This Special Focus is brought to you by Court Street Group and Neighborly.
We take this opportunity to review a variety of topics which we believe will be interesting and consequential to public finance professionals in the new year. Read more about the future of structured deals, threats to public school funding and high-speed rail. This is part two of a two-part series. Read part one here.
STRUCTURED DEALS ARE NOT A CURE ALL
Issuers will find out that the use of structured financings will not be a panacea for their problems with weak finances and the resulting impact on their ability to issue debt. Two Illinois issuers provided examples of the contrasting results of relying upon such a structure. Debt-laden Chicago was successful in establishing a secured structure segregating sales tax revenue from its large and diverse economic base. The resulting legal structure and available pool of revenue allowed the City to achieve a AAA rating on its structured issue. The rating lowered the City's borrowing costs and offered another avenue to the debt markets despite the existing pressure on its general obligation tax base.
In contrast, the Chicago suburb of Bridgeview brought a structured financing secured by its sales tax base to the market in December. The financially challenged community has placed a lot of economic development hopes on being the location and partial financier of a stadium for the Chicago Fire, the Chicago region’s Major League Soccer team. Despite decent attendance for the franchise’s games, the events have not yielded the ancillary economic development anticipated so the facility has not boosted overall town revenues. In fact, the village's general fund partially covers debt service on the bonds issued to finance stadium construction.
So when the village sought to issue debt it looked at its BB rating and sought alternatives to GO debt. Looking at its neighbor, Bridgeview decided to try its luck with a sales tax secured issue. The structured bonds did receive a BBB rating but that was disappointing for the issuer. In this case, the rating reflected a much more limited and less diverse economic base securing the debt. The structure was not enough to overcome the weak overall fundamentals of the village's credit.
These two different results serve as a strong reminder that structure can only go so far when the basic credit fundamentals of an issuer are weak. This is a dilemma which many issuers will face when they are disappointed at the lack of a Trump administration infrastructure plan. It will be stunningly unexpected if the "plan" does not require a significant investment by state and local governments to receive partial federal funding.
THREATS TO PUBLIC SCHOOL FUNDING
The public K-12 education sector is under attack from all sides -- cultural, political, economic, financial. It is enough to make one's head spin. Regardless of one's views on the subject, investors need to focus on the objective factors threatening public school finances.
The first blow comes from expanding 529 college savings accounts. 529 accounts have traditionally only offered tax advantages to encourage families to save money for college but now can cover K-12 expenses, such as private school tuition and home-schooling costs. This amendment by Senator Ted Cruz passed only because of a midnight tiebreaking vote cast by Vice President Mike Pence. Under current law, earnings on contributions to 529 plans are not subject to federal taxes. These investment vehicles work well for college savings because deposits grow tax-free over a long time. Using 529 accounts for elementary or high school tuition, however, substantially shortens that period, making these accounts a minimal boost to school choice. Nonetheless, Congress jumped in and took the populist plunge.
While this change would have only a small effect on the federal Treasury, it creates outsize impacts on the state income tax bases in the 33 states that instituted state tax deductions and tax credits to encourage 529 college savings. The federal expansion opens these state incentives to an entirely new area of expenditures, allowing private school families to funnel their tuition payments through 529s as a way to avoid state taxes. The different states offer varied state tax deductions.
Illinois, for instance, allows deductions for $20,000 in contributions a year per beneficiary to 529 plans, while Pennsylvania allows $28,000. Colorado, New Mexico, South Carolina and West Virginia have broader tax loopholes: all 529 contributions are fully deductible, so participants’ entire private school tuition could be free of state tax.
States without income taxes, like Senator Ted Cruz’s home state, Texas, have no state income tax deductions for contributions to 529 plans so as not to interfere with their state taxing sovereignty.
The second blow to state education funding would come from the new federal cap on the deductibility of state and local tax payments. Public schools are primarily funded by state and local taxes, partly by local property taxes, and partly by the state, often through income taxes. When districts are too poor to raise enough property taxes to fund schools, the state contributes funds to even the scales with wealthier districts.
Expanding 529 plans to deliver state deductions to private school families will erode the tax base that funds public schools, affecting high-poverty schools the most. By limiting state and local tax deductions at the same time, Republicans would make it harder for states and cities to raise taxes to make up for those shortfalls.
HIGH-SPEED RAIL STARTS CHUGGING ALONG
The American journey to "high speed" rail has been a crawl compared to that of the rest of the world. In addition to the fact that service around the world, especially in Europe, is a much more common and reliable experience, the last year has not been a good one for U.S. high-speed service. Whether it's the Northeast Corridor's relatively slow Acela service between Boston and DC or the recent accident on new service between Seattle and Portland on the West Coast, it has not been an auspicious environment for high-speed rail.
Nonetheless, the municipal market moves closer to being at the center of the issue in 2018 through two primary projects making their way through development.
This high-speed rail project connecting Orlando and Miami, expected to have operating speeds between 79 and 125 mph, the project hit a major milestone with FRA signing the Record of Decision, the final step in the environmental review process. The privately funded Brightline project used $600 million in private activity bonds to fund the construction of the first phase of its planned service between Miami and Orlando at the southern end of the line.
Service is slated to begin between Fort Lauderdale and West Palm Beach in the next few months.
Brightline plans to begin the second phase of construction of the line to Orlando in early 2018, when they plan to finalize the design for the rail infrastructure and the vehicle maintenance facility at Orlando International Airport. In the interim, Brightline, a subsidiary of All Aboard Florida, said that the U.S. Department of Transportation approved a $1.15 billion private activity bond allocation for Phase 2 of the project from West Palm Beach to Orlando. A notice of the record of decision will soon appear in the Federal Register, beginning a 150-day period during which legal challenges can be filed, according to the USDOT.
A proposed bill, known as the Florida High-Speed Passenger Rail Safety Act would impose new regulations on trains operating at speeds of 80 mph or more, including making their owners responsible for installing safety measures and covering the cost of rail crossing maintenance. It would also require additional safety features for pedestrian crossings. Another proposed bill would make a high-speed rail system operator solely responsible for all maintenance costs associated with the safety equipment installed at public railroad highway-grade and pedestrian crossings. The measure also states that no government would be responsible for costs associated with the maintenance necessary to operate a high-speed passenger rail system unless the governmental entity “expressly consents in writing.”
TEXAS HIGH SPEED Also near year end, DOT green-lighted the environmental impact statement review for another privately funded high-speed rail line, the Texas Central Railway, to operate within a "fully sealed" 240-mile corridor between Dallas and Houston -- a trip they say will take 90 minutes. FRA will hold 10 public hearings during a 60-day public comment period, which begins when the draft environmental impact statement is published in the Federal Register.
Joseph Krist is a Partner at Court Street Group Research who has spent his career researching, analyzing and writing about municipal credits for both buy and sell side clients.View author