This is our last post of 2019. We wish you a hopeful Christmas and a brave New Year. The MCN will return in  the first week of January.

Joseph Krist

Publisher

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CORPORATE AND MUNI CREDIT CONVERGENCE

As much of the analytical work current being done on municipal credit increases its focus on legal provisions after Detroit and Puerto Rico, the differences between our markets emerges. There is extensive case law on Chapter 11 but the number of completed municipal bankruptcy cases is perhaps 1,000. That lack of case law became painfully apparent in the Detroit case when bondholders were pitted against employee pensions. The concerns raised about special revenues in the Puerto Rico bankruptcy reinforce the lack of substantial case law.

Much will ride on the outcomes of the various proceedings involving Puerto Rico and its investors. Decisions which produce results which threaten long established norms in terms of the relative strength and standing of various creditor claims will clearly be a concern. At the same time there is enough about the Puerto Rico bankruptcy relative to that of states given its Commonwealth status to see a bit less concern. The different local governmental structure versus those of the lower 48 states puts a number of key municipal functions under central government rather than state/local control. The applicability of the outcome in Puerto Rico is not clear.

One thing which the Puerto Rico experience has done is to lessen the attractiveness of a Chapter 9 filing by a state from the investor standpoint. It is not clear how much weight legal provisions including constitutional provisions could be given if maximization of creditor recoveries were subjugated to other creditor classes (pensions and benefits versus debt service). We believe that state bankruptcies are not a likely result (no Illinois is not going Chapter 9). If we believe that Puerto Rico will have limited applicability, it still means that one basic credit tenet will remain true. That is the fact that if you make an investment based on sound economics, they will trump legal provisions every time.

What this does however, is make the case that harmonization of ratings between the municipal and corporate sectors will remain difficult. We think that the differences in accounting, reporting, and disclosure standards and scheduling will effectively block full harmonization.

FLORIDA GEORGIA WATER DISPUTE

As drought impacted the southeastern US earlier in the decade, the State of Florida and the State of Georgia found themselves at odds over the State of Georgia retention of water by Georgia which eventually flow to Florida. The dispute was submitted to the federal courts where the State of Florida had suffered defeats in its effort to have Georgia’s water restrictions overturned on environmental grounds. Florida had appealed adverse decisions to the US Supreme Court.

The Supreme Court held, however, that a prior Special Master had applied too strict a redressability standard. In light of that holding, the Court remanded the dispute to a new Special Master with instructions to make findings concerning the following questions on remand: (1) whether Florida suffered harm caused by decreased water flow into the Apalachicola River; (2) whether Florida showed that Georgia’s use of the Flint River is inequitable; (3) whether that potentially inequitable use harmed Florida; (4) whether an equity based cap on Georgia’s use of Flint River waters would materially increase stream flow in the Apalachicola River given the Corps’ operational rules or reasonable modifications that could be made to those rules; and (5) whether such additional stream flow in the Apalachicola River may significantly redress the economic and ecological harm that Florida has suffered.

Now the Special Master has issued his findings to the Court. He did  recommend that the Supreme Court grant Florida’s request for a decree equitably apportioning the waters of the ACF Basin because the evidence has not shown harm to Florida caused by Georgia; the evidence has shown that Georgia’s water use is reasonable; and the evidence has not shown that the benefits of apportionment would substantially outweigh the potential harms. The complaining state must demonstrate by clear and convincing evidence “that it has suffered a threatened invasion of rights that is of serious magnitude.”

Florida was attributing declines in its oyster industry to lower water flows. Florida alleged that lower flows in the Apalachicola River (the “River”) have harmed the ecosystems in both the River and the Apalachicola Bay (the “Bay”). Florida highlights the collapse of the Bay’s oyster fishery, but Florida has not proved that the harm to the oysters resulted from “the action of [Georgia].”

The Special Master said that ” Florida has pointed to harm in the oyster fishery collapse, but I do not find that Georgia caused that harm by clear and convincing evidence. Next, although Georgia’s use of the Flint and Chattahoochee Rivers has increased since the 1970s, Georgia’s use is not unreasonable or inequitable. Last, I have determined that the benefits of an apportionment would not substantially outweigh the harm that might result. This is especially true given that the Army Corps’ reservoir operations on the Chattahoochee River would prevent most stream flow increases from reaching Florida during the times when more stream flow is needed to alleviate Florida’s alleged harms.

As time goes on and climate change impacts water supplies and demands, the use and distribution of water from sources in multiple jurisdictions will continue to be a flashpoint for disputes. Although not the case in this dispute, other water disputes could definitely have credit implications.

PUERTO RICO

The bankruptcy judge overseeing Puerto Rico’s efforts to restructure and eliminate its debt has approved a scheduling plan proposed by a court-appointed mediation team. the mediator has recommended that the case be  litigated after efforts to avoid that did not succeed. The mediation team will submit an amended report by mid-January.

The action follows the mediator’s recommendation last month that litigation should proceed over the rights of owners of revenue bonds against the U.S. commonwealth, as well as the validity of general obligation and Public Buildings Authority bonds and whether bondholders’ claims were secured or unsecured.

The mediator said bond-related issues “have the potential to drive overall restructuring outcomes.” As the litigation unfolds, negotiated settlements of the items in dispute could occur but we see it as more likely that the litigation will determine how the parties pursue their claims. The debt subject to the litigation currently include commonwealth general obligation, Highway and Transportation Authority, and Public Building Authority bonds. 

Litigation will establish creditor classes and hopefully will provide clarity over the status of special revenue  bonds. It is the special revenue bond question which seems to have most perplexed the market. There are significant worries that a resolution of Puerto Rico’s fairly unique credit issues would lead to a significant change in the treatment and application of special revenues could establish a very negative precedent for holders of revenue bonds nationwide. The likelihood that an unfavorable litigation result through efforts by nontraditional investors with much more short term perspectives than are the case for the vast bulk of municipal bond investors is a huge concern which will overhang the market into 2020.

IOWA UTILITY P3 MOVES FORWARD

The demise of the public/private partnership concept when it involves a public university had been predicted by some after a couple of private student housing projects failed financially. The likelihood that this would be the case was lessened by news out of Iowa this week. The Board of Regents for the University of Iowa recently approved the establishment of a $1.165 billion public-private partnership (P3) with the University of Iowa (UI) utility system and ENGIE North America and Meridiam.

Under the agreement, ENGIE and Meridiam will pay $1.165 billion to the University of Iowa for a 50-year operating agreement for its utility system. Most of this upfront payment will be placed into an endowment. Annual proceeds from this endowment are projected at $15 million by the University. The UI retains ownership of the utility system and operation of the utility system will return to the university following the 50-year deal. No university staff positions will be eliminated under this agreement.

The University of Iowa will pay ENGIE and Meridiam a $35 million annual fee in years one-through-five of the deal, with the fee increasing by 1.5% annually thereafter. The UI will use $166 million of the lump sum to pay off existing utility bonds and consulting fees. The deal also addresses environmental issues. ENGIE and Meridiam will adopt the UI’s existing goal of operating coal-free by 2025 or sooner and continue campus-wide sustainability efforts. 

The project has been supported by the Governor as a way to increase university funding from other than state sources.  

WHAT WE’RE LOOKING AT FOR 2020

Here are the topics we think that municipal bond investors concerned about credit should watch.

Chicago – The largest city with the most serious credit problems. A diverse range of issuers rely on a common tax and revenue base and their demands on that base individually and collectively will cause significant strains. The flexibility these issuers have is limited both legally as well as practically and we expect that the City especially will be in the news all year. Strap in.

California – the state is facing a potentially huge disruption to and reconfiguration of its electric supply system. The PG&E bankruptcy and the state’s political environment could easily lead to a resolution which sees PG&E’s physical assets and their operation moved to a public rather than a private entity.  The move towards a public power resolution is gaining momentum and political support. There is also a strong likelihood that Proposition 13 will come under assault from a proposed ballot initiative. If adopted, the local financial picture would be significantly altered.

New York – The state is facing a significant projected budget gap for FY 2021. It is the first state to adopt a budget each year. This year policy issues will complicate the budget process as congestion pricing details have to be adopted for NYC to put its proposed scheme into effect. The budget will also be a mechanism for addressing ongoing capital needs for mass transit and public housing in NYC.

Florida – Just as California considers a public power option for tat state, Jacksonville, Florida is undertaking a proposed sale of its municipal utility to private interests. The proposed sale is controversial and there are already signs of pushback from the City Council which must approve any transaction. A sale would have to address outstanding debt from the Jacksonville Electric Authority.

Transportation and Micro Mobility – The ongoing battles between providers of ride sharing and individual mobility modalities will continue. The continuing practices of service providers which essentially ignore local regulatory concerns will insure that the currently contentious environment in which these issues are dealt with continues.  Mass transit will continue, especially in the Northeast, to face significant capital demands even as utilization slows or even declines. Systems in D.C., Boston, and New York face significant rolling stock and basic infrastructure needs which will require significant debt issuance.

TAX INCENTIVES UNDER SCRUTINY AGAIN

The past year saw a turn in the trend of municipalities and states falling all over themselves to offer tax incentives to businesses to locate within their boundaries. Opponents of a massive tax incentive plan to lure Amazon to build its headquarters 2 facility in the borough of Queens were successful in their opposition to a large tax “giveaway”. The issue continues to be debated as Amazon locates distribution facilities throughout the city while it has just announced an agreement to lease space in Manhattan to house 1500 employees. And they are doing it without direct tax incentives.

Now in Wisconsin, the state and Foxconn are engaged in a new dispute after a heavily incentivized facility has undergone a change of plans. Originally intended as a large screen production facility, the company has shifted its emphasis away from large screen to small screen products. This after it appeared that such a facility would not deliver the number and type of jobs originally promised but at lower average salaries to boot. A Governor took office in January, 2019 after the companies leading ally in the state lost his bid for a third term as Governor. The new administration has taken a dim view of the plans to reconfigure the plant away from its originally conceived form.

This has led the current administration to respond to a recent request from Foxconn to receive tax credits under its agreement for some $150 million of contracts which have been let to commence construction. In response, the state has informed Foxconn that the new project doesn’t qualify for incentives under the existing contract. The scaled-down factory in Wisconsin won’t qualify for tax credits unless the Taiwanese electronics giant renegotiates with the state. The Wisconsin Economic Development Corporation is taking the position that WEDC hasn’t evaluated the Generation 6 project (the downsized version) or properly contracted for it. As such the project is ineligible for tax credits under Wisconsin law.

Past experience with Foxconn in other states, particularly Pennsylvania where Foxconn did not deliver on its promises of new facilities in exchange for tax incentives, made many in Wisconsin cautious. Perhaps the Pennsylvania experience made Foxconn think that they could change the terms of its deal with Wisconsin without any ramifications.

We think that it is perfectly legitimate for states and cities to rethink tax incentives in the event of project changes. The history of tax incentives has yielded such a mixed bag of results versus promises that it is refreshing to see at least one jurisdiction trying to get the phenomenon under control.

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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MASSACHUSETTS CONSIDERS GAS TAX ALTERNATIVES

The Commonwealth of Massachusetts is considering legislation which would allow it to join with states like Oregon in implementing mileage based taxes on automobiles. The impact of alternative vehicles and increased fuel efficiency on gas tax revenues is well established. Now a bill has been offered to create a pilot program to test fees based on the miles people travel rather than the amount of gas used.

The idea is being considered as a part of a package of increased revenues for transportation. One plan would instruct the Department of Transportation to report on the feasibility of implementing all-electronic tolling on state and interstate highways “not currently subject to a toll.”  A second bill would expand tolls to stretches of Interstate 93, Interstate 95 and Route 2 in an attempt to apply equal charges to drivers across the Boston region. That bill also calls for implementation of dynamic “peak pricing” where the toll varies based on road conditions.

Another bill would increase the fees on ride-sharing companies such as Uber and Lyft. The state currently assesses a flat 20-cent fee on each ride through those services, regardless of length. The legislation would change that to a scaled percentage of the overall fare. Under the proposal, the fees would be 4.25 % of the total fare paid for shared rides and 6.25 % of the fare for a single passenger trip.

Reactions to the plan show the split in approaches between and among the ride sharing companies. Uber has come out general in favor of congestion pricing versus limits on the number of vehicles (like in NYC). In this case, Lyft  said in a statement that the company believes higher fees will not significantly reduce congestion. Such a position favors the ride sharing companies as it reduces funding for mass transit which has been the primary competitor targeted by these companies.

The Metropolitan Area Planning Council in July said the MBTA missed out on more than $20 million in foregone fare revenue from passengers who substituted  TNCs for public transit.  It is just another example of the clash of interests between private providers profiting through use of the public streets and providers of public mass transit. It is a battle without an apparent end.

However this saga ends, it highlights the ongoing need to fund public transit in an environment where many of those best positioned to fund or use it pursue alternatives. Until states and cities come up with a regulatory and taxing scheme which reflects the real benefit to the TNCs, transit funding will continue to be a clash with no real winners.

HEALTHCARE SPENDING DATA DRIVES CAUTIOUS CREDIT OUTLOOK

A colleague observed this week that AA and rated hospital credits traded anywhere from 40 to 100 basis points wide to AAA general obligation yields. We think that there is ample reason to ask for additional yield return when holding healthcare credits. Here is some data from the Centers for Medicare and Medicaid about costs which should give one pause.

National health expenditures (NHE) grew 4.6% to $3.6 trillion in 2018, or $11,172 per person, and accounted for 17.7% of Gross Domestic Product GDP).Medicare spending grew 6.4% to $750.2 billion in 2018, or 21 percent of total NHE. Medicaid spending grew 3.0% to $597.4 billion in 2018, or 16 percent of total NHE.

Private health insurance spending grew 5.8% to $1,243.0 billion in 2018, or 34 percent of total NHE. Out of pocket spending grew 2.8% to $375.6 billion in 2018, or 10 percent of total NHE. Hospital expenditures grew 4.5% to $1,191.8 billion in 2018, slower than the 4.7% growth in 2017. Physician and clinical services expenditures grew 4.1% to $725.6 billion in 2018, a slower growth than the 4.7% in 2017. Prescription drug spending increased 2.5% to $335.0 billion in 2018, faster than the 1.4% growth in 2017.

The largest shares of total health spending were sponsored by the federal government (28.3 %) and the households (28.4 %).   The private business share of health spending accounted for 19.9 % of total health care spending, state and local governments accounted for 16.5 %, and other private revenues accounted for 6.9 %. That state and local share poses a real risk to the states.

Under current law, national health spending is projected to grow at an average rate of 5.5 % per year for 2018-27 and to reach nearly $6.0 trillion by 2027. Health spending is projected to grow 0.8 percentage point faster than Gross Domestic Product (GDP) per year over the 2018-27 period; as a result, the health share of GDP is expected to rise from 17.9 %in 2017 to 19.4 % by 2027.

The report also provided a wide look at the geography behind the data although it is noted that the most recent year in the 15 year record was 2014. Nonetheless, in 2014, per capita personal health care spending ranged from $5,982 in Utah to $11,064 in Alaska.   Per capita spending in Alaska was 38 percent higher than the national average ($8,045) while spending in Utah was about 26 percent lower; they have been the lowest and highest, respectively, since 2012.

Health care spending by region continued to exhibit considerable variation. In 2014, the New England and Mideast regions had the highest levels of total per capita personal health care spending ($10,119 and $9,370, respectively), or 26 and 16 % higher than the national average.   In contrast, the Rocky Mountain and Southwest regions had the lowest levels of total personal health care spending per capita ($6,814 and $6,978, respectively) with average spending roughly 15 % lower than the national average.

So now the data provides a map of where higher growth in the expense side of the income statement might occur geographically. Combine that with the demographic trend of a longer lived aged population and the potential for limits on revenues and you have a risk profile which demands compensation. And remember, the elderly were the smallest population group, nearly 15 % of the population, and accounted for approximately 34 % of all spending in 2014. The question is how long will it be politically sustainable for healthcare to account for 1 out of every 5 dollars of economic activity?

PG&E WILDFIRE SETTLEMENT

Pacific Gas & Electric on Friday announced a settlement with insurers and others for several Northern California wildfires including the wine country blazes in 2017 and the fire that nearly destroyed the town of Paradise in 2018. The wine country fires in 2017 impacted more than 200,000 acres mostly in Napa County, destroyed or damaged more than 5,500 homes, displaced 100,000 people and killed at least 41. The Camp fire, which raced through Paradise in 2018, killed 86 people and destroyed more than 13,900 homes. 

PG&E already had agreed to pay $1 billion to cities, counties and other public entities, and $11 billion to insurance companies and other entities that have already paid claims relating to the 2017 and 2018 wildfires. This settlement is intended to help victims with no insurance and victims whose insurance was not enough to cover their losses. People have until Dec. 31 to file initial claims for a share from the trust fund that the settlement will create.

The settlement will largely reimburse insurance companies who have been largely taking the lead in funding recovery from the fires. Some $11 billion of the settlement will cover those costs. This highlights the importance of insurance in the recovery process highlighting the concerns around the willingness of the insurance industry to write business in the state. A one year regulatory halt to non-renewals is only a band aid while the industry and the state seek to craft longer term solutions to the ongoing wildfire risks in California.

Insurers have responded by raising rates, re-underwriting the risk, purchasing additional reinsurance if available and reconsidering risk models. The moratorium applies retroactively to the October 2019 state of emergency declared by current Governor Gavin Newsom, and insurers will need to offer to reinstate or renew the policies that have not been renewed or were canceled since October because of wildfire exposure.

OIL STATES TAKE DIVERGENT REVENUE PATHS

Texas sales tax revenue for November set a record for any month at $3.18 billion, an increase of 6.2% over the same month last year, state Comptroller Glenn Hegar reported. In the same month, neighboring Oklahoma recorded its first drop in monthly receipts in more than two and a half years, Treasurer Randy McDaniel reported.

The drop in revenue in Oklahoma is another sign of the weakness in reliance on one major industry. Oklahoma’s less diverse economy has already seen negative impacts in its agricultural sector due to the ongoing trade wars. Less prominent has been the fact that lower oil prices are impacting the state economy as well.

The news about declining Oklahoma revenues comes in the wake of recent announcements by Halliburton that it was making permanent the loss of some 1500 jobs in the state. These were not layoffs but absolute cuts in headcount. Oil services are an important source of well paying jobs so this does not bode well for Oklahoma’s near term revenue outlook. Recent moves by international producers to prop up prices highlight the weakness in oil pricing.

On the positive side, the Texas economy continues to reflect the increasing diversity of its economy. The Lone Star state benefits from migration and increasing employment away from the oil industry. That accounts for the positive revenue growth trend in Texas versus the negative trends in Oklahoma.

PRIVATE STUDENT HOUSING

Another private student housing deal has come under credit pressure as colleges and universities confront pricing and demand issues. The latest is at Claremont College in California.

A privately operated and financed housing facility saw the rating on outstanding debt (NCCD – Claremont Properties LLC’s (CA) University Housing Revenue Bonds) from 2017 was downgraded by Moody’s to Caa2. The rating change reflects  insufficient project revenues to cover operating expenses and debt service obligations, weak market position and demand that will prolong financial distress, and an imminent tap to the debt service reserve fund (DSRF) to supplement net operating income to pay semi-annual bond debt service.

Moody’s cited the fact that “the project’s 60% occupancy rate generates insufficient revenue to cover budgeted operating expenses and debt service obligations. As a result, the borrower has requested that pledged revenue be disbursed to pay operating expenses prior to required deposits to the bond fund for debt service.” Most importantly, the rating also incorporates that there is no express or implied guaranty from the universities. Though The Claremont Colleges, Inc. (Aa3 stable), Keck Graduate Institute (KGI), and Claremont Graduate University (CGU, Ba1 negative) have entered into cooperation agreements with the project, the institutions do not provide any assurances that it will take any actions to avoid a default of the project’s bonds.

The lack of a guaranty is not unusual nor is it unusual that existence of cooperation agreements does not lead to financial pledges. This has been an item of concern especially for private partners in these transactions who have often operated under the erroneous assumption that promises to direct students or to include privately operated living facilities in the array of choices available to students of a given institution imply an obligation to provide financial support to these projects when they fail to meet occupancy and/or profitability targets established by those operators.

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.