Joseph Krist

Publisher

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ISSUE OF THE WEEK

CITY OF LOS ANGELES

$312,000,000

General Obligation Bonds

$1,500,000,000

Tax and Revenue Anticipation Notes

The GO bonds are secured by the city’s dedicated, voter-approved unlimited property tax pledge. The ad valorem property taxes levied and collected for the bonds is restricted for use to pay the GO bond debt service. The notes are secured by a pledge of unrestricted fiscal 2019 receipts.

The City comes to market with its double A ratings intact and with a stable outlook. The TAN /RAN issue is a normal seasonal borrowing to address timing mismatches between the receipt of revenues and expenditure requirements.  Proceeds of the TAN/RAN issue will be applied to pre-fund the City’s fiscal 2019 pension contributions at the beginning of the fiscal year with 75% of the proceeds. The remaining proceeds will address cash flow imbalances.

The bonds will be used to address various aspects of the City’s homelessness problem. Proceeds will finance projects for providing safe, clean affordable housing for the homeless and for those in danger of becoming homeless, such as battered women and their children, veterans, senior, foster youth, and the disabled; and provide facilities to increase access to mental health care, drug and alcohol treatment, and other services.

The bond rating reflects the city’s strengthening financial position. This stems from steady gains in operating fund balances and cash reserves. Net direct debt is low. As is true for most California cities, the city’s elevated unfunded pension liability will continue to pressure the city’s finances. Continued improvement in the regional economy is contributing to steady growth in ongoing revenues.

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STADIUM GAMES MOVE TO THE MINOR LEAGUES

The Rhode Island legislature voted to forfeit up to $38 million in city and state taxes on a new stadium and its surrounding area for the Triple A Pawtucket Red Sox. Under the legislation, the Paws ox would contribute $45 million to the $83 million project. It would also be responsible for any cost overruns.

The state and city would be responsible for the remaining $38 million in bonds issued by the Pawtucket Redevelopment Agency. The municipalities’ costs for the project would be financed through tax increment revenue bonds. Only tax revenue generated directly by the stadium and its surrounding area would go toward paying off the bonds.

Having learned hard lessons through the infamous Studio 38 revenue bond financing which saw the state called on for its “moral obligation”. In this case, the state will not be guaranteeing the debt in any way. The new plan culminates a nearly two year long negotiation process.

The legislature may have been spurred into action by efforts by the city of Worcester, MA to entice the Paw Sox to move. McCoy Stadium–the current home of the Paw Sox- is the oldest active Class AAA facility in Minor League Baseball. The Paw Sox would not be the first team to use the threat of another suitor – real or imagined – to extract a better deal from their existing home. The practice which has been highly refined by major league franchises in every sport is now showing up with regularity at the minor league level.

COFINA LITIGATION

Bank of New York Mellon, the trustee of the Puerto Rico Sales and Use Tax, has requested from the court to permit it to intervene in the negotiations for a settlement in the Commonwealth-Cofina dispute, to oppose certain aspects involving the distribution of the funds. Recently, representatives of the Commonwealth and of Cofina announced a preliminary settlement.

The Commonwealth Agent wants the Bank of New York Mellon, to put in separate accounts all 5.5% of Sales and Use Tax revenues currently in the bank that were received prior to June 30 and all SUT revenues received after July 1, 2018. Once a settlement is reached, Post-July 1, 2018 funds may be allocated and released to the Commonwealth and Cofina in accordance with the percentage shares in the settlement agreement, that is 53.65% for Cofina, which would be the first dollars of the 5.5% Sales and Use Tax, and 46.35% for the Commonwealth.

The Commonwealth-Cofina dispute centers on who is the owner of the sales and use tax, whose revenues are currently used to pay for government operations and to back Cofina bonds. A resolution to the dispute is needed as part of the Title III bankruptcy proceeding so the judge can determine how to distribute assets. The Commonwealth representative in the dispute, which is the Official Committee of Unsecured Creditors, asked the court to issue an order establishing certain procedures to dispose of the Sales and Use Tax funds.

BNY Mellon would like the Court to approve an agreement between the Agents now that, in such circumstances, the Court’s hypothetical future ruling would be retroactive to July 1, 2018. In effect, the deposit of Pledged Sales Tax with BNYM after July 1, 2018, could cease to be governed by the Resolution and applicable law.

KENTUCKY PENSION REFORM UNCONSTITUTIONAL

A Circuit Court judge struck down Kentucky’s pension reform law, saying the rapid manner in which it was passed was unconstitutional. According to the judge, the six hour process from insertion of the language dealing with pensions into an unrelated sewer bill on March 29, violated safeguards to ensure “legislators and the public” can know the content of bills under consideration.

In an unusual twist, the Commonwealth’s Attorney General argued that the law illegally cuts pension benefits and that the expedited process violated the state Constitution. The Court’s order accepted the Attorney General’s argument that the bill did not get three readings in each chamber as required by the Kentucky Constitution. The normal process requires at least five days to pass a bill for it to get three readings in each chamber. In this case, SB 151 got its first five readings when it was still a sewer bill.

It also said that the legislation appropriated state funds and — as an appropriations bill — required a majority of all 100 House members and 38 senators to pass. Legislative leaders have contended the bill does not appropriate state funds, and as such required only a majority of members who voted to have voted for it — so long as at least two-fifths of each chamber’s members voted yes.

The order did not decide whether the new law’s modest changes in benefits violate contractual rights of public employees or retirees. The Governor’s office argued that the General Assembly has frequently used the speedy process and that many important state laws will surely be challenged if the court struck down the pension law on this basis. The Court took the position that other laws were not at issue in this case and that in this case the legislature had clearly used a rapid process that clearly violated the Kentucky Constitution’s mandate that the process be deliberate enough so that the public can follow the bill and react.

The law in question changes how current teachers can use accumulated sick days to determine their pension benefits. And it requires state and local government employees who started between 2003 and 2008 to begin paying 1 percent of their pay for retiree health benefits. changes how current teachers can use accumulated sick days to determine their pension benefits. And it requires state and local government employees who started between 2003 and 2008 to begin paying 1 percent of their pay for retiree health benefits.

The bill requires that new teachers starting next year be placed in a new kind of pension plan — a “hybrid cash balance” plan rather than the current traditional pension.

FLORIDA COMPLETES AAA HAT TRICK

Moody’s has upgraded the State of Florida’s general obligation bonds to Aaa. The State now has triple A ratings from the three major rating services. Moody’s cited a sustained trend of improvement in Florida’s economy and finances, low state debt and pension ratios, and reduced near-term liability risks via the state-run insurance companies. It notes that State finances are characterized by healthy reserves and historically strong governance practices and policies that are expected to continue. The state has also maintained consistently low debt and pension liabilities that compare well with other Aaa rated states.

The rating also takes into account the State’s potential risks from climate change. It references the fact that Florida’s exposure to storm-related costs and other climate risks is high. Some of the exposure – hurricane risk primarily – is addressed through the state’s insurance program. Other issues related to risks from flooding as well as encroaching seawater are not addressed so easily. There are potentially significant capital costs associated mitigation of these risks as well as the need to develop resiliency.

MICHIGAN SEEKS MEDICAID WORK REQUIREMENT APPROVAL

Michigan has enacted legislation which would add work requirements for those enrolled under expansion under the ACA, about 670,000 people. There are exemptions including for people who are disabled, pregnant, children or elderly. Those who do meet the requirements will have to work for 80 hours per month, or be in school, job training or substance abuse treatment.

There are exemptions including for people who are disabled, pregnant, children or elderly. Those who do meet the requirements will have to work for 80 hours per month, or be in school, job training or substance abuse treatment.

The legislation became a source of controversy over its inclusion of provisions which would have exempted people in counties with high unemployment rates from the work requirements. Critics argued the effect of that would have been to exempt many white people in rural areas while imposing work requirements on minorities in urban areas. This led to the provision being dropped in order to get legislative approval.

If the plan is approved by the Trump administration, Michigan would become the fifth state to add work mandates to its program.

TARIFFS AND EMPLOYMENT

The impact of the recently announced tariffs by the US and the response from the EU has begun to manifest itself in terms of domestic employment. There are few products more American than a Harley Davidson motorcycle. In recent years, an increasing number of these vehicles have been sold overseas with a steadily increasing level of sales occurring in  the EU. The company reported $5.65 billion in revenues last year and Europe is its largest overseas market, with almost 40,000 customers buying motorcycles there in 2017. This means that trade war between the US and its trading partners is of increased concern to exporters such as Harley who have begun to quantify the effect of tariffs on their overseas competitiveness. That exercise is beginning to drive production decisions which will have negative impacts on US manufacturing employment.

Harley has announced that European tariffs have jumped from 6 percent to 31 percent. That increase will add on average $2,200 to the cost of each motorcycle sold in the EU, and would cost the company $90 million to $100 million a year. So, “increasing international production to alleviate the EU tariff burden is not the company’s preference, but represents the only sustainable option to make its motorcycles accessible to customers in the EU and maintain a viable business in Europe.”

Harley has already lowered production at its Kansas City manufacturing facility. Over the next nine to eighteen months, Harley will be reviewing its production and employment levels at its York, PA and Menominee Falls, WI. The decision comes as Wisconsin is implementing its program of construction and tax subsidies to support minimum wage employment at the Foxconn plant under development in southern Wisconsin. we could see the somewhat incongruous phenomenon of the State of Wisconsin paying for lower wage jobs while concurrently watching as the trade war costs the State existing good paying manufacturing jobs.

We see this move as the beginning of a process for manufacturing concerns rather than a one off. The auto industry will face many of the same issues as will other manufacturers. In many communities, these jobs are among the best available especially for the worker cohort that includes non-college graduates. Shifts of those jobs overseas will be directly impactful on the credits of the municipalities where significant manufacturing facilities remain.

 

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

$1,699,495,000

GOLDEN STATE TOBACCO SECURITIZATION CORPORATION

Tobacco Settlement Asset-Backed Bonds

The Bonds carry a final maturity of 29 years and the 2047 bonds are estimated to have an expected average life of 21.2 years through the turbo redemption feature. Those bonds will not be rated.

The issues which impact tobacco bond credits are well known and understood. The primary risks are that cigarette sales will decline faster than projected and that this will generate lower than expected revenues. This issue will refund a similar amount of bonds issued in 2007. The expectation is that the refinancing would generate a lower debt service structure  and would therefore have a greater margin to absorb unanticipated declines in available revenues.

The consumption forecast accompanying this bond issue estimates that cigarette sales will decline 3.1% annually through the final maturity of the bonds.

We continue to view tobacco bonds as trading vehicles for institutional investors. Individuals have to be prepared for a fair amount of price volatility relative to that experienced by most municipal bonds.

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WAYNE COUNTY, MI MAKES THE GRADE

Moody’s Investors Service has upgraded to Baa2 from Ba1 the issuer rating of Wayne County, MI. The action completes the return of the County’s general obligation credit to investment grade by the major rating agencies. The action is premised on the county’s regained structural balance. The county’s current operational balance could also support tackling deferred maintenance and investments in personnel and handle to debt service costs of bonds issued to complete the County’s new criminal justice center.

 

The upgrade comes as the County still deals with a slow recovery in the labor market and persistently negative net migration. The County tax base has still not recovered to the level it was at before the recession. Even in an environment of growing tax base valuation, the rating is limited by property tax limits in Michigan which impede the County’s ability to raise revenues. The County is comprised of 34 cities, including the City of Detroit, 9 townships, and 33 public school districts. With a population of 1.8 million residents, the county remains one of the twenty largest in the country despite multiple decades of out-migration.

BUDGET BLUES RETURN TO NEW JERSEY

Those who hoped that a change in administration in New Jersey might usher in an era of relative budget peace look to be disappointed as the deadline for enacting a budget comes closer. The governor’s office and the State senate president both offered somber outlooks for the enactment of a budget by month’s end. The comments followed an announcement that talks between the legislature and the Governor had broken down and that separate budgets will be offered by the Governor and the legislature.

The Governor’s plans include a raise in the sales tax back to 7 % and a millionaires tax.  If millions of dollars in funding to “Democratic priorities,” including funding for underfunded school districts is not a part of a budget, there will be no budget by July according to the Senate President. That could lead to the second state government shutdown in as many years.

The Legislature’s alternative combines tax increases on corporations, a tax amnesty program, spending cuts and projected savings in employee health care costs. It includes a 3 percentage point increase in the tax rate paid by corporations with profits over $1 million that would expire after two years. At 12 percent, the tax rate would tie with Iowa for the highest in the U.S.

Neither budget plan deals directly with the impact of changes to the federal tax code which are expected to lead to increased federal taxable income fop NJ residents due to the elimination of the SALT deduction. If the Legislature passes its own budget, the Governor can veto all or part of the plan. To avoid a veto and/or a shutdown, negotiations continue.

ALASKA BUDGET BREAKS NEW TRAIL

The State of Alaska has enacted a budget for the fiscal year beginning July 1. The adopted budget earned the State and improved rating outlook from Standard and Poor’s. This occurred despite the fact that the budget includes funding for operating expenses derived from the use of Permanent Fund monies for those purposes for the first time in the Fund’s history. According to the Legislature and the Governor, the budget and accompanying legislation will reduce Alaska’s annual deficit from almost $2.5 billion to $700 million.

The new budget, for example, deliberately underfunds the state’s Medicaid program. Federal law requires certain payments, and the Legislature failed to approve enough money to fully pay the bills. In other cases, the Legislature paid for ongoing expenses from accounts that don’t recharge quickly. That money won’t be available next year, and the Legislature will be forced to find a new way to pay for those expenses.

This year, lawmakers approved a lower Permanent Fund dividend in order to partially balance the deficit. This year’s dividend of $1,600 per person will cost the state about $1.02 billion. Adding an extra $1,000 to bring the payment up to the level derived by use of the existing formula for the dividend would cost about $630 million

The state must also figure out how to pay a multibillion-dollar deficit in its retirement system and meet the constitutional requirement to re-fill the Constitutional Budget Reserve. That reserve has been tapped to the tune of $15 billion over the years to cover current operating deficits. There is only $700 million left in that reserve.

So looking at all of this might cause one to wonder about the timing of the improvement in the State’s rating outlook. It certainly causes us to wonder.

HOSPITAL CONSOLIDATION YIELDS RATING INCREASE

One year ago, holders of debt issued by Presence Health in Illinois were looking at a negative outlook for the rating on their minimum investment grade holdings. Presence Health is a Chicago based health system that owns and operates acute care hospitals, long-term care and senior living facilities, physician practices, clinics, diagnostic centers, home health, hospice and other healthcare services. Those who were willing to stay the course are now benefiting from ratings upgrades resulting from the merger of Presence Heath with Ascension Health.

Last week, Moody’s announced that it was raising its rating on Presence Health debt from Baa3 to Aa2. Some $1 billion of outstanding debt was affected. Effective March 1, 2018, Presence became a subsidiary of Ascension Health Alliance. On May 23, 2018, Presence’s master trust indenture (MTI) was discharged and the Presence MTI obligation was replaced by an MTI obligation of Ascension. With the substitution, the security for Presence’s bonds has been changed to that of the Ascension master trust indenture obligated group.

Ascension’s is the largest not-for-profit healthcare system in the US with $22 billion in total operating revenues. Ascension’s ratings reflect geographic and operating diversification, consolidation initiatives to drive operating improvement, prominent market positions in individual markets, large investment portfolio and the availability of $1 billion in bank facilities.

DALLAS COUNTY SCHOOLS DEFAULT

Dallas County Schools provides transportation to students at multiple school districts in Dallas County, Texas. DCS is scheduled to close this year, as mandated by voters, but the ruling allows a penny ad valorem tax to be collected for another five to six years.  The revenues are needed to pay off some $100 million of debt. DCS’ debt was primarily caused by the agency’s issuance of bonds that were hurt by DCS’ financial collapse from inside corruption.

An ongoing FBI investigation has resulted in two guilty pleas. Had the plan to pay off the debt not been accepted, creditors could have tried to obtain the DCS bus fleet (some 1500 vehicles). Plan approval allows for the distribution of the fleet to the previously served school districts which will now be responsible for transporting their students.

RHODE ISLAND PENSION REFORM WITHSTANDS CHALLENGE

The Rhode Island Supreme Court upheld a 2015 settlement to end litigation against Rhode Island’s state pension overhaul. The decision is a positive for the state’s credit. Pension funding had been a major drag on the state’s credit ratings for years. The current governor had made pension reform one of her priorities when she was State Treasurer.

The settlement included two one-time stipends payable to all current retirees; an increased cost-of-living adjustment cap for current retirees; and lowering the retirement age, which varies among participants depending on years of service. The settlement helped to stabilize the state’s ratings. A majority of state workers agreed to the plan but two plaintiffs chose to challenge it. The decision brings these sort of challenges to an end.

PROVIDENCE GETS A POSITIVE OUTLOOK

Another Rhode island credit plagued by pension funding issues received positive news this week as Moody’s raised its outlook on the City of Providence’s credit rating to stable from negative. The outlook reflects Providence’s recently improved but narrow financial position, high but manageable fixed costs and stability of the city’s underlying economy.

The change in outlook accompanied maintenance of the City’s Baa1 rating. That rating reflects a stabilized but narrow financial position and improved funding practices of its long-term liabilities. It acknowledges that the City’s unfunded pension liabilities are increasing as well as its OPEB liabilities. It also acknowledges the City’s diverse tax base and position as a regional economic center, significant institutional presence, recent tax base growth, ongoing economic development and the statutory lien on property taxes and other general fund revenues pursuant to Rhode Island statute.

State legislation passed in 2011 that provides a statutory lien on ad valorem taxes and general fund revenues, giving priority to payment of general obligation debt in bankruptcy.

NEW MEXICO DOWNGRADED AGAIN

For the second time in two years, New Mexico has been downgraded by Moody’s. This time the move is from Aa1 to Aa2. The downgrade comes in the midst of a stronger resource based markets and a generally improving economy.

The downgrade is is primarily attributable to the state’s extremely large pension liabilities, including both its direct obligation to the Public Employees’ Retirement System (PERA) and its indirect obligation to the Educational Employees’ Retirement System (EERS). The state provides K-12 school districts with essentially 100% of their operating funding. The need to assist districts in addressing their EERS pension liabilities represents a significant financial pressure for the state. That pressure is compounded by spending challenges associated with a large Medicaid caseload, a revenue structure more concentrated and volatile than most similarly-rated states.

New Mexico’s general obligation bonds are secured by the full faith and credit of the state and specifically secured by and paid from a statewide property tax levy without limit as to rate. The treasurer is required to keep the property tax proceeds separate from all other funds. The payment of general obligation bonds from other than ad valorem taxes collected for that purpose requires an appropriation by the legislature. If at any point there is not a sufficient amount of money from ad valorem taxes to make a required payment of principal of or interest on state general obligation bonds, the governor may call a special session of the legislature in order to secure an appropriation of money sufficient to make the required payment.

In spite of the overall improvement in the national economy and recent improvement in oil and gas pricing, New Mexico’s economy underperforms on a relative basis and its wealth and income indicators lag those of comparable states. Incomes are some 77% of the national average and the poverty rate is among the highest among US states. This heightens the role of pensions and Medicaid needs in the State’s budget outlook and these factors will combine to pressure the State’s fiscal positions going forward.

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 Village of Riverdale is located south of Chicago and like many smaller communities long supported by a manufacturing base it has struggled with economic and financial issues in recent years. These factors have depressed taxable values and incomes with an expected negative impact on the Village’s creditworthiness. The village’s population has declined by about 1% since 2010 and, while assessed value (AV) has increased over the last several years, it is still below its 2011 level. About 30% of the village’s residents live under the poverty level and income levels are well below the county, state, and national levels. Currently, the Village is rated CCC as a general obligation credit.

This has forced the Village to take the securitization route in order to maintain access to the capital markets. The Village is now coming to market with a BB rated credit secured by a first lien on the village’s local share of the statewide income tax. The pledged revenue includes all distributions under Section 2 of the State Revenue Sharing Act from the Local Government Distributive Fund of income tax amounts payable by the state of Illinois to the village.

The pledged revenues are secured by a “true sale” of the revenues to a bankruptcy-remote, statutorily defined issuer, the Riverdale Finance Corporation.  The state will direct all pledged income tax revenues to the trustee for benefit of corporation bondholders and the residual will flow to the village for any lawful purpose. The pledged income tax revenue is collected by the Illinois Department of Revenue, which certifies the amount collected to the state comptroller on a monthly basis. The comptroller must deposit the statutorily-dictated local share of the income tax revenue to the Local Government Distributive Fund (LGDF) no later than 60 days after the comptroller receives that certification.

The statewide income tax rate has changed several times since it was first established in 1969 and three times since 2011.  Historically, the state has offset the impact of rate changes by adjusting the local share percentage of total collections. Income tax receipts are allocated to the village based on its population as a proportion of the state population, meaning relative declines in population at a higher rate than the growth rate in state income tax revenue would lead to declines in the pledged revenue.

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CA REVENUES

State Controller Betty T. Yee reported California brought in less tax revenue than expected during the month of May. Total revenues of $8.25 billion were below monthly estimates in the governor’s FY 2018-19 updated budget proposal by $784.2 million, or 8.7 %. With one month left in the 2017-18 fiscal year that began in July, total revenues of $115.38 billion are $784.2 million less than estimates in the May budget revision, but $4.52 billion higher than expected in the enacted budget. Total fiscal year-to-date revenues are $10.10 billion higher than for the same period in FY 2016-17.

 

For May, personal income tax (PIT) receipts of $4.82 billion were $497.4 million, or 11.5 percent, higher than estimated in the governor’s May budget proposal. For the fiscal year, PIT receipts are $3.28 billion, or 4.2 percent, higher than projected in the 2017-18 Budget Act. May corporation taxes of $570.6 million were $79.2 million, or 12.2 percent, less than forecasted in the governor’s proposed budget unveiled last month. For the fiscal year to date, total corporation tax receipts are 15.9 percent above assumptions in the enacted budget. Sales tax receipts of $2.43 billion for May were $1.11 billion, or 31.4 percent, lower than anticipated in the governor’s FY 2018-19 amended budget proposal. For the fiscal year, sales tax receipts are 1.7 percent lower than expectations in the 2017-18 Budget Act.

Unused borrowable resources through May exceeded amended budget projections by 13.4 percent. Outstanding loans of $5.83 billion were $1.17 billion less than the governor’s May Revision expected the state would need by the end of May. The loans were financed entirely by borrowing from internal state funds.

WASHINGTON STATE SCHOOL FUNDING

The Washington Supreme Court declared the state had fully implemented its new school funding plan, lifted the contempt order and the $100,000-per-day sanctions, and ended their oversight of the case. In the McCleary decision in 2012, the Court had ruled that the state had violated its constitution by  underfunding K-12 schools. The issue has been a point of legislative contention ever since.

In 2017, legislators and the governor finally addressed the need for a plan to fund teacher and other school-worker salaries. That pay had been funded by local school district property-tax levies. The justices said the state needed to cover the full cost. The legislature passed a plan to raise the statewide tax rate in 2018 and phases in limits on future tax revenues collected by school districts through local levies.

This past Fall, the justices ruled that plan didn’t fully provide for schools by the September 2018 deadline established  by the court, and suggested lawmakers further increase education funding. To comply, lawmakers and the governor this spring provided an additional $776 million, and set aside another $105 million for the contempt fines.

In 2017, the Legislature committed to put $7.3 billion more in state funds into schools over the next four years through an increase of 81 cents per $1,000 of assessed value in the state property tax. State funding of education now represents more than 50 percent of the state budget for the first time since 1983.

THE FY 2019 BUDGET SEASON IS KIND TO STATE RATINGS

So far the budget season for fiscal 2019 is generating positive ratings news for some states. This past week, three states received positive changes in their ratings outlooks from Standard and Poor’s as the result of actions taken in association with adoption of budgets for the upcoming FY. S&P revised its outlook on Virginia’s general obligation (GO) rating and various issue credit ratings (ICRs) linked to its creditworthiness to stable from negative. It also affirmed its AAA rating on the state’s GO debt outstanding.

S&P also revised its outlook to stable from negative and affirmed its ‘AA’ rating on the state of Alaska’s GO debt outstanding. Adopted legislation (SB 26) outlines a percent of market value approach to use its Permanent Fund Earnings Reserve Account  (ERA) should allow for sustainable draws from the fund in future budgets.

S&P revised the outlook to stable from negative on its ‘AA’ issuer credit rating (ICR) on the state of Colorado. The revision follows the state’s adoption of pension reform in its 2018 legislative session. The state intends to reduce its unfunded liabilities and reach full funding within 30 years under the new bill, which incorporates automatic adjustments to contributions when needed to reach its goal. The liability remains underfunded by the adoption of a funding plan is a clear positive.

CA WATER UTILITY EARNS AN UPGRADE

Eastern Municipal Water District serves seven cities and unincorporated portions of the county and covers an area of 555 square miles, serving a population of over 816,000. The communities of Murrieta, Temecula, Hemet, Moreno Valley, Menifee and San Jacinto represent the district’s principal cities.  retail domestic accounts provide the majority of revenues. Revenue bonds are secured by the net revenues of the combined water and sewer enterprise. The rate covenant on the subordinate lien requires net revenues paid after O&M and senior lien debt service to be at least 1.15 times debt service. The additional bonds test is 1.15 times debt service on a 12-month look back over an 18-month period on outstanding bonds and proposed bonds. The subordinate lien bonds do not have a debt service reserve fund.

Moody’s Investors Service has upgraded Eastern Municipal Water District, CA’s senior lien water and wastewater revenue bonds to Aa1 from Aa2 and subordinate lien revenue bonds to Aa2 from Aa3. With only $13 million of senior bonds outstanding through 2021, subordinate debt is the District’s working lien. A cost-of-service rate methodology approved by the board in March 2017, encourages conservation as well as ensures a greater recovery of fixed costs from recurring, non volume related charges.

The District obtains nearly half of its water through the Metropolitan Water District of Southern California. This will require the District to shoulder a portion of MWDSC’s obligations in connection with the financing of the Delta Water Conveyance project.

UTILITY SUBSIDIES WHEN TAXES CAN’T BE RAISED

Voters in the City of long Beach, CA approved a change to the City Charter which would allow the city should be able to continue the practice of charging city-run utilities for access to rights of way, and then transferring those fees to the general fund. The practice had been carried out for decades but was recently challenged by two separate lawsuits against the city.

Measure M received some 53% support. The vote was presented as a choice between the subsidies or reduced city services. The vote can be viewed as a window onto the thinking of local residents in tax resistant California. City officials estimated that if Measure M had not passed that the general fund revenue loss —where the fees have been transferred at years’ end—could have amounted to about $18 million annually, meaning parks, road repairs, and other city services funded through the general fund could have faced cutbacks.

State law prohibits local utility providers from charging more than what it costs to provide a service and other laws prohibit municipalities from imposing taxes without voter consent. This vote serves as the required consent.

NEW JERSEY SCHOOL DEBT SUPPORT PROGRAM DOWNGRADED

Bonds issued under the program are secured by a pledge of all legally available funds of the state through replenishment provisions for the New Jersey Fund for the Support of the Free Public Schools, regardless of whether a specific budget appropriation has been made, as long as the state has enacted a budget. However, according to the state, New Jersey must enact a state budget for these guarantee funds to be available in the event a local school district misses a debt service payment. Once a state budget is enacted, money held in trust for the New Jersey Fund for the Support of the Free Public Schools is automatically available to pay debt service.

The New Jersey Fund for the Support of the Free Public Schools Program is authorized by Article VIII, Section 4 of the New Jersey Constitution. New Jersey Statutes 18A:56-19, as amended, require two reserve accounts to be maintained in the fund. The old school bond reserve account has been funded in an amount equal to at least 1.5% of aggregate school district debt issued by counties, municipalities, or school districts before July 1, 2003. The new school bond reserve account will be funded in an amount equal to at least 1% of aggregate school district debt issued on or after that date. In the event that the amounts in either the old school bond reserve account or the new school bond reserve account fall below the amount required to make payments on bonds, the amounts in both accounts are made available to make payments for bonds secured under the reserves. On or before Sept. 15 each year, fund

Trustees determine the aggregate amount of school purpose bonds outstanding and are responsible for maintaining appropriate reserve levels based on the market value of reserve investments. If at that time, the funds on deposit fall below the required levels, the state treasurer is required to appropriate and deposit into the school reserve such amounts as might be necessary to meet fund level requirements from all available state resources. To ensure sufficient liquidity, at least one-third of the obligations in the fund must be due within a year. Fund assets are direct or guaranteed U.S. government obligations and are valued annually. Funds in the trust are not available for interfund borrowing by the state.

Now the program has been downgraded by S&P to BBB+ from A-. The downgrade reflects the continued pressure on the State’s general obligation rating.

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

$580,000,000

Port of Seattle, Washington

Intermediate Lien Revenue Bonds

Moody’s: A1

The Port issues debt secured by revenues from its overall Port operations. In reality, this is an airport credit as 80% of consolidated operating revenue and 90% of the debt outstanding is connected to the airport.

The port operates Seattle-Tacoma International Airport (SEA). In addition to the airport, the port owns and operates maritime facilities and industrial and commercial properties. The port also owns container terminals and has licensed these terminals and certain industrial properties to the Seaport Alliance. The formation of the Northwest Seaport Alliance (“NWSA”) – the port’s joint venture with Port of Tacoma – serves as a stabilizing element of the port’s credit profile by sharing in operating risk, profit and capital spending for marine cargo operations in the overall Puget Sound region.

The airport is implementing a large $3 billion capital program over the next five years. $1.9 billion of new debt will be issued to fund the project which the construction of four major projects at active/operating terminals. The Port’s debt is secured by a rate covenant that provides for 1.10 times (as first adjusted) or 1.25 times (as second adjusted) coverage of annual debt service. The intermediate lien bonds are further secured by a cash funded common debt service reserve fund.

$1,100,000,000

Southeast Alabama Gas District

Gas Supply Revenue Bonds

Fitch: A

The District (SGS) was created by 14 Alabama communities to acquire, manage, and finance supplies of natural gas on behalf of certain public gas systems. It accomplishes this by entering into pre-paid gas supply contracts in order to lock in favorable prices for its individual system participants. Debt is secured by a pledge of the net revenues of the District. The risk of individual payment shortfalls is mitigated by an agreement with Morgan Stanley to purchase receivables under a guaranty from MS.

If the SGS provides notice to MSCG to remarket gas to other purchasers that it does not need, or does not accept delivered gas, MSCG is required to remarket such gas. If the gas cannot be remarketed, MSCG is required to purchase the gas for its own account. SGS anticipates approximately 25 public gas systems will participate in the SGS Project No. 2 transaction. The receivables purchase agreement with Morgan Stanley is intended to offset the risk of individual participant nonperformance.

SGS anticipates approximately 25 public gas systems will participate in the SGS Project No. 2 transaction. As a result, the rating for the deal reflects the credit rating of Morgan Stanley.

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VIRGINIA MEDICAID EXPANSION

The expansion of Medicaid under the provisions of the affordable Care Act (ACA) has been a priority of Virginia democrats which could not overcome opposition from the other side of aisle for the entirety of the McAuliffe administration. The election of a Democratic governor and the near capture of the Virginia House last November has changed the political calculus. This resulted in last week’s votes to expand Medicaid to cover an additional 400,000 Commonwealth residents.

The measure includes a requirement that many adult recipients who don’t have a disability either work or volunteer as a condition of receiving Medicaid. That was the price established to get a legislative majority. The federal government shares the overall cost of Medicaid with the states; the program covers about 75 million Americans, or 1 in 5.

The state currently has one of the most restrictive Medicaid programs in the country, covering mostly children and disabled adults. Childless adults are not eligible, and working parents earnings are limited to no more than 30 percent of the federal poverty level, or $5,727 a year. The Affordable Care Act allows states to expand Medicaid to adults earning up to 138 percent of the poverty level, which comes out to $16,643 for an individual.

To finance the Commonwealth’s share of the cost, it will tax hospitals to generate revenue for the state’s 10 percent share of the roughly $2 billion annual cost.

PUERTO RICO AID APPROVALS PLAY CATCH UP

The Federal Emergency Management Agency (FEMA) has awarded nearly $219 million in additional public assistance grants to government organizations and private non-profit organizations for Hurricane María recovery in Puerto Rico. As of May 30, FEMA says its Public Assistance program has “obligated $2.2 billion in total funding” to the government of Puerto Rico and municipalities for debris removal and “emergency protective measures,” which are “actions taken to eliminate or lessen immediate threats either to lives, public health or safety, or significant additional damage to public or private property in a cost-effective manner.”

The U.S. Department of Transportation’s Federal Transit Administration (FTA) announced the allocation of $277.5 million in emergency relief funding for public transportation systems damaged by hurricanes Harvey, Irma and Maria. About $232.3 million will be “dedicated to response, recovery, and rebuilding projects, with $44.2 million going toward resiliency projects.” Of the total, $220 million or just under 80% of the funds will go to Puerto Rico.

The announcements accompanied the beginning of the 2019 hurricane season. Concerns continue about Puerto Rico’s readiness in the event of another significant storm this year. The Puerto Rico Aqueduct and Sewer Authority delivered a mixed message when it said that it has the generators needed to support the island’s sewage system; however, it said, 550 generators, or nearly 50%, are still needed to keep the potable water system running in case of a prolonged blackout.

ON LINE TAX DECISION WILL SPUR CHANGES

It is not clear that the Supreme Court will rule in favor of the State of South Dakota in the Wayfair case, a suit that will determine policies to tax online merchandise sales by states and localities. It is also not clear as to the terms and requirements which tax collection entities will have to contend with in order to collect those taxes.

This was the subject of discussion at the Annual Meeting of the National Federation of Municipal Analysts last week. According to the National Council of State Legislatures, on line sales comprise 11% of overall sales and have been increasing at a rate of 15% annually. If South Dakota loses, states will be forced  to adopt individual legislation to deal with the “physical presence” rule. States have three broad ways to deal with the issue.

They could alter “nexus creation” requirements to establish what constitutes a “presence” in a state for taxing purposes. They could require “referral marketplaces” (like Airbnb) to collect and remit sales taxes for sales facilitated through those marketplaces. A third alternative is to establish reporting requirements for those marketplaces enabling states to follow up and collect sales taxes. Minnesota, Colorado,  and Washington have enacted such provisions.

NEW YORK’S EVER INCREASING CAPITAL NEEDS

The budget season for New York State and City has been a relatively tame process compared to other years. The lack of significant concern about the next fiscal year’s budget has allowed for concerns about capital needs to take second place in the debate over the long term fiscal outlook for both entities. Nonetheless, there is an emerging concern about the capital needs of two entities – the Metropolitan Transportation Authority and the New York City Housing Authority.

The needs of both are being highlighted by proposed plans to address the ongoing maintenance and capital facilities renewal needs of both of these entities. The MTA has garnered the most attention with the recent proposal by the newly appointed head of the Authority for a renewal plan to address capital related operating issues which have  generated much angst among the NYC subway system’s millions of riders. The plan has been assigned a price tag of some $19 billion and has revived debate about the funding responsibilities of the state, city, and federal governments in terms of the upkeep of existing facilities.

The issue of the capital needs of the Housing Authority has arisen in conjunction with the establishment of federal oversight of the Authority’s operations, especially as they pertain to funding and execution of its facilities maintenance. The New York City Housing Authority is chartered by the state, funded by rents and federal subsidies, but operated by the city. The many shortcomings of the Authority’s management of those two areas as well as instances of false reporting which raised concerns about the Authority’s ability to continue to receive federal funds. The Authority has estimated that its projects, which house 180,000 New Yorkers, need a capital investment of $20 billion.

In both cases, the state and the city will have to find resources in addition to those funds already being committed to the process. The exact proportion of responsibility is the heart of the issue. Both situations are accompanied by a sense of urgency and visibility and the solution to both problems is not eased by delay in addressing the issue. NYCHA will likely be forced to increase spending under a pending consent decree arrangement with the federal government.

So if the estimates are right, two major entities face a nearly $40 billion need for capital funding at a time of decreased federal support for both. Looking at the long-term fiscal outlook for the federal government, a substantial increase in federal funding is not necessarily viable. So diffusing this debt bomb will be a delicate task for the state and city.

VIRGIN ISLANDS OFFER FY 2019 BUDGET

The U.S. Virgin Islands Gov. Kenneth Mapp presented his proposed fiscal year 2019 budget to the VI legislature. The territory’s pension system gets special attention. In his budget the governor proposed increasing the employer contribution to the system by three percentage points each year in the coming three fiscal years. It is currently at 20.5% of payroll. Mapp said without action the pension system would be insolvent by fiscal year 2024.

Mapp proposes having the Virgin Islands Housing Finance Authority and Community Development Block Grant-Disaster Recovery be used to purchase nonperforming assets that the pension system currently owns. This meant to increase liquidity in the pension funds. A third leg of the plan would require higher paid government employees to make even larger pension fund contributions.

Even after all of this, the plan would shift the insolvency date back by one year to fiscal 2025. As for the rest of the budget, austerity is not a theme. Salaries would be raised 3% and the Governor hopes to lower water rates. Combined with the ongoing recovery efforts, it is not really clear how realistic this budget proposal is.

HIGH SPEED RAIL

The consortium which owns and operates Florida’s Brightline high speed rail project will continue to refer to itself as a private enterprise. That notion however, is weakened with the news that it has received an extension of its deadline to issue tax exempt private activity bonds to finance the second segment of its proposed project. The decision by the US DOT reflects a significant effort by project proponents to overcome a split Florida Congressional delegation.

It has been a contention here that the project is actually very dependent upon tax exempt financing to finish the project. No matter how the bonds are structured and placed, the subsidy provided to the project undermines the argument that this is a project can stand on its own merits as a privately financed endeavor. The fact that Brightline has been so persistent about its pursuit of tax exempt financing and the view that its inability to attract sufficient private capital has driven that persistence drives our skepticism about project viability.

U.S. Rep. Brian Mast, R-Palm City said “The fact that Brightline needed to request an extension underscores that their business model is questionable at best without taxpayer subsidies.”  The railroad has sought the financing authorization under surface transportation programs initially intended for highway development. This has raised issues with Congressional budget hawks regarding the funding authorization.

Brightline officials have said they also are pursuing a $1.75 billion federal Railroad Rehabilitation & Improvement Financing loan. Either funding method would reflect some level of federal subsidy for the project.

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.