Joseph Krist

Municipal Credit Consultant

PR LITIGATION WAS INEVITABLE

National Public Finance Guarantee Corporation filed a Complaint in Federal District Court in Puerto Rico as we went to press seeking a declaration from the court that the Puerto Rico Moratorium Act is preempted by Federal bankruptcy law and violates the U.S. Constitution in several respects. Similar to the Puerto Rico Public Corporation Debt Enforcement and Recovery Act that was adopted by Puerto Rico and found to be invalid by the United States Supreme Court, National believes that the Moratorium Act is likewise invalid.

With this action, National is seeking to protect the right to priority of payments established under the Puerto Rico Constitution on the General Obligation bonds that it insures, and the liens on properties that secure other National-insured bonds, which the Commonwealth has already invaded under claimed authority of the Moratorium Act. While National it is supportive of the efforts by the U.S. Congress to pass legislation to address Puerto Rico’s financial difficulties, the current draft of the PROMESA legislation approved by the House of Representatives, in its opinion, does not foreclose continued reliance on the unconstitutional Moratorium Act.

The passage of the Moratorium Act while Puerto Rico was in the middle of trying to negotiate a restructuring of its debt made the filing of litigation inevitable. In our view it was an act of bad faith towards its creditors and another in a string of poor decisions by the current Commonwealth government.

ALL ABOARD FLORIDA TRAIN MOVES TO NEXT STOP

A Leon County, Florida Circuit Judge has denied Indian River County’s writ of certiorari that was sought in an effort to block a state-created conduit issuer from selling $1.75 billion of tax-exempt bonds for a private passenger rail project. The project, owned by Fortress Investment Group, has constructed stations and upgraded infrastructure with equity,  spending a total of $787 million since January. Of the total amount spent to date, approximately $594 million corresponds to Phase I (the Miami to West Palm Beach segment), and approximately $193 million relates to Phase II (the West Palm Beach to Orlando segment).

The Florida Development Finance Corp. voted unanimously on last Aug. 5 to allow the corporation to serve as the conduit issuer for All Aboard Florida’s $1.75 billion in private activity bonds for the project. The project is expected to cost $3.5 billion.

The judge ruled that the county failed to establish that it had standing to challenge the federally approved private activity bonds to be issued for All Aboard Florida. He further ruled that even if Indian River County had standing to challenge FDFC’s vote, the county failed to establish that certiorari jurisdiction was appropriate because the corporation’s decision was “quasi-legislative as opposed to quasi-judicial.” The FDFC was created by the Florida Legislature. Its board members are appointed by the governor and confirmed by the state Senate.

All Aboard Florida has already changed its name to Brightline and expects next year to begin daily service on the 70-mile-segment from Miami to West Palm Beach, with a stop in Fort Lauderdale. Initially it will operate over existing Florida East Coast freight rail right-of-way and is building stations in Miami, Ft. Lauderdale, and West Palm Beach. Upon completion, the full 235-mile system will extend to Orlando International Airport following construction of a new, 40-mile spur between Orlando and existing rail line on the Atlantic Coast. All Aboard eventually plans to run 32 passenger trains a day between Miami and Orlando.

The passenger trains will pass through Indian River and Martin counties on the existing Florida East Coast freight railroad line with no passenger stops planned in the two counties. They have filed three different petitions in various state courts seeking reviews of FDFC’s vote. None have been successful.

Both counties also filed separate federal lawsuits— the first ever to contest a USDOT bond allocation for private activity bonds – for the project. The federal suits — the first ever to contest a USDOT bond allocation — are pending in the U.S. District Court for the District of Columbia. A hearing is scheduled June 30 on motions by USDOT and All Aboard Florida to dismiss the cases. A hearing is scheduled for June 30.

The counties contend that the bond allocation was approved in violation of the National Environmental Policy Act, and that the federal approval process failed to consider adverse impacts on traffic and public safety. The suits have stymied more than one attempt by All Aboard Florida to sell its $1.75 billion of unrated bonds to qualified institutional buyers and accredited investors several times. AAF claims that market conditions relative to bond financing began to improve earlier this year and are continuing to improve.

Permits are yet to be approved for proposed safety improvements for the roughly 170 grade crossings and monitoring of archaeological and historical items. Permit risk is always something that savvy bondholders should not accept.

COOK COUNTY

With so much attention focused on Chicago’s pension problems, there has not been as much light shed on the pension situation for the city’s slightly bigger cousin, Cook County. The official statement supporting the County’s pending general obligation bond issue does just that. The O.S. states that the County’s unfunded pension liability grew from $6.5 billion at the end of 2014 to $7.2 billion at the end of 2015. Lower numbers of employees paying into the system combined with lower investment results resulted in the County’s already low funding rate to decline to 55.4%.

The County acknowledges that the statutory formula which establishes annual funding levels from the employees and the County do not meet its actuarially required annual contribution level. In addition, the State of Illinois Pension Code does not provide for any mechanism to account for changes in demographics, assets, or benefits. Any changes for those factors must be remedied by State legislative action.

Here is where the ongoing budget and ideological stalemate between the Governor and the legislature hurts the County. Even if it wanted to address those factors on its own, those actions could be legally challenged. So the County and its ratings are between a rock and a hard place. And the prospect for a quick resolution of the stalemate in Springfield does not look good.

Our view is that the County’s credit will continue to weaken and that the relative value of its bonds should decline. We would expect further downgrades of its credit.

WAYNE COUNTY, MICHIGAN

Wayne County is another troubled borrower whose major city has garnered most of the attention of the market. As Detroit was emerging from its bankruptcy, it appeared  that the County might be headed off a fiscal cliff of its own. Fortunately, a combination of state intervention and strong expense control forestalled the worst for the County’s  grade.

Like Cook County, Wayne County faces substantial demands on its finances to fund pension obligations. In the official statement released in support of its pending tax anticipation borrowing, Wayne County reports a pension liability funding ratio of 46.8%. Such a funding level is unacceptably low however the County does deserve some credit for meeting its actuarially required annual funding level each year since 2011. In the last three years, the County’s contribution has exceeded the requirement rising to 120% in fiscal 2015.

So unlike its larger counterpart, Wayne County’s credit remains on an upward trajectory.

BOND INSURANCE MISCONCEPTIONS

One would think that after the meltdown of bond insurer ratings due to the financial crisis of the last decade, issuers would understand how the product works. It is still amazing to see how some issuers still believe that in a default, they somehow do not have an obligation to repay the insurer. We have another reminder of that misconception this week with a small Virginia issuer.

Buena Vista, VA is a community of 6000 located in the scenic hill country in the State’s south. It is not too far  from the Virginia Military Institute and Washington and Lee University. In 2005, the City issued some $9 million of lease revenue bonds backed by an annual appropriation pledge. The bonds financed a golf course which was supposed to stimulate land values and development in the City. As security for its obligation to bondholders (and ACA the insurer), the City pledged the golf course and land on which its City Hall and other city offices were located.

Like so many other golf course projects financed through munis, this one failed to meet financial projections and did not generate sufficient funds to pay off the Bonds. So the City had to choose to either default on the lease or appropriate other monies in the City’s budget to pay off the bonds. In 2011 ACA agreed to work with the City by allowing it to make reduced payments to reimburse ACA for paying debt service on time and in full to bondholders. In 2015, it chose not to make the appropriations and has continued to fail to do so. Also, the City failed to prepare and Make Public or cause to be Made Public by the Dissemination Agent, with a copy to the Bond Insurer, Annual Financial Information with respect to Fiscal Year 2015 not later than 180 days after the end of such Fiscal Year.

So it is with some amusement that the City seems surprised that ACA is seeking legal remedies to compel payment. ACA is seeking to act on its right to take possession of the pledged assets securing the obligation which means it could theoretically lose title to the golf course and land on which its City Hall and other city offices were located. “All bond holders have been paid in full because the city purchased payment insurance from ACA,” according “All bond holders have been paid in full because the city purchased payment insurance from ACA,” to the City Attorney. But that doesn’t make the problem go away. So far the City is acting like they can do just that.

 SEC INVESTIGATING MORE MUNICIPAL BONDS

The latest SEC municipal bond investigation would seem to have been brought upon the issuer themselves. In April of this year, Community High School District Number 210, Will and Cook Counties, Illinois received reports regarding certain District revenues derived from three bond issues totaling $225,000,000 for capital improvements, including the construction and equipping of two new high schools and the improvement and equipping of the District’s then-existing high schools. An outside auditor has determined that certain bond issue proceeds and  interest  earnings on those proceeds  were,  in  fact, transferred  between  District  funds  or otherwise accounted for in a manner not in accordance with best practices and without, in some instances, adequate evidence of Board approval.

Despite the direction of the Board in the 2009 Bond Resolution and without any Board direction to the contrary, the District’s records of accounts currently indicate that the proceeds of the 2009 Project Bonds were accounted for in operating funds. a significant portion ($18,000,000) of the misdirected  proceeds and an interest  transfer  was  used  to fund expenditures other than for capital improvements. Those interest earnings were not needed for capital projects, and federal  law might render the tax-exempt bonds taxable should such sum be transferred back to a capital fund. The Board determined that it could use the interest earnings for operating purposes.

The SEC will look at all of this to determine if the District was truthful with investors when it issued official statements for the three bond issues. If it was not, the District could be charged with securities fraud. The Commission has clearly become more vigilant in regard to disclosure included in official statements. our view is that any such activity by the Commission is welcome in support of the investor community’s efforts to improve disclosure in the municipal bond market.

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.