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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.

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 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.

Muni Credit News Week of March 26, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

California Health Facilities Financing Authority

$684,475,000*

SUTTER HEALTH

TAXABLE BONDS

$606 million

Tax-exempt Revenue Bonds

In the current environment, this large Northern California hospital system has determined that a taxable refunding generates sufficient savings to justify refinancing tax exempt debt with proceeds of the issue. The bonds come to market with Aa3/AA- ratings. Concurrently, the system will issue tax exempt debt to fund its significant ongoing capital program. The system plans some 44.9 billion of capital spending over the next five years.

Bonds are secured by a gross revenue pledge pursuant to Sutter’s 1985 Master Trust Indenture (MTI), with payments made by Sutter’s Obligated Group (approximately 99% of the System’s total revenues). All members of the Obligated Group are jointly and severally liable with respect to the payment of each obligation secured under the MTI. Financial covenants include a debt to capitalization requirement of less than 60%, a debt service coverage requirement of over 1.1 times, and a days cash on hand requirement of over 70 days.

Sutter operates 29 acute care facilities, operates a small health plan, manages a large number of out-patient facilities, and manages five medical foundations that contract with medical groups organized as professional corporations that account for the services of 2395 physicians. In fiscal 2017, Sutter Health produced over $12 billion in revenues, and generated over 193,000 admissions.

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FEDERAL TAX CUT WILL BOOST STATE CORPORATE TAX REVENUES

The Council On State Taxation has released a study “The Impact of Federal Tax Reform on State Corporate Income Taxes”, produced through the efforts of Ernst and Young (EY) researchers. The report estimates the impact of federal tax changes on the tax position of companies. The EY study assesses the impact that the corporate tax provisions of the TCJA will have on respective states’ corporate income taxes. Its overall conclusion is that conformity with federal tax reform will result in an estimated state corporate tax base increase averaging 12% for the first ten years, with a range generally between 7% and 14% in individual states.

According to the report, the average expansion in the state corporate tax base is estimated to be 8% from 2018 through 2022, which increases to 13.5% for the period 2022 through 2027. This increase in the later years is primarily attributable to research and experimentation (R&E) expense amortization beginning in 2022 and the change in the calculation of the interest limitation in the same year. The federal tax base expansions due to interest limitation, research and expenditure amortization, limitation of like kind exchange for personal property, and fringe benefit limitations total approximately 10%. Since virtually all of the states conform to these provisions, these changes represent a large portion of the overall expansion of the tax base in most states.

According to the report, the largest expansions in federal corporate tax base arise in the manufacturing and capital-intensive service industry sectors due primarily to the transition tax. The finance and holding company sector will be impacted mostly by the impact of the federal NOL limitations and the transition tax and GILTI. The labor intensive service sector will see the smallest overall increase in federal taxable income. While it is somewhat affected by the transition tax and the business expense interest limitation, it benefits almost equally from the expansion of bonus depreciation and the move to a territorial tax system.

What all of this implies is that, in the first year, there is a positive potential impact on state revenues as the result of the federal tax cuts. Whether this is a long run positive depends on how corporate taxpayers react. We would expect pressure to be brought to bear on state legislatures to make adjustments to their own tax codes to account for this non-legislative increase. We do have concern that as this process sorts itself out, the resulting increases in tax liability may mute the positive intended economic impact of the federal tax cut. In particular, the larger share of base expansion assigned to the manufacturing sector may help to dampen the employment impact intended by the proponents of the tax cut.

We note that states traditionally associated with manufacturing – Pennsylvania, New Jersey, New York, Iowa, Massachusetts, and Missouri – to name a few have the highest percentage rates of expansion in their corporate tax base as the result of the federal changes.

CENSUS DATA SHOWS IMPACT OF HOUSING COSTS

The US Census Bureau released data this past week revealing population trends for the country’s major metropolitan areas. Among these was Wayne County, MI which is substantially comprised of the City of Detroit. The good news for the city is that the area is now ranked ninth on the list of declining county populations rather than third as was the case in 2017. This is attributable to, among other things the availability of housing in the City of Detroit.

One criticism of the City’s efforts on renewal in the post-bankruptcy era is that it has mainly attracted higher income workers back into the city. The availability of lower cost affordable housing has not been as readily addressed. Now the State of Michigan and the City have announced a program to begin to address that demand. To the surprise of no one, it will rely in a substantial way on tax exempt financing.

Detroit is creating a $250 million affordable housing fund that would preserve 10,000 affordable housing units with expiring low-income housing tax credits and create 2,000 new ones on vacant land or in existing vacant buildings by 2023. The fund would be made up of $50 million in grant funding; $150 million in low-interest borrowing; and another $50 million in city and federal funds over the next five years.

The fund will comprise monies from bank financing, low-income housing tax credits, tax-exempt bonds, brownfield financing and historic tax credits. The first project funding commitments are expected early next year. Last year, the City Council approved an ordinance requires housing developers who receive a certain threshold of public subsidies or discounted city-owned land in Detroit to set aside at least 20% of their units for lower-income residents.

NEW JERSEY TOBACCO REFUNDING HIGHLIGHTS RECENT USE TRENDS

The State of New Jersey is undertaking a current refunding of outstanding tobacco securitization debt. The issue gives us a chance to look at historic sales data and the accompanying projections of future sales trends supplied in the prospectus. This issue will have a final maturity of 2046 and features the well established “turbo” maturity schedule which, if met, would retire approximately one-third of the bonds within 14 years.

The O.S. shows that sales of cigarettes have been declining in this century at an average of 3% per year. The rate of decline has not been consistent with large drops attributable to the Great Recession and price and taxation events. Sales actually increased twice (albeit less than 2%) on a year over year basis. The forecast of cigarette consumption which is included in the prospectus calls for annual declines in sales of 2.9% annually through 2046 (the final maturity of the bonds).

The State receives 3.8669963% of the annual $9 billion of payments made by the original and subsequent participating manufacturers under the terms of the Master Settlement Agreement. These payments are pledged to the repayment of the bonds on a subordinate basis. There is also a $52 million reserve to be maintained for the bonds.

These bonds will refund debt with a final maturity of 2041 so there is some extension of the maturity risk associated with this issue.

We have always taken the view that tobacco bonds are primarily a professional institutional investor trading vehicle. We believe that the historic price volatility that the sector has experienced due to the typically extended duration of the bonds is more than the typical individual investor should be expected to handle on their own. Nothing about the structure or security position of this issue causes us to change our view.

CONNECTICUT TO SELL BONDS IN THE FACE OF A DEFICIT

The State of Connecticut will try to sell some $600 million of general obligation bonds in the wake of the latest current deficit assessment. The State Comptroller last week announced that the State faces a General Fund deficit from operations of $192.7 million, an improvement of $2.1 million from the level reported in February. Projected revenues remain unchanged from the level reported last month. The figure does not include the impact of a deposit which is required to be made to the State’s Budget Reserve Fund if General Fund revenues exceed $3.5 billion as is expected to be the case.

Without action to mitigate the projected deficit, the balance in the BRF, after transfers to extinguish the FY 2018 deficit, is projected to be $685.1 million, equivalent to 3.6% of FY 2019 General Fund appropriations. If the projected deficit is resolved without utilizing resources from the BRF, the balance in the reserve will reach $877.8 million, or 4.7% of FY 2019 General Fund appropriations. Expenditures are estimated to be $16.2 million above the budget plan. The expenditure and revenue estimates assume that the budgeted level of rate increases and supplemental payments to hospitals will be made, and that the budgeted amount of the hospital user fee and federal revenue will be collected.

Statutory provisions require the state to process certain hospital rate and supplemental payments in advance of full federal approval. The state’s submissions are currently under federal review, but it is unclear whether and when federal approvals will be obtained. If approvals are delayed beyond the end of the fiscal year, there could be a budgetary impact of approximately $150 million.

All of this is reflected in S&P’s latest statement on Connecticut’s credit. It affirmed its ‘A+’ rating on the state’s approximately $18.5 billion of GO debt outstanding, its ‘A’ rating on state appropriation-secured debt, and its ‘BBB+’ rating on state moral obligation debt. The outlook on all long-term debt is negative. S&P cited revenue weakness because of slow economic growth and recent population decline and reduced revenue-raising flexibility after the state instituted substantial tax increases in the past two biennium budgets. Less expenditure flexibility following implementation of new constitutional spending caps; reductions in state aid to localities; implementation of a recent labor agreement that reduced costs, but also created fixed pay schedules and prohibits layoffs over the next four years; and rising fixed-debt service, pension, and OPEB expenditures all contribute to the outlook.

Muni Credit News Week of March 19, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$251,000,000

Philadelphia School District

General Obligation Bonds

The District’s debt carries an underlying Ba2 rating and an A2 enhanced rating. The underlying rating is based on strained financial position and narrow reserves, exacerbated by substantial charter enrollment pressures. As students leave the system for charter schools the District loses state revenues which are linked by formula to average daily attendance. This has been a long standing problem for the District. The trend of shift in enrollment from the public system to charter schools has slowed but is still an issue for the District and its finances.

The A2 enhanced rating reflects the credit support of the Pennsylvania School District Intercept Program, which provides that state aid will be allocated to bondholders in the event that the school district cannot meet its scheduled debt service payments. The rating reflects that Philadelphia School District has engaged a fiscal agent, and there is language in the bond documents that will trigger the state aid intercept prior to default.

The positive outlook assumes that finances will be maintained within the range of what is considered structural balance on a forward basis. Governance of the system was returned to local control in 2018. The mayor’s recent budget proposals have allocated permanent tax increases to the district.

These are general obligation bonds of the Philadelphia School District, to which the district has pledged its full faith, credit, and taxing power. The district’s GO debt is supported by a lock-box structure, whereby four dedicated tax streams (including property tax) are allocated on a daily, pro-rata basis to bondholders. The Pennsylvania School District Intercept Program is not a general obligation guarantee of the Commonwealth, and in fact, there have been times when the state has not distributed any aid to school districts, as was the case during the 2016 state budget impasse. However, with implementation of Act 85 in 2016, the state has ensured that intercept payments, for the benefit of bond debt service, will be made even in the absence of an appropriation budget.

The enhanced rating is ultimately tied to the general obligation rating of the Commonwealth. The current outlook for the Commonwealth’s rating is stable despite a difficult annual budgeting process and an excessively political environment due to the upcoming gubernatorial election in November.

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CYBERSECURITY BACK IN THE NEWS

Analysis by DHS and FBI was revealed this week that showed that since at least March 2016, Russian government cyber actors—hereafter referred to as “threat actors”—targeted government entities and multiple U.S. critical infrastructure sectors, including the energy, nuclear, commercial facilities, water, aviation, and critical manufacturing sectors. In multiple instances, the threat actors accessed workstations and servers on a corporate network that contained data output from control systems within energy generation facilities.

Russian state hackers had the foothold they would have needed to manipulate or shut down power plants. made their way to machines with access to critical control systems at power plants that were not identified. The hackers never went so far as to sabotage or shut down the computer systems that guide the operations of the plants. The report made it clear that efforts to actually shut down operations did not occur, not because of technical inability but because a conscious decision was made not to.

The groups that conducted the energy attacks are linked to Russian intelligence agencies. Affected facilities included that of the Wolf Creek Nuclear Operating Corporation, which runs a nuclear plant near Burlington, Kan. At the time of that attack in summer 2016, the corporation said that no “operations systems” had been affected and that their corporate network and the internet were separate from the network that runs the plant.

The level of disclosure available from municipal utilities as to the cyber threats they face and their response to them has varied. They range from none to very broad and inexact statements of actions usually unaccompanied by any cost estimate assigned to these efforts. This report makes clear that the potential risk from cyber attack is significant. Investors would not tolerate minimal to no discussion of various natural, legal, or regulatory risk. There is no reason for investors to tolerate a lack of disclosure in this critical area.

GUAM REVENUE ISSUERS UNDER PRESSURE

In the aftermath of Puerto Rico’s ongoing fiscal crisis, investors seeking triple tax exempt debt may have looked to Guam. After some steps were taken to improve the central government’s fiscal position, the credit became somewhat more attractive for investment. Now it appears that this may no longer be a viable strategy. The island’s GO is on negative outlook and now the revenue issuers on Guam are under pressure as well.

Moody’s announced this week that the Baa2 rating on the A.B. Won Guam International Airport Authority’s senior General Revenue Bonds was affirmed but that it had changed the rating outlook to negative from stable. The change in rating outlook to negative reflects Moody’s assessment of the linkage between Guam International Airport Authority and local economic conditions in Guam. Moody’s is concerned that a deterioration of local economic conditions could put negative pressure on travel demand to and from the island, and would likely have an impact on enplanements and routes offered by airline carriers. In that regard, Delta Airlines has recently decided to no longer serve the Guam Airport and United Airlines also reduced some of its weekly Japan flights as result of lower demand from Japan. Japan is the major source of tourism to Guam.

Moody’s affirmed the Baa2 ratings on the Guam Power Authority (GPA)’s senior revenue bonds but also changed the outlook to negative from stable. According to Moody’s, GPA operates fairly independently from the government. It expects that the authority would not be able to disconnect itself from the local economic conditions or material financial stress at the government level. Until now, the government has remained current on paying its bills and there has been no pressure to receive transfers 2017 electric revenue. A deterioration of government finances or local economic conditions could put pressure on outstanding receivables and customers’ ability to pay their bills. In addition, the Public Utility Commission’s willingness to support rate increases could weaken during time of economic stress.

WATER IN THE WEST – CALIFORNIA DRINKING WATER TAX

A new study from the University of California at Davis identifies those San Joaquin Valley residents without access to drinking water. The report names some 300 areas, many in unconsolidated communities which do not have their own water systems supplied by any of the major California water distributors. In many cases, these connections are not the result of a lack of proximity to these suppliers. Rather they are the product of a lack of funding to finance such projects.

Many of these communities rely on water supplies which are vulnerable to runoff which allows any number of dangerous chemicals to taint the supplies for these systems. This is especially common in unincorporated communities categorized as disadvantaged, which are also overwhelmingly Hispanic. Some of the systems have treatment facilities attached to them but the economics of operating these plants has led to their shutdown or abandonment. The result is the presence of substances like arsenic and nitrate. Some 300 public water systems in California are believed to be contaminated.

Now legislation has been introduced in the California legislature to provide funding for the creation of a fund to finance the cost of connecting these individual systems to larger systems which can treat the water over a larger base to reduce the per user cost of cleaning the drinking water. Senate Bill 623 would establish a fund to help those communities pay for water treatment projects.

It would seem to be an idea which would lend itself to broad based support and there is such support in the legislature. But enactment is not a sure thing due to the source of funding for the proposed fund. That source is a proposed tax on the bills of other water users. The bill would impose, until July 1, 2020, a safe and affordable drinking water fee in specified amounts on each customer of a public water system in the State. The bill, until January 1, 2033, would require a every person who manufactures or distributes fertilizing materials to be licensed by the Secretary of Food and Agriculture and to pay to the secretary a fertilizer safe drinking water fee of $0.005 per dollar of sale for all sales of fertilizing materials. The bill, on and after January 1, 2033, would reduce the fee to $0.002 per dollar of sale.

A number of large municipal water systems have registered opposition. Many systems in California have used water charges to help further water conservation during times of drought. These increased rates have led to pressure on local water boards to minimize rate increases whenever possible. In addition, the bill would impose a specific fee on milk producers. These producers are a powerful lobby in the nation’s largest milk producing state. This political pressure serves to generate opposition to the proposed tax.

The Association of California Water Agencies has come out against the bill in its current form. ACWA and more than 135 public water agencies are advancing what they present as a more appropriate alternative – a package of existing and proposed funding sources that do not include a tax on drinking water. This package includes ongoing federal safe drinking water funds, state general obligation bonds and an augmentation from the state general fund, in addition to agricultural assessments proposed in the bill.

Arguably, any increase for an individual water system which is not related to the coverage of its own operating costs and debt service could be considered credit negative.

DOJ SIDES WITH STATES IN INTERNET TAX CASE

In 1992, the US Supreme Court ruled in Quill v. North Dakota, that states could not tax mail-order products delivered from other states through common carrier or the U.S. Postal Service. Internet retailers such as Amazon have used the ruling to avoid collecting state sales taxes. Because Congress has refused to pass legislation allowing states to collect sales taxes from internet retailers, many U.S. jurisdictions have been unable to collect sales taxes they are owed from online sales.

South Dakota vs. Wayfair Inc., which will be orally argued before the Supreme Court in April, was filed after that state passed a law seeking to collect the sales tax from online retailers. The U.S. Department of Justice (DOJ) has filed a brief in the U.S. Supreme Court supporting state efforts to collect internet sales taxes. The DOJ argues that “In light of internet retailers’ pervasive and continuous virtual presence in the states where their websites are accessible, the states have ample authority to require those retailers to collect state sales taxes owed by their customers. Quill Corp. v. North Dakota should not be read to bar that result, both because the Quill Court did not and could not anticipate the development of modern e-commerce, and because Quill’s analysis was deeply flawed.”

Quill allows states to collect sales taxes only from businesses that have a physical presence in their jurisdictions. DOJ argues further that “the nature of an internet retailer’s presence in the states where its website is accessible is different in kind from any type of ‘presence’ that the court could have anticipated…. And given the proliferation of such retailers, imposition of a physical-presence requirement would substantially impede state tax collection and…distort retailers’ choices of appropriate business models.

DOJ now joins 35 states which have filed friend of the court briefs in the case supporting South Dakota’s effort.

Muni Credit News Week of March 12, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$1,000,920,000

New York City Transitional Finance Authority (TFA)

Building Aid Revenue Bonds

Educational projects in New York City’s education capital plan, including new construction, building additions, and rehabilitations, are eligible for state building aid. The State Education Department (SED) determines the amount of confirmed building aid payable annually by applying a building aid ratio to the amount of aidable debt service for the year. These funds are pledged to the payment of debt service on the bonds. The state aid intercept provision of Section 99-B of the School Finance Law is available to these bonds.

Each year the state annually appropriates money to New York City to pay for educational needs of the city’s students. A portion of this aid constitutes the state building aid. The state does not distinguish between the payment of education aid and building aid, making lump sum payments to the city. To secure the bonds and separate building aid from the rest of the education aid, the city, TFA, SED and the state comptroller entered into an MOU specifying procedures to determine the amount included in each general education aid payment that is attributable to state building aid. Prior to each general education aid payment, the TFA is required to calculate and certify to the SED, the comptroller and the state budget director the amount of the building aid payment payable to the TFA..

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THE JANUS CASE WON’T INSURE LABOR PIECE – MAYBE THE OPPOSITE

For years, vocal observers have blamed public employee salary and pension costs on unions and the collective bargaining process. Those who hold that view have placed their hopes on a decision in favor of the plaintiff in the recently argued Janus case in the US Supreme Court. Such a decision would be seen by proponents as the last nail in the coffin of public sector employee unions and their ability to bargain effectively on behalf of their employees. It is viewed as potentially ushering in a more “rational” environment for the setting of public employee salaries and benefits.

Recent events in West Virginia may reveal a serious weakness in that view. The strike being conducted by the state’s school teachers is not being conducted in support of a standard collective borrowing process. After all, West Virginia is not a collective bargaining state for its public employees. The current job action is not being led or sponsored by the teachers’ union. Costs to striking teachers are being funded through The WV Teachers Strike Support Fund, an independently created and funded organization. As of early last week, the Fund had a GoFundMe page for the striking workers which had garnered more than $218,000 by midday Monday.

The Fund had reviewed 174 requests and approved more than $71,000 — to teachers and school service personnel to cover strike costs, child care, medical bills, lost pay for aides and substitutes, re-stocking food pantries, and other efforts to support children and families during the strike. Those teachers were apparently having some success. The WV House approved a 5% raise suggested by the Governor and the Senate approved a 4% raise. The $13 million difference between the two levels of raise is the gap to be bridged in order to end the strike.

The ability of the teachers to achieve a raise outside of the typical collective borrowing process could be seen as a template for future job actions by public employees in other jurisdictions which have or hope to curtail union bargaining rights. The ability of employees to use technology and the internet to raise funds could ultimately mitigate the restrictions on union abilities to raise funds through the mandatory “dues check off”.

COAL CONTINUES LONG TERM DECLINE

For states like West Virginia and Wyoming, the handwriting is on the wall for their major commodity industry – coal. The U.S. Energy Information Administration (EIA) expects the share of U.S. total utility-scale electricity generation from natural gas-fired power plants to rise from 32% in 2017 to 33% in 2018 and to 34% in 2019. The forecast generation share from coal in 2018 averages 30%, about the same as in 2017, but then falls to 29% in 2019. The nuclear share of generation was 20% in 2017 and is forecast to average 20% in 2018 and 19% in 2019. Nonhydropower renewables provided slightly less than 10% of electricity generation in 2017 and is expected to provide about 10% in both 2018 and 2019. The generation share of hydropower was almost 8% in 2017 and is forecast to be about 7% in both 2018 and 2019.

Wind generated an estimated 691,000 megawatthours per day (MWh/d) of electricity in 2017. EIA projects that generation from wind will rise to an average of 705,000 MWh/d in 2018 and 765,000 MWh/d in 2019. If project conditions hold, generation from conventional hydropower is projected to average 730,000 MWh/d in 2019, which would make it the first year that wind generation exceeds hydropower generation. EIA projects that total solar electricity generation will increase from an estimated average of 209,000 MWh/d in 2017 to 240,000 MWh/d in 2018 and to 287,000 MWh/d in 2019.

It is clear that the forces working against employment in the coal industry continue. Much of Wyoming’s supply is mechanically surface stripped while underground mines continue to increase the use of automation to extract the mineral. Combined with steadily decreasing demand from the power generation industry, the outlook for mining employment remains grim. It is anticipated that energy firms will retire coal-fired power plants that account for 20 gigawatts of power, about 10 percent of the total amount of U.S. coal capacity.

This will continue pressure on West Virginia’s economy and fiscal outlook.

GUAM UNDER THE GUN

S&P Global Ratings has placed its ‘BB-‘ rating on the Government of Guam’s general obligation (GO) debt and its ‘B+’ rating on the government’s various certificates of participation (COPs) on CreditWatch with negative implications. S&P cited the government’s disclosure that its cash flow will be extremely constrained over the next several months, and perhaps even longer, and also reflects its view that the government’s ability to meet its ongoing obligations could be impaired. The fiscal stress is due to an estimated $67 million decrease in general fund revenue for fiscal 2018 due to the effect of The Tax Cuts and Jobs Act of 2017, signed into law by President Trump on Dec. 22, 2017.

The government’s total general fund balance was negative $106 million as of audited fiscal 2016 (ended Sept. 30), equal to negative 14% of expenditures, with the unreserved or unassigned portion growing for a third-consecutive year to negative $215

million. Audited financial statements for fiscal year-end (Sept. 30) 2017 are not yet available. S&P is looking for evidence from Guam officials addressing a history of structural imbalance in its general fund, including recurring deficits, a very large negative general fund balance, and massive long-term liabilities.

NYC IBO REVIEWS NYC BUDGET PROPOSAL

Based on the Independent Budget Office’s (IBO) reestimates of city spending and revenues, the budget for 2018 is projected to be $88.3 billion rising to $89.3 billion in 2019 (all years are fiscal years unless otherwise noted). Based on its analysis, the budgets for both years are not only balanced, but are projected to end with surpluses. IBO’s estimates yield smaller budget gaps in 2020 and 2021 than those estimated by the Mayor, while in 2022 it estimates a surplus.

What are the risks? The Governor’s current budget assumes millions of dollars less for the city than the Mayor estimates in his current financial plan. If these changes were to be adopted, the city would have to find ways to make up for these lost funds, either through reduced services or by finding other funding sources, most likely from the city itself. IBO, following the Office of Management and Budget (OMB), has assumed that the city will drop some links to the federal tax system so as to avoid impacts on the city’s own revenues, but these steps would still leave many high-income city residents facing major changes in their federal taxes.

IBO has raised its forecast of near-term U.S. economic growth. It projects an acceleration of real growth to 2.9 percent in 2018, and somewhat slower growth of 2.6 percent in 2019. New York City’s economy added 67,000 jobs in 2017—an impressive ninth consecutive year of employment growth. But the pace of employment growth—1.5 percent— was slowest since the recession. IBO forecasts continuing but diminishing employment gains in the city, from 62,400 in 2018 and 50,000 in 2019 declining to 36,900 by 2022. The bright spots for city employment growth in 2017 were health care services (+22,700), accommodation and food services (+12,800), construction (+10,000), and finance and insurance (+9,500). The latter includes an increase of 7,500 jobs in the securities sector.

Tax revenues, which are projected to grow by 6.8 percent from 2017 to 2018 account for much of the growth in total revenue. The city’s total own source revenue—excluding state, federal, and other grants—is projected to grow by 5.1 percent. For 2019, IBO anticipates a smaller gain of 1.2 percent in total revenue to $89.3 billion, pulled down by declines in city revenue from miscellaneous sources and federal grants. Tax revenue growth is expected to outpace total revenue growth with $60.2 billion in tax revenues projected for 2019, a $2.2 billion (3.8 percent) increase over the forecast for the current year. The city’s own non-tax revenues (primarily fees, fines, and sales) are projected to fall by 3.7 percent from 2018 to 2019, to $6.7 billion.

Noncity revenues in 2019 are expected to be 4.7 percent lower than in 2018, largely the result of an anticipated decrease in federal grants, which are expected to shrink by 13.8 percent. Much of the drop is due to the winding down of Sandy-related recovery aid. Annual growth of total revenue will average 3.2 percent over the last three years of the financial plan period, driven by city tax revenues growing at an average annual rate of 4.1 percent over that period, with other city revenues nearly flat (0.2 percent). Growth in noncity revenue sources is projected to average 1.1 percent annually in 2020 through 2022.

The real question for investors relates to the City’s ability to service its debt. Over the last five years the city has paid an average of $5.8 billion annually through its operating budget to service its outstanding debt, which as of June 30, 2017 totaled $86.3 billion. The preliminary budget assumes that over the next five years debt service will rise from $7.1 billion in 2019 to $8.8 billion in 2022 and cost the city an average of $7.6 billion annually. New debt the city expects to issue from 2018 through 2022 is the main driver of increases in debt service over the plan period. While higher interest rate assumptions also account for some of the increase, most of the growth is primarily the product of the city’s aggressive plan to sharply increase capital expenditures over the next few years.

IS LOUISIANA THE NEXT KANSAS?

The Louisiana Legislature gave up on addressing the state’s budget crisis on March 5 and adjourned two days before their special session was scheduled to end. The legislators left Baton Rouge without any solution to an expected budget of $994 million. The regular session of the legislature, when lawmakers write the budget that goes into effect July 1, starts next week. It’s not yet clear what services will be prioritized for funding.

Many fear that targets will leave college students, people with disabilities, hospitals, district attorneys and local sheriffs with more uncertainty about the future of their state funding. The focus is on cuts because tax bills cannot be taken up during the regular session, which opens March 12 and is supposed to end by June 4. To get around that restriction, the Governor, House Speaker, and Senate president favor adjourning the regular session 10 to 20 days early to hold another special session to raise taxes before June.

The current stalemate is about politics. The House rejected a sales tax hike for a second time in one week. Both parties appeared to be in agreement that a sales tax hike and change in state income tax deductions should be approved. But House members could not agree on the order in which those two bills should be voted upon Sunday night. The parties were concerned that if the other side got their preferred tax bill approved and out of the House, that the other group would then block the second tax bill from moving forward.

The situation is also complicated by the compromise struck in 2016 when over $1 billion worth of temporary taxes in 2016 were passed. Those taxes expire June 30, creating the current looming financial problems. At the root of all of it is the failed supply side experiment undertaken by prior Governor Bobby Jindal. In an effort to raise his national profile he convinced the state that massive tax cuts, primarily for corporations in the state would stimulate so much economic activity that the lost tax revenues would be replaced. Like so many other state supply side experiments, these results failed to come to pass.

The result is a negative rating outlook for the State and a high degree of uncertainty for bond holders.

TaaS AND HEALTHCARE

Much has been made about the potential impacts of the ride share industry on public transit and the perception of the industry to positively impact transit and related outcomes. the implication is that the benefits are so clear that existing transit models are doomed with associated negative impacts on transit related municipal bond credits. The idea has gained currency with the latest announcement that Uber is teaming up with health care organizations to provide transportation for patients going to and from medical appointments. The rides can be scheduled for patients through doctor’s offices, by receptionists or other staffers. And they can be booked for immediate pickup or up to 30 days in advance.

Uber Health will send its passengers’ ride information through an SMS text message. The company also plans to introduce the option for passengers to receive a call with trip details to their landline instead. Sounds like a no brainer, especially in addressing the needs of older, lower income patients who might not have current access to current technology communication devices.

Reality, may be different. JAMA Intern Medicine earlier this month published the results of a study conducted in Philadelphia as to the relative efficacy of ride sharing services relative to reliance on existing forms of transit to get patients to doctor appointments. The study asked what is the association between offering rideshare-based transportation services and missed appointment rates for primary care patients? The finding was that the missed appointment rate was not significantly different between patients offered rideshare-based transportation services compared with controls.

Transportation barriers contribute to missed primary care appointments for patients with Medicaid. Rideshare services have been proposed as alternatives to nonemergency medical transportation programs because of convenience and lower costs. 786 Medicaid beneficiaries who resided in West Philadelphia and were established primary care patients at 1 of 2 academic internal medicine practices located within the same building were included.

Patients assigned to both arms received up to 3 additional appointment reminder phone calls from research staff 2 days before their scheduled appointment. During these calls, patients in the intervention arm were offered a complimentary ridesharing service. Research staff prescheduled rides for those interested in the service. After their appointment, patients phoned research staff to initiate a return trip home.

The uptake of ridesharing was low and did not decrease missed primary care appointments. This does not mean that the idea is without merit. Rather it means that further study is warranted before the death of mass transit is prematurely declared. It also means that TaaS may not be as meaningful an impact on the healthcare delivery model as may be thought. We believe that current trends towards consolidation, scale, and diversity of entrance points will continue to be the drivers of healthcare credits. Technology will have much to offer the industry but transportation will not have the short term impact on credit that some advocates believe.

Muni Credit News Week of March 5, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$1,208,855,000

THE OKLAHOMA DEVELOPMENT

FINANCE AUTHORITY

Health System Revenue Bonds

(OU Medicine Project)

Moody’s: Baa3 S&P: BB+

OU Medicine, Inc. is the owner and operator of the health system previously known as OU Medical System. OU Medicine is a system of three acute care hospitals, an ambulatory surgery center and operates 22 other related clinics and other access points, composed of: OU Medical Center in Oklahoma City, Oklahoma, OU Medical Center Edmond in Edmond, Oklahoma and the Children’s Hospital in Oklahoma City. The hospitals serve as teaching and training facilities for students enrolled at the University of Oklahoma Health Sciences Center.

OU Medicine has a strong market position as a high acuity provider in Oklahoma. It’s close affiliations with and ties to University of Oklahoma entities and unique ties to the State through The University Hospitals Authority and Trust facilitates steady supplemental reimbursement payments. This helps to generate very good cashflow margins. The recent acquisition of for-profit HCA’s joint venture interest has created a more leveraged credit contributing to the split investment noninvestment grade ratings. Management of the transition to an independent not-for-profit health system is an important ratings consideration.. The rating is constrained by high pro forma leverage following the buyout of for-profit HCA’s joint venture interest, a very competitive market, modest initial liquidity, and high Medicaid and self-pay.

Children’s facilities tend to have very high Medicaid exposure and cash positions are often reflective of this factor offset by their unique abilities to raise funds through donations. Security for the bonds includes unrestricted receivables and a mortgage on certain property (including OU Medical Center and OU Medical Center Edmond). The MTI allows for a replacement master indenture if certain financial tests are met.

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KENTUCKY PENSION PROPOSAL

If the Kentucky legislature and the Governor get there way, future employees of the commonwealth will no longer have guaranteed pension benefits. A proposed bill filed by four legislators would Amend KRS 6.505 to provide that the “inviolable contract” provisions shall not apply to legislative changes to the Commonwealth’s employee Retirement Plans that become effective on or after July 1, 2018. The bill reflects the view that historic underfunding of the Commonwealth’s pension funds can only be addressed by cutting benefits and not through the increase of any taxes to generate revenues to fund Kentucky’s substantial unfunded pension liabilities.

The bill would also create a new section of KRS 61.510 to 61.705 to establish an optional 401(a) money purchase plan for new nonhazardous members who begin participating in the Kentucky Employees Retirement System (KERS) and County Employees Retirement System (CERS) on or after January 1, 2019, who elect to participate in the plan; provide that the optional money plan that will operate as another benefit tier in KERS/CERS and will include a 4% employer contribution.

The bill was introduced after significant outside pressure was brought to bear. That campaign included a one-page letter, apparently emailed to all members of the General Assembly, which said any pension changes made during the 2018 legislative session must include “moving all future employees from a defined-benefits system to a defined-contribution system.” The letter was driven by conservative think tanks and the notorious tax agitator Grover Norquist. Norquist is behind the “starve the beast” movement which seeks to significantly eliminate public sector spending.

Kentucky’s pension systems have lost more than $7 billion in value over the past 10 years through below average investment performance. The legislation would reduce cost of living adjustments (COLAs), adjust the minimum retirement age, and shift some of the costs of pensions to localities and school districts. The plan would shift more financial pressure to localities while only slowly addressing the state pension burden.

At the same time, the bill would seemingly reduce transparency regarding the pension funds’ funding and investment results. Specifically, it would provide that the Public Pension Oversight Board’s hiring of an actuary to perform a review of state-retirement system rates is voluntary.

Employees and their supporters have opposed the bill on the basis of the ideological stance of the organizations from outside the Commonwealth who are advising the Governor. The primary group – Save Our Pensions – operates outside the jurisdiction of both the Kentucky Registry of Election Finance and the Legislative Branch Ethics Commission. Since it is not advertising on behalf of a candidate, it doesn’t have to register with the state’s election finance branch. And since it isn’t lobbying legislators directly on the pension issue, it doesn’t have to register with the legislative ethics commission.

Registered as a 501(c)(4) tax-exempt social welfare group with the IRS, the group also doesn’t have to publicly disclose its donors.

The approach to pensions extends the Governor’s well established ideological approach to the Commonwealth’s overall finances including his stance on taxes, Medicaid and now, pensions.

EMPLOYEES IN WEST VIRGINIA WIN TENTATIVE RAISE

Early in the week, the US Supreme Court heard oral arguments in what is known as the Janus Case. The case was brought by an individual state employee in Illinois, backed by anti-union groups, who seeks to strip unions of their right to collect dues from all employees on whose behalf it negotiates with employers. It is widely expected that the court will rule against unions.

Ironically, in nearby West Virginia, unionized teachers in the state’s public school systems won the Governor’s support for a 5% raise for themselves after a four day strike. At the same time, all other state employees would receive a 3% raise. The proposal must now be approved by the state legislature. West Virginia law does not recognize a right for public school employees to collectively bargain. Rather, the legislature regulates public school labor by statute.

For the teachers, the legislature has been much less supportive. As we go to press, teachers will have been on strike for seven days and they appear to be dug in. The state’s teacher’s salaries were ranked 48th in the nation in 2016. The dispute comes amidst calls for teachers to become security guards, rising health costs, and a diminished state economy that makes West Virginia a more difficult place to attract teachers to.

KENTUCKY CONSIDERS GAS TAX INCREASE

While Washington dithers over whether to pass an infrastructure plan, how to fund the Highway Trust Fund, and the question of raising taxes to do it, the states continue to move forward with consideration of revenue raising proposals. The latest is in the Kentucky legislature. Like many states, transportation needs are pressing and underfunded and the feeling is that states cannot wait for the federal government to get its act together.

A bipartisan proposal in the Kentucky legislature would raise the gas tax and impose annual fees on hybrid and electric vehicles in an attempt to replenish the state’s stagnant road fund. Kentucky faces a backlog of over $1 billion in road paving projects. This does not include some 1,000 bridges that require repair or replacement. At the same time, the Commonwealth’s road fund to finance repair and replacement projects has not increased since 2014.

A study committee was formed in the summer of 2017 by the then Speaker of the Kentucky House. The results of that study led to House Bill 609 . The bill would add an extra $391 million a year to the state’s road fund. It would do so by setting the average wholesale floor price at $2.90; increase the supplemental tax on gasoline and special fuels by increasing the existing rate from five cents per gallon (cpg) on gasoline and two cpg on special fuels to eight and a half cpg for both and setting that as the minimum rate. It would establish a base fee for hybrid vehicles, hybrid electric plug-in vehicles, and nonhybrid electric vehicles and require the fee to be adjusted with any increase or decrease in the gasoline tax established. It would also increase a variety of motor vehicle fees as part of the overall program.

WHAT TARIFFS WOULD MEAN FOR CREDIT

Trade wars usually do not end well. So we greet the news that the President appears to have been convinced that steel and aluminum tariffs will be good for workers in those industries is dismaying. We see no evidence that employment will be increased in those industries as the result of higher cost US steel and aluminum. The fact is that direct employment in the steel industry is 140,000. While those workers may benefit, workers in manufacturing industries like autos and appliances will be hurt. Construction may become more expensive so employment will be hurt there.

On the other side of the trade, export businesses like agriculture, commodities, energy and technology will all potentially face reduced demand. If you are a wheat farmer in Kansas, you are now facing a wheat farmer in Canada whose country is in the TPP. Airplane manufacturers will lose to Canadian and European producers. So take the strip roughly between Idaho and Minnesota in the north right on down the front range of the Rockies and along the Mississippi and ask where will they sell their commodities?

Now if you are a manufacturer what do you do? Three years ago, Ford Motor gambled when it started selling a new version of its F-150 pickup truck made mainly of aluminum rather than steel. With lower gas prices, fuel economy is no longer a persuasive factor for many truck buyers. While sales are brisk, F-Series trucks — including the F-150 and the brawnier Super Duty — have only slightly increased their share of the full-size pickup truck segment since the aluminum models arrived and share is actually lower than it was in 2013.

In 2017, the company’s income in North America fell 17 percent, in part because of rising steel and aluminum prices. Aluminum prices have risen more than 20 percent in the last three years. New-vehicle sales in the United States are expected to decline this year and next anyway. Now they will be more expensive. And competitors are introducing different materials. For example, G.M. unveiled a GMC Sierra available with a bed of carbon-fiber composite.

The point is about more than the auto industry. The development in materials choices, costs of fuel, introduction of artificial intelligence are all factors impacting employment way beyond the cost of Chinese steel and aluminum. The inflationary aspects of tariffs are more wide ranging and negative for municipal credits than the cost of any one commodity. Lower corporate profits from higher costs and lower sales impact all states. They impact local employment and tax revenues.

It also has not taken long for there to be impacts. Electrolux, a foreign appliance manufacturer which sources all of its materials from US producers for use at plants in the US, announced that anticipated higher steel and aluminum prices would lead them to delay construction of a $250 million production facility in Tennessee. Sales, income, and property tax revenues plus jobs will be delayed as well.

WHERE ARE THE STEEL MILLS AND ALUMINUM SMELTERS IN THE US?

Michigan, Indiana, Ohio, Pennsylvania, Alabama, Colorado, Delaware, Mississippi, South Carolina. These include huge integrated mills as well as specialty mini-mills. In addition to jobs and sales of raw materials, many of these facilities are huge consumers of electric power. Primary aluminum smelters – huge consumers of electricity – are located in New York, Washington, South Carolina, Kentucky. So for the short term these facilities will get some breathing room.

WHICH STATES EXPORT?

Should there be widespread retaliation for the imposition of tariffs, it is useful to know which states have the most to lose in terms of their exporting volume. The five largest exporting states in terms of dollar value of the goods they ship are Texas, California, Washington, New York, and Illinois. This reflects significant manufacturing bases in these states as well as substantial agricultural sectors. Ohio, Louisiana, Michigan, and Florida are also major exporters.

Muni Credit News Week of February 26, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$652,855,000

Black Belt Energy Gas District (AL) Gas Prepay Revenue Bonds (Project No. 3), Series 2018

Moody’s: A3

In the last decade while natural gas prices were fluctuating, prepaid natural gas purchase transactions financed through the issuance of municipal bonds were a popular financing technique. The benefit to the issuers was simple. a supply of gas was secured at a fixed and acceptable to the issuer price. These transactions, complex by their nature due to the number of various participants in the transactions, often benefitted from the credit rating of the guarantor of the payments due under the Prepaid Natural Gas h natural gas markets primarily as commodity traders and suppliers.

As the economics of the natural gas market changed and the financial crisis negatively impacted the credit ratings of the financial institution participants weakened, the attractiveness of the transactions diminished. The declines in ratings impacted ongoing market values of the bonds, raised concerns among investors about their credit worthiness, and in some cases led to defaults and restructurings. Overall, the technique lost favor.

In the current environment, with ratings more stable and more favorable natural gas economics these transactions are making a comeback. This week’s highlighted issue is one such transaction.

Moody’s assigned an A3 rating to this issue. The list of participants explains the level of complexity in the deal. The rating reflects (i) the credit quality of Goldman Sachs Group, Inc. (Goldman) (A3 stable) as guarantor for payments due under the Prepaid Natural Gas Sales Agreement (GPA), the back-end commodity swap and the Receivables Purchase Agreement (RPA); (ii) the credit quality of City of Tallahassee electric enterprise (Aa3 stable), Greenville Utilities Commission, NC (Aa2 stable), Omaha Metropolitan Utilities District, NE gas enterprise (Aa2 stable), and Okaloosa Gas District, FL (A1 stable) (collectively, the Municipal Participants); (iii) the credit quality of the providers of the guaranteed investment contracts (GICs) provided for the debt service account, debt service reserve account and the working capital account; and (iv) the structure and mechanics of the transaction which provide for the payment of debt service consistent with the rating assigned to the Bonds.

How does the transaction work? Bond proceeds will be used by the Issuer to prepay J. Aron (the Gas Supplier) for the delivery of a specified quantity of natural gas to be delivered on a daily basis over a 30 year period. The Issuer will sell gas acquired under the GPA to the Municipal Participants listed above as well as to Clarke-Mobile Counties Gas District, AL (Clarke-Mobile), pursuant to Gas Supply Agreements. Pursuant to the GPA between the Gas Supplier and the Issuer, the Gas Supplier agrees to deliver to the Issuer natural gas in quantities specified in the agreement. The Issuer will in turn sell daily quantities, billed on a monthly basis, of delivered natural gas to the Municipal Participants and Clarke-Mobile pursuant to Gas Supply Agreements. The Contract Price which the Municipal Participants and Clarke-Mobile pay will be based upon a first-of-the-month index price per MMBtu (the Index Price), less a specified discount. Payments for gas delivered will be due on the 22nd of each month. The payments to be received from the Municipal Participants and Clarke-Mobile, plus or minus net payments made or received by the Issuer on the commodity swap described below, combined with interest earned on the debt service account will be sufficient to make the fixed payments owed to Bondholders.

Should any of the Municipal Participants and/ or Clarke-Mobile fail to make a payment for delivered gas, the Trustee will (i) draw on the working capital account in order to make payments to the Commodity Swap Counterparty and (ii) if necessary, draw on the DSRA if there is a deficiency in the debt service account. Risk of non-payment by a Municipal Participant is reflected in their ratings which are incorporated into the rating of the Bonds. In the event of a nonpayment by Clarke-Mobile, if the trustee determines that the balance in the DSRA and/or the balance in the working capital account is less than the minimum requirement and sufficient funds will not be available to pay P&I on the Bonds immediately prior to the final maturity date or a mandatory redemption date, the trustee shall deliver a put option notice under the RPA . Upon receipt of such notice, J. Aron shall purchase such receivables. Therefore, risk of non-payment by Clarke-Mobile is covered by Goldman as guarantor under the RPA.

Since the revenue received from gas sales to the Municipal Participants and Clarke-Mobile is variable and the payment owed to Bondholders is fixed, the Issuer will enter into a commodity swap (the Commodity Swap) with Royal Bank of Canada Europe Limited (the Commodity Swap Counterparty), which will result in the Issuer receiving fixed payments while paying the Index Price to the Commodity Swap Counterparty, on a net basis. In order to address the risk that a nonpayment by the Commodity Swap Counterparty under the Commodity Swap could lead to an insufficiency in the payment due to the Bondholders or result in an early termination event under the GPA and a redemption of the Bonds, all payments to be made by J. Aron under the Back-End Commodity Swap are deposited monthly with a custodian under a custodial agreement. If the Commodity Swap Counterparty fails to make a required payment under the Commodity Swap, the custodian is required under the terms of the custodial agreement to deliver to the Trustee the funds provided by J. Aron on the Back-End Commodity Swap, which funds will be applied by the Trustee in the same manner as payments made by the Commodity Swap Counterparty. In addition, should any termination of the Back-End Commodity Swap occur, J. Aron will continue to make payments to the custodian until the earlier of (i) termination of the GPA and (ii) replacement of both the Commodity Swap and the Back-End Commodity Swap.

If we haven’t lost you by now, it is pretty clear that these bonds are very difficult for the average individual investor to track and value. It has long been our view that these bonds are fraught with risk for an individual investor and that this point was clearly made during the financial crisis. Although those events were hopefully unique and of much lower probability, we still believe that bond issues with this many moving parts and sources of risk are not appropriate for individuals.

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EARLY RESULTS FOR VIRGINIA TOLLING PROJECT

A recent state study shows that Interstate 66 tolls for solo drivers in Virginia and expanded HOV hours have not slowed traffic on most major parallel routes during the morning rush hour. Whenever a toll facility opens, there is concern that drivers seeking to avoid the higher cost may switch to nearby free alternative routes resulting in higher volumes on those secondary routes and new bottlenecks replacing the old ones.

The analysis — which found the average daily toll paid in January was $12.37 — also showed that even an increased number of cars on some roads like U.S. Route 50 did not significantly change travel times in January, compared with the same time a year earlier. Speeds on parallel routes, such as U.S. 50, U.S. Route 29 and Virginia Route 7, are largely unchanged from a year ago.

The occasional spikes in tolls to high levels have created eye catching headlines and photos around the country. The State’s spin on the occasional very high toll ($40+) is that “what it’s really telling you is don’t get on, because it means the road is getting congested, this is not where you want to go.” A trip on the George Washington Parkway at 6 a.m. takes largely the same amount of time as the ride on I-66 at that time before tolling began because the highway would become clogged with drivers trying to get to work before the HOV restrictions began at 6:30 a.m.

Some 13,000 drivers are using the road eastbound each morning, and more than 15,000 drivers are using the road westbound each afternoon. Forty-three percent of the trips were vehicles with an E-ZPass Flex switched to HOV mode to indicate that they have at least one other person in the car. Forty-four percent of drivers paid the toll with an E-ZPass. The average morning toll paid in January was $8.07, while the average afternoon toll paid was $4.30. When analyzing only those drivers who paid to use the entire corridor from the Beltway to Rosslyn each way, the average round trip price was $18.06.

As for the extreme toll levels occasionally experienced, In January, 461 drivers paid $40 or more.

CALPERS ADJUSTS DISCOUNT RATE

After much criticism of its investment discount assumptions, CALPERS has decided to lower its assumed annual rate of return on its investment portfolio from 7.5% to 7%. The impact of this decision is to raise the level of contribution expected from the municipalities and their employees to fund their share of the costs of municipal employee pensions. This will increase the expense pressures facing cities across the Golden State.

The long awaited change will generate more conversation about the funding of pensions in the state and give more momentum to efforts to litigate, negotiate, and vote changes in the pension benefits available to current and future municipal employees.

CALPERS cited a number of benefits associated with reducing the discount rate. They include: strengthening long-term sustainability of the fund; reducing negative cash flows; the fact that additional contributions will help to offset the cost to pay pensions; a reduction in the long-term probability of funded ratios falling below undesirable levels; an improved likelihood of CalPERS investments earning its assumed rate of return; and a reduction in the risk of contribution increases in the future from volatile investment.

CALPERS provided a hypothetical example of the impact on a municipality. A miscellaneous plan with a current normal cost of 15% of payroll can expect an increase to 15.25 % to 15.75 percent of payroll in the first year (Fiscal Year 2018-19), and 16 % to 18 % in the fifth year (Fiscal Year 2022-23). For the UAL payment, a plan with a projected payment of $500,000 in Fiscal Year 2018-19 and $600,000 in Fiscal Year 2022-23 can expect the revised payment to be $510,000 – $515,000 ($500,000×2.00%/$500,000×3.00%) for Fiscal Year 2018-19, and $720,000 – $750,000 ($600,000×20%/$600,000×25%) for Fiscal Year 2022-23. These estimated increases incorporate both the impact of the discount rate change and the ramp up.

Obviously, each city will experience different impacts based on the level of benefits promised and the salaries they provide. This is especially true where municipalities have made significant expense increases related to public safety. In California, there has been somewhat of an arms race among cities seeking to generate economic development through a concerted effort to reduce crime. At the same time demographic trends have been unfavorable. According to CalPERS, there were two active workers for every retiree in its system in 2001. Today, there are 1.3 workers for each retiree. In the next 10 or 20 years, there will be as few as 0.6 workers for each retiree collecting a pension.

In addition to lowering its discount rate, CALPERS also has decided to shorten the amortization period to 20 from 30 years for all investment gains and losses. This will lead to a rise in contribution requirements from participating municipalities. Some cities support the change because they believe it is prudent to shore up the fund and pay down the unfunded accrued liability faster instead of pushing the financial burden to future employees, employers and taxpayers. Other more economically challenged cities are worried that that reducing the amortization schedule will increase their employer contribution rates even beyond what they can afford.

In response, multiple pieces of state legislation have been proposed. Senate Bill 1031 would allow public employers to freeze cost of living adjustments for retirees if the pension fund isn’t 80% funded. SB 1032 would make it easier for local governments to exit CalPERS without paying termination fees. These fees have been cited as a significant hurdle to those cities which would prefer (wisely or not) to manage their own plans. SB 1033, would shift the burden of increased pension costs to the last city that hired an employee.

This would primarily effect cities which like to hire trained police officers from larger municipalities in lieu of financing the cost of training themselves. This is a phenomenon seen often in suburbs across the country which run their own local forces but do not have or wish to expend local resources on training. They tend to offer higher salaries since they have not had to absorb training costs.

How big is the problem? The California League of Cities released a study in January that looked at the situation. It confirmed much of what CALPERS has told its member cities. It found that rising pension costs will require cities over the next seven years to nearly double the percentage of their General Fund dollars they pay to CalPERS. Between FY 2018–19 and FY 2024–25, cities’ dollar contributions will increase by more than 50 percent. For example, if a city is required to pay $5 million in FY 2018–19, the League expects that it will pay more than $7.5 million in FY 2024–25. In FY 2024–25, half of cities are anticipated to pay over 30.8 percent of their payroll towards miscellaneous employee pension costs, with 25 percent of cities anticipated to pay over 37.7 percent of payroll. This means that for every $100 in pensionable wages (generally base salary), the majority of cities would pay an additional $31 or more to CalPERS for pensions alone.

For “mature cities” with larger numbers of retirees, the percentages are even higher. Half of those cities are anticipated to pay 37.9 percent or more of payroll and 25 percent are anticipated to pay 42.9 percent or more of payroll. These findings are not specific to one region of the state. The data shows that cities throughout California are dealing with these challenges. Contributions are projected to be much higher for cities that employ safety personnel (police officers and firefighters). By FY 2024–25, a majority of these cities are anticipated to pay 54 % or more of payroll, with 25 % of cities anticipated to pay over 63.8 % of payroll. In other words, for every $100 in salary, the majority of cities would pay an additional $54 or more to CalPERS for pensions alone. For FY 2024–25, the average projected contribution rate as a percentage of payroll is 34.6 percent for miscellaneous employees and 60.2 percent for safety employees. For cities with a large percentage of retirees, the averages are 39.4 percent and 67.5 percent.

The California pension problem reflects not just its size and scale but also the State’s legal requirements governing spending. Under the California Constitution, a city’s options for revenue raising are strictly limited. Any increase in local taxes requires voter approval and voter tolerance for tax increases is waning. Much of a city’s budget is dedicated to employee salaries and benefits to provide fire protection, law enforcement, parks services and other municipal services. If new revenues are unavailable, as contributions rise, local agencies are forced to significantly reduce or eliminate critical programs. Pressure will continue to impact local California credits.

ANOTHER HEALTH SYSTEM MERGER

Bon Secours Health System (A2/A), an East Coast based Catholic health system and Mercy Health, a Catholic health ministry serving Ohio and Kentucky, announced their intent to merge, creating one of the largest health systems in the country spanning seven states in the eastern half of the U.S. The merger creates the fifth largest Catholic health system in the country.

The merged entity creates one of the top 20 health systems in the nation and the fifth largest Catholic health system with $8 billion in Net Operating Revenue and $293 million in operating income. Together they employ 57,000 associates and more than 2,100 employed physicians and advanced practice clinicians. Mercy Health provided care for patients more than 6.8 million times in 2017. The system included assets of $6.8 billion and nearly 500 care facilities including 23 hospitals and 26 post-acute care facilities including senior living communities, hospice programs and home health agencies. Bon Secours owns, manages, or joint ventures 20 hospitals and 27 post-acute care facilities or agencies including skilled nursing facilities, home care and hospice services, and assisted living facilities.

Bon Secours has debt outstanding of $818.1 million. Mercy Health had total debt of $1.5 billion.

NYC COMPTROLLER REVIEWS FISCAL 2019 BUDGET PROPOSAL

New York City Comptroller Scott M. Stringer presented his analysis of the Mayor’s fiscal year (FY) 2019 Preliminary Budget and Financial Plan. Highlights include spending grows a modest 1.4% in FY 2019; spending is projected to accelerate to an average annual rate of 2.6% over the entire Plan period, fiscal years 2018 to 2022; revenues are projected to grow at an average 2.2% each year until FY 2022, resulting in budget gaps of $2.2 billion in FY 2020, $1.5 billion in FY 2021, and $1.7 billion in FY 2022; and the February Plan shows a $2.6 billion budget surplus in FY 2018, down nearly $1.6 billion from the $4.2 billion budget surplus of FY 2017.

The theme is not that the City’s finances are in current trouble. Rather, the Comptroller is concerned that any short-run stimulus effects of federal tax cuts and spending are likely to wear off quickly as the Federal Reserve and markets react to rising federal deficits and inflationary expectations. In addition, job growth in the City is expected to decelerate from an average of nearly 90,000 new jobs per year since the end of the Great Recession in 2010, to 22,700 in 2020, 15,900 in 2021, and 16,300 in 2022. He is concerned that spending trends under the deBlasio administration have reduced the City’s cushion against an economic downturn. he cites the City’s declining cash balances as an early warning signal, as they currently sit more than $2 billion below last year’s level, after falling to a low in December of $1 billion – the lowest point since 2010.

A number of spending categories are increasing not as the result of policy but of need especially in the area of housing and homelessness. The increased costs of housing across all income ranges continues to be a significant problem in the City. As a result, Citywide spending on homelessness across all agencies has more than doubled from $1.1 billion in FY 2013 to a projected $2.6 billion in FY 2019 and spending on shelters alone has nearly doubled since FY 2013 – from just over $1 billion to $1.9 billion dollars in FY 2019. In spite of claims by the administration that expanded low income housing is available, the number of individuals residing in shelters has steadily increased from 49,673 in 2013 to 61,029 as of February 2, 2018. One other expense area cited relates to the City’s well documented issues with its jail system. The average daily inmate population has declined by over 30 percent, from 13,850 in 2008 to 9,500 in 2017 but, over the same period, the average annual cost of housing an inmate on Rikers has more than doubled, from about $117,000 in 2008 to over $270,000 in 2017.

According to the Comptroller, the City’s reserves are currently insufficient, at just 9% of adjusted FY 2019 spending. The Comptroller says that the optimal range for the City’s reserve cushion is between 12% and 18% of spending. At the start of the last recession in 2009, the City’s budget cushion was equivalent to more than 17% of spending. The City’s accumulated FY 2018 surplus is over $1.5 billion less than at the start of the year.

Muni Credit News Week of February 19, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

LOS ANGELES UNIFIED SCHOOL DISTRICT

(County of Los Angeles, California)

$1,350,000,000

General Obligation Bonds,

(Dedicated Unlimited Ad Valorem

Property Tax Bonds)

Moody’s Aa2

The LAUSD is the nation’s second largest public school district. It has an an estimated enrollment for fiscal 2018 equal to 613,274, inclusive of 112,492 students enrolled in independent charter schools. It includes virtually all of the City of Los Angeles and all or significant portions of the cities of Bell, Carson, Cudahy, Gardena, Huntington Park, Lomita, Maywood, San Fernando, South Gate, Vernon, and West Hollywood, among other cities, in addition to considerable unincorporated territories devoted to both residential development and industry.

The general obligation bonds of the District are secured by an unlimited property tax pledge of all taxable property within the district boundaries. Debt service on the rated debt is secured by the district’s voter-approved unlimited property tax pledge. The county rather than the district will levy, collect, and disburse the district’s property taxes, including the portion constitutionally restricted to pay debt service on general obligation bonds.

Like many other older established urban districts, enrollment continues to decline. Nonetheless, the district faces significant capital needs if only to reduce overcrowding, eliminate multi-track calendars and reduce the number of portable classrooms from 10,000 to approximately 8,000. Going forward, capital projects will focus on modernization and repairs of aging schools coupled with addressing future needs for classroom capacity to support the district’s commitment to maintaining traditional school calendars and reducing the number of portable classrooms.

The district’s Aa2 rating is based on the perceived strength of district management and their demonstrated ability to guide the district’s finances through periods of revenue uncertainty, severe state budget challenges, and erosion in enrollment figures. While management has successfully addressed long-term fiscal challenges in the past, identified outyear budget gaps will require permanent, structural cost reductions to address budgetary imbalances and maintain current credit quality. The district has an exceptionally large and diverse tax base with steady growth expected over the medium term, but also must contend with the fact that its residents have a below-average socioeconomic profile. Improved state funding, including one-time revenues, has supported increases in the district’s general fund reserves and liquidity.

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TRUMP ENDORSES GAS TAX INCREASE

In a closed-door meeting on infrastructure with members of both parties, Trump pitched the idea of a 25-cent increase in the gas tax and dedicating that money to improve our roads, highways and bridges. The tax on diesel would be increased likewise.

Republican congressional leadership opposes such an increase while groups like the US Chamber of Commerce endorses it. An increase would be useful and would bolster efforts to reinfuse the depleted federal Highway trust Fund. At the same time, a real plan would provide some provisions for alternative funding to gas taxes in light of impending technological changes to the auto industry.

The U.S. Chamber says the proposal would raise $394 billion, more than enough to pay for Trump’s $200 billion infrastructure plan and possibly even expand it further. The idea however, highlights the hurdles facing any effort at raising revenues for infrastructure just on one side of the partisan equation. The oil funded Koch network, adamantly opposes any increase in the gas tax.

BANK LOAN DISCLOSURE MUST IMPROVE

Over the last decade, municipalities have increasingly turned to direct loan from banks as an alternative to the issuance of debt in the public markets. The municipal market has been debating for some time how much disclosure about the provisions included in bank loans should be required. he issues surrounding the loans include the potential adjustability of the interest rates and terms of the loans and the resulting impact on the respective positions of holders of existing bonded debt. these holders can, in the absence of disclosure about the loans, find themselves either in junior lien positions relative to the bank lenders or with much larger parity claims than they were led to believe existed.

The various players in the discussion have taken expected positions. Investors want more disclosure, issuers cite the costs of disclosing, and lenders seem to be opposed primarily for competitive reasons. The arguments have become tiresomely predictable. This discussion is being revisited and amplified with the news that many bank loan agreement “gross up” provisions are being triggered as the result of the recent changes in the tax laws.

Specifically, many of the underlying loan agreements between bank lenders and municipalities contain provisions which provide for increases to the interest rate on loans in the event of legal changes which are determined to have reduced the value of the loans. The corporate tax cuts are one such item. After the tax law lowered the rate on taxable income, the relative value of loans to municipalities was adversely impacted. In that event, the banks are entitled to raise the rates to “gross up” the total value of the loan asset. Many municipal borrowers are being informed of the new higher rates and are calculating the new higher cost of debt service on the borrowings from banks.

To the detriment of bond investments, there is no current requirement that municipal borrowers disclose the details of these loan documents or disclose the amount of increase in their associated debt service requirements. depending on the size of the loan, these increases may be substantial. Should they be disclosed, investors could make their own determination as to the resulting impact on an individual municipality’s ability to pay and on its projected budget results. this would enable the investor to make a more informed determination as to the market value of the bonds they own. Instead the details of the loans remain shrouded in mystery, leaving investors in the dark about debt service costs, lien positions, and other repayment terms competing with their interests as creditors.

So what can be done about this? As has been the case throughout the last four decades of municipal finance, the issue is unlikely to change until investors – especially those purchasing new issues in size – demand full disclosure of this information as a condition of purchase. Insist that this become a documented disclosure issue in official statements, bond reporting covenants, and reports issued to and posted on the NRMSRs. Until such pressure is applied on a consistent basis, the market will remain inefficient and slanted against the interests of investors.

GOVERNOR PROPOSES ILLINOIS BUDGET

As required under the Illinois Constitution, the Governor has submitted a state budget to the General Assembly for the upcoming fiscal year. The budget proposes reforms to save $1.6 billion to balance the fiscal year. An important assumption is that economic growth will foster revenue growth. The recommended budget, including all proposed structural reforms, achieves a surplus for fiscal year 2019. After two fiscal years without an enacted budget, fiscal year 2018 was marked by the General Assembly’s enactment of a full budget. The legislature overrode the Governor’s objection that their budget was built on the back of a $4.5 billion income tax increase, $6 billion in long-term debt, and a continuing backlog of unpaid bills expected to be $7.5 billion at the end of the fiscal year.

The Governor proposes that the General Assembly consider two positive options – apply the surplus towards the bill backlog to pay down current operating obligations or rollback 0.25 percent of the income tax rate for Illinois taxpayers starting in fiscal year 2019. By implementing the consideration model, Illinois could realize immediate relief in the form of a tax cut.

The Governor’s priorities are clear. Fiscal year 2019 marks a record level of funding for K-12 education and includes $6.834 million for the second year of evidence-based funding. It increases early childhood education funding 55 percent from 2015 levels, continues Monetary Award Program (MAP) grants for college students, and provides new capital funding for deferred maintenance and repair of university and community college facilities. There are increases in funding for police, corrections, and criminal justice. At the same time it leaves flat spending for children’s and family services, food for the elderly, and Medicaid.

So education, public safety, and tax reductions are the main priorities. Given the State’s difficulties in recent years in generating sufficient revenues, these priorities may be a loggerheads with each other. The budget also reflects the Governor’s generally antagonistic stance towards the state’s workforce.

On the capital side, the plan provides $2.2 billion in pay-as-you-go (non-bonded) funding for the Department of Transportation’s annual capital road program. On the labor and pension sides, the Governor proposes group health insurance program changes allowing employees options for different health insurance packages with varying levels of benefits and premium costs, reintroduces the Governor’s proposal for a consideration model that offers benefit options to retirement system participants of the State Employees’ Retirement System, the Teachers’ Retirement System and the State Universities Retirement System as a means to contain long-term pension costs, and begins the incremental shift of payment responsibility for the normal costs of pensions to the school districts and institutions that employ the participants in the Teachers’ Retirement System and the State Universities Retirement System.

The impact of these changes would be to shift insurance and pension costs from the state to employees and to lower levels of government and state institutions. In fiscal year 2019, universities, community colleges and school districts would begin to pick up 25 percent of the normal pension cost for their employees who participate in SURS and TRS. Then, over the next three fiscal years, they would pick up an additional 25 percent each fiscal year until they become fully responsible for the normal pension costs related to their employees. The total cost realignment in fiscal year 2019 would be $363 million. Currently, the state pays the retiree health insurance costs for all retirees of TRS and SURS. The fiscal year 2019 budget proposes no direct state funding for retiree health benefits for retirees of TRS and SURS.

Additional education funding is provided in fiscal year 2019 to help defray these realigned costs. This is meant to offset the increased costs to local school districts. In many districts the increased aid is less than the increase in costs. These would have negative impacts on the credits supported by taxes and revenues generated by those governments and institutions. In other words, tax increases and tuition rises.

At the same time, the state credit would continue to be impacted by the fact that the unfunded pension liability has reached $129 billion, and the annual pension contributions for fiscal year 2019 from general revenue will be $7.9 billion unless changes are enacted. The bill backlog hovers around $8.5 billion—down from $16.5 billion in November 2017, when the state borrowed $6 billion to pay it down. In the 20 years from 1996 to 2016, annual contributions to the five state pension funds grew more than ten-fold, from $614 million to $7.6 billion. While pension and health benefits constituted just 7.5 percent of the budget in 2000, they now take up 25 percent of the budget.

Enrollment in Medicaid increased by 1.8 million—a 130 percent increase—between fiscal year 2000 and fiscal year 2016. Illinois now has nearly one-quarter of its population—more than 3.1 million people— enrolled in Medicaid. The growth trend in enrollment has reversed somewhat in recent years as the ACA has taken effect. Federal financial support for the expansion of Medicaid under the ACA will drop from 94 percent of costs in fiscal year 2018 to 93 percent in fiscal year 2019 to only 90 percent in fiscal year 2020 and thereafter. the fiscal year 2019 budget includes a 4 percent reduction in current rates paid to providers, excluding prescriptions and community health centers. The budget also utilizes managed care.

One time items are also included in the budget balancing scheme. The divestment of the James R. Thompson Center (JRTC) is projected to achieve net proceeds of $240 million in fiscal year 2019 and avoid deferred maintenance expenses estimated in the hundreds of millions of dollars over the next 10 years.

On what are revenue projections based? Fiscal year 2018 are projected to be $36,783 million, an increase of $6,450 million, or 21.3 percent from actual fiscal year 2017 revenues. This increase primarily reflects an increase of $4,501 million in individual income tax and corporate income tax revenues due to the increases in the individual income tax rate from 3.75 percent to 4.95 percent and the corporate income tax rate from 5.25 percent to 7.0 percent, effective July 1, 2017. Individual income taxes deposited into the general funds are estimated to total $17,610 million, while corporate income taxes are estimated to total $1,884 million for fiscal year 2018. These estimates include an estimated $1,217 million to be deposited into the Commitment to Human Services Fund and the Fund for the Advancement of Education. These numbers also reflect the impact of the direct deposit of income tax revenue sharing with local governments, estimated to reduce income tax deposits to the general funds by $1,140 million in fiscal year 2018.

Net sales tax revenue deposits into the general funds are estimated to total $7,951 million, reflecting the impact of the deposit of $448 million directly into local transit funds instead of being deposited into the general funds first. Revenues from other state sources, including Public Utility Taxes, are expected to total $3,328 million. Federal sources are projected to increase to $3,418 million in fiscal year 2018 from the fiscal year 2017 total of $2,483 million. Use of the proceeds from the November 2017 backlog borrowing to pay down prior year Medicaid liabilities is expected to add an additional $1,206 million to fiscal year 2018 totals. This additional amount is not included in the base resources for fiscal year 2018 as it is attributable to the payment of prior year liabilities. Transfers in, not including amounts from fund reallocations or interfund borrowing authorized in PA 100-23, are projected to increase to $1,718 million in fiscal year 2018 from fiscal year 2017 results of $1,542 million.

It would not be a surprise to see a most contentious budget adoption process. The state’s politics – always complicated – will be more so this year with the Democratic primary guaranteed to yield a wounded yet well funded candidate. How much leverage the traditional budget adversaries will have this year is not clear. The lack of clarity will make the process that much more difficult to favorably resolved. We believe then that the risk to the State’s credit remains weighted to the down side regardless of the perceived improvement in the State’s credit due to its recent year end bond sale.

Muni Credit News Week of February 12, 2018

Joseph Krist

Publisher

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Editor’s Note: The posting is late to reflect the issuance of the Trump infrastructure plan this past Monday.

ISSUE OF THE WEEK

Intermountain Power Agency (IPA)

$102.5 million Subordinated Power Supply Revenue Refunding Bonds, Series 2018A.

Moody’s: A1

Maybe you can teach an old dog new tricks. Conceived in the eighties as a way to site coal fired power plants to serve California without running afoul of the nation’s strictest state air pollution regulations, IPA seemed to check off all of the boxes for large scale base load power generation resource development. A couple of decades of climate change later, the coal orientation and desert location outside of California were not enough to offset the environmental regulatory demands of the California electric market.

So in March, 2016, IPA and its 35 participants executed a Second Amendatory Power Sales Contract under which IPA plans to repower its existing coal units into combined cycle natural gas units by July 1, 2025. IPA and its participants have agreed to extend the term of the existing power sales contracts that expire in 2027 by another 50 years through the Renewal Power Sales Contract (RPSC). The RPSC will provide energy generated by the natural gas units following the conversion from 2025 to 2077.

To recall, the primary purpose of IPA is the operation of the two-unit 1,800 MW Intermountain Power Project (IPP) coal-fired generation facility. IPP is located in Millard County, Utah and a significant portion of the energy is transmitted about 490 miles from the Intermountain Converter Station to the station at Adelanto, California via the Southern Transmission Line (STS). The STS line is owned by IPA with the improvements finance by the Southern California Public Power Authority (SCPPA). The generation and transmission facilities are operated by the LADWP.

Going forward, the primary risks to the credit are regulatory related cost risks. Increased regulatory pressure from Federal or California agencies on municipal electric utilities to reduce GHG emissions in the near-term. Main among these are Increased regulatory pressure from Federal or California agencies on municipal electric utilities to reduce GHG emissions in the near-term.

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INFRASTRUCTURE PLAN FALLS FLAT

After the long wait for the formal release of the trump Administration infrastructure plan, the resulting document is a huge disappointment. By emphasizing financing over funding, private over public, and uneven distribution of support relative to where the needs are, to plan comes up short effectively across the board.

The amount of spending – $1.5 trillion over ten years – was but a reinforcement of an effective 85% plus state/local share dampened state and local enthusiasm. Financing is not the issue for states and localities. They know how to finance these projects. The challenge is how to meet the need for funding. That is where the plan is likely to come up short. The draft does not comport with recent legislative realities. It envisions the use of tax-exempt private activity bonds (PAB) and advance refunding of tax-exempts. PABs withstood a significant assault before being retained under tax reform but advance refundings were eliminated.

Incentives for states to spend will be established under formulae weighted toward projects with private participation and there are limits on the percentage of federal funding. It seeks to loosen environmental reviews and encourages usage charges (tolls) to provide revenues for local shares. The end result is a program which generates benefits for the private sector while shifting much of the cost of these projects to the states and localities.

The plan can be seen as constructive for bonds from the view of the financing side of the market but credit negative for the credit side of the market through its cost shift to the states. While not explicitly referenced, asset recycling where the sale or lease of existing facilities to generate toll revenue for funding of additional projects and profits for the private asset purchasers is likely a philosophical centerpiece of any plan . These assets would likely include highways, airports, and rail facilities. In the area of federal assets, the draft suggests several electric utility assets owned by the Federal government as examples of potential asset sales.

On the funding side, the draft raised many concerns on the part of state and local governments who will see increased funding responsibilities under the anticipated state and local/federal shares of the proposed trillion dollar plan. The allotted $200 billion comes from cuts to programs including the Transportation Investment Generating Economic Recovery (TIGER) grants and transit funds.

Whether the proposal when it is formally released can garner enough support is not clear. Upon release, the plan will face challenges. Rural areas will want greater support for things like broadband provision and expansion above the proportions envisioned in the draft. States will be disappointed that traditional cost sharing ratios will be less favorable. Let’s look at three examples of major infrastructure programs requiring massive capital investment. The prime example of this would be the much discussed Gateway Tunnel. The proposed funding ratios in the draft plan would shift even more of the cost of this clearly necessary project onto the taxpayers and fare paying public in New York and New Jersey even though the trains using it serve a much wider area.

High speed rail is another area of infrastructure with a fair measure of public support. In California, high speed rail has encountered opposition from some of the state’s congressional delegation who have strongly fought to obstruct any efforts at even indirect federal funding. Yet the only recent new high speed rail project to begin service (in Florida) fought long and hard for as much of a federal subsidy as it could get through the use of tax exempt municipal bonds. And finally, the Delta water tunnel project in California would provide water resources serving large swaths of the state and a variety of arguably national economic interests. High speed rail and projects like the Delta Tunnels do not seem to have an outlet in this program.

The Administration has made clear that the document is the mere starting point for negotiating legislation. In favor of passage is the fact that the concept of infrastructure does have bipartisan and widespread regional support. At the same time, the funding of the plan through the elimination of some popular existing mass transit funding sources will make it harder to drive a bargain. One thing we know is that the adopted plan will be far different than what we see in this effort.

ADVANCE REFUNDING LEGISLATION

U.S. Representative Randy Hultgren, an Illinois Republican, and U.S. Representative Dutch Ruppersberger, a Maryland Democrat announced that they are cosponsoring bill to restore the federal tax exemption for a type of debt refunding used by U.S. states, cities, schools and other issuers to lower borrowing costs . Advance refundings were eliminated in the sweeping tax bill signed into law by President Donald Trump in December.

Advance refunding bonds are used to refund outstanding debt beyond 90 days of its call date to take advantage of lower interest rates in the municipal market. Advance refunding bond issuance totaled $91 billion in 2017, accounting for 22.2 percent of supply last year, according to Thomson Reuters data. The termination of the tax break for interest earned on the debt is expected to generate $17.3 billion for the U.S. government between 2018 and 2027.

In addition to providing cost savings due to favorable turns in interest rate trends, the refundings are an important tool for the restructuring of debt especially in the case of distressed credits. The termination of the tax break for interest earned on the debt is expected to generate $17.3 billion for the U.S. government between 2018 and 2027.Given the size of the revenue loss associated with the overall tax cut, the negative policy implications for municipal credits just don’t seem worth the loss of refudning ability.

CA REVENUES REMAIN STRONG IN JANUARY

California’s total revenues of $17.35 billion for January beat the governor’s 2018-19 proposed budget estimates by $2.37 billion, or 15.8 percent, and outpaced 2017-18 Budget Act projections by $1.45 billion, or 9.1 percent, State Controller Betty T. Yee reported today.

Personal income taxes (PIT) and corporation taxes, two of the “big three” sources of General Fund dollars, exceeded estimates for the second consecutive month and are both surpassing assumptions for the fiscal year. For the first seven months of the 2017-18 fiscal year, total revenues of $74.56 billion are higher than expected in the January budget proposal by 4.0 percent, 7.5 percent above the enacted budget’s assumptions, and 11.7 percent higher than the same period in 2016-17.

For January, PIT receipts of $15.60 billion were $2.25 billion, or 16.9 percent, above the proposed budget’s projections and $1.33 billion ahead of 2017-18 Budget Act estimates. For the fiscal year, PIT receipts of $54.70 billion are higher than anticipated in last summer’s budget by $3.61 billion, or 7.1 percent.

Corporation taxes for January of $551.6 million were $211.3 million, or 62.1 percent, higher than expected in the proposed budget and $143.4 million above the enacted budget’s estimates. This variance is partially because refunds were approximately $38.0 million lower than anticipated. For the fiscal year to date, total corporation tax receipts of $4.81 billion are $1.08 billion, or 28.8 percent, above assumptions in the 2017-18 Budget Act.

Sales tax receipts of $1.01 billion for January were $138.0 million, or 12.0 percent, lower than anticipated in the governor’s budget proposal unveiled last month. Notably, for the fiscal year, sales tax receipts of $13.03 billion are $151.2 million lower than January’s assumptions but $396.6 million, or 3.1 percent, above the enacted budget’s expectations.

Unused borrowable resources through January exceeded revised projections by $7.83 billion, or 30.8 percent. Outstanding loans of $5.64 billion were $5.19 billion, or 47.9 percent, less than the 2018-19 proposed budget estimates and $5.02 billion, or 47.1 percent, less than the 2017-18 Budget Act assumed the state would need by the end of January. The loans were financed entirely by borrowing from internal state funds.