* 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.