Muni Credit News March 10, 2016

Joseph Krist

Municipal Credit Consultant


Regular readers will remember that we view privately operated toll roads with at best a great deal of skepticism. That position was reinforced with the news last week that the private company that operates part of the Texas toll road with the highest speed limit in the country filed for bankruptcy, fewer than three years after the section of the road it oversees first opened.

The SH 130 Concession Company, a partnership between Spain-based Cintra and San Antonio-based Zachry American infrastructure, opened the 41-mile-long southern portion of the State Highway 130 toll road, from north of Mustang Ridge to Seguin, in October, 2013. The company had signed an unprecedented deal with the state to build and operate its section of the road for 50 years in exchange for a portion of the toll revenue. Lower-than-expected traffic has led to shortfalls in revenue. A year after the road opened, the lack of traffic prompted Moody’s to severely downgrade the company’s debt. Moody’s released a report eight months later warning that the company was dangerously close to defaulting. Now those ratings have been withdrawn.

SH 130, which runs a total of 91 miles from north of Austin to Seguin, was designed as a way to alleviate gridlock on Interstate 35 through the capital city. The southern section is the only part operated by the Concession Company; the rest is run by the state department of transportation. SH 130 Concession Company CEO Alfonso Orol said in a statement that the road will continue to operate while it goes through Chapter 11 bankruptcy proceedings. The company said that, while its current debt payment schedule is “unsustainable,” it hopes to announce a resolution to its financial troubles in the coming months and points to gradual traffic increases as reason for confidence moving forward.

“We believe that this trend will continue and that the road will become an increasingly popular alternative to I-35 and a valuable asset for the Central Texas region in the years to come as connectivity improves and the area’s economy and population continues to grow,” Orol said. When the southern section of SH 130 was first unveiled, then-Gov. Rick Perry hailed the project as a significant achievement for the state, after he had pushed for private toll leases despite skepticism around the Capitol. The Texas Department of Transportation, said that the company’s bankruptcy filing should have no impact on state taxpayers. “No state money was used to build the portion from SH 45SE south to Seguin operated by the SH 130 Concession Company, and the state is not liable for any of its outstanding debt. SH 130 continues to be a viable alternative for drivers who want to bypass Austin and avoid congestion on Interstate 35.”


Recent times have shown yield investors the importance of underlying project viability even in those transactions supported by an implicit or direct guarantee of debt service by an issuing municipality. Recent refusals of communities in Missouri, Illinois and Minnesota have highlighted the issue. Another example is emerging in Florida. In 2010, the City of Port St. Lucie, Florida issued bonds for the benefit of Oregon Health and Science University Vaccine and Gene Therapy Institute Florida Corp., now known as Vaccine and Gene Therapy Institute of Florida Corporation (“VGTI”).

In October, 2015 the City paid the Trustee the amount of VGTI’s loan payment of $1,506,306 which The Trustee applied to the interest payment due on the Bonds on November 1, 2015. As of February 23, 2016, the Debt Service Reserve Requirement of $4,146,212.50 was deficient in the amount of $872,254.58. VGTI made two monthly payments of $218,175 on June 16, 2015 and July 15, 2015 to replenish the Debt Service Reserve Requirement. The City made six additional monthly payments of $218,175 and has committed to make the remaining four monthly payments so that the Debt Service Reserve Requirement will be fully funded by June 15, 2016.

In September 2, 2015 the City requested the appointment of a receiver over the corporate entity VGTI, as well as its real and personal property. Appointment of a receiver would facilitate an investigation of any improper action VGTI may have taken which dissipated the collateral that secures the payment of the Bonds and recovery of any additional revenues to which the Trust Estate may be entitled. While VGTI was generally cooperative in respect to the appointment of a receiver over the property, VGTI aggressively opposed the City’s and the Trustee’s efforts to obtain the appointment of a receiver over VGTI. The Trustee joined with the City in working with VGTI and the State of Florida Department of Economic Opportunity (“DEO”) to draft an agreed upon order for the Court to enter appointing a receiver over the property.

During the course of its remedial efforts, the City obtained from VGTI a draft appraisal of the Bond-financed real property that indicates the project value is less than half of the aggregate principal amount of Bonds outstanding. The Trustee cannot verify the reasonableness of this draft appraisal. The Bond-financed building is a very expensive facility to maintain, even in “cold storage.” The cost to maintain the building by a knowledgeable manager and pay the necessary utilities aggregates approximately $150,000 per month. The payment of these monthly expenses (and other payments made by VGTI) has essentially dissipated the cash balance that VGTI has previously held. The Trustee believes that the City has agreed to pay (within limits) the cost of the receiver and the monthly maintenance costs for the building.

Thus far VGTI and the City have been unwilling to pay the Trustee’s default administration expenses, including the fees and expenses of its counsel. As of January 31, 2016, those counsel fees and expenses aggregated in excess of $350,000. Pursuant to the court’s February 2, 2016 Order, VGTI’s remaining cash of approximately $144,000 was transferred to a default administration account established and maintained by the Trustee. While funds in this account were used to pay the Trustee’s outstanding attorneys’ fees and expenses, the account did not have sufficient funds to reimburse the Trustee for all of its fees and expenses. On January 6, 2016 and February 23, 2016, the Trustee requested indemnification from the City pursuant to the Trust Indenture.

On February 24, 2016, the City contacted the Trustee and stated that it would indemnify the Trustee. Later that same day, the City paid the Trustee $213,549.29 – the amount requested in the Trustee’s February 23, 2016 demand – to reimburse the Trustee for its attorneys’ fees and costs incurred through January 31, 2016. After that payment was received, however, the City’s outside counsel stated that the payment had been initiated “by mistake.” It therefore remains unclear whether the City intends to indemnify the Trustee as required under the Indenture. If the City ultimately refuses to pay those fees and expenses, the Trustee may seek indemnity from the bondholders as is permitted by the Indenture.

VGTI had offered to deed the property to the City in lieu of foreclosure but, the City did not accept. Under the Mortgage, it is the Trustee that holds the mortgage lien. The Trustee did not think it prudent for the Trustee to accept a deed in lieu of foreclosure from VGTI because taking title to the property in the name of the Trustee or a special purpose entity established by the Trustee could adversely affect the exemption from federal income taxation of interest on the Bonds. The Trustee expects to oppose a sale or lease of the building to any entity that is not a governmental body or a 501(c)(3) organization because it believes doing so could adversely affect the exemption from federal income taxation of interest on the Bonds.

Now the bondholders are looking at a situation where they thought that they were  protected to some degree from project economics but in reality were dependant on long-term viability to insure repayment. They are exposed to the declined value of the real estate and a highly uncertain source of funding for the costs of obtaining ultimate recovery of principal.  The continued payment of debt service on the Bonds through the final maturity of May 1, 2042 will then depend upon the City’s willingness to honor its covenant to budget and appropriate and deposit funds into the Debt Service Reserve Fund to cure any deficiency therein.


The Rhode Island Economic Development Corporation (RIEDC, now called the Rhode Island Commerce Corporation) issued $75 million in bonds for the 38 Studios project as part of a state government program intended to spur economic development and increase employment opportunities by loaning bond proceeds to private companies. The Securities and Exchange Commission on Monday charged a Rhode Island agency and its bond underwriter with defrauding investors in the bond offering to finance startup video game company 38 Studios.

The RIEDC loaned $50 million in bond proceeds to 38 Studios. The loan and, in turn, bond investors would be repaid from revenues generated by video games that 38 Studios planned to develop. The bond offering document failed to disclose to investors that 38 Studios had conveyed it needed at least $75 million in funding to produce a particular video game. When 38 Studios was later unable to obtain additional financing, the video game didn’t materialize and the company defaulted on the loan. The SEC alleges that the issuer and underwriter knew that 38 Studios needed an additional $25 million to fund the project yet failed to pass that material information along to bond investors, who were denied a complete financial picture.

Investors weren’t informed that the underwriter had a side deal with 38 Studios that enabled the firm to receive nearly double the amount of compensation disclosed in offering documents. This additional compensation, totaling $400,000 and paid from bond proceeds, created a conflict of interest that Wells Fargo should have disclosed to bond investors. Now the State of Rhode Island is on the hook for the debt service on the bonds.

Rep. Karen MacBeth, who chairs the Rhode Island House Oversight Committee, has been arguing for years that tax-payers shouldn’t be the ones paying the $75 million price tag for the failed video game deal. After Monday’s announcement, MacBeth believes there’s even more reason to not pay back the bond. She is planning to introduce legislation that would ban the state from making any further payments to bond holders. MacBeth does not believe withholding funds would hurt the state’s bond rating. “How can we be knocked down in our bond rating with something that’s fraudulent?” MacBeth said.


CPS canceled classes on March 25, Good Friday, as one of three planned furlough days designed to save $30 million. The announcement immediately prompted a renewed strike threat from the teachers union on April 1. The other two furlough days for teachers and school-based workers are set for June 22 and 23, which were to have been professional development days after the end of the regular school year when students would not be in the classroom.

Chicago Teachers Union officials said the furloughs will result in a 1.6 percent salary reduction for its members. “The mayor is already seeking a 7 percent pay cut, and today’s directive adds another reduction in salary and benefits.”  The district’s top labor lawyer said an April 1 walkout would violate state law and promised that CPS would take the issue to court. CPS said “as many as 8,000 staff members” were planning to take Good Friday off, about four times the daily average. CPS said administrative staff will take forced furloughs April 21 and 22, when the district is on spring break.

The district began its fiscal year with a $480 million budget hole that it hoped to cover with help from the state. That assistance has not arrived as the state budget standoff has continued. CPS has managed its cash flow through the year by laying off employees and borrowing.

The furloughs were announced after CPS and the union spent the day negotiating a new contract, and they follow the district’s decision to eliminate its long-standing practice of picking up seven percentage points of a 9 percent salary contribution teachers make toward their pensions. The “pick up” has long been a major issue of contention between CPS and its teachers. The district has said that eliminating the pension pickup for teachers would cut $65 million in spending this year, more than a third of $182 million in planned cuts this budget year. The district has not said when it will stop making the payments, but CTU officials believe the payments could be cut off next month and threatened earlier this week to strike as soon as April 1. That would be well before teachers are allowed to strike under a state-mandated process that is now in its final phase and wouldn’t play out until the end of May.

The union has not officially committed to a strike date. Such an action depends on whether the district follows through on its plans to end the pension pickup. CTU attorney Robert Bloch said that despite the state law, the union can strike under the authority of a 1956 U.S. Supreme Court decision. “The union’s view is that if it’s not striking over the contract, but is instead striking over an unfair labor practice under that Supreme Court decision, it need not fulfill all those statutory requirements for a strike before engaging in an unfair labor practice strike,” Bloch said. “We believe there is a right to engage in a strike without concluding the contractual impasse procedures, because we’re not striking over a contract,” he said.

The district’s top labor attorney, who helped write the state law that strengthened the steps that must be taken before the city’s teachers can strike. The district’s view is that the 1956 Supreme Court case deals with the National Labor Relations Act, which “has absolutely no applicability to the Chicago Public Schools system or to the Illinois Educational Labor Relations Act.” “Strikes are illegal, they’re prohibited except under very specific circumstances,” Franczek said. “The only way you can strike at CPS is if you comply with that (state) statute.” Also at issue is a provision in the union’s contract that states that the pension pickup ends with the contract — which expired June 30. Nonetheless, the union is arguing that the district should continue making the pension contributions throughout negotiations.

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.

Leave a Reply

Your email address will not be published. Required fields are marked *