Muni Credit News December 6, 2016

Joseph Krist

Municipal Credit Consultant


An effort is underway in the lame duck session of the Michigan legislature by Republicans who last week introduced legislation to address rising costs for municipal retirees’ health care, including restricting public employees from counting banked overtime, sick leave or vacation days toward their salary before retiring. The 13-bill package is intended to help local governments that are struggling with unfunded obligations related to retiree benefits, including health care.

The legislation was not unexpected. Lawmakers have hinted in recent days that legislation to reform retiree benefits could be coming in the current lame-duck session, which ends in mid-December. Any legislation not adopted by the end of the year has to be reintroduced in the new legislative term that starts in January.

The bills would exclude overtime pay, sick or vacation leave, bonuses or other compensation “paid for the sole purpose of increasing final average compensation” in an employee’s base pay, according to bill language. They also would require increased financial disclosures to the state.

Cities, villages, townships and counties would be limited to paying 80 percent of annual retiree health care costs starting May 1, 2017, if the municipality offers such a benefit. The local unit also wouldn’t be allowed to offer health care coverage to a municipal retiree who is eligible for health care coverage from another employer.

For new employees hired after April 30, 2017, a local government could contribute only 2 percent of the employee’s base pay into a tax-deferred retirement health account, according to bill language. The bills wouldn’t affect existing labor contracts for their duration, though any contract that conflicts with the law after it’s enacted would be nullified. In addition, municipalities and labor unions would be barred from negotiating employee retirement health care plans or tax-deferred health savings accounts for contracts signed, renewed or changed after Jan. 1, 2017, according to the bills.

Legislators said the bills would only apply to municipalities whose retiree health care costs are less than 80 percent funded, or municipalities who fall below the 80 percent threshold for two straight years.


In our last issue we referenced Illinois’  poisoned politics and their potential impact on efforts to shore up pension funding in Chicago. We did not have to wait long for Gov. Bruce Rauner’s veto of a bill that would have eased Chicago Public Schools’ massive pension burden which threatens to blow a $215 million hole into a budget that has been criticized by bankers and civic groups for its reliance on uncertain state assistance. Rauner said he vetoed the bill because it was not tied to broader pension reforms that he has demanded while Democratic Senate President John Cullerton denied assurances on pension reform were part of the CPS deal.

CPS has assumed in this year’s budget it would get the money and offered no immediate plan to cover the gap left by the governor’s veto. The district’s top education official said the action could put the city’s schools in a “horrible position.” Cullerton warned the move could lead to layoffs for thousands of teachers and employees, while Mayor Rahm Emanuel called the veto “reckless and irresponsible.”  The Senate voted to override Rauner’s veto but the override’s prospects in the House, which adjourned for the holidays without taking up the issue, were far from certain.

House lawmakers have 15 days to take up the override, but the body is not scheduled to return to Springfield until Jan. 9 — two days before new lawmakers are sworn into office. It likely would take all 71 House Democrats to overturn Rauner unless a few Republicans buck the governor. Lawmakers approved the CPS bill at the end of June, but Cullerton did not send the measure to Rauner until last month. The delay was intended to provide time to reach a deal on a larger pension measure, but that was never achieved.

“If he wants to tie it to something else like pension reform, that’s something I am supportive of. We haven’t talked about putting the two things together at this point in time,” Cullerton said. Rauner said Democrats went back on a deal that tied the measure to broader changes to the state’s highly indebted employee retirement system. In his veto message, Rauner said the agreement reached last summer was clear and Republicans supported the bailout for CPS only “on condition that Democrats re-engage in serious, good-faith negotiations.” Rauner also made reference to the Senate president’s remarks.

CPS has not said how Chicago’s schools might fill a $215 million hole in its budget. Last year, CPS banked on $480 million in state assistance that never arrived and resorted to cutting millions from school budgets in the midst of the school year to help close the gap.

Rauner’s veto occurred in the midst of the process by CPS  to reconsider an annual budget that now exceeds $5.5 billion. The district had to redraw its budget to make room for tens of millions of dollars in new expenses linked to the contract deal reached in October with the CTU. That budget already relies on property tax increases that include a measure to raise $250 million for teacher pensions. That measure was approved by the General Assembly in June as part of the package that also held the promise of $215 million more for pensions.

The Civic Federation earlier this year said it could not support the CPS budget because of its reliance on state money that might not arrive and a large amount of borrowing. “Because the district provides no plan of recourse should the funding fail to materialize other than noting that there would need to be midyear cuts, the (fiscal year) 2017 budget is in effect unbalanced,” the group said in August. This view balances our belief that any real improvement in the CPS fiscal position is not a reality in the near-term. With the governor about to enter the back half of his term, we see little likelihood that the politics of the situation will abate.

The politics date back to the Daley administration. According to the Chicago Teachers’ Pension Fund, CPS must pay a remaining balance of $730 million by June 30. The sheer size of that debt is partly the result of a long-term practice of not putting in enough money or skipping payments, including an entire decade when CPS made no pension contributions under then-Mayor Richard M. Daley.

Because of that underfunding, combined with recessions that battered the pension fund’s investments, the district now must pay hundreds of millions of dollars more each year, as required under a plan to reach a state-mandated funding level of 90 percent by 2059.


One would hope that in a crisis the common good might outweigh parochial interests in reaching a resolution but such is not the case currently in Puerto Rico. The Puerto Rico Aqueduct and Sewer Authority (PRASA) asked the Energy Commission (PREC) Friday to grant the water utility a “preferential power rate” that is stable and not subject to yearly fluctuations, arguing that Puerto Ricans will benefit more in the long run from cheaper water tariffs than lower power rates.

PRASA’s executive director of infrastructure insisted that PRASA was not asking for a subsidy because PREPA could give the water utility the low preferential rate by giving it a preferential share from the savings the power utility passes on to customers from the conversion of the Costa Sur power plant to a natural gas power plant. Her comments came in testimony at an Energy Commission hearing to evaluate a new power rate for PREPA customers by determining the adequate revenue requirement and other costs.

PRASA’s argument is that PREPA has not been honoring the preferential rate established for the water utility in 2013 of 16 cents per kilowatt-hour (kWh) that was slated to come into effect earlier this year. PRASA is evaluating the possibility of suing PREPA for “breaking the law.”

The law is Act 50 of 2013 which mandated PREPA to establish a preferential rate of 22 cents per kWh hour for all electric power service accounts held by PRASA. This preferential rate was subject to the price of natural gas and is an “all-in rate” covering all charges and fees in connection to the electricity purchased by PRASA. The preferential rate was in effect during fiscal years 2014, 2015 and 2016. From fiscal 2017 onward, the rate was slated to be lowered to 16 cents per kWh. It was also limited to a maximum annual consumption of 750 million kWh by PRASA. Any consumption that exceeds the amount will be annually billed at the average energy cost that PREPA charged its customers during the previous year.

The law states that PRASA had to use the savings from the preferential rate to achieve a reduction in the rates charged to its residential clients. Starting in fiscal 2017, PRASA was required to use the savings to, among other things, develop one or more capital improvement projects targeted to achieve greater operational efficiency, improve its system reliability and provide for future expansions of its system.

PRASA said that in December 2015 PREPA informed PRASA that it was revoking the preferential rate starting in July 2016 so PREPA is not charging PRASA 16 cents per kWh. Instead, PRASA is paying an average of 18 cents per kWh. Because PRASA’s facilities fall within four different tariffs, the utility could pay between 14 cents per kWh for some facilities to 25 cents per kWh in others.  During the first three years the preferential rate was in place, PRASA saved $37 million a year that were passed on to customers. Of PRASA’s operational costs, 25% goes to PREPA for power service. “Without a fixed preferential rate, we are subject to variations and that hurts our ability to have accurate financial projections…. PRASA is the biggest customer PREPA has,” PRASA has said.

When PREPA informed PRASA it was not honoring the 16 cents per kWh rate established by Act 50, Santiago said it was forced to go to the Energy Commission because of Act 57 of 2014, known as the Puerto Rico Energy Transformation and Relief Act, gave the commission regulatory power over PREPA. PRASA said having a cheap water bill is better for the typical consumer than having an economic power rate. By PRASA’s analysis “based on the savings that we have for fiscal year [$37 million a year], if we apply that, these customers receive over $7 a month,”. However, if that ($37 million) in saving is applied to power customers who use up to 800 kWh per month, customers only save $2 a month.

It is not helpful that in making its argument, PRASA was unable during the hearing to identify any projects that were slated to be financed through the savings. In reality, during the first three years of the preferential rate, PRASA used the saving to cover operating costs and avoid water rate hikes. When asked how PRASA would ensure that total savings generated from preferential rates are used for capital expenditures PRASA replied, “Right now, we haven’t been able to do that calculation. It was supposed to start in July. But savings will actually be assigned to capital improvements.” The answer speaks for itself.


Those looking to other territories to obtain high yield triple tax-exempt returns had bad luck last week. The U.S. Virgin Islands effort to issue $225 million of bonds took a hit as Standard and Poor’s Global Ratings lowered the territory’s matching fund (rum cover-over) and Gross Receipt Tax (GRT) bonds, citing declining coverage and weak fiscal conditions as the reason for downgrading the former, and deteriorating economic and fiscal conditions for the latter. The Virgin Islands Public Finance Authority’s (PFA) senior-lien matching fund notes were lowered to ‘BB’ from ‘BBB’ and subordinate-lien matching fund notes were dropped to ‘BB-‘ from ‘BBB-‘. At the same time, a ‘BB’ long-term rating was assigned to PFA’s series 2016A senior-lien capital projects and working capital notes and its ‘BB-‘ to its series 2016B subordinate-lien working capital notes.

“The downgrade reflects weakened economic conditions, declining coverage and revenue trends, and continued reliance on this revenue source to finance operating deficits,” said S&P. “It also reflects our view of a closer linkage between the territory’s general fiscal condition and the repayment of the bonds, especially during times of significant fiscal distress.”

The matching fund bonds outlook is negative, which reflects its view that the continued significant economic, financial, and budgetary challenges the territory currently faces, absent corrective action, could lead to increased deficit financing and, over time, inadequate capacity or willingness to meet its financial commitment to its obligations, especially if market access becomes constrained.

GRT notes were downgraded seven notches from BBB+ to B. The downgrade reflects weak economic conditions, declining coverage, and the potential for further coverage dilution based on the need to issue additional debt to fund capital and cover operating deficits.

The downgrades comes on the heels of difficulties at the Juan F. Luis Hospital which was warned by CMS that it would face decertification if it did not come into compliance with CMS standards for participation by December 9. CMS further stated that it would end its current agreement with JFL by February 27 if the hospital does not comply.

“The negative outlook reflects our view that although coverage remains adequate, there are significant pressures that could lead to higher leverage, declining revenues, or both. To the extent that the USVI continues to face significant fiscal pressures, we believe significant additional deficit financing is likely,” S&P said. The government’s fiscal distress, as evidenced by its significant structural imbalance and continued reliance on deficit financing to fund operations, weak financial reporting, significantly underfunded pension liabilities, and negative fund balances, which could translate into increased debt issuance and, ultimately, impair the government’s ability or willingness to pay debt service on the bonds, especially in the absence of market access or bonding capacity.

Pledged revenues have exhibited either declining or flat growth absent tax rate increases and are levied on a limited and concentrated base. Flat revenues and rising debt service could continue to decline based on additional issuance, a weaker economy, or tax base erosion due to increased exemptions to promote economic development.

The senior-lien matching fund bonds credit reflects a narrow and concentrated base of tax generators with two companies, Diageo and Cruzan, generating all revenues. There is at least a lockbox flow of funds in which the pledged revenues are deposited directly by the U.S. Treasury into a special escrow account held by the special escrow agent.

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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