Muni Credit News March 26, 2015

Joseph Krist

Municipal Credit Consultant


Whenever a difficult political issue comes up, it’s often described as being a political “third rail”.  The national moves toward the reform of pension funding have had a common “third rail”  feature as they take shape. That feature is that the various proposals to address pensions nearly universally exempt police and firefighters from adjustments to their pension benefits. The difficulty in addressing some of the thorniest pension issues is summed up in recent comments by Gov. Bruce Rauner of Illinois. He has been promoting a plan for more than $2 billion in cuts to pensions for public employees, except police officers and firefighters. “Those who put their lives on the line in service to our state deserve to be treated differently,” Mr. Rauner said in his February budget address to the state legislature.

Similar positions have been voiced by governors in adjacent states as they address pension and other labor issues. In 2011, Gov. Scott Walker of Wisconsin signed a law that limited collective bargaining rights for government workers and required them to contribute more toward their own pensions and health coverage. The legislation, known as Act 10 excluded police officers and firefighters from its provisions. In 2012, Gov. Rick Snyder of Michigan signed a right-to-work bill, eliminating the requirement that private and public sector workers contribute dues to the unions that represent them, whether or not they are members. The bill included a “carve-out” for police officers and firefighters.

Politically, the carve outs make sense. These services are provided by members who have strong political support. Who would politically risk denying the unique risks of police officers and firefighters? Take the politics out of the issue and rely on analytics to support the basis for such exemptions – the dangerous nature of the work – the exemption is not necessarily statistically supported. They are not the only public employees whose work is dangerous. Statistically, at least, there are far more dangerous public sector jobs. According to the Bureau of Labor Statistics, on-the-job fatalities occur at a significantly higher rate for “refuse and recyclable material collectors” — sanitation workers — than for police officers. The same is true for power line installers and truck drivers. And fatality rates for these workers exceed those for firefighters by a considerable margin, though firefighters have serious health complications like cancer at relatively high rates in retirement.

Even with the public’s view of the special nature of police and fire work,there may be a more economic way to reflect that view than through pensions. Police officers and firefighters can retire with full pensions at younger ages than other state employees (beginning at age 50 in Illinois, often younger in other states). That means they frequently spend many more years drawing their pension benefits, even while being permitted to maintain full-time salaries in the private sector. This drives up long-term costs for municipalities and states. There is also an argument to be made that early retirement policies also deplete police and fire departments of the valuable experience of critical employees when their experience is most valuable.

In Wisconsin, Gov. Walker argued that it was important to exempt police officers and firefighters because the state relies on them during emergencies and cannot afford unrest in their ranks. In Michigan, Mr. Snyder worried that extending right-to-work provisions to police officers and firefighters would hurt their cohesion. For other workers, the argument in favor of right to work was based on freedom of association and more supervisory flexibility.

One would think that if policing and firefighting are the most critical services local governments provide, the public would be more likely to support improvement and modernization of operating practices. For example, municipalities could improve the productivity of their fire departments by reforming the traditional schedule of 24 hours on, followed by one or more days off. But the only way to change that is through bargaining, and the concept has been resisted  by police and fire unions.

Some backers of right-to-work laws and curbs on collective bargaining for public employees say they should be applied without exception. This however works better in theory than in practice. One governor who did not exempt public safety employees from limits on their bargaining rights was Gov. John Kasich of Ohio. His proposals were rejected by voters in a referendum within eight months.

As for Illinois, while it waits for its pension changes to work their way through the courts, Gov. Rauner has instructed state agencies to divert money from nonunion employee paychecks away from organized labor until a judge settles the matter. A memorandum obtained by The Associated Press, shows his general counsel, Jason Barclay, directing departments under the governor’s control to create two sets of books: one with the “proper pay” and one, to be processed, that reduces the worker’s gross pay by an amount equal to what is normally paid in the fees. Mr. Rauner’s action could keep about $3.74 million out of union bank accounts. Of course, two sets of books is something that municipal analysts love and always is reflective of financial dysfunction.


The Government of Puerto Rico said last week that it refinanced $246 million in outstanding bond anticipation notes (BANs) at a rate of 8.25%. Principal sinking fund payments begin July 1, 2015. The notes are secured by a pledge of $6.25 of the new tax on non-diesel petroleum products and are guaranteed by the full faith and credit of the Commonwealth of Puerto Rico. Through the transaction, the holders of the Highways and Transportation Authority (HTA) BANs released all liens on pledged HTA revenues.

The notes issued by the Infrastructure Financing Authority (PRIFA) were bought by RBC Capital Markets as a part of the plan to increase the liquidity of the Government Development Bank (GDB) and support the finances of the HTA, one of PR’s several heavily indebted public corporations. The new notes redeem and retire a previous BAN issued for the HTA that matures Sept. 1, 2015.

The BANs are ultimately expected to be refinanced prior to maturity with the proceeds of a long-term PRIFA bond issuance. The deal was expedited by Act 29 of 2015, quietly enacted into law by Gov. Alejandro García Padilla. The legislation makes technical amendments to the law authorizing an increase in the petroleum-products tax to back the $2.95 billion bond deal, which is expected to occur by early May. The new law raises the excise tax on a barrel of crude oil from $9.25 to $15.50. It includes an adjustment factor that calls for the tax to be increased in the future if revenue isn’t sufficient to repay the bonds. The first adjustment, if required, would take effect July 1, 2017, according to the bill.

Moody’s has estimated that the GDB’s liquidity could fall as much as 22% if there was no new bond offering to refinance the HTA’s debt. Moody’s also has projected that the Electric Power Authority (PREPA) will likely default by July 1, when it is scheduled to make an estimated $400 million debt service payment.

The GDB has also said that it expects to hold an investor teleconference by early April to discuss more details of the deal, as well as provide updated information on government revenue and the outlook for the proposed fiscal year 2016 budget, which will be presented in the coming weeks. Some estimates are that the bond issue could need to be sold at a yield of up to 10.5% for investors. The issue, however, has an average interest-rate cap of 8.5%. Without insurance, Puerto Rico would have to offer a discount of 88 on the issue to obtain that yield. That is estimated  to net Puerto Rico $2.5 billion if the full $2.95 billion issue were sold.

Hedge-fund investors, expected to be the prime buyers of the bonds, have been making suggestions to improve operations and accountability. One proposal is for legislation that would empower the GDB to name emergency managers for up to two years for financially troubled public corporations, government agencies and municipal governments. The emergency-manager proposal being discussed would only require the consent of the governor to name an emergency manager, without having to get Puerto Rico Senate or other legislative approval. The emergency manager would have broad powers to act independently to fix the finances at the particular entity.


In spite of rates of decline in cigarette consumption which seem to be outpacing estimates, tobacco bonds may be on their way to the biggest volume since 2007. Issuers are taking advantage of the historically low interest rates to refinance and sell additional settlement revenues. This week, California’s Golden State Tobacco Securitization Corp. will be coming to market with a $1.7 billion tobacco issue enhanced by a pledge from the state to seek an annual appropriation for debt service and operating expenses should settlement payments fall short. Proceeds will be used to repay existing tobacco bonds that do not benefit from a pledge from the state and so are more exposed to a shortfall in settlement payments. Other issues include a $621 million sale last month in Rhode Island and a proposed $875 million new money deal from Louisiana later in 2015. In 2014, only about $175 million of tobacco bonds were sold.

The official statement for the $1.7 billion for the California issue includes the latest smoking decline estimates of James Diffley, a senior director at IHS Global Inc. He forecasts that total consumption in 2045 will be 104.0 billion cigarettes (or 104.6 billion including roll-your-own tobacco equivalents), a 61% decline from the 2014 level. The report projects that from 2015 through 2045 the average annual rate of decline is projected to be approximately 3.0%.

In April 2013, IHS Global presented a similar that projected consumption in 2045 of 105.7 billion cigarettes (including roll-your-own equivalents), reflecting an average decline rate of 3.0%.

The proposed Louisiana Tobacco Settlement Financing Corp. issue would   securitize the remaining 40% of the state’s share from the Master Settlement Agreement with tobacco companies. The bond would generate revenue for operating purposes to plug projected budget gaps over the next seven years by funding the state’s higher education scholarship program. The plan is controversial and is subject to approval by the Legislature and other state agencies.

Louisiana securitized 60% of its tobacco settlement revenue in 2001 with the sale of $1.2 billion in bonds. The new securitization is expected to go before the State Bond Commission April 16, and the Joint Legislative Committee on the Budget May 20. If approved by the legislature, the bonds likely would be sold in June.

The key for investors is to determine which consumption scenario they believe in. In May 2014, Moody’ Investors Service estimated that 65%-85% of the aggregate outstanding balance of all tobacco settlements bonds that Moody’s rates, will default. More recently, S&P estimated that cigarette shipments will decline 5.25% in the next two years and 4.75% thereafter.


Last week, the California state government imposed new mandatory restrictions on lawn watering and incentives to limit water use in hotels and restaurants as part of its latest emergency drought regulations. Gov. Jerry Brown also announced a $1 billion plan to support water projects statewide and speed aid to hard-hit communities already dealing with shortages. Federal water managers have already announced a “zero allocation” of agricultural water to a key state canal system for the second year in a row. This moves come after the state has fallen behind targets to increase water efficiency in 2015 amid the state’s worst drought in 1,200 years. California’s snowpack is now at a record low—just 12 percent of normal.

The situation highlights the long standing divide between urban and agricultural water users. California’s cities have more than enough water to withstand the current drought and then some. They have low water usage per capita. Agriculture uses 80 percent of California’s water—10 percent of that on almonds alone. That may not be sustainable as  abnormally dry conditions have been recorded in 11 of the last 15 years.

So small agriculturally based water credits remain the ones with the most credit vulnerability while the larger urban districts have by and large adjusted their usage and rates to the current environment.

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