ISSUE OF THE WEEK
We focus on multiple issues this week as names which have been in the news as the result of negative credit factors seek to issue debt in the municipal market this week. That is not to say that the issues come necessarily with lower ratings but they do provide an occasion to shine a spotlight on their underlying stories.
Connecticut will issue $800 million of its special tax revenue bonds to fund transportation infrastructure in the State. Bonds are secured by a first lien on Pledged Revenues deposited into the State’s Special Transportation Fund (STF). The Second Lien Bonds are secured by Pledged Revenues on a subordinate basis to the Senior Bonds. Pursuant to Public Act 84-254 of 1984 (Act), both Senior and Second Lien Bonds are payable prior to use of pledged revenues for operations of the STF. Pursuant to the Act, all amounts necessary to pay debt service on both Senior and Second Lien Bonds are deemed appropriated from pledged revenues and no further approval of the General Assembly is required.
Both the Senior and Second Lien Bonds are also secured by debt service reserve funds funded to combined maximum annual debt service. Pledged revenues consist of taxes, fees and charges and other receipts credited to the STF. These revenues include motor fuel taxes, oil company taxes, a portion of the State’s general retail sales taxes, motor vehicles receipts, motor vehicle related licenses, permits and fees, sales taxes imposed on casual sales of motor vehicles, certain federal transportation related revenues (including federal subsidy payments relating to Build America Bonds (BABs) and interest income. The pledged revenues become subject to lien for payment of debt service when received by the State.
Burke County, Georgia will issue just under $400 million of pollution control bonds on behalf of the Oglethorpe Power Company. Oglethorpe is one of the co-owners (30%) of the Votgle Nuclear Plants. As a result, they are one of three entities along with MEAG and Georgia Power that is on the hook for the sunken costs of the troubled Units 3 and 4 which have been under construction. The future of the plants has been uncertain since last year’s bankruptcy of Westinghouse, the original primary contractor for construction of the facilities.
For weeks, the commission has gone back and forth with Georgia Power over a reasonable standard for costs. The owners of the plant have received some $3 billion of payment from Westinghouse’s parent company, Toshiba. But that still leaves almost $2 billion of sunk cost to be recovered and some estimate that additional investment of $8 billion is required to complete. On December 21, 2017, Georgia Power filed with the PSC for approval of its plan to go forward with completion of Votgle 3 and 4. The Owners have approved, a 29-month extension to the currently approved schedule for Votgle 3 & 4 as the most reasonable schedule for the Project. GPC estimates that $7 billion will be required for completion. The PSC is expected to decide on a course of action in February. Under the new project management structure, Georgia Power, along with Southern Nuclear Operating Company (“SNC” or “Southern Nuclear’) acting as the project manager, will manage the Project on behalf of the Owners pursuant to a revised Ownership Participation Agreement. Bechtel Corporation (“Bechtel”) will serve as the prime construction contractor.
The effort to continue the plant is controversial to say the least. There is substantial support from the business community to complete the plant. There is also substantial customer opposition to any rate increase. It into this credit environment that Oglethorpe seeks to refinance debt dating back to 2008. The statutory deadline for a PSC decision is February 27, 2018.
SIFMA 2018 ISSUANCE SURVEY
SIFMA released its survey of projected issuance activity for the municipal bond market in 2018. “Respondents to the 2018 SIFMA Municipal Issuance Survey1 expect total long term municipal issuance to reach $322.5 billion in 2018, down from the $407.8 billion issuance in 2017.2 Short-term issuance is expected to decline in 2018, with $40.0 billion in short-term notes expected to be financed compared to $46.7 billion in 2017. Including short-term issuance, total municipal issuance is expected to fall to $362.5 billion, down from $454.6 billion expected in 2017.
Respondents were generally unanimous that general purpose and education would be the two largest sectors for 2018, followed by utilities and transportation. In prior years, the general purpose sector has traditionally been the largest issuing sector by gross amount. Respondents expected approximately 50 issuers to default in 2018 for a par value of $2 billion, defined for the purpose of the survey as the occurrence of a missed interest or principal payment or a bankruptcy filing.”
MINNESOTA LOOKS TO FUND INFRASTRUCTURE AHEAD OF FEDERAL PLAN
Gov. Mark Dayton on Tuesday proposed a $1.5 billion public works bonding bill that prioritizes upkeep projects on college campuses but would also spread resources to improving other state buildings, constructing affordable housing and repairing clean water infrastructure.
“Now is the time to make substantial investments in our state’s future,” Dayton said in a statement, citing the state’s Triple-A bond rating and what he called an “enormous need for infrastructure improvements across Minnesota.” The governor’s plan includes $30 million for a revitalization project at Fort Snelling, $12 million for renovations at the Stone Arch Bridge in downtown Minneapolis, $100 million for affordable housing statewide, and $50 million for development of an express bus program in Hennepin County.
This will likely lead to opposition in the Legislature which has responded to previous proposals with less expansive plans. The matter is also complicated by the fact that Minnesota communities submitted proposals for projects, including trails, interchanges and water system improvements. Their requests for state money totaled $857 million. Dayton chose not to include the projects in his plan. Dayton wanted to focus on preserving state assets and getting some long-needed maintenance work done. The governor’s plan includes $998 million for maintaining and improving state infrastructure. Of that, $167 million is dedicated to local water infrastructure projects and $115 million would go to housing projects.
SOME PROGRESS IN THE US VIRGIN ISLANDS
While overall disaster aid is caught up in the ongoing Congressional budget standoff, there is some small progress to be reported for the US Virgin Islands. The U.S. Department of Transportation’s Federal Highway Administration (FHWA) announced the immediate availability of $6.5 million in “quick release” Emergency Relief (ER) funds for further repairs to roads and bridges throughout the U.S. Virgin Islands. The additional funding supplements $8 million in ER funds previously made available to the U.S. Virgin Islands for Hurricanes Maria and Irma damage, bringing the total amount to $14.5 million for emergency work. The bulk of the funds provided today will be used to restore traffic signal service on the islands of St. Thomas and St. Croix and make repairs to damaged intersections critical to highway safety.
The FHWA’s ER program provides funding for highways and bridges damaged by natural disasters or catastrophic events. The “quick release” payments to U.S. Virgin Islands are considered as initial installments of funds used to restore essential traffic and limit further highway damage, which can help long-term repair work begin more quickly.
THE OTHER FERTILIZER DEAL SEEKS TO RESTRUCTURE
Iowa Fertilizer Company LLC IS soliciting the Holders of the 2019 Bonds and the 2022 Bonds to tender in exchange for their choice of an equal principal amount of Midwestern Disaster Area Revenue Refunding Bonds (Iowa Fertilizer Company Project), Series 2017 due December 1, 2050, with a final mandatory tender on December 1, 2033 (the “Series 2017A Bonds”), or with a final mandatory tender on December 1, 2037, and a coupon of 5.00% priced at par. The Exchange will (a) permit the Company to credit the tendered and accepted (i) 2019 Bonds to all of the June 1, 2018, and December 1, 2018 Sinking Fund Installments, a portion of the June 1, 2019, Sinking Fund Installment of the 2019 Bonds, and a portion of the principal payment at final maturity of the 2019 Bonds on December 1, 2019, and (ii) 2022 Bonds to a portion of the June 1, 2020, December 1, 2020, June 1, 2021, December 1, 2021, and June 1, 2022 Sinking Fund Installments of the 2022 Bonds and a portion of the principal payment at final maturity of the 2022 Bonds on December 1, 2022, (b) reduce on a dollar-for-dollar basis the mandatory Sinking Fund Installments of the 2019 Bonds and a portion of the Sinking Fund Installments of the 2022 Bonds on such dates, and (c) constitute a refunding of 2019 Bonds and 2022 Bonds for an equivalent principal amount of the corresponding Series 2017 Bonds.
The plan reflects the disappointing operating results of the facility versus projections since it began operations in the Spring of 2017. Declines in the price of various feed stocks for the plant which produces nitrogen based fertilizer have not been sufficient to offset the market clearing price for nitrogen based fertilizers. The restructuring would relieve near term debt service pressures over the next five years and allow time for the market to rebalance. The bonds were originally rated BB-minus by Fitch and S&P Global Ratings but have since been downgraded. S&P affirmed its B rating in May, while shifting its outlook to stable from positive. Fitch in May removed the credit from negative watch but assigned a negative outlook.
PENNSYLVANIA TOBACCO DEBT GETS S&P RATING
The Commonwealth of Pennsylvania has historically used its share of tobacco Master Settlement Agreement payments to fund specific programs. Now the Commonwealth is turning to those revenues purely to balance its General Fund. It will issue debt backed by a pledge of those revenues with the proceeds to be deposited into the commonwealth’s general fund. The annual effort to balance the Commonwealth’s budget has become increasingly political and contentious over the last four years. The legislature has steadfastly refused any real effort to impose a severance tax on gas production. At the same time, it has significantly misjudged annual operating results such that missed revenue estimates of $1.1 billion and cost overruns of $400 million led to a $2 billion budget gap for this year. Pennsylvania ended fiscal 2017 with a negative $1.539 billion general fund balance on a budgetary basis. Constitutionally, it is required to adopt a balanced budget, and legislators approved the series 2018 bonds as a source of revenue to close the commonwealth’s $2.2 billion budget gap.
Total interest projections on 20-year bonds equate to 2.9% of budgeted fiscal 2018 expenditures. In addition, the Commonwealth will have to find resources to cover programmatic costs formerly funded with the tobacco payments. No matter how one tries to frame the planned issuance, the bond issue constitutes deficit financing. Pennsylvania at one time relied on annual access to the note market which held down its long term ratings. The Commonwealth worked hard over a period of years to wean itself off the need to annually borrow for deficit financing. It is quite disappointing to see the Commonwealth seem to fall back into its old discredited ways.
S&P rates the bonds at A, equivalent to the Commonwealth’s appropriated debt rating. This reflects the fact that although the commonwealth intends to pay the debt service on the bonds with tobacco master settlement payments, debt service payments are subject to appropriation. The commonwealth’s general appropriation pledge further secures the bonds.
NEW JERSEY REVENUES ARE STRONG BUT EXPENSE PRESSURE IS STRONGER
The new administration in Trenton received mixed news as the State announced a nearly 12% increase in fiscal year-to-date gross income tax collections because of strong growth in December collections. At the same time, a sales tax rate cut took effect on 1 January. All in all, it may not ease the future budget outlook as the fiscal 2019 pension contribution will increase $235 million more than previously expected owing to a recent reduction in the state’s assumed rate of return to 7.0% from 7.65%. The combined pension contribution from the general fund and lottery funds will increase to $3.4 billion (60% of the statutory annual required contribution based on the 7% return assumption) from $2.5 billion (50% of the annual required contribution, based on the 7.65% return assumption).
The December revenue increase is not considered to be indicative of a trend. Income tax growth was particularly strong in December 2017 at 30.5% from a year earlier. The state Office of Legislative Services suggests this growth was the result of two onetime events and therefore is unlikely to continue: a 2008 federal tax law requiring hedge fund managers to repatriate accumulated offshore gains by 31 December 2017 and taxpayers accelerating tax payments into 2017 to avoid the recent federal tax law changes. To the extent that the gain came from the latter, there will be an offsetting decline in April 2018 tax payments. Year to date, revenue remains 0.5% below budget when excluding lottery revenue and constitutionally restricted gas taxes.
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