Muni Credit News May 24, 2016

Joseph Krist

Municipal Credit Consultant

GOVERNOR REACTS TO PROMESA

Gov. Alejandro García Padilla reacted to the introduction of the revised Promesa legislation. He acknowledged that the revised Puerto Rico Oversight, Management Economic Stability Act (Promesa) provides a workable debt-restructuring mechanism. He continues, however to object to  the fiscal oversight entity the bill would establish. He was pretty clear about his level of opposition to that provision.  “If the bill is signed into law as it is, I would tell the United Nations that the U.S. is acting against what the Eisenhower administration told them [with respect to Puerto Rico’s self-governance],” Gov. García Padilla told reporters Thursday.

His Plan B is to continue the use of the local moratorium law. For the governor, the new bill is an improvement from its original version, but he still sees the oversight board’s powers as excessive. On the proposed debt-restructuring mechanism, he acknowledges it leaves the commonwealth in a better position to restructure a large chunk of its debt, including constitutionally protected general obligation bonds (GOs).

He is against having the board displace the local government in debt-restructuring talks with commonwealth creditors. He added he would continue to push for changes in a bid to enact an acceptable legislation that respects the island’s self-governance.

While the local government could prevent the board from using its authority to the full extent by adhering to the required fiscal practices, he believes those powers shouldn’t be granted at all, García Padilla noted.

If Promesa clears the committee vote, which could take place as soon as this week, it would go to the House floor, where it remains to be seen if there is enough support for its passage.

GDB CREDITORS ARE NOT WAITING FOR CONGRESS

Holders of bonds from Puerto Rico’s Government Development Bank are suing to challenge aspects of a debt-moratorium law that island officials say is crucial to maintaining essential services. The amended federal lawsuit filed late Friday in the U.S. District Court in San Juan names Puerto Rico’s governor and treasury secretary as well as an unidentified bank receiver. It argues that amendments to the law prioritize the rights of certain creditors at the expense of others in violation of U.S. and Puerto Rican law.

The Ad Hoc Group behind the lawsuit comprises five investment funds that hold $900 million of the GDB’s nearly $4 billion in outstanding debt. They said “Notwithstanding the Commonwealth’s unconstitutional actions, the members of the Ad Hoc Group understand that the Commonwealth faces significant challenges and want to continue  mutually beneficial restructuring.”

Gov. Alejandro Garcia Padilla said the lawsuit’s challenge of the Debt Moratorium and Financial Recovery Act could affect the commonwealth’s ability to have police in the streets, teachers in the classrooms and nurses in hospitals. He said because Congress excluded Puerto Rico from the bankruptcy code in 1984 without any explanation, and the federal courts have impeded past attempts to create a local bankruptcy law, the act is the commonwealth’s only option to restructure its debt.

“If the commonwealth cannot proceed with its intention to restructure the debt in an organized manner, chaotic litigation will ensue and the courts can take control of the limited resources of the government and make them available to the interests of the Wall street funds,” the governor said in a written statement Saturday evening. “We are not going to close the government to pay a considerable profit to the hedge funds, who bought the bonds at a big discount after the crisis began.”

PADILLA ROLLS THE DICE WITH FY 2017 BUDGET PROPOSAL

Puerto Rico Gov. Alejandro García Padilla has announced that the budget for the fiscal year 2017, set to start July 1, would be of $9.1 billion, about $700 million less than the budget that was approved for the current fiscal year. In an effort clearly influenced by the upcoming primary in two, García Padilla cast the upcoming budget as a “real reduction in expenditures of close to $3 billion when compared to the last budget of the previous administration.”

Confirming the fears of many debt holders he pointed out that “although the budget for fiscal 2017 would be lower than the current one, it would not reduce the budgets set aside for health services, education, public safety, agriculture and social welfare, and instead guarantees the services that [related] agencies bring”. The budget also would not decrease the revenues that the University of Puerto Rico gets by way of a formula, same with the judicial branch and the municipalities, he added. It allocates just $209 million for bond interest payments, reiterating his stand that the commonwealth plans to skip most debt obligations.

“Paying the debt in its totality would have meant taking health benefits away from more than a million people, or having to fire countless police officers and closing the Centro Medico” health facility and, going without school transportation and garbage collection.”

The governor stressed that the upcoming budget depends exclusively on government revenues instead of loans, like in the past. The budget also hinges on possible steps that the U.S. Congress might take to the island’s benefit, as it tries to address an ongoing debt crisis in the commonwealth.

The local legislature has five weeks to approve the budget. The House of Representatives overrode Monday Gov. Alejandro Garcia Padilla’s veto on a bill that would repeal the hike to the business-to-business (B2B) tax and the value-added tax. It is the third time in recent history that the Legislature has overridden a governor’s veto to a bill.

The B2B was slated to go into effect in June. The legislation effectively derails the governor’s most significant tax achievement, with the IVA being touted as the best alternative to reduce tax evasion, partly because it gave businesses more oversight of the tax collecting process. The B2B, which was raised to 10.5% from 4%, is expected to collect around $25 million. Lawmakers have contended that the tax reform should have been approved with a corresponding tax relief. They also said merchants are not ready for the change. Privately, they worry about the backlash of the taxes on their electoral chances, sources have said.

To override the governor’s veto, the House needed at least 34 votes out of the 51 members. The Senate, which has 27 members, needs 18 votes.

ATLANTIC CITY REPRIEVE

State lawmakers struck a deal on saving Atlantic City on Monday that gives the city time to avoid a state takeover and requires the city to make “drastic” budget cuts. The City would have 150 days to draft a five-year fiscal plan that includes a balanced budget in 2017. It would receive a state bridge loan to cover its operations in the meantime. A companion bill incorporates elements of the so-called PILOT bill, which lets casinos make fixed payments in lieu of property taxes and redirects $110 million in casino funds over 10 years to help the city pay debt and expenses.

 

Under the new compromise plan, the commissioner of the Department of Community Affairs would approve or reject the city’s five-year plan after 150 days. If the city’s plan fails to achieve fiscal stability, a state takeover would take effect. The state could also take over if the city at any point failed to follow the five-year plan. The city could appeal the commissioner’s decisions to a Superior Court judge, officials said. In addition to a balanced budget, the recovery plan must ensure the city pays the full amount in property taxes owed to the city’s school district and Atlantic County, schedule repayment of debts to the state, bondholders and other liabilities and increase revenues. The bill allows the city to offer early retirement incentives to public workers, possibly saving the city more than $5 million. The city must also restructure its bonded debt to reduce its annual debt service from $38 million to $5 million.

CA MAY REVISION

Since the January Budget, the state’s revenues have lagged expectations while the Governor and the Legislature have made major new spending commitments. The tax revenue forecast has been reduced by $1.9 billion, reflecting poor April income tax receipts and more sluggish sales tax receipts than expected.

The passage of the managed care organization financing package solidifies funding for Medi‑Cal over the next three years. Additional funding was committed to developmental disability services, higher payments to Medi‑Cal providers, and the reduction of debt. The passage of legislation that made California the first state in the nation to raise the statewide minimum wage to $15 per hour will eventually raise General Fund costs by an estimated $3.4 billion ($39 million in 2016‑17).

Since 2012, the expansion of health care coverage, the Local Control Funding Formula, and other increases in safety net spending have committed over $19 billion in increased annual General Fund costs ($10.7 billion Proposition 98). By 2019‑20, the annual shortfall between spending and revenues is forecast to be over $4 billion. This shortfall does not take into account the likelihood of an economic slowdown or recession. The emerging shortfall is in large part — but not entirely — due to the expiration of the temporary taxes imposed under Proposition 30. This November, the state’s voters will be given the choice whether to extend the Proposition 30 income tax rates for another 12 years.

The vote presents an opportunity to mitigate some of the historic boom and bust character of California’s finances. Even with a vote in favor of tax extension, California’s revenues structure will still be subject to the volatility of its income tax base and its dependence upon a relatively small proportion of tax payers for a large percentage of its income tax revenues.

ILLINOIS BUDGET NOISE

Recent rumors of progress have come out of Springfield that a framework for a budget for FY 2017 may be emerging. Our view is that seeing is believing. Among the rumored pieces of the budget puzzle are specifically: $5.4 billion in new taxes, accomplished by raising the income tax from 3.75 percent to 4.85 percent on individuals; and by broadening the sales tax to cover services. The taxes would be accompanied by $2.5 billion in cuts including pension “reforms”, in the form of shifting the cost of higher pensions away from the state and onto local districts –known controversially in Illinois as the  “cost shift” – and some reforms to procurement processes.

The Governor is still insisting that a final agreement has to have some other reform items. A bipartisan group is said to be working on items like further workers’ compensation reform, local government consolidation and some flexibility for local governments dealing with public employee unions. Important issues, such as education funding, have not been agreed to. The failure to address education funding have led to severe cost cuts at some campuses and credit downgrades across the state system.

Additional pressure on the state’s university system are seen in a review of admissions data by The Associated Press which found that applications for the 2016-2017 fall semester are down for at least four of the state’s 12 public university campuses — all of them smaller schools that don’t have as much money coming in from things like research grants and tuition and have smaller endowments. Eastern and Western Illinois, have laid off employees. Chicago State University, the hardest hit, cut a third of its employees and ended the spring semester early. Eastern Illinois, Western Illinois, University of Illinois-Springfield and Southern Illinois University-Edwardsville all say they had fewer applicants this year.

The University of Illinois’ Urbana-Champaign campus says 7,969 freshmen-to-be have accepted admission, an increase of more than 400 from last year. A record 38,075 students applied to the school.

ANOTHER STADIUM TO BE FINANCED WITH MUNICIPAL BONDS

The Rangers and the City of Arlington have reached an agreement for a new state-of-the-art ballpark to be opened by 2021. The new ballpark, which was announced at a news conference on Friday at City Hall, will be climate-controlled with a retractable roof and will be built across Randol Mill Road on the south side of Globe Life Park.

Both sides are contributing $500 million to the project. The Rangers’ portion of the financing will include revenue from the sale of individual “Stadium Builder Licenses” that enable the holder to buy tickets for certain seats in the new ballpark. The Rangers will be responsible for cost overruns. “To have a higher-than-average attendance — especially during the dog days of summer — allows us to raise revenue and spend more money on players and free agents.”

The city’s contribution, through an extension of existing taxes, must be approved via a public referendum in the Nov. 8 general election. The city plans to use the same combination of half-cent sales tax, 2 percent hotel tax and 5 percent car rental tax that it used to fund AT&T Stadium. The Cowboys and Arlington recently announced that taxpayers are seven years ahead of schedule paying off the stadium. The city will own the ballpark, while the Rangers will design and build it. The agreement runs through January 1, 2054. This ownership structure qualifies the stadium for bond financing albeit under limits for private activity bonds.

PROPOSED IRS CHANGES SEEN AS LIMITING SOME TAX EXEMPT ISSUANCE

The IRS has proposed a new definition of political subdivision that could possibly terminate the status of numerous governmental entities whose governing boards are appointed rather than elected, or whose projects are viewed by the IRS as providing more than incidental private benefit, making them ineligible to issue tax-exempt debt or use tax-exempt financed facilities as a governmental user. The proposed regulations purport to interpret and clarify current law; however, the governmental control and public purpose tests are entirely new and many governmental bond issuers may be affected.

Treasury officials have said publicly that the provision prohibiting more than incidental private benefits is intended to clarify the public purpose requirement, but it instead casts doubt on the continuing political subdivision status of governmental entities that issue bonds for public purposes with private involvement, or that are engaged in other economic development activities. Importantly, the public purpose requirement remains in place for the entire term of an entity’s bonds. If at any time the IRS determines that the issuer is operating in a way that either does not provide a significant public benefit, or that provides more than an incidental benefit to any private party, then the status of all of the issuer’s bonds issued after the effective date of the regulations would be in jeopardy.

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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