Can State Actions Have Contagious, Adverse Municipal Consequences?


February 4, 2014
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Getting Rolled in Atlantic City? Has the Governor’s Action Caused Contagion? Atlantic City yesterday sold $12 million of notes to Bank of America Corp., part of a plan to repay $12.8 million of securities coming due this week. Under the plan adopted by the City Council yesterday, the city will pay the remainder with cash. Yesterday’s event fell short of hopes, as Atlantic City officials had intended to issue new notes to raise the funds, according to Mayor Don Guardian, but the city had been unable to sell the debt until receiving three offers last Friday, or, as the Mayor noted: “Initially no one responded…everyone is nervous…The term of emergency manager I think scares people away.” The securities mature in August and pay an interest rate of 5 percent, according to Atlantic City Finance Director Michael Stinson, just about twice what top-rated city and county borrowers pay for 30-year debt, according to data compiled by Bloomberg—or, as Council President Frank Gillian puts it: “It says we’re in bad shape.” The city faces some $300,000 in interest payments alone on the borrowing; it has pledged as much as $12 million in anticipated state and federal grants to pay off the loan. The final tab is nearly three times as much as the 1.75 percent coupon it paid to issue similar debt just a year ago. The exceptional costs of borrowing will not only weigh heavily on the city’s efforts to recover, but also, as fabulous Matt Fabian of Municipal Market Analytics this week writes: “[I]t opens the window for possible debt impairment for the city and casts a shadow over the state’s local government debt. We expect investors to demand lower prices not only on Atlantic City’s bonds, but also most other local New Jersey credits.” Mr. Fabian notes that this contagion “has increased since the Emergency Manager was appointed…every New Jersey local government issuer’s credit quality is weaker because reliable, bondholder-friendly state support has evaporated.” Moody Investors Service dropped the city to junk in July because of its dependence on casinos. The company last month lowered its grade on $344 million in Atlantic City debt to Caa1, seven levels below investment grade, citing the governor’s move to install an emergency-management team that includes Kevyn Orr, who guided Detroit through its record $18 billion municipal bankruptcy in part by asking bondholders to accept less than they were owed. The high rate comes in the wake of super-downgrades of the city’s debt deep into junk bond territory by two credit rating agencies, which are concerned about a possible municipal bankruptcy filing. The bond anticipation notes were being used to pay for infrastructure projects after Hurricane Sandy. Originally issued in 2013, the notes were rolled over last year. Atlantic City has already borrowed $40 million from the state at 0.75 percent for a loan due March 31. For comparison, the yield on a 6-month Treasury note yesterday was 0.0675 percent; Long Branch, also on the New Jersey shore, yesterday sold a $13.7 million short-term bond anticipation note sale at 0.50 percent.

Unintended Consequences? In his proposed FY2016 budget the President submitted to Congress Monday, he included a revenue raising provision urging Congress to impose a minimum tax on U.S.-controlled foreign income—an action which some fear could exacerbate Puerto Rico’s already dire fiscal situation by creating even more disincentives to investment in the commonwealth. The proposal, part of the President’s proposal to tax so-called inversionary income, is at the heart of the Administration’s proposal to create a short-term, temporary federal infrastructure financing program and defer the bankruptcy of the federal Highway Trust Fund for six years. The White House is proposing the imposition of a 19% minimum tax on controlled foreign corporations operating outside the country, including a 14% tax effective on money already earned and still held overseas. Money taxed under the proposal would not be subject to further U.S. taxes―a change from current tax law (§901) under which subsidiaries of a U.S.-based corporation do not have to pay federal taxes unless the subsidiary’s profits are repatriated to a location in one of the 50 states—with this provision including Puerto Rico, even though it is not a foreign country. Under §936, U.S. corporations were permitted to repatriate or bring income from Puerto Rico to the 50 states tax free, but, under former President Bill Clinton, that provision sunset in 2005—the year, in retrospect, when Puerto Rico’s economic downturn began: many labor intensive manufacturers began to shift their operations, although pharmaceutical and medical device manufacturers appear to have largely remained. But now there is apprehension that if Congress acts on the President’s tax/budget proposal, it could be another economic blow to the island’s manufacturing sector—which today represents 44 percent of the island’s gross domestic product. Ironically, in recent years Puerto Rico has imposed its own tax on foreign corporations’ repatriation of profits from island-based subsidiaries—a move that today accounts for 20% of anticipated revenue for the General Fund—thus the apprehension that a favorable reaction to the President’s tax proposal could have significant adverse effects on Puerto Rican revenues.

Burning up Reserves. S&P has revised its rating for Kern County, California’s third largest county, to negative, after the county declared a fiscal emergency last week. One of the largest oil producing counties in the U.S. and the dominant producer in California, the County’s management estimates that $55 per barrel oil could lead to an 11.8% drop in assessed property values, and a resulting $60 million property tax revenue shortfall, S&P noted. S&P reported it was concerned with a projected $27 million budget shortfall in FY2016. By declaring a fiscal emergency, the county can access $40 million general fund reserve to cover the gap. S&P analyst Li Yang wrote that the county’s pension obligations, already high, will “continue to rise for a number of years. The county is going to need to address that deficit going forward.” The county predicts that its pension costs will increase through 2022 and has set aside portions of its reserves to account for the rising costs, according to Mr. Yang, which means, he notes: “That will translate into spending down reserves.” Under its declaration, the County could act to reduce the number of its firefighters, although Kern County officials have not said they plan to take such an action.