Joseph Krist

Publisher

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NATIVE AMERICAN CASINOS

While the debate over the benefits of casinos operated by Native American tribes will continue, there has been a resolution of one long running dispute between a tribe and the communities which host Native American casinos. Recently, an arbitrator found that the Seneca of Nation of Indians in western New York were required to continue to make revenue sharing payments to host communities. The arbitration panel ruled the Senecas must continue to pay the state a percentage of the nation’s slot machine revenues, as well as nearly two years of back payments. Buffalo, Niagara Falls and Salamanca will all receive funding they have been due but were not receiving while this battle was being waged. The arbitration panel ruled the Senecas must continue to pay the state a percentage of the nation’s slot machine revenues, as well as nearly two years of back payments. Buffalo, Niagara Falls and Salamanca will all receive funding they have been due but were not receiving while this battle was being waged.

The decision has the most meaning for the City of Niagara Falls which relies heavily on these payments. The casino had been hailed as the most significant economic development project in the City for some time. The loss of these revenues put significant pressure on the City’s finances. While it was working from a stronger financial base, the town of Salamanca would also face negative financial impacts from the tribe’s withholding of revenue sharing payments. Moody’s has noted that “had the Seneca Nation won the arbitration and refused to make payments to these cities going forward, both cities would have faced significant financial uncertainty.” 

Moody’s has declared that last week’s resolution in an arbitration between the state and the Seneca of Nation of Indians will have a positive financial impact on three Western New York cities.

COFINA REFINANCING

The Financial Oversight and Management Board has submitted its arguments in support of the pending restructuring agreement designed to refinance the Commonwealth’s outstanding $17.6 billion of Cofina’s debt. The judge overseeing the Commonwealth’s pending Title III proceedings had had asked for legal arguments to support the new Cofina structure amid concerns it would be a de facto rewrite of the commonwealth’s Constitution. 

The concern comes from the provisions of the restructuring plan which effectively commit future legislatures to appropriate for debt service. The plan would also effectively change the definition of available resources, as Cofina will be given ownership of a portion of the sales and use tax revenue. Does that clash with constitutional provisions supporting general obligation debt as the first priority of payment?

The request does reflect the concern about the willingness to interpret the Constitution in opposite ways depending on the situation. If the judge’s concerns stand, the creditors would be seen as asking for some of the very provisions established to support investment in the bonds to now be inoperative in order to “save” the existing creditors.

The Board made some substantial claims in its arguments. The bond legislation is “valid and constitutional,” the board reiterated. In order to confirm a Title III plan, section 314 of Promesa requires that the court find the debtor is not prohibited by law from taking any action necessary to carry out the plan. The board asserted that, under Promesa, the court has jurisdiction over all property of the commonwealth and has held that the determination of the extent or validity of Cofina property is a mixed question of federal and state law.

For those of you who don’t follow the ins and outs of things, the restructuring of Cofina’s debt has two parts. In the first, commonwealth and Cofina bondholders settled their dispute over ownership of the sales and use tax by agreeing to divide the 5.5% portion of the 11.5% sales and use tax. From the 5.5% portion, Cofina will keep 53.6% and the commonwealth receives the rest. According to court documents, the split will result in the commonwealth receiving about $400 million a year from the sales and use tax over the next 40 years. Secondly, under the debt plan, Cofina bondholders will exchange their current bonds for new bonds whose value is being cut. Cofina senior bondholders will recover 93% of the value of their original bonds and junior bondholders 53%.

FOXCONN IN THE INCENTIVE COOP?

It is not often that something said at the World Economic Forum in Davos has direct meaning for municipal credit issues. One thing we saw did catch our attention as it dealt with a favorite topic – the use of tax incentives as a job generator.

Until Amazon held its competition between cities vying for the location of what they thought could be 50,000 jobs, the most significant use of tax incentives to lure jobs was the deal which the State of Wisconsin arrived at with Foxconn. Away from the sheer size of the package, the timeframe for recovery by the State of its “investment” was one of the primary sources of criticism of the plan.

The consensus is that the breakeven date for the return on investment was sometime in the mid 2040s. That assumed that the employment levels advertised to arise from this deal were based on certain assumptions including the types of jobs, the products to be made there, and the availability of workers. There was concern that previous experiences with Foxconn and its failure to follow through after receiving tax incentives put the benefits of the factory at risk.

Now, we have upper management from Foxconn participating in a discussion at Davos regarding automation and production. There Foxconn stated that their goal was to have 80% of its production accomplished through automation and artificial intelligence. The comments came at the same time that the company was fighting off a spotlight on the fact that it appears that Foxconn wants to import Chinese engineers to work in Wisconsin.

The comments have raised concerns that the employment to be generated for Wisconsin residents will be concentrated in lower skilled (and lower value) assembly jobs while the higher paying technical jobs will go to others. If that is indeed the case, the economics of the deal become less favorable. That will lead to lower than expected levels of economic activity, less tax revenue, and the opportunity cost of foregoing those revenues during a time of scarce resources across the country for governmental projects.

Hopefully, Amazon will be a more reliable partner at its new locations. The Virginia legislature is moving bills through which would approve state tax incentives of up to $750 million over the next 15 years for Amazon to build a headquarters facility in Arlington.  The package would provide cash grants to the online retail giant on condition that the company create tens of thousands of jobs with average pay of at least $150,000 a year. The bill would also include giving grants of $22,000 per new full-time job for the first 25,000 jobs, for a maximum of $550 million. After that, grants of $15,564 per new job would be issued for up to 12,850 additional jobs, for a total of $200 million.

GAS TAXES ON THE DOCKET

Many state legislatures are looking at the prospect of raising gas taxes to finance infrastructure projects. The moves come amidst the lack of a federal program to fund infrastructure. States realize that they do not have a reliable federal partner so they are taking matters into their own hands.

The latest example is in Hawaii where measures introduced in both the state House and Senate would increase gas taxes and other vehicle fees to generate additional money for the State Highway Fund. The proposed legislation would increase the state gas tax from 16 cents to 21 cents per gallon on Hawaii Island and other neighbor islands, and to 22 cents on Oahu.

Other fees would be increased. The legislation also would increase annual vehicle registration fees by $5 — from $45 to $50 — and increase tax rates for each gallon of diesel oil, as well as gasoline or other aviation fuel used for airplanes, by 1 cent. The state vehicle weight tax also would increase. The state Department of Transportation estimates that an increase of 5 cents per gallon of gas would raise an extra $27.2 million in revenue. The proposed change to the vehicle weight tax is expected to generate an additional $10.12 million in revenue, while higher registration fees will generate nearly $5.6 million, for a total of $42.9 million in additional funds.

Not every state sees the same level of political support. A recent poll of Wisconsin voters showed that voters are reluctant to raise taxes and fees for roads and highways. The poll shows 52%  prefer to keep gas taxes and fees where they are — while 42% favor increasing both.

TARIFFS BITE

We finally have an estimate of the economic impact of the Administration’s tariff wars. “On net, CBO estimates that the new tariffs on both imports and exports will reduce U.S. real GDP by about 0.1 percent, on average, through 2029.” The tariffs amounted to import taxes of 10-30% $284 billion of imported goods, amounting to 12% of all imported goods. In response, U.S. trade partners put tariffs of their own on $134 billion worth of American exports, equivalent to 9%.

Supporters of the trade policies behind tariffs to the fact that In 2018, the level of revenues collected from both pre-existing and new tariffs amounted to $41 billion, or 0.2 % of GDP. CBO projected that the level of duties would rise to 0.3% in 2019 and hover between 0.3 and 0.4 % of GDP over the next decade. 

Imagine the reaction if a tax was imposed by say, a Democrat, which created a permanent drag on the economy of 0.4%. Economic drag is always the argument against regulation and other policies. So we note this self-inflicted wound which will have uneven impact throughout the economy.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Publisher

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TARIFFS INFLUENCE BUT DO NOT YET HURT RESULTS

There has been much to consider in terms of the potential impact of the ongoing US trade wars. One of the ready points of worry is whether tariffs against Chinese goods would lead to sufficiently diminished shipping volumes which would hurt port revenue bond coverage. Initially, that concern was not supported by full year results at at least one major west coast port.

The Port of Oakland reported a record-setting 2018 in cargo movement, thanks to an expected spike in imports aimed at beating new tariffs on goods shipped from China. The Port handled 2.5 million 20-foot containers in 2018, up 5% compared to 2017. Imports were up 5 % and exports were down 3.5 % over the same time period. Empty containers returning to Asia, the port’s largest trading partner by region, increased by 19.7 %. 

The bases cited for the strength of the 2018 numbers especially those for the fourth quarter do raise some ominous signs.  A spokesman for the Port did admit that “some of the shippers we talked to did indicate that there was an attempt to move cargo much more quickly, in hopes of beating the tariffs.”  Other data such as the volume of empty containers exiting the port point to support for the surge theory tied to pending tariff increases.

The same pattern is seen at the other major California ports. The Ports of Los Angeles and Long Beach said they set all-time records for moving cargo in 2018, after U.S. retailers and manufacturers pulled forward imports to avoid higher tariffs on Chinese goods. The Port of Los Angeles, North America’s busiest container port, handled 9.46 million 20-foot equivalent units (TEUs) last year, the most in its 111-year history and 1.2 percent more than in 2017.

The neighboring Port of Long Beach processed more than 8 million TEUs for the first time last year, after container cargo totals jumped 7 percent from 2017.

So like so many things, the near term outlook is really out of the control of the port operators. The failure of negotiations on trade would diminish volumes in both directions and would clearly negatively impact port revenues.

PUERTO RICO

Special Claims Committee announced that it and the Official Committee of Unsecured Creditors in Puerto Rico’s debt restructuring filed an objection in U.S. District Court to a portion of the settlement which would “annul” more than $6 billion of Puerto Rico’s bonded debt. The board and the Creditors’ Committee asked the judge overseeing Puerto Rico’s restructuring case to also disallow the claims of that debt under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act (Promesa).

All general obligation bonds, which are backed by the full faith and credit of Puerto Rico, issued by Puerto Rico in 2012 and 2014 are considered invalid debt by the board. The board asserts that the so-called “invalid debt” was issued in “clear violation” of the commonwealth’s Constitution and should be declared null and void. This comes in the wake of a study undertaken for the Board to determine the validity of the Commonwealth’s outstanding debt. The matter, involving bond issuances in 2012 and 2014, will be heard during a Jan. 30 omnibus hearing. 

GO creditors including bond insurers have challenged the determination of invalid issuance. Assured Guaranty articulated the concerns of the impacted GO creditors. “Commonwealth’s Series 2012 A GO Bonds insured by Assured Guaranty Municipal Corp. were issued in full compliance with applicable provisions of the Puerto Rico Constitution and related laws, including the constitutional debt limitation provision, and we believe that they are legal, valid and binding obligations of the Commonwealth. In 2012, AGM insured $369 million of 2012 A GO refunding bonds while at the same time coming off risk on $532 million of GO bonds we had previously insured. The $369 million has been included in the amounts of Puerto Rico exposure we regularly disclose.

L.A. TEACHERS STRIKE

The ongoing strike by the teachers of the Los Angeles Unified School District is garnering much attention. Given the job actions undertaken by teachers in several states during last year’s budget cycle, the focus of much interest and coverage has been on the issue of teacher pay.

From this standpoint, we see much much more going on. The issues included in these negotiations also include things like class size which are under the control of the District but also are on much larger issues which go beyond the District’s boundaries. The dispute is designed to focus on things like housing affordability for teachers, state aid levels, and charter schools.

These issues have arisen in other California school districts but they have not been at the scale of those in the nation’s second largest school district. The teachers, by pressing for more state aid are hoping to blunt opposition from property tax payers to  higher school taxes. Reducing that burden makes it easier to make the case for public education and traditional funding. The union also hopes to – from its perspective – level the playing field between pure public schools and charter schools.

But it is fair to ask why would a bondholder care? The rating agencies have put forth a variety of comments on the strike but they all make the point that the dispute is not seen as a credit issue.

BUT IT WILL BE FELT AT THE STATE LEVEL

The headlines make the case: Texas Lt. Gov. Dan Patrick (R), a staunch conservative, has proposed increasing teacher salaries by $5,000 across the board, an expense that would cost the state $3.7 billion over two years.

 Georgia Gov. Brian Kemp (R) has proposed a $3,000 increase, at a cost of $418 million.

 South Carolina Gov. Henry McMaster (R) wants to give teachers a 5 percent pay raise, totaling about $155 million.

Arkansas legislators will debate increasing teacher salaries over the next three years, under a bill introduced this week. 

In Indiana, Gov. Eric Holcomb (R) this week proposed using billions in state reserve funds to pay down pension liabilities, saving the state $140 million. He proposed giving all of those savings to teachers in the form of pay hikes.

Clearly the politics have moved in favor of the teachers. That will drive a demand for more state level funding to keep property taxes as low as possible.

SHUTDOWN IMPACTS

Metro is losing $400,000 a day as the federal government shutdown drags on, cutting into its ridership and parking revenue, according to a letter the agency sent to the region’s U.S. senators. the agency has suffered daily rail ridership losses averaging 16 percent; average daily ridership for Metrobus is down 8 percent.

Any transit agency which relies on federal grant money an agency is owed is not being disbursed, leaving the agencies with varying levels of capital spending that has not been reimbursed. 

States and municipalities which have large SNAP (food stamps) recipients are facing the potential need to either fund the payments due this month and next month from their own resources or see thousands of their residents unable to get food and not generate the economic activity such purchases generate. Either way the impacts of the shutdown expand daily.

The view here is that even another month of shutdown will not lead to muni defaults. It is a problem nonetheless as these sorts of artificial distortions to economic activity are detrimental to realistic revenue estimation and planning. This at the time of year when the majority of budget plans are considered and adopted. Like it or not, the federal budget has become so intertwined with those of state and local government that disputes like that over the federal budget can easily lead to negative impacts at the state and local budget level.

THREE THINGS TO WATCH FOR

The PG&E bankruptcy could be resolved in a number of ways which could easily involve public utilities. There are numerous transmission and/or generation and/or distribution utilities owned and managed by municipal utilities.  The interest is in whether any of the municipal entities become part of a solution. A federal judge is considering ordering Pacific Gas and Electric Co. to inspect its entire electric grid in the coming months and turn off power during windy weather if it has not determined its equipment is safe for those conditions through pending litigation.

The resolution of disagreements over how best to deal with the development of additional nuclear generating capacity at two southeastern US sites in the face of unfavorable economics. The two sites face different initial fates – the South Carolina plant is suspended while the Georgia plant plunges on. The former is more of a regulatory political situation while the likely decision driver in the Georgia situation is at this point a legal dispute.

The unfolding drama surrounding New York’s MTA will ultimately improve the clarity about all of the competing motives and interest groups make the MTA an interesting credit. The latest plan to repair the subway tunnel to Brooklyn is the subject of much controversy. If it is adopted, the City will have taken a number of steps like closing and reconfigurations of the streets to accommodate the lost subway volume. With the line likely to be usable much more of the time, the resulting traffic changes will reveal much about the alternative transportation space.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Publisher

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KENTUCKY CONSIDERS MARIJUANA

In the Bluegrass State, a medical marijuana legalization bill will be filed in the 2019 Regular Session. House Bill 136 will look to make medical marijuana available for up to 60,000 Kentuckians. “The intention of this legislation is not the generate tax revenue, but rather to provide relief to the thousands of Kentuckian who suffer from conditions that have not responded to traditional medicine,” according to the bill’s sponsor. The bill does not allow those using medical marijuana to “smoke in public”.  It would be up to the doctor to decide what form of cannabis patient would benefit from.

Requirements include a yearly licensing fee and limits on possession. The bill sponsors say the intention is strictly to give patients additional treatment options. Kentucky is already a producer of hemp used for medical marijuana purposes. It exports hemp for use in the production of the non-intoxicating CBD products sold in other states. Medical marijuana would be regulated by the Department of Public Protection’s Office of Alcoholic Beverage Control. The state-run system will issue licenses for cultivators, dispensaries, safety facilities, processors along with practitioners and patients.

PURPLE LINE BLUES

The long saga of Maryland’s Purple Line continues its twisted route to completion. After legal delays and other issues, Purple Line Transit Partners (PLTP), a team of companies building the 16-mile line and helping to finance its construction, has told the state the line won’t begin carrying passengers until February 2023.  That represents an 11 month delay from the most recent projection.

It comes as some State officials project an October 2022 opening. The problem is that the February 2023 opening date is possible only if work is accelerated  according to the contractor. Also, delays have added at least $215 million to the light-rail line’s cost.  The news comes amidst reporting from the Washington Post that the delays — and the potential for hundreds of millions in cost overruns — have been the subject of intense discussions between the state and PLTP for nearly two years, before construction even started.

Even the effort by the State adds to the confusion. “The Maryland Department of Transportation, Maryland Transit Administration and the Purple Line Transit Partners are still working on developing a recovery schedule to open the Purple Line for revenue service by the end of 2022.”  The delays add to the Line’s already controversial history. It also is not providing support for the P3 movement as the latest delays are attributable to construction issues as opposed to the many legal issues which slowed development.

THE LATEST FROM NYC

The mayor said a millionaire’s tax, a transportation bond act, and congestion pricing could be used to help fund the nation’s biggest subway and bus system. That is a turnaround from the mayor’s prior position against congestion fees. It is a reflection of how difficult the City’s transit situation is.

Millionaire’s taxes are becoming a more established feature of budget suggestions from “progressive” public officials and candidates. We see this proposal to have the least likelihood of success in the state legislature. It also is interesting that while the City fights calls to increase annual operating funding for the MTA, it has found funding for its attempt at universal healthcare.

All of these issues are arising at a point in the cycle where it is hard to argue that we are closer to the beginning than the end. The undertaking of these kind of significant initiatives at that point generate increased fiscal risks going forward.

GUAM – THE OTHER TERRITORY

After the Puerto Rico debt debacle, some investors sought to maintain the tax benefit of territorial debt by looking at credits in Guam. In the face of the continuing fiscal difficulties in Puerto Rico and the US Virgin Islands, it is refreshing to see ratings progress in at least one case. Last week, Moody’s maintained its Ba1 issuer rating but lifted the outlook to stable from negative.

The loss of income tax revenues triggered by federal tax cuts enacted in December 2017 led  Guam’s government to offset the lost revenue in fiscal 2018. It bolstered its liquidity with a temporary increase in the business privilege tax, one-time revenues from a tax amnesty program, and spending cuts. It offset the lost revenue in the fiscal 2019 budget with a permanent extension of the increase in the business privilege tax and a continuation of most of the previously enacted spending cuts.

The credits continue to reflect general fund deficits and debt levels which, while below those of other territories, are significantly above US state medians. Generally positive economic trends and a good economic outlook, and a favorable pension funding situation are also reflected in the rating.

The improved outlook for the general credit of Guam also benefits its other issuers. Guam Power Authority, Guam Waterworks Authority, and the Port Authority of Guam all saw the outlook on their ratings move from negative to stable.

BUDGET SEASON UNDERWAY

California has seen a proposed budget and New York will follow this week. The budget proposals for many other states have begun to emerge. There are a number of common areas of emphasis. Education is the leader with funding being proposed for better compensating teachers as well as universal pre-K. Energy is emerging as a point of emphasis with the expansion of alternative energy capacity is high on the list of many.

Another common theme seems to be transportation. Whether it be the expansion of current capacity, the maintenance of existing but aging infrastructure, or the application of “smart” road technology nearly every state of the state speech references the need to support infrastructure especially for transportation. The need to protect the environment (even if just for tourism development) is another priority given the change in policy in Washington. The current shutdown situation highlights how states view national parks and the vital economic role that some of these facilities play in those jurisdictions.

Overlaying all of this is the uncertainty surrounding the revenue outlook. It is clear that the impact of federal tax changes which led to an increase in state and local revenues has been significant. The concern is that the increases in state revenues seen in 2018 may not be permanent as taxpayers adjust behavior and the impact of changes such as the loss of the SALT deduction on economic behavior finally emerge.

There are also trends which suggest that a bit of caution is appropriate. As states report revenues through year end, there are multiple instances of drops in December’s revenue on a year over year basis. The debate over the tax cut did lead some tax payers to accelerate payments into calendar 2017 and also led to efforts to prepay 2018 taxes so that those payments could be deducted before the SALT deduction change went into effect.

IT ONCE WAS LOST BUT NOW IT’S FOUND

In 2017, a new financial management team in Philadelphia reviewed the City’s finance and accounting practices an records. This process resulted in the discovery of significant discrepancies in the City’s record keeping processes. It was said that the inability to reconcile records had led to the “loss” of $40 million. The solution was the creation of panel of officials to investigate the scope of the problem and seek ad/or implement changes to the City’s accounting practices.

The panel was led by Philadelphia’s Treasurer Rasheia Johnson and former City Controller Jonathan Saidel. It  announced last week it has fully reconciled 76 of 77 city bank accounts with reconciliation of the final account slated for early January. The efforts helped reduce the difference between Philadelphia’s city records and its bank accounts to $900,000 from $40 million identified in 2017.

It was easy to look at the situation as a significant negative. We took the view that the situation while not desirable was not a sign of impending crisis or an inability to service debt. Given the fact the problems reflected issues with a lack of technology and centralized bookkeeping, it was likely that the accounts would eventually be reconciled. And so now, what once was lost has now been found.

SHUTDOWN PAIN CENTERS

In Huntsville, Ala., the National Aeronautics and Space Administration and the U.S. Army are the two largest employers. In Chicago, the Chicago Federal Executive Board is the largest employer with nearly 50,000 employees affected by the shutdown. The Treasury Department is a major employer in both the Philadelphia and Kansas City metro regions.  Once you are outside major metropolitan areas, the story is perhaps more painful.

Rural states are among those with the highest percentage of their workforces employed by federal agencies that have shut down. Montana, Alaska, New Mexico, Wyoming and South Dakota are some of the most exposed. And it is not just the fact that people are forced out of work. These are often some of the best paying jobs in rural areas.

It’s not just rural areas that see this income effect. Metropolitan-area federal workers earn on average 50% more annually than nonfederal workers, according to 2017 data from the Labor Department. In El Paso the average federal wage is twice the local average and in Huntsville the scientists and engineers employed by NASA generate wages some 85% higher than the local average.

Other problems include holdups in home sales, distributions of monthly transit funding, issuance of Section 8 vouchers, payments to contractors. With each day, the negative impacts of lower spending related to the shutdown become greater and clearer. And pretty soon, Americans will learn about the multiplier effect as reduced spending and economic activity impact businesses which are based on their proximity to federal facilities.

PG&E

The announcement that Pacific Gas and Electric plans to enter into Chapter 11 proceedings is of interest to the municipal market. The timing of the move may have been the subject of some debate but the forces leading to the move have been obvious for some time. For owners of pollution control bonds backed by PG&E, the decision could have real ramifications.

The company, which is the largest investor-owned utility in California, said it faced an estimated $30 billion liability for damages from the 2017 and 2018 wildfires that killed scores in Northern California, a sum that would exceed its insurance and assets. The announcement was driven by state requirements that the company was required to give employees 15 days’ notice of such a move.

PG&E cited 50 complaints on behalf of at least 2,000 plaintiffs in connection with the Camp Fire, including six seeking to be litigated as a class action. It also cited 700 complaints on behalf of at least 3,600 plaintiffs related to 2017 wildfires, including five seeking to be certified as class actions.

We’ve been here before as PG&E went bankrupt early this century when a deregulation move by the state in 2000 and 2001 resulted in blackouts and soaring electricity rates.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Publisher

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This week we start the New Year with commentary on some of our favorite subjects. The latest on Florida’s high speed railroad, healthcare mergers, pensions, New York City, pensions, public education and charter schools, and the latest moves in the perpetual Santa Rosa Bay Bridge default.  We look at California’s changes to its system of oversight of fiscally distressed school districts. Happy New Year!

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BRIGHTLINE

The Office of Program Policy Analysis and Government Accountability is the research arm of the Florida Legislature. In October it issued a report on rail safety. The report got a bit more exposure as the operators of the Brightline sought an extension on the existing December 31 deadline to close on an issue of private activity bonds.  They were successful in obtaining a six month extension of that deadline. The USDOT however,  advised Brightline that “any amount of unused bond allocation following an initial bond issuance will automatically return to U.S. DOT’s remaining aggregate amount of private activity bonds, and thus be available for other eligible applicants.” The bond extension gives Brightline more time to complete a separate application for a Railroad Rehabilitation and Improvement Financing loan to further cover the cost of the Miami-to-Orlando service.

HEALTH MERGER

A proposed merger between San Francisco-based Dignity Health and Catholic Health Initiatives, based in Englewood, Colorado, has been delayed. The two hospital heavyweights have moved the expected closing date for their new combined organization to Jan. 31, 2019 from Dec. 31, 2018, according to a statement from Dignity. Dignity’s statement said the two companies “continue to finalize the last steps to bring our operations together and to combine our ministries, including the completion of licenses, certifications and other administrative items. We are looking forward to completing our alignment.”

The merger, proposed in December 2017, aims to create a new company called CommonSpirit Health that will have operations spanning 16 states and including 136 hospitals, including 30 hospitals in California. Dignity runs five hospitals in Arizona, three in Nevada and 31 in California. In the North State, it has Mercy Medical in Redding, St. Elizabeth Community Hospital in Red Bluff and Mercy Medical Mt. Shasta in Mount Shasta.

SANTA ROSA BRIDGE DEFAULT

It may the Freddy Kruger of bond defaults but the bondholders are taking another whack at the Santa Rosa Bay Bridge credit which has had a troubled financial history over its 20 year life. The trustee bank representing bondholders filed a lawsuit seeking to force the state Department of Transportation to raise tolls on Northwest Florida’s Garcon Point Bridge to pay off construction bonds that are in default. The Trustee is asking a judge to order the Department of Transportation to “upwardly adjust” the tolls. The $3.75 one-way toll has not changed since 2011.

The lawsuit, filed in Leon County circuit court, alleges the failure to increase tolls is a violation of the original bond agreement that stated the Santa Rosa Bay Bridge Authority, which has since disbanded, or the Department of Transportation would maintain tolls that “would always generate sufficient revenue” to pay off the bonds.

Since the bridge authority has no members, the lawsuit said the responsibility to raise the tolls falls on the Florida Department of Transportation, and the agency’s “intentional failure to timely respond to the revenue shortages” has resulted in the loss of toll revenue that should have been collected and paid to the bondholders. The bondholders are caught between the rock of no toll increases and the hard place of insufficient demand for the bridge.

The credit has found itself in a classic death spiral as higher tolls weaken already dampened demand which then drives the need for high tolls. As this story has unfolded, many other factors have changed. The real estate development which was supposed to result from the bridge has been buffeted by a number of events. The latest is the relatively decreased attractiveness of barrier island real estate in an era of climate change. Have the fates conspired against the project? Yes. Does that make it imperative that a speculative investment be bailed out? No.

DIFFERENT PATHS FOR PUBLIC EDUCATION

The City of New Orleans is poised to become the first city in the US to turn over its entire public school system to charter operators. What is interesting about the situation is that one of the pillars of support for the charter school model versus the traditional public school model is the need for choice. Here is the first significant example of a system where there is no choice but that the monopoly which creates this phenomenon is private rather than public. That introduces a totally new twist on the issue whichever side of the charter school issue you find yourself on.

Our interest in the issue is predominantly academic. Over time, the results delivered by the charter school space in a non-competitive environment will go a long way towards shaping the debate over how best to provide K-12 education. Those results will be seized upon by either side in the debate.

As New Orleans goes the charter route, the Los Angeles USD is gearing up for a potential strike by the District’s teachers. The nation’s second largest school district takes up this negotiation in the environment left after numerous teacher job actions across the country highlighted the lack of salary growth for teachers. California has been a less favorable environment for charter schools relative to the rest of the country. The negotiations are expected to be contentious.

PENNSYLVANIA PENSIONS

In 2017, the Commonwealth of Pennsylvania enacted legislation establishing the Public Pension Management and Asset Investment Review Commission (PPMAIRC). The Commission was charged with a comprehensive review of the investment management of the Public School Employees’ Retirement System (PSERS) and State Employees’ Retirement System (SERS). The hope was that the review could generate some $3 billion in savings for the underfunded systems.

Recently, the Commission released the results of its effort. It recommends more indexed investing, better discount rate assumptions, much more reporting transparency.  It’s major recommendation – maintaining full payment of the actuarially required contribution. Obviously, there are many variables contributing to the size of that requirement. But in the end, pensions require funding.

So much effort is expended on the retiree side of the equation – they are lazy, greedy, somehow undeserving, they hoodwinked their negotiating counterparts – that to some degree the issue of chronic underfunding (or political cowardice) has become less of a point of criticism. Where changes in conformance with the law are available should they be exploited? Certainly. But at the core the problem in its current state is underfunding.

One other issue which should be easier to address is the issue of costs of managing the funds. The report concludes that the Commonwealth’s pension funds underperform and incur higher than average expenses. According to the Commission, changes in how much work is “farmed out” to external managers or advisors, negotiation of better fee structures, and more efficient internal procedures could generate between $8.2 billion and $9.9 billion of expense savings over a 30 year period.

NEW YORK CITY BUDGET OUTLOOK

The City’s Independent Budget Office (IBO) has released its outlook for the City’s fiscal position in 2019. IBO’s latest projections of revenues and spending under the contours of the Mayor’s November 2018 Financial Plan show the city ending the current fiscal year with a surplus of nearly $400 million. Assuming this year’s surplus is used to prepay some of next year’s expenses, we project a shortfall of $2.1 billion for fiscal year 2020, just 3.0 percent of city-funded expenditures. With a reserve of nearly $1.3 billion already built into next year’s budget, this gap is very manageable, as has been the case in recent years.

IBO’s latest forecast for the local economy and tax collections does not foresee a steep slide through at least 2022. Nonetheless, there are concerning issues given the huge run up in head count by the current administration. Employment growth has slowed in 2018, and is expected to total 64,000 (fourth quarter to fourth quarter), nearly one-third lower than in 2017. It is expected that  positive employment growth to continue in 2019 through 2022 but to be well below the average of 97,000 in the preceding eight years. Assuming Amazon’s HQ2 project proceeds as scheduled, it will moderate, but not reverse, the trend.

IBO forecasts tax revenue of $60.8 billion in 2019 growing to $67.9 billion in 2022, with much of the increase attributable to the property tax, which is expected to grow at an average rate of 5.5 percent annually over that period. After an extraordinary 2018, growth in personal income tax revenue will fall off to a more typical pace. IBO’s tax forecast exceeds the de Blasio Administration’s by $558 million in 2019, $1.0 billion in both 2020 and 2021, and $1.6 billion in 2022, with much of the difference attributable to the outlook for property and the income taxes. IBO projects that total city spending will grow from $90.6 billion this year to nearly $100.5 billion in 2022, an average annual rate of 3.5 % and just below the 3.7 % rate of growth it projects for tax revenues.

There are areas of spending growth which are worrisome. The cost of health care for city employees will rise from $6.7 billion in 2019 to $8.1 billion in 2022, an increase of nearly 7 %. IBO’s forecast for tax revenue in the current fiscal year is $60.8 billion, a gain of 3.2 % ($1.9 billion) from 2018. This growth would be slower than all but one other year in the current expansion and far slower than in 2018, when tax revenue increased 8.4 %. Total tax revenue growth will be faster in 2020 and subsequent years but will still be modest compared with growth earlier in post 2009 expansion. For 2020, IBO forecasts $63.2 billion in total tax revenue, 3.8 % ($2.3 billion) greater than the 2019 forecast. We project that tax revenue will rise at an average rate of 3.7 % annually over the final two years of the financial plan period and total $67.9 billion in 2022.

MEDICAID WARS

The only state which has been permitted by the federal government to implement work rules for Medicaid eligibility under the ACA has generated data on what the impact on recipients would be. That data would seem to support the efforts of those turning to the courts for relief from those requirements.

Arkansas has seen only 1,428 low-income adults required to report their hours in November logged at least 80 hours. Roughly 8,400 failed to report 80 hours, with 98 percent of them not reporting any work activities. The state has removed more than 16,000 low-income adults for failing to log at least 80 hours of work, job training, volunteering or similar activity — including 4,655 in November.

Arkansas’ conservative governor cites the motivation for the program – it provides the help residents need to become independent as justification for the program. Unfortunately, many of the affected citizens are in areas which because of geography or economics do not have internet access. That makes it difficult to comply with reporting requirements as does the fact that the internet site is only open for a limited period each day.

All of that makes it much easier to declare noncompliance and remove recipients from the rolls. So it does not necessarily generate jobs for people or improve or maintain access to healthcare.  That makes it easier for work rule opponents to voice the view that the goal is not independence but budget savings for the state government.  All of this will be hashed out in the federal courts. Individuals who don’t adhere to the new rules for three months get removed from Medicaid for the rest of the year. Nine Arkansas Medicaid enrollees who sued the Trump administration in August to block the rules. 

CALIFORNIA DISTRESSED SCHOOL DISTRICT OVERSIGHT

The Golden State’s Office of the Legislative Analyst recently offered its views of recently enacted changes to the State’s system for supporting distressed local school systems. First, some history. In 1991, the State enacted a Formal Process for Supporting School Districts in Fiscal Distress. This system was designed a variety of levels of support and intervention to districts based on their fiscal health. All districts, regardless of their fiscal position  are subject to ongoing fiscal oversight from their county office of education (COE). Districts determined to be exhibiting signs of fiscal distress receive special COE assistance. For those districts facing the prospect of being able to meet obligations including operating expenses can request an emergency state loan in exchange for temporarily ceding control to an outside administrator. Prior to 2018, these administrators were appointed and overseen by the state Superintendent of Public Instruction.

The fiscal 2019 budget process led to the enactment of changes to the way that extremely distressed districts would be dealt with. Legislation adopted as part of the 2018-19 budget package made three notable changes to the process for supporting districts in exceptional fiscal distress. First, it authorized special grants to supplement the loans already provided to the Inglewood and Oakland Unified school districts. Second, it shifted takeover responsibilities from the state to county level. Third, it established a new process for appointing outside administrators.

The LAO expresses concerns that the special grants to the two troubled school districts will encourage more districts to seek grants in lieu of making more permanent changes. The LAO view is that the state likely has weakened incentives for all districts to make the tough decisions necessary to balance their budgets. In addition, shifting takeover responsibilities from the state to county level could weaken oversight, as the state is better positioned to provide the independent, external perspective necessary for fiscally distressed districts to recover.

The LAO went farther and made recommendations for how to address the problems they see. They recommend supporting the Inglewood and Oakland Unified school districts within the traditional loan process. If additional support for these districts is deemed necessary, they recommend providing loan payment deferrals in exchange for greater state oversight. Concurrently, the LAO recommend shifting takeover responsibilities back to the state from the county level.

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