Joseph Krist

Municipal Credit Consultant

ADMINISTRATION OFFERS A PLAN FOR PUERTO RICO

After advising and standing back from direct involvement, the Obama administration has finally offered a plan for consideration by Congress to address Puerto Rico’s debt disaster. The plan would create new territorial bankruptcy rights and impose new fiscal oversight on Puerto Rico. But it requires cooperation from a Republican-led Congress bent on imposing spending restraint. Given the current state of Republican dysfunction in Congress, the likelihood of adoption is not high.

In describing the package, administration officials emphasized that they had exhausted the limits of their own authority to help Puerto Rico, and needed action by Congress to avoid a catastrophe. “Administrative actions cannot solve the crisis,” Jacob J. Lew, the Treasury secretary, said in a joint statement with Jeffrey D. Zients, the National Economic Council director, and Sylvia Mathews Burwell, the health and human services secretary. “Only Congress has the authority to provide Puerto Rico with the necessary tools to address its near-term challenges and promote long- growth”.

The administration is attempting to jumpstart consideration of the plan by calling Puerto Rico’s situation a humanitarian crisis. One senior administration official said the situation in Puerto Rico “risks turning into a humanitarian crisis as early as this winter”. That official was quoted anonymously in the press as saying that the Puerto Rican government has already “done a lot” to restore fiscal order but “Puerto Rico cannot do it on its own, and the United States government has a responsibility to 3.5 million Americans living in Puerto Rico” to step in with additional help.

Whether that is the case is open to debate. At the same time its administration allies were making the humanitarian case, the Government Development Bank said it had ended weeks of negotiations with certain creditors, aimed at persuading them to voluntarily accept lower bond payments. The bank has a bond payment of about $300 million coming due on Dec. 1.

It is our cynical view that the GDB never expected the negotiations to produce a settlement. The view that Puerto Rico has done all that it can is not shared here or by many others. For example, even the front man for PR’s efforts in Congress –  territorial  representative Pedro Pierluisi –  told Congress last week “the Puerto Rico government must break its entrenched spending habits, which have not adjusted to changing economic and demographic realities. Our government must be a better steward of funds received from taxpayers and lenders, accounting for every dollar it spends. The local tax system requires reform, because it is complicated and unfair. Some taxpayers owe too little, while others owe too much. And the government does a poor job of collecting what it levies.”

We think that real financial disclosure and a viable structure for accounting for and collecting revenues are the bare minimum required for debt holders to make any concessions let alone any of significance. Even Bernie Sanders called for more disclosure and transparency in a letter last week that effectively criticized debt holders as vultures seeking to starve children.

CHICAGO APPROVES TAX INCREASE…

Chicago’s City Council approved a budget Wednesday that includes a massive property tax hike and other fees to help close a shortfall and improve the city’s underfunded pension system. The  $543 million property tax increase was for police and fire pensions, along with a separate $45 million property tax hike for school construction, a $9.50 monthly household garbage pickup charge and other fees. The property tax will be phased in over four years, with the largest chunk — $318 million — added to property tax bills payable in August 2016. That increase will be followed by successive increases of $109 million payable in 2017, $53 million payable in 2018 and $63 million added to the property tax bill due in 2019.

The proposal has state legislative approval but Republican Gov. Bruce Rauner has not been supportive of a tax increase. For the plan to be implemented, Gov. Bruce Rauner must sign the legislation that would give Chicago 15 more years to ramp up to 90 percent funding level for the pension funds. Business groups and a renters’ association have testified at the Capitol against the exemption, saying the property tax hike would get passed on to consumers and renters. One of Chicago’s difficulties in addressing its budget and pension problems has been the need for legislative approval. The legislatures unwillingness to approve actions taken by the City is just another indication of its lack of courage in dealing with the State’s problems.

For the owner of a home worth $250,000, the annual property tax bill will be roughly $550 more. Over four years, a homeowner’s property tax bill could rise 13% more. This is only the second increase in property tax rates in the City since 1987. The garbage collection fee, common in the suburbs, is a first for Chicago. It will be added to water bills that arrive in mailboxes every other month.

…AND REDUCES ITS RATE EXPOSURE

While the City of Chicago has been constructing a budget, it has also been taking advantage of the current interest rate environment to fix the cost of its debt. As of this month, the City has now converted to a fixed interest rate 100% of its GO, sales tax, and wastewater debt. We have seen other troubled credits with weak fundamentals also be saddled with variable rate interest exposure. The removal of this risk allows at least that one aspect of the City’s debt burden to be a lessened source of pressure on the City’s ratings. If the tax increase is finally implemented, the downward momentum impacting the City’s credit would be slowed.

PENNSYLVANIA BUDGET IMPASSE WILL HAVE TO WAIT

The Commonwealth of Pennsylvania will likely enter its fifth month without a resolution of its budget impasse. In spite of rising difficulties for localities, school districts, and social service providers, the Pennsylvania Senate adjourned for two weeks as of yesterday. While negotiations will likely continue at the staff level and the Senate could be recalled to approve legislation in the event of an agreement, the decision to adjourn is telling. State Auditor Eugene DePasquale warned that the state’s schools were approaching a half-billion dollars in borrowed money simply to stay open. Those costs, he said, could double if there’s not a budget by Thanksgiving. The Philadelphia School District has already borrowed $275 million for cash flow.
Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Municipal Credit Consultant

ILLINOIS

The Illinois legislature reconvened this week in another effort to craft a FY 2016 budget. The ongoing linkage between the Governor’s desire for policy changes in the management of the state labor force and a resolution of the state budget stalemate has come into clearer focus. As much as old-time politics has influenced the legislative side of the budget equation, Governor Rauner’s stubbornness in holding out for politically charged changes in union bargaining rights and work rule issues have come to be viewed as serious obstacles to resolution of the stalemate.

The fact that 90% of state spending is mandated statutorily or by the courts (including debt service payment) is unfortunately contributing to the entrenched stances of both sides. There are items that are not being paid. State Comptroller Leslie Munger said  Illinois will have to delay a $560 million November payment to its pension funds, and may also delay or reduce a similar payment in December. This reflects reduced cash flow associated with the lack of a budget. State pension funds will be paid in full by the time fiscal 2016 ends on June 30 using money from higher cash flow months in the spring. Illinois’ debt service payments on bonds total $3.4 billion in fiscal 2016, while payments to its five retirement systems total $6.8 billion.

So it comes as no surprise that Fitch Ratings downgraded Illinois one notch to BBB-plus.

PUERTO RICO

Puerto Rico found out how low the level of trust on the part of creditors is when they reacted to the latest proposal for an oversight board. The generally negative reaction followed the announcement that Governor Alejandro Garcia Padilla has presented to the legislature the Puerto Rico Fiscal Responsibility and Economic Revitalization Act (the “Act”), which will establish the Puerto Rico Fiscal Oversight and Economic Recovery Board (the “Board”). According to the announcement, the Board will be comprised of five members appointed by the Governor and approved by the Senate. The members will select a chairperson from among themselves. It is the lack of outside participation in the process of picking members of the Board which causes concern.

The announcement comes amidst a swirl of rumors over a potential plan by which the U.S. Treasury would assist the commonwealth government in issuing a large bond deal —a “superbond”—with the federal agency in charge of administering some of the island’s tax revenue to repay holders of the new bonds. The hope is that this would lead to Commonwealth revenues at some level going through a “lockbox” to ensure payment on the so-called “superbond”.

At the same time, Resident Commissioner Pedro Pierluisi recently presented a bill in the U.S. Congress that seeks to authorize Treasury to guarantee repayment of principal and interest on future bonds issued in by the commonwealth. The Treasury-secured bonds under Pierluisi’s bill would only be used for urgent short-term financing needs, capital expenditure projects that promote long-term economic development or to refinance existing debt at lower interest rates. Treasury would also determine and notify Congress that Puerto Rico “has demonstrated meaningful improvement in managing its public finances.”

The current unwillingness of the island to accept meaningful outside oversight in order to assuage investors concerns should create a serious roadblock to successful resolution of efforts to negotiate a debt restructuring. Currently, under a proposed debt exchange PRIFA notes would be secured with the proceeds of a rise in oil taxes adopted earlier this year. It is estimated that the PRIFA notes would have had an 8.5% coupon and a 10% yield to maturity.

The existing note holders ultimately rejected this plan, in which the holders would have exchanged their notes for PRIFA notes at 130% of their market value. In addition, there were preliminary plans to have PRIFA bonds mature from 2020 to 2037, which would have extended the maturities held by investors on some and perhaps all of their securities. The bonds would have been callable probably from 2018 onwards at a price assuring a 12% yield-to-call.

If a court impaired the effectiveness of the guarantee of the PRIFA notes, which were supposed to be senior to other PRIFA debt, then the note holders could have exchanged the PRIFA notes for the old GDB notes. If the commonwealth were not to make timely payments on its general obligation bonds or if the commonwealth were to seek bankruptcy for the PRIFA bonds, these events would be considered a default on the PRIFA bonds.

The GDB said it was disappointed that it was unable to reach a constructive and mutually beneficial agreement with the Ad Hoc Group of GDB creditors. According to the GDB, it and the Working Group for the Fiscal and Economic Recovery of Puerto Rico continue to make progress towards a comprehensive voluntary exchange offer that addresses the commonwealth’s indebtedness in a holistic manner and through which creditors across the commonwealth will agree to amended payment terms through consensual negotiations.”

Apparently, Puerto Rico has not earned the market’s trust yet.

TEXAS METHANOL PROJECT FINANCING

In 2013, a $1.8 billion financing for a fertilizer production facility sponsored by an Egyptian company spurred controversy when it came to market. There were concerns about the roots of the foreign ownership, potential dangers from the production process, and the attendant financial risk that bondholders might be assuming that could result from these factors. That financing was successfully accomplished and that project in Iowa is on track for completion by the end of this year.

Now as that plant nears completion and operation, another large financing for a methanol production plant in Texas is being readied for the market. That plant is sponsored by the same Egyptian company and its successors. The largest use of methanol by far is in making other chemicals. About 40% of methanol is converted to formaldehyde, and from there into products as diverse as plastics, plywood paints, explosives, and permanent press textiles. In the US in 2011, the Open_Fuel_Standard_Act_of_2011″ was introduced in the US Congress to encourage car manufacturers to warrant their cars to burn methanol as a fuel in addition to gasoline and ethanol. The bill is being championed by the Open_Fuel_Standard_Coalition”.

Currently, domestic production accounts for one-third of methanol production while some 20% is imported from politically unstable Venezuela. The shale gas boom and lower domestic energy prices have boosted the perceived economics of the project. The combination of supporting domestic production and the seemingly reduced role of a middle Eastern based sponsor (after the pending merger is closed) are seen as factors reducing potential controversy around the deal. The location of the plant amidst a cluster of other petrochemical production facilities reduces concerns about dangers from the process or terrorism.

Once again, the municipal market is seen as a receptive vehicle for yield hungry investors seeking credit diversification and large block size in transactions that are really venture capital financings. This deal, like so many others, presents a complex series of agreements including fuel sourcing and transportation, production, transportation and distribution agreements, and a variety of commodity price based risks. These are all in addition to basic construction and operating risks and the resulting financial risks. All in all, a deal typical of what we see in the municipal market at the end of a low interest rate cycle and a red flag to savvy municipal investors.

CALIFORNIA

State revenues fell short of Department of Finance projections by 2.6 percent in September, but are still ahead of estimates for the first quarter of the 2015-16 fiscal year. In September, two of the state’s three top revenue sources were lower than projections. Retail sales and use tax revenues of $1.7 billion were $392.5 million, or 18.8 percent, less than estimates. Corporation tax revenues of $836.6 million came up $135.2 million short of projections, or 13.9 percent. Only the personal income tax beat Department of Finance expectations. Revenues of $6.7 billion were $447.0 million (or 7.2 percent) greater than anticipated in the budget.

When all taxes and revenues are included, the state in September brought in $9.6 billion, or $252.2 million less than projected in July. Compared to a year ago, September revenues came up short by 1.8 percent. However, for the first quarter as a whole, revenues exceeded last year’s by $1.6 billion, or 7.5 percent. The state ended September with $26.9 billion in unused borrowable resources—$3.8 billion, or 16.7 percent, more than expected.

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

Joseph Krist

Municipal Credit Consultant

ARIZONA WASTE DEFAULT

The waste to energy sector of the municipal market has long been plagued with financial difficulties due to political, economic, and/or operating failures. The municipal landscape is littered with failed projects and interrupted or failed payment streams.

The latest example is a financing under taken through the Industrial Development Authority of the City of Phoenix, Solid Waste Disposal Facilities Revenue Bonds (Vieste SPE, LLC – Glendale, Arizona Project). The original project, which was negotiated in 2012, was a two-phase relationship between Vieste and the City of Glendale with phase 1 being the construction of the waste facilities to sort recyclable materials from a stream of acceptable waste to be supplied by the city. Phase 2 of the project would have built an energy facility for the conversion of solid waste into renewable energy.

Phase 1 was completed in 2014 and opened Feb. 20. Immediately, the operator – Vieste SPE – contended that the project was not required to accept yard waste and the issue was submitted to arbitration. An arbitrator’s ruling dated March 31 ruled against the city, stating, “the arbitrator finds that yard waste is not an acceptable waste type under the waste supply agreement before the date on which the phase 2 energy facilities are commissioned.” Due to the disputes with the City of Glendale, the Solid Waste Disposal Facility is not operating and is not generating any revenue to make any payments on the bonds.

In the interim, the Debt Service Reserve for the Bonds has been depleted and the limited funds remaining in the Debt Service Reserve Fund are insufficient to make payments to bondholders. Further, as a practical matter, the Vieste SPE, LLC acknowledges its obligations, but it has no ability to make payment. No further payments will be made to bondholders until a resolution of litigation can be achieved, or circumstances otherwise change.

The issue in question would seem to be one of a somewhat cut and dried nature. That will apparently be determined through an arbitration and litigation process as Vieste LLC has filed a notice of claim against the City of Glendale for $200 million for breach of contract. Vieste claims that it is willing to begin construction on phase two, which would separate all the trash, including yard waste, if the city would accept less payout per year to cover the cost of the construction. The reduced payout would finance a portion of construction costs. The City position is that the project should result in no cost to the City.

This is not the first contract to be subject to dispute as the result of upheaval in the Glendale government resulting in part from questions over the terms of contracts negotiated by previous local administrations. The much better known dispute between the City and the NHL Arizona Coyotes is the most prominent example.

Regardless of the result, the sector should set off alarm bells when these sorts of public/private projects come to the municipal market for financing. It is clear that unless the investor has a high level of knowledge and confidence in  the details and strength of the underlying contracts and operation agreements, than these sorts of issues might be best left to the high yield professionals or speculative investors.

FLORIDA BOND VALIDATION RULING

An October 1 ruling validating $700 million of clean energy bonds by the Florida Supreme Court overturned 60 years of case law and made it harder to challenge future bond validations. The Florida justices overturned a 1955 precedent set in the case Meyers v. City of St. Cloud. The Meyers case held that a party that does not appear in a bond validation proceeding in circuit court, where the cases are initiated, still had the right to appeal from the trial court’s decision directly to the state Supreme Court. From now on, litigants must appear in the initial circuit court validation case to preserve their right to appeal.

Since Meyers, the court had stated on three other occasions that citizens and taxpayers who failed to appear in the circuit court bond validation proceeding nevertheless had standing to appeal the final judgment. In this case, the Court relied upon the plain terms of the statute, which specify that “any person wishing to participate in bond validation proceedings must appear in the circuit court.  In connection with the filing of a bond validation complaint, section 75.05(1), Florida Statutes, requires that “[t]he court shall issue an order directed against the state and the several property owners, taxpayers, citizens and others having or claiming any right, title or interest in property to be affected by the issuance of bonds or certificates, or to be affected thereby, requiring all persons, in general terms and without naming them and the state through its state attorney or attorneys of the circuits where the county, municipality or district lies, to appear at a designated time and place within the circuit where the complaint is filed and show why the complaint should not be granted and the proceedings and bonds or certificates validated.” Section 75.07, Florida Statutes, goes on to provide that “[a]ny property owner, taxpayer, citizen or person interested may become a party to the action by moving against or pleading to the complaint at or before the time set for hearing.”

Under these provisions, full party status is granted only to those who appear and plead in the circuit court proceedings.

LIPA TO RESTRUCTURE MORE DEBT

This week the Long Island Power Authority (LIPA) could see a second tranche of securitized debt issued that would be applied to the early retirement of some $1 billion of its outstanding debt. The issue comes after amended legislation permitting the securitization which would add to some $2 billion of similar debt authorized by the State in 2013. Proceeds would be applied to the purchase, maturity, or redemption of some of LIPA’s outstanding revenue bond debt. The securitization would be secured by a discrete charge on customer bills which are required to be segregated for the benefit of the securitized bondholders.

This refinancing method creates a more highly rated and lower cost financing vehicle for restructuring the LIPA debt and takes advantage of the current low interest rate environment. The impact of the scheme is a net credit positive for the LIPA revenue bond credit.

MIXED SIGNALS FROM DeBLASIO ON CITY FINANCES

The announcement over the weekend that New York City and the Metropolitan Transportation Authority had reached an agreement on the MTA’s capital funding plan raises some interesting questions about the City’s fiscal policies under the DeBlasio administration. The agreement settles, for the meantime a dispute over what the appropriate level of funding on the part of the City should be for this state agency’s capital needs. Under the agreement, the state pledged $8.3 billion in state funds to the authority, while the city would contribute $2.5 billion. The city had initially agreed to provide $657 million. Where the additional City money will come from is not specified.

The dispute is long running. A recent report by the City’s Independent budget Office reviewed the history of City funding over the period since 1982. The city makes an annual payment to the Metropolitan Transportation Authority (MTA) to support the authority’s capital program. According to the IBO, if the City contribution had remained constant in inflation-adjusted terms since the 1982-1986 Plan, Annual Aid would have exceeded $360 Million in 2014. The city’s contribution to the MTA’s first five-year capital plan (1982-1986) averaged $136 million a year. In nominal terms, the city’s contribution was highest during the 1987-1991 and 1992-1999 plans and has remained fairly constant at around $100 million per year since 2000. The city’s contribution to the MTA’s 1982-1986 capital plan averaged 1.2 percent of total city-funded expenses over the five-year period. Over time the city’s contribution as a share of total city-funded expenses has declined dramatically. The city’s contribution to the MTA capital plan in 2010-2014 averaged just 0.2 percent of total city-funded expenses a year.

$1.9 billion of its funding will come from the city budget and $600 million will come from alternative revenue sources that were still being negotiated with the authority. City officials said one option being considered was a method called value capture, which pays for upgrades by collecting taxes and fees from new development spurred by transit access.

The agreement continues a worrying pattern of inconsistency on the part of the DeBlasio administration. At first, the City takes a position that its finances are stretched and that further increases would damage fiscal stability. This tactic has been used in its general labor negotiations, police staff level debates, and in the ongoing MTA funding dispute. Each time, the issues have been resolved with the City eventually agreeing to higher funding levels than it says it can afford or, in the case of police force staffing, an agreement to a level in excess of that requested. This sends an extremely foggy message about the true state of the City’s budget as well as the outlook for the years ahead.

As for the MTA, any agreement that increases intergovernmental funding should be viewed as a positive for the credit to the extent it slows the growth in its massive current and future debt burden. The agreement as proposed still leaves the Authority some $700 million short of its own estimate of its needs. This in a system that is becoming increasingly expensive for its working class riders while retaining a seemingly insatiable appetite for capital. This in an environment that sees increasing regional competition for potential additional funding sources throughout the region.

NASSAU COUNTY DREAMS ON

One example of regional competition for revenues is Nassau County, NY. The financially troubled and management challenged county, recently released  a 2016-2019 Multi Year Financial Plan. The plan relies on several heroic assumptions. The redevelopment of Nassau Veterans Memorial Coliseum is projected to generate a minimum of $334 million in rental income over 49 years  to the County, or a minimum of 8% of gross income, whichever is greater. Additional revenues are expected to be derived from projected sales and related economic activity including entertainment, sales and hotel taxes, parking, arena revenues (ticket fees, merchandising, rental/leasing, concessions), and plaza rental revenues.

The MYP reflects the possible sales tax shortfall of $37 million for 2015 and has budgeted 2% growth in 2016 from this reduced base. As the economy expands, sales tax is projected to grow by 2.5% in 2017, 3.0% in 2018, and 3.0% in 2019. The sales tax is where regional competition comes in. The MTA would love additional sales tax revenues to reduce pressure on fares and to derive it from a regional base. At the same time, Nassau County proposes that if the New York State Legislature would allow for the regionalization of the downstate sales tax rate the affected counties would receive significant recurring revenues. Currently, the New York City sales tax rate is 8⅞%, whereas the Nassau and Suffolk sales tax rate is 8⅝%.

At the same time, the County will seek State approval to amend current State law that requires the County to contribute annually to the cost of MTA-LIRR station maintenance. The County is seeking for the State to take over the cost of station maintenance or allow County personnel to perform the maintenance at lower cost. The result would be to potentially reduce revenue to the MTA while increasing Authority expenses.

We see this as the sort of thinking that has continually hindered resolution of the County’s financial decline. Along with this kind of thought, the County continues to place great faith in privatization – the County is currently exploring a potential public-private partnership that could result in the sale, lease, or private operation of the County’s district energy facility. The plant consists of a combined heat and power facility and central utility plant that provides thermal and electrical energy to the marketplace. A request for proposals is expected to be issued by end of 2015. Also to be revived is a plan advisor to explore a P3 to improve sewer service to County residents and strengthen its infrastructure assets. This follows on a previously failed effort to accomplish the same goal.

Overall we see questions about the long-term for New York City, continuation of the constant grind for funding by the MTA in the face of greater limitations, and a continued long unrealistic path to recovery for Nassau County.

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

Joseph Krist

Municipal Credit Consultant

HOUSTON – DO YOU HAVE A PROBLEM ?

In 2004, the issue of pension reform for municipal government really came to the forefront through a study done by University of Chicago professor Joshua Rauh. In brief, it created a concern that consistent underfunding and underperformance of investments was creating a crisis that could potentially bankrupt many American cities. Among the potential hot spots were cities including Chicago, Houston, Philadelphia, San Diego and Milwaukee. Since that time we have seen the issue of pensions play a prominent role in the financial difficulties of cities including Detroit, Stockton, and San Bernardino which have all declared bankruptcy.

Prominent in  the news now are pension issues confronting the Commonwealth of Pennsylvania, the States of Illinois and New Jersey, and the City of Chicago. But a recent report from the Laura and John Arnold Foundation has returned the pension spotlight to Houston. According to the Arnold Foundation report, Chicago was in roughly the same position 10 years ago that Houston is in today. the city’s strong economic position has helped to cushion the impact of poor pension funding decisions thus far, but conditions are changing. The drop in the oil markets along with the property tax revenue cap could quickly magnify the city’s pension problems and result in a crisis much like the one in Chicago.

The Foundation suggests that Houston should obtain local control over the city’s pension systems in order to negotiate changes directly with workers and enact those changes locally. In addition, they posit that the City must fully fund the pension systems; paying off the unfunded liability in 20 years or less. In 2001, the City’s unfunded liability was $300 million. In 2014, it had grown to $3.1 billion. The funding gap is due in large part to the fact that the city hasn’t been paying enough into the pension fund on an annual basis. Houston’s Annual Required Contribution has more than doubled since 2003 and is now equal to nearly one-fifth of the total general fund revenue. Yet, Houston has only paid a portion of the amount each year since 2006, despite the fact that it has increased the amount of money dedicated to pensions from about $150 million to nearly $300 million.

The report says that the pension systems for Houston’s firefighters and municipal employees use the highest investment return assumption for any major plan in the United States—8.5 percent. Meanwhile, the pension system for Houston’s police officers uses an investment return assumption of 8 percent, a number that is still higher than the national average. Under an assumed rate of return of 7.5 percent, the plans’ funded ratio, when considering the market value of assets, would fall from 75 percent to 67 percent and the debt would jump to approximately $5 billion. When assumptions are lowered to 7 percent—which is considered to be a reasonable expectation for future returns—   the funding level falls to just 63 percent.

Houston also was one of the cities that in prior years – Philadelphia, San Diego and Milwaukee which used DROP, or deferred retirement option programs. The basic concept works as follows: When an employee becomes eligible to retire, he instead opens an escrow account, and then keeps on working at normal pay. His pension benefit stops growing, just as if he had retired. The pension fund starts sending monthly checks to his escrow account. The escrow money earns interest, and when the employee finally does retire, he gets a lump sum. He also starts receiving his monthly pension checks, which are based on his benefits before the escrow accounts were created.

TAX EXEMPTION COULD BE UNDER ATTACK AGAIN

A lengthy tax relief and job creation bill recently introduced in the House has once again raised concerns that the tax exemption on municipal bonds could be revisited again. The 299-page bill, H.R. 3555 called “Jobs! Jobs! Jobs! Act of 2015,” was introduced by Rep. Frederica Wilson, D-Fla., and has more than 30 Democrats as co-sponsors.

It provides an exemption for private-activity bonds issued from 2015 through 2018 from the alternative minimum tax, repeal sequestration, and creates an infrastructure bank. The bill includes a number of provisions aimed at tax relief for workers and businesses, putting workers back on the job while rebuilding and modernizing the country and providing pathways for job-seeking Americans to get back to work through infrastructure projects.

It would however, cap the value of the municipal bond tax exemption at 28%. The measure also would repeal federal spending cuts known as sequestration which have included reductions in the subsidy payments issuers receive from the Treasury Department for their direct-pay bonds, such as Build America Bonds. One of the offsets for the bill would be the limit on certain deductions and exclusions, including the exclusion for tax-exempt interest. Other offsets include taxing carried interest in investment partnerships as ordinary income, closing the loophole for corporate jet depreciation and repealing oil subsidies.

The bill would exempt PABs issued from 2015 through 2018 from the AMT. Generally, these types of bonds are subject to the AMT, increasing their yields, but PABs issued in 2009 and 2010 were exempt from AMT under the terms of the American Recovery and Reinvestment Act. By exempting PABs from the AMT, but subjecting all bonds to the 28% cap, PAB issuers may not be better off than they are under current law, and issuers of other types of bonds would be worse off by some estimates.

Under current conditions in Congress, most particularly the House, we view the chances of enactment of serious and/or comprehensive tax reform to be effectively nil. What we do take note of is the fact that the idea of capping the value of the municipal bond tax exemption is being forwarded from the legislative side. It had previously been floated primarily by the Administration.

PUERTO RICO WILL LEAVE SOME DEBT AS IS

Try as one might to go a week without a story on the Commonwealth, it is well nigh impossible. At least the news is somewhat better this week. The GDB announced that debt  from the Municipal Finance Agency (MFA), Children’s Trust and Housing Finance Authority (HFA) are not currently expected to be restructured as part of the ongoing effort to manage the Commonwealth’s debt. Who would have thought that under any scenario, that tobacco bonds would look better than a general obligation with a constitutional revenue pledge?  That is because, according to the GDB, MFA is backed by municipal property taxes and  the Children’s Trust is a dedicated source. [What is going to be restructured] is everything else that is part of the government’s cash flow.

The Puerto Rico government intends to begin debt-restructuring talks with its creditors by mid-October. To that end, six groups have already signed confidentiality agreements as part of the overall debt-restructuring process, while other creditor groups are amending nondisclosure agreements that were previously signed for other transactions. While it faces a severe cash crunch that is expected to worsen by November if no additional liquidity measures are taken, the commonwealth faces two debt-service payments on Dec. 1, of $354.7 million, and Jan. 1, of $331.6 million, corresponding to GDB and general obligation (GO) debts.

Meanwhile the PREPA negotiations lurch along. PREPA announced Thursday that the Ad Hoc Group and fuel-line creditors have agreed to extend their forbearance agreements until Oct. 15. Talks with the monoline insurers hit another snag when the Puerto Rico Energy Commission (PREC) rejected Wednesday a petition filed Sept. 17 by National in which it sought a rate revision and hike of 4.2 cents per kilowatt-hour. PREC denied the petition alleging National didn’t meet requirements to prompt a rate revision procedure, nor provided enough evidence.

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

Joseph Krist

Municipal Credit Consultant

IS A P3 PUBLIC OR PRIVATE?

A recent letter from a local tax entity in Texas has raised an interesting issue with regard to the tax exempt status of student housing projects operated as public private (P3) partnerships on public lands. Brazos Central Appraisal District (“BCAD”) has requested seek an  Attorney General opinion to assist BCAD and its chief appraiser in  determining  whether  certain properties and improvements located in Brazos County, Texas are exempt  from  taxation. This request concerns two student housing  projects  on  property  owned  by  the  Texas A&M University System (“TAMUS”) in College Station, Texas. The first project described below is under  construction,  and  the  second  project  described  below  is  completed and occupied.

The District makes the case that these projects will be in competition with private  housing projects that do not enjoy tax exempt  status, and when those private projects  compete against tax exempt projects they are at a competitive disadvantage. The projects in question comprise a 3,400-bed complex with rooms ranging from studio apartments to three-bedroom,  garden-style units built on 48 acres of A&M land.

According to the District, there does not appear to be any definite restriction on the right to lease to persons other than faculty, staff and students of TAMUS or Blinn College. The lease contemplates that the facilities will be subleased to students, faculty and staff of Texas A&M, and also to students, faculty and staff of Blinn College, but it appears to permit subleases to persons who are not faculty, staff or students  of  Texas A&M or Blinn College. A&M’s agreement with the developer says that during the term of the land lease, all improvements will be owned by the developer and therefore the developer will have the legal title to those improvements.

A&M is relying on existing case law, including a 1992 case in which the court held that improvements to state land were exempt from taxation, despite the fact that the legal title to the improvements was not owned by the state. A&M maintains that “the new projects clearly serve a public purpose directly related to the University’s mission, providing housing for our students. “The concerns of local officials and local apartment owners are misplaced. The new projects are exempt from property taxes because they serve a public purpose, like the Corps of Cadets dorms and other dorms on the University campus.”

We suspect that the projects will be found to be exempt from local property taxes but the question raised is interesting and has implications for other P3 projects as well as possible challenges to property tax exemptions for other “not for profit” entities.

PUERTO RICO

On Monday, the trustee of the Puerto Rico Electric Power Authority (PREPA) filed a notice in which it warns the utility about the end, since Sept. 15, of a period in which the trustee had limited power to take such actions as sending default cure notices and impose other enforcement measures, as a result of the forbearance agreements that were in place with PREPA’s main creditor constituencies — the Ad Hoc Group of bondholders, fuel-line lenders and monoline insurers.

The trustee, U.S. Bank National Association, stated that as a result of the Sept. 15 deadline expiration, its power to send cure, or need for corrective action notices and take enforcement actions with respect to defaults is no longer limited by a requirement that called for a written request from a majority of principal holders for the trustee to act. Moreover, a temporary relief that allowed PREPA to not fulfill its obligation to transfer money “from the General Fund to the Revenue Fund has also ended.”

“The Trustee continues at this time to monitor and assess the negotiation process, and reserves all rights and remedies under the Trust Agreement, including, without limitation, the right to send cure notices and the right to pursue enforcement actions following an event of default,” the filing states.

As first reported by CARIBBEAN BUSINESS, PREPA reached an agreement with its fuel-line lenders last week to restructure about $700 million in debt held by the group of banks, which also agreed to further extend their forbearance agreement from Sept. 25 to Oct. 1. Meanwhile, the utility reached a restructuring agreement at the beginning of the month with the Ad Hoc Group that calls for an exchange of unwrapped, or uninsured, bonds for new, securitized paper; a 15% haircut, or debt reduction, on principal; and a moratorium on principal payments for the next five years, among other items. PREPA also secured an additional extension on its forbearance agreements with the Ad Hoc Group, through Oct. 1.

However, PREPA hit a snag with its other main creditor constituency, monoline insurers, when they failed to reach an agreement before negotiations hit the Sept. 25 deadline. In addition, while bond insurers Syncora and Assured Guaranty first agreed to extend their forbearance agreement with the utility from Sept. 18 until Sept. 25, MBIA Inc.’s National Public Finance Guarantee did not consent to it. National filed a petition Sept. 17 at the Puerto Rico Energy Commission (PREC), seeking a rate revision and hike of 4.2 cents per kilowatt-hour, which should take place within four months. The insurer is expecting a response from PREPA by Oct. 1, according to the document filed by the insurer at PREC.

The utility remains deadlocked with its monoline insurers, with all three currently out of their forbearance agreements with PREPA. “We continue to negotiate with our bond insurers in an effort to reach an agreement that will allow the authority to further progress in its transformation,” PREPA Chief Restructuring Officer Lisa Donahue stated after reaching the preliminary deal with fuel-line lenders. Insurers are now technically allowed to notify the trustee of a default event, putting the utility on a 30-day clock to address the issue after a notice is sent by the trustee requiring corrective action, or potentially face litigation..

The PREPA negotiations have been a litmus test of sorts, separate from the García Padilla administration’s recent announcement that it intends to restructure some $47 billion — not including PREPA and the Puerto Rico Aqueduct & Sewer Authority — of the commonwealth’s $72 billion debt. The commonwealth was hopeful that the financially troubled public corporation, with its outsized debt towering at $9.4 billion, could represent an example for creditors of the shape of restructuring to come.

TRYING TO HAVE IT BOTH WAYS

For many of us who have observed Puerto Rico’s unwillingness to honestly face its financial failings, Tuesday’s hearing before the Senate Finance Committee was yet another example of why it is hard to take the Puerto Rican government seriously. The officials sent by that government were told once again that the numbers they were using to make their case were too incomplete to persuade lawmakers that help was warranted — or that the money would be well spent. This reflects long-held views of the municipal bond analytical community.

Senator Orrin G. Hatch of Utah, chairman of the Senate Finance Committee, said that while he sympathized with the island’s plight, Congress needed to know more detail about the causes and structure of its debt, and whether help from Washington would benefit it in the long run. “We’d better get the right information, or nothing’s going to be done,” Senator Hatch warned.

The officials  came before the committee to argue for changes in various federal laws, which they said currently discriminate against Puerto Rico. It occurred in the face of large debt payments due in November and December, and warnings that it will not have enough cash to pay them while still providing an acceptable level of government services. None of the officials asked explicitly for a bailout, but they said the United States had a moral duty to help Puerto Rico, and identified a number of federal laws and programs that they said were discriminatory and ought to be changed.

“I want to help you,” Mr. Hatch told them. “I don’t think Puerto Rico is treated fairly. But we have to get really good information in order to help you.” Melba Acosta Febo, the head of the Government Development Bank, told Senator Hatch that the lack of financial data reflected Puerto Rico’s antiquated computer systems, which the government wanted to replace. She promised to gather as much information for the senators as possible. Given the need for such data, one would think that some of the island’s huge debt could have financed an updated system. But yet again, Puerto Rico failed to take responsibility for their own shortcomings.

These shortcomings have been well known for a long time but have continued to go unaddressed. They affect not only Puerto Rico’s ability to generate financials that can be audited but also casts doubt as to whether the island can actually account for ongoing cash flow and develop a base of economic data to support realistic planning and execution of economic development plans.

Instead, the Puerto Ricans relied on old complaints about federal laws they considered inequitable, particularly those that govern health care for the elderly and the poor, like Medicare and Medicaid. Yes, Puerto Rico’s population is older, and considerably poorer, than the rest of the United States. Ms. Acosta estimated that amending the relevant laws would be worth an additional $1.5 billion for Puerto Rico.

Sergio M. Marxuach, policy director for the Center for a New Economy, a nonpartisan research institute in San Juan, said that the best way Washington could reduce poverty and promote growth in Puerto Rico was to extend a version of the federal earned-income tax credit program to the island. The credit is for low- and moderate-income working individuals and couples — particularly those with children. He said this could be done even though residents of Puerto Rico do not now pay federal income tax — a questionable assumption. He also acknowledged that at some point Puerto Rico’s legal status as a territory would have to be changed. That message was mixed at best.

Pedro Pierluisi, Puerto Rico’s nonvoting member of Congress, chose to take a less diplomatic route. “We should treat Puerto Rico equally,” he said. “They are fellow American citizens. You shouldn’t be looking the other way. You shouldn’t be ignoring us. If you do so, you do so at your peril.”

Interestingly, the only witness who was not from Puerto Rico, Douglas Holtz-Eakin, the former head of the Congressional Budget Office, and now president of the American Action Forum expressed skepticism that giving Puerto Rico more federal health care money would bring about the structural economic changes the island needed. “You don’t generate long-term economic growth by increasing health care spending in Puerto Rico,” said Mr. Holtz-Eakin. “You might relieve some budget pressure, but so would a check for anything else.” “The primary emphasis should be on economic growth,” rather than simply finding new sources of money, he said. This supports arguments that many have made regarding the long-term outlook for Puerto Rico.

The hearing did produce some firm statements from the GDB which will only serve to steel the resolve of general obligation bondholders in any upcoming negotiation. Senator Hatch asked the witnesses about other types of debt that Puerto Rico owes, such as its pension obligations to retired government workers. He wanted to know which had priority in the hierarchy of creditors — Puerto Rico’s general obligation bondholders, or Puerto Rico’s pensioners. He elicited a response from Ms. Acosta that affirmed that general obligation bonds have an explicit constitutional guarantee and pensions did not. “It’s a very big problem,” she added. Further, she stated that the pension system will probably run out of cash in 2018. She said that at that point Puerto Rico would have to pay retirees directly from its general fund. “This is one of the reasons that we’re saying that we have to restructure the debt,”. “The idea is to use some of that money to put into the pension plans, because they badly need it.” As was the case in Detroit, this directly pits bondholders against pensioners.

From our standpoint, it was a very poor performance from the Puerto Rico officials both strategically and tactically. At this point, the Puerto Rican government appears to be clearly outmatched and its interests are not being best served by the current cast of characters. It also raises questions about the quality of the advice it is receiving. Sadly, this is not anything new. It points to our standing belief that the restructuring process will be long and messy and not be settled anytime soon.

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

Joseph Krist

Municipal Credit Consultant

CHICAGO BUDGET

Mayor Rahm Emmanuel announced his proposed budget for fiscal year 2016 on Tuesday. It includes a record city property tax increase ($543 million), a Chicago Public Schools construction property tax increase ($45 million), a new garbage hauling fee ($62.7 million), Uber and cabdriver tax and fee hikes ($48.6 million), new electronic cigarette taxes ($1 million) and building permit fee increases ($13 million). The city property tax hike, to be phased in over four years, would go toward the police and fire pension fund. It would amount to an estimated 70-percent increase in the city’s levy. The mayor wants state lawmakers to pass a law to exempt private homes valued at less than $250,000. The CPS money goes to the school district. The rest of the money goes toward reducing the year-to-year operating deficit, also known as the structural deficit.

The sharp increase in payments to the pension funds has been looming over the City for some time. Now that the actual numbers required have been made public, the issue becomes a political one. The City Council has avoided these kinds of increases for a long as possible but it has become clear that the State’s own pension and  difficulties preclude any real current help from that source. Emmanuel will have to obtain the votes of 26 of the 51 council alderman. The property tax increase may actually be the least contentious item if the homestead exemption is allowed. The garbage fee will actually be politically more difficult.

According to the Mayor, cutting its way to find the money for increasing pension payments would cause the City to cut 2,500 police officers, or about 20 percent of the force. He also said 48 fire stations — about half the city’s total — would have to be shut down while laying off 2,000 firefighters, or 40 percent of the department. Even if he wins approval of all the tax hikes, Emanuel’s $7.8 billion budget proposal comes with a measure of risk. It counts on Republican Gov. Bruce Rauner not standing in the way of legislation, supported by the Democratic legislative leadership,  that gives Chicago more leeway on required increases in police and fire pension payments. If that bill is not enacted, the city could find itself $219 million in the hole next year. The uncertainty over the outlook for the proposed budget continues to pressure the City’s ratings and supports the continuing maintenance of the current negative ratings outlooks.

PREPA RESTRUCTURING

The Puerto Rico Electric Power Authority (PREPA) announced Saturday morning that it secured extensions on its forbearance agreements with the Ad Hoc Group through Oct. 1, and fuel-line lenders through Sept. 25. Although monoline bond insurers, the public corporation’s other main creditor constituency, are not parties to the extension agreements, they continue to engage in discussions with PREPA and other creditors, according to the utility. “We are making progress and will continue working toward a consensual resolution that benefits PREPA and all of its stakeholders,” said Lisa Donahue, PREPA chief restructuring officer.

Without an agreement with the monoline insurers ahead of the deadline, they are technically allowed to notify PREPA’s trustee of a default event, which would commence a 30-day cure period, or potentially face litigation. Supposedly, the utility believes it will not end up in litigation with its bond insurers, which along with the Ad Hoc Group and the fuel-line lenders are PREPA’s three main creditor constituencies.

PREPA’s fuel-line creditors, a group of banks, and the Ad Hoc Group, which holds about 35% of the utility’s $9 billion debt, were willing to grant the forbearance agreement extensions Friday. Monoline insurers continued to hold out. At the beginning of the month, MBIA Inc.’s National Public Finance Guarantee chose not to join the other forbearing creditors in granting the deadline extension.

Meanwhile, the preliminary agreement reached between the utility and the Ad Hoc Group is said to call for an exchange of uninsured bonds for new, securitized paper; a 15% haircut on principal; and a moratorium on principal payments for the next five years, among other items. National is exposed to approximately $1.4 billion on PREPA. The utility’s other monoline backers, Assured and Syncora, insured about $900 million and $170 million, respectively, according to Bloomberg. National has a total exposure of some $5 billion across the commonwealth.

The way this deal [with the Ad Hoc Group] is structured is said to be viewed as being punitive to National relative to Assured in that National has a lot of front-ended maturities. The cost to National is about twice what the cost is to Assured, even on an equal dollar basis. Even on something that they both have $100 worth of exposure to, the cost to National is about $30 and the cost to Assured is about $15 on a present value basis.  The commonwealth has hoped a PREPA workout could be a template  for creditors in the overall restructuring to come.

The utility still faces significant hurdles before it can successfully complete a consensual restructuring plan, among them securing participation of at least 75% of bondholders that have not previously been part of the yearlong restructuring talks. Also, legislation is required for many of the plan’s components — including approval for the debt-exchange procedure and changes to PREPA’s governance provisions.  Securing majority support from the Legislature has proven to be difficult at best in many instances for the García Padilla administration.

SANTA ROSA BRIDGE

One of the best examples of a deal that could only be done in the muni market has always been bonds issued for the Santa Rosa Bay Bridge near Pensacola FL. The bridge was built in 1999 primarily to support real estate development on Santa Rosa Island on Florida’s Gulf Coast. “Bo’s Bridge” as it was known in the area, was driven primarily by support from its biggest backer, former House Speaker Bolley “Bo” Johnson. It remains a prime example of speculative investment backed by poor research by both the consultant and bond investor communities. Usage has never met projections and underutilization along with demand diminishing toll increases have combined to produce a facility which will likely never cover its debt service. Coverage shortfalls have characterized the credit since 2010.

The bridge is now back in the news with a move by the Trustee for the bonds to initiate litigation against the FL DOT. Representatives of Trustee’s counsel and a project consultant met with State Representative Doug Broxson (Santa Rosa) to discuss potential resolutions to the situation in November, 2014 and February, 2015. Neither of the meetings were successful. On March 16, 2015, the Trustee notified FDOT of the Authority’s noncompliance with the Bond Resolution, and demanded that FDOT immediately implement a toll schedule recommended by the project toll consultant. In May, 2015, FDOT’s general counsel sent a response r that posed numerous questions to the Trustee and also requested additional items that the Trustee will not be able to provide. These included a request for indemnification by the Trustee of FDOT from individual Bondholders’ claims that, following the requested adjustment to tolls, cause revenues to either decline or remain insufficient to timely pay debt service on the Bonds and to fully meet all other requirements of the Resolution. Trustee’s counsel responded to FDOT, reiterating that FDOT is contractually required to raise tolls, and requesting that FDOT raise the rates.

The Trustee has now notified bondholders that it is willing to file suit against FDOT provided it receives direction and satisfactory indemnity against the costs, expenses and liabilities, including attorneys’ fees and expenses from Bondholders that may be incurred as a result of such litigation. Bondholders representing not less than a majority in aggregate principal amount of the Bonds Outstanding would have to approve the litigation. Without Bondholder support, the Trustee is unwilling to file suit against FDOT given the costs of such litigation and the potential damage to Bondholders who are satisfied with the partial debt service payments currently being disbursed to Bondholders.

When the financing was done in 1996, it was clear that it had been structured so that all of the risk of shortfalls in use and revenues would be borne by the bondholders. Many investors felt that despite the lack of any guarantees, the State would ultimately step in and pay debt service. We do not see what has changed to make the State of Florida suddenly decide that it should take on responsibility for payment of the bonds.

TEXAS WATER

The State Water Board will issue its first series of bonds under its SWIFT program. SWIFT finances the purchase of obligations from local water systems secured by either their general obligation or revenue pledge. Pledged revenue bonds would be secured by one year of reserves and required annual coverage. The Board has been funded with a $2 billion appropriation by the Texas legislature under voter approved constitutional changes. It differs from existing state revolving fund bonds in that there are no federal dollars involved in funding the pool of money available to be lent.

The program is designed to help local communities develop new water resources to meet growing water needs to support new development which is occurring at a rapid pace. The pooled nature of the borrowing and the high credit ratings obtained through the proposed structure are intended to achieve the lowest possible financing cost for the underlying borrowers.

The Board will make subsidized low interest loans, deferred interest loans, and financings accomplished through board ownership of projects which will then be sold back over long-term schedules to the underlying local agency. Loans may be substituted as appropriate.  The portfolio was structured and secured in such a way as to obtain a program rating of triple A. Those ratings have been obtained from Fitch and S&P.

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

Joseph Krist

Municipal Credit Consultant

CA FINANCES OFF TO STRONG START

The State Controller has released results for the first two months of the State’s fiscal year. Strong August numbers pushed overall receipts for the 2015-16 fiscal year to $674.7 million, or 5.0 percent, above projections. For the fiscal year to date, all three major sources of revenue are surpassing expectations. August receipts were$1.5 billion higher than a year ago, and year-to-date receipts $1.9 billion higher. August retail sales and use tax revenues of $3.1 billion beat those from a year ago by 36.7 percent, while personal income tax revenue of $4.2 billion came in 6 percent higher, and corporation tax revenue of $159.1 million was 26.2 percent higher. The state ended the month of August with unused borrowable resources of $29.8 billion, which is 10.1 percent more than anticipated. This year, because of the state’s improved fiscal position, the Controller anticipates internal borrowing will be sufficient to meet cash flow without having to issue revenue anticipation notes (RANs). In 2013, California issued a $5.5 billion RAN with an 11- month term. In the next year, the state borrowed $2.8 billion from private investors for roughly nine months.

ILLINOIS IN MONTH THREE WITHOUT A BUDGET

Nearly four dozen state-funded social service programs have been denied state tax dollars in the midst of the budget impasse, some of which report being near the point of having to close their doors. Among them: After school programs for teens, early childhood intervention, autism assistance, domestic violence shelters and services, funeral and burial services for the poor, and programs to help parents prevent Sudden Infant Death Syndrome. These entities are a share of the 10% of state spending don’t have a law or court order to keep their funding flowing. Even with federal money making its way to some programs, it’s not enough to fund the services. Domestic violence programs, for example, are 91% unfunded because they don’t have access to state funding. Fortunately, state debt service is included in the 90% of state spending which is able to be maintained even without an enacted budget. This may account for the lack of real alarm from bondholders about the state’s seemingly intractable budget impasse.

SEATTLE SCHOOLS

While the State legislature continues to try to figure out how to meet state court funding mandates for education, After four months of negotiations, a five-day strike and one final all-night talk, the Seattle teachers union and Seattle Public Schools reached a tentative contract agreement early Tuesday, and school is scheduled to start Thursday for the city’s 53,000 students. It was the first strike by Seattle teachers in some 30 years.

The Seattle Education Association’s board of directors and its elected building representatives both voted Tuesday afternoon to suspend the strike, after four months of negotiations, a five-day strike and one final all-night talk, recommending the union’s membership approve the deal. The agreement will go to a full vote of the union’s 5,000 members at a Sunday meeting.

PENNSYLVAIA BUDGET

Pa. Senate Republicans are trying to force a vote on a stopgap budget which would eliminate about a third of the funding that was included in the GOP-passed $30.2 billion budget that Gov. Wolf vetoed in its entirety on June 30. That would provide temporary relief to social service agencies and school districts that have laid off staff, curtailed some services and put off paying bills while awaiting a budget agreement. The plan is to call for a vote to move a stopgap budget bill out of the appropriations committee on Wednesday to set up a vote by the full chamber on Friday.

A simple majority of the votes is required to gain passage and send the bill to the House for consideration. The Republican-controlled House returns to session next Monday and plans to begin its consideration of the stopgap proposal. The House rules would allow that chamber to consider it for final passage by Wednesday, at the earliest. The Governor could then  veto it, sign it, or use his line-item veto authority and veto only certain budgetary lines.

NORTH CAROLINA

Its history of conservative and strong financial operations has allowed North Carolina’s lack of a budget for the biennium which began July 1 to fly under the radar. So investors may be surprised to find out the State legislature is just getting around to approving a budget. After 11 weeks without one, the State Senate approved a budget which includes a cut in marginal income tax rates but increase in sales taxes through an expansion of the items subject to the tax to cover repairs, maintenance and installations. Division of Motor Vehicles fees also would rise. On the spending side, the plan spends barely 3 percent more than last year, with much of the increase going to the public schools and the University of North Carolina system. All teachers and state employees get $750 bonuses.

PRASA SETTLES WITH U.S. EPA

In the midst of efforts to restructure its already troubled finances, the Puerto Rico Aqueduct and Sewer Authority (PRASA) has agreed to make major upgrades, improve inspections and cleaning of existing facilities within its Puerto Nuevo system and continue improvements to its systems island-wide, according to an announcement from the U.S. Justice Department. The sewer system serves the municipalities of San Juan, Trujillo Alto, and portions of Bayamón, Guaynabo and Carolina. It updates existing agreements reached in 2004, 2006 and 2010. The improvements will supplement projects already being implemented under the previous settlements including construction of infrastructure at wastewater treatment and sludge treatment systems, as well as the Puerto Nuevo collection system.

In recognition of the financial conditions in Puerto Rico, the U.S. government waived the payment of civil penalties associated with violations alleged in the complaint filed Tuesday. “These upgrades are urgently needed to reduce the public’s exposure to serious health risks posed by untreated sewage,” said the Justice Department’s Environment and Natural Resources Division. “The United States has taken Puerto Rico’s financial hardship into account by prioritizing the most critical projects first, and allowing a phased-in approach in other areas, but … these requirements are necessary for the long-term health and safety of San Juan area residents.”

Violations include releases of untreated sewage and other pollutants into waterways in the San Juan area including the San Juan Bay, Condado Lagoon, Martín Peña Canal and the Atlantic Ocean. These releases have been in violation of PRASA’s National Pollutant Discharge Elimination System (NPDES) permits and the Clean Water Act. PRASA also violated its NPDES permit by failing to report discharges in the Puerto Nuevo collection system and by failing to meet effluent limitations and operations and maintenance obligations at numerous facilities island-wide.

Under the agreement, PRASA will spend approximately $1.5 billion to make necessary improvements. The utility will undertake a comprehensive operation and maintenance program in the Puerto Nuevo sanitary sewer system, including conducting an analysis of the system to determine whether subsequent investments must be made to ensure the system is brought into legal compliance and to conduct immediate repairs at specific areas of concern. PRASA has also agreed to invest $120 million to construct sanitary sewers that will serve communities surrounding the Martín Peña Canal, a project that will benefit approximately 20,000 people.

The settlement is subject to a 30-day public comment period and approval by the federal court.

PUERTO RICO PLAN ALREADY UNDER ASSAULT

The battle has begun in reaction to the Puerto Rican government’s plan to restructure all of its debt, including general obligations. There are already two competing analyses which have been made public, at least on a limited basis, which call into question many of the government plan specifics. These questions question many of the economic assumptions relied on by the government as well as the absolute level of cash shortfalls to be realized over the plan’s five year time horizon. A Virginia-based group called Main Street Bondholders accused the governor on Wednesday of distorting the island’s financial situation.

The reaction sets the stage for a protracted battle between the government and its creditors as well as one between the government and its employees and taxpayers. The politics of the restructuring are a minefield of competing and somewhat mutually exclusive interests and past history shows that reliance on political will provides a shaky foundation at best for belief that a resolution will be relatively quick. That belief is rooted in the recent statement by the Governor when he said that if Puerto Rico’s creditors would not negotiate concessions, he would have to execute the five-year plan without them. Legislators from both the opposition and the governor’s own party said this week that the plan does not have the votes needed to be adopted, especially provisions that call for slashing the budget of the island’s largest public university by one-third and imposing a 10-year waiver from future minimum wage increases for young workers.

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

Joseph Krist

Municipal Credit Consultant

PUERTO RICO – STILL HAVEN’T FOUND WHAT WE’RE LOOKING FOR

An independent financial control board will be tasked with ensuring that the recently released Fiscal & Economic Growth Plan (FEGP), once approved, is followed. It would comprise “experienced individuals from inside and outside the commonwealth,” according to an executive summary of the FEGP, with most of its members selected from a list that will not be determined by the government. It assumes that it would have the necessary powers to ensure compliance, particularly if subsequent administrations decide to do away with the final plan. The board would have the authority to approve the plan, as well as the power to force budgetary cuts, among other corrective actions that will be part of draft legislation submitted to allow for its establishment. It has yet to be revealed when the Economic Recovery Working Group will deliver its proposed legislation to Puerto Rico lawmakers for their necessary approval.

The board will oversee new budgetary regulations and practices, pursuant to a proposed law that would be known as the Fiscal Responsibility & Economic Revitalization Act. Constitutional questions have surrounded this topic since the group first began its work back in July. Legislation to this effect would have to be thoroughly analyzed to ensure it doesn’t infringe on the commonwealth’s Constitution and the delegation of powers.

Puerto Rico’s government will also need to get help from Washington, D.C., with many of the plan’s critical aspects depending heavily on federal action, as the commonwealth attempts to achieve economic growth and solve its fiscal woes. The plan again highlights the commonwealth’s lack of an orderly procedure to restructure its liabilities.

To control healthcare costs, the plan urges for parity in Medicare and Medicaid funding from the federal government. The FEGP recommends a long list of initiatives that would provide the commonwealth with equal treatment under both federal programs, allowing the local government to control healthcare costs.

Commonwealth efforts to achieve budget balance include extension until FY 2021 the Act 66 of2014’s freeze of new hires, formula-based appropriations, service costs, increase in salaries and collective bargaining agreements although the impact does not include the negative effect on Additional Uniform Contribution to the public pension systems. To reduce payroll costs the Commonwealth would implement a 2% annual attrition target. To achieve the attrition target, the Office of Management and Budget (“OMB”) may offer early retirement window to selected public sector employees. The Commonwealth may use a portion of the proceeds of P3 initiatives to incentivize voluntary retirement.

The FEGP calls for legislation to, beginning FY 2018, gradually adjust subsidies provided to municipalities by the central government, while empowering municipalities with the proper legal, administrative and operational tools for them to offset such decrease. The Commonwealth proposes significant changes to the funding scheme for the University of Puerto Rico in order to reduce the general fund subsidy requirement.

Much has been made of the demands from certain creditor groups to reduce education spending. This reflects the facts that since 1980, enrollment at public schools has declined 41% and, due to demographic trends, it is expected to fall an additional 25% (317,000 students) by 2020. This decline has led to a reduction in school utilization and a decrease in the student to teacher ratio to 12:1 (US average is 16:1). The Commonwealth proposes reduction of the  PRDE payroll through 2% attrition.

Other Commonwealth actions include proposals to concession remaining toll roads, including PR-20, PR-52 and PR-66 as well as maritime transport and bus system operations. These include 5-year minimum concession agreement for the operation and maintenance of the public maritime transportation services.

Several efforts will be made  to encourage Congress to provide Puerto Rico with tax treatment that encourages US investment on the island, such as the amendment of the US Internal Revenue Code to add new Section 933A to permit US-owned businesses in Puerto Rico to elect to be treated as US domestic corporations; enactment of  an economic activity tax credit for US investment in Puerto Rico designed as a targeted, cost-efficient version of former Section 936 of the US Internal Revenue Code; and in the event the US moves towards a territorial taxation system, exempt Puerto Rico from base erosion and/or minimum tax measures.

Other Federal action that could provide short-term impact include financing from the Department of Energy for the Aguirre Offshore GasPort project and finalizing its federal permit process; Federal Aviation Administration approval for airport consolidations; and technical assistance from the Bureau of Economic Analysis, Census Bureau, National Agricultural Statistical Service and Build America Transportation Investment Center.

The plan will also need an extension of the ruling that allows manufacturing companies that pay the Act 154 excise tax to deduct it against federal taxes. Successfully achieving an extension will allow the Puerto Rico government to extend the 4% tax until December 2017, after which it would be replaced by a “modified source income rule tax.” The large share of the island’s General Fund revenue comes from the levy, accounting for about 20%.

The plan’s base-case scenario assumes approximately -1% real growth in GNP while the high-growth scenario assumes structural reforms lead to GNP growth of 2% by 2020 (2% inflation is assumed in both cases). In the end however, the plan comes up short in terms of providing for sustainable budgetary balance. The government estimates a $ 27.8 billion cumulative financing gap over five years but 27.8 billion cumulative financing gap even after full implementation of the plan the proposed initiatives, together with economic growth, are expected to reduce the five-year financing gap by only about $13.8 billion, when taking into account $2.5 billion in incremental costs of the measures.

As for the Commonwealth’s debts, here is what the report concludes. “As difficult as debt restructuring is likely to be, the Working Group has instructed its advisors to begin working on a voluntary exchange offer to be made to its creditors as part of the implementation of the Fiscal and Economic Growth Plan  In the design of the voluntary exchange offer, the Working Group has directed its advisors to take into account the priority accorded to various debt instruments across the Puerto Rico debt complex, including its GO debt, while recognizing that, even assuming the clawback of revenues supporting certain Commonwealth tax-supported debt, available resources may be insufficient to service all principal and interest on debt that has a constitutional priority  Therefore, a consensual compromise of the creditors’ competing claims to the Commonwealth’s revenues to support debt service will be required in order to avoid a destabilizing default on the Commonwealth’s debt and to avoid a legal morass that will further destabilize the Commonwealth’s economy and finances  Accordingly, the Working Group has directed its advisors to meet with the creditor groups that have already been organized (and those that may be formed hereafter) to explain the Fiscal and Economic Growth Plan and to begin negotiation of the terms of a voluntary exchange offer that can garner widespread creditor acceptance  It is the Working Group’s belief that a voluntary adjustment of the terms of the Commonwealth’s debt that allows the measures contained in the FEGP to be implemented is the best way to maximize all creditor recoveries.”

Undermining the statements about voluntary exchanges is the Commonwealth’s announcement on Wednesday of its long-awaited debt restructuring proposal. The plan does not include the debt payments of its electric utility and its water and sewer authority which are being handled separately. Nor did they include debts structured without any payments due in the next five years. That leaves DEBT with a face value of some $47 billion. Five years’ worth of interest and principal payments on them is estimated at $18 billion. These include Puerto Rico’s general obligation bonds, which were sold to investors with an explicit constitutional promise that timely repayment would take priority over all other expenditures on the island.

The restructuring would provide $13 billion to finish paying for government services over the coming five years, which would leave just $5 billion for the bondholders over that period. It was not detailed how they thought this might be divided among the different classes of debt. Creditors are expected to get a more detailed set of cash-flow projections from the working group and form negotiating groups of their own over the next few weeks, according to the types of debt they hold. Then the negotiations over altering the repayment are expected to begin.

One way or another, it is clear that the Commonwealth is likely relying on both a reduction and an extension of its debt repayment schedule to finance itself. We continue to believe that this will lead to a protracted and uncertain process which can and should hamper the Commonwealth’s ability to access needed capital financing in the public debt markets.

KENTUCKY DOWNGRADE TO A PLUS

Standard & Poor’s downgraded Kentucky’s debt and credit rating last Thursday, citing the enormous and growing unfunded liabilities of its public pensions plans, as well as the lack of commitment by the state’s elected officials to do anything about it. The rating was lowered from AA- to A+. S&P said, “the downgrade reflects our view of Kentucky’s substantially underfunded pension liabilities that are the result of chronic underfunding and that we view as placing long-term pressures on the state’s finances. Despite pension reform efforts that began in 2008, Kentucky lawmakers have yet to make meaningful progress in reducing its long-term pension liability, especially as it relates to Kentucky Teachers’ Retirement System (KTRS). Although pension reform was discussed in the 2015 legislative session, the session ended without a resolution on how to address  KTRS’ large unfunded liability.”

The estimated combined $48 billion of unfunded liabilities for both pension systems is the equivalent of $12,000 for every man, woman and child in the state.

DETROIT SCHOOLS CONTINUE TO BLEED

In communities with large numbers of charter schools, legacy school districts struggle with declining enrollments that can lead to school closings and leave the remaining schools with students who often are the most difficult to educate. One such example is the Detroit Public Schools. Population declines and the availability of charter schools have reduced revenues distributed to it on a per pupil basis. This has made it more difficult for the DPS to balance its operations and reduced available funds for debt service.

As a result, Standard & Poor’s Rating Service announced its downgrade of two series of long-term bonds issued by the Michigan Finance Authority for DPS. S&P lowered the rating on 2011 revenue bonds to “A” from “A+” while 2012 revenue bonds dropped to “A-” from “A+.” This even though the bonds are pledged to be repaid from state aid to the schools, with the money passing each month directly from the state to a trustee charged with making the bond payments.

WASHINGTON STATE SCHOOL FUNDING

Washington State’s highest court declared last week that much of the law underpinning new charter schools around the state was unconstitutional. The court set a 20-day clock, at which time the charter system could be dismantled — a step that legal experts said no other state court had ever taken. The failure to enact school funding reform was already a huge budget and political issue. The panel that struck down the charter law, last month began assessing $100,000 a day in fines on the state until the Legislature comes up with a plan to better fund the K-12 system as a whole. Some teachers unions, including Seattle’s — the state’s biggest system — have been threatening to strike over issues of pay and staffing. Classes are scheduled to start on Wednesday in Seattle.

The court ruled that under the state Constitution, charter schools had to be run by a locally elected school board because they are operated with public money. The Washington court defined public schools in a unique way — the court cited in particular a 1909 legal precedent requiring that schools be governed by locally elected school boards —other states.

In the initial schools case, McCleary et al v. Washington, which led to the order last month on fines, the court said years of underfunding had created a patchwork of rich and poor, with some districts better able to raise taxes and money for their schools than others. The court said it would put the $700,000 a week in contempt-order fines assessed on the state into an education fund and keep collecting the money until a new plan was approved.

In its new ruling on the second case, League of Women Voters of Washington et al v. State of Washington et al, the court said that public funding and local control were intertwined and enshrined in Washington law and that privately run charter school boards did not constitute that elected control. “The fiscal impact of the initiative was merely to shift existing school funding from existing (common) schools to charter schools,” the court said.

One option under consideration if the State Legislature does not address the issue soon, is to treat the charter schools as extensions of home school, allowing students to continue in their current schedules and classes while issues of money were sorted out.

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

Joseph Krist

Municipal Credit Consultant

It was a mixed week for Puerto Rico.

DEBT PLAN DELAYED

Investors were disappointed when it was announced at the start of the week that Puerto Rico’s long awaited overall debt restructuring proposal was to be delayed for one week until September 8. We viewed the announcement with some suspicion when the delay was attributed to the impact of Tropical Storm Erika. It seemed to be just another in a long line of missteps by the government in its effort to cope with its mountain of “unpayable debt”. The decision made more sense in light of later events.

PRASA

The Puerto Rico Aqueduct & Sewer Authority announced Monday it had secured an extension until Sept. 15 on a $90 million credit-line payment due Aug. 31 to Banco Popular. As a part of the deal, Bank of America will assume $75 million of this debt beginning Sept. 15, with payment due Nov. 31. Popular will keep the remaining $15 million.

In a release the Authority said “PRASA achieved an extension of the $90 million credit facility maturing Aug. 31. It will run until Sept. 15 with Banco Popular, and thereafter with Bank of America, until Nov. 30. Bank of America will acquire about $75 million, while Popular will keep about $15 million.

The utility’s initial plan was to pay the $90 million credit line to Popular with part of the $750 million bond deal PRASA had to effectively cancel due to high uncertainty in the minds of investors. These included the government’s looming deadlines to deliver the five-year fiscal stability & economic development plan, and a consensus restructuring plan between the Puerto Rico Electric Power Authority (PREPA) and its creditors.

The Authority went on to say “This extension will allow the corporation to continue its process of accessing financial markets for the issuance of up to $750 million in bonds, through which we will be able to meet the payment of this credit line and other obligations, as well as the capital improvement plan on agenda.

After the utility was unable to close the $750 million bond deal, PRASA Executive President Alberto Lázaro had said PRASA would wait until the beginning of September to make another attempt at closing the deal, particularly after several of the uncertainty factors surrounding it had cleared.

Technically, the bond issuance is in a day-to-day status, which means it is waiting for the right time to go to market. Other external, but pending, issues before the issuance include the conclusion of negotiations with PREPA bondholders and the release of the commonwealth’s fiscal adjustment plan report. Once these issues are clearer, PREPA will be better positioned to sell its bonds in the market, according to PRASA’s statement.

If the utility had failed to get the credit-line extension, it could have been forced to tap its rate-stabilizer operational fund, something that, according to Lázaro, is being avoided since it could trigger a sooner-than-expected water rate hike.

PREPA RESTRUCTURING

Puerto Rico announced that it had agreed on terms for restructuring up to $5.7 billion of bonds late Tuesday, even though its plans to propose a much broader debt moratorium remained delayed. The restructuring plan covers only the uninsured bonds of PREPA. Its outstanding bonds have a total face value of about $8.1 billion, but of that, about $2.4 billion are insured and not part of the agreement.

The main party to the agreement was The Ad Hoc Group owns about $4.5 billion in Puerto Rico debt and comprises more than 30 funds, such as BlueMountain Capital Management, Franklin Advisors, Oppenheimer and Knighthead, among others. The group includes some who had been considered most likely to litigate.

The Ad Hoc Group will exchange all of its outstanding power revenue bonds for new securitization notes and receive 85% of their existing bond claims in new securitization bonds, which must receive an investment grade rating.  Bondholders will have the option to receive securitization bonds that will pay cash interest at a rate of 4.0% – 4.75% (depending on the rating obtained) (“Option A Bonds”) or convertible capital appreciation securitization bonds that will accrete interest at a rate of 4.5% – 5.5% for the first five years and pay current interest in cash thereafter (“Option B Bonds”).

Option A Bonds will pay interest only for the first five years, and Option B Bonds will accrete interest but not receive any cash interest during the first five years.  All uninsured bondholders will have an opportunity to participate in the exchange.  Ad Hoc Group will negotiate with PREPA in good faith to backstop a financing that will allow PREPA to conduct a cash tender for bonds held by non-forbearing creditors.

Melba Acosta Febo, president of Puerto Rico’s Government Development Bank, called the deal “an example of the promising results that can be achieved when the commonwealth and its creditors work together.” The agreement calls for an exchange of debt, according to press accounts. Current bondholders are to accept new bonds with a par value 15 percent less than the bonds they now hold. At the same time, the new bonds are to be backed by a securitized stream of revenue that is intended to make them much safer and likelier to repay investors than PREPA’s current bonds.

The planned new bonds are also intended to cost PREPA less in interest. The bonds have not yet been rated, but the securitization is supposed to make them so much stronger that they could have a coupon rate somewhere between 4 and 5 percent. The terms also call for a portion of the new bonds to pay only interest — no principal — for the first five years, to help PREPA conserve its cash. An Ad Hoc counterproposal carried a lower average interest rate of 4.11% versus PREPA’s proposal of 5.45%, depends on securitization of debt, guaranteed by 2 cents per kilowatt-hour (kWh) of PREPA’s electricity rate, which would go to a repayment fund.

The agreement assumes participation from 75% of uninsured bondholders outside the Ad Hoc Group, is forecasted to reduce PREPA’s total debt principal by approximately $670 million, save more than $700 million in principal and interest payments over the next five years and substantially reduce PREPA’s interest rate expense on the exchanged bond debt. In addition to its agreement with the Ad Hoc Group, PREPA announced an extension of its forbearance agreements through Sept. 18. All of the creditors that were parties to the existing forbearance agreements agreed to the extension other than National Public Finance Guarantee Corp.

The announcement that PREPA had an agreement with a big block of its creditors gives Puerto Rico a needed positive step in its effort to deal with its debt. The government is likely to use the PREPA agreement  something to show to other creditors the merits of negotiating consensual restructurings instead of litigating and insisting on full payment.

GDB MOVES FORWARD ON RESTRUCTURING

Press reports indicate that the GDB is taking initial steps towards a restructuring of some of its obligations as it faces continuing liquidity issues. The GDB is reported to be entering into nondisclosure agreements with some of its creditors, as the bank aims to begin debt-restructuring negotiations and raise capital. Talks would reportedly begin as soon as Sept. 8 — the same day the Puerto Rico government expects to deliver the delayed  five-year fiscal stability & economic development plan.  An exchange of GDB notes has been mentioned by government officials as one of the most sought-after measures to bring in liquidity to the government to secure its operations beyond November.  The GDB is said to have drafted a nondisclosure agreement for creditor group being represented by law firm Davis Polk & Wardwell and advised by Ducera Partners. The group includes such firms as Avenue Capital Management, Brigade Capital Management, Candlewood Investment Group and Fir Tree Partners.

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

Joseph Krist

Municipal Credit Consultant

WHY WE WOULD NOT BUY PRASA

The abandonment of a current sale of $750 million of revenue bonds may finally show the municipal bond market saying enough is enough to Puerto Rico. Initially the sale was delayed until this week ostensibly to give more investors time to absorb new information and better “understand” the credit. A supplement to the preliminary statement for the issue was then released. After reviewing all of the documentation, we believe that the case against buying PRASA debt is even stronger.

We have previously covered our concerns about the Authority’s unwillingness to provide adequate ongoing financial disclosure. We see this as being very important given our concerns about the Authority’s ability to service its own debt as well as uncertainties about the level of insulation that exists for Authority debt holders from the Commonwealth’s overall debt problems.

In connection with the postponement of the sale, the GDB went out of its way to say that PRASA has no need to avail itself of pending legislation permitting the Authority to restructure its debts. At the same time, the supplement to the preliminary official statement makes clear that ” the Commonwealth’s three major public utilities, which provide electricity, water , and roads for its citizens, have a combined debt of some$20 billion which they cannot pay. The final nail in the coffin was the move by Puerto Rico to appeal a ruling to the U.S. Supreme Court that prevents the agency from reorganizing under Chapter 9. The petition said that it needed to have a legal framework in case PRASA’s debts have to be restructured.

The government assumes that if PRASA meets its financial projections that it will not have to restructure. But the supplemental disclosure also details the limits on debt service costs through interest rate limits of 12% and limits on the size of annual rate increases. All of these should be red flags for potential investors (and some speculators) in the debt of the Authority. It also details potential hurdles to the use of acceleration as a tool for debt holders if the pending legislation survives ultimate judicial review.

PRASA’s senior bonds are secured by a first lien on the gross revenues of the authority. Under the Master Agreement of Trust (MAT), authority revenues flow to a trustee-held account from which monthly transfers are made to the bonds’ debt service funds. Only after the required amounts have been set aside for debt service do funds become available for PRASA’S operating expenses and other purposes. The MAT also requires the authority to manage its debt burden and service rates such that gross revenues will cover maximum annual debt service by at least 2.5 times. The bonds will be issued under New York State law, with the exception of any provisions related to receivership.

The gross lien pledge is offset by two factors. One, is that the utility must operate to generate revenues and those expenses have to be covered. Second is that overhanging all of this is the fact that currently, there just is not enough water to meet demand. There are already significant water use restrictions and effective rationing in place and there is no way to determine when the highly unfavorable climate conditions will end.

We think that investors should be exactly that – investors – in municipal bonds. If one wants to gamble in Puerto Rico, then go visit and play in one of the island’s casinos. Last time we looked, its municipal bonds were not available through casinos.

VA. TO TRY P3 HIGHWAY FINANCING AGAIN

Virginia will attempt another P3 development of a major highway project after earlier unsuccessful ventures. This project is the Transform66 Outside the Beltway Project designed to address congestion near the District of Columbia in northern Virginia. The project would cost $2.1 billion and has been certified for approval.

Under the proposed plan, I-66 would be improved to provide three regular lanes in each direction, two express lanes in each direction, high-frequency bus service with predictable travel times, and direct access between the express lanes and new or expanded commuter lots. The proposed express lanes would be dynamically-priced toll lanes that are designed to provide a reliable, faster trip. Drivers traveling with three or more occupants would be considered high occupancy vehicles, and could use the express lanes for free at any time.

By the end of 2016, the team is working to complete environmental work and begin construction in 2017. VDOT will decide between three options. A toll revenue concession – similar to the 495 and 95 Express lanes, in which the state would make a public contribution, but the private entity would take the risk in financing, designing, building, operating and maintaining the project; a design-build-operate-maintain project where the state would finance the project and collect the toll revenues, but the private sector would take the risk in designing, building, operating and maintaining the project, or a design-build-alternative technical concepts project where the state would finance the project, collect toll revenues as well as operate and maintain the project while the private sector would take the risk in designing and building the project and be able to come up with engineering savings during the bidding process, which cannot be done  currently under a typical design-build project.

Under any scenario chosen, a toll revenue concession – similar to the 495 and 95 Express lanes, in which the state would make a public contribution, the private entity would take the risk in financing, designing, building, operating and maintaining the project.

PA. BUDGET IMPASSE DRAGS ON

Pennsylvania House Republicans failed in their unprecedented attempt to partially override Governor Wolf’s eight week old veto of the state budget. Democrats, including Governor Wolf, declared unconstitutional the effort to override the veto on a selective line by line basis. The stunt-like effort reflected a view on the part of some Republicans expressed by one member who said “it shouldn’t matter” if the move was not legal or sustainable.

The effort reflected pressure on legislators to maintain funding for certain programs like human service agencies whose programs are supported by recipients of many political stripes. The lack of a budget and spending authorization is beginning to pinch those providers. The process remains mired in the dispute over efforts to increase taxes, impose new taxes on the natural gas industry, and increase education funding by the Commonwealth.

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.