Muni Credit News June 1, 2017

Joseph Krist

Senior Municipal credit Consultant



COFINA bondholders will find out today whether or not the interest due on some of their bonds will be paid on time. As it stands, U.S. District Judge Laura Taylor Swain said The $16 million payment on the bonds, known as Cofinas, and subsequent payments will be halted until several disputes over who owns the money — and who should get it — can be resolved. As we have previously discussed, the issue comes down to whether or not the Commonwealth’s obligation to “clawback” the money from COFINA under the PR Constitution is trumped by the legislation authorizing the issuance of the COFINA bonds.

While the issue is litigated, the judge wishes to  “keep the money safe and intact” while the broader disputes are resolved. She made her decision at the request of the bondholder trustee, Bank of New York Mellon Corp. If the decision and subsequent failure to pay is considered to be an act of default, ultimate remedies could include acceleration of the COFINA debt.


Detroit has a balanced budget and a near $63 million surplus.

Figures were released Wednesday from Detroit’s Comprehensive Annual Financial Report for the fiscal year that ended June 30, 2016. It’s the city’s second consecutive balanced budget. There was a 45 percent reduction in audit findings. Mayor Mike Duggan’s office says a $51 million surplus is projected for the current fiscal year which ends June 30. It will use the surplus funds for blight remediation, capital improvements and other projects that improve the city in the long-term.

For the first time in more than a decade, the city didn’t have any costs scrutinized for its federal grant use. The fiscal surplus for 2016 was about $22 million higher than the city projected, which was attributed to improved financial controls, stronger-than-anticipated revenues and lower costs due to unfilled vacancies. The city must have three consecutive years of deficit-free budgets to exit oversight by the Financial Review Commission under terms of Detroit’s exit from municipal bankruptcy protection in 2014.


The State of New Jersey (A3 stable) plans to close its large structural budget gap through a combination of higher revenue and economic growth and increasing pension contributions, but the state’s expectations are at odds with its historic revenue trends and likely pension investment returns, Moody’s Investors Service says in a new report. “If New Jersey’s revenue growth continues at the five-year average pace of 2.8%, pension investment returns do not meet actuarial assumptions, and the state does not implement structural budget changes, rising pension contributions would increase annual operating deficits to $3.6 billion by 2023.”

The report goes on to note that New Jersey plans to improve pension funding by raising contributions each year until 2023. However, the rapid rise in these contributions will pressure the budget and make it increasingly difficult to afford other operating costs. While the state projects to balance rising pension contributions with faster revenue growth, revenues will be hampered by recent tax cuts adopted last October that will result in a loss of $1.1 billion by FY 2021.

Outside of structural budget changes, New Jersey has few options for balancing future gaps, particularly as operating reserves are projected to decline to 1.3% of revenues in fiscal 2017. The projected 2023 deficit’s size will also make it politically difficult to close the gap solely with budget cuts and expense reduction. Should the rising pension contribution schedule prove unaffordable in the future, New Jersey could cut or eliminate part or all of its scheduled pension payments. However, any drop in pension cash inflows would lower the assets available to pay benefits, which would exacerbate the state’s pension problems. New Jersey’s adjusted net pension liabilities stood at $90.2 billion in FY 2015, which was fifth highest among states as a percent of revenues.

Should all of this come to pass, we would expect ratings to decline throughout the foreseeable future.


It is the equivalent of junk science but a recent paper sponsored by the NCPERS (National Conference on Public Employee Retirement Systems), takes another stab at supporting the issuance of pension obligation bonds. It is included as part of a thesis that the current pension “crisis” is overblown and that the need to fund existing pension systems at levels anywhere near actuarial soundness are unnecessary. It postulates that efforts to rein in pension costs through plans other than taxpayer funded defined benefit plans are damaging to the economy and promote economic injustice.

The one significant element of the paper we discuss here is the effort by the author’s to promote the efficacy  of the issuance of pension obligation debt in place of honest and responsible efforts to absorb the costs of actuarially sound funding in annual budgets by all levels of government. The paper argues that full funding is not required because of the inability of states to go bankrupt unlike private entities. They use this as the justification for using unattainable investment return assumptions to determine unfunded liability levels.

Ironically, the organization which ostensibly supports public employees advocates among other things the privatization and outright sale of public assets. The same constituency has habitually fought the concept of privatization for decades. So there is a disconnect there. They also advocate the use of the proceeds to fund pensions, ignoring the fact that these are usually assets owned by the public at large and not the employees. The local water system is a public good, not an ESOP.

Finally, the paper advocates the issuance of pension obligation bonds – long maturity, bullet maturity pension bonds – in lieu of current funding on an annual basis. It acknowledges that interest on the bonds should be paid annually – at least they are not using zero coupon bonds. They also advocate the use of derivatives to protect against losses on the invested proceeds. It is as if the last two decades or so of experience by municipal issuers with this kind of strategy had never existed. It is as if Detroit, Orange County, New Jersey, and Illinois were planets in another solar system.


No matter which side of the pension debate one stands on, one clear truth emerges. At least on the state level, those names which have been consistently in the news for having difficulties coming up with balanced budgets either currently or structurally all have underfunded pension systems. Ask your self – what do Illinois, New Jersey, Kansas, and Pennsylvania all have in common? Structurally unbalanced budgets, current budget deficits, and underfunded pensions. So the idea that the issue is somehow overblown or just part of a vast anti-worker conspiracy just does not hold up on closer analysis.


CareAlliance Health Services’ (d/b/a Roper St. Francis Healthcare, RSFH) is a South Carolina system with approximately $100 million of revenue bonds outstanding rated A3 by Moody’s. The rating outlook  was just revised to negative reflecting weaker than expected performance in FY 2016 and through three months FY 2017. Moody’s believes RSFH will be pressured to return operating cash flow to historical levels over the near term given recent challenges in labor expense and ongoing Medicaid DSH settlements with the state that have reduced cash flow in recent periods (RSFH is suing the state over the revised DSH payment methodology).

The rating reflects RSFH’s good market position in the growing market of Charleston and the surrounding areas. The rating further reflects the organization’s ownership model and Liquidity Replenishment Agreement with its Founding Members that provides a floor to key balance sheet ratios. Primary credit challenges include lower than budgeted operating cash flow and revenue during a period of expansion and growth as the organization builds a new hospital and related services, and higher than planned debt resulting from lower cash flow in FY 2016.

RSFH is a three hospital system in Charleston, SC. The organization operates over 650 beds. It has a unique and complex ownership and operating structure which underpins its debt. The bonds are secured by a gross receivables pledge by the obligated group based on the Amended and Restated Master Trust Indenture (MTI) dated January 1, 1999. The obligated group members consist of the parent company, CareAlliance Health Services (d/b/a Roper St. Francis Healthcare, Roper Hospital, Inc., Bon Secours-St. Francis Xavier Hospital, Inc., Roper St. Francis Mount Pleasant Hospital, Roper St. Francis Physicians Network, and Roper St. Francis Hospital-Berkeley, Inc.). Under the MTI, the obligated group is required to maintain financial covenants including 1.1 times (1.25 times under bond insurance agreement) debt service coverage ratio (if falls below would be required to hire an independent consultant with an event of default occurring if falls below 1.0 times).

Under its bank agreements, it is an event of default if debt service coverage ratio falls below 1.25 times. The bank agreements permit maximum total debt to capitalization of 65% at fiscal year end and the bond insurance agreement requires the hiring of an independent consultant if such ratio exceeds 65%. In addition, an event of default would occur under the amended and restated MTI if the Founding Members (collectively the Medical Society of South Carolina, Bon Secours Health System, and The Charlotte Mecklenburg Hospital Authority d/b/a the Carolinas HealthCare System) fail to make a contribution of unrestricted cash and investments to the obligated group in an amount equal to the contribution amount, which is the difference between 85 and days cash on hand reported on the testing date of June 30 and December 31, pursuant to the Liquidity Replenishment Agreement executed on January 2014 (except that no such contribution will be required if CareAlliance Health Services has at least 75 days cash on hand as of the testing date and increases days cash on hand such that it is at least 85 days cash on hand three months after the testing date).


Moody’s Investors Service has placed the City of Hartford, Connecticut’s Ba2 general obligation debt rating under review for possible downgrade, affecting approximately $550 million of outstanding debt. On October 7, 2016, Moody’s downgraded the city’s GOs to Ba2 and maintained the negative outlook. The review for downgrade will be concluded within 90 days. The review will focus on the city’s prospects for sustainably balancing its financial operations and it will also consider state funding to be provided to the city over the next two fiscal years that may be incorporated in the biennial state budget to be adopted over the next several weeks.


The April announcement that Whittier Law School in CA would close at the end of this academic year drew attention to the increasingly difficult financial plight of smaller law schools in a time of diminished demand. The law school will be the first with full American Bar Association accreditation to close in recent memory. Its accreditation dates to 1985, and it was founded in 1966, so it does not fit the profile of a new, unestablished institution that might be expected to shutter under normal circumstances. Just 22 percent of its students taking the California bar examination for the first time in July 2016 passed. That was almost 40 percentage points below the passage rate across all of the state’s ABA-accredited institutions.

In light of that action we note that this week Moody’s reaffirmed its A2 rating on debt issued by Hastings College of the Law in California. In spite of its affiliation with the University of California, growing state support, and healthy liquidity its rating outlook was maintained at negative. Like many in the fundamentally challenged niche law school market it has a small scope of operations, expectations for flat net tuition revenue through fiscal year,  and deficit operations going forward. University of California Hastings College of the Law is a small stand-alone public law school, located in San Francisco. The college has approximately 965 full-time equivalent students, with approximately $56 million of operating revenue.

We expect that this sector will experience a shakeout unless there is a significant turnaround in financial and demand trends. Smaller, specialized law schools without significant geographic reach are especially vulnerable in the current environment. Law schools also face new accreditation pressure. The American Bar Association has taken action against four law schools in the last year over issues including loose admissions policies and low bar-examination passage rates. The pressures could push less prestigious law schools into a death spiral. Their applicant pools are declining, and their top students often transfer to better-known institutions. As a result, they can lose the students they admit who are most likely to pass the bar. That can make it harder for them to increase their bar-passage rates over time, which in turn cuts down on their applicant pools and drives their best students to transfer — continuing the spiral.

William Mitchell College of Law and Hamline University School of Law, in St. Paul, Minn., decided to merge in 2015. Indiana Tech Law School in Fort Wayne this fall announced plans to close in June 2017. Administrators at that law school, which opened its doors in 2013 and had provisional ABA accreditation, said it had incurred an operating loss of nearly $20 million in its brief existence. A fall 2016 survey from Kaplan Test Prep of officers at 111 of the 205 ABA-accredited law schools in the country found 65 percent agreed with the statement that “it would be a good idea if at least a few law schools closed.”

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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