Muni Credit News January 14, 2016

Joseph Krist

Municipal Credit Consultant

The first week of January usually is the start of the upcoming fiscal year budget cycle. The most visible sign is the release of the Governor’s preliminary budget proposal in California. This year is a bit different as two of the largest states – Pennsylvania and Illinois – have yet to complete the enactment of budgets for the current fiscal year ending July 1, 2016.


The adoption of a partial budget in Pennsylvania has reduced some of the cash flow pressure on the Commonwealth’s school districts. The action has shifted attention to the Commonwealth’s own cash position. In a move that only the very weak state credits employ, the Commonwealth has announced a plan for the General Fund to borrow from other state funds to finance a potential negative balance of $922 million after the governor’s line-item veto of a budget plan allowed its expenditure.

The Treasury has announced the creation of a $2 billion line of credit to cover expenses of the Commonwealth’s General Fund. The $2 billion credit line is the largest ever extended by the Treasury to cover General Fund expenses, exceeding the second-largest credit line of $1.5 billion extended in September 2014. The announcement Particularly noted the public school subsidy being withheld during the Commonwealth’s ongoing budget impasse until the partial budget plan was signed last week, the Treasury noted the General Fund’s balance was artificially inflated and, without the loan, would have fallen into a likely negative balance until the tax revenue collection spike in the spring.

As of last week, the Wolf administration has borrowed $1 billion of the available funds to cover expenses. The funds were borrowed from Treasury’s cash investment “Trust 99” fund and any borrowed funds will carry a 0.6 percent interest rate, which is lower than the Commonwealth could have obtained in the private sector while also allowing Treasury to make a positive gain for taxpayers when the loan is paid back.

The credit line also had to be approved by Auditor General Eugene DePasquale, who noted the credit line is necessary due to the Commonwealth’s structural deficit. “This is the second consecutive year the state hit a cash flow problem and needs to borrow money halfway through the fiscal year. As I said 16 months ago, the need to borrow money this early in the fiscal year is a strong indicator that the commonwealth’s unsustainable structural budget deficit continues to grow,” he said. “The long-term structural budget deficit and this year’s budget impasse should be a wake-up call to everyone involved that it is time to come to a resolution on these critical issues.”

The Commonwealth will have to repay the loan by June 30, 2016.


With so much attention devoted to Puerto Rico’s default and budget standoffs in Illinois and Pennsylvania, it is easy for some more familiar weak fiscal performers to get lost in the noise. One of those is perennial credit laggard Louisiana. Louisiana’s budget woes are even worse than the incoming administration of Governor-elect John Bel Edwards had anticipated. The shortfall for the fiscal year ending in June 2016 is estimated at $750 million. The chief fiscal adviser to the Governor said that the administration has not settled on a plan for fixing the problems with the current fiscal year’s $25 billion budget, but it has not ruled out tax increases, which would need legislative approval.

New revenue estimates showed a continuing drop in oil prices and a slump in collections from corporate income taxes and sales taxes. He said a $1.9 billion shortfall is estimated for the next fiscal year, which starts in July. The departing governor, Bobby Jindal, a Republican who mounted a failed presidential bid, refused to support anything he considered a net tax increase and leaned on short-term budget fixes.


As we have predicted in earlier discussions of the Puerto Rico credit situation, litigation has been filed to test the validity of the “clawback” provisions supporting general obligation debt of the Commonwealth. Two insurers of Puerto Rican bonds that are now in default sued the governor and other senior officials on Thursday, saying they had illegally diverted money from some creditors so they could pay other creditors in full. Assured Guaranty Corporation and the Ambac Assurance Corporation said in their complaint that Puerto Rico had diverted at least $163 million that had been pledged to pay debts they had insured. Those debts were in the form of municipal bonds issued by three governmental authorities on the island.

The governor responded that the litigation was a sign that a dreaded “race to the courthouse” had begun, leading to “litigation pandemonium” as different creditors sought to enforce their claims on the island’s resources. He called on Congress to enact legislation that would give Puerto Rico the ability to take shelter in bankruptcy, where such creditor litigation would be automatically stayed. “With no legal framework to handle this impending litigation crisis, both the Commonwealth and its creditors will soon face the opposite of due process and rule of law,” Mr. García Padilla warned.

Last week, the governor confirmed the use of at least $163 million — slightly less than the earlier reported $174 million — to help make a large payment due Jan. 1 to investors who hold Puerto Rico’s general obligation bonds. That type of bond is given the highest payment priority by the Puerto Rican constitution. Mr. García Padilla diverted the money by issuing an executive order on Nov. 30, starting what is called a “clawback” of funds from lower-priority bondholders.

Assured Guaranty and Ambac contend that the clawback was unconstitutional, because it “substantially and unjustifiably” impaired their contract rights under the United States Constitution. They also said they had constitutionally protected property interests in the money, because they held liens on the pledged funds. They acknowledged that their liens were subject to being paid after the general obligation bonds, but said the use of the clawback was still unlawful under the circumstances, “namely, where other available resources exist from which the public debt could be paid.”

The two insurers asked the court to declare the clawback unconstitutional and bar the Puerto Rican government from diverting any more pledged money. Their suit was filed in United States District Court in San Juan. The three public authorities whose bonds have been affected by the clawback are the Highways and Transportation Authority, the Convention Center District Authority and the Infrastructure Financing Authority. Holders of those bonds received some of the principal and interest payments due Jan. 1, from debt service reserves, which is considered a technical default. The Infrastructure Financing Authority did not have reserves in place to make the payment, and Ambac stepped in and provided $10.3 million.


The troubles of Puerto Rico and Detroit have overshadowed the more traditional sectors prone to default in our market. In a more typical situation, the village of Lombard, a Chicago suburb, wants bondholders to agree to a proposed restructuring of its $190 million of hotel/conference center debt. The village has since January 2014 not paid on its pledge to cover revenue shortfalls needed to avoid defaults on a portion of the bonds issued to finance construction of the Westin hotel. The restructuring proposal was made to bondholders in October but disclosed publicly only in December. It would cancel $29 million of unsecured C series 2005 bonds.

A exchange has been offered to holders of $64 million A-1 series, $54 million A-2 series, and $43 million B series, each of which carries different security.

The restructuring was initiated by ACA Financial Guaranty Corp. — which backstops $19 million of the $54 million series — and Lombard officials. If they can convince bondholders to agree to the new capital structure, it could lead to a resolution through a consensual bankruptcy filing by debt issuer Lombard Public Facilities Corp., according to documents and city officials. Under the restructuring proposal, the Lombard Public Facilities Corp. would retain ownership of the project. Without a restructuring, the Series A and B bondholders have a mortgage claim if the project were to declare bankruptcy.

Like other suburban hotel credits relying on corporate conference events in various sections of the country, the property has long failed to generate the revenue needed to support its debt. It includes a 500-room hotel, two restaurants, 39,000 square feet of meeting and convention space, a 25-meter indoor swimming pool and fitness center, and a 675-car, four-story parking deck. Village officials are promoting the plan as a means to align hotel revenues with debt repayment while also preserving the hotel’s business prospects. The hotel is operated by Westin Hotels & Resorts, part of Starwood Hotels & Resorts.

“Given market conditions, the hotel’s operational and financial performance and its inability to service the existing capital structure, a comprehensive restructuring is needed to preserve asset value and maximize bondholders’ return,” the plan reads. “If a restructuring plan is not undertaken to solve the default, the asset’s value may further deteriorate, including the potential loss of the Westin brand.” The hotel’s capital needs are increasing with few resources to cover upgrades because its revenues now go primarily to repay the bonds.

As part of the restructuring, the village would contribute $2.5 million for capital work at the hotel and be freed of further obligations on the debt. Lombard has seen its bond rating negatively impacted as the otherwise affluent village saw S&P lower Lombard’s credit rating six notches to a speculative-grade B from BBB in February 2014. Lombard’s previous refusal to make up shortfalls came ahead of a July debt service payment when it declined to cover a $2.6 million gap. The trustees have long taken the position that the village is not legally obligated to burden its taxpayers. The Lombard Public Facilities Corp. drained reserves to cover the Jan. 1, 2015 payment on the A series which carries an indirect appropriation pledge.

Like many project refinancings, coupon rates and maturities would be adjusted to better match operating realities. In this case, the A-1 bonds would be broken into a “hard” and “subordinate” series with $32.7 million paying an interest rate of 5.25% and carrying a 30-year term and a $32.7 million subordinate series also paying 5.25%, but with a maximum term of 55 years. The A-2 series would be similarly divided, with $27.3 million paying 5.25% and a 30-year term, and a subordinate $27.4 million piece paying a rate of 5.25% with a maximum term of 55 years. The B series would be divided into an $18.5 million tax revenue bond series with an interest rate of 3% and a 30-year term and a subordinate $28.1 million series paying 3% with a maximum 55-year term.

The A-1 bonds paid initial yields of between 6% and 7% on term bonds due in 2015 and 2036. The A-2 bonds paid yields between 4.11% and 4.8% with the final maturity in 2036. The B bonds paid initial yields between 4.125% and 4.59% on the final maturity in 2036. The plan argues that additional benefits of the new structure include the maintenance of bondholder claims and of the bonds’ tax-exemption, and the creation of marketable and tradable securities.

The July 1 default marked the fourth default on the $43 million B series that carries the village’s appropriation pledge. No payments have been made on $29 million of C series bonds. The January 2014 default marked the first actual payment default and it gave bondholders of the A and B bonds the right to accelerate repayment but they have not done so.

Originally, the village pledged — subject to appropriation — to cover debt-service shortfalls on the Series A bonds before reserves are tapped. The backstop was first triggered in 2012. The B series carried a more direct appropriation pledge but reserves were tapped first before the village was asked to cover shortfalls. The village in 2013 tried to issue a $10 million new-money issue of certificates but investors showed no interest in a non-general obligation debt that would have been secured by any legally available and appropriated funds. Property tax caps limit the non-home rule village’s ability to use a GO pledge. Lombard has no near-term borrowing needs for capital expenses.

The restructuring marks the second attempt by the village to get bondholders to agree to a plan that giving the project more breathing room. A proposed tender of the Series A and C bonds that asked holders to take a loss in 2011 failed due to bondholders’ competing interests.

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