Joseph Krist

Municipal Credit Consultant

WHEN A TAXABLE REFUNDING MAKES SENSE

Many tax-exempt revenue bonds are issued for activities Congress has classified as private because most of the benefits from the activities appear to be enjoyed by private individuals and businesses. The annual volume of a subset of these tax-exempt private-activity bonds is capped. The cap has been adjusted for inflation since 2004. The annual volume cap applies to the total of bonds issued primarily for but not limited to multi- and single-family housing, industrial development, exempt facilities, student loans, and bond-financed takeovers of investor-owned utilities (usually electric utilities).

Exempt facilities subject to the volume cap are the following: mass commuting facilities, water furnishing, sewage treatment, solid waste disposal, residential rental projects, electric energy or gas furnishing, local district heating or cooling provision, and hazardous waste disposal and 25% of high-speed rail facility bonds.

This does not mean governmental ownership in the conventional sense. It simply means that lease arrangements for private management and operation of bond-financed facilities must be structured to deny accelerated depreciation benefits to the private operator, lease length must conform to the facility’s expected service life, and any sale of the facility to the private operator must be made at fair market value.

El Paso County Texas recently closed on an issue of taxable refunding bonds that refunded general obligation bonds and certificates of obligation  which were tax exempt. The Bonds which were recently issued were refunding in advance bonds which were already refunding bonds themselves or which issued for the purposes outlined in the prior paragraph. So a taxable issue was the only way the refunding bonds could be advance refunded. The remaining bonds would have created cap issues for the County. So with rates where they are demand for this kind of paper strong – including from foreign institutional buyers – this kind of issue makes tremendous sense for the County and other borrowers who find themselves confronting a similar situation.

OLD NEWS TO MUNI VETERANS

According to a new audit from Pennsylvania Auditor General Eugene DePasquale, mandated cost increased and an inability to raise revenue are hampering the Philadelphia School District with persistent budget deficits. This release may be news to some but to veterans of the municipal bond market they represent a continuation of history.

The District has had a long history of declining demographics, declining outside resources, and mismanagement dating at least to the 1970’s. Over time, the District was able to overcome what had become a mounting set of obstacles to market access for both operating and capital purposes. These needs were financed by a variety of commercial bank liquidity facilities and credit enhancements. While these facilitated market access, there was continued deterioration in the District’s credit fundamentals. Declining enrollment related to demographics as well as to increased competition from charter schools. These combined to pressure the level of revenues available from the Commonwealth of Pennsylvania based on average daily attendance levels.

At the same time these factors were negatively impacting the District, weaknesses in the City’s tax collection and assessment practices also played their part. When the District also calculated its ongoing maintenance and capital needs, it realized that it also faced serious pension funding requirements. Options to address these needs were limited as the District’s credit fell below investment grade Commonwealth’s state aid secured lending program. This effectively limited the District’s ability to borrow.

Over the years the Commonwealth has experienced increased difficulties balancing its own budget. As is true on the national level, the annual budget process in Pennsylvania has become more acrimonious and partisan. Recent years have seen increased  delays and outright failure in the efforts to adopt budgets for the Commonwealth. Funding for education has been at the center of these failed efforts whether the sticking point should be over efforts to lessen property tax burdens or absolute levels of state aid. Aid to Philadelphia has been a particular point of conflict along regional and racial lines.

Unfortunately, we don’t see this combination of factors resolving itself politically anytime soon. That directly points to a continued negative trend for the District’s credit in spite of the clear need for additional help – fiscal and political  – that the District clearly needs.

ATLANTIC CITY STEPS BACK FROM THE LEDGE

Atlantic City Mayor Don Guardian said that the city managed to make a $1.8 million interest payment due on 2012 municipal bonds and avoid becoming the first New Jersey town to default since the 1930s. The payment covers interest on 2012 municipal bonds sold to raise money to pay back casinos who successfully appealed their taxes. He said he made the decision to make the payment after considering the bond ratings for Atlantic County and other New Jersey municipalities “as well as the effects for my city.”

Guardian estimated that the city has about $7 million on hand, and is receiving some $1.5 million in daily as May quarterly taxes come in. Residents and businesses had until May 10 to pay before penalties took effect, and many businesses including casinos were expected to wait until then.

The mayor said he would be able to make the $7 million monthly payroll. Unions agreed to switch from a 14-day payroll schedule to allow the city flexibility. And he said he was committed to making the $8.5 million May school payment next due May 15.

We believe that the outlook for a short term resolution is cloudy at best as the issue remains politically charged in the legislature. There are huge negative implications for municipal finance across the state without some resolution but we are reminded that New Jersey remains one of the most political of jurisdictions.

NEW YORK CITY

Both the City’s Office of Management and Budget and the Independent Budget Office  have recently released outlooks for the City’s fiscal health going forward. The OMB outlook, which reflects the Mayor’s view is expectedly positive. It emphasizes the accumulation of reserves, settlement of 95% of its labor contracts and funding for its policy priorities. Of more interest to this observer are the views of the IBO.

In the IBO view, “Mayor Bill de Blasio’s Executive Budget for 2017 and Financial Plan Through 2020 proposes an increase in spending to support a bevy of new or expanded programs as well as a substantial infusion of city aid for the fiscally ailing municipal hospital system. His budget plan also includes doses of fiscal caution in the form of a larger citywide savings program and an increase in the amount of funds held in reserves. Based on IBO’s latest economic forecast and re-estimate of tax revenue and spending projections under the contours of the Mayor’s executive budget and financial plan, there are reasons for optimism and prudence. Our latest economic forecast anticipates that local economic growth will slow, with a decline in job growth from the record levels of the past few years and a corresponding slowdown in revenue growth in the years ahead. Still, IBO expects that the city’s fiscal condition will remain stable—budget surpluses this year and next and shortfalls in future years that will be relatively modest as a share of city-generated revenue.

IBO projects that the city will end the current fiscal year with a surplus of $3.5 billion, $151 million more than the Mayor’s estimate. After adjusting for the use of this surplus to prepay some of next year’s expenses, we project a comparatively small surplus of $812 million in 2017 under the Mayor’s plan. This amount may understate the “real” surplus because the Mayor’s plan includes two reserve funds within the 2017 budget totaling $1.5 billion—dollars that are recorded as expenditures but do not currently support any specific spending needs. Taking these reserves into account, the projected surplus for next year is effectively $2.3 billion.”

All in all, the IBO findings seem to support the general aura of conservatism presented by OMB in its presentation. Our view of the NYC credit has always been premised on the structural and reporting requirements imposed on the City over the last four decades. While nothing is fool proof, as long as those structures and requirements remain in place we see the City’s debt as a safe bet for investors.

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