Muni Credit News November 3, 2016

Joseph Krist

Municipal Credit Consultant









It comes as no surprise that the State of New Jersey, through its Department of Community Affairs, rejected the City of Atlantic City’s plan for fiscal recovery. Dependant on asset sales and bond issues and shifts of costs as much as cuts in costs, the plan faced an uncertain reception at best. The next step is a likely takeover of the City’s fiscal affairs by the State through the DCA.

The DCA found that the City failed to take the steps necessary to implement the signature components of its Plan during the past 150 days. That inaction, combined with the Plan’s disappointing shortcomings, compelled the Department to conclude that the Plan is not likely to achieve financial stability for the City. The DCA finding said it was incumbent upon the City to include those specific actions statutorily mandated to be included in the recovery plan. Here are its summary conclusions.

First, the City’s submission does not meet basic requirements of the Act. It does not include a proposed balanced budget for 2017 that complies with all of the applicable conditions of the Local Budget Law. Nor is it adequately responsive to all of the Act’s eight specific directives insofar as some important details are missing and some are factually wrong.

Second, there is a significant financial gap each year and a cumulative financial shortfall across the recovery period in excess of approximately $106 million. Even more modest estimates of the fiscal gap would yield a structural deficit that could never be closed by the actions outlined in the City’s Plan. Some glaring errors or omissions that contribute to the shortfall include: understating debt service over the next five years by approximately $18 million; failing to accurately estimate the revenues collected from the investment alternative tax by improperly anticipating an excess of IATs of approximately $31 million over the life of the Plan; and overstating property tax revenues by approximately $20.5 million, based on the City’s flawed assumption that the property tax base will remain constant for the Plan period.

Third, the Plan presents a number of other operational and qualitative concerns described within this Decision. Although the Plan outlines an additional headcount reduction of 100 over the life of the Plan, it is not enough to sustainably address one of the biggest cost drivers in the City’s budget. Indeed, more generally, the City neglects to quantify operational savings achieved through full implementation of cost cutting strategies. Independent financial experts advise that in the current financial marketplace, given Atlantic City’s credit rating, the cost would be significantly higher than the City’s projections. The DCA finds that the City’s proposed sale of Bader Field is not likely to aid the City in achieving financial stability and is not prudent fiscal management.

Despite the extraordinary need to raise revenue, the City chose not to increase taxes at any point during the five-year recovery term and provided no analysis to support its decision. Further, the City has not provided evidence of negotiated PILOT agreements with casino properties as required by the PILOT Act, thereby jeopardizing revenue collections during calendar year 2017 and beyond. Nor does the Plan sufficiently account for future payments for off balance sheet liabilities.

So the City is left to rely on political machinations in Trenton. Much will be made about the importance of local control and the override of the elective process. Many will insist that the decision was a fait accompli and that this is the outcome the Governor wanted all along. It is hard to overlook the City’s history of inept and corrupt operations especially in the light of the obvious difficulties the City’s one dimensional economy faces.  The 150 day process since Memorial Day has been characterized by fits and starts, missed deadlines, and declarations of default under a loan agreement with the State. For creditors, the threat of bankruptcy is effectively taken off the table.


The “clawback” provisions that GO creditors have historically counted on to buttress their case for full repayment have never been challenged in or affirmed by a court. That may soon change as senior creditors of the Puerto Rico Sales Tax Financing Corp. (Cofina) have filed a petition to intervene in the action entitled Lex Claims LLC et al. v. García-Padilla pending in the U.S District Court for the District of Puerto Rico to enforce the stay on the litigation established by the Puerto Rico Oversight, Management and Economic Stability Act (Promesa).

The holders of COFINA debt have intervened with some intensity. “In response to certain General Obligation (“GO”) bondholders’ meritless assertions directed at COFINA in the Action, we have filed a motion to intervene for the limited purpose of enforcing the stay on litigation established under PROMESA. At the appropriate time, our group will comprehensively set forth why challenges to COFINA lack merit,” the senior creditors said in a statement.

The GO bondholders under Lex Claims sued the government in June to stop it from transferring funds to pay for services instead of debt. Earlier this month, they sought to amend their original complaint to force Puerto Rico to use Cofina funds to pay its GO debt. Lex Claims contends the commonwealth continues to favor certain bondholders, namely Cofina bondholders, by siphoning off hundreds of millions of dollars in tax revenues each year to pay them in disregard of the Puerto Rico Constitution and in violation of Promesa. GO bonds are explicitly protected by the Puerto Rico Constitution, and are therefore protected by Promesa, they contend.

The senior Cofina creditors’ position assumes that Congress deemed the temporary stay essential to stabilize Puerto Rico for the purposes of resolving its fiscal crisis. “Unfortunately, the Plaintiffs (Lex Claims) appear committed to evading the restructuring process set out by Congress and doubling down on the obstructionist positions they took in the lead up to Promesa’s passage. We agree with the Financial Oversight & Management Board for Puerto Rico’s recent observation ‘that ongoing litigation is a major distraction that interferes with the Oversight Board’s congressional mandate.’

“As constructive participants engaging in good faith negotiations with the Government of Puerto Rico and other bondholder groups, we believe that the Plaintiffs’ efforts to circumvent congressional intent and disrupt established processes undermine the best interests of the Commonwealth, its citizens and creditors,” the Cofina creditors maintain.

In the recently filed proposed Second Amended Complaint, Lex Claims advance legal theories premised on “fundamental mischaracterizations of Promesa and a complete disregard for the statutory and constitutional framework” under which the Commonwealth established Cofina nearly a decade ago. Cofina already establishes that part of its revenues goes to a trust fund automatically to pay bondholders. “In short, the Plaintiffs’ claims amount to a baseless, untimely request to declare that the Sales & Use Tax [SUT, or IVA by its Spanish acronym] is an ‘available resource’ under the Puerto Rico Constitution and to strip Cofina creditors of their vested property interests. Not only do the Plaintiffs’ claims find no support under Promesa or Commonwealth law, but they ignore the express admonitions in the offering documents for the GO bonds, which specifically provide that COFINA’s portion of the SUT is not an ‘available resource,’ and is not subject to clawback should there be a shortfall in payment of the GO bonds,” the COFINA creditors said.

In the nearly 10-year period since the Puerto Rico Legislative Assembly first transferred a portion of the then newly created IVA to Cofina, no challenges to the agency have been made. Given Cofina’s bi-partisan support since its creation, a COFINA creditors’ release said this is not surprising. “Indeed, the Commonwealth and investors alike, including the Plaintiffs, all benefited from the low-cost financing that COFINA offered. The lack of any challenge to COFINA underscores the manifest deficiencies in the Plaintiffs’ claims and is also fatal to their attempts to now evade PROMESA’s mandatory stay,” the group added.

The Promesa Board filed a request to intervene in three other bondholder lawsuits, two against the Puerto Rico Highway and Transportation Authority (HTA) and one against the Employees Retirement System (ERS). In its filing it said “the Oversight Board is also entitled to intervene because it has an interest relating to the transaction (lifting PROMESA’s automatic stay) that is the subject matter of these actions; lifting the stay could impair the Oversight Board’s ability to perform its statutory functions; and the other parties to this litigation are not likely to represent the Oversight Board’s interest adequately.” The board, created by the Puerto Rico Oversight, Management and Economic Stability Act, intervened in the three consolidated cases as it did on Oct. 21 in four other lawsuits from litigants who challenged the constitutionality of the Emergency Moratorium and Financial Rehabilitation Act.

The hearing on the three consolidated cases was slated to begin Nov. 3. One lawsuit was filed by Altair Global Credit Opportunities Fund and some 30 hedge funds against the Employees Retirement System. Peaje Investments and Assured Guaranty Corp. have both sued the government for diverting funds from the HTA. The Altair case wants employees’ contributions to retirement to be put in a separate account for their benefit even though in the lawsuit filed Sept. 21, the plaintiffs said they intend to work with the board to manage Puerto Rico’s finances and renegotiate its public debt.

Before the board’s intervention, federal Judge Francisco Besosa had denied a government request for a continuance of the Nov. 3 hearing to allow the parties more time for discovery. The government argued that after the court agreed to consolidate on Oct. 14, the lawsuit of Altair with the cases of Peaje and Assured, the movants in the Altair case haven’t started the process of meeting-and-conferring about witnesses, exhibits or stipulations—neither with the commonwealth nor with the plaintiffs in Peaje or Assured. The government also argued that the continuance was going to give the board time to decide whether to intervene in the three consolidated cases.

here will be no quick and easy resolution or restructuring of Puerto Rico’s debt. The decision will have to made as to whether a stautory action can override constitutional provisions. If the litigation to enforce the “clawback” succeeds it will have hugely positive ramifications for the GO debt and very negative consequences for the COFINA debt. This is a battle that it was in the interest of many to avoid. The action’s of the current administration have in large part forced the issue and that choice of path has been hard to understand outside of the political context. Those politics seem to be leading to an undesirable political conclusion for their perpetrators so the choice makes even less in that light.


It has been four years since the City of San Jose attempted to reform its pension plans covering police and firemen. At the June 2012 election, San Jose voters adopted Measure B. Among other things, Measure B required employees to make additional retirement contributions. Measure B also required the City Council to adopt a retirement program under which employees who “opted in” to a lower retirement formula would not be required to make the additional retirement contributions, and would retain some existing benefits and have others reduced. It required the City to adopt a retirement plan for new employees that could include social security, a defined benefit plan and/or a defined contribution plan, and included caps on the retirement benefits of new employees. It also limited disability retirements.

In April of this year, a judge upheld an order from last month to accept a request from the San Jose Police Officers’ Association and the city to overturn the measure on a “procedural defect” — that the city didn’t fully bargain with labor unions before placing the initiative on the ballot. That was the city’s strategy to overturn Measure B and replace it with a negotiated settlement with its unions.

Instead on November 8, voters will be asked to approve Measure F to amend the San Jose City Charter to change employee retirement contributions and benefits, and retiree healthcare benefits. According to the City, retirement benefits for Tier 2 members would be improved to levels similar to other Bay Area agencies as well as providing that the costs of the benefit are shared 50/50 between the City and employees in specified increments. The defined benefit retiree healthcare plan that established levels of healthcare benefits would be closed to new members. Tier 1 Employees who return after leaving the City would be Tier 1 Employees.

The pre-Measure B definition of disability would be reinstated. An independent medical panel would be created to determine eligibility for disability retirements. The elimination of the SRBR would continue and be replaced with a Guaranteed Purchasing Power benefit to protect retirees against inflation. Both City and employees would be required to make the full annual required plan contributions calculated by the Retirement Board. Voter approval would be required for any future enhancements to defined retirement benefits. Retroactive benefit enhancements would be prohibited.

The City’s Budget Director and an outside actuary have concluded that Measure F and the related agreement will secure $40 million in taxpayer savings in its first year, with savings projected to grow each following year. The mayor and 10 of 11 members of the City Council are on record as being in support of the measure. Opposition is centered in local anti-tax groups.


Indian River and Martin counties filed separate motions for summary judgment Oct. 20, setting their 2015 suits involving All Aboard Florida’s planned Brightline service on course for a final decision. The two Florida counties say they have proven in federal lawsuits that the $1.75 billion private activity bond allocation for an in-state passenger train project should be vacated. “We’re hoping the case will be submitted to the judge in early December, and then the judge will dispose of the case as he sees fit,” said an attorney representing Martin County.

Both counties filings asked that the judge should rule in favor of their claim that the U.S. Department of Transportation violated the National Environmental Policy Act at the time it approved All Aboard Florida’s request for tax-exempt bond financing. In its response to the suit, the USDOT said it didn’t violate the law, and the counties are not entitled to relief, which would be a reversal of the agency’s approval of the bonds. USDOT also claims it is not required to conduct a review under NEPA, the National Historic Preservation Act, or the Department of Transportation Act.

Although the company said that when the suits were filed no Final Environmental Impact Statement or Record of Decision – documents associated with the NEPA process – had been issued for the project. The final Environmental Impact Statement has since been released, but the Record of Decision – a document that concludes the NEPA review process – has never been issued.

All Aboard Florida has until Jan. 1 to issue the bonds. With other financing, construction is well under way on stations in Miami, Fort Lauderdale and West Palm Beach where service is expected to start next year. U.S. District Judge Christopher R. Cooper, in an August ruled that the counties proved that the USDOT bond allocation should have been considered in a federal environmental review process. The judge said that the counties had legal standing to proceed with their challenges because they demonstrated that the project likely would not be built without tax-exempt financing – a reversal from a decision in June 2015.

Information produced during discovery, the judge said, raised “legitimate questions” about All Aboard Florida’s commitment to completing the second phase of its project, from West Palm Beach to Orlando, without the use of private activity bonds. He said the issue “casts some doubt as to whether AAF is truly serious about moving forward with phase 2 of the project regardless of the outcome of this lawsuit.” USDOT and All Aboard Florida must file responses to the motions by Nov. 4. Reply briefs from the counties are due Nov. 14.


Dignity Health (A3) and CHI (A3/BBB+) have signed a nonbinding agreement to evaluate “an alignment” between the systems, according to a release. A full merger would create the nation’s largest not-for-profit hospital company with combined revenue of $27.6 billion ahead of the $20.5 billion posted by Catholic-sponsored Ascension. A CHI-Dignity merger would leave it trailing only Kaiser Permanente as the largest not-for-profit health system. The companies did not disclose terms of the agreement, only alluding to last month’s news that they had formed a partnership called the Precision Medicine Alliance, which the two systems called the nation’s largest community-based precision medicine program.

“The potential to align the strengths of these two organizations will allow us to play a far more significant role in transforming health care in this country,” CHI CEO Kevin E. Lofton said in a news release. “Together, we could enhance our shared ministry as the health industry transitions to a system that rewards the quality and cost-effectiveness of care.”

Englewood, Col.-based CHI has 103 hospitals in 18 states and focuses on clinical and home-health services in addition to research. CHI, however, is facing some financial struggles having incurred a net loss of $568.1 million in the first nine months of fiscal 2016, which began July 1, 2015. Health IT costs, investment losses and troubles with its health insurance company were cited. CHI’s credit rating from Fitch, which covers $6 billion of outstanding debt, now sits at BBB+ from A+. It was lowered in July. That loss was a substantial deterioration from its fiscal 2015. For all of 2015, CHI managed a meager $3.1 million gain on operations on revenue of $15.2 billion. CHI’s debt-to-equity ratio has been a huge negative metric  in recent years. At about 50% in 2011, it rose to nearly 100% in 2013 and on to 110% in 2015.

San Francisco-based Dignity Health operates in 22 states with 9,000 physicians, 62,000 employees and 400 care centers. Dignity has 39 hospitals. It is the nation’s sixth-largest not-for-profit health system. It posted an operating loss of $63.4 million on revenue of $12.4 billion in its 2016 fiscal year ended June 30.

The Precision Medicine Alliance will initially focus on advanced diagnostic tumor profiling in cancer patients, but will eventually expand to treating other areas of cancer and cardiac illnesses, according to a news release. The program will also build a collection of clinical cancer data that can be used to better diagnosis and treat patients. The systems will integrate patient electronic health records in order to build the database. Both systems operate Catholic and non-Catholic hospitals and delivery hubs.

Given the similarities in ratings, from that standpoint the initial impact on the credit should  not be great. Integration risk is the most likely source of uncertainty in the short run. Longer term the proposed merger has the potential to stabilize and strengthen the overall credit of the resulting entity.

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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