Muni Credit News August 9, 2016

Joseph Krist

Municipal Credit Consultant

CHICAGO LOOKS TO WATER BILLS TO FUND PENSIONS

The latest credit development in the Chicago pension saga is a proposal by Mayor Rahm Emmanuel to generate the $239 million over five years needed to save Chicago’s largest city employee pension fund. Emanuel proposed  a “utility tax” on water and sewer bills over the next four years. The plan is to start with a 7 percent tax, double it in year two, impose a 21 percent tax in year three and end at 28 percent in years four and five.

After that, the tax would rise annually to meet the “actuarially required contribution” to achieve a 90 percent funding ratio by 2057 for a Municipal Employees pension with $18.6 billion in unfunded liabilities that is due to run out of money in 2025. The average Chicago household currently pays $686.04 a year for water and sewer services that use 7,500 gallons of water.

The plan faces some clear hurdles. It rests on City Hall’s assumption that the new tax can be enacted by the City Council in September under the city’s sweeping home-rule power and does not require state legislative approval. It is expected to cost the average homeowner $4.43 more month or $53.16 a year in 2017. In the fourth year, the added tax burden will be $225.96 a year.

The plan would undoubtedly be well received by investors who view the pension situation as the primary factor weighing on the City’s credit but it will undoubtedly be just the opposite for homeowners who will see the city’s property tax levy double under Emanuel’s leadership and the aldermen who represent them. Emmanuel acknowledges this by saying “I’m not saying this is not tough. It is tough . . . But the Council has always stepped up for Chicago’s future and I’m absolutely confident they will step up and be part of that solution so that, once and for all, the bow can be tied as it relates to the pensions”.

One outsider view that carries considerable weight in analytical circles is that of the Civic Federation. Its president called it a “positive and politically reasonable step” to try to “use water fees” instead of raising property or sales taxes that would only compound the “high tax situation that already exists.” He added a caveat when he characterized the plan as “a creative and brave effort by the mayor but it will require continued monitoring. We have not seen the actuarial detail to prove” the tax will generate enough money “in the longer term,” he said.

A property tax increase based on the value of a home would have been less regressive than a tax on water and sewer bills based on water usage needed to live, a property tax hike would have had the added advantage of being deductible on federal taxes for homeowners. In spite of that, a property tax hike is considered untenable at present.

PENNSYLVANIA – STABLE OUTLOOK?

The upcoming sale of GO debt by the Commonwealth of Pennsylvania occasioned Moody’s to review its Aa3 rating and to maintain with a revised outlook, upwards to stable . Their rationale – “The revision of the commonwealth’s outlook to stable recognizes that Pennsylvania’s problems – while sure to persist – are unlikely to lead to sharp liquidity deterioration, major budget imbalances, or other pressures consistent with lower ratings for US states. Pennsylvania continues to make steady progress toward better funding of its pension liabilities, which remain large but not abnormally large by state standards. The commonwealth is likely to continue struggling to balance its budgets in future years, but the magnitude of its budget gaps will be solvable. And while legislative gridlock, depletion of its rainy day balances, and a long history of pension underfunding reflect poorly on the commonwealth’s governance practices, none of these is inconsistent with the current rating category, which is already below the median for a US state.

Whenever a rating is challenged in court by aggrieved investors, the rating agencies wriggle off the hook by citing their First Amendment right to express an “opinion”. So exercising the same right let us express our opinion that the phrases “likely to continue struggling to balance its budgets in future years, depletion of its rainy day balances, and a long history of pension underfunding” are not consistent with a double A rating. Especially in a state where so much economic activity is concentrated geographically in two areas with the rest in an extended state of deep decline.

Our advice to investors is, if they must, invest in this name at a spread to other comparably rated credits and please do not be surprised when partisan considerations hold up serious structural budget reform in the second two years of Governor Wolf’s term. Only a serious rebalancing of the legislature in November should lead to a view of credit stability.

NUCLEAR POWER – COSTLY ON THE WAY IN AND THE WAY OUT

The Omaha Public Power District in Nebraska is planning to sell $175 million of revenue bonds this month. OPPD has operated a nuclear generating facility – the Fort Calhoun generating station since 1983. The official statement updates investors about its plans to close the plant at the end of 2016 and replace the generating capacity with purchased power generated by natural gas fired facilities.

We see the details of this change as indicative of a number of factors influencing power generation decisions by both public and investor owned utilities. First, it continues a trend of closures of nuclear plants. These are occurring in spite of the perceived positive impact on global warming of these facilities due to their lack of carbon emissions. The perceived environmentally friendly status of natural gas fired plants combined with their OPPD is not making a particularly daring decision.

It is also a decision which is not without cost. The official statement estimates the cost of decommissioning the Calhoun plant at $1.256 billion. At present, the District estimates that it has accumulated some $387 million of assets in decommissioning trust funds. There are two shortfalls that exist in these funds. One is the difference between the asset values and the total estimated decommissioning costs – a long term problem. Of more concern is that the NRC requires $435 million of funding to demonstrate assurance of funding for decommissioning. So the District will have to generate at least $50 million of additional funding by year end. The District will also have to pay Exelon, the plant operator, $5 million for early termination of its operating agreement.

The plant is for accounting purposes now carried as a regulatory asset for the purpose of recovering its costs of decommissioning. A 10 year amortization period commenced in December, 2013 for cost recovery and there is a balance of $117 million on that asset. Each year the District will recognize a depreciation charge against the balance of that asset. So there is a way to recover some of the cost.

At the same time, the New York State Public Service Commission has issued an order that will allow upstate utilities to charge their customers nearly $500 million a year in subsidies aimed at keeping some upstate nuclear power plants operating. Exelon has said it may have to close its R. E. Ginna and Nine Mile Point nuclear plants unless it receives financial help from the state. Another company, Entergy, had said that it would close the James A. FitzPatrick plant, which neighbors Nine Mile Point on the shore of Lake Ontario in Oswego County, by early next year.

Starting in 2017, the subsidies would cost utility ratepayers in the state $962 million over two years. The overall cost of the clean energy program to utility customers would be less than $2 a month. Exelon has pledged to invest about $200 million in its upstate plants next spring if the program is approved.

The plants also provide economic benefits in job starved localities by maintaining employment. In some cases, they are by far the largest property tax payers in their localities. No one is arguing that this is the cheapest way forward.

SNAKE EYES FOR ATLANTIC CITY

Just after avoiding a default on its debt, the Atlantic City economy and the effort to restore it took a hit when the Taj Mahal announced that it will be closing after Labor Day. The story will get lots of publicity since it still has the Trump “brand” in its name even though Mr. Trump is no longer involved. It is actually owned by Carl Ichan. A long strike and a steady decline in business at the facility will lead to a loss of 3,000 jobs just at a time when the City does not need it.

The decision reflects the long term challenges faced by the gambling industry in Atlantic City. With continuing competition from the newly established Pennsylvania facilities draining customers, Atlantic City remains under pressure. Potential additional new competition from New England reinforces the fear that gaming is becoming a zero sum proposition in the Northeast.

PURPLE LINE P3 TAKES LEGAL HIT

The proposed mass transit project in Maryland known as the Purple Line suffered a significant legal setback when a federal judge issued an order that will force the project to submit an environmental impact study. The project, a 16.2-mile light rail transit project in Montgomery and Prince George’s Counties, Maryland is planned to be constructed through a public private partnership or P3 arrangement. The judge found that that the recent revelations regarding Washington Metropolitan Area Transit Authority’s (“WMATA”) ridership and safety concerns merit a supplemental Environmental Impact Statement (SEIS) under NEPA and reserved judgment as to the remaining issues. Accordingly, plaintiffs’ motion for summary judgment was granted in part, and federal defendants’ and defendant-interveners cross­ motions for summary judgment  were denied  in part.

The NEPA requires that federal agencies consider the environmental effects of proposed actions by requiring them to “carefully consider detailed information concerning significant  environmental  impacts.”  The plaintiffs claimed that defendants’ failure to prepare an SEIS based on recent events that raise substantial concerns about WMATA ‘s safety and in turn its possible decline in future ridership. The judge found that defendants’ failure to adequately consider WMATA’ s ridership and safety issues was arbitrary and capricious, and that these conditions create the “seriously  different picture” that warrant an SEIS.

Plaintiffs pointed to a “series of incidents that have raised questions about passenger safety”, explained that the National Transportation Safety Board had found that the “FTA and WMATA’s Tri-State Oversight Commission are incapable of restoring and ensuring the safety of WMATA’s subway system,” and emphasized how these developments directly undermined the rationale for the Purple Line. Plaintiffs stated that ridership on the  WMATA  subway  has  declined  every year  since 2009. In their view, the news of (declining Metrorail ridership) . . . casts an additional shadow over the rosy projections of ever­ increasing ridership for the Purple Line, which  is inextricably  linked to and dependent upon the use of several subway stops from beginning to end.

The Maryland Transportation Authority (MTA) offered in response only that the Purple Line is not part of the WMATA’s Metrorail  system.  The  Purple Line would be owned by MTA and operated by MTA’s contractor. Therefore, the financial or other issues currently being experienced by WMATA do not involve the Purple Line, and they  have no relationship to the environmental impacts of the Purple Line. Therefore, the WMATA-related issues cited in FCCT’s letter provide no basis for preparing  an SEIS.

This was sufficient for the relevant federal regulators but the judge found such reliance to be arbitrary and capricious given the need for access to the Purple Line through the WMATA system. He found that defendants wholly failed to evaluate the significance of the documented safety issues and decline in WMATA ridership, skirting the issue entirely on the basis that the Purple Line is not part of WMATA. While it is true that WMATA is a distinct entity from MTA, which would own and operate the Purple Line, this does not provide a rational basis for defendants’ summary conclusion that a decline in ridership thereon has no effect on the Purple Line, given that the previous projections estimated over one quarter of Purple Line riders would use the WMATA Metrorail as part of their trip.

We never fail to be amazed when projects underestimate the role of the environmental review process as a potential source of delay and/or blockage of transportation projects whether they be for road, rail, or air projects. In assessing project viability whether before or during investment, investors need to be concerned with the status of the environmental review process and satisfy themselves that they are being compensated for the associated risk.

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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