Joseph Krist

Municipal Credit Consultant

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THE HEADLINES…

ADIOS CHARGERS

STATE OF THE STATES

DALLAS RATINGS HIT ON PENSIONS

CALIFORNIA DROUGHT SEES SOME RELIEF

BAYOU BUDGET BLUES

ILLINOIS TRYS AGAIN

CYBERSECURITY AN ISSUE BUT NOT YET A DISCLOSURE ISSUE

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ADIOS CHARGERS

In the grand scheme of things, the announced departure of the San Diego Chargers for Los Angeles doesn’t amount to much as a municipal credit event. If anything, it may be a positive for the city. The team’s presence ranked very low in terms of impact on things like hotel occupancy and restaurant patronage versus the league’s other teams. The winter climate certainly won’t change because the team left. And the city had seen the team make only one Super Bowl appearance in its history since when it moved to San Diego from yes, L.A. in 1961.

The Chargers have a contract with the City of San Diego to play at Qualcomm Stadium that runs through the 2020 season. They have a four-month window that begins Feb. 1 and ends May 1 to opt out of the team’s lease at Qualcomm Stadium. By ending the lease early, they will pay the City $12 million for the buyout. Now that they are leaving, Mayor Kevin Faulconer has proposed increasing the city’s hotel room tax via a public ballot measure in 2018, to finance a long-sought expansion of the San Diego Convention Center. The exact percentage amount, a project financing plan and other details would need to be determined through upcoming discussions involving the Mayor’s Office, City Council, the Port of San Diego, and hotel and tourism officials.

California law requires that tax hike measures geared to raising money for specific projects obtain at least two-thirds support of voters. This the same standard which this past November’s initiative had to meet. Guests at San Diego hotels currently pay a 10.5 percent transient occupancy tax, which goes to the city’s general fund for basic services; plus a 2 percent assessment that goes specifically toward local tourism programs.

Officials of San Diego Tourism Authority and San Diego Convention Center Corp. quickly voiced support for the mayor’s proposal, noting that events at the waterfront facility generated $1.1 billion in regional impact and $23.9 million in hotel and sales tax revenue during the past fiscal year. Officials said an expansion is needed to attract and retain large gatherings. The latest effort to expand the facility dates back around five years, and the latest cost estimate is $520 million. The project’s original funding plan was struck down by the courts, and a decision is pending in another case challenging the project’s 2013 approval by the California Coastal Commission.

I’m looking really hard for the credit downside here but I’m having a really hard time finding it. And as for public stadium financing, L.A. gets two teams with limited cash outlays and Las Vegas’ hockey team will play in a privately financed arena. There’s at least one sector where the private approach may start a trend. We do note that stadium construction is one item that supposedly fits into President trump’s idea of infrastructure.

STATE OF THE STATES

A State of the State address is often the vehicle by which many governors effectively make their initial budget proposals. Just two weeks after advising the incoming Trump administration to follow his failing tax cut policy for economic development, Gov. Sam Brownback  of Kansas supported an increase in alcohol and tobacco taxes and proposed taking more money from the State’s highway fund to help avert a projected shortfall of more than $900 million over 18 months. Well that’s at least one approach to infrastructure.

Showing a real sense of vision and responsibility as he approaches the back end of his term limited tenure (not really), he also supported a plan to liquidate a long-term investment fund and sell off the state’s future payment stream received under the Master Settlement Agreement from tobacco companies to get cash now. While emptying the tool box of one time revenues, he wants to preserve a key income tax exemption for certain businesses that a growing number of lawmakers seek to repeal. The state receives approximately $60 million annually from the MSA. Under Brownback’s plan, the state would forgo that payment in the next 30 years in exchange for cash now — an estimated $530 million over two years.
Yet another proposal that puts paid to the theory of supply side economics at least in Kansas, is a proposal to increase taxes by $377 million over two years. He would double the tax on liquor in July to 16 percent and increase the tax on cigarettes by one dollar a pack to $2.29. He also would double the tax rate on other tobacco products to 20 percent. Brownback tried to get a similar tax increase for cigarettes and a liquor tax of 12 percent enacted in 2015. The Legislature approved a 50-cent-a-pack increase for cigarettes that year. Another crack in the theory is reflected in the proposal by the governor to freeze the income tax rate for the lowest tax bracket at 2.7 percent instead of letting it drop to 2.6 percent in 2018.

He still apparently considers his income tax exemption for limited liability companies, S corporations and other closely held businesses to be untouchable. Many legislators would support repeal. Repealing the exemption entirely would bring in about $250 million. He  also proposed taxing rents and royalties to bring in $40 million a year. At the same time he would  increase the annual filing fee for for-profit entities from $40 to $200.

Under these proposals, the governor’s office estimates, the state would have $216 million in its general fund at the end of June 2018. To fill the current fiscal year’s shortfall of more than $340 million, Brownback wants to liquidate the state’s long-term investment fund. The state invests idle funds from state agencies every year. The governor can unilaterally use some $45 million from the fund, which represents investment profits, but will need the Legislature’s approval to take $317 million in principal. Brownback proposes paying back the fund over seven years.

Once again, the governor also wants to freeze the state’s contribution to KPERS, the state employees’ pension fund, at 2016 rates, which would allow it to keep $85 million. Under that plan, it would take another 10 years to pay down the state’s unfunded pension liability. If lawmakers agree to these proposals, the state would have roughly $99 million in its general fund at the end of June. If he succeeds in reducing liquidity, increasing unfunded pension liabilities, and increasing one shot revenues, it is hard to see how the State’s ratings can be maintained.

DALLAS RATINGS HIT ON PENSIONS

The City of Dallas saw S&P downgrade the City’s general obligation bonds from AA to AA-, with a negative outlook. S&P also downgraded the Dallas Convention Hotel Development Corporations bonds from A to A-, with a negative outlook. S&P affirmed its A rating for the Downtown Dallas Development Authority, with a stable outlook.  S&P said that despite the City’s broad and diverse economy, which continues to grow, stable financial performance, and very strong management practices, the continued deterioration in the funded status of the Dallas Police and Fire Pension negatively affects the City’s creditworthiness.

The City’s official response came from Chief Financial Officer Elizabeth Reich: “S&P’s actions today are not a surprise.  The more the rating agencies learn about the crisis facing Dallas as a result of the police and fire pension, the more they understand what the City has been saying for some time – the pension is a significant risk to the fiscal health of the City.” Legislature to provide a secure, stable retirement for our public safety workforce, and to reaffirm the City’s sovereign immunity.  Our plan to save the pension does not request state funds.  We will continue to work to reach agreement with the Pension system.

“Dallas is a thriving City, our economy is strong, and our residents want safe neighborhoods and effective City services.  The taxpayers are willing to contribute to this fix, but unless the Legislature gives the City the tools to fix its pension issues, massive tax hikes, continued street deterioration, and drastic reductions in all other City services would be the only way to resolve the pension crisis without seeking Federal judicial relief.”

What we find most interesting is that the CFO statement essentially parrots what regular MCN readers have already been told since the early fall of 2016. We are glad to see those viewpoints affirmed. As we have said, there is much pressure on the state legislature to pass enabling legislation to facilitate the changes which must be made to maintain credit quality.

CALIFORNIA DROUGHT SEES SOME RELIEF

It may be hard to appreciate if your home is one of the ones in the photos of flooded ones but the Golden State seems to have received some real water supply relief from a recent combination of huge snow and rain events. Water came to many areas of the West due to this week of moisture-laden Pacific storms and an already wet Water Year (WY). California was the greatest recipient of drought improvements this week. With more than 2 inches of precipitation falling from southwestern Washington southward to Los Angeles, CA, including over a foot along the northern and central California coast and on the Sierra Nevada range, significant increases were made to the capacity of the state’s major reservoirs as most were above the normal Jan. 10 historic levels and still filling with most USGS monitored streams at near or at record high flows.

The state’s Sierra snow water content (SWC) was also well above its Jan. 10 normal, with the north (13.5”, or 111%), central (16.9”, or 130%), and south (17.9”, or 171%) producing a state average of 16.2”, or 135%. The Northern Sierra, San Joaquin, and Tulare basin station precipitation indices all exceeded their wettest year (1982-83; 1968-69 for Tulare) as of January 10 with 41.9 (203%), 30.8” (199%), and 20.0 (190%) inches, respectively. In fact, the Northern Sierra index gained 13.2 inches since Jan. 1, or 26% of its ANNUAL average in 10 days. Oroville Reservoir started the New Year with a deficit in its conservation pool of 750,000 acre-feet, but has gained 350,000 acre-feet in the past 2 days. Since northern portions of California also benefited from a decent Water Year last year, 1- to 2-category improvements were made.

In contrast, with long-term drought impacts more severe and widespread in southern sections since the 2015-16 WY marked its fifth consecutive year of drought, only a 1-category improvement was made to most areas since above ground (reservoirs) and underground (wells) water supplies still lagged below normal. And in southern Santa Barbara, Ventura, southern Kern, and northwestern Los Angeles counties, drought levels remained intact as the WYTD has been below normal while hydrologic impacts lingered. For example, Lake Cachuma (205,000 acre-feet facility) currently has 16,386 acre-feet, including a measly 191 acre-feet gained during the past 2 days. Lakes Casitas and Piru in Ventura County and several reservoirs in Los Angeles County are still well below normal and have not received any recharge. Lastly, even with the rains, no stream flows have been generated in the Santa Ynez, Ventura, and Santa Clara watersheds.

BAYOU BUDGET BLUES

Last week it became apparent that a special session may be just around the corner for the legislature in Louisiana. The state lawmakers embraced a reality they avoided a month ago. The state is short $313 million for the current fiscal year, which ends on June 30th. State economists say the state’s still struggling economy is fueling the shortfall as the state has lost jobs each month since last August. As a result, income tax and sales tax are generating less money for the state than expected. Corporate tax returns are also down.

The Governor’s office is preparing for an emergency special session to address the budget mess, saying the state constitution restricts what can be cut outside of a special session. Governor Edwards, a Democrat, and others have been discussing the potential need for a special session for several weeks, even as some Republicans have downplayed the prospect of one. Edwards said he believes a $300 million or more deficit would automatically trigger the need for a special session because it would exceed the amount he is able to cut from the budget on his own.

One advantage of a special session is that it would allow more flexibility in. “I’m confined to a narrow spectrum of the budget as to where I can make adjustments,” Edwards said, referring to the legal framework for how to handle balancing the budget when legislators are not officially meeting. “If we have a special session, every part of the budget, including the judiciary and legislative budget can be opened up. That’s a much more responsible approach than just hammering the hell out of higher education and health care.”

The problem comes despite the fact that Edwards and lawmakers have made $850 million in cuts to the state budget over the past year. The Legislature also increased the sales tax to generate $1.2 billion in additional revenue and approved an increase in the cigarette tax during the special sessions. A panel that sets the state’s revenue forecasts will ultimately decide the size of Louisiana’s latest fiscal hole, based on advice from the state’s economists.

ILLINOIS TRIES AGAIN

There are signs that the Illinois legislature is trying to create the framework for a “grand bargain” to resolve the existing standoff between it and the Governor. Some of the aspects include an increase in the personal income tax rate from 3.75 percent to 4.95 percent, a plan to generate $4.1 billion a year. With spending cuts, Democrats argue, that could eliminate what the governor’s office estimates will be a $5.3 billion deficit on the June 30 end of the fiscal year. There would also be an unspecified amount of borrowing to pay down debt. In actuality it is borrowing for operations. The legislation would allow Illinois to borrow $7 billion by selling bonds to pay off overdue bills, which on Friday totaled $10.7 billion. The loan would get the state back to paying vendors and service providers within 30 days of receiving their bills.

The plan includes $694 million to cover expenses for the first half of 2017 for seven agencies, including prisons and the Human Services Department. A six-month, temporary budget agreed to last summer expired Jan. 1 and the state is back to operating without appropriations. The deal would eliminate pensions for future legislators. It aims to save up to $1 billion a year by offering what House Speaker Cullerton has termed “consideration” — essentially a choice between how future pay raises figure into retirement income or whether pensioners receive cost-of-living adjustments in retirement. The measure would move Chicago’s responsibility for paying the employer’s portion of teachers’ pensions to the state — a $215 million obligation for 2017 alone. That would remedy a long-running complaint about fairness, since the state already picks up the employer share for teachers outside the city.

The bargain would again look to gaming for revenue. It would create a land-based casino in Chicago and add riverboat casinos in Lake County, Rockford, the south suburbs of Chicago, Danville, and in Williamson County, in southern Illinois, as well as giving horse racing tracks a piece of the action by permitting slot machines at Arlington Heights, Cicero and Collinsville.

In a nod to labor interests, Democrats have argued they made important changes to the injured-workers program in 2011 and that the insurance industry hadn’t caught up to those cost-saving measures. This plan would further restrict claims when injuries are accidents, set maximum compensation rates, and limit physical therapy, among other things. The minimum wage would be raised from $8.25 an hour to $9 on July 1, then by 50 cents each year until 2021, when it will be $11. According to the U.S. Labor Department, the wage exceeds $8.25 in 21 places outside Illinois, including the District of Columbia, which is highest at $11.50.

CYBERSECURITY AN ISSUE BUT NOT YET A DISCLOSURE ISSUE

LADWP is in the process of issuing half a billion dollars of revenue bonds. So given the interest in the subject over recent days and weeks, we took a glance at the POS for a discussion of cybersecurity as an issue for investors to consider. Given the potential damage such an act could o to distribution capabilities, we would think that it could have financial risk implications at least equal to natural disasters or litigation related to dairy cows.

So we were a little disappointed to see in the discussion of factors affecting the electric industry only a five word reference to terrorism or cyberterrorism. We did not expect a truly extensive discussion but the lack of any is part of why we choose to focus some attention on it. We will continue to do so on a regular basis. We’d like to think that is would not require a major disruptive event to focus concern about it among investors. And we think that the risk (because it is truly unknown) is right up there with natural disasters that folks seem to take a bit more seriously.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Municipal Credit Consultant

THE HEADLINES…

MOODY’S MOVES AGAINST RECALCITRANT ISSUERS

CALIFORNIA BUDGET PROCESS BEGINS

PENNSYLVANIA BUDGET BACK IN THE NEWS

PORT AUTHORITY FACES DISCLOSURE CHARGES 

INFRASTRUCTURE WILL BE A MESS

ILLINOIS PENSION NEWS

HIGH YIELD LOOKS AT SUBORDINATE TOBACCO DEBT

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MOODY’S MOVES AGAINST RECALCITRANT ISSUERS

Moody’s Investors Service has placed the ratings of 8 local government obligors on review with direction uncertain, affecting approximately $382.3 million of outstanding debt. In addition, the City of Ithaca, NY’s MIG 1 BAN rating has been placed on review for possible downgrade. The review is prompted by the lack of sufficient, current financial information. If the information is not received over the next 30 days, Moody’s will take appropriate rating action which could include the withdrawal or lowering of the ratings.

The action reflects a continuing crackdown by Moody’s against issuers who are unable or unwilling to provide complete, accurate, and timely financial information to support their ratings.  These actions have been welcomed by the investment community and ratings, especially those of smaller and infrequent issuers.

This round includes the following credits: Hampton (Town of) NH, Blooming Grove (Town of) NY, Bridgehampton Fire District, NY, Ithaca (City of) NY, Montebello (Village of) NY, Ramapo (Town of) NY, St. Lawrence (County of) NY, Northampton (Borough of) PA. The Town of Ramapo has a developing outlook reflecting uncertainty around the eventual outcome of the federal charges, including the possibility that the town’s financial position could be materially different than what was presented in previous audited financial statements.

CALIFORNIA BUDGET PROCESS BEGINS

Governor Edmund G. Brown Jr. today proposed a balanced state budget that eliminates a projected $2 billion deficit and bolsters the state’s Rainy Day Fund while continuing to invest in education, health care expansion and other core programs. In a letter to the Legislature, the Governor explained that while this year’s budget “protects our most important achievements,” it is also “the most difficult that we have faced since 2012” and “uncertainty about the future makes acting responsibly now even more important.”

Significant details of the Governor’s 2017-18 State Budget include: Without corrective action, this year’s budget would face a deficit of $1.6 billion, or 1.3 percent of annual spending. Without action, the state would face annual deficits into the future of about $1 to $2 billion. The two main factors causing this deficit are a revenue forecast that is $5.8 billion lower than expected and a current year shortfall in the Medi‑Cal program. The deficit would be billions worse if not for the passage of a number of ballot measures at the November election, including Proposition 52 (hospital fee), Proposition 56 (tobacco tax), and Proposition 57 (prison reform). Proposition 55’s extension of temporary income tax rates on the wealthiest Californians will begin to help balance the budget in 2018‑19.

As the economy and revenues were surging in recent years, budgets consistently upgraded revenue forecasts from the prior year. Yet, now, the January Budget is the second straight downgrade of revenue expectations over the past 12 months. The Budget reflects a revised revenue forecast that is $5.8 billion lower for 2015‑16 through 2017‑18. This represents a modest adjustment to expectations compared to the 2016 Budget Act—1.6 percent lower over the three years of revenues. Across the board, each of the state’s “big three” revenues — the income, sales, and corporation taxes — are showing weakness.

The budget proposes $3.2 billion in solutions to ensure a balanced budget. By tempering spending growth rather than cutting existing program levels, these actions minimize the negative effects on Californians. The solutions include adjusting Proposition 98 spending, recapturing unspent allocations from 2016 and constraining some projected spending growth. In total, General Fund spending remains flat compared to 2016-17.

Proposition 2 establishes a constitutional goal of having 10 percent of tax revenues in the state’s Rainy Day Fund. With a $1.15 billion deposit in the budget, the Rainy Day Fund will total $7.9 billion by the end of 2017-18, 63 percent of the constitutional target. While a full Rainy Day Fund might not eliminate the need for further spending reductions in case of a recession or major federal policy changes, saving now would allow the state to soften the magnitude and length of necessary cuts.

K-14 funding is expected to grow to $73.5 billion in 2017-18, up 55 percent – or $26.2 billion – from 2011-12. For K-12 schools, funding levels will increase by about $3,900 per student in 2017-18, over 2011-12 levels. Under the optional expansion provisions of the federal Affordable Care Act, the budget increases enrollment of this Medi-Cal population to 4.1 million Californians, with the state’s General Fund share of cost increasing from $888 million to nearly $1.6 billion.
Annual maintenance and repairs of California’s highways, roads and bridges are billions of dollars more than can be funded annually within existing revenues. The budget reflects the Governor’s transportation package, first proposed in September 2015, which would provide $4.2 billion annually to improve the maintenance of highways and local roads, expand public transit and strengthen critical trade routes.

All of this assumes that federal actions in terms of potential tax reform, healthcare changes, and other policy changes do not negatively impact the state. The reality that they most likely will. As such, the May revision to the budget will likely represent a substantial change from this blueprint and the final budget actually adopted could easily change again. It has been estimated that up to one-third of California’s budget is exposed to substantial potential impact from possible federal actions under a Trump administration and the new Congress.

PENNSYLVANIA BUDGET BACK IN THE NEWS

It will be nearly one month until Gov. Tom Wolf will formally present his proposed executive budget for fiscal 2018 but he did recently offer extensive comments to the press on his views of the environment for that budget in an interview with the Scranton Times Tribune which we summarize and excerpt.

Pennsylvania’s distressed cities can be helped by a three-pronged approach of providing school property tax relief, targeting state economic aid and easing municipal pension debt, Gov. Tom Wolf said.  He said there’s real interest in Harrisburg in achieving property tax relief and the key to success is getting a bill in the right form. It would help cities like Scranton by cutting the biggest tax bill that residents pay. “Places like Scranton would see a big drop in the tax bill and a big increase in property values,” said Mr. Wolf.

The House passed a bill last session to replace nearly $5 billion worth of property taxes with higher state income and sales taxes while the Senate narrowly rejected a bill to mostly eliminate property taxes with that same combination of higher state taxes. As examples of how state government can target aid to cities, Mr. Wolf cited recent grants of $2.5 million for a medical complex corridor in West Scranton, $2 million for the Innovation Squared program in downtown Wilkes-Barre and $3 million for the “Cornerstone Commons” project at Lackawanna College in Scranton through the Redevelopment Assistance Capital Program.

He said the state needs to be a partner in helping cities like Scranton escape from municipal pension debt. Bills to increase state oversight of troubled municipal pension systems didn’t advance beyond the committee level last session.

The governor said he has been able to work with GOP lawmakers in recent months on education funding and tackling the opioid abuse epidemic. Of note is the fact that Mr. Wolf said he won’t call for hikes in broad-based state taxes for the fiscal 2017-18 budget, thereby removing a major sticking point with GOP lawmakers that fueled a lengthy budget stalemate in his first year in office.

Mr. Wolf also discussed with the newspaper his stance on school aid, a severance tax and health care. State education spending has been restored to the level of fiscal 2011-12, before a wave of cuts, but he said that more needs to be done to help public schools, early education programs and community colleges and career programs. Having a state severance tax on natural gas production would help gas drillers win acceptance from residents living in regions of Pennsylvania that don’t have drilling yet face pipeline development. The MCN has discussed the peculiarity of the Commonwealth’s lack of a severance tax given the role of the fracking industry in the Commonwealth (see December 8, 2016 MCN).

In the face of the upcoming Congressional debate over the ACA and its potential replacement, the governor said he will do his best to protect some 700,000 Pennsylvanians receiving health care through an expansion of federally funded Medicaid as a GOP-controlled Washington vows to scrap the federal Affordable Care Act. Readers are referred to our January 3, 2017 MCN where we highlighted Temple University Health System’s role as a huge Medicaid provider.

Mr. Wolf’s comments came on the opening day of the 2017-18 legislative session amid a backdrop of expanded Republican majorities in the House and Senate.

PORT AUTHORITY FACES DISCLOSURE CHARGES

In our last issue, we highlighted the Port Authority’s upcoming 10 year capital program. So it was disturbing that right after we went to press, the Securities and Exchange Commission announced that the Port Authority of New York and New Jersey has agreed to admit wrongdoing and pay a $400,000 penalty to settle charges that it was aware of risks to a series of New Jersey roadway projects but failed to inform investors purchasing the bonds that would fund them.

The SEC’s order finds that the Port Authority offered and sold $2.3 billion worth of bonds to investors despite internal discussions about whether certain projects outlined in offering documents, including the Pulaski Skyway, ventured outside its mandate and potentially weren’t legal to pursue.  One internal memo noted, “There is no clear path to legislative authority to undertake such projects.” Another memo explicitly identified “the risk of a successful challenge by the bondholders and investors” in connection with the funding of the roadway projects.  But the Port Authority omitted any mention in its offering documents about these risks surrounding its ability to fund the projects.  Its offering documents stated that it issued bonds “only for purposes for which the Port Authority is authorized by law to issue bonds.”

“The Port Authority represented to investors that it was authorized to issue bonds while not disclosing significant known risks that its actions were not legally permitted,” said Andrew M. Calamari, Director of the SEC’s New York Regional Office.  “Municipal bond issuers must ensure that their disclosures are complete and accurate so that investors can make fully informed decisions about whether to invest.”

The Port Authority is the first municipal issuer to admit wrongdoing in an SEC enforcement action. The SEC’s order finds that the Port Authority violated Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933.  The SEC’s order acknowledges the Port Authority’s cooperation and prompt remedial acts.  The projects at issue have proceeded as planned.

We do note that, at least in the NY/NJ metro area, there was very extensive press coverage of the fact that Gov. Christie’s use of the Port Authority to fund the Pulaski Skyway project was highly controversial and possibly illegal as the sale process was unfolding. Institutional investors certainly were aware of the risk at the time of sale.

INFRASTRUCTURE WILL BE A MESS

Learning anything about a Trump administration’s plans for the future from the current Senate confirmation hearings has been well nigh impossible. In the case of infrastructure, it’s a real struggle if proposed Transportation Secretary Chao’s responses are any indication. We did not hear confirmation of whether she favors the private sector to deliver infrastructure projects. We also learned nothing about what the administration considers infrastructure to be.

We do know however, what some sense of the Senate is. Ted Cruz advocates that the apportionment formula be adjusted to benefit Texas. Sen. Cory Booker thinks that that the Hudson River Tunnels carried the entire population of South Dakota between New York and New Jersey every day when the actual levels are some 20% of that number. Alaska Sen. Dan Sullivan cited how few roads his state had—fewer miles than Texas and even Connecticut—despite its size. I’ve been to Alaska and there aren’t many people to drive there.

West Virginia Sen. Shelley Moore Capito expressed that she was “concerned about how we’re going to be able to incentivize the private dollars to go to the less populated, less economically developed areas of our country?” And weighing in for the aforementioned South Dakota was its Sen. Thune who said “the urban-rural thing is my version of bipartisanship.” For those of us interested in infrastructure and its implications for municipal credit, it was not a hopeful exercise.

ILLINOIS PENSION STANDOFF

As we go to press, Illinois Governor Bruce Rauner has signaled a likely veto of newly passed legislation to stave off possible insolvency for two of Chicago’s pension funds. This will simply increase the pressure on the city’s ratings should it come to pass and further poison the state’s already toxic budget environment.

By a 41-0 vote, the Illinois Senate approved the proposed rescue, which cleared the House overwhelming in December. The plan would authorize new city funding for Chicago’s municipal and laborers retirement systems. As we have noted on multiple occasions, the systems are projected to run out of money in the coming decade and were depending on legislative sign-off of the city’s enactment of a water and sewer usage tax and telephone surcharge designed to help get them 90 percent funded in 40 years. City officials have acknowledged that more money will be needed starting in 2023 when payments will reach actuarially required levels.

“The bill essentially authorizes another property tax hike on the people of Chicago and sets a funding cliff five years out without any assurances that the city can meet its obligations,” the Governor’s spokeswoman said in a statement. “The governor cannot support this bill without real pension reform that protects taxpayers.” It’s not clear that this is news to anyone who follows Chicago’s finances and it is less clear how this contributes to a resolution of the state’s many other problems given that it is the Chicago Board of Alderman who take the real political hit.

Meanwhile, a bipartisan, statewide fix to Illinois’ $129.8 pension crisis did not get called for a vote in the Illinois Senate as part of a legislative plan to end an 18-month budget stalemate, pass non-budgetary reforms sought by Rauner and expand casino gambling, among other things. On a separate budgetary track, the House approved a $657.3 million appropriation plan for universities and social service agencies that lost spending authority on Jan. 1. The House-passed legislation that would fund operations through June awaits Senate approval, but Rauner has expressed past reluctance to support new stopgap spending without other reforms. A veto on the Chicago plan will serve to nearly ensure that those reforms won’t happen.

HIGH YIELD LOOKS AT SUBORDINATE TOBACCO DEBT

The City of New York’s tobacco securitization entity, TSASC, is planning to issue $495 million of subordinate tobacco securitization bonds. The deal was originally expected to close in November, 2016 but a several factors outside of a rise in interest rates intervened to make a closing at that time less feasible. These most prominently include a proposal by BAT (British American Tobacco) to purchase all of the stock of Reynolds American not already owned by BAT. Reynolds was an original producing manufacturer (OPM) under the Master Settlement Agreement securing the revenues pledged as security by issuers of tobacco bonds. Reynolds rejected BAT’s initial offer but would consider a higher offer.

It matters because such a transaction would increase the concentration risk related to  the financial ability of fewer but larger contributors to the settlement payment requirements. We don’t view this as a significant increase in the overall risk profile of tobacco bonds but ones as to which investors should make their own judgment as to how much industry concentration with which they are comfortable.

The deal represents the first substantial tobacco offering in an environment in which investors have received positive high yield returns and the sector is seeing positive flows after an extended period of the reverse. The subordinated bonds in this issue are unrated. We have always taken the position that senior lien tobacco debt from any issuer represents a speculative investment and one subject to valuation volatility. We believe that unrated subordinated tobacco debt carries with it those characteristics at a much higher level. As such, these bonds remains best appropriate as an institutional trading vehicle rather than an attractive opportunity for individuals.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Municipal Credit Consultant

THE HEADLINES…

TUITION FREE SUNY?

PENSION CHANGES

PORT AUTHORITY OF NY/NJ

PROMINENT NUCLEAR PLANTS SLATED FOR CLOSURE

TBTA COMING TO MARKET

PR EXTENSION REQUEST

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The administration of Gov. Andrew M. Cuomo indicated that it is ready to move ahead with a proposal to cover tuition costs at state colleges for hundreds of thousands of middle-and low-income New Yorkers. Under the governor’s plan, college students who have been accepted to a state or city university in New York (this includes two-year community colleges) would be eligible, provided they or their family earn $125,000 or less a year.

A plan like that would reflect proposals made during the 2016 Democratic primary by Senator Bernie Sanders of Vermont. If the proposal goes forward, it would establish New York at the forefront of such efforts; Tennessee and Oregon have programs to cover the costs of community college. The governor’s plan would include four-year schools, including dozens of campuses that are part of the state university system, as well as the city’s university system. CUNY was originally a free system.

Under the proposal, the state would complete students’ tuition payments by supplementing existing state and federal grant programs — essentially covering the balance, though administration officials said some students could have their entire four-year education covered. Mr. Cuomo hopes for enactment in the upcoming FY 2018 budget for his idea, with a three-year rollout beginning in the fall, with a $100,000 income limit, rising to $125,000 by 2019.

Initial estimates provided by the administration said the program would allow nearly a million New York families with college-age children, or independent adults, to qualify. The actual number of students receiving tuition-free education would probably be about 200,000 by the time it was fully enacted in 2019, according to the director of state operations. The administration estimated that the state’s annual budget outlay would be $163 million by 2019, though it acknowledged that estimate could be affected by participation and level of need. Costs for the state could also rise as enrollment rises. Some 400,000 students attend state or city universities full time, but the administration projects that the lure of a tuition-free system could increase the student population by 10 percent by 2019.

At present, New York offers in-state students one of the lowest tuition rates in the nation. Current full-time tuition at four-year State University of New York schools for tuition-and-fees is $6,470; at two-year community colleges, the cost is $4,350. Full-time costs for City University of New York schools are about the same. The state also provides nearly $1 billion in support through its longstanding tuition assistance program, which has an adjusted gross income limit of just under $100,000. Those awards top out at $5,165; many grants are smaller.

The plan has the potential to serve as a real support to upstate economies in a number of ways. It would increase the quality of the workforce. It would also serve as a support to employment at the state university system campuses. By increasing the attractiveness of the workforce it could also stabilize the declining upstate population and inject some youth into upstate demographics.

PENSION CHANGES

The Center for Retirement Research at Boston College is a great source of data on public pension systems across the country. This month it has released a study which compares the reform patterns for over 200 major state and local plans between 2009 and 2014 and investigates how and why the changes were made. The study covers all 114 state plans and 46 local plans from the Public Plans Database (PPD) and an additional 86 local plans. In total, the sample includes the major plans for every state. According to the study, 74 percent of state plans made some type of reduction compared to 57 percent of local plans. Second, while the majority of plans reduced benefits only for new employees, about one-quarter also cut benefits for current employees.

The following table from the report describes the legal constraints on changing pension systems.

Table 1. Legal Basis for Protection of Public Pension Rights under State  Laws

Benefit accruals protected

Legal basis	Past and future	Past and maybe future	Past only                       None
State constitution	AK, IL, NY	AZ	HI, LA, MI
Contract	CA, GA, KS, MA, NE, NH, NV, OR, PA, TN, VT, WA, WV	CO, ID, MD, MS, NJ, RI, SC	AL, AR, DE, FL, IA, KY, MO, MT, NC, ND, OK, SD, UT, VA
Property	ME, WY	CT, NM	WI, OH
Promissory estoppel	MN
Gratuity			IN, TX

Promissory estoppel is the protection of a promise even where no contract has been explicitly stated.

In Texas, this gratuity approach applies only to state-administered plans. Accruals in many locally-administered plans are protected under the Texas constitution.

Sources: Munnell and Quinby (2012); and subsequent communications with plan administrators and legal experts.

This next table, also from that report, indicates the some of the jurisdictions where changes have been made and the nature of those changes.

 

Table A1. Plans Making Changes to Current Employee Core Benefits, 2009-2014	Core Benefits, 2009-2014
Strength of protection
	Explanation
Plan name
Constitutional
Detroit Police and Fire Retirement System*	Agreement reached after negotiations.
Detroit General Retirement System*	City bankruptcy prompted vote by plan participants.
Fort Worth Employees’ Retirement Funda*	Reforms apply to future service, ongoing litigation.
Contract: Past and future accruals
Vermont Teachers’ Retirement System	Agreement reached after negotiations.
Contract: Past and maybe future accruals
Baltimore Fire and Police Employees’ Retirement System	Passed after litigation.
Rhode Island Employees’ Retirement System*	Reached settlement after litigation.b
Rhode Island Municipal Employees’ Retirement System*	Reached settlement after litigation.b
Contract: Past accruals only
Arkansas Teacher Retirement System*	Reforms apply to future service.
Lexington Policemen’s and Firefighters’ Retirement Fund*	Accruals before retirement are not protected.
Miami Firefighters’ and Police Officers’ Retirement Trust	Non-vested employees are not protected.
Newport News Employees’ Retirement Fund	Reforms apply to future service.
North Dakota Teachers’ Retirement Fundc*	No legal action.
Pensacola General Pension and Retirement Fund*	Reforms apply to future service.
South Dakota Retirement System	Reforms apply to future service.
Virginia Retirement Systemd	Accruals before retirement are not protected.
Property-based approach: Past accruals only
Cincinnati Retirement System*	Reached settlement after litigation.
Milwaukee County Employees’ Retirement System	Reforms apply to future service.
Ohio Public Employees Retirement System*	Accruals before retirement are not protected.

Our readers may notice that some of the leading “pension offenders” we referenced in our January 3, 2017 issue are not among the list of those who have made positive changes with those listed above. This information can serve as a starting point for investors concerned over the role of pension demands on the fiscal bases supporting their credit choices. Our thanks to the Center for Retirement Research at Boston College.

PORT AUTHORITY OF NEW YORK AND NEW JERSEY

The commissioners of the Port Authority of New York and New Jersey approved a budget that determines how they would spend $32 billion over the next 10 years. The budget was not universally supported especially by some strenuous objections by lawmakers from  New Jersey who argued that the commissioners were shortchanging commuters from their state by including only $3.5 billion for a new bus terminal in Manhattan in their long-term capital plan. The bus terminal is expected to cost much more than that, possibly twice as much.

Gov. Cuomo wanted more of the budget for big projects to go toward improving the airports in New York City, so the budget that resulted was called a “grand compromise.” It allocates $1 billion for a plan to revamp Kennedy International Airport that Mr. Cuomo unveiled a day earlier. It also included about $1.5 billion for a train link between La Guardia Airport and the city’s subway system.

The agency’s chairman said there were no plans for toll increases above the rate of inflation over the next 10 years. That decision constrains the Authority in terms of how much debt it can support for projects over that period. The choices also included new train tunnels under the Hudson, an extension of the PATH train to Newark Liberty International Airport, an overhaul of Terminal A at Newark Liberty and the replacement of Terminals C and D at La Guardia.

The commissioners agreed to include all of those projects, but not to the tune that the New Jersey lawmakers wanted to hear. The lawmakers said they feared that budgeting only a portion of the estimated cost of a replacement for the Port Authority Bus Terminal, which serves 115,000 daily commuters would reduce its chances of timely completion. The project is also being criticized for its proposed location one block west of its current site which would make it less accessible to mass transit connections. The Port Authority will hold two public hearings on the capital plan — on Jan. 31 in Lower Manhattan and Feb. 7 in Jersey City — and before its board takes a final vote on it on Feb. 16.

PROMINENT NUCLEAR PLANTS SLATED FOR CLOSURE

The New York Times reports that the Indian Point nuclear plant will shut down by April 2021 under an agreement New York State reached with Entergy, the utility company that owns the facility in Westchester County, according to a person with direct knowledge of the deal. This despite the fact that the plant is an important supplier of inexpensive power to the metropolitan area. Its generating capacity of more than 2,000 megawatts is about one-fourth of the power consumed in New York City and Westchester County.

Under the terms of the agreement, one of the two nuclear reactors at Indian Point will permanently cease operations by April 2020, while the other must be closed by April 2021. The shutdown has long been a priority for Gov. Andrew M. Cuomo, who — though supportive of upstate nuclear plants — has repeatedly called for shutting down Indian Point, which many feel  poses too great a risk to New York City, less than 30 miles to the south. The governor’s office estimated that, at most, the proposed shutdown would add $3 a month to electric bills in the metropolitan area. Utility customers in New York City already pay rates that are higher than anywhere in the country, except Hawaii.

Political opposition to Indian Point, on the edge of the Hudson River in Buchanan, N.Y., has long emanated from both the public and elected officials.  Options for replacing that power are so far unclear, but potentially could include hydropower from Quebec and power from wind farms already operating across New York, according to the person. Unlike upstate nuclear facilities scheduled to receive operating subsidies under plans we detailed in the summer of 2016,the Indian Point facilities are not dominant employers in Westchester County in the way that the upstate plants are. The plant employs nearly 1,000 full-time workers, about 550 of whom are union members. Entergy estimated that its work force would shrink by about 20 percent, or about 200 jobs, in 2021. After the shutdowns, about 190 workers would stay on for the decommissioning process.

That is not to say that some underlying entities will not suffer a real fiscal and economic impact. Perhaps no single entity will suffer the financial effects of the shutdown more than Hendrick Hudson schools, a district with 2,400 students that draws from parts of a half-dozen towns and villages near the plant. The superintendent said taxes from the company that owns Indian Point, Entergy, made up one-third of the district’s $75.8 million operating budget annually. “We’ve enjoyed some of the lowest property tax increases of any school district in Westchester County and that has made this a very appealing community to move to and stay in,” he said. “Entergy plays a major, major role in keeping taxes down. If they are not operating at the capacity that we’re accustomed to, we are going to have budget deficits.”

Another aspect of the move is that State officials believe the agreement will help convince renewable energy providers that the state is serious about looking for new sources of energy. There is the risk however, that should a viable replacement source not materialize, ratepayers in New York City could face even  higher energy prices for years. The agreement also provides for flexibility if the state cannot find a replacement for Indian Point’s energy: The deadlines in 2020 and 2021 can be pushed to 2024 and 2025 if both the state and Entergy agree.

Entergy has been seeking a 20-year renewal of its license from the federal Nuclear Regulatory Commission since 2007. But New York State officials have challenged that renewal on several fronts and have refused to grant permits that they say the plant needs to continue operating. Leading that opposition has been NYS Attorney General Eric Schneiderman who has opposed Entergy’s relicensing bid in the courts, arguing that the plant poses safety and environmental hazards to the surrounding area; the agreement calls for Mr. Schneiderman to drop that challenge.

TBTA COMING TO MARKET

New York’s other major bridge and tunnel financier and operator, the Triborough Bridge and Tunnel Authority plans to issue new debt this month. The TBTA’s facilities include: Robert F. Kennedy Bridge (formerly the Triborough Bridge), Verrazano-Narrows Bridge, Bronx-Whitestone Bridge, Throgs Neck Bridge, Henry Hudson Bridge, Marine Parkway-Gil Hodges Memorial Bridge, Cross Bay Veterans Memorial Bridge, Hugh L. Carey Tunnel (formerly the Brooklyn-Battery Tunnel), and the Queens Midtown Tunnel. All are major links in the metropolitan area’s transit infrastructure and lucrative revenue sources to the Authority’s parent, the MTA.

When assessing the TBTA credit it is important to note its role as a source of subsidy to the MTA’s mass transit operations. The Authority’s toll rates are reflective not of the direct operating and maintenance needs of the TBTA facilities but of their relatively inelastic demand profiles. This enables the TBTA to charge relatively high tolls which then generate excess revenues for transfer to the MTA. Those tolls also fulfill a role in the attempt to reduce auto traffic into the borough of Manhattan.

Senior lien general revenue bonds secured by a first lien on net revenues of bridges and tunnels; subordinate lien by a second lien on net revenues. The bonds do not benefit from a debt service reserve fund. There is a rate covenant that requires net revenues to be maintained at 1.25x annual debt service for senior lien debt and a strong additional bonds test that requires net revenues to be 1.40 times debt service on outstanding and planned bonds if the bonds are not being issued to keep the facilities in good operating condition. Ratings reflect solid credit fundamentals and assume that the TBTA will continue to grow net revenues; prudently fund asset maintenance and support senior lien revenue DSCRs at or above the 1.75 times board adopted target and total DSCRs at or above 1.50 times.

The reality is that stated coverage levels from net revenues, the security for the TBTA revenue bonds, will always be robust. At the same time, every dollar of those revenues is spoken for from a management and budgeting standpoint. Nonetheless, the TBTA general revenue bonds remain a strong and consistent underlying credit.

PR EXTENSION REQUEST

The Puerto Rico government has formally requested the Financial Oversight & Management Board to extend the stay on litigation provided by the federal Promesa legislation, as well as the deadline for submitting a revised tax plan. In a letter dated January 4,signed by Elías Sánchez, the government’s representative before the board, the administration of Gov. Ricardo Rosselló said it wants to validate and update the fiscal information available to date, address its cash flow problem and resume negotiations in good faith with creditors. It gives three reasons for a delay.

“First, a January 31, 2017 deadline for achieving a certifiable fiscal plan is problematic because Governor Rosselló Nevares will only have been in office since January 2, 2017. Less than a month is simply not enough time for the New Administration’s appointees and the “high- level task force” (as suggested by the Oversight Board in the Letter) to fully and responsibly understand and assess Puerto Rico’s fiscal challenges. It would be far more helpful, as well as consistent with PROMESA, to allow the New Administration and the “task force” sufficient time to perform their responsibilities and to develop their own understanding of the situation so as to maximize the fiscal plan’s reliability and the Government’s autonomy.

Second, because the fiscal plan is the cornerstone of the restructuring process under PROMESA, developing the fiscal plan without leaving enough time to vet and finalize the underlying financial and economic data could lead to a flawed fiscal plan and undermine the success of any restructuring efforts. A rushed restructuring process not based upon a reliable and credible fiscal plan, even if certified, is a recipe for serial restructurings and could prevent Puerto Rico from achieving fiscal responsibility within 10 years.

Third, the Oversight Board’s fiscal plan deadline will undercut the New Administration’s ability to properly engage its creditors in good-faith negotiations to achieve a consensual restructuring of Puerto Rico’s debts. We note that there are 63 covered entities with multiple variations of debt held by different groups of bondholders with different and competing interests. Under Title II of PROMESA, the Government is responsible in the first instance to engage in good-faith negotiations aimed at achieving consensual voluntary agreements with its bondholders. ”

The letter goes on to say that although it may be difficult to achieve consensual Title VI voluntary agreements with every covered entity issuer, even within the time period suggested below, it will be important as a precursor to any restructuring action taken by or on behalf of the Government that various bondholder groups are given adequate financial information for productive dialogue. These discussions could lead to at least a short-term liquidity solution and/or forbearance of remedies, if not a longer term solution. For these reasons, the New Administration respectfully requests the Oversight Board to extend its January 31, 2017 deadline for submitting a certifiable fiscal plan by at least 45 days, subject to further reasonable extensions as may be necessary under the circumstances.

An extension to the stay on lawsuits against the government was also requested. Under federal law, the stay expires mid-February, but the oversight board can extend it for an additional 75 days. However, Promesa stipulates that such extension should be granted in order to provide time to finalize consensual agreements between the government and creditors. Were the stay’s extension not granted, the short time available would force the government to take the “bankruptcy route in court,” which was the past administration’s strategy, Sánchez explained.

While the letter acknowledges it will be difficult to reach voluntary agreements with each of the creditor groups, the extension would provide room for the government to provide more accurate information and provide a basis for constructive dialogue before any debt restructuring action. Although the oversight board published government figures last month after receiving information from the past administration, Sánchez said these “were preliminary, not final ones,” and that “the board itself in its last communication makes clear that they’re going to hire another group of external advisers to look at the numbers.”

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Municipal Credit Consultant

THE HEADLINES…

THE LATEST IN P3 PROJECTS

PENSION NEWS

FIRST MUNI TECH BREACH OF 2017

NYC BUDGET OUTLOOK

CONGRESSIONAL REPORT ON PR

HOSPITAL DOWNGRADE

———————————————————————————————————–THE LATEST IN P3 PROJECTS

Miami Beach officials are considering a plan for a South Beach streetcar line utilizing a public-private partnership (P3/PPP). The estimated cost of the project is $244 million. Officials originally planned for a loop around the center of South Beach, stretching from Beach High west on Dade Boulevard and south on Alton Road. Last month, that loop was cut in half because of rising costs and logistical issues. Commissioners heard public comments on the proposed line before a December meeting in which they voted unanimously Wednesday to temporarily stop the fast-tracked light rail project. The commissioners agreed to wait for Miami-Dade County commissioners to make a binding commitment to building a connection across Biscayne Bay, including a funding plan. A final contract for the project would also have to be approved by voters.

The Federal Transit Administration (FTA) and Maryland Transit Administration (MTA) wrote in filings submitted Friday in U.S. District Court in Washington, D.C., that even if no Metro riders used the Purple Line, the light-rail line would still have about 50,000 weekday riders by 2040, compared to the 69,300 currently projected. Ridership at that level would still be enough to meet the line’s purpose—to create a reliable east-west transit system between Montgomery and Prince George’s counties, according to the agencies.

The latest analysis was conducted to satisfy Judge Richard Leon’s November order in the suit brought by two Chevy Chase residents and the trail advocacy group Friends of the Capital Crescent Trail. Leon revoked the project’s federal approval in August andin November he asked the FTA and MTA to prepare a report about whether the agencies believe a new Supplemental Environmental Impact Statement, which would trigger a new public approval process, is needed because of Metro’s ongoing problems.

“There is no plausible basis for finding that reduced ridership (even if it were to occur) would create a seriously different picture of the environmental impacts of the Purple Line,” the MTA wrote in its court filing. The agency also said the analysis of Metro’s problems satisfies Leon’s order and asked the judge to reinstate federal approval of the project to allow construction to begin.

Responding Friday, the agencies said a new environmental study is not needed because even if there were to be a ridership decline on the Purple Line because fewer riders were transferring from Metro, it wouldn’t change the footprint of the project or its environmental impact. About 27 percent of the Purple Line’s ridership is expected to transfer from Metro.

“Potential effects that may result from a Purple Line ridership decline due to [Metro] issues would be minimal,” the FTA wrote in its filing. The agency also notes that federal law does not require it to analyze other alternatives—such as a Bus Rapid Transit line. Instead, it’s only required to consider the new information about Metro.

In addition to what the FTA considers to be the highly unlikely scenario of no Metro riders using the Purple Line, the agency also looked at four other scenarios to determine Metro’s potential impact on the Purple Line. The agency found: if Metrorail ridership grows by about 40 percent from 2018 to 2040, then Purple Line ridership would be estimated at 66,766 riders per weekday. If Metrorail ridership grows at about 20 percent from 2018 to 2040, then Purple Line ridership would be 64,463 per weekday. If Metrorail ridership stabilizes, but doesn’t grow from 2018 to 2040, then Purple Line ridership would be 62,768 per weekday. If Metrorail ridership continues to decline at the rate it has declined from 2008 to 2015—about 5 percent—then Purple Line ridership would be 60,276 per weekday.

Construction was scheduled to begin this year, but has been delayed due to the lawsuit. The Purple Line project director, wrote in a court document recently filed that further delaying the construction could cost the state $13 million per month and that an extended delay could cause the state to lose the $400 million it already invested in the project.

Now that the two transit agencies have responded to the order, the plaintiffs in the case have two weeks to respond to the motion. After that, the judge is expected to consider the arguments and issue a new ruling.

PENSIONS

After twice vetoing similar measures, New Jersey Gov. Chris Christie at year end signed a bill that will require the state to make quarterly pension contributions, as opposed to one annual lump-sum payment. The bill cleared both state legislative chambers unanimously in November.

However, there’s skepticism around the new law because it still doesn’t require the state to make full payments — and New Jersey has historically shorted its contributions or skipped them entirely. The new law will require governor to make pension payments on a quarterly basis by Sept. 30, Dec. 31, March 31 and June 30 of each year, instead of at the end of the fiscal year in June. In exchange, the pension fund would reimburse state treasury for any losses incurred if the state has to borrow money to make a payment.

The Supreme Court of California has a case before it with the potential to alter the political and legal conversations about pensions in the Golden State and beyond. Sometime in the first half of the year, the court is expected to hear an appeal of a landmark pension ruling out of Marin County that challenges the decades-old precedent known as the “California Rule.”

An appellate court ruled unanimously in August that the Marin County Employees’ Retirement Association was free to modify the pension formula to reduce unearned benefits for current employees, a decision is at odds with the state Supreme Court’s 1955 ruling granting employees the right to continue earning pension benefits throughout their careers that are at least as good as those offered when they were hired.

A date for arguments has not been set, as the Supreme Court is waiting for another similar case from Alameda County to work its way through the appellate process before it takes up the question itself. The case arose in the aftermath of California’s Public Employees’ Pension Reform Act, or PEPRA, which took effect in January 2013.

The law was an effort by reform advocates to crack down on pension benefit “spiking,” which is the practice of inflating pension benefits by calculating things like unused vacation time or various bonuses into the formula at the end of an employee’s career to raise the amount employees are entitled to after retirement.

California Gov. Jerry Brown vigorously attacked spiking in supporting PEPRA, labeling the practice “abusive.” PEPRA said that pensions had to be calculated based only on an employees’ regular pay, but MCERA’s move to apply the anti-spiking change to existing employees rather than only new hires landed the issue in court.

Experts on pensions and bankruptcy said that the ruling has the potential to be far-reaching not only in how pension benefits are negotiated in California, but also in other states because of how influential the California Rule decision has been nationally.

In a May 2012 paper critical of the rule published in the Iowa Law Review it was noted that courts in at least twelve states have cited the California Rule in their own pension decisions. They include Alaska, Colorado, Idaho, Kansas, Massachusetts, Nebraska, Nevada, Oklahoma, Oregon, Pennsylvania, Vermont, and Washington.

“In nearly all of these jurisdictions, the courts adopted the California Rule without much discussion, appearing to merely find it the most attractive of the available non-gratuity options,” according to the ILR paper. Some states went on to subsequently modify the rule, and some states, such as New Jersey, explicitly rejected it.

But the California Rule remains influential, and lawyers and pension reform advocates are closely watching the MCERA case to see if the state’s top judges, themselves public employees entitled to pensions, will alter the landscape Californians have been living with for 60 years. Even if the Supreme Court does rule that changes to the existing benefit formula are legal, it would not force those changes to be made. The Supreme Court could take several months to make a ruling even once oral arguments are held.

FIRST MUNI TECH BREACH OF 2017

The Burlington VT Electric Department has acknowledged that a Russian campaign linked to recent cyberattacks had breached a single laptop within the utility, though it was not connected to the organization’s electrical grids. Does the breach signal vulnerabilities within the American electrical grid? The penetration, first reported by the Washington Post, which cited U.S. officials including at least one senior administration official, could be an attempt to test Russian capability to disrupt other utilities.

American officials believe a cyber-campaign against the U.S. energy industry in 2014 resulted in at least 17 companies’ systems being penetrated, including four electric utilities. The U.S. Department of Homeland Security has said the attackers in the 2014 blitz were able to steal data and gain private network access, which could allow them to remotely adjust equipment settings.

Such efforts have been a long term fear of industry professionals and antiterrorism professionals for the crippling impact on national life that an attack on America’s highly computer dependant and connected national utility grids could have. It makes sense that such efforts would start on a small scale. The limited scope of this event provides some comfort but not much in the grand scheme of things. It supports our view of the potential negative impact on smaller municipal operations.

NYC BUDGET OUTLOOK

Recently, the NYC Independent Budget Office said that Mayor de Blasio’s latest  financial  plan might   best be described as a placeholder. It recognizes some new spending needs, realizes additional federal and state support, and carves out some   savings in city spending. IBO estimates the city will end the current fiscal year  with  a surplus of  $801  million,  which is $362 million above the de Blasio Administration’s   estimate.

This surplus estimate does not include the $1.5 billion currently sitting in two reserves within the fiscal year 2017 budget—these reserves are counted as expenditures but  do  not  currently  support any specific spending needs. If these funds are not used to cover unexpected spending needs or revenue shortfalls, they will become part of the    surplus, which would more than suffice to close the $1.9 billion budget gap (3.0 percent of city-funded   expenditures) IBO forecasts for 2018.

 

Total Revenue and Expenditure Projections Dollars in millions
	2017	2018	2019	2020	Average Change
Total Revenue	$83,884	$85,551	$88,916	$92,451	3.3%
Total    Taxes	54,232	57,174	60,043	63,019	5.1%
Total Expenditures	83,522	87,778	91,468	93,899	4.0%
IBO Surplus/(Gap) Projections	$-	($1,865)	($2,551)	($1,448)
Adjusted for Prepayments and Debt Defeasances:
Total Expenditures	$86,878	$88,415	$93,240	$95,678	3.3%
City-Funded Expenditures	$62,430	$65,222	$68,036	$70,002	3.9%
NOTES:  IBO  projects   a   surplus   of   $801   million   for 2017,  $362  million  above  the  de  Blasio Administration’s forecast. The surplus  is  used  to prepay some 2018 expenditures, leaving 2017 with a balanced    budget.    Figures    may    not    add    due    to rounding. New York City Independent Budget Office

 

Although IBO expects the  local  economy to continue to grow throughout the 2017- 2020 financial plan period, the pace will slow markedly from  the  last seven years of expansion. Following the record increase of nearly 140,000 new jobs created  in calendar year 2014, job growth slipped to  86,400 last  year.  The  city  has added 67,200 jobs  through the   first 10 months of this year—but with no net growth since July.

IBO’s forecast for 2018 and beyond  has far more uncertainties than   usual.   For    now    it is premised  on Congress agreeing to infrastructure spending and tax cuts, generating considerable fiscal  stimulus in 2018. In a forecast largely completed before the  presidential election,  IBO expects New York City’s economy to extend its long expansion through the financial plan period, but at an attenuated pace. The election itself has introduced the prospect of far-reaching changes in  federal policy  that   may   impact the city in a variety of ways, some positive, some negative, but at this point all remain highly uncertain. Individual and corporate tax cuts could boost the city economy, but if federal rate cuts are paid for in part by curbing  state and local tax deductibility,  that would work against the city, which disproportionately benefits from that deduction.

And insofar as federal tax cuts are not paid for, it is difficult to say how  a rapid escalation of debt will effect expectations of both national and local growth. The city economy might also be adversely affected by uncertainty about the future status of its large immigrant    population. There  is anecdotal evidence that this is already prompting a slowdown in nonessential spending in some city neighborhoods with heavy concentrations of undocumented residents.

CONGRESSIONAL REPORT ON PR

On December 20, 2016, the Congressional Task Force on Economic Growth in Puerto Rico released is long awaited report containing its recommendations for what tax and legislative actions might be taken by the U.S. Congress to stimulate near-term economic growth in support of improved fiscal conditions for the Commonwealth of Puerto Rico. The report included a significant of information on Puerto Rico’s economic conditions which need not be reiterated here. Of more interest are some of the recommendations the Task force offers to address these ills.

The Task Force recommends that Congress enact fiscally-responsible legislation to address the impending Medicaid cliff established by the ACA. The Task Force recommends that Congress begin to address the funding issue early in calendar year 2017 to enable the Puerto Rico Medicaid agency to engage with more certainty when formulating capitation payment contracts with its managed care organizations for Puerto Rico Fiscal Year 2017-2018, which begins on July 1, 2017. In addition, the Task Force recommends that,  going forward, federal financing of the Medicaid programs in Puerto Rico and the other territories should be more closely tied to the size and needs of the territory’s low-income population.

The Task Force recommends that Congress amend federal law so that, going forward, Medicare beneficiaries in Puerto Rico are automatically enrolled in Medicare Part B with the option to opt out of coverage, the same way their counterparts in every state and other territory are treated.

As long as Puerto Rico remains the only U.S. jurisdiction where Medicare beneficiaries are required to opt in to Part B coverage, the Task Force recommends that the Centers for Medicare and Medicaid Services and the Social Security Administration take timely and targeted steps to educate island residents about the existence of the opt-in requirement and  the financial consequences of late enrollment.

The Task Force recommends that Congress amend Section 24 of the Internal Revenue Code to authorize otherwise eligible families in Puerto Rico with one child or two children to claim the additional child tax credit, with the amount of the credit equal to the amount of annual federal payroll taxes paid by the family or $1,000 per qualifying child,  whichever  is  lower. It has been estimated that this proposal could benefit about 355,000 newly- eligible families and 404,000 newly-eligible children in Puerto Rico, with an average credit for all Puerto Rico families of $770, which will help reduce child poverty on the island.

The Task Force recommends that Congress make the full amount of the rum cover-over payment to Puerto Rico and the U.S. Virgin Islands permanent, rather than permanent in part and subject to tax extenders legislation in part. The Task Force further recommends that Congress increase the cover-over payment from the current rate of $13.25 per proof gallon to the generally applicable distilled spirits rate, currently $13.50 per proof gallon. At a minimum, the Task Force recommends that Congress extend the additional $2.75 per proof gallon component of the rum cover-over payment beyond 2016. Failure to extend the provision will cause harm to Puerto Rico’s (and the U.S. Virgin Islands’) fiscal condition at a time when it is already in peril.

As long as the Section 199 domestic production activities deduction remains part of U.S. tax law, the Task Force believes that it should apply in Puerto Rico, a U.S. jurisdiction home to American workers. The Task Force recommends that Congress amend Section 199 so that it applies to Puerto Rico on a permanent basis.  At a minimum, the Task Force recommends  that Congress—for the sixth time since 2006—extend the provision beyond 2016.

The Task Force believes that the Puerto Rico Electric Power Authority’s record of service  has not inspired confidence among its customer base in Puerto Rico, and recommends that  the government of Puerto Rico continue efforts to make operational reforms at PREPA, improve the efficiency of electricity generation and transmission, and diversify Puerto Rico’s energy supply—all with the ultimate goal of making electric power more reliable and affordable.

HOSPITAL DOWNGRADE

While we maintain that large multi-state systems are better credits within the hospital sector, a road without bumps is not guaranteed by that structure. Trinity Health is one of the largest not-for-profit healthcare systems in the U.S. and represents the May 2013 merger of Trinity Health and Catholic Health East. The system operates over 90 hospitals in 22 states across the U.S. and is headquartered in Livonia, Michigan. Trinity is issuing four series of bonds to reimburse itself for prior capital expenditures and pay down a portion of its outstanding commercial paper.

All debt of the legacy organizations are secured on parity through a Master Trust Indenture. Trinity Health may not withdraw from the Obligated Group. The Credit Group consists of Members of the Obligated Group and the Designated Affiliates. The Designated Affiliates include the majority of the hospitals except for New York facilities and Mercy Chicago. The Obligated Group pledges to cause the Designated Affiliates to pay, loan or otherwise transfer to the Obligated Group such moneys as are necessary to pay amounts due on the bonds. Its pledge of revenue is derived from the operation of all facilities of the majority of the Designated Affiliates, including rights to receivable accounts and health care insurance receivables.

Its low AA ratings reflect several key strengths including the organization’s large size and geographic diversity across many markets, with broad diversity of revenue and cash flow. Key challenges include weaker performance in 2016 with expectations that it will take several years to return performance to prior levels. Additional challenges include operations in some markets with challenging demographics including weaker payor mix, low population growth, or modest market share within those service areas.

 

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Municipal Credit Consultant

Happy New Year to our readers! We begin the year with a view of what we think are the issues which investors should give primary attention to on their municipal credit radar screens.

THE HEADLINES…

PENSIONS WILL REMAIN FRONT AND CENTER

TECHNOLOGY WILL CREATE CREDIT RISK

HEALTHCARE UNCERTAINTY

WILL CHANGES IN ENERGY POLICIES HELP OR HURT?

WHAT WILL INFRASTRUCTURE ACTUALLY MEAN UNDER TRUMP?

P3 WILL BE THE BUZZWORD OF THE YEAR

CONNECTICUT, ILLINOIS, AND NEW JERSEY

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PENSIONS WILL REMAIN FRONT AND CENTER

Chicago, IL, San Jose, CA, Miami, FL, Baltimore, MD, Portland, OR. These five cities have the highest annual pension expenditure requirements as a percentage of revenues. Chicago’s is over 30%. Chicago, IL, Detroit, MI, Houston, TX, Portland, OR, Dallas, TX. These five cities pay the lowest proportion of required pension costs as a percentage of total  revenues. It is not an accident that Chicago (MCN 12/1/16) is the “leader” in both categories. It is merely a data based affirmation of what most investors already believe. It is why we believe that any upgrades of ratings or outlooks for the city are or will be premature.

Dallas (MCN 10/11/16) and Houston(9/29/16) will continue to be in the news for their pension problems. Benefit levels are a problem as are investment management deficiencies in both jurisdictions. What makes these situations interesting is that both cities ultimately have sufficient resources to finance these and capital needs. What is limited is their ability to access those resources without relaxing taxing limits established under the State Constitution. As is the case in other jurisdictions, they serve as an example of the reliance on state legislative action in order for localities to effect necessary financial changes.

And investors will have to increase scrutiny of the pension funding levels of other sorts of entities. The pension problems of Chicago’s water and sewer utilities have been well documented. Information released in the fall of 2016 shows that Boston’s transit system,  the MBTA, faces increasing investment difficulties as the result of poor overall performance and some very poor individual investment choices. All of these situations will pressure revenues at a time of increased resistance to fare box increases. No entity is immune to these issues.

TECHNOLOGY WILL CREATE CREDIT RISK

Allegheny County, PA as we have previously discussed was the victim of a hack for ransom that resulted in a $1400 payment.

Los Angeles County acknowledged that confidential health data or personal information of more than 750,000 people may have been accessed in a cyber attack on Los Angeles County employees in May that led to charges this week against a Nigerian national. The May 13 attack targeted 1,000 county employees from several departments with a phishing email. The message tricked 108 employees into providing usernames and passwords to their accounts, some of which contained confidential patient or client information, officials said.

Most of the 756,000 people whose information may have been accessed had contact with the Department of Health Services, according to the county. A smaller amount of confidential information from more than a dozen other county departments also was compromised. Among the data potentially accessed were names, addresses, dates of birth, Social Security numbers, financial information and medical records — including diagnoses and treatment history — of clients, patients or others who received services from county departments.

Recent press reports have documented a raft of problems with software used since August 2016 by the Alameda County criminal justice system. The resulting ” glitches” have resulted in a number of false arrests stemming from poor case status management, erroneous documentation, and other issues which potentially could lead to civil liability on behalf of impacted defendants. Depending on the scale of the problem, there could be significant liability for the County.

Each of these situations highlight an ongoing and increasing potential liability facing municipal credits stemming from technology. Tech is not an area which has traditionally received a high priority as a spending item for municipalities, especially smaller ones. We think that this is one area which needs additional attention going forward.

HEALTHCARE UNCERTAINTY

We believe that healthcare will be the greatest source of uncertainty in 2017. The Trump administration has signaled significant changes in Medicaid through its appointment of a conservative ideologue in the field to head the CMS, The Centers for Medicare & Medicaid Services. CMS administers Medicare, Medicaid, the Children’s Health Insurance Program (CHIP), and the Health Insurance Marketplace. She has worked with Vice President Pence in Indiana to impose payment requirements for recipients and stringent regulations which tend to reduce enrollment. Similar programs in other states have been abandoned due to what has been viewed as a poor cost/benefit result but it is likely that she will support this general policy direction.

This will occur with the uncertainty associated with the likely repeal of the Affordable Care Act as backdrop. There has been so much speculation about the timing and form of replacement, if any, that we would only be pretending to know what will result. Imagine how the CEO and CFO of any size hospital must be thinking. We can say that stand alone, small rural, and big city (Temple 10/25/16) Medicaid providers face the greatest uncertainty. “We were finally in a situation where for most of our patients there was a coverage option,” said Temple’s director of patient financial services, already speaking about the health law in the past tense. “Now there’s just a total unknown about what will be left.”

Diversely funded, geographically diverse providers would still be the credits to own as the process plays out. Cash on the balance sheet will continue to be the best cushion against such an uncertain outlook.

WILL CHANGES IN ENERGY POLICIES HELP OR HURT?

The U.S. Department of Energy has projected energy prices for 2017. While prices are projected to be higher across the board, they are nowhere near the levels of the halcyon days of just three years ago. This would bode poorly for the energy dependent states which have continued to experience lower production related revenues as well as lower general revenues as a result of decreased overall economic activities.

	2014	2015	2016	2017
WTI Crude Oil dollars per barrel	93.17	48.67	43.07	50.66
Brent Crude Oil dollars per barrel	98.89	52.32	43.46	51.66
Gasoline dollars per gallon	3.36	2.43	2.14	2.30
Diesel dollars per gallon	3.83	2.71	2.31	2.70
Heating Oil dollars per gallon	3.71	2.65	2.12	2.62
Natural Gas dollars per thousand cubic feet	10.94	10.36	10.24	11.02
Electricity cents per kilowatt-hour	12.52	12.65	12.53	12.87

North Dakota is a state were growth rates were in excess of 2% for four consecutive years. The 2014 prices of oil coincide with North Dakota registering the highest growth rate in the country in  2014-15.  In 2015-16 however, North Dakota’s growth fell to 0.15 percent, ranking 37th among states.

WHAT WILL INFRASTRUCTURE ACTUALLY MEAN UNDER TRUMP?

We believe that infrastructure will obviously be a major topic in 2017 but, we are concerned that there will remain a huge disconnect between Washington and the local level as to what their priorities should be under any infrastructure “program”. Recently, Politico conducted a discussion among a number of Rust Belt politicians and policymakers regarding what their concerns were as to what the most important infrastructure projects should be. We found their comments interesting in that they reflected projects on which economic growth could be supported and developed versus projects which might generate profits for their providers. Their unattributed comments as presented by Politico are in italics.

One good example cited was the challenge of updating 19^th Century sewers that handle both waste and storm water. A mandate from the EPA to upgrade sewers without accompanying federal funds is creating a major challenge for cities and property owners who cannot afford the costs of replacement. The costs are holding back economic development. Participants suggested that sewer repairs should be combined with street projects as part of a national infrastructure push.

“Sewers are a major issue for all Midwestern cities and the EPA is killing us with costs and regulations. If I were running the federal government, my number one thing I’d do by far is pay all these unfunded sewer mandates, which are by far the largest capital expense in many of these cities.” “It’s a huge deterrent to businesses and residents—sewers. And it’s being funded by low income, regressive taxes.” “The EPA’s speed at which they expect us to fix it, to bring it up to clean air and clean water standards, is terrible, because it requires these massive local tax increases—rate increases for sewers that compound the cost of living.”

Local officials complained about by free-riding suburban residents who pay no taxes in the cities they commute to every day. Free riders have long been an issue in the provision of public goods.

There was disagreement among participants over the value of investing in large rail projects which can be costly to build and maintain, but there was broad support for expanded bus systems. “Cities depend on a robust public transit system. And in the Midwest, I think that’s primarily bus transit, and I think that needs to be dramatically expanded.” “I think these speculative rail transit investments are really not going to deliver the results … I think the back bone of these highly dispersed, sprawling Midwest cities has to be bus—plain old bus service in select areas.” “Is there an argument to be made to give us the money for the regional transportation system that is going to preserve the rural communities, and enhance the industrial manufacturing capacity, jobs creating capacity, of this city, so that people do not have to move away?”

Several participants suggested that transportation infrastructure should combine public transit, bike lanes, and access to ride sharing services such as Uber and Lyft. Many policy makers are concerned that for-profit transit providers will be a substitute for cost of service mass transit. There are potential issues of income based tiers of levels of service if Uber and Lyft is used to replace mass transit, specifically buses, as we know them. Leaders of smaller cities seem to lean in that direction. “So it’s a mix of fixing up 50 and 60-year-old transit systems like they have in Chicago, like we have here [in Washington, DC]. Fixing up roads and bridges, but adding to those alternative forms of transportation. Bus rapid transit means you buy new buses.

Mayors expressed enthusiasm for the creation of a national infrastructure bank. “An infrastructure bank where cities can borrow money—patient money, to invest—to deal with industrial sites, old and abandoned industrial sites.” “Don’t put a lot of requirements in it; just make it straight. And part of the dilemma is the federal government, in the best of times, is difficult to deal with.” There was also support for increased funding for the Transportation Infrastructure Finance and Innovation Act (TIFIA) and the Transportation Investment Generating Economic Recovery Act (TIGER). TIFIA is the lone program that allows cities to come innovative, creative, take some private dollars, take some state dollars—boom. Build a new bridge, fix a bridge, fix a transit system, build a walking and biking path.”

One of our concerns is the willingness of Congress, especially the House, to fund  infrastructure spending. “The Trump people are talking a good game about infrastructure, but Obama proposed an infrastructure bank at $50 billion and the Republican Congress said no. Now, we still have a Republican Congress; we have a Republican president, so maybe now that it’s Trump’s idea, and it’s not Obama’s idea, they’ll like it.” “Whatever we do in America, we need a big pot of money.” Participants predicted that despite interest at the local level for a creative approach to infrastructure, a federal infrastructure effort would remain focused on building highways—and that’s not necessarily a good thing. “I think if there’s an infrastructure bill, 80 percent or 90 percent of it will go to highways, because that’s the powerful lobbies, and it will be 10 percent of it going to transit.”

P3 WILL BE THE BUZZWORD OF THE YEAR

No matter what sort of project is undertaken, the term P3 will likely be attached to it. What that means for individual projects will be different in every case. Will it be a privately financed and operated new or expanded road facility (new toll HOV lanes) ? Will it be the use of design/build contracting programs to produce traditional public facilities on a turnkey basis (the Goethals Bridge Replacement Project for the Port Authority of NY/NJ or the Tappan Zee bridge replacement)? Will it be some mix of design/build/operate for profit (LaGuardia Airport replacement)?

Many of the highest return infrastructure investments — such as improving roads, repairing 60,000 structurally deficient bridges, upgrading schools or modernizing the air traffic control system — do not generate a commercial return and so are excluded from his plan.  Nor can the non-taxable pension funds, endowments, and sovereign wealth funds that are the most promising sources of capital for infrastructure take advantage of the program. In many cases, the kind of improvements that people would choose would realistically turn currently free facilities into revenue generators – tolling many of the currently free interstate highways for example. I’m not sure that is what folks in the hinterlands were voting for.

Each has its own policy and credit implications and there is no correct answer for each undertaking. All of them have strengths and weaknesses in terms of which is most likely to generate the most positive result for investors. Investors will have to weigh all of the issues when evaluating P3 projects as they are developed.

CONNECTICUT, ILLINOIS, AND NEW JERSEY

The toxic mixture of pensions, taxes, and politics will be played out most prominently in these three states. Each of them have massive pension underfunding problems. Each of them has a highly tax averse voting base. Each of them has a highly unpopular governor. These form a tripod of likely inaction in each of these jurisdictions, at least over the next year.

In New Jersey, Gov. Chris Christie is term limited and his popularity ratings are one point above the historic low recorded for any New Jersey Governor in modern times. Lacking little if any political capital, the Governor is unlikely to be able to use his usual package of tactics in order to maneuver the legislature into any serious changes to pensions. We think that investors should be pleased if the State actually makes its four required payments as established under legislation recently signed by the Governor. We see no potential for credit improvement for the State in 2017.

In Illinois, Gov. Bruce Rauner’s first term may only be half over but he has already announced his intention to run for reelection and to heavily finance his own campaign. In response, we would expect a continuation of the political mud wrestling which has characterized the last two years. Investors will get a sense of which way things will go as the budget agreement reached for FY 2017 only covered its first half. The governor and legislature will need to reach a new agreement for the remainder of the FY immediately after the beginning of the New Year. We see a reversal of negative credit trends to be in the realm of the miraculous.

In Connecticut, Gov. Dannel Malloy faces a tax resistant electorate as well. Here the problem with pensions is at both the State and local level. While dealing with its own pension problem, localities will increasingly look to the State for additional aid. Coming  up with the funding for either is highly problematic. It may not be for two years but, if he runs for reelection, Malloy would be seeking a third term. His poll numbers are low, among the five worst in the country. That embattled status will make meaningful reform difficult and will continue to weigh negatively on the State’s ratings.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Municipal Credit Consultant

_________________________________________________________________________________

We close the year with updates on the status of major projects and issues which we have covered over the course of 2016. Our next edition will post on January 3, 2017.

STADIUM NEWS

N.F.L. owners have indicated their support for allowing the San Diego Chargers to move to Los Angeles and the Oakland Raiders to leave for Las Vegas, with plans for stadiums in the teams’ current cities having all but vanished. The potential relocations dominated discussion publicly and behind closed doors at a league meeting as momentum grew for the teams to make the moves. They would represent the most significant reordering of the N.F.L.’s geographic lineup in two decades.

The only thing left is for the Chargers to decide next month whether to exercise their option to leave for Los Angeles and for the Raiders to submit a formal proposal to relocate to Las Vegas. Nevada lawmakers have promised to contribute $750 million toward a stadium. Although the league has said it prefers teams to remain in their home markets, a growing number of owners acknowledged that the Raiders and the Chargers might end up playing in new cities as soon as next season. The Chargers have until Jan. 15 to decide whether they want to join the Rams or stay in San Diego.

The owner of the Indianapolis Colts, Jim Irsay said there was “no reason for optimism” that the Chargers and the Raiders would find a solution allowing them to stay put. In San Diego. Irsay said, “everything has been done that could be done” to get a new stadium. The owners smoothed the road for the Chargers to move when they approved a proposal to let the team raise $325 million to pay for half of the $650 million relocation fee that would be required for it to move to Los Angeles. Teams are ordinarily prohibited from having more than $250 million in debt under league rules.

The owners also approved a lease between the Chargers and the Rams — who are now building a stadium in Inglewood, Calif. — in the event the Chargers elect to move. The owner Dean Spanos of the Chargers said that he would announce whether he was moving the team after the regular season ended on New Year’s Day. Spanos has been unhappy with Qualcomm Stadium, one of the oldest stadiums in the league. A ballot measure that would have let the Chargers build a stadium in downtown San Diego with hundreds of millions of dollars in taxpayer money was soundly defeated in November.

The executive who oversees relocation efforts for the N.F.L., said the owners could give the Chargers an extra year to decide whether they wanted to move to Los Angeles, to give them more time to negotiate a stadium deal in San Diego.

The Raiders appear committed to moving to Nevada, where state lawmakers approved a new hotel bed tax that would contribute $750 million toward construction of a domed stadium in Las Vegas. The Raiders have not applied to relocate, however, and the owners were told that an application would not be filed until the Raiders’ season ended. With their best record in years, the Raiders are likely to play in the postseason. If they make it to the Super Bowl, their season will extend into February.

In an effort to keep the team from moving, the Oakland City Council on Tuesday gave the Fortress Group exclusive rights to negotiate a stadium deal on behalf of the city and Alameda County. The investment group has yet to produce a stadium proposal for the Raiders to consider.

BULLET TRAIN

California’s bullet train plan is the state’s biggest public works project. If all goes to plan, the $64 billion rail line would carry passengers between San Francisco and Los Angeles in 2 hours 40 minutes. Other rides would make stops in the Silicon and Central Valleys. Currently, construction is happening in the Central Valley with three construction contracts awarded and executed to build the first 119 miles of the system. Completion however, will not occur in the near future. A segment between San Jose and a station near Bakersfield is expected to begin operating in 2025. The target date for the San Francisco-Los Angeles line isn’t until 2029.

The funding is coming from a mix of federal grants through the American Recovery and Reinvestment Act, California Proposition 1A funds (which are bonds that were voter approved), and cap-and-trade proceeds. Unexpectedly, there has been a reduction in overall capital costs from $67.6 billion to $64.2 billion and this trend may continue.

TAPPAN ZEE BRIDGE

The New NY Bridge, as the Tappan Zee replacement is known, has reached a major milestone with the topping off of the eight main span towers, and with the final concrete pour completed this week. The New NY Bridge is on track to meet its scheduled opening in 2018 and is on budget at $3.98 billion. Additionally, 90 percent of support structures on the project are installed, including the fabrication and placement of 126 steel girders sections. To date, 3,000 roadway panels have been installed to connect the Rockland and Westchester shorelines up to the main span, taking one of the largest active bridge projects in the nation one step closer to completion.

STATE PRISON TRENDS

The Sentencing Project recently observed that since 2011, at least 22 states have closed or announced closures for 92 state prisons and juvenile facilities, resulting in the elimination of over 48,000 state prison beds and an estimated cost savings of over $333 million. The opportunity to downsize prison bed space has been brought about by declines in state prison pop­ulations as well as increasing challenges of managing older facilities. Reduced capacity has created the opportunity to repurpose closed prisons for a range of uses outside of the correctional system, including a movie studio, a distillery, and urban redevelopment.

In Manhattan, the Osborne Association, a non­profit organization, is working to convert a closed women’s prison into a space that provides services to women leaving incarceration. An entrepreneur in California purchased a closed correctional facility and plans to repurpose it as a medical marijuana cultivation center. At least four states – Missouri, Ohio, Pennsylvania, and West Virginia – have con­verted closed prisons into tourist destinations which are open to visitors and even host Halloween events.  Some prisons have closed following the termination of a contract due to prison population declines or other factors. In recent years states like Colorado, Mississippi, Kentucky, and Texas have closed pri­vately owned or managed prisons.

During 2016, our readers will recall that the Department of Justice announced plans to phase out the use of private for-profit prisons to house persons convicted of federal offenses. The Obama administration cited declines in the federal prison population as one reason for-profit contracts could be phased out. As of 2016, BOP maintained con­tracts with 13 private prisons. Illinois officials sold the closed Thomson Correctional Cen­ter to the overcrowded federal Bureau of Prisons for $165 million to house persons convicted of federal offenses. States like Michigan have continued to manage previously closed prisons. In 2012, Michi­gan officials reopened the Muskegon Correctional Facility which had closed in 2010; Pennsylvania prisoners were incarcerated there during 2011.

AMERICAN DREAM MALL

On its third developer since 2003, the mall, which started out as Xanadu and along the way became American Dream, is now slated to open in fall 2018, the developer, Triple Five Group, says. After an eight-month hiatus, hundreds of construction workers are back at work on the site. The developers had planned to sell more than $1 billion worth of tax-free bonds in September to help pay for the project, but the offering was delayed by a lawsuit. By the time a judge had decided in Triple Five’s favor, interest rates had started climbing after Mr. Trump’s victory, and investor appetite for bonds cooled as rates rose.

The developer says that the company had leased 70 percent of the 2.9 million square feet available at American Dream. The company, which has already poured $700 million into the project, is now spending roughly $1 million a day on construction. On top of the $1.9 billion already spent, Triple Five is still planning to sell $1.15 billion in high-yield bonds to finish the project. The company is also seeking $1.5 billion in bank loans. The project’s subsequent delays and setbacks, as well as the likelihood that American Dream now wouldn’t open until after he leaves office in early 2018,  led Governor Christie to say it was no longer a “front-burner” issue for his administration.

TAX EXEMPTION GETS SURPRISING SUPPORT

Leadership from the U.S. Conference of Mayors had a meeting with the president-elect at Trump Tower last Thursday and expressed surprise with his reaction when they pressed Trump to keep the exemptions. “He’s the president-elect, and he said he would keep it,” said Tom Cochran, the CEO and executive director of the U.S. Conference of Mayors. “My lobbyist has been up on the Hill, and they said to us everything is on the table. We didn’t know what would happen. “He definitely said he would keep the exemptions,” said Steve Benjamin, the Democratic mayor of Columbia, S.C.

We’ll see. It would be a welcome development for our market. We have to keep in mind that almost simultaneously his son in law was touting the tax credit based “infrastructure” plan which has been widely discussed. Our attitude is to wait and see until we see what actually “infrastructure” means going forward. Is it what have historically considered as public goods or is it the development of facilities for the commercial benefit and profit of private entities?

PUERTO RICO

We would have to include a final discussion of Puerto Rico in light of recent actions and comments. The Financial Oversight & Management Board told the Gov. Alejandro García Padilla administration to redo its proposed 10-year fiscal plan by removing additional federal funds from the plan that Puerto Rico was hoping to receive, which are deemed uncertain, particularly in a Donald Trump presidential administration.

Business entities on the island expressed their view. “The Puerto Rico Manufacturers Association [PRMA] does not support any policy that establishes debt restructuring as the primary issue. We support all initiatives aimed at government austerity and financial transparency, clarifying that we must defend all private and public jobs and we do not support any efforts to downsize government that may have a negative impact on our weak economy and very fragile labor market. Efforts must be made toward the consolidation of agencies, functions and services through budgetary austerity measures and other efforts toward governmental efficiency. However, retraining government employees should be a priority,” said PRMA President Rodrigo Masses.

David Skeel, is a board member who recently put in writing his views. They include the idea that creditors should recover as much as reasonably possible, while government agencies should get cuts. Skeel, a lawyer, said creditors must be protected from “unfair discrimination” and “best interests” in order to avoid another Detroit scenario. “The rule of law took a beating in the Detroit bankruptcy. Creditors who held that city’s GO [general obligation] bonds, which had the same priority as pensions, received only about 41% of what they were owed, and several classes of creditors that voted against the plan received far less. Pensioners, meanwhile, received 60% [to] 70%.”

He believes that Congress should explicitly require that recovery rates for creditors with the same priority cannot deviate more than a specified amount, such as 15% or 20%, as this would be a way to “discriminate fairly.” Additionally, he said a restructuring plan should guarantee as much recovery for creditors as is reasonably possible, as opposed to the “something’s better than nothing” ruling handed down in Detroit. Skeel also said any restructuring should address the obvious governance dysfunction that is frequently a primary cause of fiscal distress.

“Puerto Rico exemplifies this dysfunction, as about 120 government agencies provide services on the island with insufficient centralization to avoid overlap and to coordinate responsibilities. A plan that fails to eliminate or consolidate government agencies should be rejected as not feasible,” he stated.

The view that debts should be paid and that government be more efficient are ones which we are comfortable supporting.

CHRISTMAS GREETINGS

Although cultural issues are not the regular fare of this newsletter, we do make an occasional musical or movie reference as we express our views over the course of the year. So we note the announcement last week of the passing of Emerson, Lake, and Palmer guitarist and vocalist Greg Lake. Mr. Lake authored an enduring song for this season which gets great play on classic rock radio at this time of year. “I Believe In Father Christmas” contains a verse which richly summarizes our wish for our loyal and growing readership as we publish our last edition of 2016.

I wish you a hopeful Christmas,

I wish you a brave new year,

All anguish, pain, and sadness,

Leave your heart and let your road be clear.

Merry Christmas and Happy New Year from the MuniCreditNews and our partners at Court Street Group Research.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Municipal Credit Consultant

_____________________________________________________________________________________

THE HEADLINES…

HOSPITAL CONSOLIDATION CONTINUES

ALL ABOARD FLORIDA LITIGATION TRAIN CHUGS ON

NEW YORK STATE CREDITS GET GOOD RATINGS NEWS

DALLAS FINALLY GETS A DOWNGRADE

COURSE CHANGE COMING FOR MCDC

_____________________________________________________________________________

HOSPITAL CONSOLIDATION CONTINUES

MultiCare Health System is a low double A rated not-for-profit health system based in Tacoma, Wash. Recently, it announced that it has reached a deal to purchase the for-profit Rockwood Health System. MultiCare Health System plans to purchase the assets of Rockwood Health System in Spokane from subsidiaries of Tennessee-based Community Health Systems, Inc. (CHS). The facilities are currently run on a for profit basis. Rockwood Health System includes Deaconess and Valley Hospitals and Rockwood Clinic, a multispecialty physician practice. When the transaction is complete, the agreement will expand MultiCare’s  network of to the state’s eastern region.

MultiCare may not stop its acquisition plans with this deal. MC said that “it is continuously looking for like-minded organizations dedicated to improving the health of communities that can join it on its journey to strengthen and expand its care network.”  Rockwood has a network of urgent and ambulatory care and surgery centers in and around Spokane which serves as a health care service hub for the 1.5 million people in the region comprising eastern Washington, northern Idaho and western Montana.

MultiCare will become the largest community-based, locally-governed health system in the state when the transaction is complete. The transaction is expected to be completed in the first quarter of 2017. Rockwood Health System will become part of MultiCare’s integrated not-for-profit health care system, which includes four acute-care adult hospitals, one acute-care children’s hospital, and a robust network of community-based primary, specialty and urgent care facilities.

We see this transaction as indicative of a continuation of the trend of consolidation in the healthcare industry. We feel that regardless of what results from a trump administration in terms of insuring Americans, that the pressure on costs and need to drive volume will continue to motivate market concentrating consolidations.

ALL ABOARD FLORIDA LITIGATION TRAIN CHUGS ON

The ongoing All Aboard Florida saga continues. Attorneys for Martin and Indian River counties would like a federal judge to examine the new bond financing strategy employed by the private developer of the passenger train project in order to evaluate the “full extent” of the proposal. Attorneys for the counties contended in court filings last week  that All Aboard Florida has told them and the court “half of the story” about its planned use of federal private activity bonds to fund two separate phases of the project to link Miami and Orlando.

“It is clear from what little information the defendants have provided that AAF has not abandoned its strategy of financing the project in its entirety with private activity bonds,” the attorneys said. “It has merely reshuffled the capital stack to secure that funding in a two-step process in order to circumvent the court’s prior ruling in these actions.”

The counties, in separate lawsuits, filed motions seeking a stay to conduct a “limited” amount of discovery. The motions were opposed by the U.S. Attorney General, on the behalf of the U.S. Department of Transportation.

The counties are looking for material that will support their views of AAF’s real financing intentions.  They are primarily interested in information about the  $1.15 billion PAB application to fund the much-contested second phase of the project between West Palm Beach and Orlando, which would take the train through Martin and Indian River counties without stopping. The counties are seeking documents about the first phase of the project from Miami to West Palm Beach as well, saying they want to ensure that bonds allocated to it would not fund phase two, raising questions about whether phase one debt will be used to finance the trains that would travel the entire 235-mile route.

AAF, a company owned by Fortress Investment Group LLC (FIG), recently developed a new plan to finance its Brightline-branded train service in two phases – a plan that AAF and USDOT have said would “moot” or negate a need for a final ruling in the federal lawsuits. The second phase has not received final federal clearance through the NEPA process.

The counties said in a joint filing that they want to see documents pertaining to the $1.15 billion application “because it goes to the heart” of whether DOT has truly withdrawn the PAB allocation. Project opponents as well as the counties said they also want to determine whether AAF and USDOT are attempting to navigate around U.S. District Judge Christopher R. Cooper’s Aug. 16 ruling to avoid “a looming adverse final decision.” Many observers believe that this is the case.

The case is of interest for projects like this in general as an ultimate ruling in the counties’ favor would be precedent-setting because it would – for the first time – subject USDOT bond allocations to strenuous NEPA reviews. AAF and USDOT have both said that a number of environmental, historical and public safety issues were not considered in the NEPA review that was conducted but to date has not been completed. The

Assistant U.S. Attorney General has said  that USDOT had not received an application for $1.15 billion of PABs from All Aboard Florida and the agency opposed the counties’ motions.

NEW YORK STATE CREDITS GET GOOD RATINGS NEWS

In a region where three of its bordering states face significant ongoing pension and budget issues, New York State has stood out as a positive outlier. That status was recently reinforced when Moody’s Investors Service announced that it has affirmed its Aa1 rating on New York State’s general obligation, personal income tax revenue, sales tax revenue, New York Local Government Assistance Corporation (LGAC), and New York City Sales Tax Asset Receivable Corporation (STARC) bonds. Moody’s also affirmed Aa2 ratings on most other appropriation-backed debt and affirmed Aa2 issuer ratings on state intercept programs and enhanced Aa2 ratings on most intercept financings.

Moody’s affirmed the Aa3 rating on DASNY 4201 School Facilities Program revenue bonds. Moody’s affirmed the enhanced Aa3 rating on certain DASNY OMRDD intercept financings. Moody’s also affirmed the enhanced VMIG 1 on variable rate demand obligations backed by stand by bond purchase agreements associated with the New York Local Government Assistance Corporation.

According to Moody’s the Aa1 rating reflects New York’s fiscal governance that has produced on-time budgets with moderate spending growth to match the state’s economic capacity, manageable projected budget gaps, the size and wealth of the state economy, and healthy liquidity. The rating also recognizes New York’s expensive business environment, reliance on financial services and other NYC-based economic drivers, high state debt burden offset by below-average net pension liabilities, and a history of structural budget gaps requiring reliance on non-recurring resources to achieve budget balance.

In affirming the rating, Moody’s also affirmed its outlook for the ratings. Moody’s stated that the outlook for New York is stable, reflecting its adequate liquidity, growth of formal and informal reserves, and continued control of spending growth. The outlook also reflects its expectation that the state will build on its improvements in fiscal management, close budget gaps largely with recurring solutions and contain its structural fiscal imbalance.

The State has managed to achieve this while operating in a highly dysfunctional political environment. Legislative leadership has been significantly impacted by ongoing federal corruption investigations which resulted in convictions and resignations of multiple senior leadership figures. Despite these changes, the annual budget process has proceeded relatively smoothly for several years. Some of this reflects that State’s status as the 3rd largest US state by population. New York continues to have a large and diverse economy with high per capita income at 121% of the US average and gross state product of $1.422 trillion in spite of some ongoing difficulties in its upstate region.

DALLAS FINALLY GETS A DOWNGRADE

We previously commented on the City of Dallas, Texas and its significant pension issues. These have finally impacted the City’s ratings. Moody’s Investors Service has downgraded to A1 the City of Dallas, TX’s outstanding general obligation limited tax (GOLT) debt. The rating action affects $1.6 billion of debt. At the same time, it put the city’s GOLT, Waterworks and Sewer Enterprise, Downtown Dallas Development Authority, Convention Center Hotel Development Corporation and Civic Center Convention Complex bonds under review for possible downgrade. The review of these ratings will be concluded within 60-90 days. We believe that downgrades are most likely.

Moody’s said that the downgrade to A1 from Aa3 on the GOLT debt is based on the city’s ongoing challenges surrounding its poorly funded public safety pension plan and a sizable potential liability associated with a back-pay referendum lawsuit. These challenges have been exacerbated by considerable draws on the public safety pension fund which have reduced liquid assets. The city’s recently announced reform plan includes actuarial projections that the unfunded liability will be amortized in 30 years.

As we have noted, the plan has significant implementation risk because it relies heavily on actions of the state legislature and includes only modest increases in cash contributions to improve funding levels. Absent enactment at the state level of material reforms, and/or a large cash-infusion to the fund, the public safety pension fund is likely to become insolvent within ten years. Also, senior leaders have repeatedly stated that a failure to achieve relief to its financial challenges, or an adverse court ruling in the pending back-pay case, could lead to consideration of bankruptcy.

We believe that the problems are serious and that there are no easy answers. We believe that the likelihood of an actual bankruptcy is relatively remote. Dallas’ issues are the product of a number of acts of poor judgment and poor management. One key difference between this and other recent distressed city credit is the nature and size of the City’s economic base. There may be a shortage of political will but there is not a shortage of means to address the problem.

COURSE CHANGE COMING FOR MCDC

The Securities and Exchange Commission will not bring any more settlements under its Municipalities Continuing Disclosure Cooperation initiative. The MCDC initiative promised underwriters and issuers would receive lenient settlement terms if they self-reported instances over the last five years where issuers falsely said in offering documents that they were in compliance with their continuing disclosure agreements. In total, the initiative led to settlements with 72 issuers from 45 states. In addition, 72 underwriters representing 96% of the underwriting market by volume paid a total of $18 million in MCDC settlements.

The SEC will instead focus on those underwriters and issuers that did not voluntarily disclose violations under the MCDC. The unit’s enforcement lawyers view the underwriters and issuers who may have committed violations but did not self-report as part of MCDC as a high risk for future violations, according to the head of the SEC enforcement division’s public finance abuse unit. “That is a group of particular interest to us and we intend to devote significant resources to identifying violations by those parties.”

This comes at the same time that a legislative proposal has been announced in the U.S. House of Representatives which would shift the responsibility for proper disclosure from underwriters to issuers. HR 6488 would amend the Securities Act of 1933 and the Securities Exchange Act of 1934 to remove the exemption from registration for certain private activity bonds, to authorize the Securities and Exchange Commission to require the preparation of periodic reports by issuers of municipal securities, to authorize the Securities and Exchange Commission to establish baseline mandatory disclosure in primary offerings of such securities, and for other purposes.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Municipal Credit Consultant

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THE HEADLINES…

SAN BERNARDINO BANKRUPTCY NEARS CONCLUSION

SUPREME COURT REVISITS CHAPTER 11

HEALTHCARE UNCERTAINTY DEEPENS

NEW JERSEY PENSION SHENANIGANS

NUCLEAR SUBSIDIES IN ILLINOIS

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SAN BERNARDINO

The end of the four year journey through Chapter 9 for San Bernardino is in sight with the announcement that U.S. Bankruptcy Judge Meredith Jury confirmed the City’s bankruptcy planlast week, clearing the way for the city to exit bankruptcy. City officials don’t expect the plan — the comprehensive blueprint for how much the city will pay creditors and when — to become effective until March, after at least one more court hearing.

Judge Jury cited actions by the city to improve its finances and its governance, pointing to voter approval of a new charter and better working relationships among elected officials. At the same time, San Bernardino will pay many of its creditors far less than they would otherwise be entitled to — for many creditors, just 1 cent for every dollar they’re owed. But the plan also outsources of refuse and fire services.

The city estimates that while direct costs of the bankruptcy — attorneys and consultants — had cost more than $20 million, the city and its taxpayers saved more than $300 million in debts that were being discharged. A major provision was an agreement with the California Public Employees’ Retirement System — in that instance, an agreement to pay CalPERS everything it’s owed to the detriment of many creditors including debt holders.

SUPREME COURT HEARS ARGUMENTS ON CHAPTER 11

The Supreme Court heard arguments last week in a case that could upend the common practice that ranks lenders, employees and other creditors in order of priority as they try to recover their money when a company files for bankruptcy. The case has attracted wide attention from academics, workers’ groups and state tax authorities. A decision could affect how much power bankruptcy courts have to approve settlements that do not follow the conventional order of creditor priority and potentially block some parties, in this case the company’s former employees, from any financial recovery. The issue should be of concern to holders of municipal bonds, especially in the high yield space as many of the healthcare, project finance, and corporate backed credits populating that space are governed  by these procedures.

Jevic Transportation Company, a New Jersey trucking company, filed for bankruptcy in 2008, two years after a $77.4 million leveraged buyout financed by private equity which former employees say heaped too much debt on its books. The bankruptcy put 1,785 drivers and staff members out of work, but they sued for wages under a federal law and state law that requires employers to give 60 days’ notice before mass layoffs. The drivers assumed that the company owed them approximately $8 million in pay because they were not warned that their jobs were ending. At the same time, the drivers and other creditors filed suit against Sun Capital and Jevic’s main lender, the CIT Group, saying their buyout had fraudulently pushed Jevic into bankruptcy.

By historic precedents, employees who lose their jobs are supposed to rank higher in the line of those owed money than some others, so the drivers anticipated recouping their lost wages. But they got a surprise. Sun and CIT settled with the other unsecured creditors in their fraud case. In exchange for a $3.7 million payment to them, including the lawyers on the case, the creditors agreed to abandon their claim. The drivers were not part of that settlement and were left with nothing.

There are a few cardinal rules about bankruptcy that have been followed for decades. Lenders whose debts are secured by the company’s assets are paid first, for example. Next are the lawyers and professionals who work on the bankruptcy, followed by the so-called junior creditors, starting with employees who worked for the company who are owed wages, followed by employee benefits and unpaid taxes, among other groups. And those who hold the company’s shares, or equity, are generally last. Congress created this pecking order. Senior creditors must be paid in full before any junior creditors — unless all the parties agree otherwise.

The case which was the subject of oral argument is Czyzewski v. Jevic Holding Corporation. Should the Supreme Court side with Jevic and its owner and chief lender, the decision could upend bankruptcy law by altering the rights and expectations of these various groups. A friend-of-the-court brief signed by 19 law professors in support of the drivers says such a decision could lead to cases where the stronger parties in a bankruptcy gang up to squeeze out whichever creditors they decide to target: workers, say, or the Internal Revenue Service.

Alternatively, were the court to ban all bankruptcy settlements that do not strictly follow the order of priority, supporters on Jevic’s side say it could create chaos with a number of established practices involving payments to creditors, especially in the early part of a bankruptcy. And they say it could handicap the efforts of judges in finding the right resolution in an individual case. Some hold the view that if the court rejects priority in settlements, there is a danger that the position of secured creditors who now stand at the front of the line of repayment also could be in jeopardy.

The solicitor general took a position in a brief on behalf of the drivers that the absolute priority rule “is designed to protect intermediate creditors from being squeezed out by a deal between senior and junior creditors.” The law itself does not detail this priority rule, but it has been followed since the 1930s.

The company and its private equity owner contend that the settlement was the fairest result because if the company were liquidated, all of the small creditors would have been left empty-handed because of secured creditor liens on the company’s assets. By paying some of the small creditors a fraction of their claims, rather than zero, they argued, the settlement was in the best interest of most of the creditors. Their argument persuaded not only the bankruptcy judge, but also a divided panel of the United States Court of Appeals for the Third Circuit.

HEALTH INSURERS AND INVESTORS SHARE UNCERTAINTIES

The chief executive of America’s Health Insurance Plans, a leading industry trade group, spoke out last week and publicly outlined for the first time what the industry wants to stay in the state marketplaces, which have provided millions of Americans with insurance under the law. The insurers, some which have already started leaving the marketplaces because they are losing money, say they need a clear commitment from the Trump administration and congressional leaders that the government will continue offsetting some costs for low-income people. They also want to keep in place rules that encourage young and healthy people to sign up, which the insurers say are crucial to a stable market for individual buyers. Insurers could decide within a few months whether to pull out of the state marketplaces for 2018, a deadline they are pushing to have delayed.

Hospital groups also held a news conference to warn of what they said would be the dire financial consequences of a repeal if the cuts to hospital funding that were part of the Affordable Care Act were not also restored. While insurers say they do not plan to fight the Republicans’ efforts to repeal the law, they are in no hurry to see it unwound. And the industry said the industry would support a delay so it could prepare for the changes. “We would love to see a three-year time frame, as long as possible,” she said.

AHI acknowledged that the current law “needed to be improved.” But cited widespread agreement among Republicans about the need for some the law’s provisions, including covering people with expensive medical conditions. President-elect Donald J. Trump has also signaled his support of this popular provision. “There are common starting platforms,”  said the industry spokesperson without revealing details about her group’s positions, She said its top priority was to stop the immediate threat of eliminating the subsidies for plans sold to low-income people. House Republicans have already sued to block these payments, and the lawsuit is now delayed. If the new administration chose not to defend the lawsuit, the money would disappear, and insurers would probably rush to the exits because fewer potential customers would be available.

Other concerns include ensuring that enough young and healthy people sign up to stabilize the market. Republicans have discussed eliminating one of the law’s main tools, the so-called individual mandate, a tax levied on those who do not enroll. Insurers are emphasizing the need for some alternative, especially after criticism by insurers that the penalty is not large enough to persuade enough people to enroll. “There’s not one magic solution,” she said. She pointed to some of the provisions in Medicare that encourage people to sign up before they become sick. The insurers say they had no desire to return to the time before the law was passed, when people with pre-existing conditions were routinely denied coverage in the individual market.

As for alternatives, one is the creation of high-risk pools, where people with expensive medical conditions might be covered, bringing down the coverage costs for everyone else. “We would hesitate to rush back to that,” said the AHI. In the past, those programs, typically run by the states, have not been adequately funded. AHI  expressed concern over a potential overhaul of Medicare, pushed by the House speaker, Paul D. Ryan, who favors so-called premium support, or vouchers, as a way for people to find coverage. “We’re not big fans of that approach.”

So the focus of the debate remains centered on unsurprising issues – Medicare and Medicaid; low income patients; pre-existing conditions. These are the same issues which were the foundation of the healthcare funding debate as long as one can remember.

NEW JERSEY CONTINUES ITS HABIT OF PENSION REALITY DENIAL

A bill introduced earlier last week would allow the State of New Jersey’s $73 billion pension system to invest heavily in Transportation Trust Fund (TTF) bonds just as the state is planning to ramp up transportation spending over the next eight years. Currently, the state Division of Investment, which manages the pension system’s assets on a day-to-day basis, is only allowed to purchase up to 10 percent of an individual bond issue. The proposed legislation would remove that limit, but only for TTF bonds.

The sponsors of the legislation said it makes sense to give the pension system  the option to invest heavily in transportation fund bonds because that way all of the interest on the bonds would go into the pension system instead of to outside investors. They also said the state could save money on underwriting fees, which are levied as a percentage of the bond issues, to further stretch the TTF’s resources.

The bill’s introduction comes as lawmakers have been trying to find new ways to help address the pension-funding issue after the state’s credit-rating was downgraded again, largely due to the pension system’s ongoing problems. And that followed a new analysis by Bloomberg that determined New Jersey’s pension deficit has become the largest among U.S. states.

The legislation also comes in the face of a plan by a leading Democratic gubernatorial hopeful Phil Murphy to establish a public bank in New Jersey that would utilize taxpayer resources to circumvent big commercial banks by directly funding government priorities like long-term infrastructure improvements.

Under the TTF legislation enacted in October, the state would to issue $12 billion in bonds over the next eight years to help pay for road, bridge and rail improvements. Those funds will be combined with new revenue raised by a 23-cent gas-increase that went into effect at the beginning of November to support a total of $16 billion in planned transportation spending.

The proposal to allow the pension system to invest in the TTF bonds would enable the Division of Investment to exceed the 10 percent ceiling, but it would not require the agency to do so. The measure would also limit the funds that could be used by the pension system to invest in transportation fund bonds to those that have already been set aside for investment in fixed-income securities. The plan does raise concerns about whether there would be mechanisms in place to objectively determine a borrowing rate for the TTF. Otherwise, directly placed TTF debt could be a backdoor subsidy for the pension system. which have not been producing great returns in recent years.

“Allowing the TTF to borrow directly from the pension fund is a smart move that guarantees a rate of return while helping to support the infrastructure work that is so important to our economy,” said Sen. Dawn Marie Addiego, another sponsor. Hence, the concern. Smart is the word used for the variety of failed policies adopted on a bipartisan basis over the last 20 years to support the legislature’s unwillingness to honestly address the state’s pension needs. The sale of pension bonds, the under appropriation of general revenues, and unwillingness to find revenues to address the state’s pension needs have left the State in the unenviable fiscal position in which it finds itself today. This would be just another link in the long chain of irresponsible actions taken over those two decades.

Last month, lawmakers passed with wide bipartisan support a bill that attempts to help address the pension system’s funding gap by changing the way the state makes its pension contributions each year. Instead of making the payment in one lump sum at the end the fiscal year, which is the current practice, the bill calls for a quarterly payment schedule. That change is designed to better protect the pension contributions from falling victim to midyear budget cuts, but also to help the pension system generate bigger returns by getting more money into its investments as soon as possible. We’re not sure that we agree with that view. It could just be three more chances to underfund.

ILLINOIS FOLLOWS NY DOWN NUCLEAR SUBSIDY TRAIL

Exelon announced in June that, absent a rescue bill, it would close the Quad Cities station by June 2018 and the Clinton station by June 2017. Both are aging nuclear plants. In response, a bill that would subsidize Exelon Corp. to keep the two financially struggling nuclear plants in operation—and save as many as 4,200 jobs—was passed by Illinois legislators and now is on Gov. Bruce Rauner’s desk for final approval.

Supporters had dubbed the legislation as The Future Energy Jobs Bill. It would provide Exelon and Commonwealth Edison with a $235 million annual credit for the carbon-free energy produced by the otherwise unprofitable Clinton and Quad Cities nuclear plants. Critics contested the subsidy plan and called it a corporate bailout. Exelon and Com Ed officials said it preserved jobs and clean energy technology at the cost of no more than 25 cents per month on the average Com Ed residential customer’s bill.

Critics had cited a study using the IMPLAN economic modeling tool alleging that the Exelon-backed plan would cost about 43,000 jobs lost through 2030. A product of the Rural Development Act of 1972, IMPLAN is a system of county-level secondary data input-output models designed to meet the mandated need for accurate, timely economic impact projections of alternative uses of various resources. In this case, it predicted that Illinois government tax revenue would fall by $419.6 million and result in the large rate hike in U.S. history at $16.4 billion.

The legislation established a Zero Emission Standard (ZES) to reward the state’s at-risk nuclear plants. Proponents say the ZES would position Illinois as one of the first states to fully recognize the environment benefit of nuclear power, which does not produce carbon pollution. Nuclear power provides more than 90 percent of Illinois’ zero-carbon energy, supporters said.

There are more states in line to be targeted for these subsidies. Exelon has already made it clear that it will seek such help in Pennsylvania and as they have more success, we would anticipate that others would make such efforts. It is difficult to support market intervention moves like this but they are to be expected in light of the type of tax related transactions advocated by the President-elect.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Municipal Credit Consultant

MICHIGAN ATTEMPTS OPEB REFORM

An effort is underway in the lame duck session of the Michigan legislature by Republicans who last week introduced legislation to address rising costs for municipal retirees’ health care, including restricting public employees from counting banked overtime, sick leave or vacation days toward their salary before retiring. The 13-bill package is intended to help local governments that are struggling with unfunded obligations related to retiree benefits, including health care.

The legislation was not unexpected. Lawmakers have hinted in recent days that legislation to reform retiree benefits could be coming in the current lame-duck session, which ends in mid-December. Any legislation not adopted by the end of the year has to be reintroduced in the new legislative term that starts in January.

The bills would exclude overtime pay, sick or vacation leave, bonuses or other compensation “paid for the sole purpose of increasing final average compensation” in an employee’s base pay, according to bill language. They also would require increased financial disclosures to the state.

Cities, villages, townships and counties would be limited to paying 80 percent of annual retiree health care costs starting May 1, 2017, if the municipality offers such a benefit. The local unit also wouldn’t be allowed to offer health care coverage to a municipal retiree who is eligible for health care coverage from another employer.

For new employees hired after April 30, 2017, a local government could contribute only 2 percent of the employee’s base pay into a tax-deferred retirement health account, according to bill language. The bills wouldn’t affect existing labor contracts for their duration, though any contract that conflicts with the law after it’s enacted would be nullified. In addition, municipalities and labor unions would be barred from negotiating employee retirement health care plans or tax-deferred health savings accounts for contracts signed, renewed or changed after Jan. 1, 2017, according to the bills.

Legislators said the bills would only apply to municipalities whose retiree health care costs are less than 80 percent funded, or municipalities who fall below the 80 percent threshold for two straight years.

CHICAGO PUBLIC SCHOOL PENSION LAW CAUGHT IN POLITICS

In our last issue we referenced Illinois’  poisoned politics and their potential impact on efforts to shore up pension funding in Chicago. We did not have to wait long for Gov. Bruce Rauner’s veto of a bill that would have eased Chicago Public Schools’ massive pension burden which threatens to blow a $215 million hole into a budget that has been criticized by bankers and civic groups for its reliance on uncertain state assistance. Rauner said he vetoed the bill because it was not tied to broader pension reforms that he has demanded while Democratic Senate President John Cullerton denied assurances on pension reform were part of the CPS deal.

CPS has assumed in this year’s budget it would get the money and offered no immediate plan to cover the gap left by the governor’s veto. The district’s top education official said the action could put the city’s schools in a “horrible position.” Cullerton warned the move could lead to layoffs for thousands of teachers and employees, while Mayor Rahm Emanuel called the veto “reckless and irresponsible.”  The Senate voted to override Rauner’s veto but the override’s prospects in the House, which adjourned for the holidays without taking up the issue, were far from certain.

House lawmakers have 15 days to take up the override, but the body is not scheduled to return to Springfield until Jan. 9 — two days before new lawmakers are sworn into office. It likely would take all 71 House Democrats to overturn Rauner unless a few Republicans buck the governor. Lawmakers approved the CPS bill at the end of June, but Cullerton did not send the measure to Rauner until last month. The delay was intended to provide time to reach a deal on a larger pension measure, but that was never achieved.

“If he wants to tie it to something else like pension reform, that’s something I am supportive of. We haven’t talked about putting the two things together at this point in time,” Cullerton said. Rauner said Democrats went back on a deal that tied the measure to broader changes to the state’s highly indebted employee retirement system. In his veto message, Rauner said the agreement reached last summer was clear and Republicans supported the bailout for CPS only “on condition that Democrats re-engage in serious, good-faith negotiations.” Rauner also made reference to the Senate president’s remarks.

CPS has not said how Chicago’s schools might fill a $215 million hole in its budget. Last year, CPS banked on $480 million in state assistance that never arrived and resorted to cutting millions from school budgets in the midst of the school year to help close the gap.

Rauner’s veto occurred in the midst of the process by CPS  to reconsider an annual budget that now exceeds $5.5 billion. The district had to redraw its budget to make room for tens of millions of dollars in new expenses linked to the contract deal reached in October with the CTU. That budget already relies on property tax increases that include a measure to raise $250 million for teacher pensions. That measure was approved by the General Assembly in June as part of the package that also held the promise of $215 million more for pensions.

The Civic Federation earlier this year said it could not support the CPS budget because of its reliance on state money that might not arrive and a large amount of borrowing. “Because the district provides no plan of recourse should the funding fail to materialize other than noting that there would need to be midyear cuts, the (fiscal year) 2017 budget is in effect unbalanced,” the group said in August. This view balances our belief that any real improvement in the CPS fiscal position is not a reality in the near-term. With the governor about to enter the back half of his term, we see little likelihood that the politics of the situation will abate.

The politics date back to the Daley administration. According to the Chicago Teachers’ Pension Fund, CPS must pay a remaining balance of $730 million by June 30. The sheer size of that debt is partly the result of a long-term practice of not putting in enough money or skipping payments, including an entire decade when CPS made no pension contributions under then-Mayor Richard M. Daley.

Because of that underfunding, combined with recessions that battered the pension fund’s investments, the district now must pay hundreds of millions of dollars more each year, as required under a plan to reach a state-mandated funding level of 90 percent by 2059.

PREPA/PRASA

One would hope that in a crisis the common good might outweigh parochial interests in reaching a resolution but such is not the case currently in Puerto Rico. The Puerto Rico Aqueduct and Sewer Authority (PRASA) asked the Energy Commission (PREC) Friday to grant the water utility a “preferential power rate” that is stable and not subject to yearly fluctuations, arguing that Puerto Ricans will benefit more in the long run from cheaper water tariffs than lower power rates.

PRASA’s executive director of infrastructure insisted that PRASA was not asking for a subsidy because PREPA could give the water utility the low preferential rate by giving it a preferential share from the savings the power utility passes on to customers from the conversion of the Costa Sur power plant to a natural gas power plant. Her comments came in testimony at an Energy Commission hearing to evaluate a new power rate for PREPA customers by determining the adequate revenue requirement and other costs.

PRASA’s argument is that PREPA has not been honoring the preferential rate established for the water utility in 2013 of 16 cents per kilowatt-hour (kWh) that was slated to come into effect earlier this year. PRASA is evaluating the possibility of suing PREPA for “breaking the law.”

The law is Act 50 of 2013 which mandated PREPA to establish a preferential rate of 22 cents per kWh hour for all electric power service accounts held by PRASA. This preferential rate was subject to the price of natural gas and is an “all-in rate” covering all charges and fees in connection to the electricity purchased by PRASA. The preferential rate was in effect during fiscal years 2014, 2015 and 2016. From fiscal 2017 onward, the rate was slated to be lowered to 16 cents per kWh. It was also limited to a maximum annual consumption of 750 million kWh by PRASA. Any consumption that exceeds the amount will be annually billed at the average energy cost that PREPA charged its customers during the previous year.

The law states that PRASA had to use the savings from the preferential rate to achieve a reduction in the rates charged to its residential clients. Starting in fiscal 2017, PRASA was required to use the savings to, among other things, develop one or more capital improvement projects targeted to achieve greater operational efficiency, improve its system reliability and provide for future expansions of its system.

PRASA said that in December 2015 PREPA informed PRASA that it was revoking the preferential rate starting in July 2016 so PREPA is not charging PRASA 16 cents per kWh. Instead, PRASA is paying an average of 18 cents per kWh. Because PRASA’s facilities fall within four different tariffs, the utility could pay between 14 cents per kWh for some facilities to 25 cents per kWh in others.  During the first three years the preferential rate was in place, PRASA saved $37 million a year that were passed on to customers. Of PRASA’s operational costs, 25% goes to PREPA for power service. “Without a fixed preferential rate, we are subject to variations and that hurts our ability to have accurate financial projections…. PRASA is the biggest customer PREPA has,” PRASA has said.

When PREPA informed PRASA it was not honoring the 16 cents per kWh rate established by Act 50, Santiago said it was forced to go to the Energy Commission because of Act 57 of 2014, known as the Puerto Rico Energy Transformation and Relief Act, gave the commission regulatory power over PREPA. PRASA said having a cheap water bill is better for the typical consumer than having an economic power rate. By PRASA’s analysis “based on the savings that we have for fiscal year [$37 million a year], if we apply that, these customers receive over $7 a month,”. However, if that ($37 million) in saving is applied to power customers who use up to 800 kWh per month, customers only save $2 a month.

It is not helpful that in making its argument, PRASA was unable during the hearing to identify any projects that were slated to be financed through the savings. In reality, during the first three years of the preferential rate, PRASA used the saving to cover operating costs and avoid water rate hikes. When asked how PRASA would ensure that total savings generated from preferential rates are used for capital expenditures PRASA replied, “Right now, we haven’t been able to do that calculation. It was supposed to start in July. But savings will actually be assigned to capital improvements.” The answer speaks for itself.

VI BONDS TAKE ANOTHER RATINGS HIT

Those looking to other territories to obtain high yield triple tax-exempt returns had bad luck last week. The U.S. Virgin Islands effort to issue $225 million of bonds took a hit as Standard and Poor’s Global Ratings lowered the territory’s matching fund (rum cover-over) and Gross Receipt Tax (GRT) bonds, citing declining coverage and weak fiscal conditions as the reason for downgrading the former, and deteriorating economic and fiscal conditions for the latter. The Virgin Islands Public Finance Authority’s (PFA) senior-lien matching fund notes were lowered to ‘BB’ from ‘BBB’ and subordinate-lien matching fund notes were dropped to ‘BB-‘ from ‘BBB-‘. At the same time, a ‘BB’ long-term rating was assigned to PFA’s series 2016A senior-lien capital projects and working capital notes and its ‘BB-‘ to its series 2016B subordinate-lien working capital notes.

“The downgrade reflects weakened economic conditions, declining coverage and revenue trends, and continued reliance on this revenue source to finance operating deficits,” said S&P. “It also reflects our view of a closer linkage between the territory’s general fiscal condition and the repayment of the bonds, especially during times of significant fiscal distress.”

The matching fund bonds outlook is negative, which reflects its view that the continued significant economic, financial, and budgetary challenges the territory currently faces, absent corrective action, could lead to increased deficit financing and, over time, inadequate capacity or willingness to meet its financial commitment to its obligations, especially if market access becomes constrained.

GRT notes were downgraded seven notches from BBB+ to B. The downgrade reflects weak economic conditions, declining coverage, and the potential for further coverage dilution based on the need to issue additional debt to fund capital and cover operating deficits.

The downgrades comes on the heels of difficulties at the Juan F. Luis Hospital which was warned by CMS that it would face decertification if it did not come into compliance with CMS standards for participation by December 9. CMS further stated that it would end its current agreement with JFL by February 27 if the hospital does not comply.

“The negative outlook reflects our view that although coverage remains adequate, there are significant pressures that could lead to higher leverage, declining revenues, or both. To the extent that the USVI continues to face significant fiscal pressures, we believe significant additional deficit financing is likely,” S&P said. The government’s fiscal distress, as evidenced by its significant structural imbalance and continued reliance on deficit financing to fund operations, weak financial reporting, significantly underfunded pension liabilities, and negative fund balances, which could translate into increased debt issuance and, ultimately, impair the government’s ability or willingness to pay debt service on the bonds, especially in the absence of market access or bonding capacity.

Pledged revenues have exhibited either declining or flat growth absent tax rate increases and are levied on a limited and concentrated base. Flat revenues and rising debt service could continue to decline based on additional issuance, a weaker economy, or tax base erosion due to increased exemptions to promote economic development.

The senior-lien matching fund bonds credit reflects a narrow and concentrated base of tax generators with two companies, Diageo and Cruzan, generating all revenues. There is at least a lockbox flow of funds in which the pledged revenues are deposited directly by the U.S. Treasury into a special escrow account held by the special escrow agent.

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