Muni Credit News May 26, 2016

Joseph Krist

Municipal Credit Consultant


Two months after the Illinois Supreme Court struck down his plan to save two of four city employee pension funds, Mayor Rahm Emanuel agreed Monday to save the smaller of the two funds with a mix of union concessions and revenue generated by a telephone tax increase once earmarked for both funds. Using a legal window the Supreme Court left open, the agreement with Laborers Locals 1001 and 1092 calls for employees hired on or after Jan. 1, 2017, to become eligible for retirement at 65 in exchange for an 11.5 percent pension contribution. The City’s position is that “They haven’t earned any benefit, so we can change their benefits going forward,”

Veteran employees hired after Jan. 1, 2011, will have a choice. They can retire at 65 with an 11.5 percent pension contribution or wait until 67 with an 8.5 percent contribution, a 35 percent increase. Emanuel’s original plan called for a 29 percent increase in employee contributions. The city is still working on a trade-off for employees hired before Jan. 1, 2011. In exchange for those cost-saving concessions, Emanuel has agreed to earmark all of the revenue from a 56 percent increase in Chicago’s telephone tax approved by the City Council in 2014 to shore up a Laborers Pension Fund with $1.3 billion in unfunded liabilities due to run out of money in 12 years.

The city’s payments to the fund will increase by “no less than 30 percent a year for the next five years. The $40 million a year generated by the $3.90 a month surcharge applies to both land lines and cell phones and was supposed to be used to cover the city’s first-year contribution to both the Laborers and Municipal Employees Pension Funds.

The city will be forced to find another funding source to save the Municipal Employees Pension Fund with $9.8 billion in unfunded liabilities due to run out of money in just eight years. An additional telephone tax increase in two years is a possibility. Talks with union leaders whose members draw their retirement checks from the Municipal Employees Pension Fund are seen as being nowhere near agreement.

The Supreme Court, in rejecting the original plan did note that an ironclad “pension protection” clause in the Illinois Constitution “was not intended to prohibit the legislature from providing ‘additional benefits’ and requiring additional employee contributions or other consideration in exchange.” A spokesman Laborers Local 1092, said he is confident the new agreement will pass legal muster despite the Illinois Constitution’s ironclad pension protection clause that says pension benefits “may not be diminished or don’t want them to be changed,” according to the spokesman.

Federation said the partial plan is “better than not doing anything.” But it pointed out that the Laborers pension fund has the “smallest of the unfunded liabilities” of the city’s four pension funds. “Laborers is at 52.9 percent. Municipal is at 32.9 percent. Police is 26 percent. Fire 23 percent. All of these funds are in desperate financial shape. A comprehensive solution for all of them is needed. “This plan would have the city going on a 40-year plan to get to 90 percent with a five-year ramp or phase-in,” he said. “That’s an improvement over the current structure, but not what actuaries recommend for solving a pension crisis. They recommend 100 percent funding within 30 years or less.”

In our view, the effort signifies recognition of the credit concerns and within Illinois’ strict limits on pension changes an attempt to deal with the issue. The City’s challenges remain formidable  and much more will be needed to reverse the negative pressures on its ratings.


The Washington Metropolitan Area Transportation Authority is coming to market amidst a storm of negative publicity regarding the condition of its capital facilities and an ongoing decline in ridership on its buses and its flagship facility, the Metro subway system. A series of incidents involving fires as well as significant service interruptions related to deficient maintenance have focused attention from several oversight bodies on these issues. That attention has focused on the System’s significant need to improve

As has been the case since the decision to build a subway in D.C. in the 1960’s, the process of constructing, operating, and maintaining that system has been fraught with politics. Competing interests including two states, the Congress, and multiple federal agencies have created numerous opportunities for confusion, missteps, and grandstanding by the numerous entities and politicians given opportunity by this complicated oversight structure.

These various stresses have created concerns among investors and the rating agencies as they try to assess the actual creditworthiness of the Authority’s debt as it attempts to grapple with these many serious issues. In periods like this, it is easy for investors to get lost amongst the weeds and make decisions which might not be to their benefit.

What are the implications of all of this negative publicity for bondholders? In the short-term, there is the negative price impact. There is also a likelihood that the authority will have to issue significant new debt to fund capital replacement so there is the factor of increased supply and its impact on prices. The spotlight also serves to highlight the long term lack of stable, dependable revenue sources from the various communities which provide non-farebox revenues. This includes the federal government along with the local jurisdictions.

There has never been a shortage of members in Congress, particularly in the House to use WMATA as a political punching bag. It is just one more way for Congressional conservatives to fight to impose their will on a political jurisdiction for which they have always had a fair amount of disdain. That desire for control has always outweighed the willingness to fund the system adequately.

But in the end, does this really mean anything for bondholders? The security for WMATA debt is a gross revenue pledge. Theoretically, debt service comes before anything else. On that basis, over the last five years coverage has increased from 27 to 63 times debt service. Farebox revenues alone provide 30 times coverage. Practically, the system must run in order to produce those farebox revenues and it is not practical to run the system without outside funding. But the legal structure of the security does allow the outside atmospherics of hearings and headlines to be put aside to a great extent for the bondholders. We think that a ride on WMATA debt will end up at the correct destination.


By June 15, Fitch Ratings intends to withdraw the current outstanding structured finance ratings on all of its rated U.S. Tobacco asset-backed securities (ABS).

The primary reason for the intended withdrawal is that individual, custom modifications (by several participants) to material calculations originally part of the base Master Settlement Agreement (the MSA) have eroded Fitch’s confidence that ratings can be consistently maintained, as insufficient information exists to predict the likelihood and effect of future modifications or that insufficient information will exist to support new, material variables included in them.

Historically, the method for calculating the amount of the annual and strategic contribution fund payments was solely prescribed by the terms of the MSA. The calculation, which includes multiple adjustments of varying complexity, determines the total payment amount due from the participating tobacco manufacturers (the PTMs). This amount is then distributed amongst the jurisdictions that are party to the MSA according to the allocation percentages contained therein and a portion of these funds are then ultimately transferred to the issuers of the securities. In this manner, there was historically a single, consistent application of the calculation adjustments that affected all participating jurisdictions in the same way.

However, more recent settlement agreements related to disputed payments connected to the non-participating manufacturer (NPM) adjustment have eroded Fitch’s confidence in the predictability of the calculation of MSA payments going forward. In the past few years, two material settlements, one between New York State (NYS) and the PTMs (the New York Settlement), and the other among California, 23 other states and the PTMs (the Settling States Agreement, collectively, with the New York Settlement, the Settlement Agreements) modified the calculation of the NPM Adjustment outside of original MSA calculations. The New York Settlement also introduces a new variable, a calculation related to Tribal Sales, which is based on estimates initially and its past and future volatility is unknown.

Fitch acknowledges that the Settlement Agreements have positive features – most notably the release of previously escrowed funds held in the disputed payment account, more clarity regarding disputed payment calculations going forward, and in the case of the New York Settlement, the removal of uncertainty that would be introduced by protracted arbitration in relation to these disputed amounts. However, the longer-term ramifications of the modifications to the NPM Adjustment calculation for both settling and non-settlings jurisdictions is less clear and more problematic.

We do not see this decision as having a major impact on the market for tobacco securitization debt. Over the nearly two decades of issuance, the major credit factors and concerns for investors have become clear. Investors are either comfortable with these risks or they are not. Their appeal to yield based investors are clear. For those wary of volatility – either market or credit based – we have always felt that tobacco bonds are likely not appropriate for them. The move by Fitch does not alter our view one way or another.

Of more importance are the continuation of negative consumption trends. The CDC reports that the prevalence of current cigarette smoking among U.S. adults declined from 24.7% in 1997 to 15.1% in 2015. Current cigarette smokers were defined as those who had smoked more than 100 cigarettes in their lifetime and now smoke every day or some days. For both sexes combined, the percentage of adults who were current cigarette smokers by age group was lower among adults aged 65 and over (8.4%) than among those aged 18–44 (16.5%) and 45–64 (16.9%).

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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