Muni Credit News March 24, 2016

Joseph Krist

Municipal Credit Consultant

CHICAGO TAKES ANOTHER CREDIT HIT

Already facing a short term pension crisis, the City of Chicago suffered a severe body blow today when the Illinois  found unconstitutional a law that sought to cut benefits and require employees to pay more toward their retirement. The state’s high court agreed with a Cook County judge who found that the state law that Mayor Rahm Emanuel pushed through in 2014 violated a clause in the Illinois Constitution that states pension benefits once granted “shall not be diminished or impaired.” “These modifications to pension benefits unquestionably diminish the value of the retirement annuities the members of (the city workers and laborers funds) were promised when they joined the pension system. Accordingly, based on the plain language of the act, these annuity reducing provisions contravene the pension protection clause’s absolute prohibition against diminishment of pension benefits, and exceed the General Assembly’s authority,” the justices wrote in their opinion.

Losing the case frees up some money in the short term because the Emanuel administration won’t have to pay as much money into the two pension funds for non-uniformed municipal workers and laborers. But for the police and firemen’s funds a looming year-end budget shortfall has forced Mayor Rahm Emanuel’s administration to borrow $220 million in yet another sign of the city’s precarious pension funding status. The city drew the money down from its $900 million line of short-term credit, which carries an interest rate of about 3 percent. The money is not due to police and fire pension funds until the end of the year. But the city had to borrow the money to meet a March 1 deadline for having the cash in its treasury. State law requires that the city deposit the money with the treasurer to demonstrate it has the money available if it’s needed. The city doesn’t expect to raise enough from property taxes so, it must deposit the anticipated shortfall by March 1.

The City Council voted in October to increase property taxes by $543 million annually in phases over four years, with nearly all of the money dedicated to police and fire pension fund contributions. But that budget still depended on Gov. Bruce Rauner to sign a bill that would stretch out the payments and reduce this year’s cost by $219 million. Although the state House and Senate, both controlled by Democrats, approved the bill, they have not sent it to the governor for fear he’ll veto it if they don’t sign on to his pro-business, union-weakening agenda. The governor’s spokesman has said Rauner would sign the bill only “as part of a larger package of structural reform bills.”

That argument has been keeping the state from approving a budget for more than eight months now. And there’s no end in sight to that stalemate, given that last week’s primary elections did not change the state’s partisan political landscape despite the record amounts of money spent on some General Assembly contests. If the governor signs the bill, the city will return the $220 million to its line of credit. If not, it goes to the police and fire pension funds at the end of the year. If the bill isn’t signed, the city will have to pay off the $220 million loan. That could mean service cuts, further tax increases or both. Some political observers believe the Springfield logjam could break after the November general election. But if the Chicago police and fire pension bill is not signed by Rauner, the city could end up more than $1.2 billion short over the next five years.

An additional negative concern is that leaders of one pension fund think the city has to pay up well before the end of the year. The Firemen’s Annuity and Benefit Fund of Chicago board last week voted to notify city Treasurer Kurt Summers that it expects the city to remit $47 million — its share of the $220 million — to the pension fund within 31 days of depositing the borrowed cash. The police and fire retirement fund shortfalls aren’t the city’s only pension concerns. If the court upholds the trial court determination that the law is unconstitutional, the city would no longer be obligated to make the increased contributions, but the shortfall would continue to grow — meaning the city would have to pay more over the long haul. That could ultimately mean even higher property taxes.

PR SHOWS ITS HAND

Seven-members of the Supreme Court (Justice Samuel Alito recused himself from the case because of a financial conflict and no one has yet replaced the late Justice Antonio Scalia) heard arguments urging them to overturn a ruling last year by the U.S. Court of Appeals for the First Circuit in Boston, that concluded the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (DERA) is illegal. The appeals court sided with funds that hold over $2 billion of bonds by the Puerto Rico Electric Power Authority and concluded that DERA violates a section of the U.S. Bankruptcy Code that prohibits states from passing laws allowing their authorities to restructure debt without the approval of those entities’ creditors. The  high court is expected to rule on the case by June.

But even if four of the seven Justices rule in favor of Puerto Rico and overturn DERA, several of them seemed to be concerned that DERA might violate the contract clause of the U. S. Constitution, which prohibits states from impairing private contracts. The lawyer for the Commonwealth told judges the contract clause issue could be argued if the case is remanded back to the appeals court, but it is not an issue before the high court.

Congress could eventually pass legislation that either gives, or refuses to give, Puerto Rico or its authorities bankruptcy protection under Chapter 9 and that measure would supersede any ruling by the Supreme Court.

During oral arguments the lawyer representing hedge fund BlueMountain Capital Management as well as Franklin and Oppenheimer funds was asked, “Why would Congress put Puerto Rico in this never-never land, that is, it can’t use Chapter 9 and it can’t use a Puerto Rico substitute for Chapter 9?” Puerto Rico “is locked out … It has to take the bitter but it doesn’t get any benefit at all,” she said. Justice Sonia Sotomayer, said, “It is inherent in state sovereignty that states have to have some method, their own method, of controlling their municipalities.”

The Commonwealth’s attorney argued that two sections of Chapter 1 of the bankruptcy code serve as a “gateway” that keeps Puerto Rico out of Chapter 9 altogether, including Section 903(1) which says state law cannot prescribe “a composition of indebtedness” that bind creditors without their consent. Section 101(52) of the code says in part that the definition of state “includes the District of Columbia and Puerto Rico” except for the purposes of defining who may be a debtor under Chapter 9.”

Section 109(c)(2) of the code says an entity is only a debtor under Chapter 9 if it “is specifically authorized, in its capacity as a municipality or by name, to be a debtor under such chapter by State law, or by a governmental officer or organization empowered by State law to authorize such entity to be a debtor under such chapter.” The Commonwealth feels that section means Puerto Rico is categorically precluded from authorizing its municipalities to enter Chapter 9 and that it is simply not part of Chapter 9.

The justices noted that the bankruptcy code does not mention Guam or the Virgin Islands and wondered if Congress intended to treat the territories differently. (The Menendez legislation does.) Roberts asked why it doesn’t make sense to think Congress wanted to keep Chapter 9 for the states and make the territory come to it for help. In response to the argument that it would be very anomalous [for] Puerto Rico [to be] in a worse position, let’s say, than Guam and the Virgin Islands, Roberts asked why did Congress lump Puerto Rico with the District of Columbia in saying in the bankruptcy code that there were not states except for the purpose of defining who would be a debtor under Chapter 9.

Ginsburg also asked the hedge funds’ lawyer, “What explains Congress wanting to put Puerto Rico in this anomalous position of not being able to restructure its debts?” His answer was that Congress has always micro-managed Puerto Rico’s debt, citing a change to the Jones Act aid that limited the amount of debt it could take on. Second, he said, Puerto Rico debt is triple tax-free and therefore is held by bondholders all over the U.S. Finally, he noted, when Congress amended the bankruptcy code in 1984 to say Puerto Rico is a state except for defining who a debtor is under Chapter 9, it was concerned about the amount of indebtedness of both Puerto Rico and D.C.

The real strategy of the current PR administration was reinforced after the hearing. Resident Commissioner Pedro Pierluisi said “it continues to be my view that the most responsible course of action is not to wait for the Court to rule, but rather for Congress to swiftly enact legislation that, on the one hand, authorizes Puerto Rico to restructure a meaningful portion of its debt and, on the other hand, establishes a temporary and independent board that enables the Puerto Rico government to engage in more disciplined fiscal policymaking, to publish transparent and timely financial information, and to regain access to the credit markets on reasonable terms. The board can also between debt-issuing entities and their creditors and serving as a gatekeeper before any debt-issuing entity can ask a federal judge to make a restructuring agreement  binding on all creditors.”

FERTILIZER PLANT FAILS TO YIELD A GOOD CREDIT

Back in 2012, over $1 billion bonds were issued by the Iowa Finance Authority under its Midwestern Disaster Area Revenue Bond program on behalf of the Iowa Fertilizer Company. Iowa Fertilizer was a subsidiary of an Egyptian based production company. At the time, the issue generated much controversy due to the foreign ownership of the Company and its use of materials that were considered to be useful to terrorists. The plant was also being built shortly after a massive explosion at a Texas fertilizer production facility had occurred. Many questions were raised as to the appropriateness of the use of tax exempt financing in such a large amount for such a foreign owned project.

That facility is back in the news for more traditional high yield market reasons. The company behind a $1.9 billion fertilizer plant under construction in southeast Iowa stopped making payments and held on to tools of one of the project’s contractors, according to a lawsuit filed in U.S. District Court. In the lawsuit, the contractor claims Orascom E&C USA hired the company to work as a subcontractor on the fertilizer plant. The company claims Orascom E&C paid it for its work up until September 2015.

According to the suit, after that date Orascom E&C stopped making payments. Maintenance Enterprises says Orascom E&C has made no payments regarding certain work since Oct. 29, 2015. Overall, Maintenance claims Orascom E&C owes it more than $53.4 million. Maintenance also claims Orascom E&C “physically barred” the company from removing small tools, protection equipment and other property Maintenance says it purchased for use on the plant. Maintenance has filed a mechanic’s lien with the Iowa Secretary of State’s office against the Iowa Fertilizer property for more than $50 million. It is not the only company to issue a mechanic’s lien on the property.  Other liens include one for more than $119 million filed by Texas-based RW Constructors. Liens for millions of dollars each have also been filed by companies based in Iowa, Illinois and Washington.

Now the bond trustee has informed holders of the bonds that the commissioning of the plant has been delayed due to construction delays. The EPC Contractor is revising the Mechanical Completion and Provisional Acceptance dates. This has resulted in the Company incurring additional administrative costs during the delay period. In order to complete the project, the Company will need to rely on funds outside of the Committed Funds, as defined in the Collateral Agency Agreement, such as profits from production earned prior to Provisional Acceptance, cash deposits by customers on fall prepay sales customary for the Midwest fertilizer market, and potentially support from its parent. OCI N.V., the ultimate parent of the Company remains committed to completing the project.

The Company is required to provide notice within ten business days that it filed a Requisition with the Collateral Agent in accordance with the Collateral Agency Agreement. The Company filed such a Requisition on February 22, 2016, which will be disbursed from the Equity Construction Account in accordance with the provisions of the Collateral Agency Agreement. The Company did not satisfy the requirement of the Collateral Agency Agreement, providing for a certification by the Company on each requisition that Provisional Acceptance  can be achieved by the Scheduled Provisional Acceptance Date. The Company did not satisfy the requirement of the Collateral Agency Agreement, providing for a certification by the Company on each requisition that Other Project Costs are not reasonably expected to exceed amounts budgeted therefore in the aggregate in the Other Project Costs Budget.

The Company also did not satisfy the requirement the Collateral Agency Agreement, providing for a certification by the Company on each requisition that the Committed Funds are reasonably expected to be sufficient to complete the Project according to the terms of the EPC Contract and the Other Project Costs Budget. The Collateral Agency Agreement provides that, due to the omission in Requisition 38 of the certifications, any subsequent requisition submitted by the Company that omit any required certification shall not be funded by the Trustee and Collateral Agent if the beneficial owners of at least a majority of the aggregate principal amount of the outstanding Series 2013 Bonds direct the Trustee and Collateral Agent not to fund the requisition. After the payment of Requisition 38, the remaining amounts on deposit with the Trustee and Collateral Agent for Project costs are $41,038,647 in the Equity Construction Account of the Company Construction Fund, $0 in the Equity Contingency Account of the Company Construction Fund and $0 in the Indenture Construction Account.

This all matters because if the plant can’t be completed and operated hence the bondholders will have to rely on debt service reserves and the willingness of the foreign owner to provide additional funds for debt service. If the market is concerned it isn’t showing up in prices with bonds trading through the coupon below 5%. One has to ask if that is enough to compensate for the risk.

ATLANTIC CITY BRINKMANSHIP CONTINUES

The mayor of this New Jersey resort city said on Monday that dismal finances would force a three week long shutdown of all nonessential government services starting early next month if the city does not get state aid. Mayor Donald Guardian, a Republican, said the shutdown would start on April 8 and was likely to last until at least May 2, when quarterly tax revenue is set to arrive. Police, fire and sanitation workers would perform their jobs without pay but would be paid when the tax money came in. Mr. Guardian said the city could be in a similar situation in a couple of months, especially if the state withheld aid. The city’s tax base has contracted since four of its 12 casinos closed. State lawmakers are debating a financial takeover plan that Mr. Guardian said goes  too far in wresting control from city officials. The comments reflect the conflict between the City and Governor Christie who in his usual low key way said that he would not sign the legislation if “one word” in it was changed.

MUNIS REMAIN AT THE FOREFRONT ON NEW NUCLEAR DEVELOPMENTS

From 2029 to 2035, three dozen of the nation’s 99 reactors, representing more than a third of the industry’s generating capacity, will face closure as their operating licenses expire. Nuclear energy, which provides 19 percent of the nation’s electricity but has struggled in recent years to compete against subsidized solar and wind power and plants that burn low-priced natural gas. Industry advocates say that by removing sources of clean electricity — a nuclear reaction produces no carbon dioxide or other greenhouse gases — the closings could affect the government’s ability to fulfill its pledge, made at the Paris climate talks last year, to reduce emissions.

The Southern Co. with whom the Municipal Electric Authority of Georgia participates in nuclear generation, announced in January that it would receive up to $40 million from the Department of Energy to develop an advanced reactor that uses molten salt as a coolant instead of water, which all current designs use. The process is being developed by a company called NuScale. It’s design has been under development since 2000. It has lined up a potential first customer, Utah Associated Municipal Power Systems, or UAMPS, which operates in the Intermountain West, and hopes to have 12 of the small reactors operating at a site in Idaho by the mid-2020s. NuScale has been testing its design for 13 years, using a nonnuclear prototype. Later this year, it plans to submit an 11,000-page application to the N.R.C. to have its design certified. The commission then has up to 40 months to review the application.

The certification process, and a later application by UAMPS for a construction and operating license, could be delayed if the N.R.C. asks for more information. But even if all goes smoothly, the plant will produce only about half the electricity of many existing reactors. About 50 of these 12-reactor plants would be needed to replace the generating capacity that could be lost by 2035. Many hope that extending the licenses of existing reactors will forestall at least some closings. Nuclear plants were originally licensed for 40 years, but almost all have sought and received 20-year extensions.

The regulatory commission has begun researching what would be required to extend a plant’s life to 80 years. “We’re asking very basic questions, like how long can a reactor vessel remain acceptable since it’s being bombarded by neutrons,” said a spokesman. “The information we have at this point is that those are issues that are not showstoppers.” So far one operator has announced plans to seek such an extension, for two reactors set to close in the early 2030s, but an application and possible approval are still years away. Duke Energy, owner of the Robinson plant in South Carolina, said it was evaluating whether to pursue an extension.

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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