Joseph Krist

joseph.krist@municreditnews.com

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THE HEADLINES…

FOCUS SHIFTS FROM ACA TO TAX REFORM

RAUNER VETO FOR CHICAGO PENSION FUNDING

KENTUCKY PENSION PROBLEMS LINGER DESPITE ATTENTION

PREPA NEGOTIATION TWISTS AND TURNS

NIH CUTS – UNIVERSITIES AND HOSPITALS

ANOTHER INFRASTRUCTURE PLAN PROPOSED

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FOCUS SHIFTS FROM ACA TO TAX REFORM

The failure to repeal and replace the ACA is, in the short run, it’s good news for states especially those who expanded Medicaid and for New York State in particular. The failed effort takes some of the short-term heat off of state budget making efforts in this cycle. But along with this turn of events comes a change in focus to tax reform. And like any good sentry we know that the elimination of one source of incoming fire does not mean that the threat is over.

If the focus does indeed turn to tax reform, then threats remain for state and local government. They come from a number of directions. Will tax reform mean elimination of the tax exemption and a rising cost of capital for municipal borrowers? Will tax reform mean the elimination of the deduction for state and local income taxes? Would tax reform include elimination of the mortgage interest deduction leading to uncertainties in the housing market which could impact taxable valuations? The possibilities are myriad. None of them can be spun as particularly positive for municipal credit.

Tax reform on the scope of what has been suggested would severely impact the federal budget deficit. It can only be addressed through the types of spending cuts which were briefly outlined in the “skinny budget” recently released. We have already indicated our concerns with those proposals from a municipal credit perspective and reiterate those concerns here.

The one source of temperance regarding those concerns is that the scenario whereby the budget and policy hawks in the Freedom Caucus torpedoed ACA repeal might be repeated in the tax reform process. Will their insistence on deficit reduction not just neutrality be enough to torpedo efforts to make significant changes in tax policy (as opposed to just changes in rates) and thereby prevent significant change to the tax code to be enacted? That will have to play itself out as the process unfolds.

RAUNER VETO FOR CHICAGO PENSION FUNDING

Gov. Bruce Rauner on Friday vetoed legislation designed to shore up the pension funds for city of Chicago laborers and other city workers. “While I appreciate the effort to address the insolvency of certain pension funds for Chicago’s public employees, the legislation will create another pension-funding cliff that the city does not have the ability to pay,” Rainer said in a statement Friday. “This legislation will result in increased taxes on Chicago residents.”

Senate Bill 2437 would have put more money into retirement systems covering some 88,000 city workers, excluding police officers and firefighters, who are covered by separate pension funds. The Illinois House passed the bill in December and it was unanimously approved by the Senate in January. Instead the Governor’s ideological battle continues as Rainer had previously said he wouldn’t support the bill without more systemic wide-reaching government pension reforms. He also questioned the use of revenue in the bill, which would resort to the city using property-tax money to fund pensions after it runs out of funds from a new tax on city water and sewer service.

The veto comes despite workers’ concessions calling for employees hired after Jan. 1 to become eligible for retirement at age 65 in exchange for an 11.5 percent pension contribution. That’s 3 percentage points higher than employees pay now. Veteran employees hired after Jan. 1, 2011, get to choose between contributing 11.5 percent for the right to retire at 65 or continuing to pay 8.5 percent and waiting until 67 to retire.

It is this sort of move that belies the Governor’s efforts to portray the current financial disaster that is the State of Illinois as being solely based on legislative intransigence. He seems hell bent on getting the State and its largest city downgraded again rather than working for a solution.

KENTUCKY PENSION PROBLEMS LINGER DESPITE ATTENTION

There has been much focus on the public pension systems sponsored by the Commonwealth of Kentucky as they have served as a sort of poster child for the problem of chronic underfunding of state pensions. So it was with some interest that we examined the latest disclosure from the Commonwealth in support of its planned issue of state appropriation bonds.

That disclosure focused on the Teachers Retirement Fund and the funds covering the Commonwealth’s non-pedagogical employees. The Teachers Fund has seen its unfunded accrued actuarial liability grow in four of the last five years. As of June 30, 2016, the UAAL totaled $14,551,333,000. That results in a funding ratio of 54.6%. That ratio actually declined from the prior year’s 55.6%.

The funds covering the state’s other employees are in substantially worse shape. The UAAL has increased in each of the last five years. At the same time the funding ratio has substantially declined from an already unacceptable 30.2% to an incredibly low 19.5% in 2016. The funds had been using an assumed investment rate of 7.75%. As pension fund managers have discovered across the country, this assumed rate has been unrealistically high. Two of the general employee funds have reduced this assumed rate of return to 6.75%. The Teachers Fund and two other general employee funds slightly lowered their annual return assumptions to 7.5%.

So it really should not come as any surprise that these actions have not yielded significant improvement in the funding position of the funds. In FY 2016, the Actuarially Determined Employer Contribution for the Commonwealth was $562.1 million which was fully funded but this did nothing to address the existing shortfalls. The biennial budget calls for $186 million in contributions above the ADEC requirement. Since 2014, new employees have joined a hybrid pension plan. Localities may opt out of the plans but must repay their full actuarial liability to the Commonwealth in order to do so. So that is not an option which is particularly attractive. There are provisions to dedicate 25% of state surplus to the pension funds but with four months remaining in the current FY, revenues are still some 4.4% short of estimates. So the odds of any real help from that source seem pretty low.

PREPA NEGOTIATION TWISTS AND TURNS

The Puerto Rico Fiscal Agency and Financial Advisory Authority (FAFAA) filed  proposed terms for a new restructuring support agreement (RSA) with Puerto Rico Electric Power Authority (PREPA) bondholders. However, PREPA’s Ad Hoc Group of Bondholders issued a statement rejecting it. The filing takes place amidst a U.S. congressional subcommittee holding a hearing on the RSA. One PREPA board member called the hearing is a pressure tactic to push the government into accepting the current RSA, which the government wishes to amend to obtain better terms.

Later, FAFAA issued a statement saying the discussions are ongoing and that the entity “remains committed to a good faith negotiation with PREPA’s creditors in order to consensually achieve important improvements to the RSA. In the hearing in Congress however, Governor Rosella expressed worries about the impact of the 3-cent transition charge on Puerto Rican ratepayers; the effect the transaction may have on the capital and liquidity available to PREPA to complete its operational transition; the failure of certain creditor groups, such as monoline bond insurers, to provide significant concessions; the reality that the RSA does not provide for sufficient capital to close the transaction; and that under the current conditions, the RSA would not be sustainable for bondholders.

The current RSA, which expires March 31, calls for a 15% haircut on the principal of the debt, which is around $9 billion. But the government is proposing a split between 80% in securitization bonds and 5% in new PREPA bonds to maintain 85% of the total debt. While the current RSA proposes a debt service reserve fund of 10%, the government is proposing a reserve fund ramp up to 3.5% by year five. The current RSA calls for a bond exchange in which current PREPA bonds will be exchanged with bonds from PREPA’s Revitalization Corp. Those new bonds are required to be of  investment-grade credit quality. The government now says these shouldn’t need to be an investment-grade requirement for securitization.

Under the current RSA, bondholders can elect between two types of bonds, whose terms were proposed to be amended to, among other things, extend their maturity to 2047. The Ad Hoc group issued a statement saying the proposal would not simply modify the existing RSA but “fundamentally change it and undermine the value and structural integrity of the new PREPA

PREPA has a major bond payment of roughly $455 million of combined principal and interest due July 1. “Without the cash flow relief provided by the terms of the RSA and without any other viable options for making such a payment afforded to the distressed utility, PREPA will once again default.

NIH CUTS – UNIVERSITIES AND HOSPITALS

The skinny budget issued by the Trump administration provides for an approximate 20% cut in funding for the National Institutes of Health (NIH). Trump’s $5.8 billion reduction is roughly equivalent to what NIH spent last year to reimburse universities for the so-called indirect costs of research, which include overhead items like utility bills and the staff needed to comply with federal research regulations. Some speculate that the White House wants to reduce those indirect payments in hopes of saving money without reducing the amount of research that NIH funds. But university officials have long maintained that they could not afford to accept NIH grants if the government didn’t also pay reasonable overhead costs.

In the absence of budget specifics, one is left to applying some rudimentary calculations to estimate where these potential cuts might impact. So we go to data supplied by NIH listing the largest university recipients of NIH grants and how much that represents.

U.S. Department of Health and Human Services, NIH Awards by Location & Organization

These are clearly meaningful amounts of resources to these programs. Municipal bond investors should care because these funds often represent funds available for debt service in support of capital facilities in which research is physically carried out. Even if not directly pledged or otherwise dedicated to debt service, the lack of these resources would pressure already weakened resource bases for debt repayment by forcing the universities to make additional hard budget choices as they face diminishing state support and pressures on sources of full tuition paying students.

Similar concerns logically apply to hospitals. So we applied the same observation to hospital grant data.

U.S. Department of Health and Human Services, NIH Awards by Location & Organization

We are not taking the view that any particular near-term credit issue will result if these proposals are adopted. We do however think that the phenomenon should be highlighted as an additional issue to be included in the credit evaluation and valuation process undertaken by investors.

MORE INFRASTRUCTURE PLANS PROPOSED

The Partnership to Build America Act would create a new American Infrastructure Fund to pay for state and local projects. Another bill is called the Infrastructure 2.0 Act. It includes the AIF and provides additional long-term revenues to stabilize and expand the Highway Trust Fund. The Partnership to Build America Act finances $750 billion dollar in infrastructure investment using no appropriated funds, According to its sponsor. The  Infrastructure 2.0 Act is designed to provide six years of funding for the Highway Trust Fund. The American Infrastructure Fund (AIF) which would provide loans or guarantees to state or local governments to finance qualified infrastructure projects. The states or local governments would be required to pay back the loan at a market rate determined by the AIF to ensure they have “skin in the game.”  In addition, the AIF would invest in equity securities for projects in partnership with states or local governments.

The AIF would be funded by the sale of $50 billion worth of Infrastructure Bonds which would have a 50 year term, pay a fixed interest rate of 1 percent, and would not be guaranteed by the U.S. government. U.S. corporations would be incentivized to purchase these new Infrastructure Bonds by allowing them to repatriate a certain amount of their overseas earnings tax free for every $1.00 they invest in the bonds.  This multiplier will be set by a “reverse Dutch auction” allowing the market to set the rate. The bill assumes a 1:4 ratio, meaning a company repatriates $4.00 tax-free for every $1.00 in Infrastructure Bonds purchased, a company’s effective tax rate to repatriate these earnings would be approximately 8 percent and the $4.00 could then be spent by the companies however they chose. The AIF would leverage the $50 billion of Infrastructure Bonds at a 15:1 ratio to provide up to $750 billion in loans or guarantees. At least 25 percent of the projects financed through the AIF must be Public-Private Partnerships for which at least 20 percent of a project’s financing comes from private capital using a public-private partnership model.

The bill reflects many of the problems that infrastructure finds itself in. Many of the ideas look for ways to avoid the use of current revenues for spending on infrastructure, try to force the issue of P3s, and get themselves entwined with other issues such as the effort to repatriate foreign derived corporate income. This kind of approach to funding unnecessarily complicates an already complex issues and raises the kind of issues which make it harder to find consensus. Repatriation, tax credits, low interest non-guaranteed debt financing in a time of rising interest rates are nor really beneficial to the municipalities. Neither is the lack of specificity as to what constitutes a “market rate” for repayment of loans made to states while at the same time benefitting corporations with equity infusions and tax credits. All will serve to delay the provision of meaningful infrastructure improvement.

At the same time, Rep. Peter DeFazio (D-Ore.), the ranking Democrat on the House Transportation and Infrastructure Committee, proposed a bill which  would raise the federal gas tax by approximately 1 cent per year, to generate about $500 billion for revitalizing U.S. roads, bridges and transit systems over the next 30 years.

As many have observed, the federal gasoline tax has not been increased over 20 years. The bill would index the gas and diesel tax to the cost of constructing transportation projects and to the reduction in motor-fuel usage, which would approximately translate into a 1-cent increase every year. The hike would be capped at 1.5 cents annually.

The Treasury Department would use that new revenue to issue and pay back 30-year “Invest in America Bonds,” and deposit the cash from those bond sales into the ailing Highway Trust Fund. The measure, which would lead to a 30% boost in infrastructure investment every year, would ensure that the money is invested proportionally among highway, transit and safety programs. Raising gas taxes at the state level has not been a political landmine. Seventeen states have raised their gas taxes since 2013, including nine red states. Those increases range from 1 cent to 27 cents.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

joseph krist, municreditnews.com

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THE HEADLINES…

INFRASTRUCTURE CLUES IN THE TRUMP BUDGET PROPOSAL

TEXAS CONSIDERS DEFUNDING ROADS TO BALANCE THE BUDGET

ACA IMPACT ON STATE AND LOCAL CREDITS AND ECONOMIES

IS PUERTO RICO’S DEBT PLAN REALLY A SURPRISE?

CALIFORNIA PENSION CHANGES GET S&P SUPPORT

COLLEGES FACE DECLINING INTERNATIONAL DEMAND

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INFRASTRUCTURE CLUES IN THE TRUMP BUDGET PROPOSAL

Those looking for clues about how Trump budget policies would support campaign rhetoric supporting infrastructure spending, got some last week. Trump would slash programs that invest in rural infrastructure. The “skinny plan” proposes to eliminates the “duplicative” Water and Wastewater loan and grant program, a savings of $498 million from the 2017 annualized continuing resolution (CR) level. Rural communities can be served by private sector financing or other Federal investments in rural water infrastructure, such as the Environmental Protection Agency’s State Revolving Funds according to the document. It eliminates the Economic Development Administration, which provides small grants with, in the view of this administration provides limited measurable impacts and duplicates other Federal programs, such as Rural Utilities Service grants at the U.S. Department of Agriculture and formula grants to States from the Department of Transportation. By terminating this agency, the Budget saves $221 million from the 2017 annualized CR level.

It increases DOD’s budget authority by $52 billion above the current 2017 level of $587 billion. This increase alone exceeds the entire defense budget of most countries, and would be one of the largest one-year DOD increases in American history. It is exceeded only by the peak increases of the Reagan Administration and a few of the largest defense increases during the World Wars and the conflicts in Korea, Vietnam, Iraq, and Afghanistan (in constant dollars, based on GDP chained price index). Unlike spending increases for war, which mostly consume resources in combat, the increases in the President’s Budget primarily invest in a stronger military.

As for specific sectors supporting municipal bonds, the budget proposes an additional $1.5 billion above the 2017 annualized CR level for expanded detention, transportation, and removal of illegal immigrants. This bolsters the private and contract prison sector. At airports, the budget proposes to raise the Passenger Security Fee to recover 75 percent of the cost of TSA aviation security operations. This will make it harder to raise other PFCs for capital needs. The Federal Aviation Administration’s funding for commercial service to rural airports takes a major cut.

Mass transportation would be seriously impacted. The American Public Transit Association has identified 23 projects around the nation which would face viability threatening funding shortfalls if the Trump budget proposals are adopted. Among those projects are some which we have previously discussed in the Muni Credit News. They include Chicago’s proposed Red and Purple Line Modernization Project; Maryland’s Purple Line; New York and New Jersey’s Hudson Tunnel Project; and New York’s Second Avenue Subway Phase 2.

States will be pressured by the proposal to eliminate or reduce State and local grant funding by $667 million for programs administered by the Federal Emergency Management Agency (FEMA) that are either unauthorized by the Congress, such as FEMA’s Pre-Disaster Mitigation Grant Program, or that must provide more measurable results and ensure the Federal Government is not supplanting other stakeholders’ responsibilities, such as the Homeland Security Grant Program. For that reason, the Budget also proposes establishing a 25 percent non-Federal cost match for FEMA preparedness grant awards that currently require no cost match. This is the same cost-sharing approach as FEMA’s disaster recovery grants. The activities and acquisitions funded through these grant programs are viewed in this budget as primarily State and local functions. $210 million is eliminated for the State Criminal Alien Assistance Program, in which two-thirds of the funding primarily reimburses four States for the cost of incarcerating certain illegal criminal aliens.

An additional pressure on states is the proposal to decrease Federal support for job training and employment service formula grants, shifting more responsibility for funding these services to States, localities, and employers. It eliminates funding for specific regional efforts such as the Great Lakes Restoration Initiative, the Chesapeake Bay, and other environmental programs. These program eliminations produce spending $427 million lower than the 2017 annualized CR levels. The Budget returns the responsibility for funding local environmental efforts and programs to State and local entities. It eliminates infrastructure assistance to Alaska Native Villages and the Mexico border.

Cuts to HUD’s Community Development Block Grant program, which since the 1970s has devoted billions to helping improve housing and living conditions in cities, would be eliminated. How great an impact would that be? For example,Michigan communities could lose some $111 million compared to the current year — including $31 million for Detroit. The rest would be spread around the state, including $5 million for Wayne County, $4 million for Oakland County and nearly $2 million for Macomb County. In Detroit, CDBG funds have helped pay for homeless shelters and transportation for seniors as well as defraying costs for rehabilitation projects for housing and some acquisition and demolition costs in the city’s fight against blight. The loss of another HUD program would cost state communities $29 million total.

What is missing may be the most important consideration to the municipal market and that is tax policy. There is nothing to indicate what the Trump administration policy is towards municipal bonds and the tax exemption for them. So from the point of view, the document is fairly useless. As a policy document, the “skinny budget” comes up quite short but this is to be expected given the White House-centric nature of this administration’s policy apparatus. Effectively, it is a political document that provides few directional surprises so it does not provide much of use to those who are trying to make current investment decisions.

TEXAS CONSIDERS DEFUNDING ROADS TO BALANCE THE BUDGET

In 2015 to boost funding for the state’s public roadways and bridges, which have strained under a growing population, Proposition 7 amended the Texas Constitution to route some taxes collected on car sales to the State Highway Fund.  Some 83 percent of voters supported Proposition 7.

Nonetheless, the Texas House’s chief budget writer filed legislation last week that would pave the way for lawmakers to claw back billions of dollars that voters approved for state highways, freeing them up for other budget needs. House Appropriations Chairman John Zerwas  filed a resolution that would cut that initial cash infusion, aiming to free up money at a time when cash is tight. House Concurrent Resolution 108 could cut the first transfer under Proposition 7 of nearly $5 billion in half, but only if two-thirds of lawmakers in both the House and Senate support such a move.  It is possible because of  a “safety valve” in Senate Joint Resolution 5, the legislation that the Legislature approved in 2015  to send Proposition 7 to voters later that year.

At the Texas Department of Transportation, agency officials have  plans for all of the Prop 7 money. Gov. Greg Abbott also released a proposed budget in January that called for directing all of the Prop 7 funds to TxDOT as voters intended. Tax cuts in 2015 cut available state revenues by about $4 billion, and a slowdown in the oil patch also shrunk the budgetary pie. The voter-approved transfer of funds to the highway fund would leave even fewer dollars available to put toward areas such as health care, education and the state’s collapsed foster care system.

It is ironic that highway funding, often the subject of specific voter actions in support of infrastructure spending, is the source of budget bailouts for states experiencing general revenue shortfalls whether because of lower overall economic activity or as the result of poorly thought through tax cuts. Kansas is the most obvious example. The moves to use these funds merely provide temporary budget relief but then diminish the credits supported by transportation related revenues. So in the end neither credit experiences long term benefit.

ACA IMPACT ON STATE AND LOCAL CREDITS AND ECONOMIES

We have recently commented on our view of the highly negative anticipated impacts of the AHCA in its present form on state credits. Recent statistics show that Employment in health care also continued to trend up in January (+18,000), following a gain of 41,000 in December. The industry has added 374,000 jobs over the past 12 months. While many focus on the higher end jobs in the healthcare sector, the reality is that healthcare has largely stepped into the role which manufacturing used to serve as a source of jobs for the less skilled, less educated, and immigrant populations in the workforce. The loss of these jobs would have serious implications for state budgets on both the tax and expense sides of the ledger. Recent academic work has supported our concerns. One example is a study from the Milken Institute School of Public Health at George Washington University. That study indicates that consequences of repealing both premium tax credits and Medicaid expansions include: About 2.6 million jobs could be lost nationwide in 2019, rising to almost 3 million by 2021. Every state would experience major job losses. Almost all of the jobs lost are in the private sector. Almost  a  million (912,000) are in health care, while the remaining two-thirds are in other industries, including construction, real estate, retail trade, finance and insurance. States with the highest job losses in 2019 include: California (334,000 jobs), Florida (181,000), Texas (175,000), Pennsylvania (137,000), New York (131,000), Ohio (126,000), Illinois (114,000), Michigan (102,000), New Jersey (86,000), and North Carolina (76,000).  The states with the highest percentage of healthcare employment versus total employment in excess of 10% are West Virginia, Rhode island, Ohio, Maine, Massachusetts, Mississippi, Pennsylvania, North Carolina, and New York. All of them are states in which manufacturing used to serve as a source of jobs for the less skilled, less educated, and immigrant populations in the workforce. They also will see the impact in their major cities. Estimates of the share of employment in represented by healthcare in cities ravaged by a declined manufacturing bases include Cleveland -11.2%, Pittsburgh-10.4%, Detroit-10.3%, Philadelphia-10.5%, Youngstown-10.7%, Providence-11%, Charlestown WV- 11.4%. Louisville, Gary IN, Cincinnati are all above the national average of 9%.

15 Republican governors have raised concerns about the House GOP’s health care bill amid the fiery debate surrounding the long-promised repeal of Obamacare. And no governors have publicly expressed strong support for the American Health Care Act. Arkansas Gov. Asa Hutchinson said “There needs to be some adjustments to relieve some of that cost-shift to the states and to make sure we don’t go back to where we were before, which was that we just had our emergency rooms filled with those who did not have coverage.” “Phasing out Medicaid coverage without a viable alternative is counterproductive and unnecessarily puts at risk our ability to treat the drug-addicted, mentally ill and working poor who now have access to a stable source of care,” Ohio Gov. John Kasich said.

Recent research by the Urban Institute and Dobson, DaVanzo & Associates estimated a $400 billion loss in total hospital revenue from 2018 to 2026 and $166 billion loss in net income would rise by $1.1 trillion from 2019 to 2028. This would lead to significant pressure to include higher uncompensated care funding from already strained state budgets. Those states would also experience declines in revenues from lower sales and income taxes resulting from lower employment and lower purchasing by hospitals and care providers. There is almost nothing favorable for the states in this legislation.

CALIFORNIA PENSION CHANGES GET S&P SUPPORT

The CalPERS’ board voted on December 21, 2016, to lower the discount rate to 7.375% from 7.5% in the upcoming actuarial valuation for June 30, 2016; 7.25% in the 2017 valuation; and 7.0% in the 2018 valuation. Six weeks later, on February 1, 2017, the CalSTRS board decided to move slightly faster, reducing its discount rate to 7.25% in the 2016 valuation and 7.0% in 2017 from 7.5%. The two largest public pension systems in the U.S. both have committed to lowering their discount rates without changing their funds’ asset allocations.

S&P explains that CalPERS’ discount rate had an inflation assumption of 2.75% and a real rate of return of 4.75%. The real rate of return is scheduled to decrease 0.5% over the next three years while the inflation assumption is stable and will be looked at in 2018 in the experience study, which CalPERS conducts every four years. The impact on the cost of earning a year of service (the normal cost) will add 1% to 3% of pay for non-safety groups and 2% to 5% for most safety groups. S&P expects most unfunded liability payments to increase 30% to 40% over the next seven years as the costs are realized. For the state alone, that will ultimately mean contributing $2 billion a year more toward pension costs.

Reducing the discount rate will accelerate the slope of cost increases, intensifying the pressure that state and municipalities will face as growing pension contributions account for larger portions of their budget, especially in this slow revenue growth environment. Reducing the inflation assumption softens the discount rate reduction’s impact. Pension benefits are calculated based on years of service and salary, so a lower inflation assumption implies that salaries are growing more slowly than before, lowering projected benefits and total liability.  Reducing the inflation assumption softens the discount rate reduction’s impact. Pension benefits are calculated based on years of service and salary, so a lower inflation assumption implies that salaries are growing more slowly than before, lowering projected benefits and total liability.  State legislation AB 1469 sets the contribution rate for schools through fiscal year 2021. This schedule more than doubles their contribution rates from fiscal years 2015 to 2021, so S&P anticipates significant strain on schools’ budgets over the next several years. However, while their contributions will continue to increase due to the phase-in of AB 1469, the effect of the discount rate change has no impact on school contribution rates until fiscal 2022. Even after that window opens, school yearly contribution changes are capped at 1% and in total can only grow by 1.15% more than the bill’s current schedule. So absent further statutory changes, the resulting contribution burden to schools is both delayed and limited to a minimal 1.15% of their payroll. The result is to raise the near term cost of pensions for both the state and its localities and school districts. Ultimately, the total obligation for pensions will see slower growth thereby reducing the total liability. This then improves the liability side of the balance sheet resulting in a more favorable credit profile. As a result, S&P takes a more positive view of California’s credit profile.

IS PUERTO RICO’S DEBT PLAN REALLY A SURPRISE?

The initial market reaction to Puerto Rico’s plans for limited debt service payments was negative based on limited trading. The fiscal plan certified for the administration of Ricardo Rosselló, for the next 10 years, allocates $800 million for the payment of debt starting in 2019. The government’s debt obligations range from $3.8 billion to $5 billion a year over the next decade. It is the government’s position that $800 million is the amount available and that  this should serve as a base assumption for a restructuring.

One of the disappointing aspects of the situation is contained in comments from the fiscal board. The board’s interim executive director said that its approach over the past few months was to certify a fiscal plan and ensure that by the end of this year the government can achieve enough savings to continue to meet pension obligations to retirees and the ability to manage the healthcare system when Affordable Care Act funds are exhausted.

The fiscal plan certified for the next 10 years included Cofina and funds subject to clawbacks as part of the general fund revenue. The assumption in the fiscal plan assumes that in a debt restructuring these funds are available for the payment of general expenses. The board’s emphasis now is on reaching consensual agreements that restructure the debt at a level that is sustainable for Puerto Rico.

That language builds in a bias in favor of public services and more importantly, pensioners. This would continue a pattern of pensioners being treated much more favorably than bondholders. The difference here between this and other municipal bankruptcy situations is the existence of the constitutional provisions in favor of bondholders. We understand the practical and political realities of the Commonwealth’s financial and debt situation. We remain troubled by the precedent which would be set if a restructuring deal  were ultimately forced upon bondholders that resulted in less than full payment for the general obligation debt.

COLLEGES FACE DECLINING INTERNATIONAL DEMAND

In January, we discussed the economic impact of foreign students in the U.S. We highlighted the growing importance of these full tuition consumers of education to an increasing number of institutions, especially state institutions who have suffered declining state support. Now there is news which may expose the vulnerabilities inherent  in relying on that demand cohort.

A survey undertaken by a a coalition of six higher education associations in February 2017 produced the following findings from more than 250 U.S. institutions which responded to the short survey, with representation of all sizes, types and geographic diversity of higher education in the United States. 39% of responding institutions reported a decline in international applications, 35% reported an increase, and 26% reported no change in applicant numbers. There are more than 100,000 students studying in the U.S. from the Middle East, making up just under 10% of our international student enrollment nationwide. 39% of institutions have reported declines in undergraduate applications for Fall 2017 from the Middle East. 31% of Institutions have reported declines in graduate applications for Fall 2017 from the Middle East.

Almost half a million Indian and Chinese students study in the U.S. 26% of institutions have reported undergraduate application declines from India and 25% reported application declines from China. o 32% of institutions have reported graduate application declines from China, and 15% have reported application declines from India.

The most frequently noted concerns of international students and their families, as reported by institution-based professionals, include a perception of a rise in student visa denials at U.S. embassies and consulates in China, India and Nepal; a perception that the climate in the U.S. is now less welcoming to individuals from other countries; concerns that benefits and restrictions around visas could change, especially around the ability to travel, re-entry after travel, and employment opportunities; and concerns that the Executive Order travel ban might expand to include additional countries.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

joseph.krist@municreditnews.com

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THE HEADLINES…

CBO SCORES AHCA

CONSERVATIVE CMS HEAD APPROVED

CHICAGOLAND HOSPITAL MERGER HITS LEGAL ROADBLOCK

 ACA DEBATE DOESN’T SLOW HEALTH EMPLOYMENT

MOODY’S WEIGHS IN ON THE ACA 

DISCLOSURE LIKELY TO WEAKEN IN CURRENT ENVIRONMENT

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CBO SCORES AHCA

CBO and JCT estimate that enacting the legislation would reduce federal deficits by $337 billion over the 2017-2026 period. That total consists of $323 billion in on-budget savings and $13 billion in off-budget savings. Outlays would be reduced by $1.2 trillion over the period, and revenues would be reduced by $0.9 trillion. The largest savings would come from reductions in outlays for Medicaid and from the elimination of the Affordable Care Act’s (ACA’s) subsidies for nongroup health insurance. The largest costs would come from repealing many of the changes the ACA made to the Internal Revenue Code—including an increase in the Hospital Insurance payroll tax rate for high-income taxpayers, a surtax on those taxpayers’ net investment income, and annual fees imposed on health insurers—and from the establishment of a new tax credit for health insurance.

CBO and JCT estimate that, in 2018, 14 million more people would be uninsured under the legislation than under current law. Most of that increase would stem from repealing the penalties associated with the individual mandate. Some of those people would choose not to have insurance because they chose to be covered by insurance under current law only to avoid paying the penalties, and some people would forgo insurance in response to higher premiums. Later, following additional changes to subsidies for insurance purchased in the nongroup market and to the Medicaid program, the increase in the number of uninsured people relative to the number under current law would rise to 21 million in 2020 and then to 24 million in 2026.

The reductions in insurance coverage between 2018 and 2026 would stem in large part from changes in Medicaid enrollment—because some states would discontinue their expansion of eligibility, some states that would have expanded eligibility in the future would choose not to do so, and per-enrollee spending in the program would be capped. In 2026, an estimated 52 million people would be uninsured, compared with 28 million who would lack insurance that year under current law.

In 2018 and 2019, according to CBO and JCT’s estimates, average premiums for single policyholders in the nongroup market would be 15 percent to 20 percent higher than under current law, mainly because the individual mandate penalties would be eliminated, inducing fewer comparatively healthy people to sign up. Changes in premiums relative to those under current law would differ significantly for people of different ages because of a change in age-rating rules. Under the legislation, insurers would be allowed to generally charge five times more for older enrollees than younger ones rather than three times more as under current law, substantially reducing premiums for young adults and substantially raising premiums for older people.

Over ten years through 2026, a reduction of $880 billion in federal outlays for Medicaid is estimated. In our view, such a reduction in combination with the loss of insurance coverage would create an impact on the hospital sector which would be devastating. And these impacts are with the law as it is. Should conservative opponents prevail in their efforts against a tax credit versus a reduction, the impact would be even worse.

The White House has made efforts to discredit the forecasts from the nonpartisan CBO. “We disagree strenuously with the report that was put out,” Health and Human Services Secretary Tom Price told reporters Monday about the CBO after leaving a Cabinet meeting with President Donald Trump at the White House. “It’s just not believable is what we would suggest.” Ironically, the OMB did an analysis of what it thought the CBO estimate might look like and the analysis found that under the American Health Care Act, the coverage losses would include 17 million for Medicaid, 6 million in the individual market and 3 million in employer-based plans. A total of 54 million individuals would be uninsured in 2026 under the GOP plan, according to this White House analysis. That’s nearly double the number projected under current law.

It is already clear that the final law will not be this bill. Senate Republicans have suggested changes to the bill which would  lower insurance costs for poorer, older Americans and an increase in funding for states with high populations of hard-to-insure people. It was noted that Americans over 60 who earn a little too much to qualify for Medicaid would “have a hard time affording insurance” under the House plan, since insurance premiums would rise far higher than the modest tax credits on offer. AARP has denounced the plan as an “age tax.”

CONSERVATIVE CMS HEAD APPROVED

President Donald Trump’s pick to run Medicare and Medicaid was confirmed by a divided Senate as lawmakers engaged in the battle over the government’s role in health care and society’s responsibility toward the vulnerable. Indiana health care consultant Seema Verma, a protégé of Vice President Mike Pence, was approved by a 55-43 vote, largely along party lines. She’ll head the Centers for Medicare and Medicaid Services, the $1 trillion agency that oversees health insurance programs for more than 130 million people, from elderly nursing home residents to newborns. It’s part of the Department of Health and Human Services.

Verma takes over at CMS with the agency facing sweeping changes under the House Republican health care bill backed by Trump. She’s been critical of Medicaid, saying “the status quo is not acceptable” for the federal-state insurance program that covers more than 70 million low-income people. In Indiana, Verma designed a Medicaid expansion along conservative lines for Pence. Most beneficiaries are required to pay modest premiums. And the program uses financial rewards and penalties to steer patients to primary care providers instead of the emergency room. Critics say the plan has been confusing for beneficiaries and some have incurred penalties through no fault of their own.

At her Senate confirmation hearing, Verma defended her approach by saying that low-income people are fully capable of making health care decisions based on rational incentives. She also said she does not support turning Medicare into a voucher plan under which retirees would get a fixed federal contribution to purchase private coverage from government-regulated private insurance plans. Her boss, HHS Secretary Tom Price, is a prominent advocate of such an approach. Medicare covers more than 56 million seniors and disabled people.

CHICAGOLAND HOSPITAL MERGER HITS LEGAL ROADBLOCK

A U.S. District Judge granted the Federal Trade Commission and state of Illinois’ request for a preliminary injunction to temporarily stop the merger of Advocate Health Care and North Shore University Health System. The proposal would have created the 11th largest health care system in the U.S., combining Advocate’s 11 hospitals and two-campus children’s hospital with North Shore’s four hospitals.

The two institutions contended that a merger would lead to improvements in care and lower costs for patients. They planned to offer an insurance product 10 percent less expensive than the lowest-priced comparable product available, saving consumers at least $210 million a year. The FTC challenged the deal in late 2015, saying it would probably hurt consumers with higher prices for health care and lower incentives to improve the quality of care. The FTC said the deal would lead to an 8 percent, or $45 million, price increase at the hospitals. The FTC, however, said if the systems merged, they would have had enough leverage to impose price increases on insurers without insurers being able to refuse.

It is currently not possible to analyze the data behind the decision as the judge filed his opinion under seal to give those involved in the case time to request competitively sensitive information be redacted before the opinion is released publicly. This will occur sometime later in the month.  Advocate and North Shore argued the FTC too narrowly defined their market, leaving out competitors such as Northwestern Memorial Hospital and Rush University Medical Center.

Rush University Medical Center, an academic hospital on the Near West Side, Rush-Copley Medical Center in Aurora and Rush Oak Park Hospital in that west suburb are now officially operating as one academic health network. They have a new parent system simply called Rush. The system is positioning itself to be among the handful of local hospital networks still operating in the coming years.

Rush is packaging and selling itself as one overall entity. The framework is based on a research-focused hub with a built-in pipeline of future medical workers (doctors, nurses, researchers) now studying at Rush University. It has about 1,800 physicians and an expansive outpatient footprint, with new sites opening in Chicago’s River North and South Loop neighborhoods, and in Oak Brook. An estimated $500 million outpost on Rush University Medical Center’s campus is underway. Each hospital in the system will retain its own board and management.

Rush Copley is already a market share leader on Chicago’s west side but lacked certain specialists, such as neurologists, on its roster. Through the new structure, patients at Copley can now gain access to those specialists. Rush Oak Park is about to break ground on a new $30 million emergency department, and it plans to add about 30 specialists from Rush University Medical Center. That’s about a third more than this community hospital has now.

ACA DEBATE DOESN’T SLOW HEALTH EMPLOYMENT

The healthcare sector created 26,800 jobs in February, surpassing the 18,300 new positions in January, according to the February jobs report issued Friday by the Bureau of Labor Statistics. Healthcare was among the sectors that drove total national jobs creation in February to a better-than-expected 235,000 jobs. The ambulatory healthcare services subsector grew the most with 18,300 jobs created. Ambulatory services grew by 7,100 jobs in January.

Hospitals added jobs in February as well. Hospital jobs grew by 6,300 positions compared to 1,700 added in January. The industry still needs more workers to care for patients. The aging population remains a long-term demographic driver for the industry.

MOODY’S WEIGHS IN ON THE ACA

Moody’s recently released its overview of the credit impact of legislation to repeal and alter aspects of the Affordable Care Act (ACA) on hospitals. It views many of them as credit negative because they would reduce the number of people with health insurance and increase bad debt and uncompensated care costs. However, some elements of the legislation in Moody’s view, such as preserving federal funding for Medicaid expansion for several years, have no immediate credit effect, while others, such as eliminating scheduled Disproportionate Share (DSH) cuts for states that did not expand Medicaid, are credit positive. Components of the legislation most likely to negatively affect hospitals are the Medicaid expansion freeze in 2020, transitioning federal Medicaid payments to a per-capita payment to the states and changes to how subsidies are calculated for people who buy coverage on the exchanges. Restoring DSH cuts to nonexpansion states is credit positive for hospitals in those states. Repealing the individual mandate to obtain health insurance and replacing it with a “continuous coverage” requirement will only modestly increase insurance coverage.

Importantly, the legislation does not repeal Medicaid expansion; states would be allowed to maintain expanded Medicaid eligibility, but they would bear a greater share of the costs starting in 2020. Expansion of Medicaid eligibility has been the single largest driver of insurance coverage gains under the ACA. Starting in 2020, federal support for Medicaid would involve per-capita payments indexed to inflation (currently, federal Medicaid payments are not capped and rise or fall with state expenditures on Medicaid).

We expect that federal payments will grow more slowly than Medicaid program costs, forcing states to make changes that would likely be credit negative for hospitals, including lowering payments to hospitals and other providers, reducing coverage or benefits and reducing targeted payments to safety-net hospitals. States that have not expanded Medicaid would still have the ability to do so before 2020. Eliminating cuts to Medicaid DSH (payments to hospitals that care for a disproportionately large share of uninsured individuals) for the 19 states that did not expand Medicaid would be credit positive for hospitals in those states, particularly for safety-net providers.

Changes to subsidies available to people purchasing insurance on the exchanges would be credit negative for hospitals because they would reduce the subsidy available to many people, prompting them to drop insurance coverage. Subsidies under the legislation would be based on age, with no subsidies available to people who exceed the income threshold. The legislation would also allow insurers to charge up to 5x more for older people than younger people, versus 3x today.

This would lower costs for younger enrollees, encouraging more of them to purchase insurance and contributing to stability on the exchanges. However, this will also raise costs for older enrollees, causing more of them to drop coverage, which is credit negative for hospitals. We believe that the effect of older enrollees losing coverage will outweigh the positive effect of younger people gaining coverage given that older people have greater healthcare needs and as they lose coverage, hospitals would incur greater uncompensated care and bad-debt costs.

Repealing the individual mandate would be credit negative for hospitals because some individuals would drop insurance coverage if they no longer face a financial penalty for not purchasing insurance. However, the credit effect on hospitals is not material given that the current financial penalties for not purchasing insurance are too small to compel many young and relatively healthy people to buy insurance. Likewise, the discontinuation of the mandate is not as material proportionately because the proposed changes to Medicaid expansion are responsible for the majority of insurance gains since the passage of the ACA.

The House legislation replaces the individual mandate with a continuous coverage requirement to incentivize people to purchase coverage. Under continuous coverage, insurers cannot deny coverage to anyone (regardless of pre-existing conditions) so long as they have maintained continuous coverage. If coverage has lapsed, insurers must charge rates that are 30% higher than they would otherwise charge. The ability of the continuous coverage requirement to keep people from dropping insurance coverage in the absence of an individual mandate will depend on the prices of available health plans and the level of subsidies available to offset premiums. However, we do not believe that the threat of a rate increase in the future will be enough to entice relatively healthy people to purchase insurance if they believe they do not need it.

WILL DISCLOSURE HOLD UP IN THE CURRENT ENVIRONMENT

There has been some static on the disclosure front recently which sends at best mixed messages to the market. The Securities and Exchange Commission today voted to propose rule amendments to improve investor protection and enhance transparency in the municipal securities market.

Rule 15c2-12 under the Securities Exchange Act of 1934 requires brokers, dealers, and municipal securities dealers that are acting as underwriters in primary offerings of municipal securities subject to the Rule, to reasonably determine, among other things, that the issuer or obligated person has agreed to provide to the Municipal Securities Rulemaking Board (MSRB) timely notice of certain events.  The amendments proposed by the SEC today would add two new event notices.

Incurrence of a financial obligation of the issuer or obligated person, if material, or agreement to covenants, events of default, remedies, priority rights, or other similar terms of a financial obligation of the issuer or obligated person, any of which affect security holders, if material; and Default, event of acceleration, termination event, modification of terms, or other similar events under the terms of the financial obligation of the issuer or obligated person, any of which reflect financial difficulties.

The Municipal Securities Rulemaking Board (MSRB) today endorsed the Securities and Exchange Commission (SEC) for proposing regulatory changes to improve the content and timeliness of disclosure of information about bank loans and other alternative financings entered into by issuers of municipal securities. The risks of these transactions include terms and conditions of alternative financings that may require the acceleration of debt repayment if the borrower encounters financial stress or the dilution of a bondholders’ security position if a bank loan is on parity with or senior to other outstanding debt.

Overall, these incremental improvements are fine but the key is whether they will receive the robust support they will need from a Trump administration. Many market participants are skeptical about the long-term commitment to issuer oversight and disclosure from an administration so committed to the reduction of government regulation in all sectors of oversight. These proposed changes will only help if they are supported by adequate resources, staffing, and leadership at the agency level.

WHY DISCLOSURE WILL MATTER WITH SMALLER HOSPITAL ISSUERS

Many times the discussion of disclosure can seem a bit remote especially if you deal with only the larger more well distributed credits. In the healthcare space, the most vulnerable credits are often the one’s with the least robust disclosure practices. These are institutions which because of their relatively small size and infrequent use of or access to the public debt markets, are not attuned to the information needs of investor participants.

These institutions are the kind of hospitals which are vulnerable by their size, service array, and location to the changes in funding included in the proposed AHCA. These are primarily smaller rural institutions which provide a lower level of care or they are specialty institutions which are vulnerable to procedure specific reimbursement changes. The rural institutions tend to be weaker credits for a variety of reasons. They tend to be smaller and their customer bases tend to be older and less economically well off than is the case with large urban based hospital systems. As such, their profitability is more marginal and their ability to develop and accumulate cash on their balance sheets is lessened.

Of the 25 states that have seen at least one rural hospital close since 2010, those with the most closures are located in the South, according to research from the North Carolina Rural Health Research Program. Thirteen hospitals in Texas have closed since 2010, the most of any state. Tennessee has seen the second-most closures, with eight hospitals closing since 2010. In third place is Georgia with six closures followed by Alabama and Mississippi, which have each seen five hospitals close over the past six years.

80 rural hospitals closed between January 2010 and November 2016, as tracked by the NCRHRP. For the purposes of its analysis, the NCRHRP defined a hospital closure as the cessation in the provision of inpatient services. As of November, all of the facilities no longer provided inpatient care. However, many of them still offered other services, including outpatient care, imaging, emergency care, urgent care, primary care or skilled nursing and rehabilitation services.

Our feeling is that this sector has been underrepresented in the public debt markets. It is likely to need to access the market as rates increase and the need to reach more sophisticated investors who are comfortable with risk rises. These more sophisticated investors will tend to need more information in order to meet their own internal and external compliance requirements. The trend of closures and the credit weakness it reflects only heighten the need for good current information.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

joseph.krist@municreditnews.com

THE HEADLINES…

PUERTO RICO’S PLAN GETS PROMESA APPROVAL

FLORIDA HIGH SPEED RAIL ANNOUNCES DELAY

TECH HELPING CREDIT

CIVIL ENGINEERS GRADE INFRASTRUCTURE

REGULATORS GET A PLEA BUT IS IT A ONE OFF?

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PUERTO RICO’S PLAN GETS PROMESA APPROVAL

After a week of vigorous back and forth debate between the Government of Puerto Rico and the Promesa fiscal control board it was announced that the fiscal control board approved its plan for Puerto Rico: a “progressive” 10% cut to pensions, a $450 million reduction to the University of Puerto Rico (UPR) budget and the approval of measures presented by Gov. Ricardo Rosselló in his revised fiscal plan, which was delivered over the weekend.

The board approved a partial reduction to the workweek of public employees and teachers— not including public safety personnel—along with the elimination of the Christmas bonus for these employees. The board argued that without this measure it could not be possible to guarantee the government would have enough money for the provision of essential services.

To avoid the furlough, the government will have to identify, by summer, on its next budget to be delivered April 30 along with a liquidity plan, about $200 million in contingency funds. If not, the board will reevaluate the situation in September, when it will determine whether to modify or eliminate the workweek reduction and the Christmas bonus. For his part, the governor’s representative to the board said he is “confident” this will not happen and that it represents a “precautionary measure” in case the government does not achieve having the expected cash flow.

During its fifth public meeting, which was held in New York, the financial control board announced what it called amendments to the latest version of the fiscal plan presented by the governor. The board said it reached agreements with the administration regarding economic projections and in identifying greater government resources, mainly through an increase to the tax on tobacco products.

The cuts to pensions and the UPR must be carried out on or before fiscal year 2020. In the case of pensions, the board said it had differences with the Rosselló administration and will therefore work side by side during the next 30 days on a plan to establish a simple paygo, or pay-as-you-go, system; liquidate assets to finance the benefits due in the previous plan; and place all pensioners and public employees in defined-contribution plans, segregating their contributions in individual accounts that ensure the payment of their benefits in the future.

Another measure was included that seeks to provide Social Security benefits for all new teachers and police officers. Although not discussed at the public meeting, the certified plan keeps a $450 million cut over three years for the UPR that was recently required by the board, government officials publicly confirmed later.

Prior to the approval, The Financial Oversight and Management Board had said that, in its view, the Government of Puerto Rico’s cash position is “so critically low that unless emergency actions are taken immediately, in a matter of months it will run out of money to pay for essential services such as education, healthcare and public safety.” A report by auditing firm Ernst & Young on the government’s bridge between the 2014 audited financial statements and the 2017 baseline numbers the government used in its originally proposed fiscal plan,  the government’s fiscal year 2017 expenditures could be understated by $360 million to $810 million, “based on historical expenditure trends.”

The board had recommended: Immediate implementation of a furlough program to achieve $35 million to $40 million in monthly savings, through the equivalent to four days per month for most executive branch government personnel and two days per month for teachers and frontline personnel at 24-hour institutions. Frontline law enforcement personnel should be exempted from the furlough program. Reductions comparable to the executive branch furlough savings described above for other entities across the government, including public corporations and instrumentalities and the legislative and judicial branches. Reductions in professional service contract expenditures of up to 50 percent and significant reductions in all government contract expenditures. Reductions in healthcare costs, by negotiating drug pricing and reductions of rates to health plans and providers.

The board did say that it understands the difficulty in implementing a $300 million cut to the UPR for fiscal year 2019, and says the magnitude of the deficit requires the number raised to $450 million by fiscal year 2021. As for pensions, it insisted that the adjustment should be of at least 10% to prevent other sectors from assuming a greater burden as a result of the insolvency of pension plans. If the retirement system runs out of money at the end of the year, general fund money would have to compensate for the shortfall, which would mean fewer resources available to cover other essential services such as education and the healthcare system. The board calls for further cuts to pension benefits and for the government to demonstrate that it is segregating the contributions of public employees so as to ensure the money is not misused. The governing body also proposes that government payroll be cut more, to $1.3 billion by 2021.

The government adjusted some of its proposed measures and baseline numbers in the revised document delivered to the board on Saturday morning, in a bid to keep alive its chances to have its plan—and not the board’s—be certified. Now that it is approved by the board, the government must move toward the preparation and certification of a budget by April 30. Likewise, any law approved by the Legislature must be consistent with the fiscal blueprint. Failure to do so, as the board determines in its sole discretion, would invalidate the legislation. The plan also lays down the groundwork for negotiations with Puerto Rico’s different creditor groups, as both the government and the board would know how much money is available to pay for debt service each year.

FLORIDA HIGH SPEED RAIL ANNOUNCES DELAY

A former executive with the New York Mets and the Madison Square Garden Co., Dave Howard has been named CEO of the high speed rail line sponsor. The announcement was accompanied by the news that the West Palm Beach-to-Orlando portion of the train project, referred to as Phase II, needs additional permits. A concrete financing plan is not yet in place either. Service between South Florida and Orlando International Airport was slated to begin by year-end.

The delay is due to ongoing litigation that has tangled financing plans for the project since 2015, when two Treasure Coast counties sued Brightline and the U.S. Department of Transportation. As we have previously documented, Martin and Indian River County allege the DOT skirted protocol pertaining to environmental impact studies, giving Brightline improper access to over $1 billion worth of tax-exempt government bonds to build the train project through their cities.

We do not see anything in the current news which improves the credit profile of the project or enhances the likelihood of a near-term financing for the project in the municipal bond market.

TECH HELPING CREDIT

As an older city with structural financial difficulties, an emphasis on technology in Philadelphia’s financial management might not be expected. The Mayor’s proposed FY 2018 budget message offers comments which suggest otherwise. The comments detail how applying the right enforcement tool at the right time on the right account is essential for the efficient collection of delinquent revenue, and data analysis allows the City’s Department of Revenue to better understand the characteristics of an account and identify the best course of action. In FY17, the City launched a Data Warehouse and Case Management system. When fully implemented, the system will pull information about the individuals and businesses that have debts to the City into a single location, allowing a comprehensive picture to emerge and providing the tools to turn information into revenue.

In partnership with researchers from the University of Pennsylvania, the City tested various messages in letters to delinquent account holders to determine the most effective communications to produce payment. By the end of FY17, the Department of Revenue will begin using predictive analytics to score delinquent accounts to see how much money will likely be collected and what type of enforcement will be the most efficient. Without this data-driven approach, resources and time would be used less efficiently either pursuing cases that would resolve on their own or are unlikely to respond to a particular approach. Revenue has already made progress toward collecting every dollar that is owed. For example, the percent of real estate taxes owed that are paid within the first year has increased from 86.6% in Calendar Year 2011 to 94.2% in Calendar Year 2015.

CIVIL ENGINEERS GRADE INFRASTRUCTURE

Every four years, America’s civil engineers provide a comprehensive assessment of the nation’s 16 major infrastructure categories in the American Society of Civil Engineers’s Infrastructure Report Card. Using a simple A to F school report card format, the Report Card examines current infrastructure conditions and needs, assigning grades and making recommendations to raise them. The latest report was released last week and the results were not good. The overall grade assigned was a D+.  A D+, according to the report, means the infrastructure is in poor to fair condition and mostly below standard, with many elements approaching the end of their service life. It also indicates that a large portion of the system exhibits significant deterioration. Condition and capacity are of serious concern with strong risk of failure.

A grade reflects a wide variety of criteria. Does the infrastructure’s capacity meet current and future demands? What is the infrastructure’s existing and near-future physical condition? What is the current level of funding from all levels of government for the infrastructure category as compared to the estimated funding need? What is the cost to improve the infrastructure? Will future funding prospects address the need? What is the owners’ ability to operate and maintain the infrastructure properly? Is the infrastructure in compliance with government regulations?

To what extent is the public’s safety jeopardized by the condition of the infrastructure and what could be the consequences of failure? What is the infrastructure system’s capability to prevent or protect against significant multi-hazard threats and incidents? How able is it to quickly recover and reconstitute critical services with minimum consequences for public safety and health, the economy, and national security? What new and innovative techniques, materials, technologies, and delivery methods are being implemented to improve the infrastructure?

The findings are not a surprise to those of us who follow these events. California has extensive needs in a number of areas as does Pennsylvania and Texas. Drinking water and wastewater needs are greatest in the northern rural states. Bridges are a particular issue in California, Oklahoma, Pennsylvania, and Iowa. Road costs are highest on the West Coast and in the northeast. School needs are the greatest in poorer rural areas. Rail is an issue in the northeast and the Rust Belt as well as in Texas.

Depending on the category, the needs are not all based on age. In a category like schools for instance, much of the need is based on the use of short-term measures to meet greater demand which has now become permanent. As knowledge has increased, much of the need is based on the requirement for more environmental resilience for facilities new and old.

Specific sectors are detailed. U.S. airports serve more than two million passengers every day.  Congestion at airports is growing; it is expected that 24 of the top 30 major airports may soon experience “Thanksgiving-peak traffic volume” at least one day every week. With a federally mandated cap on how much airports can charge passengers for facility expansion and renovation, airports investment needs face a $42 billion funding gap between 2016 and 2025.

American transit systems carried 10.5 billion passenger trips in 2015. This is a 33% increase from 20 years ago, when transit carried 7.9 billion trips, but is 250 million trips less than in 2014 (the Uber effect). 11% of American adults reported taking public transportation on a daily or weekly basis in 2015. Buses are the most common form of public transportation, accounting for approximately half of passenger trips in 2015. The 15 heavy rail (subway/metro) systems comprise the majority of non-bus trips, accounting for over a third of total passenger trips. While transit has higher ridership in urban areas, there are nearly 1,400 public transit systems in rural areas, providing paratransit, bus, commuter bus, and vanpool service.

In 2016 alone, U.S. roads carried people and goods over three trillion miles—or more than 300 round trips between Earth and Pluto. After a slight dip during the 2008 recession, Americans are driving more and vehicle miles travelled is at its second highest-ever level, second only to 2007. More than two out of every five miles of the nation’s urban interstates are congested. Of the country’s 100 largest metro areas, all but five saw increased traffic congestion from 2013 to 2014. In 2014, Americans spent 6.9 billion hours delayed in traffic—42 hours per driver. All of that sitting in traffic wasted 3.1 billion gallons of fuel. The lost time and wasted fuel combine for a total economic impact in 2014 of $160 billion.

Nearly 240 million Americans – 76% of the population – rely on the nation’s 14,748 treatment plants for wastewater sanitation. By 2032 it is expected that 56 million more people will connect to centralized treatment plants, rather than private septic systems – a 23% increase in demand. In the U.S., there are over 800,000 miles of public sewers and 500,000 miles of private lateral sewers connecting private property to public sewer lines. Each of these conveyance systems is susceptible to structural failure, blockages, and overflows.

The U.S. has 614,387 bridges, almost four in 10 of which are 50 years or older. 56,007 — 9.1% — of the nation’s bridges were structurally deficient in 2016, and on average there were 188 million trips across a structurally deficient bridge each day. While the number of bridges that are in such poor condition as to be considered structurally deficient is decreasing, the average age of America’s bridges keeps going up and many of the nation’s bridges are approaching the end of their design life. The most recent estimate puts the nation’s backlog of bridge rehabilitation needs at $123 billion.

REGULATORS GET A PLEA BUT IS IT A ONE OFF?

Aaron Troodler, the former executive director of the Ramapo (NY) Local Development Corp. has pleaded guilty to securities fraud — the first conviction for criminal federal securities fraud in connection with municipal bond issuances, according to a U.S. attorney. The U.S. alleges that Troodler and Ramapo’s supervisor and director of finance lied to investors in the town’s and RLDC’s bonds, some of which were used to finance a minor league baseball stadium, in order to conceal the deteriorating state of Ramapo’s finances and the inability of the RLDC to make scheduled payments of principal and interest to holders of its bonds from its own money.

The fraudulent activity, which included information provided in the preliminary official statement for the bonds, was designed to conceal the town’s deteriorating general fund Ramapo’s primary operating fund. The general fund was estimated to have faced deficits ranging between $250,000 and $14 million between the town’s fiscal years 2009 and 2014. As of August 2015, the town had more than $128 million in outstanding bonds that had been issued for various municipal purposes while the RLDC, which is owned by the town, had issued $25 million in bonds to pay for the minor league baseball stadium.

The fraud preceded the construction of the baseball stadium. Ramapo paid more than half the cost even after the town’s citizens had voted to reject paying for the stadium through bonds in a 2010 referendum.  The finance director had publicly stated that no public money would be used. It is charged that the finance director also lied to agencies which rated the RLDC’s bonds in 2013 when he said the 2012 general fund balance would remain unchanged from the 2011 balance.

The plea is an important step in support of ongoing efforts to improve disclosure and to discourage fraudulent activities by those who issue bonds in the public markets. While it may have required a fairly egregious act of fraud to spur criminal prosecution, municipal investors should take heart that there will finally be real consequences for perpetrators. At the same time our optimism is tempered by the recent moves to replace U.S. prosecutors who have been active in working against municipal securities fraud.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Municipal Credit Consultant

THE HEADLINES…

ACA REPLACEMENT INTRODUCED TO A VERY TEPID RECEPTION

NEW JERSEY

COULD PENNSYLVANIA BUDGET SEE A HIGH FROM MARIJUANA?

PHILADELPHIA BUDGET

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ACA REPLACEMENT INTRODUCED TO A VERY TEPID RECEPTION

Speaker Paul Ryan has finally released drafts of two measures which would dismantle the core aspects of the ACA, including its subsidies to help people buy coverage, its expansion of Medicaid, its taxes and its mandates for people to have insurance. In its place, Republicans would put in place a new system centered on a tax credit to help people buy insurance. That tax credit would range from $2,000 to $4,000 a year, increasing with someone’s age. That system would provide less financial assistance for low-income and older people than The ACA, but it could give more assistance to younger people and those with higher incomes.

Republicans acknowledge that their plan will cover fewer people. House committees are expected to vote on the measures this week, with the full House voting on it soon after that. The repeal of the Medicaid expansion would not take effect until 2020, and the bills would grandfather in current enrollees so that they can stay on the program. But once 2020 arrives, the federal government would no longer provide the extra federal funds that allow for expansion.

Passage is not a certainty in the House. Conservatives in the House Freedom Caucus call the bill’s tax credit is a “new entitlement.”  As for other widely discussed issues, the bill would maintain the ACA’s protections for people with pre-existing conditions, who could still not be denied coverage. Instead of The ACA’s mandate, the bill would seek to encourage healthy people to sign up by allowing insurers to charge people 30 percent higher premiums if they have a gap in coverage.

The measure repeals The ACA’s taxes, such as the medical device tax and health insurance tax, starting in 2018. To avoid one of the most controversial issues, the bill does not include a Republican proposal in earlier drafts to start taxing some employer-sponsored health insurance programs. Instead, the measure would keep The ACA’s “Cadillac tax” on generous healthcare plans starting in 2025 in order to prevent that legislation from adding to the deficit in that decade.

A number of points will prove contentious in the Senate. Four “moderate” Republican senators from states that expanded Medicaid under the ACA have sent a letter to the Majority Leader saying they can’t support a draft House repeal bill because it won’t protect people enrolled in the health entitlement. “We are concerned that any poorly implemented or poorly timed change in the current funding structure in Medicaid could result in a reduction in access to life-saving health care services,” Sens. Rob Portman of Ohio, Shelley Moore Capito of West Virginia, Cory Gardner of Colorado and Lisa Murkowski of Alaska wrote in a letter to Majority Leader Mitch McConnell.

“The February 10th draft proposal from the House does not meet the test of stability for individuals currently enrolled in the program and we will not support a plan that does not include stability for Medicaid expansion populations or flexibility for states.” Nationwide, more than 11 million people got Medicaid through the expansion under The ACA. In Ohio alone, some 700,000 residents obtained insurance because of the state’s expansion.

Senators Capito and Murkowski have been clear in expressing their concerns about the impact on rural healthcare availability under repeal. Other Senate opposition could come from Sen. Orrin Hatch who will not support a repeal which does not include a repeal of all the including the Cadillac tax. The American Hospital Association announced Tuesday its opposition to the GOP’s healthcare reform plan. It referenced the proposal that would strike funding for states to expand Medicaid beyond 2019. The AHA suggested other alternatives, such as greater use of federally approved waivers, which have given states a method to test out different ways to implement Medicaid that maintain the program’s objectives but do not follow federal rules.

“The expanded use of waivers with appropriate safeguards can be very effective in allowing state flexibility to foster creative approaches and can improve the program more effectively than through imposing per-capita caps,” it said. It asked Congress to wait for the Congressional Budget Office (CBO) to score and release estimates on how many individuals the GOP version would cover before moving the bill forward.

The American Medical Association also weighed in. While it agrees that there are problems with the ACA that must be addressed, it cannot support the AHCA as drafted because of the expected decline in health insurance coverage and the potential harm it would cause to vulnerable patient populations. The AMA has long supported advanceable, refundable tax credits as a preferred method for assisting individuals in obtaining private health care coverage. It is important, however, that the amount of credits available to individuals be sufficient to enable one to afford quality coverage. We believe that credits should be inversely related to an individual’s income. This structure provides the greatest chance that those of the least means are able to purchase coverage. The AMA  believes credits inversely related to income, rather than age as proposed in the committee’s legislation, not only result in greater numbers of people insured but are a more efficient use of tax-payer resources.

The AMA policy also supports increased flexibility in the Medicaid program so that states may pursue innovations that improve coverage for patients with low incomes. It expressed concern, however, with the proposed rollback of the Medicaid expansion under the ACA. It urged that that Medicaid, CHIP, and other safety net programs are maintained and adequately funded.

States that did not expand Medicaid

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States that expanded Medicaid

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State, county, and hospital credits will all see a negative impact from the current bill. Less coverage overall and less coverage for low income and indigent patients will strain state and county budgets. Not only will hospitals face lower revenues but greater uncompensated care burdens and a reversal of the trend away from use of the emergency room as the source of primary care. Hospitals in areas which already face service constraints and weaker financial profiles will be placed under additional stress.

There is no official estimate from the Congressional Budget Office, they have no idea yet how much their American Health Care Act costs and how many people might lose their health coverage because of it. Seven Republican senators have gone record opposing parts of the bill. Republicans can lose only two votes in the Senate and still pass the repeal bill through a fast-track process that requires a simple majority vote. The outcome is far from certain.

NEW JERSEY

One of Gov. Chris Christie’s legacies will be his failure to fund or fundamentally restructure his state’s pension underfunding problems. He  used his budget address to one last attempt at addressing government worker pensions, proposing to dedicate revenues from lottery ticket sales to the distressed fund. Christie said pledging the lottery as an asset to the pension fund would have “the same effect as a cash infusion,” slashing $13 billion from the pension fund’s $66.2 billion in unfunded liabilities.

The lottery, which is expected to bring in $965 million this year, helps fund higher education programs, psychiatric hospitals, centers for people with developmental disabilities and homes for disabled soldiers. The lottery, which is expected to bring in $965 million this year, helps fund higher education programs, psychiatric hospitals, centers for people with developmental disabilities and homes for disabled soldiers.

Under the state Constitution, lottery proceeds must be spent on state institutions and state aid for education. The state pays a number of costs on behalf of local school districts that can be categorized as aid, including the employer share of the Teachers’ Pension and Annuity Fund. Under the state Constitution, lottery proceeds must be spent on state institutions and state aid for education. The state pays a number of costs on behalf of local school districts that can be categorized as aid, including the employer share of the Teachers’ Pension and Annuity Fund.

The proposal raised questions about how the services currently funded by lottery proceeds would be funded. Christie contends that the plan  “if implemented correctly, would not only increase the value and stability of the pension funds immediately, but it would also please bond investors and credit rating agencies.” We could not disagree more. Regardless of the funding scheme adopted, a signature feature of the Governor’s tenure has been his consistent failure to fund annual required contributions (ARC). Wherever he finds the money, a payment equal to at least the ARC would be much more impressive to raters and investors alike. funds immediately, but it would also please bond investors and credit rating agencies.

COULD PENNSYLVANIA BUDGET SEE A HIGH FROM MARIJUANA?

Auditor General Eugene DePasquale said Pennsylvania should strongly consider regulating and taxing marijuana to benefit from a booming industry expected to be worth $20 billion and employ more than 280,000 in the next  more sane policy to deal with a critical issue facing the state. Other states are already taking advantage of the opportunity for massive job creation and savings from reduced arrests and criminal prosecutions. In addition, it would generate hundreds of millions of dollars each year that could help tackle Pennsylvania’s budget problems.” “The revenue that could be generated would help address Pennsylvania’s revenue and spending issue. But there is more to this than simply tax dollars and jobs,” DePasquale said. “There is also social impact, specifically related to arrests, and the personal, emotional, and financial devastation that may result from such arrests.”

DePasquale cited Colorado’s experience with legalization. In Colorado’s experience, after regulation and taxation of marijuana, the total number of marijuana arrests decreased by nearly half between 2012 and 2014, from nearly 13,000 arrests to 7,000 arrests. Marijuana possession arrests, which make up the majority of all marijuana arrests, were nearly cut in half, down 47 percent, and marijuana sales arrests decreased by 24 percent.

DePasquale said Pennsylvania has already benefited by some cities decriminalizing marijuana. In Philadelphia, marijuana arrests went from 2,843 in 2014 to 969 in 2016. Based on a recent study, the RAND Corporation estimated the cost for each marijuana arrest and prosecution is approximately $2,200. Using those figures, that’s a savings of more than $4.1 million in one Pennsylvania city. Last year, York, Dauphin, Chester, Delaware, Bucks and Montgomery counties each had more arrests for small amounts of marijuana than Philadelphia. Those counties had between 800 and 1,400 arrests in 2015.

In Colorado, total state revenues from all sources of marijuana sales taxes and licensing fees in 2016 was $119.8 million. This was an increase of 57% above 2015 collections. In Washington state, FY 2017 marijuana sales tax collections are estimated to total $201 million, an increase of over 7% above FY 2016 collections.

We suspect that legalization will not be an easy sell in socially conservative state is wide. The Auditor General’s statement does start a conversation however in a state that faces serious revenue and pension expense issues going forward.

PHILADELPHIA BUDGET

It has only been in place for less than three months and is the subject of pending litigation challenging its validity, but the Philadelphia Beverage Tax is being counted on heavily by the City’s Mayor for three major policy initiatives. Full implementation of the three programs cannot happen, however, until the resolution of litigation brought to try to block the tax. The FY18 Budget and FY18-22 Five Year Plan continue an effort to ensure all three- and four-year-olds in the city can gain access to pre-K through Philadelphia Beverage Tax revenues.

The Philadelphia Beverage Tax revenue also provides necessary revenue to fund a community schools initiative. Over the Five Year Plan, 25 community schools will be created. The third major initiative to be funded through the Philadelphia Beverage Tax is Rebuilding Community Infrastructure (Rebuild), a multi-year program to transform neighborhood parks, recreation centers, and libraries across the city. The tax will support debt service to pay for $300 million in borrowings, which, combined with $48 million in the City’s capital program, will leverage foundation support (such as support from the William Penn Foundation) and funds from other governments to bring the total amount of the program to $500 million.

On September 14, 2016, a lawsuit challenging the PBT was filed by the American Beverage Association and other co-plaintiffs in the Court of Common Pleas. This complaint was dismissed in its entirety by the Court of Common Pleas on December 16, 2016. Following the decision, the plaintiffs appealed the ruling to the Commonwealth Court of Pennsylvania. The appeal is currently on an expedited scheduling track before the Commonwealth Court and is scheduled for oral argument during the first week of April 2017. Until the PBT litigation is resolved, the City will not be able to issue borrowings for the $300 million that it plans to invest in Rebuild. In addition, the City will not be able to use $75 million of William Penn grant funds that are conditioned on bond issuance. An additional $20 million is contingent on funding from other sources, such as grants from other foundations.

Three-quarters of the City’s General Fund revenue comes from local taxes, and 18.5% of this tax revenue is Real Property Tax. In addition, over 60% of the local tax revenue generated for the School District of Philadelphia comes from the Property Tax. The General Fund started FY17 with an unreserved fund balance of $148.3 million and is projected to end FY17 with a fund balance of $100.7 million. The year-end fund balance for FY18 is projected to be $87.5 million. Over the next five years, the fund balance is projected to decrease to a low of $68.7 million in FY20 and then build back up to $101.8 million in FY22. For each year of the plan, the fund balance is below the City’s target. With high fixed costs such as the City’s contribution to the pension fund, the School District of Philadelphia, debt service, and indemnities, other important services and programs are squeezed for resources.

The Philadelphia Municipal Retirement System is currently 44.8% funded with a $6 billion unfunded liability, based on the July 1, 2016 preliminary valuation. Each year, an increasing share of City resources goes towards paying pension costs and therefore cannot be used to provide additional resources for current services or to pay for further tax rate reductions. To address this challenge, the Kenney Administration, working with municipal employees, the Pension Board, and City Council, has launched a three-pronged approach to improve the health of the Pension Fund from 44.8% to 80% in about 13 years.

In 2014, the State Legislature required that the City dedicate a portion of local sales tax revenue to the Fund. Although the additional sales tax revenues could be counted toward satisfying minimum municipal obligation (MMO), the amount required under state law, the City will meet its MMO independent of these revenues, so that sales tax dollars directed to the Fund will be over and above the MMO. Over this Five Year Plan, the sales tax revenues are projected to be worth about $233 million.

Current employees would make additional contributions based on a progressive tiered contribution structure; those with higher annual salaries would pay a higher contribution rate. These additional contributions would increase the assets of the pension fund over time rather than be used to reduce the City’s contribution to the fund. At the same time, newly hired workers would participate in a new, stacked hybrid pension plan. The proposed stacked hybrid plan combines a traditional defined benefit for the first $50,000 of an employee’s pensionable earnings, and an optional 401k, with an employer match, for earnings above this amount.

The Board of Pensions has also been consistently making the Fund’s actuarial assumptions more conservative – reducing the chances of the plan falling short of projected investment returns. Since FY08, the Board has incrementally lowered the assumed rate of return eight times from 8.75% to the current rate of 7.70%. Through consultation with the City’s actuary, the Board also approved changes to make the mortality rate and other demographic factors more conservative. While fiscally prudent, these changes also lower the actuarial funding percentage in the short-term and increase the City’s required contribution. The most recent reduction to the earnings assumption, from 7.75% to 7.70% in February 2017, reduced the funding percentage by 0.02% and increased the MMO by approximately $5 million each year, for an additional $27.6 million over this Five Year Plan (across all funds).

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