Joseph Krist

Municipal Credit Consultant

ALL GOING WRONG FOR PUERTO RICO

If it had not already, PR’s financial crisis has reached critical mass for sure. The GDB was a source of loads of negative news. First, it announced that the Commonwealth would be unable to meet its required annual financial disclosure by May 1. Then the Bank released a letter to the Legislature which suggested that the Commonwealth would be unable to meet its liquidity requirements at the start of the fiscal year on July 1.

The bank made the warning in a letter made public a day after it was sent to Gov. Alejandro Garcia Padilla and the presidents of the island’s Senate and House of Representatives. “The island’s financial state is extremely uncertain,” the letter said. “A government shutdown would have a devastating impact on the economy, with salary and public service cuts, and a long and painful recovery.”

The letter urged legislators to immediately implement measures to cut costs and balance the budget and that  the government needs to approve a five-year plan to help reduce a $73 billion public debt as well as approve sweeping changes to the island’s  tax system.

In a number of interviews, David Chafey, president of the bank’s board of directors said once the government does that and presents a balanced budget, then it can be in a better position to issue bonds. “Time is passing, and it’s passing quickly,” he told The Associated Press. “We need to provide investors with some kind of comfort.”

Typically one agency of the government will not write to the rest of the government so openly but the letter was issued amidst negotiations between  Gov. Garcia and members of his party who oppose legislation that would impose a 16% value-added tax that he says is needed to help generate more revenue. In the House of Representatives a group of legislators reached a tentative agreement to impose a 14% value-added tax. If passed, the measure would then go to the Senate.

Stunningly, the GDB letter and the Governor’s efforts appear to have been for naught. Earlier in the morning of the the Governor’ s speech the House convened to consider the Governor’s plan to impose a value added tax of VAT as part of his financial reform package. In the session which ran past 3 a.m., the House of Representatives voted down the tax reform bill after failing to secure enough votes from the Popular Democratic Party (PDP) majority. Along with the New Progressive Party minority delegation, six PDP members voted against the measure. The final vote count was 22 in favor and 28 against.

The governor characterized their vote as “irresponsible” and “disloyal,” and the House speaker said that the PDP caucus will seek disciplinary sanctions for the six legislators.

After the vote, Puerto Rico Gov. Alejandro Garcia Padilla unveiled a $9.8 billion operating budget Thursday night in which he pledged to reduce crime, create jobs, boost school attendance and expand the U.S. territory’s tourism sector during a state of the commonwealth address. Padilla said he plans to reduce the island government’s $2.2 billion deficit to $775 million in one year, in part by taxing those who earn $200,000 or more a year or who buy homes valued at $1 million or more. He did not provide details about those taxes. On the sales tax front, Padilla also said that by Dec. 1, he will reduce the 7 percent sales tax to 6.5 percent and continue to exempt items including prescription medicine, books and non-processed foods. Those looking for an austere budget will be disappointed that Padilla promised that overall, more than 40,000 public employees in 28 agencies will see pay increases by next February. Padilla’s proposal is $750 million higher than the current budget, which legislators of the opposition party questioned.

According to recent reports by Bloomberg and Reuters, PREPA bondholders will be granting the utility a 30-day extension on its forbearance agreement, which had been set to expire today. This would be the third extension conceded to the troubled utility after the original March 31 deadline.

 PRISON DEBT BACK IN THE SPOTLIGHT

It has always been one of the riskier areas of the high yield market so the news of at least two facilities having debt problems in Texas is not a surprise. One is the now empty  Willacy County Correctional Center in Raymondville. One morning late last month, the prisoners rioted. Guards put down the uprising in about five hours, but the destruction was so extensive as to force the closure of the facility leading to all 2,800 inmates being transferred. “Worst scenario, we’ll lose about $2.3 million annually, which is about 23 percent of our income,” said one Willacy County commissioner.

The County counts on the prison as a business generating revenue. The prison’s water and sewer bill is $50,000 a month. Once insurance pays for extensive repairs to the prison, the county needs to fill those beds again as the facility is looked as a way to generate revenue and create jobs. Willacy County built three of them. The Correctional Center was the largest, with a staff of nearly 400. They’re now unemployed.

The County sold bonds, built the prison and hired an operator — Management & Training Corporation (MTC). MTC contracted with the U.S. Bureau of Prisons to incarcerate low-security male immigrants who are serving out sentences for illegal border crossings and aggravated felonies. Many if not most of the private prisons in the Southwest were built to service this “market”. For that service, the federal agency paid MTC to manage the prison. Then MTC paid the county $2.50 per prisoner, per day. But ultimately, it’s the county that’s on the hook for its $63 million debt on the nine-year-old prison.

When the U.S. Bureau of Prisons canceled its contract with Willacy County last week, it explained that the federal inmate population was down, and it didn’t need additional beds. The prison will be in competition with several other facilities for a more scarce “commodity”.  Like many private facilities, inmates have complained of bad living conditions and substandard medical care. MTC emphatically disputes this criticism. The company has hired a third party to investigate why the inmates mutinied. Meanwhile, Willacy County plans to cut all non-essentials in its budget — such as plans for a courthouse renovation and a new hurricane shelter.

Elsewhere in Texas, on February 2, 2015, the Trustee, UMB Bank, N.A., for the $42 Million Bondholders has notified the Maverick County Public Facility Corporation that Maverick County failed to make a scheduled $1,415,000 principal payment on Bonds on February 1, 2015, but did make the February 1, 2015 interest payment. Consequently, the Trustee had advised the Maverick County Public Facility Corporation that there are “several events of default have occurred and are continuing under the Indenture.

As is usually the case, all Project Revenues are pledged as security for the Bonds and the County is obligated to cause all Project Revenues to be delivered directly to the Trustee. The County continues to intercept Project Revenues, which constitutes a violation of the County’s obligations under the Lease.The County has then remits funds that it requisitions back for payment of operating expenses. Under the terms of the Lease, all Project Revenues must be delivered directly to the Trustee and are to be used to pay Rental Payment Deposits first, prior to using such revenues to pay Project operating costs and expenses. The County’s failure to deliver intercepted funds to the Trustee for application towards the Rental Payment Deposit caused an Event of Default.

A further complication is the fact that the Corporation had its non-profit corporate charter forfeited in August 28, 2009. The Maverick County Public Facility Corporation continued to enter into many legal agreements regarding the operation, management, and detention of federal prisoners at its Maverick County Detention Center as well as with the $42 Million Bondholders and Trustee, the U.S. Marshal’s Service, financial advisors, legal counsel, and other third party contractors. All of these actions potentially expose Maverick County to significant financial risks and liabilities.

The Maverick County Public Facility Corporation is in negotiations with the $42 Million Bondholders and Trustee in either restructuring the principal and interest payments owed on the debt and/or the forbearance of these payments and recently terminated its long standing financial advisor, Southwestern Capital Markets, Inc., while retaining a new one in First Southwest Capital.

The potential workout is additionally complicated by events associated with ongoing federal corruption investigations of the County. A Maverick County commissioner and former justice of the peace were arrested last week as part of an ongoing bribery investigation in the border city of Eagle Pass that has resulted in arrests bringing the total number of people charged in the ongoing investigation into a bid-rigging and kick-back scheme in Maverick County to 22. Among the others charged are three former county commissioners all of whom have pled guilty.

In Burnet County, a private jail deal will produce significant principal losses for bond holders after the facility is sold to the County. The 587 bed jail has been privately operated until 2014 when the County took it over. The County will pay $14.85 million for the facility while there are some $32,770,000 of bonds outstanding. The jail had been consistently underutilized and had proven to be a less than secure facility after several escapes. County inmates are sufficient to occupy only about 30% of the beds.

WAYNE COUNTY FINANCIAL UPDATE

Earlier this year we reported on the financial woes facing Wayne County which includes the City of Detroit within its borders. This week County  Executive Warren Evans unveiled a recovery plan with deep cuts – including wiping out retiree health care – in an effort to avoid bankruptcy. According to Evans, “this plan will prevent bankruptcy even though in some areas we are worse off [than when] Detroit was pre-bankruptcy.”  Wayne has just under $700 million of limited-tax general obligation bonds and $302 million of LTGO notes outstanding.

The plan eliminates the county’s $52 million structural deficit but the pension system that’s only 45% funded with a $910 million shortfall and a $200 million, bond-funded jail project in downtown Detroit that the county abandoned half built due to lack of money are not dealt with. Since 2008, the county’s has plugged general fund shortfalls by shifting money from its pooled cash fund. According to the County Executive, the county will not be liquid enough to rely on fund transfers anymore and will be entirely out of money by next summer.

The plan would eliminate health care for future retirees. It would move most employees and some retirees to high-deductible insurance plans and provide retirees with fixed and limited subsidies for the purchase of supplemental insurance, likely under the new federal health care law. That’s similar to what Detroit did in its bankruptcy, shifting retirees to the national exchange. These cuts would save $28.4 million in 2015, with annually increasing savings rising to $49.8 million by 2020.

It raises the retirement age to 62 and reduces future pension benefits by changing the pension multiplier. It increases the number of years used to determine compensation to 10 years from the current three- to five-year equation. All county employees would see 5% salary cuts. The total impact of these cuts would mean $60.3 million in savings for the county, including $53.4 million in the general fund.

In February, Evans blamed the county’s problems on a loss of property tax revenue and “fiscal and managerial mismanagement.” The county receives 60% of its general fund revenue from property taxes, which fell to $289 million by fiscal 2013 from $408 million in fiscal 2008. The plan assumes no increase in property tax revenue until 2018, and then only a $4 million boost.

The problems on the capital side are based in the county issue of $200 million of bonds in 2010 for a new jail, which is supposed to replace the current aging criminal justice facilities. But the county was forced to abandon the project in 2013 when it became too costly, and the county cannot return to the markets for additional financing in its current fiscal condition.

The county lost its last investment-grade ratings shortly after initial comments about the county’s finances in February.

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

TOBACCO USE DATA RELEASED

This is the time of year when tobacco securitization investors refocus attention on sales figures and funds available for distribution at mid-month under the terms of the Master Settlement Agreement. As the states and their subdivisions calculate exactly how much is available to them from the April distribution, other data becomes available regarding smoking trends which are central to the analysis of these bonds.

The most recent Morbidity and Mortality Weekly Report (MMWR) from the Centers for Disease Control and Prevention and the U.S. Food and Drug Administration’s Center for Tobacco Products (CTP) showed that Current e-cigarette use among middle and high school students tripled from 2013 to 2014, according to the data. Findings from the 2014 National Youth Tobacco Survey show that current e-cigarette use (use on at least 1 day in the past 30 days) among high school students rose from 4.5 percent in 2013 to 13.4 percent in 2014, or from approximately 660,000 to 2 million students. Among middle school students, current e-cigarette use more than tripled from 1.1 percent in 2013 to 3.9 percent in 2014—a rise from approximately 120,000 to 450,000 students.

This is the first instance since the survey started collecting data on e-cigarettes in 2011 that current e-cigarette use has surpassed current use of every other tobacco product overall, including conventional cigarettes. Hookah smoking roughly doubled for middle and high school students, while cigarette use declined among high school students and remained unchanged for middle school students. Among high school students, current hookah use rose from 5.2 percent in 2013 (about 770,000 students) to 9.4 percent in 2014 (about 1.3 million students). Among middle school students, current hookah use rose from 1.1 percent in 2013 (120,000 students) to 2.5 percent in 2014 (280,000 students).
There was no decline in overall tobacco use between 2011 and 2014. Overall rates of any tobacco product use were 24.6 percent for high school students and 7.7 percent for middle school students in 2014.

What is problematic for investors is that In 2014, the products most commonly used by high school students were e-cigarettes (13.4 percent), hookah (9.4 percent), cigarettes (9.2 percent), cigars (8.2 percent), smokeless tobacco (5.5 percent), snus (1.9 percent) and pipes (1.5 percent). The products most commonly used by middle school students were e-cigarettes (3.9 percent), hookah (2.5 percent), cigarettes (2.5 percent), cigars (1.9 percent), smokeless tobacco (1.6 percent), and pipes (0.6 percent).

The results are problematic as MSA revenues are based on sales of actual cigarettes or “sticks” rather than sales of all tobacco products such as roll-your-own tobacco and smokeless tobacco e-cigarettes, hookahs and some or all cigars. Should this trend continue, expected rates of cigarette shipment declines should be anticipated with negative impacts on securitization cash flows.

KANSAS REVENUE WOES CONTINUE

A new forecast issued Monday projects that the state will collect $187 million less in taxes through June 2016 than anticipated. This may force Gov. Sam Brownback and the Legislature to consider larger tax increases than they had expected to balance the state budget. Before the new forecast, they had been working on budget proposals requiring about $150 million a year in tax increases. Revising a forecast made in November, state officials and university economists reduced the estimate for total tax collections for the current fiscal year by nearly $88 million, to about $5.7 billion. They also cut the tax collection estimate for the fiscal year beginning in July by nearly $100 million.

MORE NEGATIVE NEWS FOR PREPA

OFG Bancorp announced that its Oriental Bank subsidiary (“Oriental”) will place its $200 million participation in a fuel purchase line of credit with the Puerto Rico Electric Power Authority (PREPA) on non-accrual status and will take a $24.0 million provision. The move reflects Oriental’s view that PREPA, despite its oil price related increasing ability to meet contractual obligations with creditors, has signaled an unwillingness do so.

Oriental, said, “Our credit analysis, based principally on data provided by PREPA and its advisors, shows the utility has the financial capability to pay its creditors. However, in the recent negotiation for extending the more than 8-month forbearance period previously granted by its creditors, PREPA clearly demonstrated a reluctance to commit to do so, despite the utility’s improved cash flows.”

Oriental’s $200 million PREPA exposure was acquired through the late 2012 purchase of BBVA’s Puerto Rico operations, and is part of a syndicated $550 million fuel purchase line of credit.

NEW JERSEY DOWNGRADE

Moody’s downgraded New Jersey’s general obligation bonds to A2 from A1. The outlook is negative. Ratings on the state’s appropriation-backed, other GO-related debt, and intercept programs were also lowered one notch. The downgrade to A2 was driven by the continuation of the state’s weak financial position and large structural imbalance, reflecting continued pension contribution shortfalls. Liquidity and structural balance are projected to remain very weak through fiscal 2016 – a longer period than contemplated. While some stabilization in budget performance, economy, and liquidity was noted, Moody’s is concerned that beyond fiscal 2016, the state’s plan to restore long-term structural balance relies on economic growth and further pension reforms, which have uncertain timing and impact.

The negative outlook reflects anticipated further decline in the state’s financial and pension position before pension reform, if successful, is implemented. Without meaningful structural changes to the state’s budget, such as pension reform that dramatically improves pension affordability, the state’s structural imbalance will continue to grow, and the state’s rating will continue to fall.

ATLANTIC CITY

The City of Atlantic City was granted a 60-day extension on a $40 million state loan that was due on March 31. The extension comes as a lawsuit was filed by the Borgata Hotel Casino that could challenge future bond sales. The city’s emergency manager Kevin Lavin released a report on March 24 recommending cutting expenses by $10 million this year as well as negotiating with key stakeholders to help create “fiscal stability.” Atlantic City is facing a projected $101 million budget gap in 2015.

Recent economic news includes a grand-opening for a new 85,450-square-foot Bass Pro Shops Outpost store with 200 employees on April 15. A new 16,000-square-foot development from BET Investments featuring upscale stores is also scheduled to open this year next to the Boardwalk Hall sports arena. One day after Polo North, a Wellington, Fla.-based developer received court approval to buy the Revel casino for $82 million, Polo North Inc. and Stockton University in Galloway Township, N.J. announced plans on April 3 to invest more than $500 million in the city.

Stockton, a public college, is slated to open its new Island Campus at the former Showboat Casino Hotel site in Atlantic City this fall. Polo North deposited $26 million in escrow for Stockton, which covers the $18 million purchase price the university paid for the former casino property as well as other costs incurred such as maintenance, utilities, employees and insurance.

Stockton has an 18-month first right to purchase or lease the property for educational purposes. A contingency in the deal allows the university a 90-day period to terminate the contract as it evaluates potential legal challenges from the neighboring Trump Taj Mahal, which has tried to block the bid because it doesn’t want college students living next to its casino.

CA WATER RATE DECISION

A California state appeals court on Monday ruled that a tiered water rate structure used by the city of San Juan Capistrano to encourage conservation was unconstitutional. The Orange County city used a rate structure that charged customers who used small amounts of water a lower rate than customers who used larger amounts.

The 4th District Court of Appeal struck down San Juan Capistrano’s fee plan, saying it violated voter-approved Proposition 218, which prohibits government agencies from charging more for a service than it costs to provide it. “We do hold that above-cost-of-service pricing for tiers of water service is not allowed by Proposition 218 and in this case, [the city] did not carry its burden of proving its higher tiers reflected its costs of service,” the court said in its ruling.

The court opinion means that tiered prices are legal as long as the government agency can show that each rate is tied to the cost of providing the water. A group of San Juan Capistrano residents sued that city, alleging that its tiered rate structure resulted in arbitrarily high fees. The city’s 2010 rate schedule charged customers $2.47 per unit — 748 gallons — of water in the first tier and up to $9.05 per unit in the fourth. The city, which has since changed its rate structure, was charging customers who used the most water more than the actual cost to deliver it, plaintiffs said. The law, they argued, prohibits suppliers from charging more than it costs to deliver water.

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

STADIUM FINANCE BACK IN THE SPOTLIGHT

The upcoming NFL draft has focused most attention and interest on who will be playing where next season. Based on recent performance, fans of the St. Louis Rams should be focused on player personnel issues but instead the primary issue is how long will they have a team to root for. Last month, NFL Commissioner Roger Goodell announced that the league was accelerating its efforts to move a team to Los Angeles. St. Louis Rams owner Stan Kroenke, with land in Los Angeles and a fully developed construction proposal, is a frontrunner in the race.

It has been pretty well established that the financing of professional sports facilities with public funds has generated questionable returns on that investment to the taxpayers of the entities backing those projects. Nonetheless, Missouri Gov. Jay Nixon’s two-man stadium task force has been working for months to solidify financing and sidestep project-killing delays before presenting plans for a $985 million riverfront stadium to a National Football League owners committee this spring.

The plans have been controversial and it is unclear that local residents would support such investment, especially in the City of St. Louis. There has been significant pressure to submit the question to a public referendum. In response, the public body that owns and operates the Edward Jones Dome filed suit Friday against the city of St. Louis, seeking to avoid a civic vote on the use of taxpayer money for a new downtown football stadium. Filed in state court, the suit claims that a 2002 city ordinance requiring a public vote is “overly broad, vague and ambiguous.” The suit seeks a ruling that the ordinance either does not apply, conflicts with state statute or is unconstitutional.

The suit is complicated by the fact that the City and State political establishments have been working together to build a new stadium. At the same time, the city counselor has a responsibility to vigorously defend all the laws of the city. City of St. Louis residents voted in favor the ordinance in 2002 by nearly 10 percentage points — 55 percent to 45 percent. St. Louis County voters approved a similar measure two years later, 72 percent to 28 percent. Approved as a municipal ordinance in the city and a charter amendment in the county — the two laws prohibit any “financial assistance” from the city and county to a professional sports facility without voter approval. They define “financial assistance” to include tax reduction, tax-increment financing, land preparation, loans, donations, payment of obligations, and the issuance, authorization, or guarantee of bonds.

The initial plans for the stadium included up to $450 million from the NFL and team, $130 million in personal seat licenses, some tax incentives and as much as $350 million through a “bond extension.” To support debt issued for the current stadium, the state sends $12 million a year to the authority which operates the existing Edward Jones Dome. Those funds amortize construction bonds and cover upkeep on the stadium. The city and county each send $6 million.

Now the political winds may be changing. St. Louis County Executive Steve Stenger has said that the Governor is no longer looking to funding from the County.  The lawsuit spells out the city’s now-expanded role in a new facility. According to the new filing the city will issue new bonds, which will pay off the city’s debt on the existing stadium as well as provide funding for construction of the new stadium. Debt service, the suit says, will not exceed the $6 million a year in current payments. The city also will donate land to the project, and provide tax-increment financing or creation of a transportation development district or community improvement district.

The Governor and Jim Shrewsbury, the Nixon-appointed Dome authority chairman and former city aldermanic president said that they didn’t think “another public vote” was required. Dome authority attorneys agree. Ten of the authority’s 11 board members at a meeting in January unanimously passed a resolution that allowed the authority chair to hire contractors and file suit on behalf of the board. The Mayor of St. Louis has not taken a public position on the financing but has written to city aldermen, promising to “vigorously defend the validity of our ordinance” and, whatever the outcome, follow the law. Confusing many, the  letter went on to describe plans to continue the City’s $6 million annual payments beyond the current debt expiration in 2021.

We are of the view that the stadium backers should follow the route taken by MLB’s San Francisco Giants and the owners of the NFL’s Jets and Giants and privately finance a new stadium. That is not to say that provision of land is out of the question. But the use of limited tax revenues and borrowing capacity for a private benefit facility like this is not the way to go.

SMUD COMPLETES LONG CREDIT ROAD BACK

The recent announcement by Moody’s that it has upgraded the rating on the Sacramento Municipal Utility District’s (SMUD) outstanding $1,873,105,000 electric revenue bonds to Aa3 from A1 and the rating on the $347,850,000 subordinate lien revenue bonds to A1 from A2 with a stable outlook completes a long journey on the road to credit recovery.

June 7 will mark the 16th anniversary of the vote to close the Rancho Seco Nuclear plant after a failure of power supply for the plant’s non-nuclear instrumentation system led to steam generator dryout which the NRC called the third most serious safety-related occurrence in the United States at a nuclear generating plant.

In supporting the upgrade Moody’s cited timely rate-setting as an unregulated utility with no revenue transfer requirement to city or regional governments; effective risk management program; improved financial metrics; the strong competitive position against regional peers; the improvement in the diverse local area economy; and the sourcing of 26% of renewable energy for retail load while maintaining competitive prices. Ironically, the forced closing of Rancho Seco may have been a long-term blessing in disguise for SMUD given California’s aggressive stance towards renewable energy. For example, California contemplates ramping up the renewable power standard to 50% by 2030.

SMUD may need to incur incremental capital expenses for a potential major pumped storage facility that would be used to help manage intermittent power flows owing to the state’s increased reliance on renewable energy. SMUD’s leverage ratios reflect a much more favorable debt profile, Any new capital spending is expected to be funded significantly from internal sources and the cost of construction of a pumped storage facility could be shared with area utilities.

LATEST PUERTO RICO REVENUE DATA…

Treasury Secretary Juan Zaragoza Gómez announced that General Fund revenues totaled $838.6 million in March, up by $53.5 million from March 2014. The 6.8% year-over-year increase is the highest increase registered during the past eight months. corporate income tax revenues were $104.8 million; this figure was up $36.2 million from March 2014 and $22.4 million above estimates. In addition, the Treasury Secretary pointed out that corporate revenues have not exceeded $100 million for a month of March since 2007. Individual income tax collections exceeded March 2014 collections by $22.0 million, a 13.2% increase.

Foreign corporation excise tax (Act 154) revenues were up by $57.9 million, or 40.5%, year-over-year. Alcoholic beverages and tobacco products collections increased by $1.3 and $1.4 million, respectively. In March, Motor vehicle excise tax collections, which have registered consecutive double digit percentage reductions throughout the fiscal year-to-date, registered the smallest reduction ($1.7 million, or 5.6%) in the last 9 months. The Treasury Secretary announced that fiscal year-to-date revenues total $6.0 billion, which is $153.2 million, or 2.5%, below estimates.

WHILE DEBT REMAINS THE FOCUS

Efforts continue to work out PREPA’s debt troubles as bondholders have offered to extend their forbearance agreement with the utility for another 30 days. The offer includes a mutual commitment to continue working together on the refinement of a capital investment and rate plan, a timeline for PREPA agreeing to a work production plan and outside review of the work plan and information exchanges between the parties with provisions for public review. The news came as the PR legislature held hearings with the lead witness being the Authority’s Chief Restructuring Officer. Increasing frustration is being expressed by all sides at the slow pace of negotiations and the market impact of such a significant cloud of uncertainty. The authority’s chief restructuring officer, Lisa Donahue, told the commission she will present a first draft of a restructuring plan by June 1.

Those concerns are reflected in an increasing and more frequent Federal presence on that part of various U.S. Treasury officials who have been seen in more frequent meetings with Commonwealth financial officials. This reflects potential roadblocks emerging in the effort to reliquify the GDB with one report indicating that A group of hedge funds is demanding that as one condition of lending $2.2 billion to Puerto Rico, lawmakers must balance its budget for the long haul or agree to be found in default if a gap emerges. This would be a heretofore unseen requirement in the municipal market. During a local radio interview early Wednesday, GDB President Melba Acosta admitted it will be difficult to go to the market in the near future as tax reform, the fiscal year 2016 budget proposal and the situation at the Puerto Rico Electric Power Authority, among others, converge.

CA DROUGHT UPDATE

The Metropolitan Water District, which sells imported water to more than two dozen local agencies serving 19 million people in Southern California, voted Tuesday to reduce regional deliveries by 15 percent as the state grapples with a fourth year of drought. The board will revisit the issue in December. Cities that want to buy more water will have to pay penalties of up to four times the normal price for extra deliveries.

Moody’s has weighed in with its view that the governor’s executive order imposing water use restrictions to achieve 25% statewide reductions is overall credit negative for the state’s water utilities. It is their view that the utilities have little time to increase rates and fees to promote conservation, and the mandated conservation will reduce operating revenue. The fiscal impact will be to reduce the sector’s debt service coverage and reserves.

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

RHODE ISLAND PENSION SETTLEMENT PROPOSED

Rhode Island and most of its public employee unions reached a tentative settlement last week to the comprehensive challenge to the state’s 2011 overhaul of its beleaguered pension system. The settlement, which affects 59,000 current and past state employees, provides for adjustments to the minimum retirement age, the chance for more frequent cost-of-living increases and an increase in the defined-benefit pensions available to longtime public employees. If approved by the court and the General Assembly, the proposal would end litigation from six challenges arising from changes made to the pension system in 2009, 2010 and 2011. The court will set a schedule for the parties to implement the settlement, and the remaining three lawsuits will be addressed by the Court. The April trial date will be vacated for the purpose of implementing the settlement. It still must be approved by the General Assembly.

Six of the nine unions that sued the state agreed to the settlement. The three unions that have not settled represent about 800 employees; their challenge will be addressed by the court after the settlement is implemented. But a trial scheduled to begin this month has been averted. The settlement also relieves the new governor, Gina Raimondo of a major headache as she seeks to address Rhode Island’s struggling economy. In her prior role as the state’s general treasurer, she was the chief architect of the pension overhaul under challenge.

“The state had a very strong case, but Ms. Raimondo said that “to take the litigation risk off of the table is the right thing to do.” The settlement gives financial certainty to employees and retirees, she said, and is affordable for taxpayers. “All of the structural elements of the original pension legislation remain intact,” she said, adding that those elements provide “a fundamental restructuring of the system and fundamentally puts the system in a much healthier position.”

The $14.8 billion pension system was overhauled by the legislature when it created a hybrid plan that split direct contributions between the state and employees. It also suspended cost-of-living adjustments and raised the retirement age by five years, measures intended to save $4 billion over 20 years. Those changes angered public employee unions, which then sued to  challenge the plan as unconstitutional. The unions actively opposed Ms. Raimondo’s candidacy last year for governor.

The proposed settlement has received generally favorable reviews from outside observers. Frank Shafroth, the director of the Center for State and Local Government Leadership at George Mason University, said the settlement appeared to be good for Rhode Island, “because not agreeing to it means the long-term problem gets worse.” Part of the problem for pension systems across the country is that employees are living longer than in previous generations, Mr. Shafroth said, so settlements like this are going to become more necessary. He added that he regarded the Rhode Island settlement “as a very constructive development.” Roger Boudreau, who leads the Rhode Island Public Employees’ Retiree Coalition, told The Associated Press that retirees would not be happy with the settlement because they were getting “a fraction” of what they were promised. But, he added, they knew their chances of prevailing at trial were “very slim at best.”

The perception of continuing progress of pension reform in Rhode Island removes a significant drag on its credit standing. The state still needs to renew its economy after long term declines in its old manufacturing base but the pension issue is a major building block in the establishment of structural balance for the state’s finances.

ILLINOIS LEGISLATURE LOOKS AT CHAPTER 9 FOR CITIES

Illinois statutes don’t currently grant general legal authority allowing for a Chapter 9 filing by municipal entities with the one exemption being for the Illinois Power Agency. A recent hearing was held by the House Judiciary-Civil Law Committee on House Bill 298, sponsored by Rep. Ron Sandack, R-Downers Grove, which would permit local governments to file for Chapter 9 bankruptcy. Conditions allowing for such a filing such as state approval and potential alternatives were also discussed at the March 20 hearing.

The committee heard from representatives of the public finance community and civic organizations who pressed to make new options available for struggling communities and offered an alternative in the form of a new authority to assist local governments solve fiscal problems without bankruptcy. While a bankruptcy provision has not gained much traction with Democrats who control the General Assembly, discussions over whether Illinois should add such a law has received heightened attention since the new Republican governor, Bruce Rauner, proposed the option. Police and fire unions urged against permitting Chapter 9.

Sandack said his bill would require municipalities to first show they truly are insolvent and have made a good faith effort to restructure their debts with creditors. “By sponsoring this bill I am not encouraging municipalities to abandon efforts to regain financial stability on their own. The bill would simply provide municipalities with an additional tool to help them get their financial affairs in order,” he said.

Local governments face big increases in their public safety pension contributions next year due to a prior state mandate to shift to an actuarially required contribution level. There is a school of thought that says that the Governor and others want to give local governments more leverage in negotiating pension reforms. There is also the fact that Rauner has proposed to halve the amount of income tax revenue distributed to municipalities.

The well-regarded Chicago Civic Federation, is supporting a measure to create an authority designed to intervene before a government’s fiscal strains reach crisis stage. The quasi-judicial authority would help local governments deal with pension-related and other fiscal burdens threatening their solvency. The goal would be to avoid defaults and bankruptcy while putting a government on a sustainable path.

Existing law in the form of The Fiscally Distressed City Act is for cities with a population under 25,000. Under its terms, a local government must ask the General Assembly for the appointment of a special commission to consider whether the municipality meets the act’s criteria and if approved it can qualify for state financing assistance.

We would favor a mechanism for more robust intervention and oversight vs. the bankruptcy option. The Detroit experience showed the vulnerability of debt holders under that process and we think that any trend in that direction should be opposed.

CHICAGO ELECTION

A brief word about the Chicago election results which saw Rahm Emanuel elected to a second term. Viewed through the prism of a bondholder, the result has to be viewed positively. While significant financial issues remain for the City, many of the actions for which the mayor was criticized politically – school reform, higher taxes and utility rates, and pension change proposals – were all positive for bondholders. That is not to say that we expect rating stability or improvement but the uncertainty over the direction of city policies over the next four years were a significant drag on the City’s credit which has now been somewhat mitigated.

KANSAS GOES THE PENSION BOND ROUTE

The Kansas legislature approved an authorization for pension bonds as part of its overall budget process. Kansas is now expected to issue $1 billion in bonds to bolster its pension system for teachers and government employees. The Kansas Public Employees Retirement System would receive an infusion of cash, immediately narrowing a long-term gap in funding for retirement benefits. The pension system would invest the money and expects its investments to earn significantly more than the state would pay on the 30-year bonds.

The bill limits the state to paying 5 percent or less in interest to bond investors, and the pension system expects to earn 8 percent annually on its investments the long-term. The state issued $500 million in pension bonds in 2004, paying almost 5.4 percent in interest. The pension system’s investment earnings have averaged 7.7 percent annually since then.

Whether or not the plan is a good budget or credit move is subject to debate because the move also is designed to help with the state budget by decreasing state contributions to public pensions by $64 million over the next two years. The pension system already was on track to close a projected $9.8 billion gap between revenues and benefit costs from now until 2033 under laws enacted in recent years that require increasing state contributions to pensions.

The state must close a budget shortfall projected at nearly $600 million for the fiscal year beginning July 1. The gap arose after lawmakers, at Brownback’s urging, slashed personal income taxes in 2012 and 2013 to stimulate the economy. This would appear to be yet another iteration of borrowing for operating expenses regardless of the academic arguments supporting such debt. The borrowing would not be necessary if sound financial practices were not overruled by ideological zeal.

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 REMAINS TURBULENT

The Puerto Rico Electric Power Authority (PREPA) announced Monday that it agreed with its creditors to extend their previously negotiated forbearance agreements for 15 days. Creditors agreed not to take any enforcement actions against the utility while the forbearance agreements remain in effect. The creditors, who hold more than$9 billion of its debt, have the right to accelerate their claims, potentially forcing the utility into insolvency. PREPA previously missed a deadline  March 2 when it was supposed to present bondholders with a comprehensive restructuring plan. PREPA had previously told creditors restructuring would likely take 10 years instead of an expected five years. The creditors did not take action when the March 2 milestone was missed.

Some of the creditors are said to have offered additional financing to overhaul operations in return for concessions such as using the current drop in oil prices to pay off debt. Other measures needed to secure additional financing could include collecting unpaid electricity bills from the government and taking stronger action against electricity theft.  The savings to PREPA from the recent drop in oil prices is estimated by some at around $1 billion.

The negotiating creditor group represents over 60 percent of PREPA’s bondholders and includes large hedge funds such as Blue Mountain Capital and Appaloosa Management, mutual funds Oppenheimer and Franklin Templeton, bond insurers, as well as Citibank and Scotiabank.

On the general obligation front, the Commonwealth seeks to move forward on its proposed $2.95 billion refinancing to reliquify the GDB. After four rounds of legislative amendments, the bonds are projected to come at an original-issue discount lower than 93 cents on the dollar. When the bond issue finally comes (with an interest-rate cap of 8.5%), it could end up yielding as much as 10% when the original-issue discount is factored in.

A little more than a week has gone by since the passing of new taxes to support the bond issue (la crudita). There have already been increases at the gasoline pump of 4 cents a liter, which will cost the average consumer about $277 annually in additional transportation costs alone, according to estimates by some economists. The cost to large corporations is estimated by these same economists as the equivalent of a 2.4% tax rate. No formal economic-impact study was conducted before la crudita was approved. Government statistics already indicate a decline in the volume of gasoline sold in PR during the past five years. Some of the reasons for the decline include the use of more fuel-efficient vehicles, including hybrids, and a population decrease due to migration and a lower birth rate.

At the same time, longer term tax reform continues to be considered in the legislature. Intense and widespread opposition to the initial tax reform proposed by the administration of Gov. Alejandro García Padilla is forcing major changes to that plan, which is expected to substantially cut down on the size of the proposed increase in the consumption tax, and as a result, the amount of revenue it will raise. House Speaker Jaime Perelló is proposing a 12% VAT, which would still provide space for substantial income-tax relief. That plan would raise an estimated $500 million, rather than the $1.2 billion originally proposed by the administration, according to House Finance Committee Chairman Rafael “Tatito” Hernández.

Top administration officials, including the governor, have said that lowering the proposed tax to that level would require cutting back on the income-tax relief proposed under the tax-reform plan. Senate Finance Committee Chairman José R. Nadal Power said budget discussions would also be a guide to determining the final outlines of the proposed reform, but added that keeping the VAT to 12% would be a “great achievement.”

PA. P3 FINANCING

PennDOT has begun to use its authority to issue up to $1.2 billion in Private Activity Bonds (PABs) as granted by the U.S. Department of Transportation. These tax-exempt bonds, which are less expensive than traditional financing options available to private firms, will account for the majority of the total capital costs of the Pennsylvania Rapid Bridge Replacement Project at a low borrowing cost. This is consistent with other P3 projects in other states.

The first tranche of debt for the  Pennsylvania Rapid Bridge Replacement Project recently closed. The consortium successfully priced $721,485,000 of tax-exempt Private Activity Bonds (PABs) on February 24th. The BBB rated bonds, priced at a premium, were oversubscribed, and were purchased by over 40 different investors. J.P. Morgan and Wells Fargo acted as the underwriters.

The project is the first public-private partnership (P3) to bundle multiple bridges in a single procurement in the U.S. Granite Construction Company anticipates booking a 40 percent share of the contract. Plenary Group is the project sponsor, financial arranger and primary investor for the Plenary Walsh Keystone Partners consortium, which has been contracted by the Pennsylvania Department of Transportation (PennDOT) to deliver the project. The Plenary Walsh Keystone Partners consortium includes The Walsh Group, Granite and HDR. Construction is expected to begin in May 2015, with a projected completion date of December 2017.

Under the contract, Plenary Walsh Keystone Partners will finance and manage the design, accelerated construction, financing, maintenance and rehabilitation of 558 geographically dispersed, structurally deficient bridges across the state over a 28-year contract term. PennDOT will be responsible for routine maintenance such as snow plowing and debris removal. To ensure PennDOT’s construction program is met, Plenary Walsh Keystone Partners is utilizing 18 different Pennsylvania-based subcontractors to leverage local knowledge and existing sub-contractor networks

PennDOT will continue to own all of the bridges included in the project. The department is contracting the design, construction and lifecycle maintenance responsibilities for 25 years. The Plenary Walsh Keystone Partners team will be responsible for any failures or defects that might occur during the term of the contract in addition to expected maintenance, similar to an extended warranty. If properly designed and constructed a bridge should not require significant maintenance during the first 25-35 years, but the contract serves as a warranty to ensure the bridges are constructed to achieve the lowest lifecycle cost of ownership.

This project includes 558 of the roughly 4,000 structurally deficient bridges in Pennsylvania that are in need of replacement or repair. A majority of those projects will be procured as traditional design, bid, build projects contractors are accustomed to. The bridges selected as eligible for the project have similar characteristics; most importantly they are relatively small and can be designed and constructed to standard sizes. The similarity of the bridges allows for streamlined design, prefabrication (mass production) of standardized components such as beams, and the replacements can be done relatively quickly. All of these factors make bundling the projects as one P3 contract the most efficient and cost effective way to deliver these bridge projects according to the Commonwealth.

THIS COULD BE THE PEAK

It seems that the end of every positive interest rate cycle in the municipal bond market is signaled by attempts to finance unlikely amusement deals in the high yield space. It appeared that a proposed tourist facility based on a reproduction of Noah’s Ark in Kentucky in 2014 might have been that signal but that deal failed in the traditional market. Another amusement facility may be poised to assume that role, this time in Arizona. A property developer, the Granger Group, has primarily been a developer of  health care and senior living complexes. Granger is now in the process of completing development plans for a $500million theme park and resort development in Williams, Arizona.

Williams is a town of some 3000 which is the self-proclaimed Gateway to the Grand Canyon. Millions annually pass through on the way to the Grand Canyon National Park and the developers are predicating their plans on the attraction of four million of those visitors each year. The attraction would include a selection of rides, an adventure course, a wilderness area, an amphitheatre, hotel and spa and themed restaurants.

The sponsors are seeking approval for state legislation allowing for an Arizona theme park district board to issue as much as $1billion in bonds to pay for any number of theme parks inside a certain land space approved in December by the Williams City Council, the Phoenix City Council and the Coconino County Board of Supervisors.

If the proposal from the Granger Group is accepted, 9 per cent of revenue generated would be used to pay off the initial capital investment. The proposal predicts such a park would generate around $125million annually of gross revenue. Initial plans for the theme park include Route 66, wild west, mining and Navajo Nation themed areas. The group also promises rides, interactive exhibits, animal encounters, stunt shows, gold panning, archery, rock climbing, kayaking, ziplining, mountain biking, and hot air balloon rides.

The Granger Group is currently conducting a feasibility study for the project, which is due in later this month. The developer is yet to finalize an operator for the project and in May will focus on refining the plans. It is fair to say that this deal has to potential to join a large list of failed recreation projects that have been visited upon the tax exempt market at times of overvaluation of high yield credits. We urge investors direct and indirect (as owners of high yield mutual fund shares) to approach this type of credit with a high degree of skepticism and caution as it moves closer to market.

In the interim, overall first quarter issuance was the highest since 2010 – and third highest since 2006. Muni issuance is up 58.8% to $102.551 billion in 3,071 issues from $64.568 billion in 2,132 issues for the first quarter in 2014, Thomson Reuters data show. Refundings doubled in volume to $18.65 billion in 590 issues in March from $9.26 billion in 307 issues a year earlier. Combined refunding and new money deals increased 33.1% to $12.01 billion from $9.02 billion, while new-money issues were up 0.9% to $10.33 billion. Taxable and tax-exempt deals increased almost the same percentage, with taxables increasing 45.1% to $3.39 billion and tax-exempts increasing 45.9% to $37 billion.  Education more than tripled to $17.47 billion from $5.28 billion. Health care almost quadrupled to $2.72 billion from $720 million. The declining general perception of the creditworthiness of these two sectors coupled with increased issuance also suggests that our thesis has merit.

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

PENSION REFORM AND PUBLIC SAFETY EMPLOYEES

Whenever a difficult political issue comes up, it’s often described as being a political “third rail”.  The national moves toward the reform of pension funding have had a common “third rail”  feature as they take shape. That feature is that the various proposals to address pensions nearly universally exempt police and firefighters from adjustments to their pension benefits. The difficulty in addressing some of the thorniest pension issues is summed up in recent comments by Gov. Bruce Rauner of Illinois. He has been promoting a plan for more than $2 billion in cuts to pensions for public employees, except police officers and firefighters. “Those who put their lives on the line in service to our state deserve to be treated differently,” Mr. Rauner said in his February budget address to the state legislature.

Similar positions have been voiced by governors in adjacent states as they address pension and other labor issues. In 2011, Gov. Scott Walker of Wisconsin signed a law that limited collective bargaining rights for government workers and required them to contribute more toward their own pensions and health coverage. The legislation, known as Act 10 excluded police officers and firefighters from its provisions. In 2012, Gov. Rick Snyder of Michigan signed a right-to-work bill, eliminating the requirement that private and public sector workers contribute dues to the unions that represent them, whether or not they are members. The bill included a “carve-out” for police officers and firefighters.

Politically, the carve outs make sense. These services are provided by members who have strong political support. Who would politically risk denying the unique risks of police officers and firefighters? Take the politics out of the issue and rely on analytics to support the basis for such exemptions – the dangerous nature of the work – the exemption is not necessarily statistically supported. They are not the only public employees whose work is dangerous. Statistically, at least, there are far more dangerous public sector jobs. According to the Bureau of Labor Statistics, on-the-job fatalities occur at a significantly higher rate for “refuse and recyclable material collectors” — sanitation workers — than for police officers. The same is true for power line installers and truck drivers. And fatality rates for these workers exceed those for firefighters by a considerable margin, though firefighters have serious health complications like cancer at relatively high rates in retirement.

Even with the public’s view of the special nature of police and fire work,there may be a more economic way to reflect that view than through pensions. Police officers and firefighters can retire with full pensions at younger ages than other state employees (beginning at age 50 in Illinois, often younger in other states). That means they frequently spend many more years drawing their pension benefits, even while being permitted to maintain full-time salaries in the private sector. This drives up long-term costs for municipalities and states. There is also an argument to be made that early retirement policies also deplete police and fire departments of the valuable experience of critical employees when their experience is most valuable.

In Wisconsin, Gov. Walker argued that it was important to exempt police officers and firefighters because the state relies on them during emergencies and cannot afford unrest in their ranks. In Michigan, Mr. Snyder worried that extending right-to-work provisions to police officers and firefighters would hurt their cohesion. For other workers, the argument in favor of right to work was based on freedom of association and more supervisory flexibility.

One would think that if policing and firefighting are the most critical services local governments provide, the public would be more likely to support improvement and modernization of operating practices. For example, municipalities could improve the productivity of their fire departments by reforming the traditional schedule of 24 hours on, followed by one or more days off. But the only way to change that is through bargaining, and the concept has been resisted  by police and fire unions.

Some backers of right-to-work laws and curbs on collective bargaining for public employees say they should be applied without exception. This however works better in theory than in practice. One governor who did not exempt public safety employees from limits on their bargaining rights was Gov. John Kasich of Ohio. His proposals were rejected by voters in a referendum within eight months.

As for Illinois, while it waits for its pension changes to work their way through the courts, Gov. Rauner has instructed state agencies to divert money from nonunion employee paychecks away from organized labor until a judge settles the matter. A memorandum obtained by The Associated Press, shows his general counsel, Jason Barclay, directing departments under the governor’s control to create two sets of books: one with the “proper pay” and one, to be processed, that reduces the worker’s gross pay by an amount equal to what is normally paid in the fees. Mr. Rauner’s action could keep about $3.74 million out of union bank accounts. Of course, two sets of books is something that municipal analysts love and always is reflective of financial dysfunction.

PUERTO RICO FINANCING

The Government of Puerto Rico said last week that it refinanced $246 million in outstanding bond anticipation notes (BANs) at a rate of 8.25%. Principal sinking fund payments begin July 1, 2015. The notes are secured by a pledge of $6.25 of the new tax on non-diesel petroleum products and are guaranteed by the full faith and credit of the Commonwealth of Puerto Rico. Through the transaction, the holders of the Highways and Transportation Authority (HTA) BANs released all liens on pledged HTA revenues.

The notes issued by the Infrastructure Financing Authority (PRIFA) were bought by RBC Capital Markets as a part of the plan to increase the liquidity of the Government Development Bank (GDB) and support the finances of the HTA, one of PR’s several heavily indebted public corporations. The new notes redeem and retire a previous BAN issued for the HTA that matures Sept. 1, 2015.

The BANs are ultimately expected to be refinanced prior to maturity with the proceeds of a long-term PRIFA bond issuance. The deal was expedited by Act 29 of 2015, quietly enacted into law by Gov. Alejandro García Padilla. The legislation makes technical amendments to the law authorizing an increase in the petroleum-products tax to back the $2.95 billion bond deal, which is expected to occur by early May. The new law raises the excise tax on a barrel of crude oil from $9.25 to $15.50. It includes an adjustment factor that calls for the tax to be increased in the future if revenue isn’t sufficient to repay the bonds. The first adjustment, if required, would take effect July 1, 2017, according to the bill.

Moody’s has estimated that the GDB’s liquidity could fall as much as 22% if there was no new bond offering to refinance the HTA’s debt. Moody’s also has projected that the Electric Power Authority (PREPA) will likely default by July 1, when it is scheduled to make an estimated $400 million debt service payment.

The GDB has also said that it expects to hold an investor teleconference by early April to discuss more details of the deal, as well as provide updated information on government revenue and the outlook for the proposed fiscal year 2016 budget, which will be presented in the coming weeks. Some estimates are that the bond issue could need to be sold at a yield of up to 10.5% for investors. The issue, however, has an average interest-rate cap of 8.5%. Without insurance, Puerto Rico would have to offer a discount of 88 on the issue to obtain that yield. That is estimated  to net Puerto Rico $2.5 billion if the full $2.95 billion issue were sold.

Hedge-fund investors, expected to be the prime buyers of the bonds, have been making suggestions to improve operations and accountability. One proposal is for legislation that would empower the GDB to name emergency managers for up to two years for financially troubled public corporations, government agencies and municipal governments. The emergency-manager proposal being discussed would only require the consent of the governor to name an emergency manager, without having to get Puerto Rico Senate or other legislative approval. The emergency manager would have broad powers to act independently to fix the finances at the particular entity.

TOBACCO COMEBACK

In spite of rates of decline in cigarette consumption which seem to be outpacing estimates, tobacco bonds may be on their way to the biggest volume since 2007. Issuers are taking advantage of the historically low interest rates to refinance and sell additional settlement revenues. This week, California’s Golden State Tobacco Securitization Corp. will be coming to market with a $1.7 billion tobacco issue enhanced by a pledge from the state to seek an annual appropriation for debt service and operating expenses should settlement payments fall short. Proceeds will be used to repay existing tobacco bonds that do not benefit from a pledge from the state and so are more exposed to a shortfall in settlement payments. Other issues include a $621 million sale last month in Rhode Island and a proposed $875 million new money deal from Louisiana later in 2015. In 2014, only about $175 million of tobacco bonds were sold.

The official statement for the $1.7 billion for the California issue includes the latest smoking decline estimates of James Diffley, a senior director at IHS Global Inc. He forecasts that total consumption in 2045 will be 104.0 billion cigarettes (or 104.6 billion including roll-your-own tobacco equivalents), a 61% decline from the 2014 level. The report projects that from 2015 through 2045 the average annual rate of decline is projected to be approximately 3.0%.

In April 2013, IHS Global presented a similar that projected consumption in 2045 of 105.7 billion cigarettes (including roll-your-own equivalents), reflecting an average decline rate of 3.0%.

The proposed Louisiana Tobacco Settlement Financing Corp. issue would   securitize the remaining 40% of the state’s share from the Master Settlement Agreement with tobacco companies. The bond would generate revenue for operating purposes to plug projected budget gaps over the next seven years by funding the state’s higher education scholarship program. The plan is controversial and is subject to approval by the Legislature and other state agencies.

Louisiana securitized 60% of its tobacco settlement revenue in 2001 with the sale of $1.2 billion in bonds. The new securitization is expected to go before the State Bond Commission April 16, and the Joint Legislative Committee on the Budget May 20. If approved by the legislature, the bonds likely would be sold in June.

The key for investors is to determine which consumption scenario they believe in. In May 2014, Moody’ Investors Service estimated that 65%-85% of the aggregate outstanding balance of all tobacco settlements bonds that Moody’s rates, will default. More recently, S&P estimated that cigarette shipments will decline 5.25% in the next two years and 4.75% thereafter.

CA WATER NEWS

Last week, the California state government imposed new mandatory restrictions on lawn watering and incentives to limit water use in hotels and restaurants as part of its latest emergency drought regulations. Gov. Jerry Brown also announced a $1 billion plan to support water projects statewide and speed aid to hard-hit communities already dealing with shortages. Federal water managers have already announced a “zero allocation” of agricultural water to a key state canal system for the second year in a row. This moves come after the state has fallen behind targets to increase water efficiency in 2015 amid the state’s worst drought in 1,200 years. California’s snowpack is now at a record low—just 12 percent of normal.

The situation highlights the long standing divide between urban and agricultural water users. California’s cities have more than enough water to withstand the current drought and then some. They have low water usage per capita. Agriculture uses 80 percent of California’s water—10 percent of that on almonds alone. That may not be sustainable as  abnormally dry conditions have been recorded in 11 of the last 15 years.

So small agriculturally based water credits remain the ones with the most credit vulnerability while the larger urban districts have by and large adjusted their usage and rates to the current environment.

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

ARGUMENTS BEGIN IN ILLINOIS PENSION CASE

Initial oral arguments were presented to the Illinois Supreme Court last week. Solicitor General Carolyn Shapiro offered the initial argument and cited Illinois’ need to protect the public welfare in the face of a fiscal emergency as a basis for cutting pension benefits despite their state constitutional protections. The court’s seven justices will decide the fate of legislation approved in December 2013 that reduced benefits with the goal of stabilizing a system facing $111 billion in unfunded obligations that has dragged down the state’s bond ratings and threatened its fiscal solvency.

A circuit court judge last November found that the legislation violated the pension clause adopted in a 1970 constitutional convention that gave contractual status to pensions and protects them from impairment or diminishment.

In the state’s view, the justices must decide whether the state is correct in its position that “the pension clause provides the same robust but not absolute constitutional protections provided to all contracts”. Or it can side with unions and the plan participants who are challenging the changes and find that it is instead a “categorical and absolute ban on any reductions to pensions even under extraordinary circumstances,” said the Solicitor General.

She also said that “Plaintiffs position is remarkable”. “If the state’s bond rating collapsed rendering borrowing prohibitively expensive, pensions would be entirely off limits regardless of the essential state services that might have to be eliminated.” If a natural disaster struck, pensions could not be even temporarily reduced, she added.

Shapiro acknowledged that such scenarios were extreme. But that is what plaintiffs are asking for,” Shapiro went further. “It is the state’s solemn responsibility to protect the public interest, the public health, safety and welfare in extreme situations but the necessary consequence of what plaintiffs are demanding and circuit agreed would tie the state’s hands when its need to act is most pressing.”

The State seeks to portray the diminished and impaired language as a reference to the enforceable contract status afforded to pensions, not to the pension benefits themselves and argued that past contract law precedent over the last 150 years allow the state to modify a contract under some circumstances. The State argues that there is little debate that the state is not facing a fiscal crisis given its budget deficit, massive unpaid bill backlog between $5 billion to $6 billion, and a credit rating that is the weakest among states.

The state further argued that “Like all contracts, they can be altered…they are not absolute” and argued that if the protections are absolute the clause does not legally meet the definition of a contract as the state constitution allows for contract modifications.

The attorney representing the union plaintiffs asked the court to look at both the plain language of the pension clause and the intent of the delegates to the 1970 constitutional convention that established the pension clause. It is “explicit, clear and unambiguous” and “is subject to no stated exception,” and the language is so “simple and plain” that the voters’ guide on the constitutional changes simply said “this section is new and self-explanatory.” The unions contend that the drafters anticipated the very situation that the court is now reviewing by which a General Assembly would act during a time of fiscal distress to “invalidate a constitutional protection” and so created “a binding contractual relationship for public employees” .

The state contends the U.S. Supreme Court has long held that a state can’t enter into binding contracts that would preclude it from exercising its police power in the future to protect the public welfare while the unions accuse the state of wrongly applying federal law. Justices pressed the state’s lawyers on whether a ruling in its favor would give it too much power, potentially unleashing future attacks on statutory and constitutional provisions. Justice Robert R. Thomas asked whether granting the use of police powers would give the state too great a “license” to modify its contractual obligations.

Shapiro stressed that the state constitution provides only a few exceptions for such modifications. She further argued that if the justices agree that the pension benefits are subject to police powers, a check on its power lay in future arguments that would be made at the circuit court level.

“The lower court will conclude whether the circumstances justify the state’s actions,” she said. Justices also questioned how the state’s pension funds sunk so low, suggesting it was a mess of the state’s own making. The state pinned the blame on the recession and economic conditions with inflationary levels driving big cost-of-living adjustments and stressed that the pension cuts don’t put the tab for past underfunding on employees but only the costs going forward.

One justice questioned whether the state faces what it considers a dire budget situation due to the state General Assembly’s failure to extend the 2011 income tax hike. The higher rates partially expired and lawmakers have not acted to make up the lost revenue.  Justices questioned why the state –if it in the midst of fiscal emergency – has asked the court to decide only whether the pension contract is subject to modification under state police powers and to then send the case back to the lower court for review. Justices said the case only would land back before them delaying legislative action possibly on new reforms. The state said it believed there would be sufficient time for lawmakers to act.

PA PENSION BONDS

Citing “a difficult second half of the year,” the underfunded, $27 billion-asset Pennsylvania State Employees’ Retirement System says its investments returned only 6.4 percent last year, below the system’s annual target of 7.5 percent, according to a report by Chief Investment Officer Tom Brier.

SERS’s stocks, bonds, real estate and hedge funds all posted returns below the fund target. Only one category, “alternative investments,” posted higher returns than the benchmark, thanks in part to soaring private equity valuations attributable to the strong U.S. stock market of the past few years. But even alternative investment returns lagged, posting a loss of 0.3 percent, during the fourth quarter of last year as stocks turned down.

New Pennsylvania Gov. Tom Wolf in his recent budget address called for SERS and the teachers’ pension system PSERS to reduce their reliance on high-fee private managers, and put more in indexed investments. A majority of the SERS board seats are held by legislators and appointees who in the past supported buying a wide range of investments from private managers. The results were announced as debate heats up over the Governor’s inclusion of a $3 billion pension issuance as a part of his budget plans for FY 2016. Bonds to fund pension funding have been long championed by Democratic legislators in the Commonwealth but did not have gubernatorial support. The election of Gov. Wolf is seen by pension bond supporters as creating a more favorable environment for consideration of such a debt issue.

We do not look favorably on the issuance of pension bonds for funding purposes. we equate the issuance of debt for what are arguably current expenses as bad policy and a negative ratings impact.

PUERTO RICO

Gov. Alejandro García Padilla worked to boost support for his tax-reform plan to a skeptical public earlier this week through a taped, prerecorded address Monday evening, March 9. The governor backed his reform as the best way to fix a broken system, and said nobody could defend Puerto Rico’s current “unjust” tax system. García Padilla announced no changes to his tax-reform plan, despite strong opposition from nearly every sector of society, as well as nearly daily protests in the past week. “I am going to the finish line to do what is right,” he said. “Puerto Rico’s tax system is unjust. I didn’t come here to put a patch, but to fix it.”

The heated rhetoric that has accompanied support for the plan continued in the Governor’s speech. The governor said the Treasury Department “confiscates” taxes before salaried workers get their pay, while nonsalaried professionals report an average $16,500 annually in earnings. Moreover, he said 82% of all taxpayers in Puerto Rico are either poor or middle class. García Padilla sought to reassure consumers, saying that the new 16% value-added tax (VAT, or IVA by its Spanish acronym) that is at the heart of his reform wouldn’t apply to the “immense majority of what you buy,” citing exemptions to non-processed food, automobiles, education, prescription drugs and most medical services.

“We live in an unjust system and have to make it just. It’s like a salary increase. You, not Treasury, will decide what you will pay in taxes,” the governor said. He criticized economists who have criticized implementing the reform at a time of economic crisis, saying the 160 countries that have a VAT implemented the tax system in similar situations.

While the governor redoubling his efforts on behalf of the reform in his message, some legislative leaders such as House Finance Committee Chairman Rafael “Tatito” Hernández and Senate Finance Committee Chairman José Nadal Power said changes would be needed to win sufficient support for passage in the Legislature. One possibility is that a substitute measure would either increase the 7% sales & use tax (IVU by its Spanish acronym)to 10%, or have a VAT of 12%. Along with tax reform there is support for the executive branch to reduce spending by $250 million to $500 million annually, about half the amount initially proposed by Senate President Eduardo Bhatia.

Meanwhile, technical amendments to a bill boosting the petroleum-products tax are still necessary for Puerto Rico to undertake a bond issue of nearly $3 billion, which it needs to shore up the Government Development Bank’s liquidity, refinance existing loans and keep the government afloat for the next two years. Lawmakers had previously approved the petroleum-products tax hike that will support the issue, but further amendments were needed to make the bond transaction viable. This month, the excise tax on a barrel of crude oil will be increased to $15.50 from $9.25.

Lawmakers already amended the legislation once to clarify language regarding when the petroleum-products tax hike takes effect and other related issues. Both the House and Senate approved amended legislation to take away the limit placed on the discount they could offer investors, but that isn’t sufficient to get a $2.95 billion deal done.

Another factor is the oil-tax hike escalator. Without it, the government can only borrow $2 billion, and hedge-fund investors don’t want to participate unless it is a $2.95 billion deal. They want to ensure the government stays out of the market for the next two years to protect the value of the bonds they will buy. Bond issuers will also likely participate in the deal if the escalator is in place, which will also work to make the deal more attractive.

Another important provision is the underlying security of pledged revenue, and language protecting it from being clawed back. Lawmakers have already agreed to extend a general-obligation constitutional guarantee for the deal, as well as giving investors the right to sue in New York City courts to resolve any claims arising from the deal. Investors are also pressing to have Puerto Rico commit to revenue and spending cut targets, with penalties for missed targets.

The Senate approved a bill last week with stronger “anti-clawback provisions” and an adjustment clause to ensure the tax would raise sufficient revenue to pay for the bond issue in the future. However, by this week’s deadline, the House hasn’t acted, although sources said the bill “was being prepared for the governor’s signature.”

FED FLOW OF FUNDS REPORT

The total amount of outstanding municipal securities and loans in the market rose 0.6% to $3.65 trillion in the fourth quarter of last year. Bank holdings increased 2.5% and mutual fund holdings rose to a record high of $658 billion.

The Federal Reserve Board released the data this week in its quarterly Flow of Funds report. The total size of the market was up from $3.63 trillion in the third quarter of 2014, but still experienced an overall year-over year decline from $3.67 trillion at the end of 2013. The size of the market has generally been declining for the past several years.

Bank holdings have risen sharply in recent years, totaling $452 billion at the end of 2014 compared to $419 billion the previous year and only $255 billion in 2010. Money market mutual fund muni holdings were up 1.1% to $281.7 billion in the fourth quarter, the only quarterly increase of the year. The category has dropped sharply since it was $386.7 billion at the end of 2010 and $509.5 billion at the end of 2008.  Dealers held $18.9 billion of munis at the end of 2014, a $2.7 billion increase over the previous quarter but a steep decline from the $40 billion dealers accounted for in 2010.

State and local governments accounted for $2.9 trillion of muni debt, with nonprofit organizations and industrial revenue bonds making up the balance. $2.87 trillion of those munis are long-term obligations, the Fed data shows.

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

TRYING AGAIN ON DISCLOSURE

The issue of municipal issuers’ disclosures of financial and operating data is back in the spotlight. Speaking at the National Municipal Bond Summit last week, Municipal Securities Rulemaking Board executive director Lynnette Kelly said there was a 40% increase in the financial and operating documents issuers filed to EMMA between June 2013 and June 2014. That is greater than the 7% increase the MSRB normally sees year over year, she said. At the same disclosures of bank loans have been disappointing.

Ms. Kelly attributed some of this increase to the Securities and Exchange Commission’s Municipalities Continuing Disclosure Cooperation initiative. The MCDC, announced last March, allowed both issuers and underwriters to voluntarily report, for any bonds issued in the last five years, any time they misled investors about their compliance with their continuing disclosure obligations. Underwriters had to report by Sept. 10 and issuers by Dec. 1 last year.

The SEC was focused on issuers who maintained in offering documents that they were fully in compliance with their self-imposed obligations to file annual financial and operating information by certain dates, when they had actually filed the documents late or not at all. SEC offered lenient settlement terms in exchange for the voluntary reporting under the MCDC program.

The MSRB began urging muni bond issuers to voluntarily post information about their bank loans on EMMA in 2012. Since then it has only received 88 such filings. Kelly said,  “That is far too low.” Concerns regarding such loans have grown as issuers have increasingly turned to bank loans to meeting their financing needs, typically because of lower interest and transaction costs, a simpler execution process, the lack of need for a rating, greater structuring flexibility, or the desire to deal to interact with a bank rather than multiple bondholders. Bank loans is a term used broadly to mean a bank’s direct loan to an issuer or the private placement of an issuer’s bonds to a bank. But there are no requirements that these be disclosed.

The MSRB, rating agencies, and some market groups have all said it’s important for issuers to disclose such loans, because they could affect an issuer’s financial condition, its credit or liquidity profile, as well as its outstanding bonds and the holders of those bonds. Ms. Kelly’s comments coincided with the National Federation of Municipal Analysts release of a paper detailing what disclosure practices it thinks should be adopted for bank loans.

In January, the MSRB made its most recent call for disclosure of bank loans well as other alternative debt such as direct loans from hedge fund investors. “Where we’ve not seen an increase in disclosures and would like to is … bank loans,” Kelly said. Kelly told those attending the conference that the MSRB has urged the SEC to revisit its Rule 15c2-12 on disclosure and that bank loan disclosure is one of the areas the MSRB wants the SEC to address.

HOSPITAL MERGERS CONTINUE

University Hospitals in Cleveland and Ashland’s Samaritan Regional Health System (SRHS), a small system anchored by a 55-bed hospital in Ashland OH, last week signed a letter of intent to merge. Should the merger close, SRHS will become part of the UH system like Parma Community General Hospital and Elyria’s EMH Healthcare did in 2013. Samaritan, which employs 35 physicians, would be UH’s southernmost outpost in the state. This is yet another sign of the changes wrought by the ACA. Those changes reward efficiency and scale, two things which are not characteristic of smaller stand alone facilities. UH has been pursuing other mergers with smaller institutions with various degrees of success. We expect that the trend of mergers in the industry will be long-term regardless of the outcome of current legal challenges to the ACA.

CONNECTICUT BUDGET

Connecticut’s governor released his proposal for a budget for the biennium beginning in July. The budget reflects General Fund expenditures of $18.0 billion for FY 2016, cutting $590 million from current law spending levels.  In addition, it cuts more than $753 million in FY 2017. The budget is $6.3 million below the spending cap for FY 2016 and $135.8 million below for FY 2017.  Payments on the state’s long term obligations and debt service will not be deferred, whether contributions to the state’s pension system or paying off Economic Recovery Notes.  The budget includes a proposal to lower the state sales tax rate albeit by widening the base.

The budget maintains funding for statutory formula grants at the FY 2015 level, including Education Cost Sharing (ECS) and Payment in Lieu of Taxes (PILOT).  Additionally, funding is increased for Municipal Projects by $3.6 million per year to provide $60 million annually to support local infrastructure. It establishes a new $20 million grant for green infrastructure, level funds Small Town Economic Assistance Program (STEAP) and the Local Capital Improvement Program (LoCIP), and maintains funding of $60 million annually for Town Aid Road (TAR). It maintains support for education, by keeping the commitment to local school construction (with nearly $600 million pledged annually) and continues funding for the teachers retirement system.

Health costs are a prime target for spending reductions. The majority of the reductions in DSS impact reimbursements to Medicaid providers.  The state’s share of Medicaid expenditures is reduced by: $43.0 million in FY 2016 and $47.0 million in FY 2017 by reducing provider rates ($107.5 million in FY 2016 and $117.5 million in FY 2017 after factoring in the federal share of Medicaid expenditures); $10.0 million in each year of the biennium by restructuring rates to achieve the savings assumed in the enacted budget for medication administration ($20.0 million in each year of the biennium after factoring in the federal share); $6.2 million in FY 2016 and $6.8 million in FY 2017 from changes to the pharmacy dispensing fee and reimbursement for brand name drugs ($18.9 million in FY 2016 and $20.6 million in FY 2017 after factoring in the federal share); $5.1 million in each year of the biennium from the elimination of the supplemental pool for low‐cost hospitals ($15.1 million in each year of the biennium after factoring in the federal share); $4.3 million in FY 2016 and $5.1 million in FY 2017 from ensuring that ambulance providers do not receive a combined Medicare and Medicaid payment that is higher than the maximum allowable under the Medicaid fee schedule ($8.6 million in FY 2016 and $10.2 million in FY 2017 after factoring in the federal share).

The budget also devotes significant resources to highways and mass transit, particularly the state’s commuter railroads. Known as  Let’s Go CT!  the plan will include expanded rail service on existing Metro‐North and Shore Line East lines, and expanded service on the New Haven‐Hartford‐Springfield line.  Additional station construction will also be complemented by Transit‐Oriented Development (TOD) and responsible growth programs which will enable the impacted communities to add more economic and housing options for their residents and visitors, while preventing sprawl. An additional $2.78 billion in transportation bond authorizations is recommended over the next five years to begin to implement Let’s Go CT!

WILL STATES LEARN ON PENSION FUNDING?

Last week in Kansas, the state Senate passed a bill, by a vote of 21-17, that would authorize the sale of $1 billion in POBs, the proceeds of which would be provided to the Kansas Public Employees’ Retirement System pension fund, which is roughly 60 percent funded, with a projected $9.8 billion shortfall. The $1 billion in new bonds is less than the $1.5 billion that Republican Gov. Sam Brownback’s administration had lobbied for.

Proponents are relying on a study by KPERS in which its actuaries concluded the House bill would save the state $2.8 billion in contribution obligations to the plan. Gov. Brownback has already reduced the state’s statutory contribution rate for fiscal year 2015. Supporters argue that the current historically low level of interest rates means that POBs are a relatively safe bet for state taxpayers. The cash raised would return a higher rate than the cost to service the debt, so long as the pension investments return their historical averages over the term of the bond, which can be as long as 30 years. Servicing the bonds is expected to cost Kansas $90.3 million annually, according to a blog post by Republican state Rep. Troy Waymaster.

The bill will now move to the Kansas House, where, last week, the Pensions and Benefits House committee passed its own version of the bill, authorizing $1.5 billion in POB sales, and capping the maximum interest rate on the notes at 5 percent.

An opposite approach is being taken in Kentucky. After that state’s House voted to authorize $3.3 billion in POBs for the state’s stressed teachers’ pension, the Senate strongly rejected the proposal, killing it by a 28-8 margin. The Kentucky Teachers Retirement System is funded at just over 50 percent, with nearly $14 billion in unfunded liabilities. Republican Robert Stivers, the Kentucky Senate president, said the POBs would create debt obligations that would tie up future governors and legislatures in issuing debt for other necessary projects.

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 ANNOUNCES UPDATE ON ITS RESTRUCTURING

Once again the market finds itself disappointed by the lack of timely follow through by the government of PR. The pattern of failed promises and lack of decisive timely action has become more than tiresome but unfortunately it is the basic m.o. in regard to its ongoing debt crisis. The latest example is the announcement on February 27 that PREPA continues in talks with creditors on the possibility of extending leniency agreements, which expire by its mandate on March 31, 2015.

PREPA said the Authority continues in productive talks with creditors on extending existing forbearance agreements,” through Lisa Donahue who leads the  official restructuring of the public corporation. “We have been working diligently with the Authority and all stakeholders in the operational transformation of the company.   To date, we have progressed significantly, but much remains to be done and as a result, we have not finalized the plan to present to creditors. Some time ago, we informed creditors would not reach the agreed date. Creditors are aware of the situation and have not taken any adverse action, “said Donahue.

“While most of the media coverage has focused on restructuring the debt of the Authority and talks with creditors, it is important that all employees, suppliers and customers understand that the restructuring of the Authority includes an operational transformation complete to ensure the reliability of service. We continue to work on efforts to create the infrastructure and financial resources needed to overcome the energy challenges of Puerto Rico and transform the Authority in a self-sustaining corporation, “said John F. Alicea Flores, executive director of the public corporation.

At some point the government of PR must realize that the juxtaposition of events such as that which occurred last week – the House hearings on Chapter 9 authorization followed by the PREPA announcement the next day – simply reinforce the image of disarray and frankly ineptitude in the handling of the restructuring needed for much if not all of Puerto Rico’s debt. The longer it takes the government to act decisively and competently, the more difficult it will be for the island to recover and move on. The trail of broken promises and deadlines must come to an end.

ISSUANCE CONTINUES ITS STRONG PACE

Favorable relative trends in yield movements benefitted issuance last month. Long-term municipal bond issuance in February increased 78.5% to $29.46 billion from a year earlier, the seventh monthly gain in a row, as refundings more than doubled to $14.53 billion from $5.11 billion in February of 2014, according to Thomson Reuters. Advanced refundings were the catalyst for issuance as long and intermediate tax exempt yields declined whie shorter dated treasury yields increased. AA 10 year yields are about 50 basis points lower this year relative to last year, while the 30 year yields are about 90 basis points lower in yield from this time last year.

Some estimate that if volume continues at the pace through February, yearly issuance could total $440 billion. Volume for the two months adds up to $56.54 billion, the most since 2010’s $59.714. January volume alone annualized to $450 billion.  New-money issuance increased 8.7% to $10.48 billion from $9.64 billion in February 2014. Negotiated issues rose to $21.85 billion (635 deals) from $10.82 billion (423 deals) for February of last year. Competitive deals increased to $7.46 billion (357 deals) from $3.78 billion (237 deals) while private placements dropped to $151.6 million from $1.90 billion.

Education, utilities and general purpose led the way. Education rose to $11.80 billion (501 deals) from $5.57 billion (257 deals), while general purpose rose to $6.78 billion (258 deals) from $3.77 billion (148 deals) in February 2014. State agencies increased issuance to $6.81 billion from $2.69 billion. Cities and towns lifted issuance to $3.60 billion from $2.06 billion while district bond sales rose to $8.63 billion from $4.37 billion. Bond insurers increased their footprint increasing par value insured to $1.93 billion in 166 deals compared to $1.16 billion in 93 deals in 2014.

The top five state issuers this past month were Texas, California, New York, Pennsylvania and Washington. Texas remained first, with $6.65 billion, up from $5.54 billion. California and New York switched positions, with California in second, at $5.43 billion from $3.84 billion. New York was third, at $4.15 billion versus $4.50 billion in 2014. Pennsylvania was fourth up from 12th, rising to $3.66 billion from $903.6 million. Washington state was fifth at $3.16 billion, up from $1.06 billion in 2014.

LOUISIANA BUDGET

Gov. Bobby Jindal of Louisiana introduced an FY 2016 budget proposal last Friday with deep cuts designed  to deal with a $1.6 billion shortfall and an entrenched structural deficit. The proposed cuts are substantial, even after years of moderate and severe reductions. They would potentially result in the closures of community health care clinics and historic sites. Hospitals partly privatized by Mr. Jindal would get $142 million less than they had sought. Spending on higher education would be lower by $141 million, a further 6 percent reduction after years of cuts.

The plan attempts to avoid some of the worst-case situations by reworking certain tax credits ways that would make an additional $526 million available to meet current expenses. Previously, Gov. Jindal has been firm in his opposition to new taxes. Even the renewal of existing taxes has been off limits. Officials insisted that the proposed changes did not constitute a tax increase, because they would simply take some refundable tax credits and turn them into nonrefundable tax credits. The change would not raise taxes as far as the state is concerned but, it could result in a net higher tax burden for businesses when certain local taxes are included. The plan also includes a complicated arrangement to raise cigarette taxes to pay for a tax credit that families could use to offset a new cost, called “an excellence fee” for students attending colleges and universities.

A fight is expected in the Louisiana Legislature as many believe that greater changes are needed in the state’s generous and expensive distribution of tax credits and exemptions. At the same time, significant pressure is expected from business groups against the proposed tax credit changes. The president and chancellor of Louisiana State University  called the current proposal “a bad budget for higher education,” but also said the situation would be devastating if the Legislature were to turn down the tax credit changes and fix the deficit on cuts alone. In that case, Mr. Alexander said, thousands of classes would have to be canceled, the state’s sole dentistry school and as many as half of the agriculture centers would have to close.

PENNSYLVANIA BUDGET

Gov. Tom Wolf issued his first budget proposal as the new chief executive. The budget reduces the Corporate Net Income Tax (CNIT) from 9.99 percent to 5.99 percent – improving the commonwealth’s ranking from second highest to fourteenth-lowest and bringing Pennsylvania’s tax rate below the national average and below all of its neighboring states. It ends the often delayed phase out of the Capital Stock and Franchise Tax by eliminating it effective January 1, 2016. The personal income tax would rise to 3.7 percent – the third lowest of all states with an income tax and significantly lower than all of Pennsylvania’s surrounding states. In addition, a family of four earning up to 150 percent of the poverty level (approximately $36,000) would pay no state income taxes.

Funds reserved for property tax and rent relief will be transferred from personal income tax revenues into a restricted account. Beginning in October 2016, $3.6 billion will be transferred to the Property Tax Relief Fund and distributed to homeowners and renters. The sales tax is proposed to be expanded to be more consistent with the modern economy and the rest of the nation. The sales tax rate would increase by 0.6 percentage points, and exemptions for food, clothing and prescription drugs would remain in place. Over the next two years, the budget provides an $80.9 million increase to Penn State University, the University of Pittsburgh, Temple University and Lincoln University.

Holders of local school district credits will look favorably on proposed increases in education funding. Proposed is a $400 million (7.0 percent) increase in the Basic Education Subsidy. This increase – the largest in Pennsylvania history – will fully restore the Accountability Block Grant and Educational Assistance Program funds that were previously cut. In addition, as part of the Basic Education Subsidy, school districts will receive a reimbursement for approximately 10 percent of their mandatory charter school tuition payments. This would have a positive impact on the Philadelphia School District. Additional resources will be provided to help close the funding gap based on Basic Education Subsidy cuts instituted since the 2010-11 school year.

A $100 million (9.6 percent) increase in the Special Education Subsidy is also proposed by the Governor. This increase will continue Pennsylvania’s transition to the formula enacted in 2014 reflecting the work of the bipartisan legislative Special Education Funding Commission. The budget incorporates that formula as a permanent component of the state’s education law, known as the Public School Code. Another item is a $120 million (87.9 percent) increase in high-quality early childhood education to enroll more than 14,000 additional children in Pennsylvania Pre-K Counts and the Head Start Supplemental Assistance Program.

We expect that the final budget will be substantially different. There is however, support for local property tax relief and the expansion of the sales tax base as well as increased education  funding.

COLLEGE CLOSING

Sweet Briar College, a 700 student women’s school in VA announced that it would close at the end of the 2014-2015 school year. Continuing declines in demand created operating pressures including tuition and fees covering less than  one-third of expenses. A 10% operating loss and a 10% spend rate on its endowment reflected unsustainable trends. The school’s $25mm of debt outstanding (B- by S&P) can be paid off from remaining endowment funds which will also be applied to severance costs and the cost of assistance to students who need to transfer. The demand for single sex, rural liberal arts colleges has continued to decline and one should not be surprised to see additional instances where institutions close when they can no longer effectively compete in a changing marketplace.

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 BANKRUPTCY BILL REINTRODUCED AGAIN

The U.S. House Judiciary Committee’s subcommittee on regulatory reform, commercial and antitrust law, which has jurisdiction over bankruptcy law, will hold a hearing as we go to press on legislation that would allow Puerto Rico government-owned corporations to restructure their debts under Chapter 9 of the federal Bankruptcy Code. The bill, the Puerto Rico Chapter 9 Uniformity Act of 2015, is sponsored by Democrat Pedro Pierluisi, Puerto Rico’s non-voting representative to the House. Pierluisi introduced the bill last session, but it failed to move.

Puerto Rico is looking for alternatives to restructure its debts after a federal court in Puerto Rico struck down the Puerto Rico Debt Enforcement and Recovery Act on February 9. That law was enacted last year to give the island’s public corporations a process to restructure their debts. Pierluisi did not support that law, and has said repeatedly that Chapter 9 would be a better approach.

Pierluisi said “it is my hope and expectation that the hearing will be productive,” “Many stakeholders support this bill, and this hearing will provide them with the opportunity to memorialize and explain their support.  Although no objections to the bill have been registered with me up until now, if there are any concerns about the legislation, those concerns can be raised and addressed at the hearing.  The point of the hearing is to create a comprehensive record that will help the committee’s leadership determine whether to take the next step in the legislative process, which would be to hold a vote on the bill.”

Investors have concerns about the proposed bill as it could be key for those holding the bonds of financially distressed government corporations on the island. The Puerto Rico Electric Power Authority had to draw on its debt service reserves to make a July 1 interest payment. PREPA, which has more than $8 billion of bonds outstanding, is now in discussions with its creditors, and there had been speculation that it might ultimately use the Recovery Act. The Puerto Rican government has said that it supports amending Chapter 9.

STOCKTON BANKRUPTCY ENDS

It began with a bang and ends with an effective whimper but the City of Stockton emerged from bankruptcy this week. The well documented fiscal difficulties of the City led to the elimination of OPEB benefits for its retired employees and defaults on a number of lease revenue obligations. But most importantly, the City’s pensioners survived the process with those benefits intact. This creates one more brick in the emerging structure around municipal bankruptcy whereby pension obligations are assuming a superior position to debt obligations in the restructuring of liabilities through Chapter 9.

TRANSPORTATION FUNDING DEBATE

Since the advent of the automobile as the nation’s primary source of transport , the gasoline tax has provided the financial foundation for the nation’s roads. For each gallon pumped, motorists have paid several additional cents in taxes to their state and federal governments. So long as vehicle ownership grew and driving remained increasingly popular, this model worked. But as vehicles have become more fuel-efficient and younger people are less eager to obtain drivers licenses, gas tax revenue has flattened.

Generally decreased support for tax increases over time has impacted the federal gas tax such that it has lost more than one-third of its value to inflation since it was last raised to 18.4 cents a gallon in 1993. This has altered the debate over long-term transportation funding, especially for highways. As a result, state and federal officials are more willing to look at  alternatives to help pay for repairs and upgrades to highways. Those alternatives are briefly summarized.

In lieu of the traditional model of taxing retail sales of gasoline –  taxing each gallon of gas pumped, some states have begun levying a tax on the wholesale price. Virginia in 2013 repealed its 17.5-cents-a-gallon gas tax and replaced it with a 3.5 percent wholesale tax on gasoline. Minnesota Gov. Mark Dayton has proposed a wholesale tax that would be added to the state’s current per-gallon tax. Because of price swings, wholesale tax revenue can be volatile from year to year. Advocates believe it could provide more revenue growth than a flat, per-gallon tax over the long term.

Some states have begun funding highway projects by taxing all retail sales. Arkansas voters in 2012 approved a half cent sales tax increase with that portion dedicated to highways. The Michigan electorate will decide in May whether to impose a 1-cent sales tax for transportation. Because they are broad-based, retail sales taxes can generate large sums for highways. Opponents most commonly object that sales taxes tend to have a larger proportional effect on lower-income residents. That helped Missouri voters last August to defeat a proposed sales tax increase for transportation.

One new concept is the idea of a tax on the number of miles traveled. It is one of the most commonly discussed alternatives to direct fuel taxes but has not been widely implemented. Oregon plans to test the concept this July with 5,000 volunteers, who will be charged 1.5 cents for each mile they drive while getting a refund on their gas taxes. The vehicle mileage tax also has been studied in California, Minnesota and Nevada. One major obstacle has been privacy concerns from people reluctant to have their vehicles tracked with GPS devices.

Toll roads have existed in some form since the earliest eras in the country’s history and are receiving renewed interest in some places. Delaware raised tolls last year after legislators rejected the governor’s proposed gasoline tax increase. Governors in Connecticut and Missouri also recently referenced the potential for tolls. Opponents cite the relatively high levels of toll which might be required to pay for major projects.  One study found that covering the cost of rebuilding a 200-mile stretch of Interstate 70 in Missouri could mean tolls as high as $30 per car and $90 for heavy trucks.

Public private partnerships continue to be considered and tried although they have had very mixed operating results. In December, Virginia opened a 29-miles stretch of express toll lanes on Interstate 95 outside Washington, D.C. The state funded less than 10 percent of the cost for the $925 million project. Private entities invested their own money, secured a federal loan and made use of tax-exempt bonds. In exchange, Virginia gave them the right to manage the road and collect tolls for the next 73 years. A number of private toll facilities have failed to live up to operating results. The most glaring failure has been the Indiana Toll Road which is in the midst of Chapter 11 proceedings after it failed to achieve projected revenue levels.

One other alternative to increasing existing or establishing new taxes is for states to redirect existing revenue to roads. Idaho last year shifted part of its cigarette tax revenue to highways. Texas voters in November approved the transfer of a portion of oil and gas severance taxes from the state’s rainy day fund to roads. Some states have increased vehicle registration fees. Washington has imposed fees on owners of electric vehicles, and Gov. Jay Inslee recently proposed a carbon-emissions tax on the state’s largest polluters that would help finance transportation projects. He describes it as “transportation pollution paying for transportation solutions.”

The area of most uncertainty has been the issue of the establishment of a consistent funding plan for the federal Highway Trust fund. After years of relative consensus on the issue and regular approval of five year funding programs, the issue has become caught up in annual political wrangles.  Currently, various proposals from President Barack Obama and U.S. Senate and House members would help finance the federal Highway Trust Fund with taxes on the foreign-earned profits of U.S. corporations. Some proposals also would create a $50 billion infrastructure fund, to be financed by selling bonds to private companies or by taxes on foreign profits. Such a fund could be used to make equity investments and loans for state and local infrastructure projects.

NEW JERSEY PENSIONS DECISION; GOVERNOR CHRISTIE’S BUDGET PRESENTATION

New Jersey Superior Court Judge Mary Jacobson ruled Monday that the state’s failure to make a full pension payment is “substantial impairment” of the contractual rights of the police, firefighters, teachers and office workers who sued. “Because the state will now make nearly 70 percent less than the statutorily required $2.25 billion payment,” the expectations of workers have been “substantially impaired,” the judge ruled. “In short, the aim of the legislation is not being met.”

The decision is a change in course from last year for the same judge. Jacobson’s ruling contrasts with her decision days before the last fiscal year ended June 30, when Christie said he faced a fiscal emergency. Workers sued then as well, and the judge said Christie acted reasonably in paying $696 million to the pension system to cover current employees while deferring $887 million to help close the gap left by previous governors.

Jacobson’s ruling contrasts with her decision days before the last fiscal year ended June 30, when Christie said he faced a fiscal emergency. Workers sued then as well, and the judge said Christie acted reasonably in paying $696 million to the pension system to cover current employees while deferring $887 million to help close the gap left by previous governors.  The legislative and executive branches “have now had almost 10 months to find a solution to the pensions crisis for FY 2015,” Jacobson said in the latest ruling.  “Time is of the essence for the legislative and executive branches to work together to come up with a solution to the pension crisis,” Jacobson said, adding that there’s no evidence of “any serious efforts to find a solution since the revenue shortfall accrued.”

A  spokesman for the Governor blamed “liberal judicial activism” for the decision. Democrats faulted Christie for refusing to adopt their proposed balanced budget that fully funded the state’s pension obligation. “This ruling is the predictable and unfortunate result of the governor’s fiscally irresponsible decision,” Assembly Speaker Vincent Prieto, Majority Leader Lou Greenwald and Budget Chairman Gary Schaer said in a statement.

In his FY 2016 budget presentation, Mr. Christie called for a freeze of the existing state-run pension system and proposed that public workers be shifted into a different type of retirement plan, one that would not force state taxpayers to make what the Governor deems to be open-ended contributions. Both the existing plan and the new follow-on plan would be placed within a new legal entity – a trust –  over which public worker unions would have oversight. The freeze would not eliminate the underfunding in the existing pension system. Mr. Christie called for paying it down over 40 years proposing a constitutional amendment making the payments necessary to do so mandatory.

One major problem emerged immediately. Mr. Christie declared in the address that he had an agreement with the state’s largest teachers’ union to solve the pension problem, but the union countered that it had agreed only to a framework, and to keep talking. He offered no details as to how he would meet the obligations the judge said had to be made — to pay the full pension payments that were due this year under the legislation he signed in 2011. The governor fell short of that amount by about $1.57 billion. For next year, the governor proposed making another partial payment — $1.3 billion instead of the $2.9 billion called for in the 2011 legislation.

Another Christie proposal would require local government, including school districts, to finance their employees’ pensions, rather than leaving the state to do so as it currently does. It is unclear where that money would come from, as state law caps property tax increases at 2 percent and the Governor did not specify how localities were to develop the funding necessary to cover the new expense.

The governor’s proposal was although noteworthy in that it excluded any proposal for new or increased taxes as a potential source of revenue to finance pension and health benefit costs associated with the need to make up the State’s long existing pension shortfall. It does include a $1.3 billion payment for pensions but this appears to be below the required level of funding required by legislation enacted in 2011. There was no mention of the State’s Transportation Trust Fund difficulties. Should the proposals be adopted intact – something we see as unlikely – there would appear to be little prospect of relief on the horizon for the State’s beleaguered bond ratings based on this presentation. All in all a negative day for New Jersey bond holders.

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