Muni Credit News July 9, 2015

Joseph Krist

Municipal Credit Consultant


The most recent analysis of a scaled-back, Republican-authored public employee pension reform bill reduces the projected long-term savings from $18.3 billion back to $11.1 billion. None of those savings would show up for state government or Pennsylvania’s school districts in the 2015-16 fiscal year. The analysis done for the Public Employee Retirement Commission said the adjustment rests on House actions to delete a provision to try to unwind 2001 retirement benefit increases.

That clause – sure to invite a court challenge from public sector employee unions – was the biggest single cost-saver in the original bill. It would have required current employees to pay more to keep the higher benefits granted in 2001. New Gov. Tom Wolf opposes increased payroll deductions for existing employees. The remaining reforms include the shift of most future state employees and school teachers into a something more like the 401(k)-style plans now prevalent in the private sector.

In 2001, Pennsylvania’s lawmakers granted pension benefit increases to themselves, plus all public school employees and state workers. They then delayed payments on the resulting higher cost structure in order to avoid tax increases and keep funding available for other state needs. Since then, taxpayer-funded “employer contributions” have grown from under $1 billion in 2010 to more than $4 billion in the fiscal year 2015, and are projected to reach $5.9 billion by fiscal 2016-17.

If  not for the 2001 revisions, the current requirement would about 40 percent of what it is today – or less than $2 billion. The Legislature believes reform requires converting the state’s two major pension plans – at least for future employees – to a 401(k)-style. The Governor, with the support of public sector unions, contends that reforms approved in 2010 for workers hired after that date are working as intended and that funding is the issue. The Governor supports the issuance of $3 billion in bonds secured by increased profits from an enhanced state liquor store system.

The legislature wants employees to contribute 6 percent of their salary for retirement, half in the defined contribution plan matched by 2.59 percent of pay for teachers and 4 percent for state employees. The other three percent of salary would go into a cash balance plan with no additional employer contribution, earning interest tied to yields on 30-year U.S. Treasury bonds, capped at 4 percent. Retirement system gains in excess of that guarantee would be retained by the funds, and go toward paying off their liabilities, a provision union leaders have derided as “inter-generational theft” as new hires see investments on their contributions used to pick up the tab for the changes in 2001.

About 20 percent of the state’s current workforce, mostly law enforcement staff like state troopers and corrections officers, would remain in the current defined-benefit plan, under the House amendment.

The debate is over whether the proposed changes are enough. According to an analysis by the Pew Charitable Trusts’, the biggest discrepancies come for those who work to full retirement, or 35 years, in the public sector. Under the defined contribution plan set out in Senate Bill 1, Pew says a 35-year state worker qualifying for the maximum annuity at age 62 would see their pension drop from 67.6 percent of salary now, to 39.5 percent (assuming annual investment returns of 7.5 percent.)

Assume an average annual return on those 401-(k) investments to 5 percent, and the prospective new worker’s pension would be just 28.6 percent of final salary – an income cut of 58 percent from someone hired today. If the system provides retiree health care benefits, as the State Employees Retirement System does now, proponents argue that the new system – because of an enhanced ability to take funds with them if workers switched jobs – would actually outperform the current defined benefit system for people who leave the public sector before retirement for other careers.

The Pennsylvania State Education Association notes that their members don’t get free health care in retirement, and none of the state or school retirees get an inflation adjustment on their pensions. The PSEA worries that by definition, workers’ benefits will be less certain in the proposed plan because of the built-in risk of depending on future investment returns, as opposed to the current defined benefit plan.

Coloring the debate is the perception that the proposed bill doesn’t appear to generate a lot of savings. For example, the defined contribution portion of SB 1 only generates, according to the PERC report, a long-term savings of about $6.6 billion between both systems. The current PSERS bill through 2035, when pension costs are finally expected to crest, is $109.7 billion. Under the new bill, the cost is pegged at $105.2 billion, or a cut of little more than 4 percent. That is because the biggest savings source –  the piece that tells current workers to pay a higher contribution for the benefit they won in 2001 no longer exists.


Puerto Rico filed a supplement to its May 7 quarterly report that updates the financial state of the commonwealth to reflect recent developments. It states, “if no significant measures are implemented to increase the government’s cash flow, absent new financing from GDB or third parties, during the first quarter of fiscal year 2016 the government may not be able to continue funding all governmental programs and services while continuing to meet all of its debt service obligations in a timely manner.”

The Government Development Bank (GDB) states that the most recent projections point to a fiscal year 2015 budget deficit of $705 million to $740 million, after previously estimating to close this fiscal year with a deficit amounting to about $191 million. That figure does not include nearly $291 million in pending tax refunds. It is also not a figure based on GAAP.

For fiscal 2016, “the Commonwealth faces set aside payments to the Redemption Fund for the Commonwealth’s general obligation bonds of approximately $276 million during the first three months of the fiscal year (approximately of $92 million per month), $93.7 million in appropriations which are due on July 15, 2015 to the Puerto Rico Public Finance Corporation for the payment of debt service, and $300 million in TRANs issued by the GDB plus accrued interest that mature on July 10, 2015, (which the Commonwealth expects to offset during July 2015 with a new $300 million TRANs to be issued by GDB).”

To finance cash needs, the government will delay the payment of income tax refunds by the Treasury and issue about $400 million in TRANs to certain public corporations. GDB President Melba Acosta said that the government was moving forward with various efforts aimed at securing the remaining $800 million needed to operate the government during the beginning of the fiscal year, including a potential deal with private banks that amounts to $400 million.

Legislation also allows the Treasury Secretary to “suspend, totally or partially,” monthly deposits made to cover principal and interest payments on GO debt if it fails to either secure $1.2 billion in TRANs or at least $2 billion in a bond deal backed by the latest petroleum-products tax increase. The supplement also showed a liquidity position at the Treasury Department, with a book overdraft on its cash balance expected to exceed the $271 million figure at the end of May.

Meanwhile PREPA avoided a payment default on July 1 by borrowing from its bond insurers and drawing down its reserves. It’s day of reckoning is now postponed until December.

Supporters of bankruptcy for the Commonwealth may have gotten a boost from a U.S. appeals court affirmation of a lower court decision to strike down Puerto Rican legislation aimed at granting local municipalities the right to enter bankruptcy, but said excluding the U.S. territory’s public entities from federal bankruptcy law was unconstitutional. In the decision, the Court seems to support the idea by saying that “besides being irrational and arbitrary, the exclusion of Puerto Rico’s power to authorize its municipalities to request federal bankruptcy relief should be re-examined in light of more recent rational-basis review case law,”.

Thus the 75-page ruling ostensibly vindicates the suing bondholders’ position, while also making a case that Puerto Rico should be given access to Chapter 9 of the U.S. bankruptcy code, which deals with municipal bankruptcies. Bondholders have consistently opposed this view. The detailed ruling, citing much legislative history, appears to strengthen the case for Congress to act on a bill, currently before a House committee, that seeks to change Chapter 9 to allow Puerto Rico to file for bankruptcy.


Under a settlement announced by Gov. Terry McAuliffe  the Commonwealth of Virginia  will recover $46 million already paid to US 460 Mobility Partners and avoid paying $103 million in additional claims submitted by the developer for the U.S. 460 project. The road  was a four-lane, 75-mph toll expressway between Suffolk and Petersburg which never was able to receive U.S. Army Corps of Engineers approval to destroy wetlands in its planned route. A total of $260 million had been spent the before the project had the permit from the Corps in hand. The project did result in a new state law new law which creates a committee that will include General Assembly representation to ensure that proposed deals under the Public-Private Transportation Act serve the public interest; require the mitigation of potential risks such as federal permitting; and force the secretary of transportation to attest in writing that a project delivers what was promised before a final agreement is signed.

In prior discussions, we had pointed out that the Corps often becomes an effective vehicle for environmental opposition to road development  involving wetlands. It was a surprise that investors did not apparently give this risk the weight it deserved when the bonds initially came to market. While the investors will ultimately recover their principal through a state financed redemption, the intervening threat to principal value and opportunity cost of investing in the project should give pause to those evaluating future projects.


Reports out of the State of Washington show an estimated $250 million in marijuana sales in the past year , generating $62 million in marijuana excise taxes. The state’s original forecast was $36 million. When state and local sales and other taxes are included, the tax take for the state and local governments tops $70 million. One year after legalization, the state has about 160 shops open, sales top $1.4 million per day.

This month, two new laws take effect, one to regulate and tax medical marijuana, and one to cut Washington’s three-level excise tax on pot to a single, 37-percent tax. In Washington, marijuana is taxed at 25 percent each time it moves from the growers to the processors to the retailers. That’s been especially tough on retailers, who must pay federal income tax on the marijuana tax they turn over to the state. The new tax rate should help. The law makes clear that the 37 percent tax is the responsibility of the customer — not the retailer. That means stores won’t have to claim that money as income on their federal filings.

The numbers reflect that few growers were harvesting by the time the first stores opened, with the average price of a gram of legal marijuana rising to nearly $30 last summer — about three times the cost in medical marijuana shops. But prices have been dropping with larger harvests and Washington has harvested 13.5 tons of marijuana flower intended to be sold as bud, but stores have only sold about 10 tons. Some of the excess can be turned into marijuana extracts, such as oil, but the harvest has helped drive down the prices to an average of about $11.50 per gram.

The Washington Liquor Control Board is soon to be renamed the Liquor and Cannabis Board. It regulates the business  by adopting background checks and financial investigations of pot-license applicants, and capping the total amount of production to try to keep it in line with in-state demand. The state required strict packaging and labeling requirements to keep children from buying and products that appeal to them.

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