MuniCreditNews January 21, 2016

Joseph Krist

Municipal Credit Consultant

GREAT LAKES WATER AUTHORITY BEGINS OPERATIONS

With so much attention being focused on the City of Flint, MI and its problems with a tainted public water supply, it would be easy to overlook a major development  for the primary supplier of water to the greater Detroit metropolitan area. January 1, 2016 marked the launch of a regional water authority in Southeast Michigan.  The City of Detroit, the counties of Macomb, Oakland, and Wayne, and the State of Michigan have officially united to form the Great Lakes Water Authority (GLWA).  The new Authority was formed as a part of the Grand Bargain resolving Detroit’s bankruptcy. The new structure gives suburban water and sewer customers a voice in the management and direction of one of largest water and wastewater utilities in the nation.

GLWA begins management and control of regional water and wastewater services, while Detroit, like suburban communities throughout the region,  will retain control of water and sewer services within the City limits.  The GLWA has signed a 40 year lease with Detroit for $50 million a year. Detroit will use these funds to overhaul its aging infrastructure.  The lease also provides for a $4.5 million Water Residential Assistance Program to help low-income customers of GLWA customer communities pay their water and sewer bills.

The GLWA is comprised of six board members: two from the City of Detroit, and one each from Wayne, Oakland and Macomb counties, plus one representing the State of Michigan. The Authority also has a new old customer. In order to address the City of Flint’s needs for potable drinking water in the face of its crisis, it will return to its former status as a customer of the City of Detroit’s water system. It was an effort to avoid feared increased costs from the resolution of Detroit’s bankruptcy that drove Flint officials to seek a different water supply leading to its current dire situation.

PUERTO RICO AUDIT MAY FINALLY BE MADE PUBLIC

Office of Management & Budget Director Luis Cruz told reporters that the commonwealth’s audited financial statements for fiscal year 2014, which ended June 30, 2014, could be finally released within the next few weeks, as the process being conducted by KPMG nears its end. “[The audited statements] should be ready by the end of this month; first week of February,” Cruz said. The commonwealth’s audited financial statements for fiscal year 2014 were due in May 2015, and the government has previously missed self-imposed deadlines to release it.

Meanwhile, the Puerto Rico government budget for fiscal year 2016, which ends June 30, has been adjusted, from $9.8 billion to $9.27 billion, mainly as a result of lower than expected revenue entering the commonwealth coffers, the revised budget translates into roughly $250 million in additional, across-the-board government spending cuts, including such areas as healthcare, security, social well being and education. The $250 million figure also includes a $119 million adjustment in debt service under the budget, mainly as a result of the default on certain Infrastructure Financing Authority (Prifa) bonds.

Cruz stressed the budgetary cuts are being made without affecting essential services to citizens, while ensuring government employees continue to receive their paychecks. “In a surgical manner, we are adjusting the budget…affecting in the least possible way and ensuring essential services to citizens. At the same time, we also want to ensure government payroll is met each pay period, as well as the least impact on the economy. Those are the judgment elements in making this decision,” Cruz explained.

Fiscal 2017 starts with more than $1.5 billion in payments due July 1. Since the release of the Fiscal and Economic Growth Plan (FEGP) in September, the fiscal crisis on the Island has worsened, and the Commonwealth is now facing even larger estimated financing gaps in both the near and long term. Specifically, the General Fund revenues included in the FEGP have decreased from a previous estimate of $9.46 billion for FY 2016 to $9.21 billion; the estimated five-year projected financing gaps increase from approximately $14 billion to $16.1 billion, even with the inclusion of economic growth and the implementation of all of the proposed measures in the FEGP; and the ten-year projections estimate a $23.9 billion aggregate financing gap.

Melba Acosta Febo, President of the Government Development Bank reiterated that it expects to sit with creditors shortly and put forth a comprehensive restructuring proposal. The proposal will  include a comprehensive adjustment of its debt that reflects the Commonwealth’s actual capacity to pay its creditors over the long term. It continues to characterize lobbying efforts as being of  those seeking to lock in speculative gains but hope that creditors will sit and work on a solution that will allow investment in Puerto Rico and repay its creditors through growth in the  economy over the long run.”

NASSAU COUNTY TESTING THE MARKETS

A pair of troubled credits have recently released preliminary official statements in connection with the hoped for sale of debt. We have taken the opportunity to review them for updates on their relative precarious financial positions. The first is A2 rated Nassau County, NY which operates under the oversight of a state financial control board. The County hopes to refund $273 million of outstanding GO bonds and issue $120.3 million of new bonds and $23 million of bond anticipation notes.

The County is currently projecting a $24.9 million deficit for fiscal 2015. According to the oversight board (NIFA), it ran a deficit of $190 million in fiscal 2014. The County budget and rejected by NIFA. After a period of changes and legislative actions, a revised budget was submitted to NIFA which approved the proposed debt issue. The $2.92 billion budget is considered to have some 480 million at risk in the form of unrealized revenues and/or expense savings.

The County is still undertaking to resolve long standing issues related to required substantial property tax refunds and the unwillingness of the County legislature to enact increased property taxes. So long as the refund issues require external borrowings to finance and structural budget balance remains unattained, the County’s credit will remain under pressure. Investors may take some comfort in the County’s lack of legal authorization under New York State law to resort to bankruptcy.

CHICAGO PUBLIC SCHOOLS

The Board of Education of the City of Chicago is a more troubled story. A long history of budget difficulties, turbulent labor relations, and dependence upon the increasingly troubled State of Illinois have combined to pressure the Board’s finances over an extended period. The tax base supporting the credit is also the same as that supporting the City of Chicago and other tax backed credits which all have increasing demands on that common revenue . Like the City, the Chicago Public Schools also have substantial unfunded pension obligations that require increased revenues.

In addition, CPS estimates that its system requires some $4 billion of capital to maintain an aging and outdated physical infrastructure. The ability to reduce those needs through closings and other consolidation initiatives is hamstrung by a very difficult and complex political environment reflecting the dire economic straits of a huge portion of the student population. Those issues have challenged multiple city administrations and board management over many years. The result has been a steady decline in the credit’s relative creditworthiness and the bonds are now rated below investment grade without any external credit support.

Concerns about the Board’s credit have been heightened due to the ongoing lack of an enacted budget by the State. This has raised questions about potential impacts on the Boards cash flow and ability to service its debt. The Board expects to receive 92% of the statutory State aid anticipated in its current budget. It also expects to receive $597 million in scheduled block grants from the State. The lack of a State budget has made the receipt of some $490 million of additional aid anticipated in the current FY budget highly uncertain.

This has required the Board to undertake and consider a range of expense cutting actions to offset the reduced funding. In addition, the cuts have influenced the negotiations being undertaken with the teachers union. These negotiations are ongoing and include the recent participation of a mediator as the teachers have reacted negatively to proposals that would reduce the Board’s pension contributions. The teachers have threatened to strike in an effort to influence negotiations. The primary impact of a strike would be to reduce state aid according to a formula penalizing CPS 1/176th for each day there is no class. Some 5 weeks’ worth of the school year could be lost in the event of a strike.

The ongoing uncertainty led S&P to lower its rating on the district’s $6 billion of general obligation bonds this past Friday to B-plus from BB and left it on CreditWatch with negative implications “while it continues to monitor the board’s efforts to maintain sufficient liquidity to meet its financial obligations.”

In the midst of this effort to complete the bond issue, Gov. Bruce Rauner and Republican legislative leaders on Wednesday proposed a state takeover of Chicago Public Schools and permitting the troubled district to declare bankruptcy to get its finances in order, billing the controversial ideas as a “lifeline” and not “a state bailout.” As described by the GOP leaders, the legislation would allow the Rauner-appointed State Board of Education to remove the current Chicago Board of Education and create an independent authority to run CPS until it is determined the district is no longer in financial difficulty. The leaders said the change would add CPS to a state financial oversight law that it is exempted from but that applies to all other Illinois school districts. Another measure would allow school districts like CPS to declare bankruptcy, which could allow it to void union contracts.

House Speaker Michael Madigan and Senate President John Cullerton made it clear the Republican takeover plan is dead on arrival at the Capitol.  Madigan said in a statement. “Republicans’ ultimate plans include allowing cities throughout the state to file for bankruptcy protection, which they admitted today would permit cities and school districts to end their contracts with teachers and workers — stripping thousands of their hard-earned retirement security and the middle-class living they have worked years to achieve. “When Detroit was granted bankruptcy protection, retirement security was slashed for employees and retirees. That is not the path we want to follow in Illinois.”

This type of political infighting has hampered serious reform of CPS operations. Investors should not be fooled now into thinking that the Governor and his allies are looking at the bondholders are a primary interest. The Governor’s anti-union agenda (whether you are for or against it) has been at the core of the budget impasse at the state level and is at the core of the Governor’s effort to jump into the middle of this dispute. Like Pennsylvania, the Illinois crisis is as much a creature of ideological political considerations as it is about economic or financial realities. All in all a toxic mix for current and potential investors.

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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