Muni Credit News July 21, 2016

Joseph Krist

Municipal Credit Consultant

PHILADELPHIA BUDGET STORY

Philadelphia will be getting lots of attention later this summer as the site of the Democratic National Convention. The City hopes that the event will draw positive attention to many aspects of local development which have occurred in the three decades since the City reached its nadir as a center of urban decline and mismanagement. In the interim before the convention, we get a chance to view the outlook for the City’s near term finances.

City Controller Alan Butkovitz this week recommended that the Pennsylvania Intergovernmental Cooperation Authority (PICA) accept the City’s FY2017-2021 Budget Plan. The budget submission highlighted areas of concern about the City’s financial future. One is the newly adopted Sugary Drink Tax, a contentious point of revenue development for the City.

The City estimates that $416 million will be collected over the five years, before additional costs for collection, advertising and auditing.  The City has indicated that the revenues from the Sugary Drink Tax will fund three major initiatives: expanded Pre-K, community schools, and debt service for Rebuilding Community Infrastructure program when those programs are fully funded.

At the same time, opposition to the tax from producers as well as consumers is expected to move from the political arena to the legal front. The Controller acknowledges that PICA must be mindful of any litigation that could occur from critics of the Sugary Drink Tax, who have vowed court challenges against the tax. “While no litigation has been initiated, the outcome of such litigation could significantly affect the forecasted revenues and obligation amounts over the life of the Plan,” admits the Controller.

The Plan also comes up short in the area of labor costs. The City Controller’s analysis also indicated that the Plan does not include any potential costs above $200 million in obligations for future labor agreements over the five years.  AFSCME DC 33 and DC 47 Local 810 Courts are currently in negotiations. “The City would be responsible for identifying additional funds to cover any costs above the budgeted amount,” said the Controller.

GREEN BONDS

As the municipal market continues to evolve, new classifications of bonds have been developing to meet the needs of specialized investors. The mutual fund industry has been familiar with primarily equity funds that advertise themselves as socially responsible investors. They allow individuals with strong political or ethical beliefs to participate in the investment markets without feeling as if they have compromised those values.

This trend has expanded into the municipal market. There are funds and fund sponsors who practice “green investing” through our market. in response, issuers are working to achieve that status for their issues. Green Bonds are so designated according to  generally accepted Green Bond Principals as promulgated by the International Capital Market Association. The purpose of the label is to allow for investors to evaluate the environmental merits and benefits of bonds so labeled.

The latest example of Green Bonds is an issue of $415 million scheduled for sale next week by the City of Aurora, CO. The City Utility Enterprise is offering water revenue  particular project was designed to increase the efficiency of its existing water system and expand water supplies without the acquisition of additional land for its water rights. This is consistent with the principals supporting a Green Bond designation.

A Green Bond  designation does not lead to any changes in the basic characteristics of the bonds in terms of security or structure. In the case of the Aurora issue, the bonds are traditional first lien net revenue bonds of the water system featuring a traditional serial/term maturity structure. The only thing different is the Green Bond designation. The benefit is that it helps to expand the market for the debt by supporting an expanded class of investors. It looks like a win/win for the overall municipal market.

PENNSYLVANIA FUNDS ITS BUDGET

Early in July, Governor Tom wolf signed a budget that was underfunded by over $1 billion. That led to general derision and threats of further downgrades. The reaction seems to have spurred the legislature and the Governor to get together on a revenue package to fund the shortfall. Perhaps now the Commonwealth can move forward with its recently postponed general obligation bond issue.

That final revenue package is expected to raise nearly $1.3 billion through a $1.00-per-pack tax increase on cigarettes, an expansion of gambling, liquor reforms and applying the personal income tax on Pennsylvania Lottery winnings. There is an increase tax on the expanded vaping industry but cigars will not see a tax increase. Other revenues under consideration include tuition at the 14 state universities rising by as much as 3 percent in the coming academic year to fill the anticipated budgetary shortfall that the State System of Higher Education is facing. Tuition  has increased 13 percent over the last five years. A rise of 3 percent would mean a $212 increase in the yearly tuition rate, bumping up the base rate to $7,272.

Among other  tax changes signed by Gov. Tom Wolf this week, the state’s 6 percent sales tax will be extended to the purchase of digital downloads including games and music. This tax expansion is expected to be worth about $47 million in 2016-17, according to Wolf Administration estimates.

Missing from all of the budget deliberations is any serious reform of the Commonwealth’s underfunded pension liability. The pension issue is the elephant in the room in terms of the Commonwealth’s long-term credit outlook. The short-term resolution of the FY 2017 budget could be enough to hold off a rating downgrade in the near term. Absent meaningful reform of the Commonwealth’s pension situation, we see the credit as a consistent underperformer.

TEXAS HIGH SPEED RAIL HITS SPEED BUMP

Texas Central Railroad and Infrastructure, Inc. and Texas Central Railroad, LLC, propose to build a 240-mile high speed rail line between Dallas and Houston, Tex. In April of this year,  Texas Central filed  a petition for an exemption from the state prior approval requirements due to oversight from the U.S. Surface Transportation Agency. Such oversight would ease the process of right of way development and acquisition. That process is being used by opponents of the route and the plan overall to delay and/or halt the project. this in turn, has complicated financing for the project. Texas Central anticipates beginning construction in 2017 and plans to initiate passenger service as early as late 2021. Texas Central estimates the cost of construction, which is being privately financed, to be over $10 billion.

Texas Central made its request for federal jurisdiction based on the claim that the Line is part of the interstate rail network, despite the absence of a physical connection with Amtrak. Texas Central compares itself to the state-owned Alaska Railroad, which is located entirely in the State of Alaska, does not physically connect at any location with the interstate rail network and relies on water carriers to interchange and connect with other United States railroads; yet, the railroad is part of the interstate rail network and subject to the Board’s jurisdiction. The Alaska Railroad and the water carriers that it uses to connect to the interstate rail network are part of the noncontiguous domestic trade statutorily subject to the Board’s jurisdiction.

The Surface Transportation Board declined the request to supervise the project. The proposed Line would have no direct connection with Amtrak, such as a shared station or a clearly defined arrangement to connect passengers using through ticketing. The Line and Amtrak need not share the same track, but with no direct connection to the interstate rail network the construction and operation of the proposed Line is not subject to the Board’s jurisdiction.

While the Texas project is entirely private, we are interested in it for its potential precedent setting impact for high speed rail projects which hope to rely in whole or in part on municipal bonds for their financing. Understanding the various obstacles which could impact construction planning and scheduling and their potential effects on financing viability will be important to the credit analysis by potential investors in these sort of projects.

PROMESA CHALLENGES CONSOLIDATED

A U.S. Federal Judge consolidated the various cases brought up by a hedge fund firm, an insurance firm and private investors to resolve the issue on whether the Puerto Rico Oversight Management and Economic Stability Act (Promesa) has stayed their lawsuits. The government recently had asked the court to stay the three lawsuits, contending that there is a disposition to that effect contained in Promesa, but the judge declined to do so.  Currently, there are six cases in the Federal District Court in Puerto Rico and one in New York related to bond defualts and fiscal matters.

A hedge fund recently sued to stop the Government Development Bank from transferring assets. National Public Finance Guarantee Corporation,  which insures approximately $3.84 billion of debt issued by the Commonwealth of Puerto Rico and related entities, and a group of bondholder plaintiffs want the Puerto Rico Emergency Moratorium and Financial Rehabilitation Act to be declared unconstitutional.

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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