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Muni Credit News Week of April 22, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$250,000,000

Michigan Finance Authority

Henry Ford Health System

The system comes to market supported by a rating upgrade from Moody’s. The upgrade of existing ratings to A2 reflects Moody’s view that Henry Ford Health System will continue generating stronger margins and cash flow over the next year, leading to improved leverage metrics and stronger liquidity, despite the additional debt incurred with the proposed bond transaction. Although it expect favorable performance trends to continue in both the provider and insurance divisions, Moody’s anticipates it will take some time for the insurance division to generate consistently stronger margins.

Henry Ford Health System is a large, fully integrated health system based in the Detroit metropolitan area. The system operates five acute care hospitals, two behavioral health hospitals, more than 60 ambulatory care and outpatient service facilities, a sizable health insurance business, and a large employed group physician practice. The flagship hospital, Henry Ford Hospital, is a tertiary/quaternary referral hospital located near downtown Detroit.

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SANCTUARY CITIES

A three-judge panel in a federal appeals court decided unanimously that most of California’s so-called sanctuary laws can continue to be enforced. The decision came in a case brought by the US DOJ against California’s decision to declare itself a “sanctuary state”. The far reaching law prohibits police and sheriff’s officials from notifying federal immigration authorities of the release dates of immigrant inmates.

That provision is of particular concern to sanctuary city opponents, something acknowledged by the court. According to the decision, the law “may well frustrate the federal government’s immigration enforcement efforts. However, whatever the wisdom of the underlying policy adopted by California, that frustration is permissible.” The law also requires that employers to notify workers of inspections by immigration agents.

“Only those provisions that impose an additional economic burden exclusively on the federal government are invalid,” the court said. The court did say that the state, in inspecting federal detention centers, cannot impose requirements on the federal government that will force it to spend money. It did note however, that the law did “not treat the federal government worse than anyone else; indeed, it does not regulate federal operations at all.”

The Trump administration could request an en banc hearing for its appeal. That would require the whole 9th Circuit to review the ruling or ask the U.S. Supreme Court to overturn the decision. If it ultimately stands, the decision would be a victory for those jurisdictions which do not support the specific tactics of the federal government in its enforcement of immigration laws. It would reduce their financial exposure to the threat of cutoffs of funding from the federal government for a variety of purposes including law enforcement.

WHAT’S GOING ON WITH THE CENSUS?

One of the fears going into the 2020 national census has been that urban populations will be undercounted. It is based on a number of concerns not limited to illegal immigration but also to the millennial aversion to answering questions from the government especially if they are not in an online format. Those issues may be superseded by problems already emerging in terms of urban area counting.

Last week, the Census Bureau released its estimates of population trends. It appears that changes in the Bureau’s methodology may be producing less reliable data. The change in methodology meant to make one of the American Community Survey questions less ambiguous. Instead of asking people born abroad when they arrived in the United States, the bureau based its latest count on a more specific question: It asked where they lived a year ago.

That change is being blamed for an effective undercount. Major cities are clearly being impacted regardless of which region is located in. Chicago, New York, Houston, Dallas, greater Los Angeles, and San Diego are among the losers of population. This would seem to run contrary to the prevailing wisdom regarding the attractiveness of cities and the Sun Belt.

It is an important question which needs to be resolved. With localities facing increasing funding demands for issues including transportation, resilience, and adaptation to climate change, accurate data will be essential to allowing these localities to qualify for and receive federal funding under a plethora of programs.

One data point of interest is the growth in exurban areas. It reflects a growing trend of movement to more outlier locations. It is reflected in increased demand for services like rural broadband which support small business establishment and expansion in many rural areas. The Census data shows that many rural areas are experiencing net in migration as individuals seek a lower cost of living especially in terms of housing costs.

ANOTHER STEP ON THE ROAD TO RECOVERY

Stockton, CA saw its rating upgraded by Moody’s. The upgrade to A3 reflects the continued moderate growth in the city’s assessed value and improved financial position supported by healthy reserves and liquidity. The city’s five year average available operating fund balance is strong at 39.6% of operating revenues. The A3 rating incorporates the city’s sizeable and diverse tax base and weak socioeconomic indicators. The rating also reflects the city’s low debt burden and elevated pension burden. Rising pension costs and funding city infrastructure needs will also continue to be budgetary pressures.

The stable outlook reflects Moody’s expectation that the city’s assessed value will continue to benefit from moderate growth and a sound financial position supported by the city’s formal policy of maintaining a working capital reserve at 17%. The move comes even despite court decisions favoring pensioners over debt holders.

THE UBER REALITY

A recent study released by Georgetown University documents a number of hurdles faced by jurisdictions trying to arrive at a regulatory scheme which satisfy the many competing interests resulting from the growth of the ride sharing industry. The study follows a group of drivers working for Uber in the District of Columbia. D.C. has been a leader in efforts to regulate the industry while accommodating some of its realities.

In 2014 the D.C. Council adopted regulations to govern Transportation Network Companies (TNCs). The Vehicle for Hire Innovation Amendment Act of 2014 (“VHIAA”) required background checks, set general vehicle standards, mandated insurance coverage, and arranged for the collection of 1% of gross receipts for all UberX rides provided in the city. The law has weaknesses however. Under the VHIAA, regulatory authority over TNCs was delegated to the Department of For Hire Vehicles. However, the Department is prohibited from requiring companies to submit a list or inventory of vehicles or operators.

To address some of these issues, in 2018 the D.C. Council approved a 6% tax on TNC services to support Metro, and passed a data-sharing requirement for ride-hailing services. The Private Vehicle-For-Hire Data Sharing Amendment Act of 2018 requires quarterly transmissions of data on: numbers of drivers; trip location pick-ups and drop-offs; dates and times of ride requests, pick-ups and drop-offs; total miles driven by drivers en route to a pick-up and during a ride (but not while waiting for a ride request); and average fares and distances driven.

The point of all of this is that even in a jurisdiction which seems to be proactive or ahead of the curve, regulation is a difficult matter. Many of the hurdles to regulation, operations, are imposed by the legislation enacted ostensibly to better regulate the services. Under the 2014 D.C. law, Reports on safety and consumer protection are prohibited from public release. Finally, journalists, researchers, and policymakers may not use the federal Freedom of Information Act to access basic information about the operation of TNCs in its jurisdiction. The 2018 law also seeks to impede inquiries under the Freedom of Information Act.

These provisions support the tendency of TNCs to observe secrecy as a prime modus operandi. It is difficult to square the position of the industry as a positive force when it is so resistant to simple informational requirements. We believe that the tendency towards opacity and secrecy will only impede the growth of technology especially in the transportation sector and its acceptance. Can you imagine if a public transit system refused to make operating data available or did not take responsibility for the background of the individuals it employs?

TOBACCO REGULATION GETS A NEW ALLY

The new realities of the tobacco industry can be summed up in this week’s news that Senator Mitch McConnell will introduce legislation to raise the legal age to buy tobacco from 18 to 21, calling it a “top priority” when the Senate returns from recess in late April. McConnell said he wants to change the law to discourage vaping and teenage nicotine addiction and improve Kentucky’s public health.

The news is interesting from a public health point of view but does little to change the overall trajectory of cigarette sales. The attraction of vaping to the next generation of nicotine consumers is troubling if this becomes the preferred nicotine conveyance method. As for tobacco credits, the preferred return of principal date should still be sooner than later. If anything, the trend towards vaping bodes poorly for those bonds with the longest maturity.

It’s the fact that McConnell represents the nation’s second largest producer of tobacco as much as his Senate leadership position that makes this move especially relevant. It means that he will probably get the bill passed given the bipartisan nature of current tobacco politics. That will address the variety of age-related sale and marketing restrictions existing under the current state based structure. So one gets a bit of regulatory consistency but also gets a bit of pressure on overall sales.

FITCH ON SPECIAL REVENUE BONDS

In response to the March 26, 2019 ruling by the United States Court of Appeals for the First Circuit regarding the bondholder protections provided by special revenue status under Chapter 9 of the U.S. bankruptcy code, Fitch Ratings has developed rating sensitivities corresponding to the likelihood and severity of potential rating changes resulting from a final court ruling upholding the decision.

Fitch Ratings has placed the seven U.S. Public Finance ratings that are more than six notches higher than the Issuer Default Rating (IDR) for the associated local government on Rating Watch Negative. According to Fitch, The ratings placed on Rating Watch Negative have the highest ratings relative to their associated governments’ IDRs. Ratings on special revenue bonds that are closer to the associated government’s IDR are less likely to be affected by a re-evaluation of special revenue protections. While special revenues offer substantial protections in the event of a bankruptcy filing, the ruling creates uncertainty about full and timely payment of special revenue obligations during the bankruptcy of the associated government.

Going forward, Fitch will offer one of three comments regarding the rating sensitivities corresponding to the likelihood and severity of potential rating changes resulting from a final court ruling upholding the decision. Ratings for which the sensitivities are relevant are utility and tax-supported ratings that are higher than but within six notches of the related government’s Issuer Default Rating (IDR).

For special revenue ratings between one and three notches above the IDR: “The rating is unlikely to be affected by a recent ruling by the United States Court of Appeals for the First Circuit regarding the protections provided to holders of bonds secured by pledged special revenues. Fitch believes those protections warrant a distinction in ratings above the IDR regardless of the outcome of the case.”

For special revenue ratings between four and six notches above the IDR: “The rating may be affected by the recent appeals court ruling regarding the protections provided to holders of bonds secured by pledged special revenues. Fitch believes those protections warrant a distinction in ratings above the IDR regardless of the outcome of the case. However, a final decision consistent with the First Circuit’s ruling may result in security ratings closer to the IDR.”

For California school districts with ratings above the IDR that are not currently on Rating Watch Negative because of the ruling: “The rating may be affected by the recent appeals court ruling regarding the protections provided to holders of bonds secured by pledged special revenues. Fitch believes those protections warrant a distinction in ratings above the IDR regardless of the outcome of the case. However, a final decision consistent with the First Circuit’s ruling may result in security ratings closer to the IDR. Given state constitutional and statutory restrictions, Fitch believes potential rating changes would be modest.”

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

Muni Credit News Week of April 8, 2019

Joseph Krist

Publisher

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ISSUE OF THE WEEK

The Brightline debt train finally picked up passengers this past week with a $2.7 billion private activity bond issue. The bonds were said to be strongly oversubscribed with ultimate yields above 6.5% on the long dated maturities. In this market, that represents a significant yield premium even for high yield municipal bond debt generally. That reflects the relatively strong market conditions and generally narrow credit spreads which characterized the municipal market throughout the first quarter of 2019.

The market seems a bit entranced with the participation of Richard Branson’s Virgin Group in the Brightline project. As we pointed out to the Associated Press, “Branson is a huge branding success — and that’s not to say he hasn’t been an economic success,” Krist said, calling him a “genius” when it comes to getting Virgin’s name in front of the public. “His brand as an innovative, somewhat thinking out-of-the-box kind of guy has survived regardless of the absolute level of operating success achieved by his various businesses.” I also noted that while Branson has had success in widely divergent fields, from recording to transportation, his British train operation has had a mixed record over 20 years.

The completion of the financing does answer one major credit concern – will project completion to Orlando be funded? The adoption of the Virgin brand does create some more opportunities for ridership but the risk of underperformance continues to be tipped against the bondholder. Only time will answer the overarching question shadowing the enterprise – has the municipal market once again fallen for a technology and a plan which supposedly wiser heads chose to decline participation in?

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HEALTHCARE TECH GETS A GENTLE NUDGE

Those who subscribe to economic nudge theory will be heartened by the news that the Centers for Medicare and Medicaid Services is moving to expand the range of beneficiaries eligible for telemedicine benefits. Telemedicine has been proceeding forward at a less than rapid pace and the move by CMS to nudge hospitals to more widely adopt the services is seen as enhancing the adoption of the technology on a wider scale.

The new rule, scheduled to go into effect in the 2020 plan year, will allow Medicare Advantage to offer telehealth services as part of their basic benefits package, providing patients more options to receive healthcare services from locations like their home. This is a significant change from current policy which historically had been limited to beneficiaries in rural areas with limited access to brick-and-mortar care facilities.

Medicare Advantage plans previously had the flexibility to provide telehealth services under their supplemental benefits banner. The new rule shifts remote visits to a core part of the benefits covered by CMS. Under the current rules MA plans are not permitted to directly allocate federal dollars to telehealth services.

CONGESTION PRICING – CREDIT POSITIVE?

There seems to be a discernable wave of academic/professional support for the congestion pricing proposal adopted by the NYS Legislature. We choose our words carefully as it is important to emphasize was that what was approved was a serious concept but nowhere near a detailed plan. The devil as always will be in the details and significant interests have staked out potentially difficult implementation issues.

Despite the lack of detail – the level of charge and the potential exemptions from the base – are the most prominent issues to be left to an “independent” board. The likelihood is that a plan will be adopted and implemented by the scheduled January 1, 2021 start date. It is likely that there will be substantial exemptions for a variety of transit cohorts so it is difficult to estimate a real sustainable revenue stream the plan will provide.

If it succeeds in reducing congestion in a meaningful and clearly manifest way, than congestion pricing will be credit positive for a variety of New York credits including those of the City and State of New York. Recently, Moody’s indicated that it views a congestion pricing plan as credit positive. We agree with a significant amount of Moody’s comments in support of its view. We differ in that in the absence of real details about who pays how much under whatever final scheme emerges, we are less comfortable estimating future funding realities and their implications for the MTA credit and that of its related credit partners.

ONE SMALL COLLEGE FIGHTS THE TREND

One college in New Rochelle NY is in the news for its announced closing and criminal financial mismanagement. It could be just one more chapter in the recent history of small college financial difficulties. There are always exceptions to trends. In this case one does not have to leave New Rochelle to find another small college with a credit that is on the way up.

Moody’s Investors Service has revised Iona College, NY’s outlook to positive from stable and affirmed the Baa2 rating on roughly $74 million of outstanding revenue bonds. According to Moody’s, ” The revision of the outlook to positive incorporates the combination of continued solid operating cash flow, material growth in flexible reserves fueled by retained surpluses, and modest but steady debt reduction achieved over the past several years. The college’s management has a track record of strong fiscal discipline, consistently generating robust debt service coverage. This is particularly impressive given that the college’s student market position, which accounts for over 80% of revenue, is experiencing strong competition and has limited ability to generate net tuition revenue gains. That competition is reflected in a very high selectivity rate of 88%, a very low matriculation rate of 9.6%, and volatility in enrollment and net tuition revenue. Despite those challenges the college’s liquidity continues to improve and its spendable cash and investments provide a good cushion to debt and expenses.”

COMMUNITY HOPSITAL FIGHTING CHOPPY WATERS

Milford Regional Medical Center is a 145 bed community hospital located approximately 40 miles southwest of Boston and 15 miles southeast of Worcester, Massachusetts. The obligated group also includes Milford Regional Physician Group (MRPG), a multi-specialty physician group practice with 94 employed physicians across multiple sites. It has some $102 million of debt outstanding rated below investment grade at Ba2 after a recent downgrade.

Like so many hospitals of this size, high financial leverage id a significant issue. At the same time, incremental debt borrowings associated with a new IT project hurt the credit but are likely necessary as technology becomes more and more prominent in the provision of direct patient care (see our earlier comments on CMS changes in funding) . It competes with the high level Boston institutions for patients but struggles with its ultimate level of profitability. Ultimately, significant profitability is not likely.

SINKING FERRY SERVICE

The NYC Comptroller has proposed that the city’s Department of Transportation “immediately explore” taking over NYC Ferry. The DOT, he said, already has experience running the 202-year-old Staten Island Ferry and could improve the efficiency of NYC Ferry’s six routes. The service has been controversial due to the high level of subsidy provided by the City to support low fares on the ferries.

The Citizens Budget Commission found the ferry service costs city taxpayers $10.73 per ride, compared to $1.05 for each subway ride. Critics have noticed that the contract with the operator finds the City having committed to buy boats from the operator. Recent press reports indicate that a runner-up bid for the ferry contract could have saved money by providing its own boats. The contract was won with a bid that was about $30 million lower than its competitor’s. But that bid left city taxpayers on the hook for $232 million to purchase 38 vessels, with another $137 million allocated for future ferry purchases.

It is one thing to push for expanded means of public transport. It is another to be open about the full economic implications of any alternative transit program. In this case the continued level of high individual ride subsidy indicates that the economics of public ferry service at its current scale just does not make a lot of sense. It makes less sense when that level of individual ride subsidy applied to the subway would fund lots of capital upgrades.

METRICS MATTER IN A DATA DRIVEN AGE

One of the challenges facing the municipal market is the increasing reliance on data by all participants – underwriters, raters, investors, analysts – to evaluate the creditworthiness of borrowers and to accurately price risk. When municipal bonds come under attack as they did in the tax cut debate in Congress in 2017, it is often hard for proponents of municipal bonds to make the case for the positive impact of municipal bonds on society as a whole.

So in the middle of this kind of debate, it is important that cities and other borrowers employ data to monitor performance and impact of major programmatic initiatives. That is why it is so disappointing to see the lack of such data on two major program initiatives undertaken by NYC mayor Bill DeBlasio and his wife Chirlaine McCray. Recent hearings conducted by the NYC Council shined a spotlight on the difficulties facing those seeking to evaluate the efficacy and impact of large social service programs.

In 2017, The Mayor announced New York Works, a plan to create 100,000 jobs paying an average of $50,000 per year. The $850 million initiative should be subject to normal oversight with metrics established to measure to efficiency and impact of that level of spending. Alas that is not the case. Officials from the Economic Development Corporation, the agency charged with delivering upon the mayor’s plan say it is “impractical for the city to track specific jobs created.”

The second program is Thrive NYC, a program with the very laudable goal of increasing awareness and treatment of mental health issues especially among lower income residents. Led by the Mayor’s wife, that program has received some $250 million in funding. Recently, the NYC Council criticized the management of the program citing a lack of transparency as to spending and programmatic results.

These two programs are in the spotlight in the wake of the ending of a program known as Renewal. Renewal was an effort to turn around failing schools that cost $773 million over three years but improved only a quarter of the schools in the program. That program was also plagued by a lack of good supporting data.

Why do we care? The three programs have in common high levels of spending, poor results relative to promises, and questionable management. “Renewal Schools is failing to renew. ThriveNYC is failing to thrive and New York Works is failing to work,” according to one Councilperson, “because there is a pattern of failing to measure outcomes.” It is not an accident. According to the NY Times, officials from the economic development agency said they had chosen “not to burden” companies “with tracking every single job created by their actions,” since “further actions” are often required by the city’s partners to create the jobs.

In today’s market, a municipal borrower just cannot consume resources without some accountability to those who provide those resources. If you wonder why there is such suspicion about the implementation of things like congestion pricing to fund mass transit, look no farther than the Mayor’s office and its lack of data transparency to understand why.

Muni Credit News

The Muni Credit News is moving its headquarters and will not publish this week. See you in April.

Muni Credit News Week of March 18, 2019

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$120,000,000*

IOWA FINANCE AUTHORITY

Midwestern Disaster Area Revenue Refunding Bonds

(Iowa Fertilizer Company Project)

The Authority is issuing refunding bonds now that the facility is operational and has established at least a short-term financial track record. The Bond’s B- rating from Fitch was recently affirmed and its outlook was upgraded to positive. The Positive Outlook reflects the project’s successfully resolved ramp-up issues, and is operationally positioned to benefit from an improving pricing environment assuming it can maintain its operating profile and control costs while favorable pricing trends endure.

Commodity pricing risk remains as an important credit dampener as IFCo sells its nitrogen products to farmers, distributors, wholesalers, cooperatives, truck stop operators and blenders at market prices. The project’s main products have historically exhibited considerable price volatility. The project’s ability to meet ongoing mandatory debt payments is vulnerable to product pricing remaining at current depressed levels on a sustained basis.

The project has been operating for almost a year and a half, and after encountering some ramp-up issues has achieved higher than nameplate capacity on its production lines. The pricing of nitrogen products is somewhat correlated to the price of feedstock, which may be oil, coal or natural gas depending on the region and producer. In recent years, the substantial declines in oil and natural gas prices have driven nitrogen prices to levels approaching 10-year lows. In 2018 the project’s actual DSCR was 1.5x compared with last year’s base and rating case expectation at 2.3x and 1.5x for that year, although actual result is weighted down by early ramp-up issues in 2018. The project realized higher revenues but also incurred higher expenses.

The project has passed a key milestone with construction completion and operability achieved. Now the risk focus turns to the ability to maintain operating reliability and the achievement of assumed project results in the face of product price pressures.

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CALIFORNIA

California’s total revenues of $5.51 billion in February were lower than forecasted in the governor’s proposed 2019-20 fiscal year budget by $1.34 billion, or 19.5 percent, and in the FY 2018-19 Budget Act by $2.01 billion, or 26.7 percent. Two-thirds of the way through FY 2018-19, total revenues of $79.93 billion were lower than expected in the proposed and enacted budgets by $4.20 billion and $3.33 billion, respectively. For the fiscal year to date, state revenues are 1.4 percent lower than the same time last year.

Last month, sales and corporation taxes –– two of the state’s “big three” revenue sources –– came in higher than assumed in the governor’s proposed budget released in January. For February, personal income tax (PIT) receipts of $1.39 billion were $1.82 billion, or 56.6 percent, less than the Department of Finance forecasted in January; and they were $2.05 billion, or 59.5 percent, lower than assumed in the budget enacted last June. In the current fiscal year, PIT is 6.0 percent below the FY 2018-19 budget forecast.

Sales tax receipts of $3.76 billion for February were $407.7 million higher than anticipated in the proposed FY 2019-20 budget but $58.3 million less than expected in the FY 2018-19 Budget Act. Corporation taxes of $258.4 million in February were 59.8 percent higher than estimates in the FY 2019-20 proposed budget and 78.5 percent higher than in the enacted FY 2018-19 budget.

AIRBNB UNDER THE TAX GUN

The ongoing battle between Airbnb, its clients, and those who use it to book rooms continues to rage. The company is fighting ongoing efforts by law enforcement in New York City to force property owners and renters to comply with various laws regulating short term rentals. Charges were recently filed against real estate brokers who were violating those regulations. Other municipalities are following a different tactical approach.

In New Jersey, the state enacted a tax on those who use internet based services to rent out their homes last fall. Anyone using short-term rental booking websites will have to collect the state’s 6.625% sales tax and the 5% hotel occupancy fee, in addition to any fees a municipality has in place. It is designed to level the playing field by imposing the same taxes and fees that hotels and motels currently must pay to the state on “transient accommodations,” or residences used as temporary lodging.

Miami Beach is undertaking a stricter level of enforcement of its laws covering short-term rentals. Currently, the city is taking a non-financial approach with code enforcement officers directly contacting individuals on either or both sides of an Airbnb transaction.

REAL ESTATE COULD FUND TRANSIT IN NEW YORK

The battle to find funding for needed repairs to New York’s battered mass transit system is opening on a new front. New York is poised to become the first US city to levy what is known as a pied-à-terre tax. A pied-à-terre tax would institute a yearly tax on homes worth $5 million or more, and would apply to homes that do not serve as the buyer’s primary residence. The office of the city comptroller, Scott M. Stringer, estimated that a pied-à-terre tax would bring in a minimum of $650 million annually if enacted today.

Supporters would like to see the proceeds of the tax dedicated to funding mass transit. The revenue stream could be pledged to support bonds issued to finance capital projects. One version would establish a scale based on value. For properties valued between $5 million and $6 million, a 0.5% surcharge would be added on the value over $5 million. Fees and a higher surcharge would apply to homes that sold for more than $6 million, topping out at a $370,000 fee and a 4% surcharge for homes valued at more than $25 million.

The issue reflects the politics around a number of issues at the core of New York politics – income inequality, wealth concentration, real estate and housing prices, and the perception of diminishing housing affordability. The recent closing on the purchase of a $238 million apartment on Central Park South by a hedge fund billionaire with an estimated net worth of $10 billion, may have helped make the legislation more feasible.

MEDICAID WORK RESTRICTIONS COMING TO OHIO

Starting in 2021, Medicaid beneficiaries ages 19 through 49 in Ohio will need to work, attend school, volunteer or attend job training for at least 80 hours a month to remain in the health care program. Beneficiaries who do not meet the requirements for 60 days will lose their coverage. This continues the trend of conservative states seeking to restrict Medicaid spending by making it harder to expand.

There is one key difference on Ohio – people who lose coverage in Ohio will be allowed to immediately reapply for enrollment. Approval does not always result in the implementation of these changes. Only Arkansas has implemented their requirements. The backlash against the resulting cuts in enrollment have been widely criticized. In Ohio, the state estimated that just over 18,000 people — about half the people who will be subject to the work requirements— will lose coverage. The requirements won’t apply to adults who are disabled, pregnant women, children, caretakers or people living in parts of the state with high unemployment.

The approval of work requirements was expected with the appointment of a former aide to Vice President Mike Pence. The latest approval comes at the same time that a federal judge who is overseeing court challenges to Arkansas and Kentucky’s work requirement scheme , said he will decide by April 1 whether to block further implementation in Arkansas and if the rules should be struck down in Kentucky.

FREE TUITION TAKES ANOTHER STEP

The state supported University of Tennessee will begin providing free tuition to students from low-income families. The policy will apply to students who are in-state and whose families make a combined annual income of less than $50,000 per year. The program is named UT Promise. Launching in fall 2020, this innovative last-dollar scholarship will guarantee free tuition and fees to qualifying Tennessee residents enrolling at UT campuses in Knoxville, Chattanooga and Martin. UT Promise is an expansion of scholarship offerings and does not replace existing scholarships.

Free tuition and fees (will be applied after all other financial aid is received) for in-state students meeting all of the following criteria which include meeting the academic qualifications of the University. As for the question of how this will be paid for, The University of Tennessee Foundation will simultaneously launch the UT Promise Endowment campaign to help fund this initiative. In the interim, the University will cover the cost.

CONSOLIDATION TO BE CONSIDERED ANEW

In many cases, analysts can effectively cite consolidation of government functions into county governments as transfers and/or partnerships have provided real efficiencies and savings. Now a new candidate is emerging to see if the idea could prove to be a major improvement to the fiscal structure of Puerto Rico. Puerto Rico Gov. Ricardo Rosselló announced that before the current legislative session goes into recess June 30, he will be introducing a measure to create counties on the island.

The governor’s office estimated that the proposal could result in about $800 million in savings. The approval process will be difficult however with entrenched interests in maintaining the status quo. Supporters cite the difficult financial position of many of the Commonwealth’s 78 municipalities. Nonetheless, many existing government officials fear the loss of position and the many “perks” that go with them.

UNIVERSITY OF PUERTO RICO – COLLATERAL DAMAGE

Among the many challenged quasi-governmental entities, the University of Puerto Rico stands out. The UPR’s 11 campuses are on show cause for lack of compliance with the Middle States Commission on Higher Education (MSCHE) Requirements of Affiliation 11 and 14, which address financial planning and documentation, and access to information, respectively. The UPR is also in non-compliance with the Standard of Accreditation VI, which pertains to financial resources.

While the requirements refer to apparent internal issues regarding long-term financial planning, as well as not submitting financial statements on time, for the Standard of Accreditation VI the Middle States has concerns about the ability of the UPR to have enough resources to fulfill its mission, given the budget cuts it has experienced and the ones expected in the fiscal plan approved Oct. 23, which drops its central government allocation from about $650 million for fiscal year 2019 to $441 million for fiscal 2023.

Middle States requested, among other documents, for “updated information on the impact of the Fiscal Oversight Management Board’s plan and proposed restructuring on the institution’s status and finances.

Muni Credit News Week of March 11, 2019

Joseph Krist

Publisher

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NEW JERSEY BUDGET

Governor Phil Murphy released his second budget. It includes appropriations totaling $38.6 billion, with a projected surplus of $1.16 billion and projected savings of $1.1 billion. The plan would increase funding for NJ TRANSIT, boost school funding, and provide local property tax relief through the Homestead Benefit Program.

The Governor claims $1.1 billion in real and sustainable savings, including nearly $800 million in public employee health benefit cost savings and over $200 million in departmental savings. It reduces one-shot revenues to just 1.7% of the total budget, a reduction of $400 million from the current budget and half of the average of 3.4% under the previous administration.

The budget includes an additional $100 million in General Fund support for NJ TRANSIT, for a total subsidy of $407.5 million. Of this, $75 million will replace diversions from other sources and $25 million represents new direct funding. In addition, NJ TRANSIT will not raise commuter fares in FY2020.

The Governor proposed applying the millionaire’s tax enacted in FY 2019 to all millionaires. The budget projects a surplus of $1.2 billion for FY2020, and expects to close FY2019 with a surplus of more than $1 billion. The budget also counts on revenues from the legalization of recreational marijuana. Enactment has been much more difficult than originally expected (it was planned for January 1 of this year.)

NYC BUDGET

The NYC Independent Budget Office (IBO) has released its analysis of the Mayor’s proposed FY 2020 budget.Under the Mayor’s plan, the continued growth in the size of the budget is largely driven by three factors: debt service, salaries, and fringe benefits. The financial plan estimates obscure the total size of the budget in each year by not accounting for the use of $4.6 billion of 2018 resources to pay for 2019 expenses and the use of $3.2 billion of 2019 resources to prepay some 2020 expenses. Adjusted for prepayments, IBO project that the 2019 budget will total $93.7 billion (6.2% larger than the 2018 budget after adjustments) and the 2020 budget will reach $95.9 billion (an increase of 2.4% from 2019).

With revenues from the city’s tax on personal income rising nearly 21% in 2018, overall tax revenue growth was boosted to 8.5%. As expected, tax revenue growth has slowed and IBO now projects an increase of 3.6% this year, with collections net of refunds totaling $61.0 billion. Growth is expected to be slightly higher in 2020 (4.0%), yielding $63.5 billion. For the remaining three years of the financial plan IBO forecasts that growth in tax revenues will average 3.6% annually with revenue reaching $70.5 billion by 2023. Continued strength in the property tax and—to a lesser extent—growth in the general sales and unincorporated business taxes will offset weaker growth in the personal income tax (annual average of 1.4% between 2018 and 2023).

Based on the proposals included in the Mayor’s Preliminary Budget and IBO’s re-estimates of city spending and revenues, IBO projects that the budget for 2019 will end with a surplus of $3.4 billion and 2020 with a $722 million surplus. Assuming the 2020 surplus is used to prepay expenses in the following year, it forecasst budget gaps of $1.97 billion in 2021 (2.7% of projected city–funded expenditures), $1.84 billion in 2022 (2.4%), and $1.62 billion (2.1%) in 2023.

Between 2018 and the final year of the financial plan agency expenditures will increase an average of 2.1% annually. The large increase in agency spending between 2018 and 2019 is primarily due to the settlement of the city’s labor contracts. In June 2018 the city settled its labor contract with DC 37, which provided for 7.42% compounded wage increases over a 44-month period—2.0% for the first 12 months, 2.25% for the next 13 months, and 3.0% for the remaining 19 months. This contract set the wage increase pattern for the remaining city unions.

In order to fund this pattern the city added resources in 2019 through 2022 over and above what had previously been budgeted in the labor reserve for this round of settlements. The steep increase in 2019 agency costs reflects the cost of retroactive wages resulting from the settlement of these contracts as well as retroactive payments made for previous contracts, in particular for the United Federation of Teachers (UFT). After 2019, agency expenditure growth will average 1.0% annually.

In 2018 the city spent slightly under $10 billion in fringe benefit costs; in the current year these costs are expected to be $10.9 billion, and by 2023 they are estimated to increase to nearly $13.4 billion, an annual growth rate of 6.2%. IBO estimates that health care costs, by far the biggest component of fringe benefits, will grow at a rate of 5.8% during the same period, from $6.2 billion in 2018 to $8.2 billion by 2023. Debt service is projected to grow at an average annual rate of 8.4%, from $6.1 billion in 2018 to $9.1 billion in 2023, an increase of over $3.0 billion. In contrast, from 2014 through 2018 actual debt service costs increased by an average of 2.3% annually, from $5.5 billion to $6.1 billion. Debt service on new long-term bonds during the plan period is estimated to add approximately $2.0 billion in costs by 2023, net of any savings accrued from the retirement of older debt and refundings. $36.8 billion the total amount of new long-term debt the city plans to issue through 2023 would greatly exceed any previous five-year period.

Pension costs are often cited as a primary driver of expenditure growth, although in recent years they have accounted for less of the growth than debt service and fringe benefit costs. In 2018 the city spent $9.6 billion on pension costs. OMB estimates that the city’s pension costs will increase to $9.9 billion in 2019, $10.0 billion in 2020, and $11.1 billion by 2023, an average growth rate of 2.8% from 2018 through 2023. The current rate of growth in pension costs is greater than at this time last year, with the increase primarily attributable to the recent contract settlements. In the November plan an additional $1.1 billion was allocated for pension costs across the plan period to cover the pension costs associated with the salary increases included in the settlements. Excluding the pension increases attributable to the recent contract settlements, annual growth in city funded pension expenditures over the plan period would have averaged 1.5%.

GET THE LEAD OUT

Here’s a potential source of issuance going forward. The Minnesota Department of Health estimated last week that it could cost up to $4 billion over two decades to replace lead pipe from drinking systems. In 2012 the Centers for Disease Control and Prevention determined that there is no level of safe exposure. An estimated 100,000 old lead service lines remain across Minnesota primarily in Minneapolis (60,000), St. Paul (28,000) and Duluth (5,000).

The State is considering whether to finance the costs of pipe replacement through bonds issued for and secured by the Drinking Water State Revolving Fund. Funding the repairs will be important as replacing lead service lines can cost a homeowner anywhere from $2,500 to more than $8,000 per line. A program in Saint Paul covers half the cost of a residential replacement. Unfortunately, fewer than half of residents choose to pay the $3,000-$4,000 required to address their half of the work.

SMALL COLLEGE PRESSURES CONTINUE

The National Center for Education Statistics annually compiles statistics to project the demand for college enrollment in the US over an extended period. The newest report estimates demand through 2027. NCES is the primary federal entity for collecting, analyzing, and reporting data related to education in the United States and other nations. It fulfills a congressional mandate to collect, collate, analyze, and report full and complete statistics on the condition of education in the United States; conduct and publish reports and specialized analyses of the meaning and significance of such statistics; assist state and local education agencies in improving their statistical systems; and review and report on education activities in foreign countries.

Total public and private elementary and secondary school enrollment was 56 million in fall 2015, representing a 3% increase since fall 2002. Between fall 2015, the last year of actual public school data, and fall 2027, a further increase of 4% is expected. Both public and private school enrollments are projected to be higher in 2027 than in 2015. Public school enrollments are projected to be higher in 2027 than in 2015 for Blacks, Hispanics, Asians/Pacific Islanders, and students of Two or more races. Enrollment is projected to be lower for Whites and American Indians/Alaska Natives. Public school enrollments are projected to be higher in 2027 than in 2015 for the South and West, and to be lower for the Northeast and Midwest.

Enrollments are projected to be higher in 2027 than in 2015 for 33 states and the District of Columbia, with projected enrollments 5 % or more higher in 24 states and the District of Columbia; and less than 5% higher in 9 states. Enrollments are projected to be lower in 2027 than in 2015 for 17 states, with projected enrollments 5% or more lower in 10 states; and less than 5% lower in 7 states. Public elementary and secondary enrollment is projected to decrease 4% between 2015 and 2027 for students in the Northeast; decrease 1% between 2015 and 2027 for students in the Midwest; increase 9% between 2015 and 2027 in the South; and increase 2%between 2015 and 2027 in the West.

The data drives one to the conclusion that the pressure on small independent colleges will not abate. It also shows that the risk is likely to be geographically concentrated as well. Unsurprisingly, much of the risk is concentrated in New England and the Rust Belt. The locus of small colleges and declining overall demographics are bound to increase the competitive pressures for small colleges with limited scale or ability to attract students from outside their region. These overwhelmingly private tuition dependent institutions will be hard pressed to fund operations in the face of demand trends dampening demand.

CANNABIS LEGALIZATION

Efforts continue on two fronts to advance legalized marijuana through the legislative process rather than through the ballot process. Florida senators voted 34-4 to remove the current ban on smokable forms of medical marijuana. The law currently only allows patients to use cannabis oils and baked goods. In 2018 – the year following a ballot initiative which legalized medical marijuana – state lawmakers passed measures to ban the sale of smoking products, saying that patients could use medical marijuana through other methods, such as vaping, food and oils.

A Leon County Circuit Court Judge ruled that the ban was unconstitutional. The sponsor of the ban on smokable marijuana has said that it was “time to move on.” The Governor said that he will not would not appeal the decision if the state legislature passed a new law by March 15.

In New Mexico, the House of Representatives voted to legalize marijuana for recreational purposes. The outlook for the bill in the State Senate remains uncertain. It is a compromise designed to address Senate concerns and it includes state-run marijuana stores, something that has not yet happened in other legalization states.

Muni Credit News Week of March 4, 2019

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$173,500,000

FLORIDA DEVELOPMENT FINANCE CORPORATION

SOLID WASTE

DISPOSAL REVENUE BONDS

(SOUTHEAST RENEWABLE FUELS, LLC PROJECT)

Coming to a high yield portfolio of yours could be a piece of this issue. This meets all of the traits of a muni high yield deal complete with (for many investors) a less familiar technology and product, a bit of speculation, construction risk, commodity price risk, and operating risk.

The project is designed to convert waste fiber from a variety of sources: biomass, sugar cane waste, and sorghum. The plant will take the fiber product and convert it into pulp usable to produce certain forms of paper packaging. Currently, the technology is in operation in Asia and Europe but is still in the construction stage in the US.

Revenue for the project and ultimately payment of debt service will be produced through the sale of the final pulp product. A contract with an entity to distribute the product is in place and that party guarantees to purchase amounts equal to some 38% of the project’s capacity.

As is always the case with these projects, the risk is borne by the investor. It is a true project financing with the only revenue available for debt service derived from the operation of the facility and sale of the product. There some performance guarantees but there are no direct financial guarantees. All of this is reflected in the Limited Distribution to Qualified Investors and $100,000 minimum denominations.

In reality these Qualifies Investors will largely be representing retail investors who may or may not understand what they own.

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AIRPORT BONDING NEEDS

The Airports Council International has released the results of a survey of the capital needs facing airports in the United States. In 2017, 1.7 billion passengers and 31.7 million metric tons of cargo traveled through U.S. airports. The Council estimates that America’s airports are facing more than $128 billion in new infrastructure needs across the system and a debt burden of $91.6 billion from past projects. That’s about a 28 percent bump up from ACI-NA’s last study. The Council uses their data to support increases in PFC’s. The Council cites the fact that the PFC cap – last adjusted in 2000 – has seen its purchasing power eroded by 50% in the past two decades.

The Council takes the position that modernizing the federal government’s PFC cap is the simplest and most free-market option for providing airports with the locally controlled self-help they need to finance vital infrastructure projects. They view PFCs as locally generated revenues used for “local” projects. The airline industry to say the least disagrees. Airlines for America takes the view that “PFCs are nothing more than a tax on travelers — a tax that isn’t needed considering there’s almost $7 billion in the Aviation Trust Fund which airports can access.”

The debate comes in parallel with the debate being played out in the Congress. The House Transportation Committee chair and Aviation Subcommittee co-chair are on the record in favor of an increase in the cap on PFCs. “A number of airports are bonded out, and in order to issue new bonds and do additional capacity or terminal work,” they need the cap raised, Chairman DeFazio said. “And we’re still working on the details of what that might be.” The subcommittee chair mentioned hiking the cap to $8.50. It’s now $4.50 per flight segment.

O’HARE HYPERLOOP DYING ON THE VINE

One immediate result of the Chicago mayoral race is that the future of the O’Hare hyperloop project was a loser along with the fifteen candidates who did not qualify for the runoff. In June, Musk and his Boring Co. were selected to build the underground tunnel system where passengers would be transported between Block 37 in the Loop and O’Hare Airport in just 12 minutes each way. On its website, Musk and The Boring Co. said that passengers would be transported by electric skates that can travel at speeds of up to 155 miles per hour. “It will take 12 minutes to travel from O’Hare to downtown. The Chicago Express Loop is three to four times faster than existing transportation systems between O’Hare Airport and downtown Chicago.”

Neither of the two candidates remaining in the race is viewed as a supporter of the project. It is true that the project as proposed by Musk would be 100% privately funded. The reality is that the project is competing for political bandwidth along with issues like taxes, schools, public safety, and pension funding.

CANNABIS IN ILLINOIS

One of the sources of potential new revenue for the State of Illinois is the tax revenue which is expected to be generated from the legalization of recreational marijuana. Proponents were heartened by the release of the results of a survey commissioned by the state legislature. A private sector consultant has developed data around the issue of demand and the industry’s ability to meet that demand and enable the legal market to overtake the illicit market.

That study showed that demand could be as high as 550,000 pounds a year, far more than the state’s licensed growers can supply. The 16 licensed growers in the state would take issue with that. The study projects demand based on information generated from a survey of those who were willing to respond and ‘admit” current marijuana use. The survey says current growers could meet only 35 to 54 % of demand if recreational marijuana were legalized.

The study follows one conducted by Illinois NORML which says the state has the most expensive marijuana in the country and is already seeing shortages of some products for medical customers. That study suggested licensing more cultivators and allowing existing dispensaries to begin growing marijuana, since they have already been vetted and authorized by the state to handle the drug.

The findings will be seized upon by those who believe that the issues of incarceration resulting from past drug law enforcement should be addressed through the licensing of many smaller growers and distributors. If the expected market were fully met, the report says, the state could collect at least $440 million annually in tax revenue. Sponsors of a bill to legalize recreational cannabis have said they plan to introduce a proposal in March or April. If it becomes law, recreational sales might not start until 2020.

The issues at play in Illinois are being replicated across the country. The idea of conflating marijuana legalization with the issues of judicial and correctional reform, and the emerging issues of reparations has seriously compromised debate on the issue. These factors are holding up legalization for recreational purposes in New York and New Jersey.

THE CREDIT IMPACT OF THE DECLINE OF COAL

Much of the focus of public opinion on the issue of coal consumption and its role in climate change is on the environmental aspect of the issue. For municipal investors, the decline of coal has other consequences. The immediate impact of declining coal production is the decline in the level of revenues derived from severance taxes. In Kentucky, state government collects the coal severance tax and makes distributions to counties. Supported spending includes road maintenance and construction of 11 regional industrial parks, education programs, mine safety research and workers’ compensation for injured miners, water and sewer infrastructure, and facilities like senior centers, community centers, and cemeteries. Localities also used a portion of the coal severance tax to pay for law enforcement, and waste management.

Now the counties and localities are feeling the pinch. In 2012, Kentucky distributed $32.2 million back to 29 coal-producing counties. That amount fell to $12.4 million in 2018 — a 61% decline in six years. In Virginia, where severance taxes are levied on coal and natural gas producers, the Virginia Coalfield Economic Development Authority, funded by a portion of the coal and natural gas severance tax, saw the tax drop 62% from 2011 to 2017.

For localities, the cuts have been painful. The decline in production also lowers the value of the property used in coal production. The lower severance revenue represents a double whammy for localities which face both the cuts as well as a diminished tax base against which they can generate replacement revenues. They also generate population declines which diminishes the job base and the overall economic base which generates revenues.

MOODY’S SENDS MIXED SIGNALS ON NEW YORK CITY

When Amazon backed out of its deal with New York City and State, Moody’s was quick to describe the situation as credit negative for the city. They were concerned about what message the City was sending to the tech industry and whether the City was becoming less business friendly. They expressed concern about the City’s ability to diversify its economy going forward. So now, just a couple of weeks later, Moody’s has taken the opportunity to revisit the credit. In the interim, the Amazon deal may be showing signs of resuscitation and the City is preparing for reduced revenue growth stemming from the late 2017 federal tax law changes.

So we question the basis for this week’s upgrade of the City’s GO credit. The Mayor’s supporters are latching onto this as proof that the Mayor is managing the City responsibly. The City still faces significant capital demands, directly for its public housing stock which is now being operated under a consent decree by a temporary manager. It can expect to be called upon to make significant additional funding actions to support the MTA’s massive capital plan.

The issues cited – strong financial management and steady improvement in its financial position that reflect greater flexibility to react to the next downturn – were questioned this week by the City’s Controller who questions the City’s reserve position in the face of a growing consensus around a recession occurring by 2020. The report references lower benefit costs but simultaneously expresses concern about rising healthcare expenses.

It is confusing to say the least. Given where the State and City are in their budget processes, the upgrade might make more sense once those processes are completed and a clearer picture of the economic outlook emerges. It might also makes more sense if it did not accompany real questions about recent new spending on education and mental health which clearly did not and is not achieving its goals. The inability to show any tangible results for some $1 billion in new spending should be concerning to all.

EDUCATION: PUBLIC VS. CHARTER

The issue of charter schools versus public schools continues to be debated. Municipal bonds investors have the opportunity to invest in both as well as in one or the other. In determining whether to invest it is best to understand the continuing dynamic between the two school philosophies.

One of the issues which has often hindered the debate is the issue of standards and comparability. Now, California is poised to take the lead in the development of common sets of standards for both types. Last week, A proposal championed by Gov. Gavin Newsom to require new transparency standards for charter schools across California was passed by state legislators. Senate Bill 126 codifies a recent opinion from California Atty. Gen. Xavier Becerra that governing boards of charter schools should be subject to the same open-meetings laws and conflict-of-interest standards as public school districts.

The California Teachers Assn. endorsed the measure and the charter school groups involved took a neutral position. Charter school supporters spent heavily in the 2018 election cycle in favor of opponents of the new Governor. Their lack of a position on this issue and support for two teacher job actions in large districts created the political dynamic that supported passage.

Now the state and its school systems must find ways to increase the funding needs stemming from settlement of the labor disputes.

Muni Credit News Week of February 25, 2019

Joseph Krist

Publisher

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CONNECTICUT BUDGET

With a new administration taking hold in the Nutmeg State, investors hope to see real action on the state’s budget and in particular on pensions. This week the Governor articulated his budget plans. They include revenue expansions and tolling on four of the state’s primary highways.

So how would the Governor raise revenues? The Governor proposed expanding the sales tax to include many new products and services, like tax preparation, haircuts, dry cleaning, veterinary services and newspapers. The 1% tax on digital downloads will be increased to the 6.35% sales tax rate and the sales tax on boats will be increased from 2.99% to the standard 6.35%. All together, Lamont’s budget counts on more than $1 billion in new sales tax revenue over two years.

Other tax increases include raising the hotel occupancy tax from 15% to 17%, with 10% of the total money going into a tourism account and raising the real estate conveyance tax on sales of more than $800,000 from 1.25 % to 1.5 %. To soften the blow of higher taxes, the Governor wants to restoration of the $200 property tax credit to all tax filers (it’s currently limited to the elderly and those with dependents) and the elimination of the $250 business entity tax that companies in Connecticut have to pay every other year.

The proposal to toll the state’s highways has been a source of contention for some time. To address prior political opposition, the Governor’s plan includes two options. One is a trucks-only proposal. Rhode Island currently has such a scheme in place on its section of I 95. The second proposal would raise about $800 million a year once it was fully implemented in 2025. The Governor estimates that 40% of the revenue raised from the second option would be paid by out of states drivers.

The state’s pension underfunding position would rely on the use of current surplus while relying on the municipalities assuming 25% of pension costs for their employees. This has always been a heavy political lift in the Legislature. Even harder is the Governor’s hope that state employee unions would voluntarily make changes to the way cost of living adjustments are handled for state retirees, tying them to the stock market rather than guaranteeing a certain percentage increase.

Other revenue adds would include a 10 cent tax on single-use plastic bags, a 75% on e-cigarettes, a 1.5 cent per ounce tax on sugar-sweetened beverages and new bottle deposits on wine bottles, liquor bottles and nips. According to the Governor’s estimates the plastic bag tax would raise $57 million over two years, taxing e-cigarettes would generate $16.4 million over two years and the tax on sugary drinks would raise $163.1 million in its first full year.

ILLINOIS BUDGET

Governor J.B. Pritzker presented his first budget proposal of his tenure. His words make clear the challenges facing the Governor and the Legislature. “Illinois is faced with a $3.2 billion budget deficit and a $15 billion debt from unpaid bills. Last year alone, the state paid out more than $700 million in late payment penalties. That’s enough to cover free four-year university tuition for more than 12,000 students.” There is a structural deficit today of over $3 billion per year that if left unaddressed will continue to grow. There is a backlog of unpaid bills and debt associated with it that exceeds $15 billion.”

“Out of this year’s $39 billion budget, approximately $20 billion is required payments on our debt, on our pensions, on our court-ordered obligations or federally protected programs. To balance the budget by simply cutting government, we would have to reduce discretionary spending on all these direct services our jobs, our families and our businesses rely on by approximately 15%.”

The Governor’s proposal includes legalizing and regulating adult-use cannabis in this legislative session. He estimates that it would bring in $170 million in licensing and other fees in fiscal year 2020. The budget also includes the legalization and taxation of sports betting. He estimates that Illinois can realize more than $200 million from sports betting fees and taxes in FY 2020.

Other revenue enhancements include a proposal to enact a tax on insurance companies, specifically a managed care organization assessment to help cover the costs of the State’s Medicaid program. It would be structured to generate approximately $390 million in revenue to cover a portion of the state’s Medicaid costs. This would be a way to increase Illinois’ federal match.

The Governor offered proposals to deal with the state’s well documented pension funding problem. His administration is offering a 5-point program. It revolves around the enactment of a graduated income tax versus the current flat rate regime. The Governor says that a portion of the proceeds from the graduated tax would be applied to the pension system, over and above the state’s required pension payments.

Pension bonds are also part of the plan. in addition, it would make the optional retiree buyout program permanent and smooth the pension ramp by “modestly” extending it. The state’s university system would see an increase of 5% in funding from the state after years of cuts. This would be credit positive for the debt issued by those institutions.

The proposal is the easy part of this process. The state’s political atmosphere remains strained after four years of standoff between the legislature and the Governor.

NYC, AMAZON, AND JOBS

With so much attention focused on the City and State of New York’s failed effort to conclude an agreement with Amazon, it might seem as if NYC was a jobless desert reliant on tax handouts to sustain its economy. A recent report from NYC Controller puts those concerns to rest.

The City’s economy grew 3.9% in Q4 2018, the strongest growth since 4.0% in Q2 2017, driven by a surge in the labor market and modest wage growth (as measured by average hourly earnings). For the year, the gross city product grew 3.0%, the most robust year over year growth rate since 2015. The banking sector, a key driver of the City’s economy, continued to perform strongly as a result of higher interest rates, lower corporate tax rates, and deregulation. Net income after taxes for the top six banks in the U.S. rose to almost $30.0 billion in Q4 2018, compared to a loss of over $6.2 billion in Q4 2017 driven by robust growth (16.9%) in pre-tax income (mostly from higher interest rates) and a steep decline in taxes. (Taxes for the top six U.S. banks fell by 84.1 % in Q4 2018 from the prior year, following enactment of the Tax Cuts and Jobs Act (TCJA), which reduced the federal corporate income tax rate from 35% to 21%).

The City’s private sector added 34,000 jobs or 3.5% (SAAR) in Q4 2018, the highest gain since the 37,000 jobs created in Q3 2014. The public sector added 1,300 jobs in Q4 2018. National private-sector employment grew 2.1% (SAAR) in Q4 2018, the fastest since the 2.1% increase in Q1 2018 (Chart 2). This is amazingly strong growth for so late in a business cycle.

But the next comment reflects why the Amazon tax breaks were controversial. over half of the new private-sector jobs created were in low-wage industries. Low-wage industries added 21,100 jobs and accounted for 62.0 % of total private-sector jobs created in Q4 2018. Medium-wage industries accounted for 29.8 % of the new private-sector jobs as they added 10,100 jobs in Q4 2018 and high-wage sectors accounted for 8.2 % and added 2,800 jobs. In comparison, 63.3% of new private-sector jobs in the U.S. in the fourth quarter were in low-wage industries, while 20.4% were in medium-wage industries, and 16.3% were in high-wage industries.

Moody’s has expressed the view that the failure of the Amazon deal is credit negative for the city. That finding is interesting in light of the Controller’s comments. Moody’s acknowledges that New York City has a younger workforce than the US as a whole — almost 66% of the population is between 25 and 54 years old — and also a more educated one: 36% of New York City residents have a bachelor’s degree or higher, compared with 30% for the US overall. New York City also has one of the lowest crime rates among the big US cities. But interestingly, Moody’s also cites the city’s transportation system and access to the national transportation system. Given the public uproar over the condition and reliability of the city’s transit system, this is a bit puzzling. Especially, since the impact on transit was one of the foundations for local opposition to the deal.

Intentional or otherwise, Moody’s takes a fairly strong position in favor of tax breaks as an economic development tool. Effectively, they pit classes of the city’s population against each other. One of the issues which Amazon ran away from was how it could provide employment to historically economically limited segments of the population – like the residents of the nation’s largest public housing facility located essentially across the street.

Moody’s undercuts is view by citing the fact that “companies such as Google and Facebook have expanded significantly in New York City without direct state or city support because they want access to its creative workforce. In addition, jobs and wages in New York City’s high-tech sector, while accounting for only 1% of total employment, are growing faster than every other industry, growth we expect will continue. ” One has to wonder why Amazon did not feel that it could compete on a level playing field with Amazon and Google.

BUDGET SEASON IS REGULATION SEASON

For those many states which conduct limited legislative sessions, the budget negotiations are often the site of significant new regulations. This year is no different with a variety of proposals being introduced as part of the budget process across the country.

In Oregon, a proposal for statewide rent control is headed for a vote on the Oregon House floor. Senate Bill 608 , is expected to be approved and sent to a supportive governor for her signature. The bill would limit annual rent increases to 7% plus inflation throughout the state. Annual increases in the Consumer Price Index, a measure of inflation, for Western states has ranged from just under 1% to 3.6% over the past five years. New construction would be exempt for 15 years and vacancy decontrol would apply after existing tenants leave.

Other components of the bill mimic those seen in other jurisdictions like New York. The bill would require most landlords to cite a cause, such as failure to pay rent or other lease violation, when evicting renters after the first year of tenancy. So-called “landlord-based” for-cause evictions would be allowed, including the landlord moving in or a major renovation. In those cases, landlords would have to provide 90 days’ notice and pay one month’s rent to the tenant, though landlords with four or fewer units would be exempt from the payment.

Oregon would become the first state to enact a statewide rent control program. In other states with rent control policies, cities enact and administer local programs. Oregon law provides that rent control is not a power granted to localities.

In addition to New Jersey, New York State is debating the legalization of recreational marijuana. It is likely that the debate will continue beyond the budget cycle. The debate in New York is complicated by the politics of criminal justice reform and economic development. The industry is looked to as a potential source of “reparations” to benefit historically disadvantaged individuals and groups.

In plain English, proponents of reparations want to see recreational licenses issued to formerly incarcerated individuals who were convicted under prior more strict drug enforcement practices. That debate will b complicated by positions of some Presidential candidates in support of reparations. We would not be surprised to see these concerns derail current efforts to establish legal recreational marijuana outlets.

Muni Credit News Week of February 18, 2019

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$206,710,000*

NORTH CAROLINA MEDICAL CARE COMMISSION

Health Care Facilities Revenue Bonds

(Wake Forest Baptist Obligated Group)

Moody’s: A2 S&P: A

WFB is the largest academic medical center in its region but that has not relieved pressure on the ratings. The Moody’s rating carries a negative outlook. The concerns driving the outlook include WFB’s the fact that operating cash flow margins, which were already moderate in fiscal 2017, fell lower in fiscal 2018 and will likely remain modest in fiscal 2019. The system is absorbing its acquisition of High Point Regional. That merger is leading to higher expenses associated with HPR and unfavorable payor mix shifts. These expenses are negatively impacting cash balances while the balance sheet was increasingly leveraged due to the acquisition. Another source of uncertainty is the potential financial impact of the State’s plan to convert its Medicaid population to a managed care model.

Wake Forest Baptist (WFB) consists of Wake Forest University Baptist Medical Center (WFBMC), North Carolina Baptist Hospital (NCBH), Wake Forest University Health Sciences (WFUHS), and their respective affiliates. WFBMC was created in 1975 and houses the senior management team and many of the centralized functions of three organizations: WFUHS, NCBH, and WFBMC. WFUHS includes the faculty practice plan, the School of Medicine and Wake Forest Innovations (formerly the Piedmont Triad Research Park). NCBH (885 beds) is WFB’s flagship tertiary and quaternary academic medical center. WFB also owns four smaller hospitals: Lexington Medical Center (94 beds located 26 miles south of NCBH), Davie Medical Center (81 beds located 12 miles southwest of NCBH), Wilkes Medical Center (130 bed located 56 miles west NCBH), and High Point Regional Medical Center (351 beds located 20 miles southeast of NCBH).

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BAD MONTH FOR TAX INCENTIVES

The Amazon debacle will be chewed over for some time and a variety of reasons will be offered. None of them individually will account for the company’s decision to take their project and go home. There are however, a few items which stand out that do not require a lot of analysis.

Amazon showed no ability to navigate anything other extremely calm political waters. The company has faced almost no opposition in any of its other locations whether they be headquarters or warehouses. They have been able to steamroll the political structures in so many locations. They got the City Council to reverse itself on housing finance matters merely by threatening not to expand. So they came into the most political jurisdiction in the nation unprepared to work with it.

They failed to appreciate that an anti-union position in New York will galvanize a critical mass of opposition to any entity espousing such a view. They were apparently unaware of the City’s history of successful skepticism of projects of this scale (Westway anyone?). And they apparently did not have the stomach for any real confrontation. That may have been the real miscalculation.

These sorts of machinations are not the prime concern of individual investors who hold municipal bonds. But they are interesting in that the experience does provide certain clues as to how governments and companies will balance their view of local needs versus the views of the general public. One issue that is becoming clearer is the level of public opposition to “tax incentives” and other funding transfers at a time of underinvestment in infrastructure. It was hard to explain in simple terms why the state and city would give up $3 billion at a time when two major agencies (excluding Gateway tunnel costs) need some $60-70 billion of capital funding.

And there was this view – “Google and Apple just expanded their offices,” he said. “And they did it quietly, without any handouts. It just seems that, also, Amazon wanted a bit more than their fair share when everybody else was still doing it the old-fashioned way.” “There should be a more altruistic concept of these companies like Amazon joining the community and earning loyalty rather than, ‘Punch my meal ticket,’” Both of those tech giants have landed in NY and expanded and Google is a significant employer now and going forward. Apple’s stores are fairly ubiquitous throughout Manhattan. So while not a sophisticated expression, the quote speaks volumes. Those interests which tend to speculate in these situations – real estate and retail – did exactly that and are being reminded of the fact that sometimes speculators lose.

It also bears mention that the Amazon project would have been developed within an Opportunity Zone. Ironically, opportunity zones were championed by tech funded interests. The people who invest in Opportunity Funds are able to minimize their tax burden through preferential treatment of capital gains. The people who invest in Opportunity Funds are able to minimize their tax burden through preferential treatment of capital gains. An investor who retains an investment for seven years will pay only 85 percent of the capital gains taxes that would have been due on the original investment. If the investment is held beyond 10 years, the investor permanently avoids capital gains taxes on any proceeds from the Opportunity Fund investment.

The point of the bill was to stimulate investment especially in smaller (less than 1 million) communities. It was not designed to support projects like Amazon’s in Long Island City (LIC). Gentrification was already a well established fact in the surrounding neighborhoods. Some investment in development was already happening with some developers repurposing projects in development in response to the planned Amazon campus. Would it have accelerated existing developments and attracted some newer ones? Of course. That will still happen at a slower and likely more diverse pace.

The public is catching on to these sorts of major revenue concessions to attract development. This is the second prominent such transaction to unfold somewhat differently than contemplated as it follows the reconfiguration of the Foxconn deal in Wisconsin. In both cases, the deals were likely not going to deliver promised job booms for the non-college manufacturing cohort. The continuing efforts by corporations to tie taxes to development run counter to the current political winds. It will be important to see how government tailors its policies to reflect these trends.

CALIFORNIA JANUARY REVENUE

State Controller Betty T. Yee reported California’s total revenues of $18.79 billion in January were lower than estimates in the governor’s 2019-20 fiscal year budget proposal by $1.81 billion, or 8.8%, but higher than projections in the FY 2018-19 Budget Act by $1.21 billion, or 6.9%. Total revenues of $74.42 billion for the first seven months of FY 2018-19 were lower than expected in the proposed and enacted budgets by $2.87 billion and $1.32 billion, respectively. In the fiscal year to date, state revenues are just 0.2% lower than the same time last year.

Sales tax and corporation tax –– two of the state’s “big three” revenue sources –– came in higher than assumed in last month’s proposed budget. For January, personal income tax (PIT) receipts of $16.36 billion were $2.53 billion, or 13.4%, less than the Department of Finance forecasted last month but $403.6 million, or 2.5%, higher than assumed in the budget enacted last June. PIT revenue was still 4.8% higher than in January 2018. Sales tax receipts of $1.59 billion for January were $602.8 million higher than anticipated in the proposed FY 2019-20 budget and $647.4 million higher than in the FY 2018-19 Budget Act. Last month’s $579.2 million in corporation taxes were 9.0% higher than estimates in the FY 2019-20 budget proposal and 12.0% higher than in the enacted FY 2018-19 budget.

ILLINOIS PENSIONS

The new administration in Illinois is attempting to undertake an overall program of asset sales and the use of pension obligation bonds in an effort to improve the State’s woefully underfunded pension plans. Our view of pension bonds has been and continues to be negative. Away from the obvious risk of investment underperformance, we are philosophically opposed to the bonds in that they are always a mechanism to relieve the current pain associated with a current problem. They are a political answer rather than a sound financial answer.

That view is supported by Deputy Gov. Dan Hynes who suggested the key to the plan is to extend the period of time the state has to reach full funding of its pension plays by seven years, to 2052. “Full funding” currently is defined has having 90% of the assets needed to pay promised benefits. He acknowledges that current budget relief is a goal. Extending the full-payment ramp to 2052 will reduce the amount the state has to contribute next year by about $800 million. In fairness, the administration is also suggesting that it will provide a guaranteed annual share of revenues from the graduated income tax Gov. Pritzker hopes to enact into law after voters consider a constitutional amendment in 2020.

The Governor also supports a plan to consolidate hundreds of smaller pension funds, mostly downstate plans covering police and fire workers, to allow them to cut resources and get better returns on investment. These funds have been a source of contention leading to court actions seeking to segregate operating funds and requiring them to be applied to pension funding. This has significantly reduced the operating flexibility of the smaller communities often exacerbating already weakening financial positions.

TEXAS DEVELOPMENT FINANCING

One of the tried and true methods of financing infrastructure in unincorporated areas of the Lone Star State is the use of municipal utility districts (MUD). MUDs are created under Texas law and are managed by a board of directors often consisting of developer representatives. The construction of the infrastructure is undertaken to support development against which taxes are levied for the monies needed to pay off the MUD debt. In reality, the hope for a MUD is that the larger municipality next to which many MUDs are located will annex the land in the MUD. The MUD debt is then refinanced with debt secured by the much larger revenue base of the annexing entity. MUDs are regulated by the state, require a local election to issue bonds, and exist separately and out of the control of a city or county government.

That structure raises issues of control and management for the municipalities which are expected to absorb the debt acquired through annexation. One solution to those control issues is the use of public improvement districts (PID). PIDs issue debt backed by special assessments which are fixed for the life of the issue. PID are created within existing municipalities. PID bonds are issued by cities or counties but, they are clearly only repaid from assessments and not by the local government’s general obligations. They carry separate ratings from the government’s credit.

PID debt much more closely resemble assessment backed debt issued by jurisdictions in Florida and California. This will introduce an increased level of risk from exposure to the willingness and ability of developers to pay the assessments through the build out phases of these developments. While a newer risk for Texas investors, the use of PID debt is much more familiar to the high yield municipal investors across the market. With PIDs effectively restricted to larger minimum denominations ($100,000) yields tend to be higher reflecting the developer risk . Significant increases in the issuance of this debt (MUDs outstanding exceed PIDs outstanding by a factor of 10) will provide a new sector for institutional high yield investment.

One characteristic of Texas MUD debt is that it is highly concentrated around the Houston area. Historically, this was seen as a positive. Recent attention focused on the chronic flood problem facing Houston and surrounding Harris County has raised some concerns about the potential for flooding to alter or limit development. The Dallas Fed has raised the issue as it surveys the outlook for economic growth in the Houston region. ” The high concentration of MUDs in the Houston area may expose this financing model to new risks — those associated with more frequent and catastrophic flooding events. While MUDs will likely remain a vital part of the developer’s toolkit, this type of debt could become costlier and raise home prices in residential developments. And rising costs for homeownership might diminish one of the Houston area’s traditional selling points: affordability.”

Muni Credit News Week of February 11, 2019

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$900,000,000

District of Columbia

General Obligation Bonds

Moody’s: Aaa S&P: AA+

Those of us who go back far enough to remember when the District of Columbia could not borrow without outside credit support appreciate how high a hill the District had to climb to get to the level it has achieved. The rating reflects both improved management of the City and the benefits of the District’s development into a much more diverse and dynamic economy since the 1980’s. Its per capita income is higher than that of all 50 states, and its GDP is greater than that of17 states. In addition, the District is seen as having exemplary fiscal governance, and its updated four-year financial plan is its strongest ever. The District already has among the lowest pension liabilities of any large city, and has pre-funded its other postretirement benefits (OPEB) liability, which affords it significant financial flexibility.

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BRIGHTLINE FIGHT TO CONTINUE

The effort to deny the Virgin/Brightline consortium access to private activity bond financing continues. Indian River County, Florida, voted 4-1 Tuesday to spend up to $400,000 to appeal the denial of the county’s motion for summary judgment in a federal lawsuit it filed to challenge the Brightline project’s $1.15 billion of private activity bonds and federal agency environmental approvals. The consortium recently received another extension in the deadline to June 30 to issue private activity bonds to finance its continued expansion.

Indian River County’s action follows a decision on Dec. 24, 2018 by Federal Judge Christopher Cooper to grant motions for summary judgment sought by the USDOT and Brightline. The county’s appeal of Cooper’s ruling will be heard by the U.S. Court of Appeals for the District of Columbia Circuit. Ironically, the appeal comes as Brightline / Virgin Trains USA, is in the equity markets with an initial public offering as another way to finance the continued expansion of the private passenger train system. The IPO launch announced Jan. 30 and calls for the issuance of 28.3 million shares of common stock at $17 and $19 per share. The initial offering is expected to raise between $468 million and $540 million, depending on the price of shares. Fortress Investment Group LLC will retain majority ownership of the train company. The company will transition its consumer facing brand to Virgin Trains USA during this year.

The IPO raises legitimate issues as to the need for the project to rely on PAB financing. If they have access to equity, it undermines the case for the necessity of subsidized PAB financing. The continued effort to obtain the financing in spite of access to other sources of funding lends credence to the view that the project does not stand on its own economic viability without subsidies.

KC AIRPORT P3 MOVES FORWARD

The City of Kansas City, MO announced that it has reached a tentative airline agreement and a new $1.5 billion price tag for the Kansas City International Airport single-terminal modernization project. The new $1.5 billion total does not include financing. According to the previous estimate, at the $1.64 billion price tag, the total cost with financing would be about $1.9 billion. The city expects six of the eight airlines to sign on including Southwest, American, Delta, United, Alaska and Spirit. Frontier does not sign lease agreements of this nature, according to the City and Allegiant has indicated it does not plan to sign. Those airlines still can fly out of KCI, but they will pay a different rate than the airlines that sign the agreement.

The project now awaits an environmental review. The City must now figure out how to fund initial project work such as demolition of an existing terminal. Bonds ultimately would fund much of the project but, the city needs roughly $90 becomes available. It has been publically pledged that “taxpayer monies” would not be used for the airport. Some local legislators take the view that allowing the City’s Aviation Project to use general fund monies, even if it would be repaid from bond proceeds would violate that pledge.

NEW YORK STATE

Local sales tax collections continued to climb in 2018, growing for the third year in a row, according to a report released today by State Comptroller Thomas P. DiNapoli. Collections across the state of $17.5 billion grew by $872 million, or 5.3%. “Local sales tax collections grew at a faster pace in 2018 than in recent years, boosting local revenues,” DiNapoli said. “Despite the good news, a slowdown in collection growth in the fourth quarter shows that sales tax revenue can be unpredictable. Local officials should keep a watchful eye on consumer spending and this revenue source and be prepared to react accordingly.”

Every region in the state has experienced an increased annual growth rate in sales tax collections in each of the last three years, with the exception of the Finger Lakes (which slowed from 4.9% in 2017 to 3.7% in 2018). Year-over-year growth was especially strong in several upstate regions. The Southern Tier saw the highest year-over-year increase at 6.8%, the strongest for the region since 2011. The North Country had the second highest (5.9%), followed by the Mohawk Valley (5.8%). Downstate, the Long Island and Mid-Hudson regions saw collections grow by 4.5% and 5.1% in 2018. Notably, Central New York has seen a significant turnaround in its collections, climbing 5.1% in 2018, having been the only region with a decline in collections (-0.9 %) in 2016.

New York City’s sales tax collections grew by 5.7%. The city’s increases have typically been robust over the past several years. For the 57 counties outside of New York City, collections grew in 55 of them. Sullivan County experienced the largest increase (16.4%), followed by Tioga and Hamilton counties (16.1%). Collections were down in 2018 in Cayuga (-1.3%) and Madison (-0.7%) counties.

All but one of the cities with their own sales tax experienced an increase in year-over-year collections in 2018. Gloversville had the strongest growth (17.8%), along with the cities of Norwich (12.8%) and Salamanca (8.3%). Oneida was the only city that saw its collections decrease (5.2%), mostly due to technical adjustments.

Two proposed changes to the state sales tax, including one related to the taxation of sales through online marketplaces – such as Amazon – have the potential to drive millions of dollars in additional sales tax revenues to local governments.

This will be important as the state is facing a $2.3 billion tax-revenue shortfall. Laying the blame primarily on the impact of federal tax law changes, the state cited the move of wealthy individuals to other taxing jurisdictions (Florida?) as a cause of the lower revenue estimate. Other states which have historically benefitted from the SALT deduction are also reporting shortfalls in year-end income tax revenues. They include, unsurprisingly, California and New Jersey.

TOBACCO TARGETED AGAIN

An Arizona state lawmaker introduced the proposal that would increase the current $2-a-pack on cigarettes by an additional $1.50. A similar increase on vaping products is also a part of the proposal. The proceeds of the increased tax would generate funding for the state’s Board of Regents to award scholarships to residents who received A or B grades in each academic course required for graduation. The Arizona Legislature would have to agree to place the measure on the 2020 ballot.

In Hawaii, one legislator has introduced a bill which would raise the minimum smoking age incrementally each year to 30 in 2020, 40 in 2021, 50 in 2022, 60 in 2023 and 100 in 2024. The bill only addresses cigarettes while leaving e cigarette and vaping restrictions as is. The Hawaii Island lawmaker said he doesn’t think taxes or regulations are doing enough to stem their use. He wants to see them off store shelves all together.

A state senator introduced SB 887, which would increase the excise tax on cigarettes to 21 cents, instead of 16 cents, in July. It mandates revenue be used for health programs and research.

PG&E IMPACTS BEGIN TO EMERGE

A January 31 ruling from the judge overseeing the PG&E bankruptcy approved motions including an order to maintain existing arrangements between community choice aggregators (CCAs) and PG&E. CCAs are an emerging municipal credit sector especially in the California market. CCAs were established to provide electricity customers choice of generation supplier in the service areas of California’s investor-owned utilities. Once a CCA is formed, it becomes the default provider for generation services in the defined area. CCA customers have the option to opt-out and return to PG&E for their generation service but most customers elect to stay with the CCA. The CCA is unregulated on its cost recovery like municipal electric utilities and has a local governance role in power supply planning, local greenhouse gas reduction policies and customer choice.

In the case of PG&E, it has a contract with Marin Clean Energy (MCE), the first CCA to operate in California . Under that agreement, PG&E includes the charges for generation services provided by MCE on the monthly electricity bill that PG&E sends to customers. The customer pays the bill, and on a daily basis, PG&E transfers collected CCA generation revenues to MCE. So there was concern that revenues due to MCE which would, among other things, get tied up while the bankruptcy proceedings proceeded.

The judge’s order also included an acknowledgment that the revenues are not a part of PG&E’s estate; that PG&E must return to regular banking and billing operations, including remitting bill collections to CCAs; and that CCA revenues cannot have a lien placed against them by the debtor-in-possession lender. The positive effect on CCA finances stems primarily from the increased stability to CCAs’ cash flow collections, which enables their power suppliers and other vendors to have greater certainty that CCA revenues and cash flow will remain unaffected by the utility’s bankruptcy filing.

Muni Credit News Week of February 4, 2019

Joseph Krist

Publisher

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NEGATIVE RURAL HOSPITAL TREND CONTINUES

There continue to be signs that the single facility rural community hospital facility remains under significant pressure. The latest example shows that even a facility that is larger than what is typical still faces the same pressure. Yakima Valley Memorial Hospital does business as Virginia Mason Memorial. It is a 226 staffed bed community hospital located in Yakima, WA. It saw 11,751 admissions in the last year.

The hospital, like so many others in the rural space, makes a significant economic contribution employing 2,800 and generating annual revenues of $433,163,870. But it still operates as a single site rural provider. So while revenue growth was solid, expense growth still exceeded revenues and the operating margin was still negative 0.9%.

It is not a surprise that these numbers impacted the hospital’s rating. The hospital issues debt secured by a receivables pledge and a lien on the primary hospital campus. There is also a debt service reserve fund. Key financial covenants include minimum days cash on hand of 40 days, and debt service coverage of 1.2x. This should all provide for coverage of debt service but it’s the trend which concerns.

So Moody’s downgraded Yakima Valley Memorial Hospital’s revenue bond rating to Ba1 from Baa3. This reflected expectation of continued weak performance in fiscal 2019 following a miss to budget in fiscal 2018. Importantly, the outlook remains negative for the rating even after this downgrade. The negative outlook reflects an expectation of still modest margins in fiscal 2019, despite expectations of improvement, reflecting continued cost and market challenges.

So in a nutshell, there you have the rural hospital sector.

PUERTO RICO

The latest turn of events in Puerto Rico’s ongoing effort to restructure its debt is the decision by the judge overseeing the Commonwealth’s Title III proceedings to grant an urgent motion establishing procedures to handle a request by the island’s Financial Oversight and Management Board to dismiss $6 billion in general obligation (GO) debt issued by the commonwealth after 2012. This will include a “two-stage procedure” that will ensure disagreements over the proposals are worked out. Judge Swain said the “best thing for me to do” was to ask the objectors and respondents to have a “meet and confer” that would result in a revised procedural order.

If the definition of justice is a result which leaves both parties disappointed, then this fits the bill. Bondholders said the procedures did not provide adequate notice to creditors and potential objectors, and granted the government substantive advantages that were not provided to the holders of the challenged GO bonds. Bondholders say that the proposed procedures force creditors to file joint responses, compromising their ability to present their arguments adequately; treats creditors differently according to the amount of their claim; and prematurely forces creditors to answer discovery requests.

The judge takes the position that case management orders call for all bondholders to receive notices and answers were needed regarding whether anyone was at risk of a default judgment and what would happen to those creditors who do not answer notices of the proposed repeal of $6 billion in debt. The judge asked for improvements to the language of the notices and for assurances that all bondholders, large and small, be informed. She also cited the fact that creditors could seek the committee by petitioning the United States Trustee. The U.S. Trustee is part of the U.S. Department of Justice and is responsible for overseeing the administration of bankruptcy cases.

GO bondholder representatives expressed a view that parties should have 60 days to announce if they will participate in the process. Attorneys for the fiscal board’s Special Claims Committee are not supportive of smaller holders receiving any more protection basing that position on its perception that most of the creditors that purchased the challenged bonds were not retail bondholders, as they were sold in increments of $150,000.

Experienced high yield investors know that initial denominations do not prevent bonds from winding up in “small bondholder” hands, so we take that argument with a grain of salt. Once again, the small bondholder finds themselves in a disadvantaged position. It shouldn’t be that way. As the Special Claims Committee representative said about another aspect of this case – “It does not have to be that complicated.”

While these events unfolded, the executive director of the Puerto Rico Fiscal Agency and Financial Advisory Authority and the Puerto Rico Sales Tax Financing Corp. (Cofina) announced that the U.S. District Court approved the “Third Amended Title III Plan of Adjustment” between Cofina bondholders and monoline insurers. The Plan of adjustment is the first under Title III of the Puerto Rico Oversight, Management and Economic Stability Act (Promesa) and follows the recent restructuring of the Government Development Bank for Puerto Rico under the law’s Title VI.

SANTEE COOPER IN PLAY?

The State of South Carolina has received four legitimate offers to buy all of Santee Cooper and pay off the state-owned utility’s $8 billion in debt according to Virginia-based ICF, a consultant advising on a possible sale of the municipal utility. ICF was hired by a special committee of lawmakers and the governor. ICF estimates the sale of Santee Cooper would leave its customers paying less for the V.C. Summer debacle than customers of SCE&G, the majority partner in the failed $9 billion project. SCE&G customers collectively must pay an additional $2.3 billion for two unfinished reactors over the next 20 years even though the utility was bought by Virginia-based Dominion Energy earlier this year.

It is estimated that customers that Santee Cooper directly serves will be forced to pay roughly $6,200 more per household in higher rates for the unfinished reactors over the next four decades. Customers of the 20 co-ops who buy power from Santee Cooper contractually are obligated to pay about $4,200 per household for the failed project.

Seventeen parties expressed interest in Santee Cooper at one point but, only 10 submitted preliminary bids. Companies that privately have shown interest in Santee Cooper include Florida-based NextEra Energy, Charlotte-based Duke Energy, Virginia-based Dominion Energy, Greenville-based Pacolet Milliken Enterprises, Atlanta-based Southern Co., New York-based LS Power and South Carolina’s 20 electric co-ops – who together buy three-fifths of Santee Cooper’s electricity. Dominion said it is interested in managing Santee Cooper – but not buying it.

The report begins a process of evaluation of proposals by the State legislature. The likely timeline for the process would not likely provide for a resolution before the fall. The outcome is far from a slam dunk as there are many perspectives being brought to the debate. They include issues of public versus private ownership, the jobs of current Santee Cooper employees. Skepticism is seen as being a bigger issue in the State Senate where members have been skeptical that a for-profit company can buy Santee Cooper, pay off its more than $8 billion in total debt, and still charge lower electric rates than the not-for-profit state agency.

A more subtle issue would be the long term status of Santee Cooper’s coal fired generation assets. The report acknowledges that any buyer could find cost savings by investing in more natural gas generation and moving away from Santee Cooper’s coal-fired power plants. Those decisions will have real implications for the locations of those facilities.

Ultimately, the coop customers probably hold the hammer in the resolution of the situation. The co-ops could opt out of their long-term contract to buy power from Santee Cooper if they don’t like the buyer, taking 60% of the utility’s business with them. But the co-ops have said they favor a sale or transformation of Santee Cooper that would lower their customers’ power bills.

NEWARK UPGRADE

Moody’s Investors Service has assigned a Baa2 underlying rating and upgraded the city’s outstanding GOULT, GOLT, GOULT & GOLT-backed non-contingent lease debt, and GOLT-backed custodial receipt debt to Baa2 from Baa3. The upgrade was attributed to “the city’s weak, albeit improved, fund balance and cash position, a sizeable and diverse tax base, and an elevated debt and pension burden. The rating also incorporates the city’s weak resident wealth and income levels, elevated poverty, and recent tax base growth.”

The outlook on the underlying rating remains positive. The outlook relies on the premise that the recent positive trend of financial operations will continue, leading to a strengthened reserve and liquidity position. The outlook also incorporates expectations that ongoing redevelopment will lead to material tax base expansion. It is important to note that Newark is the county seat for Essex County (Aaa) and New Jersey’s most populous city. It has a population of approximately 285,000 and is a major regional economic center and transportation hub.