Muni Credit News Week of September 25, 2017

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$565,000,000

Pennsylvania Economic Development Financing Authority

University of Pittsburgh Medical Center

Revenue Bonds

Fresh off the assignment of a negative outlook to its A1 rating from Moody’s, the dominant provider in the western Pennsylvania market plans to issue debt this week.

UPMC is an integrated delivery and financing system (IDFS) based in Pittsburgh, Pennsylvania, having primarily served residents of western Pennsylvania. It also has drawn patients for highly specialized services nationally and internationally. As of September 1, 2017 Pinnacle Health System, a seven-hospital regional provider in Harrisburg, Pa., has joined UPMC. UPMC’s more than 27 hospitals and more than 500 clinical locations comprise the largest health care delivery system in Pennsylvania. UPMC is the largest nongovernment employer in the Commonwealth. UPMC also offers a variety of insurance products that cover more than 3.2 million lives.

It is the new merger which raises concerns for Moody’s which cited the potential financial and cultural stress of integrating multiple facilities, a good portion of which bring an absence of a longer track record of operations as a NFP facility, while simultaneously expanding the system’s geographic reach. Adding to the strain is the continuation of very modest performance at UPMC’s legacy operations, representing approximately 85% of pro-forma revenue, despite efforts to improve performance. Given the magnitude of the financial leverage, any notable deviation from management’s plans may pressure the rating further.

There is an additional concern that the expansion into central PA represents a new, discreet market for UPMC that carries its own competitive challenges given the presence of sizable providers who are consolidating, as well as the lackluster economy of the local service area.

The debt is secured as a  joint and several commitment of the obligated group secured by a lien on gross revenues. The Obligated Group under the 2007 Master Trust Indenture consists of the Parent Corporation, UPMC Presbyterian Shadyside Hospital, Magee-Womens Hospital of UPMC, UPMC Passavant and UPMC St. Margaret. The system also includes several additional hospitals throughout western Pennsylvania, international operations and a variety of insurance subsidiaries as part of its integrated delivery and financing system.

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NEW YORK CASINOS – IS THE HOUSE WINNING?

In 2013, Gov. Andrew M. Cuomo signed a law allowing for seven new, full-scale casinos in New York. Prior to that time, only so-called racinos were allowed such as those at Aqueduct and Yonkers Raceway in and near New York City. They feature video lottery terminals — similar to slot machines — but no table games like blackjack and craps. That expansion has led to an estimated $70 million in new gaming tax and jobs at new facilities and constructions sites, according to casino operators.

The experience at the new casino upstate has been different. While the data only covers the period since February of this year, results have been disappointing. The Del Lago Resort & Casino in Seneca County upstate is on pace to gross about $151 million in gaming revenue in its first year, significantly lower than the $262 million it had projected when it applied for the license in 2014. The Rivers Casino and Resort in downtown Schenectady opened based on first-year projections which ran between $181.5 million and $222.2 million. Since opening on Feb. 8, the casino has grossed $81.8 million —77 percent of even its low estimate.

Supporters of casinos note that some of the new casinos’ amenities, like hotels, are still under construction or only recently opened. Others note that new casinos due in Massachusetts and Connecticut and a $1.2 billion resort in the Catskills, scheduled to open early next year. The owner of Tioga Downs, near Binghamton, N.Y., admits that estimates of income had been optimistic, saying that the gambling market is oversaturated; Tioga Downs faces competition from casinos in nearby Scranton, Pennsylvania. But he argued that the casino expansion had created jobs and contends that that was enough in the weakened lower tier of the state.

The new casinos pay a gaming tax, ranging from 37 to 45 percent on slots and 10 percent of table game revenue which is divided among education purposes and host cities and counties and nearby counties. The Seneca County casino has generated

Of more concern is the fact that new facilities seem to be cannibalizing existing ones. For example, the Saratoga Casino Hotel has seen a significant drop in its net winnings since the opening of the Rivers casino, some 30 miles to the south. On a comparable month basis, the racino brought in about $16 million last August. This August, its net winnings were down by nearly 25 percent and for the year the casino is on pace to contribute nearly $14 million less than it did during the 2016-17 fiscal year. In June, the state agreed to $2 million in tax relief to keep afloat Vernon Downs outside Utica, something he said would save 300 jobs in “a part of the state where we can’t afford to lose 300 jobs.” The problem is the facility was originally pitched as requiring no assistance.

In addition, the state is mired in disputes with native American tribal operations which were established under separate compacts.  The Seneca Tribe is one of three that operate casinos and in June it stopped making contractual payments to the state from its casinos. The tribe contends that it has fulfilled their obligations under a 2002 compact, which allowed them the exclusive right to open casinos in a huge chunk of Western New York in exchange for payments to the state. The state filed a demand for arbitration seeking to force the Senecas to pay approximately $31 million under a purported compact extension.

THE REALITY OF REPEAL AND REPLACE

There is no way around it. The Graham-Cassidy bill is bad news for municipal credit. The impact on hospital credits and state credits is obvious. For hospitals, the blow to revenues would be quick and direct. There is no argument against the idea that the bill would increase the ranks of the uninsured, reduce the number of services funded by Medicaid, and generally reduce available revenues to hospitals. On the cost side, it would increase the use of emergency room care as the primary point of contact with substantially more patients. There is plenty of evidence that this is the highest cost and least efficient way to provide medical care.

States would be left with a substantial cost burden. While it is not expected that states would fill all of the gap, there will be great pressure to do so. What will lose funding to compensate? Will it be less education spending in an era where business demands a more highly trained workforce? Will it be for roads thereby making certain areas less attractive to businesses and reducing the likelihood of good paying jobs? Will states have to choose between resident health and the demands of often contractually mandated pension spending?

At the local level, there will be a direct hit to employment. In some areas, healthcare is the major provider of public sector employment. What will be the impact on the entire range of job classes provided by healthcare in cities like Boston, New York, Philadelphia, Pittsburgh, and Houston just to name a few where major national medical facilities are primary employment drivers. The result will be a smaller income base, less retail spending, and less economic activity that stems from a growing and sustained base of disposable income. Will this result in increased demands for state aid from governments already under increasing expense pressure?

And what happens to specialty sectors like continuing care retirement communities (CCRC). The skilled nursing sector (on its own and as part of CCRC) is especially dependent upon Medicaid. There are estimates that some two-thirds of nursing home revenues are derived nationwide from Medicaid as aging seniors outlive their accumulated resources. Does the planned level of reduced Medicaid spending drive the elderly back to family supplied care and maintenance thereby pressuring workforce participation levels and reducing incomes available to fund government?

Should the bill pass the plan is to make significant changes to the federal tax code which will initially pressure the states as many of them key their tax codes off the federal code. Significant changes will then need to be followed by appropriate state statutory changes which will be held hostage to the unique individual quirks of legislative scheduling in each of the 50 states. All of this will conspire to create a brew of uncertainty in which states and cities will have meet the challenge of balancing their budgets.

PENNSYLVANIA DOWNGRADE

It seems that passing only the expense side of a budget is a major step on the road to a downgrade. After waiting nearly three months for a revenue package to be passed, S&P Global Ratings lowered its general obligation (GO) rating on the Commonwealth of Pennsylvania to ‘A+’ from ‘AA-‘. It also lowered ratings on the commonwealth’s appropriation debt to ‘A’ from ‘A+’  and the rating on departmental and moral obligation rating to ‘BBB+’ from ‘A-‘. The outlook is stable.

The downgrade largely reflects the commonwealth’s chronic structural imbalance dating back nearly a decade, a history of late budget adoption, and the weakening of Pennsylvania’s liquidity position, notably the delay or non-payment of scheduled expenditures for the first time in the commonwealth’s history. Its reliance on one-time revenues has stressed its available cash, making internal resources insufficient to timely meet certain obligations.

On Sept. 15, 2017, Pennsylvania missed $1.167 billion in reimbursement payments for medical care under Medicaid, and on Sept. 18, it missed a $581 million payment due to school districts to cover the state’s share of pension obligations. The state treasurer and auditor general announced in a letter that they would not provide another loan to cover the commonwealth’s general fund deficit through the short-term investment program. They called lending to the commonwealth under current circumstances an economic “moral hazard” that would increase long-term risk to the commonwealth’s finances, and stated that they would not lend to the general fund without a balanced budget.

There is a lack of consensus among the branches of the general assembly and the administration on how to balance the fiscal 2018 budget, all plans eliminate the negative $1.54 billion negative general fund balance (4.8% of the budget), which would significantly reduce the commonwealth’s cash flow pressures. Currently, legislators are considering $1.25 billion of certificates of participation secured by tobacco settlement payments and general fund appropriations to help close this gap. The governor released a statement on Sept. 18 that legislators will agree to and vote on a compromise prior to Oct. 1.  S&P endorsed the use of borrowing to fund operations. ” Borrowing that restores the commonwealth’s liquidity to a position in which it can make timely payments would be preferable from a credit perspective than an accumulation of unpaid bills.”

A STABLE SOUTH CAROLINA NUCLEAR CREDIT 

While the major public power provider in South Carolina has been taking its lumps over a failed nuclear generating project, another agency in the State has been faring better. Piedmont Municipal Power Agency has ten members, all of which are Participants in the Catawba Project. PMPA commenced supplying power and energy to the Participants on June 21, 1985. PMPA is required to sell and each Participant is required to purchase from PMPA such Participant’s All Requirements Bulk Power Supply. PMPA has an undivided ownership interest of 25% in Unit 2 of the Catawba Nuclear Station, which was constructed and being operated by Duke Energy.

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 were challenged by one member and subsequently upheld. 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.

Recently, Moody’s maintained its A3/stable rating on PMPA’s debt which is secured by 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 were challenged by one member and subsequently upheld. 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.

Moody’s cited PMPA’s continued focus on recovering annual costs fully through rate increases, resulting in improved financial metrics during the last five years. The rating also recognizes the benefits that such rate increases have had on PMPA’s internal liquidity, which has noticeably improved over the period. A key factor in the rating is PMPA’s demonstrated willingness to implement rate increases over a sustained period, which is in contrast with the past when indenture specified coverage levels were met through the inclusion of rate stabilization funds. Moreover, the rating considers the completion of the capital spending program for Fukushima related capital investments, and that leverage, which is high, has started to decline with scheduled debt amortization and in the absence of a major spending program.

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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