Muni Credit News July 28, 2016

Joseph Krist

Municipal Credit Consultant

CALIFORNIA PENSION RETURNS HAVE NEGATIVE LOCAL IMPLICATIONS

The California Public Employees’ Retirement System (CalPERS) reported a preliminary 0.61 percent net return on investments for the 12-month period that ended June 30, 2016. CalPERS assets at the end of the fiscal year stood at more than $295 billion. Fixed Income earned a 9.29 percent return, nearly matching its benchmark. Infrastructure delivered an 8.98 percent return, outperforming its benchmark by 4.02 percentage points, or 402 basis points. A basis point is one one-hundredth of a percentage point. The CalPERS Private Equity program also bested its benchmark by 253 basis points, earning 1.70 percent.

For the second year in a row, international markets weighed CalPERS’ Global Equity returns. However, the program still managed to outperform its benchmark by 58 basis points, earning negative 3.38 percent. The Real Estate program generated a 7.06 percent return, underperforming its benchmark by 557 basis points.

So we have a very mixed bag. The total absolute return is unacceptably low. Two of the discrete investment sectors reflected negative and/or below benchmark performance. Some positive performance still reflected poor performance relative to benchmarks.

CalPERS 2015-16 Fiscal Year investment performance will be calculated based on audited figures and will be reflected in contribution levels for the State of California and school districts in Fiscal Year 2017-18, and for contracting cities, counties, and special districts in Fiscal Year 2018-19. The ending value of the CalPERS fund is based on several factors and not investment performance alone. Contributions made to CalPERS from employers and employees, monthly payments made to retirees, and the performance of its investments, among other factors, all influence the ending total value of the Fund.

CalPERS has underperformed its targeted 7.5% return over the past 3, 5, 10 and 20 years. The low overall return means that there will be pressure on localities and their employees to increase their contributions for pensions. For localities, the lower investment performance is a credit negative as they face higher expenses not necessarily coincident with the state of the economy at the time of those requirements.

HAMILTON COUNTY REFUNDS STADIUM BONDS

Regular readers know by now of our ongoing interest in the issue of public financing for professional sports facilities. Hamilton County, OH has been undertaking a financing program for stadia for the NFL Cincinnati Bengals and the MLB Cincinnati Reds since 1998. The program has utilized sales tax revenue bonds with proceeds of those taxes dedicated to the repayment of those bonds. While there have been no issues in terms of the level of resources available for bond repayment, the program has been controversial as the County’s overall fiscal position has been tight and difficult choices have had to be made as to the priority of programs for funding.

The structure of a currently outstanding issue of these bonds and the continuation of a favorable low interest rate and high demand market has made possible the refunding of some $320 million of debt related to the stadium finance program. The refunding is designed to achieve ongoing actual savings on debt service but will also be used as an opportunity to adjust the security provisions supporting the bonds which will make more monies available to the County for current spending

Those changes include an increase in reserves held by the Trustee for the bondholders. Previously, the County had been required to hold funds equal to 10% of one half of 1% of sales tax collections. The County will now be able to take those $7.4 million of funds and use them for any County purpose. In exchange, the size of the trustee held reserve is changed to of average of annual debt service to the lesser of100% of those amounts. The debt service reserve requirement can be fulfilled through a Credit Support Instrument from Build America Mutual.

Clearly the County through the refunding and the use of a surety for the debt service reserve is trying to address the concerns from its citizenry about the level of County resources benefitting the two teams. It is another indication of public misgivings about the propriety of using public funds to support what are in the end facilities used to generate a high level of private profit.

NJ TRIES AGAIN ON TRANSIT FUNDING

With the Republican convention now concluded, NJ Governor Chris Christie can try again to reach an agreement with the NJ legislature over how to raise increased funds for the State Transportation Trust Fund. Under a plan released Friday by Democratic leaders in the Legislature, the state would spend $20 billion over the next 10 years on roads, rails, bridges and other transit projects, using new revenue from higher gas taxes and borrowing.

The proposal would raise the gas tax by 23 cents a gallon to be offset by a phase out of the estate tax over 3.5 years at an annual cost of $552 million. In addition, the plan would increase the earned income tax credit for the working poor – annual cost: $137 million; increase income tax exclusions for retirees over four years, to $100,000 for joint filers and $75,000 for individuals – annual cost: $164 million;  give a $500 income tax deduction to all motorists with incomes below $100,000 – annual cost: $20 million; and give a $3,000 income tax exemption for all military veterans – annual cost: $23 million. The total cost of the tax cuts and credits: $896 million.

The NJ debate is occurring within a context of changes in gas taxes nationwide. Six states have changes to their gas tax rates. California and North Carolina are decreasing their tax rates, while Washington State is instituting its second gas tax increase in less than a year. Three other states, Iowa, Maryland, and Nebraska, will see revisions via formula. All states are dealing with the phenomena of much better vehicle fuel efficiency and decreases in driving frequency by millennials.

KANSAS RATINGS PAY THE PRICE

S&P Global Ratings dropped its rating for Kansas to “AA-,” from AA, three months after putting the state on a negative credit watch. S&P earlier dropped the state’s credit rating in August 2014. The ratings agency cited the state’s lack of cash reserves, even after multiple rounds of budget adjustments during the past year. Budget director Shawn Sullivan said the S&P report criticizes the state’s ongoing diversion funds for highway projects to general government programs and says the state continues to underfund pensions for teachers and government workers.

The state says that it is unfair to see diverted highway dollars as a one-time source of funds to help balance the budget because the state has done it regularly for years. It also feels that criticism of Kansas for underfunding its public pension system, which includes delaying nearly $96 million in payments otherwise due under the current budget, is unfair.  The state wants more of the focus to be on the fact that with funding improvements mandated in 2012, the state is spending significantly more on pensions than it did in the past.

Our view is to wonder what has taken the rating agencies this long to recognize that the current administration is so ideologically driven as to effectively preclude a more positive reading of recent events.

RATINGS GO DOWN WITH THE TUBES

Somerset, Kentucky general obligation bonds were downgraded to Baa2 from Baa1 on Monday, because of park subsidies totaling $7.6 million since 2007, by Moody’s Investors Service. The financial support from the city’s general and sanitation funds was for SomerSplash Waterpark, which opened in 2006 with six water slides and other attractions, including a “lazy river” for tubing and a wave pool.

“The downgrade to Baa2 reflects the further deterioration of the city’s financial reserves and consecutive operating deficits that result, in part, from ongoing and substantial general fund subsidy of its water park,” said Moody’s.

Somerset operations are “unusual” because the city owns a 155-mile-long gas pipeline that connects eastern Kentucky gas fields to major interstate pipelines. The pipeline has historically provides “substantial” margins that have subsidized general operations of the city such that tax revenues cover only half of expenses. The Gas Department is an enterprise fund that is self-supporting, and does not receive revenues from the general fund, The Gas Department is an enterprise fund that is self-supporting, and does not receive revenues from the general fund, according to the city’s 2015 audit.

In fiscal 2015, the general fund received $2.7 million from the Gas Department and $3.1 million from the Water Department, representing 46.5% of general fund revenues. The outlook remains negative for this formerly A1 credit due uncertainty from the ongoing support of the water park as well as potential risks surrounding the operations of the Gas Department.

We believe that recreational facilities should only be financed on a standalone basis. This is just one more of the countless examples of small communities being forced to pressure their general fund revenue bases to support clearly non-essential activities.

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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