Joseph Krist

Publisher

___________________________________________________________________

ISSUE OF THE WEEK

$600,000,000*

Florida Development Finance Corporation

Surface Transportation Facility Revenue Bonds

(Brightline Passenger Rail Project — South Segment), Series 2017

It has taken some three years, numerous court challenges, and now the prospect of a tax reform bill which would eliminate the proposed financing but the forces behind the high speed rail project on Florida’s east coast may finally partially achieve their goal of tax exempt financing for their project. The developers of the All Aboard Florida project – now known as the Brightline – have long sought up to $1.7 billion of tax exempt financing for this speculative venture. The financing on tap will achieve some 35% of that goal.

 

The proposed financing will reimburse the developers for that portion of the cost of construction of the segment of the line from Miami to West Palm Beach. That segment has seen the conclusion of construction and the line is now in the process of testing prior to operations. They have not gone off necessarily smoothly – a Brightline train derailed during testing earlier this year, causing more than $400,000 of damage and recently a woman was killed by a train during testing.

We acknowledge that the completion of construction removes a significant risk from the analysis but we remain highly skeptical about the line’s ultimate financial success. We note that the completed section only involves three stations – the terminals at Miami and West Palm Beach and the intermediate stop in Fort Lauderdale. We believe that successful completion through to Orlando remains essential to the project.

We are always extremely wary of demand projections. As hard as they may try, these surveys always seem to capture a level of optimism and support in the abstract that is ultimately hard to actually quantify. We note that the projections are characterized as “being investment grade with respect to accuracy, reliability, and credibility”. But these are the characterizations of the consultant rather than an outside reviewer. The demand study acknowledges that the project represents “an entirely new type of service for the region” with “unique features”.

We note that time savings seem to be the primary motivation for demand for the service. Our experience tells us that the perception of the value of time savings is almost always overestimated and that the results of the surveys to determine this value are often influenced by the timing and circumstances under which the surveys were taken. We also note that this project – which assumes 1 million trips a day on average – expects the novelty of the service and its attractiveness to tourists to “induce demand”. we are always wary of concepts like “induced demand” when we evaluate new projects. We note the lack of success for other “novel” services in tourist areas financed in the municipal bond space.

We also have to ask whether the projections for the project sufficiently address the potential impact of technological change on the transportation sector. Is it even possible to accurately model the success and timing of the emergence of transportation as a service? Will self driving cars offset the perceived inconveniences of driving versus high speed rail? Do the projections account for the allure of timing one’s own travel versus the structure of a fixed schedule? Does emerging road management technology combined with emerging auto technology reduce the time saving component and render the estimates of demand irrelevant?

We do not purport to answer these questions here. We do believe that these questions reflect a greater level of uncertainty into the investment analysis that they require a higher level of skepticism than the developers agree is warranted. What follows from this is the belief that any investment requires a level of current income compensation that is most likely in excess of what the project can support. We would therefore – based on our long experience with speculative startup transportation credits – respectfully suggest that there are better investments for the overwhelming majority of municipal bond investors.

___________________________________________________________________

FEDERAL HIGHWAY FUNDING CONTINUES ON UNCERTAIN PATH

The board of directors of the American Association of State Highway and Transportation Officials called on Congress to stop reducing federal highway budget authority that state agencies use to bid out transportation projects, saying this “budgetary artifice” disrupts their project planning. The resolution they unanimously approved makes the case that Congress effectively approves one level of investment in federal-aid highway projects in multiyear surface transportation legislation but then sometimes whittles parts of it away again in subsequent appropriations bills.

In spite of this resolution, President Trump’s disaster relief supplemental budget request to Congress for $44 billion includes a proposal to rescind $1 billion in states’ unused federal highway contract authority. The provision reflects a big, $7.6 billion rescission effective July 2020 of unused, accumulated contract authority that might be on the books of state DOTs at that time, with the amounts to be proportionally stripped out of a certain group of federal programs that include those that pay for new highways and bridges.

Congress in the Fixing America’s Surface Transportation Act in December 2015 approved the first new long-term surface transportation authorization in a decade, “which signaled its commitment to ensure predictable, stable federal funding between 2016 and 2020.” At the same time, the bill included the rescission provisions. Since lawmakers had fully funded the entire five-year bill with specified revenue streams, transportation officials said Congress was using the highway program rescission to help cover unrelated federal spending.

Congress in its fiscal 2017 full-year spending bill lopped off $857 million more that state DOTs had to absorb this past June, with very little notice. And now a House appropriations measure for the 2018 budget year that starts Oct. 1 would strip out another $800 million in project contract authority, while the Senate version proposes no such rescission.

Instead of receiving their funds through block grants to apply how they wish, state DOTs are apportioned federal funds through contract authority that is subdivided to the dozens of active qualifying accounts, for such things as safety and construction funds. When Congress rescinds some unused contract authority, state planners have to go back through and see how they can apply the remaining funds to projects they had in the pipeline, and which ones they might have to delay. And when Congress applies a rescission only to certain highway program accounts, state officials find they might have to cut more deeply into how they planned to use the funding.

The state CEOs urged lawmakers to take several steps. First, they asked that Congress remove in any final 2018 appropriations bill the House’s proposed $800 million rescission. In addition, they urged Congress “to repeal the $7.6 billion rescission scheduled for July 2020 under the FAST Act.” The agency chiefs said if lawmakers cannot find acceptable resources or “pay-fors” to prevent these rescissions, that Congress should at least provide state DOTs with “maximum flexibility” to apply the cuts as each DOT needs across all federal highway program accounts. State officials also called on Congress to end that practice for the future – “ceasing its reliance on highway contract authority rescissions as an offset for unrelated programs” – so that it does not continue to recur.

These sorts of provisions will take on greater importance if tax reform goes through with its restrictions on municipal bonds and the revenues to support them are included. The introduction of uncertainty into the funding process makes it harder to evaluate debt capacity and revenue requirements which will complicate the analysis of transportation related credits.

MINNESOTA COP PAYMENT CASE

On May 25, 2017, the Minnesota Legislature  adjourned, ending the special session that began on May 23, 2017. On May 30, 2017, the Governor vetoed line-item appropriations to the Legislature for its biennial budget. By the last day of the 2017 regular session, May 22, 2017, most of the final budget bills for the next biennium—fiscal years 2018–2019—had not been presented to the Governor. Legislative leaders and the Governor agreed that the special session would “be confined to the outstanding budget bills and the tax bill,” the bills would be “voted upon or passed by either body within one legislative day,” and the Legislature would “adjourn the Special Session no later than 7:00 a.m. on May 24, 2017.”

One of the bills passed during the special session and presented on May 26 was the state government appropriations bill, Senate File No. 1. In article I, section 14 of this bill, the Legislature appropriated funds to the Department of Revenue for that agency’s biennial budget. Section 2 of Senate File No. 1 provided appropriations to the Legislature for each fiscal year (FY) in the next biennium. The Governor notified the Senate that he had “line-item veto[ed] the appropriations for the Senate and House of Representatives to bring the Leaders back to the table to negotiate provisions” in three bills that the Governor had just signed and that subsequently became law.

Specifically, the Governor said that there were provisions in the “Tax, Education and Public Safety” bills that he could not “accept.” He explained to legislative leaders that he “veto[ed] the appropriations for the House and Senate” for the next biennium because the Legislature’s “job has not been satisfactorily completed.” He offered to call a special session if the Legislature would agree to “remove” or “re-negotiate” the provisions the Governor found objectionable in the Tax, Education, and Public Safety bills.

The Governor was using the veto to make it difficult if not impossible for the Legislature to operate in order to induce the Legislature to negotiate terms of the budget legislation. On June 13, 2017, the Legislature filed a complaint in Ramsey County District Court.   In count one, the complaint sought a declaration that the Governor’s line-item vetoes were unconstitutional as a violation of the Separation-of-Powers clause in the Minnesota Constitution. The Governor and the Legislature asked the district court to enter a temporary injunction directing MMB to “take all steps necessary” to fund the Legislature based on “fiscal year 2017 base general fund funding” during the appeal period—defined as completion of all appellate review and issuance of the appellate court’s mandate—or until October 1, 2017, whichever occurred first.

In July, the district court declared the Governor’s line-item vetoes null and void as a violation of the Separation-of-Powers clause in Article III because they “impermissibly prevent[ed] the Legislature from exercising its constitutional powers and duties.” the court concluded that, by vetoing the appropriations for the Legislature, the Governor’s line-item vetoes “both nullified a branch of government and refashioned the line-item veto as a tool to secure the repeal or  modification  of  policy legislation unrelated to the vetoed  appropriation,” The court therefore concluded that the appropriations struck by the Governor’s line- item vetoes “became law with the rest of the bill.”

The questions raised in this case involve powers the Minnesota Constitution confers on the State’s three branches of government. The district court found that the Governor’s line-item vetoes were applied to an “item of appropriation and those sums were “dedicated to a specific purpose,” funding the Senate and the House in the 2018–2019 biennium. Article IV of the state constitution, an article that generally addresses the powers of the Legislative Branch says “If a bill presented to the governor contains several items of appropriation of money, he may veto one or more of the items while approving the bill.”. According to the Supreme Court, the plain language of Article IV places only one substantive limit on the line-item veto power, specifically, the requirement that the veto be made as to an “item” of “appropriation.”  It held that the Governor’s line-item vetoes of the Legislature’s biennial budget appropriations did not violate Article IV, Section 23 of the Minnesota Constitution. It also noted that the language of Article XI, Section 1 of the Minnesota Constitution is unambiguous: “No money shall be paid out of the treasury of this state except in pursuance of an appropriation by law.” It also notes that Article XI, Section 1 of the Minnesota Constitution does not permit judicially ordered funding for the Legislative Branch in the absence of an appropriation.

So why does a municipal bond investor care about a dispute between the Governor and the Legislature that does not speak directly to a municipal bond issue? Fair question. The concern is that the decision clearly establishes that the Governor may use his line item veto to veto appropriations by the Legislature. The Legislature asserts that the Governor improperly vetoed its biennial appropriations in an effort to coerce concessions on tax and policy provisions. The Governor counters that his line-item veto power was the only tool he could use to respond to the Legislature’s conditional appropriation of funding for the Department of Revenue, which he argues was intended to coerce his agreement to the tax and policy provisions. The Court said that the parties’ dispute about coercion essentially asks the court to assess, weigh, and judge the motives of co-equal branches of government engaged in a quintessentially political process. It added that resolution of . . . budget issues by the other branches through the political process is preferable to our issuance of an advisory opinion adjudicating separation of powers issues that are not currently active and may not arise in the future.”

So investors in securities backed by appropriations are concerned that they can now get caught up in other political issues which could hold up the full and timely payment of their obligations. Frankly, this is always a risk in any appropriation backed debt but it is not often that a ruling is issued by a state court which seems to cause the courts to be reluctant to rule in favor of debt holders. It concluded that principles of judicial restraint and respect for our coordinate branches of government dictate that it refrain from deciding whether the Governor’s exercise of the line-item veto power over the Legislature’s appropriations to itself violated Article III by unconstitutionally coercing the Legislature.

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.