New York City: A Great Place
if They Ever Finish It

December 1, 2011

By Howard J. Cure

Director of Municipal Research

New York City is throwing its considerable financial weight behind several major construction projects. These projects, along with maintaining its basic infrastructure, have significantly increased the municipality’s outstanding debt burden, which just passed $100 billion after rising 83% in ten years. At this rate, debt service costs will comprise 10% of the city’s annual expense budget by 2015.

This may be money well spent, however. Funding these projects will help secure the municipality’s role as a prime commercial and cultural center and, at the same time, diversify its volatile tax base. New York, as William Sydney Porter, better known as O Henry, put it, will be a great place, if they ever finish it.

These developments also represent an opportunity for individual investors. The city, in recognition of the need for investors to diversify their municipal holdings (and its own need to stay within legal debt limits), has developed a number of different types of debt and securities to finance its capital expenditures. These can provide investors with a range of yields without significantly sacrificing credit quality.

Background

New York City recently lent its financial support, through its bonding capacity, to two major Manhattan real estate development projects. The first is a $1 billion issuance for Hudson Yards, a 45-block area near Pennsylvania Station allowing for the expansion of the midtown central business district as well as for the realization of the development potential of Manhattan’s far Westside. The second is the $1.25 billion offering for 4 World Trade Center issued through the New York Liberty Development Corporation. The World Trade Center redevelopment plan includes five office towers, a September 11th memorial and museum, a transportation hub, a retail complex and a performing arts center.

These construction projects are enormous. Together, they have a projected new office space of 38.5 million square feet, greater than the existing central business district office space of Cleveland and Cincinnati combined. They represent an investment in the expected continuing demand and attractiveness for businesses to operate in one of the world’s commercial centers. These projects do contain risks with development and occupancy that can still lag original projections. However, the city is willing to financially support these developments and expects to reap the monetary rewards, through increased tax receipts and economic diversification.

Additionally, the city is in the process of selecting one of the seven proposals from higher education institutions in building Applied Sciences NYC, delivering on Mayor Michael Bloomberg’s vision for a technology campus. Leading candidates include New York institutions Columbia, Cornell, New York University, City University and SUNY Stony Brook and out-of-state institutions, notably Stanford and Carnegie Mellon. The city will contribute $100 million, and applicants can either propose a privately owned site or choose one of four city-owned properties: Roosevelt Island; Governors Island; The Brooklyn Navy Yard; and Farm Colony Staten Island. The proposals contain plans for new facilities ranging from just under 400,000 square feet to over 2 million, designed to accommodate hundreds of faculty and thousands of new graduate students. Besides new lab, classroom and research space, there are plans for new public open space and space for companies that will spin out from these institutions.

Diversifying the Economic Base

Economic diversification is a fundamental credit strength for any municipality. A single factory town is vulnerable to market fluctuations – and no market fluctuates as often or as widely as the securities industry that dominates New York City. Still, it does create very lucrative jobs. For New York, the trick will be to diversify its economy while preserving its existing securities industry base.

The city has a strong and well-deserved reputation in science and technology education and research. New York receives $1.3 billion in National Institute of Health research grants, second in the country only to the Boston region, and it boasts a concentration of research universities focused on science and engineering. However, the city has not been as successful as Boston or parts of California in translating all of that activity into a community of thriving businesses based on biotechnology and other science and technology fields. As a result, New York remains heavily dependent on Wall Street, which faces significant challenges caused by the ongoing European sovereign debt crisis, an economic slowdown in the United States, regulatory changes, heightened market volatility and slumping market indices.

Securities-related activities account for almost 7% of New York City’s tax revenues and 14% of those of New York State, according to a recent report by the New York State Comptroller’s Office. Although the securities industry is largely based in New York City, it has an even greater impact on the state as a whole, which relies more heavily on the business and personal taxes of commuters. The effects of these concentrations are further magnified by the city’s and state’s progressive income tax system.

The Debt and New York City

New York City’s growth and infrastructure needs are comprised of much more than these three massive real estate projects. The forms of debt the city issues have also diversified. Ten years ago, basic general obligation debt comprised over half of total municipal debt outstanding. Today, it is only 40%. Other major forms of City debt include:

Any discussion of debt obligations should also include the city’s pension costs. Pensions in New York City, in contrast to those in many other major metropolitan areas, are actually funded; the city consistently funds 100% of its actuarially required pension contribution. But they do represent an increasingly large claim on revenues. The estimated pension contribution of $8.3 billion for fiscal 2012 has risen from $7 billion in 2011 (10.6% of total expenditures) and $1.3 billion in 2002. Municipal authorities are now proposing a variety of pension reforms which they project will save $1 billion by 2019. New York City’s ability to achieve pension reform and negotiate pensions with organized labor is dependent on state legislation, with controlling these costs a key factor is to the city’s long-term financial stability.

Credit Spreads

As the chart indicates, broad based general obligation debt of New York City as well as the Transitional Finance Authority’s, or TFA’s, dedicated revenue debt and essential purpose City Municipal Water revenue debt on the long end of the yield cure (20+ years) comprising 89% of the city’s outstanding debt, trades in a very narrow range and within approximately 20 basis points of the Bank of America Merrill Lynch AAA municipal scale. This consistency is derived from the relative stability of the city’s economy and management over the last few years.

Additional yield can be obtained through other separate corporation debt comprising a less direct obligation of New York City. The appropriation mechanism of the Hudson Yards, 4 WTC and NYC Health transactions is not a general obligation pledge nor do these three issuers possess specific significant revenue sources such as income or sales tax securing these bonds. However, the city has maintained a long commitment to various health and educational institutions, as well as to the development of property, and is likely to provide continued financial support.

Conclusion

The city’s financial support to further develop real estate is tied to the need to expand its tax base, provide updated facilities and transportation links to its existing businesses, while diversifying its economy away from the financial services area. We believe these efforts will eventually reap large benefits for New York City and may provide investment opportunities away from the basic general obligation, dedicated revenue and essential purpose revenue debt.

It should also enhance the economic viability of the municipality in ways that will benefit all holders of these securities. The City will still need to maintain its advanced, effective budget monitoring and management along with conservative budgetary forecasting to see it through this evolutionary phase.

At Evercore Wealth Management, we believe that a diversified holding of New York City debt continues to be an attractive investment, both for New York residents as well as for out-of-state residents under certain market conditions. Affluent New York State residents subject to high and progressive income tax rates can additionally derive additional after-tax yield rewards.

Howard Cure has 25 years of experience in analyzing tax- exempt municipal securities. He can be contacted at cure@evercore.com.

Appendix
As with many of the City’s greatest and costliest development projects, the major benefits may not occur until years into the future but will, hopefully, solidify New York’s commercial position. Below is a list of the major New York City debt issuances with senior lien debt ratings from Moody’s Investors Service and Standard & Poor’s, respectively:

New York City General Obligation Debt: (Aa2/AA $42.9 billion outstanding) Basic general obligation debt secured by the full faith and credit of the city is limited by state law to 10% of its average full value of taxable real estate for the most recent five years. As lower property values during prior recessions, beginning in the early 1990s, entered the calculation, the debt limit fell. In order to fund the city’s capital plan, the state in 1997 created the New York City Transitional Finance Authority;

Transitional Finance Authority: (Aaa/AAA$21.9 billion outstanding) TFA State Building Aid (Aa3/AA- $5.1 billion outstanding). TFA debt is primarily secured by city personal income tax imposed on City residents and nonresidents. The secondary source is sales tax imposed by the state, net of the funding requirements of the Municipal Assistance Corporation. TFA debt is not a debt of the State or the City, and TFA bondholders are protected from bankruptcy of the city. The TFA may not declare bankruptcy. TFA State Building Aid: This debt is not secured by the income and sales tax revenues generated in the City but are payable from State Building Aid – subject to annual appropriation of the State;

Municipal Finance Water Authority: (Aa1/AAA $28.9 billion outstanding) Bonds are secured by the system’s gross revenues on a priority basis, before operating and maintenance expenses. There is independent rate setting authority. Water authority bond holders are protected from bankruptcy of the city.

Hudson Yards Infrastructure Corporation: (A2/A $3 billion outstanding) The Corporation’s debt is secured by various property taxes within the project area derived from new development. To stimulate growth in the project area, the Corporation issued $3 billion of debt with proceeds used to extend the Number 7 subway line into the project area and make other infrastructure improvements. The city has pledged to cover the interest costs for the life of the bonds when those project area revenues are insufficient. The city’s obligation to pay is subject to appropriation and is not a general obligation pledge. The bonds are structured with a 40- year final maturity with revenues from the project in excess of bond interest required to be used to amortize bonds on a “turbo” basis.

New York Liberty Development Corporation 4 World Trade Center LLC: (Not rated/A+ $1.25 billion outstanding) Tower 4 is currently under construction and, when completed, will contain approximately 64 stories and 1.8 million square feet of space. The Port Authority of New York and New Jersey owns the Tower 4 facility and the World Trade Center site. Bonds are payable from Port Authority and New York City as lease payments for these two future tenants. Because the Port Authority is not responsible to pay the city’s portion as long as the city is a tenant, the credit is based on the weaker of the Port Authority’s or New York City’s rating. Should the city terminate or not renew the lease at its renewal option dates, the Port Authority will be contractually obligated to pay the full debt service costs. The city has a long track record of paying its lease obligations as a result of its historically strong control, centralization, and oversight of its large portfolio of lease obligations.

New York City Health and Hospital Corporation: (Aa3/A+ $1.08 billion outstanding) The Health and Hospital Corporation is the nation’s largest municipal public health system. It includes 11 acute care hospitals, four long-term care facilities, more than 60 community health clinics, and a Medicaid managed care plan with 390,000 enrollees. Revenues are derived from Medicaid, Medicare, other insurance and other medical, hospital and patient care reimbursements. This will pay debt service first through a lock-box mechanism. These revenues provide over 50X coverage on a gross basis. The city has a legal obligation to fund any shortfall in the Capital Reserve Fund to cover one year’s maximum annual debt service. This is subject to annual appropriation with the City having a long history of strong financial support.

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