Joseph Krist

Municipal Credit Consultant

THE HEADLINES…

NUCLEAR POWER BACK IN THE NEWS

DENVER HOTEL UPGRADE

TWO HOSPITALS TELL TWO TALES

WAYNE COUNTY REBUILDS

P3 UPDATES

ATLANTIC CITY BETS AGAIN

CONNECTICUT TAXES

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NUCLEAR SUBSIDY CHALLENGED IN NY

It comes as no surprise that a group of energy companies and trade associations have filed a lawsuit in an effort to overturn a decision by the administration of Gov. Andrew M. Cuomo to subsidize several struggling upstate nuclear plants. The lawsuit alleges that the state overstepped federal authority to regulate energy prices. Filed in Federal District Court in Manhattan less than ninety days after the Governor announced a plan that would have provided hundreds of millions of dollars in annual subsidies to four upstate plants. The subsidies were included in an order from the Public Service Commission.

The plaintiffs  argue that the order conflicts with the federal government’s policy of allowing market forces to set wholesale energy prices. It will raise electric rates for New York residents to prop up the plants, several of which would have failed without the governor’s plan, the suit claims. “Unless enjoined or eliminated, these credits will result in New York’s captive ratepayers paying the owners an estimated $7.6 billion over 12 years,” according to the filing.

The Governor sees the subsidies as a way to help achieve renewable energy goals as part of his so-called Clean Energy Standard, which requires half of the state’s electricity to be produced by sources like wind and solar by 2030. In its order, the Public Service Commission claims that the state’s upstate nuclear plants “avoid the emission of over 15 million tons of carbon dioxide per year,” and that losing their production “would undoubtedly result in significantly increased air emissions due to heavier reliance on existing fossil-fueled plants or the construction of new gas plants to replace the supplanted energy.”

In response, the PSC disputes the cost estimates made in the suit, saying it believes the financial impact would be “less than $2 per month for a typical residential customer.” The four plants scheduled to receive the financial benefit include two at the Nine Mile Nuclear Station in Scriba, N.Y., and the Robert Emmett Ginna Plant, east of Rochester, as well as the James A. Fitzpatrick Nuclear Power Plant, also in Scriba. The suit contends that only one of the two Nine Mile plants is financially feasible.

The PSC order is part of a larger scheme to keep the Fitzpatrick plant running after a sale to Exelon, a Chicago-based company that also has controlling stakes in the other three subsidized plants. Exelon also operates other nuclear plants in the state. The plan would advancing clean energy goals as well as facilitating efforts  to save good-paying jobs and tax cost the region $500 million in lost wages and tax revenue. Pro-business groups like some 25,000 jobs which they claim would be saved through the subsidies.

DENVER HOTEL UPGRADE SHOW WORTH OF A REAL COMMITMENT

Over time, we have looked at the varying characteristics of bond issues for hotels and the wide range of credit results which those various characteristics produce. Generally, these deals have reflected disappointing credit results. An upcoming issue reflects a different outcome reflecting the benefits of its particular structure.

Moody’s Investors Service has upgraded the Denver Co. Convention Center Hotel authority’s approximately $330 million in outstanding bonds to Baa2 from Baa3. The rating outlook is stable. The upgrade is in connection with the Authority’s planned issue of $270 million Convention Center Hotel Senior Revenue Refunding Bonds, Series 2016.

The Baa2 rating reflects the security of pledged revenues, which include net revenues of the Hyatt Regency Denver hotel project, and annually appropriated economic development payments from Denver. The bonds are also secured by mortgage liens on the land and facilities which have been assigned to the trustee and collateralized with a deed of trust, as well as various reserve funds. In addition to the annual economic development payments, there is a room block agreement. The development of the hotel was accompanied by substantial investment in convention center improvements and downtown revitalization.

The hotel has a strong market position. It is the second-largest hotel in Denver. The hotel opening occurred in December 2005 as the Hyatt Regency Denver at Colorado Convention Center. It totals approximately 1.2 million gross square feet, including 1,100 hotel guest rooms, a 300-seat full-service restaurant, a lobby bar rooftop lounge, a health club, approximately 60,000 net square feet of meeting space, and a three-level 570-car parking garage., with a trend of above average operating performance and a large and well maintained facility.

The city payments in tandem with the substantial group business of the hotel generate above-average predictability of project cash flows relative to standalone hotel projects, particularly those more exposed to transient business. Relative to those projects, financials are augmented by significant indenture required reserves and the retention of net cash flow within the project.

The refunding restructures the authority’s debt to provide significant excess cash flow for capital investment over the next five years to finance planned upkeep and renewals to keep a competitive asset while foregoing the need for additional debt. The plan of finance is also intended to enable the buildup of liquidity in cash trap reserves over the next five years while sizing the $11 million annual economic development payment to cover at least 50% of maximum annual debt service.

The Baa2 rating incorporates Moody’s expectation that the hotel will continue to receive  payments from the city which will be sufficient to maintain consolidated debt service coverage ratios ranging from 1.7 times to 2.2 times.

CEDARS SINAI MEDICAL CENTER

We have commented on a number of instances where the consolidation of hospitals and systems reflects a trend in that direction in response to the ACA. Of course, there are always exceptions to any trend. One of these is reflected by Moody’s Investors Service assignment of a Aa3 rating to Cedars-Sinai Medical Center’s (CA) Revenue Bonds Series 2016A and Refunding Revenue Bonds Series 2016B. The bonds are expected to be issued in an aggregate amount of $675 million. The Series 2016A bonds are expected to mature in 2036 and the 2016B bonds in 2039. The rating outlook remains stable.

The Aa3 rating reflects multiple factors including Cedars-Sinai’s large size and strong reputation for clinical services and research, excellent financial performance that has allowed the organization to deleverage significantly over the last several years, and strong and improving balance sheet metrics. The stable outlook reflects an expectation that Cedars Sinai will continue to grow patient volumes and revenue, and that the organization will continue to generate strong operating performance and cash flow.

The Bonds are secured by gross revenues of the Cedars-Sinai Medical Center (excluding the Foundation and Greater Valley MSO, which are a small portion of overall System revenue). The debt service coverage ratio test is 1.1x and there are no covenant restrictions on additional debt, or additional financial covenants. This is in keeping with current market trends.

Cedars-Sinai is a well regarded academic medical center located in Los Angeles. The organization operates over 800 beds on its main campus, generating approximately 50,000 admissions annually. Cedars-Sinai maintains a number of teaching and research programs and is nationally recognized in many service lines. It is the major teaching hospital for the UCLA Medical School. As a major research facility it is currently conducting over 1,100 research projects.

The new money portion of the proposed bond issue will finance the purchase of an office building currently being leased by CSMC. The purchase will eliminate an annual operating expense for rent of $14 million.

Cedars is able to maintain itself as a “stand alone” facility through its size, strategic location, and wide range of services it is able to provide at a high level. It maintains strong occupancy levels of 80%. Revenues are derived primarily through privately insured patients, with government payers generating only 30% of revenues. MediCal represents only 5% of revenues. Cedar’s status as a significant teaching and research institution generates a higher level of patient acuity which favorably impacts reimbursement rates.

TEMPLE UNIVERSITY HEALTH SYSTEM

Revenue sourcing under the ACA can be an important consideration in the credit status of a hospital bond credit. Low government funding dependence can be a strong factor in favor of a credit. But it is not a hurdle which cannot be overcome for a government dependant hospital in its effort to improve its rating.

Temple University Health System in Philadelphia is the largest provider of Medicaid funded healthcare in the Commonwealth of Pennsylvania. This would have been a challenge under any circumstances but the first years of the ACA occurred in an environment where the state administration in place was politically against using the opportunity provided by the ACA to expand Medicaid. So Temple faced an effective “double-whammy” as it attempted to maintain its credit standing.

So it says something about the System’s management that Moody’s Investors Service  announced an upgrade to Ba1 from Ba2 on Temple University Health System (TUHS), PA, $507 million of rated debt issued through the Hospitals and Higher Education Facilities Authority of Philadelphia. Moody’s also assigned a stable outlook.

The upgrade to Ba1 reflects durability of TUHS’ financial turnaround with a second consecutive fiscal year of marginally profitable operating performance. The rating also acknowledges the health system’s large size, clinical diversification, its role as a safety net provider for the City of Philadelphia, as substantiated by historically sizable funding from the Commonwealth, and close working relationship with Temple University (TU). The rating remains constrained by still modest margins, above average Medicaid exposure, heavy reliance on supplemental funding, a highly leveraged balance sheet relative to operations and cash, and an especially competitive market which continues to consolidate.

The upgrade to Ba1 reflects Moody’s view of the durability of TUHS’ financial turnaround with a second consecutive fiscal year of marginally profitable operating performance. The rating also takes into account the health system’s large size, clinical diversification, and its role as a safety net provider for the City of Philadelphia. Moody’s acknowledges historically sizable funding from the Commonwealth, and a close working relationship with Temple University (TU). The still less than investment rating continues to reflect a still modest level of margins, the aforementioned above average Medicaid exposure, heavy reliance on supplemental funding, a highly leveraged balance sheet relative to operations and cash, and an especially competitive market which continues to consolidate.

Clearly investment in the TUHS credit involves a taste for risk but it shows that strong management can overcome even the most challenging of credit environments.

WAYNE COUNTY

Michigan has approved Wayne County’s request to be released from its 14-month financial management agreement with the state. County Executive Warren Evans announced that the county had satisfied the consent agreement with the state by eliminating a $52 million structural deficit and restoring overall financial stability. Evans’ office said the county has restructured employee and retiree health care and pensions, and raised the funding level of the county’s pension system from 45% to 54%.  His goal is to increase the funding level to 70%.

The State found  that the county has satisfied the Consent Agreement terms found in Subsections 1l(a)(l )-(3) of the Agreement. As a result of this determination, the County has successfully completed and is released from its Consent Agreement. Post consent agreement, the county shall apply the proceeds from all asset sales which    exceed $25 million to the county’s pension funds, absent prior State Treasurer approval to use the proceeds otherwise. In addition, the Departmental review of other future county budget amendments is now waived pursuant to Section 15 of the Agreement. This budget amendment waiver does not release the county from its September 8, 2016 pledge to apply proceeds from a sale of the Downriver Sewer facility to the county’s pension and  OPEB funds.

The County Executive was candid in his assessment of the County’s current condition saying that the county is in its best fiscal shape in some time, but still has a long way to go. “We still have unfunded liabilities,” said Evans. “So I don’t want anyone to think this is a victory lap. This is a recovery that’s gotten us out of fiscal distress.” The county has balanced its budget for two years in a row with an accumulated surplus of $35.7 million for fiscal year 2015, and that surplus is expected to increase for fiscal year 2016. Key challenges still lie ahead including remaining health care liabilities, under-funded pensions, and completing the construction of the county jail.

P3 UPDATES

The Commonwealth of Virginia has been an active participant in the P3 marketplace as it attempts to find creative ways to finance the road development and expansion needs of its growing population. These efforts have met with mixed success as we have documented. News this past week updates the status of these projects.

One will represent a failed effort at least in terms of its municipal bond market experience. Globalvia has been named as the preferred bidder for the Pocahontas Parkway in Virginia, valued at $600m. This is the Spanish firm’s first acquisition in the North American market. Financial close is subject to the Virginia Department of Transportation’s (VDOT) approval, which is expected sometime this fall. The transaction is slated to reach financial close before the end of the calendar year.  The concession period will end in 2105.

The Pocahontas Parkway had been owned by Macquarie, and a consortium comprising TPG and Citigroup. The Macquarie unit acquired TPG and Citigroup’s stake in August 2015 for approximately $400m. That transaction occurred after initial operating results were not robust enough to cover debt service on municipal bonds issued for its construction. This acquisition will have no effect on the public traveling the Pocahontas Parkway.

On October 11, 2016, VDOT and VAP3 received two proposals from two private sector teams –Express Partners  and I-66 Express Mobility Partners – to design, build, finance, operate and maintain the I-66 Outside the Beltway Project. Proposals are under review.  The Department intends to announce the successful proposer at the end of October 2016, with commercial close expected at the end of December 2016.  Construction is anticipated to begin in 2017.

ATLANTIC CITY

The city will pay down tax-appeal debt by selling Bader Field and issuing bonds, according to a plan Mayor Don Guardian announced. The plan may be the City’s last stand to avoid a state takeover of its finances. As part of its fiscal plan to avoid a state takeover, the city would sell the 143-acre former airstrip to its water authority for $110 million, using the proceeds to pay down “a majority of our liabilities,”  according to the Mayor.

The city would then issue tax-exempt bonds secured by the state’s Municipal Qualified Bond Act to cover the remaining tax appeal debt, the statement said. The city expects interest rates of less than 4 percent. The city owes Borgata Hotel Casino & Spa about $160 million in tax refunds before interest. The casino, the city’s largest taxpayer and biggest creditor, has withheld about $23 million in property taxes so far this year to offset the refunds.

“In order to move Atlantic City forward, we must address every one of the outstanding liabilities that are crippling us financially, rendering the city helpless to face the challenges ahead,” Guardian said. “Now is the time to clean the slate of these past debts so we can move forward.” City Council approved the first reading of an ordinance Wednesday that sells Bader Field to the Municipal Utilities Authority for $110 million. Guardian didn’t say how much money the city would borrow to cover the remaining tax appeal debt after the Bader Field sale. But he said debt service on the bonds would be about $4 million per year for five years and $7 million per year for the remaining 20 years.

The city would pay the bonds using proceeds from the casino Investment Alternative Tax, which was redirected from the Casino Reinvestment Development Authority as part of the so-called PILOT bill enacted in May. “Most importantly, debt service will be fully covered by the cost savings initiatives included in our Recovery Plan while we also restore the $33 million in lost revenues from taxpayer credits currently choking the city’s budget,” Guardian said. The final approval and enactment of the plan remains in doubt as we go to press.

TAXES ARE IN THE EYE OF THE BEHOLDER

A random encounter after a recent analysts meeting generated a conversation about raising taxes to fund pension liabilities. One Connecticut resident expressed to me vehement opposition to Connecticut’s level of income tax rates blaming them for an exodus of residents and businesses. It got me to wondering exactly what the rates were in states which border the Nutmeg State.

The Tax Foundation provides data on marginal income tax rates for the neighboring states. Massachusetts (where GE moved 525 jobs this summer) has a flat 5.1% rate regardless of income. Rhode Island is at 5.99%, New York is at 6.875% (8.82% for individuals over $1 million; $2 million for joint filers), Vermont tops out at 8.99%, and New Hampshire taxes interest and dividends only at 5%.

So while not the lowest, Connecticut is certainly not an outlier. But perceptions are everything when it comes to raising taxes. So it may be a hard sell to get Nutmeggers to ante up to cover the State’s rising liability costs but the resistance may not be as grounded in reality as some may think.

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…

SEC ENFORCEMENT

GUAM POWER AUTHORITY

CHICAGO PUBLIC SCHOOLS

LAS VEGAS STADIUM

PENSION REALITY FOR A SMALL TOWN

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SEC ENFORCEMENT IN FY 2016

The Securities and Exchange Commission today announced that, in fiscal year 2016, it filed 868 enforcement actions exposing financial reporting-related misconduct by companies and their executives and misconduct by registrants and gatekeepers, as the agency continued to enhance its use of data to detect illegal conduct and expedite investigations. It was a new single year high for SEC enforcement actions for the fiscal year that ended September 30.

The agency also brought impactful first-of-their-kind actions in fiscal year 2016, including some involving the municipal bond market:  municipal advisors for violating the municipal advisor antifraud provisions of the Dodd-Frank Act; a private individual for acting as an unregistered broker.  In addition, fiscal year 2016 included a first-of-its-kind trial victory: the first federal jury trial by the SEC against a municipality and one of its officers for violations of the federal securities laws.

Public finance market actions included enforcement actions against 14 municipal underwriting firms and 71 municipal issuers and other obligated persons for violations in municipal bond offerings as part of the Municipalities Continuing Disclosure Cooperation (MCDC) Initiative. Charges against State Street Bank and Trust Company, a former State Street senior vice president, and a lobbyist with conducting a pay-to-play scheme to win contracts to service Ohio pension funds.

It charged Ramapo, N.Y., its local development corporation, and four town officials who allegedly hid a deteriorating financial situation from their municipal bond investors; charged California’s largest agricultural water district, its general manager and former assistant general manager with misleading investors about its financial condition as it issued a $77 million bond offering; and charged a municipal advisor, its CEO, and two employees for breaching their fiduciary duty.

GUAM POWER BACK IN THE MARKET

With investors looking for yield and diversity, territorial issuers have some interest. So we look at the Guam Power Authority. It shares many characteristics which have proven problematic in Puerto Rico but also has its own characteristics to offset those negatives. Guam Power Authority is rated Baa2 with a stable outlook.

GPA’s outstanding senior lien bond rating reflects GPA’s monopoly position as the sole provider of electricity services to the Guam customer base.  That base includes residential, commercial, and Guam’s governmental customers, in addition to the US Navy, the authority’s largest customer. The rating recognizes the authority’s financial and operational resilience since an August 31, 2015 fire idled two of the authority’s most efficient generating plants. Contrast that with the impact on PR of a fire-related incident. The rating also reflects GPA’s improving debt service coverage and liquidity levels relative to GPA’s Baa-rated peer group. This has occurred  in spite of a declining sales environment.

The local economy remains highly dependent on tourism and US military spending. Fuel oil remains the virtually exclusive fuel source, but GPA is working toward increasing fuel diversity through a mix of renewables, battery storage and construction of a combined cycle plant with dual-fuel capabilities. This plan is motivated by increasingly stringent Environmental Protection Agency (EPA) requirements, which the authority is currently negotiating. The rating also considers the dependence of the island’s economy on historically volatile international tourism. Economic conditions in Japan tend to have a significant effect on tourism levels.  The lack of transfer payments to the general fund of the government of Guam is another positive factor.

CHICAGO PUBLIC SCHOOLS

Chicago will use surplus TIF revenues to help Chicago Public Schools pay for a new teachers’ contract. Mayor Rahm Emanuel unveiled a proposed 2017 budget that declares a $175 million TIF surplus. Based on the distribution formula, the city will receive about $40.5 million while about $88 million will flow to the financially distressed school district. CPS had included $32 million of TIF money into its fiscal 2017 budget, expecting the city to declare a more modest $60 million surplus.CPS received $103 million in fiscal 2016.

The budget follows CPS and the Chicago Teachers’ Union reaching a tentative agreement on a new four-year contract that averted a strike set to begin October11. The city has annually freed up surplus TIF revenue but limited the amount with the annual releases varying in size. The action — promoted and endorsed by some city council members and union officials and initially resisted by Emanuel — has prompted debate.

These issues include what is the appropriate use of TIF revenues, which are supposed to be set aside for development purposes, whether even more should be freed, and whether the funds provided too easy a political escape for the district, which was seeking deeper concessions from the Chicago Teachers’ Union. Other issues include whether or not the revenue represents a non-recurring revenue stream that can’t be counted annually to cover an annual operating expense, a position Emanuel seemed to previously back in statements.

The city budget director now says “I don’t see TIF surplus at this stage as a one-time revenue. ” “I see it as an ongoing revenue.” Much of the surplus funding being freed up comes from frozen, canceled, and expiring TIFs as well as the “declared” amount. The budget director projects that surpluses will be available for well over a decade, and therefore should not be considered a so-called one-shot. The majority of this year’s surplus comes from the seven downtown TIF districts that were frozen last year and will be retired when existing projects are paid off.

Those districts will generate about $250 million in surplus revenue over the next five years, according to the city’s annual financial analysis.

The district’s historic use of one-shots, from debt restructurings to a three-year partial pension holiday to cover past deficits, have driven the school district’s structural deficit up to $1 billion. One of Emanuel’ top council allies acknowledged TIF funding is only a temporary patch. ” Mayor Emanuel’s floor leader, Alderman Patrick O’Connor, acknowledged TIF funding is a one- or two-year fix.  “We’ve done it this year so we can keep the schools open…but what we need to do is find a permanent solution.”

TIF has long been used to support school capital projects — the city committed funds to bond issues in 2007 and 2010 under former Mayor Richard Daley’s school modernization program — so it’s not improper to now use to help with an operating expense, O’Connor added. Chicago’s 146 TIF districts are expected to generate $475 million next year. The program began in 1984.  Once designated a TIF district, the amount of property taxes that flows to general government coffers is frozen and revenue growth goes to fund qualified work in the district to support development for 23 to 24 years. The city has also issued bonds backed by the revenue.

Emanuel implemented reforms after taking office in 2011 and signed an executive order in 2013 that required the city to declare a surplus from TIF districts annually of at least 25 % of the available cash balance after accounting for current and future projects or commitments. Emanuel froze the downtown TIFs last year. Since 2011, a total of $853 million of surplus revenue has been distributed but the amount has varied significantly on an annual basis from $97 million to $276 million.

The state committed $215 million to help fund teachers pensions’ but it is dependent upon passage of a state budget and agreement on state pension reforms. An additional $130 million of state aid is also uncertain beyond fiscal 2017. CPS has failed to provide a price tag for the new teachers contract.

The district’s $5.4 billion fiscal 2017 budget was based on figures from a January offer that was rejected by union delegates. It assumed $30 million in savings this year from the phase out of the $130 million annual expense of covering 7% of teachers’ 9% pension contribution. The tentative agreement leaves intact that benefit for existing teachers. It phases the cost out for teachers hired after Jan. 1 but gives them a 7% base pay raise. Cost-of-living raises proposed in January were scaled back and occur in only year three and year four. Teachers also agreed to healthcare concessions. An early retirement offer for some teachers adds to the unknown costs of the deal. The contract would be retroactive to last year, when the previous pact expired.

LAS VEGAS STADIUM MOVES FORWARD

The Nevada Legislature approved a plan that would use $750 million in public money to build an NFL stadium in Las Vegas, despite opposition to a project partly funded by billionaire casino mogul Sheldon Adelson. Oakland Raiders owner Mark Davis pledged $500 million toward the building of the stadium. NFL owners would still need to vote by a three-fourths majority to allow the Raiders to move from Oakland to Las Vegas. The matter is expected to be addressed at next week’s fall owners meetings, but there will not be any votes. The Raiders cannot apply for relocation until Jan. 15.

Lobbyists for the project worked hard to meet the necessary two-thirds threshold. It scraped by with the minimum amount of support, when lawmakers called for a quick vote without the customary speeches. Republican Gov. Brian Sandoval, signed  the deal Monday in Las Vegas. The Nevada Senate gave final approval to some minor changes after the Assembly voted 28-13 and the Senate voted 16-5 in favor of the bill. The measure would raise hotel taxes by up to 1.4 percentage points in the Las Vegas area to fund a convention center expansion and build a 65,000-seat domed stadium. Nine Democrats and four Republicans in the Assembly opposed the bill, which united members on the far left and far right of the political spectrum.

The project was nearly derailed by a state report that said the Nevada Department of Transportation wants to accelerate nearly $900 million in planned road work to accommodate stadium-related traffic. Lawmakers said they felt blindsided after the project estimate did not arise during routine discussions on the project. Transportation officials clarified that the projects were already planned and wouldn’t require raising additional revenue. Unsurprisingly, critics also decried the rushed deal, which is happening in an abbreviated special session rather than the four-month regular session next spring. They complained that the legislature was applying new tax revenue to a stadium instead of reserving it to alleviate an anticipated state budget shortfall.

The public contribution will be larger in raw dollars than for any other NFL stadium, although the public’s share of the costs — 39 percent — is smaller than for stadiums in cities of a similar size, such as Indianapolis, Cleveland and Cincinnati. Defenders of the stadium say Las Vegas’ outsized tourism economy, with 150,000 hotel rooms and 42 million visitors each year, is different than other markets that are more dependent on locals and where stadiums are more likely to cannibalize other businesses. The economist who helped develop the deal admitted that,. “I do not disagree with the analyses that have been done. … If we take the visitor component out of our economic impact model, it is negative . He justified it by saying that a traditional analysis is inappropriately applied here.”

Proponents project 451,000 new visitors will come to Las Vegas as a result of the stadium, producing $620 million in economic impact. That assumes the stadium hosting 46 events, including 10 NFL games, six UNLV football games and a variety of concerts, sports and other events. Laborers and veterans said they needed the estimated 25,000 construction jobs the project to revive an industry which was devastated in the recession. The stadium is estimated by proponents  to bring 14,000 permanent jobs to the Las Vegas area. The total deal also sends $420 million for convention center improvements aimed at keeping Las Vegas’ lucrative convention industry competitive. The hotel bill for an average-price night at a Las Vegas Strip hotel would go up about $1.50 as a result.

THE FUTURE IS ARRIVING NOW

Loyalton, Calif.,  is  a fading town of just over 700 that had not made much news since the gold rush of 1849. Its sawmill closed in 2001, wiping out jobs, paychecks and just about any reason an outsider might have had for giving Loyalton a second glance. The town however is at the forefront of looming pension problems facing cities large and small.  Recently, the California Public Employees’ Retirement System, or Calpers, said Loyalton had 30 days to hand over $1.6 million, more than its entire annual budget, to fund the pensions of its four retirees. Otherwise, Loyalton stood to become the first place in California  where a powerful state retirement system cut retirees’ pensions because their town was a deadbeat.

One employee retired in 2004 with an annual pension of about $48,000, but because of Loyalton’s troubles, Calpers is threatening to cut that to about $19,000. Employees often think of public pensions as bulletproof, because cities seldom go bankrupt, and states never do. Of all the states, California is thought to have the most protective pension laws and legal precedents. Once public workers join Calpers, state courts have ruled, their employers must fund their pensions for the rest of their careers, even if the cost was severely underestimated at the outset — something that has happened in California and elsewhere.

Those municipalities contemplating leaving the state system find that Calpers is strict, telling its 3,007 participating governments and agencies how much they must contribute each year and going after them if they fail to do so. Even municipal bankruptcy is not an excuse.  “The State of California is not responsible for a public agency’s unfunded liabilities,” said Calpers’s chief of public affairs. Nor is Calpers willing to take more from wealthy communities to help poorer communities. And if it gave a break to one, other struggling communities would surely ask for the same thing, setting up a domino effect.

When Stockton, Calif., was in bankruptcy, the presiding judge,  said the city had the right to break with Calpers — but it could not switch to a cheaper pension plan without first abrogating its labor contracts. Stockton chose to stay with Calpers and keep its existing pension plans, cutting other obligations and pushing through the biggest sales tax increase allowed by law. Loyalton severed ties with Calpers three years ago. It has no labor contracts to break. Though the town is not bankrupt, its finances are in disarray: It recovered more than $400,000 after a municipal employee caught embezzling was fired. But a recent audit found yet another shortfall of more than $80,000.

Calpers has total assets of $290 billion, so an unpaid bill of $1.6 million seems minute. But if Calpers gave one struggling city a free ride, others might try the same thing, causing political problems. Palo Alto may have lots of money, but its taxpayers still do not want to pay retirees who once plowed the snow or picked up the trash in far-off Loyalton. In September, Calpers sent “final demand” letters to Loyalton and two other entities, the Niland Sanitary District and the California Fairs Financing Authority. The Niland Sanitary District has struggled with bill collections, and the fairs financing authority was disbanded several years ago when the state cut its funding. Both entities stopped sending their required contributions to Calpers in 2013 but have continued to allow Calpers to administer their pension plans.

Loyalton, hoped to save $30,000 a year or more that the town had paid. Loyalton did not plan to offer pensions to new workers. And it had been paying its required yearly contributions to Calpers, so officials thought its pension plan must be close to fully funded. But Calpers calculates the cost of pensions differently when a local government wants to leave the system — a practice that has caught many by surprise. If a city stays, Calpers assumes that the pensions won’t cost very much, which keeps annual contributions low — but also passes hidden costs into the future, critics say. If a city wants to leave, Calpers calculates a cost that doesn’t rely on any new money and requires the city to pay the whole amount on its way out the door.

Loyalton’s expenditures for all of 2012 were only $1.2 million, and much of that money came from outside sources, like the federal and county governments. Local tax collections yielded just $163,000 that year, according to a public finance website maintained by the Stanford Institute for Economic Policy Research. The bill was due immediately, but Loyalton did not pay it. It has been accruing 7.5 percent annual interest ever since.

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

Last week, The Association of Financial Guaranty Insurers (AFGI) held a conference on the subject of how best to move the economy of Puerto Rico forward as it attempts to address the current debt default and provide for a sustainable economy. We heard many ideas, most of which reflected the particular interests and political views of the participants. This motivated us to offer the following perspective  as free of ideological biases and economic motivations as possible.

AN INVESTING PERSPECTIVE ON WHAT THE P.R. ECONOMY NEEDS

As the Puerto Rico debt crisis has unfolded, there have been many suggestions about how to fix the Puerto Rican economy. While the primary focus has often been on the role of debt restructuring, it has been in the context of the debtor/creditor relationship. There has not necessarily been enough discussion of this restructuring as just one of many interrelated components that would comprise a plan to create a long lasting economic environment which benefits all of the Commonwealth’s stakeholders – residents, businesses, creditors, and the government.

This reflects the fact that the problems have too often been viewed through the prism of antagonistic points of view. The fact is the interests of business, the residents, the creditors, and the government are the same. They are in effect one team with each representing a player playing their position with its individual responsibilities within the concept of a single goal.

So what is needed. The primary need is to create an environment where business can thrive, grow, and expand private employment. Without such an environment, there will be no way to expand and sustain the aboveground economy. Without such an economy, the government will not be able to finance the service needs of its people and the debt service needs of its creditors, present and future. To do that business needs certain resources. A reliable and capable workforce; reliable modern infrastructure; reasonable and capable administration and regulation are the minimum needs. So the question is how can this be done within existing limitations – physical, financial, and cultural/political.

A good starting point is to talk about infrastructure. Recent events have unfortunately served to highlight many of the weakness and vulnerabilities of the island’s basic infrastructure. The issues faced by PREPA and PRASA over the years are well known and have been unfortunately highlighted in recent weeks. The focus needs to be on improvement. To do that, there needs to be a change in approach to the management, administration, and finance of those services. Fortunately, there are successful templates to view which provide possibilities for PR to address the need to meet those service challenges while addressing the need to deal with their debt.

For the utilities, the need to reduce debt service on existing debt and allow for the finance of additional capital investment is clear. The Long Island Power Authority is a good example of one way for a public agency to deal with the issues of service provision, refinancing, management, and regulation in an environment of high debt and a politicized management environment. LIPA’s use of securitization financings secured by fixed portions of end user rates allowed for the cost effective refinance of existing debt in a non-coercive manner through use of the tender process. The plan lowered the near term annual debt service burden without haircuts and was accomplished voluntarily. It was facilitated a change in philosophy by the political establishment which  was convinced to see the merit in the concept that oversight and operational control were not mutually exclusive from maintenance of ownership by a government entity.

Both PREPA and PRASA have been and will continue to be handicapped by the non-acceptance of that concept. These utilities both have an opportunity to continue to be owned by the government – the people – but to partner with the private sector to achieve an optimal result for all stakeholders. There are qualified able private entities with management and operational expertise who would enable each utility to benefit from objective assessment of the management, administrative, and physical needs of the utilities. Once that process is complete, private management contractors are out there who oversee management without necessarily impacting the use of local personnel. This would minimize the warping impact of politics and increase the confidence of business in the results of any such review. That confidence is key to the process of attracting those businesses.

In the area of future growth, the utilities must be open to the use of new renewable technologies. Much is made of PR’s geographical limitations as they impact their operations, especially at PREPA. At the same time, PR has virtually unlimited sun, wind, and mountains. These provides strong opportunities for renewable energy development. Not only would it reduce fuel dependence, its installation and expansion would provide employment and skills development on both a macro and micro level. The financing mechanisms for these sources exists in the public finance market and the increasing market for green bonds should be exploited by both utilities.

For both utilities, Promesa could effectively be used as an agent for change in the oversight and regulation of utility prices and finances. Obviously this is a sensitive issue in PR and we do not ignore that. But the fact of the matter is that current events have only highlighted the weaknesses of the current structure. Much as was the case in Long Island, issues of politically influenced management and ratemaking threatened the viability of the credit. The linkage of the securitization refinancing to outside rate review and privatized operational management were key to generating business support for a program and confidence that efficiency, cost effectiveness, and disincentives for corruption were the pillars of operations.

What can the general Puerto Rican government do to support business growth? It can assure that a reasonable tax, regulatory, and administrative environment exists that allows business to have reasonable expectations about what can be consistently expected from a timing and cost perspective. It is the government’s role to establish priorities and policies that meet the needs of all of its constituents including the Promesa board  in an effort to maintain and grow the population. In addition to these basic management and governance issues, it must improve its information capabilities. The Congressional Task Force is concerned about the relative lack of reliable data pertaining to certain aspects of the economic, financial, and fiscal situation in Puerto Rico, which are necessary for productive analyses that may lead to sound public policy recommendations.

It must address the basic issues that all people in all cultures at all economic levels require – safety, housing, education, and economic success. Obviously, safety and education are usually the province of local government. But there are real issues associated with those services. Education can be achieved through a variety of models. Fortunately for Puerto Rico, the public finance market has experience with all of the various forms of educational provision from pre-K right through the full university level, both public and private. The ability to finance new and different modes of education at all levels should not be held back by concerns over the ability to finance them.

Once the issues of methods of provision and finance of education are dealt with, the issues of the quality of the product must be addressed. This is another issue which lends itself to collaboration amongst all of the stakeholders including investors. A trained, multilingual workforce is essential. None of this implies an effort in any way to limit or denigrate the longstanding and beautiful culture of Puerto Rico and its people. The fact of the matter is that all around the world, on all of its continents and countries and cultures and races, English has become the lingua franca in nearly all forms of commercial activity as well as technological advancement and applications.

As for the issues of tax and regulation, the suggestions as to which taxes and regulations are best are not really appropriate to this particular discussion. What is appropriate is to emphasize the need for these policies to be well thought out on a consultive basis with all stakeholders using reasonable economic assumptions. In many ways it can be argued that this may be the most effective area in which the federal government could make an affirmative active difference. While Promesa may be unpopular among the local body politic, it does provide an opportunity to develop a coordinated tax and policy approach for PR that allows for Puerto Rico’s unique needs and situation.

It is through this process that the best opportunity exists to address questions like the earned income tax credit, the level of available Medicaid funding, the level of the minimum wage and issues such as the continued applicability of the Jones Act. The arguments in favor of equalization of Medicaid funding, the availability of the earned income tax credit, and for at least some period of the time exemption from the limitations of the Jones Act are compelling. Each of them would have some role in lowering costs to business and increasing the attractiveness and availability of “legitimate” employment opportunities for residents. Each of them requires federal action.

Medicaid is especially important as it not only addresses the obvious issue of healthcare availability  for all regardless of economic status but also addresses the issue of reasonable compensation for professional service providers. The question of the relative gap between the amount and type of resources available for equipment as well as the economic potential for doctors, nurses, and technicians is an undeniable factor in the current negative demographic trends on the island. The need and desire for a viable healthcare system is universal whether it be for the poorest resident or the highest level executive.

The case for the earned income tax credit is undeniable. Studies have found that EITC expansions are the most important reason why employment rose among single mothers with children— the EITC was more effective in encouraging work than either welfare reform or the strong economy. It creates an incentive for people to leave welfare for work and for low-wage workers to increase their work hours. It encourages large numbers of single parents to leave welfare for work, especially when the labor market is strong.

All of these issues I have discussed factor into the decision as to whether or not one can and should invest in Puerto Rico. They all address the issue of will I be paid, how much will I be paid, and what is the relative risk of the investment in Puerto Rico. These are not unique to Puerto Rico and it is unrealistic for Puerto Rico to hope or expect that investors will not apply these most fundamental tenets of their decision process as it pertains to Puerto Rico. Without outside investment in debt issued by the Commonwealth and its various entities, none of the economic goals of the Commonwealth and its people can be achieved.

The issues which I have addressed in this discussion would remain regardless of  whether Puerto Rico remains a Commonwealth or becomes a State. The issues of health, education, infrastructure, and economic expansion will still have the same importance. To the extent that Commonwealth status provides opportunity – flexibility in terms of thing like the minimum wage, access to a broader bond market through triple tax exempt financing – these opportunities must be maximized. Status itself should not be the determinative issue in deciding the course of action required to generate economic growth.

We take no position on the question of statehood versus commonwealth status. We do note that statehood alone can in no way be viewed as a panacea. Statehood would provide some additional certainty and volume of resources but it would also limit some benefits that Puerto Rico receives. It certainly does not address issues of good and efficient government. All one has to do is to look at states like Illinois or Louisiana to see that state government can be corrupt and inefficient as well as any other governmental entity. It will only retard the expansion of the economy in Puerto Rico to allow, in the short-term, issues of status to determine what is best for Puerto Rico and its economic stakeholders.

Of course, any or all of the ideas expressed to help Puerto Rico rebuild its economy and credit require a serious governmental and political environment. As of the moment, that does not exist. The Padilla administration has made it abundantly clear that it is bankrupt in terms of ideas, practicality, and courage. Its latest presentation to the Promesa fiscal oversight board was simply not a serious proposal. It follows on its policies grounded in the crudest forms of populism and disrespect for established institutions. Asking the Commonwealth to run an efficient government is not a call for austerity. It is not a threat to sovereignty or an attempt to impose a new cultural construct. Yet the Padilla administration continues to push this line.

As a result it has forfeited any serious policy role, harming the economy and destroying the credibility of institutions like the Government Development Bank. The GDB under this administration has been stripped of its ability to act as any sort of honest source of data, ideas, and financing. By turning the GDB into a facilitator of opacity and obstruction, the Padilla administration has made the process of recovery exponentially more difficult. The trust which has been so cavalierly discarded will not be easily recovered but the exit of the current administration and its mindset will be a constructive start.

Disclaimer:  The opinions and statements expressed in this speech are solely mine, who is solely responsible for the accuracy and completeness of it.  The opinions and statements expressed 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 at this time, 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.  Listeners are encouraged to obtain disclosure information 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

With so much focus on the Presidential race and its many bizarre twists and turns, it is easy to lose focus on items which do not have impacts on elective office. Many important state and local spending, taxing, and capital investment issues are subject to a vote of the people. To that end, this edition of the Muni Credit News is devoted to a summary of the major tax and bond ballot initiatives on the November 8 ballot across the country.

TAX INITIATIVES

There are 32 initiatives on ballots across the country dealing with various increases and decreases in taxes as well as changes to various deductions from state income. There are eight in Washington state alone. Four are in Missouri and three each are in Florida and California. Of interest are a Missouri initiative to ban the extension of sales tax to services, an end to the deduction for Federal taxes for state tax purposes in Louisiana, and a ban on increasing sales tax rates in Washington. Here are proposed tobacco tax changes:

COLORADO – shall state taxes be increased $315.7 million annually by an amendment to the Colorado constitution  increasing tobacco taxes beginning January 1, 2017 by 8.75 cents  per pack ($1.75 PER PACK OF 20 CIGARETTES) and on other tobacco products by 22%?

MISSOURI – The current tax on a pack of 20 cigarettes is 17 cents. Proposition A is designed to increase this tax by 13 cents in January 2017 and by 5 cents in January of 2019 and, again, in January of 2021, when the total tax increase would reach 23 cents per pack. It would also tax non-cigarette tobacco products 5 percent of the manufacturer’s invoice price, paid by the seller. Tax revenue would be used to fund transportation infrastructure projects.

Proposition A is competing against Amendment 3, which would increase the cigarette tax to 77 cents by 2020 in 15 cent increments each year until then. In addition to the cigarette tax, the measure would also impose a fee on wholesalers of 67 cents per pack on cigarettes produced by a “non-participating manufacturer,” as defined by the state of Missouri. At least 75 percent of the revenue generated from these taxes would be devoted to increasing access to early childhood education programs. Around 10 percent of the funds would go toward grants for Missouri health care facilities, and approximately 5 percent would be devoted to smoking prevention programs.

In the event that both Proposition A and Amendment 3 pass, the measure with the most affirmative votes supersedes the other.

NORTH DAKOTA – Statutory Measure 4 is designed to increase the tax on cigarettes from 44 cents per pack to $2.20 per pack and to increase the tax price to 56 percent of the wholesale price. The definition of “tobacco products” would expand to include liquid nicotine and electronic inhalation devices. Measure 4 was designed to create a veterans’ tobacco trust fund, which would be funded by half of the new revenues. The remaining revenues would be dedicated to a community health trust fund for a comprehensive behavioral health plan, county-level health services, and chronic illness prevention and control programs. No revenue from the increase would be allocated to tobacco prevention or cessation programs.

Tax questions dealing with other than tobacco taxes include:

FLORIDA – Constitutional Amendment 5 is an amendment to the State Constitution to revise the homestead tax exemption that may be granted by counties or municipalities for property with just value less than $250,000 owned by certain senior, low-income, long-term residents to specify that just value is determined in the first tax year the owner applies and is eligible for the exemption.

Constitutional Amendment 3 an amendment to the State Constitution to authorize a first responder, who is totally and permanently disabled as a result of injuries sustained in the line of duty, to receive relief from ad valorem taxes assessed on homestead property, if authorized by general law.

HAWAII – Amendment 2 is a constitutional amendment to add alternatives for the disposition of excess general fund revenues. Allows the appropriation of general funds for the pre-payment of general obligation bond debt service or pension or other post-employment benefit liabilities.

ILLINOIS – House Joint Resolution 36 to amend the Revenue Article of the Illinois Constitution. Adds a new Section concerning highway funds. Provides that no moneys derived from taxes, fees, excises, or license taxes, relating to registration, titles, operation, or use of vehicles or public highways, roads, streets, bridges, mass transit, intercity passenger rail, ports, or airports, or motor fuels, including bond proceeds, shall be expended for other than costs of administering laws related to vehicles and transportation, costs for construction, reconstruction, maintenance, repair, and betterment of public highways, roads, streets, bridges, mass transit, intercity passenger rail, ports, airports, or other forms of transportation, and other statutory highway purposes, including the State or local share to match federal aid highway funds. Limits the costs of administering laws related to vehicles and transportation to direct program expenses of the Secretary of State, the State Police, and the Department of Transportation related to the enforcement of traffic laws and safety. Provides that the revenues described herein shall not be diverted to any other purpose. Provides that any additional modes of transportation proposed for State funding shall have dedicated sources of funding. Provides that federal funds may be spent for any purposes authorized by federal law.

LOUISIANA – Amendment 3 eliminates the deductibility of federal income taxes paid in computing state corporate income taxes.

MISSOURI – Amendment 4 amends the Missouri Constitution to prohibit a new state or local sales/use or other similar tax on any service or transaction. This amendment only applies to any service or transaction that was not subject to a sales/use or similar tax as of January 1, 2015.

NEW JERSEY – Public Question 2 provides that an additional three cents of the current motor fuels tax on diesel fuel, which is not dedicated for transportation purposes, be dedicated to the Transportation Trust Fund. In doing so, the entire State tax on diesel fuel would be used for transportation purposes. The entire State tax on gasoline is currently dedicated to the Transportation Trust Fund and used for transportation purposes. The amendment would also provide that all of the revenue from the current State tax on petroleum products gross receipts be dedicated to the Transportation Trust Fund. In doing so, the entire State tax on petroleum products gross receipts would be used for transportation purposes. This amendment does not change the current tax on motor fuels or petroleum products gross receipts.

OKLAHOMA – State Question 779 creates a limited purpose fund to improve public education. It levies a one cent sales and use tax to provide revenue for the fund. It allocates funds for specific institutions and purposes related to the improvement of public education, such as increasing teacher salaries, addressing teacher shortages, college and career readiness, and college affordability, improving higher education and career and technology education, and increasing access to voluntary early learning opportunities for low-income and at-risk children. It requires an annual audit of school districts’ use of monies from the fund. It prohibits school districts’ use of these funds for administrative salaries. It provides for an increase in teacher salaries. It requires that monies from the fund not supplant or replace other education funding.

OREGON – Measure 97 increases annual minimum tax on corporations with Oregon sales of more than $25 million; imposes minimum tax of $30,001 plus 2.5% of amount of sales above $25 million; eliminates tax cap; benefit companies (business entities that create public benefit) taxed under current law. Applies to tax years beginning on/after January l, 2017. Revenue from tax increase goes to: public education (early childhood through grade 12); healthcare; services for senior citizens.

This list is by no means exhaustive but represents summaries of proposed changes which would represent significant policy changes or offer clear benefits to debt holders.

BOND BALLOT ITEMS

ARKANSAS – Issue 3 removes the cap on the amount of bonds the state is allowed to issue to a corporation, association, institution or individual to help finance economic development projects and services; requires voter approval.

MAINE – Question 6 creates $100,000,000 bond issue for construction, reconstruction and rehabilitation of highways and bridges and for facilities, equipment and property acquisition related to ports, harbors, marine transportation, freight and passenger railroads, aviation, transit and bicycle and pedestrian trails, to be used to match an estimated $137,000,000 in federal and other funds.

MONTANA – I-181 authorizes the creation of state bond debts for $20 million per year for a period of ten years. I-181 establishes the Montana Biomedical Research Authority to oversee and review grant applications for the purpose of promoting the development of therapies and cures for brain diseases and injuries and mental illnesses, including Alzheimer’s, Parkinson’s, brain cancer, dementia, traumatic brain injury and stroke. The grants, which are funded by state general obligation bonds, can be used to pay the costs of peer-reviewed biomedical research and therapy development, recruiting scientists and students and acquiring innovative technologies at Montana biomedical research organizations. I-181 provides specifics for the Montana Biomedical Research Authority’s membership, powers, staffing, grant eligibility and evaluation requirements, and reporting requirements.

NEW MEXICO – Bond Question A the 2016 Capital Projects General Obligation Bond Act authorizes the issuance and sale of senior citizen facility improvement, construction and equipment acquisition bonds. Shall the state be authorized to issue general obligation bonds in an amount not to exceed fifteen million four hundred forty thousand dollars ($15,440,000) to make capital expenditures for certain senior citizen facility improvement, construction and equipment acquisition projects and provide for a general property tax imposition and levy for the payment of principal of, interest on and expenses incurred in connection with the issuance of the bonds and the collection of the tax as permitted by law?

Bond Question B the 2016 Capital Projects General Obligation Bond Act authorizes the issuance and sale of library acquisition bonds. Shall the state be authorized to issue general obligation bonds in an amount not to exceed ten million one hundred sixty-seven thousand dollars ($10,167,000) to make capital expenditures for academic, public school, tribal and public library resource acquisitions and provide for a general property tax imposition and levy for the payment of principal of, interest on and expenses incurred in connection with the issuance of the bonds and the collection of the tax as permitted by law?

Bond Question D the 2016 Capital Projects General Obligation Bond Act authorizes the issuance and sale of public safety capital improvement and acquisition bonds. Shall the state be authorized to issue general obligation bonds in an amount not to exceed eighteen million one hundred ninety-six thousand dollars ($18,196,000) to make capital expenditures for capital improvements and acquisitions for state police, public safety communications and national guard facilities statewide and provide for a general property tax imposition and levy for the payment of principal of, interest on and expenses incurred in connection with the issuance of the bonds and the collection of the tax as permitted by law?

Rhode Island – $35,000,000 in general obligation bonds to invest in the environment and recreation.

$45,500,000 in general obligation bonds to fund higher education-related construction projects at the University of Rhode Island.

$50,000,000 in general obligation bonds to help fund the construction of affordable housing, support urban revitalization and blight remediation.

$70,000,000 in general obligation bonds to fund improvements to the Port of Davisville at Quonset and the Port of Providence.

$27,000,000 in general obligation bonds to complete the construction of a new Veterans Home and support renovations of existing Veterans facilities in Rhode Island.

MCN IS A PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News has partnered with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

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Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

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…

KANSAS REVENUE EXPERIMENT CONTINUES TO FAIL

MORE STATES SEE REVENUE SHORTFALLS

IS MIAMI GOING TO SETTLE WITH THE SEC?

EVEN GOOD CREDITS GOING COVENANT LITE

CAT BONDS IN THE SPOTLIGHT

DALLAS PENSION FUNDING

HARTFORD TAKEN BELOW INVESTMENT GRADE

MORAL OBLIGATION HOTEL DEAL IN CALIFORNIA

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KANSAS REVENUE EXPERIMENT CONTINUES TO FAIL

The experiment masterminded by the “mad scientist of the budget”, Governor Sam Brownback of Kansas, continues in the face of continued failed results. The State collected nearly $45 million less in taxes in September than expected and now faces a shortfall of over $60 million, just three months — or one quarter — into the fiscal year. Barring a dramatic turnaround, lawmakers and the governor will confront a bleak financial situation when the Legislature returns in January.

Some legislators believe that Brownback is required by law to make cuts himself because state finances are in the red. The governor’s office said the administration is not planning to make allotments. Month after month, with only a few exceptions, revenue been below projections. Sometimes the shortfall is small — $10.5 million in August. In other months, the numbers are staggering: May fell $76 million below expectations.

Individual income tax collections were down $14 million, or 6 percent. The Kansas Department of Revenue cited weaker than expected quarterly payments related to capital gains and the stock market in explaining the figures. Corporate income taxes were short by $17 million, or 21 percent. Retail sales tax collections fell short by $9 million, or about 5 percent.

The approximately $45 million monthly shortfall represents a miss of about 8 percent. So far during the fiscal year, which began in July, Kansas has collected $69 million less in taxes than projected.  The state began the fiscal year in July with an anticipated positive ending balance of only $5 million that was quickly wiped away by poor July and August tax collections. Continued monthly revenue shortfalls could realistically push the figure past $100 million. A twice-yearly revenue forecast will also be released in November, and that projection could send the figure even higher.

State budget director Shawn Sullivan asked agencies in August to provide budget scenarios featuring a 5 percent cut. Last week, he said Brownback’s budget proposal in January wouldn’t include across-the-board cuts, but acknowledged the current budget will have to be adjusted. The governor’s opponents have said taxes cannot be cut without also cutting spending. No significant spending reductions were made in 2012 when the Legislature passed and Brownback signed tax cuts into law.

Kansas has faced rounds of budget cuts over the past two years. And in 2015, during the longest legislative session in Kansas history, the Legislature passed and Brownback signed an increase in sales and cigarette taxes in an effort to raise revenues while the Governor’s response was to cut public university spending by 4 percent. He also imposed a 4 percent reimbursement cut to KanCare providers.

Looming over all of this is an upcoming ruling from The Kansas Supreme Court in a school finance lawsuit that could force millions in additional education spending. Estimates vary, but legislators may have to appropriate upwards of $900 million to comply with a ruling unfavorable to the state.

OTHER STATES ARE FALLING SHORT TOO

In a troubling sign a review of other state revenue reports shows that revenue shortfalls are not uncommon. West Virginia is reporting across the board shortfalls in nearly all of its general fund revenue sources through the end of the first quarter of FY 2017. Given the declining demand for coal this is not a complete surprise. With prices down and employment negatively impacted, it is not unexpected that economic activity would slow impacting both income and sales related taxes.

It is only one month of results but the State of Texas reports a 3% decline in year over year revenues for the month of September. Energy price declines are also playing a major role here as taxes from oil and gas production decline and the effect of those changes bleeds into the rate of growth of sales taxes, the State’s major non-energy revenue source.

IS MIAMI SETTLING WITH THE SEC?

Miami’s City Commission is set to consider paying a $1 million fine to settle securities fraud claims brought by the U.S. Securities and Exchange Commission, according to documents posted on the city’s website. The proposed settlement is said be the largest penalty the SEC has ever imposed on a municipal bond issuer. In a Sept. 22 court filing, the parties said they had reached a tentative settlement, though terms were not then disclosed. The deal must still be approved by the city commission, which will consider a resolution to approve it at an Oct. 13 meeting. The SEC has not confirmed this.

One time budget director Michael Boudreaux  however, has not reached a settlement with the SEC. The former budget director remains confident he will be fully exonerated. It is unusual for an enforcement action against a municipal issuer to go to trial and a rare instance of monetary penalties being sought against a municipality. The SEC has  The SEC has in recent years sought to be more aggressive in its regulation of the municipal bond market. Success in Miami will further embolden the agency’s efforts, although this marks the second time that the city has been cited for securities fraud.

SAN ANTONIO WATER TO COME WITHOUT RESERVE FUND

The City of San Antonio TX is planning a $300 million issue of new money and refunding bonds that seeks to take the fullest advantage of the current favorable environment for issuers. The bonds will be secured as junior lien revenue bonds but they are no secured by any sort of reserve fund. Certainly, not cash and not even a surety bond. It would appear that the “covenant lite” phenomenon getting so much press in the tax exempt environment is bleeding over into the tax exempt market, albeit with a high quality issuer.

The issue is refunding debt maturing from 3 to 23 years from now carrying coupons from 4% to 5.375% . As a solid double A credit their ability to effect a successful refunding is not questioned. But in addition to the expected cost savings, the City is structuring the deal to give it more flexibility in terms of the security, thereby increasing the amount of principal available for their refinancing and capital financing goals.

Effectively, the “no reserve” structure creates another lien of debt within the existing junior lien security waterfall. There are now two classes of junior lien water debt. Given the systems strong financial position and history, it may not make much of a difference That may not look so favorable under less favorable credit conditions and/or a higher rate environment in the future.

In the case of this credit, we do not see it as a reason not to buy it. We are interested in seeing over time if the market makes a measurable valuation differentiation going forward between reserve secured and no reserve debt from the same credit. At current  yield levels, we think that investors are already giving up enough and are dismayed to see the merger of more characteristics of the corporate market make their way into the municipal bond credit mainstream.

CAT BONDS

With all of the attention focus on Florida as the result of Hurricane Matthew and its aftermath,  it’s a good time to focus on the funding and status of the Florida Hurricane Catastrophe Fund (FHCF). The Fund reimburses insurers for losses caused by covered events within a given contract year. To fund itself, FCHF issue bonds backed by Reimbursement Premium s charged to participating insurers under contracts with the Fund and by Emergency Assessments of 6% of losses during any contract year and up to 10% of aggregate losses. Those funds are invested and the earnings on those investments along with the premium and assessment revenues are pledged to the repayment of its bonds.

The State of Florida has been fortunate in that a hurricane has not made landfall in Florida  in eleven years. This has provided an opportunity to accumulate revenues without offsetting expenditures and has provided a favorable environment for insurers to participate in. Over the last five years through FY 2015, annual premiums collected by the Fund have been at least $1.2 billion and have created a reported net position of $11.6 billion.

So the State is positioned well to deal with the effects of Hurricane Matthew. In the short run it provides ready funding to deal with immediate needs and in the long term it provides an incentive for insurance carriers to continue to do business in the State. It’s broad assessment base, established mechanism for collections of assessments, and credit. This allows it to reasonably achieve its financial goals while providing Florida  residents some assurance that insurance will be available in order to allow them to continue to maintain their homes, businesses, and the economy in the face of the

CHICAGO GETS G.O. OUTLOOK UPGRADE

S&P has maintained its BBB-plus rating for Chicago’s general obligation bonds. At the same time, it revised the outlook to stable from negative. It reflects the impact of the recent City Council action to approve tax increases to fund a portion of the City’s huge unfunded pension liabilities. The city’s action had previously led to an outlook revision to stable from negative in August from Fitch Ratings, which rates Chicago’s GO bonds BBB-minus. Moody’s Investors Service still rates the City’s debt below investment grade. It has a negative outlook on its Ba1 rating for Chicago.

The timing of the changes to the City’s outlook is interesting in that that they precede the presentation of the fiscal 2017 budget plan next week by Mayor Rahm Emanuel. The achievement of budget balance on a year to year basis has been increasingly difficult. One would think that a view of that plan would provide a more sustainable view as to the City’s outlook.

MOODY’S TAKES HARTFORD BELOW INVESTMENT GRADE

Moody’s Investors Service has downgraded the City of Hartford, CT’s general obligation debt rating to Ba2 from Baa1. The par amount of debt affected totals approximately $550 million. The outlook remains negative. The downgrade to Ba2 reflects the challenges the city faces in achieving structurally balanced operations, closing its current year (fiscal 2017) budget gap and subsequent year projected shortfalls. The city has limited operating flexibility, exacerbated by weak and declining reserves and rising costs (including debt service and pension payments) over the next several years.

The action also factors in narrowing liquidity and expansion of the current year budget gap since its last review. The city’s options for addressing the growing revenue/expenditure mismatch and eliminating the structural imbalance are limited with property tax revenue constrained by an already high tax rate and prospects for additional state aid limited by the state’s own fiscal challenges. Further expenditure reductions will prove difficult after cuts in the current and prior fiscal years and extended negotiations with unions. Moody’s acknowledges that it is increasingly unlikely that the city will be able to address its financial challenges on its own and, external assistance, either from the state or region will be needed. The city’s position as the state capital and regional economic and employment center is a positive credit factor; however, those strengths are offset, to some extent, by depressed wealth and income levels, and high tax payer concentration.

The maintenance of the negative outlook reflects the expectation that the city will remain challenged to restore and maintain fiscal stability given the expected ramp up  revenue growth prospects. The outlook also incorporates the city’s significant reliance on state aid and the financial challenges that the state is facing which could adversely impact the city.

WHILE FITCH DOWNGRADES DALLAS TX ON PENSION FUNDING

Fitch announced that it had downgraded City of Dallas, Texas general obligation ratings to ‘AA’ from ‘AA+. The downgrade was based on Fitch’s heightened concern about the city’s unfunded pension liabilities given the reporting of updated plan valuations since the time of Fitch’s last review. Those results increased the total unfunded pension liability to the city’s general fund by about 40%. There are particular issues with the city’s DPFP (combined) plan reflecting persistent investment losses and risks highlighted by recent developments related to its deferred retirement option plan (DROP).

The city’s ‘AA’ rating continues to reflect strong operating performance enabled by robust economic and revenue growth prospects, strong control over revenues, conservative budgeting , solid reserve funding, and long-term liabilities that Fitch expects to remain a moderate burden on resources if current extensive pension reform efforts are successful.

CITY TO STAND BEHIND HOTEL DEBT

We have commented before on the intersection of the end of an interest rate cycle, risk, and the demand for diversified yield by investors. We present another example in the form of a financing for a 203 bed extended stay hotel in Montebello CA. In this case the security for the bonds is the revenue generated by the hotel. In the event that there is a revenue insufficiency, the City can be called upon to make appropriations sufficient to make up the shortfall.

The City expects to generate revenues from the collection of transient occupancy taxes collected from hotel guests as well as taxes from the operator of the property.  This does not limit the City’s exposure to the project to only those revenues. The City’s covenant to appropriate is from any available revenues. Demand for the facility is to be generated primarily from businesses and groups looking for conference facilities with access to golf. This hotel would be located within the City’s Montebello Golf Course.

We focus on this deal because it reminds us of a number of other deals like it. They share suburban locations, a business/conference orientation, and were financed at fairly similar points in the economic and interest rate cycles. Unfortunately, these facilities in New Brunswick, NJ, Lombard, IL, and Cambridge, MD all had something else in common – they did not work for their initial investors. Demand did not materialize, cash flows were not sufficient, and in Lombard, the City decided not to make good on its financial support pledges on which bondholders relied.

In this case, it would make for a truly awkward situation as the project has been sold by the City Council to its constituents as one that will generate $1 million annually to the City’s general fund. The deal has other “hair” on it in that there was only one contractor which bid on the project and it was connected by family ties to a member of the approving city council. Caveat emptor!!

MCN PARTNERS WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News has partnered with Court Street market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

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…

WESTERN WATER WARS AND MUNICIPALITIES

WAYNE COUNTY CREDIT CONTINUES RECOVERY

ALASKA TURNS TO PENSION BONDS

INVESTMENT BLUES HIT HARVARD

CALIFORNIA COUNTY UPGRADES

VA. P3 ROAD MAY GET ANOTHER CHANCE

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WESTERN WATER WARS – MONTANA

Mountain Water Company (Mountain Water) owned the water system that provides potable water to the residents of Missoula, MT. Mountain Water is  owned by Carlyle Infrastructure Partners, LP (Carlyle), a global investment firm that invests in utilities. The City desired to own the water system that serves its residents because City officials believe a community’s water system is a public asset best owned and operated by the public. In January 2014, the City offered to purchase the water  system from Carlyle for $50 million, but Carlyle declined the offer. On May 5, 2014, the City sought to exercise its power of eminent domain to condemn the water system. Carlyle, Mountain Water, and the employees of Mountain Water opposed the condemnation.

As a municipality, the City of Missoula had the power under Montana’s constitution to take private property for public use as long as the private property owner  is justly compensated. Water supply systems are one of the forms of private property that may be condemned for public use. In order to exercise its power of eminent domain, the City had to prove that the water system would be put to a public use, and that the City’s ownership of the water system is more necessary to that public use than private ownership. The Fourth Judicial District Court conducted a three-week bench trial to determine whether the City could prove that its ownership of the water system was more necessary than private ownership. On June 15, 2015, the Court concluded that the City had borne its burden of  proof, and issued a preliminary order of condemnation.

On June 23, 2015, the Defendants appealed the preliminary order of condemnation to the Montana Supreme Court. On appeal, the Defendants challenged several of the District  Court’s  orders  that  preceded  the  condemnation  order,  including  rulings   on pre-trial motions and evidentiary rulings at trial. The Defendants also challenged the District Court’s ultimate finding that public ownership of the water system was more necessary than private ownership.

The Montana Supreme Court held that the District Court’s factual finding that City ownership of the water system is more necessary than private ownership was supported  in the record by substantial credible evidence. That evidence included testimony about public support for condemnation; evidence about the condition of the water system and the implications of such a condition under public or private ownership; evidence regarding the City’s ability to effectively manage the water system if it were condemned; evidence from all parties about the financial considerations relating to owning and operating the water system, including administrative expenses, profit motive, rate setting, and the cost of acquisition and needed capital improvements; evidence about the effect of condemnation on the Mountain Water employees; and evidence concerning economic  and public policy factors like coordination of water services with other municipal services, urban planning, environmental conservation, and public health, safety, and welfare.

The District Court received evidence and testimony from all parties concerning all the above factors, and concluded that although there was conflicting evidence in the record, overall the evidence favored condemnation. The Supreme Court conducted a thorough review of the record and was satisfied that the District Court’s finding that public ownership of the water system was more necessary than private ownership was based upon substantial credible evidence. The Supreme Court therefore affirmed the District Court’s preliminary order of condemnation.

WESTERN WATER WARS – CALIFORNIA TOWN FACES LOSS OF WATER

The fate of a small northern California town’s drinking water will be a much more complicated problem to figure out. The city of Weed waters half its population from the Beaughan Springs source that flows through the  property of the Oregon-based company, Roseburg Forest Products in town. The city had a lease to access the company’s rights to the water for the last 50 years. That lease expired earlier this year. In February, the city announced  that the city of Weed has not been able to reach agreement on contract renewal or extension to continue to receive water for the residents of the city.

The city staff and company representatives disagree on some fundamental issues, like who actually owns the water rights. The California Water Resource Board’s water rights database brings up nothing for the city of Weed, and just one inactive right to a different creek is under Roseburg’s name. The property in question, a lumber mill, has changed hands several times since its founding in the late 1890s. With each change of hands came a change of water rights, but some in Weed residents say the rights transferred to the city in 1982 in a letter written to International Paper Co., which was the lumber company that owned the property and the rights at the time, when it sold its assets to Roseburg Forest Products. In it, the watermaster allocates a specific part of the water rights “for domestic and municipal purposes to the City of Weed” and industrial purposes for the company.

Since that time Weed has leased its allocated amount of water for municipal purposes, and Roseburg Forest Products has sold part of the other rights to Crystal Geyser, a water bottling company. Roseburg believes that it could sell the City’s allocation to Crystal Geyser at much more favorable prices. The city and company ended up signing an agreement that allowed the city to use the water for up to 15 years. In the meantime, Weed had to show that it is making “best efforts to obtain an alternate water supply,” reads the agreement. It paid $97,500 every year for the water, increasing 2 percent annually after five years. Under its prior lease, the city was paying $1 a year.

While the city already has about three wells providing water to the south end of town but, it lacks the infrastructure to get the water to the northern homes and businesses that need it. That infrastructure will be costly, and require easements through other people’s properties. Well water is not reliable and it will need to be treated. The spring water it currently uses does not need to be treated. The city is looking for something in the ownership records to show it could be determined as an owner.

WAYNE COUNTY MI UPGRADE

Recovery continues to be a theme of the greater Detroit area. Moody’s announced that it had upgraded to Ba2 from Ba3 the rating on Wayne County, MI’s outstanding general obligation limited tax (GOLT) debt and assigned a positive outlook. The county has $510 million of long-term GOLT and GOLT-supported lease bonds outstanding and $287 million of short-term GOLT delinquent tax anticipation notes. The upgrade reflects improvement in the county’s financial position. This is in the wake of substantial reductions in retirement liabilities and associated costs. Moody’s feels that these resources may be applied to address outstanding capital facility needs. The economy is viewed as recovering but still comparatively weak. The demands on the tax base are steep when you include the liabilities of overlapping governments (primarily the City of Detroit), and limitations on the county’s ability to raise revenue to accommodate growth in costs including debt service.

The upgrade, while still resulting a in below investment grade rating, marks a milestone on the path back from near insolvency. The county can hopefully continue to enhance its operating reserves while accommodating increased costs associated with outstanding criminal justice facility needs. These include the ongoing capital costs of a new jail. In spite of all of the challenges experienced by its primary municipalities, the one of the twenty largest in the country despite multiple decades of contraction.

ALASKA TURNS TO PENSION BONDS

The steady drumbeat of oil prices and their impact on the State of Alaska’s finances have been well documented here. The effect of low interest rates and declining investment returns nationwide for pension investors have been as well. These two factors have combined to pressure the state’s pension funding levels. With lower levels of resources and political will to spend them, it is becoming more difficult for Alaska to deal with its pension funding needs. Hence, the upcoming planned offering of some $2.3 billion of taxable pension bonds.

Alaska is one of the state’s where pension benefits are constitutionally protected. Under Article 12, Section 7 of the State Constitution establishes that membership in an employee benefit plan constitutes a contractual relationship and that accrued benefits may not be impaired. Article 1, Section 15 of that same Constitution prohibits legislation impairing contracts.

In 2005, the state closed its defined benefit plans and instituted defined contribution plans for its employees. Nonetheless, the legislation establishing the change required up to $5 billion of debt to fund it. Among the conditions to any such borrowing are that the State have certain minimum debt ratings. With is credit weakening, the window for the State to issue such debt is closing.

Like most pension bond offerings, this issue relies on annual appropriations from the legislature. Proceeds will fund portions of the unfunded liabilities of the Teachers and Public Employees Retirement funds. The plan expects to achieve a funding ratio of 81% for the Public Employees fund by the end of FY 2017. The borrowing also helps to compensate for investment returns in FY 2016 of negative 0.36% versus an assumed rate of return of 8%.

CRIMSON FEEL THE INVESTMENT BLUES

We’ve spent a lot of time on public pension funding difficulties related to the challenging investment faced by public pension funds. It reinforces the view of the difficulties for even the largest and most sophisticated investors to view the preliminary official statement issued to support the upcoming issues of debt to be sold on behalf of Harvard University. The document includes information on the University endowment for the  fiscal year ending June 30, 2016.

The University blames the results on volatility in the investment markets. The University does note that it smoothes the results of endowment revenues into its revenue assumptions underlying its annual budgets. The distribution rate from the endowment have averaged 4.4% over the last twenty years. It should be noted however, that the distribution rate has been a higher 5% annually for each of the last five years.

Like many similar investors, the University’s outlook and goals are somewhat ahead of current rates of return. The University’s goal for real returns on the endowment are 5% going forward. At the same time, the endowments returns have declined steadily in terms of outperformance over the last ten years. Now before you go off and despair over the future prospects for the Crimson going forward, keep in mind that even with the loss, the endowment was valued at $35.7 billion after the FY 2016 results. And Harvard

It is however, one more reinforcement of the notion that pension fund and endowment currently bedeviling investment managers will continue to be difficult. The pension and endowment issues simply will not go away for public and non-profit investors.

CALIFORNIA MUNICIPALITIES BENEFIT FROM MOODY’S STANDARDS

On July 26, 2016 Moody’s announced a series reviews of county and local ratings in conjunction with developments of the Lease, Appropriation, Moral Obligation, and Comparable Debt of US State and Local Governments methodology used to evaluate these credits. The latest series of ratings changes have impacted municipalities in California, in large part favorably.

At quarter end, the Lease, Appropriation, Moral Obligation, and Comparable Debt ratings were upgraded for Shasta, San Joaquin, Los Angeles Counties. Poway, Newark,  and San Mateo also received upgrades. The bonds are generally secured by lease payments made by the municipalities for use and occupancy of the leased assets.

CAROUSEL CENTER BACK TO THE MARKET

One of the more interesting high yield credits in the New York market has been debt issued for the Carousel Center in Syracuse, NY. With many changes challenging the retailing industry (Macy closings, the difficulties of K Mart and Sears, the recently announced merger of Bass Pro and Cabelas), many investors are reexamining the viability of debt which relies on viable retail projects for repayment of that debt. They include bonds like these which rely on developer/operator payments and debt which relies on retail development t to generate property tax revenue to repay debt.

The Carousel Center is a 1.5 million square foot (gross leasable area GLA) shopping mall that is part of a total 2.4 million GLA retailing facility known as Destiny USA. The Carousel Center serves as the anchor for the larger project. Some 18% of the Carousel Center consists of a Lord and Taylor and a Macy’s, which retain the right to exclusive possession of their respective spaces through mid-December 2056.

The bonds are special obligations of Syracuse Industrial Development Agency, secured solely by scheduled PILOT payments for the existing Carousel Center (pursuant to a PILOT agreement between the Carousel owner and SIDA). A DSRF requirement equal to 125% of average annual debt service is also provided. Failure to pay its PILOT obligations, barring an equity cure, would result in a foreclosure on the Carousel Center. The security incorporates structural support, such as the seniority of PILOT payments to the Carousel Center’s operating and maintenance expenses, mortgage costs, and owner distributions.

When originally conceived, the project was believed by its developers at that time to be capable of drawing the same numbers of visitors annually as Las Vegas did. While that lofty goal has not been realized, Destiny USA did draw some 26 million visitors in 2016. It is the sixth largest enclosed mall in the US. The property’s stable sales per square foot and occupancy are both comparable with other high-end commercial malls around the country. Historical operating performance includes approximately 94% occupancy on average as reported by the owner. That performance has now generated Baa1 (Moody’s) and A- (Fitch) ratings for these refunding bonds.

VA. ROAD MAY GET ANOTHER CHANCE BUT WILL IT BE A P3?

Virginia’s beleaguered U.S. 460 project got a key provisional permit from the U.S. Army Corps of Engineers last week. The lack of such an approval derailed prior efforts after nearly $300 million in spending. Other signoffs remain before the state can build and reconstruct about 17 miles of road from U.S. 58 in Suffolk and west through Zuni. The state also must find funding for the project, which is now estimated at $425 million beyond money already spent without ever turning dirt. This Corps of Engineers permit puts plans further along than they’ve ever been, though, despite decades of expansion talk. The state canceled the prior project in 2014.

VDOT’s wetlands permit is provisional at the moment, though most of what remains there is just a formal signatory process. Their plan now calls for an untolled four-lane divided highway from Suffolk, bypassing Windsor to the north. The state would also rebuild the current U.S. 460 through Zuni with a new bridge across the Blackwater River. The state recently overhauled its roads prioritization process, implementing a grading process dubbed “Smart Scale.” Opponents  predicted that the new 460 likely won’t score well under that formula, which weighs various project benefits, such as congestion reduction and safety improvements.

The revised and scaled back project impacts some 35 acres of wetlands, according to VDOT. The initial design impacted more than 480 and the mitigation efforts regulations would have required to offset that impact would have been the largest in Virginia history.

MCN IS A PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News has partnered with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com.

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

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…

NEW JERSEY FINDS NEW TRANSPORTATION FUNDING

ILLINOIS FACES DEADLINE; GETS DOWNGRADE

GREAT LAKES WATER AUTHORITY

PROMESA MOVES AHEAD

MORE PRIVATE PRISON BOND PROBLEMS

______________________________________________________________________________

NEW JERSEY LEADERS AGREE ON GAS TAX HIKE

The Governor, Assembly Speaker, and Senate President jointly announced that they had reached an agreement to raise the state’s gasoline tax by 23 cents a gallon to pay for improvements to roads, bridges and mass transit systems. A compromise  was found after an impasse that had lasted for months and stalled hundreds of transportation projects. In exchange for Mr. Christie’s agreement on what he said was the first tax increase of his two terms in Trenton, the legislative leaders agreed to lower the state’s sales tax by less than half a penny and to phase out the estate tax by 2018.

According to the Governor, the sales tax rate would decrease next year to 6.875 percent, from 7 percent, and then in 2018 to 6.625 percent. He claims that the gas tax would pay for an eight-year, $32 billion reauthorization of the state’s Transportation Trust Fund. He said that “$32 billion will be invested in infrastructure and improvements and modernizations in the state of New Jersey over the next eight years.”

The announcement comes one day after a horrible crash involving a New Jersey Transit commuter train. The third-busiest commuter system in the country, New Jersey Transit has been operating without an executive director for nearly a year and its board of directors has not met for three months. It faces an unfunded $45 million gap in its budget this year. The board began suspending monthly meetings in June, when New Jersey Transit’s interim management found itself with a state budget that left the agency about $45 million short of what it needed to operate this year. At 37.5 cents a gallon, gas taxes in the Garden State will go from second-lowest in the U.S. to seventh-highest.

The Transportation Trust Fund provided more than one-fifth of New Jersey Transit’s annual budget. In July, Mr. Christie ordered the suspension of all highway and transit projects paid for by the trust fund. The near depletion of its funds this summer reflects the declining annual contribution to New Jersey Transit from the state’s general fund, less than $35 million last year — about one-tenth of what it was in 2009. Over the period of time the fund was stopped from spending this summer, NJ Transit has seen three accidents in its bus and train systems including two with fatalities.

While its ability and willingness to fund debt service on its bonds has not been questioned, the Transportation Fund has been under sustained pressure to cut costs. It’s spending on rail has been a prominent topic. That will only increase in the face of this latest incident. A technology known as positive train control automatically brakes a train when it runs a stop signal or exceeded speed limits. Federal officials have called for passenger railroads to adopt positive train control by the end of 2018.The Federal Railroad Administration said that New Jersey Transit had not yet installed the technology.

ILLINOIS G.O. RATINGS UNDER THE GUN

S&P Global Ratings lowered Illinois’ credit rating one notch to BBB and warned it could fall further absent a long-term solution that deals with the state’s chronic structural budget deficit and pension woes. “The downgrade reflects our view of continued weak financial management and increased long-term and short-term pressures tied to declining pension funded levels.” S&P said another downgrade could follow “should the state continue to demonstrate a lack of ability or willingness to adopt a long-term structural budget solution that also incorporates a credible approach to its long-term liabilities.”

The state’s liquidity position, a lingering source of concern was also referenced. “Although we don’t foresee this in the immediate future, challenges to the state’s debt payment priority could emerge should liquidity dwindle to the point where it affects the state’s ability to provide essential services,” S&P said.

Fitch Ratings rates the general obligation (GO) bonds of the state of Illinois at BBB+. Illinois plans to issue $1.349 billion GO refunding bonds and $483.045 million new money GO bonds this month and next month. Fitch maintained a Rating Watch Negative on the ratings of the state and related credits like the Illinois Sports Facilities Authority sports facilities bonds;  Metropolitan Pier and Exposition Authority McCormick Place expansion project bonds; and city of Chicago motor fuel tax revenue bonds.

Fitch expects to resolve the Rating Watch by the end of January based on the progress of the fiscal 2017 budget for the fiscal year that began July 1, 2016. At that time, Fitch will assess state action to address the chronic and growing financial imbalance that has resulted from an unwillingness to make use of the significant gap-closing tools available to the state.

The rating continues to be pressured in spite of State statutory mechanisms which include an irrevocable and continuing appropriation for all GO debt service, and continuing authority and direction to the state treasurer and comptroller to make all necessary transfers from any and all revenues and funds of the state. The state funds debt service in advance by setting aside 1/12 of principal and 1/6 of interest every month for payments due in the ensuing 12 months.

Fitch is clear. To stabilize the rating, the state will need to address the fiscal 2017 budget following the election in November or at the latest during a January legislative session. While it is unlikely that any actions taken would fully address the fiscal 2017 budget gap, Fitch will be looking for a solution that is comprehensive in its approach, addressing structural budget balance and including a plan to address accumulated liabilities. Failure to do so would result in a rating downgrade.

Illinois’ GO ratings were affirmed at Baa2 by Moody’s.

Governor Bruce Rauner’s office said of the situation with the State’s ratings “It’s time for the super majority in the legislature to recognize the current pension system is fatally flawed and requires immediate action. “Governor Rauner continues to fight for pension reform and other fundamental, structural reforms that will free up resources to help balance the budget.”

GREAT LAKES WATER AUTHORITY

The Great Lakes Water Authority has been operating the largest regional water and sewer system in Detroit and its suburban area since the beginning of 2016. This area comprises nearly 4 million people, approximately 38% of the population of the State of Michigan. The Authority provides service on a wholesale and retail basis. It operates the filtration and treatment facilities of the former City of Detroit Water and Sewer systems which have been the historic lynchpin of the southwestern Michigan regional water and sewer service area.

The Authority leases the treatment and filtration facilities from the City of Detroit. It derives revenues from the sale of water at retail to customers formerly served by the City of Detroit Water Department and at wholesale to 127 suburban water systems in all or part of eight counties in the greater Detroit metropolitan area through 87 contracts. Water is supplied from drawings from Lake Huron.

Revenues are applied to the operation and maintenance costs of the leased treatment and transmission facilities. Rates are expected to be sufficient to cover operation and maintenance, debt service, and reserve requirements and to cover debt service 1.15 times.  After application to O&M, revenues are applied monthly in installments in amounts sufficient to meet one sixth and one twelfth of annual interest and principal requirements. Debt service reserves must be maintained equal to maximum annual debt service. The Authority is permitted to issue junior lien bonds which are payable from net revenues after all requirements of senior lien debt are provided for including maintenance of required reserves.

Total debt outstanding is $2.275 billion including amounts representing City of Detroit Water and Sewer revenue bonds assumed by the Authority as a part of the overall plan of remediation adopted by the City of Detroit as part of its exit from Ch. 9 bankruptcy. The Authority is authorized to issue additional debt subject to either historical or projected net revenue coverage tests.

These sales will come in the wake of an upgrade to the Authority’s Water and Sewer bonds to A3 from Baa1 and to Baa1 from Baa2 the senior and second lien revenue ratings. The upgrades reflect improved financial metrics resulting from revenue growth, rate restructuring to enhance collections, and ongoing implementation of operating efficiencies. The ratings also incorporate the massive scale of sewer operations in southeast Michigan, a recovering but highly vulnerable economic base, very high leverage of pledged revenue, and the large share of revenue sourced from retail operations in the City of Detroit .

PROMESA MOVES FORWARD

The board established by the Puerto Rico Oversight, Management and Economic Stability Act (Promesa) officially has taken over the fiscal course the island will be following  for the next few years. During a recent public meeting in New York, the appointment of Jose Carrión  III as board chairman was unanimously approved. The members also established that the process to select the board’s executive director would be utilizing a talent search firm to identify the most competent person for the job. The date on which the official appointment will be made was not revealed.

Along with the executive director, also to be filled will be the position of coordinator as well as the rest of the team, which Carrión said will include attorneys. The chairman said the decision to seek legal advice is related to a request by Gov. Alejandro García Padilla in order to intervene in cases that his administration faces in Federal Court. Members listed the  public entities to be placed under the board’s immediate oversight. Puerto Rico’s central government, three retirement systems (teachers, judicial and employees), university (UPR) and all its public corporations, including the Aqueduct and Sewer Authority and Electric Power Authority, were placed under the immediate control of the entity.

Gov. Alejandro García Padilla was also required to inform the board periodically on cash flow, bank accounts, revenue, receipt and disbursement of federal funds and payroll. Oct. 14 was established as the date of for the governor to deliver the fiscal plan, although it is yet to be known if the board adopted a timeline proposed by the governor in his broadcast message Thursday.

PRIVATE PRISON PROBLEMS CONTINUE

The Internal Revenue Service (IRS) is conducting an audit of the Baker Correctional Development Corporation $45,000,000 First Mortgage Revenue Bonds (Baker County Detention Center Project) Series 2008. Although no final notice or determination has been received from the IRS, the IRS has informally advised the Issuer that the IRS’s position is that the interest on the Bonds is not excluded from gross income for federal income tax

The finance director for the Baker County Sheriff’s Office, confirmed that the IRS audit found the bonds failed to meet the private payment use test due to the jail’s large federal inmate population. “From what I can gather from speaking with the IRS and our attorneys, the IRS is wanting us to pull the bonds off the market as quickly as we can,” the finance director said. “We’ve interpreted that to be 60-90 days.”

As of last week, the Baker County Detention Center, located in Macclenny, Fla., has 480 inmates, roughly 350 of which are federal. The detention center, which opened in Sept. 2009 and is roughly 30 miles west of Jacksonville, is owned by BCDC and operated by the Baker County Sheriff’s Office. BCDC was formed as a nonprofit in 2006 to acquire, construct, maintain and/or operate one or more jails in Baker County.

The tax exemption issue just adds to the difficulties for the County in its prison operation.  The U.S. Immigration and Customs Enforcement’s (ICE) enforcement and removal operations division began housing detainees at Baker County Detention Center in 2009 under an intergovernmental service agreement with Baker County, according to ICE. The use of private facilities by the USDOJ will be ending and ICE is also reviewing its use of contract facilities to house detainees.

Tax-exempt bonds become private activity bonds if more than 10% of the proceeds are used for private use and more than 10% of the debt service payments are from or secured by private parties. Under the federal tax code, PABs are only exempt if they are issued for “qualified” purposes; jails do not fall under a qualified category. The federal government is deemed a private entity in under the federal tax code, while state and local governments are classified as governments.

In 2011, BCDC entered a forbearance agreement for principal payments on the $45 million bond issuance in 2008. The move came after the jail had lower-than-projected inmate counts and higher-than-expected startup costs. On average, the jail is comprised of roughly 60-70% federal inmates, the finance director said, making it more than six times as high as the private payment test allows. That ratio has been relatively consistent over the past six years. The federal government pays BCDC $84.72 per day for each federal inmate it houses.

Tax counsel for BCDC, told bondholders that he and the IRS have set a “joint target date” to wrap up the audit by the end of October. Dame said Baker is considering refunding the jail bonds with a bank loan, but no letters of interest have been sought yet.

MCN AND COURT STREET GROUP RESEARCH

The Muni Credit News has partnered with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com.

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

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

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

OREGON

The State of Oregon will be issuing general obligation bonds. The preliminary official statement gives us a chance to look at the state’s pension position as it deals with the aftereffects of a state Supreme Court decision voiding enacted changes to COLAs and benefit levels and consecutive years of low investment returns. While funding levels remain adequate, the trends and signs do not give comfort.

The State Pension Board approved changes in 2013 that would have limited COLAs and reduced benefit increases for pensioners who had moved out of state. The Board estimated that these changes would have reduced the unfunded liability of the State by some $5 billion. Unsurprisingly, beneficiaries initiated litigation to fight these changes. In April, 2015 the Oregon Supreme Court issued a decision.

The Court found that the changes to benefits for out of state retirees were legal but found that the proposed changes to COLAs for benefits earned before June, 2013 were unconstitutional. The change in COLAs for benefits earned after that date were legal to be enacted.

In light of the 2015 decision, the State Pension Board made several changes to the assumptions used to determine the state’s liability funding requirements. Primarily, it changed the investment earnings rate assumption from 7.75% to 7.5%.  However, this change follows a prior adjustment lower in employer contribution rates and it comes on the heels of another year of low returns, 2% for 2015.

The net result has been a decrease in the funded liability ratio. Ten years ago the State’s two primary pension systems were actually overfunded at 115% and 112%. Now in the face of unfavorable demographics, lower contributions, and unfavorable investment results, the funded ratios are at 84%. When market values are used, the funded ratio is below 80%.

The State’s pension consultant estimates that an increase of 10.9% in the employer contribution would be required for the State to begin to recover the changes in the unfunded liability. This would represent a substantial burden for the State which has already seen reserves drop by 50% over the current biennium. Under those circumstances, such increased spending is not likely. The combination of lower reserves and a lack of progress on reversing the state’s pension funding trends do not bode well for the State’s credit going forward.

HOUSTON PENSION PROPOSAL RECEIVES SCRUTINY

The mayor of Houston has issued a proposal to deal with the city’s longstanding pension funding issues. Houston today faces an increasing unfunded liability for its employee pensions that totals at least $3.9 billion, as of 2015, up from $212 million in 1992. All three of Houston’s pension systems are underfunded, with the Houston Municipal Employees Pension System (HMEPS) being the most severely underfunded.  Underfunding has arisen from a variety of sources, including (1) annual payments that do not ensure full funding and (2) assumed rates of investment returns that are higher than the national average and higher than recent experience.

The City has been under scrutiny since the turn of the millennium for its pension practices. Now a comprehensive plan has been advanced to fund the City’s liability for pensions over a 30 year period. The plan includes lowering the assumed rate of return on investments to 7 percent instead of the current 8 to 8.5 percent, cuts to some retiree benefits, and the issuance of some $1 billion of pension obligation bonds. It also includes a system of thresholds — as of yet undefined — that would trigger further negotiations between the city and the pension boards in the future, depending on changing financial conditions. Notably, the plan does not include a switch to a defined contribution plan.

A lack of support so far from the firefighters’ pension board is a potential roadblock. To move forward, the plan must win approval from three pension boards.  The proposal will go before city council within the next few weeks, according to the mayor’s office, then it would need approval in the legislature. In addition, litigation could be filed against any changes enacted. Failure to achieve these changes would likely result in a property tax increase which would likely receive a chilly reception from voters.

Raising the revenue cap would increase property taxes up to previous levels but has the potential to raise $40 million to $60 million per year or more if the economy picks up and property values rise. Increasing HMEPS employee contributions could generate $30 million per year at first, rising to $100 million per year over time, but would reduce workers’ take-home pay. Reducing the COLA to 1 percent could save close to $100 million per year by some estimates at first but would put retirees at risk of falling behind inflation.

ALASKA CUTS PERMANENT FUND DIVIDEND

Earlier this year, we profiled the magnitude of the budget problems facing the State of Alaska in an era of low energy prices. Governor Bill Walker announced the amount of the 2016 Permanent Fund Dividend. Starting October 6th, over 643,000 eligible Alaskans will receive a $1,022 check. Had the Governor not vetoed part of this year’s PFD appropriation, eligible Alaskans would have received a $2,052 check, or $1.3 billion total. This exceeds the $1.2 billion in revenue the state is projected to collect in fiscal year 2017. In late June, Governor Walker announced his fiscal year 2017 budget vetoes and his intention to veto half the money appropriated to dividends as a move to preserve the state’s savings.

Since the program’s inception, the average PFD has been about $1,100. Over the past two years, Alaska has lost over 80 percent of its income, resulting in an over $4 billion budget deficit. According to the Governor, Alaska has been drawing down on the Permanent Fund at a rate of $12 million a day. He contends that if Alaska does address its budget issues soon, it will have burned through the money available for future dividend checks.

Governor Walker had offered a fiscal year 2017 budget calling for $100 million in additional cuts from the operating budget and $425 million in cuts from oil exploration credits. His plan would have changed the oil and gas tax credit system into a low-interest loan program, wherein the rates would have been determined by the number of Alaskans the companies hire. To honor existing commitments for credits, that FY17 budget allocated $1.2 billion for a transition fund and loan program.

The minimum tax on the oil industry would have increased by $100 million. The mining, fishing and tourism industries would have been taxed for projected revenue of about $47 million. The plan also called for an income tax of 6 percent of federal tax liability, which is about 1.5 percent of income for the average Alaskan family, for projected revenue of about $200 million. Taxes will also would have been levied on alcohol, tobacco and motor fuel for projected revenue of $112 million. The legislature would not go along.

LEGISLATION PROPOSED TO AID HISTORICALLY BLACK COLLEGES

Rep. Keith Ellison (D-Minn.) last week introduced the HBCU Investment Expansion Act,  (local, state, and federal).  The bill is co-sponsored by Alma Adams (D-N.C.), whose district includes HBCUs in Greensboro, Salisbury and Charlotte. A recent study by Drexel, the University of Notre Dame, Duke University, and University of California San Diego found black colleges pay higher fees to raise money through bonds and often forced to sell them at a discount. The study was an analysis of 4,145 bonds issued by tax-exempt colleges between 1988-2010. Among those bonds, 102 were issued by 45 HBCUs.

TEXAS FUEL TAX BONDS

We have discussed recent trends in motor fuel tax revenues across the country and the impact that changes in driving habits and sustained low oil prices could lead to changes in the long term in how the states and federal government fund highway development. This does not mean that motor fuel tax financings are dead or not viable. The latest example is the pending Texas Transportation Commission State Highway Fund bond issue.

The Texas State Highway Fund generates revenues from retail motor fuel taxes, motor vehicle registration fees, and funding from the Federal government. Fuel tax revenues and Federal funds are about equal. All told, these revenue sources aggregated $7.4 billion in FY 2015. Texas collects $0.20 per gallon for gasoline and $0.15 for diesel at the pump. After deducting 1% for administration, 50% of the remaining revenues are distributed to the Fund.

Motor vehicle registration fees are distributed to the Fund and to the state’s counties. These monies have averaged 32% of total fund revenues over a period of six years. Federal monies are received pursuant to Congressional authorizations and they reimburse the Fund for projects financed by the State of Texas. Historically, these monies were appropriated pursuant to multi-year authorizations. From 2009 to 2014, authorizations were made annually after protracted budget disputes between Congress and the Administration. Finally in 2015, Congress passed a multi-year authorization that is in place through the end of Federal fiscal 2020.

While there are general concerns about national trends, these revenues have a strong record in Texas. The Commission projects that based on FY 2015 available pledged revenue, that debt service coverage will average some 17.5 times over the life of the issue. That is enough to earn the credit a rare triple A rating.

PROMESA

A hearing Friday in U.S. District Court where plaintiffs in four consolidated lawsuits are seeking a relief from the stay imposed by Promesa provided some insight as to the hurdles going forward faced by The Fiscal Oversight Board in charge of managing the island’s fiscal affairs. According to witnesses for the P.R. government , the Board is getting briefings from the U.S. Treasury Department on Puerto Rico’s fiscal problems and is in the process of hiring technical and legal advisors.

It was suggested the government may try to convince the fiscal oversight board to use a “consolidated approach” toward the restructuring of Puerto Rico’s debt instead of doing individual restructurings. The Puerto Rico Oversight, Management and Economic Stability Act (Promesa) contains a process toward debt restructuring. The board is slated to meet Sept. 30 to select its chairman.

The plaintiffs are concerned that creditors could lose what they lent the government if money destined to repay debt is used for other purposes while the Board conducts its work. It won’t be however until at least mid-October when Besosa is expected to issue a ruling on the stay. He instructed the parties to file post-hearing memoranda ten days after the transcript of the hearings, which ended Friday, are filed and include in their memoranda their response to the United States Statement of Interest submitted earlier last week.

The U.S. Justice Department urged the hearing judge not to grant any relief from the stay to the plaintiffs: U.S. Bank Trust National Association, Brigade Leveraged Capital Structures Fund Ltd, National Public Finance Guarantee Corp. and the Dionisio Trigo group of bondholders, until the fiscal control board is organized. The Justice Department said it has a strong interest in ensuring that Promesa’s statutory purpose—stemming the downward spiral of Puerto Rico’s fiscal and economic condition—is not vitiated by the lifting of the stay.

“The United States, nevertheless expresses its view that, given the unique context of a Federal statute that provides a comprehensive framework for Puerto Rico to restructure its debts in a fair and orderly process as well as the establishment of an independent Oversight Board to ensure fiscal responsibility, relief from the automatic stay at this juncture could frustrate Congress’s intent in designing Promesa,” the document states.

The plaintiffs are claiming, essentially, that the Moratorium Act, which allows the governor to suspend debt payments of certain obligations, be declared unconstitutional because it substantially impairs contracts; takes property for the benefit of the commonwealth without just compensation and is preempted by the federal Bankruptcy Code. They also say the statute is hindering negotiations with creditors because it establishes a priority of payments for certain creditors. The government contends it needs the stay to remain in place to have breathing space to start a process of debt restructuring and accumulate funds to pay creditors. Officials also said the Moratorium Act has established an orderly process for the government to make payments. Repealing the statute will cause a “rush by creditors.”

A plaintiff witness said the Moratorium Act aborted negotiations to restructure Government Development Bank (GDB) debt because amendments made in May to the law gave island credit unions, or coops, a preferential treatment in the disbursement of payments. He said the Act has contributed to the level of uncertainty that has prevented negotiations to restructure the debt. The Ad-Hoc had agreed to a 53% haircut on its bonds. A government witness contended that the  negotiations with the Ad Hoc group went downhill because they sued the government and not because of the Moratorium Act.

Each side has offered “expert” testimony in support of their contentions. The bondholders contend  the government has made the conscious decision to renege on its debt commitments when it could actually pay. They insist that the government is not doing its best efforts to reduce expenses. To operate, the government is taking money destined to pay debt and using it to pay for services but it is not tackling expenditures. They claim that In the current budget, the government decided not to allocate $1.2 billion for debt service but increased other expenditures.

An Assistant Secretary of the Treasury for the Treasury Department, testifying for the Commonwealth, testified that the Moratorium Act was needed because it has provided an orderly structure for the central government and its agencies to make payments to keep essential services while at the same time attempt to restructure the debt.  She described the government’s liquidity as delicate and situations, such as the recent power outage, have made matters worse. She noted that after the hearing she had to go to Banco Popular, where the government accounts are kept, to authorize payments to police officers because of an overdraft in the Police Department’s account. The agency failed to notice the overdraft because of the power outage.

According to that witness, if it were not for the Moratorium Act, the government would be forced to shut down because it would not be able to pay for general services nor save funds to pay bondholders. She said the government issued an executive order declaring a default because of the shortage of funds in the government’s central account. The government had to pay $779 million in general obligations; some $257 million in tax refunds and over $394 million to suppliers. However, it had $244 million available.

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

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

PREPA

Following an explosion in its Aguirre central power facility on Sept. 21, most of the 1.5 million people subscribed to the P.R. Electric Power Authority (PREPA) had no energy service, while approximately 400,000 PRASA clients were affected. As of this writing, those numbers were reduced to 300,000 clients without electricity, and 140,000 without water— figures that are still changing. The Electric Power Authority said it is investigating what caused the fire at the Aguirre power plant in the southern town of Salinas.

The fire knocked out two transmission lines that serve the broader grid, which tripped circuit breakers that automatically shut down the flow of power as a preventive measure, officials said. Executive director Javier Quintana said a preliminary investigation suggests that an apparent failure on one transmission line that might have been caused by lightning caused the switch to explode.

Garcia denied the blackout was caused by maintenance problems that have plagued the utility for years, largely a result of the island’s economic crisis. He said the switch where the fire happened had been properly maintained. It was not yet clear how much damage the fire caused. The utility is struggling with a $9 billion debt that it hopes to restructure as it faces numerous corruption allegations. Company officials have said they are seeking revenue to update outdated equipment.

This could not have come at a worse time for the Authority. Its effort to renegotiate its debt requires legislative support for a substantial rate increase. Now that there are additional questions about reliability and maintenance, that support will be harder to gather. The outage also comes in the midst of court proceedings involving corruption in P.R. agencies the Authority. All in all a more difficult environment in which to effect a  settlement of PREPA’s debts and avoid additional defaults.

PRASA

The Puerto Rico Water and Sewer Authority, PRASA, was a major victim of the power outage as well. Approximately 400,000 customers were impacted as filtration and pumping equipment could not be operated. This damaged supply as well as deliveries. The costs of recovery have yet to be calculated and the event will obviously impact revenues. There will be demands for better backup and redundancy which will raise even greater financial challenges for the Authority as it fights to meet its debt service obligations. The greater repair and other capital requirements will increase both its needs for capital and the likelihood of interruptions in the payment of existing debt service.

ATLANTIC CITY AT THE BRINK

Atlantic City has until Oct. 3 to correct its breach of a $73 million bridge loan from the state. the city is in default under its bridge loan agreement with the State as it failed to come up with a plan as required to divest itself of its municipal utilities authority. See the 9/15/16 MCN for more on this situation.

Even if the City comes up with a plan, the state must approve like it. This is far from assured. Should the City be unable to satisfy the State, the likelihood of a state takeover of the city’s finances increases substantially. The relatively short deadline for the City to come up with a cure for the default, makes such a takeover more imminent then we initially thought.

The city has drawn at least $13.5 million from the state, but most of the loan is dedicated to paying back the state for deferred employee health and pension payments and a city school-tax payment. City officials have said the city wouldn’t be able to repay the loan at this time. Liberty & Prosperity, an organization represented by a former City Councilman, has a pending lawsuit that aims, in part, to void the loan agreement. Grossman claims a July 28 council meeting when the loan was approved violated state Sunshine and Local Budget laws.

One thing has swung in the city’s favor. The businessmen leading a group  supporting a November ballot referendum to bring casinos to northern New Jersey all but conceded defeat last week when they announced an end to their advertising campaign. Polling shows the referendum is opposed by a 2-1 margin. If the referendum is rejected Nov. 8, state lawmakers would have to wait two years to attempt to put it on the ballot again.

As we go to press the City has unveiled a proposal for the Municipal Utilities Authority to buy the city’s airport, the former Bader Field, in an effort to satisfy  a key demand from state officials who are threatening to take over the City’s operations. The mayor said the land sale is the first of seven major debt reduction initiatives his administration will introduce over the coming weeks to fend off a state takeover and avoid the need for a bankruptcy filing.  Proceeds from a Bader Field sale are part of the collateral the city put up against its state loan, but Guardian said the city has one year to monetize its utilities authority before the state can intervene.

Bader Field was the first aviation facility anywhere in the world to be called an “airport.” The authority’s executive director said the authority will not dispose of the property without first getting an agreement from the city. The city has suggested that Stockton University, which is building a new campus next to the land, may eventually want some or all of it for athletic fields, an athletic building or dormitories. The city tried to sell Bader Field earlier this year, but did not get bids in excess of $50 million, or about half what the city feels it is worth.

We see this proposal as a part of an ongoing process whereby the City introduces any number of trial balloons in its effort to avoid state control. Should they amount to nothing, we see a state takeover as the more likely outcome than bankruptcy.

CHICAGO BOARD OF EDUCATION

Over the years, one of the greatest hurdles to be overcome in the effort to balance the finances of the Chicago Public Schools and deal with its pension liabilities has been the consistent lack of cooperation from its teachers union. Long one of the most militant of the nation’s teachers unions, it has employed a number of hardball tactics essentially given up by other teacher representatives across the country.

In that tradition, the Chicago Teachers Union announced this week that its members have authorized its leaders to call a strike if contract talks break down. The union said just over 90 percent of its members voted in a petition distributed over three days last week, and about 95 percent of those who voted gave the go-ahead for a strike. State law requires at least 75 percent of total CTU membership to authorize a strike before one can occur. The move was not unexpected. The union has to give at least 10 days’ notice before a walkout can take place. A date could also be set for a later time. The first possible date for a teachers strike” would be Oct. 11.

A strike would harm the interests of both sides as state aid to the school district is tied to daily attendance over a prescribed number of days. No school, no aid. Union members also authorized a strike in a vote taken last December.  Should a strike occur this time, it would be the third one since Mayor Rahm Emanuel took office in 2011. In the end, the union’s ongoing resistance to reform is a major negative weight on the CPS credit.

NYC AND TAX ABATEMENTS

The presidential debate has helped to focus much attention on Donald Trump and his use of tax abatements to enhance the profitability of his New York developments. One report estimated that he has benefitted to the tune of $889 million from such abatements over his four decade career. Those of us who have economics in our background know that these sorts of deals are also called tax expenditures. While there may not be a direct monetary expenditure to support a project, an abatement or tax expenditure serves the same purpose.

Earlier this year, one of New York City’s major development-related tax abatement programs, 421-a, expired, impacting the development of multi-family housing.  Just because the program was suspended does not mean the city is not still paying for previously granted tax breaks. In 2017, the current fiscal year, the city will forego $1.4 billion in property tax revenue due to exemptions granted in prior years. The last of the properties awarded 421-a benefits before the program’s expiry are not expected to fully return to the property tax roll until 2044. The abatement for the Hyatt Hotel project at Grand Central – the project that launched the Donald’s career in 1980 – will not expire until 2020.

This particular program has some troublesome characteristics. Since fiscal year 1998, only 16 percent of the total tax expenditure awarded each year on average is attributable to newly exempted properties. For the 2017 tax roll, $94.2 million in new 421-a tax expenditures were added, the largest volume increase since 2013 and $14.2 million greater than the 20-year average. Buildings that started construction after 2008 are subject to a cap on the amount of value exempted regardless of appreciation. However, for older buildings the value of the exemption can continue to grow as properties appreciate.

The takeaway is that these programs must be carefully targeted and designed. While many were granted during times of economic uncertainty, the long-term budget impact and current economy of the City argue against maintenance of the same design. There are many ways to address the City’s shortage of affordable housing without impacting the revenues available for services for the residents.

HARTFORD BUDGET WOES GROWING

Yet another state capital is in the news for its poor financial condition, this time it is Hartford, CT. Days after Mayor Luke Bronin revealed that the city’s budget gap has grown to more than $22 million this year, Standard & Poor’s lowered Hartford’s G.O. bond rating to BBB from A+. The change ” reflects the city’s structural imbalance without a credible plan in place to return to balanced operations.”

The fiscal 2017 budget imbalance is blamed on the use of reserves and labor concessions that have not been realized.  The city is facing significant out-year budget gaps in excess of $30 million in 2018 and $50 million as well. The mayor has said what Hartford did for many years was to hide its true position. City projections show Hartford’s budget shortfall has widened to $22.6 million this year, up from $16.5 million. The deficit is linked to employee concessions that haven’t materialized, a sizable legal settlement and debt service on a baseball park.

The mayor has asked frequently in recent weeks for legislative reform that would give Hartford and other cities new ways of raising revenue. Connecticut’s municipalities have long relied primarily on property taxes to fund critical services. He renewed that view after the S&P downgrade saying “we can put Hartford and the capital region on a path to fiscal health and economic growth, but it’s going to take everyone coming together — in Hartford, the region and the state — to face the realities that we need to face.” His position is that the city of Hartford can’t cut or tax its way out of this challenge by itself.

Waterbury was the last Connecticut municipality to seek state oversight when the legislature established a financial review board in March of 2001. The specific goal in that case was balancing the city’s budget for five straight years. That review board maintained control of Waterbury’s finances until 2007. Bankruptcy has been mentioned but we see the likelihood of that as being quite small given the State’s history of intervention when the City of Bridgeport filed for Chapter 9 protection in 1991.

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

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

LATEST TWIST IN CHICAGO OPEB SAGA

On September 15, a state appeals court ruled on an appeal in the ongoing Korshak litigation which deals with OPEB benefits for city employees after 2013. We discussed that ruling in our July 18, 2016 issue. A three judge panel unanimously agreed that the trial court erred by striking defendants’ motion to enforce a settlement agreement. The settlement was modified and the court had jurisdiction to enforce the modification. The City agreed to provide benefits to its retirees for the entire 2013 plan year and its assumed obligation imposed a duty to reconcile and to pay the amount it agreed to pay under the settlement agreement.

The trial court found that, because the agreement by its own terms expired in June 2013 and because the City’s actions did not constitute a modification of the original settlement agreement, it lacked jurisdiction. The appeals court  reversed that ruling and remanded the case to the circuit court with directions that it enter an order in favor of the retirees.

The appeals court found that the retirees’ theory is that they are not asking the court to modify or amend the agreement. Instead, the retirees maintain that the City itself extended the agreement and they are seeking to enforce the City’s modified obligation. The Court referenced numerous City documents in its decision. The City maintains that whatever it agreed to do and whatever obligations it took on, there was never an extension of the settlement agreement beyond June 30, 2013. The City’s letter explains that “Under the Korshak (April 2003) Settlement Agreement, the City of Chicago agreed to provide support for annuitants through June 30, 2013″and establish a commission to make recommendations for the plan going forward. “The City will extend current coverage and benefit levels through December 31, 2013. This additional time will allow retirees to maintain coverage for a full plan year, recognizing what we heard from many retirees who have planned deductible and out of pocket expenditures based on an expectation of full year coverage. The City will, however, adjust the benefit levels provided under the current plan starting January 1, 2014. After January 1, 2014, the City will provide a healthcare plan with continued contribution from the City of up to 55% of the cost for that plan for their lifetimes to the City retirees who are members of the Korshak (subclass) . . . For all annuitants who retired on or after August 23, 1989, in light of the evolving landscape of national healthcare and challenges faced by Chicago taxpayers, the City will need to make changes to the current retiree healthcare plan.

“The letter from the City commits it to continue to provide coverage at the same levels as under the April 2003 agreement for the rest of the plan year. The City, however, argues that its “voluntary extension of benefits” did not “constitute an extension of the 2003 settlement agreement.” The City’s letter expressly invokes the settlement agreement and commits the City to “extend current coverage and benefit levels through December 31, 2013,” giving retirees “additional time” so that they “maintain coverage for a full plan year.”

The City suggests that it never said it would extend the agreement, only that it would extend the benefit levels. But that overexacting reading fails to give the commitment expressed in the letter a reasonable interpretation in light of the words used and their context. Moreover, the reading the City would have us ascribe to the letter ignores the nature and realities of the parties’ relationship, failing to account for what both parties understood the commitment to mean along with what actually transpired.

In its letter, in light of the commission’s suggestions, the City committed itself to “extend current coverage and benefit levels.” Those are the essential terms of the settlement agreement being “extended.” The reason for the extension was to give retirees “additional time” allowing them to “maintain coverage for a full plan year.” The full “plan year” went to December 31, 2013, suggesting an unbroken continuation of the status quo. Not what the City proffers—some separate conferral of benefits—but maintaining what was in place until the end of the plan year.

The letter then explains that the City would “adjust the benefit levels provided under the current plan starting January 1, 2014.” The letter also states that, beginning in 2014, “in light of the evolving landscape of national healthcare and challenges faced by Chicago taxpayers, the City will need to make changes to the current retiree healthcare plan.” If the then-current plan ceased in June 2013, why would the City repeatedly state that it would start to make changes to that plan in 2014. The only reasonable interpretation is that it remained the operative plan.”

The initial amount at stake is $50 million covering the last six months of 2013. More importantly, the Court indicated in its decision that any changes going forward needed to be negotiated. This leaves the City in a more difficult position. For us it is an indication that any ratings moves based on the City’s pension outlook be made slowly and cautiously.

PR PROMESA NOT OFF TO A GOOD START

The political pressures are off to an early start as the fiscal oversight board in Puerto Rico begins its work. One example of why many investors are skeptical about the willingness of the body politic to do what is necessary is the current debate about the board’s powers as they pertain to government employment. Recently, Senate President Eduardo Bhatia of the pro-Commonwealth Popular Democratic Party said that Promesa “does not establish anywhere” that government employees hired after May 4 or those who obtained their permanent status after that date, could be let go, as stated previously by the pro- statehood New Progressive Party (NPP) president and gubernatorial candidate Ricardo Rosselló.

No one argues that 4,117 permanent positions were granted after May 4 as the government was planning its July bond default. The minds of investors cannot be faulted for reeling at the idea of hiring for example, additional teachers for a school system that is steadily losing students during a time of obvious financial crisis. In the meantime, Richard Ravitch,  the representative at the federally appointed board, of which the governor is a nonvoting member offered a number of unsettling thoughts.

He predicted that the García Padilla administration’s long-term  fiscal plan would include a “majorly worse” fiscal outlook. He said after meeting four members of the board that they could face a “steep learning curve.” He recommended fixes for Puerto Rico he thinks the U.S. Treasury missed, he mentioned Act 154—the 4% excise tax on certain multinationals doing business on the island, currently set to phase out in 2017. It accounts for almost one-fourth, or $2 billion, of the island’s annual tax revenue.

It is generally thought that the board’s chairman is expected to be named, as required by the federal law. Then the long slog to recovery can hopefully begin. That effort will not be aided by the most recent news from Puerto Rico’s Institute of Statistics that 64,000 Puerto Ricans left last year, matching the highest number reported in the past 11 years. The vast majority of Puerto Ricans are settling in the U.S. mainland.

In the meantime, Rafael Hernández Montanez, a leading legislator has called for the resignation of one of the board members. Montanez was one of the legislators who initially backed tax increases in April of this year but then reversed himself in a move that helped to hasten a default. This is exactly the kind of political grandstanding that will impede efforts to resolve the financial crisis.

NEW MEXICO UNDER REVIEW

The Land of Enchantment may not have a large amount of general obligation debt outstanding ($327 million) but it is rated Aaa by Moody’s. That may not be true much longer as Moody’s has placed the rating under review. The state recently released August revenue estimates which show an extremely large reduction in estimated General Fund revenues for both fiscal 2016 and fiscal 2017, compared to its prior forecast prepared in January. The fiscal 2016 revenue estimate was reduced by $348 million, resulting in a significant drawdown of total General Fund reserves to $130 million or 2.3% of recurring revenues. The fiscal 2017 revenue estimate was reduced by $556 million, throwing the budget into structural imbalance. Absent any legislative action, the August estimates would result in an ending reserve deficit for 2017 of $326 million or -5.7% of recurring revenues. The legislature will convene in special session this month to address the shortfalls. If they do not, the rating could be impacted.

New Mexico’s GO bonds are paid from a dedicated statewide property tax levy without  without limit as to rate; the treasurer is required to keep tax proceeds separate from all other funds; and the state’s practice is to levy the tax in advance so that debt service is pre-funded. The state’s more widely issued severance tax backed bonds were downgraded in May of this year. That downgrade was primarily attributable to the sharp reduction in coverage for the senior and subordinate lien bonds resulting from the decline in oil and gas prices and the expectation that coverage will not return to prior levels in the near term. The ratings also reflect the inherent volatility of the pledged revenue stream, which consists primarily of taxes on the production of natural gas and oil in the state.

New Mexico is the 36th-largest state by population, at 2.1 million. Its state gross domestic product, $92.2 billion, is the 37th-largest. The state’s wealth levels are below average, with per capita personal income equal to 81.5% of the US level and a poverty rate among the highest for US states.

SAN BERNARDINO HOPES TO CLOSE OUT CH. 9 PROCESS

In our most recent issue, we discussed the issue of market vs. actuarial valuations for calculating pension liability requirements for California’s units of local government. One of those cities is San Bernardino which recently concluded four years of operations under Chapter 9. The City has started, what it hopes to be, the final step on the path to exit bankruptcy. A hearing to consider confirmation of “Third Amended Plan for the Adjustment of Debts of the City of San Bernardino” is set for 10 a.m. on Friday, October 14, 2016. Implementation is complete or underway on all actions targeted for 2015 under that Plan. In addition, implementation of several elements targeted for 2016 are already underway.

If finally approved, the City will have reached agreements to adjust general obligation debt, unsecured pension debt (the City has reached agreement with creditor. Obligation reduced from $95.8 million to $50.7 million. Annual payments reduced from $3.3 to $4.7M per year to $1.0 to $2.5M per year.), and achieved an estimated total of $60 million in cost savings related to employee healthcare. A new draft charter is under development and has been reviewed at public meetings. The Charter Committee provided recommendations to Council in May and anticipates a November 2016 election.

ARKANSAS REVIEWING P3 OPTIONS FOR HIGHWAY

The Arkansas Highway and Transportation Department is commissioning a study on the feasibility of not only using tolls to help build a new section of Interstate 49 in western Arkansas, but also to have a private entity operate and maintain the tollway. The Arkansas Highway Commission last week approved an order to solicit consultants to study using tolls and a public-private partnership to complete a 13-mile section of I-49 from Interstate 40, where I-49 ends now, south to Arkansas 22 in Barling. It would be the first public-private partnership on a roadway project in Arkansas, state highway officials said.

The department director stated  “The thought, if the money part works out, is that a private entity would design, build, operate and maintain what would actually be a design-build-finance-operate-maintain project. Part of the study should also evaluate the costs and benefits of operations and maintenance by a third party versus operations and maintenance by the department.”

The move would be a logical next step in the Department’s use of the private sector. Currently, the department is using a more limited design-build method on its Interstate 30 corridor project, a series of improvements through downtown Little Rock and North Little Rock, including replacing the I-30 bridge over the Arkansas River. Longer term, a likely candidate for a toll financed P3 would be the previously discussed  I-49, which is a north-south corridor between Kansas City, Mo., and Shreveport, La. More than $1.2 billion has been spent on improvements in the Arkansas stretch of the highway that is 99 percent complete from I-40 to Canada. The environmental impact statement for the project is outdated as the Federal Highway Administration approved it in 1997.

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