Muni Credit News Week of January 8, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$413,000,000

Commonwealth Financing Authority (PA)

Revenue Bonds

The bonds are special obligations of the CFA, which was created in 2004. Debt service is now derived first from a statutory continuing appropriation of Article II revenues (the statewide 6% sales tax and 6% hotel tax) to a restricted account within the commonwealth’s general fund. This account can only be applied toward payments of CFA debt service. The monthly Article II transfers by the state treasurer are made pursuant to a letter agreement with the treasurer and equal one-sixth of biannual interest payments and 1/12th of annual principal payments. Under the agreement, the payments are timed to be fully accumulated 30 days prior to debt service due dates. Article II revenues provide ample coverage of the monthly transfers.
In the event the Article II transfers are insufficient, the bonds are also secured by payments from the commonwealth to the CFA under multiple service agreements, subject to annual legislative appropriation.

Pennsylvania continues to struggle to balance its budget. A contentious political climate and significant pension obligations have combined to make the annual budget process difficult at best. Negotiations have taken to dragging on until well after the traditional July 1 deadline with significant negative impacts on the Commonwealth’s underlying municipalities and the many non-profit service providers on which the commonwealth relies. The pending gubernatorial election in November will only complicate the process for FY 2019.

The outlook for the Commonwealth’s ratings is negative and this should only be exacerbated by these factors.

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US AUTO SALES DECLINE FOR FIRST TIME SINCE FINANCIAL CRISIS

For the first time since the financial crisis, US auto sales declined on an annual basis. Though sales dropped 1.8% from the last year to 17.2 million vehicles, 2017 still marks the fourth-best sales year in U.S. history. This is because this is the first time that the industry has cleared the 17-million mark for three consecutive years.

Of the six major American and Japanese automakers, Fiat Chrysler posted the biggest sales decline of 8.2%, followed by modest declines of 1.3% for General Motors, 1.1% for Ford Motor, and 0.6% for Toyota. Nissan Motor  and Honda sales were up 1.9% and 0.2%, respectively. Should negative trends continue the finances of auto and parts manufacturing states could be negatively impacted.

BRANSON AIRPORT PROPOSES SETTLEMENT

Near the end of the last tidal wave of junk bond issuance in the municipal bond market, one of the more conspicuous deals was one for the construction of an airport at Branson, Missouri. The airport was the vision of a group of local developers – Branson Airport, LLC – who hoped to transform the essentially regional entertainment mecca, reliant on an auto oriented market, into a national destination. For those of us who were skeptical as to the viability of this concept, the ensuing history of operations was somewhat vindicating.

Financial distress has prevented the Company from paying scheduled debt service to Bondholders since 2011. Bondholders have in that time received a single interim payment in 2016 from extraordinary proceeds the Company received. The Airport has during this same period reported a single calendar year where operating income exceeded operating expenses (2013). When total expenses are included, the Company has reported an overall net loss every year since the Airport opened in 2009. Multiple prior notices reflect multiple efforts by the Company to attract sustained air service to the Airport from legacy carriers, low cost carriers, and scheduled charter carriers.

The Company retained ICF SH&E as financial adviser in the spring of 2017, and the Company’s financial adviser prepared an assessment of the Company’s prospects, including its go-forward business plan. Branson Airport, LLC is proposing a global settlement with its bondholders which ostensibly has the support of a majority of those holders which would allow the airport to continue to operate free of the constraints of its currently outstanding debt.

The proposal includes a mix of new debt and equity in the operating entity. Specifically, each Bondholder would receive a pro rata share of new “Series A Bonds”, in the principal amount of $32.5 million, and a pro rata share of 65 percent of the equity of the Company and its affiliates BKG Branson Airport, LLC, Branson JetCenter, LLC, FlyBranson Travel, LLC and Branson Land, LLC. They would also be given “opportunities to invest in $3 million of new “Series B Bonds” and a pro rata share of an additional 23 percent of the equity of the Airport Parties to provide the Company working capital. The Series B Bonds would have a liquidation preference over the Series A Bonds if the Company is liquidated while principal, interest or other fees or charges remain outstanding on the Series B Bonds.

12 percent of the equity of the Airport Parties which may take the form of warrants will be allocated to management and sub debt holders. And so it goes for yet another deal that never made sense to begin with which could only really be done in the municipal bond market.

ALASKA MUNICIPAL UTILITY PROPOSES SALE TO MUNICIPAL CO-OP

The City of Anchorage AK has announced a proposed sale of its municipal light and power utility to the Chugach Electric Association , a neighboring rural electric cooperative. Chugach currently serves the area around Anchorage in an area extending from Anchorage to the northern Kenai Peninsula, and from Whittier on Prince William Sound to Tyonek on the west side of Cook Inlet.

The proposed sale, valued at $1 billion, must be approved by both voters and the Regulatory Commission of Alaska (RCA) to proceed. The sale is expected to close no later than fall 2019, if approved by voters and the RCA. The sale would likely result in the full funding of the City of Anchorage’s outstanding 4325 million of revenue bonds backed by municipal light and power revenues.

The municipality expects to dedicate a significant amount of transaction proceeds to its permanent trust fund, which would boost ongoing interest income and could ease near-term budget pressures.

NEW YORK’S GOVERNOR LAYS OUT AMBITIOUS CAPITAL PLANS

This year’s State of the State Address by Governor Andrew Cuomo laid out an ambitious capital facilities wish list for consideration. The transportation sector was the area of concentration with updates and expansions of a variety of facilities suggested. They include improving transportation access to the Red Hook area of Brooklyn and surrounding communities, including the potential extension of subway service from lower Manhattan to a new station in Red Hook through an underwater tunnel.  This would involve the MTA.

On the highway front, the Governor plans to implement cashless tolling technology on all toll collection points along the Thruway. The project will utilize Design-Build construction to reduce costs and accelerate the construction schedule. Cashless tolling throughout the Thruway system will be operational in 2020. The Governor urged the Port Authority of New York and New Jersey to study the possibility of installing cashless toll collection on all PANYNJ operated Bridges and Tunnels. These follow the successful P3 replacement of the Tappan Zee, Kosciusko, and Goethals Bridges.

He also discussed the renovation of JFK Airport which would also include associated mass transit and highway access expansion. The plans follow on from the expansion of Newark Liberty Airport and the ongoing P3 project to renovate and expand LaGuardia Airport.

CAN A MUNICIPAL CHARITABLE TRUST WORK AROUND THE SALT LIMIT?

Paramus, Park Ridge and Fair Lawn, N.J. announced that they will start charitable trusts to work around the loss of the SALT deduction. A taxpayer who pays $20,000 in annual property taxes would contribute that exact amount to the charitable trust. The charitable trust would then allocate the $20,000 to various entities — the schools, the police department and other agencies — as though the donation were a tax payment. The town would then credit the taxpayer for 90 to 95 percent of the donation, making it nearly entirely deductible. (The town could factor in administrative costs to lessen a donation’s value.) Such a plan would require approval by each town’s local governing body.

There are other hurdles as explained by the Tax Foundation. To be deductible, charitable contributions must have a genuinely charitable aspect, and cannot primarily benefit the contributor or involve a quid pro quo. Payments which function as taxes may be classified as taxes even if states choose to call them something else. While governmental entities are qualifying organizations for purposes of claiming the charitable deduction, expressly delineated at IRC § 170, contributions are only deductible if, per IRS guidance, the contribution “is solely for public purposes (for example, a gift to reduce the public debt or maintain a public park).”

Internal Revenue Service Publication 526 outlines what qualifies as a deductible charitable contribution, specifically excluding contributions from which one benefits, to the extent of that benefit. For instance, if one purchases a $250 ticket to a benefit dinner, and the fair market value of the dinner is $50, then $200 can be deducted—not $250. Arguably, the benefit of, say, a $20,000 “contribution” to one’s state which yields a $20,000 credit against state tax liability is, in fact, $20,000, completely wiping out deductibility. The contributor actually receives two benefits: one, the benefit of government services, and two, the benefit of a reduction in overall tax liability.

Kevin de León, president pro tempore of the California Senate is offering a bill in the state Senate to let Golden State residents make charitable donations to a state fund and receive a dollar-for-dollar tax credit for the donations. The proposal rests on the fact that the California legislature in 2014 passed a measure that gives people a tax credit for donations to a state higher education grant program. That program does not establish a direct benefit to the contributor or involve a quid pro quo.

OR PAYROLL TAXES VERSUS INCOME TAXES

Eliminating the state income tax on wages would put more money in worker paychecks and mitigate the loss of full deductibility of such taxes on the federal level. That revenue would instead be raised by a statewide payroll tax, paid by employers, and still legally deductible on their federal taxes. The state would then make employers whole through a tax credit or some other mechanism. Another alternative would be for the state to keep its income tax but also implement an additional payroll tax, the revenue from which would be funneled back to taxpayers as a credit or wage supplement.

In either the case of charitable trusts or payroll taxes, we expect significant legal pushback from the federal government. The level of economic growth required to make the tax reform plans numbers work remains substantial with little room for error. So the viability of all of the enacted “pay fors” remains crucial. If we had to hazard a guess, the payroll tax idea is likely the more viable of the two.

MIDWEST FERTILIZER DEBT IS TAXABLE

Indiana’s troubles with private entities and municipal bonds continued with the announcement by the IRS of a Notice of Proposed Adverse Determination regarding some $1.2 billion of economic development bonds issued to finance the construction of an nitrogen based fertilizer plant in Posey County. The IRS determined after an audit that the bonds did not meet the criteria for qualified Midwest Disaster Area Recovery Bonds.

The plant and the financing for it have had a checkered history. In October of 2008, Congress passed the Heartland Disaster Tax Relief Act (the “Disaster Act”) in response to severe storms, tornadoes and flooding throughout the Midwest. The Disaster Act created a new category of federally tax-exempt bonds called Midwestern Disaster Area Bonds (“Disaster Bonds”) which are designed to finance capital expenditures for business that suffered a loss caused by these disasters or are designated by the Governor as a business that is carrying on a trade or business that could have suffered a loss caused by these disasters. The original bonds were issued by the Indiana Finance Authority in late December of 2012 to beat the December 31, 2012 deadline for issuance under the Disaster Act.

In a May 17, 2013 letter addressed to Fatima Group, an investor in the Company, the Indiana Economic Development Corporation (the “IEDC”) announced that it was withdrawing its offer of incentives, as initially conveyed to and accepted by the Company on November 30, 2012. On the same date, Governor Mike Pence announced that the State of Indiana was withdrawing its offer of economic incentives for the Project. This led Posey County to step in and offer to use its bond issuance authority to finance the plant. It did so through the issuance of $1,259,000,000 Posey County, Indiana Economic Development Revenue Bonds, Refunding Series 2013A in May, 2013. This was after the deadline for Disaster Act bonds. Proceeds were applied to the refunding of the IFA debt.

The project is described as one of the largest fertilizer manufacturing investments in the U.S. in more than 20 years. According to economic impact calculations by the Indiana Economic Development Corporation (IEDC), the construction of Midwest Fertilizer’s plant alone is expected to have an economic impact of $425 million and, at full employment, the company’s operations are expected to have a total economic impact of $138.6 million annually on state and local GDP.

When finished, Midwest Fertilizer says up to 185 permanent jobs will be created. In addition to the bonds, the state has agreed to kick in nearly $3 million in tax credits, and $400,000 in training grants. The Indiana Economic Development Corporation also offered up to $300,000 in conditional incentives from the Hoosier Business Investment (HBI) tax credit based on the company’s planned investment. This project will create 2,500 construction jobs over the next three years and is expected to open in 2022.

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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