Muni Credit News Week of October 9, 2017

Joseph Krist

Publisher

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ISSUE OF THE WEEK

NORTH TEXAS TOLLWAY

$1,792,905,000 System Revenue and Refunding Bonds First Tier Bonds

Moody’s: “A1”  S&P: “A”

$776,590,000 System Revenue and Refunding Bonds Second Tier Bonds

Moody’s: “A2”  S&P: “A-”

In a somewhat abbreviated week, these two issues dominate the new issue calendar.  The NTTA manages an established multi-asset tollway system in the Dallas-Fort Worth MSA. Assets include two bridges; one tunnel and four highways, approximately 150 miles in length and with 745 lane miles. Traffic is predominantly two axle passenger cars with only 2.4% multi-axle vehicles. The NTTA bonds are secured by net system revenues, with first tier having a priority claim, followed by the second tier and the Capital Investment Fund (CIF) bonds that are secured only by balances in the CIF.

A rate covenant in the amended and restated trust agreement dated April 1, 2008 requires net revenues to provide at least 1.35 times coverage of first tier debt service requirements, 1.2 times coverage of outstanding first tier and second tier debt service, and 1.0 times coverage of all outstanding obligations. The first tier bonds are additionally secured by a DSRF equal to average annual debt service the and second tier equal to one-half of average annual debt service.

The Moody’s ratings are based on NTTA’s essential roadway network located in one of the fastest growing US service areas. Moody’s projects that they will produce strong revenue growth from continued traffic growth and automatic biennial toll increases. Debt service coverage ratios over the next five years are expected to be consistent with its A1 rated peers, however leverage will remain elevated over the period. NTTA’s ability to fund its five-year growth needs without additional debt and minimal reduction in liquidity additionally supports the rating. The A2 rating on the second tier obligations reflect payment of debt service made after first tier debt and a relatively weaker debt service reserve fund that is cash funded at half of average annual debt service requirements.

The S&P rating on the first-tier bonds reflects its view of the region’s economic strength, with significant development along the corridors where the NTTA’s roads are located. These strengths are offset by the S&P view of the NTTA’s highly leveraged system of toll facilities that requires continuous revenue growth to meet its financial forecast. The ‘A-‘ rating on the second-tier bonds reflects S&P’s view of their subordinate status.

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PUERTO RICO CAUGHT IN TRUMP’S IGNORANCE

Bondholders got caught in another hurricane of sorts when President Trump made a few incredibly ignorant remarks about Puerto Rico’s debt. Upon his return from a very quick trip to the Commonwealth, the President stated the following: “They owe a lot of money to your friends on Wall Street and we’re going to have to wipe that out. You can say goodbye to that.”  “I don’t know if it’s Goldman Sachs, but whoever it is, you can wave goodbye to that.” Prices on the Commonwealth’s uninsured debt tanked into the low $30 range and the equity of bond insurers also took a significant hit.

The fact that OMB Director Mick Mulvaney tried to walk back the statements did not enhance the discussion. “I wouldn’t take it word for word with that,” OMB Director Mick Mulvaney said on CNN. “We are not going to deal right now with those fundamental difficulties that Puerto Rico had before the storm.” Added Mulvaney: “Puerto Rico’s going to have to figure out how to fix the errors that it’s made for the last generation on its own finances.”

The statement from the President showed a real ignorance of the situation and a lack of interest in policy and programmatic details that have characterized his Administration. They did encourage others who subscribe to the view that Puerto Rico’s debt should be forgiven. Disappointingly, these include representatives of some larger players in the market. Perhaps it is their own realization that they for so long enabled a series of Commonwealth administrations to conduct their finances recklessly and do so under the cover of inadequate disclosure.

In the meantime, the legal process to determine the legitimacy of Puerto Rico’s debt and the ultimate positions of the various debt holders continues. To make comments of the sort that the President indulged in before those processes have run their course is a disservice to all municipal bond market participants. It also shows real disregard for the many individuals who hold the triple tax exempt debt directly or through mutual fund proxies.

An intervention that absolves Puerto Rico of a significant segment of its debt obligations would have significance for the entire market. Municipal bonds are by and large secured by not just legal (constitutional and statutory) but moral obligations and these have allowed borrowers to access the public markets under very favorable comparative  terms. In exchange, they have been granted access to bankruptcy and debt repudiation under only the most limited of circumstances compared to other classes of borrowers. It is what separates the municipal market from other markets such as the ones that the Trump family have so successfully used to their advantage when they mismanaged their businesses.

So we have real trouble with the Presidents latest fulminations. We are also troubled by a fairly weak response from the Administration’s senior economic and finance advisors. To allow these sorts of remarks to negatively impact a market as large ($3.5 trillion) and diverse that is so vital to the provision of basic capital based services is the height of irresponsibility.

WILL PROMESA BE SUPPORTED?

The President’s “casual” remarks about Puerto Rico’s debt come as the financial control board is seeking help from the US Congress. the board asked for quick federal action, including the authorization of a short-term, low-interest loan to keep Puerto Rico’s government functioning. The board urged “the maximum federal assistance to Puerto Rico to help it respond to and to recover from Hurricanes Irma and Maria.”

“This federal assistance should come in the form of grants and reimbursements to assist Puerto Rico in responding to the catastrophic damage it has suffered, and pursuant to an emergency liquidity program, low-interest loans to assist Puerto Rico in responding to its cash flow deficiencies.” Ideally, Congress would waive matching fund requirements and provide aid in grants versus loans which would simply add to the debt burden. in addition it would  increase the limits of disaster recovery programs, allow it to benefit from recovery programs and give Puerto Rico parity for receiving Medicaid funds.

One wild card is the fact that the president has no direct power over the territory’s debt, though he can fire members of the federal board that was set up to oversee the island’s finances and nominate others. If the President sought to become engaged on the matter, he could throw a major wrench into the works through altering the membership of the board. Executive support is crucial to the Board’s efforts to oversee a recovery of the Commonwealth’s finances and debt.

WILL MIGRATION BE A SHORT OR LONG TERM ISSUE FOR PUERTO RICO?

The media has begun to focus on the fact that the long term nature of the recovery in Puerto Rico from hurricane Maria is forcing many to explore alternative off island living arrangements. The impact on hospitals and schools driven by the lack of basic utilities if forcing those with children and significant medical conditions to seek schools and medical care. their status as citizens and the significant Puerto Rican diaspora in the US makes this a viable choice.

While the US population is concentrated in certain metropolitan areas, the area most likely to be on the front line in dealing with this phenomenon is Florida, especially the Orlando area. In Florida, Gov. Rick Scott declared a state of emergency last week for all 67 counties in the state in order to facilitate  counties’ efforts to house, educate and help Puerto Ricans by waiving regulations. It is hoped that the  declaration could also attract more federal money to the state. Florida will also establish ” relief shopping centers” at relief shopping centers at ports and airports relief shopping centers. These centers will provide one-stop locations  where Puerto Ricans can seek assistance with jobs, education, housing and programs like Medicaid and food stamps.

Since many of these current migrants are of less economic means than have been those in the steady stream of migrants over the last decade, there will likely be strains on housing, Medicaid, and education budgets in destination locations.

PENNSYLVANIA BUDGET NEWS

The Pennsylvania Legislature is still debating the revenue side of the FY 2018 budget despite its potential negative impact on the Commonwealth’s credit. The Assembly could not deliver votes for a commercial storage tax or a hotel tax despite their offering of both as counters to a severance tax. The commercial storage tax would have raised approximately $100 million in year one and approximately $170 million in year two. The severance tax passed by the Senate will raise the same amount and is widely supported throughout the commonwealth and among bipartisan legislators. Pennsylvania is the only major gas producing state without a severance tax.

Now the Governor has proposed a different revenue source. Governor Wolf will securitize profits from our state’s liquor system. It will raise $1.25 billion to pay off nearly all of our prior year deficit and significantly reduce the need for additional temporary borrowing to pay our bills. The Liquor Control Board transferred $210 million to the General Fund last year, far in excess of the annual amount necessary to make payments on this loan.

Such a move would keep the Commonwealth in the retail liquor business resulting in monopoly based higher prices for state residents. Such a financing would be in lieu of a much debated tobacco settlement fund securitization.

BASKETBALL SCANDAL COULD IMPACT U OF LOUISVILLE CREDIT RATING

The well publicized scandal involving the University of Louisville basketball program has already claimed famed head coach Rick Pitino’s job. Now it has placed the University’s credit rating in jeopardy. Moody’s has announced that it has decided to revisit a review of the University’s rating for downgrade which it had concluded on July 21.

Moody’s said “newly developing credit issues including recent criminal allegations against senior athletic personnel have the potential for increased financial burden on a currently weakened university liquidity profile and support renewal of the review for downgrade of the ratings. It also noted that questions surrounding integration risk and funds flow impacting the university resulting from the July 1, 2017 academic affiliation agreement with University Medical Center further support the current rating credit action.

The review “will focus on the University of Louisville’s ability to maintain stakeholder confidence and structural balance given its current weak liquidity, which Moody’s estimates at approximately $80 million of unrestricted cash as of June 30, 2017. Timing and intention for installing permanent leadership, along with an assessment of sustainable remediation of ongoing governance concerns, will also be incorporated into the review. Moreover, legal considerations and challenges related to the integration of the new hospital relationship, incremental to other competing operating priorities – such as immediate and longer term trends effects on enrollment, net tuition revenue growth and donor support – will also be central to the analysis.

Adverse impacts from the confluence of these governance, legal, operational and financial risks could put multiple notch downgrade pressure on the ratings.

BEING THE BUSIEST DOES NOT ALWAYS HELP

Madison Square Garden may be the “World’s Most Famous Arena” but the Barclays Center in Brooklyn has actually been the busiest based on number of days in use. In spite of this however, financial performance for fiscal year (FY) ended June 30, 2017 was weaker than expected, owing to a drop in revenues and cash flow caused by the attendance and related ticket sales decline at the New York Islanders home games held at the Barclays Center. Moody’s projects that that similar financial under

performance will continue for the next 12 to 18 months owing in large part to the contractual arrangements between the Islanders and the Barclays Center.

Specifically, weak financial performance during FY 2017 was in large part driven by the Barclays Center’s obligation to make fixed annual payments to the Islanders for an anchor tenant guarantee fee. These payment obligations, which are part of a 25-year license agreement, coupled with lower revenues stemming from attendance related underperformance for the Islanders has resulted in a net loss from Islanders’ related business activities for the Barclays Center for the most recent FY, a financial performance that Moody’s anticipates continuing this season and next season unless there is a substantial improvement in attendance.

So now despite the booming demand for entertainment based in the rapid gentrification of Brooklyn, Moody’s changed Its rating outlook to negative from stable on approximately $526.8 million PILOT Revenue Bonds, (Barclays Center Project) issued by the Brooklyn Area Local Development Corporation (PILOT Bonds) which are rated Baa3.

The Barclays Center’s debt service coverage ratio (DSCR), as calculated by Moody’s, declined to 1.31x during FY 2017 from 1.51x in FY 2016. In addition, the DSCR as calculated by Moody’s for the current fiscal year ended June 30, 2018, is forecasted to decline even further to 1.07x. This differs from the calculation of forecasted DSCR by the arena’s management of 1.35x for FY 2018 because they have bolstered liquidity by including excess cash flow that would otherwise have been distributed. In arriving at the 1.07x DSCR calculation for FY 2018, Moody’s has excluded this excess cash and has reflected only cash flow from operations for that year.

The situation could be improved if the Islanders are able to persuade state and local government to help them construct a new arena closer and more attractive to their core Long Island fan base. There are negotiations underway regarding such a facility to be located on land at the Belmont Park racing facility located adjacent to the Queens-Long Island border with access to highways and Long island railroad facilities.

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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