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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.

Muni Credit News Week of January 1, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$385,000,000

New Jersey Economic Development Authority

State Lease Revenue Bonds

Fitch: A

It will only be the first week of a new administration in Trenton after the end of the Chris Christie era but the State will see its first test of investor perceptions of its credit outlook through this issue of state lease revenue bonds. The bonds are secured by the authority’s payments is derived from separate lease-sublease arrangements for each project under each series of bonds between NJEDA and the Department of the Treasury’s Division of Property Management and Construction (DPMC). A trustee has been assigned all of NJEDA’s rights to receive DPMC’s rental payments, funded via annual legislative appropriation, under the subleases related to these bonds for the benefit of bondholders.

New Jersey uses annual appropriation debt to finance over 95% of its direct capital needs as the result of a cumbersome electoral approval requirement for the issuance of general obligation debt. The State has a very mixed history of success in seeking voter approval. This builds in a pretty strong incentive for the state legislature to annually appropriate monies for its lease revenue debt. Unsurprisingly, a lawsuit has been filed challenging the legality of this bond issue under the debt limitation clause of the state constitution; however, bond counsel strongly believes NJEDA’s ability to issue debt authorized by its enabling act is not subject to the limitations of the clause. Bond counsel will render a clean legal opinion concurrent with the sale of the bonds.

The change in administrations has not changed the basic challenges facing the state. Pension contributions of $1.9 billion approximated 5.4% of fiscal 2017 adjusted appropriations, but were only four-tenths of the $4.7 billion actuarially-determined contribution (ADC). A contribution at the ADC would have resulted in pensions consuming 13.5% of fiscal 2017 adjusted appropriations. The state has appropriated $2.5 billion for its fiscal 2018 contribution, 50% of the ADC, consistent with its stated plan to incrementally add one-tenth each year until full funding of the ADC is reached, in fiscal 2023. Under the 2017 Lottery Enterprise Contribution Act (LECA) the state’s payment is offset by anticipated net lottery receipts, resulting in a net $1.5 billion payment from operating funds. Pressure to aid education to limit growth in local taxes continues as does the need to fund health expenses. Like any state with significant health expenses, it would be vulnerable to decrease which the Congress will likely try to impose on Medicaid funding and possible other healthcare funding.

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ISSUES TO WATCH FOR IN 2018

TOLL ROADS

Pennsylvania will see a tenth consecutive annual rise in tolls on its Pennsylvania Turnpike. The toll hike will raise the most common toll, a trip between two interchanges, from $1.95 to $2.10 for cash customers, about 7.7 percent, and the E-Z Pass toll from $1.23 to $1.30, about 5.7 percent. Tolls have been rising annually ever since the Commonwealth enacted its now infamous plan to use turnpike revenues to fund non-Turnpike transit projects throughout the State. The associated state transportation law that requires turning over $450 million of turnpike revenues to regular state coffers for mass transit through fiscal year 2022. After that, the law says the amount drops to $50 million.

By Ii2nmd at English Wikipedia, CC BY-SA 4.0, https://commons.wikimedia.org/w/index.php?curid=61002291

Originally the plan was to be part of an overall scheme in 2007 that included tolling Interstate 80. I-80 tolls would have ended the turnpike payment. When the federal government rejected tolling I-80, the state’s main east-west highway, the turnpike had to keep paying $800 million a year to the state for mass transit and non-turnpike road and bridge improvements. Since 2007, the turnpike has turned over about $5.65 billion — about $2.25 billion to the state motor license fund for road and bridge projects and $3.4 billion to the public transportation trust fund for mass transit systems. The turnpike has generally met projections of 4 percent annual growth in costs set out in a 2007 management plan while also selling $1 billion in bonds annually to pay for turnpike repairs and upgrades.

Before the 10-year streak of hikes, the turnpike only raise tolls five times since opening in 1940.

CONGESTION PRICING

Congestion pricing is likely to get its biggest test yet as it looks like New York City may get some form of it in 2018. A combination of available tested technology on other City roads, greater political support, and a recent study supporting the notion that vehicles for hire (Uber et al) are choking the City’s streets to the point of perpetual gridlock. So it is believed that at least a fee on user of vehicles will be proposed with the proceeds going to fund improvements to MTA systems – primarily the subway – in the City.

The well funded car services which the City estimates account for some 103,000 vehicles a day are expected to object vociferously with extensive media efforts. The situation is complicated by the Mayor’s opposition to congestion pricing which is seen by many as the result of pressure and financial support from the industry. A fee on vehicles for hire would address some of the long standing concerns that “outer borough” state legislators have used as a basis for refusing to support the needed state legislation enabling the City to impose such a plan.

The San Francisco County Transportation Authority is considering turning existing car pool lanes on Highway 101, as well as Interstate Highway 280 to toll lanes in an effort to ease congestion on those roads. The transportation authority must get approval from its board, which is made up of members of the Board of Supervisors, before any carpool or paid lanes are created. So far the Board has expressed skepticism about the plan citing increased costs for their constituents.

HEALTHCARE INNOVATION

The healthcare sector will continue to be challenged as the result of changes to the individual mandate and an expected campaign to significantly alter the federal Medicaid and even Medicare plans. The sector will continue to consolidate. In addition to the normal risks associated with implementation of a merger, the merging institutions will often be expanding their footprint into what for them are non-traditional markets. They include essentially urban entities absorbing more rurally based facilities in an effort to expand their revenue base. These efforts carry with them however, the risks associated with poorer rural patient bases whose access to primary care may already be limited as well as their access to affordable insurance.

This will require these facilities, as well as those whose base is primarily the underinsured less economically well off inner city populations to be especially innovative as they meet the challenges of these poorer cohorts. This will require hospitals to use technology not only not only in their medical procedures but also apply it to coordination of services in and out of their facilities. These efforts, which have been applied at some large urban facilities, have been shown to have a positive impact on cost trends as well as patient outcomes.

These steps will become more of a necessity as hospitals face an increasingly challenging funding environment as well as an evolving competitive landscape. While it has always been important factor for investors and analysts, a solid understanding of all of the market forces impacting a hospital credit will take on even greater importance in this rapidly changing industry.

STATE BUDGET CHALLENGES

Connecticut, Louisiana, and Oklahoma are already facing significant current year budget gaps. We expect contentious processes to resolve these issues to be front and center in 2018. We also expect that the overall state budget process will be more difficult than usual with much confusion emanating from the extended rollout of IRS regulations resulting from the new tax laws. The lack of guidance as to details of the implementation of a law whose provisions go into effect January1. The timing of these events will complicate revenue estimates for the states, likely require changes to state tax procedures since so many are linked to federal policies, and will face pressures on both the expense and revenue sides due to the loss of the SALT deduction above $10,000 and expected expenditure requirements related to an infrastructure program.

SPEAKING OF THE SALT DEDUCTION

The IRS did finally provide some clarity to the effort on the part of many taxpayers to prepay 2018 local property taxes in an effort to fully deduct them under existing regulations which ended on December 31. Taxpayers will be able to take advantage of the maneuver — but only under limited circumstances. The IRS said that taxpayers can claim an additional property tax deduction when paying their 2017 taxes if they pay the tax in 2017 and if the local tax authority has notified homeowners prior to 2018 of how much they owe in property taxes, known as a tax assessment. State and local laws vary as to when this occurs.

COBB COUNTY STADIUM – DISAPPOINTMENT ON AND OFF THE FIELD

The Atlanta Braves were not the most successful franchise in Major League Baseball with the year ending in significant scandal involving the team’s front office. On top of this, it appears that the stadium is not turning into the economic windfall that was promised by government supporters of Cobb County’s role in financing the project. Those supporters had predicted positive revenue effects for the County from the County directly but also from its “halo effect” on economic activity indirectly linked with the project.

By Thomson200 – Own work, CC0, https://commons.wikimedia.org/w/index.php?curid=58721303

Former Cobb County Chairman Tim Lee predicted “a 60 percent annual return on investment from the SunTrust Park partnership. “In fact, it will be the first private public partnership of its kind to result in a return on investment to taxpayers in the very first year.” The County then undertook an increase in spending including employee compensation increases. Now the new County Finance Director Bill Volckmann said even though income from the stadium is on track to meet or even exceed expectations, “It’s not going to be a windfall.”

As a result of the activity disappointment and increased spending, Cobb is facing a $30 to $55 million budget shortfall after raiding $21 million in rainy-day funds to plug a gaping hole in the 2018 budget. The public debt obligation on the stadium amounts to $16.4 million a year. Of that, $6.4 million is paid by Cobb residents out of the county’s general fund, while the remaining $10 million is funded through taxes and fees, including a countywide hotel/motel tax, a countywide rental car tax, a localized Cumberland hotel/motel tax, and localized Cumberland commercial property taxes. Cobb pays another $1.2 million for stadium operation and maintenance and about $1 million for police overtime and traffic management at games and events.

In total, Cobb County is paying a minimum of $8.6 million out of its general fund just for debt service, stadium operations and public safety. The Cumberland Community Improvement District is 50% developed and the commercial project around the stadium has generated about $460,000 in property taxes for the county’s general fund and $1.3 million for schools. The Braves pay $6.1 million toward the debt service.

PROGRESS ON CYBERSECURITY

While many have expounded on the potential for financially disruptive effects on municipal credit from technological change in the future – near and far -, a different threat emerged in the early summer of 2017. The threat involved the use of security software from a Russian vendor – Kaspersky Labs – whose ownership had links to the Kremlin. It was feared that the software might actually be making those systems which used the software more vulnerable to malevolent hackers and it was recommended by the Federal Government that that civilian agencies remove Kaspersky Lab software within 90 days. that civilian agencies remove Kaspersky Lab software within 90 days.

Investigative reporting by NBC News and the Washington Post revealed that the use of Kaspersky software was rather widespread among U.S. municipalities. After various hacking of operating systems at some municipal utilities and ransomware efforts to extort funds from some municipalities, pressure grew to force these entities to find some other source of security for their various computer systems.

Much of the resistance to changing to different software seemed to be based on the cost of replacements. After all, the success of the software was in many ways tied to its relatively inexpensive cost and widespread availability through distributors like Best Buy. A smaller municipality could literally walk into Best Buy and purchase the software and install it relatively cheaply so it was attractive to many.

Since that time, the publicity surrounding the background of Kaspersky’s ownership has led to public pressure to replace the software. Some municipalities admit that this rather than the occurrence of any actual hacking event led to changes. Now the effort has been reinforced by President Donald Trump signing into law legislation that bans the use of Kaspersky Lab within the U.S. government. This will likely embolden users as well as constituents in the effort to replace the software.

We view the action as positive as an increasing number of efforts to access and impede municipal operating systems increase. In addition to the risk to major utility and public safety entities, the potential for financial mischief and potential financial damages should create momentum to insure that security for municipal operating systems is subject to the fewest risks. This will mitigate any potential negative financial impacts resulting from technological change on municipal credit.

Muni Credit News December 18, 2017

Joseph Krist

Publisher

joseph.krist@municreditnews.com

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ISSUE OF THE WEEK

Rather than focus on one new bond issue, we think that it is more appropriate for a pure opinion piece in this space. We recognize that our view may not be unique but it should be expressed nonetheless. For those of us who care about municipal credit from the investment standpoint or the policy standpoint, the tax reform package expected to be enacted this week borders on the pathetic. There is no reform here. It may be 1,000 pages, excruciatingly detailed and complex but it is not reform. One’s politics have nothing to do with the fact that the plan is at its core an effort to massively shift the tax base away from the corporate sector and onto the individual. Specifically, it is designed to shift the burden to the wage earner.

It would be one thing if there had been a clear electoral mandate to make such a change. We are not relitigating the 2016 here. It is clear that what those who voted for the current regime in the White House and in Congress did not vote to increase the individual tax burden. They did not vote to make wage income less attractive. They did not vote to make it harder for state and local government to provide the services they demand. And so, one does not have to be an old hippie retread to think that moneyed corporate interests managed to put one over on the working class this time.

If one is honest and looks at how ownership and management are compensated, there is no way to honestly argue intellectually that this plan will lead ownership and management to take their increased disposable income and shift it to the employee. Enlightened self interest, the bedrock of capitalist philosophy for over 200 years, dictates that ownership and management will enhance their own positions by increasing the value of their equity. That directly conflicts with trickling down the benefits of lower taxes on corporate income.

So where does this leave municipal credit? Certainly not better off. The package’s combination of reduced revenue demands, likely slowdowns in the growth of federal revenues (Kansas, e.g.), serious capital needs, and less and more expensive health insurance, create a potentially toxic brew of financial and economic pressures for state and local government. States will likely be at the forefront with the exact impact on individual governments below that level depending on the responses we see on a state by state basis.

So we would expect the response to be much more reliance on revenue enhancements (tolls, fees, and the like) to make up for the negative impact of tax policy. That is before the expected attack on entitlements which the current majority has been virtually drooling at the thought of. Regardless of whether one thinks that entitlements need to be cut, the fact is that any successful effort will initially reduce incomes and tax bases especially in areas currently experiencing economic weakness (rural, formerly manufacturing centers, and areas depending on jobs requiring lesser skills and education). None of this is good for municipal credit.

TAX REFORM?

One would have thought that when the Congress gave birth to this bill, it would have looked much different than it does. Even stadium finance seems to have survived the attack on municipal bonds. It’s important to separate municipal bond impacts from the impact on state and local credit. We wish that we could be sanguine on the latter. The fact is that now that the dust has settled, there are clear losers in this process.

The biggest loser appears to be New Jersey. As a state characterized by a real estate market reliant on certain specific high income industries, aging demographics, and an inordinate reliance on local property taxes, the Garden State is particularly vulnerable to the loss of the SALT deduction. The demographic aspect is a concern as older populations typically waver in their support of property taxes for education.

With the limit of deductibility at $10,000, many residents will see a substantial increase in taxes as the result of this “reform”. We suspect that residents will insist on a halt to steady increases in property taxes and will also look for a slowdown in spending growth. This will clash with a need to maintain the education system and help the State to deal with its ongoing pension issues. So the potential for difficult politics and finances really dampens the fiscal outlook for the entire range of tax backed credit in New Jersey.

Without a real yield premium, we see little advantage to owning New Jersey paper for other than New Jersey residents.

MILEAGE TAXES GET A BOOST

A four-month study in Colorado enlisted 150 drivers to evaluate the prospect of calculating state transportation funding based on the miles they drive. CDOT released results Tuesday from its Road Usage Charge Pilot Program, which was conducted from December 2016 through April of this year. More than 90 percent of participants thought the system, which let drivers record and report their mileage manually or with a device plugged into their car, was accurate and easy to use.

And 81 percent of participants said a road usage charge is a “fair funding method” to address the glaring needs of a state. Colorado’s 22-cent gas tax last got a boost 26 years ago. The taxes are not indexed to inflation, so as prices for concrete and other construction materials rise, there is no equivalent rise in the value of the levy at the pump. CDOT estimates that it will see a $1 billion-a-year budgetary shortfall for the next 10 years, largely because an expected decline in gas taxes.

Concerns reflected in the survey included privacy. Many drivers uncomfortable about the government knowing where they might be headed on any given day. So CDOT gave pilot program participants the option of reporting their mileage the old-school way — by snapping a picture of the odometer and submitting it online. For drivers comfortable with a plug-in data device, CDOT doesn’t track where people go — it just wants to know mileage. It works with a third-party data collection vendor, which destroys the information drivers send in after 30 days.

CDOT imposed a theoretical 1.2 cents-per-mile charge during the pilot program. Fuel-efficient vehicles that pay little tax at the gas pump will end up paying more under per-mile charge, while gas-guzzling SUVs will pay less. CDOT determine when a Colorado driver has left the state and is no longer on its road system. But trying to track and charge an out-of-state motorist for use of Colorado roads is a far harder proposition.

The state relies on 75 percent of its road construction and repair budget coming from the federal government, Lewis said, and the lack of funding is showing in the conditions of the state’s roads. As of June 2016, Colorado’s population had grown by 53 percent since 1990, while lane miles on the state’s highways only increased by 2 percent in the same time frame.

The $2.2 billion CDOT is looking to secure includes the $1.8 billion price of adding express lanes to the entirety of north I-25 — from downtown Denver to the Wyoming border — as well as an additional $400 million needed to add express lanes south of that project’s target area through Denver.

GATEWAY TUNNEL FINANCE AGREEMENT

Gov. Chris Christie and New York Gov. Andrew Cuomo announced commitments to fund 100 percent of their respective share of the new Gateway tunnel. The agreement for a combined $5.5 billion states that the State of New York will contribute $1.75 billion with NJ Transit committing $1.9 billion and the Port Authority contributing $1.9 billion. The federal government agreed to fund 50 percent of the project. Gov. Cuomo will propose in the state’s forthcoming executive budget an appropriation each year over a 35-year period to pay debt service on a $1.75 billion fixed-interest loan to the Gateway Development Corp. with a 35-year term under the US DOT’s Railroad Rehabilitation & Improvement Financing (RRIF) program.

The Port Authority, at the direction of the two governors, committed $2.7 billion in its ten-year capital plan, adopted in early 2017, for Gateway. This includes the Port Authority’s approximately $300 million commitment for the Portal North Bridge Project – another urgent element of the Gateway Program. The remaining $2.4 billion is being dedicated to the new Gateway tunnel – which will net $1.9 billion towards construction after USDOT fees and accrued interest during construction.

New Jersey Transit will use fare surcharges to fund its portion of the Garden State’s share. It will initiate a per-trip fare increase for rail customers of 90 cents beginning in 2020. The cost would increase to $1.70 in 2028 and $2.20 in 2038.

The $12.7 billion Gateway Hudson Tunnel Project consists of three elements: (i) a new two-track tunnel, (ii) the Hudson Yards Concrete Casing and (iii) the rehabilitation of the existing Amtrak North River Tunnel. The commitments announced today include $1.9 billion by NJ Transit, $1.75 billion by the State of New York and $1.9 billion previously committed by the Port Authority of New York and New Jersey Board of Commissioners. Together these commitments totaling $5.55 billion fully fund 100 percent ‎of the local share for the most urgent, time sensitive elements of the Project: the construction of a new tunnel and the Hudson Yards Concrete Casing which total $11.1 billion of the $12.7 billion construction cost.

There is however, one huge caveat to this whole discussion. The Trump Administration is claiming both a higher cost estimate and that there is no formal agreement for Federal funding. Trump wants to scrap the grant program the states applied to and handle Gateway in its infrastructure initiative, which it plans to unveil next month. We try not to be too political but this situation highlights how incredibly stupid and shortsighted Chris Christie’s decision not to participate in the initial plan when it had a chance to actually was.

FARE INCREASE IN CHICAGO

It’s been nine years since the Chicago Transit Authority last voted to increase fares for public transportation users. The CTA did so on Wednesday as part of its 2018 budget. Starting January 7, the cost of a single fare bus ride on a Ventra card will go up from $2.00 to $2.25 and “L” and cash bus fares from $2.25 to $2.50. The cost of 30-day passes will increase from $100 to $105. All other fares and passes, including those for students, will remain the same. Free rides will remain free.

Starting January 7, the cost of a single fare bus ride on a Ventra card will go up from $2.00 to $2.25 and “L” and cash bus fares from $2.25 to $2.50. The cost of 30-day passes will increase from $100 to $105. All other fares and passes, including those for students, will remain the same. Free rides will remain free. The increase is designed in part to replace reduced funding from the State of illinois. The Civic Federation, a fiscal watchdog group, opposes the budget, which, they say, in addition to the fare hikes, relies on unrealistic expectations and short-term borrowing to make ends meet. The CTA’s budget must still be approved by the Regional Transit Authority. Once that happens, the fare hikes will go into effect on January 7. And it’s not just the CTA. Hit by the same cuts in state funding, Metra and PACE have already approved their own fare hikes for 2018.

TEXAS FOLLOWS THROUGH ON REDUCING THE ROLE OF TOLLS

After the Governor expressed a strong view against any additional use of tolls as a source of funding for highway expansion, the State awaited a decision from the Texas DOT regarding its Unified Transportation Program. Now that decision is in with implications for long term road development.

The Texas Transportation Commission has effectively removed plans to add four managed toll lanes on I-35. The commission, which is the governing body for the Texas Department of Transportation, approved an amendment to its 10-year planning document called the Unified Transportation Program that did not include managed toll lanes on I-35 in the Austin area or on I-635 in Dallas. The 2018 UTP now has no projects with any tolled elements.

Both the Governor and his Lieutenant Governor consistently pressured the Commission over not using propositions 1 and 7 funding on projects with tolled elements. The commission opted to side with the state’s top leadership instead of local officials. On Oct. 30, TxDOT announced a plan to add two managed toll lanes in each direction on I-35 from RM 1431 in Round Rock to SH 45 SE near Buda. Just a few weeks later on Nov. 16, Abbott and Patrick notified the transportation commission that they do not support TxDOT using propositions 1 and 7 money on projects that have tolled elements.

WATER WAR UPDATE

In the past we have cited a number of situations regarding various disputes over efforts to establish water rights on behalf of municipalities. These have included privatizations, public purchase of water systems, and the occasional legal battle. One of those stories involved a small northern California lumber town. The City of weed and its major economic entity a lumber company were embroiled in a dispute over who owned a spring which provided the community of 2700 residents with their drinking water.

The lumber company that it intended to retain its exclusive right to the water forcing the City to find another source for its residents. a group of residents sent a letter to the district water office asking to clarify the ownership of the municipal water. They also convinced the Weed City Council to back their request. Roseburg responded by suing the residents and the Weed City Council.

Attorneys for the individual residents asked a Superior Court Judge to dismiss the suit against the individuals on the grounds that it violated their freedom of speech. The lawyers invoked a California law that allows defendants to strike down lawsuits meant to silence criticism, cases known as strategic lawsuits against public participation, or SLAPP suits. Last week the judge ruled in favor of the residents.

The answer to the question of who owns the water is yet to be determined but now the effort to overpower the residents has been moved aside so that the merits of the ownership issue can be determined.

MERRY CHRISTMAS

After all of this good news it seems somewhat inconsistent to do so but we do wish our loyal readership a very Merry Christmas and a Happy New Year. 2017 was a year of consistent growth in our readership and we appreciate your loyalty and interest. And so, we will take a bit of a break at this special time of year and come back the first week of January to help to guide you through what we believe will a most challenging year in the world of municipal credit. Enjoy your families, be careful travelling, and enjoy the good feelings of the season.

Muni Credit News December 11, 2017

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$934,015,000*

Composite Issue

PARTNERS HEALTHCARE SYSTEM

REVENUE BONDS

Some eleven months after having its rating outlook revised downward to negative, Partners Health returns to the market with a significant debt issue and an outlook revised to stable. It’s Moody’s Aa3 remains based on “multiple factors including Partners’ significant scale and leading market presence in eastern Massachusetts combined with a national and international draw for high acuity and complex patients to the system’s two academic medical centers. Further undergirding the rating is Partners’ large research organization that helps the organization attract high caliber physicians and researchers and supports the system’s large fundraising operations.”

The outlook has been revised to stable based on Moody’s expectation that operating performance at the provider division will largely return to historical levels in FY 2018 and that the insurance division will generate roughly breakeven results. The assumption is the provider division will generate a roughly 2% operating margin and that the insurance division will generate roughly breakeven results. The outlook could be changed again to negative if these targets are not met throughout the year or if the acquisition currently being contemplated results in material financial dilution or other challenges.

Partners Health is Massachusetts General Hospital (MGH), Brigham Health (parent of Brigham and Women’s Hospital and Brigham and Women’s Faulkner Hospital), NSMC HealthCare Inc. (parent of North Shore Medical Center), Newton-Wellesley Hospital, Partners Continuing Care (parent of several non-acute service providers, including the Spaulding Rehabilitation Hospital Network), Neighborhood Health Plan, Partners Medical International and Partners HealthCare International. Partners also controls Partners Community Physicians Organization which is a management services organization that supports an integrated managed care strategy and administers its physician network. MGH is the sole member of The General Hospital (commonly referred to as Massachusetts General Hospital), Cooley Dickinson Health Care Corporation, McLean HealthCare, Martha’s Vineyard Hospital, Nantucket Cottage Hospital and Wentworth-Douglass Hospital.

Partners is considering the integration of the Massachusetts Eye and Ear facility which is located adjacent to Mass General. Partners is holding out for insurers to bring Mass. Eye and Ear up to rates received by Partners’ top teaching hospitals. This would likely address Moody’s dilution concerns. If completed, the merged entities would control 45 percent of all ear, nose and throat visits and day surgery in Massachusetts and 36 percent of ophthalmology care.

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TAX REFORM IMPACTS STADIUM DEBT BEFORE IT TAKES EFFECT…

The potential impact of tax reform limitations on stadium and arena financing has begun even before the legislation is enacted and signed into law. This week a financing for the Louisville Arena Authority’s Project Revenue Bonds was amended to alter the nature of a private operator’s role in the deal to ensure that the transaction retained its tax exemption.

Specifically, the contract with AEG Management (AEG) originally included a $1.5 million annual minimum contractual guarantee from AEG Management to Louisville Authority Arena (LAA). This guarantee has been removed to eliminate the risk that the bonds could lose their tax-exempt status for having too much private use revenue. The contract was amended to state that if the $1.5 million target is not met for two consecutive years then LAA and AEG will endeavor, but are not required, to work together to remedy the shortfall within two or three months or reduce the future $700,000 annual payment made to AEG to make up the difference.

This change lowers the cash flow certainty under this AEG contract because if the contract becomes uneconomical for AEG for several years, the contractual requirement to remain is weak, especially given AEG paid funds to LAA for capital and thus would be paid out if their contract was eventually terminated by LAA.

A new debt service schedule was issued and is notably lower than the prior one with the smallest decline being about $2 million in one year with a higher decline in debt service costs in all other years, which improves the resiliency of the structure. The lower debt service also offsets any potential loss of revenues from the AEG contract.

Issues like this are all part of the mix of challenges facing stadium finance planners going forward. We are looking to see how Las Vegas structures its plan for a new Raiders facility and how San Diego approached a facility designed to attract a Major league Soccer franchise and redevelop the Qualcomm Stadium area.

…WHILE IN ST. LOUIS THE BLUES GET THEIR DEAL AFTERALL

This week the NHL’s St. Louis Blues scored a huge goal in their effort to get the City of St. Louis to supply public funding for a renovation of the Scottrade Center, their downtown St. Louis home. St. Louis Comptroller Darlene Green followed court orders Tuesday and turned over her signed copy of a $64 million stadium financing agreement. In August, Ms. Green had refused to approve an agreement because in her view it was injurious to the City’s credit.

The Blues filed a motion in St. Louis Circuit Court saying Green violated an order from Nov. 27 to sign the agreement. Clearly the Comptroller was unhappy with the outcome. “The Comptroller does not comply with this finance agreement voluntarily. As she has stated, this financing agreement is not in the best interest of city taxpayers; it draws upon the city’s general fund for repayment and may harm the city’s credit.”

The exact form of how the City will come up with the funding is now uncertain given the pending ban on tax exempt private activity bonds expected to be included in the tax reform package awaiting Congressional approval. The agreement does contemplate the issuance of debt to be secured by City revenues. The Court said nothing in the city charter gives the comptroller “the discretion to refuse to countersign the financing agreement based on her belief that the expenditure is imprudent.”

A separate lawsuit against the deal was also settled after the Comptroller’s agreement was reached. The plaintiffs in that suit contended the public-private partnership it amounted to an unconstitutional gift of public money to primarily benefit private interests. Blues President and CEO Chris Zimmerman said the Blues will now turn their attention to the Missouri Legislature to secure millions of dollars in additional public financing for future phases of Scottrade Center renovations. A bill to secure state funding has been pre-filed for the 2018 session, Zimmerman said.

During a Blues broadcast we heard on Saturday, the team has been influenced by amenities offered in new arenas which have been opened by other teams. He made those comments from the new Little Caesars Arena in Detroit. Since the 1960’s, St. Louis had lost three other professional sports franchises to other cities – the NBA Hawks, and the NFL Cardinals and Rams.

SCRANTON PARKING P3 CONTINUES TO UNDERPERFORM

In an effort to help the City of Scranton avoid bankruptcy earlier in the decade, a decision was made to enter an agreement to turn over the operation of the city’s parking system operator. ABM Parking Systems now has the daily control and management of all five of Scranton’s parking garages and nearly 1500 parking meters under a 45-year lease concession agreement.

Recently, Standard and Poor’s announced that it had lowered the rating on debt issued and secured by system revenues to BB- from BB+. It referenced the parking system’s materially weak financial performance, erosion in liquidity, and reliance on factors outside of the concessionaire’s control that we believe considerably influence the parking system’s financial performance, liquidity, and ability to fund the project’s capital requirements.

A negative outlook was assigned reflective of an expectation that coverage may remain below the rate covenant over the near term and a view that outside capital (which has yet to be secured) may be necessary to stabilize cash flows from operations over the two-year outlook period. The move highlights the point that private operation is not always a panacea when the underlying economics of an area supporting a particular project financing are weak. It is an important point to keep in mind when evaluating any project, whether it be publicly or privately managed.

MEAG AND GEORGIA POWER EXPECT VOGTLE GUARANTEE PAYMENT

The owners of the expansion facilities at the Vogtle nuclear plant have moved one step closer to at least some financial relief due to the suspension of the two unit expansion at the long standing generating facility. The U.S. Department of Energy (DOE) has issued the final approval needed for Georgia Power’s new agreement with Toshiba, the parent company of former primary Vogtle contractor Westinghouse, to receive all remaining scheduled payments from Toshiba in the amount of approximately $3.2 billion by Dec. 15, 2017. Georgia Power’s proportionate share of the payments is approximately $1.47 billion.

To date, the Vogtle co-owners (Georgia Power, Oglethorpe Power, MEAG Power and Dalton Utilities) have received $455 million in total scheduled payments from Toshiba under the parent guarantee for the Vogtle project – a structure which was put in place to protect Georgia electric customers as part of the original contract.

On August 31, Georgia Power filed a recommendation with the Georgia Public Service Commission (PSC) to continue construction of the Vogtle nuclear expansion supported by all of the project’s other co-owners. The recommendation was based on the results of a comprehensive schedule, cost-to-complete and cancellation assessment launched following the Westinghouse bankruptcy. The Georgia PSC is reviewing the recommendation to move forward and is expected to make a decision regarding the future of the Vogtle 3 and 4 project as part of the 17th Vogtle Construction Monitoring (VCM) proceeding. That process continues this week.

Recognizing that completing the Project in the absence of the EPC Agreement will entail different risks and may require additional decision-making points for the Owners, the Owners agreed to revise the Project Ownership Participation Agreement to establish additional conditions that will require Owner approval.

MORE TAX REFORM DRIVEN ACTIVITY

Two major airports are in the market this week for just under $2 billion of refunding debt in advance of tax reform legislation which would end this financing tool and possibly eliminate capital development projects at airports.

Phoenix will issue nearly $500 million of junior lien debt while Philadelphia will issue the balance. Houston will offer $135 million of soon to be eliminated special facilities bonds for its anchor tenant United Airlines. They are examples of just what sort of damage the proposed limitations could do to efforts to modernize the nation’s air transport infrastructure. You know, the stuff candidate Trump called third world. Now that he is a President without any policy expertise, he advocates policies which would stymie achievement of his stated goals. Go figure!

There are also, in addition to our issue of the week, another six hospital issues scheduled for sale this week before tax provisions which are feared to interfere with tax exempt hospital bonds are voted on.

BACK TO WORK ON THE OKLAHOMA BUDGET

The special session of the Oklahoma Legislature ended in mid-November during which 194 measures were proposed. Out of those 194 bills, a total of four became law—though one of those four successful measures—the budget bill—was line-item vetoed by Governor Mary Fallin.

When the special session began, the state was facing a potential budget shortfall of $215 million. By the end of the session, that number had been brought down to $118 million, though if no new revenue bills are passed soon, that number could balloon to $600 million by 2019. Lawmakers rejected a total of almost a billion dollars’ worth of additional revenue over the next two years.

Now with just over two months before the 2018 legislative session is due to begin, Oklahoma Gov. Mary Fallin called lawmakers to their second special session the week before Christmas in hopes of raising revenue to patch a $111 million budget gap in the current fiscal year.

The governor reports there is still a need for additional revenue to address the loss of funding and also to fund a pay raise for the state’s teachers. She believes lawmakers will need to find a plan that will raise around $800 million. Fallin’s office reports that $509 million of the 2018 fiscal year budget is one-time funds and future obligations. The state will face a starting deficit of approximately $700 million in 2019.

Muni Credit News Week of December 11, 2017

Joseph Krist

Publisher

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ISSUE OF THE WEEK

Trinity Health is one of the largest not-for-profit healthcare systems in the U.S. and represents the May 2013 merger of Trinity Health and Catholic Health East. The system operates over 90 hospitals in 22 states across the U.S. and is headquartered in Livonia, Michigan; the number of states will decline to 21 following the planned divestiture of its New Jersey hospitals. All debt of the legacy organizations are secured on parity through Master Trust Indenture dated October 3, 2013. Trinity Health may not withdraw from the Obligated Group.

The Credit Group consists of Members of the Obligated Group and the Designated Affiliates. The Designated Affiliates include the majority of the hospitals except for the New York facilities and Mercy Chicago. The Obligated Group pledges to cause the Designated Affiliates to pay, loan or otherwise transfer to the Obligated Group such moneys as are necessary to pay amounts due on the bonds. Pledge of revenue derived from the operation of all facilities of the majority of the Designated Affiliates, including rights to receivable accounts and health care insurance receivables.

Like many large hospital systems in the Affordable Care Act environment, Trinity has used a strategy of expansion and consolidation to amass a diverse stream of revenues from a multiplicity of jurisdictions and reimbursement environments. This has allowed Trinity to achieve higher margins and absorb the costs of integration as well as strategic divestitures from less favorable markets like New Jersey.

Now Trinity is taking advantage of what is apparently the last available window to restructure some of its significant municipal bond debt on a tax exempt basis. The system will issue some $1 billion of bonds through four state agencies with a significant portion of the proceeds being applied to refinancing. The issue serves as one of the prime examples of issuance driven at this time by impending tax reform legislation rather than the absolute best case savings which could drive such a transaction.

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TAX REFORM DRIVING SOME FAMILIAR NAMES TO MARKET FOR ONE LAST SHOT

The provisions in tax reform which would limit advance refundings are driving all manner of historically familiar names to the market for one last ride into the refunding sunset. The Successor Agency to the Redevelopment Agency of the City of San Jose (CA) will refund some $1.6 billion of its debt. Those who have ridden through the various ups and downs of this credit from its growth in the 90’s and early oughts right through the crisis years after the financial crisis will see their patience rewarded. A non investment grade senior living project in Massachusetts (New Bridge on the Charles) will refund nearly $240 million of debt. Kentucky’s Louisville Arena Project checks off two boxes as it refunds an arena deal.

More standard names in terms of investment grade credit quality pursuing refundings include transportation offerings like the PA Turnpike Commission, the Tampa Hillsborough Highway Authority, and the Central Florida Expressway Authority. The electric utility sector will see the Sacramento Municipal Utility District, and the Omaha Public Power District all bring refunding offerings to market.

In addition to refundings, a number of sectors to be restricted under proposed tax reform will rush to market. They include several senior living projects, privatized student housing in Chicago, multifamily housing, and private university and charter school financings. It is a measure of the impact on financing options that such a diverse range of issuers is rushing to meet the end of year deadline.

INFORMATION IS STILL A PROBLEM IN PUERTO RICO

Timely information on the Commonwealth’s revenue collections has always been a problem for investors and guarantors. Even the pressure to restructure however, has not seemed to have altered this unfortunate characteristic. Ambac Assurance Corp., which insures some $1.35 billion in Puerto Rico Sales Tax Financing Corp. (Cofina) bonds, has asked the U.S. District Court to allow it to examine the collection of the sales and use tax (IVU buy its Spanish acronym) under Bankruptcy Rule 2004 so it can evaluate restructuring proposals for the in-court bankruptcy process underway.

In a recent filing Ambac said “Without the information sought, Ambac cannot participate meaningfully in the process of advancing these Title III cases towards successful plans of adjustment,” the insurer said. “Ambac accordingly seeks an order from this Court compelling the [Financial] Oversight Board, AAFAF [Spanish acronym for Fiscal Agency and Financial Advisory Authority], the Commonwealth, and Cofina to produce this information.” The Federal Rule of Bankruptcy Procedure 2004 states that the court may order the examination of any entity.

A Federal Magistrate has scheduled a hearing for Dec. 14 to determine whether the Ad Hoc Committee of General Obligation Bondholders and bond insurers are allowed a discovery process into the state of the government’s finances. Their request had previously been denied without explanation, but after new urgent motions were filed, the judge chose to schedule a hearing. In addition to the Ad Hoc Group, insurers Ambac Assurance Corp., Assured Guaranty Corp., Assured Guaranty Municipal Corp., the Mutual Fund Group and the National Public Finance Guarantee Corp. are requesting discovery.

WHILE ECONOMIC ACTIVITY REMAINS IN DECLINE

The Fiscal Agency and Financial Advisory Authority and the Government Development Bank (GDB) published its Economic Activity Index (EIA) for August, which reflects a 1.9 % drop when compared with the same month last year. It highlights the hurdles Puerto Rico faced before it was ravaged by Hurricane Maria. The latest numbers have August ending with an EIA of 121, while for the same month last year, the indicator was at 123.4. The last time the index saw an uptick compared with the prior year was in December 2013.

The four main indicators that make up the EAI are the total non-farm payroll employment, cement sales, gasoline consumption and electric power generation. Total non-farm payroll employment for August averaged 868,000, a 1.2% decrease compared with August 2016. The preliminary estimate of gasoline consumption for August was 81.3 million gallons, for an annual decrease of 2.9%. Electric power generation for August averaged 1,862.7 million kilowatt-hours (kWh), an annual reduction of 1.1%. The indicator includes petroleum, natural gas, coal and renewable energy sources supplied by utility-scale solar photovoltaic generating capacity, two wind farms and landfill gases sources.

The only positive number was for cement sales which for August totaled 1.02 million bags, an annual increase of 0.5%.

DAN GILBERT EXTENDS HIS INFLUENCE IN DETROIT REVIVAL

He has become the single largest commercial property owner in downtown Detroit and along with the Illitch family has been among the most prominent drivers of downtown Detroit’s recovery. Now Mr. Gilbert is participating in a land swap deal which is seen as facilitating development while helping Wayne County realize its long held goal of a new criminal justice complex. The county and Gilbert are moving closer to an agreement on building a new criminal justice center in exchange for the unfinished jail site on Gratiot near Interstate 375 in the city’s Greektown district.

The announcement came about 10 days after Detroit’s City Council approved a land swap deal with Wayne County that will enable Rock Ventures to build a $520 million criminal justice complex on city-owned land near I-75 and Warren in exchange for the existing jail site. The county announced it had reached an agreement with Rock Ventures on the land swap in October. The land swap still requires approval from the 15-member Wayne County Commission and the Wayne County Land Bank Board, which owns the property for the new proposed jail site. In addition, the county needs to get approval from Internal Revenue Service to use bonds for the jail at another site.

Gilbert submitted to Wayne County a plan to build a criminal justice complex for the county with a 2,280-bed jail that will cost at least $520 million at the other site. Gilbert and Detroit Pistons owner Tom Gores have announced their desire to build a 25,000-seat Major League Soccer stadium on the jail site as well as retail and residential units, a hotel, covered parking and plazas.

ARE OPIODS THE NEXT TOBACCO FOR THE STATES ?

Purdue Pharma LP has acknowledged in writing that the maker of the opioid painkiller Oxycontin is in “negotiations’’ with state attorneys general over lawsuits accusing the company of creating a public-health crisis with its mishandling of the drug. A letter was written to Ohio’s Attorney General in response to his decision to withdraw from a multistate probe of the drug maker by 41 of his fellow attorneys general. It is the first time an opioid maker has disclosed negotiations with state attorneys general who are seeking a big tobacco-style multibillion-dollar payout to cover the costs of drug epidemics in their states.

The Ohio Attorney General has executed an agreement that he says preserves his state’s legal claims while the investigation and negotiations were conducted. A report by the Council of Economic Advisers, or CEA says that The epidemic cost the American economy $504 billion in 2015, which was the equivalent of 2.8 percent of gross domestic product that year.

The Purdue letter to the Ohio AG says “As you know, we have been working on an expedited basis with more than 30 state attorneys general as part of a bipartisan multistate process to resolve serious issues.’’ It states further that “It is uncontroversial that the multistate process is the best and fastest way for states to get resources to address this crisis.’’ Opioid manufacturers are facing an estimated 60 lawsuits filed so far in federal courts across the country from cities and counties. Purdue Pharma LP is proposing a global settlement in an attempt to end state investigations and lawsuits over the U.S. opioid epidemic.

Purdue’s lawyers raised the prospect with several southern-state attorneys general who haven’t sued the company. Not every state participated in the Master Settlement Agreement with the tobacco industry which produced a $245 billion payout and led to the massive tobacco securitization sector in the municipal bond market. Opioid makers argue in court filings that states and local governments are barred from suing because opioids are regulated by the FDA. The FDA regulates efficacy but does rule on the overall marketing strategies of manufacturers.

Muni Credit News November 27, 2017

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$600,000,000*

Florida Development Finance Corporation

Surface Transportation Facility Revenue Bonds

(Brightline Passenger Rail Project — South Segment), Series 2017

It has taken some three years, numerous court challenges, and now the prospect of a tax reform bill which would eliminate the proposed financing but the forces behind the high speed rail project on Florida’s east coast may finally partially achieve their goal of tax exempt financing for their project. The developers of the All Aboard Florida project – now known as the Brightline – have long sought up to $1.7 billion of tax exempt financing for this speculative venture. The financing on tap will achieve some 35% of that goal.

The proposed financing will reimburse the developers for that portion of the cost of construction of the segment of the line from Miami to West Palm Beach. That segment has seen the conclusion of construction and the line is now in the process of testing prior to operations. They have not gone off necessarily smoothly – a Brightline train derailed during testing earlier this year, causing more than $400,000 of damage and recently a woman was killed by a train during testing.

We acknowledge that the completion of construction removes a significant risk from the analysis but we remain highly skeptical about the line’s ultimate financial success. We note that the completed section only involves three stations – the terminals at Miami and West Palm Beach and the intermediate stop in Fort Lauderdale. We believe that successful completion through to Orlando remains essential to the project.

We are always extremely wary of demand projections. As hard as they may try, these surveys always seem to capture a level of optimism and support in the abstract that is ultimately hard to actually quantify. We note that the projections are characterized as “being investment grade with respect to accuracy, reliability, and credibility”. But these are the characterizations of the consultant rather than an outside reviewer. The demand study acknowledges that the project represents “an entirely new type of service for the region” with “unique features”.

We note that time savings seem to be the primary motivation for demand for the service. Our experience tells us that the perception of the value of time savings is almost always overestimated and that the results of the surveys to determine this value are often influenced by the timing and circumstances under which the surveys were taken. We also note that this project – which assumes 1 million trips a day on average – expects the novelty of the service and its attractiveness to tourists to “induce demand”. we are always wary of concepts like “induced demand” when we evaluate new projects. We note the lack of success for other “novel” services in tourist areas financed in the municipal bond space.

We also have to ask whether the projections for the project sufficiently address the potential impact of technological change on the transportation sector. Is it even possible to accurately model the success and timing of the emergence of transportation as a service? Will self driving cars offset the perceived inconveniences of driving versus high speed rail? Do the projections account for the allure of timing one’s own travel versus the structure of a fixed schedule? Does emerging road management technology combined with emerging auto technology reduce the time saving component and render the estimates of demand irrelevant?

We do not purport to answer these questions here. We do believe that these questions reflect a greater level of uncertainty into the investment analysis that they require a higher level of skepticism than the developers agree is warranted. What follows from this is the belief that any investment requires a level of current income compensation that is most likely in excess of what the project can support. We would therefore – based on our long experience with speculative startup transportation credits – respectfully suggest that there are better investments for the overwhelming majority of municipal bond investors.

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FEDERAL HIGHWAY FUNDING CONTINUES ON UNCERTAIN PATH

The board of directors of the American Association of State Highway and Transportation Officials called on Congress to stop reducing federal highway budget authority that state agencies use to bid out transportation projects, saying this “budgetary artifice” disrupts their project planning. The resolution they unanimously approved makes the case that Congress effectively approves one level of investment in federal-aid highway projects in multiyear surface transportation legislation but then sometimes whittles parts of it away again in subsequent appropriations bills.

In spite of this resolution, President Trump’s disaster relief supplemental budget request to Congress for $44 billion includes a proposal to rescind $1 billion in states’ unused federal highway contract authority. The provision reflects a big, $7.6 billion rescission effective July 2020 of unused, accumulated contract authority that might be on the books of state DOTs at that time, with the amounts to be proportionally stripped out of a certain group of federal programs that include those that pay for new highways and bridges.

Congress in the Fixing America’s Surface Transportation Act in December 2015 approved the first new long-term surface transportation authorization in a decade, “which signaled its commitment to ensure predictable, stable federal funding between 2016 and 2020.” At the same time, the bill included the rescission provisions. Since lawmakers had fully funded the entire five-year bill with specified revenue streams, transportation officials said Congress was using the highway program rescission to help cover unrelated federal spending.

Congress in its fiscal 2017 full-year spending bill lopped off $857 million more that state DOTs had to absorb this past June, with very little notice. And now a House appropriations measure for the 2018 budget year that starts Oct. 1 would strip out another $800 million in project contract authority, while the Senate version proposes no such rescission.

Instead of receiving their funds through block grants to apply how they wish, state DOTs are apportioned federal funds through contract authority that is subdivided to the dozens of active qualifying accounts, for such things as safety and construction funds. When Congress rescinds some unused contract authority, state planners have to go back through and see how they can apply the remaining funds to projects they had in the pipeline, and which ones they might have to delay. And when Congress applies a rescission only to certain highway program accounts, state officials find they might have to cut more deeply into how they planned to use the funding.

The state CEOs urged lawmakers to take several steps. First, they asked that Congress remove in any final 2018 appropriations bill the House’s proposed $800 million rescission. In addition, they urged Congress “to repeal the $7.6 billion rescission scheduled for July 2020 under the FAST Act.” The agency chiefs said if lawmakers cannot find acceptable resources or “pay-fors” to prevent these rescissions, that Congress should at least provide state DOTs with “maximum flexibility” to apply the cuts as each DOT needs across all federal highway program accounts. State officials also called on Congress to end that practice for the future – “ceasing its reliance on highway contract authority rescissions as an offset for unrelated programs” – so that it does not continue to recur.

These sorts of provisions will take on greater importance if tax reform goes through with its restrictions on municipal bonds and the revenues to support them are included. The introduction of uncertainty into the funding process makes it harder to evaluate debt capacity and revenue requirements which will complicate the analysis of transportation related credits.

MINNESOTA COP PAYMENT CASE

On May 25, 2017, the Minnesota Legislature adjourned, ending the special session that began on May 23, 2017. On May 30, 2017, the Governor vetoed line-item appropriations to the Legislature for its biennial budget. By the last day of the 2017 regular session, May 22, 2017, most of the final budget bills for the next biennium—fiscal years 2018–2019—had not been presented to the Governor. Legislative leaders and the Governor agreed that the special session would “be confined to the outstanding budget bills and the tax bill,” the bills would be “voted upon or passed by either body within one legislative day,” and the Legislature would “adjourn the Special Session no later than 7:00 a.m. on May 24, 2017.”

One of the bills passed during the special session and presented on May 26 was the state government appropriations bill, Senate File No. 1. In article I, section 14 of this bill, the Legislature appropriated funds to the Department of Revenue for that agency’s biennial budget. Section 2 of Senate File No. 1 provided appropriations to the Legislature for each fiscal year (FY) in the next biennium. The Governor notified the Senate that he had “line-item veto[ed] the appropriations for the Senate and House of Representatives to bring the Leaders back to the table to negotiate provisions” in three bills that the Governor had just signed and that subsequently became law.

Specifically, the Governor said that there were provisions in the “Tax, Education and Public Safety” bills that he could not “accept.” He explained to legislative leaders that he “veto[ed] the appropriations for the House and Senate” for the next biennium because the Legislature’s “job has not been satisfactorily completed.” He offered to call a special session if the Legislature would agree to “remove” or “re-negotiate” the provisions the Governor found objectionable in the Tax, Education, and Public Safety bills.

The Governor was using the veto to make it difficult if not impossible for the Legislature to operate in order to induce the Legislature to negotiate terms of the budget legislation. On June 13, 2017, the Legislature filed a complaint in Ramsey County District Court. In count one, the complaint sought a declaration that the Governor’s line-item vetoes were unconstitutional as a violation of the Separation-of-Powers clause in the Minnesota Constitution. The Governor and the Legislature asked the district court to enter a temporary injunction directing MMB to “take all steps necessary” to fund the Legislature based on “fiscal year 2017 base general fund funding” during the appeal period—defined as completion of all appellate review and issuance of the appellate court’s mandate—or until October 1, 2017, whichever occurred first.

In July, the district court declared the Governor’s line-item vetoes null and void as a violation of the Separation-of-Powers clause in Article III because they “impermissibly prevent[ed] the Legislature from exercising its constitutional powers and duties.” the court concluded that, by vetoing the appropriations for the Legislature, the Governor’s line-item vetoes “both nullified a branch of government and refashioned the line-item veto as a tool to secure the repeal or modification of policy legislation unrelated to the vetoed appropriation,” The court therefore concluded that the appropriations struck by the Governor’s line- item vetoes “became law with the rest of the bill.”

The questions raised in this case involve powers the Minnesota Constitution confers on the State’s three branches of government. The district court found that the Governor’s line-item vetoes were applied to an “item of appropriation and those sums were “dedicated to a specific purpose,” funding the Senate and the House in the 2018–2019 biennium. Article IV of the state constitution, an article that generally addresses the powers of the Legislative Branch says “If a bill presented to the governor contains several items of appropriation of money, he may veto one or more of the items while approving the bill.”. According to the Supreme Court, the plain language of Article IV places only one substantive limit on the line-item veto power, specifically, the requirement that the veto be made as to an “item” of “appropriation.” It held that the Governor’s line-item vetoes of the Legislature’s biennial budget appropriations did not violate Article IV, Section 23 of the Minnesota Constitution. It also noted that the language of Article XI, Section 1 of the Minnesota Constitution is unambiguous: “No money shall be paid out of the treasury of this state except in pursuance of an appropriation by law.” It also notes that Article XI, Section 1 of the Minnesota Constitution does not permit judicially ordered funding for the Legislative Branch in the absence of an appropriation.

So why does a municipal bond investor care about a dispute between the Governor and the Legislature that does not speak directly to a municipal bond issue? Fair question. The concern is that the decision clearly establishes that the Governor may use his line item veto to veto appropriations by the Legislature. The Legislature asserts that the Governor improperly vetoed its biennial appropriations in an effort to coerce concessions on tax and policy provisions. The Governor counters that his line-item veto power was the only tool he could use to respond to the Legislature’s conditional appropriation of funding for the Department of Revenue, which he argues was intended to coerce his agreement to the tax and policy provisions. The Court said that the parties’ dispute about coercion essentially asks the court to assess, weigh, and judge the motives of co-equal branches of government engaged in a quintessentially political process. It added that resolution of . . . budget issues by the other branches through the political process is preferable to our issuance of an advisory opinion adjudicating separation of powers issues that are not currently active and may not arise in the future.”

So investors in securities backed by appropriations are concerned that they can now get caught up in other political issues which could hold up the full and timely payment of their obligations. Frankly, this is always a risk in any appropriation backed debt but it is not often that a ruling is issued by a state court which seems to cause the courts to be reluctant to rule in favor of debt holders. It concluded that principles of judicial restraint and respect for our coordinate branches of government dictate that it refrain from deciding whether the Governor’s exercise of the line-item veto power over the Legislature’s appropriations to itself violated Article III by unconstitutionally coercing the Legislature.

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$600,000,000

Florida Development Finance Corporation

Surface Transportation Facility Revenue Bonds

(Brightline Passenger Rail Project — South Segment), Series 2017

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FEDERAL HIGHWAY FUNDING CONTINUES ON UNCERTAIN PATH

MINNESOTA COP PAYMENT CASE

Muni Credit News November 20, 2017

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Joseph Krist

Publisher

ISSUE OF THE WEEK

New York’s Metropolitan Transportation Authority plans to issue $2 billion of transportation revenue bonds this week. The effort comes coincident with the publication of a scathing report by the New York Times highlighting the long process of political interference in the Authority’s operations. The report comes as the Authority faces its first decline in ridership in decades after a year of highly visible and seemingly regular service interruptions. While the issues facing the Authority are substantial, it does not appear that these issues have a substantial negative impact on the Authority’s bond credit.

Just last week, Moody’s reaffirmed its A! rating with a stable outlook . It cited ” MTA’s strong operating environment, including the healthy service area economic growth and sound financial condition of supporting governments New York State (Aa1 stable) and New York City (Aa2 stable). The A1 also reflects MTA’s satisfactory finances, supported by sound budget management, governance, and planning, as well as bondholder protections provided by the gross pledge of a highly diversified revenue stream. The A1 also acknowledges the high fixed costs, substantial capital program, and the financial and operational challenges posed by strong collective bargaining units and a massive, aging transportation infrastructure.”

That is not to say that the Authority’s significant reliance on its bonding capacity to fund its capital needs in the wake of consistent reductions in annual funding subsidies from state and local sources do not have implications for the ongoing value. We try not to let our familiarity with the MTA over six decades of ridership color our view of the credit. When one is stuck in a tunnel or packed in an increasingly unreliable subway car, it’s hard to have the words “investment grade” be one’s first thought. Nonetheless, the issues raised in the report highlight valid issues which have been raised about how legislative decisions made by both the State and City of New York which have reduced current funding for MTA operations and capital needs.

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PUERTO RICO HEARINGS REVEAL CONGRESSIONAL GAME PLAN

“Puerto Rico has the potential of being the Hong Kong of the United States, where businesses would flood in there.” Louie Gohmert (R) TX

“Maria gives us the opportunity to bring Puerto Rico’s infrastructure into the 21st century. How can innovative energy technology, such as fuel cells that utilize our nation’s resource of clean-burning natural gas, be used to revitalize the Puerto Rico energy grid?” Rep. Glenn Thompson, R-Penn. Those were just two of the less than realistic comments made by members of the House committee overseeing the Commonwealth of Puerto Rico.

Committee Chair Bob Bishop stated on Tuesday, the main purpose of this week’s hearing was for the Natural Resources Committee to affirm it has the fiscal control board’s back in the bankruptcy-like court proceedings where Puerto Rico’s financial future now sits. The hearings occurred in the wake of the court decision which effectively vetoed the appointment of a chief executive for PREPA, the Commonwealth’s troubled electric utility.

One cannot help but notice the lack of references to the well-being of the citizens, of the role of the rule of law in terms of repayment of debt or the potential for developing mechanisms for supporting efforts to prevent crises like this from happening again. Instead, many of the members saw their prime duty as that of appealing to interest groups in particular the fossil fuel industry. It looked by the end of the week that the answer to the island’s major problems were imported liquefied natural gas.

It looks now that the committee’s greatest objection to the performance of the executive director of PREPA was not the state of the power grid post-Maria but his apparent reluctance to adopt gas fueled generation. One clearly got the sense that the PROMESA board was complicit in this and that it’s attempt to appoint a so-called Chief Technology Officer to run PREPA was a thinly veiled attempt to put someone in the pocket of the natural gas industry in charge.

The hearing bode poorly for the concept of a well thought out plan of recovery for the island. It is not a surprise that Puerto Rico will not get the amount of money it is asking for nor is it a surprise that there will be significant strings attached. It repeats a pattern that emerged in the aftermath of Katrina. The extension of federal recovery aid then was accompanied by efforts to achieve political/policy goals rather than a reasonably quick restoration of life for thousands of displaced residents. We try to avoid politics as much as possible in our analysis but this effort to impose policies through the extension of recovery aid is much more likely to happen when the impacted area is poor and the party in power is “conservative”.

The process has claimed its first major scalp with the announcement that PREPA’s executive director, Ricardo Ramos, was resigning. In his acceptance of the resignation, the Governor said that the ED’s continuance in his role would be a distraction. The hearings this week hammered on the director for his response in reaching out for outside assistance as well as the well publicized Whitefish contract debacle.

In terms of the execution of a PREPA debt restructuring, we see the replacement of the executive director as having no impact on the timetable or amount of any agreement on the debt.

COULD SANTEE COOPER BECOME A REGULATED UTILITY?

It has happened before to other municipal utilities (LIPA, e.g.) but it would be a negative turn of events for the South Carolina Public Service Authority Credit if proposed legislation is enacted by the South Carolina legislature. The State of South Carolina House of Representatives filed a bill for the 2018 legislative session that would require the South Carolina Public Service Authority (Santee Cooper, A1 negative) to gain approval from the state Public Service Commission before changing rates. Currently, state-owned Santee Cooper, which provides electricity and other services, is self-regulated. The legislation also would preclude Santee Cooper from implementing new rates or altering current ones to cover any costs related to its abandonment of Summer Nuclear Station Units 2 and 3.

A foundational aspect of Santee Cooper’s credit quality is a record of timely, self-regulated rate setting that allows the utility to maintain sound financial metrics such as debt service coverage while providing competitive electricity rates. Regulatory oversight would add an additional step and potentially restrict rate raising. With the legislation calling for a prohibition on Santee Cooper’s ability to recover costs related to the abandoned Sumner nuclear project, debt service payments on about $4 billion of outstanding nuclear-related revenue bonds becomes more difficult. Santee Cooper’s current plan is to recover such debt service costs by raising rates sometime after 2021.

The proposal comes before the full impact of Santee Cooper’s rate mitigation plan through 2021 can be implemented. Before 2021, Santee Cooper planned to use an $898.7 million upfront cash payment it received from the monetization of the Toshiba Corporation parental guarantee on the nuclear project to offset some of the costs associated with the abandoned project. Santee Cooper, which serves both wholesale and retail customers, has announced a cost-reduction plan aimed at mitigating the size of any future rate increase needed to recover Summer 2 and 3 costs.

RATING IMPACT OF HARVEY BECOMES CLEARER

Moody’s Investors Service has concluded rating reviews on 18 issuers that were affected by Hurricane Harvey. The ratings were placed under review for downgrade on September 22nd due to the potential for significant economic and revenue loss associated with damage caused by Hurricane Harvey and the related rainfall that inundated the region for several days. The rating process determined that there was no effective negative impact on the credits. The credits that were the subject of the announcement include:

CNP Utility District, TX (A1/NOO)

Corinthian Point Municipal Utility District 2, TX (Baa3/STA)

Cypress-Klein Utility District, TX (A1/NOO)

Fort Bend County Municipal Utility District 144, TX (Baa2/STA)

Fort Bend County Municipal Utility District 25, TX (A2/NOO)

Fort Bend County Municipal Utility District 117, TX (A2/NOO)

Harris County Municipal Utility District 109, TX (A2/NOO)

Harris County Municipal Utility District 153, TX (A1/NOO)

Kleinwood Municipal Utility District, TX (A2/NOO)

Montgomery County Municipal Utility District 94, TX (A3/NOO)

Montgomery County Municipal Utility District 95, TX (Baa2/STA) Montgomery County Municipal Utility District 95, TX (Baa2/STA)

Montgomery County Municipal Utility District 46 (Aa3/NOO)

Montgomery County Municipal Utility District 9, TX (A1/NOO)

Montgomery County Municipal Utility District 90, TX (Baa2/STA)

Oakmont Public Utility District, TX (A2/NOO)

Pecan Grove Municipal Utility District, TX (A1/NOO)

Varner Creek Utility District, TX (Baa1/NOO)

DALLAS RATING AFFIRMED

This was a difficult year for the City of Dallas, TX. It confronted fiscal difficulties associated with its mounting unfunded pension liability position. After difficult negotiation with its employee labor unions and a complex legislative process at the state level, a resolution to at least a part of the City’s pension funding schemes was obtained. Now that those pieces are in place, the City’s ratings which were on negative outlook by Moody’s have been reviewed and reaffirmed at A1 with a stable outlook.

According to Moody’s, “the rating incorporates the positive effects of pension reform (House Bill 3158) on the city’s near to medium term financial position, specifically the significant reduction in unfunded liabilities associated with the Dallas Police and Fire Pension Fund, as well as the city’s ability to integrate higher pension contributions into its biennial budget. The rating additionally reflects the fact that even with reform, the pension burden relative to operating revenues and the tax base remains elevated and an outlier when compared to peers. Further, pension contributions, while higher, are still below a “tread water” level and we expect the liabilities to grow. The A1 rating also factors in the city’s dynamic economy, adequate reserves and manageable debt burden.”

ENJOY THANKSGIVING!

On the busiest travel holiday of the year (yes, bigger than Christmas) we wish you safe travel. Enjoy your time with family and/or friends and whatever your favorite holiday feast might be.

Muni Credit News Week of September 5, 2017

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$922,300,000

CHICAGO BOARD OF EDUCATION

General Obligation Refunding Bonds

Moody’s: B3

The Board is trying to take advantage of the generally favorable rate environment and a halt in the long term trend of credit decline to refund a significant amount of outstanding GO debt. In September, Moody’s reviewed its rating in the light of the State’s first budget agreement in three years. It sustained the B3 rating and revised the outlook to stable from negative.

The City’s general economic health is reflected in the tax base which the Board and the City share. In combination with the state budget accord, combined property taxes and state aid are estimated to increase by approximately $500 million for fiscal 2018. For fiscal 2018, CPS revenues and expenditures will nearly be in balance after several years of very large shortfalls.

Over the long run, a 2% growth in annual expenses would translate to increased spending of some $120 million annually. This will be hard to achieve given the likelihood of increasing pension contributions and debt service costs. This does not take into account the potential for higher wage costs as the result of its contentious relationship with its employee unions. In fiscal 2018, the district will receive more than $300 million in increased state aid owing to a gain from a new funding formula and state payment of the district’s normal pension cost. However, Illinois continues to have ongoing financial and governance challenges, and the state’s willingness and ability to meet future funding targets is uncertain.

The Board could try to raise taxes but this would coincide with other local entities such as Chicago and Cook County also raising property and sales taxes. There are practical limitations on continually raising taxes on the same group of taxpayers.

Clearly this is a credit that on its own is not for the faint of heart. More than most of the other credits sharing the Chicago tax base, it relies on a more difficult management and pension situation and is the most prominent target for those in Springfield who have a negative bias against the City. As a result, it will have the hardest time recovering its credit position over an extended time period.

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PUERTO RICO

Puerto Rico’s financial control board published the first report on the investigation underway into the commonwealth’s debt. The report states that 84 notifications of document preservation have already been sent in relation to public debt issuance made in the past 20 years. Issuing entities, advisers, credit rating companies and underwriting institutions, among others, have received them. On Oct. 18, the board turned the probe into a formal procedure, as defined by its investigation protocol, given the need to use subpoenas to carry out the effort.

Kobre & Kim, a firm specializing in disputes and investigations, was retained on Sept. 1 to investigate all the factors that triggered the fiscal crisis in Puerto Rico, as well as all public debt transactions the government has made, as requested by the board. This includes the practices employed in the purchase and sale of Puerto Rico and its public corporations’ bonds, and the associated disclosures to market participants. To date, the firm has examined documentation related to public debt issuance since 1990, the government’s certified fiscal plan and a government liquidity analysis conducted by accounting firm and board adviser Ernst & Young. Documents have also been requested of Puerto Rico’s Fiscal Agency and Financial Advisory Authority.

The firm said it does not expect to have a final report until the end of March, and warned it may be delayed due to the complications that could arise in the aftermath of Hurricane Maria. The report also indicates that priority in the investigation has focused on those aspects that affect electricity and water services and other critical infrastructure affected by the major hurricane.

As for PREPA, the government of the Commonwealth is moving forward with steps to void its controversial contract with Whitefish Energy to repair the power grid. The Commonwealth will instead avail itself of the mutual aid program which will allow it to employ crews from utilities in Florida and New York to do the work. A U.S. Congress committee, the Office of the Inspector General (OIG), and FEMA are all investigating the contract. The FBI is conducting its own investigation.

On the economic front, a report by Hunter College’s Center for Puerto Rican Studies projects that outmigration from the island as a result of Hurricane Maria could be as high as 14% of the local population in the next two years. Researchers project that the majority of local residents will move to Florida, followed by Pennsylvania, Texas, New York and New Jersey. Florida alone could face an influx of as many as 164,000 new residents from Puerto Rico in the next two years. The island’s United Retailers Association says ten percent, or about 5,000 of Puerto Rico’s 50,000 small and midsize businesses will not operate again after the devastation left by Hurricane Maria. A survey conducted by the organization revealed, more than a month after Hurricane Maria’s passage, that about 35% of small and midsize businesses have not resumed operations because they do not have electricity.

The news this past week that the Federal government was implementing a new form of its Transitional Sheltering Assistance which has been historically used to temporarily relocate displaced residents to neighboring states. In the iteration being applied to Puerto Rico, the agency is arranging charter flights for residents, beginning with those still in shelters. Destinations are as far away as New York. While FEMA does provide reimbursement for costs of return, the real impact will be to facilitate more emigration from the island and reduce the pressure to reconstruct and restore housing destroyed in the hurricane.

These grim projections have obvious negative connotations for the Commonwealth’s finances over the short and long term. Creditors are clearly taking this into account. At an investor forum in which we participated last week, investors noted selling by heretofore patient mutual fund owners of PR debt and cited prices on the Commonwealth’s benchmark 8% of 2035 general obligation bonds at dollar prices in the $25-30 range.

COURT DECISION HURTS MISSISSIPPI SCHOOL DISTRICTS

The Mississippi Supreme Court recently upheld a lower court ruling that the state legislature does not have to fully fund the Mississippi Adequate Education Program (MAEP). In August 2014, 21 school districts sued the state for $236 million of state aid shortfalls between 2010 and 2015. A Hinds County judge ruled in July 2015 that the state school funding formula did not constitute a mandate and therefore the legislature was not required to fully fund the formula. The Supreme Court supported that view.

The MAEP codifies the funding formula which has been in use since 1997 to determine state aid for local school districts, including average daily attendance, district growth, and local contributions. Mississippi’s 2018 budget allocates $2.2 billion in education funding for local school districts, roughly $214 million less than the fully funded MAEP amount. For 2009-17, the state underfunded MAEP by $1.9 billion. The number of districts which have been underfunded by at least 5% is in double digits. Mississippi school districts typically receive 40%-50% of their revenue from state aid, with the balance from local property taxes.

The support for continued declines in state support is credit negative Mississippi school districts typically receive 40%-50% of their revenue from state aid, with the balance from local property taxes. for the impacted districts. Their real ability to raise sufficient revenue from property taxes is constrained by the State’s chronically weak economy. Mississippi is the poorest state in the US. On a more general basis, the declines in school funding will make the State less economically competitive and make it more reliant on incentives and low labor costs to attract jobs, thereby making the state’s less competitive a more entrenched feature of its economy and credit.

OKLAHOMA BUDGET STRUGGLES CONTINUE

The Sooner State continues to struggle to balance its budget after the Oklahoma Supreme Court ruled that a tax on cigarettes was unconstitutional on August 10. That removed $215 million from the revenue side of the budget ledger and the legislature has since struggled to find ways to fill the resulting gap. The budget gap at 4.0% of estimated general fund spending is not huge. The tax did not pass judicial muster because it failed to garner a 75% supermajority in both legislative houses for new revenue. It also was prohibited by constitutional provisions which prohibit raising new revenue in the last five days of a session.

There is currently not sufficient legislative support to enact a revenue bill. A house budget committee passed a series of stopgap measures but these must be passed by the full houses. That is not a sure thing. So the State continues to limp along without any signs of structural balance being achieved. The difficulties are a result of its energy dependent economy and lower fossil fuel prices. The state has reduced appropriations by 5.3% ($387 million) in the three years since the peak in fiscal 2015 but there is no appetite for additional cuts. The state needs approximately $405 million of onetime fixes to balance the fiscal 2018 budget plan. The governor projects a $500 million shortfall next year. The rainy day fund currently is set to fall to just $70 million, or 1.0% of fiscal 2018 appropriations.

MORE GOVERNMENT AID FOR NUCLEAR GENERATION

After failing to approve similar bills over two years, the Connecticut House of Representatives voted 75 to 66 for final passage of a measure to permit, not require, state energy officials to change the rules for how Dominion Energy sells electricity from its nuclear plant, Millstone. The plant has been less profitable as competing generating sources have become cheaper. Dominion has broadly hinted that without the changes it would prematurely retire the two reactors at the plant, which is the largest power plant in New England. Its output, which is the equivalent of about half the state’s needs, is sold throughout the region.

Environmental justifications reference the fact that Millstone produces nearly all of Connecticut’s zero-carbon energy, and its loss would jeopardize the state’s ability to meet its long-term goals for reducing carbon emissions. Job related arguments in favor reference the 1,500 women and men working at Millstone power station. It has been difficult to judge exactly what the plant’s economics are as Dominion has refused to provide the state with copies of proprietary documents supporting its claim of a need for financial relief, saying it was not confident a promise of confidentiality would survive a challenge under the Freedom of Information Act.

The plan continues a trend of nuclear operators seeking “subsidies” to support nuclear generating facilities which are facing increased pressure from solar and wind based generation as states seek to expand reliance on renewable energy sources.

MORE PRESSURE ON PUBLIC SCHOOLS

In Section 1202 of the tax bill is a provision that would significantly alter the terms of something called a Coverdell account, which families have used for years to save for both private school and college. Elementary and high school expenses of up to $10,000 per year would become “qualified” expenses for 529 plans. An individual could use $10,000 each year out of their 529 account for private school and avoid paying taxes on any previous growth. There are no income limits on who can use 529 plans, and one would be able to continue saving for college as well.

Paul Coverdell, a senator (hence the name) in the 1990s wanted to create tax breaks for parents whose children do not attend public schools. In 2001, President George W. Bush signed a bill allowing holders of the accounts to use any earnings in them for tuition in kindergarten through 12th grade as well as college. The current proposal, initially an idea from the conservative Heritage Foundation, would end contributions to Coverdell accounts while offsetting the impact with the change to the 529 provisions.

Coverdell contributions had previously had an annual contribution cap of $2,000. The benefit was therefore somewhat limited. 529 plans have few contribution restrictions and very high limits on balances.

The chief beneficiaries would be those in the highest marginal brackets. The New York Times estimated a potential tax savings of $34,000 over 15 years of savings based on $10,000 of annual withdrawls. Effectively, that would benefit the many households who use private schools to avoid their children being exposed to the diversity of the public school system. This hurts public schools as so many states use average daily attendance as the basis for distributions of state aid and provides a competing subsdy to religiously based schools.

Muni Credit News Week of November 6, 2017

Joseph Krist

Publisher

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ISSUE OF THE WEEK

This week we focus not on a bond transaction but on what truly will the issue for the municipal bond market – tax reform. The proposal or framework that was laid out this past week for how to “reform” the tax code is a potential watershed event for our market. The numerous provisions regarding municipal bonds included in the proposal came as a real surprise to market participants. The state and local tax deduction has actually been on the table for a while. But the provisions eliminating private activity bonds, the alternative minimum tax, and advance refundings were all unexpected. We argue here that individually and in total, they represent a narrow minded philosophy which contradicts basic beliefs espoused by both the president and the congressional majority party while making it much harder for the needs of those who voted for them less achievable.

Tax reform at its best would be undertaken for the purposes of simplicity, fairness, and stimulation of the economy. It would not be undertaken to fulfill narrow partisan interests. The House bill is clearly a political document meant to be a sop to the wealthiest in the country, those who benefit from their ownership of business rather than the providers of its labor, those who hate local government, and those who believe in a more regressive tax system. It is the manifestation of the “starve the beast” philosophy against government at all levels.

We do not argue here that government is the most efficient provider of services but we do believe in the idea that some of those services are most rightly classified as public goods. That is not inconsistent with a belief that private entities have a real role to play in the provision of public services. What we are somewhat astounded by is the lack of support for private participation in the efficient provision of public goods which is reflected in this bill. Our amazement is based in the espoused philosophy of the President and the majority especially as it pertains to the renewal and development of the nation’s infrastructure.

We acknowledge that each of the targeted provisions which impact the municipal bond market have and can be the subject of abuse. We applaud for instance the proposals which would end public funding for stadiums. But we question the basis for limiting the options available to government to finance infrastructure that are inherent in the proposed bans on all private activity bonds. We question whether the reductions in revenue associated with the corporate tax cuts that will make it harder to finance projects of national benefit (mass transit, interstate transit, airports and associated facilities, environmental control at private industrial facilities) are worth the price.

The limitation on the deduction for state and local taxes to property taxes only will increase the reliance on more regressive taxes like property to finance basic local services especially schools. In so many jurisdictions, property taxes especially for schools are the greatest source of local discontent. Economics 101 questions the efficacy of taxation based on perceived wealth rather than income. It increases pressure on first time homeowners and the elderly. It does that at a time when state and local government potentially face issues from the majority party’s belief in block grants (which always represent reductions) to finance federal aid. These reductions will impact service delivery especially in areas like health and social services which have greater impact on the less fortunate segments of society. That pressure is a major credit negative for state and local tax backed credits.

The Administration and many in the Congressional majority favor a greater private role in the provision of infrastructure. Exactly how does the elimination of private activity bonds achieve that goal? It doesn’t mean that the private sector can no longer participate but by raising the cost of capital it makes projects more expensive for end users while making it harder for private vendors to achieve their desired rates of return on capital. That is true even if those rates of return are reasonable. And if the returns are low will the private sector want the government participant in these projects to assume more of the development risk? If so, that is another source of increased risk to government which will further hinder the development of necessary infrastructure.

Finally, there is the issue of whether the proposed package which by all accounts benefits the wealthiest taxpayers relative to others will indeed achieve the job growth projections which have been cited as the overarching reason to accept the clear weaknesses of this proposal. Unfortunately, history tells us that it will likely not based on the quantitative facts available.

History is instructive as to whether this was indeed the case with the Reagan and Bush tax cuts. In the immediate years after the Reagan tax cuts, average weekly wages for rank-and-file workers (non-supervisors) went from $285 a week in the autumn of 1986 to $282 a week in October 1987, according to Labor Department statistics that are adjusted for inflation. Average weekly wages hit $271 a week by 1990. After the Bush tax cuts, median real wages actually dropped from 2003 to 2007. Household income from business-cycle peak to business-cycle peak declined for the first time since tracking started in 1967. This was followed by the Great Recession. In both cases, the federal deficit exploded which contributes to larger borrowing requirements competing with the financing needs of state and local government and businesses.

Proponents such as the President are trying very hard to show that the plan is a job and income creator. The President cited the concurrent announcement of the tax cut with that of plans for Broadcom, an electronics manufacturer, to “return” its corporate headquarters to the US. He cited revenue forecasts (confusing that with income) to tout the increase to the tax base which would support his plan. In fact, Broadcom already physically has it headquarters in San Jose, CA. It is legally domiciled in Singapore and that legal domicile is what will be returned to the US through incorporation in Delaware. Apparently, this decision was already made before the tax plan was announced and obviously before enactment. The reason for the relocation likely has nothing to do with the US tax plan.

Currently, the government of Singapore give Broadcom tax breaks which facilitated its domicile there. Recently, it was announced that Singapore would end those tax breaks four years earlier than expected. Broadcom is also pursuing the acquisition of a US company and that transaction is subject to, and threatened to be held up by, a legally required review of the takeover by a foreign based company which derives some 40% of its revenue from China. The “relocation” to the US would stop that review without changing any of the other characteristics of the company.

So what would the net result be for states and municipalities by this plan? Less revenue (unless significant decoupling of state tax schemes from the federal scheme occur), a greater share of costs for many basic services, a higher cost of borrowing, less flexibility in infrastructure development, less financing flexibility during times of declining rates (which is a reflection of diminishing economic activity), and a reduced ability to maintain existing infrastructure especially in areas like health and the environment.

All in all a stunningly comprehensive attack on the funding of basic government responsibilities likely to contribute to a less functional and more slowly expanding economy.

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INDIANA TOLL ROAD STUDY

According to a feasibility study awaiting review by Gov. Eric Holcomb, there is an 85 percent chance that revenues would exceed $39 billion from 2021 to 2050 by converting six Indiana interstates into toll roads. The estimates were prepared by HDR Inc. for the Indiana Department of Transportation, which was assigned to do the feasibility study by the Indiana General Assembly this past session. HDR was to examine the feasibility of tolling six Indiana interstates.

The revenue predictions do not account for the costs of toll collections or insurance. However, INDOT would be encouraged to explore the use of electronic tolling so drivers would not need to stop or slow down. The state would need to build about 370 devices that house cameras to capture transponders and license plates, costing about $1 million. The analysis was based on an INDOT economic model assuming that passenger vehicles would pay 4 cents per mile; light/medium trucks would pay 6 cents per mile and heavy trucks 19 cents a mile.

Among other claims in the study – “Tolling paired with widening I-65 and I-70 and a decrease in fuel taxes over time could increase Indiana’s Gross State Product by almost $27 billion.” While I-65 would become the largest revenue generator — up to $16.2 billion — it could also see a 10 percent decrease in traffic along its 261-mile northwest-to-southeast route due to tolls. In the case of I-65, the $16.2 billion figure comes with 50 percent confidence level. A tolling system along I-69 could raise between $8.4 billion (85 percent chance) to $11 billion (50 percent chance). Under the same levels, tolls along the east-west I-70 could likewise produce $6.9 billion to $9.1 billion. Similarly, I-74 could bring in $3.2 billion to $4.2 billion.

The state would need to build about 370 devices that house cameras to capture transponders and license plates, costing about $1 million. The analysis was based on an INDOT economic model assuming that passenger vehicles would pay 4 cents per mile; light/medium trucks would pay 6 cents per mile and heavy trucks 19 cents a mile. “This is a feasibility study, designed to inform discussions about the feasibility of a statewide tolling program. This study is not an investment-grade study that can be used to secure financing for a tolling project,” the study said.

CHICAGO BOARD OF ED OUTLOOK BENEFITS

The troubled Chicago Board of Education credit received positive news in the form of an outlook revision to stable from negative from Standard and Poor’s. The Board’s general obligation bonds remain rated B. The outlook revision reflects the district’s higher state aid revenue as a result of the state’s new funding formula, and lower pension costs, with the state now picking up more of the employer pension contribution, and the district’s ability to extend a higher property tax levy to support the pension contribution. These were a result of the FY 2018 state budget accord.

In July 2017, bond proceeds were used to reimburse the district for swap termination payments and capital expenses, and to pay for near-term debt service expenses, which improved the district’s cash position. The credit still exhibits extremely weak liquidity and its vulnerability to unexpected variances in its cash flow forecast. The district has shown an ability to weather unexpected obstacles such as the increased delays in block grants from the state in fiscal 2017, and City of Chicago officials have indicated a willingness to provide the district with limited financial help if needed. But the district’s cash flow was worse than budgeted in fiscal 2017, and the potential for the state’s own financial problems to negatively affect the district remains an issue.

MOVEMENT ON CHIP RENEWAL

The House approved the CHAMPIONING HEALTHY KIDS Act of 2017 (H.R. 3922), legislation that includes a five-year extension of funding for the Children’s Health Insurance Program and two years of relief from Medicaid disproportionate share hospital payment cuts. Among the CHIP provisions, the legislation specifies that funding for the federal matching rate would remain at 23% through fiscal year 2019, change to 11.5% for FY 2020 and return to a traditional CHIP matching rate for FYs 2021 and 2022. In addition, the bill would eliminate $2 billion in scheduled Medicaid DSH reductions in FY 2018 and $3 billion in reductions in FY 2019.