Muni Credit News December 13, 2016

Joseph Krist

Municipal Credit Consultant

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THE HEADLINES…

SAN BERNARDINO BANKRUPTCY NEARS CONCLUSION

SUPREME COURT REVISITS CHAPTER 11

HEALTHCARE UNCERTAINTY DEEPENS

NEW JERSEY PENSION SHENANIGANS

NUCLEAR SUBSIDIES IN ILLINOIS

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SAN BERNARDINO

The end of the four year journey through Chapter 9 for San Bernardino is in sight with the announcement that U.S. Bankruptcy Judge Meredith Jury confirmed the City’s bankruptcy planlast week, clearing the way for the city to exit bankruptcy. City officials don’t expect the plan — the comprehensive blueprint for how much the city will pay creditors and when — to become effective until March, after at least one more court hearing.

Judge Jury cited actions by the city to improve its finances and its governance, pointing to voter approval of a new charter and better working relationships among elected officials. At the same time, San Bernardino will pay many of its creditors far less than they would otherwise be entitled to — for many creditors, just 1 cent for every dollar they’re owed. But the plan also outsources of refuse and fire services.

The city estimates that while direct costs of the bankruptcy — attorneys and consultants — had cost more than $20 million, the city and its taxpayers saved more than $300 million in debts that were being discharged. A major provision was an agreement with the California Public Employees’ Retirement System — in that instance, an agreement to pay CalPERS everything it’s owed to the detriment of many creditors including debt holders.

SUPREME COURT HEARS ARGUMENTS ON CHAPTER 11

The Supreme Court heard arguments last week in a case that could upend the common practice that ranks lenders, employees and other creditors in order of priority as they try to recover their money when a company files for bankruptcy. The case has attracted wide attention from academics, workers’ groups and state tax authorities. A decision could affect how much power bankruptcy courts have to approve settlements that do not follow the conventional order of creditor priority and potentially block some parties, in this case the company’s former employees, from any financial recovery. The issue should be of concern to holders of municipal bonds, especially in the high yield space as many of the healthcare, project finance, and corporate backed credits populating that space are governed  by these procedures.

Jevic Transportation Company, a New Jersey trucking company, filed for bankruptcy in 2008, two years after a $77.4 million leveraged buyout financed by private equity which former employees say heaped too much debt on its books. The bankruptcy put 1,785 drivers and staff members out of work, but they sued for wages under a federal law and state law that requires employers to give 60 days’ notice before mass layoffs. The drivers assumed that the company owed them approximately $8 million in pay because they were not warned that their jobs were ending. At the same time, the drivers and other creditors filed suit against Sun Capital and Jevic’s main lender, the CIT Group, saying their buyout had fraudulently pushed Jevic into bankruptcy.

By historic precedents, employees who lose their jobs are supposed to rank higher in the line of those owed money than some others, so the drivers anticipated recouping their lost wages. But they got a surprise. Sun and CIT settled with the other unsecured creditors in their fraud case. In exchange for a $3.7 million payment to them, including the lawyers on the case, the creditors agreed to abandon their claim. The drivers were not part of that settlement and were left with nothing.

There are a few cardinal rules about bankruptcy that have been followed for decades. Lenders whose debts are secured by the company’s assets are paid first, for example. Next are the lawyers and professionals who work on the bankruptcy, followed by the so-called junior creditors, starting with employees who worked for the company who are owed wages, followed by employee benefits and unpaid taxes, among other groups. And those who hold the company’s shares, or equity, are generally last. Congress created this pecking order. Senior creditors must be paid in full before any junior creditors — unless all the parties agree otherwise.

The case which was the subject of oral argument is Czyzewski v. Jevic Holding Corporation. Should the Supreme Court side with Jevic and its owner and chief lender, the decision could upend bankruptcy law by altering the rights and expectations of these various groups. A friend-of-the-court brief signed by 19 law professors in support of the drivers says such a decision could lead to cases where the stronger parties in a bankruptcy gang up to squeeze out whichever creditors they decide to target: workers, say, or the Internal Revenue Service.

Alternatively, were the court to ban all bankruptcy settlements that do not strictly follow the order of priority, supporters on Jevic’s side say it could create chaos with a number of established practices involving payments to creditors, especially in the early part of a bankruptcy. And they say it could handicap the efforts of judges in finding the right resolution in an individual case. Some hold the view that if the court rejects priority in settlements, there is a danger that the position of secured creditors who now stand at the front of the line of repayment also could be in jeopardy.

The solicitor general took a position in a brief on behalf of the drivers that the absolute priority rule “is designed to protect intermediate creditors from being squeezed out by a deal between senior and junior creditors.” The law itself does not detail this priority rule, but it has been followed since the 1930s.

The company and its private equity owner contend that the settlement was the fairest result because if the company were liquidated, all of the small creditors would have been left empty-handed because of secured creditor liens on the company’s assets. By paying some of the small creditors a fraction of their claims, rather than zero, they argued, the settlement was in the best interest of most of the creditors. Their argument persuaded not only the bankruptcy judge, but also a divided panel of the United States Court of Appeals for the Third Circuit.

HEALTH INSURERS AND INVESTORS SHARE UNCERTAINTIES

The chief executive of America’s Health Insurance Plans, a leading industry trade group, spoke out last week and publicly outlined for the first time what the industry wants to stay in the state marketplaces, which have provided millions of Americans with insurance under the law. The insurers, some which have already started leaving the marketplaces because they are losing money, say they need a clear commitment from the Trump administration and congressional leaders that the government will continue offsetting some costs for low-income people. They also want to keep in place rules that encourage young and healthy people to sign up, which the insurers say are crucial to a stable market for individual buyers. Insurers could decide within a few months whether to pull out of the state marketplaces for 2018, a deadline they are pushing to have delayed.

Hospital groups also held a news conference to warn of what they said would be the dire financial consequences of a repeal if the cuts to hospital funding that were part of the Affordable Care Act were not also restored. While insurers say they do not plan to fight the Republicans’ efforts to repeal the law, they are in no hurry to see it unwound. And the industry said the industry would support a delay so it could prepare for the changes. “We would love to see a three-year time frame, as long as possible,” she said.

AHI acknowledged that the current law “needed to be improved.” But cited widespread agreement among Republicans about the need for some the law’s provisions, including covering people with expensive medical conditions. President-elect Donald J. Trump has also signaled his support of this popular provision. “There are common starting platforms,”  said the industry spokesperson without revealing details about her group’s positions, She said its top priority was to stop the immediate threat of eliminating the subsidies for plans sold to low-income people. House Republicans have already sued to block these payments, and the lawsuit is now delayed. If the new administration chose not to defend the lawsuit, the money would disappear, and insurers would probably rush to the exits because fewer potential customers would be available.

Other concerns include ensuring that enough young and healthy people sign up to stabilize the market. Republicans have discussed eliminating one of the law’s main tools, the so-called individual mandate, a tax levied on those who do not enroll. Insurers are emphasizing the need for some alternative, especially after criticism by insurers that the penalty is not large enough to persuade enough people to enroll. “There’s not one magic solution,” she said. She pointed to some of the provisions in Medicare that encourage people to sign up before they become sick. The insurers say they had no desire to return to the time before the law was passed, when people with pre-existing conditions were routinely denied coverage in the individual market.

As for alternatives, one is the creation of high-risk pools, where people with expensive medical conditions might be covered, bringing down the coverage costs for everyone else. “We would hesitate to rush back to that,” said the AHI. In the past, those programs, typically run by the states, have not been adequately funded. AHI  expressed concern over a potential overhaul of Medicare, pushed by the House speaker, Paul D. Ryan, who favors so-called premium support, or vouchers, as a way for people to find coverage. “We’re not big fans of that approach.”

So the focus of the debate remains centered on unsurprising issues – Medicare and Medicaid; low income patients; pre-existing conditions. These are the same issues which were the foundation of the healthcare funding debate as long as one can remember.

NEW JERSEY CONTINUES ITS HABIT OF PENSION REALITY DENIAL

A bill introduced earlier last week would allow the State of New Jersey’s $73 billion pension system to invest heavily in Transportation Trust Fund (TTF) bonds just as the state is planning to ramp up transportation spending over the next eight years. Currently, the state Division of Investment, which manages the pension system’s assets on a day-to-day basis, is only allowed to purchase up to 10 percent of an individual bond issue. The proposed legislation would remove that limit, but only for TTF bonds.

The sponsors of the legislation said it makes sense to give the pension system  the option to invest heavily in transportation fund bonds because that way all of the interest on the bonds would go into the pension system instead of to outside investors. They also said the state could save money on underwriting fees, which are levied as a percentage of the bond issues, to further stretch the TTF’s resources.

The bill’s introduction comes as lawmakers have been trying to find new ways to help address the pension-funding issue after the state’s credit-rating was downgraded again, largely due to the pension system’s ongoing problems. And that followed a new analysis by Bloomberg that determined New Jersey’s pension deficit has become the largest among U.S. states.

The legislation also comes in the face of a plan by a leading Democratic gubernatorial hopeful Phil Murphy to establish a public bank in New Jersey that would utilize taxpayer resources to circumvent big commercial banks by directly funding government priorities like long-term infrastructure improvements.

Under the TTF legislation enacted in October, the state would to issue $12 billion in bonds over the next eight years to help pay for road, bridge and rail improvements. Those funds will be combined with new revenue raised by a 23-cent gas-increase that went into effect at the beginning of November to support a total of $16 billion in planned transportation spending.

The proposal to allow the pension system to invest in the TTF bonds would enable the Division of Investment to exceed the 10 percent ceiling, but it would not require the agency to do so. The measure would also limit the funds that could be used by the pension system to invest in transportation fund bonds to those that have already been set aside for investment in fixed-income securities. The plan does raise concerns about whether there would be mechanisms in place to objectively determine a borrowing rate for the TTF. Otherwise, directly placed TTF debt could be a backdoor subsidy for the pension system. which have not been producing great returns in recent years.

“Allowing the TTF to borrow directly from the pension fund is a smart move that guarantees a rate of return while helping to support the infrastructure work that is so important to our economy,” said Sen. Dawn Marie Addiego, another sponsor. Hence, the concern. Smart is the word used for the variety of failed policies adopted on a bipartisan basis over the last 20 years to support the legislature’s unwillingness to honestly address the state’s pension needs. The sale of pension bonds, the under appropriation of general revenues, and unwillingness to find revenues to address the state’s pension needs have left the State in the unenviable fiscal position in which it finds itself today. This would be just another link in the long chain of irresponsible actions taken over those two decades.

Last month, lawmakers passed with wide bipartisan support a bill that attempts to help address the pension system’s funding gap by changing the way the state makes its pension contributions each year. Instead of making the payment in one lump sum at the end the fiscal year, which is the current practice, the bill calls for a quarterly payment schedule. That change is designed to better protect the pension contributions from falling victim to midyear budget cuts, but also to help the pension system generate bigger returns by getting more money into its investments as soon as possible. We’re not sure that we agree with that view. It could just be three more chances to underfund.

ILLINOIS FOLLOWS NY DOWN NUCLEAR SUBSIDY TRAIL

Exelon announced in June that, absent a rescue bill, it would close the Quad Cities station by June 2018 and the Clinton station by June 2017. Both are aging nuclear plants. In response, a bill that would subsidize Exelon Corp. to keep the two financially struggling nuclear plants in operation—and save as many as 4,200 jobs—was passed by Illinois legislators and now is on Gov. Bruce Rauner’s desk for final approval.

Supporters had dubbed the legislation as The Future Energy Jobs Bill. It would provide Exelon and Commonwealth Edison with a $235 million annual credit for the carbon-free energy produced by the otherwise unprofitable Clinton and Quad Cities nuclear plants. Critics contested the subsidy plan and called it a corporate bailout. Exelon and Com Ed officials said it preserved jobs and clean energy technology at the cost of no more than 25 cents per month on the average Com Ed residential customer’s bill.

Critics had cited a study using the IMPLAN economic modeling tool alleging that the Exelon-backed plan would cost about 43,000 jobs lost through 2030. A product of the Rural Development Act of 1972, IMPLAN is a system of county-level secondary data input-output models designed to meet the mandated need for accurate, timely economic impact projections of alternative uses of various resources. In this case, it predicted that Illinois government tax revenue would fall by $419.6 million and result in the large rate hike in U.S. history at $16.4 billion.

The legislation established a Zero Emission Standard (ZES) to reward the state’s at-risk nuclear plants. Proponents say the ZES would position Illinois as one of the first states to fully recognize the environment benefit of nuclear power, which does not produce carbon pollution. Nuclear power provides more than 90 percent of Illinois’ zero-carbon energy, supporters said.

There are more states in line to be targeted for these subsidies. Exelon has already made it clear that it will seek such help in Pennsylvania and as they have more success, we would anticipate that others would make such efforts. It is difficult to support market intervention moves like this but they are to be expected in light of the type of tax related transactions advocated by the President-elect.

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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