Muni Credit News January 17, 2017

Joseph Krist

Municipal Credit Consultant

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THE HEADLINES…

ADIOS CHARGERS

STATE OF THE STATES

DALLAS RATINGS HIT ON PENSIONS

CALIFORNIA DROUGHT SEES SOME RELIEF

BAYOU BUDGET BLUES

ILLINOIS TRYS AGAIN

CYBERSECURITY AN ISSUE BUT NOT YET A DISCLOSURE ISSUE

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ADIOS CHARGERS

In the grand scheme of things, the announced departure of the San Diego Chargers for Los Angeles doesn’t amount to much as a municipal credit event. If anything, it may be a positive for the city. The team’s presence ranked very low in terms of impact on things like hotel occupancy and restaurant patronage versus the league’s other teams. The winter climate certainly won’t change because the team left. And the city had seen the team make only one Super Bowl appearance in its history since when it moved to San Diego from yes, L.A. in 1961.

The Chargers have a contract with the City of San Diego to play at Qualcomm Stadium that runs through the 2020 season. They have a four-month window that begins Feb. 1 and ends May 1 to opt out of the team’s lease at Qualcomm Stadium. By ending the lease early, they will pay the City $12 million for the buyout. Now that they are leaving, Mayor Kevin Faulconer has proposed increasing the city’s hotel room tax via a public ballot measure in 2018, to finance a long-sought expansion of the San Diego Convention Center. The exact percentage amount, a project financing plan and other details would need to be determined through upcoming discussions involving the Mayor’s Office, City Council, the Port of San Diego, and hotel and tourism officials.

California law requires that tax hike measures geared to raising money for specific projects obtain at least two-thirds support of voters. This the same standard which this past November’s initiative had to meet. Guests at San Diego hotels currently pay a 10.5 percent transient occupancy tax, which goes to the city’s general fund for basic services; plus a 2 percent assessment that goes specifically toward local tourism programs.

Officials of San Diego Tourism Authority and San Diego Convention Center Corp. quickly voiced support for the mayor’s proposal, noting that events at the waterfront facility generated $1.1 billion in regional impact and $23.9 million in hotel and sales tax revenue during the past fiscal year. Officials said an expansion is needed to attract and retain large gatherings. The latest effort to expand the facility dates back around five years, and the latest cost estimate is $520 million. The project’s original funding plan was struck down by the courts, and a decision is pending in another case challenging the project’s 2013 approval by the California Coastal Commission.

I’m looking really hard for the credit downside here but I’m having a really hard time finding it. And as for public stadium financing, L.A. gets two teams with limited cash outlays and Las Vegas’ hockey team will play in a privately financed arena. There’s at least one sector where the private approach may start a trend. We do note that stadium construction is one item that supposedly fits into President trump’s idea of infrastructure.

STATE OF THE STATES

A State of the State address is often the vehicle by which many governors effectively make their initial budget proposals. Just two weeks after advising the incoming Trump administration to follow his failing tax cut policy for economic development, Gov. Sam Brownback  of Kansas supported an increase in alcohol and tobacco taxes and proposed taking more money from the State’s highway fund to help avert a projected shortfall of more than $900 million over 18 months. Well that’s at least one approach to infrastructure.

Showing a real sense of vision and responsibility as he approaches the back end of his term limited tenure (not really), he also supported a plan to liquidate a long-term investment fund and sell off the state’s future payment stream received under the Master Settlement Agreement from tobacco companies to get cash now. While emptying the tool box of one time revenues, he wants to preserve a key income tax exemption for certain businesses that a growing number of lawmakers seek to repeal. The state receives approximately $60 million annually from the MSA. Under Brownback’s plan, the state would forgo that payment in the next 30 years in exchange for cash now — an estimated $530 million over two years.
Yet another proposal that puts paid to the theory of supply side economics at least in Kansas, is a proposal to increase taxes by $377 million over two years. He would double the tax on liquor in July to 16 percent and increase the tax on cigarettes by one dollar a pack to $2.29. He also would double the tax rate on other tobacco products to 20 percent. Brownback tried to get a similar tax increase for cigarettes and a liquor tax of 12 percent enacted in 2015. The Legislature approved a 50-cent-a-pack increase for cigarettes that year. Another crack in the theory is reflected in the proposal by the governor to freeze the income tax rate for the lowest tax bracket at 2.7 percent instead of letting it drop to 2.6 percent in 2018.

He still apparently considers his income tax exemption for limited liability companies, S corporations and other closely held businesses to be untouchable. Many legislators would support repeal. Repealing the exemption entirely would bring in about $250 million. He  also proposed taxing rents and royalties to bring in $40 million a year. At the same time he would  increase the annual filing fee for for-profit entities from $40 to $200.

Under these proposals, the governor’s office estimates, the state would have $216 million in its general fund at the end of June 2018. To fill the current fiscal year’s shortfall of more than $340 million, Brownback wants to liquidate the state’s long-term investment fund. The state invests idle funds from state agencies every year. The governor can unilaterally use some $45 million from the fund, which represents investment profits, but will need the Legislature’s approval to take $317 million in principal. Brownback proposes paying back the fund over seven years.

Once again, the governor also wants to freeze the state’s contribution to KPERS, the state employees’ pension fund, at 2016 rates, which would allow it to keep $85 million. Under that plan, it would take another 10 years to pay down the state’s unfunded pension liability. If lawmakers agree to these proposals, the state would have roughly $99 million in its general fund at the end of June. If he succeeds in reducing liquidity, increasing unfunded pension liabilities, and increasing one shot revenues, it is hard to see how the State’s ratings can be maintained.

DALLAS RATINGS HIT ON PENSIONS

The City of Dallas saw S&P downgrade the City’s general obligation bonds from AA to AA-, with a negative outlook. S&P also downgraded the Dallas Convention Hotel Development Corporations bonds from A to A-, with a negative outlook. S&P affirmed its A rating for the Downtown Dallas Development Authority, with a stable outlook.  S&P said that despite the City’s broad and diverse economy, which continues to grow, stable financial performance, and very strong management practices, the continued deterioration in the funded status of the Dallas Police and Fire Pension negatively affects the City’s creditworthiness.

The City’s official response came from Chief Financial Officer Elizabeth Reich: “S&P’s actions today are not a surprise.  The more the rating agencies learn about the crisis facing Dallas as a result of the police and fire pension, the more they understand what the City has been saying for some time – the pension is a significant risk to the fiscal health of the City.” Legislature to provide a secure, stable retirement for our public safety workforce, and to reaffirm the City’s sovereign immunity.  Our plan to save the pension does not request state funds.  We will continue to work to reach agreement with the Pension system.

“Dallas is a thriving City, our economy is strong, and our residents want safe neighborhoods and effective City services.  The taxpayers are willing to contribute to this fix, but unless the Legislature gives the City the tools to fix its pension issues, massive tax hikes, continued street deterioration, and drastic reductions in all other City services would be the only way to resolve the pension crisis without seeking Federal judicial relief.”

What we find most interesting is that the CFO statement essentially parrots what regular MCN readers have already been told since the early fall of 2016. We are glad to see those viewpoints affirmed. As we have said, there is much pressure on the state legislature to pass enabling legislation to facilitate the changes which must be made to maintain credit quality.

CALIFORNIA DROUGHT SEES SOME RELIEF

It may be hard to appreciate if your home is one of the ones in the photos of flooded ones but the Golden State seems to have received some real water supply relief from a recent combination of huge snow and rain events. Water came to many areas of the West due to this week of moisture-laden Pacific storms and an already wet Water Year (WY). California was the greatest recipient of drought improvements this week. With more than 2 inches of precipitation falling from southwestern Washington southward to Los Angeles, CA, including over a foot along the northern and central California coast and on the Sierra Nevada range, significant increases were made to the capacity of the state’s major reservoirs as most were above the normal Jan. 10 historic levels and still filling with most USGS monitored streams at near or at record high flows.

The state’s Sierra snow water content (SWC) was also well above its Jan. 10 normal, with the north (13.5”, or 111%), central (16.9”, or 130%), and south (17.9”, or 171%) producing a state average of 16.2”, or 135%. The Northern Sierra, San Joaquin, and Tulare basin station precipitation indices all exceeded their wettest year (1982-83; 1968-69 for Tulare) as of January 10 with 41.9 (203%), 30.8” (199%), and 20.0 (190%) inches, respectively. In fact, the Northern Sierra index gained 13.2 inches since Jan. 1, or 26% of its ANNUAL average in 10 days. Oroville Reservoir started the New Year with a deficit in its conservation pool of 750,000 acre-feet, but has gained 350,000 acre-feet in the past 2 days. Since northern portions of California also benefited from a decent Water Year last year, 1- to 2-category improvements were made.

In contrast, with long-term drought impacts more severe and widespread in southern sections since the 2015-16 WY marked its fifth consecutive year of drought, only a 1-category improvement was made to most areas since above ground (reservoirs) and underground (wells) water supplies still lagged below normal. And in southern Santa Barbara, Ventura, southern Kern, and northwestern Los Angeles counties, drought levels remained intact as the WYTD has been below normal while hydrologic impacts lingered. For example, Lake Cachuma (205,000 acre-feet facility) currently has 16,386 acre-feet, including a measly 191 acre-feet gained during the past 2 days. Lakes Casitas and Piru in Ventura County and several reservoirs in Los Angeles County are still well below normal and have not received any recharge. Lastly, even with the rains, no stream flows have been generated in the Santa Ynez, Ventura, and Santa Clara watersheds.

BAYOU BUDGET BLUES

Last week it became apparent that a special session may be just around the corner for the legislature in Louisiana. The state lawmakers embraced a reality they avoided a month ago. The state is short $313 million for the current fiscal year, which ends on June 30th. State economists say the state’s still struggling economy is fueling the shortfall as the state has lost jobs each month since last August. As a result, income tax and sales tax are generating less money for the state than expected. Corporate tax returns are also down.

The Governor’s office is preparing for an emergency special session to address the budget mess, saying the state constitution restricts what can be cut outside of a special session. Governor Edwards, a Democrat, and others have been discussing the potential need for a special session for several weeks, even as some Republicans have downplayed the prospect of one. Edwards said he believes a $300 million or more deficit would automatically trigger the need for a special session because it would exceed the amount he is able to cut from the budget on his own.

One advantage of a special session is that it would allow more flexibility in. “I’m confined to a narrow spectrum of the budget as to where I can make adjustments,” Edwards said, referring to the legal framework for how to handle balancing the budget when legislators are not officially meeting. “If we have a special session, every part of the budget, including the judiciary and legislative budget can be opened up. That’s a much more responsible approach than just hammering the hell out of higher education and health care.”

The problem comes despite the fact that Edwards and lawmakers have made $850 million in cuts to the state budget over the past year. The Legislature also increased the sales tax to generate $1.2 billion in additional revenue and approved an increase in the cigarette tax during the special sessions. A panel that sets the state’s revenue forecasts will ultimately decide the size of Louisiana’s latest fiscal hole, based on advice from the state’s economists.

ILLINOIS TRIES AGAIN

There are signs that the Illinois legislature is trying to create the framework for a “grand bargain” to resolve the existing standoff between it and the Governor. Some of the aspects include an increase in the personal income tax rate from 3.75 percent to 4.95 percent, a plan to generate $4.1 billion a year. With spending cuts, Democrats argue, that could eliminate what the governor’s office estimates will be a $5.3 billion deficit on the June 30 end of the fiscal year. There would also be an unspecified amount of borrowing to pay down debt. In actuality it is borrowing for operations. The legislation would allow Illinois to borrow $7 billion by selling bonds to pay off overdue bills, which on Friday totaled $10.7 billion. The loan would get the state back to paying vendors and service providers within 30 days of receiving their bills.

The plan includes $694 million to cover expenses for the first half of 2017 for seven agencies, including prisons and the Human Services Department. A six-month, temporary budget agreed to last summer expired Jan. 1 and the state is back to operating without appropriations. The deal would eliminate pensions for future legislators. It aims to save up to $1 billion a year by offering what House Speaker Cullerton has termed “consideration” — essentially a choice between how future pay raises figure into retirement income or whether pensioners receive cost-of-living adjustments in retirement. The measure would move Chicago’s responsibility for paying the employer’s portion of teachers’ pensions to the state — a $215 million obligation for 2017 alone. That would remedy a long-running complaint about fairness, since the state already picks up the employer share for teachers outside the city.

The bargain would again look to gaming for revenue. It would create a land-based casino in Chicago and add riverboat casinos in Lake County, Rockford, the south suburbs of Chicago, Danville, and in Williamson County, in southern Illinois, as well as giving horse racing tracks a piece of the action by permitting slot machines at Arlington Heights, Cicero and Collinsville.

In a nod to labor interests, Democrats have argued they made important changes to the injured-workers program in 2011 and that the insurance industry hadn’t caught up to those cost-saving measures. This plan would further restrict claims when injuries are accidents, set maximum compensation rates, and limit physical therapy, among other things. The minimum wage would be raised from $8.25 an hour to $9 on July 1, then by 50 cents each year until 2021, when it will be $11. According to the U.S. Labor Department, the wage exceeds $8.25 in 21 places outside Illinois, including the District of Columbia, which is highest at $11.50.

CYBERSECURITY AN ISSUE BUT NOT YET A DISCLOSURE ISSUE

LADWP is in the process of issuing half a billion dollars of revenue bonds. So given the interest in the subject over recent days and weeks, we took a glance at the POS for a discussion of cybersecurity as an issue for investors to consider. Given the potential damage such an act could o to distribution capabilities, we would think that it could have financial risk implications at least equal to natural disasters or litigation related to dairy cows.

So we were a little disappointed to see in the discussion of factors affecting the electric industry only a five word reference to terrorism or cyberterrorism. We did not expect a truly extensive discussion but the lack of any is part of why we choose to focus some attention on it. We will continue to do so on a regular basis. We’d like to think that is would not require a major disruptive event to focus concern about it among investors. And we think that the risk (because it is truly unknown) is right up there with natural disasters that folks seem to take a bit more seriously.

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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