Category Archives: Municipal Bonds

Muni Credit News July 6, 2017

Joseph Krist

Senior Municipal Credit Consultant

joseph.krist@municreditnews.com

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This week saw at best an abbreviated new issue calendar due to the extended holiday weekend. In lieu of new issue reviews, we summarize the status of the major state budget issues which were left unresolved when we went to press with our last issue.

WASHINGTON

The new state budget for the biennium beginning July 1 totals $43.7 billion, a $5.2 billion revenue increase from existing and new taxes, including a hike in the state property tax. It raises spending by 13.5 percent over the state’s present two-year operating budget. That plan adds $7.3 billion to K-12 education over four years. Of that, $1.8 billion is spent in the 2017-19 budget.

The bulk of the new revenue comes from an increase in the state property-tax levy, which raises $1.6 billion through 2019. As that new levy is put in place, local property-tax levies used for school-worker salaries and other needs will be capped at a lower rate. Property owners who qualify for the senior citizen tax-exemption program would not be affected by the property-tax increase.

The greatest impact would be in the greater Seattle area where property values have risen the most. $464 million in new revenue is generated through the expansion of online sales-tax collections, and the elimination of tax breaks on bottled water and extracted fuels, the latter of which benefits oil refineries.

ILLINOIS

Finally, the legislature agreed on a balanced budget. The $36 billion spending plan would bring in an extra $5 billion in revenue, mostly by raising personal income taxes from 3.75 percent to 4.95 percent. It did not include provisions demanded by the governor – restrictions on the compensation program for injured workers and state-employee pensions [and] a four-year statewide property tax freeze – so the Governor vetoed the bill. The legislature has begun the process of overriding the Governor’s veto. The Senate has already done so and as we go to press, the House is expected to do the same. If enacted, the budget will at least stop the bleeding of the state’s credit rating for the short term.

PENNSYLVANIA

There is an agreement on how much to spend for fiscal 2018 but there is no agreement on how to fund these expenditures. Closed-door negotiations are ongoing in the Capitol among the Legislature’s political bosses, their top aides and Gov. Tom Wolf’s staff. The legislators are not in Harrisburg. There is a hope that a deal can be reached and votes taken at the end of this week. Tax, bond borrowing, gambling expansion, financial transfers and other bills will have to be passed for a budget to be considered enacted. This method keeps the Commonwealth in operation despite the lack of a completed budget. A prior state Supreme Court decision precludes a governor from not paying state employees who show up to work during a budget impasse. In 2015-16 all state employees were paid, including in the Legislature. It is expected that the results will only address short-term concerns with the major structural issues negatively impacting the commonwealth’s finances left to another day. this bodes poorly for any improvement in Pennsylvania’s long-term credit outlook.

NEW JERSEY

It took a state government shutdown and a now infamous photograph of the Governor lounging on an otherwise closed state beach but, the stalemate between the Governor and the Legislature has been overcome. A compromise was struck on the use of the “surplus” reserves of the state’s non-profit health insurer Horizon Blue cross Blue Shield to balance the state’s budget. In addition, the legislature approved a transfer of the state lottery assets to the state’s pension funds as a way of lowering the unfunded liability of the pension funds. As in the case of other states, the agreement addresses short term problems without fundamentally addressing the State’s long term financial issues.

CONNECTICUT

It is no surprise that Connecticut was unable to enact a budget on time for fiscal 2018. The problems facing the State have been well chronicled as is the fact that from the legislature’s point of view there are no good answers. Fears of corporate departures based on high profile announcements from GE and Aetna have complicated tax policies. Pressures from Connecticut’s many credit challenged localities and weak pension funding situations have complicated the expense side. As always, politics matter as the Governor remains highly unpopular. Were it not for the state’s overall favorable wealth profile, we believe that ratings would be lower as well on a negative track.

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PUERTO RICO

Puerto Rico’s financial control board certified with some amendments the commonwealth’s next budget. The board also approved budgets—with certain conditions—for the Government Development Bank (GDB), the Highways & Transportation Authority (HTA), the Electric Power Authority (PREPA), and the Aqueduct & Sewer Authority (PRASA). The list of corrective actions required by the board included additional cuts of $119 million in budget allocations that would cover expenses related to the Legislature, sports, municipalities, payroll and non-profit organizations, among others.

It also asked the government to provide more evidence on how exactly it would implement cuts in government spending that, according to the fiscal plan, must total $440 million during the next fiscal year. Of the estimated amount, the board says that some $200 million still lack implementation plans that demonstrate how the Rosselló administration will hit the target.

In its bankruptcy proceedings, the Puerto Rico government and its Sales Tax Financing Corp. (Cofina) submitted late last week the initial list of creditors to whom they owe money—601,867 businesses and individuals. The commonwealth government delivered the information as part of its bankruptcy proceedings under Promesa’s Title III. Cofina, however, only listed five companies as creditors. These were Ambac Assurance Corp., Assured Guaranty Corp., Bank of New York Mellon, KPMG, Lehman Brothers Holdings Inc. and MBIA Insurance Corp.

So when the advocates for debt restructuring based on significant bond holder haircuts because only evil hedge funds would benefit from meeting debt obligations, keep that number in mind – 601,867.

Over the holiday weekend, the financial control board filed a Title III petition for PREPA in the commonwealth’s federal district court. PREPA’s unsecured creditors includes Scotiabank ($553.2 million), Solus ($146 million), Freepoint Commodities ($60 million), EcoEléctrica ($44.8 million), AES ($44.1 million), JPMorgan ($34.4 million), Puma Energy ($19.9 million), and other claims related to litigation that amount roughly $1.2 billion.

A group of PREPA bondholders stated that before the RSA expired Wednesday, they had offered an extension to the agreement, as well as additional liquidity to fully cover a $450 million debt payment due July 1, in a bid to keep negotiations alive.

MINNESOTA

S&P Global Ratings has affirmed its ‘AA+’ rating on the State of Minnesota’s general obligation debt, and its ratings on the state’s standing appropriation debt, moral obligation-backed debt, and school program guaranteed debt. At the same time, S&P Global Ratings removed the ratings from CreditWatch, where they had been placed with negative implications on June 15, 2017. The outlook is stable.

S&P placed the state on CreditWatch because of a lack of clarity about how the rental payments and debt service on the state’s $80.1 million certificates of participation series 2014 (Legislative Office Facility Project) would be paid when the governor defunded the legislature’s budget. However, on June 26, the Ramsey County Court issued an order based on an agreement between the Minnesota Legislature and Gov. Dayton. The court ordered continued funding for the House and Senate until Oct. 1, 2017, unless the legal dispute is resolved earlier. The order requires the Senate to make its June 2017 payment for the Senate Office Building, and to continue paying the lease payments during the appeal period. According to the state, the governor and legislature made the proposal in part to insulate the Senate Building lease payments from the legal dispute. The lease rental payments that will be made through the appeal period are more than enough to make the Dec. 1 debt service payment on the state’s certificates of participation, and the court further acknowledged that the Senate is permitted to use its reserve funds to make the lease payments after the order expires.

BUDGET ROUNDUP

Maine ended its government shutdown with the enactment and signing of a fiscal 2018 budget. In Maine, the process featured private negotiations between the Governor and legislative leaders – a practice often derided when practiced in New York. The end of a lodging tax and increased school funding clinched the deal.

Alaska ended its budget impasse when the legislature agreed to a $2.5 billion drawdown of the state’s constitutional budget reserve to balance the budget. That fund will not have enough money left to cover anticipated structural imbalances which will occur for Fiscal 2019.

An intraparty policy dispute has held up enactment of a budget in Rhode Island. Finances are not the issue. Rather the problem is disagreements on items like gun control, minimum wage increases, and labor contract policies. Nonetheless, they are enough to suspend legislative activity and prevent enactment of a budget. State law provides for operations to be funded without a budget so a shutdown is not part of the equation.

Minnesota started 2017 in the enviable position of deciding how to apply an apparent budget surplus. It ended the budget season with major disagreements between the Governor and the legislature which culminated in the Governor “defunding” the Legislature for the upcoming fiscal year. The problem is that this threw the payment of debt service on certain state certificates of participation. The Governor made some additional unhelpful comments regarding his preference for paying salaries over debt service. This put the state’s S&P rating on negative credit watch. Subsequent litigation produced opinions that the debt service should be paid and the credit watch placement has been resolved favorably.

The problems of its New England neighbors have diverted some attention away from the lack of a budget agreement in Massachusetts. The pressure is mitigated somewhat by the fact that in June, the legislature passed and the governor signed an interim budget totaling $5.5 billion, helping keep the state operating through the month of July.

Oregon also entered FY 2018 without a budget but progress was being made. An additional $400 million in anticipated revenue over the next two years based on two positive state revenue forecasts and passage of a plan to raise $550 million from higher taxes on hospitals and a new tax on insurance plans helped to close a budget gap. The health tax will keep intact Medicaid health insurance for hundreds of thousands of needy Oregonians.

WITHER NPFG

The news that National Public Financial Guaranty was getting out of the new insurance business in the wake of its S&P ratings downgrade struck another blow to the municipal bond insurance sector. National’s lack of progress in developing new business reflected the lower value of the product in the aftermath of the financial crisis and the brutal competition in a market that puts a premium on low pricing in an environment of low absolute rates and compressed credit spreads. Outstanding debt insured by National should be fine as the business is effectively operated in a runoff mode. NPFG will still maintain a robust surveillance and information technology infrastructure but has dismantled the new business side of the firm.

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

Muni Credit News June 29, 2017

Joseph Krist

Senior Municipal Credit Consultant

joseph.krist@municreditnews.com

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As we go to press, many budget situations remain in negotiation. Thus, they may be resolved tomorrow (the end of the fiscal year) or after. With the Tuesday July 4 holiday we will not publish again until July 6. Please enjoy the holiday safely. leave the fireworks to the professionals (and I don’t mean the legislators negotiating budgets). Happy 241st Birthday America!!

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NEW JERSEY BUDGET DOWN TO THE WIRE

Governor Chris Christie has the option to order a state shutdown if a budget doesn’t get passed by both houses of the Legislature and signed by the governor by midnight on Friday. He is attempting to broker a deal with legislative leaders that would allow an extra $125 million into state education funding in exchange for legislation that would allow the governor to take $300 million from Horizon Blue Cross Blue Shield of New Jersey’s reserves to expand access to addiction treatment. In addition, he seeks legislation to shift the State Lottery into the state pension fund as an asset.

The lottery shift would be just that in accounting terms. It would take an existing asset and its associated cash flows and allow them to be applied to the unfunded pension liability without actually spending any money to do so. It would be yet another in a series of gimmicks employed by the Christie administration to avoid having tax revenues applied to pensions. This has been a chronic shortcoming of the Christie administration financial management plan that has led to multiple rating downgrades on his watch.

PUERTO RICO

The Financial Oversight and Management Board refused to certify the Puerto Rico Electric Power Authority’s (PREPA) financial agreement to restructure its $8.9 billion debt under Title VI of the federal Promesa law. The creditors and the government agreed in April to modify the existing RSA reached in 2015. The modified RSA maintained a 15% haircut but extended the maturities of the new bonds to 2047. The new agreement saves $2.2 billion in debt service costs for the next five years.

The board said “negotiations with creditors of [PREPA] concerning a possible transaction have taken place between the Oversight Board’s representatives and the PREPA creditors. Those negotiations are continuing.” The board said “the most likely course of action under the circumstances would be a debt restructuring process under Title III instead,”

The board said it would have approved the RSA as a valid consensual agreement under Title VI of the federal law, if creditors were willing to introduce certain amendments. For instance, it sought to cap the utility’s transition charge—which would pay for PREPA’s new bonds as part of the exchange transaction—in an escalating manner. Specifically, the board sought to cap the transition charge at 2.7 cents per kilowatt-hour (kWh) by 2018, 3.6 cents per kWh by 2023 and 3.95 cents per kWh by 2026. The board said it was concerned about the current RSA’s treatment of this special charge, which would spike amid a declining electricity demand on the island.

MAINE

A two-year, $7.1 billion budget proposal offered by Senate Republicans would scrap a voter-approved surtax for schools while still boosting education spending by $146 million. the state’s tax on lodging would be increased from 9 percent to 10 percent in October to help pay for the additional education funding and property tax relief. Their biggest concerns remain overall spending, funding to eliminate waitlists for the disabled and education initiatives like a pilot program for a statewide teachers’ contract.

A budget must be in place by July 1 to avert a government shutdown over the Fourth of July weekend. Any budget deal would need two-thirds support in the House and Senate to be enacted on time and withstand a governor’s veto. Governor LePage in the past has taken 10 days to act on the budget, as the state Constitution allows. If a budget isn’t in place by the end of the day Friday, all non-emergency state services will end temporarily. State officials would declare which positions are “emergency” by Friday’s end.

Local communities predict challenges for vehicle registrations, marriage licenses and birth or death certificates. Maine government last shut down in 1991.

WEST VIRGINIA ROAD PLAN

West Virginians will have the opportunity to decide whether they want to support a $1.6 billion measure to support upgrades to the state’s roads and bridges in a special election on October 7. Governor Justice also signed Senate Bill 1003, giving more power to the West Virginia Parkways Authority to continue charging tolls beyond the previous deadline of 2019 and to establish other tolls for supporting specific projects. That legislation, which when combined with the bond measure and the provisions of Senate Bill 1006 to increase the gas tax and Division of Motor Vehicles fees, is estimated to provide a $3 billion.

The Governor estimates there are nearly 500 shovel-ready projects throughout the state and that they will generate 48,000 jobs in the state. The legislation increases the state’s gas tax, some Division of Motor Vehicles fees, and the privilege tax on buying a car from 5 percent to 6 percent.

CYBERATTACK HITS US PORT

A cyberattack that infected originated in Europe and then spread into the United States halted operations at the Port of Los Angeles’ largest terminal this week. APM Terminals — where Danish shipping carrier A.P. Moller-Maersk operates — turned truckers away all day, as did their terminals in Rotterdam, New York and New Jersey. The carrier is the world’s largest — accounting for about 16 percent of the world’s shipping fleet.

Earlier this year, APM Terminals, Maersk and Mediterranean Shipping Company launched a pilot program to track cargo and share information with their clients. Major retailers such as The Home Depot and Lowe’s were among others, are participating in the project.

TEMPORARY REPRIEVE FOR HOSPITALS AND STATES

The decision to delay a vote on the BCRA only extends the uncertainty for states and hospitals at an important point in the calendar for both sectors. Now states face increased uncertainty as they begin their fiscal years with many still battling over budget adoptions. For hospitals, the uncertainty over the reimbursement and utilization environment continues heightening the risk associated with this sector.

That reflects the fact that the only legislation out there as we go to press is the Senate bill would increase the number of people who are uninsured by 22 million in 2026 relative to the number under current law. By 2026, an estimated 49 million people would be uninsured, compared with 28 million who would lack insurance that year under current law. As expected, the largest savings would come from reductions in outlays for Medicaid—spending on the program would decline in 2026 by 26 percent in comparison with what CBO projects under current law—and from changes to the Affordable Care Act’s (ACA’s) subsidies for nongroup health insurance.

ACCOUNTING TREATMENT OF LEASES

The Governmental Accounting Standards Board (GASB) issued guidance that establishes a single approach to accounting for and reporting leases by state and local governments. This single approach is based on the principle that leases are financings of the right to use an underlying asset. a lessee government is required to recognize (1) a lease liability and (2) an intangible asset representing the lessee’s right to use the leased asset. A lessor government is required to recognize (1) a lease receivable and (2) a deferred inflow of resources. A lessor will continue to report the leased asset in its financial statements.

A lessee also will report the following in its financial statements: Amortization expense for using the lease asset (similar to depreciation) over the shorter of the term of the lease or the useful life of the underlying asset; Interest expense on the lease liability; Note disclosures about the lease, including a general description of the leasing arrangement, the amount of lease assets recognized, and a schedule of future lease payments to be made.

A lessor also will report the following in its financial statements: Lease revenue, systematically recognized over the term of the lease, corresponding with the reduction of the deferred inflow; Interest revenue on the receivable; Note disclosures about the lease, including a general description of the leasing arrangement and the total amount of inflows of resources recognized from leases.

Limited exceptions to the single-approach guidance are provided for: Short-term leases, defined as lasting a maximum of 12 months at inception, including any options to extend; Financed purchases; Leases of assets that are investments; and certain regulated leases, such as between municipal airports and air carriers.

MID YEAR REVIEW

At mid-year we look at the major federal topics that would likely have impact on municipalities versus where we were at the beginning of the year relative to the President’s stated goals and points of emphasis.

Infrastructure – So far we have an effort underway to upgrade the federal air traffic control system through a program of privatization. House Transportation Chairman Bill Shuster‘s FAA bill has now made it as far as it did last year, with the committee again approving the bill (H.R. 2997) almost entirely along party lines. Shuster has said that House leadership could bring the bill to the floor for debate in July. It has failed in its previous attempts. Otherwise, all of the real debate on infrastructure continues on the state and local level with a variety of plans and funding mechanisms being debated and/or adopted. It is at this level that the real leadership is occurring.

Tax reform – The effort remains stalled at the one page concepts stage with no legislation currently on offer. Debates about the viability of a border adjustment tax championed by Speaker Ryan continue.

Healthcare reform – As we enter the weekend, the House and Senate efforts appear unsuccessful and the Administration’s concerted effort to undermine the state insurance exchanges continues. The threat of budget destroying Medicaid reform continues to overhang state budget deliberations.

Cybersecurity – In spite of the President’s extensive tweeting activities, that would appear to be the extent of his efforts in this space. just this week, the nation’s largest port saw its largest operator unable to process freight through the port after it was the victim of a hacking effort initially directed at the Ukraine.

Energy – While states are either moving forward with renewables which have generated 10 times as many jobs as the coal mining industry, they face requests from nuclear operators for direct operating subsidies from states like New York, Illinois, and Pennsylvania. So with one industry being pummeled by market forces (coal) and another admitting that it can’t be profitable (nuclear) it still comes as no surprise the the US DOE is expected to soon release a survey favoring those two sectors going forward.

What we see here is either a lack of effort or a persistent reliance upon politically less viable policies from the White House which have the effect of increasing financial uncertainty and pressure on state and local budgets.

Muni Credit News June 26, 2017

Joseph Krist

Senior Municipal Credit Consultant

joseph.krist@municreditnews.com

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The first half of the year ends up with a raft of transportation financings as local agencies continue to move forward while federal infrastructure remains mired in the politics of investigations, taxes, and healthcare legislation.

$500,000,000*

METROPOLITAN TRANSPORTATION AUTHORITY

Transportation Revenue Green Bonds

Moody’s: A1

In the midst of a rash of bad publicity about day to day operating problems and the huge capital needs facing the subways, the MTA saw its Moody’s rating maintained at A1. According to Moody’s, “the A1 rating reflects MTA’s strong operating environment, including the healthy service area economic growth and sound financial condition of supporting governments New York State (Aa1 stable) and New York City (Aa2 stable). The A1 also reflects MTA’s satisfactory finances, supported by sound budget management, governance, and planning, as well as bondholder protections provided by the gross pledge of a highly diversified revenue stream. The A1 also acknowledges the high fixed costs, substantial capital program, and the financial and operational challenges posed by strong collective bargaining units and a massive, aging transportation infrastructure.”

In addition,” the outlook for the Transportation Revenue Bond (TRB) rating is stable, reflecting Moody’s expectation that the MTA and its supporting governments will take actions, as they have in the past, to continue to balance the system’s fiscal operations and capital program while maintaining adequate infrastructure quality and reasonable leverage ratios.”

$255,405,000*

COMMONWEALTH TRANSPORTATION BOARD

Commonwealth of Virginia

Transportation Capital Projects Revenue Bonds

Moody’s: Aa1 Standard & Poor’s: AA+ Fitch: AA+

Primary bondholder security rests with the commonwealth’s continued willingness to appropriate sufficient funds to meet debt service requirements. The state legislature must appropriate revenues into the Priority Transportation Fund (PTF)-a special non-reverting fund within the Transportation Trust Fund (TTF)-to facilitate debt service taxes, a portion of motor fuel taxes, and excess revenues from the highway maintenance and operating fund. The state also has flexibility to transfer or allocate from other appropriate funds, as necessary, including monies from the General Fund. All monies deposited into the PTF must be used for debt service first before any other expense. Remaining PTF funds stay in the fund after designated expenditures are paid.

The Commonwealth has long been known for its strong financial results and its ability to address budget balancing needs as required.

$200,370,000*

WASHINGTON METROPOLITAN AREA TRANSIT AUTHORITY

Gross Revenue Transit Refunding Bonds

Moody’s: A2 S&P: AA- Fitch: AA-
WMATA’s Moody’s rating was downgraded in May to A2 due to ongoing restrictions that limit WMATA’s timely access to federal capital grants; declining ridership the result of weakened public confidence in the system; the expectation that WMATA’s large capital plan will increase as it addresses system safety and performance challenges; the magnitude of system’s deferred maintenance needs; and large unfunded pension and OPEB liabilities that add to WMATA’s financial challenges.

WMATA’s gross transit revenue bonds are secured by a pledge of gross revenues, including farebox revenues and operating subsidies from participating jurisdictions. WMATA is confronting daunting maintenance requirements and substantial capital improvement needs. It needs to establish a consistent regionwide funding source to support expected substantial bond issuance.

Service issues including regular delays and service outages as well as extended maintenance related interruptions have contributed to real pressure on passenger levels. This increases the pressure to find a new source of funding for operating subsidies. A new audit report from Metro’s Office of Inspector General found $68 million in bus, paratransit or rail car vehicle and parts purchases did not meet federal contracting requirements, and $517 million of the $1.4 billion in contracts reviewed did not follow the Federal Transit Administration’s nonbinding suggested best practices.

WMATA is taking steps to address the issues raised by the audit so we see no credit issue stemming from it. But the issue does highlight the frustration with the volume of hollow comments from the current administration as it struggles to articulate and implement an infrastructure plan.

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PUERTO RICO

It appears that the Financial Oversight and Management Board may be wavering Financial Oversight and Management Board in its position regarding government employment levels. According to what the board approved in its March 13 meeting, a furlough program was scheduled go into effect July 1, unless the government secures a $200 million cash reserve and demonstrates government spending cuts as established under its fiscal plan. Were the government to convince the board that it is not necessary to implement the measures starting July 1, these would be postponed until Sept. 1, by which time the board would reevaluate the situation.

Now the board has espoused the view that the governing body would seek to implement the public employee working hour reduction measure starting Sept. 1, and not July 1 as originally scheduled. The board has said that replied “if the government doesn’t want to comply after we analyze the budget and decide that we indeed need to implement a limited reduction in working hours, then that will be an issue for lawyers and we will have to clarify the issue in court.”

The governor has threatened court action to uphold the other side of this argument. So the uncertainty and delay continues as Puerto Rico continues to resist the hard decisions which must be made for it to recover a sound financial position.

SOLID WASTE CREDITS IMPACTED BY CORPORATE DOWNGRADE

At week’s end, Moody’s announced the downgrading of the corporate family rating (CFR) of Covanta Holding Corporation (Covanta) to Ba3 from Ba2 and senior unsecured rating to B1 from Ba3. The action had a direct impact on four issues of solid waste disposal bonds for waste to energy plants operated by Covanta. These credits are secured under performance guarantees from Covanta which are seen as being negatively impacted by Covanta’s financial profile.

The four municipal deals were issued by the Delaware County Industrial Dev. Auth., PA, the Essex County Improvement Authority, NJ, the Massachusetts Development Authority, and the Niagara Area Development Corporation, NY. The issues are now rated Ba3. “Covanta continues to face pressures from the weakened power prices and unpredictable metals prices, resulting in lower earnings and cash flows. These results in key credit metrics that are more appropriate for the Ba3 rating, including cash flow from operations before changes in working capital (CFO pre-WC) to debt in the high single digits”.

Covanta will be more exposed to market power prices with significant PPA contract expirations in 2017. At the same time, generally stable cash flows from the waste disposal and service revenues which represents approximately 70% of Covanta’s consolidated revenue in 2017.

RUTGERS OUTLOOK IMPROVEMENT

One credit which provides a ray of hope in New Jersey’s generally declining credit environment is Rutgers, the State University of New jersey. Moody’s has raised the outlook on Rutgers Aa3 rating to stable. The revision reflects stabilizing operations at slightly better than break-even levels, resulting in modest operating cash flow growth. It also incorporates a view that the university will be able to absorb some reductions in state and federal funding, that it will limit any additional debt to current levels, and that liquidity will not deteriorate further.

Moody’s reiterated its rating which “positively incorporates the university’s large scale of operations and critical role in the State of New Jersey’s (A3 stable) educational framework as the flagship and land grant university and member of the Big Ten Conference. Favorably, university leadership continues to demonstrate the ability to plan and execute complex strategic change and to increase the university’s already sizeable financial resources through fundraising, providing a growing cushion to adjust to moderate revenue volatility. Offsetting characteristics include high leverage and the increasingly pressured state environment, including shifting of the pension burden from the state to the university. In addition, Rutgers’ ambitious capital plan and aging facilities require significant capital investment.”

OSF Healthcare System (OSF)

This IL based hospital system benefitted when the Seventh Circuit affirmed a federal appeals court refusal to revive a $300 million lawsuit accusing St. Francis Medical Center of violating antitrust laws by carving other Peoria, Ill., providers out of its exclusive contracts with commercial insurers. The Court affirmed OSF Saint Francis Medical Center’s summary judgment win in the US$300 million antitrust suit brought by a smaller competitor alleging unlawful exclusive dealing and attempted monopolization. The opinion found that “competition for the contract is a form of competition that antitrust laws protect rather than proscribe.”

The decision is seen as a notable precedent for hospital and provider networks—particularly those with substantial market shares—that wish to negotiate narrow and exclusive network agreements.

STATE BUDGET UPDATE

Alaska and New Hampshire recently ended extended budget standoffs with the adoption of budgets which represented compromises and/or delayed consideration of the primary issues driving budget imbalance. Connecticut, Pennsylvania, and Illinois remain at the forefront of continuing budget dysfunction. We expect that deliberations will extend right up to if not past the deadline for budget adoption of June 30.

OHIO HOSPITAL CREDIT UNDER PRESSURE

Summa Health entered 2017 expecting its finances to show a surplus of $30 million to $35 million by year end – about the same as it did in 2016. Now Summa Health, Akron’s largest employer, is cutting hundreds of jobs in the face of an expected fiscal 2017 loss of $60 million – a nearly $100 million turnaround for the local health care organization that has annual revenue of about $1.45 billion.

Under these circumstances, one would express the ratings reaffirmed in November, 2016 would be under pressure. Hospital leadership certainly seems besieged. Summa’s interim President and Chief Executive Officer said this week that “unless things improve, he wrote, “I can assure you the name on our badges will no longer say Summa Health, our employees at all levels of the organization and our community will see unprecedented change, and our independent physicians will be faced with the reality of what it means to practice in a community that no longer has an independent, local option for them.”

Summa Health plans to eliminate about 300 positions and will discontinue and consolidate some services to reduce current expenses by about $12 million. The projected year-end losses on a variety of factors, including the changing health care industry, some large doctor groups not referring patients to Summa claiming concerns over the quality of care.

Since Jan. 1, patient admissions are down 7 percent from a year ago and outpatient visits are down 5 percent, while surgeries are up 1 percent from a year ago and baby deliveries about the same. In recent months, a growing portion of Summa’s revenues has been coming from lower-paying government programs while payments from higher-paying private insurance contracts are declining.

Muni Credit News June 22, 2017

Joseph Krist

Senior Municipal Credit Consultant

joseph.krist@municreditnews.com

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AMERICAN DREAM DEAL MODIFIED

We profiled the Public Finance Authority (WI) bond issue for the American Dream retail project in the New Jersey Meadowlands last week. Since then, we note that the deal was “improved” in response to investor feedback. The PILOT rate has been increased to 90% of the regular property tax rate. A reserve fund and a schedule for funding it has also been established. The disclosure requirements have also been enhanced to call for monthly construction updates. More frequent leasing information on the project has also been added to the supporting documents.

It is good to see that the investment community was not willing to roll over for the deal as presented. At the same time, the enhancements are not a replacement for underlying economic viability. Nonetheless, it is a positive development for potential investors.

PUERTO RICO

The recently announced deal between the Government Development Bank (GDB) and a group of its creditors has been approved by a majority of its creditors. The transaction as laid out in the RSA must still be approved by the Financial Oversight and Management Board for Puerto Rico and the U.S. District Court. FAFAA and the GDB have said that support for the transaction to date increases the likelihood of a successful reorganization of the bank.

Acceptance and execution of the agreement should result in a better result for the creditors versus what would have been achievable in a bankruptcy proceeding.

TEXAS DEFAULT UPDATE

Dallas County Schools, the entity which provides transportation for public school students in the city defaulted on six series of outstanding bonds on June 1. As of June 16, 2017, the District has made all outstanding interest payments due June 1, 2017 on all six series. In addition, as of June 16, 2017, the District has paid in full all amounts due on their lease obligations.

MSRB ANNOUNCES 2017 GOALS

The self regulating body for the municipal bond industry, the MSRB announced its strategic goals for 2017. They include expanding the utility of its Electronic Municipal Market Access (EMMA®) website, which is available free to all holders of municipal bonds to provide widespread access to municipal market data and tools that support fair transactions and facilitate decision-making, and maximizing the use of data to support market transparency and regulation. Additionally, the MSRB will conduct a comprehensive analysis of relevant market data to maximize its availability, utility and quality for the benefit of all market stakeholders and the public.

The MSRB’s updated strategic goals are: Facilitate industry understanding of and compliance with MSRB rules through rule guidance, clarification and education in support of market efficiency; Further evolve the EMMA website into a comprehensive transparency platform that meets the needs of municipal market participants and the public; Optimize the use and dissemination of municipal market data to further support market transparency and inform regulation; Leverage the MSRB’s unique perspective and expertise as an independent self-regulatory organization; and Promote financial sustainability by assessing fair and equitable fees, diversifying funding sources and spending responsibly.

NEW MEXICO TURNS TO FINANCING TRICKS TO BALANCE BUDGET

New Mexico had a contentious budget process this year but even after that concluded, the state will still rely on the use of short term financing to balance its FY 2018 budget. New Mexico plans to sell $120.4 million in supplemental notes and $38.2 million in senior notes this month. The note proceeds will be used to reimburse the general fund for capital expenditures. This will “release cash” in the Severance Tax Bonding Fund and boost the state’s general fund reserves. The state will sell long-term severance tax bonds in July to finance the school capital program, instead of applying that moneyto statecapital projects.

A major component of the FY 2018 financial plan involves the “sweep” of non-General Fund balances into the General Fund in order to achieve General fund balance. All of these techniques along with the note issuance and bond proceeds swap plan are one-time actions that only put off the day of reckoning for the State in terms of spending and taxation. For bondholders, they point to a more vulnerable fiscal position for the State and a weaker ratings outlook for the State’s debt.

ALASKA RATING MELTING AWAY

S&P Global Ratings has placed its ‘AA+’ general obligation (GO) rating, ‘AA’ appropriation rating, and ‘A+’ moral obligation rating on the state of Alaska’s debt on CreditWatch with negative implications.

S&P said “The CreditWatch action reflects our view that the state could remain structurally imbalanced for fiscal 2018 based on the impasse for budget negotiations regarding adopting fiscal reforms,” said S&P Global Ratings. As noted in our prior reports, without structural fiscal reform in the 2017 legislative session, we would likely lower the state debt ratings. Over the next 90 days, we expect the state will enact a fiscal 2018 budget. “If Alaska uses a significant amount of its reserves again and remains structurally imbalanced, we would likely lower the rating, “but should it adopt a balanced budget with fiscal reforms that does not significantly rely on reserves, we may remove the state’s ratings from CreditWatch without downward rating action.” The state legislature failed to adopt a budget during its regular session and first special session. On June 16, 2017, the governor called for a second special session specifically to address the operating budget before the end of the fiscal year (June 30). In our opinion, given the limited scope of the second special session and an ongoing political impasse over adopting the governor’s proposed fiscal reforms, it is unlikely significant fiscal reforms will be implemented as part of the 2018 budget, resulting in yet another year of structural imbalance.”

CHARTER SCHOOL CREDIT IMPROVEMENT

While charter schools are often in the news for financial difficulties and debt defaults, it is refreshing to see a charter school program show positive credit trends. S&P announced that it has raised its rating to ‘BBB’ from ‘BBB-‘ on the California School Finance Authority’s educational facilities series 2014 and 2015 fixed-rate charter school revenue bonds, issued on behalf of KIPP LA Schools which as $106 million of outstanding debt. KIPP has 14 schools currently operating throughout the greater Los Angeles area. S&P cites “its very healthy financial profile, which includes growth in unrestricted liquidity and excellent revenue over expenses that is commensurate with the higher rating.” S&P assessed KIPP’s financial profile as strong, with exceptional positive operating margins, a sound cash position, a moderate maximum annual debt service (MADS) position, and a large operating base. It assessed KIPP’s enterprise profile as adequate, characterized by healthy demand with exceptional enrollment growth, a moderate waiting list, solid academics, and a stable management team. A higher rating is precluded “by KIPP LA’s significant growth plans for the next three to five years and the construction risk associated with its current and planned projects that might pressure the school’s financial profile.

KIPP operates 80 elementary, 94 middle and 26 high schools in 31 locations across the country. KIPP schools are tuition-free, which are primarily funded through public federal, state, and local dollars, along with supplemental funding through charitable donations from foundations and individuals.

SENATE HEALTH PLAN TARGETS MEDICAID

In what would be a blow to state finances, the Senate has released its draft legislative proposal to repeal the ACA. The major source of savings are to be found in the proposed changes to Medicaid. They include limiting how much the federal government would pay for each person enrolled in the program (the per capita approach vs. the block grant approach). The bill is rolls back Obamacare’s enhanced Medicaid spending — states would be left deciding whether to raise more money to make up the difference, or to cut back on medical coverage for people using the program which is likely to force governors to cut coverage — over four years beginning in 2020. Earlier Senate conversations called for a three-year phase out.

Americans who get tax credits to buy insurance based on their age, as the House bill does, the Senate would offer them based on “financial need”—which is more or less how Obamacare works. But under the GOP’s proposal, fewer Americans would qualify for help. Under the Affordable Care Act, households can receive insurance subsidies if they earn up to 400 percent of the poverty line. Senate Republicans would lower that threshold to 350 percent. Subsidies will also be smaller for those who still qualify.

The bottom line is that the plan as is cuts revenues to the states, increases the ranks of the uninsured and the need for more indigent care, and makes it more likely that the oldest Americans will see lesser care. So the bill is negative for state credits, hospital credits, and continuing care retirement communities.

Muni Credit News June 20, 2017

Joseph Krist

Senior Municipal Credit Consultant

joseph.krist@municreditnews.com

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NYC TRANSITIONAL FINANCE AUTHORITY

$850,000,000

Future Tax Secured Tax-Exempt Subordinate Bonds

Moody’s: Aa1

The state legislature established TFA as a separate and distinct legal entity from the city. Further, the state did not grant TFA itself the right to file for bankruptcy. While bondholders are protected from bankruptcy, city or state fiscal stress still could pose risks because both the city and the state retain the right to alter the statutory structure that secures TFA’s bonds. The city has covenanted not to exercise those rights if debt service coverage were to fall below 1.5 times MADS on outstanding bonds. Since enactment of the TFA, policy actions have both increased and decreased the pledged revenues. Those actions have included the abolition of the city’s income tax on commuters, and establishment of various sales tax exemptions.

The pledged taxes are collected by the New York State Department of Taxation and Finance and held by the state comptroller, who makes daily transfers to the trustee (net of refunds and the costs of collection). The trustee makes quarterly set-asides of amounts required for debt service due in the following quarter on the outstanding bonds, as well as TFA’s operational costs (with the collection quarters beginning each August, November, February and May). Half of each quarterly set-aside is made beginning on the first day of the first month of each collection quarter and the second half is made beginning on the first day of the second month of each collection quarter. If sufficient amounts for debt service are not on deposit after those two months, the trustee continues to set aside funds in the third month, on a daily basis, until the deficiency is cured. Functionally, personal income tax revenues are expected to provide sufficient amounts for debt service; if they do not provide at least 1.5 times coverage of maximum annual debt service (MADS), sales tax revenues are available to make up the difference. Additionally, the TFA’s future tax secured bonds issued before November 2006 have a first lien on appropriations of state building aid to the city if necessary to meet debt service requirements.

The TFA was created by the state legislature in 1997 to provide a method of financing New York City’s vital capital construction program but outside the constraints of the debt limit imposed on the city by the state constitution (the city’s general obligation bonds are rated Aa2 with a stable outlook). TFA’s original statutory authorization was $7.5 billion. In 2000, it was increased by $4.0 billion and following the 2001 World Trade Center attacks, that amount was increased to permit $2.5 billion of subordinate “Recovery Bonds” used partly as deficit financing to bolster the city’s general fund in fiscal 2003. Authorized issuance was increased again by an additional $2.0 billion in 2006, to an aggregate of $13.5 billion (the Recovery Bonds were excluded from that cap) for senior and subordinate lien bonds.

CHICAGO AIRPORT ENTERPRISE
$825 million new money and refunding senior lien general airport revenue bonds (GARB)

Moody’s: A2 Fitch: A

The ratings reflect the strong local market, the strategic location of Chicago, IL as a hub and the demonstrated importance of the airport to both United Airlines and American Airlines. The rating also reflects continued favorable progression of the airport capital programs with overall costs remaining in line within existing budgets, while airport traffic is trending in a positive direction. Leverage is elevated at nearly 12x but should evolve to a lower level over the next five years.

The passenger base ranks among the nation’s largest for both origination and destination (O&D) traffic as well as international services. Nearly 60 domestic and foreign-flag carriers operate out of O’Hare to 168 domestic and 65 international non-stop destinations. In 2016, the airport handled 38.9 million enplaned passengers with slightly over half being origination/destination traffic. O’Hare has experienced a healthy rate of traffic growth over the past three years, up 16.7% since 2013. Early traffic data for fiscal 2017 indicate marginally positive traffic increases. Both domestic and international segments realized increases over the past three years, as well as ongoing increases in service from low-cost carriers.

Three of four new runways have been completed along with one of the two planned runway extensions. Remaining costs will cover additional airfield projects such as another new runway and runway extension project, are also anticipated to be close to $1.6 billion. Other projects include a nine-gate expansion at terminal 5, a facility used for international and domestic flights. Airport management is also exploring future terminal projects to increase capacity. The timing and costs are unclear but will likely take many years to fully complete.

CALIFORNIA HEALTH FACILITIES FINANCING AUTHORITY

(SUTTER HEALTH)

$442,135,000 REVENUE BONDS

Moody’s: Aa3 S&P: AA- Fitch: AA-

Sutter Health is issuing bonds to refinance outstanding debt. Sutter’s ratings reflect its strong presence in northern California, its large size, its history of generally stable cash flow production, and its conservative asset-liability structure, including a well-funded pension plan. Challenges include relatively high leverage, more modest operating performance in recent years, cash balances that are modest compared to other Aa rated credits, and a $4.5 billion capital plan over the next five years. The system operates 28 acute care facilities, manages four medical foundations that contract with medical groups organized as professional corporations that account for the services of over 2500 physicians, recently started a small health plan, and operates a large number of out-patient facilities.

Bonds are secured by a gross revenue pledge pursuant to Sutter’s 1985 Master Trust Indenture (MTI), with payments made by Sutter’s Obligated Group (approximately 96% of the System’s total revenues). All members of the Obligated Group are jointly and severally liable with respect to the payment of each obligation secured under the MTI. Operating EBITDA margins have consistently been around 10% since 2014 (Dec. 31 fiscal year end). Operating performance has weakened in the first quarter of 2017 due to lower than expected patient volume. However, management has implemented necessary expense reduction initiatives and the full year operating EBITDA margin budget of 8.4% should be met or exceeded based on management’s historical track record.

This issuance is expected to reduce pro forma MADS to $239.7 million from the current $242.7 million, which was also a reduction from prior levels due to refinancings in 2016. Debt service coverage is adequate at 4.8x in 2016, 4.3x in 2015 and 5.3x in 2014 compared to the ‘AA’ category median of 6x. The capital plan for 2017-2021 totals $4 billion with a significant reduction in 2020 after the San Francisco facilities are complete. Sutter typically finances capital expenditures from cash flow and issues debt for reimbursement based on a balancing of cash and leverage metrics. An additional $500 million debt financing is expected in the next two to three years to fund or reimburse capital expenditures.

Moody’s assigns a stable outlook to its rating based on an assumption that operating measures will continue to improve over time, and that balance sheet measures will generally improve, despite the very large capital plan.

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PUERTO RICO

The U.S. House Natural Resources Committee demanded that the board approve the agreement to restructure PREPA’s $9 billion debt. It also follows various groups’ call, including the Puerto Rico Manufacturers Association and the Coalition for the Private Sector, which urged stopping the RSA, whose terms were renegotiated earlier this year. PREPA extended a deadline to June 28 to finalize the required documentation and begin the creditor voting process over the “qualifying modification,” as defined by Promesa’s Title VI. The extensions followed a Wall Street Journal report that the deal was on the verge of collapsing because fiscal board members could not reach a consensus over the RSA’s terms.

PREPA’s executive director, Ricardo Ramos, said he had expected the RSA to go through the process of court approval in July. He had previously said PREPA is receiving a lot of pressure from Congress to move the RSA forward.

On another front, The recently announced deal between the Government Development Bank (GDB) and a group of its creditors does not exclude the possibility that the bank could end up in a Title III bankruptcy process to restructure its debt. While the proposed deal calls for using most of the deposits and assets left in the GDB as collateral for payment of the new bonds to be issued by a special-purpose vehicle (SPV), there are no guarantees either. According to the RSA, if there is not enough money to pay in full all interest on the new bonds, any unpaid balance shall be paid in kind, which means it would be accumulated until the next payment.

The proposed transaction seeks a bond exchange mechanism for the bank’s $3.76 billion debt, in which three different tranches would be issued by an SPV. Haircuts would hover from 25% to 45%, depending on the tranche, while GDB assets, particularly the municipal loan portfolio, would pay for these bonds. The process under the federal Promesa law calls for Financial Oversight & Management Board approval of the RSA as a “qualifying modification,” after which the GDB will need more than 66.6% of its voting creditors to be in favor of the deal. The agreement would then have to be certified by a judge.

INDIANA P3 CRASH

The State of Indiana announced an agreement to take control of construction of the 21-mile stretch of I-69 from Bloomington to Martinsville, an admission that its touted public-private partnership failed. The agreement terminates a contract with I-69 Development Partners, the private company responsible for designing and building I-69 Section 5 and maintaining it for 35 years.

The agreement would settle all disputes and allow the Indiana Finance Authority to assume direct control of the project, which is about 60 percent finished. The project was supposed to be completed by October 2016, but has been delayed four times since construction started. The new estimated completion date is August 2018, nearly two years late.

In a news conference, state officials insisted that the state made no mistakes concerning the project. They also did not discount the possibility of using a public-private partnership for I-69 Section 6 from Martinsville to Indianapolis. The state however, now assumes the risk of costs increasing beyond projections to operate and maintain the road for 35 years. The contract that was terminated called for the state to make annual $22 million “availability payments” to I-69 Development Partners for 35 years. That company was to have operated and maintained the road during that time.

State officials said Friday that — in today’s dollars — the entire project, including maintenance costs, would cost $560 million. They say it would have cost $590 million with its now-former private partner. The emphasis on savings to taxpayers over 35 years, represents a real change in how the state sold the project to the public in 2014.

When the agreement was signed, the state emphasized the $325 million winning bid by I-69 Development Partners. That was the cost of construction. The state will have to pay off bondholders and cover about $115 million in increased construction costs, Huge said. The state says it will get the money from a bond issue, at a lower interest rate than the bonds for the public-private partnership. It also negotiated a $50 million settlement payment from the company. As part of the termination agreement, I-69 Development Partners also will pay $12 million to the bondholders.

LOUISIANA BUDGET PASSES

A $28 billion-plus Louisiana operating budget won final legislative passage, a week after a stalemate in the spending negotiations forced lawmakers into a special session. The spending plan for the fiscal year that begins July 1 would keep most agencies free of cuts and fully funds TOPS. More than 38,000 state government workers would get 2% pay raises, and dollars would be allocated to open a vacant new juvenile prison in Acadiana. Prisons, state police, public colleges and the child welfare agency would be among those areas shielded from reductions. It would be the first time college campuses would be spared cuts to their state financing in nearly a decade.

Some programs would see cuts. Mental health services would get less money, as would a program for “medically fragile” children and the private operators of Louisiana’s safety-net hospitals and clinics. A gas tax increase failed. Another special session is planned over the next eight months (an exact date hasn’t been set) for lawmakers to consider raising taxes before Louisiana hits what is called the “fiscal cliff.” That’s when temporary sales taxes expire June 30, 2018 and leave a budget hole estimated to be as much as $1.3 billion or more.

Muni Credit News June 13, 2017

Joseph Krist

Senior Municipal Credit Consultant

joseph.krist@municreditnews.com

______________________________________________________________________

PUERTO RICO

We see the effort by the Governor of Puerto Rico and his supporters to achieve statehood for the Commonwealth of Puerto Rico as being not constructive for the Commonwealth’s near term financial situation. We believe that there are a number of hurdles to be overcome that can only be addressed by the Commonwealth before statehood could begin to be seriously considered by Congress. The recent plebiscite on the question of status we see as being far less decisive than the results would indicate.

The Soviet-style result (97% in favor of statehood) is as much the result of a highly successful boycott effort by opposition parties. We see the meager 23% voter turnout as being a more relevant indicator. In addition, we see the decision by the US Department of Justice to disapprove the plebiscite and any funding for it to be relevant concerns. DOJ noted that the ballot omits Puerto Rico’s current territorial status. “This omission,” the letter says, “appears to be based on a determination that the people of Puerto Rico definitively rejected Puerto Rico’s current status in the plebiscite held on November 6,2012.” The 2012 vote, however, has been “a subject of controversy” according to the Department, and “significant political, economic, and demographic changes have occurred in Puerto Rico and the United States” since that vote.

“As a result,” the letter concludes, “it is uncertain that it is the present will of the people to reject Puerto Rico’s current status.”“Accordingly, any plebiscite that now seeks to ‘resolve Puerto Rico’s future political status’ should include the current territorial status as an option,” the letter states, “[o]otherwise, there would be ‘real questions about the vote’s legitimacy’ and its ability to reflect accurately the will of the people.” DOJ had other issues with technical aspects of the ballot’s wording that it felt would be prejudicial.

Meanwhile, The Puerto Rico Electric Power Authority (PREPA) and its creditors have agreed once more to extend several deadlines under their restructuring support agreement (RSA), the commonwealth’s Fiscal Agency & Financial Advisory Authority (FAFAA) announced. Once the RSA is approved by the fiscal board under Title VI of the federal Promesa law, PREPA will now have until June 28 to finalize the required documentation and begin the voting process by all creditors over the “qualifying modification,” as defined by the out-of-court restructuring process provided by Title VI. June 28 is also the deadline for an agreement with certain creditors to fund Prep’s short-term liquidity needs, as well as to retaining a claims agent as established under the RSA.

Concerns have been expressed that the seven-member panel does not have the votes to finally restructure PREPA’s $8.9 billion debt load, as well as the utility’s operations. All the creditors to the RSA and the commonwealth have agreed the deal should be implemented through Title VI of Promesa, which allows for voluntary agreements for debt restructuring among stakeholders but, it is reported, there may be some portions of the deal that may have to go through Title III or the court-brokered bankruptcy process.

SUFFOLK COUNTY NY DOWNGRADE

Standard & Poor’s (“S&P”), downgraded the County of Suffolk, NY General Obligation Issuer rating to A- from A. “The downgrade reflects our view of the county’s available reserve levels, which have been negative for the past seven years, and our opinion that while the county’s continued efforts to narrow its operating gaps are improving, these efforts are unlikely to allow for the accumulation of reserves to positive levels over the next four to five years,” said S&P Global Ratings.

“Despite improvements in recurring revenue and expenditures, we believe the county is unlikely to generate an operating surplus without the continued use of one-shot revenue and expenditure items over the next two years, which we view as a credit weakness. It is our opinion that while the county’s operating performance has stabilized, the county will experience continued difficulty in generating surpluses over the near term, which would allow it to significantly improve fund balance over the near to medium term to levels in line with higher rated peers. We believe that current reserve levels are more comparable with those of lower rated peers, and despite the county’s very strong economy, result in a weakened ability to meet financial obligations if a period of substantial economic distress were to occur.”

ILLINOIS PUTS OFF ONE DAY OF RECKONING

In one piece of good news for Illinois, the State Comptroller has confirmed that the state has renegotiated the termination terms of some of its outstanding swap agreements. The new terms provide that the swaps cannot be terminated until the state’s general obligation bond rating is lowered below BB+ and Ba1. The increases the state’s ratings margin by one notch in terms of the agreement. With the perceived increasing likelihood of the state’s ratings being lowered as soon as July 1, this change does provide some cushion against increasing demands on the state’s cash. It is estimated that the cost of terminating the swap agreement would have been an immediately payable $70 million.

MORE BAD NEWS FOR THE HOUSE HEALTHCARE BILL

We know that it will not be adopted but the ongoing efforts in the Senate will have to take heed of the recent report by the Centers for Medicare and Medicaid Services’ Office of the Actuary. That report estimates that repeal bill would leave 13 million more Americans uninsured over the next decade and reduce federal spending by $328 billion. Both of those numbers, based on differing assumptions, are respectively lower and higher than the CBO estimates.

In 2018, the number of uninsured is estimated to be about 4 million higher under the AHCA than under current law, mainly due to the impact of repealing the individual to 31 million in 2018 and to 32 million in 2019. By 2026, the number of uninsured is estimated to be roughly 13 million higher under the AHCA. Most of the longer term coverage losses stem from the anticipated rollback of Medicaid expansion. CMS estimates that 6 million fewer individuals would be shut out because of the House bill’s tighter eligibility criteria, and that an additional 2 million will cycle out of the program because of new requirements.

There will be 35 million uninsured in 2020 under the AHCA, a figure that is about 8 million higher than under current law. For those Medicaid enrollees who would lose coverage under the AHCA, most are assumed to ultimately be uninsured, though a small fraction would choose to purchase individual insurance. All States are assumed to choose to operate within the per capita caps. So even with the more “favorable” assumptions, cuts along these lines remain credit negative for the states. The reduction in available federal revenues as well as the increased pool of potential charity care patients would be damaging to State financial positions.

STADIUM FINANCING UNDER FIRE AGAIN

Cory Booker, D-N.J., and James Lankford, R-Okla., are sponsoring a bill that would prohibit teams from using municipal bonds, whose interest is exempt from federal taxes, to help finance stadium construction. The two senators could not be farther apart on the political spectrum but they have joined forces in this latest legislative effort against municipal bonds for stadiums.

A similar bill was introduced by Congressman Steve Russell, R-Okla., into the House of Representatives in March 2016. Municipal bonds have been used to fund 36 newly built or renovated sports stadiums since 2000. The bill would end federal subsidies for stadium financing, but would not prevent localities and states from bidding and offering economic incentives to teams.

This is the next of many efforts to eliminate bonds for stadium projects. While the evidence against the productivity of such financings is questionable at best, we see the likelihood of success to be low based on past history. So keep your eye out for Las Vegas Sports Authority bonds soon.

TREASURY RECOGNIZES MUNICIPAL BOND CREDIT QUALITY

It is buried pretty in a report on bank regulatory reform but the US Treasury has joined a growing chorus in recognizing the credit quality on an overall basis of municipal bonds. Executive Order 13772 instructs the Treasury Secretary to report to the President the extent to which the existing financial regulatory system promote the Administration’s “Core Principles” of financial regulation, which include empowering Americans to make independent financial decisions, save for retirement, build wealth and prevent taxpayer-funded bailouts. In its section on Improving Regulatory Coherence to Improve the Functioning of Capital Markets, Treasury recommends expanded treatment of certain qualifying instruments as HQLA. This would include categorizing high-grade municipal bonds as Level 2B liquid assets (rather than generally not being counted as HQLA currently). This the latest iteration of what has been a changing position as to whether or not municipal bonds fit the bill.

The Federal Reserve has supported this position. Bipartisan legislation to this effect was introduced in the last session. Inclusion in the category of HQLA can be nothing but good for the market and support the generally favorable credit standing of municipal bonds among the public.

Muni Credit News June 13, 2017

Joseph Krist

Senior Municipal credit Consultant

joseph.krist@municreditnews.com

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PUBLIC FINANCE AUTHORITY

$800,000,000

Limited Obligation PILOT Revenue Bonds

$300,000,000

Grant Revenue Bonds

The long awaited bond issues for infrastructure supporting the massive American Dream shopping mall and entertainment center in New Jersey is finally coming to market. The bonds should prove to be a real test for the high yield market’s appetite for debt essentially backed by the bricks and mortar retail sector. The project has been some phase of development since 2003. It was first proposed by the Mills Corporation as the Meadowlands Xanadu. After the bankruptcy of that company in 2007, the project was taken over by Colony Capital.

In May 2009, construction stalled due to the bankruptcy of Lehman Brothers. The Triple Five Group announced the intent to take over the mall in May 2011, and on July 31, 2013, officially gained control of the mall and the surrounding site. Anyone who has traveled by bus or automobile to New York through the Lincoln Tunnel has undoubtedly seen the project located along New Jersey Route 3.

The effort to bring the project to fruition has been bedeviled by construction delays, environmental issues, unstable ownership, and financial difficulties. Ground was broken on the complex on September 29, 2004, and, at the time, was expected to open two years later. The project is now scheduled for a 2018 opening. It is slated for some 500 retail stores and a variety of amusements including an indoor ski slope. It most resembles conceptually the two other mega retail/entertainment facilities in North America – the West Edmonton Mall and Mall of America. Both of these are operated by Triple Five.

To say that the PILOT credit is speculative is an understatement. The sector itself is among the market’s riskiest – debt secured by payments from a developer derived from the revenues obtained from the operation of the mall. Tenants will rent space from the developer who will then be required to make quarterly payments to the Borough of East Rutherford, NJ which will then make payments to the New Jersey Economic Development Authority (NJEDA).

Proceeds from the Public Finance Authority bonds – the PFA a subdivision of the State of Wisconsin – will be applied to the purchase of bonds from NJEDA. The payments by East Rutherford made to the NJEDA will be used to make payments on the NJEDA debt which will then be applied to the payment of the debt service on the PFA debt. The PILOT payments by the Developer are set at 86.25% of the regular property tax assessment that would normally be leveled on property of this category by East Rutherford.

The risk lies primarily in the fact that over the period of time from original conception to actual opening of the mall, the retail sector has undergone an overwhelming level of change which have not been in its favor. If the demand for the malls stores and the entertainment facilities are below the assumed levels driving the project, the developer will not have enough revenue to make the required payments to support debt service. There is no other source of funds pledged to the bonds.

It is always a clue when a development project relies on the low cost financing of the tax exempt market, especially to the extent that this one has. The fact that construction had been at a halt for significant periods of time while all of the legal and logistical obstacles to this transaction were dealt with – which reflected the lack of available sufficient private sector financing for this project – is an indication that the risk reward ratio is not compelling.

Where the demand will come from is uncertain. Other regional competitors have been under severe pressure and many of the expected anchor tenants or prominent tenants have scaled back their national brisk and mortar footprints. When asked, proponents have pointed to the above average incomes of the immediate region but also tourism to New York City as a source of significant demand. We find that concerning. A recession would negatively impact domestic demand and current Administration policies are already negatively impacting foreign tourism levels in the New York market. So we question the major underpinning assumptions of the project.

The Grant Revenue Bonds are payable from grants to the project to be annually appropriated by the State of New Jersey. The grants are to be made to the developer to facilitate the project. They have been the subject of great controversy as residents have questioned the wisdom of these large payments to the developer of a highly questionable project during a prolonged period of fiscal distress for the State. In a time of huge infrastructure needs and declining funding for things like mass transit, healthcare, and the State’s well documented pension liability funding difficulties, these annual payments will compete for scarce state revenues.

Should the project not succeed, bondholders could find themselves in the middle of a political crossfire as underfunded service demands would be competing with subsidies for a failed private sector real estate project owned by a non-US corporation. That is not a place I would want to be in.

$449,860,000

State of Mississippi

General Obligation Bonds

Moody’s: “Aa2 (negative outlook)” S&P: “AA (negative outlook)” Fitch: “AA (stable outlook)”

Actions in the state’s fiscal 2016 expenditure of financial reserves to address revenue shortfalls, as well as its suspension of a statutory cap (at 98% of projected revenue) on annual appropriations have led to a negative ratings outlook. The state’s economy will likely continue to underperform the US, potentially leading to further fiscal pressure. The credit is characterized by an above-average debt burden and low per-capita income.

$342,000,000

State of Wisconsin

General Obligation Refunding Bonds

Moody’s: Aa2 S&P: AA

Moody’s rates the State of Wisconsin at Aa2 reflecting its view of a very well funded pension system and limited OPEB liability, moderate economic growth, as well as governance constraints evidenced by limited executive authority to reduce mid-year appropriations. The rating also acknowledges recent revenue volatility and a fund balance position that remains below average.

The rating is also assigned a positive outlook based on recent improvements in liquidity, conservative management of retiree benefits that limits future budgetary pressures, and reductions in the state’s long standing negative GAAP fund balance, if continued, would allow the state to improve its reserves and balance sheet.

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BUDGET TIME IN FULL SWING

June is the time when all of the rhetoric comes to a relative halt and the time comes for state legislatures to fish or cut bait when it comes to annual budget adoption. Here are the states where the outcome is far from certain as we enter the home stretch of the budget crunch and where we are paying special attention.

Washington – 26,000 employees are facing the potential to be laid off if the legislature cannot come to agreement. The sticking points are the desire to reduce property taxes throughout the State which has faced court orders governing education spending. One side wishes to use higher capital gains taxes and carbon taxes to support aid to local schools while the other resists. Observers are betting on a resolution but the state employees are already pawns in this game.

Pennsylvania – The annual budget has become a more and more political game through each year of the Wolf administration. With the legislature in control of Republicans and the Governor being a Democrat, intransigence has characterized the proceedings. Some progress has been made on pension reform but other issues like property tax reform, potential sale of the state liquor system, and a questionable reliance on gambling based revenues. Some in the Commonwealth have raised the issue of a severance tax on natural gas extraction. Pennsylvania is one of the leading shale gas producers in the nation. Based on recent experience, a delayed budget adoption is not out of the question.

Illinois – the problems are well known and increasingly publicized but the level of political brinksmanship and intransigence is unprecedented. We will believe a budget when we see it.

Alaska – Alaska continues to grapple with the realities of lower oil prices and the political hurdles involved in developing a more diversified revenue base. The legislature is in a special session to consider a variety of proposals. It is likely that they will decide to raid the oil funded Permanent Fund and put off the hard decisions necessary to address long-term fossil fuel pricing trends.

Ohio – Through April, the tenth month of Ohio’s fiscal year, state tax receipts year-to-date ($17.7 billion) were 4.2 percent less than expected, according to the state Budget Office. A key component of total tax receipts, state income tax collections ($6.3 billion), lagged its estimate by 8.1 percent (that is, by about $554 million). This is creating pressure to rescind tax cuts for smaller businesses but that faces substantial legislative opposition. That change lets a taxpayer “deduct up to 100 percent of [his or her] business investor income, the deduction not to exceed $125,000 for each spouse if spouses file separate returns or $250,000 for all other taxpayers.”The standoff has delayed final budget consideration for over one month.

Louisiana – The Bayou State’s legislature is in a special session to try to reach a balanced budget consensus. Various spending cuts and tax increases have been proposed to no avail. Spending cuts center on proposed reforms to the State prison system (Louisiana has the nation’s highest incarceration rate). Tax increases proposed on income have been non-starters and the Governor’s proposal for establishment of a gross receipts tax on corporations has been weakly received.

Connecticut – were it not for Illinois, Connecticut would likely be the state of most concern. The problems facing the state and it’s localities are legion but there are no easy answers. The recent announcement by Aetna that it planned to move its headquarters out of state complicated matters significantly. With lagging revenues on the state and local level, the state is under enormous pressure to balance its own budget without offloading its own problems onto its struggling localities.

MASSACHUSETTS DOWNGRADE

S&P announced that it has downgraded the rating on the Bay State’s general obligation bonds to AA from AA+. The difficulties of many other states had moved Massachusetts off the center of many credit radar screens. “The downgrade reflects what we view as the commonwealth’s failure to follow through on rebuilding its reserves as stipulated through its own fiscal policies aimed at mitigating the state’s propensity for revenue volatility,” said S&P Global Ratings. S&P said it believed that the state’s “strong economic growth and proactive management” will allow it to navigate through mid-year revenue shortfalls with “some continued use of one-time measures to balance the budget.

Despite above-national average economic growth through a prolonged period of economic expansion, the state has not demonstrated a commitment to its adopted budget reserve policies, upon which our 2011 upgrade to ‘AA+’ was predicated, in part. We therefore view it as a missed opportunity that the state has opted against building its reserve according to its policies and leaves it on a course to experience greater fiscal stress in the event of an economic downturn or if federal funding were capped or trimmed in a material way.”

Moody’s and Fitch recently reaffirmed Massachusetts’ ratings at AA 1 and AA+, respectively, with a stable outlook. According to the administration of Governor Baker, the stabilization fund has grown 20 percent since the governor took office, including the reversal of a $140 million withdrawal authorized in fiscal 2015 by the previous administration. The governor has proposed a $98 million deposit into the “rainy day” at the start of fiscal 2018, and a new process for building the reserves that would include a second deposit at the end of the fiscal year equal to 50 percent of all tax revenue exceeding projections.

CALIFORNIA BUDGET MOVES FORWARD

The CA Legislature’s budget-writing committee approved a spending plan late last week that expands a tax credit for the poor and imposes direct budget control on the University of California’s office of the president. The plan also includes a controversial plan to borrow up to $6 billion from a state investment account to make an extra payment to CalPERS to reduce the state’s pension obligations.

While the borrowing plan does reduce the unfunded liability portion of CalPERS’ accounts is does create an amount to be repaid to the state investment account which will further pressure the pension fund manager’s to achieve outsized performance results. Recent years have seen just the opposite at CalPERS so it seems a bit questionable as to how the whole scheme will work out.

Muni Credit News June 8, 2017

Joseph Krist

Senior Municipal Credit Consultant

joseph.krist@municreditnews.com

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PUERTO RICO

The proceedings in Puerto Rico’s Title III have raised concerns among some that the established treatment of special revenues under Chapter 9 could be altered by decisions in this case. the concern rises from Federal bankruptcy Judge Laura Taylor Swain decision to hold a hearing in August when she will entertain arguments on an action to stop the retention, or clawback, of toll revenues that back the Highways & Transportation Authority (HTA) debt obligations . Creditor groups contend that they have a lien over those. HTA bondholders sued on May 31 seeking an injunction to stop the HTA from diverting pledged toll revenues. Last week, three municipal bond insurers followed suit.

The Commonwealth and the financial control board—which represents the Puerto Rico government as debtor—insist that taking toll revenues from the HTA could force it to shut down its operations, including that of the Urban Train. The commonwealth contends that the lien is not a statutory one. They said the opposite last year to a U.S. District Court Judge as well as the U.S. First Circuit Court of Appeals. The Commonwealth contends that the liens were in place before the Puerto Rico Oversight, Management & Economic Stability Act, or Promesa, was enacted in 2016.

Its position is that the lien can’t be destroyed because the retroactive invalidation of a statute-covered lien is unconstitutional. Under the terms of that lien, the HTA must first deposit sufficient funds into the 1968 Resolution bondholders’ collateral account to meet debt service obligations before it can spend the funds elsewhere. Expropriating the “gross” lien to pay for “necessary operating expenses” at the HTA would effectively convert it into a “net” lien, which would constitute an illegal taking according to the plaintiffs.

They cite the fact that that the fiscal plan shows $530 million in toll revenues and other fees being transferred to the commonwealth’s general fund. The fiscal board argues that creditors have only “an unsecured lien unless they have other secured interest.”

Investor concerns center on the idea that a decision in favor of the Commonwealth could have wider implications for the treatment of special revenues generally. The issues in this case however, seem to turn on the unique aspects of the clawback provision which is not typical in many special revenue secured bonds. Here, the nature of the constitutional versus statutory dispute lies at the heart of the argument in this restructuring. We note that this issue has not arisen with regard to the electric or water utility credits where the issue of the clawback does not exist.

BOND INSURERS UNDER FIRE

Standard & Poor’s (“S&P”) announced that it had placed the ratings of Build America Mutual and National Public Financial Guarantee on a “negative outlook”. The move reverses a generally positive trend in the perception of the creditworthiness of the insurers.

In response, National said, “We are disappointed by S&P’s announcement and do not believe that a rating downgrade of National is warranted. National’s financial strength is evidenced by $1.7 billion of excess capital above our estimate of S&P’s AAA requirement. National has also, in a relatively short period of time, significantly increased its new business activity, as measured both by insured par amount and transaction count, as well as the number of intermediaries who have recommended purchase of National’s guarantees. This market acceptance has been growing despite an environment where S&P’s rating on National has been one notch lower than its competitors. The strong trading value of National’s wrap further attests to the success of National’s disciplined re-entry into the municipal bond market.” Mr. Fallon added, “We will continue to work with S&P during its ongoing review to do everything in our power to maintain National’s AA- credit rating.”

BAM took a similar tack. ” S&P Global Ratings’ decision to place BAM’s rating on CreditWatch Negative represents a departure from their stated criteria and previous communications to the market. BAM’s managing directors said they intend to engage with S&P during the CreditWatch period to demonstrate that BAM’s financial strength and low-risk, low-volatility strategy of insuring only U.S. municipal bonds from essential public purpose issuers supports BAM’s current rating. Our portfolio strategy does not limit BAM’s competitive position: Only 3% or less of the U.S. insured municipal market is sold in sectors that BAM does not insure, and diversification outside the municipal market has historically exposed bond insurers to excessive risk of loss. According to municipal market default studies by Moody’s and S&P, 70% of the defaults by credits that were rated investment grade at issuance were from the sectors BAM has chosen not to insure. In contrast to the industry’s past, we will not change our risk tolerance in response to rating agency pressure.”

If S&P’s problem is the municipal only risk profile of the insurers than that position is confusing. In the aftermath of the 2008 financial meltdown and the damage it did to the bond insurers, the multi-sector model was clearly not viable from a ratings standpoint. If that has changed, does it represent a paradigm shift in the thinking of the rating agencies? If so, they should make that change clear. Otherwise, the monoline municipal bond insurers are in an untenable position as are holders of the bonds they insure.

PRIVATE DOES NOT ALWAYS INSURE A SMOOTH ROAD YET AGAIN

The latest blow to the P3 concept for highway bonds occurs yet again in Indiana. This week it was announced that the state of Indiana intends to take control of the troubled I-69 project from Bloomington to Martinsville as the public-private partnership used to finance and build the highway crumbles. The project’s completion date will again be delayed from May 2018 to August 31, 2018. This is the fourth such delay. The original completion date was October 2016. This is the fourth opening delay as the state’s design-build contractor struggles to pay subcontractors and meet deadlines.

I-69 Development Partners originally bid $325 million to win the project, begun in 2014. The state notified bondholders last week about its plans. It stated that it would take nearly $237 million to complete the project versus the $72 million that is available. That means $164 million is needed to “complete construction and resolve claims.” State officials declined to confirm whether taxpayers would have to foot the bill for the $164 million that is needed.

The Indiana Finance Authority (IFA) has sought to negotiate a settlement with the holders of the Bonds under which IFA would redeem the Bonds by paying termination compensation under the PPA. The funding of such termination compensation amount would be provided from the proceeds of bonds that would be expected to be issued by IFA by September 1, 2017. IFA’s most recent offer was an amount equal to the sum of: the principal amount of all Bonds, plus accrued interest to the redemption date, plus release of the debt service reserve amount (approximately $6.2 million), less all other unspent Bond proceeds (approximately $30 million), subject to agreement on other terms. As of the expiration of a Non Disclosure Agreement, negotiations have not resulted in an agreement.

I-69 Development Partners won a bid to design, construct and maintain the highway for decades after completion. In March the Spanish company Isolux Corsan — which initially comprised more than 80 percent of I-69 Development Partners — entered insolvency proceedings in Spain. It had four months to reach an agreement with creditors and avoid potential bankruptcy. In the interim, the IFA says it’s offering to buy out private activity bonds issued for the project (rated CCC by Fitch and S&P) and take it over, but the bond holders haven’t accepted the offer.

The announcement has implications for the Trump Administration’s plan to finance highway improvements through P3s. The failed initial Indiana Toll Road privatization and this failing project contain many of the concepts expected to be featured in the upcoming trump infrastructure plan. It represents another failure in Indiana’s (and Governor Mike Pence’s) P3 schemes for road development in the State. It cannot bode well that the results from the Vice President’s P3 incubator have turned out so poorly.

KANSAS GIVES UP ON SUPPLY SIDE EXPERIMENT

The Kansas Senate and House have overridden Governor Sam Brownback’s veto of Senate Bill 30. Income taxes will increase across the board but most tax rates will still be below where they were before the 2012 tax cuts. The increases are projected to generate more than $1.2 billion for the state over the next two years. The bill replaces the state’s two-bracket income tax system with three brackets. Income up to $30,000 for married couples would be taxed at 3.1 percent, income between $30,000 and $60,000 would be taxed at 5.25 percent, and income above $60,000 would be taxed at 5.7 percent.

The bill also would repeal an exemption on certain business income that Brownback has championed. That provision was pushed by the Governor as the key to the job creation which was supposed to arise from a “supply side” stimulus. Lawmakers who supported the bill and the override said the 2012 policy was a mistake that had drained the state of revenue. Revenue shortfalls lead to multiple budget cuts and reduced investments in roads and support for local school districts. Those tax changes led to significant and ongoing decreases in state revenues which created ongoing current and structural imbalance. This led to downgrades in the State’s credit rating and a negative outlook for those ratings.

The tax plan was the first to pass the Legislature since February, when lawmakers passed a similar plan. Brownback also vetoed that bill, but the override effort fell three votes short in the Senate. It had become evident to many observers that Brownback would reject whatever tax plan lawmakers approved. The change reflects the political implications of state elections in 2016 and are an effective repudiation of the Governor’s experiment. Once again, an ideological approach to state finances has failed to achieve its goals.

Muni Credit News June 6, 2017

Joseph Krist

Senior Municipal Credit Consultant

joseph.krist@municreditnews.com

73 years ago today, more than 160,000 Allied troops — about half of them Americans — invaded Western Europe. In the military, D–Day is the day on which a combat attack or operation is to be initiated. While fewer and fewer of the young men who participated are still around to remind us, we take this opportunity to do it for them.

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Metropolitan Washington Airports Authority

$598,000,000

Airport System Revenue and Refunding Bonds

Moody’s upgrade recipient MWAA comes to market with this issue this week. The upgrade to Aa3 and stable outlook reflect Moody’s view of MWAA’s system wide improving financial and operating performance at its two airports, Reagan National (National or DCA) and Dulles International Airport (Dulles or IAD) supported by strong growth in concession revenues and non-aeronautical revenues, steady enplanement growth driven by a diverse and growing service area economy that we expect will grow at an above-average pace.

The upgrade also considers expected continued growth in air service, a new airline use and lease agreement through 2024 that supports projects for both airports, continued conservative and well-executed operational, financial and capital management, very small exposure to pension liabilities and expected continued growth in air service, particularly for international passengers at Dulles, satisfactory forecasted debt service coverage ratios (DSCRs) and liquidity.

According to Moody’s, the authority is carefully managing and mitigating construction risks on a large capital improvement project at DCA; however, it expects execution and delivery of this project on schedule and budget and the authority expects moderate capital needs going forward.

The credit was assigned a stable outlook on the basis of Moody’s that increased MSA economic activity will contribute to growth in enplanements, which will continue to stabilize costs. The outlook assumes the authority will continue to conservatively manage its financial operations to achieve forecasted metrics and support higher capital project expense (CPE) and maintain DSCRs over the next five years as it undertakes significant debt-financed capital projects at DCA, and also that no additional large capital projects are being planned.

East Bay Municipal Utility District CA

$218,000,000 Water System Revenue Bonds (Green Bonds)

$264,000,000 Water System Revenue/Refunding Bonds

This traditionally strong water revenue credit is rated Aa1. According to Moody’s, the rating reflects the largely built-out nature of the district’s large and economically diverse service area with customer wealth and income levels significantly above national medians. It also incorporates an ample supply of high quality water with good reliability, a large degree of independence from Bay Delta quality and supply issues, strengthening of the system’s water supply and storage and improved financial position despite the challenges associated with the severe multi-year drought. The rating additionally factors a manageable long term capital plan, which the district intends on funding with greater reliance on cash versus debt and an improved debt position marked by a more conservative debt structure and the significant decline in amount of variable rate debt outstanding.

The rating incorporates Moody’s view of a stable history of sound financial operations with timely rate increases resulting in ample liquidity. Debt service coverage levels while significantly below the median for similarly rated systems, have remained very stable in the midst of period of financial uncertainty associated with the drought. Also reflected in the rating is the proven expertise of management, which has a long history of success in meeting the immense challenges inherent to the water system, including upgrading its seismic reliability, while maintaining affordability for its customers, and the successfully tested program which has significantly enhanced dry weather water supply.

Texas A&M University System

$500,000,000 (approx.) Revenue Financing System Bonds

Some 75% of the bonds to be issued will be taxable municipals. Revenue Financing System debt is a general obligation of the Board of Regents of The Texas A&M University System, secured by a lien on and pledge of a broad pledge of system-wide revenues. Pledged revenues exclude state appropriations, in addition to the system’s interest in the AUF, which consists of annual distributions from the PUF, and amounts appropriated to system participants from the Higher Education Fund (HEF). Fiscal year 2016 pledged revenues totaled $3.1 billion, providing 12 times coverage of the RFS pro-forma debt maximum annual debt service.

Permanent University Fund bonds are secured by a first lien and pledge of The Texas A&M University System’s one-third interest in distributions from the PUF, with ultimate access to the value of the Permanent University Fund for debt repayment. There is an additional bonds test limiting TAMUS’ debt issuance to no more than 10% of the value of the PUF, excluding the value of PUF Lands. TAMUS had $915 million in outstanding PUF bonds at FYE 2016 compared to its $7.7 billion share of the PUF.

Proceeds will be used to provide construction funds for projects on various system campuses (the tax exempt bonds) and (the taxable bonds) to refund certain outstanding long-term parity RFS obligations.

The Moody’s Aaa rating reflects robust financial resources relative to operations, strong capital and operating support from the Aaa-rated State of Texas, and the system’s large scale, with 11 campuses serving an estimated 150,000 headcount students throughout the state in fall 2016. Tempering factors include rising, though still manageable, leverage relative to revenue and cash flow, with ongoing infrastructure needs across the system, and the complexity of a rapidly increasing number of third party partnerships.

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PUERTO RICO

The decision by US bankruptcy Judge Laura Swain to freeze assets held by the trustee for some of COFINA’s Sales Tax debt effectively insured a payment default on June 1. The assets will be held until both sides in the dispute over the right of the Commonwealth to apply sales tax revenues to the payment of general obligation debt can be decided upon. The question comes down to whether the constitutionally established “clawback” provisions apply to the COFINA revenues or if those provisions were overridden by statutory actions by the Puerto Rican legislature when the COFINA credit was established.

The public corporation is one of the entities that had filed for bankruptcy under Title III of Promesa. BNYM lawyers said at a hearing May 17 in Puerto Rico that since the commonwealth had taken actions that call into question its commitment to pay the bonds, it faces claims in the New York court that it breached its duties. BNYM lawyers said that because of the commonwealth’s actions, it had been subjected to competing demands by bondholders with respect to a default, whether to accelerate the bonds and whether to make payments on the bonds.

The default occurred effectively simultaneously with the release of the proposed budget for fiscal year 2018 by the Governor. That budget includes more than $2 billion in pension benefits spending as a result of the transition to a pay-as-you-go system but initially provides no funding for the payment of debt service. None of this is a surprise given many of the statements and actions by the Puerto Rican government throughout the days and weeks leading up to the delayed budget release. The budget must be approved by the PROMESA oversight board. The fiscal control board has to date shown no real inclination to support the interests of Puerto Rico’s outstanding debt holders.

ILLINOIS DEBACLE CONTINUES

The deadline for enacting a budget for the State of Illinois by a simple majority vote in the Legislature came and went on June 1 without enactment of a budget. The action resulted in multiple downgrades of the State’s general obligation debt by the rating agencies and poised the State to be rated below investment grade if a budget is not enacted by July 1.

Moral obligation or annual appropriation debt is already in non-investment grade territory as the result of the ongoing feud between the legislature and the equally stubborn Governor. The fact that the operations of all sorts of governmental and non-governmental service providers throughout the State are being negatively impacted seems to be of no consequence. One can hope that a potential downgrade below investment grade might motivate more adult behavior by all parties to the deadlock but we are in the camp of “see it to believe it”.

We do not believe that an actual payment default is in the cards but that does not prevent additional downside valuation risk as this bizarre circus act continues.

FLORIDA BUDGET STANDOFF TO END

It arrived three days beyond the required schedule but, the Florida Legislature did vote out an $82.4 billion budget. It then took weeks for the Governor to decide to sign it but sign it he did after extended negotiations over vetoed items and the terms of a special legislative session to take place this week. Those negotiations reflected a number of items over which there was real disagreement between the Governor and the Legislature.

For example, the Governor requested $100 million for tourism marketing; they gave him $25 million. $85 million in job incentives to lure businesses to Florida; they gave him zero. $200 million to speed up work on rebuilding the leaking dike around Lake Okeechobee; they gave him nothing.

During the special session, an extra $215 million for schools will be added to the original $24 billion budget, increasing the amount of funding by $125 per student over the current year, instead of just $25 in the original budget. Lawmakers will also put $76 million into Visit Florida, the state’s tourism marketing agency, maintaining its current year funding. The original budget included $25 million for the group. A new program will also set aside $85 million to be spent on workforce training as well as infrastructure such as roads to encourage economic development.

The Legislature agreed to decrease property-tax rates to offset a rise in home values that would have caused many homeowners to pay more in taxes. That will save homeowners in Florida a combined $510 million in increased property taxes.

NYC REACHES BUDGET ACCORD

NYC has announced that an agreement has been reached on a budget for FY 2018. The $85.2 billion budget provides for increases in a number of categories designed to appeal to voters. It includes increased capital spending, increases for a variety of anti-poverty programs, education initiatives, and budget reserves. The agreement represents the earliest agreement on a budget in a quarter century and takes major points of contention off the table prior to the start of the City’s election season. Primaries are in September and the general election for the mayoralty and the entire City Council is in November.

The budget does represent a positive view of the City’s near term economic outlook. It also occurs in an atmosphere of federal uncertainty regarding funding for programs which would be considered to be a priority for any incoming administration. The one potential weak spot for the City could be the Health and Hospitals Corporation which runs the nation’s largest municipal hospital system. New York City Health & Hospitals reported a $776 million operating loss for the first half of fiscal 2017, according to unaudited financial statements.

The public health system’s operating loss widened by 84.5% over 2015, when the system lost $420.4 million. After investment losses and interest expenses, the system lost $842.6 million.

The city paid the health system $78.8 million in capital contributions, resulting in a $763 million net loss. Enrollment in MetroPlus, its insurance arm, showed modest gains. But the system’s goal of increasing the number of patients it serves is in jeopardy following declines in utilization at its hospitals and outpatient clinics. The potential for cutbacks in federal dollars through Medicaid restrictions included in possible healthcare reform legislation would bode ill for HHC. The City increased support for H&H by 10.9%, to $766.8 million, for fiscal 2018, which begins July 1. That total represents cash support but does not include spending to cover the health system’s debt service, medical malpractice claims and employee health insurance costs. When accounting for those expenses, as well as the city’s share of supplemental Medicaid payments, the city’s support for H&H could reach $1.9 billion next fiscal year, according to an Independent Budget Office report.

DEFAULT IN TEXAS

In light of an anticipated cash-flow shortfall, the Dallas County Schools District pursued the issuance of refunding bonds to restructure certain outstanding debt and a tax anticipation note to provide operating liquidity. On May 26, 2017, the District received notification from the Texas Attorney General that his office would not approve these transactions. On June 1, 2017, the District failed to make payments on six series of outstanding Public Property Finance Contractual Obligations issued in the years 2012 through 2014.

On May 27, 2017, the Texas Legislature approved legislation allowing for the dissolution of the District effective November 15, 2017, unless the continuation of the District is approved by a majority of voters in the District at an election to be held on November 7, 2017. As of the date of this Notice, the Governor has yet to sign or veto this legislation. The Governor must sign or take no action on the bill by June 18, 2017, for the legislation to take effect September 1, 2017.

Muni Credit News June 1, 2017

Joseph Krist

Senior Municipal credit Consultant

joseph.krist@municreditnews.com

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PUERTO RICO

COFINA bondholders will find out today whether or not the interest due on some of their bonds will be paid on time. As it stands, U.S. District Judge Laura Taylor Swain said The $16 million payment on the bonds, known as Cofinas, and subsequent payments will be halted until several disputes over who owns the money — and who should get it — can be resolved. As we have previously discussed, the issue comes down to whether or not the Commonwealth’s obligation to “clawback” the money from COFINA under the PR Constitution is trumped by the legislation authorizing the issuance of the COFINA bonds.

While the issue is litigated, the judge wishes to “keep the money safe and intact” while the broader disputes are resolved. She made her decision at the request of the bondholder trustee, Bank of New York Mellon Corp. If the decision and subsequent failure to pay is considered to be an act of default, ultimate remedies could include acceleration of the COFINA debt.

DETROIT REPORTS A SURPLUS

Detroit has a balanced budget and a near $63 million surplus.

Figures were released Wednesday from Detroit’s Comprehensive Annual Financial Report for the fiscal year that ended June 30, 2016. It’s the city’s second consecutive balanced budget. There was a 45 percent reduction in audit findings. Mayor Mike Duggan’s office says a $51 million surplus is projected for the current fiscal year which ends June 30. It will use the surplus funds for blight remediation, capital improvements and other projects that improve the city in the long-term.

For the first time in more than a decade, the city didn’t have any costs scrutinized for its federal grant use. The fiscal surplus for 2016 was about $22 million higher than the city projected, which was attributed to improved financial controls, stronger-than-anticipated revenues and lower costs due to unfilled vacancies. The city must have three consecutive years of deficit-free budgets to exit oversight by the Financial Review Commission under terms of Detroit’s exit from municipal bankruptcy protection in 2014.

NEW JERSEY GETS MORE NEGATIVE CREDIT ATTENTION

The State of New Jersey (A3 stable) plans to close its large structural budget gap through a combination of higher revenue and economic growth and increasing pension contributions, but the state’s expectations are at odds with its historic revenue trends and likely pension investment returns, Moody’s Investors Service says in a new report. “If New Jersey’s revenue growth continues at the five-year average pace of 2.8%, pension investment returns do not meet actuarial assumptions, and the state does not implement structural budget changes, rising pension contributions would increase annual operating deficits to $3.6 billion by 2023.”

The report goes on to note that New Jersey plans to improve pension funding by raising contributions each year until 2023. However, the rapid rise in these contributions will pressure the budget and make it increasingly difficult to afford other operating costs. While the state projects to balance rising pension contributions with faster revenue growth, revenues will be hampered by recent tax cuts adopted last October that will result in a loss of $1.1 billion by FY 2021.

Outside of structural budget changes, New Jersey has few options for balancing future gaps, particularly as operating reserves are projected to decline to 1.3% of revenues in fiscal 2017. The projected 2023 deficit’s size will also make it politically difficult to close the gap solely with budget cuts and expense reduction. Should the rising pension contribution schedule prove unaffordable in the future, New Jersey could cut or eliminate part or all of its scheduled pension payments. However, any drop in pension cash inflows would lower the assets available to pay benefits, which would exacerbate the state’s pension problems. New Jersey’s adjusted net pension liabilities stood at $90.2 billion in FY 2015, which was fifth highest among states as a percent of revenues.

Should all of this come to pass, we would expect ratings to decline throughout the foreseeable future.

THE PENSION BOND CROWD TAKES ANOTHER SHOT

It is the equivalent of junk science but a recent paper sponsored by the NCPERS (National Conference on Public Employee Retirement Systems), takes another stab at supporting the issuance of pension obligation bonds. It is included as part of a thesis that the current pension “crisis” is overblown and that the need to fund existing pension systems at levels anywhere near actuarial soundness are unnecessary. It postulates that efforts to rein in pension costs through plans other than taxpayer funded defined benefit plans are damaging to the economy and promote economic injustice.

The one significant element of the paper we discuss here is the effort by the author’s to promote the efficacy of the issuance of pension obligation debt in place of honest and responsible efforts to absorb the costs of actuarially sound funding in annual budgets by all levels of government. The paper argues that full funding is not required because of the inability of states to go bankrupt unlike private entities. They use this as the justification for using unattainable investment return assumptions to determine unfunded liability levels.

Ironically, the organization which ostensibly supports public employees advocates among other things the privatization and outright sale of public assets. The same constituency has habitually fought the concept of privatization for decades. So there is a disconnect there. They also advocate the use of the proceeds to fund pensions, ignoring the fact that these are usually assets owned by the public at large and not the employees. The local water system is a public good, not an ESOP.

Finally, the paper advocates the issuance of pension obligation bonds – long maturity, bullet maturity pension bonds – in lieu of current funding on an annual basis. It acknowledges that interest on the bonds should be paid annually – at least they are not using zero coupon bonds. They also advocate the use of derivatives to protect against losses on the invested proceeds. It is as if the last two decades or so of experience by municipal issuers with this kind of strategy had never existed. It is as if Detroit, Orange County, New Jersey, and Illinois were planets in another solar system.

WHILE PENSIONS STILL BEDEVIL STATE BUDGETS

No matter which side of the pension debate one stands on, one clear truth emerges. At least on the state level, those names which have been consistently in the news for having difficulties coming up with balanced budgets either currently or structurally all have underfunded pension systems. Ask your self – what do Illinois, New Jersey, Kansas, and Pennsylvania all have in common? Structurally unbalanced budgets, current budget deficits, and underfunded pensions. So the idea that the issue is somehow overblown or just part of a vast anti-worker conspiracy just does not hold up on closer analysis.

MORE HOSPITALS UNDER PRESSURE

CareAlliance Health Services’ (d/b/a Roper St. Francis Healthcare, RSFH) is a South Carolina system with approximately $100 million of revenue bonds outstanding rated A3 by Moody’s. The rating outlook was just revised to negative reflecting weaker than expected performance in FY 2016 and through three months FY 2017. Moody’s believes RSFH will be pressured to return operating cash flow to historical levels over the near term given recent challenges in labor expense and ongoing Medicaid DSH settlements with the state that have reduced cash flow in recent periods (RSFH is suing the state over the revised DSH payment methodology).

The rating reflects RSFH’s good market position in the growing market of Charleston and the surrounding areas. The rating further reflects the organization’s ownership model and Liquidity Replenishment Agreement with its Founding Members that provides a floor to key balance sheet ratios. Primary credit challenges include lower than budgeted operating cash flow and revenue during a period of expansion and growth as the organization builds a new hospital and related services, and higher than planned debt resulting from lower cash flow in FY 2016.

RSFH is a three hospital system in Charleston, SC. The organization operates over 650 beds. It has a unique and complex ownership and operating structure which underpins its debt. The bonds are secured by a gross receivables pledge by the obligated group based on the Amended and Restated Master Trust Indenture (MTI) dated January 1, 1999. The obligated group members consist of the parent company, CareAlliance Health Services (d/b/a Roper St. Francis Healthcare, Roper Hospital, Inc., Bon Secours-St. Francis Xavier Hospital, Inc., Roper St. Francis Mount Pleasant Hospital, Roper St. Francis Physicians Network, and Roper St. Francis Hospital-Berkeley, Inc.). Under the MTI, the obligated group is required to maintain financial covenants including 1.1 times (1.25 times under bond insurance agreement) debt service coverage ratio (if falls below would be required to hire an independent consultant with an event of default occurring if falls below 1.0 times).

Under its bank agreements, it is an event of default if debt service coverage ratio falls below 1.25 times. The bank agreements permit maximum total debt to capitalization of 65% at fiscal year end and the bond insurance agreement requires the hiring of an independent consultant if such ratio exceeds 65%. In addition, an event of default would occur under the amended and restated MTI if the Founding Members (collectively the Medical Society of South Carolina, Bon Secours Health System, and The Charlotte Mecklenburg Hospital Authority d/b/a the Carolinas HealthCare System) fail to make a contribution of unrestricted cash and investments to the obligated group in an amount equal to the contribution amount, which is the difference between 85 and days cash on hand reported on the testing date of June 30 and December 31, pursuant to the Liquidity Replenishment Agreement executed on January 2014 (except that no such contribution will be required if CareAlliance Health Services has at least 75 days cash on hand as of the testing date and increases days cash on hand such that it is at least 85 days cash on hand three months after the testing date).

MORE BAD NEWS FOR HARTFORD, CONNECTICUT

Moody’s Investors Service has placed the City of Hartford, Connecticut’s Ba2 general obligation debt rating under review for possible downgrade, affecting approximately $550 million of outstanding debt. On October 7, 2016, Moody’s downgraded the city’s GOs to Ba2 and maintained the negative outlook. The review for downgrade will be concluded within 90 days. The review will focus on the city’s prospects for sustainably balancing its financial operations and it will also consider state funding to be provided to the city over the next two fiscal years that may be incorporated in the biennial state budget to be adopted over the next several weeks.

LAW SCHOOLS UNDER PRESSURE

The April announcement that Whittier Law School in CA would close at the end of this academic year drew attention to the increasingly difficult financial plight of smaller law schools in a time of diminished demand. The law school will be the first with full American Bar Association accreditation to close in recent memory. Its accreditation dates to 1985, and it was founded in 1966, so it does not fit the profile of a new, unestablished institution that might be expected to shutter under normal circumstances. Just 22 percent of its students taking the California bar examination for the first time in July 2016 passed. That was almost 40 percentage points below the passage rate across all of the state’s ABA-accredited institutions.

In light of that action we note that this week Moody’s reaffirmed its A2 rating on debt issued by Hastings College of the Law in California. In spite of its affiliation with the University of California, growing state support, and healthy liquidity its rating outlook was maintained at negative. Like many in the fundamentally challenged niche law school market it has a small scope of operations, expectations for flat net tuition revenue through fiscal year, and deficit operations going forward. University of California Hastings College of the Law is a small stand-alone public law school, located in San Francisco. The college has approximately 965 full-time equivalent students, with approximately $56 million of operating revenue.

We expect that this sector will experience a shakeout unless there is a significant turnaround in financial and demand trends. Smaller, specialized law schools without significant geographic reach are especially vulnerable in the current environment. Law schools also face new accreditation pressure. The American Bar Association has taken action against four law schools in the last year over issues including loose admissions policies and low bar-examination passage rates. The pressures could push less prestigious law schools into a death spiral. Their applicant pools are declining, and their top students often transfer to better-known institutions. As a result, they can lose the students they admit who are most likely to pass the bar. That can make it harder for them to increase their bar-passage rates over time, which in turn cuts down on their applicant pools and drives their best students to transfer — continuing the spiral.

William Mitchell College of Law and Hamline University School of Law, in St. Paul, Minn., decided to merge in 2015. Indiana Tech Law School in Fort Wayne this fall announced plans to close in June 2017. Administrators at that law school, which opened its doors in 2013 and had provisional ABA accreditation, said it had incurred an operating loss of nearly $20 million in its brief existence. A fall 2016 survey from Kaplan Test Prep of officers at 111 of the 205 ABA-accredited law schools in the country found 65 percent agreed with the statement that “it would be a good idea if at least a few law schools closed.”