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Muni Credit News Week of September 24, 2018

Joseph Krist

Publisher

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INDIANA TOLL DEAL APPROVED

The board of the Indiana Finance Authority unanimously approved a new deal Thursday with the vendor operating the Indiana Toll Road, allowing 35% fee increases for large trucks. (The rate increase applies to vehicles with three or more axles.) The rate hike takes effect Oct. 5 and the state would receive $400 million that same day from the Indiana Toll Road Concession Co.

Indiana would receive a total of $1 billion over three years. The risk of non-payment of the latter two installments is secured by a bank letter of credit. $600 million is projected to facilitate completion of the Interstate 69 extension in southern Indiana; $190 million for projects on U.S. Routes 20, 30 and 31; $100 million to boost rural broadband access; $90 million for improving hiking and biking trails; and $20 million to attract new direct flight routes to the state’s airports.

SUFFOLK COUNTY, NEW YORK

Quite rightly, most of the negative credit attention focused on Long Island has been directed towards Nassau County. The County still operates under the review of a state control board and the County is still coping with fallout from federal corruption trials involving recent County officials. Now it appears that Nassau’s eastern neighbor may be gaining its share of the negative credit glare.

Moody’s Investors Service has downgraded to Baa1 from A3 Suffolk County, New York’s issuer rating and general obligation limited tax (GOLT) rating. The county has $1.6 billion in GOLT debt outstanding. The county’s deteriorated financial position resulting from recurring operating deficits, deferment of pension contributions, and reliance on significant annual cash flow borrowing were cited as the basis for the downgrade.

The county’s negative available fund balance position (GAAP basis) and negative net cash position persist and grew to a negative 12% and 10.9% of revenues. The GOLT bonds are secured by the county’s general obligation pledge as limited by the Property Tax Cap Legislation (Chapter 97 (Part A) of the Laws of the State of New York, 2011). The lease appropriation bonds are secured by the county’s obligation to pay debt service subject to appropriation.

The stable outlook (revised from negative) reflects the expectation that the county will continue to make strides in reducing budget one shots and nonrecurring revenues to achieve structural balance. The outlook also reflects the county’s efforts to improve its financial position by implementing expenditure control measures and utilizing resources provided by the county’s sizeable and diverse tax base.

WASTE TO ENERGY

Investors in the high yield waste to energy space have learned the hard way over the years the importance of the financial strength of the operator can be to the credit integrity of waste to energy project financings. ratings risk comes not just from the operating performance of the project but also from the credit of the operator who often has financial obligations tied up in the operations of the facility.

A recent example is noted at the Solid Waste Authority of Palm Beach County’s (two waste to-energy plants. Earlier this month, Covanta Holding Corporation acquired the Babcock & Wilcox Enterprise, Inc. (B&W) subsidiary Palm Beach Resource Recovery Corporation (PBRRC) which operates the two plants. The change led Moody’s to note that replacing B&W with Covanta is credit positive for the authority because Covanta is a financially stronger entity and will be the guarantor for payment and performance of all of PBRRC’s covenants and obligations under the operations and maintenance agreements.

B&W announced two separate restructurings in 2016 and 2017, and the company has reported seven out of eight past consecutive quarters of net losses and three consecutive quarters of negative adjusted EBITDA through the second quarter of 2018. The company’s second-quarter 2018 GAAP net loss from continuing operations was $209.7 million, its GAAP net loss inclusive of discontinued operations was $265.8 million, and adjusted EBITDA was negative $96.2 million.

In contrast, Covanta’s ratio of cash flow from operations before any changes in working capital (CFO pre-WC) to debt, which was above 7% in each of the past three years (2015-17).

TEN YEARS AFTER (NOT THE BAND)

OK, the title dates me. Nonetheless, we are in the midst of many commemorations and retrospectives regarding the 2008 financial crisis and subsequent Great Recession. Our review takes us back to the mortgage market and the default epidemic which infected many regional real estate markets. Many have argued that the epicenter of the crisis may have been in Nevada, especially the greater Clark County (Las Vegas) market. At one point, one out of three homes was delinquent or in foreclosure. Stories abounded where lenders went to foreclose on properties only to find them vacant with the keys on the kitchen counter.

So it is with interest that at the ten year anniversary, things have changed in that market. The latest sign is the fact that S&P Global Ratings revised its outlook to positive from stable and affirmed its ‘AA’ long-term rating on Nevada’s general obligation (GO) limited-tax bonds outstanding. The basis for the move – “The positive outlook reflects our expectation that Nevada will maintain its proactive budget management as it did during the extreme economic downturn during the Great Recession along with our expectation that the state will continue to build its reserves during the economic expansion to mitigate future revenue volatility.”

With the real estate market in much better shape, S&P expects to see continued increases in the state’s reserves which improved from about 7% in fiscal 2011 to a projected, strong 14% at the end of fiscal 2018. It is noted that the economy remains subject to cyclical forces and that it still rests on the twin pillars of tourism and related gaming and entertainment revenues.

PENSION IMPACT ON LOCAL ILLINOIS RATING

The potential for rising pension costs to wreak havoc with the ratings of individual municipalities in Illinois becomes more apparent over time. The latest victim is Alton, Il. S&P announced last week that lowered its long-term rating to ‘A’ from ‘A+’ on Alton, IL’s existing general obligation (GO) debt. The outlook is negative.

The reasoning behind the move is clear. “The downgrade and negative outlook reflect a view of Alton’s significant pension liabilities stemming from its policemen’s and firefighters’ pension plans and the pressure the liabilities are exerting on the budget. City officials are justifiably concerned about the low funding levels, the affordability of the required contributions, and the city budget’s ability to absorb the costs.

The action comes in spite of the pending sale by the City of its wastewater treatment plant and sewer system to Illinois American Water. From S&P’s standpoint, the sale and the proceeds it will produce while directed towards funding its pension costs will not be enough on its own. Said S&P: “While we recognize the sale presents a measure of budget predictability in the near term, the city will still have a significantly high pension liability and exposure to escalating pension contributions, and we believe it will need to devise a long-term plan to stabilize its policemen’s and firefighters’ pension funds.”

MASS TRANSIT LOW INCOME DISCOUNTS COME TO THE MILE HIGH CITY

The Denver Regional Transit District’s low-income fare program was approved. It will take effect in early 2019 and provide a 40 % fare discount to households at or below 185 % of the federal poverty level. Denver now joins cities including Seattle and New York in operating similar programs. A deeper-than-existing 70 percent fare discount for riders between the ages of six and 19 was also approved. The low income discounts are added to the existing array of discounts available to Denver residents including discounts which serve seniors ages 65 and up, individuals with disabilities, Medicare recipients, and elementary, middle and high school students ages six to 19. Children five and younger already ride free with a fare-paying adult. Base fares on buses and on the region’s rail transit line to Denver International Airport will rise from $2.60 to $3, and regional bus fares from $4.50 to $5.25. Fares will go up along the region’s A-Line train, driving the cost of a one-way trip between Denver and the airport from $9 to $10.50.

THE MARKET CLAIMS ANOTHER COAL PLANT…

The Navajo Generating Station (NGS) on the Arizona-Utah border will cease operations in a year’s time. A planned sale to two investors was called off. They could not come to terms after failing to find clients who would be interested in buying electricity from the coal fired power.

The announcement comes despite significant efforts by Interior Secretary Zinke to find ways to keep the plant open. Navajo was for many years considered a major source of regional air pollution being blamed for among other things smog in and around the Grand Canyon. Nevertheless, the Interior Secretary strongly supports keeping the plant open. This flies in the face of the market’s clear message regarding the long term relative uneconomic viability of coal generation in the power supply marketplace.

…WHILE NATURE PRESSURES ANOTHER

The water itself might have been enough, if it wasn’t then the hog waste in the water may have been enough. Now another aspect of coal fired generation having deleterious environmental effects is rearing its head in North Carolina. The earthen dam separating Sutton Lake from the Cape Fear River breached near Wilmington, N.C. Now coal waste threatens to drain into the Cape Fear River.

The breach follows reached the news that water had the dam that separates the lake from the coal ash ponds for the L.V. Sutton Power Station (operated by Duke Energy). Floodwaters had displaced about 180 truckloads of coal ash from a nearby pond. Coal ash contains heavy metals like arsenic and cadmium, and its disposal is federally regulated.

A prior coal ash spill at a Duke facility in 2014 saw Duke admitting fault and paying more than $100 million in fines and restitution for that incident.

NEGATIVE SENIOR LIVING TRENDS

This year we have seen two studies of overall national occupancy rates at senior living facilities. The National Investment Center for Seniors Housing & Care reports that skilled-nursing facilities had fewer patients in the second quarter than ever before. Occupancy reached a record low of 81.7% in the second quarter of 2018, down from 83.1% in the second quarter of last year.

The Affordable Care Act drives demand downward as it rewards new care models that facilitate primary and home healthcare. Additionally, the Centers for Medicare and Medicaid (CMS) recently finalized a new payment rule for SNFs that ties payments to the complexity of patients’ clinical needs rather than volume of services provided.

Earlier in the year, a similar survey of assisted living data for the first quarter of 2018 showed a similar experience. Assisted living occupancy reached a record low in the first quarter of 2018, according to data released by the National Investment Center for Seniors Housing & Care.

Occupancy in assisted living hit 85.7% during the quarter, down 0.7 percentage points from the fourth quarter and down 1.3 percentage points from year-earlier levels. Overall, average seniors living occupancy fell to a six-year low of 88.3% in the first quarter, down 0.5 percentage points from the previous quarter and down 0.9 percentage points from year-earlier levels. This rate put senior living occupancy 1.4 percentage points above its cyclical low of 86.9% reached during the first quarter of 2010 and 1.9 percentage points below its most recent high of 90.2% in the fourth quarter of 2014.

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 Week of September 17, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$253,000,000

City of Minneapolis

Fairview Health System

Health Care System Revenue Bonds

A2/A+

The issue comes to market with its A2 rating intact but with an outlook lowered from stable to negative. The negative outlook reflects the increased financial challenges that the system will need to absorb given the higher level of funding to the University and the losses at HealthEast. The higher funding requirement is part of a Letter of Intent (LOI) between Fairview and the University of Minnesota for a new affiliation agreement.

The LOI, if executed, would further solidify Fairview’s essential and long-standing role as the academic health system for the University of Minnesota and create greater incentives for physicians to increase productivity. Tthe proposed agreement would require increased funding to the University from Fairview, which might thwart margin improvement. Hence the shift to a negative outlook.

At the same time, Fairview’s integration of HealthEast will pressure the new entity’s margins as it seeks to improve its modest financial performance and moderate liquidity. In addition, despite its broad offerings, Fairview will remain highly reliant on its more profitable specialty pharmacy services. Further, the entry of for-profit health plans will raise market uncertainty.

All bonds are secured by an unrestricted receivables pledge from the System’s Obligated Group which includes HealthEast. This deal will allow the system to refinance insured debt with restrictive covenants. The system has obtained credit facilities not subject to the restrictive covenants. Total combined operating revenue in fiscal 2017 was $5.2 billion with over 90,000 admissions. The System owns and operates eleven hospitals, including the University of Minnesota Medical Center, and also operates over 100 primary and specialty care clinics, seven ambulatory care centers, over 40 retail and specialty pharmacies, as well as senior care housing and long term care facilities, hospice and home care, medical transportation and a health plan.

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CHARTER SCHOOLS

The California legislature has enacted legislation which would ban for-profit charter schools within the state. 25,000 students are now enrolled in 34 for-profit charter schools in the state, according to the California Charter Schools Association and an analysis by the California State Assembly. Now a real source of competition for the nonprofit charter school base has been eliminated. This occurs at a time when overall school enrollment trends are negative.

Some 10% of California students are enrolled in charter schools so the overall market for charter schools should remain strong. Enrollment and the number of charter schools continue to increase. During 2000-10, the number of charter schools jumped to 809 from 299, according to the California Charter Schools Association. In recent years, growth trends have slowed as traditional public schools have responded to competition with the introduction of specialized programs and both charter and district schools confront ongoing erosion of their student population, with the state projecting additional declines totaling around 3% over the next decade.

65 new charter schools opened in the fall of 2017, but this followed 46 closures from the prior spring, for a net gain of only 19 schools statewide. The demand has become centered in urban centers and areas with stronger population growth. By precluding new market entrants with lower cost structures, the legislation helps ensure the competitiveness of schools with outstanding debt as well as market demand for existing school facilities in the event of a charter school closure.

MISSISSIPPI FUNDS INFRASTRUCTURE

Mississippi has gained notoriety for the poor condition of many of its bridges and has been serving as an unwilling poster child for the issues underlying the national infrastructure debate. 12% of the state’s bridges deemed structurally deficient. The state has taken a step forward toward funding and addressing its most glaring infrastructure needs through several pieces of recent legislation.

The laws include directing a portion of the state use tax for local roads and bridges, create a state lottery and codify the distribution of remaining BP settlement funds, will provide an estimated $220-$270 million in annual funds for sorely needed transportation and infrastructure projects and distribute $750 million of funds related to BP’s Deepwater Horizon oil spill settlement.

The first law, the Mississippi Infrastructure Modernization Act of 2018 (MIMA), diverts a number of revenue streams – most prominently 35% of the state use tax – to local roads and bridges, yielding approximately $120 million annually in infrastructure funds. It also approves the issuance of up to $300 million in revenue bonds for the Emergency Road and Bridge Fund ($250 million) and the Transportation and Infrastructure Fund ($50 million). The bill appropriates funding for several Infrastructure Fund projects in 2018, with notable project grants (greater than $2 million.

The statewide lottery – a long-contentious proposition – is projected by the state to generate $80 million in new revenue annually ($40 million in the first year). Until 2028, the first $80 million in revenue will be dedicated to the State Highway Fund. The BP Settlement law distributes the remaining $600 million of $750 million in settlement funds that the state expects to receive through 2033 ($40 million annually). The remaining 25% of the annual disbursement will be deposited into the state’s BP Settlement Fund for use on projects throughout the state. Of the nearly $100 million in funds currently held by the state (approximately $50 million has been already spent), $52.9 million will be allocated to the Transportation and Infrastructure Fund.

As significant as these resources are and although they are received over time, they will effectively function as one shot revenues. The reality is that Mississippi will need to find some $400 million of recurring revenues to meet the state’s ongoing infrastructure maintenance and repair costs on an annual basis.

TEACHER PAY MOVES TO THE DISTRICTS AS AN ISSUE

Throughout the Spring, attention was focused on statewide teacher job actions in several states. They generally resulted in more funding for education at the state level. Now the attention focuses to local negotiations as districts grapple with the demands from teachers for their share of the newly enlarged resource pool. The latest battleground is in Washington state where teachers in four districts including Tacoma, with an enrollment of more than 29,000 students, or 2.6 percent of the state’s total. Across the state, some 53,000 students are out of school as negotiations take place.

The funding mechanisms have made it clear that the increased funding from the State mandated by the decade long school-finance case known as McCleary may not be the windfall expected. The extra money also automatically opened teacher contracts for renegotiation in virtually all of the state’s 295 school districts. The Centralia School District received an extra $50 million this year, while cutting $46 million from a levy that the district relied on to fund its budget last year, resulting in a near-wash.

LITIGATION HURTS JEA RATING

S&P Global Ratings has placed its ratings on debt from the Jacksonville Electric Authority CreditWatch with negative implications: Its ‘AA-‘ rating on JEA, Fla.’s senior-lien, fixed-rate electric system, bulk power supply system and Saint Johns River Power Park debt; Its ‘A+’ rating on the utility’s subordinate-lien, fixed-rate, electric system debt; Its ‘AA-/A-1+’, ‘AA-/A-1’, and ‘A+/A-1’ ratings on several series of JEA senior and subordinate-lien variable rate debt; andIts ‘A-1+’ rating on the utility’s senior-lien, variable-rate demand bonds that are in the commercial paper mode.

The outlook revision is based on JEA’s Sept. 11 court filing asking a Florida state court to release it from a power purchase agreement (PPA) with the Municipal Electric Authority of Georgia (MEAG). The contract commits JEA to pay the first 20 years’ debt service on 41.175% of the debt MEAG has issued and will issue to fund its 22.7% interest in the two 1,100 megawatt Plant Vogtle nuclear units under construction in Georgia. JEA’s Sept. 11 court filing asking a Florida state court to release it from a power purchase agreement (PPA) with the Municipal Electric Authority of Georgia (MEAG). The contract commits JEA to pay the first 20 years’ debt service on 41.175% of the debt MEAG has issued and will issue to fund its 22.7% interest in the two 1,100 megawatt Plant Vogtle nuclear units under construction in Georgia. In the next month, the owners of Plant Vogtle will meet to decide on whether to continue construction. If ownership interests representing at least 10% of the project choose not to proceed, unless the courts provide JEA with a judicially sanctioned method of exit, abandonment could leave the utility responsible for debt service without an associated revenue-producing asset.

We understand S&P’s point of view but we believe that the litigation is a negotiating tactic on the part of JEA. MEAG has been steadfast in its view that the Plant Vogtle expansion should continue. This is unlike the situation in South Carolina where the state’s largest public power agency (Santee Cooper) is a partner in a nuclear expansion which has been suspended. Both of these situations highlight the exceptional level of financial risk inherent in the construction of a nuclear power plant. The Georgia situation would seem to have a greater level of uncertainty attached to it versus the suspended South Carolina project. While both offer the potential for a rate impact the Georgia project presents a level of risk which cannot be fully measured at this time. In South Carolina, the costs are more certain.

Muni Credit News Week of September 10, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$500,000,000

Las Vegas Convention and Visitors Bureau

Convention Center Expansion Revenue Bonds

Moody’s: Aa3

These revenue bonds are all secured by the authority’s first lien pledge of net revenues from hotel room taxes collected throughout Clark County as well as revenues from its convention facilities after the payment of operating expenses. The current issuance is also secured by the Las Vegas Convention Center.

The rating was upgraded in connection with this issue. Increasing hotel room rates are generating pledged tax receipts to new all-time highs. Average daily hotel occupancy has been uncommonly strong at 89%. These factors have combined to result in maximum annual debt service coverage of 3.0 times from fiscal 2017 pledged revenues. The issue represents a significant increase in debt but the coverage levels provide sufficient cushion to absorb the new debt.

Las Vegas remains the nation’s market leader for large-scale conventions. While total visitor totals show a slight drop from their peak, the tourist market remains strong. At 42 million visitors, the market for hotel rooms remains quite strong. With the market evolving from its gambling base to a much more diverse demand base centered on entertainment and recreation, the ability to maintain revenues growth is bolstered.

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GUAM

S&P Global Ratings affirmed its ‘BB-‘ long-term rating on the Government of Guam’s (GovGuam) general obligation (GO) bonds and its ‘B+’ long-term rating on GovGuam’s certificates of participation. The credit has become the object of interest for those seeking triple exempt income not derived from Puerto Rico. At the same time, S&P Global Ratings removed the ratings from CreditWatch, where they had been placed with negative implications on March 5, 2018. The outlook is stable.

GovGuam improved its general fund cash flow and its financial results for fiscal 2018 as a result of a fiscal realignment plan. It also succeeded in balancing its fiscal 2019 budget. Guam’s credit reflects increased stability. This has occurred at a time of improving economic conditions and activity. The tourism markets are more stable (Japan is a major source of tourist demand for Guam)and the US commitment to military spending given Guam’s significant a forward role as base in the Pacific.

THE PUERTO RICO CONUNDRUM The National Federation of Municipal Analysts has filed an amicus brief in support of the major bond insurers who are suing to prevent the “clawback” of tax revenues to provide funds to help to pay the Commonwealth’s direct, tax backed debt. A district court decision in the action is under appeal by the insurers and the NFMA has chosen to support the plaintiffs argument.

The plaintiffs argue that the application of the tax revenues pledged included in the security for the bonds to another purpose is improper. We do not disagree with the notion that the statutes authorizing the bonds are clear in their intent in terms of directing those revenues towards the authority’s bonds not the Commonwealth’s general obligation bonds. The question is though: which controls the pledge? The statute or the Constitution?

A plain reading of the official statement makes the risk of “clawback” pretty clear. The fact that there is lots of statutory authority that has never been reviewed in connection with a judicial validation proceeding should be viewed through a cautious lens. Until these statutory pledges are validated, there is a risk that the pledged funds will not be available. ” Market expectations regarding the treatment of Project revenues and revenue bondholders simply do not outweigh constitutional provisions.

We heard a lot about relying on the plain language of the Constitution during the past weeks Congressional hearings regarding the confirmation of Brett Kavanaugh to a seat on the Supreme Court. So applying the plain language test would not seem to be in the favor of the Authority’s bondholders. Their cause is also hurt by the fact that, if anything, the “subsidy flow” is usually from the utility to the general fund rather than the other way around.

We have long thought that reliance upon legal provisions is important but that the most important factor to insure the timely and full payment of debt service is underlying viability of the project or enterprise. In the case of the Highway Authority’s debt, a view of the overall economic viability of the Commonwealth that allowed debt holders to rely on true operating revenues would remove the risk confronting PRHTA creditors.

MUNICIPAL OVERSIGHT IN CONNECTICUT

Since the bankruptcy of Detroit was declared after the intervention of the State of Michigan in Detroit’s financial affairs, the various state oversight programs for distressed localities have undergone a higher level of scrutiny. The latest program to take the spotlight is the Municipal Accountability Review Board , Connecticut’s local financial affairs overseer. Currently, that board is evaluating the plans of West Haven which is seeking to have a financial recovery plan approved.

The Municipal Accountability Review Board (MARB) was established by Section 367 of Public Act 17-2 as a State Board. It is to be composed of 11 members appointed as follows: Secretary of OPM, or designee, Chairperson, State Treasurer, or designee, Co-chairperson, five members appointed by the Governor: a municipal finance director, a municipal bond or bankruptcy attorney; a town manager; a member having significant experience representing organized labor from a list of three recommendations by AFSCME; ? a member having significant experience as a teacher or representing a teacher’s organization selected from a list of three joint recommendations by CEA and AFT-CT.

One member appointed by the President Pro Tempore of the Senate, one member appointed by the Speaker of the House of Representatives, one member appointed by the Minority Leader of the Senate and one member appointed by the Minority Leader of the house of Representatives, each of whom shall have experience in business, finance or municipal management. The board’s powers are not unusual. It has the power to review and approve or disapprove the municipality’s annual budget, including, but not limited to, the general fund, other governmental funds, enterprise funds and internal service funds. No annual budget, annual tax levy or user fee for the municipality shall become operative until it has been approved by the board.

West Haven is a Tier III city under the oversight program. A tier III municipality has at least one bond rating from a bond rating agency that is below investment grade, or (2) the municipality has no bond rating from a bond rating agency, or, if its highest bond rating is A, Baa or BBB, provided the municipality has no 18 rating that is not investment grade, and it has either (A) a negative fund balance percentage, or (B) an equalized mill rate that is thirty or more and it receives thirty per cent or more of its current or prior fiscal year general fund budget revenues were or are in the form of municipal aid from the state. West Haven is rated Baa/BBB. have the power to pass and implement an interim budget, raise the city’s tax rate or impose mid-year spending cuts and have greater latitude to approve or disapprove new labor contracts.

The city and the board have been working over the summer to achieve agreement over a budget and the City’s five year financial plan. The city is working to avoid Tier IV status which would allow the board to have the power to pass and implement an interim budget, raise the city’s tax rate or impose mid-year spending cuts and have greater latitude to approve or disapprove new labor contracts. The board would like to see the city build into the recovery plan a timetable to restore the city’s fund balance — currently in the red — to about 5% of the city budget. That would require a fund balance of about $8 million in the City’s $162 million budget.

The city will consider a proposed financial plan this week which it hopes it can present to the Board for approval by the end of September. Approval would allow the city to collect significantly more state aid than has been available in the absence of an approved plan.

RATING AGENCIES IN THE GLARE

The latest comments to come from the entity investigating Puerto Rico’s debt issuance and subsequent default released its comments on the role of the rating agencies. When we summarize the findings, the intent is not to bash the rating agencies. Rather it is to highlight the fact that there is virtually nothing new in this latest critique. Instead, the comments reinforce existing feelings about the rating agencies approach to distressed municipal credits.

According to the report, “In light of the evidence we reviewed, reasonable minds can differ regarding the point at which the CRAs should have stopped relying on prospective information supplied by or on behalf of the Issuers, anticipated an increased likelihood of default, or taken more aggressive actions like downgrading Puerto Rico-related bonds below investment-grade status. Indeed, our investigation uncovered evidence that the CRAs had persistent concerns with respect to certain Issuers and their issuer-supplied information prior to the 2014 downgrades.

“There is evidence that, in hindsight, there may have been a basis to take earlier or more aggressive action to change the positive ratings of certain Puerto Rico-Related Bond ratings. At least some of the CRA Analysts with whom we spoke identified longstanding concerns…. There is also evidence that certain CRA Analysts were skeptical of prospective issuer-supplied information,”

One would hope so. But the comments highlight a dilemna faced by the rating agencies when deciding that they will lower a distressed credit’s rating. The rating agencies do not want to be seen as market moving actors or even more especially a hindrance to issuer access to capital. This alone explains the belief of many who manage and or actively trade bonds that bond ratings are lagging rather than leading indicators.

Bottom line: you have to do your own homework. This is already the case for institutions and hopefully will become more of a practice among individuals. Ask questions, look at rating reports, but don’t use these as a substitute for common sense and a healthy skepticism regarding the ultimate sources of information. Keep up with the news and if something looks wrong, it probably is.

Muni Credit News Week of September 4, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$750 million

New York City Transitional Finance Authority’s (TFA)

Future Tax Secured Subordinate Bonds

Moody’s: Aa1

It may be a short week but what better time for a well known tried and true credit to make another appearance in the market. New York City Transitional Finance Authority bonds offer investors an opportunity to invest in the City while remaining somewhat insulated from the City’s general credit. The state legislature established TFA as a separate and distinct legal entity from the city. It did not grant TFA itself the right to file for bankruptcy. So there is that legal protection.

In terms of the City’s year to year financial operations, the statutory authorization for the bonds provides that both the city and the state retain the right to alter the statutory structure that secures TFA’s bonds. The city has covenanted not to exercise those rights related to personal income taxes if debt service coverage would fall below 1.5 times MADS on outstanding bonds. This means that the City can change the income tax base as was the case when the abolition of the city’s income tax on commuters occurred and when certain items were removed from the sales tax base.

TFA’s original statutory authorization of $7.5 billion has been increased to $13.5 billion (plus $2.5 billion “Recovery Bonds”) for senior and subordinate lien bonds. In 2009, legislation was enacted permitting TFA to exceed the $13.5 billion cap but counts debt over that amount, along with city general obligation debt, against the city’s overall debt limit. As of July 31, 2018, the city had $35.8 billion of debt capacity.

The authorizing statute also provided for bondholder protections including the fact that the pledged taxes are collected by the New York State Department of Taxation and Finance and held by the state comptroller, who makes daily transfers to the trustee (net of refunds and the costs of collection). The trustee makes quarterly set-asides of amounts required for debt service due in the following quarter on the outstanding bonds, as well as TFA’s operational costs (with the collection quarters beginning each August, November, February and May).

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PUERTO RICO

The Commonwealth has been in the news primarily as the result of the news that the official death toll attributable to Hurricane Maria has been raised from 64 to 2975. By now the shortfall in the federal response is obvious to all so there is no need to say more here other than to observe that the difficulty in generating real data about the storm and its aftermath are clearly an obstacle to reaching a resolution of the Commonwealth’s effort to restructure its debt.

It is easy to focus on the federal shortcomings but it becomes clearer that the Commonwealth government has much to answer for itself. As the data about the death toll has come out, the emphasis on that data has served to obscure the government’s continuing lack of realism when it comes to the realities of the Commonwealth’s finances. This is clear when one views the debate over whether or not to continue the practice of awarding Christmas bonuses to government workers.

The ongoing debate between the government and the PROMESA fiscal board continues. The debate is fueled by a mixture of pride and political factors which ignore the realities of the current situation. There would not be demands for more and timely operating information which some in the island’s body politic continue to resist. The fact that the Commonwealth has no history of credibility to fall back on in terms of its ability to provide accurate and timely information to its many and varied stakeholders continues to overhang any of the currently ongoing negotiations whether they involve the government and the board or the government and its creditors.

We are not looking for the government of Puerto Rico to turn over all of its sovereign rights but it would be helpful for it to accept the reality that the effort to shift losses onto creditors is only going to work if accompanied by a real effort to upgrade the government’s willingness to significantly improve its performance. Only by establishing a track record of accomplishment can it establish the level of credibility needed to persuade stakeholders to allow Puerto Rico more autonomy.

SOME VOTERS APPROVE TAX HIKES FOR SCHOOLS

Many have wondered if this past Spring’s labor unrest in the education sector would do anything to alter the trend of tighter and tighter revenue constraints which keep school district’s from addressing the wage concerns which generated the unrest. This year’s state budget cycle did produce some improvement in school funding at the state level but the real test comes at the local level when local taxpayers are asked for more revenue.

In at least one case, the recent evidence is positive. On 28 August, voters in Florida’s Broward County School District approved a one-half-mill property tax increase, primarily earmarked for salary increases for teachers. The tax runs through fiscal 2023 (which ends 30 June 2023), after which it will expire if voters do not renew it. The salary increases will sunset when the tax sunsets in 2023, unless voters renew the tax. The vote comes in the wake of a minimal funding increase from the state.

At the end of fiscal 2017, the district had an available operating fund balance of $157 million, equaling a narrow 5.9% of revenue, and an operating cash balance of $491 million, or a moderate 18.5% of revenue. In fiscal 2017, Broward schools received approximately 41% of the district’s $2.66 billion in operating revenue from the state. For fiscal 2019, the district’s basic state aid (through the Florida Education Finance Program) funding increased by just 0.96%, or $18.8 million.

BRIGHTLINE GETS ITS BONDS (AND THEIR SUBSIDY)

Florida’s monument to private enterprise – the tax exempt bond funded Brightline – received another subsidized boost when its was announced that the board of the Florida Development Finance Corp. unanimously signed off on a $1.75 billion bond issue for the Brightline rail service. The tax exempt bond will bankroll its expansion to Orlando.

The announcement comes as data on the service’s operations between Miami and Palm Beach have become available. Brightline’s ridership numbers have fallen far below its own projections. In a bond document in late 2017, Brightline predicted 2018 ridership of 1.1 million and passenger revenue of $23.9 million. During the first three months of 2018, Brightline said it carried just 74,780 passengers who spent $663,667 on tickets.

Brightline management says that ticket sales have been increasing. He said focusing on early ridership numbers before Brightline began serving Miami is “out of context and unfair.” Brightline told bond investors last year that in 2020, it expects to ferry 2.9 million passengers and collect $96 million in fares. Brightline told bond investors last year that in 2020, it expects to ferry 2.9 million passengers and collect $96 million in fares.

The debate over the bonding authorization has highlighted some other facts about this private enterprise. Palm Beach and other counties as well as municipalities along the route are responsible for the maintenance of its grade crossings.

A STREECAR NAMED DE BLASIO

One of the ongoing debates in New York is how and where to find the resources to address the City’s well publicized difficulties experienced with its mass transit system. Owned by the City but funded and operated by a state agency, the system’s problems have been the source of a regular but unproductive debate between Mayor DeBlasio and Governor Cuomo. It has become an issue in the ongoing Democratic primary campaign for Governor.

So it may seem strange that now is the time which the mayor has chosen to announce the revival of his plan for a streetcar system to serve neighborhoods along the Brooklyn-Queens waterfront. The DeBlasio Administration announced that it will move forward with the proposed Brooklyn Queens Connector (BQX) streetcar following the completion of a two-year feasibility study.

Honorable people can disagree over the necessity of the new system and how it will be funded. One thing that all can agree on is that funding for urban mass transit is under attack by the Trump Administration. So it is surprising that the Mayor’s announcement included that it will seek federal funding, among other sources, to deliver the project. The funding sought from the federal government is estimated at $1 billion.

At a time when much more regionally beneficial projects like the Gateway tunnel continues its uphill battle for federal funding, it seems like quite a reach to hope that 37% of the projects cost will be picked up by the federal government. Nonetheless, that is the plan. How the other portions of the funding needed will be generated is left to the future.

The needs of the existing bus and subway system are pretty clear. Less clear is the need for this project. For instance, at planned service frequencies, ridership modeling indicated significant spare capacity during BQX’s opening years, with peak demand potentially approaching available capacity at scheduled frequency in 2050. In the meantime, the subways are bursting at the seams and the streets are overcrowded by ride sharing cars that limits on their number have recently been enacted. So it seems like a strange time to emphasize this project.

Muni Credit News Week of August 20, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$920,190,000

STATE OF ILLINOIS

General Obligation Refunding Bonds

Moody’s: “Baa3” (Stable Outlook)
S&P: “BBB-” (Stable Outlook)
Fitch: “BBB” (Negative Outlook)

The refinancing of state debt at more favorable terms is always a positive. That is not what we see as the important part of this effort to come to market. In this case, the focal point should be the nature of the disclosure included in the offering documents as it pertains to the State’s budget outlook.

From that perspective, the statement that the State has a structural budget deficit of $1.2 billion is important. While the State did enact a “balanced budget”, the level of the ongoing hurdles to be overcome to generate truly positive momentum for the State’s credit is important. The number indicates that regardless of the outcome of this November’s gubernatorial ballot, the next Governor and the Legislature have a significant road to hoe.

The structural deficit accompanies an ongoing backlog of unpaid bills estimated at $7.4 billion. So long as the State is unable to address its structural deficit the backlog will continue to serve as a significant drag on the State’s credit and ratings. In addition, the prospectus reminds investors once again of the magnitude of the State’s unfunded pension liabilities which plague not only the State but also its underlying municipalities and subdivisions. Overall the State’s unfunded liability position remains significant with an actuarial liability of $128.9 billion and a funding ration of 39.9%.

While the language dealing with factors which could potentially impact the State’s budget, we note that there is particular attention drawn in the document to the negative effects of US trade policy. Illinois, in addition to being significantly exposed to agricultural tariffs, is also impacted by tariffs on steel and aluminum which are significant manufacturing inputs to businesses in the State. In addition to raising costs of production and final products for domestic consumption, the trade war will negatively impact the State’s manufacturing sector. We take this view notwithstanding some isolated examples of manufacturing capacity being restarted in certain industries.

All of these factors place the enacted budget at significant risk of negative variance.

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GAS TAXES AND ELECTIONS

Ninety-six percent of state lawmakers who voted in favor of a gas tax increase and faced reelection in 2018 primaries will advance to the Nov. 6 general election, according to new data from the American Road & Transportation Builders Association’s Transportation Investment Advocacy Center. The 2018 primaries saw 802 legislators who voted on gas tax increase legislation from 12 states – California, Iowa, Indiana, Montana, Nebraska, Oregon, South Carolina, Utah, Oklahoma, Tennessee, Michigan and Washington – run for reelection. Of those lawmakers, 558 voted in favor of a gas tax increase and ran for reelection, with 538—or 96 percent—advancing to November’s general election.

The numbers include 97 percent of the 263 Democratic lawmakers, and 96 percent of 295 Republican lawmakers. Of the 222 legislators who voted against a gas tax increase and ran for reelection, 216—or 97 percent—will move on to November’s general election. This includes 96 percent of 52 Democratic lawmakers, and 97 percent of 170 Republican lawmakers. An additional 22 lawmakers did not cast a vote on a gas tax increase measure and ran for reelection.

Earlier findings from the advocacy group showed voting for a gas tax increase does not affect a lawmaker’s chance of reelection. In the 16 states that increased their gas tax rates or equivalent measures between 2013 and 2016, nearly all (92 percent) of the 1,354 state legislators who voted for a gas tax increase and stood for reelection between 2013 and 2017 were sent back to the state house by voters. Of the 712 elected officials who voted against a gas tax increase, 93 percent were also given another term.

The stats seem to show that excuses for not raising gas taxes over time have been just that – excuses. With a 90% success rate for advancement in the primaries occurring regardless of one’s voting record on gas taxes, it seems somewhat obvious that gas taxes just aren’t an issue. We suspect that gas tax levels matter far less than healthcare, education, and whether or not one has a job. Gerald Ford once said that the inflation rate doesn’t matter if you don’t have an income.

SEQUESTRATION TO IMPACT DIRECT PAY BONDS

Pursuant to the requirements of the Balanced Budget and Emergency Deficit Control Act of 1985, as amended, refund payments issued to and refund offset transactions for certain state and local government filers claiming refundable credits under section 6431 of the Internal Revenue Code applicable to certain qualified bonds are subject to sequestration.

This means that refund payments and refund offset transactions processed on or after October 1, 2018, and on or before September 30, 2019, will be reduced by the fiscal year 2019 6.2 percent sequestration rate. The sequestration reduction rate will be applied unless and until a law is enacted that cancels or otherwise affects the sequester, at which time the sequestration reduction rate is subject to change.

These reductions apply to Build America Bonds, Qualified School Construction Bonds, Qualified Zone Academy Bonds, New Clean Renewable Energy Bonds, and Qualified Energy Conservation Bonds for which the issuer elected to receive a direct credit subsidy pursuant to section 6431.

PREPA SETTLEMENT ONLY ONE STEP

It is hard to be optimistic about the long term financial outlook for Puerto Rico. In the case of PREPA, the electric utility, a proposed settlement with debt holders generates some encouragement but reality has a way of rearing its head at inopportune times.

The latest evidence of that is The Puerto Rico Comptroller’s Office finding evidence of irregularities in the electric power company’s fuel purchasing and payments for professional service. The report establishes that in eight contracts and an amendment for the purchase of $4.6 billion worth of fuel between 2008 and 2012, the Puerto Rico Electric Power Authority (PREPA) did not include in the contracts a clause to charge interest for delays. Despite the absence of this clause in the contracts, the utility disbursed $3.3 million to the suppliers. The audit of three findings indicates that $2.3 billion in payments were made to a company that had pleaded guilty to fraud in 2006.

“The Report states that a fuel supplier that filed and paid their Monthly Tax Return to the Department of the Treasury more than two years after the term established by the Law was identified,” the comptroller said.

Puerto Rico’s electric power restoration after Hurricane María mangled the island’s grid entailed an estimated $2.5 billion. The utility is now entering a phase that consists of improving the temporary work done to put the lights back on as quickly as possible, which means outages are imminent during the coming six months. “There will be one or more blackouts in one sector or another because we have to remove [utility] poles that aren’t installed in the best way. We’re going to be notifying people in time so they know when there’ll be some [work done] to be able to change their poles to firmer ones and do a job well done.”

THUMB ON THE BRIGHTLINE SCALE?

We are more than interested in the news that current Governor and Senate candidate Rick Scott and his wife invested at least $3 million in a credit fund for All Aboard Florida’s parent company, Fortress Investment Group, according to recently disclosed financial documents. One has to wonder what impact this decision, which generates the Governor some $150,000 in annual investment income has sweetened the environment for All Aboard Florida’s plan to expand service from Orlando to Tampa.

In 2011, Gov. Rick Scott canceled a $2.4 billion federally funded and shovel-ready bullet train from Orlando to Tampa because it carried “an extremely high risk of overspending taxpayer dollars with no guarantee of economic growth.’’ Now he thinks that such a venture is “a good idea”. The Governor’s investments are in a blind trust but most of his and his wife investments are held in her name limiting the disclosure requirements about his investments.

This is exactly the kind of thing that clouds the municipal finance universe. It’s not the first ethically challenged investment activity for the Governor. When he ran HCA, that for profit hospital chain paid fines in excess of $1 billion to the federal government. While all parties deny that the Scott’s investments directly benefit from the ultimate success or failure of the Brightline, it creates an unsightly perception that moves the project from the realm of sound economic development to that of politicized investing.

It all harkens back to earlier times in the US where infrastructure development was influenced by the role of various private participants and investors. One could hope that those days were behind us but in the instance that does not appear to be the case. It is no surprise that privatization and public private partnerships are viewed through a skeptical prism by so many.

SEC ENFORCEMENT CONTINUES

The ongoing efforts by the Securities and Exchange Commission (SEC) to police the municipal bond market continue. The latest charges two firms and 18 individuals in a scheme to improperly divert new issue municipal bonds to broker-dealers at the expense of retail investors. According to the SEC’s complaint, the defendants – known in the industry as “flippers” – purchased new issue municipal bonds, often by posing as retail investors to gain priority in bond allocations. The defendants then “flipped” the bonds to broker-dealers for a fee. The SEC also charged a municipal underwriter for accepting kickbacks from one of the flippers.

Many issuers require underwriters to give retail investor orders the highest priority when allocating new issue bonds, particularly retail investors within the municipal issuer’s jurisdiction. According to the SEC’s complaint, these defendants used fictitious business names, falsely linked their orders to ZIP codes within the issuer’s jurisdiction, and split orders among dozens of accounts. After acquiring the bonds, the SEC alleges that the defendants quickly resold them to broker-dealers, typically for a fixed, pre-arranged commission, and often sought to hide the flipping activity from issuers and underwriters by manipulating sales tickets.

Fifteen individuals charged settled the SEC’s charges without admitting or denying the allegations, agreeing to injunctions, to return allegedly ill-gotten gains with interest, pay civil penalties, be subject to industry bars or suspensions, and to cooperate with the SEC’s ongoing investigation. Three individuals face criminal proceedings.

The continued vigilance of the agency under the current administration is an overall positive for the market. With infrastructure demands increasing almost daily it is important that the municipal market be able to appeal to the widest range of investors. These efforts will help to increase the long-term attractiveness of the market to potential investors whether they be individuals seeking tax sheltered income or to non-traditional institutional investors looking to enter the market for the first time.

SOUTH CAROLINA PUBLIC SERVICE AUTHORITY DOWNGRADE FINALLY COMES

Moody’s Investors Service has downgraded the rating on the South Carolina Public Service Authority (Santee Cooper) revenue bonds to A2 from A1. The rating action is based on consideration of the continued unstable governance with uncertainty about future rate setting as Santee Cooper operates without a board chairman. The downgrade also reflects the very high leverage that will persist for many years owing to the termination of the Summer Nuclear project which has introduced cost recovery challenges to Santee Cooper, particularly in the near-to-medium term. Another consideration in the downgrade is the continued uncertainty about the ultimate outcome of the litigation brought by Central Power Electric Cooperative (Central), Santee Cooper’s major wholesale customer that provides more than 60% of its revenues.

No legislative action was enacted in the 2018 session which curtails the Santee Cooper board’s unregulated authority to establish rates and charges to meet bond covenants in a timely manner. An existing state statute prohibits the state from doing anything including enacting new laws that would impact bond covenant compliance. An additional factor in favor of the rating is the fact that Santee Cooper does not have to immediately replace the planned Summer addition with a new generation. This would lead the fact that Santee Cooper does not have to immediately replace the planned Summer addition with a new generation. This would lead to an even more unfavorable debt profile which would further increase downward pressure on the rating.

Muni Credit News Week of August 13, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

CITY AND COUNTY OF DENVER, COLORADO

FOR AND ON BEHALF OF ITS DEPARTMENT OF AVIATION

AIRPORT SYSTEM SUBORDINATE REVENUE BONDS

$2,200,000,000

The issue will provide financing for the public private partnership undertaking the renovation and reconfiguration of Denver International Airport. It is hard to believe that DIA opened in 1995 but the passage of time, increased security issues, and ever increasing passenger volumes have led to the plan to update the main terminal at the airport.

Major components of the project include: Enhancements to security by removing today’s exposed checkpoints on level 5; Increased Transportation Security Administration (TSA) throughput; Increased capacity and life of the terminal for the future, allowing the airport to grow its operations in the terminal and concourses to match increasing passenger demand; Better utilization of airline ticket spaces, including increased check-in counter space; An upgraded meet and greet area at the south end of the terminal, and a new “front door” to the airport, including a children’s play space and flight info displays; Improved food and retail offerings throughout the Jeppesen terminal; Curbside improvements for increased passenger drop-off capacity, including a quick drop-off location directly at the TSA checkpoints.

The Jeppesen Terminal was built to serve only 50 million annual passengers, and it served over 58 million passengers in 2016. TSA checkpoints are at capacity. The airport also has an underutilized and inefficient ticket lobby space and is lacking the adequate amount of concessionaires to accommodate projected passenger growth. Today, DEN has 30 standard checkpoint lanes that accommodate about 4,500 passengers per hour. The Great Hall project will include 34 state-of-the-art automated screening lanes, which can each serve an estimated 8,500 passengers per hour.

The P3 established for this project (The Great Hall Partners) is comprised of Equity Partners: Ferrovial Airports International Ltd., JLC/Saunders joint venture, which includes Saunders and Magic Johnson Enterprises & Loop Capital. The Design & Build partners: Ferrovial Agroman and Saunders Construction, Inc. The Architects: Luis Vidal + Architects, Harrison Kornberg Architects and Anderson Mason Dale. Local Engineers/Contractors: Intermountain Electric, Civil Technology, Gilmore Construction, Sky Blue Builders. Equity Partners Legal Advisors: Gibson, Dunn & Crutcher.

The City and the airport still maintain the ownership and the private partner is in a long-term lease. The Great Hall Partners were granted an exclusive license to develop and manage terminal concessions and will contract directly with individual concession operators. The agreement requires that 70 percent of concession locations must be competitively procured; so existing concessionaires will have the opportunity to bid on concession opportunities in the terminal area.

The initial plan calls for the project to be completed in four main construction phases. Phase one of the project will primarily focus on work in Mod 2, east and west, including airline ticket lobbies, baggage claim areas, the food court (which will be demolished), as well as the area of the A bridge from the terminal to the Airport Office Building, Phase two will focus on Mod 3, with similar ticket lobby and baggage claim area work. Phase three will be in Mod 1, preparing for the current Mod 1 ticket counters for conversion into new passenger security screening area, and the final phase will entail work in the tented space of the terminal on level 5, along with median and curbside work on level 6 on both the east and west sides of the terminal. Milestones for the project include opening of the ticket counters in early 2020, opening the checkpoints in late 2020, and the entire project will complete in late 2021.

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PR MOVES TO SETTLE COFINA DEBT

The news that the government and a number of bondholders reached a deal to restructure the instrumentality’s debt secured by sales taxes (the COFINA debt) was generally greeted favorably. Contrary to many who postulated that the sales tax debt had been legally structured to be immune to the travails of the general obligation debt, the proposed settlement will require COFINA debt holders to take a substantial haircut. The deal provides for more than a 32% reduction in COFINA debt, providing Puerto Rico about $17.5 billion in future debt-service payments.

It provides for 53.65% of the Pledged Sales Tax Base Amount (“PSTBA”) cash flow through and including 2058 to be dedicated to the new COFINA bonds which are proposed to be issued to the debt holders. The new bonds will result effectively in an extension of maturity (no surprise). The new debt will come in the form of both current interest and capital appreciation bonds.

As it exists now, the proposal allows the issue of final judicial review of the strength of the statutory lien of COFINA bonds against the constitutional lien which the general obligation bond holders contend supersedes it. Because this point has yet to be adjudicated, we expect that general obligation bondholders will seek to intervene in the proceedings and to challenge the claim on revenues by COFINA bond holders.

We do not pretend to know how this conflict will eventually be resolved. It has long been our view that a constitutionally established lien is stronger than a statutory lien. We understand why the Commonwealth did not seek to have the lien judicially validated (it very well might not have been upheld) but it is not as clear why investors did not consider the issue of a statutory vs. a constitutional lien. Regardless of the outcome, our view is that the issue validates our long held belief that economics always trump legal provisions if one wants to feel secure in one’s investment.

One market cohort which is undoubtedly pleased by the terms of the proposed settlement is the monoline bond insurers. National Public Finance Guarantee Corporation is estimated to have nearly $1.2 billion of par exposure to COFINA senior bonds. Assured Guaranty Municipal Corp. is estimated to have $264 million of net par exposure to subordinate COFINA bonds. Moody’s estimates that National will incur ultimate losses on its total COFINA insured debt service obligations of around $80 million on a present value basis, while AGM’s will be around and $130 million.

NORTH CAROLINA TAX CAPS

North Carolina’s allowable maximum income tax rate is currently 10%. The state moved to a flat tax rate of 5.8% in 2014. On Jan. 1, 2019, the state budget lowers the personal income tax rate to 5.25% from 5.499%. Now, the legislature has approved initiatives to be submitted to the voters this November which would “limit future, legitimately-elected legislatures’ power to set state income tax rates higher than 7%, which could limit funding for programs.

The action comes as multiple studies have been released which raise issues of equity among various income cohorts which result from the establishment of taxing limitations. In addition, North Carolina’s politics have become substantially more partisan and polarized. This has led to the filing of a lawsuit by the Governor of North Carolina against, among others, the President pro Tem of the Senate and the Speaker of the House in North Carolina.

The Governor seeks to have the initiatives annulled as violations of the separation of powers. The Governor charges that the initiatives were crafted for the purpose of deceiving the electorate. He is concerned that the proposed amendments could allow the legislature to enact laws which then had to be enforced by the Governor even if he vetoed them. The proposed veto exception for judicial vacancy bills is not expressly limited to bills on that subject “and containing no other matter.”

LONG RELIEF FOR THE YANKEES GARAGE

Since Opening Day of 2009, the new Yankee Stadium has been the home of the 26 time world champions. While their performance on the field has been generally favorable, the financial performance of the garage at Yankee Stadium has been seriously deficient. There have been a variety of proposals made for development which might provide revenues to support a restructuring of the bonds issued by the New York Industrial Development Corporation.

The bonds were issued in 2007 on behalf of the Bronx Development Corporation (BDC). The garage is the only asset pledged as security for the bonds and the only source of revenues. From the start, below expected demand has been a constant feature of operations. This, coupled with a high $35 per game parking fee, served to permanently suppress demand as the Stadium is quit accessible via public transportation.

Now the other tenant at Yankee Stadium, Major League Soccer’s New York City FC, may be part of a solution to the financial conundrum faced by the BDC. The is a four-level parking structure that sits immediately south of the old stadium site. The garage along with two other structures would be demolished to create a roughly eight-acre plot of land just big enough to squeeze in a soccer-specific stadium. The city would sell or lease it to a private developer. The developer would sublease the garage site to NYCFC, which would erect on it a 26,000-seat, $400 million soccer stadium.

Certainly enough moving parts are here to interest investors. One wild card (the Yankees are competing for that spot) is that the garages only become available if the Yankees agree to lift the requirement, agreed to in 2006, that the city provide a minimum of 9,500 parking spaces for fans — a provision that even the team owners no longer care about, but which they can decline to do away with unless the city agrees to use the garage property for a project of their liking.

One thing in favor of the project going through – NYCFC is owned by the Steinbrenner family and Abu Dhabi’s Sheikh Mansour bin Zayed Al Nahyan.

CA JULY REVENUE UPDATE

During the first month of the 2018-19 fiscal year, California took in less revenue than estimated in the budget enacted at the end of June according to the State Controller. Total revenues of $6.63 billion for July were lower than anticipated by $294.7 million, or 4.3 percent. While sales taxes missed the mark, personal income tax (PIT) and corporation tax – the other two of the “big three” revenue sources – came in higher than projected.

For July, PIT receipts of $5.22 billion were $231.7 million, or 4.6 percent, more than expected. July corporation taxes of $446.4 million were $82.2 million, or 22.6 percent, above 2018-19 Budget Act assumptions. Sales tax receipts of $818.4 million for July were $659.1 million, or 44.6 percent, less than anticipated in the FY 2018-19 budget. Most of the variance was due to when the money was recorded.

At the beginning of FY 2018-19, the state’s General Fund had a positive cash balance of $5.54 billion. Receipts were $3.62 billion less than disbursements in July, which left a cash balance of $1.92 billion at the end of the month. There was no internal borrowing, which was $2.19 billion less than the 2018-19 Budget Act estimated the state would need by the end of July. Unused borrowable resources were 7.5 percent higher than projected in the budget.

NEW YORK STATE SALES TAX GROWTH

Sales tax revenues in New York secure a variety of debt issues in the state. So it is good news that the State Comptroller’s Office announced that first-half of calendar year 2018 sales tax collections grew 6% over 2017, the highest six-month increase since 2010. In addition to individual bond issues, sales taxes are a significant revenue source to local governments across the State. They are also a good current indicator of the trend of economic activity. Sales tax growth was strong in virtually every region of the state.

The Comptroller cited a number of factors to account for this strong growth trend. They include low unemployment (the lowest in more than a decade), improved consumer confidence, steady wage growth and the highest inflation rate since 2011. Also driving the increase, particularly in counties bordering Pennsylvania, was increased collections of motor fuel tax. The comptroller noted that this was likely because of gas prices being lower in New York than in neighboring Pennsylvania.

The trend becomes more solid when viewed in the context of where sales tax revenues are generated. New York City has a strong tourist economy which lends itself to relatively outsized sales tax revenues. It is telling that counties which do not rely on tourism also exhibited strong growth lending credence to the view of a strong and expanding economy.

Muni Credit News Week of August 8, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$366,250,000

California Statewide Communities Development Authority

Revenue Bonds

Loma Linda University Medical Center

The Medical Center comes to market fresh on the heels of a rating downgrade from Fitch to BB from BB+. The bonds are secured by a gross receivables pledge and mortgage pledge of the obligated group (OG). There are also debt service reserve funds. The OG includes LLUMC, LLU Children’s Hospital, LLUMC – Murrieta, and Loma Linda University Behavioral Medicine Center. The OG accounted for almost all of the consolidated system assets and revenues. The increasing leverage being added to the Medical Center’s already highly leveraged balance sheet is the primary basis for the downgrade.

The capital program began over a year ago. The project includes two new patient towers on a shared platform (16-story adult tower and 9-story children’s tower) with all private rooms, expanded and separate emergency rooms, expanded neonatal intensive care unit and birthing center, 16 new operating rooms (five additional), enhanced diagnostic imaging services and cardiovascular labs. The project will result in 983,000 square feet of new space with a total capacity of 693 licensed beds (320 adult and 377 children’s) once the shelled space is built out for the additional 60 beds.

LLUMC is located 60 miles east of Los Angeles in Loma Linda, CA. It operates a total of 1,077 licensed beds: University Hospital (371), East Campus Hospital (134), Surgical Hospital (28 bed) (all three share a license and are located on the main campus), Children’s Hospital (343 beds), Behavioral Medicine Center (89-bed facility in Redlands) and LLUMC- Murrieta Hospital (112 beds in Murrieta). LLUMC offers quaternary and tertiary series and has the only level I trauma center and level IV neonatal intensive care unit in the service area of the Inland Empire (San Bernardino and Riverside counties). University Hospital and Children’s Hospital are undergoing a capital intensive campus transformation project which will also address state-mandated seismic requirements that go into effect on Jan. 1, 2020, although the project is a year behind schedule and will require an extension from the state legislators.

LLUMC’s market share in its service area, the Inland Empire, was stable in 2016 after slight growth between 2012 and 2015. While not leading the service area market share, LLUMC offers a greater depth and breadth of quaternary and tertiary services with the only level-I trauma center and level-IV neonatal intensive care unit in the service area. Its role as a major provider of children’s services is a double edged sword. It drives utilization but increases its dependence upon Medicaid. Medicaid currently represents approximately 41% of gross revenues and 32% of net revenues. LLUMC is a major beneficiary of California’s HQAF program. HQAF provides supplemental Medi-Cal payments to hospitals that are net recipients of the hospital provider fee program; however, there is a lag in payment receipts after the pertaining services are provided.

The service area is competitive. LLUMC’s market share in the Inland Empire was 11% in 2016 and the next closest competitor, Kaiser-Fontana, had a 7.2% market share. However, Kaiser has several facilities in the area and Kaiser’s combined market share in the region was 12%. Other leading competitors in this service area include UHS (8.1%), Tenet (7%), and Dignity Health (6%).

LLUMC reported a 10.9% operating margin and 16.1% operating EBITDA margin in the nine-month statements of fiscal 2018 (ended March 31) partly due to the recording of additional net program benefits. Operating improvement in fiscal 2018 has been driven largely by initiatives to reduce length of stay and cost management.

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SAN DIEGO GETS BAD NEWS ON PENSION REFORM

The six year old pension reform program undertaken by the City of San Diego was overturned by the California Supreme Court last week. The court ruled that the plan was not legally placed on the ballot because city officials failed to negotiate with labor unions before pursuing the measure. The court ordered the appeals court to take the case back and evaluate the state labor board’s conclusion that 4,000 employees hired since pensions were eliminated must receive compensation that would make them financially whole.

The ruling sends the case back to the appeals court and directs that court to enact “an appropriate judicial remedy” for the city’s failure to follow the legally required steps before placing the measure on the ballot. The city has said that the only way to do that would be to invalidate the ballot measure and nullify the pension cuts. The measure was approved by more than 65% of city voters. It replaced guaranteed pensions with 401(k)-style retirement plans for all newly hired city employees except police officers.

At the time of the vote, the then mayor of the City took a leading role in promoting support for the initiative. The fact that the mayor took such a public role in supporting it became a key factor in the court’s decision. The mayor maintained that he supported the measure only as a citizen, not as mayor, and as a result negotiations with unions were not required. The Court found that his interpretation of his role was incorrect and that he was obligated to meet with the unions before placing the measure on the ballot because he used his power and influence as mayor to support the measure.

The mayor relied on legal advice he received but acknowledged he should have handled things differently. The ruling reinstates a 2015 decision by the state labor board that concluded the city was legally required to conduct labor negotiations before placing Proposition B on the ballot. The board then ordered San Diego to make employees hired since 2012 whole by compensating them for the loss of pensions and paying them interest penalties of 7%. Estimates of how much that would cost the city have ranged from $20 million to $100 million.

It is important to note that the Court only ruled on the procedural issue. It noted that it was not ruling on the pension cuts. “We are not called upon to decide, and express no opinion, on the merits of pension reform or any particular pension reform policy.” San Diego is the only city in California to discontinue pensions for new hires. The ruling also bolsters the role of the employee union and is notable in that it follows fairly closely the US Supreme Court ruling in the Janus case which is seen as a negative for unions.

PUERTO RICO

The Financial Oversight and Management Board for Puerto Rico has published its second annual report to the U.S. president, Congress and the governor and legislature of Puerto Rico, as required by the Puerto Rico Oversight, Management and Economic Stability Act (Promesa). The review period includes the aftermath of Hurricane Maria. “Immediately after Hurricanes Irma and Maria struck, the Oversight Board provided the Government with the flexibility to reapportion up to $1 billion in budgeted expenditures to cover disaster related expenses. The Oversight Board also worked with the Government to forecast the liquidity needs of the Government in the months ahead, which eventually led to Congress providing Puerto Rico with access to specialized forms of Community Disaster Loans to offset the projected revenue shortfalls caused by the hurricanes.”

The report documents the impasse with the government encountered by the Board. “The Government initially rejected the most critical component of labor reform – changing the law of Puerto Rico to make it an at-will jurisdiction for private sector employees like 49 of the 50 states.” “While this fiscal plan contains many of the fiscal measures necessary to rightsize the Government, it contains only those structural reforms that the Government agreed to implement, such as ease of doing business and energy reform, but not comprehensive labor reform because of the Legislature’s failure to pass the requisite legislation.

In addition, the report includes several recommendations from the Board. It requests federal support with Medicaid and Medicare by legislating a “long-term Medicaid program solution to mitigate the drastic reduction in federal funding for healthcare in Puerto Rico that will happen next year,” as well as providing “fair and equitable treatment to residents of Puerto Rico in all Medicare programs.” It also suggests special provisions be increased to enhance Puerto Rico’s attractiveness for investments in the U.S. Tax Code’s Opportunity Zone (OZ) rules, such as for property acquired from the Puerto Rico Government, extending the time in which an OZ fund must invest in Puerto Rico, providing “special basis rules for investors that invest in a Puerto Rico OZ Fund,” and reducing the holding period applicable to an investment in a Puerto Rico OZ Fund.”

The Board also reiterated “the long road ahead for Puerto Rico but is resolute in fulfilling its mission of helping Puerto Rico to achieve fiscal responsibility, regain access to capital markets, restructure its outstanding debt, and return to economic growth.”

MORE CHICAGOLAND CREDIT IMPROVEMENT

Moody’s continued its moves to improve the outlooks for ratings for a variety of credits in and around the City of Chicago. The latest beneficiaries are the Regional Transportation Authority (RTA) and the Chicago Transit Authority (CTA). Moody’s has revised the outlook on the Regional Transportation Authority’s (IL) sales tax revenue bonds to stable from negative, while affirming the bonds’ A2 rating. This affects $1.6 billion out of the Authority’s $2.2 billion outstanding debt. The outlook change is based on the recently stabilized credit positions of key related governments, Illinois and Chicago. With solid economic trends in Chicago and its surrounding suburbs, pledged regional sales tax collections will tend to increase, supporting RTA’s credit position for the next one to two years.

RTA’s debt is secured by liens on sales tax imposed by the RTA in its service area and on matching payments from the state’s Public Transportation Fund (PTF). The sales taxes are levied at various rates throughout the region. In Cook County (A2 stable), for example, the tax rate for general sales tax is 1%, while the tax on drugs and prepared food is 1.25%. Collar county general sales are subject to a 0.5% RTA tax. Unlike some state obligations supported by revenue collected by the state’s Department of Revenue, the RTA benefits from a primary source that is separated from the state government’s operations, flowing directly to a trust account held for RTA outside the state treasury. The payment of regional taxes has generally not been subjected to budgetary deliberations or to deferral, and it does not require legislative appropriation for payment. Fare-box collections of the RTA’s service boards are not available for payment of debt service.

Moody’s Investors Service has revised the outlook for bonds issued by the Chicago Transit Authority to stable from negative, while affirming the ratings at current levels (A3). The same factors justifying the improvement in the RTA rating outlook were cited to support the CTA outlook change. CTA’s sales tax revenue bonds are secured by CTA’s Sales Tax Receipts Fund (STRF), which receives transfers of RTA sales tax revenues and the state’s PTF matching payments. CTA’s sales tax and PTF revenues that exceed debt service requirements are released for operations. These revenues are allocated under a statutory formula and are transferred by RTA after it has satisfied debt-service requirements on its own sales-tax secured bonds. The CTA’s bonds therefore are in effect subordinate to the RTA bonds.

An exception to this subordination is that the CTA’s 2008 retirement benefit-funding bonds, the largest share of CTA’s outstanding sales-tax revenue bonds, are additionally secured by Chicago real estate transfer tax (RETT) payments. The RETT revenues are deposited in the Transfer Tax Receipts Fund. The CTA’s share of RETT is assessed at a rate equal to $1.50 per $500 under legislation passed in connection with the 2008 bonds. RETT revenues have averaged about $67 million in the past five fiscal years.

Muni Credit News Week of July 30, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

THE INDUSTRIAL DEVELOPMENT AUTHORITY OF THE

CITY OF MARYLAND HEIGHTS, MISSOURI

$50,250,000

Revenue Bonds

$5,400,000*

Subordinate Revenue Bonds

(Saint Louis Community Ice Center Project)

Ice skating facilities have a relatively poor credit history in the municipal bond market. Regardless of the involvement of a variety of public and private entities, many bond financed facilities have failed to reach projected levels of demand. This has produced a number of defaults which have troubled municipalities and challenged them to provide financing through either initial funding agreements or restructurings.

In spite of this checkered history for these projects, the City of Maryland Heights, MO is undertaking the financing of a new ice facility in the City through the issuance of bonds. The non-rated bonds are intended to be repaid from operating revenues and a pledge of sales tax dollars generated by economic activity in a Community Improvement District.

A variety of private interests are supporting the project including a hotel casino located within the boundaries of the community improvement district as well as the St. Louis Blues NHL hockey franchise. The Blues are a popular team which has enjoyed strong fan support and the community is considered to be a major source of junior hockey participation and interest. a number of current NHL players were initially developed through local St. Louis youth hockey programs.

This proposed deal will be secured by proceeds of a 1% sales tax collected within the District beginning January 1, 2019. Risks to the transaction include construction risk in addition to operating risk and dependence upon economically sensitive sales tax revenues. A mortgage on the facility will be offered to secure the debt.

Nonetheless, many unsuccessful facilities have offered similar profiles – the support of a local professional team and strong interest in youth hockey. This deal does attempt to address many of these historic hurdles to successful ice projects. It will employ a professional manager which does e have experience in the local market, sponsorship agreements providing revenues, and provisions for events unrelated to hockey including concerts.

In any event, the bonds are planned to be sold only to “qualified investors” but that does not prevent them from being placed into high yield bond funds which means that individuals will wind up having these bonds securing their investments. Caveat emptor!

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VIRGIN ISLANDS

The US Virgin Islands will move forward with the reopening of the former Hess/HOVENSA owned oil refinery now that the Legislature has approved an agreement last week with ArcLight Capital Partners’ Limetree Bay to operate the facility. The refinery had historically been an important revenue source for the USVI government as well as the source of some 1200 jobs on the island of St. Croix. In the wake of Hurricane Maria, a way to recreate many of those jobs was an important part of the post-Maria recovery plan.

The plan as approved by the Legislature was not all that had been hoped for by the Governor of the USVI. He had wanted revenue received by the government from the project to be dedicated to the USVI’s significantly underfunded public employee pension plan. The pension plan in the 2017 fiscal year had about $4.7 billion less than it needs to cover all the benefits that have been promised, according to the Government Employees’ Retirement System, and is projected to run out of money as soon as 2023. The Legislature did not include the revenue dedication in its approval.

The appropriation of the funds will be determined through negotiations between the Governor and the Legislature. ArcLight Capital will make a $70 million payment to the Virgin Islands government upon finalization and implementation of the agreement. It will continue to make annual payments ranging from $14 million to $70 million, based on the performance of the refinery.

The deal is positive for the USVI credit in that it will provide increased revenue as well as replacement of an estimated 700 of the jobs lost to the economy when the refinery closed.

AURORA ADVOCATE HEALTH SYSTEM

Whenever two health systems merge, there is always ratings risk associated with the endeavor. In April, Aurora Health merged with Advocate Health to create a new substantial regional health provider serving portions of Illinois and Wisconsin. AAH now provides a continuum of care through its 25 acute care hospitals, an integrated children’s hospital and a psychiatric hospital, which in total have 6,563 licensed beds, primary and specialty physician services, outpatient centers, physician office buildings, pharmacies, behavioral health care, rehabilitation, home health and hospice care in northern and central Illinois, eastern Wisconsin and the upper peninsula of Michigan.

The merger impacted the ratings of the outstanding debt of both entities. For those who own debt from Advocate, the impact was negative. Debt formerly rated Aa2 will now be rated Aa3. Debt from Aurora was upgraded from A2 to Aa3. The rating incorporates challenges including integration risk, especially as it relates to realignment of management and governance, fierce competition in rapidly consolidating markets and noted revenue slowdowns attributable to pricing pressure and unfavorable payer mix shifts, particularly in the Illinois region.

The rating also is based on the size and scale Advocate Aurora will have as a market leader over a large geographic service area, potential to capitalize on synergies related to core infrastructure, purchasing and materials management, a strong liquidity position as measured against expenses and financial leverage, both legacy organization’s demonstrated history of successful operations and absorption of growth, and anticipated savings that will be achieved from the debt refinancing.

Security will be a general, unsecured obligation of the obligated group. There is no additional indebtedness tests. The members of the obligated group under the Master Indenture will be: Advocate Aurora Health, Inc., Advocate Health Care Network, North Side Health Network, Advocate Condell Medical Center, Aurora Health Care, Inc., Aurora Health Care Metro, Inc., Aurora Health Care Southern Lakes, Inc., Aurora Health Care Central, Inc. d/b/a Aurora Sheboygan Memorial Medical Center, Aurora Medical Center of Washington County, Inc., Aurora Health Care North, Inc. d/b/a Aurora Medical Center Manitowoc County, Aurora Medical Center of Oshkosh, Inc., Aurora Medical Group, Inc., Aurora Medical Center Grafton LLC.

LOW INCOME TOLL RELIEF IN VIRGINIA

The area around the cities of Norfolk and Portsmouth are best known as the locations for major US Navy facilities. While these facilities provide a significant economic base, not all of the region’s residents benefit. The two cities have poverty rates that hover around 20 percent, above the national rate and well above the average in Virginia. Nearly half of the residents in both cities spend at least 30 percent of their income on housing costs. So an agreement to have a private operator run two tunnels between the two cities – an agreement that allows the private operator to levy tolls for use of the tunnels has been viewed as an economic hardship for some who travel between the two cities.

Some 115,000 cars that cross the river between the two cities each day through the either the Downtown or Midtown tunnel. Tolls were put into place in early 2014 under an agreement between Elizabeth River Crossings and the Virginia Department of Transportation that also involves repairs and additions to the tunnels. Each car that passes through either tunnel pays at least $1.73 – up to $5.53 during peak hours without E-Z Pass – each way.

A recent study found that tolls accounted for a 13% decline in annual traffic volume through the two tunnels between 2013, the last year before the tolls were implemented, and 2016. It estimates that the tolls deterred $8.8 million of taxable sales from Portsmouth in 2017, which amounts to nearly $500,000 in lost tax revenue for the city.

Recently, former Governor Terry McAuliffe brokered an agreement between state government and Elizabeth River Crossings, the private company that manages the tunnels. Through the Virginia Toll Relief Program developed by the Virginia Department of Transportation, Elizabeth River Crossings pledged $5 million in toll rebates to low-income individuals over a span of 10 years.

Eligible individuals must reside in Norfolk or Portsmouth, earn no more than $30,000 each year and cross through the Elizabeth River tunnels at least eight times per month. Using an EZ Pass, a 75-cent credit per trip – between a 13.6 and 43.4 percent discount that adds up to about $30 per month – is refunded to the accounts of enrolled participants after each eighth trip.

2,100 people enrolled in the program in its inaugural year. That increased to just over 3,000 in year two, with two-thirds of enrollees residing in Portsmouth and one-third in Norfolk. For P3 projects to gain acceptance where they involve formerly free facilities, innovative programs to address the concerns of less well off users will likely grow in importance. They are emerging at the same time that discount programs for low income users of public transport systems are growing in major municipalities across the country.

CHICAGOLAND RATING UPGRADE

S&P Global Ratings raised its rating to ‘B+’ from ‘B’ on the Chicago Board of Education’s outstanding unlimited-tax general obligation (GO) bonds. The outlook is stable. S&P cited “the board adopting a balanced budget for fiscal 2019 when accounting for management’s articulated plan to close a small $59 million initial gap and the state adopting a fiscal 2019 budget that includes the promised higher state aid revenue as a result of Illinois’ new evidence-based funding formula (EBF), along with estimates for fiscal 2018 indicating an operating surplus and a resulting positive fund balance.”

Other positive factors include Continued evidence that the board has improved its cash and fund balance position (by an estimated $575 million), reduced reliance on lines of credit (by $455 million), and notable wins for the board in 2017 from the state now picking up more of the employer pension contribution and the board’s authority to extend a higher property tax levy to support that contribution.

The outlook was raised to positive in April of this year. At that time, S&P said the rating could be raised by one notch after further evidence of increased state funding for fiscal 2018, fiscal 2018 estimates showing a surplus result and a positive fund balance, the board adopting a balanced fiscal 2019 budget, the state adopting a fiscal 2019 budget that included full EBF funding, and the cash flow continuing to show improvement in line with or better than projections—all of which have occurred. a higher rating is precluded at this time given increased operational costs (over 9% increase from fiscal 2018 projections, a 5% increase from the fiscal 2018 amended budget) spending and the affordability of capital spending in fiscal 2019 and beyond, special education spending pressures, and unresolved sexual harassment scandals and lawsuits.

Muni Credit News Week of July 23, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$850,000,000

New York City Transitional Finance Authority (TFA)

Future Tax Secured Subordinate Bonds

Fiscal 2019 Series A

Moody’s: Aa1

New York City comes back to the market in size with subordinated future tax secured debt. The issue carries a high rating despite its subordinate status. High debt service coverage is provided by the pledge of City of New York personal income tax and sales tax revenues, a strong legal structure that insulates TFA from potential city fiscal stress, the open subordinate lien that permits future leverage of the pledged revenues, and New York State’s ability to repeal the statutes imposing the pledged revenues. We do not expect that the State will ever choose to do the latter.

The state legislature established TFA as a separate and distinct legal entity from the city. Further, the state did not grant TFA itself the right to file for bankruptcy. The city has covenanted not to exercise its bankruptcy rights related to personal income taxes if debt service coverage would fall below 1.5 times MADS on outstanding bonds. TFA’s original statutory authorization of $7.5 billion has been increased several times to $13.5 billion (plus $2.5 billion “Recovery Bonds”) for senior and subordinate lien bonds. In 2009, legislation was enacted that allows TFA to exceed the $13.5 billion cap but counts debt over that amount, along with city general obligation debt, against the city’s overall debt limit.

Mechanics of the security are strong. The pledged taxes are collected by the New York State Department of Taxation and Finance and held by the state comptroller, who makes daily transfers to the trustee (net of refunds and the costs of collection). The trustee makes quarterly set-asides of amounts required for debt service due in the following quarter on the outstanding bonds, as well as TFA’s operational costs (with the collection quarters beginning each August, November, February and May). Half of each quarterly set-aside is made beginning on the first day of the first month of each collection quarter and the second half is made beginning on the first day of the second month of each collection quarter. If sufficient amounts for debt service are not on deposit after those two months, the trustee continues to set aside funds in the third month, on a daily basis, until the deficiency is cured.

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NEW JERSEY SPORTS BETTING REVENUE

Sports betting is underway at four locations in the state with commencement on June 14. The New Jersey Division of Gaming Enforcement has released tax data for the first month of operations. Sports Wagering commenced at Monmouth Park and Borgata on June 14, 2018 and Ocean Resort on June 28, 2018. Hard Rock and Ocean Resort commenced limited soft play on June 25, 2018 and opened to the public on June 27, 2018. Hard Rock commenced Internet gaming operations on June 28, 2018.

Sports Wagering Gross Revenue, which commenced June 14th, was $3.5 million for the month. For the month of June 2018, the Racetrack Economic Development Tax of 1.25% of racetrack sports wagering gross revenue was $28,490.

A recent Pew study purports to show that taxes like this are not a magic bullet for state finances. While lawmakers are enticed by taxes on gambling, revenue growth from newly legalized casinos and “racinos” (casino-racetrack hybrids) tends to be short-lived. Competition is a significant contributing factor, suggesting that as more states legalize these activities, states already collecting gaming revenue could see further erosion in these tax streams.

Pew notes that “for all the attention they garner, sin taxes typically represent a small portion of state revenue. In 2015, they made up just over 2 percent of total state revenue. That year, sin taxes accounted for 12 percent of Nevada’s revenue, the highest share in the nation. In North Dakota, however, they made up less than 1 percent. In real dollars, alcohol and tobacco raised $25 billion in state tax revenue nationwide in 2016. Gambling accounts for roughly the same amount: In 2015, the most recent year for which data are available, lotteries, casinos, and racinos generated almost $28 billion for states.”

DETROIT’S PROBLEMS HAVE NOT MAGICALLY DISAPPREARED

The recent announcement that a proposed bond-financed regional transit plan for the Greater Detroit metropolitan area was not approved for the November ballot brings into focus the regional divide which has and continues to plague the City of Detroit as it continues its process of recovery from bankruptcy in 2014. Recent announcements of an end to state oversight and news about redevelopment efforts in the City have encouraged thought among some that the City’s travails are over. The reality is that while the City is out of bankruptcy, it still faces significant obstacles to restore its place as the thriving center of this significant metropolitan area.

The plan needed to have a unanimous “yes” vote Thursday in the Funding Allocation Committee, but Oakland and Macomb counties voted it down. It was called “Connect Southeast Michigan,” and it called for a 1.5 mill property tax levy on Wayne, Washtenaw, Oakland and Macomb counties.

The millage was projected to raise $5.4 billion over 20 years to fund expanded regional transit service and plan forward flexible transit innovations as technology changes the transportation and mobility industries. The average house in the RTA region is worth $157,504, meaning it would cost $118 a year, or less than $10 per month.

Connect Southeast Michigan would also leverage an additional $1.3 billion in farebox, state and federal revenues for Southeast Michigan. Opposition was framed as being based in a perception that non-Detroit residents would have been subsidizing Detroit residents. We suspect that there is more to it than just tax policies. We suspect that the old race based issues which stimulated flight out of Detroit to near suburbs like Oakland and Macomb continue to rear their heads.

This type of thinking has stymied the development of regional solutions to many of metropolitan Detroit’s problems over the last half century.

WHILE MICHIGAN COUNTIES GET A NEW FINANCING TOOL

Moody’s Investors Service has assigned an initial Aa3 rating to a newly established enhancement program, the Michigan Counties Distributable State Aid Intercept Program. This program covers bonds that are secured by a county’s receipt of state aid, a pledge that also carries a statutory lien and interest in a statutory trust established for the benefit of bondholders. Further, the state treasurer is party to an agreement by which a county’s appropriated state aid will be paid directly to a bond trustee. Debt service payments will then be set aside by the trustee before state aid is made available for general county operating purposes.

The Michigan Counties Distributable State Aid Intercept Program reflects a programmatic rating established by Moody’s to assess bonds issued and secured by a county’s allocation of state shared taxes. Pursuant to Act 34, Public Act of Michigan, 2001, counties may issue unvoted debt secured by state revenue sharing payments under the Glenn Steil State Revenue Sharing Act of 1971 (Act 140). The programmatic rating further incorporates the use of statutory authority provided under Act 140 to direct the state treasurer to remit all DSA payments to a trustee to meet set-aside obligations on debt service.

ILLINOIS OUTLOOK UPGRADE CHICAGO ON STABLE STATUS

Moody’s Investors Service has revised the outlook on the State of Illinois to stable from negative. The action reflects expectations that, despite continued under-funding of pension liabilities, any credit deterioration in the next two years will not affect the state’s finances, economy, or overall liabilities to an extent sufficient to warrant a lower rating. The current Baa3 rating reflects Moody’s view of substantial credit strengths – sovereign capacity to raise revenue and reduce expenditures, and a broad, diversified tax base – as well as increasing challenges from fixed costs attributable to employee pension and retirement health benefits.

The improvement in the State’s outlook accompanies actions which saw the affirmation of the Baa2 and Baa3 ratings on the city’s senior and second lien sewer revenue bonds, respectively. Concurrently, the outlook has been revised to stable from negative. The ratings apply to $10 million of senior lien water revenue bonds, $1.3 billion of second lien water revenue bonds, $35 million of senior lien sewer revenue bonds and $1.3 billion of second lien sewer revenue bonds. The city’s senior lien water rating is three notches above the GO rating given that the water system’s service area extends well beyond the city’s boundaries. The ratings also consider the nature of the water and sewer systems as enterprises of the city, the City Council’s authority to adjust rates and the expectation that growing revenue needs of the city government and overlapping units of government could limit the capacity, both practical and political, to implement considerable adjustments if needed.

STOCKBRIDGE GA DEANNEXATION

The legal battle to prevent the de-annexation of land from the City of Stockbridge, GA completed its first round in Henry County Superior Court. A judge ruled that two bills signed by Gov. Nathan Deal in May – one cutting Stockbridge in half and another allowing for a referendum to create the new city of Eagle’s Landing – did not violate the state’s constitution.

The city can immediately appeal to the Georgia Supreme Court which is where this question would ultimately be decided. The decision, although negative for remaining Stockbridge residents and creditors, was necessary in order to move the issue through the courts. If the move is ultimately judged to be legal, it would be a real negative for all Georgia local credits and would reflect a degree of bad faith by the State which would be taking an action which arguably impairs existing contracts between borrowers and creditors.

Muni Credit News Week of July 16, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$10,245,000*

SOUTH CAROLINA JOBS-ECONOMIC DEVELOPMENT AUTHORITY

Solid Waste Disposal Revenue Bonds

(Ridgeland Pellet Company, LLC Project)

As we move through the interest rate cycle, we are not surprised to see yet another high yield issue for a relatively untested technology project financing being foisted on the municipal bond market. In this case, the project is designed to produce wood pellets for use as heating fuel overseas. The fuel for the pellets is wood waste produced at sawmills.

Some projects in this sector have been economically viable but the experience with these sorts of projects in the municipal bond space have been decidedly negative. Whether it be for use as fuel or for conversion into products such as medium density fiberboard, the municipal market is littered with a trail of failed projects of this type. As is often the case, the security for the debt is the project itself. The corporate entity operating the plant was newly established in January of this year so there are no other substantial assets behind the project.

The investors once again are being asked to assume all of the construction and operating and financial risk of the project. It has been my experience that these deals are financed in the municipal market after the traditional taxable financing sources have passed on the opportunity. One always has to wonder why operators who have supposedly executed similar successful projects have taken this financing route. This is especially true when a smaller scale individually owned business shifts its source of financing from its traditional sources to the municipal market.

Whenever it occurs at the later point of an economic cycle when interest rates are trending upward, warning lights should go off. Deals in the municipal high yield space that have these characteristics when refinancing options are limited and the perception of overall economic risk is greater present a situation that should motivate investors to strike as hard a deal as possible to mitigate these concerns. Unfortunately, the supply/demand dynamics of the municipal high yield market often result in a deal more favorable for the project rather than for the investor. Caveat emptor!

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BRIGHTLINE

We continue to watch the rollout of the Brightline high speed rail service in Florida from a number of vantage points. The development of successful service would of course mark an important milestone in the evolution of mass transit in the country. Coming at a time of rapid technological change in the transportation sector, the success of this service on a sustainable basis would put the US in a better position to catch up with much of the industrialized world in terms of its long distance passenger rail service.

What interests us about the Brightline story is its continued insistence that it is a privately financed project even as it continues its intense efforts to obtain tax exempt financing for its construction. Those efforts continue as Brightline seeks to complete its expansion from the east coast of Florida to Orlando. Even as the long term outlook for the sustained financial viability of the project, its sponsors are already moving on to additional frontiers for its ambitions.

Now sponsors are pushing for an expansion of service from Orlando to Tampa and are mentioning the potential for projects in other states such as Texas. What we are to make of this is unclear, as the information on passenger utilization and revenues has yet to show that the existing Miami to Palm Beach service corridor is producing a long term viable framework on which expansion can be supported. Suffice to say that we remain unconvinced as the service remains in the “novelty” phase including a substantial publicity effort and promotional pricing.

ARIZONA

Supporters of The Invest in Education Act announced that they have collected enough signatures to put the question on the ballot in November. The measure proposes raising the income tax rate from 4.5 percent to 8 percent for people making at least $250,000 and for families earning at least $500,000. For individuals making $500,000 and joint filers making $1 million, the tax rate would be 9 percent. If passed, the tax is projected to raise $690 million annually for teacher salaries and supplies, as well as restoring full-day kindergarten and reducing class sizes.

In May, Gov. Doug Ducey signed a budget giving teachers a 20 percent pay raise over three years plus more than $300 million in discretionary funds over that period. Ducey’s “20 by 2020 plan” is expected to cost $240 million this fiscal year, increasing to $580 million by 2021. The Governor’s plan is based on a new car registration fee of about $18 per vehicle, which is expected to generate an extra $140 million per year.

The governor has repeatedly said he would not support a tax hike on Arizonans. A telephone poll conducted three weeks after the teacher strike ended found that 65 percent of voters said they would support the initiative in November.

MEDICAID

The ACA has been given up for dead many times but there continues to be momentum for expansion of Medicaid. The latest example is in conservative Nebraska where an activist group seeking Medicaid expansion in Nebraska, announced that it had gathered more than 133,000 signatures in support of a ballot initiative to authorize the expansion. 85,000 valid signatures are required to put the proposal on the ballot.

The initiative would extend Medicaid coverage to some 90,000 Nebraska residents, who currently do not qualify for the program but have difficulty purchasing health care on their own through the Affordable Care Act. The state will join Idaho and Utah with a Medicaid expansion initiative on its ballot. The initiative is an effort to get around the steadfast opposition to expansion expressed by the state’s governor.

Mississippi has revamped its request to impose work requirements on its Medicaid beneficiaries, a move to address federal concerns that its original proposal would have left some without insurance. In the overhauled proposal, Mississippi guarantees beneficiaries will receive up to 24 months of coverage if they comply with the proposed work requirements, which include working at least 20 hours per week, volunteering or participating in an alcohol or other drug abuse treatment program. Mississippi submitted its initial request late last year.

CALIFORNIA

California received more tax revenue than expected during the month of June and for the 2017-18 fiscal year, which ended June 30. Total revenues of $19.91 billion for June were greater than anticipated in the budget signed in June 2017 by $2.30 billion or 13.1 percent. All of the “big three” revenue sources came in higher than projected. Overall revenues for FY 2017-18 of $135.29 billion were $1.53 billion more than estimates in the May budget revision and $6.82 billion higher than expected in the 2017-18 Budget Act. Total fiscal year revenues were $13.38 billion higher than in FY 2016-17.

For June, personal income tax (PIT) receipts of $12.57 billion were $691.8 million, or 5.8 percent, higher than estimated in the budget proposal released in May. For the fiscal year, PIT receipts of $93.48 billion were $4.34 billion, or 4.9 percent, more than projected in the 2017-18 Budget Act. June corporation taxes of $3.23 billion were $577.2 million, or 21.7 percent, above assumptions in the governor’s May budget proposal. For the fiscal year, total corporation tax receipts were 14.8 percent above assumptions in the enacted budget. Sales tax receipts of $3.15 billion for June were $759.0 million, or 31.8 percent, more than anticipated in the governor’s FY 2018-19 amended budget proposal. For the fiscal year, sales tax receipts were 2.0 percent higher than expectations in the 2017-18 Budget Act.

At the conclusion of FY 2017-18, the state’s General Fund had $10.38 billion more in receipts than disbursements, and $4.84 billion were used to repay outstanding loans from the previous fiscal year. At the end of June, there were $39.93 billion available for internal borrowing from the state’s own funds, which was more than anticipated in the May budget proposal by $1.81 billion.

PUERTO RICO

The government of Puerto Rico sued Puerto Rico’s Financial Oversight and Management Board for attempting to “usurp” the island government’s powers and right to home-rule. The suit is the government’s response to the fiscal board’s rejection of an $8.7 billion budget passed by the legislature, contending it was not compliant with the commonwealth fiscal plan the panel certified. The board proceeded to impose its own budget, which cuts funds for municipalities and workers’ year-end pay, known as the Christmas bonus.

The suit outlines the Government’s position. “The Oversight Board cannot compel the Governor to comply with its policy recommendations, whether those recommendations are free-standing or advanced in a fiscal plan. And the Board certainly cannot force those recommendations on the Commonwealth via a budget. Specifically, the Oversight Board cannot do what it is attempting to do: impose mandatory workforce reductions, change the roles and responsibilities of certain government officials, criminalize certain acts under Puerto Rico law and otherwise seek to micromanage Puerto Rico’s government.”

The suit seeks a ruling declaring that the “substantive policy mandates” in the board’s budget exceed the oversight panel’s “powers and are null and void,” as well as a ruling “enjoining the Oversight Board from implementing and enforcing the Oversight Board’s rejected policy recommendations.” As is nearly always the case, Puerto Rico seeks special treatment. For example, the District of Columbia Financial Responsibility and Management Assistance Act of 1995, which granted the District of Columbia’s Financial Control Board the power to nullify legislative acts and “compel the mayor and city council to adopt its policy recommendations”.

The suit accuses the PROMESA board of attempting to micromanage Puerto Rico’s fiscal affairs. In our view, micromanagement is what Puerto Rico needs. We have asked in a variety of forums why Puerto Rico’s American citizens should be exempt from such supervision when numerous mainland jurisdictions have operated under it. It is a question which never receives an answer. This makes it hard to support the Puerto Rico government’s position as it seeks to regain market access and has multi-billions of defaulted debt outstanding.

FITCH RATINGS ON HOSPITALS

A request from the Lexington County Health Services District, Inc., SC (the district) on behalf of Lexington Medical Center (LMC) to Fitch to withdraw its non-investment grade rating has served to highlight changes to Fitch’s rating criteria for hospital credits. Under the revised criteria, Fitch includes operating leases and net pension liabilities as debt equivalents when assessing a hospital’s leverage profile.

The District’s debt had been rated A+ by Fitch as recently as November, 2017. The application of the new criteria resulted in a new rating of BB+. LMC’s management did not participate in the rating process for this review. The below investment grade rating was applied despite “strong medical and surgical volume growth as a result of successful expansion strategies with a highly integrated physician platform and ambulatory network and further bolstered by population growth in the county.” Fitch also notes that the district returned to strong double digit operating EBITDA margins on an unaudited basis in 2017 and currently in unaudited 2018.

Fitch applied a 20 year period to achieve full pension funding. This is shorter than the 30 year period used by many municipal issuers. Complicating the hospitals position is its status as a governmental entity which participates in state managed pension plans. The District is therefore limited in its ability to alter its pension position outside of actions to spend more currently on pension contributions.

As a result of all of this, the District has asked for the rating to be withdrawn. We see the basis for Fitch’s actions and do not argue that the A+ rating was no longer warranted under the terms of Fitch’s methodology. Whether or not, an enterprise which is projected to produce operating EBITDA margins of approximately 5% to 5.5% in the coming years net of pension contributions is deserving of a speculative grade rating is another issue.

We are not surprised at the request to withdraw the rating. We do not see this sort of pension funding assumption applied to many other credit sectors, so it is understandable that this issuer would exercise such a request. A six notch downgrade does seem to be excessive.

TRUCKERS SUE AGAINST TOLLS IN RHODE ISLAND

In June of this year, the State of Rhode Island began charging tolls on trucks using the major highway in the State. Under the plan, which was signed into law back in 2016, 18-wheelers will pay up to $20 to cross the state traveling on Interstate 95. A single truck will be capped at paying $40 a day.

The tolls are intended to finance a 10-year plan to repair deteriorating bridges in the Ocean State; Rhode Island has the highest percentage of structurally deficient bridges in the country. The tolls, to be collected electronically via 14 gantries, are expected to bring in around $45 million a year once they are up and running.

The scheme seeks to impose costs on those vehicles which contribute to the most wear and tear on roads as well as to address congestion issues. The American Trucking Association and three companies said the toll system launched last month discriminates against out-of-state trucking companies, violating the commerce clause of the U.S. Constitution.

It asks a judge to stop the tolls, now operating at two locations on Route 95 in Washington County, and eventually slated to include 14 tolls throughout the state. The two Route 95 tolls charge $3.25 and $3.50 respectively, so 133,000 transactions would result in somewhere in the neighborhood of $450,000 in charges since the system has been running.

The toll program is but one step in efforts at the state level to develop usage based schemes for road users in the face of inaction at the federal level to finance infrastructure. It would seem to be the type of effort supported by the Trump Administration as it seeks to move the finance of infrastructure to a fee based model and to increase the role of the private sector in infrastructure development and execution.