Muni Credit News October 8, 2015

Joseph Krist

Municipal Credit Consultant


In 2004, the issue of pension reform for municipal government really came to the forefront through a study done by University of Chicago professor Joshua Rauh. In brief, it created a concern that consistent underfunding and underperformance of investments was creating a crisis that could potentially bankrupt many American cities. Among the potential hot spots were cities including Chicago, Houston, Philadelphia, San Diego and Milwaukee. Since that time we have seen the issue of pensions play a prominent role in the financial difficulties of cities including Detroit, Stockton, and San Bernardino which have all declared bankruptcy.

Prominent in  the news now are pension issues confronting the Commonwealth of Pennsylvania, the States of Illinois and New Jersey, and the City of Chicago. But a recent report from the Laura and John Arnold Foundation has returned the pension spotlight to Houston. According to the Arnold Foundation report, Chicago was in roughly the same position 10 years ago that Houston is in today. the city’s strong economic position has helped to cushion the impact of poor pension funding decisions thus far, but conditions are changing. The drop in the oil markets along with the property tax revenue cap could quickly magnify the city’s pension problems and result in a crisis much like the one in Chicago.

The Foundation suggests that Houston should obtain local control over the city’s pension systems in order to negotiate changes directly with workers and enact those changes locally. In addition, they posit that the City must fully fund the pension systems; paying off the unfunded liability in 20 years or less. In 2001, the City’s unfunded liability was $300 million. In 2014, it had grown to $3.1 billion. The funding gap is due in large part to the fact that the city hasn’t been paying enough into the pension fund on an annual basis. Houston’s Annual Required Contribution has more than doubled since 2003 and is now equal to nearly one-fifth of the total general fund revenue. Yet, Houston has only paid a portion of the amount each year since 2006, despite the fact that it has increased the amount of money dedicated to pensions from about $150 million to nearly $300 million.

The report says that the pension systems for Houston’s firefighters and municipal employees use the highest investment return assumption for any major plan in the United States—8.5 percent. Meanwhile, the pension system for Houston’s police officers uses an investment return assumption of 8 percent, a number that is still higher than the national average. Under an assumed rate of return of 7.5 percent, the plans’ funded ratio, when considering the market value of assets, would fall from 75 percent to 67 percent and the debt would jump to approximately $5 billion. When assumptions are lowered to 7 percent—which is considered to be a reasonable expectation for future returns—   the funding level falls to just 63 percent.

Houston also was one of the cities that in prior years – Philadelphia, San Diego and Milwaukee which used DROP, or deferred retirement option programs. The basic concept works as follows: When an employee becomes eligible to retire, he instead opens an escrow account, and then keeps on working at normal pay. His pension benefit stops growing, just as if he had retired. The pension fund starts sending monthly checks to his escrow account. The escrow money earns interest, and when the employee finally does retire, he gets a lump sum. He also starts receiving his monthly pension checks, which are based on his benefits before the escrow accounts were created.


A lengthy tax relief and job creation bill recently introduced in the House has once again raised concerns that the tax exemption on municipal bonds could be revisited again. The 299-page bill, H.R. 3555 called “Jobs! Jobs! Jobs! Act of 2015,” was introduced by Rep. Frederica Wilson, D-Fla., and has more than 30 Democrats as co-sponsors.

It provides an exemption for private-activity bonds issued from 2015 through 2018 from the alternative minimum tax, repeal sequestration, and creates an infrastructure bank. The bill includes a number of provisions aimed at tax relief for workers and businesses, putting workers back on the job while rebuilding and modernizing the country and providing pathways for job-seeking Americans to get back to work through infrastructure projects.

It would however, cap the value of the municipal bond tax exemption at 28%. The measure also would repeal federal spending cuts known as sequestration which have included reductions in the subsidy payments issuers receive from the Treasury Department for their direct-pay bonds, such as Build America Bonds. One of the offsets for the bill would be the limit on certain deductions and exclusions, including the exclusion for tax-exempt interest. Other offsets include taxing carried interest in investment partnerships as ordinary income, closing the loophole for corporate jet depreciation and repealing oil subsidies.

The bill would exempt PABs issued from 2015 through 2018 from the AMT. Generally, these types of bonds are subject to the AMT, increasing their yields, but PABs issued in 2009 and 2010 were exempt from AMT under the terms of the American Recovery and Reinvestment Act. By exempting PABs from the AMT, but subjecting all bonds to the 28% cap, PAB issuers may not be better off than they are under current law, and issuers of other types of bonds would be worse off by some estimates.

Under current conditions in Congress, most particularly the House, we view the chances of enactment of serious and/or comprehensive tax reform to be effectively nil. What we do take note of is the fact that the idea of capping the value of the municipal bond tax exemption is being forwarded from the legislative side. It had previously been floated primarily by the Administration.


Try as one might to go a week without a story on the Commonwealth, it is well nigh impossible. At least the news is somewhat better this week. The GDB announced that debt  from the Municipal Finance Agency (MFA), Children’s Trust and Housing Finance Authority (HFA) are not currently expected to be restructured as part of the ongoing effort to manage the Commonwealth’s debt. Who would have thought that under any scenario, that tobacco bonds would look better than a general obligation with a constitutional revenue pledge?  That is because, according to the GDB, MFA is backed by municipal property taxes and  the Children’s Trust is a dedicated source. [What is going to be restructured] is everything else that is part of the government’s cash flow.

The Puerto Rico government intends to begin debt-restructuring talks with its creditors by mid-October. To that end, six groups have already signed confidentiality agreements as part of the overall debt-restructuring process, while other creditor groups are amending nondisclosure agreements that were previously signed for other transactions. While it faces a severe cash crunch that is expected to worsen by November if no additional liquidity measures are taken, the commonwealth faces two debt-service payments on Dec. 1, of $354.7 million, and Jan. 1, of $331.6 million, corresponding to GDB and general obligation (GO) debts.

Meanwhile the PREPA negotiations lurch along. PREPA announced Thursday that the Ad Hoc Group and fuel-line creditors have agreed to extend their forbearance agreements until Oct. 15. Talks with the monoline insurers hit another snag when the Puerto Rico Energy Commission (PREC) rejected Wednesday a petition filed Sept. 17 by National in which it sought a rate revision and hike of 4.2 cents per kilowatt-hour. PREC denied the petition alleging National didn’t meet requirements to prompt a rate revision procedure, nor provided enough evidence.

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