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.
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