Kate Smith, a reporter at Bloomberg Brief, talks with Joe Mysak about this week’s municipal market news.

Watch the video.

May 14, 2015

CHICAGO — Chicago began an uphill battle in court on Wednesday to keep its cost-saving pension reform law from meeting the same fate as an Illinois law that was declared unconstitutional last week by the state supreme court.

The city is trying to salvage a 2014 law aimed at stopping two of its four retirement systems from running out of money. It is also dealing with the aftermath of Tuesday’s credit rating downgrade to “junk” by Moody’s Investors Service.

Cook County Circuit Court Judge Rita Novak set a July 9 hearing on motions by lawyers for city unions and retirees to toss out the 2014 law based on the high court’s sweeping ruling that found the state constitution gives public sector workers iron-clad protection against their pension benefits from being cut.

Michael Freeborn, an attorney who filed one of the two lawsuits challenging the law, said a ruling by Novak could come soon after the July hearing, adding that Friday’s supreme court ruling leaves “little if any wiggle room” to keep Chicago’s law alive.

At a Wednesday status hearing on the lawsuits, Novak acknowledged that no matter how she rules, her decision will be appealed to the Illinois Supreme Court.

Chicago’s top staff attorney, Stephen Patton, urged the judge to hear the case quickly, saying a prolonged process would be “extremely harmful to the city.”

“We need certainty no later than the end of this year,” Patton said.

Chicago contends its law, which boosted pension contributions by the city and its workers to the municipal and laborers’ retirement funds and reduced benefits, differs from the now-voided 2013 law aimed at easing Illinois’ $105 billion unfunded pension liability for state workers and educators. Illinois argued its so-called police powers to fund essential services allowed it to cut retirement benefits, but the supreme court disagreed.

“(Chicago’s law) doesn’t diminish and impair pensions, it saves pensions,” Patton told the judge. “That argument has not been addressed.”

Without additional funding and reforms, Chicago’s municipal and laborers’ retirement systems are projected to run out of money in 2026 and 2029. Meanwhile, the city must increase payments to its police and fire funds by $550 million next year.

Moody’s downgrade triggered $2.2 billion in accelerated debt payments and fees related to Chicago’s debt that banks could force the city to make.

Richard Prendergast, an attorney representing Chicago, said the city was engaged in “time-sensitive” negotiations with banks over those payments.

By REUTERS

MAY 13, 2015, 2:14 P.M. E.D.T.

(Editing by Matthew Lewis)

SAN BERNARDINO, Calif. — The Southern California city of San Bernardino wants to repay its pension bondholders just a penny on the dollar while paying the state pension fund Calpers in full under its long-awaited bankruptcy exit plan released on Thursday.

Under the bankruptcy plan, called a plan of adjustment, San Bernardino also intends to virtually eliminate retiree health insurance costs, and outsource its fire, emergency response and trash services.

Gary Saenz, San Bernardino’s city attorney, said of the offer to the pension bondholders: “It’s obviously a tiny offer. From a fairness point of view, it looks like an insulting offer. But it is not an insult. Given the city’s circumstances, it is all the city can afford.”

San Bernardino’s bankruptcy blueprint follows the approach taken in the recent bankruptcies of Detroit, Michigan and Stockton, California, where bondholder debt and retiree healthcare costs were slashed or eliminated, while pensions emerged relatively unscathed.

In Detroit, general obligation bondholders received between a 22 percent and 66 percent cut to their debt.

The move could likely make capital market lenders more wary about loaning money to struggling cities, and could increase borrowing costs for cities already in debt.

“The city needs a workforce. And you can’t have a workforce without pensions,” Saenz told Reuters in January.

That issue was the driving force underpinning the bankruptcy plan, another city official said on the condition of anonymity, noting the city has a daily relationship with its workers that it needs to maintain for survival as a municipality, while its Wall Street lenders are wealthy absentee creditors.

San Bernardino proposes paying the Luxembourg-based bank EEPK, holder of $50 million in pension obligation bonds and the city’s second largest creditor, a fraction of its original debt, according to the plan, posted on the city’s website.

EEPK, along with Ambac Assurance Corp, which insures a portion of the pension bonds, and Wells Fargo, the bond trustee, have the $50 million principal amount of their debt slashed to just $500,000, or a penny on the dollar, under the bankruptcy plan.

Vincent Marriott, a legal representative for EEPK, said the bank would have no comment until it had fully read and considered the plan.

Under San Bernardino’s plan, the city also asks that any creditor, including its pension bondholders, who object to its terms be forced to a judicial “cramdown”, where the judge overseeing the case orders that the city’s debt cutting wishes be met.

Final approval of a bankruptcy plan, which must be ratified by U.S Federal Bankruptcy Judge Meredith Jury, is likely to take months. Negotiations with city firefighters, who are suing San Bernardino over contract issues, have broken down. The police union still has not signed off on parts of the bankruptcy deal affecting its members. Bondholders are likely to vigorously fight the virtual elimination of their debt under the plan.

In March, San Bernardino revealed terms of a deal with the California Public Employees’ Retirement System (Calpers), its largest creditor.

Calpers, which administers San Bernardino’s pensions, is America’s largest public pension fund, with assets of $300 billion. It is the administrator of pensions for more than 3,000 California state and local agencies, and has long argued that pensions cannot be touched or renegotiated, even in a bankruptcy.

The judges overseeing the bankruptcies of Detroit and Stockton both stated that pension rights are not inviolate in a bankruptcy. But city leaders in Stockton, and now San Bernardino, have chosen not to take on Calpers, despite the fact that the pension giant is hiking city contribution rates by up to 50 percent over the next 10 years.

Under San Bernardino’s bankruptcy exit plan, the city under covenant pledges to pay Calpers all arrears and to continue paying Calpers in full in the future.

San Bernardino, a city of 205,000 that is 65 miles east of Los Angeles, declared bankruptcy in August 2012 with a $45 million deficit. Along with Detroit and Stockton, its bankruptcy is one of a handful that have been closely watched by the $3.6 trillion U.S. municipal bond market.

By REUTERS

MAY 14, 2015, 7:41 P.M. E.D.T.

(Editing by Bernard Orr)

When is a triple-B bond safer than a triple-A? The answer, based on historical default rates, is when the triple-B is a municipal bond and the other is a corporate security.

The ratings divergence isn’t only a consideration for investors trying to choose between munis and corporates. On June 15 a Dodd-Frank Act rule goes into effect that requires rating agencies to adopt procedures designed so credit ratings weigh default risk “in a manner that is consistent” for all rated obligors and securities.

The approaching deadline “creates an imperative to get everything lined up,” said Mark Adelson, a former chief credit officer at Standard & Poor’s.

S&P and Moody’s spokesmen said they were taking the rule seriously.

“We’ve been making preparations for this for years,” a Moody’s spokesman said. “Most of the preparations are pretty much done. We’ve already made most of the changes.”

In the long run, the new rule “will only help the municipal upgrade trend,” said Municipal Market Analytics managing director Matt Fabian. “Historically municipal ratings have been too low and have exaggerated the risk of default.”

An attorney with experience in SEC regulatory compliance, speaking anonymously, said he was skeptical the current ratings for munis and corporates would be acceptable to the SEC.

“There is no way that is a uniform scale, and all it really takes to get the ball rolling is a complaint to the SEC that points out that disparity in default statistics,” he said.

As for the investor implications, since BBB munis offer higher yields than AAA corporates as well as a tax exemption that the corporates lack, some may ask: why should anyone or any entity own corporates?

Default Rates and Yields

Studies published by Moody’s Investors Service and Standard & Poor’s show that the default rates of munis 10 years after being rated BBB are lower than the default rates of corporates 10 years after being rated AAA.

According to a Moody’s report “US Municipal Bond Defaults and Recoveries, 1970-2013,” the 10-year cumulative default rate for munis rated Baa1, Baa2 or Baa3 was 0.32%. According to the same study, the rate for Aaa corporates was 0.49%.

S&P Wednesday released its latest default report. The study by analyst Lawrence Witte found that in the 10 years after municipal bonds were rated BBB-plus, BBB, or BBB-minus, 0.42% defaulted. A March 2014 study by S&P managing director Diane Vazza and several others found that in the 10 years after corporate bonds were rated AAA, 0.87% defaulted.

If that history provides guidance, then Chicago (Baa2) is a safer investment over the long-term than Microsoft (Aaa). Moody’s dropped the city’s general obligation rating in February, citing the city’s high levels of debt and pension obligations and expected growth in unfunded pension liabilities. S&P rates Chicago A-plus.

Even with lower default rates, investors in the munis are getting higher yields. On April 27, according to S&P Global Fixed Income, the average yield for a triple-A corporate bond with a 10 year maturity was 2.69%.

By comparison, according to Municipal Market Data on that date the average yield for a BBB general obligation municipal bond with a 10-year maturity was 2.94% and for a BBB taxable municipal bond with this maturity it was 4.13%. The BBB-rated muni yields are the average for BBB-plus, BBB, BBB-minus, Baa1, Baa2, and Baa3 bonds.

The interest of the GO would be tax-free while the interest from the corporate would be taxable.

After federal taxes, for those in the highest federal tax bracket, a corporate 10-year AAA bond bought on April 27 would have yielded 1.51% and the taxable muni would have yielded 2.31%. For those in a more moderate federal 25% tax bracket, these same bonds would have yielded 2.02% and 3.10% after federal taxes, respectively. These after-tax yields take into account federal taxes but not state or local taxes, which would normally lower the effective yield further.

Triple-B category GO muni bonds have consistently had more yield than AAA corporates. One year ago the spread was 31 basis points, five years ago 43 basis points, and 10 years ago nine basis points. None of these spreads take into account the impact taxes have in lowering corporate bonds’ effective yields.

At any given point on the rating scale, munis have far less history of default than do corporates. In the 10 years after being rated Aaa 0.00% of the munis defaulted, while 0.49% of corporates defaulted, according to Moody’s. Ten years after being rated Baa1, Baa2, or Baa3, 0.32% of munis defaulted, while 4.61% of corporates defaulted. Finally, in the 10 years after being rated Ba1, Ba2, or Ba3, 3.53% of munis defaulted, but 19.27% of corporates defaulted.

The Differences’ Origin and Significance

Given munis’ apparent superiority over corporates in terms of both yield and safety, The Bond Buyer asked several investment firms about the wisdom of holding corporates instead of munis. Citi, JPMorgan, Franklin Templeton, OppenheimerFunds, and Bank of America Merrill Lynch declined to answer.

MMA’s Fabian said munis were frequently less liquid and less transparent than corporates. As for the liquidity issue, many munis “lack price discovery or ready markets,” he said. Corporate bonds “often have a homogenous security pledge while municipal deals are essentially bespoke financings requiring that investors fully read the documents to know what they own.”

“Lenders will look past these problems with municipals only because the default rates are so low,” Fabian said.

At Charles Schwab, managing director Rob Williams and director Collin Martin wrote in an email that the default studies looked backward not forward. The migration of ratings upward by Moody’s and S&P in the munis space in recent years may make their default rates more closely compare to corporates in the future. “Still, we expect that the default rate, on average, for investment-grade munis should remain lower than the default rate on investment-grade corporates,” they wrote.

The Schwab officials also said there are fewer high-yield munis to choose from, compared with the selection of corporates. For investors who want to buy higher-yield bonds, corporates offer a wider choice, they said.

Corporate bonds can also be a wise choice for investors who plan to put them into tax-deferred accounts, like 401(k)s, they said.

“While default and recovery statistics appear better for municipal than like-rated corporate debt, that is based on historical information,” said Howard Cure, director of municipal research at Evercore Wealth Management. “We are in a new era where we can see more municipal defaults going forward.”

Alexandra Lebenthal, chief executive officer of Lebenthal Holdings, said she assumed that most corporate bonds are held in tax-deferred accounts, and people generally want to spread their eggs around.

The default rates and returns “show why munis make more sense,” she said.

The U.S. Securities and Exchange Commission provision requiring comparability of ratings within an agency is paragraph (b)(3) of Rule 17g-8 on Nationally Recognized Statistical Rating Organizations.

In the final rule the SEC noted that the divergence between ratings’ default rates at ratings agencies are not just between safer munis and riskier corporates. According to one study up to 2005, the five-year default rates of collateralized debt obligations at the lowest investment grade ratings from one ratings agency was about 10 times higher than the five-year default rates for corporate bonds, the SEC said.

The 2010 Dodd-Frank Act requires the SEC to examine each nationally recognized statistical rating organization once a year and issue an annual report summarizing the examination findings. The annual report to Congress is required by the Credit Rating Agency Reform Act of 2006.

In a December 2014 story on the SEC’s increased demands on the ratings agencies, Moody’s said in a statement to The Bond Buyer, “Moody’s continues to enhance our policies and procedures in light of regulatory developments, and the SEC staff’s findings and recommendations are helpful in that effort.”

Ratings Agencies Respond

How the new rule affects ratings agencies’ ratings remains to be seen.

In recent years both Moody’s and S&P have engaged in recalibrations or applied new criteria to U.S. public finance, leading to broadly higher ratings for munis.

On average the changes were subtle. For example, in 2013 and 2014 S&P introduced a new local government rating criteria. This led to an approximately average 0.4 notch increase in the local government credits. Local government credits are 28% of all credits that S&P’s U.S. Public Finance Group handles. So the changes to the local government rating criteria led to an average increase in ratings of about 0.1 notch across all the credits.

In 2010 Moody’s did a recalibration of some of its municipal issuer ratings to address the category’s comparative lack of risk at different rating levels. In categories closest to government, like general obligation and public water and sewer utility bonds, it raised ratings about one notch in the Aa category, two in the A category, and about three in the Baa category. Speculative grade ratings were left unchanged. For non-utility enterprise, public university, mass transit and a few other categories, S&P raised the ratings by one notch around the Aa and A categories. It left ratings unchanged for several other categories like nonprofits and public electric power utility bonds.

Neither S&P nor Moody’s provided details on the overall average shift in their ratings due to these broad-based rating shifts.

One reason the ratings agencies maintain different levels of credit risks for given ratings between munis and corporates is that, “if you call [all municipal bonds] AAA then one is not creating a lot of value,” for the user of municipal ratings, said Adelson, the former S&P chief credit officer, who now is chief strategy officer at BondFactor.

In response to queries from The Bond Buyer about the divergent default histories at a given rating between munis and corporates, S&P and Moody’s gave similar answers.

“Comparability of ratings across asset classes and geographies is one of Standard & Poor’s main goals and one of the benefits of our global ratings scale,” S&P said in an email. “To accomplish this goal, we’ve adjusted all of our ratings to a common set of stress scenarios and definitions, which are embedded in all of our criteria.

“Our criteria are subject to regular periodic review across sectors to provide additional transparency and comparability. These improvements are intended to help market participants understand our approach to assigning ratings, enhance the forward-looking nature of these ratings, and enable better comparisons across ratings.”

Moody’s vice president Al Medioli said, “This is why Moody’s underwent its recalibration back in 2010, which put all our ratings on a single, universal scale.” He added, “Muni default rates are rising although still very low, and recovery rates are now similar to corporates in recent bankruptcies.”

Both S&P and Moody’s have known that default risks of their ratings diverge between corporates and munis since at least the early 1990s, Adelson said. They have shifted their responses back and forth over time but have never gone beyond making small adjustments to the ratings, he said.

THE BOND BUYER

BY ROBERT SLAVIN

MAY 6, 2015

Kyle Glazier contributed to this article.

Seven years after their ranks were decimated by the housing crisis, bond insurers are back in the spotlight as Puerto Rico struggles to stave off default.

Companies including Assured Guaranty Ltd., MBIA Inc. and others insure more than $14 billion out of the $72 billion in debt outstanding by the commonwealth’s government, utilities and other agencies, according to financial documents from the insurers.

But investors and analysts say the lack of detailed disclosure has made it hard to assess the insurers’ capacity to pay potential Puerto Rico claims should the territory default. While companies disclose principal and interest owed across their entire portfolios, sizable interest costs aren’t disclosed for individual bonds in some cases–including certain Puerto Rico debt.

Insurance-company financial statements are “more complex than looking at your average government,” said Bill Bonawitz, director of municipal research at PNC Capital Advisors, which oversees $6.5 billion in municipal debt. “There’s a lot more moving parts.”

Puerto Rico has been burdened for years with a sluggish economy and a high debt load, and warned in a report this month that it “may lack sufficient resources” to fund government programs and pay its debt in the upcoming fiscal year. Puerto Rico has been negotiating with creditors, but it is unclear whether the talks will allow the island to avoid what could rank as one of the largest municipal defaults ever.

Puerto Rico bonds are widely held by U.S. mutual funds and individual investors, in part because of generous tax advantages. If an issuer such as Puerto Rico defaults, insurers agree to make the scheduled principal and interest payments.

The island’s financial problems represent a major test for a bond-insurance industry that is still recovering from the financial crisis. Insurers lost billions of dollars during the crisis on the default of mortgage-backed securities and some have stopped writing new policies.

Investors have penalized surviving bond insurers in part for the difficulty of analyzing their books. Shares of Assured Guaranty and MBIA trade below their adjusted book value, a measure of net worth. Assured Guaranty stock closed Friday at $27.07, a 50% discount to adjusted book value, according to brokerage firm BTIG. MBIA closed at $8.74, a 65% discount.

“The stock prices of the bond insurers are where they are in part because of the complexity discount,” said Mark Palmer, an equity analyst at BTIG.

Assured’s stock is up 4.2% on the year and MBIA is down 8.4%, compared with a 2.8% advance on the S&P 500. Both companies’ shares, however, are trading higher than they were during the depths of the downturn. From 2007 to 2009, MBIA’s stock fell 94% to $4.50, while Assured Guaranty’s fell by 58% to $11.29.

Some insurers are planning to improve their disclosures, making it easier for investors to assess their claims-paying abilities. National Public Finance Guarantee Corp., a unit of MBIA, said it plans on Monday to update its website to include both principal and interest exposure for individual bond issues. Currently, only the principal amount is listed.

The distinction is important because bond insurers are on the hook for both principal and interest payments if an issuer defaults.

Assured Guaranty doesn’t provide a full list of individual bonds it insures across its various subsidiaries. But a spokesman said it provides principal and interest exposure on specific issuers “where we feel that may be useful to the market.” A breakdown of its principal and interest exposure to Puerto Rico entities is available on its website.

For a report in January, research firm CreditSights had to estimate certain figures regarding the insurers’ principal and interest exposure to Puerto Rico.

The firm concluded that Assured Guaranty and MBIA are strong enough to withstand defaults from Puerto Rico public agencies that were subject to a restructuring law passed last year. The law has been struck down by a federal court, but is on appeal.

Rob Haines, senior insurance analyst at CreditSights, said it would be “very helpful” if insurers offered more information on both their principal and interest exposure.

“I don’t see why the companies can’t disclose this themselves,” Mr. Haines said. “It won’t violate any kind of conflict of interest they have or any kind of confidentiality that they have.”

Of particular concern to some investors are so-called zero-coupon or capital-appreciation bonds, which pay no interest until they mature and can cost municipalities more in interest than regular bonds. Puerto Rico has sold billions of dollars of these bonds, including $2.6 billion tied to sales tax revenue in 2007.

Ambac Financial Group Inc., another large insurer, backs $808 million of that. When interest is factored in, Ambac is actually responsible for roughly $7.3 billion. The numbers were disclosed in a special report regarding Ambac’s Puerto Rico exposure. In a separate spreadsheet, Ambac lists the principal amount for every bond issue it insures, but it doesn’t provide the interest.

“A more accurate disclosure would be to provide full principal and interest,” Mr. Bonawitz said. “The issue is more acute when you have a zero, because the difference between the principal and interest is so much greater.”

A recent report by Kroll Bond Rating Agency showed insurance policies can still be beneficial, saying bond insurers paid claims in full and on time in 26 of 29 insured municipal-bond defaults between 2008 and the present.

Bond insurance “has some value,” said Doug Benton, an analyst at Cavanal Hill Investment Management, which oversees roughly $6 billion in assets. “But anybody that’s lived through ’07 through ’09, you’ve got to discount it.”

THE WALL STREET JOURNAL

By MIKE CHERNEY

MAY 10, 2015

The Florida Supreme Court is debating a 2010 clean energy measure allowing homeowners to fund improvements through special assessments. Challengers are attacking the process itself and the agency that administers it.

In 2010 the state Legislature passed the PACE act. The measure allows local governments to set up a program funding home improvements for clean energy or storm preparedness through the Florida Development Finance Corporation, or FDFC. But rather than extending money for the improvements in the form of a loan—which would follow the borrower, this program is funded through the special assessment process. FDFC attorney Raoul Cantero explains.

“This allows a homeowner—let’s use an example, to spend $20,000 on solar panels, and later, three years later, if the homeowner sells the house they’re not responsible for that $20,000. It stays with the house, so homeowners are more comfortable making these kinds of improvements,” Cantero says.

The idea is that homes that can better withstand a storm or place a lighter burden on the power grid provide benefits to the entire community. So to encourage homeowners to make those improvements, liability is tied to the property, and repayment is made through an increase tacked on to the homeowner’s property tax.

Justice Fred Lewis says the system could provide an important tool for improving blighted areas.

“You know I could look at this, and I could say Detroit and some of the blighted cities, this could be a way that they could come right back,” Lewis says

But he’s also skeptical of employing special assessments, which are primarily used for public improvements, to fund projects for private homes.

“You know just because somebody puts a name on something, you know as well as I do you can call it anything,” Lewis says. “I have never seen a case where it is benefits to an individual home that are being made like a home improvement loans, and it is qualified as a special assessment.”

Those assessments have the Florida Bankers Association upset. While the program looks an awful lot like a loan, it’s treated differently in the event of a foreclosure, with repayment of the tax assessment taking priority over the mortgage. Association attorney Ceci Berman says this violates the state constitution.

“And we know that under Florida law that it is an immediate contract impairment when you supersede a lien position,” Berman says, “I meant that’s been in the law for many years.”

The FDFC came up again in the next case Justices heard Thursday; this time the complaint focused on bonding. The money homeowners use for their improvements has to come from somewhere, and Florida’s program raises funds by selling municipal bonds. But attorney James Dinkins, argues only local governments can issue bonds—not the state-backed FDFC.

“The reason that these bonds are not valid is not because of any infirmity in section 163.08,” Dinkins says, “but instead because Florida Development Finance Corporation is simply not a local government that’s authorized to impose these assessments, to enter into financing agreements as is specified in that statute.”

“They didn’t follow the statute,” Dinkins concludes, “therefore the bonds are not valid.”

But the lawyer for the finance corporation says it simply administers the program on the municipality’s behalf.

WFSU

By NICK EVANS • MAY 7, 2015

Investors wondering about the U.S. government’s role in the Puerto Rican debt crisis are hearing echoes of Detroit.

In 2013, lawmakers opposed a federal bailout of the auto-producing hub, and the Obama administration didn’t step in to prevent the largest municipal bankruptcy in U.S. history, in July of that year. The Treasury has a similar no-rescue approach with the Caribbean island beset by unsustainable debt.

What Treasury officials are offering Puerto Rico is advice on how to help ease its fiscal burdens and ensure the U.S. territory receives all federal funding it’s eligible for — about $6 billion a year. More extensive aid such as loan guarantees requiring Congressional approval is unpopular with lawmakers, and it’s unlikely the federal government will aid Puerto Rico after refusing to help Detroit, investors said.

“I can’t see any way that they would do that when they didn’t do it for Detroit,” said Brandon Barford, partner at Beacon Policy Advisors LLC in Washington and a former Senate Banking Committee staffer. “Treasury could ask, but it would only exacerbate market disruptions if prices spiked and then fell even further after an inevitable congressional defeat.”

Instead, the Obama administration is making a special effort to support the $100 billion Puerto Rican economy by helping the commonwealth and its residents take full advantage of aid that’s available to it through programs such as Social Security and Medicaid, and funds for nutrition, education and agriculture.

Infrastructure Funds

Another channel is financing for infrastructure expenditures with federal money that allows the Puerto Rican government to use its own funds elsewhere, said Daniel Hanson, an analyst at Height Securities LLC, a Washington-based broker-dealer.

Puerto Rico and its agencies owe $73 billion. The U.S. municipal debt market, which includes securities of states, cities and counties, is worth $3.6 trillion. While debt sold by the commonwealth and its agencies has lost 2.3 percent this year through Tuesday, the broader municipal market has gained about 0.3 percent.

Even though the law allows the Fed to buy municipal bonds in durations of up to six months, “it would be extraordinarily unlikely that the Fed would take such action on any muni debt, much less that of Puerto Rico,” Hanson said in an e-mail Tuesday.

‘Political Fallout’

“The Fed would need to be comfortable establishing such a precedent” and “be able to stomach the political fallout,” he said.

While Puerto Rico’s debt is tax-exempt and was once popular among traditional buyers of municipal bonds such as mutual funds, its financial troubles are pushing more of the securities into the hands of alternative asset managers and distressed buyers speculating on price swings.

As a result of the shift, the Fed no longer sees a Puerto Rico default as a threat to the broader U.S. financial system, Barford said.

A Fed spokesman declined to comment.

The Government Development Bank of Puerto Rico, which acts as the island’s fiscal agent, financial adviser on bond sales and handles the same debt-management functions local treasury officials perform in the U.S. states, is not federally regulated and doesn’t have access to Fed’s discount window, a lending facility aimed at boosting liquidity, according to Hanson.

Weiss Visits

As the crisis dragged on, Treasury officials have traveled to the territory since at least 2013 to discuss its finances. Antonio Weiss, counselor to the Treasury secretary, and Kent Hiteshew, who runs the office of state and local finance, met with officials in San Juan earlier this year.

Secretary Jacob J. Lew spoke by phone with Puerto Rico Governor Alejandro Garcia Padilla, Senate President Eduardo Bhatia and House of Representatives President Jaime Perello Borras on April 28. Lew urged the officials to develop a “credible” budget and implement a long-term fiscal plan.

Treasury spokesman Daniel Watson reiterated on Monday that “federal policy experts are sharing their expertise with the Puerto Rican officials that are leading the Commonwealth’s economic policies, but these efforts should not be interpreted as any kind of federal intervention.”

Options such as the federal government possibly guaranteeing a Puerto Rico financing haven’t been offered by the U.S. Treasury or the Federal Reserve, Senator Jose Nadal Power, said in an interview May 5 in San Juan.

‘Helpful’ Advice

“So far they haven’t been open to that,” said Nadal Power, who chairs the Senate Finance Committee in the Puerto Rican legislature. “They’ve been very helpful in terms of advice. And they’ve been very aware of what is going on on the island.”

The U.S. Treasury’s efforts may include crisis planning and facilitating talks with investors, Barford said.
Another option would be to help Puerto Rico’s electric authority by seeking legislation that would allow it to bypass some federal regulations, said Richard Larkin, senior vice president and director of credit analysis in Boca Raton, Florida, with Herbert J. Sims & Co.

Matt Fabian, a partner at Concord, Massachusetts-based Municipal Market Analytics, said the only situation in which the administration would be willing to provide aid to Puerto Rico would be to help keep order if a default leads to social unrest.

Cash Crunch

Puerto Rico, which has struggled to grow since 2006, faces a cash crunch and has been unable to pass a tax overhaul that would have paved the way for a $2.9 billion debt sale.

Standard & Poor’s, which downgraded Puerto Rico to CCC+ in April, doesn’t expect any extraordinary federal assistance.

“Our general-obligation rating on the commonwealth does not assume any federal intervention to either improve the island’s economy or to provide extraordinary financial assistance,” S&P analyst David Hitchcock said in an e-mail Monday. “To the extent there was extraordinary federal assistance, it would be a positive rating development, but one that we do not expect.”

After the financial crisis of 2008, Congress took some tools away from Treasury. For instance, the Exchange Stabilization Fund, which had been used to help Mexico during the 1990s, can no longer be tapped for emergency purposes, Barford said.

“Beyond asking for Congress to appropriate money or the Fed purchasing bonds — highly unlikely due to politics — there are no other pots of money that could be used for direct and unrestricted fiscal relief,” he said.

Bankruptcy Bill

Even a bill that would allow Puerto Rico to file for Chapter 9 bankruptcy protection is unlikely to pass, according to analysts including Robert Donahue at Municipal Market Analytics in Concord, Massachusetts.
Intervening to rescue the island’s finances could actually spook markets, signaling that problems are larger than investors now believe, Hanson said.

“If Treasury were to take such extraordinary steps, the types of steps that are supposed to be reserved for a Lehman-style crisis, to bail out Puerto Rico, that would send the wrong message,” he said, referring to the $613 billion collapse of investment bank Lehman Brothers Holdings Inc. in 2008.

Bloomberg

by Kasia Klimasinska

May 6, 2015

1. Standard & Poor’s Ratings Services is requesting comments on proposed changes to its methodology for assigning stand-alone credit profiles (SACPs), issuer credit ratings (ICRs), and issue credit ratings to not-for-profit public and private colleges and universities globally.

2. The request for comment (RFC) proposes changes that are intended to provide additional transparency to help market participants better understand our approach in assigning ratings to not-for-profit public and private colleges and universities globally, to enhance the forward-looking nature of these ratings, and to enable better comparison between these ratings and ratings in other sectors and asset classes.

3. If adopted, these criteria will supersede “Approaches To Rating U.K. Universities Amid Growing Credit Diversity,” published March 28, 2003. These criteria would also partially supersede the “Higher Education” criteria, published June 19, 2007. Specifically, the sections “Private College and University Credit Ratings”, “Management and Governance”, “Debt”, and “Rating Public Colleges and Universities” would be superseded by these criteria. This methodology is related to our criteria article: “Principles Of Credit Ratings”, published on Feb. 16, 2011.

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08-Apr-2015

Standard & Poor’s Ratings Services’ U.S. Public Finance Housing Enterprise Group assigned and released its ‘AA’ issuer credit rating (ICR) on Clearinghouse CDFI, Calif. on April 2, 2015. Subsequently, on April 28, 2014, Standard & Poor’s assigned and released its ‘AA-‘ ICR on Housing Trust Silicon Valley (HTSV), Calif. For both ratings, despite comprising a very minimal sample, Standard & Poor’s found some common trends within the community development finance institution (CDFI) industry involving strategy and management (impact) and financial performance. In particular, we found CDFIs have minimal loss exposure that can typically be absorbed through reserves and unrestricted equity. Moreover, the debt profiles of those assessed, and the first two CDFI entities we rated publicly, have low-risk debt, with little long-term liabilities. In addition, we found the history of loan performance for publicly rated CDFIs has historically been positive, with very few delinquencies. We believe the ratings for Clearinghouse and HTSV are solid and present a level of stability in line with the ‘AA’ rating category.

Standard & Poor’s began analyzing the industry using its housing finance agency (HFA) criteria to assess various CDFIs nationwide, where public financial statements were made available via their respective public websites. We concluded with a small sample of five distinct CDFIs using three to five years of financial statements to assess common trends. We subsequently found each CDFI to be a unique entity, despite having similar core social missions. Each has their own distinct lending activity, ranging from housing finance (first-time homebuyers and affordable multifamily housing) and commercial/small business lending to charter school lending. We determined that our state “Housing Finance Agencies” criteria (published June 14, 2007) was most applicable to form an appropriate credit opinion for each CDFI, factoring core missions, portfolio, credit risk, and management. We also used “Criteria: Principles of Credit Ratings” (published Feb. 16, 2011) to apply U.S. Public Finance ICR criteria for this analysis. As a result, we view CDFIs as similar to HFAs, albeit with a broader range of lending activity for community development, rather than mortgage loan programs, posing the greatest risk.

In our initial financial analysis using the above-mentioned criteria, we found from our publicly rated CDFIs and the small sample assessed that the CDFIs’ liquidity ratios tend to be similar to those of state HFAs — and, in some scenarios, with equity ratios in line with or above our rating categories for social lending issuers. In our view, funding sources and equity levels go hand-in-hand. For example, CDFIs with more reliance on federal grants may have more annual revenue volatility. In some instances, however, prudent risk management allows for a gradual increase in equity, leading to very stable financial performance. While some CDFIs’ equity may be lower than those of publicly rated social lending institutions, their total equity-to-total debt tends to be either extremely high (representing little debt, with adequate equity), or very steady, coupled with stable financial performance. Despite the size of the CDFIs’ balance sheets and overall loan portfolios, their assets and liabilities tend to be adequate or have appropriate ratios.

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07-May-2015

Read the Brief.

Municipal Market Analytics | May 5

States and localities are afraid to take on new debt these days, missing a golden opportunity to invest in infrastructure and other long-term projects.

As states and localities have adjusted to a slow-growth economy, one of the main casualties of the shift has been investments in infrastructure and other long-term programs. In other words, governments aren’t taking on new debt these days. It’s a surprising development since interest rates are at historic lows, making it cheaper than ever to borrow.

State debt has slowed so much that Iowa State Treasurer Michael Fitzgerald is urging cities, counties and the state to borrow more. “Our infrastructure continually needs to be improved, whether it’s schools, roads, even prisons,” Fitzgerald told the Des Moines Register earlier this year. “With interest rates as close to zero as you’re ever going to find them, we could be missing an opportunity.”

Still, by all indications, the debt shrinkage will continue in 2015 as governments focus much of their bonding efforts on refinancing rather than issuing new debt. “We’ve seen a political anti-debt sentiment build up in parts of the country,” said Emily Raimes, a state government analyst with Moody’s Investors Service. “It’s partly due to the federal debt ceiling that’s made people very aware of the issues around having a lot of debt and partly due to the mood around pensions and issues of funding being a real long-term burden.”

So has debt become a four-letter word for states and localities?

While there are many kinds of healthy debt, there’s also no such thing — despite Fitzgerald’s pleadings — as too little debt from a credit perspective, said Raimes. “To the extent states pay for projects with cash on hand and not with long-term debt,” she said, “we do not see that as any kind of credit negative.”

Different kinds of long-term debt can mean different things for a government’s health and outlook. Most of this debt is viewed as reasonable in the sense that it is typically issued for a public institution or a project that will continue to be a benefit to the community over the lifetime of the debt. And, of course, there are nuances. For example, Moody’s last month downgraded Bristol, Va., largely because the agency saw the city as over-leveraged in risky debt.

But there is one kind of debt that many agree is the equivalent to sending out a distress flare: long-term debt to cover budget shortfalls, also called deficit financing. Governments that take on this type of debt are usually doing so under extreme duress. It’s not unusual for governments to issue short-term debt to cover cash flow throughout the year. That process is akin to a consumer using a credit card to cover payments, then paying off the card at the end of the month when his paycheck comes in. But deficit financing can mask systemic problems with a government’s budget.

Chicago issued roughly $9.8 billion in bonds between 2000 and 2012. An investigation by The Chicago Tribune found that less than a third went to fund capital improvements while nearly half went to meet short-term budget needs like equipment purchases and one-time legal expenses. Chicago’s money troubles have led to multiple downgrades and a deteriorating pension system.

A big unfunded pension liability can also entice lawmakers to issue bonds to pay down that liability. But such a move carries the risk that the government could pay more in bond interest than that investment will earn in the pension system.

What’s important when it comes to debt is what a government can handle financially and politically. California suffered downgrades during the Great Recession as the state faced a budget crisis with little wiggle room to fix it. The state has a volatile income tax revenue stream, a tax hike requires a two-thirds approval from the legislature and it has statutory school funding requirements. Since then, California has passed two major ballot measures that raised taxes and established a new funding formula for its rainy day fund that manages against the state’s revenue volatility. Both of these have significantly contributed to the state’s improved credit picture.

It’s also important not to take on too much debt. Generally analysts like to see states leverage no more than 15 to 20 percent percent of their general fund to service debt. But there are exceptions. A decade ago, Loudoun County, Va., had a substantially higher debt burden, says Moody’s local government analyst Julie Beglin. But it was also the fastest-growing county in the country. “It was clear that a lot a developments were going in and they had a very high debt burden because of that,” she said. “But we did not take down their rating because we thought they could afford it.”

GOVERNING.COM

BY LIZ FARMER | APRIL 30, 2015

The Illinois Supreme Court rejected the state’s solution for its worst-in-the-U.S. $111 billion pension shortfall, handing organized labor a victory while deepening a crisis with national implications.

The court unanimously struck down a 2013 law, saying cuts in cost-of-living increases and a higher retirement age violate the state constitution’s ban on reducing worker retirement benefits.

Across the nation, state and local governments grapple with pension deficits that exceed a combined $2 trillion, according to a Moody’s Investors Service report last year. Closing that gap by reducing payments to retirees would abrogate union contracts in many states and even constitutional guarantees. In Illinois, Chicago is grappling with $20 billion in unfunded pension liabilities that threaten its solvency.

“Crisis is not an excuse to abandon the rule of law,” the seven-member Illinois court ruled. “It is a summons to defend it.”

State constitutions have been invoked elsewhere to prevent cuts to public pensions. In Rhode Island, unions settled with the state over cuts before their constitutional challenge could be put to the test. In municipal bankruptcy cases in Detroit and California, judges ruled that federal law can override state bans on cutting pensions.

Illinois Governor Bruce Rauner said he wasn’t surprised by Friday’s ruling. The Republican told reporters in Chicago that the measure “violates basic contract law.” His own pension proposal, which is central to his budget for the coming fiscal year, is legal, Rauner said. He said his plan wouldn’t reduce currently promised benefits.

Downgrade Threat

Friday’s ruling raised the prospect of further downgrades by credit-rating firms. Investors already have been punishing Illinois. Its 10-year bonds yield about 3.7 percent, the highest since November and the most among the 20 states tracked by Bloomberg.

The Illinois bill was signed by former Governor Pat Quinn, a Democrat, in late 2013. A judge blocked the measure before it took effect after public-worker unions sued. Attorney General Lisa Madigan in March asked the high court to resurrect it.

During arguments before the court in March, Solicitor General Carolyn Shapiro argued the state should be able to make laws to protect public welfare and safety during fiscal crisis.

But the judge who voided the law concluded it violated a provision of Illinois’s constitution that bars the diminishment of public-worker retirement benefits. The seven-member high court agreed.

“We do not mean to minimize the gravity of the state’s problems or the magnitude of the difficulty facing our elected representatives,” Justice Lloyd Karmeier wrote. “It is our obligation, just as it is theirs, to ensure that the law is followed.”

Natalie Bauer Luce, a spokeswoman for Madigan, said in an e-mailed statement that, “The Court has provided a definitive interpretation of the Constitution that must now guide the legislature and the Governor.”

Chicago Mayor Rahm Emanuel, a Democrat, drew a distinction between the rejected law and a separate agreement his administration negotiated with some city unions whose members will pay more for fewer benefits.

“That reform is not affected by today’s ruling, as we believe our plan fully complies with the State constitution because it fundamentally preserves and protects worker pensions,” Emanuel said in a statement.
Illinois Republicans lamented the court’s action.

“I respect the Illinois Supreme Court, but disagree with the ruling,” House of Representatives Republican Leader Jim Durkin said in an e-mailed statement. “I am prepared to continue working on meaningful legislative reforms to save our public pension systems.”

Retiree ‘Victory’

Democratic Senate President John Cullerton called the ruling “a victory for retirees, public employees and everyone who respects the plain language of our constitution.”

The outcome, he said, “should be balanced against the grave financial realities we will continue to face without true reforms.”

We Are One Illinois, a coalition of public-worker unions that pressed the legal challenge, applauded the decision.

“With the Supreme Court’s unanimous ruling, we urge lawmakers to join us in developing a fair and constitutional solution to pension funding,” state AFL-CIO President Michael T. Carrigan said Friday in a coalition statement. “We remain ready to work with anyone of good faith to do so.”

The case is In Re Pension Reform Litigation, 111585, Illinois Supreme Court (Springfield).

Bloomberg

by Andrew M Harris and Elizabeth Campbell

May 8, 2015

Pre-refunded munis, which are tax-exempt bonds whose repayment is guaranteed by holdings of U.S. government debt, yield about 0.9 percent on average, the same as similar-maturity Treasuries, Bank of America Merrill Lynch index data show. The munis typically yield less than Treasuries because investors aren’t taxed on the income. In February, the gap was as much as 0.26 percentage point.

That difference disappeared for the first time in 17 months after a jump in refinancings caused muni prices to tumble. Bank of America and Municipal Market Analytics recommend buying pre-refunded munis, anticipating they will outperform and provide a hedge against bond-market losses as the Federal Reserve prepares to raise interest rates.

“This is a way for people who want Treasury credit to buy it extremely cheap,” said Phil Fischer, head of muni research at Bank of America in New York. “There are a lot of investors who are concerned that rates are going to rise. You have the benefit of tax-exempt revenue on a Treasury bond.”

Bond Rout

U.S. government-bond investors have lost more than $195 billion since mid-April on speculation borrowing costs will increase. Fed Chair Janet Yellen said Wednesday that investors “could see a sharp jump in long-term rates” once the central bank raises its benchmark rate from near zero, where it’s been since 2008.

The slide in the price of pre-refunded munis relative to Treasuries is the result of a rush by states and localities to borrow while interest rates are still close to five-decade lows. They’ve issued $145 billion of debt in 2015, the most to start a year since at least 2003, when Bloomberg data begin. More than two-thirds of the deals have refinanced higher-cost debt, an amount not seen in more than two decades.

Pre-refunded bonds are created by advance refundings, which allow municipalities to refinance securities before their call dates. Municipalities sell bonds and use the proceeds to buy Treasuries or other federally backed debt. The income from the government securities is used to pay off the higher-cost munis as they mature.

The refinanced bonds typically gain in price because repayment is assured. Moody’s Investors Service even has a separate rating for debt backed by escrow funds holding U.S.- guaranteed obligations: #Aaa. A rally hasn’t happened because public officials have saturated the market with debt.

Honolulu Haven

Pre-refunded Honolulu bonds maturing in July 2018 traded last month at an average yield of 0.95 percent, data compiled by Bloomberg show. Treasury notes with the same maturity traded at a 0.96 percent yield.

The comparable yields mask the fact that the interest rate on the municipal bond is equivalent to 1.68 percent on taxable debt for those in the highest federal tax bracket.

That differential should provide a buffer for investors if fixed-income yields continue to rise, Municipal Market Analytics, a Concord, Massachusetts-based advisory firm, said in a May 4 report. Even if rates don’t increase, pre-refunded bonds will probably rally as market demand catches up with the pace of issuance, according to the report.

Ten-year Treasuries yield about 2.23 percent, compared with about 2.2 percent for benchmark munis.

“From a relative value standpoint, why not buy a pre-re?” said Dawn Mangerson, who helps oversee $8 billion of munis at McDonnell Investment Management in Oakbrook Terrace, Illinois. “There’s no credit risk. They got cheap.”

Bloomberg

by Brian Chappatta

May 6, 2015

Assured Guaranty Ltd. fell the most since June 2013 after the Puerto Rico House of Representatives rejected a tax-overhaul bill that would have paved the way for a $2.9 billion debt sale needed to avert a cash crunch.

Assured Guaranty shares plunged 4.3 percent to close at $25.99 at 4 p.m. in New York, the lowest price since March 27. The Bermuda-based bond insurer’s subsidiaries Assured Guaranty Municipal Corp. and Assured Guaranty Corp. backed a combined $3.6 billion of Puerto Rico obligations as of Dec. 31, company filings show.

The odds of Puerto Rico defaulting on general obligations increased to 50 percent after lawmakers struck down the bill championed by Governor Alejandro Garcia Padilla, according to Daniel Hanson, an analyst at broker-dealer Height Securities. Bond investors agreed on the increased risk, with debt maturing in July 2035 trading Thursday at the lowest price since it was issued in March 2014, data compiled by Bloomberg show.

The Caribbean island and its agencies have $73 billion of bonds, whose interest is tax-exempt nationwide and which are held by mutual funds, hedge funds and individuals.

Shares of MBIA Inc., whose subsidiary National Public Finance Guarantee Corp. also insures Puerto Rico debt, fell 4.5 percent to close at $8.75, the lowest since March 27.

Bloomberg

by Brian Chappatta

April 30, 2015

Taylor Riggs, an editor at Bloomberg Brief: Municipal Market, talks with Natalie Cohen, head of municipal research at Wells Fargo Securities.

Watch the video.

April 30, 2015

Taylor Riggs, an editor at Bloomberg Brief, talks with Joe Mysak about this week’s municipal market news.

Watch the video.

May 7, 2015

New York, May 07, 2015 — In the first quarter of 2015, upgrades for US public finance rating revisions continue to outpace downgrades, Moody’s Investors Service says in a new report. As well, the quarter saw the most rating upgrades in nearly seven years.

There were 148 upgrades in the first quarter compared to 115 downgrades in the public finance sector owing to continuing economic stabilization, strengthening financial operations and balance sheet metrics as well as solid managerial oversight. Moreover, upgrades as a percent of total rating revisions was the highest since Q3 2008 at 56.2%.

Among the quarterly upgrades were four obligors raised to the Aaa-rating level, Moody’s says in “Upgrades Continue to Lead Downgrades in Q1 2015; Debt Affected by Downgrades is Larger.”

“We typically change the rating of only a small number of public finance entities each quarter, but the number of rating revisions in Q1 had a larger number of rating revisions than the past few quarters. We changed the rating on approximately 2.1% of public finance obligors in the first quarter 2015. In contrast, the 924 rating revisions in all of 2014 represented only 7.3% of the public finance rated universe,” author of the report and Moody’s AVP — Analyst Mark Lazarus says.

However, the dollar value of downgraded debt surged to $89.1 billion compared to$18.1 billion in upgraded debt. The disparity is attributable to the obligor downgrades of the Commonwealth of Puerto Rico (Caa1 negative), the City of Chicago, IL (General Obligation Baa2 negative), Chicago Public Schools, IL (Baa3 negative) and Catholic Health Initiatives (A2 negative), which accounted for $73 billion of the affected debt.

In addition, the publication of an updated methodology for utility revenue bonds resulted in 35 rating revisions subsequent to the completion of Moody’s surveillance reviews in the first quarter. From these reviews, 11 obligors were downgraded compared to 24 upgrades, and 14 were confirmed at existing ratings.

The methodology-driven downgrades reflected 9.6% of the first quarter’s total downgrades. Conversely, methodology-driven upgrades represented 16.2% of the period’s tally.

Even without the methodology-driven revisions, first quarter upgrades still surpassed downgrades.

The report is available to Moody’s subscribers here.

The Illinois Supreme Court declared in a ruling Friday that the state’s landmark 2013 pension overhaul violates the state constitution, unraveling an effort by state lawmakers to rein in benefits for a public-sector pension system they have consistently underfunded over the years.

The current pension shortfall is estimated at $111 billion, one of the largest nationally.

The high court affirmed a decision in November by a state circuit court that the legislative changes violated pension protection measures written into the state constitution. The decision sided with public-sector unions, who challenged the law. The ruling said the constitution is unambiguous on the issue and dismissed the state’s argument that so-called police powers in place to protect public safety and welfare give lawmakers the authority to cut retirement benefits.

“From the beginning of our pension reform debates, I expressed concern about the constitutionality of the plan that we ultimately advanced as a test case for the court,” said John Cullerton, Illinois’s Senate president and a Democrat. “Regardless of political considerations or fiscal circumstances, state leaders cannot renege on pension obligations.”

Last month, the Oregon Supreme Court reversed a core element of that state’s controversial 2013 pension overhaul, concluding that annual cost-of-living adjustment cuts to its retired workforce were unconstitutional.

State and local governments have tried to remedy their growing pension-funding gaps by curbing benefits—some for current employees. Those pension cuts have faced legal challenges in more than a dozen states, including Illinois and Oregon, according to the Center for Retirement Research at Boston College.

The Illinois law would have reduced future retirement costs by shrinking cost-of-living increases for retirees, raising retirement ages for younger employees and capping the size of pensions.

Union leaders hailed the victory. “The court’s ruling confirms that the Illinois Constitution ensures against the government’s unilateral diminishment or impairment of public pensions,” said Michael Carrigan, president of the Illinois ALF-CIO, speaking on behalf of the We Are One Illinois coalition of unions.

But the rejection of the law as unconstitutional poses a huge challenge for the state’s new Republican governor, Bruce Rauner, who also faces a looming budget deficit after a special recession-era tax increase expired at the end of last year.

A spokesman for Mr. Rauner said the governor’s office planned to issue a statement soon.

Meanwhile, the city of Chicago also faces its own pension and budget woes. A spokesman for Mayor Rahm Emanuel, who was re-elected last month to a four-year term, also didn’t immediately respond to a request for comment.

Justices acknowledged that the state is in a financial fix, but that doesn’t allow lawmakers to violate the constitution. “The financial challenges facing state and local governments in Illinois are well known and significant,” the high court said. “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 WALL STREET JOURNAL

By JOE BARRETT And BEN KESLING

Updated May 8, 2015 1:30 p.m. ET

Write to Joe Barrett at [email protected] and Ben Kesling at [email protected]

Successful Investing In Charter School Bonds

Finding Best Practices in a High-Yielding Sector

Bond Buyer Web Seminar – June 5, 2013

OVERVIEW

• State Law Differences
• Basic Legal Structure for Charter Bond Financing
• Variations on the Theme

STATE LAW DIFFERENCES

43 states permit the formation and operation of charter schools under statutory schemes that are fundamentally similar in purpose, though often differing in ways that are relevant to bond financing.

Charter Authorization

• Charter schools are formed by the approval of the school’s constitutional document called a “charter” or “contract”.
• Charters are approved by “authorizers” which may be governmental entities, such as the state board of education, state university system, local governments or local school districts, or by quasi-governmental or nongovernmental entities.
• In New York, only [three] governmental authorizers exist for the 300+ charter schools in the state.
• In Ohio nearly 70 authorizers include private nonprofit corporations, universities and quasi-governmental entities for over 350 charter schools.
• In California each of the over 1000 school districts has power to authorize charters, and over 1000 charter schools are operating in the 2012-13 year.

Organization and Independence

• Charter schools may be formed as nonprofit corporations, for profit corporations, unincorporated associations, limited liability companies or cooperatives, depending on local law.
• Control of the charter school’s governing board may be autonomous, controlled entirely by the authorizer, or some combination thereof, depending on local law.
• In California, charters may, but aren’t required to, be established as nonprofit corporations, and can exist instead as quasi-governmental entities with no specific corporate character.
• In Nevada, charter schools may not be established as nonprofit corporations, and must exist as quasi-governmental entities.
• In Ohio and Texas, the law provides for independent charter school boards for some schools, but not others.
• Statutory independence of the board can affect a range of operational concerns such as employee eligibility for public pensions, collective bargaining rules, and federal tax status.

Corporate Powers

• Ordinary powers of a private corporation may be granted to charter schools entirely, or only in part or subject to statutory limitations, depending on local law.
• In states where charter schools may be organized as nonprofit corporations under local laws, the typical powers of a nonprofit corporation are granted to charter schools, including the power to own or lease property and enter into contracts.
• In states where charters are organized as associations, cooperatives or quasi-governmental entities, the scope of the charter school’s corporate powers may be unclear (unless specifically outlined in law).
• Texas, New Mexico, Nevada and California are examples of states that either require or permit charter schools to be formed as entities other than nonprofit corporations.

Charter Revocation

• Each state’s charter school law describes the conditions under which a charter may be unilaterally nullified or revoked by its authorizer.
• Certain states, such as Arkansas, impose a high degree of objectivity and clearly defined criteria upon the revocation process, and some allow for automatic revocation upon the occurrence of certain extraordinary conditions (e.g., misconduct, fraud, chronically low test scores, etc).
• Other states permit a high degree of subjectivity in the revocation process, or provide little definition of the criteria or conditions justifying revocation.
• Some states, such as Colorado and California, maintain revocation appeals procedures that mirror or simulate constitutional due process procedures, while other states have no appeals process at all.
• Finally, in states with multiple charter authorizers, schools may be able to avoid revocation by simply “shopping” for a new authorizer without addressing the conditions that gave rise to the original revocation process.

Charter School Funding

• Charter schools are almost uniformly funded based on attendance, from the same public money that funds traditional K-12 school districts. The per-pupil funding may vary in amount, however, from the level provided to traditional public schools.
• Certain states, such as the District of Columbia and California, augment charter school operating funds with separate per-pupil funding specifically available for facilities expenses.
• Charter school funding may typically be pledged to secure indebtedness, pursuant to corporate powers of the school, however certain states such as New York specifically prohibit any security interest in charter school funds.
• Other states, such as Arizona and California, permit charter school funds to be “intercepted” before disbursement to the charter school, for direct transfer to a bond trustee as security for bond repayment.

 

EXEMPLAR TRANSACTIONS

Bronx Charter School for Excellence (Bronx, NY) (2013)

Structure

• Bonds issued to finance acquisition, construction and renovation of facilities.
• Charter school entity is the borrower.
• Senior lien on financed facility given to bond trustee.
• Track record of school garners “BBB-” rating.

Observations

• Pledge of school’s per-pupil revenues not permitted under New York law, and no intercept of funds available.

Rocketship Alma Academy (San Jose, CA) (2011)

Structure

• Bonds issued to refinance construction loan and finance additional project costs.
• Borrower (landlord) is limited liability company (LLC) sole member of which is nonprofit corporation controlled by the CMO.
• Borrower complies with financial covenants in loan agreement.
• Charter school (tenant) complies with financial covenants in lease agreement.

Observations

• Borrower (LLC) may pledge revenues (rental receipts) to bond trustee.
• Liquidity and coverage covenants require charter school to maintain cash and balance sheet, but CA rent reimbursement law creates disincentive to pledge charter school revenues.

Aspire Public Schools (multiple cities, CA) (2010)

Structure

• Bonds issued to acquire and construct charter school facilities.
• Nonprofit borrower/landlord uses operating leases to schools (short terms with renewals).
• Multiple properties/leases secure bond repayment, with ability of landlord/borrower to adjust “Additional Rent” to capture payments from one school to cover shortfall of another, if needed.

Observations

• California law limits power of charter school A to pay obligations of charter school B, but special purpose entity landlord may comingle rental revenues from multiple tenants to pay bonds.

New Plan Learning (Dayton and Lorraine, OH; Chicago, IL) (2011)

Structure

• Bonds issued to finance acquisition, construction of facilities and refinance existing debt.
• Leases from multiple landlord entities (commonly controlled) to multiple charter schools, landlords own property and improvements.
• Landlord entities pool property and revenues to secure single obligation.
• Borrower is obligated group representative, but repayment is joint/several obligation of entire group.

Observations

• Neither Ohio nor Illinois laws permit intercept of school revenues.
• Financial covenants embedded in school leases as well as borrower documents.

Tri-Valley Learning Corporation (Livermore, CA)

Structure

• Bonds issued to finance tenant improvements, including construction and renovation of facilities, on leased property.
• Charter school is tenant and borrower.
• Payments to ground lessor subordinate to bond debt service.

Observations

• California law permits intercept of bond debt service payments directly from state controller to bond trustee.
• Intercreditor agreement controls exercise of remedies by bondholders and landlord against charter school borrower/tenant.

Last Updated: April 29 2015

Article by Eugene H. Clark-Herrera

Orrick

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

U.S. lawmakers are renewing efforts to expand the use of municipal bonds to attract private investment in the nation’s crumbling roads and bridges.

Senator Ron Wyden, the Democrat who backed legislation creating the $188 billion market for Build America Bonds, introduced a bill Monday with Republican Senator John Hoeven of North Dakota that would facilitate the use of private-activity debt for transportation projects. Separately, Republican Representative Todd Young wants to double the limit on the securities for transportation and allow their use for facilities such as courthouses. Companies use private-activity bonds to borrow in the municipal market.

The plans may face an uphill battle because of their cost and gridlock on Capitol Hill. Yet increasing financing options for public-private partnerships would be a boon for municipalities and help fill a void, the lawmakers said. Authorization for federal highway funding is set to expire May 31, and Congress has been unable to agree on a plan to address what Treasury Secretary Jacob J. Lew says is a $1 trillion backlog of infrastructure work.

“You can come up with bipartisan approaches to get private-sector money off the sidelines and into transportation,” Wyden, 66, the ranking Democrat on the Finance Committee, said in a phone interview. “The transportation system needs more than a face lift; it basically needs full re-constructive surgery.”

Debt Limit

States and localities issue private-activity bonds on behalf of companies that build and operate facilities such as airports, ports and highways. There’s a limit to how much of the debt can be sold: as of April 15, $11.1 billion of the $15 billion allotted for transportation had been issued or approved, including for the replacement of the Goethals Bridge between New York City and New Jersey.

Municipalities nationwide sold Build America Bonds, taxable debt with a federal subsidy on interest costs, for infrastructure. Wyden, who represents Oregon, has tried unsuccessfully to revive the program, which debuted in 2009 and expired at the end of 2010.

The senator calls his latest proposal the “Move America” program. It would authorize as much as $180 billion of tax-exempt bonds over 10 years and provide as much as $45 billion in new infrastructure tax credits to match private-equity investment.

Cost Consideration

Interest on the bonds wouldn’t be subject to the alternative minimum tax, which limits the tax benefits and exemptions that high-earning individuals can claim. The plan would change other rules, including allowing use of the bonds for privately owned public infrastructure, such as highways.

The proposal would cost as much as $15 billion in foregone tax revenue over 10 years, Wyden’s office said.

“Move America bonds and tax credits are an effective way to leverage private-sector dollars to build the infrastructure we need across the country to grow America’s economy and create jobs,” Hoeven said in a release.

Young, a member of the House Ways and Means Committee, said he’d double the cap on issuance of private-activity bonds for transportation work to $30 billion and expand their use, including for public buildings.

“It’s almost inevitable that this will be part of the solution,” the 42-year-old Indiana representative said in a phone interview. “There’s no reason we should be lagging behind countries like Canada in bringing in private-sector expertise as well as capital to ensure we build more of these projects.”

‘Uphill Slog’

Young acknowledged hurdles, including resistance to the cost. He said he’s exploring introducing his proposal or incorporating it with other plans.

In January, President Barack Obama proposed tax-exempt debt, dubbed Qualified Public Infrastructure Bonds, that would have no issuance cap and wouldn’t be subject to the alternative minimum tax.

At the time, it had a low probability of being enacted by the Republican-controlled Congress, said Matt Posner, a managing director at Municipal Market Analytics, a Concord, Massachusetts-based research firm.

While getting approval to expand the use of private-activity bonds would be “an uphill slog,” interest is picking up, he said.

The debt might expedite work on badly needed projects, Christopher Leslie, New York-based chief executive officer of Macquarie Infrastructure Partners Inc., said in an interview last week at a Bloomberg Government event in Washington. He oversees almost $9 billion in three funds dedicated to investments in the U.S. and Canada.

“The private sector remains keen to invest and, in fact, sees itself potentially as part of the solution to the slowness of Congress,” Leslie said.

Bloomberg Muni Credit

Mark Niquette

May 3, 2015 9:01 PM PDT

California’s drought is starting to spread to the market for bonds issued by water utilities, long considered one of the safest types of debt sold by state and local governments.

Some investors are steering clear of the bonds from hard-hit areas of the U.S. west, amid concerns that restrictions on water use will drive down water-authority revenue. Some authorities may have a tough time raising rates to offset that lost income.

If shortages persist, credit ratings may weaken and prices for outstanding bonds fall, according to analysts and rating firms.

California water and sewer bonds lost value in April for the second month in three, falling 0.61% after Gov. Jerry Brown imposed mandatory water restrictions. All California municipal bonds posted a 0.55% decline for the month, counting price moves and interest payments, according to Barclays PLC.

California is in its fourth year of drought, one of the worst on record for the nation’s most populous state. It is costing billions of dollars in losses in its agricultural sector and prompting the first-ever mandatory statewide cutbacks in water use.

It is also a rare fissure in one of the most-secure and widely traded sectors of the $3.7 trillion municipal-bond market. During last year’s rally in bonds, water and sewer debt nationwide outperformed the market, rising 9.7% compared with 9% for tax-exempt bonds overall, according to Barclays. California water and sewer agencies have issued about $28.8 billion in bonds since 2010, according to Thomson Reuters.

Water-utility bonds seldom default because they’re typically backed by residents’ payments on an essential service. And so far the drought hasn’t kept water authorities from tapping the debt market.

But the persistent water shortages show how a market prized for safety and stability can contain hidden pockets of risk, some investors said.

“The way investors have looked at water in California in the past needs to go through some evolution,” said Michael Johnson, co-chief investment officer at Gurtin Fixed Income Management LLC, in Solana Beach, Calif.

Mr. Johnson said heavy investor demand for California debt of all types has raised the prices of most water bonds. That means investors may be overpaying for debt from districts with growing but unacknowledged financial problems.

His firm, which manages about $9 billion, has avoided some authorities facing challenges such as limited water storage or small financial reserves.

An April report by Moody’s Investors Service warned investors that the state’s water restrictions could curb revenue at water agencies. While rate increases can offset declining water use, utilities have little time to make them, and such increases may further discourage consumption.

Fitch Ratings said downgrades could occur if policy makers hesitate to make rate increases.

California isn’t the only place these bonds are under scrutiny. Robert Fernandez, director of environmental, social and governance research at Boston-based Breckinridge Capital Advisors, said his firm sold bonds from at least one water authority in Texas because of inconsistent revenue and water supplies.

Breckinridge, which manages about $21.4 billion, uses 11 indicators to analyze how water availability, demand and oversight can affect an agency’s ability to repay debt, looking for factors including adequate backup supplies and contingency planning, Mr. Fernandez said.

“We’re not looking to say, ’we want to avoid all water systems in this area,’” he said. “We want to look for the ones that are well managed and know how to manage through these issues.”

Sharlene Leurig, who directs the sustainable water infrastructure program at Ceres, a nonprofit group that promotes sustainable investing, said that while bondholders are beginning to pay more attention, the threat posed by water shortages is still poorly understood.

“I think we have a long way to go before those risks are properly disclosed and priced,” she said.

‘I think we have a long way to go before those risks are properly disclosed and priced.’
—Sharlene Leurig of Ceres
Maintaining investor demand will be important in California, where officials are accelerating parts of a voter-approved plan to sell more than $7 billion in general obligation bonds to pay for new water projects. That plan includes grants to local authorities, who may sell their own bonds.

Gary Breaux, chief financial officer for the Metropolitan Water District of Southern California, a consortium of 26 cities and water authorities that provide drinking water to about 19 million people in cities including Los Angeles and San Diego, said he’s spoken with investors to reassure them that the triple-A-rated agency has plenty of sources for water and isn’t foreseeing effect on its budget. Several water agencies’ recent bond sales were well received, he added.

“I think investors feel reassured that we’re watching all these different variables and we’ll take them into account when we set our next budget, as well as the rates,” he said.

Jamison Feheley, head of banking for public finance at J.P. Morgan Chase & Co., said California issuers are well prepared by prior droughts and haven’t had to adjust bond offerings, though investors are paying attention.

“There are a lot of discussions with investors and rating agencies about `what’s the plan? How do you expect to manage the drought issue?’” he said.

Demand for water utility debt has grown nationwide since Detroit’s bankruptcy, because those investors proved better-protected than those holding tax-supported bonds, said Matt Fabian, partner at Concord, Massachusetts-based research firm Municipal Market Analytics. And while water bills may go up as the drought goes on, they’re still a small portion of most households’ expenses.

“Frankly, they just need to charge more for it,” he said. “Once they start laying in new capital, either to fund conservation, or reuse, or desalination or whatever, it’s just going to cost a lot more money.”

THE WALL STREET JOURNAL

By AARON KURILOFF

May 4, 2015 2:19 p.m. ET

Write to Aaron Kuriloff at [email protected]

WASHINGTON – Sens. Ron Wyden, D-Ore. and John Hoeven, R-N.D., on Monday introduced legislation that would create Move America Bonds, which would generally be treated as exempt-facility, private-activity bonds but would have fewer restrictions and separate state volume caps that could be converted into tax credit allocations.

The bill, called Move America Act of 2015, would also allow states to convert volume cap for the bonds to allocations for tax credits. The Senators’ proposal, which is designed to increase private investment in infrastructure, has some similarities to, and also differences from, the Obama administration’s proposal for qualified public infrastructure bonds (QPIBs).

“Move America will turbocharge investment and give states and localities the flexibility they need to quickly and efficiently break ground on projects,” Wyden, the top Democrat on the Senate Finance Committee, said in a news release. “An injection of private capital, in addition to sustainable funding for transportation programs, will help get America’s economic engine running at full speed.”

Move America Bonds could be used to finance airports, docks and wharves, mass commuting facilities, railroads, highways and freight transfer facilities, flood diversion projects and inland waterway improvements.

The bonds would generally follow the same rules as exempt-facility bonds, with some exceptions.

Move America Bonds would not be subject to the alternative minimum tax. Exempt-facility bonds for airports, docks and wharves and mass commuting facilities have to be governmentally owned, but Move America Bonds used for those purposes could be privately owned. Up to 50% of the proceeds of Move America Bonds could be used for land acquisition, compared to 25% for most types of PABs. Also, certain rules for exempt-facility bonds for high-speed rail facilities and for highway and freight transfer facilities would not apply to these new bonds.

Move America Bonds would be subject to new, separate state volume caps equal to 50% of the state volume caps for PABs. As with PABs, states could carry forward unused volume cap for up to three years, but with Move America Bonds any volume cap unused after the three years could be reallocated to states that fully used their cap.

Wyden and Hoeven’s bill would also authorize Move America Credits — tax credits aimed at attracting private investment in infrastructure. The credits could be used on projects financed with Move America Bonds and they could be combined with the bonds and other federal and state funding.

States would have to trade in some of their Move America Bond volume cap to get allocations for the credits. They would receive $0.25 of credit allocation for every $1 of volume cap converted. The amount of credits on a project could not be more than 20% of the project’s estimated cost and could not be more than 50% of the project’s total private investment.

States could sell the credits or allocate them to sponsors of projects. The sponsors could claim the credits themselves or sell them to raise capital. The credits would be available to taxpayers once projects are placed into service, and taxpayers could claim the credit at 10% for 10 years.

Move America Bonds would be similar to Obama’s proposed QPIBs in that both would be new types of PABs used to finance infrastructure projects that would be exempt from the AMT. However, QPIBs would have to be used for governmentally-owned projects and would not be subject to any volume caps. Also, there would be no tax credits associated with QPIBs.

Municipal bond experts were generally positive about the bill.

“Tax-exempt bonds have been a cost-effective way to finance critical infrastructure and community investment projects for more than 100 years,” said Bond Dealers of America chief executive officer Mike Nicholas. “Creating additional opportunities to use these bonds will increase their benefits to the small issuers that regional and middle-market dealers work with and, particularly, to taxpayers and local communities.”

“Senator Wyden’s proposal represents a creative and thoughtful approach to bridging the gap between infrastructure funding needs and available resources,” said Michael Decker, managing director and co-head of municipal securities at the Securities Industry and Financial Markets Association. “We are particularly encouraged that Senator Wyden’s bill proposes to leverage the existing and well-proven tax-exempt bond market, which is the single most important tool for funding infrastructure in the U.S.”

Susan Collet, president of H Street Capitol Strategies, said that the goal of the bill appears to be to provide as much flexibility as possible to private investors for infrastructure projects. “It’s great to see a thought-provoking, bipartisan bill” on this topic, she said.

Micah Green, a partner at Squire Patton Boggs, said that while he’s not prepared to comment on the specifics of the bill, “this is yet another example of the broad based bipartisan support that exists to not only infrastructure finance, but also for ideas utilizing the municipal bond market as a mechanism for delivering lower cost financing for this needed public investment.”

THE BOND BUYER

BY NAOMI JAGODA

MAY 4, 2015 3:52pm ET

CHICAGO – Chicago will phase out the use of scoop-and-toss debt restructuring, convert $900 million of floating-rate debt to fixed rate and exit the attached interest rate swaps under measures announced by Mayor Rahm Emanuel Wednesday.

The city also plans over the next four years to reduce its reliance on debt to cover operating expenses like judgments and legal settlements and continue rebuilding reserves partially drained before Emanuel took office four years ago.

“They are the right steps” for the financial well-being of the city, Emanuel said during an address to the Chicago Civic Federation, a government research organization that follows the city’s budgeting and fiscal policies and has chided some of its borrowing practices.

Canceling the interest rate swap agreements attached to the city’s general obligation and sales tax-backed floating-rate debt would result in costly termination payments based on recent negative mark-to-market valuations of about $200 million. The city will use its short-term commercial paper line to cover the costs and eventually fold it into a long-term GO bond sale, said Chicago’s chief financial officer Lois Scott.

The city has three general obligation-backed floating rate deals outstanding from 2003, 2005, and 2007 with swaps attached that are negatively valued at $162 million. Another 2002 sales tax deal has a swap attached that’s negatively valued at $29 million. The city’s most recent downgrade triggered swap termination events on four derivative contracts, adding to the city’s fiscal headaches.

The city’s 24 swaps tied to $2.4 billion of floating-rate general obligation and revenue-backed paper were almost $400 million underwater based on market valuations at the close of 2014, but the mayor did not propose any changes to revenue-backed credits.

In announcing the debt-related measures, Emanuel is taking aim at practices attacked by his critics during the recent mayoral election and criticized by many market participants as shoddy fiscal maneuvers used by distressed issuers for near-term relief that add to the city’s long-term structural budget woes.

Emanuel acknowledged as much, saying the debt maneuvers “mask the true costs of government.”

The time is right, Emanuel said to take a “bigger step forward” on righting the city’s fiscal ship with the debt reforms as the local economy is on the mend following the recession and the budget’s structural deficit has been cut in half.

The plan, dubbed a roadmap for reform, comes three weeks after Emanuel won a second term following a runoff contest during which the city’s deteriorating credit ratings and fiscal hardships took center stage. The city’s massive $19 billion tab of unfunded liabilities and the burden of funding a $550 million increase in its pension contribution for police and firefighters next year have driven the credit rating dive.

The debt-related policy changes don’t solve the city’s most daunting challenge, its pension funding shortfalls, and will actually pose a near-term burden as the city uses more operating funds to cover legal costs and phases out the practice of pushing of upcoming debt principal payments off.

Emanuel acknowledged the measures may not stabilize or boost the city’s credit standing, but he’s hoping analysts and investors will view them “as very good and positive steps.”

Moody’s Investors Service in late February knocked the city’s down one notch to Baa2, only two levels above speculative-grade territory, but assigned a negative outlook.

The downgrade triggered termination events on four swaps with a combined negative valuation of nearly $60 million. BMO Harris Bank agreed to lower the rating threshold on one swap relieving the city from a potential $20 million payment if demanded by the bank. Wells Fargo Bank, the counterparty of the other three, has so far refused.

The city is expected to soon shift the 2003 floating-rate paper attached to one of those swaps to a fixed-rate and cancel out the swap and three others on the transaction that all combined carry a negative valuation of $33 million.

To cover any swap expenses, the city could tap its short-term borrowing program, although that is one of the practices Emanuel is targeting in his reform plan. The city last year drew $36.3 million from its short-term borrowing program to cover termination payments on two of its swaps on a notional principal amount of $206 million from a 2002 issue. The city then planned to convert the paper to a fixed-rate structure.

THE BOND BUYER

BY YVETTE SHIELDS

APR 29, 2015 5:05pm ET

When Steve Czepiel talks about traffic on the Pennsylvania Turnpike or retirement communities in Florida, odds are he isn’t referring to his daily commute or plans for his golden years. As co-manager of the $944 million Delaware National High-Yield Municipal Bond fund (ticker: CXHYX), Czepiel spends his days thinking about the economics of toll roads, charter schools, hospitals, and other projects financed by municipal bonds.

Over the past decade, his fund has averaged 5.6% returns annually, putting it in the top 2% of Morningstar’s high-yield muni category, with most of its total return coming from income. Those results, however, aren’t the product of interest-rate bets—the fund keeps its duration in line with its Lipper peer group—or wagers on places like Puerto Rico or Detroit. It is the product of careful securities selection. “Our focus is on building the portfolio bond by bond,” Czepiel says.

Those bonds are typically rated just above or below investment grade or, in the case of 22% of its holdings, not rated at all. The managers’ goal: Find a mismatch between the viability of a project and the rating of its bond to deliver high yield to investors without an inordinate amount of risk. “At times, it’s like finding a needle in a haystack,” says Czepiel of choosing the right securities; high-yield muni bonds represent just a sliver of the muni-bond market. “It’s a regionalized and fragmented market that can be very quirky.” Investors who understand the twists and turns are earning 5% to 7% in tax-exempt income.

Czepiel, 57, for his part, has made a career of navigating the nuances of the muni market. After graduating from high school, the Pittsburgh native worked road construction for three years to save up enough to study finance and economics at Duquesne University. When he graduated in 1982, he was the first person in his family to have gone to college. “I always tell people I’m most proud that I put myself through school,” says Czepiel, who landed a job at Kidder Peabody after graduation and went on to trade muni bonds for more than two decades. In 2004, Patrick Coyne, president of Delaware Investments, and Joe Baxter, head of municipal bonds, recruited Czepiel to join the Philadelphia firm.

In a typical week, Czepiel, his two co-managers, and seven credit analysts look at a dozen deals, ultimately passing on most. They add about 30 new holdings to the portfolio a year, with most of these bonds coming in as new issues. “Once these bonds are issued, you may never see them again,” Czepiel says, noting that most are owned by individuals and held to maturity. Because of this, the team spends two to three weeks peeling back the many layers of each project and deal structure. “In some cases, we’ll suggest changes to the underwriter,” he adds.

The fund’s universe is composed of revenue-based bonds that get dinged by credit-rating agencies for any number of reasons. “An example would be a hospital in a lower-income area,” says Baxter, who is a co-manager on the fund. “It might get a lower rating because of its location, but that doesn’t mean it’s going to default.”

 

Unlike general-obligation bonds, which are backed by the taxing authority of local and state governments, these high-yield bonds are typically earmarked for specific projects and depend on relatively narrow sources of revenue to repay that debt. Investors need to go into these deals with their eyes wide open, says Czepiel, but the default rate among below-investment-grade municipal bonds is significantly lower than that of junk-rated corporate bonds. Between 1970 and 2013, for example, the cumulative default rate for U.S. speculative-grade muni bonds was 6.5%, versus 33.1% for speculative global corporate bonds, according to Moody’s Investors Service.

One of the more interesting sectors is health care—more than 22% of the fund. This group includes hospitals, nursing homes, assisted-living facilities, and continuing-care retirement communities. The fund recently owned debt tied to six such developments in Florida, including one in Boca Raton with a 6.75% coupon. “This facility was a start-up,” says Czepiel, “but we were reassured by a number of factors, including a high level of investment from the developers.”

Corporate issuers make up 19% of the fund. “You see corporate debt in the muni world if the bonds are being issued for the public good,” Czepiel says. These bonds provide financing for everything from tobacco settlements and pollution control to opening new gates at airports.

Education is another area rich in tax-exempt income. The fund recently owned debt from dozens of charter schools in 16 states and the District of Columbia. One such holding is View Park Preparatory Accelerated Charter School in Los Angeles, which raised $15 million in BB-rated bonds last fall to build a new facility. “This is an established school that had gone through several charter renewals,” says Czepiel. “They have good test scores, a strong school board, and a 94% student-retention rate.” The revenue, based on per-pupil payments from the state, is enough to cover its debt and expenses, says Czepiel, but the slim margins of charter schools tend to lead to lower credit ratings. In this case, the bonds yield nearly 6%.

Though turnover is low, “the ongoing surveillance of these projects is critical,” says Czepiel, who keeps tabs on everything from construction timelines and budgets to revenue and operation costs. “If we see that something isn’t tracking properly, we’ll sell.”

One trend that Czepiel is keeping a close eye on is the intersection of private investors and public issuers in what’s known as a public-private partnership, or P3. The fund has invested in a number of these deals, including one that is building and repairing bridges in Pennsylvania, putting a light rail line from downtown Denver to its airport, and helping water-starved California desalinate seawater. If everything goes according to schedule, the Carlsbad Desalination Project will begin producing 50 million gallons of fresh water daily by 2016. “It will provide 7% of San Diego County’s daily water usage,” says Czepiel. In the meantime, the municipal bonds that financed the lion’s share of the $1 billion project are pumping out 4.5% tax-free income.

BARRON’S

By SARAH MAX

May 2, 2015

May 1 (Reuters) – Issuance of U.S. municipal bonds fell slightly in April, but sales for the first four months of 2015 jumped over 67 percent compared with the same period a year earlier, according to Thomson Reuters data released on Friday.

Total sales in April were $39.3 billion, 9.5 percent lower than March, but 55 percent higher than the $25.3 billion sold in April 2014.

The spike in sales this year – there has been $143.2 billion of municipal issuance in the first four months of 2015 compared to $85.4 billion during the same period last year – is due to more issuers refinancing, market watchers say.

Issuers sold $101.2 billion of refunding bonds in 2,544 deals during the first four months of this year, more than double the $42.2 billion of refunding bonds sold during the same period in 2014 across 1,244 deals, the data shows.

“The story for the first part of 2015 – and April specifically – has been low interest rates,” said Tom Kozlik, managing director and municipal credit analyst at Janney Capital Markets. “That environment has created refundings, refundings, refundings.”

New debt sales rose slightly in April as issuers sold $14 billion in new bonds across 579 deals, compared to $13 billion over 474 deals in April 2014. Overall, new money deals fell slightly in the first four months of 2015 with $41.9 billion compared to the same period in 2014 with $43.2 billion of new sales.

“New issuance has been down,” said Kozlik. “Muni credits do not want to add more fixed costs than they already have.”

Next week’s sales will be relatively small in size, with an estimated $9.8 billion of issuance, according to Thomson Reuters data. This week, municipal issuance totaled $4.9 billion.

Next week’s four largest deals are the state of Louisiana with $335 million of general obligation bonds; the Los Angeles Unified School District with $330 million of general obligation refunding bonds; the Los Angeles Community College District with $310 million of general obligation refunding bonds, and the Indiana Finance Authority with $302 million of stadium lease appropriation refunding bonds.

BY ROBIN RESPAUT

(Reporting by Robin Respaut, editing by G Crosse)

It’s an exceedingly rare thing that I’d ever point to anything my adoptive state of Florida does in the area of insurance markets as an example that others might want to copy. But in at least one important respect, recent moves by the state-run Citizens Property Insurance Corp. offer a model not only for other residual markets, but also for the National Flood Insurance Program and, perhaps most importantly, for Citizens’ sister agency, the Florida Hurricane Catastrophe Fund.

Citizens’ efforts to slim down its portfolio and shift more risk to private reinsurance markets already are paying off in a big way. Late last week, the rating agencies Moody’s and Fitch both upgraded Citizens’ debt credit rating ahead of a planned $1 billion municipal bond issuance, Citizens’ first in three years.

Moody’s upgraded both Citizens’ personal lines and commercial lines accounts from A2 to A1, and assigned an A1 rating to the pending $750 million of tax-exempt senior secured bonds and $250 million of floating-rate notes.

The upgrade to A1 on all the Accounts notes CPIC’s track record and expertise with administering the assessment mechanism, during and after heavy storm seasons, as well as the state’s robust economy and the corporation’s successful efforts to transfer risk and reduce the necessity for post-event bonding in coming years.

Fitch upgraded more than $2.6 billion of Citizens’ outstanding senior secured debt from AA- to A+. Those bonds include $746.6 million issued in 2009, $1.24 billion issued in 2010 and $645 million issued in 2011. For the forthcoming issues, Fitch again assigned an AA- rating.

The upgrade to ‘AA-‘ from ‘A+’ on the senior secured bonds reflects Citizens’ successful efforts to lower and transfer risk, reducing its exposure to claims and reducing the magnitude of potential future borrowing.

How these changes, particularly the Moody’s upgrade, ultimately affect Citizens’ cost of borrowing will be seen more definitively when the issues come to market May 18. The last time Citizens did a bond issuance, in 2012, its 10-year bonds were priced at 3.77 percent, about 180 basis points above the benchmark.

As seen in the ratings guidance, credit goes to Citizens management for embarking on a bold plan to leverage soft pricing conditions in the private reinsurance markets. Citizens previously only received reinsurance from the Cat Fund, thus multiplying the solvency risk should the state be hit by a major storm. In addition to purchasing billions in traditional reinsurance in recent seasons, Citizens also followed the lead of entities like North Carolina’s Beach Plan, Massachusetts’ FAIR plan and Louisiana’s own all-purpose Citizens by jumping into the catastrophe bond market in a major way.

Between them, Citizens’ Everglades Re and Everglades Re II entities have issued catastrophe bonds for $750 million in April 2012, $250 million in March 2013, $1.5 billion in May 2014 and, most recently, a $250 million issuance this coming month. The $1.5 billion 2014 cat bond remains the largest single issuance in history, and Citizens’ combined $2.75 billion in cat bonds represents about 12 percent of the $23 billion global market.

Credit also belongs to Citizens’ successful depopulation program, as its policy count has fallen by more than half in the past three years (from 1.5 million to about 600,000) and their total insured value has over the past four years fallen from $518 billion to less than $200 billion.

Of course, these improvements have only been made possible by an unprecedented nearly decade-long drought of major storms hitting the Sunshine State. Citizens ended 2005, following the strike of Hurricane Wilma, with a deficit of $1.8 billion. Were it a private company without the ability to assess “hurricane taxes” on other privately sold policies, that would have been the end of the line for Citizens. Instead, policyholders across Florida were forced to pick up the slack and, thanks to the lucky streak, Citizens was able to end 2014 with a surplus of $7.4 billion.

Now, the next step is to import that same success to the Cat Fund. Earlier this month, the Florida Cabinet approved a plan by the fund to buy $1 billion of retrocessional reinsurance cover, which would mark its first ever private reinsurance deal. The Citizens upgrades suggest similar improvements are possible for the Cat Fund should it follow through with these risk-transfer plans.

Not only would transferring more risk back to the private market better protect Florida taxpayers and policyholders from future hurricane taxes (and given current pricing, with no or close to no impact on rates) but it would mean cheaper borrowing costs in the long term. Approving the final deal should be a no brainer for the State Board of Administration.

By Ray Lehmann | Right Street Blog | April 30, 2015

Insurance Journal

Standard & Poor’s Ratings Services continues to maintain high-investment-grade ratings on most U.S. regulated water utilities (USRWUs) even though we estimate these companies’ capital spending will exceed more than $2 billion in capital spending annually by 2020. We’ve identified three key areas that we expect will likely affect USRWUs’ ability to manage regulatory and operating risks in coming years: Regulatory lag, drought, and declining sales. USRWUs have fared well thus far in managing these risks. And this is reflected in USRWU ratings, which compare favorably to ratings for regulated gas and electric utilities (see chart 1). Nevertheless, USRWUs will continue to confront these three aforementioned issues, which could likely affect their credit quality over the long term. In evaluating these…

Purchase the Report.

The Obama Administration this week announced eight additional Promise Zones across the country. Promise Zones are high-poverty communities where the federal government partners with local leaders to increase economic activity, leverage private investment, improve educational opportunities, reduce violent crime, enhance public health and address other priorities identified by the community, according to the U.S. Department of Housing and Urban Development. Through the Promise Zone designation, these communities will work directly with federal, state and local agencies to give local leaders proven tools to improve the quality of life in some of the country’s most vulnerable areas.

The new Promise Zone communities are:

• Camden, New Jersey
• Hartford, Connecticut
• Indianapolis, Indiana
• Minneapolis, Minnesota
• Sacramento, California
• St. Louis/St. Louis County, Missouri
• Pine Ridge Indian Reservation of the Oglala Sioux Tribe, South Dakota
• South Carolina Low Country

“The Promise Zone effort is proof positive that partnerships are the key to community economic development,” said Agriculture Secretary Tom Vilsack. “Families and children in rural and tribal communities are full of potential to compete and succeed in the 21st Century. When we invest our resources and establish long-lasting public-private alliances to strengthen educational opportunities, deliver health care, build infrastructure and create jobs, we are investing in our country’s future.”

The newly designated zones join five others that were named in January 2014 — San Antonio; Los Angeles; Philadelphia; Southeastern Kentucky Highlands and the Choctaw Nation of Oklahoma.

All Promise Zones will receive priority access to federal investments that further their strategic plans, federal staff on the ground to help them implement their goals, and five full-time AmeriCorps VISTA members to recruit and manage volunteers and strengthen the capacity of the Promise Zone initiatives.

A competition to select a third round of Promise Zones will commence later this year. HUD will publish this summer a notice in the Federal Register requesting public comment on the proposed selection process, criteria, and submissions for the final round of the Promise Zones initiative.

NCPPP

By Editor April 30, 2015

In this week’s Extra Credit, Senior Director Dave Hitchcock discusses our recent rating action on Puerto Rico and Director Sussan Corson and Associate Director Debra Boyd explain the rationale behind our rating actions on Louisiana’s universities.

Listen to the Podcast.

Apr 30, 2015

Read the Brief.

Municipal Market Analytics | Apr. 28 |

In the current economic climate, opportunities are expanding significantly for municipal underwriters and derivatives specialists as states and municipalities across the country clamor to pay for infrastructure and services, fill expanding budget gaps, and shore up unfunded or underfunded pension obligations. In evaluating and pursuing these opportunities, however, banks need to proceed with caution. Regulators are ever more focused on the activities of financial institutions in the municipal market due to possible disparities in sophistication between underwriters and municipal decisionmakers, the potential for municipal financial advisor conflicts of interest, and issues surrounding the adequacy of disclosure concerning the risk profile of different financial products in a period of elevated volatility in global financial markets. In particular, banks should cautiously assess and carefully document the appropriateness and suitability of proposed financing solutions and the disclosure to counterparties of risks associated with those solutions.

The Securities and Exchange Commission (SEC), Municipal Securities Rulemaking Board (MSRB), and the Financial Industry Regulatory Authority (FINRA) are all paying greater attention to these issues in 2015. The importance of scrutinizing transactions in this area cannot be overstated – a finding by the SEC of inadequate or inaccurate risk disclosure or a conflict of interest can lead to significant liability.

Continue reading.

Benjamin Neaderland and Harriet Hoder

WilmerHale

April 21, 2015

(Reuters) – Michigan Governor Rick Snyder on Wednesday signed into law a bill aimed at reducing interest rate costs for an upcoming Detroit bond sale.

Detroit privately placed $275 million of variable-rate bonds with Barclays Capital to finance its Dec. 10 exit from the biggest-ever municipal bankruptcy. As part of the city’s U.S. Bankruptcy Court-approved plan, that debt is due to be sold in the U.S. municipal market in a fixed-rate mode by May 9. The deal will mark the city’s first post-bankruptcy public bond sale.

“We need to ensure Detroit’s debt is repaid under the terms of the bankruptcy to allow the city to continue its recovery,” the Republican governor said in a statement. “The savings from lower interest costs will allow Detroit to reinvest in critical areas like public safety and municipal services.”

The new law boosts security for the bonds by placing a specific statutory lien on Detroit income tax revenue pledged to pay off the debt. The move is expected to result in investment-grade ratings for the bonds, which in turn could save Detroit between $20 million and $30 million over the life of the issue, according to the governor’s office.

There was no immediate comment from Detroit Mayor Mike Duggan’s office on the status of the bond sale.

Proceeds from the bonds were earmarked for retiring a prior $120 million Barclays loan to the city, to pay certain creditor claims from the bankruptcy and to finance city improvements.

Wed Apr 22, 2015

(Reporting By Karen Pierog in Chicago; Editing by Lisa Shumaker)

Summary

• Declining oil prices should be of particular interest to municipal bond investors, as many U.S. state and local budgets have a substantial dependence on oil production and exploration revenue.
• The impact of lower oil prices varies from state-to-state, with states with a heavier dependence on oil revenue being affected most negatively.
• The increased consumer spending that is typically associated with a decline in oil prices may offset the decline in oil-related revenue in some states.

Continue reading.

Seeking Alpha

By Stephanie Larosiliere, Client Portfolio Manager, Invesco

Apr. 21, 2015 5:56 PM ET

By most measures, U.S. state budget conditions are adequate to favorable—and they should be. Not only is the economic expansion mature at this point, it showed signs of accelerating during the middle of 2014. And yet, a majority of states—32 by our count—face budget gaps in either fiscal 2015, 2016, or both. In most cases the gaps are manageable and do not represent an immediate threat to credit quality. But in Standard & Poor’s Ratings Service’s view, the fact that so many states confront shortfalls at all serves as an early warning of sorts. After all, if a state is grappling with a budget deficit now, with the economic expansion approaching its sixth anniversary, what will be its condition when the next slowdown strikes?

Benefitting from the myriad advantages that come with being sovereign entities, U.S. states comprise one of the most creditworthy sectors we rate. We rate 43 ‘AA’ or higher. At the same time, a large majority of the states rely on a combination of sales or personal income taxes to fund their operations. That means that at any time, current economic conditions—over which the states only have limited influence—effectively dictate the tone of their budget negotiations. What tends to differentiate the direction of any individual state’s credit quality, therefore, is financial management. Indeed, the states are among the least passive of all the credit sectors within U.S. public finance; fiscal policy decisions have a significant effect on the degree to which economic conditions will affect their credit quality.

Overview

• A majority of states face budget gaps this year or next; most will be manageable.
• Yet this serves as an early warning, as the recovery nears its sixth anniversary.
• Thus the state sector could be approaching a period of rating volatility.

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27-Apr-2015

The financial close of the $899-million Pennsylvania Rapid Bridge Replacement Project on March 18 is a game changer for the P3 market.

• It is the first big U.S. P3 deal to close since Florida’s I-4 Ultimate six months ago.
• Rapid Bridges is the largest road project in Pennsylvania history. Yet the concession agreement survived untouched in the transition from conservative Republican Gov. Tom Corbett to liberal Democrat Gov. Tom Wolf.
• Developer Plenary Walsh Keystone Partners and its financial advisor, Plenary Group, arranged the largest Private Activity Bond financing of a P3 deal in U.S. history: $721.5 million in appropriation-risk debt, rated BBB, which drew 40 different investors. No TIFIA loan was sought by Pennsylvania Department of Transportation (PennDOT). $59 million of equity was contributed by Plenary Group (80%) and Walsh Investors (20%).
• It is the first bundling of publicly owned assets under a single, fixed-price construction program management contract. The agreement also shares permitting risk on 558 discrete projects between PennDOT and the Plenary-Walsh project company.

(This is the project’s greatest risk, and greatest potential benefit. PennDOT negotiated a SEP-15 waiver from the Federal Highway Administration that allows it to delegate the NEPA documentation to the private program managers. If it works well, other states may pursue the same categorical exclusion from FHWA rules and this approach could become standard procedure. Key to its success is the extensive technical due diligence done by the joint venture to prepare its bid.)

“I think that one of the things that will make our project hugely successful or frankly cause a lot of consternation for the Plenary-Walsh team is how smoothly the permitting process goes,” says Bryan Kendro, Director for the PennDOT Public-Private Partnership (P3) Office (until recently a one-man shop but now also run by Deputy Director Dale Witmer and supporting staff.)

• Rapid Bridges involved the first use of a UK-style performance bond, adapted for this project by Walsh Group, its surety, Travelers, and Standard & Poors (see below).
• The secret sauce: To gain the support of local labor and small contractors, all of the bridge rehabilitation work will be subcontracted, and long-term maintenance will be staffed locally—”to make the workforce in each community look like the people who live in that community,” says Matthew Walsh, chairman of The Walsh Group of Chicago, Illinois.

Also, money to fund the Rapid Bridges project came from a large increase in annual highway funding to $2.5-billion, which was enacted just as the RFQ for the P3 project was being issued in December 2013.

That new money allowed PennDOT to increase design-bid-build lettings in 2014 from $1.5 billion to $2 billion.

“We passed a massive funding increase, so basically there was a lot of design-bid-build work going out at the same time, so if you didn’t like the P3 program, there was plenty of other work to bid on,” says Kendro.

The leadership at PennDOT took a risk on Rapid Bridges in hopes that it would help energize local contractors to be more efficient. “I think we’re envisioning that this is going to be kind of a shock to our local contracting community, just how fast they can actually build a bridge if they are incentivized to do so and when given the opportunity to be more innovative,” says Kendro. “We think that [Rapid Bridges] is going to be proof that there are certain things that can be done differently with our bridge program, and we’re going to do them differently.”

Where Credit Is Due

Plenary Walsh Keystone Partners has contracted with joint venture Walsh Construction Company (60%) and Granite Construction Company (40%), with HDR, to permit and manage the design and replacement of 558 mostly small bridges by December 2017.

Major maintenance over 25 years will be performed by Walsh Infrastructure Management, LLC (an affiliate of The Walsh Group.)

Advising Plenary Walsh Keystone Partners are Fasken Martineau, of Toronto (legal); BTY Group (technical); InTech (insurance); and Plenary Group (financial).

Advising PennDOT are KPMG (financial and overall strategic advisor); URS (program management); CDM Smith/ Lochner (technical); Allen & Overy (transactional counsel); Ballard Spahr (bond counsel).

Bond underwriters are J.P. Morgan and Wells Fargo, advised by Ashurst LLP (legal).

An American Performance Bond

What Travelers’ construction services calls an “Expedited Dispute Resolution Performance Bond“ is described by S&P “as a new form of performance bond, which we view as providing liquidity equaling as much as 10% credit to the performance bond for contractor replacement.

“Although typically performance bonds have the potential for protracted arbitration, under the terms of this policy, the maximum number of days before resolution/payment is 82, and we thus provide credit for some project downside costs. In addition, the bond provider has documented its obligation under the performance bond as a financial obligation, such that its failure to pay could result in ratings consequences for the insurer.”

In fact, the Rapid Bridges financing is the first time in the U.S. that a rating agency has recognized the value of a performance bond, according to Stan Halliday, chief underwriting officer for Travelers construction services group. Zurich American and Federal (Chubb) worked as co-sureties with Travelers.

Walsh has also proposed using the new performance bond to help secure its $408-million contract with WMB Heartland Partners (Meridiam/Walsh Investors/Balfour Beatty Capital) to build the Marion County Consolidated Justice project in Indianapolis. The fate of that social infrastructure P3 project will be determined in April.

As use of the new bond spreads, the hope is that letters of credit will no longer be required from contractors on P3 deals. If so, says Halliday, that would eliminate a competitive advantage now held by non-U.S. contractors who have broader access to LOCs. “This sets the stage for U.S. contractors to have a greater role in P3s,” he says. “It’s a solution that works in North America.”

The total security package provided by Walsh-Granite includes a $22.5 million letter of credit (2.5% of the construction value), and retainage of $22.5 million. The contractors also will provide a performance bond equal to about 100% of the contract price, in addition to parent guarantees with a liability cap of 40% under the design-build agreement.)

Public Works Financing is a monthly newsletter covering P3s in all infrastructure markets, since 1988. It is widely read and cited in the media, academic research, federal reports and congressional testimony.

NCPPP
By Editor April 24, 2015

Editor’s note: As part of our strategic partnership with Public Works Financing, NCPPP will republish two articles each issue of the journal of record on public-private partnerships in infrastructure development. For a limited time, NCPPP Members can receive a 10% discount on a subscriptions to and advertising within this outstanding publication. – PK

By William Reinhardt, PWF editor

In this week’s Extra Credit, Director Jessica Wood discusses our outlook revision on Colorado State University’s bonds and Associate Director Tim Tung discusses the impact of California’s drought and water rationing on its water utility revenue bonds.

Listen to the Podcast.

Apr 23, 2015

Read the Brief.

Municipal Market Analytics | Apr. 20

HARRISBURG, PA–(Marketwired – April 22, 2015) – The Pennsylvania Treasury today announced it has successfully completed the first-ever competitive bidding process for the selection of a law firm to provide bond counsel legal services to the Commonwealth. Based on their responsive proposal, Pennsylvania Treasury selected Saul Ewing, LLP to serve as bond counsel for an upcoming general obligation debt issuance. Treasury’s Request for Proposal process is expected to result in an approximate savings of 36% to the Commonwealth, as compared to the existing legal fee payment formula.

“Treasury is proud to serve as the first state agency to exercise this type of bidding process for bond counsel services,” Executive Deputy State Treasurer Christopher Craig said. “The type of legal services required for a bond issuance lent itself well to the competitive bidding process, which is an open, efficient way to procure quality services at a competitive price.”

Craig noted that while Treasury is not bound by the Wolf administration policy of engaging legal counsel through competitive proposals, the department chose to follow the administration’s lead due to its shared commitment to bring greater business efficiencies to state government.

“Treasury is an independent state agency, but in our core role as fiscal stewards for the Commonwealth, we are committed to identifying financial savings at any opportunity,” Craig said. “We are pleased to heed the Governor’s call for the use of a competitive procurement process for this bond issuance and provide savings for taxpayers.”

Representatives from the Governor’s Budget Office, the Department of the Auditor General and Treasury reviewed and evaluated bid proposals submitted from 17 different law firms. The General Obligation debt issuance, for which these legal services were procured, is expected to be issued prior to the end of the fiscal year. The proceeds of the bond sale will be used to refinance existing debt, fund transportation projects and support various capital improvements.

Pennsylvania Department of Treasury

CONTACT INFORMATION

Doug Rohanna
717.787.2991
[email protected]

The cheapest borrowing costs in five decades aren’t enough of an incentive for states and cities to address their crumbling bridges and roads.

While municipalities have issued a record $130 billion of long-term, fixed-rate bonds this year, an unprecedented 70 percent of the deals have gone to refinance higher-cost debt, rather than fund capital expenditures, according to Bloomberg and Bank of America Merrill Lynch data.

At about $40 billion, muni sales to finance projects are unchanged from the same period last year — even though the nation’s aging infrastructure has become a problem so dire and obvious that it was the subject of a feature by comedian John Oliver last month on HBO’s “Last Week Tonight.”

“Refunding has taken precedence over infrastructure financing,” said Phil Fischer, head of municipal research at Bank of America in New York. “It’s going to save state and local governments a lot on debt-service costs, and it’s going to help them catch up in terms of their pensions and other fixed obligations.”
“That can’t go on forever,” he said. “Infrastructure projects are needed all over the country.”

D+ Grade

The country requires about $3.6 trillion of investment in infrastructure by 2020, according to the American Society of Civil Engineers. The group’s 2013 report gave the country a “D+” grade.

This year’s issuance mix shows state and local officials are reluctant to add debt even though the recession ended almost six years ago and yields on 20-year general obligations, at about 3.5 percent, are close to a generational low set in 2012.

The $3.6 trillion municipal market shrank in 2014 for the fourth-straight year, the longest stretch of declines in Federal Reserve data going back to 1945.

Municipalities often sell bonds that they can refinance after a set period, which is a windfall if interest rates decline. California lowered debt-service payments by about $180 million through a $1 billion refunding this week, according to the state treasurer’s office. Four of the five largest muni deals this year were for refinancing, including tobacco debt from California.

Deferred Needs

“The refundings have been stronger than we expected because interest rates are lower than we expected,” said Michael Zezas, Morgan Stanley’s chief muni strategist in New York. “There’s still a lot of deferred capital needs throughout the municipal issuer system, both at the state and local level.”

Issuance is on pace to eclipse the record $408 billion of supply in 2010, when states and cities clamored to borrow in the final year of the federally subsidized Build America Bonds program. The $188 billion initiative, which debuted in 2009, was designed to boost infrastructure investment.

Should this year’s pace of refunding persist, it would beat the record set in 1993 of 67 percent of deals that reissued debt at lower yields, according to Bank of America data.

Fischer said he raised his supply forecast to $400 billion from $350 billion because of the refinancing wave. Zezas said he’s sticking with his prediction of $354 billion, for now.

At some point, bonds sales to fund infrastructure will have to go up because the spending isn’t “optional,” according to Fischer.

“America got the same grade that a 10th-grade teacher gives a nightmare kid so she doesn’t have to deal with him for another year,” Oliver said in the March 1 episode of his satire news program on HBO.

The segment, with about 3.8 million views on YouTube, carries the description: “America’s crumbling infrastructure: It’s not a sexy problem, but it is a scary one.”

Bloomberg News

by Brian Chappatta

April 22, 2015

Norwalk, CT, April 24, 2015—The Governmental Accounting Standards Board (GASB) yesterday voted to initiate pre-agenda research on improvements to going concern and debt disclosure guidance. In a related action, the Board also decided to remove the project on Economic Condition Reporting from the current technical agenda.

The Board decided to initiate research on going concern disclosures based on feedback from stakeholders, who suggested that the GASB should examine the relevance of the “going concern” concept as it applies to governments and government organizations. Stakeholders noted that governments rarely go out of business.

The going concern research will focus on whether existing GAAP standards provide state and local government financial statement preparers with sufficient guidance about management’s responsibilities for evaluating and disclosing uncertainties associated with severe financial stress.

The economic condition project—which contemplated financial reporting requirements related to financial projections—was put on hold in 2012 and has not been subject to deliberations since that time.

“The input and feedback we received from stakeholders on the Preliminary Views on economic condition reporting was highly valuable and will likely serve to inform our work in the future—including the research the Board has called for regarding going concern disclosures,” said GASB Chair David A. Vaudt.

The GASB also approved research on potential improvements to debt disclosure guidance. With state and local governments diversifying their debt-issuance practices—increasingly seeking direct bank loans rather than issuing municipal bonds—disclosures in this area have been inconsistent. The research will focus on whether notes to the financial statements currently provide sufficient debt information to financial statement users for decision making and assessments of accountability.

Both going concern and debt disclosure guidance were identified as high priorities by the members of the Governmental Accounting Standards Advisory Council (GASAC) at their March 2015 meeting. Based on the outcomes of the research and feedback from stakeholders, including the GASAC, the Board will decide whether to add projects to the current technical agenda to consider amending the existing standards.

More information about the new pre-agenda research activities will available in the coming weeks at www.gasb.org.

Several governments in Europe are now borrowing at negative interest rates. Switzerland recently auctioned 10-year bonds at a yield of minus 0.055 percent. Within the Eurozone, yields have turned negative on German, French and Dutch bonds maturing within five years.

Even less fiscally sound countries are able to float paper at extremely low rates. For example, 30-year bonds issued by Spain recently yielded 2.04 percent — this from a country with 23 percent unemployment and a 98 percent debt-to-GDP ratio.

European government interest rates are low due to sluggish economic growth, fears of deflation and an aggressive bond-buying program implemented by the European Central Bank. The benefits of low Eurozone interest rates are not only being realized by European governments. Foreign companies and countries are also enjoying the cheap money, borrowing over $20 billion in Europe during the first quarter, while U.S corporations issued $50 billion in Euro-denominated debt last year.

Can U.S. states — and perhaps even large cities and counties — benefit from Europe’s sale on money? Judging from the experience of Ontario and other Canadian provinces, the answer appears to be yes. Ontario has been issuing Euro-denominated debt for many years. Earlier this year, Ontario issued a 10-year Euro bond with a coupon of 0.875 percent; recently, the bond was trading at yields below 0.5 percent. This compares quite favorably to New York State general obligation bonds maturing in 2025 that recently yielded 1.8 percent.

In fact, Ontario has a weaker credit rating than New York, so the Empire State might fare even better in the Euro market. The province is rated one notch lower than New York by both S&P and Moody’s, and a look at relative fiscal conditions suggests that this rating differential is, if anything, too modest. In 2013, Ontario had a primary government debt-to-GDP ratio of 38.8 percent, while New York State’s ratio was only 4.4 percent.

U.S. states may not have previously considered issuing overseas because of the tax exemption on interest. But some municipal securities, such as pension obligation bonds, are taxable. Further, the benefits of tax exemption in the U.S. have been offset by negative sentiment in the domestic municipal-bond market. European investors used to funding governments with high levels of debt and aging populations may be less frightened by the negative news about state finances reported in the U.S.

A couple of cautionary notes are in order. By borrowing in a foreign currency, a state takes on currency risk. This can be ameliorated by purchasing a currency swap. When negotiating a swap agreement with a financial institution, however, treasurers should learn from the bad experiences that Chicago and other municipal borrowers have had with interest-rate swaps. These deals often have fine print that could mandate balloon payments in the event of a rating downgrade.

Second, American states borrowed in Europe during the 19th century, and the story had an unhappy ending. Many European investors were stuck with Reconstruction-era bonds that were later repudiated by the Southern states that had issued them. The London-based Corporation of Foreign Bondholders pressed states to honor these bonds into the 1930s, at which point Britain and other European countries needed relief from their World War I debts to the U.S. federal government. The U.S. state defaults then became a non-issue.

Since another Civil War does not appear in the offing, perhaps European investors will be ready to once again lend to American states — and to so at the low interest rates they afford to foreign companies, sovereigns and our neighbors to the north.

GOVERNING.COM

BY MARC JOFFE | APRIL 20, 2015

[email protected]

In this CreditMatters TV segment, Standard & Poor’s Managing Director Robin Prunty explains why some U.S. state governments continue to face pension funding dilemmas.

Watch.

Apr 14, 2015

The Federal Reserve may soon allow U.S. banks to hold municipal bonds to meet liquidity rules, opening up more demand for municipal securities and potentially lifting munis-related exchange traded funds.

After the fall off in March, munis have remained relatively flat for the year. Year-to-date, the iShares National AMT-Free Muni Bond ETF (NYSEArca: MUB) gained 0.6%, SPDR Nuveen Barclays Municipal Bond ETF (NYSEArca: TFI) increased 0.6% and Market Vectors Intermediate Municipal Index ETF (NYSEArca: ITM) rose 1.0%.

However, the municipal bond market could experience greater activity ahead if the Fed amends the liquidity rules for U.S. banks. According to people familiar with the matter, U.S. banks may soon be able to utilize municipal bonds as part of “high quality liquid assets” to fund operations for 30 days, the Wall Street Journal reports.

Previously, the Fed and two other bank regulators excluded city and state debt from the liquidity rules in September. While the Fed is cogitating on relaxing the rules, the Office of the Comptroller of the Currency officials argue that munis are not traded easily enough to be included in the rule.

Consequently, the Fed may push for changes, but the OCC could stand pat. The Fed’s version of the liquidity rule would then apply to bank holding companies with $250 billion or more in assets, along with a less-severe version for bank-holding companies with between $50 billion and $250 billion in assets. However, the OCC has jurisdiction over some of the largest banks and would likely continue to exclude munis.

Back in September, Fed governor Daniel Tarullo said he expects the central bank to change its stance on munis inclusion as evidence that some state and local debt is frequently traded may be “comparable to that of the very liquid corporate bonds” that qualify under the high-quality liquid assets rule.

Big banks, such as Citigroup (NYSE: C) and Wells Fargo (NYSE: WFC), along with state and local officials and top Congressmen, have been pushing for the changes. Proponents contend that excluding all muni-debt securities from the liquidity rules could push banks to shun the $3.7 trillion market and force local governments to cut back on projects and spending.

According to the Fed, banks now account for 12% of the total outstanding municipal debt market. Banks have held on to munis because the asset class is seen as less risky than corporate debt and competitively priced relative to other bonds.

ETF Trends

April 20th, 2015 at 9:30am by Tom Lydon

Both sides are claiming victory after an unexpected twist in the fight to save an imploding college
The announcement that Sweet Briar College, a 114-year -old all-women’s liberal arts college in Virginia, will close after the current semester sent shock waves through the world of academia this spring. And it caused extreme heartache to a deeply loyal community of students and alumni.

But the small college’s closing isn’t just hurting the world of higher education, it’s also worrisome for investors in the municipal bond market who buy the debt of colleges and universities.

Sweet Briar College, with an enrollment of 530 students, had its revenue bonds downgraded from a BBB to a B- by Standard and Poor’s credit rating agency following the announcement of its closure. The news and subsequent rating downgrade led to its bonds trading at a discount, at 83 cents on the dollar compared to 102 cents the day before.

And other small colleges – at least 22 institutions with under 4,500 students – have experienced an uptick in trading since Sweet Briar’s announcement, according to an article in Bloomberg on Sunday.

“The market definitely should be concerned,” said Michael Johnson, managing partner at Gurtin Fixed Income Management, told Bloomberg. “I could see some investors deciding they’ll sell anything that looks like this.”

The increased trading in these college bonds reflects anxiety in the municipal market and the larger question looming over the future of higher education.

The debate over the future of small colleges has been ramping up over the past few years, with Mark Cuban as a vocal participant in the conversation warning of a “student loan bubble.” After Sweet Briar’s announcement, Cuban tweeted: “This is just the beginning of the college implosion.”

Cuban points to the rising cost of college tuition, and the ability of students to take out loans in excess of what they can reasonably be expected to repay.

“There’s a growing education bubble, with rising tuition and students taking out loans they might not be able to pay back,” Cuban told Business Insider in March.

BUSINESS INSIDER

ABBY JACKSON

APR. 20, 2015

(Reuters) – A planned $300 million sale by the Chicago Board of Education next week will test the municipal bond market’s appetite for the board’s debt in the wake of recent rating downgrades, a federal probe and unresolved financial problems.

The sale comes as issuance in the market is slated to reach $9.3 billion next week, including notes, its highest since the end of March as the amount of new bonds coming to market this year continues to exceed previous years.

The Chicago Board of Education is planning to sell $296.6 million of general obligation bonds on Tuesday through PNC Capital Markets. The board has been beset by problems in recent weeks, pushing out the spreads on the bond.

Illinois Governor Bruce Rauner reportedly said earlier this week that the nation’s third-largest public school system could be headed to bankruptcy, although such a move is not currently allowed under state law.

Some of the board’s bonds traded on Thursday at as much as 254 basis points over Municipal Market Data’s benchmark triple-A yield scale.

Last month both Moody’s Investors Service and Fitch Ratings dropped their ratings to one notch above the junk level, citing the Chicago Public Schools’ $1.1 billion projected budget deficit and big unfunded pension liability. The downgrades triggered the termination of interest-rate hedges on variable-rate debt that unless renegotiated could cost the district about $228 million in payments to banks.

A recent sale by the board of $178.1 million of variable-rate general obligation refunding bonds due in 2032 resulted in an eye-popping, two-year initial rate of 4 percent over the SIFMA Index. Just two years ago, the board’s bonds were priced at only 75 basis points and 83 basis points over the index.

Next week will see a plethora of small deals. The largest negotiated deal is a $887.9 million sale by Energy Northwest, which is refunding taxable revenue bonds through JP Morgan Chase for its nuclear power plant, the Columbia Generating Station, in Richland, Washington.

The state of California will sell a total of $1.1 billion of taxable and tax exempt general obligations bonds in three competitive deals next week.

Next weeks sales will bring the year-to-date issuance to over $136 billion, 70 percent higher than the same period last year. New issuance in the first quarter of the year represented the strongest start to the year since the first quarter of 2010.

NEW YORK, APRIL 17

(Reporting by Edward Krudy; Additional reporting by Karen Pierog; Editing by Chizu Nomiyama)

The dangers of underfunded pensions continue to loom over many cities, and budgets and economic development rank at the top of the list of things that keep mayors up at night. In a survey of municipal finance officers last fall, 80 percent said cities were “better able” to meet financial needs last year, but despite this, revenue was projected to remain flat for 2014.

According to the National League of Cities, states may be keeping their cities from bouncing back from the recession. The League’s new report, “Cities and States Fiscal Structures,” found that no state has expanded the fiscal authority of its cities since the start of the recession.

The report compares municipal fiscal systems in 50 states by looking at taxing authority, revenue reliance and capacity, state aid, and tax and expenditure limits.

“The … report supports the fact that cities and towns need more fiscal autonomy to balance their budgets, create economic growth and meet their communities’ needs,” Clarence E. Anthony, CEO and president of the National League of Cities, said in a statement.

Idaho, Maine, Massachusetts, New Jersey and Rhode Island are among the states classified as “behind the pack” in the study, while Alabama, Missouri, New York and Pennsylvania give municipalities more authority, thus putting them in the “ahead of the pack” category.

According to the study:

City finances have been slow to recover from the recession in part because of continued constraints from states on cities’ ability to raise revenues. hinder cities’ fiscal autonomy by providing limited access to tax sources, placing caps on tax revenue and cutting aid.

With taxing power, cities continue to demonstrate creative and effective approaches to growth — from Chicago’s upcoming polka-dotted intersection makeover to Houston’s successful tax credit program to spur downtown development.

NEXTCITY.ORG

BY JENN STANLEY | APRIL 17, 2015

In this week’s Extra Credit, Standard & Poor’s Senior Director Lisa Schroeer reviews this week’s rating actions and Senior Director Matthew Reining explains the rationale behind our rating action on Phoenix Civic Improvement Corp. of Arizona’s subordinated excise tax bonds.

Listen to the Podcast.

Apr 16, 2015

Read the Brief.

Municipal Market Analytics | Apr. 14

For years, if residents of Rocklin, Calif., near Sacramento, wanted to review the city’s budget priorities or see how those priorities linked to revenue and spending, they had to sort through numerous PDFs. While the financial information was useful, it wasn’t very user-friendly. And that didn’t satisfy city leaders who prided themselves on Rocklin’s long tradition of transparency, according to Kim Sarkovich, Rocklin’s chief financial officer and assistant city manager.

But when a city posts its financial data in a format that’s easy to find, read and understand, the payoff can be huge. That has certainly been the case with New York City’s Checkbook NYC. The website, which was launched in 2010, lets residents track how the city spends its money through a very navigable dashboard of charts and tables. New York was not the first city to make its financial information so readily available and transparent, but the Sunlight Foundation says it’s “one of the best examples of an open checkbook-style website that we’ve found.”

As a growing number of cities have embraced the financial transparency trend and started creating their own versions of open checkbooks, they’ve either gone the route laid down by New York, using open-source software to develop their own dashboards of fiscal information, or have turned to third parties. These outside companies help with the task of transforming tabular data that often resides in proprietary software programs into the kind that can be viewed, visualized and, in some cases, republished for other purposes.

The U.S. Public Interest Research Group found in 2013 that 17 of America’s 30 largest cities had some kind of online database of expenditures. But just two cities, Chicago and New York, were considered true models of public accessibility, according to the group. Some of the problems with the other fiscal websites, included poor usability, search issues, spotty information on spending, and a lack of information on which companies and nonprofits receive taxpayer funds.

Two years ago, Rocklin launched its own checkbook-style website. Sarkovich, who has been in city government for 23 years, says interest in financial data has ebbed and flowed over the years. But today’s online tools have made financial viewing much more interesting and understandable. For example, she says, when a Walmart store opened in Rocklin many people expected the city’s revenue to jump from the store’s property taxes. “I was able to show them on the website why that wasn’t the case,” says Sarkovich. With the same financial transparency, she was able to show neighborhoods clamoring for a new park just how much it would cost. “They could see how it would affect our revenue,” she says.

The ease of use explains the growing popularity of companies like Socrata and OpenGov, which have built public financial websites for more than 250 governments, including Rocklin, in just three years. “The technology is easy to install and everyone gets very excited when they see the charts,” says Zac Bookman, CEO of OpenGov.

There are hurdles, however. “I get calls weekly from other cities that want to do what we’re doing, but when I explain the process, some city officials realize the amount of work involved in closing their books in order to display accurate and up-to-date financial information,” says Jason Johnson, Rocklin’s budget and technology manager.

In addition to the initial work, there are upfront costs. Rocklin currently pays $1,800 a year to display its annual financial data, but will begin spending $3,600 when it starts updating financial data on a monthly basis. Larger cities spend more: New York spent $7 million developing Checkbook NYC.

Financial transparency, in the view of advocacy groups like the Sunlight Foundation, is fundamental to democracy. City officials agree, although they see it in more practical terms. “These dashboards,” says Sarkovich, “allow citizens to better understand the mechanics of how city government works.”

Governing.com

Tod Newcombe Tod Newcombe | Senior Editor

APRIL 16, 2015

A lot more municipal bonds are coming to market this year than last, judging by the latest quarterly figures on requests for new CUSIP numbers gathered by S&P Capital IQ. CUSIP stands for the Committee on Uniform Securities Identification Procedures, which issues nine character codes used to identify stocks and bonds.

Municipal bond CUSIP orders jumped by 51% in the first quarter of 2015 to 3,689 requests from 2,446 in the same period in 2014.

In March alone, there were 1,438 request — the most monthly orders since May 2013 when 1,569 CUSIPs were ordered.

“It’s a positive indicator for the public finance arena,” says Richard Peterson, senior director at S&P Capital IQ.

Last year was a down year in overall CUSIP requests for munis. In 2014 there were 12,749 orders down from 13,152 in 2013. If 2015 stays at its current pace, it would easily top that number.

Texas had the most orders for municipal debt CUSIPs, with 460 in the first quarter. That was a 44% increase from 321 orders in 2014.

Barron’s

By Amey Stone

April 17, 2015

Almost two decades after U.S. states settled with tobacco companies on payments for health-care costs, officials are still finding new ways to tap the revenue stream to close budget gaps and fund programs.

Bond deals in the past 14 months from New Jersey and Rhode Island, and a planned offer from Louisiana, show how cash-strapped states are getting creative in using the dwindling money flowing from the 1998 accord. Yet the moves are drawing criticism from holders of older debt and officials who view the deals as budget gimmickry.

OppenheimerFunds Inc. sued Rhode Island, claiming it was diverting money from earlier bondholders. In New Jersey, Democratic lawmakers said the state’s move to pledge tobacco revenue to investors in exchange for almost $92 million was a budget stunt. Louisiana’s plan for more debt backed by cigarette cash is “an act of desperation,” according to its treasurer.

“You’re seeing aggressiveness here because it’s almost like there’s no downside for the state to do this,” said Paul Ricotta, a partner in Boston at law firm Mintz Levin who specializes in distressed debt and restructuring. “It’s a really painless way for politicians to get more cash.”

Tobacco Tradeoff

In the settlement, Lorillard Inc., Philip Morris USA and Reynolds American Inc. agreed to make annual payments to states in perpetuity to settle liabilities for health-care costs tied to smoking. States and cities have about $94 billion of securities backed by the revenue, data compiled by Bloomberg show.

The sales gave officials cash upfront and let them offload the risk that the money would dry up as smoking rates drop. Most of the bonds get junk grades.

New Jersey, which sold about $7 billion of tobacco bonds from 2002 to 2007, adopted a new approach in March last year. Grappling with a budget shortfall, the state pledged its remaining settlement payments from 2017 through 2023 to some debt due in 2041. In return, it got $91.6 million for expenses.

The bonds rallied to an average of 24 cents on the dollar by the end of March 2014, from 9 cents the previous three months, Bloomberg data show, as investors bet the debt will be repaid on time. Standard & Poor’s raised it 10 steps to A-, seventh-highest, after the agreement.

Paved Way

“New Jersey kind of paved the way for other people to say there are ways to look at restructuring outstanding bonds,” said Kym Arnone, a managing director who heads tobacco securitization in New York at Barclays Plc, which handled the deal.

Rhode Island’s tobacco-bond offer last month showed the risk perceived by investors. OppenheimerFunds questioned the deal, partly because the state, which projected a $190 million deficit for next fiscal year, received $30 million of the proceeds. A judge ruled in January that the issuer was within its rights to adjust the payments.

The money manager said in a statement that its lawsuit “increased value over the originally proposed bond sale.”

Kimberly Weinrick, an OppenheimerFunds spokeswoman, declined to comment further.

Rhode Island tobacco bonds maturing in June 2025 priced to yield 2.99 percent, about 0.8 percentage point more than benchmark munis, in line with similarly rated debt.

Risk Seeking

Investors have sought tobacco bonds as interest rates in the $3.6 trillion municipal market hover close to five-decade lows. Junk-rated tobacco securities rallied 11.5 percent in the past 12 months, compared with 5.9 percent for all munis, Barclays data show.

“States that securitized portions or all of their Master Settlement Agreement payments in the past are looking at their outstanding debt portfolio and seeing if they can take advantage of the current low rates,” said Thomas Green, head of infrastructure finance in Citigroup Inc.’s public-finance unit. The bank led underwriters on Rhode Island’s sale.

Louisiana may be next. Its tobacco agency has used 60 percent of its revenue stream to back bonds, said Kristy Nichols, the commissioner of administration. It’s seeking approval to use the remainder for a deal as large as $875 million to fund scholarships and coastal restoration, she said. Citigroup would lead underwriters.

Money Grab

“Market rates are good, the spreads are good, and tobacco revenue overall has some risks,” Nichols said. The state would consider the deal if it can use the proceeds over seven or eight years, instead of in one shot, she said.

John Neely Kennedy, Louisiana’s treasurer, said in an interview that he worries the estimated $1.6 billion deficit for the year starting July 1 will pressure officials to use the funds as a one-time plug.

“They’re trying to rush this through so they can get their hands on the money to spend it,” Kennedy said. “The administration can’t give any assurance beyond their word that they won’t dump the money into their operating account.”

Louisiana last issued tobacco debt in 2013 for refinancing. With investment grades from S&P and Fitch Ratings, the securities differ from those that Moody’s Investors Service projects will default, including bonds from Ohio and Virginia.

In the seven years through 2006, cigarette shipments fell 1.7 percent annually on average, National Association of Attorneys General data show. The pace of declines almost tripled in the following seven years. At a 4 percent annual decline, four of five bonds would default, according to Moody’s.

Bondholders want to be paid on time. States want to make the most of tobacco funds. That’s why they’ll come to an agreement, Arnone said.

“Absent an additional infusion, restructuring or inflation igniting in the future, some of these outstanding bonds are not going to be able to withstand the huge smoking declines that have occurred,” she said. “People are going to be looking at alternatives to refinance more tobacco bonds.”

Bloomberg

by Brian Chappatta

April 12, 2015

From a white ranch house in the Florida Panhandle, Ed Gray presides over a municipal-bond money machine.
The former mayor of the city of Gulf Breeze has turned the riskiest segment of the municipal-bond market into a boon for the Pensacola suburb, which has built recreation centers and boosted reserves with $11 million in fees charged on bond sales and loans since 2002. The payments also benefited Gray: He was paid $3.8 million to arrange the deals.

Capital Trust Agency, a unit set up by the city in 1999 and run by Gray, has issued more than $1.5 billion in tax-exempt debt for apartment complexes and assisted-living facilities around Florida, private jet facilities in Texas and Mississippi, and Hard Rock hotels for the Seminole Indian tribe.

Called conduits, public agencies like Capital Trust operate in a little-regulated corner of the $3.6 trillion municipal market. They issue bonds for private companies and nonprofit organizations that would otherwise lack access to tax-exempt borrowing. Local taxpayers benefit from the fees without being on the hook to repay the bonds, which are often used for risky real-estate projects.

“You have local debt being issued without adequate oversight,” said Christopher “Kit” Taylor, former executive director of the Municipal Securities Rulemaking Board, the industry’s regulator. “The state should never be permitting this sort of thing.”

More Defaults

Conduit bonds make up as much as 30 percent of the market but account for almost 60 percent of defaults, according to Matt Fabian, a partner at Concord, Massachusetts-based Municipal Market Analytics. The U.S. Securities & Exchange Commission in 2012, noting the default rate, sought to require conduit borrowers to disclose more about their finances. The proposal failed to advance in Congress.

All 50 states have conduit issuers, according to the Columbus, Ohio-based Council of Development Finance Agencies, a trade group. Florida is one of seven that allow some conduits to issue debt for out-of-state projects, according to the CDFA.

In December, Phoenix’s Industrial Development Authority sold $107.4 million in tax-exempt bonds for school facilities in Guam, more than 6,000 miles (9,700 kilometers) away. The Phoenix agency received $101,177, which will go toward small-business and community-lending programs, according to Lydia Lee, an administrator. The bonds were rated B+, four levels below investment grade.

IRS Cap

Under Internal Revenue Service regulations, private entities can issue tax-exempt bonds as long as they meet public purposes. The federal government sets a limit on the amount of tax-exempt debt issued on behalf of private entities, giving each state an allocation based on population. This year, the total cap is $35.2 billion, according to the Bond Buyer.

Investors are aware that debt issued by conduits carries more risk than bonds backed by the taxing power of state and local governments, and the securities are priced accordingly, said Jason Rittenberg, director of research at the CDFA. Deals are vetted by lawyers to ensure that they comply with IRS rules, and by banks underwriting the bonds, he said.

“It’s a different borrower class,” Rittenberg said. “These deals are required to be sold to investors aware of how the market operates.”

Gulf Breeze Story

Gulf Breeze sits on a land spit that juts into Pensacola Bay, 680 miles northwest of Miami. The affluent suburb of 5,800 is known for its beaches, including the Gulf Islands National Seashore.

The City Council created the Capital Trust Agency with the town of Century, under a Florida statute that allows two or more counties or municipalities to jointly issue debt.

The city hired Gray’s firm, Municipal Advisory Services, to run Capital Trust, which has two other employees in the city-owned ranch house, an analyst and administrative assistant. Mayor Matt Dannheisser, who was then city attorney, was its lawyer, and the city manager worked as a paid consultant.

Capital Trust attracted borrowers by charging lower fees than other conduits and by being more efficient, Dannheisser said. The agency also issued bonds for air-cargo facilities and charter schools.

Since 2002, Capital Trust and another financing arm, Gulf Breeze Financial Services, contributed an average of $850,000 annually to the city budget, equal to about 50 percent of annual property-tax collections. A developer contributed $500,000 from the sale of an apartment complex whose purchase was financed by Capital Trust to scholarships for low-income students in the Pensacola area.

IRS Scrutiny

About $81 million of debt issued through the agency, about 5 percent, has defaulted, according to data compiled by Bloomberg. The rating on an additional $50 million of bonds issued for Million Air Inc., a Houston-based jetport operator, was cut in December to B3, six levels below investment grade, by Moody’s Investors Service. Investors may declare the bonds in default, the rating company said.

In 2010, officials in Lauderhill, Florida, declared unsafe for residents a 352-unit apartment complex whose purchase was financed by Capital Trust, according to the Florida Sun-Sentinel. Another property in Tampa had “numerous” fire code violations, according to the Tampa Tribune.

Capital Trust deals have also drawn scrutiny from the IRS, which looks into whether the tax exemption is being misused. In 2007, Capital Trust settled an IRS audit of $410 million of bonds sold from 2002 through 2004 to finance Hard Rock hotels at two Seminole casinos.

The IRS said the bonds shouldn’t have been tax-exempt because the hotel and convention center weren’t used “in the exercise of an essential governmental function.” Capital Trust paid $100,000 to settle the case while others in the deal, who weren’t identified, paid $10 million, according to a Capital Trust financial statement.

Gary Bitner, a spokesman for the Seminoles, said he couldn’t immediately respond to what amount, if any, the tribe paid to the IRS.

Stopped Payments

In 2004, Capital Trust settled with the IRS over a $220 million bond issued to refurbish derelict apartments, which produced $12 million in fees for banks and advisers even though the proceeds were never spent.

“Examinations by the IRS of selected project financings have never resulted in the bonds being declared taxable,” Gray said in an e-mail. “We have always cooperated with regulatory agencies in concert with the borrowers to properly answer inquiries and reach satisfactory settlement on any tax questions raised.”

Last year, city officials discovered that in 2006 Gray had stopped making required annual reimbursements to the city. Gray, 63, who was elected mayor in 1984 and retired in 1992, said it was an oversight and repaid $122,250.

The lapse led Gulf Breeze officials to bring in an outside auditor to review his compensation. Based on the auditor’s interpretation of his contracts, Gray’s pay since October 2002 should have been $500,000 less.

Incentive-Based

“I’ve been quite satisfied with compensation,” Gray said in a telephone interview. “The contract is incentive-based. I didn’t get paid if we didn’t have success.”

He said the auditor misinterpreted contract language. City management and Capital Trust’s board always approved his pay, he said. Dannheisser, the mayor, declined to comment on whether Gray was overpaid, citing Florida rules regulating attorneys.

Dannheisser made about $627,000 serving as counsel on Capital Trust deals from 1999 through 2014, according to bond-closing documents obtained under a public-records request.

The city last week approved a new contract for Gray, though it lowered his pay.

Joseph Henderson, the mayor pro tem, hasn’t been able to assemble a majority of council members to recoup money from Gray.

“Sometimes we think there are individuals within this city that are too big to fail, and that’s unfortunate,” Henderson said.

Bloomberg

by Martin Z Braun

April 14, 2015

Taylor Riggs, an editor at Bloomberg Brief, talks with Joe Mysak about this week’s municipal market news.

Watch the Video.

April 16, 2015

The much-maligned bond-insurance industry has one thing going for it: The insurers pay up most of the time.

That’s the conclusion of a new report, planned to be released Thursday, from Kroll Bond Rating Agency. Analysts at Kroll identified 29 cases of insured municipal-bond defaults from 2008 to the present, and said the insurers are paying investors in full and on time in 26 of those cases.

In only three instances, certain bond insurers missed payments or did not pay in full. But those instances are high-profile cases, including Detroit, Jefferson County, Ala., and a struggling monorail system in Las Vegas.

“We believe that these defaults, because they were so highly publicized, have overshadowed a generally favorable record on muni bonds by the guarantors,” said Karen Daly, senior managing director at Kroll, in an interview.

Before the financial crisis, roughly 50 percent of new municipal bonds carried bond insurance, allowing issuers to get lower interest rates because the insurers had high credit ratings. That figure fell precipitously, however, as the insurers faced losses on mortgage-backed securities during the crisis and were downgraded by credit rating firms.

About 6% of new municipal bonds carried insurance last year, according to Thomson Reuters data. Some investors have said that whether a bond carries insurance factors little into their investment decisions.

The Kroll report, however, indicates that bond insurance has value. The firm gives ratings to two affiliates of Assured Guaranty Ltd.AGO -0.61%, as well as National Public Finance Guarantee Corp., a subsidiary of MBIA Inc.MBI -2.05% All are rated double-A-plus, the second highest grade.

“What we’re trying to explain to the markets is that the record of bond insurers paying municipal claims is in fact better than perception,” Ms. Daly said.

In its report, Kroll defined a default as an instance where an issuer missed a principal or interest payment, and did not include draws on reserve funds or breaches of certain financial covenants.

Kroll said “partial payment” was made by Financial Guaranty Insurance Co., or FGIC, and Syncora Guarantee Inc. in Jefferson County, by FGIC in Detroit and by Ambac Assurance Corp. in connection with the Las Vegas monorail project. Other insurers, however, made full payments in the Detroit and Jefferson County situations.

THE WALL STREET JOURNAL

By MIKE CHERNEY

Apr 16, 2015

WASHINGTON—In a change of heart, the Federal Reserve will allow big U.S. banks to use some municipal bonds to meet new rules aimed at ensuring they have enough cash during a financial-market meltdown, according to people familiar with the matter.

The Fed and two other bank regulators had excluded debt issued by cities and states when approving liquidity rules in September, part of their post-2008 efforts to fortify banks against market turmoil.

But the Fed’s decision is only a partial victory for the banks, state officials and lawmakers who had pushed for the change. The other two regulators, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp., currently don’t plan to follow the Fed, people with knowledge of those agencies said.

At issue is the treatment of municipal debt under the new liquidity requirements, which call for large banks to hold enough “high-quality liquid assets” to fund their operations for 30 days. The Fed plans to issue a proposal to let some municipal bonds qualify as safe assets.

OCC officials have indicated they aren’t convinced municipal bonds can be traded easily enough to be included in the rule. The FDIC’s position is unclear, but its portion of the rule affects only a few banks.

The change being crafted by the Fed has been sought by big banks such as Citigroup Inc. and Wells Fargo & Co., as well as state and local officials and top lawmakers in Congress including Sen. Charles Schumer (D., N.Y.). They warned that excluding all municipal-debt securities from the liquidity rules could eventually prompt banks to retreat from the $3.7 trillion market and force governments to scale back spending on roads, schools and other infrastructure projects financed with the bonds.

Those arguments largely fell on deaf ears at the OCC, where officials are privately dismissive of including the bonds in the rule, according to people familiar with the conversations. Representatives for the OCC and the FDIC declined to comment.

FDIC Chairman Martin Gruenberg at a September Senate hearing expressed some openness to considering including certain munis “based on supporting research or thoughts from the Fed,” he told Mr. Schumer.

Michael Decker, a managing director at the Securities Industry and Financial Markets Association, a Wall Street trade group, said it welcomes any action to recognize “the inherent liquidity of municipal securities as bank investments.”

Spokesman for Citigroup and Wells Fargo declined to comment.

Fed officials have long expressed more willingness to consider adding munis to the new rules. Fed governor Daniel Tarullo, at the same September Senate hearing, said he expected the central bank to reconsider the issue in response to evidence that some state and local debt is frequently traded and may be “comparable to that of the very liquid corporate bonds” that qualify as high-quality liquid assets.

The plan under discussion falls short of including all investment-grade municipal bonds, for which states and banks had pushed. The exact criteria for which kinds of municipal bonds would count under the rule hasn’t been set. A key focus of the criteria will be the ability of a bank to sell the bonds in a fairly short time frame, according to one of the people.

In addition, the bonds are expected to be treated on par with investment-grade corporate debt, meaning banks would only be able to count 50% of their face value when counting them as part of their funding buffers. Municipal officials and banks had pushed for an 85% credit.

The market for municipal debt is vast, with roughly 60,000 borrowers and 1.2 million individual bonds. Only a relatively small number of the bonds—from large states and cities such as California and New York—are frequently traded, according to industry experts. That is partly because the features of the market, including the tax-exempt status of most securities, encourage most investors to hold their bonds until maturity.

Banks underwrite bonds on behalf of states and localities, and also buy the securities as investments and to sell to their clients. They play an increasingly important role in the market, with banks having nearly doubled their ownership of municipal securities over the past decade, to more than 12% of the total amount outstanding, according to Fed data.

The full impact of just the Fed making such a change is unclear. The Fed’s version of the liquidity rule applies to bank holding companies with $250 billion or more in assets. A less-severe version of the requirements applies to bank-holding companies with between $50 billion and $250 billion in assets. For instance, those holding companies need only a 21-day funding buffer. But for some of the largest banks, like Citigroup and Wells Fargo, their national bank units are subject to the OCC’s rule, which would still exclude munis.

Smaller banks in the $50 billion to $250 billion asset range would be in the clear under the Fed’s contemplated change, however, because only the Fed’s rule applies to them.

To date, banks have by and large continued to hold lots of municipal bonds despite their exclusion from the rule, in part because they are seen as less risky than corporate debt and are priced competitively to other types of debt, according to officials at two large banks. If interest rates rise this year, they expect banks to begin to pare their holdings.

Some lawmakers aren’t waiting for the regulators to act. Rep. Luke Messer (R., Indiana) is preparing to introduce legislation as early as next week requiring regulators to alter the rule to include municipal bonds.

THE WALL STREET JOURNAL

By ANDREW ACKERMAN And VICTORIA MCGRANE

April 16, 2015 8:56 p.m. ET

Write to Andrew Ackerman at [email protected] and Victoria McGrane at [email protected]

(Reuters) – The U.S. Federal Reserve may allow big banks to use some municipal bonds to meet new liquidity rules that ensure they have enough cash during a credit crunch, the Wall Street Journal reported, citing people familiar with the matter.

The Fed had excluded debt issued by cities and states when it approved liquidity rules for large banks in September, part of a global effort to make banks such as JPMorgan Chase and Citigroup more resilient in a financial crisis.

Fed officials had at that time said they did not think the rule would have significant implications for the $3.7 trillion municipal bond market. The Fed had also said it planned to propose allowing certain high-liquid municipal securities to count as a sellable asset at a later date, after further review.

U.S. cities and states have been urging the Fed, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) to classify muni bonds as highly liquid if they are investment grade and have demonstrated reliable liquidity during times of economic stress.

However, the plan under discussion falls short of including all investment-grade municipal bonds, the Journal said.

The exact criteria for the kind of municipal bonds that would count under the rule has not been set, but a key focus will be the ability of a bank to sell the bonds in a fairly short time frame, the newspaper said.

The other regulators – the OCC and the FDIC, do not plan to follow the Fed, the newspaper said.

Reuters could not immediately reach the regulators for comment outside regular U.S. business hours.

The U.S. municipal bond market grew to $3.652 trillion during the fourth quarter, with banks picking up $41.1 billion, up from the prior quarter’s $34.5 billion, according to data released by the Fed in March.

By REUTERS
APRIL 17, 2015, 12:04 A.M. E.D.T.

(Reporting by Supriya Kurane in Bengaluru; Editing by Anupama Dwivedi)

A shortage of high-quality bonds is disrupting the $2.6 trillion U.S. repurchase agreement market, the Wall Street Journal reports. These short-term loans, also known as repos, provide liquidity in the financial system, and the shortages “are amplifying price swings in government bonds and related debt markets at a time when many investors are reshuffling their portfolios around new interest-rate expectations, following a period of low volatility.” The impact has been manageable, according to traders quoted in the article, but “the broad concern is that scarcity in repos will pressure rates and could complicate efforts by the Federal Reserve to lift interest rates when the time comes.”

The GFOA best practice, Monitoring the Value of Securities in Repurchase Agreements, points out that an important factor in managing the risk of default in repurchase transactions is the valuation of the purchased securities. For the term of the repo agreement, it is common practice for the counterparty to deliver purchased securities to the investor in a total value amount (market value plus accrued interest) that is equal to the investor’s investment plus a margin percentage. The margin percentage, typically 102% for Treasury and GSE securities, protects the investor from a decline in the price of the purchased securities during the time the repo transaction is in effect. The value of the securities must be monitored frequently to insure the market value remains at least equal to the invested amount plus margin percentage in case of default of the counterparty. If the value of the purchased securities falls below the invested amount plus margin percentage, then the counterparty is required to deliver additional securities to the investor upon their request. The frequency of the valuation depends on several factors:

• The maturity of the purchased securities, since longer maturities have greater price volatility;
• The security types, since certain securities have greater price volatility;
• Market volatility; and,
• The margin percentage that is required by the investor; the lower the margin percentage, the more frequent the valuation of the purchased securities.

Because the investor may need to liquidate the purchased securities in the secondary market in the event the counterparty defaults on the repurchase agreement transaction, GFOA recommends that government entities establish a policy and procedure for monitoring the value of the purchased securities in a repo transaction to insure that it does not drop below the value of the repo investment plus any required margin percentage. For maximum protection, government entities should value the purchased securities in their repo transactions to their current market price evert dat. At a minimum, the purchased securities should be valued weekly, whenever there is a major increase in rates or market volatility is high; or whenever a coupon and/or principal payment on the purchased securities is wired back to the counterparty.

For more information on repos, see the GFOA best practice, Establishing a Policy for Repurchase Agreements, which defines the kinds of repos, outlines the benefits and risks of using them, and suggests strategies for mitigating the risk.

GFOA

Tuesday, April 14, 2015

Community banks are getting an unexpected shot to compete against Wall Street firms in the area of municipal finance.

Local governments have historically relied on selling bonds to finance operations. The process is cumbersome, but is typically cheaper than borrowing from a bank, even after accounting for legal and underwriting costs.

Low interest rates, combined with rising costs of taking bond issues public, are making traditional loans a more tempting option for many local governments. As a result, smaller banks, many of which already hold municipal deposits, are seizing on an opportunity to bulk up the other side of the balance sheet.

Loans have become “competitive with interest rates obtainable in the capital markets,” said Daniel Malpezzi, a lawyer at McNees, Wallace and Nurick in Harrisburg, Pa., adding that an increasingly large segment of local government borrowing has moved away from the bond market.

Banks are eager to take the new business, given the sterling performance of most municipal loans. Banks that have made a business providing deposit and treasury management services to municipalities have proven to be especially well-placed to reap a windfall, though plenty of others seem to be lining up to get in on the game.

Robin Russell, a lawyer at Andrews Kurth in Houston, is set to give a webinar this week on lending to municipalities. Through last Thursday, 36 banks had signed up for the session, which is sponsored by the Texas Bankers Association. While that number might not seem overly impressive, it is up from 11 participants in last year’s webinar, Russell said.

“That tells me there’s interest,” Russell said.

Despite bankers’ complaints, the long stretch of artificially low interest rates has been crucial to the growth of bank lending to local governments, municipal finance experts said.

Municipal lending has been growing steadily in Texas the past five years, Russell said, linking the surge directly to low rates. “With tax-affected interest rates on commercial debt at all-time lows, the rate on low-risk tax-free municipal obligations is competitive and attractive to investors and lenders,” she said.

Comprehensive statistics on banks’ municipal lending are difficult to obtain. Local governments, which are required to make bond issues public, are not required to disclose bank loans.

Individual banks do not always break out their lending to local governments, though the Federal Deposit Insurance Corp. keeps an industry-wide account of loans to “states and political subdivisions in the U.S.” Its numbers indicate a steady increase in municipal lending, rising from $66.5 billion in 2010 to $131.4 billion last year.

A quick check of local governments in northern Virginia showed that at least two jurisdictions used bank loans in recent years. In its Comprehensive Annual Financial Report for fiscal 2014, Fairfax County reported borrowing $25 million from TD Bank in December 2013 to refurbish county-owned buildings. Similarly, in its fiscal 2014 report, the neighboring city of Alexandria reported an $18.7 bank loan.

Such loans present an opportunity for banks to deepen ties to local governments, though banks that were already major players have chalked up the greatest gains.

At Carter Bank and Trust in Martinsville, Va., municipal lending jumped 25% in 2014 from a year earlier, to $332 million. Century Bancorp in Somerville, Mass., had nearly $41 million in municipal loans at Dec. 31; it didn’t report any municipal loans as late at 2011.

Huntington Bancshares in Columbus, Ohio, has a specialty lending unit, Huntington Public Capital, to focus exclusively on government lending. The yields might not be as high as loans to private-sector businesses, but there are few, if any, problems with the loans, Dave Schamer, the $66 billion-asset company’s managing director of government banking, said.

Because of their strong performance, “we don’t have to set aside as much capital” for government loans, Schamer said. “Our book is very clean. I can’t remember the last problem. … We love the space.”

Huntington, which has been lending money to local governments in its Midwestern footprint for decades, “double downed” in the space at a time other banks were abandoning it, Schamer said. “We see it as an opportunity to show our commitment to the communities we serve,” he said, adding that public finance “is knitted into the fabric of who Huntington is.”

Barry Sloane, $3.6 billion-asset Century’s president and chief executive, said his bank was the largest municipal banker in Massachusetts, holding deposits for 200 of the commonwealth’s 351 towns and cities. According to the FDIC, Century’s municipal deposits totaled $1.1 billion at the end of 2014, comprising nearly 49% of its $2.3 billion deposit book.

Given such dominance, Century’s entry into local government lending was relatively easy, Sloane said. “In a lot of cases, we just walked across the hall” to a different official’s office, he said.

“We can’t do $40 million [deals], but we can do $5 million,” Sloane said. “We’ll do the little deals, and we’ll consider bigger ones.”

Sterling Bancorp in Montebello, N.Y., is following a path markedly similar to Century’s, taking its municipal lending from zero in 2011 to $33 million on Dec. 31, according to FDIC data. The $7.4 billion-asset company is looking to accelerate that growth, hiring a team of five veteran government lenders last month.

“We feel strongly that the sizable public finance market presents a significant opportunity for growth,” Jim Peoples, Sterling’s chief banking officer, said in a release announcing the newly hired bankers.

AMERICAN BANKER

by JOHN REOSTI

APR 13, 2015 3:14pm ET

The New York City comptroller, Scott Stringer, went public last week with news that some financial reporters found blindingly obvious, but still should get the rest of the public steaming mad. It is that billions of dollars have been leaking out of the city’s five public-employee pension funds, in payment for Wall Street money management that wasn’t worth it.

Mr. Stringer’s office did an analysis of the funds over the last 10 years, and found that managers’ high fees and failure to reach performance goals had eaten away $2.5 billion of the pension systems’ value. If you take the funds’ gains since 2004, and subtract the fees, the analysis said, you end up basically at zero.

To be more precise: The analysis found that over the 10 years, the managers of “private” asset classes, such as hedge funds and real estate, fell $2.6 billion short of target benchmarks after fees were accounted for. Over the same period, managers of public asset classes, like stocks and bonds, slightly exceeded their benchmarks. “However, those managers gobbled up more than 95 percent of the value added — over $2 billion — leaving almost no extra return for the funds,” Mr. Stringer’s office said.

It’s commonly known that active investment management is expensive, that Wall Street wolves always take their bite, and that they can make bad bets as often as good ones. But it seems fair to ask why it has to be this way with this giant pool of taxpayer money, a pension system of nearly $160 billion that is supposedly run by the best minds the city can find, for the benefit of 715,000 retired cops, firefighters, teachers and others.

Even nonexperts can grasp a primal personal-finance principle: buy low-cost funds linked to the overall performance of the stock market, be patient and don’t try to outsmart the market or pay someone an arm and a leg to do it for you. That a succession of city comptrollers and fund trustees — who, it should be noted, once included Mr. Stringer, a trustee in his old job as Manhattan borough president — would never have thought of this before and found ways to reduce the damage done by excessive fees, is incredible.

Mr. Stringer told The Times that the problem stems from bad decisions and overlooked data. Relevant information about fees lay buried deep in footnotes of financial reports that no previous comptroller’s office had ever bothered to extract or publicize. Which leads the obvious next question: Mr. Stringer announced the bad results, but did not name names or firms behind them. He says he will do so in coming months, as his office does what it says is a tedious, complicated job of dissecting reports and correlating dollars with performance.

He should keep that promise. Transparency and accountability is unusual in the murky world of public pensions, which have seen their share of criminality and abuse. Now that Mr. Stringer has taken up the cause, his next task is to offer ways to better protect taxpayer funds. At the very least, the city should drive a harder bargain with Wall Street, and cultivate in-house investing expertise over high-priced outside management. And it should give city pensioners a clear, honest, easy-to-understand accounting of where the money goes, and to whom.

THE NEW YORK TIMES

By THE EDITORIAL BOARD

APRIL 13, 2015

Citi maintained its position as the top muni underwriter in the first quarter, just beating out Bank of America Merrill Lynch, according to data from Thomson Reuters.

First Quarter Rankings

Citi closed the quarter with a par amount of $12.92 billion in 128 deals, good for 12.5% of the market. BAML earned $12.90 billion in 117 deals, to garner a 12.4% market share. JPMorgan finished third with $12.45 billion in 103 deals for 12% market share. Rounding out the top five were Morgan Stanley and Barclays Capital.

JPMorgan saw improvement year over year, after finishing the first quarter of 2014 with $5.842 billion in 55 deals, for 9.7% of the market.

“We got off to a slow start in 2014, mainly due to the light volumes in the first half,” said Jamison Feheley, head of banking, public finance at J.P. Morgan. “However, we had a big fourth quarter last year and that has carried into 2015. That said, we have benefited from increased new issue volume so far this year. Clients are still being cautious with new money projects, but we’re seeing refinancing business doing very well. Refundings are the primary reason why we’re seeing high volumes, as clients are taking advantage of the lower interest rate environment to achieve savings.”

Morgan Stanley moved up two spots from the first quarter of 2014, while Barclays remained in the fifth spot. RBC Capital Markets fell two spots into the sixth spot this quarter. RBC was involved in more deals than any other company on the list, with 206, just edging out Stifel Nicolaus, which worked on 202 deals this quarter.

Rounding out the top ten are Wells Fargo, Raymond James, Stifel and Piper Jaffray. The gap between number one and number ten is quiet large at roughly $9.39 billion.

PFM Leads Advisors

Public Financial Management ranked first in all financial advisor categories; financial advisor, FA $10 million and under, FA for negotiated deals, FA for competitive deals and FA number of issues. The Philadelphia based firm finished the first quarter advising on 235 sales with a value of $15.28 billion, for a market share of 18.2%.

“It’s always gratifying to retain the leadership position PFM has held for many years,” said John Bonow, chief executive officer and managing director for the PFM Group. “However, we believe that our ongoing dedication to serving the client’s interests with our market and pricing resources is what has enabled PFM to stay here. Governments and non­profits are looking for an advisor they can trust, and we believe they find that at PFM.”

Bonow also said that with interest rates remaining low, many of PFM’s clients have proactively refinanced outstanding debt for savings and when appropriate they have also financed new capital needs.

“PFM helps our clients analyze the range of project funding alternatives without bias, and the economics of the current bond market are often compelling,” said Bonow.

FirstSouthwest finished in second place, advising on 197 sales with a value of $8.58 billion, a market share of 10.3%. Public Resources Advisory Group advised issuers on 32 sales with a value of $6.84 billion, which is good for 8.2% of the market. Swap Financial LLC and Piper Jaffray finished the quarter numbers four and five respectively.

Negotiated Underwriting

JPMorgan vaulted up the rankings in negotiated under writing from year to date. After being fifth with only 6.8% market share and $3.10 billion in par amount in the first quarter of 2014, JPMorgan ranked first in first quartet of this year with $10.52 billion in par amount, good for 12.8% of the market.

“We are very focused in the negotiated market, but also in the competitive market as well,” said Feheley. “The competitive market hasn’t grown as much this year given the market volatility so we’ve seen more issuers taking advantage of the flexibility in the negotiated market.”

Citi dropped from first to second, with $9.91 billion in par amount, for a 12.1% market share. Morgan Stanley also made a significant jump year over year in the negotiated field, jumping from ninth to third. Morgan Stanley finished the quarter with $8.49 billion in par amount, which is good for 10.4% of the market. BAML and Barclays rounded out the top five.

Competitive Underwriting

BAML earned the top spot for competitive underwriting, with a par amount of $4.88 billion and a market share of 22.5%, leaving a wide gap between themselves and the rest of the pack.

Citi finished second with $3.01 billion and 13.9% of the market, Morgan Stanley finished third with $2.38 billion and 11%, JPMorgan was fourth with $1.94 billion and 8.9%. Robert W Baird with $1.92 and 8.8% ranked fifth.

Co­Manager Rankings

Wells Fargo ranked first in the co­manager rankings, in what was a very tight race. Wells finished the first quarter with $3.966 billion of par amount, followed by BAML with $3.760 billion, Raymond James with $3.407 billion, Piper Jaffray with $3.348 billion and Morgan Stanley with $3.290 billion. RBC Capital Markets finished the first quarter with 237 deals, 58 deals ahead of No. 2 Raymond James.

Wells Fargo finished 2014 in the top spot for co­managers; jumping from eighth a year earlier.

$10 Million and Under

Robert W Baird & Co. Inc., ranked first for overall book runners in deals $10 million and under and competitive deals $10 million and under, as they owned 9.1% and 13.5% of the market, respectively, and the most deals with 143 and 77.

RBC Capital Markets lead the way for negotiated deals $10 million and under with 12.2% of the market and 96 deals. Stifel was second with 10.9% and 88 deals.

California Dreaming

Three of the top five issuers in the first quarter of 2015 hail from the state of California. Leading the way is the Regents of the University of California, who had four issues totaling $2.850 billion. Second was the state of California, which had a single del for $1.945 billion. The Michigan Finance Authority finished third, with eight issues totaling $1.725 billion. The Golden State Tobacco Securitization Corp. made its one issue count, as it totaled $1.692 billion. Rounding out the top five was the Texas Transportation Commission, with four issues totaling $1.608 billion.

THE BOND BUYER

by Aaron Weitzman

APR 6, 2015 3:01pm ET

In this week’s Extra Credit, Director Bianca Gaytan-Burrell discusses our request for comment for rating not-for-profit public and private colleges and universities.

Listen to the Podcast.

Apr 09, 2015

Read the Brief.

Municipal Market Analytics | Apr. 6

The U.S. Department of the Treasury’s Community Development Financial Institutions Fund (CDFI Fund) today opened the fiscal year (FY) 2015 application period for the CDFI Bond Guarantee Program. Application materials are available on the CDFI Fund’s website in anticipation of the publication of the Notice of Guarantee Authority (NOGA) in the Federal Register later this week. The NOGA makes up to $750 million in bond guarantee authority available to eligible Community Development Financial Institutions (CDFIs) in FY 2015.

Through the CDFI Bond Guarantee Program, selected certified CDFIs or their designees will issue bonds that are guaranteed by the Federal government and use the bond proceeds to extend capital for community development financing and for long-term community investments. Authorized uses of the loans financed through bond proceeds may include a variety of financial activities, such as supporting commercial facilities that promote revitalization, community stability, and job creation/retention; housing that is principally affordable to low-income people; businesses that provide jobs for low-income people or are owned by low-income people; and community or economic development in low-income and underserved rural areas.

For FY 2015, the Secretary of the Treasury may guarantee bond issues having a minimum size of $100 million each, up to an aggregate total of $750 million. Multiple CDFIs may pool together in a single $100 million bond issuance provided that each eligible CDFI participates at a minimum of $10 million.

New this application round, the CDFI Fund will review Guarantee Applications submitted by Qualified Issuers that propose to use alternative financing structures. The FY 2015 NOGA describes how an Affiliate of a Controlling CDFI may apply for CDFI certification for the sole purpose of participating as an Eligible CDFI in the CDFI Bond Guarantee Program. The NOGA describes each CDFI certification criterion and how it applies to the Affiliate/Controlling CDFI proposal.

Read more.

For years, in the absence of redevelopment, it has been difficult to get infrastructure project proponents, local governments, and investors to agree on much besides this: Since the state’s popular economic development tool was dismantled in 2011, experts have been unsure how California communities were going to make tens of billions of dollars of needed investments in the state’s aging infrastructure.

In a first-of-its-kind meeting last week co-hosted by the Bay Area Council Economic Institute and the California Economic Summit, a group of more than a hundred infrastructure financing professionals discussed just how quickly that may be about to change.

Only a few months after a broad new local authority known as Enhanced Infrastructure Financing Districts became law, there was general consensus among experts that this new tool would provide communities with a robust alternative to redevelopment—one they can begin using right away.

“This is no longer an abstraction; it’s a tool we can use now, one whose principles are being used all around the world,” said Mark Pisano, a senior fellow at USC’s Sol Price School of Public Policy, who also serves as one of the co-leads of the Summit Infrastructure Action Team, a group that helped craft the legislation. Pisano pointed to the $25 billion Crossrail Project in London as an example of a major new infrastructure investment that is using a model akin to an EIFD, with the project managed by multiple jurisdictions and funded with a mix of public, private, and local resources.

Presenters in the meeting explored how a range of California infrastructure projects could also take advantage of this new authority—from the $4 billion extension of BART into Silicon Valley and the $1 billion restoration of the Los Angeles River to major upgrades of the Long Beach Civic Center.

Continue reading.

APRIL 06, 2015 BY JUSTIN EWERS

Fitch Ratings-New York-08 April 2015: The governor’s executive order to reduce California’s water usage will lead to lower revenues for the state’s utilities and could pressure a few ratings, Fitch Ratings says. The order is the latest sign that the current drought and minimal 2014 snowpack have reached a severity that will test drought preparedness and water supply planning statewide. However, widespread downgrades are unlikely, as many California utilities can mitigate this risk by decoupling revenues from sales.

California Governor Jerry Brown signed an executive order last week that aims to cut the state’s overall water usage by 25% from 2013 levels over the coming nine months. Fitch expects water sales to decline by 10% to 15% in fiscal 2015, based on reporting from rated issuers. We expect it to fall further in fiscal 2016 due to the governor’s order. Drought and the mandated conservation requirements will have a negative impact on the revenues of many utilities, though the impact will vary widely.

The impact of the governor’s order on budgets will vary and depend mostly on the way the regulatory framework is implemented. The California Department of Water Resources (which has the mandate) has not generally taken a one-size fits all approach to conservation enforcement. Top-down conservation orders that ignore local supply conditions could force water utilities with stronger supplies to conserve more than they actually need to, reducing the value of investments in supply reliability, storage, water recycling and groundwater management. Fitch believes the state is likely to take a more balanced approach. However, rulemaking is ongoing, and use restrictions could have negative impact on credit quality if they fail to consider local supply conditions as well as local use levels.

The impact on credit quality will depend heavily on utilities’ rate-setting decisions. As utilities generally have the ability to offset revenue losses with rate adjustments and their expenses are generally fixed, California water rates will rise. Some utilities have structural rate design features that smooth revenue declines when water sales drop. The city of Santa Cruz, for instance, has implemented aggressive drought rate structures designed to raise prices and stabilize revenues as sales volumes fall. Others such as the Eastern Municipal Water District in Riverside County have significant fixed meter charges and water budget-based rate structures in which tier sizes can be adjusted to reflect drought stresses and supply availability. Even in the absence of self-stabilizing rate structures, Fitch believes most utilities will raise rates as needed to maintain solid financial performance. Where policymakers hesitate to make necessary adjustments, rating changes could occur.

Contact:

Andrew Ward
Director
U.S. Public Finance
+1 415 732-5617
650 California Street, 4th Floor
San Francisco, CA

Kathryn Masterson
Senior Director
U.S. Public Finance
+1 512 215-3739
111 Congress Avenue
Suite 2010
Austin, TX

Rob Rowan
Senior Director
Fitch Wire
+1 212 908-9159
33 Whitehall Street
New York, NY

Media Relations: Elizabeth Fogerty, New York, Tel: +1 (212) 908 0526, Email: [email protected].

Additional information is available on www.fitchratings.com.

Fitch Ratings-New York-06 April 2015: U.S. Federal Reserve (the Fed) rates are likely to begin to rise in mid 2015 and to tighten gradually, Fitch Ratings says. We expect the average policy rate for 2016 to be 1.6%. However, we created an interest rate shock scenario impact to gauge how faster rate increases and a decline in the economy would impact state, local, and transportation infrastructure issuers. In the interest rate shock scenario, we assumed inflation to peak at 4.5% in 2016, forcing the Fed to raise its annual target sharply to 4.0% in 2016. We also assumed 0% real U.S. GDP growth, unemployment rising steadily to 7.0% in 2016, and the yield on 10-year Treasuries to reach 5.5%.

Under this interest rate shock scenario we would expect most state budgets to weather the interest rate changes. However, the lack of growth and rise in unemployment would trigger declines in income and consumer spending, which would reduce sales tax revenues. In 2014, sales taxes were approximately 28% total state and local tax revenues according to the U.S. Census Bureau. We also believe a spike in interest rates would cause a decline in the stock markets that would reduce capital gains tax collections in wealthier states and reduce state and local employee pension plan assets. Under this interest rate shock scenario, we would expect some level of federal intervention and states could exercise some of their flexibility in funding services.

Since funding is an important source for local governments, tightening state funding without changes to other program funding would be detrimental. However, the largest funding for most local governments is property taxes. Zero growth combined with increases in borrowing costs would likely hurt property values and their associated taxes. Many local governments are still recovering from the funding declines during (and after) the Great Recession. An interest rate shock in 2016 would lead to rating pressures on local governments with fund balances that are still recovering.

The impact on many transportation projects would be felt in declining transportation volumes. Seaport, airport, and road volumes are all tied directly to GDP changes. So, stalling US GDP would have a significant impact. The rise in unemployment would also have a broad impact. The larger international gateway airports would fare better than smaller leisure and secondary hub airports. Import volumes at ports would decline as spending falls. Export volume could also decline if the turbulence in the US economy spread to other economies. The impact of lower toll road volume could be offset by the pricing power many authorities have.

Contact:

Olu Sonola
Senior Director
US Public Finance
+1 212 908-0583

Thomas McCormick
Managing Director
US Public Finance
+1 212 908-0235

Rob Rowan
Senior Director
Fitch Wire
+1 212 908-9159

Media Relations: Elizabeth Fogerty, New York, Tel: +1 (212) 908 0526, Email: [email protected].

Additional information is available on www.fitchratings.com.

Read the comment letter.

Read the discussion.

THE NEW YORK TIMES

APRIL 8, 2015

Investors have embraced bond mutual funds and exchange-traded funds as sound and solid places to keep their money. But that growing popularity rings alarm bells with some regulators, who worry that these same vehicles could become sources of instability in a future market crisis.

The Federal Reserve, in a February report on monetary conditions, suggests that individual investors may have gotten the misleading impression that mutual funds and E.T.F.s trade more readily than the bond markets themselves, and the consequences could be quite serious.

“These funds now hold a much higher fraction of the available stock of relatively less liquid assets — such as high-yield corporate debt, bank loans and international debt — than they did before the financial crisis,” the Fed said in the report. And as the funds expand, they may pose a threat, it said: “Their growth heightens the potential for a forced sale in the underlying markets if some event were to trigger large volumes of redemptions.”

The Fed is essentially asking how smoothly bond E.T.F. shares will trade when markets are in turmoil, as they will surely be one day. It is also concerned that, if people start to panic, traditional fixed-income mutual funds will have trouble raising the cash they need to cover redemptions.

In the report, the Fed didn’t answer its own questions. But it clearly intends to keep monitoring these parts of the market carefully. For one thing, the Fed has raised these issues previously. So has a 2014 report from the International Monetary Fund as well as a 2013 report by the Treasury’s Office of Financial Research.

These concerns have been fueled, in part, by the rapid expansion of bond E.T.F.s, which were introduced only a dozen years ago. By the end of January, they held assets of just over $308 billion, up from $57 billion in 2008. In contrast, fixed-income mutual funds, a fixture of the marketplace for decades, held about $3.5 trillion in assets at the end of January, up from about $3.2 trillion at the end of 2013.

It’s no wonder that mutual funds and E.T.F.s have become so popular: In almost every year since the 2008 financial crisis, bond E.T.F.s and mutual funds have performed well. Average bond E.T.F. returns, for example, hit 9.3 percent in 2009 and stayed strong through 2012, according to Morningstar. They moved slightly into the red in 2013, but rebounded to 4.5 percent last year and gained just over 1 percent in the first quarter of this year. Average bond mutual funds, which gained 17.7 percent in 2009, have trailed E.T.F.s a bit since then; the average bond fund gained 4.4 percent last year, and just under 1 percent in the first quarter.

But although the funds have prospered, regulators are concerned about the nature of the underlying bond market, which is far less liquid and transparent than the robust market for stocks in the United States.

“Bonds are like houses,” said Dave Nadig, chief investment officer at the analytical website ETF.com. Like houses, he said, they are unique, some don’t sell quickly or easily, and reliable price quotes can be hard to come by. By Mr. Nadig’s estimate, there are more than 150,000 individual debt instruments outstanding. Of those, only a few thousand trade as frequently as once a day.

As a result, he said, establishing perfectly accurate market prices for fixed-income securities with the frequency that many retail investors expect is impossible. “How would you propose the market determine a fair price for a Krispy Kreme bond that hasn’t traded in four days?”

Industry pricing services gather estimates of what that Krispy Kreme bond would actually fetch if it were sold. But those values may or may not be obtainable in the real world on a normal day, much less during a panic.

Another worrisome fact of life in today’s bond market is that many large financial institutions, wary of tighter risk standards imposed after 2008, are unwilling to hold a large inventory of bonds. This makes the overall market much less liquid than it was not long ago.

The mutual fund and E.T.F. industry, on the other hand, is worried that regulatory concerns will give rise to wrongheaded regulations that will damage the retail market and deprive investors of popular, useful products.

For example, in a report in late February, the Investment Company Institute, an industry trade group, said that all but 5 percent of the assets in long-term bond mutual funds were held by households, typically in retirement accounts, and that history has shown that “retirement savers don’t flee in hard financial times.”

Moreover, statistics provided by institute economists show that the share of total bond market assets held by these funds is lower than the regulatory worries might suggest.

As of 2014, according to the institute, bond mutual funds, whose assets dwarf those of bond E.T.F.s, owned about 10 percent of the total supply of Treasury and government bonds and 26 percent of the supply of municipal bonds. In the high-yield bond market and some sections of the international bond market, already thinly traded and likely to be more troublesome in a future crisis, mutual funds hold about 22 percent of high-yield bonds and less than 1 percent of international bonds.

Still, one significant problem is that the interaction between the funds and the underlying fixed-income markets can be quite complex. When it comes to E.T.F.s, for example, not even the regulators are in agreement about the liquidity risks they pose.

Academic research is inconclusive, with two Fed studies reaching opposite conclusions. Recently, Michael S. Piwowar, a member of the Securities and Exchange Commission, told a fund industry conference that he thought some regulatory worries about E.T.F.s were “misinformed,” “unsubstantiated” and “overblown.”

IT’S easy to see how even regulators could be fuzzy about how much liquidity there is in the E.T.F. market. The first question they meet is, “Which E.T.F. market?”

That’s because there are actually two markets — the primary market occupied by big institutions, and the secondary market where retail investors trade.

This, briefly, is how it works. In the primary market, only big institutions (called “authorized participants”) can do some important kinds of business with the E.T.F. sponsor. They can redeem shares to get a prorated portion of the fund’s assets, or they can deliver a fresh supply of those assets to the sponsor in exchange for a stack of newly created E.T.F. shares.

Continue reading the main storyContinue reading the main storyContinue reading the main story
“Authorized participants are the linchpin of the E.T.F. ecosystem,” said Ben Johnson, an analyst at Morningstar. “They intervene to create and redeem shares to keep market prices in line with underlying values.”

Imagine, for example, that a bond E.T.F.’s shares trade in the secondary market for $9 but their net asset value — that is, the value of the underlying bonds — is actually $10 a share. In such a case, authorized participants could buy the shares in the secondary market and redeem them in the primary market for full value, pocketing a dollar profit per share. Their purchases in the secondary market would, in time, drive up the price of those discounted shares.

One dilemma noted by Mr. Johnson is that if panic selling were underway for whatever reason, the authorized participants who were expected to buy E.T.F. shares in the secondary market and exchange them for bonds from the underlying portfolio would instantly sell the bonds to lock in their profit. As a consequence, he said, no matter how well the primary market works, it cannot fully insulate the underlying bond market from the impact of panicky secondary-market selling. That has regulators worried.

Investment industry representatives say that the E.T.F. markets have performed well under difficult circumstances. Rochelle Antoniewicz, senior economist with the Investment Company Institute, cites “an ideal test case” that arose in the summer of 2013, when investors feared the Fed would raise rates sooner than expected. Fixed-income E.T.F.s continued to trade smoothly, she said.

Individual investors may not be aware of these issues, though they should be, Mr. Nadig of ETF.com said.

“It is important for investors to understand all of the aspects of liquidity for their E.T.F.s,” he said. They should know what the long-term volume of secondary market trading in their fund’s shares has been, because E.T.F.s with skimpy daily trading volume are especially vulnerable to large price gaps in turbulent times.

Investors also need to understand the risks of holding E.T.F.s that, in turn, invest in less liquid assets like high-yield debt and foreign bonds. No amount of secondary market trading will prevent the E.T.F.s from losing money when the value of that underlying asset falls — and the less liquid the asset, the steeper its decline could be when the market falls.

Finally, investors need to know that the second-by-second prices quoted for their fixed-income E.T.F. shares, and the daily prices reported for their bond mutual funds, typically do not entirely reflect purchases and sales in the underlying bond markets.

Deeper solutions may not be forthcoming soon. Matthew Hougan, the president of ETF.com, who calls himself an “eternal optimist,” said he hoped that today’s regulatory worries about liquidity would “in the end, be refocused on reforming the bond market” to make prices more reliable and trading more visible.

But Mr. Nadig, his ETF.com colleague, said he found that unlikely. Bond prices “ultimately have to be set by market participants,” he said. “If they’re not willing to do that, then no amount of regulatory hand-wringing” can solve the basic liquidity problem.

That problem may not be evident every day. But bond E.T.F. and mutual fund investors may want to remember that, by the time any serious pricing and liquidity problems do arise, it may be too late for them to worry.

THE NEW YORK TIMES

By DIANA B. HENRIQUES

APRIL 11, 2015

Banks led by JPMorgan Chase & Co. and Wells Fargo & Co. are boosting municipal-debt holdings to a record even as regulators say the securities aren’t liquid enough to help during a credit crisis.

U.S. lenders owned $452 billion of munis as of Dec. 31, double their ownership at the end of the recession in June 2009, according to the latest Federal Reserve data. The demand has helped push yields on city and state bonds close to the lowest since the 1960s, reducing financing costs for schools, roads and water systems.

JPMorgan and Wells Fargo have roughly tripled muni holdings since 2009. Banks have reasons to stock up even though regulators decided in September that munis aren’t easy to sell quickly in a cash crunch. The bonds offer higher yields than some alternatives, and banks deem them liquid enough to sell down the road as the economy strengthens and lending picks up. Buying municipalities’ obligations may also foster business relationships.

“They know which cities they should be worried about and which ones they can be comfortable with,” said Marty Mosby, an analyst at Vining Sparks, a broker-dealer in Memphis, Tennessee. “And it provides a liquid asset that they can get in and out of as we have stronger loan demand.”

Lobby Effort

Banks own about 13 percent of munis, making them the third-largest holder after households and mutual funds. U.S. lenders added about $33 billion in 2014, helping drive a 9.8 percent gain last year for the securities. It was the best performance since 2011, Bank of America Merrill Lynch data show.

Issuers and analysts have said the liquidity rule, formulated by the Fed, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency, risks raising borrowing costs in the $3.6 trillion municipal market.

The September measure was among steps regulators introduced to avert a repeat of the 2008 financial crisis. It requires lenders to hold enough assets that are considered high quality – – such as Treasuries and highly rated corporate bonds — to withstand a 30-day squeeze.

JPMorgan, the largest U.S. bank by assets, boosted municipal holdings to $40.6 billion at year-end, up $3.2 billion from a year earlier and almost triple the level in December 2009, bank filings show. Brian Marchiony, a spokesman in New York, declined to comment on the holdings.

Wells Fargo, the most valuable U.S. bank by market capitalization, held about $47 billion as of Dec. 31, more than triple the December 2009 figure.

Ancel Martinez, a spokesman in San Francisco, declined to comment.

Relative Value

Bank of America Corp., the second-biggest lender by assets, increased holdings by $3.6 billion in 2014 to end the year with $9.5 billion, the most since December 2009, bank documents show.

“We don’t comment on our portfolio,” said Jerry Dubrowski, a spokesman in Charlotte, North Carolina.
Banks are buying munis for their relative value, said Alan Schankel, a managing director of fixed-income strategy at Janney Capital Markets in Philadelphia.

Interest rates on 30-year tax-exempt debt have averaged about 0.2 percentage point above Treasuries for the past five years, data compiled by Bloomberg show. Before the recession, investors typically accepted lower yields on munis than Treasuries because of munis’ tax-free interest.

Benchmark munis maturing in three decades yield about 2.9 percent, equivalent to a 4.8 percent taxable yield for top earners. That compares with about 2.55 percent on 30-year Treasuries.

Tax Lift

“A high-quality municipal bond will give them a much better after-tax return than an agency or a Treasury or a high-grade corporate,” Schankel said. “So it’s a compelling argument to include munis.”

U.S. localities can also claim a better track record for repayment than companies. From 1970 to 2013, an average of 0.08 percent of investment-grade munis sold a decade or more earlier defaulted, compared with 2.87 percent for similarly rated company bonds, according to Moody’s Investors Service.

Not all banks are adding. Citigroup Inc. held less than it did at the end of 2009. Mark Costiglio, a spokesman for New York-based Citigroup, declined to comment.

U.S. lenders may curtail buying as consumers’ appetite for borrowing increases, Mosby said.

“If loan demand was to pick up, if it was to get much stronger, then you would see some pullback of the demand that you’ve seen in recent years,” Mosby said.

Purchasing debt from a state or city may also create opportunities to provide banking services, said Joseph Rosenblum, director of muni credit in New York at AllianceBernstein Holding LP, which manages about $32 billion of munis.

“Some of it has to do with enhancing relationships,” Rosenblum said. “So you buy the bond — now you’re the trustee bank, or you’re the depository bank.”

Bloomberg

by Michelle Kaske

April 7, 2015

Municipal Bond Market Monthly

Janney Fixed Income Strategy

April 6, 2015

Municipal Bond Market Credit Analyst Survey – First Annual

• The most important issue/trend facing the municipal bond market is currently Public Pensions
(funding levels, POBs). 86% of municipal credit analysts polled included the category in their
top five, according to our survey results.
• Over half (61%) of analysts surveyed believe state and local government credit quality has
recovered from the Great Recession. But, a total of 39% think they have not recovered in one
form or another: (22%) not recovered, (8%) are undecided and (9%) answered “Not Yet”.
• 57% of analysts polled have a “very” or “somewhat” favorable opinion of ratings from Moody’s
and Fitch. Kroll’s total favorability was only 7%. 66% of analysts surveyed have an unfavorable,
undecided or “do not consider” Kroll ratings.
• We collected responses from 162 municipal bond credit analysts during our survey. Over half of
the replies (63%) were from buy-side analysts. The majority describe themselves as Generalists
(59%) or as analysts who specialize in Tax-Backed (30%) bonds.
• California was upgraded by Fitch; Connecticut’s outlook was lowered by S&P; Louisiana’s outlook
was lowered by S&P; and Puerto Rico was downgraded by all three rating agencies.

Read the Survey.

Public pensions are one of the top issues confronting the municipal bond market, according to the vast majority of credit analysts responding to a survey released on Monday.

The survey asked 162 municipal bond credit analysts to name the five most important issues or trends currently facing the market. Of the respondents, 86 percent included matters related to pensions, such as funding levels and pension obligation bonds, on their top five list.

The second most-noted topic was Puerto Rico, which 50 percent of the analysts included as one of their top five issues or trends. The island commonwealth is currently mired in a debt crisis.

Tom Kozlik, a sell-side municipal credit analyst at the Philadelphia-based financial services firm Janney Montgomery Scott, LLC, conducted the survey.

While he emphasized that he was not speaking for all of the respondents, Kozlik said that, for him, public pensions are a key source of concern.

“It’s 2015, we’re multiple years out of the recession and there are still several state and local governments that are experiencing structural imbalances and their pension funding levels are still inadequate, or I’d say very inadequate,” Kozlik said during an interview on Tuesday.

Following the onset of the Great Recession in late 2007, contributions to public pension plans in cities and states around the U.S. saw declines. As a credit analyst, Kozlik said he is looking ahead, considering how the already lagging levels of pension funding in some jurisdictions would affect their finances when another economic downturn hits.

“They’re dragging down credit quality for several state and local governments now,” he said, referring to pension funding levels. “It’s going to be even worse after the next recession.”

As for whether the quality of state and local government credit has recovered from the Great Recession, 61 percent of analysts responding to the survey said “yes,” while 22 percent said “no.” Another 17 percent were either undecided or said some variation of “not yet.”

The survey was conducted between March 20 and March 31. Of the municipal bond credit analysts that responded, 59 percent identified themselves as generalists and 63 percent said they were on the buy-side of the market.

The other issues and trends that the analysts most commonly included on their top five lists were: infrastructure (44 percent), the proliferation of chapter 9 municipal bankruptcies (38 percent) and disclosure (35 percent).

Kozlik said that a common reason analysts pay attention to infrastructure is that deferring maintenance or new projects can affect the creditworthiness of a state or local government.

As for disclosure, he said there tends to be broad agreement among municipal credit analysts that governments should issue information about their finances more regularly. He noted that companies release quarterly financial reports. Municipalities, he said, might not issue financial statements until a year, or 18 months, after the close of a fiscal year.

Another survey result that Kozlik found interesting had to do with ratings agencies. Over half of the surveyed analysts expressed a neutral or favorable view of Fitch, Moody’s and Standard & Poor’s.

But the results were distinctly different when they were asked about Kroll Bond Rating Agency, a relative upstart established in 2010. Sixty-six percent of analysts either don’t consider, or have an “unfavorable” or “undecided” opinion of Kroll’s municipal bond ratings.

Government Executive

By Bill Lucia April 7, 2015

In this week’s Extra Credit, Associate Director Carol Spain discusses how declining oil prices are affecting North Dakota’s municipalities, and Senior Director David Bodek explains what’s behind our recent rating action on California Department of Water Resources’ power bonds.

Listen to the Podcast.

Apr 02, 2015

The municipal bond insurance industry showed continued growth in the first quarter of 2015, as insured penetration rose to 5.8%, a sizeable uptick from the 4.3% of long-term bond deals wrapped by insurance in the first quarter a year ago.

Volume Totals

The month of March saw bond insurance more than triple from numbers in the previous year, as $2.70 billion of long-term bonds were wrapped by insurance, compared with $865 million for the same period the previous year.

Assured Guaranty led the bond insurance market in par insured volume and total number of deals. They finished the first quarter with a 56.6% market share with insured volume of $3.353 billion over 270 deals, according to Thomson Reuters data which includes Assured’s subsidiary Municipal Assurance Corp.

“Once again, Assured Guaranty retained its market leadership position in the U.S. public finance market,” said Robert Tucker, head of communications and investor relations at Assured. “Our first quarter insured new-issue volume increased 134% over our first quarter volume a year ago, substantially outpacing the 72% growth in overall new issuance.

Tucker also said that Assured’s wrap was used by 17 credits with an underlying rating in the double-A category to launch new issues. “That indicates market recognition of our financial strength and the other benefits of our insurance,” he said.

Build America Mutual grabbed a 39.6% market share, insuring $2.347 billion in 236 transactions. BAM’s market share is down from 48.2% in the first quarter of 2014. Despite the decline in market share from 48.2% in the first quarter of 2014, BAM’s insured volume increased by more than $1 billion and their number of deals increased by more than 100 from that quarter a year ago.

“The first quarter was very successful for BAM, with our primary-market volume up about 75% from a year earlier, and the industry’s gains driven by transactions with an issue size below $50 million and ratings in the single-A or triple-B categories,” said Sean McCarthy, chief executive offer and managing director for BAM. “Serving those issuers and the regional broker-dealers that handle their transactions has always been at the core of BAM’s mission as a mutual insurer, which is designed for financial strength, ratings durability, and transparency.”

McCarthy added that as the insured universe grows, they have seen increased demand from traders, underwriters and investors for BAM’s Obligor Disclosure Briefs, which provide credit summaries for every transaction BAM insures.

“We now have more than 1,600 ODBs available for free on our website, and we’re increasingly making them available on other platforms as well,” said McCarthy. “It’s a busy time, but we’re seeing the benefits of the robust technology infrastructure we designed starting at the company’s launch and we haven’t missed a beat or a bid in keeping up with the market’s growth.”

National Public Finance Guarantee accounted for a 3.8% share of the insured market share, wrapping $222 million over three deals in the first quarter.

“Although we do not comment on specifics until our financial results are released, it is clear that our marketing efforts and willingness to work harder are paying off and National is building momentum,” said Tom Weyl, head of new business development for National.

“The market is recognizing the value of our financial guarantee as we have insured deals ranging in size from roughly $2 million to over $200 million. Our aggressive marketing and deal execution efforts will continue as we strive to touch all municipal market participants,” Weyl said.

THE BOND BUYER

BY AARON WEITZMAN

APR 6, 2015 2:59pm ET

Municipal bond volume continued its surge, as the market was flooded in March with issuers hoping to take advantage of low interest costs while they still can. First quarter issuance was the highest since in 2010 – and third highest since 2006.

Monthly Data

“Refundings are the primary reason why issuance is so high,” said Jim Grabovac, managing director and senior portfolio manager at McDonnell Investment Management LLC. “There is sharp contrast with the first quarter of this year and the first quarter of last year; the start we have had so far is much more robust than most analysts anticipated.”

Long-term municipal bond issuance increased 43.7% to $40.99 billion in 1,187 issues from $28.52 billion in 741 issues a year earlier, the eighth monthly gain in a row. Overall for the first quarter, muni issuance is up 58.8% to $102.551 billion in 3,071 issues from $64.568 billion in 2,132 issues for the first quarter in 2014, Thomson Reuters data show.

“Overall, I would expect to see issuance higher in almost every category because of the interest rate environment in the beginning of 2015 versus that in the beginning of 2014,” said Tom Kozlik, municipal credit analyst, Janney Capital Markets. “Issuers are doing an excellent job of taking advantage of the low interest rate environment and refunding outstanding bonds for debt service savings. This makes complete sense to us.”

Refundings doubled in volume to $18.65 billion in 590 issues in March from $9.26 billion in 307 issues a year earlier.

“Mostly, it is refundings that will make the primary municipal bond market world go ’round,” Kozlik said. “That is as long as interest rates remain low and state and local governments revenues do not keep up with expenditures.”

Combined refunding and new money deals increased 33.1% to $12.01 billion from $9.02 billion, while new-money issues were up 0.9% to $10.33 billion. Taxable and tax-exempt deals increased almost the same amount percentage wise, with taxables increasing 45.1% to $3.39 billion and tax-exempts increasing 45.9% to $37 billion.

Negotiated deals advanced 44.8% to $33.14 billion, while competitive deals increased 71.9% to $7.61 billion.

Private placement bonds plunged 80.3% to $239 million from $1.21 billion during the same period the previous year.

Revenue bonds jumped 54.5% to $21.20 billion and general obligation bonds increased 33.8% to $19.79 billion.

Fixed rate deals increased 46% to $39.44 billion.

“This is a case where people wanted to lock in the low rates while they are at historic lows and not be exposed to the shorter end of the curve,” Grabovac said.

Bond insurance more than tripled from first quarter of 2014 to $2.70 billion to $865 million.

Sectors were mixed, as six posted increases in year over year volume and four had decreases. Issuance surged for education and healthcare, two sectors with negative outlooks from ratings agencies and high yields. Education more than tripled to $17.47 billion from $5.28 billion. Health care almost quadrupled to $2.72 billion from $720 million.

Municipal bond market participants and observers are trying to figure out if this rise in bond issuance means there is less of an appetite by municipal issuers for direct bank loans.

“There is some evidence that tells me issuers are increasingly interested in potential bond sales,” Kozlik said. “I have also found evidence that higher education, health-care and 501C3 issuers are still interested in using direct bank loans. There is a special level of interest in direct loans from those on the edge and over the edge of investment grade.”

Dawn Mangerson, managing director and senior portfolio manager at McDonnell Investment Management, said she is interested in the changing demographics in the healthcare and high education sectors.

“We are extremely picky with what we are buying: there is more yield than your plain vanilla GOs, but we are being careful, buying the better names in higher education, like a flagship university for example,” she said.

State governments decreased issuance by 41.2% to $4.47 billion, while cities and towns decreased sales by 10.2% to $6.48 billion.

“State and local government issuers are also keeping new money issuance relatively low, despite interest rates near historical lows, which I expected would be the case,” said Kozlik. “It is because the credit status of state and local government issuers is not as healthy as some believe and issuers are doing what they can do in order to not add more to the liability side.”

The top five state issuers this past month were California, Texas, New York, Pennsylvania and Florida.

California claimed the top spot with $15.36 billion, up from ranking third in the same period of last year with $7.88 billion. Texas dropped from first to second despite having $12.69 billion, an increase from $9.37 billion the year before. New York dropped from second to third with $7.65 billion in March this year, down from $8.12 billion in March of 2014. The Keystone state made the biggest jump – from ninth to fourth, issuing $5.50 billion from $1.50 billion the year before. Florida moved up one spot from sixth to fifth to $4.54 billion from $3.30 billion.

On the other end of the spectrum, the District of Columbia, Vermont, Montana, North Dakota and Wyoming round out the bottom five.

“It was nice to have the supply come into the market from an investor’s standpoint,” said Mangerson. “There is still relatively strong demand, although it did lessen with seasonal tax payments due,” she added. “The demand varied depending on the type of issues but it was spotty. Longer and higher yielding bonds got the attention of the muni market. We also saw strong demand on the long end of the curve.”

THE BOND BUYER

BY AARON WEITZMAN

MAR 31, 2015 2:52pm ET

April 2 (Reuters) – U.S. municipal bond investors pulled money out of muni bond funds last week for the first time this year, likely as taxpayers liquidate some short-term assets to pay what they owe for 2014 taxes.

Muni funds reported $300.6 million of net outflows in the week ended April 1, compared with $581.7 million in inflows in the previous week, according to data released on Thursday by Lipper, a unit of Thomson Reuters.

One institutional intermediate fund appears to have skewed the results: JPMorgan’s Tax Aware Real Return Fund-Institutional, which shed $187.3 million, Lipper data showed. The fund now has about $1.4 billion of assets under management.

Excluding that single result, total net muni outflows would have been closer to $100 million, and “almost all of that would have been from short and ultra-short muni funds,” said Chris Mauro, Director of municipal bond research at RBC Capital Markets.

“Flows out of very short duration funds are not unexpected this close to April 15,” he said, referring to the deadline for filing taxes.

Fund managers at JPMorgan did not immediately respond to a request for comment on Thursday.

(Reporting by Hilary Russ in New York)

(Reuters) – Sales of U.S. municipal bonds and notes will total an estimated $7 billion next week, according to Thomson Reuters estimates on Thursday.

With no deals over $1 billion, the biggest individual offering on the calendar is from the North Texas Tollway Authority for $871.3 million of system second-tier revenue refunding bonds.

JPMorgan is leading the deal, which is rated ‘BBB+’ by Standard & Poor’s Ratings Services.

The authority said it was notified on Tuesday that the Internal Revenue Service (IRS) had selected some of its 2009 bonds and commercial paper notes for examination in connection with “part of a project/initiative involving transportation bonds” by the IRS.

The IRS also said in letters to the authority that it “has no reason to believe such debt issuances fail to comply with any applicable tax requirements,” according to a Thursday supplement to the deal’s preliminary official statement.

APRIL 2

(Reporting by Hilary Russ in New York; Editing by Lisa Shumaker)

CHICAGO — Struggling Illinois local governments should have the option of municipal bankruptcy, one mayor told lawmakers during the first airing of legislation that would add Chapter 9 to the state’s statutes.

“Simply put, if cities are put in a position where they can’t pay all of their bills this provision would provide the best way amongst not a lot of good choices … to help cities continue to provide public safety to citizens while protecting our ability to access the financial markets and provide fairness to all creditors,” said Rockford Mayor Larry Morrissey, who stressed the city was not in need of the option.

The testimony came during a recent hearing held by the House Judiciary-Civil Law Committee on House Bill 298, sponsored by Rep. Ron Sandack, R-Downers Grove, which would permit local governments to file for Chapter 9 bankruptcy.

Conditions allowing for such a filing such as state approval and potential alternatives were also discussed at the March 20 hearing.

While a bankruptcy provision has not gained much traction with Democrats who control the General Assembly, discussions over whether Illinois should add such a law has received heightened attention since the new Republican governor, Bruce Rauner, proposed the option.

The committee heard from representatives of the public finance community and civic organizations who pressed to make new options available for struggling communities and offered an alternative in the form of a new authority to assist local governments solve fiscal problems without bankruptcy.

Police and fire unions urged against permitting Chapter 9.

“Our members provide critical service,” said Pat Devaney, representing a firefighters union. “It’s very convenient for people to place their woes at the feet of … police and firefighter pensions.”

Some believe Rauner and others want to give local governments more leverage in negotiating pension reforms.

Local governments face big increases in their public safety pension contributions next year due to a prior state mandate to shift to an actuarially required contribution level.

Giving local governments more leverage to ease pension obligations could also help ease pressures if Rauner’s proposal to halve the amount of income tax revenue distributed to municipalities is approved.

Sandack said his bill would require municipalities to first show they truly are insolvent and have made a good faith effort to restructure their debts with creditors.

“By sponsoring this bill I am not encouraging municipalities to abandon efforts to regain financial stability on their own. The bill would simply provide municipalities with an additional tool to help them get their financial affairs in order,” he said.

Lawrence Msall, president of the Chicago Civic Federation, pushed lawmakers to consider a measure backed by the group and developed by municipal restructuring expert James Spiotto to create an authority designed to intervene before a government’s fiscal strains reach crisis stage.

The quasi-judicial authority would help Illinois local governments deal with pension-related and other fiscal burdens threatening their solvency. The goal would be to avoid defaults and bankruptcy while putting a government on a sustainable path.

“Bankruptcy is a very dangerous place for us to be heading,” Msall said at the hearing.

Illinois Finance Authority board chairman William Brandt stressed the availability of help now through the existing Financial Distressed City Act and warned of the toll bankruptcy takes on an issuer.

Illinois statutes don’t currently grant general legal authority allowing for a Chapter 9 filing with the one exemption being for the Illinois Power Agency.

The Fiscally Distressed City Act is for cities with a population under 25,000.

The local government must ask the General Assembly for the appointment of a special commission to consider whether the municipality meets the act’s criteria and if approved it can qualify for state financing assistance.

Currently, 12 states with Chapter 9 statutes require a second look by a governing body like the state. Another 12 states don’t require an additional layer of review.

Two states prohibit local governments from filing bankruptcy and 21 states are either unclear or do not have a specific law, while three states allow it under very limited circumstances, as Illinois does.

The hearing was for testimony only; no action was taken.

THE BOND BUYER

BY YVETTE SHIELDS

APR 1, 2015 2:58pm ET

One night in the 1980s, a skinny red-headed kid tried in vain to get into a Guns N’ Roses show in Los Angeles. Now matter how much he pleaded, his name wasn’t on the list and he couldn’t get a ticket.

This is how Axl Rose got locked out of his band’s show and Duff McKagen became lead singer for a night, probably not one of their better shows.

What on earth does this have to do with Tucson’s bonding capacity and sales tax revenues from the general fund? Everything.

The Charter Review Committee has forwarded a recommendation to the City Council to ask voters to give the city the power to use sales tax money to pay down debts without voter approval. To make gosh-darn sure voters didn’t think this was a tax increase the committee full of smart people also refused to advise an increase to the city’s sales tax limit beyond where it is now — just two percent.

The net effect would be to burden future city leaders with bond debts paid from a typically cash-strapped general fund or worse, instigate a revolt against “back room bonds” a new council may seek to disavow themselves of with disastrous results.

Bond dollars are VIP dollars that need to be dropped off back stage. They need a clear path from the city coffers to the bond holder’s wallets and have nowhere else to go. The minute they are in competition with other money or the crowd out front trying to talk their way in, bad things can happen.

That’s it in a nutshell, but because a smart reader is a stronger citizen let’s talk about why.

Warning: The degree of dorking out that will follow may not be suitable for some readers. Whatever discretion leads you to watch “Dancin With the Stars” is advised.

Bonding. It’s just debt. It’s how cities, states and businesses pay for debt. We first need to disabuse folks of the ideas that debt is always bad or that the federal debt is anything like municipal bonds. Debt allows for you to pay for today’s big ticket “capital” costs with tomorrow’s more powerful dollars. In that sense, it’s good. It’s smart financial planning. It’s why even if you have $200,000 in cash laying around, you would be smarter to mortgage it.

Say you could put that $200,000 into an investment that would earn about $8,000 a year, tax-free. That would be enough — according to Zillow — to pay off your mortgage with other people’s money. Then, when you are done, you would get the original $200,000 back.

Now that $200,000 in 30 years isn’t what it was today but that’s the point.

Tomorrow’s dollars are bigger and more powerful than today’s so you are addressing big purchases with financial force. Also every dime of income that you would have spent on a mortgage instead went into a retirement account that has you set for life (note, this is for an insanely low interest rate and to qualify these days, you better have never missed a homework assignment in 7th grade. But even if it pays half your mortgage — you get the point). What is this wonder, tax-free, safe-as-can-be investment we’re talking about?

A municipal bond.

It’s how the other one percent lives. In fact, munis as they are called, are one way that super-rich does invest in America, providing the financing for roads, libraries, etc., while getting their annual live-on money tax free.

The city’s budget stays in balance even as it takes on debt because there is a dedicated funding source to cover the cost of paying off bonds.

That’s the secondary property tax. Primary property taxes pay for pencils, cop cars and salaries. The secondary property can only tax pay for roads and new buildings and bond holders know the money is coming. However, to keep everyone cool with the debt, voters have to approve it. The city, the voters and the bondholders are all on the same page.

In fact, when those evil Koch Brothers decide to pay for an expansion somewhere, they probably finance it this way — choosing to let tomorrow’s dollars pay for today’s investments and using other people’s money to do it. It’s smart.

Debt isn’t bad. It’s a tool. It’s like a drill. So long as you aren’t powering it through your thigh or into the antique China, it’s good to use if you use it right. How do you use it wrong? Glad you asked.

The federal deficit and debt is something completely different. That’s Dodge City and Wild West accounting. The feds use deficits to finance day-to-day operations. The city ledgers would more or less make sense to a corporate accountant. That same accountant would look at the federal deficit and wail, “Oh God! My eyes!”

So back to the Charter Review Committee, whose idea is to let the Council simply have more flexibility to pay for today’s needs with tomorrow’s dollars and it has what bureaucrats would call “merit.”

The rest of us would say it’s not as completely stupid as it sounds.

Say the city had this ability in 2010. Potholes would have been fixed a lot sooner. The city could have taken out $50 million in debt an repaid it over 10 years, probably saving some money because potholes just get bigger.

Plus, there are some items the City Council might want to bond to buy that are just a few million dollars, meaning holding a special election costing a million bucks doesn’t make much sense, city officials would say. So, it allows the Council to react smartly and pay for things with a degree of agility.

But, the Council would simply be siphoning off the existing sales tax revenues to pay for them and that’s when the trouble stars and Axl gets angry.

Sales taxes are nothing like secondary property taxes. The secondary property tax provides the undisturbed path for VIP dollars. Bondholders like that. Secondary property tax debt is something called G.O. (general obligation) debt.

If for some reason, the city can’t pay, well, then bondholders can take it to a judge who will force the necessary tax hike to get G.O. debt repaid. The bondholders love that. There’s not a lot of risk and interest rates are low. The city is happy. Bonds paid with sales taxes carry higher interest rates because lenders can’t go to a judge and take over Speedway if the city doesn’t pay up in time.

Bond interest rates aren’t usually debilitatingly high. “Revenue bonds” are used all the time to pay for new water lines and the Pima County Regional Transportation Plan is being paid for this way. However, the RTA also carried with it an extra funding source: sales taxes were raised a half cent to pay for it. So the county scoops up that dedicated money, puts into an account and zips it over to bondholders. Everyone is happy, except for the Pima Association of Taxpayers, who are never happy.

The charter committee wanted to give the Council the authority to be financially nimble but were worried voters would see a sales tax coming their way and revolt. So, committee members figured the way to head that off (because reason always carries the day in public debate) was to not allow the city to raise any more sales tax revenues. Problem solved. The city gets nimble. The voters won’t fear sales taxes. Right?

Well, true enough but it just creates all sorts of havoc on the back end.

The Council has the ability to raise sales taxes with a 4-3 vote but can’t today without smacking into a two-cent sales taxes limit in the Charter. The Council also has the ability to bond without voters’ approval. It agrees to let, for instance, Tucson Water build new water lines and pay back bonds out of water rates. It can also use something called certificates of participation to pay for physical assets, such as a parking garage. Fees paid by users will pay the cost of building it and bondholders could take possession of the garage if the city defaults.

Neither of these powers has any real effect on the general fund, which is the $480 million in discretionary money for services that do not pay for themselves. Parks. Parks are paid for with the general fund. Police. Police are paid for with the general fund. After-school programs are paid with the general fund. The general fund money is almost exclusively paid for with sales taxes — the same ones the committee thinks should be used to pay off bonds.

If that happens, the sales taxes that cannot be raised would now be available for bonds and would be in direct competition with other general fund programs.

Now the problem becomes acute. The general fund more often than not during the past 15 years has been … what’s the word? Oh! Broke. After the last two recessions, the budget doesn’t have much to give, or for the conservatives in the room, it doesn’t have much that isn’t a sacred cow. Nipping and tucking $10 million here and $20 million there turns into a brutal cat fight.

Had the review committee raised the sales tax limit by just a smidge for the purposes of bonding, the city would be able to issue a limited amount of small-ticket debt without putting more pressure on the already hard-pressed general fund. Then the situation starts to resemble Axl Rose at the door,because the money is milling around with a bunch of non-VIP (that feel pretty VIP to those who get them) and the path between the dollars and bond holders gets dicey.

The real-world truth is that bondholders aren’t that worried. Cities and counties issuing these debts know full freaking well that every time a city issues debt it puts its full faith and credit on the line. That money comes out first — the theory goes.

However, the Legislature in Phoenix is trying to undo the social contract at every level in Arizona and slashing state-shared sales taxes. Our pension system isn’t paying for itself. Arizona sluggishly limps behind the rest of the country in terms of economic growth. The last thing the general fund needs right now is another big slice paid out.

Sales taxes rerouted to debt would almost certainly force general fund cuts in services voters expect, pitting cops against parks yet again. Worse, the situation could make the prospect of defaulting or reworking debt that much less unthinkable. Without voter buy-in on debt that had been issued, future Councils could decide “Know what? Screw it,” and win elections running against “back-room debt.”

A weakness of democracy is how voters believe that at the end of the day elected leaders are not full-bore crazy, and is that a dangerous assumption.

Over time, the new power to issue bonds without voter approval could come back to haunt the city, when 10 years on the Council looks at the municipal ledger and wonders, “How is it we have $40 million in annual debt payments to make from the general fund? When did that happen?”

That’s when the new city manager says, “Yeah, that was two city managers ago, but you are still on the hook.”

It’s not at all a leap that at that very moment the Council member looking at his or her sacred cow then becomes an instant hero asking the follow up: “Is there any way we can tell the bond market that they can bite me?”

It wasn’t that long ago that the prospect of defaulting on our debt at the national level was utterly unthinkable. Today, it’s a tweetable chirp with 140-character appeal to voters.

After the last war, the last recession and Rio Nuevo, never ever, ever listen to a smart guy in a suit last line of defense says, “Oh, but they’ll never be that stupid.” Charters exist for that very reason: to prevent idiocy before it starts.

Dollars for debt must get VIP treatment and be delivered safely to bondholders. Once they start milling around with the rabble, they become less distinguishable. That’s when Axl can’t get back stage and Duff must sing. On the municipal level, services are cut and the full faith and credit of the city is at risk.

The hair’s breadth between this idea having merit and it being a dangerous is in the political calculation the review committee made: a hope of being able to sell the change as not being a tax increase. They essentially decided to drop Axl off at the front of the club, telling him to fight his way past security. Does it sound smart?

I’m not simply here to cast aspersions because two tools remain to give the city agility, protect bond holders and city programs. One, is raising the sales tax limit by a fraction and the other is to carve out a small portion of the budget for non-discretionary sales tax dollars and swallow the hit to the general fund. Codify it. Add it to the Charter. The money is just gone for any and all general fund purposes, not in practice, but by law.

If the Council wants to have the power but can’t think of a way to pay for it, then Tucson is already turning off the road from wise debt to the kind that blinds accountants and, truthfully, wins City Hall reporters a bunch of awards (First Place Beat Reporting when debt money in Flagstaff wound up in the general fund).

Posted Apr 1, 2015, 3:34 pm

Blake Morlock

TucsonSentinel.com

Blake Morlock covered Arizona government and politics for 15 years, including 11 in the Tucson Citizen. He also worked on Democratic Party campaigns in the field of political communications. Now he’s telling you things that the Devil won’t.

The phrase “mergers and acquisitions” conjures to mind white-shoe investment banks, private equity and Fortune 500 firms. But as cities struggle to balance budgets, shave bureaucracies and cope with unsustainable pension and healthcare obligations to public employees, an intriguing concept could offer some relief: city and county mergers.

In the same way that private-sector consolidations offer efficiencies and economies of scale, municipal mergers can cut operational redundancies, saving taxpayers money in the process. Combined resources also offer a bulwark against state budget cuts and prevent tax hikes.

In 2011, the $3.7 trillion municipal bond market was comprised of more than one million different municipal bonds outstanding that had been sold by 44,000 state and local issuers, according to data from the Securities and Exchange Commission.

Source: Technology Investor

The sheer volume and complexity of the marketplace suggests considerable overlap in the scope and scale of these bonded projects. Additionally, consolidating county and local governments can also save money by hiring fewer bankers to sell their bonds in the marketplace. (As an aside, this post focuses on local governments; not-for-profit, 501c3 hospitals issuing municipal bonds have also seen fast and furious consolidation in the wake of the Affordable Care Act.)

This month, newly-elected Illinois Governor Bruce Rauner, a Republican, said he would create a Local Government and Unfunded Mandates Task Force to examine possible mergers. Moody’s Investors Service, my former employer, dubbed the move a “credit positive” for the Illinois local government sector.

Moody’s reports that the Land of Lincoln has more units of local government than any state with 6,963, as of 2012. This saddles taxpayers with the costs of redundant core and administrative functions, from schooling to road maintenance.

On the East Coast, in November 2011, voters of New Jersey’s Princeton Borough and Princeton Township approved a consolidation of the two towns into a single municipal entity called Princeton. Voters relied on a report from the Center for Government Research, a Rochester, New York-based non-profit advising Princeton on proposal, estimating $3.1 million in savings from the merger within the first three years (The merger took effect in January 2013, so results aren’t final yet.).

It took nearly sixty years for the marriage to finally occur; Princetons had voted on the measure five times previously without approving the merger and had already shared services for years. However, when residents learned they could save an estimated $200 in average annual tax savings per property in each town, they voted for it by an overwhelming margin. Princetons also had backing from the state (including an offer from Gov. Chris Christie to cover 20 percent of the total $1.7 million in merger costs); the New Jersey 2008 Municipal Consolidation Act encouraged contiguous municipalities to consider consolidation to better manage growth and save money.

Elsewhere, the City of Louisville, Kent., merged with Jefferson County in 2004, creating the nation’s 17th largest city. The move won an upgrade by Moody’s for the combined entity; the whole was greater than the sum of the parts.

Taxpayers are likely to agree as well, and this is a trend we could see continuing to increase across the country.

FORBES

CARRIE SHEFFIELD

3/31/2015 @ 6:23PM

 

 

BRADENTON, Fla. — A Florida county asked a federal judge to block the issuance of $1.75 billion in tax ­exempt private activity bonds for the All Aboard Florida private passenger train project.

Indian River County filed the lawsuit Tuesday in the U.S. District Court for the District of Columbia.  It contends that the bond allocation by the U.S. Department of Transportation violated the National Environmental Policy Act.

Also named as plaintiffs along with Indian River County are the county’s emergency services district and a nonprofit archaeological group called Old Vero Ice Age Sites Committee Inc.

U.S. Transportation Under Secretary Peter Rogoff, who signed the bond allocation letter, is a defendant along with the USDOT.

Rogoff stipulated that the bonds must be issued by July 1, and that bond proceeds could not be expended until 45 days after the final environmental impact statement is issued.

USDOT spokesman Ryan Daniels said the agency doesn’t comment on pending litigation.

Daniels also did not respond to questions asking if All Aboard Florida could lose its PAB allocation because of the lawsuit, or if there has ever been a previous legal challenge to a USDOT private activity bond allocation.

All Aboard Florida is not named in the suit, though an attorney not affiliated with the company said the train owners could intervene in the litigation.

AAF did not immediately respond to a request seeking comment about the lawsuit. The company is owned by Florida East Coast Industries, which is owned by Fortress Investment Group LLC.

Attorneys who spoke on the condition of anonymity said they do not believe there has ever been a legal challenge involving a USDOT bond allocation that was granted before a final environmental impact statement was issued, or a bond allocation stipulating that bond proceeds cannot be expended until after the final EIS is issued, as in the case of AAF.

All Aboard plans to run 32 passenger trains a day on a 235 ­mile route between Miami and Orlando.

The company has federal environmental clearance and most permits for phase 1 of the project in south Florida, where stations are planned in Miami, Fort Lauderdale, and West Palm Beach.

The lawsuit filed Tuesday involves phase 2, which runs from West Palm Beach to Orlando, where trains will pass through Martin, St. Lucie, Indian River, and Brevard counties though no stops or train stations are currently planned.

The lawsuit was filed Tuesday because Indian River County was concerned that All Aboard Florida would issue the bonds before the NEPA process was completed, according to County Attorney Dylan Reingold.

The County Commission has approved spending up to $600,000 for the legal action, which will cover the costs for all three plaintiffs, he said. The lawsuit was filed by Bryan Cave LLP, the county’s outside counsel.

“The National Environmental Policy Act does not allow a federal agency to authorize the sale of $1.75 billion of bonds to investors without an EIS, and then make the use of the investors’ funds contingent on completing the EIS,” Reingold said.

The Federal Railroad Administration, which is the lead USDOT agency for the NEPA review, has not released the final EIS. The agency had said that it received more than 12,000 comments on the draft EIS.

All Aboard applied for the private activity bonding last August, after the Florida Development Finance Corp. agreed to be the conduit issuer of the debt. Rogoff approved the allocation Dec. 22.

“One of the key purposes of an EIS is to inform the decision-­making of the federal government,” said Reingold. “That purpose was subverted here because the DOT approved the bonds before the EIS process was completed.”

There has been no indication when the final environmental clearance will be given. Once that occurs, Reingold said, the county would review the document and examine its options.

In addition to the contention that USDOT could not allocate the bonding authority before completion of the environmental statement, the lawsuit said that the federal administrative procedures act was violated because the federal government failed to consult with Indian River County under Section 106 of the National Historic Preservation Act.

“The defendants acted in an arbitrary and capricious manner, in an abuse of discretion, and contrary to law in excluding Indian River County from the consultation on the basis that the project would not affect historic resources in the county,” court documents said.

The county cited its conservation and recreation resources, and archeological sites that are being uncovered by the Old Vero Ice Age Sites Committee. Those sites were not assessed in the environmental review process to determine whether vibration from increased freight and new passenger operations could damage artifacts, or if expansion of rail operations would “foreclose or hinder future artifact recovery efforts,” the suit
said.

The railway plans no new right-­of-­way in the county, but would add the passenger train service on the existing Florida East Coast freight rail corridor.

Indian River County has asked a federal judge to find that the USDOT violated the NEPA and to vacate the bond allocation. The suit also seeks temporary and permanent injunctions to require that the government comply with NEPA before considering a bond allocation.

All Aboard applied for the financing from the USDOT last August.

At the time, company president Michael Reininger said that the project was well under way and that the PAB financing was “a crucial factor in ensuring our project is financed and completed,” according to a letter filed with court documents Tuesday.

The company said its financing plan would include returning $405 million in high-­yield notes sold last year to creditors that are now held in escrow. AAF would use the private activity bond proceeds for the entire Miami­-to-Orlando corridor.

“We believe the resulting simplified capitalization … is critical to the successful marketing of the private activity bonds necessary to complete our project,” said Reininger. AAF said it is also investing more than $400 million in cash equity and $600 million in land and easements toward construction of the project.

The PAB application included a draft bond counsel opinion letter from Greenberg Traurig PA, but it did not identify a financial advisor or underwriters.

The train company planned to issue the debt as early as last December, documents said.

Since that time, the Florida Development Finance Corp. has been in a state of flux after losing nearly all of its five board members, which prevented the board from giving final approval to AAF’s financing.

Gov. Rick Scott appointed three new board members on March 27. His office said this week that two additional board appointments are under consideration.

THE BOND BUYER

BY SHELLY SIGO

APR 1, 2015 2:36pm ET

Pennsylvania set out to fix a major statewide problem: structurally deficient bridges.

Its solution could set a precedent.

The Rapid Bridge Replacement Project, Pennsylvania’s first public-private partnership, is also the first P3 in the U.S. to bundle multiple bridges into a single procurement

Pennsylvania intends to replace 558 bridges over three years. Last month the commonwealth raised $800 million through an oversubscribed sale of private activity bonds led by JPMorgan and Wells Fargo Securities.

The sale, which closed March 18, attracted more than 40 investors. Standard & Poor’s rated the bonds BBB.

“What we’re doing is addressing a serious problem in a calculated way,” said Bryan Kendro, the P3 director at the Pennsylvania Department of Transportation.

“I think if I could pick an initial P3 for a state, this one would be straight out of central casting,” said John Schmidt, a partner at Mayer Brown LLP in Chicago. “It does something very important, is less expensive, had strong competition and you had a winning team, all with an $800 million private activity bond.”

Plenary Walsh Keystone Partners, a consortium of construction, engineering and financing companies, won the bid last October. The team consists of Plenary Group, Walsh Group, Granite Construction Inc. and HDR Engineering Inc. Walsh and HDR maintain Pennsylvania offices. The team also includes 11 Pennsylvania-based subcontractors.

“I believe Plenary Walsh will do everything they said they’ll do,” said Schmidt, who advised Chicago in its $1.8 billion privatization of the Chicago Skyway toll bridge.

Ross Moskowitz, a partner at New York’s Stroock & Stroock & Lavan LLP, sees multiple benefits with the deal.

“You’d have to hold their feet to the fire, but my guess that it would cost significantly less than the standard PennDOT projects,” said Moskowitz, a former executive vice president with the New York City Economic Development Corp. and former executive director of the New York City Industrial Development Agency. “Whatever the delta is, the generated savings can go into other projects. That’s the beauty of it.

“Take bridges – you have similar classes of bridges for what’s needed,” Moskowitz said. “You probably have a similarity of types of bridges with the same character, structural design and deficiencies. You could do a mass production, putting them all together as one P3 contracting, allowing respondents to bid with greater efficiencies.”

Plenary Walsh expects to begin the work in May. According to Kendro, the company anticipates completing 77 bridges in the first year – up from its original projection of 58 — and targets completion of the overall project by the end of 2017.

The bid process triggered a healthy competition, Kendro said.

“We were able to rely on Plenary Walsh to execute a plan of finance,” he said. “We were just the beneficiaries of being in the market at the right time, and we were able to realize an additional $25 million in interest savings. These were very attractive bonds.”

Pennsylvania’s project could also spark a flurry of P3 activity in the Northeast, which has lagged other regions.

“I think Pennsylvania’s one of the leading Northeast P3 states right now. It’s putting some other local states to shame,” Squire Patton Boggs LLP attorney Roddy Devlin said in a recent Bond Buyer video. “It’s a very interesting project. Common approach in Europe and Canada, less common in the U.S., but if that model takes hold, it has the potential to open up the floodgates for adding lots of smaller projects into a single P3.”

The commonwealth is also seeking qualifications from companies interested in competing for a P3 that would fund, build, and operate up to 37 facilities to fuel public transit buses with compressed natural gas produced in the state. The Public-Private Transportation Partnership Office expects to issue a request for proposals later this spring.

Moody’s Investors Service said last fall the U.S. has the potential to become the world’s largest P3 market, given the sheer size of its infrastructure.

“Late to develop its P3 availability-payment market, the U.S. is able to benefit from lessons learned in the U.K. and Canada, and to some extent Mexico,” Moody’s said in a commentary.

Pennsylvania’s bridge project is one of several transportation-related P3 transactions in active procurement or expected to some to market in 2015. Others include Interstate 70 in Colorado, the Indianapolis Consolidated Justice Complex in Indiana, and managed lanes, bridge replacement and toll concession deals in Texas.

U.S. P3 activity in recent years has clustered around California, Florida, Texas and Virginia.

Then-Gov. Tom Corbett signed a Pennsylvania P3 law in 2012. One year later, lawmakers passed a transportation bill that called for a $7.4 billion investment over five years. The Act 89 bill restructured the state’s gas tax and increased a variety of fees, but armed the commonwealth with new revenue to fix its decaying infrastructure amid declining federal aid.

In crafting the P3 deal, Pennsylvania had to fend off in-state skeptics who recalled former Gov. Ed Rendell’s failed efforts in 2007 and 2008 to privatize the Pennsylvania Turnpike. A plan to lease Turnpike operations over 75 years to Spain’s Abertis Infraestructuras and Citi Infrastructure Investors died in the legislature.

“We have a long history of P3s that never made it to the finish line,” said Kendro. Most recently, at the local level, efforts to sell Philadelphia’s Gas Works utility stalled in City Council.

“If you ask the contracting community, they were skeptical about our ability to get something different done,” Kendro said.

“The biggest skeptics we were seeing were the P3 people at the national level, the contractors, investors and design firms that may have bid on the Turnpike,” he said. “From the start, we tried to build credibility and prove that this is not a one-off proposal.”

According to Moskowitz, transparency early in the process is essential.

“You’ve got to communicate early and often with all the stakeholders. That doesn’t mean everyone has to be in agreement, but the worst thing for any P3 project is for there to be mistrust within a community,” he said.

“Before and during meetings with the government, you have to meet with the community repeatedly in order to avoid any accusation of bait and switch. In any PPP, you have some guiding principles and one of them is to have an aligned vision on what is the ultimate goal, and here the ultimate goal is the rehabilitation of these bridges.”

The project straddled the tenures of governors Corbett, a Republican, and Tom Wolf, a Democrat who unseated Corbett last November.

“I can’t praise both administrations enough,” said Kendro. “Gov. Corbett and [former DOT Secretary] Barry Schoch were very supportive, then the new administration came in after the signing and helped with the financial close. We didn’t miss a beat.”

Pennsylvania thus calmed a P3 market that quickly gets skittish about political risk, said Mayer Brown’s Schmidt, a former associate attorney general in the U.S. Department of Justice and former chief of staff for Chicago Mayor Richard M. Daley.

“This was a very well done deal that transcended a shift in gubernatorial administrations from one party to another,” said Schmidt.

In New York, Gov. Andrew Cuomo’s executive budget proposal to extend design-build authority could stall in the legislature. Such authorization expired last December. Design-build enables a contractor to submit a singular bid for both the design and construction of projects. Proponents cite cost and time savings, and innovation incentives.

“It’s going to be a challenge,” said Maria Doulis, director of New York City studies for the Citizens Budget Commission watchdog organization. “It’s a little discouraging because if it’s so tough to enact design-build, how will New York be able to catch up in this P3 environment?”

THE BOND BUYER

BY PAUL BURTON

MAR 27, 2015 11:13am ET

The International Capital Market Association, a trade group, released an updated version of the “green-bond principles”–voluntary guidelines for issuers and bankers to help determine whether a bond should be labelled “green.”

It’s the first update since the guidelines were initially released in 2014, a year that saw a record $36.6 billion in new green bonds sold. The 2015 tally is currently $5.6 billion, according to the Climate Bonds Initiative.

As the market has grown, however, some investors and analysts have questioned whether the existing guidelines were strong enough to prevent bond issuers, including local municipalities, corporations and international development banks, from using green bonds for environmentally dubious projects. Whether to call a bond “green” is largely up to the issuer and underwriters.

Among the projects that have come under scrutiny is a parking garage at Salem State University near Boston. Environmental activists have questioned whether a structure that supports greenhouse-gas-emitting automobiles should be considered green. State officials have said the garage will have some electric-vehicle charging stations and is designed to meet green-building standards.

The new version released Friday updated what types of projects can be considered green, saying they should provide “clear environmentally sustainable benefits.” The guidelines previously listed categories such as renewable energy and clean transportation, but Friday’s update added climate-change adaptation to the list. The update also identified four areas of overarching concern: climate change, natural-resources depletion, biodiversity conservation and pollution.

The new version also more strongly recommended that issuers get an outside party to review their bond offering to ensure it’s compatible with the green-bond principles. The new version says some of these reviews are private but can be made public “at the discretion of the issuer.”

The update “is an incremental evolution from the previous standard and aims to provide further clarity on what can be expected from issuers,” according to updated principles. The executive committee that worked on the update includes issuers, underwriters and investors.

Like the previous version, however, the update does not explicitly exclude any types of projects, even those even involving greenhouse-gas-emitting fossil fuels. The standards “continue to reflect the diversity of opinion on the definition of green projects,” the new version says.

In February, a group of investors coordinated by Ceres, a nonprofit that focuses on sustainability, released their own guidance and took a stronger stand against fossil-fuel projects. The investors said they welcomed green bonds from all issuers but cautioned that projects involving fossil fuels may be better served with conventional bonds.

Some of those investors, such as BlackRock and Zurich Insurance Group, also served on the executive committee that worked on the updated principles.

Chris Davis, senior director of the investor program at Ceres, said on Friday that the changes were “nothing dramatic” but showed “incremental progress.” He said he would like to see a general requirement that any outside-party reviews on new green bonds be made public.

“I’m encouraged by the direction,” Mr. Davis said. “There’s some positive additions in there.”

THE WALL STREET JOURNAL

By MIKE CHERNEY

MAR 27, 2015

Read the Brief.

Municipal Market Analytics | Mar. 31

I’ve always been fascinated by the challenge of finding funding for front-end investment for programs that promise downstream, long-term savings. Early childhood education, geriatric fall prevention, prisoner recidivism, permanent supportive housing — are examples of programs that appear to pay for themselves.

One set of challenges is programmatic: selection of an evidence-based intervention; identification of a sufficiently narrow group of high-risk individuals to avoid prohibitively high costs; execution of the intervention with sufficient fidelity to achieve expected outcomes; and rigorous evaluation to determine whether cost avoidance has been achieved.

The second set of challenges reflects the complexity of funding streams. Often, the agency that may benefit from front-end investments sees no incentive to redirect its own funds to another agency offering the front-end service. Rarely do leadership and incentives line up well enough for a public agency or agencies to provide risk capital on the confidence that savings or benefits will materialize.

In the last decade, a confluence of interests across several sectors has given rise to a different approach to capitalizing these up-front investments. Interchangeably called pay-for-performance bonds or social impact bonds, these lending vehicles are instruments through which high-net-worth individuals, foundations and financial institutions with community lending obligations invest in promising interventions while accepting higher risk and lower returns than they might from conventional investment vehicles. (An excellent toolkit for the practice is found at payforsuccess.org.) Public agencies pay back the loans only with proof of desired outcomes or cost avoidance as spelled out in the contract. Intermediary entities such as Social Finance US have formed to provide necessary connections and support in structuring these transactions.

The field is young and proliferating. A Stanford Innovation Review paper from 2014 traces an acceleration of social impact bonds globally but notes challenges resulting from the practice’s immaturity. Youthful enthusiasm in the field may well outpace development of accepted standards of “exemplary” programs, public officials’ understanding of the rewards and risks, and commonly accepted and pragmatic definitions of success that would trigger repayment of investments.

In Philadelphia, two pay-for-performance bonds are being explored for feasibility. The first is with the Philadelphia prison system to reduce the rate of recidivism of young adult males; the second, with the city’s human-services department and the Philadelphia school district, aims to reduce placements outside of the city of for children in the child-welfare system.

The city chose these two areas for examination in part because of their high financial and human cost. They are also problems for which there are tested approaches for addressing effectively. The feasibility studies underway with an intermediary contractor involve deep dives into current programming, current costs and effective strategies that either have not been tried or need scaling up to have significant impact. The aim is to propose cost-effective interventions that are “bankable” to potential investors.

For recidivism, possible strategies include workforce and educational programs that are available pre-sentencing, in prison and post-release. To reduce out-of-town placements of troubled children and youth, the hope is that strong behavioral health supports in the community for both children and families can slow foster-care and institutional placements, which disrupt family ties as well as educational continuity.

Pay for performance and evidenced-based programming are the currency of social-service practice today. One might ask what this innovation really brings to the field. One advantage, of course, is “new money” from prospective investors who have traditionally shied away from direct support of governmental programs. The structuring of multi-year contracts, identification of high-quality providers and independent verification of results provide a level of assurance that proffered funding is not simply flowing ineffectually into general funds.

But more importantly, the process brings expertise to guide a rigorous analysis of evidenced-based interventions and their costs and benefits, an assessment of provider and agency readiness, and independent verification of outcomes. This is a level of focused discipline that is often missing in public agencies. If it succeeds, it could become a broader best practice which could ultimately provide more confidence in front-end investments that are hard to fund in times of tight budgets.

GOVERNING.COM

BY FEATHER O’CONNOR HOUSTOUN | APRIL 1, 2015

San Bernardino, Calif., could become one of the first U.S. local governments to enter a fiscal Twilight Zone — a forbidding place where anything can happen. The city’s federal bankruptcy judge, Meredith Jury, has been explicit: If the city fails to meet a May 30 deadline to complete and submit its plan of debt adjustment, its bankruptcy petition could be dismissed.

By freeing San Bernardino’s creditors — a list of them runs to more than 85 pages — to go after the city’s assets, such a dismissal would open the door to the figurative dismemberment of the municipality. The threat to vital public services from such a catastrophic fiscal event would almost certainly force the state, which has been missing in action throughout the city’s bankruptcy throes, to act. No one can say what that might portend.

There are real reasons to fear that the city may miss that May 30 deadline. The city’s outside auditor, Macias, Gini and O’Connell, has disclosed that it may not have all of its work completed in time. And San Bernardino’s elected officials still have much work ahead of them as they put together a strategic plan for returning the city to solvency, reducing the factors that contributed to that insolvency and agreeing on a blueprint for a sustainable fiscal future.

Unlike a corporate bankruptcy, where the business simply shuts down and the keys are effectively turned over to the federal bankruptcy court for the assets to be divvied up; municipal bankruptcy is a wholly different breed intended to ensure that there is no disruption of essential public services, such as 911 or water. Thus the federal bankruptcy court can act as a vital bulwark to protect the public. But that protection cannot last forever.

In Detroit, U.S. Bankruptcy Judge Steven Rhodes’ acceptance of the city’s bankruptcy petition immediately protected the Motor City from the claims of more than 100,000 creditors. It granted the city nearly 18 months to negotiate with its different classes of creditors and reach a consensus with the vast majority.

There are big differences, however, in the way municipal bankruptcy works in different places, thanks to variations in state law. In Michigan, for example, when a local government files for federal bankruptcy protection, its elected leaders are removed from authority until a bankruptcy exit plan is approved; the state steps in and appoints an emergency manager. In California, elected officials remain responsible not only for governmental operations but also for communicating with citizens throughout the formulation of both a strategic plan and a plan of debt adjustment. That is a singular challenge.

To date in San Bernardino, work on the city’s bankruptcy exit plan, detailing how each of the of the city’s thousands of creditors will be treated and incorporating a 20-year forecast, has been done behind closed doors: A gag order prohibited much of the information related to that plan from being disclosed even to members of the city council.

Now that the gag order has expired and the seven council members are privy to the information, Mayor Carey Davis has made clear that the time for public involvement is coming: “We can’t have the strategic plan and the plan of adjustment pulling in two different directions,” he says. What the community wants in a plan of adjustment — improving education or reducing crime, for instance — will need to be funded appropriately in the plan of adjustment. As City Attorney Gary Saenz puts it: “We’re going to require a significant amount of engagement from all stakeholders — residents; businesses; important institutions, for example the school district. … We want to involve many more people now.”

U.S. Bankruptcy Judge Thomas Bennett told me that one of his greatest concerns in the Jefferson County, Ala., case was the absence of the county’s taxpayers from a key role in helping it put together its exit plan. That isn’t going to be the case in San Bernardino. But involving the public in the creation of San Bernardino’s plan to exit bankruptcy is likely to be a messy process.

That prospect is inescapable. Democracy is messy. It is hard. And time is short: May 30 is just around the corner. If municipal democracy does not work in San Bernardino, it could mean the end of the city as a viable entity — and a trip to the fiscal Twilight Zone.

GOVERNING.COM

BY FRANK SHAFROTH | APRIL 2, 2015

Atlantic City’s fiscal crisis may prompt New Jersey to depart from its historic practice of supporting local-government finances as the gambling hub heads down a path similar to Detroit’s.
An emergency-management team hired by Governor Chris Christie that includes Kevyn Orr, who guided Detroit’s record bankruptcy, is considering deferring bond payments to help fix the seaside city’s finances, according to a March 23 report.

Asking bondholders to accept less than they’re owed would undermine New Jersey’s reputation for nurturing distressed cities, said Ted Molin, a senior credit analyst at Wilmington Trust Co. in Delaware. The last time a municipality in the state defaulted was during the Great Depression, according to its Department of
Community Affairs.

“We’ve always taken comfort in the strong state oversight of local governments,” said Molin, whose company oversees $4 billion of munis. “I was hoping that Atlantic City’s situation was so dire and unique, and it doesn’t necessarily represent a policy change, but I’m starting to have my doubts.”

Any debt losses in the city of about 40,000 would probably cause borrowing costs to rise for fiscally strained New Jersey cities, said Matt Fabian, a partner at Concord, Massachusetts-based research firm Municipal Market Analytics.

“For cities with even a chance of distress, you have to assume the state would pursue bondholder losses,” Fabian said.

Christie, a second-term Republican, in January appointed the emergency-management team, which also includes restructuring specialist Kevin Lavin. He acted after four of 12 Atlantic City casinos closed last year after being battered by out-of-state competition. Casino revenue fell to $2.5 billion in 2014 from a high of $5.2 billion in 2006, state figures show.

The city relied on casinos for 70 percent of its annual property taxes from 2010 to 2013. The eight remaining resorts now represent 49 percent of the tax base, according to the emergency manager’s report.
Atlantic City has borrowed to repay casinos property taxes that they said were too high. Including a $40 million state loan, debt service totals $86.7 million this year, according to the report.

‘Ambitious Timeline’

The team identified a $101 million gap in 2015 and listed potential cuts, including eliminating jobs and renegotiating employee-benefit payments. Its plan calls for proposing a restructuring and negotiating with creditors and unions through June 30.

The team said it’s not contemplating bankruptcy. Still, the installation of Orr and Lavin and their “ambitious timeline” for resolution echoes what happened in Detroit, Molin said. Detroit’s $18 billion bankruptcy ended after bondholders agreed to take losses.

The team’s plan is bad for credit, according to Moody’s Investors Service, which lowered its grade on $344 million of Atlantic City debt to Caa1, seven levels below investment grade, after Christie hired the emergency managers.

Debt payments in August and December may be at risk without quick state action to prop up the city, Moody’s said.

‘Positive’ Development

Michael Stinson, the city’s revenue and finance director, said the emergency manager team “should be viewed as a positive” development.

“We’re working collaboratively with the state,” he said. “Everybody’s on point that what needs to get done will get done in the timeframe that needs to get done.”

Moody’s has placed seven other New Jersey cities on review for a ratings cut, saying the team’s appointment for Atlantic City “may demonstrate a limit to the state’s willingness to provide emergency financial support to other municipalities.” Also, New Jersey’s “constrained” finances increases the risk of its curbing local aid, the company said.

New Jersey has had eight credit-rating downgrades under Christie amid revenue shortfalls and rising costs for pensions, benefits and debt service.

Kevin Roberts, a Christie spokesman, said he didn’t have a comment on the Moody’s report. He didn’t respond to questions regarding the possibility of the city’s bond losses and access to capital markets.

Bond Insurance

While Camden filed for bankruptcy in 1999, its case was dismissed because the city wasn’t authorized to do so by the state, said James Spiotto, a bankruptcy specialist and managing director at Chicago’s Chapman Strategic Advisors LLC, which advises on financial restructuring.

Paul Brennan, a money manager in Chicago at Nuveen Asset Management, said he expects insurance to cover any debt-service shortfalls in Atlantic City for the company, which oversees about $100 billion of munis, including city securities.

That’s not an option for most Atlantic City investors; about 58 percent of city bonds carry no insurance, according to data compiled by Bloomberg.

Any imposition of debt reductions would curtail market access for Atlantic City, said Dan Solender, who helps manage $17 billion as director of munis at Lord Abbett & Co. in Jersey City.

“Why would you lend them money if they’re already cutting the payments to existing lenders?” he said.

Stinson, the revenue director, said the city plans to sell long-term bonds by May that would refinance notes due in August and a state loan due June 30.

The city would still have market access if the team takes actions such as extending debt maturities, Stinson said.

“As long as it makes sense, and everybody’s in agreement and it’s not done unilaterally, it could be worked out,” he said.

BLOOMBERG

by Romy Varghese

March 31, 2015

The P3 for Colorado’s U.S. Interstate 36, first P3 project for Colorado’s High Performance Transportation Enterprise (HPTE), has provided the best overall value for taxpayers based upon the goals set by its project partners, according to a new report from the state auditor’s office.

The report examined the processes and the value of the project based on the project’s goals, including improving mobility, shifting financial risk away from Colorado Department of Transportation (CDOT), releasing the agency from a $60 million loan from the federal government, and shifting operations and maintenance responsibilities to the private sector.

In addition, the auditor found HPTE’s practices for developing and procuring the project were generally consistent with industry standard practices and identified areas of improvement.

“CDOT and HPTE are committed to make all P3 projects open and transparent to the public, stakeholders and our legislators,” CDOT Executive Director Shailen Bhatt said. “We take seriously the lessons learned from US 36, HPTE’s first P3 project, and are already implementing or working on the recommendations we’ve received to improve all our processes.”

As part of the report, the auditor advised HPTE to improve planning, communications and monitoring efforts and to establish a project management framework for the P3 program in the future.

The US-36 Express Lanes project was with Plenary Roads Denver allows the firm to collect revenues from toll lanes being built in both directions of U.S. 36 between Denver and Boulder.

NCPPP

By Editor March 30, 2015

Tobacco bonds may be on their way to the biggest volume since 2007, led by Wednesday’s $1.7 billion sale from California, as issuers take advantage of historically low interest rates to refinance.

Amid a decline in smoking that’s cut deeply into revenue, tobacco bond issuance this year is also highlighted by a $621 million sale last month in Rhode Island and a possible $875 million deal from Louisiana later in 2015.

Under the 1998 Master Settlement Agreement, tobacco companies agreed to pay 46 states for expenses related to smoking illnesses. Many states then formed corporations to raise cash by selling bonds backed by future settlement revenue streams from the tobacco firms.

Since 1999, more than $62 billion of tobacco bonds have been sold, according to Thomson Reuters. Most of the issuance took place in 2005 and 2007 when about $6 billion and $17 billion were issued, respectively. In 2014, only about $175 million of tobacco bonds were sold. Assuming all three deals are completed, 2015 issuance would bring the most supply in eight years.

Many of the older bonds were sold when U.S. cigarette consumption was higher, boosting revenue to the tobacco companies — the basis of their payments to the states. The revenue decline combined with lowered ratings on some issues has led market professionals to look at the sector as a source of both consternation and opportunity.

“One key thing to look at with these bonds is: `Who is doing the study of cigarette demand and consumption and how accurate is it?’,” said Michael C. Craft, managing director of credit at Lumesis, Inc.

Craft said that original tobacco bonds performed acceptably, based on the assumption of consumption declines. The problem is that the declines have now outpaced the predictions.

“Within the tobacco sector, the bonds that were issued earlier have better credits for two main reasons: one is that the financial structure and degree of leverage was conservative,” he said. “The other is that they have had a chance to pay down some of the bonds before factors became an issue, such as [non-participating manufacturer] adjustments and more rapid decline in consumption.”

Legal experts caution investors to know what they are buying — both now and in the future.

“Whether investors are buying new bonds in the primary or existing bonds in the secondary, they would be well advised that after doing their credit analysis to look at the bond indentures,” Leonard Weiser-Varon principal at the law firm of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo told The Bond Buyer. “They should look at the plumbing as to determine what the true risks are in what they are getting.”

Both Weiser-Varon and colleague Paul Ricotta also foresee some legal skirmishes ahead.

“Many expect debt service defaults on some tobacco bonds to occur within the next five years,” they wrote in a March 18 Bond Buyer commentary. “Although such defaults have not yet occurred, it is not too early for holders to take a hard look at the applicable bond documents to evaluate their rights and leverage in the restructurings or refinancings that have begun and which may proliferate in the years ahead.”

Rhode Island Roughhouse

On March 11, Citigroup Global Markets priced the Rhode Island Tobacco Settlement Finance Corp.’s $621 million of asset-backed bonds. But the bonds weren’t issued without a legal fight.

OppenheimerFunds Inc., in its capacity as a holder of Series 2007 B and C bonds, had filed a suit to halt the sale. It had argued the offering wrongfully created an amendment of the 2007 indenture and would have constituted a fraudulent transfer intended to circumvent a subordination structure.

In January, a judge dismissed the suit. The new issuance resulted in a $36 million payment to the corporation and the state, said Timothy Mungovan, a partner in the law firm of Proskauer Rose who represented the TSFC. The state is expected to save almost $1 billion over 40 years, he added.

Citi priced the TSFC’s $15.26 million Series 2015A taxables at par to yield 0.59% in 2015 and 0.80% in 2016. The bonds were rated A by Standard & Poor’s and triple-B-plus by Fitch Ratings. The TSFC’s $288.64 million Series 2015B were priced at par to yield 2.25% in 2041, as 4 1/2s to yield 4.625% in 2045 and as 5s to yield 4.80% in 2050. The bonds were rated triple-B-plus by Fitch.

The TSFC’s $317.05 million Series 2015A tobacco settlement asset-backeds were priced to yield from 0.46% with a 3% coupon in 2016 to 3.81% with a 5% coupon in 2030; a 2035 term was priced as 5s to yield 4.09% and a 2040 term was priced as 5s to yield 4.34%. The bonds were rated A by S&P and triple-B-plus by Fitch except for the 2026 to 2030 and 2035 maturities which are rated A-minus by S&P and the 2040 maturity which is rated triple-B-plus by S&P.

According to the Municipal Securities Rulemaking Board’s EMMA website, the TSFC’s Series 2015A 5s of 2040 were last traded on March 18 at a low yield of 4.14%.

California: Different, Yet the Same

This week, California’s Golden State Tobacco Securitization Corp. will be coming to market with its $1.7 billion tobacco bond deal.

The bonds are enhanced by a pledge from the state to seek an annual appropriation for debt service and operating expenses should settlement payments fall short. Proceeds will be used to repay existing tobacco bonds that do not benefit from a pledge from the state and so are more vulnerable to a shortfall in settlement payments.

“My sense is that the ‘state backed’ tobacco bonds trade more like state debt (particularly state appropriated), than like ‘pure’ tobacco bonds,” Craft said. “The investors in these bonds are exposed to MSA payments only if the state doesn’t meet its appropriation obligations to bondholders.”

The asset-backed bonds, scheduled to be priced by Citi on Wednesday after a one-day retail order period, are rated A1 by Moody’s Investors Service and A by both S&P and Fitch.

The Golden State Tobacco Securitization Corp. originally sold tobacco settlement bonds in 2003 to provide one-time resources for the state general fund under two separate, parity indentures, according to Fitch. The master indenture for series 2003B, to which 43.43% of the state’s future tobacco settlement revenues under the master settlement agreement are pledged, was enhanced with the state appropriation backup. The other bonds originally issued under a separate 2003A master indenture do not carry the state appropriation enhancement.

The official statement for the $1.7 billion for the CGSTC offering includes a research report prepared by James Diffley, a senior director at IHS Global Inc., that forecasts a continued decline in U.S. cigarette consumption through 2045.

“Our forecast indicates that total consumption in 2045 will be 104.0 billion cigarettes (or 104.6 billion including roll-your-own tobacco equivalents), a 61% decline from the 2014 level,” the report said. “From 2015 through 2045 the average annual rate of decline is projected to be approximately 3.0%.”

The report includes key factors affecting cigarette consumption such as electronic cigarettes, medical cessation benefits, price elasticity of demand, disposable income and smoking bans, to name a few.

The report also stated that in April 2013, IHS Global presented a similar study — a forecast of U.S. cigarette consumption (2012-2045) for the Tobacco Settlement Financing Corporation. That report projected consumption in 2045 of 105.7 billion cigarettes (including roll-your-own equivalents), reflecting an average decline rate of 3.0%.

“The difference, 1.1 billion, is primarily due to weaker than expected consumption in 2013,” according to the report.

Louisiana TSFC Gives Preliminary Bond OK

The Louisiana Tobacco Settlement Financing Corp. is moving ahead to securitize the remaining 40% of the state’s share from the Master Settlement Agreement with tobacco companies.

The deal, in which $875 million of bonds would be issued to raise funds for the state’s higher education scholarship program, still must be approved by the Legislature and other state agencies.

Louisiana securitized 60% of its tobacco settlement revenue in 2001 with the sale of $1.2 billion in bonds. The agency will retain the same finance team that worked on a $660 million tobacco bond refunding in 2013. The professionals on the 2013 deal were Public Resources Advisory Group Inc. as financial advisor, Citi as senior underwriter, and Foley & Judell LLP and Hawkins Delafield & Wood LLP as co-bond counsel.

The new securitization is expected to go before the State Bond Commission April 16, and the Joint Legislative Committee on the Budget May 20. A bill authorizing the deal is expected to be filed and assessed in the legislative process. If lawmakers approve the issuance, the bonds likely would be sold in June.

Rating Agencies Perspectives

In May 2014, Moody’ Investors Service published a report on the impact of declining cigarette shipments on U.S. tobacco settlement bonds. Moody’s based the projections of declining shipments (4.9% in 2013) and performed a break-even analysis that estimates the annual rate of decline in cigarette shipments that would lead to bond defaults under its base-case cash flow assumptions. Moody’s expects that 65%-85% of the aggregate outstanding balance of all tobacco settlements bonds that Moody’s rates, will default.

Earlier this month, Standard & Poor’s released a rating direct presale report on the tobacco settlement financing corp. Series 2015. S&P conducted a cigarette volume decline test, which is intended to assess the transactions ability to withstand steeper than historical average annual declines in U.S. cigarette consumption. S&P used the cash flow assumption that cigarette shipments will decline 5.25% in the transactions first year two years and 4.75% thereafter.

“Based on our calculations, the results of our `standard’ stress tests indicate that all rated classes in this transaction were able to withstand the rest, with a sizeable cushion to absorb additional potential disruptions or reductions of the MSA payments,” the report stated.

Market Performance, Trading

Tobacco bond performance has been characterized in general by stability in between bouts of volatility combined at times with illiquid trading conditions.

“Liquidity has been an issue lately for tobacco bonds,” an analyst at Markit said. “The usual factors pressuring tobacco are decreased consumption and credit risk. The latest pressure is now the uncertainty as to when the Federal Reserve will increase rates.”

Looking at two separate issuers, the Buckeye Tobacco Settlement Financing Authority, Ohio, and the Golden State Tobacco Securitization Corp., Calif., the patterns of trading activity are similar.

The Buckeye Series 2007 A-2 asset-backed 6 1/2s of 2047 starting off 2015 trading yielding 7.54% on Jan. 2 and yielding 7.38% on March 16. The bonds traded as high as 7.535% on Jan. 5 and as low as 7.14% on Jan. 30, according to Markit.

The Golden State Series 2007 A-1 asset-backed 5 3/4s of 2047 started off the year trading at a yield of 7.11% and ending on March 16 at 6.96%. The bonds traded as high as 7.11% on Jan. 2 and as low as 6.61% on Jan. 30, according to Markit.

THE BOND BUYER

BY CHIP BARNETT and AARON WEITZMAN

MAR 24, 2015 12:41pm ET

Paul Burton, Shelly Sigo and Allison Bisbey contributed to this report.

HIGHLIGHTS:

• The U.S. Department of Transportation (DOT) announced a pilot program that would permit state and local recipients of federal highway and federal transit funds to issue solicitations with “local hire” preferences.
• In its notice, DOT states “the DOT believes that local and other geographic-based hiring preferences are essential to promoting Ladders of Opportunity for the workers in these communities.” DOT also intends to permit the use of veteran hiring preferences and hiring preferences for economically disadvantaged (i.e., low-income) workers.
• There have been – and will likely continue to be – several significant legal issues to local hiring preference programs. DOT states that it will use the pilot program “to determine whether state and local preferences may be used consistent with the [DOJ’s] 2013 legal opinion.”

The U.S. Department of Transportation (DOT) announced a pilot program that would permit state and local recipients of federal highway and federal transit funds to issue solicitations with “local hire” preferences. DOT also proposes to amend its regulations to permit the use of such hiring preferences “whenever not otherwise prohibited by Federal statute.” According to the notice, the pilot program appears to apply – effective immediately – to new bid announcements. Comments on the proposed changes to DOT’s regulations are due April 6, 2015.

DOT Seeks to Promote Local “Ladders of Opportunity”

Many state and local governments have local hiring provisions that otherwise apply to their procurements, however, federal law has long been held to preclude the use of such preferences when using federal highway or transit funds. As set forth in the notice, DOT is in favor of these preferences and states “the DOT believes that local and other geographic-based hiring preferences are essential to promoting Ladders of Opportunity for the workers in these communities.” FR 12092. To this end, DOT also intends to permit the use of veteran hiring preferences and hiring preferences for economically disadvantaged (i.e., low-income) workers. However, as discussed below, there have been – and will likely continue to be – several significant legal issues to local hiring preference programs.

A federal statutory provision (23 USC 112), requires full and open competition in the bidding of federally funded transportation contracts, and has been interpreted to prohibit local hiring preferences in projects receiving federal funding. This statutory directive has been carried over into DOT’s regulations that are now found in the federal “Common Rule” applicable to federal assistance agreements (2 CFR 200.319(b)) (prior to last year this provision was set forth in DOT’s regulations at 49 CFR 18.36(c)(2)(2014)).

This long-standing statutory and regulatory scheme was interrupted, at least in part, by a narrow provision in the FY2015 Consolidated Appropriations Act (2015 CAA) which precludes the Federal Transit Administration (FTA) from using any fiscal year 2015 funds “to implement, administer or enforce” the provisions of 49 CFR 18.36(c)(2). __ P.L. ___ §418. According to DOT, the result of this “no funds” language is, “at least for FTA-funded project (sic) in FY 2015, Congress has diminished the legal effectiveness of this provision,” (i.e., the regulatory provision barring local hiring preferences).

23 USC §112 requires recipients of federal aid highway grant funds to award federally funded construction contracts by “competitive bidding.” The statute goes on to specify that awards are to be made on the basis of the “lowest responsive bid submitted by a bidder meeting established criteria of responsibility.” It also provides that a recipient may only deviate from competitive methods if it can demonstrate the other method is “more cost effective or that an emergency exists.” 112(b)(1).

DOT Using Its Pilot Program to Test DOJ’s 2013 Opinion

For many years DOT has interpreted this provision as creating an outright ban on local hiring preferences. In 2013, DOT’s Office of Legal Counsel received a lengthy opinion from the Department of Justice (DOJ) in 2013, which concludes that

Section 112 authorizes FHWA to exercise discretion to approve federally funded highway construction contracts – notwithstanding state or local requirements that have more than an incidental impact on the pool of eligible bidders and are unrelated to the necessary work – so long as such requirements, in FHWA’s judgment, advance the purposes of this statute and thus do not unduly limit competition.

Against this backdrop DOT has unveiled the pilot program and states that it will use the pilot “to determine whether state and local preferences may be used consistent with the 2013 legal opinion.” FR 12093. DOT invokes certain “experimental authorities” to justify its use of a pilot and states that it will “monitor and evaluate whether the contract requirements approved for use under the pilot program have an undue restriction on competition.” FR 12093.

FHWA and FTA Pilot Programs Vary Regarding Prior Approval

Because the “experimental” authorities DOT invokes are slightly different for FHWA and for FTA, the pilot programs vary slightly.

For FHWA-funded projects, state and local recipients must receive prior approval by FHWA to impose local hire preferences. DOT directs state and local recipients (and subrecipients) to “follow the normal process that includes submitting work plans to the appropriate FHWA division office.” Notice, p. 6-7. DOT further suggests some minimum points that such work plans should address, including describing:

• the project
• any contracting requirement that may be found inconsistent with the general requirement for full and open competition
• how the relevant contracting requirement would increase the efficiency and effectiveness of the project
• how it would “protect the integrity of the competitive bidding process”

The FTA provisions are largely the same and suggest recipients and subrecipients address virtually identical criteria. However, DOT has not imposed a prior approval requirement. In declining to do so, DOT points to the “no funds” language in Section 418 of the FY2015 CAA as prohibiting DOT from taking any action to approve such preference provisions in advance. However, DOT is still requiring recipients and subrecipients to provide reports on the implementation of these policies so DOT can evaluate them.

Debate and Litigation of Federal Statutory Bidding Requirements Will Continue

The debate over the extent of federal statutory competitive bidding requirements is far from new. As noted in the DOJ’s 2013 Opinion, the scope and applicability of those requirements – and the extent to which state and local bidding and evaluation criteria are permissible – has been the subject of debate and litigation for decades. This includes several cases in the fairly recent past about the use of project labor agreements. Putting aside whether DOT’s stated goals are meritorious from a policy standpoint, it seems likely that the body of case law in this area is about to grow again.

Last Updated: March 24 2015

Article by Robert K. Tompkins and Michael L. Wiener
Holland & Knight

Robert K. “Bob” Tompkins is a Partner in our Washington DC office and Keith M. Wiener is a Partner in our Atlanta office.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

The Pennsylvania Governor’s Office of General Counsel (“OGC”) is updating its general pool of qualified Law Firms to serve as Bond Counsel. From time to time, to the Commonwealth of Pennsylvania Office of the Budget and other agencies and authorities subject to the General Counsel’s authority, including but not limited to the Pennsylvania Economic Development Financing Authority; Pennsylvania Energy Development Authority; Pennsylvania Housing Finance Agency; Pennsylvania Infrastructure Investment Authority; Pennsylvania Industrial Development Authority; Pennsylvania Higher Educational Facilities Authority; State Public School Building Authority; and the State System of Higher Education have need for bond counsel services.

A Request for Qualifications (“RFQ”) has been issued pursuant to Section 518 of the Commonwealth Procurement Code, 62 Pa.C.S. §518, in accordance with Executive Order 2015-2 dated January 20, 2015, to specify a uniform format for Statements of Qualifications to be submitted by Law Firms in order to be qualified in the new Bond Counsel Pool. The Bond Counsel Pool that is being established pursuant to this procurement replaces, in its entirety, the prior pools of qualified Bond Counsel that were established beginning in 2007.

The Commonwealth will consider the Statements of Qualifications submitted in response to this RFQ and will establish a general Bond Counsel Pool of Law Firms meeting the Minimum Qualifications contained herein. Subject to the exceptions and conditions set forth in Executive Order 2015-2, when a specific financing transaction is identified, the Commonwealth issuer (“Agency”) will issue a request for proposals (“RFP”) with the specific requirements (the “Specific Qualifications”) relating to the transaction and the timeframe for responses to the Bond Counsel Pool. Only Law Firms qualified in the Bond Counsel Pool may respond to the RFP. The Agency will select the bond counsel firm determined to be the best qualified based on the evaluation factors set forth in the RFP. The final amount of fair and reasonable compensation shall be determined through negotiation.

ALL Law Firms wishing to participate in any capacity as Bond Counsel to the Commonwealth of Pennsylvania must submit their qualifications pursuant to this RFQ. OGC desires a diverse pool of bond counsel firms for the purpose of best assisting its Commonwealth issuers in meeting their financing goals. Firms of all kinds and sizes, including but not limited to small, diverse and women-owned firms, are encouraged to apply for admission to the Pool. Accordingly, this RFQ application process does not have a deadline. However, a Law Firm must be qualified in the Bond Counsel Pool in order to submit a proposal for a specific financing transaction announced by the Commonwealth.

The following firms are current members of OGC’s Bond Counsel Pool:

Archer Greiner, PC
Ballard Spahr, LLP
Barley Snyder
Buchanan Ingersoll & Rooney, PC
Clark Hill, PC
Cohen & Grigsby, PC
Cozen O’Connor
Dilworth Paxson, LLP
Drinder Biddle & Reath, LLP
Duane Morris, LLP
Eckert Seamans Cherin & Mellott, LLC
Fox Rothschild, LLP
Greenberg Traurig, LLP
Hartman Underhill & Brubaker, LLC
King Spry Herman Freund & Faul, LLC
Kutak Rock, LLP
McNees Wallace & Nurick, LLC
Mette, Evans & Woodside
Obermayer Rebmann Maxwell & Hippel, LLP
Rhoads & Sinon, LLP
Saul Ewing, LLP
Squire Patton Boggs, LLP
Stevens & Lee
Stradley Ronon Stevens & Young, LLP
Zarwin Baum DeVito Kaplan Schaer Toddy, PC

Pennsylvania set out to fix a major statewide problem: structurally deficient bridges.

Its solution could set a precedent.

The Rapid Bridge Replacement Project, Pennsylvania’s first public-private partnership, is also the first P3 in the U.S. to bundle multiple bridges into a single procurement

Pennsylvania intends to replace 558 bridges over three years. Last month the commonwealth raised $800 million through an oversubscribed sale of private activity bonds led by JPMorgan and Wells Fargo Securities.

The sale, which closed March 18, attracted more than 40 investors. Standard & Poor’s rated the bonds BBB.

“What we’re doing is addressing a serious problem in a calculated way,” said Bryan Kendro, the P3 director at the Pennsylvania Department of Transportation.

“I think if I could pick an initial P3 for a state, this one would be straight out of central casting,” said John Schmidt, a partner at Mayer Brown LLP in Chicago. “It does something very important, is less expensive, had strong competition and you had a winning team, all with an $800 million private activity bond.”

Plenary Walsh Keystone Partners, a consortium of construction, engineering and financing companies, won the bid last October. The team consists of Plenary Group, Walsh Group, Granite Construction Inc. and HDR Engineering Inc. Walsh and HDR maintain Pennsylvania offices. The team also includes 11 Pennsylvania-based subcontractors.

“I believe Plenary Walsh will do everything they said they’ll do,” said Schmidt, who advised Chicago in its $1.8 billion privatization of the Chicago Skyway toll bridge.

Ross Moskowitz, a partner at New York’s Stroock & Stroock & Lavan LLP, sees multiple benefits with the deal.

“You’d have to hold their feet to the fire, but my guess that it would cost significantly less than the standard PennDOT projects,” said Moskowitz, a former executive vice president with the New York City Economic Development Corp. and former executive director of the New York City Industrial Development Agency. “Whatever the delta is, the generated savings can go into other projects. That’s the beauty of it.

“Take bridges – you have similar classes of bridges for what’s needed,” Moskowitz said. “You probably have a similarity of types of bridges with the same character, structural design and deficiencies. You could do a mass production, putting them all together as one P3 contracting, allowing respondents to bid with greater efficiencies.”

Plenary Walsh expects to begin the work in May. According to Kendro, the company anticipates completing 77 bridges in the first year – up from its original projection of 58 — and targets completion of the overall project by the end of 2017.

The bid process triggered a healthy competition, Kendro said.

“We were able to rely on Plenary Walsh to execute a plan of finance,” he said. “We were just the beneficiaries of being in the market at the right time, and we were able to realize an additional $25 million in interest savings. These were very attractive bonds.”

Pennsylvania’s project could also spark a flurry of P3 activity in the Northeast, which has lagged other regions.

“I think Pennsylvania’s one of the leading Northeast P3 states right now. It’s putting some other local states to shame,” Squire Patton Boggs LLP attorney Roddy Devlin said in a recent Bond Buyer video. “It’s a very interesting project. Common approach in Europe and Canada, less common in the U.S., but if that model takes hold, it has the potential to open up the floodgates for adding lots of smaller projects into a single P3.”

The commonwealth is also seeking qualifications from companies interested in competing for a P3 that would fund, build, and operate up to 37 facilities to fuel public transit buses with compressed natural gas produced in the state. The Public-Private Transportation Partnership Office expects to issue a request for proposals later this spring.

Moody’s Investors Service said last fall the U.S. has the potential to become the world’s largest P3 market, given the sheer size of its infrastructure.

“Late to develop its P3 availability-payment market, the U.S. is able to benefit from lessons learned in the U.K. and Canada, and to some extent Mexico,” Moody’s said in a commentary.

Pennsylvania’s bridge project is one of several transportation-related P3 transactions in active procurement or expected to some to market in 2015. Others include Interstate 70 in Colorado, the Indianapolis Consolidated Justice Complex in Indiana, and managed lanes, bridge replacement and toll concession deals in Texas.

U.S. P3 activity in recent years has clustered around California, Florida, Texas and Virginia.

Then-Gov. Tom Corbett signed a Pennsylvania P3 law in 2012. One year later, lawmakers passed a transportation bill that called for a $7.4 billion investment over five years. The Act 89 bill restructured the state’s gas tax and increased a variety of fees, but armed the commonwealth with new revenue to fix its decaying infrastructure amid declining federal aid.

In crafting the P3 deal, Pennsylvania had to fend off in-state skeptics who recalled former Gov. Ed Rendell’s failed efforts in 2007 and 2008 to privatize the Pennsylvania Turnpike. A plan to lease Turnpike operations over 75 years to Spain’s Abertis Infraestructuras and Citi Infrastructure Investors died in the legislature.

“We have a long history of P3s that never made it to the finish line,” said Kendro. Most recently, at the local level, efforts to sell Philadelphia’s Gas Works utility stalled in City Council.

“If you ask the contracting community, they were skeptical about our ability to get something different done,” Kendro said.

“The biggest skeptics we were seeing were the P3 people at the national level, the contractors, investors and design firms that may have bid on the Turnpike,” he said. “From the start, we tried to build credibility and prove that this is not a one-off proposal.”

According to Moskowitz, transparency early in the process is essential.

“You’ve got to communicate early and often with all the stakeholders. That doesn’t mean everyone has to be in agreement, but the worst thing for any P3 project is for there to be mistrust within a community,” he said.

“Before and during meetings with the government, you have to meet with the community repeatedly in order to avoid any accusation of bait and switch. In any PPP, you have some guiding principles and one of them is to have an aligned vision on what is the ultimate goal, and here the ultimate goal is the rehabilitation of these bridges.”

The project straddled the tenures of governors Corbett, a Republican, and Tom Wolf, a Democrat who unseated Corbett last November.

“I can’t praise both administrations enough,” said Kendro. “Gov. Corbett and [former DOT Secretary] Barry Schoch were very supportive, then the new administration came in after the signing and helped with the financial close. We didn’t miss a beat.”

Pennsylvania thus calmed a P3 market that quickly gets skittish about political risk, said Mayer Brown’s Schmidt, a former associate attorney general in the U.S. Department of Justice and former chief of staff for Chicago Mayor Richard M. Daley.

“This was a very well done deal that transcended a shift in gubernatorial administrations from one party to another,” said Schmidt.

In New York, Gov. Andrew Cuomo’s executive budget proposal to extend design-build authority could stall in the legislature. Such authorization expired last December. Design-build enables a contractor to submit a singular bid for both the design and construction of projects. Proponents cite cost and time savings, and innovation incentives.

“It’s going to be a challenge,” said Maria Doulis, director of New York City studies for the Citizens Budget Commission watchdog organization. “It’s a little discouraging because if it’s so tough to enact design-build, how will New York be able to catch up in this P3 environment?”

THE BOND BUYER

BY PAUL BURTON

MAR 27, 2015 11:13am ET

DALLAS — President Obama’s revised six-year, $487 billion transportation proposal, delivered to Congress on Monday, would allow states to levy variable tolls on existing roads to alleviate traffic congestion, in addition to removing the long-standing ban on tolling existing interstate highways.

The Grow America Act 2.0, an expanded and extended revision of a similarly named four-year measure by the president in 2014, includes $317 billion for road projects, an increase of 29% from current funding, and $116 billion for mass transit, an increase of 76%. The transportation measure would be supported with $240 billion of fuel tax revenues and $238 billion from a new mandatory 14% transition tax on corporate foreign earnings.

The six-year proposal goes to Congress two months before the lapse of the current $10.8 billion extension of the Highway Trust Fund on May 31.

The new transportation proposal would remove the current federal prohibition of tolls on existing interstate highways if the new revenue is dedicated to road improvements anywhere on a state’s system, not just the tolled segment. Revenues generated by road tolls could be used to upgrade mass transit systems within the highway’s transportation corridor.

States and other public agencies could also levy variable-priced tolls on existing roads, bridges, and tunnels for congestion management, and could convert high-occupancy vehicle lanes to tolled express lanes.

Transportation Secretary Anthony Foxx said the six-year plan is needed to provide states with long-term funding assurance.

“Our proposal provides a level of funding and also funding certainty that our partners need and deserve,” he said. “This is an opportunity to break away from 10 years of flat funding, not to mention these past six years in which Congress has funded transportation by passing 32 short-term measures.”

Foxx warned that transportation infrastructure will continue to deteriorate without increased funding.

“I’m not going to sugar-coat it,” he said at a transportation forum Monday sponsored by Politico.

“Our road systems are really falling apart. The truth is that after years of under-investment our transportation infrastructure is starting to show cracks.”

Foxx conceded that it would be difficult to pass a multiyear transportation bill funded through corporate tax reform before the May deadline, but said the effort is worthwhile.

“We have a bill and it is paid for,” he said. “We’ve got to get out of this box of rooting against ourselves as a country. The answer to the problem is a political one.”

Foxx encouraged state and local officials to contract their congressional delegation in support of the president’s transportation bill.

“During these next two months, though, all of us who work in Washington need to be relentless in trying to get to ‘yes’ on a bill that is truly transformative and that brings the country together,” he said.

The administration’s proposal supports public-private transportation investments by creating an undersecretary position for innovative finance within DOT and raising the cap for federally allocated transportation-dedicated private activity bonds to $19 billion from the current $15 billion, Foxx said.

The six-year bill would provide $77.16 billion of total federal transportation spending in fiscal 2016, rising to $82.3 billion by fiscal 2023. Current spending is about $55 billion a year.

Revenues from federal gasoline and diesel taxes are expected to total $239.3 billion over the period.

The proposal includes a new $6 billion competitive grant program for innovative highway and transit projects and doubles the current funding for the Transportation Investment Generating Economic Recovery discretionary grant program to $7.5 billion.

A new intermodal competitive grants program would provide $18 billion over six years for rail, highway, and port freight movement projects. The measure would also provide $28.6 billion for high performance rail and passenger rail.

THE BOND BUYER

BY JIM WATTS

MAR 30, 2015 2:51pm ET

Sometimes knowing what not to invest in is better than knowing what to buy. No longer hiding in plain sight are the public unfunded state, city and teachers pension liabilities. The numbers are staggering. Some of our elected officials have chosen to load their unfunded liabilities onto the backs of municipal bond investors. Don’t fall for it.

Here are some specifics: According to Bloomberg, there have been $340 million worth of pension bonds sold so far in 2015. But wait—billions more are on the way. Those currently on the radar screen include Kentucky Teachers Retirement for $3.3 billion; Pennsylvania with $9 billion; Kansas with $1.5 billion; and New Haven, CT with $125 million.

From the Detroit bankruptcy, Pension Obligation COP bond owners recovered a measly 13 cents on the dollar. That’s all, just 13 cents. The pension plans (composed of voters) fared far better.

The rationale proposed by these under funded entities is to sell taxable municipal bonds, then inject the proceeds into their respective funds. They’re betting the farm that they can earn more investing in the markets than it costs them to pay you, the pension bondholder. Sounds like a good idea. Until, you remember that the equity markets have hit all-time highs. How much higher do these savants think it will go before it retreats?

A decade ago New Jersey tried the same thing and Illinois followed. The market went against them. Their pension payments fell behind. Now they’re in even worse shape than if they had never issued the pension bonds. These pension bond issues are generally going against professional wisdom and advice. The Government Finance Officers Association recommends against it. BlackRock, a manager overseeing $116 billion in state and local debt, does too.

What do the rating agencies have to say about Pension Obligation Bonds? A lot. Moody’s is now weighing in on those unfunded liabilities in their overall bond ratings. For that I am glad. However, beware that retail investors will be the last to learn about any downgrades due to unfunded pensions.

Do not invest in any taxable pension obligation bonds. Corporate bonds will prove a better source of taxable income.

One that I like is DirecTV. They may be blessed by the regulators to be acquired by AT&T. If the acquisition happens the two companies combined will have a formidable market share of the video and television business. It also appears there will be business synergies. Buy DirecTV 3.80% due March 15, 2022 CUSIP: 25459HBF1.

The issue size is $1.493 billion so execution is not a problem. If you pay 104, that’s 3.16% yield to maturity on this non-callable bond. Even though the bond has a change of control provision investors will welcome the acquisition because the rating agencies have it on an upgrade watch.

Most investors are familiar with REITs. Digital Realty is a specialized REIT in the technology space. Its facilities house tech industry enterprise data centers that Digital Realty customizes and leases to their clients. Buy Digital Realty bonds, 3.625% due October 1, 2022, CUSIP: 25389JAK2. If you pay 100.75, you’ll earn 3.51% to maturity with a well-deserved BBB investment grade rating.

Leave those Pension Obligation Bonds to those who don’t do their homework. The risk isn’t worth it.

Forbes

Marilyn Cohen, Contributor

3/26/2015

Traditionally, investors seeking retirement income have put a significant portion of their assets into municipal bonds.

After all, the risks are supposedly low, and the income is free from federal income tax. That’s an important consideration for those in a high tax bracket even after retirement.

But today I’d like to issue a stern warning for all upcoming retirees…

In the current low-interest-rate environment, the risk-return tradeoff for muni bonds is downright frightening.

America’s Growing Gap

Across the country, state pension fund deficits have yawned since the 2008 financial crash. And the problem has only appeared to lessen recently because of the Fed-fueled stock market rise. When the Fed normalizes interest rates, it’s likely that the stock market will normalize, too, which will further increase state pension fund deficits.

If a recession occurs at the same time, it’s unlikely that state revenue will be able to cover pension fund holes… As a result, numerous state and municipal bankruptcies could occur.

If you want to see the kinds of losses muni investors could face if things go wrong, look no further than Detroit’s recent bankruptcy.

Even the most senior general obligation bondholders received just $0.74 on the dollar, while more junior bondholders received as little as one-third of their money. Municipal pension recipients, meanwhile, were almost fully protected.

It also doesn’t help that valuable assets – in this case, the $8-billion Detroit municipal art collection – proved impossible to liquidate for the benefit of bondholders. That failure reversed the deal bondholders thought they had, where senior debtholders were supposed to rank ahead of almost everybody except the IRS.

Editor’s Note: Muni bonds sure look hazardous – but where are investors supposed to turn? Well, did you know there’s a brand-new, private currency sweeping America right now? One simple investment could net $56,700 in the next 9 to 12 months. But you must act fast to maximize your gains…
So where are the biggest pitfalls right now?

According to a Bloomberg report, 2013’s worst state pension-funding gap was in Illinois, where state pensions are 39% funded. Kentucky (44% funded) and Connecticut (49% funded) weren’t far behind. New Jersey (64% funded) ranked 17th worst. But more recent 2014 data, calculated on a new accounting basis with less “smoothing” of investment returns, suggests that New Jersey pensions were only 28% funded.

The problem is widespread, with only six of 50 states more than 90% funded. Naturally, investors should avoid the states with the biggest gaps – especially when bonds from the country’s worst-funded state only yield a little over 2% for a 10-year maturity, according to Municipalbonds.com. That yield (which barely covers inflation) carries considerable price risk should interest rates rise. And in no way does it compensate investors for the Illinois default risk.

Plus, investors once had an additional advantage when buying their own state’s municipal bonds – interest is free from both state and federal income tax in that instance – but today’s ultra-low interest rates have mostly destroyed that benefit.

Consider Illinois’ 5% income tax rate, for example. An Illinois resident only receives an additional 0.1% (2% x 5%) yield on an Illinois state bond compared to an out-of-state buyer.

Meanwhile, there’s another factor investors often overlook: If the state gets into financial trouble, taxes on residents will undoubtedly be raised, much as they were in 2011 when the state income tax rate rose from 3% to 5%.

Few, if Any, Investments Worth the Time

Finally, investing in truly safe municipal bonds doesn’t seem worth the effort, either. The Wells Fargo Advantage Wisconsin Tax-Free Fund (SWFRX), for example, invests in the obligations of that fully funded state, but offers a measly 1.4% yield from doing so. While the fund managed a satisfactory 6.9% return in 2014, that gain was the result of a general decline in interest rates; at current levels, the fund is extremely vulnerable to a general rise in rates.

Oddly enough, one area where you may do better is in high-yield municipal bonds. These assets focus on revenue bonds related to somewhat-risky municipal-backed investments. Naturally, some of these investments will fail. A recent famous case involved a waste incinerator constructed by Harrisburg, Pennsylvania that suffered a two-fold cost overrun. It caused the city to default on $280-million worth of debt.

Still, the risk from rates rising is somewhat less on these bonds, because their yields are already far above the Treasury bond yield. Plus, the tax exemption is naturally worth more when you’re receiving more interest.

One potential investment is the T. Rowe Price Tax-Free High Yield (PRFHX) bond fund, a $3.4-billion fund that yields a solid 4%. It has also outperformed the Lipper High-Yield Municipal Bond index over the last 10 years. The fund invests in a very broad range of obscure municipal bonds, and the biggest holding is just 1.3% of assets. The risk, therefore, is diversified. Though a deep recession would doubtless affect it badly.

In general, though, given the risks involved and the modest size of their tax benefit at current yields, municipal bonds aren’t an especially good deal right now.

Good investing,

Martin Hutchinson

Published Wed, Mar 25, 2015 | Martin Hutchinson, World Banking Analyst

wallstreetdaily.com

In this week’s Extra Credit, Standard & Poor’s Senior Director Kate Choban discusses our recent rating action on Willacy County LGC’s jail revenue bond and Director John Kenward explains what’s behind Chicago Public School’s rating and our thoughts on swap termination payments.

Listen to the Podcast.

Mar 26, 2015

Read the Brief.

Municipal Market Analytics | Mar. 23

Amid bitter political battles over the rising costs of teacher’ pensions, policy-makers typically overlook an important cost driver: the salary raises offered to late-career teachers.

Here’s how it works: When a teacher retires, the highest few years (or, in the case of California, the highest single year) of salary determine the teacher’s pension payout. Because of the highest-salary feature, the cumulative value of the pension payout is highly sensitive to even modest changes to late-career salaries. Give a raise in the final year of teaching, and the teacher gets a raise for life.

While most public-pension plans have rules in place to prevent the “spiking” of salaries just before retirement, it is still standard practice for school districts to award the largest dollar-amount raises to the most-senior teachers. Take San Diego Unified, where leaders awarded a 5 percent raise for 2014-15. For a veteran teacher set to retire at the end of the year and earning $93,900, this raise brought in a $4,700 boost. (For a junior teacher earning $40,000, the raise paid only $2,000.) Because a higher final salary means larger pension payments, the retiring teacher will see lifetime pension earnings jump by $101,000 as a result of the raise.

New analysis by Georgetown University’s Edunomics Lab shows just how responsive pension obligations are to a teacher’s final salary. A near-retirement teacher in California earns an average of $91,000, which triggers a starting pension of about $70,000. Every dollar increase of that teacher’s salary during his or her last year triggers over 13 times as much in cumulative pension payments. The situation is the similar in other states: In New Jersey, every salary dollar awarded in the final average salary (based on the last four years) creates $9.96 in pension obligations; in Illinois (based on the last three years), the multiplier figure is $15.51.

Why aren’t school-district leaders controlling pension debt by better managing final salaries? Because districts don’t own the pension bill. States do. If the school district had to pay the pension costs for their employees directly, leaders might think twice about awarding big raises to teachers just before retirement. But the pension fund is a shared fund across all districts in the state.

And so districts behave as we’d expect, by maximizing their individual interests at the expense of the whole. In economics terms, this is called the “tragedy of the commons.” Consider a group of ranchers grazing their cattle on open land. Each rancher, looking at his own costs and benefits, has an incentive to overgraze the land, even though collectively the group of ranchers is better off if no one overgrazes.

Similarly, each school district concludes that it can leverage more earnings for its staff by boosting the pay of senior teachers (at the expense of junior teachers) and “overgrazing” the state pension fund. The pension arrangement distorts spending choices, since younger teachers get no such subsidy. In the end, the pension debt takes a toll on all districts when state coffers have few funds left over for schooling.

This is not a critique of the defined-benefit pension plans that teachers typically enjoy. Social Security is a defined-benefit plan, but it bases the pension annuity on 35 years of earnings, so there are no incentives for this type of gaming.

What’s the remedy for teachers’ pensions? States could start by requiring school districts to pay their proportionate full share of the pension bill. Where districts’ salary policies create more pension debt, those districts would pay that incremental portion directly to the pension fund. District leaders then would have to consider the full pension costs of raises as they negotiate them.

Where pension costs continue to be unsustainable, districts and labor organizations might start considering tradeoffs in salary and pension-calculation rules, including the number of years factored into the benefit calculation.

If nothing is done, we may be headed, as in the cattle-ranching example, toward a landscape of barren, overgrazed pension funds. That’s a frightening prospect for taxpayers, school districts and educators alike.

GOVERNING.COM

BY MICHAEL PODGURSKY, MARGUERITE ROZA | MARCH 26, 2015

Taylor Riggs, an editor at Bloomberg Brief Municipal Market, talks with Bill Gurtin, chief investment officer at Gurtin Fixed Income.

Watch the Video.

March 26, 2015

(Bloomberg) — Charter schools are selling a record amount of municipal debt. For investors, the challenge is that defaults by the publicly funded, privately run institutions have also never been higher.

Underscoring the risk to bondholders such as Nuveen Asset Management, two New York schools are set to shut at the end of this school year after their charters were revoked this month for academic shortcomings. The closings represent a default under terms of the $15 million bond deal that financed the land acquisition and construction of Brighter Choice’s middle schools for boys and girls, which opened in 2010 under the same roof.

While charter schools are gaining popularity across the U.S. as an alternative to local systems, their default rate reached an all-time high last year of 5 percent of outstanding issues, according to a biannual study by the New York-based Local Initiatives Support Corp. That’s up from 3.8 percent in 2012.

“Charter schools not only wrestle with financial operations and student demand, but also with maintaining their charter, which is highly dependent on their educational outcomes,” said Matt Fabian, a partner at Concord, Massachusetts-based research firm Municipal Market Analytics.

Record Haul

The schools began tapping the $3.5 trillion municipal market in 1998 and have issued about $10.4 billion of bonds in 800 transactions, according to Local Initiatives Support Corp., a community-development organization. Last year’s tally of about $2 billion was the most yet, according to Municipal Market Analytics.

While accounting for less than 1 percent of sales, the schools are gaining stature in the tax-exempt market as enrollment climbs. The institutions enrolled 4.6 percent of U.S. public school students in 2013, up from 2.1 percent a decade ago, according to the National Center for Education Statistics.

For investors who can stomach the risk, the securities offer a way to pad returns.

Brighter Choice obligations sold for the middle schools and maturing in July 2042 priced three years ago to yield 7.5 percent, data compiled by Bloomberg show. That was about 4 percentage points above benchmark munis.

Fitch Ratings cut the debt March 20 to C, 11 steps below investment grade. The tax-exempt bonds were sold through a Phoenix industrial development authority.

Securities sold for Brighter Choice’s elementary schools and that mature in April 2020 traded last month at about par, to yield 4.75 percent, or about 4.2 percentage points above benchmark debt, Bloomberg data show. Fitch grades the bonds B+, seven steps above the middle-school debt.

Bond Compliance

The State University of New York Charter Schools Institute’s board of directors, which oversees authorization, voted not to renew the middle schools’ charters this month, even as the organization reported compliance with bond covenants, according to Mahati Tonk, the institute’s director of charter-school information. Brighter Choice’s two elementary schools had their charters renewed last week.

In the 2013-2014 year 53.8 percent of the middle school’s 8th-grade boys scored at or above state-mandated proficiency levels for science, short of the 75 percent benchmark set by the SUNY authority. The boys’ school ranked in the 23rd percentile statewide in math.

Falling Short

“They knew that they were falling far from the academic expectations and were in jeopardy of losing their renewal,” said Susie Miller Barker, executive director at the SUNY institute in Albany.

The finances were on more solid footing. As of the end of December, Brighter Choice reported 76.42 days of cash on hand, almost quadruple the required amount, bond filings show. The debt-service coverage ratio of about 1.3 exceeded the required 1.10 figure, according to the filings.

Calls to the Brighter Choice schools were referred to Lynea Woody, vice president of improvement at the Albany Charter School Network, which runs them. The organization runs Brighter Choice. Woody said she didn’t have an immediate comment.

Bondholders will try to sell the schoolhouse to recoup their investment, said John Miller, who oversees $100 billion of munis as co-head of fixed income at Nuveen in Chicago. The company has invested in more than 250 schools, Miller said.

“Recovery rates are all over the place,” he said. “In some cases we’ve been in the 60 to 70 percent range for the rare foreclosure.”

Nuveen is the biggest holder of the Brighter Choice middle-school debt, data compiled by Bloomberg show.

Students’ Fate

The majority of the 400 students attending the middle schools will look to switch to the Albany district, which doesn’t have room, said Ron Lesko, a district spokesman.

“We have our own enrollment growth that’s been fairly significant in recent years,” Lesko said. “We’re already at max capacity.”

To accommodate the influx, the district may buy the Brighter Choice building, keep the students there and hire staff, Lesko said.

“We want to come to some sort of reasonable financial arrangement,” Lesko said. “But if that’s not possible and we can’t, we have another building in mind.”

The alternative site is available for a reason: It housed another failed charter school that closed in 2010, Lesko said.

The building had about $20 million in obligations attached to it and the district bought it for $2.5 million in 2012.

by Kate Smith

March 24, 2015

To contact the reporter on this story: Kate Smith in New York at [email protected]

To contact the editors responsible for this story: Stephen Merelman at [email protected] Mark Tannenbaum, Alan Goldstein

Taylor Riggs, an editor at Bloomberg Brief, talks with Joe Mysak about this week’s municipal market news.

Watch the Video.

March 26, 2015

(Bloomberg) — The $3.5 trillion municipal market’s fallen angels are rising again.

U.S. localities that failed to pay investors or got swept up in costly development projects have seen their prospects brighten after sinking to junk. While names such as Harrison, Menasha and Vadnais Heights may not resonate with most Americans, they gained infamy among bond investors after stumbling into fiscal peril.

They’re among communities getting a boost from almost six years of economic growth: Moody’s Investors Service’s upgrades outpaced downgrades last quarter for the first time since 2008.

“It’s not for us to keep these places in the penalty box,” said Alfred Medioli, a Moody’s analyst in New York. “They don’t have major economic issues. There’s new management in place, so presumably they wouldn’t be making the same mistake of underwriting projects that they couldn’t pay for.”

In the past seven months, Moody’s raised Harrison, which had struggled with debt tied to the New Jersey home of Major League Soccer’s Red Bulls, to Baa3, one step above junk; and elevated Menasha, Wisconsin, and Vadnais Heights, Minnesota, to Baa2, one level higher. The upgrades are rebuilding trust between investors and the localities, which got burned by backstopping debt for commercial or sports-related development projects.

Menasha’s Mishap

Menasha, 100 miles (161 kilometers) north of Milwaukee, got a three-step increase from Moody’s in January. The community of about 17,600 hasn’t had a grade that high since 2009, when it fell to junk for failing to appropriate funds to pay debt backing a distressed steam plant. Investors ended up getting 75 percent of what they were promised.

“It wasn’t a dollar-for-dollar payback, and I know that’s one of the things that Moody’s didn’t like and the reason they didn’t want to go back to investment grade,” said Peggy Steeno, the treasurer.

Steeno took the post in 2013 and said she highlighted to Moody’s how the locality has moved past its struggles. The sale of the plant last year stabilized its finances, Moody’s said.

“Appropriating is critical,” she said. “I would never issue bonds without making sure the appropriation was there and the proper steps were in place.”

Downgrade Debacle

About 280 miles west, in the Minneapolis suburb of Vadnais Heights, officials in 2012 refused to appropriate funds for a youth sports complex that didn’t meet projections and left the city on the hook for debt. Its rating plunged to junk after it formerly carried the third-best investment grade.

Last year, holders of senior-lien lease bonds backing the sports center recovered 45 percent of what they were owed after the surrounding county bought the facility, Moody’s said in a report. Without the complex burdening its finances, the community earned a two-level upgrade from Moody’s in October.

“We will certainly consider past experience when evaluating future projects,” Kevin Watson, the city administrator, said in an e-mail.

The credit rebound may encourage other localities to consider walking away from lease or appropriation debt, said Tom McLoughlin, head of muni fixed-income in New York at UBS Wealth Management Americas, which oversees about $85 billion in munis.

‘Penalty Box’

“Their time in the penalty box appears to be shorter,” McLoughlin said. “It increases our concern about local-government general-fund obligations and whether they deserve a big place in individual investor portfolios.”

Standard & Poor’s also sees signs of strength from once-downtrodden municipalities, known as fallen angels when they lose their investment-grade ranks.

This month, S&P revised the outlook to positive on Central Falls, the formerly bankrupt Rhode Island city rated two steps below investment grade. In February, it put a positive outlook on Moberly, Missouri, which in 2011 opted not to make payments on $39 million of bonds that a local authority sold to lure an artificial-sweetener plant project that collapsed.

Moberly “has other appropriation debt that they’ve budgeted on time,” said John Sauter, an S&P analyst in Chicago. “The real mover that’s different now is that they’ve gotten to the point where they’ve adopted a new debt policy.”

Moberly Moves

Moberly in December created an economic-development commission that would use an independent third-party to vet companies, according to S&P, which says it’s holding off on an upgrade because the policies haven’t been tested.

There are exceptions to the revival, as some municipalities grapple with more than just failed projects. About 50 localities are rated below investment grade, or 0.5 percent of those rated by Moody’s, Medioli said.

Atlantic City, New Jersey, for one, became a fallen angel in July. The gambling center is confronting a downward economic spiral as casinos expand in neighboring states.

Moody’s said in a report Thursday that Atlantic City may default on its bonds. Its emergency manager released a report this week that proposed debt deferrals as one solution.

Moody’s also cut Wayne County, Michigan, home of Detroit, three steps to speculative grade last month after its county executive warned of a “financial Armageddon” in 2016 unless it reduces a projected $70 million deficit.

The lesson for localities is that choosing to not pay for debt tied to development may prove a better option than appropriating and straining their finances, said Howard Cure, director of municipal credit research in New York for Evercore Wealth Management LLC, which oversees $5.7 billion.

That means investors shouldn’t expect lasting punishment for governments reneging on obligations.

“If they can explain why they didn’t pay for a particular series of debt, but continue to pay for their other series, the rating agencies are willing to eventually forgive and forget what they did,” Cure said.

by Brian Chappatta

March 25, 2015

To contact the reporter on this story: Brian Chappatta in New York at [email protected]

To contact the editors responsible for this story: Stephen Merelman at [email protected] Mark Tannenbaum, William Selway

(Bloomberg) — The $3.5 trillion municipal market is on pace for its best March performance since 2008, defying a history of weakness in the month as higher tax rates stoke demand.

Munis have gained about 0.3 percent in March, after posting losses in the month in eight of the past 10 years, partly as investors sold to pay tax bills, Bank of America Merrill Lynch data show.

With the top federal tax rate climbing to 39.6 percent as of last year, the highest since 2000, investors have less incentive to sell before the April 15 tax-filing deadline. Underscoring the heightened demand, muni mutual funds have lured $1.3 billion in March, the most for the month since 2012, Lipper US Fund Flows data show.

“Given the higher federal marginal tax rate, there’s more of a compelling argument to hold muni positions,” said Jeffrey Lipton, head of muni research at Oppenheimer & Co. in New York.

City and state debt has earned about 1.1 percent this year, after a 9.8 percent gain in 2014, the best annual performance since 2011.

Munis still aren’t keeping up with Treasuries, which have returned 1.3 percent this year.

Surging supply is contributing to the underperformance, said Dan Heckman, a fixed-income strategist who helps oversee $126 billion at U.S. Bank Wealth Management in Kansas City.

Issuers are taking advantage of interest rates close to generational lows to refinance, pushing 2015 sales to about $92 billion, compared with $54.1 billion in the same period last year, data compiled by Bloomberg show.

If history is any guide, April may bring more gains. Local-government bonds rose in April in nine of the past 10 years.

“When investors are looking at alternatives, there are very few in the fixed-income market that have as many positive aspects as the municipal market,” Heckman said.

BLOOMBERG

by Meenal Vamburkar

March 27, 2015

To contact the reporter on this story: Meenal Vamburkar in New York at [email protected]

To contact the editors responsible for this story: Stephen Merelman at [email protected] Mark Tannenbaum, William Selway

NEW YORK — Conditions were nearly perfect for municipal bonds last year, leading to sizable returns. Perfection never lasts, though, and managers of municipal-bond funds are forecasting more modest returns in upcoming years.

The backdrop for municipal bonds last year was as pleasant as the first warm, spring breeze: Interest rates were falling, the economy was strengthening, demand was high for bonds that pay tax-free income and supply was relatively low. Add it up, and the Barclays Municipal Bond index returned 9.1 percent in 2014. Just don’t expect a repeat.

“Definitely manage those expectations,” says Diederik Olijslager, who co-manages the $3.9 billion USAA Tax Exempt Intermediate-Term fund, among other municipal-bond offerings. “It’s fixed-income investing, it shouldn’t be 10 percent returns a year.”

Gains are still likely in coming years, but managers say they’re likely to be closer to 2 percent or 3 percent, depending on the type of bond. Another cloud in the forecast: Managers also expect volatility to pick up following a very calm 2014.

Investors have already had a sneak peek: The Barclays Municipal Bond index fell in February, its first monthly loss since 2013, snapping what had been its longest winning streak in more than two decades. Among the factors affecting the municipal-bond market:

— YIELDS ARE LOW.

Municipal bonds are producing less income than a year ago because their yields key off Treasury rates, and the yield on the 10-year Treasury note is below 2 percent. It was around 2.70 percent a year ago and close to 4 percent five years ago.

Rates are so low, the worry is that they will rise and knock down the price of existing bonds. And the improved job market means most economists expect the Federal Reserve to raise short-term rates later this year.

Conventional wisdom says that investors worried about rising rates should focus on short-term bonds. That’s because long-term bonds lock in yields for longer periods of time, which makes their prices more sensitive to rate changes.

But even after the Fed hikes rates, long-term rates could continue to stay low given how weak inflation is. That’s one reason Josh Gonze, a portfolio manager at Thornburg Investment Management, is staying neutral on interest rates and refraining from leaning on just short-term bonds. Thornburg manages $10 billion in municipal bonds.

Gonze says he’s not willing to bet on where long-term rates will go relative to short-term rates: “I know that I don’t know, and I know that no one else knows either.”

— SUPPLY IS RISING.

States, cities and other local governments are issuing bonds at a faster pace this year, and when the supply of anything increases, that can push prices lower. Just look at what’s happening to oil, where a buildup in supplies has caused its price to more than halve since last summer.

Local governments issued $62.2 billion in bonds through the end of February, a big jump from the $36 billion they issued at the same point last year. Governments are taking advantage of cheap borrowing costs to replace higher-cost debt and pay for new projects.

Continue reading the main storyContinue reading the main storyContinue reading the main story
“They’re borrowing money at basically nothing,” says Gonze. “If I were a city, county or state, I would go ahead and borrow as much as I could.”

— DEMAND REMAINS STRONG.

Supplies are rising, but so is demand, which means buyers are snapping up all those additional municipal bonds.

Individual investors make up the bulk of the market for municipal bonds and they’re pouring in billions of dollars each month. They’re attracted to the prospect of tax-free income, particularly given higher federal income-tax rates. Income from muni bonds is free from federal taxes and can also be exempt from state and local taxes in some cases.

Municipal-bond mutual funds and exchange-traded funds drew a net $32 billion in investment in 2014. In the first two months of 2015 alone, they’ve attracted another $8.6 billion. That demand is helping to offset the impact of higher supplies.

— THE ECONOMY IS IMPROVING.

The strengthening job market is helping the finances of state and local governments. A larger workforce means higher collections of income taxes, sales taxes and other revenue. That raises confidence in municipalities’ ability to repay their debts.

Managers have concerns about finances in some high-profile areas of the market, including Illinois and Puerto Rico, as well as bonds from government that are reliant on oil-related revenue. But managers say financial strength is generally improving across the country.

— WORRIES ARE RISING ABOUT EASE OF TRADING.

When times are good, it’s easy for fund managers to find buyers for their municipal bonds. The concern is what will happen when times are tough.

Historically, Wall Street banks and other broker-dealers have stepped in to buy bonds during stressed markets. In financial-ese, the banks provided liquidity, helping the market to remain free-flowing. But new regulations mean banks are less willing to hold bonds on their balance sheets.

That has several fund managers bulking up their holdings of cash and the highest-quality municipal bonds to help protect them in case liquidity dries up during a sell-off.

By THE ASSOCIATED PRESS

MARCH 26, 2015, 3:06 P.M. E.D.T.

Investor demand for municipal high-yield securities has been muted for the past month as preoccupation with rising interest rates and the stigma surrounding speculative credits outweigh the lure of wider-than-average spreads, according to two market analysts.

They say the ongoing uncertainty over interest rates, bulging supply in the investment-grade sector, and the negative performance of credits such as tobacco and Puerto Rico, are distracting investors from the municipal high-yield market.

The spread between the S&P Municipal Investment Grade and S&P High Yield indices has widened to 407 basis points as of March 19, an indication of value in the municipal high yield sector, said Stephen P. Winterstein, managing director of research and chief municipal strategist of municipal fixed income at Wilmington Trust Investment Advisors Inc., in a March 17 report.

The spread, he said in a March 19 interview, is “fairly compelling” compared with the past three-years, during which spreads tightened to 217 basis points in February 2013 and were as wide as 421 basis points in August 2014.

The spread is more attractive than other fixed-income alternatives, but that doesn’t seem to be enough to attract many investors who are waiting on the sidelines, according to Jim Colby, senior municipal strategist at Van Eck Global.

As if the expectation for higher interest rates had not already provoked uncertainty and volatility in the fixed income markets in general, the suggestion of yet another delay from the Federal Open Market Committee last week is exacerbating the torpor in the municipal high-yield market, Colby said in an interview on March 19.

“That played into investors taking a step backward and waiting to see if rates do indeed rise and then return to the high-yield world,” he said.

The removal of the word “patient” from the FOMC’s language at a meeting on March 18 caught the market off guard, Colby added.

“The market was preparing itself for a different outcome” other than Fed chairman Janet Yellen indicating a possible June time frame for an initial increase, Colby said. “The market was more prepared that the Fed was going to raise rates in April,” he added.

Yellen said given the continued improvement in economic conditions, the Fed doesn’t want to rule out the possibility that an increase in the target range could come at subsequent meetings to the April FOMC meeting.

“Today’s modification of our guidance should not be interpreted to mean that we have decided on the timing of that increase,” Yellen said. “In other words, just because we removed the word ‘patient’ from the statement doesn’t mean we’re going to be impatient.”

The latest in a long line of delays has curtailed trading activity and demand for municipal high-yield over the last four to five weeks, Colby said — except for some limited trading volume among professional money managers.

“We really haven’t seen any activity or any interest in the high-yield space since a mid-February time frame” when the market traded off slightly and new issue supply in the investment-grade space increased amid ongoing uncertainty about rates, he said.

Colby said neutral flows into Van Eck’s own Market Vectors exchange-traded fund products in particular are a barometer of recent non-activity in the municipal high-yield sector.

“Market-makers are biding their time waiting for indications of interest on the investor side,” Colby said.

There has been no new net cash to put to work, he said, adding that flows into the ETFs have “flat-lined” so far in 2015 – which is consistent with last year.

Colby noted that the Barclays Municipal High Yield Index is up just 1.53% and the Van Eck High Yield Index is up 2% year to date as of March 19 – but said much of that growth accrued back in January, when the market presented a strong tone after the fourth quarter.

Any growth has been minimal since then, as “the market is struggling to find indexes that are showing much more than just a minor positive profile in terms of returns,” Colby said.

In addition, the uncertainty over the timing of a planned Puerto Rico Infrastructure Finance Authority sale could further slow the municipal high-yield market, Colby noted.

The deal, which has been postponed more than once, could reportedly come as large as $2.95 billion.

“Without that $3 billion deal floating into high-yield, the rest of the supply in the high-yield marketplace will likely get more attention and prices are likely to rise because there isn’t an immediate substitute on the horizon,” Colby said.

Still, in the meantime, the municipal high-yield sector is “very favorable,” he added. The value is derived from the technical factors – including the after-tax comparison to other fixed income asset classes, as well as to corporate high-yield securities, according to Colby.

“The ratio comparison of municipal high yield to corporate high yield at 106.97% 9 [as of Feb. 27, 2015] suggests that municipal high yield – not even adjusted for taxes – is nominally higher,” he said.

That was up from 96.28% as of Jan. 30, and is compared with an average of 83.12% dating back to March 31, 2005, according to data from Van Eck and FactSet, an independent financial and analytical data firm cited in Colby’s report.

The ratio peaked at 136.05% as of June 30, 2014, the data showed.

Winterstein warned that the spread widening comes with a caveat.

The S&P municipal high-yield index is comprised of 26% of Puerto Rico bonds and 15% of tobacco paper — two of the market’s riskiest sectors, he pointed out.

“Investors should have little to no Puerto Rico or tobacco exposure,” given their track records, he said.

Puerto Rico Gov. Alejandro Garcia Padilla has come under fire for his proposed tax overhaul, which includes a shift from a 7% sales tax to a 16% value added tax to help the commonwealth pay debt service.

While tobacco bonds provided some of the highest returns in the municipal market in 2014 and yields soared during a sell-off in the fourth quarter after Bill Gross’ departure from PIMCO, as structured finance instruments, they are also sensitive to high-yield corporate funds, traders have said.

“With domestic consumption rates in a secular decline,” Winterstein said of tobacco. “We don’t think the long-term economics support the sector.”

A new $1.7 billion tobacco deal from California’s Golden State Tobacco Securitization Corp. is planned for pricing by Citigroup Global Markets on March 24. The bonds are rated A1 by Moody’s Investors Service, AA by Standard & Poor’s, and A by Fitch Ratings.

THE BOND BUYER

BY CHRISTINE ALBANO

MAR 23, 2015 1:50pm ET

Language in the fiscal 2015 defense authorization bill is spurring the Army to fully embrace a unique partnership authority allowing installations to enter into intergovernmental support agreements with local communities to provide municipal services. Traditionally, military bases have been cloistered communities separate from nearby municipalities and providing redundant services for soldiers.

Read More.

March 19, 2015

Read the Brief.

Municipal Market Analytics | Mar. 17

A Governing analysis shows how a new accounting rule dramatically changes some plans’ pension liabilities and will likely force many states to finally face their obligations.

Standing in a crowded hallway outside a committee room in the Kentucky State Capitol, House Speaker Greg Stumbo is surrounded by thankful teachers and skeptical reporters. It is mid-February and the committee has just approved his proposal to borrow $3.3 billion to shore up the state’s teacher retirement system. Stumbo has argued that current, historically low interest rates are a window of opportunity to solidify funding for the troubled system. But, notes one reporter, borrowing $3.3 billion would be a challenge since it would be the largest bond offering in Kentucky’s history.

Yes, Stumbo counters, but the state already owes the money. “You shouldn’t be scared of that fact,” he says. The key questions are: Is the market favorable? Is the plan sound? Will it bring stability to the fund? “The answer to all three of those,” he says emphatically, “is yes.”

For now, Kentucky won’t be borrowing the $3.3 billion. The state Senate voted in March to study the funding issue further. Meanwhile the problem is clear. Last year, the Kentucky Teachers’ Retirement System (KTRS) saw its unfunded pension liability swell by nearly $9 billion. Suddenly, the system appeared to have less than half the assets it needed to pay its retirees. Kentucky’s funding status stood at 46 percent — a drop of 6 percentage points from 2013. It was the biggest single-year drop reported by the plan since the tech stock bubble burst in 2001.

This time, however, the culprit wasn’t a slide in the stock market — it was accounting. Thanks to new pension accounting rules put forth by the Governmental Accounting Standards Board (GASB), Kentucky, along with a handful of other plans, has been forced to lower its discount rate — that is, the rate of return on its investments that it uses to determine the value of its total pension liabilities. The higher the expected rate of return, the lower the amount of funding a government needs to pay into its pension plan. The opposite is true when the rate of return is lowered. For Kentucky, which had to bring its rate down by more than two points to 5.23 percent, the effect was to increase the total liability. With the lower rate for investment performance, the plan will need more money to pay its pension obligations.

In a Governing analysis of 80 pension plans that had comparable data available, about one-third adjusted their discount rate downward but just nine plans in four states lowered it by more than a half-percentage point. The results for most of those plans were dramatic changes in their total pension liabilities while their assets on hand either improved somewhat or stayed the same.

Overall, the total liability of the plans reviewed increased an average of only 9 percent, a hike generally attributed to retirees living longer. But some plans saw more dramatic changes. In New Jersey, pension liabilities for the state employee retirement plan increased 55 percent. While the aggregate average plan saw a boost in its funded ratio of 4 percentage points, New Jersey’s funded status fell by nearly one-fifth to 28 percent.

The discount rate rule, known as GASB 67, is just part of the story. Another piece of the new rule, GASB 68, will hit financial statements starting later this year. Under that new rule, governments that are members of a pension plan — say, localities that pool their money with a state plan — are required to report their share of that plan’s unfunded liability on their governmentwide balance sheet for the 2015 fiscal year, something most of those governments have never before had to do. Now most will be adding millions of dollars in liabilities, forcing lawmakers to acknowledge the role pension payments play in their government’s overall financial picture.

Volatility and uncertainty are likely as governments grapple with the fiscal adjustment to this latest round of GASB accounting rules. But in the long run, the new accounting standards will call attention to the need for governments to contribute regularly to pensions and to acknowledge the role that funding plays in mitigating ballooning liabilities. The rules may also force a decision for some governments who will either be pushed into meeting their funding obligations or finding other strategies to keep plans solvent.

In some ways, the change to pension accounting couldn’t have come at a more convenient time. The new assumptions also require plans to report current market-value assets instead of asset values that “smooth in” — and tend to hide — investment gains and losses over time. As late as 2013, actuaries were still smoothing in the asset losses from 2008 and 2009. Many plans were reporting a lower actuarial value of their assets than was actually in the fund. Now, the market assets reported reflect the big gains in the stock market over the prior year. Plans in the Governing sample had an average annual increase in assets of an impressive 14.6 percent. All but eight plans recorded increases. The average funded status of plans jumped from 70 percent in 2013 to more than 74 percent in 2014.

Still, the discount rate treatment remains a key dividing force in the pension accounting rule, GASB 67. This rule requires plan actuaries to assess whether the pension fund will run out of money by considering factors such as past contribution patterns and expected future contributions from state and local governments, as well as expected contributions from employees, investment performance, and projected overall pension payouts. If there is a depletion date, the actuary must use a market rate of return (these days around 3 or 4 percent) to calculate the value of what the plan still owes after the fund runs out of money. The result is a blended discount rate that skews lower for plans that are low on assets.

Plans like KTRS that have not had reliable government contributions must use a more conservative measurement. Because of the rule, Kentucky’s total payouts to KTRS retirees went from a projected $28.8 billion in 2013 to its current projection of $39.7 billion. Although the Kentucky bond proposal was not a direct result of the accounting changes, the rule adds a strain to a system that is already under pressure, says KTRS Executive Secretary Gary Harbin. “It puts that out there that if the cash flow is not there, it gets to a point where it starts impacting investments,” he says. “We feel we’re at that point.”

Most plans, however, say they won’t have a depletion date. Therefore, their actuaries can use the long-term expected rate of return (typically between 7 and 8 percent for most pension plans) to calculate the total pension liability. The Teachers’ Retirement System of Louisiana, a plan similar in size to KTRS, has a solid stream of government contributions and reported a much smaller total liability increase than its Kentucky counterpart.

Kentucky’s teacher retirement plan isn’t the only pension plan in trouble in the state. The Kentucky Employees Retirement System (KERS) has been in a free-fall for years. Its funded status is 25 percent, the lowest ratio of any system reviewed. But unlike the teachers plan, KERS avoided using a lower discount rate, which would have sunk its funded status even further. That’s because in 2013, the Kentucky Legislature created a funding plan and has set aside its full contribution to the system for 2015 and 2016, something it has not done in more than a decade. Funding plans in other states have potentially saved other shaky pension systems from raising their total pension liability. In 2014, California enacted legislation that required increased contributions to teacher pensions in an effort to shore up funding for that system.

Of course, the funding plan has to be followed. New Jersey enacted pension reform in 2011 that called for the state to ramp up payments into its pension funds over the course of seven years. But New Jersey has failed to follow through on those payments. A New Jersey Superior Court judge ruled in February that Gov. Chris Christie violated state law when he twice declined to make the full payment into the state’s pension system. Now, Christie is pushing controversial pension legislation that cuts the benefits current employees can earn in the future. The new accounting rules lend an air of urgency to Christie’s plan as the funded status for two state plans plummeted this year. It is now 28 percent for New Jersey’s state employees fund and 34 percent for the state’s teachers plan. “This new reporting system,” Christopher Santarelli, spokesman for the state department of the treasury, said, “only underscores the urgent need for additional, aggressive reform of a pension and health benefits system that if fully funded would eat up 20 percent of New Jersey’s budget.”

This same fate could meet other plans that don’t keep up their pension funding. “Keep in mind, it is a ‘trust but verify’ condition,” says GASB Chairman David Vaudt. “There will be fluctuations in liabilities if governments don’t meet their funding commitments.”

The impact of GASB’s proposed accounting practices is not far off. GASB 68, the rule that requires governments to report their share of a pension plan’s unfunded liability on their governmentwide balance sheet, calls for the new math to appear in a government’s 2015 Comprehensive Annual Financial Report.

The prospect of adding millions in debt on the balance sheet isn’t exactly inviting, but it’s something larger governments are braced for. But smaller governments and municipalities, particularly school districts that may see outsized liabilities on their financial sheets, could be blindsided. For most local governments, managing their pension responsibilities has simply meant paying the bill that the pension plan sends them. “The responsibility of paying benefits has for so long been not transparent, nobody feels like they have the responsibility,” says Sheila Weinberg, the founder and CEO of Truth in Accounting, a national nonprofit that advocates fiscal transparency. “There has been some education, but I think it still will be a shock to the smaller governments.”

The new liability is a volatile one. It could swing up or down from year to year depending on the pension plan’s market performance or if governments take a break in funding. Still, many agree that requiring governments to report their own liabilities is a common-sense move. Adjustment to it will take years. But ultimately, governments will have a truer picture of their fiscal health, and that will force many to take ownership of the issue.

Whether the tide goes toward figuring out a way to steadily fund pensions, as some in Kentucky would like, or negotiating benefit reductions and a change in plan structure, as is proposed in New Jersey, remains to be seen.

“This liability has already existed,” says Ted Williamson, a partner in RubinBrown’s Public Sector Services Group. “It’s just that up until now, this hasn’t been reflected. This change makes it top-of-mind for lawmakers. They need to think about a long-term strategy for their pension plans.”

View financial data for the 80 state and local retirement systems reviewed.

GOVERNING.COM

BY LIZ FARMER, MIKE MACIAG | MARCH 17, 2015

 

Faced with constrained resources, government officials continue to turn to public-private partnerships (P3s) for various reasons, including maximizing capital resources, transferring risk, accelerating project delivery, achieving cost savings and enhancing accountability. This is particularly true for capital-intensive, highly complex infrastructure projects.

But what evidence exists from projects that have been completed or are under construction to show whether P3s are delivering public value? An examination of some of the larger P3 infrastructure projects across the country offers reasons for optimism.

The P3 market has developed dramatically over the past 25 years. In the 1990s, Indianapolis pioneered a host of P3 transactions. Using a philosophy of managed competition — in which public, private and nonprofit organizations competed to provide government-funded projects of the highest quality for the best price — over $400 million of value was created for the city’s taxpayers. Notably, a P3 involving the city’s wastewater treatment system saved $189 million over 10 years.

The 2000s offer a more complex set of P3 data points as, too often, transactions involving the leasing of existing public assets moved from the goal of best taxpayer value to one of near-term monetization of future revenues. In reflecting the optimism of the times, the private sector often overpaid for the long-term leases that governments put to bid. On toll roads alone, estimated equity write-downs — private partners’ losses — are in excess of $2 billion, with approximately $800 million of that represented by the Indiana Toll Road bankruptcy alone.

These losses and bankruptcies confuse the public, although an area for further research would be to explore whether such investor losses were in a sense public gains, given that governments collected upfront payments and reinvested the proceeds. At this point, however, these kinds of controversial privatization transactions are few and far between.

Most recently, over the last three years, eight U.S. P3 projects involving new construction have been completed and have opened for use. While each of these P3s offers different lessons, the outcomes achieved on three of them — a toll road project in Florida, a container terminal expansion at the Port of Baltimore and a new courthouse development in Long Beach, Calif. — demonstrate that significant public value can be created through the responsible fusion of private- and public-sector resources.

In Florida, the Interstate-595 P3 provided capacity improvements 15 years sooner than a conventional plan would have offered. The innovative expansion of the Port of Baltimore’s Seagirt Marine Terminal was completed two years ahead of schedule via a P3 model, and as a result in 2014 the port was able to handle a record 484,410 containers, a 10 percent increase from 2013. And in California, the Administrative Office of the Courts used a P3 to deliver a new 535,000-square-foot courthouse in Long Beach ahead of schedule and under budget. The new courthouse received a 2014 Urban Land Institute Global Award for Excellence.

These projects offer tangible evidence of the value creation potential of P3s. But do they illustrate a decisive trend? Only time will tell, of course, but it’s worth looking at early indicators for some of the 14 projects listed in the table below that were bid as P3s and are or soon will be in the construction phase.

Scheduled Completion	Projects
2015	LBJ Express (Texas), Presidio Parkway (California), Carlsbad Desalination Project (California)
2016	Denver FasTracks, East End Crossing (Indiana/Kentucky), US36 Express Lanes-Phase 2 (Colorado)
2017	Elizabeth River Crossings (Virginia), North Tarrant Express-Segment 3A (Texas)
2018	Goethals Bridge (New Jersey/New York), Indianapolis Justice Center, I-77 Express Lanes (North Carolina), Pennsylvania Rapid Bridge Replacement (Pennsylvania), Portsmouth Bypass (Ohio)
2021	I-4 Ultimate (Florida)

 

While it is difficult to make general conclusions across all of these projects, early evidence is positive, at least as far as Wall Street is concerned. Take for example, the $2.7 billion LBJ Express variable toll managed lanes project in the Dallas/Fort Worth area. According to a Fitch Ratings analysis issued last month, construction “has proceeded on schedule and on budget, and operations are on target to begin during 2015.”

Similar results have been noted on the $925 million Carlsbad Desalination Project in California, the largest planned desalination plant in the Western Hemisphere. In December, Fitch affirmed the project’s underlying bond ratings, citing “timely construction progress of the project with provisional acceptance expected to be achieved several months ahead of guaranteed completion date in 2015.”

So overall, the evidence — both looking backward and looking forward — from the current crop of U.S. P3 projects is largely positive. As the industry continues to evolve, P3 advocates would be wise to focus less on ideological arguments and more on the growing body of evidence that P3s are largely delivering genuine public value.

GOVERNING.COM

BY STEPHEN GOLDSMITH, ANDREW DEYE | MARCH 18, 2015

Stephen Goldsmith | Contributor
[email protected]

Andrew Deye | Contributor
[email protected]

(Bloomberg) — To ease Pennsylvania’s pension obligation, Governor Tom Wolf isn’t targeting public workers, the focus in neighboring New Jersey and around the country. He’s eyeing payments to Wall Street.

The first-term Democrat is calling for Pennsylvania’s two pension systems to reduce investment-manager fees that are higher than the average U.S. public plan. He’s also counting on Wall Street banks to market bonds the state would use to bolster one of the funds.

As retirement costs consume a growing share of municipal budgets, pension boards are scrutinizing payments to money managers. California Public Employees’ Retirement System plans to liquidate its hedge-fund program, while Pennsylvania’s Montgomery County moved most of its holdings to cheaper, passively managed funds, which track indexes. Wolf wants to adopt lower-cost approaches that may save $200 million annually.

“We’re not talking about suddenly overnight going to a 100 percent passive investment strategy,” said Randy Albright, Wolf’s budget secretary. “We’re talking about strategically re-evaluating the mix and trying to look at ways that they can reduce risk and reduce fees.”

Taxpayer Dollars

Pennsylvania ranked second-to-last after New Jersey among states by the percentage of the required pension contribution that it made from 2001 to 2013, according to a March report from the National Association of State Retirement Administrators. Ratings companies cite the pension burden in giving Pennsylvania a grade two steps below the average for U.S. states. Standard & Poor’s and Fitch Ratings cut their marks in September to AA-, fourth-highest. Moody’s Investors Service lowered it to an equivalent Aa3 in July.

In his first budget address this month, Wolf said Pennsylvania “has been wasting hundreds of millions of taxpayer dollars on Wall Street managers.”

Across the country, pension funds are examining their relationships with investment firms, said Greg Mennis, director of the states’ public-sector retirement systems project at the Pew Charitable Trusts. They’re reconsidering their strategies after expanding higher-cost alternative investments, such as hedge funds, he said.

County Shift

California’s retirement system, the biggest state pension fund, said this month it expects to pay 8 percent less for money managers as it drops hedge funds. In Montgomery County northwest of Philadelphia, shifting most assets to Valley Forge-based Vanguard Group Inc. cut expenses by more than two-thirds, Josh Shapiro, county board of commissioners chairman, wrote in the Philadelphia Inquirer this month.

Pennsylvania administers two plans covering about 700,000 people. The funds had 62 percent of assets needed to cover promised benefits in 2013, down from 75 percent in 2010, for a combined unfunded liability of about $53 billion.

The largest system, the Public School Employees’ Retirement System, paid 1.14 percent of assets in fees in 2013, compared with the 0.42 percent average for U.S. public plans, according to the Center for Retirement Research at Boston College. The Pennsylvania State Employees’ Retirement System also exceeded the average, paying 0.66 percent.

Fee Sideshow

Officials are asking the retirement boards to lower fees to about 0.6 percent, said Albright, the budget secretary.

The call to reduce payments represents a “distraction” and a “sideshow” that won’t reverse years of underfunding and the costs of a system that guarantees worker payments, said Paul Mansour, head of municipal research at Conning.

“You really need to attack the benefit levels either for existing employees, or certainly for new ones,” said Mansour, whose Hartford, Connecticut-based company oversees $11 billion in munis. “Otherwise, it’s going to be a continued problem.”

Public pension officials can’t just look at savings — they have a responsibility to do what’s best for their funds and beneficiaries, said Keith Brainard, research director for the state retirement administrators’ group.

“You’re not investing the money to save money,” he said from Georgetown, Texas. “You’re investing the money in order to generate investment earnings within an acceptable level of risk.”

Liability Focus

Albright said he’s confident the funds would achieve the same return target. Yet Evelyn Williams, a spokeswoman for the school workers’ pension, said a strategy involving lower fees would probably produce a lower assumed rate of return.

“The unfunded liability is too large for any significant impact, even if there were no management fees at all,” she said in an e-mail.

Williams and Pamela Hile, a spokeswoman for the state workers’ system, said the management fees resulted from investment strategies that propelled their funds to earnings above indexes while meeting risk standards.

Over the past 15 years, the school workers’ fund paid managers $4.96 billion and generated a net $11.5 billion in returns above indexes, Williams said. The fund for state employees earned $19.7 billion net of fees while paying $2.4 billion in fees in the past decade, Hile said.

Savings Quest

The state workers’ system “constantly looks for cost savings and aggressively negotiates fees, and that focus has reduced total investment costs by $70 million over the past five years,” Hile said in an e-mail.

Wolf, a 66-year-old former businessman, also wants to sell $3 billion of pension bonds and direct the proceeds into the school workers’ fund, which has the greater unfunded liability at $35 billion. The move would pay off if the pension’s investment earnings are greater than the borrowing costs on the debt, underscoring the significance of any changes in the system’s asset managers.

Pennsylvania’s projected contributions to the systems rise to a combined $6 billion annually in 2035, from about $3 billion next fiscal year.

Unlike Illinois, which is fighting a court battle to cut worker benefits, and New Jersey, where Governor Chris Christie wants teachers to freeze current pension benefits, in Pennsylvania, Wolf isn’t seeking givebacks from employees.

Pennsylvania’s task is to make up for years of underfunding rather than trim benefits, Albright said. Legislation enacted in 2010 already raised retirement ages and cut costs, he said.

“We already have restructured our current employee benefit plan to a relatively inexpensive one,” he said.

Bloomberg News

by Romy Varghese

March 19, 2015

To contact the reporter on this story: Romy Varghese in Philadelphia at [email protected]

To contact the editors responsible for this story: Stephen Merelman at [email protected] Mark Tannenbaum, Stacie Sherman

New York, March 16, 2015 — The release of 2014 Comprehensive Annual Financial Reports (CAFRs) by US public pension plans that comply with Government Accounting Standards Board (GASB) Statement 67 have only a modest credit impact, and are in line with Moody’s expectations, Moody’s Investors Service says in a new report.

US public pension plans are now releasing 2014 financial statements that comply with GASB Statement 67 for the first time. Moody’s analysis of 54 public pension plans with liabilities over $10 billion finds the new data not only align to expectations, but offer new insight to funding trajectories.

In fiscal 2015 disclosures by state and local governments must comply with GASB 68, which for the first time requires placing net pension liabilities on their balance sheets. Moody’s rating methodologies already consider unfunded pension liabilities as debt-like obligations. Thus, the new accounting has little credit impact because Moody’s already approaches the liabilities in a similar way.

“While GASB 67 and 68 impose many new rules related to pension accounting disclosure, our approach to evaluating credit risk stemming from public pension remains fundamentally unchanged,” Moody’s Assistant Vice President — Analyst Thomas Aaron says in “New Pension Accounting Increases Clarity of Plan Funding Trajectories.”

Moody’s finds that contributions for nearly three quarters of public pension plans studied are insufficient to prevent reported net pension liabilities from growing, even if plan assumptions are met. Of the plans in Moody’s sample, just 13 received government contributions that were enough to reduce reported net pension liabilities. Even among the plans that received 100% of the actuarially determined contribution, only a minority received contributions large enough to prevent liabilities from growing.

Rules surrounding public pension discount rates change dramatically under the new GASB rules. However, Moody’s findings indicate these changes will impact only a few pension plans. Therefore, the discount rates for the large majority of pension plans will continue to match assumed rates of investment return under GASB 67 and 68.

The full report can be purchased here.

Global Credit Research – 16 Mar 2015

Read the Study.

WASHINGTON DC – March 16, 2015 –The Urban Institute today launched an initiative to ensure “Pay for Success” (PFS) transactions are well-designed, informed by rigorous research, and deliver outcomes as intended.

The Laura and John Arnold Foundation (LJAF) will commit $8.4 million over three years for the Urban Institute, a nonprofit research organization, to establish a broad Pay for Success Initiative at Urban and ensure current and future PFS transactions are evidence-based and effective.

Pay for Success is an innovative funding approach that aims to drive government resources toward proven social programs to deliver better results to those in need. The model provides a way for state and local governments to tackle social problems by tapping private investors to cover the up-front costs of the programs. If the programs are successful, governments pay the investors back. If they are not, the investors absorb the cost and the governments pay nothing.

Currently there is only a handful of Pay for Success deals operating nationwide; however, with rapid growth expected, Urban’s scholars will bring a research perspective to assess and advise both existing and future PFS projects, at little to no cost to the field.

“The ultimate goal of our initiative is to identify and scale evidence-based interventions through effective service providers to help people and communities. We are advocates for the evidence that forms the foundation of these agreements to pay for interventions which would otherwise go unfunded, or be funded on a smaller scale. Knowing the rate and scale at which these programs are expanding, we want to make PFS deals as strong and research-based as possible,” said John Roman, a senior fellow at the Urban Institute.

Pay for Success already is an exciting and rapidly growing field. Urban aims to support and complement the work of a number of other organizations and public leaders who have created a strong foundation for others to follow. Ultimately, Urban will help accelerate what the field can learn together.

Scholars supported by Urban’s new PFS Initiative will be engaged in a range of activities, including:

• Providing training and technical assistance;
• Developing toolkits and templates for others to follow;
• Designing new PFS transactions based on existing research;
• Helping ensure programs are evaluated accurately; and
• Sharing lessons learned for other leaders and researchers through collaborative events.

As one of the first undertakings for the PFS Initiative, Urban will host a series of virtual events in May examining the areas of public and social service that are most promising for PFS. The panel series will bring together subject matter experts, researchers, service providers, and philanthropic and government leaders from across the country. It will focus on which evidence-based programs and strategies are best poised for a PFS approach in housing, economic development, poverty reduction, and justice system reform.

Urban Institute Fellow and Director of Urban Policy Initiatives Erika Poethig explained, “Urban is uniquely positioned to conduct this work given its independent perspective, the breadth of its expertise on social and economic policy issues, and its commitment to empirical evidence. Since its founding, Urban has used research to improve public sector programs. Pay for Success is a natural extension of that effort, and Urban’s scholars are committed to helping maximize the potential of these new opportunities.”

There are roughly 30 PFS projects in various stages of development in the United States, and PFS investments could total $1 billion across the next three years.

March 16, 2015

CONTACT: Laura Greenback, [email protected], (202) 261-5709

The nonprofit Urban Institute is dedicated to elevating the debate on social and economic policy.
For nearly five decades, Urban scholars have conducted research and offered evidence-based solutions that improve lives and strengthen communities across a rapidly urbanizing world. Their objective research helps expand opportunities for all, reduce hardship among the most vulnerable, and strengthen the effectiveness of the public sector.

Click here to read more about how Wylie ISD and Lake County Schools are utilizing the GFOA’s Best Practices in School Budgeting to prioritize spending on student achievement. Also learn more about how the GFOA is expanding its early adopter group – the Alliance for Excellence in School Budgeting – to assist more districts in implementing the Best Practices.

NEW YORK, NY, March 12, 2015 – CUSIP Global Services (CGS) today announced the release of its CUSIP Issuance Trends Report for February 2015. The report, which tracks the issuance of new security identifiers as an early indicator of debt and capital markets activity, suggests a possible increase in corporate and municipal debt issuance over the next several weeks.

Total CUSIP requests for new U.S. and Canadian corporate equity and debt increased 7% in February, with a total of 1,818 new identifiers requested over the course of the month. Within those totals, domestic corporate debt CUSIP demand rose to 666 new requests in February. On a year-over-year basis, corporate CUSIP request volume was down 17.3%, reflecting a sharp slowdown in January 2015 versus January 2014.

Municipal CUSIP volume surged for a second month straight in February, increasing 37% over January totals, with a total of 1,302 new identifier requests made over the course of the month. Texas led the way among municipal bond issuers, with a total of 144 new CUSIP requests made in February alone. So far this year, Texas-based municipal securities account for more than 10% of total municipal bond identifier requests.

International debt and equity CUSIP International Numbers (CINS) orders showed mixed results in February. Requests for new international debt CINS increased 31% in February, while requests for new equity CINS decreased 2.6%.

“The real story this month is in the municipal bond market,” said Gerard Faulkner, Director of Operations for CUSIP Global Services. “After a skittish 2014, municipal issuers are driving enormous volume so far in 2015, driven largely by re-fundings of older debt at lower interest rates.”

“This may be the last hurrah for bond issuers to take advantage of historic low interest rates,” said Richard Peterson, Senior Director of Global Markets Intelligence, S&P Capital IQ. “As the marketplace continues to hang on every word from the Fed, we expect to see a healthy volume of new bond issuance in the coming weeks that will take advantage of the current low rates.”

To view a copy of the full CUSIP Issuance Trends report, please click here.

WASHINGTON – An expected months-long Treasury Department suspension of sales of state and local government series securities is likely to be most challenging for small issues with short defeasance escrows, market participants said.

The Treasury suspended sales of SLGS on Friday as one of the “extraordinary measures” it takes when the U.S. government reaches its debt limit. The limit was reinstated on Monday after having been suspended since February 2014.

SLGS are special purpose Treasury securities that help municipal bond issuers avoid violating arbitrage rebate or yield restriction requirements. Issuers most often purchase SLGS for advance refunding escrows to ensure their investment yield will not significantly exceed the yield of their refunding bonds.

Issuance of SLGS count against the debt limit and the Treasury halts the sales of them to conserve headroom under the ceiling, the department said. This is the 11th time the SLGS window has been closed during the past 20 years. Often, the window has been closed for two months or less, but this time it is likely to be closed longer.

The Congressional Budget Office estimated earlier this month that Treasury is likely to have sufficient cash to make its regular payments through October or November without a debt limit increase. The Bipartisan Policy Center said Treasury could have cash until sometime in the fourth quarter because the main tax refund season has passed and there likely will be surpluses in some upcoming months. Also, revenues have increased while expenditures are fairly flat.

Treasury doesn’t typically reopen the SLGS window until the debt limit is raised or suspended, and Congress doesn’t typically take action on the debt limit until the U.S. is close to a default, said Bill Daly, director of governmental affairs for the National Association of Bond Lawyers.

An alternative to SLGS is n to open-market Treasury securities. While SLGS are bought directly from Treasury, open-market Treasuries are purchased after soliciting bids from banks and other financial institutions. Larger issuers often consider buying Treasuries even when the SLGS window is open.

Bond sales are unlikely to be delayed due to the SLGS window closure, some market participants said.

For most issuers, the SLGS window closure is “probably going to be a non-event,” said Sam Gruer, managing director of Cityview Capital Solutions.

Bill Glasso, a principal at Causey Demgen & Moore, which provides bidding agent services, said his firm was involved in escrow transactions for seven issuers on Tuesday. Every one of the issuers did better than they would have if they had purchased SLGS, he said.

But market participants cautioned that purchasing open-market Treasuries rather than SLGS can make things more complicated, especially for small bond issues with short refunding escrows.

Open-market Treasuries are “less user-friendly” than SLGS, said Michael Decker, managing director and co-head of municipal securities for the Securities Industry and Financial Markets Association.

Moody’s Investors Service considers the SLGS window closure to be negative for municipal issuers overall. Nick Samuels, Moody’s vice president and senior credit officer, said that using open market securities “makes doing some refundings for some issuers more costly, somewhat more complex.”

For small deals, acquiring open-market Treasuries could be more costly than just keeping the proceeds in cash, said David Cholst, a partner at Chapman and Cutler in Chicago. For short escrows, acquiring Treasuries may similarly be counterproductive for short escrows, he said.

Amy Kron, a senior investment officer with BLX group, an escrow bidding agent, said that issuers with smaller, shorter deals may consider holding bond proceeds in cash or delaying deals.

And the providers of the open-market Treasuries don’t have the capacity to deal with every bid they receive. As a result, “they’re being more selective” and are picking the deals that they think they can receive the most profit from and that they think they can win, said Glasso.

It may be hard for small issuers with short escrows to excite bidders, and the issuers may receive few or no bids, Gruer said. “SLGS just work better” for these kinds of transactions, Cholst said.

Receiving fewer than three bids for open-market Treasuries can lead to tax questions, market participants said. Under Treasury rules, issuers must establish that yield-restricted investments are valued at fair market value. The rules provide a safe harbor under which the fair market value of investments in a defeasance escrow can be established if the issuer receives bids from at least three disinterested parties.

There is no bidding requirement for SLGS, since they are treated as purchased at fair market value because they are purchased directly from Treasury.

Bob Eidnier, a partner at Squire Patton Boggs in Cleveland, said that the SLGS window closure may mean tax lawyers and issuers will have to accept fair market value on a basis other than by meeting the safe harbor. They may have to accept the better of two bids. In other cases, parties may accept that investments were at fair market value based on a certificate from the underwriter.

If an issuer gets no bids, it could keep its bond proceeds in cash. But this is costly because the issuer will not receive any return and the IRS could still impute a yield on the escrow. If that yield is higher than the bond yield, there could be a problem, Gruer said.

The SLGS window closure also makes things more complicated in cases where the returns on escrow investments are supposed to be rolled over into SLGS with zero yield. Under IRS guidance, if SLGS are not available, the issuer should buy other investments that should have maturities of no more than 90 days. Any return on those investments has to be paid to the federal government, Cholst said.

In May, NABL recommended that Treasury continue to allow subscriptions for 0% SLGS during periods of extraordinary measures and that only larger SLGS purchases be suspended. In July, Treasury declined to adopt the recommendations but did not explain its reasoning.

Jessica Giroux, general counsel and managing director of the Bond Dealers of America, said the SLGS window closure could present a compliance hardship for small issuers who have not engaged MAs.

“If SLGS are not available, the small issuer may suddenly need advice on investing bond proceeds, which their underwriter is not going to be able to provide per the MA rule,” she said. “So, if they have not engaged an MA, they may need to employ and pay an MA for advice or forgo investment advice altogether, whereas creating a SLGS escrow does not constitute advice and is routinely done by their underwriter in compliance with the MA rule.”

Under the municipal advisor rule, someone who provides particularized advice about escrow investments would be an MA. An underwriter can provide advice about structuring refunding escrow cash flow requirements, but it can’t provide recommendations about what to invest in unless it relies on the independent registered municipal advisor exception, according to the rule. Someone merely providing the brokerage of escrow investments would not be an MA.

Teri Guarnaccia, a partner at Ballard Spahr in Baltimore, said that it’s unlikely that the information an underwriter would provide about purchasing open-market Treasuries would be considered investment advice.

THE BOND BUYER

BY NAOMI JAGODA

MAR 18, 2015 3:37pm ET

CHICAGO – Chicago took a gamble by voluntarily laying out in stark terms the fiscal threats that could lead to further credit erosion and the impact on its swap and liquidity contracts, market participants said.

Mayor Rahm Emanuel’s administration won praise for its openness, but the sobering information could also contribute to market jitters over the city’s battered credit ratings, which have driven up interest rates on Chicago debt.

The voluntary disclosure March 6 that accompanied the city’s reporting of its latest downgrade from Moody’s Investors Service’s offered investors information on swap terminations triggered by the latest action and the proximity of other contracts to triggers.

“There’s an evolving disclosure standard and we’ve tried to be a case study in best practices,” chief financial officer Lois Scott said in an interview after release of the filing to the Municipal Securities Rulemaking Board’s EMMA site. “We haven’t been in the bond market for some time and we felt there was a consistent pattern of questions as we talked to rating agencies, investors, and banks so we wanted to make sure that we were communicating the same information to all parties.”

Moody’s Feb. 27 downgrade to Baa2 triggered termination events on four interest rate swap contracts, exposing the city to payments totaling $60 million if demanded by the counterparties. The city has renegotiated the terms of one of the swaps, avoiding a potential $20 million payment, and negotiations continue on the others.

The disclosure offers the city protection against accusations that it withheld material financial information as regulators scrutinize disclosure practices, market participants said.

Some investors said it compliments city strides in building better investor relationships through improved access, expanded disclosure, and annual investor conferences.

On the other hand, some market participants said the information underscores the pressures on the city’s balance sheet.

“We think that knowledgeable municipal investors should find the disclosure disturbing,” said Michael Johnson, managing partner and head of research at Gurtin Fixed Income Management LLC.

“Once a termination has occurred, the city is at the mercy of the counterparty bank,” he said. “This loss of control is a hallmark of a distressed credit.” The firm shed its Chicago bonds prior to 2013 over credit concerns.

Brian Battle, director of trading at Performance Trust Capital Partners, called the voluntary disclosure “shrewd and prudent” and “the right thing to do.”

The city’s chief financial officer “has been around a long time,” Battle said, previously working as a banker and financial advisor, and “what’s she done is met a disclosure burden that might not have been a regulatory mandate but was a market mandate.”

Market concerns will remain heightened until the city solves its pension woes, Battle said, which is unlikely to happen soon amid state-level inaction and a Chicago mayoral runoff April 7 pitting Emanuel against challenger Jesus “Chuy” Garcia.

Garcia has not said how he would address a looming $550 million annual spike in the city’s public safety pension contributions, and Emanuel continues to count on so far nonexistent action by state lawmakers to enact benefit reforms and allow the city to phase the higher contribution levels in.

Institutional investors welcome information that’s useful, so any details on that front are welcome, said Ernie Lanza, a partner at Greenberg Traurig and former MSRB deputy executive director. “By and large more information is better,” he said, unless there’s some error in the content. “In principle everybody should have the same information,” he said.

Duane Morris LLP attorney Steven Gray is the city’s lead disclosure counsel. The firm and Cotillas & Associates were co-disclosure counsel on a September offering statement that offered expanded disclosure on the impact of Chicago’s credit rating deterioration.

The latest GO downgrade escalates the pressures posed by the city’s floating-rate portfolio – inherited by the Emanuel administration – and leaves the city open to “more exposure to banks than is ideal” between the letter of credit support behind the deals and the swap counterparties, city officials said.

The city’s 24 swaps tied to $2.4 billion of floating-rate general obligation and revenue-backed paper were almost $400 million underwater based on market valuations at the close of 2014.

The city has renegotiated terms with BMO Harris Bank on a $66.8 million floating-to-fixed-rate swap that was part of a $223 million 2005 floating rate GO issue.

It avoided a $20 million payment based on current valuations. The threshold was moved to the level under Baa2.

Wells Fargo has notified the city it reserves its right to designate an early termination date on the three swaps in which terminations were triggered by the downgrade. “The city is in ongoing discussions with Wells Fargo regarding the swaps,” the disclosure says.

The city reported posting as collateral a letter of credit issued by PNC Bank in connection with a sale/leaseback transaction the city entered into in 2005 on the city-owned portion of the Orange Line rail transit route to Midway Airport. The lease deal expires in 2031.

The downgrade requires the city “to use reasonable efforts” to replace the PNC letter of credit with other collateral by March 29.

The administration’s financial team has tinkered with its derivative portfolio, tightening up mismatches in basis trades and maturity dates, winning changes in rating thresholds, and terminating its swap options and other swaps in deals converting the underlying debt to a fixed-rate structure.

The city has terminated seven swap or swap options on $1 billion of floating-rate debt and struck more favorable terms on termination triggers on 12 derivatives tied to $1.3 billion of debt since 2011.

While the city has not entered into any new swaps, it did strike amendments last year on some forward starting swaps in which it captured up-front payments based on market conditions at the time.

On its LOCs, the city has sought to diversify its bank exposure and struck more favorable rating terms on new LOCs in an effort to reduce exposure on the city’s weaker credits, like its GO bonds, so banks are not “in the driver’s seat,” administration officials said.

City officials stress that the cash flows under the swap terms are not pressuring its balance sheet but rather the termination triggers based on its credit ratings.

When the credit thresholds were set, the city’s credit was stable, and even on the upswing following its establishment of a permanent $500 million reserve with proceeds of its Chicago Skyway toll bridge lease in 2005.

Two additional swaps face termination triggers if the city’s GO rating is lowered one notch.

The first is one of four floating-to-fixed swaps tied to a $202.5 million 2004 GO issue. The swap is with Bank of New York Mellon for $136 million. It expires in 2019 and is negatively valued at $4.1 million. Amendments were struck on the contract in 2014.

The other swap that could see a termination triggered by another downgrade from Moody’s is tied to a $117 million sales tax issue from 2002. The floating-to-fixed swap is with JPMorgan for $111.7 million. The swap expires in 2034 and is negatively valued at $29 million. The city’s sales tax rating is tied to its GO level.

In addition to Chicago’s GO bond swaps, it has swaps tied to its Midway Airport, water and wastewater enterprise revenue credits with rating triggers in the triple-B category.

Three second-lien water swaps have triggers at below the Baa1 level. Moody’s recently affirmed the credit’s A3 rating.

Three second-lien wastewater swaps are tied a $332 million issue from 2008, including two with triggers below the Baa1 level. Moody’s recently downgraded the second lien wastewater credit to Baa1 level, meaning another downgrade would trigger the termination events for those Bank of America and JPMorgan derivatives. Each of the two is for $49.8 million. They expire in 2039 and are each negatively valued at about $11 million.

The city bears no collateral posting obligations on any of its swaps.

The city has 26 liquidity support, letter of credit, and direct purchase facilities on more than $2 billion of floating rate bonds from issues between 2002 and 2014 sold under its GO credit, Midway Airport second lien, O’Hare International Airport third lien, water, wastewater, sale tax credit, and tax-increment financing bonds.

The rating thresholds for events of default on most are triggered at a speculative grade rating, with the exception of four totaling $372 million that are tied to the city’s wastewater credit and O’Hare International Airport, which have a threshold below the BBB level.

The city’s lowest wastewater bond rating is A3 from Moody’s on junior-lien revenue bonds. Its lowest underlying rating for third-tier O’Hare airport revenue bonds is A-minus from Fitch Ratings.

A default under the city’s revolving lines of credit at a speculative grade rating would allow the termination of its credit facilities, requiring the city to immediately pay all outstanding amounts. The city currently has $294 million outstanding under its short term borrowing program which has a capacity of $900 million.

The filing also highlights Standard & Poor’s affirmation of the city’s A-plus rating and negative outlook on Feb. 27 and Fitch Ratings’ Feb. 24 affirmation of the city’s A-minus rating and negative outlook. The Moody’s downgrade impacted $8.38 billion of general obligation debt, $542 million of sales tax bonds, and $268 million of motor fuel bonds, and $1.5 billion of wastewater debt.

THE BOND BUYER

BY YVETTE SHIELDS

MAR 17, 2015 2:08pm ET

March 18, 2015 — In several meetings today on Capitol Hill, water utility leaders urged U.S. Congress to increase the effectiveness of the Water Infrastructure Finance and Innovation Act (WIFIA) by repealing a ban on the use of tax-exempt bonds in WIFIA-funded projects.

Signed into law as part of the Water Resources and Reform Development Act (WRRDA) in 2014, WIFIA provides low-interest federal loans for up to 49 percent of large drinking water, wastewater and water reuse projects (see “President Obama signs WRRDA into law”). However, the law, as written, prohibits tax-exempt bonds from funding the remaining 51 percent, withdrawing the most cost-effective tool for communities seeking WIFIA loans.

More than 130 water utility leaders from 47 states are visiting Washington D.C. March 18-19 for the “Water Matters! Fly In,” event, sponsored by the American Water Works Association (AWWA) and the Water Environment Federation (WEF). Delegates wore “Free WIFIA” buttons as they visited Congress to discuss infrastructure and other water issues.

“Let’s free WIFIA to reach its full potential,” said AWWA CEO David LaFrance. “The water and wastewater infrastructure needs in the United States will likely top 2 trillion over the next 25 years, and WIFIA is an important tool to help communities manage those costs. But the prohibition on the use of tax-exempt bonds is an unnecessary barrier that impairs WIFIA’s effectiveness.”

During deliberations, the Joint Committee on Taxation scored WIFIA as inducing the issuance of additional tax-exempt debt and thus generating a small tax expenditure requiring a revenue offset. At JCT’s suggestion, House and Senate conferees included the prohibition on combining tax-exempt bonds with WIFIA as the required offset. There is no infrastructure policy supporting this prohibition; it was included to address a tax score when no revenue offset could be identified.

If the ban were repealed, utilities would likely use lower-cost tax-exempt debt for the non-WIFIA share of project costs, lowering the overall cost of using the WIFIA program. As a result, WIFIA would be a cost-effective option for the much broader range of utilities that it was intended to serve. “Water Matters! Fly In” delegates also called on Congress to support full funding for WIFIA and drinking water and wastewater state revolving loan fund programs, as well as to protect the tax-exempt status of municipal bonds.

WaterWorld.com

In 2013 the city of Atlanta lost its baseball team to one of its suburban neighbors, the more prosperous and populous Cobb County. The Braves won’t move for two more years, but in the meantime, one Georgia state senator from Atlanta has come up with a crazy idea: Expand Atlanta’s municipal boundary by nearly 2 miles into unincorporated Cobb County, and annex the 60 acres where the team is building its stadium.

The proposed land grab is about as likely as 81-year-old Hank Aaron starting this season in right field, but it might not be any less reasonable than the proposal from the Braves that Atlanta rejected: Hand over $77 million in real estate and float a $200 million municipal bond issue to rehabilitate a ballpark still in its teenage years.

What happened in Georgia was a lesson in the business of American pro sports. Like the San Francisco 49ers—the ones now playing in Santa Clara—the Braves took advantage of a highly fragmented metropolitan area to pit city and county against each other in a kind of prisoner’s dilemma. After more than a year negotiating with both governments, the Braves got what they wanted from Cobb: $397 million in public money for stadium construction.

At the center of such stadium bidding wars are government bonds, which, in Cobb County, will be paid off mostly by homeowners. For a ballpark in their backyard, they’ll fork over $8.6 million in property taxes every year for the next three decades. They’d better hope the Braves stick around longer than the 20 years they will have spent in Atlanta’s Turner Field.

Or better yet: The next time the Cobb County Braves decide they’re ready to spin the Wheel of Taxpayer Subsidy, we should all hope the whole practice has become illegal.

That’s what the Obama administration proposed in its budget last month: to end the issuance of tax-free government bonds for professional sports facilities, a practice that has, according to research by Bloomberg, siphoned $17 billion of public money into arenas for NFL, MLB, NBA, and NHL franchises over the last 30 years and cost Americans $4 billion in forgone federal taxes on top of that. It’s too late for residents of Cobb County, but Congress might yet save the rest of us some dough.

It’s been clear for decades that new stadiums don’t bring the business they promise.
Extortion at the hands of our sporting oligarchs is, of course, a popular source of outrage. The U.S. has enough major league sports stadiums built with public money to fill an NCAA bracket. The ascent of stadium costs and the financial myopia of public officials ensure that the contest will stay lively for some time to come.

So how did we wind up in this situation? Local authorities have long used tax-exempt bonds to raise money for certain private uses—whether factories, train stations, or home mortgage loans—in addition to schools, sewers, and other infrastructure projects. In most cases, the ensuing economic growth was at least intended to pay back the municipal investment. Sports stadiums were no different: Governments could raise money in exchange for a share of future revenue.

After an initial attempt in the 1960s to steer government bonds toward true public works, Congress placed a provision in the 1986 Tax Reform Act that seemed sure to kill tax-free, no-limit stadium deals. It had exactly the opposite effect. Essentially, qualifying projects now need either to serve public uses or to rely on public funding. With pro sports facilities, the former is obviously impossible, so the latter, though politically improbable, has become the way billionaire team owners retain access to cheap government financing. Cities and counties wound up borrowing more for their teams than ever before.

It’s been clear for decades that new stadiums don’t bring the business they promise, let alone enough economic activity to justify the investment. It’s a ruse, but it works because public officials are more worried about being blamed for the loss of a team in the short run than, say, for failing public schools in the long run. And it works because the country has more big cities and rich counties than sports teams in each league, so that even if Cincinnati taxpayers wise up, their counterparts in Austin will step in.

The professional sports industry demands consumer loyalty but shows little in return. In Bloomberg, Aaron Kuriloff and Darrell Preston illustrate how smoothly the tax-money merry-go-round spins: “In March 1984, the Colts left Baltimore one snowy morning for Indianapolis and a new $95 million stadium built partly with public debt. Baltimore lured the Browns from Cleveland after the 1995 season with a $229 million muni-bond-financed structure. To land an expansion team in 1998, Cleveland provided a $315 million publicly financed building.”

But with only two intercity moves in the last 17 years of the NFL, MLB, and NHL (NBA teams have been more mobile), it’s clear that the era of big moves has largely made way for a period of intra-metropolitan battles. These face-offs don’t grab national headlines, require new jerseys, or motivate big fan protests. But they cost just as much money.

Atlanta is just one recent example. When voters on Long Island rejected a $400 million renovation of the Nassau Veterans Memorial Coliseum, New York Islanders owner Charles Wang announced he would move the team across the county line to Brooklyn’s new Barclays Center, which was able to pick up hundreds of millions of dollars in subsidies. The 49ers spurned an offer from San Francisco and instead moved some 40 miles down the peninsula to Santa Clara.

Obama’s budget isn’t the first national political effort to impose federal taxes on stadium deals. New York Sen. Daniel Patrick Moynihan proposed ending the loophole in 1996, and it’s been kicked around in committee since. But with groups like the Koch brothers’ Americans for Prosperity now opposing stadium deals at the local level, Obama’s idea has a chance of gaining bipartisan support.

Still, it wouldn’t stop cities from paying for stadiums. The last time Congress made public financing more onerous, in 1986, the result was a disaster: Cities jumped to meet the new, harsher terms, opening a three-decade stadium construction spree.

One solution, instead, could be to change the way teams operate, either by bringing antitrust suits against the leagues (which sports economist Andrew Zimbalist has suggested) or by allowing cities to exert greater control over their brands (as law professor Mitchell Nathanson has imagined). Should names like the Irving Cowboys, the East Rutherford Giants, and the Orchard Park Bills be forced upon suburban squads? In his 2000 book Leveling the Playing Field, Harvard Law professor Paul Weiler fantasizes about a nationwide union of cities that could lock out pro sports teams to obtain a league-imposed “stadium cap” on taxpayer subsidies, which would effectively end bidding wars.

Stadiums may be the brightest stars in our constellation of subsidized businesses, but they are not the biggest. The main event, for subsidy reformers, is the $80 billion per year in tax breaks and incentives that cities, counties, and states use to lure and retain corporations of all stripes. In Camden, New Jersey, the state is providing a $315,000 subsidy per job. If Tesla’s growth projections in Nevada fall short—as they so often do in these deals—the state could wind up paying $400,000 per job. It’s a destructive cycle for every function of government and a zero-sum game.

That’s a crisis that tests the limits of federalism. If we’re going to meet it, we might as well warm up with a little baseball.

Slate Magazine

By Henry Grabar

MARCH 17 2015 4:30 PM

Florida lawmakers last year approved a plan to set aside $7 million in sales-tax dollars to help pay for building or renovating sports stadiums. But last month the Joint Legislative Budget Commission punted on the decision on whether or not to fund the four stadium projects that were before them — EverBank Field in Jacksonville, Daytona International Speedway, Sun Life Stadium in Miami-Dade County and an Orlando soccer stadium.

The issue of whether to give tax breaks to millionaires for such stadiums has been an issue for decades, and in the lead-up to the legislative session, the group Americans for Prosperity has been leading the opposition to it in Tallahassee.

Potentially a bigger threat to those and other stadiums getting funded in the future is a proposal in President Obama’s 2016 budget, presented to Congress last month, that would bar the use of tax-exempt bonds to finance professional sports facilities, if more than 10 percent of the facility is used by private businesses. That means it would fall to cities and states to finance stadiums with bonds that aren’t tax-exempt.

Numerous blogs and news agencies reported on this development when the president released his budget in February, but it is receiving more attention after a report in today’s Wall Street Journal.

Between 1986 and 2012, sports facilities accounted for $17 billion in tax-exempt bond debt. That debt will be paid off 30 years from now and, by that time, the exemption will cost federal taxpayers $4 billion under Obama’s plan.

The federal savings would be about $542 million between 2016 and 2025; however, federal tax payers will no longer be responsible for subsidizing stadiums far from their home team.

As Politico reported last month, tax-exempt bonds are not the only way local governments can use taxpayer resources to fund stadium projects, but they are a popular avenue for raising this money.

“Tax-exempt municipal bonds represent the least-expensive source of capital available to most team owners and are the preferred method of financing stadium construction,” according to a 2012 UBS research report.

The owners of the Tampa Bay Rays are expected to look toward public financing of a new ballpark, if and when they ever get the opportunity to search for locations in Hillsborough County. The estimated costs of a retractable dome park to be built in the Tampa Bay area have been estimated to be around $550-600 million. Rays management has said in the past they would consider paying up to a third of those costs.

In the fall of 2012, a report by the Baseball Stadium Financing Caucus listed the potential sources of revenue in the Tampa Bay area to fund a new stadium. In Hillsborough that included using tax-increment financing (TIF) from the city of Tampa’s downtown Community Redevelopment Agency; redirecting part of the Community Tax (CIT) to improvements for a stadium; adding a new 5 percent surcharge on car rentals, and a new 6th cent added to the tourist/bed tax. In Pinellas some of the measures include redirecting using the bonds going to pay for Tropicana Field, which will expire at the end of this year, as well as redirecting a part of the Penny for Pinellas tax.

SaintPetersBlog

By Mitch Perry on March 9, 2015

Positive rating activity has returned to Fitch Ratings’ U.S. public finance rating activity, coinciding with improved U.S. economic conditions following a protracted recovery. Downgrades trailed upgrades in 2014, by a margin of 0.7 to 1, compared with the 2 to 1 ratio recorded in 2013, according to a new Fitch report.
The share of municipal ratings downgraded and upgraded was relatively low at 3.4% and 4.9% in 2014, respectively, with rating activity volume at similar levels to 2013. The overall majority of ratings – 86.9% – remained unchanged year over year.

The tax-supported sector represents the majority (57%) of Fitch public finance security ratings and thus led rating activity with largely even results of 3.9% downgraded versus 4.1% upgraded. Rating activity was generally positive across the other public finance sectors.

Fitch-rated U.S. public finance security ratings recorded no defaults in 2014. Over the long-term period of 1999 to 2014, the U.S. public finance average annual long-term security default rate was 0.04%.

Fitch’s new study provides data and analysis on the performance of its U.S. public finance ratings in 2014 and over the long term, capturing the period 1999-2014. The report provides summary statistics on the year’s key rating trends.
The full report is titled ‘U.S. Public Finance 2014 Transition and Default Study’ and is available on Fitch’s website.

Additional information is available at ‘www.fitchratings.com’.

Applicable Criteria and Related Research: Fitch Ratings U.S. Public Finance 2014 Transition and Default Study

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY’S PUBLIC WEBSITE ‘WWW.FITCHRATINGS.COM’. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH’S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE ‘CODE OF CONDUCT’ SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Contact:

Fitch Ratings, Inc.
Charlotte Needham
Senior Director
+1-212-908-0794
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004

or

Media Relations
Elizabeth Fogerty, +1-212-908-0526
[email protected]

Business Wire

Press Release: Fitch Ratings – Mon, Mar 16, 2015 18:18 GMT

Municipal bond investors should use the volatility that kicked off in February as a buying opportunity, advises investment management firm BlackRock.

“One of our themes is living with volatility,” says Peter Hayes, who runs the municipal bonds group at BlackRock, which has $116 billion in assets under management. “We recommend taking advantage of any selloff to lock in a better entry point.”

March has provided one such entry point after a rough February in which the S&P Municipal Bond Index returned -0.92%. For the 13 months prior, munis did well, says Hayes, so he wasn’t surprised there was a correction. He says the decline wasn’t due to a dramatic change in investor sentiment, but was partly due to increased supply.

That’s because the decline in yields over the course of 2014 inspired local governments to refinance their debt at the new lower rates. “It took a market adjustment to absorb,” says Hayes.

The new supply isn’t going away anytime soon. “As long as rates stay low, we will see more refundings,” says Hayes, although he thinks the rush to lock in the low rates will cool somewhat by year end.

The Federal Reserve is likely to raise rates later this year, but Hayes doesn’t expect a dramatic rise in muni yields in 2015.

He concludes a research note this week on muni market performance:

Muni-to-Treasury ratios remain historically compelling, and recent market action has left munis attractive vs. corporate bonds as well.

Barron’s

By Amey Stone

March 13, 2015, 3:10 P.M. ET

WASHINGTON — The total amount of outstanding municipal securities and loans in the market rose 0.6% to $3.65 trillion in the fourth quarter of last year, as U.S. bank muni holdings increased 2.5% and mutual fund muni holdings rose to a record high of $658 billion.

The Federal Reserve Board released the data this week in its quarterly Flow of Funds report. The total size of the muni market was up from $3.63 trillion in the third quarter of 2014, but the muni market still experienced an overall year-over year decline from $3.67 trillion at the end of 2013. The size of the muni market has generally been declining for the past several years.

Michael Decker, a managing director and co-head of municipal securities at the Securities Industry and Financial Markets Association, said that the quarterly uptick in the market size could mean that the slide is ending, though it might be too early to draw any conclusions.

“The total outstanding is creeping back up,” Decker said. “Maybe the trend of the market is starting to reverse.”

Bank holdings have risen sharply in recent years, totaling $452 billion at the end of 2014 compared to $419 billion the previous year and only $255 billion in 2010. Decker said banks would probably continue to increase their holdings of state and local obligations.

“Banks have clearly discovered that this product fits in their portfolios,” he said.

Matt Fabian, a partner at Municipal Market Analytics, said the rising bank holdings could actually signal that economic conditions aren’t good enough for banks to trust riskier and more lucrative investments.

“That’s a bit of an indictment that economic growth is not as strong as people would like,” Fabian said.

Fabian said the strong growth in mutual fund muni holdings, and a corresponding drop of $15 billion in household muni holdings from the third quarter of last year, is probably due in part to brokers and their firms directing retail customers into more managed products and away from direct investments. Mutual fund muni holdings were as low as $500 billion as recently as the first quarter of 2010. Regulatory requirements that apply to broker-dealers for retail investors in the fixed-income market are creating an incentive for the firms to move to mutual funds, Fabian said.

“From a compliance perspective, it’s just easier,” he said, but added that the household holdings category is a catch-all that can fluctuate depending on how the Fed decides to evaluate the data.

Money market mutual fund muni holdings ticked up 1.1% to $281.7 billion in the fourth quarter, the only quarterly increase of the year. The category has dropped sharply since it was $386.7 billion at the end of 2010 and $509.5 billion at the end of 2008.

Decker pointed to the relatively low holdings of broker-dealers as a significant sign of market conditions. Dealers held $18.9 billion of munis at the end of 2014, a $2.7 billion increase over the previous quarter but a steep decline from the $40 billion dealers accounted for in 2010.

“Clearly broker-dealers are holding less inventory,” Decker said. “That suggests overall that the market is less liquid than it was five years ago.”

State and local government holdings of munis have remained stable, rising slightly quarter-over-quarter to $13.6 billion at the end of last year.

State and local governments accounted for $2.9 trillion of muni debt, with nonprofit organizations and industrial revenue bonds making up the balance. $2.87 trillion of those munis are long-term obligations, the Fed data shows.

The Fed funds data is next scheduled for release on June 11.

THE BOND BUYER

BY KYLE GLAZIER

MAR 13, 2015 2:46pm ET

CHICAGO – Legal observers aren’t placing any bets on the outcome after watching the oral arguments in the Illinois Supreme Court case that will decide the fate of the state’s overhaul of most of its employee pensions.

Only the three Republican justices on the seven-member court posed questions to the state’s lead attorney, Solicitor General Carolyn Shapiro, and the two private attorneys representing the unions, retirees, and employees challenging the legislation.

The four Democratic justices remained silent during the nearly one-hour session Wednesday in which attorneys argued their sides in the dispute over whether the 2013 legislation that cut benefits for four of the state’s five pension funds violates the state constitution.

The court is expected to rule sometime this spring.

“I think it was fully and fairly presented by both the state and plaintiffs,” said municipal law and restructuring veteran James Spiotto, who is co-publisher of MuniNet Guide. “It’s always very hard to judge from the questions what the result will be based on the questions because it’s only guessing.”

Silence among justices is also a hard read. “Sometimes, certain justices may take the lead on questioning on some issues and others allow them to do that,” Spiotto said.

“I’m not a gambler so I wouldn’t put a bet on it, but I think there’s a chance it may go down to the lower court for an argument on the merits,” said Ty Fahner, a partner at Mayer Brown and a former Illinois attorney general who heads up the Civic Committee of the Commercial Club of Chicago, which has lobbied for pension reforms.

If sent back to the lower court, “I think there’s a lot of work to be done to convince the court that the state has met the standard,” Fahner said.

A delay could aid the state’s argument that it faces a fiscal emergency as it budgetary situation is not easing.

The Supreme Court is considering the case on an expedited basis.

It could uphold a lower court ruling from November voiding the legislative package as a violation of the state constitution’s pension clause, siding with union attorneys who argue the guarantee is absolute.

Or, it could decide the protections are on par with other state contracts and subject to modification in the case of a fiscal emergency as the state argued. Under that scenario, the case would likely be sent back to the Sangamon County Circuit Court where the argument over whether the state met strict standards for altering a contract would be vetted.

The court could issue a more sweeping ruling upholding the legislation, but it was not asked by the state to do so as there was no debate over whether conditions existed for the state to tap its police powers when the case was before the lower court.

Fahner also did not read too much into the silence of the majority of justices but said the probing questions and demeanor of Justice Robert R. Thomas are not a good sign for the state.

The state senator who sponsored the pension legislation offered a foreboding assessment after attending the arguments.

“I think the indications are that we’ll be back to the negotiation table,” said state Sen. Kwame Raoul, D-Chicago, adding he hoped the court’s eventual ruling provides some guidance for lawmakers on what could withstand a legal challenge. “That may or may not happen, hopefully it will.”

The questioning led by Thomas was primarily aimed at the state’s arguments about its police powers, the centerpiece of its argument that it needs to override language in the state constitution protecting pensions.

Shapiro, the solicitor general, told the judges the plaintiffs’ position that pensions can never be cut “remarkable.”

“If the state’s bond rating collapsed rendering borrowing prohibitively expensive, pensions would be entirely off limits regardless of the essential state services that might have to be eliminated,” she said.

But Thomas pressed her on whether granting the use of police powers would give the state too much future license.

“If the court holds that the state can invoke its police powers to violate core constitutional guarantees to respond to an emergency that at least arguably the state itself created, then aren’t we giving the state the power to modify its contractual obligations whenever it wants? For instance, the state could simply fail to fund the pension systems and then claim an emergency,” the justice asked.

Shapiro stressed that the state constitution provides only a few exceptions for such modifications. “The lower court will conclude whether the circumstances justify the state’s actions,” she said.

Justice Thomas also questioned how much of the state’s fiscal woes are due to the General Assembly’s failure to extend the 2011 income tax hike. The higher rates partially expired and lawmakers have not acted to make up the lost revenue. Shapiro acknowledged that the state’s budget situation remains unresolved.

Justice Lloyd A. Karmeier pressed Shapiro further on the role of sovereign power in the constitution.

“If sovereign power resides in the people, and the people adopt a constitution which specifically provided for a pension clause having different wording than the contract clause,” does that not indicate the how the public has directed the state to act, he asked.

Shapiro answered that the state and federal constitution prohibit the state from entering into a contract that would limit its ability to act to “protect the public welfare in extreme situations.”

Chief Justice Rita Garman asked union attorney Gino DiVito whether the state’s police powers could ever be used to impair pensions. DiVito did not directly answer, instead saying “not under these circumstances.”

Union attorney Aaron Maduff then addressed the question pointedly.

The state constitution lays out situations where the state can act and “those limitations are not in the pension clause,” Maduff said.

The Illinois constitution states that membership in any Illinois pension system “shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired.”

Shapiro argued that questions over the extent and cause of the state’s fiscal emergency and pension woes should be made at the lower court level.

Justices questioned why, if the state is mired in such a fiscal emergency, they were not asked to rule on whether the standard for invoking police powers was met, since further debate at the lower court level would simply delay a final decision.

Shapiro said the state believed there is enough time for the state to act on its budget.

The state contends its fiscal solvency is under threat and argues that position is underscored by its unfunded pension tab of $111 billion in a system that is just 39% funded. Rising payments are crowding out funding for essential services and infrastructure, the state argues, and the state’s bond rating has been pummeled, driving up its borrowing costs. The state is saddled with a backlog of unpaid bills of at least $5 billion and faces a $6 billion budget deficit.

THE BOND BUYER

BY YVETTE SHIELDS

MAR 12, 2015 5:04pm ET

Read the NASACT Response.

GASB’s PVs on Leases are available here.

Read the NASACT Response.

GASB’s PVs on Financial Reporting for Fiduciary Responsibilities are available here.

In his outlook report this week, Municipal Market Analytics’ Matt Fabian coined a new acronym: MPR. It stands for Mythical Pension Reform, a term that just might catch on as two states are attempting to overhaul their flailing pension systems. The reform is imaginary; politicians like to include the expected savings in proposed budgets before the reform actually passes. This is a mistake, Fabian says. In his analysis this week on Illinois Gov. Rauner’s proposed 2016 budget, Fabian says that any reliance on MPR in the budget should only be applied to future years as the state’s courts “have not shown much sympathy for state budget concerns or timeliness when considering the legality of past pension reforms.” (New Jersey is the other state this year attempting a major reform.)

Rauner is seeking to slash current employees’ retirement benefits in an effort to close his state’s continual budget gaps, including one in 2016. A previous pension reform, which cuts benefits already accrued by employees, is tied up in a legal battle. Rauner’s proposal would allow current employees to keep the pensions they’ve already earned but future employees would get less generous benefits. The governor estimated the move would save $2.2 billion in 2016 alone.

GOVERNING.COM

LIZ FARMER | MARCH 13, 2015

(Reuters) – The U.S. Treasury confirmed on Friday that it had indefinitely shuttered a key facility used to refinance debt in the $3.7 trillion municipal bond market in a move set to slow a surge of new bond issuance that has inundated the market this year.

The suspension of the issuance of State and Local Government Series (SLGS) securities, known as the “slugs window”, as of noon on Friday was ordered by the Treasury as a temporary extension to the U.S. government’s borrowing limit expires on Sunday with little sign Congress will act to extend it promptly.

“Protecting the full faith and credit of the United States is the responsibility of Congress,” Treasury Secretary Jacob Lew said in a letter to the legislature on Friday, informing it of the suspension and other extraordinary measures.

Issuing Treasury slugs counts against the debt limit.

Closure of a facility used by municipal governments in debt refinancing transactions is likely to slow refunding operations that have contributed the bulk of new municipal bonds issuance so far this year, analysts say.

“Suspension of slugs sales could disrupt advance refunding activity as the only main alternative is acquiring open-market Treasuries through a competitive bidding process,” Oppenheimer said in a research note this week.

Municipal governments purchase slugs in advanced refinancing deals when the bonds they are refinancing are not immediately callable. The municipality puts the slugs in an escrow account and the cash flow is used to repay the debt.

Municipalities prefer to use slugs for advanced refinancing deals rather than Treasuries purchased in the open market because the Treasury tailors coupons and terms of slugs to match the refinanced debt.

Municipal bond issuance has been surprisingly strong so far this year. Refinancing deals have made up the bulk of the deals. New issuance totaled $58.8 billion in the first two months of the year, nearly double the same period last year.

Of that total, refunding deals amounted to $39.8 billion, or over two thirds of the total muni bond issuance, according to data compiled by Thomson Reuters.

“Suspending slug purchases will slow that, limiting debt service savings opportunities for state and local budgets,” Moody’s Investors Service wrote in a report.

Fri Mar 13, 2015 2:39pm EDT

By Edward Krudy

(Reporting by Edward Krudy; Editing by Leslie Adler and Jonathan Oatis)

Municipal Market Analytics | Mar. 10

Read the Brief.

For more extensive, longer-term energy efficiency projects, owners may consider property-assessed clean energy (PACE) financing — a financing vehicle that allows owners to borrow money from a local government and pay it back over time on the building’s property tax bill. PACE is now available in 31 states covering about 80 percent of the population in the U.S. “We’ve seen a definite uptake in the commercial market (for PACE), despite the rocky regulatory landscape,” says ACEEE’s Bell.

NAESCO’s Gilligan agrees. “We see a lot of potential in PACE,” he says. “It’s a little more complicated than other financing, and it requires a state law plus a local law plus a program to enable it. But if you can do PACE, you’ve got lower-cost money. PACE makes it easier for comprehensive retrofits.”

A recent PACE project in Los Angeles illustrates PACE’s potential — in 2013 the Hilton Los Angeles/Universal City completed $7 million in upgrades using PACE financing and $1 million in utility rebates. The 500,000-square-foot hotel replaced HVAC, elevators, controls, lighting, and restroom fixtures. The project has a return on investment of 78 percent and owners have calculated an increase in the value of the building of more than $30 million.

“It was an aging property that needed all kinds of upgrades,” says Marky Moore, CEO of the Capital Review Group, which participated in the project. “They had big buy-in from their financial officer, and it turned out to be a stunning project. In the grand scheme of things a property is improved and value is better using a PACE program.”

More Lenders

One of the reasons PACE, as well as other financing programs, including increasingly specialized loan programs on a city-by-city or state-by-state basis, are becoming more prevalent is that “we are seeing a lot more lenders looking to participate in the energy market than we did five to 10 years ago,” says Goulding. “I believe this is a testament to the fact that lenders are realizing that many energy projects are excellent projects where the ROI can be accurately calculated.”

That’s all good news for facility managers — both in terms of the fact that there are more options for inexpensive money for energy efficiency, and also because it raises facility managers’ profile in any organization as their expertise is appreciated and relied upon. In many organizations, it won’t be the facility managers making the ultimate decision about the type of financing — but being well-versed in the options and knowing which will meet the organization’s needs can be the main catalyst to getting an energy project funded. “Facility managers need to be involved in the discussion regarding layering in incentives and financing projects efficiently,” says Moore. “It’s the facility manager who really knows the property.”

FACILITIESNET

By Greg Zimmerman, Executive Editor – March 2015 – Energy Efficiency

When the Great Recession delivered the biggest blow to government budgets this side of World War II, it wasn’t just slashing revenue streams — it also made certain financing agreements more costly in the long run.

The agreements are called interest rate swaps, a holdover from the years leading up to 2008 when the booming market made even risky investments seem like a good idea. But in reality, these financing agreements with banks have come back to haunt governments following the financial markets crash and severe drop in interest rates. Last week, Chicago became the latest example when a credit rating downgrade by Moody’s Investors Service triggered a potential $58 million penalty for the fiscally beleaguered city.

Penalties related to ratings downgrades are common in swaps, says Municipal Market Analytics Partner Matt Fabian. But typically, the ratings floor is well below the government’s rating at the time of the deal.

“Remember, Chicago was super-downgraded back in 2013 — that kind of rating action is almost never expected,” Fabian says. “This latest downgrade is a result of the city’s huge pension liability, the complete lack of momentum in coming up with any sort of solution and a shifting [emphasis] by Moody’s on outstanding liabilities.”

Still, Chicago is not alone. Dozens of cities and states across the country still have swaps deals on the books. These deals were meant to save taxpayer money but are in fact doing just the opposite.

In an interest rate swap, a government wants to alter debt it has sold that must be paid back with a varying interest rate that periodically resets, depending on the market. Buying that type of debt is appealing to investors, who believe that interest rates will grow and they will get a higher return on their investment. But governments need to plan out their budgets and it is difficult for budgeters to project debt payments that will vary versus payments that are based on a fixed interest rate. So, the government makes a deal on that debt with a bank: The bank agrees to pay out the investors at the variable interest rate and the government pays the bank a fixed rate that they negotiate. It’s a way for the government to hedge against skyrocketing interest rates.

These types of deals were very common in the early to mid-2000s, particularly among larger issuers like major cities, some states and public agencies like housing or airport authorities. Many thought that they were saving taxpayer money: that the interest rate they were paying banks was lower than if they sold that debt and paid out a fixed, market rate of return to investors. But swaps fell largely out of favor after interest rates plummeted — and stayed rock-bottom-low. Governments found themselves stuck paying an interest rate far above the market while the banks pocketed the profits.

Some question the legality of such deals. The Roosevelt Institute’s Saqib Bhatti argued some cities could take legal actions against the banks to recoup some of their losses. Bhatti, director of the institute’s ReFund America Project that advocates for better Wall Street accountability, noted Chicago Public Schools is potentially leaving millions of dollars on the table with inaction. Last November the Chicago Tribune published a series that found banks knew the risky auction-rate bond market was in trouble during the summer of 2007, yet they turned around and sold the school district $263 million in auction-rate debt anyway.

“There’s been a number of organizations in the city calling for legal action to recover past payments on these swaps,” says Bhatti. “And thus far, the city has not pursued that option.”

All told, the Tribune estimated that Chicago’s school district issued $1 billion worth of auction-rate securities between 2003 and 2007, nearly all of it paired with interest rate swaps. The city of Chicago holds nearly $3 billion in debt tied up in swaps, an amount nearly equal to its operating budget. The city is likely renegotiating with banks to reset the terms of the four swaps tied to last week’s ratings downgrade instead of paying the $58 million termination fee, although the current administration has unwound some deals by paying tens of millions in fees. If the city wanted to terminate all of its swaps, it would cost north of $300 million, according to its most recent Comprehensive Annual Financial Report. The termination fee represents the amount the debt is underwater, similar to when a homeowner owes more on a house than it’s worth.

GOVERNING.COM

BY LIZ FARMER | MARCH 6, 2015

Transparency is a divisive issue in the state and local financial market. The main sticking point is time. Governments, the argument goes, cannot be expected to operate at the speed or with the savviness that corporate markets do. But for those dragging their feet on the issue, keep this in mind: States and localities are potentially leaving billions of dollars on the table by not having financial transparency on par with the corporate world.

A new study from the University of Oregon supports this idea. Looking at the municipal bond market, researchers found that timelier information can reduce transaction fees on trades by up to 30 percent. This is particularly true for individual investors, who make up the bulk of the $3.6 trillion U.S. municipal bond market. The report, co-authored by finance professor John Chalmers, looked at the difference in municipal bond trading before and after the Municipal Securities Rulemaking Board’s (MSRB) Real-Time Transaction Reporting System kicked off at the start of 2006. The system required trades to be reported in 15 minutes instead of at the end of the day. It allowed for much better price comparison by buyers.

Although Chalmers is studying trades on municipal bonds by dealers or individuals after the issuer initially sells them, he said transparency still could lead to lower costs for issuers. “The lower these trading costs, it ultimately should affect the [interest rate] you need to set on your bonds to get them sold,” he said. “An investor is going to look at their return after costs and taxes. If those costs are lower, they’d be willing to settle for less.”

The idea builds on work published in 2006 by Lawrence Harris and Michael Piowar, which found that poor market quality was the primary reason that municipal bond trades were significantly more expensive than similarly sized trades in the corporate market. Additional research by Andrew Ang and Richard C. Green for the Brookings Institution in 2011 concluded that state and local governments might be paying billions of dollars each year in unnecessary fees, transactions costs, and interest expense due to the lack of both transparency and liquidity in the municipal bond market.

Ang and Green estimated that the liquidity cost alone represents approximately $30 billion per year on the current $2.9 trillion stock of outstanding bonds. “When the market is liquid and transparent, both borrowers and investors incur fewer fees and lower costs,” wrote Ang and Green. “All of these factors contribute to reduced interest expense for issuers.”

Massachusetts has adopted this concept and is taking a cue from the way the corporate world interacts with its investors. It launched a new investor website that has 40,000 downloadable documents on things like bond authorizations, revenue reports, budgets, audits, official statements, economic reports and pension valuations. Free software is also available so that investors can download and manipulate data.

A year ago this March, the state launched its MassDirect Notes program in which the state sells its bonds directly to investors for a two-week period each month, allowing individual investors to buy the state’s bonds directly. This is akin to buying NFL tickets directly from the team versus paying more on secondary markets like StubHub. More recently, Massachusetts became the first U.S. government to launch a smartphone app for investors.

Assistant State Treasurer for Debt Management Colin MacNaught said this effort will save taxpayers millions in borrowing costs over the long term. “Whether the credit news for Massachusetts is good or bad, investors know that they’ll always get good and current disclosure from the state,” he said. “We think that gives them an added measure of confidence in our bonds, thus enhancing the liquidity of our paper. And every dollar we save on our borrowing is one more dollar we can redirect elsewhere to other budget areas.”

What Massachusetts is doing is potentially groundbreaking. But despite the data on investor costs, there’s no concrete proof that issuers can lower their borrowing costs via transparency, said Lynnette Kelly, MSRB’s executive director. The Bay State is providing the market a test case in this theory.

That is reason enough to keep an eye on Massachusetts’ success in this arena but here’s one more: The Securities and Exchange Commission is getting tough on the municipal market and disclosures is a big part of the picture. In this respect, the more governments can take this responsibility on themselves, the better.

To that end, the MSRB is telling smaller governments, which tend to be less savvy about financial disclosures because they issue few, how they can increase transparency on their own. Most governments post their Comprehensive Annual Financial Reports online, said Kelly. But they could also make available such relevant information as meeting minutes, budgets and a list of top local employers. “This stuff is pretty easily accessible,” she said. “So we’re trying to make sure smaller issuers know that it should be top-of-mind and it’s very, very easy to do.”

GOVERNING.COM

BY LIZ FARMER | MARCH 12, 2015

That’s what a new report proposes as states limit potentially life-saving but expensive new drugs. But some say that would be surrendering to drug makers.

When the maker of a breakthrough hepatitis C drug Sovaldi set the price at $1,000-a-pill but promised a cure that could lower costs in the long term, states scrambled last year to limit treatment to patients with the most severe cases, anticipating billions in near-term costs. A new report argues a good solution might be to use an approach that state governments already prefer with infrastructure and some social programs — taking out bonds.

The idea comes from the California-based RAND Corporation, a research organization that specifically drew on the case of Sovaldi, which earned $10 billion in sales last year for its maker, Gilead Sciences. The company boasted that its clinical trials proved the drug effectively cures the slow-moving liver disease in more than 90 percent of patients at a cost of about $84,000 for a 12-week treatment, far better than a liver transplant, which costs about $600,000.

But critics in Congress, state governments and elsewhere alleged price-gouging, noting Gilead charges other markets at a fraction of the U.S. In addition, critics say, the drug’s effectiveness outside of controlled clinical settings is unclear, and hepatitis C moves so slowly that restricting Sovaldi until cheaper alternatives enter the market is the most sensible option. Express Scripts, the pharmacy benefit management company, estimated covering all of the 750,000 hepatitis C patients in state programs would cost governments more than $55 billion.

RAND is suggesting a way to make the drug more affordable, though some critics question its strategy. With more specialty drugs and breakthrough vaccinations expected to hit the market in the coming years, insurers — including state Medicaid agencies — should consider a strategy that promotes long-term investment, argued Soeren Mattke, an author of the report.

Mattke recommended that insurers issue debt instruments like bonds or mortgages directly with manufacturers. If the insurer issued a bond, it could pay interest to the manufacturer until the maturity date followed by a larger balance payment. Or they could offer fixed monthly payments, or credit lines with payments at pre-established points.

What those agreements should also include, RAND argued, are performance agreements that set payments according to proven outcomes. Scotland already has such an arrangement over Olysio, another hepatitis C treatment, according to RAND. To reduce the administrative cost of tracking patients, RAND recommended letting an impartial outside group study a sample group that represents the population.

Mattke said he had Medicaid agencies in mind specifically when he developed the idea, along with middle-income nations like Brazil and less cash-rich countries — southern Europe, for instance — that face short-term budgetary constraints. “I think Medicaid is actually the only situation where it would work in the U.S.,” he said. Rather than limiting treatment to, say, 10 percent of patients, agencies should think long-term, he added. “It’s a bad financial decision, because those 90 percent will continue to accrue medical costs while they’re waiting for Sovaldi.”

But the key problem with RAND’s proposal is that it concedes the policy fight over the steep cost of drugs like Sovaldi, countered Matt Salo, executive director of the National Association of Medicaid Directors. The paper’s approach “completely throws the white flag of surrender on drug prices,” he said by email. “It says, ‘We’re okay with the price of Sovaldi being $84,000 or even $200,000, because if we can spread the actual costs out over 20 years or so, nobody will actually notice or feel the pain.’”

But additionally, Salo argued, reports from the Institute for Clinical and Economic Review call into question cost-effectiveness over the long windows envisioned under a debt agreement. If RAND’s idea extends into areas like Alzheimer’s, which pharmaceutical companies argue costs society trillions of dollars, manufacturers could continue charging staggering sums under questionable assumptions, he said.

Jeff Myers, who heads the trade group for private Medicaid plans, didn’t dismiss the idea of debt-financing outright, but he argued that pharmaceutical companies will have to bear substantially more risk before insurers should agree to bond deals, and introductory costs do need to go down. That means accounting for actual outcomes outside of clinical settings and potentially finding ways to help patients adhere to their medications, he said.

“With hepatitis C, Gilead says [it’s a] 90 percent [cure rate], but it turns out in the real world it’s a lot less,” he said. “That percentage has a true cost in the health system, yet Gilead bears no risk when it doesn’t actually work as well as they say it does.”

Chris Koller, a former insurance commissioner who runs the Milbank Memorial Fund, said he thinks the RAND idea does take cost-effectiveness into consideration. But he does question whether manufacturers that are already raking in profits would be interested in revenue streams that grant them less control, and unlike other countries, the U.S. system of public and private payers for different populations and different age groups poses logistical challenges and questions about who actually receives the financial reward of breakthrough medications.

Still, he said, he’s seen arrangements in which different payers pool their money for things like vaccines in Rhode Island, where he served as a health insurance commissioner. “This is, by its design, meant to trigger discussion,” he said. “We shouldn’t shoot it down just because it’s hard to implement.”

GOVERNING.COM

Chris Kardish | Staff Writer

March 12, 2015

(Bloomberg) — Illinois’s remedy for the state’s worst-in-the-nation $111 billion pension-funding shortfall was disliked by lawmakers who voted for it, the new governor who inherited it and public employee unions who sued to void it.

Attorney General Lisa Madigan on Wednesday asked the state’s Supreme Court to resurrect it.

The 2013 measure to cut cost-of-living increases and boost the retirement age was struck down last year by an Illinois judge who found it violated the state constitution’s ban on reducing public worker retirement benefits. The dispute is being watched around the country as state and local governments faced total pension shortfalls of more than $1 trillion in 2013.

Illinois Solicitor General Carolyn Shapiro argued Wednesday that the state should be able to invoke its “police powers” in a time of fiscal crisis.

“Invoking police powers is not something the state could do willy nilly,” Shapiro said responding to a question from Justice Robert Thomas. “Raising taxes cannot always be the answer to a fiscal crisis.”

Few Questions

The state Supreme Court’s seven-judge panel asked few questions during Wednesday’s hearing and gave no timeframe for a ruling. To win a reversal, Madigan must convince at least four of the court’s seven justices that the constitutional provision — which says a public worker’s pension membership is a contract “the benefits of which shall not be diminished or impaired” — is something less than absolute.

Thomas pressed Shapiro on whether the drafters of the provision intended to protect those benefits in difficult economic times. When Shapiro replied she didn’t believe that was the entirety of the intent, Thomas asked if it would be “problematic” if the court believed it was.

The state cannot be forced to surrender its sovereign power to protect the general welfare of the people, Shapiro responded.

Gino DiVito, an attorney for the suing unions, countered that the provision was “explicit, clear and unambiguous” regardless of the state’s argument for recognition of a possible “doomsday scenario.”

Illinois has the lowest credit among the 50 U.S. states. Last month, Governor Bruce Rauner, who defeated Democrat Pat Quinn in November, proposed an array of spending cuts to close a $6.2 billion budget shortfall.

Pension Repair

If the pension fix is upheld, Illinois will save about $1 billion on its $7.5 billion contribution requirement for 2015, which means that money can be spent elsewhere, said Laurence Msall, president of the Civic Federation, a Chicago-based independent budget watchdog group.

As a candidate, Rauner criticized the pension-repair bill, under which lawmakers planned to save about $145 billion over 30 years.

Before the legislators voted on it, Rauner said the plan “barely scratches the surface of the problem.” The Republican, a former venture capitalist, has called for shifting some public employees to a defined-contribution plan, similar to a 401(k).

Illinois pension changes were attained in 2013 following years of legislative gridlock and an unsuccessful attempt by Quinn to dock lawmakers’ pay to force a resolution.

Public worker unions, banding together as a coalition called We Are One Illinois, sued to block the measure in January 2014, arguing its members’ benefit plans are inviolable. Springfield Judge John Belz put the plan on hold in May and declared it void in November.

Health Plans

His ruling came just four months after the state Supreme Court rejected Illinois’ attempt to reduce its contributions for government retiree health-insurance plans. The justices, in a 6-1 decision, relied on the same constitutional provision.

“We believe the language of the pension clause is very clear,” said Anders Lindall, a spokesman for the American Federation of State County and Municipal Employees Council 31, which has more than 75,000 members.
The provision was added to the state constitution to protect public workers from lawmakers making “irresponsible choices” and then looking to retirees’ life savings for a remedy, Lindall said.

Super-Contracts

Madigan maintains that interpreting the constitution that way would create super-contracts and nullify the state’s power to act for the greater good.

“If the pension clause really bars the state’s exercise of its police powers under every possible circumstance, no matter how dire, then the ‘contractual relationship’ the clause creates is unlike any other contractual relationship recognized in American law,” she said in court papers.

Illinois House Speaker Michael Madigan, the attorney general’s father, won’t comment on the issue, his spokesman Steve Brown said. State Senate President John Cullerton believes the law violates the Illinois constitution, spokeswoman Rikeesha Phelon said.

“He supported last year’s pension reform so that it could advance as a test case,” Phelon in a March 9 e-mail. Both legislative leaders are Democrats.

Nationally, state and local government pension plans in 2013 had about 72 percent of the money needed to meet retirement obligations, according to a study released in June by the Center for Retirement Research at Boston College.

State constitutions have been invoked elsewhere to try to prevent cuts to public pensions. In Rhode Island, unions settled with the state over pension cuts before their constitutional challenge could be put to the test. In municipal bankruptcy cases in Detroit and California, judges ruled that federal law overrode state bans on cutting pensions.

With the Supreme Court arguments looming, two lawsuits involving changes to Chicago employee benefits have been put on hold because their fate might hinge on what the justices decide.

“The governor’s office will take appropriate action depending on how the Illinois Supreme Court rules,” said Rauner’s press secretary, Catherine Kelly. “The current pension system is unaffordable and is choking the state’s budget.”

The case is In re Pension Reform Litigation, 118585, Illinois Supreme Court (Springfield).

by Andrew M Harris

March 11, 2015

To contact the reporter on this story: Andrew Harris in federal court in Chicago at [email protected]

To contact the editors responsible for this story: Michael Hytha at [email protected] Sophia Pearson, David Glovin

Taylor Riggs, an editor at Bloomberg Brief, talks with Joe Mysak about this week’s municipal market news.

Watch.

March 12, 2015

(Bloomberg) — U.S. mutual funds’ holdings of municipal debt grew to a record $658 billion in 2014 as individuals shunned direct purchases in favor of managed money amid Puerto Rico’s woes and the loss of top-rated bond insurance.

The funds increased their stake by almost 40 percent in the past five years, solidifying their position as the second-biggest category of muni buyers, according to Federal Reserve data released Thursday.

Even as regulators seek to promote transparency in the market for state and city debt, the shift underscores the diminishing role of individuals who buy bonds for their own account. Households, while still the largest muni holders, reduced ownership to the lowest in almost a decade as Detroit’s historic bankruptcy and junk-rated Puerto Rico’s struggle to repay $73 billion of debt steer them toward more diversified investments.

“Credit concerns, especially Detroit and Puerto Rico, have caused a lot of individuals to want professional credit advice,” said Phil Fischer, head of muni research at Bank of America Merrill Lynch in New York.

Growing Influence

Mutual funds are expanding their influence as the supply of munis is shrinking. The tax-exempt market, which localities use to finance roads, bridges, public schools and water systems, dwindled for the fourth straight year, to $3.65 trillion as of Dec. 31 as officials hesitate to take on borrowing for new projects.

It’s the longest stretch of declines in data going back to 1945, and the market is still contracting: Local-government obligations tallied $3.5 trillion as of Wednesday, data compiled by Bloomberg show.

The declining amount of debt and buying by funds helped munis advance 9.8 percent in 2014, the most since 2011, according to Bank of America Merrill Lynch data.

With the top federal income-tax rate the highest since 2000, the appetite for munis’ tax-free interest isn’t waning. Investors are just reconsidering how they buy the securities.

Holdings of households have dropped every quarter since March 2013, to $1.54 trillion at the end of 2014, the least since March 2005, Fed data show. Their ownership has dropped to 42 percent of the market, from 50 percent at the end of 2010.

Insurance Crutch

The transition gained momentum after the companies that insure munis lost their top credit ratings in the wake of the financial crisis. Unable to rely on the guarantee, buyers had to take a closer look at the creditworthiness of specific holdings, said Alan Schankel, a managing director of fixed-income strategy at Janney Capital Markets in Philadelphia.

“It’s tough for individual investors,” he said. “If they have 20 different positions in their portfolio, it may be difficult for them to keep on top of all of them.”

The concerns of individual buyers have grown as Puerto Rico’s fiscal challenges mount. The debt load of the island and its agencies is greater than all states but California and New York, even though it has about 3.5 million people. Because the territory’s bonds are tax-exempt nationwide, they’re widely held by both individuals and mutual funds.

Puerto Rico lost its investment grades last year as officials struggle to revive the commonwealth’s economy. Its Electric Power Authority is negotiating with creditors to potentially reduce $8.6 billion of obligations, in what may become the largest muni restructuring.

Stress Push

Reports of financial stress and failures “have pushed a growing amount of investors towards some kind of managed solution,” Schankel said.

Professional money managers can also help investors deal with a potential increase in interest rates, which can reduce prices on muni holdings, said Fischer at Bank of America. The consensus on Wall Street is that the Federal Reserve will raise its target interest rate from near zero this year as the economy strengthens.
Benchmark 10-year munis yield about 2.2 percent, close to the highest since November.

“They’re willing to buy more assistance when they’re anxious,” Fischer said. “They can have a variety of anxieties, and certainly one of them is credit and another one of them deals with interest rates.”

Bloomberg Muni Credit

by Michelle Kaske

March 12, 2015

To contact the reporter on this story: Michelle Kaske in New York at [email protected]

To contact the editors responsible for this story: Stephen Merelman at [email protected] Mark Tannenbaum, William Selway

Fitch Ratings-New York-10 March 2015: The settlement of the Morris Model highlights the need for local government obligors to assess whether construction contractors have the technical and financial capacity to assume the risks of the project’s completion including the potential for cost overruns, schedule slippage, and equipment underperformance, Fitch Ratings says. It also underscores that solar power project development is among the lowest risk asset classes of the power sector, but not risk free.
In our view, in addition to managing the construction contractor risks, government obligors should also assess the stability of revenue generation including whether debt repayment is supported by an assumption of a certain level of energy delivery and/or dependent on volatile regulated renewable energy credits.

The project was designed to support the development of multiple solar power installations on school and county government buildings in a single financing. The initiative was financed by the Morris County Improvement Authority (NJ) and Somerset County Improvement Authority and the debt was guaranteed by the counties. Morris, Somerset, and Sussex Counties, involved in the transaction, recently agreed to a settlement with the contractor that will complete the installations after cost overruns and delays, according to The Bond Buyer.

The events around this transaction have been a jolt to the financial community. However, investor demand for renewable power development remains high. More robust structures that minimize the likelihood that local governments will be called on to support debt repayment are required to maintain their continued interest in participating.

Contact:

Yvette Dennis
Senior Director
Global Infrastructure & Project Finance Group
+1 212 908-0668
33 Whitehall Street
New York, NY

Rob Rowan
Senior Director
Fitch Wire
+1 212 908-9159

Media Relations: Elizabeth Fogerty, New York, Tel: +1 (212) 908 0526, Email: [email protected].

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY’S PUBLIC WEBSITE ‘WWW.FITCHRATINGS.COM’. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH’S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE ‘CODE OF CONDUCT’ SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Maryland-based Standard Solar Inc. will design and install a 3.6 MW solar power system for the Town of Stafford, Conn., as part of a program to make the town’s municipal load completely satisfied by renewable energy.

The project will feature three arrays: two 1.3 MW arrays located at Stafford Middle School and a 954 kW array at the town’s landfill. The town is also installing a geothermal heat pump system that will replace four oil burners in the town’s four largest public buildings. Replacing oil with geothermal will actually increase the electrical load; however, this will be compensated for by the output of the three solar arrays, which are expected to produce approximately 4.6 GWh of electricity per year.

Rather than follow a typical financing route for a municipality – which cannot avail itself of the federal investment tax credit (ITC) – by financing the solar project through a power purchase agreement (PPA) or lease, the town elected to purchase the systems through a tax-exempt lease purchase (TELP). This option is available to public, nonprofit and other tax-exempt organizations and enables the buyer to spread the purchase cost over the period of the lease.

“There’s been a lot of talk about TELPs for municipal purchases in the U.S., but they haven’t really been used for solar in my experience,” says Tony Clifford, CEO of Standard Solar. “This really is pretty novel.”

One of the reasons for the scarcity of TELPs in municipal solar deals is the combination of factors that move the Stafford solar project forward. Richard Shuck, Stafford’s first selectman, says the town has a very active energy committee with excellent engineering support that was willing and able to take on the task of owning a solar array large enough to meet the town’s needs.

“We looked at our consumption and wanted to know the most cost-effective way we could reduce energy costs,” Shuck says. “The town has recognized the value of energy independence and formulated a plan to get the town to a net zero energy goal.”

According to Dennis Milanovich, Stafford’s town engineer, the conventional wisdom is that because municipalities cannot take advantage of the 30% ITC, they typically finance solar projects through PPAs or lease agreements. However, if the town was prepared to take on the complexities of issuing a request for proposals and assuming financial responsibility for the project, it was able to eliminate the overhead of having a third-party developer involved.

“The reality was that because we were willing to buy in such large quantity and buy it as a construction project, we got our dollars per kilowatt down to about $2.50,” Milanovich says.

As currently configured, the solar project will consist of approximately 11,780 Canadian Solar CS6X 310 W modules. The two arrays at the school will be fixed-tilt ground mounts, while the landfill will have a ballasted system that won’t penetrate the cap. The inverter type has yet to be determined.

Key to the viability of this approach was Connecticut’s Zero-Emission Renewable Energy Credit (ZREC) program combined with the state’s virtual net-metering policy. The ZRECs provide the financial returns that the town can use to pay for the system. Virtual net-metering gives the town some flexibility about where it can place the arrays and still get credit for them.

“Our existing expenditures combined with the ZRECs actually more than make up for the lack of any federal tax credit on this project,” Shuck says. “Our project – combined with the geothermal – is projected to be cashflow positive right from the start.”

Because the town owns the three sites selected for the solar arrays, no lease was required for the land. The two locations for the arrays near the school are also near one of the town’s three circuits from the substation. The third site at the landfill where there are no loads, and thus is rendered useful solely due to virtual net metering, is on a separate circuit. This is expected to balance the project from an interconnection standpoint and facilitate utility approval.

“We couldn’t have done this without the ZRECs and the virtual net metering,” says Standard Solar’s Clifford. “If you could only use the power at the place it was being generated, the project wouldn’t be possible.”

The combination of Connecticut policies enabling the Stafford project underscores the importance of a state’s legislative and regulatory climate in promoting the growth of a vibrant solar sector. This importance of state and local policies is going to become even more significant if the ITC expires as scheduled at the end of 2016.

SOLAR INDUSTRY

by Michael Puttre on Tuesday 10 March 2015

The billions of dollars in pension obligations faced by cities and states across the country have politicians from many of them calling for some type of reform. A commission appointed by New Jersey Gov. Chris Christie wants to freeze the state’s current pension plan, while in California, Gov. Jerry Brown has signed a bill that increases the retirement age, among other things. In Illinois, Gov. Bruce Rauner wants to eliminate overtime in the determination of pension benefits.

But now rulings by judges in Michigan and California have sparked a debate about another way to deal with pension issues, namely municipalities filing for Chapter 9 protection so that they can break contracts with retirees.

Judge Steven Rhodes of the U.S. Bankruptcy Court for the Eastern District of Michigan in Detroit and, more recently, Judge Christopher Klein in the U.S. Bankruptcy Court for the Eastern District of California in Sacramento, both arrived at a similar conclusion while adjudicating the Chapter 9 filings of the city of Detroit and the city of Stockton, respectively: municipalities can’t be stopped from changing or breaking contracts by state law, even if they involve agreements with their pensioners.

“When Judge Rhodes ruled the city was eligible for bankruptcy in December 2013, his opinion pointed out that the Supremacy Clause [in the U.S. Constitution] meant that pension agreements are subject to compromise in bankruptcy court despite their state constitutional protections,” said Kenneth Buckfire of Miller Buckfire & Co. LLC, which served as Detroit’s financial advisor and investment banker.

Forty-eight states, all but Indiana and Texas, have specific protections for pension accruals. Seven states, including Michigan, put such language in their constitutions.In August 2012, Boston College’s Center for Retirement Research reported that the majority of states protect the benefits as a contract, including California. Others label them as property. Minnesota guarantees protection even if there is not an explicit contract.

For now, the two decisions have limited reach. And the process of filing for bankruptcy isn’t easy. But officials of cash-strapped governments can be forgiven if they see the rulings as a lifeline.

The two judges, at least, weren’t impressed by state protections of something that involves federal law, which governs bankruptcies.

“The state of Michigan itself cannot legally provide for the adjustment of pensions debts or any debts of the city of Detroit,” Rhodes wrote. “It has long been understood that bankruptcy law entails impairment of contracts. For purposes of the Tenth Amendment and state sovereignty, nothing distinguishes pension debt in a municipal bankruptcy case from any other debt. e eligibility decision. The state constitutional provisions prohibiting the impairment of contracts and pensions impose no constraint on the bankruptcy process.”

Just as the language in Michigan’s constitution didn’t cow Rhodes, neither does California’s protections intimidate Klein, who, on Feb. 4, actually called the Golden State’s largest pension fund, the California Public Employees’ Retirement System, or CalPERS, a bully.

“[A]s will be seen, it is doubtful that CalPERS even has standing to defend the City pensions from modification,” Klein opined. “CalPERS has bullied its way about in this case with an iron fist insisting that it and the municipal pensions it services are inviolable.”

The state law forbidding a contract rejection with CalPERS is “constitutionally infirm in the face of the exclusive power of Congress to enact uniform laws on the subject of bankruptcy … the essence of which laws is the impairment of contracts-and the Supremacy Clause,” Klein wrote.

Atlantic City, N.J., could very well become the next battlefield on the pension reform question and whether a bankruptcy filing can help solve it.

Christie on Jan. 22 signed an executive order appointing Kevin Lavin, who previously worked at FTI Consulting Inc., as Atlantic City’s emergency manager and Kevyn Orr, who shepherded Detroit through its bankruptcy, as his special counsel.

The seacoast city’s main problem is its withering casino industry, but its pension obligations also pose issues.

“I think we are definitely going to continue to see pensions be a focus of municipal bankruptcy, even if it’s not the [main] cause of a municipality’s filing,” said Laura Napoli Coordes, a visiting professor of law at the Arizona State University Sandra Day O’Connor College of Law.

Fox Rothschild LLP partners Nicholas Casiello, Jr., and Michael Viscount, in a Feb. 2 analysis of the city’s financial condition, noted that while the emergency manager has said it’s too early to discuss bankruptcy, his background in restructuring and the appointment of Orr as Lavin’s special counsel has “led to speculation that this alternative is clearly on the table.”

For the town once known as The Queen of Resorts to file, the city council would have to approve the step by a two-thirds vote. The state Municipal Finance Commission would also have to clear the move.

According to a 2012 paper from law firm Chapman and Cutler LLP, 12 states have laws expressly allowing one of its political subdivisions to file for bankruptcy, while another 12 states will let a municipality seek court protection upon certain conditions. New Jersey, California and Michigan fall into the latter category. In 21 states, the laws are unclear or do not have specific authorization statutes on the books, while Georgia and Iowa generally prohibit bankruptcy filings.

Not everyone believes that the Rhodes and Klein decisions about pensions being alterable in bankruptcy will firmly take root. Bill Brandt, president and CEO of turnaround consulting firm Development Specialists Inc. and the current chair of the Illinois Finance Authority, said there is “ample debate” as to whether the decisions by Rhodes and Klein would pass muster while under consideration in other courts.

Some in the bankruptcy community may say that retirement benefits can be impaired in bankruptcy court, said Brandt, who has been active in the restructuring world for decades. But, he added, there are “substantial and incredibly important political concerns attached to that.”

To be sure, the Stockton and Detroit decisions aren’t binding on other municipal bankruptcy cases, said ASU’s Coordes.

“[A]s far as the rulings’ precedential value, the basic rule is that bankruptcy judges are not bound by decisions of other bankruptcy judges,” she explained. “This is true even when the bankruptcy judges are in the same district.”

The same holds true for U.S. District Courts.

“But, in general, district court rulings that are not directly related to a bankruptcy court appeal are not binding on the bankruptcy courts,” she said.

But district court rulings on bankruptcy appeals are binding, Coordes said.

Stockton’s and Detroit’s treatment of pensions in those cities’ debt-cutting plans were largely left intact. Healthcare benefits took the hit in both plans of adjustment; the coverage was essentially eliminated for both cities’ retirees.

Stockton didn’t impair its pensions directly, said John H. Knox, the city’s debtor counsel from Orrick, Herrington & Sutcliffe LLP.

He said the municipality impaired pensions indirectly by renegotiating contracts and eliminating most medical benefits.

The Stockton plan divides retirees into two categories. The first group received an average of $24,000 in pension benefits per year with no medical benefits. The second group, which receives $51,000 annually from CalPERS and $26,000 in medical benefits, will lose the medical benefit contribution but could pay for the benefits out of their own pockets.

Employees hired before Jan. 1, 2013, will no longer receive free medical benefits but could pay for the insurance out of their own pockets. Employees now pay a portion of the CalPERS contribution, which is 7% for all non-safety employees and 9% for safety employees or sworn police and fire personnel.

The city decided not to change its pension system, in part, to maintain its ability to attract quality employees. Under California law, municipalities are not required to participate in CalPERS, but doing so allows workers the benefit of portability, or taking benefits earned at one CalPERS job to another CalPERS job. Losing that, Knox said, would put the city at an “extreme disadvantage of hiring people.”

Stockton also eliminated retiree medical benefits for some, but the city allowed them to participate in its group health plans so they could get lower rates, Knox said.

Detroit, meanwhile, reduced retirement benefits and cost-of-living adjustments slightly for its pensioners.

Under the plan of adjustment, non-uniformed workers participated in the general retirement system and agreed to a 4.5% cut in pension benefits in addition to a loss of future cost-of-living adjustments. Uniformed employees received benefits from in the police and fire Retirement System participants will have no reduction in pension payments, but cost-of-living escalators will be reduced 55%. When it comes the city’s underfunded pension plans, Detroit will pay off 60% of it, or $1.88 billion, over a 40-year period.

Almost all the experts interviewed for this story agreed that a Chapter 9 filing is not the ideal choice, but sometimes there are no alternatives. “I’m fond of saying it’s a terrible option until it’s the only option,” Orrick Herrington’s Knox said.

Development Specialists’ Brandt said municipal financial turmoil that requires seeking bankruptcy court protection is “a failure of public policy.”

Brandt also noted that the Chapter 9 process is more arduous than a Chapter 11. After a company files a Chapter 11 petition, it’s in bankruptcy. A municipality, though, must be deemed eligible for bankruptcy by meeting several requirements, including express approval from its state and fulfilling the definition of insolvency under the Bankruptcy Code.

Coordes noted that even though Stockton and Detroit received rulings allowing changes to retirement benefits, the cities took some steps to protect the pensioners. She pointed to Stockton’s decision to not reduce current beneficiary payments and Detroit’s efforts to bring in private money to help ease pension cuts.

Detroit’s debtor counsel, Heather Lennox of Jones Day, said when Motown’s professionals began to look the city’s finances, the parties did not approach it with a “preordained idea.”

“Everyone was going to have to make some sacrifices as a part of this case if the city was going restructure,” she said.

Perhaps the most widely discussed aspect of the Detroit case was the so-called “Grand Bargain,” which entailed private foundations, the state of Michigan, and the Detroit Institute of Arts each chipping in various amounts of money that eventually amounted to around $816 million in an attempt to blunt the axing of pensions.

“Consequently, the pension reductions for retirees on account of the [unfunded actuarial accrued liability] are now significantly less than the City had originally concluded would be necessary,” Rhodes wrote of the global settlement.

“In many ways this is unique,” Lennox said, explaining that Detroit retained “good, solid hardworking people and key industries.” She added that history aided them in putting together the joint effort to help shore up the retirement benefits, as the municipality was “kind of a shining city at one time.”

Such deals are not likely not to become fixtures in Chapter 9 cases, however.

“There’s not enough philanthropic money in the world to bail out all the municipal pensions in this country,” she said.

Buckfire said that, while it is true that pension fund benefits only suffered “nominal reductions” under Detroit’s plan of adjustment, those were also ultimately achieved through settlements with the unions.

Pursuant to those deals, cost-of-living adjustments to pensions were either cut out completely or reduced by more than half, depending on the pension plan, and retirees gave up health care coverage in exchange for coverage under Affordable Care Act. This resulted in net reductions of $6 billion out of $7 billion in debt cut under the plan, he said.

Little more than seven years ago, the idea of touching pensions in bankruptcy “was treated as a little short of crazy,” said bankruptcy historian David Skeel, currently a visiting professor at Harvard Law School.

But the Detroit and Stockton cases were not the first time cities flirted with impairing pensions, Skeel wrpte in an October 2013 paper for The Federalist Society’s White Paper Series. Most prominently, Central Falls, R.I., which filed a Chapter 9 petition on Aug. 1, 2011, cut its pensions by roughly half and the city’s retirees and employees agreed to it.

“One thing we now know, with significant confidence, is that pensions can be restructured in bankruptcy,” Skeel noted.

Indeed, as the nation’s cities battle financial issues and increasing pension obligations, filing for Chapter 9 protection will loom as a true alternative. And if that’s the case, retirees in those cities under distress yet to come had better hope that they can get as good a result as those in Detroit and Stockton, even with the strict rulings of the bankruptcy judges in those cases.

THE DEAL PIPELINE

by contributor Andrew Hedlund | Published March 11, 2015 at 1:17 PM

Even though the price of money will increase sometime this year, municipal bonds should still have decent, if unspectacular, returns, investment managers said Tuesday.

“We feel that, despite rising interest rates, that we will still be able to have for municipal investors a low- to middle-single-digit return,” Greg Gizzi, senior portfolio manager for municipal fixed income at Delaware Investments said at a conference hosted by the firm in Manhattan.

Income, not appreciating price, is the key to obtaining good numbers in municipal bonds, he said.

The recent 10-year return on municipal bonds was 4.69 percent, according to the S&P Municipal Bond Index.

Gizzi’s prediction is based on his belief that income from the portfolio will offset any price drop due to the Federal Reserve increasing interest rates.

The modest interest rate increase will be accompanied by a flattening of the yield curve, he added.

The Fed, another Delaware manager said, now has the justification to increase rates.

“They have the cover to do so. The employment picture is clearly pretty strong,” said Brian McDonnell, senior portfolio manager, senior structured products analyst, Delaware Investments.

“If you look at a lot of the measures of inflation, while they don’t look like they are high enough or close enough to the Fed’s target to raise rates, one of the things they like to look at is inflation expectations,” he added.

McDonnell said that the expected inflation rate is 2.7 percent over the next year and about the same rate over five years.

McDonnell said the Fed increase comes at a time when most other central banks continue to ease money supply, which means the dollar will likely strengthen. So Delaware Investments is looking for bonds that can perform well in a deflationary environment.

But so far, Gizzi added, with the market already counting on the Fed rate hike, the environment has been good for muni bonds. That’s because many cities, towns and states have been cleaning up their balance sheets.

Delaware Investments has steered clear of problem spots, he said. It has no Illinois munis, noting that the effort of the new governor to correct its spending problems was recently nullified in court, although the state is appealing. Delaware Investments also has only one bond position in Puerto Rico, a hospital with a strong balance sheet, he said.

Gizzi also said that because the rate hike has been talked about for so long, it will already have been discounted by the market by the time it happens, possibly in June.

What could happen to interrupt his scenario?

Unexpected events, he added, are the greatest potential problem. It depends, Gizzi said, on the way in which interest rates are increased by the Fed.

“Are we going to see a gradual rate rise where the curve shift is flatter,” Gizzi asked, “where income is going to drive the day? Or are we going to see a severe spike in rates and the long end of the curve steepen out?”

Gizzi doesn’t expect the latter.

What about tax reform changing the climate for municipal bonds or bonds in general, such as inversions or corporate tax reforms?

Substantial tax changes, Gizzi said, won’t happen until the next administration takes office in January 2017.

FINANCIAL ADVISOR

MARCH 11, 2015 • GREG BRESIGER

The Treasury Department has announced that subscriptions for SLGS will not be accepted after noon Eastern Time next Friday, March 13. The SLGS window will remain closed until further notice. Subscriptions received by noon Eastern Time next Friday will be issued on the date requested. The Treasury Department notice is available here.

Turbulence is in store for municipal-bond investors following a record run, as a gathering U.S. economic recovery pushes interest rates higher and issuance grows.

In February, municipal debt posted its first monthly decline in returns since December 2013, bringing an end to a record-tying 13 consecutive months of gains. The market this year is off to its worst start since 2008, returning 0.14%, including price appreciation and interest payments, according to Barclays PLC.

“I think volatility is probably going to be the theme for this year,” said Peter Hayes, head of municipal bonds at BlackRock Inc., which has about $116 billion in tax-exempt debt.

Pressuring the $3.6 trillion municipal-bond market is a surge of new issuance by cities, states and other government entities, which sold about $68.5 billion in bonds this year through Friday, according to Thomson Reuters data. That is a record for the period and 88% increase over a year ago.

Many issuers have taken advantage of low yields to refinance outstanding debt, reducing interest payments and shoring up their fiscal health. The flood of new debt is driving municipal-bond prices lower. Yields rise as prices fall.

At the same time, long-term interest rates have begun to pick up following a steep decline, as the U.S. economy gains steam. That has raised prospects that the Federal Reserve may start increasing interest rates as soon as June, undermining the value of outstanding bonds.

The Fed’s monetary stimulus following the 2008 financial crisis has been a big factor pushing up prices in global bond markets.

The 10-year U.S. Treasury yield on Friday hit 2.25%, its highest since December, following the latest strong U.S. jobs report. Despite the February wobble in returns, yields on municipal bonds remain near five-decade lows.

The wave of debt issuance and rising rates has some investors worried that the municipal market could stumble as it did during 2013’s selloff, which was triggered when the Fed began discussing plans to end its massive bond-buying program.

There are seasonal factors are work as well: Muni-bond prices tend to slump in the spring as investors sell securities to raise money for tax payments, said James Iselin, head of municipal fixed income at Neuberger Berman Group LLC, which manages about $9.5 billion in state and local debt.

If demand wanes amid uncertainty about the Fed’s next step, that could put additional pressure on prices.

“My confidence that the market can power through it is less than it was at this time last year,” Mr. Iselin said.

The longest winning streak since 1992 lifted municipal bonds to a 9% return in 2014, outpacing gains in corporate and U.S. government debt.

The broad debt-market rally last year fueled a surge of investor funds into municipal bonds, many of which are considered as safe as Treasurys because they are backed by tax revenue. Investors also like the bonds because they provide tax-exempt income.

Investors are still seeking out such debt, dropping about $7.26 billion into municipal-bond mutual funds in 2015 through February, far ahead of the $1.75 billion that flowed into these types of funds in the same period of 2014, but behind 2013’s $9.3 billion, according to Lipper data. The pace has slowed in recent weeks, however.

BlackRock’s Mr. Hayes said he is taking advantage of recent weakness to buy new bonds from large issuers such as New York, California and Georgia at better yields. Higher yields and lower prices could also mean a buying opportunity for individual investors, he said.

He also said he believed last year’s price rally made many bonds overvalued, contributing to the recent retreat.

Rising rates could also affect the supply of new bonds and slow the “red-hot” issuance seen this year, according to Chris Mauro, head of U.S. municipal strategy at RBC Capital Markets.

“To me, this looks eerily similar to 2013, where you had heavier-than-expected issuance in the first part of the year and then it diminished in the second,” he said.

A Citigroup Inc. report in February predicted about $35.5 billion in March issuance and $380 billion for 2015. Issuance was $27.3 billion last March and $314.9 billion for 2014, according to Thomson Reuters. Sluggish issuance in the beginning of last year helped propel 2014’s rally, with demand for bonds outstripping supply.

Jim Kochan, chief fixed-income strategist at Wells Fargo Asset Management, said bond markets started 2015 priced for weak economic data, and Treasurys attracted buyers from outside the U.S., helping to sustain the rally into January. That created the space for a pullback in February, he said.

“March is going to be volatile,” he said. With U.S. employment growth and wages having picked up in recent months, investors will increasingly have an “eye toward when the Fed is going to start raising the funds rate.”

THE WALL STREET JOURNAL

By AARON KURILOFF

Updated March 8, 2015 6:32 p.m. ET

Every two years, the residents of Richmond, Calif., a city long known for some of the highest rates of violence in the United States, gather to discuss its priorities. For years, the No. 1 concern was crime.

But things have started to look up in Richmond, a city of about 100,000 people in the midst of Bay Area opulence. At the most recent meeting, Richmond residents were more concerned about blight. An obvious — and seemingly fixable — example was the city’s 800 or so abandoned homes, which cost it thousands of dollars a year to maintain in their dilapidated state.

Enter a twist on social impact bonds.

Typically, social impact bonds are contracts, not bonds as investors think of them. If the group receiving the proceeds can improve a certain social condition, the investors are paid back with some interest; if it fails, the investors lose. The bonds have been used to reduce recidivism rates for criminals released from prison and to reduce teenage pregnancy rates.

A sale of $3 million in bonds is expected this month, pending final approval by the Richmond City Council. That would pay for the rehabilitation of 20 properties a year over five years. And Mr. Becker believes there is investor interest for another $3 million.

“The challenge right now is these properties don’t turn enough of a profit for a typical real estate investor,” Mr. Becker said. “An investor wants a 30 percent to 40 percent return.” Under Mr. Becker’s plan, investors receive a 2 percent return on the money they put in, and if the project is profitable, up to half of their original investments.

While the bond issue is small, it is an example of increased investor interest in social impact projects, a niche that has long appealed to two types of investors: those who want to avoid companies that clash with their beliefs, and those with a desire to put a small portion of their wealth into an investment that could do some good, whatever the return. What has held social impact investing back is the perception that its returns are lower than those of investments without that social overlay.

One type of social impact investment is green bonds, which focus on projects like wind power, clean water and sustainable agriculture. There is also a range of investing strategies known as environmental, social and governance investing, or E.S.G. Some strategies screen out companies that make certain kinds of products, like alcohol or tobacco; newer strategies look for positive screens, such as seeking companies that work in certain areas or employ best practices in their businesses.

A spate of recent studies and a conference this week worked hard to show that the returns on investments with environmental, social and governance screens were similar to other investments — in both good and bad ways — and in some cases, were better when compared with indexes since the financial crash.

Certain areas are growing rapidly, like green bonds. Since 2007, about $60 billion worth of green bonds have been sold, according to Marilyn Ceci, a managing director and the head of green bonds at JPMorgan Chase. But $37 billion of that came in 2014. One prediction at a U.S. Trust conference on Wednesday put that amount at more than $100 billion this year.

Why do people invest in an area that does good but can be complicated to understand and has a reputation of modest returns? The reasons are varied.

Banks make these investments because they help fulfill the requirements of the Community Reinvestment Act of 1977, which requires them to meet a range of credit needs, “with the added bonus of qualifying for great P.R.,” said Robert T. Esposito, a lawyer at Orrick, Herrington & Sutcliffe. “If you’re a foundation, you can meet your 5 percent distribution” of assets as required by law, he said. “Or if you’re an impact investor, you must be willing to trade off some returns.”

But Andy M. Sieg, head of global wealth and retirement solutions for Bank of America Merrill Lynch, views this as a chance for retail investors to drive the creation of a new investment category. “We’re in the early stages of an innovation cycle,” he said. “Client demand emerges. Advisers become stimulated by this demand. It drives product creation. It’s happened again and again, and it’s taking place in the era of impact investing.”

He said Merrill Lynch now has $9 billion in social impact investments, compared with $6.4 billion last year. (Over all, the firm has more than $2 trillion in assets.)

Of course, the newest thing doesn’t always catch on with everyone.

In one study, 71 percent of investors were interested in making investments with an environmental, social and governance screen, and 72 percent thought companies benefited from carrying out those principles. But 54 percent believed they had to give up performance if they made such investments, said Audrey Choi, chief executive of the Morgan Stanley Institute for Sustainable Investing.

Yet in a study not yet released of 10,000 equity mutual funds in the United States over the last seven years, Ms. Choi said, the returns of sustainable funds met or exceeded the median returns of traditional funds 64 percent of the time and had the same or lower volatility.

In essence, sustainable funds could perform just as well or better than traditional funds and also just as badly.

“Manager selection absolutely matters,” Ms. Choi said. “I often say just because you add the word sustainable into an investment, the laws of physics aren’t suspended. If we want this market to really grow, we have to make sure we go into this in a ‘best in class’ way.”

Cary Krosinsky, an adjunct professor at the Earth Institute at Columbia, found in research on the returns of 850 funds that social impact investments made with positive screens outperformed by more than four percentage points those made with screens that excluded sectors.

While he also argued for the need for expertise in making environmental, social and governance investments, he said a bigger advantage to investors might be to make E.S.G. another factor in their analysis of an investment. “If you don’t, you’re not doing anything wrong,” he said. “But if you do bring it in, you know you’re not missing out.”

Green bonds, for example, seem to be growing rapidly because they carry the risk of the issuer, say, a utility, and not that of the project they are financing, like a windmill. “The essence of green bond debt is the project,” Ms. Ceci said. “The purpose is to transition to a low-carbon economy. But the risk is the credit decision of the issuer — you’re not exposed to the project directly.”

Last year, when Massachusetts sold $350 million worth of green bonds, $260 million of that was bought by retail investors. “It wasn’t just investors from Natick, Newton and Wellesley,” Ms. Choi said. “They had investors from California and around the country buying it.”

Yet for those tempted to invest, these are still early days, with plenty of pitfalls. If the Richmond project fails, the investors get back whatever money the program still has and the titles to their properties. That is not exactly a double-digit return for tying up an investment for so long.

THE NEW YORK TIMES

by PAUL SULLIVAN

MARCH 6, 2015

In this week’s “Extra Credit,” Senior Director Larry Witte discusses the fourth-quarter ratings round-up for U.S. public finance and Director Helen Samuelsson updates us on Chicago.

Listen.

Mar 05, 2015

In this CreditMatters TV segment, Standard & Poor’s Senior Director, Larry Witte, discusses his recent report about the rating actions in U.S. Public Finance during the fourth quarter of 2014.

Watch.

Mar 03, 2015

Read the Brief.

Municipal Market Analytics

March 3, 2015

By putting off dealing with its retirement-system underfunding problems, New Jersey has dug itself into a ‘draconian’ fiscal hole.

When government discovers a problem, addressing it can be difficult. But if state and local leaders put off dealing with the problem, difficult often becomes disastrous.

New Jersey provides the most recent proof of this simple truth. In the mid-1990s, the state started deferring payments to its pension plan, instead using the money to plug short-term budget holes. Predictably, the state’s public-pension and retiree-health-benefits system is now the fourth most underfunded in the country.

Gov. Chris Christie and state legislators finally tried to address the issue in 2011. They enacted legislation under which the state would increase its pension contribution and state employees would pay more toward both their pensions and health benefits.

But by then the magnitude of the problem had grown exponentially. Last year, almost 20 years after the state began deferring pension payments, a bipartisan state commission pegged New Jersey’s pension and health-care liability at $90 billion — almost three times the annual state budget.

Last summer, just a few weeks before the commission released its estimate, state revenues were well below projections and New Jersey faced a $2.7 billion shortfall. Gov. Christie responded during the final days of the 2014 fiscal year by cutting that year’s pension payment from nearly $1.6 billion to less than $700 million. For fiscal 2015, what was supposed to be a state contribution of almost $2.3 billion was again slashed to less than $700 million. It was exactly what the 2011 law that Christie had signed was designed to prevent.

Public-employee unions sued to reverse both the fiscal 2014 and 2015 pension-payment cuts. Last June, Superior Court Judge Mary Jacobson allowed the 2014 cut to stand, finding that the state’s revenue shortfall created a fiscal emergency. But last month the same judge ruled that the fiscal 2015 cut “substantially impaired” employees’ contractual rights to payments guaranteed under the 2011 reforms.

Unless an appeal is successful, Christie and the legislature will have to find an additional $1.57 billion in a $32.5 billion budget. According to State Assembly Majority Leader Lou Greenwald, the resulting cuts would be “draconian.”

New Jersey’s plight raises many questions, such as why state revenues fell so far short of projections during relatively good economic times. But the headline here is that New Jersey faces a crisis that could easily have been avoided had elected officials acted to address the issue soon after the state started using pension payments to close budget shortfalls. It’s all too easy to let difficult grow into disastrous, and the biggest victims are New Jersey’s taxpayers and its government workers.

GOVERNING.COM

BY CHARLES CHIEPPO | MARCH 3, 2015

(Bloomberg) — Investors are pouring a record amount of money into exchange-traded funds that focus on municipal debt even as the consensus on Wall Street calls for higher interest rates in coming months.

Individuals this year have added about $1 billion to ETFs that purchase state and local bonds, the fastest annual start since the funds started in 2007, according to data compiled by Bloomberg. The investment tools, which typically track indexes and can be bought and sold during the trading day, have taken on a growing role for muni investors, almost doubling in assets since 2010.

With local-government finances improving five years after the recession and the top federal income-tax rates the highest since 2000, investors are increasingly turning to ETFs as a way into the tax-exempt market. The 2015 inflow underscores that investors aren’t shying away from munis in the face of projections that the Federal Reserve will lift its benchmark interest rate from near zero, where it’s been since 2008.

They “have heard this cry-wolf call for so long,” said Vikram Rai, a municipal analyst at Citigroup Inc. in New York. “They’ve become a little jaded towards it.”

2014 Lure

The $3.5 trillion municipal market is coming off its strongest year since 2011, after posting a 9.8 percent return in 2014, according to Bank of America Merrill Lynch data. That performance may be luring investors, said Tom Doe, president of Concord, Massachusetts-based Municipal Market Analytics.

“Individual investors who predominately use the ETFs through their registered investment advisers are chasing last year’s phenomenal returns,” Doe said.

Munis may not repeat their 2014 earnings as states and localities increase borrowings with interest rates close to 50-year lows, Doe said. Municipal securities have gained about 0.5 percent in 2015, the worst start to a year since 2011, according to Bank of America data.

About a third of the added cash has flowed into the largest muni ETF, the $4.5 billion iShares National AMT-Free Muni Bond ETF, known as MUB. The ETF traded Thursday at about $109.90 per share, close to the lowest since December.

Issuance Swing

Issuers from Washington to New York sold $62 billion of fixed-rate, long-term debt in the first two months of the year, almost double the $32.1 billion tally for the same period in 2014.

Bond investors face another headwind as a growing economy spurs bets that the Fed will increase its target rate as soon as July, according to the median forecast of 39 analysts surveyed by Bloomberg.

Treasury yields may head higher too. Interest rates on 30-year federal debt will probably reach 3.38 percent in the first quarter of 2016, from about 2.7 percent now, a separate poll shows.

That shift in yields may reverse ETF inflows, said Bart Mosley, co-president of Trident Municipal Research in New York. Investors may pull money from muni ETFs depending on how high interest rates rise, he said.

“As soon as they start to see last year’s gains get challenged, people will become a lot more cautious on bonds fairly quickly,” Mosley said.

A reversal may not diminish the role of ETFs in the tax-exempt market.

Investors held $13.4 billion in muni ETFs as of Sept. 30, up from $7.6 billion at the end of 2010, according to Fed data. In comparison, muni mutual fund assets climbed about 23 percent in that period, to $645 billion.

“It’s hard to source bonds,” Citigroup’s Rai said. “So this is a quick way of investing your money into munis.”

Bloomberg Muni Credit

by Michelle Kaske

March 4, 2015

To contact the reporter on this story: Michelle Kaske in New York at [email protected]

To contact the editors responsible for this story: Stephen Merelman at [email protected] Mark Tannenbaum, Mark Schoifet

Taylor Riggs, an editor at Bloomberg Brief Municipal Market, talks with Mark Muller, senior municipal vice president at Loews Corp.

Watch the video.

March 5, 2015

Taylor Riggs, an editor at Bloomberg Brief, talks with Joe Mysak about this week’s municipal market news.

Watch the video.

March 5, 2015

(Bloomberg) — After logging its first monthly loss since 2013, the $3.5 trillion municipal market faces headwinds again in March amid accelerating issuance and speculation investors will sell local debt to make tax payments.

With yields hovering above five-decade lows, refinancing boosted muni sales to a combined $62 billion in January and February, almost double the 2014 pace, data compiled by Bloomberg show. City and state bonds have lost money in March in eight of the past 10 years, partly as investors sold to help pay tax bills before the April 15 filing deadline.

“Heading into this time horizon, seasonal factors tend to provide the foundation for market weakness,” said Jeffrey Lipton, head of municipal research at Oppenheimer & Co. in New York. “The road to performance will certainly be paved with volatility.”

The municipal market has lost about 0.3 percent in March, according to Bank of America Merrill Lynch data. It declined about 1 percent in February, snapping a record 13-month rally as fixed-income assets dropped while offerings by localities surged.

March Slog

If history is any guide, more losses are ahead: Yields on benchmark 10-year munis have risen in March for six straight years, with the average increase about 0.16 percentage point, Bloomberg data show. Bond yields move inversely to prices.

Munis aren’t alone in their March struggles. Treasuries declined in March in seven of the past 10 years, and corporate debt in six.

At about 2.16 percent, the benchmark 10-year muni interest rate is the highest since December. Yet municipalities are still coming to market to reap savings through refinancing. The University of California, New York City and Dallas are set to lead about $6 billion in refinancing next week, out of about $10.4 billion of sales.

Since 2004, supply has been higher in March than in January and February every year except 2011, Bloomberg data show. The sales upswing often coincides with declining demand from investors because they’ve mostly already reinvested coupon payments received in December and January, according to Citigroup Inc. research.

Tax Shift

Tax-related selling has also contributed to the pattern of March weakness, although that may be shifting as income levies have risen, said James Dearborn, head of munis in Boston at Columbia Management Investment Advisers, which oversees $30 billion in local debt. The top federal rate climbed to 39.6 percent as of last year, the highest since 2000, increasing the appeal of tax-exempt income, he said.

“The increase in the personal income-tax rate has changed people’s sense about selling munis to pay for taxes,” Dearborn said. “As they’re looking at their tax bill, they’re often thinking, munis are the last thing I want to be selling.”

State and city debt is faring better this month than both Treasuries and corporate debt, both of which have lost about 0.5 percent since the end of February.

“We could certainly be positioning ourselves for negative performance in March, but the question is, with that negative performance, are we still going to outperform Treasuries?” said Lipton at Oppenheimer. “There’s a real possibility that we can.”

Bloomberg Muni Credit

by Meenal Vamburkar

March 5, 2015

To contact the reporter on this story: Meenal Vamburkar in New York at [email protected]

To contact the editors responsible for this story: Stephen Merelman at [email protected] Mark Tannenbaum, William Selway

New York, March 05, 2015 — Annual budget contributions and liabilities associated with retiree healthcare, also known as other post-employment benefits (OPEBs), vary widely and burden some local governments more significantly than others, Moody’s Investor Service says in a new report, “Retiree Healthcare Contributions Typically Low for Largest US Local Governments; Potential Wildcard for Outliers in Bankruptcy.”

Typical non-pension OPEBs consist of retiree healthcare and life insurance. They are usually not pre-funded, and instead are paid on a pay-as-you-go basis.

“The pay-as-you-go method of funding OPEB benefits is less expensive in the near term for most of the 50 largest local governments,” says lead author of the report and Moody’s Associate Analyst David Gutierrez. “As such, OPEBs are not currently an outsized budgetary burden for most of the issuers.”

Moody’s views OPEBs differently than pensions or debt. “OPEBs are not a dollar-certain future liability as with debt or defined-benefit pensions. As such, we analyze OPEBs primarily as a budgetary expense, although the long-term obligation of unfunded liabilities is also important to our analysis,” according to Gutierrez.

Usually these benefits are a small budgetary cost for issuers and are about a third the size of the median pension contribution or one-tenth the size of debt service cost across the top 50 issuers (ranked by debt outstanding). In the short term, median costs for OPEBs for local governments are not likely to significantly exceed the 1.5% of operating revenue last reported in fiscal 2013, Moody’s says, but OPEB outlays will rise in the future due to healthcare inflation and growing retiree populations, and as more governments move from pay-as-you-go funding to a prefunding approach.

But, Buffalo, NY (A1 stable), Honolulu City and County (Aa1 stable) both have budgetary contributions five times the median.

Detroit’s bankruptcy settlement included major cuts to retiree healthcare costs while leaving the city’s pension plan only slightly impaired. Pre-bankruptcy Detroit had the highest OPEB outlays at 12.8%, with Buffalo and Honolulu City and County coming in at 8.5% and 8.1%, respectively.

Detroit’s OPEB contributions were computed prior to the judicial approval of its bankruptcy settlement. The city has since slashed its OPEB liability as much as 90%, after the emergency manager negotiated significant cuts by rolling unused assets into a fund and discontinuing the plan for current retirees.

The sweeping reforms seen in Detroit are unlikely to occur in other local governments. However, some governments are shifting more of these costs to employees or discontinuing plans to new hires altogether. Moody’s found 20% of the top local government issuers have taken steps to reform retiree healthcare.

While OPEB liabilities have weaker legal protections, reforms may prove difficult. Strategies include negotiating prices for services, increasing contribution rates for active employees, raising service length eligibility, reducing dependent care, and directing retirees to healthcare exchanges.

The report is available here.

(Bloomberg) — The U.S. municipal bond market shrank in February by $7.84 billion, contracting for at least the 14th month in a row as redemptions and maturities overwhelmed sales of new securities.

States and localities issued $31.5 billion of new bonds last month, compared with $23.2 billion that came due and $16.2 billion of debt called early, according to data compiled by Bloomberg. Since the start of 2014, the amount of outstanding securities has decreased by $167.6 billion, reducing the $3.5 trillion market by 4.54 percent.

The shrinkage helps explain why munis outperformed Treasuries even as the U.S. debt market declined last month. The Bank of America Merrill Lynch US Municipal Securities Index lost 0.99 percent in February, the first drop since the end of 2013, while the Bank of America Merrill Lynch US Treasury & Agency Index fell 1.69 percent, the most since May 2013.

Municipal bond sales are set to be little changed in the next month while the amount of redemptions and maturing debt falls.

States and localities plan to issue $11.4 billion of bonds over the next 30 days, according to data compiled by Bloomberg. A week ago, the calendar showed $11.6 billion planned for the coming month. Supply figures exclude derivatives and variable-rate debt. Some municipalities set their deals less than a month before borrowing.

California Bonds

California plans to sell $1.9 billion of bonds, Maryland has scheduled $922 million, Los Angeles Department of Water and Power will offer $495 million and Cypress and Fairbanks Texas Independent School District will bring $297 million to market.

Municipalities have announced $13.1 billion of redemptions and an additional $10 billion of debt matures in the next 30 days, compared with the $26.3 billion total scheduled a week ago. Last year, the market shrank by 4 percent. This year, maturities are poised to drop 38 percent to $176 billion from the 2014 levels.

Issuers from New York have the most debt coming due in the next month, with $2.52 billion, followed by California at $1.17 billion and Wisconsin with $488 million. California has the biggest amount of securities maturing, with $803 million.

Investors added $274 million to mutual funds that target municipal securities in the week ended Feb. 18, compared with $693 million in the previous period, according to Investment Company Institute data compiled by Bloomberg.

Muni Yields

Exchange-trade funds that buy municipal debt increased in value by $206 million last month, or 1.29 percent, to $16.1 billion.

State and local debt maturing in 10 years now yields 106.2 percent of Treasuries, Bloomberg data show. Since 2000, the gap has averaged 93.8 percent.

Bonds of Michigan and California had the best performance over the past year compared with the average yield of AAA rated 10-year securities, the data show. Yields on Michigan’s securities narrowed 11 basis points to 2.38 percent while California’s declined 10 basis points to 2.30 percent.

Puerto Rico and New Jersey handed investors the worst results. The yield gap on Puerto Rico bonds widened 66 basis points to 9.61 percent and New Jersey’s rose 13 basis points to 2.70 percent.

by Kenneth Kohn

March 2, 2015

To contact the reporter on this story: Ken Kohn in New York at [email protected]

To contact the editors responsible for this story: Ken Kohn at [email protected] Stacie Sherman, Mark Tannenbaum

WASHINGTON – The Federal Reserve is working to identify municipal securities that could be treated as high-quality liquid assets under rules requiring banks to maintain liquidity coverage ratios, Fed chairwoman Janet Yellen told members of a House committee.

“We’re working very expeditiously on that, and hope to be able to identify some of those bonds that would qualify for … different LCR treatment,” Yellen told members of the House Financial Services Committee at a hearing on Wednesday. “We’re in discussions with the other banking agencies.”

Yellen was asked about the Fed’s progress by Rep. Gwen Moore, D-Wis., who along with other House members, sent at least two letters last year, urging the Fed to reconsider excluding munis as HQLA under rules that require large financial institutions to maintain minimum liquidity coverage ratios so they can better handle financial stress.

The liquidity rules apply to U.S. banks and other financial institutions with at least $250 billion of total assets or consolidated on-balance sheet foreign exposures of at least $10 billion.

An LCR is defined as the ratio of HQLA to total net cash outflows. Assets would qualify as HQLA if they could be easily and quickly convertible to cash with or no loss of value during a period of liquidity stress.

Bank regulators failed to include munis as HQLA in the rules, contending are not liquid or easily marketable. They also said banks don’t hold munis for liquidity.

But muni market participants, Moore, Sen. Chuck Schumer, D-N.Y., and other lawmakers have fought the exclusion, arguing that investment-grade munis have lower default rates than corporate bonds and are very marketable. They also have warned that the exclusion will raise borrowing costs for issuers, as well as decrease liquidity and increase volatility in the muni market.

THE BOND BUYER

BY LYNN HUME

FEB 26, 2015 12:40pm ET

Summary: Rising costs over the last decade have prompted many local governments to make changes to their health plans and strategies. Cost sharing, wellness program, and disease management initiatives are widely reported. Other changes cited include increased reliance on high-deductible plans, dependent eligibility audits, and altering retiree benefits.

Authors: Elizabeth Kellar, Christine Becker, Christina Barberot, Ellen Bayer, Enid Beaumont, Bonnie Faulk, Joshua Franzel, Mark Ossolinski, and Danielle Miller Wagner.

Publication date: 12/14

Key findings:

• The top cost drivers of local government health care increases were increased claim costs (64 percent); prescription drugs (57 percent); an aging workforce (46 percent); insurance company price increases (45 percent) and federal health care policy (45 percent).
• Fifty-seven (57) percent of respondents increased cost sharing of premiums paid by employees and nearly half of respondents reported that their local governments changed the way health insurance is provided.
• Nineteen (19) percent of those reporting health plan changes shifted employees to a high-deductible plan with a health savings account and 14 percent established a health reimbursement arrangement.
• Disease management programs, on-site clinics, dependent eligibility audits, and regular review and rebidding of health care vendor contracts have achieved significant savings.
• Respondents reported that providing easy access to health services at work sites not only supports employee wellness, but also reduces employee absenteeism and health care costs.

Download the Report.

Center for State and Local Government Excellence

​A multi-practice Orrick team recently advised Goldman Sachs as lead arranger of an innovative, multi-lender $171 million term loan facility to provide bridge financing for Phase 1 of the Transbay Joint Powers Authority’s (“TJPA”) visionary Transbay Transit Center Project in San Francisco.

The ambitious $4.5 billion project will transform downtown San Francisco and the Bay Area’s regional transportation system by creating what has been dubbed the “Grand Central Station of the West”, replacing the former Transbay Terminal with a modern regional transit hub that will connect eight Bay Area counties and the State of California through 11 different transit providers. The project is at the center of a vibrant new neighborhood emerging in San Francisco’s South of Market area, helping catalyze the development of thousands of new housing units and millions of square feet of new office space, as well as new parks, pedestrian areas and retail shops. Phase 1 of the project – scheduled to be completed in 2017 – entails construction of a new five-story Transit Center consisting of an above-ground bus level, a ground floor for general passenger circulation, a concourse level including retail space, and two floors of an underground “train box” – the core and shell of the rail facilities that, upon completion of those rail facilities during Phase 2 of the project, will serve as the terminal for the extension of Caltrain service to downtown San Francisco and, ultimately, California’s future high-speed rail system.

The term loan arranged by Orrick’s client Goldman provided an innovative solution to TJPA’s interim financing needs for Phase 1. While TJPA had previously secured a $171 million commitment for long-term financing from the United States Department of Transportation under the Transportation Infrastructure Finance and Innovation Act (“TIFIA”) loan program, the TIFIA loan proceeds will only be available to TJPA after certain conditions are met, expected by TJPA to occur in late 2015 or early 2016. Goldman was able to help TJPA address this funding gap by structuring a financing that allows TJPA to optimize the timing of the sale to private developers of certain TJPA real estate assets in the greater project area while at the same time providing TJPA funds needed in the near term to move construction work ahead on schedule. In addition to a pledge of net tax increment revenue generated from escalating property values in and around the project area, the bridge financing is secured by certain real property interests. In addition to structuring and arranging the financing, Goldman Sachs funded just over half of the term loan, with Wells Fargo funding the remaining portion.

“This transaction is one of the first examples we’ve seen of a bank arranging a sizeable syndicated loan to a governmental borrower,” said Justin Cooper, lead Public Finance partner on the transaction, noting that “we may see more of this structure in the future given the unique needs of certain governmental projects and issuers and the heightened interest in this type of transaction we have observed from banks and other market participants.”

Zach Finley, the lead Banking & Finance partner on the deal, added, “This transaction played perfectly to Orrick’s core strengths in the areas of public finance, syndicated lending and real estate. We are honored to have been involved in this landmark project for San Francisco and the greater Bay Area by advising Goldman Sachs on the legal aspects of such a tailored financing solution for TJPA.”

The Orrick team, which combined lawyers from our Public Finance, Banking & Finance and Real Estate groups, was led by partners Justin Cooper and Zach Finley and included associates Julie Eum (Banking & Finance), Devin Brennan (Public Finance) and Dustin Calkins (Real Estate).

02-23-2015

About Orrick

Orrick is a leading global law firm focused on counseling companies in the Tech, Energy & Infrastructure and Finance sectors. Financial Times consistently recognizes Orrick among the 10 most innovative firms ​in North America. Law360 named Orrick among the “Practice Groups of the Year” in Technology, Intellectual Property and Restructuring for 2014. Recognizing Orrick’s strong culture of client service excellence, mentoring, inclusion an​d community responsibility, The American Lawyer recently named the firm to its 10-Year A-List.

On this week’s Extra Credit, Managing Director Gabe Petek dispels the notion that temporary revenues are behind California’s better operational financial performance, and Director Sussan Corson discusses our outlook on Louisiana.

Listen to the Podcast.

For the first time since 2007, U.S. public finance (USPF) nonhousing and housing bonds both recorded more upgrades than downgrades in every quarter of the year. Overall, this was due to a combination of an improving economy and criteria changes. Standard & Poor’s Ratings Services upgraded 2,396 USPF ratings (2,265 nonhousing) and lowered 895 ratings (844 non-housing). For the year, Standard & Poor’s Ratings Services raised 2.68 ratings for every downgrade for nonhousing bonds and raised 2.57 ratings for every housing downgrade. The fourth quarter of 2014 was the ninth consecutive quarter in which upgrades outnumbered downgrades for USPF nonhousing bonds, and upgrades outpaced downgrades in all USPF sectors except health care and higher education. Furthermore, the upgrade-to-downgrade ratio for USPF sectors increased after two quarters of declines.

Improving local economies were the leading cause of the higher overall ratio this quarter in nonhousing bonds, spurring more than 150 local government upgrades compared with about 50 downgrades. A second influence on the positive ratio was our upgrade of the general obligation (GO) rating on California, to ‘A+’ in November 2014, which affected ratings on bonds issued by the state, California State University, and California community college districts. Housing rating actions were a major improvement relative to 2013, as the ratio of upgrades to downgrades was 2.57 in 2014 and just 0.40 in 2013. The main contributor for the housing rating actions in the quarter was the implementation of new multifamily housing criteria.

Continue reading.

26-Feb-2015

Read the Brief.

Municipal Market Advisors | Feb. 24

Standard & Poor’s Ratings Services is currently seeking comments on proposed changes in the criteria it uses to rate debt from publicly owned waterworks, sanitary sewer, and drainage utility systems. Our initial testing of the effects of these proposed changes—which will apply only to revenue-backed debt—indicate that roughly 75% of our more-than 1,500 ratings in this sector will remain the same if we adopt the criteria revisions. Of the remaining 25% of ratings, we are likely to see an even split between upgrades and downgrades, and nearly all will be no more than one notch. We don’t expect any rating to shift to speculative-grade status from investment-grade status, or vice versa. We view this sector as relatively safe and stable, and most of our ratings are in the ‘A+’ and ‘AA-‘ categories. Moreover, because several very large issuers dominate issuance in this sector, we expect the criteria changes to affect ratings on less than 25% of the par value of public water and sewer debt now in the market.

Standard & Poor’s last revised the criteria for public water and sewer facilities in 2008, and before, that in, 2002. The changes we’re considering now will increase the transparency and replicability of our criteria across the sector and more accurately reflect current and potential future risks associated with these debt issues, which are issued by cities, counties, or other public entities of widely divergent size and in all regions of the country. These new criteria will include some significant changes in how we assess water and sewer debt issues. (See “Request For Comment: U.S. Public Finance Waterworks, Sanitary Sewer, And Drainage Utility Systems: Methodology And Assumptions”, published Dec. 10, 2014.) We ask interested parties to send their comments on the proposed criteria revisions to http://www.standardandpoors.com/en_US/web/guest/ratings/rfc, or to [email protected] by Feb. 28, 2015, and we will take them into consideration before issuing a definitive update to our criteria.

Here are answers to some frequently asked questions about the most significant changes we’re proposing to our criteria for these ratings.

Frequently Asked Questions

Can you explain the new “operational management” assessment in the proposed criteria?
As proposed, this assessment will account for 10% of an issuer’s total enterprise risk assessment and will take into account several factors pertaining to an entity’s day-to-day operations that can have an impact on credit quality. One of these factors, for instance, would be a water utility’s drought management plan—a factor that has taken on more importance in some states, such as California. Some questions to consider include “Does the issuer have a clear plan to address a prolonged decline in water availability?” and “Does the utility have the management expertise to fulfill its drought planning and to communicate effectively to its stakeholders?”

Another factor that we’ll now explicitly and separately consider as part of the operational management assessment is the utility’s rate-setting practices. Although municipal water and sewer systems tend to have wide latitude in their rate-setting ability, they must still comply with state and federal environmental regulations to ensure public health and safety, and doing so may sometimes require rate adjustments.

The operational management assessment is designed to not only assess the adequacy of the water supply or treatment capacity, but will also take a hard look at the physical integrity and capacity of a system’s assets, its ability to meet peak demand in its service area, along with its compliance with all environmental regulations.

How will the proposed “financial management” assessment section of the criteria work?
The financial management assessment will account for 10% of an issuer’s total financial risk assessment. This assessment will consider the robustness of a utility’s financial policies and internal controls and evaluate whether its long-term planning is well-constructed and realistic, and will also look at the assumptions that go behind that planning. We will also, as part of this assessment, consider the quality, transparency, and timeliness of the utility’s financial reports. The financial management assessment would be in line with a similar assessment that Standard & Poor’s currently performs for local government general obligation (GO) ratings.

The financial management assessment analyzes how a utility makes financial decisions, including how it identifies and addresses both ordinary and extraordinary costs, its ability to fund them, and whether it transparently reviews and publicly reports those risks. We assume that financial results manifest themselves in other visible ways and address them elsewhere in the criteria, specifically in coverage and liquidity assessments.

What is the “market position” assessment in the proposed criteria?
The market position assessment will essentially look at the rate affordability within a utility’s service area. It will account for 25% of the total enterprise risk assessment. Affordability has been an increasingly important factor in some localities, despite the long-held contention that because people can’t live without water, they’ll always find a way to pay for it. We’ve recently seen instances where a significant percentage of water bills are going unpaid and management is struggling with collections in light of public health concerns. Affordability has also been an issue for other systems facing consent decrees and rising capital costs. The affordability of water has also come under discussion by the U.S. Conference of Mayors and the Environmental Protection Agency.

This assessment will look at typical water usage in a utility’s service area and its cost to consumers, both on an absolute basis and as a share of median household income in that area. And recognizing that there will be households living well below an area’s median income, the proposed criteria change will also take into consideration the poverty rate in the utility’s service area. These measures will allow us to assess affordability across an area’s income spectrum to give a more complete picture of overall affordability.

Will evaluating affordability be separate from looking at an area’s local economy?
Although household income is clearly related to an area’s economy, we will continue to use a separate assessment of economic fundamentals as the largest part of an issuer’s total enterprise risk assessment score, at 45%. The economic fundamentals will continue to include assessments of a utility’s customer base, the demographics of its service area, the major employers located there, and trends in the local economy.

Can you explain the changes to coverage metrics in the proposed criteria?
We will now evaluate the total financial capacity of water and sewer bonds using a single metric of “all-in” coverage, regardless of the specific nature of the debt or its lien position. That means we will include any debt or debt-like instruments that are ultimately supported by ongoing utility revenues, whether on- or off-balance-sheet, in our calculation of all-in debt service coverage. We propose to include any debt that receives regular support from surplus net operating revenues, whether specifically pledged or not. We would also include any net revenue transfers from the utility to other jurisdictions (which we now treat as an operating expense) as part of this calculation.

We thus define all-in coverage as: (Revenues-Expenses-Net Transfers + Fixed Costs)/ (All Revenue Bond Debt Service + Fixed Costs + Self-Supporting Debt).

The effect of this change could, in many cases, reduce the debt service coverage we calculate for a utility. For instance, the coverage of its senior debt might be 2x, but when all-in coverage is the measurement, the ratio might fall to 1.5x. The use of a single metric for all-in debt coverage is, under the proposed criteria, similar to Standard & Poor’s treatment of coverage for U.S. public power utilities.

Will other major rating factors in your criteria remain the same?
Yes. We will continue to heavily weight economic fundamentals when rating these issues, and a utility’s liquidity and reserves—both the number of days of cash on hand and actual cash in dollar terms—will remain significant rating factors. A utility’s total debt will also continue to be a major rating factor, including not just the dollar figure, but also the allocation of debt by lien and how quickly or slowly that debt matures. And we will still evaluate how aggressive management has been in the type of debt it has selected, and whether its choices have introduced any contingent risks for the utility.

Will ratings that come out of the proposed criteria be subject to the same caps as before?
We are introducing several specific ratings caps into the rating process. These generally relate to very weak management or exceptionally poor financial performance that threatens timely bond repayment. We will base these caps on the presence or absence of particular characteristics or events that pose extreme risks, which likely have already indicated extraordinary credit weakness.

Writer: Robert McNatt

24-Feb-2015

Under Standard & Poor’s policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its subject matter have not been the subject of Rating Committee action and should not be interpreted as a change to, or affirmation of, a Credit Rating or Rating Outlook.

Primary Credit Analysts:

Geoffrey E Buswick, Boston (1) 617-530-8311;
[email protected]

James M Breeding, Dallas (1) 214-871-1407;
[email protected]

There’s an old adage: Politicians are all for efficiency, but only for programs they don’t like. That’s why asking if a program is cost-effective is usually a political nonstarter.

But sometimes what stuff costs becomes a hot political question. In fact, we’ve seen a predictable pattern since the mid-1980s: The economy starts to bounce back from the most recent recession; state and local leaders recall the dreadfully blunt ways in which they cut their budgets during that recession; and they vow that if they ever have to do it again, they’ll get the right information to whittle down spending in a strategic, focused way. Around this time they start to hear about an accounting method known as activity-based costing (ABC) that can solve this problem.

We replay this cycle precisely because ABC has never really taken hold. But in the post-Great Recession world, the money, technology and, most important, the politics might have finally aligned for ABC.

To illustrate how ABC works, say a county health department runs a restaurant licensing program. Department staff visit restaurants, document any public health concerns, and report to appropriate state and local authorities. Let’s assume the program’s budget is organized around things the department must purchase to issue licenses, such as salaries, travel and office supplies. If the program spends $75,000 in a year, and if the department issues 150 licenses in a year, then traditional cost accounting suggests the cost per inspection is $500.

Activity-based costing shifts the focus from “what” the inspection program spent to “why” it spent it. To issue a license, the program carries out such activities as restaurant site visits and communications with restaurant owners. Each activity requires a bundle of salaries, commodities, overhead and other costs. Under ABC, the cost per license is the cost of the activities it demands. A routine case that involves a quick site visit and a few emails might cost $50. But a restaurant with health code violations and an uncooperative owner might cost up to $2,500 once the program accounts for all the expensive communication and coordination.

Here’s what’s really different: Activities can absorb costs from many different programs and services. For instance, a restaurant inspector concerned about an outbreak of foodborne illness might coordinate a response with the local disease prevention program and the public outreach staff. Under traditional cost accounting, the costs to these other programs don’t really impact the cost per license. Under ABC, each agency involved would assign those costs to the “coordinated responses” activity.

Governments can use the information ABC produces to set fees that better reflect the true cost of the goods or services they provide, to better scrutinize bids for contracted services and to improve benchmarking. ABC also sheds light on the “hidden” costs of activities that don’t fall neatly into a single program or agency. Moreover, it’s easy to implement with advanced GPS and new HR management systems that can carefully track how employees spend their time.

ABC clearly has a lot going for it, and yet, only about a quarter of state and local governments report that they use it systematically. Why? Some critics say it’s too costly and that it’s invasive for employees to track the time they spend on activities. Others say it places too much emphasis on outputs and not enough on benefits you can’t directly observe, like preventing crime or reducing chronic disease.

But in the wake of the Great Recession, ABC can serve a different and new purpose. For the past few decades the central question in state and local finance was how to do “more with less.” Oddly enough, better cost information adds little to that debate, mostly because efficiency has no natural political constituency.

But today many jurisdictions want to know how to do “less with less.” To that end, ABC has great promise. It can show whether a program pays for itself. It can facilitate meaningful comparisons of different service delivery models. It can help leaders argue for programs that don’t operate at maximum efficiency. In short, it can be the connective tissue between cost analysis and priority setting. That’s why it might enjoy a bright future.

GOVERNING.COM

BY JUSTIN MARLOWE | FEBRUARY 2015

(Bloomberg) — For the first time in four years, New York and its localities are borrowing less to cover retirement contributions as rallying investments ease the strain of pension costs.

The state and its communities are poised to borrow at least $952 million from New York’s $176.8 billion pension fund in 2015 to make required payments into the system, marking a drop of about 30 percent from last year’s record, according to preliminary data from Comptroller Thomas DiNapoli and some localities. Among suburban counties such as Westchester, some declines are even steeper, at 40 percent or greater.

The IOUs are part of programs that let the governments defer pension expenses for as long as 12 years with interest. DiNapoli implemented the system starting in 2011 to offset rising contribution rates, which almost tripled for state and local workers by 2014. With stock indexes reaching record highs, assets in the state retirement fund have swelled, requiring smaller contributions from localities.

“If you’re amortizing pension payments, your budget is structurally imbalanced,” said Valentina Gomez, a Moody’s Investors Service analyst in New York. “So if you’re amortizing less, that’s a good thing.”

Rating Divergence

From California to New York, pledges to retirees have stressed municipal budgets. State and local retirement plans are short at least $1.3 trillion because of investment losses triggered by the recession that ended in 2009 and inadequate contributions, according to Federal Reserve data.

Even as Standard & Poor’s raised New York’s grade to its highest since 1972 in July, rating companies have reduced the marks of New York City’s suburbs, citing the pension loans as a sign budgets aren’t balanced. The deferrals are also inflating the state’s unfunded retirement liability, the companies say.

This year’s drop in borrowing to meet those obligations signals that the pressure is ebbing, said Thomas Nitido, deputy comptroller for the New York State and Local Retirement System, the third-largest U.S. public fund.

“As the economy improves and pension contribution rates have begun to decline, fewer employers are opting to participate in the program,” Nitido said via e-mail.

Record Assets

The comptroller, the fund’s sole trustee, sets contribution rates annually based on actuarial assumptions that move the system toward full funding. The rate for 2015 for state and local workers is 20.1 percent of payroll, after peaking last year at 20.9 percent, the highest since 1974.

Assets in the system set a record in the fiscal year through March, led by a 22.3 percent return on domestic equities. As of 2013, only seven states had stronger pensions than New York. New York had 87.3 percent of assets needed to meet obligations, down from 105.9 percent in 2008, data compiled by Bloomberg show.

New York’s pension bill is set to fall to $2.4 billion in 2015 from $2.7 billion in 2014, according to budget documents. The state still needs to defer payments because the contribution rates remain elevated, said Morris Peters, a spokesman for Governor Andrew Cuomo’s budget division.

Exit Plan

Cuomo had planned to exit the borrowing program in 2016, then decided not to after DiNapoli adopted longer life expectancies for retirees, increasing the fund’s liabilities.

The state’s IOU is falling 24 percent to $713 million, according to budget documents.

Suburban Westchester, with almost a million residents north of Manhattan, entered the program in 2013 when it faced the possibility of firing 420 workers so it could pay its full obligation, said Ned McCormack, a spokesman for County Executive Rob Astorino.

Moody’s lowered Westchester’s rating to one step below the top in November 2013, citing the borrowing for retirement bills.

The county is deferring 27 percent of its $97.2 million bill, down from 42 percent in 2014, when its tab was $104.3 million, according to data from DiNapoli’s office.

“We always want to amortize as little as possible,” McCormack said by phone.

Suffolk County, home to the Hamptons beach towns, plans to reduce pension borrowing by 31 percent in 2015, according to Justin Meyers, a spokesman for County Executive Steve Bellone.

Tax Bump

Nassau, which borders New York City on Long Island and is under a state financial control board, is using a projected extra $50 million in sales-tax collections for 2015 to lower its borrowing by about 14 percent to $60.8 million.

The county’s total bill declined 2.4 percent to about $209 million, according to DiNapoli’s data.

Rockland County, northwest of Manhattan, is spending a $5 million surplus from sales-tax collections on its pension bill, further reducing borrowing, said Stephen DeGroat, the finance commissioner.

Its IOU for 2015 fell by more than half to about $6 million, DeGroat said. Next year, the county may forgo the deferral altogether, he said.

“It’d be a good thing to get out of,” he said.

by Freeman Klopott

February 22, 2015

To contact the reporter on this story: Freeman Klopott in Albany at [email protected]

To contact the editors responsible for this story: Stephen Merelman at [email protected] Mark Tannenbaum, William Selway

(Bloomberg) — School districts in Nevada and South Carolina are leading about $6 billion of refinancing sales this week, showing that municipalities can still reap savings from refunding even as yields soar to 2015 highs.

The district of Clark County, home to Las Vegas, is selling about $399 million on Tuesday to refinance higher-cost borrowings, according to data compiled by Bloomberg. In South Carolina, Pickens School District in the northwest part of the state is offering $255 million through a local agency, for anticipated savings of about $21 million, according to Brian Nurick, its bond counsel.

The projected savings, which will go toward maintaining infrastructure, were “slightly higher when we started the process,” Nurick said in an interview. “But we’re still in what we would consider the sweet spot to move forward.”

Refinancings are set to make up about 68 percent of issuance this week, up from 50 percent last week, Bloomberg data show. The sales are gaining momentum even as yields are climbing. The $3.5 trillion municipal market has lost 1.2 percent this month, leaving it poised to break a record 13-month rally.

Benchmark 10-year notes yield 2.14 percent, the highest since December, after rising three straight weeks for the first time since June. Yet this week’s calendar shows states and localities can still expect to save.

Sarasota County on Florida’s Gulf Coast plans to issue about $33 million in refunding securities. The municipality seeks savings of at least 5 percent and this offering should deliver 5.3 percent, said Regina Foss, who helps oversee the county’s finances.

“We expected to get a little bit higher savings,” Foss said in an interview. “But it’s still within our threshold.”

Next month, Maryland may sell about $400 million for refunding, Bloomberg data show.

by Meenal Vamburkar

February 23, 2015

To contact the reporter on this story: Meenal Vamburkar in New York at [email protected]

To contact the editors responsible for this story: Stephen Merelman at [email protected] Mark Tannenbaum, Mark Schoifet

New York, February 24, 2015 — The credit effects of lower oil prices for US public finance will vary broadly depending on each issuer’s reliance on oil-related revenues, Moody’s Investor Service says in a new report. However, it will have a mostly positive impact on most public finance sectors, with exceptions being states and local governments that rely on oil and gas revenues for a large percentage of their budgets.

Most states and municipalities will generally benefit from the drop in oil prices as consumer spending ramps up, owing to an increase in disposable income. States such as Florida (Aa1 stable) or Nevada (Aa2 stable) which rely on sales tax as a primary source of revenue will see a moderately positive credit influence.

But the State of Alaska’s (Aaa negative) reliance on oil revenues for almost 90% of its budgetary needs leaves it vulnerable to sharp price swings. Local governments that also benefit directly from oil extraction revenues like Midland, TX (Aa1) are also vulnerable.

“The more dependent a sector is on oil revenue and consumer spending, the more negative the credit implications. These sectors will experience more pressure to budgets and debt coverage the longer and lower oil prices fall,” says Marcia Van Wagner, Vice President — Senior Credit Officer and lead author of “Low Oil Prices Hit a Few US Municipal Sectors Hard, but Most Face Mildly Positive Effects.”

Non-oil producing states and some local governments will experience moderate support from sales tax growth to their mass transit agencies, such as Dallas Area Rapid Transit (Aa2 stable) and the Metropolitan Atlanta Regional Transit Authority (Aa2 stable). Mass transit funded by enterprise revenues will see a mildly negative impact as commuters opt to drive.

Low gas prices should cause traffic to grow on US toll roads, with growing urban areas like San Francisco, and Denver benefiting the most. US airports will also benefit; Moody’s says 2015 passenger boarding will increase between 3% and 4%, up from 2% in 2014.

The drop in oil prices is also positive for US seaports, which garner support from the reduction in fuel costs. The 2015 ports outlook changed to stable from negative amid cost reductions and lower fuel costs.

Water and sewer utilities will be positively affected by more flexibility to raise rates created by easing household budgets. However, the impact to public power and cooperative electric utilities is minimal since oil is an insignificant percentage of the fuel used to generate electricity, says Moody’s.

The impact on public and private colleges will be mixed. While some colleges and universities will see reduced heating costs, public colleges located in oil-producing states like Louisiana may see reduced funding as state budgets tighten. State housing finance agencies will see a positive impact as HFA families will apply savings from lower heating and transportation to mortgages.

Not-for-profit healthcare will not see any effect from declining oil and gas prices since they purchase fuel through group purchasing organizations or suppliers through long-dated contracts.

The report is available to subscribers at

https://www.moodys.com/research/US-Public-Finance-Low-Oil-Prices-Hit-a-Few-US–PBC_1002874.

A bill that would give Puerto Rico’s government agencies access to the same bankruptcy protections provided to cities such as Detroit would provide a road map for investors if one or more runs out of money, a senior government official told a U.S. House committee Thursday.

Melba Acosta, president of the island’s Government Development Bank, told the panel of the House Judiciary Committee that a bill permitting the island to let its so-called public corporations seek protection under Chapter 9 of the U.S. Bankruptcy Code would help protect public services and plans for long-term growth. Puerto Rico is currently barred from allowing its government entities to use Chapter 9.

A recent decision by a federal judge to block a local law that would have provided a pathway for the power, water and highway agencies to restructure about $20 billion in debt leaves Puerto Rico in a legal void, creating an uncertain environment that threatens the island’s economic future, she said. That lack of clarity reduces investor demand for Puerto Rico debt, affecting the government’s strained cash flow, and undermines the administration’s goal of making the agencies self-sufficient.

Without a legal process in place, defaults could prompt “a race to the courthouse,” which could “trigger years of litigation, exacerbate liquidity pressures at these public entities and have adverse consequences on economic growth, which only exacerbates Puerto Rico’s overall fiscal situation,” she said in written testimony. “Creditors would be in a worse position than they would be under an orderly, consensual process.”

The House bill would allow the agencies to follow the same path as Detroit, which emerged from a record municipal bankruptcy last year, and aims to reassure investors who are already familiar with the Chapter 9 process, according to Pedro Pierluisi, Puerto Rico’s nonvoting congressional representative, who sponsored it. Puerto Rico isn’t asking for a bailout or special favors, he said.

The U.S. commonwealth is struggling with a weak economy and a declining population. It has about $73 billion in debt, which is widely held by individuals and mutual funds nationwide because of its tax advantages. Moody’s Investors Service said in a report last week that there is high probability of default on central government obligations within two years.

Robert Donahue, managing director at Concord, Mass.-based research firm Municipal Market Analytics, called the bill a “technical fix” that may help avert chaotic defaults, receivership, years of lawsuits and even social unrest if agencies such as the Puerto Rico Electric Power Authority run out of cash to provide services. The utility, which has about $9 billion in municipal bonds and notes outstanding, is in talks with creditors, and Moody’s expects a default some time this year.

“Among investors, many believe this is the lesser of two evils,” Mr. Donahue, who also testified, said in an interview. “This is not a bailout bill. It doesn’t require any congressional resources. So for Congress it seems like a straightforward, simple way to keep Puerto Rico and the capital markets from negative consequences.”

The bill’s opponents include Thomas Mayer, partner and co-chairman of the corporate restructuring and bankruptcy group at Kramer Levin Naftalis & Frankel LLP, who told the committee that the use of Chapter 9 by Puerto Rico agencies would cause more harm than good. Mayer represents funds managed by Franklin Templeton Investments and OppenheimerFunds Inc., which hold about $1.6 billion in bonds from the Puerto Rico Electric Power Authority and sued in federal court to block the island’s local restructuring law.

Mr. Mayer said Chapter 9 harms bondholders, takes years, costs millions and has no established body of case law. Puerto Rico isn’t a state, and its law already provides for a receivership if an agency can’t pay its debts. And the power authority, known as Prepa, doesn’t need the law—it could raise rates, which have declined with fuel prices, he said.

“Chapter 9 itself does not offer ’certainty,’” he said in prepared remarks. “Chapter 9 is the Wild West.”

University of Michigan law professor John Pottow, however, said the bill was an overdue correction to the bankruptcy code. It faces little opposition in the academic community where it’s not even clear why Puerto Rico was excluded from Chapter 9 in the first place, he said.

Chairman Bob Goodlatte (R. Va.) said in a statement that Chapter 9 could “provide predictability, transparency and stability” to a Puerto Rico agency bankruptcy, which would rank among the largest in U.S. history. He also cautioned that proposals to retroactively impact bondholders’ rights deserve cautious analysis.

Some investors remained skeptical about the bill’s chances this week. Even if it advances beyond the committee, “it is highly unlikely to be passed by either chamber of Congress, certainly the Senate,” according to a report by Bank of America Merrill Lynch.

THE WALL STREET JOURNAL

By AARON KURILOFF

Feb. 26, 2015 2:10 p.m. ET

Write to Aaron Kuriloff at [email protected]

A misperception persists among some that defined contribution plans save money, when compared with traditional pensions, but several states that switched to DC plans have experienced a much different reality over time, according to a recent study from the National Institute on Retirement Security. Pensions deliver the same amount of lifetime income for about half of the cost of providing the lifetime income from a typical DC plan, according to the study, titled Case Studies of State Pension Plans that Switched to Defined Contribution Plans. The paper summarizes the switch from DB to DC in West Virginia, Michigan, and Alaska, which found that changing from a DB plan to a DC plan did not help an existing underfunding problem, and, in fact, increased pension plan costs. Each state found that workers under the DC plan also face increased levels of retirement insecurity, and that the best way to address a pension underfunding problem is to implement a responsible funding policy of making the full annual required contribution each year and to evaluate and adjust assumptions and funding over time.

Friday, February 20, 2015

First in Detroit, then in Stockton, Calif., and now in New Jersey, judges and other top officials are challenging the widespread belief that public pensions are untouchable.

Gov. Chris Christie of New Jersey delivered the latest blow on Tuesday, when he proposed to freeze that state’s public pension plans and move workers into new ones intended not to overwhelm future budgets or impose open-ended demands on taxpayers.

The first crack came in Detroit, where a judge ruled that public pensions could, in fact, be reduced, at least in bankruptcy. Then, just a few weeks ago, an opinion by the bankruptcy judge for Stockton, which emerged from Chapter 9 on Wednesday, called California’s mighty public pension system, Calpers, a bully for insisting in court that pension cuts were wholly out of the question.

Such dogma “encourages dysfunctional strategies,” wrote the judge, Christopher Klein, chief judge of the United States Bankruptcy Court for the Eastern District of California. He said Calpers’s legal arguments were invalid, and he concluded that it lacked standing to dominate the courtroom discussion the way it had. Stockton did not even seek permission to freeze its pension plans, but the judge nevertheless wrote that it was entitled to do so and went on to cite steps that struggling cities in general should take to trim their pension costs legally.

For starters, he recommended negotiating with their unions.

It may be sheer coincidence, but New Jersey seems have taken Judge Klein’s instructions to heart, even though states cannot file for bankruptcy and thus lack that particular leverage. For months, a pension commission formed by Governor Christie has been working quietly with the New Jersey Education Association, normally one of the state’s most litigious pension adversaries. By talking to each other instead of battling in court again, the two groups managed to find enough common ground to issue what they called a “road map” toward solving New Jersey’s daunting pension problems.

Many details remain in flux, and the union took pains on Tuesday to say it was not endorsing Mr. Christie’s full proposal and might never do so. But the road map identifies certain issues that are so important to New Jersey’s teachers that the union is willing to consider a pension freeze if that is what it takes to fully protect its members from the state’s looming pension collapse.

To appreciate how unusual it is for a state to propose a pension freeze, it helps to understand the “vested rights doctrine,” the legal argument that public pension plans cannot be frozen or reduced. Most states uphold some form of this doctrine, though in some it is a matter of statute, in others it is enshrined in the constitution and in still others it stems from court precedent. Often, the provisions have been in place for decades and attracted little notice until recently, when baby boomers began to retire in large numbers, placing unexpected pressure on public pension funds and the state and local budgets that support them.

People have sometimes suggested freezing public pension plans to keep the hole from getting deeper. But officials usually say that is impossible, and few want to mount a costly test of the doctrine, especially because the judges who would decide such a case usually participate in public pension systems themselves.

Companies, by contrast, can legally freeze their pension plans and have been doing so for years. Since 1974, companies with pension plans have been governed by a single federal law, the Employee Retirement Income Security Act, or Erisa, which details how freezes must take place to pass legal muster. One basic requirement is that workers midway through their careers are entitled to keep whatever portion of a pension they managed to earn until the date of the freeze.

The states have long argued that because they are legal sovereigns, federal pension law does not apply to them. When states, cities and other local governments try to rein in pension costs, they often create new “tiers” of much smaller benefits for workers they expect to hire in the future, and call it a reform. But there is no freeze for existing workers, who keep accruing the same benefits as before.

In some places, it is increasingly clear that reducing benefits only for future hires does not save enough money to preserve overstretched pension plans, especially in places where retirees outnumber current workers.

The clearest solution is to curb benefit accruals, but that runs directly into the vested rights doctrine. Seeing no other way out, officials often resort to issuing bonds to obtain cash for their pension funds, a risky strategy that has failed in Detroit, Stockton and other places.

Detroit issued such debt in 2005, responding to what seemed a particularly strong rule against tampering with public pension plans: an explicit constitutional provision to that effect.

But Detroit’s bankruptcy judge, Steven W. Rhodes, ruled that the state constitutional protection was not in force while the city sought a fresh start under Chapter 9 of the bankruptcy code. In addition to cutting part of the retirees’ pensions, Detroit froze its existing pension plan and shifted its workers into a new plan that is supposed to have limited ability to tap taxpayers for any investment losses.

Judge Rhodes’s ruling was groundbreaking and so unnerved Calpers over 2,000 miles away that it immediately issued a statement that it had no bearing in California. Unlike Detroit, which operated its own pension fund, many cities and other local governments in California participate in big pooled pension systems, the largest of which is Calpers. Once they join, Calpers makes it extremely difficult to withdraw, demanding a huge termination payment. It also claims to have an enforceable lien it would use to seize the assets of any city that tried to leave without paying.

In his legal analysis in the Stockton case, Judge Klein dissected Calpers’s lien and found that it was flawed and unenforceable in any municipal bankruptcy.

“The bully may have an iron fist, but it also turns out to have a glass jaw,” he wrote.

His opinion seems likely to play a role in other fiscal hot spots. Already, two creditors have referred to it in the continuing bankruptcy case of San Bernardino, Calif. The creditors, a European bank known as E.E.P.K. and the bond insurer Ambac Assurance, are arguing that the city is playing favorites, something not allowed in bankruptcy, where sacrifices are supposed to be roughly equal. Specifically, San Bernardino has been paying its bills to Calpers while leaving E.E.P.K. and Ambac in the lurch.

And while bankruptcy is limited to cities, the ruling may also inform a pension battle in Illinois, where in November a county judge found that a state-led effort to restructure its ailing pension system was illegal because of a constitutional provision that says: “Membership in any pension or retirement system of the state” or its instrumentalities “shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired.”

The state’s attorney general, Lisa Madigan, is appealing that decision, arguing in essence that public pensions can in fact be reduced in Illinois, despite what the constitution says, if that is what it takes “to protect the general public welfare.”

“This is one of those things where there’s a learning curve,” said Karol K. Denniston, a bankruptcy lawyer with Squire Patton Boggs in San Francisco who represented a local taxpayer group in Stockton’s case. “People will try things that don’t work quite right at first, then build on them. We’ve added to the municipalities’ tool kit.”

THE NEW YORK TIMES

By MARY WILLIAMS WALSH

FEB. 25, 2015

FROM THE CHAIRMAN’S DESK

GASB Chair Dave Vaudt looks ahead to major project goals for 2015, including finalizing proposed standards on retiree health care benefits, a potential re-examination of the financial reporting model, and the new project on external investment pools. More.

WHAT YOU NEED TO KNOW ABOUT

Fair Value

Fair value refers to the measurement of assets and liabilities—primarily investments—at the estimated price they would bring in the current market. The GASB soon will issue guidance that harmonizes terms with the FASB and brings clarity to areas of uncertainty. More.

ON THE HORIZON

This issue’s On the Horizon focuses on the Board’s efforts to educate and assist stakeholders in understanding its new pension standards and forthcoming guidance on retiree health care benefits. More.

RESEARCH UPDATE: THE FINANCIAL REPORTING MODEL

In 2015, the GASB expects to conclude its most important pre-agenda research project: a potential re-examination of the financial reporting model. This article will bring you up to speed on where things stand and what’s coming up. More.

ADDED TO AGENDA: EXTERNAL INVESTMENT POOLS

The GASB recently added a project on external investment pools to its current agenda. This effort will consider and address potential impacts of changes recently adopted by the Securities and Exchange Commission in this area.

Parties interested in submitting written comments or participating in public hearings on the Governmental Accounting Standards Board (GASB) Preliminary Views, Financial Reporting for Fiduciary Responsibilities and/or its Preliminary Views, Leases, should file comment letters or register to participate at the hearings by Friday, March 6, 2015.

The Preliminary Views on fiduciary responsibilities, which was issued November 20, 2014, presents the Board’s current thinking on fundamental issues associated with the reporting of activities in which a government has a fiduciary responsibility. In this context, fiduciary responsibility generally relates to a government controlling assets belonging to others in a trustee or custodial capacity. The primary objective is to enhance the consistency and comparability of when and how governments report their fiduciary activities.

The Preliminary Views on leases, also issued November 20, 2014, addresses these transactions from both a lessee and lessor perspective. The document presents the Board’s current thinking on the associated issues—which are based on the foundational principle that all leases are financings of the right to use an underlying asset. It includes proposals on how leases would be presented in the financial statements and the information related to leases that governments would disclose in the notes.

Submit Comment Letters

Individuals and organizations are urged to review these Preliminary Views documents and provide written comments by March 6, 2015. Comments should be addressed to the Director of Research and Technical Activities, Project No. 3-13P (for fiduciary responsibilities) and Project No. 3-24P (for leases), and emailed to [email protected] or mailed to the following address:

Governmental Accounting Standards Board
401 Merritt 7
P.O. Box 5116
Norwalk, CT 06856-5116

Public Hearings

The GASB will also host a series of concurrent public hearings on both projects to obtain feedback on the Preliminary Views from interested individuals and organizations:

• April 8, 2015, 8:30 a.m. EDT, at the Sheraton LaGuardia East Hotel, Flushing, NY
• April 9, 2015, 8:30 a.m. CDT at the Sheraton DFW Airport Hotel, Irving, TX
• April 10, 2015, 8:30 a.m. PDT, at the Westin Los Angeles Airport Hotel, Los Angeles, CA

The deadline for written notice of intent to participate in the public hearings is also March 6, 2015. Instruction for registering to participate in the hearings can be found in the front of the:

• Preliminary Views on fiduciary responsibilities
• Preliminary Views on leases.

http://www.gasb.org
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You are receiving this because you indicated that you would like to be informed about Financial Accounting Foundation and Governmental Accounting Standards Board activities.

Our mailing address is:

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The federal debt limit, which has been suspended for more than a year, will be reinstated on Sunday, March 15. The limit will be set at the amount of debt outstanding, meaning that the federal government will be immediately at the limit. Unless Congress acts to raise or suspend the debt limit before March 15 (a highly unlikely event), the federal government will begin the “extraordinary measures” necessary to avoid default.

The first extraordinary measure typically undertaken is suspending SLGS subscriptions. If the Treasury follows its recent practice, it is likely to announce sometime in the week of March 9 that it will not accept SLGS subscriptions after noon ET, Friday, March 13. In the past, the Treasury Department has fulfilled all requests for SLGS filed before the deadline.

It is unclear how long the SLGS window will remain closed, but it quite likely could be several months. The window will not reopen until the debt limit is raised or suspended again. The Congress and President will have to negotiate the terms of suspending or raising the debt limit and, if the recent past is any guide, they may not come to an agreement until the country is close to a default. The extraordinary measures, together with cash receipts, provide the Treasury with the ability to pay the government’s obligations in full for an uncertain period of time depending on the pattern of receipts and expenditures. The period of late March and early April is one where the federal government’s receipts are fairly high, so many observers believe that the Treasury can avoid default until sometime in the summer.

NABL will send another alert when we have an announcement from the Treasury Department.

 

National Association of Bond Lawyers
601 Thirteenth Street, NW, Suite 800 South, Washington, DC 20005-3875
Phone: (202) 503-3300 | Fax: (202) 637-0217 | Email: [email protected]

Remember when Goldman Sachs – dubbed by Matt Taibbi the Vampire Squid – sold derivatives to Greece so the government could conceal its debt, then bet against that debt, driving it up? It seems that the ubiquitous investment bank has also put the squeeze on California and its school districts. Not that Goldman was alone in this; but the unscrupulous practices of the bank once called the undisputed king of the municipal bond business epitomize the culture of greed that has ensnared students and future generations in unrepayable debt.

In 2008, after collecting millions of dollars in fees to help California sell its bonds, Goldman urged its bigger clients to place investment bets against those bonds, in order to profit from a financial crisis that was sparked in the first place by irresponsible Wall Street speculation. Alarmed California officials warned that these short sales would jeopardize the state’s bond rating and drive up interest rates. But that result also served Goldman, which had sold credit default swaps on the bonds, since the price of the swaps rose along with the risk of default.

In 2009, the lenders’ lobbying group than proposed and promoted AB1388, a California bill eliminating the debt ceiling requirement on long-term debt for school districts. After it passed, bankers traveled all over the state pushing something called “capital appreciation bonds” (CABs) as a tool to vault over legal debt limits. (Think Greece again.) Also called payday loans for school districts, CABs have now been issued by more than 400 California districts, some with repayment obligations of up to 20 times the principal advanced (or 2000%).

The controversial bonds came under increased scrutiny in August 2012, following a report that San Diego County’s Poway Unified would have to pay $982 million for a $105 million CAB it issued. Goldman Sachs made $1.6 million on a single capital appreciation deal with the San Diego Unified School District.

Green Light to Exploit

In a September 2013 op-ed in SFGate.com called “School Bonds Are a Wall Street Scam,” attorney Nanci Nishimura wrote:

“. . . AB1388, signed by then-Gov. Arnold Schwarzenegger in 2009, [gave] banks the green light to lure California school boards into issuing bonds to raise quick money to build schools.

Unlike conventional bonds that have to be paid off on a regular basis, the bonds approved in AB1388 relaxed regulatory safeguards and allowed them to be paid back 25 to 40 years in the future. The problem is that from the time the bonds are issued until payment is due, interest accrues and compounds at exorbitant rates, requiring a balloon payment in the millions of dollars. . . .

Wall Street exploited the school boards’ lack of business acumen and proposed the bonds as blank checks written against taxpayers’ pocketbooks. One school administrator described a Wall Street meeting to discuss the system as like “swimming with the big sharks.”

Wall Street has preyed on these school boards because of the millions of dollars in commissions. Banks, financial advisers and credit rating firms have billed California public entities almost $400 million since 2007. [State Treasurer] Lockyer described this as “part of the ‘new’ Wall Street,” which “has done this kind of thing on the private investor side for years, then the housing market and now its public entities.”

Gullible school districts agreed to these payday-like loans because they needed the facilities, the voters would not agree to higher taxes, and state educational funding was exhausted. School districts wound up sporting shiny new gymnasiums and auditoriums while they were cutting back on teachers and increasing classroom sizes. (AB1388 covers only long-term capital improvements, not daily operating expenses.) The folly of the bonds was reminiscent of those boondoggles pushed on Third World countries by the World Bank and IMF, trapping them under a mountain of debt that continued to compound decades later.

The Federal Reserve could have made virtually-interest-free loans available to local governments, as it did for banks. But the Fed (whose twelve branches are 100% owned by private banks) declined. As noted by Cate Long on Reuters:

The Fed has said that it will not buy muni bonds or lend directly to states or municipal issuers. But be sure if yields rise high enough Merrill Lynch, Goldman Sachs and JP Morgan will be standing ready to “save” these issuers. There is no “lender of last resort” for muniland.

Debt for the Next Generation

Among the hundreds of California school districts signing up for CABs were fifteen in Orange County. The Anaheim-based Savanna School District took on the costliest of these bonds, issuing $239,721 in CABs in 2009 for which it will have to repay $3.6 million by the final maturity date in 2034. That works out to $15 for every $1 borrowed.

Santa Ana Unified issued $34.8 million in CABs in 2011. It will have to repay $305.5 million by the maturity date in 2047, or $9.76 for every dollar borrowed.

Placentia-Yorba Linda Unified issued $22.1 million in capital appreciation bonds in 2011. It will have to repay $281 million by the maturity date in 2049, or $12.73 for every dollar borrowed.

In 2013, California finally passed a law limiting debt service on CABs to four times principal, and limiting their maturity to a maximum of 25 years. But the bill is not retroactive. In several decades, the 400 cities that have been drawn into these shark-infested waters could be facing municipal bankruptcy – for capital “improvements” that will by then be obsolete and need to be replaced.

Then-State Treasurer Bill Lockyer called the bonds “debt for the next generation.” But some economists argue that it is a transfer of wealth, not between generations, but between classes – from the poor to the rich. Capital investments were once funded with property taxes, particularly those paid by wealthy homeowners and corporations. But California’s property tax receipts were slashed by Proposition 13 and the housing crisis, forcing school costs to be borne by middle-class households and the students themselves.

The same kind of funding shift has occurred in college education nationally. Tuition at public universities and colleges was at one time free. But in successive economic downturns, states have made up for shortfalls in educational budgets by raising tuition. By 2012, tuition was covering 44% of the operating expenses of public higher education. According to a March 2014 report by Demos, 7 out of 10 college seniors now borrow, and their average debt on graduation is over $29,000. The result nationally is a student debt that has grown to $1.5 trillion.

The State that Escaped: North Dakota

According to Demos, per-student funding has been slashed since 2008 in every state but one – the indomitable North Dakota. What is so different about that state? Some commentators credit the oil boom, but other states with oil have not fared so well. And the boom did not actually hit in North Dakota until 2010. The budget of every state but North Dakota had already slipped into the red by the spring of 2009.

One thing that does single the state out is that North Dakota alone has its own depository bank. The state-owned Bank of North Dakota (BND) was making 1% loans to school districts even in December 2014, when global oil prices had dropped by half. That month, the BND granted a $10 million construction loan to McKenzie County Public School No. 1, at an interest rate of 1% payable over 20 years. Over the life of the loan, that works out to $.20 in simple interest or $.22 in compound interest for every $1 borrowed. Compare that to the $15 owed for every dollar borrowed by Anaheim’s Savanna School District or the $10 owed for every dollar borrowed by Santa Ana Unified.

How can the BND afford to make these very low interest loans and still turn a profit? The answer is that its costs are very low. It has no exorbitantly-paid executives; pays no bonuses, fees, or commissions; pays no dividends to private shareholders; and has low borrowing costs. It does not need to advertise for depositors (it has a captive deposit base in the state itself) or for borrowers (it is a wholesale bank that partners with local banks, which find the borrowers). The BND also has no losses from derivative trades gone wrong. It engages in old-fashioned conservative banking and does not speculate in derivatives. Unlike the vampire squids of Wall Street, it is not motivated to maximize its bottom line in a predatory way. Its mandate is simply to serve the public interest.

North Dakota currently has a population of about 740,000, or the size of Santa Ana and Anaheim combined. If a coalition of several such cities were to form a municipally-owned bank, they too could have their own low-cost capital funding mechanism, allowing them to escape the budget-sucking tentacles of Wall Street’s vampire squids.

By Ellen Brown

Global Research, February 21, 2015

Ellen Brown is an attorney, founder of the Public Banking Institute, and author of twelve books including the best-selling Web of Debt. Her latest book, The Public Bank Solution, explores successful public banking models historically and globally. Her blog articles (nearly 300) are at EllenBrown.com.

A draft document issued by the Federal Accounting Standards Advisory Board (FASAB) calling for greater disclosure of risks associated with P3s by federal agencies raises a number of challenging questions according to a column published this week in The Wall Street Journal’s Risk and Compliance Journal.

Risk disclosure for P3s is necessary to help financial statement users understand how taxpayer assets are used and what risks have been taken into account, according to the draft standards. Currently, there is no common reporting standard that would allow a financial statement user to compare them across agencies.

FASAB staffers suggested the kinds of risks that should be disclosed include the costs to oversee P3s, legacy costs, and remote or unlikely risks should be accounted for when turning to the private sector.

“The exposure draft, as applied, would have a chilling effect on sensible risk transfer initiatives within government,” Christopher Voyce, senior managing director at Macquarie Capital, said. “My concern about the exposure draft is it treats P3 as a financing decision that doesn’t transfer risk.”

The problem is that there is no way to account for the benefit a P3 provides by shifting the risk of meeting deadlines and quality standards to the private partner, Voyce explained.

In some circumstances, disclosure of remote risks might be appropriate, depending on the harm that could result from the risk, said Anita Molino, president of Bostonia Partners LLC, and chairman of NCPPP.

At the same time, Molino said, “I don’t know how a government accounting officer could, at the start of a relationship, think through what the business risks might be and would they be important enough to be disclosed. In my mind it’s way too subjective unless there’s something pretty obvious in the relationship.”

NCPPP

By Editor February 19, 2015

In this week’s Extra Credit, Senior Director Jane Ridley, Director Ken Rodgers, and Senior Director Dave Hitchcock discuss our rating actions on Wayne County, Thomas Jefferson University, and Puerto Rico, respectively.

Listen to the Podcast.

Feb 19, 2015

The National Council for Public-Private Partnerships has signed an agreement with the Chesapeake Bay Trust and the U.S. Environmental Protection Agency (EPA) to provide community support on the emerging subject of community-based public-private partnerships (CBP3s). NCPPP will provide outreach to support alternative financing for green infrastructure-driven stormwater management. This collaboration supports implementation of President Obama’s 2009 Chesapeake Bay Protection and Restoration Executive Order that made restoration of the bay a federal priority.

The highlight of the year-long project will be a CBP3 Stormwater Summit in Philadelphia this spring for communities and potential private sector partners interested in or unfamiliar with the CBP3 model.

According to EPA, this model develops a strong, long-term partnership between a municipality and a private equity group, sharing the risk and creating greater accountability by reinvesting cost savings and revenues to create a pool of funds for reinvestment in future projects. The model was developed by the EPA Region 3 office in Philadelphia and is being employed on a major green stormwater system retrofit project in Prince George’s County, Maryland.

“NCPPP is excited to provide its one-of-a-kind educational resources in support of the valuable restoration work that EPA and the Chesapeake Bay Trust are undertaking,” NCPPP Executive Director Todd Herberghs said. “Working together, we will be able to foster an understanding of the CBP3 model that can be used to meet some of our nation’s growing infrastructure financing needs.”

NCPPP also will work with its project partners to develop a model for a one-day charrette to be conducted in the Mid-Atlantic. During the hands-on planning exercise, public and private sector leaders would learn how CBP3 innovations can benefit their particular projects and, specifically, how a value-for-money analysis can be conducted to demonstrate the financial value of the CBP3 model.

These events will help inform a third element of the project — a strategic plan for education, outreach and awareness of the issue. With recommendations from NCPPP, EPA will create a series of educational materials that will further the dialogue about the CBP3 model.

By Editor February 19, 2015

The investment tool is catching on as a better, safer way to invest scarce public resources.

In 2009, President Obama announced the first social innovation fund (SIF), an initiative of the Corporation for National and Community Service, which I chaired at the time. SIFs provide a new way of thinking about how to fund government services: Instead of prescriptively asking nonprofits to respond to a bid, we would ask them to nominate an important social problem and describe how they would go about solving it. Over the years, the fund has invested more than a half-billion dollars to address social challenges.

Building on those successes, governments across the country have begun to utilize social impact bonds (SIBs) to solve complex problems with the help of private investors — and to put those resources only into approaches that work. I recently spoke with Ben McAdams, mayor of Utah’s Salt Lake County and champion of a pioneering SIB in the field of early childhood education. The Utah High Quality Preschool Program provides assistance to increase school readiness and academic performance among 3- and 4-year-olds to reduce the number of children who require costly special education and remedial services.

As part of the SIB, Goldman Sachs and J.B. Pritzker are providing funding for early education services for more than 3,500 children. Goldman Sachs, the senior lender, will provide up to $4.6 million to the United Way of Salt Lake, which is overseeing implementation of the program. J.B. Pritzker will loan another $2.4 million to the United Way as a means of reducing the senior lender’s risk should the preschool program prove to be ineffective. There is no upfront cost to the taxpayer. With the first $1 million investment, more than 450 children were able to attend the preschool program in the fall of 2013.

The amount of the SIB repayments to the lenders is based on the actual savings realized by the state from reducing the number of students who may require special education programs. If the intended results are achieved, the lenders will receive payments equal to 95 percent of the savings, or $2,470 per child each year from kindergarten through sixth grade, plus interest of 0.5 percent. Pay-for-success payments thereafter will be 40 percent of the savings, or $1,040 per child per year of special education services avoided. If the preschool program does not result in increased school readiness and a decrease in the use of special education services, there is no obligation by the United Way or Salt Lake County to repay the loans.

In practice, SIBs are not really bonds at all, but creative procurement solutions that allow public and private stakeholders to work together toward positive outcomes. Part of Mayor McAdams’ excitement, which we have also seen in other jurisdictions, results from the fact that these types of innovative investments are collaborative efforts that can be replicated and create positive social impacts across policy areas.

For now, though, the focus is on this particular pioneering program addressing the needs of young children. “We’re following data and evidence to ensure that children — no matter what their economic status — get a chance for a great educational start in life,” McAdams said. “We know the county’s budget will benefit due to avoiding costs of juvenile crime, drugs and gangs. But the most important bottom line is the measurably better lives for these children.”

GOVERNING.COM

BY STEPHEN GOLDSMITH | FEBRUARY 18, 2015

[email protected]

Governments that lack the resources for effective oversight should consider turning to independent monitors.

Fraud by government contractors and vendors is all too common, and attempts, particularly by local governments, to spot or prevent it often fall short due to limited funds and staff with too much work and not enough time.

Governments seeking an alternative to a too-often-underfunded inspector general’s office, an overburdened contract-compliance unit or an audit staff focused only on internal operations may want to consider an independent monitor. A monitor can keep a watchful eye on contractors and slam the door on potentially unscrupulous vendors before they have an opportunity to engage in fraud.

In the past, independent monitors have been reserved for corporate deferred-prosecution agreements, allowing a business to avoid prosecution after law enforcement has exposed fraud or serious compliance violations. But why wait for the fraud to occur? For governments, it’s far better to take a proactive approach and avoid reputation-damaging news about wasted tax revenue.

In considering the independent-monitor approach, it’s important for governments to analyze their history. What problems have occurred in the past? Do staff members feel ill-equipped to effectively and efficiently respond to complaints? Would an audit by a funding source reveal agency wrongdoing? If so, a monitor may be the answer to these concerns.

But how can a government with limited funds and a host of programs to service afford to fund an independent-monitor program? The answer is that they can pass the cost on to the contractors themselves. They can build a provision into their requests for proposals and inform potential vendors that they will bear the cost of the monitoring, and vendors can then build the cost into their bids.

So instead of increasing long-term budget allocations to properly fund oversight offices, expenditures will increase incrementally and only on matters that warrant further inspection. Once in place, the monitor reports to appropriate staff inside the government agency who can review any significant findings, report to management if necessary and determine the proper course of action.

To start, though, governments should follow a couple of straightforward guidelines for developing a successful independent-monitoring program:

• When issuing requests for qualifications for independent monitors, governments should evaluate respondents based on their neutrality, objectivity and professionalism. Then evaluators can create a pool of qualified service providers — preferably numerous vendors in each service area. A few red flags to watch out for include respondents that would likely have conflicts with the engagements needing monitoring, inexperienced respondents and vendors that have other business with the governmental agency.

• Governments also should provide the contractor with a list of approved and available professional service firms and let them select one, subject to the government’s approval. After a conflicts check to ensure that there are no hidden relationships, the monitor can begin the engagement with a scope of work written by the government.

So what’s the return on investment for governments? An effective independent monitoring program can investigate bribery and kickback allegations, ethics policy violations, compliance with minority and women-owned business participation requirements, overbilling, false claims and a myriad of other potential schemes. For example, an independent monitor could require a contractor in an industry known for wining and dining public officials to allow the monitor to review all relevant employee expense reports. This drastically decreases the potential for fraud in this area.

As governments increasingly face tighter budgets and increasing pressure to protect taxpayer dollars, it’s crucial that they identify ways to put fraud checks in place across all levels of their organizations. Employing independent monitors is a cost-effective way to help ensure that governments focus on their primary mission: better serving their constituents.

GOVERNING.COM

Jim Sullivan | Contributor

[email protected] | @sikichllp

FEBRUARY 19, 2015

(Bloomberg) — Municipalities across the U.S. are reaping the benefits of interest rates close to five-decade lows, refinancing billions of dollars of debt and freeing up money for roads, schools and environmental projects.

Washington, under court order to boost education spending, expects to save almost $90 million in the next two years, the cost of operating two community colleges. In Oregon, refundings last month saved about $72 million, equivalent to what it paid to fund a Portland research hospital for two years. Louisiana, which faces a $1.6 billion deficit next fiscal year as oil prices slide, will steer a $109 million windfall to transportation work.

“We’re spending less money on interest and more money on roads,” Louisiana Treasurer John Kennedy said in a telephone interview. “Every penny counts.”

Municipal borrowing costs dropped the past four quarters, the longest stretch since 2011, as fixed-income markets rallied amid concern that global economic growth was slowing. Benchmark 10-year munis yield about 2.1 percent, down from about 3 percent at the start of 2014, data compiled by Bloomberg show.

Doubling Up

As interest rates sank, refunding issuance tallied about $70 billion last quarter, up from $36 billion a year earlier, Bloomberg data show.

Since the start of 2015, state and local governments have refunded $27.6 billion in debt as of Feb. 12, for combined savings of $1 billion to $2 billion, said Phil Fischer, head of municipal bond research at Bank of America Merrill Lynch in New York.

The refunding leap spurred the busiest January for muni-bond sales since 2010 — at about $27 billion — and may signal higher issuance for the year ahead, according to Chris Mauro, head of U.S. municipal strategy at RBC Capital Markets in New York.

For local treasurers, the refinancings come at an opportune time, bringing an influx of cash as officials balance rising pension costs with the need to invest in neglected infrastructure projects.

“Incremental funds are always helpful and can accelerate improvements in state finances,” Fischer said.

Washington Shortfall

Refunding volume may reach about $235 billion this year, $45 billion higher than last year, Fischer wrote in a Jan. 23 report. The last time refundings were as high was in 2012, he said. Ten-year yields for benchmark muni issuers fell to about 1.5 percent that year, the lowest since at least 2010.

Washington faces a projected budget shortfall of more than $2 billion for the two-year cycle that begins July 1, according to Ralph Thomas, a spokesman for the Office of Financial Management.

A Jan. 21 refunding of about $460 million in general-obligation debt produced $5 million in savings in the two-year budget cycle that begins July 1, said Scott Merriman, a spokesman for the treasurer. A separate refinancing this month generated more than $32 million in savings, the treasurer’s office said.

“We’re a profit center in state government,” Treasurer James McIntire said in an interview. “We finance long-term capital projects, and when we get the opportunity, we refinance them, just like any homeowner would take advantage of lower mortgage rates.”

Taxpayers’ Gain

A state Supreme Court order requiring Washington to boost support for K-12 education accounts for the biggest piece of the budget gap, said Thomas, the spokesman for the financial management office.

Oregon also took advantage of the drop in interest rates, saving about $72 million by refunding lottery-revenue bonds and highway user-tax revenue bonds, according to a Jan. 15 news release.

In Iowa, a refinancing this month by a state authority will generate $33 million of savings for a fund that finances drinking-water and wastewater infrastructure improvements.

Louisiana, which had its credit outlook revised to negative Feb. 13 by Moody’s Investors Service and Standard & Poor’s, generated its savings through a refinancing of gasoline and fuel-tax bonds last month.

The state, where mining activity, including oil, gas and coal, accounts for almost 13 percent of the economy, is confronting budget deficits as oil prices are down about 50 percent since June.

“We’re giving taxpayers more bang for the buck,” said Kennedy, the treasurer.

Bloomberg Muni Credit

by Alison Vekshin
5:00 PM PST
February 16, 2015

To contact the reporter on this story: Alison Vekshin in San Francisco at [email protected]

To contact the editors responsible for this story: Stephen Merelman at [email protected] Mark Tannenbaum, William Selway

(Bloomberg) — The $3.5 trillion municipal market’s record 13-month rally is poised to end as fixed-income assets slide and localities sell the most debt since 2007.

Munis have lost 1.2 percent this month, and are headed for the first monthly decline since December 2013, Bank of America Merrill Lynch data show. The streak of gains, the longest since the data began in 1989, drove the local-debt market to a 9.8 percent return in 2014.

Treasuries and corporate bonds are also posting February losses after a strengthening labor market signaled the U.S. economy is gaining momentum. State and city obligations face the added headwind of surging issuance from refinancing: Municipalities have sold about $46 billion of securities this year through Feb. 13, the busiest annual start since 2007, data compiled by Bloomberg show.

The borrowing jump “seems to be probably the predominant factor” behind the declines, said Kevin Ramundo, a fund manager who helps oversee $30 billion in munis at Fidelity Investments in Merrimack, New Hampshire. “We certainly didn’t think that the returns that we saw in 2014 were likely to be repeated in 2015.”

Refunding Pace

States and localities picked up the pace of refunding after interest rates fell to 20-month lows at the start of February. Yields on benchmark 10-year munis have since risen to about 2.1 percent, close to this year’s high, from 1.78 percent on Feb. 2. Yields climbed after Labor Department data for January showed the biggest three-month jobs gain in 17 years.

Refinancings are set to account for about 42 percent of sales this week, Bloomberg data show. Scottsdale, Arizona, and Pennsylvania’s Montgomery County Industrial Development Authority are among issuers refunding.
The leap in bond sales may increase issuance forecasts for 2015, according to Michael Zezas, chief muni strategist at Morgan Stanley. Offerings this year may exceed his December forecast of about $354 billion, which would be 15 percent higher than in 2014 and end a four-year market contraction, he said.

“The upside in supply is pretty substantial,” Zezas said at a Bond Buyer conference in New York on Wednesday. In addition to the flood of refinancings, the economic expansion has also strengthened local finances and made voters more open to debt sales for infrastructure, he said.

Beating Treasuries

While munis are on pace for a monthly loss, Treasuries and corporate debt have declined even more, by 2.1 percent and 1.6 percent, respectively.

Munis have benefited from demand for tax-free income, with the top federal income-tax rate at 39.6 percent as of last year, the highest level since 2000.

Even as munis outperform Treasuries in February, tax-free yields still exceed those on federal debt for 10-year maturities. The ratio of the yields, a measure of relative value between the two markets, is about 101 percent, where the six-year average is about 99 percent. The higher the figure, the cheaper munis are in comparison.

Munis remain “one of the cheaper asset classes,” said Dan Heckman, a fixed-income strategist who helps oversee $126 billion at U.S. Bank Wealth Management in Kansas City. “Fundamentally, most municipalities are doing well.”

Minutes’ Signal

The reaction to Wednesday’s release of minutes for the Federal Reserve’s January meeting suggests municipalities have more room to refinance. Treasuries climbed as the minutes showed many policy makers favored keeping the overnight benchmark at virtually zero “for a longer time.”

The Fed will raise its target, which it’s held in a range of zero to 0.25 percent since 2008, as soon as the third quarter, according to the median forecast in a Bloomberg News survey.

The prospect for higher rates in 2015 means the tax-free market will struggle to match last year’s performance, according to Zezas.

In his 2015 outlook, published in December, Zezas estimated munis will earn 1.14 percent this year.
“I imagine you’ll see much more modest returns than you had in 2014, and the path to get there is likely to be much more volatile,” he said Wednesday.

Bloomberg Muni Credit

by Meenal Vamburkar and Brian Chappatta

February 18, 2015

To contact the reporters on this story: Meenal Vamburkar in New York at [email protected]; Brian Chappatta in New York at [email protected]

To contact the editors responsible for this story: Stephen Merelman at [email protected] Mark Tannenbaum, William Selway

Public-private partnership (P3) risks are on the agenda of the Federal Accounting Standards Advisory Board, which sets financial reporting standards for the federal government. An exposure draft issued in October called for more disclosure of the risk of deals where the government turns to the private sector to provide infrastructure, goods and services. Comments on the draft closed in January.

In conversations with Risk & Compliance Journal, FASAB staff have pointed to the increasing use of P3 arrangements, and their complexity, as sources of undisclosed risk. The complexity begins with the very definition of a public-private partnership, a task so elusive that rather than provide a definition, the draft provides a matrix of factors to determine whether disclosure is appropriate. Risks to be addressed, the staff suggested, might include costs of overseeing the P3, legacy costs such as the human resource expenditure for employees whose functions are transferred to the private sector, and even “remote” or unlikely risks.

The exposure draft points out that better disclosure is necessary to help financial statement users understand how taxpayer assets are used and what risks are being incurred in P3 deals. Although public-private partnerships are increasingly the resort of government agencies trying to make the most of scarce budget resources, there is no common reporting standard that would allow a financial statement user to compare them across agencies.

For example, the Forest Service’s 2014 budget justification described a new program to “develop public-private partnerships to reduce risks to communities in fire-prone landscapes; to protect public service utilities and enhance wa­ter quality in municipal watersheds; and to maintain and restore the resilience of aquatic ecosys­tems ” However, disclosure is limited. Steve Lohr, director of partnerships for the Forest Service, said in an interview, “Currently there is no broader framework for reporting than what our agency requires.”

Some industry participants have concerns about the new disclosure requirements, though.

“The exposure draft, as applied, would have a chilling effect on sensible risk transfer initiatives within government,” said Christopher Voyce, senior managing director at Macquarie Capital, which advises on and arranges financing for public-private partnerships. “My concern about the exposure draft is it treats P-3 as a financing decision that doesn’t transfer risk,” he said.

Mr. Voyce noted for example that when a government agency builds and operates something on its own, such as a hospital, it bears all of the risk associated with the project. The same hospital built and operated in a P3 arrangement might well require the private partner to bear the risk of meeting deadlines and quality standards, and reduce the cost to the agency if the private partner didn’t deliver on commitments.

Such risk transfer has value that the accounting treatment does not reflect, and Mr. Voyce said that without full accounting for the benefit of the arrangement, P3 would effectively be handicapped in a comparison with other structures.

Another point at issue is the draft’s treatment of those “remote” risks that, while unlikely to materialize, could have high impact if they did. “Disclosure of remote risks is the biggest dilemma,” said Wendy M. Payne, executive director of the FASAB. According to the draft, “The Board believes that significant P3 risks, including those that may be deemed remote should be disclosed.”

Anita Molino, president of Bostonia Partners LLC, and chairman of the National Council for Public-Private Partnerships, concurred that, in some circumstances, disclosure of remote risks might be appropriate, depending on the harm that could result from the risk. However, she said, “I don’t know how a government accounting officer could, at the start of a relationship, think through what the business risks might be and would they be important enough to be disclosed. In my mind it’s way too subjective unless there’s something pretty obvious in the relationship.”

She said she supports an alternative view discussed in the Exposure Draft, narrowing the scope of the definition and reducing the disclosure requirements.

In issuing a standard for P3, the FASAB is following the state and local government accounting standard setter, the Governmental Accounting Standards Board, which in 2010 issued a standard for a specific form of public-private partnership, the service concession, but excluded all others, such as construction of infrastructure. A spokesman for the GASB told Risk & Compliance Journal, “There is nothing broader underway.”

THE WALL STREET JOURNAL

February 17, 2015, 6:00 AM ET

By GREGORY J. MILLMAN

(Gregory J. Millman is a senior columnist with Risk & Compliance Journal He is the author of The Vandals’ Crown: How Rebel Currency Traders Overthrew the World’s Central Banks, and several other books. He can be reached at +1 (212) 416-2352 or by email at [email protected] Follow on Twitter @GregoryJMillman)

COLUMBUS, Ohio — Certain local zoning laws aimed at limiting fracking can’t be used to circumvent the state’s authority over oil and gas drilling, a fiercely divided Ohio Supreme Court ruled Tuesday.

In a 4-3 decision with three written dissents, the high court said that the home rule clause of Ohio’s constitution doesn’t allow a municipality to block drilling activities otherwise permitted by the state.

The decision came in a case brought by the Akron suburb of Munroe Falls against Beck Energy Corp. over a 2004 state law that gives Ohio “sole and exclusive authority” to regulate the location of wells.

Beck received a state-required permit from the Ohio Department of Natural Resources in 2011 to drill a traditional well on private property in Munroe Falls. The city sued, saying the company illegally sidestepped local ordinances.

The lawsuit has been closely watched nationally, raising a question in cities and towns where lucrative oil and gas is trapped in underground shale: Can regulations put in place by states eager for the jobs and tax revenues that come with drilling trump local restrictions on hydraulic fracturing, or fracking, that communities are enacting to protect against haphazard development.

Writing for the court’s majority, Justice Judith French said, “The issue before us is not whether the law should generally allow municipalities to have concurrent regulatory authority, but whether (the law) and Home Rule Amendment do allow for the kind of double license at issue here. They do not.”

Chief Justice Maureen O’Connor and Justice Sharon Kennedy joined her in determining that Munroe Falls’ particular drilling restrictions constituted an exercise of police power — not the local self-government that’s protected under home rule.

“Here, the city’s ordinances do not regulate the form and structure of local government,” French wrote. “Instead, they prohibit — even criminalize — the act of drilling for oil and gas without a municipal permit.”

Beck Energy attorney John Keller said the company was pleased but not surprised with the decision.

“This is an area which is, and should be, highly regulated,” he said. “The question is not should it be regulated, the question is should it be regulated by people that have the expertise to regulate it or by the local officials who just simply don’t have that expertise.”

Three justices — Paul Pfeifer, Judith Lanzinger and William O’Neill — dissented in the decision.

“Let’s be clear here. The Ohio General Assembly has created a zookeeper to feed the elephant in the living room,” wrote O’Neill. “What the drilling industry has bought and paid for in campaign contributions they shall receive.”

In their dissents, both Lanzinger and Pfeifer said they saw room for the state and local laws to live side-by-side. Lanzinger noted that the high court has regularly ruled that state laws written to pre-empt local laws can’t divest a community of its constitutional home-rule protections.

Justice Terrence O’Donnell opted to concur on the opinion in judgment only. Munroe Falls attorney Tom Houlihan said that means that the court was divided 3-1-3 on the legal reasoning behind Tuesday’s decision.

“It’s obviously a very complicated and difficult case,” he said. “None of the reasons got a majority of votes, which could be carefully read by future courts that there’s still a role for local zoning in the oil and gas field. I’m hopeful that is the case.”

By THE ASSOCIATED PRESS

FEB. 17, 2015, 1:31 P.M. E.S.T.

NEW YORK, NY, February 12, 2015 – CUSIP Global Services (CGS) today announced the release of its
CUSIP Issuance Trends Report for January 2015. The report, which tracks the issuance of new security
identifiers as an early indicator of debt and capital markets activity, suggests a possible slowdown in U.S.
and international corporate debt issuance and an increase in municipal bond issuance over the next
several weeks.

Total CUSIP requests for new U.S. and Canadian corporate equity and debt fell 11% in January, with a
total of 1,697 new identifiers requested over the course of the month. Within those totals, domestic
corporate debt CUSIP demand fell to just 697 in January. On a year-over-year basis, corporate CUSIP
request volume fell 18%.

By contrast, municipal CUSIP volume surged 14% in January with a total of 1,076 new identifier requests
made over the course of the month. This represents the best opening month for municipal CUSIP orders
since 2013 and a 24.5% increase over the year-ago period.

Following steady growth throughout 2014, international debt and equity CUSIP International Numbers
(CINS) orders eased in January. Total requests for new international equity CINS were down 2.3%, while
international debt CINS requests decreased 4.8% on a year-over-year basis.

“We’ve seen a mixed volume of new CUSIP orders so far in 2015, with request for new municipal bond
identifiers increasing sharply on an annualized basis,” said Gerard Faulkner, Director of Operations for
CUSIP Global Services. “This month’s data also reveals some interesting trends being driven by
regulatory reform, such as increased derivatives requests and conversions of tender option bonds to be
Volcker Rule compliant.”

“Volatility continues to be the name of the game when it comes to new capital creation trends in the U.S.
and internationally,” said Richard Peterson, Senior Director of Global Markets Intelligence, S&P Capital
IQ. “As the macroeconomic environment continues to keep the markets on their toes, we expect to see
new instrument issuance ebb and flow with the perceived level of opportunity over the course of Q1.”

To view a copy of the full CUSIP Issuance Trends report, please click here.

On February 6, 2015, Judge Francisco Besosa of the U.S. District Court for the District of Puerto Rico held that the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (the “Recovery Act”) is expressly preempted by section 903 of the Bankruptcy Code and is therefore unconstitutional. The court also denied the Commonwealth’s motion to dismiss the plaintiffs’ claims under the Contracts Clause and certain of the plaintiffs’ claims under the Takings Clause. The decision is among the first to explicitly hold that section 903 of the Bankruptcy Code preempts the States, including Puerto Rico, from enacting a municipal debt adjustment scheme that results in the discharge of indebtedness. The court’s ruling also removes a major leverage point for the Commonwealth and its public agencies attempting to negotiate restructurings with creditors and restores remedies available to bondholders, including the right to appoint a receiver.

Background

On June 25, 2014, Puerto Rico’s legislature introduced and approved the Recovery Act. Shortly thereafter, Governor Alejandro Garcia Padilla signed the Recovery Act into law. The Recovery Act permits Puerto Rico’s three major public corporations (PREPA, PRHTA, and PRASA)1 to pursue two non-consensual alternatives to a restructuring of their debts. The first alternative, Chapter 2, permits a public corporation to modify, amend, or exchange certain of its debt instruments if (i) at least 50 percent of the debt in a given class votes on whether to accept the changes and (ii) at least 75 percent of participating voters approve the changes to the debt instruments. The second alternative, Chapter 3, is modeled after chapter 9 of the Bankruptcy Code and permits a debtor to propose a plan that adjusts its debts without the consent of all of its creditors. The Chapter 3 plan may be confirmed if at least one class of affected debt has voted to accept the plan by a majority of the votes cast in such class and two-thirds of the aggregate principal amount of affected debt in such class that is voted. In addition, the Recovery Act:

• Eliminated existing statutory remedies for certain secured bondholders, including the right for PREPA bondholders to appoint a receiver;
• Permitted debtors to use cash collateral and obtain DIP financing with a priming lien without providing any adequate protection to prepetition creditors, provided that the use of cash collateral or the DIP financing would be to serve a public function;
• Permitted debtors to sell their assets with court approval; and
• Stayed prepetition creditors from enforcing remedies against the debtor during the pendency of the Chapter 2 or 3 case.

Two groups of creditors filed complaints against the Commonwealth of Puerto Rico and PREPA, seeking a declaration that the Recovery Act is unconstitutional because it infringed on the federal bankruptcy power and a declaration that the Recovery Act is expressly preempted by section 903(1) of the Bankruptcy Code. The plaintiffs also sought declarations that the Recovery Act violated the Takings and Contracts Clauses of the U.S. Constitution and that provisions in the Recovery Act that would stay federal proceedings are unconstitutional. The Commonwealth moved to dismiss these claims, and the creditors cross-moved for summary judgment.

The Court’s Decision

In Franklin California Tax-Free Trust v. Commonwealth of Puerto Rico and Blue Mountain Capital Management LLC v. Governor Alejandro Garcia-Padilla,2 the court first addressed ripeness, concluding that the plaintiffs’ preemption and Contracts Clause claims were ripe for review because, among other things, the claims relied on the enactment of the Recovery Act, not on its application. The plaintiffs’ claims were not dependent on any hypothetical facts, presented purely legal issues, and also alleged direct injuries to the plaintiffs’ interests. Notably, the court observed:

[N]ot having the guarantee of remedial provisions that they were promised affects plaintiffs’ day-to-day business as PREPA bondholders, particularly when negotiating with PREPA over remedies and potential restructuring. Indeed, the threat of PREPA’s invocation of the Recovery Act hangs over plaintiffs and diminishes their bargaining power as bondholders.

The court also concluded, however, that certain of the plaintiffs’ Takings Clause claims and stay of proceedings claims were not ripe for adjudication, because they were contingent on hypothetical events that had not yet occurred. In addition, the court dismissed the plaintiffs’ claims against PREPA, as the plaintiffs did not sufficiently allege any injuries that are traceable to an action by PREPA.

1. Preemption

Having determined that the preemption claims were ripe for review, the court held that the plain language of section 903 of the Bankruptcy Code expressly preempted the Recovery Act. “Express preemption” occurs when congressional intent to preempt state law is made explicit in the text of a federal statute. In addition, a state law may be preempted when it conflicts with or frustrates the purpose of a federal statute. The latter type of preemption is known as “conflict preemption.”

Section 903 of the Bankruptcy Code provides, in pertinent part, that a “State law prescribing a method of composition of indebtedness by such municipality may not bind any creditor that does not consent to such composition.”3 Under the Bankruptcy Code, Puerto Rico is a “State,” except for the purposes of who may be a chapter 9 debtor. However, section 903 does not, on its face, apply only to chapter 9 debtors. Further, unlike other provisions in chapter 9, section 903 applies broadly to the term “municipalities,” which would include public agencies like PREPA. The court also found that the Recovery Act was a “method of composition” because the law permits the adjustment and discharge of debts. Accordingly, the court concluded that the Recovery Act was preempted by section 903.

The court also found that the legislative history of section 903 evidenced Congress’s intent to preempt state municipal debt adjustment laws. Specifically, the House Report to section 903’s predecessor, section 83(i) of chapter IX, stated:

An amendment to section 83(i) provides that State legislation dealing with compositions of municipal indebtedness shall not be binding on non-consenting creditors. State adjustment acts have been held to be valid, but a bankruptcy law under which bondholders of a municipality are required to surrender or cancel their obligations should be uniform throughout the 48 States, as the bonds of almost every municipality are widely held. Only under a Federal law should a creditor be forced to accept such an adjustment without his consent.5

According to the court, the legislative history of section 903 evidenced a clear intent to reserve the power to adjust municipal debts for the federal government. The court concluded that the Recovery Act stood as an obstacle to section 903’s stated purpose to permit nonconsensual adjustments of municipal debt under a uniform federal law.

In so holding, the court rejected several of the Commonwealth’s defenses. First, the Commonwealth argued that section 903 could not apply to it because Puerto Rico’s municipalities are ineligible for chapter 9 relief. The court reasoned, however, that the plain language of the Bankruptcy Code only exempts Puerto Rico from the term “State” in one limited circumstance: chapter 9 eligibility. It does not, on its face, exempt Puerto Rico from the term State in all of chapter 9.

Second, the Commonwealth argued that it would be nonsensical to read the Bankruptcy Code as precluding Puerto Rican municipalities from filing for chapter 9 relief, but simultaneously preempting Puerto Rican laws that govern municipal debt adjustments. However, the court found:

“Congress’s decision not to permit Puerto Rico’s municipalities to be Chapter 9 debtors…reflects its considered judgment to retain control over any restructuring of municipal debt in Puerto Rico. Congress, of course, has the power to treat Puerto Rico differently than it treats the fifty states.”

Third, the Commonwealth contended that section 903 could only apply to states whose municipalities are eligible for chapter 9 relief. The court, though, found nothing in section 903’s text or legislative history to suggest that Congress intended section 903 to apply only to states whose municipalities are eligible to be chapter 9 debtors.

Finally, the court rejected the Commonwealth’s argument that section 903 could not apply because Puerto Rico’s bondholders could not qualify as “creditors,” as such term is defined in the Bankruptcy Code. Specifically, the Commonwealth maintained that the term “creditor” is limited to those who hold claims against a “debtor.” Because the Commonwealth’s public agencies cannot be chapter 9 debtors, the Commonwealth reasoned that section 903 could not apply because the Commonwealth’s bondholders are not “creditors.” However, the court found that the Commonwealth’s interpretation was strained and that nothing in the Bankruptcy Code’s definition of “creditor” suggested that the term was limited to claims against a debtor that is eligible for bankruptcy relief.

The court ultimately concluded that this was “not a close case,” even though federal preemption is a “strong medicine.” According to the court, section 903 of the Bankruptcy Code and its legislative history “provide direct evidence of Congress’s clear and manifest purpose to preempt state laws that prescribe a method of composition of municipal indebtedness that binds nonconsenting creditors…and to include Puerto Rico laws in this preempted arena.” Accordingly, having found that the Recovery Act is expressly preempted by section 903 of the Bankruptcy Code, the Court held that the Recovery Act is unconstitutional under the Supremacy Clause.

2. The Contracts Clause

The Contracts Clause of the U.S. Constitution prohibits states from impairing their own contracts. To validly state a claim under the Contracts Clause, a plaintiff must demonstrate that (i) the state law operates as a “substantial impairment” of a contractual relationship and (ii) that such impairment is not a reasonable or necessary means to serve an important government interest.

First, the court found that the plaintiffs adequately alleged that the Recovery Act substantially impaired contractual relations. Both the PREPA Trust Agreement and the PREPA Enabling Act created a contractual relationship between PREPA, its bondholders, and the Commonwealth. The plaintiffs alleged that the Recovery Act substantially impaired that contractual relationship by (i) permitting PREPA to modify its debts without creditor consent in a manner that is inconsistent with the PREPA Trust Agreement; (ii) permitting PREPA to grant priming liens on prepetition collateral, notwithstanding prohibitions on such liens in the PREPA Trust Agreement; (iii) permitting PREPA to sell its assets with court approval; (iv) rendering the PREPA Trust Agreement’s ipso facto clause unenforceable; (v) limiting PREPA bondholders’ rights to enforce Trust Agreement remedies during a Chapter 2 or 3 proceeding; and (vi) eliminating the PREPA bondholders’ right to seek the appointment of a receiver.

The court found that Faitoute Iron & Steel Co. v. Asbury Park,6 the principal authority relied on by the Commonwealth, was misplaced. In Asbury Park, the New Jersey statute barred the reduction of principal, affected only unsecured bonds that had no real remedy, and only provided for an extension of the maturity on the bonds and a reduction in the coupon. In contrast, the Recovery Act affects secured bonds that have meaningful remedies, permits the reduction in principal amount on those bonds, and permits modifications to debt obligations that extend beyond the amendments in Asbury Park.

Likewise, the court rejected the Commonwealth’s argument that it would be difficult at this juncture to determine whether any contractual relationships are substantially impaired as a result of the Recovery Act. According to the Commonwealth, one cannot make such a determination until a restructuring occurs under the Recovery Act. The court found this argument unpersuasive. Rather, the court held that when a state law authorizes a party to do something that a contract prohibits it from doing, or when a state law prohibits a party from exercising rights or remedies under a contract, the state law itself impairs the contractual relationship, independent of how a party acts pursuant to that law.

The court further found that the right to receive payment and certain covenants and remedies under the Trust Agreement likely induced bondholders to purchase PREPA’s bonds. In particular, the court noted that the Recovery Act did not merely modify existing rights and replace them with comparable security provisions, but rather “it completely extinguishes all of them.” Because the Recovery Act eliminated such rights, covenants, and remedies that are central to the Trust Agreement, the court concluded that the plaintiffs adequately alleged that the Recovery Act substantially impairs a contractual relationship.

Second, the court held that the plaintiffs adequately alleged that the Recovery Act was not a reasonable and necessary means to serve an important government purpose. Alternatives to the Recovery Act, identified by the plaintiffs included: (i) PREPA could raise its rates; (ii) PREPA could collect overdue accounts from the Commonwealth and other public agencies; (iii) PREPA could reform the manner in which municipalities are charged and eliminate subsidies; (iv) PREPA could correct inefficiencies with its management; and (v) PREPA could negotiate with its creditors to restructure its debts in a consensual manner. The court inferred from these allegations that the Recovery Act imposed a drastic impairment when more moderate courses were available. Thus, the court concluded that the plaintiffs adequately stated a claim under the Contracts Clause and therefore denied the Commonwealth’s motion to dismiss.

3. The Takings Clause

The Takings Clause of the U.S. Constitution provides that private property may not be taken for public use without just compensation. Here, the plaintiffs claimed that the Recovery Act violates the Takings Clause because (i) it eliminates plaintiffs’ right to appoint a receiver and (ii) permits public corporations to grant priming liens.

The court determined that plaintiffs stated plausible claims that the Recovery Act’s elimination of plaintiffs’ right to appoint a receiver violated the Takings Clause. According to the court, the Recovery Act provides no compensation for eliminating bondholders’ contractual rights, and therefore, may qualify as an impermissible taking. Furthermore, the court concluded that the plaintiffs’ claims based on the elimination of the receiver remedy are facial takings claims, and therefore are ripe for review.

The court rejected the Commonwealth’s defenses. For example, the Commonwealth argued that the receivership remedy did not even exist because PREPA had not yet defaulted on its obligations. Thus, the Commonwealth argued, there was no contractual right for the Commonwealth to take. However, the court found that even though the right to appoint a receiver is contingent on a default, the right nevertheless currently existed under terms of PREPA Enabling Act and PREPA Trust Agreement.

By contrast, the court concluded that plaintiffs’ claims that the Recovery Act constitutes a taking on plaintiffs’ liens on PREPA’s revenues were not ripe for review, because the claims were “as applied” claims that were contingent on events that not yet occurred (i.e., a Commonwealth court’s approval of the priming lien pursuant to section 322 of the Recovery Act).

Conclusion

The decision in Franklin California Tax-Free Trust v. Commonwealth of Puerto Rico is significant because it reaffirms the principle that only the federal government may pass bankruptcy laws. The decision also clarifies that Puerto Rico remains subject to Congress’s plenary powers. Where, as in the case of Puerto Rico, a state passes a law that allows states or municipalities to adjust and discharge debts, that law would likely be unconstitutional and preempted by section 903 of the Bankruptcy Code.

Footnotes

1 The full names of these public corporations are: the Puerto Rico Electric Power Authority, the Puerto Rico Highways and Transportation Authority, and the Puerto Rico Aqueduct and Sewer Authority.

2 Civ. Nos. 14-1518 and 14-1569 (ECF No. 119), available at http://cases.justia.com/federal/district-courts/puerto-rico/prdce/3:2014cv01518/111423/119/0.pdf?ts=1423304308

3 11 U.S.C.§ 903(1).

4 11 U.S.C. § 101(52).

5 H.R. Rep. No. 2246, 79th Cong., 2d Sess. 4 (1946) (emphasis added).

6 316 U.S. 502 (1942)

February 10 2015

Article by Thomas Curtin, Mark C. Ellenberg, Howard R. Hawkins, Jr., Ivan Loncar and Lary Stromfeld

Cadwalader, Wickersham & Taft LLP

(Reuters) – Lawmakers in financially strapped Illinois have introduced a bill that would make it easier for the state’s many struggling local governments to file for Chapter 9 bankruptcy, and they have support from the newly elected governor.

Bill co-sponsor Representative Joe Sosnowski said municipalities should have more options for repairing their finances, including seeking protection from creditors without the state’s approval as currently required.

“You don’t want to make it too easy and you don’t want to make it near impossible,” the Republican from Rockford said. “The problem now is it’s near impossible.”

House Bill 298, now before the House rules committee, proposes that “any municipality may file a petition and exercise powers pursuant to applicable federal bankruptcy law.”

Governor Bruce Rauner, who entered office in January, is lending his support. He is “committed to turning around Illinois – that includes providing relief to communities that are struggling,” his office said in an email to Reuters.

Illinois has the lowest credit rating of any state, and the bill may shield the state from the financial woes of local governments by allowing them to file for bankruptcy.

“I believe municipalities are going to be left more and more to their own devices,” said Republican Rep. Ron Sandack of Downers Grove, the bill’s sponsor. “We ought to give them all of the financial tools they can have to handle their own affairs.”

Local governments in Illinois, with the exception of the Illinois Power Agency, currently may not voluntarily petition for Chapter 9 protection without specific authority from the state. Supporters of HB 298 describe that process as convoluted.

Karol Denniston, a partner at Squire Patton Boggs, cautioned that Illinois should also look to follow the example of states with programs for intervening when local finances fall on hard times to help avert bankruptcy filings.

“How do you make sure the process isn’t chaotic?” said Denniston, who helped draft rules for guiding Chapter 9 filings in California. “If you’re going to say, ‘Have at it,’ impose some oversight and discipline.”
Michigan appoints emergency managers with the power to restructure finances and modify and renegotiate contracts for local governments. They may also file Chapter 9 petitions, with the governor’s approval, as Detroit did due to its overwhelming financial problems.
Some see House Bill 298 being more about giving local officials leverage in labor talks over pensions after judges in the bankruptcy cases of Stockton, California, and Detroit said pensions may be impaired in Chapter 9.

“Chapter 9 gives you the negotiating benefit of saying ‘we want to make these changes – or else,'” said municipal bankruptcy expert James Spiotto of Chapman Strategic Advisors.

Jim Christie

REUTERS LEGAL
Copyright © 2015 Thomson Reuters
February 13, 2015

In this segment of Extra Credit, Senior Director David Bodek discusses the credit implications for public power and cooperative utilities with stakes in delayed nuclear plants, and Associate Li Yang explains what’s behind our recent rating action on Kern County.

Listen to the Podcast.

Feb 12, 2015

The Obama administration’s proposed 2016 budget, released on February 2, 2015, reflects the administration’s commitment to finding ways to finance the country’s growing infrastructure requirements. The 2016 budget includes many of the tax-exempt bond proposals previously introduced in the administration’s 2014 and 2015 budgets, as well as four new bond proposals.

Highlighted below are the new bond proposals:

Provide a New Category of Qualified Private Activity Bonds for Infrastructure Projects –Qualified Public Infrastructure Bonds

The administration proposes a new category of tax-exempt qualified private activity bonds called Qualified Public Infrastructure Bonds (QPIBs) that are eligible to finance specific categories of facilities financed with exempt facility bonds under current law. A significant aspect of this proposal is that, unlike other categories of qualified private activity bonds (PABs), QPIBs are not subject to the bond volume cap requirement and the alternative minimum tax (AMT) preference for interest on qualified PABs. For years, advocates of qualified PABs have requested that bonds not be subject to AMT, thereby putting them on the same footing as governmental bonds. Also, proponents of qualified PABs have argued that the volume cap requirement hinders the use of these bonds for larger projects such as sewage and water facilities. The QPIB proposal addresses both concerns.

Facilities eligible for QPIB financing include airports, docks and wharves, mass commuting facilities, facilities for the furnishing of water, sewage facilities, solid waste disposal facilities, and qualified highway or surface freight transfer facilities. The proposal imposes two core eligibility requirements for QPIBs: a governmental ownership requirement and a public use requirement. The proposal provides a safe harbor for establishing governmental ownership of financed projects so that property leased by a governmental unit is treated as owned by the governmental unit if the lessee makes an irrevocable election (binding on the lessee and all successors in interest under the lease) not to claim depreciation or an investment credit related to such property, the lease term is not more than 80 percent of the reasonably expected economic life, and the lessee has no option to purchase the property other than at fair market value (at the time the option is exercised).

Existing categories of exempt facilities that overlap with QPIBs would be removed on the effective date of the proposal (which applies to bonds issued starting January 1, 2016), subject to a transitional exception for qualified highway or surface freight transfer facilities. Alternatively, the proposal provides that Congress consider continuing the existing categories of exempt facilities that overlap with QPIBs for privately owned projects, subject to the unified annual state bond volume cap.

Qualified highway or surface freight transfer facilities are eligible for QPIBs at the same time as other eligible facilities when QPIBs become available and the existing category of exempt facility bonds also continues to be available until the Secretary of Transportation has allocated the existing $15 billion of authorization (and the additional $4 billion proposed by the administration in one of its other proposals).

Modify Qualified Private Activity Bonds for Public Educational Facilities

Under existing law, tax-exempt private activity bonds may be issued for “qualified public educational facilities” under section 142(k) that are part of public elementary or secondary schools. The current rules require that a private corporation own the public school facilities under a public-private partnership agreement with a public state or local educational agency and that the private corporation transfer the ownership of the school facilities to the public agency at the end of the term of the bonds for no additional consideration. A special separate annual volume cap (equal to $10 multiplied by the state’s population or $5 million, whichever is greater) applies to these bonds.

The proposal eliminates the private corporation ownership requirement and allows any private person, including private entities organized in ways other than as corporations (such as partnerships, limited liability companies, or sole proprietors) either to own the public school facilities or to operate those school facilities through a lease, concession, or other operating agreement. The aim of the proposal is to encourage use of these types of bonds. To date, no bonds have been issued under this category because of the constraint that only private corporations may own the school facilities. The proposal goes one step further by removing the separate volume cap for qualified public educational facilities and instead including these facilities under the unified annual state bond volume cap for private activity bonds. The proposal is effective for bonds issued after the date of enactment.

Modify Treatment of Banks Investing in Tax-Exempt Bonds

For tax-exempt bonds issued in 2009 and 2010, the American Recovery and Reinvestment Act of 2009 (ARRA) established a temporary rule that lifted the total prohibition on deducting the interest expense allocable to tax-exempt bonds, which permitted the 80 percent deduction. Bonds that benefited from this rule could not exceed 2 percent of the taxpayer financial institution’s total assets. ARRA also modified the definition of “qualified small issuer” to allow up to $30 million of these bonds instead of the previously allowed $10 million. For 501(c)(3) bonds, the $30 million limit, unlike the pre-ARRA $10 million limit, applied at the borrower level rather than the issuer level. For conduit financings and composite or pooled issues where each borrower is a 501(c)(3), each borrower was treated as a separate issuer for the applicable qualified portion borrowed. The administration proposes to permanently expand the qualified small issuer limit in the definition of qualified tax-exempt obligations to include issuers of up to $30 million of tax-exempt bonds annually.

However, the proposal does not appear to expand the limit at the borrower level. During ARRA, increasing the $10 million limit to $30 million proved to be a very successful way to expand the tax-exempt market. The proposal aims to capture the same benefits of that time period on a long-term basis. Beginning with bonds issued in 2016, the proposal permanently implements the ARRA exception that allowed financial institutions to deduct up to 80 percent of interest expenses allocable to any tax-exempt bonds. This exception would continue to be limited to 2 percent of the taxpayer’s assets.

Repeal Tax-Exempt Bond Financing of Professional Sports Facilities

Currently, professional sports stadiums can be financed with tax-exempt governmental bonds, even if use by a professional sports team of a bond financed facility exceeds 10 percent of the facility’s total use, if the debt service is paid from sources other than sports facility revenues or other private payments, such as generally applicable taxes.

For years, there have been public debates (including congressional hearings) on whether sports facilities should be financed with tax-exempt bonds. Opponents argue that tax-exempt bond financing should not be used to benefit private sport team owners but should be available to construct a sports facility for the team. The administration’s proposal eliminates the private payment test for professional sports facilities so that bonds issued to finance these facilities would have to be taxable bonds if more than 10 percent of the facility is used for private business. The proposal is effective for bonds issued after December 31, 2015.

28 Percent Cap and other Prior Years’ Proposals Included

While the administration continues to show strong support for encouraging the financing of infrastructure projects, the 2016 budget includes the proposal from the prior years’ budgets to limit the tax rate where upper-income taxpayers can use itemized deductions and other tax preferences, including interest on tax-exempt bonds to reduce the tax liability to a maximum of 28 percent. This limitation would reduce the value of the specified exclusions and deductions that would otherwise reduce taxable income in the top three individual tax rate brackets of 33 percent, 35 percent, and 39.6 percent to 28 percent.

For the last few years, opponents have strenuously argued that the 28 percent cap proposal would severely limit investor appetite for tax-exempt bonds and should be eliminated. In response, the administration has noted that the proposal should not be viewed as a direct attack on tax-exempt bonds but rather as part of a broader reform of tax expenditures.

Other proposals carried over from the administration’s 2014 and 2015 budgets are the America Fast Forward Bond proposal (a broader category of taxable bonds similar to Build America Bonds at a 28 percent subsidy rate), as well as proposals to:

• Allow current refundings of state and local governmental bonds
• Repeal the $150 million non-hospital bond limitation on qualified section 501(c)(3) bonds
• Increase the national limitation amount for qualified highway of surface freight transfer facility bonds
• Allow more flexible research agreements for purposes of private business use limits
• Modify tax-exempt bonds for Indian tribal governments
• Simplify arbitrage investment restrictions and single-family housing mortgage bond targeting requirements
• Streamline private business limits on governmental bonds

by Vicky Tsilas, Linda B. Schakel, Brian Walsh, and Steve T. Park

February 6, 2015

Attorneys in Ballard Spahr’s Public Finance Department have participated in every kind of private activity financing, including exempt facility bonds, qualified 501(c)(3) bonds, and exempt facility bonds.

For more information, please contact Vicky Tsilas at 202.661.2283 or [email protected], Linda B. Schakel at 202.661.2228 or [email protected], Brian Walsh at 215.864.8510 or [email protected], or Steve T. Park at 215.864.8533 or [email protected].

Copyright © 2015 by Ballard Spahr LLP.
www.ballardspahr.com
(No claim to original U.S. government material.)

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, including electronic, mechanical, photocopying, recording, or otherwise, without prior written permission of the author and publisher.

This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.

Read the Brief.

Municipal Market Advisors | Feb. 10

NEW YORK (Standard & Poor’s) Feb. 12, 2015–In a report released today, Standard & Poor’s Ratings Services said it expects generally stable credit quality in 2015 for most U.S. airports it rates, with large-hub airports in a stronger position. With U.S. air travel demand gradually improving, although not uniformly across all airports, following the Great Recession and numerous airline mergers, the U.S. airport sector’s median financial and operational metrics have continued to recover gradually (according to 2013 data).

Enplanements, or the number of passengers boarding a plane, increased in 2013 for more than half the airports we rate, although only a third reached levels exceeding those of 2007. To address a loss in traffic or added uncertainty management teams are taking steps to shore up their finances, such as raising rates, building cash by enhancing non-airline revenues, and deferring demand-driven and maintenance capital projects. Some are also renegotiating agreements with airlines and concessionaires, funding projects from other revenue streams, paying down their debt, and limiting increases to operating expenses and reducing debt service expense from refunding bonds to take advantage of low interest rates.

“We believe these measures have enabled airports to maintain steady financial performance despite experiencing lower traffic levels,” said Standard & Poor’s credit analyst Joseph Pezzimenti in the report, entitled “2015 U.S. Airport Medians Report: Proactive Management Actions And Improving Demand Should Allow
Most Airports To Maintain Credit Quality.”

Although the majority our airport credits has a stable outlook, we believe the future could hold some risks for airports’ financial metrics. All airports are susceptible to the effects of airlines’ service decisions and pricing strategies, the integration of consolidated airlines, limited or unpredictable federal support for capital projects, weaker-than-expected economies, and increases in fuel prices. “All of these could lead to lower or less predictable demand and strain financial flexibility for some, especially those with high or increasing debt burdens or lower liquidity after funding necessary capital improvements,” Mr. Pezzimenti added.

Under Standard & Poor’s policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its subject matter have not been the subject of Rating Committee action and should not be interpreted as a change to, or affirmation of, a Credit Rating or Rating Outlook.

The report is available to subscribers of RatingsDirect at www.globalcreditportal.com and at www.spcapitaliq.com. If you are not a RatingsDirect subscriber, you may purchase a copy of the report by calling (1) 212-438-7280 or sending an e-mail to [email protected]. Ratings information can also be found on Standard & Poor’s public Web site by using the Ratings search box located in the left column at www.standardandpoors.com. Members of the media may request a copy of this report by contacting the media representative provided.

Primary Credit Analyst: Joseph J Pezzimenti, New York (1) 212-438-2038;
[email protected]

Media Contact: Olayinka Fadahunsi, New York (1) 212-438-5095;
[email protected]

Taylor Riggs, an editor at Bloomberg Brief, talks with Joe Mysak about this week’s municipal market news.

View the video.

(Bloomberg) — New Yorkers are living longer, which is good news for the state’s 19.7 million residents. For Governor Andrew Cuomo, it’s triggering a budget headache.

The fiscal strain emerged in September, when Comptroller Thomas DiNapoli factored in longer life expectancies for retirees in the third-largest U.S. public plan, as actuaries estimated that pensioners would be around at least an extra two years. The longer lives raised the $176.8 billion fund’s liability, boosting the 2016 pension bill to $355 million more than Cuomo had projected.

The added cost has Cuomo, a second-term Democrat, tapping a program allowing the state and its municipalities to borrow part of their annual pension bill from the fund with interest. Since 2011, Cuomo has used the tool to defer about $3.2 billion in payments. While he’d planned to exit the program in 2016, the budget he introduced last month includes borrowing $395 million for that year.

“Amortization takes volatility out of the state’s pension contribution costs and helps us maintain stability,” Morris Peters, a spokesman for Cuomo’s budget division, said via e-mail.

Swelling Liability

Since Cuomo took office in 2011, he’s closed more than $12 billion in budget gaps, capped annual spending growth at 2 percent and won the state’s first four consecutive on-time budgets since 1977. The moves spurred Standard & Poor’s to award the state a AA+ mark in July, its highest since 1972. Yet the company also said the pension borrowing is swelling the state’s unfunded retirement liability.

Most municipalities are dealing with similar fiscal strains. U.S. state and local retirement plans are short at least $1.3 trillion because of investment losses triggered by the recession that ended in 2009 and insufficient contributions, according to Federal Reserve data.

To help public and corporate pensions estimate costs, the Society of Actuaries last year released a new scale that predicts the rate at which life expectancy will increase over decades. As the method is adopted, liabilities will rise by a range of 4 percent to 8 percent, said Dale Hall, the Schaumburg, Illinois-based group’s managing director of research. The society is the largest group of financial-risk assessors.

Corporate Takeover

Investors in companies such as AT&T Inc. and Northrop Grumman Corp. have gotten a glimpse of the fallout from aging societies as they incorporated new life-expectancy estimates. Companies including Motorola Solutions Inc. are paying insurers to take over their plans to avoid ballooning costs from years of additional pension checks.

In New York, investment losses led annual contribution rates to almost triple from 2010 to 2014 for state and local workers. The 2010 law allowing the payment deferments was designed to smooth out the jump by spreading it over a decade.

While only seven states had stronger pensions than New York as of 2013, its funding ratio isn’t as robust as it once was. The fourth-most-populous state had 87.3 percent of assets to meet obligations, down from 105.9 percent in 2008, data compiled by Bloomberg show. The median was about 69 percent in 2013.

Extra Years

The society’s new mortality scale was its first revamp in 15 years. From 2000 to 2014, the life expectancy for 65-year-old American men rose 2 years to 86.6, while for women it climbed 2.4 years to 88.8, according to the society.

Before adopting the new scale, New York had been using the version released by the society in 2000.
“Mortality rates have been improving faster than the last study predicted,” said Bill Hallmark, who leads the public plans subcommittee for the Washington-based American Academy of Actuaries, which consults for policy makers.

Based on advice from the state actuary to adopt the new scale, DiNapoli set the contribution rate for state and local workers for fiscal 2016, which starts April 1, at 18.2 percent of payroll. The Cuomo administration was expecting 14.2 percent, according to budget documents. The difference raised the fiscal 2016 pension bill by about $355 million, to about $2.2 billion.

DiNapoli, the sole trustee of New York’s retirement fund, didn’t see many options, said Thomas Nitido, deputy comptroller for the New York State and Local Retirement System.

“We were mindful that this had an impact on rates, but anything we don’t pay now will only increase costs in the future,” he said.

While the deferments hurt New York’s credit profile, the approach is preferable to forgoing payments, said Marcia Van Wagner, an analyst at New York-based Moody’s Investors Service.

“Many states, as a matter of routine, do not pay their full actuarially designated contribution and they don’t have a formal payback program,” she said by phone. “We don’t see it as weakening New York substantially relative to its peers.”

Bloomberg Muni Credit

by Freeman Klopott

February 12, 2015

To contact the reporter on this story: Freeman Klopott in Albany at [email protected]

To contact the editors responsible for this story: Stephen Merelman at [email protected] Mark Tannenbaum, Mark Schoifet

New York, February 09, 2015 — The State of Texas (Aaa stable) and its local governments will encounter difficult budget decisions during the remainder of this fiscal year and the next biennium owing to lower oil prices, Moody’s Investors Service says in a new report “Tough State and Local Government Budget Decisions Ahead as Oil Sector Slows.”

Despite having a robust and diverse economy, output and revenue growth will slow due to the steep price drop in oil. Budgetary priorities will therefore vie against lower revenues amid the slowdown.

“The state comptroller expects tax revenue growth to slow considerably and for growth to remain low during the next few years,” said Moody’s Vice President — Senior Credit Officer Nicholas Samuels. “The price drop is occurring while Texas considers how to spend more on schools, increase transportation funding, bolster its pensions and a political desire to cut taxes,”

The Texas general fund budget is not as directly exposed to oil and gas severance taxes as other states.

Oil and gas taxes comprise 11.2% of Texas’ general revenue fund, compared with sales tax, which constitutes 53% of general revenue. While state revenue growth will slow in the next few years, because of the drag of lower oil prices, the lower oil prices could also boost consumer sentiment and buying power, which could positively impact sales tax receipts.

Economic and budgetary impact from lower oil prices will vary regionally. Houston (Aa2 stable) and Harris County (Aaa stable) are the most vulnerable to the downturn because of the high concentration of energy-related employment. Houston has 4.7% of its employment tied to the sector and 10 of Harris County’s top 11 employers are oil- and natural gas-related.

These localities are regarded as the “world’s oil and gas capital,” Moody’s Assistant Vice President — Analyst Adebola Kushimo says in a new report, “Harris County and Houston’s Economies Poised to Slow Due to Declining Oil Prices.” Kushimo says the region’s employment is heavily tied to the sector and until oil prices stabilize, job losses will lead to declines in sales tax revenues.

Austin (Aaa stable), Dallas (Aa1 stable) and San Antonio (Aaa negative) are less susceptible to oil price fluctuations since their respective economies are more diverse with technology, transportation, and healthcare among their key employment components. Outside of large metro areas, some regions where oil production is concentrated will slow and see significant contraction, such as Midland (Aa1) and Odessa (Aa2).

In addition, the local economies of some Texas Independent School Districts (ISDs) will be affected by a significant and prolonged oil price decline, which could affect some ISDs’ abilities to make timely or complete debt service payments. In a new report, “Fund Exposed to Oil Slowdown but Retains Strong Ability to Cover Calls on Guarantee,” Moody’s Analyst John Nichols says the Texas Permanent School Fund (Aaa stable) is fundamentally sound despite its exposure to ISDs in high oil-producing areas.

However, downside risk would outweigh upside potential for Texas and its major metro areas if oil prices remain below $50 per barrel for a prolonged period, particularly in the current fiscal year. Greater job losses would constrain the state’s revenue forecast, resulting in budget cuts felt at local levels.

Subscribers can access the report at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBM_1002523.

Fitch Ratings-New York-11 February 2015: A recent appellate court ruling could lead to increased financial pressure for California cities that transfer revenue from electricity utilities to general operating funds, Fitch Ratings says. We believe this decision could lead to similar lawsuits in other locations.

The court ruled that the city of Redding’s electric system payments in lieu of taxes (PILOTs) constitute a tax and, therefore, require two-thirds voter approval to remain in place. If the decision from this court stands or if the case is upheld by the state Supreme Court, it would remove an important income stream from the city of Redding’s general fund. In fiscal 2014, the electric fund PILOT accounted for 7.8% of general fund revenues and transfers in. Electric system transfers account for a significant amount of general fund inflows in a number of other California, cities including Glendale, Lodi, Los Angeles, Pasadena and Riverside. Fitch believes a trend of similar legal actions could become a rating sensitivity in the coming years for those cities.

The appellate court decision would require two-thirds voter approval under Proposition 26 for the PILOTs to remain in place unless Redding can demonstrate that the transfers recover costs associated with providing electric service.

Momentum to limit utility transfers for general government purposes has been building for decades. Proposition 218 (passed in 1996) required new fees or taxes levied by local governments to receive two-thirds voter approval but excluded electric and gas rates. Proposition 218 and a subsequent ruling by the California Supreme Court in 2006 (Bighorn Desert-View Water Agency v. Verjil) successfully limited utility transfers not related to cost recovery. Proposition 26, passed in 2010, more broadly defines taxes with fewer exclusions.

Contact:

Matthew Reilly
Director
U.S. Public Finance, Tax Supported
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(Reuters) – The federal judge who oversaw Detroit’s historic bankruptcy case ruled on Thursday that the nearly $178 million charged to the city by law firms and consultants for fees and expenses was reasonable.

U.S. Bankruptcy Court Judge Steven Rhodes said he based his decision mainly on the complexity of the bankruptcy case filed in July 2013 as well as substantial reductions that the firms agreed to make in their bills.

“The city is now on a path to success precisely because of the expertise, skill, commitment, endurance, personal sacrifice, civility and proficiency of all of the professionals in the case, including most certainly those whose fees are subject to review in this opinion,” the judge wrote.

The biggest bill in the biggest-ever U.S. municipal bankruptcy came from law firm Jones Day, which had employed Kevyn Orr before he was tapped by Michigan Governor Rick Snyder as Detroit’s emergency manager in March 2013. For its role as the city’s lead attorney in the case, Jones Day charged $57.9 million. It shaved about $17.7 million off its fees and expenses, according to the judge’s order.

Financial advisory firm Miller Buckfire dropped its fee for work on the city’s debt restructuring to $22 million from $29.1 million, the order added. Fees from dozens of other firms covered legal, actuarial, consulting and art appraisal services, as well as mediation and court-appointed experts.

Detroit exited bankruptcy on Dec. 10 with a court-approved plan to shed about $7 billion of its $18 billion of debt and obligations.

Rhodes said that the case involved numerous parties and drafts of the debt adjustment plan, a myriad of legal and factual issues, appeals and court-ordered mediation. His order noted that actual fees and expenses totaled $183.2 million and that amount was reduced to $178 million after the state of Michigan covered $5.29 million of the costs.

By REUTERS

FEB. 12, 2015

(Reporting by Karen Pierog; Editing by G Crosse and Jonathan Oatis)

Detroit’s historic trip through Bankruptcy Court ended in December 2014 with the confirmation of the City’s Plan of Adjustment, which trimmed $7 billion in debt from the city’s balance sheet and promised improved resident services. At the beginning of the case, no one predicted that the city would emerge from bankruptcy so quickly — only about 18 months — or that the final Plan of Adjustment would enjoy such widespread support among creditors and politicians. What can we learn from the largest municipal bankruptcy ever?

1. Not all municipalities can take advantage of Chapter 9. Detroit’s very first battle after it filed for bankruptcy was whether it was even eligible to do so. This dispute underscored a little known fact: Most U.S. municipalities are unable to file for Chapter 9 bankruptcy. A Chapter 9 filing must be “specifically authorized” by the law of the state where the city is located. So, in the case of municipal bankruptcies, the states themselves control access to the bankruptcy courts. About one-half of the states do not say anything at all about Chapter 9, so the municipalities in those states lack the “specific authority” to file bankruptcy. Other states, such as Michigan, have very rigorous prerequisites that must be satisfied before filing. Missouri law specifically permits most municipalities to file Chapter 9. Incidentally, the term “municipality” is much broader than “city.” Other political subdivisions, such as water, school or levy districts, are also included within the definition of “municipality.” States cannot themselves file bankruptcy, so Illinois will have to find another way to solve its financial problems. Even if a municipality can file bankruptcy, however, there is another very important threshold question.

2. Can public pension obligations be modified in Chapter 9 cases? Private industry long ago mostly moved from defined benefit pension plans to defined contribution plans. But defined benefit plans are still popular for government employees, including many municipal employees. Many states, including Michigan, have special protections for public pensions in their statutes or even their state constitutions. For instance, Michigan’s state constitution says: “The accrued financial benefits of each pension plan and retirement system of the state and its political subdivisions shall be a contractual obligation thereof which shall not be diminished or impaired thereby.” Therefore, when Detroit filed its case, there was a legitimate question about whether the public pensions could be modified in the Chapter 9 case.

Michigan’s Attorney General argued that Michigan’s constitution absolutely prohibited any restructuring of vested pension benefits. Not surprisingly, various retiree groups also opposed the city’s efforts to reduce pension benefits. The bankruptcy judge ultimately determined, however, that pension benefits were not entitled to any more protections than any other contractual benefits and permitted Detroit to propose a plan that reduced vested benefits. The judge in the Stockton, California, Chapter 9 case ruled the same way a few months later. Public retirees can no longer assume that their vested benefits are sacrosanct. A definitive trend is developing in the law that a federal bankruptcy court can modify those kinds of benefits, even though state or local law suggests that they cannot be modified.

3. Bondholders and pensioners vs. residents. The Detroit case was mind-numbingly complex; one observer called it the Olympics of Restructuring. But in its simplest terms, the case was all about balancing the interests of three groups:

• Bondholders who held billions of dollars of debt issued by Detroit or its city agencies and for whom the prospect of a massive municipal default was utterly unthinkable.
• Retirees who had worked for the city for decades at below-market wages but who looked forward to a stable pension in their retirement.
• And the city’s residents, who had seen city services deteriorate to a level not often seen in this country; indeed, one Forbes columnist called Detroit “America’s first Third World city.”

Each of the three groups had strong legal and equitable arguments that they claimed should be favored at the expense of the others. The bondholders argued that the entire municipal finance market was predicated on a municipality’s solemn promise to pay the bonds, no matter what, and that the cost of municipal credit would increase all across the country if Detroit were permitted to default. The retirees argued that their pensions were not overly generous (the pensions generally ranged from $1,500 to $3,000 per month) and pointed out that many of the former employees were ineligible for Social Security because they did not have sufficient service time in the private sector. The residents pointed to Detroit’s dramatic population decline, from 1.8 million in 1950 to less than 700,000 in 2013, as evidence that its residents were “voting with their feet” by leaving the City whenever they were able.

Of course, there were also many differences within the three major groups. Some of the bonds (but not all) were insured by large insurance companies, but the exposure of the bond insurers was so large that their own existence was threatened if they had to pay out. Some bonds were secured by income streams from specific projects, but others were not. Even the pension obligations were complicated. The police and firefighters had a separate pension plan from the other retirees, and it was in considerably better financial shape than the general plan. Moreover, the former city employees were entitled to other post-employment benefits (called “OPEB” in pension parlance) in the form of health and life insurance benefits that were not pre-funded at all. When everything was totaled up, Detroit had a staggering $18 billion or so in liabilities.

4. It really helps to own a $1 billion art collection.  Along with its 78,000 abandoned buildings and 70 Superfund sites, Detroit also happened to own a world class art collection that included Van Gogh’s “Self-Portrait,” Rembrandt’s “The Visitation,” and Matisse’s “The Window.” Detroit’s involvement in the art world dated back to 1919, when the City bailed out its then-bankrupt local art. In the 1920s, when Detroit was riding particularly high, the museum went on a buying spree and accumulated a collection that was the envy of museums in much larger cities. By 2013 when Detroit filed Chapter 9, the art collection was probably the city’s most valuable asset, and the bondholders and retirees, who could agree on almost nothing else, both argued that it would be unfair for Detroit to keep its valuable artwork while asking for creditors to take deep discounts. After months of legal wrangling and public sniping, with estimates of the art collection’s value ranging from $350 million to $2 billion, the parties reached the so-called “Grand Bargain.”

This agreement, forged in dozens of court-ordered mediation sessions, formed the cornerstone of Detroit’s bankruptcy plan. The deal called for the transfer of the art collection to a charitable trust in exchange for $816 million contributed from the State of Michigan, private donors, and several large charitable foundations, including the Ford Foundation, which donated $125 million itself. The retirees had to agree to accept relatively modest reductions in their monthly pensions (less than 5%) but future cost of living adjustments were eliminated. Also, almost all of the other post-employment benefits, such as retiree health care and life insurance, were slashed or eliminated.

5. Retirees fared much better than bondholders.  The consensus is that the retirees fared much better than the bondholders in Detroit’s case, and that the disparity in treatment was as more because of political concerns than legal distinctions. For instance, the funders of the Grand Bargain insisted that their contributions go toward shoring up the pension plans — not into the pockets of the bondholders. As the case progressed, the judge, the court-ordered mediators, and the other parties began clearly discounting the bondholders’ arguments that the entire U.S. municipal bond market would be harmed if Detroit did not pay back its bond debt in full. The city reached agreements with its other creditor groups before turning its attention to the bondholders (or more precisely, the companies that insured the bonds against a default). Faced with the prospect of being the only remaining major hold-out, the bondholders began a frantic round of last-minute deal making.

For instance, Detroit and Syncora (one of the largest bond insurers) reached a deal that will set the creativity bar very high for future settlements in other cases. Syncora just happened to own the company that operates the Detroit-Windsor tunnel, having acquired that company when it filed bankruptcy several years ago. The lease on the tunnel was set to expire in 2020. As part of its settlement with Syncora, the City of Detroit agreed to extend the tunnel lease through 2040, and to give a Syncora a long term lease on a city-owned parking lot, conditioned on Syncora’s commitment to make $13 million in improvements on the garage. The city also gave Syncora credits to purchase additional city-owned property in the future, including the old Joe Louis Arena. Similarly creative arrangements were reached with the other major bond insurer.

6. Not all bonds are alike.  The bondholders were treated very differently, depending on the types of bonds they held. Some of the bonds that were well secured by project revenues will actually receive payment in full. Other bonds, which were secured by little or no collateral, will receive as little as 15% of their claims. This result turned the municipal bond market on its head. Historically, the bond market has considered so-called “general obligation” bonds as the safest debt that a municipality can issue because the municipality can always raise taxes to make bond payments. Special revenue bonds, on the other hand, have historically been viewed as more risky because the bond payments could come only from the collateral securing them. In the Detroit case, however, “general obligation” bonds were considered unsecured claims that are typically among the last to receive any payment in a bankruptcy case. To-date, however, the gloom and doom predictions about the future of the municipal bond market have been unfounded.

7. Municipal reorganizations are expensive.  The total bill for Detroit’s bankruptcy professionals was around $170 million, or about $10 million per month. Jones Day, the city’s lead bankruptcy counsel, is set to collect over $51 million in fees, which it claims equates to about $17 million in discounts from its normal billing rates. Dentons, the lead bankruptcy counsel for the official retirees committee, made over $14 million. Dozens of other law firms and consultants also worked on the case. A law firm was even appointed to review and monitor the other professionals’ bills, and that firm has been paid over $500,000.

8. City services should improve.  Residents and visitors to Detroit have long endured abysmal city services. The average response time for a Detroit police call in 2013 was 58 minutes, compared to 11 minutes nationwide. Forty percent of the city’s street lights were burned out in 2013. As part of the bankruptcy restructuring, Detroit plans to spend $1.7 billion over 10 years in so-called reinvestment and restricting initiatives, including $400 million to demolish the 78,000 or so blighted or abandoned buildings, $91 million to replace police vehicles — more than half of which are over 10 years old — and $152 million in IT expenditures — about 80% of the city’s computers still run Windows XP.

Thankfully, Detroit is sui generis. No one expects a flood of municipal bankruptcies based on the relative success (at least insofar as we can tell at this point) of Detroit’s restructuring. Missouri’s large cities, however, are not immune from some of the same pressures and problems that contributed to Detroit’s financial melt-down.

2/11/2015

by David Warfield | Thompson Coburn LLP

(This article originally appeared in Missouri Lawyers Weekly.)

On January 22, 2015, New Jersey Governor Chris Christie issued Executive Order No. 171 through which he appointed an Emergency Manager for the City of Atlantic City. Drastic as this measure may seem, the Executive Order only grants the Emergency Manager the limited powers to analyze and assess Atlantic City’s financial condition, recommend a plan to the governor within 60 days, negotiate with affected parties and consult with all stakeholders. The Emergency Manager is not empowered to directly run the city or make any unilateral decisions regarding Atlantic City’s financial condition.

This alert outlines the powers granted to the Emergency Manager in the Executive Order, offers a brief summary of the statutes and other documents cited within and briefly discusses the pre-conditions necessary for a New Jersey municipal bankruptcy filing.

Emergency Manager Powers

The Executive Order grants the Emergency Manager the authority to perform three main tasks:

1. Analyze and assess the financial condition of Atlantic City;
2. Prepare and recommend, within 60 days of appointment, a plan to place the finances of Atlantic City in a stable condition on a long-term basis by any and all lawful means, including the restricting of municipal operations and the adjustment of the debts of Atlantic City pursuant to law; and
3. Negotiate with parties affected by the recommended plan for an adjustment of Atlantic City’s debts and the restructuring of its municipal operations and, in [the Emergency Manager’s] discretion, to recommend modifications of the plan as a result of such negotiations.

Executive Order No. 171 (January 22, 2015).

In support of these tasks, the Emergency Manager is granted wide discretion to consult with any and all parties necessary to secure the long-term financial stability of Atlantic City (i.e., the mayor and council of Atlantic City, creditors, representatives of bondholders, collective bargaining representatives, etc.). Id. And, the Emergency Manager is granted unlimited access to “all financial and other information, documents, and records of, or pertaining to Atlantic City.” Id.

The Executive Order does not grant the Emergency Manager the power to make any unilateral decisions, despite his significant authority to investigate and assess Atlantic City’s financial condition. Nor does the text of the Executive Order indicate that any power has been taken away from the mayor or city council. Thus, the mayor and city council remain in control of the city. The power to act on the Emergency Manager’s recommendations is expressly reserved in the Executive Order for Governor Christie. The specific language of the Executive Order makes this undeniable, stating, “[p]ending receipt of recommendations from the Emergency Manager, I reserve the right to take such additional actions, invoke such emergency powers and issue such emergency order or directives as may be necessary…” Id. Accordingly, the Emergency Manager is limited to assessing, recommending, negotiating and consulting.

The Emergency Manager’s powers should not be trivialized, even though they are less than the total control granted to the recent Detroit Emergency Manager. The Executive Order expressly permits the Emergency Manger to make any lawful recommendations he sees fit, no matter how drastic, in stabilizing Atlantic City’s finances. Id. This includes recommending the restructuring of municipal operations and the adjustments of the debts of Atlantic City. Id. Although they may just be recommendations for now, it is likely that some, if not all of them, will be implemented in the future.

Statutes and Documents Cited in the Executive Order

There are four main citations referenced in the Executive Order.

The Local Government Supervision Act, N.J.S.A. 52:27BB-54 et seq.
The act permits the state to appoint a Fiscal Control Officer to oversee and supervise the finances of a municipality in unsound financial condition, of which Atlantic City has been subject to since September 2010. Under this law, the Local Finance Board has the authority to approve all expenditures and any incurrence of debt.

Local Finance Board Resolution of September 10, 2014.
The Local Government Supervision Act requires the Local Finance Board to vote annually for the continuation of oversight and supervision of a city, otherwise the oversight automatically expires. This resolution was simply the most recent vote by the Local Finance Board extending its supervision over Atlantic City for another year.

Executive Order No. 11. Executive Order 11, issued February 3, 2010.
This Executive Order by Governor Christie created the New Jersey Gaming, Sports and Entertainment Advisory Commission. The Advisory Commission “is charged with developing recommendations for the governor for a comprehensive, statewide approach regarding the issues and financial needs of New Jersey’s gaming, professional sports and entertainment industries and making proposals for the implementation of its recommendations.” Exec. Order No. 11 (Feb. 3, 2010).

The Advisory Commission’s November 12, 2014, report.
Among a number of financial problems and recommended solutions, this report suggested that an Emergency Manager be appointed immediately with “extraordinary supervisory powers” under the act. The report also notes that to appoint an Emergency Manager, legislative action may be required to augment the existing statute.

Thus, no statute cited in the Executive Order specifically authorizes the appointment of an Emergency Manager.

Pre-Conditions to New Jersey Municipal Bankruptcy

While the Emergency Manager has said that it is too early to discuss bankruptcy, his background in restructurings and the appointment as his special counsel of the former bankruptcy lawyer who shepherded Detroit through its bankruptcy, has led to speculation that this alternative is clearly on the table. New Jersey municipalities cannot file for bankruptcy under the United States Bankruptcy Code without state approval. Section 109 of the code, titled, “Who may be a debtor,” provides that a municipality must be specifically authorized to be a debtor by state law. 11 U.S.C. § 109(c).

New Jersey state law requires the state Municipal Finance Commission to approve the filing of a petition, as well as any plan of readjustment, prior to a municipality filing a petition in bankruptcy court. N.J.S.A. 52:27-40.

A petition to file for bankruptcy must also be authorized by an ordinance of the governing body of the municipality. N.J.S.A. 52:27-41. The governing body must adopt this ordinance by an affirmative vote of not less than two-thirds of the governing body’s elected members. Id. After the ordinance is adopted, the municipality must submit the petition (and a plan of readjustment, if there is one) to the commission for approval. Ultimately, the commission possesses the discretion to approve any petition for bankruptcy or plan of readjustment. N.J.S.A. 52:27-43.

In the past 75+ years, only two New Jersey municipalities have even attempted to file for bankruptcy protection: the City of Asbury Park in 1936 and more recently the City of Camden in 1999.1 This is most likely the result of “New Jersey [having] one of the most significant set of laws, budgetary tools and state oversight programs, including aid funds from the state, to monitor local government finance….”2 The Division of Local Government Services in the Department of Community Affairs and its Local Finance Board serve as a constant check over the financial health of municipalities. There are numerous red flags under state law that identify when a municipality is experiencing financial difficulty, specifically designed to avoid a full-fledged bankruptcy. See N.J.S.A. 52:27-1 et seq. If any of the red flags are signaled, the state is empowered to step in and assume either partial or full supervisory control over a municipality’s finances until stabilization.

Conclusion

The Executive Order primarily empowers the Emergency Manager to assess Atlantic City’s financial condition while ultimately recommending solutions for long-term economic stability. Despite not possessing any actual “power” to take action, the Emergency Manager certainly has an abundant amount of influential “power” in shaping Atlantic City’s economic future. For now, only Governor Christie can act on the Emergency Manager’s recommendations while the mayor and city council remain in control of Atlantic City.

If you have any questions regarding this alert, please contact Gaming Practice Chair Nicholas Casiello, Jr. at 609.572.2234 or [email protected], or restructuring attorney Michael Viscount at 609.572.2227 or [email protected].

* Nick Casiello is Chair of the Gaming Practice Group and a resident in the Atlantic City office of Fox Rothschild. Michael Viscount is a partner in the Financial Restructuring and Bankruptcy department of the firm and managing partner of the Atlantic City office of Fox Rothschild. Assistance in the preparation of this alert was provided by Jeffrey Yaffa, a corporate associate of Fox Rothschild in Atlantic City.

1 Shortly after the City of Camden filed for bankruptcy protection, the state sought to dismiss its bankruptcy petition because it had not received state approval prior to filing. Within days of filing the petition, Camden withdrew its bankruptcy petition in exchange for $62.5 million in immediate state aid.

2 Richard Keevey, New Jersey’s Laws and Fiscal Safeguards Make Municipal Bankruptcy Unlikely, NJ Spotlight, Oct. 28, 2013, at 2.

Investors in billions of dollars of Puerto Rico bonds secured a major legal victory when a federal judge ruled that the commonwealth’s recently enacted debt-restructuring law was unconstitutional.

In the decision Friday night, Judge Francisco A. Besosa of the United States District Court in Puerto Rico said the Puerto Rico Public Corporations Debt Enforcement and Recovery Act was void and enjoined commonwealth officials from enforcing it.

The recovery act was passed by Puerto Rico lawmakers last summer to enable the commonwealth to overhaul the debts and labor contracts of the island’s struggling public corporations, including the Puerto Rico Electric Power Authority, which is known by its acronym, Prepa.

Like states, Puerto Rico cannot seek protection from creditors under federal bankruptcy law, leaving the commonwealth with few ways to straighten out the finances of troubled agencies like Prepa, which supplies electricity to the island’s roughly 3.6 million people.

A group of Prepa bond holders, including BlueMountain Capital and OppenheimerFunds, that own about $2 billion of the power’s authority’s debt sued the commonwealth in federal court, arguing that the recovery act violated their contractual rights.

The ruling is “a major victory for municipal bondholders,” Amy Caton, a lawyer for Oppenheimer and Franklin Mutual, another Prepa investor, said in a statement.

The passage of the recovery act in June rattled investors, particularly hedge funds, which had been buying up bonds issued by Prepa and other Puerto Rico entities at distressed prices. Investors feared that the new law showed how the government of Puerto Rico was willing to unilaterally change the rules, without warning.

The law spawned a spate of downgrades by the ratings firm Moody’s, which had already rated the commonwealth’s debt as junk.

On Friday, Judge Besosa denied the commonwealth’s motion to dismiss the investors’ lawsuit, saying that the recovery act was pre-empted by federal bankruptcy law.

“The commonwealth defendants, and their successors in office, are permanently enjoined from enforcing the recovery act,” he wrote in a 75-page decision.

A spokesman for the Government Development Bank, which oversees the commonwealth’s debt deals, said: “We will be reviewing all the aspects of the ruling rendered by Judge Francisco Besosa. In due time and after careful examination, we will decide on a course of action.”

The ruling is a significant setback for the Puerto Rico government, which has been engaged in a high-wire act — trying to restructure the debts of its public corporations while still maintaining the confidence of the municipal bond market that it needs to keep financing its operations.

The recovery act allows for the revamping of debts at certain public corporations. But it does not apply to the commonwealth’s general obligation bonds.

Prepa is mired in about $9 billion in municipal bond and other debt and has been struggling with high fuel costs, though the drop in oil prices has relieved some of that strain.

“This is a victory for the rule of law,” said Laurence L. Gottlieb, chairman and chief executive of Fundamental Advisors, a hedge fund and private equity firm with investments in Puerto Rico debt. “But now the question is what’s next in terms of dealing with Prepa’s debt.”

THE NEW YORK TIMES

By MICHAEL CORKERY

FEBRUARY 8, 2015

Read the Brief.

Municipal Market Advisors | Feb. 3

President Barack Obama’s record $4 trillion proposed budget would provide boons to states and localities in a host of areas, from infrastructure to education, but the White House’s spending plan again includes cuts or limits to popular programs such as community development block grants.

After calling for an end to “mindless austerity,” Obama released a proposal Monday that would end spending caps on discretionary spending, which are yearly appropriations encompassing nearly every government function, with particular impact for state governments in areas such as education, transportation, veteran’s benefits and natural resource protection. That, combined with a host of new initiatives, would likely mean an influx of state-level spending, but there are some notable cuts or limits.

Some of those have appeared in Obama’s budgets for years, and the Republican-controlled Congress will balk at much of the plan’s spending and tax changes. That means the final product will look far different, if the two branches of government can come to an agreement at all — a rarity in the Obama era. The budget is for the new federal fiscal year starting Oct. 1.

While the president anticipates the annual budget deficit will dip to $474 billion in 2016 and $463 billion in 2017, it would begin to pick up again, reaching $687 billion by 2025. But as a percentage of the overall economy, that would be lower than current levels of 3.2 percent. The overall national debt — the accumulation of annual deficits — would gradually decrease to 73.3 percent of the overall economy because of changes to health care and other areas, the president argued. The budget never reaches balance, which will prompt further criticism from Congressional Republicans.

Much of the items that will get the most attention focus on new tax credits for middle-class families along with new tax increases for some businesses and higher earners. But there’s also much that will directly affect states and cities. The White House budget estimates that federal grants to state and local governments will total $652 billion in 2016, representing a 13 percent increase from 2014.

That’s in part possible because the budget assumes the end of spending caps imposed by the 2011 deficit-reduction deal known as sequestration. Under that deal, spending would have inched up by 1 percent, or $2 billion, from the 2015 fiscal year. The president’s budget lifts spending in 2016 by $28 billion, or nearly 3 percent, to $1.17 trillion. The White House budget estimates that sticking with the current caps next year “would mean the lowest real funding level for research since 2002 — other than when sequestration was in full effect in 2013 — and the lowest real per-pupil funding levels for education since 2000, a major disinvestment in exactly the areas where investment is needed to support growth.”

Under the new plan, the federal government would spend a total of $333 billion more than originally allotted for discretionary funds over the next decade.

The increased caps for non-discretionary spending — things like yearly social programs such as Medicare — may also be a relief for states that been essentially been operating on the assumption that federal appropriations for their programs won’t change. Although the president’s budget is unlikely to pass as is, a lift on spending caps could end up increasing funding levels for certain grant programs, such as education programs. However, much will depend on decisions in future spending legislation that spells out program appropriations in detail to know the actual impacts.

Here’s a rundown of specific areas the budget would boost — and specific areas it would cut.

Infrastructure

The president’s budget includes $478 billion over six years paid for with new taxes on companies that incorporate abroad to avoid higher taxes in the U.S.

The administration called for more transportation spending than it has in past years, even though Congress has been deadlocked on long-term transportation spending for years. Since the last long-term surface transportation law expired in September 2009, Congress has passed 32 short-term fixes to keep transportation money coming to the states.

The major culprit has been the declining buying power of federal fuel taxes. The federal gasoline tax, for example, has been 18.4 cents-per-gallon since 1993. The current extension expires in May. There is bipartisan interest in passing another long-term law like the one the president proposed, but talks have always stopped when it comes to finding a way to pay for the new spending.

The fact that Obama’s budget identifies a specific mechanism for paying for the new spending proposal is a “good place to start in a discussion with Congress,” said Lloyd Brown, a spokesman for the American Association of State Highway and Transportation Officials (AASHTO).

“There seems to be more conversation and discussion going on right now than maybe we’ve had in the past, but I think that’s also indicative of this looming situation,” with the expiration of the current spending bill in May, Brown said.

In addition, the budget proposal includes new initiatives to spur private investment through a national infrastructure bank, new financing and bonds, such as tax-exempt Qualified Public Infrastructure Bonds, which are specifically geared toward helping states and localities attract new sources of capital. Packaged together, the incentives for private investment are expected to cost relatively little in 2016 — just $181 million — but will jump to $433 million the following year and $1.7 trillion by 2025.

New matching programs

The president included an already extensively previewed idea to make two years of community college free for qualified students in participating states. The budget provides $60 billion over 10 years, which would pay for three quarters of tuition, with states picking up the rest.

The budget also includes about $2 billion over three years to encourage states to reimburse workers for taking leave for specific family or medical reasons. Three states (California, Rhode Island and New Jersey) already have family leave programs, which allow workers to pay monthly premiums into an insurance fund that they can tap if they have to leave work for an extended period of time. The federal budget would cover half the benefits costs for up to five states, in addition to another $35 million in technical assistance for states already in the process of setting up paid-leave programs.

Health, education, police and research

The president’s budget includes more than $100 million in new spending to try reduce opioid abuse through direct spending in states for strengthening drug monitoring programs, expanding access to treatment and broadening the use of drugs that counteract overdoses.

In addition, the budget seeks to reverse cuts made to early childhood education that resulted in about 60,000 children losing spots in the federal Head State and Early Head Start programs.

Likewise, the budget would partially undo cuts to federal support of community policing. Hiring grants for the Office of Community Oriented Policing Services (COPS) have declined in recent years, from about $240 million in 2010 down to $108 million this year. Obama is calling for $182 million in 2016.

Lastly, the president bemoaned the effects of sequestration on research and development, which he argues has reached its lowest level in a decade. The president’s budget would boost funding by nearly six percent over 2015, particularly in the areas of medical research.

Proposed cuts

Perhaps the most notable area that’s routinely targeted for cuts is the community development block grant.

Among dozens of proposed cuts, the Obama administration called for $200 million less for the Community Development Block Grant program. That will surely draw criticism from the national associations that represent cities and counties, which have fought to keep the program funded at $3 billion a year.

The grants go to roughly 1,200 units of state and municipal government across the country to pay for a wide range of local needs, such as water infrastructure, affordable housing and meal programs for seniors. While the grant program saw a brief funding surge when Obama first took office, the long-term trend has been less money over time. Total federal disbursements already declined by about 30 percent between 2004 and 2014.

Another area sure to draw the ire of local policymakers is the tax-exempt status of municipal bonds, another perennial target of the White House. The Budget would limit the value of most tax deductions and exclusions to 28 cents on the dollar on higher-income earners, which would likely raise rates for governments. Currently, interest earned on municipal bonds is not taxed — a benefit to bondholders that allows governments to finance their bonds at a lower interest rate and save money. Governmental associations estimate that total borrowing costs for cities, counties and states could increase by more than 50 percent if municipal bonds’ tax-exempt status was repealed entirely.

Eliminating or limiting the bonds’ tax-free status has been discussed for years as a way to gain more federal revenue, but so far efforts have been unsuccessful. Taxing municipal bonds would add billions of dollars of new revenue to the national government — as much as $40 billion.

It’s those two changes in particular that drew the concern of groups advocating for state and local governments. The National Association of Counties, for one, said it appreciates the new infrastructure spending options, but they don’t outweigh the potential loss of others. “Counties need more financing options, not fewer,” said Executive Director Matthew Chase. “One infrastructure financing tool cannot cancel another.”

Other cuts include:

• $67 million from school districts included in the Impact Aid program, which makes up for a lack of property tax revenue in schools on or near federal land such as military bases.
• About $260 million from a variety of public health programs, including a program called Racial and Ethnic Approaches to Community Health, which focuses specifically on health disparities among minority populations.
• $450 million from the Grants-in-Aid for Airports program, which guarantees funding for large airpots. The federal government argues those hubs are better able to make up the money with fees, rather than smaller airports that need the money more.
• $185 million from the State Criminal Alien Assistance Program, which helps offset the costs of jailing unauthorized immigrants for states and localities.

GOVERNING.COM

BY LIZ FARMER, CHRIS KARDISH, J.B. WOGAN, DANIEL C. VOCK | FEBRUARY 2, 2015

Haunted state budgets

A new report from Wells Fargo’s Natalie Cohen took a look at state fiscal health midway through the 2015 fiscal year. Conditions for states are generally improving and showing fewer signs of budget instability, she said. However, some states reduced taxpayer burdens through tax cuts in prior years and anticipated revenue from expected economic activity hasn’t yet offset those revenue cuts. “Kansas is a notable example of this, where Gov. Sam Brownback’s individual and corporate income tax cuts in 2012 have only exacerbated the state’s fiscal status, as revenue collections dropped more than anticipated,” Cohen said in the Feb. 5 report.

There are others. Wisconsin is facing lower revenue partly because of a change in tax withholding rules that lets earners get more from their paychecks. Louisiana is facing challenges with low oil prices, but more of its revenue decline is tied to corporate tax breaks. The state had to make midyear budget adjustments in six of the past seven years. Michigan has a revenue shortfall thanks to earlier business tax credits. Arizona’s business tax cuts in 2011 and 2012 are also haunting the state’s current budget picture, Cohen wrote.

The revenue challenges come at a time when there is a lot of pressure to enact tax cuts now that the national economy has recovered from the recession and some states are in a position to either spend more money or allow for revenue cuts. These pressures are particularly forceful in Illinois and New Jersey, Cohen said, which both face structural budget problems and are led by Republican governors just itching to lower income taxes. The report also noted that the drop in oil prices and Medicaid expansion are playing roles in state budget adjustments this year.

Hustle and Bustle

Municipal bonds saw a lot more action in January than anyone predicted — but don’t get used to it. According to preliminary figures compiled by The Bond Buyer, the total value of bonds issued last month totaled more than $27 billion — despite the fact that bad weather artificially depressed issuance in the final week. (It may be a virtual market but bad weather still looks works like old retail.) According to RBC Capital Markets’ Chris Mauro, the total means that last month was the busiest January for the municipal market in five years. If the trend continues, 2015’s total volume could turn out to be a lot higher than many analysts’ predictions that new volume would total $335 billion. Mauro attributes the burst to a drop in interest rates. The drop prompted more governments to refinance existing bonds to save money. The Texas Department of Transportation refinanced $1.68 billion alone– it will save $380 million, the greatest savings on a single bond deal in the state’s history.

Historically, a heavy January has correlated with annual volume totals of over $400 billion (2007 and 2010). Still, governments are reluctant to take on new debt — new bond issuance was down 30 percent in January — and Mauro said, “we question whether the market can maintain this pace of issuance throughout the year.”

Bad times ahead?

Now that the Securities and Exchange Commission program encouraging governments and underwriters to disclose any inadvertent financial omissions about their bond deals has closed, there’s been a lot of speculation about what the SEC will do with the offenders. But one thing’s for sure: the string of settlements the organization releases this year, big and small, will create bad headlines for the municipal market. This, said Municipal Market Analytics’ Matt Fabian, will likely highlight disclosure problems and “incrementally raises the potential for new regulation and/or damage to [municipal bonds’ tax exempt status] in years ahead.”

Noting that governments politically sensitive to admitting past failings, Fabian predicted that means there is more potential for SEC actions against issuers versus underwriters. “The fact that potentially thousands of outstanding bond prospectuses have been flagged as inaccurately depicting past disclosure compliance,” he wrote, “does not exactly bode well for outsiders’ opinions of market operations.”

GOVERNING.COM

BY LIZ FARMER | FEBRUARY 6, 2015

(Bloomberg) — State and local bonds with the longest maturities are delivering the best returns in the $3.6 trillion municipal market even as investors brace for higher interest rates as the U.S. economy grows.

Munis due in 22 or more years have earned about 1.9 percent in 2015, outpacing shorter-dated bonds and beating the 1.4 percent advance for the entire market, Bank of America Merrill Lynch data show. They’re extending a rally after earning 15.5 percent last year, the most since 2009.

Longer maturities are gaining even as the Federal Reserve is projected to raise its benchmark interest rate this year from near zero, where it’s been since 2008. That move wouldn’t reverse momentum for munis due in decades because interest rates will rise more dramatically for debt maturing in one to three years, said Chris Alwine at Vanguard Group Inc. in Valley Forge, Pennsylvania.

“If the Fed begins to tighten, those increases will hit the front end of the curve more,” said Alwine, who oversees $145 billion as head of munis. “And in a world without high inflation, the long end of the curve won’t be hit that badly.”

Bank’s Patience

The Fed last week boosted its assessment of the economy and repeated a pledge to stay “patient” on raising interest rates. It said inflation “is anticipated to decline further in the near term.” The bank will boost its target as soon as next quarter, according to the median forecast of 41 analysts surveyed by Bloomberg.

While Fed increases might push up yields on longer-term securities, this year, subdued inflation will keep rates on longer munis from spiking, said Peter Hayes, who manages $114 billion as head of munis at New York-based BlackRock Inc.

“This time, we would argue that the growth is non-inflationary so we won’t see that steepening,” Hayes said.
The economy will expand 3.2 percent in 2015, according to the median forecast of 84 analysts surveyed by Bloomberg. It would be the fastest growth since 2005.

The Fed’s preferred inflation gauge, personal consumption expenditures, rose 0.7 percent in December and has been below the bank’s 2 percent target since May 2012. The 54 percent drop in oil since June, to about $49 a barrel, has tamped down inflation. Slower inflation preserves the value of bonds’ fixed payments.

Relative Value

Longer munis’ relative value against federal debt will also support the securities, said Clark Wagner, director of fixed income at First Investors Management Co. in New York, which oversees $1.5 billion of munis.

Yields on benchmark 30-year munis reached as high as 118 percent of those on Treasuries on Jan. 29, the most since October 2013, data compiled by Bloomberg show.

“That gives it a little cushion if rates rise,” Wagner said.

With benchmark yields close to five-decade lows, investors in January poured about $2.5 billion into U.S. muni mutual funds with an average maturity of greater than 10 years, Lipper US Fund Flows data show. It was the biggest inflow in two years.

“They are extending out,” BlackRock’s Hayes said. “When rates get very low like they are now, investors tend to extend either their duration or they take more credit risk.”

Borrower Boon

Declining yields on obligations due in decades have been a boon for issuers borrowing for construction and maintenance of schools, roads and bridges.

Last month, Washington’s King County sold bonds backed by sewer revenue to refinance higher-cost debt. The new securities have maturities as late as 2047. The sewer system, the largest in the U.S. Northwest, will save $160 million because of the lower yields, Ken Guy, the county finance director, said in an interview.
“It will save money for our rate payers,” Guy said.

The appetite for longer maturities led the county to increase the deal by about $300 million, and then lower yields by as much as 0.05 percentage point across maturities the day of the sale, said Robert Shelley, a financial adviser at Piper Jaffray & Co. in Seattle.

“There’s still some investors out there that have cash that they need to put to work,” Shelley said. “And debt of municipalities represents good value compared to some of those other options out there.”

Supply Equation

The sale was an advance refunding, where proceeds sit in escrow until the original bonds are repaid. With interest rates this low, more localities may opt for such refinancings, said Tim McGregor, head of munis in Chicago at Northern Trust, which manages $30 billion of state and local debt.

“There could be a lot of longer bonds advance-refunded” with shorter maturities, McGregor said. “And that reduces the supply out long.”

States and municipalities may sell $335 billion of debt in 2015, Chris Mauro, chief muni strategist in New York at RBC Capital Markets, estimated in December. That includes $55 billion of advance refunding.

“The $55 billion estimate looks low at the moment,” Mauro said in an e-mail. “It looks like advance refundings are running well ahead of last year in the first few weeks of the year.”

by Michelle Kaske

February 4, 2015

To contact the reporter on this story: Michelle Kaske in New York at [email protected]

To contact the editors responsible for this story: Stephen Merelman at [email protected] Mark Tannenbaum, Jeffrey Taylor

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