Joseph Krist

Publisher

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WHAT DOES A RATING REALLY SAY?

One of the characteristics of credit analysis in the municipal space is its willingness to divorce operational from financial issues. In the transportation sector this is especially true. Whether through the use of pledged revenues derived from non-transit sources (like sales taxes) or legal structures creating gross liens on revenues, the linkage between operational issues and credit perceptions remains weak.

We mention this in connection with ratings actions taken this week by Moody’s regarding debt issued by the Washington Metropolitan Transit Authority (WMATA). WMATA has been best known for its service difficulties, declining ridership, and significant capital needs. So it was a little surprising that WMATA revenue bonds had been the subject of an upgrade at this time.

Nonetheless, Moody’s Investors Service has upgraded to Aa3 from A2 the rating on gross transit revenue bonds of the Washington Metropolitan Area Transit Authority, DC (WMATA). The outlook on the rating is revised to stable from positive. Clearly the role of Virginia and Maryland in providing operating subsidies is the overriding factor in this move. “The upgrade to Aa3 incorporates the strong operating environment of the authority, which itself is grounded in continued commitments from the District of Columbia (Aaa stable) and the states of Maryland (Aaa stable) and Virginia (Aaa stable) to financially support the transit enterprise. Subsidies from these governments now cover more than half of WMATA’s annual operating costs.

We have seen though, that support for subsidizing the system has been known to waver. It is hard to see how a system like this with as many management, organizational, and political hurdles to overcome while relying so heavily on outside revenues. As operational issues arise as they did in recent years, they are a source of tension which lead to uncertainties about ongoing subsidy levels.

In making the case for the upgrade, Moody’s cited “improved internal liquidity, continued bank support through lines of credit, and greater certainty with regard to federal grant funding following the FTA’s approval of the Washington Metrorail Safety Commission’s Safety Oversight Program. ” At the same time, the announcement highlights “weak coverage of debt service by net operating revenue, though this is also mitigated by the role played by the state and local government subsidies. A key challenge factored into the rating is WMATA’s heavy post-employment benefits burden. Unfunded pension and OPEB liabilities are high relative to the authority’s revenue and will likely remain a source of rising expenses for years to come.”

It all adds up to quite a mixed bag of factors to evaluate. Our view is that these are enough to hold the rating at its previous level, hence our surprise at this point in time. It’s only been three years since the Authority’s debt was downgraded. It seems like a pretty quick turnaround from here.

LAUSD ELECTIONS HAVE CONSEQUENCES

The recent failure at the ballot box of a proposal to increase property taxes has rightly been seen as a blow to the District’s credit outlook. When the District reach an agreement with its teachers to raise wages and increase resources to the schools, it was widely assumed that support for the teachers goals would translate into support for increased funding from the taxpayers.

That turned out to be a significant miscalculation when voters rejected a proposal for a parcel tax to fund the increased costs of the settlement. The defeat has forced the District to scramble to find ways  keep its budget balanced without the increased revenue to fund a higher cost base. One had to wonder when these events would manifest themselves in the District’s ratings.

It did not take long to see action. Last week, Moody’s Investors Service has downgraded Los Angeles Unified School District, CA’s outstanding general obligation (GO) bonds to Aa3 from Aa2 affecting approximately $10.2 billion in outstanding debt. Specifically it said that “the rating downgrades reflect the district’s structural budgetary challenges and limited financial flexibility stemming from rising fixed costs and recent concessions with the teachers’ union for higher salaries and increased resources. The district faces revenue constraints arising from declining enrollment, increasing dependence on state aid growth that’s slowing and voter rejection of a recent parcel tax measure. As a result, the district is facing a $500 million budget gap.”

The nation’s second largest public school district and the largest one which issues its own debt clearly faces daunting challenges. One thing everyone agreed on at the end of the January teachers’ strike was that the funds to pay for it were not there. So let’s hope that Moody’s note that “management that has a record of outperforming budgeted projections and built up sound reserve levels that buy it time in responding to these challenges before they would cause financial strain” proves out.

PUERTO RICO

It is impossible to comment on events in the municipal space without doing so in regards to the latest efforts by Puerto Rico to evade its legal and moral responsibilities. Previously, I described the efforts to expunge debt while minimizing the pain inflicted on the electorate as being on a par with a drive by shooting. You may get your target but lots of innocent people can get hurt in the process.

Puerto Rico justifies its actions towards debt holders by invoking the specter of the evil hedge fund debt holders. Whatever anyone think of that particular investor class, it can’t be seen as a positive that issuers can decide which group of investors is worthy of fair and legal treatment. And it makes no sense to treat parties like the bond insurers in the same manner just because they are larger corporate entities.

So, it is from that perspective that we view the announcement by the Puerto Rico’s Financial Oversight and Management Board of its plan to restructure $35 billion in debt and non-debt claims of commonwealth and Public Buildings Authority creditors. The plan is to sharply reduce what is available for investors while essentially exempting the Commonwealth’s pensioners from any real pain. The 2012/2014 holders have the option to litigate for equal recovery with pre-2012 bonds, called vintage, or settle at certain levels. The 2012 GOs, which total $2.7 billion, can settle at 45% or be litigated for pari vintage recovery. The 2014 GO bondholders, which have a claim of some $3.6 billion, can settle at 35% or litigate for pari-vintage recovery. Holders of some $700 million in 2012 PBA bonds settle at 23% with net GO claim treated as 2012 GO. Vintage PBA bonds, which total about $3.9 billion can settle at 73% of the recovery.

The government was clear in expressing its position that the government will not support any proposed plan support agreement (PSA) that is based on the recently enacted fiscal plan, which calls for pension cuts. So there it is. All holders must be large holders, all of them were vultures, all of them are an excuse to walk away from responsibility. And all of this represents a corporate mentality whereby the rules of risk taking markets are applied to a risk averse market.

That’s great until one realizes that this is not the corporate market. Now Puerto Rico must face a future where its entree back into the municipal market is not clear. And if it does regain access, will it not need credit support? If it does, will the bond insurance industry be as open to exposure to the credit that treated them so poorly before? The idea that the bond insurer should be treated in the same way as a distressed buyer ignores one little point – the insurers effectively bought at par while many of the current creditors had an effective entry price into the credit of substantially less. So the bond insurers dismay is more than understandable.

It is ironic that for over 40 years potential individual investors would ask what if there’s an insurrection? The fear was of debt repudiation. Now the insurrection against debt repayment  is being generated not as much from below as it is being generated by a political establishment seeking to come out the other side of this debacle with their access to their power and relative privilege intact. They still do not appear to understand that audits and accountability matter. Just this past week, the Financial Oversight and Management Board said the commonwealth government failed to comply with the Puerto Rico Oversight, Management, and Economic Stability Act of 2016 (Promesa) because it has yet to submit certain financial and budget reports. 

The government did not submit, when due April 15, budget-to-actual reports for the University of Puerto Rico (UPR) and the Highway and Transportation Authority (HTA) for the third quarter of fiscal year 2019, as required by Section 203(a) of Promesa. The government did not submit budget-to-actual reports for PREPA, HTA and UPR for fiscal year 2018 and asked these be submitted by the new June 30 deadline. From now on, the board said, the government will also be required to publish public quarterly Section 203(a) reports one month after they are submitted to the board.

The question is will we make them pay a price?

SURPRISE MEDICAL BILLS – SIZE WILL AGAIN MATTER?

With bills under serious consideration in Congress to limit what are known as surprise medical bills, the healthcare industry has reacted with alarm. Clearly, the practice of accepting insurance and hen trying to claw additional revenues from patients usually not in a position to m informed decisions fails many tests of equity and fairness. Surprise bills usually arise from emergency services provided to patients insured patients who inadvertently receive care from providers outside of their insurance networks.

A number of solutions are on offer. Legislative solutions include capping out-of-network charges for emergency medical services at in-network levels; or setting up an arbitration process to resolve out-of-network charges. Other legislation would require a single, “bundled bill” for all care received in an emergency room or have hospitals guarantee that all of their affiliated doctors and service providers are in-network. As usual, change presents challenges and those entities with access to more resources will be best positioned to handle them. Smaller providers are likely to have high out-of-network exposures because they are challenged to negotiate favorable in-network rates from insurers. The largest providers have significant negotiating leverage with insurers, making them likely to already be in-network.

As has been the case for the decade since the enactment of the Affordable Care Act, large providers with diverse sources of reimbursement will be best positioned to withstand changes in insurance reimbursement. The legislation is considered likely to impact hospitals, physician staffing companies, laboratories, radiology and other ancillary provider companies. There are also several proposals that would impact air ambulance providers. Overall, it will be better to be bigger going forward in the healthcare sector.

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