Muni Credit News April 14, 2016

Joseph Krist

Municipal Credit Consultant

PR BILL INTRODUCED

Rep. Sean Duffy, R-Wis., introduced a bill H.R. 4900, the “Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA).” late Tuesday to address Puerto Rico’s debt crisis. It was the subject of a Natural Resources Committee hearing on Wednesday and is expected to be voted on by the committee on Thursday. We outlined the expected basic provisions in our special edition of Tuesday April 12. The main changes in the bill since it was initially discussed are in the board’s makeup, its power to unilaterally impose regulations on the commonwealth, and the required steps for an entity to undergo restructuring. The board would still only be able to file restructuring petitions on behalf of the commonwealth and its public authorities after the debtors tried to reach an agreement with their creditors through voluntary debt restructuring proposals and have provided the board with up-to-date financial statements. The bill also eliminates a provision from the earlier version that gave the oversight board power to unilaterally implement recommendations and binding regulations.

Reaction from Puerto Rican politicians was mixed. Rep. Nydia Velazquez (D-NY) was unenthused. “Given that four Board members will be appointed by Republicans, there is significant reason to believe that restructuring authority will never be granted,” Velazquez said. “This concern is compounded by section 601, a new provision, which adds a collective action clause to the bill. This clause requires two-thirds of creditors to voluntarily agree to restructure their debt, a hurdle that is not realistically achievable.” In a conference call with journalists on Tuesday, Puerto Rico’s governor, Alejandro García Padilla, said he believed that Congress had taken Puerto Rico’s complaints of federal overreach seriously and acted in good faith to tailor the oversight board to Puerto Rico’s situation.

A hearing before the House Natural Resources Committee was held this week. The Obama administration expressed concerns that undermining the minimum wage and overtime rules in Puerto Rico, thereby increasing the disparities in pay between Puerto Rico and the mainland, is not a recipe for economic growth. Rather, it believes a locally administered Earned Income Tax Credit is a more powerful and effective way to stimulate the economy and encourage work. The one time mayor of Washington D.C., Anthony Williams commented on the issue of an oversight board. “The lessons drawn from other notable places that were subject to oversight does instruct that if done with due respect for those in public office, and with keen awareness of both community leadership and an eye on business interests, good and sustainable solutions can and have occurred.”

After the hearing, the Committee chairman said that the planned schedule for consideration of legislation needed to be extended. “The Administration is still negotiating on provisions of the legislation, creating uncertainty in both parties. This legislation needs bipartisan support, but Members need time to understand the complexity of the issue and the ramifications of any proposed changes. It is unfair to all Members to force a vote with provisions still being negotiated.”  In addition, As of Thursday, the PR government still did not know when the long-awaited Commonwealth Annual Financial Report (CAFR) for the year ended June 30, 2014, would be released.

The fiscal 2014 CAFR was due nearly a year ago, in May 2015. KPMG, the independent auditors tasked with the process, said it would take the firm another eight to nine weeks to complete the audit once they receive all pending information. Since early this year, administration officials have stated the government has handed in everything on their end. But they have also acknowledged that some commonwealth components have yet to finish certain processes related to the external audit, including the cash-strapped Government Development Bank (GDB) and two of the commonwealth’s retirement systems.

P3 UPDATE

The  I-69 Section 5 project is a part of an Indiana highway that is being expanded to handle expected increased truck traffic resulting from NAFTA. The I-69 Section 5 project involves rehabilitating and upgrading 21 miles of the existing four lane State Road 37 in Morgan and Monroe counties to interstate standards from Bloomington to just south of Martinsville, Indiana. As part of the conversion, the existing partially-controlled limited access facility will be upgraded to have fully controlled access and will include the addition of travel lanes in the north and southbound lanes.

Bonds have been issued secured by a pledge of future payments from the private entity which is constructing and will operate the road. Availability payment P3s transfer cost, schedule and quality risks away from taxpayers during such time that the private sector is responsible for construction, operations and maintenance. If the road isn’t made “available” to the public in compliance with performance standards in the contract, the recurring, inflation-adjusted payments are reduced accordingly. Under terms of the contract, the state would make an $80 million “down payment” to the private partner, Isolux Infrastructure, which would pay the $325 million estimated for construction. Once that section of highway is complete, the state starts paying the partner $21.8 million a year for 35 years and the company maintains the highway.

Fitch Ratings last week downgraded the Indiana Finance Authority’s private activity bonds (PABs) issued on behalf of I-69 Development Partners LLC (I-69 DP) for the I-69 Section 5 project to ‘BBB-‘ and placed the bonds on Rating Watch Negative. The downgrade reflects the deteriorating credit quality of Isolux Corsan SA (Isolux), parent of the construction contractor, Corsan-Corviam Construccion SA, whose rating was revised to ‘B-‘/Rating Watch Negative on Feb. 12, 2016. This followed an earlier downgrade of Isolux on Dec. 7, 2015 to ‘B’/Rating Watch Negative.

The downgrade further reflects a projected eight month delay to substantial completion, initially expected in October 2016, which was disclosed in the most recent construction update published in March 2016. The revised substantial completion date is now June 28, 2017. Now the bondholder is exposed not only to project risk but financial risk of the private construction contractor. There is a Debt Service Reserve Account sized at modest a six-month’s debt service.

P3 project s have not been quite the godsend that politicians and investors have hoped for in many cases. While the private entities are often better at project execution than government, they also have brought an element of financial risk to transactions often unrelated to the project at the center of an individual bond issue. The result has been a greater shift of risk to investors than they anticipated resulting a shift in the risk balance away from the issuers onto those investors.

BOND MARKET GETS SOME REGULATORY RELIEF

U.S. cities and states won a partial victory Friday as the Federal Reserve gave final approval to a rule that will allow banks to include some municipal bonds in allocations of easy-to-sell assets meant to serve as protection against a financial crisis. A multiagency rule adopted in 2014, called for the biggest banks to hold enough high-quality liquid assets to survive a 30-day period of financial stress. The central bank revisited the idea of including munis after local governments waged a lobbying campaign for the change.

Bank regulators adopted the minimum-liquidity demand as a response to deficiencies highlighted during the 2008 credit crisis, when financial firms were stuck with assets they couldn’t sell. The Fed, which announced completion of its revised rule in a statement, said it relied on an analysis that suggested certain munis should qualify because they have liquidity characteristics similar to assets such as corporate debt securities. The victory is only a partial one for issuers in that a substantial portion of muni activity occurs in the bank units overseen by the Office of the Comptroller of the Currency. So far, neither the OCC nor the Federal Deposit Insurance Corp. has matched the Fed’s confidence in the liquidity of the muni market.

The Fed’s change, which takes effect July 1, applies to Fed-supervised lenders subject to the liquidity coverage ratio requirement. Those bank holding companies will be able to include a limited slice of munis among the Treasuries, highly-rated corporate bonds and foreign-government debt they already count against their liquidity demands. The Fed will allow munis that “have a proven record as a reliable source of liquidity in repurchase or sales markets during a period of significant stress,” according to the text of the rule. Such munis can be part of a second tier of liquid assets, which can total no more than 40 percent of the overall liquidity buffer.

The phase-in period for the liquidity rule started in 2015 and it is set to go into full effect on Jan. 1. It’s also expected to be joined this year by a separate but related liquidity demand — known as the net stable funding ratio — that considers a longer stress horizon. Even under the pressure of rules and warnings from municipal lobbyists, banks have increased their muni holdings, which rose to almost $500 billion by the end of 2015, more than twice the levels the industry held at the end of the financial crisis.

SAN BERNARDINO PENSION BOND SETTLEMENT

Pension bonds have come in for lots of criticism as to whether or not they are a good tool for governments to use to deal with ballooning pension costs. Now there is another example of how they may not be such a good idea for investors either. Moody’s Investor Service said Monday  that San Bernardino’s bankruptcy settlement agreement with two pension obligation bondholders reached last week is a “significant loss and credit negative” for the bondholders and other investors in local government debt.

San Bernardino declared bankruptcy in 2012. The settlement includes a 60 percent haircut for the creditors, cutting the city’s payments to pension bondholders by $45 million. The California city agreed to pay a total of $51 million over 30 years, beginning one year after the bankruptcy court approves the city’s plan of adjustment. Although up significantly from the city’s original 1 percent proposal, Moody’s said its own calculations determined the public obligation bondholders would actually recover less than 30 percent of their investment, not the 40 percent stated in the settlement. Commerzbank Finance & Covered Bond S.A. and Ambac Assurance Corporation are the creditors of the city’s roughly $100 million in pension obligation bonds.

STADIUM BONDS NOT JUST A MAJOR LEAGUE ISSUE

The New York Yankees and the Tampa Sports Authority announced plans Monday for a $40 million improvement project at Steinbrenner Field, the Yankees spring training facility.  It would be financed equally among the State of Florida, Hillsborough County and the Yankees. The funding includes construction of new outfield concourses and gathering spots, improved access into the ballpark and additional improvements at the team’s minor league training complex nearby. The construction is expected to be complete by March 2017.

The Yankees will pay their portion of the construction through lease payments, which will run through 2046. Six teams have left Florida since 2003 to establish spring training homes in Arizona, making the Cactus League equal in size to the Grapefruit League. In response, the state passed a hotel tax that goes to fund new or renovated facilities. Exhibition games draw a greater percentage of out-of-town visitors than regular-season games in major league cities. So this may make more sense in support of the argument over whether these projects generate economic growth. The tax is paid by visitors, and that money is used to get a commitment from teams. The Yankees have already completed more than $6 million worth of renovations on the minor league and major league training facilities, including new batting cages.

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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