Joseph Krist

Publisher

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RISING DEFAULT RATES SKEWED BY PUERTO RICO

The headline may say that defaults are rising but the fact is that 2017 was an unusual year. S&P recently released the results of its study of defaults in 2017 on debt that it rates. For the third year in a row, the number of defaults in USPF rose, reaching a record 20 in 2017. Puerto Rico accounted for 14 of the defaults. The default rate for USPF was 0.09%, the second highest since 1986. Nonetheless, this rate remains extremely low. The ratings on 903 bonds were raised in 2017, while the ratings on 708 bonds were lowered. States, higher education, health care, charter schools, and housing had more downgrades than upgrades in 2017; this was the second consecutive year of negative rating trends for states, health care, and housing and the seventh straight negative year for charter schools.

The headline data is of course skewed by the fact that Puerto Rico accounted for 14 of the defaults. S&P notes that the rising number of defaults in recent years is not an indication of general credit stress. The ratio of upgrades to downgrades was essentially the same in 2017 as in 2016, at 1.27, but five of eight sectors had a higher number of downgrades than upgrades in 2017. This is an increase from four negative-leaning sectors in 2016 and two in 2015. Where are potential problem areas? Higher education had more downgrades than upgrades in 2017, reversing the positive rating trend of 2016, which resulted from revised criteria. Charter schools also leaned negative, although not to the same degree as in previous years. Health care and housing rating movement was negative for the second consecutive year. Transportation and utilities both had more upgrades than downgrades in each of the past three years.

IRS TO ISSUE SALT DEDUCTION GUIDANCE

The U.S. Department of the Treasury and the Internal Revenue Service issued a notice today stating that proposed regulations will be issued addressing the deductibility of state and local tax payments for federal income tax purposes. Notice 2018-54  also informs taxpayers that federal law controls the characterization of the payments for federal income tax purposes regardless of the characterization of the payments under state law.

The Tax Cuts and Jobs Act (TCJA) limited the amount of state and local taxes an individual can deduct in a calendar year to $10,000. In response to this new limitation, some state legislatures are considering or have adopted legislative proposals that would allow taxpayers to make transfers to funds controlled by state or local governments, or other transferees specified by the state, in exchange for credits against the state or local taxes that the taxpayer is required to pay.

The aim of these proposals is to allow taxpayers to characterize such 2 transfers as fully deductible charitable contributions for federal income tax purposes, while using the same transfers to satisfy state or local tax liabilities. Despite these state efforts to circumvent the new statutory limitation on state and local tax deductions, taxpayers should be mindful that federal law controls the proper characterization of payments for federal income tax purposes.

The upcoming proposed regulations, to be issued in the near future, will help taxpayers understand the relationship between federal charitable contribution deductions and the new statutory limitation on the deduction of state and local taxes. The proposed regulations will make clear that the requirements of the Internal Revenue Code, informed by substance over-form principles, govern the federal income tax treatment of such transfers. The proposed regulations will assist taxpayers in understanding the relationship between the federal charitable contribution deduction and the new statutory limitation on the deduction for state and local tax payments.

PORT OF OAKLAND STABILIZES REVENUE STREAM

The Port of Oakland has taken the first step in securing long-term revenues from its maritime tenants. It approved the first reading of an ordinance extending marine terminal leases with its largest operator, SSA Terminals The lease extensions, which follow two lease extensions last year, will result in the seaport extending tenant leases that account for close to 70% of maritime revenue through 2030. This would extend visibility for more than 60% of seaport revenue by 10 years, which reduces the contract renewal risk that previously existed for all four of the port’s seaport leases.

The leases renewals provide high levels of minimum or fixed revenue to the port, and their extensions align future cash flow to match the amortization of the port’s debt. the seaport division, which accounts for more than 80% of the port’s total debt and has the most business risk of the port’s three divisions. The Port of Oakland owns the eighth-largest container port in the US and the marine cargo gateway for the Northern California region. the port owns, leases and administers, but does not directly operate, four active container terminals in the San Francisco Bay. As a landlord port authority, the division receives a combination of fixed (referred to as minimum or guaranteed payments) and variable lease payments from tenants. The higher the level of fixed payments the greater stability characterized in the credit.

The port has now reached extension agreements with its two remaining terminals, including its largest terminal, Oakland International Container Terminal (OICT), which accounts for more than 70% of container volume for the maritime division. More than 60% of current marine terminal revenue is now under lease through 2032, while more than 70% is now under lease through 2030. This will enable the Port’s infrastructure development program which a dredging program that provided 50 feet of water to accommodate larger ships and an expanded rail yard, and more recently additional rail track, an on-port cold storage facility and a 185-acre on-port distribution and warehouse complex.

Overall, transactions and the infrastructure program enhance the port’s competitive position and stabilize its ratings.

BONDHOLDER VERSUS PENSIONER RIGHTS

The resolution of the City of Detroit bankruptcy and the ongoing saga of Puerto Rico’s Title III has heightened awareness of and debate over the rights of debt holders versus those of pensioners. Now a recent decision by the Illinois Comptroller has added additional fuel to the debate. Moody’s took a recent opportunity to weigh in with its view of the impact of the move by the Comptroller to deny the City of Harvey’s request for relief from revenue withholding under a state law requiring minimum pension contributions.

Local pension plans in Illinois can request that the state withhold revenue from a sponsoring municipality if that municipality does not make minimum contributions. Harvey’s public safety pension funds have made such requests, and the state has withheld more than $2 million to date. The city asserts that it will soon be unable to meet payroll, and last month announced layoffs. The state comptroller’s office has responded that it has no discretion under state law to consider Harvey’s hardship.

Harvey is the most egregious case of local municipal credit weakness in Illinois. The city missed two debt service payments in fiscal 2016, six in fiscal 2017 and as of February had missed four in fiscal 2018. Harvey historically has underfunded actuarially determined contributions (ADCs) for its public safety pension plans. The city contributed very little to its firefighter pension fund from 2009 to 2013, and even its far higher contribution in 2017 fell far below the ADC. Harvey cannot currently file for bankruptcy under Illinois law and revenue withholding for pensions only heightens the likelihood of more bond defaults and a restructuring.

Moody’s views the decisions negatively not only for Harvey but also for other municipalities in Illinois which might find themselves in the same position.

PR LITIGATION DOINGS

U.S. District Court Judge Laura Taylor Swain, who oversees Puerto Rico debt proceedings, extended to June 29, from May 29, the deadline to file proof of claims against the commonwealth. In another related matter, the Committee of Unsecured Creditors was allowed to intervene and will be able to make discovery in a lawsuit headed by Cooperativa Abraham Rosa and five other credit unions against the commonwealth, the island’s Financial Oversight and Management Board and several other entities, accusing them of “defalcation and fraud” for selling them “unsound Puerto Rican debt” in a “ploy to obtain their assets.”

The Retirement System of the Puerto Rico Electric Power Authority (PREPA) does not want the commonwealth’s Official Committee of Retired Employees to represent its interests. The PREPA Retirement System said “the intervention of the Retiree Committee will create confusion with respect to the different positions that the retirees will have to assume in these Title III court proceedings, as they will be represented by two legal entities that might disagree in any moment about fundamental issues.”

NASSAU COUNTY BUDGET UNDER OTB THREAT

Nassau County has budgeted $15.75 million for fiscal 2018 from revenues from video lottery terminals at Resorts World Casino at Aqueduct Racetrack, which is operated by Genting New York LLC, dedicated to Nassau OTB. So far has received $3 million but only after delay and some dispute.

Nassau had hoped to apply three-quarters of the $20 million the county says is due early next year to this year’s budget, and include the remainder in the 2019 budget. Now there is real concern however, that Nassau OTB will not be able to make its next payment when due. Nassau OTB committed to paying Nassau County $3 million in the 2016 calendar year, $3 million in the state’s 2017 fiscal year — which runs from April 1 through March 31 — and $20 million in each subsequent state fiscal year.

There are exceptions. They include if a similar “full-service” casino opens within a 65-mile radius of Aqueduct, or if gambling revenue for Resorts World drops by 10 percent or more in any one year. The betting agency won’t have enough in profits this year to “permit a payment of $20 million to the county without 1,000 VLTs being operational” at Resorts World. There are only an estimated 500 machines installed. A planned $400 million expansion at Resorts World will accommodate 1,000 Nassau machines as well as a new 400-room hotel, restaurants and other amenities.

The county has been counting on the new revenues to finance an emerging budget deficit. it receives the revenues under an agreement made under a provision in state law enacted after public opposition prevented OTB from building a casino in Nassau. OTB says it expects to pay Nassau $3 million next spring if the number of VLTs still hasn’t reached 1,000. If all the machines come online sooner, the $20 million payment would be prorated, based on the number of months the 1,000 VLTs have been operating.

 

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

THE REGENTS OF THE UNIVERSITY OF CALIFORNIA

LIMITED PROJECT REVENUE BONDS

$739,195,000 Tax Exempt

$94,865,000 Taxable

Moody’s: “Aa3”  S&P: “AA-”  Fitch: “AA-”

GENERAL REVENUE BONDS

$946,580,000 Tax Exempt

$283,415,000 Taxable

Moody’s: “Aa2”  S&P: “AA”  Fitch: “AA”

The General Revenue Bonds are the broadest pledge of the university. The bonds are secured by a pledge and lien on gross student tuition and fees, indirect cost recovery from grants and contracts, net sales and service revenue, net auxiliary revenue, and unrestricted investment income. In addition, under recently enacted legislation the Regents can pledge its annual General Fund support appropriation, less the amount required to fund general obligation debt service payments for the portion of state general obligation bonds funded for university projects. UC reported $16.2 billion of General Revenues for fiscal 2017. Proceeds from the Series 2018 General Revenue AZ and BA bonds will finance projects across nine campuses. The proceeds will also be used to refund bond, pay-down $450 million of commercial paper and pay issuance costs.

The LPRBs are secured by the gross revenues generated by the projects. The pledged revenues also include any other revenues, receipts, income or miscellaneous funds designated by The Regents for the payment of principal of and interest on the bonds. Certain pledged revenues are dependent upon completion of the projects funded from the proceeds of the 2018 Bonds. There is a 1.1x rate covenant and no debt service reserve fund. In fiscal 2017, pledged revenues provided over 4x maximum annual debt service coverage. Limited Project Revenue bonds will finance housing, dining, and parking projects across seven campuses. The proceeds will also be used to refund bonds, pay-down $140 million of commercial paper and pay issuance costs.

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NYC BUDGET REVIEWED BY INDEPENDENT BUDGET OFFICE

The IBO has released its review of Mayor bill deBlasio’s FY 2019 Executive Budget. According to IBO, the Executive Budget for 2018 and Financial Plan Through 2022 is reactive, with increased spending and increased revenues the product of forces largely outside the city’s control. Compared with his Preliminary Budget, the Mayor’s latest plan includes approximately $1 billion in additional city revenue in the current year, much of which results from one-time responses by business owners and investors to changes in federal tax law. We see this as a point of concern. Fortunately for the City, IBO projects that the city will end the current fiscal year with $774 million more in tax revenue than the de Blasio Administration estimates.

IBO’s current forecast for total 2018 tax revenues has increased since its March outlook by $882 million, or 1.5 percent. It projects that near-term strength in the U.S. and local economies will be followed by weaker growth over the next couple of years. As a result, it is expected that growth in city tax revenues will also slow, from an estimated 8.4 percent increase this year to a 3.2 percent rise in 2019, when collections will reach $60.8 billion.  IBO’s property tax forecast exceeds the Mayor’s projections by $210 million in 2018, rising to $1.0 billion in 2022, mostly due to the Mayor’s office carrying larger allowances for refunds, delinquencies, and cancellations. IBO’s estimates for the personal income tax and the general corporation tax are also consistently higher each year than the Mayor’s from 2018 through 2022.

Debt service and fringe benefit costs are the two largest drivers of overall expenditure growth, growing by an average of 8.4 percent and 7.0 percent annually from 2018 through 2022.  Department of Education spending is expected to grow by $2.7 billion from 2018 through 2022, the largest increase in agency expenditure in dollar terms in the plan. IBO’s economic forecast for the city anticipates a slowing of the pace of job creation throughout the plan period, accompanied, however, by low unemployment rates and an uptick in wage growth. The outlook for Wall Street profits— though not for financial sector job growth—is strong. While the commercial real estate market is recovering from its recent doldrums, the residential market has been weakening and at best moderate growth is projected for both.

IBO’s city economic forecast anticipates a slowing of the pace of job creation throughout the plan period, accompanied, however, by low unemployment rates and an uptick in wage growth. IBO expects the pace of New York City job creation to moderate in 2018 and then decelerate over the next three years. The health care forecast, and indeed the entire city employment forecast, depends on whether home health care services sustains its recent pace of growth. Home health care employment has doubled in New York City in just six years, from 82,100 in the first quarter of 2012 to 165,500 in the first quarter of 2018, accounting for nearly a third of all the reported job growth in this sector in the entire country.

 

Taxable real estate sales in New York City were $93.2 billion in 2017, the lowest level since 2012. Commercial sales were $37.8 billion, less than half their 2015 peak. Residential sales, however, were $55.4 billion, the highest level ever recorded before adjusting for inflation. Last year was the first year since 2010 that the value of residential sales in New York City exceeded that of commercial sales. IBO expects residential sales to drop over 10 percent in 2018, with the greatest decline in Manhattan. On the residential side, higher mortgage rates and recent policy changes that reduce the tax advantages of home ownership will exert downward pressure on sales growth.

So how does IBO think that that all of this will impact the City’s budget? Tax revenue is now expected to total $58.9 billion in 2018, $882 million more than in our forecast from two months ago, and $60.8 billion in 2019, up $553 million since March. The federal effect fades further in 2020 through 2022. By the final year of our forecast (2022), tax revenues are projected to total $69.0 billion, only $63 million higher than in our March forecast. For 2019 and subsequent years, the forecasts for all taxes other than personal income, unincorporated business, and sales have either been revised down or had only minor positive changes since March.

IBO projects that revenue growth will average 3.7 annually from 2018 through 2022, which would be the slowest four year annual average since the end of the Great Recession. Since the recession, the four-year average has ranged from a low of 4.9 percent (2013-2017) to a high of 6.6 percent (2009-2013). The real property tax is expected to show the steadiest and strongest growth, averaging 5.5 percent annually from 2018 through 2022. No other tax is projected to average more than 4.3 percent annually, with several—including the personal income tax—expected to average less than 2.0 percent annual growth between 2018 and 2022.

This gets us back to the issue of whether the deBlasio administrations practice of steadily increasing City spending is sustainable. IBO projects total city spending will be $90.1 billion in 2019 under the contours of the Mayor’s latest budget plan—$900 million more than the $89.2 billion we estimate spending will total this year. We project total spending will rise to $93.3 billion in 2020 and reach $98.3 billion in 2022. Adjusting for the use of prior budget surpluses to prepay some expenses for upcoming years, IBO anticipates total city spending will increase from $89.0 billion in 2018 to $92.9 billion next year and grow to $94.8 billion in 2020.

Much of the growth in spending the next four years is driven by increased spending in two areas: fringe benefits for city employees and debt service (note that most fringe benefits and all debt service are not carried within the budgets of city agencies). IBO estimates that in 2018 the city’s expenditure on debt service and fringe benefits will comprise 18.2 percent of the total budget. By 2022 these two expenses will make up 21.2 percent of the entire city budget. These are somewhat dangerous levels driven by discretionary actions of the last two administrations and they leave the City’s budget vulnerable in the event of a significant economic downturn. we remained concerned about this risk going forward in terms of the ongoing value of the City’s debt.

NEW YORK AND MINNESOTA SETTLE FEDERAL MEDICAID LAWSUIT

Earlier this month, a federal judge signed off on an agreement that dismisses a lawsuit undertaken by the states of Minnesota and New York and directs federal officials to consult with Minnesota and New York over a new funding formula for what is called a Basic Health Plan (BHP) under the federal Affordable Care Act. The judge’s order said if the states disagree with the new formula developed by the Trump administration, they have until Aug. 1 to ask that a court reopen the case for litigation.

The Affordable Care Act (ACA) provides tax credits for individuals at certain income levels who buy private health insurance via government-run exchanges. States that create a Basic Health Plan as an alternative for these consumers can tap a large chunk of the value of tax credits individuals would receive to purchase coverage on the exchange.

In January, Minnesota Attorney General Lori Swanson filed suit to stop a Trump administration decision that would terminate an estimated $130 million in annual payments to the state. Federal funds, including those targeted by the lawsuit, have been covering most of MinnesotaCare’s costs with the rest coming from enrollee premiums and state funding.

INITIAL RATINGS IMPACT OF FOXCONN PLANT IS NEGATIVE

Racine County, WI will be the location of the much ballyhooed Foxconn manufacturing facility which will benefit from many tax incentives from the State of Wisconsin. The location of the plant may in the long term have a positive credit impact on the nearby localities, the initial effect has been negative. This week, Moody’s announced that it was lowering its outlook on Racine County’s GO credit from stable to negative.

In taking the action, Moody’s cited the significant amount ($147 million) of short-term debt coming due on December 1, 2020.  this reflects two issues of b the significant amount ($147 million) of short-term debt coming due on December 1, 2020. This reflects issuance of two bond anticipation notes to finance the purchase of land for the new Foxconn development. This is outside of any tax incentive. This amount of short-term debt is very high in Moody’s view relative to the county’s total outstanding debt (73% of the county’s debt) and the county’s available internal liquidity ($46 million as of fiscal year end 2016). These risk factors also contributed to the negative outlook on the county’s long-term debt.

The negative outlook reflects a view that the county has taken on substantial short-term leverage that could pressure the GO rating should the county experience difficulty in securing take-out financing for the BANs. The rating could also be lowered if revenue generated directly or indirectly by the Foxconn development falls short of county expectations.

GEORGIA DEANNEXATION EFFORT COULD HAVE WIDE RANGING IMPACT

When Georgia Governor Nathan Deal said legislation he signed that would de-annex parts of Stockbridge to create a new, more affluent municipality was unlikely to influence the state’s AAA bond rating, he left local ratings outside of that view. That’s a good thing as Moody’s weighed in with an opinion.

Moody’s released a four-page analysis this week that found the plan to create a new Eagles Landing would be “credit negative” to more than just Stockbridge. “The bills are also credit negative for local governments in Georgia because they establish a precedent that the state can act to divide local tax bases, potentially lowering the credit quality of one city for the benefit of the other,” according to Moody’s.

Stockbridge has $13 million of tax backed bank debt outstanding and $1.5 million of revenue bonds. The legislation did not address the issue of reallocation of the responsibility for that debt to either Eagles Landing or Henry County so it appears that the City will be stuck with those obligations in spite of a significant reduction in its tax base.

It is bad policy from any perspective and it would seem to violate the state’s moral obligation not to take any action which would undermine the ability of any of its underlying entities to meet their debt obligations.

 

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

$260,260,000

BOARD OF EDUCATION OF THE CITY OF CHICAGO

UNLIMITED TAX GENERAL OBLIGATION

REFUNDING BONDS

(DEDICATED REVENUES)

 

The bonds are coming with Assured Guaranty insurance but it is an opportunity to review the Board’s underlying credit  which remains well below investment grade. The board’s full faith and credit and unlimited taxing power secures the bonds. The bonds are alternate revenue source bonds with the pledged revenues consisting of pledged state aid revenues. The rating is based on the board’s underlying unlimited ad valorem tax pledge.

The State of Illinois’ last budget did provide for improved funding for entities like the Chicago Public Schools in recognition of their difficult financial profiles and huge pension funding burdens. The resulting improvement in aid levels has a positive effect on cash flow although the Board still maintains an extremely weak cash position, which is projected to be negative throughout almost all of fiscal 2018 and likely in fiscal 2019.  It continues to maintain a reliance on lines of credit to support operating and debt service expenses.

Nonetheless, the Board was able to show a notably improved cash flow in the district’s March and subsequent May 2018 cash flow report compared to October 2017 and evidence that increased state funding is flowing to the district as previously planned. This was enough to convince S&P to have a positive outlook for the Board’s debt. The positive outlook reflects the at least one-in-three chance that S&P could raise the rating within the one-year outlook horizon.

An upgrade would have to be supported by the 2019 budget demonstrating structural balance, continued progress on an improving financial position with a small surplus result in fiscal 2018 leading to a positive fund balance, and additional reduction in outstanding tax anticipation notes.

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SEC ENFORCEMENT

Barcelona, a municipal advisor based in Edinburg, Texas, and Mario Hinojosa, Barcelona’s sole member and associated person. Barcelona acted as the municipal advisor to the La Joya Independent School District (“LJISD”) on three bond offerings between January 2013 and December 2014, earning $386,876.52 in municipal advisory fees. During LJISD’s process of selecting Barcelona as its municipal advisor, Barcelona and Hinojosa overstated and misrepresented their municipal finance experience to LJISD. Barcelona and Hinojosa also failed to disclose that Hinojosa was employed by the attorneys who served as bond counsel for all three bond offerings. By misrepresenting their municipal finance experience and failing to disclose the conflict of interest with bond counsel, Barcelona and Hinojosa violated the federal securities laws and the rules of the Municipal Securities Rulemaking Board (“MSRB”).

Among other things, the firm distributed written information which represented that the “professionals” at Barcelona have participated in several municipal offerings and have municipal finance experience in 14 different municipal bond issuances and that Hinojosa had four years of municipal finance experience. Hinojosa was Barcelona’s only employee and had never served as advisor—municipal or otherwise—on any bond issuances. In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), which included provisions for the registration and regulation of municipal advisors. The municipal advisor registration requirements and regulatory standards are intended to mitigate some of the problems observed with the conduct of some municipal advisors, including undisclosed conflicts of interest and failure to place the duty of loyalty to their municipal entity clients ahead of their own interests.

The SEC issued a cease and desist order and ordered disgorgement of f $362,606.91 and prejudgment interest of $19,514.37 to the Commission, a civil money penalty in the amount of $160,000 to the Commission, and Mr. Hinojosa is prohibited from serving or acting as an employee, officer, director, member of an advisory board, investment adviser or depositor of, or principal underwriter for, a registered investment company or affiliated person of such investment adviser, depositor, or principal underwriter.

All in all, pretty serious stuff. It is also for the long-term benefit of the industry. There are many reputable and more than useful municipal advisory entities and individuals and actions such as these which took advantage of an unsophisticated issuer in a relatively poor area encourage people to paint our industry with a broad brush. Unfairly so, from our standpoint.

CALIFORNIA APRIL REVENUE REPORT

State Controller Betty T. Yee reported California collected more tax revenue during the month of April than in any previous month of the 2017-18 fiscal year so far. Moreover, total April revenues of $18.03 billion were higher than estimates in the governor’s FY 2018-19 proposed budget by 5.3 percent.  For the first 10 months of the 2017-18 fiscal year that began in July, total revenues of $107.13 billion are $4.72 billion above estimates in the enacted budget and $3.82 billion higher than January’s revised fiscal year-to-date predictions. Total fiscal year-to-date revenues are $10.25 billion higher than for the same period in FY 2016-17.

For April, personal income tax (PIT) receipts of $14.17 billion were $715.9 million, or 5.3 percent, higher than estimated in January. For the fiscal year, PIT receipts are $2.58 billion higher than anticipated in the proposed budget. Traditionally, April is the state’s peak month of PIT collection. April corporation taxes of $2.40 billion were $78.4 million higher than forecasted in the governor’s proposed budget. For the fiscal year to date, total corporation tax receipts are 13.5 percent above assumptions released in January.

Sales tax receipts of $946.1 million for April were $139.1 million, or 17.2 percent, higher than anticipated in the governor’s FY 2018-19 budget proposal. For the fiscal year, sales tax receipts are in line with the proposed budget’s expectations.

Unused borrowable resources through April exceeded January projections by 36.9 percent. Outstanding loans of $4.52 billion were $6.35 billion less than the governor’s proposed budget expected the state would need by the end of April. The loans were financed entirely by borrowing from internal state funds.

TOWN SELLS BONDS IN THE MIDDLE OF A FRAUD TRIAL

We may never learn in the municipal bond market. Oyster Bay, N.Y., sold a total of $191.205 million in two separate competitive sales. The $152.665 million of public improvement bonds sold at a net interest cost of 3.32%. The $38.54 million of bond anticipation notes carried an NIC of 2.28%. The bond deal is rated Baa3 by Moody’s Investors Service and BBB-minus by S&P Global Ratings.

The sale came as testimony was being taken in the federal criminal trial of former Town of Oyster Bay Supervisor John Venditto (and former Nassau County Executive John Mangano) on securities fraud charges related to municipal bond sales by the Town of Oyster Bay. Testimony has exposed a failure to disclose vital information to investors including the fact that the Town had pledged its credit to guarantee loans made to individuals doing business with the Town.

The loans were for a political supporter, who was the operator of many Oyster Bay restaurants. In exchange for the guaranteed loans, the former elected officials were allegedly bribed with meals, chauffeurs, vacations, jewelry, and a $450,000 “no-show” job for Mr. Magnano’s wife. in a superseding indictment, federal prosecutors charged Mr. Venditto with securities fraud and wire fraud related to Oyster Bay muni-bond securities offerings, alleging that he concealed the illegal loan guarantees from investors and others.  The SEC in parallel civil litigation charged Oyster Bay and Mr. Venditto with defrauding investors of the town’s bonds by hiding the existence and potential financial impact of the illegal loan guarantees. The federal criminal trial commenced in mid-March 2018 and was ongoing.

Apparently, bidders and the ultimate buyers of the securities were satisfied that the Town’s wrongdoing and that of the charged individuals was sufficiently  separate issues. It is another remarkable example of the municipal market’s willingness to effectively forgive and forget within a relatively short period of time. It has been less than six months since the filing of the original charges and it seems reasonable to ask why investors would not wait until all of the available information which could have been generated at trial had come to light.

Regardless of the existence of a rating and the level of disclosure in the offering documents, the resulting cost of the issue to the Town does not seem exceptionally punitive. While we acknowledge that the current trial is rightly focused on the actions of individuals, one must wonder what assurances can be drawn regarding the Town’s ability to properly supervise and/or over see it employees and those entering into financial arrangements involving scarce public resources.

ILLINOIS LOCAL PENSION UNDERFUNDING

75 funds in 55 municipalities are underfunding their pensions to the extent that their municipalities could be subject to requests to withhold state aid as is the case in the well publicized situation in Harvey, Illinois.

A Cook County judge has struck down a 2014 overhaul deal as unconstitutional involving the Chicago park district. The local chapter of the Service Employees International Union, which represents Park District employees, filed suit against the city in October 2015. The District is some $611 million short of what it needs to pay future benefits – and, the judge ordered the district to pay back its employees contributions with 3-percent interest.

OUTLOOK IMPROVES FOR LARGE REGIONAL HEALTH SYTEM

Catholic  Health Systems (CHI) is a faith based, not-for-profit integrated delivery system with a presence in 17 states, operating 101 hospitals, and various long-term care, assisted-and residential-living facilities, and employing over 4,500 providers. In FY 2017, it generated $15.5 billion in operating revenue. It  was formed in 1996 upon the merger of four national Catholic health care systems.

Recently, Moody’s revised its outlook on the system’s Baa1 rated debt from negative to stable. The change reflects the improved performance through the first half of fiscal 2018 and assume continuation of these operating trends as well as the successful extension of bank agreements securing some $1 billion of short term debt. CHI’s bank agreements include additional covenants, including the debt service coverage test, a debt to capitalization requirement of no more than 65%, and a days cash on hand test of no less than 75 days. The bank agreements also include the requirement that CHI maintain ratings from all three major rating agencies of at least Baa3 / BBB- or better.

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

$634,965,000*

ENERGY NORTHWEST

Columbia Generating Station Electric Revenue Refunding Bonds

Moody’s: “Aa1” (stable) S&P: “AA-” (stable) Fitch: “AA” (negative)

These bonds are supported by net billing agreements with Bonneville Power Administration (BPA, Aa1/stable) and thus are rated the same as BPA’s other supported obligations. Proceeds will refinance a like amount of outstanding debt.  Explicit US Government support features include borrowing authority with the US Treasury ($2.69 billion available as of September 30, 2017) and the legal ability to defer its annual US Treasury debt repayment if necessary.

The Columbia Generating Station nuclear facility is the third largest electricity generator in Washington, behind Grand Coulee and Chief Joseph dams. Its 1,190 gross megawatts can power the city of Seattle, and is equivalent to about 10 percent of the electricity generated in Washington and 4 percent of all electricity used in the Pacific Northwest. Columbia is the only commercial nuclear energy facility in the region. All of its output is provided to the Bonneville Power Administration at the cost of production under a formal net billing agreement in which BPA pays the costs of maintaining and operating the facility.

Four U.S. nuclear facilities have closed during the past three years, and two more are slated to close within the next four years. Two of those closed, representing a total capacity of 3,114 megawatts, were in response to return-to-service technical issues associated with plant-unique maintenance and repair challenges. The remaining four closures, representing a total 2,699 megawatts, result from unfavorable economics affecting relatively low-capacity (556 to 838 megawatts), for-profit facilities challenged by a deregulated market.

The bonds are likely closer to a low double A credit as BPA has experienced steadily declining liquidity as prices in the northwestern US wholesale power market have become relatively less favorable. BPA’s accelerated repayment of federal appropriations debt and declining availability under the US Treasury line are factors that could suggest a weakening of the US government’s explicit support features over time. In the initial discussion of a federal infrastructure package early in the Trump administration, there was floatation of the idea of the sale of the BPA’s generating assets to private interests. The idea reflects a general attitude towards entities like BPA as a source of revenue for the federal government over its mission of providing low cost power to the region to support economic development.

BPA published a new strategic plan that provides some credit positive objectives like reducing the debt ratio to a 75% to 85% range and maintaining $1.5 billion of US treasury line availability. The US federal government’s strong explicit and implicit support features are primary credit strengths that support current ratings even though BPA demonstrates financial metrics that are weak for the rating in the face of reduced prices for wholesale power.

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SANTEE COOPER FACES A DOWNGRADE

It has taken longer than one might hope but, better late than never for the announcement by Moody’s that it was putting its ratings of South Carolina Public Service Authority (Santee Cooper) under review for downgrade including the A1 rating on the outstanding $7.4 billion Revenue Bonds, the A2 bank bond rating, and the P-1 rating on the utility’s outstanding commercial paper note program. The action comes in the wake of the political fallout from the cancellation of the Summer 2&3 nuclear expansion project.

Now Santee Cooper’s  audited FY 2017 financial statements includes a $4 billion intangible regulatory asset which results in a significant and permanent increase in the utility’s debt ratio to over 130%, well above the average for an A rated public power electric utility. It remains highly uncertain as to how much if any of this investment will be allowed to be recovered through rate increases.  The ongoing litigation between Santee Cooper and its largest customer add additional uncertainty to the utility’s credit quality.

Moody’s final decision about a downgrade will “assess the legislative actions taken prior to the June 2018 end of the 2018 state legislative session; will examine Santee Cooper’s management plan to mitigate its exposure to the stranded nuclear asset; and will evaluate Central Electric Power Cooperative’s legal intentions and rights regarding its contract with Santee Cooper whose term extends to 2058.”

The S.C. House passed a bill replace its board of directors and create a panel to study a possible sale of the state-run utility. The state’s representatives voted 104-7 to give Governor McMaster, the ability to hand-pick up to 12 new board members for Santee Cooper. the legislation does nothing to prevent Santee Cooper from increasing customers’ bills to pay off its $4 billion debt for the troubled V.C. Summer nuclear project. The bill does, however, set up a new committee to vet possible purchase offers for Santee Cooper. It also calls for a study on ways to reduce costs for the utility’s 170,000 direct customers and the nearly two million customers at 20 electric cooperatives who get power from Santee Cooper.

The results of this process will go a long way to determining the rating position of the Agency.

TRANSIT HITS THE BRAKES IN NASHVILLE

With their beloved Predators in the midst of their quest for hockey’s Stanley Cup, rabid fans refer to their city as Smashville. Supporters of a plan to significantly invest in mass transit in Nashville would find the moniker appropriate in the wake of last week decisive vote against the Transit for Nashville plan. The proposed fifteen year $5.4 billion (current) dollar plan would have would have launched five light-rail lines, one downtown tunnel, four bus rapid transit lines, four new cross town buses, and more than a dozen transit centers around the city. . It would have been financed through a combination of higher sales and tourism related taxes.

The proposal faced a number of hurdles including a scandal impacting the mayor who proposed the plan, strong push back from housing advocates who saw the investment as misplaced, and those who objected to a resulting double digit sales tax. There were also concerns that too much of the investment was in center city although residents across the entire Metro area would be impacted by the sales tax. The vote fell broadly along urbanite versus suburbanite lines. Only five of 35 Metro Council districts, covering parts of East Nashville, Inglewood, downtown, 12South and Belmont, voting for the referendum. Ultimately, the proposition lost by a 2 to 1 margin.

DETROIT EMERGES FROM STATE CONTROL

Last week, Detroit’s Financial Review Commission (FRC) voted to waive oversight of the city, ending more than three years of supervision of the city’s finances following its emergence from bankruptcy in December 2014. The waiver follows passage last month of the city’s four-year financial plan. Michigan Public Act 181 of 2104 requires 13 years of oversight, but allows for scaled back oversight when the city meets certain benchmarks. The board was responsible for monitoring the city’s compliance with the bankruptcy plan of adjustment (POA) and provided general oversight of financial operations. The FRC  has faltered.

As is often the case, financial oversight is a powerful motivator for recovering cities to maintain prudent financial reporting and practices. The specter of loss of control tends to serve as a powerful check on the most irresponsible spending practices going forward. This should create a more favorable atmosphere for the kind of investment the City will need to support business growth and housing development both of which are crucial to the City’s long term success prospects.

Pension funding was a huge factor in the resolution of Detroit’s bankruptcy. City management has set aside funds in preparation for a fiscal 2024 pension contribution spike of $140 million (equal to 14% of fiscal 2017 operating revenue) in an irrevocable trust dedicated to its pension system. Detroit’s bankruptcy Plan Of Adjustment requires it to contribute just $20 million per year from its general fund to the pension system through fiscal 2019, but the city has made additional contributions of $105 million to date with the goal of amassing at least $335 million in assets in the irrevocable trust by 2023. With the monies accumulated in the irrevocable trust, Detroit will only need to increase its recurring general fund contribution by $5-$10 million per year during fiscal 2024-34 if actuarial assumptions are met.

The city also increased its reserves to available fund balance of nearly $600 million, or approximately 40% of revenue, at the close of fiscal 2017. The growth and maintenance of sufficient reserves will be necessary to counter concerns about the City’s long term budget outlook. The current positive momentum for the City is a reflection of the current administration. There is no way to assure that future mayors or City Councils will feel the same obligation to follow prudent fiscal policies. The fact is this the first time in more than 40 years that Detroit’s elected leadership has complete control of government functions.

NEW JERSEY TAX WORKAROUND IS SIGNED

Governor Phil Murphy has signed legislation to address the limitation of the SALT deduction from income under the federal tax reform bill. The legislation is designed to circumvent the law’s $10,000 cap on the deduction for state and local taxes (SALT), which has been a top concern in high-tax states like New Jersey and New York. Under the act, New Jersey taxpayers would be able to make contributions to funds set up by state localities. In return, taxpayers would be able to receive a credit against their property taxes worth up to 90 percent of the contribution.

Taxpayers would also be able to deduct the donations on their federal tax returns by using the charitable contribution deduction. New Jersey joins New York to enact legislation to create a workaround to the SALT cap that involves charitable contributions. One caveat is that it is unclear if the IRS will recognize these types of arrangements. Legislators have cited previous IRS actions which gave approval to states that give tax credits to taxpayers who make donations to private education.

THE FLIP SIDE OF CLOSING PRISONS

The movement to reverse the trend of mass incarceration in the US has resulted in closings of a number of facilities across the country. Faced with a declining population and high costs of updating older facilities some of the nation’s best known facilities have gone out of use. While much of the focus is on the cost saving associated with the closure of these facilities, there is another side of the issue which receives less attention. That is the role of these facilities as economic anchors and job creators in primarily rural areas. The correction jobs associated with these facilities are a source of replacement jobs for long time residents without college education, often previously employed in manufacturing.

The latest example of that side of the prison closing issue is currently playing out in upstate New York. Closed since 2014 because of declining incarceration rates, the Chateaugay Correctional Facility, is being sold by the state at auction.  The closing was a positive factor for the state’s budget but the local host town supervisor notes that “we lost 101 good jobs when it closed.” Some 200 miles north of Albany, the prison is located in the State’s relatively desolate North Country. This region relied primarily on agriculture – dairy farms – and industry which has seen significant consolidation in recent years.

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Chateaugay  has some 2,000 residents of whom 28% are below the federal poverty line and the median family income is $48,000. The physical plant up for auction includes 99 acres located 90 minutes from Montreal with 98,000 square feet of space spread over 30 buildings. It includes kitchens with walk-in freezers, a dining hall and a backup diesel generator. The hope is that its location near the Canadian border will make it attractive as a warehousing facility but with NAFTA under attack, the demand for that sort of facility is uncertain. The law of unintended consequences would seem to be in effect.

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