Joseph Krist

Municipal Credit Consultant

CHICAGO PUBLIC SCHOOL CREDIT UNDER MORE PRESSURE

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

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

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

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

PENNSYLVANIA BUDGET STANDOFF IMPACT ON SCHOOL DEBT

Standard & Poor’s says it has withdrawn its ratings on a state government program that helps school districts borrow by giving a guarantee to repay bondholders.

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

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

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

NUCLEAR DEVELOPMENTS IN SC

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

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

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

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

WATER IN CALIFORNIA BACK IN THE NEWS

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

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

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

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

WILL RATE HIKES OFFSET VOLUME DECREASES?

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

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

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

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

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

PUERTO RICO REVENUE SHORT AGAIN

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

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

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

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

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

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