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Moody’s places tollway under review for downgrade

Tuesday, May 14, 2019

* Last year

On January 30, the U.S. federal court overseeing Puerto Rico’s debt restructuring issued a ruling that may weaken the legal support for a subset of municipal securities known as “special revenue” bonds. In general, special revenue bonds are those backed by utility revenues, dedicated taxes or other dedicated payments and issued by a Chapter 9-eligible entity like a city, school district or special district government. Special revenue bonds often receive superior treatment to other bonds in Chapter 9 bankruptcy.

The ruling surprised many market participants, and in our view it is the first decision stemming from Puerto Rico’s insolvency that has meaningful implications for mainland credit quality. While the near-term impact of the decision is likely to be modest, it could have long-term implications. Currently, few special revenue issuers exhibit credit stress, and the decision may be overturned on appeal. However, special revenue bonds may constitute up to 35 percent of the $3.8 trillion municipal bond market. If the ruling proves lasting, it could trigger ratings downgrades, alter municipal investment strategy at some firms and compel legislative fixes, among other actions.

* Last month

The U.S. Court of Appeals for the First Circuit has affirmed a controversial ruling regarding the treatment of municipal revenue debt, leaving investors with lingering questions about the value and significance of a revenue pledge in a municipal bankruptcy.

The original U.S. District Court decision roiled the municipal markets in January 2018, when Judge Laura Taylor Swain, the judge overseeing Puerto Rico’s debt restructuring, ruled that municipal debtors were permitted, but not required, to apply special revenues to pay related bonds. Judge Swain’s ruling reversed long-held conventional wisdom regarding the mandatory application of special revenues following municipal bankruptcy. […]

Although the First Circuit’s ruling covers only Maine, Massachusetts, New Hampshire, Puerto Rico and Rhode Island, commentators and rating agencies have expressed concern that the ruling will have a broader impact on holders of municipal revenue debt, particularly given the relative scarcity of case law interpreting issues of municipal bankruptcy. The First Circuit’s affirmation raises serious concerns about the value of a municipal revenue pledge and creditors’ ability to enforce any lien on such revenues post-bankruptcy or to otherwise protect the revenue stream.

* Last week

Moody’s Investors Service has placed the Aa3 rating of the Illinois State Toll Highway Authority (ISTHA) under review for downgrade. ISTHA has approximately $6.1 billion of bonds outstanding.

RATINGS RATIONALE

The rating action is driven by the recent US Court of Appeals for the 1st Circuit ruling related to the Puerto Rico Highways and Transportation Authority (PRHTA) bonds, which calls into question the strength of credit separations between a general government and its enterprises and component units. The review will consider economic, governance, and financial interdependencies between ISTHA and the State of Illinois (Baa3 Stable) and the extent that, in light of the afore-mentioned court ruling, and such interdependencies pose risks to ISTHA that could have an impact on its credit quality.

On March 26th, the US Court of Appeals for the 1st Circuit ruled that the Commonwealth of Puerto Rico is not required to pay “special revenue” debt service on PRHTA bonds (C Negative Outlook) during the pendency of bankruptcy-like proceedings. While the Court’s jurisdiction is only the Commonwealth and those states that are within the 1st Circuit (which does not include Illinois), no appellate-level court has addressed the issue of whether pledged special revenues must be paid to bondholders in a municipal bankruptcy or restructuring process until now. In other municipal bankruptcies, utility and other enterprise revenue bonds have offered extremely high recoveries when associated with general government insolvencies, though they have not always been immune from impairment despite falling under the “special revenue” pledge.

Moody’s notes that ISTHA has both authorizing legislation which states that excess revenues in the system reserve account can only be used for tollway purposes and a master indenture with a closed flow of funds. The state also passed a ballot initiative for a transportation lock box within its constitution in November 2016 with nearly 80% voter support, precluding transportation funds from being used for non- transportation uses. Taken together, this had provided sufficient independence to support the wide differential to the state’s rating. During the review period, Moody’s will determine the degree to which the authority’s rating should have a closer linkage to the rating of the state given the 1st Circuit ruling and what it may mean to the relationship between municipal governments with materially higher rated enterprises. The range of potential outcomes include a downgrade of the ISTHA’s credit which may be one or more notches to stabilizing the outlook at the current rating level.

FACTORS THAT COULD LEAD TO AN UPGRADE

    - Reversal of the ruling by the US Court of Appeals on PRHTA bonds would be supportive of the current rating
    - Reduced uncertainty with respect to the breadth of legal implications for special revenue pledges stemming from the 1st Circuit ruling and greater demonstrated independence of ISTHA from the state

FACTORS THAT COULD LEAD TO A DOWNGRADE

    - Continued uncertainty with respect to the breadth of legal implications for special revenue pledges stemming from the 1st Circuit ruling
    - Attempts by the state to divert ISTHA funds to non-authority purposes
    - Deterioration of the state rating
    - Traffic and revenues fall short of current projections and DSCRs fall below forecasted levels consistently below two times

This looks like a serious over-reaction by Moody’s. I mean, Illinois can’t declare bankruptcy. We’re a state not a territory.

…Adding… Illinois Tollway…

The Illinois Tollway is a world-class system with quality roadways and facilities and projected revenue of $1.5 billion in fiscal year 2019. While we appreciate Moody’s role in providing credit ratings, its review is predicated on a legal case in Puerto Rico that bears little if any resemblance to the Tollway’s situation. This is a promising time for the State of Illinois with an administration that has made fiscal stability a priority. We look forward to working with the administration to continue to provide a quality experience to all we serve.

* Meanwhile, a bit of good news

State universities finally are getting a bit of good news from Wall Street—largely due to the state’s improved fiscal situation.

In a series of announcements Monday evening, Moody’s Investors Service said it has adjusted upward from negative to neutral its outlook on debt issued by Eastern, Northern, Northeastern and Southern Illinois universities, as well as Governors State University and Illinois State University.

Eastern, Southern and Illinois State also received even better news, as Moody’s actually raised its ratings on a type of debt known as certificates of participation and, in Eastern’s and Illinois State’s case, some bonds.

The actions at a minimum mean none of the schools now is in imminent danger of a downgrade, something that has been the case since ex-Gov. Bruce Rauner and state lawmakers engaged in a two-year budget feud. The actions also suggest that the schools will pay less interest than they might have should they borrow again.

…Adding… Good point from a reader…

Now here is a question for Moody’s, as my blood pressure rises. What is so different about the ‘special revenue’ standing of the state’s tollway versus the state’s universities regarding “materially higher-rated enterprises?” U of I is rated one notch lower than the toll road, so why is it, for example, not under the same scrutiny? Do they even think before they release this stuff???

…Adding… Bond Buyer

Illinois paper is gaining ground due to scant supply and a hunger for yield combined with recent fiscal developments that should help the state hold on to its investment grade rating in the near term.

Investor appeal has driven a narrowing of state spreads that remain the highest among states. They fluctuate in tandem with market appetites and state fiscal developments that stand to influence its weak ratings that are just one to two notches above junk. […]

“Presumably yield-hungry investors feel that the sixth-largest state (in terms of population) has an appealing spread that might tighten should its tax structure change,” MMD senior market strategist Dan Berger wrote in a column Friday.

- Posted by Rich Miller        

19 Comments
  1. - OneMan - Tuesday, May 14, 19 @ 12:34 pm:

    In the cast of the tollway is the ISTHA enough of a seperate entity that it could declare Chapter-9? Not that it would, but could it. That might be what Moody’s is concerned about.


  2. - Rich Miller - Tuesday, May 14, 19 @ 12:41 pm:

    ===but could it===

    No


  3. - Annonin' - Tuesday, May 14, 19 @ 12:56 pm:

    Pretty shakey
    But remembers this is the industry that gave out a lot of AAA before the Bush Cheney Depression began in 07-08.
    Looks like someone at Moody’s has a friend with a big stake shorting tollway debt which probably has to be done with derivatives.
    Hopefully they all have good lawyers


  4. - PublicServant - Tuesday, May 14, 19 @ 12:57 pm:

    Appropriate name for the ratings agency behind this, errrr, review I’d say.


  5. - TheInvisibleMan - Tuesday, May 14, 19 @ 1:03 pm:

    Ratings agencies have little to no credibility left, but even among the big 3 (Fitch, Moodys, S&P), Moodys seems to be consistently taking it to the next level.


  6. - OneMan - Tuesday, May 14, 19 @ 1:13 pm:

    The interent is a dangerous place to get information, I know that. Also I am not a lawyer.
    But…

    The ISTHA may meet the definition of an entity that could declare Chapter 9.

    https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-9-bankruptcy-basics

    Only a “municipality” may file for relief under chapter 9. 11 U.S.C. § 109(c). The term “municipality” is defined in the Bankruptcy Code as a “political subdivision or public agency or instrumentality of a State.” 11 U.S.C. § 101(40). The definition is broad enough to include cities, counties, townships, school districts, and public improvement districts. It also includes revenue-producing bodies that provide services which are paid for by users rather than by general taxes, such as bridge authorities, highway authorities, and gas authorities.

    It seems like you could argue that the last sentence would cover ISTHA since they are both a highway authority and they are a revenue-producing body that provides services paid for by users.

    Again, not a lawyer, but I think Moody’s may just be being prudent here.


  7. - Not a Billionaire - Tuesday, May 14, 19 @ 1:18 pm:

    Ok declare it an asset of the state. Fair it at 40 billion and knock out net debt down .


  8. - wordslinger - Tuesday, May 14, 19 @ 1:19 pm:

    –This looks like a serious over-reaction by Moody’s. I mean, Illinois can’t declare bankruptcy. We’re a state not a territory.–

    It doesn’t make sense. I can’t make heads or tails out of it.

    If the rating agencies want to be scared of something, they could take a look at the Chicago Skyway experience.

    Finished in 1958, the Skyway defaulted on its revenue bonds in 1963 and remained in default for 30 years, as the city, at its discretion, could keep toll money to maintain the road. Under terms of the bonds, the city was not obligated to tap other revenue sources to service the bonds.

    That revenue bond default, by the way, did not keep the city from issuing GO bonds or other revenue bonds during the default.

    https://www.lincolninst.edu/sites/default/files/pubfiles/chicago-and-its-skyway-urban-megaproject_0.pdf


  9. - RNUG - Tuesday, May 14, 19 @ 1:26 pm:

    == The ISTHA may meet the definition of an entity that could declare Chapter 9. … Only a “municipality” may file for relief under chapter 9. … ==

    That would be good news. In Illinois, municipalities are not allowed to declare bankruptcy without the explicit approval of the Legislature. Given that limitation, I have to assume the risk if bankruptcy is basically zero …


  10. - Not a Billionaire - Tuesday, May 14, 19 @ 1:31 pm:

    Skyway is owned by the Ontario Teachers Pension.The paid 2 billion . I valued the Tollway at 20 times tgat.


  11. - OneMan - Tuesday, May 14, 19 @ 1:39 pm:

    It would never fly, but selling the tollway might not be a bad idea.

    The Indidana tollroad in 2015 went for 5.7 billion when it was purchased out of bankrupcy (ironiocally) from the previous lease holder.


  12. - Lucky Pierre - Tuesday, May 14, 19 @ 1:46 pm:

    “This is a promising time for the State of Illinois with an administration that has made fiscal stability a priority.”

    Is the Tollway Authority saying that with a straight face?

    Except for the fact that the Pritzker administration would prefer to use over 1 billion pension money annually for the next 7 years to expand progressive programs and not pay down existing debts or reform pensions so the state can actually afford to pay for them


  13. - Chicagonk - Tuesday, May 14, 19 @ 1:50 pm:

    @RNUG - Harvey hasn’t paid their required GO payments since 2017 and is now being sued by bond holders in Cook County court. The bonds last traded at 50 cents on the dollar. I agree that there is no risk of bankruptcy for the state, but municipalities in Illinois can default on payments even if bankruptcy isn’t an option.

    On a slightly separate note, for those legislators that think allowing municipal bankruptcy in the state will cause a spike in interest rates, just look at what is going on in Harvey. Letting the city languish in default purgatory when the market already has priced in a haircut on the bonds is unnecessarily punitive and borderline criminally negligent. Write legislation allowing the state to take control of the city administration as part of an orderly bankruptcy process.


  14. - OneMan - Tuesday, May 14, 19 @ 1:54 pm:

    Now here is a question for Moody’s, as my blood pressure rises. What is so different about the ‘special revenue’ standing of the state’s tollway versus the state’s universities regarding “materially higher-rated enterprises?” U of I is rated one notch lower than the toll road, so why is it, for example, not under the same scrutiny? Do they even think before they release this stuff???

    Do the state universities issue revenue bonds? The court case was about revene bonds being paid when the revenue still exists.


  15. - California Guy - Tuesday, May 14, 19 @ 2:15 pm:

    @RNUG - municipal bankruptcy establishes an orderly process in the event where debt default is certain. The existence of that orderly process has no bearing on whether a municipality defaults on payments owed to creditors.

    What is a municipality going to do when they get sued by bond holders that didn’t get their payments, or a pension fund that can’t collect their mandated payments even after sales tax has been intercepted?

    Legislators think that not allowing for an orderly BK process somehow helps municipalities not default. All it does is perpetuate continued instability in the event that defaulting is the only option.


  16. - RNUG - Tuesday, May 14, 19 @ 3:02 pm:

    == Legislators think that not allowing for an orderly BK process somehow helps municipalities not default. All it does is perpetuate continued instability in the event that defaulting is the only option. ==

    I’m sure they thought the same thing that the drafters of the Pension Clause thought … that removing banktuptcy as an option would force the municipalities to be fiscally responsible. Didn’t work because the public officials are long gone before problems arise.

    It might have worked if they made the public officials personally responsible and able to be personally sued.


  17. - California Guy - Tuesday, May 14, 19 @ 3:14 pm:

    ==I’m sure they thought the same thing that the drafters of the Pension Clause thought … that removing bankruptcy as an option would force the municipalities to be fiscally responsible. Didn’t work because the public officials are long gone before problems arise.==

    Nailed it. Not having an orderly bankruptcy process hasn’t led to more fiscal responsibility.

    In the Harvey situation, the City negotiated a deal with the police and fire pension funds alongside revenue bondholders to shore up payments. The State began intercepting sales tax and State revenue to help make payments to both public safety pension funds and IMRF (Harvey was not paying the full amount due to IMRF at that time).

    Harvey is now being taken to court by general obligation bondholders who want to pull their debt service payments from the escrow fund that Harvey promised to set up as a condition of issuing the bonds. Harvey doesn’t want to set up that escrow fund because the payments that the bondholders will extract from that fund will leave Harvey even more financial destitute. They’re basically moving through a negotiation and legal process that could have been done more orderly through Chapter 9 anyways. If no one gets a haircut (bondholders, City of Chicago Water Dept., pension funds, etc) the City is doomed.


  18. - Anon Downstate - Tuesday, May 14, 19 @ 3:40 pm:

    “This looks like a serious over-reaction by Moody’s. I mean, Illinois can’t declare bankruptcy. We’re a state not a territory.”
    ————————

    That’s certainly one way to look at this. But there’s another way.

    Go back in time. On May 5, 2017, Chief Justice John Roberts appointed Judge Swain to oversee the debt restructuring case in the Puerto Rican government-debt crisis.

    Justice Roberts basically charged Judge Swain with responsibility for creating a judicial & administrative framework for dealing with non-corporate bankruptcies (read: Government & non-profits).

    Once the procedure is established, don’t be surprised if the same procedure isn’t applied to ‘insolvencies’ and other types of non-corporate fiscal failures.

    IMO, Moody’s didn’t over react in the case of the Illinois Tollway. More likely they are particularly concerned over other similar situations where the Puerto Rican case law could be applied. And they (Moody’s) are adjusting accordingly.

    My .02


  19. - BAP - Wednesday, May 15, 19 @ 8:28 am:

    InvisibleMan, keep telling yourself that. The market obviously disagrees with you.


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