Joseph Krist

Publisher

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SANTEE COOPER SEEKS DIRECT REVIEW

South Carolina Public Service Authority (Santee Cooper) has requested a direct review by the South Carolina Supreme Court of a lawsuit filed by 20 electric co-ops representing almost 2 million customers to prevent Santee Cooper from charging them for the costs of the failed nuclear generating expansion. The co-ops want the courts to order Santee Cooper to stop charging them for the unfinished reactors, which Santee Cooper and its partner, SCANA, abandoned last summer after a decade of work and $9 billion in costs. The co-ops filed suit in August to stop the billing and seek refunds.

Santee Cooper argues that the utility has the legal right to charge its customers for debts it incurred to build the reactors even after the project was cancelled, leaving billions in unpaid debt. The chairman of the board of Central Electric Power Cooperative, which buys power for the state’s coops from Santee Cooper, said, “Let’s be clear: electric cooperative consumer-members should not have to pay billions of dollars for two nuclear units that are not producing power.”

Central Electric, Santee Cooper’s largest customer, buys about 60 percent of the power that utility produces and distributes it to the state’s electric co-ops. The co-ops want a “swift resolution to this matter for our members that protects them from footing the bill for someone else’s mistakes.” Central Electric is Santee Cooper’s largest customer. It buys about 60 percent of the power that utility produces. If the co-ops should prevail, Santee Cooper “eventually would be unable to maintain its ongoing operations,”   according to its filing for review.

The Court could take the matter up, hold hearings and, ultimately, issue a ruling on Santee Cooper’s petition. Or the high court could send the issue back to a lower court for hearings, producing a record of the facts and the laws at issue.

HEAD TAX UP FOR VOTE IN NOVEMBER

The Mountain View, CA City Council voted unanimously late Tuesday to place a measure on the November ballot asking residents to authorize taxing businesses between $9 and $149 per employee, depending on their size. If the measure passes, the tax could generate upwards of $6 million a year for the city, with $3.3 million coming from Google alone. The bulk of money raised through the head tax would pay for transit projects, including bicycle and pedestrian enhancements, and 10 percent would go toward providing affordable housing and homeless services.

The effort comes in the wake of the City of Seattle’s recent effort to enact such a tax only to repeal it before it was collected in the face of heavy political pressure lead by Amazon. While the tax in Mountain View would be imposed on a variety of employers, the real target is Google. Unlike Seattle’s proposal, which was primarily meant to ease homelessness, this one would benefit not only his city’s residents but also Google’s employees, who face the same transportation and housing challenges.

Efforts of the City’s business community seem to reflect a belief that the ballot measure would succeed. The city’s Chamber of Commerce, opposed the decision, but says it now hopes to persuade a majority of council members to lower the proposed maximum tax rates before settling on the ballot’s language. The Chamber has originally proposed an alternate tax model that asks businesses with more than 1,000 workers to pay a flat $100 per employee rate.

The model the council ultimately approved would charge the city’s roughly 3,700 businesses a progressive flat rate based on their size and a progressive per employee rate. Businesses with up to 50 employees would be charged a base rate of up to $75 per year and those with more would be charged a base rate plus a per-employee fee that climbs with the work force’s size, up to a maximum of $150 each at Google, which employs a little more than 23,000.

Mountain View’s current business tax has been in place since 1954 and is based on businesses’ square footage. Head taxes are in place in other Silicon Valley communities including San Jose, Sunnyvale and Redwood City.  Cupertino is expected to propose one in 2019. The tax, to be phased in over two years starting in 2020, requires the approval of a simple majority of voters.

GREEN MOUNTAIN BUDGET BATTLE

Vermont Gov. Phil Scott announced that he will allow the legislature’s latest budget plan to become law, a decision that will prevent a July 1 government shutdown. “I’m left with no choice but to allow [the budget] to become law without my signature,” Scott said.

The budget is essentially the same as the one Scott vetoed June 14. The House passed the proposal after allegations of a procedural error. The votes came after a compromise deal that would have ended the impasse fell apart Friday.  The governor has insisted since he took office in 2017 that the state budget should not increase taxes or fees for Vermonters.

The Legislature passed three versions of the state budget which would not prevent an increase in the nonresidential property tax rate, which is is set annually under state law. Scott vetoed the first two but will not veto the latest proposal.

The lawmakers’ goal was to fund shortfalls in the state’s teacher retirement fund. The Governor hoped to do that while preventing a tax increase on nonresidential property tax payers, which includes renters, small business owners, and camp owners. The impasse was all the more frustrating as an adopted budget does not have to be balanced – Vermont remains the only state where that is the case. It would however, have forced the government to shut down if a budget had not been enacted.

KENTUCKY MEDICAID WORK RULES ENJOINED BY FEDERAL COURT

The U.S. District Court for the District of Columbia vacated the Trump administration’s approval of Kentucky’s plan and sent it back to HHS. The Court said that the Trump administration’s approval was “arbitrary and capricious” because HHS did not address how the Kentucky waiver would further the underlying purpose of Medicaid. “The record shows that 95,000 people would lose Medicaid coverage, and yet the [HHS] Secretary paid no attention to that deprivation.”

Gov. Matt Bevin has threatened to cancel the entire Medicaid expansion, which covers more than 400,000 low-income adults in his state, if courts blocked the work requirement or other changes he sought. Kentucky had the biggest improvement in its rate of uninsured residents of any state which expanded Medicaid under the ACA.

The decision continues a streak of losses for the fiscally conservative Governor. Teacher protests earlier in the year led to changes in education funding which he opposed and pension changes championed by the Governor and approved by the Legislature were recently found to be legally deficient in the courts. Now, the plan to restrict Medicaid has failed judicial review.

Effectively, the current credit outlook for Kentucky remains guarded at best as pension continue to weigh on the Commonwealth’s credit and hold down its ratings.

NEW JERSEY AVERTS A BUDGET SHUTDOWN

Gov. Philip Murphy of New Jersey and Democratic legislative leaders reached an agreement on a fiscal 2019 budget to keep the government open and avoid a state shutdown for the second time in two years. The budget agreement increases the income tax to 10.75 %from 8.97 % on those making more than $5 million a year.

The budget includes an annual surcharge of 2 % on companies that earn over $1 million annually that will be in place for four years. Mr. Murphy’s plan to raise the sales tax to 7 % from 6.625 % was not included in the final deal. That outcome reflects the compromises which had to be made by both sides. The Governor gave up a sales tax increase and the legislature allowed the income tax to be raised.

The $37.4 billion budget includes financing for nearly all of the Governor’s proposed investments, including a $242 million increase in funding for New Jersey Transit, an additional $83 million for prekindergarten, an extra $25 million for community colleges and a $3.2 billion payment into the state’s underfunded pension system.

The pension payment is a positive reversing a trend of annual underfunding even after an agreement was reached in the Christie Administration to increase annual payments by the State. The state prevailed in litigation brought by the state’s employees after the Legislature failed to meet the annual appropriation levels agreed to.  New Jersey is an outlier this year as the last state in the country that hadn’t reached some sort of a budget agreement by the fiscal deadline, according to the National Conference of State Legislatures.

PROPERTY VALUES IN CHICAGOLAND

The problems of the City of Chicago in terms of its finances are pretty well known. It is through the prism of these problems that other economic and demographic trends are viewed. For the first time in some years, there may some positive trends emerging in terms of the regional tax base which supports outstanding tax backed debt from issuers in the region.

The full market value of real estate in Cook County was approximately $559.7 billion in tax assessment year 2016 according to an annual estimate released by the Civic Federation. The 2016 total value estimate represents an increase of $30.8 billion, or 5.8%, from the 2015 estimated full value. Tax year 2016 is the most recent year for which data are available. The 2016 estimates represent the fourth year that real estate values in Cook County increased following six straight years of decline in value.

In addition to Cook County as a whole, the report estimates the full market value of real estate in the City of Chicago, northwest Cook County suburbs and southwest Cook County suburbs. The estimated full market value of real estate in the City of Chicago increased by 5.4% in tax assessment year 2016 while the northwest and southwest suburbs experienced increases of 6.4% and 6.0%, respectively.

While the estimated full value of real estate has increased since 2012, the 2016 full value of real estate was still $96.8 billion lower than it was ten years prior in 2007. Between 2007 and 2016 the estimated full value of all classes of property in Cook County as a whole declined by 14.7%. As shown in the chart below, estimated full value decreased from $656.5 billion in 2007 to a low of $414.4 billion in 2012, a decline of 36.9%, then rose to $559.7 billion in 2016.

So in spite of declines in population, the value of property continues to increase. That is the result of a lot of things (the strength of the real estate market is apparent in many regions) but we suspect that the willingness and ability of new residents to afford the higher real estate values is offsetting to some extent the declines in population that may be driven by gentrification and the move out of Chicago by lower income residents in response to higher living costs and a skills gap that keeps those residents from the better paying jobs.

ENJOY YOUR FOURTH OF JULY

Like many of you, the MCN is taking some time off this week as we celebrate the nation’s birth. It will return on July 16. Enjoy the Fourth safely!!

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

 

Joseph Krist

Publisher

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ISSUE OF THE WEEK

CITY OF LOS ANGELES

$312,000,000

General Obligation Bonds

$1,500,000,000

Tax and Revenue Anticipation Notes

The GO bonds are secured by the city’s dedicated, voter-approved unlimited property tax pledge. The ad valorem property taxes levied and collected for the bonds is restricted for use to pay the GO bond debt service. The notes are secured by a pledge of unrestricted fiscal 2019 receipts.

The City comes to market with its double A ratings intact and with a stable outlook. The TAN /RAN issue is a normal seasonal borrowing to address timing mismatches between the receipt of revenues and expenditure requirements.  Proceeds of the TAN/RAN issue will be applied to pre-fund the City’s fiscal 2019 pension contributions at the beginning of the fiscal year with 75% of the proceeds. The remaining proceeds will address cash flow imbalances.

The bonds will be used to address various aspects of the City’s homelessness problem. Proceeds will finance projects for providing safe, clean affordable housing for the homeless and for those in danger of becoming homeless, such as battered women and their children, veterans, senior, foster youth, and the disabled; and provide facilities to increase access to mental health care, drug and alcohol treatment, and other services.

The bond rating reflects the city’s strengthening financial position. This stems from steady gains in operating fund balances and cash reserves. Net direct debt is low. As is true for most California cities, the city’s elevated unfunded pension liability will continue to pressure the city’s finances. Continued improvement in the regional economy is contributing to steady growth in ongoing revenues.

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STADIUM GAMES MOVE TO THE MINOR LEAGUES

The Rhode Island legislature voted to forfeit up to $38 million in city and state taxes on a new stadium and its surrounding area for the Triple A Pawtucket Red Sox. Under the legislation, the Paws ox would contribute $45 million to the $83 million project. It would also be responsible for any cost overruns.

The state and city would be responsible for the remaining $38 million in bonds issued by the Pawtucket Redevelopment Agency. The municipalities’ costs for the project would be financed through tax increment revenue bonds. Only tax revenue generated directly by the stadium and its surrounding area would go toward paying off the bonds.

Having learned hard lessons through the infamous Studio 38 revenue bond financing which saw the state called on for its “moral obligation”. In this case, the state will not be guaranteeing the debt in any way. The new plan culminates a nearly two year long negotiation process.

The legislature may have been spurred into action by efforts by the city of Worcester, MA to entice the Paw Sox to move. McCoy Stadium–the current home of the Paw Sox- is the oldest active Class AAA facility in Minor League Baseball. The Paw Sox would not be the first team to use the threat of another suitor – real or imagined – to extract a better deal from their existing home. The practice which has been highly refined by major league franchises in every sport is now showing up with regularity at the minor league level.

COFINA LITIGATION

Bank of New York Mellon, the trustee of the Puerto Rico Sales and Use Tax, has requested from the court to permit it to intervene in the negotiations for a settlement in the Commonwealth-Cofina dispute, to oppose certain aspects involving the distribution of the funds. Recently, representatives of the Commonwealth and of Cofina announced a preliminary settlement.

The Commonwealth Agent wants the Bank of New York Mellon, to put in separate accounts all 5.5% of Sales and Use Tax revenues currently in the bank that were received prior to June 30 and all SUT revenues received after July 1, 2018. Once a settlement is reached, Post-July 1, 2018 funds may be allocated and released to the Commonwealth and Cofina in accordance with the percentage shares in the settlement agreement, that is 53.65% for Cofina, which would be the first dollars of the 5.5% Sales and Use Tax, and 46.35% for the Commonwealth.

The Commonwealth-Cofina dispute centers on who is the owner of the sales and use tax, whose revenues are currently used to pay for government operations and to back Cofina bonds. A resolution to the dispute is needed as part of the Title III bankruptcy proceeding so the judge can determine how to distribute assets. The Commonwealth representative in the dispute, which is the Official Committee of Unsecured Creditors, asked the court to issue an order establishing certain procedures to dispose of the Sales and Use Tax funds.

BNY Mellon would like the Court to approve an agreement between the Agents now that, in such circumstances, the Court’s hypothetical future ruling would be retroactive to July 1, 2018. In effect, the deposit of Pledged Sales Tax with BNYM after July 1, 2018, could cease to be governed by the Resolution and applicable law.

KENTUCKY PENSION REFORM UNCONSTITUTIONAL

A Circuit Court judge struck down Kentucky’s pension reform law, saying the rapid manner in which it was passed was unconstitutional. According to the judge, the six hour process from insertion of the language dealing with pensions into an unrelated sewer bill on March 29, violated safeguards to ensure “legislators and the public” can know the content of bills under consideration.

In an unusual twist, the Commonwealth’s Attorney General argued that the law illegally cuts pension benefits and that the expedited process violated the state Constitution. The Court’s order accepted the Attorney General’s argument that the bill did not get three readings in each chamber as required by the Kentucky Constitution. The normal process requires at least five days to pass a bill for it to get three readings in each chamber. In this case, SB 151 got its first five readings when it was still a sewer bill.

It also said that the legislation appropriated state funds and — as an appropriations bill — required a majority of all 100 House members and 38 senators to pass. Legislative leaders have contended the bill does not appropriate state funds, and as such required only a majority of members who voted to have voted for it — so long as at least two-fifths of each chamber’s members voted yes.

The order did not decide whether the new law’s modest changes in benefits violate contractual rights of public employees or retirees. The Governor’s office argued that the General Assembly has frequently used the speedy process and that many important state laws will surely be challenged if the court struck down the pension law on this basis. The Court took the position that other laws were not at issue in this case and that in this case the legislature had clearly used a rapid process that clearly violated the Kentucky Constitution’s mandate that the process be deliberate enough so that the public can follow the bill and react.

The law in question changes how current teachers can use accumulated sick days to determine their pension benefits. And it requires state and local government employees who started between 2003 and 2008 to begin paying 1 percent of their pay for retiree health benefits. changes how current teachers can use accumulated sick days to determine their pension benefits. And it requires state and local government employees who started between 2003 and 2008 to begin paying 1 percent of their pay for retiree health benefits.

The bill requires that new teachers starting next year be placed in a new kind of pension plan — a “hybrid cash balance” plan rather than the current traditional pension.

FLORIDA COMPLETES AAA HAT TRICK

Moody’s has upgraded the State of Florida’s general obligation bonds to Aaa. The State now has triple A ratings from the three major rating services. Moody’s cited a sustained trend of improvement in Florida’s economy and finances, low state debt and pension ratios, and reduced near-term liability risks via the state-run insurance companies. It notes that State finances are characterized by healthy reserves and historically strong governance practices and policies that are expected to continue. The state has also maintained consistently low debt and pension liabilities that compare well with other Aaa rated states.

The rating also takes into account the State’s potential risks from climate change. It references the fact that Florida’s exposure to storm-related costs and other climate risks is high. Some of the exposure – hurricane risk primarily – is addressed through the state’s insurance program. Other issues related to risks from flooding as well as encroaching seawater are not addressed so easily. There are potentially significant capital costs associated mitigation of these risks as well as the need to develop resiliency.

MICHIGAN SEEKS MEDICAID WORK REQUIREMENT APPROVAL

Michigan has enacted legislation which would add work requirements for those enrolled under expansion under the ACA, about 670,000 people. There are exemptions including for people who are disabled, pregnant, children or elderly. Those who do meet the requirements will have to work for 80 hours per month, or be in school, job training or substance abuse treatment.

There are exemptions including for people who are disabled, pregnant, children or elderly. Those who do meet the requirements will have to work for 80 hours per month, or be in school, job training or substance abuse treatment.

The legislation became a source of controversy over its inclusion of provisions which would have exempted people in counties with high unemployment rates from the work requirements. Critics argued the effect of that would have been to exempt many white people in rural areas while imposing work requirements on minorities in urban areas. This led to the provision being dropped in order to get legislative approval.

If the plan is approved by the Trump administration, Michigan would become the fifth state to add work mandates to its program.

TARIFFS AND EMPLOYMENT

The impact of the recently announced tariffs by the US and the response from the EU has begun to manifest itself in terms of domestic employment. There are few products more American than a Harley Davidson motorcycle. In recent years, an increasing number of these vehicles have been sold overseas with a steadily increasing level of sales occurring in  the EU. The company reported $5.65 billion in revenues last year and Europe is its largest overseas market, with almost 40,000 customers buying motorcycles there in 2017. This means that trade war between the US and its trading partners is of increased concern to exporters such as Harley who have begun to quantify the effect of tariffs on their overseas competitiveness. That exercise is beginning to drive production decisions which will have negative impacts on US manufacturing employment.

Harley has announced that European tariffs have jumped from 6 percent to 31 percent. That increase will add on average $2,200 to the cost of each motorcycle sold in the EU, and would cost the company $90 million to $100 million a year. So, “increasing international production to alleviate the EU tariff burden is not the company’s preference, but represents the only sustainable option to make its motorcycles accessible to customers in the EU and maintain a viable business in Europe.”

Harley has already lowered production at its Kansas City manufacturing facility. Over the next nine to eighteen months, Harley will be reviewing its production and employment levels at its York, PA and Menominee Falls, WI. The decision comes as Wisconsin is implementing its program of construction and tax subsidies to support minimum wage employment at the Foxconn plant under development in southern Wisconsin. we could see the somewhat incongruous phenomenon of the State of Wisconsin paying for lower wage jobs while concurrently watching as the trade war costs the State existing good paying manufacturing jobs.

We see this move as the beginning of a process for manufacturing concerns rather than a one off. The auto industry will face many of the same issues as will other manufacturers. In many communities, these jobs are among the best available especially for the worker cohort that includes non-college graduates. Shifts of those jobs overseas will be directly impactful on the credits of the municipalities where significant manufacturing facilities remain.

 

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

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$1,699,495,000

GOLDEN STATE TOBACCO SECURITIZATION CORPORATION

Tobacco Settlement Asset-Backed Bonds

The Bonds carry a final maturity of 29 years and the 2047 bonds are estimated to have an expected average life of 21.2 years through the turbo redemption feature. Those bonds will not be rated.

The issues which impact tobacco bond credits are well known and understood. The primary risks are that cigarette sales will decline faster than projected and that this will generate lower than expected revenues. This issue will refund a similar amount of bonds issued in 2007. The expectation is that the refinancing would generate a lower debt service structure  and would therefore have a greater margin to absorb unanticipated declines in available revenues.

The consumption forecast accompanying this bond issue estimates that cigarette sales will decline 3.1% annually through the final maturity of the bonds.

We continue to view tobacco bonds as trading vehicles for institutional investors. Individuals have to be prepared for a fair amount of price volatility relative to that experienced by most municipal bonds.

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WAYNE COUNTY, MI MAKES THE GRADE

Moody’s Investors Service has upgraded to Baa2 from Ba1 the issuer rating of Wayne County, MI. The action completes the return of the County’s general obligation credit to investment grade by the major rating agencies. The action is premised on the county’s regained structural balance. The county’s current operational balance could also support tackling deferred maintenance and investments in personnel and handle to debt service costs of bonds issued to complete the County’s new criminal justice center.

 

The upgrade comes as the County still deals with a slow recovery in the labor market and persistently negative net migration. The County tax base has still not recovered to the level it was at before the recession. Even in an environment of growing tax base valuation, the rating is limited by property tax limits in Michigan which impede the County’s ability to raise revenues. The County is comprised of 34 cities, including the City of Detroit, 9 townships, and 33 public school districts. With a population of 1.8 million residents, the county remains one of the twenty largest in the country despite multiple decades of out-migration.

BUDGET BLUES RETURN TO NEW JERSEY

Those who hoped that a change in administration in New Jersey might usher in an era of relative budget peace look to be disappointed as the deadline for enacting a budget comes closer. The governor’s office and the State senate president both offered somber outlooks for the enactment of a budget by month’s end. The comments followed an announcement that talks between the legislature and the Governor had broken down and that separate budgets will be offered by the Governor and the legislature.

The Governor’s plans include a raise in the sales tax back to 7 % and a millionaires tax.  If millions of dollars in funding to “Democratic priorities,” including funding for underfunded school districts is not a part of a budget, there will be no budget by July according to the Senate President. That could lead to the second state government shutdown in as many years.

The Legislature’s alternative combines tax increases on corporations, a tax amnesty program, spending cuts and projected savings in employee health care costs. It includes a 3 percentage point increase in the tax rate paid by corporations with profits over $1 million that would expire after two years. At 12 percent, the tax rate would tie with Iowa for the highest in the U.S.

Neither budget plan deals directly with the impact of changes to the federal tax code which are expected to lead to increased federal taxable income fop NJ residents due to the elimination of the SALT deduction. If the Legislature passes its own budget, the Governor can veto all or part of the plan. To avoid a veto and/or a shutdown, negotiations continue.

ALASKA BUDGET BREAKS NEW TRAIL

The State of Alaska has enacted a budget for the fiscal year beginning July 1. The adopted budget earned the State and improved rating outlook from Standard and Poor’s. This occurred despite the fact that the budget includes funding for operating expenses derived from the use of Permanent Fund monies for those purposes for the first time in the Fund’s history. According to the Legislature and the Governor, the budget and accompanying legislation will reduce Alaska’s annual deficit from almost $2.5 billion to $700 million.

The new budget, for example, deliberately underfunds the state’s Medicaid program. Federal law requires certain payments, and the Legislature failed to approve enough money to fully pay the bills. In other cases, the Legislature paid for ongoing expenses from accounts that don’t recharge quickly. That money won’t be available next year, and the Legislature will be forced to find a new way to pay for those expenses.

This year, lawmakers approved a lower Permanent Fund dividend in order to partially balance the deficit. This year’s dividend of $1,600 per person will cost the state about $1.02 billion. Adding an extra $1,000 to bring the payment up to the level derived by use of the existing formula for the dividend would cost about $630 million

The state must also figure out how to pay a multibillion-dollar deficit in its retirement system and meet the constitutional requirement to re-fill the Constitutional Budget Reserve. That reserve has been tapped to the tune of $15 billion over the years to cover current operating deficits. There is only $700 million left in that reserve.

So looking at all of this might cause one to wonder about the timing of the improvement in the State’s rating outlook. It certainly causes us to wonder.

HOSPITAL CONSOLIDATION YIELDS RATING INCREASE

One year ago, holders of debt issued by Presence Health in Illinois were looking at a negative outlook for the rating on their minimum investment grade holdings. Presence Health is a Chicago based health system that owns and operates acute care hospitals, long-term care and senior living facilities, physician practices, clinics, diagnostic centers, home health, hospice and other healthcare services. Those who were willing to stay the course are now benefiting from ratings upgrades resulting from the merger of Presence Heath with Ascension Health.

Last week, Moody’s announced that it was raising its rating on Presence Health debt from Baa3 to Aa2. Some $1 billion of outstanding debt was affected. Effective March 1, 2018, Presence became a subsidiary of Ascension Health Alliance. On May 23, 2018, Presence’s master trust indenture (MTI) was discharged and the Presence MTI obligation was replaced by an MTI obligation of Ascension. With the substitution, the security for Presence’s bonds has been changed to that of the Ascension master trust indenture obligated group.

Ascension’s is the largest not-for-profit healthcare system in the US with $22 billion in total operating revenues. Ascension’s ratings reflect geographic and operating diversification, consolidation initiatives to drive operating improvement, prominent market positions in individual markets, large investment portfolio and the availability of $1 billion in bank facilities.

DALLAS COUNTY SCHOOLS DEFAULT

Dallas County Schools provides transportation to students at multiple school districts in Dallas County, Texas. DCS is scheduled to close this year, as mandated by voters, but the ruling allows a penny ad valorem tax to be collected for another five to six years.  The revenues are needed to pay off some $100 million of debt. DCS’ debt was primarily caused by the agency’s issuance of bonds that were hurt by DCS’ financial collapse from inside corruption.

An ongoing FBI investigation has resulted in two guilty pleas. Had the plan to pay off the debt not been accepted, creditors could have tried to obtain the DCS bus fleet (some 1500 vehicles). Plan approval allows for the distribution of the fleet to the previously served school districts which will now be responsible for transporting their students.

RHODE ISLAND PENSION REFORM WITHSTANDS CHALLENGE

The Rhode Island Supreme Court upheld a 2015 settlement to end litigation against Rhode Island’s state pension overhaul. The decision is a positive for the state’s credit. Pension funding had been a major drag on the state’s credit ratings for years. The current governor had made pension reform one of her priorities when she was State Treasurer.

The settlement included two one-time stipends payable to all current retirees; an increased cost-of-living adjustment cap for current retirees; and lowering the retirement age, which varies among participants depending on years of service. The settlement helped to stabilize the state’s ratings. A majority of state workers agreed to the plan but two plaintiffs chose to challenge it. The decision brings these sort of challenges to an end.

PROVIDENCE GETS A POSITIVE OUTLOOK

Another Rhode island credit plagued by pension funding issues received positive news this week as Moody’s raised its outlook on the City of Providence’s credit rating to stable from negative. The outlook reflects Providence’s recently improved but narrow financial position, high but manageable fixed costs and stability of the city’s underlying economy.

The change in outlook accompanied maintenance of the City’s Baa1 rating. That rating reflects a stabilized but narrow financial position and improved funding practices of its long-term liabilities. It acknowledges that the City’s unfunded pension liabilities are increasing as well as its OPEB liabilities. It also acknowledges the City’s diverse tax base and position as a regional economic center, significant institutional presence, recent tax base growth, ongoing economic development and the statutory lien on property taxes and other general fund revenues pursuant to Rhode Island statute.

State legislation passed in 2011 that provides a statutory lien on ad valorem taxes and general fund revenues, giving priority to payment of general obligation debt in bankruptcy.

NEW MEXICO DOWNGRADED AGAIN

For the second time in two years, New Mexico has been downgraded by Moody’s. This time the move is from Aa1 to Aa2. The downgrade comes in the midst of a stronger resource based markets and a generally improving economy.

The downgrade is is primarily attributable to the state’s extremely large pension liabilities, including both its direct obligation to the Public Employees’ Retirement System (PERA) and its indirect obligation to the Educational Employees’ Retirement System (EERS). The state provides K-12 school districts with essentially 100% of their operating funding. The need to assist districts in addressing their EERS pension liabilities represents a significant financial pressure for the state. That pressure is compounded by spending challenges associated with a large Medicaid caseload, a revenue structure more concentrated and volatile than most similarly-rated states.

New Mexico’s general obligation bonds are secured by the full faith and credit of the state and specifically secured by and paid from a statewide property tax levy without limit as to rate. The treasurer is required to keep the property tax proceeds separate from all other funds. The payment of general obligation bonds from other than ad valorem taxes collected for that purpose requires an appropriation by the legislature. If at any point there is not a sufficient amount of money from ad valorem taxes to make a required payment of principal of or interest on state general obligation bonds, the governor may call a special session of the legislature in order to secure an appropriation of money sufficient to make the required payment.

In spite of the overall improvement in the national economy and recent improvement in oil and gas pricing, New Mexico’s economy underperforms on a relative basis and its wealth and income indicators lag those of comparable states. Incomes are some 77% of the national average and the poverty rate is among the highest among US states. This heightens the role of pensions and Medicaid needs in the State’s budget outlook and these factors will combine to pressure the State’s fiscal positions going forward.

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

 

Joseph Krist

Publisher

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ISSUE OF THE WEEK

The Village of Riverdale is located south of Chicago and like many smaller communities long supported by a manufacturing base it has struggled with economic and financial issues in recent years. These factors have depressed taxable values and incomes with an expected negative impact on the Village’s creditworthiness. The village’s population has declined by about 1% since 2010 and, while assessed value (AV) has increased over the last several years, it is still below its 2011 level. About 30% of the village’s residents live under the poverty level and income levels are well below the county, state, and national levels. Currently, the Village is rated CCC as a general obligation credit.

This has forced the Village to take the securitization route in order to maintain access to the capital markets. The Village is now coming to market with a BB rated credit secured by a first lien on the village’s local share of the statewide income tax. The pledged revenue includes all distributions under Section 2 of the State Revenue Sharing Act from the Local Government Distributive Fund of income tax amounts payable by the state of Illinois to the village.

The pledged revenues are secured by a “true sale” of the revenues to a bankruptcy-remote, statutorily defined issuer, the Riverdale Finance Corporation.  The state will direct all pledged income tax revenues to the trustee for benefit of corporation bondholders and the residual will flow to the village for any lawful purpose. The pledged income tax revenue is collected by the Illinois Department of Revenue, which certifies the amount collected to the state comptroller on a monthly basis. The comptroller must deposit the statutorily-dictated local share of the income tax revenue to the Local Government Distributive Fund (LGDF) no later than 60 days after the comptroller receives that certification.

The statewide income tax rate has changed several times since it was first established in 1969 and three times since 2011.  Historically, the state has offset the impact of rate changes by adjusting the local share percentage of total collections. Income tax receipts are allocated to the village based on its population as a proportion of the state population, meaning relative declines in population at a higher rate than the growth rate in state income tax revenue would lead to declines in the pledged revenue.

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CA REVENUES

State Controller Betty T. Yee reported California brought in less tax revenue than expected during the month of May. Total revenues of $8.25 billion were below monthly estimates in the governor’s FY 2018-19 updated budget proposal by $784.2 million, or 8.7 %. With one month left in the 2017-18 fiscal year that began in July, total revenues of $115.38 billion are $784.2 million less than estimates in the May budget revision, but $4.52 billion higher than expected in the enacted budget. Total fiscal year-to-date revenues are $10.10 billion higher than for the same period in FY 2016-17.

 

For May, personal income tax (PIT) receipts of $4.82 billion were $497.4 million, or 11.5 percent, higher than estimated in the governor’s May budget proposal. For the fiscal year, PIT receipts are $3.28 billion, or 4.2 percent, higher than projected in the 2017-18 Budget Act. May corporation taxes of $570.6 million were $79.2 million, or 12.2 percent, less than forecasted in the governor’s proposed budget unveiled last month. For the fiscal year to date, total corporation tax receipts are 15.9 percent above assumptions in the enacted budget. Sales tax receipts of $2.43 billion for May were $1.11 billion, or 31.4 percent, lower than anticipated in the governor’s FY 2018-19 amended budget proposal. For the fiscal year, sales tax receipts are 1.7 percent lower than expectations in the 2017-18 Budget Act.

Unused borrowable resources through May exceeded amended budget projections by 13.4 percent. Outstanding loans of $5.83 billion were $1.17 billion less than the governor’s May Revision expected the state would need by the end of May. The loans were financed entirely by borrowing from internal state funds.

WASHINGTON STATE SCHOOL FUNDING

The Washington Supreme Court declared the state had fully implemented its new school funding plan, lifted the contempt order and the $100,000-per-day sanctions, and ended their oversight of the case. In the McCleary decision in 2012, the Court had ruled that the state had violated its constitution by  underfunding K-12 schools. The issue has been a point of legislative contention ever since.

In 2017, legislators and the governor finally addressed the need for a plan to fund teacher and other school-worker salaries. That pay had been funded by local school district property-tax levies. The justices said the state needed to cover the full cost. The legislature passed a plan to raise the statewide tax rate in 2018 and phases in limits on future tax revenues collected by school districts through local levies.

This past Fall, the justices ruled that plan didn’t fully provide for schools by the September 2018 deadline established  by the court, and suggested lawmakers further increase education funding. To comply, lawmakers and the governor this spring provided an additional $776 million, and set aside another $105 million for the contempt fines.

In 2017, the Legislature committed to put $7.3 billion more in state funds into schools over the next four years through an increase of 81 cents per $1,000 of assessed value in the state property tax. State funding of education now represents more than 50 percent of the state budget for the first time since 1983.

THE FY 2019 BUDGET SEASON IS KIND TO STATE RATINGS

So far the budget season for fiscal 2019 is generating positive ratings news for some states. This past week, three states received positive changes in their ratings outlooks from Standard and Poor’s as the result of actions taken in association with adoption of budgets for the upcoming FY. S&P revised its outlook on Virginia’s general obligation (GO) rating and various issue credit ratings (ICRs) linked to its creditworthiness to stable from negative. It also affirmed its AAA rating on the state’s GO debt outstanding.

S&P also revised its outlook to stable from negative and affirmed its ‘AA’ rating on the state of Alaska’s GO debt outstanding. Adopted legislation (SB 26) outlines a percent of market value approach to use its Permanent Fund Earnings Reserve Account  (ERA) should allow for sustainable draws from the fund in future budgets.

S&P revised the outlook to stable from negative on its ‘AA’ issuer credit rating (ICR) on the state of Colorado. The revision follows the state’s adoption of pension reform in its 2018 legislative session. The state intends to reduce its unfunded liabilities and reach full funding within 30 years under the new bill, which incorporates automatic adjustments to contributions when needed to reach its goal. The liability remains underfunded by the adoption of a funding plan is a clear positive.

CA WATER UTILITY EARNS AN UPGRADE

Eastern Municipal Water District serves seven cities and unincorporated portions of the county and covers an area of 555 square miles, serving a population of over 816,000. The communities of Murrieta, Temecula, Hemet, Moreno Valley, Menifee and San Jacinto represent the district’s principal cities.  retail domestic accounts provide the majority of revenues. Revenue bonds are secured by the net revenues of the combined water and sewer enterprise. The rate covenant on the subordinate lien requires net revenues paid after O&M and senior lien debt service to be at least 1.15 times debt service. The additional bonds test is 1.15 times debt service on a 12-month look back over an 18-month period on outstanding bonds and proposed bonds. The subordinate lien bonds do not have a debt service reserve fund.

Moody’s Investors Service has upgraded Eastern Municipal Water District, CA’s senior lien water and wastewater revenue bonds to Aa1 from Aa2 and subordinate lien revenue bonds to Aa2 from Aa3. With only $13 million of senior bonds outstanding through 2021, subordinate debt is the District’s working lien. A cost-of-service rate methodology approved by the board in March 2017, encourages conservation as well as ensures a greater recovery of fixed costs from recurring, non volume related charges.

The District obtains nearly half of its water through the Metropolitan Water District of Southern California. This will require the District to shoulder a portion of MWDSC’s obligations in connection with the financing of the Delta Water Conveyance project.

UTILITY SUBSIDIES WHEN TAXES CAN’T BE RAISED

Voters in the City of long Beach, CA approved a change to the City Charter which would allow the city should be able to continue the practice of charging city-run utilities for access to rights of way, and then transferring those fees to the general fund. The practice had been carried out for decades but was recently challenged by two separate lawsuits against the city.

Measure M received some 53% support. The vote was presented as a choice between the subsidies or reduced city services. The vote can be viewed as a window onto the thinking of local residents in tax resistant California. City officials estimated that if Measure M had not passed that the general fund revenue loss —where the fees have been transferred at years’ end—could have amounted to about $18 million annually, meaning parks, road repairs, and other city services funded through the general fund could have faced cutbacks.

State law prohibits local utility providers from charging more than what it costs to provide a service and other laws prohibit municipalities from imposing taxes without voter consent. This vote serves as the required consent.

NEW JERSEY SCHOOL DEBT SUPPORT PROGRAM DOWNGRADED

Bonds issued under the program are secured by a pledge of all legally available funds of the state through replenishment provisions for the New Jersey Fund for the Support of the Free Public Schools, regardless of whether a specific budget appropriation has been made, as long as the state has enacted a budget. However, according to the state, New Jersey must enact a state budget for these guarantee funds to be available in the event a local school district misses a debt service payment. Once a state budget is enacted, money held in trust for the New Jersey Fund for the Support of the Free Public Schools is automatically available to pay debt service.

The New Jersey Fund for the Support of the Free Public Schools Program is authorized by Article VIII, Section 4 of the New Jersey Constitution. New Jersey Statutes 18A:56-19, as amended, require two reserve accounts to be maintained in the fund. The old school bond reserve account has been funded in an amount equal to at least 1.5% of aggregate school district debt issued by counties, municipalities, or school districts before July 1, 2003. The new school bond reserve account will be funded in an amount equal to at least 1% of aggregate school district debt issued on or after that date. In the event that the amounts in either the old school bond reserve account or the new school bond reserve account fall below the amount required to make payments on bonds, the amounts in both accounts are made available to make payments for bonds secured under the reserves. On or before Sept. 15 each year, fund

Trustees determine the aggregate amount of school purpose bonds outstanding and are responsible for maintaining appropriate reserve levels based on the market value of reserve investments. If at that time, the funds on deposit fall below the required levels, the state treasurer is required to appropriate and deposit into the school reserve such amounts as might be necessary to meet fund level requirements from all available state resources. To ensure sufficient liquidity, at least one-third of the obligations in the fund must be due within a year. Fund assets are direct or guaranteed U.S. government obligations and are valued annually. Funds in the trust are not available for interfund borrowing by the state.

Now the program has been downgraded by S&P to BBB+ from A-. The downgrade reflects the continued pressure on the State’s general obligation rating.

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

Joseph Krist

Publisher

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ISSUES OF THE WEEK

$580,000,000

Port of Seattle, Washington

Intermediate Lien Revenue Bonds

Moody’s: A1

The Port issues debt secured by revenues from its overall Port operations. In reality, this is an airport credit as 80% of consolidated operating revenue and 90% of the debt outstanding is connected to the airport.

The port operates Seattle-Tacoma International Airport (SEA). In addition to the airport, the port owns and operates maritime facilities and industrial and commercial properties. The port also owns container terminals and has licensed these terminals and certain industrial properties to the Seaport Alliance. The formation of the Northwest Seaport Alliance (“NWSA”) – the port’s joint venture with Port of Tacoma – serves as a stabilizing element of the port’s credit profile by sharing in operating risk, profit and capital spending for marine cargo operations in the overall Puget Sound region.

The airport is implementing a large $3 billion capital program over the next five years. $1.9 billion of new debt will be issued to fund the project which the construction of four major projects at active/operating terminals. The Port’s debt is secured by a rate covenant that provides for 1.10 times (as first adjusted) or 1.25 times (as second adjusted) coverage of annual debt service. The intermediate lien bonds are further secured by a cash funded common debt service reserve fund.

$1,100,000,000

Southeast Alabama Gas District

Gas Supply Revenue Bonds

Fitch: A

The District (SGS) was created by 14 Alabama communities to acquire, manage, and finance supplies of natural gas on behalf of certain public gas systems. It accomplishes this by entering into pre-paid gas supply contracts in order to lock in favorable prices for its individual system participants. Debt is secured by a pledge of the net revenues of the District. The risk of individual payment shortfalls is mitigated by an agreement with Morgan Stanley to purchase receivables under a guaranty from MS.

If the SGS provides notice to MSCG to remarket gas to other purchasers that it does not need, or does not accept delivered gas, MSCG is required to remarket such gas. If the gas cannot be remarketed, MSCG is required to purchase the gas for its own account. SGS anticipates approximately 25 public gas systems will participate in the SGS Project No. 2 transaction. The receivables purchase agreement with Morgan Stanley is intended to offset the risk of individual participant nonperformance.

SGS anticipates approximately 25 public gas systems will participate in the SGS Project No. 2 transaction. As a result, the rating for the deal reflects the credit rating of Morgan Stanley.

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VIRGINIA MEDICAID EXPANSION

The expansion of Medicaid under the provisions of the affordable Care Act (ACA) has been a priority of Virginia democrats which could not overcome opposition from the other side of aisle for the entirety of the McAuliffe administration. The election of a Democratic governor and the near capture of the Virginia House last November has changed the political calculus. This resulted in last week’s votes to expand Medicaid to cover an additional 400,000 Commonwealth residents.

The measure includes a requirement that many adult recipients who don’t have a disability either work or volunteer as a condition of receiving Medicaid. That was the price established to get a legislative majority. The federal government shares the overall cost of Medicaid with the states; the program covers about 75 million Americans, or 1 in 5.

The state currently has one of the most restrictive Medicaid programs in the country, covering mostly children and disabled adults. Childless adults are not eligible, and working parents earnings are limited to no more than 30 percent of the federal poverty level, or $5,727 a year. The Affordable Care Act allows states to expand Medicaid to adults earning up to 138 percent of the poverty level, which comes out to $16,643 for an individual.

To finance the Commonwealth’s share of the cost, it will tax hospitals to generate revenue for the state’s 10 percent share of the roughly $2 billion annual cost.

PUERTO RICO AID APPROVALS PLAY CATCH UP

The Federal Emergency Management Agency (FEMA) has awarded nearly $219 million in additional public assistance grants to government organizations and private non-profit organizations for Hurricane María recovery in Puerto Rico. As of May 30, FEMA says its Public Assistance program has “obligated $2.2 billion in total funding” to the government of Puerto Rico and municipalities for debris removal and “emergency protective measures,” which are “actions taken to eliminate or lessen immediate threats either to lives, public health or safety, or significant additional damage to public or private property in a cost-effective manner.”

The U.S. Department of Transportation’s Federal Transit Administration (FTA) announced the allocation of $277.5 million in emergency relief funding for public transportation systems damaged by hurricanes Harvey, Irma and Maria. About $232.3 million will be “dedicated to response, recovery, and rebuilding projects, with $44.2 million going toward resiliency projects.” Of the total, $220 million or just under 80% of the funds will go to Puerto Rico.

The announcements accompanied the beginning of the 2019 hurricane season. Concerns continue about Puerto Rico’s readiness in the event of another significant storm this year. The Puerto Rico Aqueduct and Sewer Authority delivered a mixed message when it said that it has the generators needed to support the island’s sewage system; however, it said, 550 generators, or nearly 50%, are still needed to keep the potable water system running in case of a prolonged blackout.

ON LINE TAX DECISION WILL SPUR CHANGES

It is not clear that the Supreme Court will rule in favor of the State of South Dakota in the Wayfair case, a suit that will determine policies to tax online merchandise sales by states and localities. It is also not clear as to the terms and requirements which tax collection entities will have to contend with in order to collect those taxes.

This was the subject of discussion at the Annual Meeting of the National Federation of Municipal Analysts last week. According to the National Council of State Legislatures, on line sales comprise 11% of overall sales and have been increasing at a rate of 15% annually. If South Dakota loses, states will be forced  to adopt individual legislation to deal with the “physical presence” rule. States have three broad ways to deal with the issue.

They could alter “nexus creation” requirements to establish what constitutes a “presence” in a state for taxing purposes. They could require “referral marketplaces” (like Airbnb) to collect and remit sales taxes for sales facilitated through those marketplaces. A third alternative is to establish reporting requirements for those marketplaces enabling states to follow up and collect sales taxes. Minnesota, Colorado,  and Washington have enacted such provisions.

NEW YORK’S EVER INCREASING CAPITAL NEEDS

The budget season for New York State and City has been a relatively tame process compared to other years. The lack of significant concern about the next fiscal year’s budget has allowed for concerns about capital needs to take second place in the debate over the long term fiscal outlook for both entities. Nonetheless, there is an emerging concern about the capital needs of two entities – the Metropolitan Transportation Authority and the New York City Housing Authority.

The needs of both are being highlighted by proposed plans to address the ongoing maintenance and capital facilities renewal needs of both of these entities. The MTA has garnered the most attention with the recent proposal by the newly appointed head of the Authority for a renewal plan to address capital related operating issues which have  generated much angst among the NYC subway system’s millions of riders. The plan has been assigned a price tag of some $19 billion and has revived debate about the funding responsibilities of the state, city, and federal governments in terms of the upkeep of existing facilities.

The issue of the capital needs of the Housing Authority has arisen in conjunction with the establishment of federal oversight of the Authority’s operations, especially as they pertain to funding and execution of its facilities maintenance. The New York City Housing Authority is chartered by the state, funded by rents and federal subsidies, but operated by the city. The many shortcomings of the Authority’s management of those two areas as well as instances of false reporting which raised concerns about the Authority’s ability to continue to receive federal funds. The Authority has estimated that its projects, which house 180,000 New Yorkers, need a capital investment of $20 billion.

In both cases, the state and the city will have to find resources in addition to those funds already being committed to the process. The exact proportion of responsibility is the heart of the issue. Both situations are accompanied by a sense of urgency and visibility and the solution to both problems is not eased by delay in addressing the issue. NYCHA will likely be forced to increase spending under a pending consent decree arrangement with the federal government.

So if the estimates are right, two major entities face a nearly $40 billion need for capital funding at a time of decreased federal support for both. Looking at the long-term fiscal outlook for the federal government, a substantial increase in federal funding is not necessarily viable. So diffusing this debt bomb will be a delicate task for the state and city.

VIRGIN ISLANDS OFFER FY 2019 BUDGET

The U.S. Virgin Islands Gov. Kenneth Mapp presented his proposed fiscal year 2019 budget to the VI legislature. The territory’s pension system gets special attention. In his budget the governor proposed increasing the employer contribution to the system by three percentage points each year in the coming three fiscal years. It is currently at 20.5% of payroll. Mapp said without action the pension system would be insolvent by fiscal year 2024.

Mapp proposes having the Virgin Islands Housing Finance Authority and Community Development Block Grant-Disaster Recovery be used to purchase nonperforming assets that the pension system currently owns. This meant to increase liquidity in the pension funds. A third leg of the plan would require higher paid government employees to make even larger pension fund contributions.

Even after all of this, the plan would shift the insolvency date back by one year to fiscal 2025. As for the rest of the budget, austerity is not a theme. Salaries would be raised 3% and the Governor hopes to lower water rates. Combined with the ongoing recovery efforts, it is not really clear how realistic this budget proposal is.

HIGH SPEED RAIL

The consortium which owns and operates Florida’s Brightline high speed rail project will continue to refer to itself as a private enterprise. That notion however, is weakened with the news that it has received an extension of its deadline to issue tax exempt private activity bonds to finance the second segment of its proposed project. The decision by the US DOT reflects a significant effort by project proponents to overcome a split Florida Congressional delegation.

It has been a contention here that the project is actually very dependent upon tax exempt financing to finish the project. No matter how the bonds are structured and placed, the subsidy provided to the project undermines the argument that this is a project can stand on its own merits as a privately financed endeavor. The fact that Brightline has been so persistent about its pursuit of tax exempt financing and the view that its inability to attract sufficient private capital has driven that persistence drives our skepticism about project viability.

U.S. Rep. Brian Mast, R-Palm City said “The fact that Brightline needed to request an extension underscores that their business model is questionable at best without taxpayer subsidies.”  The railroad has sought the financing authorization under surface transportation programs initially intended for highway development. This has raised issues with Congressional budget hawks regarding the funding authorization.

Brightline officials have said they also are pursuing a $1.75 billion federal Railroad Rehabilitation & Improvement Financing loan. Either funding method would reflect some level of federal subsidy for the project.

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

Joseph Krist

Publisher

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RISING DEFAULT RATES SKEWED BY PUERTO RICO

The headline may say that defaults are rising but the fact is that 2017 was an unusual year. S&P recently released the results of its study of defaults in 2017 on debt that it rates. For the third year in a row, the number of defaults in USPF rose, reaching a record 20 in 2017. Puerto Rico accounted for 14 of the defaults. The default rate for USPF was 0.09%, the second highest since 1986. Nonetheless, this rate remains extremely low. The ratings on 903 bonds were raised in 2017, while the ratings on 708 bonds were lowered. States, higher education, health care, charter schools, and housing had more downgrades than upgrades in 2017; this was the second consecutive year of negative rating trends for states, health care, and housing and the seventh straight negative year for charter schools.

The headline data is of course skewed by the fact that Puerto Rico accounted for 14 of the defaults. S&P notes that the rising number of defaults in recent years is not an indication of general credit stress. The ratio of upgrades to downgrades was essentially the same in 2017 as in 2016, at 1.27, but five of eight sectors had a higher number of downgrades than upgrades in 2017. This is an increase from four negative-leaning sectors in 2016 and two in 2015. Where are potential problem areas? Higher education had more downgrades than upgrades in 2017, reversing the positive rating trend of 2016, which resulted from revised criteria. Charter schools also leaned negative, although not to the same degree as in previous years. Health care and housing rating movement was negative for the second consecutive year. Transportation and utilities both had more upgrades than downgrades in each of the past three years.

IRS TO ISSUE SALT DEDUCTION GUIDANCE

The U.S. Department of the Treasury and the Internal Revenue Service issued a notice today stating that proposed regulations will be issued addressing the deductibility of state and local tax payments for federal income tax purposes. Notice 2018-54  also informs taxpayers that federal law controls the characterization of the payments for federal income tax purposes regardless of the characterization of the payments under state law.

The Tax Cuts and Jobs Act (TCJA) limited the amount of state and local taxes an individual can deduct in a calendar year to $10,000. In response to this new limitation, some state legislatures are considering or have adopted legislative proposals that would allow taxpayers to make transfers to funds controlled by state or local governments, or other transferees specified by the state, in exchange for credits against the state or local taxes that the taxpayer is required to pay.

The aim of these proposals is to allow taxpayers to characterize such 2 transfers as fully deductible charitable contributions for federal income tax purposes, while using the same transfers to satisfy state or local tax liabilities. Despite these state efforts to circumvent the new statutory limitation on state and local tax deductions, taxpayers should be mindful that federal law controls the proper characterization of payments for federal income tax purposes.

The upcoming proposed regulations, to be issued in the near future, will help taxpayers understand the relationship between federal charitable contribution deductions and the new statutory limitation on the deduction of state and local taxes. The proposed regulations will make clear that the requirements of the Internal Revenue Code, informed by substance over-form principles, govern the federal income tax treatment of such transfers. The proposed regulations will assist taxpayers in understanding the relationship between the federal charitable contribution deduction and the new statutory limitation on the deduction for state and local tax payments.

PORT OF OAKLAND STABILIZES REVENUE STREAM

The Port of Oakland has taken the first step in securing long-term revenues from its maritime tenants. It approved the first reading of an ordinance extending marine terminal leases with its largest operator, SSA Terminals The lease extensions, which follow two lease extensions last year, will result in the seaport extending tenant leases that account for close to 70% of maritime revenue through 2030. This would extend visibility for more than 60% of seaport revenue by 10 years, which reduces the contract renewal risk that previously existed for all four of the port’s seaport leases.

The leases renewals provide high levels of minimum or fixed revenue to the port, and their extensions align future cash flow to match the amortization of the port’s debt. the seaport division, which accounts for more than 80% of the port’s total debt and has the most business risk of the port’s three divisions. The Port of Oakland owns the eighth-largest container port in the US and the marine cargo gateway for the Northern California region. the port owns, leases and administers, but does not directly operate, four active container terminals in the San Francisco Bay. As a landlord port authority, the division receives a combination of fixed (referred to as minimum or guaranteed payments) and variable lease payments from tenants. The higher the level of fixed payments the greater stability characterized in the credit.

The port has now reached extension agreements with its two remaining terminals, including its largest terminal, Oakland International Container Terminal (OICT), which accounts for more than 70% of container volume for the maritime division. More than 60% of current marine terminal revenue is now under lease through 2032, while more than 70% is now under lease through 2030. This will enable the Port’s infrastructure development program which a dredging program that provided 50 feet of water to accommodate larger ships and an expanded rail yard, and more recently additional rail track, an on-port cold storage facility and a 185-acre on-port distribution and warehouse complex.

Overall, transactions and the infrastructure program enhance the port’s competitive position and stabilize its ratings.

BONDHOLDER VERSUS PENSIONER RIGHTS

The resolution of the City of Detroit bankruptcy and the ongoing saga of Puerto Rico’s Title III has heightened awareness of and debate over the rights of debt holders versus those of pensioners. Now a recent decision by the Illinois Comptroller has added additional fuel to the debate. Moody’s took a recent opportunity to weigh in with its view of the impact of the move by the Comptroller to deny the City of Harvey’s request for relief from revenue withholding under a state law requiring minimum pension contributions.

Local pension plans in Illinois can request that the state withhold revenue from a sponsoring municipality if that municipality does not make minimum contributions. Harvey’s public safety pension funds have made such requests, and the state has withheld more than $2 million to date. The city asserts that it will soon be unable to meet payroll, and last month announced layoffs. The state comptroller’s office has responded that it has no discretion under state law to consider Harvey’s hardship.

Harvey is the most egregious case of local municipal credit weakness in Illinois. The city missed two debt service payments in fiscal 2016, six in fiscal 2017 and as of February had missed four in fiscal 2018. Harvey historically has underfunded actuarially determined contributions (ADCs) for its public safety pension plans. The city contributed very little to its firefighter pension fund from 2009 to 2013, and even its far higher contribution in 2017 fell far below the ADC. Harvey cannot currently file for bankruptcy under Illinois law and revenue withholding for pensions only heightens the likelihood of more bond defaults and a restructuring.

Moody’s views the decisions negatively not only for Harvey but also for other municipalities in Illinois which might find themselves in the same position.

PR LITIGATION DOINGS

U.S. District Court Judge Laura Taylor Swain, who oversees Puerto Rico debt proceedings, extended to June 29, from May 29, the deadline to file proof of claims against the commonwealth. In another related matter, the Committee of Unsecured Creditors was allowed to intervene and will be able to make discovery in a lawsuit headed by Cooperativa Abraham Rosa and five other credit unions against the commonwealth, the island’s Financial Oversight and Management Board and several other entities, accusing them of “defalcation and fraud” for selling them “unsound Puerto Rican debt” in a “ploy to obtain their assets.”

The Retirement System of the Puerto Rico Electric Power Authority (PREPA) does not want the commonwealth’s Official Committee of Retired Employees to represent its interests. The PREPA Retirement System said “the intervention of the Retiree Committee will create confusion with respect to the different positions that the retirees will have to assume in these Title III court proceedings, as they will be represented by two legal entities that might disagree in any moment about fundamental issues.”

NASSAU COUNTY BUDGET UNDER OTB THREAT

Nassau County has budgeted $15.75 million for fiscal 2018 from revenues from video lottery terminals at Resorts World Casino at Aqueduct Racetrack, which is operated by Genting New York LLC, dedicated to Nassau OTB. So far has received $3 million but only after delay and some dispute.

Nassau had hoped to apply three-quarters of the $20 million the county says is due early next year to this year’s budget, and include the remainder in the 2019 budget. Now there is real concern however, that Nassau OTB will not be able to make its next payment when due. Nassau OTB committed to paying Nassau County $3 million in the 2016 calendar year, $3 million in the state’s 2017 fiscal year — which runs from April 1 through March 31 — and $20 million in each subsequent state fiscal year.

There are exceptions. They include if a similar “full-service” casino opens within a 65-mile radius of Aqueduct, or if gambling revenue for Resorts World drops by 10 percent or more in any one year. The betting agency won’t have enough in profits this year to “permit a payment of $20 million to the county without 1,000 VLTs being operational” at Resorts World. There are only an estimated 500 machines installed. A planned $400 million expansion at Resorts World will accommodate 1,000 Nassau machines as well as a new 400-room hotel, restaurants and other amenities.

The county has been counting on the new revenues to finance an emerging budget deficit. it receives the revenues under an agreement made under a provision in state law enacted after public opposition prevented OTB from building a casino in Nassau. OTB says it expects to pay Nassau $3 million next spring if the number of VLTs still hasn’t reached 1,000. If all the machines come online sooner, the $20 million payment would be prorated, based on the number of months the 1,000 VLTs have been operating.

 

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

 

Joseph Krist

Publisher

________________________________________________________________

ISSUE OF THE WEEK

THE REGENTS OF THE UNIVERSITY OF CALIFORNIA

LIMITED PROJECT REVENUE BONDS

$739,195,000 Tax Exempt

$94,865,000 Taxable

Moody’s: “Aa3”  S&P: “AA-”  Fitch: “AA-”

GENERAL REVENUE BONDS

$946,580,000 Tax Exempt

$283,415,000 Taxable

Moody’s: “Aa2”  S&P: “AA”  Fitch: “AA”

The General Revenue Bonds are the broadest pledge of the university. The bonds are secured by a pledge and lien on gross student tuition and fees, indirect cost recovery from grants and contracts, net sales and service revenue, net auxiliary revenue, and unrestricted investment income. In addition, under recently enacted legislation the Regents can pledge its annual General Fund support appropriation, less the amount required to fund general obligation debt service payments for the portion of state general obligation bonds funded for university projects. UC reported $16.2 billion of General Revenues for fiscal 2017. Proceeds from the Series 2018 General Revenue AZ and BA bonds will finance projects across nine campuses. The proceeds will also be used to refund bond, pay-down $450 million of commercial paper and pay issuance costs.

The LPRBs are secured by the gross revenues generated by the projects. The pledged revenues also include any other revenues, receipts, income or miscellaneous funds designated by The Regents for the payment of principal of and interest on the bonds. Certain pledged revenues are dependent upon completion of the projects funded from the proceeds of the 2018 Bonds. There is a 1.1x rate covenant and no debt service reserve fund. In fiscal 2017, pledged revenues provided over 4x maximum annual debt service coverage. Limited Project Revenue bonds will finance housing, dining, and parking projects across seven campuses. The proceeds will also be used to refund bonds, pay-down $140 million of commercial paper and pay issuance costs.

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NYC BUDGET REVIEWED BY INDEPENDENT BUDGET OFFICE

The IBO has released its review of Mayor bill deBlasio’s FY 2019 Executive Budget. According to IBO, the Executive Budget for 2018 and Financial Plan Through 2022 is reactive, with increased spending and increased revenues the product of forces largely outside the city’s control. Compared with his Preliminary Budget, the Mayor’s latest plan includes approximately $1 billion in additional city revenue in the current year, much of which results from one-time responses by business owners and investors to changes in federal tax law. We see this as a point of concern. Fortunately for the City, IBO projects that the city will end the current fiscal year with $774 million more in tax revenue than the de Blasio Administration estimates.

IBO’s current forecast for total 2018 tax revenues has increased since its March outlook by $882 million, or 1.5 percent. It projects that near-term strength in the U.S. and local economies will be followed by weaker growth over the next couple of years. As a result, it is expected that growth in city tax revenues will also slow, from an estimated 8.4 percent increase this year to a 3.2 percent rise in 2019, when collections will reach $60.8 billion.  IBO’s property tax forecast exceeds the Mayor’s projections by $210 million in 2018, rising to $1.0 billion in 2022, mostly due to the Mayor’s office carrying larger allowances for refunds, delinquencies, and cancellations. IBO’s estimates for the personal income tax and the general corporation tax are also consistently higher each year than the Mayor’s from 2018 through 2022.

Debt service and fringe benefit costs are the two largest drivers of overall expenditure growth, growing by an average of 8.4 percent and 7.0 percent annually from 2018 through 2022.  Department of Education spending is expected to grow by $2.7 billion from 2018 through 2022, the largest increase in agency expenditure in dollar terms in the plan. IBO’s economic forecast for the city anticipates a slowing of the pace of job creation throughout the plan period, accompanied, however, by low unemployment rates and an uptick in wage growth. The outlook for Wall Street profits— though not for financial sector job growth—is strong. While the commercial real estate market is recovering from its recent doldrums, the residential market has been weakening and at best moderate growth is projected for both.

IBO’s city economic forecast anticipates a slowing of the pace of job creation throughout the plan period, accompanied, however, by low unemployment rates and an uptick in wage growth. IBO expects the pace of New York City job creation to moderate in 2018 and then decelerate over the next three years. The health care forecast, and indeed the entire city employment forecast, depends on whether home health care services sustains its recent pace of growth. Home health care employment has doubled in New York City in just six years, from 82,100 in the first quarter of 2012 to 165,500 in the first quarter of 2018, accounting for nearly a third of all the reported job growth in this sector in the entire country.

 

Taxable real estate sales in New York City were $93.2 billion in 2017, the lowest level since 2012. Commercial sales were $37.8 billion, less than half their 2015 peak. Residential sales, however, were $55.4 billion, the highest level ever recorded before adjusting for inflation. Last year was the first year since 2010 that the value of residential sales in New York City exceeded that of commercial sales. IBO expects residential sales to drop over 10 percent in 2018, with the greatest decline in Manhattan. On the residential side, higher mortgage rates and recent policy changes that reduce the tax advantages of home ownership will exert downward pressure on sales growth.

So how does IBO think that that all of this will impact the City’s budget? Tax revenue is now expected to total $58.9 billion in 2018, $882 million more than in our forecast from two months ago, and $60.8 billion in 2019, up $553 million since March. The federal effect fades further in 2020 through 2022. By the final year of our forecast (2022), tax revenues are projected to total $69.0 billion, only $63 million higher than in our March forecast. For 2019 and subsequent years, the forecasts for all taxes other than personal income, unincorporated business, and sales have either been revised down or had only minor positive changes since March.

IBO projects that revenue growth will average 3.7 annually from 2018 through 2022, which would be the slowest four year annual average since the end of the Great Recession. Since the recession, the four-year average has ranged from a low of 4.9 percent (2013-2017) to a high of 6.6 percent (2009-2013). The real property tax is expected to show the steadiest and strongest growth, averaging 5.5 percent annually from 2018 through 2022. No other tax is projected to average more than 4.3 percent annually, with several—including the personal income tax—expected to average less than 2.0 percent annual growth between 2018 and 2022.

This gets us back to the issue of whether the deBlasio administrations practice of steadily increasing City spending is sustainable. IBO projects total city spending will be $90.1 billion in 2019 under the contours of the Mayor’s latest budget plan—$900 million more than the $89.2 billion we estimate spending will total this year. We project total spending will rise to $93.3 billion in 2020 and reach $98.3 billion in 2022. Adjusting for the use of prior budget surpluses to prepay some expenses for upcoming years, IBO anticipates total city spending will increase from $89.0 billion in 2018 to $92.9 billion next year and grow to $94.8 billion in 2020.

Much of the growth in spending the next four years is driven by increased spending in two areas: fringe benefits for city employees and debt service (note that most fringe benefits and all debt service are not carried within the budgets of city agencies). IBO estimates that in 2018 the city’s expenditure on debt service and fringe benefits will comprise 18.2 percent of the total budget. By 2022 these two expenses will make up 21.2 percent of the entire city budget. These are somewhat dangerous levels driven by discretionary actions of the last two administrations and they leave the City’s budget vulnerable in the event of a significant economic downturn. we remained concerned about this risk going forward in terms of the ongoing value of the City’s debt.

NEW YORK AND MINNESOTA SETTLE FEDERAL MEDICAID LAWSUIT

Earlier this month, a federal judge signed off on an agreement that dismisses a lawsuit undertaken by the states of Minnesota and New York and directs federal officials to consult with Minnesota and New York over a new funding formula for what is called a Basic Health Plan (BHP) under the federal Affordable Care Act. The judge’s order said if the states disagree with the new formula developed by the Trump administration, they have until Aug. 1 to ask that a court reopen the case for litigation.

The Affordable Care Act (ACA) provides tax credits for individuals at certain income levels who buy private health insurance via government-run exchanges. States that create a Basic Health Plan as an alternative for these consumers can tap a large chunk of the value of tax credits individuals would receive to purchase coverage on the exchange.

In January, Minnesota Attorney General Lori Swanson filed suit to stop a Trump administration decision that would terminate an estimated $130 million in annual payments to the state. Federal funds, including those targeted by the lawsuit, have been covering most of MinnesotaCare’s costs with the rest coming from enrollee premiums and state funding.

INITIAL RATINGS IMPACT OF FOXCONN PLANT IS NEGATIVE

Racine County, WI will be the location of the much ballyhooed Foxconn manufacturing facility which will benefit from many tax incentives from the State of Wisconsin. The location of the plant may in the long term have a positive credit impact on the nearby localities, the initial effect has been negative. This week, Moody’s announced that it was lowering its outlook on Racine County’s GO credit from stable to negative.

In taking the action, Moody’s cited the significant amount ($147 million) of short-term debt coming due on December 1, 2020.  this reflects two issues of b the significant amount ($147 million) of short-term debt coming due on December 1, 2020. This reflects issuance of two bond anticipation notes to finance the purchase of land for the new Foxconn development. This is outside of any tax incentive. This amount of short-term debt is very high in Moody’s view relative to the county’s total outstanding debt (73% of the county’s debt) and the county’s available internal liquidity ($46 million as of fiscal year end 2016). These risk factors also contributed to the negative outlook on the county’s long-term debt.

The negative outlook reflects a view that the county has taken on substantial short-term leverage that could pressure the GO rating should the county experience difficulty in securing take-out financing for the BANs. The rating could also be lowered if revenue generated directly or indirectly by the Foxconn development falls short of county expectations.

GEORGIA DEANNEXATION EFFORT COULD HAVE WIDE RANGING IMPACT

When Georgia Governor Nathan Deal said legislation he signed that would de-annex parts of Stockbridge to create a new, more affluent municipality was unlikely to influence the state’s AAA bond rating, he left local ratings outside of that view. That’s a good thing as Moody’s weighed in with an opinion.

Moody’s released a four-page analysis this week that found the plan to create a new Eagles Landing would be “credit negative” to more than just Stockbridge. “The bills are also credit negative for local governments in Georgia because they establish a precedent that the state can act to divide local tax bases, potentially lowering the credit quality of one city for the benefit of the other,” according to Moody’s.

Stockbridge has $13 million of tax backed bank debt outstanding and $1.5 million of revenue bonds. The legislation did not address the issue of reallocation of the responsibility for that debt to either Eagles Landing or Henry County so it appears that the City will be stuck with those obligations in spite of a significant reduction in its tax base.

It is bad policy from any perspective and it would seem to violate the state’s moral obligation not to take any action which would undermine the ability of any of its underlying entities to meet their debt obligations.

 

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

 

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$260,260,000

BOARD OF EDUCATION OF THE CITY OF CHICAGO

UNLIMITED TAX GENERAL OBLIGATION

REFUNDING BONDS

(DEDICATED REVENUES)

 

The bonds are coming with Assured Guaranty insurance but it is an opportunity to review the Board’s underlying credit  which remains well below investment grade. The board’s full faith and credit and unlimited taxing power secures the bonds. The bonds are alternate revenue source bonds with the pledged revenues consisting of pledged state aid revenues. The rating is based on the board’s underlying unlimited ad valorem tax pledge.

The State of Illinois’ last budget did provide for improved funding for entities like the Chicago Public Schools in recognition of their difficult financial profiles and huge pension funding burdens. The resulting improvement in aid levels has a positive effect on cash flow although the Board still maintains an extremely weak cash position, which is projected to be negative throughout almost all of fiscal 2018 and likely in fiscal 2019.  It continues to maintain a reliance on lines of credit to support operating and debt service expenses.

Nonetheless, the Board was able to show a notably improved cash flow in the district’s March and subsequent May 2018 cash flow report compared to October 2017 and evidence that increased state funding is flowing to the district as previously planned. This was enough to convince S&P to have a positive outlook for the Board’s debt. The positive outlook reflects the at least one-in-three chance that S&P could raise the rating within the one-year outlook horizon.

An upgrade would have to be supported by the 2019 budget demonstrating structural balance, continued progress on an improving financial position with a small surplus result in fiscal 2018 leading to a positive fund balance, and additional reduction in outstanding tax anticipation notes.

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SEC ENFORCEMENT

Barcelona, a municipal advisor based in Edinburg, Texas, and Mario Hinojosa, Barcelona’s sole member and associated person. Barcelona acted as the municipal advisor to the La Joya Independent School District (“LJISD”) on three bond offerings between January 2013 and December 2014, earning $386,876.52 in municipal advisory fees. During LJISD’s process of selecting Barcelona as its municipal advisor, Barcelona and Hinojosa overstated and misrepresented their municipal finance experience to LJISD. Barcelona and Hinojosa also failed to disclose that Hinojosa was employed by the attorneys who served as bond counsel for all three bond offerings. By misrepresenting their municipal finance experience and failing to disclose the conflict of interest with bond counsel, Barcelona and Hinojosa violated the federal securities laws and the rules of the Municipal Securities Rulemaking Board (“MSRB”).

Among other things, the firm distributed written information which represented that the “professionals” at Barcelona have participated in several municipal offerings and have municipal finance experience in 14 different municipal bond issuances and that Hinojosa had four years of municipal finance experience. Hinojosa was Barcelona’s only employee and had never served as advisor—municipal or otherwise—on any bond issuances. In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), which included provisions for the registration and regulation of municipal advisors. The municipal advisor registration requirements and regulatory standards are intended to mitigate some of the problems observed with the conduct of some municipal advisors, including undisclosed conflicts of interest and failure to place the duty of loyalty to their municipal entity clients ahead of their own interests.

The SEC issued a cease and desist order and ordered disgorgement of f $362,606.91 and prejudgment interest of $19,514.37 to the Commission, a civil money penalty in the amount of $160,000 to the Commission, and Mr. Hinojosa is prohibited from serving or acting as an employee, officer, director, member of an advisory board, investment adviser or depositor of, or principal underwriter for, a registered investment company or affiliated person of such investment adviser, depositor, or principal underwriter.

All in all, pretty serious stuff. It is also for the long-term benefit of the industry. There are many reputable and more than useful municipal advisory entities and individuals and actions such as these which took advantage of an unsophisticated issuer in a relatively poor area encourage people to paint our industry with a broad brush. Unfairly so, from our standpoint.

CALIFORNIA APRIL REVENUE REPORT

State Controller Betty T. Yee reported California collected more tax revenue during the month of April than in any previous month of the 2017-18 fiscal year so far. Moreover, total April revenues of $18.03 billion were higher than estimates in the governor’s FY 2018-19 proposed budget by 5.3 percent.  For the first 10 months of the 2017-18 fiscal year that began in July, total revenues of $107.13 billion are $4.72 billion above estimates in the enacted budget and $3.82 billion higher than January’s revised fiscal year-to-date predictions. Total fiscal year-to-date revenues are $10.25 billion higher than for the same period in FY 2016-17.

For April, personal income tax (PIT) receipts of $14.17 billion were $715.9 million, or 5.3 percent, higher than estimated in January. For the fiscal year, PIT receipts are $2.58 billion higher than anticipated in the proposed budget. Traditionally, April is the state’s peak month of PIT collection. April corporation taxes of $2.40 billion were $78.4 million higher than forecasted in the governor’s proposed budget. For the fiscal year to date, total corporation tax receipts are 13.5 percent above assumptions released in January.

Sales tax receipts of $946.1 million for April were $139.1 million, or 17.2 percent, higher than anticipated in the governor’s FY 2018-19 budget proposal. For the fiscal year, sales tax receipts are in line with the proposed budget’s expectations.

Unused borrowable resources through April exceeded January projections by 36.9 percent. Outstanding loans of $4.52 billion were $6.35 billion less than the governor’s proposed budget expected the state would need by the end of April. The loans were financed entirely by borrowing from internal state funds.

TOWN SELLS BONDS IN THE MIDDLE OF A FRAUD TRIAL

We may never learn in the municipal bond market. Oyster Bay, N.Y., sold a total of $191.205 million in two separate competitive sales. The $152.665 million of public improvement bonds sold at a net interest cost of 3.32%. The $38.54 million of bond anticipation notes carried an NIC of 2.28%. The bond deal is rated Baa3 by Moody’s Investors Service and BBB-minus by S&P Global Ratings.

The sale came as testimony was being taken in the federal criminal trial of former Town of Oyster Bay Supervisor John Venditto (and former Nassau County Executive John Mangano) on securities fraud charges related to municipal bond sales by the Town of Oyster Bay. Testimony has exposed a failure to disclose vital information to investors including the fact that the Town had pledged its credit to guarantee loans made to individuals doing business with the Town.

The loans were for a political supporter, who was the operator of many Oyster Bay restaurants. In exchange for the guaranteed loans, the former elected officials were allegedly bribed with meals, chauffeurs, vacations, jewelry, and a $450,000 “no-show” job for Mr. Magnano’s wife. in a superseding indictment, federal prosecutors charged Mr. Venditto with securities fraud and wire fraud related to Oyster Bay muni-bond securities offerings, alleging that he concealed the illegal loan guarantees from investors and others.  The SEC in parallel civil litigation charged Oyster Bay and Mr. Venditto with defrauding investors of the town’s bonds by hiding the existence and potential financial impact of the illegal loan guarantees. The federal criminal trial commenced in mid-March 2018 and was ongoing.

Apparently, bidders and the ultimate buyers of the securities were satisfied that the Town’s wrongdoing and that of the charged individuals was sufficiently  separate issues. It is another remarkable example of the municipal market’s willingness to effectively forgive and forget within a relatively short period of time. It has been less than six months since the filing of the original charges and it seems reasonable to ask why investors would not wait until all of the available information which could have been generated at trial had come to light.

Regardless of the existence of a rating and the level of disclosure in the offering documents, the resulting cost of the issue to the Town does not seem exceptionally punitive. While we acknowledge that the current trial is rightly focused on the actions of individuals, one must wonder what assurances can be drawn regarding the Town’s ability to properly supervise and/or over see it employees and those entering into financial arrangements involving scarce public resources.

ILLINOIS LOCAL PENSION UNDERFUNDING

75 funds in 55 municipalities are underfunding their pensions to the extent that their municipalities could be subject to requests to withhold state aid as is the case in the well publicized situation in Harvey, Illinois.

A Cook County judge has struck down a 2014 overhaul deal as unconstitutional involving the Chicago park district. The local chapter of the Service Employees International Union, which represents Park District employees, filed suit against the city in October 2015. The District is some $611 million short of what it needs to pay future benefits – and, the judge ordered the district to pay back its employees contributions with 3-percent interest.

OUTLOOK IMPROVES FOR LARGE REGIONAL HEALTH SYTEM

Catholic  Health Systems (CHI) is a faith based, not-for-profit integrated delivery system with a presence in 17 states, operating 101 hospitals, and various long-term care, assisted-and residential-living facilities, and employing over 4,500 providers. In FY 2017, it generated $15.5 billion in operating revenue. It  was formed in 1996 upon the merger of four national Catholic health care systems.

Recently, Moody’s revised its outlook on the system’s Baa1 rated debt from negative to stable. The change reflects the improved performance through the first half of fiscal 2018 and assume continuation of these operating trends as well as the successful extension of bank agreements securing some $1 billion of short term debt. CHI’s bank agreements include additional covenants, including the debt service coverage test, a debt to capitalization requirement of no more than 65%, and a days cash on hand test of no less than 75 days. The bank agreements also include the requirement that CHI maintain ratings from all three major rating agencies of at least Baa3 / BBB- or better.

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

 

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$634,965,000*

ENERGY NORTHWEST

Columbia Generating Station Electric Revenue Refunding Bonds

Moody’s: “Aa1” (stable) S&P: “AA-” (stable) Fitch: “AA” (negative)

These bonds are supported by net billing agreements with Bonneville Power Administration (BPA, Aa1/stable) and thus are rated the same as BPA’s other supported obligations. Proceeds will refinance a like amount of outstanding debt.  Explicit US Government support features include borrowing authority with the US Treasury ($2.69 billion available as of September 30, 2017) and the legal ability to defer its annual US Treasury debt repayment if necessary.

The Columbia Generating Station nuclear facility is the third largest electricity generator in Washington, behind Grand Coulee and Chief Joseph dams. Its 1,190 gross megawatts can power the city of Seattle, and is equivalent to about 10 percent of the electricity generated in Washington and 4 percent of all electricity used in the Pacific Northwest. Columbia is the only commercial nuclear energy facility in the region. All of its output is provided to the Bonneville Power Administration at the cost of production under a formal net billing agreement in which BPA pays the costs of maintaining and operating the facility.

Four U.S. nuclear facilities have closed during the past three years, and two more are slated to close within the next four years. Two of those closed, representing a total capacity of 3,114 megawatts, were in response to return-to-service technical issues associated with plant-unique maintenance and repair challenges. The remaining four closures, representing a total 2,699 megawatts, result from unfavorable economics affecting relatively low-capacity (556 to 838 megawatts), for-profit facilities challenged by a deregulated market.

The bonds are likely closer to a low double A credit as BPA has experienced steadily declining liquidity as prices in the northwestern US wholesale power market have become relatively less favorable. BPA’s accelerated repayment of federal appropriations debt and declining availability under the US Treasury line are factors that could suggest a weakening of the US government’s explicit support features over time. In the initial discussion of a federal infrastructure package early in the Trump administration, there was floatation of the idea of the sale of the BPA’s generating assets to private interests. The idea reflects a general attitude towards entities like BPA as a source of revenue for the federal government over its mission of providing low cost power to the region to support economic development.

BPA published a new strategic plan that provides some credit positive objectives like reducing the debt ratio to a 75% to 85% range and maintaining $1.5 billion of US treasury line availability. The US federal government’s strong explicit and implicit support features are primary credit strengths that support current ratings even though BPA demonstrates financial metrics that are weak for the rating in the face of reduced prices for wholesale power.

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SANTEE COOPER FACES A DOWNGRADE

It has taken longer than one might hope but, better late than never for the announcement by Moody’s that it was putting its ratings of South Carolina Public Service Authority (Santee Cooper) under review for downgrade including the A1 rating on the outstanding $7.4 billion Revenue Bonds, the A2 bank bond rating, and the P-1 rating on the utility’s outstanding commercial paper note program. The action comes in the wake of the political fallout from the cancellation of the Summer 2&3 nuclear expansion project.

Now Santee Cooper’s  audited FY 2017 financial statements includes a $4 billion intangible regulatory asset which results in a significant and permanent increase in the utility’s debt ratio to over 130%, well above the average for an A rated public power electric utility. It remains highly uncertain as to how much if any of this investment will be allowed to be recovered through rate increases.  The ongoing litigation between Santee Cooper and its largest customer add additional uncertainty to the utility’s credit quality.

Moody’s final decision about a downgrade will “assess the legislative actions taken prior to the June 2018 end of the 2018 state legislative session; will examine Santee Cooper’s management plan to mitigate its exposure to the stranded nuclear asset; and will evaluate Central Electric Power Cooperative’s legal intentions and rights regarding its contract with Santee Cooper whose term extends to 2058.”

The S.C. House passed a bill replace its board of directors and create a panel to study a possible sale of the state-run utility. The state’s representatives voted 104-7 to give Governor McMaster, the ability to hand-pick up to 12 new board members for Santee Cooper. the legislation does nothing to prevent Santee Cooper from increasing customers’ bills to pay off its $4 billion debt for the troubled V.C. Summer nuclear project. The bill does, however, set up a new committee to vet possible purchase offers for Santee Cooper. It also calls for a study on ways to reduce costs for the utility’s 170,000 direct customers and the nearly two million customers at 20 electric cooperatives who get power from Santee Cooper.

The results of this process will go a long way to determining the rating position of the Agency.

TRANSIT HITS THE BRAKES IN NASHVILLE

With their beloved Predators in the midst of their quest for hockey’s Stanley Cup, rabid fans refer to their city as Smashville. Supporters of a plan to significantly invest in mass transit in Nashville would find the moniker appropriate in the wake of last week decisive vote against the Transit for Nashville plan. The proposed fifteen year $5.4 billion (current) dollar plan would have would have launched five light-rail lines, one downtown tunnel, four bus rapid transit lines, four new cross town buses, and more than a dozen transit centers around the city. . It would have been financed through a combination of higher sales and tourism related taxes.

The proposal faced a number of hurdles including a scandal impacting the mayor who proposed the plan, strong push back from housing advocates who saw the investment as misplaced, and those who objected to a resulting double digit sales tax. There were also concerns that too much of the investment was in center city although residents across the entire Metro area would be impacted by the sales tax. The vote fell broadly along urbanite versus suburbanite lines. Only five of 35 Metro Council districts, covering parts of East Nashville, Inglewood, downtown, 12South and Belmont, voting for the referendum. Ultimately, the proposition lost by a 2 to 1 margin.

DETROIT EMERGES FROM STATE CONTROL

Last week, Detroit’s Financial Review Commission (FRC) voted to waive oversight of the city, ending more than three years of supervision of the city’s finances following its emergence from bankruptcy in December 2014. The waiver follows passage last month of the city’s four-year financial plan. Michigan Public Act 181 of 2104 requires 13 years of oversight, but allows for scaled back oversight when the city meets certain benchmarks. The board was responsible for monitoring the city’s compliance with the bankruptcy plan of adjustment (POA) and provided general oversight of financial operations. The FRC  has faltered.

As is often the case, financial oversight is a powerful motivator for recovering cities to maintain prudent financial reporting and practices. The specter of loss of control tends to serve as a powerful check on the most irresponsible spending practices going forward. This should create a more favorable atmosphere for the kind of investment the City will need to support business growth and housing development both of which are crucial to the City’s long term success prospects.

Pension funding was a huge factor in the resolution of Detroit’s bankruptcy. City management has set aside funds in preparation for a fiscal 2024 pension contribution spike of $140 million (equal to 14% of fiscal 2017 operating revenue) in an irrevocable trust dedicated to its pension system. Detroit’s bankruptcy Plan Of Adjustment requires it to contribute just $20 million per year from its general fund to the pension system through fiscal 2019, but the city has made additional contributions of $105 million to date with the goal of amassing at least $335 million in assets in the irrevocable trust by 2023. With the monies accumulated in the irrevocable trust, Detroit will only need to increase its recurring general fund contribution by $5-$10 million per year during fiscal 2024-34 if actuarial assumptions are met.

The city also increased its reserves to available fund balance of nearly $600 million, or approximately 40% of revenue, at the close of fiscal 2017. The growth and maintenance of sufficient reserves will be necessary to counter concerns about the City’s long term budget outlook. The current positive momentum for the City is a reflection of the current administration. There is no way to assure that future mayors or City Councils will feel the same obligation to follow prudent fiscal policies. The fact is this the first time in more than 40 years that Detroit’s elected leadership has complete control of government functions.

NEW JERSEY TAX WORKAROUND IS SIGNED

Governor Phil Murphy has signed legislation to address the limitation of the SALT deduction from income under the federal tax reform bill. The legislation is designed to circumvent the law’s $10,000 cap on the deduction for state and local taxes (SALT), which has been a top concern in high-tax states like New Jersey and New York. Under the act, New Jersey taxpayers would be able to make contributions to funds set up by state localities. In return, taxpayers would be able to receive a credit against their property taxes worth up to 90 percent of the contribution.

Taxpayers would also be able to deduct the donations on their federal tax returns by using the charitable contribution deduction. New Jersey joins New York to enact legislation to create a workaround to the SALT cap that involves charitable contributions. One caveat is that it is unclear if the IRS will recognize these types of arrangements. Legislators have cited previous IRS actions which gave approval to states that give tax credits to taxpayers who make donations to private education.

THE FLIP SIDE OF CLOSING PRISONS

The movement to reverse the trend of mass incarceration in the US has resulted in closings of a number of facilities across the country. Faced with a declining population and high costs of updating older facilities some of the nation’s best known facilities have gone out of use. While much of the focus is on the cost saving associated with the closure of these facilities, there is another side of the issue which receives less attention. That is the role of these facilities as economic anchors and job creators in primarily rural areas. The correction jobs associated with these facilities are a source of replacement jobs for long time residents without college education, often previously employed in manufacturing.

The latest example of that side of the prison closing issue is currently playing out in upstate New York. Closed since 2014 because of declining incarceration rates, the Chateaugay Correctional Facility, is being sold by the state at auction.  The closing was a positive factor for the state’s budget but the local host town supervisor notes that “we lost 101 good jobs when it closed.” Some 200 miles north of Albany, the prison is located in the State’s relatively desolate North Country. This region relied primarily on agriculture – dairy farms – and industry which has seen significant consolidation in recent years.

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Chateaugay  has some 2,000 residents of whom 28% are below the federal poverty line and the median family income is $48,000. The physical plant up for auction includes 99 acres located 90 minutes from Montreal with 98,000 square feet of space spread over 30 buildings. It includes kitchens with walk-in freezers, a dining hall and a backup diesel generator. The hope is that its location near the Canadian border will make it attractive as a warehousing facility but with NAFTA under attack, the demand for that sort of facility is uncertain. The law of unintended consequences would seem to be in effect.

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

 

Joseph Krist

Publisher

________________________________________________________________

ISSUE OF THE WEEK

$150,000,000

Norfolk Economic Development Authority, VA.

Revenue Refunding Bonds, Series 2018

The bonds are secured under a Master Trust Indenture (MTI), whereby the parent company (Sentara Healthcare) is the only Obligated Group Member. Sentara Healthcare’s obligation is essentially an unsecured general obligation from a parent corporation with limited assets and revenues. The MTI, in turn, requires that each Obligated Group Affiliate (Sentara Hospitals and Sentara Enterprises) pay, loan or transfer sufficient financial resources to the Obligated Group to pay the principal and interest on all obligations outstanding under the MTI (‘Funding Agreements’). Rockingham Memorial Hospital and Martha Jefferson Hospital have each entered into a Funding Agreement with Sentara; each are dated as of November 28, 2011. Potomac Hospital has entered into a Funding Agreement with Sentara, dated July 2, 2012.

Sentara Healthcare reflects the strength inherent in a regional system. Its primary service area is around Hampton Roads, and comprises an approximately 1,600 square mile area in southeastern Virginia where Sentara controls seven hospitals and its secondary service area known as the Blue Ridge Service Area, where Sentara controls the Sentara RMH Medical Center in Harrisonburg, Virginia, and Sentara Martha Jefferson Hospital in Charlottesville, Virginia. Additionally, Sentara controls certain physician groups; Sentara Halifax Regional Hospital in South Boston, Virginia; and, Sentara Albemarle Medical Center in Elizabeth City, North Carolina. Through its subsidiaries and affiliated companies, Sentara operates a total of twelve hospitals, as well as skilled and intermediate nursing and assisted living facilities, numerous diagnostic and rehabilitative programs, physician offices and clinics, neighborhood medical centers, home health services and two health maintenance organizations.

We continue to believe that those hospital credits which are supported by geographically diverse revenue and demand bases will the credits best able to perform in the current environment of reimbursement pressures and technological advancement.

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PENSIONS ARE NOT JUST A LOCAL ISSUE

In the current environment, the funding and level of pensions has served as a source of much debate. One aspect of the discussion which does not come up that much is the issue of where that money goes. Where do the retirees receiving the pensions actually live? Is a state or city exporting its wealth through pension payments or does that money largely stay within local economies?  Is New York for instance, shoveling significant amounts of money to places like Florida? Some interesting data recently published by New York City’s Independent Budget Office provides some answers to those questions.

In 2017, New York City’s five pension systems for municipal employees paid $12.9 billion in benefits to more than 332,000 retirees or their beneficiaries.  There are no residency requirements for the receipt of one’s pension. Of the $12.9 billion in payments made by the city’s pension funds in 2017, $5.5 billion, or 43 percent, was paid to recipients living in New York City. Payments to municipal retirees within the state of New York equaled $9.3 billion, or 73 percent of total payments over the year.

The average per capita payment to all beneficiaries in 2017 was $38,711, with a median of $34,259. The comparable figure for New York State was $40,098. Among the states with at least 100 city retirees, pensioners living in Hawaii received the largest average payment: $41,700. Among municipal retirees still living in New York City, per capita benefit payments averaged $36,092. Of the 25 largest counties by recipient population nationwide, Orange County, New York, had the highest per capita payments, $55,524. The County is one of the most popular places for retired law enforcement officers.

About 46 percent of retirees receiving pensions from the city live in one of the five boroughs. An additional 22 percent live in one of the six nearby New York State counties. Of the top 10 counties in which New York City pension recipients resided, only one was outside of New York State—Palm Beach, Florida, with 7,868 city pensioners. Other leading counties home to New York City government pensioners included Broward County, Florida; and Ocean, Monmouth, and Bergen counties in New Jersey.

After New York and Florida, the eight other states with the most New York City government retirees are New Jersey, North Carolina, Pennsylvania, South Carolina, Georgia, Virginia, California, and Connecticut. All 50 states and the District of Columbia have New York City pensioners residing within their borders, from 5 in North Dakota to the 35,410 Floridians who were paid $1.3 billion in pension benefits in 2017. The 1,601 beneficiaries living in Puerto Rico received $42 million in benefits, while an additional $24.4 million was paid to 866 retirees living outside the United States and its territories.

So New York’s pension payments remain significant contributors to the metropolitan area economy. They provide a steady flow of income to support local economies and tax bases throughout the region. The idea that all of these employees break family ties and escape the cold weather just is not borne out by the facts. Something to think about when forming one’s views about government employee pensions.

NEW YORK CITY EXECUTIVE BUDGET

Now that the State has concluded its budget process, the Mayor of New York City has released his executive budget. The release was characterized by a number of complaints about how the City was treated in the State budget including areas such as mass transit and public housing. these have been ongoing areas of dispute in the long running feud between the governor and the Mayor. In spite of the picture painted by a the Mayor of a City under siege, the budget actually represents a significant increase on a year over year basis.

The budget includes spending of $89 billion, some $3.82 billion larger than the budget adopted last year. It adds 1,700 more employees. It is also an increase over the $88.7 billion preliminary spending plan that Mr. de Blasio introduced in February. The plan includes $349 million more for homeless services in addition to $300 million for homeless services that was added in February’s preliminary budget. The money covers the 2019 fiscal year, along with some costs from the current fiscal year.

The budget does appear to build in increased spending without sustainable sources of revenue to cover it, The gap for the coming fiscal year was covered by what all seem to agree is an $800 million one-time revenue boost. In spite of the Mayor’s view of state support, we note that nearly 17% of planned spending is funded by revenues from the State.

Education accounts for 35% of spending with social services and criminal justice combining with schools to account for 68% of local spending. The State Budget provides $250 million for capital projects and other improvements at the New York City Housing Authority (NYCHA) in accordance with the development of an emergency remediation plan under the Governor’s Executive Order. Total spending on housing is $7.8 billion.

Capital investment benefits from authorization of more efficient procedures. The State Budget grants the New York City Department of Design and Construction and NYCHA two years of design-build authority to remediate certain conditions. The budget also authorizes design-build for the rehabilitation of the Brooklyn-Queens Expressway and the construction of borough based facilities to facilitate Rikers closure plans.

The City will contract out a significant amount of services to private and non-profit providers. The 2019 Executive Contract Budget contains an estimated 17,664 contracts totaling over $16.17 billion. Over 76 percent of the total contract budget dollars will be entered into by the Department of Social Services, the Administration for Children’s Services, the Department of Homeless Services, the Department of Health and Mental Hygiene and the Department of Education. The Administration for Children’s Services has over $1.76 billion in contracts, approximately 66 percent of which represents contracts allocated for Children’s Charitable Institutions ($470 million) and Day Care ($696 million). Of the over $7.15 billion in Department of Education contracts, approximately 46 percent of the contracts are allocated for Transportation of Pupils ($1.23 billion) and Charter Schools ($2.09 billion).

From a credit perspective, the Plan essentially maintains the status quo. It does not anticipate significant economic changes or represent any significant rethink of how and what the City funds. We see nothing in the budget that will significantly address the primary concerns impacting day to day life in the City. Given the state of affordable housing and transportation, these are not positive for the City. Given those factors, the lack of any sense of anticipation of any serious impacts from higher interest rates and/or moderating economic growth is troubling. The Mayor’s continued expansion of the workforce and blindness to the sentiment against him in Albany are reflective of his lack of foresight. The City’s finances are now much more vulnerable to outside factors than has been the case for some time.

EDUCATION FUNDING WILL NOT GO AWAY

Arizona joined the ranks of states whose teachers have taken a front line role in the effort to increase salaries in particular and education in general as many school districts closed as teachers protested in the state capital. They were joined by teachers in Colorado where the legislature is considering legislation to make job actions by teachers illegal. The growing movement across the country is more than a straightforward labor dispute. The walkouts have addressed salary levels it is true but also have highlighted issues over funding of facilities and supplies as well as the impact of the student loan crisis.

Teachers in both states have referred to the need to pay student loans in association with their demands for better compensation. According to the state’s auditor general, the average teacher salary in Arizona was $48,372 last year, well below the national average.  Also, per pupil funding was estimated at $8,141 per pupil in 2017, well below the national average. The starting salary for teachers in Arizona was about $35,000.

In Colorado, union leaders note that half of the districts in the state now have four-day school weeks, and the state’s low teacher pay has helped create a 3,000-person staffing shortage. The state teachers’ union, the Colorado Education Association, says the state has shorted the education system $6.6 billion since 2009.

The strikes have tended to have received widespread support from the public. The difficulties at the legislative level have arisen when the hard decisions as to how increased funding can be achieved. The movement to increase school funding highlights the general debate over levels of taxation and the increasing competition for funds to pay for growing costs of things like pensions at the state level.

PENNSYLVANIA STATE UNIVERSITY SYSTEM STUDY

The Pennsylvania Legislative Budget and Finance Committee in the State’s general Assembly commissioned a study by the Rand Corp., a conservative think tank to review the existing structure of the Commonwealth’s state university system. The State System was established in 1982 and is the largest provider of higher education in the Commonwealth of Pennsylvania.  Like so many state systems of higher education it faces funding and cost pressures in an era of scarce resources at the state level.

Students are paying a greater share of costs because state appropriations are limited and have declined.  System enrollment has declined 13 percent between 2010 and 2016. As of 2016, 11 of the 14 State System universities are operating in deficit (although some of this effect may stem from 2015 changes in accounting rules for retiree pensions).

The study explored five options ranging from maintaining essentially the status quo with marginal changes to merger of  the State System universities into one or more of the state-related universities as branch campuses. One option would place the State System and all its institutions under the management of a large state-related university, building on their strong performance, possibly for a defined period of time such as ten years. Rand recommended the adoption of one of those two options if large, state-related universities are willing.

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