Joseph Krist

Senior Municipal Credit Consultant

joseph.krist@municreditnews.com

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For what it’s worth, this is the 200th edition of the Muni Credit News since we started publishing in the fall of 2014. Over that time our regular readership has steadily expanded and we continue to achieve new levels of readership on a monthly basis. We hope to continue to deliver the kind of timely and actionable information and insights that support your investment in municipal bonds.

For the rest of August, 2015, we will be taking what we hope is a well deserved break from publishing. We will return the first week in September when we will return to our original weekly schedule. We will continue to generate the same volume of and hopefully, quality of product that we have been providing twice weekly. Our hope is that the Muni Credit News continues to be one of your primary tools as you navigate the ever more complicated municipal bond landscape.

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PURPLE LINE GETS A WIN

It was an active and potentially pivotal week for Maryland’s Purple Line. The Federal Transit Administration  joined the Maryland Transit Administration in its appeals case in efforts to get the Purple Line project moving. FTA experts have already offered a view in favor of the Purple Line and concluded that a delay is not necessary. The take the position that additional environmental studies are not necessary. Plaintiffs against the Purple Line say the latest environmental impact study doesn’t fully address issues of cost and ridership and is missing important information on about “how Metro’s decline in ridership and safety and reliability would affect the Purple Line, which would depend on it.”

The appeal turned out to be somewhat successful for the project. A federal appeals court ruling will allow Maryland to begin building the Purple Line while a lawsuit opposing it continues, clearing the way for the state to pursue federal funding for the light-rail project.  The U.S. Court of Appeals for the D.C. Circuit reinstated the Purple Line’s environmental approval, which a lower-court judge had revoked last year, while the legal case continues.

The ruling allows the state to continue its efforts to obtain $900 million in federal grants for the line’s $2 billion construction costs while Maryland’s attorney general appeals an earlier ruling in the 2014 lawsuit seeking to block it. Congress has appropriated $325 million to the Purple Line, but the state can’t access that money until a full funding agreement is signed.

CYBERSECURITY

The ongoing investigations by the Department of Justice, Office of the Special Counsel, and the intelligence community have shed light on a number of facets of Russian hacking and cybersecurity issues. We were intrigued by an MSNBC report focusing on the activities of a large and successful Russian based cybersecurity firm, Kaspersky Lab. Kaspersky Lab’s products include anti-virus software which is sold throughout the world. It is even available to individuals and others through chains like Best Buy. Concerns have been raised about the use of such software by American consumers given the alleged events of 2016 and suspected links between the company’s founder and CEO and the Russian intelligence services.

The federal government has used some Kaspersky products but the company has been removed from its list of approved vendors. Nonetheless, the Washington Post has found that several local governments across the U.S. are using Kaspersky security software. More troubling is that many of the cities and government entities using it were unaware of the federal action.

Among the entities are Portland, OR, Picayune, MS, San Marcos, TX, the State of Connecticut Public Defender Office, and Fayetteville, GA. The concern is that those systems, even if they are not protecting critical infrastructure, can be targeted by hackers because they provide access to much sensitive information. Even if an entity’s main systems do not use the software, employees connecting remotely through computers using the software provide a gateway for mischief.

The concern comes from the background of the firm’s founder. Kaspersky Lab was founded in 1997 by Eugene Kaspersky, only ten years after he had graduated from a KGB-supported cryptography school and had subsequently worked in Russian military intelligence agencies. He denies any connection to the Kremlin and insists that his company, despite its US presence and global footprint, has never been solicited for help by the Russian government. In the US, Kaspersky Government Security Solutions, or KGSS, had been hosting an annual cybersecurity summit in Washington. The acting FBI director, CIA Director, Director of National Intelligence and National Security Agency Director all testified before Congress this year they would not use Kaspersky.

It is just another front in the battle that municipalities face in their growing need to devote resources and stay ahead of the curve in terms of cybersecurity. It is clear that the level of risk associated with the use of technology by municipalities grows every day.

NUCLEAR PLANTS IN THE MIDST OF A BANKRUPTCY

Earlier this year, the primary contractor overseeing the construction at two nuclear plant expansions in Georgia and South Carolina –  Westinghouse – declared bankruptcy. The two plants are partially owned by the Municipal Electric Authority of Georgia and the South Carolina Public Service Authority respectively. The bankruptcy threw into doubt the ability of the plants to be completed. Already over budget, the projects risked further increases in cost related to potential delays in construction due to the uncertainty over Westinghouse’s ability to perform.

Late last week, Georgia Power finalized a new service agreement with Westinghouse for the Vogtle nuclear expansion – the first new nuclear units to be built in the United States in more than 30 years. Under the new service agreement, approved by the U.S. Department of Energy on July 27, Southern Nuclear (the Southern Company subsidiary which operates the existing units at Plant Vogtle) will oversee construction activities at the site.

The service agreement includes engineering, procurement and licensing support from Westinghouse, as well as access to Westinghouse intellectual property needed for the project. Georgia Power also continues work with the project’s Co-owners (Oglethorpe Power, MEAG Power and Dalton Utilities) to complete a full-scale schedule and cost-to-complete analysis of the project.

After that work is completed, it will rest with the Georgia Public Service Commission to determine the best path forward for customers.

At the Sumner plant expansion where South Carolina Public Service Authority co-owns the project a South Carolina Public Service Authority along with IOU South Carolina E&G, Toshiba Corp. also said Friday it has agreed to pay $2.168 billion to walk away from the two other unfinished nuclear reactors. Toshiba is the parent of Westinghouse. SCANA Corp and its partner, Santee Cooper, are more cautious about finishing the VC Summer nuclear units in South Carolina.

The project is years behind schedule. Santee Cooper and South Carolina Electric & Gas will halt work immediately on two nuclear reactors, ending months of deliberation over the future of the troubled project that already has cost consumers billions of dollars. Santee Cooper, a state-owned electricity provider, said early Monday afternoon it would stop construction on the partially completed power units in Fairfield County, which have cost South Carolina utility customers nearly $9 billion so far. The proposal was approved unanimously by the utility’s board at a meeting in Columbia.

Santee Cooper said it would seek to preserve the work that has been completed so far and look for buyers to take over the project. The utility now expects the project would cost 75 percent more than initially anticipated.  Santee Cooper says it is suspending construction. SCE&G refers to abandoning the project. The Santee Cooper board is interested in shutting down the construction in such a way that could make it possible to resurrect the project if future conditions make completion more attractive. SCANA however, needs to make sure that it is able to recover as much of the costs of the project as possible from customers to protect its shareholders.

While the payments from Toshiba are clearly mitigating to some of the risk to the co-owners of both projects, bondholders of the municipal agencies’ debt must be aware that these credits are still not out of the woods yet. Ratepayers will be saddled with higher than anticipated rate requirements for some time as the result of the Westinghouse difficulties. Santee Cooper has raised power rates five times to cover the cost of the project. Overall, the utilities’ competitive positions will have sustained long term damage no matter how the projects ultimately work out.

NO ROOM AT THE INN FOR DEBT SERVICE

It’s taken 12 years of underperformance and restructurings but he Lombard convention center hotel project has finally succumbed and entered Chapter 11 bankruptcy. The petition was filed this week by The Lombard, Ill. Public Facilities Corp. which issued the bonds. The 2005 project was initiated to host corporate meetings and other functions in the Chicago suburb. Like many of these projects, the 2008 financial crisis put a seemingly permanent dent in the demand for the kind of services these hotel facilities provide.

This was a project financing which was originally secured by project revenues as well as an agreement with the Village of Lombard to make up shortfalls in debt service. When the project failed to meet its initial projections for occupancy and revenues, the Village was called upon to meet its obligations. It declined to and the most junior tranches of debt service defaulted.

The project went through a restructuring in 2011  and the hotel operations limped along thereafter. Corporations have cut back nationwide in terms of their willingness to pay for offsite meetings and that change in demand has been deadly for more than one of these projects. It has become clear that without a significant additional restructuring, the project cannot cover debt service,

Among the project’s creditors are the bond insurance company ACA which insured some $53.9 million of the original issue of bonds. The Chapter 11 filing was undertaken pursuant to an agreement with the majority of bondholders.

PUERTO RICO DEBT INVESTIGATION

The fiscal control board confirmed that it will launch its own process to  investigate the causes of Puerto Rico’s fiscal crisis, including the commonwealth’s debt issuance, disclosure and selling practices. The findings of this investigation will be made public. The board will create a special committee that will appoint an independent investigator. The investigation will be carried out according to the investigative protocol recently approved by the board.

A committee representing unsecured creditors in Puerto Rico’s Title III bankruptcy cases filed a lawsuit July 21 for federal Bankruptcy Court Judge Swain to authorize a discovery process to investigate the role played by Banco Popular, Banco Santander and the Government Development Bank (GDB) in the issuances and transactions related to the commonwealth’s debt.

According to the panel, federal law empowers it to “conduct an investigation into Puerto Rico’s debt and its connection to the current fiscal crisis.”  The judge last week delegated the creditor committee’s request for investigation to Judge Judith Dein. The matter will be dealt with Aug. 9 as part of an omnibus hearing in San Juan for bankruptcy cases under Title III of Promesa. As for the mechanism used by the board to carry out the investigation, it recently approved a protocol to carry out “informal” and “formal” investigations into any matter it deems worthy, as Promesa allows.

The protocol was approved by the board during a May 26 executive meeting.

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

Senior Municipal Credit Consultant

joseph.krist@municreditnews.com

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$550,000,000*

BAY AREA TOLL AUTHORITY

SAN FRANCISCO BAY AREA TOLL BRIDGE REVENUE BONDS

(Senior Bonds)

$550,000,000*

BAY AREA TOLL AUTHORITY

SAN FRANCISCO BAY AREA SUBORDINATE TOLL BRIDGE REVENUE BONDS

(Fixed Rate Subordinate Bonds)

BATA was created by an act of the state legislature in 1997 and began operations in January 1998 as the successor agency to California Transportation Commission’s Northern and Southern units of the San Francisco Bay Bridges. BATA’s mandate has been to manage the tolls on the seven Bay Area bridges and oversee the implementation of Regional Measures (RM)-1 and RM-2 approved by voters in two general elections. In July 2005 the state legislature passed AB 144 which granted BATA project financing and management responsibility as well as independent toll-setting authority for the bridges. The legislation also established the Toll Bridge Program Oversight Committee which has implemented a project oversight and project control process for Benecia-Martinez project and the SRP. The Committee consists of the Director of Caltrans, the Executive Director of the California Transportation Commission (the CTC) and the Executive Director of the authority. The oversight committee’s project oversight and control processes include reviewing bid specifications and documents, providing field staff to review ongoing costs, reviewing and approving significant change orders and claims and preparing project reports.

The senior lien bonds are secured by a prior claim on net toll revenues collected on the seven Bay Area bridges operated by BATA: San Francisco-Oakland Bay Bridge (SFOBB); San Mateo-Hayward Bridge; Dumbarton Bridge; Antioch Bridge; Benicia-Martinez Bridge; Carquinez Bridge and Richmond-San Rafael Bridge. The senior bonds have a cash-funded debt service reserve fund (DSRF) equal to the lesser of MADS; 125% AADS. The subordinate bonds are secured by a subordinate claim on the same net revenues and have a DSRF funded at maximum interest on the bonds at the option of BATA. All subordinate series currently have a DSRF equal to maximum interest.

The authority has independent rate-setting authority and no legislation or outside approval is required to adjust toll rates, though electronic and cash toll rates must be the same. The authority is required to increase tolls according to its adopted toll schedule in order to meet bond covenants, or for maintenance or construction. The authority must hold a public hearing and two public meetings 45 days before the toll increase, and provide 30 days’ notice to the Legislature.

$200,000,000*

CALIFORNIA HEALTH FACILITIES FINANCING AUTHORITY

REVENUE BONDS

(LUCILE SALTER PACKARD CHILDREN’S HOSPITAL AT STANFORD)

The proceeds will provide funds for its expansion project, to fund routine capital expenditures and potentially acquire the long-term ground lease interest in land and improvements adjacent to the hospital for future use (owned by Stanford University). The bonds are secured by a gross revenue pledge of the obligated group. LPCH’s $1.2 billion hospital expansion project is almost complete, although the project is slightly behind schedule and cost overruns are likely. This bond issuance was unexpected and will provide another funding source for the sizeable project.

LPCH operates a 266-bed pediatric and obstetric hospital on the Stanford University campus in Palo Alto and 36 beds in several inpatient care units on its license in nearby community hospitals. In addition, LPCH manages several neonatal and pediatric units through joint ventures with other adult providers in the region. The obligated group includes only the hospital, which accounted for 98% of total assets and 94% of total revenue of the consolidated entity in fiscal 2016. Like many children’s hospitals,  LPCH has a strong track record in fundraising through the Lucile Packard Foundation with the last two capital campaigns raising over $1 billion. In the most recent campaign, $265 million is expected to be raised for the new facility and year-to-date $262 million has been raised with $256 million received in cash. The foundation is in the quiet phase of another campaign with a goal of raising $750 million.

Year-to-date fiscal 2017 operating results are negative due to one-time issues related to the loss of certain high-margin procedures. This impact was mostly in the first half of the fiscal year and the quarter-over-quarter trend has improved as LPCH has backfilled volume with the development of new related programs. The expectation is that fiscal 2018 operating performance will be in line with historical results.

$188,380,000*

REGIONAL TRANSPORTATION AUTHORITY

Cook, DuPage, Kane, Lake, McHenry and Will Counties, Illinois

General Obligation Refunding Bonds

Moody’s downgraded the Authority’s sales tax backed general obligation debt to A2 from Aa3, affecting about $2.2 billion of outstanding debt. The outlook remains negative. The outlook remains negative. The downgrade was tied to the State of Illinois’ ongoing fiscal instability. Payment deferrals have led RTA to rely on short-term borrowings that have created biennial refinancing requirements. This practice, while manageable, is only one measure of RTA’s potential stress stemming from the continuing financial erosion of its two largest related governments – the State of Illinois (Baa3 negative) and the City of Chicago (Ba1 negative). Over the long term, pressures to provide funding for constitutionally guaranteed state and local pension plans are increasingly apt to harm RTA’s economic base, eroding its ability to generate funding to support transit system capital investment and operating needs. Although these factors are outside the RTA’s control, they will pose increasingly serious challenges.

Nonetheless, the credit is seen as stronger than that of the State or City. The fact that the sales tax base includes the six county Chicagoland region is an important credit consideration. It also reflects the legal and practical insulation of pledged regional sales tax revenues.

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PUERTO RICO

As has been the case with the Puerto Rico restructuring process, the GDB process is running into significant opposition before it is even formalized. In spite of the fact that is has not yet been presented formally in the Legislature, San Juan Mayor Carmen Yulín Cruz announced Friday that she will challenge in state and federal courts a bill that seeks to validate the Government Development Bank’s (GDB) restructuring support agreement (RSA).

The bill is one of five to be considered in a special session called for July 31. It would create a new government entity that would issue bonds backed by GDB assets. The government bank’s bondholders and depositors, which mostly comprise municipalities, will have to select one of three tranches of notes. The plan is to close the GDB within a 10-year period.

The mayor of San Juan’s view is that the bill intends to prevent municipalities from going to court to demand reimbursement of funds they deposited in the GDB, which remain mostly frozen. Cruz’s position is that since the bill proposes to determine the balance of certain GDB liabilities, this confirms that the government bank “does not have clarity in its accounts” and is looking to “appropriate” certain funds deposited there.

Regarding the disbursement of special additional tax (CAE by its Spanish acronym) funds the bill would allow, the expressed a view that there could be preferences between towns and asked all mayors to prepare to fight the measure. “The request to the mayors is to do the math, because the money taken from them is money they won’t have available, unless they don’t start passing the problem onto citizens,” the San Juan mayor said, adding that the capital’s deposits would be used for essential services. This is true of the vast majority of the cities which deposited funds with the GDB.

NEW YORK

New York State is facing signs of increasing fiscal challenges, including lower revenue targets and possible federal budget and tax changes, according to a report on the state’s Enacted Budget Financial Plan issued today by New York State Comptroller Thomas P. DiNapoli. “The state’s fiscal outlook is clouded because of uncertainty in Washington, falling revenues, and fiscal practices that obscure the level of spending,” DiNapoli said. “If revenues continue to fall short, projected out-year budget gaps may grow further.” DiNapoli’s report found the state Division of the Budget estimates state tax receipts will increase by 4.8 percent in State Fiscal Year (SFY) 2017-18, below the 6.1 percent projected in February. Personal income tax receipts in the first quarter of the fiscal year were $1.7 billion lower than February projections and $1.5 billion lower than what was collected in the same period last fiscal year.

The General Fund balance at March 31, 2017 was $7.7 billion. Settlement money represented more than two-thirds of the total. By the end of the current fiscal year the balance is expected to be one-third lower than its recent peak of $8.9 billion two years earlier. Through March 31, the state has spent $3.1 billion from settlements received in the last three fiscal years. Nearly half has been used for budget relief. Another $461 million of these one-time resources is expected to be spent for budget-balancing purposes this fiscal year. The state is also using settlement funds for cash flow and debt management purposes.

The Financial Plan shows that spending from State Operating Funds will rise 2 percent this year, to $98.1 billion. This figure reflects several actions that complicate the picture of year-over-year spending growth. These include: the use of prepayments; certain program restructurings which result in costs being reflected as reduced receipts rather than disbursements; shifting spending to capital projects funds; deferring expenditures to future years; and the use of off-budget resources to pay for certain program costs. Adjusting for such actions, the increase in State Operating Funds spending is approximately 4 percent.

No deposits to rainy day reserves were made in SFY 2016-17, and none are projected in the current fiscal year. Reserves represented more than 13 percent of General Fund disbursements in SFY 2015-16, primarily because of settlement revenues. They are projected to decline over five consecutive years to less than 4 percent by SFY 2020-21. State-Funded debt outstanding is projected to rise 4.1 percent this year, to $63.9 billion, and to reach $73.7 billion by the end of the Capital Plan period. State-Funded debt service is expected to approach $8.4 billion as of SFY 2021-22, reflecting an average annual increase of 3.1 percent over the coming five years.

This outlook accompanies the news that State tax collections totaled $18.6 billion in the first quarter of the new fiscal year, $1.2 billion less than the same period last year and $315.7 million below projections, according to the latest state cash report issued by State Comptroller DiNapoli. “We’re three months into New York’s fiscal year and personal income tax collections are falling short of what was expected,” DiNapoli said. “Taxpayer anticipation of federal tax changes has contributed to the decline. Offsetting that, business tax collections are well over estimates.”

Through June 30, All Funds receipts totaled $37.7 billion, representing a decline of $680.6 million or 1.8 percent from a year earlier. The drop was primarily due to the personal income tax (down $1.5 billion or 11.6 percent) and miscellaneous receipts (down $640.8 million or 10.9 percent), but was partially offset by an increase in business tax collections (up $266.6 million or 16.5 percent) and federal receipts (up $1.2 billion or 9.2 percent). Overall tax collections totaled $18.6 billion through the first quarter, representing a decline of $1.2 billion or 6.1 percent from the same period last year.

All Funds spending totaled $41.1 billion in the first quarter of the fiscal year, approximately $3.1 billion or 8.3 percent higher than for the same period last year. Significant increases include spending for Medicaid (up $1.6 billion primarily from federal sources) and education (up $767.1 million). All Funds spending was $1.4 billion below projections, primarily in local assistance and capital projects. The General Fund ended June with a balance of $3 billion, which was nearly $4.2 billion lower than a year earlier but $548.3 million higher than the latest projection.

WHAT IS WISCONSIN DOING?

The deal announced that calls for $3 billion of state and local tax breaks for Taiwanese manufacturer to build a manufacturing facility in southeast Wisconsin has generated much comment. Much of it has questioned the basic underlying economics for the deal. Critics point out the Foxconn workers worldwide are much less productive than the average Wisconsin manufacturing worker. They also point out that the average compensation promised is about 50 cents an hour higher than the average wage in Wisconsin. Details made public so far do not indicate whether this annual amount is just salary but all in employee costs including insurance and other benefits. If it does than the hourly wage is below the private sector average in a state with a 2.9% unemployment rate.

This may account for the language in the state’s release that acknowledges a possible in-state worker shortage for the plant.  Given it’s proximity to Illinois, is Wisconsin subsidizing jobs for Illinois residents? Wisconsin is seen as promising to pay Foxconn the equivalent of $66,600 per employee, based on having 3,000 workers in the plant, for each of the next 15 years, while Foxconn is promising pay of less than $54,000 a year. Foxconn has implied that it could eventually employ 13,000 but it’s track record of keeping promises in other US jurisdictions is poor.

One analyst asks if it’s worth it for each Wisconsin household is stuck with a nearly $1,200 bill to subsidize a company that is half as productive as Wal-Mart, and one-tenth as productive as Harley-Davidson. Tax breaks for manufacturing jobs have been a topic of long term debate and the evidence is quite mixed at best.

CHANGES AT LAGUARDIA AIRPORT P3 STILL MAINTAINS PRIVATE ROLE

The Port Authority board signed off on a revised financing package for Delta’s facility update which is being undertaken separate from the overall renewal of LaGuardia Airport. Often times when issues arise for one of the private entities in a P3, the public entity in the partnership winds up increasing its financing risk.  Here, the Port Authority had agreed in January to enter a 33-year lease for the Delta terminal with an entity owned jointly by Delta and West Street Infrastructure Partners III, a fund managed by Goldman Sachs.

The entity was to contribute $300 million in equity investments and $3.6 billion in debt financing for the design, construction, and financing of a new 37-gate terminal. Now Delta plans to pay for nearly the entire project by itself after Goldman exited the deal. The Port Authority of New York and New Jersey will still contribute up to $600 million as previously agreed.

It is not clear why Goldman dropped out. Without Goldman, the equity component is no longer necessary and Delta will use a combination of direct investments and debt financing. Delta alone will be responsible for any potential cost overruns. It is good to see a situation where financing issues on the private side occur and they are solved on the private side of the P3 equation.

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 advisers prior to making any investment decisions.