Municipal Credit Consultant
The sale of $550 million of general obligation debt last week by the State of Illinois managed to reflect much of the frustration that many long term observers feel towards the municipal market and its ability to use market forces to discipline irresponsible credits. An analysis published by the University of Illinois Institute of Government and Public Affairs noted that “due to a decline in overall market interest rates and favorable conditions in the municipal market at the time of the bond sale, the state realized a historically low overall borrowing cost…from an absolute interest rate level perspective.”
The political and financial dysfunction of Illinois saw the state pay the highest yield penalty over the triple-A curve imposed on a sovereign state Thursday. The deal’s 10-year maturity priced at a yield of 3.32%, 185 basis points over the Municipal Market Data top-rated benchmark and 111 basis points over the BBB benchmark, up from its last sale in January. The true interest cost of 3.7425% reflecting the widening spreads benefitted from lower overall yields in a market that has seen record lows across scales, disguising the true cost of the state’s fiscal deterioration.
The cost of the issue allowed Governor Bruce Rauner to say with a straight face “Given the decade of fiscal mismanagement at the hands of the Democrats, we are pleased with the record-low interest rate on the bond sale.” A spokesperson later added “It’s clear from today’s bond sale that investors realize Illinois now has a governor that is trying to turn the state around and right its fiscal ship.
The UI study estimated that the issue cost the state $12 million on Thursday’s $550 million bond pricing compared to its previous sale in January. The relative penalty rises to $70 million when the new sale’s results are held up against a decade-old sale that benefitted from double-A level ratings. Since the state’s sale in January, Moody’s and S&P both dropped the state one notch, to Baa2 and BBB-plus, respectively, and Fitch has put the state’s BBB-plus rating on negative watch. The legislature just adjourned without adopting a budget.
The Civic Federation of Chicago, a local government research organization, earlier this year estimated the state paid an additional $43 million over what other single-A credits paid to borrow on the January sale. The 185 basis point spread on the state’s 10-year bond in the recent issue marked a 30 basis point jump just since January.
Once again, the market finds itself at the end of an interest rate cycle with lots of cash becoming more narrow, the pressure to invest at anything that looks like relative value than becomes its own worst enemy in disciplining wayward issuers. This deal is a prime example of that failure.
This trend continues one that was evident in 2015. SIFMA has just released research on state by state issuance in 2015. It shows that Illinois issuers sold some $14.760 billion of municipal bonds in 2015. Some 35% of that debt was issued by the City of Chicago and the Chicago Board of Education. These two troubled credits faced significant pension liability funding issues, declining ratings, and were hamstrung by inaction at the state level to address their problems. Yet both were able to achieve access to the market, albeit at some yield penalty.
PENNSYLVANIA ALSO BENEFITS FROM EASY ACCESS
The same SIFMA survey also showed Pennsylvania in a similar light. Issuers in the Commonwealth, buffeted by State budget inaction and reduced aid from the state managed to sell some $18.272 billion of municipals. The Commonwealth and its agencies accounted for 19% of the total even without a budget being adopted 9 months into fiscal 2016. Its largest City, Philadelphia which faces its own set of daunting pension issues managed to sell $1107.5 billion or 6% of debt sold in the Commonwealth. Like the Illinois issuers, the sales came at some penalty but access was never the issue.
You can view the entire data set at https://states.sifma.org/#state.
TOBACCO FACES INCREASED SALES RESTRICTIONS
With California’s recently approved increase in the age at which tobacco may be legally purchased from 18 to 21, another brick in the wall supporting tobacco securitization debt has been removed. California is by far the largest jurisdiction to make such a change joining Hawaii as the second state to do so. Similar legislation has passed the Senate in New Jersey and Vermont. Since 2013, when Hawaii and New York City increased the minimum age, 100 communities in Massachusetts, Kansas City, Cleveland, Boston and San Francisco joined the list of big cities to adopt an increase. As of June, 2016, 159 municipalities in 12 states, and the entire states of Hawaii and California, have taken this step, covering over 58.5 million people.
The tobacco industry strongly resists such efforts. Its own work has found that “raising the legal minimum age for cigarette purchase to 21 could gut our key young adult market (17-20) where we sell about 25 billion cigarettes and enjoy a 70 percent market share.”
DISCLOSURE LEGISLATION MOVING FORWARD IN CALIFORNIA
The California Senate unanimously passed a bill which would require state and local government debt issuers to report to the California Debt and Investment Advisory Commission (CDIAC) specified information about proposed and outstanding debt. Among other things the bill would require all local governments issuing Mello-Roos Community Facilities District bonds to provide a fiscal status report containing specified information to CDIAC by October 30 of every year until the bonds have been retired. All joint powers authorities issuing bonds pursuant to the Marks-Roos Bond Pooling Act must provide a fiscal status report containing specified information to CDIAC by October 30 of every year until the final maturity of the bonds.
Issuers would be required to report the use of proceeds of issued debt during the reporting period, which must include: debt proceeds available at the beginning of the reporting period, proceeds spent during the reporting period and the purposes for which it was spent, and debt proceeds remaining at the end of the reporting period.
In January, 2015, news reports revealed that millions of dollars in bond proceeds held by the Association for Bay Area Governments’ Finance Authority were missing. A former employee of the authority subsequently admitted to taking the missing proceeds. In response to these disclosures, State Treasurer John Chiang created the Task Force on Bond Accountability. The Treasurer’s task force worked to develop best practice guidelines for how bond proceeds should be managed to reduce the risk of fraud, waste, and abuse and to identify strategies to increase transparency and oversight of the use of bond funds.
Our view is that anything that increases transparency, especially in the murky world of land based financings (a favorite of individual high yield investors and high yield funds) is a positive thing.
Days after the PR legislature appeared to approve it, the PRASA Revitalization Act, or House Bill 2786 is being called back by the PR Senate to address “certain discrepancies”. The legislation would prevent PRASA from implementing water-rate hikes to its clients within the next three years, while allowing the utility to issue as much as $900 million in debt.
PRASA’S bill calls for a securitization mechanism, whereby a new corporation is created with the sole purpose of issuing new debt for the utility. This new debt would be backed by a portion of water bills PRASA’s clients receive each month. The bill would also allow PRASA to restructure its roughly $4 billion in debt, although the utility would be required to meet a range of conditions in doing so. Moreover, H.B. 2786 calls on PRASA to reduce its water loss by 5%, a goal that must be reached by 2019.
The legislation would give PRASA the opportunity to pay its contractors, who are owed roughly $150 million, and resume its capital improvement program. PRASA estimates it needs about $375 million to resume capital investment. It is estimated that can take up to four months to establish the mechanism following the bill’s enactment into law.
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