Joseph Krist

Municipal Credit Consultant

PR SHORTCHANGES COFINA INVESTORS ON INFORMATION

The recent information call held by the GDB continued the Commonwealth’s trend of coming up short in terms of information for its investors. In this case, it was the discussion of the Commonwealth’s plans to shift the sales tax base supporting its outstanding COFINA debt from a traditional retail sales base to a value added tax base. The intent of the change is to make it more likely that a greater share of economic activity on the island that should be subject to taxation might be more readily captured. This reflects the ongoing reality that a substantial portion of the economy remains “underground”  thereby reducing available revenues for the payment of the island’s most marketable debt.

Moody’s estimates that the tax’s collection rate has historically been about 60 percent. In October 2013, S&P reported that the Commonwealth budgeted a capture rate of 88percent on highly regulated companies and 68 percent for other businesses. Under current conditions, it would take a relatively insubstantial decrease in the annual rate of increase in collections to create a situation in which debt service requirements would exceed available revenues, especially for subordinate debt.

This is an important factor as the island looks for ways to fund its capital needs while it strengthens and reforms its overall fiscal and debt structure. Many have seen COFINA  as the best debt for investors to hold. This makes the proposed change in the method of sales tax generation and collection as would be envisioned of even greater interest. The method itself has actually received a positive reception at least from institutional investors recently quoted in the press.

It makes it all the more puzzling why the Commonwealth would advertise such a proposal with so little detail. To date, no implementing legislation has been proposed or filed so it is impossible to evaluate the likelihood of adoption. In addition to making it harder to value the currently outstanding bonds, the lack of information raises more questions than it answers. The continuation of such practices is one of the great negatives weighing on the credit quality of Commonwealth debt. It is therefore, disappointing to see this practice continue despite a change in administration and changes in leadership at the GDB.

ILLINOIS ACTIONS REMAIN UNCERTAIN AFTER ELECTION

Investors who hoped to get a clue as to whether or not Governor-elect Bruce Rauner would stick to his campaign positions regarding taxes and fiscal policy will have to wait until 2015 for answers. Rauner campaigned on allowing tax raises in the personal and corporate income tax levies in January 2011  scheduled  to expire at the end of this year to do so. Rauner told reporters after the election that he’s had discussions with Democrats and Republicans in the legislature and plans to meet with them to “address our state’s very significant financial problems.”  “I’ll be working very closely with members of the General Assembly to provide both short-term solutions and long-term solutions to fix the financial health of the state.”  It will be important to do so as the State’s cash flow problems are not improving, thereby continuing the need to conserve cash, slow payments to state institutions (e.g., universities) and vendors. Billions of dollars of bills remain unpaid. The state is short of revenue to get itself through the fiscal year ending June 30. Along with a lack of progress on pension reform, the cash situation and fiscal policy uncertainty are more likely than not to lead to additional downgrades until action is taken.  A sign of the potential difficulty in holding up real reform is the well known political difficulties in the State. Immediately on election night these became apparent. Rauner said during his victory speech on Nov. 4, “Just a few minutes ago, I placed two very important phone calls — I called Speaker Madigan,” and “I called President Cullerton, and I said to them, ‘This is an opportunity for us to work together’”. While the anecdote appeared to signal Rauner’s desire for bipartisan cooperation, spokesmen for the speaker said that Rauner and Madigan didn’t speak on election night, and there was no record of any voicemail or call. A spokesman for the Senate President said that while someone from Rauner’s campaign contacted his staff, Rauner and the Senate president didn’t talk. So investors will apparently just have to wait and see. LOUISIANA HIGHLIGHTS MUNI REPORTING ISSUES

Situations keep arising that only reinforce the image of the municipal bond market as one of opaque disclosure. The most recent example is Louisiana. State Treasurer John Kennedy warned this week that the state general fund is running a historically high negative balance through the first four months of the fiscal year. Kennedy said, “I’m concerned.  This negative balance is evidence that we are spending more than we’re taking in.  We’ve been doing it for a while, but this historically large negative balance demonstrates that it’s getting worse,” In fact, the Department of Health and Hospitals just announced that we are already $171 million over budget in our Medicaid program with eight months to go in the fiscal year.”
The end-of-the-month state general fund balance for October was a negative $925 million, forcing the Treasurer’s Office to borrow from other funds in order to maintain cash flow.  This was Louisiana’s negative end-of-the-month state general fund balance for that time period in five years.  The fund balance on October 31 of last year was a negative $657 million.  The end-of-the-month negative general fund balances for October 31 through the prior three years were: $181,531,912.38 (2010), $565,169,822.53 (2011), $476,665,313.52 (2012).

As problematic as these figures may be, the fact that the Governor’s office disputes them so strongly is more so. That office insists that the State has a surplus but this is based on some $300 million of previously unaccounted for funds. These newly discovered monies have supposedly created a deficit. Such a discrepancy would normally be a substantial concern for a corporate borrower in the public debt markets but apparently not so for this municipal borrower.

The state does have strong constitutional protections for its general obligation debt but the fact that a payment default may not result does not mean that risk of a growing deficit is accurately or fairly being priced in the market. While Moody’s maintained its Aa2 rating, it cited the dwindling impact of a post-Katrina reconstruction boost; continued budget gaps due to underperforming revenues; and the challenges the state faces in dealing with its large Medicaid caseload and significant unfunded pension liabilities.

The state said that it will take until January 2015 to resolve the differing views of its fiscal position.

NYPA BENEFITS FROM IMPROVING STATE CREDIT

The New York State Power Authority saw its Moody’s rating upgraded to Aa1. The upgrade reflected the continuation of the Authority’s favorable balance sheet and operating characteristics. These have always been hallmark traits of the Authority as well as the benefits of reliance on the Niagara hydroelectric facilities as core resources for power generation. What has improved is the decreasing reliance by the State of New York for transfers from the Authority to bolster the State’s annual budget position. As the State’s operating fundamentals have improved, the Authority has not had to transfer funds to the State and may actually receive some repayments of prior transfers dating back to 2009. All of this should improve the Authority’s liquidity and help to finance its ongoing capital needs.

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