Senior Municipal Credit Consultant
The proceedings in Puerto Rico’s Title III have raised concerns among some that the established treatment of special revenues under Chapter 9 could be altered by decisions in this case. the concern rises from Federal bankruptcy Judge Laura Taylor Swain decision to hold a hearing in August when she will entertain arguments on an action to stop the retention, or clawback, of toll revenues that back the Highways & Transportation Authority (HTA) debt obligations . Creditor groups contend that they have a lien over those. HTA bondholders sued on May 31 seeking an injunction to stop the HTA from diverting pledged toll revenues. Last week, three municipal bond insurers followed suit.
The Commonwealth and the financial control board—which represents the Puerto Rico government as debtor—insist that taking toll revenues from the HTA could force it to shut down its operations, including that of the Urban Train. The commonwealth contends that the lien is not a statutory one. They said the opposite last year to a U.S. District Court Judge as well as the U.S. First Circuit Court of Appeals. The Commonwealth contends that the liens were in place before the Puerto Rico Oversight, Management & Economic Stability Act, or Promesa, was enacted in 2016.
Its position is that the lien can’t be destroyed because the retroactive invalidation of a statute-covered lien is unconstitutional. Under the terms of that lien, the HTA must first deposit sufficient funds into the 1968 Resolution bondholders’ collateral account to meet debt service obligations before it can spend the funds elsewhere. Expropriating the “gross” lien to pay for “necessary operating expenses” at the HTA would effectively convert it into a “net” lien, which would constitute an illegal taking according to the plaintiffs.
They cite the fact that that the fiscal plan shows $530 million in toll revenues and other fees being transferred to the commonwealth’s general fund. The fiscal board argues that creditors have only “an unsecured lien unless they have other secured interest.”
Investor concerns center on the idea that a decision in favor of the Commonwealth could have wider implications for the treatment of special revenues generally. The issues in this case however, seem to turn on the unique aspects of the clawback provision which is not typical in many special revenue secured bonds. Here, the nature of the constitutional versus statutory dispute lies at the heart of the argument in this restructuring. We note that this issue has not arisen with regard to the electric or water utility credits where the issue of the clawback does not exist.
BOND INSURERS UNDER FIRE
Standard & Poor’s (“S&P”) announced that it had placed the ratings of Build America Mutual and National Public Financial Guarantee on a “negative outlook”. The move reverses a generally positive trend in the perception of the creditworthiness of the insurers.
In response, National said, “We are disappointed by S&P’s announcement and do not believe that a rating downgrade of National is warranted. National’s financial strength is evidenced by $1.7 billion of excess capital above our estimate of S&P’s AAA requirement. National has also, in a relatively short period of time, significantly increased its new business activity, as measured both by insured par amount and transaction count, as well as the number of intermediaries who have recommended purchase of National’s guarantees. This market acceptance has been growing despite an environment where S&P’s rating on National has been one notch lower than its competitors. The strong trading value of National’s wrap further attests to the success of National’s disciplined re-entry into the municipal bond market.” Mr. Fallon added, “We will continue to work with S&P during its ongoing review to do everything in our power to maintain National’s AA- credit rating.”
BAM took a similar tack. ” S&P Global Ratings’ decision to place BAM’s rating on CreditWatch Negative represents a departure from their stated criteria and previous communications to the market. BAM’s managing directors said they intend to engage with S&P during the CreditWatch period to demonstrate that BAM’s financial strength and low-risk, low-volatility strategy of insuring only U.S. municipal bonds from essential public purpose issuers supports BAM’s current rating. Our portfolio strategy does not limit BAM’s competitive position: Only 3% or less of the U.S. insured municipal market is sold in sectors that BAM does not insure, and diversification outside the municipal market has historically exposed bond insurers to excessive risk of loss. According to municipal market default studies by Moody’s and S&P, 70% of the defaults by credits that were rated investment grade at issuance were from the sectors BAM has chosen not to insure. In contrast to the industry’s past, we will not change our risk tolerance in response to rating agency pressure.”
If S&P’s problem is the municipal only risk profile of the insurers than that position is confusing. In the aftermath of the 2008 financial meltdown and the damage it did to the bond insurers, the multi-sector model was clearly not viable from a ratings standpoint. If that has changed, does it represent a paradigm shift in the thinking of the rating agencies? If so, they should make that change clear. Otherwise, the monoline municipal bond insurers are in an untenable position as are holders of the bonds they insure.
PRIVATE DOES NOT ALWAYS INSURE A SMOOTH ROAD YET AGAIN
The latest blow to the P3 concept for highway bonds occurs yet again in Indiana. This week it was announced that the state of Indiana intends to take control of the troubled I-69 project from Bloomington to Martinsville as the public-private partnership used to finance and build the highway crumbles. The project’s completion date will again be delayed from May 2018 to August 31, 2018. This is the fourth such delay. The original completion date was October 2016. This is the fourth opening delay as the state’s design-build contractor struggles to pay subcontractors and meet deadlines.
I-69 Development Partners originally bid $325 million to win the project, begun in 2014. The state notified bondholders last week about its plans. It stated that it would take nearly $237 million to complete the project versus the $72 million that is available. That means $164 million is needed to “complete construction and resolve claims.” State officials declined to confirm whether taxpayers would have to foot the bill for the $164 million that is needed.
The Indiana Finance Authority (IFA) has sought to negotiate a settlement with the holders of the Bonds under which IFA would redeem the Bonds by paying termination compensation under the PPA. The funding of such termination compensation amount would be provided from the proceeds of bonds that would be expected to be issued by IFA by September 1, 2017. IFA’s most recent offer was an amount equal to the sum of: the principal amount of all Bonds, plus accrued interest to the redemption date, plus release of the debt service reserve amount (approximately $6.2 million), less all other unspent Bond proceeds (approximately $30 million), subject to agreement on other terms. As of the expiration of a Non Disclosure Agreement, negotiations have not resulted in an agreement.
I-69 Development Partners won a bid to design, construct and maintain the highway for decades after completion. In March the Spanish company Isolux Corsan — which initially comprised more than 80 percent of I-69 Development Partners — entered insolvency proceedings in Spain. It had four months to reach an agreement with creditors and avoid potential bankruptcy. In the interim, the IFA says it’s offering to buy out private activity bonds issued for the project (rated CCC by Fitch and S&P) and take it over, but the bond holders haven’t accepted the offer.
The announcement has implications for the Trump Administration’s plan to finance highway improvements through P3s. The failed initial Indiana Toll Road privatization and this failing project contain many of the concepts expected to be featured in the upcoming trump infrastructure plan. It represents another failure in Indiana’s (and Governor Mike Pence’s) P3 schemes for road development in the State. It cannot bode well that the results from the Vice President’s P3 incubator have turned out so poorly.
KANSAS GIVES UP ON SUPPLY SIDE EXPERIMENT
The Kansas Senate and House have overridden Governor Sam Brownback’s veto of Senate Bill 30. Income taxes will increase across the board but most tax rates will still be below where they were before the 2012 tax cuts. The increases are projected to generate more than $1.2 billion for the state over the next two years. The bill replaces the state’s two-bracket income tax system with three brackets. Income up to $30,000 for married couples would be taxed at 3.1 percent, income between $30,000 and $60,000 would be taxed at 5.25 percent, and income above $60,000 would be taxed at 5.7 percent.
The bill also would repeal an exemption on certain business income that Brownback has championed. That provision was pushed by the Governor as the key to the job creation which was supposed to arise from a “supply side” stimulus. Lawmakers who supported the bill and the override said the 2012 policy was a mistake that had drained the state of revenue. Revenue shortfalls lead to multiple budget cuts and reduced investments in roads and support for local school districts. Those tax changes led to significant and ongoing decreases in state revenues which created ongoing current and structural imbalance. This led to downgrades in the State’s credit rating and a negative outlook for those ratings.
The tax plan was the first to pass the Legislature since February, when lawmakers passed a similar plan. Brownback also vetoed that bill, but the override effort fell three votes short in the Senate. It had become evident to many observers that Brownback would reject whatever tax plan lawmakers approved. The change reflects the political implications of state elections in 2016 and are an effective repudiation of the Governor’s experiment. Once again, an ideological approach to state finances has failed to achieve its goals.
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