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Muni Credit News May 12, 2016

Joseph Krist

Municipal Credit Consultant

PR BUDGET YET TO BE ISSUED AS IT ARGUES FOR CREDIBILITY

One can understand that the administration of the Commonwealth might be overwhelmed by simultaneous efforts to mange scarce resources, lobby Congress for fiscal assistance, and negotiate a debt restructuring with a variety of creditors. At the same time it is difficult to see the Commonwealth as a credible partner in the current crisis when Gov. Alejandro García Padilla has yet to present a budget as he waits for the U.S. Congress to approve debt-restructuring and other economic-development mechanisms for Puerto Rico. When he says “the budget is being worked on responsibly and comprehensively to allow for the continuation of services to citizens”, we feel that we have heard this song before.

Senate President Eduardo Bhatia said Tuesday that the budget “is very late; I’m not happy. I know it’s a difficult time, but we have to have three scenarios,” which he explained as a budget “with the payment of debt, another without its payment and a third one with only the payment of the debt’s interest.” “If these aren’t available soon, it’s impossible as a legislature to fulfill our constitutional duty.” He also reminded the parties that “it is the latest in history to receive a budget.”

Clearly it would be easier to formulate a budget with at least the framework for a potential “bailout” (yes, we said it) to be available but, this is just another fiscal management failure by the current administration. It is not a matter of whether significant expense cuts need to be made, but how and where. We don’t see evidence of the obviously needed process of triage that will accompany any near term financial resolution. The continued brinksmanship and lobbying being relied upon by the current administration simply is not useful.

We will see how effective the lobbying effort will be. Gov. Alejandro García Padilla met Wednesday with House Speaker Paul Ryan (R-Wis.), Natural Resources Committee Chairman Rob Bishop (R-Utah) and House Minority Whip Steny Hoyer (D-), according to a statement released by La Fortaleza. He also held talks with Reps. Sean Duffy (R-Wis.), who is sponsoring Promesa, Raúl Labrador (R-Idaho) and Charles Dent (R-Pa.). The expected release of a revised Puerto Rico Oversight, Management & Economic Stability Act was delayed due to continued discussions in committee. The stumbling blocks continue to be reducing minimum wage, failing to protect pensioners and doing away with overtime rules.

Meanwhile, the bond-purchase agreement between the Puerto Rico Electric Power Authority, a group of bondholders and bond-insurance companies will expire Thursday unless the creditors give PREPA $111 million or the pact is extended. The agreement is part of PREPA’s larger debt restructuring deal. Puerto Rico lawmakers passed a debt moratorium in April that allows Governor Alejandro Garcia Padilla to skip debt-service payments on all island debt. PREPA’s creditors are reluctant to lend the utility more money unless Puerto Rico lawmakers amend the moratorium law to exempt PREPA.

PREPA’s position is that “conditions required for creditors to fund the $111 million bond purchase under PREPA’s restructuring support agreement and related documents have been satisfied, and as a result such creditors are required to fund the $111 million bond purchase on May 12, 2016,” the utility said in the statement. “PREPA paid $111 million in interest to these creditors in January 2016 in reliance on the creditors’ agreement to re-lend the same amount if two important milestones in PREPA’s restructuring occurred.” The obligation of creditors to buy the three-year bonds is subject to several conditions being fully satisfied, including that no Puerto Rico statue enacted after the agreement shall have an adverse affect on the rights and remedies of the 2016 bonds or their validity or enforceability. Obviously, something has to give.

On another front the Commonwealth’s credibility was under attack this week when Ambac sued the Puerto Rico Highways & Transportation Authority (HTA) on federal court on Tuesday that calls for the appointment of a receiver for the Authority. Ambac’s argument is that the HTA has failed to meet its fiduciary and contractual duties to its creditors. It cites the “suspect timing” during which HTA and Metropistas, a local subsidiary of Spanish firm Abertis, recently agreed to extend the concession contract of PR-22 and PR-5 for $115 million, of which $100 million has been already disbursed.

It is not challenging the contract itself. Instead, Ambac is focused on the use of the funds, arguing these “would likely be siphoned off by the commonwealth government” for purposes not related to HTA. This suit follows suits filed earlier this year by Ambac and Assured Guaranty, challenging the redirection of pledged revenues, known as “clawbacks,” to pay for public debt, a move the monolines deem as illegal and invalid under the U.S. Constitution. Gov. Alejandro Garcia Padilla’s clawback order covers one of HTA’s revenue sources for the repayment of its debt.

WHAT MAKES AN ISSUE TAXABLE

We’ve always taken an interest in what makes a tax-exempt bond taxable. The latest case involves a California authority and a high school district which announced this week that they are prepared to file a protest and appeal of an expected Internal Revenue Service proposed adverse determination that $25.4 million of tax-exempt variable rate demand bonds are taxable.

The California Statewide Communities Development Authority and the Sweetwater Union High School District have received a “Notice of Proposed Issue” in which the IRS tax-exempt bond office asserted that the 2005 bonds are taxable private-activity bonds.

“”If TEB issues a proposed adverse determination, the authority and the district will respond by filing a protest, including a request for view of the [IRS] Office of Appeals.”

Typically, cases handled by the appeals office result in out-of-court settlements.

The case revolves around an unusual conduit structure used to address concerns about state laws. The authority issued $25.4 million of tax-exempt variable rate demand revenue bonds and $8.2 million of taxable variable rate bonds in February 2005. The proceeds were lent to Plan Nine Partners, LLC, a subsidiary of California Trust for Public Schools, a nonprofit that helps expedite land acquisitions for public schools, according to group’s Form 990 tax form.

The proceeds funded the purchase a 23.82 acre parcel of industrial mixed-use land located Chula Vista, Calif. Plan Nine Partners were to lease the land to the Sweetwater school district, which wanted to build a new administrative headquarters, academic buildings and a bus yard on about 73% of it. The official statement estimated that some $120 million of additional bonds would be needed to finance the development of those projects. It does not appear those bonds were issued. The land was to be held in the name of Plan Nine Partners until the bonds were paid off in 30 years and was to then be conveyed to Sweetwater in an exchange agreement. The district would pay rent equal to the bond debt service to Plan Nine Partners.

The IRS began an audit in September 2013, and issued an information document request in October 2014. The authority and Sweetwater responded to the IDR in January 2015, arguing the tax-exempt bonds issued were not taxable. TEB filed a Notice of Proposed Issue on January 26 again asserting the bonds were taxable PABs.

Under the federal tax code, at least 95% of the proceeds of 501(c)(3) bonds must be used for “good” or non-private purposes. About 27% of the land was to be used for development and sale for private business use, the OS stated.

“The authority and the district still disagree with the IRS analysis and its conclusion.

ONE WAY TO DEAL WITH THE IRS

The Indianapolis Airport Authority (the “Authority”) is providing voluntary notice that, in connection with a random examination of its 2006 F Bonds which were purchased by the Indianapolis Local Public Improvement Bond Bank with proceeds of a $346 million of bonds issued by the Bond Bank. The Internal Revenue Service’s Field Office has asserted a rebate liability with respect to the Bonds. Although the Authority disagrees with and has opposed the Field Office’s position, the Authority and the Internal Revenue Service have agreed to a settlement of the dispute that will close the examination with no change to the tax exempt status of the Bonds.

This is how a large number of these disputes are settled. While upsetting to holders, the IRS has stated that it typically is not its goal to penalize individual holders of bonds. Rather, it seeks to come to some financial arrangement with the issuer of a contested issue.

SEC CONTINUES ENFORCEMENT ALONG WITH CRIMINALCHARGES

The Securities and Exchange Commission today charged a father and son and five associates with defrauding investors in sham Native American tribal bonds in order to steal millions of dollars in proceeds for their own extravagant expenses and criminal defense costs. The SEC alleges that Jason Galanis conducted the scheme in which the “primary objective is to get us a source of discretionary liquidity,” he wrote in an e-mail to other participants. Galanis and his father John Galanis convinced a Native American tribal corporation affiliated with the Wakpamni District of the Oglala Sioux Nation to issue limited recourse bonds that the father-and-son had already structured. Galanis then acquired two investment advisory firms and installed officers to arrange the purchase of $43 million in bonds using clients’ funds.

The SEC further alleges that instead of investing bond proceeds as promised in annuities to benefit the tribal corporation and generate sufficient income to repay bondholders, the money wound up in a bank account in Florida belonging to a company controlled by Jason Galanis and his associates. Among their alleged misuses of the misappropriated funds were luxury purchases at such retailers as Valentino, Yves Saint Laurent, Barneys, Prada, and Gucci. Investor money also was diverted to pay attorneys representing Jason and John Galanis in a criminal case brought parallel to the SEC’s stock fraud charges last year.

In addition five other individuals were charged with violations of the antifraud provisions of the federal securities laws and related rules. The SEC seeks disgorgement plus interest and penalties as well as permanent injunctions. In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against the same seven individuals.

This continues the emerging strategy of stronger enforcement of civil regulations backstopped by criminal actions in order to increase the deterrent effect against bad actors in the municipal space.

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 May 10, 2016

Joseph Krist

Senior Municipal Credit Consultant

L.A. TAKES THE PRIVATE ROUTE FOR SPORTS FACILITIES

We have recently discussed proposals for public financing for stadiums for professional sports franchises, including those for teams in California. We note however, that the state’s largest city has been taking a different route. While most attention has been rightfully focused on the relocation of the NFL Rams from St. Louis to a privately financed stadium, the groundwork was being laid for a new facility for a major league soccer facility in Los Angeles.

Those efforts culminated in the announcement of Friday that the Los Angeles City Council unanimously approved plans for a privately financed $250-million stadium in Exposition Park, clearing the way for the expansion Los Angeles Football Club to begin construction on the most expensive soccer-specific project in Major League Soccer history.

The 22,000-seat stadium will be the cornerstone of a complex that will include a conference center, restaurants and a soccer museum. It will be built next to the Coliseum on the site of the 56-year-old Sports Arena, which held its final event in March. Construction, including the demolition of the Sports Arena, is scheduled to begin this summer with the target of getting the stadium finished in time for LAFC’s first home game in March 2018.

LAFC’s facility will be the first open-air professional sports stadium built in the City of Los Angeles since Dodger Stadium, which played host to its first game in 1962. That too was a private project although it was catalyzed by a donation of land by the City to the O’Malley family. Likewise, this new facility is being built on City land.

THE DONALD WEIGHS IN ON PUERTO RICO

Regardless of what you think his chances are, it is important for investors to know and weigh the views of Presidential candidates on matters impacting the municipal bond market. This week, Donald Trump let us know his views on Puerto Rico’s debt crisis. In his own words – “I know more about debt than practically anybody, I love debt. I also love reducing debt, and I know how to do it better than anybody. I will tell you with Puerto Rico they have too much debt. You can’t just restructure; you have to use the laws, cut the debt way down, and get back to business, because they can’t survive with the kind of debt they have. I would not bail out if I were — if I were in that position I wouldn’t bail them out.”

So now we have the presumptive Republican presidential nominee standing with the Obama administration in favor of allowing the Commonwealth access to Chapter 9. He stands against those Republicans who are against a “bailout” of the Commonwealth. He is consistent in favoring a haircut for debtholders, something his high yield creditors in the 90’s are all too familiar with. Confused yet?

IF YOU ARE CONFUSED, THIS WON’T HELP

Much of the debate on both sides of the Puerto Rico issue seem to be ignoring certain facts. Supporters of the Puerto Rican government like to lament the end of Section 236 tax in the last decade which had formerly encouraged manufacturing businesses to locate production facilities on the island. Many of those supporters portray the island as having been cut adrift to fend for itself by an evilly motivated U.S. government. As for the “anti-bailout” faction of the body politic, they fail to acknowledge a huge amount of funding the Commonwealth gets for its General Fund from U. S. tax policy. What both sides share is an ignorance of provisions under Act 154 of 2010.

Under Act 154, Puerto Rico enacted a special excise tax on American companies there — mostly pharmaceutical and medical device companies — in an effort to offset lost revenues as the result in reductions in the marginal tax rates on income levied by the Commonwealth on its residents. But the government had effectively promised many of those companies that it would not raise their taxes. So it designed the tax to be eligible for the foreign tax credit in the U.S. That took advantage of the fact that Puerto Rico is treated as a foreign country for foreign tax purposes. That way, it would basically be a wash for the companies, while Puerto Rico could still reap the money it would raise. The plan left U.S. taxpayers footing the bill as companies here can take a foreign tax credit for paying standard taxes there.

So since 2010, U.S. taxpayers have effectively been subsidizing 20% of Puerto Rico’s revenues. Ironically, the amount of money provided essentially covers the Commonwealth’s annual debt service requirements for its general obligation and guaranteed debt obligations. This under actions promulgated by Treasury not by Congressional authorization. Further, these provisions have been under scrutiny by the IRS (part of the Treasury) which conveniently will not address the “creditability” of these taxes for corporations.

So in the end, the U.S. is providing a pretty favorable subsidy via the Administration of the tax code and Congress does not seem to be fully aware of the issue as it debates whether or not it should start to bailout Puerto Rico. Confused yet?

PREPA UPDATE

The Puerto Rico Electric Power Authority (“PREPA”) Bondholder Group today announced an offer to pre-fund the purchase price of the 2016 Bonds that the Group agreed to purchase under the Bond Purchase Agreement (“BPA”) to facilitate the completion of the Restructuring Support Agreement (“RSA”) with PREPA. Under the terms of the offer, the BPA deadline would be extended until the earlier of the passage of an amendment by the Puerto Rico legislature excluding PREPA as an RSA party from the Moratorium Act or May 31, 2016.

The Bondholder Group is prepared to deposit the approximately $61 million to fund the BPA into escrow or other segregated accounts. Under the arrangement, the funds would be transferred to the PREPA bond trustee following the passage of legislation, which would address issues created by the Moratorium Act preventing the consummation of the BPA, and the satisfaction of other agreed-upon conditions precedent to the BPA.

MEAG PROPOSES LOOSENING TERMS OF ITS BOND RESOLUTION

We find it interesting and something for investors to look at that the Municipal Electric Authority of Georgia (MEAG) is proposing changes to its Project One bond resolution designed to provide management with additional “flexibility” in its requirements for future financings and oversight requirements. This at a time when MEAG is a participant in construction of new nuclear generating capacity, a risky financial venture to say the least.

The proposed changes would loosen restrictions on when and how MEAG can issue debt, reduce the requirement for outside review of projects and operations by consulting engineers which are required to be reported to the Trustee for the bondholders. The proposed changes would also create new categories of senior debt which may be identified as being “Refundable Principal Installments”. These bonds would require fewer assets to be accumulated for their payment prior to maturity. They would also alter the method of calculating debt service coverage in favor of the Agency. Additional proposed changes would also allow MEAG to decide to divest the agency of assets without the review of some outside entities as is currently required.

While quality management in our mind always trumps bond requirements, we are always concerned by changes that position investors to get less information and fewer sets of “outside eyes” acting on their behalf. MEAG does have a good track record overall and a good record with nuclear construction and generation, we are more comfortable with an overabundance of protection given the risks of participation in a new nuclear project at this time.

ILLINOIS TRANSPORTATION FUNDING TO BE UP TO THE VOTERS

If the constitutional amendment is approved Nov. 8, all money raised through various transportation-related levies such as the gas tax, tolls, licenses fees and vehicle registration costs would be put into what amounts to budget “lockbox.” That money could then only be spent on road construction and repair, enforcing traffic laws, paying off debt on transit projects and even costs associated with workers injured on the job. The change would not apply to state and local sales taxes that are added on top of the gas tax collected at the pump. The proposed change to the Illinois Constitution that would prevent cash-strapped state government from raiding funds intended to be used on transportation projects.

Illinois imposes a base tax rate of 19 cents per gallon for gasoline and 21.5 cents a gallon for diesel. The gas tax has not been increased since 1991, and revenue collections have been essentially flat as vehicles become increasingly fuel-efficient. The effort comes as the Legislature grapples with an overall state budget for the second straight year.

Illinois has over the years segregated various revenue streams to support specific programs or categories of debt to enhance their security and insulate them from claims of general obligation bondholders. While the segregation enhanced the security for the benefiting bonds, it did theoretically weaken the ultimate security of general obligation debt. We view the proposed segregation of transportation of revenues as a continuation of this trend. Given the current budget conditions facing the State, it is an additional point of concern for the state’s general obligation creditors.

Muni Credit News May 5, 2016

Joseph Krist

Municipal Credit Consultant

WHEN POLITICIANS RUN AMOK

We observe two recent credit events that show how politicians’ lack of knowledge about municipal bonds can cause headaches for bondholders. Sometimes silence is golden. The first is the circus going on in Harvey, IL where a relatively poor, small municipality has seen its credit driven off a cliff by irresponsible local government officials. (See our most recent posting for the mechanics of what happened.) The resulting impact on bondholders could have been foreseen if the City had complied with municipal market disclosure standards. The lack of audits for the last two fiscal years and a failure to post required disclosures of material events left both investors and citizens in the dark as to the City’s real fiscal position. This is yet another incident where the lack of knowledge on the part of responsible officials actually results in the interests of bondholders and the citizenry being aligned in regard to the need for available, current, and accurate information.

The second case is the current effort to deflect blame away from responsible officials by mainland proxies for the Government of Puerto Rico. in this case, the somewhat financially ill-informed Speaker of the New York City Council Melissa Mark-Viverito has asked the Securities and Exchange Commission to investigate OppenheimerFunds Inc., saying the asset-management company has played a role in worsening Puerto Rico’s fiscal crisis by increasing its investments in the island’s debt. Mark-Viverito has blamed the island’s financial crisis on hedge funds, banks and other investors in Puerto Rican general-obligation bonds and utility debt. She has described the companies as “vultures” feeding off the instruments’ high yields and claimed they have lobbied against legislation that would reduce its payments to bondholders.

The comments reflect her lack of knowledge as to the difference between mutual funds which act as proxies for individual investors and large institutional investors who represent more speculative investors. Their interests are often not in alignment in terms of goals and expectations. The level of naiveté reflected by her comments are disappointing given that they come from one of the major elected officials from New York City, one of the largest annual issuers of municipal bonds.

Situations like this are why the pressure for timely disclosure and outside oversight continues to come from the municipal analytic community.

ATLANTIC CITY

The political brinksmanship over Atlantic City’s financial woes continues. Assembly Speaker Vincent Prieto cancelled a vote on his Atlantic City rescue bill, saying three lawmakers needed to pass it missed the voting session. Another session will take place Wednesday, Prieto said, adding that it could be for a new compromise bill. Gov. Chris Christie and Senate President Stephen Sweeney support a bill that would let the state sell city assets and terminate union contracts.

In his usual blustery way, Christie said the city is out of cash in 10 days. Then came the disappointing comment. “If they come up with something, great,” Christie said of the Legislature. “If they don’t, then bankruptcy will be the only option.” New Jersey investors have traditionally been able to rely on the State’s history on intervention and oversight for troubled local credits. The embrace of Chapter 9 by the state’s highest ranking official should be a concern for investors going forward.

CHARGERS STADIUM INITIATIVE

The Chargers last weekend began their attempt to gather the 66,447 signatures of registered San Diego city voters required to qualify for the Nov. 8 ballot. Last week, the team unveiled what executives described as a design concept for a joint-use stadium, convention center and two-acre park adjacent to Petco Park in downtown San Diego’s East Village neighborhood. The Chargers emphasized that the actual design and cost would be determined by a public stadium authority or other city-controlled entity under the ballot initiative’s advisory provisions.

The initiative is silent on the project’s estimated costs and financing details, but it does call for a professional football team to contribute $650 million from private sources toward stadium construction, as well as cover stadium-specific cost overruns and help fund future upgrades and maintenance if a public capital reserve falls short.

Chargers financial advisers said the initiative could raise enough revenue to sell at least $1.15 billion in bonds to help pay for construction, operations and maintenance, with $350 million going toward the stadium, $600 million for the convention center and $200 million for land acquisition and moving a public bus yard at the site.

An increase in hotel taxes to 16.5 percent from 10.5 percent would fund the public’s share, with 5 percent of hotel bills in the city reserved for bond repayment. The city’s 2 percent tourism fee would be eliminated, but 1 percent of the tax would be allocated to tourism marketing, increasing to 2 percent once debt service was sufficient.

The terms of bond financing, final construction costs, size of the convention center and its operations, and a host of other details raised by the mayor would be controlled by the authority, and not the team. The initiative requires the stadium’s football team to sign a 30-year lease and agree to not relocate for 30 years, but the mayor pointed out that it also allows bond financing for up to 40 years, potentially leaving the authority repaying bonds without a team for some period.

RAIDERS LOOK TO LAS VEGAS

Oakland Raiders owner Mark Davis told the Southern Nevada Tourism Infrastructure Committee, an advisory panel appointed by Gov. Brian Sandoval, that he would provide $500 million toward the construction of the 65,000-seat stadium if a public-private financing plan is approved by the Legislature. Davis wants the Raiders playing in Las Vegas by 2020. Public funds would cover $750 million of the project’s construction costs, according to a proposal from the Las Vegas Sands casino company and Majestic Realty, which are partnering to develop and operate the stadium. Those costs would be financed over 30 years through $50 million annual payments, likely from a hotel room tax. Funding for the stadium construction could come by increasing the tax, perhaps by a fraction of 1 percentage point. Lawmakers would need to sign off on any increase to the hotel room tax or the creation of the tax increment area.

They would need also to act to create the proposed Clark County Stadium Authority — an umbrella entity that would coordinate the project and issue and secure bonds. Majestic and Sands might front the remaining $150 million, but they are also proposing a “tax increment area” that could help them recoup that cost and fund ongoing stadium maintenance.

Legal bookmaking in Las Vegas has always been looked upon as a serious hurdle to location of a “big four” major league franchise in the city. Two factors may mitigate that. One is the likelihood that an NHL expansion franchise could begin operating in 2018. The other is the fact that NFL games are played twice a year in London, where betting is legal on a much more extensive basis than would likely be the case in Las Vegas.

Muni Credit News May 3, 2016

Joseph Krist

Municipal Credit Consultant

The GDB and a group of hedge funds — which own about one-fourth of the bank’s $4 billion debt — have agreed to enter into a 30-day forbearance agreement. It would cover more than $100 million of the bank’s payment on Monday. The bank would have faced a $400 million payment on principal, with an additional $22 million in interest. But during the past week, The Puerto Rico government announced late Friday that the cash-strapped GDB had reached an agreement with a group of local cooperatives that pushes, for a year, payment on roughly $33 million that was originally due May 2.

The announcement followed on the heels of a televised message Sunday, in which Gov. Alejandro García Padilla announced he has declared a moratorium on the Government Development Bank’s (GDB) debt service, as the commonwealth stood ready to partially default on as much as $270 million due May 2 on the bank’s debt. “Pursuant to Act 21 [Puerto Rico Emergency Moratorium & Financial Rehabilitation Act], I ordered a moratorium on the debt service payment due by GDB [on May 2]. In light of Congress’s inaction, we were forced to enact Act 21 to protect the education, health and public safety and other essential services of our citizens from creditors,” the governor said. “Let me be very clear, this was a painful decision.”

García Padilla reiterated there is simply not enough cash to pay for both government services and the commonwealth’s debt service. The García Padilla administration has been lobbying Capitol Hill for months to achieve a broad debt-restructuring mechanism. For their part, the Republican majority delegations in both chambers of Congress have been skeptic of granting access to such a restructuring regime and instead have leaned toward establishing strong fiscal oversight on the island.

During the next few weeks, sides are expected to continue negotiations after agreeing to a “framework of indicative terms,” in an effort to reach a debt-restructuring agreement in principle, the GDB stated Sunday. The bank warned that important items remain which are still subject to further negotiation, while several conditions “would need to be met over the coming months before the deal could proceed.” “To be very clear, this is but one piece in a complicated process that will require every Commonwealth creditor to participate,” Acosta stressed.

A bill being pushed in the U.S. House Natural Resources Committee seeks to strike a balance between both demands, but has yet to garner enough support to secure passage. The Governor said, “We would welcome an oversight board that would assist the elected government of Puerto Rico in balancing its budgets and improving its fiscal discipline,” “But we strongly oppose a board that overrules an elected government by deciding how our taxpayer money is spent or who gets paid first, or that is permitted to veto, amend or repeal our laws at will and without any accountability to the people of Puerto Rico.”

Plans call for having any debt restructuring deal reached with GDB creditors become a part of the commonwealth’s superbond proposal, if it is achieved down the road. To date, the so-called “superbond” is a “global” structure whereby the island’s different would include a “two-step restructuring” of the bank’s debt, in which holders would first exchange their GDB debt for new paper, amid haircuts, or reductions to principal, of 43.75%. Once and if the superbond takes place, GDB creditors would agree a haircut of 53%. However, even if timely achieved, these deals would only cover about half of the $422 million in a best-case scenario, which would prompt the government to miss the remainder of the bank’s payment, officials have warned.

Under this scenario, the governor is expected to declare a moratorium on the GDB’s debt-service payments, as allowed under the recently enacted Puerto Rico Emergency Moratorium Financial Rehabilitation Act. García Padilla has already declared an emergency at the bank, with an executive order that placed restrictions on GDB’s cash outflows. It is highly expected that the García Padilla administration meets in full roughly more than $40 million in debt payments across other commonwealth credits that are also due on Monday.

LAGUARDIA AIRPORT DEBT POISED FOR TAKE OFF

For many years, LaGuardia Airport has come in for criticism for the condition of its aging facilities. Vice president Joe Biden even compared them to air facilities in third world countries. These sorts of comments have finally motivated the State of New York to undertake a renovation and expansion of the terminal infrastructure at LaGuardia. The financing for the project will be in the form of a bond issue that will be sold as early as this week.

The $2.5 billion issue will be sold through the New York Transportation Development Corporation. The proceeds will be sold to a special purpose corporation which will construct and operate the new terminal (Terminal B) and will construct additional facilities(a terminal and connecting facility) as a part of the overall airport development. The SPC will operate the existing terminal that is being replaced by the project during construction of the new facility.

The security differs from that seen at many other airport projects. Payments on the loan made from NYTDC to the SPC will be repaid from revenues derived from the operation of the terminal facilities such as payments for use of the gates and payments from concessionaires. Landing fees paid by airlines for the right to land at the airport and paid to the Port Authority of NY/NJ as operator of the airport will not be available for repayments on the loan by the SPC operating the terminal to the NYTDC. Those payments will be secured under the Loan Agreement which creates a leasehold mortgage in favor of the bondholders.

Only terminal revenues are pledged to the bonds. There will be a 1.25x rate covenant supporting the borrower’s ability to generate revenues and there will be a debt service reserve account funded at completion from construction account monies so that it will eventually be funded at six months maximum principal and interest.

The credit as structured is weaker in some aspects for bondholders than a general airport revenue bond would be as the result of the concentration of risk in the one facility. That reflects the lack of those revenues in the pledged credit. At the same time, there are benefits in that the credit is a true project credit, rising and falling on its own merits rather than being caught up in the bureaucratic morass that is the Port Authority of NY/NJ. Then there is the issue of the always complicated ownership structure at the New York airports.

Bondholders must member that the airports are owned by the City and leased to the Port Authority which in turn leases facilities to builders, operators, and tenants. In the event of bankruptcy, these ownership structures complicate the analysis of who owns what for determining rights and remedies under bankruptcy.

So the determination of a credit equivalency for purposes of a bond like this must take into account traditional metrics like those of the local air demand market, the strength of the builder/operators, and the overall creditworthiness and ratings of the potential tenants as well as the technical provisions of the tenant base. Given all of those factors, it would be a surprise if the bonds were to receive a rating better than a BBB.

HARVEY ILLINOIS

The recent news that Harvey, Illinois might default on some of its outstanding debt is actually the culmination of a long process. The Securities and Exchange Commission announced that on January 27, 2015, an Illinois federal court entered a default judgment against Joseph T. Letke, a certified public accountant, served as the comptroller for several municipalities, mostly in the south suburbs of Chicago, including the City of Harvey, Illinois (the “City of Harvey”). According to the complaint, Letke and a firm he owned and controlled also served as a financial advisor to the City of Harvey in connection with certain municipal bond issuances in 2008, 2009 and 2010.

The complaint alleged that according to the offering documents for the 2008, 2009, and 2010 Bond Offerings, the purpose of these offerings was to finance the development of a full-service hotel and conference center in the City of Harvey (the “Hotel Development Project”). But according to the complaint, Letke participated in a scheme to divert the proceeds from these bond issuances for improper purposes, including undisclosed payments to Letke beyond what was disclosed in the offering documents, for payroll for the City of Harvey, and for other purposes unrelated to the Hotel Redevelopment Project. The complaint alleged that as the result of the scheme to divert bond-related proceeds, the Hotel Redevelopment Project turned into a fiasco, with the Hotel Redevelopment Project never having been completed.

Since then, the economically troubled south side municipality of 25,000 has been dealing with the political fallout of this situation. That aftermath has included charges of corruption against various city officials and difficulties administrating basic issues such as the levy and collection of property taxes. A recent effort to enact a tax increase and to collect taxes in amounts sufficient to generate revenues to pay debt service came to a head last week.

On Friday, the Cook County clerk’s office reversed course and approved a levy that will keep Harvey residents paying property taxes for city services. The reversal Friday comes two days after the county clerk declared the same ordinance invalid. The ordinance was passed during a chaotic meeting in which just two of Harvey’s six aldermen voted for it. The mayor argued another two aldermen were in the room, so they were recorded as no votes, which the mayor argued allowed him to break a 2-2 tie to pass the levy. The levy was deemed valid despite a majority of aldermen opposing it. Those aldermen have long argued that the Mayor couldn’t be trusted to honestly spend levy cash.

The levy was deemed valid despite a majority of aldermen opposing it. Those aldermen have long argued Kellogg couldn’t be trusted to honestly spend levy cash. The opposition to the tax had called a special meeting Friday night to attempt to pass a smaller levy. But, after news of the county clerk’s decision spread, only two of the group’s four aldermen came to city hall, and then for only a portion of the meeting.

It is the latest chapter in the debate in Harvey over what is typically in other cities a routine function: passing a property tax levy. Four of the suburb’s six aldermen argue that the Mayor has refused to explain how city money is spent, so they can’t support a tax levy that would continue to pump money to his administration. The Mayor contends that the aldermen are power hungry and played politics in ways that could force the city of about 25,000 to lay off half of its police, firefighters and public works employees.

Caught in the middle has been the County Clerk, whose office has the duty to process local governments’ levy ordinances. State law says municipalities must pass a levy ordinance by the last Tuesday in December, but the Clerk pushed that deadline back to May 2 for Harvey. With the deadline looming, and no budging from the anti-mayor group, the Mayor and his supporters said the ordinance was introduced at Monday’s council meeting — during which two anti-tax aldermen had already walked out of the meeting in protest and a shouting citizen was removed out of the council chambers by police.

Two aldermen voted for the levy, they said. The mayor said the final two anti-tax aldermen were present for the vote but didn’t respond, allowing their votes to count as no votes and the Mayor to cast the tie-breaking yes vote. The clerk’s office initially told Harvey officials Wednesday the vote was invalid because — in a city of a mayor and six aldermen — at least four of them needed to vote yes. But the Mayor responded that Harvey had home-rule powers, under which the city had adopted different rules that would allow such a vote to count. In a letter Friday, the Clerk’s office said based on what Kellogg sent, the levy appears to be valid. The Harvey city clerk “attested” to the fact two of the anti-Kellogg aldermen were there, and he said the office has only an “administrative rather than an investigative role” in the tax levy process.

Muni Credit News April 28, 2016

Joseph Krist

Municipal Credit Consultant

PR HURDLES TOWARDS DEFAULT THIS MONDAY

Puerto Rico’s government still has not set a delivery date for Puerto Rico’s audited financial statements for fiscal year 2014, Public Affairs Secretary Jesús Manuel Ortiz said Wednesday. “Certainly, we don’t have a delivery date,” said Ortiz, while adding that meetings between KPMG and government officials are still underway. The government of Gov. Alejandro García Padilla was expected to release the financial statements early this month. However, uncertainty over the Government Development Bank (GDB) has again delayed the delivery of the statements, which were due almost a year ago.

At the GDB, there remains uncertainty in figuring out the government bank’s loan loss reserves. If the government can restructure its debt, then there would be more money on hand; if the government isn’t able to restructure, then there is less money. Many assumptions tied to the central government are difficult to value.

Ironically the administration is currently evaluating a proposal from KPMG to perform the audited financial reports for fiscal year 2015, which are due May 1. KPMG also produced the audit for fiscal 2013, which was delivered two months past its deadline. During the past three years, KPMG has been paid roughly $20 million in professional-services contracts, according to government records.

Congress heading out of Washington on Friday, missing deadlines on the budget and on helping Puerto Rico with its financial crisis. Having failed to enact a bill by the May 1 deadline to help the territory, lawmakers are now focusing on a July 1 deadline, when around $2 billion in principle and interest payments come due.

The government is expected to keep operating as usual, but economists warn that its access to capital markets will shut down and that eventually this will curtail public services if a debt-restructuring mechanism isn’t approved. Puerto Rico expects multiple lawsuits to be filed shortly after Monday’s anticipated default. A House bill would create a control board to help manage the island’s $70 billion debt and oversee debt restructuring. But the legislation has stalled in the Natural Resources Committee, as some conservatives and Democrats have objected to the approach.

Speaker Paul Ryan, R-Wis., has pushed the bill, saying the U.S. may eventually have to bail out the territory if Congress doesn’t act soon. Utah Rep. Rob Bishop, the Republican chairman of the Natural Resources panel, says he hopes the island’s impending default will create more urgency among his colleagues. The Senate is expected to wait to see what happens in the House first.

The Puerto Rico government is expected to keep operating as usual, but economists warn that its access to capital markets will shut down and that eventually this will curtail public services if a debt-restructuring mechanism isn’t approved. Puerto Rico expects multiple lawsuits to be filed shortly after Monday’s anticipated default.

Democrats called upon House leaders to modify this spring’s three-weeks on, one-week off legislative schedule to keep working, as Puerto Rico moves toward its default on Sunday. “It’s very, very hard to get anything done if you are a drive-by Congress,” said House Minority Leader Nancy Pelosi, D-Calif. “We’re barely here. And these deadlines are coming.” Hours later, however, Democrats joined Republicans in adjournment.

It is clear that Congress has yet to figure out which outcome generates political upside. With national attention focused on the presidential nomination process, it has been hard for Puerto Rico to generate a sufficient level of political traction and attention in order to drive a resolution of its situation. In the meantime, it appears that the coalition of political leaders who initially supported tax increases earlier this year is falling apart. With the island’s gubernatorial election process beginning to take shape, Sen. President Eduardo Bhatia Gautier, Sen. José Nadal Power, House President Jaime Perelló Borrás, Rep. Rafael Hernández Montañez, and PDP gubernatorial candidate David Bernier all announced their opposition to the planned tax changes. A scheduled increase in VAT has been delayed due to this opposition.

Meanwhile it has been about seven months since the initial announcement of a PREPA restructuring agreement and it has still to be implemented. PREPA is seeking to prolong a bond-purchase agreement with its creditors to May 2, averting a potential termination of a larger debt-restructuring deal. The agreement would have bondholders and insurance companies agree to buy $111 million of three-year bonds from PREPA. The contract expired late Wednesday and is part of PREPA’s plan to restructure $9 billion of debt. The larger restructuring pact will end if the bond-purchase agreement fails to continue.

MEANWHILE IN ATLANTIC CITY

Assembly Speaker Vincent Prieto will post his Atlantic City rescue bill for a vote next Thursday. Prieto released a schedule for the Assembly on that includes a voting session on Thursday. Prieto’s bill gives the city two years to meet benchmarks in order to solve its financial crisis. If the city fails to do that, it will be taken over by the state.

Senate President Steve Sweeney is reported to have tried to compromise with Prieto by offering a bill that gives the city 130 days to meet benchmarks, but Prieto is said to have been unwilling to accept it. Atlantic City Mayor Don Guardian and Council President Marty Small have repeatedly said they support Prieto’s bill.

May 15 is the deadline date for action by the State that would enable Atlantic City to avoid a default. Much of this has been lost in the fog of the market’s attention on Puerto Rico and its woes.

We believe that while much smaller in terms of dollars, the failure of the State of New Jersey to help Atlantic City avoid a default would have implications for the market, especially for the ability of not only New jersey’s municipalities but also for the State itself.

Muni Credit News April 26, 2016

Joseph Krist

Municipal Credit Consultant

FL ADOPTS P3 LEGISLATION

Recent legislation created The Florida Department of Transportation Financing Corporation as a nonprofit corporation for the purpose of financing or refinancing projects for the department. It permits the Department to finance P3 projects through the issuance of tax-exempt bonds. It shall be governed by a board of directors consisting of the director of the Office of Policy and Budget within the Executive Office of the Governor, the director of the Division of Bond Finance, and the Secretary of Transportation. The director of the Division of Bond Finance will be the chief executive officer of the corporation and shall direct and supervise the administrative affairs of the corporation and control, direct, and supervise the operation of the corporation.

The legislation authorizes the department to adopt relevant federal environmental standards as the standards for a program. Sovereign immunity from civil suit in federal court is waived. The Legislature found that there is a public need for the rapid construction of safe and efficient transportation facilities for the purpose of traveling within the state, and that it is in the public’s interest to provide for the construction of additional safe, convenient, and economical transportation facilities. The law requires that in connection with a proposal to finance or refinance a transportation facility pursuant to this section, the department consult with the Division of Bond Finance of the State Board of Administration. The department must provide the division with the information necessary to provide timely consultation and recommendations. The Division of Bond Finance may make an independent recommendation to the Executive Office of the Governor.

Specifically, The Department of Transportation may request the Division of Bond Finance to issue bonds secured by toll revenues collected on the Alligator Alley , the Sunshine Skyway Bridge, the Beeline-East Expressway, the Navarre Bridge, and the Pinellas Bayway to fund transportation projects located within the county or counties in which the project is located. The law provides that the department’s Pinellas Bayway System may be transferred by the department and become part of the turnpike system under the Florida Turnpike Enterprise Law. Upon transfer of the Pinellas Bayway System to the turnpike system, the department shall also transfer to the Florida Turnpike Enterprise the funds deposited in the reserve account established shall be used by the Florida Turnpike Enterprise solely to help fund the costs of repair or replacement of the transferred facilities.

The department may enter into a service contract for a project may enter into one or more such service contracts with the corporation and provide for payments under such contracts, subject to annual appropriation by the Legislature. Each service contract may have a term of up to 35 years. The obligations of the department under such service contracts do not constitute a general obligation of the state or a pledge of the full faith and credit or taxing power of the state, and such obligations are not an obligation of the State Board of Administration or entities, but are payable solely from amounts available in the State Transportation Trust Fund, subject to annual appropriation. The Florida Department of Transportation Financing Corporation may issue and incur notes, bonds, certificates of indebtedness, and other obligations payable from and secured by amounts payable to the corporation by the department under a service contract. The duration of any such note, bond, certificate of indebtedness, or other obligation or evidence of indebtedness may not exceed 30 annual maturities. Debt may be sold through competitive bidding or negotiated contracts, whichever is most cost-effective.

Such obligations are exempt from taxation; however, such exemption does not apply to any tax imposed under chapter 220 on the interest, income, or profits on debt obligations owned by corporations.

KANSAS – THE SONG REMAINS THE SAME

Last year at this time, Kansas legislators were facing a $400 million hole in the FY 2016 budget. This year the gap is $290 million after increases in sales and cigarette taxes. Governor Sam Brownback would fill the gap by taking $185 million from the state highway fund, delaying more than two dozen projects, and he would cut spending to state universities by 3 percent, about $17 million, for the fiscal year beginning July 1. That would continue a 3 percent cut he ordered earlier this month.

More than $1.5 billion has been shifted from the highway fund to the state’s general fund and other state agencies since 2011. Until now, Brownback made assurances that all highway projects would go forward. But his budget message last week led the state Department of Transportation to announce the delay of 25 projects slated to begin over the next two to three years, including a Kansas 68 widening project in Miami County. Projects currently underway aren’t affected.

Other moves would require approval by the Legislature, which returns from a spring recess on Wednesday. Three options have been offered by the Governor.

One option would sell off a portion of the state’s future tobacco settlement money for quick cash. The first option was to sell a portion of the state’s future payments from a national tobacco settlement, which Kansas dedicates to early childhood education programs, to bondholders for a one-time infusion of $158 million. It’s a contentious idea. Kansas along with most other states receives a payment each year of some $58 million, although the annual payment is expected to decline in the future as smoking declines.

A second option would delay a $99 million state payment to the Kansas Public Employees Retirement System until fiscal year 2018. Current retirees’ benefits wouldn’t be affected by the delay, he said. A third option would make 3 to 5 percent cuts to most state agencies, including funding to K-12 public schools and state universities. A 3 percent reduction to K-12 schools would be about $57 million.

The options offered by the Governor are either one-shots (the tobacco bonds), irresponsible pension funding deferrals (Kansas has one of the lowest pension funding ratios). None of them are positive for the State’s credit and would continue a pattern of offloading the results of the failed tax cut experiment on to the credits of underlying entities to the detriment of their ratings. We see Kansas as an environment to avoid for credit conscious investors so long as Governor Brownback clings to his failed tax cut program. S&P would seem to agree keeping the State’s credit on negative outlook this week.

HIGH YIELD DOWNGRADE

Iowa Fertilizer Company LLC has been downgraded by Fitch to B+. The project generating revenues for the company’s controversial $1.2 billion tax-exempt deal has experienced a substantial delay in start-up is expected to necessitate a draw on the cash-funded debt service reserve for mandatory 2016 payments. These payments and construction cost shortfalls are expected to be funded by a $150 million letter of credit-backed (LOC) subordinated loan facility from sponsor OCI N.V.

The project fully exhausted its contingency and issued an additional $100 million of combined senior debt and sponsor equity in June 2015, and additional funding will be required to complete the facility. Further change orders and contractor claims are still being negotiated, indicating that final costs could rise further.

The project will utilize commercially proven technologies with relatively low maintenance risk. At the same time, it’s main products have historically exhibited considerable price volatility. Fitch estimates that a shift in the supply-demand balance could negatively impact prices, as a 10% change in nitrogen product prices will result in a 0.40x-0.50x change in debt service coverage ratios. Management’s latest expectation is that ammonia production will begin in the September/October 2016. These obligations total an estimated $168.3 million. Construction progress, the status of OEC’s claims, and market fertilizer prices over the next few months will determine the likelihood that IFCo can meet its obligations relying only on projected sources of funds available to the project company.
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 April 21, 2016

Joseph Krist

Municipal Credit Consultant

KENTUCKY BUDGET MAKES SOME EFFORT AT PENSION FUNDING

The Kentucky General Assembly has passed a $21 billion Executive Branch budget for the next two fiscal years that will pour $1.28 billion into the state pension systems and make no cuts to K-12 education while authorizing the governor’s plan to cut most state agency funding by nine percent over the biennium. Most new money in HB 303 will go for state pension in the Kentucky Employees Retirement System and the Kentucky Teachers’ Retirement System. Funding in FY 2017 will be $933.1 mn and in FY 2018 will be $888.8 mn. That is 5.7% of enacted spending for the upcoming biennium.

Funding for K-12 education will not be cut under HB 303, which protects funding to schools and gives the Department of Education up to $20 million in additional funds over the biennium as a necessary governmental expense if there are not enough per-pupil SEEK funds available. Public preschool will be made available to families with incomes below 200 percent of the poverty level as part of a pilot program, and $15 million in preschool funding will be set aside for grants to help develop full-day programs for children eligible for state child care assistance.

In the area of higher education, HB 303 authorizes lesser cuts of 4.5 percent over the biennium for state colleges and universities that faced the possibility of 9 percent cuts under the governor’s original proposal. A performance-based funding formula for state universities is also found in the bill that will require 5 percent of state university base funding to be gauged on an institution’s performance. Kentucky State University would be exempt from the performance-based model.

LOUISIANA

On April 12, 2016, Louisiana Governor John Bel Edwards released his proposal for the state’s fiscal year 2017 budget. Citing shortfalls in the state budget, Edwards said that deep cuts to many state services were necessary to close gaps for the overall improvement of the state’s financial health. The proposal included cuts to the state’s primary college scholarship program (TOPS), cuts to “safety net hospitals” for low-income families, and cuts to education at both the K-12 and college levels. The funding for the TOPS program, in particular, would be reduced by about two-thirds of its current level, leaving the total funds at about $110 million. The state legislature went on to debate several bills that would alter how cuts.

The cuts followed up a series of tax increases adopted during a special session of the legislature in late winter. These included a rise in the State sales tax rate of 1%, an expansion in the taxable base for the existing 4% sales tax through FY 2018, and the stabilization fund and appropriated $200 million of monies from funds received under the BP settlement agreement.

According to the U.S. Census, Louisiana had 14 state pension plans as of April 2015. Between fiscal years 2008 and 2012, the funded ratio of Louisiana’s state-administered pension plans decreased from 69.2 percent to 55.5 percent. The state paid 96 percent of its annual required contribution, and for fiscal year 2012 the pension system’s unfunded accrued liability totaled $18.4 billion. This amounted to $4,161 in unfunded liabilities per capita.

The State continues to be negatively impacted by low oil prices. These have had a negative impact of revenues and employment and increased pressure on the expenditure side of the budget. So long as oil prices remain in a relatively depressed state, the negative pressure on the State’s credit ratings will persist. These are exacerbated by the State’s weak pension funding position reflecting years of underfunding now creating annual budget gaps.

RHODE ISLAND PENSION DEVELOPMENTS

So far this year’s budget process has not continued positive momentum which the State and the Governor had hoped to carry forward in regard to the State’s longstanding pension funding issues. In 2007, legislation was enacted which provided for surplus General Fund monies to be transferred to the State Retirement Fund. Pressures on the General Fund diminished support for this plan as it was felt that the funds were needed elsewhere and last year the Legislature effectively repealed these provisions keeping those surpluses within the General Fund.

Most prominent among those pressures were the need for additional state aid to struggling municipalities. Those struggles are based in changes in the local economies but also fiscal pressures resulting from increasing pension demands. Some 20 of the 36 municipal pension plans have funding ratios below 60%. These pressures resulted in the Chapter 9 bankruptcy of the City of Central Falls in 2011.

Now nearly five years later, several municipalities are considered to be distressed. For FY 2017, eight are determined to be eligible for funding from Rhode Island’s Distressed Communities Relief Fund. Pension requirements are but one of several criteria used to determine qualification for Fund monies. It is hoped that at least one community will be able to drop out of the program in FY 2017.

These factors are among many that weigh negatively on Rhode Island’s credit outlook as it continues to deal with the long-term decline of its major manufacturing industries. Its efforts to do so have been stymied by competition from the larger neighboring states in the region and larger and more established entities in those states in the commercial and service sectors that Rhode Island seeks to expand.

Our view is that those pressures will continue and will be sufficient to outweigh the impact of the positive steps which the State is undertaking. We would view that State’s debt as one to underweight versus other comparably rated state bonds.

PR CREDITOR AGREEMENT

According to press reports, the Government Development Bank (GDB) and a group of its creditors have struck a tentative deal, providing the bank with some relief ahead of its $422 million debt payment due May 2. The group of GDB creditors, which hold about a fourth of the bank’s roughly $4 billion debt, would agree to a forbearance agreement that covers only $120 million of the May payment. The government could still be pressed to declare a partial moratorium on the remainder of the payment, as there is not enough money to meet the payment in full. The tentative plan reportedly would also include a debt-exchange process whereby GDB creditors would get new with a haircut estimated at 50%. Creditors would have to accept that they would receive no principal payments in the next few years. The rest of the bank’s creditors would still need to join the agreement if the exchange is to take place.

Meanwhile in Washington, the Puerto Rico debt restructuring bill was still short of votes. The bill is still being rewritten, and as of yet the vote has not been rescheduled. The U.S. House Natural Resources Committee issued a statement Tuesday seeking support for its bill. “Congress cannot pass legislation to erase the decades of fiscal mismanagement and socialist policies that brought the territory to its knees. But a growing number of Members understand we must act on a responsible solution to prevent U.S. taxpayers from footing the bill,” the panel statement said.

Meanwhile, the situation on Puerto Rico remains “fluid”. The Puerto Rico House of Representatives passed a bill that would exclude general obligation (GO) and Sales Tax Financing Corp. (Cofina) bonds from the law that allows the governor to declare a debt moratorium. The leader of the PDP in the Senate said in an interview that he agrees that the government should not include general obligation debt or debt that is sustainable such as Cofina debt, which is guaranteed by the sales and use tax, in the moratorium. He also said he believes the debt that was recently restructured at the Puerto Rico Electric Power Authority should not be part of the debt moratorium.
I don’t support including the general obligation bonds in the negotiation to restructure debt because it would be in violation of the constitution.”

However, Gov. Alejandro García Padilla immediately advised lawmakers in a statement that he plans to veto the bill if it reaches his desk. These maneuverings are why it is a fool’s errand for analysts to try to predict the outcome of this process. Those with the means and capacity to deal with these day to day machinations are most appropriately equipped to play in these bonds. Rare is the individual investor who is.

In the meantime, the Government Development Bank has filed with regulators to sell taxable debt that would mature May 2017 as officials negotiate with creditors about a $422 million payment owed at the start of May. And no, the Puerto Rican government has not released audited financial statements for FY 2014. They are requesting proposals from auditors for FY 2015 financial statements. And yes, it is FY 2017 that begins this July 1.

Muni Credit News April 19, 2016

Joseph Krist

Municipal Credit Consultant

SEC STEPS UP MUNI FRAUD EFFORT

It will perhaps be of more interest locally in the NY metro area than nationally but the recent actions of the SEC enforcement staff in the municipal bond market should be encouraging to investors. The SEC alleges that Ramapo officials resorted to fraud to hide the strain in the town’s finances caused by the approximately $60 million cost to build a baseball stadium as well as the town’s declining sales and property tax revenues. It is alleged that they cooked the books of the town’s primary operating fund to falsely depict positive balances between $1.4 million and $4.2 million during a six-year period when the town had actually accumulated balance deficits as high as nearly $14 million. And because the stadium bonds issued by the Ramapo Local Development Corp. (RLDC) were guaranteed by the town, certain officials also masked an operating revenue shortfall at the RLDC and investors were unaware the town would likely need to subsidize those bond payments and further deplete its general fund.

According to the SEC’s complaint, inflated general fund balances were used in offering materials for 16 municipal bond offerings by Ramapo or the RLDC to investors, who consider the condition of a municipality’s general fund when making investment decisions. After town supervisor Christopher P. St. Lawrence purposely misled a credit rating agency about the town’s general fund balance before certain bonds were rated, he told other town officials to refinance the short-term debt as fast as possible because “we’re going to all have to be magicians” to realize the purported financial results.

Christopher P. St. Lawrence, who served as RLDC’s president in addition to being town supervisor, masterminded the scheme to artificially inflate the balance of the general fund in financial statements for fiscal years 2009 to 2014. St. Lawrence and Aaron Troodler, a former RLDC executive director and assistant town attorney, concealed from investors that RLDC’s operating revenues were insufficient to cover debt service on bonds to finance the stadium. Troodler helped conceal the fictitious sale and boost the account balance of the town’s general fund by approving RLDC financial statements reflecting a purchase of property that never actually occurred. Troodler also signed offering documents that contained an additional fabricated receivable totaling $3.66 million for another transfer of land from the town to the RLDC. The only land transferred from the town to the RLDC during the time of the purported transaction was property donated for the baseball stadium, which St. Lawrence and Troodler knew did not impose any payment obligation on the RLDC.

Town attorney Michael Klein helped conceal outstanding liabilities related to the $3.08 million receivable recorded in the town’s general fund for the sale of a 13.7-acre parcel of land to the RLDC. But because the title of the property was never transferred from the town to the RLDC, Klein also made misleading statements about the receivable’s source. Troodler helped conceal the fictitious sale and boost the account balance of the town’s general fund by approving RLDC financial statements reflecting a purchase of property that never actually occurred. Troodler also signed offering documents that contained an additional fabricated receivable totaling $3.66 million for another transfer of land from the town to the RLDC. The only land transferred from the town to the baseball stadium, which St. Lawrence and Troodler knew did not impose any payment obligation on the RLDC. The town’s deputy finance director Nathan Oberman participated in activities to inflate the town’s general fund by arranging $12.4 million in improper transfers from an ambulance fund to bolster the troubled general fund during a six-year period.

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against St. Lawrence and Troodler.

CONNECTICUT BUDGET WOES CONTINUE

Although by various measures, Connecticut is a wealthy state it’s budget is not immune from the pressures of declining revenues and accelerating expenses. In part because the state’s legislators are forced to rely heavily on its highest earners to fill the state’s coffers. Nearly 61% of tax revenues is from the income tax. They are fearful of alienating more of the highest-earning residents after a tax increase last year. Since an initial budget was accepted in February, revenues have

To counter this trend, the Governor released a revised budget for FY 2017 that reflects a 4.89% decline in revenues from the February estimate. It employs layoffs of state employees to reduce expenses by 8.1%. This does result in a small surplus if nothing else changes. Connecticut is in a tough spot as it wealth is highly concentrated and much of it is mobile. On the expense side, flexibility is limited by the need to fund pensions after a long period of underfunding. Spending for those costs account for 5.6% of spending. In addition, debt service eats up a very high 12.8% of expenses.

So the outlook for Connecticut remains negative. This reflects the poor revenue trend and the maintenance of expenditure pressures going forward in an atmosphere of limited management flexibility.

PUERTO RICO

Puerto Rico Secretary of State Víctor Suárez disclosed that discussions with a group of GDB creditors could involve a request for a forbearance agreement that would cover roughly $120 million of the May 2 payment due from GDB. “If we strike a forbearance agreement, there is still the possibility of declaring a partial moratorium,” said Suárez. Suárez said it is not currently being contemplated that the creditor group would be asked for additional cash flow lending. He did acknowledge that “the cash flow situation of the government continues to be delicate. The government needs to follow up every week on its cash flow to make the calls with respect to the July 1 payments. It is very hard, very hard that the government can make any payment in July 1.

YOUTH SMOKING TRENDS

It’s the time of year when the states receive their annual payments from the tobacco companies under the Tobacco Settlement Agreement (TSA). As consumption of cigarettes (not other tobacco products) is one of the prime variables impacting the level of these payments tobacco securitization bonds, annual trends in consumption are closely followed.

The Centers for Disease Control(CDC) and the U.S. Food and Drug Administration’s (FDA) Center for Tobacco Products in its Morbidity and Mortality Weekly Report (MMWR) showed that overall tobacco use by middle and high school students has not changed since 2011. Data from the 2015 National Youth Tobacco Survey show that 4.7 million middle and high school students were current users (at least once in the past 30 days) of a tobacco product in 2015, and more than 2.3 million of those students were current users of two or more tobacco products. Three million middle and high school students were current users of e-cigarettes in 2015, up from 2.46 million in 2014. Sixteen percent of high school and 5.3 percent of middle school students were current users of e-cigarettes in 2015, making e-cigarettes the most commonly used tobacco product among youth for the second consecutive year. During 2011 through 2015, e-cigarette use rose from 1.5 percent to 16.0 percent among high school students and from 0.6 percent to 5.3 percent among middle school students.

From 2011 through 2015, significant decreases in current cigarette smoking occurred among youth, but there was no significant change in the prevalence of current cigarette smoking among this group during 2014 – 2015. In 2015, 9.3 percent of high school students and 2.3 percent of middle school students reported current cigarette use, making cigarettes the second-most-used tobacco product among both middle and high school students. The importance of this particular data trend is that levels of youth smoking have a direct correlation to levels of adult smoking over the long term. Any change in this direction of this trend is noteworthy. This one, should it continue could slow or stabilize the overall decline in cigarette consumption which has negatively impacted levels of available revenues for the repayment of tobacco bonds in recent years.

Muni Credit News April 14, 2016

Joseph Krist

Municipal Credit Consultant

PR BILL INTRODUCED

Rep. Sean Duffy, R-Wis., introduced a bill H.R. 4900, the “Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA).” late Tuesday to address Puerto Rico’s debt crisis. It was the subject of a Natural Resources Committee hearing on Wednesday and is expected to be voted on by the committee on Thursday. We outlined the expected basic provisions in our special edition of Tuesday April 12. The main changes in the bill since it was initially discussed are in the board’s makeup, its power to unilaterally impose regulations on the commonwealth, and the required steps for an entity to undergo restructuring. The board would still only be able to file restructuring petitions on behalf of the commonwealth and its public authorities after the debtors tried to reach an agreement with their creditors through voluntary debt restructuring proposals and have provided the board with up-to-date financial statements. The bill also eliminates a provision from the earlier version that gave the oversight board power to unilaterally implement recommendations and binding regulations.

Reaction from Puerto Rican politicians was mixed. Rep. Nydia Velazquez (D-NY) was unenthused. “Given that four Board members will be appointed by Republicans, there is significant reason to believe that restructuring authority will never be granted,” Velazquez said. “This concern is compounded by section 601, a new provision, which adds a collective action clause to the bill. This clause requires two-thirds of creditors to voluntarily agree to restructure their debt, a hurdle that is not realistically achievable.” In a conference call with journalists on Tuesday, Puerto Rico’s governor, Alejandro García Padilla, said he believed that Congress had taken Puerto Rico’s complaints of federal overreach seriously and acted in good faith to tailor the oversight board to Puerto Rico’s situation.

A hearing before the House Natural Resources Committee was held this week. The Obama administration expressed concerns that undermining the minimum wage and overtime rules in Puerto Rico, thereby increasing the disparities in pay between Puerto Rico and the mainland, is not a recipe for economic growth. Rather, it believes a locally administered Earned Income Tax Credit is a more powerful and effective way to stimulate the economy and encourage work. The one time mayor of Washington D.C., Anthony Williams commented on the issue of an oversight board. “The lessons drawn from other notable places that were subject to oversight does instruct that if done with due respect for those in public office, and with keen awareness of both community leadership and an eye on business interests, good and sustainable solutions can and have occurred.”

After the hearing, the Committee chairman said that the planned schedule for consideration of legislation needed to be extended. “The Administration is still negotiating on provisions of the legislation, creating uncertainty in both parties. This legislation needs bipartisan support, but Members need time to understand the complexity of the issue and the ramifications of any proposed changes. It is unfair to all Members to force a vote with provisions still being negotiated.” In addition, As of Thursday, the PR government still did not know when the long-awaited Commonwealth Annual Financial Report (CAFR) for the year ended June 30, 2014, would be released.

The fiscal 2014 CAFR was due nearly a year ago, in May 2015. KPMG, the independent auditors tasked with the process, said it would take the firm another eight to nine weeks to complete the audit once they receive all pending information. Since early this year, administration officials have stated the government has handed in everything on their end. But they have also acknowledged that some commonwealth components have yet to finish certain processes related to the external audit, including the cash-strapped Government Development Bank (GDB) and two of the commonwealth’s retirement systems.

P3 UPDATE

The I-69 Section 5 project is a part of an Indiana highway that is being expanded to handle expected increased truck traffic resulting from NAFTA. The I-69 Section 5 project involves rehabilitating and upgrading 21 miles of the existing four lane State Road 37 in Morgan and Monroe counties to interstate standards from Bloomington to just south of Martinsville, Indiana. As part of the conversion, the existing partially-controlled limited access facility will be upgraded to have fully controlled access and will include the addition of travel lanes in the north and southbound lanes.

Bonds have been issued secured by a pledge of future payments from the private entity which is constructing and will operate the road. Availability payment P3s transfer cost, schedule and quality risks away from taxpayers during such time that the private sector is responsible for construction, operations and maintenance. If the road isn’t made “available” to the public in compliance with performance standards in the contract, the recurring, inflation-adjusted payments are reduced accordingly. Under terms of the contract, the state would make an $80 million “down payment” to the private partner, Isolux Infrastructure, which would pay the $325 million estimated for construction. Once that section of highway is complete, the state starts paying the partner $21.8 million a year for 35 years and the company maintains the highway.

Fitch Ratings last week downgraded the Indiana Finance Authority’s private activity bonds (PABs) issued on behalf of I-69 Development Partners LLC (I-69 DP) for the I-69 Section 5 project to ‘BBB-‘ and placed the bonds on Rating Watch Negative. The downgrade reflects the deteriorating credit quality of Isolux Corsan SA (Isolux), parent of the construction contractor, Corsan-Corviam Construccion SA, whose rating was revised to ‘B-‘/Rating Watch Negative on Feb. 12, 2016. This followed an earlier downgrade of Isolux on Dec. 7, 2015 to ‘B’/Rating Watch Negative.

The downgrade further reflects a projected eight month delay to substantial completion, initially expected in October 2016, which was disclosed in the most recent construction update published in March 2016. The revised substantial completion date is now June 28, 2017. Now the bondholder is exposed not only to project risk but financial risk of the private construction contractor. There is a Debt Service Reserve Account sized at modest a six-month’s debt service.

P3 project s have not been quite the godsend that politicians and investors have hoped for in many cases. While the private entities are often better at project execution than government, they also have brought an element of financial risk to transactions often unrelated to the project at the center of an individual bond issue. The result has been a greater shift of risk to investors than they anticipated resulting a shift in the risk balance away from the issuers onto those investors.

BOND MARKET GETS SOME REGULATORY RELIEF

U.S. cities and states won a partial victory Friday as the Federal Reserve gave final approval to a rule that will allow banks to include some municipal bonds in allocations of easy-to-sell assets meant to serve as protection against a financial crisis. A multiagency rule adopted in 2014, called for the biggest banks to hold enough high-quality liquid assets to survive a 30-day period of financial stress. The central bank revisited the idea of including munis after local governments waged a lobbying campaign for the change.

Bank regulators adopted the minimum-liquidity demand as a response to deficiencies highlighted during the 2008 credit crisis, when financial firms were stuck with assets they couldn’t sell. The Fed, which announced completion of its revised rule in a statement, said it relied on an analysis that suggested certain munis should qualify because they have liquidity characteristics similar to assets such as corporate debt securities. The victory is only a partial one for issuers in that a substantial portion of muni activity occurs in the bank units overseen by the Office of the Comptroller of the Currency. So far, neither the OCC nor the Federal Deposit Insurance Corp. has matched the Fed’s confidence in the liquidity of the muni market.

The Fed’s change, which takes effect July 1, applies to Fed-supervised lenders subject to the liquidity coverage ratio requirement. Those bank holding companies will be able to include a limited slice of munis among the Treasuries, highly-rated corporate bonds and foreign-government debt they already count against their liquidity demands. The Fed will allow munis that “have a proven record as a reliable source of liquidity in repurchase or sales markets during a period of significant stress,” according to the text of the rule. Such munis can be part of a second tier of liquid assets, which can total no more than 40 percent of the overall liquidity buffer.

The phase-in period for the liquidity rule started in 2015 and it is set to go into full effect on Jan. 1. It’s also expected to be joined this year by a separate but related liquidity demand — known as the net stable funding ratio — that considers a longer stress horizon. Even under the pressure of rules and warnings from municipal lobbyists, banks have increased their muni holdings, which rose to almost $500 billion by the end of 2015, more than twice the levels the industry held at the end of the financial crisis.

SAN BERNARDINO PENSION BOND SETTLEMENT

Pension bonds have come in for lots of criticism as to whether or not they are a good tool for governments to use to deal with ballooning pension costs. Now there is another example of how they may not be such a good idea for investors either. Moody’s Investor Service said Monday that San Bernardino’s bankruptcy settlement agreement with two pension obligation bondholders reached last week is a “significant loss and credit negative” for the bondholders and other investors in local government debt.

San Bernardino declared bankruptcy in 2012. The settlement includes a 60 percent haircut for the creditors, cutting the city’s payments to pension bondholders by $45 million. The California city agreed to pay a total of $51 million over 30 years, beginning one year after the bankruptcy court approves the city’s plan of adjustment. Although up significantly from the city’s original 1 percent proposal, Moody’s said its own calculations determined the public obligation bondholders would actually recover less than 30 percent of their investment, not the 40 percent stated in the settlement. Commerzbank Finance & Covered Bond S.A. and Ambac Assurance Corporation are the creditors of the city’s roughly $100 million in pension obligation bonds.

STADIUM BONDS NOT JUST A MAJOR LEAGUE ISSUE

The New York Yankees and the Tampa Sports Authority announced plans Monday for a $40 million improvement project at Steinbrenner Field, the Yankees spring training facility. It would be financed equally among the State of Florida, Hillsborough County and the Yankees. The funding includes construction of new outfield concourses and gathering spots, improved access into the ballpark and additional improvements at the team’s minor league training complex nearby. The construction is expected to be complete by March 2017.

The Yankees will pay their portion of the construction through lease payments, which will run through 2046. Six teams have left Florida since 2003 to establish spring training homes in Arizona, making the Cactus League equal in size to the Grapefruit League. In response, the state passed a hotel tax that goes to fund new or renovated facilities. Exhibition games draw a greater percentage of out-of-town visitors than regular-season games in major league cities. So this may make more sense in support of the argument over whether these projects generate economic growth. The tax is paid by visitors, and that money is used to get a commitment from teams. The Yankees have already completed more than $6 million worth of renovations on the minor league and major league training facilities, including new batting cages.

Muni Credit News April 12, 2016

Joseph Krist

Municipal Credit Consultant

NEW PLAN FROM PR

On Monday, Puerto Rico said it had found a way to make debt payments of $1.85 billion a year, compared with the $1.7 billion a year it had offered before. The new restructuring plan covers $49.3 billion of Puerto Rico’s total debt, most of which is in the form of municipal bonds. The larger margin is a result of using projected government revenue for fiscal year 2021, instead of fiscal 2016, as the basis for the restructuring team’s 15% debt-service target as a percentage of annual revenue.

It calls for creditors to exchange existing bonds for two new classes of bonds. The offer is up from a previous offer of $26.5 billion. Puerto Rico has taken the position that all types of creditors must sacrifice, however. The new offer announced on Monday reflects that position. General obligation bonds held by investors who do not live on the island would get a recovery rate of 74 percent under the new proposal. Holders of sales-tax-backed bonds would get 57 percent; and holders of bonds issued by the Government Development Bank would get just 36 percent.

The first type would be a “base bond” with a total face value ranging from $32.6 billion to $37.4 billion, depending on whether bondholders in Puerto Rico opted in or took advantage of the special offer available to them alone. The new base bonds would start out paying 1.1 percent interest for the coming fiscal year. (Under Puerto Rico’s previous offer, interest payments would not have started until a year later.) The interest rate would then rise gradually to 5 percent in 2021, the same year principal repayments would start. Bondholders living in Puerto Rico would, however, have the chance to recover more of their initial investment if they were willing to wait. Instead of trading in their holdings for the regular base bonds, they could opt for “local holder base bonds,” which would have a value equal to the face amount of the bonds being handed over. The local holder base bonds would pay a fixed, 2 percent rate of interest over a longer period of time.

For investors not living in Puerto Rico, there would be only a chance of getting a full recovery. In addition to their base bonds, they would get a second type, called “capital appreciation bonds,” which would not offer any cash payments until after the base bonds had been fully repaid and it was clear how much of a loss each type of bondholder had suffered. The CABs would be repaid in full upon maturity as they accrete value — at 5% annually over a 49-year period under the commonwealth’s most recent offer. CABs would ensure creditors fully recover initial losses, only if they hold onto these until maturity.

The higher recovery rates and a debt instrument tailored for local bondholders are the major changes in the government’s revised debt-restructuring proposal, which was presented to creditors on March 23 before it was released publicly Monday. Negotiations between the commonwealth and its creditors are slated to continue this week. The commonwealth first proposed to creditors in January an exchange offer with two types of instruments: a mandatorily payable base bond; and a growth bond to be paid only if the island achieved economic recovery. Cuts to principal, or haircuts, hovered around 45%, and only $1.75 billion of government revenue would be available each year for debt service. This amount now increases to $1.85 billion, allowing the U.S. territory to offer more base bonds — and higher recovery rates — under the revised proposal. The larger margin is a result of using projected government revenue for fiscal year 2021, instead of fiscal 2016, as the basis for the restructuring team’s 15% debt-service target as a percentage of annual revenue.

Growth bonds would be replaced with capital appreciation bonds (CABs), which are repaid in full upon maturity as they accrete value — at 5% annually over a 49-year period under the commonwealth’s most recent offer. CABs would ensure creditors fully recover initial losses, only if they hold onto these until maturity. The commonwealth’s advisers believe this instrument will eventually become highly tradable as the island recovers its creditworthiness along the way.

Puerto Rico residents, who happen to mostly own the island’s less-secured debt, could now choose a par-for-par exchange, instead of taking discounted base bonds. These par bonds would mean a longer maturity for local bondholders, while receiving 2% interest payments for more than 50 years beginning in January 2017. Under the new offer, the amount of base bonds could reach as much as $27.8 billion, depending on the participation of Puerto Rico residents on the local instrument, while roughly $1.75 billion in CABs and up to $8 billion in local holder bonds would also be issued. While seeking a leveled debt-service schedule, the commonwealth’s most recent offer would translate into a longer debt-repayment calendar. No principal payments until fiscal 2021 are still contemplated, but interest payments would now be paid current, scaling up until reaching 5% annually by fiscal 2021. The local bond option would always be paid a 2% annual interest during its life.

Proposed haircuts include about 16% for commonwealth-guaranteed debt, including general obligations (GOs), and 43% for Sales Tax Financing Corp. (Cofina) bonds. Less-secured paper, such as the Highways & Transportation Authority and the GDB’s, could see cuts to principal of 44% and 64%, respectively, while other credits end up in the 50% range. If the commonwealth fails to obtain a legal mechanism by which to bind holdouts or if the federal government significantly reduces financial support to the island, the terms of the exchange offer would have to be revised, which could mean larger haircuts for creditors.

At least three different creditor groups have countered with their own offers. These include constitutionally guaranteed GOs; sales tax-backed, lockbox-structured Cofina; and a group of local cooperatives and credit unions that mostly own less-secured paper.

For the administration, the creditors’ proposed fixes fell short, often solving only part of the problem and placing an unfair burden on less-protected credits. None of the counteroffers would deal with the government bank’s debt woes. None would contemplate cuts to principal.

So far, creditors have sought more government revenue dedicated to debt service, less impairment and higher recoveries. Commonwealth advisers recognize there is a tug of war over the administration’s 15% target of annual government revenues destined to debt service, and has said the idea is to make it the least painful possible to creditors.

PREPA

The passage of the debt moratorium legislation has created much uncertainty as to its impact on the existing agreement framework for a restructuring of Puerto Rico electric Power Authority’s outstanding debt. In a report issued late Friday, Moody’s weighed in with its opinion. “The moratorium law could also create complications for negotiations between the Puerto Rico Electric Power Authority (PREPA – Caa3/negative) and its lenders, which have been underway for 18 months and appear to be approaching a resolution. The law encompasses the commonwealth’s numerous debt-issuing entities including PREPA and gives Puerto Rico’s governor the power to invoke a state of emergency with respect to PREPA (or any other government agency), thereby beginning a moratorium. However, the law does not include the PREPA Revitalization Corp., the special purpose vehicle that is expected to issue securitization bonds to complete the restructuring of PREPA’s $9 billion of debt. We continue to believe that PREPA and its creditors are working constructively toward a consensual agreement.”

The next turn in the PREPA restructuring process will come when the utility will obtain a ruling on its securitization charges within the next 87 days, followed by a validation process. In parallel, PREPA’s restructuring team will be making its case before the credit rating agencies, which will ultimately decide if the new securitization bonds are worthy of investment grade.

AND IN CONGRESS

The House Natural Resources Committee had been expected to release a revised version of its Puerto Rico bill early this week, including a modification designed to avoid a constitutional challenge if the legislation is enacted. Some have warned the bill would violate the Uniformity Clause of the U.S. Constitution. That clause, in Article 1, Section 8, says, “Congress shall have power … to establish … uniform laws on the subject of bankruptcies throughout the United States.”

The bill would be revised to permit the other four U.S. territories, should their financial situations plummet, to opt into its provisions. The territory’s Governors would have to sign them. As a result, Guam, the U.S. Virgin Islands, America Samoa, and the Northern Mariana Islands could opt for the creation of an oversight board that would have the sole ability to file a petition for debt restructuring.

Under the bill, debtors could not have a proposed financial control board file a petition for restructuring on their behalf until they have released their most recent audited financial report and engaged in voluntary debt restructuring discussions with creditors. The bill borrows from Chapter 9 of the U.S. Bankruptcy Code but explicitly avoids amending that statute and instead uses the Territorial Clause of the Constitution as the basis for its debt restructuring provisions. The other territories don’t want to be in the measure.