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Muni Credit News Week of June 11, 2018

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.

Muni Credit News Week of June 4, 2018

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.

Muni Credit News Week of May 28, 2018

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.

Muni Credit News Week of May 21, 2018

Joseph Krist

Publisher

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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.

Muni Credit News Week of May 14, 2018

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.

Muni Credit News Week of May 7, 2018

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.

Muni Credit News Week of April 30, 2018

Joseph Krist

Publisher

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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.

Muni Credit News Week of April 23, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$1,400,000,000

NEW YORK TRANSPORTATION DEVELOPMENT CORPORATION

Special Facilities Revenue Bonds, Series 2018

(Delta Air Lines, Inc. – LaGuardia Airport Terminals

C&D Redevelopment Project)

While New York’s LaGuardia Airport is undertaking a complete replacement of its main terminal, Delta Airlines is undertaking an upgrade of its own standalone terminal facilities.

Right now is a fine time from an airlines perspective to be issuing special facilities debt secured by its own credit. Oil prices are relatively favorable, planes are flying at high capacity factors, and the consolidation of the domestic US air market has created significantly reduced competition in the industry. This has resulted in a period of profitability for carriers which is significantly improved from the last boom period of airline issuance.

The security for the bonds includes leasehold mortgage language and other provisions but at the end of the day the Bonds are effectively secured under an unsecured guaranty of Delta Airlines. The project includes the demolition of Delta’s existing facilities and their replacement. Effectively, there will be periods of time when there is less physical asset security than is equal to the value of the Bonds outstanding. Hence, the rating of the Bonds is on parity with the airline’s unsecured debt.

It is important to remember that any unsecured financing of airline special facilities bonds is backed by general economic risk (this economic expansion has been exceptionally long and driven by policy and other factors which may make any response to an economic downturn problematic), the industry risk of a historically cyclical business, the fact that on a net basis the airline industry as a whole is inherently unprofitable over nearly a century of operating history We have seen since the turn of the century the vulnerability of the industry to a variety of external risks significantly beyond the airlines’ control.

We point all of this out, not in anticipation of default and/or bankruptcy, but as a reminder that investors should ask for a yield premium reflective of the fact that this issuance is occurring at an optimal time for the borrower. Coupon protection is important when the downside risk is likely greater than the upside risk associated with investment in unsecured airline debt.

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MISSISSIPPI BRIDGE CRISIS

Recently, Mississippi Governor Phil Bryant declared a state of emergency resulting in the nearly immediate closure of 102 locally owned and managed bridges across the state. They were determined to have significant structural deficiencies that posed immediate safety risks. The situation will put new negative credit pressure on Mississippi counties, the primary local governments responsible for bridge maintenance. The state itself will also face pressure to develop new capital funds to pay for needed infrastructure upgrades.

The state of emergency followed the US Department of Transportation (DOT) notification to the state that numerous bridges were out of compliance with national bridge inspection standards, and that failure to close the identified structures could result in reduced federal aid for the Mississippi Department of Transportation. According to the DOT, 2,008, or 12%, of the state’s 17,012 bridges are structurally deficient. This share is higher than the nationwide state median of 9% of all bridges.

In spite of the notification, the legislature authorized only $50 million in bonds for infrastructure needs for fiscal 2019 (which ends 30 June 2019). That is however, $30 million more than the usual authorization. The state estimates an additional $40-$50 million will be needed for local bridge repairs, in addition to approximately $400 million The Governor is considering calling a special session of the legislature to develop an infrastructure plan. The number of locally owned and managed closed bridges now totals 644 statewide, with the county median of closed bridges at 4%.

The State’s credit outlook is already negative. The need for additional capital funding and a likely increase in debt associated with it will make it harder for the State to retain its current Aa2 rating on its GO debt.

PR FISCAL BOARD PUTS FORTH FINANCIAL PLANS

The Financial Oversight and Management Board for Puerto Rico voted and certified its own version of fiscal plans for the commonwealth, the Puerto Rico Electric Power Authority (PREPA) and the Puerto Rico Aqueduct & Sewer Authority (PRASA). The vote came despite government efforts to convince the fiscal oversight board that its own fiscal plans unveiled April 5 achieved savings and complied with the Promesa law. The governor and several lawmakers rejected the fiscal plans. Fiscal board Chairman José Carrion said that if the governor does not implement the plans as approved, “we would have to consult with our lawyers.”

The government continued to object board-sought cuts of over 10% to pensions, which are unfunded by about $50 billion, and the repeal of labor protection laws, including the elimination of the statutory Christmas Bonus and two-week vacation and sick leave. The fiscal plan proposed by the board would make Puerto Rico an at-will employment jurisdiction, which allows employers to dismiss workers for any reason. The plan also calls for raising the minimum wage 25 cents to people older than 25. The board-certified fiscal plan estimates labor reform could raise $330 million for the government, but any related changes will require legislative approval.

The board’s version of the commonwealth fiscal plan achieves a $1.6 billion surplus, some of which may be used to pay debt, compared to a surplus of $1.4 billion in the government’s plan. The board’s document reflects a 6% increase in revenue and an 11% spending reduction. The board contends that if the government were not to implement labor or energy reforms, the island would be back in deficit by 2029.

KENTUCKY FILES OPIOID LAWSUIT

The state of Kentucky has filed suit against Johnson & Johnson and two of its subsidiaries over what the state’s attorney general alleges was a deceptive marketing campaign that caused widespread addiction to opioid-based prescription painkillers. The lawsuit seeks repayment for Kentucky’s “Medicaid, workers’ compensation, and other spending on opioids, disgorgement of Janssen’s unjust profits, civil penalties for its egregious violations of law, compensatory and punitive damages, injunctive relief, and abatement of the public nuisance Janssen has helped create.

The suit was filed in state court so it is a distinct action away from suits filed by other states. Arkansas, Louisiana, Mississippi, Missouri, New Mexico, Ohio, Oklahoma and South Dakota have also sued the company. Kentucky has a high rate of opioid use. The suit claims 1,404 people in Kentucky died from drug overdoses in 2016. the state had an opioid prescribing rate of about 97 prescriptions per 100 individuals.

ARIZONA TEACHER STRIKE

Teachers in Arizona voted Thursday night to launch the state’s first statewide teachers’ strike for this week. Seventy-eight percent of school employees voted in favor of the walkout, which will begin this Thursday. Arizona’s Gov. Doug Ducey (R) has proposed and supports legislation to provide the state’s teachers with a 20% raise by 2020. The strike is intended to pressure the legislature to enact the plan.

Teachers in the state are among the lowest paid in the nation, with the average salary for a state teacher sitting at $48,372. Union organizers want to see that number raised by at least $10,000. The move follows successful efforts in West Virginia and Oklahoma to obtain pay increases for teachers and other school personnel. Other personnel voting to strike included crossing guards and cafeteria workers.

The specific demands of the school teachers and employees include 20 percent salary increase: According to an analysis by the Arizona School Boards Association published in January, the median teacher pay in 2018 is $46,949. A 20 percent increase would amount to $9,390, for a total of $56,339; restore education funding to 2008 levels: This would require adding about $1 billion more in state funding to education. Arizona spends $924 less per student in inflation-adjusted dollars today than it did in 2008, according to the Joint Legislative Budget Committee; competitive pay for all education support staff. Ducey’s proposal does not include raises for these individuals; permanent salary structure, including annual raises; no new tax cuts until per-pupil finding reaches the national average. According to the U.S. Census Bureau’s 2015 figures, the most recent available, Arizona spent $7,489 per pupil, compared with the national average of $11,392.

In the end, the debate will be about funding and whether the revenues can be found to support it. It is not considered likely that the legislature will approve new taxes to fund the increases so the debate over how to fund raises is expected to be fierce.

CONGRESS QUESTIONS BRIGHTLINE’S USE OF PAB DEBT

At a hearing before the House Subcommittee on Government Operations, Brightline President Patrick Goddard and U.S. Department of Transportation official Grover Burthey were questioned harshly about how the railroad project qualified for the tax-exempt bonds. The Committee chair and Freedom Caucus leader Rep. Mark Meadows indicated that he believed that the use of such financing for the privately owned and operated high speed railway was inappropriate.

Two committee members highlighted an aspect of the project which we have criticized for some time. That is the potential inconsistency of All Aboard Florida instances that it is getting no government money, while federal rules require that PABs can be used only on projects that are, in fact, getting federal money.

The railroad tracks between West Palm Beach and Cocoa have received $9 million in federal money for street crossing upgrades. That Brighline insists, makes the railroad route eligible, even though the money was used to improve the streets crossing the tracks, not the railroad itself; and even though the tracks are not owned by Brightline, but by the Florida East Coast Railway.

Committee members indicated that they considered all surface transportation projects to be roads by definition, not railroads. The chairman indicated that “I do not see this as fitting the definition of surface transportation, not any, even if you read the statute, it doesn’t seem to apply. So at this point I have a real concern that the intent of Congress is being overridden on the Private Activity Bond measure here.”

TRANSPORTATION ON THE BALLOT

Voters in Nashville have begun early voting on a $5.4 billion transportation plan designed to address growing downtown congestion and a perceived increase in demand for mass transit in the city. The ambitious plan incorporates high capacity buses, designated bus lanes, a tunnel designed to facilitate through traffic in the downtown, and a light rail system. Funding for the plan would come primarily from reliance on increased sales taxes derived primarily from the city’s significant tourist industry and, in the case of the light rail component, a healthy share of federal assistance.

Critics of the plan which will fully unfold over a 15 year time period insist that it relies on the current state of technology and would lock the city into a system that could be effectively obsolete upon completion. The debate centers around peoples individual views as to the pace of technological change and whether or not that change will occur as quickly as proponents suggest. Some referendum critics contend that light rail will be too expensive, rely too heavily on uncertain federal funding, and not attract enough riders. One group, Plan B, has floated a separate alternative that consists of a fleet of vans that use rideshare technology. Initiative supporters argue that the reliability and implementation of technology like autonomous vehicles is too far away to rely solely on it. Once it is functional, they say it would work in tandem with light rail and other high-capacity transit.

Omaha, Nebraska voters will have a chance in May to vote on a $151 million bond authorization to fund a variety of improvement and expansion projects to facilitate transportation in the City. The proceeds would be applied to a range of street and road improvements including widening and extensions to the city’s street and bridge system over a six year period. Proponents say that the debt can be financed without a tax increase.

SPORTS FACILITIES IN THE POST TAX BILL ERA

Spokane County, Washington commissioners approved issuance of $25 million in bonds to help build the Spokane Sportsplex – a proposed multiuse sports facility with capacity to host national and local events. The $42 million Sportsplex would include a multipurpose fieldhouse with a 200-meter, six-lane indoor hydraulic banked track, 17 volleyball courts, 10 basketball courts, 21 wrestling mats and an NHL-sized ice rink with 1,000 seats.

Funding for the Sportsplex is to be accomplished through a combination of $11 million in bond reserve funds from the facilities district which owns and operates the Spokane Veterans Memorial Arena, the INB Performing Arts Center and the Spokane Convention Center, $5 million from the city of Spokane and $2 million from a state capital budget request – in addition to $25 million in bonds from the county.

Those county bonds would be repaid over 25 years through lodging and sales tax generated from tourism. The district’s lodging tax allocation committee also pledged $5 million to cover any shortfall in revenue or operating losses for the first five years.

A ballot measure to fund construction costs for the Sportsplex was considered, but the county withdrew the measure citing increased taxpayer burden. The new financing structure does not require a public vote because existing tax dollars already generated will be used to fund the project. A study commissioned by the Sportsplex estimates that the facilities would generate $33 million in direct tourism spending with an estimated 46,000 annual hotel stays.

Muni Credit News Week of April 16, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$588,025,000

COUNTY OF SACRAMENTO, CA

Airport System Revenue

Senior and Subordinate Lien

Moody’s: A2/A3 S&P: A+/A

The proposed senior and subordinate bonds are secured by a pledge of net general airport revenues, with a prior claim of these revenues by the senior lien bonds. The subordinate lien bonds can be additionally supported by PFC revenues, but are not pledged.

The County of Sacramento owns and operates the Sacramento County Airport System, which includes four airports: the Sacramento International Airport, Mather Airport, Executive Airport, and Franklin Field. The main passenger airport for Sacramento County is the Sacramento International Airport, which is comprised of two terminal buildings, and offers service to domestic and international destinations.

A growing service area economy reflected in steady population growth at the county level, the opening of the Golden One Center arena in downtown Sacramento in October 2016, the expansion of the Sacramento Convention Center, and the opening of Amazon’s 10th fulfillment center in October 2017 support the rating. Strong financial management of the airport is reflected in solid financial metrics, a diverse mix of air carriers and an expectation of no additional general airport revenue bonds (GARBs). This is based on a perception of ample capacity to expand service in existing facilities. Pressures on the rating are the airport’s high leverage as well as a high airline cost per enplanement (CPE). These would likely decrease with traffic and revenue growth and no new debt issuance expected during the outlook period.

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CALIFORNIA REVENUE UPDATE

California’s total revenues of $8.02 billion for March were higher than estimates in the governor’s 2018-19 proposed budget by 6.0 percent, and above 2017-18 Budget Act projections by 10.8 percent, according to the monthly revenue report from State Controller Betty T. Yee. For the fiscal year overall, the “big three” sources of General Fund revenue–personal income tax (PIT), retail sales and use tax, and corporation tax–are beating estimates in the enacted budget. For the first nine months of the 2017-18 fiscal year, total revenues of $89.10 billion are 3.4 percent higher than expected in the January budget proposal and 6.4 percent above the enacted budget’s assumptions.

For March, PIT receipts of $4.22 billion were 6.2 percent higher than the 2017-18 Budget Act’s projections, but 4.2 percent lower than anticipated in the proposed budget. For the fiscal year, PIT receipts are $3.17 billion higher than expected in the 2017-18 Budget Act. Corporation taxes for March of $1.31 billion were $549.2 million, or 72.4 percent, higher than forecasted in the governor’s proposed budget. This variance is largely because receipts were about $530 million more than anticipated. For the fiscal year to date, total corporation tax receipts are 32.5 percent above assumptions in the 2017-18 Budget Act. Sales tax receipts of $2.06 billion for March were $10.4 million lower than anticipated in the governor’s budget proposal unveiled in January. For the fiscal year, sales tax receipts are $410.1 million higher than the enacted budget’s expectations.

Unused borrowable resources through March exceeded revised projections by 41.0 percent. Outstanding loans of $11.84 billion were $5.18 billion less than expected in the governor’s proposed budget and $6.43 billion less than 2017-18 Budget Act estimated the state would need by the end of March. The loans were financed entirely by borrowing from internal state funds.

WHY THE NEW YORK CITY HOUSING AUTHORITY CRISES ARE NOT A CREDIT EVENT

The announcement that the chief executive of the New York City Housing Authority would leave her post at the end of April was not a surprise to observers of the Authority’s recent history. Scandals surrounding lead paint mitigation, inadequate capital maintenance, and a failure to provide heat made her position untenable. The Housing Authority’s operations had become yet another political conflict between the Mayor and the Governor of New York. The NYS budget for the fiscal year included funds to address immediate capital repair needs of the authority tied to oversight by the State. The city is in ongoing negotiations with federal prosecutors who in 2016 began an expansive inquiry into conditions in the city’s housing developments; the mayor has said that could result in a federal monitor for the authority, which already has a court-appointed special master to address mold.

NYCHA is in the front line of the City’s ongoing battle to provide affordable housing for low income New Yorkers. 257,143 families are on the waiting list for public housing. 146,808 families are on the waiting list for Section 8 housing. 15,096 applicants are on both waiting lists. There was a 2.6 percent turnover rate for public housing apartments in 2016 and there is a 0.7 percent vacancy rate of apartments available. Changes and challenges to federal financing for public housing programs have dampened issuance directly by NYCHA.

So it is important that the City’s Housing development Corporation be able to regularly access the public capital markets to finance ongoing development of new multifamily housing units. To finance NYCHA’s capital needs, the HDC issues bonds secured by a pledge of revenues received by NYCHA from the federal government annually appropriated by Congress under the Capital Grant Program. These funds are intended primarily to finance capital maintenance needs for upkeep of existing facilities.

The fact that the recent omnibus spending bill enacted by Congress includes increased funding for the program is credit positive. The change in leadership at NYCHA presents a huge opportunity for improved management and execution and could provide an improved negotiating position for NYCHA in its ongoing negotiations with the federal government. Our view is that additional oversight would only improve the support for funding under the Capital Grant program and would therefore be credit positive for bondholders.

POLITICS INTRUDE ON NJ TOBACCO BOND REFUNDING

The son of the former Governor of New Jersey issued a letter threatening legal action in an attempt to delay or prevent the formal closing on the State’s recent issue of refunding bonds. State Senator Ton Kean, Jr. issued a letter to the State Treasurer describing the refunding bonds as a “restructuring” of an existing issue rather than a refunding which usually results in the funding of debt service on the original issue and ultimately results in the original bonds being defeased and no longer considered outstanding under the authorizing bond resolution.

The distinction is important as the Senator cites the provisions of Article 8, Section 2, Paragraph 3 of the New Jersey Constitution which provides that all debt must be discharged within thirty-five years from the time it is contracted. The debt effectively being refunded by the Tobacco Settlement Financing Corporation was first issued in 2003 and the latest discharge date under the New Jersey Constitution would be 2038. However, under the pending restructuring, the final maturity (2046) is 8 years beyond this deadline. The flaw in the argument is the interchangeable use of the terms refunding and restructuring. If the original bonds are refunded, defeased, and ultimately discharged than it would seem that the newly issued refunding bonds fall within the maturity requirements of Article 8.

The real motive would seem to be an effort to draw attention to budget positions taken by various members of the NJ legislature. The letter calls the deal a $250 million one-shot budget gimmick. It is not surprising that an increased level of partisanship should be observed in the first budget process to occur under a new Governor. So we were surprised when the tobacco bonds successfully closed. Efforts like this often occur when bond issues can be used as a vehicle for political disputes but there has usually been too much sound legal work done to construct them to see those efforts bear any fruit. The Senator ends up looking naive at best.

LOCAL PENSION TROUBLES TRIGGER STATE WITHHOLDING

The City of Harvey, Illinois is a southside suburb of the City of Chicago. Like many Illinois municipalities, the City has significant unfunded pension liabilities. The State of Illinois has decided to withhold some $1.4 million of state aid from the City to cover pension costs that have gone unpaid for years. The city has sued the Illinois State Comptroller’s office, seeking to force the state to release the funds but in the interim is expected to lay off about 30 people working in the police and fire departments.

State Comptroller Susana Mendoza said “the legislature passed a law allowing pension funds to certify to our office that local governments have failed to make required payments to pension funds. The local government has a chance to respond. Once it’s certified, the law requires us to redirect the payments to the pension fund – the Comptroller’s Office has no choice. A judge ruled Monday in favor of the Harvey Police Pension Fund and against the City of Harvey’s request to stop this process, saying the funds were appropriately put on hold. The Comptroller’s Office does not want to see any Harvey employees harmed or any Harvey residents put at risk, but the law does not give the Comptroller discretion in this case.”

Without the funding being held by the state, Harvey officials said there might not be enough money to continue making payroll after Friday. The City contends that it is appropriating sufficiently for pensions but the State disagrees. The Comptroller said it’s up to the city and the police officers’ pension fund to negotiate a deal that would allow the state to release funding for the Harvey payroll.

BROADBAND AT A CROSSROADS IN KENTUCKY

Kentucky Wired started in 2015 with the goal of extending high-speed internet across the state. The plan was to install 3,400 miles of fiber-optic cable, much of it strung on existing utility poles. This would create an access point in each county to high-speed service which would then be provided through private services to individual locations. The project was designed to bring the service to the Commonwealth’s many residents who do not have access. It was seen as a key factor in the Commonwealth’s continuing transformation of its rural economies.

It is a public-private project, with privately-issued bonds to pay for it and a private company, Macquarie Capital of Australia, building and operating it. Much of its revenue would come from providing internet service to state offices. The entire project was originally planned for completion by late 2018. That schedule has fallen behind as the result of delays in getting permission to attach the cable to poles owned by telephone companies and others.

These delays have slowed the revenue flow that was designed to pay contractors doing the installation work. The contractor has made claims for payments related to those delays which were not part of the original project budget, and the state has to pay some $8 million to satisfy some of those claims. State officials worked out a deal with the private-sector partners in the project to resolve the outstanding claims and reset the construction schedule for completion in mid 2020. Like many P3 projects, the contracts would include incentives for ahead of schedule completion.

The transaction needs legislative approval for funding and a vehicle, Senate Bill 223, which would have given the network authority the ability to borrow another $110 million for the project. $88 million of that funding would deal with claims and create funding contingencies. The total project cost would come in at $342 million. Now the bill is running into opposition in the Legislature and the Governor has warned that not making good on the contract to build the broadband network would hurt the state, leaving taxpayers potentially facing hundreds of millions in costs, but with no network to show for it and no revenue from it to pay those costs.

Some legislators object to the state providing infrastructure to support a profit making service. The dispute however, is calling into question the State’s willingness to meet obligations which rely on state appropriations. This is crucial as Kentucky is one of the states which relies on appropriation backed debt to finance the vast majority of its capital needs. The legislature did not set aside money in the General Fund to make payments the state owes Macquarie for operating the network and repaying the bonds, called availability payments. However, legislators designated money in the state’s budget reserve fund, the rainy day fund, to make the payments to Macquarie.

Fitch Ratings said in a report this week that the failure of the legislature to authorize funding for the settlement through SB 223 or another mechanism “threatens the viability of the settlement agreement and the project itself.” A failure to complete the deal could raise issues about the relative creditworthiness of appropriation backed deals which could hurt the Commonwealth’s ratings.

BLUEGRASS EDUCATION FUNDING

Kentucky was another state facing protests by teachers over the level of state aid to education. Unlike other states where protests focused on teacher wages, this time the issue was overall education funding. The protests had forced some 30 districts to close as teachers converged on the state capitol. This time the effort succeeded.

The two-year state operating budget includes record new spending for public education, fueled by a 50-cent increase in the cigarette tax and a 6 percent sales tax on some services, including home and auto repairs. Kentucky lawmakers voted to override the Republican governor’s veto of a two-year state budget that increases public education spending with the help of a more than $480 million tax increase.

The teachers protest followed the enactment of a pension reform bill which will no longer guarantee defined retirement benefits to new teachers. Instead, they will be placed into a “hybrid” retirement plan that includes features of both a traditional pension — like teachers in Kentucky have now — and a 401(k)-style savings plan. In this hybrid plan, teachers would contribute 9.1 percent of their salary to the plan, while employers would contribute 8 percent. The plan is portable, meaning that if future teachers decide to leave Kentucky public schools, they can take their plan and benefits with them. The bill does not include any reduction in annual cost-of-living increases for retired teachers, leaving them at 1.5 percent. Earlier versions of the pension bill had proposed not only reducing the adjustment, but also freezing it for five years.

Muni Credit News Week of April 9, 2018

Joseph Krist

Publisher

We hope that you all enjoyed the holidays. Now that you’re back from various Spring breaks, so are we.

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ISSUE OF THE WEEK

$647,955,000

Clark County, Nevada

General Obligation (Limited Tax), Series 2018A

Moody’s: Aa1

This general obligation bond is secured under the typical full faith and credit pledge, subject to Nevada’s constitutional and statutory limitations on overlapping levy rates for ad valorem taxes. The bonds are additionally secured by incremental room taxes legally dedicated by statute under Senate Bill 1 to fund the public portion of constructing a new stadium to host a National Football League (NFL) team. The pledged room tax rates are 0.88% within the Stadium District’s Primary Gaming Corridor and 0.5% elsewhere within the district.

This reflects the use of the proceeds to finance costs associated with full faith and credit pledge, subject to Nevada’s constitutional and statutory limitations on overlapping levy rates for ad valorem taxes. The bonds are additionally secured by incremental room taxes legally dedicated by statute under Senate Bill 1 to fund the public portion of constructing a new stadium to host a National Football League (NFL) team. The pledged room tax rates are 0.88% within the Stadium District’s Primary Gaming Corridor and 0.5% elsewhere within the district.

The proceeds will finance a substantial share of the public portion of the costs to construct the stadium project for the Oakland raiders NFL franchise as well as fund a deposit to the bonds’ debt service reserve account. The stadium project is being overseen and managed by The Clark County Stadium Authority, a discreet component unit of the county which will also own the facility.

The County economy shows steady improvement on a statistical basis over each of the last four years. Employment, personal income, and home prices are all showing strong growth. Clearly there remains a concentration in and dependence on the hospitality industry which leaves the economy vulnerable to a national economic downturn.

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WHEN IS INSURANCE NOT INSURANCE?

Iowa Gov. Kim Reynolds signed a controversial bill allowing sales of health coverage exempt from state and federal regulations, including the Affordable Care Act. The bill, Senate File 2349, will allow Wellmark Blue Cross & Blue Shield to partner with the Iowa Farm Bureau Federation to sell a new type of health policy. The bill defines the new coverage as not technically being health insurance. It won’t be regulated by the Iowa Insurance Division and it won’t have to comply with rules under the Affordable Care Act.

Wellmark and the Farm Bureau could resume denying coverage to applicants if they have pre-existing health problems, such as diabetes, high blood pressure or a history of cancer. Such denials have generally been banned since 2014 by the ACA. The bill also would let Wellmark and the Farm Bureau delete some types of coverage, such as for maternity or mental health care, from the new coverage.

Medica is a Minnesota-based insurer that is the sole carrier selling individual policies in Iowa this year. Medica leaders say it would be unfair to exempt the Farm Bureau and Wellmark from government regulations but require all other carriers to follow them. The bill is alleged to have been written specifically to allow Wellmark Blue Cross & Blue Shield to underwrite the policies.

It will be determined by the Farm Bureau as to what benefits will be offered in the new plans and how they will deal with applicants with pre-existing health conditions. The bill also allows small businesses to band together to buy “association health plans,” which could provide lower premiums for employees than the businesses now are offered on their own. Both of these ideas were floated in the Congressional debate last summer over healthcare “reform”. If the plans are allowed to stand, it would likely create higher costs for the seriously ill in Iowa by allowing them to insure only healthy customers.

The plan anticipates that the Trump administration will not challenge the changes. The precedent for this hope is a program run through the Tennessee Farm Bureau, which began decades ago and has continued under the ACA without ever being challenged by the federal government. No one noticed until the individual mandate was repealed. Now that it has been, it is thought that more consumers may be attracted to similar plans.

Overall, these are not helpful developments for providers in Iowa. They would drive more patients requiring higher levels of care into a system without the requisite resources to pay for them. This would occur at the same time that state resources will likely be strained as Iowa is one of the states that would see their economy seriously impacted by the effects of limits on trade. So the likelihood is that overall, the health system in the state will see fewer resources available to treat its most acutely ill and economically less well off patients than was the case before. Should trade barriers such as tariffs be implemented, the resulting economic damage anticipated to occur in Iowa would only increase the impact.

COMPREHENSIVE INFRASTRUCTURE PLAN FADING – A CREDIT NEGATIVE

A variety of signs point to the likelihood that the federal approach to infrastructure will be piecemeal at best and likely tailored to a particular set of interests. They include indications that federal legislation will consist of several distinct pieces, rather than one fully committed and funded approach. There are also clues that the shift towards privatization as a centerpiece of any plan will continue if not increase.

This week, Speaker Ryan commented support for public-private partnerships and other ways of getting non-governmental sources to help pay for infrastructure needs. “All these infrastructure problems we have in America, there’s no way we can tax you to pay for all of it,” he said. “It’s not possible.” He added: “We’re going to have to think of more creative ways to get the private sector dollars involved in infrastructure, and whether it’s asset recycling or other kinds of creative ideas like that, with the right rules in place for the public good, I think it’s all good.”

We highlight his specific reference to asset recycling and this week’s announcement that DJ Gribbin, President Trump‘s infrastructure policy adviser, is departing the White House. Gribbin will be better positioned to advance the “recycling’ concept in the private sector. He previously worked for asset recycling’s leading champion – the Australian bank Macquarie Capital. Macquarie has been looking for more receptive audiences for the concept after a mixed record and dwindling support for the concept Down Under. The move out of the White House is a sign that Congress is not as receptive to an overall infrastructure plan as once may have been the case.

We think that there is a substantial role for the private sector in any infrastructure plan especially in the design, building, and management of many infrastructure projects. We do understand the reluctance to convert fully paid for public assets into privately owned and operated assets the operation of which is designed to generate a profit. We hold the view that the contribution of the private sector is best directed at efficiency and economics. The achievement of reasonable rates of return for the private sector is not inconsistent with retention of ownership by the public sector. We would cite airports as a good example of a sector which lends itself to private participation.

What would be credit positive for municipalities and authorities is an infusion of funding. Too much of the debate has been about financing. Our view is that financing is not the problem – there is no shortage of ideas. It is funding to help the entities already under pressure to fund existing and steadily increasing expenditures away from capital needs which would be the most helpful answer.

SUTTER HEALTH FACES STATE LAWSUIT OVER COMPETITIVE PRACTICES

WHY IT SHOULD MATTER TO ALL INVESTORS

In our most recent issue of the MuniCreditNews (3/26/18), we discussed the credit of Sutter Health in our issue of the week section, highlighting the system’s plans to use taxable debt to economically refund outstanding tax exempt debt. In the interim the System has found itself named as defendant in litigation brought by the state of California citing illegally anticompetitive practices by Sutter. The suit comes in the midst of Sutter’s efforts to market the aforementioned debt.

California Attorney General Xavier Becerra announced the filing of a lawsuit against Sutter Health, the largest hospital system in Northern California, for anticompetitive practices that result in higher healthcare costs for Northern Californians. The action aims to stop Sutter Health from unlawful conduct under state antitrust laws.

The complaint alleges that Sutter Health engaged in anticompetitive behavior. These illegal practices resulted in higher prices for health care in Northern California by: establishing, increasing and maintaining Sutter Health’s power to control prices and exclude competition; foreclosing price competition by Sutter Health’s competitors; and enabling Sutter Health to impose prices for hospital healthcare services and ancillary products that far exceed the prices it would have been able to charge in an unconstrained, competitive market.

The University of California Berkeley’s Petris Center on Health Care Markets and Consumer Welfare has issued a report which it says documents how the rapid consolidation of healthcare markets in California has led to rising healthcare costs for consumers throughout the state. Market consolidation in Northern California was especially glaring. The cost of the average inpatient hospital procedure in Northern California ($223,278) exceeded that in Southern California ($131,586) by more than $90,000.

The AG complaint cites a variety of studies conducted over several years to support his determination of anti competitive practices. A 2008 U.S. Federal Trade Commission retrospective study of the merger of Alta Bates, owned by Sutter, and Summit Medical Center found that the contracted price increases for Summit following the merger ranged from approximately 29% to 72% depending on the insurer, compared to approximately 10% to 21% at Alta Bates, and that the Summit post-merger price increases were among the highest in California.

The AG asserts that since at least 2002, Sutter has compelled all, or nearly all, of the Network Vendors operating in Northern California to enter into unduly restrictive and anticompetitive written Healthcare Provider agreements that have: established, increased and maintained Sutter’s power to control prices and exclude competition; foreclosed price competition by Sutter’s competitors; and enabled Sutter to impose prices for hospital and healthcare services and ancillary services that far exceed the prices it would have been able to charge in an unconstrained, competitive market.

The complaint further asserts that Sutter’s agreements with insurance vendors force Health Plans to include all Sutter hospitals and Healthcare Providers in their Healthcare Provider Networks—even those Sutter hospitals and providers that are located in areas where it would be far less costly to assemble a Provider Network using Sutter’s lower-priced and/or higher quality competitors instead of Sutter. That the agreements require that Sutter’s inflated prices for its general acute care hospital services (including inpatient and outpatient services) and ancillary and other provider services may not be disclosed to anyone before the service is utilized and billed.

Collectively, Sutter’s anticompetitive contract terms unreasonably restrain price competition among general acute care hospitals, between hospitals and ambulatory surgery centers for outpatient surgery services, and between hospital and non-hospital ancillary service providers, in Northern California and enable Sutter to price its general acute care services (including inpatient and outpatient services), and ancillary and other provider services at artificially inflated levels, according to the complaint.

Sutter is the largest provider of general acute care hospital services and ancillary services in Northern California. In 2016, Sutter had 193,161 hospital discharges, 873,992 emergency room visits, and 8,763,470 outpatient visits. 54. Sutter provides healthcare services to individuals in more than 100 Northern California cities within the following counties: Yolo, Sutter, Yuba, Nevada, Placer, El Dorado, Amador, Sacramento, Solano, San Joaquin, Stanislaus, Merced, Contra Costa, Alameda, Santa Clara, Santa Cruz, San Francisco, San Mateo, Lake, Napa, Sonoma, Del Norte, and Marin.

So what is the contractual structure at the heart of the AG’s assertions? There are at least two contractual arrangements that must be in place before any prospective patient is able to use a particular hospital or other Healthcare Provider as an in network, healthcare employment benefit: a Network Vendor must agree to include the hospital or other Healthcare Provider in its Health Plan Provider Network at pricing levels established through contract negotiations between the hospital or other Healthcare Provider and the Network Vendor. The patient’s Employer or Healthcare Benefits Trust must contract for access by its Health Plan Enrollees to the Network Vendor’s previously assembled Provider Network.

A hospital can be a “must have” hospital. A “must have” hospital is a hospital that Network Vendors have to include in their provider network for that network to be commercially viable. A hospital can be a “must have” because of physician referrals, reputation, or the lack of alternatives in a geographic location. Likewise, other healthcare providers such as an ambulatory surgery center or physicians’ group could be a “must have” provider because of physician referrals, reputation, or the lack of alternatives in a geographical location. Ownership of a “must have” hospital or other healthcare provider can give a Healthcare Provider market power.

By requiring Network Vendors to sign contracts that are designed to interfere with the formation of competitive Provider Networks and restrict the incentives that Health Plans can offer their enrollees and restrain price competition, a hospital system like Sutter can improperly limit the ability of rival hospitals, rival Healthcare Providers, as well as rival Hospital Systems as a whole to compete effectively. In this way, Sutter can exert control over the prices for general acute care (including inpatient and outpatient services), ancillary, and other provider services paid by Employers and Healthcare Benefits Trusts.

At the core of the complaint is what is cited as Sutter’s All-or-Nothing Terms and practices and the other agreement provisions described below, Sutter illegally ties or bundles the price-inflated services and products available at Sutter hospitals located in potentially more price competitive markets to its entire network of other hospitals and providers (including Sutter “must have” hospitals and providers) forcing Self-Funded Payors and Commercial Insurance Companies to pay for services and products they do not want to offer their Health Plan Enrollees at prices that dramatically exceed the prices Sutter could charge absent the illegal tie or bundle.

Sutter ensures that its de facto All-or-Nothing Terms are effectuated by specific Excessive Out-of-Network Pricing Provisions in their contracts with Network Vendors (“Excessive Out-of-Network Pricing Provisions”). If an enrollee requires services at a Healthcare Provider that is not in his or her Health Plan (e.g., he or she gets into an accident and is taken to the emergency room of a hospital outside of his or her plan), the contracts between Network Vendors and the Healthcare Provider or Hospital System fix the rate at which that non-participating provider shall be paid.

In the absence of a specific contract rate, services at a non-participating provider are to be charged at a “reasonable and customary” rate, where under state law as well as federal law that rate is to be determined with reference to such criteria as in-network rates of rivals or Medicare rates. The preference for alternatives close to where patients live or work becomes even more acute as the need and urgency increase, e.g., a patient has a heart attack or a stroke. However, the out-of-network rates set by Sutter are excessive and render uneconomical any narrow networks that exclude that Hospital System or any of its members from a Network Vendor’s provider networks because of this need for emergency services.

So what does it all mean? The issue of consolidation and efficiency will be a keystone supporting the evolution of the healthcare delivery model in the US in the 21st century. How these issues are viewed, valued, and judged whether or not to be effective will be some of the primary determining variables in the assessment of creditworthiness. To the extent consolidation results in efficiencies and cost reductions to individuals and the system as a whole, the creditworthiness of hospitals and hospital systems is likely to be sustained and even improved. Should consolidation result in price gouging and inefficient markets and competition, many hospitals could find themselves in a weakened position which will benefit neither consumers not investors.