Joseph Krist

Publisher

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Hopefully, you’re reading this after an enjoyable holiday weekend. Before you do, take a minute to remember someone in your family who may have served our nation but was fortunate enough to come home. Take just a minute, and remember what they were willing to do. For you and me, even if they never knew quite who they were ultimately doing it for.  And then enjoy the country they left us in to show our appreciation.

It may also surprise you to know that it only became an official federal holiday in 1971. As a part of the process of creating the holiday, in 1966 the federal government declared Waterloo, New York, the official birthplace of Memorial Day. Waterloo—which first celebrated the day on May 5, 1866—was chosen because it hosted an annual, community-wide event, during which businesses closed and residents decorated the graves of soldiers with flowers and flags.

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BETTER HEALTH IS A CREDIT ISSUE

New research shows states that expanding Medicaid improves the health of women of childbearing age: increasing access to preventive care, reducing adverse health outcomes before, during and after pregnancies, and reducing maternal mortality rates. While more must be done, Medicaid expansion is an important means of addressing persistent racial disparities in maternal health and maternal mortality. Better health for women of childbearing age also means better health for their infants. States that have expanded Medicaid under the Affordable Care Act saw a 50% greater reduction in infant mortality than non-expansion states.

The uninsured rate for women of childbearing age is nearly twice as high in states that have not expanded Medicaid compared to those that have expanded Medicaid (16 % v. 9%). States with the highest uninsured rates for women of childbearing age are: Alabama, Alaska, Florida, Georgia, Idaho, Mississippi, Nevada, North Carolina, Oklahoma, South Carolina, Texas and Wyoming. Ten of these twelve states have not expanded Medicaid.

The research, from the Georgetown University Health Policy Institute, highlights the benefit of Medicaid expansion. Yes, expansion does result in some increased cost to the states but those increases are often more than mitigated by the significant reduction in maternal mortality as well as the lower level of expenditure associated with a healthier start in life.

For hospitals, the arguments in favor of Medicaid expansion are clear. The national rates of decline in the number of uninsured women of childbearing age from 2013-2017 were just under 9%. In states which expanded, all of the states with the exception of Florida saw rates of decline in excess of the national average. And what did all of those states have in common? They expanded Medicaid under the ACA.

THE HOSPITAL PAYMENT DEBATE

RAND Corporation researchers used data from three sources — self-insured employers, state-based all-payer claims databases, and health plans — to assess $13 billion in hospital spending in terms of hospital price levels, variation, and trends from 2015 through 2017 in 25 states. The study yielded results which highlight the many differences between individual markets making generalizations difficult. This has complicated the debate over health insurance.

The primary findings: relative prices varied twofold among states. Some states (Michigan, Pennsylvania, New York, and Kentucky) had relative prices in the range of 150 to 200 percent of Medicare rates; other states (Colorado, Montana, Wisconsin, Maine, Wyoming, and Indiana) had relative prices in the range of 250 to 300-plus percent of Medicare rates. However, eight states — Michigan, New York, Tennessee, Massachusetts, Louisiana, New Hampshire, Montana, and Maine — stand out as exceptions to this general finding, with relative prices that are roughly equal for inpatient and outpatient services.

Transparency by itself is likely insufficient to reduce hospital prices, and employers may need state or federal policy interventions to rebalance negotiating leverage between hospitals and employer health plans. Such interventions could include placing limits on payments for out-of-network hospital care or applying insurance benefit design innovations to target high prices paid to providers and allowing employers to buy into Medicare or another public option that pays providers prices based on Medicare rates.

The hospitals have real concerns around the issue of reimbursements. The data shows that a change to a single payer system would have real negative revenue repercussions for providers. The shift from private to public insurance also would produce a significant cut in hospital costs. We have yet to see robust analyses of the likely impact of a single payer system. The math regarding the issue is not straightforward. A single payer system may increase usage of services. That increased usage could replace some revenues through volume while incurring lower costs for care through reduced chronic illness demand and reduced acuity levels.

Hospitals will be central to the acceptance of any significant change in the US health insurance scheme. Hospitals were a crucial ally in the effort to pass the ACA, and they remain key to ongoing efforts to improve the 2010 health law. At present, the interests of the various hospital subgroups – rural, inner city safety net, for profit – do not converge. So a variety of different stances emerge.  More government-funded coverage could actually help safety net hospitals.  For the profit-based sector,  “A public option for us is a complete nonstarter. We are totally opposed and would fight it.” 

Whatever the result, the current environment will allow the debate to linger on well after the 2020 elections.

PENSION PROPOSAL IN ILLINOIS

This legislative session in Illinois is one of the more intriguing ones nationally as the Legislature attempts to deal with the impact of a new governor and his effect on policy. Most of the focus has been on his proposal to shift the state from a flat rate income tax to a graduated income tax and on the legalization of recreational cannabis. This has shifted attention away from other issues of import to investors. One of those issues – pensions. So it is meaningful to see what if anything legislators are willing to risk in making proposals to reduce the liability and shore up the state’s credit.

HJRCA0021 was offered earlier this year to deal with real and imagined legal barriers to real pension reform. The bill would amend the General Provisions Article of the Illinois Constitution. In a provision that specifies that membership in any pension or retirement system of the State, any unit of local government or school district, or any agency or instrumentality thereof shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired, limits the benefits that are not subject to diminishment or impairment to accrued and payable benefits. It also provides that nothing in the provision shall be construed to limit the power of the General Assembly to make changes to future benefit accruals or benefits not yet payable, including for existing members of any public pension or public retirement system. 

If ultimately adopted, the change would create a real basis for changing the state’s pension benefit outlook. Removing the constitutional impediment to changes (including those regarding future benefit terms for existing employees) would then eliminate a crutch which has been leaned on by both sides in this issue to explain away the failure to act. While the ability to act does not guarantee that action will occur, the change would nonetheless help to focus attention on the core issues at hand.

CARLESS IN SEATTLE

Seattle has ranked among the top four major U.S. cities in growth for five consecutive years. Since 2010, over 100,000 people have moved here– and more are on the way. Seattle–area jobs are projected to grow 28 % by 2035. This rapid growth will present some challenges, particularly when it comes to traffic and congestion. Recent experiences with the impacts (or lack thereof) of the closing of the Alaska Way viaduct have emboldened proponents of congestion pricing to encourage such fee in Seattle.

The City’s transportation department screened 11 tools based on four preliminary areas of focus (equity, climate and health, traffic congestion, and implementation). That process caused the department to identify four tools: cordon pricing, area pricing, fleet pricing, and a road usage charge. 

The department’s report on how it plans to conduct its study of congestion pricing alternatives highlights some of the difficulties in developing reliable data to present to support its plans. Data is limited and largely regional in scale, meaning fine-grained results are not yet possible. It also shows how these plans can be complicated by a desire to address not only transportation issues but larger socio economic concerns. Seattle’s program articulates a number of “social justice” goals which it is much harder to develop data on. For example, the report notes that structuring pricing to reduce the impacts on specific communities of concern, such as low-income households, can make a pricing program more equitable.

The issue is complicated and controversial enough as a simple transit issue but becomes almost unmanageable when implemented as a tool of “social justice” implementation. The City believes that 13% of workers who drive in the region would be affected by a downtown pricing program. The report devotes, for a transportation issue, a significant amount of time discussing race. Under the banner of equity issues, the report unwittingly emphasizes issues which could easily derail support for a plan. 

In the City’s own words “Implementing a pricing program is challenging: public support can be expected to rise and fall over the course of public conversation leading up to implementation, and to rise again after the public experiences the benefits of the project. Pricing policies often trigger the phenomenon known as “acceptability decreases with detail.”

The Seattle Transportation Benefit District was established in 2010, and the state authorizing legislation for transportation benefit districts provides the authority to charge vehicle tolls within the boundaries of the district. Tolls may not be imposed without the approval of a majority of the votes in the district voting on a proposition at a general or special election. This would seem to give the public an even larger role than is typical in the imposition of such a system.

PUERTO RICO ATTACKS DEBT HOLDERS AGAIN

The latest legal attempt by Puerto Rico’s Financial Oversight & Management Board (FOMB)  to claw back debt service payments on debt issued for the Employee retirement System. The actions filed by the FOMB intend to recover interest and principal from bondholders who own at least $2.5 million worth of bonds that the FOMB said the ERS was “never authorized” to issue to the public in 2008 because the issuance was not submitted to the Legislature.

The FOMB hopes to recover some $392 million in aggregate payments made to bondholders. The $2.5 million threshold for being exposed to the suit clearly establishes that the real effort is to target different classes of pari passu bondholders. It is one thing to issue multiple debt securities backed by clearly delineated sources of repayment. It is another to arbitrarily or otherwise change the rules of the game after you realize you are losing.

The Commonwealth is continuing on a path on which it acts like a bankrupt foreign country. Bankrupt not only economically but also politically. A small concentrated political class, supported by a vast employment network of local government, should know better than to play upon post-hurricane sympathy as an excuse to execute one of the most dishonorable restructuring efforts in the history of this market.

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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TAX INCENTIVES

The extent of the effect varied based on the type of incentive being offered. Research and development tax credits were shown to have the largest negative effect, followed by investment tax credits and property tax abatements. Job training grants were shown to increase a state’s dependence on the federal government for additional funding, whereas job-creation credits were found to have no significant effect on the fiscal health of a state.

The role and value of tax incentives in the economic development process has long been a favorite topic. So we are intrigued by the findings of some North Carolina State University researchers who wanted to see if the granting of financial incentives to encourage the creation, expansion, or relocation of businesses within their borders. The study used data from 32 states (accounting for more than 90 percent of all incentives offered by state governments) for the years 1990 to 2015.

Spoiler alert: “After controlling for the governmental, political, economic, and demographic characteristics of a state, we find that incentives draw resources away from the state. Ultimately, the results show that financial incentives negatively affect the overall fiscal health of a state.” The results of the analysis show that financial incentives negatively impact the overall fiscal health of the states offering the incentives.

The question is why? Tax incentives, for example, limit the revenue available for a government to collect, while also requiring additional expenditures to meet the increased demand for public services that come with economic expansion.

The research also generated some findings about state financial health in general. One of the areas of interest was the relationship between tax policies and the state/federal relationship. “States that have a Democratic majority in their legislature are healthier than their Republic majority counterparts… Specifically, legislatures that have a Democratic majority have a lower dependence on the federal government by 3.5% and a 48.0% lower debt ratio.

DISCLOSURE

It was almost amusing to see that the Government Finance Officers Association (GFOA) is upset with the tone of the latest effort by the municipal analyst community to get municipal issuers to accept disclosure requirements. It has been nearly 45 years since the Tower Amendment was passed. This effectively was taken as a thumbs up for issuers to come to market with only the most minimal disclosure requirements. Since then, the need for better, faster, and more detailed disclosure has never been clearer. Just ask those investors burnt by Puerto Rico’s almost comical lack of disclosure and accountability.

It has become a rule of thumb that whenever a GFOA officer or representative appears before an analyst gathering and the subject of disclosure comes up, that the GFOA rep will make an impassioned case against disclosure. Disclosure apparently prevents children from receiving a good education, citizens from receiving proper public safety protection, and will cause grass to grow in the cracks of the unrepaired pavement of city streets. Yes disclosure costs money but there are alternatives for borrowers who can’t or will not disclose. Finance your needs through bank loans. Some of your compatriots do it and they do not apparently have to disclose the existence of what is potentially a parity obligation with that securing holders of an entity’s public debt.

I do not know of another public debt market which permits different classes of borrower to meet widely divergent standards of disclosure. Yes we have many small borrowers in the municipal market and yes compliance and disclosure is a cost but that is true for many small corporate borrowers as well. That is why there is a significant bank lending role in the corporate market. And that is where small corporate borrowers finance their capital needs.

So now the small municipal borrowers are offended. Well, the refusal to act like serious professional entities could be construed as offensive, a tone which lenders might have trouble with. And perhaps the borrower/issuer community could give this some thought. The analysts have rightly called for more and better disclosure. Would the small issuer community rather be shut out of the market altogether? Would it prefer to have a narrower market for its needs rather than a larger, more diverse, and probably cheaper source of financing?

And here is where we get to take some blame. No matter how much we complain, cajole, or beg the buy side always caves in. The pressure to keep fully invested seems to have always outweighed the logic of having the best information possible to support our investment decisions. The litany of municipal defaults which occurred against a backdrop of insufficient disclosure is well known – Cleveland, WPPSS, Detroit, and Puerto Rico. And every time one of these events rocks our market there is lots of righteous indignation but ultimately market access is granted in a relatively short period of time.

All of those defaults were accompanied by shoddy disclosure which supported questionable practices. In the end however, the price to be paid for those defaults was nothing close to the value of the losses incurred. In that sense, the market has failed. None of these examples are small borrowers. They were each substantial entities, each of whom should have been in a position to provide basic and timely information. Yet they were able to borrow because the buyers allowed them to.

The GFOA has always been in a position of obstruction of real serious logical evolution of municipal disclosure. What they have never been able to sufficiently address is the point that they are government officials which means that everything they do is public business. A government entity is a public entity therefore everything that entity does is public. It’s not that the information needed to meet disclosure is unavailable. It’s that the issuers are unwilling to assemble it or provide access to it.

So in the face of long standing intransigence and opposition, where else was the market supposed to turn? It was Congress under the Tower Amendment that set the legal standards contributing to this mess and it is likely Congress that will have to act to undo the damage. Going forward, a broad market based on good consistent and timely information will be key to addressing the nation’s infrastructure needs. Our market will need to expand its base and its horizons if we want it to play a central role in that process.

Clinging to outdated and parochial notions about how borrowers interact with the market will only hurt those communities most in need of the financing capacity and abilities. That will require a change in mindset on the part of borrowers. But it also must be followed by legislative support at the state level.  

The existing codified reporting structures and requirements are clearly in need of updates (that’s you New Jersey, e.g.). So long as local finance officers are required to develop and maintain reports conforming to state law requirements, our hopes for disclosure that is meaningful and usable will continue to be seen as simply and extra and unneeded expense.

Absent these changes, the National Federation of Municipal Analysts is more than right to seek SEC involvement. The issuers can complain but when they wind up with much more onerous disclosure requirements than currently exist in order to gain access to the public debt markets, they will have no one to blame but themselves.  

AND ANOTHER THING

The SEC has announced a settlement with a municipal bond advisory firm. Clear Scope Advisors Inc. agreed to pay more than $25,000 to settle charges the firm violated the federal securities laws and MSRB Rules G-2 and G-3 by not having its advisors properly qualified. Clear Scope provided municipal advisory services to two issuers without having any municipal advisor professionals who took and passed the Series 50, according to the SEC. The MSRB sent reminders to firms to take the Series 50 exam, which became required on Sept. 12, 2017. All municipal advisors have to pass the test before engaging in municipal advisory activities on behalf of a municipal advisory firm.

Situations like this usually stem from some action by an advisor that hurts an issuer. Interestingly, The MSRB notes that it maintains a list of advisors who have met SEC requirements. The MSRB has been trying to direct issuers to its website to see if their municipal advisor is qualified. As the MSRB Chief Compliance Officer notes, “You can’t stop people who don’t want to follow the rules. They will always be out there, but I’m trying to get issuers to start looking at our website because it’s listed there.” Clear Scope Advisors was not listed on the site because it did not have at least one qualified person.

As for the issuer “victims”? Looking at a website requires no significant expertise, staff, or financial resources. Unlike disclosure, there really is no excuse for not exercising due diligence regarding the people advising you.

INFRASTRUCTURE ANNIVERSARY

Amidst all of the debate and angst over the state of the nation’s transportation infrastructure, an important anniversary passed recently. May 11 was the 150th Anniversary of the Golden Spike Ceremony, marking the completion of the first American Transcontinental Railroad. Within three years of this event, trains could travel from New York City to San Francisco in just one week.  Prior to the completion of the railroad, travelers spent up to six arduous months traveling by ship or covered wagon, often enduring great dangers at great cost.

Projects like the Transcontinental Railroad were an early form of public private partnership. The federal government provided land to the railroads who then undertook the financing and funding and construction of the railroad. Now there were many aspects of the process that were highly troubling in the light of history in terms of the sourcing and use of labor. Frankly, those practices were unacceptable. Today, structures exist to better protect workers and outlaw the exploitation of them as was the case with the Transcontinental Railroad.

All of the positive aspects of such a project could easily translate into a workable P3 concept for financing public capital facilities. Land use regulation, a current regulatory framework, and a financing capability are bought to the table by government. The actual physical execution of the project, its management, and operation are easily within the province of the private sector.

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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CALIFORNIA BUDGET  REVISION

California Governor Gavin Newsome released his revised budget proposal. The May Revision reflects the following changes: it now includes a portion of the Proposition 98 settle-up that was not reflected in the Budget. This marks the first time in over a decade that all budgetary debts are completely paid off. An additional $1.2 billion deposit into the Rainy Day Fund brings the reserve to $16.5 billion in 2019-20. The Rainy Day Fund is now expected to reach its constitutional cap of 10 percent of General Fund Revenues in 2020-21—two years earlier than predicted in January. By the end of 2022-23, the Rainy Day Fund balance is projected to be $18.7 billion. In addition, for the first time, $389 million in Proposition 98 funding is reserved in the Public School System Stabilization Account. This transfer is required by Proposition 2.

The total budget for the year is proposed at $219 billion of which $150 billion is in the General Fund. Overall, revenues are projected to increase by some 3.1%. The budget remains subject to California’s continued reliance on the income tax, especially at the higher end of the income spectrum. Personal income taxes are estimated at $102 billion. Education remains a high priority. The May Revision includes total funding of $101.8 billion ($58.9 billion General Fund and $42.9 billion other funds) for all K-12 education programs. Some of that is driven by Proposition 98 requirements imposed by the voters. Total K-14 Proposition 98 funding at May Revision is $75.6 billion in 2017-18, $78.1 billion in 2018-19, and $81.1 billion in 2019-20.

On pensions, another area of concern to investors, The Governor’s Budget proposed funding to reduce employer contributions to CalSTRS from 18.13 percent to 17.1 percent in 2019-20, based on current assumptions. The May Revision adds $150 million one-time non-Proposition 98 General Fund to reduce the employer contribution rate to 16.7 percent in 2019-20.

Recent negotiations with teachers in Los Angeles highlighted many issues confronting education funding in the state. Those concerns are reflected in this proposal. In addition to providing money, the budget also reflects the current tide running against charter schools in  the state. The budget would require charters to abide by new requirements including prohibiting charter schools from discouraging students from enrolling in a charter school or encouraging students to disenroll from a charter school on the basis of academic performance or student characteristic, such as special education status. It would also prohibit charter schools from requesting a pupil’s academic records or requiring that a pupil’s records be submitted to the charter school prior to enrollment.

FLORIDA TOLL ROAD POLITICAL BACKUP

The Florida Legislature approved a bill which would set up a new organization called the Greater Miami Expressway Agency to replace the Miami-Dade Expressway Authority (MDX) It would freeze toll rates until 2029. Current MDX members would be blocked from serving on the new agency. The law responds to political pressures which stem from a view that too much of the Authority’s toll revenue does not benefit county residents.

The bill would replace the MDX on July 1 with a new toll agency with a similar governing structure and the same toll rates. Provisions call for a 10-year freeze on tolls, but allow the board of the new Greater Miami Expressway Agency to overrule that rule with super-majority votes. Other changes in the bill include a 25% rebate for Miami-Dade County residents who utilize the toll system frequently. Once a Miami-Dade SunPass holder incurs $12.50 in tolls each month, they become eligible for the rebate. MDX officials have already indicated they will file a lawsuit challenging the legislation.

MDX calls the bill an unconstitutional unwinding of a 1996 agreement creating the agency, when it paid $91 million for the five former state expressways that make up its toll system. Along with the 112 and the 836 (the Dolphin), the MDX expressways include the Don Shula, the Gratigny and the Snapper Creek. The Authority became less popular in 2014 when it ended toll-free stretches along its busiest expressway, the 836, and one to the north, the 112. 

The mechanics of the bill which allegedly protect the interests of the Authority’s holders of outstanding debt are overwhelmed by the politics behind the move. Simply reconstituting the board without addressing its pressing debt needs more resembles meddling than oversight.  The S&P move to downgrade the Authority’s debt reflects real concerns about the willingness of a new board to adjust tolls appropriately given the politics behind the move.

STADIUM GAMES

For their time, the Oakland A’s had the coolest uniforms but the worst stadium in Major League Baseball (MLB). Their finances, along with those of the City of Oakland, have not always been the healthiest. This has hindered any plan for a new stadium. Effectively, the A’s have been searching for a new home for some two decades.

Now the City through the Port of Oakland appears ready to sign a four-year term sheet to lease the Howard Terminal waterfront property to the team for construction of a new waterfront ballpark.  The A’s will pay the Port $100,000 for the right to continue negotiations over the purchase of the 50-acre property located west of Jack London Square. The team hopes to build a 35,000-seat ballpark on the site that also includes 3,000 housing units and retail.

Under terms of the agreement, the A’s would pay an additional $150,000 to the Port if a deal is not consummated after one year; $200,000 after two years; and $250,000 after three years. Legislation that would help the City of Oakland finance infrastructure and transportation projects for the ballpark was approved by the State Senate on a 34-0 vote. The bill would allow Oakland to create an infrastructure financing district. Funding of the actual stadium is expected to be privately financed. A portion of any tax increment revenue generated would be allocated to the Oakland School District which helped to blunt opposition to the legislation.

In a reverse of the Oakland situation, the Village of Bridgeview, IL approved a memorandum of understanding with the Chicago Fire of Major League Soccer to end the team’s lease. Ending the lease would free the club to move back to Chicago and most likely Soldier Field. The Fire are expected to pay $60.5 million to leave SeatGeek Stadium. The lease runs through 2036.

The Fire will pay Bridgeview $60.5 million over 15 years — $10 million of it upfront . A team in the women’s professional soccer league will still play at the Bridgeview venue. The funds will be used to pay down the debt service remaining on the venue, and avoid raising property taxes. Bridgeview sold $134.6 million of bonds in 2005 to finance the project. But development in the area — and the projected revenues — failed to materialize creating a financial burden for the Village.

PORTS GETTING INFRASTRUCTURE HELP?

The House Transportation and Infrastructure Committee was scheduled to approve the “Full Utilization of the Harbor Maintenance Trust Fund Act,” H.R. 2396. It is designed to unlock federal money collected in the fund, which currently has a $9.3 billion balance. The fund is backed by a tax of 0.125% on the value of commercial cargo loaded at federally funded ports.

Harbor maintenance funds have previously been used to offset the federal deficit rather than being spent on actual port projects. The bill would enable spending of $34 billion over the next 10 years by making it easier for Congress to appropriate both the trust fund’s current balance and new revenue collected during the next decade. That would enable the Army Corps of Engineers to address a $20.5 billion backlog in harbor dredging projects, as well as other needed navigation work.

THE COST OF NATURAL DISASTER

“At a time of constrained budgets, it is fiscally prudent to understand the amount and the scope of the Federal Government’s involvement in providing disaster-related assistance to communities in need. The Federal Government does not provide a single, publicly available estimate of the amount it is spending on disaster-related assistance.  Because recovery is a long-term process, providing disaster-related assistance requires significant Federal resources to support a multi-agency, multi-year restoration of infrastructure and commerce in affected communities.”

“Understanding the expenditures of individual Federal agencies for disaster-related assistance will help better inform the congressional appropriations process, as well as presidential budget requests. (5) Knowledge about disaster-related expenses will illustrate opportunities for reducing these expenses through efforts to reduce vulnerabilities to future natural disasters. Disaster-related assistance encompasses Federal obligations related to disaster response, recovery, and mitigation efforts, as well as administrative costs associated with these activities.”

It is one of the great frustrations of a municipal bond analysts life that there is so little coherent data available against which to test one’s assumptions. Much of it is proprietary and subject to the whims of finance officers. This stuff is public information which in any normal decision making process should be available to all stakeholders. Better information leads to better results.

ANOTHER NUKE BITES THE DUST

Exelon Corp. said it will close Three Mile Island Nuclear Generating Station in September.  Efforts to obtain what were effectively government subsidies to support plant economics for the plant are falling short. A pair of bills that would have helped nuclear by allowing facilities to qualify for Pennsylvania’s alternative energy standard. Climate concerns in part drove the NYS legislature to approve operating subsidies for non- carbon emitting nuclear plants.

Following the Sept. 30 end date, the TMI site will begin its decommissioning phase. The utility has already filed a decommissioning plan with the Nuclear Regulatory Commission, which entails a cooling period during which the site will sit mothballed for nearly 50 years as some of the radioactivity wears out. Known as SAFSTOR, the decommissioning strategy will delay teardown of the plant until 2074.

RESILIENCE – A CREDIT ISSUE

One of the leading federal voices calling for resiliency projects and funding has been the Department of defense (DOD). DOD has previously identified 79 bases on its “mission assurance priority installation” list. Congress sought additional and more granular data including the 10 most at risk facilities for each service. Now the Air Force has produced such a list.

Southern California’s Vandenberg Air Force Base takes the top spot while Florida bases take up six spots on the new list. The other three spots went to bases located in Virginia, Delaware and South Carolina. The most endangered Navy base was Naval Air Station at Key West, Florida, and the most endangered Army base is Fort Hood in Texas.

The risks projected to stem from climate change were flooding, drought, desertification and wildfires. Declining permafrost is an issue for maintaining and siting training facilities. The inability to fully utilize facilities diminishes their attractiveness and reduces the resources put into the facilities and their surrounding communities.

HOW PUERTO RICO IMPACTS THE MARKET (THE WRONG WAY)

The uproar over the decision of the Court overseeing Puerto Rico’s financial restructuring is beginning to cast its ripple effect across the revenue bond market. In light of the decision allowing the Commonwealth of Puerto Rico to apply PR Highway Authority revenues to pay direct Commonwealth debt instead of highway bond debt, investors are reevaluating the legal strength of the pledges securing their bonds from other issuers.

The credit agencies have taken notice as well. Moody’s Investors Service has placed the Aa3 rating of the Illinois State Toll Highway Authority (ISTHA) under review for downgrade. ISTHA has approximately $6.1 billion of bonds outstanding. Moody’s specifically cited the decision. “The rating action is driven by the recent US Court of Appeals for the 1st Circuit ruling related to the Puerto Rico Highways and Transportation Authority (PRHTA) bonds, which calls into question the strength of credit separations between a general government and its enterprises and component units. The review will consider economic, governance, and financial interdependencies between ISTHA and the State of Illinois (Baa3 Stable) and the extent that, in light of the afore-mentioned court ruling, and such interdependencies pose risks to ISTHA that could have an impact on its credit quality.”

It makes sense that an entity similar in construct to PRHTA in the weakest state financially should come under this scrutiny. At the same time, we view the Puerto Rico situation to be somewhat unique. The politics of the island are not comparable, there are cultural issues contributing to intransigence, and there are risks associated with being in the hurricane zone which do not necessarily translate when comparing situations and credits.

Nevertheless, Puerto Rico does not exist in a vacuum so what happens in Puerto Rico does not necessarily stay in Puerto Rico. What does translate is that economics always matter. At the end of the day, economically sustainable fiscal and borrowing policies will always be more important than politics or legal protections. Legals do not matter when a project is not economically viable.

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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PENSIONS CLAIM ANOTHER RATING

Birmingham, AL became the latest casualty of the pension wars. Moody’s announced both a downgrade of the City’s GO rating but also continued placement on negative outlook. The downgrade of the issuer rating to Aa3 reflects continued growth of the city’s pension liabilities, primarily the result of the repeated annual underfunding of pensions. The Aa3 rating also takes into consideration a diverse and regionally significant economy located in central Alabama as well as a stable financial position marked by healthy reserve levels. Debt levels are moderately above-average but remain affordable given the lack of near-term debt plans and ongoing tax base growth.

The city of Birmingham is located in Jefferson County (A3 stable) and is the largest city in the state of Alabama with an estimated population of 212,265 (2017 American Community Survey). It faces a continuing and significant pension underfunding situation. The negative outlook reflects the expectation that the city will be challenged over the near-term to adequately fund its pension liability. The negative outlook reflects the expectation that the city will be challenged over the near-term to adequately fund its pension liability. That is a nice way of saying that the City was not able to articulate a plan to fund pensions.

ENERGY NORTHWEST RATING POWER DIMMED

This week Moody’s announced that it had changed the outlook for BPA and for all BPA supported obligations to negative from stable. The explanation was fairly extensive.

“The change in BPA ‘s rating outlook to negative from stable reflects the steady erosion of BPA’s internal and external liquidity since 2015, which we expect will continue through the new FY2020-2021 rate period, and BPA’s intent to further extend the Energy Northwest nuclear debt beyond the scope of the current “Regional Cooperation” program. Over the last three years, BPA’s liquidity has steadily declined to 89 days cash on hand at FY2018 compared to an average of 135 days cash on hand from FY2013-FY2015. Looking forward, we expect continued deterioration of this metric trending towards BPA’s minimum objective of 60 days cash on hand although the extent and timing of the decline will likely be affected by wholesale market prices and hydrology conditions. We further note that BPA’s availability under its US Treasury line has declined by over $1 billion since 2015 on an adjusted net basis (netting out deferred borrowing) and BPA’s FY2020-2021 proposed rates incorporate further availability declines possibly below the $1.5 billion quantitative threshold previously outlined in past research for consideration of a downward rating action.”

The continuing pressure on rates is not surprising. politically, raising rates is difficult in the best of times but many rural ratepayers in Washington have limited capacity to absorb increases. In addition, federal policies are designed to pay off the direct federal investment in BPA faster than the investment provided by investors in bonds like those issued by Entergy. Moody’s cites the fact that “the continued extension of non-federal debt in exchange for the accelerated payment of debt owed to the federal government that effectively undermines the de facto subordination of federal debt to non-federal debt. Since 2013, BPA has accelerated the repayment of a net $2.5 billion of subordinated, federal appropriations debt while extending maturing debt on the ENW’s nuclear projects. On the look forward basis, we expect BPA will continue to extend the ENW debt as part of a broader plan to prevent an even greater depletion of the US Treasury line availability than currently expected.”

CHICAGO HOSPITAL DRAMA (NOT THE ONE ON TV)

It isn’t a rural hospital but it is a facility which shares many characteristics which have led to financial pressures for those providers.  Westlake Hospital is a community facility with 230 beds which serves the village of Melrose Park in suburban Chicago. It was sold to an out of state private operator. It now loses $2 million a month and the owners cite the need for some $30 million of capital investment. From that standpoint, the numbers don’t bode well for continued operation.

The owners sought approval from the state to close the hospital. A decision in favor of closing had been the subject of a temporary injunction keeping the hospital open. That injunction was only in effect until the state board made its decision. Now that a decision has been rendered, the injunction is likely to be lifted. The Village of Melrose Park is considering an appeal. It will continue litigation against the owner for fraud but that litigation does not involve keeping the hospital open.

The fact is that community hospitals within reasonable proximity to teaching/research hospitals like the large urban facilities are going to be hard pressed to compete. Westlake has this locational disadvantage with the added burden of a large cohort of government pay patients. The hospital can then only compete on the basis of cost efficiency which a facility with a service area profile like this one (poorer, older, less mobile) has a harder time with. As mobility options develop and expand, the locational disadvantage would only worsen.  

TRANSIT FUNDING

The Minnesota House passed a Democratic-backed transportation budget bill Monday night that includes the Governor’s proposal to increase the state’s gasoline tax by 20 cents per gallon to pay for road and bridge projects. The proposal would raise the gas tax by a nickel per year for four years for a 70% total increase from the current tax of 28.5 cents per gallon. The proposal is at the center of the state’s transportation debate.

On the local level, the bill would also raise the sales tax in the Twin Cities metropolitan area by a half-cent to generate more money for public transportation. And it would raise vehicle registration fees. The overall debate is emerging as one based on populism with the impact on the less well off and rural residents at the center of opposition to transportation financing.

In Illinois, there are multiple transit funding bills pending. One would raise the gas tax from 19 cents to 38 cents, along with raising automobile registration fees, including those for electric cars. The state “lock box” amendment for motor fuel tax which permits its use only for safety of roads and bridges is a part of this bill.  Another would increase the gas tax even further while phasing out the sales tax on motor fuel among other wide-ranging changes.

THE US TERRITORIAL RELIEF ACT

This legislation would give U.S. territories like Puerto Rico the option to terminate their debt if they meet certain criteria, like being struck by a disaster, suffering major population loss, and staggering under overwhelming debt. In reintroducing the bill, Senator Elizabeth Warren made sure to say that debt held by bond insurers and “Wall Street” would not be paid.

The bill, originally introduced last year, establishes a Puerto Rico Debt Restructuring Compensation Fund. It provides federal funds to compensate eligible unsecured creditors, to be allocated by a special master. It allocates $7.5 billion for Puerto Rican creditors whose debt was terminated, including Puerto Rican residents, banks and credit unions that did business solely in Puerto Rico, the island’s unions and public pension plans, and businesses with a principal place of business in Puerto Rico.

It allocates $7.5 billion for mainland creditors whose debt was terminated, including individual investors, trade unions, pension plans, and open-end mutual funds that pledge to waive the manager’s fee for any compensation received. It also excludes hedge funds and their investors, bond insurers, many financial firms with consolidated assets greater than $2 billion, and repo or swaps investors from the distribution.

The U.S. Territorial Relief Act gives territories the option to terminate their non-pension debt obligations if they meet certain stringent eligibility criteria. If Puerto Rico chooses to terminate its debt load within three years of the bill’s enactment, the bill makes $15 billion in federal funds available to Puerto Rican residents and other creditors whose holdings were terminated. This is the closest we have seen a proposal come to any portion of a “federal put”. The theory that the federal government would never let Puerto Rico debt holders go unpaid was always a selling point  of the less scrupulous set of investment advisors and brokers who sold Puerto Rico bonds and funds to retail investors. The aspect of federal reimbursement of losses based on investor class status should be troubling. 

PUERTO RICO LITIGATION TURNS AGAINST THE BANKS

It is not clear, other than the voiding of $9 billion of debt, what the strategic goal of Puerto Rico’s latest legal gambit. The Financial Oversight and Management Board for Puerto Rico filed complaints to recover more than $1 billion from holders of bonds issued in excess of Puerto Rico’s constitutional debt limit, and from firms and advisers that helped with the issuance of those bonds. The entities sued include Barclays Capital, BofA Securities, Merrill Lynch Capital Services Inc., Citigroup Inc., Goldman Sachs, J.P. Morgan Chase & Co., Jefferies Group LLC, Mesirow Financial Inc., Morgan Stanley, Ramírez & Co., RBC Capital Markets, Santander Securities, UBS Financial Services Inc. of Puerto Rico, VAB Financial, BMO Capital Markets, Raymond James, Scotia MSD, and TCM Capital.

Claims were also filed against ANB Bank, Jefferies and Bank LLC, Northern Trust Company/OCH-ZIFF Capital Management, Union Bank and Union Bank Trust Co., Bank of New York Mellon, and First Southwest Co. The Board also listed the law firm of Sidley Austin LLP of Chicago as a defendant.

The lawsuit has some aspects of a drive by hit with a spray of legal gunfire being unleashed on just about everyone who helped Puerto Rico issue  debt. It begs the question of how suing this group will do anything to help Puerto Rico in the future. If the defendants decide that doing business with the Commonwealth is a bad idea, who will facilitate the financing of the island’s significant capital needs?

The fiscal panel also filed several hundred complaints against entities to recover payments they received on account of “invalid” bonds. The board said it intends to proceed with the clawback litigation against large bondholders who own at least $2.5 million worth of the bonds that are being challenged in the U.S. District Court for the District of Puerto Rico. At the same time it acknowledges that “Bondholders may have relied on information provided by the issuers, underwriters, and other professionals and lenders when they invested in the bonds.”

So the lawsuit is filed on behalf of, among others, the Commonwealth which the suit lists as a potential source of information and assurances as to the legitimacy of the debt. Does that put the Commonwealth in the position of having fraudulently issued the debt? Did it make false and/or misleading representations?

One example cited in the suit are bonds issued by Puerto Rico’s Public Buildings Authority to build and maintain public schools were to be repaid by rental payments on the buildings. So the Board’s position is that any debt funded by a general fund expenditure is actually a general obligation? Most investors knew the difference and so did the Commonwealth. Now some did ultimately look at this debt as a GO but the language in the offering documents was pretty clear.

The precedent which would be established by success would have far reaching effects throughout the market. It would be a real negative for the finance of public capital facilities if the Board succeeds.

IS ANOTHER CALIFORNIA CITY IN TROUBLE?

The city manager of  Oxnard, CA has informed nearly 1,900 employees that some of their jobs will be eliminated as the City faces increasing pressure to balance its budget. Pension costs and spikes in health care are some of the reasons for the budget shortfall. Projected expenditures are approximately $10 million more than anticipated revenue.

Last year, the city closed a $7 million shortfall mostly be eliminating vacant positions and other cutbacks. While these costs are undeniably rising, they were not unanticipated. At the same time, the current position of the City reflects a legacy of shortsighted decisions. As the mayor said, “We’re making decisions that should have been made 10, 20 years ago to put the city on a sustainable path. These are very painful cuts, but we have to live within our means. The city historically has not lived within our means.”

In a nutshell, the situation illustrates the realities facing many local credits. The employee beneficiaries are usually a convenient target but the fact of the matter is that pensions and other costs of employees are the product of negotiations between two sides. We expect that the usual debate over the City’s problems will ensue with employees pressured to give up  benefits while legislators do everything they can to cover for historical shortsightedness.

The song remains the same.

POLITICS WILL LIKELY SINK INFRASTRUCTURE PLAN

The President and the democratic leadership of the Congress have agreed on a spending goal to support an “infrastructure” package at the federal level. Republicans say they are against raising taxes to pay for an infrastructure initiative. The senate majority whip noted “If we’re going to do infrastructure, I think we ought to pay for it. I don’t think we ought to put it on the debt. I think $2 trillion is really ambitious. If you do a 35-cent increase in the gas tax, for example, indexed for inflation, it gets you only half a trillion.”

Some GOP lawmakers have since raised concerns that funding a wide array of projects ranging from roads to railroads to airports, broadband and power grids, could deplete money available for the upcoming Highway Trust Fund reauthorization, which they want to pass this year. So the issue is, is the problem infrastructure itself or is it a question of the price tag? The Senate leadership is already coalescing around a $1 trillion plan. That would assume that with a gas tax increase (or vehicle mileage tax) only a half a trillion gap would need to be “paid for”.

There were positives and negatives to emerge from the initial discussions. Trump agreed the old 20-80 [federal-private split in funding] was much too low and that he doesn’t like these private-public partnerships. Once again, such a stance places the states and localities at the forefront of innovation in the production of capital projects. It is at that level that we are seeing the most ambitious use of and experimentation with concepts like public-private partnerships.

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