Joseph Krist

joseph.krist@municreditnews.com

THE HEADLINES…

ENERGY STATE BLUES BLEEDING THROUGH TO RATINGS

KANSAS COURT RULING ON EDUCATION SPELLS BAD NEWS

ILLINOIS BUDGET STANDOFF CONTINUES

P.R. DRAMA TO DRAG ON

LARGE HEALTH SYSTEM DOWNGRADE

NYC BUDGET REVIEW

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ENERGY STATE BLUES BLEEDING THROUGH TO RATINGS

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

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

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

KANSAS COURT RULING ON EDUCATION SPELLS BAD NEWS

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

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

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

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

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

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

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

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

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

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

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

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

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

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

ILLINOIS BUDGET STANDOFF CONTINUES

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

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

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

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

P.R. DRAMA TO DRAG ON

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

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

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

LARGE HEALTH SYSTEM DOWNGRADE

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

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

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

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

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

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

NYC BUDGET REVIEW

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

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

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

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

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

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

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

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

Joseph Krist

joseph.krist@municreditnews.com

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THE HEADLINES…

“nobody knew that health care could be so complicated” 

MASSACHUSETTS PENSIONS UNDER SCRUTINY

DETROIT PENSION PROPOSAL

FINANCIAL RISKS OF NUCLEAR HIGHLIGHTED AGAIN

SEC TO CONSIDER DISCLOSURE ENHANCEMENTS

PRESIDENTS SPEECH AND MUNICIPALS

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“nobody knew that health care could be so complicated” 

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

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

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

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

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

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

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

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

MASSACHUSETTS PENSIONS UNDER SCRUTINY

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

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

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

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

DETROIT PENSION PROPOSAL

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

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

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

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

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

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

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

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

FINANCIAL RISKS OF NUCLEAR HIGHLIGHTED AGAIN

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

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

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

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

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

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

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

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

SEC TO CONSIDER DISCLOSURE ENHANCEMENTS

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

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

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

PRESIDENTS SPEECH AND MUNICIPALS

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

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

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

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

Joseph Krist

joseph.krist@municreditnews.com

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THE HEADLINES…

KANSAS BUDGET VETO

MICHIGAN HOLDS THE LINE ON TAXES

INFRASTRUCTURE FOCUS – DAMS

PHILADELPHIA SODA TAX

SCRANTON KEEPS LOCAL SERVICE TAX

MORE PA. DISTRESSED CITY NEWS

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KANSAS BUDGET VETO

After years of declining revenues and lowered credit ratings, it appeared that the Kansas legislature might enact a package of tax increases to address a $364 million budget gap for the current fiscal year. Since 2010, the state has faced a stagnant economy which has not responded to the tax cut stimulus. Most recently, S&P Global Ratings issued a “negative” outlook for its credit rating for Kansas. Last summer, S&P downgraded Kansas’ credit rating, to AA-.

The hope that the state might rely on more than spending cuts was not realized as eighty-five of the 125 representatives — one more than was necessary to override a veto — voted to enact the plan over Mr. Brownback’s objections. But, the Senate voted 24 to 16 and sustained Mr. Brownback’s veto, falling three votes short of the minimum for an override. The proposal called for increased income tax rates, as well as the elimination of a controversial tax exemption that benefited business owners. It would have raised more than $1 billion over two years

The tax exemption has been the cornerstone of Governor Sam Brownback’s plan to create jobs. Mr. Brownback said that the proposal before the Legislature would hurt job creators. So now the legislature is expected to embark on a course of continuing to try to raise revenues as reliance on cuts would likely require additional cuts to local school aid which have proved highly unpopular. It is thought that an extended period of resubmitted legislation and vetoes will go on until a final resolution.

In light of recent ratings actions in places like West Virginia, we wonder how long the rating agencies will take to recognize the dysfunctionality of Kansas’ budget process and to downgrade the state’s credit. As long as the Governor clings to his ideologically based approach to the state’s finances, we see the state’s credit as a declining situation.

MICHIGAN HOLDS THE LINE ON TAXES

The Michigan House of Representatives voted down legislation to roll back the state’s income tax with 52 votes for and 55 against. House Bill 4001 would continue to cut the tax rate to 4.15 percent in 2018 and 4.05 percent in 2019. If the state’s Budget Stabilization Fund — more commonly known as the “rainy day fund” — was over $1 billion by 2020, the rate would drop to 3.95 percent. If that were still true in 2021, it would drop to 3.9 percent. There is currently $734 million in that fund.

The House Fiscal Agency estimated the rollback to 3.9 percent would result in incremental revenue loss to the state, reaching a $1.1 billion budget hole by Fiscal Year 2022, when fully phased in. The Michigan individual income tax is now the largest source of State tax revenue, with net revenue of approximately $8.0 billion in fiscal year (FY) 2013-14, representing 39% of combined State General Fund and School Aid Fund revenue. In FY 2013-14, the individual income tax provided 62.7% of General Fund/General Purpose revenue and 20.5% of School Aid Fund revenue.

According to the Senate Fiscal Agency, (Public Act 94 of 2007) which increased the individual income tax rate from 3.9% to 4.35% as of October 1, 2007. (An expansion of the use tax to certain services also was approved; however, the use tax expansion was repealed two months later, on the day that it was to take effect, and replaced with a Michigan Business Tax surcharge.)

The income tax rate was to remain at 4.35% for four years, then decline over six years back to 3.9%. Instead of the reduction from 4.35% to 3.9% over five years, Public Act 38 of 2011 made a single reduction from 4.35% to 4.25% as of January 1, 2013, although Public Act 223 of 2012 subsequently accelerated the rate reduction by three months, to October 1, 2012. the current tax rate of 4.25% is lower than the rate levied during most of the history of the individual income tax, including the 25 years between 1975 and 2000. Over the 48-year life of the individual income tax, the median average tax rate levied was 4.4%.

INFRASTRUCTURE FOCUS – DAMS

Infrastructure issues will be addressed in President Trump’s joint speech to Congress this week as well as in the budget. That will help to bring focus to an issue crying out for it. In 2016, the Association of State Dam Safety Officials estimated that it would cost $60 billion to rehabilitate all the dams that needed to be brought up to safe condition, with nearly $20 billion of that sum going toward repair of dams with a high potential for hazard. By 2020, 70 percent of the dams in the United States will be more than 50 years old, according to the American Society of Civil Engineers. In 2015, Representative Sean Patrick Maloney, Democrat of New York, introduced the Dam Rehabilitation and Repair Act, an amendment to the National Dam Safety Program Act, minimum safety standards. The bill is still pending, but it would not apply to a majority of the dams in the United States because more than half of them (69%) are privately owned.

There are 90,000 dams across the country, and more than 8,000 are classified as major dams by height or storage capacity, according to guidelines established by the United States Geological Survey. The average age of the dams in the U.S. is 52 years old. Other than 2,600 dams regulated by the Federal Energy Regulatory Commission, the rely on state dam safety programs for inspection.

Budgets for dam safety at the state level however, are not significant. They range from a high of $11.1 million in California to $0 in Alabama. State dam safety programs have primary responsibility and permitting, inspection, and enforcement authority for 80% of the nation’s dams. Therefore, state dam safety programs bear a large responsibility for public safety, but unfortunately, many state programs lack sufficient resources, and in some cases enough regulatory authority, to be effective. In fact, the average number of dams per state safety inspector totals 207. In South Carolina, just one and a half dam safety inspectors are responsible for the 2,380 dams that are spread throughout the state. Alabama remains the only state without a dam safety regulatory program.

So the problem will clearly require investment at both a state and federal level. It highlights the need to focus the discussion of infrastructure on maintenance of the existing infrastructure let alone its expansion. As for how much may be needed, $1 trillion may sound like a huge amount. But in the context of overall infrastructure needs, assuming every pipe would need to be replaced, the cost over the coming decades could reach more than $1 trillion, according to the American Water Works Association (AWWA). That is just for drinking water distribution. No dams, highways, roads, ports, or wastewater upgrades.

PHILADELPHIA SODA TAX

Is it the real thing? So far there is one month available on the tax on sugary drinks implemented as of January 1 in Philadelphia. The city is the first to put such a tax into effect. The tax is levied at a rate of 1.5 cents per ounce raising the wholesale price of the typical 2 liter bottle by about 50 cents. In January, the city collected $5.7 million  some $91 million. That would require the city to collect the tax at a monthly rate of some $7.7 million.

The collections exceeded expectations even though the drop in sales by volume was well in excess of estimates. Supermarkets and distributors have claimed declines from 30 to 50%. The tax continues to be challenged in the courts. Three dozen state legislators filed a brief calling for the Commonwealth Court to overturn it. They contend that the tax is not constitutional, violates the law, and will result in lost sales tax revenue collection into the commonwealth’s general fund.

Opponents contend that successful implementation would spawn other efforts in Pennsylvania cities to tax sugar based products. They claim that other cash-strapped cities such as Harrisburg, Chester, and Williamsport will use the appellant’s tax as a way to increase their revenues. “It is not unrealistic to expect that next year there will be a ‘candy tax’ based upon volume in Philadelphia, a sweetened beverage tax based upon volume in Harrisburg, and a ‘snack/cookie tax’ based upon volume in another cash-strapped city.”

A city spokesman said  the city’s “economist demonstrated that the PhillyBevTax would have little impact on state sales tax revenue and under certain circumstances could actually increase state sales tax revenue.”  Boulder, CO voters approved a 2 cent per ounce tax last fall and voters approved “soda taxes” in the California cities of San Francisco, Oakland, and Albany.

SCRANTON KEEPS LOCAL SERVICE TAX

In the summer of 2016, the MCN discussed the efforts of local libertarian community activist Gary St. Fleur to legally challenge the collection of a local services tax by the City of Scranton, PA. Rejecting residents’ claims that Scranton violates a tax cap, visiting Senior Judge John Braxton of Philadelphia approved Scranton’s petition to levy the higher local services tax of $156 on anyone who works in the city and earns above $15,000.

Braxton approved Scranton’s tripled LST petitions for each of 2015 and 2016, up from the prior typical LST of $52 a year, as planks of the city’s Act 47 recovery plan. Neither of those petitions generated opposition. This time, however, eight residents formally opposed the city’s LST petition for 2017. They and their attorney, John McGovern, contended the city routinely goes way over a total cap on a group of taxes allowed under state Act 511, which includes the local services tax.

In a hearing on Feb. 13, city officials testified that while Act 511 allows the usual $52 levy the $104 LST increase. Braxton agreed with the city and rejected the residents’ claims. This means that eligible workers will continue to pay an LST of $3 week, or $156 this year, instead of $1 a week, or $52. The LST applies to about 32,000 people who work in Scranton.

Special counsel for the city, Kevin Conaboy, argued that the residents’ opposition was misplaced because they should have fought the tax on different grounds, called a mandamus action. Braxton agreed. He dismissed the opposition to the LST “without prejudice,” meaning the residents could pursue another avenue of attack. “Nothing in this order shall prevent respondents from objecting to the imposition of this tax at the appropriate time and through the proper procedural mechanisms,” the judge said in his one-page order.

So the issue may not be dead but for now Scranton can adopt a budget including those revenues as it continues its efforts to restore the city’s finances.

MORE PA. DISTRESSED CITY NEWS

Just to the south of Scranton, the City of Wilkes-Barre struggles with debt, budget, and infrastructure issues. Their project may not be large, bright, and shiny but it is of great importance to the city. The Solomon Creek wall repair would restore a flood control structure dating back to the 1930’s. Absent help from the state or federal governments, the city has pushed for a $5.5 million bond to pay for the repairs. As the transaction has been considered, the issue of whether or not to tie the project financing to a larger debt refinancing has been under consideration.

The restructuring would restructuring reduce upcoming annual long-term debt payments to make them more affordable in order to avoid possible distressed status and strict state oversight of spending under Act 47. The plan before the council was presented by the city’s consultant, PFM Financial Advisors LLC, of Harrisburg, and calls for lower payments this year and next. But the difference in payments is scooped up and tossed further along, leaving the city to pay higher amounts down the road. The city would refinance $3.9 million of its $86.2 million debt and issue $5.5 million in new money through a bond for the repairs. The debt payment would drop to $5.1 million from $5.4 million this year. Next year it would fall to $4.9 million from $7.6 million. But in 2019 and 2020, the payments climb to more than $8 million, decreasing to $1.7 million in 2036.

Final consideration of the plan has been postponed until March. This will provide more time for the city to consider alternatives including asset sales and renewed efforts to negotiate expense reductions associated with the city’s workforce.

P3 FOR PRIVATE COLLEGE DORMITORIES

Howard University is one of the leading historically black colleges and universities (HBCU) in the US. In spite of that status it faces many financial challenges as it attempts to remain competitive in a highly fluid environment. One of the challenges many schools face is in the renovation and expansion of on campus residential facilities. Howard has chosen a different course than the traditional tax exempt bond financed revenue bond model.

Howard Dormitory Holdings 1, LLC, a wholly-owned and title-holding company of Howard University (“Howard SPE”), Howard University (the “University”) and Corvias, a Rhode Island-based company, announced a 40-year partnership that will completely renovate and maintain two of the University’s largest residence halls and manage two additional halls. Corvias will renovate the East and West Towers of Howard’s Plaza Towers residence, located at 2251 Sherman Ave., N.W. and manage the University’s Drew and Cook residence halls, which are located on the north side of the main campus.  The Howard Plaza Towers, and Drew and Cook residence halls were transferred by the University to the Howard SPE.

Corvias raised $144 million for the project from institutional investors. Proceeds will fund renovation and modernization, the retirement of some debt, transactions costs and the creation of a sizable reserve fund for future capital expenses. Corvias will manage the renovation and operations of the facilities on a day-to-day basis for a performance-based management fee, but all residual cash flow will flow to the University Parties. A portion of these funds will be dedicated to a reserve fund for reinvestment into the residence halls and a portion will be collected by the University Parties to fund other discretionary initiatives.

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

Joseph Krist

Municipal Credit Consultant

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THE HEADLINES…

TEXAS BUDGET

INDIANA TOLLING LEGISLATION

AND WHILE WE ARGUE ABOUT INFRASTRUCTURE FUNDING

CALIFORNIA PROJECT CAUGHT IN THE CROSSHAIRS

LOCAL JAILS COULD BENEFIT FROM IMMIGRATION CRACKDOWN

LEX CLAIMS CASE GETS MORE COMPLEX

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TEXAS BUDGET

The  Governor’s Budget  for the 2018-2019 biennium implements many of the 4 percent cuts suggested by state agencies and further reduces agency expenditures, except public school funding formulas and certain other priorities, by an additional 2 percent. It purports to do so without issuing new debt, raising taxes or utilizing the Economic Stabilization Fund. The Governor’s Budget calls for a business tax reduction, property tax reforms and maintaining funding for roads. This budget also calls for a constitutional amendment that would permanently limit the state’s spending growth to the rate of growth in population and inflation. This despite the fact that the legislature passed a budget for the current biennium that limited growth in state fund expenditures within this population and inflation benchmark.

It proposes to continue down the path to franchise tax elimination by cutting the rate to achieve another $250 million in savings for Texas employers. Other policy initiatives would adopt real revenue caps that prevent local governments from endlessly raising taxes without voter approval. Second, it calls for meaningful limits on the overlay of special purpose districts.

On the revenue side, The Governor’s Budget  utilizes  a four-year look back of historical population and inflation data. This methodology creates a 5.81 percent allowable growth rate, which is significantly below the lowest personal income growth estimate provided to the Legislative Budget Board (LBB) (9.9 percent) and well below the number adopted by the LBB (8 percent).

The budget does reference the local pension difficulties plaguing the State’s major cities but makes clear that, in the Governor’s view, there is no affirmative role for the State in resolving them. This budget calls for a constitutional prohibition on using state funds to bailout local pensions. A recent Attorney General Opinion has made clear that the state has no legal obligation to finance floundering plans. At the same time, the Governor’s comments on pensions are somewhat conflicting.

He expresses the view that the state government should get out of the business of micromanaging local pension decisions while unequivocally making clear that statewide taxpayers will not be on the hook to bailout local pensions. The entities that are financially responsible to their employees, retirees and taxpayers should work with municipal leaders, pensioners and stakeholders to develop solutions — are still dependent upon state action to implement meaningful changes.

In terms of how the biennial budget deals with the uncertainties of ACA repeal and replacement, it relies on block grants. In the Governor’s view, Block grants should be used for the administration of state-managed Medicaid programs, and Congress should act to authorize this important reform. The block grants should be designed in a way that protects states from cost growth due to population growth or the economy and should be accompanied by reforms that significantly reduce or eliminate federal requirements. The reformed Texas Medicaid program would include personal responsibility requirements for certain populations. This the approach favored by the most ideological conservatives.

One small in dollars but large in policy aspect of Gov. Abbot’s budget has already been challenged in the courts. A federal judge issued a preliminary injunction against a Texas plan to cut off funding for Planned Parenthood from the state’s Medicaid program. It is only some $4 million in question but it would complete efforts to eliminate PP from participation in Texas’ Medicaid program. State health officials let it be known in December that Planned Parenthood would no longer receive funding from the program. The group had 30 days before the change took effect unless it filed an appeal.

The preliminary injunction preserves what Planned Parenthood contends are funds to provide cancer screenings, birth control access and other health services for nearly 11,000 low-income women. Similar defunding efforts have also been blocked in Arkansas, Alabama, Kansas, Mississippi and Louisiana. All of these efforts simply create greater uncertainty about the viability of proposed budgets and, for the weaker credits, expose them to more downside risk.

INDIANA LOOKING AT INCREASED USE OF TOLLS FOR ROADS

House Bill 1002 passed the state’s lower legislative chamber. Among a variety of increases in fuel and motor vehicle taxes and fees, it also Repeals restrictions on when a tolling project can be undertaken.  The bill also includes a provision which Requires the Indiana department of transportation (INDOT) to seek a Federal Highway Administration waiver to toll interstate highways. It also limits the first toll lanes under the waiver to certain interstate highways and provides for a public comment period and requires replies to the public comments for a toll road project by INDOT or a tollway project carried out using a public private partnership.

The bill, by requiring an outside consulting firm to perform a tolling feasibility study, could increase INDOT expenditures in FY 2017. The state of Wisconsin recently published a tolling feasibility study (December 2016) that was performed by a third-party vendor. The reported costs for this study were$700,000. INDOT reports the cost of a tolling feasibility study could be between $200,000 and $500,000. Increases in INDOT expenditures for a tolling feasibility study would come from the State Highway Fund.

AND WHILE WE ARGUE ABOUT INFRASTRUCTURE FUNDING…

# of bridges         # deficient            % deficient

Iowa	24,184	4,968	20.5%
Pennsylvania	22,791	4,506	19.8%
Oklahoma	23,053	3,460	15.0%
Missouri	24,468	3,195	13.1%
Nebraska	15,334	2,361	15.4%
Illinois	26,704	2,243	8.4%
Kansas	25,013	2,151	8.6%
Mississippi	17,068	2,098	12.3%
Ohio	28,284	1,942	6.9%
New York	17,462	1,928	11.0%

 

The table depicts the ten states with the largest number of structurally deficient bridges in the U.S. as reported by the American Road and Transportation Builders Association.  Historically, Pennsylvania had been the dubious annual leader in this category but in the last two years has been overtaken by Iowa.

There are some common threads which run through this list. Pennsylvania, Illinois, and Kansas have all been known for their respectively dysfunctional budgeting processes. They have each let transportation funding lag with Kansas transferring money from highway funds to cover general fund shortfalls resulting from unrelated tax cuts. Each state on the list has a substantial rural component to their transportation system which leads to a larger number of smaller yet important bridges often which are the responsibility of entities below the state level. This has complicated funding for upkeep and replacement.

From our standpoint, it reinforces our view of the importance of infrastructure maintenance as Congress debates not only funding but project priority. Maintenance clashes with the well-known administration preference for new, big, and shiny projects. The empirical evidence would seem to lean in favor of restoration over new construction, especially in rural areas where commercial activities rely on a strong local transportation system to facilitate the movement of goods to market.

CALIFORNIA PROJECT CAUGHT IN THE CROSSHAIRS

Many infrastructure proponents are looking to see whether Transportation Secretary Elaine Chao reconsiders her decision as to whether or not to allow federal funding at this time for a project in northern California. Caltrain formally petitioned the administration to reverse course on its recent decision to halt $647 million worth of grant money for the transit agency until the start of the federal fiscal year in October. Caltrain commuter rail that runs between San Francisco and San Jose. The rub is that the project would also eventually benefit the state’s high-speed rail project.

The electrification project is scheduled to begin on March 1. It is probably the best example of “shovel ready” around. The existing commuter rail line has experienced significant ridership increases and few doubt the need to increase capacity on that line. The work would most likely be needed regardless of its ability to facilitate the high speed rail project.

Based on that reality, the decision not to fund at this time is seen as politically motivated. Regardless of the ultimate outcome, it illustrates the difficulty in managing the politics and execution of any large scale infrastructure plan. Just in the case of rail expansion, major projects requiring significant funding are awaiting execution and funding decisions in Democratic strongholds including RTA updates in Chicago, a new trans-Hudson rail tunnel between New York and New Jersey and, the MBTA in Boston to name a few. Should political considerations become a prime funding consideration all of these projects could be at risk. In Chicago and Boston, negative decisions would be seen as having potentially negative impacts on the underlying credits sponsoring those projects.

LOCAL JAILS COULD BENEFIT FROM IMMIGRATION CRACKDOWN

The plans announced this week to ramp up efforts by the Trump administration to deport larger numbers of undocumented aliens may have resulted in an unintended benefit for investors in high yield local detention facility bonds. The sector had been under pressure as the result of announcement by the DOJ under the Obama administration to significantly curtail the use of these facilities for a variety of reasons. There was also concern that policies that deemphasized deportations would reduce demand for cells by the Immigration, Customs, and Enforcement Service which used these facilities to hold potential deportees while they awaited final adjudication of their cases.

Under the plans announced this week, a much higher level of apprehension and detention of the undocumented would result. This would create a much higher level of demand for cells, thereby reducing the short-term financial risk associated with these projects. This change in policy should create – at least as long as it remains in effect – an opportunity for investors in this sector.

The whole turn of events does highlight the long term political risk of investment in this class of bonds. It renders individual project economics less relevant to investors. It also shows how quickly the outlook for these credits to change. We are always less comfortable when the foundation for a credit is not fundamental economic viability so we still believe that it is a class of bonds that individual investors should curb their enthusiasm for.

WEST VIRGINIA DOWNGRADE

In our last issue, we outlined the Governor’s proposal for a fiscal year 2018 budget. Before the budget process was allowed to play out, Moody’s announced that it has downgraded the State of West Virginia’s general obligation debt to Aa2 from Aa1, affecting approximately $393.6 million in debt outstanding. The state’s lease appropriation and moral obligation debt has been downgraded one notch to Aa3 and A1, reflecting the ties to the general obligation rating.

Moody’s said that “the downgrade of the general obligation and related lease ratings expenditures and available resources, which is generally inconsistent with a Aa1 rating. While the state has used a mixture of revenue enhancements, expenditure reductions and reserves to close budget gaps, revenues continue to lag budgeted estimates and the structural imbalance is likely to continue at least through 2018. Additionally, while the economy has begun to stabilize some, the demographic profile remains weak. Pension liabilities remain above average and the state’s debt burden could increase under the Governor’s new infrastructure proposal.”

At the same time, Moody’s expressed its view that the economy is stabilizing and liquidity remains healthy, allowing the state financial flexibility to weather a slower rebound. Additionally, it expects the state to continue with what it called its prudent management practices, managing through what will likely be a longer term but more moderate revenue decline.

LEX CLAIMS CASE GETS MORE COMPLEX

We recently discussed ongoing litigation over the rights of general obligation versus those of COFINA bondholders to revenues legislatively dedicated to outstanding COFINA debt.  Since then there have been new developments. The COFINA Senior Bondholders, the Puerto Rico Funds, and the Major COFINA Bondholders, all  own COFINA bonds in differing amounts. If no federal statute grants an unconditional right to intervene, the Court is nonetheless required to grant a party’s motion to intervene if that party has “demonstrate[d] that: (1) its motion is timely; (2) it has an interest relating to the property or transaction that forms the foundation of the ongoing action; (3) the disposition of the action threatens to impair or impede its ability to protect this interest; and (4) no existing party adequately represents its   interest”.

The Puerto Rico Funds and the Major COFINA Bondholders’ made respective motions to intervene which raise similar arguments as to why each should be permitted to intervene as of right. Specifically, both the Puerto Rico Funds and the Major COFINA Bondholders argued that they have an interest in the revenues that back the COFINA bonds which they hold.  The Puerto Rico Funds and the Major COFINA Bondholders asserted that no existing party to this action can adequately represent their respective interests.

The COFINA Senior Bondholders’ motion to intervene was denied in light of the Court’s conclusion that the PROMESA counts are not stayed. The Court is satisfied that the Puerto Rico Funds and the Major COFINA Bondholders have met their modest burden of showing that there is a possibility that no named defendant may adequately represent their interests. That rests on the somewhat technical issue that BNYM Trustee — the named defendant the GO Bondholders allege adequately represents the interests  of  the  Puerto  Rico  Funds  and  the  Major COFINA Bondholders—has moved to dismiss the second amended complaint in this case on grounds that could result in BNYM Trustee being dismissed as a defendant.  Should BNYM Trustee prevail on its motion to dismiss, no COFINA Bondholder representative would remain as a litigant in this case unless the Court permits intervention.

The Court denied the Commonwealth Defendants’ motion to stay, and the COFINA Senior Bondholders motion to intervene . The Court granted  the motions to intervene of the Oversight Board, Ambac, the Puerto Rico Funds, and the Major COFINA Bondholders. So it would seem that opposing interests have been aligned with each other making for a much more difficult process of speculating as to how this is all going to turn out. We are comfortable with saying that a final resolution is a long way off and that we are glad to be in the position of spectator rather than speculator with anything at risk.

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

Joseph Krist

joseph.krist@municreditnews.com

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THE HEADLINES…

WEST VIRGINIA BUDGET

ATLANTIC CITY SETTLES BORGATA TAX APPEAL

PUERTO RICO GO SUIT ADVANCES

HOUSE VERSION OF ACA REFORM EMERGES

PORTS IN A TRADE WAR

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WEST VIRGINIA BUDGET

Classroom teachers would receive a 2-percent pay raise, highway projects including Interstate 70 in Ohio County would be finished, and motorists would pay 10 cents more per gallon of gasoline if Gov. Jim Justice’s proposed budget is enacted by the West Virginia Legislature.

The Governor calls his proposal West Virginia’s “Save Our State Budget”. The plan combines  spending cuts, tax increases and fee increases and a $123 million withdrawal from the state’s Rainy Day Fund to fund an estimated $500 million shortfall for fiscal year 2018. Justice’s relies on $450.15 million raised through a half-percent increase in the sales tax to 6.5 percent; eliminating tax exemptions for professional services and advertising and raising the gasoline excise tax by 10 cents a gallon from the current 20.5 cents to 30.5 cents. The proposed general fund budget would increase to about $4.8 billion, with total spending, including federal and other funds, at $12.9 billion.

During his State of the State speech, Justice dramatically advocated for the proposed tax increases. “I truly, from the bottom of my heart, hate tax increases,” he said, adding it’s “the most painless way I think you can get out of this mess. If you don’t do this, you’re dead. You’re dead beyond belief.” All of the proposed tax increases wouldn’t be permanent. After three years, he proposes eliminating the sales tax as well as a proposed 0.2-percent commercial activities tax he wants businesses to pay. Justice’s proposal emphasizes a “bold and aggressive” $1.4 billion road program that shows Justice’s commitment to long-term economic growth according to state budget officials. In addition, Justice proposes a $105 million Save Our State Fund, to be used for economic development and infrastructure investment.

The roads program “will invest heavily in roads and bridges,” and is expected to create up to 25,000 new jobs throughout the state, including temporary jobs, according to the administration. Among the projects listed in the $1.4 billion Phase I of the program — the phase that lists projects that have passed most requirements and are ready to go — is the $135 million I-70 bridge rehabilitation and replacement project in Ohio County. The $1.5 billion Phase II includes W.Va. 2 widening projects in Hancock, Marshall and Wetzel counties. Those include a $10.5 million Hancock County project that widens it through New Cumberland; an $80 million project in Wetzel County from Proctor to Kent; and creates four lanes through Marshall County.

Justice called his plan for $26.6 million in cuts as “responsible cuts,” stating alternatives could cost the state 3,000 jobs, in addition to cuts that could have eliminated all state parks and shut down dog and horse tracks, and veterans’ services. The planned cuts include eliminating the eight, regional education service agencies (RSEA) that provide services to public schools and cost the state more than $3.5 million per year. The services RESAs provide include training bus drivers, and hiring special needs teachers, and managing substitute teacher schedules.

ATLANTIC CITY SETTLES BORGATA TAX APPEAL

The City of Atlantic City has settled a long standing major tax-appeal debt owed to the Borgata Hotel, Casino & Spa. The state says the city agreed to accept less than half of the $165 million owed it. The settlement was reached by overseers appointed by Gov. Christie under a law that placed control of Atlantic City under the oversight of the state Department of Community Affairs. The announcement came from the state, which headlined its release, “Christie Administration and Borgata Reach Settlement Agreement.”

The state said Borgata agreed to accept $72 million to cover all judgments and claims for 2009 to 2015. The settlement precludes Borgata from pursuing tax appeals for 2013 to 2015. Borgata also agreed to make payments under the Payment in Lieu of Taxes program that applies to the city’s casinos beginning this year, the statement said. Previous efforts overseen by state monitors, an Atlantic County Superior Court judge, and the city itself had failed to resolve the debt.

The latest negotiations were conducted with the involvement of the state’s new overseer. Christie had made settlement of the Borgata deal a priority of past emergency managers appointed by the state, but blamed the city for the lack of a settlement before now. “This settlement has been one of my administration’s priorities since Atlantic City’s fiscal crisis forced us to assume control of operations there in November,” Christie said in a statement. “The city administration, despite all the time and opportunity given to them, failed to accomplish the goal, as they have with so many others.” Christie noted that the $72 million was $30 million less than what the city had proposed  in its own five-year recovery plan, which was rejected by the state.

Changes in the ownership of the Borgata may have been as much of a factor in the settlement as anything else. Borgata is run by MGM Resorts International, which took sole control of the property from its partner Boyd Gaming last August. MGM paid up for full control — $900 million for half of the property — even as the judgment from the tax appeals had reduced Borgata’s total assessed value to about $800 million. MGM is seen as wanting to pursue further development in Atlantic City or North Jersey.

It is not clear how the city would finance the $72 million. Other tax settlements with casinos were funded through bond payments. The city had proposed selling its municipal airstrip, Bader Field, to its Municipal Water Authority to help pay off debts, but that plan was rejected by the state.

PUERTO RICO GO SUIT ADVANCES

A U.S. District Court Judge denied the commonwealth’s motion to stay a lawsuit filed by general obligation (GO) bondholders and a motion to intervene presented by senior Sales Tax Financing Corp. (Cofina) bondholders. Motions were granted allowing intervention by the Financial Oversight and Management Board; Ambac Assurance Corp., which insures $800 million in Cofina funds; the Puerto Rico Funds and by major Cofina bondholders.

The judge said that “this is not an action to recover a liability claim against the government of Puerto Rico that arose before the enactment of Promesa because the GO Bondholders seek only declaratory and injunctive relief.” The ruling was made as part of the Lex Claims case, a lawsuit filed by GO bondholders against the island’s governor, Treasury secretary and director of the Office of Management Budget, as well as the Bank of New York Mellon Corp. That suit was amended to include Cofina and its executive director.

The GO bondholders are hoping to stop the government from diverting the sales and use tax to pay Cofina bondholders. The GO creditors say their bonds are guaranteed by the commonwealth’s full faith and credit and taxing power and have payment priority over Cofina. This would be based on their belief that the constitutional clawback that supports GO debt  supersedes legislative dedication of sales tax revenues to the COFINA debt.

The judge ruled on six motions: (1) the Commonwealth and Cofina defendants’ motion to stay the action in its entirety pursuant to section 405 of Promesa; (2) the fiscal oversight board’s motion to intervene pursuant to Promesa; (3) Ambac Assurance’s motion to intervene as a defendant pursuant and to stay the action pursuant to Promesa; (4) the Cofina senior bondholders motion to intervene; the Puerto Rico-based funds’ motion to intervene; and (6) the major Cofina bondholders’ motion to intervene.

The GO bondholders’ complaint challenged the government’s moratorium order that diverted funds to pay services, the commonwealth’s failure to allocate funds for future GO obligations, and legislation diverting funds to the Government Development Bank. The complaint alleges the commonwealth and Cofina defendants have deprived them “of rights, privileges, and immunities secured by the laws of the United States.”

The judge’s decision to allow the fiscal board, Ambac, Puerto Rico Funds and major Cofina bondholders to intervene because “the Court is required to grant a party’s motion to intervene if that party has demonstrated that: (1) its motion is timely; (2) it has an interest relating to the property or transaction that forms the foundation of the ongoing action; (3) the disposition of the action threatens to impair or impede its ability to protect this interest; and that (4) no existing party adequately represents its interest.”

HOUSE VERSION OF ACA REFORM EMERGES

House Republican leaders presented their rank-and-file members with the outlines of their plan to replace the Affordable Care Act, leaning heavily on tax credits to finance individual insurance purchases and sharply reducing federal payments to the 31 states that have expanded Medicaid eligibility. The talking points they provided did not say how the legislation would be paid for, essentially laying out the benefits without the more controversial costs. It also included no estimates of the number of people who would gain or lose insurance under the plan, nor did it include comparisons with the Affordable Care Act, which has extended coverage to 20 million people.

It purports to lower costs, expands access, improves quality, and puts patients and families in charge of their care, while protecting patients with pre-existing conditions and ensuring dependents up to age 26 can stay on their parents’ insurance. To lower the cost of healthcare, Republicans would eliminate all the Obamacare tax increases, including: The tax on health insurance premiums; The medicine cabinet tax; The tax on prescription drugs; The tax on medical devices; the increased expense threshold for deducting medical expenses. It would provide additional assistance for younger Americans and reduce the over-subsidization older Americans are receiving.

The legislation creates a new code section – 36C— to do this. The credit is: Under current law, in 2017, the maximum amount that can be contributed (both employer and individual contributions) to an HSA  is $3,400 for self and $6,750 for a family. H.R. 1270 (114th Congress) and A Better Way significantly increase the contribution limits by allowing contributions to an HSA to equal  the maximum out of pocket amounts allowed by law. For 2017, those amounts are $6,550 for self-only coverage and $13,100 for family coverage.

H.R. 1270 and A Better Way provide that if both spouses of a married couple are eligible for catch-up contributions and either has family coverage, the annual contribution limit that can be divided between them includes both catch-up contribution amounts. Thus, for example, they can agree that their combined catch-up contribution amount is allocated to one spouse to be contributed to that spouse’s HSA. In other cases, as under present law, a spouse’s catch-up contribution amount is not eligible for division between the spouses; the catch-up contribution must be made to the HSA of that spouse.

H.R. 1270 and A Better Way provide that, if an HSA is established during the 60-day period beginning on the date that an individual’s coverage under a high deductible health plan begins, then the HSA is treated as having been established on the date that such coverage begins for purposes of determining if an expense incurred is a qualified medical expense. Thus, if a taxpayer establishes an HSA within 60 days of the date that the taxpayer’s coverage under a high deductible health plan begins, any distribution from an HSA used as a payment for  a medical expense incurred during that 60-day period after the high deductible health   plan coverage began is excludible from gross income as a payment used for a qualified medical expense even though the expense was incurred before the date that the HSA was established.

Here is the bad news for state credits and for hospitals. Obamacare’s Medicaid expansion for able-bodied adults enrollees would be repealed in its current form. States that chose to expand their Medicaid programs under Obamacare could continue to receive enhanced federal payments for currently enrolled beneficiaries for a limited period of time. However, after a date certain, if states choose to keep their Medicaid programs open to new enrollees in the expansion population, states would be reimbursed at their traditional match rates for these beneficiaries.

States would also have the choice to receive federal Medicaid funding in the form of a block grant or global waiver. Block grant funding would be determined using a base year and would assume that states transition individuals currently enrolled in the Medicaid expansion out of the expansion population into other coverage. States would have flexibility in how Medicaid funds are spent, but would be required to provide required services to the most vulnerable elderly and disabled individuals who are mandatory populations under current  law. Block grants are intended to provide less money. The rest of the discussion about flexibility etc. is just cover for lower funding.

The plan relies on “high risk pools”. Before Obamacare, 34 states had high risk pools. Building on the idea of high risk pools, A Better Way envisions new and innovative State Innovation Grants. But instead of being tied to a separate pooling mechanism, these resources would give states sole flexibility to help lower the cost of care for some of their most vulnerable  patients. Some may suggest State Innovation Grants would lead to enrollment caps or waiting lists – like certain high risk pools functioned prior to Obamacare. There is a reason they were eliminated under the ACA as well as its progenitor in Massachusetts under then Gov. Mitt Romney.

What is most notable about this set of talking points is an almost complete absence of any discussion of how the federal government would pay for this. Like many of Paul Ryan’s efforts over the years, the plan seems to be detailed and thought out but in reality is full of platitudes and short on operational substance. This is what should be of concern to state governments, consumers, providers, and investors.

PORTS IN A TRADE WAR

Recently we were interviewed by the Daily Bond Buyer on the issue of the potential impact of a trade war on municipal credits. The primary items of concern were the major West Coast ports and municipalities on the border with Mexico. The issue comes up as the result of comments made over the course of the campaign and since by President Trump. Here is what we said.

We said that we view a potential trade war with China as more of an economic event than a credit event, but acknowledged that the impact on West Coast ports could be notable. I mentioned the Alameda Corridor Transportation Authority, which operates a bond-financed rail line from the ports of Long Beach and Los Angeles 20 miles north to downtown Los Angeles, carrying containers from dockside to the yards of the freight railroads that send them onwards.

“Obviously they have grown and benefited from trade with China as you go up and down the West Coast,” we said of the ports. “There would be kind of the obvious ramifications for those ports, in terms of lower volumes and lower revenues.” Its revenues are volume-dependent as are some small tax-allocated land deals for warehouse facilities that could be vulnerable to an extended trade slowdown.

We mentioned that “Seattle and Oakland both benefit from the mitigating factor that they also include airports that account for major chunks of their revenue. This somewhat insulates them from the risks associated with a decline in container volume.”

The border cities would be impacted by the impact on property values, employment, and incomes because so much economic activity revolves around warehousing activity associated with NAFTA. The mayor of Nogales, AZ has worried that the impact could be to the tune of a 50% decline in those items should tariffs be imposed sufficient to adversely affect trade.

In southern California, the LAEDC estimates that 1 out of 15 jobs is related to trade coming through the Ports of Long Beach and Los Angeles. That is one example of why the overall economic impact could be greater than the direct credit impact. Either way the impact of a trade war would be negative. Even if our trade strategy is based on a border adjustment tax, there are many scenarios where the impact would not be as neutral as its proponents believes, the. In those instances the net impact on economic activity in terms of the movement of goods would be negative for the American side of the equation.

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

Joseph Krist

joseph.krist@municreditnews.com

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THE HEADLINES…

IMPACT OF FOREIGN STUDENTS ON U.S. UNIVERSITIES

NYS COMMON RETIREMENT FUND ANNOUNCES EARNINGS

HOSPITALS IN LEGISLATIVE WAITING ROOM

PENNSYLVANIA BUDGET PROPOSAL

CONNECTICUT BUDGET PLAN ANNOUNCED

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IMPACT OF FOREIGN STUDENTS ON U.S. UNIVERSITIES

Much of the recent debate about the executive order limiting immigration has revolved around the potential effect on the U.S. economy and businesses. While it is clear that certain industries such as technology and research and development feel vulnerable, there has been less focus on its potential impact on the demand for and economics of U.S. institutions of higher education. This is especially true for public universities.

Over the last several years, states have been reducing their contributions to general state universities as they face increasing budget demands and demands for lower taxes. At the same time, the impact of student debt as an economic drag has increased pressure to slow the rate of tuition growth to in-state residents. One way to do this has been to increase the admittance of foreign students to these institutions.

The “flagship” campuses of state universities lead this trend. Illinois, Indiana, Iowa and University of California campuses in Berkeley and Los Angeles all had at least 10 percent foreign freshmen this academic year, more than twice that of five years ago. The University of Washington’s 2016 freshman class comprised 18% foreign students. Some charge international students additional fees besides tuition: at Purdue University, it was $1,000 this year and will double next year; engineering undergraduates at the University of Illinois at Urbana-Champaign had to pay a $2,500 surcharge this year.

Financially, the logic is compelling. Each seat occupied by a foreign “full fare” student lessens the revenue per seat required from in-state students either in the form of lower tuition or lower general revenue transfers from the respective states. In addition, these students (and relatives) spend what are effectively outside dollars in the local economies in the college towns.

The Institute of International Education, Inc. has assembled estimates of the economic impact from international students. For example, using the institutions referenced above, international economic impact was estimated at: Washington $825.5 million; Illinois $1.57 billion; Iowa $365.8 million; Indiana $956.5 million; California $5.2 billion. This includes tuition and fees, living expenses, and real estate investment by parents of these students (especially from China) who choose to either buy housing for their students or to live here while their students attend U.S. colleges.

For investors, the actual makeup of the student body at a given school should only be of concern as it pertains to the ability of a given institution to maintain a strong financial profile over a sustained period of time. The “moral”, political, and other social issues that arise from these enrollment trends are secondary from a pure investor point of view. That is not to say that they are not something to be monitored. If public low cost universities are not sufficiently available to the children of in-state taxpayers, political support for continued expenditure tax dollars will be further strained. And should stringent immigration limitations become so tight as to greatly limit the admission of international students, then there will be financial implications. But current trends in this area do not seem to be impacting credits supported by these institutions.

NYS COMMON RETIREMENT FUND ANNOUNCES EARNINGS

The New York State Common Retirement Fund’s (CRF) overall return in the third quarter of state fiscal year 2016-2017 was 1.11 percent for the three-month period ending Dec. 31, 2016, with an estimated value of $186 billion, according to New York State Comptroller Thomas P. DiNapoli. “The state pension fund enjoyed a solid third quarter and, barring a significant downturn, is headed for a successful year. We continue to focus on prudent, long-term management of investments to make sure our assets match our liabilities,” DiNapoli said. “Not long after I became Comptroller, the global financial crisis reduced our pension fund’s value to $108.9 billion. Despite volatility in the markets, my staff and I have rebuilt and strengthened the state pension fund to what it is today – a highly diversified fund with its highest ever estimated value.”

The CRF’s estimated value reflects benefits paid out during the quarter. The CRF ended its first quarter on June 30, 2016 with an overall return of 2 percent for the three-month period and an estimated value of $181 billion. Its second quarter closed on Sept. 30, 2016 with an overall return of 3.51 percent and an estimated value of $184.5 billion, the  investments. The CRF’s audited value was $178.6 billion as of March 31, 2016, which is the end of the state fiscal year. That would translate to an increase of 4.4%. While this is below benchmarks for observes like the Boston College Center for Retirement Research which would use 6% growth as a target, it is better than many major pension funds have achieved.

As of Dec. 31, 2016, the CRF has 38.5 percent of its assets invested in publicly traded domestic equities and 15.6 percent in international public equities. The remaining Fund assets by allocation are invested in cash, bonds and mortgages (26.8 percent), private equity (7.7 percent), real estate (6.8 percent), absolute return strategies (3.2 percent) and opportunistic and real assets (1.4 percent).

HOSPITALS IN LEGISLATIVE WAITING ROOM

We’ve all had to sit endlessly in a doctor’s office or emergency room waiting area  worrying about a diagnosis or outcome wondering if the cure will be worse than the disease. Well now hospital financial managers are getting to have a similar experience courtesy of the new administration. President Trump said in an interview that aired during the Super Bowl pre-game that a replacement health care law was not likely to be ready until either the end of this year or in 2018. “Maybe it’ll take till sometime into next year, but we’re certainly going to be in the process.”

This represents a major shift from promises by both him and Republican leaders to repeal and replace the law as soon as possible.  “It statutorily takes awhile to get,” Mr. Trump said. “We’re going to be putting it in fairly soon, I think that, yes, I would like to say by the end of the year at least the rudiments but we should have something within the year and the following year.” Yes it may even be until 2018 until a replacement is enacted. Mr. Trump acknowledged that replacing the Affordable Care Act is complicated, though he reiterated his confidence that his administration could devise a plan that would work better than the law — despite having provided few details of how such a plan would work.

Asked about Trump’s comments, Sen. John Cornyn (R-Texas), the Senate’s No. 2 Republican emphasized that the initial repeal bill under reconciliation is just the beginning of the process, and that a series of smaller bills will follow.  “We’ve said all along we’re going to start the process using budget reconciliation, but it’s not going to be all in one piece of legislation, they’ll be multiple steps,” Cornyn said. “You’ll have to ask him what he meant, but I think it’s going to take — it’s not going to be instantaneous, because there is going to need to be a transition period.”

Speaker Paul D. Ryan has vowed to move legislation for a replacement for the Affordable Care Act by the end of March. But some Republicans are worried about a political backlash if they repeal the law without an adequate replacement — potentially throwing millions of people off their insurance . One Republican congressman from California had to be escorted out of a town hall meeting on health reform by local police to ensure his safety.

Mr. Trump said that he wanted to present a replacement soon after the Senate confirmed his nominee for secretary of health and human services, Representative Tom Price, Republican of Georgia. The Senate is scheduled to vote on Mr. Price’s confirmation this week. “We’re going to be submitting, as soon as our secretary is approved, almost simultaneously, shortly thereafter, a plan,” Mr. Trump said in January. Senator Lamar Alexander of Tennessee, a Republican who is the chairman of the Senate Committee on Health, Education, Labor and Pensions, recently proposed repairing parts of the health care law ahead of scrapping the whole package.

Congressional Republicans have said they could include elements of a replacement plan in the repeal bill. Yet they note that full replacement cannot pass under the fast-track rules of reconciliation that allow a measure to avoid a filibuster. So far, the only action to repeal the ACA was last month when the president signed an executive order to begin unwinding the Affordable Care Act. It gave the Department of Health and Human Services the authority to ease what it called “unwarranted economic and regulatory burdens” from the existing law.

In the midst of this discussion, a consulting firm said that a Republican proposal to fund Medicaid could save up to $150billion over five years. The analysis from healthcare firm Avalere Health shows that if Medicaid were funded through block grants instead of through the open-ended commitment the program receives now, the federal government would save $150 billion by 2022. Savings from a shift to per capita caps, in which states would receive a set amount of money per beneficiary, would save $110 billion over five years. According to the study, only one state – North Dakota — would see increased funding under the block grant model. Through per capita funding, 26 states and D.C. would see decreases in federal funding while 24 would get an increase.

In the meantime, that isn’t much to go on for hospital managements looking at a June 30 FY end to embark on a serious planning process.

PENNSYLVANIA BUDGET PROPOSAL

Gov. Tom Wolf proposed a budget for fiscal 2018 in which there are no broad-based tax increases. It purports to set the Commonwealth on a sustainable fiscal course that will grow its rainy day fund from $245,000 today to almost $500 million by 2022. According to the Governor, this budget proposes reforms that, altogether, will save taxpayers more than $2 billion. The plan calls for an additional $125 million for K through 12 classrooms, $75 million to expand high-quality early childhood education, and $8.9 million for our state system of higher education.

The General Fund budget would be $32.3 billion, an increase of 1.8%. Motor license revenues are projected to increase by 3% but only account for $82 million. Tax revenue in the General Fund constitutes more than 97 percent of annual General Fund revenue. Four taxes account for the vast majority of General Fund tax revenue. The Personal Income Tax, the Sales and Use Tax, the Corporate Net Income Tax and the Gross Receipts Tax together provide approximately 86 percent of annual General Fund revenue. For non-tax revenue, the largest sources of revenue are typically from profit transfers from the Pennsylvania Liquor Control Board, licenses and fees, and the escheats or “unclaimed property” program.

For the five fiscal years ending with 2015-16, total General Fund revenue increased by 11.6 percent, an annual rate of increase of approximately 2.8 percent. The rate of growth for revenue during the period has been affected by the recent recovery from the economic recession and the increased economic growth during the post-recessionary period. Without adjusting for tax rate and base changes, the major tax revenue sources experiencing the largest growth during this period were the Realty Transfer Tax, the Personal Income Tax, and the Inheritance Tax. Five-year total increases for these tax types were 64.8 percent, 15.8 percent and 16.2 percent, respectively. Revenue from some tax sources declined or was flat over the period. Receipts from the Gross Receipt and Cigarette taxes decreased over this period. Non-tax revenue sources increased over this five-year period.

The Budget Stabilization Reserve Fund is to receive an annual transfer of 25 percent of the General Fund’s fiscal year ending balance. The transfer requirement is reduced to 10 percent of the General Fund’s ending balance if the balance of the Budget Stabilization Reserve Fund equals or exceeds 6 percent of actual General Fund revenues received for the fiscal year. Appropriations out of the Budget Stabilization Reserve Fund require approval by two-thirds of the members of each house of the General Assembly.

This budget proposes an overall decrease in the commonwealth’s current authorized salaried complement level in 2017-18 of 3,442 positions, from 81,036 to 77,594 positions. Pension and health benefit funding is projected at $6.9 billion, up from $6.7 billion in FY 2017. These expenses are projected to increase annually to $7.5 billion in period.

The projected growth in spending for reserves and employee pension and healthcare costs would be $1.3 billion by FY 2022. This growth assumes favorable economic and investment conditions through the period. The budget will be subject to a high level of risk as the Commonwealth is only a recent participant in Medicaid expansion under the Affordable Care Act. It would likely face significant pressure to cut expenses under either a block grant or per capita aid scenario. This will increase the pressure to address pensions and healthcare benefits for state retirees which have already weakened the Commonwealth’s ratings.

We expect another difficult  and contentious budget approval process like those which have occurred during the first two years of the Wolf administration. We see no respite from the pressure on the Commonwealth’s ratings going forward.

CONNECTICUT BUDGET PLAN ANNOUNCED

The budget contains a total of $18 billion in General Fund spending. The expense increase is within the state spending cap and is at a pace well below inflation. It makes required increased contributions to the pension systems of more than $357 million in the first year. The Governor states that the plan contains $1.36 billion in new spending reductions. The budget assumes approximately $700 million in state employee labor savings. They would have to be achieved through negotiation.

At more than $5 billion, municipal aid accounts for our single largest state expenditure. And addressing town aid also means addressing educational aid, which amounts to $4.1 billion – or 81 percent – of all municipal funding from the state. The budget changes the educational cost sharing formula, or ECS. For the first time in more than a decade, the formula counts current enrollment. It is intended to stop reimbursing communities for students that they no longer have.

By recognizing shifting demographics in small towns and growing cities, state funding can change with time to reflect changing communities. The new formula also uses a different measure of wealth by using the equalized net grand list as well as a new measure of student poverty. In the proposed budget, Special Education is now a separate formula grant from ECS, and Special Education funding is increased by $10 million. School systems will also be required to seek Medicaid reimbursement where available, ensuring that no community leaves federal dollars on the table.

This year, state government is set to pay $1.2 billion for a system that supports 86,000 active and retired teachers and administrators. The Governor not proposing that teachers’ benefits be limited or cut back. The budget asks the towns and cities – all of them – to contribute one-third of the cost toward their teacher pensions. This would begin to match state pension policies for policemen, or firemen, or other municipal employees. While pressure on local budgets would be raised under this budget, it will create a Municipal Accountability Review Board, chaired by the State Treasurer and the Secretary of OPM.

This will be the most controversial part of the budget process. we would anticipate that there will be great resistance to the concept of localities assuming one-third of the teacher’s pension costs. we would not be surprised to see the entire process crater over this proposal. In combination with the reliance on negotiations to achieve other labor cost savings, we see the budget proposal as being of high risk to the State’s credit. We would expect the existing downward pressure on the ratings to exist, not only for the State, but also for many of its localities.

The Governor knows this and explicitly addressed it in his budget presentation. “My budget leaves $75 million in year one and $85 million the following year in local aid unallocated. This is my way of saying to you – the legislature – that I am ready to negotiate.” Those negotiations will occur and will be quite difficult. In the meantime the pressure on state and local finances will continue.

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.