Muni Credit News October 25, 2016

Joseph Krist

Municipal Credit Consultant

THE HEADLINES…

NUCLEAR POWER BACK IN THE NEWS

DENVER HOTEL UPGRADE

TWO HOSPITALS TELL TWO TALES

WAYNE COUNTY REBUILDS

P3 UPDATES

ATLANTIC CITY BETS AGAIN

CONNECTICUT TAXES

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NUCLEAR SUBSIDY CHALLENGED IN NY

It comes as no surprise that a group of energy companies and trade associations have filed a lawsuit in an effort to overturn a decision by the administration of Gov. Andrew M. Cuomo to subsidize several struggling upstate nuclear plants. The lawsuit alleges that the state overstepped federal authority to regulate energy prices. Filed in Federal District Court in Manhattan less than ninety days after the Governor announced a plan that would have provided hundreds of millions of dollars in annual subsidies to four upstate plants. The subsidies were included in an order from the Public Service Commission.

The plaintiffs  argue that the order conflicts with the federal government’s policy of allowing market forces to set wholesale energy prices. It will raise electric rates for New York residents to prop up the plants, several of which would have failed without the governor’s plan, the suit claims. “Unless enjoined or eliminated, these credits will result in New York’s captive ratepayers paying the owners an estimated $7.6 billion over 12 years,” according to the filing.

The Governor sees the subsidies as a way to help achieve renewable energy goals as part of his so-called Clean Energy Standard, which requires half of the state’s electricity to be produced by sources like wind and solar by 2030. In its order, the Public Service Commission claims that the state’s upstate nuclear plants “avoid the emission of over 15 million tons of carbon dioxide per year,” and that losing their production “would undoubtedly result in significantly increased air emissions due to heavier reliance on existing fossil-fueled plants or the construction of new gas plants to replace the supplanted energy.”

In response, the PSC disputes the cost estimates made in the suit, saying it believes the financial impact would be “less than $2 per month for a typical residential customer.” The four plants scheduled to receive the financial benefit include two at the Nine Mile Nuclear Station in Scriba, N.Y., and the Robert Emmett Ginna Plant, east of Rochester, as well as the James A. Fitzpatrick Nuclear Power Plant, also in Scriba. The suit contends that only one of the two Nine Mile plants is financially feasible.

The PSC order is part of a larger scheme to keep the Fitzpatrick plant running after a sale to Exelon, a Chicago-based company that also has controlling stakes in the other three subsidized plants. Exelon also operates other nuclear plants in the state. The plan would advancing clean energy goals as well as facilitating efforts  to save good-paying jobs and tax cost the region $500 million in lost wages and tax revenue. Pro-business groups like some 25,000 jobs which they claim would be saved through the subsidies.

DENVER HOTEL UPGRADE SHOW WORTH OF A REAL COMMITMENT

Over time, we have looked at the varying characteristics of bond issues for hotels and the wide range of credit results which those various characteristics produce. Generally, these deals have reflected disappointing credit results. An upcoming issue reflects a different outcome reflecting the benefits of its particular structure.

Moody’s Investors Service has upgraded the Denver Co. Convention Center Hotel authority’s approximately $330 million in outstanding bonds to Baa2 from Baa3. The rating outlook is stable. The upgrade is in connection with the Authority’s planned issue of $270 million Convention Center Hotel Senior Revenue Refunding Bonds, Series 2016.

The Baa2 rating reflects the security of pledged revenues, which include net revenues of the Hyatt Regency Denver hotel project, and annually appropriated economic development payments from Denver. The bonds are also secured by mortgage liens on the land and facilities which have been assigned to the trustee and collateralized with a deed of trust, as well as various reserve funds. In addition to the annual economic development payments, there is a room block agreement. The development of the hotel was accompanied by substantial investment in convention center improvements and downtown revitalization.

The hotel has a strong market position. It is the second-largest hotel in Denver. The hotel opening occurred in December 2005 as the Hyatt Regency Denver at Colorado Convention Center. It totals approximately 1.2 million gross square feet, including 1,100 hotel guest rooms, a 300-seat full-service restaurant, a lobby bar rooftop lounge, a health club, approximately 60,000 net square feet of meeting space, and a three-level 570-car parking garage., with a trend of above average operating performance and a large and well maintained facility.

The city payments in tandem with the substantial group business of the hotel generate above-average predictability of project cash flows relative to standalone hotel projects, particularly those more exposed to transient business. Relative to those projects, financials are augmented by significant indenture required reserves and the retention of net cash flow within the project.

The refunding restructures the authority’s debt to provide significant excess cash flow for capital investment over the next five years to finance planned upkeep and renewals to keep a competitive asset while foregoing the need for additional debt. The plan of finance is also intended to enable the buildup of liquidity in cash trap reserves over the next five years while sizing the $11 million annual economic development payment to cover at least 50% of maximum annual debt service.

The Baa2 rating incorporates Moody’s expectation that the hotel will continue to receive  payments from the city which will be sufficient to maintain consolidated debt service coverage ratios ranging from 1.7 times to 2.2 times.

CEDARS SINAI MEDICAL CENTER

We have commented on a number of instances where the consolidation of hospitals and systems reflects a trend in that direction in response to the ACA. Of course, there are always exceptions to any trend. One of these is reflected by Moody’s Investors Service assignment of a Aa3 rating to Cedars-Sinai Medical Center’s (CA) Revenue Bonds Series 2016A and Refunding Revenue Bonds Series 2016B. The bonds are expected to be issued in an aggregate amount of $675 million. The Series 2016A bonds are expected to mature in 2036 and the 2016B bonds in 2039. The rating outlook remains stable.

The Aa3 rating reflects multiple factors including Cedars-Sinai’s large size and strong reputation for clinical services and research, excellent financial performance that has allowed the organization to deleverage significantly over the last several years, and strong and improving balance sheet metrics. The stable outlook reflects an expectation that Cedars Sinai will continue to grow patient volumes and revenue, and that the organization will continue to generate strong operating performance and cash flow.

The Bonds are secured by gross revenues of the Cedars-Sinai Medical Center (excluding the Foundation and Greater Valley MSO, which are a small portion of overall System revenue). The debt service coverage ratio test is 1.1x and there are no covenant restrictions on additional debt, or additional financial covenants. This is in keeping with current market trends.

Cedars-Sinai is a well regarded academic medical center located in Los Angeles. The organization operates over 800 beds on its main campus, generating approximately 50,000 admissions annually. Cedars-Sinai maintains a number of teaching and research programs and is nationally recognized in many service lines. It is the major teaching hospital for the UCLA Medical School. As a major research facility it is currently conducting over 1,100 research projects.

The new money portion of the proposed bond issue will finance the purchase of an office building currently being leased by CSMC. The purchase will eliminate an annual operating expense for rent of $14 million.

Cedars is able to maintain itself as a “stand alone” facility through its size, strategic location, and wide range of services it is able to provide at a high level. It maintains strong occupancy levels of 80%. Revenues are derived primarily through privately insured patients, with government payers generating only 30% of revenues. MediCal represents only 5% of revenues. Cedar’s status as a significant teaching and research institution generates a higher level of patient acuity which favorably impacts reimbursement rates.

TEMPLE UNIVERSITY HEALTH SYSTEM

Revenue sourcing under the ACA can be an important consideration in the credit status of a hospital bond credit. Low government funding dependence can be a strong factor in favor of a credit. But it is not a hurdle which cannot be overcome for a government dependant hospital in its effort to improve its rating.

Temple University Health System in Philadelphia is the largest provider of Medicaid funded healthcare in the Commonwealth of Pennsylvania. This would have been a challenge under any circumstances but the first years of the ACA occurred in an environment where the state administration in place was politically against using the opportunity provided by the ACA to expand Medicaid. So Temple faced an effective “double-whammy” as it attempted to maintain its credit standing.

So it says something about the System’s management that Moody’s Investors Service  announced an upgrade to Ba1 from Ba2 on Temple University Health System (TUHS), PA, $507 million of rated debt issued through the Hospitals and Higher Education Facilities Authority of Philadelphia. Moody’s also assigned a stable outlook.

The upgrade to Ba1 reflects durability of TUHS’ financial turnaround with a second consecutive fiscal year of marginally profitable operating performance. The rating also acknowledges the health system’s large size, clinical diversification, its role as a safety net provider for the City of Philadelphia, as substantiated by historically sizable funding from the Commonwealth, and close working relationship with Temple University (TU). The rating remains constrained by still modest margins, above average Medicaid exposure, heavy reliance on supplemental funding, a highly leveraged balance sheet relative to operations and cash, and an especially competitive market which continues to consolidate.

The upgrade to Ba1 reflects Moody’s view of the durability of TUHS’ financial turnaround with a second consecutive fiscal year of marginally profitable operating performance. The rating also takes into account the health system’s large size, clinical diversification, and its role as a safety net provider for the City of Philadelphia. Moody’s acknowledges historically sizable funding from the Commonwealth, and a close working relationship with Temple University (TU). The still less than investment rating continues to reflect a still modest level of margins, the aforementioned above average Medicaid exposure, heavy reliance on supplemental funding, a highly leveraged balance sheet relative to operations and cash, and an especially competitive market which continues to consolidate.

Clearly investment in the TUHS credit involves a taste for risk but it shows that strong management can overcome even the most challenging of credit environments.

WAYNE COUNTY

Michigan has approved Wayne County’s request to be released from its 14-month financial management agreement with the state. County Executive Warren Evans announced that the county had satisfied the consent agreement with the state by eliminating a $52 million structural deficit and restoring overall financial stability. Evans’ office said the county has restructured employee and retiree health care and pensions, and raised the funding level of the county’s pension system from 45% to 54%.  His goal is to increase the funding level to 70%.

The State found  that the county has satisfied the Consent Agreement terms found in Subsections 1l(a)(l )-(3) of the Agreement. As a result of this determination, the County has successfully completed and is released from its Consent Agreement. Post consent agreement, the county shall apply the proceeds from all asset sales which    exceed $25 million to the county’s pension funds, absent prior State Treasurer approval to use the proceeds otherwise. In addition, the Departmental review of other future county budget amendments is now waived pursuant to Section 15 of the Agreement. This budget amendment waiver does not release the county from its September 8, 2016 pledge to apply proceeds from a sale of the Downriver Sewer facility to the county’s pension and  OPEB funds.

The County Executive was candid in his assessment of the County’s current condition saying that the county is in its best fiscal shape in some time, but still has a long way to go. “We still have unfunded liabilities,” said Evans. “So I don’t want anyone to think this is a victory lap. This is a recovery that’s gotten us out of fiscal distress.” The county has balanced its budget for two years in a row with an accumulated surplus of $35.7 million for fiscal year 2015, and that surplus is expected to increase for fiscal year 2016. Key challenges still lie ahead including remaining health care liabilities, under-funded pensions, and completing the construction of the county jail.

P3 UPDATES

The Commonwealth of Virginia has been an active participant in the P3 marketplace as it attempts to find creative ways to finance the road development and expansion needs of its growing population. These efforts have met with mixed success as we have documented. News this past week updates the status of these projects.

One will represent a failed effort at least in terms of its municipal bond market experience. Globalvia has been named as the preferred bidder for the Pocahontas Parkway in Virginia, valued at $600m. This is the Spanish firm’s first acquisition in the North American market. Financial close is subject to the Virginia Department of Transportation’s (VDOT) approval, which is expected sometime this fall. The transaction is slated to reach financial close before the end of the calendar year.  The concession period will end in 2105.

The Pocahontas Parkway had been owned by Macquarie, and a consortium comprising TPG and Citigroup. The Macquarie unit acquired TPG and Citigroup’s stake in August 2015 for approximately $400m. That transaction occurred after initial operating results were not robust enough to cover debt service on municipal bonds issued for its construction. This acquisition will have no effect on the public traveling the Pocahontas Parkway.

On October 11, 2016, VDOT and VAP3 received two proposals from two private sector teams –Express Partners  and I-66 Express Mobility Partners – to design, build, finance, operate and maintain the I-66 Outside the Beltway Project. Proposals are under review.  The Department intends to announce the successful proposer at the end of October 2016, with commercial close expected at the end of December 2016.  Construction is anticipated to begin in 2017.

ATLANTIC CITY

The city will pay down tax-appeal debt by selling Bader Field and issuing bonds, according to a plan Mayor Don Guardian announced. The plan may be the City’s last stand to avoid a state takeover of its finances. As part of its fiscal plan to avoid a state takeover, the city would sell the 143-acre former airstrip to its water authority for $110 million, using the proceeds to pay down “a majority of our liabilities,”  according to the Mayor.

The city would then issue tax-exempt bonds secured by the state’s Municipal Qualified Bond Act to cover the remaining tax appeal debt, the statement said. The city expects interest rates of less than 4 percent. The city owes Borgata Hotel Casino & Spa about $160 million in tax refunds before interest. The casino, the city’s largest taxpayer and biggest creditor, has withheld about $23 million in property taxes so far this year to offset the refunds.

“In order to move Atlantic City forward, we must address every one of the outstanding liabilities that are crippling us financially, rendering the city helpless to face the challenges ahead,” Guardian said. “Now is the time to clean the slate of these past debts so we can move forward.” City Council approved the first reading of an ordinance Wednesday that sells Bader Field to the Municipal Utilities Authority for $110 million. Guardian didn’t say how much money the city would borrow to cover the remaining tax appeal debt after the Bader Field sale. But he said debt service on the bonds would be about $4 million per year for five years and $7 million per year for the remaining 20 years.

The city would pay the bonds using proceeds from the casino Investment Alternative Tax, which was redirected from the Casino Reinvestment Development Authority as part of the so-called PILOT bill enacted in May. “Most importantly, debt service will be fully covered by the cost savings initiatives included in our Recovery Plan while we also restore the $33 million in lost revenues from taxpayer credits currently choking the city’s budget,” Guardian said. The final approval and enactment of the plan remains in doubt as we go to press.

TAXES ARE IN THE EYE OF THE BEHOLDER

A random encounter after a recent analysts meeting generated a conversation about raising taxes to fund pension liabilities. One Connecticut resident expressed to me vehement opposition to Connecticut’s level of income tax rates blaming them for an exodus of residents and businesses. It got me to wondering exactly what the rates were in states which border the Nutmeg State.

The Tax Foundation provides data on marginal income tax rates for the neighboring states. Massachusetts (where GE moved 525 jobs this summer) has a flat 5.1% rate regardless of income. Rhode Island is at 5.99%, New York is at 6.875% (8.82% for individuals over $1 million; $2 million for joint filers), Vermont tops out at 8.99%, and New Hampshire taxes interest and dividends only at 5%.

So while not the lowest, Connecticut is certainly not an outlier. But perceptions are everything when it comes to raising taxes. So it may be a hard sell to get Nutmeggers to ante up to cover the State’s rising liability costs but the resistance may not be as grounded in reality as some may think.

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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