Muni Credit News September 29, 2016

Joseph Krist

Municipal Credit Consultant


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The State of Oregon will be issuing general obligation bonds. The preliminary official statement gives us a chance to look at the state’s pension position as it deals with the aftereffects of a state Supreme Court decision voiding enacted changes to COLAs and benefit levels and consecutive years of low investment returns. While funding levels remain adequate, the trends and signs do not give comfort.

The State Pension Board approved changes in 2013 that would have limited COLAs and reduced benefit increases for pensioners who had moved out of state. The Board estimated that these changes would have reduced the unfunded liability of the State by some $5 billion. Unsurprisingly, beneficiaries initiated litigation to fight these changes. In April, 2015 the Oregon Supreme Court issued a decision.

The Court found that the changes to benefits for out of state retirees were legal but found that the proposed changes to COLAs for benefits earned before June, 2013 were unconstitutional. The change in COLAs for benefits earned after that date were legal to be enacted.

In light of the 2015 decision, the State Pension Board made several changes to the assumptions used to determine the state’s liability funding requirements. Primarily, it changed the investment earnings rate assumption from 7.75% to 7.5%.  However, this change follows a prior adjustment lower in employer contribution rates and it comes on the heels of another year of low returns, 2% for 2015.

The net result has been a decrease in the funded liability ratio. Ten years ago the State’s two primary pension systems were actually overfunded at 115% and 112%. Now in the face of unfavorable demographics, lower contributions, and unfavorable investment results, the funded ratios are at 84%. When market values are used, the funded ratio is below 80%.

The State’s pension consultant estimates that an increase of 10.9% in the employer contribution would be required for the State to begin to recover the changes in the unfunded liability. This would represent a substantial burden for the State which has already seen reserves drop by 50% over the current biennium. Under those circumstances, such increased spending is not likely. The combination of lower reserves and a lack of progress on reversing the state’s pension funding trends do not bode well for the State’s credit going forward.


The mayor of Houston has issued a proposal to deal with the city’s longstanding pension funding issues. Houston today faces an increasing unfunded liability for its employee pensions that totals at least $3.9 billion, as of 2015, up from $212 million in 1992. All three of Houston’s pension systems are underfunded, with the Houston Municipal Employees Pension System (HMEPS) being the most severely underfunded.  Underfunding has arisen from a variety of sources, including (1) annual payments that do not ensure full funding and (2) assumed rates of investment returns that are higher than the national average and higher than recent experience.

The City has been under scrutiny since the turn of the millennium for its pension practices. Now a comprehensive plan has been advanced to fund the City’s liability for pensions over a 30 year period. The plan includes lowering the assumed rate of return on investments to 7 percent instead of the current 8 to 8.5 percent, cuts to some retiree benefits, and the issuance of some $1 billion of pension obligation bonds. It also includes a system of thresholds — as of yet undefined — that would trigger further negotiations between the city and the pension boards in the future, depending on changing financial conditions. Notably, the plan does not include a switch to a defined contribution plan.

A lack of support so far from the firefighters’ pension board is a potential roadblock. To move forward, the plan must win approval from three pension boards.  The proposal will go before city council within the next few weeks, according to the mayor’s office, then it would need approval in the legislature. In addition, litigation could be filed against any changes enacted. Failure to achieve these changes would likely result in a property tax increase which would likely receive a chilly reception from voters.

Raising the revenue cap would increase property taxes up to previous levels but has the potential to raise $40 million to $60 million per year or more if the economy picks up and property values rise. Increasing HMEPS employee contributions could generate $30 million per year at first, rising to $100 million per year over time, but would reduce workers’ take-home pay. Reducing the COLA to 1 percent could save close to $100 million per year by some estimates at first but would put retirees at risk of falling behind inflation.


Earlier this year, we profiled the magnitude of the budget problems facing the State of Alaska in an era of low energy prices. Governor Bill Walker announced the amount of the 2016 Permanent Fund Dividend. Starting October 6th, over 643,000 eligible Alaskans will receive a $1,022 check. Had the Governor not vetoed part of this year’s PFD appropriation, eligible Alaskans would have received a $2,052 check, or $1.3 billion total. This exceeds the $1.2 billion in revenue the state is projected to collect in fiscal year 2017. In late June, Governor Walker announced his fiscal year 2017 budget vetoes and his intention to veto half the money appropriated to dividends as a move to preserve the state’s savings.

Since the program’s inception, the average PFD has been about $1,100. Over the past two years, Alaska has lost over 80 percent of its income, resulting in an over $4 billion budget deficit. According to the Governor, Alaska has been drawing down on the Permanent Fund at a rate of $12 million a day. He contends that if Alaska does address its budget issues soon, it will have burned through the money available for future dividend checks.

Governor Walker had offered a fiscal year 2017 budget calling for $100 million in additional cuts from the operating budget and $425 million in cuts from oil exploration credits. His plan would have changed the oil and gas tax credit system into a low-interest loan program, wherein the rates would have been determined by the number of Alaskans the companies hire. To honor existing commitments for credits, that FY17 budget allocated $1.2 billion for a transition fund and loan program.

The minimum tax on the oil industry would have increased by $100 million. The mining, fishing and tourism industries would have been taxed for projected revenue of about $47 million. The plan also called for an income tax of 6 percent of federal tax liability, which is about 1.5 percent of income for the average Alaskan family, for projected revenue of about $200 million. Taxes will also would have been levied on alcohol, tobacco and motor fuel for projected revenue of $112 million. The legislature would not go along.


Rep. Keith Ellison (D-Minn.) last week introduced the HBCU Investment Expansion Act,  (local, state, and federal).  The bill is co-sponsored by Alma Adams (D-N.C.), whose district includes HBCUs in Greensboro, Salisbury and Charlotte. A recent study by Drexel, the University of Notre Dame, Duke University, and University of California San Diego found black colleges pay higher fees to raise money through bonds and often forced to sell them at a discount. The study was an analysis of 4,145 bonds issued by tax-exempt colleges between 1988-2010. Among those bonds, 102 were issued by 45 HBCUs.


We have discussed recent trends in motor fuel tax revenues across the country and the impact that changes in driving habits and sustained low oil prices could lead to changes in the long term in how the states and federal government fund highway development. This does not mean that motor fuel tax financings are dead or not viable. The latest example is the pending Texas Transportation Commission State Highway Fund bond issue.

The Texas State Highway Fund generates revenues from retail motor fuel taxes, motor vehicle registration fees, and funding from the Federal government. Fuel tax revenues and Federal funds are about equal. All told, these revenue sources aggregated $7.4 billion in FY 2015. Texas collects $0.20 per gallon for gasoline and $0.15 for diesel at the pump. After deducting 1% for administration, 50% of the remaining revenues are distributed to the Fund.

Motor vehicle registration fees are distributed to the Fund and to the state’s counties. These monies have averaged 32% of total fund revenues over a period of six years. Federal monies are received pursuant to Congressional authorizations and they reimburse the Fund for projects financed by the State of Texas. Historically, these monies were appropriated pursuant to multi-year authorizations. From 2009 to 2014, authorizations were made annually after protracted budget disputes between Congress and the Administration. Finally in 2015, Congress passed a multi-year authorization that is in place through the end of Federal fiscal 2020.

While there are general concerns about national trends, these revenues have a strong record in Texas. The Commission projects that based on FY 2015 available pledged revenue, that debt service coverage will average some 17.5 times over the life of the issue. That is enough to earn the credit a rare triple A rating.


A hearing Friday in U.S. District Court where plaintiffs in four consolidated lawsuits are seeking a relief from the stay imposed by Promesa provided some insight as to the hurdles going forward faced by The Fiscal Oversight Board in charge of managing the island’s fiscal affairs. According to witnesses for the P.R. government , the Board is getting briefings from the U.S. Treasury Department on Puerto Rico’s fiscal problems and is in the process of hiring technical and legal advisors.

It was suggested the government may try to convince the fiscal oversight board to use a “consolidated approach” toward the restructuring of Puerto Rico’s debt instead of doing individual restructurings. The Puerto Rico Oversight, Management and Economic Stability Act (Promesa) contains a process toward debt restructuring. The board is slated to meet Sept. 30 to select its chairman.

The plaintiffs are concerned that creditors could lose what they lent the government if money destined to repay debt is used for other purposes while the Board conducts its work. It won’t be however until at least mid-October when Besosa is expected to issue a ruling on the stay. He instructed the parties to file post-hearing memoranda ten days after the transcript of the hearings, which ended Friday, are filed and include in their memoranda their response to the United States Statement of Interest submitted earlier last week.

The U.S. Justice Department urged the hearing judge not to grant any relief from the stay to the plaintiffs: U.S. Bank Trust National Association, Brigade Leveraged Capital Structures Fund Ltd, National Public Finance Guarantee Corp. and the Dionisio Trigo group of bondholders, until the fiscal control board is organized. The Justice Department said it has a strong interest in ensuring that Promesa’s statutory purpose—stemming the downward spiral of Puerto Rico’s fiscal and economic condition—is not vitiated by the lifting of the stay.

“The United States, nevertheless expresses its view that, given the unique context of a Federal statute that provides a comprehensive framework for Puerto Rico to restructure its debts in a fair and orderly process as well as the establishment of an independent Oversight Board to ensure fiscal responsibility, relief from the automatic stay at this juncture could frustrate Congress’s intent in designing Promesa,” the document states.

The plaintiffs are claiming, essentially, that the Moratorium Act, which allows the governor to suspend debt payments of certain obligations, be declared unconstitutional because it substantially impairs contracts; takes property for the benefit of the commonwealth without just compensation and is preempted by the federal Bankruptcy Code. They also say the statute is hindering negotiations with creditors because it establishes a priority of payments for certain creditors. The government contends it needs the stay to remain in place to have breathing space to start a process of debt restructuring and accumulate funds to pay creditors. Officials also said the Moratorium Act has established an orderly process for the government to make payments. Repealing the statute will cause a “rush by creditors.”

A plaintiff witness said the Moratorium Act aborted negotiations to restructure Government Development Bank (GDB) debt because amendments made in May to the law gave island credit unions, or coops, a preferential treatment in the disbursement of payments. He said the Act has contributed to the level of uncertainty that has prevented negotiations to restructure the debt. The Ad-Hoc had agreed to a 53% haircut on its bonds. A government witness contended that the  negotiations with the Ad Hoc group went downhill because they sued the government and not because of the Moratorium Act.

Each side has offered “expert” testimony in support of their contentions. The bondholders contend  the government has made the conscious decision to renege on its debt commitments when it could actually pay. They insist that the government is not doing its best efforts to reduce expenses. To operate, the government is taking money destined to pay debt and using it to pay for services but it is not tackling expenditures. They claim that In the current budget, the government decided not to allocate $1.2 billion for debt service but increased other expenditures.

An Assistant Secretary of the Treasury for the Treasury Department, testifying for the Commonwealth, testified that the Moratorium Act was needed because it has provided an orderly structure for the central government and its agencies to make payments to keep essential services while at the same time attempt to restructure the debt.  She described the government’s liquidity as delicate and situations, such as the recent power outage, have made matters worse. She noted that after the hearing she had to go to Banco Popular, where the government accounts are kept, to authorize payments to police officers because of an overdraft in the Police Department’s account. The agency failed to notice the overdraft because of the power outage.

According to that witness, if it were not for the Moratorium Act, the government would be forced to shut down because it would not be able to pay for general services nor save funds to pay bondholders. She said the government issued an executive order declaring a default because of the shortage of funds in the government’s central account. The government had to pay $779 million in general obligations; some $257 million in tax refunds and over $394 million to suppliers. However, it had $244 million available.

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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