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Muni Credit News May 19, 2016

Joseph Krist

Municipal Credit Consultant

PROMESA BILL INTRODUCED…

H.R. 5278, the bipartisan Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA), which addresses the fiscal crisis in Puerto Rico while preventing a taxpayer bailout for the territory. The bill establishes an oversight board which will be given the Authority to order audited financial statements, hold hearings, prevent the execution of legislation, orders, regulations rules, or contracts that would violate the Act.

It provides that any debt adjustment must respect liens in effect prior to the execution of the Act. At the same time, it would stay litigation pending litigation pending the production of audited financials. During such stays, Puerto Rico must pay interest when due. The Act explicitly excludes the Commonwealth from Chapter 9 and designates the Board as the entity to direct the adjustment of Puerto Rico’s finances. Only the Oversight Board could present a plan of adjustment for creditor vote or judicial approval.

On the economic front, it would provide for a lower minimum wage than the prevailing mainland minimum and would increase the age it applies to from 20 to 25. As for its applicability to other entities, the Act is explicit in its enactment under the territories and insular affairs provisions of the U.S. code not as any amendment to the 10th Amendment. A state seeking to use its provisions would have to ask to have its status as a state revoked and return to territorial status.

The legislation (http://naturalresources.house.gov/uploadedfiles/promesa_hr_5278.pdf) is not truly bipartisan in that it is sponsored by the Republicans on the Natural Resources. House Speaker Ryan has made it clear that the legislation will be moved out of committee for a vote under the Hastert rule which means that unless a majority of the majority in the House supports the measure it will not move forward.

The introduction of the bill for committee consideration now sets out the opposing views of what to do about Puerto Rico’s debt crisis. It follows Monday’s statement from Senator Bernie Sanders on the subject. It reads straight out of the Garcia administration’s playbook. According to his campaigns statement, “Bernie Sanders believes the U.S. has an obligation to help Puerto Rico with its ongoing financial crisis by allowing it to declare bankruptcy. To that end he sent a letter to the U.S. Treasury which could have been written by the current government of Puerto Rico.

He would urge the Administration to take the following steps. First, he would urge a meeting as soon as possible with the government of Puerto Rico, key elected officials, its major creditors, labor unions, business leaders, and pension advocates, to work out a debt repayment plan that is fair to all sides. At this meeting, it should be made clear that the last thing Puerto Rico needs right now is more austerity. The economic situation in Puerto Rico, in Sanders’ view will not improve by eliminating more public schools, slashing pensions, laying off workers, and allowing corporations to pay workers starvation wages by suspending the minimum wage and relaxing labor laws.

Second, before any debt restructuring plan is agreed to, there needs to be an independent and transparent audit of Puerto Rico’s debt and the results need to be made public — consistent with recent legislation that was signed into law in Puerto Rico. Importantly, if any debt was issued to creditors in violation of Puerto Rico’s constitution , it must be immediately set aside.

Third, he strongly believes Puerto Rico must be afforded the same bankruptcy protections that exist for municipalities and public utilities across the United States. Puerto Rico must be given the same authority granted to every state in this country to restructure the debt of public utilities and municipalities under the supervision of a bankruptcy court.

If there is not action soon, Sanders says the well-being of 3.5 million American citizens who live there will be put at risk. He notes that the people of Puerto Rico pay the same Medicare and Social Security taxes as we do, but they only get about half the rate of federal health care dollars as those who live in the 50 states.”

If this all sounds familiar, it is because these are almost verbatim the arguments advanced by the Governor. It represents a very doctrinaire and populist response to PR’s difficulties and does little to advance the debate.

… FOLLOWING PRHTA REVENUE FREEZE

Puerto Rico Gov. Alejandro García Padilla froze the transfer of revenues from the Puerto Rico Highways and Transportation Authority to its bonds, making the commonwealth the biggest technical defaulter in United States municipal history. While not imposing moratorium on HTA’s debt-service payments — which the government says are covered until next year — Gov. Alejandro García Padilla is suspending the remittance of certain funds that go toward paying debt obligations in a bid to guarantee continuity of essential services provided by HTA. The administration says HTA needs $25 million a month to do the latter, and $150 million more to pay down what it owes to its suppliers.

“The executive order is suspending the obligation of the HTA to transfer revenues to its bondholders from tolls and any other income received and imposes a ‘stay’ in legal claims and of any kind,” the Commonwealth stated. The HTA is expected to meet in full roughly $240 million in debt service due July 1, but would do so by using its reserve accounts.

The moratorium law provides for a legal stay mechanism that seeks to shield public entities against creditors’ remedies, once they are placed under an emergency period. However, it is still uncertain whether it has a retroactive effect. Last week, Ambac Assurance Corp., a bond insurer with exposure to HTA debt, sued in federal court, calling for a receiver to be appointed at the public entity. Earlier this week, the monoline asked the court to freeze $100 million received from the 10-year extension to the PR-5 and PR-22 concession contract between HTA and Metropistas. Whether those actions may be stayed under the law, is yet to be seen.

LIPA DEBT LIMIT PROPOSED

Legislation introduced Thursday by two Suffolk County legislators would require a public referendum when LIPA wants to issue new debt. The measure which would be known as the Long Island Power Authority Ratepayers Protection Act, would also replace the current appointed LIPA board with eight trustees who are elected by voters from eight districts and a chairman appointed by the governor. The board would have full discretion to consider rate increases and could not approve a final plan until public hearings were held in impacted service areas.

LIPA has consistently been the target of populist legislators. The proposal would interfere with changes enacted by the NY legislature which froze rates for three years but also provided for a significant restructuring and refinancing of LIPA’s massive tax exempt debt load. The regulation of rates by the State along with the initial rate freeze had effectively capped the Authority’s ratings at their present level, but also facilitated the construction of a securitization plan that satisfied credit concerns in the taxable market.

We believe that outside oversight is essential to reassure investors over the long term. The nature of the political situation over many years on Long Island should be of concern to investors who do not have tolerance for any additional credit weakness. Standard & Poor’s and Fitch Ratings revised LIPA’s credit outlook to stable from negative last November ahead of a $266 million electric system general revenue bond sale citing a three-year rate hike from 2016 to 2018 approved by the New York Department of Public Service. Public Service Commission oversight is essential in our view to the maintenance of a more solid credit profile.

GAME ON FOR MILWAUKEE BUCKS ARENA

The Wisconsin Center District is preparing to sell $203 million in bonds in June toward financing the new Milwaukee Bucks arena. The District board is scheduled to vote Friday on authorizing the bond issue. Assuming the board votes for the authorization, it is anticipated that a sale of bonds “in early to mid-June.” The vote follows months of maneuvering and threats to move the franchise to Seattle which had hoped that such a move would advance financing for a hockey and basketball arena there.

The financing from the Wisconsin Center District will provide the majority of the $250 million in public financing for the $500 million Bucks downtown arena. The Bucks owners will contribute $150 million and former owner Herb Kohl is donating $100 million. The state legislation in 2015 that provided for public funding of the arena designated the Wisconsin Center District as the owner of the arena, which the Bucks will manage under a 30-year lease.

The city of Milwaukee will provide the final $47 million in public funding via tax-incremental financing. The majority of the tax-increment funds will finance a new parking structure for the arena. The Bucks’ owners plan a groundbreaking ceremony for June 18 on the arena with a goal of completing the project before the 2018-2019 NBA season that starts in fall 2018.

The two primary revenue sources backing the bonds include annual appropriations of $4 million each from Milwaukee County and the state of Wisconsin and existing sales-tax revenue streams already collected by the Wisconsin Center District. The district collects sales taxes from hotel rooms, local food and beverages, and car rentals. This package was used by arena advocates to say that no “local” revenues are used for the project since the taxpayers would be mostly visitors to the arena and the City.

CA WATER AGENCIES GET REGULATORY RELIEF

On May 9, 2016, the Governor issued an Executive Order that directs the State Board to adjust and extend its emergency water conservation regulations through the end of January 2017 in recognition of the differing water supply conditions for many communities. The Order notes that the drought conditions that formed the basis of the Governor’s emergency proclamations continue to exist; and the drought conditions will likely continue for the foreseeable future and additional action by both the State Water Resources Control Board and local water suppliers will likely be necessary to prevent waste and unreasonable use of water and to further promote conservation.

It maintains limits on use for landscaping, outdoor plants, and car washing. It does provide that each urban water supplier shall: Beginning June 1, 2016, reduce its total potable water production by the percentage identified as its conservation standard in this section each month, compared to the amount used in the same month in 2013 and the supplier’s total potable water demand for each of the next three years will be the supplier’s average annual total potable water production for the years 2013 and 2014. The supplier’s total potable water supply shall include only water sources of supply available to the supplier that could be used for potable drinking water purposes.

Growth experienced by urban areas and significant investments that have been made by some suppliers towards creating new, local, drought-resilient sources of potable water supply, an urban water supplier’s conservation standard shall be reduced by an amount, not to exceed eight (8) percentage points total. Other adjustments to reflect the drought resiliency of new water supplies and growth in commercial/industrial establishments as well as population are provided.

Bondholders should be heartened by these changes which will relieve at least a portion of the pressures which have resulted from the drought. They are clearly credit positive for water credits throughout the state with primarily non-agricultural customer bases, thus relieving downward pressure on these credits.

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 May 17, 2016

Joseph Krist

Municipal Credit Consultant

WHEN A TAXABLE REFUNDING MAKES SENSE

Many tax-exempt revenue bonds are issued for activities Congress has classified as private because most of the benefits from the activities appear to be enjoyed by private individuals and businesses. The annual volume of a subset of these tax-exempt private-activity bonds is capped. The cap has been adjusted for inflation since 2004. The annual volume cap applies to the total of bonds issued primarily for but not limited to multi- and single-family housing, industrial development, exempt facilities, student loans, and bond-financed takeovers of investor-owned utilities (usually electric utilities).

Exempt facilities subject to the volume cap are the following: mass commuting facilities, water furnishing, sewage treatment, solid waste disposal, residential rental projects, electric energy or gas furnishing, local district heating or cooling provision, and hazardous waste disposal and 25% of high-speed rail facility bonds.

This does not mean governmental ownership in the conventional sense. It simply means that lease arrangements for private management and operation of bond-financed facilities must be structured to deny accelerated depreciation benefits to the private operator, lease length must conform to the facility’s expected service life, and any sale of the facility to the private operator must be made at fair market value.

El Paso County Texas recently closed on an issue of taxable refunding bonds that refunded general obligation bonds and certificates of obligation which were tax exempt. The Bonds which were recently issued were refunding in advance bonds which were already refunding bonds themselves or which issued for the purposes outlined in the prior paragraph. So a taxable issue was the only way the refunding bonds could be advance refunded. The remaining bonds would have created cap issues for the County. So with rates where they are demand for this kind of paper strong – including from foreign institutional buyers – this kind of issue makes tremendous sense for the County and other borrowers who find themselves confronting a similar situation.

OLD NEWS TO MUNI VETERANS

According to a new audit from Pennsylvania Auditor General Eugene DePasquale, mandated cost increased and an inability to raise revenue are hampering the Philadelphia School District with persistent budget deficits. This release may be news to some but to veterans of the municipal bond market they represent a continuation of history.

The District has had a long history of declining demographics, declining outside resources, and mismanagement dating at least to the 1970’s. Over time, the District was able to overcome what had become a mounting set of obstacles to market access for both operating and capital purposes. These needs were financed by a variety of commercial bank liquidity facilities and credit enhancements. While these facilitated market access, there was continued deterioration in the District’s credit fundamentals. Declining enrollment related to demographics as well as to increased competition from charter schools. These combined to pressure the level of revenues available from the Commonwealth of Pennsylvania based on average daily attendance levels.

At the same time these factors were negatively impacting the District, weaknesses in the City’s tax collection and assessment practices also played their part. When the District also calculated its ongoing maintenance and capital needs, it realized that it also faced serious pension funding requirements. Options to address these needs were limited as the District’s credit fell below investment grade Commonwealth’s state aid secured lending program. This effectively limited the District’s ability to borrow.

Over the years the Commonwealth has experienced increased difficulties balancing its own budget. As is true on the national level, the annual budget process in Pennsylvania has become more acrimonious and partisan. Recent years have seen increased delays and outright failure in the efforts to adopt budgets for the Commonwealth. Funding for education has been at the center of these failed efforts whether the sticking point should be over efforts to lessen property tax burdens or absolute levels of state aid. Aid to Philadelphia has been a particular point of conflict along regional and racial lines.

Unfortunately, we don’t see this combination of factors resolving itself politically anytime soon. That directly points to a continued negative trend for the District’s credit in spite of the clear need for additional help – fiscal and political – that the District clearly needs.

ATLANTIC CITY STEPS BACK FROM THE LEDGE

Atlantic City Mayor Don Guardian said that the city managed to make a $1.8 million interest payment due on 2012 municipal bonds and avoid becoming the first New Jersey town to default since the 1930s. The payment covers interest on 2012 municipal bonds sold to raise money to pay back casinos who successfully appealed their taxes. He said he made the decision to make the payment after considering the bond ratings for Atlantic County and other New Jersey municipalities “as well as the effects for my city.”

Guardian estimated that the city has about $7 million on hand, and is receiving some $1.5 million in daily as May quarterly taxes come in. Residents and businesses had until May 10 to pay before penalties took effect, and many businesses including casinos were expected to wait until then.

The mayor said he would be able to make the $7 million monthly payroll. Unions agreed to switch from a 14-day payroll schedule to allow the city flexibility. And he said he was committed to making the $8.5 million May school payment next due May 15.

We believe that the outlook for a short term resolution is cloudy at best as the issue remains politically charged in the legislature. There are huge negative implications for municipal finance across the state without some resolution but we are reminded that New Jersey remains one of the most political of jurisdictions.

NEW YORK CITY

Both the City’s Office of Management and Budget and the Independent Budget Office have recently released outlooks for the City’s fiscal health going forward. The OMB outlook, which reflects the Mayor’s view is expectedly positive. It emphasizes the accumulation of reserves, settlement of 95% of its labor contracts and funding for its policy priorities. Of more interest to this observer are the views of the IBO.

In the IBO view, “Mayor Bill de Blasio’s Executive Budget for 2017 and Financial Plan Through 2020 proposes an increase in spending to support a bevy of new or expanded programs as well as a substantial infusion of city aid for the fiscally ailing municipal hospital system. His budget plan also includes doses of fiscal caution in the form of a larger citywide savings program and an increase in the amount of funds held in reserves. Based on IBO’s latest economic forecast and re-estimate of tax revenue and spending projections under the contours of the Mayor’s executive budget and financial plan, there are reasons for optimism and prudence. Our latest economic forecast anticipates that local economic growth will slow, with a decline in job growth from the record levels of the past few years and a corresponding slowdown in revenue growth in the years ahead. Still, IBO expects that the city’s fiscal condition will remain stable—budget surpluses this year and next and shortfalls in future years that will be relatively modest as a share of city-generated revenue.

IBO projects that the city will end the current fiscal year with a surplus of $3.5 billion, $151 million more than the Mayor’s estimate. After adjusting for the use of this surplus to prepay some of next year’s expenses, we project a comparatively small surplus of $812 million in 2017 under the Mayor’s plan. This amount may understate the “real” surplus because the Mayor’s plan includes two reserve funds within the 2017 budget totaling $1.5 billion—dollars that are recorded as expenditures but do not currently support any specific spending needs. Taking these reserves into account, the projected surplus for next year is effectively $2.3 billion.”

All in all, the IBO findings seem to support the general aura of conservatism presented by OMB in its presentation. Our view of the NYC credit has always been premised on the structural and reporting requirements imposed on the City over the last four decades. While nothing is fool proof, as long as those structures and requirements remain in place we see the City’s debt as a safe bet for investors.

Muni Credit News May 12, 2016

Joseph Krist

Municipal Credit Consultant

PR BUDGET YET TO BE ISSUED AS IT ARGUES FOR CREDIBILITY

One can understand that the administration of the Commonwealth might be overwhelmed by simultaneous efforts to mange scarce resources, lobby Congress for fiscal assistance, and negotiate a debt restructuring with a variety of creditors. At the same time it is difficult to see the Commonwealth as a credible partner in the current crisis when Gov. Alejandro García Padilla has yet to present a budget as he waits for the U.S. Congress to approve debt-restructuring and other economic-development mechanisms for Puerto Rico. When he says “the budget is being worked on responsibly and comprehensively to allow for the continuation of services to citizens”, we feel that we have heard this song before.

Senate President Eduardo Bhatia said Tuesday that the budget “is very late; I’m not happy. I know it’s a difficult time, but we have to have three scenarios,” which he explained as a budget “with the payment of debt, another without its payment and a third one with only the payment of the debt’s interest.” “If these aren’t available soon, it’s impossible as a legislature to fulfill our constitutional duty.” He also reminded the parties that “it is the latest in history to receive a budget.”

Clearly it would be easier to formulate a budget with at least the framework for a potential “bailout” (yes, we said it) to be available but, this is just another fiscal management failure by the current administration. It is not a matter of whether significant expense cuts need to be made, but how and where. We don’t see evidence of the obviously needed process of triage that will accompany any near term financial resolution. The continued brinksmanship and lobbying being relied upon by the current administration simply is not useful.

We will see how effective the lobbying effort will be. Gov. Alejandro García Padilla met Wednesday with House Speaker Paul Ryan (R-Wis.), Natural Resources Committee Chairman Rob Bishop (R-Utah) and House Minority Whip Steny Hoyer (D-), according to a statement released by La Fortaleza. He also held talks with Reps. Sean Duffy (R-Wis.), who is sponsoring Promesa, Raúl Labrador (R-Idaho) and Charles Dent (R-Pa.). The expected release of a revised Puerto Rico Oversight, Management & Economic Stability Act was delayed due to continued discussions in committee. The stumbling blocks continue to be reducing minimum wage, failing to protect pensioners and doing away with overtime rules.

Meanwhile, the bond-purchase agreement between the Puerto Rico Electric Power Authority, a group of bondholders and bond-insurance companies will expire Thursday unless the creditors give PREPA $111 million or the pact is extended. The agreement is part of PREPA’s larger debt restructuring deal. Puerto Rico lawmakers passed a debt moratorium in April that allows Governor Alejandro Garcia Padilla to skip debt-service payments on all island debt. PREPA’s creditors are reluctant to lend the utility more money unless Puerto Rico lawmakers amend the moratorium law to exempt PREPA.

PREPA’s position is that “conditions required for creditors to fund the $111 million bond purchase under PREPA’s restructuring support agreement and related documents have been satisfied, and as a result such creditors are required to fund the $111 million bond purchase on May 12, 2016,” the utility said in the statement. “PREPA paid $111 million in interest to these creditors in January 2016 in reliance on the creditors’ agreement to re-lend the same amount if two important milestones in PREPA’s restructuring occurred.” The obligation of creditors to buy the three-year bonds is subject to several conditions being fully satisfied, including that no Puerto Rico statue enacted after the agreement shall have an adverse affect on the rights and remedies of the 2016 bonds or their validity or enforceability. Obviously, something has to give.

On another front the Commonwealth’s credibility was under attack this week when Ambac sued the Puerto Rico Highways & Transportation Authority (HTA) on federal court on Tuesday that calls for the appointment of a receiver for the Authority. Ambac’s argument is that the HTA has failed to meet its fiduciary and contractual duties to its creditors. It cites the “suspect timing” during which HTA and Metropistas, a local subsidiary of Spanish firm Abertis, recently agreed to extend the concession contract of PR-22 and PR-5 for $115 million, of which $100 million has been already disbursed.

It is not challenging the contract itself. Instead, Ambac is focused on the use of the funds, arguing these “would likely be siphoned off by the commonwealth government” for purposes not related to HTA. This suit follows suits filed earlier this year by Ambac and Assured Guaranty, challenging the redirection of pledged revenues, known as “clawbacks,” to pay for public debt, a move the monolines deem as illegal and invalid under the U.S. Constitution. Gov. Alejandro Garcia Padilla’s clawback order covers one of HTA’s revenue sources for the repayment of its debt.

WHAT MAKES AN ISSUE TAXABLE

We’ve always taken an interest in what makes a tax-exempt bond taxable. The latest case involves a California authority and a high school district which announced this week that they are prepared to file a protest and appeal of an expected Internal Revenue Service proposed adverse determination that $25.4 million of tax-exempt variable rate demand bonds are taxable.

The California Statewide Communities Development Authority and the Sweetwater Union High School District have received a “Notice of Proposed Issue” in which the IRS tax-exempt bond office asserted that the 2005 bonds are taxable private-activity bonds.

“”If TEB issues a proposed adverse determination, the authority and the district will respond by filing a protest, including a request for view of the [IRS] Office of Appeals.”

Typically, cases handled by the appeals office result in out-of-court settlements.

The case revolves around an unusual conduit structure used to address concerns about state laws. The authority issued $25.4 million of tax-exempt variable rate demand revenue bonds and $8.2 million of taxable variable rate bonds in February 2005. The proceeds were lent to Plan Nine Partners, LLC, a subsidiary of California Trust for Public Schools, a nonprofit that helps expedite land acquisitions for public schools, according to group’s Form 990 tax form.

The proceeds funded the purchase a 23.82 acre parcel of industrial mixed-use land located Chula Vista, Calif. Plan Nine Partners were to lease the land to the Sweetwater school district, which wanted to build a new administrative headquarters, academic buildings and a bus yard on about 73% of it. The official statement estimated that some $120 million of additional bonds would be needed to finance the development of those projects. It does not appear those bonds were issued. The land was to be held in the name of Plan Nine Partners until the bonds were paid off in 30 years and was to then be conveyed to Sweetwater in an exchange agreement. The district would pay rent equal to the bond debt service to Plan Nine Partners.

The IRS began an audit in September 2013, and issued an information document request in October 2014. The authority and Sweetwater responded to the IDR in January 2015, arguing the tax-exempt bonds issued were not taxable. TEB filed a Notice of Proposed Issue on January 26 again asserting the bonds were taxable PABs.

Under the federal tax code, at least 95% of the proceeds of 501(c)(3) bonds must be used for “good” or non-private purposes. About 27% of the land was to be used for development and sale for private business use, the OS stated.

“The authority and the district still disagree with the IRS analysis and its conclusion.

ONE WAY TO DEAL WITH THE IRS

The Indianapolis Airport Authority (the “Authority”) is providing voluntary notice that, in connection with a random examination of its 2006 F Bonds which were purchased by the Indianapolis Local Public Improvement Bond Bank with proceeds of a $346 million of bonds issued by the Bond Bank. The Internal Revenue Service’s Field Office has asserted a rebate liability with respect to the Bonds. Although the Authority disagrees with and has opposed the Field Office’s position, the Authority and the Internal Revenue Service have agreed to a settlement of the dispute that will close the examination with no change to the tax exempt status of the Bonds.

This is how a large number of these disputes are settled. While upsetting to holders, the IRS has stated that it typically is not its goal to penalize individual holders of bonds. Rather, it seeks to come to some financial arrangement with the issuer of a contested issue.

SEC CONTINUES ENFORCEMENT ALONG WITH CRIMINALCHARGES

The Securities and Exchange Commission today charged a father and son and five associates with defrauding investors in sham Native American tribal bonds in order to steal millions of dollars in proceeds for their own extravagant expenses and criminal defense costs. The SEC alleges that Jason Galanis conducted the scheme in which the “primary objective is to get us a source of discretionary liquidity,” he wrote in an e-mail to other participants. Galanis and his father John Galanis convinced a Native American tribal corporation affiliated with the Wakpamni District of the Oglala Sioux Nation to issue limited recourse bonds that the father-and-son had already structured. Galanis then acquired two investment advisory firms and installed officers to arrange the purchase of $43 million in bonds using clients’ funds.

The SEC further alleges that instead of investing bond proceeds as promised in annuities to benefit the tribal corporation and generate sufficient income to repay bondholders, the money wound up in a bank account in Florida belonging to a company controlled by Jason Galanis and his associates. Among their alleged misuses of the misappropriated funds were luxury purchases at such retailers as Valentino, Yves Saint Laurent, Barneys, Prada, and Gucci. Investor money also was diverted to pay attorneys representing Jason and John Galanis in a criminal case brought parallel to the SEC’s stock fraud charges last year.

In addition five other individuals were charged with violations of the antifraud provisions of the federal securities laws and related rules. The SEC seeks disgorgement plus interest and penalties as well as permanent injunctions. In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against the same seven individuals.

This continues the emerging strategy of stronger enforcement of civil regulations backstopped by criminal actions in order to increase the deterrent effect against bad actors in the municipal space.

Muni Credit News May 10, 2016

Joseph Krist

Senior Municipal Credit Consultant

L.A. TAKES THE PRIVATE ROUTE FOR SPORTS FACILITIES

We have recently discussed proposals for public financing for stadiums for professional sports franchises, including those for teams in California. We note however, that the state’s largest city has been taking a different route. While most attention has been rightfully focused on the relocation of the NFL Rams from St. Louis to a privately financed stadium, the groundwork was being laid for a new facility for a major league soccer facility in Los Angeles.

Those efforts culminated in the announcement of Friday that the Los Angeles City Council unanimously approved plans for a privately financed $250-million stadium in Exposition Park, clearing the way for the expansion Los Angeles Football Club to begin construction on the most expensive soccer-specific project in Major League Soccer history.

The 22,000-seat stadium will be the cornerstone of a complex that will include a conference center, restaurants and a soccer museum. It will be built next to the Coliseum on the site of the 56-year-old Sports Arena, which held its final event in March. Construction, including the demolition of the Sports Arena, is scheduled to begin this summer with the target of getting the stadium finished in time for LAFC’s first home game in March 2018.

LAFC’s facility will be the first open-air professional sports stadium built in the City of Los Angeles since Dodger Stadium, which played host to its first game in 1962. That too was a private project although it was catalyzed by a donation of land by the City to the O’Malley family. Likewise, this new facility is being built on City land.

THE DONALD WEIGHS IN ON PUERTO RICO

Regardless of what you think his chances are, it is important for investors to know and weigh the views of Presidential candidates on matters impacting the municipal bond market. This week, Donald Trump let us know his views on Puerto Rico’s debt crisis. In his own words – “I know more about debt than practically anybody, I love debt. I also love reducing debt, and I know how to do it better than anybody. I will tell you with Puerto Rico they have too much debt. You can’t just restructure; you have to use the laws, cut the debt way down, and get back to business, because they can’t survive with the kind of debt they have. I would not bail out if I were — if I were in that position I wouldn’t bail them out.”

So now we have the presumptive Republican presidential nominee standing with the Obama administration in favor of allowing the Commonwealth access to Chapter 9. He stands against those Republicans who are against a “bailout” of the Commonwealth. He is consistent in favoring a haircut for debtholders, something his high yield creditors in the 90’s are all too familiar with. Confused yet?

IF YOU ARE CONFUSED, THIS WON’T HELP

Much of the debate on both sides of the Puerto Rico issue seem to be ignoring certain facts. Supporters of the Puerto Rican government like to lament the end of Section 236 tax in the last decade which had formerly encouraged manufacturing businesses to locate production facilities on the island. Many of those supporters portray the island as having been cut adrift to fend for itself by an evilly motivated U.S. government. As for the “anti-bailout” faction of the body politic, they fail to acknowledge a huge amount of funding the Commonwealth gets for its General Fund from U. S. tax policy. What both sides share is an ignorance of provisions under Act 154 of 2010.

Under Act 154, Puerto Rico enacted a special excise tax on American companies there — mostly pharmaceutical and medical device companies — in an effort to offset lost revenues as the result in reductions in the marginal tax rates on income levied by the Commonwealth on its residents. But the government had effectively promised many of those companies that it would not raise their taxes. So it designed the tax to be eligible for the foreign tax credit in the U.S. That took advantage of the fact that Puerto Rico is treated as a foreign country for foreign tax purposes. That way, it would basically be a wash for the companies, while Puerto Rico could still reap the money it would raise. The plan left U.S. taxpayers footing the bill as companies here can take a foreign tax credit for paying standard taxes there.

So since 2010, U.S. taxpayers have effectively been subsidizing 20% of Puerto Rico’s revenues. Ironically, the amount of money provided essentially covers the Commonwealth’s annual debt service requirements for its general obligation and guaranteed debt obligations. This under actions promulgated by Treasury not by Congressional authorization. Further, these provisions have been under scrutiny by the IRS (part of the Treasury) which conveniently will not address the “creditability” of these taxes for corporations.

So in the end, the U.S. is providing a pretty favorable subsidy via the Administration of the tax code and Congress does not seem to be fully aware of the issue as it debates whether or not it should start to bailout Puerto Rico. Confused yet?

PREPA UPDATE

The Puerto Rico Electric Power Authority (“PREPA”) Bondholder Group today announced an offer to pre-fund the purchase price of the 2016 Bonds that the Group agreed to purchase under the Bond Purchase Agreement (“BPA”) to facilitate the completion of the Restructuring Support Agreement (“RSA”) with PREPA. Under the terms of the offer, the BPA deadline would be extended until the earlier of the passage of an amendment by the Puerto Rico legislature excluding PREPA as an RSA party from the Moratorium Act or May 31, 2016.

The Bondholder Group is prepared to deposit the approximately $61 million to fund the BPA into escrow or other segregated accounts. Under the arrangement, the funds would be transferred to the PREPA bond trustee following the passage of legislation, which would address issues created by the Moratorium Act preventing the consummation of the BPA, and the satisfaction of other agreed-upon conditions precedent to the BPA.

MEAG PROPOSES LOOSENING TERMS OF ITS BOND RESOLUTION

We find it interesting and something for investors to look at that the Municipal Electric Authority of Georgia (MEAG) is proposing changes to its Project One bond resolution designed to provide management with additional “flexibility” in its requirements for future financings and oversight requirements. This at a time when MEAG is a participant in construction of new nuclear generating capacity, a risky financial venture to say the least.

The proposed changes would loosen restrictions on when and how MEAG can issue debt, reduce the requirement for outside review of projects and operations by consulting engineers which are required to be reported to the Trustee for the bondholders. The proposed changes would also create new categories of senior debt which may be identified as being “Refundable Principal Installments”. These bonds would require fewer assets to be accumulated for their payment prior to maturity. They would also alter the method of calculating debt service coverage in favor of the Agency. Additional proposed changes would also allow MEAG to decide to divest the agency of assets without the review of some outside entities as is currently required.

While quality management in our mind always trumps bond requirements, we are always concerned by changes that position investors to get less information and fewer sets of “outside eyes” acting on their behalf. MEAG does have a good track record overall and a good record with nuclear construction and generation, we are more comfortable with an overabundance of protection given the risks of participation in a new nuclear project at this time.

ILLINOIS TRANSPORTATION FUNDING TO BE UP TO THE VOTERS

If the constitutional amendment is approved Nov. 8, all money raised through various transportation-related levies such as the gas tax, tolls, licenses fees and vehicle registration costs would be put into what amounts to budget “lockbox.” That money could then only be spent on road construction and repair, enforcing traffic laws, paying off debt on transit projects and even costs associated with workers injured on the job. The change would not apply to state and local sales taxes that are added on top of the gas tax collected at the pump. The proposed change to the Illinois Constitution that would prevent cash-strapped state government from raiding funds intended to be used on transportation projects.

Illinois imposes a base tax rate of 19 cents per gallon for gasoline and 21.5 cents a gallon for diesel. The gas tax has not been increased since 1991, and revenue collections have been essentially flat as vehicles become increasingly fuel-efficient. The effort comes as the Legislature grapples with an overall state budget for the second straight year.

Illinois has over the years segregated various revenue streams to support specific programs or categories of debt to enhance their security and insulate them from claims of general obligation bondholders. While the segregation enhanced the security for the benefiting bonds, it did theoretically weaken the ultimate security of general obligation debt. We view the proposed segregation of transportation of revenues as a continuation of this trend. Given the current budget conditions facing the State, it is an additional point of concern for the state’s general obligation creditors.

Muni Credit News May 5, 2016

Joseph Krist

Municipal Credit Consultant

WHEN POLITICIANS RUN AMOK

We observe two recent credit events that show how politicians’ lack of knowledge about municipal bonds can cause headaches for bondholders. Sometimes silence is golden. The first is the circus going on in Harvey, IL where a relatively poor, small municipality has seen its credit driven off a cliff by irresponsible local government officials. (See our most recent posting for the mechanics of what happened.) The resulting impact on bondholders could have been foreseen if the City had complied with municipal market disclosure standards. The lack of audits for the last two fiscal years and a failure to post required disclosures of material events left both investors and citizens in the dark as to the City’s real fiscal position. This is yet another incident where the lack of knowledge on the part of responsible officials actually results in the interests of bondholders and the citizenry being aligned in regard to the need for available, current, and accurate information.

The second case is the current effort to deflect blame away from responsible officials by mainland proxies for the Government of Puerto Rico. in this case, the somewhat financially ill-informed Speaker of the New York City Council Melissa Mark-Viverito has asked the Securities and Exchange Commission to investigate OppenheimerFunds Inc., saying the asset-management company has played a role in worsening Puerto Rico’s fiscal crisis by increasing its investments in the island’s debt. Mark-Viverito has blamed the island’s financial crisis on hedge funds, banks and other investors in Puerto Rican general-obligation bonds and utility debt. She has described the companies as “vultures” feeding off the instruments’ high yields and claimed they have lobbied against legislation that would reduce its payments to bondholders.

The comments reflect her lack of knowledge as to the difference between mutual funds which act as proxies for individual investors and large institutional investors who represent more speculative investors. Their interests are often not in alignment in terms of goals and expectations. The level of naiveté reflected by her comments are disappointing given that they come from one of the major elected officials from New York City, one of the largest annual issuers of municipal bonds.

Situations like this are why the pressure for timely disclosure and outside oversight continues to come from the municipal analytic community.

ATLANTIC CITY

The political brinksmanship over Atlantic City’s financial woes continues. Assembly Speaker Vincent Prieto cancelled a vote on his Atlantic City rescue bill, saying three lawmakers needed to pass it missed the voting session. Another session will take place Wednesday, Prieto said, adding that it could be for a new compromise bill. Gov. Chris Christie and Senate President Stephen Sweeney support a bill that would let the state sell city assets and terminate union contracts.

In his usual blustery way, Christie said the city is out of cash in 10 days. Then came the disappointing comment. “If they come up with something, great,” Christie said of the Legislature. “If they don’t, then bankruptcy will be the only option.” New Jersey investors have traditionally been able to rely on the State’s history on intervention and oversight for troubled local credits. The embrace of Chapter 9 by the state’s highest ranking official should be a concern for investors going forward.

CHARGERS STADIUM INITIATIVE

The Chargers last weekend began their attempt to gather the 66,447 signatures of registered San Diego city voters required to qualify for the Nov. 8 ballot. Last week, the team unveiled what executives described as a design concept for a joint-use stadium, convention center and two-acre park adjacent to Petco Park in downtown San Diego’s East Village neighborhood. The Chargers emphasized that the actual design and cost would be determined by a public stadium authority or other city-controlled entity under the ballot initiative’s advisory provisions.

The initiative is silent on the project’s estimated costs and financing details, but it does call for a professional football team to contribute $650 million from private sources toward stadium construction, as well as cover stadium-specific cost overruns and help fund future upgrades and maintenance if a public capital reserve falls short.

Chargers financial advisers said the initiative could raise enough revenue to sell at least $1.15 billion in bonds to help pay for construction, operations and maintenance, with $350 million going toward the stadium, $600 million for the convention center and $200 million for land acquisition and moving a public bus yard at the site.

An increase in hotel taxes to 16.5 percent from 10.5 percent would fund the public’s share, with 5 percent of hotel bills in the city reserved for bond repayment. The city’s 2 percent tourism fee would be eliminated, but 1 percent of the tax would be allocated to tourism marketing, increasing to 2 percent once debt service was sufficient.

The terms of bond financing, final construction costs, size of the convention center and its operations, and a host of other details raised by the mayor would be controlled by the authority, and not the team. The initiative requires the stadium’s football team to sign a 30-year lease and agree to not relocate for 30 years, but the mayor pointed out that it also allows bond financing for up to 40 years, potentially leaving the authority repaying bonds without a team for some period.

RAIDERS LOOK TO LAS VEGAS

Oakland Raiders owner Mark Davis told the Southern Nevada Tourism Infrastructure Committee, an advisory panel appointed by Gov. Brian Sandoval, that he would provide $500 million toward the construction of the 65,000-seat stadium if a public-private financing plan is approved by the Legislature. Davis wants the Raiders playing in Las Vegas by 2020. Public funds would cover $750 million of the project’s construction costs, according to a proposal from the Las Vegas Sands casino company and Majestic Realty, which are partnering to develop and operate the stadium. Those costs would be financed over 30 years through $50 million annual payments, likely from a hotel room tax. Funding for the stadium construction could come by increasing the tax, perhaps by a fraction of 1 percentage point. Lawmakers would need to sign off on any increase to the hotel room tax or the creation of the tax increment area.

They would need also to act to create the proposed Clark County Stadium Authority — an umbrella entity that would coordinate the project and issue and secure bonds. Majestic and Sands might front the remaining $150 million, but they are also proposing a “tax increment area” that could help them recoup that cost and fund ongoing stadium maintenance.

Legal bookmaking in Las Vegas has always been looked upon as a serious hurdle to location of a “big four” major league franchise in the city. Two factors may mitigate that. One is the likelihood that an NHL expansion franchise could begin operating in 2018. The other is the fact that NFL games are played twice a year in London, where betting is legal on a much more extensive basis than would likely be the case in Las Vegas.

Muni Credit News May 3, 2016

Joseph Krist

Municipal Credit Consultant

The GDB and a group of hedge funds — which own about one-fourth of the bank’s $4 billion debt — have agreed to enter into a 30-day forbearance agreement. It would cover more than $100 million of the bank’s payment on Monday. The bank would have faced a $400 million payment on principal, with an additional $22 million in interest. But during the past week, The Puerto Rico government announced late Friday that the cash-strapped GDB had reached an agreement with a group of local cooperatives that pushes, for a year, payment on roughly $33 million that was originally due May 2.

The announcement followed on the heels of a televised message Sunday, in which Gov. Alejandro García Padilla announced he has declared a moratorium on the Government Development Bank’s (GDB) debt service, as the commonwealth stood ready to partially default on as much as $270 million due May 2 on the bank’s debt. “Pursuant to Act 21 [Puerto Rico Emergency Moratorium & Financial Rehabilitation Act], I ordered a moratorium on the debt service payment due by GDB [on May 2]. In light of Congress’s inaction, we were forced to enact Act 21 to protect the education, health and public safety and other essential services of our citizens from creditors,” the governor said. “Let me be very clear, this was a painful decision.”

García Padilla reiterated there is simply not enough cash to pay for both government services and the commonwealth’s debt service. The García Padilla administration has been lobbying Capitol Hill for months to achieve a broad debt-restructuring mechanism. For their part, the Republican majority delegations in both chambers of Congress have been skeptic of granting access to such a restructuring regime and instead have leaned toward establishing strong fiscal oversight on the island.

During the next few weeks, sides are expected to continue negotiations after agreeing to a “framework of indicative terms,” in an effort to reach a debt-restructuring agreement in principle, the GDB stated Sunday. The bank warned that important items remain which are still subject to further negotiation, while several conditions “would need to be met over the coming months before the deal could proceed.” “To be very clear, this is but one piece in a complicated process that will require every Commonwealth creditor to participate,” Acosta stressed.

A bill being pushed in the U.S. House Natural Resources Committee seeks to strike a balance between both demands, but has yet to garner enough support to secure passage. The Governor said, “We would welcome an oversight board that would assist the elected government of Puerto Rico in balancing its budgets and improving its fiscal discipline,” “But we strongly oppose a board that overrules an elected government by deciding how our taxpayer money is spent or who gets paid first, or that is permitted to veto, amend or repeal our laws at will and without any accountability to the people of Puerto Rico.”

Plans call for having any debt restructuring deal reached with GDB creditors become a part of the commonwealth’s superbond proposal, if it is achieved down the road. To date, the so-called “superbond” is a “global” structure whereby the island’s different would include a “two-step restructuring” of the bank’s debt, in which holders would first exchange their GDB debt for new paper, amid haircuts, or reductions to principal, of 43.75%. Once and if the superbond takes place, GDB creditors would agree a haircut of 53%. However, even if timely achieved, these deals would only cover about half of the $422 million in a best-case scenario, which would prompt the government to miss the remainder of the bank’s payment, officials have warned.

Under this scenario, the governor is expected to declare a moratorium on the GDB’s debt-service payments, as allowed under the recently enacted Puerto Rico Emergency Moratorium Financial Rehabilitation Act. García Padilla has already declared an emergency at the bank, with an executive order that placed restrictions on GDB’s cash outflows. It is highly expected that the García Padilla administration meets in full roughly more than $40 million in debt payments across other commonwealth credits that are also due on Monday.

LAGUARDIA AIRPORT DEBT POISED FOR TAKE OFF

For many years, LaGuardia Airport has come in for criticism for the condition of its aging facilities. Vice president Joe Biden even compared them to air facilities in third world countries. These sorts of comments have finally motivated the State of New York to undertake a renovation and expansion of the terminal infrastructure at LaGuardia. The financing for the project will be in the form of a bond issue that will be sold as early as this week.

The $2.5 billion issue will be sold through the New York Transportation Development Corporation. The proceeds will be sold to a special purpose corporation which will construct and operate the new terminal (Terminal B) and will construct additional facilities(a terminal and connecting facility) as a part of the overall airport development. The SPC will operate the existing terminal that is being replaced by the project during construction of the new facility.

The security differs from that seen at many other airport projects. Payments on the loan made from NYTDC to the SPC will be repaid from revenues derived from the operation of the terminal facilities such as payments for use of the gates and payments from concessionaires. Landing fees paid by airlines for the right to land at the airport and paid to the Port Authority of NY/NJ as operator of the airport will not be available for repayments on the loan by the SPC operating the terminal to the NYTDC. Those payments will be secured under the Loan Agreement which creates a leasehold mortgage in favor of the bondholders.

Only terminal revenues are pledged to the bonds. There will be a 1.25x rate covenant supporting the borrower’s ability to generate revenues and there will be a debt service reserve account funded at completion from construction account monies so that it will eventually be funded at six months maximum principal and interest.

The credit as structured is weaker in some aspects for bondholders than a general airport revenue bond would be as the result of the concentration of risk in the one facility. That reflects the lack of those revenues in the pledged credit. At the same time, there are benefits in that the credit is a true project credit, rising and falling on its own merits rather than being caught up in the bureaucratic morass that is the Port Authority of NY/NJ. Then there is the issue of the always complicated ownership structure at the New York airports.

Bondholders must member that the airports are owned by the City and leased to the Port Authority which in turn leases facilities to builders, operators, and tenants. In the event of bankruptcy, these ownership structures complicate the analysis of who owns what for determining rights and remedies under bankruptcy.

So the determination of a credit equivalency for purposes of a bond like this must take into account traditional metrics like those of the local air demand market, the strength of the builder/operators, and the overall creditworthiness and ratings of the potential tenants as well as the technical provisions of the tenant base. Given all of those factors, it would be a surprise if the bonds were to receive a rating better than a BBB.

HARVEY ILLINOIS

The recent news that Harvey, Illinois might default on some of its outstanding debt is actually the culmination of a long process. The Securities and Exchange Commission announced that on January 27, 2015, an Illinois federal court entered a default judgment against Joseph T. Letke, a certified public accountant, served as the comptroller for several municipalities, mostly in the south suburbs of Chicago, including the City of Harvey, Illinois (the “City of Harvey”). According to the complaint, Letke and a firm he owned and controlled also served as a financial advisor to the City of Harvey in connection with certain municipal bond issuances in 2008, 2009 and 2010.

The complaint alleged that according to the offering documents for the 2008, 2009, and 2010 Bond Offerings, the purpose of these offerings was to finance the development of a full-service hotel and conference center in the City of Harvey (the “Hotel Development Project”). But according to the complaint, Letke participated in a scheme to divert the proceeds from these bond issuances for improper purposes, including undisclosed payments to Letke beyond what was disclosed in the offering documents, for payroll for the City of Harvey, and for other purposes unrelated to the Hotel Redevelopment Project. The complaint alleged that as the result of the scheme to divert bond-related proceeds, the Hotel Redevelopment Project turned into a fiasco, with the Hotel Redevelopment Project never having been completed.

Since then, the economically troubled south side municipality of 25,000 has been dealing with the political fallout of this situation. That aftermath has included charges of corruption against various city officials and difficulties administrating basic issues such as the levy and collection of property taxes. A recent effort to enact a tax increase and to collect taxes in amounts sufficient to generate revenues to pay debt service came to a head last week.

On Friday, the Cook County clerk’s office reversed course and approved a levy that will keep Harvey residents paying property taxes for city services. The reversal Friday comes two days after the county clerk declared the same ordinance invalid. The ordinance was passed during a chaotic meeting in which just two of Harvey’s six aldermen voted for it. The mayor argued another two aldermen were in the room, so they were recorded as no votes, which the mayor argued allowed him to break a 2-2 tie to pass the levy. The levy was deemed valid despite a majority of aldermen opposing it. Those aldermen have long argued that the Mayor couldn’t be trusted to honestly spend levy cash.

The levy was deemed valid despite a majority of aldermen opposing it. Those aldermen have long argued Kellogg couldn’t be trusted to honestly spend levy cash. The opposition to the tax had called a special meeting Friday night to attempt to pass a smaller levy. But, after news of the county clerk’s decision spread, only two of the group’s four aldermen came to city hall, and then for only a portion of the meeting.

It is the latest chapter in the debate in Harvey over what is typically in other cities a routine function: passing a property tax levy. Four of the suburb’s six aldermen argue that the Mayor has refused to explain how city money is spent, so they can’t support a tax levy that would continue to pump money to his administration. The Mayor contends that the aldermen are power hungry and played politics in ways that could force the city of about 25,000 to lay off half of its police, firefighters and public works employees.

Caught in the middle has been the County Clerk, whose office has the duty to process local governments’ levy ordinances. State law says municipalities must pass a levy ordinance by the last Tuesday in December, but the Clerk pushed that deadline back to May 2 for Harvey. With the deadline looming, and no budging from the anti-mayor group, the Mayor and his supporters said the ordinance was introduced at Monday’s council meeting — during which two anti-tax aldermen had already walked out of the meeting in protest and a shouting citizen was removed out of the council chambers by police.

Two aldermen voted for the levy, they said. The mayor said the final two anti-tax aldermen were present for the vote but didn’t respond, allowing their votes to count as no votes and the Mayor to cast the tie-breaking yes vote. The clerk’s office initially told Harvey officials Wednesday the vote was invalid because — in a city of a mayor and six aldermen — at least four of them needed to vote yes. But the Mayor responded that Harvey had home-rule powers, under which the city had adopted different rules that would allow such a vote to count. In a letter Friday, the Clerk’s office said based on what Kellogg sent, the levy appears to be valid. The Harvey city clerk “attested” to the fact two of the anti-Kellogg aldermen were there, and he said the office has only an “administrative rather than an investigative role” in the tax levy process.

Muni Credit News April 28, 2016

Joseph Krist

Municipal Credit Consultant

PR HURDLES TOWARDS DEFAULT THIS MONDAY

Puerto Rico’s government still has not set a delivery date for Puerto Rico’s audited financial statements for fiscal year 2014, Public Affairs Secretary Jesús Manuel Ortiz said Wednesday. “Certainly, we don’t have a delivery date,” said Ortiz, while adding that meetings between KPMG and government officials are still underway. The government of Gov. Alejandro García Padilla was expected to release the financial statements early this month. However, uncertainty over the Government Development Bank (GDB) has again delayed the delivery of the statements, which were due almost a year ago.

At the GDB, there remains uncertainty in figuring out the government bank’s loan loss reserves. If the government can restructure its debt, then there would be more money on hand; if the government isn’t able to restructure, then there is less money. Many assumptions tied to the central government are difficult to value.

Ironically the administration is currently evaluating a proposal from KPMG to perform the audited financial reports for fiscal year 2015, which are due May 1. KPMG also produced the audit for fiscal 2013, which was delivered two months past its deadline. During the past three years, KPMG has been paid roughly $20 million in professional-services contracts, according to government records.

Congress heading out of Washington on Friday, missing deadlines on the budget and on helping Puerto Rico with its financial crisis. Having failed to enact a bill by the May 1 deadline to help the territory, lawmakers are now focusing on a July 1 deadline, when around $2 billion in principle and interest payments come due.

The government is expected to keep operating as usual, but economists warn that its access to capital markets will shut down and that eventually this will curtail public services if a debt-restructuring mechanism isn’t approved. Puerto Rico expects multiple lawsuits to be filed shortly after Monday’s anticipated default. A House bill would create a control board to help manage the island’s $70 billion debt and oversee debt restructuring. But the legislation has stalled in the Natural Resources Committee, as some conservatives and Democrats have objected to the approach.

Speaker Paul Ryan, R-Wis., has pushed the bill, saying the U.S. may eventually have to bail out the territory if Congress doesn’t act soon. Utah Rep. Rob Bishop, the Republican chairman of the Natural Resources panel, says he hopes the island’s impending default will create more urgency among his colleagues. The Senate is expected to wait to see what happens in the House first.

The Puerto Rico government is expected to keep operating as usual, but economists warn that its access to capital markets will shut down and that eventually this will curtail public services if a debt-restructuring mechanism isn’t approved. Puerto Rico expects multiple lawsuits to be filed shortly after Monday’s anticipated default.

Democrats called upon House leaders to modify this spring’s three-weeks on, one-week off legislative schedule to keep working, as Puerto Rico moves toward its default on Sunday. “It’s very, very hard to get anything done if you are a drive-by Congress,” said House Minority Leader Nancy Pelosi, D-Calif. “We’re barely here. And these deadlines are coming.” Hours later, however, Democrats joined Republicans in adjournment.

It is clear that Congress has yet to figure out which outcome generates political upside. With national attention focused on the presidential nomination process, it has been hard for Puerto Rico to generate a sufficient level of political traction and attention in order to drive a resolution of its situation. In the meantime, it appears that the coalition of political leaders who initially supported tax increases earlier this year is falling apart. With the island’s gubernatorial election process beginning to take shape, Sen. President Eduardo Bhatia Gautier, Sen. José Nadal Power, House President Jaime Perelló Borrás, Rep. Rafael Hernández Montañez, and PDP gubernatorial candidate David Bernier all announced their opposition to the planned tax changes. A scheduled increase in VAT has been delayed due to this opposition.

Meanwhile it has been about seven months since the initial announcement of a PREPA restructuring agreement and it has still to be implemented. PREPA is seeking to prolong a bond-purchase agreement with its creditors to May 2, averting a potential termination of a larger debt-restructuring deal. The agreement would have bondholders and insurance companies agree to buy $111 million of three-year bonds from PREPA. The contract expired late Wednesday and is part of PREPA’s plan to restructure $9 billion of debt. The larger restructuring pact will end if the bond-purchase agreement fails to continue.

MEANWHILE IN ATLANTIC CITY

Assembly Speaker Vincent Prieto will post his Atlantic City rescue bill for a vote next Thursday. Prieto released a schedule for the Assembly on that includes a voting session on Thursday. Prieto’s bill gives the city two years to meet benchmarks in order to solve its financial crisis. If the city fails to do that, it will be taken over by the state.

Senate President Steve Sweeney is reported to have tried to compromise with Prieto by offering a bill that gives the city 130 days to meet benchmarks, but Prieto is said to have been unwilling to accept it. Atlantic City Mayor Don Guardian and Council President Marty Small have repeatedly said they support Prieto’s bill.

May 15 is the deadline date for action by the State that would enable Atlantic City to avoid a default. Much of this has been lost in the fog of the market’s attention on Puerto Rico and its woes.

We believe that while much smaller in terms of dollars, the failure of the State of New Jersey to help Atlantic City avoid a default would have implications for the market, especially for the ability of not only New jersey’s municipalities but also for the State itself.

Muni Credit News April 26, 2016

Joseph Krist

Municipal Credit Consultant

FL ADOPTS P3 LEGISLATION

Recent legislation created The Florida Department of Transportation Financing Corporation as a nonprofit corporation for the purpose of financing or refinancing projects for the department. It permits the Department to finance P3 projects through the issuance of tax-exempt bonds. It shall be governed by a board of directors consisting of the director of the Office of Policy and Budget within the Executive Office of the Governor, the director of the Division of Bond Finance, and the Secretary of Transportation. The director of the Division of Bond Finance will be the chief executive officer of the corporation and shall direct and supervise the administrative affairs of the corporation and control, direct, and supervise the operation of the corporation.

The legislation authorizes the department to adopt relevant federal environmental standards as the standards for a program. Sovereign immunity from civil suit in federal court is waived. The Legislature found that there is a public need for the rapid construction of safe and efficient transportation facilities for the purpose of traveling within the state, and that it is in the public’s interest to provide for the construction of additional safe, convenient, and economical transportation facilities. The law requires that in connection with a proposal to finance or refinance a transportation facility pursuant to this section, the department consult with the Division of Bond Finance of the State Board of Administration. The department must provide the division with the information necessary to provide timely consultation and recommendations. The Division of Bond Finance may make an independent recommendation to the Executive Office of the Governor.

Specifically, The Department of Transportation may request the Division of Bond Finance to issue bonds secured by toll revenues collected on the Alligator Alley , the Sunshine Skyway Bridge, the Beeline-East Expressway, the Navarre Bridge, and the Pinellas Bayway to fund transportation projects located within the county or counties in which the project is located. The law provides that the department’s Pinellas Bayway System may be transferred by the department and become part of the turnpike system under the Florida Turnpike Enterprise Law. Upon transfer of the Pinellas Bayway System to the turnpike system, the department shall also transfer to the Florida Turnpike Enterprise the funds deposited in the reserve account established shall be used by the Florida Turnpike Enterprise solely to help fund the costs of repair or replacement of the transferred facilities.

The department may enter into a service contract for a project may enter into one or more such service contracts with the corporation and provide for payments under such contracts, subject to annual appropriation by the Legislature. Each service contract may have a term of up to 35 years. The obligations of the department under such service contracts do not constitute a general obligation of the state or a pledge of the full faith and credit or taxing power of the state, and such obligations are not an obligation of the State Board of Administration or entities, but are payable solely from amounts available in the State Transportation Trust Fund, subject to annual appropriation. The Florida Department of Transportation Financing Corporation may issue and incur notes, bonds, certificates of indebtedness, and other obligations payable from and secured by amounts payable to the corporation by the department under a service contract. The duration of any such note, bond, certificate of indebtedness, or other obligation or evidence of indebtedness may not exceed 30 annual maturities. Debt may be sold through competitive bidding or negotiated contracts, whichever is most cost-effective.

Such obligations are exempt from taxation; however, such exemption does not apply to any tax imposed under chapter 220 on the interest, income, or profits on debt obligations owned by corporations.

KANSAS – THE SONG REMAINS THE SAME

Last year at this time, Kansas legislators were facing a $400 million hole in the FY 2016 budget. This year the gap is $290 million after increases in sales and cigarette taxes. Governor Sam Brownback would fill the gap by taking $185 million from the state highway fund, delaying more than two dozen projects, and he would cut spending to state universities by 3 percent, about $17 million, for the fiscal year beginning July 1. That would continue a 3 percent cut he ordered earlier this month.

More than $1.5 billion has been shifted from the highway fund to the state’s general fund and other state agencies since 2011. Until now, Brownback made assurances that all highway projects would go forward. But his budget message last week led the state Department of Transportation to announce the delay of 25 projects slated to begin over the next two to three years, including a Kansas 68 widening project in Miami County. Projects currently underway aren’t affected.

Other moves would require approval by the Legislature, which returns from a spring recess on Wednesday. Three options have been offered by the Governor.

One option would sell off a portion of the state’s future tobacco settlement money for quick cash. The first option was to sell a portion of the state’s future payments from a national tobacco settlement, which Kansas dedicates to early childhood education programs, to bondholders for a one-time infusion of $158 million. It’s a contentious idea. Kansas along with most other states receives a payment each year of some $58 million, although the annual payment is expected to decline in the future as smoking declines.

A second option would delay a $99 million state payment to the Kansas Public Employees Retirement System until fiscal year 2018. Current retirees’ benefits wouldn’t be affected by the delay, he said. A third option would make 3 to 5 percent cuts to most state agencies, including funding to K-12 public schools and state universities. A 3 percent reduction to K-12 schools would be about $57 million.

The options offered by the Governor are either one-shots (the tobacco bonds), irresponsible pension funding deferrals (Kansas has one of the lowest pension funding ratios). None of them are positive for the State’s credit and would continue a pattern of offloading the results of the failed tax cut experiment on to the credits of underlying entities to the detriment of their ratings. We see Kansas as an environment to avoid for credit conscious investors so long as Governor Brownback clings to his failed tax cut program. S&P would seem to agree keeping the State’s credit on negative outlook this week.

HIGH YIELD DOWNGRADE

Iowa Fertilizer Company LLC has been downgraded by Fitch to B+. The project generating revenues for the company’s controversial $1.2 billion tax-exempt deal has experienced a substantial delay in start-up is expected to necessitate a draw on the cash-funded debt service reserve for mandatory 2016 payments. These payments and construction cost shortfalls are expected to be funded by a $150 million letter of credit-backed (LOC) subordinated loan facility from sponsor OCI N.V.

The project fully exhausted its contingency and issued an additional $100 million of combined senior debt and sponsor equity in June 2015, and additional funding will be required to complete the facility. Further change orders and contractor claims are still being negotiated, indicating that final costs could rise further.

The project will utilize commercially proven technologies with relatively low maintenance risk. At the same time, it’s main products have historically exhibited considerable price volatility. Fitch estimates that a shift in the supply-demand balance could negatively impact prices, as a 10% change in nitrogen product prices will result in a 0.40x-0.50x change in debt service coverage ratios. Management’s latest expectation is that ammonia production will begin in the September/October 2016. These obligations total an estimated $168.3 million. Construction progress, the status of OEC’s claims, and market fertilizer prices over the next few months will determine the likelihood that IFCo can meet its obligations relying only on projected sources of funds available to the project company.
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 April 21, 2016

Joseph Krist

Municipal Credit Consultant

KENTUCKY BUDGET MAKES SOME EFFORT AT PENSION FUNDING

The Kentucky General Assembly has passed a $21 billion Executive Branch budget for the next two fiscal years that will pour $1.28 billion into the state pension systems and make no cuts to K-12 education while authorizing the governor’s plan to cut most state agency funding by nine percent over the biennium. Most new money in HB 303 will go for state pension in the Kentucky Employees Retirement System and the Kentucky Teachers’ Retirement System. Funding in FY 2017 will be $933.1 mn and in FY 2018 will be $888.8 mn. That is 5.7% of enacted spending for the upcoming biennium.

Funding for K-12 education will not be cut under HB 303, which protects funding to schools and gives the Department of Education up to $20 million in additional funds over the biennium as a necessary governmental expense if there are not enough per-pupil SEEK funds available. Public preschool will be made available to families with incomes below 200 percent of the poverty level as part of a pilot program, and $15 million in preschool funding will be set aside for grants to help develop full-day programs for children eligible for state child care assistance.

In the area of higher education, HB 303 authorizes lesser cuts of 4.5 percent over the biennium for state colleges and universities that faced the possibility of 9 percent cuts under the governor’s original proposal. A performance-based funding formula for state universities is also found in the bill that will require 5 percent of state university base funding to be gauged on an institution’s performance. Kentucky State University would be exempt from the performance-based model.

LOUISIANA

On April 12, 2016, Louisiana Governor John Bel Edwards released his proposal for the state’s fiscal year 2017 budget. Citing shortfalls in the state budget, Edwards said that deep cuts to many state services were necessary to close gaps for the overall improvement of the state’s financial health. The proposal included cuts to the state’s primary college scholarship program (TOPS), cuts to “safety net hospitals” for low-income families, and cuts to education at both the K-12 and college levels. The funding for the TOPS program, in particular, would be reduced by about two-thirds of its current level, leaving the total funds at about $110 million. The state legislature went on to debate several bills that would alter how cuts.

The cuts followed up a series of tax increases adopted during a special session of the legislature in late winter. These included a rise in the State sales tax rate of 1%, an expansion in the taxable base for the existing 4% sales tax through FY 2018, and the stabilization fund and appropriated $200 million of monies from funds received under the BP settlement agreement.

According to the U.S. Census, Louisiana had 14 state pension plans as of April 2015. Between fiscal years 2008 and 2012, the funded ratio of Louisiana’s state-administered pension plans decreased from 69.2 percent to 55.5 percent. The state paid 96 percent of its annual required contribution, and for fiscal year 2012 the pension system’s unfunded accrued liability totaled $18.4 billion. This amounted to $4,161 in unfunded liabilities per capita.

The State continues to be negatively impacted by low oil prices. These have had a negative impact of revenues and employment and increased pressure on the expenditure side of the budget. So long as oil prices remain in a relatively depressed state, the negative pressure on the State’s credit ratings will persist. These are exacerbated by the State’s weak pension funding position reflecting years of underfunding now creating annual budget gaps.

RHODE ISLAND PENSION DEVELOPMENTS

So far this year’s budget process has not continued positive momentum which the State and the Governor had hoped to carry forward in regard to the State’s longstanding pension funding issues. In 2007, legislation was enacted which provided for surplus General Fund monies to be transferred to the State Retirement Fund. Pressures on the General Fund diminished support for this plan as it was felt that the funds were needed elsewhere and last year the Legislature effectively repealed these provisions keeping those surpluses within the General Fund.

Most prominent among those pressures were the need for additional state aid to struggling municipalities. Those struggles are based in changes in the local economies but also fiscal pressures resulting from increasing pension demands. Some 20 of the 36 municipal pension plans have funding ratios below 60%. These pressures resulted in the Chapter 9 bankruptcy of the City of Central Falls in 2011.

Now nearly five years later, several municipalities are considered to be distressed. For FY 2017, eight are determined to be eligible for funding from Rhode Island’s Distressed Communities Relief Fund. Pension requirements are but one of several criteria used to determine qualification for Fund monies. It is hoped that at least one community will be able to drop out of the program in FY 2017.

These factors are among many that weigh negatively on Rhode Island’s credit outlook as it continues to deal with the long-term decline of its major manufacturing industries. Its efforts to do so have been stymied by competition from the larger neighboring states in the region and larger and more established entities in those states in the commercial and service sectors that Rhode Island seeks to expand.

Our view is that those pressures will continue and will be sufficient to outweigh the impact of the positive steps which the State is undertaking. We would view that State’s debt as one to underweight versus other comparably rated state bonds.

PR CREDITOR AGREEMENT

According to press reports, the Government Development Bank (GDB) and a group of its creditors have struck a tentative deal, providing the bank with some relief ahead of its $422 million debt payment due May 2. The group of GDB creditors, which hold about a fourth of the bank’s roughly $4 billion debt, would agree to a forbearance agreement that covers only $120 million of the May payment. The government could still be pressed to declare a partial moratorium on the remainder of the payment, as there is not enough money to meet the payment in full. The tentative plan reportedly would also include a debt-exchange process whereby GDB creditors would get new with a haircut estimated at 50%. Creditors would have to accept that they would receive no principal payments in the next few years. The rest of the bank’s creditors would still need to join the agreement if the exchange is to take place.

Meanwhile in Washington, the Puerto Rico debt restructuring bill was still short of votes. The bill is still being rewritten, and as of yet the vote has not been rescheduled. The U.S. House Natural Resources Committee issued a statement Tuesday seeking support for its bill. “Congress cannot pass legislation to erase the decades of fiscal mismanagement and socialist policies that brought the territory to its knees. But a growing number of Members understand we must act on a responsible solution to prevent U.S. taxpayers from footing the bill,” the panel statement said.

Meanwhile, the situation on Puerto Rico remains “fluid”. The Puerto Rico House of Representatives passed a bill that would exclude general obligation (GO) and Sales Tax Financing Corp. (Cofina) bonds from the law that allows the governor to declare a debt moratorium. The leader of the PDP in the Senate said in an interview that he agrees that the government should not include general obligation debt or debt that is sustainable such as Cofina debt, which is guaranteed by the sales and use tax, in the moratorium. He also said he believes the debt that was recently restructured at the Puerto Rico Electric Power Authority should not be part of the debt moratorium.
I don’t support including the general obligation bonds in the negotiation to restructure debt because it would be in violation of the constitution.”

However, Gov. Alejandro García Padilla immediately advised lawmakers in a statement that he plans to veto the bill if it reaches his desk. These maneuverings are why it is a fool’s errand for analysts to try to predict the outcome of this process. Those with the means and capacity to deal with these day to day machinations are most appropriately equipped to play in these bonds. Rare is the individual investor who is.

In the meantime, the Government Development Bank has filed with regulators to sell taxable debt that would mature May 2017 as officials negotiate with creditors about a $422 million payment owed at the start of May. And no, the Puerto Rican government has not released audited financial statements for FY 2014. They are requesting proposals from auditors for FY 2015 financial statements. And yes, it is FY 2017 that begins this July 1.

Muni Credit News April 19, 2016

Joseph Krist

Municipal Credit Consultant

SEC STEPS UP MUNI FRAUD EFFORT

It will perhaps be of more interest locally in the NY metro area than nationally but the recent actions of the SEC enforcement staff in the municipal bond market should be encouraging to investors. The SEC alleges that Ramapo officials resorted to fraud to hide the strain in the town’s finances caused by the approximately $60 million cost to build a baseball stadium as well as the town’s declining sales and property tax revenues. It is alleged that they cooked the books of the town’s primary operating fund to falsely depict positive balances between $1.4 million and $4.2 million during a six-year period when the town had actually accumulated balance deficits as high as nearly $14 million. And because the stadium bonds issued by the Ramapo Local Development Corp. (RLDC) were guaranteed by the town, certain officials also masked an operating revenue shortfall at the RLDC and investors were unaware the town would likely need to subsidize those bond payments and further deplete its general fund.

According to the SEC’s complaint, inflated general fund balances were used in offering materials for 16 municipal bond offerings by Ramapo or the RLDC to investors, who consider the condition of a municipality’s general fund when making investment decisions. After town supervisor Christopher P. St. Lawrence purposely misled a credit rating agency about the town’s general fund balance before certain bonds were rated, he told other town officials to refinance the short-term debt as fast as possible because “we’re going to all have to be magicians” to realize the purported financial results.

Christopher P. St. Lawrence, who served as RLDC’s president in addition to being town supervisor, masterminded the scheme to artificially inflate the balance of the general fund in financial statements for fiscal years 2009 to 2014. St. Lawrence and Aaron Troodler, a former RLDC executive director and assistant town attorney, concealed from investors that RLDC’s operating revenues were insufficient to cover debt service on bonds to finance the stadium. Troodler helped conceal the fictitious sale and boost the account balance of the town’s general fund by approving RLDC financial statements reflecting a purchase of property that never actually occurred. Troodler also signed offering documents that contained an additional fabricated receivable totaling $3.66 million for another transfer of land from the town to the RLDC. The only land transferred from the town to the RLDC during the time of the purported transaction was property donated for the baseball stadium, which St. Lawrence and Troodler knew did not impose any payment obligation on the RLDC.

Town attorney Michael Klein helped conceal outstanding liabilities related to the $3.08 million receivable recorded in the town’s general fund for the sale of a 13.7-acre parcel of land to the RLDC. But because the title of the property was never transferred from the town to the RLDC, Klein also made misleading statements about the receivable’s source. Troodler helped conceal the fictitious sale and boost the account balance of the town’s general fund by approving RLDC financial statements reflecting a purchase of property that never actually occurred. Troodler also signed offering documents that contained an additional fabricated receivable totaling $3.66 million for another transfer of land from the town to the RLDC. The only land transferred from the town to the baseball stadium, which St. Lawrence and Troodler knew did not impose any payment obligation on the RLDC. The town’s deputy finance director Nathan Oberman participated in activities to inflate the town’s general fund by arranging $12.4 million in improper transfers from an ambulance fund to bolster the troubled general fund during a six-year period.

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against St. Lawrence and Troodler.

CONNECTICUT BUDGET WOES CONTINUE

Although by various measures, Connecticut is a wealthy state it’s budget is not immune from the pressures of declining revenues and accelerating expenses. In part because the state’s legislators are forced to rely heavily on its highest earners to fill the state’s coffers. Nearly 61% of tax revenues is from the income tax. They are fearful of alienating more of the highest-earning residents after a tax increase last year. Since an initial budget was accepted in February, revenues have

To counter this trend, the Governor released a revised budget for FY 2017 that reflects a 4.89% decline in revenues from the February estimate. It employs layoffs of state employees to reduce expenses by 8.1%. This does result in a small surplus if nothing else changes. Connecticut is in a tough spot as it wealth is highly concentrated and much of it is mobile. On the expense side, flexibility is limited by the need to fund pensions after a long period of underfunding. Spending for those costs account for 5.6% of spending. In addition, debt service eats up a very high 12.8% of expenses.

So the outlook for Connecticut remains negative. This reflects the poor revenue trend and the maintenance of expenditure pressures going forward in an atmosphere of limited management flexibility.

PUERTO RICO

Puerto Rico Secretary of State Víctor Suárez disclosed that discussions with a group of GDB creditors could involve a request for a forbearance agreement that would cover roughly $120 million of the May 2 payment due from GDB. “If we strike a forbearance agreement, there is still the possibility of declaring a partial moratorium,” said Suárez. Suárez said it is not currently being contemplated that the creditor group would be asked for additional cash flow lending. He did acknowledge that “the cash flow situation of the government continues to be delicate. The government needs to follow up every week on its cash flow to make the calls with respect to the July 1 payments. It is very hard, very hard that the government can make any payment in July 1.

YOUTH SMOKING TRENDS

It’s the time of year when the states receive their annual payments from the tobacco companies under the Tobacco Settlement Agreement (TSA). As consumption of cigarettes (not other tobacco products) is one of the prime variables impacting the level of these payments tobacco securitization bonds, annual trends in consumption are closely followed.

The Centers for Disease Control(CDC) and the U.S. Food and Drug Administration’s (FDA) Center for Tobacco Products in its Morbidity and Mortality Weekly Report (MMWR) showed that overall tobacco use by middle and high school students has not changed since 2011. Data from the 2015 National Youth Tobacco Survey show that 4.7 million middle and high school students were current users (at least once in the past 30 days) of a tobacco product in 2015, and more than 2.3 million of those students were current users of two or more tobacco products. Three million middle and high school students were current users of e-cigarettes in 2015, up from 2.46 million in 2014. Sixteen percent of high school and 5.3 percent of middle school students were current users of e-cigarettes in 2015, making e-cigarettes the most commonly used tobacco product among youth for the second consecutive year. During 2011 through 2015, e-cigarette use rose from 1.5 percent to 16.0 percent among high school students and from 0.6 percent to 5.3 percent among middle school students.

From 2011 through 2015, significant decreases in current cigarette smoking occurred among youth, but there was no significant change in the prevalence of current cigarette smoking among this group during 2014 – 2015. In 2015, 9.3 percent of high school students and 2.3 percent of middle school students reported current cigarette use, making cigarettes the second-most-used tobacco product among both middle and high school students. The importance of this particular data trend is that levels of youth smoking have a direct correlation to levels of adult smoking over the long term. Any change in this direction of this trend is noteworthy. This one, should it continue could slow or stabilize the overall decline in cigarette consumption which has negatively impacted levels of available revenues for the repayment of tobacco bonds in recent years.