Muni Credit News January 19, 2017

Joseph Krist

Municipal Credit Consultant








With high yield money being drawn back to below investment grade tax-exempts, one can hope that a recent trend in the high grade corporate market translates to the municipal market. Investors recently stood fast on three investment-grade bond deals that tried to include more issuer-friendly terms. Most prominently, borrowers were forced language in new bond offerings that would have spared them from paying a make-whole premium in the event of a default (from a simple covenant breach to actual bankruptcy). The three borrowers were chipmaker Broadcom, auto lender General Motors Financial and Brazilian paper company Fibria. In addition, one junk-rated borrower, Novolex,  removed similar language from a bond for its buyout from Carlyle this week.

The action came as Moody’s Investors Service says  the covenant quality of North American high-yield bonds strengthened marginally in the final month of 2016. Moody’s Covenant Quality Index uses a five-point scale, in which 1.0 denotes the strongest covenant protections and 5.0, the weakest. The Covenant Quality Index (CQI), a three-month rolling average, strengthened to 4.19 in December from 4.20 in November, and in so doing moved out of weakest-level territory for the first time since April.  Moody’s said “High-yield bond covenant protections are just above weakest level as we enter 2017.”

Make-whole premiums have long been a sought after term for corporate and corporate backed municipal investors. It allows them to recoup all the payments they expected when first buying the securities if those securities are redeemed early.  They have appeared in natural gas prepurchase and military housing transactions. Last year some borrowers inserted language to prevent investors from demanding these payments if a company defaults. In times of low rates leading some to “chase yield”, borrowers push the envelope to see how much they can get away with. Two US court rulings last year appear to have changed market perception of what those limits may be when it comes to the premiums in question.

In a ruling against pawn shop operator Cash America, the court ordered the company to pay a make-whole premium to bondholders because the sale of the majority of a wholly owned subsidiary violated covenants in its bond indenture. Another court ruled in a case involving Energy Future Holdings ( a well-known name in the muni high yield market) that a company must pay a make-whole if notes are repaid in a bankruptcy.

Davis Polk has taken a position that investors have “traditionally understood” they are not due a make-whole premium when faced with a company’s default or bankruptcy. But, there is a distinction between events of defaults such as covenant breaches (in which case investors clearly do expect to be made whole) and actual bankruptcies (in which investors may have little choice but to accept losing money).

For the high yield muni market, an ability to fight for strong covenants is always in its interest. The average Moody’s scores for bonds rated Ba, single B and Caa/Ca were all weaker than 4.0. Now that rates have been trending upward, it is important that investors take advantage of whatever leverage they have.


Hospital executives in Illinois recently argued before the state Supreme Court to maintain not-for-profits’ property tax exemption. The arguments were in a case brought by the city of Urbana and other taxing bodies who believe that a local hospital, Carle Foundation Hospital, should pay property taxes.

Illinois passed a law in 2012 exempting not-for-profit hospitals in the state from paying property taxes so long as the value of their charitable services was equal to or greater than their tax liabilities. But local governments say the state’s hospitals are profitable enough to exceed that test and therefore should contribute their share of taxes to help fund municipalities. The state constitution only allows such exemptions if the property in question is used exclusively for charitable purposes, they say. The attorneys for the taxing bodies in Illinois argue that the 2012 law goes beyond the constitutional statute by assigning a value to the exemption, which is that hospitals can be exempt if their charitable services are at, or exceed, the value of what it would pay in property taxes.

The challenge to the resulted in the Illinois 4th District Appellate Court last year ruling that the law was unconstitutional. In the state Supreme Court, some of the justices questioned whether the Illinois 4th District Appellate Court had the jurisdiction to consider the case. The justices also questioned whether they should instead on another upcoming case, Oswald v. Hamer, ruled the law exempting hospitals from paying property taxes as constitutional.

Charitable purposes has been interpreted to mean that hospitals provide care to patients regardless of their ability to pay. Carle argued that it’s charitable services far exceed what it would pay in yearly property taxes. Carle estimates that it paid some $20 million in property taxes from 2004 to 2011. Carle contends it provided $30.6 million in charity care in 2015, according to the hospital. The Illinois Health and Hospital Association filed an amicus brief in August 2016 supporting Carle Foundation as did the American Hospital Association on behalf of Carle.

There are approximately  150 not-for-profit hospitals in Illinois. A decision in the case is expected in coming months.


We’re not sure it helps but Gov. Ricardo Rosselló’s representative before the fiscal oversight board stated that the lack of payment between agencies and the “internal liquidity game” to claw back funds from certain government entities to correct general fund deficiencies hinder the process of certifying the government’s real deficit. So said the summary of the final transition report presented to a group of legislators and heads of agency at the Puerto Rico Convention Center. This has caused the deficit to range between $6 billion, as confirmed by the incoming Transition Committee, to more than $7 billion, as the Fiscal Oversight and Management Board established by the Promesa law claims.

If no action is taken to correct this and other governmental deficiencies, there could be a government shutdown and even a “total collapse” of the government, said the representative before the fiscal oversight board. He highlighted the lack of good data. “There is an indisputable reality: The Puerto Rico government’s numbers are still a great mystery…. I predict that if Puerto Rico does not make a dramatic adjustment in the coming months, it could experience a total collapse. If it does not make the corresponding adjustments, there could even be a [government] shutdown,” the incoming Transition Committee president said during a press conference Tuesday.

In addition to this situation, the report details other findings that will be sent to the Governor’s Office, the Office of the Comptroller and the Legislature should an in-depth investigation and corresponding action be decided on, Sánchez said. The official suggested that this final transition report will justify the public policies to be established during the government’s initial months—which include the controversial labor reform being decided on in the Legislature or the fiscal plan that the government must submit shortly.

“Everything that is not essential must be cut because the crisis is real. And what agencies will face is a challenge never seen before and maybe in a few weeks we will find out just how severe things could be here due to the negligent actions of the outgoing administration,” he said. In the absence of a protocol to define what is essential in the government. Sánchez said a group of attorneys was asked to discuss, together with the fiscal board, what will be defined as essential for the Rosselló administration. “The challenge falls on the current leadership to make budget adjustments, make whatever cuts are necessary to guarantee essential services, to guarantee public servants and to protect pensions that are in a very delicate situation today,” he said.

The findings include a deficit of more than $230 million at the Department of Education, primarily for failing to pay rent to the Public Buildings Authority, the more than $500 million owed by the Highway and Transportation Authority (HTA) to its suppliers and the more than $1.4 billion in losses over four years at the Puerto Rico Electric Power Authority (PREPA). In the case of the Government Development Bank (GDB) the situation is critical: “It does not have a treasury [division]. It does not have the capacity to operate as a bank,” Sánchez said. He added that after deposits were frozen through the Moratorium Law, the GDB is exposed to fines for also having frozen federal funds.

The report also questioned $6 million spent on the Energy Commission “without producing any benefits for the population.” There is a $1.9 billion deficit in the Infrastructure Financing Authority  caused by the transfer of HTA debts—which had to be paid off with a multimillion-dollar bond issuance that never took place—and the Metropolitan Bus Authority  has accumulated a deficit of more than $98 million. The Authority, however, acquired 25 new vehicles that do not feature handicap ramps or fare processors, Sánchez said.

Other findings criticized the lack of payment of the University of Puerto Rico’s (UPR) debt despite “having the funds” to do so and the investigations for alleged corruption in the Labor Development Administration and the Puerto Rico Aqueduct and Sewer Authority (PRASA) following the case of former Popular Democratic Party (PDP) fundraiser Anaudi Hernández. As for the Fire Department, 125 positions were appointed without having the $3.25 million needed to pay for them.

These kinds of details give additional credence to the narrative that Puerto Rico’s problems are more intractable than thought. They increase the pressure on creditors to relent and accept more onerous terms of restructuring than is already the case. This while building additional justification for the view that the situation reflects gross mismanagement and political failure for which the creditors could not be responsible.


The Congressional Budget Office and the staff of the Joint Committee on Taxation (JCT) prepared at the request of the Senate Minority Leader, the Ranking Member of the Senate Committee on Finance, and the Ranking Member of the Senate Committee on Health, Education, Labor, and Pensions released its estimate of How Repealing Portions of the Affordable Care Act Would Affect Health Insurance Coverage and Premiums.

Here is some of what they said. “The number of people who are uninsured would increase by 18 million in the first new plan year following enactment of the bill. Later, after the elimination of the ACA’s expansion of Medicaid eligibility and of subsidies for insurance purchased through the ACA marketplaces, that number would increase to 27 million, and then to 32 million in 2026. That first year increase in the uninsured population would consist of about 10 million fewer people with coverage obtained in the nongroup market, roughly 5 million fewer people with coverage under Medicaid, and about 3 million fewer people with employment- based coverage.

The Restoring Americans’ Healthcare Freedom Reconciliation Act of 2015, H.R. 3762 would make two primary sets of changes that would affect insurance coverage and premiums. First, upon enactment, the bill would eliminate penalties associated with the requirements that most people obtain health insurance (also known as the individual mandate) and that large employers offer their employees health insurance that meets specified standards (also known as the employer mandate). Second, beginning roughly two years after enactment, the bill would also eliminate the ACA’s expansion of Medicaid eligibility and the subsidies available to people who purchase health insurance through a marketplace established by the ACA.

H.R. 3762 also contains other provisions that would have smaller effects on coverage and premiums. Insurers who sell plans either through the marketplaces or directly to consumers are required to: provide specific benefits and amounts of coverage; not deny coverage or vary premiums because of an enrollee’s health status or limit coverage because of preexisting medical conditions; and vary premiums only on the basis of age, tobacco use, and geographic location.

Eliminating the penalty for not having health insurance would reduce enrollment and raise premiums in the nongroup market. Eliminating subsidies for insurance purchased through the market- places would have the same effects because it would result in a large price increase for many people. Not only would enrollment decline, but the people who would be most likely to remain enrolled would tend to be less healthy (and therefore more willing to pay higher premiums). Thus, average health care costs among the people retaining coverage would be higher, and insurers would have to raise premiums in the nongroup market to cover those higher costs. CBO and JCT expect that enrollment would continue to drop and premiums would continue to increase in each subsequent year.

After weighing the evidence from prior state-level reforms and input from experts and market participants, CBO and JCT estimate that about half of the nation’s population lives in areas that would have no insurer participating in the nongroup market in the first year after the repeal of the marketplace subsidies took effect, and that share would continue to increase, extending to about three-quarters of the population by 2026. That contraction of the market would most directly affect people without access to employment-based coverage or public health insurance.”

So those are nonpartisan facts. As individuals begin to absorb these facts, there has been an initial backlash. It has become clear to residents and clients of rural hospitals that their local institutions are directly and negatively impacted by repeal. The ACA expanded Medicaid to tens of thousands of previously uninsured patients, providing new revenue streams for rural hospitals, which often serve a poorer, sicker patient population. The law also created a program that allowed some of these facilities to buy prescription drugs at a discount. So repeal creates real problems.

For example in Pennsylvania, 625,000 people enrolled in the expanded Medicaid program. Close to 300,000 came from rural areas, according to the Hospital and Health System Association of Pennsylvania. As of October, about 42,700 of Fayette County PA’s residents had Medicaid, according to state data, an increase of about 8 percent from 39,460 in June 2015. (Pennsylvania’s Medicaid expansion took effect in January of that year.) That’s close to one-third of the county’s population.

So the potential for real impacts are apparent. Lack of coverage or the perception of lack of coverage will cause real problems for rural and community providers and the patients they serve. Republicans know this hence the emphasis even during the current confirmation process of the HHS secretary nominee by them that the implementation of the terms of repeal will be over an extended period. All this does is create great uncertainty and instability for the sector. This can only be negative for those institutions and their creditworthiness.

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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