Muni Credit News May 11, 2017

Joseph Krist

joseph.krist@municreditnews.com

Editor’s Note: The Muni Credit News will not publish net week as we attend the annual meeting of the National Federation of Municipal Analysts in Washington, DC. The MCN will be back on Tuesday May, 23.

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LOS ANGELES UNIFIED SCHOOL DISTRICT

$1,089,815,000 General Obligation Refunding Bonds

Moody’s: “Aa2”   Fitch: “AAA”

The nation’s second largest school district comes to market with strong ratings. The bonds are being issued to refund outstanding debt. The district encompasses approximately 710 square miles in the western section of Los Angeles County. The district is located in and includes virtually all of the City of Los Angeles and all or significant portions of the cities of Bell, Carson, Commerce, Cudahy, Gardena, Hawthorne, Huntington Park, Lomita, Maywood, Rancho Palos Verdes, San Fernando, South Gate, Vernon, and West Hollywood, in addition to considerable unincorporated territories devoted to homes and industry. Estimated enrollment for fiscal 2017 equals 625,434.

The general obligation bonds are secured by an unlimited property tax pledge of all taxable property within the district boundaries. Debt service on the rated debt is secured by the district’s voter-approved unlimited property tax pledge. The county rather than the district will levy, collect, and disburse the district’s property taxes, including the portion constitutionally restricted to pay debt service on general obligation bonds. These are strong legal and operating provisions for the collections of pledged revenues. The district has $10 billion in outstanding GO bonds and $235.5 million in outstanding lease-backed securities.

The district has an exceptionally large and diverse tax base with moderate growth expected over the near term, coupled with district residents’ below-average socioeconomic profile. Improved state funding, including one-time revenues, has helped bolster the district’s general fund reserves and liquidity to healthy levels for a district of this size. Fiscal challenges remain, however, including expenditure pressures for salary and benefit increases, rising pension costs, and an oversized, unfunded OPEB liability. Ongoing declines in enrollment and a recent decision letter on special ed spending requirements create additional, long-term challenges. The district has an elevated debt burden and a substantial remaining amount of authorized, but unissued, GO debt. The district’s pension burden is average relative to other California school districts.
DISTRICT OF COLUMBIA

(Washington, D.C.)

$576,415,000 General Obligation Refunding Bonds

Moody’s: “Aa1”  S&P: “AA”  Fitch: “AA”

Bond proceeds will refund outstanding debt. District general obligation bonds are secured by a special real property tax unlimited as to rate or base and separate from the operating levy. All property taxes are collected by a third party collection agent and the amount allocable to the special real property tax are deposited into an account held by a separate third party custodian. Weekly, the custodian makes transfers to an escrow agent in amounts sufficient to pay debt service on the bonds.

District general obligation bonds are secured by a special real property tax unlimited as to rate or base and separate from the operating levy. All property taxes are collected by a third party collection agent and the amount allocable to the special real property tax are deposited into an account held by a separate third party custodian. Weekly, the custodian makes transfers to an escrow agent in amounts sufficient to pay debt service on the bonds.

The District also has some $4 billion of debt outstanding secured by income taxes alone. Those revenues are held by the trustee outside of the District’s general fund. In each April, May and June (the period when historically most of the pledged revenues are collected), the trustee is required to transfer to the debt service fund one-third of the amount needed for the next fiscal year’s payments of principal and interest on outstanding bonds. If the set-asides in those three months are insufficient to meet debt service requirements, amounts collected in each succeeding month are required to be transferred to the debt service fund until sufficient amounts are on deposit. This feature provides five months to cure any debt service deficiency before the first debt service payment in each fiscal year is due on December 1. Only after the set-aside requirements are met are pledged revenues released to the District for deposit in its general fund.

The District economy has become increasingly diverse over the last two decades. As the economy has diversified its has led to increased development, incomes, and tax base growth. Much of this has been private sector growth which is that much more positive for the District. District management has become much more sophisticated and professional which improves the relationship between Congress and city management. District financial operations and controls are strong and the District has been able to maintain balanced operations and generate strong fund balances.

CALIFORNIA HEALTH FACILITIES FINANCING AUTHORITY

(CHILDREN’S HOSPITAL LOS ANGELES)

$281,715,000 REVENUE BONDS

Moody’s: Baa2  S&P: BBB+

CHOLA has been in the news for its role in providing surgery to a celebrity’s baby that has become a part of the national healthcare debate. But the focus for investors is on the credit behind the bond issue. CHLA is nationally recognized pediatric hospital, providing high acuity care across a range of specialties, and conducting significant research. It is affiliated with University of Southern California’s Keck School of Medicine and operates numerous residency and training programs.

Bond proceeds will refinance three series of outstanding debt and reimburse the hospital for $35 million of capital expenses. Bonds are secured by a gross revenue pledge. There is also a mortgage on CHLA’s primary acute care facilities that will remain in place so long as the Series 2010A or 2012A bonds are outstanding. Once the Series 2010A and 2012A bonds have been defeased, the mortgage pledge will be removed. There is a debt service coverage test of 1.1x (a consultant must be called in); 1.0x (below that is an event of default).

The rating reflects fundamental strengths of the organization, including a very strong reputation for clinical and research excellence, strong brand name and long track-record of fundraising. These strengths are offset by greater competition than is typical for children’s hospitals, very high exposure to Medicaid, and financial performance that lags peer children’s hospitals with high reliance on supplemental funding. The ability to fund raise is crucial to the credit of children’s hospitals since they tend to have a high proportion of low income and indigent patients given their orientation towards sick children. This ability to raise cash through fundraising is key to allowing these institutions to ride out the uncertainties of government funding at both the state and federal levels.

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PUERTO RICO

Some headlines emphasized recent comments from Moody’s Investors Service regarding Puerto Rico’s invocation of Title III under PROMESA. There was emphasis on particular language  that the action was positive – because it should provide an orderly framework to address competing creditor claims, leading to higher overall bondholder recoveries. It is true that they indeed said that. At the same time, we notice that the context of that statement was somewhat different for different categories of bondholders.

That view received more reinforcement in terms of the impact on bond insurers. The Title III proceeding is likely to eventually incorporate other securities issued by Puerto Rico’s debt-issuing entities, resulting in what will be a lengthy and extremely complex restructuring process. However, we view this as preferable to a potentially disorderly and chaotic process involving proliferating lawsuits among competing creditors and, by extension, lower loss claims on insured exposures of the financial guarantors.

As or individual bondholders without insurance the process is still seen in a positive light but Moody’s highlights that “Even if the Title III process is more orderly than the alternative, it is unlikely to be quick or easy. Puerto Rico’s restructuring will unfold in the untested legal context of PROMESA and pose legal issues that may take even more time to resolve than a large city restructuring under Chapter 9 of the US Bankruptcy Code. Congress did not authorize pension restructurings” in PROMESA’s Title VI provisions for out-of-court debt restructurings. Puerto Rico’s three primary government pension plans are projected to run out of assets between July and December, leaving the government to provide benefits from general revenue.”

The financial guarantors are in a much better position to ride out the ups and downs of a protracted legal fight and are not as concerned with day-to-day valuation issues as an individual might be. That is why we see a real difference in context in terms of the meaning of Moody’s comments for individual vs. institutional creditor interests.

THEY MISSED THIS ONE

Standard & Poor’s (“S&P”) on March 23, 2017, downgraded the County of Grant’s General Obligation Issuer rating from “AA-“ to “BBB+” with a “negative outlook”. The notice from this Kentucky county is innocuous enough and it is not the first time that a rating has been dropped by multiple notches. But it is another example of where smaller infrequent issuers may not get the scrutiny they deserve from the big rating agencies. In 2015, the AA- rating was assigned to the county’s general obligation bonds issued to refinance debt that funded a county owned and operated jail. The original financing dates back to the late 1990’s when the County’s sleepy 28 unit jail was expanded to a 300 unit facility.

The County had counted on the jail as a source of employment and hoped that a significant number of state inmates would be assigned to the facility. States use county facilities to house inmates with shorter sentences or to house inmates who are approaching the end of their sentences as part of an effort to transition to a post incarceration life. In addition, the County is the home of the Ark Encounter theme park. This facility includes a full size replica of Noah’s ark which was controversially financed through tax exempt industrial development bonds. The County hoped that the park would generate jobs and additional economic development and thereby generate revenues to support the County budget. While the park is estimated to have attracted some 600,000 visitors to its attractions, they apparently come and go without spending much money outside of the park.

That has become a problem for the County as the Commonwealth of Kentucky, like many other states, has  reduced the number of inmates is sends to local facilities for incarceration. This has provided less revenue from operating the facility over a period of time when the County would not raise taxes. Now the jail has become an operating albatross and a drain on the County’s finances.

While this trend has been evident for some time, S&P took no rating action until the County Fiscal Court (the County’s financial management and taxing entity) openly discussed the potential bankruptcy of the County. It is a matter of public record that the County may run out of cash by June 1. So much for being guided  by the rating agencies.

PRIVATE DOES NOT ALWAYS INSURE A SMOOTH ROAD

The issue of private sector involvement in public sector projects took a strange turn in South Texas recently. A Texas engineering firm, Dannenbaum Engineering, is involved in an FBI investigation which resulted in raids on multiple offices of the firm in late April. Dannenbaum has been involved in work involving entities in the City of Laredo and Webb County. Progress on these public projects involving both roads and buildings could be held up as the investigation unfolds.

Dannenbaum is one of the bidders on a traffic signal synchronization study contract which could ultimately alleviate traffic congestion on Laredo roads by synchronizing traffic lights around town. The city says the project is expected to improve travel time by reducing constant stopping and starting of traffic and increasing the number of cars that can use the road at one time.

A road project – The Hachar Loop – that Dannenbaum received a $1 million contract for in 2014, is designed to be a “six-lane freeway with two-lane frontage roads from Mines Road through the Hachar Trust Tract, ultimately extending north through the Reuthinger Tract and connecting to IH-35 in northern Webb County. The corridor’s primary effect is to provide for expedited routing of international truck cargo to newly developed warehousing centers and access to I-35.

In the FBI’s warrant to search City Hall, agents were told to collect records relating to Dannenbaum Engineering’s attempts to secure projects, including Hachar Loop, Loop 20 extension and a traffic signal synchronization study. Dannenbaum is one of the bidders on the traffic signal synchronization study contract. The study offers the opportunity to alleviate traffic congestion on Laredo roads by synchronizing traffic lights around town. The city says the project is expected to improve travel time by reducing constant stopping and starting of traffic and increasing the number of cars that can use the road at one time.

The Hachar Loop, a project that Dannenbaum received a $1 million contract for in 2014, is designed to be a “six-lane freeway with two-lane frontage roads from Mines Road through the Hachar Trust Tract, ultimately extending north through the Reuthinger Tract and connecting to IH-35 in northern Webb County. The corridor’s primary effect is to provide for expedited routing of international truck cargo to newly developed warehousing centers and access to I-35.

On May 1, City Council voted to withhold negotiating and entering into contracts with Dannenbaum pending the outcome of the FBI’s investigation, excluding the traffic light synchronization project. Dannenbaum is one of three bidders currently being looked into as part of a special procurement process by TxDOT for the light synchronization project.

As for the road, the city has funded and submitted schematic design and environmental documents to TxDOT for a portion of the proposed roadway. Webb County has started the process of acquiring consultants for the remaining section of the roadway for schematic design and environmental, according to the city. The total project is estimated to cost $31,635,324. The city will contribute $4,919,144. The total federal and state funds available for reimbursement of the project is $25,242,681.

Some are concerned that the suspension of Dannenbaum from the projects could be seen as limiting or circumventing state grant requirements which call for an open bidding process in the selection of outside contractors. It is feared that this could lead to a loss of grant monies which would threaten the financial liability of these projects.

FLORIDA BUDGET COULD TURN INTO A STANDOFF

It arrived three days beyond the required schedule but, the Florida Legislature did voted out an $82.4 billion budget. In terms of whether it will be enacted, that is a different story. The budget approved does not satisfy three of the Governor’s priorities biggest priorities, has just a fraction of the tax cuts he sought and is almost guaranteed to incur a veto.

For example, the Governor requested $100 million for tourism marketing; they gave him $25 million. $85 million in job incentives to lure businesses to Florida; they gave him zero. $200 million to speed up work on rebuilding the leaking dike around Lake Okeechobee; they gave him nothing.
Lawmakers approved some of the governor’s education priorities, such as funding Bright Futures scholarships and increasing access to charter schools. In both chambers the budget passed by more than two-thirds, the number needed to override Scott if he opted to veto the entire budget. The House voted 98-14 for the budget. The Senate voted 34-3. Scott has the authority to veto the entire budget and force the Legislature to return to Tallahassee for a special session, it’s more likely that he will veto dozens of hometown projects packed into the spending plan
The Legislature agreed to decrease property-tax rates to offset a rise in home values that would have caused many homeowners to pay more in taxes. That will save homeowners in Florida a combined $510 million in increased property taxes.
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.

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