llion fiscal twoyear budget for 2012-13 that largely relies on spending cuts to close a projected $3.6 billion gap. If enacted, the budget will be credit positive for Wisconsin (general obligation Aa2 stable) by bringing the state¡¯s finances closer to a structural budgetary balance. However, passing the budget will be no easy feat. The governor objects to new or increased taxes, has proposed eliminating collective bargaining rights for public-sector employees, and is determined to reduce government spending. Democratic-party state legislators, staunchly opposed to the elimination of collective bargaining rights as well as the significant cuts in the budget, have fled Wisconsin. Their absence legally prevents the state from taking action on any fiscal legislation. Local government units facing burden of spending cuts and tax constraints. The state¡¯s $3.6 billion budget gap, at 13% of spending, is about average for states for fiscal year 2012. Many states are struggling to adopt balanced budgets while dealing with the phase-out of federal stimulus aid, weak revenue growth, and significant spending pressures. The governor¡¯s biennium budget proposal incorporates spending reductions in school aid ($749 million), Medicaid ($500 million), higher education ($250 million), and local government aid ($96 million). The cuts in primary school aid and local government aid are accompanied by measures that severely limit local entities¡¯ ability to increase local property taxes. The limitation on raising property taxes reduces local governments¡¯ and school districts¡¯ ability to offset the proposed cuts in state aid, but is mitigated by the governor¡¯s controversial call for increased public employee contributions to pension and retiree healthcare plans. Under Governor Walker¡¯s budget, certain public employees will be required to contribute 5.8% of their salary to the pension system and 12% of their salary to the retiree healthcare system; currently, public employees contribute a significantly lower amount to both the pension and retiree healthcare plans, although the amounts differ among various unions. Governor Walker¡¯s proposal would equalize the contributions, increasing all of them. The increased contributions are projected by the governor to bring an additional $300 million in savings to the state general fund. Additionally, the increased contributions would give local governments and school districts budget savings, alleviating spending pressure on local governments and making it easier for schools and municipalities to absorb the state aid cuts without increasing property taxes. Wisconsin experienced significant revenue declines during the recession, made worse by rising expenditure costs, primarily in Medicaid. In the current fiscal 2009-11 biennium, the state resolved a $6.3 billion budget gap with a mix of revenue increases, spending reductions, and federal stimulus funds. With just three months remaining in the current biennium, the state has to close a budget gap of $137 million. The governor previously proposed a budget repair bill that authorized a debt refunding to achieve $165 million in budget savings immediately. The budget repair bill has not been approved by the legislature because a provision in the bill would eliminate collective bargaining for certain public employees, which Wisconsin¡¯s Democratic state legislators strongly oppose. At this time, the governor¡¯s fiscal 2012-13 budget proposal incorporates solutions for the current year $137 million gap.
35
MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Enactment before the end of the current fiscal year would be credit positive. A budget resolution (at least for the current-year gap) has to be made before the end of the current fiscal year on 30 June. While the new fiscal year begins on 1 July, the state has a history of late budget adoption and given the difficult and contentious fiscal and political environment, budget adoption is likely to be delayed again.
Dmitriy Plit Analyst +1.212.553.7463 dmitriy.plit@moodys.com
Congressional Proposal Significantly Weakens Public Housing Authority Credit
Last Tuesday, the US Senate put on its legislative calendar the proposed Full-Year Continuing Appropriation Act of 2011, which would significantly reduce funding to the Public Housing Capital Fund administered by the Department of Housing and Urban Development. The legislation, which passed the House on 19 February, proposes a 42.9% reduction from the 2010 funding level. Such a reduction is credit negative for the public housing sector, as it will result in a considerable erosion of debt service coverage levels. Public Housing Authority (PHA) capital fund financings are bonds issued by, or on behalf of, PHAs and rely on federal appropriations as their primary source of debt repayment. Since the bonds are repaid solely from capital fund allocations, adequate appropriations to the capital fund are vital in maintaining sufficient coverage levels and directly affect an issuer¡¯s ability to repay the bonds. Annual funding levels are appropriated by Congress and distributed by HUD via a formula to approximately 3,200 PHAs. As shown in the exhibit below, the funding for the program has been volatile, with six years of consecutive cuts in federal appropriations from 2002-07, followed by stabilization in 2008-10. Public Housing Authority Funding 2001-2011
Federal Fiscal Year Appropriation (In Billions) % Change
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 (proposed)
Source: HUD Office of Public and Indian Housing
$2.99 $2.84 $2.71 $2.70 $2.58 $2.46 $2.44 $2.44 $2.45 $2.50 $1.43
-5.0% -4.6% -0.6% -4.3% -4.5% -1.0% 0.0% 0.5% 2.0% -42.9%
At the time of issuance, PHA bonds generally have at least 3x coverage of debt service by the individual PHA¡¯s capital fund allocation. This debt service coverage level is meant to allow the debt to withstand the risk of deep cuts, up to a two-thirds cut on average, in appropriation levels. However, the extent of the proposed 42.9% decrease in funding in one year is well above our baseline assumption supporting the ratings on these bonds.
36
MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
If the proposed appropriation is enacted into law, we expect significant deterioration in coverage levels, as the PHA bonds would have less ability to withstand further cuts in appropriations in the future. Only those bonds with high current debt service coverage levels (above the 3x following the proposed reduction in funding) will maintain sufficient coverage to absorb future reductions and are likely to maintain their current rating levels. For most of the sector, which includes 20 bond financings with current ratings ranging from Aa2 to A2, and approximately $927 million of aggregate bonds outstanding, we would expect to see downgrades of one to seven or more notches if the legislation is enacted, owing to their sharply reduced debt service coverage.
37
MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS Securitization
Lori Marks Assistant Vice President - Analyst +1.212.553.1098 lori.marks@moodys.com
Credit Implications of recent worldwide news events
Ventas¡¯s Acquisition of Nationwide Health Is Credit Positive
On 28 February, Ventas (Baa3 review for upgrade) announced a definitive agreement to acquire Nationwide Health Properties (NHP, Baa2 stable), another diversified healthcare real estate investment trust (REIT), in an all-stock transaction valued at $7.4 billion. This acquisition has positive credit implications for Ventas because it will increase its scale, enhance its tenant diversification, and improve its secured debt levels and overall leverage. It is the latest in a series of recent healthcare REIT acquisitions that are credit positive for the industry. Increased scale lowers tenant concentration. Ventas will more than double the size of its healthcare real estate portfolio, and with increased size Ventas will be making great strides towards reducing its tenant concentration. This concentration, which has long been the weakest aspect of its credit profile, had declined over the years and is lower under the acquisition, albeit still high at 19% of pro forma net operating income. Increased size also means an increased number of operator relationships across multiple healthcare property sub-sectors, including senior housing, skilled nursing facilities, hospitals, and medical office buildings. These relationships are important sources of transactions to fuel Ventas¡¯ continued growth. Metrics improve. Another key credit positive of the NHP deal is the all-stock consideration being paid, which will have an immediate positive impact on Ventas¡¯s secured debt level, its weakest financial credit metric. Bigger is better in today¡¯s market. The Ventas-NHP deal is one among a series of transformative transactions recently announced in the healthcare REIT sector, all of which are credit positive for the industry. Last December, HCP (Baa2 stable) announced a $6 billion sale-leaseback agreement to acquire most of the real estate assets of privately owned HCR ManorCare, a best-in-class skilled nursing operator. More recently, Health Care REIT (Baa2 stable) announced five large transactions totaling $4.6 billion, the most significant of which was a sale-leaseback with Genesis Healthcare, a large skilled nursing provider. All of these transactions are credit positive as the three largest healthcare REITs are increasing their scale, creating a large size gap between them and their smaller REIT peers. With increased size, modest leverage, and diversification across a spectrum of property sub-types, these REITs will improve their cost of capital. With access to attractively priced capital, the three largest healthcare REITs will be able to accommodate operators¡¯ growth in the senior living, post-acute, and medical office sub-sectors. These REITs have established relationships with some of the best and largest operators, which are seeking to grow within their respective sub-sectors. The continued economic recovery, combined with a growing population of seniors and limited new supply of senior living facilities supports the expansion of senior living businesses. In this sub-sector, demand is improving as the economic recovery improves seniors¡¯ ability to sell their hom