Muni Credit News February 19, 2015

Joseph Krist

Municipal Credit Consultant


Just after we went to press last week, S&P announced a downgrade of Puerto Rico’s  general obligation (GO) bonds and Puerto Rico Tax Financing Corp. (Cofina) bonds to B. Also downgraded was debt of the Puerto Rico Municipal Finance Agency, the Puerto Rico Employees Retirement System’s, the Puerto Rico Infrastructure Financing Authority’s (rum tax) and the Puerto Rico Convention Center District Authority. The outlook on all ratings is negative.

In particularly strong language S&P warned that “Puerto Rico’s focus more recently has turned to new rounds of financing to simply maintain critical levels of operating cash, while paying a high price for new financing. All of this poses a threat, in our view, to the commonwealth’s ability to continue providing basic governmental services. We have observed in other jurisdictions that such an environment can easily give way to political and policy instability,” the report stated. “The government’s response to the situation has vacillated between rounds of spending austerity and tax cuts, or increased taxes and limited layoffs, but in either case it has relied on debt issuance to cover operating deficits.,”

PR does not like to see its situation compared to that of sovereign debtors like Greece. It’s responses to events like this however are not helpful. As has often been the case, government spokespersons used somewhat emotional language to respond. “The continued push by this firm to provoke abrupt measures like the mass firing of public employees is not in line with the public policy of this administration,” said a government public affairs official. “We will continue taking necessary measures to straighten out public finances in a responsible way without firing employees. Government Development Bank for Puerto Rico (GDB) President Melba Acosta said “While we are disappointed with Standard & Poor’s decision, we remain committed to the implementation of our fiscal and economic development plans, and to addressing both near- and long-term challenges.”

The market continues to look for tangible evidence that the government not only has a plan but also is in a position to implement it. The concerns about its ability to successfully implement a value added tax and for the tax to achieve the projected collection levels are real. A well executed implementation would do more for the credit than the continued rhetoric of an aggrieved party.

The need for economic improvement was highlighted when it was announced that Puerto Rico government revenue missed estimates again in January by $18.8 million, increasing the revenue shortfall so far during fiscal year 2015 to $115.2 million. $699.5 million was collected in January, up $20 million from the previous year, but the $4.455 billion in net revenue through the first seven months of the fiscal year is still $183 million below what was collected during the same period last year. Corporate revenue of $54.1 million was $36.1 million below estimates and $39..8 million below last January, sales & use tax (IVU by its Spanish acronym) revenue of $91.4 million missed targets by $55.1 million and below the previous January by $500,000, and Act 154 revenue of $81.9 million was $54.1 million below revenue and $59.7 million off last January.

Individual income taxes rose by $47 million and nonresident withholdings were up by $109 million. An additional $62 million in revenue was collected in January as a result of the enactment of Act 238 of 2014, which extended the due date to make pre-payments at preferential rates on certain transactions, such as Individual Retirement Accounts (IRAs), retirement plans and other capital assets. Following the enactment of this law, taxpayers who were previously unable to make these pre-payments were able to take advantage of the law during the month of January.

Excise tax collection changes versus last year showed alcoholic beverage revenue was up by $8 million, tobacco products were down by $11 million and motor vehicles by $10 million. The Treasury secretary said he is preparing a new revenue estimate for the remainder of the fiscal year based on year-to-date collections and prevailing economic conditions. In order to close the $115 million gap, the secretary announced that as a preamble to the tax system overhaul, a bill (H.R. 2316) was introduced allowing the pre-payment of a special tax on certain transactions including taxes on corporate dividends for future distributions of accrued benefits and profits. It also allows for prepayments to  IRAs and Educational Contribution Accounts until March 31.


It hasn’t taken long for the Illinois fiscal drama to develop. Just days after it was issued the state comptroller, Leslie Munger, said Friday she would not follow an executive order by Gov. Bruce Rauner to hold up so-called fair-share union dues from nonunion workers. Ms. Munger, a Republican as is the Governor, said she would follow the guidance of Attorney General Lisa Madigan, a Democrat, who said that the fees are part of union contracts and that executive orders do not apply to offices outside the governor’s. Mr. Rauner, who appointed Ms. Munger, issued the decree on Monday explaining that it was unfair for 6,500 nonunion workers to pay dues to unions that engage in political activities — although the law already prohibits using fair-share dues on politics. He ordered the money taken from their paychecks to be held in escrow until a federal lawsuit he filed this week is settled. Union leaders contend that the fees are reasonable contributions from workers who, while choosing not to be union members, still benefit from collective bargaining agreements.

It was in front of this backdrop that the Governor made his budget proposal for FY 2016. In regards to pensions, the State currently offers two levels of pension benefits – one plan for those first hired before 2011 and another, more affordable plan for more recent hires. The Governor proposes legislation to put in a “freeze” on the level of benefits that employees hired before 2011 have earned as of July 1, 2015. For work after July 1, 2015, these employees’ newly earned benefits will be based on the plan that now applies to employees and officials first hired or elected after 2010. The key change in newly earned benefits will be moving to a lower cost-of-living adjustment (COLA). COLAs on benefits earned before July 1, 2015 would continue to be paid in retirement at 3 percent a year compounded. COLAs on newly earned benefits would be the lesser of 3 percent or half of inflation, non-compounding, and would begin later. The governor’s proposed reforms are projected  by him to reduce the state’s general-funds payments in the next budget year by $2.2 billion.

The Governor proposes to reduce the projected FY 2016 budget gap through employee benefit reform ($2.9B), reduced subsidies to other governments ($1.3B), medical provider rate reductions ($1.2B), reduced services ($0.8B), “operational efficiencies” ($0.2B), earmark eliminations ($0.1B), and moving citizens to health exchanges ($0.1B).  Tax increases not part of the formula. The proposals will be controversial. They include significant service reductions in Medicaid and payments to hospitals. Proposed employee benefit reductions  require legislation and survival of legal challenges in order to implement them.

We expect that the plan will run into significant political opposition from the full spectrum of interest groups both individual and governmental. We believe that it is unrealistic to expect that all of the proposed savings will be achieved and that the decline in the state’s relative creditworthiness will continue.


Medicaid is front and center in many budget debates across the country.  In Pennsylvania new Gov. Tom Wolf said that he would pursue a straightforward expansion of the Commonwealth’s Medicaid program for the poor, no longer charging premiums or limiting benefits for some enrollees. In Tennessee and Wyoming  bills to extend Medicaid to far more low-income residents under the law were defeated by Republican legislators, despite having the support of the states’ Republican governors. Expansion opponents do not believe the federal government would keep its promise of paying at least 90 percent of the cost of expanding the program. It currently pays the full cost, but the law reduces the federal share to 90 percent — a permanent obligation, it says — by 2020.

In Utah, Gov. Gary R. Herbert has negotiated a tentative deal with the Obama administration for an alternative Medicaid expansion but it is meeting with resistance in the state’s Republican-controlled Legislature. So far, 28 states have taken advantage of the federal funds offered through the health care law to sharply increase the number of adults eligible for Medicaid. Ten had Republican governors when they decided to expand the program, and supporters of the law hoped that the most recent, Indiana, would influence other holdouts to follow. Indiana’s governor, Mike Pence, is one of the most conservative yet he decided that accepting the federal Medicaid expansion funds — albeit with concessions from the Obama administration, like requiring many beneficiaries to pay something toward their coverage or be locked out of it for six months — was good policy.

Just after Indiana’s move, a similar plan from Gov. Bill Haslam of Tennessee went down to swift defeat by the vote of a State Senate committee. The Governor had called a special session for the Legislature to consider his plan, which he had spent months working out with the Obama administration. He had traveled the state to promote it — and persuade people that it was not part and parcel of the Affordable Care Act, partly because the Tennessee Hospital Association had agreed to pay any expansion costs beyond what the federal government covered.

In Florida, business leaders and hospital executives are pressuring conservative legislative leaders to consider alternative expansion plans in the session that starts next month. In Alaska, the new governor, Bill Walker, an independent, will try to convince state lawmakers to agree to expand Medicaid by the start of the new fiscal year on July 1. In Idaho, an alternative Medicaid expansion plan, put forth by a task force appointed by Gov. C. L. Otter may go before the Legislature in the next few months.


In November, shortly after Gov. Sam Brownback won re-election, some observers forecast that the state would bring in $1 billion less than expected over the next two years. His response was to cut state agency budgets and propose transferring of funds among various state accounts including moving funds intended for the state highway system to the general fund. In December came news of lower than expected revenue, some $15.1 million below estimates. Mr. Brownback proposed increasing taxes on liquor and cigarettes, slowed reductions in the income tax and changed the way money was distributed to public schools.

Revenue continues to disappoint: January receipts fell $47.2 million short of predictions, and Mr. Brownback has responded by cutting funding for public schools and higher education by a combined $44.5 million. The move has upset education officials across the state.  In one example, the Kansas City Public School District has received $45 million less in state revenue since 2009. A cut of 1.5 percent to public school funding statewide would amount to a loss of $1.3 million according to the District. The state has not paid the district $3 million for capital expenses required under a formula intended to help poor districts. Mr. Brownback has asked legislators to change that formula. The cuts come amidst a larger budget picture in which the governor has been forced to fill a $344 million budget gap for the fiscal year ending in June; a shortfall of nearly $600 million has been forecast for the fiscal year starting July 1. Many blame the state’s budget situation on the income tax cuts that the governor has ushered into law in recent years.

The governor has asked lawmakers to rewrite the formula used to provide aid to the neediest school districts. If the Legislature saves money by doing so, the governor says that it could restore the $28 million in cuts to K-12 public schools that he called for this month. The governor has also requested that lawmakers overhaul the means for financing schools in general. In the meantime, the state courts are addressing a lawsuit brought by a group of school districts and parents which asserts that the state has violated the Constitution by not providing adequate funding for education. In December, a state district court handed down a decision which said that Kansas schools were not adequately financed. That  decision was appealed before the state Supreme Court. If the court orders the state to increase spending, it could conflict with the cuts that the governor has ordered.


The first round of post-bankruptcy water rate changes for area municipal providers of water have been proposed. The Detroit Water Department is changing its billing practices to shift more of the cost of service to the fixed monthly fee. The new system will rely less on payments based on water use, which is subject to considerable variance. The wholesale rate increase will average 11.3% while Detroiters will pay about 3.4% more under the proposal. The potential for much larger increases for out of City customers was one of the factors that complicated negotiations over the proposed creation of a new regional water entity to finance the water system’s extensive maintenance-related capital needs going forward. According to data provided by the Detroit Free Press, most communities will see decreases in the cost of 1000 cubic feet of water but some will see increases of up to 14%.


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