Muni Credit News August 2, 2016

Joseph Krist

Municipal Credit Consultant

OUT IN THE TERRITORIES

With Puerto Rico sitting in a state of limbo as events under Promesa play  out, investors are looking at debt from other U.S. territories in a new light. So the recent downgrades of the debt issued for the Virgin Islands Water and Power Authority to below investment grade merited attention. The downgrades come on the heels of a Spring decision by the Public Services Commission to deny W.A.P.A. a requested electric rate increase and instead placed the petition under a 60-day review. W.A.P.A. said it needed the increase to help stabilize its finances, and to have, at minimum, 45 days cash on hand, which equates to roughly $34 million. It also said the rate increase would bolster the market’s confidence in the authority’s bonds. Moody’s calculates that W.A.P.A. has approximately $127 million in electric system revenue bonds outstanding and approximately $100 million in subordinated electric system revenue bonds.

In a press release, W.A.P.A. Interim C.E.O., Julio Rhymer Jr., said the downgrade was expected in wake of the P.S.C.’s decision, along with W.A.P.A.’s deteriorating financial condition. “In light of last week’s decision by the Public Services Commission to delay action on a requested emergency rate increase, resulting in W.A.P.A.’s inability to amass sufficient days of cash on hand, the rating downgrade, was largely anticipated”. The Moody’s downgrade of senior bonds from Baa3 to Ba2 and subordinate bonds from Ba3 to Ba1, follows previous pronouncements by not only Moody’s but by Fitch, another rating agency, and S&P which contend that W.A.P.A. is in a precarious financial position based largely on outstanding receivables, the lack of liquidity and a multi-million dollar lawsuit recently brought by a former fuel supplier.

Despite expected modestly improving operating cash flow generation owing to recent customer gains and access to a $13 million term loan from the Rural Utility Service (RUS), W.A.P.A.’s financial flexibility will remain tight. Bond debt service over the next 12 months is secured by a debt service and fully cash funded debt service reserve fund. The authority’s unrestricted cash position of around $13.7 million has been improved by the Virgin Islands government’s efforts since the beginning of this year to reduce outstanding electric receivables to an estimated $22 million from a peak of around $41 million at June 30, 2015.

For some time, the Authority’s credit has been characterized by a short-term approach towards liquidity and financial management as well as frequent late filing of audited financial statements. The territory’s hospitals, along with some of the semi-autonomous agencies of the government, continue to owe the authority millions of dollars for past electrical and potable water service. These agencies are not current and have sizeable outstanding balances. WAPA is effectively subsidizing their operations while its finances deteriorate.

A proposal to incorporate a permanent charge that recovers street lightning costs to help support has been made W.A.P.A., and the P.S.C.’s could go either way. However, actions are uncertain and unlikely to restore W.A.P.A.’s weak financial profile to levels commensurate with a higher rating in the short term.

ATLANTIC CITY AGREES TO LOAN TERMS; AVOIDS DEFAULT

A last minute agreement with the State of New Jersey allowed Atlantic City to avoid an August 1 default. City Council approved a loan agreement with the state during an emergency meeting Thursday night. The state asked for certain assets, including the dissolution of the city’s Municipal Utilities Authority. “I want it secured by every asset they have, so that if they don’t pay it, I get to take the assets, sell them and pay you (the taxpayer) back,” Gov. Christie said Thursday.

The council is set to start the process of dissolving the authority during its September meeting. Dissolving the authority requires two readings of the ordinance, and the council can pull the ordinance after funding has been secured. City officials contend the state has no need to worry about the repayment of the loan. The city plans on repaying the state with the two years of marketing funds that would have gone to the Atlantic City Alliance — totaling $60 million — and $18 million from the Investment Alternative Tax, as part of a rescue package signed in May.

Some Council contended that the agreement was rushed. The state countered that members were notified about the emergency meeting two hours before it was scheduled to start and that all members of council were notified of the meeting at the same time. The loan is being made pursuant to legislation the governor signed in May giving the city until Nov. 3 to draft a five-year fiscal plan that includes a balanced budget in 2017. If the city fails to submit a plan or the plan is deemed insufficient, the state can sell city assets, break union contracts and assume major decision-making powers from the city’s government for five years.

The Mayor of Atlantic City said that “a five-year projection for city budgets from 2017 through 2021 is currently being prepared under the terms of the recovery plan. The city plans to have a draft of the plan completed by late fall and the final document presented to the commissioner of the Department of Community Affairs prior to the deadline.”

PENNSYLVANIA TURNPIKE

While neighboring New Jersey battles it out over gasoline taxes, the Pennsylvania Turnpike Commission looks to market some $315 million of bonds backed by oil franchise taxes. This tax is levied at a rate of 208.5 mills per gallon of fuel sold at wholesale in the Commonwealth. In 1991, the distribution of a portion of this tax was enacted into law which dedicated 14% of the 55 mills of the tax to the Commission. The security for the bonds includes a determination that these revenues are deemed to be appropriated without additional legislative action.

This matters given the budget delays which have characterized the Commonwealth’s budget process in each of the last two years. Those delays would not have prevented the timely collection and distribution of the pledged revenues. The major risk associated with the credit is the potential for reductions in demand for fuels in the face of a decline in sales related to either the economy or to increased fuel efficiency. Those risks are common to any consumption driven tax revenue stream. Consumption has been steady to slightly declining since 2007 which is not surprising given the economy over that period as well as driving trends nationally.

NEW JERSEY

A revised plan for renewing New Jersey’s Transportation Trust fund was advanced by the State Assembly. It calls for a 23 cent per gallon increase on retail sales at the pump. and reductions in other taxes, including a phase out of the estate tax and larger tax exemptions on retirement income. The New Jersey Chamber of Commerce, the New Jersey Gasoline, Convenience Store, and Automotive Association and the New Jersey Sierra Club have come out in support of raising the gas tax to replenish the trust fund, but caution the hike proposed by lawmakers might not produce the level of revenue they expect.

The revenue concerns reflect worries that there is a good amount of the volume in the state of New Jersey that comes from New York and those people will have less reason to purchase gasoline in New Jersey anymore.

The Senate Budget Committee Chairman is trying to get a measure approved that would satisfy concerns about tax fairness. The impact on employment short term is a major political concern. The shutdown of transportation projects because of the funding stalemate has meant layoffs during what’s usually their busiest time of the year, he said.  Union supporters have said that the standoff will lead to its workers taking about a 20 percent cut in their income this year. “They’re not going to be able to make this up with overtime.”

Gov. Chris Christie has said he will veto the legislation, which he has described as an exercise in tax unfairness. Senate President Steve Sweeney said he is working to get a veto-proof majority of lawmakers before posting the bill for a Senate vote.

LIPA

The effort to lessen the rate burden on Long Island electricity users continues with a pending fourth phase of Utility Securitization Bonds. These taxable securities seek to take advantage of the current rate environment to refund outstanding tax exempt debt payable from general retail electric rates and replace it with debt secured by a standalone fixed charge designated for debt service on these bonds. The financing refunds a chunk of the Authority’s debt out of the electric system’s expense base which is used as a part of the ratemaking process.

The securitization plan was designed to lower and stabilize the Authority’s ratemaking in response to customer concerns. The Authority’s costs and overall management had become a significant political issue on the regional and state level. So in 2013, the NY state legislature enacted legislation restructuring the Authority’s management, putting its ratemaking under Public Service Commission review, and restructuring its debt. It also enacted a three year freeze on retail electric rates. Day to day operations at the Authority are managed by a subsidiary of PSEG expressly created for this purpose. These actions reduced the political heat on the Authority and stabilized its credit at investment grade.

The security for this debt is effectively independent from the operations of the Authority. The securitization charge appears as a distinct fixed line item on a customer’s bill. The idea is to lower the overall cost of power to consumers than would have been the case had the refunded debt remained outstanding.

ERIE COUNTY, NEW YORK

The Authority is making its first debt offering in nearly two years. These bonds are secured by County sales tax collections and State Aid payments made to the County. The sales tax revenues are collected for the County by the State and may only be applied to debt service payments on the bonds. Neither the state or county can appropriate the funds for any other purpose.

The Authority issues debt on behalf of the County in addition to its oversight responsibilities over the financial operations of Erie County. The economic difficulties of Western New York’s population center (anchored by Buffalo) are well documented. The County’s finances were historically impacted by those difficulties as well as its former responsibilities for a County hospital. These combined to damage the County’s bond ratings such that it had effectively lost access to the market. This led to the creation of the Authority.

The County faces some daunting challenges despite  significant redevelopment efforts undertaken in Buffalo and the direction of significant funds from state economic development resources to the region. Buffalo and the County continue to experience population declines and efforts to increase private employment have been mixed at best. Public entities still are five of the ten largest employment in the County.

CHICAGO PUBLIC SCHOOLS PLACE DEBT PRIVATELY

Chicago’s cash-strapped public school system sold $150 million worth of bonds to JPMorgan in a “private placement.” The bonds, to be paid off in 2046, were sold at yields of 7.25 percent. The deal worked out better for school officials than their last one — an open market sale in February — was for $725 million at yields of 8.5 percent. Those bonds are to be paid off in 2044.

The rates are significantly higher than they were for comparably structured CPS bond deals from last spring, when CPS sold bonds at yields of closer to 5.5 percent. A $300 million budget deficit, possible teachers’ strike and large looming pension payments have led to CPS’ bonds being rated by three ratings agencies at “junk” status.

The private placement reflects concerns about these credit issues in the face of inaction by the legislature and the Governor to negotiate a way to fund the state’s as well as the Chicagoland localities’ huge unfunded pension liabilities. It is yet another reinforcement of the overall negative credit trend for Chicago and its related credits.

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 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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