US$700m County of Los Angeles TRANs on Tap

The County of Los Angeles is eyeing a sale of US$700m worth of Tax and Revenue Anticipation Notes (TRANs), amid a massive increase in the city’s budget and turnaround in its economic health.

The municipal bonds, set to mature June 30, 2020, are intended to contribute to the fiscal year 2019-20 general fund, including current expenses, capital spending, as well as certain debt payments.

General fund revenues are expected to swell to over US$6.5bn in LA Mayor Eric Garcetti’s proposed budget for 2019-20, a rise of 5.5% above the city’s 2018-19 adopted budget.

According to the county’s Budget and Finance Committee, the mayor’s budget for the coming year includes an estimated US$1.7bn worth of TRANs issuance. The City Administrative Officer (CAO) recently noted that the associated debt service payments represent the principal and interest payments to pre-pay the city’s pension obligation for sworn and civilian employees.

The CAO then stated that through the issuance of TRANs, the city will receive around US$20m in net savings.

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Massive budget

Overall, the mayor’s proposed budget, which was recently approved by the Budget and Finance Committee, amounts to a whopping US$10.65bn, a 7.6% rise over the prior year’s adopted budget, with the largest anticipated revenue growth rates – expected to increase by more than 6% over the previous year – flowing-in from property, business and sales taxes.

Under the preliminary terms of the potential US$700m TRANs sale, total unrestricted revenues for principal and interest payments will be roughly US$10.1bn, which means almost US$9.4bn will remain in excess of the pledged note payments.

At more than US$6bn and nearly US$2bn, property taxes and service charges assume the lion’s share of the proposed general fund.

Fitch Ratings analysts recently noted that in fiscal 2018, property taxes represented 37% of LA’s total general fund revenues, followed by utility users’ taxes (12%), business taxes (10%), sales taxes (10%), and other taxes (13%).

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The ratings agency said that the city’s general fund revenues — notably property taxes – “were relatively resilient during the Great Recession, with solid post-recessionary growth,” while LA’s multi-year outlook hinges on revenue growth as a result of ongoing increases in employment, income, taxable sales, and tourism.

Fitch added that while general fund “expenditure flexibility is adequate given the city’s modestly
elevated” debt, pension, and other post-employment benefit (OPEB) carrying costs at 20% of governmental spending (ex-Los Angeles Department of Water and Power (LADWP) and other
business-type activities), there are indications that “even contributions at the actuarial level would likely be insufficient to reduce pension liabilities, meaning the contributions are likely to continue to rise.”
The city has been working with the Coalition of LA City Unions to finalize a labor contract for fiscal years 2019 through 2021.

Challenges to growth

Although pension liabilities are slated to rise, certain of LA’s economic trends appear to see ongoing improvements, while others signal significant challenges.

The Los Angeles Economic Development Corp (LAEDC) said it expects 3.0% growth in real county product for 2019 and 2.7% growth in 2020, “roughly keeping pace with state economy and exceeding national growth.” The expansion will mainly be fueled by an additional 60k jobs annually in sectors such as health care and professional and business services.

However, LAEDC noted that the likelihood of buying and owning a home and accruing associated equity has become “increasingly unlikely.” The economic research group cited figures from the California Association of Realtors, which estimated that in the fourth quarter of 2018 only 24% of households in the county could afford a home, meaning they made at least US$124,900 a year to afford the median home price of US$576,100.

In Orange County, only 20% of households were found to be able to purchase a home.

LAEDC added that changing housing preferences aside (e.g., Millennials are more likely to rent and live in urban centers), “these patterns bode poorly for economically stable household and family formation going forward.”

Muni Market Flows

Against this backdrop, LA’s TRANs issuance emerges at a time, when the muni market has been recently enjoying a solid run of fund inflows, despite some recent weakness.

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Analysts at Janney Montgomery observed that apart from “some firmness in shorter maturities, tax-free yields were unchanged during Friday’s holiday-shortened trading session.”

For the week, municipal bonds underperformed the broader taxable markets, and the yield curve steepened, with the 20-year benchmark falling by three basis points to 1.47% while the 30-year yield finished the week higher by two bps.

However, Janney added that despite “relative weakness illustrated by rising municipal to Treasury ratios (10-year = 74.4%), underlying technical factors remain favorable.”

For the week ended May 22, Thomson Reuters/Lipper U.S. Fund Flows reported a net inflow of roughly US$1.42bn into municipal bond funds – not including ETFs such as the iShares National Muni Bond Fund (NYSEARCA: MUB) and the Vanguard Tax-Exempt Bond Fund (NYSEARCA: VTEB).

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The latest inflows follow hot on the heels of around US$1.25bn that entered muni bond funds in the week ended May 15.

In fact, both MUB and VTEB were on the upswing intraday Tuesday, with slight gains that brought the two ETFs to around US$112.55 and US$52.78, respectively, according to the IBKR Trader Workstation (TWS).

The ongoing demand for the municipal debt should provide a decent backdrop for LA’s TRANs issuance if the market remains sufficiently calm.

In the meantime, the US$700m TRANs deal, which offers tax emption at both the California state and federal levels, is due to price in the week of June 3, 2019.

The issuance is being co-led by BofA Merrill Lynch and Morgan Stanley, with Drexel Hamilton, Mischler Financial Group and Stifel acting as co-managers.