Category Archives: Municipal Bonds

Muni Credit News April 6, 2016

Joseph Krist

joseph.krist@municreditnews.com

THE HEADLINES…

NEW YORK STATE BUDGET

STATE TAX OUTLOOK

CALIFORNIA REVENUE TRENDS

PUERTO RICO NEGOTIATIONS

NYC CAPITAL BORROWING TAKES SHAPE

ANOTHER BAD STADIUM DEAL

SAN DIEGO MOVES ON FROM THE CHARGERS

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NEW YORK STATE BUDGET

New York State began operating in fiscal 2018 under emergency legislation to keep the state government in operation after efforts to pass a state budget for the 2017-18 fiscal year faltered during weekend-long talks. The fiscal year began at midnight on Friday with no deal in place. The irony is that the dispute is not over monetary issues but rather about policy issues.

The extender would have a punitive side effect for the legislators, who would not be paid during its duration. And the governor’s submitting an extender that would last until the end of May — when the federal budget would come into focus — could mean a prolonged stretch without paychecks for lawmakers.

As we go to press, the Senate passed four budget bills — with more legislative action expected after midnight. The Democrat-led New York State Assembly came to terms on a bill that would raise the age of criminal responsibility in the state to 18, an issue that had been a major stumbling block in the state budget negotiations.

New York is one of two states, along with North Carolina, that treat 16- and 17-year-old defendants as adults. According to a summary of the legislation, all misdemeanor charges faced by 16- and 17-year-olds would be dealt with in Family Court. Nonviolent felony charges would be dealt with in a new youth section of Criminal Court, with many of those cases eventually being sent to Family Court, excluding cases in which a district attorney can prove “extraordinary circumstances.” Beginning in late 2018, juveniles would not be kept with adults in county jails.

Violent felony cases would remain in Criminal Court but would be subject to a three-part test: whether a “deadly weapon” was used, whether the victim sustained “significant physical injury,” and whether the perpetrator engaged in criminal sexual conduct. Barring one of those factors, violent felony cases could also be moved to Family Court.

Other issues include including a renewal for 421-a, a lapsed tax-cut program for developers that was meant to produce low income housing; support for charter schools; changes to the workers’ compensation system; and education aid. The extender did include infrastructure funds, such as a major clean water initiative, and some lesser policy proposals, like a plan to cap and manage the cost of prescription drugs under Medicaid. But many of the deals that seemingly had been settled — such as allowing ride-hailing apps to be used upstate — were not included. Lawmakers have already passed a portion of the budget approving debt payments.

STATE TAX OUTLOOK

Now that the initial effort to repeal and replace the ACA has failed, the next focus for the municipal bond market is the potential impact of tax reform. Three potential impacts on state credits are apparent: the impact on the economy; the direct impact of tax reform on state government tax bases in cases where states conform to federal tax law; and indirect impacts on state tax revenue as taxpayers change their behavior in anticipation of, and in response to, federal tax reform. Two of these are forward concerns but it appears that the third may already be having a dampening impact on tax revenues.

The likelihood of lower tax rates in 2017 likely created a large incentive for high income taxpayers to push income from wages, interest, and other sources out of 2016 into 2017, and to accelerate deductions into 2016, depressing taxable income in 2016. A proposed increase in the standard deduction created a modest incentive for middle-income taxpayers to accelerate itemized deductions into 2016. Initial data suggests a slowing of state revenue growth. Fourteen states reported declines in total tax revenue for the third quarter of 2016, with two states reporting double-digit declines. Total state government tax revenue grew 1.2 percent in the third quarter of 2016 relative to the prior year. All major tax revenue sources grew, except the corporate income tax, which declined 10.4 percent. Individual income tax collections grew 2.7 percent, while sales tax and motor fuel tax collections grew 2.0 and 1.1 percent.

It is difficult to make a blanket statement about states given the importance of energy based revenues and economic activity. The steep oil price declines throughout 2015 and early 2016 led to declines in severance tax collections and depressed economic activity. Total tax collections also declined in the other oil and mineral-dependent states, including New Mexico, Oklahoma, Texas, West Virginia, North Dakota and Wyoming. Fourteen states reported declines in personal income tax collections, with three reporting double-digit declines. Some of that was related to a depressed energy sector.

We have always used sales taxes as a good proxy for near term trends. Among individual states, thirty-three states reported growth in sales tax collections in the third quarter of 2016, with twelve states reporting declines. Six of those are oil- and mineral dependent states. For analysts such as ourselves, the usefulness of sales tax as an indicator has been diminished in recent years by the demise of brick and mortar retailing. This trend has only been partially mitigated In calendar year 2017 in that eleven states have joined other states that already collect taxes on sales by Amazon.com LLC or its subsidiaries, raising the number to forty-two out of forty-five states that impose a general sales tax. The problem is that while the dominant online retailer, state efforts alone have had limited effectiveness. Federal legislation may be the only way to fully capture retail sales activity into state tax bases.

Unfortunately, the state budget process will likely outpace the speed at which final federal tax reform can be undertaken. Thus the states will be operating in a somewhat opaque environment as they attempt to estimate revenues for the upcoming fiscal year.

CALIFORNIA REVENUE TRENDS

California revenues of $6.52 billion for February fell short of projections in the governor’s proposed 2017-18 budget by $772.7 million, or 10.6 percent. Personal income taxes (PIT), corporation taxes, and retail sales and use taxes all fell short of January’s revised budget estimates for February, and only corporation taxes—the smallest of the three—topped fiscal year-to-date projections in the governor’s proposed 2017-2018 budget. For the 2016-17 fiscal year that began in July, total revenues of $73.28 billion are $663.9 million below last summer’s budget estimates, and $888.1 million short of January’s revised fiscal year-to date predictions.

In the current fiscal year, California has collected total PIT receipts of $50.97 billion, or 0.9 percent less than January’s revised estimate. Corporation tax receipts of $168.2 million for February were 35.0 percent short of assumptions in the proposed 2017-18 budget. Fiscal year-to-date corporation tax receipts of $3.82 billion are 3.3 percent above projections in the proposed budget. February sales tax receipts of $3.06 billion missed expectations in the governor’s proposed 2017-18 budget by $710.2 million, or 18.8 percent. For the fiscal year to date, sales tax receipts of $16.29 billion are $613.5 million below the revised estimates released in January, or 3.6 percent.

PUERTO RICO NEGOTIATIONS

The Puerto Rico government and some of its creditor groups have signed confidentiality agreements—a first step toward negotiations that could begin as soon as or this week—the island’s Financial Advisory & Fiscal Agency Authority (FAFAA) confirmed Monday. The identity of creditor groups was not revealed. Advisers for the commonwealth government and Promesa’s fiscal control board hope to kick off mediation talks as soon as next week in New York City. The goal is to solve the controversy between general obligation (GOs) and Sales Tax Financing Corp. (COFINA) bondholders. A letter states that the private mediation process will not prevent “other mediations/negotiations between the same parties or others regarding these or other disputes.”

The letter outlines other details of the framework for the negotiations, which include making public any government offer made to creditors during mediation 48 hours after it ends, or April 21—whichever occurs first. Subsequent proposals from the government would need to be disclosed no later than each Friday after April 21.

Former judge Allan Gropper is listed as mediator in the process. Several creditor groups opposed the board’s plans for mediation, arguing there should be initial talks before a mediation process, which would take a long time to kick off. The group included the GO ad hoc group; OppenheimerFunds, Franklin, Goldman Sachs, UBS and Santander; and monoline insurers Assured, FGIC, Syncora and National. The government and the board are said to be open to receive restructuring proposals from creditor groups that refuse to enter the mediation process. Yet any such offer would be subject to Gropper’s input and be shared and discussed with creditors participating in the mediation.

In the meantime, the U.S. First Circuit Court of Appeals reversed a ruling by U.S. District Court Judge Francisco Besosa that has the effect of staying the entire Lex Claims case, in which general obligation (GO) bondholders challenged the constitutionality of the Sales Tax Financing Corp.’s (Cofina) structure. “The district court’s holding that the PROMESA stay did not apply to the plaintiffs’ first, second, third, and 12th causes of action is reversed, and the matter is COFINA bondholders’ motion to intervene solely for the purposes of addressing the issue is therefore moot,” the Appeals Court ruled.

NYC CAPITAL BORROWING TAKES SHAPE

The announcement by New York City of a planned issuance of $1 billion of Transitional Financing Authority bonds focuses attention on the City’s ambitious borrowing plans. The Mayor’s Office of Management and Budget (OMB) projects that the city will issue $5.5 billion in new debt in 2017, a 50 percent. increase over the $3.7 billion issued in 2016. New debt issuance is planned to grow in each of the subsequent years peaking in 2020 at $8.7 billion. In previous years, the city assigned state building aid revenue to the TFA, which is authorized to issue Building Aid Revenue Bonds (BARBs) to finance a portion of the city’s school construction needs. Because the TFA is nearing the limit of $9.2 billion in BARBs that can be outstanding, the city will use GO bonds for some projects that would have been financed using BARBs if the limit on outstanding BARB debt had not come into play. From 2013 through 2016, the city issued an average of $775 million in BARBs annually. Over the next four years, however, the city projects it will only issue an average of $248 million a year in BARBs in order to stay under the $9.2 billion cap.

The January plan includes $6.5 billion for debt service costs adjusted for prepayments and defeasances—the use of current surplus funds to prepay future interest and principal on existing debt—in 2017. After adjusting, this is a 7.6 percent increase over the debt service the city paid in 2016. The $6.5 billion in debt service forecast for 2017 in the January plan is 1.3 percent ($85 million) less than forecast in the November 2016 Financial Plan and a total of 3.5 percent ($235 million) less than forecast in the adopted budget released last June. While some debt service savings were recognized in the January financial plan for 2018 and subsequent years, OMB still projects that annual debt service costs (adjusted for prepayments) will rise over the next few years, from $6.5 billion in 2017 to nearly $8.4 billion in 2021. While variable interest rate assumptions for 2017 have been lowered, they still remain at 4.25 percent for tax-exempt debt and 6.0 percent for taxable debt in 2018 through 2021.

Debt service as a percent of tax revenue is projected to total 11.9 percent in 2017, up from 11.3 percent in 2016. Debt service as a share of city-funded expenditures is forecast to total 10.6 percent, slightly higher than 10.2 percent last year. These ratios are both projected to grow through 2021, to 12.8 percent and 11.6 percent, respectively.

ANOTHER BAD STADIUM DEAL

In 2005, the Village of Bridgeview, IL issued $135 million of general obligation (GO) bonds for a stadium that it owns and manages. The stadium serves as the home field for the Chicago Fire of Major League Soccer. Like many of the league’s franchises, it chose to pursue its own facility with a smaller capacity rather than play in an existing football stadium located in the center of a metropolitan area. The idea was to produce a venue with the atmosphere of a European ” “football” venue and take advantage of what is seen as a high level of interest among suburban residents who are seen as primary customers for the sport in the US.

With seating for as many as 28,000, Toyota Park, which opened in 2006, hosts soccer games, concerts and other events. The motivation for the Village was to create a facility which would act as a catalyst for economic activity around the games trying to capture the pre and postgame atmosphere that one often finds with European venues. Alas, the level of economic activity generated by the existence of the stadium has, not surprisingly, fallen short of expectations.

The Village has persistent weak liquidity and weak management conditions. Multiple debt restructurings as a result of management’s decision to construct and finance an underperforming stadium and declines in the tax base have led to a high debt burden. For an entity of its size its $234 million general obligation tax burden is significant. The Village has attempted to manage this debt through tax increases, asset sales, refinancing, and the use of variable rate debt. Bridgeview, which has used restructurings in the past to ease debt service payments and minimize property tax hikes, to continue the practice, possibly pushing bond maturities out to years beyond the useful life of the stadium. The most recent proposal the Village was considering to restructure $24.5 million of variable-rate bonds to a fixed-rate mode with a 2047 maturity.

The whole stadium saga has now culminated in the Village’s bond rating being lowered to BB- by S&P. S&P is concerned that the Village faces reduced market access and weakened liquidity as well as acute business, financial, and economic uncertainties related to its debt burden, particularly the debt issued for its Toyota Park stadium.

So add Bridgeview, IL to the list of cautionary tales regarding public financing for professional sports facilities. And sadly, it was an “own goal” on the part of the Village.

SAN DIEGO MOVES ON FROM THE CHARGERS

San Diego City Council is being asked to consider a special election in November for a hotel-room tax increase measure to fund an expansion of the convention center, homeless services and roads. The increase to the hotel-room tax would be 1 percent for the City of San Diego, another 1 percent for hotels south of state Route 56 and north of state Route 54 and another 1 percent for hotels downtown. That increase would be on top of the city`s 10.5 percent hotel-room tax and the 2 percent tourism marketing levy.

According to the Mayor, the proposed Phase III Contiguous Convention Center Expansion will: add another 400,000 square feet of rentable exhibit, ballroom and meeting space to the existing facility (the total current space is 816,091 square feet); allow the Convention Center to retain large conventions – the Center’s top five largest conventions have a regional economic impact of approximately $397 million annually; allow the Convention Center to attract approximately 50 more annual events and 334,000 attendees, bringing the average total attendance to over 1.1 million; generate $509 million in direct spending at local businesses, and have a regional impact of $860 million; generate over 380,000 new hotel room nights annually for the San Diego market from convention attendees, providing approximately $15 million annually in additional TOT to the City’s General Fund for critical public benefits and core city services like public safety, parks and libraries; generate thousands of construction jobs and nearly 7,000 permanent jobs; and provide numerous public benefit features including a sustainably designed 5-acre rooftop public park with views of the City and Bay, increased public access to the waterfront, and the rerouting of truck traffic away from pedestrians and visitor vehicles along the waterfront.

If the ballot measure (a special tax) is approved by two-thirds of the voters in November of 2017, the TOT increase would be levied and funds would be collected for homelessness, road repair and the Convention Center project beginning in the second half of FY 2018. Based on this preliminary timeline, short term notes would be issued in FY 2019 to begin project work for the Phase III Expansion, and bonds would be issued in FY 2020. Construction is anticipated to begin in July of 2019 and last approximately 44 months.

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 April 4, 2017

Joseph Krist

Municipal Credit Consultant

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THE HEADLINES…

HOUSTON PENSION LEGISLATION

WEST VIRGINIA PARKWAYS

BRIGHTLINER CONTINUES TO EVOLVE

MEDICAID DSH PAYMENT CLARIFICATION DISMAYS HOSPITALS

HOW A GUTTED EPA WOULD IMPACT SMALL CREDIT FINANCES

JEA COMES FULL CIRCLE

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HOUSTON PENSION LEGISLATION

After hearing testimony from Mayor Sylvester Turner among many others last week, the Texas Senate State Affairs Committee voted to send the Houston Pension Solution to the full senate for approval. With one exception, the measure passed out of committee is the same reform package supported by a 16-1 vote of City Council and forwarded to Austin by the City of Houston.

“This is a historic day,” said Mayor Turner. “With today’s vote, the state affairs committee joins the growing list of supporters for the Houston Pension Solution. Our plan eliminates $8.1 billion in unfunded liability, caps future costs, does not require a tax increase and is budget neutral. There is no other plan that achieves these goals and has the same consensus of support.” Mayor Sylvester Turner’s proposal recalculates the city’s pension payments, using lower investment return assumptions and aiming to retire the debt in 30 years, both of which would increase the city’s annual costs. To bring that cost back down, the plan would cut workers’ benefits, and includes a mechanism to cap the city’s future costs even if the market tanks.

The state affairs committee measure includes a provision requiring a vote by the citizens of Houston for the issuance of Pension Obligation Bonds (POBs). The agreement between the City and the Houston Police Officers Pension System (HPOPS) as well as the Houston Municipal Employees Pension System (HMEPS) includes the issuance of $1 billion in pension bonds to replace existing debt the city already owes HPOPS and HMEPS. They will not, it is believed under state law result in pension bonds being considered a new borrowing.

“We oppose the inclusion of this provision and will continue to fight for its removal,” said Turner. “As my father taught me, a deal is a deal. We have kept our word to the police and municipal employee pension systems. Now I am asking the Texas Legislature to do the same.” Conservatives contend the only path to true reform would be to move new hires into defined contribution plans similar to 401(k)s, which the bill does not do.

The mayor is again calling on the Houston Firefighter Relief and Retirement Fund (HFRRF) to provide data on the true costs of providing firefighter pension benefits. He was joined in that call by Texas Senator Joan Huffman who is sponsoring the Houston Pension Solution in the Texas Senate. Both the mayor and Huffman indicated willingness to revisit the proposed changes in firefighter pension benefits if HFRRF will provide the cost analysis it has, so far, refused to release. Fire leaders say an ongoing lawsuit prevents them from complying.

Mayor Turner will again testify before the Texas House Committee on Pensions. The house version of the bill does not include the requirement of a vote for POBs.

WEST VIRGINIA PARKWAYS

West Virginia has taken one of the legislative steps needed to help to implement its own infrastructure expansion as articulated by its Governor earlier this year. A bill giving give the West Virginia Parkways Authority new financing abilities is moving to the House after it passed the Senate. Senate Bill 482 would give the agency the authority to study, investigate, evaluate and, if feasible, develop a single fee program and impose a flat fee in connection with motor vehicle registration and renewal by the Department of Motor Vehicles.

The bill allows the authority to establish a program where drivers would pay a flat fee to travel the authority’s roads rather than pay individual toll fees. It also authorizes the agency to have reciprocal tolling with other states and would allow it issue revenue bonds. To aid the process, another provision of the bill would allow people to get an EZPass from the DMV instead of only from Parkways.

The bill creates and designs a special revenue account within the State Road Fund known as the State Road Construction Account and would expand the authority of the Parkways Authority to issue revenue bonds or refunding revenue bonds for parkways’ projects and for the West Virginia . It would define a “Parkway project” as any expressway, turnpike, bridge, tunnel, trunkline, feeder road, state local service road or park and forest road, or any portion or portions of any expressway, turnpike, trunkline, feeder road, state local service road or park and forest road, whether contiguous or noncontiguous to the West Virginia Turnpike which the Parkways Authority or the Department of Transportation may acquire, construct, reconstruct, maintain, operate, improve, repair or finance . It specifically provides for the Authority to issue parkway revenue bonds of the State of West Virginia, payable solely from toll revenues, for the purpose of paying all or any part of the cost of any one or more parkway projects.

BRIGHTLINER CONTINUES TO EVOLVE

For a project that has not been able to access the municipal bond market, we admit that we have spent a lot of time on it. It remains of interest as one of the more interesting transportation stories we have seen in some time. The latest turn in the saga was the announcement that Grupo Mexico Transportes — which owns Mexico’s largest railroad network and rail in Texas — is to acquire 100 percent of Florida East Coast Railway’s shares and assume its debt, pending approval of the deal by regulatory authorities. All Aboard Florida has based its business model on using the existing Florida East Coast Railway tracks. The company has said that taking advantage of existing infrastructure — All Aboard is improving existing track between Miami and Cocoa and building new track between Cocoa and Orlando — will help make the $3.1 billion railroad profitable.

Fortress — parent company of both Brightline and Florida East Coast Railway — was itself purchased in February by Japanese conglomerate SoftBank. Brightline contends it will be unaffected by the sale, that Brightline is a “separate company” that has “the right to operate passenger service,”. “We have all shared operations-related agreements in place with the Florida East Coast Railway for us to fully build out and implement our passenger rail system.”

At the same time, a controversial proposal intended to slow the planned Brightline service might have been derailed in the Florida House. The Transportation & Infrastructure Subcommittee on Tuesday declined to hear the proposal (HB 269), which in part sought to give the Florida Department of Transportation oversight of issues not preempted by federal law. The measure also sought to require private passenger-rail operations to cover the costs of installing and maintaining safety technology at crossings unless contracts are reached with local governments.

It was seen as aiding the efforts of Martin and Indian Counties in opposition to the project. Among key requirements of the Florida High Speed Passenger Rail Safety bill, were ones to build fencing around Brightline’s tracks.

MEDICAID DSH PAYMENT CLARIFICATION DISMAYS HOSPITALS

Earlier this year we discussed the appointment of Seema Verma as Administrator for Centers for Medicare & Medicaid Services. At the time we highlighted her background as an advocate for reducing Medicaid spending especially during her tenure in Indiana under governor Mike Pence. It did not take long for Ms. Verma to place her stamp on Medicaid funding practices. On March 30, the Centers for Medicare & Medicaid Services (CMS), issued a final rule addressing the hospital-specific limitation on Medicaid disproportionate share hospital (DSH) payments under section 1923(g)(1)(A) of the Social Security Act (Act. It clarified that the hospital-specific DSH limit is based only on uncompensated care costs. Specifically, this rule makes explicit in the text of the regulation, an existing interpretation that uncompensated care costs include only those costs for Medicaid eligible individuals that remain after accounting for payments made to hospitals by or on behalf of Medicaid eligible individuals, including Medicare and other third party payments that compensate the hospitals for care furnished to such individuals.

As a result, the hospital specific limit calculation will reflect only the costs for Medicaid eligible individuals for which the hospital has not received payment from any source. These regulations are effective on June 2, 2017. Hospitals had previously been able to claim reimbursement of full costs of Medicaid patient services even if a portion of those costs had been payable by private insurance which those patients might have had. One can qualify for Medicaid and still have some level of private insurance.

Many commenters suggested that the regulation will impose a great burden on all involved, which outweighs any incremental benefit in transparency and accountability, and diverts scarce financial and human resources away from providing and paying for care to beneficiaries. The CMS position is that this policy ensures that limited DSH resources are allocated to hospitals that have a net financial shortfall in serving Medicaid patients. Either way it represents a decline in the amount of revenues available to hospitals which provide significant levels of services to Medicaid populations.

HOW A GUTTED EPA WOULD IMPACT SMALL CREDIT FINANCES

When most people think of the EPA they think in terms of big concepts and big projects. Scrubbers on large power generators, huge wastewater and water treatment projects in support of large metropolitan service areas, air and water quality standards. They tend not to think of the many smaller components that comprise the effort to achieve clean air, water, and waste disposal practices. But it is at this micro level, that the greatest impact of the proposed reductions to the EPA budget on tap from the Trump administration might be to projects in medium to small size communities.

EPA funding often provides the financing catalyst for expansions or upgrades to small town water systems through replacement or expansion of piping for water delivery. EPA funding supports upgrades or retrofits of local treatment facilities. It stimulate spending for rural water reclamation projects which support agriculture reducing competition for new water supplies. EPA’s diesel emissions reduction program has covered costs for replacement or retrofitting of school buses. These programs usually benefit rural areas where lower property values impact local revenue raising activities. What local rural school district would want to bear the costs of more efficient school bus systems solely out of their own budgets?

In those areas where the manufacturing industry has passed them by where old plant sites need help to remediate the impacts of mining, metal, and chemical production, EPA brownfield programs help recovering communities. These programs provide funding and expertise to small communities looking to repurpose old industrial sites in support of new local economic development efforts.

At least in the areas of water and wastewater project finance, state revolving funds are an established source of lower cost funding for smaller municipalities. These funds will be forced to fill in more and more of the gap, as regardless of politics, water and wastewater infrastructure has come to be a necessity in the toolkit of smaller town and rural economic development.

JEA COMES FULL CIRCLE

JEA is a municipal utility based in Jacksonville, Florida, and its service territory covers Jacksonville, and parts of three adjacent counties. In the late 1970’s, the utility came under pressure due to its reliance on oil as its primary fuel used at its electric generating plants. The rises in prices and interruptions in supplies that were characteristic of the time led the Authority to embark on an effort to replace oil with more economic and stable sources of fuel for a new generation of plants using coal. The result was the construction of the St. Johns River Power Park (SJRPP), a 1,252-megawatt, coal fired electric plant jointly owned by JEA (80%) and FPL (20%).

On 17 March, JEA (Aa2 stable) announced that it had reached an agreement with Florida Power & Light Company (FPL, A1 stable) to decommission the 30-year old SJRPP . The decision reflects the changing economic and environmental realities facing large users of coal as a generating fuel. The decision is seen as credit positive because it is likely to produce material net cost savings for JEA to adequately address any remaining debt associated with SJRPP. Additionally, the agreement mitigates the potential for future costs to comply with environmental regulations relating to carbon emitting resources and helps keep customers’ rates stable and competitive versus peers in Florida.

Decommissioning SJRPP will further increase JEA’s reliance on natural gas, exposing the utility and its customers to sudden shifts in fuel prices. However, we believe that natural gas prices will remain at levels that approximate recent historically low prices for the next several years. Since JEA currently has excess capacity of about 15% and projects modest demand growth of 0.7%, replacing the estimated lost capacity from decommissioning SJRPP is not pressing and will moderate JEA’s current excess capacity position.

Subject to JEA and FPL signing definitive agreements and obtaining requisite regulatory approvals relating to plant closure, decommissioning SJRPP would commence in early 2018 and FPL would pay JEA for the costs to terminate the power purchase agreement, including employee-related expenses. In addition, FPL would share proportionately in shutdown costs and environmental remediation. As of fiscal 2016 (which ended 30 September 2016), there was approximately $494 million of long-term debt associated with the SJRPP assets, split between $210 million of Issue Two debt under the first bond resolution. Terms of the agreement between JEA and FPL appear to enable the utilizing of available funds in the debt service reserve fund for the Issue Two debt together with additional cash payments to be provided by both utilities to defease the full amount of the Issue Two debt at closing (principal amount expected to be $128 million).

Cash flow erosion associated with continuing to pay debt service on the estimated $281 million of Issue Three debt that will remain outstanding with no hard assets will be addressed through annual operations and maintenance, fuel and other cost savings. We project those savings will more than offset the $24 million of annual debt service requirements, including amortization, on the Issue Three debt, which has a final maturity of 2039. Moody’s is on record as projecting that JEA will maintain its debt service coverage metrics in line with historic levels of 2.0x or better for its electric system, without needing a further increase to its base rate beyond the 4.4% increase that became effective on 1 December 2016.

SJRPP’s capacity factors have steadily declined since 2014 owing to low natural gas prices. Decommissioning SJRPP will further increase JEA’s reliance on natural gas, exposing the utility and its customers to sudden shifts in fuel prices. However, we believe that natural gas prices will remain at levels that approximate recent historically low prices for the next several years. Since JEA currently has excess capacity of about 15% and projects modest demand growth of 0.7%, replacing the estimated lost capacity from decommissioning SJRPP is not pressing and will moderate JEA’s current excess capacity position.

In the end it is yet another example of a market driven decision against coal that ideology and political policy cannot overcome.

Muni Credit News March 30, 2017

Joseph Krist

Municipal Credit Consultant

THE HEADLINES…

A DESERVED DOWNGRADE FOR NEW JERSEY

MORE BUDGET BLUES IN N.E. PENNSYLVANIA

ST. LOUIS TO CONSIDER PRIVATIZATION FOR LAMBERT AIRPORT

KANSAS LOOKING AT A GAS TAX INCREASE

NUCLEAR FINANCE MELTDOWN REVISITED

REGULATORY ISSUES AND MUNICIPALS

RAIDERS VEGAS MOVE APPROVED WITH STATE FINANCING

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A DESERVED DOWNGRADE FOR NEW JERSEY

Moody’s Investors Service has downgraded to A3 from A2 New Jersey’s general obligation rating. The ratings on the state’s appropriation-backed debt, other GO related debt, moral obligation debt, intercept programs and certain special tax bonds that require state appropriation have also been downgraded by one notch. The downgrade affects approximately $37 billion of rated debt. The downgrade reflects the continued negative impact of significant pension underfunding, including growth in the state’s large long-term liabilities, a persistent structural imbalance, and weak fund balances. Despite the state’s significant increases in pension contributions since fiscal 2012, contributions remain well below the actuarial recommended contribution and unfunded pension debt continues to grow.

It also reflects the expectation that the statutory pension contribution schedule will be increasingly difficult to meet given the lack of structural budget adjustments to incorporate General Fund tax reductions that took effect in January 2017 (Chapter 57) and the state’s reliance on optimistic revenue growth assumptions to balance the budget. Without balancing actions, the recent tax cuts will reduce revenues by $1.1 billion by fiscal 2021 and strain the state’s ability to resolve its large structural imbalance in the near term.

One might ask what took so long. It is clear that the Christie method of bullying and bluster has been long played out and that any serious efforts at budget and pension reform will await a new administration in 2018. We believe that the long term outlook remains negative given the lack of consensus and political will which continue to plague the State’s efforts to restore fiscal integrity on both the legislative and executive fronts.

MORE BUDGET BLUES IN N.E. PENNSYLVANIA

Hazelton is one of those smaller northeastern Pennsylvania cities based in manufacturing and mining that saw its economic heyday prior to World War II. Since then, slow steady declines in those sectors have reduced employment, population, and general economic conditions. As its population ages, its demand for services has maintained itself while available resources have become more constrained. this has increased the precariousness of its municipal financial position.

Refinancing two bond issues that the city of Hazleton secured in 2005 could free up funds and help plug a revenue shortfall in the city budget. A financial advisory has pitched plans for refinancing $2,855,000 in bond issues that the city secured in 2005 at a lower interest rate. The arrangement would give the city an option of reducing debt payments or accepting a lump-sum payment that represents savings from the reduced interest rate. The savings could plug a budget gap and potentially stave off a furlough of city workers.

The city secured the bond issues in 2005 at 4.22 percent interest for a term that extends through 2025. When the city refinanced a $5.6 million borrowing in 2015 a fixed interest rate of 2.85 percent. Using that figure as a benchmark, one city council member said refinancing of the $2.855 million bond issue would yield a “conservative” estimated savings of between $90,000 and $100,000.

Council members and the mayor disagree on reasons why the city faces a shortfall. The mayor cited $371,000 in “wage cuts” that he said council made to the budget and unrealistic revenue projections when announcing earlier this month that the city will have to furlough some of its employees beginning April 3. Council, however, contends the shortfall is due to the mayor’s refusal to finalize an arrangement that it approved for selling delinquent tax to Municipal Revenue Services for an advance payment. The mayor said unpaid property taxes totaled nearly $421,000 for 2016 but the city would’ve received about $387,000 from MRS after paying fees.

The city could avoid those costs if it were to receive the money in smaller increments over a longer period of time through Luzerne County’s contracted delinquent tax collection agency. The mayor claimed recently that the city would receive about $387,000 through MRS or about $227,000 this year by receiving delinquent taxes directly from the county’s collection agency. The mayor city could make up the $160,000 revenue shortfall through savings Hazleton will realize as the police chief and administration opted for lower-risk insurance policies that should yield a savings of between $160,000 and $180,000, the mayor said.

Council will consider the 2005 bond issue refinancing when it meets April 4.

ST. LOUIS TO CONSIDER PRIVATIZATION FOR LAMBERT AIRPORT

The city of St. Louis has submitted a preliminary application to the Federal Aviation Administration’s Airport Privatization Pilot Program, which could allow it to privatize operations of St. Louis Lambert International Airport. The application is being submitted under the terms of a 1997 federal law, which was reauthorized in 2012, allows up to 10 public airports to lease the facilities to private operators. Five airports are currently approved, and city officials said they did not know how many airports are competing for the remaining five slots.

The City hopes that the plan could generate millions of dollars more from the airport, perhaps helping the city invest in projects like a north-south MetroLink expansion. The city, which owns the airport, currently receives about $6 million from the facility per current law. Grow Missouri Inc. is a nonprofit funded by billionaire investor Rex Sinquefield, a political activist pushing an end to the city’s earnings tax and a St. Louis city-county marriage.

The extra money would be generated for the city and for upgrades at the airport, would come from the private operator under a long-term lease agreement with the city. The city contends that the plan would allow the city to avoid restrictions on using airport funds for municipal purposes. In its view a deal could mean a large, upfront influx of cash for the city. The city would still own the airport under any agreement.

Lambert was at one time a major hub facility for TWA and then for American Airlines. No longer a hub facility, the airport has been pressed for funds to finance expansions after under taking a major runway expansion to support hubbing. The airport is a more likely facility than many others for a P3 . Lambert’s runways have long been used for test flights and deliveries of military aircraft by McDonnell Douglas, which built its world headquarters and principal assembly plant next to the airport; and now by Boeing, which bought McDonnell and now uses its St. Louis facilities as headquarters for its Boeing Defense, Space Security division. The plant currently builds the F-15 Strike Eagle, F/A-18 Super Hornet and Growler; and is home to Boeing Phantom Works.

KANSAS LOOKING AT A GAS TAX INCREASE

We have been following the ups and downs of Kansas’ ongoing budget crisis. The effort to balance the general fund has included the use of transfers from the State’s Highway Fund and we have been concerned that this would diminish the State Highway Fund credit. Now, House Bill 2382 has been proposed which calls for an increase in the state’s gas tax from 24 to 35 cents per gallon.

Most of the money would go the Highway Fund with the remainder being distributed to counties and cities. It is receiving support because the legislation would include constitutional provisions prohibiting transfers to the General fund. A driver driving 15,000 miles per year in a car getting 20 mph would see a tax increase of $82. The proposal joins a number of other more modest gas tax increase proposals as Kansas grapples with its ongoing deficit financing efforts.

NUCLEAR FINANCE MELTDOWN REVISITED

Westinghouse Electric Co., the nuclear engineering firm overseeing construction of new generating facilities in Georgia and South Carolina, filed for bankruptcy. The filing leaves questions about the fate of four reactors under construction in the United States. The filing results in a host of legal questions about whether Toshiba remains responsible for losses at Westinghouse and whether the utilities that own the reactors under construction will have to eat more of the cost of completing them. That could mean higher rates for consumers in those areas. In seeking protection under Chapter 11 of the bankruptcy act, Westinghouse could still finish building those plants.

Westinghouse said it has arranged $800 million in debtor-in-possession financing so that it can continue to serve customers while restructuring its business. Scana Corp and Southern Co., the power utilities which hired Westinghouse to build the first nuclear power plants in the United States in more than 30 years, have also hired restructuring advisers. In a potential Westinghouse bankruptcy, Scana and Southern Co would be among Westinghouse’s largest creditors, owed the cost overruns on the projects, which tally in the billions of dollars, one of the people added. The utilities are hoping to recover these costs in a bankruptcy process for Westinghouse.

At Georgia’s Votgle plant, the latest completion deadlines of December 2019 and September 2020 for the two new reactors — already more than three years behind schedule — “do not appear to be achievable,” Oglethorpe Power Co. said in a filing to the U.S. Securities and Exchange Commission. Georgia Power will be cutting it close to get the new nuclear plants completed ahead of a deadline contained in a deal it reached last year with state regulators.

Under that settlement with the Georgia Public Service Commission, the Atlanta electric utility must have the plants in running condition by the end of 2020, or its profit margin allowed on the project will be cut by roughly a third.

It matters to municipal bond investors in debt issued by South Carolina Public Service Authority (debt rated A1 AA- A+, co-owner of Sumner) and the Municipal Electric Authority of Georgia (debt rated A2 A+ A+, co-owner at Votgle). They are owners of significant shares of the two plants currently under construction. The financing plans are different at the two facilities. The Votgle project is the beneficiary of Energy Department loan guarantees. The Sumner project does not have any such guarantees.

Santee Cooper said it will spend up to $250 million over a period of up to 90 days to keep V.C. Summer construction on track. The utility’s board of directors authorized the spending during a special meeting Monday but did not release details of the plan until the bankruptcy was official. It owns 45% of the plant. It is conducting a study to determine whether it will need to increase power prices to help pay for the two new reactors but that review is not related to any additional costs a Westinghouse bankruptcy could bring. Santee Cooper increased rates by 3.7 percent in both 2016 and 2017 to help pay for the new nuclear units. A two notch downgrade now would seem to be appropriate at present.

As for MEAG and the Votgle project, the chairman of the Georgia Public Service Commission said the utilities developing the Alvin W. Vogtle generating station in the state would have to evaluate whether it made sense to continue. “It’s a very serious issue for us and for the companies involved,” Mr. Wise said. “If, in fact, the company comes back to the commission asking for recertification, and at what cost, clearly the commission evaluates that versus natural gas or renewables.” A termination would leave MEAG with significant sunk costs to be recovered from rates. MEAG owns 22.7% of Votgle.

REGULATORY ISSUES AND MUNICIPALS – SANCTUARY CITIES

State and local governments seeking Justice Department grants must certify they are not so-called sanctuary cities in order to receive the money, Attorney General Jeff Sessions announced. Sessions cited the Illegal Immigration Reform and Immigrant Responsibility Act, a law passed in 1996, which includes a section providing that no state or local entity can in any way restrict its law enforcement officials from communicating with federal immigration authorities about a person’s immigration status. Sessions said that compliance with federal immigration laws will be a prerequisite for states and localities that want to receive grants from the Department’s Office of Justice Programs. The office provides billions of dollars in grants and other funding to help criminal justice programs across the country. The Department of Justice will “also take all lawful steps to claw back any funds awarded to a jurisdiction that willfully violates 1373.” This would impact what he described as an expected $4.1 billion in federal grants.

The announcement followed a January 25 executive order from the President. It was timed to occur simultaneously with a conference on sanctuary city policy hosted by ThinkProgress, an editorially independent project of the Center for American Progress Action Fund. Sanctuary cities are fighting back against the move led by the larger cities which are emphasizing the role of the funding to support anti-terror activities in major metropolitan areas. One representative has characterized the move as the federal government playing Russian roulette. Away from the emotional component of the issue, the dollars involved are significant but the concept of “clawing back” already disbursed funds is the most disturbing from a credit point of view.

REGULATORY ISSUES AND MUNICIPALS – COAL POWER REGULATIONS

Just last week, Robert Murray, the founder and CEO of Murray Energy, said Trump should “temper his expectations,” given the way market forces — rather than regulations — have hurt the coal industry and reduced employment. On August 3, 2015, President Obama and EPA announced the Clean Power Plan – a plan to reducing carbon pollution from power plants. When the Clean Power Plan was fully in place in 2030, carbon pollution from the power sector was to be 32 percent below 2005 levels and by 2030, emissions of sulfur dioxide from power plants would be 90 percent lower compared to 2005 levels, and emissions of nitrogen oxides would be 72 percent lower.

President Trump this week signed an executive order to direct the Environmental Protection Agency to undo the Clean Power Plan, a rule issued under Obama to cut electricity-sector carbon emissions. “My administration is putting an end to the war on coal,” Trump said. “Perhaps no single regulation threatens our miners, energy workers and companies more than this crushing attack on American industry.” The order is meant to encourage the use of clean coal technologies. These would go beyond existing scrubbing techniques. Leading among them are carbon capture and storage (CCS). Development of CCS for coal combustion has lost momentum in the last few years, partly due to uncertainty regarding carbon emission prices.

The Global CCS Institute established in 2009 and based in Australia aims “to accelerate the development, demonstration and deployment of carbon capture and storage (CCS). In mid-2016 the Global CCS Institute said that there were 15 large-scale CCS projects in operation, with a further seven under construction. No commercial-scale power plants are operating with this process yet. At the new 1300 MW Mountaineer power plant in West Virginia, less than 2% of the plant’s off-gas is being treated for CO₂ recovery, using chilled amine technology. This has been successful. Subject to federal grants, there are plans to capture and sequester 20% of the plant’s CO₂, some 1.8 million tons of CO2 per year. Capture of carbon dioxide from coal gasification is already achieved at low marginal cost in some plants. One (albeit where the high capital cost has been largely written off) is the Great Plains Synfuels Plant in North Dakota, where 6 million tons of lignite is gasified each year to produce clean synthetic natural gas.

About 2005 the DOE announced the $1.3 billion FutureGen project to design, build and operate a nearly emission-free coal-based electricity and hydrogen production plant. Some $250 million of the funding was to be provided by industry, from about eight companies. After identifying a suitable sequestration site in Morgan County, the design phase of the project was announced in February 2013. Construction was due be completed in 2015, with the project being on line mid-2016, but this was delayed as most members of the FGA dropped out, leaving only Peabody, Glencore and Anglo American. In February 2015 DOE cancelled further funding for the project, after having spent $202 million on it.

The Trump administration plans to ask federal courts to suspend lawsuits over the EPA climate regulations and send the rules back to the agency to be rewritten or withdrawn. But the D.C. Circuit Court of Appeals, which heard arguments on the Clean Power Plan six months ago, does not have to go along. The appeals court judges could rule any day on the Clean Power Plan, and a separate D.C. Circuit panel has scheduled oral arguments on the future plant rule for April 17.

Utilities have moved away from coal in favor of cheaper and cleaner fuels, such as prevalent and inexpensive natural gas. We think that economics will continue to govern the choices made by municipal utilities and that the near term impact on municipal credits of the Trump policy changes will be minimal if any. As for the economic impact on coal producing state economies, mining jobs have been in decline for decades as automated equipment increasingly unearths coal, doing the work that once required pick axes and mules. Coal producers have had little interest in adding new federal reserves to their portfolios, amid slumping domestic demand. Existing federal leases contain at least 20 years’ worth of coal, according to Interior Department estimates.

The near term impact on municipal electric utilities should be minimal.

RAIDERS VEGAS MOVE APPROVED WITH STATE FINANCING

The Raiders are the only NFL team to share a stadium with a Major League Baseball franchise. That will change in a couple of years after they received enough votes from NFL owners on relocate to Southern Nevada. The Raiders will still play in Oakland in 2017, and possibly longer. With a 65,000-seat domed stadium that will cost $1.9 billion to be shared with UNLV not expected to open until 2020, Raiders owner Mark Davis has plans on staying in Oakland the next two seasons. The team holds a pair of one-year options at the Oakland Coliseum.

After the vote, Oakland’s mayor said “I am proud that we stood firm in refusing to use public money to subsidize stadium construction and that we did not capitulate to their unreasonable and unnecessary demand that we choose between our football and baseball franchises.” It had however, committed that the end of the 2024 season is the latest date by which the existing Coliseum would be vacated for demolition. This demolition work cost is already included in the City’s infrastructure budget.

The Raiders have committed $500 million toward the project, with another $750 million coming in the form of a hotel tax passed by the Nevada Legislature in October. The move concludes an awkward dance which has been played out repeatedly over the last nearly three decades.

Muni Credit News March 28, 2017

Joseph Krist

joseph.krist@municreditnews.com

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THE HEADLINES…

FOCUS SHIFTS FROM ACA TO TAX REFORM

RAUNER VETO FOR CHICAGO PENSION FUNDING

KENTUCKY PENSION PROBLEMS LINGER DESPITE ATTENTION

PREPA NEGOTIATION TWISTS AND TURNS

NIH CUTS – UNIVERSITIES AND HOSPITALS

ANOTHER INFRASTRUCTURE PLAN PROPOSED

_____________________________________________________________________________________

FOCUS SHIFTS FROM ACA TO TAX REFORM

The failure to repeal and replace the ACA is, in the short run, it’s good news for states especially those who expanded Medicaid and for New York State in particular. The failed effort takes some of the short-term heat off of state budget making efforts in this cycle. But along with this turn of events comes a change in focus to tax reform. And like any good sentry we know that the elimination of one source of incoming fire does not mean that the threat is over.

If the focus does indeed turn to tax reform, then threats remain for state and local government. They come from a number of directions. Will tax reform mean elimination of the tax exemption and a rising cost of capital for municipal borrowers? Will tax reform mean the elimination of the deduction for state and local income taxes? Would tax reform include elimination of the mortgage interest deduction leading to uncertainties in the housing market which could impact taxable valuations? The possibilities are myriad. None of them can be spun as particularly positive for municipal credit.

Tax reform on the scope of what has been suggested would severely impact the federal budget deficit. It can only be addressed through the types of spending cuts which were briefly outlined in the “skinny budget” recently released. We have already indicated our concerns with those proposals from a municipal credit perspective and reiterate those concerns here.

The one source of temperance regarding those concerns is that the scenario whereby the budget and policy hawks in the Freedom Caucus torpedoed ACA repeal might be repeated in the tax reform process. Will their insistence on deficit reduction not just neutrality be enough to torpedo efforts to make significant changes in tax policy (as opposed to just changes in rates) and thereby prevent significant change to the tax code to be enacted? That will have to play itself out as the process unfolds.

RAUNER VETO FOR CHICAGO PENSION FUNDING

Gov. Bruce Rauner on Friday vetoed legislation designed to shore up the pension funds for city of Chicago laborers and other city workers. “While I appreciate the effort to address the insolvency of certain pension funds for Chicago’s public employees, the legislation will create another pension-funding cliff that the city does not have the ability to pay,” Rainer said in a statement Friday. “This legislation will result in increased taxes on Chicago residents.”

Senate Bill 2437 would have put more money into retirement systems covering some 88,000 city workers, excluding police officers and firefighters, who are covered by separate pension funds. The Illinois House passed the bill in December and it was unanimously approved by the Senate in January. Instead the Governor’s ideological battle continues as Rainer had previously said he wouldn’t support the bill without more systemic wide-reaching government pension reforms. He also questioned the use of revenue in the bill, which would resort to the city using property-tax money to fund pensions after it runs out of funds from a new tax on city water and sewer service.

The veto comes despite workers’ concessions calling for employees hired after Jan. 1 to become eligible for retirement at age 65 in exchange for an 11.5 percent pension contribution. That’s 3 percentage points higher than employees pay now. Veteran employees hired after Jan. 1, 2011, get to choose between contributing 11.5 percent for the right to retire at 65 or continuing to pay 8.5 percent and waiting until 67 to retire.

It is this sort of move that belies the Governor’s efforts to portray the current financial disaster that is the State of Illinois as being solely based on legislative intransigence. He seems hell bent on getting the State and its largest city downgraded again rather than working for a solution.

KENTUCKY PENSION PROBLEMS LINGER DESPITE ATTENTION

There has been much focus on the public pension systems sponsored by the Commonwealth of Kentucky as they have served as a sort of poster child for the problem of chronic underfunding of state pensions. So it was with some interest that we examined the latest disclosure from the Commonwealth in support of its planned issue of state appropriation bonds.

That disclosure focused on the Teachers Retirement Fund and the funds covering the Commonwealth’s non-pedagogical employees. The Teachers Fund has seen its unfunded accrued actuarial liability grow in four of the last five years. As of June 30, 2016, the UAAL totaled $14,551,333,000. That results in a funding ratio of 54.6%. That ratio actually declined from the prior year’s 55.6%.

The funds covering the state’s other employees are in substantially worse shape. The UAAL has increased in each of the last five years. At the same time the funding ratio has substantially declined from an already unacceptable 30.2% to an incredibly low 19.5% in 2016. The funds had been using an assumed investment rate of 7.75%. As pension fund managers have discovered across the country, this assumed rate has been unrealistically high. Two of the general employee funds have reduced this assumed rate of return to 6.75%. The Teachers Fund and two other general employee funds slightly lowered their annual return assumptions to 7.5%.

So it really should not come as any surprise that these actions have not yielded significant improvement in the funding position of the funds. In FY 2016, the Actuarially Determined Employer Contribution for the Commonwealth was $562.1 million which was fully funded but this did nothing to address the existing shortfalls. The biennial budget calls for $186 million in contributions above the ADEC requirement. Since 2014, new employees have joined a hybrid pension plan. Localities may opt out of the plans but must repay their full actuarial liability to the Commonwealth in order to do so. So that is not an option which is particularly attractive. There are provisions to dedicate 25% of state surplus to the pension funds but with four months remaining in the current FY, revenues are still some 4.4% short of estimates. So the odds of any real help from that source seem pretty low.

PREPA NEGOTIATION TWISTS AND TURNS

The Puerto Rico Fiscal Agency and Financial Advisory Authority (FAFAA) filed proposed terms for a new restructuring support agreement (RSA) with Puerto Rico Electric Power Authority (PREPA) bondholders. However, PREPA’s Ad Hoc Group of Bondholders issued a statement rejecting it. The filing takes place amidst a U.S. congressional subcommittee holding a hearing on the RSA. One PREPA board member called the hearing is a pressure tactic to push the government into accepting the current RSA, which the government wishes to amend to obtain better terms.

Later, FAFAA issued a statement saying the discussions are ongoing and that the entity “remains committed to a good faith negotiation with PREPA’s creditors in order to consensually achieve important improvements to the RSA. In the hearing in Congress however, Governor Rosella expressed worries about the impact of the 3-cent transition charge on Puerto Rican ratepayers; the effect the transaction may have on the capital and liquidity available to PREPA to complete its operational transition; the failure of certain creditor groups, such as monoline bond insurers, to provide significant concessions; the reality that the RSA does not provide for sufficient capital to close the transaction; and that under the current conditions, the RSA would not be sustainable for bondholders.

The current RSA, which expires March 31, calls for a 15% haircut on the principal of the debt, which is around $9 billion. But the government is proposing a split between 80% in securitization bonds and 5% in new PREPA bonds to maintain 85% of the total debt. While the current RSA proposes a debt service reserve fund of 10%, the government is proposing a reserve fund ramp up to 3.5% by year five. The current RSA calls for a bond exchange in which current PREPA bonds will be exchanged with bonds from PREPA’s Revitalization Corp. Those new bonds are required to be of investment-grade credit quality. The government now says these shouldn’t need to be an investment-grade requirement for securitization.

Under the current RSA, bondholders can elect between two types of bonds, whose terms were proposed to be amended to, among other things, extend their maturity to 2047. The Ad Hoc group issued a statement saying the proposal would not simply modify the existing RSA but “fundamentally change it and undermine the value and structural integrity of the new PREPA

PREPA has a major bond payment of roughly $455 million of combined principal and interest due July 1. “Without the cash flow relief provided by the terms of the RSA and without any other viable options for making such a payment afforded to the distressed utility, PREPA will once again default.

NIH CUTS – UNIVERSITIES AND HOSPITALS

The skinny budget issued by the Trump administration provides for an approximate 20% cut in funding for the National Institutes of Health (NIH). Trump’s $5.8 billion reduction is roughly equivalent to what NIH spent last year to reimburse universities for the so-called indirect costs of research, which include overhead items like utility bills and the staff needed to comply with federal research regulations. Some speculate that the White House wants to reduce those indirect payments in hopes of saving money without reducing the amount of research that NIH funds. But university officials have long maintained that they could not afford to accept NIH grants if the government didn’t also pay reasonable overhead costs.

In the absence of budget specifics, one is left to applying some rudimentary calculations to estimate where these potential cuts might impact. So we go to data supplied by NIH listing the largest university recipients of NIH grants and how much that represents.

ORGANIZATION	CITY	STATE	COUNTRY	AWARDS	FUNDING
JOHNS HOPKINS UNIVERSITY	BALTIMORE	MD	UNITED STATES	309	$141,961,360
UNIVERSITY OF MICHIGAN	ANN ARBOR	MI	UNITED STATES	231	$105,176,124
UNIVERSITY OF CALIFORNIA, SAN FRANCISCO	SAN FRANCISCO	CA	UNITED STATES	273	$105,139,483
UNIVERSITY OF PENNSYLVANIA	PHILADELPHIA	PA	UNITED STATES	245	$99,741,661
WASHINGTON UNIVERSITY	SAINT LOUIS	MO	UNITED STATES	213	$94,088,787
YALE UNIVERSITY	NEW HAVEN	CT	UNITED STATES	242	$90,722,334
UNIVERSITY OF PITTSBURGH AT PITTSBURGH	PITTSBURGH	PA	UNITED STATES	233	$86,522,236
STANFORD UNIVERSITY	STANFORD	CA	UNITED STATES	216	$85,049,075
UNIVERSITY OF CALIFORNIA SAN DIEGO	LA JOLLA	CA	UNITED STATES	205	$80,270,406

U.S. Department of Health and Human Services, NIH Awards by Location & Organization

These are clearly meaningful amounts of resources to these programs. Municipal bond investors should care because these funds often represent funds available for debt service in support of capital facilities in which research is physically carried out. Even if not directly pledged or otherwise dedicated to debt service, the lack of these resources would pressure already weakened resource bases for debt repayment by forcing the universities to make additional hard budget choices as they face diminishing state support and pressures on sources of full tuition paying students.

Similar concerns logically apply to hospitals. So we applied the same observation to hospital grant data.

ORGANIZATION	CITY	STATE	COUNTRY	AWARDS	FUNDING
BRIGHAM AND WOMEN’S HOSPITAL	BOSTON	MA	UNITED STATES	133	$111,465,823
MASSACHUSETTS GENERAL HOSPITAL	BOSTON	MA	UNITED STATES	188	$77,287,551
BOSTON CHILDREN’S HOSPITAL	BOSTON	MA	UNITED STATES	96	$39,477,541
VANDERBILT UNIVERSITY MEDICAL CENTER	NASHVILLE	TN	UNITED STATES	103	$36,379,660
CHILDREN’S HOSP OF PHILADELPHIA	PHILADELPHIA	PA	UNITED STATES	43	$35,326,998
DANA-FARBER CANCER INST	BOSTON	MA	UNITED STATES	42	$32,324,722
CINCINNATI CHILDRENS HOSP MED CTR	CINCINNATI	OH	UNITED STATES	76	$31,054,789
ST. JUDE CHILDREN’S RESEARCH HOSPITAL	MEMPHIS	TN	UNITED STATES	29	$20,306,129
BETH ISRAEL DEACONESS MEDICAL CENTER	BOSTON	MA	UNITED STATES	47	$19,464,246

U.S. Department of Health and Human Services, NIH Awards by Location & Organization

We are not taking the view that any particular near-term credit issue will result if these proposals are adopted. We do however think that the phenomenon should be highlighted as an additional issue to be included in the credit evaluation and valuation process undertaken by investors.

MORE INFRASTRUCTURE PLANS PROPOSED

The Partnership to Build America Act would create a new American Infrastructure Fund to pay for state and local projects. Another bill is called the Infrastructure 2.0 Act. It includes the AIF and provides additional long-term revenues to stabilize and expand the Highway Trust Fund. The Partnership to Build America Act finances $750 billion dollar in infrastructure investment using no appropriated funds, According to its sponsor. The Infrastructure 2.0 Act is designed to provide six years of funding for the Highway Trust Fund. The American Infrastructure Fund (AIF) which would provide loans or guarantees to state or local governments to finance qualified infrastructure projects. The states or local governments would be required to pay back the loan at a market rate determined by the AIF to ensure they have “skin in the game.” In addition, the AIF would invest in equity securities for projects in partnership with states or local governments.

The AIF would be funded by the sale of $50 billion worth of Infrastructure Bonds which would have a 50 year term, pay a fixed interest rate of 1 percent, and would not be guaranteed by the U.S. government. U.S. corporations would be incentivized to purchase these new Infrastructure Bonds by allowing them to repatriate a certain amount of their overseas earnings tax free for every $1.00 they invest in the bonds. This multiplier will be set by a “reverse Dutch auction” allowing the market to set the rate. The bill assumes a 1:4 ratio, meaning a company repatriates $4.00 tax-free for every $1.00 in Infrastructure Bonds purchased, a company’s effective tax rate to repatriate these earnings would be approximately 8 percent and the $4.00 could then be spent by the companies however they chose. The AIF would leverage the $50 billion of Infrastructure Bonds at a 15:1 ratio to provide up to $750 billion in loans or guarantees. At least 25 percent of the projects financed through the AIF must be Public-Private Partnerships for which at least 20 percent of a project’s financing comes from private capital using a public-private partnership model.

The bill reflects many of the problems that infrastructure finds itself in. Many of the ideas look for ways to avoid the use of current revenues for spending on infrastructure, try to force the issue of P3s, and get themselves entwined with other issues such as the effort to repatriate foreign derived corporate income. This kind of approach to funding unnecessarily complicates an already complex issues and raises the kind of issues which make it harder to find consensus. Repatriation, tax credits, low interest non-guaranteed debt financing in a time of rising interest rates are nor really beneficial to the municipalities. Neither is the lack of specificity as to what constitutes a “market rate” for repayment of loans made to states while at the same time benefitting corporations with equity infusions and tax credits. All will serve to delay the provision of meaningful infrastructure improvement.

At the same time, Rep. Peter DeFazio (D-Ore.), the ranking Democrat on the House Transportation and Infrastructure Committee, proposed a bill which would raise the federal gas tax by approximately 1 cent per year, to generate about $500 billion for revitalizing U.S. roads, bridges and transit systems over the next 30 years.

As many have observed, the federal gasoline tax has not been increased over 20 years. The bill would index the gas and diesel tax to the cost of constructing transportation projects and to the reduction in motor-fuel usage, which would approximately translate into a 1-cent increase every year. The hike would be capped at 1.5 cents annually.

The Treasury Department would use that new revenue to issue and pay back 30-year “Invest in America Bonds,” and deposit the cash from those bond sales into the ailing Highway Trust Fund. The measure, which would lead to a 30% boost in infrastructure investment every year, would ensure that the money is invested proportionally among highway, transit and safety programs. Raising gas taxes at the state level has not been a political landmine. Seventeen states have raised their gas taxes since 2013, including nine red states. Those increases range from 1 cent to 27 cents.

Muni Credit News March 21, 2017

Joseph Krist

joseph krist, municreditnews.com

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THE HEADLINES…

INFRASTRUCTURE CLUES IN THE TRUMP BUDGET PROPOSAL

TEXAS CONSIDERS DEFUNDING ROADS TO BALANCE THE BUDGET

ACA IMPACT ON STATE AND LOCAL CREDITS AND ECONOMIES

IS PUERTO RICO’S DEBT PLAN REALLY A SURPRISE?

CALIFORNIA PENSION CHANGES GET S&P SUPPORT

COLLEGES FACE DECLINING INTERNATIONAL DEMAND

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INFRASTRUCTURE CLUES IN THE TRUMP BUDGET PROPOSAL

Those looking for clues about how Trump budget policies would support campaign rhetoric supporting infrastructure spending, got some last week. Trump would slash programs that invest in rural infrastructure. The “skinny plan” proposes to eliminates the “duplicative” Water and Wastewater loan and grant program, a savings of $498 million from the 2017 annualized continuing resolution (CR) level. Rural communities can be served by private sector financing or other Federal investments in rural water infrastructure, such as the Environmental Protection Agency’s State Revolving Funds according to the document. It eliminates the Economic Development Administration, which provides small grants with, in the view of this administration provides limited measurable impacts and duplicates other Federal programs, such as Rural Utilities Service grants at the U.S. Department of Agriculture and formula grants to States from the Department of Transportation. By terminating this agency, the Budget saves $221 million from the 2017 annualized CR level.

It increases DOD’s budget authority by $52 billion above the current 2017 level of $587 billion. This increase alone exceeds the entire defense budget of most countries, and would be one of the largest one-year DOD increases in American history. It is exceeded only by the peak increases of the Reagan Administration and a few of the largest defense increases during the World Wars and the conflicts in Korea, Vietnam, Iraq, and Afghanistan (in constant dollars, based on GDP chained price index). Unlike spending increases for war, which mostly consume resources in combat, the increases in the President’s Budget primarily invest in a stronger military.

As for specific sectors supporting municipal bonds, the budget proposes an additional $1.5 billion above the 2017 annualized CR level for expanded detention, transportation, and removal of illegal immigrants. This bolsters the private and contract prison sector. At airports, the budget proposes to raise the Passenger Security Fee to recover 75 percent of the cost of TSA aviation security operations. This will make it harder to raise other PFCs for capital needs. The Federal Aviation Administration’s funding for commercial service to rural airports takes a major cut.

Mass transportation would be seriously impacted. The American Public Transit Association has identified 23 projects around the nation which would face viability threatening funding shortfalls if the Trump budget proposals are adopted. Among those projects are some which we have previously discussed in the Muni Credit News. They include Chicago’s proposed Red and Purple Line Modernization Project; Maryland’s Purple Line; New York and New Jersey’s Hudson Tunnel Project; and New York’s Second Avenue Subway Phase 2.

States will be pressured by the proposal to eliminate or reduce State and local grant funding by $667 million for programs administered by the Federal Emergency Management Agency (FEMA) that are either unauthorized by the Congress, such as FEMA’s Pre-Disaster Mitigation Grant Program, or that must provide more measurable results and ensure the Federal Government is not supplanting other stakeholders’ responsibilities, such as the Homeland Security Grant Program. For that reason, the Budget also proposes establishing a 25 percent non-Federal cost match for FEMA preparedness grant awards that currently require no cost match. This is the same cost-sharing approach as FEMA’s disaster recovery grants. The activities and acquisitions funded through these grant programs are viewed in this budget as primarily State and local functions. $210 million is eliminated for the State Criminal Alien Assistance Program, in which two-thirds of the funding primarily reimburses four States for the cost of incarcerating certain illegal criminal aliens.

An additional pressure on states is the proposal to decrease Federal support for job training and employment service formula grants, shifting more responsibility for funding these services to States, localities, and employers. It eliminates funding for specific regional efforts such as the Great Lakes Restoration Initiative, the Chesapeake Bay, and other environmental programs. These program eliminations produce spending $427 million lower than the 2017 annualized CR levels. The Budget returns the responsibility for funding local environmental efforts and programs to State and local entities. It eliminates infrastructure assistance to Alaska Native Villages and the Mexico border.

Cuts to HUD’s Community Development Block Grant program, which since the 1970s has devoted billions to helping improve housing and living conditions in cities, would be eliminated. How great an impact would that be? For example,Michigan communities could lose some $111 million compared to the current year — including $31 million for Detroit. The rest would be spread around the state, including $5 million for Wayne County, $4 million for Oakland County and nearly $2 million for Macomb County. In Detroit, CDBG funds have helped pay for homeless shelters and transportation for seniors as well as defraying costs for rehabilitation projects for housing and some acquisition and demolition costs in the city’s fight against blight. The loss of another HUD program would cost state communities $29 million total.

What is missing may be the most important consideration to the municipal market and that is tax policy. There is nothing to indicate what the Trump administration policy is towards municipal bonds and the tax exemption for them. So from the point of view, the document is fairly useless. As a policy document, the “skinny budget” comes up quite short but this is to be expected given the White House-centric nature of this administration’s policy apparatus. Effectively, it is a political document that provides few directional surprises so it does not provide much of use to those who are trying to make current investment decisions.

TEXAS CONSIDERS DEFUNDING ROADS TO BALANCE THE BUDGET

In 2015 to boost funding for the state’s public roadways and bridges, which have strained under a growing population, Proposition 7 amended the Texas Constitution to route some taxes collected on car sales to the State Highway Fund. Some 83 percent of voters supported Proposition 7.

Nonetheless, the Texas House’s chief budget writer filed legislation last week that would pave the way for lawmakers to claw back billions of dollars that voters approved for state highways, freeing them up for other budget needs. House Appropriations Chairman John Zerwas filed a resolution that would cut that initial cash infusion, aiming to free up money at a time when cash is tight. House Concurrent Resolution 108 could cut the first transfer under Proposition 7 of nearly $5 billion in half, but only if two-thirds of lawmakers in both the House and Senate support such a move. It is possible because of a “safety valve” in Senate Joint Resolution 5, the legislation that the Legislature approved in 2015 to send Proposition 7 to voters later that year.

At the Texas Department of Transportation, agency officials have plans for all of the Prop 7 money. Gov. Greg Abbott also released a proposed budget in January that called for directing all of the Prop 7 funds to TxDOT as voters intended. Tax cuts in 2015 cut available state revenues by about $4 billion, and a slowdown in the oil patch also shrunk the budgetary pie. The voter-approved transfer of funds to the highway fund would leave even fewer dollars available to put toward areas such as health care, education and the state’s collapsed foster care system.

It is ironic that highway funding, often the subject of specific voter actions in support of infrastructure spending, is the source of budget bailouts for states experiencing general revenue shortfalls whether because of lower overall economic activity or as the result of poorly thought through tax cuts. Kansas is the most obvious example. The moves to use these funds merely provide temporary budget relief but then diminish the credits supported by transportation related revenues. So in the end neither credit experiences long term benefit.

ACA IMPACT ON STATE AND LOCAL CREDITS AND ECONOMIES

We have recently commented on our view of the highly negative anticipated impacts of the AHCA in its present form on state credits. Recent statistics show that Employment in health care also continued to trend up in January (+18,000), following a gain of 41,000 in December. The industry has added 374,000 jobs over the past 12 months. While many focus on the higher end jobs in the healthcare sector, the reality is that healthcare has largely stepped into the role which manufacturing used to serve as a source of jobs for the less skilled, less educated, and immigrant populations in the workforce. The loss of these jobs would have serious implications for state budgets on both the tax and expense sides of the ledger. Recent academic work has supported our concerns. One example is a study from the Milken Institute School of Public Health at George Washington University. That study indicates that consequences of repealing both premium tax credits and Medicaid expansions include: About 2.6 million jobs could be lost nationwide in 2019, rising to almost 3 million by 2021. Every state would experience major job losses. Almost all of the jobs lost are in the private sector. Almost a million (912,000) are in health care, while the remaining two-thirds are in other industries, including construction, real estate, retail trade, finance and insurance. States with the highest job losses in 2019 include: California (334,000 jobs), Florida (181,000), Texas (175,000), Pennsylvania (137,000), New York (131,000), Ohio (126,000), Illinois (114,000), Michigan (102,000), New Jersey (86,000), and North Carolina (76,000). The states with the highest percentage of healthcare employment versus total employment in excess of 10% are West Virginia, Rhode island, Ohio, Maine, Massachusetts, Mississippi, Pennsylvania, North Carolina, and New York. All of them are states in which manufacturing used to serve as a source of jobs for the less skilled, less educated, and immigrant populations in the workforce. They also will see the impact in their major cities. Estimates of the share of employment in represented by healthcare in cities ravaged by a declined manufacturing bases include Cleveland -11.2%, Pittsburgh-10.4%, Detroit-10.3%, Philadelphia-10.5%, Youngstown-10.7%, Providence-11%, Charlestown WV- 11.4%. Louisville, Gary IN, Cincinnati are all above the national average of 9%.

15 Republican governors have raised concerns about the House GOP’s health care bill amid the fiery debate surrounding the long-promised repeal of Obamacare. And no governors have publicly expressed strong support for the American Health Care Act. Arkansas Gov. Asa Hutchinson said “There needs to be some adjustments to relieve some of that cost-shift to the states and to make sure we don’t go back to where we were before, which was that we just had our emergency rooms filled with those who did not have coverage.” “Phasing out Medicaid coverage without a viable alternative is counterproductive and unnecessarily puts at risk our ability to treat the drug-addicted, mentally ill and working poor who now have access to a stable source of care,” Ohio Gov. John Kasich said.

Recent research by the Urban Institute and Dobson, DaVanzo & Associates estimated a $400 billion loss in total hospital revenue from 2018 to 2026 and $166 billion loss in net income would rise by $1.1 trillion from 2019 to 2028. This would lead to significant pressure to include higher uncompensated care funding from already strained state budgets. Those states would also experience declines in revenues from lower sales and income taxes resulting from lower employment and lower purchasing by hospitals and care providers. There is almost nothing favorable for the states in this legislation.

CALIFORNIA PENSION CHANGES GET S&P SUPPORT

The CalPERS’ board voted on December 21, 2016, to lower the discount rate to 7.375% from 7.5% in the upcoming actuarial valuation for June 30, 2016; 7.25% in the 2017 valuation; and 7.0% in the 2018 valuation. Six weeks later, on February 1, 2017, the CalSTRS board decided to move slightly faster, reducing its discount rate to 7.25% in the 2016 valuation and 7.0% in 2017 from 7.5%. The two largest public pension systems in the U.S. both have committed to lowering their discount rates without changing their funds’ asset allocations.

S&P explains that CalPERS’ discount rate had an inflation assumption of 2.75% and a real rate of return of 4.75%. The real rate of return is scheduled to decrease 0.5% over the next three years while the inflation assumption is stable and will be looked at in 2018 in the experience study, which CalPERS conducts every four years. The impact on the cost of earning a year of service (the normal cost) will add 1% to 3% of pay for non-safety groups and 2% to 5% for most safety groups. S&P expects most unfunded liability payments to increase 30% to 40% over the next seven years as the costs are realized. For the state alone, that will ultimately mean contributing $2 billion a year more toward pension costs.

Reducing the discount rate will accelerate the slope of cost increases, intensifying the pressure that state and municipalities will face as growing pension contributions account for larger portions of their budget, especially in this slow revenue growth environment. Reducing the inflation assumption softens the discount rate reduction’s impact. Pension benefits are calculated based on years of service and salary, so a lower inflation assumption implies that salaries are growing more slowly than before, lowering projected benefits and total liability. Reducing the inflation assumption softens the discount rate reduction’s impact. Pension benefits are calculated based on years of service and salary, so a lower inflation assumption implies that salaries are growing more slowly than before, lowering projected benefits and total liability. State legislation AB 1469 sets the contribution rate for schools through fiscal year 2021. This schedule more than doubles their contribution rates from fiscal years 2015 to 2021, so S&P anticipates significant strain on schools’ budgets over the next several years. However, while their contributions will continue to increase due to the phase-in of AB 1469, the effect of the discount rate change has no impact on school contribution rates until fiscal 2022. Even after that window opens, school yearly contribution changes are capped at 1% and in total can only grow by 1.15% more than the bill’s current schedule. So absent further statutory changes, the resulting contribution burden to schools is both delayed and limited to a minimal 1.15% of their payroll. The result is to raise the near term cost of pensions for both the state and its localities and school districts. Ultimately, the total obligation for pensions will see slower growth thereby reducing the total liability. This then improves the liability side of the balance sheet resulting in a more favorable credit profile. As a result, S&P takes a more positive view of California’s credit profile.

IS PUERTO RICO’S DEBT PLAN REALLY A SURPRISE?

The initial market reaction to Puerto Rico’s plans for limited debt service payments was negative based on limited trading. The fiscal plan certified for the administration of Ricardo Rosselló, for the next 10 years, allocates $800 million for the payment of debt starting in 2019. The government’s debt obligations range from $3.8 billion to $5 billion a year over the next decade. It is the government’s position that $800 million is the amount available and that this should serve as a base assumption for a restructuring.

One of the disappointing aspects of the situation is contained in comments from the fiscal board. The board’s interim executive director said that its approach over the past few months was to certify a fiscal plan and ensure that by the end of this year the government can achieve enough savings to continue to meet pension obligations to retirees and the ability to manage the healthcare system when Affordable Care Act funds are exhausted.

The fiscal plan certified for the next 10 years included Cofina and funds subject to clawbacks as part of the general fund revenue. The assumption in the fiscal plan assumes that in a debt restructuring these funds are available for the payment of general expenses. The board’s emphasis now is on reaching consensual agreements that restructure the debt at a level that is sustainable for Puerto Rico.

That language builds in a bias in favor of public services and more importantly, pensioners. This would continue a pattern of pensioners being treated much more favorably than bondholders. The difference here between this and other municipal bankruptcy situations is the existence of the constitutional provisions in favor of bondholders. We understand the practical and political realities of the Commonwealth’s financial and debt situation. We remain troubled by the precedent which would be set if a restructuring deal were ultimately forced upon bondholders that resulted in less than full payment for the general obligation debt.

COLLEGES FACE DECLINING INTERNATIONAL DEMAND

In January, we discussed the economic impact of foreign students in the U.S. We highlighted the growing importance of these full tuition consumers of education to an increasing number of institutions, especially state institutions who have suffered declining state support. Now there is news which may expose the vulnerabilities inherent in relying on that demand cohort.

A survey undertaken by a a coalition of six higher education associations in February 2017 produced the following findings from more than 250 U.S. institutions which responded to the short survey, with representation of all sizes, types and geographic diversity of higher education in the United States. 39% of responding institutions reported a decline in international applications, 35% reported an increase, and 26% reported no change in applicant numbers. There are more than 100,000 students studying in the U.S. from the Middle East, making up just under 10% of our international student enrollment nationwide. 39% of institutions have reported declines in undergraduate applications for Fall 2017 from the Middle East. 31% of Institutions have reported declines in graduate applications for Fall 2017 from the Middle East.

Almost half a million Indian and Chinese students study in the U.S. 26% of institutions have reported undergraduate application declines from India and 25% reported application declines from China. o 32% of institutions have reported graduate application declines from China, and 15% have reported application declines from India.

The most frequently noted concerns of international students and their families, as reported by institution-based professionals, include a perception of a rise in student visa denials at U.S. embassies and consulates in China, India and Nepal; a perception that the climate in the U.S. is now less welcoming to individuals from other countries; concerns that benefits and restrictions around visas could change, especially around the ability to travel, re-entry after travel, and employment opportunities; and concerns that the Executive Order travel ban might expand to include additional countries.

Muni Credit News March 16, 2017

Joseph Krist

joseph.krist@municreditnews.com

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THE HEADLINES…

CBO SCORES AHCA

CONSERVATIVE CMS HEAD APPROVED

CHICAGOLAND HOSPITAL MERGER HITS LEGAL ROADBLOCK

ACA DEBATE DOESN’T SLOW HEALTH EMPLOYMENT

MOODY’S WEIGHS IN ON THE ACA

DISCLOSURE LIKELY TO WEAKEN IN CURRENT ENVIRONMENT

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CBO SCORES AHCA

CBO and JCT estimate that enacting the legislation would reduce federal deficits by $337 billion over the 2017-2026 period. That total consists of $323 billion in on-budget savings and $13 billion in off-budget savings. Outlays would be reduced by $1.2 trillion over the period, and revenues would be reduced by $0.9 trillion. The largest savings would come from reductions in outlays for Medicaid and from the elimination of the Affordable Care Act’s (ACA’s) subsidies for nongroup health insurance. The largest costs would come from repealing many of the changes the ACA made to the Internal Revenue Code—including an increase in the Hospital Insurance payroll tax rate for high-income taxpayers, a surtax on those taxpayers’ net investment income, and annual fees imposed on health insurers—and from the establishment of a new tax credit for health insurance.

CBO and JCT estimate that, in 2018, 14 million more people would be uninsured under the legislation than under current law. Most of that increase would stem from repealing the penalties associated with the individual mandate. Some of those people would choose not to have insurance because they chose to be covered by insurance under current law only to avoid paying the penalties, and some people would forgo insurance in response to higher premiums. Later, following additional changes to subsidies for insurance purchased in the nongroup market and to the Medicaid program, the increase in the number of uninsured people relative to the number under current law would rise to 21 million in 2020 and then to 24 million in 2026.

The reductions in insurance coverage between 2018 and 2026 would stem in large part from changes in Medicaid enrollment—because some states would discontinue their expansion of eligibility, some states that would have expanded eligibility in the future would choose not to do so, and per-enrollee spending in the program would be capped. In 2026, an estimated 52 million people would be uninsured, compared with 28 million who would lack insurance that year under current law.

In 2018 and 2019, according to CBO and JCT’s estimates, average premiums for single policyholders in the nongroup market would be 15 percent to 20 percent higher than under current law, mainly because the individual mandate penalties would be eliminated, inducing fewer comparatively healthy people to sign up. Changes in premiums relative to those under current law would differ significantly for people of different ages because of a change in age-rating rules. Under the legislation, insurers would be allowed to generally charge five times more for older enrollees than younger ones rather than three times more as under current law, substantially reducing premiums for young adults and substantially raising premiums for older people.

Over ten years through 2026, a reduction of $880 billion in federal outlays for Medicaid is estimated. In our view, such a reduction in combination with the loss of insurance coverage would create an impact on the hospital sector which would be devastating. And these impacts are with the law as it is. Should conservative opponents prevail in their efforts against a tax credit versus a reduction, the impact would be even worse.

The White House has made efforts to discredit the forecasts from the nonpartisan CBO. “We disagree strenuously with the report that was put out,” Health and Human Services Secretary Tom Price told reporters Monday about the CBO after leaving a Cabinet meeting with President Donald Trump at the White House. “It’s just not believable is what we would suggest.” Ironically, the OMB did an analysis of what it thought the CBO estimate might look like and the analysis found that under the American Health Care Act, the coverage losses would include 17 million for Medicaid, 6 million in the individual market and 3 million in employer-based plans. A total of 54 million individuals would be uninsured in 2026 under the GOP plan, according to this White House analysis. That’s nearly double the number projected under current law.

It is already clear that the final law will not be this bill. Senate Republicans have suggested changes to the bill which would lower insurance costs for poorer, older Americans and an increase in funding for states with high populations of hard-to-insure people. It was noted that Americans over 60 who earn a little too much to qualify for Medicaid would “have a hard time affording insurance” under the House plan, since insurance premiums would rise far higher than the modest tax credits on offer. AARP has denounced the plan as an “age tax.”

CONSERVATIVE CMS HEAD APPROVED

President Donald Trump’s pick to run Medicare and Medicaid was confirmed by a divided Senate as lawmakers engaged in the battle over the government’s role in health care and society’s responsibility toward the vulnerable. Indiana health care consultant Seema Verma, a protégé of Vice President Mike Pence, was approved by a 55-43 vote, largely along party lines. She’ll head the Centers for Medicare and Medicaid Services, the $1 trillion agency that oversees health insurance programs for more than 130 million people, from elderly nursing home residents to newborns. It’s part of the Department of Health and Human Services.

Verma takes over at CMS with the agency facing sweeping changes under the House Republican health care bill backed by Trump. She’s been critical of Medicaid, saying “the status quo is not acceptable” for the federal-state insurance program that covers more than 70 million low-income people. In Indiana, Verma designed a Medicaid expansion along conservative lines for Pence. Most beneficiaries are required to pay modest premiums. And the program uses financial rewards and penalties to steer patients to primary care providers instead of the emergency room. Critics say the plan has been confusing for beneficiaries and some have incurred penalties through no fault of their own.

At her Senate confirmation hearing, Verma defended her approach by saying that low-income people are fully capable of making health care decisions based on rational incentives. She also said she does not support turning Medicare into a voucher plan under which retirees would get a fixed federal contribution to purchase private coverage from government-regulated private insurance plans. Her boss, HHS Secretary Tom Price, is a prominent advocate of such an approach. Medicare covers more than 56 million seniors and disabled people.

CHICAGOLAND HOSPITAL MERGER HITS LEGAL ROADBLOCK

A U.S. District Judge granted the Federal Trade Commission and state of Illinois’ request for a preliminary injunction to temporarily stop the merger of Advocate Health Care and North Shore University Health System. The proposal would have created the 11th largest health care system in the U.S., combining Advocate’s 11 hospitals and two-campus children’s hospital with North Shore’s four hospitals.

The two institutions contended that a merger would lead to improvements in care and lower costs for patients. They planned to offer an insurance product 10 percent less expensive than the lowest-priced comparable product available, saving consumers at least $210 million a year. The FTC challenged the deal in late 2015, saying it would probably hurt consumers with higher prices for health care and lower incentives to improve the quality of care. The FTC said the deal would lead to an 8 percent, or $45 million, price increase at the hospitals. The FTC, however, said if the systems merged, they would have had enough leverage to impose price increases on insurers without insurers being able to refuse.

It is currently not possible to analyze the data behind the decision as the judge filed his opinion under seal to give those involved in the case time to request competitively sensitive information be redacted before the opinion is released publicly. This will occur sometime later in the month. Advocate and North Shore argued the FTC too narrowly defined their market, leaving out competitors such as Northwestern Memorial Hospital and Rush University Medical Center.

Rush University Medical Center, an academic hospital on the Near West Side, Rush-Copley Medical Center in Aurora and Rush Oak Park Hospital in that west suburb are now officially operating as one academic health network. They have a new parent system simply called Rush. The system is positioning itself to be among the handful of local hospital networks still operating in the coming years.

Rush is packaging and selling itself as one overall entity. The framework is based on a research-focused hub with a built-in pipeline of future medical workers (doctors, nurses, researchers) now studying at Rush University. It has about 1,800 physicians and an expansive outpatient footprint, with new sites opening in Chicago’s River North and South Loop neighborhoods, and in Oak Brook. An estimated $500 million outpost on Rush University Medical Center’s campus is underway. Each hospital in the system will retain its own board and management.

Rush Copley is already a market share leader on Chicago’s west side but lacked certain specialists, such as neurologists, on its roster. Through the new structure, patients at Copley can now gain access to those specialists. Rush Oak Park is about to break ground on a new $30 million emergency department, and it plans to add about 30 specialists from Rush University Medical Center. That’s about a third more than this community hospital has now.

ACA DEBATE DOESN’T SLOW HEALTH EMPLOYMENT

The healthcare sector created 26,800 jobs in February, surpassing the 18,300 new positions in January, according to the February jobs report issued Friday by the Bureau of Labor Statistics. Healthcare was among the sectors that drove total national jobs creation in February to a better-than-expected 235,000 jobs. The ambulatory healthcare services subsector grew the most with 18,300 jobs created. Ambulatory services grew by 7,100 jobs in January.

Hospitals added jobs in February as well. Hospital jobs grew by 6,300 positions compared to 1,700 added in January. The industry still needs more workers to care for patients. The aging population remains a long-term demographic driver for the industry.

MOODY’S WEIGHS IN ON THE ACA

Moody’s recently released its overview of the credit impact of legislation to repeal and alter aspects of the Affordable Care Act (ACA) on hospitals. It views many of them as credit negative because they would reduce the number of people with health insurance and increase bad debt and uncompensated care costs. However, some elements of the legislation in Moody’s view, such as preserving federal funding for Medicaid expansion for several years, have no immediate credit effect, while others, such as eliminating scheduled Disproportionate Share (DSH) cuts for states that did not expand Medicaid, are credit positive. Components of the legislation most likely to negatively affect hospitals are the Medicaid expansion freeze in 2020, transitioning federal Medicaid payments to a per-capita payment to the states and changes to how subsidies are calculated for people who buy coverage on the exchanges. Restoring DSH cuts to nonexpansion states is credit positive for hospitals in those states. Repealing the individual mandate to obtain health insurance and replacing it with a “continuous coverage” requirement will only modestly increase insurance coverage.

Importantly, the legislation does not repeal Medicaid expansion; states would be allowed to maintain expanded Medicaid eligibility, but they would bear a greater share of the costs starting in 2020. Expansion of Medicaid eligibility has been the single largest driver of insurance coverage gains under the ACA. Starting in 2020, federal support for Medicaid would involve per-capita payments indexed to inflation (currently, federal Medicaid payments are not capped and rise or fall with state expenditures on Medicaid).

We expect that federal payments will grow more slowly than Medicaid program costs, forcing states to make changes that would likely be credit negative for hospitals, including lowering payments to hospitals and other providers, reducing coverage or benefits and reducing targeted payments to safety-net hospitals. States that have not expanded Medicaid would still have the ability to do so before 2020. Eliminating cuts to Medicaid DSH (payments to hospitals that care for a disproportionately large share of uninsured individuals) for the 19 states that did not expand Medicaid would be credit positive for hospitals in those states, particularly for safety-net providers.

Changes to subsidies available to people purchasing insurance on the exchanges would be credit negative for hospitals because they would reduce the subsidy available to many people, prompting them to drop insurance coverage. Subsidies under the legislation would be based on age, with no subsidies available to people who exceed the income threshold. The legislation would also allow insurers to charge up to 5x more for older people than younger people, versus 3x today.

This would lower costs for younger enrollees, encouraging more of them to purchase insurance and contributing to stability on the exchanges. However, this will also raise costs for older enrollees, causing more of them to drop coverage, which is credit negative for hospitals. We believe that the effect of older enrollees losing coverage will outweigh the positive effect of younger people gaining coverage given that older people have greater healthcare needs and as they lose coverage, hospitals would incur greater uncompensated care and bad-debt costs.

Repealing the individual mandate would be credit negative for hospitals because some individuals would drop insurance coverage if they no longer face a financial penalty for not purchasing insurance. However, the credit effect on hospitals is not material given that the current financial penalties for not purchasing insurance are too small to compel many young and relatively healthy people to buy insurance. Likewise, the discontinuation of the mandate is not as material proportionately because the proposed changes to Medicaid expansion are responsible for the majority of insurance gains since the passage of the ACA.

The House legislation replaces the individual mandate with a continuous coverage requirement to incentivize people to purchase coverage. Under continuous coverage, insurers cannot deny coverage to anyone (regardless of pre-existing conditions) so long as they have maintained continuous coverage. If coverage has lapsed, insurers must charge rates that are 30% higher than they would otherwise charge. The ability of the continuous coverage requirement to keep people from dropping insurance coverage in the absence of an individual mandate will depend on the prices of available health plans and the level of subsidies available to offset premiums. However, we do not believe that the threat of a rate increase in the future will be enough to entice relatively healthy people to purchase insurance if they believe they do not need it.

WILL DISCLOSURE HOLD UP IN THE CURRENT ENVIRONMENT

There has been some static on the disclosure front recently which sends at best mixed messages to the market. The Securities and Exchange Commission today voted to propose rule amendments to improve investor protection and enhance transparency in the municipal securities market.

Rule 15c2-12 under the Securities Exchange Act of 1934 requires brokers, dealers, and municipal securities dealers that are acting as underwriters in primary offerings of municipal securities subject to the Rule, to reasonably determine, among other things, that the issuer or obligated person has agreed to provide to the Municipal Securities Rulemaking Board (MSRB) timely notice of certain events. The amendments proposed by the SEC today would add two new event notices.

Incurrence of a financial obligation of the issuer or obligated person, if material, or agreement to covenants, events of default, remedies, priority rights, or other similar terms of a financial obligation of the issuer or obligated person, any of which affect security holders, if material; and Default, event of acceleration, termination event, modification of terms, or other similar events under the terms of the financial obligation of the issuer or obligated person, any of which reflect financial difficulties.

The Municipal Securities Rulemaking Board (MSRB) today endorsed the Securities and Exchange Commission (SEC) for proposing regulatory changes to improve the content and timeliness of disclosure of information about bank loans and other alternative financings entered into by issuers of municipal securities. The risks of these transactions include terms and conditions of alternative financings that may require the acceleration of debt repayment if the borrower encounters financial stress or the dilution of a bondholders’ security position if a bank loan is on parity with or senior to other outstanding debt.

Overall, these incremental improvements are fine but the key is whether they will receive the robust support they will need from a Trump administration. Many market participants are skeptical about the long-term commitment to issuer oversight and disclosure from an administration so committed to the reduction of government regulation in all sectors of oversight. These proposed changes will only help if they are supported by adequate resources, staffing, and leadership at the agency level.

WHY DISCLOSURE WILL MATTER WITH SMALLER HOSPITAL ISSUERS

Many times the discussion of disclosure can seem a bit remote especially if you deal with only the larger more well distributed credits. In the healthcare space, the most vulnerable credits are often the one’s with the least robust disclosure practices. These are institutions which because of their relatively small size and infrequent use of or access to the public debt markets, are not attuned to the information needs of investor participants.

These institutions are the kind of hospitals which are vulnerable by their size, service array, and location to the changes in funding included in the proposed AHCA. These are primarily smaller rural institutions which provide a lower level of care or they are specialty institutions which are vulnerable to procedure specific reimbursement changes. The rural institutions tend to be weaker credits for a variety of reasons. They tend to be smaller and their customer bases tend to be older and less economically well off than is the case with large urban based hospital systems. As such, their profitability is more marginal and their ability to develop and accumulate cash on their balance sheets is lessened.

Of the 25 states that have seen at least one rural hospital close since 2010, those with the most closures are located in the South, according to research from the North Carolina Rural Health Research Program. Thirteen hospitals in Texas have closed since 2010, the most of any state. Tennessee has seen the second-most closures, with eight hospitals closing since 2010. In third place is Georgia with six closures followed by Alabama and Mississippi, which have each seen five hospitals close over the past six years.

80 rural hospitals closed between January 2010 and November 2016, as tracked by the NCRHRP. For the purposes of its analysis, the NCRHRP defined a hospital closure as the cessation in the provision of inpatient services. As of November, all of the facilities no longer provided inpatient care. However, many of them still offered other services, including outpatient care, imaging, emergency care, urgent care, primary care or skilled nursing and rehabilitation services.

Our feeling is that this sector has been underrepresented in the public debt markets. It is likely to need to access the market as rates increase and the need to reach more sophisticated investors who are comfortable with risk rises. These more sophisticated investors will tend to need more information in order to meet their own internal and external compliance requirements. The trend of closures and the credit weakness it reflects only heighten the need for good current information.

Muni Credit News March 14, 2017

Joseph Krist

joseph.krist@municreditnews.com

THE HEADLINES…

PUERTO RICO’S PLAN GETS PROMESA APPROVAL

FLORIDA HIGH SPEED RAIL ANNOUNCES DELAY

TECH HELPING CREDIT

CIVIL ENGINEERS GRADE INFRASTRUCTURE

REGULATORS GET A PLEA BUT IS IT A ONE OFF?

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PUERTO RICO’S PLAN GETS PROMESA APPROVAL

After a week of vigorous back and forth debate between the Government of Puerto Rico and the Promesa fiscal control board it was announced that the fiscal control board approved its plan for Puerto Rico: a “progressive” 10% cut to pensions, a $450 million reduction to the University of Puerto Rico (UPR) budget and the approval of measures presented by Gov. Ricardo Rosselló in his revised fiscal plan, which was delivered over the weekend.

The board approved a partial reduction to the workweek of public employees and teachers— not including public safety personnel—along with the elimination of the Christmas bonus for these employees. The board argued that without this measure it could not be possible to guarantee the government would have enough money for the provision of essential services.

To avoid the furlough, the government will have to identify, by summer, on its next budget to be delivered April 30 along with a liquidity plan, about $200 million in contingency funds. If not, the board will reevaluate the situation in September, when it will determine whether to modify or eliminate the workweek reduction and the Christmas bonus. For his part, the governor’s representative to the board said he is “confident” this will not happen and that it represents a “precautionary measure” in case the government does not achieve having the expected cash flow.

During its fifth public meeting, which was held in New York, the financial control board announced what it called amendments to the latest version of the fiscal plan presented by the governor. The board said it reached agreements with the administration regarding economic projections and in identifying greater government resources, mainly through an increase to the tax on tobacco products.

The cuts to pensions and the UPR must be carried out on or before fiscal year 2020. In the case of pensions, the board said it had differences with the Rosselló administration and will therefore work side by side during the next 30 days on a plan to establish a simple paygo, or pay-as-you-go, system; liquidate assets to finance the benefits due in the previous plan; and place all pensioners and public employees in defined-contribution plans, segregating their contributions in individual accounts that ensure the payment of their benefits in the future.

Another measure was included that seeks to provide Social Security benefits for all new teachers and police officers. Although not discussed at the public meeting, the certified plan keeps a $450 million cut over three years for the UPR that was recently required by the board, government officials publicly confirmed later.

Prior to the approval, The Financial Oversight and Management Board had said that, in its view, the Government of Puerto Rico’s cash position is “so critically low that unless emergency actions are taken immediately, in a matter of months it will run out of money to pay for essential services such as education, healthcare and public safety.” A report by auditing firm Ernst & Young on the government’s bridge between the 2014 audited financial statements and the 2017 baseline numbers the government used in its originally proposed fiscal plan, the government’s fiscal year 2017 expenditures could be understated by $360 million to $810 million, “based on historical expenditure trends.”

The board had recommended: Immediate implementation of a furlough program to achieve $35 million to $40 million in monthly savings, through the equivalent to four days per month for most executive branch government personnel and two days per month for teachers and frontline personnel at 24-hour institutions. Frontline law enforcement personnel should be exempted from the furlough program. Reductions comparable to the executive branch furlough savings described above for other entities across the government, including public corporations and instrumentalities and the legislative and judicial branches. Reductions in professional service contract expenditures of up to 50 percent and significant reductions in all government contract expenditures. Reductions in healthcare costs, by negotiating drug pricing and reductions of rates to health plans and providers.

The board did say that it understands the difficulty in implementing a $300 million cut to the UPR for fiscal year 2019, and says the magnitude of the deficit requires the number raised to $450 million by fiscal year 2021. As for pensions, it insisted that the adjustment should be of at least 10% to prevent other sectors from assuming a greater burden as a result of the insolvency of pension plans. If the retirement system runs out of money at the end of the year, general fund money would have to compensate for the shortfall, which would mean fewer resources available to cover other essential services such as education and the healthcare system. The board calls for further cuts to pension benefits and for the government to demonstrate that it is segregating the contributions of public employees so as to ensure the money is not misused. The governing body also proposes that government payroll be cut more, to $1.3 billion by 2021.

The government adjusted some of its proposed measures and baseline numbers in the revised document delivered to the board on Saturday morning, in a bid to keep alive its chances to have its plan—and not the board’s—be certified. Now that it is approved by the board, the government must move toward the preparation and certification of a budget by April 30. Likewise, any law approved by the Legislature must be consistent with the fiscal blueprint. Failure to do so, as the board determines in its sole discretion, would invalidate the legislation. The plan also lays down the groundwork for negotiations with Puerto Rico’s different creditor groups, as both the government and the board would know how much money is available to pay for debt service each year.

FLORIDA HIGH SPEED RAIL ANNOUNCES DELAY

A former executive with the New York Mets and the Madison Square Garden Co., Dave Howard has been named CEO of the high speed rail line sponsor. The announcement was accompanied by the news that the West Palm Beach-to-Orlando portion of the train project, referred to as Phase II, needs additional permits. A concrete financing plan is not yet in place either. Service between South Florida and Orlando International Airport was slated to begin by year-end.

The delay is due to ongoing litigation that has tangled financing plans for the project since 2015, when two Treasure Coast counties sued Brightline and the U.S. Department of Transportation. As we have previously documented, Martin and Indian River County allege the DOT skirted protocol pertaining to environmental impact studies, giving Brightline improper access to over $1 billion worth of tax-exempt government bonds to build the train project through their cities.

We do not see anything in the current news which improves the credit profile of the project or enhances the likelihood of a near-term financing for the project in the municipal bond market.

TECH HELPING CREDIT

As an older city with structural financial difficulties, an emphasis on technology in Philadelphia’s financial management might not be expected. The Mayor’s proposed FY 2018 budget message offers comments which suggest otherwise. The comments detail how applying the right enforcement tool at the right time on the right account is essential for the efficient collection of delinquent revenue, and data analysis allows the City’s Department of Revenue to better understand the characteristics of an account and identify the best course of action. In FY17, the City launched a Data Warehouse and Case Management system. When fully implemented, the system will pull information about the individuals and businesses that have debts to the City into a single location, allowing a comprehensive picture to emerge and providing the tools to turn information into revenue.

In partnership with researchers from the University of Pennsylvania, the City tested various messages in letters to delinquent account holders to determine the most effective communications to produce payment. By the end of FY17, the Department of Revenue will begin using predictive analytics to score delinquent accounts to see how much money will likely be collected and what type of enforcement will be the most efficient. Without this data-driven approach, resources and time would be used less efficiently either pursuing cases that would resolve on their own or are unlikely to respond to a particular approach. Revenue has already made progress toward collecting every dollar that is owed. For example, the percent of real estate taxes owed that are paid within the first year has increased from 86.6% in Calendar Year 2011 to 94.2% in Calendar Year 2015.

CIVIL ENGINEERS GRADE INFRASTRUCTURE

Every four years, America’s civil engineers provide a comprehensive assessment of the nation’s 16 major infrastructure categories in the American Society of Civil Engineers’s Infrastructure Report Card. Using a simple A to F school report card format, the Report Card examines current infrastructure conditions and needs, assigning grades and making recommendations to raise them. The latest report was released last week and the results were not good. The overall grade assigned was a D+. A D+, according to the report, means the infrastructure is in poor to fair condition and mostly below standard, with many elements approaching the end of their service life. It also indicates that a large portion of the system exhibits significant deterioration. Condition and capacity are of serious concern with strong risk of failure.

A grade reflects a wide variety of criteria. Does the infrastructure’s capacity meet current and future demands? What is the infrastructure’s existing and near-future physical condition? What is the current level of funding from all levels of government for the infrastructure category as compared to the estimated funding need? What is the cost to improve the infrastructure? Will future funding prospects address the need? What is the owners’ ability to operate and maintain the infrastructure properly? Is the infrastructure in compliance with government regulations?

To what extent is the public’s safety jeopardized by the condition of the infrastructure and what could be the consequences of failure? What is the infrastructure system’s capability to prevent or protect against significant multi-hazard threats and incidents? How able is it to quickly recover and reconstitute critical services with minimum consequences for public safety and health, the economy, and national security? What new and innovative techniques, materials, technologies, and delivery methods are being implemented to improve the infrastructure?

The findings are not a surprise to those of us who follow these events. California has extensive needs in a number of areas as does Pennsylvania and Texas. Drinking water and wastewater needs are greatest in the northern rural states. Bridges are a particular issue in California, Oklahoma, Pennsylvania, and Iowa. Road costs are highest on the West Coast and in the northeast. School needs are the greatest in poorer rural areas. Rail is an issue in the northeast and the Rust Belt as well as in Texas.

Depending on the category, the needs are not all based on age. In a category like schools for instance, much of the need is based on the use of short-term measures to meet greater demand which has now become permanent. As knowledge has increased, much of the need is based on the requirement for more environmental resilience for facilities new and old.

Specific sectors are detailed. U.S. airports serve more than two million passengers every day. Congestion at airports is growing; it is expected that 24 of the top 30 major airports may soon experience “Thanksgiving-peak traffic volume” at least one day every week. With a federally mandated cap on how much airports can charge passengers for facility expansion and renovation, airports investment needs face a $42 billion funding gap between 2016 and 2025.

American transit systems carried 10.5 billion passenger trips in 2015. This is a 33% increase from 20 years ago, when transit carried 7.9 billion trips, but is 250 million trips less than in 2014 (the Uber effect). 11% of American adults reported taking public transportation on a daily or weekly basis in 2015. Buses are the most common form of public transportation, accounting for approximately half of passenger trips in 2015. The 15 heavy rail (subway/metro) systems comprise the majority of non-bus trips, accounting for over a third of total passenger trips. While transit has higher ridership in urban areas, there are nearly 1,400 public transit systems in rural areas, providing paratransit, bus, commuter bus, and vanpool service.

In 2016 alone, U.S. roads carried people and goods over three trillion miles—or more than 300 round trips between Earth and Pluto. After a slight dip during the 2008 recession, Americans are driving more and vehicle miles travelled is at its second highest-ever level, second only to 2007. More than two out of every five miles of the nation’s urban interstates are congested. Of the country’s 100 largest metro areas, all but five saw increased traffic congestion from 2013 to 2014. In 2014, Americans spent 6.9 billion hours delayed in traffic—42 hours per driver. All of that sitting in traffic wasted 3.1 billion gallons of fuel. The lost time and wasted fuel combine for a total economic impact in 2014 of $160 billion.

Nearly 240 million Americans – 76% of the population – rely on the nation’s 14,748 treatment plants for wastewater sanitation. By 2032 it is expected that 56 million more people will connect to centralized treatment plants, rather than private septic systems – a 23% increase in demand. In the U.S., there are over 800,000 miles of public sewers and 500,000 miles of private lateral sewers connecting private property to public sewer lines. Each of these conveyance systems is susceptible to structural failure, blockages, and overflows.

The U.S. has 614,387 bridges, almost four in 10 of which are 50 years or older. 56,007 — 9.1% — of the nation’s bridges were structurally deficient in 2016, and on average there were 188 million trips across a structurally deficient bridge each day. While the number of bridges that are in such poor condition as to be considered structurally deficient is decreasing, the average age of America’s bridges keeps going up and many of the nation’s bridges are approaching the end of their design life. The most recent estimate puts the nation’s backlog of bridge rehabilitation needs at $123 billion.

REGULATORS GET A PLEA BUT IS IT A ONE OFF?

Aaron Troodler, the former executive director of the Ramapo (NY) Local Development Corp. has pleaded guilty to securities fraud — the first conviction for criminal federal securities fraud in connection with municipal bond issuances, according to a U.S. attorney. The U.S. alleges that Troodler and Ramapo’s supervisor and director of finance lied to investors in the town’s and RLDC’s bonds, some of which were used to finance a minor league baseball stadium, in order to conceal the deteriorating state of Ramapo’s finances and the inability of the RLDC to make scheduled payments of principal and interest to holders of its bonds from its own money.

The fraudulent activity, which included information provided in the preliminary official statement for the bonds, was designed to conceal the town’s deteriorating general fund Ramapo’s primary operating fund. The general fund was estimated to have faced deficits ranging between $250,000 and $14 million between the town’s fiscal years 2009 and 2014. As of August 2015, the town had more than $128 million in outstanding bonds that had been issued for various municipal purposes while the RLDC, which is owned by the town, had issued $25 million in bonds to pay for the minor league baseball stadium.

The fraud preceded the construction of the baseball stadium. Ramapo paid more than half the cost even after the town’s citizens had voted to reject paying for the stadium through bonds in a 2010 referendum. The finance director had publicly stated that no public money would be used. It is charged that the finance director also lied to agencies which rated the RLDC’s bonds in 2013 when he said the 2012 general fund balance would remain unchanged from the 2011 balance.

The plea is an important step in support of ongoing efforts to improve disclosure and to discourage fraudulent activities by those who issue bonds in the public markets. While it may have required a fairly egregious act of fraud to spur criminal prosecution, municipal investors should take heart that there will finally be real consequences for perpetrators. At the same time our optimism is tempered by the recent moves to replace U.S. prosecutors who have been active in working against municipal securities fraud.

Muni Credit News March 9, 2017

Joseph Krist

Municipal Credit Consultant

THE HEADLINES…

ACA REPLACEMENT INTRODUCED TO A VERY TEPID RECEPTION

NEW JERSEY

COULD PENNSYLVANIA BUDGET SEE A HIGH FROM MARIJUANA?

PHILADELPHIA BUDGET

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ACA REPLACEMENT INTRODUCED TO A VERY TEPID RECEPTION

Speaker Paul Ryan has finally released drafts of two measures which would dismantle the core aspects of the ACA, including its subsidies to help people buy coverage, its expansion of Medicaid, its taxes and its mandates for people to have insurance. In its place, Republicans would put in place a new system centered on a tax credit to help people buy insurance. That tax credit would range from $2,000 to $4,000 a year, increasing with someone’s age. That system would provide less financial assistance for low-income and older people than The ACA, but it could give more assistance to younger people and those with higher incomes.

Republicans acknowledge that their plan will cover fewer people. House committees are expected to vote on the measures this week, with the full House voting on it soon after that. The repeal of the Medicaid expansion would not take effect until 2020, and the bills would grandfather in current enrollees so that they can stay on the program. But once 2020 arrives, the federal government would no longer provide the extra federal funds that allow for expansion.

Passage is not a certainty in the House. Conservatives in the House Freedom Caucus call the bill’s tax credit is a “new entitlement.” As for other widely discussed issues, the bill would maintain the ACA’s protections for people with pre-existing conditions, who could still not be denied coverage. Instead of The ACA’s mandate, the bill would seek to encourage healthy people to sign up by allowing insurers to charge people 30 percent higher premiums if they have a gap in coverage.

The measure repeals The ACA’s taxes, such as the medical device tax and health insurance tax, starting in 2018. To avoid one of the most controversial issues, the bill does not include a Republican proposal in earlier drafts to start taxing some employer-sponsored health insurance programs. Instead, the measure would keep The ACA’s “Cadillac tax” on generous healthcare plans starting in 2025 in order to prevent that legislation from adding to the deficit in that decade.

A number of points will prove contentious in the Senate. Four “moderate” Republican senators from states that expanded Medicaid under the ACA have sent a letter to the Majority Leader saying they can’t support a draft House repeal bill because it won’t protect people enrolled in the health entitlement. “We are concerned that any poorly implemented or poorly timed change in the current funding structure in Medicaid could result in a reduction in access to life-saving health care services,” Sens. Rob Portman of Ohio, Shelley Moore Capito of West Virginia, Cory Gardner of Colorado and Lisa Murkowski of Alaska wrote in a letter to Majority Leader Mitch McConnell.

“The February 10th draft proposal from the House does not meet the test of stability for individuals currently enrolled in the program and we will not support a plan that does not include stability for Medicaid expansion populations or flexibility for states.” Nationwide, more than 11 million people got Medicaid through the expansion under The ACA. In Ohio alone, some 700,000 residents obtained insurance because of the state’s expansion.

Senators Capito and Murkowski have been clear in expressing their concerns about the impact on rural healthcare availability under repeal. Other Senate opposition could come from Sen. Orrin Hatch who will not support a repeal which does not include a repeal of all the including the Cadillac tax. The American Hospital Association announced Tuesday its opposition to the GOP’s healthcare reform plan. It referenced the proposal that would strike funding for states to expand Medicaid beyond 2019. The AHA suggested other alternatives, such as greater use of federally approved waivers, which have given states a method to test out different ways to implement Medicaid that maintain the program’s objectives but do not follow federal rules.

“The expanded use of waivers with appropriate safeguards can be very effective in allowing state flexibility to foster creative approaches and can improve the program more effectively than through imposing per-capita caps,” it said. It asked Congress to wait for the Congressional Budget Office (CBO) to score and release estimates on how many individuals the GOP version would cover before moving the bill forward.

The American Medical Association also weighed in. While it agrees that there are problems with the ACA that must be addressed, it cannot support the AHCA as drafted because of the expected decline in health insurance coverage and the potential harm it would cause to vulnerable patient populations. The AMA has long supported advanceable, refundable tax credits as a preferred method for assisting individuals in obtaining private health care coverage. It is important, however, that the amount of credits available to individuals be sufficient to enable one to afford quality coverage. We believe that credits should be inversely related to an individual’s income. This structure provides the greatest chance that those of the least means are able to purchase coverage. The AMA believes credits inversely related to income, rather than age as proposed in the committee’s legislation, not only result in greater numbers of people insured but are a more efficient use of tax-payer resources.

The AMA policy also supports increased flexibility in the Medicaid program so that states may pursue innovations that improve coverage for patients with low incomes. It expressed concern, however, with the proposed rollback of the Medicaid expansion under the ACA. It urged that that Medicaid, CHIP, and other safety net programs are maintained and adequately funded.

States that did not expand Medicaid

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States that expanded Medicaid

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State, county, and hospital credits will all see a negative impact from the current bill. Less coverage overall and less coverage for low income and indigent patients will strain state and county budgets. Not only will hospitals face lower revenues but greater uncompensated care burdens and a reversal of the trend away from use of the emergency room as the source of primary care. Hospitals in areas which already face service constraints and weaker financial profiles will be placed under additional stress.

There is no official estimate from the Congressional Budget Office, they have no idea yet how much their American Health Care Act costs and how many people might lose their health coverage because of it. Seven Republican senators have gone record opposing parts of the bill. Republicans can lose only two votes in the Senate and still pass the repeal bill through a fast-track process that requires a simple majority vote. The outcome is far from certain.

NEW JERSEY

One of Gov. Chris Christie’s legacies will be his failure to fund or fundamentally restructure his state’s pension underfunding problems. He used his budget address to one last attempt at addressing government worker pensions, proposing to dedicate revenues from lottery ticket sales to the distressed fund. Christie said pledging the lottery as an asset to the pension fund would have “the same effect as a cash infusion,” slashing $13 billion from the pension fund’s $66.2 billion in unfunded liabilities.

The lottery, which is expected to bring in $965 million this year, helps fund higher education programs, psychiatric hospitals, centers for people with developmental disabilities and homes for disabled soldiers. The lottery, which is expected to bring in $965 million this year, helps fund higher education programs, psychiatric hospitals, centers for people with developmental disabilities and homes for disabled soldiers.

Under the state Constitution, lottery proceeds must be spent on state institutions and state aid for education. The state pays a number of costs on behalf of local school districts that can be categorized as aid, including the employer share of the Teachers’ Pension and Annuity Fund. Under the state Constitution, lottery proceeds must be spent on state institutions and state aid for education. The state pays a number of costs on behalf of local school districts that can be categorized as aid, including the employer share of the Teachers’ Pension and Annuity Fund.

The proposal raised questions about how the services currently funded by lottery proceeds would be funded. Christie contends that the plan “if implemented correctly, would not only increase the value and stability of the pension funds immediately, but it would also please bond investors and credit rating agencies.” We could not disagree more. Regardless of the funding scheme adopted, a signature feature of the Governor’s tenure has been his consistent failure to fund annual required contributions (ARC). Wherever he finds the money, a payment equal to at least the ARC would be much more impressive to raters and investors alike. funds immediately, but it would also please bond investors and credit rating agencies.

COULD PENNSYLVANIA BUDGET SEE A HIGH FROM MARIJUANA?

Auditor General Eugene DePasquale said Pennsylvania should strongly consider regulating and taxing marijuana to benefit from a booming industry expected to be worth $20 billion and employ more than 280,000 in the next more sane policy to deal with a critical issue facing the state. Other states are already taking advantage of the opportunity for massive job creation and savings from reduced arrests and criminal prosecutions. In addition, it would generate hundreds of millions of dollars each year that could help tackle Pennsylvania’s budget problems.” “The revenue that could be generated would help address Pennsylvania’s revenue and spending issue. But there is more to this than simply tax dollars and jobs,” DePasquale said. “There is also social impact, specifically related to arrests, and the personal, emotional, and financial devastation that may result from such arrests.”

DePasquale cited Colorado’s experience with legalization. In Colorado’s experience, after regulation and taxation of marijuana, the total number of marijuana arrests decreased by nearly half between 2012 and 2014, from nearly 13,000 arrests to 7,000 arrests. Marijuana possession arrests, which make up the majority of all marijuana arrests, were nearly cut in half, down 47 percent, and marijuana sales arrests decreased by 24 percent.

DePasquale said Pennsylvania has already benefited by some cities decriminalizing marijuana. In Philadelphia, marijuana arrests went from 2,843 in 2014 to 969 in 2016. Based on a recent study, the RAND Corporation estimated the cost for each marijuana arrest and prosecution is approximately $2,200. Using those figures, that’s a savings of more than $4.1 million in one Pennsylvania city. Last year, York, Dauphin, Chester, Delaware, Bucks and Montgomery counties each had more arrests for small amounts of marijuana than Philadelphia. Those counties had between 800 and 1,400 arrests in 2015.

In Colorado, total state revenues from all sources of marijuana sales taxes and licensing fees in 2016 was $119.8 million. This was an increase of 57% above 2015 collections. In Washington state, FY 2017 marijuana sales tax collections are estimated to total $201 million, an increase of over 7% above FY 2016 collections.

We suspect that legalization will not be an easy sell in socially conservative state is wide. The Auditor General’s statement does start a conversation however in a state that faces serious revenue and pension expense issues going forward.

PHILADELPHIA BUDGET

It has only been in place for less than three months and is the subject of pending litigation challenging its validity, but the Philadelphia Beverage Tax is being counted on heavily by the City’s Mayor for three major policy initiatives. Full implementation of the three programs cannot happen, however, until the resolution of litigation brought to try to block the tax. The FY18 Budget and FY18-22 Five Year Plan continue an effort to ensure all three- and four-year-olds in the city can gain access to pre-K through Philadelphia Beverage Tax revenues.

The Philadelphia Beverage Tax revenue also provides necessary revenue to fund a community schools initiative. Over the Five Year Plan, 25 community schools will be created. The third major initiative to be funded through the Philadelphia Beverage Tax is Rebuilding Community Infrastructure (Rebuild), a multi-year program to transform neighborhood parks, recreation centers, and libraries across the city. The tax will support debt service to pay for $300 million in borrowings, which, combined with $48 million in the City’s capital program, will leverage foundation support (such as support from the William Penn Foundation) and funds from other governments to bring the total amount of the program to $500 million.

On September 14, 2016, a lawsuit challenging the PBT was filed by the American Beverage Association and other co-plaintiffs in the Court of Common Pleas. This complaint was dismissed in its entirety by the Court of Common Pleas on December 16, 2016. Following the decision, the plaintiffs appealed the ruling to the Commonwealth Court of Pennsylvania. The appeal is currently on an expedited scheduling track before the Commonwealth Court and is scheduled for oral argument during the first week of April 2017. Until the PBT litigation is resolved, the City will not be able to issue borrowings for the $300 million that it plans to invest in Rebuild. In addition, the City will not be able to use $75 million of William Penn grant funds that are conditioned on bond issuance. An additional $20 million is contingent on funding from other sources, such as grants from other foundations.

Three-quarters of the City’s General Fund revenue comes from local taxes, and 18.5% of this tax revenue is Real Property Tax. In addition, over 60% of the local tax revenue generated for the School District of Philadelphia comes from the Property Tax. The General Fund started FY17 with an unreserved fund balance of $148.3 million and is projected to end FY17 with a fund balance of $100.7 million. The year-end fund balance for FY18 is projected to be $87.5 million. Over the next five years, the fund balance is projected to decrease to a low of $68.7 million in FY20 and then build back up to $101.8 million in FY22. For each year of the plan, the fund balance is below the City’s target. With high fixed costs such as the City’s contribution to the pension fund, the School District of Philadelphia, debt service, and indemnities, other important services and programs are squeezed for resources.

The Philadelphia Municipal Retirement System is currently 44.8% funded with a $6 billion unfunded liability, based on the July 1, 2016 preliminary valuation. Each year, an increasing share of City resources goes towards paying pension costs and therefore cannot be used to provide additional resources for current services or to pay for further tax rate reductions. To address this challenge, the Kenney Administration, working with municipal employees, the Pension Board, and City Council, has launched a three-pronged approach to improve the health of the Pension Fund from 44.8% to 80% in about 13 years.

In 2014, the State Legislature required that the City dedicate a portion of local sales tax revenue to the Fund. Although the additional sales tax revenues could be counted toward satisfying minimum municipal obligation (MMO), the amount required under state law, the City will meet its MMO independent of these revenues, so that sales tax dollars directed to the Fund will be over and above the MMO. Over this Five Year Plan, the sales tax revenues are projected to be worth about $233 million.

Current employees would make additional contributions based on a progressive tiered contribution structure; those with higher annual salaries would pay a higher contribution rate. These additional contributions would increase the assets of the pension fund over time rather than be used to reduce the City’s contribution to the fund. At the same time, newly hired workers would participate in a new, stacked hybrid pension plan. The proposed stacked hybrid plan combines a traditional defined benefit for the first $50,000 of an employee’s pensionable earnings, and an optional 401k, with an employer match, for earnings above this amount.

The Board of Pensions has also been consistently making the Fund’s actuarial assumptions more conservative – reducing the chances of the plan falling short of projected investment returns. Since FY08, the Board has incrementally lowered the assumed rate of return eight times from 8.75% to the current rate of 7.70%. Through consultation with the City’s actuary, the Board also approved changes to make the mortality rate and other demographic factors more conservative. While fiscally prudent, these changes also lower the actuarial funding percentage in the short-term and increase the City’s required contribution. The most recent reduction to the earnings assumption, from 7.75% to 7.70% in February 2017, reduced the funding percentage by 0.02% and increased the MMO by approximately $5 million each year, for an additional $27.6 million over this Five Year Plan (across all funds).

Muni Credit News March 7, 2017

Joseph Krist

joseph.krist@municreditnews.com

THE HEADLINES…

ENERGY STATE BLUES BLEEDING THROUGH TO RATINGS

KANSAS COURT RULING ON EDUCATION SPELLS BAD NEWS

ILLINOIS BUDGET STANDOFF CONTINUES

P.R. DRAMA TO DRAG ON

LARGE HEALTH SYSTEM DOWNGRADE

NYC BUDGET REVIEW

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ENERGY STATE BLUES BLEEDING THROUGH TO RATINGS

Oklahoma joined the ranks of energy dependant states to see their rating downgraded in the face of declining revenues as energy prices remain low. The Sooner State joined Louisiana, New Mexico, and West Virginia in experiencing revenue squeezes as the result of relatively low energy prices. S&P lowered the state’s general obligation bond debt rating from AA+ to AA. The agency also lowered its rating on the state’s appropriation debt from AA to AA-.

It kept its outlook on the state’s financial picture as stable, but warned Oklahoma’s reliance on one-time sources of revenue to balance the budget makes the state vulnerable to further revenue declines. “In the absence of meaningful structural reforms that align revenues and expenditures and that do not materially depend on one-time budget solutions or measures that carry significant implementation risk, we could lower the ratings.”

The state treasurer said “Years of suboptimal budgeting that has relied heavily on the use of nonrecurring revenue is now impossible for the rating agencies to ignore. This downgrade, and others likely to come, will lead to higher debt costs for future infrastructure projects unless sustainable corrective action is taken.”

KANSAS COURT RULING ON EDUCATION SPELLS BAD NEWS

The Kansas Supreme Court on Thursday ruled unanimously that state funding to schools is inadequate and gave the Legislature a June deadline to enact changes, scrambling a legislative session already consumed by a sprawling budget debate.

The ruling in the Gannon lawsuit came as lawmakers were away for a week-long break at the traditional midpoint of the legislative session, but it sent shockwaves throughout the state. Gov. Sam Brownback, as well as Republican and Democratic lawmakers, said the decision emphasizes the need for lawmakers to enact a new finance formula.

“Under the facts of this case, the state’s public education financing system provided by the legislature for grades K-12, through its structure and implementation, is not reasonably calculated to have all Kansas public education students meet or exceed,” educational standards, the court ruled.

The court’s opinion doesn’t give an exact amount lawmakers need to spend. But an attorney for the plaintiff school districts, Alan Rupe, said $800 million or more is needed.

The court’s opinion doesn’t give an exact amount lawmakers need to spend. But an attorney for the plaintiff school districts, Alan Rupe, said $800 million or more is needed. The court gave the Legislature a June 30 deadline to make changes. Every justice joined in the ruling, except Justice Caleb Stegall and Carol Beier, who recused themselves in the case.

A 2014 ruling by a three-judge panel in Shawnee County held the school financing system in place at the time, in both its structure and implementation was not “reasonably calculated” to have all students meeting desired educational outcomes. They were also critical of lawmakers for shifting the funding burden from the state to the local level.

That ruling came after the Supreme Court asked the district court to look at the adequacy of funding based on what it would cost to achieve desired educational outcomes for students. The desired outcomes are referred to as the Rose Standards, a concept originally used in a Kentucky court case. The standards focus on preparing students for life outside of school — from personal and civic life to careers and mental and physical well-being.

During oral arguments before the Supreme Court last September, attorneys for the districts said lawmakers were violating the state constitution by providing only enough aid to districts so a portion of students do well. “We’re leaving massive numbers of kids behind in public education,” plaintiffs’ counsel argued at the time. He referred to his fourth-grade granddaughter, Katelyn. “I’d like her generation to graduate in an adequately funded system.”

Kansas Solicitor General Stephen McAllister, arguing on behalf of the state, told the justices during oral arguments that more spending on schools won’t necessarily improve academic outcomes for students. Some of the additional money “will be wasted” on teacher salary increases and other spending. “We cannot achieve 100 percent proficiency,” McAllister told the court. “What you’ve got to do, I think, is look at what is realistic.”

The court’s Thursday ruling is the second major school finance ruling in little more than a year. In February 2016, the Supreme Court ruled that funding between schools was inequitable. The decision led to a special legislative session, where lawmakers boosted equity spending by $38 million.

The decision is credit positive for local school districts especially in the states major metropolitan areas. As for the state, a resolution would be positive on some levels but could be negative if other credits like highway fund debt are impacted by transfers of dedicated funds in order to avoid tax increases as the state balances its budget.

ILLINOIS BUDGET STANDOFF CONTINUES

After the apparent collapse of the Illinois Senate’s “grand bargain,” senators left town without taking any further action. The Senate had intended to vote for the remaining parts of the “grand bargain,” including tax hikes, but Senate President John Cullerton, D-Chicago, called off the votes after he was told by the Senate minority leader there wasn’t any Republican support.

Due to the need for tax increases in order to address the State’s substantial cash needs, the Senate democratic majority has always insisted on bipartisan support. So even though the Democrats have the vote to pass the “grand bargain”, they will not enact it without substantial bipartisan support.

The deal has fallen apart for now as Republicans say that in order to get the package of bills passed, local property taxes should be frozen permanently — something Republican Gov. Bruce Rauner has pushed for. A freeze, however, is strongly opposed by schools and municipalities that will lose revenue as a result. The Governor has been accused of intervening with individual Republican members in order to get his tax freeze resulting in the lack of votes on that side of the aisle.

As we go to press, the Senate is scheduled to be back in session, along with the House. The situation reflects the ideologically based stance of the Governor. We have decried this kind of policy making regardless of which end of the political spectrum it emanates from. Seven quarters of fiscal operations without a budget is simply unacceptable. Worse is the way the politics of the issue have eroded local credits, especially in Chicago.

P.R. DRAMA TO DRAG ON

The Puerto Rico government’s representative before the financial control board was poised send a letter requesting the fiscal entity to ask Congress to amend the federal Promesa law to extend the stay on litigation until Dec. 31. The representative made the announcement after reviewing Gov. Ricardo Rosselló’s fiscal plan, which reveals that the administration will seek an extension of Promesa’s stay, which expires in early May. What’s more, the representative admitted that such an extension has not been discussed with creditor groups. The stay’s validity was already extended by the board at the beginning of the year, days before its initial expiration date, Feb. 15. However, Promesa allowed the fiscal board to grant such extension, but it doesn’t provide for additional ones.

Promesa allows the board to offer recommendations to Congress regarding amendments to the law that would allow it to exercise its role. If the amendment were approved, the government would avoid a debt restructuring process under Title III to take place as early as May according to the representative. He noted that extending Promesa’s stay would allow the government to present audited statements, which it expects to have ready by September, and have a fiscal plan with “real numbers” and negotiations with creditors based on accurate data.

The representative also clarified that although there are active cases in federal court, such as the lawsuit filed by a group of general obligation (GO) creditors, these do not involve a collection action against the government. Even though the Lex Claims case hasn’t been stayed under Promesa, he described it is a litigation between GO bondholders and the Sales Tax Financing Corp. (Cofina) debt service coverage ratio (the ratio of cash available to pay its debt obligations) decreased in the first nine months of 2016 to 1.3 times from 1.9 times in the comparable period in 2015 while cash-to-debt decreased to 66.9%.

LARGE HEALTH SYSTEM DOWNGRADE

S&P Global Ratings cut its debt rating for Catholic Health Initiatives another notch to BBB-plus from A-minus . The current BBB-plus rating was upgraded from negative outlook to stable outlook, meaning no further downgrades were looming. “While management’s current turnaround plan has created an expectation for stabilization and modest improvement over the next 18 months, it is our opinion that it will take several years on the current financial improvement trajectory for CHI to return to a higher rating,” said S&P.

CHI called the decision disappointing claiming that it fails to reflect improvements that the hospital giant has made over the past several quarters. Colo.-based CHI is in affiliation talks with Dignity Health, another huge multistate health system. CHI said that its turnaround plan is gaining traction as evidenced by improved earnings in its second quarter ended Dec. 31. The “alignment” discussions with San Francisco-based Dignity continue, even as it works its turnaround plan, CHI. A merger between the two companies would create the nation’s largest not-for-profit hospital chain with 142 hospitals combined and annual revenue of more than $26 billion.

CHI takes the view that it has “considerable strengths,” including $16 billion in annual revenue, 103 hospitals spread across 22 states and a solid balance sheet with assets of $22.7 billion. On the operating side, CHI narrowed its operating losses in its fiscal second quarter. It posted operating losses of $75.6 million before charges in the quarter compared with operating losses of $93.7 million in the year-earlier quarter. Revenue increased in the quarter to $4.2 billion from $4 billion in the year-ago period.

It is the balance sheet which has concerned the rating agencies the most over recent months. CHI’s debt is viewed as being relatively high for a system of its size. CHI’s annual debt service, paid on its bonds and other borrowing, is about $460 million on total debt of $9 billion. When downgrading the system in July from A-plus to BBB-plus, Fitch Ratings said its maximum annual debt-service coverage ratio (the ratio of net revenues available to pay its debt obligations) decreased in the first nine months of 2016 to 1.3 times from 1.9 times in the comparable period in 2015 while cash-to-debt decreased to 66.9%.

Dignity’s overall debt is lower at $5.25 billion, but it, too, has hefty maximum debt service to carry, $408 million annually.

The two companies expect to decide sometime in 2017 whether a tie-up is in their best interests.

NYC BUDGET REVIEW

In November 2016 the de Blasio Administration released its first quarter modification to the city’s financial plan. At the time Independent Budget Office described the financial plan as a placeholder. The Preliminary Budget for Fiscal Year 2018 and Financial Plan Through 2021 released in January largely maintains this holding pattern. IBO projects an additional $133 million of resources in 2017 (all years are fiscal years unless otherwise noted), as a result of our re-estimates of expenditure projections in the January plan. These reductions in projected expenditures, coupled with IBO’s estimate of $118 million more tax revenue than the Mayor’s financial plan assumes, yield a total of $250 million in additional resources in 2017. These additional resources would increase the budget surplus for 2017 from $3.06 billion to $3.31 billion; barring a new need emerging in the remaining months of the fiscal year, the increased surplus estimated by IBO would be used to reduce future year budget gaps.

This is important as the 2018 budget as presented in the January financial plan is balanced, IBO estimates that planned expenditures will exceed revenues for 2018 by $47 million. IBO estimates $308 million in additional expenditure needs, primarily in education and homeless services. The additional spending is partially offset by IBO’s projection that tax revenues will be $262 million greater than the de Blasio Administration is forecasting. In 2019, IBO’s expenditure re-estimates add $480 million to the city-funded budget, which is offset by $324 million in additional tax revenue and the use of the remainder of the 2017 surplus, $203 million, to pay for 2019 expenses. The net result of these actions is a relatively small, $47 million reduction of the 2019 gap as presented in the January financial plan, from $3.31 billion to $3.27 billion.

IBO’s re-estimates of agency expenditures increase the planned expenditures by $523 million and $525 million in 2020 and 2021, respectively. These additional expenditures are offset by IBO’s increased revenue forecasts of $593 million and $1.1 billion for 2020 and 2021. As a result, IBO estimates another relatively small, $71 million reduction in the 2020 gap and a slightly larger $568 million reduction in the gap for 2021. The additional resources IBO estimates would reduce the gaps stated in the January financial plan from $2.5 billion to $2.4 billion in 2020 and from $1.8 billion to $1.2 billion in 2021.

After adding 136,500 jobs in calendar year 2014, measured by gains over the 12 months, job growth slowed to 94,200 in 2015, and shrank again to an estimated 70,100 in 2016. IBO forecasts continued slowing of local job growth through 2021 when it is expected to total 41,300. As job growth has slowed, real average wages have been flat or falling, continuing a downward trend underway since 2008. IBO’s lower estimates for the budget gaps than those projected by the Mayor’s Office of Management (OMB) are primarily the result of our somewhat more robust outlook for tax revenues. Overall, IBO’s tax revenue forecasts exceed the Mayor’s by just 0.2 percent in 2017, 0.5 percent in 2018, 0.6 percent in 2019, 1.0 percent in 2020, and 1.7 percent in 2021.

Over the plan period, 2017 through 2021, year-over-year spending increases by an average of 3.0 percent in the financial plan. Growth in agency spending is primarily driven by expected increases in the annual cost of fringe benefits, which rise from $9.6 billion in 2017 to $12.7 billion by 2021, an average annual increase of 7.2 percent. Health insurance costs, the largest component of fringe benefits, are budgeted to increase at an even faster rate, averaging 8.2 percent per year over the plan period. This annual rate of increase in spending on health insurance is 1 percentage point above the rate projected at this time last year.

Non-agency expenditures, driven primarily by the increase in the cost of the city’s debt service, are growing at a much faster rate than agency expenditures in the financial plan. From 2017 through 2021, planned debt service expenditures (adjusted for prepayments) grow from $6.3 billion to $8.4 billion, averaging 7.3 percent annual growth. Pension costs, the other major component of non-agency expenditures, are projected to grow somewhat slower than the budget as a whole. Pension costs in 2017 total $9.4 billion and are forecast to increase to $10.2 billion by 2021, average growth of 2.0 percent per year.

While the overall conservatism of the city’s projections is positive, the expense trends associated with rising headcount remain troubling. The consistent rate of growth well above inflation of debt service and benefit costs will continue to pressure the city to manage the rest of its expense budget in order for it to maintain its ratings.

Muni Credit News March 2, 2017

Joseph Krist

joseph.krist@municreditnews.com

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THE HEADLINES…

“nobody knew that health care could be so complicated”

MASSACHUSETTS PENSIONS UNDER SCRUTINY

DETROIT PENSION PROPOSAL

FINANCIAL RISKS OF NUCLEAR HIGHLIGHTED AGAIN

SEC TO CONSIDER DISCLOSURE ENHANCEMENTS

PRESIDENTS SPEECH AND MUNICIPALS

______________________________________________________________________________

“nobody knew that health care could be so complicated”

So said President Trump before the National Governors Association this week. We think that most, if not all, of the Governors knew better.

A leaked copy of a House Republican repeal bill would dismantle Obamacare subsidies and scrap its Medicaid expansion. The proposed bill provides for elimination of the individual mandate, subsidies based on people’s income, and all of the law’s taxes. It would significantly roll back Medicaid spending and give states money to create high-risk pools for some people with pre-existing conditions. Some elements would be effective right away; others not until 2020.

In place of the Obamacare subsidies, the House bill starting in 2020 would give tax credits — based on age instead of income. For a person under age 30, the credit would be $2,000. That amount would double for beneficiaries older than 60, according to the proposal. A related document notes that HHS Secretary Tom Price wants the subsidies to be slightly less generous for most age groups.

For Medicaid, the draft bill calls for capped payments to states based on the number of Medicaid enrollees or a per capita system. The proposal would allow for $100 billion in “state innovation grants” to help subsidize extremely expensive enrollees like those with “pre-existing conditions”, without the same broad protections as in the Affordable Care Act.

How would all of this be paid for? Republicans are proposing to cap the tax exemption for employer sponsored insurance at the 90th percentile of current premiums. That means benefits beyond that level would be taxed. This is what was derisively known as the Cadillac tax which was opposed by unions and business during the original ACA debate. The CBO has yet to opine about how much it will cost and what it will do to the federal deficit.

The legislation would allow insurers to charge older customers up to five times as much as their younger counterparts. Currently, they can charge them only three times as much. It also includes penalties for individuals who fail to maintain continuous coverage. If they have a lapse and decide to re-enroll, they would have to pay a 30 percent boost in premiums for a year.

According to the latest Kaiser Family Foundation tracking poll, released Friday morning, the public now views the Affordable Care Act more favorably than it has since the summer of its enactment. Some 48 percent view the law favorably — up from 43 percent in December. About 42 percent have an unfavorable view of the ACA — down from 46 percent in December. The pollsters say Independents are mostly responsible for the shift. A separate poll by the Pew Research Center found 54 percent approve of the health care law — the highest scores for Obamacare in the poll’s history. Meanwhile, 43 percent said they disapprove.

Like all of the plan’s talked about to date with republican sponsorship, the net result is budget negative for states and counties. The plans all produce less money, discourage Medicaid expansion, are likely to produce larger groups of underinsured sick and uninsured. None of this is good for state government as it will impose greater requirements for uncompensated care and reduce the downward pressure on costs experienced by providers under the terms of the ACA.

MASSACHUSETTS PENSIONS UNDER SCRUTINY

A Boston-based public policy research institute advocating individual freedom and responsibility, limited and accountable government released a policy brief which said that Massachusetts should set a five-year deadline for 102 public pension systems to transfer their assets to the Pension Reserves Investment Management Board. The Board — also known at PRIM — already manages both the Massachusetts State Employee Retirement System and the Massachusetts Teachers Retirement System.

The Pioneer Institute says PRIM offers better asset allocation and cash management, lower investment fees and other costs, and more attractive investment options because of its size and market power. From 1986 to 2015, the difference in gross returns between non-state public pensions (i.e., excluding the MTRS and MSERS) and PRIM implies a taxpayer loss of more than $2.9 billion. The report finds that the systems forfeited nearly $1.6 billion from 2000 to 2015 alone by not investing with PRIM, or $97 million a year.

The institute estimates that local retirement systems have forfeited about $2.9 billion over the past 30 years. Between 2000 and 2015, the number of local systems fully invested in PRIM nearly doubled from 19 to 37, and the number that were partially invested more than tripled from 17 to 53. From 1986 to 1996, PRIM achieved annualized gross returns of 11.45 percent, while systems that were partially invested achieved 10.62 percent and returns for non-PRIM funds were 10.32 percent.

From 2000 to 2015, PRIM’s annualized gross returns were 5.8 percent, partially invested systems generated 5.4 percent and non-PRIM systems returned 5.3 percent. The gulf for both time spans adds up to an unrealized $2.09 billion, not including forgone compounding and PRIM’s lower fees. In 2007, the Massachusetts General Court passed special legislation requiring underperforming public retirement systems to transfer their assets into PRIM’s custody. Any system funded below 65 percent and trailing PRIM’s average return over the prior decade by at least 2 percent was to be deemed underperforming. Alongside the subsequent financial crisis, this statute has helped double the number of systems participating in PRIM to more than 40. Only 9 out investments with PRIM.

DETROIT PENSION PROPOSAL

Many had hoped that Detroit’s major financial obligations including pensions would be addressed through the City’s Chapter 9 proceedings. It quickly became apparent that this was not the case. Pensions were projected to become problematic again as soon as 2024. Now, The Duggan administration is proposing a dedicated fund that officials project will pull together $377 million in the coming years to help address a looming Detroit pension shortfall in 2024.

The proposal was part of an overview of the Retiree Protection Fund to Detroit’s City Council during his presentation of the proposed $1 billion general fund budget for the 2017-18 fiscal year. The mayor said he will ask the council to create the dedicated account for retirees, above the required contributions laid out in Detroit’s bankruptcy plan. The fund would gather interest and investment earnings so that by 2023 it would have $377 million to help manage massive payments the city must begin contributing in 2024.

“The retirees in this city already had their pensions cut once, and we need to make sure it never happens again,” Duggan said. “We will have a dedicated account that has to be used for retirees. We can’t hit a budget problem and take it back out.”

Of more concern was that Detroit Mayor Mike Duggan said that former emergency manager Kevyn Orr kept him in the dark about calculations used to predict the city’s future pension payments. Now, as the city realizes those payments will be many millions higher than expected, Duggan said the city is considering a lawsuit against Orr’s firm, Jones Day.

Because of the secrecy from Orr’s team, the city plans to put $50 million this year into a trust fund to cover future pension payments, Duggan said. Duggan said that the potential lawsuit hinges on whether Orr was obligated to keep Duggan in the loop in 2014 during talks about what the city would owe when those pension payments resume in 2024. “The discussions between the actuary and other people of Mr. Orr’s team were concealed from (Detroit CFO John Hill) and me,” Duggan told City Council “We did not know that these assumptions were being based on these optimistic set of criteria. Had we known that, we would’ve dealt with it very differently.”

That is a very tough statement on the part of the City’s chief executive and it should raise concerns with all parties to the issue. Duggan initially raised the prospect of a lawsuit against bankruptcy consultants early last year when the city discovered an estimated $491-million shortfall between pension payments estimated in the bankruptcy exit plan, approved in 2014, and more recent figures. The consultants underestimated the pension payments because they used outdated mortality tables, which predict how long retirees are expected to live and, in turn, receive pension checks. Duggan said he expects a decision on whether the city will sue within six months.

Had he known then about Orr’s methodology, Duggan said more prudent plans could have been made during the bankruptcy rather than having to set aside money now for future pension payments. Even if the city sues, it still has to prepare because a lawsuit against Jones Day would take years, the mayor said. Jones Day eventually collected nearly $54 million for its work on the city’s bankruptcy. The firm cut $17.7 million off its bills under court-ordered mediation. The bankruptcy — authorized by Gov. Rick Snyder and directed by Orr — cost the city about $165 million in general fund dollars.

Issues like this are why there were concerns raised when Mr. Orr was retained to advise on Atlantic City’s financial difficulties. Bankruptcies are difficult enough for all of the competing creditor classes. The one thing which all parties should be able to agree on is the quality and veracity of the consultants employed as experts who provide “objective” information to the competing parties as well as the overseers of these disputes. The results of the Detroit process should serve as a cautionary tale for all participants in any future workout process.

FINANCIAL RISKS OF NUCLEAR HIGHLIGHTED AGAIN

Ever since plans were announced for the construction of new nuclear generating capacity in the southeast U.S., observers have been wondering how the economics of these projects would impact the various companies involved in them. While they are sponsored and primarily owned by two investor owned IOUs – Georgia Power and South Carolina Electric and Gas – major shares of these units are also owned by municipal power entities. The Municipal Electric Authority of Georgia owns a portion of portion of the Sumner plants in South Carolina.

Both of these entities are long standing owners of nuclear capacity so they entered these transactions with their eyes wide open. Some of us have been concerned for some time about the financial risks associated with them. These risks could have stemmed from a shifting regulatory requirement, issues with potential cost overruns, or technological change. What has been somewhat of a surprise is the potential for financial pressure on the owners of these new plants from another source of financial instability.

The news this month that the Toshiba Corp. was experiencing financial difficulties was not a total surprise given their involvement in nuclear plants in Japan stemming from the Fukushima disaster. Since then, Toshiba’s Westinghouse subsidiary purchased a nuclear construction and services business from Chicago Bridge & Iron (CB&I) in 2015. But assets that it took on are likely to be worth less than initially thought, and there is also a dispute about payments that are due. Earlier this year, Toshiba announced that it would take a $6 billion write off associated with Westinghouse and delayed the release of financial results until mid-March.

Toshiba’s nuclear business has not made a profit since 2013. In addition, Toshiba is still struggling to recover after it emerged in 2015 that profits had been overstated for seven years. The Japanese press reported Toshiba was now looking at a potential Chapter 11 filing as one of several options for Pittsburgh-based Westinghouse, as it grapples with cost overruns at the two U.S. projects.

Westinghouse is the engineering, procurement and construction contractor for Plant Vogtle as well as at V.C. Sumner. MEAG owns 22.7% of the new units at Plant Vogtle and projects that its total financing costs will be about $4.7 billion. Santee Cooper is a 45% owner in VC Summer’s new units and estimates its costs will be about $5.1 billion. A Westinghouse bankruptcy would be credit negative even with mitigation measures built into the construction contracts, including letters of credit and Toshiba’s parental guarantee on both the projects. The utilities have escrows on the project’s design and intellectual properties.

Nonetheless, Fitch Ratings placed its A-plus rating on Santee Cooper’s s$6.7 billion of revenue obligations on rating watch negative. S&P Global Ratings, which rates the various entities involved in the Georgia and South Carolina projects, said it is continuing to assess whether the financial burdens at Toshiba will translate into negative effects on credit ratings.

Toshiba confirmed its memory business will be separated from the main Toshiba business in preparation for a part or majority stake sale. It plans to raise at least 1 trillion yen from the sale, enough to cover the Westinghouse writedown and create a buffer for any fresh financial problems. It plans to raise at least 1 trillion yen from the sale, enough to cover the Westinghouse writedown and create a buffer for any fresh financial problems. It denied any knowledge of plans to seek Chapter 11 protection for Westinghouse.

So it appears that our concerns about the involvement of MEAG and Santee Cooper in new nuclear construction projects were not misplaced.

SEC TO CONSIDER DISCLOSURE ENHANCEMENTS

The Securities and Exchange Commission will weigh two amendments to required material event notices under its Rule 15c2-12 during a meeting on March 1 that may include discussion of adding bank loans and private placements to the 14-item event list.

Bank loans and the disclosure about them have been a continuing source of concern for investors as much for the lack of details about their various security provisions as for questions about amounts outstanding. Investors continue to be concerned with how to obtain the level of detail which they feel they need to assess the risk they bear from changes in the status of bank debt on a lien basis relative to their own holdings under a variety of credit scenarios. Such information can be crucial to the ongoing valuation process for assessing current and prospective holdings.

The same holds true for private placements. We are in favor of any regulatory effort that increases the amount of information available to the market and would be hopeful that the list of material events be increased.

PRESIDENTS SPEECH AND MUNICIPALS

“Crumbling infrastructure will be replaced with new roads, bridges, tunnels, airports and railways gleaming across our beautiful land. To launch our national rebuilding, I will be asking the Congress to approve legislation that produces a $1 trillion investment in the infrastructure of the United States — financed through both public and private capital.” And that is it. We have documented some of the scale of the need and the role that municipal bonds can play in satisfying that need.

As for healthcare, Americans with pre-existing conditions have access to coverage, and that we have a stable transition for Americans currently enrolled in the healthcare exchanges. Secondly, we should help Americans purchase their own coverage, through the use of tax credits and expanded Health Savings Accounts — but it must be the plan they want, not the plan forced on them by the Government. Thirdly, we should give our great State Governors the resources and flexibility they need with Medicaid to make sure no one is left out. Fourthly, we should implement legal reforms that protect patients and doctors from unnecessary costs that drive up the price of insurance — and work to bring down the artificially high price of drugs.

None of this is anything new in terms of political orthodoxy on the right and each of these provisions brings with it some level of political opposition. So for those who were looking for some effort to address the real policy issues associated with health and infrastructure, the speech comes up short. In terms of what it all means for municipal credit, the answer is not much at this point.