Muni Credit News September 8, 2016

Joseph Krist

Municipal Credit Consultant

MCN TO PARTNER WITH COURT STREET GROUP RESEARCH

We are excited to announce that the Muni Credit News is partnering with Court Street Group Research. CSGR is the publisher of The Weekly Perspective, a review of current market issues and credit issues reflecting those events. Through this partnership, investors will have access to some of the best data, thought, information and opinion available today. Make CSGR and the Muni Credit News your most important tool as you navigate the increasingly diverse municipal bond marketplace.

To inquire about becoming a CSG client, email us directly at info@courtstreetgroup.com

Check out The Weekly Perspective at  hhttp://www.courtstreetgroup.com/commentary/.

NEW JERSEY SCRAPS TAX RECIPROCITY WITH PENNSYLVANIA

If you are a Pennsylvania resident who works in New Jersey, the tax treatment of your income is about to change beginning January 1. Gov. Chris Christie is pulling the state out of a 40 year agreement that allowed New Jersey and Pennsylvania residents who work across state lines to pay income taxes where they live instead of where they work. More than 120,000 New Jersey residents commute across the Delaware River, and a similar number of Pennsylvanians work here, according to the U.S. census.

The governor was required to give Pennsylvania 120 days notice in order to withdraw from the agreement by Jan.1, the beginning of the next tax year. Christie directed New Jersey state officials to begin exploring the consequences of withdrawing from the tax pact at the end of June. The action does not require Legislative approval. The tax change will generate tens of millions of dollars for New Jersey, but comes at a cost for some residents of both states who will have to pay higher income taxes.

Under the existing agreement, New Jersey doesn’t collect income taxes from people living in Pennsylvania and working in New Jersey. Under the reciprocal agreement, a resident of New Jersey who works in Pennsylvania need only file a tax return in New Jersey. The same is true for a Pennsylvania resident working in New Jersey. It has been estimated the Garden State could gain $180 million in revenue from Pennsylvania residents forced to pay taxes here.

With the end of the agreement, a resident would have to file two tax returns and claim a credit against taxes owed where they live for taxes paid in the state where they work. This would work against higher income Pennsylvania residents working in New Jersey as Pennsylvania has a flat 3.07 percent income tax rate, while New Jersey’s highest graduated income tax rate is 8.97 percent. A highly paid executive living in Pennsylvania but working in New Jersey now can pay Pennsylvania’s 3.07 percent flat tax. But an end to the reciprocal agreement means they’ll have to pay New Jersey taxes.

But low- and middle-income New Jersey residents working in Philadelphia and other Pennsylvania jurisdictions would also owe more. A legislative analysis found that it will cost 100,000 Garden State residents earning under $110,000 a year working in Pennsylvania about $1,000 more a year in income taxes, according to the Senate Majority Office.

Governor Christie claims that the Legislature created a $250 million state budget hole in June. He called this the best option among raising state taxes, cutting property tax relief, reducing aid to education or hospitals, or reduction the state’s pension payment. The budget hole refers to the budget passed by the Legislature which assumed the state would come up with $250 million in cuts to public worker health.

Christie has linked a spending freeze to the cuts, saying he won’t release the funds until the $250 million is paid in full. He did say he will reconsider his decision to withdraw from the tax agreement with Pennsylvania if the Legislature makes good on the cuts. So the issue comes down a political argument involving the always arcane world of South New Jersey politics.

In fairness, the agreement was threatened 12 years ago when then Gov. James E. McGreevey proposed to end the agreement but dropped the plan after angering south Jersey residents and lawmakers who said many New Jerseyans who worked in Pennsylvania would have paid more in taxes.

CONNECTICUT SPECIAL TAX DOWNGRADE

Fitch announced a downgrade from AA to AA- in front of the planned sale of Special Tax Revenue bonds by the State of Connecticut. The bonds are secured by pledged taxes and fees on motor vehicle fuel, casual vehicle sales and licenses. The legislature expanded pledged revenues in its 2015 session as part of a broader initiative, called ‘Let’s Go CT!’ to accelerate transportation capital spending. Revenue changes were partly delayed during fiscal 2016 as the state sought to shore up projected weak general fund performance in fiscal 2016 and 2017.

Under the 2015 expansion of pledged resources, all taxes on oil companies’ gross earnings and a designated portion of the statewide sales tax are being deposited directly to the State Transportation Fund (STF) and pledged to bondholders; the sales tax deposit is being phased in through fiscal 2018. The inclusion of sales taxes in pledged revenues broadens the base of economic activity from which collections derive beyond transportation and ties future trends more closely to underlying state economic performance. Oil companies’ tax collections are correlated to broader energy market trends, which exposes the STF to more heightened cyclicality.

$4.2 billion in senior lien bonds and $257 million in second lien bonds are outstanding. Pledged revenues are available first for senior lien debt service and reserves, followed by second lien debt service and reserves. Thereafter, pledged revenues are available for transportation-related state general obligation bond debt service and operating expenses of the departments of transportation and motor vehicles.

Fitch’s real concern is based in the linkage of the credit to the condition of the state general fund which has led to revenue or cost shifts during periods of general fund fiscal stress, most recently in fiscal 2016. Given frequent statutory changes that shift pledged revenues or costs between the transportation fund and the state’s general fund based on general fund budgetary needs, Fitch views the credit quality of special tax bonds as being linked to the state’s general operations, and hence capped by the state’s AA- general obligation rating.

The downgrade comes just ahead of the planned issuance of some $1 billion of special tax bonds by the State with 20% providing for refinancing and the remainder for projects under the Let’s Go Connecticut program.

NUCLEAR BASED CREDIT UPGRADE

Moody’s recently upgraded $1 billion of revenue bonds from South Carolina’s Piedmont Municipal Power Agency (PMPA) to A3 from Baa1. The upgrade reflects PMPA’s continued rate increases during each of the last five years resulting in improved financial metrics particularly during the last two years. The rate increases have improved PMPA’s internal liquidity, which reflects its willingness to implement rate increases over a sustained period, in contrast with the past reliance on rate stabilization funds. PMPA’s participant weighted average credit quality remains stable at A3. PMPA debt is secured under strong court-tested take-or-pay power sales agreements with the participant electric utility systems. While the resource base is concentrated in nuclear power this is mitigated by the plants’ strong operating performance and by reliability exchange agreements, which reduces single asset concentration risk.

PMPA has an undivided ownership interest of 25% in Unit 2 of the Catawba Nuclear Station, which was constructed and is being operated by Duke Energy, an experienced successful operator. Net PMPA revenues derived from member’s take-or-pay power sales agreements and all requirements supplemental power sales agreements. Payments to the agency are considered operating expenses of the member utility systems. The take-or-pay power sales agreements have been validated by the South Carolina Supreme Court and also upheld against a challenge by one member. Under the take-or-pay power sales agreements, there is a 25% step-up provision which requires participants to increase up to 25% in their respective shares of the project in the event of a default by another participant. The debt service reserve requirement is 110% of maximum annual interest is low but is cash funded.

LOTS FOR CALIFORNIANS TO VOTE ON ASIDE FROM PRESIDENT

As momentous as the upcoming Presidential election may be, in California the voters will have many other issues to decide on when they enter the voting booth on November 8. This year the ballot will include 17 initiative items for the voters’ consideration. While many are of little concern to those outside the State, several will have consequences for the state budget and for tobacco bond holders.

Proposition 55  is the Tax Extension to Fund Education and Healthcare Initiative Constitutional Amendment. It would extend by twelve years the temporary personal income tax increases enacted in 2012 on earnings over $250,000 (for single filers; over $500,000 for joint filers; over $340,000 for heads of household). It allocates these tax revenues 89% to K-12 schools and 11% to California Community Colleges. It allocates up to $2 billion per year in certain years for healthcare programs. It would bar use of education revenues for administrative costs, but provide local school governing boards discretion to decide, in open meetings and subject to annual audit, how revenues are to be spent.

A summary of estimate by Legislative Analyst and Director of Finance of fiscal impact on state and local government says increased state revenues annually from 2019 through 2030—likely in the $5 billion to $11 billion range initially—with amounts varying based on stock market and economic trends. Increased revenues would be allocated under constitutional formulas to schools and community colleges, budget reserves and debt payments, and health programs, with remaining funds available for these or other state purposes.

Proposition 56 is known as the Cigarette Tax to Fund Healthcare, Tobacco Use Prevention, Research, and Law Enforcement. Initiative Constitutional Amendment and Statute. It would Increase cigarette tax by $2.00 per pack, with an equivalent increase on other tobacco products and electronic cigarettes containing nicotine. It would allocate revenues primarily to increase funding for existing healthcare programs; also for tobacco use prevention/control programs, tobacco-related disease research and law enforcement, University of California physician training, dental disease prevention programs, and administration. It excludes these revenues from Proposition 98 funding requirements. If the tax causes decreased tobacco consumption, the law transfers tax revenues to offset decreases to existing tobacco-funded programs and sales tax revenues. It would require a biennial audit.

A summary of estimate by Legislative Analyst and Director of Finance of fiscal impact on state and local government finds a net increase in excise tax revenues in the range of $1.1 billion to $1.6 billion annually by 2017-18, with revenues decreasing slightly in subsequent years. The majority of funds would be used for payments to health care providers. The remaining funds would be used for a variety of specified purposes, including tobacco-related prevention and cessation programs, law enforcement programs, medical research on tobacco-related diseases, and early childhood development programs.

Proposition 53 is a Constitutional Amendment which would require statewide voter approval before any revenue bonds can be issued or sold by the state for projects that are financed, owned, operated, or managed by the state or any joint agency created by or including the state, if the bond amount exceeds $2 billion. It would prohibit dividing projects into multiple separate projects to avoid statewide voter approval requirement.

A summary of estimate by the Legislative Analyst and Director of Finance of fiscal impact on state and local government found that the fiscal effect on state and local governments is unknown and would vary by project. It would depend on (1) the outcome of projects brought before voters, (2) the extent to which the state relied on alternative approaches to the projects or alternative financing methods for affected projects, and (3) whether those methods have higher or lower costs than revenue bonds.

RATINGS JUDGMENT ON PRISON BONDS

Our recent (8/23/16) alarms on prison bonds were supported this week when bonds for three private prisons in Texas suffered downgrades by Standard and Poor’s to below junk-bond status after the U.S. Department of Justice announced plans to discontinue their use. Reeves County bonds issued for the largest detention center in West Texas fell six notches to B-plus from BBB-plus and retained a negative outlook. Willacy County Local Government Corp. bonds used to build a now-vacant detention center in South Texas dropped to CC from CCC-plus. The federal Bureau of Prisons canceled its contract with the operators after an inmate uprising that left the facility uninhabitable. The Garza County Public Facility Corp. was dropped to B-plus from BBB and also retained a negative outlook.

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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