Joseph Krist

Municipal Credit Consultant

PR FINALLY RELEASES DRAFT AUDIT FOR FY 14

The long-awaited release of a draft of the Commonwealth of PR’s FY 2014 financial statements has finally occurred. Before a recitation of the numbers, this language is important. “The Commonwealth is currently experiencing a severe fiscal and liquidity crisis. The Commonwealth and its instrumentalities face a number of fiscal and economic challenges that, either individually or in the aggregate, could adversely affect their ability to pay debt service and other obligations when due. The Commonwealth is currently considering a number of emergency measures that could affect the rights of creditors. Recipients of the Draft should be advised that to the extent that the Commonwealth or any entities related to the Commonwealth are unable to materially improve their financial position in the immediate future, such entities and/or the Commonwealth may need to seek relief under existing or potential future laws regarding receivership, insolvency, reorganization, moratorium and/or similar laws affecting creditors’ rights, to the extent available, and may resort to other emergency measures including nonpayment of debt obligations.”

Nothing new or unexpected in terms of the language or the numbers. The Commonwealth’s net deficit position increased $47.48 billion at June 30, 2013 to $50.06 billion at June 30, 2014, an increase of $2.58 billion. The increase is the result of higher operating expenses than operating revenues and an increase in the Commonwealth liabilities, such as bonds and notes, net pension obligations, legal claims and compensated absences, among others. Approximately 57.39% of Governmental Activities’ revenue (including transfers) came from taxes, while approximately 35.69% resulted from grants and contributions (primarily federal financial assistance). Charges for services represented approximately 3.62% of total revenue. The largest expenses were for general government, education, public housing and welfare, health and public safety. In fiscal year 2014, Governmental Activities’ expenses, which amounted to $20.70 billion were funded by $10.78 billion in general revenues, $7.12 billion in program revenues and transfers of $214 million from Business-Type Activities.

So there it is without a surprise in the lot.

PR STILL NOT SERIOUS ABOUT PREPA

When the PR restructuring saga began, it was clear that the path to resolution would be fraught with many artificial hurdles based on the island’s strained political environment. A tradition of populist policies that resulted in artificially low taxes and charges for services was clearly going to be the largest hurdle. We saw more evidence of that this week when the PR House passed the Puerto Rico Electric Power Authority Revitalization Bill (Senate Bill 1523 ) with 26 votes in favor and 22 against. The bill  must now return to the Senate so senators can concur with the House amendments to the legislation.

The process was as untidy as expected. Two members asked to abstain from the vote because they are PREPA employees. The NPP delegation announced it was going to submit a written explanation of its vote against the bill. Members of the Irrigation & Electrical Workers Union (Utier by its Spanish acronym) protested the bill. Some began to shout their discontent from the House galleys after the bill was passed. The bill does not guarantee workers rights.

The bill would create a separate corporation, the PREPA Revitalization Corp., that will issue new bonds that will be exchanged for the PREPA bonds that are currently on the market through a new securitization that will also be used to finance the $2.4 billion Aguirre liquefied gas facility. It will restructure PREPA’s board, create a new structure of contribution in lieu of taxes with cities and promote an increase in the utility rates through the Energy Commission. The restructuring will be financed through a so-called transition charge to consumers. As part of the deal, bondholders are expected to accept a 15% haircut on their investment.

PDP Rep. Javier Aponte Dalmau expressed misgivings about the bill and wanted the vote on the bill to be postponed, insisting that bondholders and PREPA should negotiate further cuts to the utility’s $9 billion debt. He believes that the 15% cut was insufficient. He said his vote on the bill was conditioned to the amendments introduced to the bill. “I am proposing language in the bill stating that the 15% cut is the minimum amount in the cut. I don’t want us to limit ourselves…. If that does not happen, then I have to see which amendments are introduced in the bill so I can determine how am I going to vote,” Aponte Dalmau said. The amendment Aponte Dalmau requested, however, was accepted by the majority late Monday and he announced he would vote in favor of the bill.

The action comes on the heels of a PR Senate investigation into irregularities in PREPA’s fuel purchases that officials say cost millions for customers. The legislation calls for a separate office to handle the purchases. For years, it is alleged that authority bought cheap, residual oil that failed to meet federal clean-air standards, and faked tests to make it look like it had passed. Ledgers were falsified too to make it appear as though the authority had actually bought the higher-grade oil, which cost more. The higher price was then passed on to consumers. In the 1990s, the Environmental Protection Agency found that the oil being burned did  contain unacceptable levels of sulfur. If true, the accusations would go beyond errors in judgment and amount to a decades-long fraud.

During her speech in the House opposing the bill, one House member complained that the restructuring support agreement between PREPA and the bondholders was not included in the bill that enables it. “If this bill validates the agreement, why it is not in the bill? She alerted the public to the fact that the wording in the restructuring support agreement (RSA) and the wording of the bill were not the same. The RSA, she said, put consumers on the hook if the corporation or PREPA failed to pay the debt. “It appears that the debt here is not divided among everyone but that the customers are responsible for it together with PREPA,” she said.

An amendment was introduced in the bill that made it clear that PREPA’s clients could not be held liable for the debt. Another amendment introduced by the House made it easier for consumers to challenge the amount in their utility bills. It was then asked of the bill’s sponsor, if the legislation was eliminating customers as “obligors” of the debt. He did not answer the question.

During his speech on the floor, Aponte Dalmau noted that two years ago he had proposed the creation of a separate corporation for PREPA but was called “crazy.” He was referring to a bill he introduced in 2013 that would have replaced PREPA with a new entity, end the utility’s monopoly in the area of power generation and create separate entities to purchase fuel and set consumer power rates. He did so at the time to help make the utility more efficient. The utility ended up paying Alix Partners nearly $30 million to come up with the idea of creating a separate corporation to handle the securitization of PREPA’s bonds. The new corporation will not be able to incur new debt. “This new corporation will securitize the debt but the only project it can finance is the Aguirre one,” he said.

MD TO TRY ANOTHER CONFERENCE CENTER/HOTEL DEAL

In spite of a very checkered history for such projects being successfully financed in  the muni market, a Maryland community wants to try to tax-exempt finance a conference center/hotel project. These projects are seen by many suburban entities as a way to jumpstart local downtown development. Yet suburbs in New Jersey, Illinois, and Maryland previously have previously seen those projects fail to pan out.

Frederick County, MD lawmakers hope to move through the state General Assembly session as a delegation divided — at least on two issues: a downtown hotel project and a hotel tax. A bill authorizing $19.8 million of Maryland Stadium Authority bond funding to help support a proposed downtown Frederick hotel and conference center project failed to get majority support from the County delegation. The bill was nonetheless introduced in the House of Delegates on Friday. It outlines how Maryland Stadium Authority funding will move forward, if approved by the General Assembly. The bond bill represents the largest piece of public funding for the conference center, which is now projected to cost about $69.8 million.

About $44 million of that cost will be paid by the hotel’s developer, Plamondon Hospitality Partners. The rest would be a combination of city, county and state funding. The budget includes $14.8 million in bond funding from the Stadium Authority, but the bill is written to include a figure the Maryland Stadium Authority believes could be paid back through revenue generated by the project. In July, a Stadium Authority report concluded that the state could leverage up to $17.8 million in bonds that would be paid off, including interest, through the project’s revenue in 20 years. This week, that number was increased to $19.8 million, the figure included in the filed bill.

The bill outlines what would happen if the project fails to be in line with the projected budget if there are cost overruns. Those would be assigned to the city, which intends to pass along such costs and responsibilities to the developer in separate legal agreements. If the project comes in under budget, rebates would be returned to the city and county. The city of Frederick will buy the land for the hotel and conference center, and the city and Stadium Authority would each own half of the leasehold interest for the property.

Income from an increase in the County hotel tax was included as part of a funding plan for the downtown hotel and conference center, but Republican members of the County delegation voted to introduce a bill to cap the tax at its current rate of 3 percent. Those members said it would be unfair to pass a tax on to customers of other hotels to help finance the construction of a competitor. County leaders said the bill interferes with local authority to set the rate, and other revenue increases from a proposed 5 percent rate would have helped fund other tourism programs. The county collected about $1.3 million in hotel taxes last year. An increase to a 5 percent rate would increase revenue to about $2 million.

The proposed hotel and conference center will continue to face obstacles, aside from the General Assembly bill. After the session, a financing plan must be approved by the state Board of Public Works before bonds can be issued, and other legal requirements, like approval from the city’s Historic Preservation Commission, must also be met. County Executive Jan Gardner said county government would also continue to support the project.

CBO ADVOCATES TOLLING MORE INTERSTATE HIGHWAYS

From time to time, advocates for direct user financing schemes for highway expansion and development bring up the idea of imposing tolls on many currently untolled sections of the Interstate Highway System. Recent experience has shown that the introduction of tolls on those roads as well as on existing toll roads can be a political minefield. The most recent effort was in Pennsylvania where the tolling of Interstate 80 was proposed. That effort was concurrent with the enactment of a plan to use higher Pennsylvania Turnpike tolls to generate revenues for statewide road expansion.

Now the Congressional Budget Office (CBO) has weighed in on the subject through a recently released report. The report states that ” more widespread charging for the use of roads could increase economic output by giving drivers a financial incentive to switch to other roads and discouraging some travel and reducing congestion. Highly valued freight would thus move more quickly and more reliably, reducing delivery costs for producers as well as inventory costs for retailers, thereby freeing up resources to accommodate additional demand by consumers or allow for additional investment by businesses.

Similarly, shorter commutes could translate to a boost in the supply of labor in the economy by allowing workers to spend more time on the job or encouraging some people to take a job at a more distant location. Charging for the use of roads could allow for more travel overall by reducing congestion, which occurs in many urban areas during peak periods. That counterintuitive effect occurs because user fees, by diverting even a relatively small number of users to other roads or to another time of day on the same road, can cause speeds to rise sharply, increasing the total number of vehicles that can pass through a bottleneck during peak periods.1 In addition, charging drivers would raise revenues, which could be used to make repairs, expand capacity, substantially renovate the Interstate System, or pursue other purposes.”

While they make an excellent argument, it goes awry with the last three words of the excerpt from the report – pursue other purposes. This is where toll proposals go off the rails. Look at the bad reaction to a similar scheme for the PA Turnpike whereby toll revenues for that road were to be raised for other highway purposes throughout the state. It lead to lower usage, more frequent toll increases, higher bond and debt service requirements and an overall degradation of the credit. That is just one example for  tolling opponents to point to.

2015 RATINGS TRENDS

Standard & Poor’s made nearly twice the number of upgrades as downgrades in United States Public Finance in 2015, the fourth consecutive year and the 13th consecutive quarter that S&P’s upgrades outnumbered its downgrades in the sector. Every subsector except higher education and charter schools saw more upgrades than downgrades. S&P downgraded 69 higher education ratings and upgraded 29 in that group. It downgraded 25 and upgraded nine charter school ratings.

Unsurprisingly, Puerto Rico and other organizations in the commonwealth accounted for more downgrades – 115, including four defaults – and more multiple notch downgrades than any other entity. These were 7% of all of S&P’s U.S. public finance rating changes in the year. The upgrade of California to AA-minus from A-plus in July affected 97 ratings. Improved issuer finances were the primary reason for upgrades outnumbering downgrades. At the same time, S&P’s rated issuers had 12 defaults in 2015, the third highest since 1986.

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

Joseph Krist

Municipal Credit Consultant

WHAT’S UP AT WMATA?

Nearly one year ago, Moody’s downgraded debt of the Washington Metropolitan Area Transit Authority to A1 as the result of the Authority’s use of short-term debt as a tool to bridge restrictions on its receipt of federal funds. These restrictions were the result of findings from a Federal Transit Administration (FTA) audit of the Authority’s grant’s management process. The slow receipt of grants through the FTA has constrained WMATA’s liquidity and led it to draw fully on its lines of credit and enter into private financings to maintain capital spending. WMATA’s short-term debt is now in excess of its low level of long-term debt.

Since the downgrade, the Authority has continued to face declining farebox revenue coupled along with increased maintenance and upgrade expenses. While the downgrade has caused some bondholder concerns, a more recent move by the operator of the capital city’s Metrorail and Metrobus systems, along with MetroAccess paratransit has raised some more serious red flags. It has come to light that WMATA has hired leading bankruptcy lawyer Kevyn D. Orr to advise the agency on getting its finances in order. Mr. Orr comes to the Authority after stints managing Detroit’s bankruptcy and advising Atlantic City as it considered bankruptcy.

Among the options Orr could advise WMATA taking are to restructure its debt, not agree to any wage or benefit increases in this year’s contract negotiations with its labor unions, and try to get more money out of its member jurisdictions. Unlike most U.S. transit systems that enjoy dedicated funding from the Highway Trust Fund’s Mass Transit Account, WMATA relies on annual appropriations from Congress and its member jurisdictions: the District of Columbia, State of Maryland, Commonwealth of Virginia and the Maryland and Virginia counties it serves.

As muni participants who went through the Detroit bankruptcy saga know, Orr is the partner in charge of the Jones Day law firm’s Washington office. Under a contract worth up-to-$1.74 million, he will serve as “part-time strategic executive adviser” to WMATA’s newly-installed General Manager, Paul J. Wiedefeld, according to WMATA officials cited by The Washington Post.

WMATA’s major problem is reflected in its budget for fiscal year 2017 (starting July 1, 2016). Its operating budget is $1.7 billion, $1.2 billion of which is employee pay and benefits. Contracts with each of three unions expire June 30, and negotiations are expected to begin soon. WMATA officials say that management has little latitude to implement financial reforms. So it hopes to use Orr in a role of talking to officials and organizations that interact with the commuter system.

Bondholders should be concerned that the system plans to spend $1.3 billion on capital improvements in fiscal 2017, for which it is relying heavily on federal grants — money that may not be coming after an audit report revealed the agency’s extensive mishandling of such funds for years.

As an offset for delays in federal grants, WMATA has relied on short-term borrowing, amassing a debt of around $500 million with costly interest payments. Officials hope Orr will convince the jurisdictions served by WMATA to increase their funding levels. Orr was said to be on a “short list” to be WMATA’s General Manager after the January 2014 retirement of Richard Sarles, but said he was more interested in practicing law.

Metrorail ridership has been trending downward since 2010 since reductions in federal employees’ transit benefits (federal workers make up an overwhelming portion of Metro’s weekday riders), while its member jurisdictions are reluctant to increase their contributions in light of several highly publicized incidents and safety lapses in the subway system.

CONGRESS TRIES AGAIN ON INFORMATION FROM PR

The chair of the U.S. Senate Finance Committee, Sen. Orrin Hatch (R., Utah), sent on Wednesday a letter to Gov. Alejandro García Padilla, asking for a host of information to be delivered no later than March 1. Se. Hatch  is seeking information that would “prove useful” in how Congress would deal with the Puerto Rico issue. “Unfortunately, it has been challenging to acquire recent verifiable financial information about Puerto Rico’s financial condition,” Hatch wrote.

As a result, the senator is calling for the delivery of the commonwealth’s audited financial statements for fiscal year 2014, which were due last May but have yet to be delivered by the García Padilla administration. Officials have pointed to a number of reasons for the delay, and a draft of the statements is expected to be made public this week.

During a hearing to discuss the federal budget on Wednesday, featuring U.S. Treasury Secretary Jacob Lew as witness, Hatch suggested that GOP members in the Senate have already worked on legislation for the commonwealth that could be introduced as soon as March. Along with two other Republican senators, Hatch presented last year a bill that sought to implement a federal fiscal control board on the island, although without access to a debt-restructuring or funds to provide short-term liquidity assistance to Puerto Rico.

Meanwhile, in his letter to the governor, Hatch also requests detailed information on Puerto Rico’s debt and wants to know García Padilla’s position on whether general obligations (GOs) have repayment priority according to the commonwealth’s Constitution. Hatch is particularly interested in the island’s severely underfunded main pension systems.

Hatch is also questioning the expenditure side of the island’s fiscal equation. Specifically, he asks about the spending-control measures that have been implemented, and how much the Puerto Rico government has paid during the past five years in such areas as healthcare, public housing, welfare and education. Hatch is also following up on the U.S. Treasury’s technical assistance and how exactly it has been provided.

At some point Puerto Rico will realize that financial disclosure must occur. The inability or, in our view, unwillingness to provide decent ongoing financial data would be comical were it not for the overwhelming need for the data. We look forward to next week’s draft financial report.

PREPA LEGISLATION MOVES FORWARD

Puerto Rico’s Senate approved legislation that would enable the island’s main electricity provider to restructure almost $9 billion of debt. The upper chamber passed the bill in a 16 to 10 vote. The measure now moves to the House. The debt reduction agreement between the Puerto Rico Electric Power Authority and its creditors is due to expire Feb. 16 unless lawmakers pass the legislation. Two deadlines have already been missed.

DETROIT WATER RATINGS SURFACE

With so much negative attention being focused on the City of Flint’s water catastrophe, it has been easy to lose sight of the improvement in its new old water supplier, the Detroit regional water utility. That improvement was highlighted this week when Moody’s upgraded the rating of the new Great Lakes Water Authority (GLWA). The upgrade of the senior lien and second lien water revenue ratings to Baa1 and Baa2, respectively, reflects the GLWA’s assumption, in full, of all debt previously secured by net revenue of the DWSD. While DWSD retains ownership of both the City of Detroit (local) and suburban (regional) water system, it has executed a lease agreement with the GLWA whereby the GLWA will assume full responsibility of regional system operations. The GLWA is also granted sole ownership interest in revenue generated by the combined regional and local system.

This is seen as significantly limiting the risk that a future bankruptcy filing by the City of Detroit or intensified fiscal pressure on the city in general would contribute to bondholder impairment with respect to the water revenue debt. The across the board investment grade ratings vindicate the view of this newsletter that holders of Detroit Water and Sewer debt would be well served through the bankruptcy process by holding on to their debt.

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

Joseph Krist

Municipal Credit Consultant

PUERTO RICO PROPOSES RESTRUCTURING

The Working Group for the Fiscal and Economic Recovery of Puerto Rico released details of a comprehensive voluntary exchange proposal presented to advisors to the Commonwealth’s creditors last week. The proposal seeks to reduce the Commonwealth’s mandatorily payable tax-supported debt and near term debt payments. The implementation of the expense and revenue measures in the FEGP – totaling approximately $20.6 billion in revenue increases and $13.8 billion in expenditure reductions over the next ten years – are projected to reduce the Commonwealth’s projected cumulative fiscal deficit for the next decade to approximately $34.0 billion.

A voluntary exchange offer is intended to restructure more than $33 billion of payments due over the next ten years on its tax supported debt to allow the Commonwealth make its tax-supported debt sustainable. The plan provides for the Commonwealth to institute a fiscal control board to provide necessary oversight and ensure the Commonwealth complies with the FEGP and the terms of the exchange offer.

The restructuring proposal contemplates that creditors will exchange their existing securities for two new securities: a “Base Bond,” with a fixed rate of interest and amortization schedule, and a “Growth Bond,” which is payable only if the Commonwealth’s revenues exceed certain levels. The new securities would also provide creditors with enhanced credit protections, such as a Commonwealth Guarantee and statutory liens and pledges with respect to certain revenues. Enhanced credit support would include a statutory lien on and pledge of the 4.5% sales and use tax (“SUT”) and up to approximately $325 million annually of petroleum products tax revenues.

Under this proposal, the $49.2 billion of tax-supported debt would be exchanged into $26.5 billion of newly issued mandatorily payable Base Bonds (a 46% haircut) and $22.7 billion of newly issued Growth Bonds. Interest payments on the Base Bonds would begin in January 2018, scaling up to 5% per annum by FY 2021, when principal payments would begin.

The Growth Bonds would be payable only to the extent the Commonwealth’s revenues exceed its current baseline projections as a result of real economic growth on the Island. The first such payments, if any, would be made beginning in the tenth year after the close of the exchange offer. In any given year in which the Growth Bond would be payable, creditors would receive payment of up to 25% of such revenues. The proposal also seeks to lower the Commonwealth’s debt service-to-revenue on tax-supported debt to approximately 15%, a level consistent with the debt limit contemplated by the Commonwealth constitution. At 15%, Puerto Rico would still remain at levels exceeding the most heavily indebted of the U.S. states. Debt service on the Base Bonds has been structured to give the Commonwealth the opportunity to further reduce that ratio as a result of economic growth and develop into a stronger credit over time. A successful exchange offer, along with the implementation of the measures recommended in the FEGP, should improve the Commonwealth’s credit-worthiness, and, if the Commonwealth’s economy is able to grow in line with the growth assumed for the United States, investors will be able to recover the full principal amount of their investments through payments on the Growth Bonds.

The exchange offer is predicated upon a number of key assumptions, including very high participation levels from the creditor groups as well as the U.S. Federal Government maintaining at least its current percentage levels of programmatic support for the Commonwealth. If very high participation levels cannot be achieved or the U.S. Federal Government allows the level of programmatic support for Puerto Rico to materially decline, then the terms of the exchange offer will have to be revisited and creditor recoveries adjusted accordingly.

A serious proposal would accept the need for outside oversight. It can be argued that the Commonwealth has forfeited the trust of its various stakeholders to oversee its own recovery. The continuing lack of audits, reliable ongoing revenue collection reporting, and the lack of urgency with which these matters have been addressed all convey a serious lack of purpose. The risks to bondholders are basic and clear. Primary among them is that the plan assumes that the Commonwealth can reverse years of negative economic growth in the face of steady declines in population especially among the more educated and skilled segments of the population.

The effective five year moratorium in principal repayment is in line with the Commonwealth’s attempt to pose the situation as an us vs. them (as in the hedge fund investors) situation which has always been a convenient oversimplification of the situation. The size of the proposed haircut and the economic risk sharing aspects of the proposal are in line with an effort to align the various interest groups behind a Congressional bailout.

The plan continues the strategy of delay which the Commonwealth has been employing as it seeks a federal solution. It comes on the heels of a failure by island politicians to approve a PREPA restructuring which might require power users to actually pay for power. At the same time, the proposed interest rates contemplated in the tax-backed restructuring seem quite unrealistic in the face of the yields being demanded by the market for the Chicago Public Schools deal postponed from last week. Hence our view that this current proposal is preliminary at best and a mere stalling tactic for the Commonwealth.

CONGRESSIONAL ALLIES MAKE MOVES ON PUERTO RICO

At the same time Puerto Rico is offering its debt restructuring proposal, Sen. Elizabeth Warren, D-Mass., filed an amendment to an energy bill pending before the Senate to include a provision that would temporarily halt litigation over Puerto Rico debt until April 1. If the amendment is passed as part of the energy bill, it would put a stay on any creditor litigation filed on or after Dec. 18. Warren’s effort to include the amendment has support from Sens. Blumenthal, Schumer, and Menendez, co-sponsors of the legislation, as well as Sens. Kirsten Gillibrand, D-N.Y., Chris Murphy, D-Conn., and Bill Nelson, D-Fla.

The amendment asserts that as Puerto Rico continues to deal with roughly $70 billion in debt, “a temporary stay on litigation is essential to facilitate an orderly process for stabilizing, evaluating, and comprehensively resolving the commonwealth’s fiscal crisis.” A stay would avoid a disorderly race to the courthouse, benefitting creditors and other stakeholders, and will only be temporary, according to the proposal.

The April 1 deadline for the stay happens to line up with a late December directive House Speaker Paul Ryan, R-Wis., gave to House committees with jurisdiction over Puerto Rico to create a “responsible solution” for the commonwealth by the end of March. Assured Guaranty Ltd., Ambac Financial Group Inc., and Financial Guaranty Insurance Co. have all filed lawsuits in January, during the time period that would be covered by the moratorium. A judge has consolidated the insurers’ cases in the U.S. District Court for the District of Puerto Rico.

The House Natural Resources Committee held a hearing this week that may lead to legislation designed to aid Puerto Rico. Pedro Pierluisi, Puerto Rico’s sole representative in Congress and a member of the committee said he supports creating an independent board to approve things like Puerto Rico’s long-term financial plan, annual budgets, and effort to publish accurate and timely financial information. But he warned that “if the forthcoming bill seeks to extinguish rather than enhance” Puerto Rico’s democracy at the local level, he “will do everything in [his] power to defeat it.”

The question of extending Chapter 9 protections to the commonwealth’s public authorities has even less of a consensus. The argument against a Chapter 9 bankruptcy solution is that it would not force the commonwealth to take steps toward reforming its operating, accounting, and other financial reporting systems. Those who hold this view (such as we do) think that Puerto Rico should be allowed to restructure its debt only after it agrees to real lasting reforms of these practices and the assent of the majority of bondholders supporting the restructuring proposal.

In the meantime, PR House Bill 2786 would create a new, independent corporation whose only task would be to serve as a vehicle for PRASA to achieve financing at reasonable terms. It is based on the legislation that would provide for the restructuring of the Puerto Rico Electric Power Authority (PREPA), as agreed with a majority of its creditors. One difference is based in the fact that “PRASA has already a gross pledge whereby revenues go directly to the trustee, who pays first [PRASA] bondholders and then what is left is given to the utility. In this sense, PRASA does not have the same leverage to bring its bondholders to the table with the argument, ‘I won’t pay you.’” The head of PRASA has asserted that [PRASA has] repayment capacity for about $700 million, at a 10% [interest rate], but there is no access.”

Of continuing concern is the sentiment expressed against rate hikes. PRASA head Lázaro said that in the event of a rate hike, he explained the size would depend on the sacrifices the utility is willing to make when discussing the issue, but that it could be as much as $10 monthly. Lazaro said “I’m the last person who wants to increase the water rate. With House Bill 2786, “we are seeking to give certainty, mitigate the [financing] transaction’s risk and avoid a rate hike,” said Rep. Rafael Hernández, co-author of the measure and chair of the House Treasury Committee.

PRASA’s last water-rate hike back in 2013 was projected to cover all operational costs from its revenue, debt service until fiscal year 2018, and projected deficits during fiscal 2016 and 2017. But it also intended to pay for its capital improvement projects with external financing, and not with the utility’s revenues. What’s more, to pay roughly $90 million in short-term debt maturing on Feb. 29, PRASA would siphon its Rate Stabilization Fund — monies that were supposed to be used to cover projected deficits during fiscal 2016 and 2017.

CHICAGO PUBLIC SCHOOL ISSUE DELAYED AS INVESTORS RAISE QUESTIONS

The Chicago Public Schools yielded to investor uncertainty when it delayed its planned $875 million general obligation bond sale by moving it to the day-to-day calendar. The district’s finance officials said the decision was made to give investors more time to digest the deal and the underwriting syndicate time to make final structure revisions. The action followed  the General Assembly’s GOP minority leadership announcement of legislation backed by Gov. Bruce Rauner to put the district under state oversight and put it on a possible path to bankruptcy. The Board has obtained an opinion that its pledged revenues securing the planned bonds are special revenues for purposes of bankruptcy. We see that as being less than definitive.

The less than helpful comments from Springfield led to a pre-marketing wire offering spreads of more than 500 basis points to the Municipal Market Data’s top-rated benchmark. The 25-year and final 28-year maturities were offering a preliminary yield of 7.75%, 506 basis points and 502 basis points, respectively, over MMD’s AAA. Both were more than 400 basis points over a triple-B credit. The preliminary price on the taxable, 17-year maturity offered a yield of 9.75% with a coupon of 9.50%.

Chicago’s chief financial officer, Carole Brown, and CPS finance chief Ronald DeNard said that it had sufficient order interest to place with buyers at pre-marketing pricing levels distributed Tuesday. CPS bonds had been trading at a 350 to 375 basis point spread before the announcement. The district’s $300 million sale last spring saw a top yield of 5.63% on a 25-year maturity that was 285 basis points over top-rated MMD.

OLD HABITS DIE HARD

Two years ago, the use of Capital Appreciation Bonds by school districts in California for new construction led State lawmakers to pass AB 182 at the urging of then-State Treasurer Bill Lockyer after it came to light that many school districts had issued non-callable capital appreciation bonds with 40-year maturities and nominal interest-to-principal repayment ratios of 10-to-1 or even 20-to-1. The public relations poster child for the controversy was Poway Unified School District’s $105 million series, issued without a call option and requiring $1 billion of debt service through its 40-year maturity.

Initially the legislation and public uproar caused school CAB issuance to drop to $292 million of CABs in 2014. Once the concern died down, issuance of capital appreciation bonds by California school and community college districts more than tripled from 2014 to 2015. It was the highest level of school CAB issuance since 2009, according to CDIAC data. K-12 school districts conducted 46 CAB sales in 2015 totaling $691 million, compared to $250 million the prior year. The state’s community colleges executed eight CAB sales last year totaling $307 million, up from $42 million in 2014.

The legislation sought to limit CAB issuance by K-12 and community college districts, by requiring ratios of total debt service to principal for each series not exceed 4-to-1, and that bond issues include a 10-year call option. Permitted maximum interest rates were cut to 8% from 12%. Now that the negative uproar has subsided, K-12 school districts conducted 46 CAB sales in 2015 totaling $691 million, compared to $250 million the prior year. The state’s community colleges executed eight CAB sales last year totaling $307 million, up from $42 million in 2014. The increase occurred in the face of comments from some financial advisors and district officials, who have said that districts have been steering away from the structure after the wave of criticism that resulted in AB 182’s passage.

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

Joseph Krist

Municipal Credit Consultant

PREPA TALKS CRASH

It was supposed to be a model for the overall restructuring of all of the Commonwealth of Puerto Rico’s debt. Whether that was actually going to be the case was the subject of debate. Right now, the model lies in pieces – crushed by the weight of pride, impracticality, intransigence, and irresponsible politics. So it seems as it was announced that negotiations to restructure roughly $9 billion of the debt of Puerto Rico’s power company collapsed late Friday, according to a statement from a group of creditors involved in the talks.

“Today the PREPA Bondholder Group put forward an offer to extend the RSA until February 12^th in order to give the Puerto Rican legislature more time to pass the PREPA Revitalization Act. Based on our direct and positive conversations with Puerto Rican lawmakers, we are optimistic that the bill will be passed and it was our desire to be as supportive of the legislative process as possible. In addition, we also offered to extend our Bond Purchase Agreement (“BPA”) with PREPA, under which RSA creditors would provide $115 million in additional financing once the energy commission approves the securitization charge, with a deadline of May 23^rd. This amendment to the BPA reflects a milestone that was previously agreed upon, and was included in order to help ensure the deal would get done – as the energy commission approval is a vital element of the agreement.

“Unfortunately, PREPA is choosing not to extend the RSA. Over the approximately 18 months that we have been negotiating this plan it has consistently been our desire to reach a fair, collaborative agreement that would benefit all stakeholders, including the people of Puerto Rico. The plan has been described as fair to all parties and beneficial to Puerto Rico – not only by key legislative leaders but by other decision-makers in the Commonwealth. This is why we were willing to offer these further concessions, recognizing the complexities of the legislative process. While it is extremely disappointing and perplexing that PREPA has chosen to take this stance, we continue to remain open to reaching a deal with PREPA and it is our sincere hope that they reconsider their position and assume postures beneficial to the people of Puerto Rico.”

The statement did not say whether the creditors would now declare PREPA in default. If they did so it would be by far the largest and most momentous default in Puerto Rico’s growing debt crisis. PREPA has a debt payment of about $400 million due to bondholders on July 1. It also owes about $700 million to two financial institutions that help to finance fuel purchases.

It is said that PREPA was still willing to keep the negotiations going and that the talks broke down because the creditors attempted to impose a new requirement in exchange for granting more time. Before the deal could proceed, the Puerto Rico legislature had to approve it, and some lawmakers argued that PREPA and its creditors were rushing to close the deal before the island’s new public utility commission had a chance to properly review it. This is the second “deadline” missed by the legislature. The creditors had expected the legislature to approve the deal in a special session in December. When that did not happen, they said they would wait until Jan. 22, and they offered $115 million to help finance PREPA while the legislature considered an enabling bill.

It is rumored that the creditors were willing to wait until February, but the new public utility commission was more likely to need until May. The debt exchange would have required PREPA’S first increase in its base rate for power since 1989. The public utility commission is so new it has never been through a rate-setting process before. In the meantime, the Commonwealth clings to its strategy of running out the clock in the hope that the U.S. Congress can be persuaded to bail out the Commonwealth.

ATLANTIC CITY FACING TAKEOVER

The recent troubles of Flint, MI have cast a negative light on the concept of state “takeovers” of the financial operations of municipalities. The well known troubles in Flint resulted in the reinstatement of local control by the State. The usually poor reception given to outside managers has been a factor in the length of time given to Atlantic City, NJ to resolve its own deep financial troubles. As we have previously documented, a long term trend of decline and consolidation in the City’s economic engine – gambling – has resulted in a serious financial bind. The City has toyed with bankruptcy in an effort to undo contracts with Civil Service unions and to renegotiate tens of millions of dollars in tax refunds.

For the City’s creditors, the presidential race may have driven the State – or more precisely, Governor Chris Christie – to intervene in the City’s finances one week after Christie vetoed an aid package for the city, and his spokesman issued a statement denouncing local leaders for being fiscally irresponsible. “Atlantic City government has been given over five years and two city administrations to deal with its structural budget issues and excessive spending; it has not,” the statement said. “The governor is not going to ask the taxpayers to continue to be enablers in this waste and abuse.” The Council and the mayor had been scheduled to hold an emergency meeting this week to discuss a court filing under Chapter 9 of the federal bankruptcy code. In New Jersey, cities must seek approval from the state’s Local Finance Board to file for bankruptcy.

The reality is that with the Iowa caucus coming up next week, the city’s falling into bankruptcy would have proved deeply embarrassing for Mr. Christie who has sought to present himself in the race as a responsible executive, tested by crises and capable of extracting major compromises from Democratic adversaries. The timing of the announcement is reflected in the fact that the legislation still needs to be drafted and passed by the Legislature and signed by Mr. Christie. As planned , it would give the state the authority to act on the city’s behalf for five years, including the right to negotiate, amend and terminate all labor agreements for the city.

The City government, which opposes a state “takeover” faces daunting challenges. Casino revenue has fallen by half since 2006, to $2.56 billion last year from $5.2 billion. Thousands of jobs have been eliminated. And now there is the possibility that state lawmakers might end the city’s monopoly on gambling by allowing it in North Jersey. All of this combines to increase the difficulty the City faces in dealing with a declining taxable property base and more than $150 million in tax appeals from just one casino, the Borgata.

PENNSYLVANIA BUDGET MESS DRAGS ON

In two weeks, Gov. Tom Wolf is scheduled to deliver a budget proposal for the 2016-17 fiscal year, despite significant portions of the current 2015-16 fiscal year still unfinished. The Republican-controlled legislature reconvened this week amid a 7-month-old budget fight that has left billions in school aid in limbo, but lawmakers took no action on budget-related legislation. Prior to his formal proposal, the Governor made some extensive comments on the situation.

Wolf said lawmakers have not figured out how to pay for the spending in a plan they sent to him before Christmas. “If we don’t fix the budget deficit by 16-17, there are going to be huge cuts in education, and huge cuts in local services, so that local taxes are going to go up and services are going to decline”. “So we need a real balanced budget, we need some honesty, we need fiscal responsibility. It’s not just me saying that, it’s the rest of the world looking at Pennsylvania and they’re going to watch us and we’ve got to get it right.”

Wolf signed $23.4 billion of the main appropriations bill in a $30.3 billion budget package that had been written by House GOP majority leaders. He call it emergency funding to prevent schools from closing and social service agencies from laying off more workers. However, Wolf vetoed billions for public schools to keep pressure on the Republican-controlled House to pass the bipartisan deal. The action did keep some school districts from having to undertake short-term borrowings but was too late for others. Many social service providers are struggling to maintain their finances as the process drags on.

As is the case in Illinois, this situation is all about the politics. That is the one factor that separates municipal credit from all other fixed income credits. Until that changes, the concept of full equality of ratings across all classes of fixed income debt will be essentially impossible to achieve. We would not be surprised to see one more downgrade of the Commonwealth’s rating before the budget process is finally resolved.

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

Joseph Krist

Municipal Credit Consultant

GREAT LAKES WATER AUTHORITY BEGINS OPERATIONS

With so much attention being focused on the City of Flint, MI and its problems with a tainted public water supply, it would be easy to overlook a major development  for the primary supplier of water to the greater Detroit metropolitan area. January 1, 2016 marked the launch of a regional water authority in Southeast Michigan.  The City of Detroit, the counties of Macomb, Oakland, and Wayne, and the State of Michigan have officially united to form the Great Lakes Water Authority (GLWA).  The new Authority was formed as a part of the Grand Bargain resolving Detroit’s bankruptcy. The new structure gives suburban water and sewer customers a voice in the management and direction of one of largest water and wastewater utilities in the nation.

GLWA begins management and control of regional water and wastewater services, while Detroit, like suburban communities throughout the region,  will retain control of water and sewer services within the City limits.  The GLWA has signed a 40 year lease with Detroit for $50 million a year. Detroit will use these funds to overhaul its aging infrastructure.  The lease also provides for a $4.5 million Water Residential Assistance Program to help low-income customers of GLWA customer communities pay their water and sewer bills.

The GLWA is comprised of six board members: two from the City of Detroit, and one each from Wayne, Oakland and Macomb counties, plus one representing the State of Michigan. The Authority also has a new old customer. In order to address the City of Flint’s needs for potable drinking water in the face of its crisis, it will return to its former status as a customer of the City of Detroit’s water system. It was an effort to avoid feared increased costs from the resolution of Detroit’s bankruptcy that drove Flint officials to seek a different water supply leading to its current dire situation.

PUERTO RICO AUDIT MAY FINALLY BE MADE PUBLIC

Office of Management & Budget Director Luis Cruz told reporters that the commonwealth’s audited financial statements for fiscal year 2014, which ended June 30, 2014, could be finally released within the next few weeks, as the process being conducted by KPMG nears its end. “[The audited statements] should be ready by the end of this month; first week of February,” Cruz said. The commonwealth’s audited financial statements for fiscal year 2014 were due in May 2015, and the government has previously missed self-imposed deadlines to release it.

Meanwhile, the Puerto Rico government budget for fiscal year 2016, which ends June 30, has been adjusted, from $9.8 billion to $9.27 billion, mainly as a result of lower than expected revenue entering the commonwealth coffers, the revised budget translates into roughly $250 million in additional, across-the-board government spending cuts, including such areas as healthcare, security, social well being and education. The $250 million figure also includes a $119 million adjustment in debt service under the budget, mainly as a result of the default on certain Infrastructure Financing Authority (Prifa) bonds.

Cruz stressed the budgetary cuts are being made without affecting essential services to citizens, while ensuring government employees continue to receive their paychecks. “In a surgical manner, we are adjusting the budget…affecting in the least possible way and ensuring essential services to citizens. At the same time, we also want to ensure government payroll is met each pay period, as well as the least impact on the economy. Those are the judgment elements in making this decision,” Cruz explained.

Fiscal 2017 starts with more than $1.5 billion in payments due July 1. Since the release of the Fiscal and Economic Growth Plan (FEGP) in September, the fiscal crisis on the Island has worsened, and the Commonwealth is now facing even larger estimated financing gaps in both the near and long term. Specifically, the General Fund revenues included in the FEGP have decreased from a previous estimate of $9.46 billion for FY 2016 to $9.21 billion; the estimated five-year projected financing gaps increase from approximately $14 billion to $16.1 billion, even with the inclusion of economic growth and the implementation of all of the proposed measures in the FEGP; and the ten-year projections estimate a $23.9 billion aggregate financing gap.

Melba Acosta Febo, President of the Government Development Bank reiterated that it expects to sit with creditors shortly and put forth a comprehensive restructuring proposal. The proposal will  include a comprehensive adjustment of its debt that reflects the Commonwealth’s actual capacity to pay its creditors over the long term. It continues to characterize lobbying efforts as being of  those seeking to lock in speculative gains but hope that creditors will sit and work on a solution that will allow investment in Puerto Rico and repay its creditors through growth in the  economy over the long run.”

NASSAU COUNTY TESTING THE MARKETS

A pair of troubled credits have recently released preliminary official statements in connection with the hoped for sale of debt. We have taken the opportunity to review them for updates on their relative precarious financial positions. The first is A2 rated Nassau County, NY which operates under the oversight of a state financial control board. The County hopes to refund $273 million of outstanding GO bonds and issue $120.3 million of new bonds and $23 million of bond anticipation notes.

The County is currently projecting a $24.9 million deficit for fiscal 2015. According to the oversight board (NIFA), it ran a deficit of $190 million in fiscal 2014. The County budget and rejected by NIFA. After a period of changes and legislative actions, a revised budget was submitted to NIFA which approved the proposed debt issue. The $2.92 billion budget is considered to have some 480 million at risk in the form of unrealized revenues and/or expense savings.

The County is still undertaking to resolve long standing issues related to required substantial property tax refunds and the unwillingness of the County legislature to enact increased property taxes. So long as the refund issues require external borrowings to finance and structural budget balance remains unattained, the County’s credit will remain under pressure. Investors may take some comfort in the County’s lack of legal authorization under New York State law to resort to bankruptcy.

CHICAGO PUBLIC SCHOOLS

The Board of Education of the City of Chicago is a more troubled story. A long history of budget difficulties, turbulent labor relations, and dependence upon the increasingly troubled State of Illinois have combined to pressure the Board’s finances over an extended period. The tax base supporting the credit is also the same as that supporting the City of Chicago and other tax backed credits which all have increasing demands on that common revenue . Like the City, the Chicago Public Schools also have substantial unfunded pension obligations that require increased revenues.

In addition, CPS estimates that its system requires some $4 billion of capital to maintain an aging and outdated physical infrastructure. The ability to reduce those needs through closings and other consolidation initiatives is hamstrung by a very difficult and complex political environment reflecting the dire economic straits of a huge portion of the student population. Those issues have challenged multiple city administrations and board management over many years. The result has been a steady decline in the credit’s relative creditworthiness and the bonds are now rated below investment grade without any external credit support.

Concerns about the Board’s credit have been heightened due to the ongoing lack of an enacted budget by the State. This has raised questions about potential impacts on the Boards cash flow and ability to service its debt. The Board expects to receive 92% of the statutory State aid anticipated in its current budget. It also expects to receive $597 million in scheduled block grants from the State. The lack of a State budget has made the receipt of some $490 million of additional aid anticipated in the current FY budget highly uncertain.

This has required the Board to undertake and consider a range of expense cutting actions to offset the reduced funding. In addition, the cuts have influenced the negotiations being undertaken with the teachers union. These negotiations are ongoing and include the recent participation of a mediator as the teachers have reacted negatively to proposals that would reduce the Board’s pension contributions. The teachers have threatened to strike in an effort to influence negotiations. The primary impact of a strike would be to reduce state aid according to a formula penalizing CPS 1/176th for each day there is no class. Some 5 weeks’ worth of the school year could be lost in the event of a strike.

The ongoing uncertainty led S&P to lower its rating on the district’s $6 billion of general obligation bonds this past Friday to B-plus from BB and left it on CreditWatch with negative implications “while it continues to monitor the board’s efforts to maintain sufficient liquidity to meet its financial obligations.”

In the midst of this effort to complete the bond issue, Gov. Bruce Rauner and Republican legislative leaders on Wednesday proposed a state takeover of Chicago Public Schools and permitting the troubled district to declare bankruptcy to get its finances in order, billing the controversial ideas as a “lifeline” and not “a state bailout.” As described by the GOP leaders, the legislation would allow the Rauner-appointed State Board of Education to remove the current Chicago Board of Education and create an independent authority to run CPS until it is determined the district is no longer in financial difficulty. The leaders said the change would add CPS to a state financial oversight law that it is exempted from but that applies to all other Illinois school districts. Another measure would allow school districts like CPS to declare bankruptcy, which could allow it to void union contracts.

House Speaker Michael Madigan and Senate President John Cullerton made it clear the Republican takeover plan is dead on arrival at the Capitol.  Madigan said in a statement. “Republicans’ ultimate plans include allowing cities throughout the state to file for bankruptcy protection, which they admitted today would permit cities and school districts to end their contracts with teachers and workers — stripping thousands of their hard-earned retirement security and the middle-class living they have worked years to achieve. “When Detroit was granted bankruptcy protection, retirement security was slashed for employees and retirees. That is not the path we want to follow in Illinois.”

This type of political infighting has hampered serious reform of CPS operations. Investors should not be fooled now into thinking that the Governor and his allies are looking at the bondholders are a primary interest. The Governor’s anti-union agenda (whether you are for or against it) has been at the core of the budget impasse at the state level and is at the core of the Governor’s effort to jump into the middle of this dispute. Like Pennsylvania, the Illinois crisis is as much a creature of ideological political considerations as it is about economic or financial realities. All in all a toxic mix for current and potential investors.

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

Joseph Krist

Municipal Credit Consultant

The first week of January usually is the start of the upcoming fiscal year budget cycle. The most visible sign is the release of the Governor’s preliminary budget proposal in California. This year is a bit different as two of the largest states – Pennsylvania and Illinois – have yet to complete the enactment of budgets for the current fiscal year ending July 1, 2016.

PENNSYLVANIA

The adoption of a partial budget in Pennsylvania has reduced some of the cash flow pressure on the Commonwealth’s school districts. The action has shifted attention to the Commonwealth’s own cash position. In a move that only the very weak state credits employ, the Commonwealth has announced a plan for the General Fund to borrow from other state funds to finance a potential negative balance of $922 million after the governor’s line-item veto of a budget plan allowed its expenditure.

The Treasury has announced the creation of a $2 billion line of credit to cover expenses of the Commonwealth’s General Fund. The $2 billion credit line is the largest ever extended by the Treasury to cover General Fund expenses, exceeding the second-largest credit line of $1.5 billion extended in September 2014. The announcement Particularly noted the public school subsidy being withheld during the Commonwealth’s ongoing budget impasse until the partial budget plan was signed last week, the Treasury noted the General Fund’s balance was artificially inflated and, without the loan, would have fallen into a likely negative balance until the tax revenue collection spike in the spring.

As of last week, the Wolf administration has borrowed $1 billion of the available funds to cover expenses. The funds were borrowed from Treasury’s cash investment “Trust 99” fund and any borrowed funds will carry a 0.6 percent interest rate, which is lower than the Commonwealth could have obtained in the private sector while also allowing Treasury to make a positive gain for taxpayers when the loan is paid back.

The credit line also had to be approved by Auditor General Eugene DePasquale, who noted the credit line is necessary due to the Commonwealth’s structural deficit. “This is the second consecutive year the state hit a cash flow problem and needs to borrow money halfway through the fiscal year. As I said 16 months ago, the need to borrow money this early in the fiscal year is a strong indicator that the commonwealth’s unsustainable structural budget deficit continues to grow,” he said. “The long-term structural budget deficit and this year’s budget impasse should be a wake-up call to everyone involved that it is time to come to a resolution on these critical issues.”

The Commonwealth will have to repay the loan by June 30, 2016.

LOUISIANA BUDGET WOES

With so much attention devoted to Puerto Rico’s default and budget standoffs in Illinois and Pennsylvania, it is easy for some more familiar weak fiscal performers to get lost in the noise. One of those is perennial credit laggard Louisiana. Louisiana’s budget woes are even worse than the incoming administration of Governor-elect John Bel Edwards had anticipated. The shortfall for the fiscal year ending in June 2016 is estimated at $750 million. The chief fiscal adviser to the Governor said that the administration has not settled on a plan for fixing the problems with the current fiscal year’s $25 billion budget, but it has not ruled out tax increases, which would need legislative approval.

New revenue estimates showed a continuing drop in oil prices and a slump in collections from corporate income taxes and sales taxes. He said a $1.9 billion shortfall is estimated for the next fiscal year, which starts in July. The departing governor, Bobby Jindal, a Republican who mounted a failed presidential bid, refused to support anything he considered a net tax increase and leaned on short-term budget fixes.

LITIGATION BEGINS OVER THE CLAWBACK

As we have predicted in earlier discussions of the Puerto Rico credit situation, litigation has been filed to test the validity of the “clawback” provisions supporting general obligation debt of the Commonwealth. Two insurers of Puerto Rican bonds that are now in default sued the governor and other senior officials on Thursday, saying they had illegally diverted money from some creditors so they could pay other creditors in full. Assured Guaranty Corporation and the Ambac Assurance Corporation said in their complaint that Puerto Rico had diverted at least $163 million that had been pledged to pay debts they had insured. Those debts were in the form of municipal bonds issued by three governmental authorities on the island.

The governor responded that the litigation was a sign that a dreaded “race to the courthouse” had begun, leading to “litigation pandemonium” as different creditors sought to enforce their claims on the island’s resources. He called on Congress to enact legislation that would give Puerto Rico the ability to take shelter in bankruptcy, where such creditor litigation would be automatically stayed. “With no legal framework to handle this impending litigation crisis, both the Commonwealth and its creditors will soon face the opposite of due process and rule of law,” Mr. García Padilla warned.

Last week, the governor confirmed the use of at least $163 million — slightly less than the earlier reported $174 million — to help make a large payment due Jan. 1 to investors who hold Puerto Rico’s general obligation bonds. That type of bond is given the highest payment priority by the Puerto Rican constitution. Mr. García Padilla diverted the money by issuing an executive order on Nov. 30, starting what is called a “clawback” of funds from lower-priority bondholders.

Assured Guaranty and Ambac contend that the clawback was unconstitutional, because it “substantially and unjustifiably” impaired their contract rights under the United States Constitution. They also said they had constitutionally protected property interests in the money, because they held liens on the pledged funds. They acknowledged that their liens were subject to being paid after the general obligation bonds, but said the use of the clawback was still unlawful under the circumstances, “namely, where other available resources exist from which the public debt could be paid.”

The two insurers asked the court to declare the clawback unconstitutional and bar the Puerto Rican government from diverting any more pledged money. Their suit was filed in United States District Court in San Juan. The three public authorities whose bonds have been affected by the clawback are the Highways and Transportation Authority, the Convention Center District Authority and the Infrastructure Financing Authority. Holders of those bonds received some of the principal and interest payments due Jan. 1, from debt service reserves, which is considered a technical default. The Infrastructure Financing Authority did not have reserves in place to make the payment, and Ambac stepped in and provided $10.3 million.

LOMBARD HOTEL

The troubles of Puerto Rico and Detroit have overshadowed the more traditional sectors prone to default in our market. In a more typical situation, the village of Lombard, a Chicago suburb, wants bondholders to agree to a proposed restructuring of its $190 million of hotel/conference center debt. The village has since January 2014 not paid on its pledge to cover revenue shortfalls needed to avoid defaults on a portion of the bonds issued to finance construction of the Westin hotel. The restructuring proposal was made to bondholders in October but disclosed publicly only in December. It would cancel $29 million of unsecured C series 2005 bonds.

A exchange has been offered to holders of $64 million A-1 series, $54 million A-2 series, and $43 million B series, each of which carries different security.

The restructuring was initiated by ACA Financial Guaranty Corp. — which backstops $19 million of the $54 million series — and Lombard officials. If they can convince bondholders to agree to the new capital structure, it could lead to a resolution through a consensual bankruptcy filing by debt issuer Lombard Public Facilities Corp., according to documents and city officials. Under the restructuring proposal, the Lombard Public Facilities Corp. would retain ownership of the project. Without a restructuring, the Series A and B bondholders have a mortgage claim if the project were to declare bankruptcy.

Like other suburban hotel credits relying on corporate conference events in various sections of the country, the property has long failed to generate the revenue needed to support its debt. It includes a 500-room hotel, two restaurants, 39,000 square feet of meeting and convention space, a 25-meter indoor swimming pool and fitness center, and a 675-car, four-story parking deck. Village officials are promoting the plan as a means to align hotel revenues with debt repayment while also preserving the hotel’s business prospects. The hotel is operated by Westin Hotels & Resorts, part of Starwood Hotels & Resorts.

“Given market conditions, the hotel’s operational and financial performance and its inability to service the existing capital structure, a comprehensive restructuring is needed to preserve asset value and maximize bondholders’ return,” the plan reads. “If a restructuring plan is not undertaken to solve the default, the asset’s value may further deteriorate, including the potential loss of the Westin brand.” The hotel’s capital needs are increasing with few resources to cover upgrades because its revenues now go primarily to repay the bonds.

As part of the restructuring, the village would contribute $2.5 million for capital work at the hotel and be freed of further obligations on the debt. Lombard has seen its bond rating negatively impacted as the otherwise affluent village saw S&P lower Lombard’s credit rating six notches to a speculative-grade B from BBB in February 2014. Lombard’s previous refusal to make up shortfalls came ahead of a July debt service payment when it declined to cover a $2.6 million gap. The trustees have long taken the position that the village is not legally obligated to burden its taxpayers. The Lombard Public Facilities Corp. drained reserves to cover the Jan. 1, 2015 payment on the A series which carries an indirect appropriation pledge.

Like many project refinancings, coupon rates and maturities would be adjusted to better match operating realities. In this case, the A-1 bonds would be broken into a “hard” and “subordinate” series with $32.7 million paying an interest rate of 5.25% and carrying a 30-year term and a $32.7 million subordinate series also paying 5.25%, but with a maximum term of 55 years. The A-2 series would be similarly divided, with $27.3 million paying 5.25% and a 30-year term, and a subordinate $27.4 million piece paying a rate of 5.25% with a maximum term of 55 years. The B series would be divided into an $18.5 million tax revenue bond series with an interest rate of 3% and a 30-year term and a subordinate $28.1 million series paying 3% with a maximum 55-year term.

The A-1 bonds paid initial yields of between 6% and 7% on term bonds due in 2015 and 2036. The A-2 bonds paid yields between 4.11% and 4.8% with the final maturity in 2036. The B bonds paid initial yields between 4.125% and 4.59% on the final maturity in 2036. The plan argues that additional benefits of the new structure include the maintenance of bondholder claims and of the bonds’ tax-exemption, and the creation of marketable and tradable securities.

The July 1 default marked the fourth default on the $43 million B series that carries the village’s appropriation pledge. No payments have been made on $29 million of C series bonds. The January 2014 default marked the first actual payment default and it gave bondholders of the A and B bonds the right to accelerate repayment but they have not done so.

Originally, the village pledged — subject to appropriation — to cover debt-service shortfalls on the Series A bonds before reserves are tapped. The backstop was first triggered in 2012. The B series carried a more direct appropriation pledge but reserves were tapped first before the village was asked to cover shortfalls. The village in 2013 tried to issue a $10 million new-money issue of certificates but investors showed no interest in a non-general obligation debt that would have been secured by any legally available and appropriated funds. Property tax caps limit the non-home rule village’s ability to use a GO pledge. Lombard has no near-term borrowing needs for capital expenses.

The restructuring marks the second attempt by the village to get bondholders to agree to a plan that giving the project more breathing room. A proposed tender of the Series A and C bonds that asked holders to take a loss in 2011 failed due to bondholders’ competing interests.

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

Joseph Krist

Municipal Credit Consultant

THE BALL DROPS ON PUERTO RICO’S CREDIT

Puerto Rico made $594 million in bond payments due this week but still defaulted on $37 million in interest. The Governor at the same time said that there is no money available for future payments, including $400 million due in May in bonds issued by the Government Development Bank. The Governor reiterated that Puerto Rico needs Congress to give the territory access to debt reorganization under federal bankruptcy laws. “I’m not asking for a bailout,” he said. “I’m asking for the tools to address the problem.”

He said the government would default on $35.9 million in Puerto Rico Infrastructure Financing Authority bonds and $1.4 million of Public Finance Corporation bonds. This is the second time that Puerto Rico has defaulted on Public Finance Corporation bonds. The government missed a $58 million bond payment in August.

The U.S. Treasury said in a statement that the default demonstrates the gravity of the island’s situation and the need for Congress to act. “Puerto Rico is at a dead end, shifting funds from one creditor to pay another and diverting money from already-depleted pension funds to pay both current bills and debt service,” it said. The government has already increased taxes, closed schools, withheld tax returns and taken other numerous measures to cut costs and generate more revenue amid a worsening economic crisis. The Governor said government officials will start meeting with creditors in early January to discuss debt restructuring.

Previously, PREPA officials said that two bond insurers had agreed to take part in a five-year restructuring plan for the Authority. The insurers’ involvement signaled that PREPA had found a way to satisfy its bondholders, who expected to be paid about $177 million on Jan. 1, without having to part with that much cash itself. On Jan. 1, the two participating bond insurers, Assured Guaranty and National Public Finance Guarantee purchased $50 million of new revenue bonds from PREPA; a creditors’ committee known as the Ad Hoc Group will purchase an additional $65 million worth of bonds. Those purchases will give PREPA $115 million of fresh cash, which it can use to honor a large part of its scheduled bond payment due that day. PREPA was to make the rest of the payment out of its own resources.

The restructuring plan resembles terms that were made public earlier this year. They called for giving PREPA five years’ worth of interest-rate relief, which would save the utility more than $700 million. In addition, the creditors have agreed to permanently reduce PREPA’s outstanding bond principal by more than $600 million, according to a summary provided by the utility. This would be accomplished through a debt exchange, in which the holders of PREPA’s current, junk-rated bonds could turn them in and receive new investment-grade bonds. This was facilitated when  the two bond insurers agreed to backstop with a surety. The idea is to induce  investors to exchange their old bonds for the new ones, despite the lower face value, by making the new bonds a better credit risk.

The debt exchange is not expected to take place until next summer, and, until then, the negotiators must clear a number of obstacles. The first is Jan. 23 — a deadline for the Puerto Rican legislature to pass enabling legislation for the deal. Legislators have so far shown little appetite, because they would also have to request a rate increase for PREPA. In addition, a large number of PREPA’s bondholders continue to stay aloof from the restructuring talks, perhaps hoping an even better deal might appear later.

The creditors on board so far represent about 70 percent of PREPA’s $9 billion debt; they include the Puerto Rico Government Development Bank, mutual funds, hedge funds, and banks that finance PREPA’s fuel purchases. The holders of the remaining 30 percent of the debt have not yet signed onto the deal, and it is not clear whether enough of them ever will, at least under the incentives proposed by the current deal. But one more factor is expected to come into play in the first half of 2016: the hope by some investors  that Congress is preparing to make some form of bankruptcy protection available to Puerto Rico.

“While the entry into these agreements is another important milestone in PREPA’s transformation, the transaction is subject to a number of conditions and contingencies,” said Lisa Donahue, PREPA chief restructuring officer. “Chief among them are the enactment of the necessary legislation, the approval by the [Puerto Rico] Energy Commission of PREPA’s rate structure and the securitization charges, execution of a successful exchange offer, and the achievement of an investment grade rating for the securitization bonds, the last of which will of course depend on a number of factors, including the overall situation at the commonwealth.”

Effectively  the bond insurers have put up some money, in particular for the surety bonds, as their contribution for the deal, whereas the bond holders are accepting delays in principal payments and cuts in the interest rates, as their contribution for the deal. The lines of credit holders and the Government Development Bank for Puerto Rico have agreed to accept either an extended payment schedule plus lowered interest rates or to convert to bonds and accept the bond holder deal.

Officials continue to publicly hope that the PREPA agreement may serve as a template for similar agreements between creditors and Puerto Rico’s other debt-issuing entities. Whether  the collateralized debt concepts may be applicable to the ‘super bond’ structure being considered for the rest of Puerto Rico’s debt  is an open question. The statutory and constitutional issues underpinning the security for the outstanding general obligation debt create legal and political issues and involve many constituencies with clearly conflicting goals.

The commonwealth, however, still  has over $2 billion in payments due from February until July 2015. These payments are approximately as follows: $402 million in February; $ 29.3 million in March; $40.9 million in April; $469.4 million in May; $ 71.3 million in June and $1.9 billion in July 2016. In July, specifically, the government must pay $779 million in general obligations. COFINA has a $318.3 million payment due in February. The Puerto Rico Electric Power Authority must pay $423.8 million this year; the Aqueduct and Sewer Authority $147.5 million; the Public Buildings Authority $177.2 million and the Highway and Transportation Authority $232.5 million.

ALASKA

With oil prices down along with oil production, the state is facing a huge shortfall. Two-thirds of the revenue needed to cover this year’s $5.2 billion state budget cannot be collected. The governor  has proposed the imposition of a personal income tax for the first time in 35 years.  Many Alaskans are not old enough to remember a time when oil did not provide for state expenses. Oil royalties and energy taxes once paid for 90 percent of state functions. Residents received annual dividend checks from a state savings fund that could total more than $8,000 for a family of four .

Gov. Bill Walker, an independent, is proposing to scale back those dividends as he seeks to get Alaska back on a stable financial footing with less dependence on oil. The Permanent Fund has paid dividends to residents every year since 1982, from $300 to $500 a person in the early years to more than $2,000 this year, based on the fund’s investments.

The income tax would be 6 percent of the amount an Alaskan currently pays in federal taxes, so a person who owed $10,000 to the Internal Revenue Service would also need to write a $600 check to Alaska. Dividend payments would be tied directly to royalties that decrease or increase with oil production. Because oil production is down, next year’s payout would be cut by roughly half under the proposal, to about $1,000 a person. The governor would also raise taxes on alcohol and tobacco and would collect new taxes from the fishing, mining, energy and tourism industries.

Legislative leaders said the governor’s plans would be given fair consideration. The speaker of the House has conceded that some new revenue stream is probably unavoidable. In a deep first wave of budget cuts this year, Alaska eliminated almost all capital spending. The president of the State Senate, who is also an employee of the oil giant ConocoPhillips, said that he thought deeper budget cuts were still necessary and that residents would accept new taxes only when they were convinced that the old pattern of state spending — wasteful and inefficient, in his view — had been permanently changed.

Opponents argue that the governor’s plan would disproportionally hit working-class Alaskans. Which sectors of the state are hurt, or spared, will also be on the table when the Legislature returns to Juneau in January. The income tax plan, for example, would primarily hit urban Alaska, where most jobs are. A sales tax, by contrast, which some lawmakers favor, is seen as hurting rural residents more.

PENNSYLVANIA GETS A HALF A BUDGET LOAF…

Gov. Tom Wolf used line-item vetoes to allow some spending called for in a $30.3 billion budget lawmakers sent him. The vetoes strike $6.3 billion from the plan, leaving $23.4 billion in spending. The idea is funding will be restored if Wolf and lawmakers can negotiate a final plan. Wolf didn’t support lawmakers’ plan and wants one that includes an education funding boost and new tax revenue to close the recurring budget deficit.

Public schools will receive part of their basic education subsidy, but the vetoes withhold about $3 billion. Most other programs remain intact. The vetoes flat fund community colleges and state-system schools (including Kutztown University), cutting a combined $31.3 million proposed increase. Most funding is provided for student loans and grants, but $59 million is cut. A combined $521 million in proposed aid to state-related universities — Penn State, the University of Pittsburgh, Lincoln and Temple — is not included. But that’s because that funding has not been approved, not because of a veto.

The vetoes withhold the lion’s share of funding for agriculture programs, cutting $68.8 million from areas like dairy and livestock shows and agriculture research. State prisons will receive partial funding, but about $939 million is withheld. Medical assistance will be partially funded with $2 billion withheld. The vetoes cut $9.7 million of what was proposed for health items such as newborn screenings, poison control centers and programs targeting specific diseases.

Wolf flat funded the Legislature and commissions and offices that support it, vetoing a combined $64.7 million proposed increase.

… HELPING SCRANTON SCHOOLS AVOID DEFAULT

The Scranton PA School District officially secured a $40 million bond, avoiding default on tax anticipation notes due last week. The bond has a 4 percent interest rate for 2016. Earlier in 2015, the district received a note of $18.5 million and secured another note for $14.3 million in November to make payroll through the end of the year.

Directors passed a $146.5 million budget for 2016 on Dec. 21 that increases property taxes 2.8 percent and borrows millions, delays debt payments and uses money set aside for large health care claims. The district will again use procedures delaying paying nearly $10 million in debt and pushing payments into the future. Once the state passes a budget and the district begins to receive state funding again, the district hopes to pay off the loan. Scranton has 10 years to pay back the $40 million per a court order they sought in early December and a state statute.

Without state funding, the district had been unable to repay the two tax anticipation notes taken out earlier this year. After Standard & Poor’s withdrew the district’s credit rating earlier this month because of the state budget impasse, it had been much harder for the district to secure a bond. The bond has to be outstanding for one year. So if the district receives its state funding within the first half of the year, they have to wait until Dec. 1, 2016 to pay off the bond. The 4 percent interest rate is set for one year only. Rates can change through the life of the bond or the district can seek to refinance, he said. It was structured that way to allow the district to pay back as much as possible once state funding comes through. Extra money left over after the TANs are paid off will go toward paying the district’s everyday operations and payrolls, among other expenses.

HAWAII RAISES SMOKING AGE

Hawaii became the first state to raise the smoking age to 21. There will be a $10 fine the first time anyone under 21 is caught smoking and a $50 fine for every offense after that. Store owners will face a $500 penalty if caught selling to a person under the age limit. The rising popularity of electronic cigarettes led to passage of the new legislation. Officials cited a University of Hawaii study that found e-cigarette usage among Hawaiian teens is triple the national average. Twenty eight per cent of revenues received by the State under the MSA are statutorily pledged to support debt service on revenue bonds issued on behalf of the University of Hawaii. None of the revenues have been directly securitized.

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

Joseph Krist

Municipal Credit Consultant

PR OUTLINES STRUCTURE OF EXPECTED DEFAULT

PR has finally admitted that it will default on January 1 when the Puertto Rico Infrastructure Finance Authority”s (Prifa) $35.9 million debt-service payment is not made. There are no reserves to cover the payment due to the clawback of the authority’s pledged revenue stream — the rum tax proceeds received from the federal government — to help the commonwealth meet the $331.6 million GO payment due at the same time. There is also  $115 million due Jan. 1 to cover Highways & Transportation Authority (HTA) debt, as well as a $9.5 million payment corresponding to the Convention Center District, but their trustees hold enough reserves to cover both payments.

Despite the clawbacks undertaken, there is not enough to cover the full amount due on the general obligations. The governor has been lobbying Congress to include a bailout in the omnibus budget bill before Congress. this has been ruled out by House leadership. The governor is resorting to threats of a humanitarian crisis and invocation of Puerto Rico’s historic wartime activities in an attempt to shame the Congress into action.

House Speaker Paul Ryan, R-Wis., said on Wednesday that the House will work with Puerto Rico to come up with “a responsible solution” for the island’s debt problems next Unfortunately, the governor has been most closely aligning himself with some of the least mainstream and influential House members. Help will be best earned on the merits, not the emotions.

SPEAKING OF THE MERITS

Recent comments by Antonio Weiss, counselor to Treasury Secretary Jack Lew  may be seen as encouraging those who seek to achieve Puerto Rico’s goal of reducing its debts through the political process rather than through good faith efforts. Last week, Mr. Weiss gave a speech that was seen as endorsing Puerto Rico’s view that the Commonwealth itself –  not just its corporations and municipalities – be given the right to declare Chapter 9 bankruptcy. They were also viewed by some as trying to undermine ongoing negotiations to restructure PREPA’s debt. Weiss used creditor negotiations with the Puerto Rico Electric Power Authority, which have gone on for about 18 months, as a “cautionary tale” in his speech and a reason why the commonwealth needs access to a bankruptcy regime to bring creditors to the table. He is said to have called the need for audited financials before helping a “myth” and said “even without fiscal year 2014 audited financials, the magnitude of Puerto Rico’s problems, and the need for action, are clear.”

We find those remarks to be disturbing at best. The ignorance of the need for such data, if it represents Treasury’s view, is stunning given the precedents established during the New York City crisis. We view any effort to grant the Commonwealth directly the ability to declare Chapter 9 as being detrimental not only to holders of Puerto Rico debt but to the municipal market as a whole.  We agree that the portion of the Treasury plan that calls for a federal restructuring regime through Chapter 9 is advocating for a retroactive change in law that would be unfair to investors.

Assured Guaranty recently expressed such a view very well when it said that “Had Puerto Rico been eligible to file under Chapter 9 at the time these bonds were issued, investors would have priced that risk into the bonds, and Puerto Rico would have had to pay higher interest rates,” he said. “There is no justification for initiatives that would retroactively undermine the Puerto Rican constitution and the legal right and remedies that were the basis on which bondholders agreed to provide financing for the island’s development.”

We do not believe that it is extreme to believe that should Puerto Rico be successful in its quest to obtain the right for the Commonwealth to go the Chapter 9 route, that some states would want the same ability. Chapter 9 would provide a politically expedient route for irresponsible legislators to avoid making good on years of pledges to their employees.

This belief is based on the political trends which have become clear in the four decades since the New York City crisis. These reflect the increased partisanship of legislatures across the country buttressed by the highly ideological views of Republican legislators across the country. The resulting inflexibility in the face of increasing costs, especially for pensions, seems to be a perfect storm of conditions for those who would seek to reduce payments to all creditors including general obligation debt holders.

We hope that the sanctity of contracts and constitutional pledges was behind the U.S. Supreme Court’s decision last month to review a local law that would give the island’s public authorities access to bankruptcy-like restructuring capabilities. Two lower courts ruled the law is pre-empted by federal bankruptcy law but Puerto Rico appealed to the high court. The commonwealth, whose public authorities are not granted Chapter 9 protections under federal law, is arguing that it should not be left out of the federal law but also have the same federal law prevent it from trying to fix the exemption.

ST. LOUIS THROWS A HAIL MARY STADIUM PASS

It is hard to discern what actually went on in St. Louis last week when it approved a municipal financing plan that may be as ugly as the uniforms worn by the Rams in their game last Thursday night. Under the terms, the city would finance $150 million of the overall $1.1 billion project. The rest of the funding would come from the state, the NFL and the team owner. The NFL contribution is pegged at $300 million.

Two problems: the Rams owner is busy pursuing a plan to build a stadium in Los Angeles to return the Rams there and the NFL reiterated its position that the premise of the bill approved on Friday that the league has committed $300 million to the Mississippi River stadium proposal “is fundamentally inconsistent with the NFL’s program of stadium financing.”

The comments of various St. Louis aldermen express the “untidyness” of the plan best. Alderman Antonio French, once a critic of the project, turned into a supporter after amendments were added  to the bill to include minimum  requirements for ethnic and gender based owned contractors to be hired to build the stadium. French said he doubts the stadium will be built. But he said he hoped St. Louis’ action would show a “good-faith effort to hopefully sway a few votes to prevent Kroenke(the owner) from moving to Los Angeles”. Alderman Megan Green, labeled the process of generating  help from construction unions as well as minimum minority inclusion component “legalized bribery.”  But the best comment may have been from Alderman Sharon Tyus who said “we’re like at the strip club…and the stripper is throwing the money back at  us.”

The plan is being driven primarily at the State level through a task force created by the governor. It is of interest that St. Louis County has withdrawn from any plan to finance a stadium even though it is in a much better financial position than is the City. The result is an excellent reflection of the wide disagreement over the wisdom of public stadium finance that makes these financings among the most contentious in the public finance industry. The league is expected to decide in January whether or not it views the total package as viable or whether to support Rams’ ownerships desire to relocate to the L.A. market.

The Rams are in competition to relocate to that market with the San Diego Chargers and the Oakland Raiders. It is unlikely that the league would place three teams in that market. Complicating the process is the fact that interests with the Chargers and the task force supporting keeping the Rams in St. Louis are represented by the same investment banker. The whole situation is almost as ugly as those uniforms.

CHICAGO HOSPITAL MERGER UNDER FEDERAL CHALLENGE

With the enactment of the Affordable Care Act and its emphasis on cost saving, many have felt that consolidation was the way to achieve the operating efficiencies necessary to constrain costs to health consumers. To that end, significant mergers have occurred between numerous large health systems. Not all mergers have been seen by federal regulators to be in the public interest. Such is the case in Chicago where a proposed merger of Advocate Health Care, the state’s largest health system, and NorthShore University HealthSystem, (both mid AA rated systems) would create a 16-hospital system that would dominate the North Shore area of Chicago.

The Federal Trade Commission said on Friday that it planned to block the combination saying “this merger is likely to significantly increase the combined system’s bargaining power with health plans, which in turn will harm consumers by bringing about higher prices and lower quality.” “Competition between Advocate and NorthShore results in lower prices, higher quality and greater service offerings,” the F.T.C. argues in the complaint filed in the Eastern Division of the U.S. District Court for the Northern District of Illinois. The F.T.C. took similar action to halt the merger of two hospitals in West Virginia in November and, earlier this month, teamed up with Pennsylvania authorities to try to stop a deal between Penn State Hershey Medical Center and PinnacleHealth System.

Advocate argues that because the hospitals’ market was dominated by a major insurer (Blue Cross Blue Shield), the systems were “price takers, not price setters.” The hospital groups say the merger would shift health care from the traditional fee-for-service model of providing high volumes of care for high payments to one focused on a streamlined system aimed at achieving lower costs.

The hospitals believe that the federal government is subjecting mergers of providers to more scrutiny than it does to mergers of insurers to the detriment of providers.

Merry Christmas!! Our next publication date is January 7. Happy New Year!!

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

Joseph Krist

Municipal Credit Consultant

CHICAGO PUBLIC SCHOOL CREDIT UNDER MORE PRESSURE

After a series of downgrades this summer including two to below investment grade, the Chicago Public Schools credit is under pressure again. The Chicago Teachers Union has voted overwhelmingly to authorize their leaders to call a strike. The announcement was accompanied by the usual strong rhetoric from the union which only served to highlight the trouble that holds the credit down and sets the stage for another downgrade.

The union said in a statement,  “Do not cut our schools, do not lay off educators or balance the budget on our backs.” The teachers’ contract expired in June.  School administrators have threatened widespread layoffs as they deal with a half-billion dollar budget shortfall. The union, which represents close to 27,000 teachers and staff members, has said that the city is demanding changes that would result in a 12 percent cut to their compensation in the next three years.

The potential strike accompanies events in October when the former chief executive of the school system, Barbara Byrd-Bennett, pleaded guilty to accepting hundreds of thousands of dollars in bribes and kickbacks in exchange for steering $23 million in contracts to her former employer. The system has been notorious for both its contentious labor relations and managerial incompetence and corruption over the years.

Union and city officials would first have to go through mediation before a strike could take place. Under state law, at least 75 percent of union membership must approve a strike before it can be called.

PENNSYLVANIA BUDGET STANDOFF IMPACT ON SCHOOL DEBT

Standard & Poor’s says it has withdrawn its ratings on a state government program that helps school districts borrow by giving a guarantee to repay bondholders.

In a Friday note, Standard & Poor’s says Pennsylvania can’t ensure the timely payment of debt service because of the ongoing state budget stalemate. Many districts use the program to lower their debt costs but mostly poorer districts essentially rely on the state intercept program for market access because their own stand alone ratings are often too low for them to borrow at rates they feel they can afford.

Districts in this position are often the victims of long term economic deterioration that has negatively impacted their ability to raise revenues locally . These include big city as well as small rural districts. The larger districts serve huge pools of economically disadvantaged children through large and aging facilities that require capital to be maintained. The smaller districts have less diverse tax bases and/or aging populations that provide little, if any support for property tax increases to fund borrowings.

School funding has been at the center of the current budget dispute which has entered its six month without a resolution. The state auditor general’s office has tallied about $900 million in borrowing by Pennsylvania school districts to pay bills during the impasse.

NUCLEAR DEVELOPMENTS IN SC

South Carolina Public Service Authority (Santee Cooper) is one of two municipal joint action agencies undertaking financial participations in the development of new nuclear generation sources. Over the next three years, SC projects financing requirements of $2.1 billion for its 45% ownership interest in two new units at the existing Sumner Nuclear plant. Nuclear is a resource that many are looking to in order to address carbon emission issues that have been the subject of international negotiations this week.

The obstacles to nuclear power outside of the obvious post – safety issues have centered on the cost and financial risk associated with the construction of new capacity. The municipal market had much experience with these risks in the 1980’s when credit weakness and default plagued several joint action agencies involved in some well known nuclear construction projects. While much has been done in the area of design to address the safety and direct construction issues, there still  remains significant cost risk associated with financial participation.

SC is a good example. Work began on the Sumner expansion in 2008. By 2012, license and design related delays had resulted in increased costs of $113 million and construction delays of 11 and 8 months. One year later, additional delays of one year were announced. In 2014, additional delays were identified such that the units will not be completed until  mid 2019 and mid 2020. This will produce another $270 million of costs to the Authority. These could be offset by the payment of liquidated damages by the construction consortium but these damages are now capped b y agreement. This year the project costs were capped at $2.73 billion for the Authority reflecting its now 40% ownership interest in the project.

This history is instructive to other utilities considering additional nuclear capacity. Even with a streamlined approval and licensing process, along with use of a standardized design, the project will have taken 12 years to design and complete. The “smoother” licensing process still did not allow for limitations in cost and have not provided financial certainty for owners and operators. This despite the fact that SC is one of the financially stronger and well managed municipal utilities. It also has substantial nuclear experience.

WATER IN CALIFORNIA BACK IN THE NEWS

One of the ways in which water consumers in drought ravaged California have been coping with less water is to tap underground sources. Now that strategy is exposing a downside. Uranium increasingly is showing in drinking water systems in major farming regions of the U.S. West, including the major farming areas of California. The Associated Press has found that nearly 2 million people in California’s Central Valley and in the U.S. Midwest live within a half-mile of groundwater containing uranium over the safety standards.

Uranium is a naturally occurring but unexpected byproduct of irrigation, of drought, and of the overpumping of natural underground water reserves. In California, as in the Rockies, mountain snowmelt washes uranium-laden sediment to the flatlands, where groundwater is used to irrigate crops. Irrigation allows year-round farming, and the irrigated plants naturally create a weak acid that leeches increasing amounts of uranium from sediment at the bottom of aquifers.

The USGS calculates that the average level of uranium in public-supply wells of the eastern San Joaquin Valley increased 17 percent from 1990 to the mid-2000s. The number of public-supply wells with unsafe levels of uranium, meantime, climbed from 7 percent to 10 percent over the same period. USGS researchers recently sampled 170 domestic water wells in the San Joaquin Valley, and found 20 to 25 percent bore uranium at levels that broke federal and state limits.

It is difficult to assess the potential financial risk to water utilities throughout the state as there is limited data to rely on. One way of dealing with the issue has taken place in Modesto where the city of one half-million residents, recently spent more than $500,000 to start blending water from one contaminated well to dilute the uranium to safe levels. The city also retired a half-dozen other wells with excess levels of uranium. In California, changes in water standards  in place only since the late 2000s have mandated testing for uranium in public water systems.

WILL RATE HIKES OFFSET VOLUME DECREASES?

Municipal bond volume declined for the third consecutive month in November with refundings down over than one-third from the same month last year. They dropped 39.5% to $7.42 billion in 319 deals in November from $12.26 billion in 444 deals a year earlier. Long-term issuance dropped 21.6% to $23.19 billion in 834 issues from $29.56 billion in 995 issues in the prior year period, according to Thomson Reuters. This is the lowest November lower volume since 2000, when the monthly issuance $19.80 billion.

At the same time, new money issuance declined 1.7% to $11.93 billion in 449 transactions from $12.13 billion in 473 transactions a year earlier. Revenue bonds fell 17.1% to $14.22 billion, while general obligation bond sales dropped 27.7% to $8.97 billion. Negotiated deals were down 15.3% to $17.43 billion and competitive sales were lower by 26.8% to $5.62 billion.

Taxable volume was down 22.7% to $1.69 billion from $2.19 billion, while tax-exempt issuance declined by 24% to $20.42 billion. Minimum tax bonds more than doubled to $1.08 billion from $508 million. Bond insurance broke its trend of decreases, as the par amount of insured issues rose 16.8% to $2.09 billion in 121 deals from $1.79 billion in 147 deals in November 2014. Cities and towns saw an increase of 49.4% increase to $4.37 billion in 224 transactions from $2.92 billion in 254 transactions, while state governments, state agencies, counties and parishes, districts, local authorities, colleges and universities and direct issuers all saw large declines.

Swimming against the tide were sectors like the housing and public facilities sectors saw gains despite having a lower number of transactions, compared with November 2014. Housing transactions increased 23.7% to $1.19 billion in 35 deals from $967 million in 44 deals while public facilities issuance jumped up 46% to $1.65 billion in 49 deals from $1.13 billion in 57 deals. Housing and public facilities sectors increased in spite of their being a lower number of transactions, versus November 2014. Housing transactions increased 23.7% to $1.19 billion in 35 deals from $967 million in 44 deals while public facilities issuance jumped up 46% to $1.65 billion in 49 deals from $1.13 billion in 57 deals.

Our view is that initial fed moves to raise rates will be mitigated by a continued demand for tax exempt income by investors who are seeing bonds called at a faster rate than they can be replaced in the new issue market.

PUERTO RICO REVENUE SHORT AGAIN

Puerto Rico’s General Fund net revenue for November totaled $488.6 million. This is $15.4 million, or 3.2%, less than estimated for the month in the original budget for fiscal 2016. This is the third consecutive month that revenues have missed estimates. Fiscal year-to-date (July-November) revenues total $3.051 billion, an increase of approximately $149.5 million year-over-year, but $23.9 million below estimates for the same period during fiscal 2016.

Individual income taxes showed a $31.3 million decrease compared with November 2014. In fiscal 2015, the Treasury Department received $29.4 million in nonrecurring revenues associated with Act 77 of 2014, which granted a temporary period during which certain transactions, such as those involving individual retirement accounts (IRAs), retirement plans and other capital assets, could be prepaid at preferential rates.

VAT collections for November were $191.5 million, some $74.9 million more than in November 2014, the result of the increase in the VAT rate to 10.5% from 6%. VAT revenues were divided: $109.3 million, corresponding to the 6% rate, was allocated to the Sales Tax Financing Corp. (Cofina by its Spanish acronym) and other $82.2 million, corresponding to the 4.5% rate, was allocated to the General Fund.

Corporate income tax revenues registered an $8.2 million decrease. Non-resident withholdings, which include royalties from the use of manufacturing patents, registered a $21.9 million decrease. Actual revenues were $25 million below estimates. Foreign excise tax collections increased by $10 million year-over-year.

For excise taxes, alcohol taxes rose $4.9 million with motor vehicle excise taxes up by $7.6 million. This is the first year-over-year increase in motor vehicle excise taxes for a month in fiscal 2016. Year-to-date motor vehicle revenues decreased $31.9 million.

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

Joseph Krist

Senior Municipal Credit Consultant

PUERTO RICO TROUBLES CONTINUE

Just as the storm surrounding the credit woes of Puerto Rico intensifies, the worst suspicions of the most cynical investors and observers are confirmed. U.S. Attorney Rosa Emilia Rodríguez-Vélez of the District of Puerto Rico announced that 10 Puerto Rico businessmen and government officials have been indicted for their alleged participation in several schemes to corruptly give things of value to public officials within the government of the Commonwealth of Puerto Rico in exchange for favorable treatment and awarding of government contracts to various corporations. The 25-count indictment includes charges of conspiracy to commit federal programs bribery and honest services wire fraud, wire fraud, federal program bribery, extortion through fear of economic harm, money laundering, false declarations before a grand jury, and obstruction of justice.

Among the indictees are the Purchasing Director of the Puerto Rico Aqueduct and Sewer Authority and the Administrator and Special Assistant for Administration at the House of Representatives of Puerto Rico.

Just when it needs to show that it is serious about tackling its problems, Gov. Alejandro García Padilla signed into law the commonwealth’s self-imposed fiscal oversight board. Several amendments watered down the original version including provisions that the five-member board will only certify or endorse, rather than control, the commonwealth’s fiscal practices, while investigative, approving and budgetary-control powers also remained toned-down. The board will certify if each monitored entity is undertaking sustainable fiscal practices and complying with the five-year fiscal and economic plan. Such entities may request the board to be excluded from its scope if certain criteria are met, including long-term fiscal health and not running counter to the FEGP. The legislative and judicial branches, PREPA and PRASA, and the University of Puerto Rico are not considered monitored entities, so they do not fall under the board’s review powers.

SUPREME COURT ACCEPTS PR RECOVERY ACT FOR REVIEW

The Supreme Court on Friday agreed to decide whether Puerto Rico, which is in the midst of a financial crisis, may allow public utilities there to restructure $20 billion in debt. Puerto Rico’s lawyers had urged the court to take immediate action in light of the overall magnitude of the commonwealth’s debts, around $72 billion, which it says it cannot pay. “Anyone who has even glanced at the headlines in recent months knows that the commonwealth is in the midst of a financial meltdown that threatens the island’s future,” the lawyers wrote in their petition seeking review of an appeals court decision that struck down a 2014 Puerto Rico law allowing the restructurings.“Because that decision leaves Puerto Rico’s public utilities, and the 3.5 million American citizens who depend on them, at the mercy of their creditors,” the commonwealth’s lawyers wrote, “this court’s review is warranted — and soon.”

The United States Court of Appeals for the First Circuit, in Boston, said the 2014 law, the Recovery Act, was at odds with the federal Bankruptcy Code, which bars states and lower units of government from enacting their own versions of bankruptcy law. Puerto Rican officials countered that the Recovery Act addressed a gap in the way its debts are treated. Chapter 9 excludes all branches of Puerto Rico’s government, including its public utilities. The Recovery Act, Puerto Rican officials said, merely filled the gap in the overall legal structure.

Creditors of the utilities sued, arguing that the Bankruptcy Code displaced, or pre-empted, the local law. So far, the courts have agreed. The decision to accept the case for review seems to have reinforced the government’s strategy of appearing to put all of its eggs in the bankruptcy basket so to speak. PR lawmakers were informed Saturday, Dec. 5, that the Governor  won’t be calling a special session to consider the Puerto Rico Electric Power Authority (PREPA) Revitalization Act bill, after all.

CONGRESSIONAL PROPOSAL ON PR

Senate Republicans introduced a bill Wednesday to include up to $3 billion in cash relief, a payroll tax break for residents of the island and a new independent authority that could borrow for Puerto Rico — but with no taxpayer guarantee. “Consistent with the views of Congress and the administration that there will be no ‘bailout’” of Puerto Rico, said a bill summary, “the full faith and credit of the United States is not pledged for the payment of debt obligations issued by the Authority.” “Consistent with the views of Congress and the administration that there will be no ‘bailout’” of Puerto Rico, said a bill summary, “the full faith and credit of the United States is not pledged for the payment of debt obligations issued by the Authority.” The legislation also included a provision to require Puerto Rico — and all the states — to disclose, for the first time, the true financial condition of their pension systems for government workers.

The bill provides for tapping a $12 billion public-health fund created under the Affordable Care Act, for research and preventive medicine programs nationwide. The bill summary said the money was as yet “unobligated,” and could be “repurposed” with federal supervision to help Puerto Rico through an expected cash squeeze this winter. The legislation was introduced by the Republican chairmen of three Senate committees with jurisdiction over Puerto Rico’s: Senator Hatch of Utah, whose Finance Committee has jurisdiction over tax policy; Senator Grassley of Iowa, whose Judiciary Committee is responsible for bankruptcy law; and Senator Murkowski of Alaska, whose Committee on Energy and Natural Resources has jurisdiction over matters involving America’s territories.

The bill would designate a “chief financial officer” for Puerto Rico to advise the island’s governor on drafting and sticking to an annual budget. The designee would remain in place even if the government changes hands in next year’s election, giving Puerto Rico a better chance of seeing through its five-year economic recovery plan no matter who is elected. The bill proposes only further study of  how to revive Puerto Rico’s failing pension system, or changing the way doctors on the island are paid by federal programs like Medicare.

By waiting until the end of the current Congressional session, the bill’s sponsors implicitly indicate that the measure is at best a band aid to fund the upcoming January 1 general obligation bond payment and provide more time for a more serious and comprehensive plan in 2016.

PA MOVES TOWARDS A BUDGET

The Pennsylvania state Senate passed a public pension reform plan Monday by a 38-12 bipartisan vote. Monday’s vote sends the bill  to the House for further action. For school teachers hired after July 1, 2017 and state workers hired after Jan. 1 2018, the bill creates a new, two-track pension plan that combines a reduced guaranteed benefit based on years of service and final salary at retirement with a separate 401(k)-style component. It also will change some rules pertaining to current employees, though the basic form of their pension plan would not change.

Pennsylvania union leaders immediately blasted the bill as unfair to future workers, and noted that it may have passed improperly without a required independent actuarial note from the state’s Public Employee Retirement Commission. Unsurprisingly, the leader of the largest state employees’ union, vowed to continue to fight against the bill in the House, and also promised a certain court challenge if passed because of the changes for current employees.

The  director of the Pew Charitable Trusts States’ Public Sector Retirement Systems project has said that his reviews showed that while retirement benefits for a career worker hired under the new bill’s terms would be reduced about 10 to 15 percent from present, with Social Security that worker could still expect to receive an average of about 90 percent of their take-home pay through the course of their retirement.

The new benefit would cut the current “defined benefit” pension formula in place for workers hired since 2011 in half, essentially guaranteeing new hires 1 percent of their final salary for each year served as opposed to the 2 percent multiplier in place now. That would be paired with a mandatory 401(k)-style piece, into which the state would contribute the equivalent of 2.5 percent of an employees’ salary to their personal retirement account. Between the two components, school district employees hired under the new plan would contribute 7.5 percent of their salaries to their retirement. Affected state workers would contribute 6.25 percent.

There is a carve-out for “hazardous-duty” workers, including state police, corrections officers, game wardens and park rangers, for whom the current defined-benefit plans would continue. Current state and school district employees would see changes including changes to rules regarding lump-sum withdrawal of individual pension contributions for any payments made into the system, starting Jan. 1 for state workers and July 1 for school employees. Also included were resets to the final salary calculation to the higher of average salary over the last three years of employment, excluding overtime; or the average of the last five years’, overtime included.

The bill includes an adjustment up to workers’  payroll contributions by 0.5 percent if, over the prior 10-year period, the state’s two major retirement funds have missed their investment return targets by a full percentage point. On the other hand, contributions would be cut by a half-percent if investment gains beat targets by 1 percent. The review would be applied once every three years. Actual savings from the reform bill are small: the Senate released an analysis Monday putting the number at $2.6 billion over the next 20 years, against a cumulative cost of over $200 billion. As a result, other budget issues will have to be relied upon to stabilize the Commonwealth’s finances and ratings.

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