Joseph Krist

Publisher

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PENSIONS CLAIM ANOTHER RATING

Birmingham, AL became the latest casualty of the pension wars. Moody’s announced both a downgrade of the City’s GO rating but also continued placement on negative outlook. The downgrade of the issuer rating to Aa3 reflects continued growth of the city’s pension liabilities, primarily the result of the repeated annual underfunding of pensions. The Aa3 rating also takes into consideration a diverse and regionally significant economy located in central Alabama as well as a stable financial position marked by healthy reserve levels. Debt levels are moderately above-average but remain affordable given the lack of near-term debt plans and ongoing tax base growth.

The city of Birmingham is located in Jefferson County (A3 stable) and is the largest city in the state of Alabama with an estimated population of 212,265 (2017 American Community Survey). It faces a continuing and significant pension underfunding situation. The negative outlook reflects the expectation that the city will be challenged over the near-term to adequately fund its pension liability. The negative outlook reflects the expectation that the city will be challenged over the near-term to adequately fund its pension liability. That is a nice way of saying that the City was not able to articulate a plan to fund pensions.

ENERGY NORTHWEST RATING POWER DIMMED

This week Moody’s announced that it had changed the outlook for BPA and for all BPA supported obligations to negative from stable. The explanation was fairly extensive.

“The change in BPA ‘s rating outlook to negative from stable reflects the steady erosion of BPA’s internal and external liquidity since 2015, which we expect will continue through the new FY2020-2021 rate period, and BPA’s intent to further extend the Energy Northwest nuclear debt beyond the scope of the current “Regional Cooperation” program. Over the last three years, BPA’s liquidity has steadily declined to 89 days cash on hand at FY2018 compared to an average of 135 days cash on hand from FY2013-FY2015. Looking forward, we expect continued deterioration of this metric trending towards BPA’s minimum objective of 60 days cash on hand although the extent and timing of the decline will likely be affected by wholesale market prices and hydrology conditions. We further note that BPA’s availability under its US Treasury line has declined by over $1 billion since 2015 on an adjusted net basis (netting out deferred borrowing) and BPA’s FY2020-2021 proposed rates incorporate further availability declines possibly below the $1.5 billion quantitative threshold previously outlined in past research for consideration of a downward rating action.”

The continuing pressure on rates is not surprising. politically, raising rates is difficult in the best of times but many rural ratepayers in Washington have limited capacity to absorb increases. In addition, federal policies are designed to pay off the direct federal investment in BPA faster than the investment provided by investors in bonds like those issued by Entergy. Moody’s cites the fact that “the continued extension of non-federal debt in exchange for the accelerated payment of debt owed to the federal government that effectively undermines the de facto subordination of federal debt to non-federal debt. Since 2013, BPA has accelerated the repayment of a net $2.5 billion of subordinated, federal appropriations debt while extending maturing debt on the ENW’s nuclear projects. On the look forward basis, we expect BPA will continue to extend the ENW debt as part of a broader plan to prevent an even greater depletion of the US Treasury line availability than currently expected.”

CHICAGO HOSPITAL DRAMA (NOT THE ONE ON TV)

It isn’t a rural hospital but it is a facility which shares many characteristics which have led to financial pressures for those providers.  Westlake Hospital is a community facility with 230 beds which serves the village of Melrose Park in suburban Chicago. It was sold to an out of state private operator. It now loses $2 million a month and the owners cite the need for some $30 million of capital investment. From that standpoint, the numbers don’t bode well for continued operation.

The owners sought approval from the state to close the hospital. A decision in favor of closing had been the subject of a temporary injunction keeping the hospital open. That injunction was only in effect until the state board made its decision. Now that a decision has been rendered, the injunction is likely to be lifted. The Village of Melrose Park is considering an appeal. It will continue litigation against the owner for fraud but that litigation does not involve keeping the hospital open.

The fact is that community hospitals within reasonable proximity to teaching/research hospitals like the large urban facilities are going to be hard pressed to compete. Westlake has this locational disadvantage with the added burden of a large cohort of government pay patients. The hospital can then only compete on the basis of cost efficiency which a facility with a service area profile like this one (poorer, older, less mobile) has a harder time with. As mobility options develop and expand, the locational disadvantage would only worsen.  

TRANSIT FUNDING

The Minnesota House passed a Democratic-backed transportation budget bill Monday night that includes the Governor’s proposal to increase the state’s gasoline tax by 20 cents per gallon to pay for road and bridge projects. The proposal would raise the gas tax by a nickel per year for four years for a 70% total increase from the current tax of 28.5 cents per gallon. The proposal is at the center of the state’s transportation debate.

On the local level, the bill would also raise the sales tax in the Twin Cities metropolitan area by a half-cent to generate more money for public transportation. And it would raise vehicle registration fees. The overall debate is emerging as one based on populism with the impact on the less well off and rural residents at the center of opposition to transportation financing.

In Illinois, there are multiple transit funding bills pending. One would raise the gas tax from 19 cents to 38 cents, along with raising automobile registration fees, including those for electric cars. The state “lock box” amendment for motor fuel tax which permits its use only for safety of roads and bridges is a part of this bill.  Another would increase the gas tax even further while phasing out the sales tax on motor fuel among other wide-ranging changes.

THE US TERRITORIAL RELIEF ACT

This legislation would give U.S. territories like Puerto Rico the option to terminate their debt if they meet certain criteria, like being struck by a disaster, suffering major population loss, and staggering under overwhelming debt. In reintroducing the bill, Senator Elizabeth Warren made sure to say that debt held by bond insurers and “Wall Street” would not be paid.

The bill, originally introduced last year, establishes a Puerto Rico Debt Restructuring Compensation Fund. It provides federal funds to compensate eligible unsecured creditors, to be allocated by a special master. It allocates $7.5 billion for Puerto Rican creditors whose debt was terminated, including Puerto Rican residents, banks and credit unions that did business solely in Puerto Rico, the island’s unions and public pension plans, and businesses with a principal place of business in Puerto Rico.

It allocates $7.5 billion for mainland creditors whose debt was terminated, including individual investors, trade unions, pension plans, and open-end mutual funds that pledge to waive the manager’s fee for any compensation received. It also excludes hedge funds and their investors, bond insurers, many financial firms with consolidated assets greater than $2 billion, and repo or swaps investors from the distribution.

The U.S. Territorial Relief Act gives territories the option to terminate their non-pension debt obligations if they meet certain stringent eligibility criteria. If Puerto Rico chooses to terminate its debt load within three years of the bill’s enactment, the bill makes $15 billion in federal funds available to Puerto Rican residents and other creditors whose holdings were terminated. This is the closest we have seen a proposal come to any portion of a “federal put”. The theory that the federal government would never let Puerto Rico debt holders go unpaid was always a selling point  of the less scrupulous set of investment advisors and brokers who sold Puerto Rico bonds and funds to retail investors. The aspect of federal reimbursement of losses based on investor class status should be troubling. 

PUERTO RICO LITIGATION TURNS AGAINST THE BANKS

It is not clear, other than the voiding of $9 billion of debt, what the strategic goal of Puerto Rico’s latest legal gambit. The Financial Oversight and Management Board for Puerto Rico filed complaints to recover more than $1 billion from holders of bonds issued in excess of Puerto Rico’s constitutional debt limit, and from firms and advisers that helped with the issuance of those bonds. The entities sued include Barclays Capital, BofA Securities, Merrill Lynch Capital Services Inc., Citigroup Inc., Goldman Sachs, J.P. Morgan Chase & Co., Jefferies Group LLC, Mesirow Financial Inc., Morgan Stanley, Ramírez & Co., RBC Capital Markets, Santander Securities, UBS Financial Services Inc. of Puerto Rico, VAB Financial, BMO Capital Markets, Raymond James, Scotia MSD, and TCM Capital.

Claims were also filed against ANB Bank, Jefferies and Bank LLC, Northern Trust Company/OCH-ZIFF Capital Management, Union Bank and Union Bank Trust Co., Bank of New York Mellon, and First Southwest Co. The Board also listed the law firm of Sidley Austin LLP of Chicago as a defendant.

The lawsuit has some aspects of a drive by hit with a spray of legal gunfire being unleashed on just about everyone who helped Puerto Rico issue  debt. It begs the question of how suing this group will do anything to help Puerto Rico in the future. If the defendants decide that doing business with the Commonwealth is a bad idea, who will facilitate the financing of the island’s significant capital needs?

The fiscal panel also filed several hundred complaints against entities to recover payments they received on account of “invalid” bonds. The board said it intends to proceed with the clawback litigation against large bondholders who own at least $2.5 million worth of the bonds that are being challenged in the U.S. District Court for the District of Puerto Rico. At the same time it acknowledges that “Bondholders may have relied on information provided by the issuers, underwriters, and other professionals and lenders when they invested in the bonds.”

So the lawsuit is filed on behalf of, among others, the Commonwealth which the suit lists as a potential source of information and assurances as to the legitimacy of the debt. Does that put the Commonwealth in the position of having fraudulently issued the debt? Did it make false and/or misleading representations?

One example cited in the suit are bonds issued by Puerto Rico’s Public Buildings Authority to build and maintain public schools were to be repaid by rental payments on the buildings. So the Board’s position is that any debt funded by a general fund expenditure is actually a general obligation? Most investors knew the difference and so did the Commonwealth. Now some did ultimately look at this debt as a GO but the language in the offering documents was pretty clear.

The precedent which would be established by success would have far reaching effects throughout the market. It would be a real negative for the finance of public capital facilities if the Board succeeds.

IS ANOTHER CALIFORNIA CITY IN TROUBLE?

The city manager of  Oxnard, CA has informed nearly 1,900 employees that some of their jobs will be eliminated as the City faces increasing pressure to balance its budget. Pension costs and spikes in health care are some of the reasons for the budget shortfall. Projected expenditures are approximately $10 million more than anticipated revenue.

Last year, the city closed a $7 million shortfall mostly be eliminating vacant positions and other cutbacks. While these costs are undeniably rising, they were not unanticipated. At the same time, the current position of the City reflects a legacy of shortsighted decisions. As the mayor said, “We’re making decisions that should have been made 10, 20 years ago to put the city on a sustainable path. These are very painful cuts, but we have to live within our means. The city historically has not lived within our means.”

In a nutshell, the situation illustrates the realities facing many local credits. The employee beneficiaries are usually a convenient target but the fact of the matter is that pensions and other costs of employees are the product of negotiations between two sides. We expect that the usual debate over the City’s problems will ensue with employees pressured to give up  benefits while legislators do everything they can to cover for historical shortsightedness.

The song remains the same.

POLITICS WILL LIKELY SINK INFRASTRUCTURE PLAN

The President and the democratic leadership of the Congress have agreed on a spending goal to support an “infrastructure” package at the federal level. Republicans say they are against raising taxes to pay for an infrastructure initiative. The senate majority whip noted “If we’re going to do infrastructure, I think we ought to pay for it. I don’t think we ought to put it on the debt. I think $2 trillion is really ambitious. If you do a 35-cent increase in the gas tax, for example, indexed for inflation, it gets you only half a trillion.”

Some GOP lawmakers have since raised concerns that funding a wide array of projects ranging from roads to railroads to airports, broadband and power grids, could deplete money available for the upcoming Highway Trust Fund reauthorization, which they want to pass this year. So the issue is, is the problem infrastructure itself or is it a question of the price tag? The Senate leadership is already coalescing around a $1 trillion plan. That would assume that with a gas tax increase (or vehicle mileage tax) only a half a trillion gap would need to be “paid for”.

There were positives and negatives to emerge from the initial discussions. Trump agreed the old 20-80 [federal-private split in funding] was much too low and that he doesn’t like these private-public partnerships. Once again, such a stance places the states and localities at the forefront of innovation in the production of capital projects. It is at that level that we are seeing the most ambitious use of and experimentation with concepts like public-private partnerships.

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