Muni Credit News November 12, 2015

Joseph Krist

Municipal Credit Consultant


Moody’s Investors Service has downgraded the Commonwealth of Pennsylvania’s (Aa3 negative) pre-default intercept programs for school districts to A3 from A2. As a result of the downgrade of the programs, 13 pre-default intercept ratings on Pennsylvania school districts were lowered to A3 from A2 and the ratings put under review for further downgrade. This action affects the State Public School Building Authority Lease Revenue Intercept Program (Sec. 785) and the Pennsylvania School District Fiscal Agent Agreement Intercept Program (Sec. 633).

The downgrade of the Commonwealth of Pennsylvania’s pre-default school district intercept program, and 13 ratings under the program, is a consequence of the commonwealth’s chronically late budgets and the lack of clarity surrounding the intercept program’s mechanical feasibility in the absence of an approved and implemented budget. While the commonwealth is expected to cover any missed debt service payments on enhanced bonds, the current lengthy budget impasse has heightened risks to bondholders, and raises doubt about whether the pre-default mechanisms will work effectively every time without funds appropriated to districts.

The confirmed cap of A3 on school district bonds enhanced on a post-default basis (Pennsylvania Act 150 School District Intercept Program) also reflects the increased risks to bondholders given state budget delays, as well as competing claims for state aid from pre-default obligations, pensions, and charter school tuition. The downgrade of 11 post default ratings reflects revising the potential uplift from a district’s underlying rating to one notch from the previous two notches. The decision to limit the uplift to at most one notch is based on Moody’s post-default scoring method, which considers such factors as the timing of and trends in state aid distributions, and the mechanics of the program. More specifically, this change reflects a lack of funding and an increasing uncertainty surrounding program mechanics in the absence of a state budget.

In the meantime, negotiations over a budget are heating up and details of some proposals have begun leaking out. The two major points are that production of natural gas will continue to escape taxation while more of the new revenue burden will be shifted to individuals through and increase in the retail sales tax rate from 6% to 7.25%. This would result in a total sales tax rate of 8.25% in Pittsburgh and 9% in Philadelphia. These changes are designed to support increased funding to school districts but it does not appear to tie in directly to local property tax relief to slow rapid increases in many districts. Should the budget be enacted along these lines it would be a clear win for business interests with at best, mixed results for individuals.


The Puerto Rico Electric Power Authority (PREPA) reached a restructuring support agreement (RSA) with the Ad Hoc Group of PREPA Bondholders last week, just after we went to press. The Ad Hoc Group’s financial adviser said legislation on the public utility’s revitalization must be approved “this month.” The government submitted the PREPA Revitalization Act to the Puerto Rico Legislature. However, the last day for the Legislature to pass bills during the present session is Nov. 12, giving lawmakers only one week to analyze and pass the measure.

The basic terms of the agreement include:

The Ad Hoc Group will exchange all of their debt for new securitization notes and receive 85% of their existing claims in new securitization bonds, which must receive an investment grade rating.

Bondholders will have the option to receive securitization bonds that will pay cash interest at a rate of 4.0% – 4.75% (depending on the rating obtained) (“Option A Bonds”) or convertible capital appreciation securitization bonds that will accrete interest at a rate of 4.5% – 5.5% for the first five years and pay current interest in cash thereafter (“Option B Bonds”).

Option A Bonds will pay interest only for the first five years, and Option B Bonds will accrete interest but not receive any cash interest during the first five years.

All uninsured bondholders will have an opportunity to participate in the exchange.

Ad Hoc Group will negotiate with PREPA in good faith to backstop a financing on terms to be mutually agreed that will allow for a cash tender for bonds held by non-forbearing creditors.

Fuel line lenders will have the option to convert existing credit agreements into term loans with a fixed interest rate of 5.75% per annum, to be repaid over 6 years in accordance with an agreed upon schedule or exchange all or part of principal due under the existing credit agreements for new securitization bonds to be issued on the same terms described above.

PREPA’s debts owed to the Government Development Bank for Puerto Rico will be treated in substantially the same manner as those owed to the fuel line lenders.

The PREPA Bondholder Group’s financial adviser said,  “We are pleased to be able to make official what we believe is a reasonable deal with substantial concessions from bondholders that will significantly benefit the people of Puerto Rico. It has not been easy to get to this point and meaningful sacrifices have been made on the part of bondholders. We hope that this agreement can be an example to others of the positive outcome that can be realized through committed negotiation – and that PREPA and its remaining creditor constituencies can now reach similarly fair and reasonable solutions.”

Bondholders are taking substantial risk by agreeing to set rates until the deal is implemented, the bondholder group said. The transaction outlined by the RSA must be executed by June 30, 2016, as further delay could materially change the economic terms agreed to by both sides. This deadline represents an extension of the initial timeline by the PREPA bondholder group. The transaction is also contingent on PREPA coming to an agreement with its bond insurer constituencies.

The restructuring support agreement provides a structured framework to implement the previously announced economic agreements, and is designed to provide PREPA with five-year debt service relief of more than $700 million and a permanent reduction in PREPA’s principal debt burden of more than $600 million, according to a PREPA statement. The agreement also outlines other elements of PREPA’s recovery plan, including new governance standards, operational improvements, rate structure proposal and a capital plan.


As time goes on, the Brownback administration looks more and more like Ahab in pursuit of the whale in its pursuit of its tax based economic policy. The report for October for the State’s General Fund reports another shortfall in revenues versus expectations. The continued reductions in income taxes simply have not translated into the higher levels of jobs and economic activity that the administration premised its tax cut program on. While some of the shortfalls can be attributed to continued lower oil and gas prices in this natural gas state, the data shows that this is not the predominant factor.

Total tax revenues are 3.8% below estimates for the fiscal year through October 31. The largest proportion is the decline in the retail sales tax. This tax is historically an excellent indicator of current economic activity and these are running 4.2% below estimates. Now the economy in Kansas is showing positive activity relative to fiscal 2015 – tax revenues are up 2.8% year over year. But it is clear that the state’s ability to predict revenues has not improved leading to the need for mid-year budget adjustments usually in the form of cuts to local aid especially for schools.

So the song remains the same for Kansas. The great tax cut experiment continues, the State’s budget continues to be tight and under pressure, and local units especially school districts must try to plan with the constant threat of additional cuts hanging over them. All in all, this is not a formula for credit stability in the Sunflower State.


The largest deal to hit the U.S. municipal market next week is $1.75 billion of private activity bonds to help fund All Aboard Florida, a 235-mile (378 km) passenger rail project that will connect Miami to Orlando. The bonds will be sold by the Florida Development Finance Corporation, a state authorized issuer of industrial revenue bonds, and the sale will be managed by Bank of America Merrill Lynch. All Aboard Florida is a privately owned, operated and maintained passenger rail system with stations planned in Miami to Fort Lauderdale, West Palm Beach and the Orlando International Airport. The express train is expected to take approximately three hours, move at speeds up to 125 mph, and be completed by early 2017.

The transaction has met a mixed reaction with potential investors. The market for high speed rail service in Florida is speculative (a nice word for untested). We have reviewed a summary of the feasibility study produced for the project and it raises a number of questions in our mind. Our experience tells that that demand studies for controversial projects (and this one is) often rely on small sample sizes relative to projected usage which often accounts for why actual usage on transportation projects often falls short of projections.

In this case, 1,800 stated-preference surveys and 10,800 origin and destination surveys were conducted to confirm travel behavior, preferences, and willingness to pay. This is out of a projected ridership of 5.7 million in the first year of stabilized operations in 2020. Revenues are projected to rise by 3.8% annually through 2030. All of this relies on projections that gas prices will remain at a steady $4 per gallon even though recent experience tells that gas prices are very volatile and that the current environment supports a price at only 50% of that level in many areas.

According to the study, introduction of a new mode of travel, particularly premium rail service which is more convenient and improves travel time, can often encourage travelers to make trips they may not have made in the absence of the new service. This is called induced ridership. Previous studies have found that the introduction of intercity rail service can result in levels of induced travel ranging from 5 percent to 30 percent. Most of this is attributed to longer trips such as from Miami to Orlando. In this project, that better be true as the bulk of revenues are projected to be derived from long distance trips.

The proposed timing of the deal reflects a number of factors which have often aligned ultimately against a successful outcome for bondholders. One is absolute market levels, relative credit spreads reflecting those absolute levels and the demand for high yield product, and the municipal market’s proclivity for underpricing credit risk during periods of low absolute yields and demand for product to supply the plethora of high yield funds out there.

Our view is that this transaction should be approached extremely cautiously and that potential buyers should hold out for the highest possible spread and be prepared to walk away if it’s not provided. In this case walking may be a better alternative than taking the train.

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