Category Archives: Municipal Bonds

Muni Credit News January 8, 2015

Joseph Krist

Municipal Credit Consultant

2015 OUTLOOK

For many municipal market participants, 2014 turned out to be a good year in the end, although that’s not the way it looked at this time last year. At the beginning of the year most market participants didn’t expect to see anything more in the way of returns than the average coupon. Weak supply however, was overtaken by basic demand. While Detroit’s bankruptcy dominated the news, the large Puerto Rico bond issue ($3.5 billion of general obligation bonds on March 11) came to market and then traded up. The junk-rated bonds were priced with an 8% coupon to yield 8.727% in 2035 and saw strong demand from investors.

Continued growth in the economy and lower oil prices provide a favorable base for many credits in the near term. Sales tax, utility, and transportation credits based on demand and utilization should broadly benefit. General tax backed credits should also be in better shape as an improved economy supports budgets. There are of course exceptions. The State of Illinois continues to face its ongoing pension deficit problem. Kansas continues to face significant deficit problems as the result of its policy of slashing income taxes through both rate and base reductions. While not a GO issuer, other credits (primarily for highways) supported by dedicated taxes are under pressure from the need to transfer funds to fill the state’s revenue shortfall.

Another transportation credit that will face headwinds is the NY State Thruway Authority. Management is under fire with the resignation of the top two executives under pressure from a looming investigative report and funding issues related to the Tappan Zee replacement project. Another NY transportation issuer facing controversy is the Port Authority of NY/NJ. At the end of December, their Legislatures already adjourned, Governors Cuomo of New York and Christie of New Jersey, vetoed a bill that would have reformed the agency. The governors, who jointly control the bi-state Authority, then released a report of their own calling for changes. Among the proposals was one considering the elimination of service between 1 a.m. and 5 a.m. on the Port Authority Trans-Hudson, known as PATH. The Port Authority chairman, John J. Degnan, who helped write the governors’ report, has since stated that stopping overnight service is one of at least six proposals for improving the finances of the PATH system. Eliminating service would save the authority $10 million from its $330 million budget, according to the governors’ report.

Potential demand could come from investors who removed $60 billion in assets from the muni space in 2013. The 2014 market did not recover all of those assets as investors returned only $21 billion into muni funds, according to Lipper US Fund Flows data. In 2015, the amount of maturing debt is set to drop to $176 billion from $282 billion data compiled by Bloomberg show. In a sign of potential new supply from lawmakers for new projects, U.S. states and localities asked voters in November to approve $44 billion of bonds for schools, water systems, hospitals and roads, more than twice what they sought in 2010. Voters approved more than $37 billion of the measures.

One thing unlikely to change is the tax break for municipal bonds, which has been threatened by proposals advanced in Washington during the past four years. The prospect of taxing muni-bond interest has been raised since 2010 as President Obama and congressional Republicans looked to lower the deficit or pay for cuts to income-tax rates. Representative Paul Ryan of Wisconsin, the new chairman of the tax-writing House Ways and Means Committee, has said that focusing on business taxes may represent the best chance for success, given how far apart Obama and Republicans are over how to approach taxes on individuals. That lessens the odds that Congress may alter the status of municipal bonds.

The tax break, forecast to cost the Treasury about $47 billion this year in foregone revenue, has been targeted along with dozens of other provisions in overhauls that failed to advance during the past four years. Governors, legislators and local officials have lobbied Congress to prevent any such change. More than 100 House Democrats and Republicans in 2013 signed a letter supporting the break. At a hearing on the issue in the Ways and Means Committee that year, lawmakers from both parties said taxing munis would push costs onto local governments and taxpayers.

The improving economy has eased the pressure on Congress to reduce the federal budget deficit in the year ended in September, the deficit was $483.4 billion, about a third of the record $1.4 trillion hit in 2009. One potential negative is that if the economy really is as strong as 5%, then investors could anticipate that yields would rise, then munis would underperform.

A CHRISTMAS PRESENT FOR A.C.

Elsewhere, New Jersey is giving Atlantic City a $40 million short-term loan so the city won’t have to sell notes in the municipal market, according to a published report. The city had originally planned a $140 million bond sale for November, then scaled it back to a smaller note sale, which was delayed because of concerns about the city’s finances in the wake of the casino closures. The city must repay the 0.75% interest loan by March 31, according to an agreement signed by the city and the state, Reuters reported.

WATER AND CALIFORNIA

While we were on hiatus, I had a chance to travel through northern CA on the way to and from Yosemite National Park. Along with a great chance to view the wonder that is Yosemite, the trip afforded the chance to see many real examples of the importance of water and the impact of the drought on many CA industries. The trip takes in some 200 miles of rich agricultural land including fruit orchards, cattle ranches, many varieties of nuts, and much valuable timber land. The dependence on reliable fresh water sources could not have been clearer.

The trip also took in the Don Pedro, Cherry Lake, and Hetch Hetchy water storage facilities. The impact of the drought has been well documented by a variety of studies and statistics. In reality, the problem is easy to see.

The white ring just above the surface of the water in the Hetch Hetchy Reservoir represents the shortfall in water stored versus the amount usually stored here for the City of San Francisco. A similar if not greater ring was visible at Don Pedro Lake. In addition, the area had a distinct lack of snow for the time of year. Given the lack of rain and snow, no improvement is expected and that ring is likely to grow in height. It is just one example of what influenced CA voters to support Proposition 1 in November in such large numbers.

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

Muni Credit News December 18, 204

Joseph Krist

Municipal Credit Consultant

FUNDING BILL AND MUNIS

The omnibus appropriations bill passed by Congress included a little-noticed provision that would make it more difficult for municipalities to use eminent domain to condemn and seize underwater mortgages. The bill would ban the Federal Housing Administration from refinancing loans that have been seized via eminent domain. Language in the spending bill says it “prohibits funds for HUD financing of mortgages for properties that have been subject to eminent domain.”

Proponents of eminent domain such as San Francisco-based Mortgage Resolution Partners had planned to use FHA-insured loans to refinance loans that have been seized by municipalities and written down to their current appraised value. But so far, the use of eminent domain has been thwarted by industry groups like the Mortgage Bankers Association (MBA)and Securities Industry Financial Markets Association, which have strongly opposed Mortgage Resolution Partners’ efforts in cities like Richmond, Calif., Las Vegas and Newark, N.J.

Fannie Mae and Freddie Mac are not allowed to finance loans involved in an eminent domain takeover while Department of Housing and Urban Development officials have declined to take a position on the issue, contending they would have to consider the circumstances when actually presented with an application to refinance a mortgage seized via local governments exercising eminent domain.

The MBA has supported a prohibition for a number of years, According to chief lobbyist for the Mortgage Bankers Association, the use of eminent domain to achieve principal reduction would have created capital market implications. Municipalities that resorted to eminent domain would have turned into “no-fly zones,” he said, where lenders would not finance new mortgages.

LEGISLATIVE OUTLOOK FOR MUNIS

Last year, Rep. Randy Hultgren emerged as a major voice in Congress in support of municipal bonds. Recently he said municipal bonds should be encouraged, not limited, because state and local governments face challenges financing projects through other means. The Illinois Republican said at the Government Finance Officers Association’s winter meeting that communities have used munis to improve their infrastructure after disasters, and they haven’t necessarily had other tools to finance the projects. He noted that localities aren’t getting many funds from the federal government and their states’ governments.

Hultgren, who is on the financial services committee discussed challenges that munis face at the federal level. They include President Obama’s recent budget requests that proposed capping the value of the municipal bond tax exemption at 28%. Another challenge is tax reform. A proposal released last week by House Ways and Means Committee Chairman Dave Camp, R-Mich., would impose a 10% surtax on municipal bond interest for high earners. It also would eliminate the tax-exemption for new private-activity bonds.

Hultgren said he thinks Camp put out his plan to see what kind of pushback he would receive. It’s important for people to be vigilant and explain the importance of the tax exemption for municipal bonds, Hultgren said, because if they don’t, the exemption may be seen as a tax preference that can be easily changed in tax reform.

Hultgren said he is going to continue push for munis to be included in the definition of high-quality liquid assets in a federal banking rule that becomes effective Jan. 1. “Excluding investment-grade securities from HQLA’s definition will decrease the demand for such securities, and will hurt municipalities’ abilities to finance infrastructure projects”, he said.

He has introduced two bond-related bills in the last few months, which he likely would reintroduce the in the new Congress. One of the bills would increase the annual issuance limit for issuers of bank-qualified bonds to $30 million from $10 million. The other bill would increase the maximum size of an industrial development bond issue and would allow more types projects to be financed with these bonds.

SINGLE PAYER HEALTH COVERAGE UNLIKELY IN VERMONT

Gov. Peter Shumlin, a long-time supporter of moving to a universal, publicly-financed health care system in Vermont, detailed this week his Administration’s health care financing report, set to be delivered to the Legislature in January. The financial models unveiled by the Governor would require both a double digit payroll tax on Vermont businesses and an up to 9.5% public premium assessment on individual Vermonters’ income to pay for Green Mountain Care, the statewide public health care system proposed in Act 48.

The Governor acknowledged that given current fiscal realities, such a financing plan would be detrimental to Vermonters, employers and the state’s economy overall. Therefore, he said, despite his steadfast support for a publicly-financed health care system, he reluctantly will not support moving forward with a financing proposal at this time or asking the Legislature to consider or pass it.

“Pushing for single payer health care when the time isn’t right and it might hurt our economy would not be good for Vermont and it would not be good for true health care reform. It could set back for years all of our hard work toward the important goal of universal, publicly-financed health care for all. I am not going undermine the hope of achieving critically important health care reforms for this state by pushing prematurely for single payer when it is not the right time for Vermont. In my judgment, now is not the right time to ask our legislature to take the step of passing a financing plan for Green Mountain Care.”

Although the Administration explored several different benefits and financing proposals, the preferred proposal outlined by the Governor’s Deputy Director of Health Care Reform Michael Costa would cover all Vermonters at a 94 actuarial value (AV), meaning it would cover 94% of total health care costs and leave the individual to pay on average the other 6% out of pocket. Lower AV proposals create significant administrative complexity and reduce disposable income for many Vermonters.

Paying for that benefit plan would require: An 11.5% payroll tax on all Vermont businesses; a sliding scale income-based public premium on individuals of 0% to 9.5%. The public premium would top out at 9.5% for those making 400% of the federal poverty level ($102,000 for a family of four in 2017) and would be capped so no Vermonter would pay more than $27,500 per year. Even at these tax figures, the proposal would not include necessary costs for transitioning to Green Mountain Care smaller businesses, many of which do not currently offer insurance. Those transition costs would add at least $500 million to the system, the equivalent of an additional 4 points on the payroll tax or 50% increase in the income tax.

MIXED NEWS FOR TOBACCO

A new federal survey has found that e-cigarette use among teenagers has surpassed the use of traditional cigarettes as smoking has continued to decline. The survey, released Tuesday by the National Institute on Drug Abuse, measured drug and alcohol use this year among middle and high school students across the country. It is one of several such national surveys, and the most up-to-date.

It was the first time this survey measured e-cigarette use, so there were no comparative data on the change over time. The survey found that 17 percent of 12th graders reported using an e-cigarette in the last month, compared with 13.6 percent who reported having a traditional cigarette. Among 10th graders, the reported use of e-cigarettes was 16 percent, compared with 7 percent for cigarettes. And among eighth graders, reported e-cigarette use was 8.7 percent, compared with just 4 percent who said they had smoked a cigarette in the last month.

A 2013 youth tobacco survey by the federal Centers for Disease Control and Prevention released in November found that the share of American high school students who used e-cigarettes rose to 4.5 percent in 2013 from 2.8 percent in 2012. The share of middle school students who used e-cigarettes remained flat at 1.1 percent over the same period. Some experts said the new data suggested that the rate might have increased substantially since 2013, though it will be impossible to know for sure until the C.D.C. releases its 2014 data sometime next year.

We view anything that reduce purchases of actual cigarettes as negative for holders of tobacco securitization bonds.

WATER AGREEMENT IN THE PARCHED WEST

Officials from water agencies in Arizona, California and Nevada signed an agreement last week to jointly add as much as three million acre-feet of water to Lake Mead by 2020, mostly through conservation and changes in water management that would reduce the amount that the states draw from the lake. The agreement, signed at the Colorado River Water Users Association’s annual conference in Las Vegas, is aimed at forestalling further drops in the level of the lake that could endanger not just the water supply for 40 million people, but also the electricity generated by dams there and upstream at Lake Powell.

Three million acre-feet, roughly what six million households use in a year, would add about 30 feet of water to a lake whose level is now just a few feet above its record low. The agreement is a stopgap solution that is unlikely to solve the long term needs of the region. Arizona, in particular, has reason for concern. In the 1960s, it bartered away its senior rights to Colorado water to get California’s support in Congress for the Central Arizona Project.

Should Lake Mead run short, Arizona’s share of water would be rationed while California would continue to receive its full allocation — a prospect that Arizonans have feared for decades. The level of Lake Mead, now about 40 percent full, is only about 10 feet above the point at which the federal government would declare a shortage and begin rationing water to downstream users. A further 25-foot drop would dry up one of two water intakes that supply 70 percent of Nevada’s population with water.

Only last week, Nevada workers completed a three-mile, $817 million tunnel into the lower reaches of Lake Mead, giving the state a steady water source should a declining lake level disable intakes at higher elevations. At the same time, the Southern Nevada Water Authority approved plans to spend $680 million to build a pumping station for the same intake — a reflection of the fact that falling lake levels could render useless the existing pumps higher up Lake Mead’s basin.

Last week, Wyoming released the findings of research into what may be the most unusual of all the efforts to resuscitate the Colorado: cloud seeding. With financial help from Arizona, California and Nevada, Wyoming has seeded snow clouds for a decade, hoping to build a snowpack that will deliver more water to the Colorado and its tributaries in the spring.

Scientists have long been skeptical that seeding clouds with certain chemicals actually works; the National Research Council concluded in 2003 that while the process clearly changes the character of clouds, there was no proof that it produced more precipitation. But the Wyoming study found that snowfall increased by as much as 15 percent after clouds were seeded, and that the added snow increased stream flows by as much as 3.7 percent. The research found that cloud seeding could cost as little as $27 per acre-foot of water — or as much as $427 per acre-foot. But even the higher cost is lower than that of desalination, an alternative to using Colorado River water that is being considered in some states.

HOLIDAY GREETINGS TO ALL

We will take the next two weeks off the celebrate the holidays. Our next posting will be on January 8th, 2015. Best wishes for good cheer and good health to all.

Muni Credit News December 11, 2014

Joseph Krist

Municipal Credit Consultant

SIFMA DATA PROJECTS FLAT VOLUME FOR 2015

SIFMA released the results of its Municipal Issuance Survey for 2015. The respondents expect total municipal issuance, both short- and long-term, to reach $357.5 billion in 2015, up slightly from the $348.1 billion estimated issuance in 2014.

Short-term issuance is expected to remain largely unchanged in 2015, with $42.5 billion in short-term notes expected, compared to $42.8 billion in 2014. Long-term issuance is expected to rise in 2015, with $315.0 billion in long-term bonds expected, compared with $305.3 billion in 2014.

Long-term alternative minimum tax (AMT) issuance is projected to rise to $10 billion in 2015, a 16.7 percent increase from 2014; variable-rate demand obligation (VRDO) issuance to rise slightly to $9 billion in 2015, recovering from the record low of $6.6 billion issued in 2014.

Survey respondents offered a range of views on interest rates in the coming year. The federal funds rate is expected to rise from 0.13 percent in end-December 2014 to 0.75 percent by end-December 2015. Forecasts include: The two-year Treasury note yield is expected to rise from 0.50 percent end-December 2014 to 1.15 percent by end-December 2015; The 10-year Treasury note yield is also expected to climb from 2.4 percent end-December 2014 to 3.25 percent end-December 2015.

One of the factors cited for the projection of flat issuance is the increasing use of direct lending from banks by municipalities. This sector of municipal borrowing has been characterized by weak disclosure, making it difficult to assess the true debt burden of many municipal borrowers. There are a number of initiatives underway to improve the measurement and disclosure of this source of debt.

PR LEGISLATURE PASSES HTA DEBT BILL

Legislation to increase Puerto Rico’s petroleum tax to finance a bailout of the Highways & Transportation Authority and reliquify the Government Development Bank finally squeaked through Capitol on Monday. The long, strange trip of the legislation took a surprise turn Monday night when New Progressive Party Rep. Pedro “Pellé” Santiago broke ranks with his minority delegation and voted for the bill, which passed with the minimum 26 votes needed. Santiago’s vote was decisive because Popular Democratic Party Rep. Luis Raul Torres voted against the final measure despite finally agreeing to back the bill in the first House vote last week in spite of obtaining the inclusion of multiple amendments he was pushing for.

After the vote Santiago said that “Mine was the 26^th vote and I take responsibility for that,” Santiago said in a radio interview. The people elected Gov. Alejandro García Padilla in 2012 and gave him a mandate. There are two years left to deliver and I don’t want to be an obstacle in that path.”

Versions of the legislation were both passed by one-vote margins in the House of Representatives and the Senate last week as part of a special legislative session called by Gov. Alejandro García Padilla to finally get the tax hike through the legislature. The House was first to approve a substantially amended bill with the Senate following after introducing its own changes.

The House returned to work on Monday but did not concur with the Senate amendments, so a conference committee was named to hammer out a single version to send to García Padilla for signature. The conference committee version passed the Senate in a 14-12 vote along partisan lines before the surprise vote in the Senate. Left in the final version was a Senate bid that scraps an automatic hike in the petroleum tax to keep up with inflation and language to cap interest rates on issuing debt backed by the levy at 8.5 percent. Another upper chamber amendment to make the cut calls for a restructuring of the HTA.

The bulk of the House’s wording made it through, including the stipulation that the steep tax hike will take effect with a planned broader reform of the tax system in the first quarter of 2015. The bill sets a deadline for the oil tax to be implemented with the tax reform before March 15.

Puerto Rican Independence Party Sen. María de Lourdes Santiago indicated a potential court challenge to the constitutionality of the oil tax hike, as did an NPP Sen. arguing that it compels lawmakers to vote for the broader reform that has yet to be filed.

The bill will increase the petroleum excise tax from $9.25 to $15.50 a barrel. The levy had been increased from $3 just last year. Proceeds of the bond deal would be used to wipe out a $2.2 billion loan from the GDB to the HTA in light of its dwindling cash reserves.

P3 AND ELECTIONS

For the second consecutive year, the fate of a P3 transportation project will be decided by a newly elected governor. Earlier this year, a Va. highway P3 project was held up by incoming Gov. Terry McAuliffe for additional review. The Maryland Transit Administration delayed the deadline for private-sector bids on its $2.45 billion Purple Line light-rail project for two months to give newly elected Gov. Larry Hogan time to evaluate the proposed public-private partnership. Hogan, an avowed opponent of the Purple Line and the $2.9 billion Red Line rail proposal in Baltimore, defeated his Democratic opponent Lt. Gov. Anthony Brown in an upset in November by a 51.4% to 46.9% margin. Brown supported state funding for the rail projects. Hogan said during the campaign that preferred spending transportation dollars on roads rather than the rail transit projects. He said he would cancel the two rail projects but later softened the stance enough to say the Red and Purple lines are “worth considering.”

Bids from four international consortiums will be selected March 12 rather than Jan. 9 as originally scheduled. The successful consortium will invest $500 million to $900 million in the Purple Line in exchange for the concession to operate and maintain the system for 35 years. The concessionaire will receive availability payments of up to $200 million a year, which can be used to repay a federal Transportation Infrastructure Finance and Innovation Act loan of up to $732 million being sought by the state. The light rail line could be operational by 2020 if construction gets under way as scheduled in late 2015. The successful consortium will invest $500 million to $900 million in the Purple Line in exchange for the concession to operate and maintain the system for 35 years.

Maryland Transit Administration said that it did this to give the incoming administration more time to evaluate this complex project and in the meantime, is continuing with the solicitation process, right-of-way acquisitions, and agreements.” The Maryland Board of Public Works had been expected to pick the private partner in spring 2015.

In Virginia, a comment period was recently concluded regarding the plan to build a new highway by a private consortium, US 460 Mobility Partners. In this case bonds had been issued to finance a portion of project construction which was halted pending USACE’s [United States Army Corps of Engineers] decision on a 404 environmental impact permit. This action gave US 460 Mobility Partners the right to terminate the design‐Build Agreement if work has stopped for 120 consecutive days during a waiting period. VDOT estimates that the FHWA and USACE will issue their decisions on the final SEIS and a preferred alternative by the first quarter of 2015. At that time the 404 permit work would be restarted. The 404 permit decision is anticipated by the second quarter of 2015.

Bondholders have been concerned that the lack of permit approval could cause VDOT to be in default under its various agreements with US 460 Mobility Partners. Should that be the case and should such a default remain uncured, the bonds would be subject to extraordinary mandatory redemption. To meet the requirements of such a call, the unspent bond proceeds, including the balance in the capitalized interest account, will be applied and the additional amount needed will be sought from VDOT as a termination payment.

So P3 projects continue to face a mixed reception for a variety of reasons with opposition coming from various angles and segments of the political spectrum. What makes these two examples unique is that the obstacles are coming from the offices of state executives rather than from local grass roots opponents which has been the more traditional source of opposition. It serves as a reminder that these projects, while innovative, require as heavy a level of investor scrutiny as do traditional public finance projects.

CA REVENUE REPORT FOR NOVEMBER

The CA State Controller reported that November California revenues fell 2.3 percent short of plan for the month, although the State is 3.1 percent ahead of forecasts for the fiscal year to date. Disbursements were also 3.1 percent lower than expected, and remain 2.4 percent behind projections for the first five months of the fiscal year.

Personal income taxes were the major disappointment of November, some $260 million below estimates. Lower-than-expected paycheck withholding was the primary shortfall, in spite of national employment growing by 321,000 jobs in that month alone. Since California accounts for more than 10 percent of all jobs, the State should also post a gain when job data are released in late December. Personal income taxes were up relative to last November by 6.0 percent, or $188 million. Part of November’s shortfall could be due to timing.

Retail sales taxes, which have generally been weak this year, continue to trend below plan. Those taxes fell $103 million behind expectations for the month, and are approximately 6.0 percent behind projections for the fiscal year. In contrast, corporate taxes beat forecasts by $164 million in November.

Since July 1, total revenues are about $1.0 billion ahead of budget projections, with sizable “overshoots” by corporate and personal income taxes more than offsetting an underperformance in retail sales tax receipts. Disbursements were $237 million less than forecast during the month, and fiscal year to date, disbursements are $1.3 billion less than anticipated. Spending has been less than expected for education, disability services, and other social services.

Spending usually exceeds revenues during the first several months of the fiscal year, but this year’s gap has been significantly less than projected. Total receipts are more than $1.3 billion ahead of projections, while total disbursements are more than $1.3 billion below estimates. The difference, or the State’s increase in temporary borrowing, is $2.7 billion less than projected. The total outstanding loan balance of $18.5 billion is being financed via $15.7 billion of internal borrowing and $2.8 billion from external sources.

Muni Credit News December 4, 2014

Joseph Krist

Municipal Credit Consultant

PR MOVES AHEAD TOWARDS HTA REFINANCING

The current soap opera that is the effort to reengineer a portion of outstanding Highways & Transportation Administration (HTA) debt took another turn when Gov. Alejandro García Padilla announced Sunday that he had enough votes to pass a bailout of the HTA and prevent a threatened a shutdown of bus and Urban Train services. The federal government had warned Puerto Rico officials about the potential fallout from a shutdown of the mass transit systems. The consequences could include loss of federal funds and owing money to Washington.

The U.S. Department of Transportation ‘s Federal Highway Administration (FHA) and Federal Transit Administration sent letters to Puerto Rico Transportation & Public Works Secretary Miguel Torres saying that the FHA is “deeply concerned” that if the HTA ceases operations the island government would not be able to meet federal requirements on highway maintenance, enforcement and inspections. It warned that federal funds cannot be used to cover expenses from claims tied to the potential termination and consulting contracts if HTA workers are laid off.

The governor’s live televised message came after a day of talks with House Speaker Jaime Perelló and the three majority Popular Democratic Party lawmakers who had said they would vote against the tax hike. A special session to approve the bailout was in recess.

The Government Development Bank said last Wednesday it was delaying moves to protect its own shrinking liquidity and suggested the potential for at least a partial government shutdown. The GDB said it has no legal authority to float a loan to the HTA to cover payroll and keep mass transit systems operating. “Even with legal authority, granting a loan to the HTA with no repayment source would represent the type of fiscal irresponsibility that this administration has repudiated,” GDB President Melba Acosta and the board said in the statement. “It is those kinds of moves that were the main reason for the fiscal challenges the island faces now.”

“We are now confronting the consequences of the irresponsibility of these loans that were taken, situations so serious that it threatens to shut the operations of the HTA and important public works projects,” the governor also added. On Wednesday, the House passed the tax increase.

The Puerto Rico Aqueduct & Sewer Authority is also aiming to issue at least $770 million in bonds next year. The issue, planned for the first half of 2015, would be carried out only after the Government Development Bank carries out the planned $2.9 billion bond sale to bail out the Highways & Transportation Authority. That deal is now expected in 1Q 2015. One unknown at this time is the impact of the news that the U.S. Federal Bureau of Investigation raided the offices of Puerto Rico’s Highways and Transportation Authority (HTA) on December 3, taking documents and arresting the organization’s treasurer for alleged bribery in programs using federal funds. Proceeds from the PRASA bond issue would go to pay off credit lines maturing this spring and about $500 million in capital spending over the next two years.

Lost in all the political maneuvering is an answer to the question of how any of this addresses the fundamental causes of Puerto Rico’s financial difficulties. None of the proposals alter the weak economic fundamentals underpinning the Commonwealth’s finances. So at best, each of these transactions serves as a temporary bandage on a hemorrhaging financial wound.

CDC ISSUES 2013 SMOKING STATS

Last week we noted a small victory for tobacco sales in one MA locality. Such events must continue to be viewed in the larger context of trends in adult smoking habits. These are reflected in the release by the Centers for Disease Control of statistics on smoking for 2013. The cigarette smoking rate among adults in the U.S. dropped from 20.9 percent in 2005 to 17.8 percent in 2013, according to new data published by the CDC. That is the lowest prevalence of adult smoking since the CDC’s National Health Interview Survey (NHIS) began keeping such records in 1965. The report also shows the number of cigarette smokers dropped from 45.1 million in 2005 to 42.1 million in 2013, despite the increasing population in the U.S.

Drilling a bit deeper, statistics impacting individual “stick” sales showed that among current cigarette smokers, the proportion of those who smoke every day decreased from 80.8 percent in 2005 to 76.9 percent in 2013. The proportion of cigarette smokers who smoke only on some days increased from 19.2 percent in 2005 to 23.1 percent in 2013. Among daily smokers, the average number of cigarettes smoked per day declined from 16.7 in 2005 to 14.2 in 2013. The proportion of daily smokers who smoked 20 to 29 cigarettes per day dropped from 34.9 percent in 2005 to 29.3 percent in 2013, while the proportion who smoked fewer than 10 cigarettes per day rose from 16.4 percent in 2005 to 23.3 percent in 2013.

Cigarette smoking remains especially high among certain groups, most notably those below the poverty level, those who have less education, Americans of multiple race, American Indians/Alaska Natives, males, those who live in the South or Midwest, those who have a disability or limitation. Regionally, the lowest rate was in the West (13.9%) while the rate was highest in the Midwest (20.5%).

SEC DISCLOSURE PROGRAM CLAIMS FIRST ISSUER

Four years ago, a school system in California assured investors that it was making adequate financial disclosures. In fact, The Kings Canyon Unified School District had not filed or was late in disclosing a half-dozen financial statements, something it did not report in documents used to market about $7 million of bonds in November 2010. In July the district became the first municipality to accept the SEC’s leniency offer for borrowers that report by December 1 any failures in providing adequate documentation to investors.

As the leniency program ends, borrowers could be fined if they are charged with fraud. The SEC has increased its focus on the municipal market in light of the occurrence of several high profile bankruptcies by municipal borrowers. Previously, the agency has settled with the states of New Jersey and Illinois and the city of Harrisburg, for misleading investors about their financial state. Last year, in a case against an agency in Washington state, the SEC levied its first fine against a municipal issuer that misled investors.

As we have discussed in prior editions of the MuniCreditNews, the leniency program introduced in March is aimed at municipalities that fail to file timely reports on rating changes and other information of interest to investors, while claiming in bond documents that they do. It’s also open to the bankers who underwrote the debt. The SEC said borrowers could settle without fines if they turn themselves in. Banks’ penalties are capped at $500,000.

While corporations must file quarterly financial statements and have four business days to report information relevant to investors, municipalities only submit annual reports and agree to disclose material events within 10 business days. Dozens of underwriters are said to have sought have sought leniency under the SEC offer. The institutions had until Sept. 10 to do so. An SEC spokesman in Washington, declined to comment on how many submissions the agency has received. The SEC’s did say in November that the agency had received a “tremendous number of submissions.”

The SEC in 2012 issued guidance to banks instructing them to review the disclosure practices of governments whose bonds they underwrite. The program will hopefully drive the market further in that direction. When the Kings Canyon district settled with the SEC, it agreed to comply with disclosure rules within 180 days and make sure it does not break the law again. The district’s business manager, said the failures resulted from staff turnover, not an effort to deceive. “We weren’t out to purposely mislead or do any harm,” he said. “That doesn’t relieve us of the responsibility.”

DEFAULT REDUX IN VICTORVILLE

The Southern California Logistics Airport Authority has announced yet another default on three issues of its outstanding subordinate tax allocation debt. The Authority has been issuing and refinancing debt associated with the reuse and redevelopment of a former military airfield into a facility designed to provide warehouse and transportation facilities for commercial use. The impacts of the Great Recession on both economic activity and property values have led to slow and variable valuation growth in the project area on which the bonds depend for incremental tax revenue to support debt service payments. Since FY 08-09, incremental value has dropped some 5.7% annually. While multiple refinancings have lowered debt service requirements, the changes have not been sufficient to lower those costs enough. Hence the latest notice from the Authority of an impending payment default.

The bonds are another example of why, at the end of the day, economics nearly always trumps all other factors. Whether it be land development, project finance, or service revenue based credit, if the economics are not there to support the plan, the plan will fail. Something to ponder by investors in speculative credits.

Muni Credit News November 25, 2014

Joseph Krist

Municipal Credit Consultant

FIRST ROUND TO THE UNIONS IN ILLINOIS PENSION FIGHT

A Sangamon County Circuit Court judge in Springfield found that the pension overhaul enacted in December 2013, which reduced some benefits, violated a clause in the State Constitution that makes pensions “an enforceable contractual relationship” that cannot be impaired. The decision was not unexpected nor was the subsequent announcement by the state’s attorney general, Lisa Madigan, that she would appeal the decision to the State Supreme Court.

The core issue to be decided is the meaning of a provision in the State Constitution that reads: “Membership in any pension or retirement system of the state, any unit of local government or school district, or any agency or instrumentality thereof, shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired.”

Illinois argued that the constitutional clause was not airtight based on the authority known as their “police power,” which gives them the duty and the legal tools to protect the safety and well-being of their citizens. The state argued that the pension system’s breakdown was pulling money away from other essential services and making it harder for the state to borrow, causing an emergency that justified the use of such powers. In its brief, the State asserted that opponents wanted to elevate pensions “to the status of ‘supercontracts’ that were exempt from the state’s duty to use its policing powers. That premise is without any support, as the text, history and legal precedent surrounding the pension clause all make clear.”

The judge did say in a court hearing on Thursday, that no court had used the “police powers” argument to authorize changes in public pensions. The changes enacted last year tried to save money by raising the retirement age for many public workers and reduced cost-of-living adjustments. As an offset, it also lowered employees’ required contributions toward their pensions and gave the system’s trustees the power to go after the state if it failed to make regular pension contributions, as it often has in the past. The mix of cuts and inducements was designed in the hope of reducing the likelihood of litigation. Over all, the package of changes was said to produce savings of $160 billion over 30 years, but many people questioned that estimate.

Governor-elect Bruce Rauner released a statement after the decision in which he said “Today’s ruling is the first step in a process that should ultimately be decided by the Illinois Supreme Court. It is my hope that the court will take up the case and rule as soon as possible. I look forward to working with the Legislature to craft and implement effective, bipartisan pension reform.”.

UNIVERSITY OF CALIFORNIA REFLECTS NATIONAL FUNDING TRENDS

The University of California Board of Regents gave preliminary approval last Wednesday to a plan to raise tuition 27.6 percent over five years. Gov. Jerry Brown has insisted that if the Regents went ahead with the increase, they would get less from Sacramento, not more, and he bolstered his position by appointing two allies this week to vacant seats on the board. Under the plan, undergraduate tuition and fees for California residents would rise from $12,192 a year to as much as $15,560 in 2019-20. Out-of-state students, who now pay more than $35,000 in tuition and fees, could see those charges rise to nearly $45,000. Those figures do not cover room and board, now about $14,000 for all students.

California’s prices are far above the national average of about $9,100 in tuition and fees for public four-year colleges, but below some, including elite public institutions like the University of Michigan and the University of Virginia. And California officials say that with financial aid to low- and middle-income students, more than half of California residents pay no tuition, and that would remain true after the increases. A committee of the board voted 7 to 2 to approve increases of up to 5 percent in each of the next five years. A vote of the full board is expected Thursday and it appeared likely that the plan would pass.

The governor, who sits on the board, asked the Regents to delay voting on the plan until their next meeting in January, and to form a committee to find ways for the university to overhaul the way it does business. Starting during the recession, California cut support for the university system by $1 billion a year, prompting tuition increases of more than 60 percent, after inflation.

Systemwide, state support has rebounded partly in the last two years, and now supplies $2.8 billion of the university system’s nearly $7 billion core operating budget. But as Regents and university trustees noted repeatedly, it remains well below its peak, despite increased costs and enrollment that has grown to more than 230,000 students.

Nationwide, many State governments reduced support for public universities during the recession, driving big tuition increases and drawing criticism from political leaders. In several states, university administrators have frozen tuition, while protesting that they are still underfunded by their states.

Gov. Brown called on the university to look into changes like three-year bachelor’s degrees, concentrating some specialties at specific campuses, raising the number of students admitted as transfers from community colleges, sharply increasing online courses, and giving college credit for work experience. Those ideas are being debated across the country as cost-savers and ways to get more people through college, but many educators see them as an erosion of standards.

Gov. Brown has proposed 4 percent annual increases in state support for the system, but others contend that is not nearly enough. They said that if the state gave more, they would shrink the tuition increase. The governor said he would withhold the 4 percent increase if the regents went ahead with raising tuition.

SMALL VICTORY FOR TOBACCO

In the face of a revolt by townspeople, the Board of Health in Westminster, Mass., voted Wednesday to drop a proposal to ban the sale of all tobacco and nicotine products. The ban would have made the small town in north-central Massachusetts the only place in the country where no one could buy cigarettes, cigars, e-cigarettes and related products. The health board felt it had a moral obligation to restrict young people’s access to tobacco. But at a public hearing a week ago, 500 people attended, almost all of them to protest the proposed ban. The hearing became so raucous that the board ended the proceeding just 20 minutes after it began.

Local citizens said that they did not approve of smoking but saw the ban as an encroachment on civil liberties. They were also worried that it would drive smokers to spend their money elsewhere, hurting the eight merchants in Westminster who sell cigarettes. The board had planned to accept written comments on the proposal until Dec. 1 and then make a decision on whether to impose the ban. But at its regular meeting Wednesday afternoon, the board voted 2 to 1 to rescind the proposal, saying it had already heard the town’s objections loud and clear.

After the aborted public hearing, angry citizens had begun to circulate a petition to hold a recall election of the board members; it was not clear whether that effort would continue after the board’s vote to drop the ban.

CA CASH UPDATE

State Controller John Chiang released his monthly report covering California’s cash balance, receipts and disbursements in October 2014. Total revenues for the fourth month of Fiscal Year 2014-15 were $6.0 billion, coming in above Budget Act estimates by $662.2 million, or 12.3 percent. For the fiscal year to date (July 1-October 31), total revenues reached $27.9 billion, beating estimates by $1.2 billion, or 4.5 percent.

“Four months into the fiscal year, California’s coffers overflow by $1.2 billion. The news comes on the heels of two other positive developments: the vote to strengthen California’s rainy-day fund through Proposition 2, and the credit upgrade that followed one day later,” Chiang said. “To further boost California’s credit worthiness and sustain prosperity on a long-term basis, we must next tackle the growing $64 billion unfunded liability stemming from providing health benefits to our retired public workforce. To not only protect taxpayers, but also the retirement security promised to our firefighters, teachers, and other providers of critical public services, we can no longer deny, delay, or equivocate.”

Income tax collections for the month of October came in $363.5 million, or 8.4 percent, above estimates. Corporate tax revenues came in $303.6 million, or 1,222 percent, above estimates. Sales taxes fell short of estimates by $37.4 million, or 4.1 percent, for the month. As of October 31, the General Fund accumulated outstanding loans of $17.8 billion, which was down $2.6 billion from what the State expected to need by the end of October. This total was financed by $15.0 billion of borrowing from internal state funds and $2.8 billion of borrowing from banks and other outside investors.

SEC REPORTING DEADLINE LOOMS DECEMBER 1

In yet another attempt to address the municipal market’s well-known disclosure opacity, issuers face a Dec. 1 deadline to report disclosure violations to the Securities and Exchange Commission. In March the Commission launched an initiative, called MCDC, where issuers and underwriters could self-report inaccurate statements in bond documents and receive favorable settlement terms. By law, issuers must describe in bond sale documents when they did not comply with federal disclosure requirements within the previous five years. It requires issuers to scour documents that were posted before the Municipal Securities Rulemaking Board centralized disclosures on a single web platform. Issuers must also find out if underwriters disclosed violations, including underwriters that may be out of business. Smaller issuers with fewer resources are struggling to figure out if they even have any violations to report. In the last two years, the SEC has charged cities, school districts and a state with failing to disclose required information. The SEC will likely review submissions and issue cease-and-desist orders.

Muni Credit News November 20, 2014

Joseph Krist

Municipal Credit Consultant

PR MOVING FORWARD ON FINANCINGS

Governor Alejandro García Padilla announced plans to convene a special session of the Legislature. The session, announced on Friday, was being called because the House failed to complete consideration of a bill to raise the petroleum excise tax from $9.25 to $15.50 per barrel stalled in the House of Representatives. The levy was increased from $3 last year.

“I would have preferred that the House finish the work of approving this measure during the regular session,” the governor said in a statement. “Unfortunately, they couldn’t finish it because some lawmakers need more time. That’s why I am calling a special session so they can finish their job.”

When the impasse over the tax hike emerged in the House, legislation to give the HTA a short-term injection of up to $45 million for payroll and operational costs was filed and approved by the lower chamber in a session Thursday. The money would come from cigarette taxes and feed a new fund managed by the Government Development Bank. The measure wasn’t taken up by the Senate before the close of the legislative term.

The Government is seeking to assuage market concerns that HTA will follow the Puerto Rico Electric Power Authority in moving to restructure its long-term debt, but government officials insist they are working to resolve the HTA’s fiscal challenges without resorting to the Recovery Act. Officials had recently discussed plans last month to borrow up to $2.5 billion in a bond deal backed by a proposed new hike in the crude oil and petroleum products tax. The issue is now expected to increase to $2.9 billion and the target issuance date has been pushed up to this month instead of early next year. Legislation also provides additional guarantees and legal protections to investors to make the bond offering more appealing.

Puerto Rico is in talks with four bond insurers to insure at least part of up to $2.9 billion in bonds, the president of the Government Development Bank (GDB) said on Friday. GDB said last month it discussed the legislation with Assured Guaranty Ltd , Ambac Financial Group Inc, National Public Finance Guarantee Corp and FGIC Corp. The four insurers back over 70 percent of certain HTA revenue bonds.

PREPA OVERHAUL TAKES SHAPE

The first clues regarding the Puerto Rico Electric Power Authority’s potential overhaul began to emerge as the first of a series of studies was released on Monday. The report by FTI Consulting covers outstanding receivables, billing and collections, and an analysis of PREPA’s employment of contributions in lieu of taxes on its balance sheet. It said the government utility should cut service to public corporations that aren’t paying their power bills. It also said PREPA should outsource collections on inactive accounts and revamp its general collections methods.

The study marks the first major deadline in the process of restructuring PREPA required under forbearance agreements reached in August between the government utility and certain of its creditors. Under the deal, PREPA brought on a chief restructuring officer from outside the utility. Restructuring expert Lisa Donahue is heading 10-person team from her firm, AlixPartners, with FTI Consulting working alongside.

As part of the forbearance agreements, PREPA has committed to complete a five-year business plan (as required in the new energy reform law) by December 15 and complete a full debt restructuring plan by March 2, 2015 that could impact holders of its roughly $9 billion in debt.

The Recovery Act, a Puerto Rico law enacted last summer with PREPA primarily in mind, provides for public corporations to restructure their debts through a bankruptcy like process in local courts. The law provides two methods to restructure the debt. A Chapter 2 filing would allow public corporations to create plans that postpone or reduce debt service payments with the consent of a majority of creditors. A Chapter 3 filing would allow public corporations go through the local courts if voluntary repayment plans cannot be reached with a majority of creditors.

CONTINUED WEAKNESS IN PR ECONOMIC INDICATORS

The volume of cargo imports into Puerto Rico has declined to a nearly 20-year low amid the continued downturn in the PR economy. 1.7 million cargo containers reached Puerto Rico through San Juan last year, a 12 percent drop from the previous year. That was the lowest since 1994, when 1.5 million containers came in, according to American Association of Port Authorities statistics.

Earlier this month, Horizon Lines announced it is ending its Puerto Rico operation amid deepening losses and the cloudy outlook for the U.S. territory’s economy. A dockworkers union said the exit will cost 800 jobs. Industry sources say the less crowded playing field could allow rival shippers Sea-Star, Crowley and Trailer Bridge to raise rates in the Puerto Rico trade lane as they seek to buoy their own bottom lines.

Puerto Rico’s trade surplus did improve by more than 15 percent in fiscal 2014 as exports inched up while imports dropped sharply. Exports were $62.45 billion in fiscal 2014 (ended June 30), essentially flat rom $62.39 billion the previous year, according to Puerto Rico government statistics.

Exports to the United States were up 0.4 percent to $44.83 billion in fiscal 2014. Exports to foreign countries decreased 1.1 percent to $17.31 billion. Exports to the neighboring U.S. Virgin Islands rose 26.3 percent to $294 million. Imports into Puerto Rico from the United States sank by 5.7 percent to $42.47 billion. Foreign imports dropped 1.9 percent to $20.06 billion. Imports from the USVI surged by 20.7 percent to $11 million.

Puerto Rico’s trade balance of $19.98 billion in fiscal 2014 was 15.1 percent wider than the $17.35 billion mark the previous year.

WILL LOWER OIL PRICES ALLOW INCREASED GAS TAXES?

The combination of lower oil prices and fewer miles driven seem to have changed to a small degree the atmosphere for discussions of possible increases in state gas taxes. Much research has been published about the failure of these taxes to reflect inflation, changes in driving habits and fuel efficiency. The reality is that the proportion of fuel costs related to taxes has steadily decreased. State transportation planners have noticed and in at least two states have recently floated the idea of raising state gas taxes as a source of funding for rehabilitation and expansion of bridge and road infrastructure nationally.

Wisconsin seems to be the farthest ahead in this trend. Recently, the state transportation Secretary Mark Gottlieb has proposed a variety of possible funding sources for consideration by the Wisconsin legislature. Gottlieb wants to increase the 32.9-cent-per-gallon gas tax by 5 cents, to 37.9 cents in September 2015. The tax would be linked in part to the wholesale price of gasoline, which would allow it to rise and fall in future years with the price of gas, though it could not fall below 37.9 cents per gallon. A similar change would be made for diesel fuel, raising it by 10 cents a gallon. The higher gas taxes would raise an additional $358 million through June 2017. Gottlieb is asking for more than $1 million to hire a consultant to study for 18 months the feasibility of tolling Wisconsin’s highways and bridges.

In New Jersey, where the fund that supports infrastructure improvements is set to run out of funds for new projects by next summer, some are suggesting extending the state’s sales tax to gasoline. At a hearing earlier this year of the Assembly Transportation, Public Works & Independent Authorities Committee, members discussed a proposal that would apply the 7% state sales tax to gasoline purchases to help raise revenue for infrastructure improvements.

The hearing was part of a series that is examining how to fill the state’s Transportation Trust Fund. Currently, the fund is fed by New Jersey’s gas tax of 14.5 cents per gallon (CPG), state highway tolls and part of the state sales tax levied on non-gasoline purchases. The gas tax has remained at the same level since 1988 and is among the lowest in the country.

The trust fund has spent $1.6 billion this year but most of it has gone to service debt on earlier projects under constitutional requirements. Funds for new projects are expected to run out by July 1, 2015, which is the beginning of fiscal year 2016. One proposed bill would replace the current gas tax with a 7% tax on gasoline purchases, essentially extending the sales tax to fuel while eliminating the gas tax. Under a sales tax structure, revenues under this setup would vary by the price of gasoline.

Polling has shown that New Jersey residents are becoming less resistant to the idea of a gas tax increase. A recent Rutgers-Eagleton poll noted an eight-point drop from April in the percentage of respondents who opposed increasing the gas tax, to 58%.

Muni Credit News November 13, 2014

Joseph Krist

Municipal Credit Consultant

PR SHORTCHANGES COFINA INVESTORS ON INFORMATION

The recent information call held by the GDB continued the Commonwealth’s trend of coming up short in terms of information for its investors. In this case, it was the discussion of the Commonwealth’s plans to shift the sales tax base supporting its outstanding COFINA debt from a traditional retail sales base to a value added tax base. The intent of the change is to make it more likely that a greater share of economic activity on the island that should be subject to taxation might be more readily captured. This reflects the ongoing reality that a substantial portion of the economy remains “underground” thereby reducing available revenues for the payment of the island’s most marketable debt.

Moody’s estimates that the tax’s collection rate has historically been about 60 percent. In October 2013, S&P reported that the Commonwealth budgeted a capture rate of 88percent on highly regulated companies and 68 percent for other businesses. Under current conditions, it would take a relatively insubstantial decrease in the annual rate of increase in collections to create a situation in which debt service requirements would exceed available revenues, especially for subordinate debt.

This is an important factor as the island looks for ways to fund its capital needs while it strengthens and reforms its overall fiscal and debt structure. Many have seen COFINA as the best debt for investors to hold. This makes the proposed change in the method of sales tax generation and collection as would be envisioned of even greater interest. The method itself has actually received a positive reception at least from institutional investors recently quoted in the press.

It makes it all the more puzzling why the Commonwealth would advertise such a proposal with so little detail. To date, no implementing legislation has been proposed or filed so it is impossible to evaluate the likelihood of adoption. In addition to making it harder to value the currently outstanding bonds, the lack of information raises more questions than it answers. The continuation of such practices is one of the great negatives weighing on the credit quality of Commonwealth debt. It is therefore, disappointing to see this practice continue despite a change in administration and changes in leadership at the GDB.

ILLINOIS ACTIONS REMAIN UNCERTAIN AFTER ELECTION

Investors who hoped to get a clue as to whether or not Governor-elect Bruce Rauner would stick to his campaign positions regarding taxes and fiscal policy will have to wait until 2015 for answers. Rauner campaigned on allowing tax raises in the personal and corporate income tax levies in January 2011 scheduled to expire at the end of this year to do so. Rauner told reporters after the election that he’s had discussions with Democrats and Republicans in the legislature and plans to meet with them to “address our state’s very significant financial problems.” “I’ll be working very closely with members of the General Assembly to provide both short-term solutions and long-term solutions to fix the financial health of the state.” It will be important to do so as the State’s cash flow problems are not improving, thereby continuing the need to conserve cash, slow payments to state institutions (e.g., universities) and vendors. Billions of dollars of bills remain unpaid. The state is short of revenue to get itself through the fiscal year ending June 30. Along with a lack of progress on pension reform, the cash situation and fiscal policy uncertainty are more likely than not to lead to additional downgrades until action is taken. A sign of the potential difficulty in holding up real reform is the well known political difficulties in the State. Immediately on election night these became apparent. Rauner said during his victory speech on Nov. 4, “Just a few minutes ago, I placed two very important phone calls — I called Speaker Madigan,” and “I called President Cullerton, and I said to them, ‘This is an opportunity for us to work together’”. While the anecdote appeared to signal Rauner’s desire for bipartisan cooperation, spokesmen for the speaker said that Rauner and Madigan didn’t speak on election night, and there was no record of any voicemail or call. A spokesman for the Senate President said that while someone from Rauner’s campaign contacted his staff, Rauner and the Senate president didn’t talk. So investors will apparently just have to wait and see. LOUISIANA HIGHLIGHTS MUNI REPORTING ISSUES

Situations keep arising that only reinforce the image of the municipal bond market as one of opaque disclosure. The most recent example is Louisiana. State Treasurer John Kennedy warned this week that the state general fund is running a historically high negative balance through the first four months of the fiscal year. Kennedy said, “I’m concerned. This negative balance is evidence that we are spending more than we’re taking in. We’ve been doing it for a while, but this historically large negative balance demonstrates that it’s getting worse,” In fact, the Department of Health and Hospitals just announced that we are already $171 million over budget in our Medicaid program with eight months to go in the fiscal year.”
The end-of-the-month state general fund balance for October was a negative $925 million, forcing the Treasurer’s Office to borrow from other funds in order to maintain cash flow. This was Louisiana’s negative end-of-the-month state general fund balance for that time period in five years. The fund balance on October 31 of last year was a negative $657 million. The end-of-the-month negative general fund balances for October 31 through the prior three years were: $181,531,912.38 (2010), $565,169,822.53 (2011), $476,665,313.52 (2012).

As problematic as these figures may be, the fact that the Governor’s office disputes them so strongly is more so. That office insists that the State has a surplus but this is based on some $300 million of previously unaccounted for funds. These newly discovered monies have supposedly created a deficit. Such a discrepancy would normally be a substantial concern for a corporate borrower in the public debt markets but apparently not so for this municipal borrower.

The state does have strong constitutional protections for its general obligation debt but the fact that a payment default may not result does not mean that risk of a growing deficit is accurately or fairly being priced in the market. While Moody’s maintained its Aa2 rating, it cited the dwindling impact of a post-Katrina reconstruction boost; continued budget gaps due to underperforming revenues; and the challenges the state faces in dealing with its large Medicaid caseload and significant unfunded pension liabilities.

The state said that it will take until January 2015 to resolve the differing views of its fiscal position.

NYPA BENEFITS FROM IMPROVING STATE CREDIT

The New York State Power Authority saw its Moody’s rating upgraded to Aa1. The upgrade reflected the continuation of the Authority’s favorable balance sheet and operating characteristics. These have always been hallmark traits of the Authority as well as the benefits of reliance on the Niagara hydroelectric facilities as core resources for power generation. What has improved is the decreasing reliance by the State of New York for transfers from the Authority to bolster the State’s annual budget position. As the State’s operating fundamentals have improved, the Authority has not had to transfer funds to the State and may actually receive some repayments of prior transfers dating back to 2009. All of this should improve the Authority’s liquidity and help to finance its ongoing capital needs.

Muni Credit News November 6, 2014

Joseph Krist

Municipal Credit Consultant

MIXED ELECTORAL MESSAGE ON PENSIONS

Voters sent mixed messages on their view of pension reform at least in two widely watched votes. Gina Raimondo became the first Democrat elected governor in Rhode Island since 1992 in spite of heavy union discontent with her 2011 backing for changes to Rhode Island’s pension system that raised the retirement age, put workers into 401(k)-type plans and suspended raises for retirees until the system was better funded. She built her campaign around her success at cutting pension costs, while pledging to revive the economy. The pension changes she advocated followed after Central Falls became the state’s first city to go bankrupt, which eventually forced retirees to accept cuts to pension checks. She said the reductions were needed to prevent rising retirement costs from bankrupting other cities and crowding out funding for schools and other programs. The pension changes are forecast to save $4 billion over 20 years. The steps cost her thesupport of the unions, the changes were imposed through legislation instead of negotiation. In Phoenix, AZ voters rejected a ballot measure that would have made Arizona’s capital the largest U.S. city to do away with guaranteed pensions for new public workers. Nearly 57 percent of voters voted against the proposal to put new non-safetyemployees into 401(k)-style defined contribution plans that rely on individual investment returns. Retirement expenses comprised $218 million, or 22 percent, of Phoenix’s general-fund expenditures through June 2013, up from 11 percent in 2007. Phoenix voters previously approved a measure in March 2013 to increase employee contributions toward pensions and require higher retirement ages. Those changes are projected to save $600 million over 23 years. These events followed the approval of the City of Stockton’s Plan of Adjustment to emerge from bankruptcy which we discuss below.

STOCKTON BANKRUPTCY PLAN APPROVED

Stockton, California, won court approval of its plan to exit bankruptcy on October 30. “This plan, I’m persuaded, is the best that could be done in terms of restructuring the city’s debts,” U.S. Bankruptcy Judge Christopher Klein said at a hearing today in Sacramento, the state capital.

The case has drawn the attention of the municipal market to see whether pensions administered by the California Public Employees’ Retirement System would be protected from cuts. Klein ruled earlier that Calpers doesn’t deserve special protection, the first time the biggest U.S. public pension fund was found vulnerable to cuts in a bankruptcy. The earlier ruling by Klein gave Stockton the opportunity to end the Calpers contract, but it declined to do so because, as the judge said, the workers “would be the real victims.”

Ending the contract with Calpers would have reduced pensions by 60 percent and caused many employees to leave, Marc Levinson, Stockton’s lead bankruptcy attorney, has said. It would have taken years to set up a new pension system, he said. Offsetting the preservation of the pension system was done when workers agreed to “quite substantial” concessions in pay, which has an indirect effect on pensions, Klein said.

CALPERS was publicly pleased with the end result if not the actual ruling on the pension question. “The city has made a smart decision to protect pensions and find a reasonable path forward to a more fiscally sustainable future,” Calpers Chief Executive Officer Anne Stausboll said today in a statement. “We will continue to champion the integrity and soundness of public pensions.”

Not all observers were as pleased with the result. Dan Pellissier, president of Sacramento-based California Pension Reform, said Stockton is going forward with “one hand tied behind its back” by choosing not to reduce its pension burden.“Pension obligations have driven many government agencies toward financial insolvency, and Stockton is betting that they can manage their financial future without fixing its unsustainable pension obligations,” he said in a phone interview. “The purpose of bankruptcy is to get a fresh start on your finances.”

Stockton filed for bankruptcy in 2012 after spending too much on downtown improvement projects and seeing its property-tax revenue plunge in the housing crisis. Creditors filed $1.18 billion in claims. The major holdout in the case was Franklin Resources. Under the city’s plan, Calpers will be fully repaid while two Franklin funds will get back only about 1 percent of the unsecured portion of the $36 million they’re owed. Franklin will get full payment on its $4 million secured claim. A lawyer for Franklin, told the judge “We are obviously disappointed by your ruling and we will evaluate our options.”

PR HIGHWAY AUTHORITY FINANCING PLAN UNVEILED

On October 30, the Government Development Bank unveiled a detailed plan to borrow up to $2.5 billion through a bond issue backed by a new hike in the crude oil and petroleum products tax. Legislation enabling the deal was filed on Thursday, substituting a bill that was introduced last June, but never acted upon. House Bill 2212 would increase the excise tax on a barrel of crude oil to $15.50 from $9.25. That tax was increased from $3 just last year.

The $1.9 million loan on the GDB’s books was made to the Puerto Rico Highway & Transportation Authority (HTA), mostly for public works, but market conditions and the public corporation’s own fiscal problems have prevented it from returning to the market to undertake a bond issue to pay off the GDB loan.

House Bill 2212 would transfer a $1.9 billion loan on the GDB’s books which was made to the Puerto Rico Highway & Transportation Authority (HTA)to the Infrastructure Financing Authority (PRIFA) along with the revenue to pay for it to be generated by hikes in the crude oil and petroleum products that were undertaken in June 2013. This tax is expected to generate an additional $178 million per year.

The taxes would be divided as follows: $6.00 per barrel for the PRHTA to cover its operational costs and debt service obligations, $8.25 per barrel for the PRIFA to cover the new debt service from the new proposed bond issue, and $1.25 per barrel to finance the new Integrated Transportation Authority, which would combine the Metropolitan Bus Authority bus services, the ferry services (Maritime Transportation Authority) and the Urban Train system, once their transferred is completed.

The measure explicitly excludes the taxation of crude oil and its by products used by the Puerto Rico Electric Power Authority to generate electricity, as well as those that are exported from Puerto Rico; those used by local refineries and petrochemical companies in the oil refining process; and those used as lubricants or fuel for aircrafts and shipping vessels traveling by air or sea between Puerto Rico and other places; among other exclusions, according to the GDB.

The legislation also provides additional guarantees and legal protections to investors in the proposed new bonds. The Commonwealth has been impacted by downgrades since the enactment last June of the Puerto Rico Public Corporations Debt Compliance & Recovery Act (Recovery Act), which provides a mechanism for a local bankruptcy-like procedure for most public corporations to restructure their debts. Both GDB and PRIFA are barred from restructuring its debts under the Recovery Act. It has been feared that the HTA would follow PREPA in moves to restructure long-term debt, but government officials insist they are working to resolve the public corporation’s fiscal challenges without resorting to the Recovery Act.

Officials also discussed plans for a new tax reform aimed at making the tax simple more just and simplified, while providing sufficient revenue for government operations and promoting economic development. The hope is that the resulting system will feature streamlining of its numerous deductions, credits and incentives, resulting in a system that will be much easier to enforce. This is seen as an important element in any long-term plan to bolster the competitiveness of the island’s products, workers and businesses. It is expected to increase emphasize on consumption based taxes, while transitioning the island’s 7 percent sales tax into a new value added tax.

The GDB sais that the tax plan has the explicit support of the four bond insurers with the highest exposure to Highway Authority debt.

Muni Credit News October 31, 2014

DETROIT – AFTER THE FIRE…THE FIRE STILL BURNS

So now the hearings have ended and a decision will be announced on November 7 as to whether or not the City’s Plan of Remediation will be accepted. Regardless of the actual finding, it seems appropriate to consider what it is that the City actually accomplished and what the implications are for the municipal market in the long term.

Some of the conclusions are obvious and immediate while some are more subtle. Obviously, the strength of the general obligation pledge has been forever diminished. In the end, the City was effectively allowed to abdicate its responsibility to the bondholder to take all means necessary within the context of its sovereign immunity and police powers. While the immediate circumstances in Detroit may provide a stronger case for such an abdication than in some others, the fact that the City systematically failed to exercise its responsibilities over decades makes absolution a less acceptable concept.

The real triumph in this case belongs to lead bankruptcy counsel. The resolution of this case on essentially the City’s terms represents the culmination of a two decade effort on counsel’s part to weaken and permanently diminish the value of the GO pledge. 20 years and two multi-billion dollar defaults later, victory in this quest is almost within grasp. Academically and legally a success perhaps but definitely a failure for the bond market and the faith of the individual investor in it.

In the case of the City, the result is at best a very qualified win. The improvement in the City’s position is purely on the liability side of the balance sheet. The City still has overwhelming infrastructure needs, a limited economy and tax base, and a significantly weakened political base. Individually, each is a major credit negative. In combination, they create what is at best a highly speculative investing environment. Raising the revenue necessary to support the kind of capital and operating expense required over the foreseeable future remains a formidable challenge. The school system is still very poor, the jobs base for an undereducated core population remains insufficient, and the environment for raising taxes and state aid remains hostile.

So in many ways the City’s victory appears to be Pyrrhic at best given the damage done to such a significant sector of the municipal bond market. Hopefully, no one considers this to be mission accomplished.

PR BACK BY ITSELF IN THE SPOTLIGHT

The ongoing nature of the challenges facing Puerto Rico were reemphasized through the release of more negative economic data and additional cautionary commentary from Moody’s about the ongoing liquidity weaknesses of the GDB. The GDB released a revised liquidity projection earlier this month. It projected that its quarter-ending available cash might be as much as 22 % under previously forecast amounts unless a bond issue could be floated to refinance debt owed by the Highway & Transportation Authority (HTA).

The GBD’s forecast, an update from its last projection made in March, projected that available cash will stay close to $2 billion through the fiscal year ending June 30, 2015. This is contingent on the receipt by the bank of at least $1 billion or more from a proposed bond financing to repay some of HTA’s outstanding $2 billion in loans made to the Authority from the GDB. If Puerto Rico fails to refinance any of the loans, GDB’s available reserves would fall to $819 million at the end of March 2015, versus some $1.05 billion using GDB’s prior forecast.

Puerto Rico is expected to announce details of the planned financing, which Moody’s speculated would involve a pledge of new petroleum products tax revenues, subject to authorizing legislation, during a GDB investor webcast on Wednesday. The plan would be for the transaction to occur before year-end 2014, according to the liquidity projection. The GDB has maturing note principal totaling $481 million in fiscal 2015, and to $876 million in fiscal 2016.

Moody’s said, “depletion of GDB’s cash position, which serves as a proxy for that of the commonwealth, could lead the commonwealth and GDB to resort to budgetary payment deferrals and other cash management tools in order to pay debt service, which would increase the risk of default and place negative pressure on the rating of the commonwealth and its related entities. While such a scenario, with heightened default probabilities, would indicate growing credit pressure on the ratings of the commonwealth and related entities, we believe it is unlikely.”

If the proposed transaction occurs, a $1 billion infusion to GDB would result and quarter-end liquidity would rise about 72 percent above previously projected sums, reaching almost $2 billion on June 30, compared with $1.1 billion under the March forecast.

GDB reported that its net liquidity as of September 30 was $1.4 billion — $1.7 billion less than on June 30. Withdrawals of funds by the commonwealth and its corporations have reduced GDB liquidity in the intervening months. The Puerto Rico Electric Power Authority withdrew $40 million for debt service from its GDB accounts, and the commonwealth withdrew $700 million in the form of a Tax and Revenue Anticipation Note (TRAN) as well as another $700 million from its own debt service accounts for general obligation bond debt service, according to GDB’s liquidity report. An external TRAN financing subsequently allowed the commonwealth to repay $400 million to GDB.

On the economic front, The Puerto Rico Labor Department reported this week that 981,000 people were employed in September, 35,000 below the same month a year ago and 7,000 less than August. The September unemployment rate was 14.1 percent, up from 13.5 percent in August. This was however below the 14.6 percent rate in September 2013. There were 161,000 people officially unemployed in September, 12,000 less than a year ago. In August there were 154,000 people actively seeking work and collecting jobless benefits through the Labor Department.

Nearly 43 percent had been unemployed for less than five weeks; 26.7 percent for between five and 14 weeks; and 30.5 percent for at least 15 weeks. More than 51 percent of those listed as unemployed in September said they were laid off involuntarily and did not expect to be called back. In August there were 154,000 people actively seeking work and collecting jobless benefits through the Labor Department. Puerto Rico’s labor participation rate dropped back below 40 percent in September, settling at 39.6 percent, down from 40.9 percent in September 2013 and 40.1 percent in August. Agriculture employment in September dropped 2,000 jobs to 21,000 on a year-over-year basis.

PHILADELPHIA CITY COUNCIL SAYS NO TO GAS WORKS PRIVATIZATION

Philadelphia City Council President Darrell Clarke said Monady that the risksof selling Philadelphia Gas Works Co., the largest municipally owned gas utility in the U.S., outweigh the benefits. “While Council concludes that the terms of this sale proposal are insufficiently favorable for Philadelphians and pose an unacceptable degree of risk to consumers, we readily acknowledge opportunities for the enhancement and possible expansion of PGW’s operations,” Clarke said. The deal, which was struck in March, was then estimated by Mayor Michael Nutter to enable the City to apply at least $424 million into the city’s retirement system, which is 47 percent funded. UIL Holdings, the proposed buyer had promised to fund replacement of much of the system’s aging cast-iron pipe. While the Council debated the issue internally, it never held public hearings on the proposed sale. The Council President said that a report from its consultant, Concentric Energy Advisors, showed that losing PGW’s annual $18 million payment to the city dropped the value of the proposal and that there were no commitments to keep bill increases “at reasonably affordable levels” after three years of UIL ownership. The council didn’tpropose another solution to shore up the pension system, while cutting services and raising taxes to pay for pensions aren’t “particularly viable options,” according to Mayor Michael Nutter. In the interim, the S&P rating for outstanding PGW revenue bonds was upgraded to A- from BBB- on October 21.

Muni Credit News October 24, 2014

Joseph Krist

Municipal Credit Consultant

DETROIT BANKRUPTCY GETS AN ‘OUT DATE’

U.S. Bankruptcy Judge Stephen Rhodes announced at this week’s Monday hearing that he expects to announce his decision as to the feasibility of The City of Detroit’s Chapter 9 during the first week in November. This will occur essentially at the same time as Michigan voters render their verdict on whether or not to re-elect Governor Rick Snyder to his post. Snyder currently leads his opponent by an average of 3.5% points in recent polls but this gap is within the margin of error. While the overall Michigan economy is the primary issue, the vote is also seen as a referendum on the Governor’s appointment o an Emergency Manager in Detroit and the resulting Chapter 9 plan.

Investors must remember that confirmation is a determination of feasibility o the City’s Plan of Adjustment by the bankruptcy judge. Other issues such as fairness and equity have essentially been “settled away” by the City and its major creditors. The judge again urged remaining individual objectors to the plan to settle their issues by the time of his decision. The process of settlement pursued by the City effectively allowed the bankruptcy process to skirt those fairness and equity issues so his decision – especially if it affirms the Plan feasibility – will not provide clear guidance going forward to other municipalities evaluating the potential usefulness of bankruptcy as a “tool” in managing their long term liability issues especially as they pertain to pensions.

In the meantime, private economic efforts to redevelop the City core economically proceed. Mike Illitch, the owner of the Detroit Tigers and Red Wings participated in an official groundbreaking ceremony at the site of the new arena for the Red Wings designed to be the centerpiece of a large redevelopment scheme. The construction of this facility will facilitate the demolition of the Joe Louis Arena and allow the transfer to and development by major city creditors that is a key component to the achievement of claims settlements in the current bankruptcy proceedings.

PUERTO RICO REVENUES IMPROVE BUT FALL SHORT

The Treasury Department of Puerto Rico reported a mixed bag of results for revenues through the end of September. Total General Fund (GF) revenues for the three months ending September 30 were $1.774 billion. This was $75 million more than was collected during the first quarter of FY 2014, but was short of estimates by some $36.4 million. September collections were $46 million below the Treasury’s original estimate of $755 million at $709 million. The monthly shortfall was the second consecutive monthly miss in actual versus estimated collections.

Many major categories actually increased such as income and sales taxes but collections overall were another victim of congressional inaction. Revenues connected with rum excise taxes were negatively impacted as Congress failed to pass extender legislation which had the effect of reducing the tax take rebated to the Commonwealth from $13.25 to $10.50 per gallon. While this can be addressed retroactively by Congress, it is not required and the Commonwealth is counting on those revenues for budget balance and cash flow. Motor vehicle excise taxes continued to decline for the third straight month but at a slower pace.

A more recent piece of bad news was the decision of a lower court in Puerto Rico which upheld a claim for $230 million of tax refunds from the Commonwealth of Puerto Rico by Doral Financial Corp. If upheld after all appeals are exhausted, the award could be amortized through a $45 million per year payout over five years. Puerto Rico however, enacted its Fiscal Sustainability Act (Act 66-2014), which provides for all adverse judgments, other than those resulting from eminent domain or court-approved paymentplans, to be budgeted annually after consideration of the financial condition of the Commonwealth. It also provides that in no event shall such appropriation exceed $3 million for a given year. Puerto Rico apparently expects Act 66-2014 to applyin the event of a final adverse judgment in the Doral case, but one would expect this tobe contested by Doral. Puerto Rico intends to appeal the case if necessary to the Puerto Rico Court of Appeals and the Puerto Rico Supreme Court.

CHICAGO BUDGET PROPOSAL

The political morass at the state level continues to influence the efforts of the City of Chicago to address its looming pension cost crunch. Under current state law, the city will have to pay another $550 million into those funds in 2016. The initial budget proposal does not reflect that in the 2015 budget property tax levy. Instead, Mayor Emanuel hopes that he can get state legislators to restructure those funds after the upcoming legislative elections in a way that reduces that payment. The City cannot make changes in its employee pension plans without legislative action at the state level.

Away from the pension issue, the budget proposal calls for a variety of non-property tax increases totaling $62 million. These increases include a 2% rise in parking taxes at city garages, ( $10 million). Valet parking services also would have to pay that tax on their full fees to customers( $2 million). The mayor also proposes eliminating an exemption in the cable TV amusement tax, typically passed on to consumers by $12 million.

Businesses and individuals who lease office equipment and vehicles would see a 1% increase in the personal property tax on those transactions, bringing the total tax to 9 % ( $17 million). The mayor also would start applying that tax to on-the-go car rental services, like Zipcar, to raise $1 million. The plan also calls for the city to raise an extra $17 million by collecting sales taxes now evaded through rebate deals with distant suburbs — a measure expected to bring in more money from fuel purchases by airlines — and another $4.4 million by eliminating an amusement tax rebate charged on luxury skyboxes at city stadiums.

These increase are on top of previously enacted increases of $1.40 a month of the city’s 911 tax on cell phones and land lines while also raising the tax on prepaid cell phones by 2%. Those fees went fully into effect at the start of this month and are expected to increase city revenue by about $50 million by the end of the next year. These increases free up an equal amount of money to cover the city’s required additional payments into city workers’ and laborers’ pension funds next year, under a restructuring of those funds approved earlier this year by the General Assembly. In each of the four following years, the city will have to come up with another $50 million to pay into those two funds.

These increases would occur in addition to doubling sewer and water fees, increasing vehicle sticker fees, increasing weekday and higher-end garage taxes, raising hotel taxes, boosting cigarette taxes and setting up ticket-issuing speed cameras near schools and parks. And yet the police and fire pension issue still drags on the City’s credit! But is that truly a surprise? While the political outlook for the Mayor has improved in light of the illness of an expected strong opponent, the reality is that meaningful reform is likely to occur later rather than sooner. We would not be surprised to see an additional downgrade of the City prior to the enactment of meaningful reform which is likely not to occur until after the 2015 local elections in Chicago.