Joseph Krist

Publisher

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ISSUE OF THE WEEK

$920,190,000

STATE OF ILLINOIS

General Obligation Refunding Bonds

Moody’s: “Baa3” (Stable Outlook)
S&P: “BBB-” (Stable Outlook)
Fitch: “BBB” (Negative Outlook)

The refinancing of state debt at more favorable terms is always a positive. That is not what we see as the important part of this effort to come to market. In this case, the focal point should be the nature of the disclosure included in the offering documents as it pertains to the State’s budget outlook.

From that perspective, the statement that the State has a structural budget deficit of $1.2 billion is important. While the State did enact a “balanced budget”, the level of the ongoing hurdles to be overcome to generate truly positive momentum for the State’s credit is important. The number indicates that regardless of the outcome of this November’s gubernatorial ballot, the next Governor and the Legislature have a significant road to hoe.

The structural deficit accompanies an ongoing backlog of unpaid bills estimated at $7.4 billion. So long as the State is unable to address its structural deficit the backlog will continue to serve as a significant drag on the State’s credit and ratings. In addition, the prospectus reminds investors once again of the magnitude of the State’s unfunded pension liabilities which plague not only the State but also its underlying municipalities and subdivisions. Overall the State’s unfunded liability position remains significant with an actuarial liability of $128.9 billion and a funding ration of 39.9%.

While the language dealing with factors which could potentially impact the State’s budget, we note that there is particular attention drawn in the document to the negative effects of US trade policy. Illinois, in addition to being significantly exposed to agricultural tariffs, is also impacted by tariffs on steel and aluminum which are significant manufacturing inputs to businesses in the State. In addition to raising costs of production and final products for domestic consumption, the trade war will negatively impact the State’s manufacturing sector. We take this view notwithstanding some isolated examples of manufacturing capacity being restarted in certain industries.

All of these factors place the enacted budget at significant risk of negative variance.

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GAS TAXES AND ELECTIONS

Ninety-six percent of state lawmakers who voted in favor of a gas tax increase and faced reelection in 2018 primaries will advance to the Nov. 6 general election, according to new data from the American Road & Transportation Builders Association’s Transportation Investment Advocacy Center. The 2018 primaries saw 802 legislators who voted on gas tax increase legislation from 12 states – California, Iowa, Indiana, Montana, Nebraska, Oregon, South Carolina, Utah, Oklahoma, Tennessee, Michigan and Washington – run for reelection. Of those lawmakers, 558 voted in favor of a gas tax increase and ran for reelection, with 538—or 96 percent—advancing to November’s general election.

The numbers include 97 percent of the 263 Democratic lawmakers, and 96 percent of 295 Republican lawmakers. Of the 222 legislators who voted against a gas tax increase and ran for reelection, 216—or 97 percent—will move on to November’s general election. This includes 96 percent of 52 Democratic lawmakers, and 97 percent of 170 Republican lawmakers. An additional 22 lawmakers did not cast a vote on a gas tax increase measure and ran for reelection.

Earlier findings from the advocacy group showed voting for a gas tax increase does not affect a lawmaker’s chance of reelection. In the 16 states that increased their gas tax rates or equivalent measures between 2013 and 2016, nearly all (92 percent) of the 1,354 state legislators who voted for a gas tax increase and stood for reelection between 2013 and 2017 were sent back to the state house by voters. Of the 712 elected officials who voted against a gas tax increase, 93 percent were also given another term.

The stats seem to show that excuses for not raising gas taxes over time have been just that – excuses. With a 90% success rate for advancement in the primaries occurring regardless of one’s voting record on gas taxes, it seems somewhat obvious that gas taxes just aren’t an issue. We suspect that gas tax levels matter far less than healthcare, education, and whether or not one has a job. Gerald Ford once said that the inflation rate doesn’t matter if you don’t have an income.

SEQUESTRATION TO IMPACT DIRECT PAY BONDS

Pursuant to the requirements of the Balanced Budget and Emergency Deficit Control Act of 1985, as amended, refund payments issued to and refund offset transactions for certain state and local government filers claiming refundable credits under section 6431 of the Internal Revenue Code applicable to certain qualified bonds are subject to sequestration.

This means that refund payments and refund offset transactions processed on or after October 1, 2018, and on or before September 30, 2019, will be reduced by the fiscal year 2019 6.2 percent sequestration rate. The sequestration reduction rate will be applied unless and until a law is enacted that cancels or otherwise affects the sequester, at which time the sequestration reduction rate is subject to change.

These reductions apply to Build America Bonds, Qualified School Construction Bonds, Qualified Zone Academy Bonds, New Clean Renewable Energy Bonds, and Qualified Energy Conservation Bonds for which the issuer elected to receive a direct credit subsidy pursuant to section 6431.

PREPA SETTLEMENT ONLY ONE STEP

It is hard to be optimistic about the long term financial outlook for Puerto Rico. In the case of PREPA, the electric utility, a proposed settlement with debt holders generates some encouragement but reality has a way of rearing its head at inopportune times.

The latest evidence of that is The Puerto Rico Comptroller’s Office finding evidence of irregularities in the electric power company’s fuel purchasing and payments for professional service. The report establishes that in eight contracts and an amendment for the purchase of $4.6 billion worth of fuel between 2008 and 2012, the Puerto Rico Electric Power Authority (PREPA) did not include in the contracts a clause to charge interest for delays. Despite the absence of this clause in the contracts, the utility disbursed $3.3 million to the suppliers. The audit of three findings indicates that $2.3 billion in payments were made to a company that had pleaded guilty to fraud in 2006.

“The Report states that a fuel supplier that filed and paid their Monthly Tax Return to the Department of the Treasury more than two years after the term established by the Law was identified,” the comptroller said.

Puerto Rico’s electric power restoration after Hurricane María mangled the island’s grid entailed an estimated $2.5 billion. The utility is now entering a phase that consists of improving the temporary work done to put the lights back on as quickly as possible, which means outages are imminent during the coming six months. “There will be one or more blackouts in one sector or another because we have to remove [utility] poles that aren’t installed in the best way. We’re going to be notifying people in time so they know when there’ll be some [work done] to be able to change their poles to firmer ones and do a job well done.”

THUMB ON THE BRIGHTLINE SCALE?

We are more than interested in the news that current Governor and Senate candidate Rick Scott and his wife invested at least $3 million in a credit fund for All Aboard Florida’s parent company, Fortress Investment Group, according to recently disclosed financial documents. One has to wonder what impact this decision, which generates the Governor some $150,000 in annual investment income has sweetened the environment for All Aboard Florida’s plan to expand service from Orlando to Tampa.

In 2011, Gov. Rick Scott canceled a $2.4 billion federally funded and shovel-ready bullet train from Orlando to Tampa because it carried “an extremely high risk of overspending taxpayer dollars with no guarantee of economic growth.’’ Now he thinks that such a venture is “a good idea”.  The Governor’s  investments are in a blind trust but most of his and his wife investments are held in her name limiting the disclosure requirements about his investments.

This is exactly the kind of thing that clouds the municipal finance universe. It’s not the first ethically challenged investment activity for the Governor. When he ran HCA, that for  profit hospital chain paid fines in excess of $1 billion to the federal government. While all parties deny that the Scott’s investments directly benefit from the ultimate success or failure of the Brightline, it creates an unsightly perception that moves the project from the realm of sound economic development to that of politicized investing.

It all harkens back to earlier times in the US where infrastructure development was influenced by the role of various private participants and investors. One could hope that those days were behind us but in the instance that does not appear to be the case. It is no surprise that privatization and public private partnerships are viewed through a skeptical prism by so many.

SEC ENFORCEMENT CONTINUES

The ongoing efforts by the Securities and Exchange Commission (SEC) to police the municipal bond market continue. The latest charges two firms and 18 individuals in a scheme to improperly divert new issue municipal bonds to broker-dealers at the expense of retail investors.  According to the SEC’s complaint, the defendants – known in the industry as “flippers” – purchased new issue municipal bonds, often by posing as retail investors to gain priority in bond allocations. The defendants then “flipped” the bonds to broker-dealers for a fee. The SEC also charged a municipal underwriter for accepting kickbacks from one of the flippers.

Many issuers require underwriters to give retail investor orders the highest priority when allocating new issue bonds, particularly retail investors within the municipal issuer’s jurisdiction. According to the SEC’s complaint, these defendants used fictitious business names, falsely linked their orders to ZIP codes within the issuer’s jurisdiction, and split orders among dozens of accounts. After acquiring the bonds, the SEC alleges that the defendants quickly resold them to broker-dealers, typically for a fixed, pre-arranged commission, and often sought to hide the flipping activity from issuers and underwriters by manipulating sales tickets.

Fifteen individuals charged settled the SEC’s charges without admitting or denying the allegations, agreeing to injunctions, to return allegedly ill-gotten gains with interest, pay civil penalties, be subject to industry bars or suspensions, and to cooperate with the SEC’s ongoing investigation. Three individuals face criminal proceedings.

The continued vigilance of the agency under the current administration is an overall positive for the market. With infrastructure demands increasing almost daily it is important that the municipal market be able to appeal to the widest range of investors. These efforts will help to increase the long-term attractiveness of the market to potential investors whether they be individuals seeking tax sheltered income or to non-traditional institutional investors looking to enter the market for the first time.

SOUTH CAROLINA PUBLIC SERVICE AUTHORITY DOWNGRADE FINALLY COMES

Moody’s Investors Service has downgraded the rating on the South Carolina Public Service Authority (Santee Cooper) revenue bonds to A2 from A1. The rating action is based on  consideration of the continued unstable governance with uncertainty about future rate setting as Santee Cooper operates without a board chairman. The downgrade also reflects the very high leverage that will persist for many years owing to the termination of the Summer Nuclear project which has introduced cost recovery challenges to Santee Cooper, particularly in the near-to-medium term. Another consideration in the downgrade is the continued uncertainty about the ultimate outcome of the litigation brought by Central Power Electric Cooperative (Central), Santee Cooper’s major wholesale customer that provides more than 60% of its revenues.

No legislative action was enacted in the 2018 session which curtails the Santee Cooper board’s unregulated authority to establish rates and charges to meet bond covenants in a timely manner. An existing state statute prohibits the state from doing anything including enacting new laws that would impact bond covenant compliance. An additional factor in favor of the rating is the fact that Santee Cooper does not have to immediately replace the planned Summer addition with a new generation. This would lead the fact that Santee Cooper does not have to immediately replace the planned Summer addition with a new generation. This would lead to an even more unfavorable debt profile which would further increase downward pressure on the rating.

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.

 

Joseph Krist

Publisher

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ISSUE OF THE WEEK

CITY AND COUNTY OF DENVER, COLORADO

FOR AND ON BEHALF OF ITS DEPARTMENT OF AVIATION

AIRPORT SYSTEM SUBORDINATE REVENUE BONDS

$2,200,000,000

The issue will provide financing for the public private partnership undertaking the renovation and reconfiguration of Denver International Airport. It is hard to believe that DIA opened in 1995 but the passage of time, increased security issues, and ever increasing passenger volumes have led to the plan to update the main terminal at the airport.

Major components of the project include: Enhancements to security by removing today’s exposed checkpoints on level 5; Increased Transportation Security Administration (TSA) throughput; Increased capacity and life of the terminal for the future, allowing the airport to grow its operations in the terminal and concourses to match increasing passenger demand; Better utilization of airline ticket spaces, including increased check-in counter space; An upgraded meet and greet area at the south end of the terminal, and a new “front door” to the airport, including a children’s play space and flight info displays; Improved food and retail offerings throughout the Jeppesen terminal; Curbside improvements for increased passenger drop-off capacity, including a quick drop-off location directly at the TSA checkpoints.

The Jeppesen Terminal was built to serve only 50 million annual passengers, and it served over 58 million passengers in 2016. TSA checkpoints are at capacity. The airport also has an underutilized and inefficient ticket lobby space and is lacking the adequate amount of concessionaires to accommodate projected passenger growth. Today, DEN has 30 standard checkpoint lanes that accommodate about 4,500 passengers per hour. The Great Hall project will include 34 state-of-the-art automated screening lanes, which can each serve an estimated 8,500 passengers per hour.

The P3 established for this project (The Great Hall Partners) is comprised of Equity Partners:  Ferrovial Airports International Ltd., JLC/Saunders joint venture, which includes Saunders and Magic Johnson Enterprises & Loop Capital. The Design & Build partners: Ferrovial Agroman and Saunders Construction, Inc. The Architects: Luis Vidal + Architects, Harrison Kornberg Architects and Anderson Mason Dale. Local Engineers/Contractors: Intermountain Electric, Civil Technology, Gilmore Construction, Sky Blue Builders. Equity Partners Legal Advisors: Gibson, Dunn & Crutcher.

The City and the airport still maintain the ownership and the private partner is in a long-term lease. The Great Hall Partners were granted an exclusive license to develop and manage terminal concessions and will contract directly with individual concession operators. The agreement requires that 70 percent of concession locations must be competitively procured; so existing concessionaires will have the opportunity to bid on concession opportunities in the terminal area.

The initial plan calls for the project to be completed in four main construction phases. Phase one of the project will primarily focus on work in Mod 2, east and west, including airline ticket lobbies, baggage claim areas, the food court (which will be demolished), as well as the area of the A bridge from the terminal to the Airport Office Building, Phase two will focus on Mod 3, with similar ticket lobby and baggage claim area work. Phase three will be in Mod 1, preparing for the current Mod 1 ticket counters for conversion into new passenger security screening area, and the final phase will entail work in the tented space of the terminal on level 5, along with median and curbside work on level 6 on both the east and west sides of the terminal. Milestones for the project include opening of the ticket counters in early 2020, opening the checkpoints in late 2020, and the entire project will complete in late 2021.

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PR MOVES TO SETTLE COFINA DEBT

The news that the government and a number of bondholders reached a deal to restructure the instrumentality’s debt secured by sales taxes (the COFINA debt) was generally greeted favorably. Contrary to many who postulated that the sales tax debt had been legally structured to be immune to the travails of the general obligation debt, the proposed settlement will require COFINA debt holders to take a substantial haircut. The deal provides for more than a 32% reduction in COFINA debt, providing Puerto Rico about $17.5 billion in future debt-service payments.

It provides for 53.65% of the Pledged Sales Tax Base Amount (“PSTBA”) cash flow through and including 2058 to be dedicated to the new COFINA bonds which are proposed to be issued to the debt holders. The new bonds will result effectively in an extension of maturity (no surprise). The new debt will come in the form of both current interest and capital appreciation bonds.

As it exists now, the proposal allows the issue of final judicial review of the strength of the statutory lien of COFINA bonds against the constitutional lien which the general obligation bond holders contend supersedes it. Because this point has yet to be adjudicated, we expect that general obligation bondholders will seek to intervene in the proceedings and to challenge the claim on revenues by COFINA bond holders.

We do not pretend to know how this conflict will eventually be resolved. It has long been our view that a constitutionally established lien is stronger than a statutory lien. We understand why the Commonwealth did not seek to have the lien judicially validated (it very well might not have been upheld) but it is not as clear why investors did not consider the issue of a statutory vs. a constitutional lien. Regardless of the outcome, our view is that the issue validates our long held belief that economics always trump legal provisions if one wants to feel secure in one’s investment.

One market cohort which is undoubtedly pleased by the terms of the proposed settlement is the monoline bond insurers. National Public Finance Guarantee Corporation is estimated to have nearly $1.2 billion of par exposure to COFINA senior bonds. Assured Guaranty Municipal Corp. is estimated to have $264 million of net par exposure to subordinate COFINA bonds. Moody’s estimates that National will incur ultimate losses on its total COFINA insured debt service obligations of around $80 million on a present value basis, while AGM’s will be around and $130 million.

NORTH CAROLINA TAX CAPS

North Carolina’s allowable maximum income tax rate is currently 10%. The state moved to a flat tax rate of 5.8% in 2014. On Jan. 1, 2019, the state budget lowers the personal income tax rate to 5.25% from 5.499%. Now, the legislature has approved initiatives to be submitted to the voters this November which would “limit future, legitimately-elected legislatures’ power to set state income tax rates higher than 7%, which could limit funding for programs.

The action comes as multiple studies have been released which raise issues of equity among various income cohorts which result from the establishment of taxing limitations. In addition, North Carolina’s politics have become substantially more partisan and polarized. This has led to the filing of a lawsuit by the Governor of North Carolina against, among others, the President pro Tem of the Senate and the Speaker of the House in North Carolina.

The Governor seeks to have the initiatives annulled as violations of the separation of powers. The Governor charges that the initiatives were crafted for the purpose of deceiving the electorate. He is concerned that the proposed amendments could allow the legislature to enact laws which then had to be enforced by the Governor even if he vetoed them. The proposed veto exception for judicial vacancy bills is not expressly limited to bills on that subject “and containing no other matter.”

LONG RELIEF FOR THE YANKEES GARAGE

Since Opening Day of 2009, the new Yankee Stadium has been the home of the 26 time world champions. While their performance on the field has been generally favorable, the financial performance of the garage at Yankee Stadium has been seriously deficient. There have been a variety of proposals made for development which might provide revenues to support a restructuring of the bonds issued by the New York Industrial Development Corporation.

The bonds were issued in 2007 on behalf of the Bronx Development Corporation (BDC). The garage is the only asset pledged as security for the bonds and the only source of revenues. From the start, below expected demand has been a constant feature of operations. This, coupled with a high $35 per game parking fee, served to permanently suppress demand as the Stadium is quit accessible via public transportation.

Now the other tenant at Yankee Stadium, Major League Soccer’s New York City FC, may be part of a solution to the financial conundrum faced by the BDC. The is a four-level parking structure that sits immediately south of the old stadium site. The garage along with two other structures would be demolished to create a roughly eight-acre plot of land just big enough to squeeze in a soccer-specific stadium.  The city would sell or lease it to a private developer. The developer would sublease the garage site to NYCFC, which would erect on it a 26,000-seat, $400 million soccer stadium.

Certainly enough moving parts are here to interest investors. One wild card (the Yankees are competing for that spot) is that the garages only become available if the Yankees agree to lift the requirement, agreed to in 2006, that the city provide a minimum of 9,500 parking spaces for fans — a provision that even the team owners no longer care about, but which they can decline to do away with unless the city agrees to use the garage property for a project of their liking.

One thing in favor of the project going through – NYCFC is owned by the Steinbrenner family and Abu Dhabi’s Sheikh Mansour bin Zayed Al Nahyan.

CA JULY REVENUE UPDATE

During the first month of the 2018-19 fiscal year, California took in less revenue than estimated in the budget enacted at the end of June according to the State Controller. Total revenues of $6.63 billion for July were lower than anticipated by $294.7 million, or 4.3 percent. While sales taxes missed the mark, personal income tax (PIT) and corporation tax – the other two of the “big three” revenue sources – came in higher than projected.

For July, PIT receipts of $5.22 billion were $231.7 million, or 4.6 percent, more than expected. July corporation taxes of $446.4 million were $82.2 million, or 22.6 percent, above 2018-19 Budget Act assumptions. Sales tax receipts of $818.4 million for July were $659.1 million, or 44.6 percent, less than anticipated in the FY 2018-19 budget. Most of the variance was due to when the money was recorded.

At the beginning of FY 2018-19, the state’s General Fund had a positive cash balance of $5.54 billion. Receipts were $3.62 billion less than disbursements in July, which left a cash balance of $1.92 billion at the end of the month. There was no internal borrowing, which was $2.19 billion less than the 2018-19 Budget Act estimated the state would need by the end of July. Unused borrowable resources were 7.5 percent higher than projected in the budget.

NEW YORK STATE SALES TAX GROWTH

Sales tax revenues in New York secure a variety of debt issues in the state. So it is good news that the State Comptroller’s Office announced that first-half of calendar year 2018 sales tax collections grew 6% over 2017, the highest six-month increase since 2010. In addition to individual bond issues, sales taxes are a significant revenue source to local governments across the State. They are also a good current indicator of the trend of economic activity. Sales tax growth was strong in virtually every region of the state.

The Comptroller cited a number of factors to account for this strong growth trend. They include low unemployment (the lowest in more than a decade), improved consumer confidence, steady wage growth and the highest inflation rate since 2011. Also driving the increase, particularly in counties bordering Pennsylvania, was increased collections of motor fuel tax. The comptroller noted that this was likely because of gas prices being lower in New York than in neighboring Pennsylvania.

The trend becomes more solid when viewed in the context of where sales tax revenues are generated. New York City has a strong tourist economy which lends itself to relatively outsized sales tax revenues. It is telling that counties which do not rely on tourism also exhibited strong growth lending credence to the view of a strong and expanding economy.

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.

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$366,250,000

California Statewide Communities Development Authority

Revenue Bonds

Loma Linda University Medical Center

The Medical Center comes to market fresh on the heels of a rating downgrade from Fitch to BB from BB+. The bonds are secured by a gross receivables pledge and mortgage pledge of the obligated group (OG). There are also debt service reserve funds. The OG includes LLUMC, LLU Children’s Hospital, LLUMC – Murrieta, and Loma Linda University Behavioral Medicine Center. The OG accounted for almost all of the consolidated system assets and revenues.  The increasing leverage being added to the Medical Center’s already highly leveraged balance sheet is the primary basis for the downgrade.

The capital program began over a year ago. The project includes two new patient towers on a shared platform (16-story adult tower and 9-story children’s tower) with all private rooms, expanded and separate emergency rooms, expanded neonatal intensive care unit and birthing center, 16 new operating rooms (five additional), enhanced diagnostic imaging services and cardiovascular labs. The project will result in 983,000 square feet of new space with a total capacity of 693 licensed beds (320 adult and 377 children’s) once the shelled space is built out for the additional 60 beds.

LLUMC is located 60 miles east of Los Angeles in Loma Linda, CA. It operates a total of 1,077 licensed beds: University Hospital (371), East Campus Hospital (134), Surgical Hospital (28 bed) (all three share a license and are located on the main campus), Children’s Hospital (343 beds), Behavioral Medicine Center (89-bed facility in Redlands) and LLUMC- Murrieta Hospital (112 beds in Murrieta). LLUMC offers quaternary and tertiary series and has the only level I trauma center and level IV neonatal intensive care unit in the service area of the Inland Empire (San Bernardino and Riverside counties). University Hospital and Children’s Hospital are undergoing a capital intensive campus transformation project which will also address state-mandated seismic requirements that go into effect on Jan. 1, 2020, although the project is a year behind schedule and will require an extension from the state legislators.

LLUMC’s market share in its service area, the Inland Empire, was stable in 2016 after slight growth between 2012 and 2015. While not leading the service area market share, LLUMC offers a greater depth and breadth of quaternary and tertiary services with the only level-I trauma center and level-IV neonatal intensive care unit in the service area. Its role as a major provider of children’s services is a double edged sword. It drives utilization but increases its dependence upon Medicaid. Medicaid currently represents approximately 41% of gross revenues and 32% of net revenues. LLUMC is a major beneficiary of California’s HQAF program. HQAF provides supplemental Medi-Cal payments to hospitals that are net recipients of the hospital provider fee program; however, there is a lag in payment receipts after the pertaining services are provided.

The service area is competitive. LLUMC’s market share in the Inland Empire was 11% in 2016 and the next closest competitor, Kaiser-Fontana, had a 7.2% market share. However, Kaiser has several facilities in the area and Kaiser’s combined market share in the region was 12%. Other leading competitors in this service area include UHS (8.1%), Tenet (7%), and Dignity Health (6%).

LLUMC reported a 10.9% operating margin and 16.1% operating EBITDA margin in the nine-month statements of fiscal 2018 (ended March 31) partly due to the recording of additional net program benefits. Operating improvement in fiscal 2018 has been driven largely by initiatives to reduce length of stay and cost management.

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SAN DIEGO GETS BAD NEWS ON PENSION REFORM

The six year old pension reform program undertaken by the City of San Diego was overturned by the California Supreme Court last week. The court ruled that the plan was not legally placed on the ballot because city officials failed to negotiate with labor unions before pursuing the measure. The court ordered the appeals court to take the case back and evaluate the state labor board’s conclusion that 4,000 employees hired since pensions were eliminated must receive compensation that would make them financially whole.

The ruling sends the case back to  the appeals court and directs that court to enact “an appropriate judicial remedy” for the city’s failure to follow the legally required steps before placing the measure on the ballot. The city has said that the only way to do that would be to invalidate the ballot measure and nullify the pension cuts. The measure was approved by more than 65% of city voters. It replaced guaranteed pensions with 401(k)-style retirement plans for all newly hired city employees except police officers.

At the time of the vote, the then mayor of the City took a leading role in promoting support for the initiative. The fact that the mayor took such a public role in supporting it became a key factor in the court’s decision. The mayor maintained that he supported the measure only as a citizen, not as mayor, and as a result negotiations with unions were not required. The Court found that his interpretation of his role was incorrect and that he was obligated to meet with the unions before placing the measure on the ballot because he used his power and influence as mayor to support the measure.

The mayor relied on legal advice he received but acknowledged he should have handled things differently. The ruling reinstates a 2015 decision by the state labor board that concluded the city was legally required to conduct labor negotiations before placing Proposition B on the ballot. The board then ordered San Diego to make employees hired since 2012 whole by compensating them for the loss of pensions and paying them interest penalties of 7%. Estimates of how much that would cost the city have ranged from $20 million to $100 million.

It is important to note that the Court only ruled on the procedural issue. It noted that it was not ruling on the  pension cuts. “We are not called upon to decide, and express no opinion, on the merits of pension reform or any particular pension reform policy.”  San Diego is the only city in California to discontinue pensions for new hires. The ruling also bolsters the role of the employee union and is notable in that it follows fairly closely the US Supreme Court ruling in the Janus case which is seen as a negative for unions.

PUERTO RICO

The Financial Oversight and Management Board for Puerto Rico has published its second annual report to the U.S. president, Congress and the governor and legislature of Puerto Rico, as required by the Puerto Rico Oversight, Management and Economic Stability Act (Promesa). The review period includes the aftermath of Hurricane Maria.  “Immediately after Hurricanes Irma and Maria struck, the Oversight Board provided the Government with the flexibility to reapportion up to $1 billion in budgeted expenditures to cover disaster related expenses. The Oversight Board also worked with the Government to forecast the liquidity needs of the Government in the months ahead, which eventually led to Congress providing Puerto Rico with access to specialized forms of Community Disaster Loans to offset the projected revenue shortfalls caused by the hurricanes.”

The report documents the impasse with the government encountered by the Board.  “The Government initially rejected the most critical component of labor reform – changing the law of Puerto Rico to make it an at-will jurisdiction for private sector employees like 49 of the 50 states.”  “While this fiscal plan contains many of the fiscal measures necessary to rightsize the Government, it contains only those structural reforms that the Government agreed to implement, such as ease of doing business and energy reform, but not comprehensive labor reform because of the Legislature’s failure to pass the requisite legislation.

In addition, the report includes several recommendations from the Board. It requests federal support with Medicaid and Medicare by legislating a “long-term Medicaid program solution to mitigate the drastic reduction in federal funding for healthcare in Puerto Rico that will happen next year,” as well as providing “fair and equitable treatment to residents of Puerto Rico in all Medicare programs.” It also suggests special provisions be increased to enhance Puerto Rico’s attractiveness for investments in the U.S. Tax Code’s Opportunity Zone (OZ) rules, such as for property acquired from the Puerto Rico Government, extending the time in which an OZ fund must invest in Puerto Rico, providing “special basis rules for investors that invest in a Puerto Rico OZ Fund,” and reducing the holding period applicable to an investment in a Puerto Rico OZ Fund.”

The Board also reiterated “the long road ahead for Puerto Rico but is resolute in fulfilling its mission of helping Puerto Rico to achieve fiscal responsibility, regain access to capital markets, restructure its outstanding debt, and return to economic growth.”

MORE CHICAGOLAND CREDIT IMPROVEMENT

Moody’s continued its moves to improve the outlooks for ratings for a variety of credits in and around the City of Chicago. The latest beneficiaries are the Regional Transportation Authority (RTA) and the Chicago Transit Authority (CTA). Moody’s has revised the outlook on the Regional Transportation Authority’s (IL) sales tax revenue bonds to stable from negative, while affirming the bonds’ A2 rating. This affects $1.6 billion out of the Authority’s $2.2 billion outstanding debt. The outlook change is based on the recently stabilized credit positions of key related governments, Illinois and Chicago. With solid economic trends in Chicago and its surrounding suburbs, pledged regional sales tax collections will tend to increase, supporting RTA’s credit position for the next one to two years.

RTA’s debt is secured by liens on sales tax imposed by the RTA in its service area and on matching payments from the state’s Public Transportation Fund (PTF). The sales taxes are levied at various rates throughout the region. In Cook County (A2 stable), for example, the tax rate for general sales tax is 1%, while the tax on drugs and prepared food is 1.25%. Collar county general sales are subject to a 0.5% RTA tax. Unlike some state obligations supported by revenue collected by the state’s Department of Revenue, the RTA benefits from a primary source that is separated from the state government’s operations, flowing directly to a trust account held for RTA outside the state treasury. The payment of regional taxes has generally not been subjected to budgetary deliberations or to deferral, and it does not require legislative appropriation for payment. Fare-box collections of the RTA’s service boards are not available for payment of debt service.

Moody’s Investors Service has revised the outlook for bonds issued by the Chicago Transit Authority to stable from negative, while affirming the ratings at current levels (A3). The same factors justifying the improvement in the RTA rating outlook were cited to support the CTA outlook change. CTA’s sales tax revenue bonds are secured by CTA’s Sales Tax Receipts Fund (STRF), which receives transfers of RTA sales tax revenues and the state’s PTF matching payments. CTA’s sales tax and PTF revenues that exceed debt service requirements are released for operations. These revenues are allocated under a statutory formula and are transferred by RTA after it has satisfied debt-service requirements on its own sales-tax secured bonds. The CTA’s bonds therefore are in effect subordinate to the RTA bonds.

An exception to this subordination is that the CTA’s 2008 retirement benefit-funding bonds, the largest share of CTA’s outstanding sales-tax revenue bonds, are additionally secured by Chicago real estate transfer tax (RETT) payments. The RETT revenues are deposited in the Transfer Tax Receipts Fund. The CTA’s share of RETT is assessed at a rate equal to $1.50 per $500 under legislation passed in connection with the 2008 bonds. RETT revenues have averaged about $67 million in the past five fiscal years.

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