Joseph Krist

Publisher

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ISSUE OF THE WEEK

$260,260,000

BOARD OF EDUCATION OF THE CITY OF CHICAGO

UNLIMITED TAX GENERAL OBLIGATION

REFUNDING BONDS

(DEDICATED REVENUES)

 

The bonds are coming with Assured Guaranty insurance but it is an opportunity to review the Board’s underlying credit  which remains well below investment grade. The board’s full faith and credit and unlimited taxing power secures the bonds. The bonds are alternate revenue source bonds with the pledged revenues consisting of pledged state aid revenues. The rating is based on the board’s underlying unlimited ad valorem tax pledge.

The State of Illinois’ last budget did provide for improved funding for entities like the Chicago Public Schools in recognition of their difficult financial profiles and huge pension funding burdens. The resulting improvement in aid levels has a positive effect on cash flow although the Board still maintains an extremely weak cash position, which is projected to be negative throughout almost all of fiscal 2018 and likely in fiscal 2019.  It continues to maintain a reliance on lines of credit to support operating and debt service expenses.

Nonetheless, the Board was able to show a notably improved cash flow in the district’s March and subsequent May 2018 cash flow report compared to October 2017 and evidence that increased state funding is flowing to the district as previously planned. This was enough to convince S&P to have a positive outlook for the Board’s debt. The positive outlook reflects the at least one-in-three chance that S&P could raise the rating within the one-year outlook horizon.

An upgrade would have to be supported by the 2019 budget demonstrating structural balance, continued progress on an improving financial position with a small surplus result in fiscal 2018 leading to a positive fund balance, and additional reduction in outstanding tax anticipation notes.

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SEC ENFORCEMENT

Barcelona, a municipal advisor based in Edinburg, Texas, and Mario Hinojosa, Barcelona’s sole member and associated person. Barcelona acted as the municipal advisor to the La Joya Independent School District (“LJISD”) on three bond offerings between January 2013 and December 2014, earning $386,876.52 in municipal advisory fees. During LJISD’s process of selecting Barcelona as its municipal advisor, Barcelona and Hinojosa overstated and misrepresented their municipal finance experience to LJISD. Barcelona and Hinojosa also failed to disclose that Hinojosa was employed by the attorneys who served as bond counsel for all three bond offerings. By misrepresenting their municipal finance experience and failing to disclose the conflict of interest with bond counsel, Barcelona and Hinojosa violated the federal securities laws and the rules of the Municipal Securities Rulemaking Board (“MSRB”).

Among other things, the firm distributed written information which represented that the “professionals” at Barcelona have participated in several municipal offerings and have municipal finance experience in 14 different municipal bond issuances and that Hinojosa had four years of municipal finance experience. Hinojosa was Barcelona’s only employee and had never served as advisor—municipal or otherwise—on any bond issuances. In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), which included provisions for the registration and regulation of municipal advisors. The municipal advisor registration requirements and regulatory standards are intended to mitigate some of the problems observed with the conduct of some municipal advisors, including undisclosed conflicts of interest and failure to place the duty of loyalty to their municipal entity clients ahead of their own interests.

The SEC issued a cease and desist order and ordered disgorgement of f $362,606.91 and prejudgment interest of $19,514.37 to the Commission, a civil money penalty in the amount of $160,000 to the Commission, and Mr. Hinojosa is prohibited from serving or acting as an employee, officer, director, member of an advisory board, investment adviser or depositor of, or principal underwriter for, a registered investment company or affiliated person of such investment adviser, depositor, or principal underwriter.

All in all, pretty serious stuff. It is also for the long-term benefit of the industry. There are many reputable and more than useful municipal advisory entities and individuals and actions such as these which took advantage of an unsophisticated issuer in a relatively poor area encourage people to paint our industry with a broad brush. Unfairly so, from our standpoint.

CALIFORNIA APRIL REVENUE REPORT

State Controller Betty T. Yee reported California collected more tax revenue during the month of April than in any previous month of the 2017-18 fiscal year so far. Moreover, total April revenues of $18.03 billion were higher than estimates in the governor’s FY 2018-19 proposed budget by 5.3 percent.  For the first 10 months of the 2017-18 fiscal year that began in July, total revenues of $107.13 billion are $4.72 billion above estimates in the enacted budget and $3.82 billion higher than January’s revised fiscal year-to-date predictions. Total fiscal year-to-date revenues are $10.25 billion higher than for the same period in FY 2016-17.

For April, personal income tax (PIT) receipts of $14.17 billion were $715.9 million, or 5.3 percent, higher than estimated in January. For the fiscal year, PIT receipts are $2.58 billion higher than anticipated in the proposed budget. Traditionally, April is the state’s peak month of PIT collection. April corporation taxes of $2.40 billion were $78.4 million higher than forecasted in the governor’s proposed budget. For the fiscal year to date, total corporation tax receipts are 13.5 percent above assumptions released in January.

Sales tax receipts of $946.1 million for April were $139.1 million, or 17.2 percent, higher than anticipated in the governor’s FY 2018-19 budget proposal. For the fiscal year, sales tax receipts are in line with the proposed budget’s expectations.

Unused borrowable resources through April exceeded January projections by 36.9 percent. Outstanding loans of $4.52 billion were $6.35 billion less than the governor’s proposed budget expected the state would need by the end of April. The loans were financed entirely by borrowing from internal state funds.

TOWN SELLS BONDS IN THE MIDDLE OF A FRAUD TRIAL

We may never learn in the municipal bond market. Oyster Bay, N.Y., sold a total of $191.205 million in two separate competitive sales. The $152.665 million of public improvement bonds sold at a net interest cost of 3.32%. The $38.54 million of bond anticipation notes carried an NIC of 2.28%. The bond deal is rated Baa3 by Moody’s Investors Service and BBB-minus by S&P Global Ratings.

The sale came as testimony was being taken in the federal criminal trial of former Town of Oyster Bay Supervisor John Venditto (and former Nassau County Executive John Mangano) on securities fraud charges related to municipal bond sales by the Town of Oyster Bay. Testimony has exposed a failure to disclose vital information to investors including the fact that the Town had pledged its credit to guarantee loans made to individuals doing business with the Town.

The loans were for a political supporter, who was the operator of many Oyster Bay restaurants. In exchange for the guaranteed loans, the former elected officials were allegedly bribed with meals, chauffeurs, vacations, jewelry, and a $450,000 “no-show” job for Mr. Magnano’s wife. in a superseding indictment, federal prosecutors charged Mr. Venditto with securities fraud and wire fraud related to Oyster Bay muni-bond securities offerings, alleging that he concealed the illegal loan guarantees from investors and others.  The SEC in parallel civil litigation charged Oyster Bay and Mr. Venditto with defrauding investors of the town’s bonds by hiding the existence and potential financial impact of the illegal loan guarantees. The federal criminal trial commenced in mid-March 2018 and was ongoing.

Apparently, bidders and the ultimate buyers of the securities were satisfied that the Town’s wrongdoing and that of the charged individuals was sufficiently  separate issues. It is another remarkable example of the municipal market’s willingness to effectively forgive and forget within a relatively short period of time. It has been less than six months since the filing of the original charges and it seems reasonable to ask why investors would not wait until all of the available information which could have been generated at trial had come to light.

Regardless of the existence of a rating and the level of disclosure in the offering documents, the resulting cost of the issue to the Town does not seem exceptionally punitive. While we acknowledge that the current trial is rightly focused on the actions of individuals, one must wonder what assurances can be drawn regarding the Town’s ability to properly supervise and/or over see it employees and those entering into financial arrangements involving scarce public resources.

ILLINOIS LOCAL PENSION UNDERFUNDING

75 funds in 55 municipalities are underfunding their pensions to the extent that their municipalities could be subject to requests to withhold state aid as is the case in the well publicized situation in Harvey, Illinois.

A Cook County judge has struck down a 2014 overhaul deal as unconstitutional involving the Chicago park district. The local chapter of the Service Employees International Union, which represents Park District employees, filed suit against the city in October 2015. The District is some $611 million short of what it needs to pay future benefits – and, the judge ordered the district to pay back its employees contributions with 3-percent interest.

OUTLOOK IMPROVES FOR LARGE REGIONAL HEALTH SYTEM

Catholic  Health Systems (CHI) is a faith based, not-for-profit integrated delivery system with a presence in 17 states, operating 101 hospitals, and various long-term care, assisted-and residential-living facilities, and employing over 4,500 providers. In FY 2017, it generated $15.5 billion in operating revenue. It  was formed in 1996 upon the merger of four national Catholic health care systems.

Recently, Moody’s revised its outlook on the system’s Baa1 rated debt from negative to stable. The change reflects the improved performance through the first half of fiscal 2018 and assume continuation of these operating trends as well as the successful extension of bank agreements securing some $1 billion of short term debt. CHI’s bank agreements include additional covenants, including the debt service coverage test, a debt to capitalization requirement of no more than 65%, and a days cash on hand test of no less than 75 days. The bank agreements also include the requirement that CHI maintain ratings from all three major rating agencies of at least Baa3 / BBB- or better.

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