Joseph Krist

Municipal Credit Consultant

WHY WE WOULD NOT BUY PRASA

The abandonment of a current sale of $750 million of revenue bonds may finally show the municipal bond market saying enough is enough to Puerto Rico. Initially the sale was delayed until this week ostensibly to give more investors time to absorb new information and better “understand” the credit. A supplement to the preliminary statement for the issue was then released. After reviewing all of the documentation, we believe that the case against buying PRASA debt is even stronger.

We have previously covered our concerns about the Authority’s unwillingness to provide adequate ongoing financial disclosure. We see this as being very important given our concerns about the Authority’s ability to service its own debt as well as uncertainties about the level of insulation that exists for Authority debt holders from the Commonwealth’s overall debt problems.

In connection with the postponement of the sale, the GDB went out of its way to say that PRASA has no need to avail itself of pending legislation permitting the Authority to restructure its debts. At the same time, the supplement to the preliminary official statement makes clear that ” the Commonwealth’s three major public utilities, which provide electricity, water , and roads for its citizens, have a combined debt of some$20 billion which they cannot pay. The final nail in the coffin was the move by Puerto Rico to appeal a ruling to the U.S. Supreme Court that prevents the agency from reorganizing under Chapter 9. The petition said that it needed to have a legal framework in case PRASA’s debts have to be restructured.

The government assumes that if PRASA meets its financial projections that it will not have to restructure. But the supplemental disclosure also details the limits on debt service costs through interest rate limits of 12% and limits on the size of annual rate increases. All of these should be red flags for potential investors (and some speculators) in the debt of the Authority. It also details potential hurdles to the use of acceleration as a tool for debt holders if the pending legislation survives ultimate judicial review.

PRASA’s senior bonds are secured by a first lien on the gross revenues of the authority. Under the Master Agreement of Trust (MAT), authority revenues flow to a trustee-held account from which monthly transfers are made to the bonds’ debt service funds. Only after the required amounts have been set aside for debt service do funds become available for PRASA’S operating expenses and other purposes. The MAT also requires the authority to manage its debt burden and service rates such that gross revenues will cover maximum annual debt service by at least 2.5 times. The bonds will be issued under New York State law, with the exception of any provisions related to receivership.

The gross lien pledge is offset by two factors. One, is that the utility must operate to generate revenues and those expenses have to be covered. Second is that overhanging all of this is the fact that currently, there just is not enough water to meet demand. There are already significant water use restrictions and effective rationing in place and there is no way to determine when the highly unfavorable climate conditions will end.

We think that investors should be exactly that – investors – in municipal bonds. If one wants to gamble in Puerto Rico, then go visit and play in one of the island’s casinos. Last time we looked, its municipal bonds were not available through casinos.

VA. TO TRY P3 HIGHWAY FINANCING AGAIN

Virginia will attempt another P3 development of a major highway project after earlier unsuccessful ventures. This project is the Transform66 Outside the Beltway Project designed to address congestion near the District of Columbia in northern Virginia. The project would cost $2.1 billion and has been certified for approval.

Under the proposed plan, I-66 would be improved to provide three regular lanes in each direction, two express lanes in each direction, high-frequency bus service with predictable travel times, and direct access between the express lanes and new or expanded commuter lots. The proposed express lanes would be dynamically-priced toll lanes that are designed to provide a reliable, faster trip. Drivers traveling with three or more occupants would be considered high occupancy vehicles, and could use the express lanes for free at any time.

By the end of 2016, the team is working to complete environmental work and begin construction in 2017. VDOT will decide between three options. A toll revenue concession – similar to the 495 and 95 Express lanes, in which the state would make a public contribution, but the private entity would take the risk in financing, designing, building, operating and maintaining the project; a design-build-operate-maintain project where the state would finance the project and collect the toll revenues, but the private sector would take the risk in designing, building, operating and maintaining the project, or a design-build-alternative technical concepts project where the state would finance the project, collect toll revenues as well as operate and maintain the project while the private sector would take the risk in designing and building the project and be able to come up with engineering savings during the bidding process, which cannot be done  currently under a typical design-build project.

Under any scenario chosen, a toll revenue concession – similar to the 495 and 95 Express lanes, in which the state would make a public contribution, the private entity would take the risk in financing, designing, building, operating and maintaining the project.

PA. BUDGET IMPASSE DRAGS ON

Pennsylvania House Republicans failed in their unprecedented attempt to partially override Governor Wolf’s eight week old veto of the state budget. Democrats, including Governor Wolf, declared unconstitutional the effort to override the veto on a selective line by line basis. The stunt-like effort reflected a view on the part of some Republicans expressed by one member who said “it shouldn’t matter” if the move was not legal or sustainable.

The effort reflected pressure on legislators to maintain funding for certain programs like human service agencies whose programs are supported by recipients of many political stripes. The lack of a budget and spending authorization is beginning to pinch those providers. The process remains mired in the dispute over efforts to increase taxes, impose new taxes on the natural gas industry, and increase education funding by the Commonwealth.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Municipal Credit Consultant

We took a couple of weeks off to rest and recharge but it was amazing to see that when we came back the budget lunacy surrounding some of the larger states had continued unabated.

PRASA TESTS THE MARKET

As we go to press, the PR Aqueduct and Sewer Authority will attempt to sell $750 of revenue bonds in the public markets. The bonds have been rated Caa3/CCC-/CC by the three major rating agencies. PRASA has $5.4 billion of debt already outstanding and there are questions about its ability to service its current level of indebtedness. It intends to use the new funding to finance a portion of its capital improvement program through June 30, 2019, reimburse itself for certain capital costs incurred during fiscal years 2013, 2014 and 2015, and repay or refinance certain outstanding credit facilities provided by local banks and the Government Development Bank (GDB).

The fears over the ability to cover debt service and act on a transparent basis will not be eased by the language added to the official statement regarding  future financial disclosure. The Authority says that it intends to provide quarterly reports but that it is not required to. The Bonds will be secured under a gross revenue pledge which is supported by a 2.5 times rate covenant. There is no provision for funding or maintenance of a debt service reserve fund.

Capital requirements will continue to be significant. PRASA currently operates under three existing consent decrees with the US EPA and faces a proposed fourth such decree. PRASA estimates that $1.7 billion of additional capital would be required to meet the terms of the consent decrees.

Another major concern is whether or not PRASA can continue to be seen as insulated from the overall financing and operating difficulties of the Common wealth as a whole. Each of the rating agencies expressed concern regarding this aspect of the PRASA credit. As for the central governments difficulties, the Governor’s office has said that the central government’s cash flow would only generate enough money to operate until November absent any additional deal that brings $400 million to $500 million in much-needed liquidity to the government.

“November continues to be the month when we would go under if we don’t take further actions,” according to the Governor’s chief of staff . He added that the government would take a determination at “some point in September” on whether to move forward with an initiative that seeks to provide the commonwealth with the needed short-term liquidity. “The one being more actively worked on is the exchange of notes at the GDB.”

MET PIER DOWNGRADE

The circus that is the budget dispute in Illinois has claimed yet another credit scalp. S&P lowered its rating on the Metropolitan Pier & Exposition Authority after the Illinois Legislature did not appropriate the sales tax revenue that is intended to support a monthly payment for debt service. S&P said ” although the statutory construct and bond document provisions historically have insulated these monthly payments — and ultimately debt service payments — from the budget and liquidity pressures occurring at the state level, we now believe this structure is vulnerable to those pressures as they play out in the state budget and appropriations process. The rating action reflects our view that the bonds are, in fact, appropriation obligations of the state, rather than special tax bonds, and are now one notch below our current A minus/Watch Neg general obligation rating on Illinois.”

The action is a blow to bondholders who had traditionally taken comfort from their belief that their bonds were protected from that fiscal machinations of the political process. The long term damage to the state’s credibility is incalculable and should be costly to it going forward.

Ninety percent of what the state usually spends has been authorized despite having no approved budget as of mid-August. according to an  analysis by Senate Democrats. That study shows that if spending continues at this rate, Illinois is on track to spend about $38 billion this year, leading to a $5 billion deficit.

The House revenue committee is holding hearings to try to determine how much the state is spending — something all involved acknowledge is a mystery. Estimates range from $32 billion to $38 billion rate over the current fiscal year. While the failure to enact a full budget has dragged on, dozens of consent decrees issued by federal courts kicked in, mandating Illinois continue to spend money on services like the Department of Children and Family Services and Medicaid. Payments to pension funds, state debt service and tax refunds also are automatically authorized by law. A court order requires the state to continue to pay its employees at their normal salaries.

When and if the two sides do reach a budget deal, they will have to raise taxes, cut spending retroactively or make 12 months’ worth of changes in a condensed time period — making any action more painful and politically difficult.

KANSAS PENSION BONDS

The jury may still be out on whether the Kansas experiment with tax cutting has been a success but one answer may lie in the authorization of $1 billion of bonds to fund payments to the state’s pension funds. It is somewhat amazing that in light of the historically bad experiences of pension bond issuers (New Jersey and Detroit are prime examples) that support for the concept still exists. The well-documented ideological approach to budgeting under taken by the Brownback administration has led the legislature to take the easy way out in its approach to historic pension underfunding in the state. There are enough other issues pressuring the state – especially in the area of education that punting on the pension issue made sense to the legislature.

PENNSYLVANIA BUDGET

There may be a way to resolve the Commonwealth’s budget impasse as Gov. Tom Wolf is said to be open to consideration of a new type of pension benefits plan for future state and public school employees. Called a “stacked hybrid,” the new Wolf plan would maintain the current pension formula – based on a years’  of service and career-ending salary – as a foundation benefit for all employees. But once a person’s income has crossed a certain threshold – Wolf has proposed $100,000, for starters – that plan would max out. Any benefits on income over the cap would be based on a 401(k)-type plan.

It also would expose current state and school employees to higher payroll contribution rates into the retirement systems if the funds’ internal investment targets aren’t met over an extended period of time. The governor also continues to support a $3 billion pension bond issue. Wolf claims annual debt service can be covered by increased profits from Pennsylvania’s state-held liquor monopoly, based on longer operating hours, more Sunday openings and greater price flexibility.

BUILD AMERICA BOND SUBSIDIES CUT

Under the requirements of the Balanced Budget and Emergency Deficit Control Act of 1985, payments to certain state and local government filers applicable to certain qualified bonds are subject to sequestration. This means that refund payments processed on or after October 1, 2015 and on or before September 30, 2016 will be reduced by the fiscal year 2016 sequestration rate of 6.8 percent. The sequestration reduction rate will be applied unless and until a law is enacted that cancels or otherwise impacts the sequester, at which time the sequestration reduction rate is subject to change. These reductions apply to Build America Bonds, Qualified School Construction Bonds, Qualified Zone Academy Bonds, New Clean Renewable Energy Bonds, and Qualified Energy Conservation Bonds. In plain English, the level of subsidies made to each issuer of BABs will be cut 6.8%. Prior cuts have not resulted in any reductions in payments or defaults and we anticipate that will continue to be the case. The irony is that many in Congress support some form of this type of bond support for infrastructure but the ongoing gridlock in Congress over real budget reform is catching the actual level of support for a successful existing program within the confines of its rather wide net.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.