Joseph Krist

Municipal Credit Consultant

WHY YOU NEED US

Thirty six municipal bond underwriters operating in the $3.7 trillion muni market will collectively pay about $9 million to settle civil charges over fraudulent offerings, as part of the first settlement of its kind with the U.S. Securities and Exchange Commission. The SEC said that the charges stemmed from a March 2014 invitation to brokers and bond issuers to voluntarily report disclosure violations in offering documents, such as material misstatements and omissions.

The firms represented about 70 percent of the dollar value of all municipal bonds issued in the United States during the four years ended on Sept. 30. The settlement requires each firm to pay civil penalties based on the number and size of the fraudulent offering. The maximum penalty is $500,000 for large firms and $100,000 for smaller ones. The firms also must hire independent consultants to review their policies and procedures.

PUERTO RICO UPDATE

With PR fast approaching its July 1 fiscal cliff, Governor Alejandro García Padilla confirmed that his administration recently pursued a proposal to request that the U.S. Congress allow the Puerto Rico government to declare bankruptcy. García Padilla said he has since rejected the proposal in favor of a current effort to get rules that would allow only Puerto Rico’s public agencies to file for bankruptcy under Chapter 9.  A U.S. House committee is studying the issue amid growing concerns about the government’s ability to repay its debt and is holding hearings this week.

Pedro Pierluisi, Puerto Rico’s representative in Congress, criticized García Padilla for pursuing such a proposal privately. The Government Development Bank has warned that the government could have to shut down in the coming months if new measures to generate revenue are not enacted. García Padilla recently signed a bill to increase the sales and use tax (IVU by its Spanish acronym) from 7% to 11.5% and to create a new 4% tax on professional services. The sales tax increase goes into effect July 1 and the new services tax on Oct. 1, with a transition to a value-added tax by April 1.

Legislators are now debating a proposed $9.8 billion budget which includes $674 million in cuts and sets aside $1.5 billion to help pay off Puerto Rico’s debt. The budget has to be approved by June 30. In the meantime, Senate Bill 1350, which aims to enhance oversight powers and immunity protections for Government Development Bank (GDB) officials now moves to the governor’s desk after a conference committee version was approved by the Legislature.

The bill keeps immunity language, which stipulates that GDB directors, officers and employees “shall be indemnified by the bank and shall not have any personal civil liability to any entity for actions taken or not taken in good faith in their capacity and authority, absent clear and convincing proof or gross negligence comprising reckless disregard of, and failure to perform, applicable duties”. The bill also calls for the Senate’s approval of GDB directors appointed by the executive branch, beginning in January 2018.

It keeps provisions for the creation of the Audit and Risk Management committees, and places lending restrictions on loans provided by the GDB. The bank would be empowered to require from public corporations and instrumentalities access to any financial information and related documents it deems necessary, with sanctions established for noncompliance. The GDB would also be allowed to pass judgment on the “reasonability” of the government revenue estimates for each fiscal year.

The bill includes provisions requiring the bank’s president to submit a monthly report on new loans to the legislature, as well as amendments to existing ones approved by the bank’s board; appear once a year at both chambers to present the bank’s annual report on public debt; and submit both the Commonwealth’s Financial Information & Operating Data Report and Quarterly Reports within five days of publishing them. The bill also creates a Commission for the Integral Audit of Public Credit with broad powers to analyze and audit everything related to Puerto Rico’s public debt. It would act autonomously, and would comprise members from both public and private sectors, as well as academia.

Many of S.B. 1350’s original provisions, including those allowing for the appointment of emergency managers for troubled public corporations and instrumentalities, and the transfer of deposits from municipalities and the University of Puerto Rico (UPR) to the GDB were eliminated in order to secure the necessary votes for passage in both chambers.

To address the Government Development Bank’s liquidity,  a bill that seeks to raise short-term debt from some public corporations, as well as requiring reserves to cover general-obligation (GO) debt, was approved late Tuesday by the House. House Bill 2542 now moves to the Senate, which would have to consider it before Thursday, the last day for both chambers to approve measures during this session, while bills at conference committees have until June 30.

Amendments to the measure include provisions allowing the Treasury Secretary to “suspend, totally or partially” monthly deposits made to cover principal and interest payments on GO debt, if it fails to either secure $1.2 billion in tax & revenue anticipation notes (TRANs), or at least $2 billion in a bond deal backed by the latest hike to the petroleum-products tax.  The House-approved bill also requires the Office of Management & Budget (OMB) to reserve $250 million in the proposed fiscal 2016 budget, which would bring it down to $9.55 billion from the initially projected $9.8 billion, he indicated.

The bill would allow use of about $400 million for TRANs from investment funds of the Automobile Accidents Compensation Administration (ACAA), Temporary Nonoccupational Incapacity Insurance (Sinot) and State Insurance Fund (SIF). While Sinot and ACAA would provide $15 million and $50 million, respectively, SIF’s share stands to total about $335 million. The bill adds that these investments would still be carried out, regardless of the credit rating of the instrument or any restriction placed by the public corporations’ investment policies or contractual obligations.

During the House debate, the minority leader declared ominously, “we are telling bondholders that if you want certainty, invest first in Puerto Rico,” adding, “We will pay the GOs, but we have to restructure the rest of the debt.”

Under a scenario in which the government can’t accomplish any of two financing plans, the minority leader stated that with the “combination of the $400 million from the public corporations, the additional 4.5% to the sales tax, and not doing the monthly reserves for GOs, we would keep the government operating.”

Government officials have previously said that absent TRANs or short-term financing at the beginning of the fiscal year, Treasury could potentially run out of cash during the first quarter, which would affect government operations and services, as well as exacerbate the island’s economic and fiscal crisis. Several options are under consideration—including the exchange of short-term notes worth as much as $4 billion—as it pursues a parallel initiative with the U.S. Treasury Department. The GDB’s net liquidity position was $778 million, as of May 31.  It has been reported  that Puerto Rico’s government has lobbied the U.S. Treasury to purchase GDB notes in a last-resort effort to increase much-needed liquidity.

Meanwhile, as a significant July 1 principal payment looms, Puerto Rico Electric Power Authority (PREPA) and its creditors entered into yet another forbearance agreement extension, until June 30, while they continue to negotiate a restructuring plan for the financially troubled utility that prevent a potential default and court-mandated receivership. Bond insurers would have to cover much of the July 1 payment, if PREPA were to miss it. In a recent filing, U.S. Bank N.A. PREPA’s trustee, indicates that it doesn’t hold sufficient funds or investments to cover the July 1 payment, adding that no deposits have been made by PREPA to the trustee since March 31.

It said that “in advance of the July 1, 2015, bond payment date, the trustee may be required to liquidate investment obligations held in the reserve account, including substantial long-term government obligations.” Failure to extend the forbearance protection before agreeing on a restructuring deal would virtually allow creditors to ask the court to oversee the utility’s overhaul by placing a receiver in charge of the process if PREPA were to default on any of its debt obligations. Under that scenario, a default notice would be issued by the trustee, which would give PREPA 30 days to address the issue. Failure to do so would result in an event of default, allowing creditors to take the matters to court.

The net take-away is that PR well deserves a mid or lower range CCC rating. Only Moody’s has gone down that far. We think that the B and CCC+ ratings from Fitch and S&P are still too generous.

SWEET BRIAR COLLEGE REVERSES CLOSING

Sweet Briar College, the women’s liberal arts college in rural Virginia that announced it would close in August — setting off protests and lawsuits from students, faculty and alumnae — will remain open for at least one more academic year under an agreement announced Saturday by the attorney general of Virginia. The AG said the agreement, which includes plans for electing a new president and board, and calls for an alumnae group to donate $12 million for Sweet Briar’s continuing operations. The agreement also calls for the easing of restrictions on $16 million from the college’s $85 million endowment — money that, combined with the $12 million from alumnae, will help keep the school open. The alumnae group has agreed to deliver the first $2.5 million of its donation by July 2.

A judge in Amherst County, Va., whose county attorney sued to keep Sweet Briar open, approved the settlement on Monday. Away from the obvious issues – the conversion of pledged donations to hard cash, recruitment of a freshman class mid-summer, and an effort to repatriate students, faculty and employees who had  been told to leave, many of whom have already made plans to attend other schools – the decision raises real questions for debt holders. The closure plan provided for the full redemption of the school’s outstanding bonds. While the call could be seen as premature, redemption would have provided full payment and relieved the bondholders of the principal risk associated with a weak credit. Now there has been no call, and without a long-term plan, bondholders remain in limbo with potentially $16 million less in endowment assets available.

Under the memorandum of understanding released by the attorney general, 13 of Sweet Briar’s 23 board members will be replaced by at least 18 new elected members. The new board, the memorandum said, is expected to appoint Phillip C. Stone, a former president of Bridgewater College, a small private college in Virginia, to serve as the new president of Sweet Briar. The agreement also calls for the attorney general to ease restrictions on $16 million from the college’s $85 million endowment — money that, combined with the $12 million from alumnae, would finance operations.

Sweet Briar was founded in 1901 by a wealthy Virginia landowner, who bequeathed her entire estate — a former plantation — for the express purpose of educating young women. How much demand there is for a school best known for its equestrian programs is unknown. Enrollment has been in decline for some time. Fifty years ago, there were 230 women’s colleges in the United States; last year there were 46.

The fact that the school will remain open does nothing to improve the credit from a rating standpoint. The existing S&P CCC is well deserved.

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

Joseph Krist

Municipal Credit Consultant

ARENA DRAMA IN ARIZONA TAKES ANOTHER TURN

The  season on ice may have finally ended this week, but the action continues off it foe NHL fans. The Arizona Coyotes’ tortured relationship with the city of Glendale took a negative turn last week when the City Council voted to terminate its lease agreement with the team at Gila River Arena. In 2013, the city agreed to pay IceArizona, the team’s ownership group, $15 million a year for 15 years to run the building in return for a share of the naming rights and other revenue.

Bond investors care because there is some $230 million of outstanding debt issued to finance the arena. Action by the Council to void its operating agreement could put into doubt the continued viability of the debt financing. Here is some background.

At the time of the lease agreement, the mayor and some council members opposed it before it was signed, and new council members have since been elected. The city has not released the results of an annual audit of the arena for the 2013-14 fiscal year. It has been reported in the local press that the city’s assistant auditor resigned in April because some of her findings were changed.

The council voted, 4-3, last week to end the agreement citing a state statute that allows an agency to cancel a contract if an employee directly involved with the agreement becomes an employee or agent to the other party. The Coyotes hired the former city attorney as general counsel in 2013.  In November 2013, an ethics complaint with the State Bar of Arizona that the attorney went to work for the Coyotes in 2013 while still being paid a severance by Glendale.

Before the meeting, the City Council announced that the city would consider amending the deal if it “provides certainty and fairness to both parties, especially the taxpayers.” IceArizona responded that the meeting was a “blatant attempt to renege on a valid contract that was negotiated fairly and in good faith.” After the council voted to dissolve the deal the team’s chief executive and president, said the city had violated its obligations under the agreement. The N.H.L. said before the meeting that it was “extremely disappointing that the city of Glendale would do anything that might damage the club.” The league said it expected the Coyotes to continue playing at Gila River Arena.

In 2009, the prior owner of the team put the franchise into bankruptcy. The league took over the team for several years before finding new owners. The Coyotes average of 13,345 fans a game is the third-lowest in the N.H.L. The agenda posted for the Council meeting cited a state statute that allows government entities to end a contract within three years of being signed if a person involved in negotiating the contract for the city is, in effect, an employee or agent of the other party to the contract. The attorney relinquished his duties with the city when his separation agreement went into effect April 1, 2013, three months before the City Council approved a 15-year agreement with the Coyotes. He was paid his full salary through September 2013.

Glendale has still not released its audit of the Coyotes 2013-14 season a year after it notified the team that it would exercise its option to evaluate the team’s financial results. The Coyotes blamed a delay in providing information to the city on the ownership change at the end of 2014, when Barroway became the majority owner. Glendale’s losses for hockey and concerts at Gila River Arena through April were $6.3 million, or nearly 14 percent from a year earlier.

After the announcement, a Maricopa County Superior Court judge granted the team’s request for a temporary injunction to keep Glendale from killing their arena deal. Attorneys for the Coyotes filed legal claims against Glendale over the team’s lease agreement for Gila River Arena, and lawyers appeared in court Friday afternoon for a hearing about a temporary restraining order. Superior Court Judge Dawn Bergin granted the motion for a temporary injunction and set another hearing on the dispute for June 29. The next move will be when the Glendale City Council meets in executive session and decides whether to send the team a letter confirming its vote to sever the agreement.

IDEOLOGY WINS AND LOSES IN BUDGET OUTCOMES

Tax ideology has had a big influence on state budget policies in recent years. The drive to limit revenues stemming from supporters of the ideology that the only way to control government is to “starve the beast” has had great currency in recent years. This year however, the ability of that ideology to stand the pressure of service demands from constituents has tested the staying power of that ideology. The recent outcomes of budget battles in two states provided two different answers to that test.

In Kansas, it took 113 days to complete this year’s budget session, the longest ever, and more than three weeks longer than the mandated 90 days. Much of the delay was due to debate over taxes after lawmakers passed about $3.8 billion worth of tax cuts in 2012 and 2013. Democrats and moderate Republicans have cited the cuts for the budget shortfalls that have since arisen, while conservatives cite unforeseen cost drivers out of their control like Medicaid growth.

Many acknowledged that the only way to close the gap now was through tax increases. Eventually, they voted to slow the pace of income tax decreases, raised sales taxes and increased the cigarette tax by 50 cents a pack, among other measures. But overcoming the gridlock to reach that deal required long legislative sessions stretching into the early morning. Thursday morning the House failed to pass a Senate plan that leaders were optimistic would pass. Legislative leaders and Gov. Brownback issued several threats about what could happen if a tax bill was not passed — for instance, cutting all state funding for public universities and colleges.

Eventually,  a tax plan was spread over two bills and the first passed at 1:51 a.m. Friday with exactly the 63 votes needed to pass. The second vote opened at 2:24. On that item the initial count was only 59 yes votes. After two hours of effort the necessary votes in the House were obtained. Later Friday, the Senate got exactly the 21 votes it needed to send the bill to the governor’s desk.

In Louisiana, the result was much less straightforward. The $24.5 billion budget passed last week contains so many short-term fixes that next year’s governor and Legislature will inherit a budget deficit of an estimated $1 billion, documents show, and the size of the deficit is only projected to grow in the following years. All four candidates for governor — U.S. Sen. David Vitter, Lt. Gov. Jay Dardenne, Public Service Commissioner Scott Angelle and state Rep. John Bel Edwards, the only Democrat — have said that if elected, they would hold a special legislative session shortly after taking in office in January devoted to finding a long-term solution to the budget problems that Jindal and the outgoing Legislature are leaving behind.

They balanced revenue with spending during the current budget year by continuing to raid the state’s trust funds and resorting to what most analysts would consider to be  gimmicks, including a tax amnesty program that provided only a short-term windfall. In all, the budget passed by legislators in 2014 and signed into law by Jindal contained a record $1.2 billion in one-time money, that is, money that wouldn’t be available in 2015.

After oil prices dropped late last year, legislators and Gov. Jindal had to close a $1.6 billion budget deficit when this year’s session began April 13. After seven years of cutting taxes, Jindal and the Legislature moved in the opposite direction in 2015 and sought to raise new revenue. Legislators chose instead to shave 25 percent of the rebates that companies get from the state when they pay inventory taxes to local governments, increased the cigarette tax by 50 cents to a new rate of 86 cents per pack, limited a number of business breaks and the amount of subsidies for the solar energy and film and television industries.

Adding in a $50 increase in the vehicle title fee to $68.50, the state will raise about $750 million in new money next year. The Governor, in keeping with his presidential ambitions, is claiming it is not a net tax increase following passage of the SAVE fund. Under this measure, no students will pay a higher fee, no one will pay lower taxes and higher education institutions will get no extra money.

But the tax credit included in the plan allows the Governor to claim that it offsets all of the new tax revenue, under rules promulgated by Americans for Tax Reform, a national anti-tax organization headed by the noted anti-tax activist Grover Norquist. A June 9 report by the Legislative Fiscal Office several days before the budget was approved said that it  included $509 million in one-time money — by drawing down more money from trust funds, from the final year of the tax amnesty program and through a one-year plan to reimpose a one-cent sales tax on businesses’ utility bills. Legislators got $7 million for next year only by suspending the program that allows filmmakers to sell their tax credits back to the state for 85 cents on the dollar.

The Legislature found another $73 million in trust funds for the budget. Of that amount, $20 million would come from unclaimed lottery winnings and another $25 million from the state’s Medicaid Assistance Trust Fund. The problem is that the fund has a $1.3 million balance, according to the state treasury’s office, and it last had at least $25 million three years ago. The Department of Health and Hospitals plans to replenish the fund in the upcoming fiscal year through provider fees to make the $25 million available for spending.

The net result is no real improvement in  the state’s already weak budget outlook. This in turn maintains downward pressure on Louisiana’s already weak general obligation debt ratings.

GREAT LAKES WATER AUTHORITY MOVES AHEAD

Last week, the new Great Lakes Water Authority signed a lease for Detroit’s water and sewer system, two days before a deadline. This is the first in a number of steps that the Authority must take by Jan. 1, 2016, or the leases terminate and the authority could be dissolved. These steps include getting  customer communities to agree to assign their Detroit Water and Sewerage Department contracts to the authority. It also must reach an agreement with the city and Detroit General Retirement System to manage its pension obligations to the retirement system, which is now frozen.

As far as the system’s debt is concerned, the authority must get at least 51% of bondholders to agree to the transfer of the water system assets and bond obligations from DWSD to the new authority. In addition, it must persuade the bond rating agencies to confirm ratings on the bonds it is assuming from the Detroit Water and Sewerage Department that are at least as high as the current ratings. This anticipates the adoption of a bond ordinance that basically mirrors the current bond ordinance of DWSD and the receipt of  legal opinions on the validity and enforceability of the lease agreement as it relates to tax treatment of bonds.

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

Joseph Krist

Municipal Credit Consultant

NJ SUPREME COURT UPHOLDS SHORT FUNDING OF PENSIONS

New Jersey’s highest court ruled on Tuesday that Gov. Chris Christie could skip the pension payments he promised to make in 2011 in the signature law of his tenure. In the short term, it mitigates a huge fiscal crisis just weeks before the state closes its books for the year. In the long term, the 5-to-2 decision by the Supreme Court of New Jersey maintains the negative pressure on the state’s credit which has bedeviled the state’s bondholders throughout Mr. Christie’s tenure.

Christie has aggressively claimed to have fixed the state’s well known pension underfunding problem. He boasted in his keynote speech to the Republican National Convention in 2012 that he had “fixed” the problem of underfunded pensions. Unfortunately, the “Jersey Comeback” the governor regularly cites has seen the state economy lag behind his forecasts, and the nation. As a result Mr. Christie said the state could not afford to make the payments he had promised in the law.

Nine credit downgrades later, “The loss of public trust due to the broken promises” in the law, the court wrote in its decision Tuesday, “is staggering.” The court said that the governor and the Legislature violated the debt limitation clause in the State Constitution when they signed the law requiring the state to make large payments over a series of years. The court supported the view of most fiscal observers when it said  “That the state must get its financial house in order is plain,”. The decision added however, “the responsibility for the budget process remains squarely where the framers placed it: on the Legislature and executive, accountable to the voters through the electoral process. Ultimately, it is the people’s responsibility to hold the elective branches of government responsible for their judgment and for their exercise of constitutional powers. This is not an occasion for us to act on the other branches’ behalf.”

The dispute between the state’s employees and the governor stems from the implementation of the 2011 law and a companion law signed in 2010 requiring public employees to pay more toward their benefits, and in exchange, the state agreed to make the annual pension payments that several governors had ignored. Payments were made for two years, but beginning with the budget for 2014, the governor said he could not balance the budget if he made them. The payment in 2014 was $696 million instead of the $1.58 billion the law required; the 2015 payment was $681 million instead of the $2.25 billion owed.

The unions sued, and a trial court ruled in February that the law had given public employees a constitutionally protected right to those payments. That decision was reversed by the Supreme Court. Predictably, unions called the ruling “devastating” and “indefensible,” saying it was unfair that they had held up their end of the deal, while the Supreme Court allowed the governor to abandon his. In a dissent, it was pointed out that “The decision unfairly requires public workers to uphold their end of the law’s bargain — increased weekly deductions from their paychecks to fund their future pensions — while allowing the state to slip from its binding commitment to make commensurate contributions.”

The legislature is expected to send Mr. Christie a budget that makes the required pension payment in the next fiscal year, which begins in July. The governor however, is almost certain to strike the payment with his line-item veto. He has called on unions to give up more benefits. Unions and Democrats who lent him crucial support in 2011 said Mr. Christie had to guarantee that the state would finally make its payments.

JUSTICE DEPARTMENT RULING IMPACTS CCRC FACILITIES

Harbor’s Edge is an upscale continuing care retirement community in Norfolk, Va. It includes amenities, including River Terrace, a dining room with waterfront views originally open to all residents. That changed when management announced, in May 2011, that the River Terrace and certain activities like Fourth of July celebrations would be restricted to independent living residents and off-limits to everyone else. This sparked protests from residents who had lost access to that amenity.

Last month, the Department of Justice issued a complaint which charged that the facility had violated the federal Fair Housing Act by establishing policies that discriminated against people with disabilities and retaliating against those who complained. To settle the case, Harbor’s Edge admitted no wrongdoing, but will pay $350,000 to compensate those harmed, and a $40,000 civil penalty. The consent order also requires the facility to appoint a Fair Housing Act compliance officer, provide training for its staff and adopt a “reasonable accommodation” policy.

“This is a decision that’s going to put the rest of the industry on notice,” said a senior attorney for the AARP Foundation. While the settlement doesn’t create new law, “it’s a continual battle to get compliance” with the Fair Housing Act, according to Justice in Aging, an advocacy group. Such cases rarely generate the large damages that would encourage lawyers to file suits. Now, Mr. Carlson said, “if I’m running a long-term-care facility and I realize there are significant financial consequences, I think, I’d better change the way I do business.” Though complaints of discrimination or segregation more commonly crop up at communities whose residents have very different functional abilities, the Fair Housing Act applies to any senior housing or care facility — and the Justice Department clearly wants administrators to know it’s paying attention. “It’s not an isolated situation,” said Gregory Friel, deputy assistant attorney general for civil rights. “We’re looking into facilities with analogous practices.”

According to press accounts, the facility initially blamed overcrowding believed that allowing people of different disability levels to use the same facilities violated Virginia regulations. The Justice Department saw a simpler motive. “Harbor’s Edge adopted these policies because it wanted to market its facility as a place for ‘young seniors’ who wanted an active lifestyle,” its complaint said. The DOJ sent lawyers to Norfolk to interview Harbor’s Edge executives, residents and family members, and review thousands of pages of documents. Last summer, it notified the facility that it would bring suit, and executives agreed to begin negotiations.

The three-year DOJ order ensures that Harbor’s Edge can’t revert to discriminatory practices for its duration. Other facilities’ policies are also being reviewed such as the independent living section of Redstone Village in Huntsville, AL. The impact of the Norfolk settlement may be letting residents (and lawyers) around the country know that senior communities must make reasonable accommodations to enable them to use facilities. Segregating them in certain parts of their supposed homes because of their need for assistance is not reasonable. It’s illegal.

The existence of such regulations and the potential for financial penalties at already cash strapped facilities is another item of due diligence for investors in this already risky class of credits found in many high yield municipal funds.

RHODE ISLAND PENSION SETTLEMENT APPROVED

A proposed settlement to resolve years of legal uncertainty over a landmark public pension system overhaul was approved Tuesday by a judge who called it an imperfect but fair solution. The judge, Sarah Taft-Carter of Superior Court, overruled objections, putting an end to nearly all the lawsuits by public-sector unions and retirees against Rhode Island over the 2011 reform, which was designed to save $4 billion over 20 years. The deal would preserve about 90 percent of the savings. Lawmakers must also approve the settlement. Speaker Nicholas Mattiello of the House said the changes from the settlement would be incorporated into the budget, which lawmakers are considering. The settlement provides for cost-of-living increases and one-time stipends for retirees.

WHY WE DON’T LIKE PENSION BONDS

Recently, we reported that Pennsylvania Governor Tom Wolf was advancing the idea of issuance of $3 billion of pension debt to temporarily address funding shortfalls in the Commonwealth’s pension systems for teachers and other employees. We opined that this was a bad idea. We have always held to that view for a number of reasons. These mostly reflect our belief that the issuance of this debt is no different than the issuance of debt for any other operating expense. Such practices have always been indicators of fiscal irresponsibility and often strong indicators of fiscal difficulties.

A look at the history of such issuance is instructive. At the state level, major issuers of such debt include New Jersey (the first state to use the technique in 1997) and Illinois. Neither of these two states have managed to properly address their pension funding shortfalls even with the issuance. On the local level, pension funding shortfalls continued to bedevil a number of cities even after such issuance. In some cases, the overall fiscal position was made even worse as poor investment of the bond proceeds resulted in continuing shortfalls, no lessening of the current funding expense requirements, and the additional expense o f debt service associated with the issued debt.

Now, a series of decisions in recent municipal bankruptcy proceedings have increased concerns for investors in these bonds. These securities were generally issued with a security pledge that relied on annual appropriation actions by the legislatures of the issuing entities. They were effectively unsecured obligations of these issuers. As the municipalities involved in recent bankruptcies have sought to restructure their finances and associated obligations, they have sought to use this unsecured status as a basis for effectively repudiating the debt.

The successful effort by Detroit to avoid the repayment of much of the principal on its outstanding $1 billion plus of pension obligations is well documented. The most recent example is in San Bernardino where the city has contested its obligations to make payments to both CALPers and to holders of outstanding pension COPs. Last month, CALPers successfully challenged the city’s effort to avoid required contractual payments due to the pension fund. The City contends that it cannot afford both the payments to CALPers and repayment of debt service on its pension COPs. While not yet final, the city’s recovery plan is expected to include sharply reduced principal recoveries for holders of the COPs.

These efforts mirror the treatment of certificate of obligation debt by other issuers in bankruptcy or undertaking restructurings outside of bankruptcy. Given the rather thin case history that existed under Chapter 9 prior to the rash of filings over recent years, the resulting decisions upholding efforts to force debt holders to take significant haircuts has begun to establish a pattern of precedent which is highly unfavorable to bondholders.

We believe that these precedents have created a situation where pension obligation securities should not be a part of an individual’s portfolio at any price. The results of the recent restructurings have created a highly insecure obligation that provides a level of risk which is not offset by any available yield.

PENSION MANGEMENT TAKES A TURN

Over the years, the CA Public Employees Retirement System has been a leader in the management of state pension funds. Whether it be matters of investments, fund management, corporate governance activism, or non-traditional investing, CALPERS has been a leader. For years, the country’s biggest state pension fund, paid billions of dollars in fees to external managers to help finance the retirement plans of teachers, firefighters, police and other state employees.

Now Calpers, which has just more than $300 billion of assets under management, plans to cut back drastically on those fees by severing its ties with half of the external investment managers of its funds. Calpers will inform its investment board this month about its plans to reduce the number of external managers to 100 from 212. As part of the move, Calpers will reduce the number of private equity firms to 30 from 98, giving those remaining managers $30 billion to manage. Calpers invests in some of the biggest and best known private equity firms in the world, including Blackstone, TPG, Carlyle and Kohlberg Kravis Roberts.

The move follows on last year’s decision to liquidate $4 billion in hedge fund investments in an effort to simplify a portfolio that has become complex and expensive. This year, the fund will begin to make more payments to retirees than it receives from its investments. And by 2030, it could be left with a $10 billion shortfall between payments and the total amount of contributions from active workers and income from investments, Calpers said in a presentation in May.

Last year, it paid $1.6 billion in management fees, $400 million of which were a one-time payment for its real estate managers. Many other pensions funds have begun to focus on fees, too. Despite a bull market for the last several years, many state and municipal pension funds have not received large enough returns on their investments and are now faced with having too few assets to cover future costs. They now need to address issues of earning enough to make up for their failure to earn what they said they would earn in the past, and making enough in this environment to pay for new promises.

The change reflects the fact that taxpayers are increasingly being asked to pay for public pension shortfalls. Many feel that the more that is being paid to the asset managers, the less is available for public services. In Pennsylvania, where the state is looking at a $50 billion hole in its pension fund, Gov. Tom Wolf recently asked  “why are we paying Wall Street managers hundreds of millions of dollars?” In New York City, Comptroller Scott M. Stringer has noted that the city’s five pension funds have paid more than $2 billion in fees over the last decade, outpacing the returns during the same period. “Right now money managers are being paid exorbitant fees even when they fail to meet baseline targets,” Mr. Stringer said in April.

The move towards nontraditional investment strategies gained additional traction in response to the financial crisis, when the value of assets was decimated by losses. It led pension funds to shift more aggressively into private equity and hedge fund strategies. But returns after the fees — which typically follow a “2 and 20” model in which investors pay an annual management fee of 2 percent of assets under management and 20 percent of returns — have been disappointing in more recent years.

CALPERS will also use just 15 of the current 51 real estate managers to invest the fund’s $26 billion real estate portfolio. And Calpers will eliminate 24 managers from its general equities portfolio, leaving 20 firms to invest $24 billion.

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

Joseph Krist

Municipal Credit Consultant

CHICAGO POTENTIALLY GETS A BREAK ON PENSION FUNDING

Under a 2010 state law, the city’s contribution to its police and fire fighter funds next year increases by $550 million to about $839 million. A bill to restructure contributions in the near term won final legislative approval on Sunday from the Illinois Senate. The bill now awaits the Governor’s signature but earlier in May the Governor said  “For Chicago to get what it wants, Illinois must get what it needs.” As we go to press, the bill is unsigned.

The bill would reduce that amount by about $220 million, to $619 million. Chicago’s payments would increase every year between 2017 and 2020, but not as much as under the 2010 law. After 2020, the city’s contributions would be calculated at amounts that would enable the two pension systems to become 90 percent funded by 2055, which is 15 years longer than in the 2010 law.

If Chicago fails to make required pension payments, the bill allows for an intercept of state funds due the city and for the retirement funds to go to court to force payments. The bill also requires proceeds from a Chicago casino in the future to be allocated to the public safety retirement funds. Emanuel has been asking state lawmakers for a bill authorizing a city-owned casino, but that legislation did not advance.

We have previously documented the Governor’s demands for the enactment of a package of tax changes and regulatory changes considered to be “business friendly”. They are unrelated to the pension problems of either the State or to the City of Chicago. The debate over pensions and the budget have had a decidedly partisan edge with the Governor saying after the end of the legislative session he called “stunningly disappointing, “we’re going to have a rough summer.”

SPORTS FINANCING

The NBA Finals begin on June 4 and they will command the most attention from pro basketball fans. Many owners however, will also have an eye on developments surrounding the financing for a new arena in Milwaukee for the NBA Bucks. Gov. Scott Walker has finally taken a public stand in support for the major aspects of a plan to publicly fund such an arena.

As currently conceived, taxpayers would be responsible for half the initial cost of a new arena. The initial public investment would be $250 million, but taxes would ultimately pay for principal and interest on a bond issue for that amount, issued by the Wisconsin Center District. The rest of the arena — another $250 million — would be funded by the Bucks owners and former U.S. Sen. Herb Kohl, who used to own the team.

To support the planned municipal debt, lawmakers would have to change state law to extend taxes the district levies that are set to expire in coming years as it pays off the debt. It would extend for years taxes that are set to expire and could result in a boost in the tax on hotel rooms in Milwaukee County. Walker, who is preparing a run for the presidency, argued that potential hike would not be a tax increase because the Wisconsin Center Board already has the ability to raise it. “It’s already within their means, so that’s not a new tax,” Walker told reporters after a groundbreaking for a plant expansion in Portage.

The district operates the Wisconsin Center convention center, Milwaukee Theatre and UW-Milwaukee Panther Arena. In Milwaukee County, it levies three taxes: 3% on car rentals, 2.5% on hotel rooms, and 0.5% on restaurant food and beverage sales. Under current law, the district has the ability to raise the tax on hotel rooms to 3%. (The district also has the ability to raise the rental car tax to 4%, but only if it needs help from the state because its collections of that tax are falling short of the amount needed to pay its debt.)

Like the debate in many other venues over sports arena financing, this one has strong opinions on both sides. Walker claims that a deal for the Bucks is essential because the team will leave if it doesn’t have plans in place for a new arena by 2017. This would have a significant impact on the state budget. Backers hope to insert the plan into the state budget. The Joint Finance Committee is expected to complete its work on the budget by next week and forward it to the Assembly and Senate for final votes. Both houses are controlled by Republicans. Many conservative commentators object to the use of state money for such a project. Having the district raise the tax on hotel rooms to the maximum amount to help pay for a new arena would not constitute a new tax, Walker contended.

Under the plan, the state would be responsible for bonds worth more than $55 million. The state would commit $4 million a year over 20 years, or $80 million total, to cover its shares of principal and interest costs. The Wisconsin Center District would issue $93 million in zero-coupon bonds that could be paid off years from now. Officials have not detailed how much it would cost to pay back those bonds when accounting for interest.

The city would spend $35 million on a new 1,240-vehicle parking structure and provide $12 million in tax incremental financing. In the most unusual feature of the deal, Milwaukee County would “certify” tens of millions of dollars in uncollected county debt. The county, in effect, would then count on the state to recover at least $4 million of that debt a year for 20 years, a total of another $80 million that would then be funneled to the arena project. The state would also pay off the final $20 million owed on the Bradley Center, where the Bucks have played since 1989. That would bring the state’s total commitment to $100 million.

PRIVATE TOLL ROAD NEWS

IFM Investors has announced the completion of IFM Global Infrastructure Fund’s previously announced acquisition of 100 percent of the equity in the Indiana Toll Road Concession Company, LLC (ITRCC), which operates the Indiana Toll Road. The final purchase price for the ITRCC was US$5.725 billion, consistent with the purchase price and transaction structure outlined when the planned acquisition was announced.

The ITRCC is required to operate the toll road under a lease agreement that was executed in 2006, giving it the exclusive right to collect toll revenues through the term of the agreement, which has a remaining life of 66 years. The transaction is being financed using a capital structure that includes debt with maturities as long as forty years.

IFM inherits the remaining 66 years of a Concession Lease Agreement between ITRCC and the State of Indiana implemented in 2006 for a 75-year period. ITRCC on Sept. 22, 2014, announced that it had filed Chapter 11 bankruptcy. Nearly all of the $5.72 billion garnered in the toll road’s lease sale will be used to pay off bondholders who owned bonds backing up ITR Concession’s $6 billion debt. Financing for the acquisition came from some 70 U.S. pension funds and represents their first foray into the toll road market.

The jury is still out in terms of the viability of privately operated toll roads. There are numerous examples of such failed financings in the municipal market and many municipal investors remain wary of bonds in that space. A lot of the risk is based on the level of local opposition to these sorts of projects. In North Carolina, anti-toll group wants a judge to proceed with its lawsuit in an attempt to stop the state’s Interstate 77 toll project for which the P3 contract was finalized May 20. A state senator has developed a draft of a bill that would address opposition concerns. The long-shot bill would use money from an upcoming bond package to expand I-77 north of uptown without toll revenue, breaking a that contract between the N.C. Department of Transportation and a private developer to build express toll lanes.

In another sign of problems with P3 transportation projects, the VA DOT has determined in its discretion to terminate the Comprehensive Agreement with U.S. Mobility Partners, LLC (the “Design-Build Contractor”) for the construction of a 55 mile toll facility in southern VA. Boosters said it would spur development, connect military facilities, provide an alternative hurricane escape route and smooth freight shipments to and from the Port of Virginia. Instead, the project ran into environmental hurdles threatening to delay it and substantially raise its costs.

The termination of the Agreement subjects the Bonds to extraordinary redemption from funds derived from termination compensation amounts to be paid by VDOT.  VDOT will determine the portion of the termination compensation amount necessary to redeem the Bonds by or about the June 15, 2015, termination date and that the Bonds could be called for redemption as early as on or about August 1, 2015. There is no certainty that the Bonds will be called for redemption on such date and VDOT’s Notice of Termination could be rescinded, although the Corporation does not believe that rescission is likely based on discussions with VDOT and public statements made by Virginia’s Secretary of Transportation and representatives of the Governor’s Office. $114.87 million of current interest bonds and $116.73 million of capital appreciation bonds were issued for the project in 2012.

KANSAS REBOOT?

We’ve been following fiscal events for the State of Kansas for some time as the Governor undertakes a significant experiment with supply side economic theory, using the state budget as his test case. Legislation in 2012 and 2013 phased in rate reductions on personal income taxes — to 3.9 percent from 6.45 percent on the high end and 2.3 percent from 3.5 percent on the low end — by 2018. The reductions were expected to cost a total of about $7 billion through 2019. They were based on the premise that they would stimulate economic growth. But that growth did not appear, and after repeatedly trimming spending to close shortfalls, legislators find themselves facing a $400 million budget hole for the coming fiscal year.

The situation has become so serious that many of those legislators are considering whether to reverse field by raising taxes. Both houses of the Republican-controlled Legislature are proposing tax increases. The primary driver is negative public reaction to the idea of cutting more expenditures without significantly hurting popular programs, including education.

The debate  now focuses on which taxes to raise. Some believe that income taxes are off limits instead supporting a rise in sales taxes. Others advocate a mixed approach with income taxes on the table. Democrats argue that increasing sales taxes would be another blow to low-income Kansans to the benefit of the business class. Business owners were seen to be beneficiaries of the plan’s signature piece of the law passed in 2012: the elimination of taxes on certain types of small businesses.

To avoid repeal there is a proposal for removing the exemption on nonwage income for small businesses, instead giving them a 1 percent payroll tax credit. This would be accompanied by an increase in the sales tax to 6.5 percent from 6.15 percent on everything except food, which would be taxed at 6 percent. A competing plan would tax the nonwage income on small businesses at 2.7 percent and increase the sales tax to 6.45 percent, but reduce it to 5.9 percent for food.

The debate has been particularly prolonged. The legislative session reached  the 100-day mark over the weekend for just the sixth time in state history. (Sessions are typically limited to 90 days, and each additional day costs around $40,000.) Supporters of the tax cuts are not necessarily willing to concede that the cuts were the reason for the state’s fiscal problems. To meet revenue shortfalls, Gov. Sam Brownback and lawmakers have found themselves repeatedly tinkering with the budget to fill hundreds of millions of dollars in shortfalls. The governor has cut some state agency budgets by 4 percent, reduced contributions to the state pension system and shifted money between state accounts. Lawmakers have rolled back funding for poorer school districts and changed the way they allocate money to schools. They have slowed funding increases for entitlement programs.

One leading legislative proponent said “We hoped they would just be a magic lantern and everybody would react to it,” he said. “But, eh, it’s hard to get a company to uproot their business when they’re established and move to another place just because of this difference in tax policy.” He unwittingly articulated what many studies have shown. Namely that tax policy is but one of many factors that go into a relocation decision and that taxes are often not the major driver. Initial estimates were that the small business tax exemption would affect about 191,000 entities and cost about $160 million. Instead, for the 2013 tax year, 333,000 filers took advantage of the exemption at a cost of $206.8 million, according to the Revenue Department.

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

Joseph Krist

Municipal Credit Consultant

The month of June is crunch time for state budget makers and this year there is no shortage of contentious budget action. We focus on four significant state budgets and the increasingly poor outlook for favorable resolutions, at least from the perspective of bondholders.

ILLINOIS

It was not unexpected but the Illinois budget process has turned into a major battle. House Republican Minority Leader Rep. Jim Durkin  called it “a Greek tragedy.” The likelihood is that the actual budget may not be finally adopted until later this summer. While we do not expect this spectacle to impair the payment of debt service on state debt, we do expect that the various twists and turns of the soap opera will continue to pressure prices and ratings on the state’s bonds.

Illinois Democrats have offered a series of budget bills designed to restore social service cuts proposed by Gov. Bruce Rauner. Republicans have criticized the House Speaker’s budget as being irresponsibly out of balance, while Democrats retorted that the Governor’s February budget proposal counted on more than $3 billion in false savings. The Governor has said he would consider raising taxes — but only after lawmakers agreed to a series of his proposals including term limits on lawmakers, a property tax freeze and reforms to workers compensation laws. He has threatened to keep the legislature all summer if they fail to pass those measures.

Debate was focused by the introduction of a bill to restore deep cuts to human services. It included programs that the Governor’s plan had slashed or zeroed out including restoring immigrant and refugee funding as well as money for autism, epilepsy, Alzheimer’s, Boys and Girls Clubs, YWCA and YMCA programs. The bill’s sponsor said it included $134 million in cuts in all and held Medicaid spending to fiscal year 2015 levels.

House Democrats contend that the $36.3 billion spending plan would reflect “what the state of Illinois should do for Illinoisans who need the government to be helpful to them.” according to the House Speaker. He did however, acknowledge that  “we don’t have the money to pay for this budget” — in fact they’ll be about $3 billion short — but he said he’s prepared to work with Rauner to find “new money.” All the while, the State’s biggest issue – pensions – remains unresolved.

FLORIDA

The Florida legislature has one constitutionally established responsibility – the passage of a budget. Not since 1992 has the state flirted with budgetary disaster so close to the end of the fiscal year on June 30. Hoping to break the Legislature’s budget stalemate, the Senate tweaked its Medicaid expansion plan Tuesday in the face of continued opposition from the House and Gov. Rick Scott.

The House did not have a categorically negative response , but Gov. Rick Scott stepped up his criticism of what he called the Senate’s “Obamacare Expansion Plan” and accused his fellow Republicans of trying to impose higher taxes on Floridians. Gov. Scott claims that the Senate’s plan to expand Medicaid under Obamacare will cost Florida taxpayers $5 billion over 10 years. His two priorities in the special session are a package of tax cuts and more money for public schools. Scott has ordered agencies to make contingency plans to provide critical services in case of what he has called a possible “government shutdown,” and has issued dire warnings of teachers not being paid and child abuse complaints being ignored.

The Senate changes, if adopted in committee and floor votes in next week’s special session, would drop the requirement that people would first have to be enrolled in a Medicaid HMO for six months. Instead, they could use federal money to buy subsidized insurance on the private market, in an effort to head off House criticism of Medicaid as a “broken system.”

A job-seeking provision for people in the revamped Senate plan would require them to seek work by using the state workforce portal, Career Source. Patients also could enroll in insurance plans through a federal health exchange, rather than using the state-run option, and the Legislature would have to approve any major changes in the plan ordered by the federal government.

Senate President Andy Gardiner, for the first time, said that approval of a health care plan is not directly linked to passage of a state budget. “We fully intend to pass a budget,” he said. “You could have a scenario where no health care bills get done and we pass a budget and go home.”

The House’s chief budget-writer, Rep. Richard Corcoran called the revised Senate plan “exciting,” but said the House wants guarantees that the Senate will take up several unrelated House proposals. These include plans to expand ambulatory surgical centers, a requirement that hospitals to publish price lists, and an end to approval of new hospital beds through the certificate of need process.

The Legislature will reconvene on June 1, for a three-week special session to finish work on the budget. The session is scheduled to end June 20, but the state Constitution requires a three-day “cooling off” period before lawmakers can vote on the budget. To stay on schedule, they would have to finish all work on the budget by Wednesday, June 17.

 PUERTO RICO

The P.R. House of Representatives approved a tax bill that calls for the implementation of an 11.5% sales tax at cash registers, up from the current 7% paid under the sales & use tax (IVU by its Spanish acronym), after introducing several amendments on the floor. The Senate approved the tax bill after amendments were introduced by the Senate before voting on it. If the House decides not to concur with the Senate’s version, a conference committee will be needed to address the impasse, something that could further delay the legislative process.

Among the amendments is one that would establish a commission which would submit a report on the different tax models within 60 days of the law’s final approval. The commission would be created to evaluate the different alternatives to change the consumption tax, including a return to the tax at the ports. The Consumption Tax Transformation Alternatives Commission (CATIC by its Spanish acronym) would comprise the Treasury secretary as its president, the Justice secretary, the Office of Management & Budget director, the Ports Authority director, members from the Senate and the House, as well as representatives from the private and labor sectors.

If it includes findings or recommendations favoring a move toward the tax at the ports, legislation would have to be presented within 10 days of the report’s presentation to address the findings.

A last-minute amendment to the bill calls for applying the 11.5% sales tax on frozen, refrigerated, canned, packaged “or in some other way preserved or packaged” food items. It is argued that the amendment levels the playing field for all involved in the food industry. Prior to the vote, some had been pushing to exclude from the proposed sales tax prepared food items served at restaurants, which have been taxed since the implementation of the sales tax.

The tax plan calls for a nine-month transition from the sales tax to a VAT, a process that is expected to be completed by April 1, 2016. A 4% tax on business-to-business services, as well as professional services, was also included, and is slated to kick in Oct. 1. These services are exempt under the current tax system.

PENNSYLVANIA

The Commonwealth is no stranger to prolonged budget battles and this year is no exception. The new Governor, a Democrat, faces a legislature where Republicans hold significant majorities. The legislature sees pension reform as its top priority through a bill to scale back pension benefits for future and current public school and state government employees. The governor has made education funding his top priority and released an open letter last week that showed how little headway he has made in winning over opponents to a tax increase on Pennsylvania’s natural gas industry, a source of money Wolf is counting on to put more money into public schools. Overhanging all of this is a projected $2 billion deficit in the fiscal year starting July 1

The Governor’s plan requires over $4 billion annually in higher taxes, according to an Independent Fiscal Office analysis, and Republicans oppose nearly all of it. The House has passed a bill to increase state sales and income taxes as a way to reduce the school-funding burden currently funded primarily by local property taxpayers. Senate leaders are skeptical.  The House also passed a bill to privatize much of the state-controlled wine and liquor store system, but it has not been acted on in the Senate for three months and it is opposed by the Governor. As for the pension situation, the Governor supports the issuance of pension bonds – a red flag for any market observer – as a stopgap measure.

We would not be surprised to see a late budget, a failure to address the Commonwealth’s pension situation, and a greatly compromised effort to address school funding. There is simply no consensus in the Commonwealth around any of the proposed resolutions and there is a deep sense of cynicism on the part of the electorate about efforts to reform school property taxes. This discussion has colored state politics in Pennsylvania for at least a quarter century with no successful resolution achieved regardless of which party has been in power. The net result is likely additional pressure on the Commonwealth’s ratings as well as those of many localities.
Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Municipal Credit Consultant

CALIFORNIA

The May update of the budget proposed by Gov. Jerry Brown included  millions more dollars for the university system than he had originally proposed, in exchange for a tuition freeze for in-state students in the 10-campus system. The revised $115.3 billion budget plan ends a dispute between the Governor, who did not support a tuition increase and the president of the University of California. She had threatened to raise tuition unless the state gave more money to the schools. The plan freezes tuition for California residents over the next two years, while out-of-state tuition could increase by as much as 8 percent in each of the next two years and 5 percent in the third year.

The new plan, if approved would provide 4 percent increases in spending for the system in each of the next four years and provides $436 million for the system’s pension obligations. Last fall, the University of California’s regents approved annual tuition increases for in-state students of as much as 5 percent for five years. There has been pressure from the legislature to limit tuition and increase state support. One avenue of cost savings opposed by the system president is massive online open courses (MOOC) as a way to save large sums of money.

The plan also calls for university employees hired after July 2016 to choose between a pension with a defined contribution plan or a defined benefit plan capped at $117,000 per year, a significant decrease from the current cap of $265,000. Tuition and fees for in-state students is more than three times the rate in 2002 at $12,000 a year. The figure does not including room and board or other additional charges on some campuses.

Non-education provisions of the governor’s updated proposal include a new earned-income tax credit to help low-income workers.

PUERTO RICO

Puerto Rico Governor Alejandro Garcia Padilla and lawmakers agreed on a proposal to raise the island’s sales tax. The plan would raise the rate  to 11.5 percent from 7 percent for nine months, in a transition to implementing a value-added tax. The increase is estimated to generate $1.2 billion of revenue. Lawmakers also agreed to recommend $500 million in spending cuts as part of a $9.8 billion budget for fiscal 2016. Puerto Rico’s House of Representatives and Senate must vote on the plan. A sales-tax boost would be a temporary alternative to the governor’s proposal for a value-added tax applied at each level of production and distribution.

SAN DIEGO STADIUM PLAN DEBATE BEGINS

A mayoral committee Monday proposed a financial plan for building an approximately $1.1-billion NFL stadium in hopes of persuading the Chargers to stay in San Diego. The plan includes major public contributions – $121 million from the city of San Diego and $121 million from San Diego County – but not a tax increase.

The plan would also include $300 million from the Chargers, $200 million from the NFL, $173 million in construction bonds, $225 million from the sale to a developer of 75 acres at the site of the existing Qualcomm Stadium. It  includes asking the Chargers to pay $1 million per game in rent. The mayor hopes for negotiations with the Chargers to begin by June 1. If a deal can be struck, he said, negotiations will deal with when the public vote would be scheduled.

This plan competes with two rival stadium proposals which have been announced. One is in Inglewood from the owner of the St. Louis Rams and a plan announced by the Chargers and Oakland Raiders to build a joint-use venue in Carson. Officials in Inglewood and Carson have opted not to put the land-use proposals to a vote of the public. In San Diego, however, Mayor Faulconer has promised a public vote even though the funding plan does not require it. A tax-funded proposal would require a two-thirds vote for approval which is widely viewed as a political impossibility.

Putting the issue to a public vote might be the undoing of the plan. The NFL has warned that waiting to hold a vote until November 2016, the next general election, might mean that the city would be too late to persuade the team to remain. The mayoral committee, made up of nine civic leaders, had earlier recommended that the 166-acre, city-owned site in Mission Valley would provide the quickest and least expensive location to build a stadium. A Chargers plan for a stadium in downtown San Diego, near the waterfront convention center, was rejected as too expensive and too fraught with problems with multiple ownership.

To avoid a tax, the committee’s proposed city and county contributions would come not in lump-sum payments but as annual payments. The city, the committee suggested, would be able to redirect money that otherwise would be used for the upkeep of Qualcomm. Once built, the new stadium would be self-supporting, the committee report said. It would be home to the Chargers, the San Diego State Aztecs, the Holiday and Poinsettia Bowls and events including bar mitzvahs, weddings, proms, reunions, corporate gatherings, monster truck jams, music festivals and religious ceremonies, the mayoral committee suggested.

TRANSPORTATION FUNDING INCHES FORWARD

Like the traffic many of you will face this weekend, federal transportation legislation made a small bit of progress this week. The House on Tuesday approved a two-month extension of funding for transportation projects which would maintain funding for the Highway Trust Fund through July 31. The bill now goes to the Senate, which has just two legislative days left before a scheduled week long Memorial Day recess. The transportation program’s spending authority is set to expire during that break, on May 31.

The program has for years relied on fuel taxes that are no longer keeping pace with the nation’s transportation needs.  The last full plan expired in 2009. Federal gasoline and diesel taxes that provide most of the financing were last increased in 1993. There is little support for raising the fuel tax, so Congress needs to find an alternative source of funding. The fight over financing has forced Congress to pass numerous short-term extensions, often just before leaving town for recess. This would be the 33rd short-term extension in recent years.

The House bill faces some resistance in the Senate where Democrats said the short-term extension, perpetuates  uncertainty that has made it difficult for state and local officials to build and maintain infrastructure. The Obama administration released a statement shortly before the House vote saying it did not oppose the stopgap measure because more time was needed to come to a long-term agreement.

Some Republicans would like to pair consideration of a long-term highway bill with tax reform. But there is great skepticism that this could be accomplished within 60 days. The chairman of the Senate Committee on Commerce, Science and Transportation, said he was for a multiyear highway bill and raised the possibility of funding it while extending a series of business tax breaks that are renewed annually, known as tax extenders.

GAS TAX INCREASE

One state has chosen not to wait for Congress to act. In Nebraska, the state’s unicameral legislature overrode Gov. Pete Ricketts’ veto of a 6-cent-per-gallon gas tax increase to pay for road and bridge repairs. The increase would raise Nebraska’s total gas tax over four years to 31.6 cents per gallon and is estimated to generate an additional $25 million annually for the state and $51 million for cities and counties once fully implemented.

The bill received 30 yes votes — the minimum required; 16 senators voted against it. Sen. Jim Smith, the bill’s sponsor, said the gas tax remains the most effective way to pay for construction work to help improve road safety and the economy. “The need is great. The options are few. Waiting is not an option,” said Smith, a fiscal conservative who usually supports tax cuts. In a statement released after the override, Ricketts said the tax will hit low-income Nebraska residents hardest because they pay a larger share of their income on gas than wealthier drivers.

The legislature apparently agreed instead that the road situation has grown too large to address without additional revenue. In a 2014 report, the Department of Roads identified $10.2 billion in projects it says are needed over the next 20 years. Nebraska has more than 100,000 miles of roads and 20,000 bridges, mostly owned by counties and cities. Roughly 10,000 miles of road and 3,500 bridges belong to the state. The state’s share of Federal Highway Trust Fund money has fallen faster than the national average in recent years. Funding from the federal gas tax has declined for most states as vehicles became more fuel efficient and motorists cut back on driving.

The higher tax was cast the tax as a “user fee” because it’s only paid by motorists, including those from out-of-state. Smith said repairing roads and bridges would help save motorists money by reducing car maintenance costs.

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

Joseph Krist

Municipal Credit Consultant

ILLINOIS FACES THE MUSIC

Illinois provided lots of muni news this week. Within a couple of days, the IL Supreme Court was voting 7-0 to find that the state constitution would not allow the legislature to unilaterally alter worker pension benefits and the Governor released his recommended FY 2016 budget. Effectively, they are both the same story.

The enacted pension changes would have reduced future cost-of-living adjustments for workers, increased the retirement age for some and capped on pensions for those with the highest salaries. The court however, cited the state Constitution which says that benefits promised as part of a pension system for public workers “shall not be diminished or impaired.” “Crisis is not an excuse to abandon the rule of law,” Justice Lloyd A. Karmeier said. “It is a summons to defend it.”

The decision itself was anticipated but some of the direct language included in the opinion was. “The General Assembly may find itself in crisis, but it is a crisis which other public pension systems managed to avoid,” Justice Karmeier wrote. “It is a crisis for which the General Assembly itself is largely responsible.”

The Governor has suggested that voters should consider a constitutional amendment that would mark a distinction between guarantees of benefits already earned and changes to future benefits. Under the state’s Constitution, officials may assign new benefits to future workers, but cannot diminish benefits already promised. Several states have adopted “tiered” pension systems where pension terms are adjusted for prospective employees. One state which has successfully employed such a system in New York.

The court acknowledged that the decision complicates the state’s fiscal outlook. “The financial challenges facing state and local governments in Illinois are well known and significant,” the opinion read. “In ruling as we have today, we do not mean to minimize the gravity of the state’s problems or the magnitude of the difficulty facing our elected representatives. It is our obligation, however, just as it is theirs, to ensure that the law is followed.”

The Governor’s recommended budget relies on $2.2 billion in savings related to a new proposal to reform Illinois’ critically underfunded retirement systems. These savings are assumed to be realized in the fiscal year that begins on July 1, 2015, even though the pension proposal has not been introduced as legislation in the Illinois General Assembly and is likely to face its own legal challenges.  In addition to pension savings, the proposed FY2016 budget assumes a reduction of $655 million, or more than one third, in the cost of State group health insurance through collective bargaining. Both the magnitude of the projected savings and the short timeframe for reaching agreement with the State’s largest union suggest that the budgeted numbers are unlikely to be realized. Other budgeted savings, particularly in the Medicaid program, depend on changes in State law or require federal approval.  The Governor’s recommended budget cuts local governments’ share of State income taxes by half. The budget also proposed cuts to spending on community care for the elderly, disabled and those with mental illness.

The state is also not the only entity potentially impacted by the decision on pensions. The City of Chicago’s pathway out of its pension minefield most likely became more twisted. According to Moody’s, if current laws stand, Chicago’s annual pension contributions are projected to increase by 135% in 2016; by an average annual rate of 8% in 2017-21; and by an average annual rate of 3% in 2022-26. Looming contribution increases to the Municipal and Laborer plans could be reduced if the courts find Public Act 98-0641 unconstitutional. The city’s impending contribution increases to the Police and Fire plans will be reduced if the state amends Public Act 96-1495 per the city’s request.

That law requires that the City fund the Police and Fire pension funds annually in amounts are equal to (1) the normal cost of the pension fund for the year involved, plus (2) an the amount sufficient to bring the total assets of the pension fund up to 90% of the total actuarial liabilities of the pension fund by the end of municipal fiscal year 2040. Without the increased payments that current statutes require of the city, the plans will continue to liquidate assets to pay benefits. As the plans approach insolvency, risks to the city’s solvency will grow. The legislature will likely have concerns about the legality of any changes it must approve which would alter the City’s pension systems. All of this resulted in Moody’s Investors Service downgrading the city’s debt rating on bond issues backed by property, sales and fuel tax revenue to Ba1 from Baa2.

Mayor Rahm Emanuel maintains that pension changes he engineered for the workers and laborers funds can withstand the legal challenges they face. Moody’s said however that, “we believe that the city’s options for curbing growth in its own unfunded pension liabilities have narrowed considerably. “Whether or not the current statutes that govern Chicago’s pension plans stand, we expect the costs of servicing Chicago’s unfunded liabilities will grow, placing significant strain on the city’s financial operations absent commensurate growth in revenue and/or reductions in other expenditures. The magnitude of the budget adjustments that will be required of the city are significant.” Emanuel responded to the double downgrade by saying Moody’s had overreacted and noted that they did not downgrade the state of Illinois.

The cure for the pension problem is easy – new revenue and negotiated changes in benefits. The dilemma for both entities is the lack of political support for higher taxes. Other than savage cuts to services which may be even more politically unpalatable, increased revenues dedicated to pension funding seem to be the only way to address the chronic underfunding practices which created the current crisis. Unless plans emerge to address the situation, the downward pressure on ratings and valuations will continue for both entities. S&P put the State ratings on negative outlook on Friday.

PUERTO RICO FINANCIAL REPORT

It’s not an audit and while it is a “quarterly” report and it’s been seven months between releases, a current financial update was provided by the Commonwealth. It was unsurprisingly bleak. The commonwealth in fiscal 2016 “may lack sufficient resources to fund all necessary governmental programs” requiring “emergency measures [possibly including] a moratorium on payment of debt service,” the report said. It also referenced the potential for a debt adjustment, or the utilization for the payment of the commonwealth’s debt service of certain taxes and other revenues previously assigned by law to certain public corporations to secure their indebtedness.”

The government estimates a $2.4 billion deficit in the coming fiscal year, assuming no steps are taken to increase revenue or cut expenditures. In comparison, the current fiscal year budget is $9.56 billion. The report projects a current fiscal year will end deficit of $191 million. It says that there are resources to pay off its debts in the current fiscal year. It potential difficulties with the commonwealth’s and the Government Development Bank for Puerto Rico’s ability to make roughly $800 million in payments in July and August.

CALPERS WINS SAN BERNARDINO RULING

Bondholders lost another round in bankruptcy court in the ongoing tug of war between creditors and pensioners. A bankruptcy judge has dismissed a suit challenging the city of San Bernardino’s decision to make its pension payments in full to CalPERS. The ruling from U.S. Bankruptcy Judge Meredith Jury rejected the claim filed by Ambac Assurance Corp. and a Luxembourg bank named EEPK. Last fall the city, which filed for bankruptcy in 2012, said it would pay its $24 million-a-year CalPERS bill in full. Ambac and EEPK said that arrangement was unfair to other creditors.

Although San Bernardino hasn’t filed its complete repayment plan, it’s likely that many creditors would stand to receive only a portion of what they’re owed. Ambac and EEPK are owed a total of more than $59 million in the San Bernardino bankruptcy.

CalPERS welcomed the ruling saying,  “The judge in this case has ruled appropriately”. “Now the city can turn its attention to the more pressing matter of completing its plan of adjustment for exiting bankruptcy.”

Last fall, a bankruptcy judge ruled that Stockton had the legal right to reduce its payments to CalPERS. But the judge also approved Stockton’s repayment plan, in which the city agreed to continue paying CalPERS in full. Anything less than full payment by cities triggers a complicated legal mechanism that would result in a significant slashing of benefits to current and future retirees. In Stockton, for example, pension benefits would have dropped 60 percent, and city officials claimed that police, firefighters and other municipal employees would have quit for other jobs.

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

Joseph Krist

Municipal Credit Consultant

DETROIT SCHOOLS PLAN

Gov. Rick Snyder announced plans last week  to create a new debt-free Detroit public school district and pay off the old district’s debt with an additional state contribution of between $53 million and $72 million annually for up to 10 years. Snyder’s plan for overhauling education in Detroit calls for establishing a “brand-new school district, not a charter” school system that would be governed by a new seven-member board initially appointed by the governor and the mayor.

Snyder would get four appointments to the board of the new district, to be known as the City of Detroit Education District, while Detroit Mayor Mike Duggan would get three. The new education district would include operations, teachers and buildings that would transfer to them. The new DPS would inherit the district’s pensions, union contracts and employees. The old DPS district would continue to collect the 18-mill non-homestead property tax and use the money to pay down the district’s debts. The tax generates approximately $72 million annually, while the district faces debt service payments of $53 million each year, diverting $1,100 per student away from classroom instruction, according to the Citizens Research Council of Michigan.

Under the proposal, there would be a six-year “pathway” for returning to a locally elected Detroit school board by staggering out elections for two seats in November 2017, two seats in November 2019 and the remaining three seats in November 202. Detroit’s elected school board has been effectively sidelined for six years while the district has been under the control of four state-appointed emergency managers. The governor said he hoped to get legislation moving soon but added, “From a practical matter, it probably won’t be done until fall. The proposed financial assistance for DPS could be three times the $195 million lawmakers committed last year toward funding the city of Detroit’s pension funds.

The governor said the district has accumulated $483 million in debt.  Under the proposal the state would need to commit an extra $53 million to $72 million annually for 8-10 years from the School Aid Fund toward operating funding for the new DPS According to the proposal by isolating the debt  the annual cost to the state could be lowered if about $300 million in outstanding bond debt can be refinanced.

Previously, the Coalition for the Future of Detroit Schoolchildren, a 36-member group issued a report in late March with recommendations for overhauling the city’s school system. They included returning DPS to local control, putting Education Achievement Authority schools (Charter schools)  back in the district and having the state pay off the district’s debt.

While the District has not issued debt under its own property tax based credit for many years, the plan offers relief to insurers of that debt who have already been battered by the City’s bankruptcy. It also offers the potential for an upgraded entity should it eventually issue its own traditional GO debt.

MICHIGAN ROAD TAX DEFEATED

Infrastructure is a much lamented topic especially as it pertains to roads. Drivers nearly everywhere lament the condition of their area’s roads, especially after a difficult winter. So it was a bit of a surprise that Michigan voters resoundingly defeated tax changes this week that would have produced more than $1 billion a year for roads. The vote is considered a setback for Gov. Rick Snyder. A one-cent increase in the sales tax was the cornerstone of the ballot measure, which also would have created more money for education, local governments and public transit as well as fully restoring a tax break for lower-income workers.

The proposed constitutional amendment was placed on the ballot by the Republican-led Legislature and was supported by the Republican governor, Democrats, and a coalition of business, labor and government groups. It would have eliminated an existing sales tax on fuel so all taxes on motor fuels could go to transportation. It also would have restructured and doubled existing fuel taxes, and raised vehicle registration fees, to increase Michigan’s $3.7 billion transportation budget to $5 billion.

PUERTO RICO

Puerto Rico Rico Electric Power Authority (PREPA) bondholders granted the utility a 35-day extension on its forbearance agreement, which will now expire June 4, with PREPA delivering its restructuring plan by June 1. “During the new forbearance period, PREPA will have the opportunity to provide information to its creditors and meet on a timely basis to discuss all the elements of a plan that will improve PREPA,” according to the utility. This is the third extension conceded to the troubled utility after the original March 31 deadline.

“Under the agreement, PREPA has agreed to provide an informative session between the authority’s rate consultants and creditors’ advisors by May 11 and deliver a proposal for a comprehensive recovery plan to the bondholders’ advisors by June 1,” the PREPA statement said. On April 15, creditors agreed to grant PREPA a second 15-day extension “to allow all parties to continue their dialogue to develop a consensual solution to transform PREPA that will benefit all stakeholders,” Lisa Donahue, the utility’s chief restructuring officer, said.

PRIVATE ACTIVITY BOND PROPOSAL

Senators Ron Wyden (D-OR) and John Hoeven (R-ND) have proposed The Move America Act of 2015. The Act is designed to leverage additional private investment in public infrastructure. The program creates Move America Bonds, to expand tax exempt financing for public/private partnerships, and Move America Credits, to leverage additional private equity investment at a lower cost for States. Move America provides up to $180 billion in tax-exempt bond authority for States over the next 10 years and  up to $45 billion in infrastructure tax credits for States over the next 10 years.

Move America Bonds would generally be treated as exempt facility bonds under current law, with several exceptions. So long as facilities are generally available for public use, the government ownership requirements for exempt facility bonds do not apply to Move America Bonds. This retains the restriction to public-use infrastructure, while allowing more flexible ownership and management arrangements. It also allows private partners to benefit from depreciation deductions, should they take ownership of the facility either directly or through a long term leasing arrangement. The interest income on Move America Bonds is excluded from the alternative minimum tax. This eliminates the interest rate penalty placed on states for public projects with private partners.

Qualified facilities for Move America Bonds are limited to publicly-available transportation infrastructure, including airports, docks and wharves, mass commuting facilities, freight and passenger rail, highways and freight transfer facilities, flood diversion projects, and inland and coastal waterway improvements. The qualifying projects for docks and wharves is expanded to include waterborne mooring infrastructure and landside road and rail improvements that integrate modes of transportation. Move America Bonds are subject to a uniform volume cap, set equal to 50 percent of a State’s current private activity bond volume cap. As some projects have long lead times or may require more bond volume than a State receives in a single year, States would be permitted to carry forward volume cap for up to three years. Any carried over volume cap not used after three years would be reallocated to States that have fully utilized their cap, ensuring that the program is fully utilized. States would be required to report to the U.S. Treasury Department the amount of unused volume cap that is being carried forward each year.

CITI FIELD NUMBERS

The New York Mets better than expected start has garnered them some favorable attention some 30 games into the 2015 season. Mostly it is baseball fans who are interested but the bonds which financed  the Mets’ home park are also of interest to investors. NYC IDA debt for the Queens Ballpark LLC is widely held by New York investors both individually and institutionally.  The standings are reminders of the financial importance of good on the field performance as reflected in the recently released operating results for the Queens Ballpark entity that supports the outstanding debt which financed Citi Field.

The Corporation reported a 1.8% decrease in total revenue. The primary sources of decrease were ticket sales and advertising revenue. On the plus side, parking and concession revenues were up. Since only a portion of attendance-based revenues are pledged whereas all of the parking and concession revenues are pledged, lower attendance as the result of a losing season is mitigated. The means that the ultimate impact on current coverage is fairly minimal.

We feel that the bonds are appropriately rated at the BB range. The steadily increasing annual debt service requirements and inconsistent performance of the team and its impact on attendance are enough to constrain the quality of the credit over the foreseeable term.

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

Joseph Krist

Municipal Credit Consultant

ALL GOING WRONG FOR PUERTO RICO

If it had not already, PR’s financial crisis has reached critical mass for sure. The GDB was a source of loads of negative news. First, it announced that the Commonwealth would be unable to meet its required annual financial disclosure by May 1. Then the Bank released a letter to the Legislature which suggested that the Commonwealth would be unable to meet its liquidity requirements at the start of the fiscal year on July 1.

The bank made the warning in a letter made public a day after it was sent to Gov. Alejandro Garcia Padilla and the presidents of the island’s Senate and House of Representatives. “The island’s financial state is extremely uncertain,” the letter said. “A government shutdown would have a devastating impact on the economy, with salary and public service cuts, and a long and painful recovery.”

The letter urged legislators to immediately implement measures to cut costs and balance the budget and that  the government needs to approve a five-year plan to help reduce a $73 billion public debt as well as approve sweeping changes to the island’s  tax system.

In a number of interviews, David Chafey, president of the bank’s board of directors said once the government does that and presents a balanced budget, then it can be in a better position to issue bonds. “Time is passing, and it’s passing quickly,” he told The Associated Press. “We need to provide investors with some kind of comfort.”

Typically one agency of the government will not write to the rest of the government so openly but the letter was issued amidst negotiations between  Gov. Garcia and members of his party who oppose legislation that would impose a 16% value-added tax that he says is needed to help generate more revenue. In the House of Representatives a group of legislators reached a tentative agreement to impose a 14% value-added tax. If passed, the measure would then go to the Senate.

Stunningly, the GDB letter and the Governor’s efforts appear to have been for naught. Earlier in the morning of the the Governor’ s speech the House convened to consider the Governor’s plan to impose a value added tax of VAT as part of his financial reform package. In the session which ran past 3 a.m., the House of Representatives voted down the tax reform bill after failing to secure enough votes from the Popular Democratic Party (PDP) majority. Along with the New Progressive Party minority delegation, six PDP members voted against the measure. The final vote count was 22 in favor and 28 against.

The governor characterized their vote as “irresponsible” and “disloyal,” and the House speaker said that the PDP caucus will seek disciplinary sanctions for the six legislators.

After the vote, Puerto Rico Gov. Alejandro Garcia Padilla unveiled a $9.8 billion operating budget Thursday night in which he pledged to reduce crime, create jobs, boost school attendance and expand the U.S. territory’s tourism sector during a state of the commonwealth address. Padilla said he plans to reduce the island government’s $2.2 billion deficit to $775 million in one year, in part by taxing those who earn $200,000 or more a year or who buy homes valued at $1 million or more. He did not provide details about those taxes. On the sales tax front, Padilla also said that by Dec. 1, he will reduce the 7 percent sales tax to 6.5 percent and continue to exempt items including prescription medicine, books and non-processed foods. Those looking for an austere budget will be disappointed that Padilla promised that overall, more than 40,000 public employees in 28 agencies will see pay increases by next February. Padilla’s proposal is $750 million higher than the current budget, which legislators of the opposition party questioned.

According to recent reports by Bloomberg and Reuters, PREPA bondholders will be granting the utility a 30-day extension on its forbearance agreement, which had been set to expire today. This would be the third extension conceded to the troubled utility after the original March 31 deadline.

 PRISON DEBT BACK IN THE SPOTLIGHT

It has always been one of the riskier areas of the high yield market so the news of at least two facilities having debt problems in Texas is not a surprise. One is the now empty  Willacy County Correctional Center in Raymondville. One morning late last month, the prisoners rioted. Guards put down the uprising in about five hours, but the destruction was so extensive as to force the closure of the facility leading to all 2,800 inmates being transferred. “Worst scenario, we’ll lose about $2.3 million annually, which is about 23 percent of our income,” said one Willacy County commissioner.

The County counts on the prison as a business generating revenue. The prison’s water and sewer bill is $50,000 a month. Once insurance pays for extensive repairs to the prison, the county needs to fill those beds again as the facility is looked as a way to generate revenue and create jobs. Willacy County built three of them. The Correctional Center was the largest, with a staff of nearly 400. They’re now unemployed.

The County sold bonds, built the prison and hired an operator — Management & Training Corporation (MTC). MTC contracted with the U.S. Bureau of Prisons to incarcerate low-security male immigrants who are serving out sentences for illegal border crossings and aggravated felonies. Many if not most of the private prisons in the Southwest were built to service this “market”. For that service, the federal agency paid MTC to manage the prison. Then MTC paid the county $2.50 per prisoner, per day. But ultimately, it’s the county that’s on the hook for its $63 million debt on the nine-year-old prison.

When the U.S. Bureau of Prisons canceled its contract with Willacy County last week, it explained that the federal inmate population was down, and it didn’t need additional beds. The prison will be in competition with several other facilities for a more scarce “commodity”.  Like many private facilities, inmates have complained of bad living conditions and substandard medical care. MTC emphatically disputes this criticism. The company has hired a third party to investigate why the inmates mutinied. Meanwhile, Willacy County plans to cut all non-essentials in its budget — such as plans for a courthouse renovation and a new hurricane shelter.

Elsewhere in Texas, on February 2, 2015, the Trustee, UMB Bank, N.A., for the $42 Million Bondholders has notified the Maverick County Public Facility Corporation that Maverick County failed to make a scheduled $1,415,000 principal payment on Bonds on February 1, 2015, but did make the February 1, 2015 interest payment. Consequently, the Trustee had advised the Maverick County Public Facility Corporation that there are “several events of default have occurred and are continuing under the Indenture.

As is usually the case, all Project Revenues are pledged as security for the Bonds and the County is obligated to cause all Project Revenues to be delivered directly to the Trustee. The County continues to intercept Project Revenues, which constitutes a violation of the County’s obligations under the Lease.The County has then remits funds that it requisitions back for payment of operating expenses. Under the terms of the Lease, all Project Revenues must be delivered directly to the Trustee and are to be used to pay Rental Payment Deposits first, prior to using such revenues to pay Project operating costs and expenses. The County’s failure to deliver intercepted funds to the Trustee for application towards the Rental Payment Deposit caused an Event of Default.

A further complication is the fact that the Corporation had its non-profit corporate charter forfeited in August 28, 2009. The Maverick County Public Facility Corporation continued to enter into many legal agreements regarding the operation, management, and detention of federal prisoners at its Maverick County Detention Center as well as with the $42 Million Bondholders and Trustee, the U.S. Marshal’s Service, financial advisors, legal counsel, and other third party contractors. All of these actions potentially expose Maverick County to significant financial risks and liabilities.

The Maverick County Public Facility Corporation is in negotiations with the $42 Million Bondholders and Trustee in either restructuring the principal and interest payments owed on the debt and/or the forbearance of these payments and recently terminated its long standing financial advisor, Southwestern Capital Markets, Inc., while retaining a new one in First Southwest Capital.

The potential workout is additionally complicated by events associated with ongoing federal corruption investigations of the County. A Maverick County commissioner and former justice of the peace were arrested last week as part of an ongoing bribery investigation in the border city of Eagle Pass that has resulted in arrests bringing the total number of people charged in the ongoing investigation into a bid-rigging and kick-back scheme in Maverick County to 22. Among the others charged are three former county commissioners all of whom have pled guilty.

In Burnet County, a private jail deal will produce significant principal losses for bond holders after the facility is sold to the County. The 587 bed jail has been privately operated until 2014 when the County took it over. The County will pay $14.85 million for the facility while there are some $32,770,000 of bonds outstanding. The jail had been consistently underutilized and had proven to be a less than secure facility after several escapes. County inmates are sufficient to occupy only about 30% of the beds.

WAYNE COUNTY FINANCIAL UPDATE

Earlier this year we reported on the financial woes facing Wayne County which includes the City of Detroit within its borders. This week County  Executive Warren Evans unveiled a recovery plan with deep cuts – including wiping out retiree health care – in an effort to avoid bankruptcy. According to Evans, “this plan will prevent bankruptcy even though in some areas we are worse off [than when] Detroit was pre-bankruptcy.”  Wayne has just under $700 million of limited-tax general obligation bonds and $302 million of LTGO notes outstanding.

The plan eliminates the county’s $52 million structural deficit but the pension system that’s only 45% funded with a $910 million shortfall and a $200 million, bond-funded jail project in downtown Detroit that the county abandoned half built due to lack of money are not dealt with. Since 2008, the county’s has plugged general fund shortfalls by shifting money from its pooled cash fund. According to the County Executive, the county will not be liquid enough to rely on fund transfers anymore and will be entirely out of money by next summer.

The plan would eliminate health care for future retirees. It would move most employees and some retirees to high-deductible insurance plans and provide retirees with fixed and limited subsidies for the purchase of supplemental insurance, likely under the new federal health care law. That’s similar to what Detroit did in its bankruptcy, shifting retirees to the national exchange. These cuts would save $28.4 million in 2015, with annually increasing savings rising to $49.8 million by 2020.

It raises the retirement age to 62 and reduces future pension benefits by changing the pension multiplier. It increases the number of years used to determine compensation to 10 years from the current three- to five-year equation. All county employees would see 5% salary cuts. The total impact of these cuts would mean $60.3 million in savings for the county, including $53.4 million in the general fund.

In February, Evans blamed the county’s problems on a loss of property tax revenue and “fiscal and managerial mismanagement.” The county receives 60% of its general fund revenue from property taxes, which fell to $289 million by fiscal 2013 from $408 million in fiscal 2008. The plan assumes no increase in property tax revenue until 2018, and then only a $4 million boost.

The problems on the capital side are based in the county issue of $200 million of bonds in 2010 for a new jail, which is supposed to replace the current aging criminal justice facilities. But the county was forced to abandon the project in 2013 when it became too costly, and the county cannot return to the markets for additional financing in its current fiscal condition.

The county lost its last investment-grade ratings shortly after initial comments about the county’s finances in February.

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

Joseph Krist
Municipal Credit Consultant

TOBACCO USE DATA RELEASED

This is the time of year when tobacco securitization investors refocus attention on sales figures and funds available for distribution at mid-month under the terms of the Master Settlement Agreement. As the states and their subdivisions calculate exactly how much is available to them from the April distribution, other data becomes available regarding smoking trends which are central to the analysis of these bonds.

The most recent Morbidity and Mortality Weekly Report (MMWR) from the Centers for Disease Control and Prevention and the U.S. Food and Drug Administration’s Center for Tobacco Products (CTP) showed that Current e-cigarette use among middle and high school students tripled from 2013 to 2014, according to the data. Findings from the 2014 National Youth Tobacco Survey show that current e-cigarette use (use on at least 1 day in the past 30 days) among high school students rose from 4.5 percent in 2013 to 13.4 percent in 2014, or from approximately 660,000 to 2 million students. Among middle school students, current e-cigarette use more than tripled from 1.1 percent in 2013 to 3.9 percent in 2014—a rise from approximately 120,000 to 450,000 students.

This is the first instance since the survey started collecting data on e-cigarettes in 2011 that current e-cigarette use has surpassed current use of every other tobacco product overall, including conventional cigarettes. Hookah smoking roughly doubled for middle and high school students, while cigarette use declined among high school students and remained unchanged for middle school students. Among high school students, current hookah use rose from 5.2 percent in 2013 (about 770,000 students) to 9.4 percent in 2014 (about 1.3 million students). Among middle school students, current hookah use rose from 1.1 percent in 2013 (120,000 students) to 2.5 percent in 2014 (280,000 students).
There was no decline in overall tobacco use between 2011 and 2014. Overall rates of any tobacco product use were 24.6 percent for high school students and 7.7 percent for middle school students in 2014.

What is problematic for investors is that In 2014, the products most commonly used by high school students were e-cigarettes (13.4 percent), hookah (9.4 percent), cigarettes (9.2 percent), cigars (8.2 percent), smokeless tobacco (5.5 percent), snus (1.9 percent) and pipes (1.5 percent). The products most commonly used by middle school students were e-cigarettes (3.9 percent), hookah (2.5 percent), cigarettes (2.5 percent), cigars (1.9 percent), smokeless tobacco (1.6 percent), and pipes (0.6 percent).

The results are problematic as MSA revenues are based on sales of actual cigarettes or “sticks” rather than sales of all tobacco products such as roll-your-own tobacco and smokeless tobacco e-cigarettes, hookahs and some or all cigars. Should this trend continue, expected rates of cigarette shipment declines should be anticipated with negative impacts on securitization cash flows.

KANSAS REVENUE WOES CONTINUE

A new forecast issued Monday projects that the state will collect $187 million less in taxes through June 2016 than anticipated. This may force Gov. Sam Brownback and the Legislature to consider larger tax increases than they had expected to balance the state budget. Before the new forecast, they had been working on budget proposals requiring about $150 million a year in tax increases. Revising a forecast made in November, state officials and university economists reduced the estimate for total tax collections for the current fiscal year by nearly $88 million, to about $5.7 billion. They also cut the tax collection estimate for the fiscal year beginning in July by nearly $100 million.

MORE NEGATIVE NEWS FOR PREPA

OFG Bancorp announced that its Oriental Bank subsidiary (“Oriental”) will place its $200 million participation in a fuel purchase line of credit with the Puerto Rico Electric Power Authority (PREPA) on non-accrual status and will take a $24.0 million provision. The move reflects Oriental’s view that PREPA, despite its oil price related increasing ability to meet contractual obligations with creditors, has signaled an unwillingness do so.

Oriental, said, “Our credit analysis, based principally on data provided by PREPA and its advisors, shows the utility has the financial capability to pay its creditors. However, in the recent negotiation for extending the more than 8-month forbearance period previously granted by its creditors, PREPA clearly demonstrated a reluctance to commit to do so, despite the utility’s improved cash flows.”

Oriental’s $200 million PREPA exposure was acquired through the late 2012 purchase of BBVA’s Puerto Rico operations, and is part of a syndicated $550 million fuel purchase line of credit.

NEW JERSEY DOWNGRADE

Moody’s downgraded New Jersey’s general obligation bonds to A2 from A1. The outlook is negative. Ratings on the state’s appropriation-backed, other GO-related debt, and intercept programs were also lowered one notch. The downgrade to A2 was driven by the continuation of the state’s weak financial position and large structural imbalance, reflecting continued pension contribution shortfalls. Liquidity and structural balance are projected to remain very weak through fiscal 2016 – a longer period than contemplated. While some stabilization in budget performance, economy, and liquidity was noted, Moody’s is concerned that beyond fiscal 2016, the state’s plan to restore long-term structural balance relies on economic growth and further pension reforms, which have uncertain timing and impact.

The negative outlook reflects anticipated further decline in the state’s financial and pension position before pension reform, if successful, is implemented. Without meaningful structural changes to the state’s budget, such as pension reform that dramatically improves pension affordability, the state’s structural imbalance will continue to grow, and the state’s rating will continue to fall.

ATLANTIC CITY

The City of Atlantic City was granted a 60-day extension on a $40 million state loan that was due on March 31. The extension comes as a lawsuit was filed by the Borgata Hotel Casino that could challenge future bond sales. The city’s emergency manager Kevin Lavin released a report on March 24 recommending cutting expenses by $10 million this year as well as negotiating with key stakeholders to help create “fiscal stability.” Atlantic City is facing a projected $101 million budget gap in 2015.

Recent economic news includes a grand-opening for a new 85,450-square-foot Bass Pro Shops Outpost store with 200 employees on April 15. A new 16,000-square-foot development from BET Investments featuring upscale stores is also scheduled to open this year next to the Boardwalk Hall sports arena. One day after Polo North, a Wellington, Fla.-based developer received court approval to buy the Revel casino for $82 million, Polo North Inc. and Stockton University in Galloway Township, N.J. announced plans on April 3 to invest more than $500 million in the city.

Stockton, a public college, is slated to open its new Island Campus at the former Showboat Casino Hotel site in Atlantic City this fall. Polo North deposited $26 million in escrow for Stockton, which covers the $18 million purchase price the university paid for the former casino property as well as other costs incurred such as maintenance, utilities, employees and insurance.

Stockton has an 18-month first right to purchase or lease the property for educational purposes. A contingency in the deal allows the university a 90-day period to terminate the contract as it evaluates potential legal challenges from the neighboring Trump Taj Mahal, which has tried to block the bid because it doesn’t want college students living next to its casino.

CA WATER RATE DECISION

A California state appeals court on Monday ruled that a tiered water rate structure used by the city of San Juan Capistrano to encourage conservation was unconstitutional. The Orange County city used a rate structure that charged customers who used small amounts of water a lower rate than customers who used larger amounts.

The 4th District Court of Appeal struck down San Juan Capistrano’s fee plan, saying it violated voter-approved Proposition 218, which prohibits government agencies from charging more for a service than it costs to provide it. “We do hold that above-cost-of-service pricing for tiers of water service is not allowed by Proposition 218 and in this case, [the city] did not carry its burden of proving its higher tiers reflected its costs of service,” the court said in its ruling.

The court opinion means that tiered prices are legal as long as the government agency can show that each rate is tied to the cost of providing the water. A group of San Juan Capistrano residents sued that city, alleging that its tiered rate structure resulted in arbitrarily high fees. The city’s 2010 rate schedule charged customers $2.47 per unit — 748 gallons — of water in the first tier and up to $9.05 per unit in the fourth. The city, which has since changed its rate structure, was charging customers who used the most water more than the actual cost to deliver it, plaintiffs said. The law, they argued, prohibits suppliers from charging more than it costs to deliver water.

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.