Joseph Krist

Municipal Credit Consultant

The month of June is crunch time for state budget makers and this year there is no shortage of contentious budget action. We focus on four significant state budgets and the increasingly poor outlook for favorable resolutions, at least from the perspective of bondholders.

ILLINOIS

It was not unexpected but the Illinois budget process has turned into a major battle. House Republican Minority Leader Rep. Jim Durkin  called it “a Greek tragedy.” The likelihood is that the actual budget may not be finally adopted until later this summer. While we do not expect this spectacle to impair the payment of debt service on state debt, we do expect that the various twists and turns of the soap opera will continue to pressure prices and ratings on the state’s bonds.

Illinois Democrats have offered a series of budget bills designed to restore social service cuts proposed by Gov. Bruce Rauner. Republicans have criticized the House Speaker’s budget as being irresponsibly out of balance, while Democrats retorted that the Governor’s February budget proposal counted on more than $3 billion in false savings. The Governor has said he would consider raising taxes — but only after lawmakers agreed to a series of his proposals including term limits on lawmakers, a property tax freeze and reforms to workers compensation laws. He has threatened to keep the legislature all summer if they fail to pass those measures.

Debate was focused by the introduction of a bill to restore deep cuts to human services. It included programs that the Governor’s plan had slashed or zeroed out including restoring immigrant and refugee funding as well as money for autism, epilepsy, Alzheimer’s, Boys and Girls Clubs, YWCA and YMCA programs. The bill’s sponsor said it included $134 million in cuts in all and held Medicaid spending to fiscal year 2015 levels.

House Democrats contend that the $36.3 billion spending plan would reflect “what the state of Illinois should do for Illinoisans who need the government to be helpful to them.” according to the House Speaker. He did however, acknowledge that  “we don’t have the money to pay for this budget” — in fact they’ll be about $3 billion short — but he said he’s prepared to work with Rauner to find “new money.” All the while, the State’s biggest issue – pensions – remains unresolved.

FLORIDA

The Florida legislature has one constitutionally established responsibility – the passage of a budget. Not since 1992 has the state flirted with budgetary disaster so close to the end of the fiscal year on June 30. Hoping to break the Legislature’s budget stalemate, the Senate tweaked its Medicaid expansion plan Tuesday in the face of continued opposition from the House and Gov. Rick Scott.

The House did not have a categorically negative response , but Gov. Rick Scott stepped up his criticism of what he called the Senate’s “Obamacare Expansion Plan” and accused his fellow Republicans of trying to impose higher taxes on Floridians. Gov. Scott claims that the Senate’s plan to expand Medicaid under Obamacare will cost Florida taxpayers $5 billion over 10 years. His two priorities in the special session are a package of tax cuts and more money for public schools. Scott has ordered agencies to make contingency plans to provide critical services in case of what he has called a possible “government shutdown,” and has issued dire warnings of teachers not being paid and child abuse complaints being ignored.

The Senate changes, if adopted in committee and floor votes in next week’s special session, would drop the requirement that people would first have to be enrolled in a Medicaid HMO for six months. Instead, they could use federal money to buy subsidized insurance on the private market, in an effort to head off House criticism of Medicaid as a “broken system.”

A job-seeking provision for people in the revamped Senate plan would require them to seek work by using the state workforce portal, Career Source. Patients also could enroll in insurance plans through a federal health exchange, rather than using the state-run option, and the Legislature would have to approve any major changes in the plan ordered by the federal government.

Senate President Andy Gardiner, for the first time, said that approval of a health care plan is not directly linked to passage of a state budget. “We fully intend to pass a budget,” he said. “You could have a scenario where no health care bills get done and we pass a budget and go home.”

The House’s chief budget-writer, Rep. Richard Corcoran called the revised Senate plan “exciting,” but said the House wants guarantees that the Senate will take up several unrelated House proposals. These include plans to expand ambulatory surgical centers, a requirement that hospitals to publish price lists, and an end to approval of new hospital beds through the certificate of need process.

The Legislature will reconvene on June 1, for a three-week special session to finish work on the budget. The session is scheduled to end June 20, but the state Constitution requires a three-day “cooling off” period before lawmakers can vote on the budget. To stay on schedule, they would have to finish all work on the budget by Wednesday, June 17.

 PUERTO RICO

The P.R. House of Representatives approved a tax bill that calls for the implementation of an 11.5% sales tax at cash registers, up from the current 7% paid under the sales & use tax (IVU by its Spanish acronym), after introducing several amendments on the floor. The Senate approved the tax bill after amendments were introduced by the Senate before voting on it. If the House decides not to concur with the Senate’s version, a conference committee will be needed to address the impasse, something that could further delay the legislative process.

Among the amendments is one that would establish a commission which would submit a report on the different tax models within 60 days of the law’s final approval. The commission would be created to evaluate the different alternatives to change the consumption tax, including a return to the tax at the ports. The Consumption Tax Transformation Alternatives Commission (CATIC by its Spanish acronym) would comprise the Treasury secretary as its president, the Justice secretary, the Office of Management & Budget director, the Ports Authority director, members from the Senate and the House, as well as representatives from the private and labor sectors.

If it includes findings or recommendations favoring a move toward the tax at the ports, legislation would have to be presented within 10 days of the report’s presentation to address the findings.

A last-minute amendment to the bill calls for applying the 11.5% sales tax on frozen, refrigerated, canned, packaged “or in some other way preserved or packaged” food items. It is argued that the amendment levels the playing field for all involved in the food industry. Prior to the vote, some had been pushing to exclude from the proposed sales tax prepared food items served at restaurants, which have been taxed since the implementation of the sales tax.

The tax plan calls for a nine-month transition from the sales tax to a VAT, a process that is expected to be completed by April 1, 2016. A 4% tax on business-to-business services, as well as professional services, was also included, and is slated to kick in Oct. 1. These services are exempt under the current tax system.

PENNSYLVANIA

The Commonwealth is no stranger to prolonged budget battles and this year is no exception. The new Governor, a Democrat, faces a legislature where Republicans hold significant majorities. The legislature sees pension reform as its top priority through a bill to scale back pension benefits for future and current public school and state government employees. The governor has made education funding his top priority and released an open letter last week that showed how little headway he has made in winning over opponents to a tax increase on Pennsylvania’s natural gas industry, a source of money Wolf is counting on to put more money into public schools. Overhanging all of this is a projected $2 billion deficit in the fiscal year starting July 1

The Governor’s plan requires over $4 billion annually in higher taxes, according to an Independent Fiscal Office analysis, and Republicans oppose nearly all of it. The House has passed a bill to increase state sales and income taxes as a way to reduce the school-funding burden currently funded primarily by local property taxpayers. Senate leaders are skeptical.  The House also passed a bill to privatize much of the state-controlled wine and liquor store system, but it has not been acted on in the Senate for three months and it is opposed by the Governor. As for the pension situation, the Governor supports the issuance of pension bonds – a red flag for any market observer – as a stopgap measure.

We would not be surprised to see a late budget, a failure to address the Commonwealth’s pension situation, and a greatly compromised effort to address school funding. There is simply no consensus in the Commonwealth around any of the proposed resolutions and there is a deep sense of cynicism on the part of the electorate about efforts to reform school property taxes. This discussion has colored state politics in Pennsylvania for at least a quarter century with no successful resolution achieved regardless of which party has been in power. The net result is likely additional pressure on the Commonwealth’s ratings as well as those of many localities.
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

CALIFORNIA

The May update of the budget proposed by Gov. Jerry Brown included  millions more dollars for the university system than he had originally proposed, in exchange for a tuition freeze for in-state students in the 10-campus system. The revised $115.3 billion budget plan ends a dispute between the Governor, who did not support a tuition increase and the president of the University of California. She had threatened to raise tuition unless the state gave more money to the schools. The plan freezes tuition for California residents over the next two years, while out-of-state tuition could increase by as much as 8 percent in each of the next two years and 5 percent in the third year.

The new plan, if approved would provide 4 percent increases in spending for the system in each of the next four years and provides $436 million for the system’s pension obligations. Last fall, the University of California’s regents approved annual tuition increases for in-state students of as much as 5 percent for five years. There has been pressure from the legislature to limit tuition and increase state support. One avenue of cost savings opposed by the system president is massive online open courses (MOOC) as a way to save large sums of money.

The plan also calls for university employees hired after July 2016 to choose between a pension with a defined contribution plan or a defined benefit plan capped at $117,000 per year, a significant decrease from the current cap of $265,000. Tuition and fees for in-state students is more than three times the rate in 2002 at $12,000 a year. The figure does not including room and board or other additional charges on some campuses.

Non-education provisions of the governor’s updated proposal include a new earned-income tax credit to help low-income workers.

PUERTO RICO

Puerto Rico Governor Alejandro Garcia Padilla and lawmakers agreed on a proposal to raise the island’s sales tax. The plan would raise the rate  to 11.5 percent from 7 percent for nine months, in a transition to implementing a value-added tax. The increase is estimated to generate $1.2 billion of revenue. Lawmakers also agreed to recommend $500 million in spending cuts as part of a $9.8 billion budget for fiscal 2016. Puerto Rico’s House of Representatives and Senate must vote on the plan. A sales-tax boost would be a temporary alternative to the governor’s proposal for a value-added tax applied at each level of production and distribution.

SAN DIEGO STADIUM PLAN DEBATE BEGINS

A mayoral committee Monday proposed a financial plan for building an approximately $1.1-billion NFL stadium in hopes of persuading the Chargers to stay in San Diego. The plan includes major public contributions – $121 million from the city of San Diego and $121 million from San Diego County – but not a tax increase.

The plan would also include $300 million from the Chargers, $200 million from the NFL, $173 million in construction bonds, $225 million from the sale to a developer of 75 acres at the site of the existing Qualcomm Stadium. It  includes asking the Chargers to pay $1 million per game in rent. The mayor hopes for negotiations with the Chargers to begin by June 1. If a deal can be struck, he said, negotiations will deal with when the public vote would be scheduled.

This plan competes with two rival stadium proposals which have been announced. One is in Inglewood from the owner of the St. Louis Rams and a plan announced by the Chargers and Oakland Raiders to build a joint-use venue in Carson. Officials in Inglewood and Carson have opted not to put the land-use proposals to a vote of the public. In San Diego, however, Mayor Faulconer has promised a public vote even though the funding plan does not require it. A tax-funded proposal would require a two-thirds vote for approval which is widely viewed as a political impossibility.

Putting the issue to a public vote might be the undoing of the plan. The NFL has warned that waiting to hold a vote until November 2016, the next general election, might mean that the city would be too late to persuade the team to remain. The mayoral committee, made up of nine civic leaders, had earlier recommended that the 166-acre, city-owned site in Mission Valley would provide the quickest and least expensive location to build a stadium. A Chargers plan for a stadium in downtown San Diego, near the waterfront convention center, was rejected as too expensive and too fraught with problems with multiple ownership.

To avoid a tax, the committee’s proposed city and county contributions would come not in lump-sum payments but as annual payments. The city, the committee suggested, would be able to redirect money that otherwise would be used for the upkeep of Qualcomm. Once built, the new stadium would be self-supporting, the committee report said. It would be home to the Chargers, the San Diego State Aztecs, the Holiday and Poinsettia Bowls and events including bar mitzvahs, weddings, proms, reunions, corporate gatherings, monster truck jams, music festivals and religious ceremonies, the mayoral committee suggested.

TRANSPORTATION FUNDING INCHES FORWARD

Like the traffic many of you will face this weekend, federal transportation legislation made a small bit of progress this week. The House on Tuesday approved a two-month extension of funding for transportation projects which would maintain funding for the Highway Trust Fund through July 31. The bill now goes to the Senate, which has just two legislative days left before a scheduled week long Memorial Day recess. The transportation program’s spending authority is set to expire during that break, on May 31.

The program has for years relied on fuel taxes that are no longer keeping pace with the nation’s transportation needs.  The last full plan expired in 2009. Federal gasoline and diesel taxes that provide most of the financing were last increased in 1993. There is little support for raising the fuel tax, so Congress needs to find an alternative source of funding. The fight over financing has forced Congress to pass numerous short-term extensions, often just before leaving town for recess. This would be the 33rd short-term extension in recent years.

The House bill faces some resistance in the Senate where Democrats said the short-term extension, perpetuates  uncertainty that has made it difficult for state and local officials to build and maintain infrastructure. The Obama administration released a statement shortly before the House vote saying it did not oppose the stopgap measure because more time was needed to come to a long-term agreement.

Some Republicans would like to pair consideration of a long-term highway bill with tax reform. But there is great skepticism that this could be accomplished within 60 days. The chairman of the Senate Committee on Commerce, Science and Transportation, said he was for a multiyear highway bill and raised the possibility of funding it while extending a series of business tax breaks that are renewed annually, known as tax extenders.

GAS TAX INCREASE

One state has chosen not to wait for Congress to act. In Nebraska, the state’s unicameral legislature overrode Gov. Pete Ricketts’ veto of a 6-cent-per-gallon gas tax increase to pay for road and bridge repairs. The increase would raise Nebraska’s total gas tax over four years to 31.6 cents per gallon and is estimated to generate an additional $25 million annually for the state and $51 million for cities and counties once fully implemented.

The bill received 30 yes votes — the minimum required; 16 senators voted against it. Sen. Jim Smith, the bill’s sponsor, said the gas tax remains the most effective way to pay for construction work to help improve road safety and the economy. “The need is great. The options are few. Waiting is not an option,” said Smith, a fiscal conservative who usually supports tax cuts. In a statement released after the override, Ricketts said the tax will hit low-income Nebraska residents hardest because they pay a larger share of their income on gas than wealthier drivers.

The legislature apparently agreed instead that the road situation has grown too large to address without additional revenue. In a 2014 report, the Department of Roads identified $10.2 billion in projects it says are needed over the next 20 years. Nebraska has more than 100,000 miles of roads and 20,000 bridges, mostly owned by counties and cities. Roughly 10,000 miles of road and 3,500 bridges belong to the state. The state’s share of Federal Highway Trust Fund money has fallen faster than the national average in recent years. Funding from the federal gas tax has declined for most states as vehicles became more fuel efficient and motorists cut back on driving.

The higher tax was cast the tax as a “user fee” because it’s only paid by motorists, including those from out-of-state. Smith said repairing roads and bridges would help save motorists money by reducing car maintenance costs.

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 FACES THE MUSIC

Illinois provided lots of muni news this week. Within a couple of days, the IL Supreme Court was voting 7-0 to find that the state constitution would not allow the legislature to unilaterally alter worker pension benefits and the Governor released his recommended FY 2016 budget. Effectively, they are both the same story.

The enacted pension changes would have reduced future cost-of-living adjustments for workers, increased the retirement age for some and capped on pensions for those with the highest salaries. The court however, cited the state Constitution which says that benefits promised as part of a pension system for public workers “shall not be diminished or impaired.” “Crisis is not an excuse to abandon the rule of law,” Justice Lloyd A. Karmeier said. “It is a summons to defend it.”

The decision itself was anticipated but some of the direct language included in the opinion was. “The General Assembly may find itself in crisis, but it is a crisis which other public pension systems managed to avoid,” Justice Karmeier wrote. “It is a crisis for which the General Assembly itself is largely responsible.”

The Governor has suggested that voters should consider a constitutional amendment that would mark a distinction between guarantees of benefits already earned and changes to future benefits. Under the state’s Constitution, officials may assign new benefits to future workers, but cannot diminish benefits already promised. Several states have adopted “tiered” pension systems where pension terms are adjusted for prospective employees. One state which has successfully employed such a system in New York.

The court acknowledged that the decision complicates the state’s fiscal outlook. “The financial challenges facing state and local governments in Illinois are well known and significant,” the opinion read. “In ruling as we have today, we do not mean to minimize the gravity of the state’s problems or the magnitude of the difficulty facing our elected representatives. It is our obligation, however, just as it is theirs, to ensure that the law is followed.”

The Governor’s recommended budget relies on $2.2 billion in savings related to a new proposal to reform Illinois’ critically underfunded retirement systems. These savings are assumed to be realized in the fiscal year that begins on July 1, 2015, even though the pension proposal has not been introduced as legislation in the Illinois General Assembly and is likely to face its own legal challenges.  In addition to pension savings, the proposed FY2016 budget assumes a reduction of $655 million, or more than one third, in the cost of State group health insurance through collective bargaining. Both the magnitude of the projected savings and the short timeframe for reaching agreement with the State’s largest union suggest that the budgeted numbers are unlikely to be realized. Other budgeted savings, particularly in the Medicaid program, depend on changes in State law or require federal approval.  The Governor’s recommended budget cuts local governments’ share of State income taxes by half. The budget also proposed cuts to spending on community care for the elderly, disabled and those with mental illness.

The state is also not the only entity potentially impacted by the decision on pensions. The City of Chicago’s pathway out of its pension minefield most likely became more twisted. According to Moody’s, if current laws stand, Chicago’s annual pension contributions are projected to increase by 135% in 2016; by an average annual rate of 8% in 2017-21; and by an average annual rate of 3% in 2022-26. Looming contribution increases to the Municipal and Laborer plans could be reduced if the courts find Public Act 98-0641 unconstitutional. The city’s impending contribution increases to the Police and Fire plans will be reduced if the state amends Public Act 96-1495 per the city’s request.

That law requires that the City fund the Police and Fire pension funds annually in amounts are equal to (1) the normal cost of the pension fund for the year involved, plus (2) an the amount sufficient to bring the total assets of the pension fund up to 90% of the total actuarial liabilities of the pension fund by the end of municipal fiscal year 2040. Without the increased payments that current statutes require of the city, the plans will continue to liquidate assets to pay benefits. As the plans approach insolvency, risks to the city’s solvency will grow. The legislature will likely have concerns about the legality of any changes it must approve which would alter the City’s pension systems. All of this resulted in Moody’s Investors Service downgrading the city’s debt rating on bond issues backed by property, sales and fuel tax revenue to Ba1 from Baa2.

Mayor Rahm Emanuel maintains that pension changes he engineered for the workers and laborers funds can withstand the legal challenges they face. Moody’s said however that, “we believe that the city’s options for curbing growth in its own unfunded pension liabilities have narrowed considerably. “Whether or not the current statutes that govern Chicago’s pension plans stand, we expect the costs of servicing Chicago’s unfunded liabilities will grow, placing significant strain on the city’s financial operations absent commensurate growth in revenue and/or reductions in other expenditures. The magnitude of the budget adjustments that will be required of the city are significant.” Emanuel responded to the double downgrade by saying Moody’s had overreacted and noted that they did not downgrade the state of Illinois.

The cure for the pension problem is easy – new revenue and negotiated changes in benefits. The dilemma for both entities is the lack of political support for higher taxes. Other than savage cuts to services which may be even more politically unpalatable, increased revenues dedicated to pension funding seem to be the only way to address the chronic underfunding practices which created the current crisis. Unless plans emerge to address the situation, the downward pressure on ratings and valuations will continue for both entities. S&P put the State ratings on negative outlook on Friday.

PUERTO RICO FINANCIAL REPORT

It’s not an audit and while it is a “quarterly” report and it’s been seven months between releases, a current financial update was provided by the Commonwealth. It was unsurprisingly bleak. The commonwealth in fiscal 2016 “may lack sufficient resources to fund all necessary governmental programs” requiring “emergency measures [possibly including] a moratorium on payment of debt service,” the report said. It also referenced the potential for a debt adjustment, or the utilization for the payment of the commonwealth’s debt service of certain taxes and other revenues previously assigned by law to certain public corporations to secure their indebtedness.”

The government estimates a $2.4 billion deficit in the coming fiscal year, assuming no steps are taken to increase revenue or cut expenditures. In comparison, the current fiscal year budget is $9.56 billion. The report projects a current fiscal year will end deficit of $191 million. It says that there are resources to pay off its debts in the current fiscal year. It potential difficulties with the commonwealth’s and the Government Development Bank for Puerto Rico’s ability to make roughly $800 million in payments in July and August.

CALPERS WINS SAN BERNARDINO RULING

Bondholders lost another round in bankruptcy court in the ongoing tug of war between creditors and pensioners. A bankruptcy judge has dismissed a suit challenging the city of San Bernardino’s decision to make its pension payments in full to CalPERS. The ruling from U.S. Bankruptcy Judge Meredith Jury rejected the claim filed by Ambac Assurance Corp. and a Luxembourg bank named EEPK. Last fall the city, which filed for bankruptcy in 2012, said it would pay its $24 million-a-year CalPERS bill in full. Ambac and EEPK said that arrangement was unfair to other creditors.

Although San Bernardino hasn’t filed its complete repayment plan, it’s likely that many creditors would stand to receive only a portion of what they’re owed. Ambac and EEPK are owed a total of more than $59 million in the San Bernardino bankruptcy.

CalPERS welcomed the ruling saying,  “The judge in this case has ruled appropriately”. “Now the city can turn its attention to the more pressing matter of completing its plan of adjustment for exiting bankruptcy.”

Last fall, a bankruptcy judge ruled that Stockton had the legal right to reduce its payments to CalPERS. But the judge also approved Stockton’s repayment plan, in which the city agreed to continue paying CalPERS in full. Anything less than full payment by cities triggers a complicated legal mechanism that would result in a significant slashing of benefits to current and future retirees. In Stockton, for example, pension benefits would have dropped 60 percent, and city officials claimed that police, firefighters and other municipal employees would have quit for other jobs.

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

DETROIT SCHOOLS PLAN

Gov. Rick Snyder announced plans last week  to create a new debt-free Detroit public school district and pay off the old district’s debt with an additional state contribution of between $53 million and $72 million annually for up to 10 years. Snyder’s plan for overhauling education in Detroit calls for establishing a “brand-new school district, not a charter” school system that would be governed by a new seven-member board initially appointed by the governor and the mayor.

Snyder would get four appointments to the board of the new district, to be known as the City of Detroit Education District, while Detroit Mayor Mike Duggan would get three. The new education district would include operations, teachers and buildings that would transfer to them. The new DPS would inherit the district’s pensions, union contracts and employees. The old DPS district would continue to collect the 18-mill non-homestead property tax and use the money to pay down the district’s debts. The tax generates approximately $72 million annually, while the district faces debt service payments of $53 million each year, diverting $1,100 per student away from classroom instruction, according to the Citizens Research Council of Michigan.

Under the proposal, there would be a six-year “pathway” for returning to a locally elected Detroit school board by staggering out elections for two seats in November 2017, two seats in November 2019 and the remaining three seats in November 202. Detroit’s elected school board has been effectively sidelined for six years while the district has been under the control of four state-appointed emergency managers. The governor said he hoped to get legislation moving soon but added, “From a practical matter, it probably won’t be done until fall. The proposed financial assistance for DPS could be three times the $195 million lawmakers committed last year toward funding the city of Detroit’s pension funds.

The governor said the district has accumulated $483 million in debt.  Under the proposal the state would need to commit an extra $53 million to $72 million annually for 8-10 years from the School Aid Fund toward operating funding for the new DPS According to the proposal by isolating the debt  the annual cost to the state could be lowered if about $300 million in outstanding bond debt can be refinanced.

Previously, the Coalition for the Future of Detroit Schoolchildren, a 36-member group issued a report in late March with recommendations for overhauling the city’s school system. They included returning DPS to local control, putting Education Achievement Authority schools (Charter schools)  back in the district and having the state pay off the district’s debt.

While the District has not issued debt under its own property tax based credit for many years, the plan offers relief to insurers of that debt who have already been battered by the City’s bankruptcy. It also offers the potential for an upgraded entity should it eventually issue its own traditional GO debt.

MICHIGAN ROAD TAX DEFEATED

Infrastructure is a much lamented topic especially as it pertains to roads. Drivers nearly everywhere lament the condition of their area’s roads, especially after a difficult winter. So it was a bit of a surprise that Michigan voters resoundingly defeated tax changes this week that would have produced more than $1 billion a year for roads. The vote is considered a setback for Gov. Rick Snyder. A one-cent increase in the sales tax was the cornerstone of the ballot measure, which also would have created more money for education, local governments and public transit as well as fully restoring a tax break for lower-income workers.

The proposed constitutional amendment was placed on the ballot by the Republican-led Legislature and was supported by the Republican governor, Democrats, and a coalition of business, labor and government groups. It would have eliminated an existing sales tax on fuel so all taxes on motor fuels could go to transportation. It also would have restructured and doubled existing fuel taxes, and raised vehicle registration fees, to increase Michigan’s $3.7 billion transportation budget to $5 billion.

PUERTO RICO

Puerto Rico Rico Electric Power Authority (PREPA) bondholders granted the utility a 35-day extension on its forbearance agreement, which will now expire June 4, with PREPA delivering its restructuring plan by June 1. “During the new forbearance period, PREPA will have the opportunity to provide information to its creditors and meet on a timely basis to discuss all the elements of a plan that will improve PREPA,” according to the utility. This is the third extension conceded to the troubled utility after the original March 31 deadline.

“Under the agreement, PREPA has agreed to provide an informative session between the authority’s rate consultants and creditors’ advisors by May 11 and deliver a proposal for a comprehensive recovery plan to the bondholders’ advisors by June 1,” the PREPA statement said. On April 15, creditors agreed to grant PREPA a second 15-day extension “to allow all parties to continue their dialogue to develop a consensual solution to transform PREPA that will benefit all stakeholders,” Lisa Donahue, the utility’s chief restructuring officer, said.

PRIVATE ACTIVITY BOND PROPOSAL

Senators Ron Wyden (D-OR) and John Hoeven (R-ND) have proposed The Move America Act of 2015. The Act is designed to leverage additional private investment in public infrastructure. The program creates Move America Bonds, to expand tax exempt financing for public/private partnerships, and Move America Credits, to leverage additional private equity investment at a lower cost for States. Move America provides up to $180 billion in tax-exempt bond authority for States over the next 10 years and  up to $45 billion in infrastructure tax credits for States over the next 10 years.

Move America Bonds would generally be treated as exempt facility bonds under current law, with several exceptions. So long as facilities are generally available for public use, the government ownership requirements for exempt facility bonds do not apply to Move America Bonds. This retains the restriction to public-use infrastructure, while allowing more flexible ownership and management arrangements. It also allows private partners to benefit from depreciation deductions, should they take ownership of the facility either directly or through a long term leasing arrangement. The interest income on Move America Bonds is excluded from the alternative minimum tax. This eliminates the interest rate penalty placed on states for public projects with private partners.

Qualified facilities for Move America Bonds are limited to publicly-available transportation infrastructure, including airports, docks and wharves, mass commuting facilities, freight and passenger rail, highways and freight transfer facilities, flood diversion projects, and inland and coastal waterway improvements. The qualifying projects for docks and wharves is expanded to include waterborne mooring infrastructure and landside road and rail improvements that integrate modes of transportation. Move America Bonds are subject to a uniform volume cap, set equal to 50 percent of a State’s current private activity bond volume cap. As some projects have long lead times or may require more bond volume than a State receives in a single year, States would be permitted to carry forward volume cap for up to three years. Any carried over volume cap not used after three years would be reallocated to States that have fully utilized their cap, ensuring that the program is fully utilized. States would be required to report to the U.S. Treasury Department the amount of unused volume cap that is being carried forward each year.

CITI FIELD NUMBERS

The New York Mets better than expected start has garnered them some favorable attention some 30 games into the 2015 season. Mostly it is baseball fans who are interested but the bonds which financed  the Mets’ home park are also of interest to investors. NYC IDA debt for the Queens Ballpark LLC is widely held by New York investors both individually and institutionally.  The standings are reminders of the financial importance of good on the field performance as reflected in the recently released operating results for the Queens Ballpark entity that supports the outstanding debt which financed Citi Field.

The Corporation reported a 1.8% decrease in total revenue. The primary sources of decrease were ticket sales and advertising revenue. On the plus side, parking and concession revenues were up. Since only a portion of attendance-based revenues are pledged whereas all of the parking and concession revenues are pledged, lower attendance as the result of a losing season is mitigated. The means that the ultimate impact on current coverage is fairly minimal.

We feel that the bonds are appropriately rated at the BB range. The steadily increasing annual debt service requirements and inconsistent performance of the team and its impact on attendance are enough to constrain the quality of the credit over the foreseeable term.

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

ALL GOING WRONG FOR PUERTO RICO

If it had not already, PR’s financial crisis has reached critical mass for sure. The GDB was a source of loads of negative news. First, it announced that the Commonwealth would be unable to meet its required annual financial disclosure by May 1. Then the Bank released a letter to the Legislature which suggested that the Commonwealth would be unable to meet its liquidity requirements at the start of the fiscal year on July 1.

The bank made the warning in a letter made public a day after it was sent to Gov. Alejandro Garcia Padilla and the presidents of the island’s Senate and House of Representatives. “The island’s financial state is extremely uncertain,” the letter said. “A government shutdown would have a devastating impact on the economy, with salary and public service cuts, and a long and painful recovery.”

The letter urged legislators to immediately implement measures to cut costs and balance the budget and that  the government needs to approve a five-year plan to help reduce a $73 billion public debt as well as approve sweeping changes to the island’s  tax system.

In a number of interviews, David Chafey, president of the bank’s board of directors said once the government does that and presents a balanced budget, then it can be in a better position to issue bonds. “Time is passing, and it’s passing quickly,” he told The Associated Press. “We need to provide investors with some kind of comfort.”

Typically one agency of the government will not write to the rest of the government so openly but the letter was issued amidst negotiations between  Gov. Garcia and members of his party who oppose legislation that would impose a 16% value-added tax that he says is needed to help generate more revenue. In the House of Representatives a group of legislators reached a tentative agreement to impose a 14% value-added tax. If passed, the measure would then go to the Senate.

Stunningly, the GDB letter and the Governor’s efforts appear to have been for naught. Earlier in the morning of the the Governor’ s speech the House convened to consider the Governor’s plan to impose a value added tax of VAT as part of his financial reform package. In the session which ran past 3 a.m., the House of Representatives voted down the tax reform bill after failing to secure enough votes from the Popular Democratic Party (PDP) majority. Along with the New Progressive Party minority delegation, six PDP members voted against the measure. The final vote count was 22 in favor and 28 against.

The governor characterized their vote as “irresponsible” and “disloyal,” and the House speaker said that the PDP caucus will seek disciplinary sanctions for the six legislators.

After the vote, Puerto Rico Gov. Alejandro Garcia Padilla unveiled a $9.8 billion operating budget Thursday night in which he pledged to reduce crime, create jobs, boost school attendance and expand the U.S. territory’s tourism sector during a state of the commonwealth address. Padilla said he plans to reduce the island government’s $2.2 billion deficit to $775 million in one year, in part by taxing those who earn $200,000 or more a year or who buy homes valued at $1 million or more. He did not provide details about those taxes. On the sales tax front, Padilla also said that by Dec. 1, he will reduce the 7 percent sales tax to 6.5 percent and continue to exempt items including prescription medicine, books and non-processed foods. Those looking for an austere budget will be disappointed that Padilla promised that overall, more than 40,000 public employees in 28 agencies will see pay increases by next February. Padilla’s proposal is $750 million higher than the current budget, which legislators of the opposition party questioned.

According to recent reports by Bloomberg and Reuters, PREPA bondholders will be granting the utility a 30-day extension on its forbearance agreement, which had been set to expire today. This would be the third extension conceded to the troubled utility after the original March 31 deadline.

 PRISON DEBT BACK IN THE SPOTLIGHT

It has always been one of the riskier areas of the high yield market so the news of at least two facilities having debt problems in Texas is not a surprise. One is the now empty  Willacy County Correctional Center in Raymondville. One morning late last month, the prisoners rioted. Guards put down the uprising in about five hours, but the destruction was so extensive as to force the closure of the facility leading to all 2,800 inmates being transferred. “Worst scenario, we’ll lose about $2.3 million annually, which is about 23 percent of our income,” said one Willacy County commissioner.

The County counts on the prison as a business generating revenue. The prison’s water and sewer bill is $50,000 a month. Once insurance pays for extensive repairs to the prison, the county needs to fill those beds again as the facility is looked as a way to generate revenue and create jobs. Willacy County built three of them. The Correctional Center was the largest, with a staff of nearly 400. They’re now unemployed.

The County sold bonds, built the prison and hired an operator — Management & Training Corporation (MTC). MTC contracted with the U.S. Bureau of Prisons to incarcerate low-security male immigrants who are serving out sentences for illegal border crossings and aggravated felonies. Many if not most of the private prisons in the Southwest were built to service this “market”. For that service, the federal agency paid MTC to manage the prison. Then MTC paid the county $2.50 per prisoner, per day. But ultimately, it’s the county that’s on the hook for its $63 million debt on the nine-year-old prison.

When the U.S. Bureau of Prisons canceled its contract with Willacy County last week, it explained that the federal inmate population was down, and it didn’t need additional beds. The prison will be in competition with several other facilities for a more scarce “commodity”.  Like many private facilities, inmates have complained of bad living conditions and substandard medical care. MTC emphatically disputes this criticism. The company has hired a third party to investigate why the inmates mutinied. Meanwhile, Willacy County plans to cut all non-essentials in its budget — such as plans for a courthouse renovation and a new hurricane shelter.

Elsewhere in Texas, on February 2, 2015, the Trustee, UMB Bank, N.A., for the $42 Million Bondholders has notified the Maverick County Public Facility Corporation that Maverick County failed to make a scheduled $1,415,000 principal payment on Bonds on February 1, 2015, but did make the February 1, 2015 interest payment. Consequently, the Trustee had advised the Maverick County Public Facility Corporation that there are “several events of default have occurred and are continuing under the Indenture.

As is usually the case, all Project Revenues are pledged as security for the Bonds and the County is obligated to cause all Project Revenues to be delivered directly to the Trustee. The County continues to intercept Project Revenues, which constitutes a violation of the County’s obligations under the Lease.The County has then remits funds that it requisitions back for payment of operating expenses. Under the terms of the Lease, all Project Revenues must be delivered directly to the Trustee and are to be used to pay Rental Payment Deposits first, prior to using such revenues to pay Project operating costs and expenses. The County’s failure to deliver intercepted funds to the Trustee for application towards the Rental Payment Deposit caused an Event of Default.

A further complication is the fact that the Corporation had its non-profit corporate charter forfeited in August 28, 2009. The Maverick County Public Facility Corporation continued to enter into many legal agreements regarding the operation, management, and detention of federal prisoners at its Maverick County Detention Center as well as with the $42 Million Bondholders and Trustee, the U.S. Marshal’s Service, financial advisors, legal counsel, and other third party contractors. All of these actions potentially expose Maverick County to significant financial risks and liabilities.

The Maverick County Public Facility Corporation is in negotiations with the $42 Million Bondholders and Trustee in either restructuring the principal and interest payments owed on the debt and/or the forbearance of these payments and recently terminated its long standing financial advisor, Southwestern Capital Markets, Inc., while retaining a new one in First Southwest Capital.

The potential workout is additionally complicated by events associated with ongoing federal corruption investigations of the County. A Maverick County commissioner and former justice of the peace were arrested last week as part of an ongoing bribery investigation in the border city of Eagle Pass that has resulted in arrests bringing the total number of people charged in the ongoing investigation into a bid-rigging and kick-back scheme in Maverick County to 22. Among the others charged are three former county commissioners all of whom have pled guilty.

In Burnet County, a private jail deal will produce significant principal losses for bond holders after the facility is sold to the County. The 587 bed jail has been privately operated until 2014 when the County took it over. The County will pay $14.85 million for the facility while there are some $32,770,000 of bonds outstanding. The jail had been consistently underutilized and had proven to be a less than secure facility after several escapes. County inmates are sufficient to occupy only about 30% of the beds.

WAYNE COUNTY FINANCIAL UPDATE

Earlier this year we reported on the financial woes facing Wayne County which includes the City of Detroit within its borders. This week County  Executive Warren Evans unveiled a recovery plan with deep cuts – including wiping out retiree health care – in an effort to avoid bankruptcy. According to Evans, “this plan will prevent bankruptcy even though in some areas we are worse off [than when] Detroit was pre-bankruptcy.”  Wayne has just under $700 million of limited-tax general obligation bonds and $302 million of LTGO notes outstanding.

The plan eliminates the county’s $52 million structural deficit but the pension system that’s only 45% funded with a $910 million shortfall and a $200 million, bond-funded jail project in downtown Detroit that the county abandoned half built due to lack of money are not dealt with. Since 2008, the county’s has plugged general fund shortfalls by shifting money from its pooled cash fund. According to the County Executive, the county will not be liquid enough to rely on fund transfers anymore and will be entirely out of money by next summer.

The plan would eliminate health care for future retirees. It would move most employees and some retirees to high-deductible insurance plans and provide retirees with fixed and limited subsidies for the purchase of supplemental insurance, likely under the new federal health care law. That’s similar to what Detroit did in its bankruptcy, shifting retirees to the national exchange. These cuts would save $28.4 million in 2015, with annually increasing savings rising to $49.8 million by 2020.

It raises the retirement age to 62 and reduces future pension benefits by changing the pension multiplier. It increases the number of years used to determine compensation to 10 years from the current three- to five-year equation. All county employees would see 5% salary cuts. The total impact of these cuts would mean $60.3 million in savings for the county, including $53.4 million in the general fund.

In February, Evans blamed the county’s problems on a loss of property tax revenue and “fiscal and managerial mismanagement.” The county receives 60% of its general fund revenue from property taxes, which fell to $289 million by fiscal 2013 from $408 million in fiscal 2008. The plan assumes no increase in property tax revenue until 2018, and then only a $4 million boost.

The problems on the capital side are based in the county issue of $200 million of bonds in 2010 for a new jail, which is supposed to replace the current aging criminal justice facilities. But the county was forced to abandon the project in 2013 when it became too costly, and the county cannot return to the markets for additional financing in its current fiscal condition.

The county lost its last investment-grade ratings shortly after initial comments about the county’s finances in February.

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

TOBACCO USE DATA RELEASED

This is the time of year when tobacco securitization investors refocus attention on sales figures and funds available for distribution at mid-month under the terms of the Master Settlement Agreement. As the states and their subdivisions calculate exactly how much is available to them from the April distribution, other data becomes available regarding smoking trends which are central to the analysis of these bonds.

The most recent Morbidity and Mortality Weekly Report (MMWR) from the Centers for Disease Control and Prevention and the U.S. Food and Drug Administration’s Center for Tobacco Products (CTP) showed that Current e-cigarette use among middle and high school students tripled from 2013 to 2014, according to the data. Findings from the 2014 National Youth Tobacco Survey show that current e-cigarette use (use on at least 1 day in the past 30 days) among high school students rose from 4.5 percent in 2013 to 13.4 percent in 2014, or from approximately 660,000 to 2 million students. Among middle school students, current e-cigarette use more than tripled from 1.1 percent in 2013 to 3.9 percent in 2014—a rise from approximately 120,000 to 450,000 students.

This is the first instance since the survey started collecting data on e-cigarettes in 2011 that current e-cigarette use has surpassed current use of every other tobacco product overall, including conventional cigarettes. Hookah smoking roughly doubled for middle and high school students, while cigarette use declined among high school students and remained unchanged for middle school students. Among high school students, current hookah use rose from 5.2 percent in 2013 (about 770,000 students) to 9.4 percent in 2014 (about 1.3 million students). Among middle school students, current hookah use rose from 1.1 percent in 2013 (120,000 students) to 2.5 percent in 2014 (280,000 students).
There was no decline in overall tobacco use between 2011 and 2014. Overall rates of any tobacco product use were 24.6 percent for high school students and 7.7 percent for middle school students in 2014.

What is problematic for investors is that In 2014, the products most commonly used by high school students were e-cigarettes (13.4 percent), hookah (9.4 percent), cigarettes (9.2 percent), cigars (8.2 percent), smokeless tobacco (5.5 percent), snus (1.9 percent) and pipes (1.5 percent). The products most commonly used by middle school students were e-cigarettes (3.9 percent), hookah (2.5 percent), cigarettes (2.5 percent), cigars (1.9 percent), smokeless tobacco (1.6 percent), and pipes (0.6 percent).

The results are problematic as MSA revenues are based on sales of actual cigarettes or “sticks” rather than sales of all tobacco products such as roll-your-own tobacco and smokeless tobacco e-cigarettes, hookahs and some or all cigars. Should this trend continue, expected rates of cigarette shipment declines should be anticipated with negative impacts on securitization cash flows.

KANSAS REVENUE WOES CONTINUE

A new forecast issued Monday projects that the state will collect $187 million less in taxes through June 2016 than anticipated. This may force Gov. Sam Brownback and the Legislature to consider larger tax increases than they had expected to balance the state budget. Before the new forecast, they had been working on budget proposals requiring about $150 million a year in tax increases. Revising a forecast made in November, state officials and university economists reduced the estimate for total tax collections for the current fiscal year by nearly $88 million, to about $5.7 billion. They also cut the tax collection estimate for the fiscal year beginning in July by nearly $100 million.

MORE NEGATIVE NEWS FOR PREPA

OFG Bancorp announced that its Oriental Bank subsidiary (“Oriental”) will place its $200 million participation in a fuel purchase line of credit with the Puerto Rico Electric Power Authority (PREPA) on non-accrual status and will take a $24.0 million provision. The move reflects Oriental’s view that PREPA, despite its oil price related increasing ability to meet contractual obligations with creditors, has signaled an unwillingness do so.

Oriental, said, “Our credit analysis, based principally on data provided by PREPA and its advisors, shows the utility has the financial capability to pay its creditors. However, in the recent negotiation for extending the more than 8-month forbearance period previously granted by its creditors, PREPA clearly demonstrated a reluctance to commit to do so, despite the utility’s improved cash flows.”

Oriental’s $200 million PREPA exposure was acquired through the late 2012 purchase of BBVA’s Puerto Rico operations, and is part of a syndicated $550 million fuel purchase line of credit.

NEW JERSEY DOWNGRADE

Moody’s downgraded New Jersey’s general obligation bonds to A2 from A1. The outlook is negative. Ratings on the state’s appropriation-backed, other GO-related debt, and intercept programs were also lowered one notch. The downgrade to A2 was driven by the continuation of the state’s weak financial position and large structural imbalance, reflecting continued pension contribution shortfalls. Liquidity and structural balance are projected to remain very weak through fiscal 2016 – a longer period than contemplated. While some stabilization in budget performance, economy, and liquidity was noted, Moody’s is concerned that beyond fiscal 2016, the state’s plan to restore long-term structural balance relies on economic growth and further pension reforms, which have uncertain timing and impact.

The negative outlook reflects anticipated further decline in the state’s financial and pension position before pension reform, if successful, is implemented. Without meaningful structural changes to the state’s budget, such as pension reform that dramatically improves pension affordability, the state’s structural imbalance will continue to grow, and the state’s rating will continue to fall.

ATLANTIC CITY

The City of Atlantic City was granted a 60-day extension on a $40 million state loan that was due on March 31. The extension comes as a lawsuit was filed by the Borgata Hotel Casino that could challenge future bond sales. The city’s emergency manager Kevin Lavin released a report on March 24 recommending cutting expenses by $10 million this year as well as negotiating with key stakeholders to help create “fiscal stability.” Atlantic City is facing a projected $101 million budget gap in 2015.

Recent economic news includes a grand-opening for a new 85,450-square-foot Bass Pro Shops Outpost store with 200 employees on April 15. A new 16,000-square-foot development from BET Investments featuring upscale stores is also scheduled to open this year next to the Boardwalk Hall sports arena. One day after Polo North, a Wellington, Fla.-based developer received court approval to buy the Revel casino for $82 million, Polo North Inc. and Stockton University in Galloway Township, N.J. announced plans on April 3 to invest more than $500 million in the city.

Stockton, a public college, is slated to open its new Island Campus at the former Showboat Casino Hotel site in Atlantic City this fall. Polo North deposited $26 million in escrow for Stockton, which covers the $18 million purchase price the university paid for the former casino property as well as other costs incurred such as maintenance, utilities, employees and insurance.

Stockton has an 18-month first right to purchase or lease the property for educational purposes. A contingency in the deal allows the university a 90-day period to terminate the contract as it evaluates potential legal challenges from the neighboring Trump Taj Mahal, which has tried to block the bid because it doesn’t want college students living next to its casino.

CA WATER RATE DECISION

A California state appeals court on Monday ruled that a tiered water rate structure used by the city of San Juan Capistrano to encourage conservation was unconstitutional. The Orange County city used a rate structure that charged customers who used small amounts of water a lower rate than customers who used larger amounts.

The 4th District Court of Appeal struck down San Juan Capistrano’s fee plan, saying it violated voter-approved Proposition 218, which prohibits government agencies from charging more for a service than it costs to provide it. “We do hold that above-cost-of-service pricing for tiers of water service is not allowed by Proposition 218 and in this case, [the city] did not carry its burden of proving its higher tiers reflected its costs of service,” the court said in its ruling.

The court opinion means that tiered prices are legal as long as the government agency can show that each rate is tied to the cost of providing the water. A group of San Juan Capistrano residents sued that city, alleging that its tiered rate structure resulted in arbitrarily high fees. The city’s 2010 rate schedule charged customers $2.47 per unit — 748 gallons — of water in the first tier and up to $9.05 per unit in the fourth. The city, which has since changed its rate structure, was charging customers who used the most water more than the actual cost to deliver it, plaintiffs said. The law, they argued, prohibits suppliers from charging more than it costs to deliver water.

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

STADIUM FINANCE BACK IN THE SPOTLIGHT

The upcoming NFL draft has focused most attention and interest on who will be playing where next season. Based on recent performance, fans of the St. Louis Rams should be focused on player personnel issues but instead the primary issue is how long will they have a team to root for. Last month, NFL Commissioner Roger Goodell announced that the league was accelerating its efforts to move a team to Los Angeles. St. Louis Rams owner Stan Kroenke, with land in Los Angeles and a fully developed construction proposal, is a frontrunner in the race.

It has been pretty well established that the financing of professional sports facilities with public funds has generated questionable returns on that investment to the taxpayers of the entities backing those projects. Nonetheless, Missouri Gov. Jay Nixon’s two-man stadium task force has been working for months to solidify financing and sidestep project-killing delays before presenting plans for a $985 million riverfront stadium to a National Football League owners committee this spring.

The plans have been controversial and it is unclear that local residents would support such investment, especially in the City of St. Louis. There has been significant pressure to submit the question to a public referendum. In response, the public body that owns and operates the Edward Jones Dome filed suit Friday against the city of St. Louis, seeking to avoid a civic vote on the use of taxpayer money for a new downtown football stadium. Filed in state court, the suit claims that a 2002 city ordinance requiring a public vote is “overly broad, vague and ambiguous.” The suit seeks a ruling that the ordinance either does not apply, conflicts with state statute or is unconstitutional.

The suit is complicated by the fact that the City and State political establishments have been working together to build a new stadium. At the same time, the city counselor has a responsibility to vigorously defend all the laws of the city. City of St. Louis residents voted in favor the ordinance in 2002 by nearly 10 percentage points — 55 percent to 45 percent. St. Louis County voters approved a similar measure two years later, 72 percent to 28 percent. Approved as a municipal ordinance in the city and a charter amendment in the county — the two laws prohibit any “financial assistance” from the city and county to a professional sports facility without voter approval. They define “financial assistance” to include tax reduction, tax-increment financing, land preparation, loans, donations, payment of obligations, and the issuance, authorization, or guarantee of bonds.

The initial plans for the stadium included up to $450 million from the NFL and team, $130 million in personal seat licenses, some tax incentives and as much as $350 million through a “bond extension.” To support debt issued for the current stadium, the state sends $12 million a year to the authority which operates the existing Edward Jones Dome. Those funds amortize construction bonds and cover upkeep on the stadium. The city and county each send $6 million.

Now the political winds may be changing. St. Louis County Executive Steve Stenger has said that the Governor is no longer looking to funding from the County.  The lawsuit spells out the city’s now-expanded role in a new facility. According to the new filing the city will issue new bonds, which will pay off the city’s debt on the existing stadium as well as provide funding for construction of the new stadium. Debt service, the suit says, will not exceed the $6 million a year in current payments. The city also will donate land to the project, and provide tax-increment financing or creation of a transportation development district or community improvement district.

The Governor and Jim Shrewsbury, the Nixon-appointed Dome authority chairman and former city aldermanic president said that they didn’t think “another public vote” was required. Dome authority attorneys agree. Ten of the authority’s 11 board members at a meeting in January unanimously passed a resolution that allowed the authority chair to hire contractors and file suit on behalf of the board. The Mayor of St. Louis has not taken a public position on the financing but has written to city aldermen, promising to “vigorously defend the validity of our ordinance” and, whatever the outcome, follow the law. Confusing many, the  letter went on to describe plans to continue the City’s $6 million annual payments beyond the current debt expiration in 2021.

We are of the view that the stadium backers should follow the route taken by MLB’s San Francisco Giants and the owners of the NFL’s Jets and Giants and privately finance a new stadium. That is not to say that provision of land is out of the question. But the use of limited tax revenues and borrowing capacity for a private benefit facility like this is not the way to go.

SMUD COMPLETES LONG CREDIT ROAD BACK

The recent announcement by Moody’s that it has upgraded the rating on the Sacramento Municipal Utility District’s (SMUD) outstanding $1,873,105,000 electric revenue bonds to Aa3 from A1 and the rating on the $347,850,000 subordinate lien revenue bonds to A1 from A2 with a stable outlook completes a long journey on the road to credit recovery.

June 7 will mark the 16th anniversary of the vote to close the Rancho Seco Nuclear plant after a failure of power supply for the plant’s non-nuclear instrumentation system led to steam generator dryout which the NRC called the third most serious safety-related occurrence in the United States at a nuclear generating plant.

In supporting the upgrade Moody’s cited timely rate-setting as an unregulated utility with no revenue transfer requirement to city or regional governments; effective risk management program; improved financial metrics; the strong competitive position against regional peers; the improvement in the diverse local area economy; and the sourcing of 26% of renewable energy for retail load while maintaining competitive prices. Ironically, the forced closing of Rancho Seco may have been a long-term blessing in disguise for SMUD given California’s aggressive stance towards renewable energy. For example, California contemplates ramping up the renewable power standard to 50% by 2030.

SMUD may need to incur incremental capital expenses for a potential major pumped storage facility that would be used to help manage intermittent power flows owing to the state’s increased reliance on renewable energy. SMUD’s leverage ratios reflect a much more favorable debt profile, Any new capital spending is expected to be funded significantly from internal sources and the cost of construction of a pumped storage facility could be shared with area utilities.

LATEST PUERTO RICO REVENUE DATA…

Treasury Secretary Juan Zaragoza Gómez announced that General Fund revenues totaled $838.6 million in March, up by $53.5 million from March 2014. The 6.8% year-over-year increase is the highest increase registered during the past eight months. corporate income tax revenues were $104.8 million; this figure was up $36.2 million from March 2014 and $22.4 million above estimates. In addition, the Treasury Secretary pointed out that corporate revenues have not exceeded $100 million for a month of March since 2007. Individual income tax collections exceeded March 2014 collections by $22.0 million, a 13.2% increase.

Foreign corporation excise tax (Act 154) revenues were up by $57.9 million, or 40.5%, year-over-year. Alcoholic beverages and tobacco products collections increased by $1.3 and $1.4 million, respectively. In March, Motor vehicle excise tax collections, which have registered consecutive double digit percentage reductions throughout the fiscal year-to-date, registered the smallest reduction ($1.7 million, or 5.6%) in the last 9 months. The Treasury Secretary announced that fiscal year-to-date revenues total $6.0 billion, which is $153.2 million, or 2.5%, below estimates.

WHILE DEBT REMAINS THE FOCUS

Efforts continue to work out PREPA’s debt troubles as bondholders have offered to extend their forbearance agreement with the utility for another 30 days. The offer includes a mutual commitment to continue working together on the refinement of a capital investment and rate plan, a timeline for PREPA agreeing to a work production plan and outside review of the work plan and information exchanges between the parties with provisions for public review. The news came as the PR legislature held hearings with the lead witness being the Authority’s Chief Restructuring Officer. Increasing frustration is being expressed by all sides at the slow pace of negotiations and the market impact of such a significant cloud of uncertainty. The authority’s chief restructuring officer, Lisa Donahue, told the commission she will present a first draft of a restructuring plan by June 1.

Those concerns are reflected in an increasing and more frequent Federal presence on that part of various U.S. Treasury officials who have been seen in more frequent meetings with Commonwealth financial officials. This reflects potential roadblocks emerging in the effort to reliquify the GDB with one report indicating that A group of hedge funds is demanding that as one condition of lending $2.2 billion to Puerto Rico, lawmakers must balance its budget for the long haul or agree to be found in default if a gap emerges. This would be a heretofore unseen requirement in the municipal market. During a local radio interview early Wednesday, GDB President Melba Acosta admitted it will be difficult to go to the market in the near future as tax reform, the fiscal year 2016 budget proposal and the situation at the Puerto Rico Electric Power Authority, among others, converge.

CA DROUGHT UPDATE

The Metropolitan Water District, which sells imported water to more than two dozen local agencies serving 19 million people in Southern California, voted Tuesday to reduce regional deliveries by 15 percent as the state grapples with a fourth year of drought. The board will revisit the issue in December. Cities that want to buy more water will have to pay penalties of up to four times the normal price for extra deliveries.

Moody’s has weighed in with its view that the governor’s executive order imposing water use restrictions to achieve 25% statewide reductions is overall credit negative for the state’s water utilities. It is their view that the utilities have little time to increase rates and fees to promote conservation, and the mandated conservation will reduce operating revenue. The fiscal impact will be to reduce the sector’s debt service coverage and reserves.

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

RHODE ISLAND PENSION SETTLEMENT PROPOSED

Rhode Island and most of its public employee unions reached a tentative settlement last week to the comprehensive challenge to the state’s 2011 overhaul of its beleaguered pension system. The settlement, which affects 59,000 current and past state employees, provides for adjustments to the minimum retirement age, the chance for more frequent cost-of-living increases and an increase in the defined-benefit pensions available to longtime public employees. If approved by the court and the General Assembly, the proposal would end litigation from six challenges arising from changes made to the pension system in 2009, 2010 and 2011. The court will set a schedule for the parties to implement the settlement, and the remaining three lawsuits will be addressed by the Court. The April trial date will be vacated for the purpose of implementing the settlement. It still must be approved by the General Assembly.

Six of the nine unions that sued the state agreed to the settlement. The three unions that have not settled represent about 800 employees; their challenge will be addressed by the court after the settlement is implemented. But a trial scheduled to begin this month has been averted. The settlement also relieves the new governor, Gina Raimondo of a major headache as she seeks to address Rhode Island’s struggling economy. In her prior role as the state’s general treasurer, she was the chief architect of the pension overhaul under challenge.

“The state had a very strong case, but Ms. Raimondo said that “to take the litigation risk off of the table is the right thing to do.” The settlement gives financial certainty to employees and retirees, she said, and is affordable for taxpayers. “All of the structural elements of the original pension legislation remain intact,” she said, adding that those elements provide “a fundamental restructuring of the system and fundamentally puts the system in a much healthier position.”

The $14.8 billion pension system was overhauled by the legislature when it created a hybrid plan that split direct contributions between the state and employees. It also suspended cost-of-living adjustments and raised the retirement age by five years, measures intended to save $4 billion over 20 years. Those changes angered public employee unions, which then sued to  challenge the plan as unconstitutional. The unions actively opposed Ms. Raimondo’s candidacy last year for governor.

The proposed settlement has received generally favorable reviews from outside observers. Frank Shafroth, the director of the Center for State and Local Government Leadership at George Mason University, said the settlement appeared to be good for Rhode Island, “because not agreeing to it means the long-term problem gets worse.” Part of the problem for pension systems across the country is that employees are living longer than in previous generations, Mr. Shafroth said, so settlements like this are going to become more necessary. He added that he regarded the Rhode Island settlement “as a very constructive development.” Roger Boudreau, who leads the Rhode Island Public Employees’ Retiree Coalition, told The Associated Press that retirees would not be happy with the settlement because they were getting “a fraction” of what they were promised. But, he added, they knew their chances of prevailing at trial were “very slim at best.”

The perception of continuing progress of pension reform in Rhode Island removes a significant drag on its credit standing. The state still needs to renew its economy after long term declines in its old manufacturing base but the pension issue is a major building block in the establishment of structural balance for the state’s finances.

ILLINOIS LEGISLATURE LOOKS AT CHAPTER 9 FOR CITIES

Illinois statutes don’t currently grant general legal authority allowing for a Chapter 9 filing by municipal entities with the one exemption being for the Illinois Power Agency. A recent hearing was held by the House Judiciary-Civil Law Committee on House Bill 298, sponsored by Rep. Ron Sandack, R-Downers Grove, which would permit local governments to file for Chapter 9 bankruptcy. Conditions allowing for such a filing such as state approval and potential alternatives were also discussed at the March 20 hearing.

The committee heard from representatives of the public finance community and civic organizations who pressed to make new options available for struggling communities and offered an alternative in the form of a new authority to assist local governments solve fiscal problems without bankruptcy. While a bankruptcy provision has not gained much traction with Democrats who control the General Assembly, discussions over whether Illinois should add such a law has received heightened attention since the new Republican governor, Bruce Rauner, proposed the option. Police and fire unions urged against permitting Chapter 9.

Sandack said his bill would require municipalities to first show they truly are insolvent and have made a good faith effort to restructure their debts with creditors. “By sponsoring this bill I am not encouraging municipalities to abandon efforts to regain financial stability on their own. The bill would simply provide municipalities with an additional tool to help them get their financial affairs in order,” he said.

Local governments face big increases in their public safety pension contributions next year due to a prior state mandate to shift to an actuarially required contribution level. There is a school of thought that says that the Governor and others want to give local governments more leverage in negotiating pension reforms. There is also the fact that Rauner has proposed to halve the amount of income tax revenue distributed to municipalities.

The well-regarded Chicago Civic Federation, is supporting a measure to create an authority designed to intervene before a government’s fiscal strains reach crisis stage. The quasi-judicial authority would help local governments deal with pension-related and other fiscal burdens threatening their solvency. The goal would be to avoid defaults and bankruptcy while putting a government on a sustainable path.

Existing law in the form of The Fiscally Distressed City Act is for cities with a population under 25,000. Under its terms, a local government must ask the General Assembly for the appointment of a special commission to consider whether the municipality meets the act’s criteria and if approved it can qualify for state financing assistance.

We would favor a mechanism for more robust intervention and oversight vs. the bankruptcy option. The Detroit experience showed the vulnerability of debt holders under that process and we think that any trend in that direction should be opposed.

CHICAGO ELECTION

A brief word about the Chicago election results which saw Rahm Emanuel elected to a second term. Viewed through the prism of a bondholder, the result has to be viewed positively. While significant financial issues remain for the City, many of the actions for which the mayor was criticized politically – school reform, higher taxes and utility rates, and pension change proposals – were all positive for bondholders. That is not to say that we expect rating stability or improvement but the uncertainty over the direction of city policies over the next four years were a significant drag on the City’s credit which has now been somewhat mitigated.

KANSAS GOES THE PENSION BOND ROUTE

The Kansas legislature approved an authorization for pension bonds as part of its overall budget process. Kansas is now expected to issue $1 billion in bonds to bolster its pension system for teachers and government employees. The Kansas Public Employees Retirement System would receive an infusion of cash, immediately narrowing a long-term gap in funding for retirement benefits. The pension system would invest the money and expects its investments to earn significantly more than the state would pay on the 30-year bonds.

The bill limits the state to paying 5 percent or less in interest to bond investors, and the pension system expects to earn 8 percent annually on its investments the long-term. The state issued $500 million in pension bonds in 2004, paying almost 5.4 percent in interest. The pension system’s investment earnings have averaged 7.7 percent annually since then.

Whether or not the plan is a good budget or credit move is subject to debate because the move also is designed to help with the state budget by decreasing state contributions to public pensions by $64 million over the next two years. The pension system already was on track to close a projected $9.8 billion gap between revenues and benefit costs from now until 2033 under laws enacted in recent years that require increasing state contributions to pensions.

The state must close a budget shortfall projected at nearly $600 million for the fiscal year beginning July 1. The gap arose after lawmakers, at Brownback’s urging, slashed personal income taxes in 2012 and 2013 to stimulate the economy. This would appear to be yet another iteration of borrowing for operating expenses regardless of the academic arguments supporting such debt. The borrowing would not be necessary if sound financial practices were not overruled by ideological zeal.

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

PR REMAINS TURBULENT

The Puerto Rico Electric Power Authority (PREPA) announced Monday that it agreed with its creditors to extend their previously negotiated forbearance agreements for 15 days. Creditors agreed not to take any enforcement actions against the utility while the forbearance agreements remain in effect. The creditors, who hold more than$9 billion of its debt, have the right to accelerate their claims, potentially forcing the utility into insolvency. PREPA previously missed a deadline  March 2 when it was supposed to present bondholders with a comprehensive restructuring plan. PREPA had previously told creditors restructuring would likely take 10 years instead of an expected five years. The creditors did not take action when the March 2 milestone was missed.

Some of the creditors are said to have offered additional financing to overhaul operations in return for concessions such as using the current drop in oil prices to pay off debt. Other measures needed to secure additional financing could include collecting unpaid electricity bills from the government and taking stronger action against electricity theft.  The savings to PREPA from the recent drop in oil prices is estimated by some at around $1 billion.

The negotiating creditor group represents over 60 percent of PREPA’s bondholders and includes large hedge funds such as Blue Mountain Capital and Appaloosa Management, mutual funds Oppenheimer and Franklin Templeton, bond insurers, as well as Citibank and Scotiabank.

On the general obligation front, the Commonwealth seeks to move forward on its proposed $2.95 billion refinancing to reliquify the GDB. After four rounds of legislative amendments, the bonds are projected to come at an original-issue discount lower than 93 cents on the dollar. When the bond issue finally comes (with an interest-rate cap of 8.5%), it could end up yielding as much as 10% when the original-issue discount is factored in.

A little more than a week has gone by since the passing of new taxes to support the bond issue (la crudita). There have already been increases at the gasoline pump of 4 cents a liter, which will cost the average consumer about $277 annually in additional transportation costs alone, according to estimates by some economists. The cost to large corporations is estimated by these same economists as the equivalent of a 2.4% tax rate. No formal economic-impact study was conducted before la crudita was approved. Government statistics already indicate a decline in the volume of gasoline sold in PR during the past five years. Some of the reasons for the decline include the use of more fuel-efficient vehicles, including hybrids, and a population decrease due to migration and a lower birth rate.

At the same time, longer term tax reform continues to be considered in the legislature. Intense and widespread opposition to the initial tax reform proposed by the administration of Gov. Alejandro García Padilla is forcing major changes to that plan, which is expected to substantially cut down on the size of the proposed increase in the consumption tax, and as a result, the amount of revenue it will raise. House Speaker Jaime Perelló is proposing a 12% VAT, which would still provide space for substantial income-tax relief. That plan would raise an estimated $500 million, rather than the $1.2 billion originally proposed by the administration, according to House Finance Committee Chairman Rafael “Tatito” Hernández.

Top administration officials, including the governor, have said that lowering the proposed tax to that level would require cutting back on the income-tax relief proposed under the tax-reform plan. Senate Finance Committee Chairman José R. Nadal Power said budget discussions would also be a guide to determining the final outlines of the proposed reform, but added that keeping the VAT to 12% would be a “great achievement.”

PA. P3 FINANCING

PennDOT has begun to use its authority to issue up to $1.2 billion in Private Activity Bonds (PABs) as granted by the U.S. Department of Transportation. These tax-exempt bonds, which are less expensive than traditional financing options available to private firms, will account for the majority of the total capital costs of the Pennsylvania Rapid Bridge Replacement Project at a low borrowing cost. This is consistent with other P3 projects in other states.

The first tranche of debt for the  Pennsylvania Rapid Bridge Replacement Project recently closed. The consortium successfully priced $721,485,000 of tax-exempt Private Activity Bonds (PABs) on February 24th. The BBB rated bonds, priced at a premium, were oversubscribed, and were purchased by over 40 different investors. J.P. Morgan and Wells Fargo acted as the underwriters.

The project is the first public-private partnership (P3) to bundle multiple bridges in a single procurement in the U.S. Granite Construction Company anticipates booking a 40 percent share of the contract. Plenary Group is the project sponsor, financial arranger and primary investor for the Plenary Walsh Keystone Partners consortium, which has been contracted by the Pennsylvania Department of Transportation (PennDOT) to deliver the project. The Plenary Walsh Keystone Partners consortium includes The Walsh Group, Granite and HDR. Construction is expected to begin in May 2015, with a projected completion date of December 2017.

Under the contract, Plenary Walsh Keystone Partners will finance and manage the design, accelerated construction, financing, maintenance and rehabilitation of 558 geographically dispersed, structurally deficient bridges across the state over a 28-year contract term. PennDOT will be responsible for routine maintenance such as snow plowing and debris removal. To ensure PennDOT’s construction program is met, Plenary Walsh Keystone Partners is utilizing 18 different Pennsylvania-based subcontractors to leverage local knowledge and existing sub-contractor networks

PennDOT will continue to own all of the bridges included in the project. The department is contracting the design, construction and lifecycle maintenance responsibilities for 25 years. The Plenary Walsh Keystone Partners team will be responsible for any failures or defects that might occur during the term of the contract in addition to expected maintenance, similar to an extended warranty. If properly designed and constructed a bridge should not require significant maintenance during the first 25-35 years, but the contract serves as a warranty to ensure the bridges are constructed to achieve the lowest lifecycle cost of ownership.

This project includes 558 of the roughly 4,000 structurally deficient bridges in Pennsylvania that are in need of replacement or repair. A majority of those projects will be procured as traditional design, bid, build projects contractors are accustomed to. The bridges selected as eligible for the project have similar characteristics; most importantly they are relatively small and can be designed and constructed to standard sizes. The similarity of the bridges allows for streamlined design, prefabrication (mass production) of standardized components such as beams, and the replacements can be done relatively quickly. All of these factors make bundling the projects as one P3 contract the most efficient and cost effective way to deliver these bridge projects according to the Commonwealth.

THIS COULD BE THE PEAK

It seems that the end of every positive interest rate cycle in the municipal bond market is signaled by attempts to finance unlikely amusement deals in the high yield space. It appeared that a proposed tourist facility based on a reproduction of Noah’s Ark in Kentucky in 2014 might have been that signal but that deal failed in the traditional market. Another amusement facility may be poised to assume that role, this time in Arizona. A property developer, the Granger Group, has primarily been a developer of  health care and senior living complexes. Granger is now in the process of completing development plans for a $500million theme park and resort development in Williams, Arizona.

Williams is a town of some 3000 which is the self-proclaimed Gateway to the Grand Canyon. Millions annually pass through on the way to the Grand Canyon National Park and the developers are predicating their plans on the attraction of four million of those visitors each year. The attraction would include a selection of rides, an adventure course, a wilderness area, an amphitheatre, hotel and spa and themed restaurants.

The sponsors are seeking approval for state legislation allowing for an Arizona theme park district board to issue as much as $1billion in bonds to pay for any number of theme parks inside a certain land space approved in December by the Williams City Council, the Phoenix City Council and the Coconino County Board of Supervisors.

If the proposal from the Granger Group is accepted, 9 per cent of revenue generated would be used to pay off the initial capital investment. The proposal predicts such a park would generate around $125million annually of gross revenue. Initial plans for the theme park include Route 66, wild west, mining and Navajo Nation themed areas. The group also promises rides, interactive exhibits, animal encounters, stunt shows, gold panning, archery, rock climbing, kayaking, ziplining, mountain biking, and hot air balloon rides.

The Granger Group is currently conducting a feasibility study for the project, which is due in later this month. The developer is yet to finalize an operator for the project and in May will focus on refining the plans. It is fair to say that this deal has to potential to join a large list of failed recreation projects that have been visited upon the tax exempt market at times of overvaluation of high yield credits. We urge investors direct and indirect (as owners of high yield mutual fund shares) to approach this type of credit with a high degree of skepticism and caution as it moves closer to market.

In the interim, overall first quarter issuance was the highest since 2010 – and third highest since 2006. Muni issuance is up 58.8% to $102.551 billion in 3,071 issues from $64.568 billion in 2,132 issues for the first quarter in 2014, Thomson Reuters data show. Refundings doubled in volume to $18.65 billion in 590 issues in March from $9.26 billion in 307 issues a year earlier. Combined refunding and new money deals increased 33.1% to $12.01 billion from $9.02 billion, while new-money issues were up 0.9% to $10.33 billion. Taxable and tax-exempt deals increased almost the same percentage, with taxables increasing 45.1% to $3.39 billion and tax-exempts increasing 45.9% to $37 billion.  Education more than tripled to $17.47 billion from $5.28 billion. Health care almost quadrupled to $2.72 billion from $720 million. The declining general perception of the creditworthiness of these two sectors coupled with increased issuance also suggests that our thesis has merit.

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

PENSION REFORM AND PUBLIC SAFETY EMPLOYEES

Whenever a difficult political issue comes up, it’s often described as being a political “third rail”.  The national moves toward the reform of pension funding have had a common “third rail”  feature as they take shape. That feature is that the various proposals to address pensions nearly universally exempt police and firefighters from adjustments to their pension benefits. The difficulty in addressing some of the thorniest pension issues is summed up in recent comments by Gov. Bruce Rauner of Illinois. He has been promoting a plan for more than $2 billion in cuts to pensions for public employees, except police officers and firefighters. “Those who put their lives on the line in service to our state deserve to be treated differently,” Mr. Rauner said in his February budget address to the state legislature.

Similar positions have been voiced by governors in adjacent states as they address pension and other labor issues. In 2011, Gov. Scott Walker of Wisconsin signed a law that limited collective bargaining rights for government workers and required them to contribute more toward their own pensions and health coverage. The legislation, known as Act 10 excluded police officers and firefighters from its provisions. In 2012, Gov. Rick Snyder of Michigan signed a right-to-work bill, eliminating the requirement that private and public sector workers contribute dues to the unions that represent them, whether or not they are members. The bill included a “carve-out” for police officers and firefighters.

Politically, the carve outs make sense. These services are provided by members who have strong political support. Who would politically risk denying the unique risks of police officers and firefighters? Take the politics out of the issue and rely on analytics to support the basis for such exemptions – the dangerous nature of the work – the exemption is not necessarily statistically supported. They are not the only public employees whose work is dangerous. Statistically, at least, there are far more dangerous public sector jobs. According to the Bureau of Labor Statistics, on-the-job fatalities occur at a significantly higher rate for “refuse and recyclable material collectors” — sanitation workers — than for police officers. The same is true for power line installers and truck drivers. And fatality rates for these workers exceed those for firefighters by a considerable margin, though firefighters have serious health complications like cancer at relatively high rates in retirement.

Even with the public’s view of the special nature of police and fire work,there may be a more economic way to reflect that view than through pensions. Police officers and firefighters can retire with full pensions at younger ages than other state employees (beginning at age 50 in Illinois, often younger in other states). That means they frequently spend many more years drawing their pension benefits, even while being permitted to maintain full-time salaries in the private sector. This drives up long-term costs for municipalities and states. There is also an argument to be made that early retirement policies also deplete police and fire departments of the valuable experience of critical employees when their experience is most valuable.

In Wisconsin, Gov. Walker argued that it was important to exempt police officers and firefighters because the state relies on them during emergencies and cannot afford unrest in their ranks. In Michigan, Mr. Snyder worried that extending right-to-work provisions to police officers and firefighters would hurt their cohesion. For other workers, the argument in favor of right to work was based on freedom of association and more supervisory flexibility.

One would think that if policing and firefighting are the most critical services local governments provide, the public would be more likely to support improvement and modernization of operating practices. For example, municipalities could improve the productivity of their fire departments by reforming the traditional schedule of 24 hours on, followed by one or more days off. But the only way to change that is through bargaining, and the concept has been resisted  by police and fire unions.

Some backers of right-to-work laws and curbs on collective bargaining for public employees say they should be applied without exception. This however works better in theory than in practice. One governor who did not exempt public safety employees from limits on their bargaining rights was Gov. John Kasich of Ohio. His proposals were rejected by voters in a referendum within eight months.

As for Illinois, while it waits for its pension changes to work their way through the courts, Gov. Rauner has instructed state agencies to divert money from nonunion employee paychecks away from organized labor until a judge settles the matter. A memorandum obtained by The Associated Press, shows his general counsel, Jason Barclay, directing departments under the governor’s control to create two sets of books: one with the “proper pay” and one, to be processed, that reduces the worker’s gross pay by an amount equal to what is normally paid in the fees. Mr. Rauner’s action could keep about $3.74 million out of union bank accounts. Of course, two sets of books is something that municipal analysts love and always is reflective of financial dysfunction.

PUERTO RICO FINANCING

The Government of Puerto Rico said last week that it refinanced $246 million in outstanding bond anticipation notes (BANs) at a rate of 8.25%. Principal sinking fund payments begin July 1, 2015. The notes are secured by a pledge of $6.25 of the new tax on non-diesel petroleum products and are guaranteed by the full faith and credit of the Commonwealth of Puerto Rico. Through the transaction, the holders of the Highways and Transportation Authority (HTA) BANs released all liens on pledged HTA revenues.

The notes issued by the Infrastructure Financing Authority (PRIFA) were bought by RBC Capital Markets as a part of the plan to increase the liquidity of the Government Development Bank (GDB) and support the finances of the HTA, one of PR’s several heavily indebted public corporations. The new notes redeem and retire a previous BAN issued for the HTA that matures Sept. 1, 2015.

The BANs are ultimately expected to be refinanced prior to maturity with the proceeds of a long-term PRIFA bond issuance. The deal was expedited by Act 29 of 2015, quietly enacted into law by Gov. Alejandro García Padilla. The legislation makes technical amendments to the law authorizing an increase in the petroleum-products tax to back the $2.95 billion bond deal, which is expected to occur by early May. The new law raises the excise tax on a barrel of crude oil from $9.25 to $15.50. It includes an adjustment factor that calls for the tax to be increased in the future if revenue isn’t sufficient to repay the bonds. The first adjustment, if required, would take effect July 1, 2017, according to the bill.

Moody’s has estimated that the GDB’s liquidity could fall as much as 22% if there was no new bond offering to refinance the HTA’s debt. Moody’s also has projected that the Electric Power Authority (PREPA) will likely default by July 1, when it is scheduled to make an estimated $400 million debt service payment.

The GDB has also said that it expects to hold an investor teleconference by early April to discuss more details of the deal, as well as provide updated information on government revenue and the outlook for the proposed fiscal year 2016 budget, which will be presented in the coming weeks. Some estimates are that the bond issue could need to be sold at a yield of up to 10.5% for investors. The issue, however, has an average interest-rate cap of 8.5%. Without insurance, Puerto Rico would have to offer a discount of 88 on the issue to obtain that yield. That is estimated  to net Puerto Rico $2.5 billion if the full $2.95 billion issue were sold.

Hedge-fund investors, expected to be the prime buyers of the bonds, have been making suggestions to improve operations and accountability. One proposal is for legislation that would empower the GDB to name emergency managers for up to two years for financially troubled public corporations, government agencies and municipal governments. The emergency-manager proposal being discussed would only require the consent of the governor to name an emergency manager, without having to get Puerto Rico Senate or other legislative approval. The emergency manager would have broad powers to act independently to fix the finances at the particular entity.

TOBACCO COMEBACK

In spite of rates of decline in cigarette consumption which seem to be outpacing estimates, tobacco bonds may be on their way to the biggest volume since 2007. Issuers are taking advantage of the historically low interest rates to refinance and sell additional settlement revenues. This week, California’s Golden State Tobacco Securitization Corp. will be coming to market with a $1.7 billion tobacco issue enhanced by a pledge from the state to seek an annual appropriation for debt service and operating expenses should settlement payments fall short. Proceeds will be used to repay existing tobacco bonds that do not benefit from a pledge from the state and so are more exposed to a shortfall in settlement payments. Other issues include a $621 million sale last month in Rhode Island and a proposed $875 million new money deal from Louisiana later in 2015. In 2014, only about $175 million of tobacco bonds were sold.

The official statement for the $1.7 billion for the California issue includes the latest smoking decline estimates of James Diffley, a senior director at IHS Global Inc. He forecasts that total consumption in 2045 will be 104.0 billion cigarettes (or 104.6 billion including roll-your-own tobacco equivalents), a 61% decline from the 2014 level. The report projects that from 2015 through 2045 the average annual rate of decline is projected to be approximately 3.0%.

In April 2013, IHS Global presented a similar that projected consumption in 2045 of 105.7 billion cigarettes (including roll-your-own equivalents), reflecting an average decline rate of 3.0%.

The proposed Louisiana Tobacco Settlement Financing Corp. issue would   securitize the remaining 40% of the state’s share from the Master Settlement Agreement with tobacco companies. The bond would generate revenue for operating purposes to plug projected budget gaps over the next seven years by funding the state’s higher education scholarship program. The plan is controversial and is subject to approval by the Legislature and other state agencies.

Louisiana securitized 60% of its tobacco settlement revenue in 2001 with the sale of $1.2 billion in bonds. The new securitization is expected to go before the State Bond Commission April 16, and the Joint Legislative Committee on the Budget May 20. If approved by the legislature, the bonds likely would be sold in June.

The key for investors is to determine which consumption scenario they believe in. In May 2014, Moody’ Investors Service estimated that 65%-85% of the aggregate outstanding balance of all tobacco settlements bonds that Moody’s rates, will default. More recently, S&P estimated that cigarette shipments will decline 5.25% in the next two years and 4.75% thereafter.

CA WATER NEWS

Last week, the California state government imposed new mandatory restrictions on lawn watering and incentives to limit water use in hotels and restaurants as part of its latest emergency drought regulations. Gov. Jerry Brown also announced a $1 billion plan to support water projects statewide and speed aid to hard-hit communities already dealing with shortages. Federal water managers have already announced a “zero allocation” of agricultural water to a key state canal system for the second year in a row. This moves come after the state has fallen behind targets to increase water efficiency in 2015 amid the state’s worst drought in 1,200 years. California’s snowpack is now at a record low—just 12 percent of normal.

The situation highlights the long standing divide between urban and agricultural water users. California’s cities have more than enough water to withstand the current drought and then some. They have low water usage per capita. Agriculture uses 80 percent of California’s water—10 percent of that on almonds alone. That may not be sustainable as  abnormally dry conditions have been recorded in 11 of the last 15 years.

So small agriculturally based water credits remain the ones with the most credit vulnerability while the larger urban districts have by and large adjusted their usage and rates to the current environment.

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.