Category Archives: Municipal Bonds

Muni Credit News June 9, 2016

Joseph Krist

Municipal Credit Consultant

PR INVESTORS MEET…

The magnitude of the gap between the various interests involved in the process of dealing with Puerto Rico’s impending default were presented in stark relief this week at a conference for institutional investors held in NY this week. Representatives of investors, bond insurers, and one gubernatorial candidate attended as did the head of the GDB.

The lack of information transparency was noted by several, especially the continued lack of audited fiscal 2014 audited financials. The head of Assured Guaranty expressed sentiments which have bothered us for some time. “You have a government that seems to ignore every law…. How can we do anything if they don’t follow the law. When do we get to choose which law or constitutional provision is enforced?” he said.

The comments of various participants shed a light on the continuing schisms between the various investors classes. Representatives from the credit-union group, believe an entity-by-entity approach should be quickly adopted and that the commonwealth’s negotiation strategy “has been divided among creditor groups.” Individual investors representatives explained how the group representing their interests formed precisely out of local bondholders’ frustration from not being part of the negotiations. The director of the GDB said the superbond would help the commonwealth manage its debt more efficiently, but conceded the structure is not set in stone.

Many views on Promesa were expressed. Gubernatorial candidate Rosselló was quick to point out his opposition to Promesa, and proposes a joint commission, “which essentially is a fiscal control board, but specifically for managing the debt restructuring,” he said. He still believes federal government involvement is important moving forward, providing assistance in such areas as tax-revenue collection. He explained his plans to reduce the government’s size and spending, and how his plans are more suitable to solve the island’s problems.

AMBAC’s representative expressed support for Promesa and its debt-restructuring components, includingTitle VI, which provides for collective action as did institutional investor reps. Assured’s chairman would rather see a voluntary process under Title VI, instead of following the path of Title III, where both Puerto Rico and the market could lose. Title III would allow for a court-ordered debt-restructuring process if the fiscal oversight board approves it.

Meanwhile, P.R. House Treasury Committee Chairman Rafael “Tatito” Hernández is cancelling, through the 2017 fiscal budget, the contracts extended to Millstein & Co. as restructuring. Hernández said that instead of getting paid from the general fund, the advisers should be paid at the closing of the transaction as it was done in the case of AlixPartners and Chief Restructuring Officer Lisa Donahue, who handled the Puerto Rico Electric Power Authority’s $9 billion debt restructuring. Cleary Gottlieb’s Richard Cooper and Millstein & Co.’s founder, Jim Millstein, were hired by the Government Development Bank as restructuring advisers, and they have been paid more than $65 million. The cancellation will take place starting in July with the new fiscal year.

…AND A LEGAL SHOE DROPS…

The U.S. Supreme Court ruled in the case of COMMONWEALTH OF PUERTO RICO v. SANCHEZ VALLE ET AL. The case involved an issue of double jeopardy in a criminal matter but the decision reached would be based on the Court’s interpretation of Puerto Rico’s status as a commonwealth. Prosecutors argued that Puerto Rico and the United States are separate sovereigns for double jeopardy purposes and so could bring successive prosecutions against each defendant. The Puerto Rico Court of Appeals consolidated the cases and reversed. The Supreme Court of Puerto Rico granted review and held, in line with the trial court, that Puerto Rico’s gun sale prosecutions violated the Double Jeopardy Clause.

The justices’ 6-2 ruling on the Puerto Rico v. Sánchez Valle case says Congress is the ultimate source of the island’s legal power even though Puerto Rico has its own constitution. Opponents of a fiscal control board being imposed on PR through Congressional action had pinned their hopes on a ruling in favor of the Commonwealth. The court had to decide what is “the ultimate source” of the commonwealth’s authority to prosecute. If the local and federal courts derive their prosecutorial power from the same ultimate source, they are not separate sovereigns.

Those in favor of a Congressionally imposed solution process for Puerto Rico’s debt problems will be heartened by the decision. Our view is that Puerto Rico has been trying to have things both ways in its approach to investors, justifying many of its requests on its status as part of the U.S. while invoking sovereignty when it came to matters of oversight, fairness, and transparency.

The ruling would seem to limit the potential scope of legal challenges to Promesa should it ultimately be adopted by the Congress.

…WHILE A FY 2017 BUDGET IS CONSIDERED

It is proposed that in the next fiscal year, the Puerto Rico government would have to pay $1.78 billion in total debt service payments, an amount that is around 19.5% of the service is 12% of the budget of $9.5 billion. In 2013, debt service was 6% of the $9 billion budget. In 2012, the debt was 7% of the $9.2 billion budget.

The budget package is comprised of 11 measures. One of the most controversial would amend the 2006 Fiscal Reform Act to require that all monetary earmarks given to entities will be fixed according to the fiscal state of the government and not as established by special laws. “There will be no debt or obligation resulting from any difference between the amount that has to be provided and what is provided,” the bill states. For example, if the government were required by a special law to earmark $5 million to a program in the Family Department, it would be able to allocate a lower amount under the proposed legislation.

Another measure, House Bill 2962, would suspend all monthly payments to the Amortization and Redemption Fund for General Obligation (GO) bond payments. The government has been since 1976 setting aside GO payments in the fund. The government would stop all deposits to the fund unless it is able to obtain $1.2 billion in tax-revenue anticipation notes. The government owes $1.78 billion in total debt payments that include $24 million owed by the Treasury Department, $21.4 million by the Land Authority, $408 million by the Aqueduct and Sewer Authority, $322 million in public debt, $64.4 million by the University of Puerto Rico, $10 million by the courts, $545 million by the Electric Power Authority, $1.4 million by the Infrastructure Financing Authority, $20.8 million by the Puerto Rico Industrial Development Company, $17.6 million by the Public Housing Administration, $31.2 million by the Housing Financing Authority, $283.4 million by the Public Buildings Authority, $3.8 million by the Infrastructure Financing Authority and $30 million by the Convention Center District Authority.

STADIUM FINANCE SEASON IN FULL SWING

Maybe municipalities are learning something about stadium finance and its risks. Manchester, NH has seen the downside of government funding for sports facilities with its negative experience with its indoor arena. That facility was financed with entertainment tax debt through the State of NH. Ultimately those revenues were insufficient and the local American Hockey League franchise was moved to California. Now the city’s Board of Mayor and Aldermen voted unanimously to approve an agreement with the minor league baseball New Hampshire Fisher Cats that commits city funds to pay for stadium improvements at a ten year old facility.

This agreement contains a concession from team ownership regarding collateral if they attempt to move out of Manchester before 2028. In exchange for the city funding $948,000 in repairs to Northeast Delta Dental Stadium, the contract contains language that pledges that the ownership team (NH Triple Play) will pay $9 million of principal balance on the city’s stadium bonds if there is an attempt to move the team out of the city prior to 2028.

According to an amortization schedule provided by the city, approximately $18 million of principal balance remains on the city’s bond for the stadium project. According to the agreement, half of the principal balance will be paid from NH Triple Play’s annual payments to the city. Under the new agreement proposed Tuesday, ownership agrees to secure the remaining $9 million of bond payments by providing the city with a security agreement, secured by its financial interest in the team.

The original request made last year was for the city to pay for about $1 million in improvements at Northeast Delta Dental Stadium, including putting in a new fire suppression system and replacing the playing field at the ballpark. The city’s deal with the stadium ends when the stadium bonds are fully paid off, projected to be in 2028. The team currently pays a $730,000 rent-like payment plus another $167,627 a year to cover stadium building costs it agreed to pay beyond the $25 million stadium project.

Ownership offers to pay the city $500,000 a year in rent beginning from 2029 to 2035, if city officials will commit to earmark half that amount for a capital reserve fund to be used for stadium maintenance. if the stadium capital reserve fund doesn’t cover capital expenditure costs for any given year, the team will fund any additional money required. After five years, if capital reserve funds come up short for any year, the additional funding needed will be split 50-50 between the city and team “after both parties agree on the need.” The city will also prepare a city-owned parcel of land between the stadium and the railroad tracks for additional parking.

So the deal does force the team to provide more security, lessening the chance that the city will be left with stranded costs. In our view, it is good to see municipalities insisting on better protections for their own investment and some mitigation of the long run risk to taxpayers.

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.

Muni Credit News June 7, 2016

Joseph Krist

Municipal Credit Consultant

STATE FINANCIAL HEALTH RANKINGS

The Mercatus Center at George Mason University annually ranks each US state’s financial health based on short- and long-term debt and other key fiscal obligations, such as unfunded pensions and healthcare benefits. This ranking of the 50 states and Puerto Rico is based on their fiscal solvency in five separate categories: Cash solvency. Does a state have enough cash on hand to cover its short-term bills? Budget solvency. Can a state cover its fiscal year spending with current revenues, or does it have a budget shortfall? Long-run solvency. Can a state meet its long-term spending commitments? Will there be enough money to cushion it from economic shocks or other long-term fiscal risks? Service-level solvency. How much “fiscal slack” does a state have to increase spending if citizens demand more services? Trust fund solvency. How much debt does a state have? How large are its unfunded pension and healthcare liabilities?

Alaska, Nebraska, Wyoming, North Dakota, and South Dakota rank in the top five states. Kentucky, Illinois, New Jersey, Massachusetts, and Connecticut rank in the bottom five states, largely owing to the low amounts of cash they have on hand and their large debt obligations. There were big movers in each of the five categories that make up the overall ranking: Colorado, Delaware, New Mexico, and Iowa all moved down in the ranking of cash solvency, while Maine and Minnesota both improved.

While the methodology of the study is clear, its results show its limitations. The bottom five states would be likely to finish near the bottom of any such survey. At the same time, states like Kansas with limited direct debt issuance powers inflate their relative position. On the other hand, current oil/gas productions states like Alaska and North Dakota are clearly under current fiscal distress. Alaska is balancing its budget by running down reserves accumulated in prior years of higher oil prices. North Dakota and its municipalities, like Williston, are seeing significant revenue impacts. No one would call them financially strong on a current basis.

Our point is to help investors place surveys like this in context. Information without context is like trying to operate a new piece of electronics without reading the instructions. It’s likely to go a lot better if you follow the guidance of the professionals. That is also true for municipal bond investing. It’s something to keep in mind when you try to interpret data and evaluate it in relation to your municipal bond portfolio.

FLORIDA CITY UNDER STATE REVIEW AGAIN

Just weeks after Miami-Dade County officials sent letters to the governor warning that the City of Opa-Laka could be shut down because of gaping budget shortfalls in the millions Governor Rick Scott issued an executive order declaring that it needs state assistance to resolve the state of financial emergency that currently exists through the implementation of measures authorized by Part V, Chapter 218, Florida Statutes.

Under the Agreement, the City of Opa-locka shall obtain written approval of its proposed annual budgets, and any amendments to such budgets, from the Governor before final approval of the budget. A financial emergency board shall be established by the Governor to oversee the activities of the City of Opa-locka. The board members and chair of the financial emergency board shall be appointed by, and serve at the pleasure of, the Governor.

The financial emergency board shall adopt such rules as are necessary for conducting board business, and shall make regular reports to the Governor of its findings, recommendations , and actions. The City of Opa-locka is prohibited to issue bonds, notes, certificates of indebtedness, or any other form of debt without the prior written approval of the Governor. The City of Opa-locka shall make available for inspection and review all records, information, reports, and assets of the City at the request of the Governor.

For months, Miami-Dade County Mayor Carlos Gimenez had urged Scott to issue the order while the FBI was undertaking an investigation targeting city leaders, including the Mayor, the City Manager and a City Commissioner. Last week, one Commissioner took his own life by crashing his SUV into a tree two days before he was to turn himself in to Miami-Dade prosecutors in a state corruption case. The order follows by nine months the discovery of $8 million of previously undisclosed debts.

Publicly issued debt outstanding from the City is insured. It does not have an underlying rating. While the Governor’s order is in effect, the City does not control its fiscal affairs and cannot make any decisions of consequence without approval. The City of Opa-locka would have to obtain prior written approval from the Governor before it may seek application of the laws under the bankruptcy provisions of the United States Constitution and/or Federal Statutes.

ARE STATE CREDITS ABOUT TO WEAKEN AS A GROUP?

Some are concerned about “slowing” state revenues in the first quarter of 2016. A recent report from the Rockefeller Institute of Government is the latest source of concern. So what does it say?

It observes that personal income tax revenue growth slowed to 6.5 percent on a year-over year basis, down from 14.4 percent growth in the second quarter of 2015. Thirty-four states reported increases in personal income tax collections, while nine states reported declines. Second-quarter growth had been atypically high, likely reflecting the strong stock market of 2014 and taxpayer response to federal tax rate changes. Growth was also weak in all other major tax sources: corporate income taxes grew by 1.0 percent, sales taxes 3.2 percent, and motor fuels 5.3 percent.

The Institute also notes that states expect fiscal years 2016 and 2017 to be much weaker than fiscal year 2015. The median forecast of income tax growth in the thirty-six states for which it was able to gather recent forecasts is 4.6 percent for 2016 and 4.4 percent for 2017, compared to 7.8 percent actual growth reported for 2015. The median forecast of sales tax growth in the thirty-eight states for which we have data is 3.5 percent for 2016 and 3.9 percent for 2017, down from actual 2015 growth of 4.5 percent.

We think that it is important to note that what is being observed is slower rates of growth, not actual declines. We would also note that some of the prior rates of growth against which these rates are compared must be viewed in the context of the impact of the Great Recession on state revenues. Those impacts were unique in the post-war experience of our market and created a low base against which to measure growth. Before one panics, keep in mind that the data is available to budgeters early enough in this budget cycle for them to take into account when projecting budgets for the upcoming fiscal year.

Our view is that this data is important but we believe that political and ideological issues should be of more concern to bond investors than the absolute short term revenue trend data. We are not ready to panic yet.

PR PRIMARY RESULTS ARE ANTI PROMESA VOTE

Puerto Rico chose the son of former governor, Pedro Rosselló, who served from 1993 to 2001, and who opposes a U.S. House plan for fixing the island’s debt crisis, over their representative in Congress who supports it for the New Democratic spot in this year’s gubernatorial election. Ricardo Rosselló Nevares won 51.08 percent of the vote, while Resident Commissioner Pedro Pierluisi, Puerto Rico’s congressional representative, won 48.92 percent in the Sunday election.

Rosselló will contest the general election in November, with he and David Bernier, the pro-commonwealth Popular Democratic Party (PPD) candidate, considered the frontrunners. Bernier also opposes the bill – and has threatened to sue to block it – as do the other candidates on the ballot: María de Lourdes Santiago of the Puerto Rican Independence Party (PIP), Rafael Bernabe of the Puerto Rico Working People’s Party (PRTP) and independent candidates Alexandra Lúgaro and Manuel Cidre.

The vote shows the difficulty that is faced in determining how feasible any recovery program imposed by Congress will be. Between the high level of opposition on the island and efforts expected from the U.S. Senate against strong oversight, we think that approval and implementation of an effective restructuring and recovery program is far from a done deal.

Muni Credit News June 2, 2016

Joseph Krist

Municipal Credit Consultant

KANSAS TROUBLES CONTINUE

The ongoing saga of the Kansas fiscal experiment took another turn when the Kansas Supreme Court rejected the state legislature’s education funding formula on the grounds that it does not distribute equitably more than $4 billion in state aid among its school districts. The legislature, which ended its session earlier this month, will have until June 30 to figure out a new funding formula or the state supreme court will deem the entire formula null and essentially shut the state’s public school system down.

The decision was the second this year to find that a proposed Kansas state education funding plan was not legal. The legislature, late in its session, pushed through a bill known as the Classroom Learning Assuring Student Success Act. The law would have placed $2 million more into the state’s funding formula so that wealthy and politically powerful school districts wouldn’t financially suffer.

The unanimous decision said “Simply put, the legislature’s unconstitutional enactment is void; it has not performed its duty.” The legislature will have to reconvene, devise a new funding formula, get the governor to sign it and send it to the courts. The state’s legislators have in recent months campaigned to have the state’s appointed justices be removed from office this fall.

The education funding issue has lingered as part of the larger policy experiment undertaken by the state’s Governor. In order to finance tax cuts and resulting recurring revenue shortfalls, huge expenditure cuts have been enacted to balance the budget each year. Education is a primary expense item for the state so it has borne the brunt of the expense actions. Since 2011, state aid per pupil dropped to $3,800 from $4,400, according to the Kansas branch of the National Education Association.

Our interest is primarily academic as the state issues no GO debt. It has been a more than interesting real time test when an openly doctrinaire approach to state budget management has been undertaken. Kansas is the clearest example of the belief in supply side economics as it pertains to budgets and economic growth. So far, it is difficult to argue that the experiment has been a success. Three years remain in the Governor’s second term and, under term-limit laws, he cannot run again. Schools in Kansas are generally finished for this academic year and Wednesday was set to be the Legislature’s last day, though it could return for a special session.

CHICAGO GETS SOME PENSION RELIEF

In an unanticipated action, the Illinois legislature overrode the veto of Governor Bruce Rauner of Senate Bill 777, allowing Chicago to re-amortize the funding schedule for its public safety pensions for short-term budget relief. The pension bill trims $220 million from the city’s required contribution this year to its police and fire retirement funds, and more than $800 million over the next four years as it phases in a shift to an actuarially required contribution and stretches out to 2055 the time allowed to reach a 90% funded ratio.

The 2010 state funding mandate originally required an ARC payment this year with the goal of reaching a 90% funded ratio by 2040.

ANOTHER SMALL COLLEGE SETS TO CLOSE

While there has been so much emphasis on the cost of college and the so-called arms race between and among colleges to attract students, the pressures on small liberal arts institutions continues. The latest casualty is Dowling College, a 4,000 student liberal arts college with facilities on two campuses on Long Island in Suffolk County NY. Dowling was founded in 1955 by a financier and arts patron of the same name. For some years, it had increasing trouble competing in its chosen marketplace and struggled to maintain enrollments and revenues.

The college’s financial position had been steadily deteriorating as reflected by its continuingly declining debt ratings on its $50-odd million of outstanding debt. There are three issues of debt currently outstanding issued by the Suffolk County and Town of Brookhaven IDAs. The most recent issue was in 2006. Before its ratings were withdrawn, debt was rated B-.

In July, 2015 the College missed principal and interest payments. At that time the college entered into forebearance agreements with its bondholders covering the three series of revenue bonds that are obligations of the College and collectively account for a substantial majority of the College’s existing long term debt. During the term of the Forbearance Agreements, it was anticipated that the College will defer making any payments that relate to the Bonds. In accordance with the indenture relating to the Series 2006 Bonds, the indenture trustee for such bonds applied amounts on deposit in the debt service reserve fund to make the payment required on the Series 2006 Bonds on June 1, 2015. As a result, there now exists a deficiency in the debt service reserve fund in the amount of $437,085.73.

The College retained CohnReznik Advisory Group as special advisor to the College and adopted a budget with input from the Special Advisor. With limited exceptions the College shall limit operating expenses to types and amounts reflected in the budget. The College agreed to remit excess cash flow to the indenture trustees for the Bonds personal property that is not already pledged as collateral for those Bonds, subject to existing liens.

So what happens to debt that has a final maturity of 2032? The Trustee will ultimately look to accelerate the bonds and likely rely on the disposal of the College’s remaining real assets. The Oakdale campus is on waterfront adjacent to Long Island’s south shore and the Brookhaven campus abuts Brookhaven airport. So there is value in the College’s real estate. Whether it is enough to make the bondholders whole is questionable.

HUDSON YARDS UPDATE

The Hudson Yards Infrastructure Corporation (HYIC) collected higher than anticipated revenues from development this year— although still well-below initial forecasts—allowing the city to eliminate its $58.1 million interest support payment planned for 2018 and reduce an $89.8 million payment budgeted for 2019 to $26.8 million. Interest support payments made by the city to HYIC, however, have already exceeded amounts originally projected—and because the current savings result largely from one-time revenues, an $89.8 million interest support payment remains in the city’s financial plan for 2020. (All years refer to fiscal years.) The first of the new buildings in Hudson Yards is slated to open this week.

When the city created HYIC in 2005 to issue $3 billion in bonds to pay for the 7-line extension and other infrastructure improvements on Manhattan’s Far West Side to seed the private development expected to follow, the Mayor and City Council pledged that they would redirect both recurring tax revenue and one-time fees and bonus payments generated by new projects located in the area to repay the corporation’s bonds. Understanding that it would take time before development revenue could cover the financing costs, the city also agreed to subsidize the corporation’s interest payments until project revenue could fully support the costs.

Based on a planning study prepared by Cushman and Wakefield in 2006, the project was expected to generate from $986.6 million to $1.3 billion in HYIC development revenues through 2016—considerably above what it has actually generated. However, since 2006 HYIC has also collected $266.1 million in other revenues— mainly interest earned on investments of its unused bond proceeds—which were not included in the initial forecasts. When included with the development revenue, this brings the actual revenue received by HYIC through 2016 to a total of $1.0 billion, roughly equal to the low end of the Cushman and Wakefield forecast. Despite these unexpected interest earnings, the city has still provided more in interest subsidies than originally forecast.

While revenues from development in Hudson Yards are picking up, they still fall short of initial projections and are largely in the form of one-time payments. As interest earnings on investments of unused bond proceeds have petered out, the city’s interest support payments—although reduced through 2019—are likely to continue in future years. The majority of the corporation’s development revenue received through 2016 results from the nonrecurring sources: $487.1 million. Recurring tax revenues in the form of tax equivalency payments (TEPs) and payments in lieu of taxes (PILOTs) have accounted for only $268.3 million of HYIC’s development revenue since 2006. Initial projections forecast these tax revenues to range from $345.1 million to $500.0 million through 2016. Most of the tax revenue received thus far has come from TEPs, which—like the city’s interest support payments—are paid out of the city’s general fund.

The general fund support and maintenance of the City’s rating and financial strength have contributed to the outstanding debt retaining its mid A ratings. The three notch difference from the city’s general obligation rating reflects the need for annual appropriation of the city’s interest subsidy, the nature of the economic development projects being financed, and volatility in New York City’s real estate markets that could delay development.

Muni Credit News May 31, 2016

Joseph Krist

Municipal Credit Consultant

PR BILL MOVES TO THE FULL HOUSE

The House Natural Resources Committee approved the Promesa legislation 29-10. Now it moves to the full House for consideration. The bill will be subject to a full House vote this Wednesday at the earliest. The markup hearing saw 32 amendments introduced to House Resolution 5278. Opposition remains among several Puerto Rico politicians including Senate President Eduardo Bhatia, who called the imposition of a fiscal oversight board a “totalitarian fiscal authority.” Puerto Rico’s resident commissioner in Washington, Pedro Pierluisi, has offered “grudging support”.

Initially, three bipartisan amendments were approved through a voice vote. The first amendment seeks to employ the General Accountability Office to carry out a study on the root causes of Puerto Rico’s debt crisis. The second, called for the fiscal oversight board to have the authority to investigate whether any selling practice of Puerto Rico securities was based on misinformation. The third aimed to expand the committee’s leadership to include ways and means and finance committees of the Senate to include economic growth mechanisms for the island. The amendment also aims to shorten the time it takes to approve task force members to 15 days from 30.

A fourth amendment sought to require the congressional task force to hold at least one of their hearings in Puerto Rico to know first-hand the issues affecting the island’s residents. The amendment was approved. Another sought to include the disparity in federal healthcare programs between Puerto Rico and other U.S. jurisdictions as an issue for the board’s consideration.

Puerto Rican-born Rep. Raúl Labrador (R-Idaho), opposed that amendment. “The root cause is not that they’re getting federal money, but the poor management decisions that have gone on for years,” he said. “This amendment puts stamp on the bill [saying] we are asking for federal money, and people have said this money is a path to a bailout,”

To this, Resident Commissioner Pierluisi responded: “The Puerto Rico government is struggling with the medical indigent; if you’re looking for the task force to go into ways for Puerto Rico to grow, you must look into this issue.” The amendment passed. An amendment by Rep. Jody Hice (R-Ga.), aiming to give the oversight board the ability to promote the private sector on the island, and another by Rep. Tom MacArthur (R-N.J.) calling for a fiscal reform and economic pro-growth measures, were both approved via voice vote.

Three amendments which were not approved were all proposed by CO Rep. Jared Polis. One of them aimed to bring back some of the jobs and incentives that were lost with the phaseout of Section 936, which for decades provided tax incentives to the island’s manufacturing sector. Another amendment attempted to strike the bill’s overtime pay rule, which sets a salary cap of $47,000 to receive overtime pay. “I believe it does not lead to any additional economic growth if workers are not compensated 50 to 60 hours a week,” he said. “It drives productive people from the island.”

The third amendment sought to change the definition of the HUBzone (Historically Underutilized Business zone) program to extend to the whole island. The program creates incentives for the U.S. federal government to do contracting with businesses that operate and create jobs in communities with statistically proven economic needs. “Although it is not a bad idea, it is still out of the scope of jurisdiction of this committee,” Bishop noted.

Now the heavy lifting of garnering the needed votes, especially on the democratic side begins. Prominent Hispanic members of the House and Senate have expressed opposition primarily due to the oversight requirements. Our view is that any legislation which does not provide strong oversight would essentially gut the value of any other measures contemplated to help Puerto Rico. We discuss a major reason why next.

PR AUDIT MAY FINALLY COME IN JULY

GDB President and Chairwoman Melba Acosta stated on Monday that the Government Development Bank (GDB) is closing in on a deal to write off about 40% of the more than $5 billion owed by the central government to the troubled bank. With this move, the Alejandro García Padilla administration expects to find the way for the delivery of the commonwealth’s audited financial statements for fiscal year 2014, which were due over a year ago. This is because two commonwealth components have yet to finish their auditing processes, namely the GDB and the island’s largest retirement system. Without the completion of these, independent auditors KPMG can’t sign off on the audited statements. The central government employees’ retirement system is projected to finish its pending process this week, while the bank’s statements would be ready by mid-June.

GDB chief Acosta said in the PR House’s public hearing over the island’s budget for the next fiscal year, which begins July 1, “If the bank fails to get paid for its loans, which would give liquidity to the GDB, unfortunately we don’t see a future for the institution, and the governor should consider appointing a receiver to liquidate the bank, with the implications this would have on local creditors, including credit unions.” The bank has only $238 million in liquidity as of today. She further noted that half of its roughly $4 billion debt is held by local creditors, which prompted the bank to pay $22 million in interest due at the beginning of this month. Nevertheless, the bank defaulted on about $370 million also due May 2.

ATLANTIC CITY LEGISLATION SIGNED

Gov. Chris Christie of New Jersey signed legislation on Friday that will help Atlantic City, the struggling seaside resort, avoid bankruptcy and give local officials time to develop a recovery plan before the state intervenes. The Commissioner of the Department of Community Affairs is empowered under this bill to determine whether the city government’s proposed recovery plan is likely to achieve financial stability for Atlantic City and if he determines that the plan will fall short of this goal, the state will intervene and manage the city with all of the tools necessary to turn this troubled city

To ensure that Atlantic City’s government maintains fiscal discipline as the recovery plan is developed and implemented, if the Commissioner approves its recovery plan, he has the authority to determine at any time that state intervention is necessary if Atlantic City fails to strictly comply with its plan or if circumstances indicate that the plan is no longer likely to achieve financial stability.

The Governor is agreeing only to a secured bridge loan for the next six months, under terms and conditions set by the Commissioner of the Department of Community Affairs, the repayment of which must be factored into the recovery plan to be developed by the city. The city will also receive regular payments from casinos to help stabilize its finances. The money from casinos would amount to $120 million in the first year and increase by at least 2 percent each year for the next nine years.

The bill also allows the city to use early retirement packages to try to reduce its public work force. The city would also have to identify ways to increase revenue and reduce debt, and it would have to make required payments to the local school district and Atlantic County. The city plans to sell vacant properties in an auction this summer. It has already raised fees for city permits and will add more parking meters.

PENNSYLVANIA TO TEST MARKET PATIENCE

Pennsylvania will offer $1 billion of general obligation debt in the middle of its budget process for the fiscal year beginning July 1. Investors suffered through last year’s budget debacle which left all sides unsatisfied and the Commonwealth’s credit ratings lowered. The conditions which led to those ratings declines still exist including uncertainty over education funding and tax policies which continue to pressure localities. Above all of this looms the Commonwealth’s continued need to firmly address its unfunded pension liabilities.

Next week, legislators will return for what promises to be weeks, at least, of haggling over the budget. And Republican leaders intend to make gambling part of the discussion. The House last week considered measures that would have legalized online gambling, allowed slot machines at airports and offtrack betting sites, and permitted 24-hour liquor sales at casinos. One proposal would also have allowed video-gaming terminals at bars and truck stops. The bills failed – one was voted down by a 2-1 ratio.

Gov. Wolf has said the state must raise taxes to fill a billion-dollar budget hole blamed in part on pension, human service and corrections costs. The proposals to expand gaming are estimated to generate from $205 to $270 million.

It’s not clear yet if disagreements over taxes and level of education spending will again prevent an agreement from being reached by June 30. The situation may not result in as much of a cost penalty to the Commonwealth as it might deserve as strong market fundamentals including continuing demand could outweigh the credit fundamentals. The need to reinvest July 1 coupon payments reinforces these trends.

Muni Credit News May 26, 2016

Joseph Krist

Municipal Credit Consultant

CHICAGO

Two months after the Illinois Supreme Court struck down his plan to save two of four city employee pension funds, Mayor Rahm Emanuel agreed Monday to save the smaller of the two funds with a mix of union concessions and revenue generated by a telephone tax increase once earmarked for both funds. Using a legal window the Supreme Court left open, the agreement with Laborers Locals 1001 and 1092 calls for employees hired on or after Jan. 1, 2017, to become eligible for retirement at 65 in exchange for an 11.5 percent pension contribution. The City’s position is that “They haven’t earned any benefit, so we can change their benefits going forward,”

Veteran employees hired after Jan. 1, 2011, will have a choice. They can retire at 65 with an 11.5 percent pension contribution or wait until 67 with an 8.5 percent contribution, a 35 percent increase. Emanuel’s original plan called for a 29 percent increase in employee contributions. The city is still working on a trade-off for employees hired before Jan. 1, 2011. In exchange for those cost-saving concessions, Emanuel has agreed to earmark all of the revenue from a 56 percent increase in Chicago’s telephone tax approved by the City Council in 2014 to shore up a Laborers Pension Fund with $1.3 billion in unfunded liabilities due to run out of money in 12 years.

The city’s payments to the fund will increase by “no less than 30 percent a year for the next five years. The $40 million a year generated by the $3.90 a month surcharge applies to both land lines and cell phones and was supposed to be used to cover the city’s first-year contribution to both the Laborers and Municipal Employees Pension Funds.

The city will be forced to find another funding source to save the Municipal Employees Pension Fund with $9.8 billion in unfunded liabilities due to run out of money in just eight years. An additional telephone tax increase in two years is a possibility. Talks with union leaders whose members draw their retirement checks from the Municipal Employees Pension Fund are seen as being nowhere near agreement.

The Supreme Court, in rejecting the original plan did note that an ironclad “pension protection” clause in the Illinois Constitution “was not intended to prohibit the legislature from providing ‘additional benefits’ and requiring additional employee contributions or other consideration in exchange.” A spokesman Laborers Local 1092, said he is confident the new agreement will pass legal muster despite the Illinois Constitution’s ironclad pension protection clause that says pension benefits “may not be diminished or don’t want them to be changed,” according to the spokesman.

Federation said the partial plan is “better than not doing anything.” But it pointed out that the Laborers pension fund has the “smallest of the unfunded liabilities” of the city’s four pension funds. “Laborers is at 52.9 percent. Municipal is at 32.9 percent. Police is 26 percent. Fire 23 percent. All of these funds are in desperate financial shape. A comprehensive solution for all of them is needed. “This plan would have the city going on a 40-year plan to get to 90 percent with a five-year ramp or phase-in,” he said. “That’s an improvement over the current structure, but not what actuaries recommend for solving a pension crisis. They recommend 100 percent funding within 30 years or less.”

In our view, the effort signifies recognition of the credit concerns and within Illinois’ strict limits on pension changes an attempt to deal with the issue. The City’s challenges remain formidable and much more will be needed to reverse the negative pressures on its ratings.

WMATA

The Washington Metropolitan Area Transportation Authority is coming to market amidst a storm of negative publicity regarding the condition of its capital facilities and an ongoing decline in ridership on its buses and its flagship facility, the Metro subway system. A series of incidents involving fires as well as significant service interruptions related to deficient maintenance have focused attention from several oversight bodies on these issues. That attention has focused on the System’s significant need to improve

As has been the case since the decision to build a subway in D.C. in the 1960’s, the process of constructing, operating, and maintaining that system has been fraught with politics. Competing interests including two states, the Congress, and multiple federal agencies have created numerous opportunities for confusion, missteps, and grandstanding by the numerous entities and politicians given opportunity by this complicated oversight structure.

These various stresses have created concerns among investors and the rating agencies as they try to assess the actual creditworthiness of the Authority’s debt as it attempts to grapple with these many serious issues. In periods like this, it is easy for investors to get lost amongst the weeds and make decisions which might not be to their benefit.

What are the implications of all of this negative publicity for bondholders? In the short-term, there is the negative price impact. There is also a likelihood that the authority will have to issue significant new debt to fund capital replacement so there is the factor of increased supply and its impact on prices. The spotlight also serves to highlight the long term lack of stable, dependable revenue sources from the various communities which provide non-farebox revenues. This includes the federal government along with the local jurisdictions.

There has never been a shortage of members in Congress, particularly in the House to use WMATA as a political punching bag. It is just one more way for Congressional conservatives to fight to impose their will on a political jurisdiction for which they have always had a fair amount of disdain. That desire for control has always outweighed the willingness to fund the system adequately.

But in the end, does this really mean anything for bondholders? The security for WMATA debt is a gross revenue pledge. Theoretically, debt service comes before anything else. On that basis, over the last five years coverage has increased from 27 to 63 times debt service. Farebox revenues alone provide 30 times coverage. Practically, the system must run in order to produce those farebox revenues and it is not practical to run the system without outside funding. But the legal structure of the security does allow the outside atmospherics of hearings and headlines to be put aside to a great extent for the bondholders. We think that a ride on WMATA debt will end up at the correct destination.

FITCH SNUFFS OUT TOBACCO RATINGS

By June 15, Fitch Ratings intends to withdraw the current outstanding structured finance ratings on all of its rated U.S. Tobacco asset-backed securities (ABS).

The primary reason for the intended withdrawal is that individual, custom modifications (by several participants) to material calculations originally part of the base Master Settlement Agreement (the MSA) have eroded Fitch’s confidence that ratings can be consistently maintained, as insufficient information exists to predict the likelihood and effect of future modifications or that insufficient information will exist to support new, material variables included in them.

Historically, the method for calculating the amount of the annual and strategic contribution fund payments was solely prescribed by the terms of the MSA. The calculation, which includes multiple adjustments of varying complexity, determines the total payment amount due from the participating tobacco manufacturers (the PTMs). This amount is then distributed amongst the jurisdictions that are party to the MSA according to the allocation percentages contained therein and a portion of these funds are then ultimately transferred to the issuers of the securities. In this manner, there was historically a single, consistent application of the calculation adjustments that affected all participating jurisdictions in the same way.

However, more recent settlement agreements related to disputed payments connected to the non-participating manufacturer (NPM) adjustment have eroded Fitch’s confidence in the predictability of the calculation of MSA payments going forward. In the past few years, two material settlements, one between New York State (NYS) and the PTMs (the New York Settlement), and the other among California, 23 other states and the PTMs (the Settling States Agreement, collectively, with the New York Settlement, the Settlement Agreements) modified the calculation of the NPM Adjustment outside of original MSA calculations. The New York Settlement also introduces a new variable, a calculation related to Tribal Sales, which is based on estimates initially and its past and future volatility is unknown.

Fitch acknowledges that the Settlement Agreements have positive features – most notably the release of previously escrowed funds held in the disputed payment account, more clarity regarding disputed payment calculations going forward, and in the case of the New York Settlement, the removal of uncertainty that would be introduced by protracted arbitration in relation to these disputed amounts. However, the longer-term ramifications of the modifications to the NPM Adjustment calculation for both settling and non-settlings jurisdictions is less clear and more problematic.

We do not see this decision as having a major impact on the market for tobacco securitization debt. Over the nearly two decades of issuance, the major credit factors and concerns for investors have become clear. Investors are either comfortable with these risks or they are not. Their appeal to yield based investors are clear. For those wary of volatility – either market or credit based – we have always felt that tobacco bonds are likely not appropriate for them. The move by Fitch does not alter our view one way or another.

Of more importance are the continuation of negative consumption trends. The CDC reports that the prevalence of current cigarette smoking among U.S. adults declined from 24.7% in 1997 to 15.1% in 2015. Current cigarette smokers were defined as those who had smoked more than 100 cigarettes in their lifetime and now smoke every day or some days. For both sexes combined, the percentage of adults who were current cigarette smokers by age group was lower among adults aged 65 and over (8.4%) than among those aged 18–44 (16.5%) and 45–64 (16.9%).

Muni Credit News May 24, 2016

Joseph Krist

Municipal Credit Consultant

GOVERNOR REACTS TO PROMESA

Gov. Alejandro García Padilla reacted to the introduction of the revised Promesa legislation. He acknowledged that the revised Puerto Rico Oversight, Management Economic Stability Act (Promesa) provides a workable debt-restructuring mechanism. He continues, however to object to the fiscal oversight entity the bill would establish. He was pretty clear about his level of opposition to that provision. “If the bill is signed into law as it is, I would tell the United Nations that the U.S. is acting against what the Eisenhower administration told them [with respect to Puerto Rico’s self-governance],” Gov. García Padilla told reporters Thursday.

His Plan B is to continue the use of the local moratorium law. For the governor, the new bill is an improvement from its original version, but he still sees the oversight board’s powers as excessive. On the proposed debt-restructuring mechanism, he acknowledges it leaves the commonwealth in a better position to restructure a large chunk of its debt, including constitutionally protected general obligation bonds (GOs).

He is against having the board displace the local government in debt-restructuring talks with commonwealth creditors. He added he would continue to push for changes in a bid to enact an acceptable legislation that respects the island’s self-governance.

While the local government could prevent the board from using its authority to the full extent by adhering to the required fiscal practices, he believes those powers shouldn’t be granted at all, García Padilla noted.

If Promesa clears the committee vote, which could take place as soon as this week, it would go to the House floor, where it remains to be seen if there is enough support for its passage.

GDB CREDITORS ARE NOT WAITING FOR CONGRESS

Holders of bonds from Puerto Rico’s Government Development Bank are suing to challenge aspects of a debt-moratorium law that island officials say is crucial to maintaining essential services. The amended federal lawsuit filed late Friday in the U.S. District Court in San Juan names Puerto Rico’s governor and treasury secretary as well as an unidentified bank receiver. It argues that amendments to the law prioritize the rights of certain creditors at the expense of others in violation of U.S. and Puerto Rican law.

The Ad Hoc Group behind the lawsuit comprises five investment funds that hold $900 million of the GDB’s nearly $4 billion in outstanding debt. They said “Notwithstanding the Commonwealth’s unconstitutional actions, the members of the Ad Hoc Group understand that the Commonwealth faces significant challenges and want to continue mutually beneficial restructuring.”

Gov. Alejandro Garcia Padilla said the lawsuit’s challenge of the Debt Moratorium and Financial Recovery Act could affect the commonwealth’s ability to have police in the streets, teachers in the classrooms and nurses in hospitals. He said because Congress excluded Puerto Rico from the bankruptcy code in 1984 without any explanation, and the federal courts have impeded past attempts to create a local bankruptcy law, the act is the commonwealth’s only option to restructure its debt.

“If the commonwealth cannot proceed with its intention to restructure the debt in an organized manner, chaotic litigation will ensue and the courts can take control of the limited resources of the government and make them available to the interests of the Wall street funds,” the governor said in a written statement Saturday evening. “We are not going to close the government to pay a considerable profit to the hedge funds, who bought the bonds at a big discount after the crisis began.”

PADILLA ROLLS THE DICE WITH FY 2017 BUDGET PROPOSAL

Puerto Rico Gov. Alejandro García Padilla has announced that the budget for the fiscal year 2017, set to start July 1, would be of $9.1 billion, about $700 million less than the budget that was approved for the current fiscal year. In an effort clearly influenced by the upcoming primary in two, García Padilla cast the upcoming budget as a “real reduction in expenditures of close to $3 billion when compared to the last budget of the previous administration.”

Confirming the fears of many debt holders he pointed out that “although the budget for fiscal 2017 would be lower than the current one, it would not reduce the budgets set aside for health services, education, public safety, agriculture and social welfare, and instead guarantees the services that [related] agencies bring”. The budget also would not decrease the revenues that the University of Puerto Rico gets by way of a formula, same with the judicial branch and the municipalities, he added. It allocates just $209 million for bond interest payments, reiterating his stand that the commonwealth plans to skip most debt obligations.

“Paying the debt in its totality would have meant taking health benefits away from more than a million people, or having to fire countless police officers and closing the Centro Medico” health facility and, going without school transportation and garbage collection.”

The governor stressed that the upcoming budget depends exclusively on government revenues instead of loans, like in the past. The budget also hinges on possible steps that the U.S. Congress might take to the island’s benefit, as it tries to address an ongoing debt crisis in the commonwealth.

The local legislature has five weeks to approve the budget. The House of Representatives overrode Monday Gov. Alejandro Garcia Padilla’s veto on a bill that would repeal the hike to the business-to-business (B2B) tax and the value-added tax. It is the third time in recent history that the Legislature has overridden a governor’s veto to a bill.

The B2B was slated to go into effect in June. The legislation effectively derails the governor’s most significant tax achievement, with the IVA being touted as the best alternative to reduce tax evasion, partly because it gave businesses more oversight of the tax collecting process. The B2B, which was raised to 10.5% from 4%, is expected to collect around $25 million. Lawmakers have contended that the tax reform should have been approved with a corresponding tax relief. They also said merchants are not ready for the change. Privately, they worry about the backlash of the taxes on their electoral chances, sources have said.

To override the governor’s veto, the House needed at least 34 votes out of the 51 members. The Senate, which has 27 members, needs 18 votes.

ATLANTIC CITY REPRIEVE

State lawmakers struck a deal on saving Atlantic City on Monday that gives the city time to avoid a state takeover and requires the city to make “drastic” budget cuts. The City would have 150 days to draft a five-year fiscal plan that includes a balanced budget in 2017. It would receive a state bridge loan to cover its operations in the meantime. A companion bill incorporates elements of the so-called PILOT bill, which lets casinos make fixed payments in lieu of property taxes and redirects $110 million in casino funds over 10 years to help the city pay debt and expenses.

Under the new compromise plan, the commissioner of the Department of Community Affairs would approve or reject the city’s five-year plan after 150 days. If the city’s plan fails to achieve fiscal stability, a state takeover would take effect. The state could also take over if the city at any point failed to follow the five-year plan. The city could appeal the commissioner’s decisions to a Superior Court judge, officials said. In addition to a balanced budget, the recovery plan must ensure the city pays the full amount in property taxes owed to the city’s school district and Atlantic County, schedule repayment of debts to the state, bondholders and other liabilities and increase revenues. The bill allows the city to offer early retirement incentives to public workers, possibly saving the city more than $5 million. The city must also restructure its bonded debt to reduce its annual debt service from $38 million to $5 million.

CA MAY REVISION

Since the January Budget, the state’s revenues have lagged expectations while the Governor and the Legislature have made major new spending commitments. The tax revenue forecast has been reduced by $1.9 billion, reflecting poor April income tax receipts and more sluggish sales tax receipts than expected.

The passage of the managed care organization financing package solidifies funding for Medi‑Cal over the next three years. Additional funding was committed to developmental disability services, higher payments to Medi‑Cal providers, and the reduction of debt. The passage of legislation that made California the first state in the nation to raise the statewide minimum wage to $15 per hour will eventually raise General Fund costs by an estimated $3.4 billion ($39 million in 2016‑17).

Since 2012, the expansion of health care coverage, the Local Control Funding Formula, and other increases in safety net spending have committed over $19 billion in increased annual General Fund costs ($10.7 billion Proposition 98). By 2019‑20, the annual shortfall between spending and revenues is forecast to be over $4 billion. This shortfall does not take into account the likelihood of an economic slowdown or recession. The emerging shortfall is in large part — but not entirely — due to the expiration of the temporary taxes imposed under Proposition 30. This November, the state’s voters will be given the choice whether to extend the Proposition 30 income tax rates for another 12 years.

The vote presents an opportunity to mitigate some of the historic boom and bust character of California’s finances. Even with a vote in favor of tax extension, California’s revenues structure will still be subject to the volatility of its income tax base and its dependence upon a relatively small proportion of tax payers for a large percentage of its income tax revenues.

ILLINOIS BUDGET NOISE

Recent rumors of progress have come out of Springfield that a framework for a budget for FY 2017 may be emerging. Our view is that seeing is believing. Among the rumored pieces of the budget puzzle are specifically: $5.4 billion in new taxes, accomplished by raising the income tax from 3.75 percent to 4.85 percent on individuals; and by broadening the sales tax to cover services. The taxes would be accompanied by $2.5 billion in cuts including pension “reforms”, in the form of shifting the cost of higher pensions away from the state and onto local districts –known controversially in Illinois as the “cost shift” – and some reforms to procurement processes.

The Governor is still insisting that a final agreement has to have some other reform items. A bipartisan group is said to be working on items like further workers’ compensation reform, local government consolidation and some flexibility for local governments dealing with public employee unions. Important issues, such as education funding, have not been agreed to. The failure to address education funding have led to severe cost cuts at some campuses and credit downgrades across the state system.

Additional pressure on the state’s university system are seen in a review of admissions data by The Associated Press which found that applications for the 2016-2017 fall semester are down for at least four of the state’s 12 public university campuses — all of them smaller schools that don’t have as much money coming in from things like research grants and tuition and have smaller endowments. Eastern and Western Illinois, have laid off employees. Chicago State University, the hardest hit, cut a third of its employees and ended the spring semester early. Eastern Illinois, Western Illinois, University of Illinois-Springfield and Southern Illinois University-Edwardsville all say they had fewer applicants this year.

The University of Illinois’ Urbana-Champaign campus says 7,969 freshmen-to-be have accepted admission, an increase of more than 400 from last year. A record 38,075 students applied to the school.

ANOTHER STADIUM TO BE FINANCED WITH MUNICIPAL BONDS

The Rangers and the City of Arlington have reached an agreement for a new state-of-the-art ballpark to be opened by 2021. The new ballpark, which was announced at a news conference on Friday at City Hall, will be climate-controlled with a retractable roof and will be built across Randol Mill Road on the south side of Globe Life Park.

Both sides are contributing $500 million to the project. The Rangers’ portion of the financing will include revenue from the sale of individual “Stadium Builder Licenses” that enable the holder to buy tickets for certain seats in the new ballpark. The Rangers will be responsible for cost overruns. “To have a higher-than-average attendance — especially during the dog days of summer — allows us to raise revenue and spend more money on players and free agents.”

The city’s contribution, through an extension of existing taxes, must be approved via a public referendum in the Nov. 8 general election. The city plans to use the same combination of half-cent sales tax, 2 percent hotel tax and 5 percent car rental tax that it used to fund AT&T Stadium. The Cowboys and Arlington recently announced that taxpayers are seven years ahead of schedule paying off the stadium. The city will own the ballpark, while the Rangers will design and build it. The agreement runs through January 1, 2054. This ownership structure qualifies the stadium for bond financing albeit under limits for private activity bonds.

PROPOSED IRS CHANGES SEEN AS LIMITING SOME TAX EXEMPT ISSUANCE

The IRS has proposed a new definition of political subdivision that could possibly terminate the status of numerous governmental entities whose governing boards are appointed rather than elected, or whose projects are viewed by the IRS as providing more than incidental private benefit, making them ineligible to issue tax-exempt debt or use tax-exempt financed facilities as a governmental user. The proposed regulations purport to interpret and clarify current law; however, the governmental control and public purpose tests are entirely new and many governmental bond issuers may be affected.

Treasury officials have said publicly that the provision prohibiting more than incidental private benefits is intended to clarify the public purpose requirement, but it instead casts doubt on the continuing political subdivision status of governmental entities that issue bonds for public purposes with private involvement, or that are engaged in other economic development activities. Importantly, the public purpose requirement remains in place for the entire term of an entity’s bonds. If at any time the IRS determines that the issuer is operating in a way that either does not provide a significant public benefit, or that provides more than an incidental benefit to any private party, then the status of all of the issuer’s bonds issued after the effective date of the regulations would be in jeopardy.

Muni Credit News May 19, 2016

Joseph Krist

Municipal Credit Consultant

PROMESA BILL INTRODUCED…

H.R. 5278, the bipartisan Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA), which addresses the fiscal crisis in Puerto Rico while preventing a taxpayer bailout for the territory. The bill establishes an oversight board which will be given the Authority to order audited financial statements, hold hearings, prevent the execution of legislation, orders, regulations rules, or contracts that would violate the Act.

It provides that any debt adjustment must respect liens in effect prior to the execution of the Act. At the same time, it would stay litigation pending litigation pending the production of audited financials. During such stays, Puerto Rico must pay interest when due. The Act explicitly excludes the Commonwealth from Chapter 9 and designates the Board as the entity to direct the adjustment of Puerto Rico’s finances. Only the Oversight Board could present a plan of adjustment for creditor vote or judicial approval.

On the economic front, it would provide for a lower minimum wage than the prevailing mainland minimum and would increase the age it applies to from 20 to 25. As for its applicability to other entities, the Act is explicit in its enactment under the territories and insular affairs provisions of the U.S. code not as any amendment to the 10th Amendment. A state seeking to use its provisions would have to ask to have its status as a state revoked and return to territorial status.

The legislation (http://naturalresources.house.gov/uploadedfiles/promesa_hr_5278.pdf) is not truly bipartisan in that it is sponsored by the Republicans on the Natural Resources. House Speaker Ryan has made it clear that the legislation will be moved out of committee for a vote under the Hastert rule which means that unless a majority of the majority in the House supports the measure it will not move forward.

The introduction of the bill for committee consideration now sets out the opposing views of what to do about Puerto Rico’s debt crisis. It follows Monday’s statement from Senator Bernie Sanders on the subject. It reads straight out of the Garcia administration’s playbook. According to his campaigns statement, “Bernie Sanders believes the U.S. has an obligation to help Puerto Rico with its ongoing financial crisis by allowing it to declare bankruptcy. To that end he sent a letter to the U.S. Treasury which could have been written by the current government of Puerto Rico.

He would urge the Administration to take the following steps. First, he would urge a meeting as soon as possible with the government of Puerto Rico, key elected officials, its major creditors, labor unions, business leaders, and pension advocates, to work out a debt repayment plan that is fair to all sides. At this meeting, it should be made clear that the last thing Puerto Rico needs right now is more austerity. The economic situation in Puerto Rico, in Sanders’ view will not improve by eliminating more public schools, slashing pensions, laying off workers, and allowing corporations to pay workers starvation wages by suspending the minimum wage and relaxing labor laws.

Second, before any debt restructuring plan is agreed to, there needs to be an independent and transparent audit of Puerto Rico’s debt and the results need to be made public — consistent with recent legislation that was signed into law in Puerto Rico. Importantly, if any debt was issued to creditors in violation of Puerto Rico’s constitution , it must be immediately set aside.

Third, he strongly believes Puerto Rico must be afforded the same bankruptcy protections that exist for municipalities and public utilities across the United States. Puerto Rico must be given the same authority granted to every state in this country to restructure the debt of public utilities and municipalities under the supervision of a bankruptcy court.

If there is not action soon, Sanders says the well-being of 3.5 million American citizens who live there will be put at risk. He notes that the people of Puerto Rico pay the same Medicare and Social Security taxes as we do, but they only get about half the rate of federal health care dollars as those who live in the 50 states.”

If this all sounds familiar, it is because these are almost verbatim the arguments advanced by the Governor. It represents a very doctrinaire and populist response to PR’s difficulties and does little to advance the debate.

… FOLLOWING PRHTA REVENUE FREEZE

Puerto Rico Gov. Alejandro García Padilla froze the transfer of revenues from the Puerto Rico Highways and Transportation Authority to its bonds, making the commonwealth the biggest technical defaulter in United States municipal history. While not imposing moratorium on HTA’s debt-service payments — which the government says are covered until next year — Gov. Alejandro García Padilla is suspending the remittance of certain funds that go toward paying debt obligations in a bid to guarantee continuity of essential services provided by HTA. The administration says HTA needs $25 million a month to do the latter, and $150 million more to pay down what it owes to its suppliers.

“The executive order is suspending the obligation of the HTA to transfer revenues to its bondholders from tolls and any other income received and imposes a ‘stay’ in legal claims and of any kind,” the Commonwealth stated. The HTA is expected to meet in full roughly $240 million in debt service due July 1, but would do so by using its reserve accounts.

The moratorium law provides for a legal stay mechanism that seeks to shield public entities against creditors’ remedies, once they are placed under an emergency period. However, it is still uncertain whether it has a retroactive effect. Last week, Ambac Assurance Corp., a bond insurer with exposure to HTA debt, sued in federal court, calling for a receiver to be appointed at the public entity. Earlier this week, the monoline asked the court to freeze $100 million received from the 10-year extension to the PR-5 and PR-22 concession contract between HTA and Metropistas. Whether those actions may be stayed under the law, is yet to be seen.

LIPA DEBT LIMIT PROPOSED

Legislation introduced Thursday by two Suffolk County legislators would require a public referendum when LIPA wants to issue new debt. The measure which would be known as the Long Island Power Authority Ratepayers Protection Act, would also replace the current appointed LIPA board with eight trustees who are elected by voters from eight districts and a chairman appointed by the governor. The board would have full discretion to consider rate increases and could not approve a final plan until public hearings were held in impacted service areas.

LIPA has consistently been the target of populist legislators. The proposal would interfere with changes enacted by the NY legislature which froze rates for three years but also provided for a significant restructuring and refinancing of LIPA’s massive tax exempt debt load. The regulation of rates by the State along with the initial rate freeze had effectively capped the Authority’s ratings at their present level, but also facilitated the construction of a securitization plan that satisfied credit concerns in the taxable market.

We believe that outside oversight is essential to reassure investors over the long term. The nature of the political situation over many years on Long Island should be of concern to investors who do not have tolerance for any additional credit weakness. Standard & Poor’s and Fitch Ratings revised LIPA’s credit outlook to stable from negative last November ahead of a $266 million electric system general revenue bond sale citing a three-year rate hike from 2016 to 2018 approved by the New York Department of Public Service. Public Service Commission oversight is essential in our view to the maintenance of a more solid credit profile.

GAME ON FOR MILWAUKEE BUCKS ARENA

The Wisconsin Center District is preparing to sell $203 million in bonds in June toward financing the new Milwaukee Bucks arena. The District board is scheduled to vote Friday on authorizing the bond issue. Assuming the board votes for the authorization, it is anticipated that a sale of bonds “in early to mid-June.” The vote follows months of maneuvering and threats to move the franchise to Seattle which had hoped that such a move would advance financing for a hockey and basketball arena there.

The financing from the Wisconsin Center District will provide the majority of the $250 million in public financing for the $500 million Bucks downtown arena. The Bucks owners will contribute $150 million and former owner Herb Kohl is donating $100 million. The state legislation in 2015 that provided for public funding of the arena designated the Wisconsin Center District as the owner of the arena, which the Bucks will manage under a 30-year lease.

The city of Milwaukee will provide the final $47 million in public funding via tax-incremental financing. The majority of the tax-increment funds will finance a new parking structure for the arena. The Bucks’ owners plan a groundbreaking ceremony for June 18 on the arena with a goal of completing the project before the 2018-2019 NBA season that starts in fall 2018.

The two primary revenue sources backing the bonds include annual appropriations of $4 million each from Milwaukee County and the state of Wisconsin and existing sales-tax revenue streams already collected by the Wisconsin Center District. The district collects sales taxes from hotel rooms, local food and beverages, and car rentals. This package was used by arena advocates to say that no “local” revenues are used for the project since the taxpayers would be mostly visitors to the arena and the City.

CA WATER AGENCIES GET REGULATORY RELIEF

On May 9, 2016, the Governor issued an Executive Order that directs the State Board to adjust and extend its emergency water conservation regulations through the end of January 2017 in recognition of the differing water supply conditions for many communities. The Order notes that the drought conditions that formed the basis of the Governor’s emergency proclamations continue to exist; and the drought conditions will likely continue for the foreseeable future and additional action by both the State Water Resources Control Board and local water suppliers will likely be necessary to prevent waste and unreasonable use of water and to further promote conservation.

It maintains limits on use for landscaping, outdoor plants, and car washing. It does provide that each urban water supplier shall: Beginning June 1, 2016, reduce its total potable water production by the percentage identified as its conservation standard in this section each month, compared to the amount used in the same month in 2013 and the supplier’s total potable water demand for each of the next three years will be the supplier’s average annual total potable water production for the years 2013 and 2014. The supplier’s total potable water supply shall include only water sources of supply available to the supplier that could be used for potable drinking water purposes.

Growth experienced by urban areas and significant investments that have been made by some suppliers towards creating new, local, drought-resilient sources of potable water supply, an urban water supplier’s conservation standard shall be reduced by an amount, not to exceed eight (8) percentage points total. Other adjustments to reflect the drought resiliency of new water supplies and growth in commercial/industrial establishments as well as population are provided.

Bondholders should be heartened by these changes which will relieve at least a portion of the pressures which have resulted from the drought. They are clearly credit positive for water credits throughout the state with primarily non-agricultural customer bases, thus relieving downward pressure on these credits.

Muni Credit News May 17, 2016

Joseph Krist

Municipal Credit Consultant

WHEN A TAXABLE REFUNDING MAKES SENSE

Many tax-exempt revenue bonds are issued for activities Congress has classified as private because most of the benefits from the activities appear to be enjoyed by private individuals and businesses. The annual volume of a subset of these tax-exempt private-activity bonds is capped. The cap has been adjusted for inflation since 2004. The annual volume cap applies to the total of bonds issued primarily for but not limited to multi- and single-family housing, industrial development, exempt facilities, student loans, and bond-financed takeovers of investor-owned utilities (usually electric utilities).

Exempt facilities subject to the volume cap are the following: mass commuting facilities, water furnishing, sewage treatment, solid waste disposal, residential rental projects, electric energy or gas furnishing, local district heating or cooling provision, and hazardous waste disposal and 25% of high-speed rail facility bonds.

This does not mean governmental ownership in the conventional sense. It simply means that lease arrangements for private management and operation of bond-financed facilities must be structured to deny accelerated depreciation benefits to the private operator, lease length must conform to the facility’s expected service life, and any sale of the facility to the private operator must be made at fair market value.

El Paso County Texas recently closed on an issue of taxable refunding bonds that refunded general obligation bonds and certificates of obligation which were tax exempt. The Bonds which were recently issued were refunding in advance bonds which were already refunding bonds themselves or which issued for the purposes outlined in the prior paragraph. So a taxable issue was the only way the refunding bonds could be advance refunded. The remaining bonds would have created cap issues for the County. So with rates where they are demand for this kind of paper strong – including from foreign institutional buyers – this kind of issue makes tremendous sense for the County and other borrowers who find themselves confronting a similar situation.

OLD NEWS TO MUNI VETERANS

According to a new audit from Pennsylvania Auditor General Eugene DePasquale, mandated cost increased and an inability to raise revenue are hampering the Philadelphia School District with persistent budget deficits. This release may be news to some but to veterans of the municipal bond market they represent a continuation of history.

The District has had a long history of declining demographics, declining outside resources, and mismanagement dating at least to the 1970’s. Over time, the District was able to overcome what had become a mounting set of obstacles to market access for both operating and capital purposes. These needs were financed by a variety of commercial bank liquidity facilities and credit enhancements. While these facilitated market access, there was continued deterioration in the District’s credit fundamentals. Declining enrollment related to demographics as well as to increased competition from charter schools. These combined to pressure the level of revenues available from the Commonwealth of Pennsylvania based on average daily attendance levels.

At the same time these factors were negatively impacting the District, weaknesses in the City’s tax collection and assessment practices also played their part. When the District also calculated its ongoing maintenance and capital needs, it realized that it also faced serious pension funding requirements. Options to address these needs were limited as the District’s credit fell below investment grade Commonwealth’s state aid secured lending program. This effectively limited the District’s ability to borrow.

Over the years the Commonwealth has experienced increased difficulties balancing its own budget. As is true on the national level, the annual budget process in Pennsylvania has become more acrimonious and partisan. Recent years have seen increased delays and outright failure in the efforts to adopt budgets for the Commonwealth. Funding for education has been at the center of these failed efforts whether the sticking point should be over efforts to lessen property tax burdens or absolute levels of state aid. Aid to Philadelphia has been a particular point of conflict along regional and racial lines.

Unfortunately, we don’t see this combination of factors resolving itself politically anytime soon. That directly points to a continued negative trend for the District’s credit in spite of the clear need for additional help – fiscal and political – that the District clearly needs.

ATLANTIC CITY STEPS BACK FROM THE LEDGE

Atlantic City Mayor Don Guardian said that the city managed to make a $1.8 million interest payment due on 2012 municipal bonds and avoid becoming the first New Jersey town to default since the 1930s. The payment covers interest on 2012 municipal bonds sold to raise money to pay back casinos who successfully appealed their taxes. He said he made the decision to make the payment after considering the bond ratings for Atlantic County and other New Jersey municipalities “as well as the effects for my city.”

Guardian estimated that the city has about $7 million on hand, and is receiving some $1.5 million in daily as May quarterly taxes come in. Residents and businesses had until May 10 to pay before penalties took effect, and many businesses including casinos were expected to wait until then.

The mayor said he would be able to make the $7 million monthly payroll. Unions agreed to switch from a 14-day payroll schedule to allow the city flexibility. And he said he was committed to making the $8.5 million May school payment next due May 15.

We believe that the outlook for a short term resolution is cloudy at best as the issue remains politically charged in the legislature. There are huge negative implications for municipal finance across the state without some resolution but we are reminded that New Jersey remains one of the most political of jurisdictions.

NEW YORK CITY

Both the City’s Office of Management and Budget and the Independent Budget Office have recently released outlooks for the City’s fiscal health going forward. The OMB outlook, which reflects the Mayor’s view is expectedly positive. It emphasizes the accumulation of reserves, settlement of 95% of its labor contracts and funding for its policy priorities. Of more interest to this observer are the views of the IBO.

In the IBO view, “Mayor Bill de Blasio’s Executive Budget for 2017 and Financial Plan Through 2020 proposes an increase in spending to support a bevy of new or expanded programs as well as a substantial infusion of city aid for the fiscally ailing municipal hospital system. His budget plan also includes doses of fiscal caution in the form of a larger citywide savings program and an increase in the amount of funds held in reserves. Based on IBO’s latest economic forecast and re-estimate of tax revenue and spending projections under the contours of the Mayor’s executive budget and financial plan, there are reasons for optimism and prudence. Our latest economic forecast anticipates that local economic growth will slow, with a decline in job growth from the record levels of the past few years and a corresponding slowdown in revenue growth in the years ahead. Still, IBO expects that the city’s fiscal condition will remain stable—budget surpluses this year and next and shortfalls in future years that will be relatively modest as a share of city-generated revenue.

IBO projects that the city will end the current fiscal year with a surplus of $3.5 billion, $151 million more than the Mayor’s estimate. After adjusting for the use of this surplus to prepay some of next year’s expenses, we project a comparatively small surplus of $812 million in 2017 under the Mayor’s plan. This amount may understate the “real” surplus because the Mayor’s plan includes two reserve funds within the 2017 budget totaling $1.5 billion—dollars that are recorded as expenditures but do not currently support any specific spending needs. Taking these reserves into account, the projected surplus for next year is effectively $2.3 billion.”

All in all, the IBO findings seem to support the general aura of conservatism presented by OMB in its presentation. Our view of the NYC credit has always been premised on the structural and reporting requirements imposed on the City over the last four decades. While nothing is fool proof, as long as those structures and requirements remain in place we see the City’s debt as a safe bet for investors.

Muni Credit News May 12, 2016

Joseph Krist

Municipal Credit Consultant

PR BUDGET YET TO BE ISSUED AS IT ARGUES FOR CREDIBILITY

One can understand that the administration of the Commonwealth might be overwhelmed by simultaneous efforts to mange scarce resources, lobby Congress for fiscal assistance, and negotiate a debt restructuring with a variety of creditors. At the same time it is difficult to see the Commonwealth as a credible partner in the current crisis when Gov. Alejandro García Padilla has yet to present a budget as he waits for the U.S. Congress to approve debt-restructuring and other economic-development mechanisms for Puerto Rico. When he says “the budget is being worked on responsibly and comprehensively to allow for the continuation of services to citizens”, we feel that we have heard this song before.

Senate President Eduardo Bhatia said Tuesday that the budget “is very late; I’m not happy. I know it’s a difficult time, but we have to have three scenarios,” which he explained as a budget “with the payment of debt, another without its payment and a third one with only the payment of the debt’s interest.” “If these aren’t available soon, it’s impossible as a legislature to fulfill our constitutional duty.” He also reminded the parties that “it is the latest in history to receive a budget.”

Clearly it would be easier to formulate a budget with at least the framework for a potential “bailout” (yes, we said it) to be available but, this is just another fiscal management failure by the current administration. It is not a matter of whether significant expense cuts need to be made, but how and where. We don’t see evidence of the obviously needed process of triage that will accompany any near term financial resolution. The continued brinksmanship and lobbying being relied upon by the current administration simply is not useful.

We will see how effective the lobbying effort will be. Gov. Alejandro García Padilla met Wednesday with House Speaker Paul Ryan (R-Wis.), Natural Resources Committee Chairman Rob Bishop (R-Utah) and House Minority Whip Steny Hoyer (D-), according to a statement released by La Fortaleza. He also held talks with Reps. Sean Duffy (R-Wis.), who is sponsoring Promesa, Raúl Labrador (R-Idaho) and Charles Dent (R-Pa.). The expected release of a revised Puerto Rico Oversight, Management & Economic Stability Act was delayed due to continued discussions in committee. The stumbling blocks continue to be reducing minimum wage, failing to protect pensioners and doing away with overtime rules.

Meanwhile, the bond-purchase agreement between the Puerto Rico Electric Power Authority, a group of bondholders and bond-insurance companies will expire Thursday unless the creditors give PREPA $111 million or the pact is extended. The agreement is part of PREPA’s larger debt restructuring deal. Puerto Rico lawmakers passed a debt moratorium in April that allows Governor Alejandro Garcia Padilla to skip debt-service payments on all island debt. PREPA’s creditors are reluctant to lend the utility more money unless Puerto Rico lawmakers amend the moratorium law to exempt PREPA.

PREPA’s position is that “conditions required for creditors to fund the $111 million bond purchase under PREPA’s restructuring support agreement and related documents have been satisfied, and as a result such creditors are required to fund the $111 million bond purchase on May 12, 2016,” the utility said in the statement. “PREPA paid $111 million in interest to these creditors in January 2016 in reliance on the creditors’ agreement to re-lend the same amount if two important milestones in PREPA’s restructuring occurred.” The obligation of creditors to buy the three-year bonds is subject to several conditions being fully satisfied, including that no Puerto Rico statue enacted after the agreement shall have an adverse affect on the rights and remedies of the 2016 bonds or their validity or enforceability. Obviously, something has to give.

On another front the Commonwealth’s credibility was under attack this week when Ambac sued the Puerto Rico Highways & Transportation Authority (HTA) on federal court on Tuesday that calls for the appointment of a receiver for the Authority. Ambac’s argument is that the HTA has failed to meet its fiduciary and contractual duties to its creditors. It cites the “suspect timing” during which HTA and Metropistas, a local subsidiary of Spanish firm Abertis, recently agreed to extend the concession contract of PR-22 and PR-5 for $115 million, of which $100 million has been already disbursed.

It is not challenging the contract itself. Instead, Ambac is focused on the use of the funds, arguing these “would likely be siphoned off by the commonwealth government” for purposes not related to HTA. This suit follows suits filed earlier this year by Ambac and Assured Guaranty, challenging the redirection of pledged revenues, known as “clawbacks,” to pay for public debt, a move the monolines deem as illegal and invalid under the U.S. Constitution. Gov. Alejandro Garcia Padilla’s clawback order covers one of HTA’s revenue sources for the repayment of its debt.

WHAT MAKES AN ISSUE TAXABLE

We’ve always taken an interest in what makes a tax-exempt bond taxable. The latest case involves a California authority and a high school district which announced this week that they are prepared to file a protest and appeal of an expected Internal Revenue Service proposed adverse determination that $25.4 million of tax-exempt variable rate demand bonds are taxable.

The California Statewide Communities Development Authority and the Sweetwater Union High School District have received a “Notice of Proposed Issue” in which the IRS tax-exempt bond office asserted that the 2005 bonds are taxable private-activity bonds.

“”If TEB issues a proposed adverse determination, the authority and the district will respond by filing a protest, including a request for view of the [IRS] Office of Appeals.”

Typically, cases handled by the appeals office result in out-of-court settlements.

The case revolves around an unusual conduit structure used to address concerns about state laws. The authority issued $25.4 million of tax-exempt variable rate demand revenue bonds and $8.2 million of taxable variable rate bonds in February 2005. The proceeds were lent to Plan Nine Partners, LLC, a subsidiary of California Trust for Public Schools, a nonprofit that helps expedite land acquisitions for public schools, according to group’s Form 990 tax form.

The proceeds funded the purchase a 23.82 acre parcel of industrial mixed-use land located Chula Vista, Calif. Plan Nine Partners were to lease the land to the Sweetwater school district, which wanted to build a new administrative headquarters, academic buildings and a bus yard on about 73% of it. The official statement estimated that some $120 million of additional bonds would be needed to finance the development of those projects. It does not appear those bonds were issued. The land was to be held in the name of Plan Nine Partners until the bonds were paid off in 30 years and was to then be conveyed to Sweetwater in an exchange agreement. The district would pay rent equal to the bond debt service to Plan Nine Partners.

The IRS began an audit in September 2013, and issued an information document request in October 2014. The authority and Sweetwater responded to the IDR in January 2015, arguing the tax-exempt bonds issued were not taxable. TEB filed a Notice of Proposed Issue on January 26 again asserting the bonds were taxable PABs.

Under the federal tax code, at least 95% of the proceeds of 501(c)(3) bonds must be used for “good” or non-private purposes. About 27% of the land was to be used for development and sale for private business use, the OS stated.

“The authority and the district still disagree with the IRS analysis and its conclusion.

ONE WAY TO DEAL WITH THE IRS

The Indianapolis Airport Authority (the “Authority”) is providing voluntary notice that, in connection with a random examination of its 2006 F Bonds which were purchased by the Indianapolis Local Public Improvement Bond Bank with proceeds of a $346 million of bonds issued by the Bond Bank. The Internal Revenue Service’s Field Office has asserted a rebate liability with respect to the Bonds. Although the Authority disagrees with and has opposed the Field Office’s position, the Authority and the Internal Revenue Service have agreed to a settlement of the dispute that will close the examination with no change to the tax exempt status of the Bonds.

This is how a large number of these disputes are settled. While upsetting to holders, the IRS has stated that it typically is not its goal to penalize individual holders of bonds. Rather, it seeks to come to some financial arrangement with the issuer of a contested issue.

SEC CONTINUES ENFORCEMENT ALONG WITH CRIMINALCHARGES

The Securities and Exchange Commission today charged a father and son and five associates with defrauding investors in sham Native American tribal bonds in order to steal millions of dollars in proceeds for their own extravagant expenses and criminal defense costs. The SEC alleges that Jason Galanis conducted the scheme in which the “primary objective is to get us a source of discretionary liquidity,” he wrote in an e-mail to other participants. Galanis and his father John Galanis convinced a Native American tribal corporation affiliated with the Wakpamni District of the Oglala Sioux Nation to issue limited recourse bonds that the father-and-son had already structured. Galanis then acquired two investment advisory firms and installed officers to arrange the purchase of $43 million in bonds using clients’ funds.

The SEC further alleges that instead of investing bond proceeds as promised in annuities to benefit the tribal corporation and generate sufficient income to repay bondholders, the money wound up in a bank account in Florida belonging to a company controlled by Jason Galanis and his associates. Among their alleged misuses of the misappropriated funds were luxury purchases at such retailers as Valentino, Yves Saint Laurent, Barneys, Prada, and Gucci. Investor money also was diverted to pay attorneys representing Jason and John Galanis in a criminal case brought parallel to the SEC’s stock fraud charges last year.

In addition five other individuals were charged with violations of the antifraud provisions of the federal securities laws and related rules. The SEC seeks disgorgement plus interest and penalties as well as permanent injunctions. In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against the same seven individuals.

This continues the emerging strategy of stronger enforcement of civil regulations backstopped by criminal actions in order to increase the deterrent effect against bad actors in the municipal space.

Muni Credit News May 10, 2016

Joseph Krist

Senior Municipal Credit Consultant

L.A. TAKES THE PRIVATE ROUTE FOR SPORTS FACILITIES

We have recently discussed proposals for public financing for stadiums for professional sports franchises, including those for teams in California. We note however, that the state’s largest city has been taking a different route. While most attention has been rightfully focused on the relocation of the NFL Rams from St. Louis to a privately financed stadium, the groundwork was being laid for a new facility for a major league soccer facility in Los Angeles.

Those efforts culminated in the announcement of Friday that the Los Angeles City Council unanimously approved plans for a privately financed $250-million stadium in Exposition Park, clearing the way for the expansion Los Angeles Football Club to begin construction on the most expensive soccer-specific project in Major League Soccer history.

The 22,000-seat stadium will be the cornerstone of a complex that will include a conference center, restaurants and a soccer museum. It will be built next to the Coliseum on the site of the 56-year-old Sports Arena, which held its final event in March. Construction, including the demolition of the Sports Arena, is scheduled to begin this summer with the target of getting the stadium finished in time for LAFC’s first home game in March 2018.

LAFC’s facility will be the first open-air professional sports stadium built in the City of Los Angeles since Dodger Stadium, which played host to its first game in 1962. That too was a private project although it was catalyzed by a donation of land by the City to the O’Malley family. Likewise, this new facility is being built on City land.

THE DONALD WEIGHS IN ON PUERTO RICO

Regardless of what you think his chances are, it is important for investors to know and weigh the views of Presidential candidates on matters impacting the municipal bond market. This week, Donald Trump let us know his views on Puerto Rico’s debt crisis. In his own words – “I know more about debt than practically anybody, I love debt. I also love reducing debt, and I know how to do it better than anybody. I will tell you with Puerto Rico they have too much debt. You can’t just restructure; you have to use the laws, cut the debt way down, and get back to business, because they can’t survive with the kind of debt they have. I would not bail out if I were — if I were in that position I wouldn’t bail them out.”

So now we have the presumptive Republican presidential nominee standing with the Obama administration in favor of allowing the Commonwealth access to Chapter 9. He stands against those Republicans who are against a “bailout” of the Commonwealth. He is consistent in favoring a haircut for debtholders, something his high yield creditors in the 90’s are all too familiar with. Confused yet?

IF YOU ARE CONFUSED, THIS WON’T HELP

Much of the debate on both sides of the Puerto Rico issue seem to be ignoring certain facts. Supporters of the Puerto Rican government like to lament the end of Section 236 tax in the last decade which had formerly encouraged manufacturing businesses to locate production facilities on the island. Many of those supporters portray the island as having been cut adrift to fend for itself by an evilly motivated U.S. government. As for the “anti-bailout” faction of the body politic, they fail to acknowledge a huge amount of funding the Commonwealth gets for its General Fund from U. S. tax policy. What both sides share is an ignorance of provisions under Act 154 of 2010.

Under Act 154, Puerto Rico enacted a special excise tax on American companies there — mostly pharmaceutical and medical device companies — in an effort to offset lost revenues as the result in reductions in the marginal tax rates on income levied by the Commonwealth on its residents. But the government had effectively promised many of those companies that it would not raise their taxes. So it designed the tax to be eligible for the foreign tax credit in the U.S. That took advantage of the fact that Puerto Rico is treated as a foreign country for foreign tax purposes. That way, it would basically be a wash for the companies, while Puerto Rico could still reap the money it would raise. The plan left U.S. taxpayers footing the bill as companies here can take a foreign tax credit for paying standard taxes there.

So since 2010, U.S. taxpayers have effectively been subsidizing 20% of Puerto Rico’s revenues. Ironically, the amount of money provided essentially covers the Commonwealth’s annual debt service requirements for its general obligation and guaranteed debt obligations. This under actions promulgated by Treasury not by Congressional authorization. Further, these provisions have been under scrutiny by the IRS (part of the Treasury) which conveniently will not address the “creditability” of these taxes for corporations.

So in the end, the U.S. is providing a pretty favorable subsidy via the Administration of the tax code and Congress does not seem to be fully aware of the issue as it debates whether or not it should start to bailout Puerto Rico. Confused yet?

PREPA UPDATE

The Puerto Rico Electric Power Authority (“PREPA”) Bondholder Group today announced an offer to pre-fund the purchase price of the 2016 Bonds that the Group agreed to purchase under the Bond Purchase Agreement (“BPA”) to facilitate the completion of the Restructuring Support Agreement (“RSA”) with PREPA. Under the terms of the offer, the BPA deadline would be extended until the earlier of the passage of an amendment by the Puerto Rico legislature excluding PREPA as an RSA party from the Moratorium Act or May 31, 2016.

The Bondholder Group is prepared to deposit the approximately $61 million to fund the BPA into escrow or other segregated accounts. Under the arrangement, the funds would be transferred to the PREPA bond trustee following the passage of legislation, which would address issues created by the Moratorium Act preventing the consummation of the BPA, and the satisfaction of other agreed-upon conditions precedent to the BPA.

MEAG PROPOSES LOOSENING TERMS OF ITS BOND RESOLUTION

We find it interesting and something for investors to look at that the Municipal Electric Authority of Georgia (MEAG) is proposing changes to its Project One bond resolution designed to provide management with additional “flexibility” in its requirements for future financings and oversight requirements. This at a time when MEAG is a participant in construction of new nuclear generating capacity, a risky financial venture to say the least.

The proposed changes would loosen restrictions on when and how MEAG can issue debt, reduce the requirement for outside review of projects and operations by consulting engineers which are required to be reported to the Trustee for the bondholders. The proposed changes would also create new categories of senior debt which may be identified as being “Refundable Principal Installments”. These bonds would require fewer assets to be accumulated for their payment prior to maturity. They would also alter the method of calculating debt service coverage in favor of the Agency. Additional proposed changes would also allow MEAG to decide to divest the agency of assets without the review of some outside entities as is currently required.

While quality management in our mind always trumps bond requirements, we are always concerned by changes that position investors to get less information and fewer sets of “outside eyes” acting on their behalf. MEAG does have a good track record overall and a good record with nuclear construction and generation, we are more comfortable with an overabundance of protection given the risks of participation in a new nuclear project at this time.

ILLINOIS TRANSPORTATION FUNDING TO BE UP TO THE VOTERS

If the constitutional amendment is approved Nov. 8, all money raised through various transportation-related levies such as the gas tax, tolls, licenses fees and vehicle registration costs would be put into what amounts to budget “lockbox.” That money could then only be spent on road construction and repair, enforcing traffic laws, paying off debt on transit projects and even costs associated with workers injured on the job. The change would not apply to state and local sales taxes that are added on top of the gas tax collected at the pump. The proposed change to the Illinois Constitution that would prevent cash-strapped state government from raiding funds intended to be used on transportation projects.

Illinois imposes a base tax rate of 19 cents per gallon for gasoline and 21.5 cents a gallon for diesel. The gas tax has not been increased since 1991, and revenue collections have been essentially flat as vehicles become increasingly fuel-efficient. The effort comes as the Legislature grapples with an overall state budget for the second straight year.

Illinois has over the years segregated various revenue streams to support specific programs or categories of debt to enhance their security and insulate them from claims of general obligation bondholders. While the segregation enhanced the security for the benefiting bonds, it did theoretically weaken the ultimate security of general obligation debt. We view the proposed segregation of transportation of revenues as a continuation of this trend. Given the current budget conditions facing the State, it is an additional point of concern for the state’s general obligation creditors.