Muni Credit News October 4, 2016

Joseph Krist

Municipal Credit Consultant

THE HEADLINES…

NEW JERSEY FINDS NEW TRANSPORTATION FUNDING

ILLINOIS FACES DEADLINE; GETS DOWNGRADE

GREAT LAKES WATER AUTHORITY

PROMESA MOVES AHEAD

MORE PRIVATE PRISON BOND PROBLEMS

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NEW JERSEY LEADERS AGREE ON GAS TAX HIKE

The Governor, Assembly Speaker, and Senate President jointly announced that they had reached an agreement to raise the state’s gasoline tax by 23 cents a gallon to pay for improvements to roads, bridges and mass transit systems. A compromise  was found after an impasse that had lasted for months and stalled hundreds of transportation projects. In exchange for Mr. Christie’s agreement on what he said was the first tax increase of his two terms in Trenton, the legislative leaders agreed to lower the state’s sales tax by less than half a penny and to phase out the estate tax by 2018.

According to the Governor, the sales tax rate would decrease next year to 6.875 percent, from 7 percent, and then in 2018 to 6.625 percent. He claims that the gas tax would pay for an eight-year, $32 billion reauthorization of the state’s Transportation Trust Fund. He said that “$32 billion will be invested in infrastructure and improvements and modernizations in the state of New Jersey over the next eight years.”

The announcement comes one day after a horrible crash involving a New Jersey Transit commuter train. The third-busiest commuter system in the country, New Jersey Transit has been operating without an executive director for nearly a year and its board of directors has not met for three months. It faces an unfunded $45 million gap in its budget this year. The board began suspending monthly meetings in June, when New Jersey Transit’s interim management found itself with a state budget that left the agency about $45 million short of what it needed to operate this year. At 37.5 cents a gallon, gas taxes in the Garden State will go from second-lowest in the U.S. to seventh-highest.

The Transportation Trust Fund provided more than one-fifth of New Jersey Transit’s annual budget. In July, Mr. Christie ordered the suspension of all highway and transit projects paid for by the trust fund. The near depletion of its funds this summer reflects the declining annual contribution to New Jersey Transit from the state’s general fund, less than $35 million last year — about one-tenth of what it was in 2009. Over the period of time the fund was stopped from spending this summer, NJ Transit has seen three accidents in its bus and train systems including two with fatalities.

While its ability and willingness to fund debt service on its bonds has not been questioned, the Transportation Fund has been under sustained pressure to cut costs. It’s spending on rail has been a prominent topic. That will only increase in the face of this latest incident. A technology known as positive train control automatically brakes a train when it runs a stop signal or exceeded speed limits. Federal officials have called for passenger railroads to adopt positive train control by the end of 2018.The Federal Railroad Administration said that New Jersey Transit had not yet installed the technology.

ILLINOIS G.O. RATINGS UNDER THE GUN

S&P Global Ratings lowered Illinois’ credit rating one notch to BBB and warned it could fall further absent a long-term solution that deals with the state’s chronic structural budget deficit and pension woes. “The downgrade reflects our view of continued weak financial management and increased long-term and short-term pressures tied to declining pension funded levels.” S&P said another downgrade could follow “should the state continue to demonstrate a lack of ability or willingness to adopt a long-term structural budget solution that also incorporates a credible approach to its long-term liabilities.”

The state’s liquidity position, a lingering source of concern was also referenced. “Although we don’t foresee this in the immediate future, challenges to the state’s debt payment priority could emerge should liquidity dwindle to the point where it affects the state’s ability to provide essential services,” S&P said.

Fitch Ratings rates the general obligation (GO) bonds of the state of Illinois at BBB+. Illinois plans to issue $1.349 billion GO refunding bonds and $483.045 million new money GO bonds this month and next month. Fitch maintained a Rating Watch Negative on the ratings of the state and related credits like the Illinois Sports Facilities Authority sports facilities bonds;  Metropolitan Pier and Exposition Authority McCormick Place expansion project bonds; and city of Chicago motor fuel tax revenue bonds.

Fitch expects to resolve the Rating Watch by the end of January based on the progress of the fiscal 2017 budget for the fiscal year that began July 1, 2016. At that time, Fitch will assess state action to address the chronic and growing financial imbalance that has resulted from an unwillingness to make use of the significant gap-closing tools available to the state.

The rating continues to be pressured in spite of State statutory mechanisms which include an irrevocable and continuing appropriation for all GO debt service, and continuing authority and direction to the state treasurer and comptroller to make all necessary transfers from any and all revenues and funds of the state. The state funds debt service in advance by setting aside 1/12 of principal and 1/6 of interest every month for payments due in the ensuing 12 months.

Fitch is clear. To stabilize the rating, the state will need to address the fiscal 2017 budget following the election in November or at the latest during a January legislative session. While it is unlikely that any actions taken would fully address the fiscal 2017 budget gap, Fitch will be looking for a solution that is comprehensive in its approach, addressing structural budget balance and including a plan to address accumulated liabilities. Failure to do so would result in a rating downgrade.

Illinois’ GO ratings were affirmed at Baa2 by Moody’s.

Governor Bruce Rauner’s office said of the situation with the State’s ratings “It’s time for the super majority in the legislature to recognize the current pension system is fatally flawed and requires immediate action. “Governor Rauner continues to fight for pension reform and other fundamental, structural reforms that will free up resources to help balance the budget.”

GREAT LAKES WATER AUTHORITY

The Great Lakes Water Authority has been operating the largest regional water and sewer system in Detroit and its suburban area since the beginning of 2016. This area comprises nearly 4 million people, approximately 38% of the population of the State of Michigan. The Authority provides service on a wholesale and retail basis. It operates the filtration and treatment facilities of the former City of Detroit Water and Sewer systems which have been the historic lynchpin of the southwestern Michigan regional water and sewer service area.

The Authority leases the treatment and filtration facilities from the City of Detroit. It derives revenues from the sale of water at retail to customers formerly served by the City of Detroit Water Department and at wholesale to 127 suburban water systems in all or part of eight counties in the greater Detroit metropolitan area through 87 contracts. Water is supplied from drawings from Lake Huron.

Revenues are applied to the operation and maintenance costs of the leased treatment and transmission facilities. Rates are expected to be sufficient to cover operation and maintenance, debt service, and reserve requirements and to cover debt service 1.15 times.  After application to O&M, revenues are applied monthly in installments in amounts sufficient to meet one sixth and one twelfth of annual interest and principal requirements. Debt service reserves must be maintained equal to maximum annual debt service. The Authority is permitted to issue junior lien bonds which are payable from net revenues after all requirements of senior lien debt are provided for including maintenance of required reserves.

Total debt outstanding is $2.275 billion including amounts representing City of Detroit Water and Sewer revenue bonds assumed by the Authority as a part of the overall plan of remediation adopted by the City of Detroit as part of its exit from Ch. 9 bankruptcy. The Authority is authorized to issue additional debt subject to either historical or projected net revenue coverage tests.

These sales will come in the wake of an upgrade to the Authority’s Water and Sewer bonds to A3 from Baa1 and to Baa1 from Baa2 the senior and second lien revenue ratings. The upgrades reflect improved financial metrics resulting from revenue growth, rate restructuring to enhance collections, and ongoing implementation of operating efficiencies. The ratings also incorporate the massive scale of sewer operations in southeast Michigan, a recovering but highly vulnerable economic base, very high leverage of pledged revenue, and the large share of revenue sourced from retail operations in the City of Detroit .

PROMESA MOVES FORWARD

The board established by the Puerto Rico Oversight, Management and Economic Stability Act (Promesa) officially has taken over the fiscal course the island will be following  for the next few years. During a recent public meeting in New York, the appointment of Jose Carrión  III as board chairman was unanimously approved. The members also established that the process to select the board’s executive director would be utilizing a talent search firm to identify the most competent person for the job. The date on which the official appointment will be made was not revealed.

Along with the executive director, also to be filled will be the position of coordinator as well as the rest of the team, which Carrión said will include attorneys. The chairman said the decision to seek legal advice is related to a request by Gov. Alejandro García Padilla in order to intervene in cases that his administration faces in Federal Court. Members listed the  public entities to be placed under the board’s immediate oversight. Puerto Rico’s central government, three retirement systems (teachers, judicial and employees), university (UPR) and all its public corporations, including the Aqueduct and Sewer Authority and Electric Power Authority, were placed under the immediate control of the entity.

Gov. Alejandro García Padilla was also required to inform the board periodically on cash flow, bank accounts, revenue, receipt and disbursement of federal funds and payroll. Oct. 14 was established as the date of for the governor to deliver the fiscal plan, although it is yet to be known if the board adopted a timeline proposed by the governor in his broadcast message Thursday.

PRIVATE PRISON PROBLEMS CONTINUE

The Internal Revenue Service (IRS) is conducting an audit of the Baker Correctional Development Corporation $45,000,000 First Mortgage Revenue Bonds (Baker County Detention Center Project) Series 2008. Although no final notice or determination has been received from the IRS, the IRS has informally advised the Issuer that the IRS’s position is that the interest on the Bonds is not excluded from gross income for federal income tax

The finance director for the Baker County Sheriff’s Office, confirmed that the IRS audit found the bonds failed to meet the private payment use test due to the jail’s large federal inmate population. “From what I can gather from speaking with the IRS and our attorneys, the IRS is wanting us to pull the bonds off the market as quickly as we can,” the finance director said. “We’ve interpreted that to be 60-90 days.”

As of last week, the Baker County Detention Center, located in Macclenny, Fla., has 480 inmates, roughly 350 of which are federal. The detention center, which opened in Sept. 2009 and is roughly 30 miles west of Jacksonville, is owned by BCDC and operated by the Baker County Sheriff’s Office. BCDC was formed as a nonprofit in 2006 to acquire, construct, maintain and/or operate one or more jails in Baker County.

The tax exemption issue just adds to the difficulties for the County in its prison operation.  The U.S. Immigration and Customs Enforcement’s (ICE) enforcement and removal operations division began housing detainees at Baker County Detention Center in 2009 under an intergovernmental service agreement with Baker County, according to ICE. The use of private facilities by the USDOJ will be ending and ICE is also reviewing its use of contract facilities to house detainees.

Tax-exempt bonds become private activity bonds if more than 10% of the proceeds are used for private use and more than 10% of the debt service payments are from or secured by private parties. Under the federal tax code, PABs are only exempt if they are issued for “qualified” purposes; jails do not fall under a qualified category. The federal government is deemed a private entity in under the federal tax code, while state and local governments are classified as governments.

In 2011, BCDC entered a forbearance agreement for principal payments on the $45 million bond issuance in 2008. The move came after the jail had lower-than-projected inmate counts and higher-than-expected startup costs. On average, the jail is comprised of roughly 60-70% federal inmates, the finance director said, making it more than six times as high as the private payment test allows. That ratio has been relatively consistent over the past six years. The federal government pays BCDC $84.72 per day for each federal inmate it houses.

Tax counsel for BCDC, told bondholders that he and the IRS have set a “joint target date” to wrap up the audit by the end of October. Dame said Baker is considering refunding the jail bonds with a bank loan, but no letters of interest have been sought yet.

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