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JANUARY 9, 2014

FEATURE ARTICLES
Volcker Rules Effect on Tender Option Bonds a Credit Negative for Municipal Market
The version of the rule adopted in December prohibits banks from participating in tender option bonds as currently structured. TOB providers are seeking alternatives.

MUNICIPAL BANKRUPTCY UPDATE


2 Highlights of Recent Developments
Creditors are challenging a deal Detroit has with UBS and Bank of America, while San Bernardino, CA may look to pension restructuring.

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Single-Employer Pension Plans May Be Easiest to Restructure in Chapter 9 4


A pension plan like Detroits may be simpler to reorganize in Chapter 9 than a CalPERS-style plan burdening bankrupt California cities.

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Boeing Machinists Approve Contract, a Credit Positive for Washington State


In a reversal, Boeing machinists have a deal to build 777X jetliners in Washington state, where the manufacturer is the largest private employer.

General Obligation Spotlight: Alabama


Municipalities issue limited tax debt, while the state constitution has strict limitations on property tax rates and closely regulates revenue sources.

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Courts Offer Contrasting Outcomes for California Cities Seeking to Cut Retirement Benefits
A court upheld restrictions on pension reform in San Jose, while another affirmed San Diegos right to modify non-vested retiree health benefits.

RATING CHANGE HIGHLIGHTS


8 California Department of Water Resources Power Supply Bonds Placed Under Review for Upgrade, Rating Aa3
The review on $6.6 billion of power supply revenue bonds reflects decreasing operating risk.

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New Mexico Supreme Court Upholds Pension Reforms, a Credit Positive for the State and Local Governments
A court decision reduces the adjusted net pension liabilities of the states two cost-sharing pension plans by $2 billion, while also curbing the rate of growth of pension costs.

Mercy Medical Center's (IA) Outlook Revised to Negative, A2 Rating Affirmed


The revised outlook of $118 million in revenue bonds takes deterioration in MSC's operating margins in fiscal year 2013 into account.

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RESEARCH HIGHLIGHTS
Philadelphia School District: Fiscal Stabilization Requires Support of All Major Stakeholders
Moodys Ba2 underlying rating on the Philadelphia School Districts $3.4 billion of long-term general obligation revenue bonds reflects the districts high poverty, sizeable debt burden and history of uneven financial management.

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Greenville Utilities Commissions (NC) Revenue Bonds Upgraded to Aa3 from A1, Outlook Stable
The upgrade of $115 million in revenue bonds factors in the diverse utility revenue stream of the system, which is pledged to bondholders.

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Bon Secours Health System, Inc.'s Outlook to Positive, A3 Rating Affirmed


The outlook change on $790 million reflects expectations that operating margins in 2014 will continue at rates higher than the historical levels.

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Broward County Seaport Enterprise Port Facilities Outlook Revised to Positive, A2 Rating Affirmed
The outlook change on $224 million factors in expectations of increased traffic and operations.

17

Bard College Downgraded to Ba1 from Baa1, Outlook Revised to Negative


The downgrade and outlook change on the $135 million in debt reflect liquidity concerns and the possibility of breaching loan covenants.

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Access our moodys.com public finance landing page at moodys.com/UsPublicFinance

MOODYS.COM

Michael Loughlin Vice President Senior Analyst +1.212.553.4066 michael.loughlin@moodys.com

Volcker Rules Effect on Tender Option Bonds a Credit Negative for Municipal Market
Section 619 of the final version of the Volcker Rule adopted by federal regulators in December prohibits banks from participating in tender option bond (TOB) programs as currently structured. Unless TOB program sponsors find a way to structure TOBs that does not violate the rule, the Volcker Rule will eliminate TOBs when it becomes effective in July 2015. The elimination of the TOB market, currently about $75 billion, would be a credit negative for the municipal bond market because it would put upward pressure on municipal interest rates as TOBs are unwound. On the margin, market volatility would also increase because the market would lose the TOB investor base. A TOB transaction typically involves the deposit of tax-exempt long-term municipal bonds into a trust. The trust issues two classes of securities: floater certificates and residual certificates. Like variable rate demand bonds (VRDB), the floater certificate provides the holder the option, generally on a daily or weekly basis, to tender the floater for purchase at par. On tender dates, a remarketing agent sets an interest rate for the floater certificate at a level it expects will allow for a sale at par. Investors, primarily money market funds, purchase floater certificates based mainly on a liquidity providers commitment to purchase any floater certificates that are not successfully remarketed. Residual investors receive all interest on the underlying bond minus whatever is paid to floater certificate holders. From a business perspective, the residual investor holds the underlying bond with financing provided by investors in the floaters. Residual certificates are typically held by the program sponsor, a mutual fund or a hedge fund. Banks participate in every TOB program as sponsor, residual investor and/or liquidity support provider, in many cases all three. The removal of TOB programs as buyers of municipal bonds as well as the unwinding of existing TOB trusts between now and July 2015 will put upward pressure on municipal interest rates by eliminating a source of demand and by increasing supply. Higher rates would be credit negative for the municipal issuers, particularly for those with significant borrowing needs. Redistribution of $75 billion mostly fixed rate municipal bonds currently held by TOB programs is effectively incremental secondary market supply equal to more than 20% of the new issue supply projected for 2014 (see Exhibit 1).
EXHIBIT 1

Unwinding of TOB Market Would Increase Supply Into the Market


Amount of annual issuance; $ billions
Total Municipal Issuance 500 400 300 200 100 0 2010 2011 2012 2013 Est. 2014 TOB Market

Source: Securities Industry and Financial Markets Association (SIFMA)

The elimination of the TOB market would also be a negative for tax-exempt money market funds that rely on such investments to remain fully invested within strict average maturity and diversification requirements. At a total of about $270 billion outstanding, tax-exempt money market funds represent the primary buyer of TOB floater certificates. Without TOB floaters some tax-exempt money market funds may not be able to stay fully invested (see Exhibit 2) in tax-exempt securities.

MOODYS WEEKLY CREDIT OUTLOOK: US PUBLIC FINANCE EDITION

JANUARY 9, 2014

EXHIBIT 2

Without TOB Market Tax Exempt Funds Pressed in Decreasing Variable Rate Demand Obligation Market
Size of the Tax Exempt Money Market Funds and Municipal VRDO markets; $ billions
Total Tax Exempt Money Market Funds 500 450 400 350 300 250 200 150 100 50 0 2010 2011 2012 2013 Municipal VRDO Market

Source: Securities Industry and Financial Markets Association (SIFMA)

MOODYS WEEKLY CREDIT OUTLOOK: US PUBLIC FINANCE EDITION

JANUARY 9, 2014

Nicole Johnson Senior Vice President +1.212.553.4573 nicole.johnson@moodys.com Andrea Unsworth Analyst +1.415.274.1706 andrea.unsworth@moodys.com

Boeing Machinists Approve Contract, a Credit Positive for Washington State


On January 3, the Boeing Company (A2 stable) machinists approved the companys proposed contract extension, securing the companys assembly of its new 777X jetliners in the state of Washingtons (Aa1 stable) Puget Sound region. Workers narrowly approved (51% to 49%) a proposal similar to one they rejected in November. The vote solidifies Boeings presence in Washington, where it is the largest private employer, and is credit positive for the state and the Puget Sound region. Although Boeing made some concessions in the new contract, the rapid vote reversal largely reflects the companys willingness to relocate in another state depending on the contract outcome. Following the failed November vote, Boeing pursued incentives offered by several other states to move production. At least 22 states, including California, Missouri and South Carolina, wooed Boeing, and some offered subsidies worth billions of dollars. Had Boeings production moved from Washington, it would have been credit negative for the state. Boeings 86,000 workers in Washington account for about 3% of the states labor force. The states total aerospace-related employment is approximately 130,000. Boeings backlog of customer orders is worth $356 billion, fueling the addition of more than 4,000 jobs in the region over the past two years. The jobs have been crucial to the regions vibrant labor market and its rebound from the economic downturn, although the states economic forecast reflects modest declines in aerospace employment over the next four years. Boeing and its suppliers, employees and other related companies generated approximately $76 billion in total sales across the state and $20 billion in employee incomes, including benefits, in 2012. The revised contract extends through 2024 a November 2011 labor agreement that was set to expire in 2016. It adds a $5,000 onetime payment to each worker in January 2020, on top of the $10,000 signing bonus previously promised upon ratification, and preserves the current six-year progression to full pay rather than extending the period to at least 16 years. It also freezes pension benefits and moves workers from a defined benefit to a defined contribution retirement savings plan. As part of the 2011 agreement, Boeings union withdrew a complaint lodged with the National Labor Relations Board over the companys decision to locate a production line in South Carolina, significantly reducing the likelihood of a strike. Following the recent vote, Boeing confirmed plans to assemble its next airplane, the 777X, and build its new wing in Washington, where it has been for nearly 100 years, ensuring that thousands of high-paying, highly skilled aerospace manufacturing jobs will stay in the Puget Sound region. To help win the 777X, Washington offered to extend tax incentives that were scheduled to expire at the end of the fiscal year ending June 30, 2024. The extensions will save aerospace-related companies an estimated $8.7 billion between fiscal 2025 and 2040, the largest corporate tax break any state has ever bestowed upon an industry. The largest beneficiary is Boeing. In turn, the state expects the aerospace industry will generate $21.3 billion in direct and indirect fiscal benefits to the state over that period from additional business and occupation, sales and other state taxes. Since Washington does not levy an income tax, it relies heavily on a sales tax (48% of 2013 general fund revenues) and business and occupation tax (21% of 2013 general fund revenues). Boeing and other supporting companies paid the state a total of $544 million in various taxes in 2012, as shown in the exhibit.

MOODYS WEEKLY CREDIT OUTLOOK: US PUBLIC FINANCE EDITION

JANUARY 9, 2014

Washington State Estimated Taxes from Aerospace


$600 $500 $400

$ Millions

$300 $200 $100 $0 2004 2005 2006 2007 2008 2009 2010 2011 2012

Note: Estimated taxes include business and occupation, sales and other taxes. Source: Washington State Aerospace Industry Economic Impact Study, November 2013

MOODYS WEEKLY CREDIT OUTLOOK: US PUBLIC FINANCE EDITION

JANUARY 9, 2014

Tom Aaron Analyst +1.312.706.9967 thomas.aaron@moodys.com

Courts Offer Contrasting Outcomes for California Cities Seeking Retirement Benefit Cuts
In late December, California judicial decisions offered contrasting views on a municipalitys ability to alter retirement benefits. A court upheld restrictions on pension reform in San Jose (Aa1 stable 1), while another affirmed San Diegos (Aa3 stable) right to modify non-vested retiree health benefits. The credit implications are mixed for San Jose as the city will continue to realize $20 million in annual savings from some aspects of a 2012 reform initiative, according to the mayor. However, the city will be unable to achieve further savings called for by voters. San Diego will continue to benefit from retiree healthcare savings implemented in 2010, which at the time lowered its other post-employment benefits (OPEB) unfunded liability by 31% to $969 million, a credit positive. On December 23, a lower court ruled that certain provisions of a voter-approved reform measure in San Jose were invalid because they illegally impaired benefits. On December 26, a state appellate court upheld a ruling in favor of San Diegos ability to modify non-vested retiree health benefits. The decisions underscore a distinction between vested pension benefits, which cannot be modified even through a voter initiative, and non-vested OPEBs, which California local governments have flexibility to reduce. In San Jose, the judge blocked the city from suspending retiree cost-of-living adjustments (COLAs) and mandating that employees increase pension contributions or accept lower benefits for future work. The judge did leave in place the elimination of supplemental pension payouts and increases to employee contributions toward OPEBs, prompting the mayor to assert a continued $20 million in annual savings. The San Jose ruling upholds protections both for pension benefits that have already been earned and will be earned going forward. This locks municipal employers into the same or a more expensive benefit formula for the length of service. The San Jose mayor has proposed an amendment to the states constitution to allow pension benefit reductions for future work. Our projections show the provision could generate pension savings by reducing growth in actuarial accrued liabilities (AALs). The cost for funding one hypothetical workers pension could be trimmed by thousands of dollars annually. The liability at retirement could be lowered by hundreds of thousands of dollars, if five years into this employees career, the benefit formula were reduced from 3% of final average salary at age 65 to 2% (see Exhibit 1).

All ratings are for general obligation debt.

MOODYS WEEKLY CREDIT OUTLOOK: US PUBLIC FINANCE EDITION

JANUARY 9, 2014

EXHIBIT 1

Changes to Pension Benefit Formulas for Future Work Could Generate Significant Savings
AAL - 3% @ 65 Normal Cost - 2% reform begin at age 31 $18,000 $16,000 $14,000 AAL - 2% Reform Begin Age 31 Normal Cost - 3% @ 65 2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 25 30 35 40 45 Age 50 55 60

$12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $-

Source: Moodys. Assumptions: entry age of 25, $50,000 salary at age 30, retirement age of 65, 3% and 2% benefit multipliers of fiveyear final average salary, Entry Age Normal cost method, 7.75% discount rate, 3% annual salary growth, 3% COLA, mortality age 85.

In San Diego, a state lower courts ruling affirmed the citys reduction of retiree health benefits. The decision upheld a 2010 freeze of OPEB benefits for San Diego employees, which at the time lowered the citys OPEB unfunded liability from $1.4 billion to $969 million. Under the citys charter, changes to the pension system require a vote of employees and retirees. But the court affirmed that OPEBs are not provided under the citys pension system and do not require a vote to be changed. The San Diego ruling also relied partly on a federal Ninth Circuit Court of Appeals decision that OPEBs in San Diego are not protected contract rights, but are a term of employment that can be changed. Conversely, a recent ruling found that OPEBs for certain employees in Los Angeles (Aa2 stable) are contractually protected. That ruling concluded that sections of the citys Administrative Code signal a legislative intent to grant a vested right to retiree health benefits, unlike the case of San Diego. For more information on Moodys insights on employee pensions and the related credit impact on companies, governments, and other entities across the globe please visit Moodys on Pensions at www.moodys.com/pensions.

MOODYS WEEKLY CREDIT OUTLOOK: US PUBLIC FINANCE EDITION

JANUARY 9, 2014

$ in Millions

$ Dollars

Grayson Nichols Analyst +1.214.979.6851 john.nichols@moodys.com

New Mexico Supreme Court Upholds Pension Reforms, a Credit Positive for the State and Local Governments
On December 19, the New Mexico Supreme Court upheld recent pension reforms enacted by the state last July, rejecting a challenge by retirees. The courts decision is credit positive for New Mexico (Aaa stable) and local governments in the state because it upholds measures that reduced the adjusted net pension liabilities (ANPL) of the states two cost-sharing pension plans by $2 billion, or 8%. The reform measures also curb the rate of growth of pension costs for participating governments. The New Mexico legislature passed two bills in July to reform the Public Employees Retirement Association (PERA) and Educational Retirement Board (ERB). The reforms reduced cost-of-living adjustments(COLAs) and increased employee contribution rates. As reported by the pension plans, fiscal 2013 unfunded accrued actuarial liability (UAAL) declined by an estimated $1.7 billion for PERA over the prior year, but ERBs UAAL only declined by $6.7 million because its COLA was not reduced as much. By increasing employee contributions, the reforms also enabled a reduction in the rate of growth of employer contributions. According to our calculations that make various adjustments to reported UAAL, PERAs ANPL declined by $4.4 billion in fiscal 2013, reversing 68% of the increase from the prior year (see Exhibit 1). The ERBs ANPL declined by $1.9 billion. About $2 billion of the two plans combined $6.3 billion reduction in ANPL in fiscal 2013 is due to the positive impact of the reforms. The remaining reduction was fueled by strong investment performance over the year and the higher interest rates used to calculate the present value of the liabilities. We derive ANPL figures by making adjustments to reported numbers, such as applying a market-based interest rate (the Citibank Pension Liability Index) to estimate the present value of liabilities. The index rose to 4.81% as of June 30, 2013 from 4.13% a year earlier, and accounted for the largest portion of the ANPL decline for both plans.
EXHIBIT 1

Adjusted Net Pension Liability


PERA $17,000 $15,000 $13,000 ERB PERA without reform ERB without reform

Millions

$11,000 $9,000 $7,000 $5,000 6/30/2010 6/30/2011 6/30/2012 6/30/2013

Source: Preliminary pension valuation data and our pension adjustments, as explained in (Adjustments to US State and Local Government Reported Pension Data)

Despite the recent improvement, the average ANPL of a contributing local governmental entity of PERA and ERB is approximately three-times its operating revenues, which is significantly higher than the national median of onetime. Going forward, even with the reforms, the unfunded liabilities will remain elevated, which will be a continued source of risk to local governments participating in the plans. Mending the large liabilities would likely require deeper cuts to benefits, more substantial increases in employer and employee contributions, or having a sustained multi-year trend of making contributions at full actuarial required levels.

MOODYS WEEKLY CREDIT OUTLOOK: US PUBLIC FINANCE EDITION

JANUARY 9, 2014

The level that participating local governments contribute to the plans is set by the state. Historically, the state has set contribution levels much lower than what is actuarially required, which is a major reason why the unfunded liability is so high. The upheld reforms instituted last July raise contribution levels (see Exhibit 2), but not enough to reach levels prescribed by actuarial standards. To meet these standards, PERA and ERB would each need to increase annual statutory contribution rates by 4.3% in order to fully close unfunded liabilities over the next 30 years.
EXHIBIT 2

Shifts Increase Amortization and Employer Pension Costs


PERA FY 2012 FY 2013 FY 2012 ERB FY 2013

Member Contribution Rate

11.24% 9.58% 4.30% 13.88%

12.04% 6.88% 7.71% 14.59%

9.40% 4.39% 6.51% 10.90%

10.10% 3.06% 10.09% 13.15%

Employer Normal Cost Rate Amortization Rate Total Employer Contribution Rate

Source: PERA and ERB Fiscal Year 2013 Annual Actuarial Valuations

New Mexico is one of several of states that have enacted COLA changes affecting retirees and existing employees. Legal challenges to COLA reductions are currently in progress in a number states, such as Illinois and Montana, though these will be decided in the context of the legal framework in each state and will not be directly affected by the decision in New Mexico. For more information on Moodys insights on employee pensions and the related credit impact on companies, governments, and other entities across the globe please visit Moodys on Pensions at www.moodys.com/pensions.

MOODYS WEEKLY CREDIT OUTLOOK: US PUBLIC FINANCE EDITION

JANUARY 9, 2014

MUNICIPAL BANKRUPTCY: UPDATE & INSIGHTS


This marks the second monthly section on municipal bankruptcy offering updates and analysis on whats happening with Detroit, Stockton and other high-profile distressed local governments. We welcome your feedback at munibankruptcytaskforce@moodys.com.

Highlights of Recent Developments


DETROIT, MI (Caa3 NEGATIVE 2) Judge Reviews Proposed Swap Deal With UBS/Bank Of America Detroit has renegotiated with swap counterparties UBS and Bank of America to lower the swap termination payment to $165 million, $65 million less than the original deal. The payment would be financed by new debt. Bond insurers and other creditors are challenging the agreement, and the parties await a ruling from the presiding judge.

Detroits mediation with multiple classes of creditors continues as the parties seek to reach compromises
before the city files its plan of adjustment, expected this month. water and sewer system.

The citys negotiation with suburban leaders continues regarding a possible long-term lease of the citys Recent Publications:
1. Court Approval of Detroit Public Lighting Authority Issuance is Credit Negative 2. Detroit Eligible for Bankruptcy; Pensions Will Not Be Protected, but Debt Priority Remains Unclear HARRISBURG, PA (UNRATED) City Erases Nearly $500 Million in Debt, Remains under State Control

The state-appointed receiver filed closing papers with Pennsylvanias Commonwealth Court on December
23 that erased approximately $492 million of debt and restructured an additional $100 million through the sale of the city waste-to-energy incinerator, a 40-year lease of parking assets and creditor haircuts. million. Both transactions involved the sale of new bonds to extinguish outstanding indebtedness of the Harrisburg Authority, which operated the troubled waste-to-energy incinerator.

The centerpiece of agreements concluded on December 23 were two bond transactions totaling $415

The city will remain under the control of the receiver until at least mid-2014.
JEFFERSON COUNTY, AL (Caa3 REVIEW FOR UPGRADE) Emerges From Bankruptcy, Exit Plan on Appeal Exited bankruptcy on December 3 by retiring $3.1 billion in defaulted sewer warrants and by issuing $1.78 billion in new sewer warrants. Warrant-holders had a 35%-65% recovery rate.

The countys general obligation limited tax debt was also in default. We now expect debt service payments
to resume.

All ratings are for general obligation debt unless otherwise indicated.

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MOODYS WEEKLY CREDIT OUTLOOK: US PUBLIC FINANCE EDITION

JANUARY 9, 2014

One group of ratepayers, the Bennet group is appealing the confirmation of the countys exit plan and
prior court rulings, while another, the Wilson group has dropped their appeal. SAN BERNARDINO, CA (UNRATED) Mediation Continues, CalPERS Appealing Eligibility Mediation is scheduled to resume between the city and multiple parties on January 9 and 10.

California Public Employees Retirement System (CalPERS) is participating in the mediation, while also

opposing the citys eligibility for bankruptcy. Last month, a federal judge gave CalPERS approval to appeal to the 9th Circuit Court of Appeals. employees and retirees, bringing a direct challenge to CalPERS. The citys efforts could be emboldened by a Detroit ruling that pension agreements are contracts and are subject to impairment in bankruptcy proceedings.

Questions remain whether San Bernardino will look to Chapter 9 as a way to trim pension liabilities for

STOCKTON, CA (LEASE REVENUE Caa3 DEVELOPING) Negotiations Continue With Key Creditor In Advance Of Confirmation Hearing A court hearing to confirm exit plan is scheduled for March 5.

The citys plan faces a challenge from Franklin Advisers, Inc., which holds $35 million of the citys bonds
and would get less than 1% of par under Stocktons proposal. If Franklin does not approve the plan, the city will likely seek a cram down.

Stockton has not proposed pension reductions in bankruptcy.

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MOODYS WEEKLY CREDIT OUTLOOK: US PUBLIC FINANCE EDITION

JANUARY 9, 2014

Emily Korot Assistant Vice President-Analyst +1.212.553.3806 emily.korot@moodys.com

Single-Employer Pension Plans May Be Easiest to Restructure in Chapter 9


Treatment of public employee pensions in Chapter 9 suggests that single-employer plans like Detroits may be simpler to reorganize than multi-employer agent or cost-sharing plans, which involve more parties. Along with Detroit (Caa3 negative), where a judge ruled in December that pensions are contracts that can be impaired in bankruptcy, we find a guide in the bankruptcies of Central Falls, RI (B1 positive), Stockton, CA (lease revenue Caa3 developing) and Vallejo, CA (not rated). Depending on how its case progresses, San Bernardino, CA (not rated) may create a counterexample through altering an agent plan. Defunct Michigan school districts underscore the difficulties in restructuring a cost-sharing plan. Exhibit 1 summarizes the various types of municipal pension plans:
EXHIBIT 1

Three Types of Local Government Pension Plans


Characteristics Single-Employer Agent Cost-Sharing

Number of participating municipalities Administration and asset management Benefit determinations Sample municipality

One Municipality Municipality Detroit and Central Falls

More than one Independent agent-fiduciary, e.g. CalPERS Municipality from menu of options agent provides Vallejo, Stockton and San Bernardino

Several The plan The plan Michigan public school districts

For a more detailed discussion of pension plan types, see our Pension Landscape publication. Single-Employer Plans May Be Easier To Restructure Than Agent Plans In Central Falls, which emerged from bankruptcy in 2012, the city conducted negotiations on cutting benefits to its single-employer plan. Central Falls retirees were not represented by unions who could defend their interests with a unified voice. Additionally, Rhode Island passed a law giving bondholders greater statutory protections than retirees. Pensioners voted in favor of reductions by as much as 55%. While an outcome in Detroit is pending, the judges decision on pension impairment will likely encourage the city to look into cutting benefits.
EXHIBIT 2

Pension Plan Type Appears Correlated With Impairment of Benefits


Reported Unfunded Liability in 000s ( year reported )

City

Plan Type

Treatment

Impaired (%)

Detroit Central Falls Vallejo Stockton San Bernardino

Single-employer Single-employer Agent Agent Agent

$643,754 (2012) $148,158 (2011) $146,577 (2011) $171,935 (2011) $160,732(2011)

Likely Impaired Impaired Unimpaired Likely Unimpaired TBD

TBD 55% 0% 0% TBD

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MOODYS WEEKLY CREDIT OUTLOOK: US PUBLIC FINANCE EDITION

JANUARY 9, 2014

California Cases Offer Examples of Difficulty in Cutting Agent Plans CalPERS (the California Public Employees Retirement System, issuer rating Aa3) offers an example of a large, state-sponsored agent that has vigorously acted to protect pensions of its retirees, and current and future members. CalPERS administers agent plans for Vallejo, Stockton and San Bernardino. Agent plans inject a third party into the relationship between cities and public employees/retirees. A third party like CalPERS, may, through a combination of its legal status and mission, be more aligned with retirees than with distressed cities. State laws favoring retirees may also play a role in creating conflicts between cities and these fiduciaries. The well-financed agents may be better organized and able to press their cases through litigation more aggressively than retirees in single-employer plans, who lack the same bargaining power. CalPERS has publicly drawn distinctions between pension obligations in California and Michigan. It argues that unlike Michigan, where the judge ruled that public employees rights to their pension is by contract that can be impaired in bankruptcy courts, CalPERS administered pensions are outside of a bankruptcy courts jurisdiction. CalPERS strategy of defending pension rights has proven successful thus far by deterring cities from seeking to reduce or halt contributions to its plans. Vallejo opted not to challenge CalPERS before emerging from bankruptcy in 2011. Stockton is following the same path as it looks towards an exit in 2014. Compton (not rated), which has not filed for Chapter 9, issued a $10 million tax and revenue anticipation note to cover delinquent payments to CalPERS to avoid a costly legal battle. Following CalPERS lead, agents in other states may use or advocate a similar litigation strategy. San Bernardino May Be California Game Changer CalPERS is moving to appeal San Bernardinos bankruptcy eligibility to the 9th Circuit of Appeals. If San Bernardino is successful in restructuring its liability to CalPERS, it could embolden other distressed municipalities in agent plans, in California and elsewhere, to consider bankruptcy as an avenue to reduce their pension obligations. Cost-Sharing Plans Could Complicate Reorganization The pooled nature of cost-sharing plans reduces the likelihood that local government participants would be able to impair benefits. In Michigan, both Buena Vista (not rated) and Inkster (not rated) school districts were dissolved in 2013 amidst deteriorating finances and enrollment erosion. Any unfunded liability associated with former employees of the districts must be made up by contributions from employers remaining in the pool. We see a similar trend emerging in Pennsylvania as growth in charter schools shifts covered payroll away from school districts. Historically, employer contributions have been well below actuarial requirements, resulting in rapidly growing employer pension costs to shore up employee costsharing plans. While the state and school districts struggle to absorb rising contribution requirements, employee benefits are unlikely to be reduced.

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MOODYS WEEKLY CREDIT OUTLOOK: US PUBLIC FINANCE EDITION

JANUARY 9, 2014

Sarah Jensen Associate Analyst +1.214.979.6846 sarah.jensen@moodys.com

General Obligation Spotlight: Alabama


Alabama Constitution Limits Full Faith and Credit Pledge; State Legislature Must Approve Property Tax Increases Jefferson Countys (Caa3, review for upgrade) emergence from bankruptcy in late 2013 has spurred interest in general obligation (GO) bondholder protections in Alabama. GO debt issued by local governments is in the form of limited tax bonds or warrants. While these instruments carry an irrevocable full faith and credit pledge that applies to all of a local governments available financial resources, they do not include an explicit promise to raise property taxes or other revenues. Moreover, the Alabama Constitution has strict limitations on local property tax rates and closely regulates other local revenue sources. The difference between Alabama GO bonds and warrants is that bonds require voter approval. Both carry the same security pledge (see Exhibit 1).
EXHIBIT 1

Alabama General Obligation Pledge


Bonds Warrants

Full Faith and Credit Statutory Lien Ad Valorem Tax (State Legislature & Voter Approval Requirements) Voter Approval Required to Issue

Yes No Yes Yes

Yes No Yes No

The Alabama Constitution limits the rate and dollar amount of an ad valorem tax levy for each class of property. Property taxes are limited to a certain percentage of a propertys value based on the fair and reasonable market value, and most jurisdictions levy taxes at the maximum rate. Under Amendment 373 of the Alabama constitution, an Alabama local government can increase the maximum rate if the proposal is vetted through public hearings, and if approved by a public referendum and the state legislature. These requirements create significant barriers to increasing property tax rates. Beyond property taxes, other Alabama local government revenues that are legally available to pay GO debt service can include sales and use taxes, occupational and business license taxes, permit fees, court fines and fees, lease taxes and revenues from operation of government-owned enterprises. Sales tax revenues are often a significant revenue source for many municipalities. Paying bonds from these revenues is consistent with a full faith and credit pledge, though none of these revenues are specifically pledged as security for bonds or warrants. Hence, there is no statutory lien on these revenues. While local governments have latitude to raise rates for non-property taxes, these taxes must be levied in accordance with state law. A prime example of the risk of noncompliance is the state supreme courts invalidation of Jefferson Countys occupational and business license taxes in 2011. The loss of these major revenue sources (approximately 30% of total county General Fund revenues) was a primary driver for Jefferson Countys bankruptcy filing in 2011. Despite limitations on revenue-raising, local governments have significant authority to cut expenditures to help mitigate budget pressures. Alabama is a right-to-work state, and municipalities have a long history of cutting services and workforces to balance budgets. Alabama has an unusually high rate of municipal bankruptcies, although most have occurred in small cities and towns. Over the past 25 years through 2013, seven of the 44 municipal bankruptcies have been in Alabama (see Exhibit 2).

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MOODYS WEEKLY CREDIT OUTLOOK: US PUBLIC FINANCE EDITION

JANUARY 9, 2014

EXHIBIT 2

Notable Municipal Bankruptcy Filings


1991 1992 1996 1999 2004 2011 City of Lipscomb Town of North Courtland Greene County City of Prichard (also filed in 2009) Town of Millport Jefferson County

DEFINITION OF THE MONTH


Automatic Stay: A legal action that goes into effect immediately upon a bankruptcy filing and relieves a debtor from its debt service obligations. Creditors often suffer defaults as a result. The automatic stay remains in effect until the case is dismissed or concludes through the confirmation of a plan and discharge. Bonds backed by a pledge of special revenues are exempt from the automatic stay. Special revenues are generated by a specific project or system. They are, generally, water, sewer and electric utility revenues derived from specific projects, as well as property and sales taxes dedicated to specific projects. Special revenues do not include general property or sales taxes. In the Detroit, Stockton, Vallejo and Sierra Kings bankruptcy cases, the cities continued making debt service payments on special revenue bonds after initiating Chapter 9 proceedings. For Jefferson Countys case, special revenues were not sufficient to cover debt service, so sewer warrant-holders received partial payments after a court ruled that obligations were supported by a special revenue pledge of the sewer system.

OTHER CONTACTS Greg Lipitz, VP-Senior Credit Officer, +1.212.553.7782, gregory.lipitz@moodys.com Naomi Richman, Managing Director, +1.212.553.0014, naomi.richman@moodys.com Jack Dorer, Managing Director, +1.212.553.1332, jack.dorer@moodys.com Alfred Medioli, VP-Senior Credit Officer, +1.212.553.4173, alfred.medioli@moodys.com Genevieve Nolan, AVP-Analyst, +1.312.706.9957, genevieve.nolan@moodys.com ASSOCIATE ANALYSTS Sarah Jensen, Associate Analyst, +1.214.979.6846, sarah.jensen@moodys.com Michael Alter, Associate Analyst, +1.212.553.4180, michael.alter@moodys.com

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MOODYS WEEKLY CREDIT OUTLOOK: US PUBLIC FINANCE EDITION

JANUARY 9, 2014

RESEARCH HIGHLIGHTS
Philadelphia School District: Fiscal Stabilization Requires Support of All Major Stakeholders Moodys underlying rating (Ba2 negative) on the Philadelphia School Districts $3.4 billion of long-term general obligation and GO-backed lease revenue bonds reflects the districts high poverty, sizeable debt burden and history of uneven financial management. The districts fiscal difficulties have recently intensified due to slow growth in state and local revenues, enrollment losses to charter schools and reduced federal funding. The enhanced ratings (Aa3 stable) on the districts GO and lease revenue bonds remain unaffected by the districts credit stress, given ample amounts of interceptable state aid to cover annual debt service.

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MOODYS WEEKLY CREDIT OUTLOOK: US PUBLIC FINANCE EDITION

JANUARY 9, 2014

RATING CHANGE HIGHLIGHTS


California Department of Water Resources Power Supply Bonds Placed Under Review for Upgrade, Rating Aa3 Dec. 20 We placed under review for upgrade the Aa3 rating on the California Department of Water Resources power supply revenue bonds, totaling approximately $6.6 billion. As power contracts expire, the operating risk decreases, while the power bonds continue to benefit from the California Public Utilities Commissions supportive cost recovery, with the CPUC approving annual rate filings. Mercy Medical Center's (IA) Outlook Revised to Negative, A2 Rating Affirmed Jan. 6 As we affirmed the A2 rating on the revenue bonds of Mercy Medical Center, issued through the Iowa Finance Authority and City of Cedar Rapids, we revised the outlook to negative from stable, affecting $118 million. The outlook change was driven by significant deterioration in Mercycare Service Corporation and Related Organizations (MSC's) operating margins in fiscal year 2013, with challenges continuing into interim fiscal year 2014. The affirmation reflects MSC maintaining strong balance sheet ratios, its location in a quality service area, and the track record of good operating results it had prior to fiscal year 2013. Greenville Utilities Commissions (NC) Revenue Bonds Upgraded to Aa3 from A1, Outlook Stable Dec. 30 We upgraded the rating on Greenville Utilities Commission's $115 million in revenue bonds to Aa3 from A1. The upgrade factors in the diverse combined utility revenue stream of the system, which is pledged to the bondholders, particularly the strength of the electric revenues. The rating further reflects continued stability in the commission's financial operations, growth in the service area, with stability anchored by the presence of institutions and a manageable debt burden with rapid retirement. The outlook is stable. Bon Secours Health System, Inc.'s Outlook to Positive, A3 Rating Affirmed Dec. 27 As we affirmed the A3 rating on the bonds of Bon Secours Health System Inc. (headquartered in Maryland), totaling $790 million, we changed the outlook to positive from stable because we expect that operating margins in 2014 will continue at their 2012 and 2013 levels, higher than the historical levels. We expect solid cash flow and growth in unrestricted investments to improve BSHSIs risk profile. The A3 rating continues to reflect BSHSIs size and cash flow diversity as a $3.3 billion multistate healthcare system. Broward County Seaport Enterprise Port Facilities Outlook Revised to Positive, A2 Rating Affirmed Dec. 26 As we affirmed the A2 rating on Broward County's Seaport Enterprise (FL) Port Facilities revenue bonds, totaling $224 million, we revised the outlook to positive from stable. We expect the port to have stable revenue growth, supported by cruise operations, container traffic, petroleum distribution, while a large share of its revenues are under long-term contracts. Other credit supports include the ports minimum annual revenue guarantees and demonstrated state and federal support for the port's expansion plan. Bard College Downgraded to Ba1 from Baa1, Outlook Revised to Negative Dec. 19 We downgraded the rating on Bard College to Ba1 from Baa1 and revised the outlook to negative, affecting $135 million. The colleges liquidity is exceedingly thin, with operating lines of credit fully drawn down, cash and investments outside of sizeable investments held in trust declining materially, and weakening cash flow. The negative outlook considers the possibility that the college's liquidity will not materially improve and could breach loan covenants. It also reflects a growing reliance on lines of credit to finance operations and capital needs in advance of the receipt of pledge payments. The college has an entrepreneurial operating model that continues to grow its expense base and exposure to philanthropy.

17

MOODYS WEEKLY CREDIT OUTLOOK: US PUBLIC FINANCE EDITION

JANUARY 9, 2014

CREDIT RATINGS & ANALYSIS


Michel Madelain President and Chief Operating Officer Michael Rowan Managing Director, Global Public, Project & Infrastructure Finance Gail Sussman Managing Director, US Public Finance John Nelson Director of Research, Global Public, Project, Infrastructure Finance Christopher Holmes Director of Research, US Public Finance

State Government Ratings


Robert Kurtter Managing Director, US Public Finance Tim Blake Managing Director, US Public Finance

EDITORIAL CONTENT
Crystal Carrafiello Senior Vice President, Rating Communications Robert Cox Senior Editor, Rating Communications

Healthcare, Higher Education, Not-for-Profits


Kendra Smith Managing Director, US Public Finance

MARKETING & PRODUCT STRATEGY


John Walter Director, Senior Product Strategist Sara Harris Assistant Director, Product Strategist

Housing
Kendra Smith Managing Director, US Public Finance

PRODUCTION
Jason Lee Vice President, Production

Local Government Ratings


Jack Dorer Managing Director, US Public Finance Naomi Richman Managing Director, US Public Finance

Public Infrastructure
Chee Mee Hu Managing Director, Project Finance

WEBSITE

www.moodys.com

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