concern. The shutdown of transportation projects because of the funding stalemate has meant layoffs during what’s usually their busiest time of the year, he said.  Union supporters have said that the standoff will lead to its workers taking about a 20 percent cut in their income this year. “They’re not going to be able to make this up with overtime.”

Gov. Chris Christie has said he will veto the legislation, which he has described as an exercise in tax unfairness. Senate President Steve Sweeney said he is working to get a veto-proof majority of lawmakers before posting the bill for a Senate vote.

LIPA

The effort to lessen the rate burden on Long Island electricity users continues with a pending fourth phase of Utility Securitization Bonds. These taxable securities seek to take advantage of the current rate environment to refund outstanding tax exempt debt payable from general retail electric rates and replace it with debt secured by a standalone fixed charge designated for debt service on these bonds. The financing refunds a chunk of the Authority’s debt out of the electric system’s expense base which is used as a part of the ratemaking process.

The securitization plan was designed to lower and stabilize the Authority’s ratemaking in response to customer concerns. The Authority’s costs and overall management had become a significant political issue on the regional and state level. So in 2013, the NY state legislature enacted legislation restructuring the Authority’s management, putting its ratemaking under Public Service Commission review, and restructuring its debt. It also enacted a three year freeze on retail electric rates. Day to day operations at the Authority are managed by a subsidiary of PSEG expressly created for this purpose. These actions reduced the political heat on the Authority and stabilized its credit at investment grade.

The security for this debt is effectively independent from the operations of the Authority. The securitization charge appears as a distinct fixed line item on a customer’s bill. The idea is to lower the overall cost of power to consumers than would have been the case had the refunded debt remained outstanding.

ERIE COUNTY, NEW YORK

The Authority is making its first debt offering in nearly two years. These bonds are secured by County sales tax collections and State Aid payments made to the County. The sales tax revenues are collected for the County by the State and may only be applied to debt service payments on the bonds. Neither the state or county can appropriate the funds for any other purpose.

The Authority issues debt on behalf of the County in addition to its oversight responsibilities over the financial operations of Erie County. The economic difficulties of Western New York’s population center (anchored by Buffalo) are well documented. The County’s finances were historically impacted by those difficulties as well as its former responsibilities for a County hospital. These combined to damage the County’s bond ratings such that it had effectively lost access to the market. This led to the creation of the Authority.

The County faces some daunting challenges despite  significant redevelopment efforts undertaken in Buffalo and the direction of significant funds from state economic development resources to the region. Buffalo and the County continue to experience population declines and efforts to increase private employment have been mixed at best. Public entities still are five of the ten largest employment in the County.

CHICAGO PUBLIC SCHOOLS PLACE DEBT PRIVATELY

Chicago’s cash-strapped public school system sold $150 million worth of bonds to JPMorgan in a “private placement.” The bonds, to be paid off in 2046, were sold at yields of 7.25 percent. The deal worked out better for school officials than their last one — an open market sale in February — was for $725 million at yields of 8.5 percent. Those bonds are to be paid off in 2044.

The rates are significantly higher than they were for comparably structured CPS bond deals from last spring, when CPS sold bonds at yields of closer to 5.5 percent. A $300 million budget deficit, possible teachers’ strike and large looming pension payments have led to CPS’ bonds being rated by three ratings agencies at “junk” status.

The private placement reflects concerns about these credit issues in the face of inaction by the legislature and the Governor to negotiate a way to fund the state’s as well as the Chicagoland localities’ huge unfunded pension liabilities. It is yet another reinforcement of the overall negative credit trend for Chicago and its related credits.

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 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.