Muni Credit News March 2, 2017

Joseph Krist

joseph.krist@municreditnews.com

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THE HEADLINES…

“nobody knew that health care could be so complicated” 

MASSACHUSETTS PENSIONS UNDER SCRUTINY

DETROIT PENSION PROPOSAL

FINANCIAL RISKS OF NUCLEAR HIGHLIGHTED AGAIN

SEC TO CONSIDER DISCLOSURE ENHANCEMENTS

PRESIDENTS SPEECH AND MUNICIPALS

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“nobody knew that health care could be so complicated” 

So said President Trump before the National Governors Association this week. We think that most, if not all, of the Governors knew better.

A leaked copy of a House Republican repeal bill would dismantle Obamacare subsidies and scrap its Medicaid expansion. The proposed bill provides for elimination of  the individual mandate, subsidies based on people’s income, and all of the law’s taxes. It would significantly roll back Medicaid spending and give states money to create high-risk pools for some people with pre-existing conditions. Some elements would be effective right away; others not until 2020.

In place of the Obamacare subsidies, the House bill starting in 2020 would give tax credits — based on age instead of income. For a person under age 30, the credit would be $2,000. That amount would double for beneficiaries older than 60, according to the proposal. A related document notes that HHS Secretary Tom Price wants the subsidies to be slightly less generous for most age groups.

For Medicaid, the draft bill calls for capped payments to states based on the number of Medicaid enrollees or a per capita system. The proposal would allow for $100 billion in “state innovation grants” to help subsidize extremely expensive enrollees like those with “pre-existing conditions”, without the same broad protections as in the Affordable Care Act.

How would all of this be paid for? Republicans are proposing to cap the tax exemption for employer sponsored insurance at the 90th percentile of current premiums. That means benefits beyond that level would be taxed. This is what was derisively known as the Cadillac tax which was opposed by unions and business during the original ACA debate. The CBO has yet to opine about how much it will cost and what it will do to the federal deficit.

The legislation would allow insurers to charge older customers up to five times as much as their younger counterparts. Currently, they can charge them only three times as much. It also includes penalties for individuals who fail to maintain continuous coverage. If they have a lapse and decide to re-enroll, they would have to pay a 30 percent boost in premiums for a year.

According to the latest Kaiser Family Foundation tracking poll, released Friday morning, the public now views the Affordable Care Act more favorably than it has since the summer of its enactment. Some 48 percent view the law favorably — up from 43 percent in December. About 42 percent have an unfavorable view of the ACA — down from 46 percent in December. The pollsters say Independents are mostly responsible for the shift. A separate poll by the Pew Research Center found 54 percent approve of the health care law — the highest scores for Obamacare in the poll’s history. Meanwhile, 43 percent said they disapprove.

Like all of the plan’s talked about to date with republican sponsorship, the net result is budget negative for states and counties. The plans all produce less money, discourage Medicaid expansion, are likely to produce larger groups of underinsured sick and uninsured. None of this is good for state government as it will impose greater requirements for uncompensated care and reduce the downward pressure on costs experienced by providers under the terms of the ACA.

MASSACHUSETTS PENSIONS UNDER SCRUTINY

A Boston-based public policy research institute advocating individual freedom and responsibility, limited and accountable government released a policy brief which said that Massachusetts should set a five-year deadline for 102 public pension systems to transfer their assets to the Pension Reserves Investment Management Board. The Board — also known at PRIM — already manages both the Massachusetts State Employee Retirement System and the Massachusetts Teachers Retirement System.

The Pioneer Institute says PRIM offers better asset allocation and cash management, lower investment fees and other costs, and more attractive investment options because of its size and market power. From 1986 to 2015, the difference in gross returns between non-state public pensions (i.e., excluding the MTRS and MSERS) and PRIM implies a taxpayer loss of more than $2.9 billion. The report finds that the systems forfeited nearly $1.6 billion from 2000 to 2015 alone by not investing with PRIM, or $97 million a year.

The institute estimates that local retirement systems have forfeited about $2.9 billion over the past 30 years. Between 2000 and 2015, the number of local systems fully invested in PRIM nearly doubled from 19 to 37, and the number that were partially invested more than tripled from 17 to 53. From 1986 to 1996, PRIM achieved annualized gross returns of 11.45 percent, while systems that were partially invested achieved 10.62 percent and returns for non-PRIM funds were 10.32 percent.

From 2000 to 2015, PRIM’s annualized gross returns were 5.8 percent, partially invested systems generated 5.4 percent and non-PRIM systems returned 5.3 percent.  The gulf for both time spans adds up to an unrealized $2.09 billion, not including forgone compounding and PRIM’s lower fees.  In 2007, the Massachusetts General Court passed special legislation requiring underperforming public retirement systems to transfer their assets into PRIM’s custody. Any system funded below 65 percent and trailing PRIM’s average return over the prior decade by at least 2 percent was to be deemed underperform­ing. Alongside the subsequent financial crisis, this statute has helped double the number of systems participating in PRIM to more than 40. Only 9 out investments with PRIM.

DETROIT PENSION PROPOSAL

Many had hoped that Detroit’s major financial obligations including pensions would be addressed through the City’s Chapter 9 proceedings. It quickly became apparent that this was not the case. Pensions were projected to become problematic again as soon as 2024. Now, The Duggan administration is proposing a dedicated fund that officials project will pull together $377 million in the coming years to help address a looming Detroit pension shortfall in 2024.

The proposal was part of an overview of the Retiree Protection Fund to Detroit’s City Council during his presentation of the proposed $1 billion general fund budget for the 2017-18 fiscal year. The mayor said he will ask the council to create the dedicated account for retirees, above the required contributions laid out in Detroit’s bankruptcy plan. The fund would gather interest and investment earnings so that by 2023 it would have $377 million to help manage massive payments the city must begin contributing in 2024.

“The retirees in this city already had their pensions cut once, and we need to make sure it never happens again,” Duggan said. “We will have a dedicated account that has to be used for retirees. We can’t hit a budget problem and take it back out.”

Of more concern was that Detroit Mayor Mike Duggan said that former emergency manager Kevyn Orr kept him in the dark about calculations used to predict the city’s future pension payments. Now, as the city realizes those payments will be many millions higher than expected, Duggan said the city is considering a lawsuit against Orr’s firm, Jones Day.

Because of the secrecy from Orr’s team, the city plans to put $50 million this year into a trust fund to cover future pension payments, Duggan said. Duggan said that the potential lawsuit hinges on whether Orr was obligated to keep Duggan in the loop in 2014 during talks about what the city would owe when those pension payments resume in 2024. “The discussions between the actuary and other people of Mr. Orr’s team were concealed from (Detroit CFO John Hill) and me,” Duggan told City Council “We did not know that these assumptions were being based on these optimistic set of criteria. Had we known that, we would’ve dealt with it very differently.”

That is a very tough statement on the part of the City’s chief executive and it should raise concerns with all parties to the issue. Duggan initially raised the prospect of a lawsuit against bankruptcy consultants early last year when the city discovered an estimated $491-million shortfall between pension payments estimated in the bankruptcy exit plan, approved in 2014, and more recent figures. The consultants underestimated the pension payments because they used outdated mortality tables,  which predict how long retirees are expected to live and, in turn, receive pension checks. Duggan said he expects a decision on whether the city will sue within six months.

Had he known then about Orr’s methodology, Duggan said more prudent plans could have been made during the bankruptcy rather than having to set aside money now for future pension payments. Even if the city sues, it still has to prepare because a lawsuit against Jones Day would take years, the mayor said. Jones Day eventually collected nearly $54 million for its work on the city’s bankruptcy. The firm cut $17.7 million off its bills under court-ordered mediation. The bankruptcy — authorized by Gov. Rick Snyder and directed by Orr — cost the city about $165 million in general fund dollars.

Issues like this are why there were concerns raised when Mr. Orr was retained to advise on Atlantic City’s financial difficulties. Bankruptcies are difficult enough for all of the competing creditor classes. The one thing which all parties should be able to agree on is the quality and veracity of the consultants employed as experts who provide “objective” information to the competing parties as well as the overseers of these disputes. The results of the Detroit process should serve as a cautionary tale for all participants in any future workout process.

FINANCIAL RISKS OF NUCLEAR HIGHLIGHTED AGAIN

Ever since plans were announced for the construction of new nuclear generating capacity in the southeast U.S., observers have been wondering how the economics of these projects would impact the various companies involved in them. While they are sponsored and primarily owned by two investor owned IOUs – Georgia Power and South Carolina Electric and Gas – major shares of these units are also owned by municipal power entities. The Municipal Electric Authority of Georgia owns a portion of  portion of the Sumner plants in South Carolina.

Both of these entities are long standing owners of nuclear capacity so they entered these transactions with their eyes wide open.  Some of us have been concerned for some time about the financial risks associated with them. These risks could have stemmed from a shifting regulatory requirement, issues with potential cost overruns, or technological change. What has been somewhat of a surprise is the potential for financial pressure on the owners of these new plants from another source of financial instability.

The news this month that the Toshiba Corp. was experiencing financial difficulties was not a total surprise given their involvement in nuclear plants in Japan stemming from the Fukushima disaster. Since then, Toshiba’s Westinghouse subsidiary purchased a nuclear construction and services business from Chicago Bridge & Iron (CB&I) in 2015. But assets that it took on are likely to be worth less than initially thought, and there is also a dispute about payments that are due. Earlier this year, Toshiba announced that it would take a $6 billion write off associated with Westinghouse and delayed the release of financial results until mid-March.

Toshiba’s nuclear business has not made a profit since 2013. In addition, Toshiba is still struggling to recover after it emerged in 2015 that profits had been overstated for seven years. The Japanese press reported Toshiba was now looking at a potential Chapter 11 filing as one of several options for Pittsburgh-based Westinghouse, as it grapples with cost overruns at the two U.S. projects.

Westinghouse is the engineering, procurement and construction contractor for Plant Vogtle as well as at V.C. Sumner. MEAG owns 22.7% of the new units at Plant Vogtle and projects that its total financing costs will be about $4.7 billion. Santee Cooper is a 45% owner in VC Summer’s new units and estimates its costs will be about $5.1 billion. A Westinghouse bankruptcy would be credit negative even with mitigation measures built into the construction contracts, including letters of credit and Toshiba’s parental guarantee on both the projects. The utilities have escrows on the project’s design and intellectual properties.

Nonetheless, Fitch Ratings placed its A-plus rating on Santee Cooper’s s$6.7 billion of revenue obligations on rating watch negative. S&P Global Ratings, which rates the various entities involved in the Georgia and South Carolina projects, said it is continuing to assess whether the financial burdens at Toshiba will translate into negative effects on credit ratings.

Toshiba confirmed its memory business will be separated from the main Toshiba business in preparation for a part or majority stake sale. It plans to raise at least 1 trillion yen from the sale, enough to cover the Westinghouse writedown and create a buffer for any fresh financial problems. It plans to raise at least 1 trillion yen from the sale, enough to cover the Westinghouse writedown and create a buffer for any fresh financial problems. It denied any knowledge of plans to seek Chapter 11 protection for Westinghouse.

So it appears that our concerns about the involvement of MEAG and Santee Cooper in new nuclear construction projects were not misplaced.

SEC TO CONSIDER DISCLOSURE ENHANCEMENTS

The Securities and Exchange Commission will weigh two amendments to required material event notices under its Rule 15c2-12 during a meeting on March 1 that may include discussion of adding bank loans and private placements to the 14-item event list.

Bank loans and the disclosure about them have been a continuing source of concern for investors as much for the lack of details about their various security provisions as for questions about amounts outstanding. Investors continue to be concerned with how to obtain the level of detail which they feel they need to assess the risk they bear from changes in the status of bank debt on a lien basis relative to their own holdings under a variety of credit scenarios. Such information can be crucial to the ongoing valuation process for assessing current and prospective holdings.

The same holds true for private placements. We are in favor of any regulatory effort that increases the amount of information available to the market and would be hopeful that the list of material events be increased.

PRESIDENTS SPEECH AND MUNICIPALS

“Crumbling infrastructure will be replaced with new roads, bridges, tunnels, airports and railways gleaming across our beautiful land. To launch our national rebuilding, I will be asking the Congress to approve legislation that produces a $1 trillion investment in the infrastructure of the United States — financed through both public and private capital.” And that is it. We have documented some of the scale of the need and the role that municipal bonds can play in satisfying that need.

As for healthcare, Americans with pre-existing conditions have access to coverage, and that we have a stable transition for Americans currently enrolled in the healthcare exchanges. Secondly, we should help Americans purchase their own coverage, through the use of tax credits and expanded Health Savings Accounts — but it must be the plan they want, not the plan forced on them by the Government. Thirdly, we should give our great State Governors the resources and flexibility they need with Medicaid to make sure no one is left out. Fourthly, we should implement legal reforms that protect patients and doctors from unnecessary costs that drive up the price of insurance — and work to bring down the artificially high price of drugs.

None of this is anything new in terms of political orthodoxy on the right and each of these provisions brings with it some level of political opposition. So for those who were looking for some effort to address the real policy issues associated with health and infrastructure, the speech comes up short. In terms of what it all means for municipal credit, the answer is not much at this point.

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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