Joseph Krist

Publisher

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ISSUE OF THE WEEK

$565,000,000

Pennsylvania Economic Development Financing Authority

University of Pittsburgh Medical Center

Revenue Bonds

Fresh off the assignment of a negative outlook to its A1 rating from Moody’s, the dominant provider in the western Pennsylvania market plans to issue debt this week.

UPMC is an integrated delivery and financing system (IDFS) based in Pittsburgh, Pennsylvania, having primarily served residents of western Pennsylvania. It also has drawn patients for highly specialized services nationally and internationally. As of September 1, 2017 Pinnacle Health System, a seven-hospital regional provider in Harrisburg, Pa., has joined UPMC. UPMC’s more than 27 hospitals and more than 500 clinical locations comprise the largest health care delivery system in Pennsylvania. UPMC is the largest nongovernment employer in the Commonwealth. UPMC also offers a variety of insurance products that cover more than 3.2 million lives.

It is the new merger which raises concerns for Moody’s which cited the potential financial and cultural stress of integrating multiple facilities, a good portion of which bring an absence of a longer track record of operations as a NFP facility, while simultaneously expanding the system’s geographic reach. Adding to the strain is the continuation of very modest performance at UPMC’s legacy operations, representing approximately 85% of pro-forma revenue, despite efforts to improve performance. Given the magnitude of the financial leverage, any notable deviation from management’s plans may pressure the rating further.

There is an additional concern that the expansion into central PA represents a new, discreet market for UPMC that carries its own competitive challenges given the presence of sizable providers who are consolidating, as well as the lackluster economy of the local service area.

The debt is secured as a  joint and several commitment of the obligated group secured by a lien on gross revenues. The Obligated Group under the 2007 Master Trust Indenture consists of the Parent Corporation, UPMC Presbyterian Shadyside Hospital, Magee-Womens Hospital of UPMC, UPMC Passavant and UPMC St. Margaret. The system also includes several additional hospitals throughout western Pennsylvania, international operations and a variety of insurance subsidiaries as part of its integrated delivery and financing system.

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NEW YORK CASINOS – IS THE HOUSE WINNING?

In 2013, Gov. Andrew M. Cuomo signed a law allowing for seven new, full-scale casinos in New York. Prior to that time, only so-called racinos were allowed such as those at Aqueduct and Yonkers Raceway in and near New York City. They feature video lottery terminals — similar to slot machines — but no table games like blackjack and craps. That expansion has led to an estimated $70 million in new gaming tax and jobs at new facilities and constructions sites, according to casino operators.

The experience at the new casino upstate has been different. While the data only covers the period since February of this year, results have been disappointing. The Del Lago Resort & Casino in Seneca County upstate is on pace to gross about $151 million in gaming revenue in its first year, significantly lower than the $262 million it had projected when it applied for the license in 2014. The Rivers Casino and Resort in downtown Schenectady opened based on first-year projections which ran between $181.5 million and $222.2 million. Since opening on Feb. 8, the casino has grossed $81.8 million —77 percent of even its low estimate.

Supporters of casinos note that some of the new casinos’ amenities, like hotels, are still under construction or only recently opened. Others note that new casinos due in Massachusetts and Connecticut and a $1.2 billion resort in the Catskills, scheduled to open early next year. The owner of Tioga Downs, near Binghamton, N.Y., admits that estimates of income had been optimistic, saying that the gambling market is oversaturated; Tioga Downs faces competition from casinos in nearby Scranton, Pennsylvania. But he argued that the casino expansion had created jobs and contends that that was enough in the weakened lower tier of the state.

The new casinos pay a gaming tax, ranging from 37 to 45 percent on slots and 10 percent of table game revenue which is divided among education purposes and host cities and counties and nearby counties. The Seneca County casino has generated

Of more concern is the fact that new facilities seem to be cannibalizing existing ones. For example, the Saratoga Casino Hotel has seen a significant drop in its net winnings since the opening of the Rivers casino, some 30 miles to the south. On a comparable month basis, the racino brought in about $16 million last August. This August, its net winnings were down by nearly 25 percent and for the year the casino is on pace to contribute nearly $14 million less than it did during the 2016-17 fiscal year. In June, the state agreed to $2 million in tax relief to keep afloat Vernon Downs outside Utica, something he said would save 300 jobs in “a part of the state where we can’t afford to lose 300 jobs.” The problem is the facility was originally pitched as requiring no assistance.

In addition, the state is mired in disputes with native American tribal operations which were established under separate compacts.  The Seneca Tribe is one of three that operate casinos and in June it stopped making contractual payments to the state from its casinos. The tribe contends that it has fulfilled their obligations under a 2002 compact, which allowed them the exclusive right to open casinos in a huge chunk of Western New York in exchange for payments to the state. The state filed a demand for arbitration seeking to force the Senecas to pay approximately $31 million under a purported compact extension.

THE REALITY OF REPEAL AND REPLACE

There is no way around it. The Graham-Cassidy bill is bad news for municipal credit. The impact on hospital credits and state credits is obvious. For hospitals, the blow to revenues would be quick and direct. There is no argument against the idea that the bill would increase the ranks of the uninsured, reduce the number of services funded by Medicaid, and generally reduce available revenues to hospitals. On the cost side, it would increase the use of emergency room care as the primary point of contact with substantially more patients. There is plenty of evidence that this is the highest cost and least efficient way to provide medical care.

States would be left with a substantial cost burden. While it is not expected that states would fill all of the gap, there will be great pressure to do so. What will lose funding to compensate? Will it be less education spending in an era where business demands a more highly trained workforce? Will it be for roads thereby making certain areas less attractive to businesses and reducing the likelihood of good paying jobs? Will states have to choose between resident health and the demands of often contractually mandated pension spending?

At the local level, there will be a direct hit to employment. In some areas, healthcare is the major provider of public sector employment. What will be the impact on the entire range of job classes provided by healthcare in cities like Boston, New York, Philadelphia, Pittsburgh, and Houston just to name a few where major national medical facilities are primary employment drivers. The result will be a smaller income base, less retail spending, and less economic activity that stems from a growing and sustained base of disposable income. Will this result in increased demands for state aid from governments already under increasing expense pressure?

And what happens to specialty sectors like continuing care retirement communities (CCRC). The skilled nursing sector (on its own and as part of CCRC) is especially dependent upon Medicaid. There are estimates that some two-thirds of nursing home revenues are derived nationwide from Medicaid as aging seniors outlive their accumulated resources. Does the planned level of reduced Medicaid spending drive the elderly back to family supplied care and maintenance thereby pressuring workforce participation levels and reducing incomes available to fund government?

Should the bill pass the plan is to make significant changes to the federal tax code which will initially pressure the states as many of them key their tax codes off the federal code. Significant changes will then need to be followed by appropriate state statutory changes which will be held hostage to the unique individual quirks of legislative scheduling in each of the 50 states. All of this will conspire to create a brew of uncertainty in which states and cities will have meet the challenge of balancing their budgets.

PENNSYLVANIA DOWNGRADE

It seems that passing only the expense side of a budget is a major step on the road to a downgrade. After waiting nearly three months for a revenue package to be passed, S&P Global Ratings lowered its general obligation (GO) rating on the Commonwealth of Pennsylvania to ‘A+’ from ‘AA-‘. It also lowered ratings on the commonwealth’s appropriation debt to ‘A’ from ‘A+’  and the rating on departmental and moral obligation rating to ‘BBB+’ from ‘A-‘. The outlook is stable.

The downgrade largely reflects the commonwealth’s chronic structural imbalance dating back nearly a decade, a history of late budget adoption, and the weakening of Pennsylvania’s liquidity position, notably the delay or non-payment of scheduled expenditures for the first time in the commonwealth’s history. Its reliance on one-time revenues has stressed its available cash, making internal resources insufficient to timely meet certain obligations.

On Sept. 15, 2017, Pennsylvania missed $1.167 billion in reimbursement payments for medical care under Medicaid, and on Sept. 18, it missed a $581 million payment due to school districts to cover the state’s share of pension obligations. The state treasurer and auditor general announced in a letter that they would not provide another loan to cover the commonwealth’s general fund deficit through the short-term investment program. They called lending to the commonwealth under current circumstances an economic “moral hazard” that would increase long-term risk to the commonwealth’s finances, and stated that they would not lend to the general fund without a balanced budget.

There is a lack of consensus among the branches of the general assembly and the administration on how to balance the fiscal 2018 budget, all plans eliminate the negative $1.54 billion negative general fund balance (4.8% of the budget), which would significantly reduce the commonwealth’s cash flow pressures. Currently, legislators are considering $1.25 billion of certificates of participation secured by tobacco settlement payments and general fund appropriations to help close this gap. The governor released a statement on Sept. 18 that legislators will agree to and vote on a compromise prior to Oct. 1.  S&P endorsed the use of borrowing to fund operations. ” Borrowing that restores the commonwealth’s liquidity to a position in which it can make timely payments would be preferable from a credit perspective than an accumulation of unpaid bills.”

A STABLE SOUTH CAROLINA NUCLEAR CREDIT 

While the major public power provider in South Carolina has been taking its lumps over a failed nuclear generating project, another agency in the State has been faring better. Piedmont Municipal Power Agency has ten members, all of which are Participants in the Catawba Project. PMPA commenced supplying power and energy to the Participants on June 21, 1985. PMPA is required to sell and each Participant is required to purchase from PMPA such Participant’s All Requirements Bulk Power Supply. PMPA has an undivided ownership interest of 25% in Unit 2 of the Catawba Nuclear Station, which was constructed and being operated by Duke Energy.

Net PMPA revenues derived from member’s take-or-pay power sales agreements and all requirements supplemental power sales agreements. Payments to the agency are considered operating expenses of the member utility systems. The take-or-pay power sales agreements have been validated by the South Carolina Supreme Court and also were challenged by one member and subsequently upheld. Under the take-or-pay power sales agreements, there is a 25% step-up provision which requires participants to increase up to 25% in their respective shares of the project in the event of a default by another participant.

Recently, Moody’s maintained its A3/stable rating on PMPA’s debt which is secured by Net PMPA revenues derived from member’s take-or-pay power sales agreements and all requirements supplemental power sales agreements. Payments to the agency are considered operating expenses of the member utility systems. The take-or-pay power sales agreements have been validated by the South Carolina Supreme Court and also were challenged by one member and subsequently upheld. Under the take-or-pay power sales agreements, there is a 25% step-up provision which requires participants to increase up to 25% in their respective shares of the project in the event of a default by another participant.

Moody’s cited PMPA’s continued focus on recovering annual costs fully through rate increases, resulting in improved financial metrics during the last five years. The rating also recognizes the benefits that such rate increases have had on PMPA’s internal liquidity, which has noticeably improved over the period. A key factor in the rating is PMPA’s demonstrated willingness to implement rate increases over a sustained period, which is in contrast with the past when indenture specified coverage levels were met through the inclusion of rate stabilization funds. Moreover, the rating considers the completion of the capital spending program for Fukushima related capital investments, and that leverage, which is high, has started to decline with scheduled debt amortization and in the absence of a major spending program.

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

Publisher

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ISSUE OF THE WEEK

$247,330,000

Philadelphia Hospital and Higher Education Facilities Authority, PA

Temple University Health System (TUHS)

Hospital Revenue Bonds, Series 2017

Moody’s: Ba1

The Commonwealth’s largest provider of Medicaid services is coming to market with debt which will be used to current refund all of the Series 2007A and 2007B bonds as well as a portion of the Series 2012B bonds. Proceeds will also be used to fund a deposit to the debt service reserve fund. Temple University Health System (TUHS) is a $1.7 billion academic health system anchored in northern Philadelphia. The Health System consists of Temple University Hospital (TUH); TUH-Episcopal Campus; TUH-Northeastern Campus; Fox Chase Cancer Center, an NCI designated comprehensive cancer center; and Jeanes Hospital a community-based hospital offering medical, surgical and emergency services. TUHS also has a network of community-based specialty and primary-care physician practices. TUHS is affiliated with the Lewis Katz School of Medicine at Temple University.

The obligated group consists of Temple University Hospital, Inc., Temple University Health System, Inc. (TUHS), Jeanes Hospital, the Fox Chase Entities, Temple Health System Transport Team, Inc. and Temple Physicians, Inc. Each member of the obligated group is jointly and severally liable for all obligations issued under or secured by the Loan and Trust Agreement. The Bonds are secured on parity basis with the obligations currently outstanding issued under the Loan and Trust Agreement. As security for the obligated group’s obligations under the Loan and Trust Agreement, each member of the obligated group has pledged its respective gross receipts. The Bonds are also secured by mortgages on certain real property of certain members of the obligated group. With the issuance of the Series 2012 bonds, a liquidity covenant was set at 60 days.

The Moody’s rating reflects “the health systems large size, clinical diversification, its role as a safety net provider for the City of Philadelphia, as substantiated by historically sizable funding from the Commonwealth, and close working relationship with Temple University (TU). The rating acknowledges the System’s operating vulnerabilities as evidenced by FY 2017’s unexpectedly weaker performance with higher than anticipated expenditures related to an electronic health record implementation and limited balance sheet flexibility due to slim unrestricted reserves. TUHS’ weak unrestricted cash and investments, which we do not expect to grow in the near term, and heavy reliance on governmental payers and special funding constrain the rating.”

The rating was assigned a stable outlook.

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CALIFORNIA REVENUES CONTINUE POSITIVE TREND

The state brought in $8.90 billion in August, exceeding projections in the state budget by $343.7 million, or 4.0 percent. After July revenues exceeded expectations, the positive August numbers put total fiscal year-to-date revenues at $14.99 billion, $532.5 million higher than projections in the state budget enacted in June. Revenues for the first two months of the fiscal year were $1.01 billion higher than they were one year ago.

Led by personal income taxes (PIT), each of the “big three” revenue sources beat expectations. PIT receipts of $5.22 billion in August were $135.7 million higher than 2017-18 Budget Act estimates. For the current fiscal year, California collected total PIT receipts of $9.96 billion, $212.9 million more than anticipated in the 2017-18 Budget Act.

August corporation tax receipts of $95.2 million were $70.0 million – or a whopping 277.8 percent – more than anticipated in the budget. Fiscal year-to-date corporation tax receipts of $458.7 million are $88.9 million above 2017-18 Budget Act projections.

Retail sales and use tax receipts of $3.12 billion for August were $67.3 million, or 2.2 percent, above budget estimates. For the fiscal year to date, sales tax receipts of $4.02 billion are $151.9 million higher than expected.

Outstanding loans of $8.66 billion in August were $1.26 billion less than budget estimates. This loan balance consists of borrowing from the state’s internal special funds. Available borrowable resources in August exceeded projections by $3.82 billion. Compared to 2017-18 Budget Act forecasts, total disbursements were $890.7 million lower than expected.

MASSACHUSETTS REVENUE REPORT

Preliminary revenue collections for August 2017 totaled $1.712 billion, which is $25 million or 1.5% less than August 2016 actual state tax collections. August 2017 preliminary collections are $16 million, or 0.9%, below the monthly benchmark. Over the first two months of Fiscal Year 2018, total actual tax collections are up $66 million, or 1.9%, over the same period last year, and $11 million below the year-to-date benchmark. The small shortfall in August collections reflects mostly lower than expected income withholding payments, partially offset by slightly better than expected performance in regular sales tax and estate tax.

August is a small tax collection month with no quarterly estimated payments due for most individuals and businesses. Income tax collections for August were $927 million, which is $54 million or 5.5% less than a year ago and $33 million below the monthly benchmark. Withholding collections for August totaled $913 million, down $53 million or 5.5% from last August and $30 million below the monthly benchmark. Income tax payments with returns or tax bills for August totaled $41 million, up $3 million or 9.1% over last August and $3 million above the monthly benchmark. Income tax estimated payments totaled $29 million for August, $5 million or 19.7% more than a year ago and $5 million above the monthly benchmark.

Income cash refunds in August totaled $56 million in outflows, which are $9 million greater than last August and $9 million above the monthly benchmark. Corporate and business tax collections for the month totaled $41 million, up $2 million or 6.0% from last August and $2 million above the monthly benchmark. Sales and use tax collections for August totaled $541 million, an increase of $20 million or 3.9% from last August and $8 million above the monthly benchmark. Other tax collections for August totaled $203 million, up $7 million or 3.4% from last August and $6 million above the monthly benchmark.

HARTFORD DOWNGRADE

With the state struggling to finalize its budget and its cities waiting to see what aid might be forthcoming, the city with the most dire situation -Hartford – saw its rating downgraded by Moody’s. The multi-notch move from B2 to Caa1 comes amidst a growing market consensus that the City will file for Chapter 9 protection imminently. Recent statements by the mayor that the city will run out of funds in 60 days in the absence of a state budget providing adequate funding to the city. He reiterated the city’s commitment to restructuring its debt regardless of the state budget outcome and level of support (if any) from the state.

The city has a $5.9 million debt service payment due on October 1st and $21 million in tax anticipation notes payable on October 31st. Additionally, the city has debt service payments in every month of the fiscal year. The rating from Moody’s remains under review pending the outcome of the State budget negotiations and their impact on the city.

PR LITIGATION

Federal Judge Laura Taylor Swain denied a request by several creditor groups of the Puerto Rico Electric Power Authority (PREPA) that sought relief from the bankruptcy stay to commence a lawsuit against the public corporation to put it under receivership. The Ad Hoc Group of PREPA Bondholders and insurers National Public Finance Guarantee Corp., Assured Guaranty Corp. and Syncora Guarantee Inc., which together hold $5.3 billion, or 65%, of the utility’s debt, intended to put PREPA under receivership in order to ensure rates could be raised so the public corporation could pay its debt.

creditors argued that PREPA bonds were secured by “a lien” on the utility’s revenues, “a covenant” that rates would be sufficient to cover its debt service obligations and “a right” to seek the appointment of a receives upon a default event. PREPA and the fiscal board argue that a near-term rate increase will harm Puerto Rico’s prospects for economic recovery. The board further stated that an increase in electricity prices beyond 21.4 cents per kilowatt-hour will result in Puerto Rico not becoming fiscally sustainable.

the official committee of unsecured creditors, which represents the commonwealth government, sued Bettina Whyte, who stands for the interests of the Sales Tax Financing Corp. (Cofina)—a lockbox entity that has more than $17 billion in bonds under its belt and receives a portion of sales tax collections to pay for its debt service. According to the complaint, the commonwealth seeks to stop these transfers and tap into this money by arguing the Cofina structure is “unconstitutional and void,” and as such, the contested sales tax revenues belong exclusively to the government.

Judge Swain is expected to rule on the commonwealth vs. Cofina issue by Dec. 15. The government argues that the legislation that created the entity, Act 91 of 2006, evaded or violated the Puerto Rico Constitution, particularly the commonwealth’s constitutional debt limit.

GAS TAX OPPONENTS FILE FOR A REPEAL INITIATIVE

Reform California, headed by a former San Diego City Councilman, filed papers with the state attorney general’s office Thursday to start the process to collect 587,407 signatures to qualify the measure aimed at repealing a gas tax and vehicle fee increases and require future tax hikes be approved by voters for the November 2018 ballot. Enacted legislation will raise $5.2 billion annually for road and bridge repairs and expanded mass transit. The hikes — raising the gas tax from 18 cents to 30 cents per gallon — start Nov. 1.

A second initiative proposed to repeal the gas tax filed paperwork to get a ballot measure going, but that’s tied up in a court dispute.

FOXCONN TAX BREAKS MOVE FORWARD

The Wisconsin Assembly sent Scott Walker a multibillion-dollar subsidy package for a Taiwanese company, putting within reach the governor’s bid to site a massive flat-screen plant in Racine County.  Walker and GOP lawmakers have promised that the Foxconn Technology Group plant will bring thousands of jobs to Wisconsin and transform the state’s economy. The electronics-maker could receive up to $2.85 billion in cash from state taxpayers under the deal, which would make it the largest incentive package for a foreign company in U.S. history.

The legislation would exempt the Foxconn project from some state rules to protect wetlands and waterways — provisions that environmental groups have threatened to challenge in court. Foxconn would not need to write a state environmental impact statement or procure state permits to build in bodies of water but would have to comply with federal environmental laws. The bill would expedite appeals of litigation over the project, creating a path that would likely get any case to the state Supreme Court more quickly. Any trial court rulings in that litigation would be automatically suspended until a higher court rules.

Foxconn has yet to specify a proposed location and that announcement is the subject of ongoing negotiations with local entities. So even if the Governor signs the bill into law, the plant is still not a “done deal”.

NEW SCHOOL YEAR BRINGS CHALLENGES FOR NY COLLEGES

The start of a new school year is always a time of excitement and apprehension for students and schools alike. One area in which this is especially true is the private college space in New York State. This September marks the beginning of New York State’s Excelsior Scholarship Program which will provide students in New York from families under specific income levels with free tuition at state public colleges. At the same time, the Enhanced Tuition Awards Program, which provides up to $6,000 for students who choose to attend private colleges instead of one of the state’s SUNY or CUNY colleges begins as well.

Enhanced TAP recipients must reside in New York State for up to four years after completing their degrees, or else the grants will convert into loans. Students also must complete 30 credits per year, earn passing grades and graduate within four years (for four-year programs) to receive the aid. Under both programs, if you receive a regular TAP award from the state, this will be subtracted and reduce the amount of your Enhanced TAP grant. However, unlike with the Excelsior Scholarship, if you receive a Pell Grant or outside scholarships to go toward your tuition, these will not reduce the amount of your grant.

The Enhanced Program is designed to lessen the impact on the state’s 95 private colleges which might result from reduced demand which would likely tax private college resources who felt the need to offer additional aid in the form of tuition reductions to eligible students. These institutions were among the main opponents to the program when it was debated in the state legislature prior to enactment.

So it is initially surprising to see that two-thirds of colleges in the state (66 out of 95) have not enrolled in the program. The reasons vary. Private colleges who have not enrolled say they found the program too expensive since they already provide generous financial aid for students. They also cite the timing of the program (since most students received their financial aid packages earlier this spring) as well as the restrictions placed on students who receive the scholarship as reasons for not participating. Some object to requirements that recipients had to stay in the state after they graduated or that they had to have a full load every semester or that they had to maintain a particular grade point average.

So those schools have chosen to roll the dice that there are a sufficient number of students who wish more limited class loads or who are looking to go to school near home but do not intend to live in the state after graduation. It will take some time to see if those beliefs are wisely held or if the decision turns out to have significant financial implications. It does however, introduce an additional level of uncertainty and risk into the analysis of small private colleges. It is a space that has been under significant pressure for some time and this does nothing to mitigate that pressure.

 

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

Publisher

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ISSUES OF THE WEEK

A number of established issuers are scheduled to come to market this week with significant issues.

The largest issue is for NYC GO debt ($855,560,000). The issue comes as the city’s electorate selects in candidates in party primaries. The mayor is expected to cruise to victory in both the primary and general election, implying no changes in fiscal policy.

The MN Board of Regents plans some $424,775,000 of new 424,775 money and refunding revenue bonds which unconditional, direct and general obligations of the university.

The TN State School Bond Authority will issue $239 million of new money bonds and $154,170,000 of refunding bonds. The bonds are secured under provisions whereby State appropriations for each institution are available to bondholders for debt service if the institution does not make debt service payments to the bond trustee on a timely basis. Student fees and charges for the institutions are pledged to bond  holders.

Reedy Creek Improvement District is a public corporation, created by a Special Act of the Florida Legislature in 1967 to provide municipal services within its boundaries, primarily for one customer, Walt Disney World. The Walt Disney World Resort Complex – its theme parks, recreational facilities, hotels and film studio – dominates the 40-square-mile district and comprises 85.2% of fiscal 2017 taxable value. It plans to issue $195,195,000 of tax backed bonds.

Idaho Energy Resources Authority (IERA) will issue $200 million of revenue bonds backed by lease payments from the Bonneville Power Administration made unconditionally directly to the bond trustee. this security structure offsets some longer term concerns about the BPA credit which reflect the fact that hydrology and wholesale market prices are the greatest volatility drivers of BPA’s financial performance and have been the main driver of BPA’s declining internal liquidity over the last ten years.

These factors are likely to persist owing to the volatility associated with hydro resources along with the weak wholesale power that exists in the Pacific Northwest. Additionally, BPA’s accelerated repayment of federal appropriations debt and declining availability under the US Treasury line are continuing factors that diminish the US government’s explicit support features over time and weakens BPA’s positioning within its rating. After the FY 2018-2019 rate period, the combination of declining US Treasury line availability, declining internal reserves for risk, sustained weak wholesale power market and a reduction in the degree of federal debt subordination could lead to a negative rating action.

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CHICAGOLAND CREDIT ROUNDUP

The unending tide of rating pressure on the Chicago public Schools credit may have abated for now. When the state failed to pass an on time budget, the rating was put on review for downgrade by Moody’s. After a tumultuous state legislative process and override of a gubernatorial veto, Moody’s has reviewed its position. It announced that it confirms Chicago Board of Education, IL’s B3 GO rating. The outlook was revised to stable .

Moody’s cited its view that the district’s financial distress that will likely persist but not materially worsen in the coming year given new state and local revenues. The additional revenue should balance the district’s operations in fiscal 2018, but will leave little margin to rebuild liquidity from its currently extremely weak position. The district will remain heavily reliant on cash flow borrowing and likely face budget gaps in future years without further budgetary adjustments. The outlook also incorporates the district’s covered abatement structure on its GOULT debt, which reduces the likelihood of default outside of bankruptcy. The outlook is also supported by the close governance ties to the City of Chicago.

All of the district’s rated debt is secured by its GO unlimited tax pledge. The majority of the district’s rated debt is GO alternate revenue debt, which is additionally secured primarily by pledged state aid revenues. An unlimited tax levy is filed with the county at the time of issuance. The property tax is abated only after sufficient revenues have deposited with the trustee into a debt service fund. If the deposit is not made with the trustee, the levy is extended.

The district funded 670 schools including district run traditional schools and 134 charter schools. With an enrollment of 381,349 in fiscal 2017, the district is the third largest in the nation.

The Chicago Water and Sewer Revenue Bonds saw Moody’s confirm their Baa1 and Baa2 ratings (senior and subordinate liens). The ratings apply to $26 million of senior lien water revenue bonds, $1.8 billion of second lien water revenue bonds, $35 million of senior lien sewer revenue bonds, and $1.3 billion of second lien sewer revenue bonds. The outlook however, remains negative for the ratings.

The overlap in the service area with the City remains a concerning element in the ratings. The ratings also consider City Council’s authority to adjust rates and the expectation that growing revenue needs of the city government and overlapping units of government could limit the capacity, both practical and political, to implement considerable adjustments if needed.  Moody’s view is that the credit profiles of the water and sewer systems, as business enterprises of Chicago, are connected to the city’s general obligation credit profile, which also carries a negative outlook due to very high tax base leverage and a very close governance relationship with a fiscally distressed school district.

As for the City itself, its Moody’s rating was confirmed at Ba1 with a still negative outlook. Moody’s noted that the city recently applied its broad taxing authority to raise new local revenue and accelerate pension funding, but new taxes remain far from sufficient to arrest growth in unfunded pension liabilities. The city’s new taxes also coincide with increases enacted by overlapping governments, such as Cook County and Chicago Public, the latter of which just received expanded taxing authority from the state. The rating considers long-term operating risks associated with rising costs and potential limited capacity to further raise local taxes, as well as the city’s very close governance and political ties to the fiscally weak CPS.

PUERTO RICO SPARED THE WORST

It says something when a storm causes 70% of the population to lose power but the impact of Hurricane Irma could have been much worse. Power outages initially  left about 17 percent of the territory without running water. Roughly 40 percent of the territory’s hospitals were functioning and were even accepting transfers of about 40 patients from the United States Virgin Islands.

The Virgin Islands fared much worse with substantial structural damage on St. Thomas. Even worse, The U.S. Virgin Islands has redirected money intended to help pay insurance claims after large disasters for other needs. Since 2007, nearly $200 million was transferred from the V.I. Insurance Guaranty Fund, including $45 million in fiscal 2011.

REGULATION NOT THE ONLY HURDLE FOR INFRASTRUCTURE

So far the Trump administration has focused on regulatory relief in its limited comments on infrastructure plan details. Litigation however is an additional hurdle even when funding for a project has secured voter approval. Santa Clara County voters last year overwhelmingly approved Measure B,  a half-cent sales tax to invest more than $6 billion in transportation infrastructure. The measure won more support than any transit tax in county history and was planned to fund bringing BART to downtown San Jose, upgrading Caltrain and highways, and expand the region’s network of bicycle and pedestrian paths.

The single plaintiff filed Litigation earlier this year. She is a retired urban planner from Saratoga who once sued Santa Clara County over its mosquito fogging and is holding Measure B hostage. $40 million has been collected to date.  The suit questions that the measure’s language was too broad.

The real issue behind her suit is her belief that an “ancient aquifer” beneath the site of the planned BART station downtown could collapse once construction commences. A judge dismissed her claim earlier this summer but, she appealed to a higher court. That review could extend the process for another year or more.

All Measure B tax revenue will remain in escrow until the court releases the funds. The suit is much like litigation which has held up Maryland’s Purple Line P3 as a small group of litigants pursues numerous appeals against the project through the federal courts.

It’s just another example of how tough it is to execute infrastructure whether public, private, or P3 in the current environment.

HARTFORD THREATENS BANKRUPTCY TO JUMP START STATE BUDGET

The city has been talking about it for so long that the latest threat to file for Chapter 9 could just be an effort to jumpstart the state budget debacle. In its latest pronouncement, Mayor Luke Bronin said Hartford would seek permission to file for bankruptcy if the city didn’t get the state aid it needs by early November. Specifically he said, “If the state fails to enact a budget and continues to operate under the governor’s current executive order, the city of Hartford will be unable to meet its financial obligations in approximately 60 days.”

Projections show the city faces a $65 million deficit this year and will run into cash-flow issues in November and December, including a $39.2 million end-of-year shortage. In 2016, the mayor laid off 40 workers and cut millions from city departments. He also used most of Hartford’s rainy-day fund to help offset deficits.

Still, Hartford had to borrow millions in June to help pay its bills.

He has asked for at least $40 million more this year from the state. As he has hinted before, “A well-planned bankruptcy is a tool that can be used to address long-term liabilities like debt and pension obligations.”

OKLAHOMA

Gov. Mary Fallin intends to call for a special session on Sept. 25 to make adjustments to the current fiscal year’s budget. The session results from the Oklahoma Supreme Court decision rejecting a proposed cigarette tax that resulted in a $215 million budget shortfall. The $1.50 fee on every pack of cigarettes was earmarked for four agencies: The Oklahoma Health Care Authority, the Alcoholic Beverage Laws Enforcement Commission, the Department of Human Services and Department of Mental Health and Substance Abuse Services. With federal funds that are tied to state appropriations, those agencies stand to lose an estimated $500 million.

Without a new source of revenue, and if lawmakers spread the cuts across all state spending, all appropriated agencies could lose more than 3 percent of their spending authority. Some support a cigarette tax but want to see other revenue measures alongside it. Those legislators seek to raise the tax rate on oil and gas production.

If there is not a legislative fix, a cigarette tax proposal will be put to a statewide vote.

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

Publisher

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ISSUE OF THE WEEK

NEW JERSEY ECONOMIC DEVELOPMENT AUTHORITY

$595,720,000 Motor Vehicle Surcharges Subordinate Revenue Bonds

Moody’s: Baa2

This is the first rating from Moody’s on the subordinate lien for this credit. The bonds are secured by a subordinate lien on motor vehicle surcharges and unsafe driver surcharges, subject to legislative appropriation. After appropriation, the pledged revenues will be transferred monthly to the EDA by the state Treasurer pursuant to state statute and a contract between the two parties.

If you have ever paid a speeding ticket in New Jersey, you have supported this credit. It is, as revenue bonds go, a fairly narrow stream of revenues and as driving decreases is vulnerable to decline. The use of proceeds is not the best. Originally, the program financed loans and grants to governmental, not-for-profit, and private developers to provide permanent housing and community residences for individuals with special needs and mental illness.

Now the program supports state General Fund operations and capital improvements to the Motor Vehicle Administrative Office of the Courts. So capital funds are used for operating expenses. This issue in particular will refund a portion of the Motor Vehicle Surcharge bonds (senior lien) into a new subordinate lien resolution, for estimated net present value savings that the state will take upfront in the first year for budgetary relief.

So the fiscal gimmickry continues under the Christie administration. The credit remains tied to that of the State. So of the risk is mitigated by the structure of the issue which includes a turbo feature on the last five maturities that will likely decrease future debt service and reduce revenue risk, as well as an Advance Account that provides liquidity against a timing mismatch between revenue collection and debt service payments.

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MASSIVE BOND ISSUE DECLARED TAXABLE

Whenever there is a large scale natural disaster, one of the ways that Congress addresses the resulting capital needs of a recovering area is to authorize special municipal bond issuance authority. The issuance is authorized for projects in designated areas and the bonds must usually be issued within designated time limits. We expect that this will be one of the mechanisms employed in the program of relief in the aftermath of Hurricane Harvey, just as was the case with hurricane Katrina and the Liberty Bond program for New York after 9/11. One of the characteristics of these programs is that they often result in some dubious financings.

That factor was revisited recently when it was announced that  the Internal Revenue Service has preliminarily determined that $1.26 billion of economic development revenue bonds as well as refunding bonds issued for Indiana-based Midwest Fertilizer Company are taxable.

Midwest Fertilizer is sponsored by one of the largest conglomerates in Pakistan. The company disclosed on July 27 that the IRS had issued a “Notice of Proposed Issue” stating that the revenue and refunding bonds violate federal tax laws and are therefore not tax-exempt.

One of the first cautionary signs was the fact that the Indiana Finance Authority issued the $1.3 billion of bonds for the project in the latter half of December 2012 to take advantage of the Midwestern Disaster Area Bond program, which expired at the end of 2012. My experience has led me to call the post Thanksgiving period “the silly season” in the high yield market. Deals like this one are one of the reasons.

Away from the size of the deal and the type of project, the deal was plagued by a number of other questionable characteristics. The bonds were issued in late 2012 to build a state-of-the-art, nitrogen fertilizer production plant on 220 acres in the county, which is located in the Southwestern corner of the state. The cost of the plant is now expected to be almost $3 billion, according to a Midwest Fertilizer press release dated July 27 of this year.

While it was offered under a program of disaster relief, it was a new project. As for immediate relief, groundbreaking of the project is now expected in 2018 and the plant is not expected to begin operating until 2022 – some twelve years after the disaster. It is designed to produce about 2 million tons annually of ammonia, urea ammonium nitrate solution and diesel exhaust fluid, a diesel additive that reduces diesel exhaust emissions.

In order to land the project, the Indiana Economic Development Corp. (IEDC) had offered an incentive package accepted by the company on Nov. 30, 2012, that included access to tax-exempt financing through the allocation of a portion of the state’s volume cap under the disaster bond program.

The package included up to $2.9 million of conditional tax credits and up $400,000 training grants based on the company’s job creation estimates. It also offered the company up to $300,000 in conditional incentives from the Hoosier Business Investment tax credit. But the IEDC made clear that the company would have to create jobs and invest in Indiana to receive the incentives. Additionally, Posey County agreed to provide a tax incentive package under which certain tax increment revenues and special assessments would be applied over a 25-year period to repay tax increment and special assessment bonds.

The company told the state it would create more than 2,500 construction jobs and as many as 200 ongoing regulator and contract employment opportunities. It also said U.S. farmers in the state would benefit from its fertilizer product.

While Midwest Fertilizer is a U.S. company it is actually owned by multinational investors, the principal one being Fatima Group, one of the largest conglomerates in Pakistan. The U.S. Defense Department’s Joint-Improvised-Threat Defeat Agency (JIDA) determined that the Fatima Group had been “less than cooperative” in implementing security for its fertilizer products to prevent them from being used in explosive devices deployed against American soldiers in Afghanistan and Pakistan.

Gov. Mike Pence, a day after taking office in January 2013, halted state support of the project and then formally dropped all state involvement in mid-May of that year. Posey County stepped in and offered the company tax increment incentives valued at $144 million and up to $480,000 in employment incentives. In spite of all of the questions about the company’s background, Gov. Pence sought to revive Indiana’s support for the project.

In the meantime, Posey County became the project’s main supporter and refunded or remarketed the bonds six times between July 2013 and November 2015. Over that period, Posey County and the company agreed to a revised tax incentives package. Midwest Fertilizer since executed a purchase of all of the bonds through a mandatory tender.

Unanswered is the question of how anyone thought it was a good idea to use scarce private activity bond capacity and create a revenue loss to the US Treasury to support an entity that could not prove that its products were not used to kill and maim US servicemen. A clear example that the road to hell is paved with good intentions.

WHY HOUSTON GETS FLOODED SO BADLY

Shortly after the Allen brothers chose to establish Houston at the confluence of Buffalo and White Oak Bayous, virtually every structure in the new settlement flooded. After the tremendously destructive floods of 1929 and 1935, on April 23, 1937, after local leaders petitioned the State of Texas, the 45th Texas Legislature unanimously passed the bill that created the Harris County Flood Control District and established the Harris County Commissioners Court as the District’s governing body. The Harris County Flood Control District originally served as the local partner for the U.S. Army Corps of Engineers for flood control projects.

Costly floods were almost an annual event. More homes and businesses were built in improvident locations, prior to establishing the standard of the 1% (100-year) flood. Throughout Harris County, close to 30 damaging floods have occurred in the area, resulting in hundreds of millions of dollars in damages in just under 70 years. Flooding problems continued, with 21 damaging storms from 1950-1980. Since 1986, there have been six “100 year” floods in Harris County. A major flood still occurs somewhere in Harris County about every two years. No area of the country has received more federal disaster aid over the years as the result of floods than the greater Houston metropolitan area. More flood insurance funds have been paid here than in any other National Flood Insurance Program-participating community.

Many have said that going forward the topic of Houston’s lack of zoning regulations is effectively off limits for debate. It is fair to say that four and a half feet of water was going to be catastrophic in any event. At the same time, it is not wrong to say as Governor Greg Abbott did that “it would be insane for us to rebuild on property that has been flooded multiple times. I think everyone is probably in agreement that there are better strategies that need to be employed.” Unfortunately, we have heard such talk before but the sentiment usually fades with time.

HOW WILL THE HURRICANE IMPACT CREDIT?

Initially, there is no expectation that ratings will be impacted. Damage needs to be assessed, resources identified, and a timetable for repair and relief established. Experience tells us that the rating agencies will let all of this unfold before taking any action. The potential exists for short-term defaults due to administrative issues but these are usually resolved quickly as banking and municipal facilities are reopened and records recovered. This is more likely to be true for smaller municipalities where records are less likely to be electronically compiled and maintained and where staffing is minimal even during normal operations.

For the larger entities, any impact will be longer term. The State has indicated that it will rely on its estimated $10 billion rainy day fund until outside resources are delivered. The State Legislature is not scheduled to convene again until January, 2019 but the Governor is able to call it back into a 30 day special session if necessary.

CAVS ARENA PLAN BACK FROM THE BRINK

The Cleveland Cavaliers will reconsider the decision to pull out of a $140 million deal to renovate Quicken Loans Arena now that referendum petitions have been withdrawn. A faith based coalition has announced that it was withdrawing petitions for a voter referendum on financial support for the renovation of the 22 year old facility. The group was holding the deal hostage for more County investment in mental health facilities. Like many areas, cuts in such funding have made prisons the primary place for the severely mentally ill to be housed.

 

The Cavaliers’ owner, Dan Gilbert, had announced that he would not go ahead with the project (the same Dan Gilbert who has invested so heavily in downtown Detroit) if a referendum was required. A delay in the renovation was connected to the potential loss of an NBA All Star game and the project was seen as a source of jobs. It was claimed that no new tax revenues would have been needed for the project.

 

The initial plan for the makeover of the 22-year-old arena was to be financed jointly by the Cavs, the city of Cleveland and the county. The deal included a lease extension that would ensure the Cavaliers will remain at the arena through 2034, a seven-year extension of the existing lease. Interest on two, $70 million bond issues would bring the cost over 17 years to $282 million. The Cavaliers would pay $122 million of that in increased rent, while the city and county would cover the remaining $160 million.

The arena is publicly owned, by the city and county through the Gateway Economic Development Corp. The county would issue bonds that would be repaid by available funds from existing local admissions and hotel taxes, and from increased rent payments from the Cavs. The city is involved because part of the financing for the renovation will come from a city admissions tax.

As we go to press, Puerto Rico and the Virgin Islands are being impacted by Hurricane Irma. experience tells us that damage will be significant and that both entities will be even more reliant on federal aid given their very weak financial positions. The storm will add to the already high burden of negative credit factors facing them. The potential exists for the storm to be a final crippling blow to efforts to keep the Virgin Islands effectively solvent. It highlights the lack of viable alternatives for investors looking for the benefit of triple tax exempt income in the face of Puerto Rico’s ongoing fiscal crisis. We expect to have much clearer information in next week’s edition.

 

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.