Joseph Krist

Publisher

__________________________________

CONNECTICUT BUDGET

With a new administration taking hold in the Nutmeg State, investors hope to see real action on the state’s budget and in particular on pensions. This week the Governor articulated his budget plans. They include revenue expansions and tolling on four of the state’s primary highways.

So how would the Governor raise revenues? The Governor proposed expanding the sales tax to include many new products and services, like tax preparation, haircuts, dry cleaning, veterinary services and newspapers. The 1% tax on digital downloads will be increased to the 6.35% sales tax rate and the sales tax on boats will be increased from 2.99% to the standard 6.35%. All together, Lamont’s budget counts on more than $1 billion in new sales tax revenue over two years.

Other tax increases include raising the hotel occupancy tax from 15% to 17%, with 10% of the total money going into a tourism account and raising the real estate conveyance tax on sales of more than $800,000 from 1.25 % to 1.5 %. To soften the blow of higher taxes, the Governor wants to restoration of the $200 property tax credit to all tax filers (it’s currently limited to the elderly and those with dependents) and the elimination of the $250 business entity tax that companies in Connecticut have to pay every other year. 

The proposal to toll the state’s highways has been a source of contention for some time. To address prior political opposition, the Governor’s plan includes two options. One is a trucks-only proposal. Rhode Island currently has such a scheme in place on its section of I 95. The second proposal would raise about $800 million a year once it was fully implemented in 2025. The Governor estimates that 40% of the revenue raised from the second option would be paid by out of states drivers.

The state’s pension underfunding position would rely on the use of current surplus while relying on the municipalities assuming 25%  of pension costs for their employees. This has always been a heavy political lift in the Legislature. Even harder is the Governor’s hope that state employee unions would voluntarily make changes to the way cost of living adjustments are handled for state retirees, tying them to the stock market rather than guaranteeing a certain percentage increase.

Other revenue adds would include a 10 cent tax on single-use plastic bags, a 75% on e-cigarettes, a 1.5 cent per ounce tax on sugar-sweetened beverages and new bottle deposits on wine bottles, liquor bottles and nips. According to the Governor’s estimates the plastic bag tax would raise $57 million over two years, taxing e-cigarettes would generate $16.4 million over two years and the tax on sugary drinks would raise $163.1 million in its first full year.

ILLINOIS BUDGET

Governor J.B. Pritzker presented his first budget proposal of his tenure. His words make clear the challenges facing the Governor and the Legislature. “Illinois is faced with a $3.2 billion budget deficit and a $15 billion debt from unpaid bills. Last year alone, the state paid out more than $700 million in late payment penalties. That’s enough to cover free four-year university tuition for more than 12,000 students.”  There is a structural deficit today of over $3 billion per year that if left unaddressed will continue to grow. There is a backlog of unpaid bills and debt associated with it that exceeds $15 billion.”

“Out of this year’s $39 billion budget, approximately $20 billion is required payments on our debt, on our pensions, on our court-ordered obligations or federally protected programs.  To balance the budget by simply cutting government, we would have to reduce discretionary spending on all these direct services our jobs, our families and our businesses rely on by approximately 15%.”

The Governor’s proposal includes legalizing and regulating adult-use cannabis in this legislative session. He estimates that it would bring in $170 million in licensing and other fees in fiscal year 2020. The budget also includes the legalization and taxation of sports betting.  He estimates that Illinois can realize more than $200 million from sports betting fees and taxes in FY 2020. 

Other revenue enhancements include a proposal to enact a tax on insurance companies, specifically a managed care organization assessment to help cover the costs of the State’s Medicaid program. It would be structured to generate approximately $390 million in revenue to cover a portion of the state’s Medicaid costs. This would be a way to increase Illinois’ federal match.

The Governor offered proposals to deal with the state’s well documented pension funding problem. His administration is offering a 5-point program. It revolves around the enactment of a graduated income tax versus the current flat rate regime. The Governor says that a portion of the proceeds from the graduated tax would be applied to the pension system, over and above the state’s required pension payments. 

Pension bonds are also part of the plan. in addition, it would make the optional retiree buyout program permanent and smooth the pension ramp by “modestly” extending it. The state’s university system would see an increase of 5% in funding from the state after years of cuts. This would be credit positive for the debt issued by those institutions.

The proposal is the easy part of this process. The state’s political atmosphere remains strained after four years of standoff between the legislature and the Governor.

NYC, AMAZON, AND JOBS

With so much attention focused on the City and State of New York’s failed effort to conclude an agreement with Amazon, it might seem as if NYC was a jobless desert reliant on tax handouts to sustain its economy. A recent report from NYC Controller puts those concerns to rest.

The City’s economy grew 3.9% in Q4 2018, the strongest growth since 4.0% in Q2 2017, driven by a surge in the labor market and modest wage growth (as measured by average hourly earnings). For the year, the gross city product grew 3.0%, the most robust year over year growth rate since 2015. The banking sector, a key driver of the City’s economy, continued to perform strongly as a result of higher interest rates, lower corporate tax rates, and deregulation. Net income after taxes for the top six banks in the U.S. rose to almost $30.0 billion in Q4 2018, compared to a loss of over $6.2 billion in Q4 2017 driven by robust growth (16.9%) in pre-tax income (mostly from higher interest rates) and a steep decline in taxes. (Taxes for the top six U.S. banks fell by 84.1 % in Q4 2018 from the prior year, following enactment of the Tax Cuts and Jobs Act (TCJA), which reduced the federal corporate income tax rate from 35% to 21%).

The City’s private sector added 34,000 jobs or 3.5% (SAAR) in Q4 2018, the highest gain since the 37,000 jobs created in Q3 2014. The public sector added 1,300 jobs in Q4 2018. National private-sector employment grew 2.1% (SAAR) in Q4 2018, the fastest since the 2.1% increase in Q1 2018 (Chart 2). This is amazingly strong growth for so late in a business cycle.

But the next comment reflects why the Amazon tax breaks were controversial. over half of the new private-sector jobs created were in low-wage industries. Low-wage industries added 21,100 jobs and accounted for 62.0 % of total private-sector jobs created in Q4 2018. Medium-wage industries accounted for 29.8 % of the new private-sector jobs as they added 10,100 jobs in Q4 2018 and high-wage sectors accounted for 8.2 % and added 2,800 jobs. In comparison, 63.3% of new private-sector jobs in the U.S. in the fourth quarter were in low-wage industries, while 20.4% were in medium-wage industries, and 16.3% were in high-wage industries.

Moody’s has expressed the view that the failure of the Amazon deal is credit negative for the city. That finding is interesting in light of the Controller’s comments. Moody’s acknowledges that New York City has a younger workforce than the US as a whole — almost 66% of the population is between 25 and 54 years old — and also a more educated one: 36% of New York City residents have a bachelor’s degree or higher, compared with 30% for the US overall. New York City also has one of the lowest crime rates among the big US cities. But interestingly, Moody’s also cites the city’s transportation system and access to the national transportation system. Given the public uproar over the condition and reliability of the city’s transit system, this is a bit puzzling. Especially, since the impact on transit was one of the foundations for local opposition to the deal.

Intentional or otherwise, Moody’s takes a fairly strong position in favor of tax breaks as an economic development tool. Effectively, they pit classes of the city’s population against each other. One of the issues which Amazon ran away from was how it could provide employment  to historically economically limited segments of the population – like the residents of the nation’s largest public housing facility located essentially across the street.

Moody’s undercuts is view by citing the fact that “companies such as Google and Facebook have expanded significantly in New York City without direct state or city support because they want access to its creative workforce. In addition, jobs and wages in New York City’s high-tech sector, while accounting for only 1% of total employment, are growing faster than every other industry, growth we expect will continue. ” One has to wonder why Amazon did not feel that it could compete on a level playing field with Amazon and Google.

BUDGET SEASON IS REGULATION SEASON

For those many states which conduct limited legislative sessions, the budget negotiations are often the site of significant new regulations. This year is no different with a variety of proposals being introduced as part of the budget process across the country.

In Oregon, a proposal for statewide rent control is headed for a vote on the Oregon House floor. Senate Bill 608 , is expected to be approved and sent to a supportive governor for her signature. The bill would limit annual rent increases to 7% plus inflation throughout the state. Annual increases in the Consumer Price Index, a measure of inflation, for Western states has ranged from just under 1% to 3.6% over the past five years. New construction would be exempt for 15 years and vacancy decontrol would apply after existing tenants leave.

Other components of the bill mimic those seen in other jurisdictions like New York. The bill would require most landlords to cite a cause, such as failure to pay rent or other lease violation, when evicting renters after the first year of tenancy. So-called “landlord-based” for-cause evictions would be allowed, including the landlord moving in or a major renovation. In those cases, landlords would have to provide 90 days’ notice and pay one month’s rent to the tenant, though landlords with four or fewer units would be exempt from the payment.

Oregon would become the first state to enact a statewide rent control program. In other states with rent control policies, cities enact and administer local programs. Oregon law provides that rent control is not a power granted to localities.

In addition to New Jersey, New York State is debating the legalization of recreational marijuana. It is likely that the debate will continue beyond the budget cycle. The debate in New York is complicated by the politics of criminal justice reform and economic development. The industry is looked to as a potential source of “reparations” to benefit historically disadvantaged individuals and groups.

In plain English, proponents of reparations want to see recreational licenses issued to formerly incarcerated individuals who were convicted under prior more strict drug enforcement practices. That debate will b complicated by positions of some Presidential candidates in support of reparations. We would not be surprised to see these concerns derail current efforts to establish legal recreational marijuana outlets.

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

________________________________________________________________

ISSUE OF THE WEEK

$206,710,000*

NORTH CAROLINA MEDICAL CARE COMMISSION

Health Care Facilities Revenue Bonds

(Wake Forest Baptist Obligated Group)

Moody’s: A2  S&P: A

WFB is the largest academic medical center in its region but that has not relieved pressure on the ratings. The Moody’s rating carries a negative outlook. The concerns driving the outlook include WFB’s the fact that operating cash flow margins, which were already moderate in fiscal 2017, fell lower in fiscal 2018 and will likely remain modest in fiscal 2019. The system is absorbing its acquisition of High Point Regional. That merger is leading to higher expenses associated with HPR and unfavorable payor mix shifts. These expenses are negatively impacting cash balances while the balance sheet was increasingly leveraged due to the acquisition. Another source of uncertainty is the potential financial impact of the State’s plan to convert its Medicaid population to a managed care model.

Wake Forest Baptist (WFB) consists of Wake Forest University Baptist Medical Center (WFBMC), North Carolina Baptist Hospital (NCBH), Wake Forest University Health Sciences (WFUHS), and their respective affiliates. WFBMC was created in 1975 and houses the senior management team and many of the centralized functions of three organizations: WFUHS, NCBH, and WFBMC. WFUHS includes the faculty practice plan, the School of Medicine and Wake Forest Innovations (formerly the Piedmont Triad Research Park). NCBH (885 beds) is WFB’s flagship tertiary and quaternary academic medical center. WFB also owns four smaller hospitals: Lexington Medical Center (94 beds located 26 miles south of NCBH), Davie Medical Center (81 beds located 12 miles southwest of NCBH), Wilkes Medical Center (130 bed located 56 miles west NCBH), and High Point Regional Medical Center (351 beds located 20 miles southeast of NCBH).

__________________________________

BAD MONTH FOR TAX INCENTIVES

The Amazon debacle will be chewed over for some time and a variety of reasons will be offered. None of them individually will account for the company’s decision to take their project and go home. There are however, a few items which stand out that do not require a lot of analysis.

Amazon showed no ability to navigate anything other extremely calm political waters. The company has faced almost no opposition in any of its other locations whether they be headquarters or warehouses. They have been able to steamroll the political structures in so many locations. They got the City Council to reverse itself on housing finance matters merely by threatening not to expand. So they came into the most political jurisdiction in the nation unprepared to work with it.

They failed to appreciate that an anti-union position in New York will galvanize a critical mass of opposition to any entity espousing such a view. They were apparently unaware of the City’s history of successful skepticism of projects of this scale (Westway anyone?). And they apparently did not have the stomach for any real confrontation. That may have been the real miscalculation.

These sorts of machinations are not the prime concern of individual investors who hold municipal bonds. But they are interesting in that the experience does provide certain clues as to how governments and companies will balance their view of local needs versus the views of the general public. One issue that is becoming clearer is the level of public opposition to “tax incentives” and other funding transfers at a time of underinvestment in infrastructure. It was hard to explain in simple terms why the state and city would give up $3 billion at a time when two major agencies (excluding Gateway tunnel costs) need some $60-70 billion of capital funding.

And there was this view – “Google and Apple just expanded their offices,” he said. “And they did it quietly, without any handouts. It just seems that, also, Amazon wanted a bit more than their fair share when everybody else was still doing it the old-fashioned way.” “There should be a more altruistic concept of these companies like Amazon joining the community and earning loyalty rather than, ‘Punch my meal ticket,’” Both of those tech giants have landed in NY and expanded and Google is a significant employer now and going forward. Apple’s stores are fairly ubiquitous throughout Manhattan. So while not a sophisticated expression, the quote speaks volumes. Those interests which tend to speculate in these situations – real estate and retail – did exactly that and are being reminded of the fact that sometimes speculators lose.

It also bears mention that the Amazon project would have been developed within an Opportunity Zone. Ironically, opportunity zones were championed by tech funded interests. The people who invest in Opportunity Funds are able to minimize their tax burden through preferential treatment of capital gains. The people who invest in Opportunity Funds are able to minimize their tax burden through preferential treatment of capital gains. An investor who retains an investment for seven years will pay only 85 percent of the capital gains taxes that would have been due on the original investment. If the investment is held beyond 10 years, the investor permanently avoids capital gains taxes on any proceeds from the Opportunity Fund investment.

The point of the bill was to stimulate investment especially in smaller (less than 1 million) communities. It was not designed to support projects like Amazon’s in Long Island City (LIC). Gentrification was already a well established fact in the surrounding neighborhoods. Some investment in development was already happening with some developers repurposing projects in development in response to the planned Amazon campus. Would it have accelerated existing developments and attracted some newer ones? Of course. That will still happen at a slower and likely more diverse pace.

The public is catching on to these sorts of major revenue concessions to attract development. This is the second prominent such transaction to unfold somewhat differently than contemplated as it follows the reconfiguration of the Foxconn deal in Wisconsin. In both cases, the deals were likely not going to deliver promised job booms for the non-college manufacturing cohort. The continuing efforts by corporations to tie taxes to development run counter to the current political winds. It will be important to see how government tailors its policies to reflect these trends.

CALIFORNIA JANUARY REVENUE

State Controller Betty T. Yee reported California’s total revenues of $18.79 billion in January were lower than estimates in the governor’s 2019-20 fiscal year budget proposal by $1.81 billion, or 8.8%, but higher than projections in the FY 2018-19 Budget Act by $1.21 billion, or 6.9%. Total revenues of $74.42 billion for the first seven months of FY 2018-19 were lower than expected in the proposed and enacted budgets by $2.87 billion and $1.32 billion, respectively. In the fiscal year to date, state revenues are just 0.2% lower than the same time last year.

Sales tax and corporation tax –– two of the state’s “big three” revenue sources –– came in higher than assumed in last month’s proposed budget. For January, personal income tax (PIT) receipts of $16.36 billion were $2.53 billion, or 13.4%, less than the Department of Finance forecasted last month but $403.6 million, or 2.5%, higher than assumed in the budget enacted last June. PIT revenue was still 4.8% higher than in January 2018. Sales tax receipts of $1.59 billion for January were $602.8 million higher than anticipated in the proposed FY 2019-20 budget and $647.4 million higher than in the FY 2018-19 Budget Act. Last month’s $579.2 million in corporation taxes were 9.0% higher than estimates in the FY 2019-20 budget proposal and 12.0% higher than in the enacted FY 2018-19 budget.

ILLINOIS PENSIONS

The new administration in Illinois is attempting to undertake an overall program of asset sales and the use of pension obligation bonds in an effort to improve the State’s woefully underfunded pension plans. Our view of pension bonds has been and continues to be negative. Away from the obvious risk of investment underperformance, we are philosophically opposed to the bonds in that they are always a mechanism to relieve the current pain associated with a current problem. They are a political answer rather than a sound financial answer.

That view is supported by Deputy Gov. Dan Hynes who suggested the key to the plan is to extend the period of time the state has to reach full funding of its pension plays by seven years, to 2052. “Full funding” currently is defined has having 90% of the assets needed to pay promised benefits. He acknowledges that current budget relief is a goal. Extending the full-payment ramp to 2052 will reduce the amount the state has to contribute next year by about $800 million. In fairness, the administration is also suggesting that it will provide a guaranteed annual share of revenues from the graduated income tax Gov. Pritzker hopes to enact into law after voters consider a constitutional amendment in 2020. 

The Governor also supports a plan to consolidate hundreds of smaller pension funds, mostly downstate plans covering police and fire workers, to allow them to cut resources and get better returns on investment. These funds have been a source of contention leading to court actions seeking to segregate operating funds and requiring them to be applied to pension funding. This has significantly reduced the operating flexibility of the smaller communities often exacerbating already weakening financial positions.

TEXAS DEVELOPMENT FINANCING

One of the tried and true methods of financing infrastructure in unincorporated areas of the Lone Star State is the use of municipal utility districts (MUD). MUDs are created under Texas law and are managed by a board of directors often consisting of developer representatives. The construction of the infrastructure is undertaken to support development against which taxes are levied  for the monies needed to pay off the MUD debt. In reality, the hope for a MUD is that the larger municipality next to which many MUDs are located will annex the land in the MUD. The MUD debt is then refinanced with debt secured by the much larger revenue base of the annexing entity. MUDs are regulated by the state, require a local election to issue bonds, and exist separately and out of the control of a city or county government.

That structure raises issues of control and management for the municipalities which are expected to absorb the debt acquired through annexation. One solution to those control issues is the use of public improvement districts (PID).  PIDs issue debt backed by special assessments which are fixed for the life of the issue. PID are created within existing municipalities. PID bonds are issued by cities or counties but, they are clearly only repaid from assessments and not by the local government’s general obligations. They carry separate ratings from the government’s credit.

PID debt much more closely resemble assessment backed debt issued by jurisdictions in  Florida and California. This will introduce an increased level of risk from exposure to the willingness and ability of developers to pay the assessments through the build out phases of these developments. While a newer risk for Texas investors, the use of PID debt is much more familiar to the high yield municipal investors across the market. With PIDs effectively restricted to larger minimum denominations ($100,000) yields tend to be higher reflecting the developer risk . Significant increases in the issuance of this debt (MUDs outstanding exceed PIDs outstanding by a factor of 10) will provide a new sector for institutional high yield investment.

One characteristic of Texas MUD debt is that it is highly concentrated around the Houston area. Historically, this was seen as a positive. Recent attention focused on the chronic flood problem facing Houston and surrounding Harris County has raised some concerns about the potential for flooding to alter or limit development. The Dallas Fed has raised the issue as it surveys the outlook for economic growth in the Houston region. ” The high concentration of MUDs in the Houston area may expose this financing model to new risks — those associated with more frequent and catastrophic flooding events. While MUDs will likely remain a vital part of the developer’s toolkit, this type of debt could become costlier and raise home prices in residential developments. And rising costs for homeownership might diminish one of the Houston area’s traditional selling points: affordability.”

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

________________________________________________________________

ISSUE OF THE WEEK

$900,000,000

District of Columbia

General Obligation Bonds

Moody’s: Aaa  S&P: AA+

Those of us who go back far enough to remember when the District of Columbia could not borrow without outside credit support appreciate how high a hill the District had to climb to get to the level it has achieved. The rating reflects both improved management of the City and the benefits of the District’s development into a much more diverse and dynamic economy since the 1980’s. Its per capita income is higher than that of all 50 states, and its GDP is greater than that of17 states. In addition, the District is seen as having exemplary fiscal governance, and its updated four-year financial plan is its strongest ever. The District already has among the lowest pension liabilities of any large city, and has pre-funded its other postretirement benefits (OPEB) liability, which affords it significant financial flexibility.

__________________________________

BRIGHTLINE FIGHT TO CONTINUE

The effort to deny the Virgin/Brightline consortium access to private activity bond financing continues. Indian River County, Florida, voted 4-1 Tuesday to spend up to $400,000 to appeal the denial of the county’s motion for summary judgment in a federal lawsuit it filed to challenge the Brightline project’s $1.15 billion of private activity bonds and federal agency environmental approvals. The consortium recently received another extension in the deadline to June 30 to issue private activity bonds to finance its continued expansion.

Indian River County’s action follows a decision on Dec. 24, 2018  by Federal Judge Christopher Cooper to grant motions for summary judgment sought by the USDOT and Brightline. The county’s appeal of Cooper’s ruling will be heard by the U.S. Court of Appeals for the District of Columbia Circuit. Ironically, the appeal comes as Brightline / Virgin Trains USA, is in the equity markets with an initial public offering as another way to finance the continued expansion of the private passenger train system. The IPO launch announced Jan. 30 and calls for the issuance of 28.3 million shares of common stock at $17 and $19 per share. The initial offering is expected to raise between $468 million and $540 million, depending on the price of shares. Fortress Investment Group LLC will retain majority ownership of the train company. The company will transition its consumer facing brand to Virgin Trains USA during this year.

The IPO raises legitimate issues as to the need for the project to rely on PAB financing. If they have access to equity, it undermines the case for the necessity of subsidized PAB financing. The continued effort to obtain the financing in spite of access to other sources of funding lends credence to the view that the project does not stand on its own economic viability without subsidies.

KC AIRPORT P3 MOVES FORWARD

The City of Kansas City, MO announced that it has reached a tentative airline agreement and a new $1.5 billion price tag for the Kansas City International Airport single-terminal modernization project.  The new $1.5 billion total does not include financing. According to the previous estimate, at the $1.64 billion price tag, the total cost with financing would be about $1.9 billion. The city expects six of the eight airlines to sign on  including Southwest, American, Delta, United, Alaska and Spirit. Frontier does not sign lease agreements of this nature, according to the City and Allegiant has indicated it does not plan to sign. Those airlines still can fly out of KCI, but they will pay a different rate than the airlines that sign the agreement.  

The project now awaits an environmental review. The City must now figure out how to fund initial project work such as demolition of an existing terminal. Bonds ultimately would fund much of the project but, the city needs roughly $90 becomes available. It has been publically pledged that “taxpayer monies” would not be used for the airport. Some local legislators take the view that allowing the City’s Aviation Project to use general fund monies, even if it would be repaid from bond proceeds would violate that pledge.

NEW YORK STATE

Local sales tax collections continued to climb in 2018, growing for the third year in a row, according to a report released today by State Comptroller Thomas P. DiNapoli. Collections across the state of $17.5 billion grew by $872 million, or 5.3%. “Local sales tax collections grew at a faster pace in 2018 than in recent years, boosting local revenues,” DiNapoli said. “Despite the good news, a slowdown in collection growth in the fourth quarter shows that sales tax revenue can be unpredictable. Local officials should keep a watchful eye on consumer spending and this revenue source and be prepared to react accordingly.”

Every region in the state has experienced an increased annual growth rate in sales tax collections in each of the last three years, with the exception of the Finger Lakes (which slowed from 4.9% in 2017 to 3.7% in 2018). Year-over-year growth was especially strong in several upstate regions. The Southern Tier saw the highest year-over-year increase at 6.8%, the strongest for the region since 2011. The North Country had the second highest (5.9%), followed by the Mohawk Valley (5.8%). Downstate, the Long Island and Mid-Hudson regions saw collections grow by 4.5% and 5.1% in 2018. Notably, Central New York has seen a significant turnaround in its collections, climbing 5.1% in 2018, having been the only region with a decline in collections (-0.9 %) in 2016.

New York City’s sales tax collections grew by 5.7%. The city’s increases have typically been robust over the past several years. For the 57 counties outside of New York City, collections grew in 55 of them. Sullivan County experienced the largest increase (16.4%), followed by Tioga and Hamilton counties (16.1%). Collections were down in 2018 in Cayuga (-1.3%) and Madison (-0.7%) counties.

All but one of the cities with their own sales tax experienced an increase in year-over-year collections in 2018. Gloversville had the strongest growth (17.8%), along with the cities of Norwich (12.8%) and Salamanca (8.3%). Oneida was the only city that saw its collections decrease (5.2%), mostly due to technical adjustments.

Two proposed changes to the state sales tax, including one related to the taxation of sales through online marketplaces – such as Amazon – have the potential to drive millions of dollars in additional sales tax revenues to local governments.

This will be important as the state is facing a $2.3 billion tax-revenue shortfall. Laying the blame primarily on the impact of federal tax law changes,  the state cited the move of wealthy individuals to other taxing jurisdictions (Florida?) as a cause of the lower revenue estimate. Other states which have historically benefitted from the SALT deduction are also reporting shortfalls in year-end income tax revenues. They include, unsurprisingly, California and New Jersey.

TOBACCO TARGETED AGAIN

An Arizona state lawmaker introduced the proposal that would increase the current $2-a-pack on cigarettes by an additional $1.50. A similar increase on vaping products is also a part of the proposal. The proceeds of the increased tax would generate funding for the state’s Board of Regents to award scholarships to residents who received A or B grades in each academic course required for graduation. The Arizona Legislature would have to agree to place the measure on the 2020 ballot.

In Hawaii, one legislator has introduced a bill which would raise the minimum smoking age incrementally each year to 30 in 2020, 40 in 2021, 50 in 2022, 60 in 2023 and 100 in 2024. The bill only addresses cigarettes while leaving e cigarette and vaping restrictions as is. The Hawaii Island lawmaker said he doesn’t think taxes or regulations are doing enough to stem their use. He wants to see them off store shelves all together.

A state senator introduced SB 887, which would increase the excise tax on cigarettes to 21 cents, instead of 16 cents, in July. It mandates revenue be used for health programs and research.

PG&E IMPACTS BEGIN TO EMERGE

A January 31 ruling from the judge overseeing the PG&E bankruptcy approved motions including an order to maintain existing arrangements between community choice aggregators (CCAs) and PG&E. CCAs are an emerging municipal credit sector especially in the California market. CCAs were established to provide electricity customers choice of generation supplier in the service areas of California’s investor-owned utilities. Once a CCA is formed, it becomes the default provider for generation services in the defined area. CCA customers have the option to opt-out and return to PG&E for their generation service but most customers elect to stay with the CCA. The CCA is unregulated on its cost recovery like municipal electric utilities and has a local governance role in power supply planning, local greenhouse gas reduction policies and customer choice.

In the case of PG&E, it has a contract with Marin Clean Energy (MCE), the first CCA to operate in California . Under that agreement, PG&E includes the charges for generation services provided by MCE on the monthly electricity bill that PG&E sends to customers. The customer pays the bill, and on a daily basis, PG&E transfers collected CCA generation revenues to MCE. So there was concern that revenues due to MCE which would, among other things, get tied up while the bankruptcy proceedings proceeded.

The judge’s order also included an acknowledgment that the revenues are not a part of PG&E’s estate; that PG&E must return to regular banking and billing operations, including remitting bill collections to CCAs; and that CCA revenues cannot have a lien placed against them by the debtor-in-possession lender. The positive effect on CCA finances stems primarily  from the increased stability to CCAs’ cash flow collections, which enables their power suppliers and other vendors to have greater certainty that CCA revenues and cash flow will remain unaffected by the utility’s bankruptcy filing.

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

__________________________________

NEGATIVE RURAL HOSPITAL TREND CONTINUES

There continue to be signs that the single facility rural community hospital facility remains under significant pressure. The latest example shows that even a facility that is larger than what is typical still faces the same pressure. Yakima Valley Memorial Hospital does business as Virginia Mason Memorial. It is a 226 staffed bed community hospital located in Yakima, WA. It saw 11,751 admissions in the last year.

The hospital, like so many others in the rural space, makes a significant economic contribution employing 2,800 and generating annual revenues of $433,163,870. But it still operates as a single site rural provider. So while revenue growth was solid, expense growth still exceeded revenues and the operating margin was still negative 0.9%.

It is not a surprise that these numbers impacted the hospital’s rating. The hospital issues debt secured by a receivables pledge and a lien on the primary hospital campus. There is also a debt service reserve fund. Key financial covenants include minimum days cash on hand of 40 days, and debt service coverage of 1.2x. This should all provide for coverage of debt service but it’s the trend which concerns.

So Moody’s downgraded Yakima Valley Memorial Hospital’s  revenue bond rating to Ba1 from Baa3. This reflected expectation of continued weak performance in fiscal 2019 following a miss to budget in fiscal 2018. Importantly, the outlook remains negative for the rating even after this downgrade. The negative outlook reflects an expectation of still modest margins in fiscal 2019, despite expectations of improvement, reflecting continued cost and market challenges.

So in a nutshell, there you have the rural hospital sector.

PUERTO RICO

The latest turn of events in Puerto Rico’s ongoing effort to restructure its debt is the decision by the judge overseeing the Commonwealth’s Title III proceedings to grant an urgent motion establishing procedures to handle a request by the island’s Financial Oversight and Management Board to dismiss $6 billion in general obligation (GO) debt issued by the commonwealth after 2012. This will include a “two-stage procedure” that will ensure disagreements over the proposals are worked out. Judge Swain said the “best thing for me to do” was to ask the objectors and respondents to have a “meet and confer” that would result in a revised procedural order.

If the definition of justice is a result which leaves both parties disappointed, then this fits the bill. Bondholders said the procedures did not provide adequate notice to creditors and potential objectors, and granted the government substantive advantages that were not provided to the holders of the challenged GO bonds. Bondholders say that the proposed procedures force creditors to file joint responses, compromising their ability to present their arguments adequately; treats creditors differently according to the amount of their claim; and prematurely forces creditors to answer discovery requests.

The judge takes the position that case management orders call for all bondholders to receive notices and answers were needed regarding whether anyone was at risk of a default judgment and what would happen to those creditors who do not answer notices of the proposed repeal of $6 billion in debt. The judge asked for improvements to the language of the notices and for assurances that all bondholders, large and small, be informed. She also cited the fact that creditors could seek the committee by petitioning the United States Trustee. The U.S. Trustee is part of the U.S. Department of Justice and is responsible for overseeing the administration of bankruptcy cases.

GO bondholder representatives expressed a view that parties should have 60 days to announce if they will participate in the process. Attorneys for the fiscal board’s Special Claims Committee are not supportive of smaller holders receiving any more protection basing that position on its perception that most of the creditors that purchased the challenged bonds were not retail bondholders, as they were sold in increments of $150,000.

Experienced high yield investors know that initial denominations do not prevent bonds from winding up in “small bondholder” hands, so we take that argument with a grain of salt. Once again, the small bondholder finds themselves in a disadvantaged position. It shouldn’t be that way. As the Special Claims Committee representative said about another aspect of this case – “It does not have to be that complicated.” 

While these events unfolded, the executive director of the Puerto Rico Fiscal Agency and Financial Advisory Authority and the Puerto Rico Sales Tax Financing Corp. (Cofina) announced that the U.S. District Court approved the “Third Amended Title III Plan of Adjustment” between Cofina bondholders and monoline insurers. The Plan of adjustment is the first under Title III of the Puerto Rico Oversight, Management and Economic Stability Act (Promesa) and follows the recent restructuring of the Government Development Bank for Puerto Rico under the law’s Title VI.

SANTEE COOPER IN PLAY?

The State of South Carolina has received four legitimate offers to buy all of Santee Cooper and pay off the state-owned utility’s $8 billion in debt according to Virginia-based ICF, a consultant advising on a possible sale of the municipal utility. ICF was hired by a special committee of lawmakers and the governor. ICF estimates the sale of Santee Cooper would leave its customers paying less for the V.C. Summer debacle than customers of SCE&G, the majority partner in the failed $9 billion project. SCE&G customers collectively must pay an additional $2.3 billion for two unfinished reactors over the next 20 years even though the utility was bought by Virginia-based Dominion Energy earlier this year.

It is estimated that customers that Santee Cooper directly serves will be forced to pay roughly $6,200 more per household in higher rates for the unfinished reactors over the next four decades. Customers of the 20 co-ops who buy power from Santee Cooper contractually are obligated to pay about $4,200 per household for the failed project.

Seventeen parties expressed interest in Santee Cooper at one point but,  only 10 submitted preliminary bids. Companies that privately have shown interest in Santee Cooper include Florida-based NextEra Energy, Charlotte-based Duke Energy, Virginia-based Dominion Energy, Greenville-based Pacolet Milliken Enterprises, Atlanta-based Southern Co., New York-based LS Power and South Carolina’s 20 electric co-ops – who together buy three-fifths of Santee Cooper’s electricity. Dominion said it is interested in managing Santee Cooper – but not buying it.

The report begins a process of evaluation of proposals by the State legislature. The likely timeline for the process would not likely provide for a resolution before the fall. The outcome is far from a slam dunk as there are many perspectives being brought to the debate. They include issues of public versus private ownership, the jobs of current Santee Cooper employees. Skepticism is seen as being a bigger issue in the State Senate where members have been skeptical that a for-profit company can buy Santee Cooper, pay off its more than $8 billion in total debt, and still charge lower electric rates than the not-for-profit state agency.

A more subtle issue would be the long term status of Santee Cooper’s coal fired generation assets. The report acknowledges that any buyer could find cost savings by investing in more natural gas generation and moving away from Santee Cooper’s coal-fired power plants. Those decisions will have real implications for the locations of those facilities.

Ultimately, the coop customers probably hold the hammer in the resolution of the situation. The co-ops could opt out of their long-term contract to buy power from Santee Cooper if they don’t like the buyer, taking 60% of the utility’s business with them. But the co-ops have said they favor a sale or transformation of Santee Cooper that would lower their customers’ power bills.

NEWARK UPGRADE

Moody’s Investors Service has assigned a Baa2 underlying rating  and upgraded the city’s outstanding GOULT, GOLT, GOULT & GOLT-backed non-contingent lease debt, and GOLT-backed custodial receipt debt to Baa2 from Baa3. The upgrade was attributed to “the city’s weak, albeit improved, fund balance and cash position, a sizeable and diverse tax base, and an elevated debt and pension burden. The rating also incorporates the city’s weak resident wealth and income levels, elevated poverty, and recent tax base growth.”

The outlook on the underlying rating remains positive. The outlook relies on the premise that the recent positive trend of financial operations will continue, leading to a strengthened reserve and liquidity position. The outlook also incorporates expectations that ongoing redevelopment will lead to material tax base expansion. It is important to note that Newark is the county seat for Essex County (Aaa) and New Jersey’s most populous city. It has a population of approximately 285,000 and is a major regional economic center and transportation hub.

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.