Muni Credit News March 7, 2017

Joseph Krist

joseph.krist@municreditnews.com

THE HEADLINES…

ENERGY STATE BLUES BLEEDING THROUGH TO RATINGS

KANSAS COURT RULING ON EDUCATION SPELLS BAD NEWS

ILLINOIS BUDGET STANDOFF CONTINUES

P.R. DRAMA TO DRAG ON

LARGE HEALTH SYSTEM DOWNGRADE

NYC BUDGET REVIEW

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ENERGY STATE BLUES BLEEDING THROUGH TO RATINGS

Oklahoma joined the ranks of energy dependant states to see their rating downgraded in the face of declining revenues as energy prices remain low. The Sooner State joined Louisiana, New Mexico, and West Virginia in experiencing revenue squeezes as the result of relatively low energy prices. S&P lowered the state’s general obligation bond debt rating from AA+ to AA. The agency also lowered its rating on the state’s appropriation debt from AA to AA-.

It kept its outlook on the state’s financial picture as stable, but warned Oklahoma’s reliance on one-time sources of revenue to balance the budget makes the state vulnerable to further revenue declines. “In the absence of meaningful structural reforms that align revenues and expenditures and that do not materially depend on one-time budget solutions or measures that carry significant implementation risk, we could lower the ratings.”

The state treasurer said “Years of suboptimal budgeting that has relied heavily on the use of nonrecurring revenue is now impossible for the rating agencies to ignore. This downgrade, and others likely to come, will lead to higher debt costs for future infrastructure projects unless sustainable corrective action is taken.”

KANSAS COURT RULING ON EDUCATION SPELLS BAD NEWS

The Kansas Supreme Court on Thursday ruled unanimously that state funding to schools is inadequate and gave the Legislature a June deadline to enact changes, scrambling a legislative session already consumed by a sprawling budget debate.

The ruling in the Gannon lawsuit came as lawmakers were away for a week-long break at the traditional midpoint of the legislative session, but it sent shockwaves throughout the state. Gov. Sam Brownback, as well as Republican and Democratic lawmakers, said the decision emphasizes the need for lawmakers to enact a new finance formula.

“Under the facts of this case, the state’s public education financing system provided by the legislature for grades K-12, through its structure and implementation, is not reasonably calculated to have all Kansas public education students meet or exceed,” educational standards, the court ruled.

The court’s opinion doesn’t give an exact amount lawmakers need to spend. But an attorney for the plaintiff school districts, Alan Rupe, said $800 million or more is needed.

The Kansas Supreme Court on Thursday ruled unanimously that state funding to schools is inadequate and gave the Legislature a June deadline to enact changes, scrambling a legislative session already consumed by a sprawling budget debate.

The ruling in the Gannon lawsuit came as lawmakers were away for a week-long break at the traditional midpoint of the legislative session, but it sent shockwaves throughout the state. Gov. Sam Brownback, as well as Republican and Democratic lawmakers, said the decision emphasizes the need for lawmakers to enact a new finance formula.

“Under the facts of this case, the state’s public education financing system provided by the legislature for grades K-12, through its structure and implementation, is not reasonably calculated to have all Kansas public education students meet or exceed,” educational standards, the court ruled.

The court’s opinion doesn’t give an exact amount lawmakers need to spend. But an attorney for the plaintiff school districts, Alan Rupe, said $800 million or more is needed.  The court gave the Legislature a June 30 deadline to make changes. Every justice joined in the ruling, except Justice Caleb Stegall and Carol Beier, who recused themselves in the case.

A 2014 ruling by a three-judge panel in Shawnee County held the school financing system in place at the time, in both its structure and implementation was not “reasonably calculated” to have all students meeting desired educational outcomes. They were also critical of lawmakers for shifting the funding burden from the state to the local level.

That ruling came after the Supreme Court asked the district court to look at the adequacy of funding based on what it would cost to achieve desired educational outcomes for students. The desired outcomes are referred to as the Rose Standards, a concept originally used in a Kentucky court case. The standards focus on preparing students for life outside of school — from personal and civic life to careers and mental and physical well-being.

During oral arguments before the Supreme Court last September, attorneys for the districts said lawmakers were violating the state constitution by providing only enough aid to districts so a portion of students do well. “We’re leaving massive numbers of kids behind in public education,” plaintiffs’ counsel argued at the time. He referred to his fourth-grade granddaughter, Katelyn. “I’d like her generation to graduate in an adequately funded system.”

Kansas Solicitor General Stephen McAllister, arguing on behalf of the state, told the justices during oral arguments that more spending on schools won’t necessarily improve academic outcomes for students. Some of the additional money “will be wasted” on teacher salary increases and other spending. “We cannot achieve 100 percent proficiency,” McAllister told the court. “What you’ve got to do, I think, is look at what is realistic.”

The court’s Thursday ruling is the second major school finance ruling in little more than a year. In February 2016, the Supreme Court ruled that funding between schools was inequitable. The decision led to a special legislative session, where lawmakers boosted equity spending by $38 million.

The decision is credit positive for local school districts especially in the states major metropolitan areas. As for the state, a resolution would be positive on some levels but could be negative if other credits like highway fund debt are impacted by transfers of dedicated funds in order to avoid tax increases as the state balances its budget.

ILLINOIS BUDGET STANDOFF CONTINUES

After the apparent collapse of the Illinois Senate’s “grand bargain,” senators left town without taking any further action. The Senate had intended to vote for the remaining parts of the “grand bargain,” including tax hikes, but Senate President John Cullerton, D-Chicago, called off the votes after he was told by the Senate minority leader there wasn’t any Republican support.

Due to the need for tax increases in order to address the State’s substantial cash needs, the Senate democratic majority has always insisted on bipartisan support. So even though the Democrats have the vote to pass the “grand bargain”, they will not enact it without substantial bipartisan support.

The deal has fallen apart for now as Republicans say that in order to get the package of bills passed, local property taxes should be frozen permanently — something Republican Gov. Bruce Rauner has pushed for. A freeze, however, is strongly opposed by schools and municipalities that will lose revenue as a result. The Governor has been accused of intervening with individual Republican members in order to get his tax freeze resulting in the lack of votes on that side of the aisle.

As we go to press, the Senate is scheduled to be back in session, along with the House. The situation reflects the ideologically based stance of the Governor. We have decried this kind of policy making regardless of which end of the political spectrum it emanates from. Seven quarters of fiscal operations without a budget is simply unacceptable.  Worse is the way the politics of the issue have eroded local credits, especially in Chicago.

P.R. DRAMA TO DRAG ON

The Puerto Rico government’s representative before the financial control board was poised send a letter requesting the fiscal entity to ask Congress to amend the federal Promesa law to extend the stay on litigation until Dec. 31. The representative made the announcement after reviewing Gov. Ricardo Rosselló’s fiscal plan, which reveals that the administration will seek an extension of Promesa’s stay, which expires in early May. What’s more, the representative admitted that such an extension has not been discussed with creditor groups. The stay’s validity was already extended by the board at the beginning of the year, days before its initial expiration date, Feb. 15. However, Promesa allowed the fiscal board to grant such extension, but it doesn’t provide for additional ones.

Promesa allows the board to offer recommendations to Congress regarding amendments to the law that would allow it to exercise its role. If the amendment were approved, the government would avoid a debt restructuring process under Title III to take place as early as May according to the representative.  He noted that extending Promesa’s stay would allow the government to present audited statements, which it expects to have ready by September, and have a fiscal plan with “real numbers” and negotiations with creditors based on accurate data.

The representative also clarified that although there are active cases in federal court, such as the lawsuit filed by a group of general obligation (GO) creditors, these do not involve a collection action against the government. Even though the Lex Claims case hasn’t been stayed under Promesa, he described it is a litigation between GO bondholders and the Sales Tax Financing Corp. (Cofina) debt service coverage ratio (the ratio of cash available to pay its debt obligations) decreased in the first nine months of 2016 to 1.3 times from 1.9 times in the comparable period in 2015 while cash-to-debt decreased to 66.9%.

LARGE HEALTH SYSTEM DOWNGRADE

S&P Global Ratings cut its debt rating for Catholic Health Initiatives another notch to BBB-plus from A-minus . The current BBB-plus rating was upgraded from negative outlook to stable outlook, meaning no further downgrades were looming.  “While management’s current turnaround plan has created an expectation for stabilization and modest improvement over the next 18 months, it is our opinion that it will take several years on the current financial improvement trajectory for CHI to return to a higher rating,” said S&P.

CHI called the decision disappointing claiming that it fails to reflect improvements that the hospital giant has made over the past several quarters. Colo.-based CHI is in affiliation talks with Dignity Health, another huge multistate health system. CHI said that its turnaround plan is gaining traction as evidenced by improved earnings in its second quarter ended Dec. 31. The “alignment” discussions with San Francisco-based Dignity continue, even as it works its turnaround plan, CHI. A merger between the two companies would create the nation’s largest not-for-profit hospital chain with 142 hospitals combined and annual revenue of more than $26 billion.

CHI takes the view that it has “considerable strengths,” including $16 billion in annual revenue, 103 hospitals spread across 22 states and a solid balance sheet with assets of $22.7 billion. On the operating side, CHI narrowed its operating losses in its fiscal second quarter. It posted operating losses of $75.6 million before charges in the quarter compared with operating losses of $93.7 million in the year-earlier quarter. Revenue increased in the quarter to $4.2 billion from $4 billion in the year-ago period.

It is the balance sheet which has concerned the rating agencies the most over recent months. CHI’s debt is viewed as being relatively high for a system of its size. CHI’s annual debt service, paid on its bonds and other borrowing, is about $460 million on total debt of $9 billion. When downgrading the system in July from A-plus to BBB-plus, Fitch Ratings said its maximum annual debt-service coverage ratio (the ratio of net revenues available to pay its debt obligations) decreased in the first nine months of 2016 to 1.3 times from 1.9 times in the comparable period in 2015 while cash-to-debt decreased to 66.9%.

Dignity’s overall debt is lower at $5.25 billion, but it, too, has hefty maximum debt service to carry, $408 million annually.

The two companies expect to decide sometime in 2017 whether a tie-up is in their best interests.

NYC BUDGET REVIEW

In November 2016 the de Blasio Administration released its first quarter modification to the city’s financial plan. At the time Independent Budget Office described the financial plan as a placeholder. The Preliminary Budget for Fiscal Year 2018 and Financial Plan Through 2021 released in January largely maintains this holding pattern.  IBO projects an additional $133 million of resources in 2017 (all years are fiscal years unless otherwise noted), as a result of our re-estimates of expenditure projections in the January plan. These reductions in projected expenditures, coupled with IBO’s estimate of $118 million more tax revenue than the Mayor’s financial plan assumes, yield a total of $250 million in additional resources in 2017. These additional resources would increase the budget surplus for 2017 from $3.06 billion to $3.31 billion; barring a new need emerging in the remaining months of the fiscal year, the increased surplus estimated by IBO would be used to reduce future year budget gaps.

This is important as the 2018 budget as presented in the January financial plan is balanced, IBO estimates that planned expenditures will exceed revenues for 2018 by $47 million.  IBO estimates $308 million in additional expenditure needs, primarily in education and homeless services. The additional spending is partially offset by IBO’s projection that tax revenues will be $262 million greater than the de Blasio Administration is forecasting. In 2019, IBO’s expenditure re-estimates add $480 million to the city-funded budget, which is offset by $324 million in additional tax revenue and the use of the remainder of the 2017 surplus, $203 million, to pay for 2019 expenses. The net result of these actions is a relatively small, $47 million reduction of the 2019 gap as presented in the January financial plan, from $3.31 billion to $3.27 billion.

IBO’s re-estimates of agency expenditures increase the planned expenditures by $523 million and $525 million in 2020 and 2021, respectively. These additional expenditures are offset by IBO’s increased revenue forecasts of $593 million and $1.1 billion for 2020 and 2021. As a result, IBO estimates another relatively small, $71 million reduction in the 2020 gap and a slightly larger $568 million reduction in the gap for 2021. The additional resources IBO estimates would reduce the gaps stated in the January financial plan from $2.5 billion to $2.4 billion in 2020 and from $1.8 billion to $1.2 billion in 2021.

After adding 136,500 jobs in calendar year 2014, measured by gains over the 12 months, job growth slowed to 94,200 in 2015, and shrank again to an estimated 70,100 in 2016. IBO forecasts continued slowing of local job growth through 2021 when it is expected to total 41,300. As job growth has slowed, real average wages have been flat or falling, continuing a downward trend underway since 2008. IBO’s lower estimates for the budget gaps than those projected by the Mayor’s Office of Management (OMB) are primarily the result of our somewhat more robust outlook for tax revenues. Overall, IBO’s tax revenue forecasts exceed the Mayor’s by just 0.2 percent in 2017, 0.5 percent in 2018, 0.6 percent in 2019, 1.0 percent in 2020, and 1.7 percent in 2021.

Over the plan period, 2017 through 2021, year-over-year spending increases by an average of 3.0 percent in the financial plan. Growth in agency spending is primarily driven by expected increases in the annual cost of fringe benefits, which rise from $9.6 billion in 2017 to $12.7 billion by 2021, an average annual increase of 7.2 percent. Health insurance costs, the largest component of fringe benefits, are budgeted to increase at an even faster rate, averaging 8.2 percent per year over the plan period. This annual rate of increase in spending on health insurance is 1 percentage point above the rate projected at this time last year.

Non-agency expenditures, driven primarily by the increase in the cost of the city’s debt service, are growing at a much faster rate than agency expenditures in the financial plan. From 2017 through 2021, planned debt service expenditures (adjusted for prepayments) grow from $6.3 billion to $8.4 billion, averaging 7.3 percent annual growth. Pension costs, the other major component of non-agency expenditures, are projected to grow somewhat slower than the budget as a whole. Pension costs in 2017 total $9.4 billion and are forecast to increase to $10.2 billion by 2021, average growth of 2.0 percent per year.

While the overall conservatism of the city’s projections is positive, the expense trends associated with rising headcount remain troubling. The consistent rate of growth well above inflation of debt service and benefit costs will continue to pressure the city to manage the rest of its expense budget in order for it to maintain its ratings.

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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