Joseph Krist
Municipal Credit Consultant
MSRB DISAPPOINTS ON BANK LOAN DISCLOSURE
Participants in the municipal bond market have been fighting the glacial pace of disclosure reform for as long as I can remember. The latest development in this effort is in the realm of disclosure of credit exposure by municipal issuers through direct lending by banks. In an effort to avoid the time, cost, and financial disclosure requirements associated with a public debt offering, smaller municipalities have increasing turning to commercial banks as a source of financing. While there have been some benefits for issuers, this lending has raised a number of credit issues for analysts and investors attempting to ascertain the actual level of risk associated with investment in a given issuers bonds.
One of the big concerns associated with this kind of borrowing is the lack of disclosure available to debt investors surrounding the exact security provisions for these loans. While the loans themselves are usually secured on a subordinate basis to outstanding debt, that can change in the event of a default on a loan. Often, in the event of default, the lending bank can demand that the borrower issue actual bonds which are secured on a parity with previously issued debt. holders of those bonds can suddenly find themselves with a significantly larger amount of debt secured on a parity with theirs. This complicates the analysis of potential recovery in the event of a default and/or bankruptcy and makes valuation of the total amount of outstanding debt much more problematic.
So it was with some disappointment that we see that the Municipal Securities Rulemaking Board (MSRB) announced this week that the U.S. muni market’s self-regulating group would not pursue “at this time” a rule to facilitate disclosure of bank loans taken out by states, cities, schools and other bond issuers. The board, which regulates muni dealers, bond underwriters and financial advisors, but not state and local government issuers, has been trying to devise a way to boost disclosure of such private loans for the reasons we have discussed.
The MSRB’s decision likely means that most investors will not be able to get this information. This despite the fact that the regulator itself acknowledged in March that only a small number of issuers had disclosed the loans “The board continues to believe that disclosure of alternative financings is important for assessing a municipal entity’s creditworthiness.” She said the board would instead continue to push for voluntary c”We preserve our ability in the future to do rule-making, but we wanted to give it a little more time,” Kelly said.
Our view continues to be that the industry needs to err on the side of more rather than less disclosure. As the old saying goes “sunlight is the best disinfectant”. With more municipalities using this technique and bankruptcy becoming more prevalent, this is an increasing concern for investors.
CHICAGO MAKES ITS CASE TO INVESTORS
This week the City of Chicago held its annual investor presentation. Given the daunting challenges the city faces, the update is timely. The City’s total revenues for 2016 are projected to end on target, although certain revenues are projected to end substantially under budget due to factors unrelated to Chicago’s economy. These revenues include utility taxes and the personal property replacement tax (PPRT). Utility tax revenues are expected to come in 2.6 percent or $11 million below budgeted amounts. The decline is driven by continuing low prices for natural gas, the mild winter, and the cooler than normal spring and early summer. Electricity tax, cable television tax, and telecommunication tax revenues are projected to end even with the 2016 budgeted amounts.
In addition to the decline in utility tax revenue, the City estimates that it will receive $40 million less in PPRT revenue in 2016 than budgeted. This reduction is due primarily to a misclassification of income taxes by the State of Illinois in 2014 and 2015 that resulted in the overpayment of PPRT revenues to local governments. The State adjusted downward its PPRT payments to local government earlier this year to reflect amounts that are owed. Local governments will be required to reimburse the State beginning in 2017.
Personal property lease tax revenues are expected to end 16.8 percent, or $29.8 million, above budget due to greater than previously anticipated compliance by the technology industry. The City lowered the personal property lease tax rate and waived taxes penalties and interest for years prior to 2015 for certain cloud software and infrastructure. Transportation-related taxes, including the garage tax and ground transportation tax, are anticipated to finish 2016 near budget at $238 million.
Corporate fund expenditures are currently expected to end the year at $3,548.7 million, or 1.0 percent, below the budgeted level of $3,570.8 million. These estimates are based on year-to-date spending, incorporating payroll trends, market pricing for relevant commodities, and any known changes or events that have or are anticipated to occur during the remainder of 2016. Based on current revenue and expenditure projections, the City estimates a 2017 corporate fund gap of $137.6 million.
The $137.6 million gap for 2017 is the lowest projected gap since 2007, and is substantially smaller than was projected for 2017 in the 2014 and 2015 Annual Financial Analysis. For the first time since 2011, the gap for the coming year is put forward without separate consideration of the City’s pension funds.
Corporate fund resources are projected to decrease from 2016 year-end estimates, and 2016 budget, by 1.6 percent or $58 million to $3,513 million in 2017, largely due to further expected declines in PPRT revenue. The 2017 PPRT estimates are anticipated to decline an additional $34.6 million, making these revenues 27 percent below the 2016 year-end expectations, as the State further decreases PPRT payments to recoup overpayments in previous years.
Economically sensitive tax revenues are anticipated to increase in 2017 above the 2016 level. Sales tax revenues are expected to grow at a rate of almost 3.0 percent through 2017 as consumer confidence figures continue to improve. Compliance levels for the personal property lease tax are projected to remain high, causing revenues to grow 4.5 percent on top of the growth in 2016 revenues. Utility tax revenues are expected to return to levels consistent with the 2016 budget on the expectation 2017 will bring more typical winter weather and natural gas tax revenue will increase over 2016 revenues. Other utility taxes are projected to remain flat or experience small fluctuations. Even though real property transfer tax revenues are projected to decrease by nearly 12 percent in 2017 compared to 2016 year-end, they are expected to grow over the 2016 budget by almost 4 percent. The decline from year-end is due to one-time increases from the transfer of ownership interests in the Skyway and Millennium Park garages in 2016.
The 2017 expenditures are forecasted to grow by approximately $80 million over the 2016 budget to $3,650.6 million. The majority of the projected expense increases for 2017 are personnel costs, primarily wages. The 2017 projection for these expenses assumes the same number of employees as 2016 with wages growing based on required contractual wage and prevailing rate due to the final phase-out of retiree health care and other initiatives designed to reduce growth in the cost of the City’s health care plan.
And of course no discussion is complete without news on pensions. As of July 29, 2016, the City has identified a permanent, reoccurring source to fund three of its four pension funds. In the fall of 2015, the City adopted a four-year property tax increase that provides funding for the City’s pension contributions to the Police and Fire pension funds through 2018. A small additional payment is needed in 2019 which is incorporated in the 2019 projections. Increases in pension contributions necessary to stabilize the Municipal pension fund are not included in the 2017 budget shortfall, as any increase in contribution will be coupled with a dedicated revenue source. Prior to the adoption of the 2017 budget, the City anticipates reaching a funding plan and reform agreement with the Municipal pension fund following the same framework as was achieved with the Laborers’ pension fund.
These projections assume status quo in terms of state action regarding pension reform. They also assume a successful outcome to ongoing litigation over the City’s obligation to fund healthcare benefits for retirees. The next step in that litigation is August 11.
The City’s presentation is consistent with our view that the Emmanuel administration is trying to do the right thing within the constraints of a challenged local political environment and an unsupportive state political environment. The disparate views represented on a 50+ member City Council and a dysfunctional state government severely handcuff anyone trying to enact broad reforms in Chicago’s long term credit trajectory. To the extent that management can influence a rating, this administration has to be viewed as a net positive factor.
BRAVES STADIUM HAS A POLITICAL COST
It won’t reduce the $400 million contribution from the County’s revenue base, but the voters of Cobb County, GA have exacted some political price for the County’s funding of part of the new stadium for the Atlanta Braves under construction for the 2017 season. The project has been controversial for a number of reasons unrelated to its cost and financing. Their current facility, Turner Field in central Atlanta, is only twenty years old. Nevertheless, the publicly financed facility has been declared outmoded after less than 20 seasons of use by the Braves.
Sun Trust Park will be supported by $397 million of bonds to be issued by the Cobb-Marietta Coliseum & Exhibit Hall Authority. The stadium will supposedly be more convenient to the majority of the Braves’ fan base but for many fans the real issue may be that this will result in a less “urban” tilt to the fan base. Ironically, it has not been the cost or the public financing of that cost that has raised the ire of Cobb county’s residents.
It has been reported that the Cobb County Commission—the five-person local governing body – that approved the Braves’ plan without public debate by standing in hallways to get around open-meetings laws — has determined that if county residents want to get the $40 million in new parks they voted for way back in 2008, they’ll have to raise taxes, because that money has now been siphoned off for the new baseball facility. The park bonds were never issued, then when the property tax hike funding them was set to run out, the commission decided to renew it for the stadium instead of spending it on what voters had intended it for.
So, when it came time for the primary election for the chairmanship of the Commission Incumbent Chairman Tim Lee lost his reelection bid . Some of the voters who voted against Lee said they were in favor of the Braves’ move to Cobb, but objected to the way the deal was negotiated in secret and committed some $400 million in public money to build and maintain a new stadium without a popular referendum. One said simply, “He should have asked.”
So the takeaway is not very straightforward. Voters seemed to be more concerned about the process than the result. A lot of the local opposition seemed to be development related rather than stadium related. This instance provides little clue as to whether politician’s usual fear of stadium referenda was validated. We see no applicability of this result to any possible result in November on a referendum in San Diego for a new Chargers stadium.
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