Joseph Krist
Municipal Credit Consultant
THE HEADLINES…
WESTERN WATER WARS AND MUNICIPALITIES
WAYNE COUNTY CREDIT CONTINUES RECOVERY
ALASKA TURNS TO PENSION BONDS
INVESTMENT BLUES HIT HARVARD
CALIFORNIA COUNTY UPGRADES
VA. P3 ROAD MAY GET ANOTHER CHANCE
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WESTERN WATER WARS – MONTANA
Mountain Water Company (Mountain Water) owned the water system that provides potable water to the residents of Missoula, MT. Mountain Water is owned by Carlyle Infrastructure Partners, LP (Carlyle), a global investment firm that invests in utilities. The City desired to own the water system that serves its residents because City officials believe a community’s water system is a public asset best owned and operated by the public. In January 2014, the City offered to purchase the water system from Carlyle for $50 million, but Carlyle declined the offer. On May 5, 2014, the City sought to exercise its power of eminent domain to condemn the water system. Carlyle, Mountain Water, and the employees of Mountain Water opposed the condemnation.
As a municipality, the City of Missoula had the power under Montana’s constitution to take private property for public use as long as the private property owner is justly compensated. Water supply systems are one of the forms of private property that may be condemned for public use. In order to exercise its power of eminent domain, the City had to prove that the water system would be put to a public use, and that the City’s ownership of the water system is more necessary to that public use than private ownership. The Fourth Judicial District Court conducted a three-week bench trial to determine whether the City could prove that its ownership of the water system was more necessary than private ownership. On June 15, 2015, the Court concluded that the City had borne its burden of proof, and issued a preliminary order of condemnation.
On June 23, 2015, the Defendants appealed the preliminary order of condemnation to the Montana Supreme Court. On appeal, the Defendants challenged several of the District Court’s orders that preceded the condemnation order, including rulings on pre-trial motions and evidentiary rulings at trial. The Defendants also challenged the District Court’s ultimate finding that public ownership of the water system was more necessary than private ownership.
The Montana Supreme Court held that the District Court’s factual finding that City ownership of the water system is more necessary than private ownership was supported in the record by substantial credible evidence. That evidence included testimony about public support for condemnation; evidence about the condition of the water system and the implications of such a condition under public or private ownership; evidence regarding the City’s ability to effectively manage the water system if it were condemned; evidence from all parties about the financial considerations relating to owning and operating the water system, including administrative expenses, profit motive, rate setting, and the cost of acquisition and needed capital improvements; evidence about the effect of condemnation on the Mountain Water employees; and evidence concerning economic and public policy factors like coordination of water services with other municipal services, urban planning, environmental conservation, and public health, safety, and welfare.
The District Court received evidence and testimony from all parties concerning all the above factors, and concluded that although there was conflicting evidence in the record, overall the evidence favored condemnation. The Supreme Court conducted a thorough review of the record and was satisfied that the District Court’s finding that public ownership of the water system was more necessary than private ownership was based upon substantial credible evidence. The Supreme Court therefore affirmed the District Court’s preliminary order of condemnation.
WESTERN WATER WARS – CALIFORNIA TOWN FACES LOSS OF WATER
The fate of a small northern California town’s drinking water will be a much more complicated problem to figure out. The city of Weed waters half its population from the Beaughan Springs source that flows through the property of the Oregon-based company, Roseburg Forest Products in town. The city had a lease to access the company’s rights to the water for the last 50 years. That lease expired earlier this year. In February, the city announced that the city of Weed has not been able to reach agreement on contract renewal or extension to continue to receive water for the residents of the city.
The city staff and company representatives disagree on some fundamental issues, like who actually owns the water rights. The California Water Resource Board’s water rights database brings up nothing for the city of Weed, and just one inactive right to a different creek is under Roseburg’s name. The property in question, a lumber mill, has changed hands several times since its founding in the late 1890s. With each change of hands came a change of water rights, but some in Weed residents say the rights transferred to the city in 1982 in a letter written to International Paper Co., which was the lumber company that owned the property and the rights at the time, when it sold its assets to Roseburg Forest Products. In it, the watermaster allocates a specific part of the water rights “for domestic and municipal purposes to the City of Weed” and industrial purposes for the company.
Since that time Weed has leased its allocated amount of water for municipal purposes, and Roseburg Forest Products has sold part of the other rights to Crystal Geyser, a water bottling company. Roseburg believes that it could sell the City’s allocation to Crystal Geyser at much more favorable prices. The city and company ended up signing an agreement that allowed the city to use the water for up to 15 years. In the meantime, Weed had to show that it is making “best efforts to obtain an alternate water supply,” reads the agreement. It paid $97,500 every year for the water, increasing 2 percent annually after five years. Under its prior lease, the city was paying $1 a year.
While the city already has about three wells providing water to the south end of town but, it lacks the infrastructure to get the water to the northern homes and businesses that need it. That infrastructure will be costly, and require easements through other people’s properties. Well water is not reliable and it will need to be treated. The spring water it currently uses does not need to be treated. The city is looking for something in the ownership records to show it could be determined as an owner.
WAYNE COUNTY MI UPGRADE
Recovery continues to be a theme of the greater Detroit area. Moody’s announced that it had upgraded to Ba2 from Ba3 the rating on Wayne County, MI’s outstanding general obligation limited tax (GOLT) debt and assigned a positive outlook. The county has $510 million of long-term GOLT and GOLT-supported lease bonds outstanding and $287 million of short-term GOLT delinquent tax anticipation notes. The upgrade reflects improvement in the county’s financial position. This is in the wake of substantial reductions in retirement liabilities and associated costs. Moody’s feels that these resources may be applied to address outstanding capital facility needs. The economy is viewed as recovering but still comparatively weak. The demands on the tax base are steep when you include the liabilities of overlapping governments (primarily the City of Detroit), and limitations on the county’s ability to raise revenue to accommodate growth in costs including debt service.
The upgrade, while still resulting a in below investment grade rating, marks a milestone on the path back from near insolvency. The county can hopefully continue to enhance its operating reserves while accommodating increased costs associated with outstanding criminal justice facility needs. These include the ongoing capital costs of a new jail. In spite of all of the challenges experienced by its primary municipalities, the one of the twenty largest in the country despite multiple decades of contraction.
ALASKA TURNS TO PENSION BONDS
The steady drumbeat of oil prices and their impact on the State of Alaska’s finances have been well documented here. The effect of low interest rates and declining investment returns nationwide for pension investors have been as well. These two factors have combined to pressure the state’s pension funding levels. With lower levels of resources and political will to spend them, it is becoming more difficult for Alaska to deal with its pension funding needs. Hence, the upcoming planned offering of some $2.3 billion of taxable pension bonds.
Alaska is one of the state’s where pension benefits are constitutionally protected. Under Article 12, Section 7 of the State Constitution establishes that membership in an employee benefit plan constitutes a contractual relationship and that accrued benefits may not be impaired. Article 1, Section 15 of that same Constitution prohibits legislation impairing contracts.
In 2005, the state closed its defined benefit plans and instituted defined contribution plans for its employees. Nonetheless, the legislation establishing the change required up to $5 billion of debt to fund it. Among the conditions to any such borrowing are that the State have certain minimum debt ratings. With is credit weakening, the window for the State to issue such debt is closing.
Like most pension bond offerings, this issue relies on annual appropriations from the legislature. Proceeds will fund portions of the unfunded liabilities of the Teachers and Public Employees Retirement funds. The plan expects to achieve a funding ratio of 81% for the Public Employees fund by the end of FY 2017. The borrowing also helps to compensate for investment returns in FY 2016 of negative 0.36% versus an assumed rate of return of 8%.
CRIMSON FEEL THE INVESTMENT BLUES
We’ve spent a lot of time on public pension funding difficulties related to the challenging investment faced by public pension funds. It reinforces the view of the difficulties for even the largest and most sophisticated investors to view the preliminary official statement issued to support the upcoming issues of debt to be sold on behalf of Harvard University. The document includes information on the University endowment for the fiscal year ending June 30, 2016.
The University blames the results on volatility in the investment markets. The University does note that it smoothes the results of endowment revenues into its revenue assumptions underlying its annual budgets. The distribution rate from the endowment have averaged 4.4% over the last twenty years. It should be noted however, that the distribution rate has been a higher 5% annually for each of the last five years.
Like many similar investors, the University’s outlook and goals are somewhat ahead of current rates of return. The University’s goal for real returns on the endowment are 5% going forward. At the same time, the endowments returns have declined steadily in terms of outperformance over the last ten years. Now before you go off and despair over the future prospects for the Crimson going forward, keep in mind that even with the loss, the endowment was valued at $35.7 billion after the FY 2016 results. And Harvard
It is however, one more reinforcement of the notion that pension fund and endowment currently bedeviling investment managers will continue to be difficult. The pension and endowment issues simply will not go away for public and non-profit investors.
CALIFORNIA MUNICIPALITIES BENEFIT FROM MOODY’S STANDARDS
On July 26, 2016 Moody’s announced a series reviews of county and local ratings in conjunction with developments of the Lease, Appropriation, Moral Obligation, and Comparable Debt of US State and Local Governments methodology used to evaluate these credits. The latest series of ratings changes have impacted municipalities in California, in large part favorably.
At quarter end, the Lease, Appropriation, Moral Obligation, and Comparable Debt ratings were upgraded for Shasta, San Joaquin, Los Angeles Counties. Poway, Newark, and San Mateo also received upgrades. The bonds are generally secured by lease payments made by the municipalities for use and occupancy of the leased assets.
CAROUSEL CENTER BACK TO THE MARKET
One of the more interesting high yield credits in the New York market has been debt issued for the Carousel Center in Syracuse, NY. With many changes challenging the retailing industry (Macy closings, the difficulties of K Mart and Sears, the recently announced merger of Bass Pro and Cabelas), many investors are reexamining the viability of debt which relies on viable retail projects for repayment of that debt. They include bonds like these which rely on developer/operator payments and debt which relies on retail development t to generate property tax revenue to repay debt.
The Carousel Center is a 1.5 million square foot (gross leasable area GLA) shopping mall that is part of a total 2.4 million GLA retailing facility known as Destiny USA. The Carousel Center serves as the anchor for the larger project. Some 18% of the Carousel Center consists of a Lord and Taylor and a Macy’s, which retain the right to exclusive possession of their respective spaces through mid-December 2056.
The bonds are special obligations of Syracuse Industrial Development Agency, secured solely by scheduled PILOT payments for the existing Carousel Center (pursuant to a PILOT agreement between the Carousel owner and SIDA). A DSRF requirement equal to 125% of average annual debt service is also provided. Failure to pay its PILOT obligations, barring an equity cure, would result in a foreclosure on the Carousel Center. The security incorporates structural support, such as the seniority of PILOT payments to the Carousel Center’s operating and maintenance expenses, mortgage costs, and owner distributions.
When originally conceived, the project was believed by its developers at that time to be capable of drawing the same numbers of visitors annually as Las Vegas did. While that lofty goal has not been realized, Destiny USA did draw some 26 million visitors in 2016. It is the sixth largest enclosed mall in the US. The property’s stable sales per square foot and occupancy are both comparable with other high-end commercial malls around the country. Historical operating performance includes approximately 94% occupancy on average as reported by the owner. That performance has now generated Baa1 (Moody’s) and A- (Fitch) ratings for these refunding bonds.
VA. ROAD MAY GET ANOTHER CHANCE BUT WILL IT BE A P3?
Virginia’s beleaguered U.S. 460 project got a key provisional permit from the U.S. Army Corps of Engineers last week. The lack of such an approval derailed prior efforts after nearly $300 million in spending. Other signoffs remain before the state can build and reconstruct about 17 miles of road from U.S. 58 in Suffolk and west through Zuni. The state also must find funding for the project, which is now estimated at $425 million beyond money already spent without ever turning dirt. This Corps of Engineers permit puts plans further along than they’ve ever been, though, despite decades of expansion talk. The state canceled the prior project in 2014.
VDOT’s wetlands permit is provisional at the moment, though most of what remains there is just a formal signatory process. Their plan now calls for an untolled four-lane divided highway from Suffolk, bypassing Windsor to the north. The state would also rebuild the current U.S. 460 through Zuni with a new bridge across the Blackwater River. The state recently overhauled its roads prioritization process, implementing a grading process dubbed “Smart Scale.” Opponents predicted that the new 460 likely won’t score well under that formula, which weighs various project benefits, such as congestion reduction and safety improvements.
The revised and scaled back project impacts some 35 acres of wetlands, according to VDOT. The initial design impacted more than 480 and the mitigation efforts regulations would have required to offset that impact would have been the largest in Virginia history.
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