Joseph Krist

Publisher

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RISING DEFAULT RATES SKEWED BY PUERTO RICO

The headline may say that defaults are rising but the fact is that 2017 was an unusual year. S&P recently released the results of its study of defaults in 2017 on debt that it rates. For the third year in a row, the number of defaults in USPF rose, reaching a record 20 in 2017. Puerto Rico accounted for 14 of the defaults. The default rate for USPF was 0.09%, the second highest since 1986. Nonetheless, this rate remains extremely low. The ratings on 903 bonds were raised in 2017, while the ratings on 708 bonds were lowered. States, higher education, health care, charter schools, and housing had more downgrades than upgrades in 2017; this was the second consecutive year of negative rating trends for states, health care, and housing and the seventh straight negative year for charter schools.

The headline data is of course skewed by the fact that Puerto Rico accounted for 14 of the defaults. S&P notes that the rising number of defaults in recent years is not an indication of general credit stress. The ratio of upgrades to downgrades was essentially the same in 2017 as in 2016, at 1.27, but five of eight sectors had a higher number of downgrades than upgrades in 2017. This is an increase from four negative-leaning sectors in 2016 and two in 2015. Where are potential problem areas? Higher education had more downgrades than upgrades in 2017, reversing the positive rating trend of 2016, which resulted from revised criteria. Charter schools also leaned negative, although not to the same degree as in previous years. Health care and housing rating movement was negative for the second consecutive year. Transportation and utilities both had more upgrades than downgrades in each of the past three years.

IRS TO ISSUE SALT DEDUCTION GUIDANCE

The U.S. Department of the Treasury and the Internal Revenue Service issued a notice today stating that proposed regulations will be issued addressing the deductibility of state and local tax payments for federal income tax purposes. Notice 2018-54  also informs taxpayers that federal law controls the characterization of the payments for federal income tax purposes regardless of the characterization of the payments under state law.

The Tax Cuts and Jobs Act (TCJA) limited the amount of state and local taxes an individual can deduct in a calendar year to $10,000. In response to this new limitation, some state legislatures are considering or have adopted legislative proposals that would allow taxpayers to make transfers to funds controlled by state or local governments, or other transferees specified by the state, in exchange for credits against the state or local taxes that the taxpayer is required to pay.

The aim of these proposals is to allow taxpayers to characterize such 2 transfers as fully deductible charitable contributions for federal income tax purposes, while using the same transfers to satisfy state or local tax liabilities. Despite these state efforts to circumvent the new statutory limitation on state and local tax deductions, taxpayers should be mindful that federal law controls the proper characterization of payments for federal income tax purposes.

The upcoming proposed regulations, to be issued in the near future, will help taxpayers understand the relationship between federal charitable contribution deductions and the new statutory limitation on the deduction of state and local taxes. The proposed regulations will make clear that the requirements of the Internal Revenue Code, informed by substance over-form principles, govern the federal income tax treatment of such transfers. The proposed regulations will assist taxpayers in understanding the relationship between the federal charitable contribution deduction and the new statutory limitation on the deduction for state and local tax payments.

PORT OF OAKLAND STABILIZES REVENUE STREAM

The Port of Oakland has taken the first step in securing long-term revenues from its maritime tenants. It approved the first reading of an ordinance extending marine terminal leases with its largest operator, SSA Terminals The lease extensions, which follow two lease extensions last year, will result in the seaport extending tenant leases that account for close to 70% of maritime revenue through 2030. This would extend visibility for more than 60% of seaport revenue by 10 years, which reduces the contract renewal risk that previously existed for all four of the port’s seaport leases.

The leases renewals provide high levels of minimum or fixed revenue to the port, and their extensions align future cash flow to match the amortization of the port’s debt. the seaport division, which accounts for more than 80% of the port’s total debt and has the most business risk of the port’s three divisions. The Port of Oakland owns the eighth-largest container port in the US and the marine cargo gateway for the Northern California region. the port owns, leases and administers, but does not directly operate, four active container terminals in the San Francisco Bay. As a landlord port authority, the division receives a combination of fixed (referred to as minimum or guaranteed payments) and variable lease payments from tenants. The higher the level of fixed payments the greater stability characterized in the credit.

The port has now reached extension agreements with its two remaining terminals, including its largest terminal, Oakland International Container Terminal (OICT), which accounts for more than 70% of container volume for the maritime division. More than 60% of current marine terminal revenue is now under lease through 2032, while more than 70% is now under lease through 2030. This will enable the Port’s infrastructure development program which a dredging program that provided 50 feet of water to accommodate larger ships and an expanded rail yard, and more recently additional rail track, an on-port cold storage facility and a 185-acre on-port distribution and warehouse complex.

Overall, transactions and the infrastructure program enhance the port’s competitive position and stabilize its ratings.

BONDHOLDER VERSUS PENSIONER RIGHTS

The resolution of the City of Detroit bankruptcy and the ongoing saga of Puerto Rico’s Title III has heightened awareness of and debate over the rights of debt holders versus those of pensioners. Now a recent decision by the Illinois Comptroller has added additional fuel to the debate. Moody’s took a recent opportunity to weigh in with its view of the impact of the move by the Comptroller to deny the City of Harvey’s request for relief from revenue withholding under a state law requiring minimum pension contributions.

Local pension plans in Illinois can request that the state withhold revenue from a sponsoring municipality if that municipality does not make minimum contributions. Harvey’s public safety pension funds have made such requests, and the state has withheld more than $2 million to date. The city asserts that it will soon be unable to meet payroll, and last month announced layoffs. The state comptroller’s office has responded that it has no discretion under state law to consider Harvey’s hardship.

Harvey is the most egregious case of local municipal credit weakness in Illinois. The city missed two debt service payments in fiscal 2016, six in fiscal 2017 and as of February had missed four in fiscal 2018. Harvey historically has underfunded actuarially determined contributions (ADCs) for its public safety pension plans. The city contributed very little to its firefighter pension fund from 2009 to 2013, and even its far higher contribution in 2017 fell far below the ADC. Harvey cannot currently file for bankruptcy under Illinois law and revenue withholding for pensions only heightens the likelihood of more bond defaults and a restructuring.

Moody’s views the decisions negatively not only for Harvey but also for other municipalities in Illinois which might find themselves in the same position.

PR LITIGATION DOINGS

U.S. District Court Judge Laura Taylor Swain, who oversees Puerto Rico debt proceedings, extended to June 29, from May 29, the deadline to file proof of claims against the commonwealth. In another related matter, the Committee of Unsecured Creditors was allowed to intervene and will be able to make discovery in a lawsuit headed by Cooperativa Abraham Rosa and five other credit unions against the commonwealth, the island’s Financial Oversight and Management Board and several other entities, accusing them of “defalcation and fraud” for selling them “unsound Puerto Rican debt” in a “ploy to obtain their assets.”

The Retirement System of the Puerto Rico Electric Power Authority (PREPA) does not want the commonwealth’s Official Committee of Retired Employees to represent its interests. The PREPA Retirement System said “the intervention of the Retiree Committee will create confusion with respect to the different positions that the retirees will have to assume in these Title III court proceedings, as they will be represented by two legal entities that might disagree in any moment about fundamental issues.”

NASSAU COUNTY BUDGET UNDER OTB THREAT

Nassau County has budgeted $15.75 million for fiscal 2018 from revenues from video lottery terminals at Resorts World Casino at Aqueduct Racetrack, which is operated by Genting New York LLC, dedicated to Nassau OTB. So far has received $3 million but only after delay and some dispute.

Nassau had hoped to apply three-quarters of the $20 million the county says is due early next year to this year’s budget, and include the remainder in the 2019 budget. Now there is real concern however, that Nassau OTB will not be able to make its next payment when due. Nassau OTB committed to paying Nassau County $3 million in the 2016 calendar year, $3 million in the state’s 2017 fiscal year — which runs from April 1 through March 31 — and $20 million in each subsequent state fiscal year.

There are exceptions. They include if a similar “full-service” casino opens within a 65-mile radius of Aqueduct, or if gambling revenue for Resorts World drops by 10 percent or more in any one year. The betting agency won’t have enough in profits this year to “permit a payment of $20 million to the county without 1,000 VLTs being operational” at Resorts World. There are only an estimated 500 machines installed. A planned $400 million expansion at Resorts World will accommodate 1,000 Nassau machines as well as a new 400-room hotel, restaurants and other amenities.

The county has been counting on the new revenues to finance an emerging budget deficit. it receives the revenues under an agreement made under a provision in state law enacted after public opposition prevented OTB from building a casino in Nassau. OTB says it expects to pay Nassau $3 million next spring if the number of VLTs still hasn’t reached 1,000. If all the machines come online sooner, the $20 million payment would be prorated, based on the number of months the 1,000 VLTs have been operating.

 

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