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Muni Credit News August 18, 2016

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 CONSIDERS CASH FLOW BORROWING

It has never a good sign when a state undertakes short-term borrowing to fill in gaps in cash flow. In bygone times, revenue anticipation notes (RANS) were often issued to deal with timing issues between receipts and expenses. They also were used to cover gaps resulting from revenue shortfalls resulting from poor forecasting practices or unanticipated economic changes. As time has gone by, revenue estimation has become more sophisticated and better overall cash management practices have taken hold so the need for this type of borrowing at the state level has diminished significantly.

So it was disappointing to see that the State of Louisiana will consider this week a proposal to issue some $500 million of RANS to finance cash shortfalls in the first half of the fiscal year which began on July 1. The State budget process was particularly difficult and protracted this year as a new administration sought to rectify some of the questionable budget practices of the prior administration of Bobby Jindal. His program of tax and expense cuts led to a weaker financial position for the historically low rated State of Louisiana credit.

Legislative supporters of the Jindal era are attributing the need for the borrowing to naturally occurring timing differences between revenues and expenses. The more likely explanation is that In the past the state has been able to shift funding from savings accounts as needed to keep up. Those pools of money, including a Medicaid trust fund and contingency fund in the Division of Administration are now gone. those funds were applied to cover shortfalls in prior fiscal years.

Should such a borrowing be authorized and undertaken, it would be the first time since the 1980’s that Louisiana had needed such a borrowing. We view the use of such a borrowing to be a negative credit event which should place pressure on the State’s already low ratings. This despite the efforts of the new administration to address the impacts of the Jindal era budget practices.

ILLINOIS MOVING FORWARD WITH P3 TOLL PROJECT

The Illinois Department of Transportation is soliciting private partners to help develop the Interstate 55 managed lane project — new toll lanes from Bolingbrook to Chicago designed to alleviate congestion. This project is anticipated to include the addition of one lane in each direction within the existing median of I-55 between I-355 to the west and on the east at I-90/94 needed to accommodate implementation of a managed lane, which could include Express Toll Lane (ETL), High Occupancy Vehicles (HOV) lane, High Occupancy Toll (HOT) lane, Congestion Priced lane, or other feasible managed lane configurations as determined to be appropriate for a projected 2040 travel demand.

Interstate 55 experiences severe congestion for extended periods of time on a daily basis and is unable to accommodate the existing traffic demands (regional, daily commuter and local) due to limited roadway capacity, roadway design constraints at some locations, high truck volumes and numerous interchanges. In addition, commuters have limited available public transit options. This has resulted in increasingly long and unreliable travel times, decreased safety and increased costs for delivery of goods and services.

The Federal Highway Administration (FHWA) has determined that the Illinois Department of Transportation’s proposed I-55 Managed Lane Project will have no significant impact on the human environment. The FHWA issued a Finding of No Significant Impact (FONSI) based on the Environmental Assessment (EA) prepared for the study. The Illinois Department of Transportation (IDOT) has completed the voting process among property owners and occupants identified as benefited receptors regarding proposed noise mitigation along the I-55 Managed Lane Project corridor.

Thirteen noise walls totaling over 11 miles in length with 1,776 benefited receptors were found to be feasible. As established by Federal Highway Administration regulations, property owners and/or tenants identified as benefitted receptors are able to vote for or against noise walls in their area. In order for a person to be eligible to vote, the noise wall must decrease the noise level at the property by at least 5 decibels, which is a readily perceptible change in noise (typically homes within 300 feet of a noise wall). If more than 50% of the votes received are in favor of a wall, the wall is likely to be implemented with the proposed project.

Private developers would help defray the estimated $425 million cost of the project, according to IDOT. Private partners would have a hand in designing, building, operating and managing the toll lanes. Potential partners need to submit proposals by Sept. 8. IDOT needs approval from the General Assembly for the I-55 toll project. If all goes as planned, construction could start as early as next year and wrap up in 2019, officials said.

Last month, the state approved a similar project — a public/private toll bridge linking Interstate 80 to the CenterPoint intermodal facility in Joliet and Elwood. The Houbolt Road bridge will cost $170 million to $190 million, with CenterPoint building and operating the toll bridge over the Des Plaines River. IDOT is covering $21 million of that cost.

LIPA UPGRADED BY MOODY’S

Moody’s Investor Service upgraded the Long Island Power Authority’s (LIPA) credit rating one notch to A3 from Baa1 (senior debt) and to Baa1 from Baa2 (subordinate debt). Moody’s cited “enhancements” to its ability to recover costs from customers following last year’s rate-hike proceeding. It also noted improvements in LIPA’s operating performance, better customer satisfaction levels, more transparent and credit supportive regulatory relationships and an expectation for better financial performance on a sustained basis.

On January 1, 2016 a three-year rate plan was put into effect, which called for modest electric distribution rate increases and automatic recovery mechanisms that provide protection against certain external factors. Supportive automatic recovery mechanisms approved and implemented include a revenue decoupling mechanism (RDM) and a delivery service adjustment (DSA). Together, these mechanisms provide automatic cost recovery should certain external events occur, including revenue variations that result from changes in economic conditions, weather or energy efficiency programs as well as higher-than-budgeted storm costs.

LIPA’s has received grant funds from FEMA, which along with internal generated cash flow sources and incremental debt will fund a capital investment program focused on storm hardening and enhancing system reliability. Because of the existence of the FEMA funds, currently held in a restricted cash account, the debt ratio is expected to continue its declining trend even while incremental debt is incurred to fund the capital investment program. A higher rating could occur if the fixed obligation charge coverage were to reach 1.50 times while its debt ratio declined below 100%, both on a sustained basis.

PREPA ROAD TO RECOVERY HITS MORE SNAGS

The path to recovery for PREPA appears to have run into some more problems. It appears that the time line for recovery will be extended through year end with the announcement of an extension of the contract of PREPA”s restructuring advisor through December 15. The extension, which will cost $6.713 million, has been criticized with the news that the advisor had paid Standard and Poor’s some $365,000 in consulting fees to help secure an investment grade rating for bonds to be exchanged as part of an Special Purpose Vehicle that is a cornerstone of the Restructuring Support Agreement (RSA) it has secured with 70% of its bondholders. As of yet, all of the credit rating agencies declined to give the new bonds an investment grade. Since that did not happen, PREPA must return to the negotiating table with bondholders.

PREPA continues to believe that there is a path to obtaining an investment grade rating for the securitization bonds and intends to initiate a formal rating process with rating agencies in the near future. The investment grade, which is key to consummate the deal for an exchange of debt for new securitization notes to receive 85% of their existing claims in new securitization notes, is not yet guaranteed by credit rating agencies despite a securitization mechanism tied to a rate hike that could surpass 22%.

That rate hike is already facing potential challenges. As we go to press, it is expected that eight leading Puerto Rico business and industry organizations will announce the filing of a major lawsuit to block no-limit (“blank check”) rate increases as part of the controversial Puerto Rico Electric Power Authority (PREPA) debt restructuring scheme. U.S. groups are also joining in support of the litigation effort.

The industry groups are the Institute for Competitiveness and Economic Sustainability of Puerto Rico, the Puerto Rico Manufacturers Association, the United Retailers or “Centro Unido de Detallistas,” the Puerto Rico Products Association, the Chamber of Marketing, Industry and Food Distribution, Puerto Rico Hospitals Association, the Puerto Rico Hotel & Tourism Association, and the Association of Contractors and Consultants of Renewable Energy.

ALL ABOARD FLORIDA BONDS DERAILED IN COURT

Martin and Indian River Counties in Florida won a favorable decision in a U.S. District Court in their challenge to the private activity bond allocation granted to the private developer of the high speed train project, All Aboard Florida. Now known as the Brightliner, the project would provide service between Miami and central Florida. (See the MCN, 6/16/16) The counties have sought to block the project on environmental grounds, a hurdle which we have discussed numerous times as a major investor risk in public-private (P3) projects.

Fourteen months ago, the Court denied preliminary-injunction motions filed by the two Florida counties, which sought to invalidate the U.S. Department of Transportation’s (“DOT’s”) authorization of $1.75 billion in tax-free bonds to be issued to finance a private passenger-rail project known as All Aboard Florida. The Court found that the counties had not met their burden of demonstrating standing because they had failed to show that enjoining DOT’s authorization would significantly increase the likelihood of halting construction on Phase II of the project, the portion that runs through their borders. The Court did permit the Counties to conduct discovery designed to provide Plaintiffs an opportunity to uncover evidence to support their assertion that, without the ability to issue $1.75 billion in tax-free private activity bonds (“PABs”), AAF would be significantly less likely to proceed with the project.

Both counties allege violations of the National Environmental Policy Act (“NEPA”), the National Historic Preservation Act (“NHPA”), the Department of Transportation Act (“DTA”), and Martin County additionally alleges a violation of Section 142 of the Internal Revenue Code, as amended by the Safe Accountable Flexible Efficient Transportation Equity Act (“SAFETEA”). Because Plaintiffs have alleged facts showing that the AAF project qualifies as major federal action, the Court denied Defendants’ motions to dismiss Plaintiffs’ NEPA, NHPA, and DTA claims.

The project is divided into two phases. In Phase I, AAF intends to provide rail service linking West Palm Beach, Fort Lauderdale, and Miami. Phase I has received private funding and is in development; in fact, it is nearly complete. Thus far, AAF and its parent company, Florida East Coast Industries (“FECI”), have spent over $612 million on development and construction and expect to commit to spending an additional $200 million.

To fund Phase II of the project, AAF applied for a $1.6 billion loan through the Railroad Rehabilitation and Improvement Financing program (“RRIF”). RRIF is both a loan and loan- guarantee program administered by the FRA for the development and improvement of railroad tracks, equipment, and facilities. RRIF loans are subject to NEPA review of the proposed project’s environmental effects. FRA has been acting as the lead agency in preparing an Environmental Impact Statement (“EIS”) and Record of Decision to determine the environmental effects of Phase II prior to making a final determination as to AAF’s loan application. FRA, in cooperation with the U.S. Army Corps of Engineers, U.S. Coast Guard, and Federal Aviation Administration, issued a draft EIS in September 2014 and a final EIS (“FEIS”) in August 2015. The FEIS analyzed a wide range of potential environmental and other consequences of the project and “identified and evaluated measures that would avoid, minimize, or mitigate impacts that would result from the Project.” under the RRIF program.

The Court cannot to address the sufficiency of the allegations in the counties’ complaints unless they have standing to bring their claims. With a finding of standing, the Counties can challenge on environmental grounds. The hope to at least delay bond issuance through the current (after two extensions) January 1, 2017 deadline to issue the bonds. The counties’ burden in this phase of the case was to show that invalidating the PAB authorization would significantly increase the likelihood that AAF would abandon Phase II of the project. The Court found that they have. An appeal is expected.

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

Muni Credit News August 16, 2016

Joseph Krist

Municipal Credit Consultant

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

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/.

ANOTHER P3 TOLL ROAD BANKRUPTCY

On March 22,2007, a concession agreement was executed between the Texas Department of Transportation and SH130 providing for the financing, construction, and operation of a toll highway in Texas. Financing was provided one year later by a consortium of foreign banks and a TIFIA loan ($440 million) from the U.S. Government. If you recall, privatization of roads had been a goal of the Bush administration and then Texas Governor Rick Perry.

Texas State Highway 130 (SH 130), also known as the Pickle Parkway, is a highway from Interstate 35 in San Antonio along Interstate410(Texas) and Interstate 10 to east of Seguin, then north as a tollway from there to Interstate 35 north of Georgetown. SH 130 runs in a 131-mile (211 km) corridor east and south of Austin. The route parallels I-35 and is intended to relieve the Interstate’s traffic volume through the San Antonio-Austin corridor by serving as an alternate route.

The highway was developed in response to the tremendous surge in truck traffic on the I-35 corridor brought on by the North American Free Trade Agreement during the late 1990s, especially truck traffic originating from Laredo. The road opened for operation in November, 2012. It quickly became known for two things – it had the highest speed limit in the U.S. at 85 mph and almost no traffic.

It is difficult for toll highways which run essentially parallel to free limited access roads like 1-35, to attract sufficient numbers of users. It is often difficult to convince potential users that the savings in time and fuel are enough to offset the cost of tolls. SH 130 levied a toll for a passenger car that was nearly $20 and a heavy truck would be over three to five times over in recent years, which made the cost/benefit analysis less favorable to potential users.

These forces combined to generate revenue yields from the road coming in well below ability to service the $1.1 billion of outstanding debt that financed construction. The continuation of these trends and the lack of any real alternatives led the to consortium to seek bankruptcy protection earlier this year.

Last week, the debtors proposed a plan of reorganization which effectively turns the project over to its creditors. A new corporate entity will be formed to operate the road and the outstanding debt will be refinanced with a combination of debt and Payment in Kind or PIK instruments. So effectively, it is up to the lenders to fix the problem and recover their investment.

What is of real interest to municipal investors is the role of Cintra, S.A. as one of the members of the original consortium which built and operated the project, This represents the third failed P3 project in the US in which Cintra has been a primary participant which has not achieved the desired results. It was the initial purchaser of the Chicago Skyway which benefitted the City of Chicago but which Cintra divested itself of in a year’s time and the ill-fated Indiana Tollway privatization. That deal was hailed as a huge success for Indiana and its Governor Mitch Daniels but was a financial failure for Cintra. Based on that track record we would be wary of any P3 involving Cintra.

MOODY’S GREEN BOND RATINGS

The Upper Mohawk Valley Regional Water Finance Authority received a green bond assessment of GB1 for $8.78 million of water system revenue bonds the first GBA from Moody’s Investors Service to be issued in the U.S. The assessments range from GB1 for excellent to GB5 for poor. The assessment is designed to help investors determine if green bond proceeds are being used to achieve “positive environmental outcomes,” according to Moody’s.

Beginning in July, the rating agency has assigned four GBAs, the first three of which went to European entities. There a growing number of investor classes both individual and institutional who invest specifically in projects designed to address environmental issues. There are mutual funds which are marketed as “green” investment funds. Moody’s attributed the demand for these ratings to institutional buyers primarily . The existence of an outside “objective” assessment of the “green” status of the bonds will address compliance and marketing issues for the funds.

The Upper Mohawk Valley Regional Water Finance Authority bonds are to be issued soon to help finance an increase in the water system’s resiliency and the furtherance of its mission to provide safe drinking water to users. The authority is an instrumentality of New York State that serves 130,000 residents through 38,900 service connections in the eastern portions of the eastern portions of Oneida and Herkimer counties as well as the city of Utica.

According to Moody’s calculations, global green bond issuance during the second quarter reached a new quarterly high of $20.3 billion, raising total volume for the first half of the year to $37.2 billion, an 89% increase over the same period a year ago. The U.S. accounted for about 22.8% of the second quarter issuance and 19.8% of first quarter issuance, Moody’s said. U.S. Issuers in the second quarter were from Massachusetts, New York, California, Maryland, Indiana, Cleveland, Ohio, New Jersey, Rhode Island, and St. Paul, Minn.

Determining factors would include whether bonds issued to finance a project will reduce a carbon footprint, deter climate change, or improve water quality. The GBA will be based in part on the disclosure practices of the issuer and borrower and how transparent they are. The GBA is determined according to five key factors: organization; use of proceeds; disclosure of the use of proceeds; management of proceeds; and ongoing reporting and disclosure on environmental projects financed or refinanced with the bonds.

In the example of the Upper Mohawk Valley Regional Water Finance Authority, Moody’s said the authority is effectively organized and properly staffed with qualified and experienced personnel. The bonds, are explicitly designated as green bonds in the draft official statement by the Authority. They are being issued under the authority’s capital improvement plan to improve the water system’s infrastructure through increased capacity and dependability with proceeds allocated to raw water transmission upgrades that will improve the authority’s ability to draw water from the Hinckley Reservoir during major droughts that lead to below-normal water levels in the reservoir.

A small share of proceeds will finance design of two new water storage facilities as well as improvements to a water treatment plant and pumps and regulating stations. The authority discloses information on these projects in its annual comprehensive financial reports and on its website in capital projects committee reports.

The projects are expected to be completed within 12 months and the first-year initial disclosure is supposed to indicate in detail how the proceeds were expended, the contractors performing the work and receiving payments, and the actual work that was completed. In order to maintain the designation Moody’s says that “annual reporting will also include updates on four key metrics that at the same time link up to base line disclosures that permit comparative analysis”. “These include reservoir water levels versus transmission capacity, conveyance of purified potable water during the year, trihalomethane levels and the total amount of hydroelectric power produced by the turbines within the water treatment facility.”

It is fair to ask if there should be any concern as to whether the rating agency is stepping outside of its area of expertise. Would it be more proper to consider this the realm of engineering and/or environmental consultants? On whose expertise are they relying for ongoing chemical or other water quality analysis? Will a credit like the NYC Water and Sewer Finance Authority get credit for its renowned water quality and minimal treatment requirements? We ask because historically the rating agencies have relied on their stand that their credit ratings are just opinions to protect themselves from the consequences of overrating bonds. They seem to be making the case that the GBA is a more quantitative assessment rather than just an opinion.

ILLINOIS TESTS THE MARKET

Illinois is going to see if it can take advantage of its most highly rated credit by issuing Sales Tax Revenue Bonds during the week of August 22. Build Illinois bonds have a first and prior claim on the state share of the 6.25% unified sales tax and a first lien on revenues deposited into the Build Illinois Bond Retirement and Interest Fund (BIBRI). Debt service payments on the junior obligation bonds are subordinate to outstanding senior lien debt service; the senior lien is not closed. The security includes strong non-impairment language, and no requirement for annual appropriation.

These provisions are seen as providing a degree of insulation to the bonds from the larger credit problems plaguing the State’s GO credit. The trustee and the state’s debt manager transfer monthly 1/12th of the greater of 150% of the certified annual debt service or 3.8% of the state’s share of the sales tax up to the certified annual debt service requirement. The 3.8% of revenues has, since fiscal 2013, been greater than the debt service requirement, accelerating annual debt service funding.

Coverage of annual debt service and MADS requirements is very high for both liens. Additional security features include additional bonds tests that require debt service be no more than 5% of the state’s prior year sales tax receipts to issue senior lien bonds and 9.8% to issue junior obligation bonds; this effectively requires 20x coverage to issue senior lien bonds and 10.2x coverage to issue junior obligation bonds.

Revenue performance since the end of the recession has shown good year-over-year growth in all years except 2013. Sales tax revenues grew 4.1% and 4.5% in fiscal years 2014 and 2015, respectively. This year has been impacted by lower gasoline prices, with just 0.7% year-over-year growth in sales tax revenues in fiscal 2016. The state taxes gasoline sales as a percentage of the per-gallon price.

This issue is coming to market with ratings from S&P (AAA negative outlook) and Fitch AA+ (stable outlook). Moody’s has a much different view of the degree of insulation the credit has from the State’s well-known problems, assigning a Baa 2 rating to the bonds. Over the years the segregation of state sales tax collections in a variety of jurisdictions and credit environments, in our view, has stood the test of time. That serves as the basis for our view that the Moody’s assessment is too harsh supporting the State’s move to come to market without soliciting a Moody’s rating.

At the same time, the fact that the senior lien is not closed precludes a AAA rating in our view. This in spite of the strong credit provisions we have described. All in all, the bonds represent a solid AA credit.

Muni Credit News August 11, 2016

Joseph Krist

Municipal Credit Consultant

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

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 PENSION PARALYSIS

Senate President Stephen Sweeney all but declared dead a ballot question to mandate more funding for New Jersey’s troubled pension system – costing an estimated $20 billion over five years. It had been his top legislative priority. He is expected to run for governor in 2017 and spent more than a year pitching his plan as a lasting fix to New Jersey’s pension-funding crisis, one of the worst in the country.

By cutting more than $2 billion from pension payments during the budget crisis in 2014, Gov. Christie triggered a series of downgrades from Wall Street credit-rating agencies and several lawsuits from unions. The state Supreme Court upheld Christie’s pension cuts last year, even though Christie had signed a law pledging to make them in full. Democrats in response proposed a constitutional amendment – which must be approved by the voters – to overturn that court ruling.

The Assembly approved the ballot question in June. But the Senate has not done so and needed to act before the constitutional deadline on this past Monday to place the measure on November’s ballot. Sweeney said it would be “irresponsible” to proceed with the pension amendment at a time when lawmakers do not know how much a potential transportation deal will cost in future tax revenue (see the 7/28/16 MCN). Of the two leading transportation plans, one would cost $550 million and the other $1.7 billion in lost annual revenue after being phased in over several years. Sweeney ruled out raising taxes or cutting from other areas of the budget to meet pension and transportation costs.

Sweeney’s position represents a shuffle in the usually expected politics of pensions. Union leaders called the democrat ” a liar” and the state director of the Communications Workers of America union, said the amendment is needed because politicians like Christie and Sweeney keep moving the goal posts on their pension-funding promises, she added. “It’s been over two decades since any administration – Republican or Democrat – made a full pension payment,” she said. The amendment would increase pension payments over five fiscal years with some of the strongest legal language available anywhere in the country. Pension payments would have become the top priority in the state budget every year in perpetuity – impervious to any budget cuts even after the first five years. The amendment also would have required state officials to make pension payments on a quarterly basis. No state mandates quarterly pension payments through its constitution.

Spread out over five years, the amendment’s cost would have been $20 billion, according to the nonpartisan Office of Legislative Services, starting with a $2.4 billion payment in fiscal year 2018. New Jersey’s state budget this year is $34.5 billion, and Christie is proposing to make a $1.9 billion pension payment, what would be the largest in state history, but only 40 percent of what actuaries say is needed to fully fund the retirement benefits workers have earned.

Sweeney supported the amendment for months, stressing that pension costs grow exponentially for state taxpayers over the long term with each passing day that the pension system’s problems are further neglected. Christie, Republican lawmakers and business groups are all opposed to the pension amendment. Bondholders should be concerned about provisions which place pension payments ahead of debt service no matter how positive the full funding of pensions would be from a ratings perspective.

NEW HAVEN, CONNECTICUT

Recently the outlook for the State of Connecticut come under scrutiny. We note the fact that while aggregate state wealth indicators are strong, many of its cities had been hollowed out economically and faced significant financial challenges on their own. The recent release of a preliminary official statement by the City of New Haven in support of a pending GO bond sale gives us an opportunity for a case study.

The City’s role as the home of Yale University is well known. The surrounding city has not benefitted from its presence as much as one might think and the relationship between the University and the residents has been fraught for years. The local economy has struggled and the property tax base has stagnated. As a result, the City has high demands for services but its capacity to raise revenues has been strained.

In recent years, the City has been able to maintain control of expenditure growth with the budget growing less than 2% per year since 2009. Expenditures have increased from $456 million to $509 million over that period. Unfortunately, like the State, the City faces steady growth in its liabilities for pensions and other post employment benefits (OPEB). These have grown to present the greatest fiscal challenge to the City.

Pension funding contributions have been increasing regularly if at uneven rates since 2009, growing by a total 65.8% over that period. In spite of this effort, which has increased the share of pension funding from 6% to 9% of total expenditures, the funding ratio for these liabilities has decreased from 60% to 39% for non-uniformed employees and 58% to 50% for uniformed employees. This reflects a combination of disappointing investment returns combined with a rapid rate of increase in accrued liabilities as employees age out and retire. It also reflects a nationwide policy of addressing lower salary growth through the use of increased pension benefits as a negotiating tactic with employee unions.

Scarier is the lack of asset accumulation for OPEB by the City. It essentially funds these on a pay as you go basis. These liabilities have now increased to 184% of annual payroll. At the same time, the funding ratio for these liabilities has stood at 0.1%. This because the City only began the asset funding process in 2012 and only made appropriations for this purpose in two years.

The City is rated Baa1 by Moody’s and A- by S&P and Fitch. The latter two have positive outlooks on their ratings. Our view is that such an outlook is hard to justify in the face of these liability issues along with the low return investment environment we are in. Given that the funding ratios reflect assumed annual investment returns of 8% (and that is a decrease) each additional year of investment underperformance will further pressure funding ratios. In the face of this kind of fiscal pressure, we cannot see this as a positive situation and the bonds are a triple B credit. They need to be priced accordingly.

KANSAS POLITICS COULD REVERSE FISCAL TRENDS

We normally would not give a lot of weight to primary results in state government races but this year’s primary in Kansas is a unique situation. For some time we have negatively commented on the outlook in Kansas which results from the strong ideological bent of its legislature and Governor Sam Brownback. Last week, voters went to the polls to choose candidates for the November general elections for state legislators. To say that they sent a message is an understatement.

The results cut deeply into the Senate’s conservative voting majority and may have reversed it in the House, especially if Democrats pick up a few more seats in November. Moderates and Democrats regularly teamed up to block right-wing legislation until conservative challengers purged the Senate of most of its moderates in the 2012 Republican primaries.

The moves to eliminate the income tax were designed to stimulate business growth and employment but failed to do so. The governor’s signature tax plan exempted more than 300,000 business owners from paying any income tax. What they did accomplish was to diminish state revenues and force cutbacks in expenditures in the form of lower aid to local school systems and highways. Schools and roads are among the more cherished services for Kansas voters.

In the meantime, Kansas missed revenue expectations for June by more than $33 in the 2016 fiscal year, which ended June 30, and after the state lowered revenue estimates significantly in April. The bulk of the June shortfall can be attributed to lower-than-expected income tax receipts. Corporate income tax receipts are expected to be $20 million below expectations, and individual income tax receipts are expected to be $18 million off the mark. Some other types of taxes outperformed estimates, but not enough to fully offset the loss.

SCRANTON FACES DAUNTING CHALLENGES

Scranton, PA has been a city on the decline for nearly a century. The demise of the anthracite coal industry and its role as a railroad hub have long been documented. It has led to long term declines in population and property values. This led to continuing budget imbalance and reliance on increased tax and financial gimmickry. Eventually, the City’s bag of tricks emptied and it found itself in the Commonwealth of Pennsylvania’s Act 47 Distressed Cities Program.

Under the program, the City was supposed to undertake a five year plan of fiscal renewal such that it could leave the program in 2017. Unfortunately, the City was unsuccessful in its implementation of the revenue adjustments and workforce changes required under the 2012 plan. A deficit is projected for each of the next five fiscal years with the 2020 deficit estimated at $19 million or nearly 20% of expenditures. A revised recovery plan along with an extension of the Recovery Period to 2020 has been adopted. The plan is designed to help the City to avoid a declaration of fiscal emergency in the next two years.

The plan includes an increase in the local services tax from $52 to $156 per year. Right now, earned income and local property tax revenues cover on $56 million out of $71 million of employee expenses (wages and pensions). It seeks to sell the City-owned parking system and looks to the fees charged for sewer services as a source of funding for the City’s unfunded pension obligations. It calls for asset sales and application for grants from the Commonwealth.

The City has applied to sell the Sewer System to a private operator. Estimated proceeds re $110 to $120 million, with 80% due to the City. If successful, the City will apply its proceeds to defeasance of $18 million of debt and to funding $65 million of unfunded pension liabilities. In spite of this significant cash infusion, the funding ratios for the City’s pension funds will still be only 50%.

It is the view of the Plan’s developer that without implementation of all elements of the Plan, the City will need to declare a fiscal emergency. Even if implemented, property taxes may have to be raised. The City’s $132 million of debt will need to be refinanced. The Plan suggests the use of pension bonds payable from dedicated earned income tax revenues as a part of the solution.

Of more immediate concern is the need to issue some $35 million of GO notes. These notes, maturing in 10 and 15 years, will be full faith and credit obligations of the City. Unfortunately, the problems outlined above present a very weak credit in support of that pledge. There has been a lack of public political support for raising taxes and fees and even less political will on the part of local politicians. Without those to factors and the means to pay, the City’s debt remains at best a highly speculative investment.

INDIANA P3 DOWNGRADED AGAIN

In our April 14, 2016 issue we commented on the problems facing the I-69 Section 5 project that is a part of an Indiana highway that is being expanded to handle expected increased truck traffic resulting from NAFTA. Isolux Corsan SA (Isolux) is the parent of the construction contractor, Corsan-Corviam Construccion SA, whose rating was revised to ‘B-‘/Rating Watch Negative on Feb. 12, 2016. Those problems have continued. Now, Fitch Ratings has downgraded the Indiana Finance Authority’s private activity bonds (PABs) issued on behalf of I-69 Development Partners LLC (I-69 DP or the Developer) for the I-69 Section 5 project to BB from BBB-. The bonds remain on Rating Watch Negative.

The downgrade reflects continued delays in construction and unresolved payment issues between the construction contractor and subcontractors, culminating in two Notices of Default issued by the Developer to the construction contractor, citing failure to promptly pay subcontractors and falling behind on an existing remedial plan, which have 20 and 60 day cure periods, respectively.

Delay risk is also heightened by the financial deterioration of Isolux Corsan SA (Isolux), parent of the construction contractor, Corsan-Corviam Construccion SA, whose rating was revised to ‘RD’ (Restricted Default) from ‘C’ on Aug. 3, 2016, reflecting the execution of a Distressed Debt Exchange following recent filings for forms of court protection. The company has confirmed that, to date, it has met payments but non-payments are planned under restructuring plans.

This transaction continues to be a great advertisement for the perils of P3 projects for both investors and for governments who hope to benefit from the “efficiencies” of the private sector in lieu of traditional funding for public projects.

Muni Credit News August 9, 2016

Joseph Krist

Municipal Credit Consultant

CHICAGO LOOKS TO WATER BILLS TO FUND PENSIONS

The latest credit development in the Chicago pension saga is a proposal by Mayor Rahm Emmanuel to generate the $239 million over five years needed to save Chicago’s largest city employee pension fund. Emanuel proposed a “utility tax” on water and sewer bills over the next four years. The plan is to start with a 7 percent tax, double it in year two, impose a 21 percent tax in year three and end at 28 percent in years four and five.

After that, the tax would rise annually to meet the “actuarially required contribution” to achieve a 90 percent funding ratio by 2057 for a Municipal Employees pension with $18.6 billion in unfunded liabilities that is due to run out of money in 2025. The average Chicago household currently pays $686.04 a year for water and sewer services that use 7,500 gallons of water.

The plan faces some clear hurdles. It rests on City Hall’s assumption that the new tax can be enacted by the City Council in September under the city’s sweeping home-rule power and does not require state legislative approval. It is expected to cost the average homeowner $4.43 more month or $53.16 a year in 2017. In the fourth year, the added tax burden will be $225.96 a year.

The plan would undoubtedly be well received by investors who view the pension situation as the primary factor weighing on the City’s credit but it will undoubtedly be just the opposite for homeowners who will see the city’s property tax levy double under Emanuel’s leadership and the aldermen who represent them. Emmanuel acknowledges this by saying “I’m not saying this is not tough. It is tough . . . But the Council has always stepped up for Chicago’s future and I’m absolutely confident they will step up and be part of that solution so that, once and for all, the bow can be tied as it relates to the pensions”.

One outsider view that carries considerable weight in analytical circles is that of the Civic Federation. Its president called it a “positive and politically reasonable step” to try to “use water fees” instead of raising property or sales taxes that would only compound the “high tax situation that already exists.” He added a caveat when he characterized the plan as “a creative and brave effort by the mayor but it will require continued monitoring. We have not seen the actuarial detail to prove” the tax will generate enough money “in the longer term,” he said.

A property tax increase based on the value of a home would have been less regressive than a tax on water and sewer bills based on water usage needed to live, a property tax hike would have had the added advantage of being deductible on federal taxes for homeowners. In spite of that, a property tax hike is considered untenable at present.

PENNSYLVANIA – STABLE OUTLOOK?

The upcoming sale of GO debt by the Commonwealth of Pennsylvania occasioned Moody’s to review its Aa3 rating and to maintain with a revised outlook, upwards to stable . Their rationale – “The revision of the commonwealth’s outlook to stable recognizes that Pennsylvania’s problems – while sure to persist – are unlikely to lead to sharp liquidity deterioration, major budget imbalances, or other pressures consistent with lower ratings for US states. Pennsylvania continues to make steady progress toward better funding of its pension liabilities, which remain large but not abnormally large by state standards. The commonwealth is likely to continue struggling to balance its budgets in future years, but the magnitude of its budget gaps will be solvable. And while legislative gridlock, depletion of its rainy day balances, and a long history of pension underfunding reflect poorly on the commonwealth’s governance practices, none of these is inconsistent with the current rating category, which is already below the median for a US state.

Whenever a rating is challenged in court by aggrieved investors, the rating agencies wriggle off the hook by citing their First Amendment right to express an “opinion”. So exercising the same right let us express our opinion that the phrases “likely to continue struggling to balance its budgets in future years, depletion of its rainy day balances, and a long history of pension underfunding” are not consistent with a double A rating. Especially in a state where so much economic activity is concentrated geographically in two areas with the rest in an extended state of deep decline.

Our advice to investors is, if they must, invest in this name at a spread to other comparably rated credits and please do not be surprised when partisan considerations hold up serious structural budget reform in the second two years of Governor Wolf’s term. Only a serious rebalancing of the legislature in November should lead to a view of credit stability.

NUCLEAR POWER – COSTLY ON THE WAY IN AND THE WAY OUT

The Omaha Public Power District in Nebraska is planning to sell $175 million of revenue bonds this month. OPPD has operated a nuclear generating facility – the Fort Calhoun generating station since 1983. The official statement updates investors about its plans to close the plant at the end of 2016 and replace the generating capacity with purchased power generated by natural gas fired facilities.

We see the details of this change as indicative of a number of factors influencing power generation decisions by both public and investor owned utilities. First, it continues a trend of closures of nuclear plants. These are occurring in spite of the perceived positive impact on global warming of these facilities due to their lack of carbon emissions. The perceived environmentally friendly status of natural gas fired plants combined with their OPPD is not making a particularly daring decision.

It is also a decision which is not without cost. The official statement estimates the cost of decommissioning the Calhoun plant at $1.256 billion. At present, the District estimates that it has accumulated some $387 million of assets in decommissioning trust funds. There are two shortfalls that exist in these funds. One is the difference between the asset values and the total estimated decommissioning costs – a long term problem. Of more concern is that the NRC requires $435 million of funding to demonstrate assurance of funding for decommissioning. So the District will have to generate at least $50 million of additional funding by year end. The District will also have to pay Exelon, the plant operator, $5 million for early termination of its operating agreement.

The plant is for accounting purposes now carried as a regulatory asset for the purpose of recovering its costs of decommissioning. A 10 year amortization period commenced in December, 2013 for cost recovery and there is a balance of $117 million on that asset. Each year the District will recognize a depreciation charge against the balance of that asset. So there is a way to recover some of the cost.

At the same time, the New York State Public Service Commission has issued an order that will allow upstate utilities to charge their customers nearly $500 million a year in subsidies aimed at keeping some upstate nuclear power plants operating. Exelon has said it may have to close its R. E. Ginna and Nine Mile Point nuclear plants unless it receives financial help from the state. Another company, Entergy, had said that it would close the James A. FitzPatrick plant, which neighbors Nine Mile Point on the shore of Lake Ontario in Oswego County, by early next year.

Starting in 2017, the subsidies would cost utility ratepayers in the state $962 million over two years. The overall cost of the clean energy program to utility customers would be less than $2 a month. Exelon has pledged to invest about $200 million in its upstate plants next spring if the program is approved.

The plants also provide economic benefits in job starved localities by maintaining employment. In some cases, they are by far the largest property tax payers in their localities. No one is arguing that this is the cheapest way forward.

SNAKE EYES FOR ATLANTIC CITY

Just after avoiding a default on its debt, the Atlantic City economy and the effort to restore it took a hit when the Taj Mahal announced that it will be closing after Labor Day. The story will get lots of publicity since it still has the Trump “brand” in its name even though Mr. Trump is no longer involved. It is actually owned by Carl Ichan. A long strike and a steady decline in business at the facility will lead to a loss of 3,000 jobs just at a time when the City does not need it.

The decision reflects the long term challenges faced by the gambling industry in Atlantic City. With continuing competition from the newly established Pennsylvania facilities draining customers, Atlantic City remains under pressure. Potential additional new competition from New England reinforces the fear that gaming is becoming a zero sum proposition in the Northeast.

PURPLE LINE P3 TAKES LEGAL HIT

The proposed mass transit project in Maryland known as the Purple Line suffered a significant legal setback when a federal judge issued an order that will force the project to submit an environmental impact study. The project, a 16.2-mile light rail transit project in Montgomery and Prince George’s Counties, Maryland is planned to be constructed through a public private partnership or P3 arrangement. The judge found that that the recent revelations regarding Washington Metropolitan Area Transit Authority’s (“WMATA”) ridership and safety concerns merit a supplemental Environmental Impact Statement (SEIS) under NEPA and reserved judgment as to the remaining issues. Accordingly, plaintiffs’ motion for summary judgment was granted in part, and federal defendants’ and defendant-interveners cross motions for summary judgment were denied in part.

The NEPA requires that federal agencies consider the environmental effects of proposed actions by requiring them to “carefully consider detailed information concerning significant environmental impacts.” The plaintiffs claimed that defendants’ failure to prepare an SEIS based on recent events that raise substantial concerns about WMATA ‘s safety and in turn its possible decline in future ridership. The judge found that defendants’ failure to adequately consider WMATA’ s ridership and safety issues was arbitrary and capricious, and that these conditions create the “seriously different picture” that warrant an SEIS.

Plaintiffs pointed to a “series of incidents that have raised questions about passenger safety”, explained that the National Transportation Safety Board had found that the “FTA and WMATA’s Tri-State Oversight Commission are incapable of restoring and ensuring the safety of WMATA’s subway system,” and emphasized how these developments directly undermined the rationale for the Purple Line. Plaintiffs stated that ridership on the WMATA subway has declined every year since 2009. In their view, the news of (declining Metrorail ridership) . . . casts an additional shadow over the rosy projections of ever increasing ridership for the Purple Line, which is inextricably linked to and dependent upon the use of several subway stops from beginning to end.

The Maryland Transportation Authority (MTA) offered in response only that the Purple Line is not part of the WMATA’s Metrorail system. The Purple Line would be owned by MTA and operated by MTA’s contractor. Therefore, the financial or other issues currently being experienced by WMATA do not involve the Purple Line, and they have no relationship to the environmental impacts of the Purple Line. Therefore, the WMATA-related issues cited in FCCT’s letter provide no basis for preparing an SEIS.

This was sufficient for the relevant federal regulators but the judge found such reliance to be arbitrary and capricious given the need for access to the Purple Line through the WMATA system. He found that defendants wholly failed to evaluate the significance of the documented safety issues and decline in WMATA ridership, skirting the issue entirely on the basis that the Purple Line is not part of WMATA. While it is true that WMATA is a distinct entity from MTA, which would own and operate the Purple Line, this does not provide a rational basis for defendants’ summary conclusion that a decline in ridership thereon has no effect on the Purple Line, given that the previous projections estimated over one quarter of Purple Line riders would use the WMATA Metrorail as part of their trip.

We never fail to be amazed when projects underestimate the role of the environmental review process as a potential source of delay and/or blockage of transportation projects whether they be for road, rail, or air projects. In assessing project viability whether before or during investment, investors need to be concerned with the status of the environmental review process and satisfy themselves that they are being compensated for the associated risk.

Muni Credit News August 4, 2016

Joseph Krist

Municipal Credit Consultant

MSRB DISAPPOINTS ON BANK LOAN DISCLOSURE

Participants in the municipal bond market have been fighting the glacial pace of disclosure reform for as long as I can remember. The latest development in this effort is in the realm of disclosure of credit exposure by municipal issuers through direct lending by banks. In an effort to avoid the time, cost, and financial disclosure requirements associated with a public debt offering, smaller municipalities have increasing turning to commercial banks as a source of financing. While there have been some benefits for issuers, this lending has raised a number of credit issues for analysts and investors attempting to ascertain the actual level of risk associated with investment in a given issuers bonds.

One of the big concerns associated with this kind of borrowing is the lack of disclosure available to debt investors surrounding the exact security provisions for these loans. While the loans themselves are usually secured on a subordinate basis to outstanding debt, that can change in the event of a default on a loan. Often, in the event of default, the lending bank can demand that the borrower issue actual bonds which are secured on a parity with previously issued debt. holders of those bonds can suddenly find themselves with a significantly larger amount of debt secured on a parity with theirs. This complicates the analysis of potential recovery in the event of a default and/or bankruptcy and makes valuation of the total amount of outstanding debt much more problematic.

So it was with some disappointment that we see that the Municipal Securities Rulemaking Board (MSRB) announced this week that the U.S. muni market’s self-regulating group would not pursue “at this time” a rule to facilitate disclosure of bank loans taken out by states, cities, schools and other bond issuers. The board, which regulates muni dealers, bond underwriters and financial advisors, but not state and local government issuers, has been trying to devise a way to boost disclosure of such private loans for the reasons we have discussed.

The MSRB’s decision likely means that most investors will not be able to get this information. This despite the fact that the regulator itself acknowledged in March that only a small number of issuers had disclosed the loans “The board continues to believe that disclosure of alternative financings is important for assessing a municipal entity’s creditworthiness.” She said the board would instead continue to push for voluntary c”We preserve our ability in the future to do rule-making, but we wanted to give it a little more time,” Kelly said.

Our view continues to be that the industry needs to err on the side of more rather than less disclosure. As the old saying goes “sunlight is the best disinfectant”. With more municipalities using this technique and bankruptcy becoming more prevalent, this is an increasing concern for investors.

CHICAGO MAKES ITS CASE TO INVESTORS

This week the City of Chicago held its annual investor presentation. Given the daunting challenges the city faces, the update is timely. The City’s total revenues for 2016 are projected to end on target, although certain revenues are projected to end substantially under budget due to factors unrelated to Chicago’s economy. These revenues include utility taxes and the personal property replacement tax (PPRT). Utility tax revenues are expected to come in 2.6 percent or $11 million below budgeted amounts. The decline is driven by continuing low prices for natural gas, the mild winter, and the cooler than normal spring and early summer. Electricity tax, cable television tax, and telecommunication tax revenues are projected to end even with the 2016 budgeted amounts.

In addition to the decline in utility tax revenue, the City estimates that it will receive $40 million less in PPRT revenue in 2016 than budgeted. This reduction is due primarily to a misclassification of income taxes by the State of Illinois in 2014 and 2015 that resulted in the overpayment of PPRT revenues to local governments. The State adjusted downward its PPRT payments to local government earlier this year to reflect amounts that are owed. Local governments will be required to reimburse the State beginning in 2017.

Personal property lease tax revenues are expected to end 16.8 percent, or $29.8 million, above budget due to greater than previously anticipated compliance by the technology industry. The City lowered the personal property lease tax rate and waived taxes penalties and interest for years prior to 2015 for certain cloud software and infrastructure. Transportation-related taxes, including the garage tax and ground transportation tax, are anticipated to finish 2016 near budget at $238 million.

Corporate fund expenditures are currently expected to end the year at $3,548.7 million, or 1.0 percent, below the budgeted level of $3,570.8 million. These estimates are based on year-to-date spending, incorporating payroll trends, market pricing for relevant commodities, and any known changes or events that have or are anticipated to occur during the remainder of 2016. Based on current revenue and expenditure projections, the City estimates a 2017 corporate fund gap of $137.6 million.

The $137.6 million gap for 2017 is the lowest projected gap since 2007, and is substantially smaller than was projected for 2017 in the 2014 and 2015 Annual Financial Analysis. For the first time since 2011, the gap for the coming year is put forward without separate consideration of the City’s pension funds.

Corporate fund resources are projected to decrease from 2016 year-end estimates, and 2016 budget, by 1.6 percent or $58 million to $3,513 million in 2017, largely due to further expected declines in PPRT revenue. The 2017 PPRT estimates are anticipated to decline an additional $34.6 million, making these revenues 27 percent below the 2016 year-end expectations, as the State further decreases PPRT payments to recoup overpayments in previous years.

Economically sensitive tax revenues are anticipated to increase in 2017 above the 2016 level. Sales tax revenues are expected to grow at a rate of almost 3.0 percent through 2017 as consumer confidence figures continue to improve. Compliance levels for the personal property lease tax are projected to remain high, causing revenues to grow 4.5 percent on top of the growth in 2016 revenues. Utility tax revenues are expected to return to levels consistent with the 2016 budget on the expectation 2017 will bring more typical winter weather and natural gas tax revenue will increase over 2016 revenues. Other utility taxes are projected to remain flat or experience small fluctuations. Even though real property transfer tax revenues are projected to decrease by nearly 12 percent in 2017 compared to 2016 year-end, they are expected to grow over the 2016 budget by almost 4 percent. The decline from year-end is due to one-time increases from the transfer of ownership interests in the Skyway and Millennium Park garages in 2016.

The 2017 expenditures are forecasted to grow by approximately $80 million over the 2016 budget to $3,650.6 million. The majority of the projected expense increases for 2017 are personnel costs, primarily wages. The 2017 projection for these expenses assumes the same number of employees as 2016 with wages growing based on required contractual wage and prevailing rate due to the final phase-out of retiree health care and other initiatives designed to reduce growth in the cost of the City’s health care plan.

And of course no discussion is complete without news on pensions. As of July 29, 2016, the City has identified a permanent, reoccurring source to fund three of its four pension funds. In the fall of 2015, the City adopted a four-year property tax increase that provides funding for the City’s pension contributions to the Police and Fire pension funds through 2018. A small additional payment is needed in 2019 which is incorporated in the 2019 projections. Increases in pension contributions necessary to stabilize the Municipal pension fund are not included in the 2017 budget shortfall, as any increase in contribution will be coupled with a dedicated revenue source. Prior to the adoption of the 2017 budget, the City anticipates reaching a funding plan and reform agreement with the Municipal pension fund following the same framework as was achieved with the Laborers’ pension fund.

These projections assume status quo in terms of state action regarding pension reform. They also assume a successful outcome to ongoing litigation over the City’s obligation to fund healthcare benefits for retirees. The next step in that litigation is August 11.

The City’s presentation is consistent with our view that the Emmanuel administration is trying to do the right thing within the constraints of a challenged local political environment and an unsupportive state political environment. The disparate views represented on a 50+ member City Council and a dysfunctional state government severely handcuff anyone trying to enact broad reforms in Chicago’s long term credit trajectory. To the extent that management can influence a rating, this administration has to be viewed as a net positive factor.

BRAVES STADIUM HAS A POLITICAL COST

It won’t reduce the $400 million contribution from the County’s revenue base, but the voters of Cobb County, GA have exacted some political price for the County’s funding of part of the new stadium for the Atlanta Braves under construction for the 2017 season. The project has been controversial for a number of reasons unrelated to its cost and financing. Their current facility, Turner Field in central Atlanta, is only twenty years old. Nevertheless, the publicly financed facility has been declared outmoded after less than 20 seasons of use by the Braves.

Sun Trust Park will be supported by $397 million of bonds to be issued by the Cobb-Marietta Coliseum & Exhibit Hall Authority. The stadium will supposedly be more convenient to the majority of the Braves’ fan base but for many fans the real issue may be that this will result in a less “urban” tilt to the fan base. Ironically, it has not been the cost or the public financing of that cost that has raised the ire of Cobb county’s residents.

It has been reported that the Cobb County Commission—the five-person local governing body – that approved the Braves’ plan without public debate by standing in hallways to get around open-meetings laws — has determined that if county residents want to get the $40 million in new parks they voted for way back in 2008, they’ll have to raise taxes, because that money has now been siphoned off for the new baseball facility. The park bonds were never issued, then when the property tax hike funding them was set to run out, the commission decided to renew it for the stadium instead of spending it on what voters had intended it for.

So, when it came time for the primary election for the chairmanship of the Commission Incumbent Chairman Tim Lee lost his reelection bid . Some of the voters who voted against Lee said they were in favor of the Braves’ move to Cobb, but objected to the way the deal was negotiated in secret and committed some $400 million in public money to build and maintain a new stadium without a popular referendum. One said simply, “He should have asked.”

So the takeaway is not very straightforward. Voters seemed to be more concerned about the process than the result. A lot of the local opposition seemed to be development related rather than stadium related. This instance provides little clue as to whether politician’s usual fear of stadium referenda was validated. We see no applicability of this result to any possible result in November on a referendum in San Diego for a new Chargers stadium.

Muni Credit News August 2, 2016

Joseph Krist

Municipal Credit Consultant

OUT IN THE TERRITORIES

With Puerto Rico sitting in a state of limbo as events under Promesa play out, investors are looking at debt from other U.S. territories in a new light. So the recent downgrades of the debt issued for the Virgin Islands Water and Power Authority to below investment grade merited attention. The downgrades come on the heels of a Spring decision by the Public Services Commission to deny W.A.P.A. a requested electric rate increase and instead placed the petition under a 60-day review. W.A.P.A. said it needed the increase to help stabilize its finances, and to have, at minimum, 45 days cash on hand, which equates to roughly $34 million. It also said the rate increase would bolster the market’s confidence in the authority’s bonds. Moody’s calculates that W.A.P.A. has approximately $127 million in electric system revenue bonds outstanding and approximately $100 million in subordinated electric system revenue bonds.

In a press release, W.A.P.A. Interim C.E.O., Julio Rhymer Jr., said the downgrade was expected in wake of the P.S.C.’s decision, along with W.A.P.A.’s deteriorating financial condition. “In light of last week’s decision by the Public Services Commission to delay action on a requested emergency rate increase, resulting in W.A.P.A.’s inability to amass sufficient days of cash on hand, the rating downgrade, was largely anticipated”. The Moody’s downgrade of senior bonds from Baa3 to Ba2 and subordinate bonds from Ba3 to Ba1, follows previous pronouncements by not only Moody’s but by Fitch, another rating agency, and S&P which contend that W.A.P.A. is in a precarious financial position based largely on outstanding receivables, the lack of liquidity and a multi-million dollar lawsuit recently brought by a former fuel supplier.

Despite expected modestly improving operating cash flow generation owing to recent customer gains and access to a $13 million term loan from the Rural Utility Service (RUS), W.A.P.A.’s financial flexibility will remain tight. Bond debt service over the next 12 months is secured by a debt service and fully cash funded debt service reserve fund. The authority’s unrestricted cash position of around $13.7 million has been improved by the Virgin Islands government’s efforts since the beginning of this year to reduce outstanding electric receivables to an estimated $22 million from a peak of around $41 million at June 30, 2015.

For some time, the Authority’s credit has been characterized by a short-term approach towards liquidity and financial management as well as frequent late filing of audited financial statements. The territory’s hospitals, along with some of the semi-autonomous agencies of the government, continue to owe the authority millions of dollars for past electrical and potable water service. These agencies are not current and have sizeable outstanding balances. WAPA is effectively subsidizing their operations while its finances deteriorate.

A proposal to incorporate a permanent charge that recovers street lightning costs to help support has been made W.A.P.A., and the P.S.C.’s could go either way. However, actions are uncertain and unlikely to restore W.A.P.A.’s weak financial profile to levels commensurate with a higher rating in the short term.

ATLANTIC CITY AGREES TO LOAN TERMS; AVOIDS DEFAULT

A last minute agreement with the State of New Jersey allowed Atlantic City to avoid an August 1 default. City Council approved a loan agreement with the state during an emergency meeting Thursday night. The state asked for certain assets, including the dissolution of the city’s Municipal Utilities Authority. “I want it secured by every asset they have, so that if they don’t pay it, I get to take the assets, sell them and pay you (the taxpayer) back,” Gov. Christie said Thursday.

The council is set to start the process of dissolving the authority during its September meeting. Dissolving the authority requires two readings of the ordinance, and the council can pull the ordinance after funding has been secured. City officials contend the state has no need to worry about the repayment of the loan. The city plans on repaying the state with the two years of marketing funds that would have gone to the Atlantic City Alliance — totaling $60 million — and $18 million from the Investment Alternative Tax, as part of a rescue package signed in May.

Some Council contended that the agreement was rushed. The state countered that members were notified about the emergency meeting two hours before it was scheduled to start and that all members of council were notified of the meeting at the same time. The loan is being made pursuant to legislation the governor signed in May giving the city until Nov. 3 to draft a five-year fiscal plan that includes a balanced budget in 2017. If the city fails to submit a plan or the plan is deemed insufficient, the state can sell city assets, break union contracts and assume major decision-making powers from the city’s government for five years.

The Mayor of Atlantic City said that “a five-year projection for city budgets from 2017 through 2021 is currently being prepared under the terms of the recovery plan. The city plans to have a draft of the plan completed by late fall and the final document presented to the commissioner of the Department of Community Affairs prior to the deadline.”

PENNSYLVANIA TURNPIKE

While neighboring New Jersey battles it out over gasoline taxes, the Pennsylvania Turnpike Commission looks to market some $315 million of bonds backed by oil franchise taxes. This tax is levied at a rate of 208.5 mills per gallon of fuel sold at wholesale in the Commonwealth. In 1991, the distribution of a portion of this tax was enacted into law which dedicated 14% of the 55 mills of the tax to the Commission. The security for the bonds includes a determination that these revenues are deemed to be appropriated without additional legislative action.

This matters given the budget delays which have characterized the Commonwealth’s budget process in each of the last two years. Those delays would not have prevented the timely collection and distribution of the pledged revenues. The major risk associated with the credit is the potential for reductions in demand for fuels in the face of a decline in sales related to either the economy or to increased fuel efficiency. Those risks are common to any consumption driven tax revenue stream. Consumption has been steady to slightly declining since 2007 which is not surprising given the economy over that period as well as driving trends nationally.

NEW JERSEY

A revised plan for renewing New Jersey’s Transportation Trust fund was advanced by the State Assembly. It calls for a 23 cent per gallon increase on retail sales at the pump. and reductions in other taxes, including a phase out of the estate tax and larger tax exemptions on retirement income. The New Jersey Chamber of Commerce, the New Jersey Gasoline, Convenience Store, and Automotive Association and the New Jersey Sierra Club have come out in support of raising the gas tax to replenish the trust fund, but caution the hike proposed by lawmakers might not produce the level of revenue they expect.

The revenue concerns reflect worries that there is a good amount of the volume in the state of New Jersey that comes from New York and those people will have less reason to purchase gasoline in New Jersey anymore.

The Senate Budget Committee Chairman is trying to get a measure approved that would satisfy concerns about tax fairness. The impact on employment short term is a major political concern. The shutdown of transportation projects because of the funding stalemate has meant layoffs during what’s usually their busiest time of the year, he said. Union supporters have said that the standoff will lead to its workers taking about a 20 percent cut in their income this year. “They’re not going to be able to make this up with overtime.”

Gov. Chris Christie has said he will veto the legislation, which he has described as an exercise in tax unfairness. Senate President Steve Sweeney said he is working to get a veto-proof majority of lawmakers before posting the bill for a Senate vote.

LIPA

The effort to lessen the rate burden on Long Island electricity users continues with a pending fourth phase of Utility Securitization Bonds. These taxable securities seek to take advantage of the current rate environment to refund outstanding tax exempt debt payable from general retail electric rates and replace it with debt secured by a standalone fixed charge designated for debt service on these bonds. The financing refunds a chunk of the Authority’s debt out of the electric system’s expense base which is used as a part of the ratemaking process.

The securitization plan was designed to lower and stabilize the Authority’s ratemaking in response to customer concerns. The Authority’s costs and overall management had become a significant political issue on the regional and state level. So in 2013, the NY state legislature enacted legislation restructuring the Authority’s management, putting its ratemaking under Public Service Commission review, and restructuring its debt. It also enacted a three year freeze on retail electric rates. Day to day operations at the Authority are managed by a subsidiary of PSEG expressly created for this purpose. These actions reduced the political heat on the Authority and stabilized its credit at investment grade.

The security for this debt is effectively independent from the operations of the Authority. The securitization charge appears as a distinct fixed line item on a customer’s bill. The idea is to lower the overall cost of power to consumers than would have been the case had the refunded debt remained outstanding.

ERIE COUNTY, NEW YORK

The Authority is making its first debt offering in nearly two years. These bonds are secured by County sales tax collections and State Aid payments made to the County. The sales tax revenues are collected for the County by the State and may only be applied to debt service payments on the bonds. Neither the state or county can appropriate the funds for any other purpose.

The Authority issues debt on behalf of the County in addition to its oversight responsibilities over the financial operations of Erie County. The economic difficulties of Western New York’s population center (anchored by Buffalo) are well documented. The County’s finances were historically impacted by those difficulties as well as its former responsibilities for a County hospital. These combined to damage the County’s bond ratings such that it had effectively lost access to the market. This led to the creation of the Authority.

The County faces some daunting challenges despite significant redevelopment efforts undertaken in Buffalo and the direction of significant funds from state economic development resources to the region. Buffalo and the County continue to experience population declines and efforts to increase private employment have been mixed at best. Public entities still are five of the ten largest employment in the County.

CHICAGO PUBLIC SCHOOLS PLACE DEBT PRIVATELY

Chicago’s cash-strapped public school system sold $150 million worth of bonds to JPMorgan in a “private placement.” The bonds, to be paid off in 2046, were sold at yields of 7.25 percent. The deal worked out better for school officials than their last one — an open market sale in February — was for $725 million at yields of 8.5 percent. Those bonds are to be paid off in 2044.

The rates are significantly higher than they were for comparably structured CPS bond deals from last spring, when CPS sold bonds at yields of closer to 5.5 percent. A $300 million budget deficit, possible teachers’ strike and large looming pension payments have led to CPS’ bonds being rated by three ratings agencies at “junk” status.

The private placement reflects concerns about these credit issues in the face of inaction by the legislature and the Governor to negotiate a way to fund the state’s as well as the Chicagoland localities’ huge unfunded pension liabilities. It is yet another reinforcement of the overall negative credit trend for Chicago and its related credits.

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

Muni Credit News July 28, 2016

Joseph Krist

Municipal Credit Consultant

CALIFORNIA PENSION RETURNS HAVE NEGATIVE LOCAL IMPLICATIONS

The California Public Employees’ Retirement System (CalPERS) reported a preliminary 0.61 percent net return on investments for the 12-month period that ended June 30, 2016. CalPERS assets at the end of the fiscal year stood at more than $295 billion. Fixed Income earned a 9.29 percent return, nearly matching its benchmark. Infrastructure delivered an 8.98 percent return, outperforming its benchmark by 4.02 percentage points, or 402 basis points. A basis point is one one-hundredth of a percentage point. The CalPERS Private Equity program also bested its benchmark by 253 basis points, earning 1.70 percent.

For the second year in a row, international markets weighed CalPERS’ Global Equity returns. However, the program still managed to outperform its benchmark by 58 basis points, earning negative 3.38 percent. The Real Estate program generated a 7.06 percent return, underperforming its benchmark by 557 basis points.

So we have a very mixed bag. The total absolute return is unacceptably low. Two of the discrete investment sectors reflected negative and/or below benchmark performance. Some positive performance still reflected poor performance relative to benchmarks.

CalPERS 2015-16 Fiscal Year investment performance will be calculated based on audited figures and will be reflected in contribution levels for the State of California and school districts in Fiscal Year 2017-18, and for contracting cities, counties, and special districts in Fiscal Year 2018-19. The ending value of the CalPERS fund is based on several factors and not investment performance alone. Contributions made to CalPERS from employers and employees, monthly payments made to retirees, and the performance of its investments, among other factors, all influence the ending total value of the Fund.

CalPERS has underperformed its targeted 7.5% return over the past 3, 5, 10 and 20 years. The low overall return means that there will be pressure on localities and their employees to increase their contributions for pensions. For localities, the lower investment performance is a credit negative as they face higher expenses not necessarily coincident with the state of the economy at the time of those requirements.

HAMILTON COUNTY REFUNDS STADIUM BONDS

Regular readers know by now of our ongoing interest in the issue of public financing for professional sports facilities. Hamilton County, OH has been undertaking a financing program for stadia for the NFL Cincinnati Bengals and the MLB Cincinnati Reds since 1998. The program has utilized sales tax revenue bonds with proceeds of those taxes dedicated to the repayment of those bonds. While there have been no issues in terms of the level of resources available for bond repayment, the program has been controversial as the County’s overall fiscal position has been tight and difficult choices have had to be made as to the priority of programs for funding.

The structure of a currently outstanding issue of these bonds and the continuation of a favorable low interest rate and high demand market has made possible the refunding of some $320 million of debt related to the stadium finance program. The refunding is designed to achieve ongoing actual savings on debt service but will also be used as an opportunity to adjust the security provisions supporting the bonds which will make more monies available to the County for current spending

Those changes include an increase in reserves held by the Trustee for the bondholders. Previously, the County had been required to hold funds equal to 10% of one half of 1% of sales tax collections. The County will now be able to take those $7.4 million of funds and use them for any County purpose. In exchange, the size of the trustee held reserve is changed to of average of annual debt service to the lesser of100% of those amounts. The debt service reserve requirement can be fulfilled through a Credit Support Instrument from Build America Mutual.

Clearly the County through the refunding and the use of a surety for the debt service reserve is trying to address the concerns from its citizenry about the level of County resources benefitting the two teams. It is another indication of public misgivings about the propriety of using public funds to support what are in the end facilities used to generate a high level of private profit.

NJ TRIES AGAIN ON TRANSIT FUNDING

With the Republican convention now concluded, NJ Governor Chris Christie can try again to reach an agreement with the NJ legislature over how to raise increased funds for the State Transportation Trust Fund. Under a plan released Friday by Democratic leaders in the Legislature, the state would spend $20 billion over the next 10 years on roads, rails, bridges and other transit projects, using new revenue from higher gas taxes and borrowing.

The proposal would raise the gas tax by 23 cents a gallon to be offset by a phase out of the estate tax over 3.5 years at an annual cost of $552 million. In addition, the plan would increase the earned income tax credit for the working poor – annual cost: $137 million; increase income tax exclusions for retirees over four years, to $100,000 for joint filers and $75,000 for individuals – annual cost: $164 million; give a $500 income tax deduction to all motorists with incomes below $100,000 – annual cost: $20 million; and give a $3,000 income tax exemption for all military veterans – annual cost: $23 million. The total cost of the tax cuts and credits: $896 million.

The NJ debate is occurring within a context of changes in gas taxes nationwide. Six states have changes to their gas tax rates. California and North Carolina are decreasing their tax rates, while Washington State is instituting its second gas tax increase in less than a year. Three other states, Iowa, Maryland, and Nebraska, will see revisions via formula. All states are dealing with the phenomena of much better vehicle fuel efficiency and decreases in driving frequency by millennials.

KANSAS RATINGS PAY THE PRICE

S&P Global Ratings dropped its rating for Kansas to “AA-,” from AA, three months after putting the state on a negative credit watch. S&P earlier dropped the state’s credit rating in August 2014. The ratings agency cited the state’s lack of cash reserves, even after multiple rounds of budget adjustments during the past year. Budget director Shawn Sullivan said the S&P report criticizes the state’s ongoing diversion funds for highway projects to general government programs and says the state continues to underfund pensions for teachers and government workers.

The state says that it is unfair to see diverted highway dollars as a one-time source of funds to help balance the budget because the state has done it regularly for years. It also feels that criticism of Kansas for underfunding its public pension system, which includes delaying nearly $96 million in payments otherwise due under the current budget, is unfair. The state wants more of the focus to be on the fact that with funding improvements mandated in 2012, the state is spending significantly more on pensions than it did in the past.

Our view is to wonder what has taken the rating agencies this long to recognize that the current administration is so ideologically driven as to effectively preclude a more positive reading of recent events.

RATINGS GO DOWN WITH THE TUBES

Somerset, Kentucky general obligation bonds were downgraded to Baa2 from Baa1 on Monday, because of park subsidies totaling $7.6 million since 2007, by Moody’s Investors Service. The financial support from the city’s general and sanitation funds was for SomerSplash Waterpark, which opened in 2006 with six water slides and other attractions, including a “lazy river” for tubing and a wave pool.

“The downgrade to Baa2 reflects the further deterioration of the city’s financial reserves and consecutive operating deficits that result, in part, from ongoing and substantial general fund subsidy of its water park,” said Moody’s.

Somerset operations are “unusual” because the city owns a 155-mile-long gas pipeline that connects eastern Kentucky gas fields to major interstate pipelines. The pipeline has historically provides “substantial” margins that have subsidized general operations of the city such that tax revenues cover only half of expenses. The Gas Department is an enterprise fund that is self-supporting, and does not receive revenues from the general fund, The Gas Department is an enterprise fund that is self-supporting, and does not receive revenues from the general fund, according to the city’s 2015 audit.

In fiscal 2015, the general fund received $2.7 million from the Gas Department and $3.1 million from the Water Department, representing 46.5% of general fund revenues. The outlook remains negative for this formerly A1 credit due uncertainty from the ongoing support of the water park as well as potential risks surrounding the operations of the Gas Department.

We believe that recreational facilities should only be financed on a standalone basis. This is just one more of the countless examples of small communities being forced to pressure their general fund revenue bases to support clearly non-essential activities.

Joseph Krist

Municipal Credit Consultant

Pension liabilities are increasingly moving front and center in the analysis of municipal credits. As states and cities attempt to make adjustments to future benefits for their employees, resistance from those employees has led to increasing litigation in the state and federal courts on this matter. This issue of Muni Credit News discusses two recent court decisions impacting those efforts to change benefits – one state and one federal – which had differing results for the cities involved.

CHICAGO OPEB DECISION – THE DEVIL WAS IN THE DETAILS

Recently a hearing was held in ongoing litigation between the City of Chicago and its employees over efforts by the City to reduce its expenses related to other post employment benefits (OPEB) primarily healthcare expenses. Last week, a Cook County judged ruled on motions filed by the employees to compel the City to provide “lifetime healthcare benefits”.

The decisions rendered by the Court were a mixed bag for the City. In one ruling against the City, for three classes of employees, terms established under 1983 and 1985 amendments to their benefit packages were not time-limited and were in effect when the those classes entered into the Funds’ retirement systems. They provided those sub-class annuitants with healthcare benefits which were “lifetime” or “permanent”. Krislov & Associates, who represents the fund members who filed the lawsuit put the number of employees hired before the 1989 cutoff at about 20,000.

For benefits established under 1989, 1997 and 2003 amendments to the Illinois Pension Code, the judge ruled that they were time limited at creation. By their express terms, these amendments specifically did not provide the annuitants with “lifetime” or “permanent” healthcare benefits. Rather, the annuitants who became members of the retirement systems during the effective period of these amendments could, and d id, agree to the amended time-limited healthcare benefits as conditions of their membership in the system.

Accordingly, the Court ruled that a cause of action for relief to employees as to the City’s and Funds’ obligations under the 1983 and 1985 amendments exists, but claims under the 1989, 1997 and 2003 amendments were dismissed with prejudice.

The employees argued that the City of Chicago Annuitant Medical Benefits Plan handbook (“City Handbook”) constitutes a binding agreement requiring the City to provide lifetime subsidized healthcare premiums. The Court found that the Handbook’s provision for termination of the Plan clearly contradicts any contractual obligation to provide lifetime healthcare benefits. The Police Handbook does not contain any provision promising lifetime subsidized healthcare benefits. Because Plaintiffs failed to show the existence of any valid contract for the provision of lifetime subsidized healthcare benefits, that claim is dismissed with prejudice.

The City argued that all of Plaintiffs’ claims under the 1983 and 1985 amendments are barred by the statute of limitations. The Firemen and Municipal Funds contended that all of Plaintiffs’ claims arising under each of the amendments to the Pension Code are time-barred. Initially, Plaintiffs argued that the City waived this argument by not raising it on the City’s motion to dismiss the Amended Complaint. However, the City asserted this defense after this court ruled that the city has a derivative obligation to provide, through the collection of the special tax levy, the monies used by the Funds to subsidize/provide healthcare for the Funds’ annuitants. Therefore, the City did not waive its right to assert a statute of limitations defense. Because the rights claimed by Plaintiffs under the Pension Clause are contract based, the ten-year statute of limitations applies.

One class of employees known as Sub Class 3 did receive for now, a favorable ruling. The Court said that the Sub-Class 3 annuitants were not parties to the original litigation, let alone the later settlement agreement. Indeed, the exact language of the 1989 settlement agreement only covers the Korshak and Window Sub-Class annuitants. The original litigants could not bind the non-party Sub-Class 3 participants to the 1989 settlement agreement, nor could the non-party Sub-Class 3 participants have preserved any of their claims through that 1989 settlement. So, the court ruled it has not been established when members of Sub-Class 3 knew or should have known of any claims they possessed.

The court would not assume that the members of Sub-Class 3 were aware of the facts in the I987 litigation or were put on notice of the potential for their claims against the Funds. Nor would the court assume without sufficient evidence as to how many, if any, of the Sub Class 3 participants either knew of the terms of the 1989 settlement agreement or, as of August 23, 1989, “had a reasonable belief that their injury was caused by wrongful conduct” of the City or the Funds. The Court said that speculation about the matter was not a sufficient basis upon which to grant the current Motion to Dismiss.

A status hearing is set for Aug. 11. The city could seek to settle the case, offering some sort of payout to compensate for the lost subsidies to resolve the dispute and obtain more clarity in financial planning going forward, or the litigation could go on. The city’s recently released 2015 certified annual financial results showed a reduction in the unfunded OPEB liability to $781 million from $965 million.

FEDERAL PENSION RULING FAVORS TEXAS CITY

Fort Worth operates a defined benefits pension plan for the benefit of its employees. All of the plaintiffs are vested members of the plan. At the time each of the plaintiffs vested, the three highest annual salaries received by the retiring employee were averaged to reach a base amount, which was then multiplied by the employee’s years of service and then subjected to a 3% multiplier. The plaintiffs also had the right to a cost-of-living adjustment, or “COLA.” Like most public pension plans in Texas, Fort Worth’s is underfunded. Over the years, Fort Worth has sought to improve the financial condition of its pension plan. In 2012, the City made two primary changes. For new employees, it replaced existing formula to one averaging the five highest paid years. It also uses a 2.5% multiplier instead of a 3% multiplier.

The second noteworthy change concerned the COLA. The City eliminated cost-of-living adjustments for future employees, provided that current employees would instead receive a simple 2% COLA, and allowed current employees who had previously taken the ad hoc COLA “to revert to 2% simple.” Due to a collective bargaining agreement, City firefighters were not affected but shortly after that agreement expired, however, the City imposed essentially the same reform on its firefighters. Two lawsuits us challenged those ordinances – one by a pair of police officers, the other by a trio of firefighters.

Both cases were resolved at the summary judgment stage. State law under Section 66(d) provides that on or after the effective date of this section, a change in service or disability retirement benefits or death benefits of a retirement system may not reduce or otherwise impair benefits accrued by a person if the person could have terminated employment or has terminated employment before the effective date of the change; and would have been eligible for those benefits, without accumulating additional service under the retirement system, on any date on or after the effective date of the change had the change not occurred. Section 66(d) applies to all non-statewide public retirement systems except in San Antonio and in political subdivisions where voters have rejected it by ballot measure.

The Court had to decide whether Section 66 prohibits pension reform that would decrease expected but as-yet unearned benefits. This case came down to the meaning of the word accrued. The Court found that Benefits accrue on an ongoing basis as service is performed, and accrued benefits are those benefits that have been earned to date. Meanwhile, vesting is a one-time event giving rise to a right to the accrued benefits. “In summary, the notion of benefit accrual quantifies actual benefit accumulations. The Court found that the term “benefits” refers to payments and does not encompass the formula by which those payments are calculated. It stated that when it comes to public pension protection, Texas is known to be an outlier, citing literature that notes that Texas as one of only two states that takes a “gratuity approach” to public pensions, meaning pension benefits are viewed as gratuity rather than a contractual or statutory right.

The Court concluded that Section 66 permits prospective changes to the pension plans of the public employees within its reach. If the changes to the pension plan impact only benefits that have not yet accrued, amendment is permissible. It went further and said that the reform has been designed to protect all accrued benefits while impacting only the rate at which future benefits accrue. This aspect of the Pension Reform therefore passes constitutional muster.

This is a definite win for Texas cities. The Texas courts and the state legislature have weighed in on the subject and now cities, absent further state action, have firm guidance on how they can deal with their pension liabilities. We see this as credit positive for Texas cities with unfunded pension liability issues.

Muni Credit News July 21, 2016

Joseph Krist

Municipal Credit Consultant

PHILADELPHIA BUDGET STORY

Philadelphia will be getting lots of attention later this summer as the site of the Democratic National Convention. The City hopes that the event will draw positive attention to many aspects of local development which have occurred in the three decades since the City reached its nadir as a center of urban decline and mismanagement. In the interim before the convention, we get a chance to view the outlook for the City’s near term finances.

City Controller Alan Butkovitz this week recommended that the Pennsylvania Intergovernmental Cooperation Authority (PICA) accept the City’s FY2017-2021 Budget Plan. The budget submission highlighted areas of concern about the City’s financial future. One is the newly adopted Sugary Drink Tax, a contentious point of revenue development for the City.

The City estimates that $416 million will be collected over the five years, before additional costs for collection, advertising and auditing. The City has indicated that the revenues from the Sugary Drink Tax will fund three major initiatives: expanded Pre-K, community schools, and debt service for Rebuilding Community Infrastructure program when those programs are fully funded.

At the same time, opposition to the tax from producers as well as consumers is expected to move from the political arena to the legal front. The Controller acknowledges that PICA must be mindful of any litigation that could occur from critics of the Sugary Drink Tax, who have vowed court challenges against the tax. “While no litigation has been initiated, the outcome of such litigation could significantly affect the forecasted revenues and obligation amounts over the life of the Plan,” admits the Controller.

The Plan also comes up short in the area of labor costs. The City Controller’s analysis also indicated that the Plan does not include any potential costs above $200 million in obligations for future labor agreements over the five years. AFSCME DC 33 and DC 47 Local 810 Courts are currently in negotiations. “The City would be responsible for identifying additional funds to cover any costs above the budgeted amount,” said the Controller.

GREEN BONDS

As the municipal market continues to evolve, new classifications of bonds have been developing to meet the needs of specialized investors. The mutual fund industry has been familiar with primarily equity funds that advertise themselves as socially responsible investors. They allow individuals with strong political or ethical beliefs to participate in the investment markets without feeling as if they have compromised those values.

This trend has expanded into the municipal market. There are funds and fund sponsors who practice “green investing” through our market. in response, issuers are working to achieve that status for their issues. Green Bonds are so designated according to generally accepted Green Bond Principals as promulgated by the International Capital Market Association. The purpose of the label is to allow for investors to evaluate the environmental merits and benefits of bonds so labeled.

The latest example of Green Bonds is an issue of $415 million scheduled for sale next week by the City of Aurora, CO. The City Utility Enterprise is offering water revenue particular project was designed to increase the efficiency of its existing water system and expand water supplies without the acquisition of additional land for its water rights. This is consistent with the principals supporting a Green Bond designation.

A Green Bond designation does not lead to any changes in the basic characteristics of the bonds in terms of security or structure. In the case of the Aurora issue, the bonds are traditional first lien net revenue bonds of the water system featuring a traditional serial/term maturity structure. The only thing different is the Green Bond designation. The benefit is that it helps to expand the market for the debt by supporting an expanded class of investors. It looks like a win/win for the overall municipal market.

PENNSYLVANIA FUNDS ITS BUDGET

Early in July, Governor Tom wolf signed a budget that was underfunded by over $1 billion. That led to general derision and threats of further downgrades. The reaction seems to have spurred the legislature and the Governor to get together on a revenue package to fund the shortfall. Perhaps now the Commonwealth can move forward with its recently postponed general obligation bond issue.

That final revenue package is expected to raise nearly $1.3 billion through a $1.00-per-pack tax increase on cigarettes, an expansion of gambling, liquor reforms and applying the personal income tax on Pennsylvania Lottery winnings. There is an increase tax on the expanded vaping industry but cigars will not see a tax increase. Other revenues under consideration include tuition at the 14 state universities rising by as much as 3 percent in the coming academic year to fill the anticipated budgetary shortfall that the State System of Higher Education is facing. Tuition has increased 13 percent over the last five years. A rise of 3 percent would mean a $212 increase in the yearly tuition rate, bumping up the base rate to $7,272.

Among other tax changes signed by Gov. Tom Wolf this week, the state’s 6 percent sales tax will be extended to the purchase of digital downloads including games and music. This tax expansion is expected to be worth about $47 million in 2016-17, according to Wolf Administration estimates.

Missing from all of the budget deliberations is any serious reform of the Commonwealth’s underfunded pension liability. The pension issue is the elephant in the room in terms of the Commonwealth’s long-term credit outlook. The short-term resolution of the FY 2017 budget could be enough to hold off a rating downgrade in the near term. Absent meaningful reform of the Commonwealth’s pension situation, we see the credit as a consistent underperformer.

TEXAS HIGH SPEED RAIL HITS SPEED BUMP

Texas Central Railroad and Infrastructure, Inc. and Texas Central Railroad, LLC, propose to build a 240-mile high speed rail line between Dallas and Houston, Tex. In April of this year, Texas Central filed a petition for an exemption from the state prior approval requirements due to oversight from the U.S. Surface Transportation Agency. Such oversight would ease the process of right of way development and acquisition. That process is being used by opponents of the route and the plan overall to delay and/or halt the project. this in turn, has complicated financing for the project. Texas Central anticipates beginning construction in 2017 and plans to initiate passenger service as early as late 2021. Texas Central estimates the cost of construction, which is being privately financed, to be over $10 billion.

Texas Central made its request for federal jurisdiction based on the claim that the Line is part of the interstate rail network, despite the absence of a physical connection with Amtrak. Texas Central compares itself to the state-owned Alaska Railroad, which is located entirely in the State of Alaska, does not physically connect at any location with the interstate rail network and relies on water carriers to interchange and connect with other United States railroads; yet, the railroad is part of the interstate rail network and subject to the Board’s jurisdiction. The Alaska Railroad and the water carriers that it uses to connect to the interstate rail network are part of the noncontiguous domestic trade statutorily subject to the Board’s jurisdiction.

The Surface Transportation Board declined the request to supervise the project. The proposed Line would have no direct connection with Amtrak, such as a shared station or a clearly defined arrangement to connect passengers using through ticketing. The Line and Amtrak need not share the same track, but with no direct connection to the interstate rail network the construction and operation of the proposed Line is not subject to the Board’s jurisdiction.

While the Texas project is entirely private, we are interested in it for its potential precedent setting impact for high speed rail projects which hope to rely in whole or in part on municipal bonds for their financing. Understanding the various obstacles which could impact construction planning and scheduling and their potential effects on financing viability will be important to the credit analysis by potential investors in these sort of projects.

PROMESA CHALLENGES CONSOLIDATED

A U.S. Federal Judge consolidated the various cases brought up by a hedge fund firm, an insurance firm and private investors to resolve the issue on whether the Puerto Rico Oversight Management and Economic Stability Act (Promesa) has stayed their lawsuits. The government recently had asked the court to stay the three lawsuits, contending that there is a disposition to that effect contained in Promesa, but the judge declined to do so. Currently, there are six cases in the Federal District Court in Puerto Rico and one in New York related to bond defualts and fiscal matters.

A hedge fund recently sued to stop the Government Development Bank from transferring assets. National Public Finance Guarantee Corporation, which insures approximately $3.84 billion of debt issued by the Commonwealth of Puerto Rico and related entities, and a group of bondholder plaintiffs want the Puerto Rico Emergency Moratorium and Financial Rehabilitation Act to be declared unconstitutional.

Muni Credit News July 19, 2016

Joseph Krist

Municipal Credit Consultant

ALASKA BUDGET CRISIS REVISTED

Two years ago I had the good fortune to spend time in interior Alaska. The trip gave me an appreciation for its vast scale, unique attributes, and the role of nature and the State in the creation of a unique role for its State government. These are some of the reasons that back in the first quarter of this year we commented on the looming budget crisis facing the State of Alaska in the face of consistently lower oil prices. The state is facing huge ongoing deficits as oil prices remain stubbornly low. This is forcing the State to consider – given its history – radical approaches to manage the state fiscal position going forward in an era of diminished oil revenues.

The State Office of Management and Budget has just issued a report suggesting two potential remedies for consideration by the Legislature. One remedy proposed is the “No Action Plan” and requires a state budget of $1.5 billion revenue. This revenue level assumes an optimistic $55/bbl price of oil, increasing over time to offset production declines. The other is the “SB128 but No Tax Plan” and assumes a budget of $3.4 billion, $1.5 billion current revenue at $55/bbl plus $1.9 billion, the amount expected if SB128 passes the legislature, but no other revenue measures. State budget reserves will be completely depleted in FY18 without new revenue measures. In FY19, Alaska could be facing these scenarios.

The budget would be one-third of the current FY17 budget and only one-quarter of the FY15 budget. Most government agency operating budgets would be 10 to 20% of current levels, a level similar to state spending experienced in the late 1960’s. School funding would be reduced to 32% of the current $1.25 billion, dropping to $400 million. Local education employment would fall from the current 24,400 to an estimated 10,000 statewide. The Alaska Performance Scholarship and Power Cost Assistance would end in FY19.

Medicaid and other health formula funding would be reduced by 25% to maintain as much federal coverage as possible. All other health programs would be shut down, privatized, or significantly reduced. These include senior benefits, child care benefits, homeless assistance, victim’s assistance, housing programs, pioneer homes, health clinics, public health labs, etc. Fish and Game, Environmental Conservation, and Natural Resources combined would have $18 million in operating revenue compared to $134 million total in FY17. This represents less than 10% of the FY15 funding level.

Transportation’s operating budget would be less than $40 million compared to the $218 million. Road maintenance and ferry service would end for some segments and be significantly curtailed on others. Many of the 240 state maintained airports would be closed, and the rest would have reduced operations. The legislature would have a budget of $11.6 million compared to the current $64 million 15% of FY15. The current budget is just over $1M per legislator, it would drop to $193,000 per legislator. There would be no ‘on behalf’ retirement payments, no school debt reimbursement, and no community revenue sharing, shifting all those costs to local governments. There would be no rural school construction funding or rural school maintenance.

Most prisons would be closed, and prisoners either released early or send to out of state facilities as a result of funding at 25% of current level. Public safety would be 25% of current level, leaving most areas without trooper presence. The capital budget would be less than $20 million costing the state federal highway match funding. AVTEC and most University campuses would lose all state funding. Any remaining campuses would receive one-third or less of current revenue. Up to 50% of state and university facilities would need to be sold or shuttered. State Library and Museum facilities would operate only at the level that could be sustained by earned revenue and fund raising.

State employment would drop by an estimated 12,000 employees (25,000 total, ~13,000 UGF funded, cut 70% of UGF employees, and cut 25% of state employees on other fund sources due to lack of matching funds). The drop in state and education employment plus the reduction in Medicaid would precipitate significant reduction in health care spending compounding overall state job losses. The amount spent for the Permanent Fund Dividend would nearly match the total state budget.

If the Senate Bill 128 (the Permanent Fund Protection Act) is passed in its current form, state revenue will increase by ~$1.9 billion and provide total Unrestricted General Fund revenues of $3.4 billion. The budget would be 78% of the current FY17 budget and just over half, 56%, of the FY15 budget. Most government agency operating budgets would be cut an additional 25% from the current levels and operate at 40-60% of the FY15 level. School funding would be reduced to 80% of the current $1.25 billion, dropping to $1.0 billion. Local education employment would see 3,000 to 5,000 fewer employees from the current 24,400.

Medicaid and other health formula funding would be reduced by 10% to protect federal coverage. All other health programs would see an additional 25% reduction, impacting senior benefits, child care benefits, homeless assistance, victim’s assistance, housing programs, pioneer homes, health clinics, public health labs, etc. Fish and Game, Environmental Conservation, and Natural Resources combined would have $100 million in operating revenue compared to $134 million total in FY17. This represents about 59% of the FY15 funding level. Higher fees for permitting and inspections would be expected.

The transportation operating budget would be $163 million compared to $218 million. Road maintenance and ferry service would be curtailed. Many of the 240 state maintained airports would be closed or have reduced operations. The legislature would have a budget of $48.5 million compared to the current $64 million over 60% of FY15. The current budget is just over $1 million per legislator, it would drop to $800,000 per legislator. There would be no ‘on behalf’ retirement payments, no school debt reimbursement, and no community revenue sharing shifting those costs to local governments.

The Alaska Performance Scholarship and Power Cost Assistance would be reduced and eliminated within 5 years. There would be no rural school construction funding and minimal rural school maintenance. Corrections would be reduced an additional 10%. Two or possibly three prisons would be closed and some prisoners would be housed out of state. Public safety would be reduced an additional 10% from the current level, leaving some areas without trooper presence. The capital budget will remain at the minimal level to meet federal highway and other match requirements at $100 million. University funding would be reduced another $80 million likely forcing campus closures and possible divestitures to communities. Some state and university facilities would need to be sold or shuttered. State employment would drop by another 2,000 employees on top of the 2,100 fewer expected by the end of FY17.

Clearly these are worst case scenarios designed to stimulate thought and debate. Many of the contemplated spending cuts would be self-defeating for the State and its economy. We do note that the document does not make any reference to the State seeking to address its problems on the backs of its bondholders. Perhaps the harsh if beautiful environment and self-sufficient spirit of most Alaskans serve to better focus the mind on solutions in a way that warm tropical winds do not.

CHICAGO RELEASES FY 15 FINANCIAL REPORT

The City of Chicago released its Comprehensive Annual Financial Report for calendar 2015. It includes a huge reported increase($17 billion) in liabilities consisting almost entirely of unfunded liability in the city’s four employee pension funds, covering police, firefighters, laborers and white-collar workers. The increased figure reflects two changes in how the liability is reported. First, it had to report the true shortfall in assets for its pension funds, using real actuarial figures. And it had to reduce the assumed rate of return on pension assets from 7.5 percent to 5 percent, an action that pushed up the unfunded liability.

The number also reflects the impact of the recent Illinois Supreme Court decision overruling, on constitutional grounds, a prior city pension rescue plan that relied on a combination of tax hikes and benefit cuts. The court ruled out those cuts, saying full benefits amount to a contractual promise that cannot be infringed.

There is some good news in that the shortfall between what the city is now contributing and what it actuarially should be contributing is down to the lowest level since between 2006 and 2011, depending on which fund is examined. But the city still isn’t meeting its actuarially required contribution or ARC and won’t fully begin to do so until 2020-22, under the current plans. The funds now have just 20.3 percent to 33.6 percent of the assets needed to pay promised benefits.

On the positive side, the amount of unrestricted cash in the city’s operating fund has roughly doubled in the past year, to $93 million, and that the city spent $106 million less than budgeted in its operating fund. Also, the city has removed all variable-rate and swap debt, but total outstanding general obligation debt rose about $1 billion during the year, to $23 billion.

On balance, there are positive things that stand out. The adoption of more realistic earnings assumptions for the pension funds, the improved ARC shortfall ratio, the reduction of exposure to variable rate risk, and the restraint on City spending relative to budget must be noted. While Chicago has a plethora of problems, lack of understanding on the part of the mayor is not one of them.

PROPOSED TRADING TAX WOULD INCLUDE MUNICIPALS

Municipal bond investors always have to be on the lookout for innocent sounding legislative proposals that target something else but hurt municipal bonds. The latest example is from Rep. Peter DeFazio (D-OR). Last week, he introduced legislation that would levy a 0.03 percent tax on transactions of stocks, bonds and derivatives to discourage speculative financial trading. “The ‘Putting Main Street First Act’ is designed to stop the sorts of high-speed trading that adds volatility to the markets.

According to supporters, a “Wall Street speculation tax” would not only help move our financial markets away from dangerous high-frequency trading, but also raise significant revenue to address unmet needs.” Oh by the way, according to the Joint Committee for Taxation, the tax would raise $417 billion over ten years.

While well intentioned, the tax would, by including munis, be effectively throwing out the baby with the bathwater. “This tax is a great way to raise money for the federal government by making the financial sector more efficient,” said Dean Baker, Co-Director of the Center for Economic and Policy Research. “The cost of the tax will be fully covered by the savings from reduced trading. This means that the ordinary investor will be left unharmed by this tax. The only people who feel the impact will be the short-term traders and the financial intermediaries.” We could not disagree more as it pertains to municipal bonds. Fortunately, DeFazio admits that there is no chance of passage in the current Congress.