Joseph Krist

Municipal Credit Consultant

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

PREPA

Following an explosion in its Aguirre central power facility on Sept. 21, most of the 1.5 million people subscribed to the P.R. Electric Power Authority (PREPA) had no energy service, while approximately 400,000 PRASA clients were affected. As of this writing, those numbers were reduced to 300,000 clients without electricity, and 140,000 without water— figures that are still changing. The Electric Power Authority said it is investigating what caused the fire at the Aguirre power plant in the southern town of Salinas.

The fire knocked out two transmission lines that serve the broader grid, which tripped circuit breakers that automatically shut down the flow of power as a preventive measure, officials said. Executive director Javier Quintana said a preliminary investigation suggests that an apparent failure on one transmission line that might have been caused by lightning caused the switch to explode.

Garcia denied the blackout was caused by maintenance problems that have plagued the utility for years, largely a result of the island’s economic crisis. He said the switch where the fire happened had been properly maintained. It was not yet clear how much damage the fire caused. The utility is struggling with a $9 billion debt that it hopes to restructure as it faces numerous corruption allegations. Company officials have said they are seeking revenue to update outdated equipment.

This could not have come at a worse time for the Authority. Its effort to renegotiate its debt requires legislative support for a substantial rate increase. Now that there are additional questions about reliability and maintenance, that support will be harder to gather. The outage also comes in the midst of court proceedings involving corruption in P.R. agencies the Authority. All in all a more difficult environment in which to effect a  settlement of PREPA’s debts and avoid additional defaults.

PRASA

The Puerto Rico Water and Sewer Authority, PRASA, was a major victim of the power outage as well. Approximately 400,000 customers were impacted as filtration and pumping equipment could not be operated. This damaged supply as well as deliveries. The costs of recovery have yet to be calculated and the event will obviously impact revenues. There will be demands for better backup and redundancy which will raise even greater financial challenges for the Authority as it fights to meet its debt service obligations. The greater repair and other capital requirements will increase both its needs for capital and the likelihood of interruptions in the payment of existing debt service.

ATLANTIC CITY AT THE BRINK

Atlantic City has until Oct. 3 to correct its breach of a $73 million bridge loan from the state. the city is in default under its bridge loan agreement with the State as it failed to come up with a plan as required to divest itself of its municipal utilities authority. See the 9/15/16 MCN for more on this situation.

Even if the City comes up with a plan, the state must approve like it. This is far from assured. Should the City be unable to satisfy the State, the likelihood of a state takeover of the city’s finances increases substantially. The relatively short deadline for the City to come up with a cure for the default, makes such a takeover more imminent then we initially thought.

The city has drawn at least $13.5 million from the state, but most of the loan is dedicated to paying back the state for deferred employee health and pension payments and a city school-tax payment. City officials have said the city wouldn’t be able to repay the loan at this time. Liberty & Prosperity, an organization represented by a former City Councilman, has a pending lawsuit that aims, in part, to void the loan agreement. Grossman claims a July 28 council meeting when the loan was approved violated state Sunshine and Local Budget laws.

One thing has swung in the city’s favor. The businessmen leading a group  supporting a November ballot referendum to bring casinos to northern New Jersey all but conceded defeat last week when they announced an end to their advertising campaign. Polling shows the referendum is opposed by a 2-1 margin. If the referendum is rejected Nov. 8, state lawmakers would have to wait two years to attempt to put it on the ballot again.

As we go to press the City has unveiled a proposal for the Municipal Utilities Authority to buy the city’s airport, the former Bader Field, in an effort to satisfy  a key demand from state officials who are threatening to take over the City’s operations. The mayor said the land sale is the first of seven major debt reduction initiatives his administration will introduce over the coming weeks to fend off a state takeover and avoid the need for a bankruptcy filing.  Proceeds from a Bader Field sale are part of the collateral the city put up against its state loan, but Guardian said the city has one year to monetize its utilities authority before the state can intervene.

Bader Field was the first aviation facility anywhere in the world to be called an “airport.” The authority’s executive director said the authority will not dispose of the property without first getting an agreement from the city. The city has suggested that Stockton University, which is building a new campus next to the land, may eventually want some or all of it for athletic fields, an athletic building or dormitories. The city tried to sell Bader Field earlier this year, but did not get bids in excess of $50 million, or about half what the city feels it is worth.

We see this proposal as a part of an ongoing process whereby the City introduces any number of trial balloons in its effort to avoid state control. Should they amount to nothing, we see a state takeover as the more likely outcome than bankruptcy.

CHICAGO BOARD OF EDUCATION

Over the years, one of the greatest hurdles to be overcome in the effort to balance the finances of the Chicago Public Schools and deal with its pension liabilities has been the consistent lack of cooperation from its teachers union. Long one of the most militant of the nation’s teachers unions, it has employed a number of hardball tactics essentially given up by other teacher representatives across the country.

In that tradition, the Chicago Teachers Union announced this week that its members have authorized its leaders to call a strike if contract talks break down. The union said just over 90 percent of its members voted in a petition distributed over three days last week, and about 95 percent of those who voted gave the go-ahead for a strike. State law requires at least 75 percent of total CTU membership to authorize a strike before one can occur. The move was not unexpected. The union has to give at least 10 days’ notice before a walkout can take place. A date could also be set for a later time. The first possible date for a teachers strike” would be Oct. 11.

A strike would harm the interests of both sides as state aid to the school district is tied to daily attendance over a prescribed number of days. No school, no aid. Union members also authorized a strike in a vote taken last December.  Should a strike occur this time, it would be the third one since Mayor Rahm Emanuel took office in 2011. In the end, the union’s ongoing resistance to reform is a major negative weight on the CPS credit.

NYC AND TAX ABATEMENTS

The presidential debate has helped to focus much attention on Donald Trump and his use of tax abatements to enhance the profitability of his New York developments. One report estimated that he has benefitted to the tune of $889 million from such abatements over his four decade career. Those of us who have economics in our background know that these sorts of deals are also called tax expenditures. While there may not be a direct monetary expenditure to support a project, an abatement or tax expenditure serves the same purpose.

Earlier this year, one of New York City’s major development-related tax abatement programs, 421-a, expired, impacting the development of multi-family housing.  Just because the program was suspended does not mean the city is not still paying for previously granted tax breaks. In 2017, the current fiscal year, the city will forego $1.4 billion in property tax revenue due to exemptions granted in prior years. The last of the properties awarded 421-a benefits before the program’s expiry are not expected to fully return to the property tax roll until 2044. The abatement for the Hyatt Hotel project at Grand Central – the project that launched the Donald’s career in 1980 – will not expire until 2020.

This particular program has some troublesome characteristics. Since fiscal year 1998, only 16 percent of the total tax expenditure awarded each year on average is attributable to newly exempted properties. For the 2017 tax roll, $94.2 million in new 421-a tax expenditures were added, the largest volume increase since 2013 and $14.2 million greater than the 20-year average. Buildings that started construction after 2008 are subject to a cap on the amount of value exempted regardless of appreciation. However, for older buildings the value of the exemption can continue to grow as properties appreciate.

The takeaway is that these programs must be carefully targeted and designed. While many were granted during times of economic uncertainty, the long-term budget impact and current economy of the City argue against maintenance of the same design. There are many ways to address the City’s shortage of affordable housing without impacting the revenues available for services for the residents.

HARTFORD BUDGET WOES GROWING

Yet another state capital is in the news for its poor financial condition, this time it is Hartford, CT. Days after Mayor Luke Bronin revealed that the city’s budget gap has grown to more than $22 million this year, Standard & Poor’s lowered Hartford’s G.O. bond rating to BBB from A+. The change ” reflects the city’s structural imbalance without a credible plan in place to return to balanced operations.”

The fiscal 2017 budget imbalance is blamed on the use of reserves and labor concessions that have not been realized.  The city is facing significant out-year budget gaps in excess of $30 million in 2018 and $50 million as well. The mayor has said what Hartford did for many years was to hide its true position. City projections show Hartford’s budget shortfall has widened to $22.6 million this year, up from $16.5 million. The deficit is linked to employee concessions that haven’t materialized, a sizable legal settlement and debt service on a baseball park.

The mayor has asked frequently in recent weeks for legislative reform that would give Hartford and other cities new ways of raising revenue. Connecticut’s municipalities have long relied primarily on property taxes to fund critical services. He renewed that view after the S&P downgrade saying “we can put Hartford and the capital region on a path to fiscal health and economic growth, but it’s going to take everyone coming together — in Hartford, the region and the state — to face the realities that we need to face.” His position is that the city of Hartford can’t cut or tax its way out of this challenge by itself.

Waterbury was the last Connecticut municipality to seek state oversight when the legislature established a financial review board in March of 2001. The specific goal in that case was balancing the city’s budget for five straight years. That review board maintained control of Waterbury’s finances until 2007. Bankruptcy has been mentioned but we see the likelihood of that as being quite small given the State’s history of intervention when the City of Bridgeport filed for Chapter 9 protection in 1991.

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

Municipal Credit Consultant

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

LATEST TWIST IN CHICAGO OPEB SAGA

On September 15, a state appeals court ruled on an appeal in the ongoing Korshak litigation which deals with OPEB benefits for city employees after 2013. We discussed that ruling in our July 18, 2016 issue. A three judge panel unanimously agreed that the trial court erred by striking defendants’ motion to enforce a settlement agreement. The settlement was modified and the court had jurisdiction to enforce the modification. The City agreed to provide benefits to its retirees for the entire 2013 plan year and its assumed obligation imposed a duty to reconcile and to pay the amount it agreed to pay under the settlement agreement.

The trial court found that, because the agreement by its own terms expired in June 2013 and because the City’s actions did not constitute a modification of the original settlement agreement, it lacked jurisdiction. The appeals court  reversed that ruling and remanded the case to the circuit court with directions that it enter an order in favor of the retirees.

The appeals court found that the retirees’ theory is that they are not asking the court to modify or amend the agreement. Instead, the retirees maintain that the City itself extended the agreement and they are seeking to enforce the City’s modified obligation. The Court referenced numerous City documents in its decision. The City maintains that whatever it agreed to do and whatever obligations it took on, there was never an extension of the settlement agreement beyond June 30, 2013. The City’s letter explains that “Under the Korshak (April 2003) Settlement Agreement, the City of Chicago agreed to provide support for annuitants through June 30, 2013″and establish a commission to make recommendations for the plan going forward. “The City will extend current coverage and benefit levels through December 31, 2013. This additional time will allow retirees to maintain coverage for a full plan year, recognizing what we heard from many retirees who have planned deductible and out of pocket expenditures based on an expectation of full year coverage. The City will, however, adjust the benefit levels provided under the current plan starting January 1, 2014. After January 1, 2014, the City will provide a healthcare plan with continued contribution from the City of up to 55% of the cost for that plan for their lifetimes to the City retirees who are members of the Korshak (subclass) . . . For all annuitants who retired on or after August 23, 1989, in light of the evolving landscape of national healthcare and challenges faced by Chicago taxpayers, the City will need to make changes to the current retiree healthcare plan.

“The letter from the City commits it to continue to provide coverage at the same levels as under the April 2003 agreement for the rest of the plan year. The City, however, argues that its “voluntary extension of benefits” did not “constitute an extension of the 2003 settlement agreement.” The City’s letter expressly invokes the settlement agreement and commits the City to “extend current coverage and benefit levels through December 31, 2013,” giving retirees “additional time” so that they “maintain coverage for a full plan year.”

The City suggests that it never said it would extend the agreement, only that it would extend the benefit levels. But that overexacting reading fails to give the commitment expressed in the letter a reasonable interpretation in light of the words used and their context. Moreover, the reading the City would have us ascribe to the letter ignores the nature and realities of the parties’ relationship, failing to account for what both parties understood the commitment to mean along with what actually transpired.

In its letter, in light of the commission’s suggestions, the City committed itself to “extend current coverage and benefit levels.” Those are the essential terms of the settlement agreement being “extended.” The reason for the extension was to give retirees “additional time” allowing them to “maintain coverage for a full plan year.” The full “plan year” went to December 31, 2013, suggesting an unbroken continuation of the status quo. Not what the City proffers—some separate conferral of benefits—but maintaining what was in place until the end of the plan year.

The letter then explains that the City would “adjust the benefit levels provided under the current plan starting January 1, 2014.” The letter also states that, beginning in 2014, “in light of the evolving landscape of national healthcare and challenges faced by Chicago taxpayers, the City will need to make changes to the current retiree healthcare plan.” If the then-current plan ceased in June 2013, why would the City repeatedly state that it would start to make changes to that plan in 2014. The only reasonable interpretation is that it remained the operative plan.”

The initial amount at stake is $50 million covering the last six months of 2013. More importantly, the Court indicated in its decision that any changes going forward needed to be negotiated. This leaves the City in a more difficult position. For us it is an indication that any ratings moves based on the City’s pension outlook be made slowly and cautiously.

PR PROMESA NOT OFF TO A GOOD START

The political pressures are off to an early start as the fiscal oversight board in Puerto Rico begins its work. One example of why many investors are skeptical about the willingness of the body politic to do what is necessary is the current debate about the board’s powers as they pertain to government employment. Recently, Senate President Eduardo Bhatia of the pro-Commonwealth Popular Democratic Party said that Promesa “does not establish anywhere” that government employees hired after May 4 or those who obtained their permanent status after that date, could be let go, as stated previously by the pro- statehood New Progressive Party (NPP) president and gubernatorial candidate Ricardo Rosselló.

No one argues that 4,117 permanent positions were granted after May 4 as the government was planning its July bond default. The minds of investors cannot be faulted for reeling at the idea of hiring for example, additional teachers for a school system that is steadily losing students during a time of obvious financial crisis. In the meantime, Richard Ravitch,  the representative at the federally appointed board, of which the governor is a nonvoting member offered a number of unsettling thoughts.

He predicted that the García Padilla administration’s long-term  fiscal plan would include a “majorly worse” fiscal outlook. He said after meeting four members of the board that they could face a “steep learning curve.” He recommended fixes for Puerto Rico he thinks the U.S. Treasury missed, he mentioned Act 154—the 4% excise tax on certain multinationals doing business on the island, currently set to phase out in 2017. It accounts for almost one-fourth, or $2 billion, of the island’s annual tax revenue.

It is generally thought that the board’s chairman is expected to be named, as required by the federal law. Then the long slog to recovery can hopefully begin. That effort will not be aided by the most recent news from Puerto Rico’s Institute of Statistics that 64,000 Puerto Ricans left last year, matching the highest number reported in the past 11 years. The vast majority of Puerto Ricans are settling in the U.S. mainland.

In the meantime, Rafael Hernández Montanez, a leading legislator has called for the resignation of one of the board members. Montanez was one of the legislators who initially backed tax increases in April of this year but then reversed himself in a move that helped to hasten a default. This is exactly the kind of political grandstanding that will impede efforts to resolve the financial crisis.

NEW MEXICO UNDER REVIEW

The Land of Enchantment may not have a large amount of general obligation debt outstanding ($327 million) but it is rated Aaa by Moody’s. That may not be true much longer as Moody’s has placed the rating under review. The state recently released August revenue estimates which show an extremely large reduction in estimated General Fund revenues for both fiscal 2016 and fiscal 2017, compared to its prior forecast prepared in January. The fiscal 2016 revenue estimate was reduced by $348 million, resulting in a significant drawdown of total General Fund reserves to $130 million or 2.3% of recurring revenues. The fiscal 2017 revenue estimate was reduced by $556 million, throwing the budget into structural imbalance. Absent any legislative action, the August estimates would result in an ending reserve deficit for 2017 of $326 million or -5.7% of recurring revenues. The legislature will convene in special session this month to address the shortfalls. If they do not, the rating could be impacted.

New Mexico’s GO bonds are paid from a dedicated statewide property tax levy without  without limit as to rate; the treasurer is required to keep tax proceeds separate from all other funds; and the state’s practice is to levy the tax in advance so that debt service is pre-funded. The state’s more widely issued severance tax backed bonds were downgraded in May of this year. That downgrade was primarily attributable to the sharp reduction in coverage for the senior and subordinate lien bonds resulting from the decline in oil and gas prices and the expectation that coverage will not return to prior levels in the near term. The ratings also reflect the inherent volatility of the pledged revenue stream, which consists primarily of taxes on the production of natural gas and oil in the state.

New Mexico is the 36th-largest state by population, at 2.1 million. Its state gross domestic product, $92.2 billion, is the 37th-largest. The state’s wealth levels are below average, with per capita personal income equal to 81.5% of the US level and a poverty rate among the highest for US states.

SAN BERNARDINO HOPES TO CLOSE OUT CH. 9 PROCESS

In our most recent issue, we discussed the issue of market vs. actuarial valuations for calculating pension liability requirements for California’s units of local government. One of those cities is San Bernardino which recently concluded four years of operations under Chapter 9. The City has started, what it hopes to be, the final step on the path to exit bankruptcy. A hearing to consider confirmation of “Third Amended Plan for the Adjustment of Debts of the City of San Bernardino” is set for 10 a.m. on Friday, October 14, 2016. Implementation is complete or underway on all actions targeted for 2015 under that Plan. In addition, implementation of several elements targeted for 2016 are already underway.

If finally approved, the City will have reached agreements to adjust general obligation debt, unsecured pension debt (the City has reached agreement with creditor. Obligation reduced from $95.8 million to $50.7 million. Annual payments reduced from $3.3 to $4.7M per year to $1.0 to $2.5M per year.), and achieved an estimated total of $60 million in cost savings related to employee healthcare. A new draft charter is under development and has been reviewed at public meetings. The Charter Committee provided recommendations to Council in May and anticipates a November 2016 election.

ARKANSAS REVIEWING P3 OPTIONS FOR HIGHWAY

The Arkansas Highway and Transportation Department is commissioning a study on the feasibility of not only using tolls to help build a new section of Interstate 49 in western Arkansas, but also to have a private entity operate and maintain the tollway. The Arkansas Highway Commission last week approved an order to solicit consultants to study using tolls and a public-private partnership to complete a 13-mile section of I-49 from Interstate 40, where I-49 ends now, south to Arkansas 22 in Barling. It would be the first public-private partnership on a roadway project in Arkansas, state highway officials said.

The department director stated  “The thought, if the money part works out, is that a private entity would design, build, operate and maintain what would actually be a design-build-finance-operate-maintain project. Part of the study should also evaluate the costs and benefits of operations and maintenance by a third party versus operations and maintenance by the department.”

The move would be a logical next step in the Department’s use of the private sector. Currently, the department is using a more limited design-build method on its Interstate 30 corridor project, a series of improvements through downtown Little Rock and North Little Rock, including replacing the I-30 bridge over the Arkansas River. Longer term, a likely candidate for a toll financed P3 would be the previously discussed  I-49, which is a north-south corridor between Kansas City, Mo., and Shreveport, La. More than $1.2 billion has been spent on improvements in the Arkansas stretch of the highway that is 99 percent complete from I-40 to Canada. The environmental impact statement for the project is outdated as the Federal Highway Administration approved it in 1997.

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

Municipal Credit Consultant

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

CALIFORNIA PENSIONS

A story about pension funding in California in the New York Times this weekend has focused attention on the different ways of accounting for pension liabilities. The story was about a small six employee municipal district which wanted to shift out of the state retirement system – Calpers – and convert their employees to a 401 k system. That switch would have required it to pay Calpers an amount of money to fund a termination pool it maintains to make sure that funds are available for remaining fund participants. In the case of this small district, it thought that its pension liability was overfunded. When it went to terminate, Calpers charged it a much higher amount.

The difference has to do with which method is used to determine a given entity’s liability – the actuarial approach (which is geared toward helping employers plan stable annual budgets, as opposed to measuring assets and liabilities), and the market approach. Fortunately for investors, in California, both the market values and the actuarial pension values for many places are available on a website run by the Stanford Institute for Economic Policy Research. But for the 49 other states, the market numbers remain unknown.

We decided to look at the data assembled by Stanford to see how California’s cities and districts rank. Stanford uses market valuation of fund assets and determines a per capita liability for each jurisdiction. The entity in the worst position is the southern California suburb of Irwindale, at $134,000 per capita. San Francisco is fifth worst at $47,288 per capita. Beverly Hills was seventh worst at $42,056. The City of L.A. was 13th at $26,847. San Jose was 29th at $19,908. San Bernardino, still waiting to emerge from bankruptcy, was 55th at $17,027. Stockton was 90th at $14,355. Sacramento was 110th at $13,458.

A total of 1,068 units of government has data available to be examined. There are a number of prominent entities for which market value data was not available. These include Los Angeles County, the cities of Bakersfield and Oakland, and a number of the larger school districts in the state. While imperfect, the survey is clearly a good starting point and the data does serve to focus attention on the whole question of what the appropriate method of measurement for pension liabilities is.  It is an issue that won’t go away whether you are an employee, investor, local financial official or taxpayer.

SEC ENFORCEMENT EFFORTS GET LEGAL BOOST

In a case that had its origins in actions taken by Miami, FL financial officials in 2007, a Miami jury found that Miami and its former budget director, Michael Boudreaux, were guilty of securities fraud for faulty disclosures in connection with three 2009 municipal bond offerings. The jury decision is considered to be the first of its kind. The trial was held in the U.S. District Court for the Southern District of Florida in Miami. It took just over two weeks.

Andrew Ceresney, the SEC’s enforcement director, said the commission is very pleased by the ruling. “This was the first federal jury trial by the SEC against a municipality or one of its officers for violations of the federal securities laws. We will continue to hold municipalities and their officers accountable, including through trials, if they engage in financial fraud or other conduct that violates the federal securities laws.”

The verdict is expected to be appealed. The next step for the SEC will be  to file a motion seeking remedies from the case, including an injunction barring Miami and Boudreaux from future securities law violations and financial penalties. The SEC previously obtained an order that commanded Miami to comply with a prior cease-and-desist order from 2003 that resulted from an earlier securities fraud case. “Based on the jury’s findings, the SEC anticipates that the federal district court judge will also enter a finding that the city of Miami violated [the] prior SEC order, imposed after a fully litigated administrative trial, prohibiting it from engaging in fraudulent conduct,” according to the enforcement director.

The jury found that Miami was guilty on all four counts that the SEC sought, which were based in fraud provisions contained in Section 17(a) of the Securities Exchange Act of 1933 and Section 10b-5 of the Securities and Exchange Act of 1934. Finance Director Boudreaux was found guilty on all counts except for the first, which was based in Section 17(a)(1) and would have required the jury to find that Boudreaux “used a device, scheme, or artifice to defraud in connection with the offer to sell or sale of any securities.”

The defense was based reliance on auditors in connection with the alleged fraud and misrepresentations. The jury found that neither defendant completely disclosed the facts about the conduct at issue to the auditors, sought advice from the auditors about their specific course of action, received advice from the auditors about that course of action, or relied on and followed the advice in good faith.

The alleged omissions and misrepresentations were made in: bond offering documents for the three offerings in 2009 that totaled $153.5 million; presentations to bond rating agencies; and the city’s comprehensive annual financial reports (CAFRs) for fiscal years 2007 and 2008, according to the SEC. The city disclosed the inter-fund transfers in each of their CAFRs and official statements, but, according to the SEC, the defendants said the transfers contained money that was not expended and was being returned to the general fund. The SEC contended that money had already been pledged to several ongoing capital projects and some of it was restricted by city law for designated purposes and not the general fund. The assertion to the contrary was considered to be securities fraud.

Defense lawyers argued that the commission could not base its claims on the city’s 2007 CAFR because it was not incorporated into any of the three 2009 bond offerings cited in the complaint. They also argued that the 2008 CAFR did not have any misrepresentations. Additional arguments asserted that the SEC was trying to hold their clients, who they say followed Governmental Accounting Standards Board and other recognized requirements, to a higher standard that does not exist. They also argued that they could not be held responsible for the use of the information by rating agencies.

They claimed that that the fact misstatements were only part of the rating analysis was not tantamount to fraud. Their view was that this was because their analysis encompassed more about  Miami’s finances than just the fund transfers. The fact that certain data would have skewed some of the quantitative ratio formulae used at the rating agencies in the City’s favor is something the City and its finance director either did not understand or overlooked. Neither explanation speaks well for them.

PRIVATE PRISON PROBLEMS CONTINUE

A privately operated Mississippi prison that a federal judge found that was run by gang related inmates was closed last week. The closing is the second by the State of Mississippi of a private facility. The 1400 inmate facility, the Walnut Grove Correctional Facility, was originally financed by a county authority. The original financing was refunded by that issuer and then subsequently refunded twice by the State. Those transactions made the debt an annual appropriation obligation of the State. The most recent refinancing was in July when the decision to close the facility was already public knowledge. The MDOC has said the state simply no longer needed the private prison beds in Walnut Grove.

Due to the impact on the local economy, local authorities have been overstating the debt impact on the State. Walnut Grove is losing 215 jobs in a town of less than 500 and $180,000 in tax revenue than isn’t likely to be replaced to pay for city services. The total annual impact to the city is estimated at $618,500. In reaction, city workers were furloughed and the Town police took a $2-per-hour pay cut.  Approximately $33 million of debt is outstanding for the project maturing through 2027. Like the debt for the first closed facility which was paid through maturity, the State has pledged to appropriate monies for full payment of these bonds. Should that occur, it will mean that all $93 million of the original project cost will have been repaid.

Investors who own locally issued bonds for private prisons will take solace from this outcome. They will hope that it serves as a template  for the resolution of any issues which might arise as the result of similar actions across the country.

CONNECTICUT TO APPEAL SCHOOL FUNDING RULING

The State of Connecticut said on Thursday that it would appeal a ruling in a schools funding case that found that Connecticut was “defaulting on its constitutional duty” to give all children an adequate education because the state was allowing students in poor districts to lag behind while those in wealthy districts excelled.

The state said in its appeal that the judge demanded changes to educational policies that could be enacted only by the Connecticut General Assembly. The judge gave the state 180 days to revamp teacher evaluations and compensation, school funding policies, special education services and graduation requirements.

The Governor accepted the attorney general’s decision to appeal and hoped systemic education problems could be addressed in the coming session of the General Assembly, calling a legislative approach “always preferable to a judicial decision.”

LAS VEGAS STADIUM MOVES FORWARD

The 11-member Southern Nevada Tourism Infrastructure Committee sent a proposal that could bring the NFL to Las Vegas to Gov. Brian Sandoval for his consideration. The stadium developers’ preferred funding option requires a $750 million public investment, eliminates a 39 percent public contribution cap and allows the private partners to reap all stadium profits during the lifetime of the Raiders’ lease. The deal requires the family of Las Vegas Sands Corp. Chairman Sheldon Adelson, Majestic Realty and the NFL’s Oakland Raiders to pay the remainder of the construction costs for the 65,000-seat stadium, along with any cost overruns. Adelson has pledged to contribute at least $650 million, while the Raiders would pay $500 million.

A special session of the state Legislature to approve the financing plan would have to be called. The plan hinges on a Clark County hotel room tax increase. If lawmakers approve the plan, the Oakland Raiders have promised to pursue relocation to Las Vegas. Stadium supporters said that if the state Legislature doesn’t hold a special session before the Nov. 8 election, then it could make it more difficult for a Raiders relocation package to be approved by the NFL in January. They acknowledge that the final call must come from Sandoval.

“I would like to extend my sincere gratitude to the members of the Southern Nevada Tourism Infrastructure Committee and its Technical Advisory Council for their tireless efforts and dedication to completing the recently approved recommendations… I will begin my review of the Committee’s recommendations and will also begin discussions with legislative leadership, local stakeholders, and my cabinet to clarify any outstanding questions. I will not move forward until all questions have been resolved,” said Governor Brian Sandoval.

“More than one year ago, I signed an Executive Order bringing together many of the brightest minds in gaming and hospitality as well as community leaders in an effort to identify the untapped potential and unfulfilled demands in the Southern Nevada tourism industry. Nevada has served as the standard bearer for global tourism, gaming, and conventions for decades. In order to remain the top destination, we must explore potential opportunities and push forward to lead this international  committee will serve as a roadmap to Southern Nevada’s unrivaled and continued success.”

It sounds like he is a fan.

SHIPPING BANKRUPTCY SHOULD NOT IMPACT U.S. PORTS

Last month, Hanjin, the South Korean shipping giant filed for bankruptcy, leaving dozens of ships literally stranded at sea around the world. Of these, 14 were bound for U.S. ports. Some of the stranded ships have been turned away by ports that are fearful their dockworkers won’t get paid. Others have been seized by authorities, with crews prevented from disembarking. But there are a couple of reasons that this should not be an issue for U.S. ports and their revenue bonds.

A U.S. judge has issued a court order allowing some vessels to dock at U.S. ports without the risk of being seized by creditors. The company received authority to spend money needed to dock at U.S. ports and begin unloading four vessels that have been stranded at sea by the company’s failure last week, a company lawyer told a U.S. court on Friday. “We have the money,” an attorney for Hanjin, told a U.S. Bankruptcy Court hearing in Newark, New Jersey on Friday. “We want to call these ports and say, please accept our ships and we want to pay for the services to work the ships.” The attorney said at least $10 million was authorized by a Korean court to begin servicing the four ships.

How, one might ask, can a U.S. judge be involved? We asked and found out about Chapter 15 of the U.S. Bankruptcy Code. Chapter 15 was added to the Bankruptcy Code by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. It is the U.S. domestic adoption of the Model Law on Cross-Border Insolvency promulgated by the United Nations Commission on International Trade Law (“UNCITRAL”) in 1997, and it replaces section 304 of the Bankruptcy Code. Because of the UNCITRAL source for chapter 15, the U.S. interpretation must be coordinated with the interpretation given by other countries that have adopted it as internal law to promote a uniform and coordinated legal regime for cross-border insolvency cases.

The purpose of Chapter 15, and the Model Law on which it is based, is to provide effective mechanisms for dealing with insolvency cases involving debtors, assets, claimants, and other parties of interest involving more than one country. This general purpose is realized through five objectives specified in the statute: (1) to promote cooperation between the United States courts and parties of interest and the courts and other competent authorities of foreign countries involved in cross-border insolvency cases; (2) to establish greater legal certainty for trade and investment; (3) to provide for the fair and efficient administration of cross-border insolvencies that protects the interests of all creditors and other interested entities, including the debtor; (4) to afford protection and maximization of the value of the debtor’s assets; and (5) to facilitate the rescue of financially troubled businesses, thereby protecting investment and preserving employment.

When I was just staring out in this business, a great mentor of mine told me that what was fascinating about municipal bond analysis is that eventually everything comes through the municipal bond market. This is just the latest example of why that advice was so true.

Disclaimer:  The opinions and statements expressed in this column are solely those  of the author.  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

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

CHICAGO PENSION VOTE

The City Council by a vote of 40 to 10 approved the mayor’s plan to put a 29.5 percent tax on water and sewer bills to fund a Municipal Employees Pension Fund with $18.6 billion in unfunded liabilities that’s estimated to run out of money in 2025. The tax will be phased in over a four-year period to minimize the burden on homeowners and businesses already facing an $838 million in property tax increases for police, fire and teacher pensions and school construction.

The average homeowner will pay $53.16 more next year; $115.20 in 2018; $180.96 in 2019 and $225.96 in 2020 and 2012. During the four-year phase-in, the city’s annual take will rise — from $56.4 million next year to $240.1 million in 2020. The plan was “sold” as the most “reasonable” alternative given the relatively lower water and sewer rates that Chicagoans pay for Lake Michigan Water.

It is acknowledged that the tax is not a total answer for the city’s $30 billion pension crisis but many argue that the influx of $240 million in annual revenue by 2020 will go a long way toward helping Chicago meet the challenge. The largest of four city employee pension funds would still be left with a hole in 2023 — even after the utility tax is fully phased in. That hole will require “more revenue” to honor the city’s ironclad commitment to reach 90 percent funding over a 40-year period. Cost-cutting and future benefit reductions could fill at least part of the gap.

After the vote, Emanuel acknowledge that the aldermen may well pay a political price for saving the “fourth and final” city employee pension fund. The mayor’s City Council floor leader said, “I don’t think anybody who is living in Chicago thinks this is the last tax increase that any City Council member is gonna vote on in this body for the next 10 or 15 years. There will be more.” “But this is going to put us into a situation where our pension funds will be ramped up to an actuarial funding. And it will allow us to, at the state level, begin to work on some answers that help us long-term. And that’s really where we want to be.”

The Council insisted on last-minute language that would prohibit the city from spending utility tax proceeds on anything but the Municipal Employees Pension Fund. The Mayor accused the Illinois Supreme Court of putting a “straight-jacket” on Chicago by overturning his plan to save the city’s largest and smallest pension funds. The vote creates a way out of those legal constraints, albeit at a heavy price for Chicago taxpayers and a potential political price for himself and the aldermen who supported it. The Illinois General Assembly needs to sign off on the employee concessions tied to the mayor’s plan to save the Municipal Employees and Laborers pension funds.

ATLANTIC CITY TO MISS LOAN DEADLINE

Atlantic City Mayor Don Guardian said his troubled resort town will miss the Sept. 15 deadline to pass a resolution dissolving the water authority, one condition for a $73 million state loan. The mayor said, “Although the September 15th deadline will pass tomorrow without a City Council resolution dissolving the MUA or designating it as collateral in case of default, we have asked the state for a reprieve on this, because we believe that the MUA will actually be a better part of the overall financial solution if it is kept whole,” Guardian said in a statement.  “In the end, we think this will be the best plan to move Atlantic City forward while at the same time maintaining our sovereignty and decision making rights now held by locally elected leaders.”

Under the terms of the agreement, the state can demand immediate repayment if the city fails to disband the Municipal Utilities Authority. As we went to press Governor Chris Christie, had not issued a response to Guardian’s statement. The city has until November to develop a five-year plan to restore fiscal stability and avoid a state takeover. The state could sell its assets and void or change labor contracts through he stated that the “150-day plan is moving forward quickly.  We just need the time to finish the plan and to present it publicly.”

Should the State move to take control of the City, there is likely to be litigation seeking to delay or stop the effort. The powers that be in Atlantic City may not be the best managers or leaders but they will fight as long as possible to maintain home rule for the City. The governor’s role in the Trump campaign may be enough of a distraction to preempt action at this time but once the election passes and the deadline for a financial plan has arrived state action is more likely.

EAST CLEVELAND, OHIO

East Cleveland is located only minutes from University Circle, the cultural hub of Cleveland. Cultural institutions located here include the Cleveland Museum of Art, which is celebrating its centennial year after completion of a $350 million renovation and expansion. Other institutions located here include the dynamic new Museum of Contemporary Art, the Cleveland Institute of Music, Severance Hall, home of the world renowned Cleveland Orchestra, the Cleveland Botanical Garden, the Museum of Natural History and Case Western Reserve University.

John D. Rockefeller purchased Forest Hill Park in 1873 and built his summer home there. His plan was to develop an upscale residential and commercial development featuring French Norman-style homes. After a fire which destroyed the Rockefeller home in 1917, the Rockefeller family donated the property to the cities of East Cleveland and Cleveland Heights, with the stipulation that it be developed as a park and recreational area. The Rockefeller homes are listed on the National Registry of Historic Places as the “Forest Hill Historic District.”

Rockefeller also donated the land for Huron Hospital in 1931 which was the city’s largest employer when it closed in 2011. East Cleveland is also notable as the home of General Electric Corporation’s Lighting Division at NELA Park, established in 1911, the first industrial research park in the world, following General Electric’s acquisition of the National Electric Lamp Company in East Cleveland.

Much has changed over the years as the industries which fuelled the City’s development changed and moved on and little was done to replace them. Now, the City is essentially  insolvent facing bankruptcy and trying to negotiate a merger with Cleveland. Over 40 percent of the population lives in poverty, streets are dotted with abandoned homes and unemployment remains at double digit levels.

In the midst of those negotiations which have been contentious to say the least, the Cuyahoga County Board of Elections and East Cleveland City Council Clerk’s office have certified more than 600 petition signatures to force a recall vote of Mayor Gary Norton and City Council President Tom Wheeler. The board’s executive director said he expects to set the election for Dec. 6.

The special election, which could cost the city between $25,000 and $30,000, will come just 10 months before the next mayoral primary election. The residents needed 560 valid signatures to force a special recall election. More than 1,200 signatures were submitted to the board. Under the East Cleveland charter, if the mayor did not resign by yesterday, he will face a recall election within 60-90 days. Norton does not plan to resign. Norton said the money the election will cost will have to be cut from other city services. He pointed to possible cuts in police and fire.

The City Council has already faced recall efforts twice since December, and an effort to recall the mayor last spring failed. An amendment to the city’s charter meant to curtail the ease with which residents can trigger a recall is currently being reviewed by the board of elections and has not been finalized for the November ballot. Eventually, the annexation question will be put to a vote of East Cleveland residents. East Cleveland’s proximity to University Circle means that in a merger with Cleveland, land could be ceded for potential luxury developments drawing wealthy residents desirous of living near the cultural heart of the city.

CA. DISCLOSURE BILL SIGNED INTO LAW

Gov. Jerry Brown signed into law Senate Bill 1029. This bill would require that the report of proposed debt include a certification by the issuer that it has adopted local debt policies, which include specified provisions concerning the use of debt and that the contemplated debt issuance is consistent with those local debt policies.

This bill would also require a state or local public agency to submit an annual report for any issue of debt for which it has submitted a report of final sale on or after January 21, 2017. The bill would require the annual report to cover a reporting period of July 1 to June 30, inclusive, and to include specified information about debt issued and outstanding and the use of proceeds from debt during the reporting period. The bill would require that the report be submitted within 7 months after the end of the reporting period by any method approved by the commission. The bill would require the commission to consult with appropriate state and local debt issuers and organizations representing debt issuers prior to approving any annual method of reporting pursuant to these provisions, as provided.

California’s 4,200 units of local government have issued $1.5 trillion in debt since 1984. The California Debt and Investment Advisory Commission (CDIAC) was created in 1982 to provide information, education, and technical assistance on debt issuance and investments to local public agencies and other public finance professionals. Existing law requires the issuer of debt of state or local government to submit reports to the commission, within specified timeframes, of the proposed issuance of debt and of final sale, as provided.

It is the intent of the Legislature that all debt issuance of state and of local governments be published in a single, transparent online database that allows the citizens of California to analyze, interpret, and understand how debt authorized by the public is utilized to finance facilities and services at the state and local level. The issuer of any proposed debt issue of state or local government shall, no later than 30 days prior to the sale of any debt issue, submit a report of the proposed issuance to the commission by any method approved by the commission.

This subdivision shall also apply to any nonprofit public benefit corporation incorporated for the purpose of acquiring student loans. The commission may require information to be submitted in the report of proposed debt issuance that it considers appropriate. Failure to submit the report shall not affect the validity of the sale. The report of proposed debt issuance shall include a certification by the issuer that it has adopted local debt policies concerning the use of debt and that the contemplated debt issuance is consistent with those local debt policies.

OPA LOCKA FLORIDA INVESTIGATION

Earlier this year (MCN, 6/7/16) we noted that Governor Rick Scott issued an executive order declaring that the City of Opa-Locka in Dade County needed  state assistance to resolve the state of financial emergency that currently exists through the implementation of measures authorized  by Part  V, Chapter  218, Florida Statutes. We also noted that the FBI was undertaking an investigation targeting city leaders, including the Mayor, the City Manager and a City Commissioner.

So we are not surprised by this week’s report that David Chiverton, the Opa-locka manager pleaded guilty in federal court on Monday to using his office to pocket thousands in cash bribes from local business owners. Opa-locka government leaders were caught shaking down businesses in exchange for permits and water connections. An indictment is expected to be returned by a grand jury in Miami that will likely name other known figures, including City Commissioner Luis Santiago, according to sources. Public Works Supervisor Gregory Harris pleaded guilty two weeks ago to a bribery charge. Four years ago, Chiverton was hired as assistant city manager and was named city manager November, 2015 after the commission fired his predecessor, following his public disclosures that Opa-locka was almost broke.

It remains a depressingly common thread in these instances that small suburban local governments in areas with very poor socio economic conditions continue to feature corruption along with financial difficulties. In this case, the indicted City Manager is charged with being involved in the crimes he plead to over at least a two year period.

UNIVERSITY OF ILLINOIS

The state university system in Illinois has been a well documented victim of the state’s ongoing budget mess. It is still a more highly rated entity (Aa3/A+) than the State itself despite its long reliance on the State for substantial funding of its public mission as an educational and research resource. So it is with interest that we review the financial information presented in association with its planned sale of some $116 million of revenue bonds.

As is often the case, the most recent audited financials are over one year old covering fiscal 2015. State operating support declined 2.3% or $15 million. Tuition revenues are now over $1 billion or 19% of revenues. Total state funding still totals $1.825 billion, some 31% of revenue. As one could imagine, compensation and benefits account for two thirds of expenses. When a student enrolls, their level of tuition is guaranteed for four years. While even for FY 2016, the University anticipates increases going forward as new students enroll.

The University has done a good job of maintaining its cash position in the face of the State’s budget delays and reductions. Cash and investments were essentially unchanged to slightly increased on a year over year basis. This does the reflect the deferral of funding of certain obligations including pensions. The greatest ongoing pressure facing the Board’s credit is the potential for declines or interruptions in cash flows from the State as it continues to battle over annual state budgets.

Until the State is able to make meaningful lasting progress on its annual budgeting process and funding of pension liabilities, the University’s credit will continue to be under pressure. As it is, the ratings are effectively capped at their current levels. So long as the University relies on a substantial portion of its revenues for its operating budget, this will continue to be the case.

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 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

HENRY FORD HEALTH SYSTEM

Henry Ford Health System is an established multi-hospital system serving southeastern Michigan. HFHS is a large, fully integrated health system based in the Detroit metropolitan area. The system operates four acute care hospitals, two behavioral health hospitals, multiple ambulatory care and outpatient service facilities, a sizable health insurance business, and a large employed group physician practice. HFHS’s flagship hospital, Henry Ford Hospital, is a tertiary/quaternary referral hospital located near downtown Detroit. It has long been positioned to cope with the ever changing healthcare landscape. This has been borne out by its latest rating review in association with an $820 million financing scheduled for this week.

HFHS plans  to implement a new Master Trust Indenture as a component of the contemplated transaction. Bonds will now be secured by a pledge of Gross Receivables from Obligated Group Members. The MTI will include a debt service covenant of 1.1x and it will be an event of default if it fails to maintain coverage of at least 1.0x for two consecutive years. If coverage results between 1.0x – 1.1x, a consultant must be called in. HFHS’s insurance division is a Designated Affiliate and not an Obligated Group Member. However, Obligated Group Members may cause Designated Affiliates to upstream money to the Obligated Group.

The bonds under the new Master Trust Indenture earned an A3 rating with a positive outlook. The rating is based in the system’s large size and HFHS has a long history of operating an integrated delivery network with a large group of employed and community physicians, multiple hospitals including high acuity facilities, and a large health insurance division. The rating would likely be higher were it not for HFHS’ location in highly competitive markets which include other large and well-funded competitors. Its  operating margins have historically been below that of peer organizations which is somewhat reflective of its service to the inner Detroit market.

HFHS is another reflection of our ongoing thesis that size does and will continue to matter in the healthcare sector.

STADIUM FINANCE

Cumberland County, NC is considering a proposal which would dedicate up to 75 percent of new property tax receipts generated around a proposed baseball stadium to help pay for it. County  commissioners recently discussed in a closed meeting giving up to three-fourths of any new tax revenue from a special tax district to help the city of Fayetteville build a proposed minor league ballpark.

City officials have not yet revealed the proposed district’s boundaries, but they would include private, taxable investment around the stadium site of almost 10 acres. The city has capped the potential stadium project at $33 million. The city would borrow money for it. The city also asked if the county could make a one-time contribution to help defray the debt. He said the county commissioners considered using some of the reserves from the county’s recreation tax district, which is levied on property outside the city limits, but they were told using the money inside the city would be restricted.

In August, the council unanimously approved a nonbinding memorandum of understanding that would bring a Class A team owned by the Houston Astros. The memorandum would guarantee the city a Minor League Baseball team for 30 years, with lease payments during that period totaling more than $9 million. The city would use the lease revenue to help retire the construction debt. Other sources would include new city taxes from the special district around the stadium – and apparently, three-fourths of the county’s portion of the new tax revenues from the district.

The city would open the stadium by April 2019, although the team would play for two years in a temporary venue, starting next season. The team would play in the Carolina League as part of an expansion that would include a new Texas Rangers-affiliate in Kinston in eastern NC. It’s not clear what, if any, other revenue sources the city would require, or how much including $60million invested on a new hotel, retail and residences next to the stadium. They also are planning a $15 million renovation of an existing hotel into rentable apartments. The renovation and new investment would be part of the special district covering 10 acres around the stadium from which new tax revenues would be dedicated

While this project is under consideration, opponents of such financings will find plenty of ammunition in a new study from the Brookings Institution on the cost to the federal government due to subsidies in the form of municipal bond issuance for major professional sports facilities. Brookings examined the financing for all professional sports stadiums newly constructed, majorly renovated, or currently under construction since 2000 for Major League Baseball, the National Football League, the National Basketball Association, and the National Hockey League.  It estimated that the value of the total subsidy including lost revenues on the tax exempt interest amounted to $3.7 billion.

NEW JERSEY MALL FACES NEW HURDLE

The high yield municipal market has often been the last resort for projects of questionable value. This reflects the nature of the risk that underpins the credits for these deals whether it be based in the technology of the project, the uniqueness of the project, or the lack of fundamental economics of the project. These projects often have been unable to obtain cost effective financing in the traditional home for such speculative investments. It’s why things such as medium density fiber board from recycled wood, manure to methane, small scale ethanol manufacturing, and various dubious entertainment venues have all been financed in the tax exempt high yield market with often poor investment results.

The latest potential entrant to this arena is the proposed $1.15 billion financing for infrastructure costs at the American Dream project in East Rutherford, NJ. It’s the project one has seen under construction for seemingly forever next to Met Life Stadium in the Meadowlands. The one where the cranes haven’t operated for a year. The one that has gone through multiple developers and governors. The one that has generated lots of negative headlines but no sales after thirteen years of development. So in many ways it is a natural for the municipal high yield market. Now the project faces another hurdle.

The New Jersey Alliance for Fiscal Integrity, a nonprofit group said to be backed by retailers has filed a motion with New Jersey’s appellate court to stop state agencies from helping a private developer build what would be one of the biggest malls in America. The suit could stop, or at least delay, currently idled construction of American Dream, a retail-entertainment complex in the Meadowlands that’s been in development since 2003. Triple Five, a Canadian-based company, is the third developer to try to complete the project, which had previously been known as Xanadu.

The  lawsuit,  raised a number of procedural objections to actions taken by the New Jersey Sports and Exposition Authority and the New Jersey Economic Development Agency to help the developer borrow over $1 billion through tax-free municipal bonds to finish construction. The Sports and Exposition Authority board approved the issuance of what it contends will be non-recourse bonds — which means that the bond buyers take the risk should the project fail — and then have them be purchased by the Wisconsin Public Finance Authority.  The Wisconsin issuer has the ability to issue private purpose bonds which the New Jersey entities do not have driven by tax regulations. While infrequent, the use of out of state issuers is not new.

This construct would ostensibly prevent the State of New Jersey from financial involvement. Throughout the long life of the project, there has been consistent political concern regarding the potential for the project to require direct financial resources from the State of New Jersey. This plan to assist Triple Five – the current developer – was made public this summer and then approved over a matter of weeks. Usually, projects like this turn to the municipal bond market as the financier of last resort when traditional sources are either unavailable of prohibitively expensive. That usually reflects a lack of belief on the part of the usual sources in project viability. This project has been plagued by consistent questions about the need or demand for a project of this scale in this marketplace.

According to the Alliance, the board’s no-bid selection of the Wisconsin agency violates a two-decade-old executive order that requires that private bonds be sold through a competitive bidding process. The group also asserts that changes in the language of the bond issuance also mean that the bond sales can’t go forward unless the state Local Finance Board approves the new terms. The suit follows a formal written request to New Jersey Sports and Authority Chairman Michael Ferguson to delay any issuance of the bonds.

The Alliance is a 501c(4) organization, and is exempted from disclosing its funders. It has said the group includes retailers and other businesses as well as “concerned citizens”. Increasing the intrigue, the Alliance’s attorney has a longstanding professional relationship with Governor Chris Christie, having worked both within the Christie administration, and for Christie when he was U.S. Attorney for New Jersey.

CCRC DEAL FLOW CONTINUES

As has been the case with previous interest rate cycles, the volume of continuing care retirement community (CCRC) deals continues as we approach the fourth quarter. With talk of a rise in interest rates influencing the markets, we are not surprised to see a potential dampening effect on home sales activities. It is exactly those factors which should give investors pause and make sure that they are compensated for the risks which they are being asked to finance.

The last period of low absolute rates and relatively favorable spreads saw many   investors including funds make extensive purchases of this paper. The perceived high level of real estate activities convinced investors that the risk of depending on sufficient numbers of older home owners to be able to readily sell their homes at high prices was enough to offset the marketing risk associated with these projects. When the real estate market crashed, that ability did as well leaving many operators with inventories of unsold units and shortfalls in revenues for operations. This left many unable to pay off shorter term construction debt from unit sales and created shortfalls in net revenue for debt service on the longer term debt owned by the funds and individuals. The result was spectacular defaults and difficult workouts for investors and sponsors.

So many investors have overestimated the demand for these facilities versus the desire by individuals to age in place in their homes. The lack of mobility in the work force which is often cited as a key dampening effect on home sales also works against these facilities in that it keeps extended families together in the same locales which facilitates aging in place. The result is to create an environment where an individual CCRC must take a larger share of the local population (the penetration rate) to create a sufficient customer base to support a given project. At the same time, tighter lending requirements have reduced the velocity of home sales. This makes it more difficult to fill beds and CCRCs thereby increasing the risk for new projects.

We are not saying that all CCRC projects are bad, only that investors be extremely diligent when selecting individual credits. Make sure that you understand that at their heart, these are real estate based transactions not health based transactions. I once worked for an institutional investor who did not understand that crucial fact. He wanted to lessen his risk of real estate exposure through land development deals and instead shifted resources into CCRCs. His resulting exposure to real estate risk at best remained static if not increased. We are also advising that investors demand a greater risk premium as an inducement to take on the 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

Municipal Credit Consultant

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

NEW JERSEY SCRAPS TAX RECIPROCITY WITH PENNSYLVANIA

If you are a Pennsylvania resident who works in New Jersey, the tax treatment of your income is about to change beginning January 1. Gov. Chris Christie is pulling the state out of a 40 year agreement that allowed New Jersey and Pennsylvania residents who work across state lines to pay income taxes where they live instead of where they work. More than 120,000 New Jersey residents commute across the Delaware River, and a similar number of Pennsylvanians work here, according to the U.S. census.

The governor was required to give Pennsylvania 120 days notice in order to withdraw from the agreement by Jan.1, the beginning of the next tax year. Christie directed New Jersey state officials to begin exploring the consequences of withdrawing from the tax pact at the end of June. The action does not require Legislative approval. The tax change will generate tens of millions of dollars for New Jersey, but comes at a cost for some residents of both states who will have to pay higher income taxes.

Under the existing agreement, New Jersey doesn’t collect income taxes from people living in Pennsylvania and working in New Jersey. Under the reciprocal agreement, a resident of New Jersey who works in Pennsylvania need only file a tax return in New Jersey. The same is true for a Pennsylvania resident working in New Jersey. It has been estimated the Garden State could gain $180 million in revenue from Pennsylvania residents forced to pay taxes here.

With the end of the agreement, a resident would have to file two tax returns and claim a credit against taxes owed where they live for taxes paid in the state where they work. This would work against higher income Pennsylvania residents working in New Jersey as Pennsylvania has a flat 3.07 percent income tax rate, while New Jersey’s highest graduated income tax rate is 8.97 percent. A highly paid executive living in Pennsylvania but working in New Jersey now can pay Pennsylvania’s 3.07 percent flat tax. But an end to the reciprocal agreement means they’ll have to pay New Jersey taxes.

But low- and middle-income New Jersey residents working in Philadelphia and other Pennsylvania jurisdictions would also owe more. A legislative analysis found that it will cost 100,000 Garden State residents earning under $110,000 a year working in Pennsylvania about $1,000 more a year in income taxes, according to the Senate Majority Office.

Governor Christie claims that the Legislature created a $250 million state budget hole in June. He called this the best option among raising state taxes, cutting property tax relief, reducing aid to education or hospitals, or reduction the state’s pension payment. The budget hole refers to the budget passed by the Legislature which assumed the state would come up with $250 million in cuts to public worker health.

Christie has linked a spending freeze to the cuts, saying he won’t release the funds until the $250 million is paid in full. He did say he will reconsider his decision to withdraw from the tax agreement with Pennsylvania if the Legislature makes good on the cuts. So the issue comes down a political argument involving the always arcane world of South New Jersey politics.

In fairness, the agreement was threatened 12 years ago when then Gov. James E. McGreevey proposed to end the agreement but dropped the plan after angering south Jersey residents and lawmakers who said many New Jerseyans who worked in Pennsylvania would have paid more in taxes.

CONNECTICUT SPECIAL TAX DOWNGRADE

Fitch announced a downgrade from AA to AA- in front of the planned sale of Special Tax Revenue bonds by the State of Connecticut. The bonds are secured by pledged taxes and fees on motor vehicle fuel, casual vehicle sales and licenses. The legislature expanded pledged revenues in its 2015 session as part of a broader initiative, called ‘Let’s Go CT!’ to accelerate transportation capital spending. Revenue changes were partly delayed during fiscal 2016 as the state sought to shore up projected weak general fund performance in fiscal 2016 and 2017.

Under the 2015 expansion of pledged resources, all taxes on oil companies’ gross earnings and a designated portion of the statewide sales tax are being deposited directly to the State Transportation Fund (STF) and pledged to bondholders; the sales tax deposit is being phased in through fiscal 2018. The inclusion of sales taxes in pledged revenues broadens the base of economic activity from which collections derive beyond transportation and ties future trends more closely to underlying state economic performance. Oil companies’ tax collections are correlated to broader energy market trends, which exposes the STF to more heightened cyclicality.

$4.2 billion in senior lien bonds and $257 million in second lien bonds are outstanding. Pledged revenues are available first for senior lien debt service and reserves, followed by second lien debt service and reserves. Thereafter, pledged revenues are available for transportation-related state general obligation bond debt service and operating expenses of the departments of transportation and motor vehicles.

Fitch’s real concern is based in the linkage of the credit to the condition of the state general fund which has led to revenue or cost shifts during periods of general fund fiscal stress, most recently in fiscal 2016. Given frequent statutory changes that shift pledged revenues or costs between the transportation fund and the state’s general fund based on general fund budgetary needs, Fitch views the credit quality of special tax bonds as being linked to the state’s general operations, and hence capped by the state’s AA- general obligation rating.

The downgrade comes just ahead of the planned issuance of some $1 billion of special tax bonds by the State with 20% providing for refinancing and the remainder for projects under the Let’s Go Connecticut program.

NUCLEAR BASED CREDIT UPGRADE

Moody’s recently upgraded $1 billion of revenue bonds from South Carolina’s Piedmont Municipal Power Agency (PMPA) to A3 from Baa1. The upgrade reflects PMPA’s continued rate increases during each of the last five years resulting in improved financial metrics particularly during the last two years. The rate increases have improved PMPA’s internal liquidity, which reflects its willingness to implement rate increases over a sustained period, in contrast with the past reliance on rate stabilization funds. PMPA’s participant weighted average credit quality remains stable at A3. PMPA debt is secured under strong court-tested take-or-pay power sales agreements with the participant electric utility systems. While the resource base is concentrated in nuclear power this is mitigated by the plants’ strong operating performance and by reliability exchange agreements, which reduces single asset concentration risk.

PMPA has an undivided ownership interest of 25% in Unit 2 of the Catawba Nuclear Station, which was constructed and is being operated by Duke Energy, an experienced successful operator. Net PMPA revenues derived from member’s take-or-pay power sales agreements and all requirements supplemental power sales agreements. Payments to the agency are considered operating expenses of the member utility systems. The take-or-pay power sales agreements have been validated by the South Carolina Supreme Court and also upheld against a challenge by one member. Under the take-or-pay power sales agreements, there is a 25% step-up provision which requires participants to increase up to 25% in their respective shares of the project in the event of a default by another participant. The debt service reserve requirement is 110% of maximum annual interest is low but is cash funded.

LOTS FOR CALIFORNIANS TO VOTE ON ASIDE FROM PRESIDENT

As momentous as the upcoming Presidential election may be, in California the voters will have many other issues to decide on when they enter the voting booth on November 8. This year the ballot will include 17 initiative items for the voters’ consideration. While many are of little concern to those outside the State, several will have consequences for the state budget and for tobacco bond holders.

Proposition 55  is the Tax Extension to Fund Education and Healthcare Initiative Constitutional Amendment. It would extend by twelve years the temporary personal income tax increases enacted in 2012 on earnings over $250,000 (for single filers; over $500,000 for joint filers; over $340,000 for heads of household). It allocates these tax revenues 89% to K-12 schools and 11% to California Community Colleges. It allocates up to $2 billion per year in certain years for healthcare programs. It would bar use of education revenues for administrative costs, but provide local school governing boards discretion to decide, in open meetings and subject to annual audit, how revenues are to be spent.

A summary of estimate by Legislative Analyst and Director of Finance of fiscal impact on state and local government says increased state revenues annually from 2019 through 2030—likely in the $5 billion to $11 billion range initially—with amounts varying based on stock market and economic trends. Increased revenues would be allocated under constitutional formulas to schools and community colleges, budget reserves and debt payments, and health programs, with remaining funds available for these or other state purposes.

Proposition 56 is known as the Cigarette Tax to Fund Healthcare, Tobacco Use Prevention, Research, and Law Enforcement. Initiative Constitutional Amendment and Statute. It would Increase cigarette tax by $2.00 per pack, with an equivalent increase on other tobacco products and electronic cigarettes containing nicotine. It would allocate revenues primarily to increase funding for existing healthcare programs; also for tobacco use prevention/control programs, tobacco-related disease research and law enforcement, University of California physician training, dental disease prevention programs, and administration. It excludes these revenues from Proposition 98 funding requirements. If the tax causes decreased tobacco consumption, the law transfers tax revenues to offset decreases to existing tobacco-funded programs and sales tax revenues. It would require a biennial audit.

A summary of estimate by Legislative Analyst and Director of Finance of fiscal impact on state and local government finds a net increase in excise tax revenues in the range of $1.1 billion to $1.6 billion annually by 2017-18, with revenues decreasing slightly in subsequent years. The majority of funds would be used for payments to health care providers. The remaining funds would be used for a variety of specified purposes, including tobacco-related prevention and cessation programs, law enforcement programs, medical research on tobacco-related diseases, and early childhood development programs.

Proposition 53 is a Constitutional Amendment which would require statewide voter approval before any revenue bonds can be issued or sold by the state for projects that are financed, owned, operated, or managed by the state or any joint agency created by or including the state, if the bond amount exceeds $2 billion. It would prohibit dividing projects into multiple separate projects to avoid statewide voter approval requirement.

A summary of estimate by the Legislative Analyst and Director of Finance of fiscal impact on state and local government found that the fiscal effect on state and local governments is unknown and would vary by project. It would depend on (1) the outcome of projects brought before voters, (2) the extent to which the state relied on alternative approaches to the projects or alternative financing methods for affected projects, and (3) whether those methods have higher or lower costs than revenue bonds.

RATINGS JUDGMENT ON PRISON BONDS

Our recent (8/23/16) alarms on prison bonds were supported this week when bonds for three private prisons in Texas suffered downgrades by Standard and Poor’s to below junk-bond status after the U.S. Department of Justice announced plans to discontinue their use. Reeves County bonds issued for the largest detention center in West Texas fell six notches to B-plus from BBB-plus and retained a negative outlook. Willacy County Local Government Corp. bonds used to build a now-vacant detention center in South Texas dropped to CC from CCC-plus. The federal Bureau of Prisons canceled its contract with the operators after an inmate uprising that left the facility uninhabitable. The Garza County Public Facility Corp. was dropped to B-plus from BBB and also retained a negative outlook.

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

Municipal Credit Consultant

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

PUERTO RICO OVERSIGHT BOARD MEMBERS NAMED

President Barack Obama named the members of the Fiscal Oversight Board that will manage the island’s finances for at least five years. Obama named Republicans Carlos García, Jose Carrión III, Andrew Biggs and David Skeel. The Democratic appointees include Arthur González, José Ramón González and Ana Matosantos. Gov. Alejandro García Padilla is the eighth member of the board, but does not have voting rights.

Andrew Biggs is a former trustee of the Social Security administration. David Skeel is a professor at the University of Pennsylvania and has written at length about how bankruptcy laws are inherently biased against creditors. Skeel has argued that “rule of law took a beating in the Detroit bankruptcy,” and has argued that Congress should go out of its way to ensure that rule of law is enforced in Puerto Rico. José Carrión III as a Puerto Rico-based bankruptcy professional with an extensive history in Puerto Rico workers’ compensation system and other insurance vehicles on the island. Carlos García is close to the administration of former Gov. Luis Fortuño.

José Ramón González a  former Puerto Rico banking executive and current CEO of the Federal Home Loan Bank in New York. Arthur González is the former chief judge of the U.S. Bankruptcy Court for the Southern District of NY. Ana Matosantos was formerly a senior advisor to Governors Arnold Schwarzenegger (R-CA) and Jerry Brown (D-CA) on budget policy.

Candidates were chosen from lists submitted by Senate Majority Leader Mitch McConnell, Speaker of the House Paul Ryan, Senate Minority Leader Harry Reid and this was seen as limiting the availability of many individuals who might have been considered. This along with unfavorable tax provisions impacting sales of securities which these provisions would have required rendered service on the board (which is pro bono) economically infeasible for many candidates. There was no political support for amending the Act to deal with these issues.

As for the political reaction in P.R., it was immediate. One independence backing politician said “The appointment of various individuals with a Puerto Rican background in the board is only an attempt by the U.S. government to soften the blow, to give the impression that the board, in a twisted way, represents us. But at this juncture, nobody should fall for it. These people will respond, in the same way that their U.S.-mainland colleagues would, to the interests that lobbied for the board to act as a collection agency. Also, some of them, due to their close association with Popular Democratic Party (PDP) and New Progressive Party (NPP) administrations, are also responsible for the crisis they will allegedly address.”

The President of the Puerto Rico Senate said “It’s lamentable that Carlos García, who has direct and indirect links to the terrible Fortuño administration, is among [the board members]. Let us remember it was García who was the protagonist of the biggest period of loan-taking in Puerto Rico’s history, loans whose repayment terms have brought the country down to one of its worst economic crises. With these appointments, [this development] puts the crown on the campaign of lobbyists who present the island as a possible bastion of support for all the extreme right-wing policies of the Republican Party.”

A PDP representative said that while he was concerned about the appointments of various members, he also agreed with some of them.  “In my view, there are three figures in that board who will not benefit the country, and it has nothing to do with their professional capacities, because they’re are well prepared. In the case of Carlos García, he could have a conflict of interest with the lawsuits related to pension obligation bonds, and I believe that disqualifies him to become part of the board. Carrión, due to his proximity with the resident commissioner, also seems like he should be disqualified,” he said.

“In the case of González, who is a retired judge in the New York Bankruptcy Court, he would also have a conflict of interest because the bondholders want their cases to be addressed precisely in that court. I find that suspicious. His vision is not in Puerto Rico’s best interests,”

We would have been almost disappointed if there had been a measured non-political response to the control board. It has been that which has been so sorely lacking throughout the debt crisis so there is no real expectation that we would begin to see one now.  We note that there seemed to be little concern expressed about individual capabilities. As they say, let the games begin. It is going to be a long slog.

FEDERAL GRANTS FOR EXPLORING GAS TAX ALTERNATIVES

Earlier this year we discussed efforts to move away from volume based taxes on gasoline to fund roads in the U.S. and varying reactions to the idea. This week the concept received a boost when The U.S. Department of Transportation’s Federal Highway Administration announced $14.2 million in grants for states under a new program to explore alternative revenue mechanisms to help sustain the long-term solvency of the Highway Trust Fund.

The Surface Transportation System Funding Alternatives (STSFA) grant program will fund projects to test the design, implementation and acceptance of user-based alternative revenue mechanisms. The program will help address some of the concerns outlined in Beyond Traffic, the USDOT report issued last year that examines the challenges facing America’s transportation infrastructure over the next three decades, such as a rapidly growing population and increasing traffic.

Eight projects will pilot a variety of options to raise revenue, including on-board vehicle technologies to charge drivers based on miles traveled and multi-state or regional approaches to road user charges. The projects will address common challenges involved with implementing user-based fees such as public acceptance, privacy protection, equity and geographic diversity. The projects will also evaluate the reliability and security of the technologies available to implement mileage-based fees.

The participating state Departments of Transportation are California, Hawaii, Delaware, Minnesota, Missouri, Oregon, and Washington. The studies will cover fees based on odometer checks at pumps, charging stations, and inspection stations among other methods. Oregon will run two distinct programs. The grants total $14,325,000.

JACKSONVILLE VOTES FOR TAX TO FUND PENSIONS

Duval County voters voted nearly two to one for a half-cent sales tax to pay off the city’s $2.7 billion pension deficit. Duval County Referendum No. 1, said “Permanently closing up to three of the City’s underfunded defined benefit retirement plans, increasing the employee contribution for those plans to a minimum of 10%, and ending the Better Jacksonville ½-cent sales tax are all required to adopt a ½-cent sales tax solely dedicated to reducing the City’s unfunded pension liability.  Shall such pension liability sales tax, which ends upon elimination of the unfunded pension liability or in 30 years maximum, be adopted?”

In English, it proposed a 30-year half-cent tax to begin in 2030, when the existing half-cent tax paying for city construction projects expires. The Mayor said the tax, along with closure of the city’s three existing pension plans and  a requirement for  existing employees to pay 10 percent toward their own retirement, will address the city’s pension liability obligation issues.

It should be noted that the plan to increase employee contributions still has to negotiated with the unions, but hopes are that those talks will begin in the fall. The Mayor hopes to have it done by the end of the year or shortly thereafter.”  The vote took place despite the efforts of a group opposed to the plan which filed a lawsuit against the amendment, saying the language in the referendum was just too confusing, and voters wouldn’t know what the amendment means.

SCRANTON REFINANCES PARKING DEBT ALBATROSS WITH P3

In 2012, the City of Scranton, PA defaulted on its obligation to guarantee debt service on bonds issued by its public parking authority. The City, which operates under the Commonwealth of PA Distressed Municipalities Program, lost its bond rating and access to the public debt markets as the result of its actions. Earlier this year, the City returned to the market with a sale of bonds in June. Now the City has moved forward with a second bond issue that helps to address its position as guarantor of parking authority debt.

In June, the City partnered with a non-profit organization the National Development Council, which will run Scranton’s street meters and 5 parking garages  under a 40- to 45-year concession lease. NDC agreed to pay $28 million upfront to the city, which will retain ownership of the meters and garages, except for Electric City garage, which is being sold to a private entity. NDC will have a separate firm, ABM Parking, operate the meters, garages and 500 parking spaces at a mall as city monthly parking spaces.

The second City bond issue sold last week at lower-than-anticipated interest rates. The $32.8 million issue will refinance Scranton Parking Authority debt and $3 million pays for costs of the issuance. About $1.8 million will go toward improving city firehouses, a capital project added to the package. The parking bond issuance’s two series had an average “yield” of 3.7 percent, as compared to about 8 percent yields of post-default bonds of 2012-13. The city will no longer have an over $3 million-a-year financial obligation and actually reduce current parking rates in the garages.

On the downside, the City disclosed that the planned sale of its sewer system has run into regulatory hurdles. The City had hoped to generate up to $130 million from the transaction and apply half of that amount to funding its pension liabilities. Notwithstanding, the Public Utilities Commission’s public advocate has recommended against the sale and two administrative law judges in the PUC have also opposed aspects of the sale.

The City has vowed to clarify the part of the deal which is causing the opposition – an agreement to cap the growth of rates for Scranton and Dunmore customers at 1.9 percent per year over the next decade or pay an increased sale price — called a variance adjustment — if revenues end up exceeding the cap. Customers outside of those two communities object to the possibility that their rates could rise faster. If that issuer can be overcome, a PUC approval could continue to be pursued and the deal finalized.

The pension rise issue is an important downward weight on the City’s rating. Now rated below investment grade at BB, it is difficult to see how the City can rise above that rating without making a real dent in its pension liability.

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

Municipal Credit Consultant

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

DISCLOSURE STILL A PROBLEM

Regular readers of our twice weekly comments know by now that we feel strongly that the disclosure practices of municipal bond issuers are, to put it kindly, deficient. Now we see that the U.S. Securities and Exchange Commission has problems with those practices as well. We were heartened to see last week’s announcement of enforcement actions against 71 municipal issuers and other obligated persons for violations in municipal bond offerings.

The actions were brought under the Municipalities Continuing Disclosure Cooperation (MCDC) Initiative, a voluntary self-reporting program targeting material misstatements and omissions in municipal bond offering documents.  The initiative offered favorable settlement terms to municipal bond underwriters, issuers, and obligated persons that self-reported certain violations of the federal securities laws.  Obligated persons are typically nonprofit entities such as hospitals and colleges that borrow the proceeds of bond issuances and are obligated to pay principal and interest on the bonds.

The SEC found that from 2011 to 2014, the 71 issuers and obligated persons sold municipal bonds using offering documents that contained materially false statements or omissions about their compliance with continuing disclosure obligations.  Continuing disclosure provides municipal bond investors with important information, including annual financial reports, on an ongoing basis.  The SEC’s 2012 Municipal Market Report identified issuers’ failure to comply with their continuing disclosure obligations as a major challenge for investors seeking information about their municipal bond holdings.

The parties settled the actions without admitting or denying the findings and agreed to  agreed to undertake to establish appropriate policies, procedures, and training regarding continuing disclosure obligations; comply with existing continuing disclosure undertakings, including updating past delinquent filings, disclose the settlement in future offering documents, and cooperate with any subsequent investigations by the SEC.

The SEC has now filed a total of 143 actions against 144 respondents as part of the MCDC Initiative.  These actions are the first against municipal issuers since the first action under the initiative was announced in July 2014 against a California school district.  The SEC filed actions under the initiative against a total of 72 municipal underwriting firms, comprising 96 percent of the market share for municipal underwritings, in June 2015, in September 2015, and in February 2016.

There is disappointment in that the list of settling parties includes large and  sophisticated issuers. The usual arguments against stronger disclosure requirements tend to emphasize the relative small scale of many issuers and the cost of compliance relative to available resources. In this case, the 71 parties included state agencies, large cities and counties, and even two states. The list undermines the size argument as a defense against weak disclosure.

We have a relatively stark position on the question of disclosure. Our view is that issuance in the public debt markets is a privilege and that compliance with disclosure requirements is the price of participation in that market. We hope that the Commission continues to vigorously support the right of investors to full and timely disclosure and that issuers take their responsibilities more seriously.

MARIN COUNTY PENSION CHANGE UPHELD IN CA. COURT

Public employees in Marin County, California, failed to prove a state-mandated change in how their pensions are calculated unconstitutionally violated their employment contracts, an appeals court ruled. At issue in the case was a 2013 amendment to the County Employees Retirement Law that the state Legislature passed in order to curb the practice of “pension spiking.” Pension spiking occurs when “public employees use various stratagems and ploys to inflate their income and retirement benefits,” explained Justice James Richman, of the First District California Courts of Appeals, in an August 17 ruling.

Four Marin County employees, joined by five organizations that represent county employees, sued the Marin County Employees Retirement Association to stop the implementation of the new formula. They complained that they “agreed to accept employment and remain employees of their respective employers based on the promised pension benefit.” The trial court ruled in favor of the retirement association, stating that the new formula did not violate the employees’ constitutional rights.
The employees appealed, but the appeals court affirmed the decision. “While a public employee does have a ‘vested right’ to a pension, that right is only to a ‘reasonable’ pension—not an immutable entitlement to the most optimal formula of calculating the unconstitutional. “Here, the Legislature did not forbid the employer from providing the specified items to an employee as compensation, only the purely prospective inclusion of those items in the computation of the employee’s pension,” Richman added. A pension can be spiked through an increase in final compensation or the inclusion of unused vacation pay in the benefit calculation.

After the economic downturn of 2008, underfunded public pensions received national attention. California’s legislature excluded some items from the calculation of county employees’ retirement income. Since then, localities have been seeking ways to reduce their future pension and health liabilities. this decision is clearly useful and credit positive for California localities seeking to make similar changes.

HOMELAND SECURITY TO REVIEW PRIVATE PRISONS

Last week we discussed the department of Justice’s decision to eliminate the use of private prisons. At that time, we warned that the real fear for municipal bond investors would be if facilities operating under contract with Immigration and Customs  Enforcement were to reach a similar decision. That day has now come one step closer.

Department of Homeland Security Secretary Jeh Johnson announced Monday that the Department  is considering curbing private immigration detention operations. The Secretary said that he directed the Homeland Security Advisory Council, chaired by Judge William Webster, to evaluate whether the immigration detention operations conducted by Immigration and Customs Enforcement should move in the same direction.

The DHS advisory council has until Nov. 30 to determine whether to follow the Justice Department’s lead. Johnson said he asked Webster to create an advisory council subcommittee “to review current policy and practices concerning the use of private immigration detention and evaluate whether this practice should be eliminated.” The subcommittee will lead the review, while the full council will file its evaluation to Johnson in November.

Should the DHS decide to suspend its involvement with private prison operators, it would strike a huge blow to the creditworthiness of many transactions which generate the majority if not the bulk of their pledged revenues through contracts with the DHS. These deals are located throughout the country although unsurprisingly many are located proximate to the southern U.S. border.

TOBACCO

We think that it is always useful to review the cigarette consumption data that is available whenever a new tobacco securitization issue is poised to come to market. A smaller deal for a group of seven New York counties presents our latest opportunity to do so.

While we do not think that anything in the data suggests that the long-term trends in cigarette consumption will change, we would be remiss not to note that U.S. cigarette shipments did rise some 1.9% in 2015. IHS Global, the entity which projects cigarette consumption for securitizations, did not attribute the rise to any particular factor. The study also projects that the share of sales by participating manufacturers in the Tobacco Settlement Agreement will remain constant after a period of efforts by non-participants to increase sales.

What we found most interesting in this official statement, was data presented on the impact of New York State and particularly New York City’s tax policies on cigarettes. New York City has the highest taxes and retail per pack prices in the nation. It also has a thriving underground retail cigarette market. IHS data shows that less than 4 in 10 cigarettes purchased in New York are legitimately purchased and properly taxed. This is through smuggled packs sold at retail establishments or through the sale of individual cigarettes through street vendors.

While this phenomenon may not have a direct impact on the creditworthiness of tobacco securitizations, it is instructive as to the efficacy of extremely high tax policies as a deterrent to cigarette sales. Otherwise, we continue to believe that tobacco bonds serve best as a trading vehicle for larger investors and that the long-term risks to the credits don’t serve the needs of many individual investors.

NEW YORK HOTEL TAX BONDS RETURN TO THE MARKET

The New York Convention Center Development Corporation, a subsidiary of the State’s Empire State Development Corporation, is planning to market some $413 million of revenue bonds backed by the proceeds of a $1.50 per night hotel room fee collected on hotel rooms in New York City. The bonds will fund a portion of the cost of the expansion of the thirty year old Javits Convention Center on Manhattan’s west side.

The City was somewhat late to the game of using hotel tax revenue bonds to finance public facilities. After years of concerted efforts by the Bloomberg administration to develop a tourist based economy, enough confidence in the durability of the tourism boom that followed and continues to this day was generated to support the issuance of hotel tax backed bonds. The pledged revenues in 2015 generated over $45 million of available revenues.

This produces coverage of just over 1 times debt service. The plan of finance assumes consistent annual growth in revenues of at least 1% through final maturity. Given the historical trend of revenues, it is not an unreasonable assumption. The world economic meltdown wasn’t enough to halt the trend and issues like relative currency values have not seemed to dent the trend either. It comes down to the fact that the one factor which could seriously impede the maintenance of positive tourism trends would be a breakdown in security in the City.

Fifteen years after 9/11, New York continues to be the area of the most concern in terms of it being a prime terrorist target. That regardless of the fact that the most recent attacks have occurred elsewhere. Paris has shown that there is a level and number of events which will damage tourism. This summer, after a number of incidents, the City of Light has seen a decline of one million in the number of visitors relative to prior summers. So it can happen but it takes a sustained number of incidents.

LABOR DAY

According to the U.S. Department of Labor, Labor Day, the first Monday in September, is a creation of the labor movement and is dedicated to the social and economic achievements of American workers. It constitutes a yearly national tribute to the contributions workers have made to the strength, prosperity, and well-being of our country.

Through the years the nation gave increasing emphasis to Labor Day. The first governmental recognition came through municipal ordinances passed during 1885 and 1886. From these, a movement developed to secure state legislation. The first state bill was introduced into the New York legislature, but the first to become law was passed by Oregon on February 21, 1887. During the year four more states — Colorado, Massachusetts, New Jersey, and New York — created the Labor Day holiday by legislative enactment.

By the end of the decade Connecticut, Nebraska, and Pennsylvania had followed suit. By 1894, 23 other states had adopted the holiday in honor of workers, and on June 28 of that year, Congress passed an act making the first Monday in September of each year a legal holiday in the District of Columbia and the territories.

We honor Labor Day by only putting out one issue of the Muni Credit News this week. Enjoy your weekend and look for our next issue on Tuesday, September 6.

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

Municipal Credit Consultant

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

LOUISIANA

A week ago we discussed the State’s proposed cash flow borrowing. This before the full scope of the damage from flooding in the Baton Rouge area had become apparent. Now that the level of devastation is clearer, it is easy to conclude that the State fiscal condition could be in serious trouble as a result.

The picture is, as in the case of most large scale natural disasters, much more complex. Clearly, there will be real disruption to the economic life of the area and significant expense demands on government. But they may not be as harmful as one might assume. Many of the costs of recovery will be borne by the federal government. FEMA will reimburse the vast majority of government expenditures. As for the impact on the State’s fiscal position, the interruption to some revenue sources will be offset by a high level of retail sales and economic activity related to the repair and replacement of homes and businesses.

This activity will drive a large and concentrated burst of sales tax revenues. Businesses that generate these revenues will also receive taxable income. Clearly, there will be dislocation and disruption but the overall effect on the State’s credit will be less than one would imagine at first blush. It’s been proven time after time in areas impacted by natural disasters.

PENNSYLVANIA

Earlier this month, we questioned the assignment of a stable outlook to the Commonwealth of Pennsylvania’s general obligation bond rating. Our stance was reaffirmed with the announcement from Pennsylvania Treasurer Timothy A. Reese that he had extended a $2.5 billion line of credit to the Commonwealth of Pennsylvania. A draw of $400 million from the line of credit to the General Fund was immediately made to prevent the General Fund cash balance from falling into the negative this month.

This is the second time in 2016 and the third time in 23 months that the state has needed to borrow money to meet short-term cash needs illustrating the ongoing structural budget deficit facing the commonwealth. While progress has been made on reducing the structural deficit, additional revenues enacted as part of the 2016-17 budget will not be fully realized until late in the fiscal year and, as a result, the General Fund balance began this fiscal year with $500 million less than the previous fiscal year.

The Treasurer said “The General Fund’s low cash balance so early in the fiscal year is a troublesome sign and illustrates the need for Pennsylvania to adequately and decisively address its ongoing structural deficit. While Treasury will continue to work with the administration and the General Assembly to manage these continuing shortfalls, until our state’s fiscal house is in order Pennsylvania’s credit rating will continue to suffer, and taxpayers will pay more to fund our debt.”

In our view this is exactly why we questioned the assignment of the stable outlook. Just because this kind of borrowing is internal rather than public, it doesn’t make it a better situation than is the case in, for example, Louisiana which is borrowing less in public. We understand that the Commonwealth has borrowed to cover a short term General Fund shortfall 15 times over the past 24 years. The borrowing maximum under this line however, is $1 billion greater than at any time since 1991.

MTA HUDSON RAIL YARDS TRUST

One of the more prolific issuers in our market is bringing a new credit to the new issue marketplace. One of New York’s best known real estate development projects is the West Side Redevelopment project. Any visitor to the city would likely be familiar with the huge amount of commercial and residential high rise construction underway from 9th Avenue to the Hudson River. One of the more complicated and controversial aspects of the plan was the construction of platforms over a long existing railroad yard complex which serves Pennsylvania Station.

The air rights and the platform over the yards will serve as the base on which additional construction will take place. The Metropolitan Transportation Authority owns this asset and is now in a position to monetize it. Hence the creation of the MTA Hudson Rail Yards Trust.

The Trust plans to issue $1.057 billion Metropolitan Transportation Authority (MTA) Hudson Rail Yards Trust Obligations. The bonds to be issued  will be payable solely from the Trust Estate established under a Trust Agreement. The trust estate consists principally of monthly ground rent from tenants of the ERY and WRY, monthly scheduled transfers from a capitalized interest fund, payments made by the tenant upon the exercise of fee purchase options, contingent support payments made by the MTA (including interest reserve advances), and rights of the MTA to exercise remedies under the leases and rights of the Trustee to exercise remedies under the leases and the Fee Mortgage.

The trustee will have a first secured lien on the MTA’s fee simple interest in the owned property under the Eastern Rail Yard and Western Rail Yard leases which are not cross defaulted nor cross-collateralized. The mortgages will secure the MTA’s obligation to pass on payments of ground rent and fee option payments received from tenants under the ground lease. If the MTA does not exercise cure rights following a lease non-payment event of default, the trustee may exercise its remedies under the each fee mortgage. These include foreclosing MTA’s fee interest. The Trustee will have the right to step into the MTA’s position as owner of the property and act as landlord under the defaulted lease. This gives the trustee the right to terminate the lease and sell and/or re-lease the property.

At its core, the financially responsible party for the obligations is the MTA. The leases call for   escalating, fixed ground rent payments, as well as a requirement that the MTA provides for interest reserve replenishment for up to 7 years following a lease default.  Proceeds will finance transit and commuter projects of the various affiliates and subsidiaries of the MTA, to fund an interest reserve requirement of 1/6th of the greatest amount of interest in the current or future years, pay capitalized interest and fund costs of issuance.

The bonds received an A2 rating from Moody’s. While constructed to be a primarily stand alone credit, the financial health of the MTA will still be a key factor in any rating analysis. This reflects the liquidity provision requirements in the event of a lease default. Moody’s is clear that the rating on these bonds is tied to the rating for  the MTA’s Transportation Revenue Bonds.

THE REALITIES OF PENSION REFORM IN CHICAGO

The realities of the difficulties inherent in funding Chicago’s pension liabilities was highlighted when Mayor Emanuel announced that senior citizens would get a break on the water and sewer service tax, proposed in early August. Some 66,000 or so Chicago residents 65 or older who live in single-family homes would be exempt from the new tax. The proposal is meant to appease aldermen unhappy with the plan to shore up the municipal workers pension fund.

Seniors already do not pay for sewer service, which accounts for half of the bimonthly bill. Those who do not get separate water and sewer bills, as is often the case in condominiums and town homes, will continue to be eligible for a $50 annual rebate on their water and sewer bill, but they would not get a break on the new tax.

Many aldermen would prefer a number of alternative revenue sources such as a city income tax or another property tax increase. Those would be more difficult to enact. An income tax would require state authorization, posing political difficulties for legislators. The mayor opposes  another property tax increase after two property tax increases for the City and Chicago Public Schools.

The City estimates the water and sewer tax to eventually raise $239 million a year, to be used to increase contributions to the municipal pension fund. A group of 11 aldermen have asked the administration for the schedule of contributions to the city municipal worker pension system over the next 40 years. They want to be sure that the new water and sewer tax would cover the pension cost before they vote on it next month.

City officials however,  said the city has yet to run those numbers. It is still doing calculations on existing new plans to increase contributions to the city laborer’s plan with revenue from the already increased emergency communications fees on all landlines and cell phones billed to city addresses.

STUDY HIGHLIGHTS RISKS IN SAN DIEGO STADIUM PROPOSAL

At the City’s request, Public Resources Advisory Group (PRAG) reviewed portions of the San Diego Integrated Convention Center Expansion/Stadium and Tourism Initiative’s (the “Initiative”) financing approach for a combined convention center and Chargers stadium. PRAG did not independently verify is the reasonableness of the total Project Cost estimate of $1.8 billion.

The Initiative relies on increasing the City’s Transient Occupancy Tax rate by 6%. Of the new 6% levy, the first 1% would be transferred “off the top” to the Tourism Trust Fund (“TTF”). The remaining 5% would then be available for the transfer of a second 1% to the TTF (after the payment of debt service), which together with the initial 1%, would replace the current 2% Tourism and Marketing District Assessment (“TMDA”), and for the financing, planning, construction, operations and maintenance and future capital improvement costs of the Project. These TOT revenues would be used on a pay‐go basis and to pay debt service on TOT‐backed revenue bonds. In addition, they are required to be used in a certain order, with the City’s general fund having the lowest priority in the flow of funds. The ability of these TOT revenues to meet the Initiative’s requirements is the primary financial risk factor to the City.

Various aspects of the current Project Cost are still being evaluated and are subject to change over time. Goldman Sachs (GS), the Chargers’  banker, estimates a 30 year interest rate of 4.25% on the project. The GS financial model assumes a $1.8 billion total project cost: the Chargers would contribute $650 million to the Project, and 5% of the 6% TOT increase in the Initiative would be available to fund or finance $1.15 billion of Project Costs. Those Project Costs would include convention center construction costs, any allocated costs in the combined convention center/stadium, and all costs for land acquisition, environmental mitigation and ancillary infrastructure.

Currently, PRAG found that with only 1% of the 6% of the TOT levy associated with the Initiative having priority over debt service, the credit quality of the TOT‐ backed revenue bonds is much more protected from revenue shortfalls and cost overruns than Overall Coverage which includes debt service, the second 1% transfer to the TTF, O&M and CapEx, all of which have to be met prior to the City’s general fund receiving any of these TOT revenues.

PRAG states that the future TOT revenue growth assumptions, the current Project Cost estimate and a 4.25% all‐in interest rate reflected in GS’ numbers underpin the ability of the Initiative to pencil out financially. PRAG views each of these assumptions and all three of them on a combined basis as not conservative for a Project with this long of a lead time and are subject to significant risk of change.

All of this will be part of what will be an active debate leading to the vote on November 8. The study is one more piece in the complex debate over the entire phenomenon of public financing of stadiums for professional sports teams.

PR LEGAL UPDATE

A U.S. District Court Judge stayed a lawsuit filed by Ambac Assurance Corp. against the Puerto Rico Highway Authority (PRHTA) seeking to block a lease extension of two island toll roads.  The stay was granted  because Ambac did not challenge the applicability of a provision of the Puerto Rico Oversight, Management and Economic Stability Act (Promesa) that stays lawsuits against the government. Ambac was given until Friday to say whether they wish to join other parties in other cases at a September hearing to determine if cause exists to vacate the Promesa stay.

Plaintiffs in the lawsuit Lex Claims v. García Padilla until Aug. 25 to file a motion on a notice of stay filed by the government. Aurelius Capital Management, Autonomy Capital, Covalent Partners, FCO Advisors, Monarch Alternative Capital and Stone Lion Capital Partners had filed suit July 20 to stop the government from transferring funds from bondholders contending it violated Promesa.

The judge  is planning to schedule a hearing in September to determine whether to stay lawsuits filed by National Public Finance, which seeks to limit the island’s moratorium law and by Brigade Leveraged Structures, which seeks to stop the Government Development Bank from transferring funds to agencies.

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

Municipal Credit Consultant

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com. 

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

CHARTER SCHOOL ABCs

With the start of the school year looming just around the corner, education facilities come to mind. The low rate environment and the steady demand for higher yielding issues has led to a steady stream of charter school financings. For investors new to the sector, here’s a little primer.

The first law allowing the establishment of charter schools was passed in Minnesota in 1991. There are approximately 6,700 charter schools now. The basic criteria for these offerings are based in demand for seats, the supply of seats in a given area, the quality of the management of the school from both a financial and educational standpoint, the nature of the assets pledged, and the security for those assets in favor of the bondholder. More subjective criteria include the sponsorship of the particular school, their level of participation and oversight, and their record of academic results both at the individual school securing the bonds and at other schools they own or sponsor.

What nearly all of these credits have in common is the reliance on state per capita aid payments which are based on statutorily established formulas. Usually, a minimum  percentage of the student enrollment must regularly attend a school and an amount of aid for each of those pupils is appropriated by the state and delivered by the state to the school. These monies are the predominant source of revenues pledged to the bondholders.

So what are the risks to this revenue stream?  There are several. The state aid payments may be diminished if a school does not maintain attendance at the proscribed levels. The aid payments may be diminished if, for a variety of reasons, the state does not make the required annual appropriation of these monies. They can be diminished by formula changes enacted by the legislature or other changes to state per capita aid payments enacted for reasons having nothing to do with an individual school. Perhaps the biggest risk for bondholders is the possibility that a school’s charter may fail to be renewed or revoked in the event of academic or financial management deficiencies.

The risk of closure due to academic non-performance is real. One example is Michigan. Michigan was an early and enthusiastic participant in the charter school movement. The program in that state has existed since 1993. Currently, there are 302 charter schools in the State. Since the inception of the program in 1993 however, the charters of 108 such schools have been revoked by the State.

Charters are issued to each school by oversight entities established under state law. They are issued for varying amounts of time usually three, five, or ten years. What is important to bondholders is the fact that the charter usually is shorter than the maturity of the bonds. This exposes the bondholder to all of the financial risk associated with a school which loses its charter or other accreditation. It is the responsibility of the sponsor of each school to meet the criteria for charter renewal and to take the necessary remedial steps to address changes in charter status.

Should a school be unable to operate or operate in a financially deficient manner, the facilities are usually pledged to the bondholders under a first mortgage in their favor. This is a remedy which comes with some practical limitations. Often the building housing the school is on land  which is not part of the pledged assets, and some facilities are limited as to what purposes the facilities may be used. There can be zoning or other restrictions which limit the use of the facilities. This often limits the marketability of pledged property in the event of a liquidation. These are important factors in determining the actual value of a pledged asset.

For all of these reasons, many of these credits are rated below investment grade and are marketed to only qualified institutional investors. Hence the presence of these credits in so many high yield mutual fund portfolios. For the individual investor, these credits do provide additional income but they require a good deal of research and monitoring to avoid the kind of workout situation for which individual investors are generally unsuited.

PENNSYLVANIA STATE INTERCEPT UPGRADE

Eight months after downgrading it to Baa1, Moody’s has upgraded Pennsylvania’s school district pre-default enhancement program to A2 from Baa1. It also raised the maximum rating on school district bonds enhanced under Pennsylvania’s post-default intercept to A3 from Baa1. The upgrades incorporate a law Pennsylvania passed on July 13 that would provide for state funds to be intercepted and diverted to bondholders in the event of a default even without appropriations due to school districts.

The law eliminates the doubts about the program’s swiftness and effectiveness that arose during the commonwealth’s fiscal 2016 budget impasse, during which school districts operated for months without any appropriations due to them, and therefore no funds available to be intercepted to prevent or cure a default. With the new law in place, funds will always be available to prevent or cure defaults, regardless of whether the commonwealth has passed a budget.

This upgrade is more justified than was the recent credit upgrade for the state. The law on which this upgrade is based is clearly an identifiable structural change. It does not reflect any perception that financially the credit is any stronger. (See the 8/9/2016 MCN for our views on the Commonwealth’s financial outlook) The move is a benefit for the school districts which depend on the program, especially a credit challenged one like Philadelphia.

PROVIDENCE HEALTH MERGER REFLECTS ACA IMPACT…

One of the expected results from the pressure to reduce costs on providers under the Affordable Care Act was a wave of consolidation in the industry. One example of that trend is the merger of two major West Coast health systems. Providence St. Joseph Heath  is a multistate, not-for-profit healthcare system formed on July 1, 2016, and comprised of Providence Health System and St. Joseph Health System. The organization is headquartered in Renton, Washington (the corporate headquarters of PHS) and has a second base of operations in Orange County (the corporate headquarters for SJHS). PSJH is co-sponsored by Providence Ministries and St. Joseph Health Ministry, and is active in Alaska, Washington, Oregon, Montana, California, and Texas. Pro forma annual revenues is approximately $21 billion. Altogether, Providence St. Joseph Health will have $6.4 billion total debt outstanding after closing on a pending bond issue.

The combination results in a  large, mostly contiguous, service area covering much of the western United States; a large consolidated pro forma revenue base of over $20 billion; a leading market share in most of its markets; an integrated care delivery platform which includes significant inpatient and outpatient services, employed physicians, and various health plan products; and an experienced, capable, management team with significant experience executing large and complicated affiliations.

For the pending bond issue, PSJH was assigned a Aa3 rating by Moody’s which is consistent with Providence’s pre-merger rating. St. Joseph was rated A1 pre-merger.

…AS DOES HACKENSACK/MERIDIAN MERGER IN NEW JERSEY

On July 1, 2016, a merger between two major providers in New Jersey closed. System are now Hackensack Meridian Health Network. HMHN is now one of the largest systems in the state. Hackensack is the largest provider in Bergen County, and Meridian Health System, is a sizable $1.9 billion integrated multi-hospital system in Monmouth and Ocean counties. The combination results in a $3.5 billion entity. The expectation is that synergies that will be realized over time will outpace the costs to capture such efficiencies.

This positions the ultimate credit –  the debt obligations of each system remain separately secured at this time – to ultimately be positioned for another upgrade. For now, Hackensack University Medical Center is upgraded to A2 from A3. This in spite of Hackensack’s historically high operating lease exposure declined following the debt-financed acquisition of a clinical plaza and parking garage which will reduce future lease expenses. While Hackensack has taken several steps to mitigate its growing pension liabilities and low investment returns, weakening the absolute measure of total debt relative to unrestricted cash.

One other major difference is that while HMHN is now bigger and more diverse, it still is exposed to potentials for change in state funding for Medicaid by having all of its facilities in the one state. The multi-state nature of Provident St. Joseph diversifies that risk.

ANOTHER SMALL COLLEGE DOWNGRADE

The issues of rising tuition and student debt were front and center during the national political conventions. Proposals for student debt forgiveness and free tuition at public colleges were bandied about. Interestingly, it was the managements of small private colleges who were the most vocal in their concern about the possible negative impact of free tuition on the demand for small private colleges. In the last two years, the closings of Sweet Briar and Dowling Colleges made news in the municipal bond market.

Last week, Bard College, a well known small private college in New York saw its rating continue its three year plunge below investment grade. Moody’s lowered the rating on Bard’s $131 million of debt from Ba3 to B1. The downgrade comes on the heels of ongoing declines in total cash and investments decreasing spendable cash and investments further and an increase in debt, including amounts outstanding under lines of credit and lender financing incurred for the purchase of an historic site adjacent to the Annandale-on-Hudson (NY) campus. Bard is increasingly dependent on operating lines of credit, even as it expects to have violated financial covenants in the bank agreements again for FY 2016.

The ongoing depletion of liquidity and increased exposure to bank agreements heightens the prospects for a liquidity crisis in the absence of extraordinary donor support. With a cash flow from operations insufficient to cover debt service, prospects for a material increase in liquidity apart from collecting pledges receivable or benefiting from additional gifts remain slim. A settlement with the US Department of Justice for $4 million in FY 2016, is likely to result in more weak operating performance. One positive element is that the Bard Graduate Center benefits from an external trust that held $111 million in investments as of June 30, 2016.

PRIVATE PRISONS UNDER THE GUN

Localities which have looked to private prisons as a source of revenues and/or jobs got a jolt last week when the U.S. Justice Department announced plans to end its use of private prisons.  A DOJ memo instructs officials to either decline to renew the contracts for private prison operators when they expire or “substantially reduce” the contracts’ scope. The goal is “reducing — and ultimately ending — our use of privately operated prisons.”

Officials concluded the facilities are both less safe and less effective at providing correctional services than those run by the government. “They simply do not provide the same level of correctional services, programs, and resources; they do not save substantially on costs; and as noted in a recent report by the Department’s Office of Inspector General, they do not maintain the same level of safety and security.”

There are 13 privately run privately run facilities in the Bureau of Prisons system, and they will not close overnight. The Justice Department will not terminate existing contracts but instead review those that come up for renewal. All the contracts would come up for renewal over the next five years.

The Justice Department’s inspector general recently released a report concluding that privately operated facilities incurred more safety and security incidents than those run by the federal Bureau of Prisons. The private facilities, for example, had higher rates of assaults — both by inmates on other inmates and by inmates on staff — and had eight times as many contraband cell phones confiscated each year on average, according to the report.

Private operators have said that comparing Bureau of Prisons facilities to privately operated ones was “comparing apples and oranges.” They generally dispute the inspector general’s report.

Three weeks ago the bureau declined to renew a contract for 1,200 beds at the Cibola County Correctional Center in New Mexico. Plans would allow the Bureau of Prisons over the next year to discontinue housing inmates in at least three private prisons, and by May 1, 2017, the total private prison population would stand at less than 14,200 inmates. According to the inspector general’s report, private prisons housed approximately 22,660 federal inmates as of December 2015. That represents about 12 percent of the Bureau of Prisons total inmate population, according to the report. By 2013, the private prison population was 32,000 but it began to decline because of efforts to adjust sentencing guidelines and to change the way low-level drug offenders are charged. DOJ said the drop in federal inmates gave officials the opportunity to reevaluate the use of private prisons.

The real threat will come if the Bureau of Immigration, Customs, and Enforcement follow the Justice Department’s lead. There are many rural jurisdictions which built facilities “on spec” to house illegal immigrants under occupancy based contracts with that agency. Many of the outstanding bonds were issued under those circumstances. Bonds secured by those payments would be immediately at risk if those contracts were not to be renewed. So, if you own bonds backed by payments from the federal government for prisons financed with local certificates of participation be very alert to any moves by ICE to follow the DOJ lead.

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.