Joseph Krist

Publisher

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UNLIKELY ALLY IN THE MOVEMENT AGAINST TAX INCENTIVES

The World Trade Organization concluded last year that Boeing benefited from unfair subsidies in the form of tax incentives from the State of Washington worth roughly $100 million a year. The decision was made over a complaint from the Trump Administration against Airbus, Boeing’s European rival.

In its case, the U.S. cited the fact that Airbus received billions in so-called launch aid from European countries as it developed new aircraft. In its defense, Airbus cited the receipt by Boeing of tax incentives for its Washington State and South Carolina manufacturing facilities. After the WTO decided in favor of Boeing, the company remained concerned that the tax breaks could be used to justify the imposition of tariffs by the EU in retaliation for those imposed by the U.S. after the WTO decision.

In reflection of those fears, Boeing is now seeking to end those tax incentives at least in Washington State. Legislation has been introduced on behalf of Boeing to do so. A sponsor of the bill, said the proposal had come from Boeing itself. It is under current consideration by the Washington legislature. Doing away with the state tax breaks eliminates a target for European Union trade representatives.

This response from the State and Boeing is reflective of the changing landscape over which these entities approach economic development. Tax incentive schemes in the U.S. reflect 20th century rules and thinking. The globalization of not only production but also supply chains means that incentives are no longer an intramural fight between U.S. entities. They have global trade implications which could seriously impact local economies.

There are many sound arguments against the use of these incentives. The potential impact on trade  and the economies reliant on it have just created more of those arguments.

THE FUTURE OF TRANSPORTATION REVENUES

New research for The Pew Charitable Trusts shows that even moderate use of  autonomous vehicles (AV) could affect the fiscal outlook of states that collect substantial taxes and fees from cars and trucks through a range of revenue streams that would diminish.  The research, conducted by a professor at the University of Tennessee at Knoxville, and published by Pew, examines the effect of the adoption of AVs on tax revenue in California, New Hampshire, New York, Ohio, Tennessee and Texas. The research focused only on transportation-related taxes and fees, assumed that AVs will be largely electric-powered, and modeled the direct fiscal changes using each state’s current tax structure.

First, the data.  States currently collect about 8 % of their total revenues from vehicle-related taxes and fees on sales, licensing, registration, and fuel.  That percentage involves a range of outcomes. Transportation-related revenues in Texas would drop by nearly a third over a 15-year period, from 18.4 % of total state revenue in 2025 to 12.7 % in 2040. New York’s vehicle-related revenues are already less than 5% of total state revenue. Although vehicle-related revenues would drop by more than half in the Empire State, the projected decrease in overall revenues is still only from 4.6% in 2025 to 2.1% in 2040.

Now the caveats. The study only covered six states. Importantly,  it assumes that current tax regimes remain as they are. While the difficulties to date in establishing vehicle mileage taxes to replace gas taxes are clear,  a consensus is forming around the issue and it currently has bipartisan committee leadership support in the U.S. House. The other is the analysis assumes that AVs eventually replace person-driven vehicles entirely.

What does this tell us? The concentration by advocates on transportation without taking into effect the overall economic impacts of full AV adoption is a major flaw in approach. Eight percent, while significant,  is a manageable revenue drop.  The real costs come when one looks at the implications for employment especially among lower skilled workers. The revenue drop would occur in the context of massive employment disruptions which would have a greater impact on state revenue bases. At the same time, at least initially, a significant social service funding impact would have to be absorbed by the states.

PRIVATE COLLEGES CONTINUED HEADWINDS

Yet more small private liberal arts institutions finds the current headwinds facing the sector too much for their ratings to bear. There are two latest casualties which have seen their Moody’s ratings downgraded. Saint Michael’s College (SMC)  is  a small private coeducational Catholic institution located in Colchester, Vermont offering experiential learning near Burlington, Vermont. Like so many of its size it is dependent upon ongoing demand to generate sufficient operating revenues through tuition. Under current economic conditions and demographic trends, this leaves an institution’s finances under constant pressure.

In the case of SMC, net tuition revenue decreased 15% over the fiscal 2015-19 period as enrollment declined 20%. In fiscal 2019 the college recorded operating revenues of $73 million and for fall 2019 enrolled 1,721 full-time equivalent (FTE) students. Outstanding rated bonds are an unsecured general obligation of the college. There are no debt service reserve funds. So the College’s ability to cover debt service is not in peril in the short run but, the long term outlook is quite negative in the face of current enrollment trends.

All of this added  up to a downgrade of the SMC debt by Moody’s to Baa2 from Baa1. Some $50 million of bonds are subject to the downgrade. The rating outlook remains negative. The school needs to diversify its revenue streams (especially in terms of donation support) or it will continue its tuition reliance, vulnerability to several negative trends, and need to draw down quasi-endowment funds to cover operations.

On the West Coast, Linfield College is a small undergraduate college with two locations in Oregon. The main, primarily traditional liberal arts campus is in McMinnville, Oregon. The college also has the Linfield Good Samaritan School of Nursing in Portland and the Online and Continuing Education division with online students nationwide. Linfield generated $62 million of revenue in fiscal 2019, and in fall 2019, the college had 1,763 full-time equivalent students. Their rating action reports could have been essentially exchanged for each other.

Linfield was downgraded to Baa2. Its rating outlook is negative. Pardon us if the rest sounds familiar. The credit is highlighted by prior multiple years of significant enrollment declines. absent continued net tuition revenue growth, the college will struggle to restore fiscal balance. Enrollment losses led to two consecutive years of deepening operating deficits, with debt service coverage below 1x in fiscal years 2018 and 2019. A comparatively small and shrinking scale, with $62 million of revenue, down nearly 8% over the past five years, will make material expense reductions difficult as the college invests in programs and facilities to sustain competitiveness.

The sector remains a minefield for investors.

RED LIGHT ON TOLLS IN CONNECTICUT

It appears that the ongoing inability of the State of Connecticut to agree on a program to fund transportation hit another red light. For some time, the Governor has been trying to persuade legislators and voters that a plan to levy tolls on trucks using the interstate highways in the state was away to enhance transportation funding without increasing the burden on state residents. a significant portion of annual truck volume originates  and ends out of state so the view was that tolls on trucks were a painless way for the state to develop a new funding source.

It appears now however, that the plan has been overwhelmed by politics. Gov. Ned Lamont announced that he was withdrawing his plan to collect tolls. It had always been the subject of Republican opposition but it became clear that even with a substantial Democratic majority in the Senate, that the votes were not there to enact it. That reflects the excessive politization of the issue on both sides of the debate.

This means that regardless of one’s view of the toll plan, the defeat puts the state’s credit back to square one in some ways. The immediate response would be to issue general obligation debt for transportation crowding out a myriad of projects from capital funding. That would put more pressure on general revenues during a period of high anti-tax sentiment. This effectively closes off an increase in any of the state’s major taxes for transportation funding.

It is a credit negative outcome for the State of Connecticut.

AND CAUTION LIGHTS FOR OTHER TOLLS

When the State of Alabama decided not to move forward with a toll funded project to improve resilience through the Interstate 10 Mobile River Bridge and Bayway project, opposition to tolls was a main driver supporting the opposition.  The project would have marked the first tolled interstate through a public-private partnership. Now that project decision has emboldened other opponents of tolls to finance needed highway infrastructure.

Alabama law now states that prior to building any new toll roads, bridges, or tunnels, the state Department of Transportation must conduct a public hearing in each affected county. A pending bill, SB151,  would add a requirement for the Alabama DOT to complete an economic impact study prior to any toll project being undertaken. A second bill, SB 152, would give voters the final say on any toll project. Specifically, voters would decide whether to put into the state’s Constitution a requirement for a public vote in any county where a toll project is planned.

A 1978 Maryland law requires the state to get consent from local government leaders in the nine counties on the Eastern Shore before moving forward with any toll plans in the area. Now legislation would be introduced which would impose that requirement statewide. It is in direct response to plans tolls to cover costs to widen Interstate 270 between I-495 and I-70, and portions of I-495 in Montgomery and Prince George’s counties. The project would create toll lanes to relieve congestion along existing roads which would remain toll free.

The Wyoming legislature early in its current session rejected proposals to place tolls on Interstate 80 where it runs through the state. Recently, the Florida DOT announced that it was suspending the use of dedicated lanes subject to tolling along the Palmetto Expressway. The State will reduce the number of northbound express lanes from two to one, add a regular southbound lane and create new access to the express lane. It will also reduce the minimum 50-cent toll to zero, meaning tolls will be suspended indefinitely.

The change in Florida reflects the perception that congestion was not meaningfully reduced as the toll lanes did not see the demand which was expected. Two Miami-area legislators who say the tolls lanes have had a disastrous effect on traffic gridlock sponsored a bill to get rid of the tolls and convert the express lanes to regular lanes which was pending at the time of the suspension announcement. During the suspension, construction will take place on the highway, along with short-term work like restriping lanes and moving lane dividers. 

ILLINOIS BUDGET

Gov. J.B. Pritzker released a $42 billion state budget that ties education support, pension funding and other programs to the fate of a constitutional amendment authorizing a graduated income tax to pay for more spending.  “To address the uncertainty in our revenues, this budget responsibly holds roughly $1.4 billion in reserve until we know the outcome in November. Because this reserve is so large, it inevitably cuts into some of the things that we all hold most dear: increased funding for K-12 education, universities and community colleges, public safety and other key investments—but as important as these investments are, we cannot responsibly spend for these priorities until we know with certainty what the state’s revenue picture will be.”

This puts the vote in November, 2020 at the forefront of the effort to solidify and improve the state’s credit. Fiscal 2021 is projected to be the first year that the State will fully fund its required pension contribution after years and years of delay and underfunding. It reflects the Governor’s view that a constitutional amendment necessary to cut benefits would not be approved by the electorate. On the spending side, Pritzker said his administration has already identified $225 million in budget savings for the upcoming fiscal year, and as much as $750 million through the end of his first term. The biggest share of the savings, according to Pritzker’s office, came from are costs for state employees reduced health care costs for state employees, accounting for $175 million in the upcoming year, and an estimated $650 million over the next three years. These cuts were negotiated with the relevant unions.

Under the Evidence Based Funding formula that lawmakers approved in 2017, state funding for public schools is supposed to increase by at least $350 million. Meanwhile the state’s mandated pension costs, including the cost of paying down pension obligation bonds  that were issued in 2003, are scheduled to increase nearly $460 million, to a total of $10.4 billion.

ILLINOIS CANNABIS

The sale of legal recreational cannabis products began on January 1 in Illinois. We now have at least one month of data to see what the take from cannabis taxes is and how that relates to expectations. So far, the buzz seems to be pretty good from the revenue standpoint.

According to the Illinois Department of Revenue, January sales generated more than $7.3 million in cannabis tax revenue and more than $3.1 million in sales tax revenue. This represents some over 37% of the amount projected to be collected by the end of June. Customers spent more than $39.2 million on recreational marijuana during the first month of legal product.

The majority of sales were to residents. As has been the case where adjacent states have no or only some level of legality, out-of-state residents spent more than $8.6 million some 22% of the total sales. The strong numbers were produced despite shortages. Shortages have become a staple of the startup phase of any legal sales regime.

Illinois is just the latest example of the disjointed way in which government has undertaken the process. By now there ought to be a better way to assess demand and permit supply accordingly. It has been characteristic to see regulatory impacts on one problem can needlessly impede the industry from operating standpoint. The numbers also reveal the potential. Marijuana-infused products are taxed at 20%. All other marijuana with 35% THC or less is taxed at 10%, and marijuana with THC content higher than 35% is taxed at 25%. Municipalities can levy an additional 3% tax however those revenues were not included in the state data.

So will New York be next?

UTILITY CYBER ATTACK

The Cybersecurity and Infrastructure Security Agency (CISA) of the Department of Homeland Security responded to a cyberattack affecting control and communication assets on the operational technology (OT) network of a natural gas compression facility. A cyber threat actor used a Spearphishing Link to obtain initial access to the organization’s information technology (IT) network before pivoting to its OT network. The threat actor then deployed commodity ransomware to Encrypt Data for Impact on both networks. Specific assets experiencing a Loss of Availability on the OT network included human machine interfaces (HMIs), data historians, and polling servers. Impacted assets were no longer able to read and aggregate real-time operational data reported from low-level OT devices, resulting in a partial Loss of View for human operators.

The attack did not impact any programmable logic controllers (PLCs) and at no point did the victim lose control of operations. Although the victim’s emergency response plan did not specifically consider cyberattacks, the decision was made to implement a deliberate and controlled shutdown to operations. This lasted approximately two days, resulting in a Loss of Productivity and Revenue, after which normal operations resumed. 

The attack highlights the need for utilities to have robust defense and recovery plans against cyber attacks. In this case, the victim’s existing emergency response plan focused on threats to physical safety and not cyber incidents. The victim cited gaps in cybersecurity knowledge and the wide range of possible scenarios as reasons for failing to adequately incorporate cybersecurity into emergency response planning.

Absent disclosure from municipal issuers, this situation sounds a lot like what one would expect to find at a smaller municipal utility. Two days of lost service, production, and or revenues is no small thing and this happened to a sophisticated private operator. Even if your local utility operations are prepared, those entities are at the mercy of other providers. The US natural gas pipeline industry, now the primary fuel supplier to the US power generation fleet, has no federally mandated cybersecurity standards.

Moody’s rightly points out that “Natural gas distribution utilities rely on pipeline infrastructure for gas distribution to customers for heating and other purposes, exposing them to the safety, operational and financial risks from pipeline cyberattacks. Because of the increased interdependence between electric utilities and natural gas pipelines amid the growing use of low-cost natural gas as a transition fuel to renewables and away from coal, the electric grid infrastructure is exposed to cyberattacks on natural gas pipelines.”

In addition to actions taken by utilities, investors can add to their protection by demanding robust disclosure as to cyber security actions being taken over and above procuring insurance. Insurance to provide funding for remediation is fine but some disclosure about the ability of an insurer to effect real change in terms of preparedness should be available. It is important to  have some sense of the potential damage to revenue streams which support for debt service since after all that is what pays debt service.

FLORIDA HIGH SPEED RAIL BACK IN COURT

Earlier this year, Indian River County announced that it decided to throw in the towel on its efforts in the federal courts to challenge the use of tax exempt debt to fund the development of the high speed rail line serving the Miami to Palm Beach corridor. It had been to date a costly and unsuccessful process. The county has spent $3.5 million on litigation with Virgin Trains, including other cases over other safety issues. Now, the Indian River County Commission has rethought that position and decided to move forward with an appeal to the U.S. Supreme Court. $200,000 of private money and a legal team including a retired judge once short-listed for the Supreme Court convinced the County that an appeal is viable.

Our view on this issue is colored by our view that it becomes tiresome to see private entities insist on being viewed as private risk takers while fully exploiting the use of tax exempt financing. No matter how you slice it, the use of tax exempt financing is the use of a public subsidy. We would like to see these private entities stand on their own to prove their point that private is better than public.

MANAGED RETREAT IN THE SPOTLIGHT

We have discussed the various approaches available to and taken by municipalities to deal with the specific issue of rising sea levels resulting from climate change. for some time. There haven’t been many examples where a municipality has been able to develop public support for the issue. Lately, one such municipality has been in the spotlight for its efforts to deal with the issue of rising sea levels which do not focus on hard infrastructure answers.

Marina is located along the central coast of California, 8 miles west of Salinas, and 8 miles north of Monterey. It has a population of some 22,000. Sea walls are forbidden, and sand replenishment projects do not have local support. It does require real estate disclosures for sea level rise. It works to move infrastructure away from the water. It is working with a private resort in town to relocate its oceanfront . 

Much of the shoreline remains undeveloped. Marina’s coast has one of the highest rates of erosion in California and the city was also the site of an industrial facility which effectively removed tons and tons of sand annually. There are some other facilities including office buildings, a sewer pump and an aging water treatment facility. They are all subject to the impact of continuing erosion.

At some point, many of these facilities as well as public facilities including public beach infrastructure such as a parking lot and public restrooms will have to be moved. those types of facilities will be needed to maintain access to the ocean. Some of that can be accomplished through regulation but buy in from the public and from private property owners is essential. Municipal credits are in a position to be at the center of that debate.

We find the Marina example instructive. There is much focus on large events like natural disasters which inflict large scale damage and inspire large scale reactions. In reality, the impact of rising water levels is smaller scale. It’s situations like Marina, its steadily crumbling walkways and access points around the Great Lakes and other places seeing smaller scale but increasing incidents of erosion and undermining. Cities will increasingly face a choice between ongoing and incident based remediation – essentially an ongoing patching process or a longer term policy based approach.  

AV SPEED BUMP

Columbus, Oh has been at the forefront of efforts to test out the realistic potential of autonomous vehicle technology to provide practical mass transit alternatives. The city has been testing a small scale shuttle service with two 12-passenger shuttles which began running Feb. 5. An operator is always on board to monitor the shuttle. Now, a recent incident has taken the shuttles out of service. One unexpectedly stopped in the middle of a route and a woman fell from her seat onto the floor.

Now, the city has decided to take the vehicles out of service until the vendor can investigate the causes of the unplanned stoppage. It is portrayed as erring on the side of caution and we do not dispute that. It does highlight the fact that like many other implementations of new technologies, the use of AV technology will be a gradual process with both forward and backward steps being a part of the process.

In the wake of the Columbus incident, the vendor who provided the vehicles is coming under closer inspection by regulators. The National Highway Traffic Safety Administration (NHTSA) said operation of the battery-powered buses in 10 U.S. states would be suspended pending an examination of “safety issues related to both vehicle technology and operations.” The vehicles are all provided by Easy Mile now all Easy Mile vehicle use is subject to the suspension.

The deployment in Columbus that started earlier this month was the first public self-driving shuttle in a residential area. It is not the first incident with Easy Mile vehicles however. In July, one passenger in Utah was injured and required medical assistance when the EasyMile shuttle he was in came to an abrupt stop.

It is not a reason not to move forward but it is a reason for governments to be involved in the process at the earliest possible point. Successful development of AV technology into a major component of the mass transit service plan will rely on reliability and transparency throughout every phase of the development and implementation process. That will be the case for emerging micromobility technologies in their efforts to become mainstream.

HARTFORD UPGRADE

Some two and a half years after the city seriously contemplated bankruptcy, Hartford, CT has begun to move forward on the path to fiscal recovery. Those efforts were rewarded this week with an upgrade in its rating at least from Moody’s.  Moody’s Investors Service has upgraded the city of Hartford, CT’s long term issuer rating to Ba3 from B1. The outlook has been revised to stable from positive.  While it does not have any debt outstanding based solely on its underlying rating, the move does signal that the City may have turned a corner in its efforts to recover its financial standing.

Moody’s cited “stable financial operations and improved liquidity that has been achieved through adherence to the city’s financial recovery plan including the benefits of the state’s contract assistance agreement and cost saving measures taken by the city through labor contract agreements and tight expenditure controls. The rating also incorporates strong and continued state oversight through the Municipal Accountability Review Board (MARB) and contract assistance agreement.”

That discipline and oversight will remain important as Hartford has limited revenue flexibility resulting in part from the high percentage of exempt properties within the tax base, persistent challenges of high poverty, above average unemployment and low median family income. Those factors will continue to be the City’s prime credit characteristics and will make it difficult for the City to regain investment grade status on its own for a long time.

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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IS CONGESTION PRICING HITTING A ROADBLOCK?

It has been the expectation that the era of congestion pricing in the US would officially begin on January 1, 2021. When the NYS Legislature authorized the City of New York to impose a scheme of congestion pricing to fund part of the Metropolitan Transportation Authority’s (MTA) massive capital funding needs, the goal was for the charges to begin on that date. This would provide time for the Legislature to work out the details of such a plan and the expectation was that the State’s budget process would lead to  the development of a full mechanism for the collection of the charges and the distribution of any resulting funds.

Now it looks as though achieving a January 1 start will be difficult if not impossible. That is because the pricing scheme must be approved by the US government – the Department of Transportation – as the result of federal funding for the MTA. That approval process also includes an environmental impact component. Therein lies the rub. The State and the City would be responsible for producing an analysis of the environmental impact of the plan. It would help if they knew to what level of analysis the feds would require any assessment to meet. Alas, the federal government has sat on the decision for the last ten months  and now the planning process is held up.

The issue is – does New York State and New York City have to undertake a more limited environmental assessment or a complete “environmental impact statement? It is a big deal because of the serious time implications of such a decision. A report by the National Association of Environmental Professionals on reviews concluded in 2018 cited academic data that showed that for agencies like the MTA that have conducted environmental impact statements with the Federal Highway Administration, it took an average of 2,691 days to complete the process. The shortest time any agency completed such a review with any agency in the federal government was 637 days.

With the State and the Trump Administration at virtual war right now over immigration policy, it would not be realistic to expect any help from the Administration. So it becomes increasingly unlikely that we see any monies paid until the approvals are secured. There also has to be time reserved for the inevitable flow of  litigation which the final regulations should generate. Those are ironically not anticipated to be made public until mid- November.

The situation begs the question of whether or not a full environmental review process just should have been part of the process to begin with. It is easy to become suspicious of just what everyone is afraid of as the result of a full review? Would proponents case for environmental benefit be undercut? Would the impact on the economy cause opposition? Would it support expanded use of the concept both in New York City and in other jurisdictions nationally? Why can’t supporters of significant policy changes based on issues like the environment just do the research, make the case, and then get on with making it successful?

It is a sign of how politically rather than policy driven so much of the current debate over climate, environment, and issues like “car culture”, “micromobility”, and the like find themselves. Government finds itself in the middle of the implementation conundrum. It is easy to criticize government – especially smaller less sophisticated levels of government – for their response to cultural and technological change. The situation in which New York’s congestion pricing scheme finds itself illustrates the difficulty government and therefore municipal credits face when  dealing with these sorts of issues.

FLORIDA UTILITIES

HB 653 is a bill pending in the Florida legislature which would forbid cities from using utility revenue for anything other than the maintenance and upgrade of the utility system’s infrastructure. Attention is being paid to the bill which does not have a companion bill in the Senate as local officials are rallying against it. The debate highlights a phenomenon which has been around for a long time.

Utilities have long been used to keep property tax rates lower primarily for residential properties. The political logic is pretty clear. The idea was that the electric rates paid by large commercial/industrial customers would not be such a significant marginal cost to those entities that they would care. Over the years, cities came to be reliant on often significant annual transfers of revenues out of municipal utilities.

How reliant? Recent press accounts cite examples like the State Capital in Tallahassee where $31 million was transferred to the City’s general operating funds, Jacksonville transferred $118 million to the city’s general revenue fund this fiscal year, and Gainesville’s utility provided $38 million (30%) for general revenue. So it is a significant issue in the Sunshine State. That easily explains the effort to derail the bill early in the legislative process. For utility investors, such a ban would reduce the level and timing of future rate increases. These would expect to be offset by a payment in lieu of taxes mechanism of some other which would require the utility to generate revenues for direct city use.

Nonetheless, the cities should be concerned. Obviously, that level of concern should reflect the proportion of operating funding derived from transfers. It’s generally a subject which comes up in times of fiscal stress on the part of entities on either side of the equation. When those pressures lead one side of the equation to seek changes in the rate of transfer, real credit implications can result.

More recently, it reflects the increasing attention being paid to the issue of infrastructure and the electric grid in particular. The understanding on the part of electric consumers and their desire for more flexibility in their own utility sourcing decisions increases daily. This places more attention on operating and economic efficiency with direct pressure on costs. This will only increase with the development of battery technologies, microgrids, and less centralized generation. Those pressures will be driven from the bottom up as climate change, sustainability, and other environmental issues alter the utility landscape.

PUERTO RICO

“The elected government of Puerto Rico does not support a plan based on the [February] Plan Support Agreement because the government has concluded that the current terms — standing alone — are not in the best interests of the people of Puerto Rico. And, without government support for the PSA and Amended Plan [of Adjustment], the Amended Plan cannon become a reality.” So now we see where the political establishment stands in what should be seen as a reinforcement of the belief that until populism ceases to be the primary driving force in the debt resolution process, that process will not result in resolution of the Commonwealth of Puerto Rico’s debt problems.

Puerto Rico’s Fiscal Agency and Financial Advisory Authority filed an objection to a central government debt-restructuring plan. Cutting through the technicalities, the motion indicates that further concessions to bondholders can only be seen as being detrimental to pensioners. Other legal moves saw the Ad Hoc Group of General Obligation Bondholders, Ad Hoc Group of Constitutional Debtholders, Assured Guaranty Corp, Assured Guaranty Municipal Corp., and Invesco Funds filed a motion to dismiss the board’s and the Unsecured Creditors Committee’s challenges to late vintage GO and Public Building Authority bonds.

It seems that there is little appetite for negotiation outside of legal proceedings. That is not positive at all.

PRIVATE HIGHER ED CREDIT SIEGE CONTINUES

We have hammered the point home for some time in a variety of forums about the enormous pressure small private college/university credits are under. Demographics are trending against maintaining demand over the short run. Those institutions depending on ongoing demand to generate tuition revenues will continue to display rating distress. We saw yet another example with the recent action by Fitch Ratings to downgrade the ratings on Immaculata University  to ‘BB-‘ from ‘BB’.

Immaculata was the first Catholic women’s college established in the Philadelphia area and it celebrates its centennial in 2020. recent times have not been kind as full time equivalent (FTE) enrollment declined by about 18% between fiscal years 2016 and 2019. That trend did end with a 3% increase in enrollments but it was achieved through an acceptance rate of over 80%. That is because on 20% of those accepted enroll.

The fundamental credit weakness in  the current environment is the fact that student-generated revenues constitute approximately 90% of university operations. Fitch notes that ” Immaculata’s student base exhibits an elevated level of price sensitivity, as even modest increases in net tuition and fee revenues are likely to result in further demand pressure.”  

Currently FTE enrollment is approximately 1,700 students in 53 undergraduate majors, seven master’s degree programs, three doctoral degree programs, and over 40 additional professional endorsement, certificate and certification programs. This puts the University right in the middle of a large pool of comparably sized and oriented private institutions competing for a currently limited demographic cohort.

We continue to believe that this sector is one to currently avoid. This is more evidence in support of that view.

INTERNATIONAL STUDENT ACCESS UNDER PRESSURE

Each year, the International Educational Exchange releases its Open Doors report on enrollment trends for international students. International students make up 5.5% of the total U.S. higher education population. According to data from the U.S. Department of Commerce, international students contributed $44.7 billion to the U.S. economy in 2018, an increase of 5.5 percent from the previous year. Because of that economic impact and the importance of these usually “full fare” students, they have become increasingly important to universities in particular.

There have been ongoing concerns that the immigration policies of the Trump administration might put a damper on demand from that sector. There have been a variety of reports on the difficulties students from a wide variety of countries have experienced with obtaining visas and visa renewals.  Overall, data shows that international student enrollments in the US increased 0.05% in 2019. One would have expected more robust demand absent conflicts with China and nation specific limits and bans.

One institution which is not happy with the current regime is the University of Illinois at Urbana-Champaign. It has the fifth-largest population of international students in the country. , according to the 2019 Open Doors. More than 15,000 are enrolled in the university system, including the Chicago campus. UI is at the forefront of a group of presidents and chancellors from nearly 30 colleges and universities in Illinois are pushing for lawmakers to do more to help international students and scholars who face new obstacles tied to immigration policy.

The group has sent a letter to the Illinois congressional delegation expressing “concern about changes in immigration policy and procedures that undermine the ability of our institutions — and the state of Illinois — to continue benefiting from the important skills and contributions of international students and scholars.”  That concern reflects academic concerns but also the fact that more than 53,000 international students went to colleges and universities in Illinois, according to the Open Doors report – contributing $1.9 billion to the state’s economy. 

It matters and is a situation worth continued monitoring.

DISCLOSURE

Recently, the various facets of the disclosure issues facing the municipal bond market were indirectly debated in an industry publication. And as expected, it featured the usual litany of reasons why investor demands for timely information are so difficult to fulfill. After some five decades in the municipal credit analysis sector, I have to admit to a high level weariness with the laments of issuers of various sizes and structures and their difficulties in meeting those demands.

My views are built on a foundational view that one knows the rules associated with access to the public securities markets. It is not that we don’t understand that there is a very wide range of municipal issuers and municipal credits. A single regulatory mandate does not fairly address everyone and every credit. That is not what the investing community is asking for and it is simply disingenuous to imply otherwise. And it becomes tiresome to hear arguments about the massive costs that good disclosure would create for ” taxpayers and rate payers who end up paying more for necessary infrastructure projects.” Please do not tell me that if it wasn’t for those pesky municipal bond analysts we could magically have more infrastructure.

There are reasons why private entities remain so when they are staring out or as they remain successful but at a smaller scale. These  entities often survived and thrived without the use of or access to private capital. They also have to provide less ongoing financial disclosure. Many of the sources of finance which supported those ventures have admittedly changed and become more concentrated. At the same time, the overall level and global availability of capital has created a whole new universe of funding outlets.

That creates opportunities for those who are prepared to compete in the current digital world. Instead of creating never ending hurdles to disclosure, the issuer  community would be better served putting its efforts into trying to generate and provide the kind of information which would serve to expand rather than limit our market. With every day the financial markets become more globalized. It may be that some levels of municipal bond issuer may not be able to access those markets (especially the international space). That means that there needs to be a better match between issuer and investor. That may mean that less fulsome and timely disclosure may still satisfy some investor classes while restricting access to others. Sorting that out is what markets do.

The challenge to issuers is to find and if necessary develop demand for their debt at a level of disclosure which is mutually satisfactory.  That could be bond banks, direct loan relationships with private lenders both bank and non-bank, or with state or municipally owned banks. The answer for those who trade and invest through the public markets should never be one which encourages less transparency.

NYS BUDGET

With some 40 days to go before the New York State budget must be enacted, the State Comptroller Tom DiNapoli has weighed in with his analysis of the Governor’s proposed fiscal 2021 budget. School Aid would increase by $826 million, or 3%, to $28.5 billion in the coming school year. This increase is less than the 4% growth allowable under a statutory limit related to personal income in the state. Funding for most local governments aid programs would be held flat, continuing a trend in recent years of decreases or level funding in such areas. These include Aid and Incentives for Municipalities, also known as AIM, the largest unrestricted aid program for local governments, as well as major funding for streets, highways and bridges.

Total capital spending over the current and next four years is projected at $66.7 billion, little changed from the estimate based on the SFY 2019-20 Enacted Budget. Projected transportation spending is increased $3.3 billion, partly offset by certain unspecified reductions from the previous plan. The budget would appropriate $3 billion for the Metropolitan Transportation Authority’s 2020-2024 capital program, although funding sources are not identified. 

The State’s own spending on Medicaid rose by nearly $10 billion through the decade ending in State Fiscal Year (SFY) 2018-19. While most of that growth was expected, unplanned cost increases more recently led to deferral of $1.7 billion in Medicaid payments from the end of SFY 2018-19 into the current year. The Division of the Budget anticipates a second consecutive deferral of $1.7 billion, into the coming fiscal year. The SFY 2020-21 Executive Budget Financial Plan relies on unspecified actions to generate $2.5 billion in Medicaid savings during SFY 2020-21, with the savings amount projected to rise to $3.5 billion within three years.

The budget recommends presenting a $3 billion Restore Mother Nature General Obligation (GO) Bond Act to the voters that, if approved, would provide funding to restore habitats, reduce flood risks, improve water quality, protect open space, expand the use of renewable energy and support other environmental projects. The budget would authorize an additional $10.3 billion in new state-supported debt, all to be issued by public authorities except the proposed $3 billion Restore Mother Nature GO Bond Act. Outstanding state-supported debt is projected to rise 20.3%, and annual debt service 48.4%, by SFY 2024-25. The Executive anticipates elimination of 2,500 state prison beds in the coming fiscal year, and a $181.5 million reduction in spending for the Department of Corrections and Community Supervision, partly reflecting budget language that would authorize additional prison closures. The Financial Plan assumes a deposit of $428 million to the Rainy Day Reserve Fund at the end of the current fiscal year.

The State has long been a utilizer of creative accounting maneuvers and the coming year is no exception. The Comptroller gives particular attention to recent actions In recent years which he feels serve to obscure actual spending increase amounts. The Executive has set a non-statutory goal of limiting annual growth in State Operating Funds spending to no more than 2%. The Financial Plan includes a number of budget actions – including timing-related adjustments, program restructurings, shifts and new categorizations of spending and other steps – that cloud the picture of spending growth. The readily identifiable actions described in this report are expected to reduce SFY 2020-21 State Operating Funds expenditures by a net of approximately $1.1 billion. Adjusting for such differences, State Operating Funds spending in the coming year would increase by 3.1 percent, compared to the 1.9 percent presented in the Executive Budget Financial Plan.

SANTEE COOPER SALE UNDER CONSIDERATION

The South Carolina Legislature has received information on three bids which have been submitted for the purchase of the South Carolina Public service Authority from the State. Dominion Energy, and NextEra energy of Florida were both chosen as possible companies that could take over. Santee Cooper itself also submitted a bid that is still on the table as it hopes to stay its own entity.

The bid from NextEra seems to be getting the most attention. NextEra is ready to pay off the Santee Cooper’s debt, provide refunds and rebates to customers, and settle an important class-action ratepayer lawsuit over a failed nuclear plant expansion. At the same time, NextEra wants the Legislature to “pre-approve” 800 megawatts of new solar generation; an expansion of Santee Cooper’s Rainey gas-fired power station in Anderson County; and the construction of a new, 1,250-megawatt gas-fired plant in Fairfield County. Here’s the catch. NextEra also wants assurances that it can bill customers for those plants if the projects are scrubbed because of state or federal regulatory changes, like a nationwide tax on carbon emissions.

The plan also anticipates that it would cut more than 40% of Santee Cooper’s workforce — some 700 employees. Dominion Energy also entered an offer to take over Santee Cooper’s management but leave the utility under state ownership. The House and Senate’s budget committees each must pick their preferred bid within the next month. Santee Cooper has already charged its direct customers and the members of South Carolina’s 20 electric cooperatives roughly $670 million for the abandoned Sumner nuclear project. Santee Cooper’s nuclear-related debt now stands at $3.6 billion.

State officials reached out to 55 companies and received interest or bids from 10 businesses. The Governor has thrown his support behind the NextEra bid. As for bondholders, the choice would be between the Santee Cooper bid and the investor owned utility bids. A private owner would have to defease the existing Santee Cooper debt. If Santee Cooper remains the owner, the debt would remain outstanding and the bondholders would continue to face the risk of potential litigation. NextEra’s proposal offers slightly higher rates in the long term but, it provides money to settle a major lawsuit brought by ratepayers over the failed V.C. Summer project. The Santee Cooper offer features lower rates over the next 20 years but no certainty as the utility heads to court in April. 

CANNABIS GROWS

The Colorado Department of Revenue’s Marijuana Enforcement Division reported that 2019 generated $1.75 billion in sales of legal cannabis. This represents a new high in sales and is a 13% increase in sales from 2018. Since legalization and the commencement of sales in 2014, sales have totaled $7.78 billion.

Taxes, license, and fee revenues for 2019 accruing to the State were $302,458,426. This raised the State’s total revenue take from these sources at $1,207,966,842. For FY 2015-16, the first $40M of the Retail Marijuana Excise Tax revenue was distributed to the PSCCAF. Excise tax collections in excess of $40M, $2.5M for FY 2015-16, were transferred to the Public School Fund. For FY 2016-17, the first $40M of the Retail Marijuana Excise Tax revenue was distributed to the administered by the PSCCAF. Excise tax collections in excess of $40M, $31.6M for FY 2016-17, were transferred to the Public School Fund.

For Fiscal Year (FY) 2017-18*, the first $40M of the Retail Marijuana Excise Tax revenue was distributed to the Public School Capital Construction Assistance Fund (PSCCAF) administered by the Colorado Department of Education’s Building Excellent Schools Today (BEST) program. Excise tax collections in excess of $40M, $27.8M for FY 2017-18, were transferred to the Public School Fund. Starting FY2018-2019, pursuant to HB18-1070, the greater of $40M or 90 percent of excise tax revenue will be credited to the PSCCAF. Any excess will be transferred to the Public School Fund.

On the regulatory front, the U.S. Department of Transportation (DOT) issued a notice clarifying that workers in safety-sensitive positions under its regulations will not be tested for CBD. The federal legalization of hemp means that cannabidiol derived from the crop is no longer a controlled substance. The notice made three specific points.

DOT “requires testing for marijuana and not CBD.”  Workers should remain wary of using CBD products because they are not currently regulated by the Food and Drug Administration and “labeling of many CBD products may be misleading because the products could contain higher levels of THC than what the product label states. The department said “CBD use is not a legitimate medical explanation for a laboratory-confirmed marijuana positive result.” So, if an employee using CBD that contains excess THC tests positive, it cannot be defended as a medical use.

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

________________________________________________________________

NASSAU COUNTY

The Nassau Interim Finance Authority (NIFA) took control of the finances of the public benefit corporation running Nassau University Medical Center, saying the hospital’s condition “poses a material threat” to the county. NuHealth, the public benefit corporation that is the medical center’s parent, had a cumulative loss of $193.9 million between 2015 and 2018. The resolution adopted by the Authority allows NIFA to “take whatever actions they deem necessary or appropriate” to enforce the resolution placing NuHealth under NIFA’s control. This is effectively the kind of oversight which the Authority exercises over the County. They will not run the hospital but will have significant sway over those who do.

NIFA controls could lead to imposition of an employee wage freeze and requirements that NUMC submit contracts, budgets and union agreements to the control board for approval. NUMC showed cumulative losses of $193.9 million between 2015 and 2018, according to the NIFA resolution. It estimates operating losses were $46.6 million in 2018, compared with $25.7 million in 2017.

NIFA’s basis for intervening is the guarantee of some $188 million of debt by Nassau County. NIFA has determined that current trends will exacerbate the hospital’s problems and is an unacceptable risk for the County. There  is a long record of county owned and operated hospitals experiencing operating losses which were funded by the counties. Ultimately, those situations would have significantly hampered general county finances so spinoffs of those institutions generally resulted.

The decision to impose oversight comes at a time of great uncertainty for safety net providers in the State. Sharp increases in Medicaid costs are at the center of the State’s current budget debate as the Legislature grapples with an estimated $6 billion budget gap for the fiscal year beginning April 1. It is therefore unlikely that the County will be able to rely on additional outside funding for its operations. This makes the oversight role of NIFA even more important.

PUERTO RICO

An agreement with bondholders announced by the Commonwealth’s federally created financial oversight board Is estimated to effectively eliminate some $24 billion of debt. The deal would reduce $35 billion of bond debt and other claims to about $11 billion.  Bondholders would face average haircuts of 29% for GO bonds and 23% for PBA bonds. This is less than proposed  haircuts of 36% to 65% that were included in the September plan of adjustment. According to the PROMESA board, “lowers total debt payments relative to the agreement we reached last year, pays off commonwealth debt sooner, and has significantly more support from bondholders, further facilitating Puerto Rico’s exit from the bankruptcy that has stretched over three years.”

Pensions remain at the center of the negotiations. The board has been seeking a maximum 8.5% cut for retirees who receive more than $1,200 in monthly benefits. Pensioners and the Governor of Puerto Rico insist that if the bondholders position improved that their position should also improve.

Of importance to investors is that the deal if ultimately adopted calls for the Commonwealth to stop its efforts to have some $6 billion of Commonwealth debt declared invalid. Those bonds, issued between 2012 and 2014 were the subject of litigation which contended they were issued in violation of Puerto Rico’s constitutional debt limit. Under the terms of the revised proposal, creditors would receive $10.7 billion in new debt, divided between GO bonds and sales tax-backed junior lien bonds, along with $3.8 billion in cash. Positively, the plan also reduces the timeframe to retire the Commonwealth’s legacy debt to 20 years from 30 years.

Regardless of how negotiations over the restructuring of the Puerto Rico Electric Power Authority (PREPA) end up, it appears that a giant opportunity is being squandered to create a more sustainable and viable electric utility. This week, the executive director of the Fiscal Control Board, said that PREPA is “arms crossed” on the negotiations of renewable energy projects for Puerto Rico. “As of today, PREPA has not finished any discussion and, much less, some negotiation with renewable energy producers so that the people of Puerto Rico benefit from cheaper, cleaner and more reliable energy. To the extent that PREPA remains arms crossed, the people continue to be penalized while unsustainable rates are paid month by month.”

We have consistently argued since the immediate aftermath of Hurricane Maria that an opportunity had been created to reimagine the island’s utility grid. We advocated for the greater use of renewables to take advantage of Puerto Rico’s abundant wind and solar exposure. We also advocated for the creation of microgrids centered around diverse local sources of generation. Since that time, the recent experience of earthquakes highlighted the attractiveness and viability  of local generation and distribution. In the limited  number of jurisdictions with access to these modalities, the disruption from the earthquakes was mitigated. So the case is being made. Just like so many other things in Puerto Rico, populism and politics keep getting in the way.

The perception of a government less than focused on efficiency was supported by the news that the finance director of the government-sponsored Puerto Rico Industrial Development Company said in the police report that the island’s government had unwittingly handed over $2.6 million to thieves after being fooled by a bogus email message. An email message contained instructions to transfer money intended for the public pension system to a different bank account than had been used before. The finance director  said his office sent the money to a foreign account on Jan. 17. They are not alone. Another government entity, the Puerto Rico Tourism Company, had been fooled into transferring $1.5 million. 

It has been noted that training for the Commonwealth’s work force was less than sufficient. One observer noted “Training is forgotten because it costs. Hospitals have to have them because they have to comply with regulations. Government agencies have no regulations.”

TRANSPORTATION

Legal proceedings challenging Washington State Initiative 976 are underway. The Initiative passed in November. It limits most taxes paid through annual vehicle registration at $30 and largely revokes state and local authority to add new taxes and fees. A coalition of cities, King County and Garfield County’s transit agency sued to overturn the Initiative which the state Office of Financial Management estimates would cost the state and local governments more than $4 billion in revenue over the next six years.

While the legal process plays out, local transportation agencies have been raising the specter of unpalatable cuts. Seattle said it would have to cut 110,000 bus hours. Garfield County said it would have to halve the transportation services it provides to help seniors and disabled people.

The hearing follows a ruling from the same court in November that the initiative’s ballot title was misleading because it said the measure would “limit annual motor-vehicle-license fees to $30, except voter-approved charges.” The judge has already indicated that the litigation against the initiative would succeed.  He believes that the language in the initiative referring to “voter-approved charges” led some voters to believe that existing local funding sources would not be affected.

The effort to defend the Initiative is part of a long battle waged by an anti-tax activist who is now running for Governor. Previously, he had sued to stop the car tab taxes unsuccessfully. He believes that the initiative would allow for the end of voter approved taxes in the Puget Sound region used to expand Sound Transit.

Meanwhile, Seattle’s southern neighbor Portland, OR has decided to ask voters to approve a 10-cents-per gallon gas tax in May. The tax would continue the gas tax program for another four years. Portland voters approved the gas tax in 2016 with 56% of the vote.

WHO’S STREETS? OUR STREETS!

We will employ this headline for our ongoing observations of the transportation sector especially as it involves “micromobility”. We were struck by two recent themes we saw expressed in current literature on the subject. One put forth the view that cities have “lost” the technology battle. The other unwittingly showed where the problem lies.

In a sector that is evolving as quickly as the “micromobility” space, it is not realistic to expect that municipalities could be prepared for the essentially lawless approach that so-called transportation disrupters would take. It’s clear that the approach reflects a conscious decision that it is somehow better or easier to deploy a given modality without consideration for any regulatory process. Whether it is ride sharing, rental bikes, or motorized devices, the proven practice has been to deploy often without any attempt to engage with local jurisdictions. That is of course until the problems associated with them generate enough public support for action.

The question is what are local jurisdictions supposed to do when a particular player insists on deployment under its terms or not at all. A current example is the ongoing dispute between Uber and the City of Los Angeles over the City’s regulation of electric scooters. The City Council last year adopted a pilot program that regulates the number of electric bicycles and scooters each company can have in its fleet. After demonstrating compliance with program requirements and meeting certain performance criteria, LADOT can allow companies to increase their fleet size.

The approval of e scooters by the City accompanied the rollout of the City’s Mobility Data Specification (MDS) technology. It is designed to receive real time trip data each scooter is equipped to provide. It has been the subject of robust debate within the industry as providers struggle to placate the City while addressing the perceived privacy concerns of its users. MDS can be used to inform policy decisions, like where to put a protected bike lane or how to ensure low-income residents have access to dockless vehicles. It also allows the agency to use MDS to send instructions back to the mobility companies. That enhances the City’s ability to address issues like illegal parking of scooters especially in places like sidewalks.

Of the major scooter providers (Uber owns JUMP), only Uber refuses to provide the data. Consequently, the City has banned JUMP scooters and bikes from its streets. In keeping with its annoying history, Uber has chosen to fight the regulation in court. So how is this a failing on the part of the City? They made a rule, implemented and enforced a regulatory structure and one potential provider did not like it. Unsurprisingly, Uber suffered another defeat legally when a city hearing officer upheld the Los Angeles Department of Transportation’s temporary ban on Uber’s JUMP e-bicycles.

At some point, the industry will realize that they do not own the streets and that government has a duty to regulate the use of those streets. Especially, when private entities seek to exploit those streets for private gain at the expense of public facilities and services. For an example of how these things can work, look to the recent approval of a pilot program for electric bikes and scooters approved in Jacksonville, FL. The State of Florida legalized e-scooters and similar devices throughout the state in June through   House Bill 453 which provides for Florida cities to regulate micro mobility devices. For a company to install a corral and operate scooters in Jacksonville there will be permit, renewal and annual fees. The companies also will have to purchase performance bonds for each device up to $10,000. The program sets travel boundaries for the electric scooters and bikes.

TRUMP INFRASTRUCTURE PROPOSAL

The proposed FY 2021 budget from the Trump Administration includes an $89 billion budget request for USDOT FY 2021 funding – a nearly 2 percent increase above FY 2020 appropriations, of which $64 billion would come via the Highway Trust Fund (HTF). The request is step one in a proposed 10 year plan to invest $86 billion in infrastructure annually through 2030. The administration noted, however, that its request for $21.6 billion in discretionary transportation budget authority for FY 2021 is a $3.2 billion or 13 percent decrease from what was enacted for FY 2020.

The proposed $810 billion, 10-year surface transportation package would increase spending by 12% over the amount the Congressional Budget Office of current surface transportation funding projection based on existing law. That would produce an average annual investment of $60.2 billion for highways over the decade, with $15.5 billion yearly for transit, $2 billion for National Highway Traffic Safety Administration and Federal Motor Carriers Safety Administration, $1.7 billion for rail, and $100 million for pipeline and hazmat safety. A serious proposal would have included ideas for fully funding the program. Efforts to impose higher fuel taxes and/or vehicle mileage taxes should be at the center of any of those discussions and there is support for both.

Ironically, the budget does include non-fuel based fees for infrastructure financed through the Inland Waterways Trust Fund. Here the budget offers ideas such as a per vessel tax on commercial boats. Contrast this with the road proposals where the Highway Trust Fund is facing a cash shortfall in FY 2021 and FY 2022. This proposed budget for FY 2021 seeks to eliminate general fund supplements to transportation outlays made by Congressional appropriators in recent years and seeks to build those additional dollars into affected program baselines, supported by the HTF rather than the general fund.

AIRPORTS

The Des Moines, IA Airport board voted in 2016 to build a new terminal at the airport grounds and rebuild the runways. The total cost of the overhaul was estimated at about $500 million. Some $300 million in funding has been identified for the project relying on a combination of sources including cash on hand, passenger and airline fees, authority-issued bonds and grant money.  The last 40% of the funding gap has been hard to fill.

One source which will not be tapped is private facilities to be constructed at the airport. In the case of Des Moines, there was a proposal to build a casino and hotel on the airport’s grounds. The project proponents claimed that the project could generate some $194 million for the airport capital plan. Like so many projects like this, the motives of a proposed developer have gotten in the way much as they did in St. Louis.

Here’s the catch. There is one casino operating in Des Moines and Polk County. It originated as a race track and as that industry declined, casino gambling provided greater potential. So 16 years ago, Des Moines, Polk County and Prairie Meadows Casino and Hotel entered into an agreement that requires elected officials to reject any proposed new casino in the city or county in exchange for a share of gaming revenue from the casino. The city receives about $6 million in gaming revenue annually from the county-owned Prairie Meadows.

So this drives the airport board to look at traditional financing away from a P3. Federal and state grants and passenger facility charge revenues are the likely sources. This is where the current state of federal infrastructure policy (or more correctly the lack thereof) comes in and highlights the role of municipal bonds. The level of passenger facility charge caps is a constant source of conflict between air carriers and airports. Many airports would love to raise the charges above their currently capped $4.50 level. That would require federal legislation to lift the cap.

In the absence of some policy consensus at the federal level, raising the PFCs looks like the easy thing to do. Of course, this debate will occur during both an election year and a likely much less profitable year for the airlines as they grapple with the corona virus issue. So an increase in PFCs is hardly a foregone conclusion. If it does happen, we would expect to see a flurry of municipal bond financings for airport improvements.

RATINGS AND GOVERNANCE

We were struck by the juxtaposition of two headlines regarding recent developments in the credit supporting debt issued by the Town of Oyster Bay, NY. The first covered the engagement of a consultant to improve the City’s disclosure under the terms of a settlement agreement with the Securities and Exchange Commission (SEC). In November 2017, the SEC charged Oyster Bay and a former Oyster Bay supervisor with defrauding investors in Oyster Bay’s municipal securities offerings by hiding the existence and potential financial impact of side deals with a businessman who owned and operated restaurants and concession stands at several town facilities.  Oyster Bay agreed to settle the case by agreeing to permanent injunctions against violating the antifraud provisions of Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 and to the retention of an independent consultant to advise the town on its policies, procedures, and internal controls regarding its disclosures for securities offerings.

At the same time the formal engagement of the consultant was announced, Moody’s announced that it has upgraded the town’s issuer and general obligation limited tax (GOLT) ratings to Baa2 from Baa3. The outlook remains positive. According to Moody’s, “the upgrade to Baa2 reflects recent improvements to the town’s financial position resulting from cost cutting and substantial tax increases as well as improved liquidity eliminating the need for annual cash flow borrowing and successful resolution of the bulk of the town’s legal problems, including the SEC suit, without material ill effects. The issuer and GOLT ratings also reflect the town’s large tax base, strong resident wealth and income, exposure to litigation, and weak, albeit much improved, financial position.”

From our standpoint, the move essentially imposes no cost to the Town in terms of its ratings even though it engaged in practices intended to deceive. It might have been more appropriate to maintain the rating even with a positive outlook. This would recognize that the Town has indeed made fiscal progress without rewarding the governance failures which led to the SEC investigation and settlement. Let the Town put out clean financials and honest sale disclosure before effectively rewarding it.

Our view is that individual investors continue to put too much faith in the rating agencies to protect them from bad actors. Whether that is the appropriate role for rating agencies is up for debate but given the fact that they are trying to stake out positions and roles associated with the growth of the ESG sector on the buy side, they need to decide quickly what constitutes good governance. Oyster Bay was an opportunity to establish some benchmarks but instead the opportunity was passed up.

AUTONOMOUS VEHICLES

A House hearing on autonomous vehicle deployment served to highlight many of the issues holding back implementation and regulation of these vehicles. The testimony served to highlight the potential of AV technology to address issues such as safety and improved access for the elderly and disabled. At the same time, it also drew attention to the many areas of concern the public has with many aspects of AV deployment.

The hearing did not address measures that should be taken if a human needs to override; for example, if a human needs to take over and operate a vehicle, a steering wheel and pedals might be useful in this endeavor. Issues around cybersecurity were raised.  One Congressperson raised the potential for “bad actors to hack and commandeer vehicles.”

One other issue holding things back is the issue of liability. Current safety standards and insurance practices and regulations assume that humans are operating vehicles. As one witness put it, “the difference between an automated vehicle and a human-driven vehicle is a promise. It is a promise from the manufacturer of that automated driving system that they will operate the vehicle safely on our roads.”  

The resolution of insurance and regulatory issues will be a key to full implementation of AV technology on the nation’s roads. This places government at all levels at the center of the process of resolving these issues. It is another example of a question we asked earlier – Whose streets?

HEALTHCARE

The federal government continues its efforts to limit access to healthcare through the Medicaid program. In addition to its efforts to limit expansion of the program and overturn Affordable Care Act provisions supporting it, it is now using the regulatory apparatus to add layers of bureaucracy to the process. The latest example is this week’s announcement that the Centers for Medicare & Medicaid Services (CMS) has issued a proposed Medicaid Fiscal Accountability Rule (MFAR).

The rule would among other things establish requirements regarding state plan amendments (SPAs) proposing new supplemental payments, and addresses the financing of supplemental and base Medicaid payments through the non-federal share, including states’ uses of healthcare-related taxes and provider-related donations, as well as the requirements on the non-federal share of any Medicaid payment. 

States have reacted negatively. The proposed changes would make it harder for states to manage the use and allocation of its (as opposed to federal resources) own resources. The proposed amendment would clearly limit permissible state or local funds that may be considered as the state share to state general fund dollars appropriated by the state legislature directly to the state or local Medicaid agency; intergovernmental transfers (IGTs) from units of government (including Indian tribes), derived from state or local taxes (or funds appropriated to state university teaching hospitals), and transferred to the state Medicaid Agency and under its administrative control; or certified public expenditures (CPEs), which are certified by the contributing unit of government as representing expenditures eligible for federal financial participation (FFP).   

It is hard to see how the reporting and data production asks being made under the proposed rule reflect much more than a desire to cut the federal share of healthcare funding. That would likely result in a higher cost burden for states as they would be looked to for the funding of charity care in an era of lower overall reimbursements. That would be credit negative for both government and the provider 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

________________________________________________________________

NEW YORK CITY PROPERTY TAXES

New York City’s property tax scheme has always created wide disparities in how individual properties are valued and taxed. This has created tax burdens unrelated to ability to pay and has wound up creating valuations in high value neighborhoods which result in lower tax burdens for those with the ability to pay versus those who face constrained incomes. One example – Co-ops and condos are not taxed at their true market value under the current system, but rather on the income generated by similar rental buildings.

The Commission recommends moving coops, condominiums and rental buildings with up to 10 units into a new residential class along with 1-3 family homes. The property tax system would continue to consist of four classes of property: residential, large rentals, utilities, and commercial. It calls for a sales-based methodology to value all properties in the residential class and for assessing every property in the residential class at its full market value. It wants annual market value changes in the new residential class be phased in over five years at a rate of 20% per year, and that Assessed Value Growth Caps should be eliminated. A partial homestead exemption for primary resident owners with income below a certain threshold is another recommendation. The exemption would be available to all eligible primary resident owners in the residential class and would replace the current Coop-Condo Tax Abatement.

The changes could affect 90 percent of all homeowners in New York City, according to the commission chairman. The City Council and the State Legislature would both have to approve any changes which create significant hurdles to implementation. For that to happen, lots of opposition on the ground will have to be overcome as there is no constituency for paying more especially with the Legislature up for reelection in November.

NYC IBO BUDGET ANALYSIS

The Independent Budget Office for the City of New York has released its preliminary review of Mayor Bill de Blasio’s proposed budget. IBO projects a fiscal year 2020 surplus of $2.66 billion—$65 million less than the  de Blasio Administration. It estimates a surplus of $240 million in 2021 and a shortfall of $1.7 billion in 2022. IBO’s forecast of tax revenue exceeds the de Blasio Administration’s by $210 million this year, rising to $644 million in 2021 and $906 million in 2022. IBO forecasts tax revenue growth of 5.0 percent this year, slowing to increases of 2.6 percent and 3.4 percent over the next two years. It projects that tax revenues will increase more rapidly than city-funded expenditures from 2019 through 2024.

On the expenditure side, IBO projects that the city’s cost of providing shelter for the homeless will be $216 million more in 2021 than budgeted by the de Blasio Administration. That finding combines with a less optimistic view of the city’s budget cushion than that of the Mayor. IBO projects the fiscal year 2020 surplus will total $2.66 billion, $65 million less than expected by OMB. This as IBO forecasts a sharp decline in employment growth over the next two years. That reflects projected slower employment growth across all private-sector industries. education and health services are expected to be the primary employment drivers but the health sector could be negatively impacted by proposed state budget cuts.

CYBER SECURITY RISKS NOW CLEAR

The credit risk associated with a ransomware attack has now been made clear to municipal bondholders. Pleasant Valley Hospital in West Virginia was the victim of such an attack. It now is reporting that the cost of recovering from the attack and the ransom demand it ultimately resulted in have materially impacted its credit. Because of the attack, the hospital was forced to spend about $1 million on new computer equipment and infrastructure improvements. It has occurred at a time when the hospital was already experiencing a decline in patient volumes which negatively impacted revenues.

The result is that financial performance has been inadequate and the bond trustee for the hospital has notified bond holders that the hospital’s debt service coverage for the fiscal year that ended on Sept. 30 to fall to 0.78 times. That is substantially below the 1.20 times debt service coverage the loan agreement requires, according to the material notice to bondholders.

This event shines a light on the problems our industry has had with dealing with the issue of cybersecurity risk. While the hospital has disclosed about the level of unplanned remedial spending it was forced to do, it did not answer one key question which investors should be interested in – was the ransom paid. The hospital declined to deal with that leaving its cybersecurity insurer to answer which it declined to do.

If cyber attack victims begin to be seen as willing payers of ransoms, we believe that the level and volume of these incidents will continue. Recent incidents have led to payments (mostly healthcare providers) in response to demands. Governments have seemed less willing to do so. This will increase the risk associated with healthcare credits even more if they make themselves into a target rich sector.

CALIFORNIA DAMS BACK IN THE NEWS

The California State Auditor recently issued the results of an audit of conditions and inspection practices at the over 1200 dams in the state. Unsurprisingly, it found that the State’s flood control structures, like the highway system, are aging and deteriorating. California experienced exceptional levels of precipitation in the winter of 2016–17 caused by a series of atmospheric rivers that caused flooding throughout the State and exposed vulnerabilities in the flood control infrastructure. In early 2017, after multiple storms, a large hole broke open in the main spillway of the Oroville Dam. Dam operators decreased the outflow to minimize the damage, but with the heavy rain and quickly rising water levels on Lake Oroville, the reservoir filled and water crested over the emergency spillway for the first time in the dam’s history. The runoff caused the upper portion of the hillside below the emergency spillway to erode rapidly, and county officials ordered the evacuation of approximately 180,000 downstream residents until the risk of flooding could be reduced.

Oroville Dam is just the most prominent example. According to the Auditor, most of the major dams in the State are vulnerable, with a median construction date of 1955. Data from the dams safety division show that, as of August 2017, 98 of the 1,249 dams throughout California are in less‑than‑satisfactory condition due to seismic, structural, and other deficiencies. Many of the dams in less‑than‑satisfactory condition are near urban areas in the Bay Area, Southern California, and the Central Valley and, as a result, pose an extremely high downstream hazard potential. Data from the dams safety division show that it has placed restrictions on 39 percent of the dams in the State that are in less‑than‑satisfactory condition.

It must be noted that a significant number of these structures are privately owned and operated. Although the State is responsible for regulating and supervising the construction and repair of major dams, improvements to dams are ultimately the responsibility of their owners, who are generally not state or federal agencies. The state requires that by 2021 all dams—except those with low hazard potential—must submit emergency action plans and make those plans publicly available. That will provide a better measure of the potential level of demand for capital investment needed to address the problem.

It is likely that municipal bond financing will be involved.

PENNSYLVANIA TURNPIKE COURT VICTORY

On 27 January, the US Supreme Court denied the Owner Operator Independent Drivers Association’s (OOIDA) petition for a writ of certiorari to review the Third Circuit’s decision to affirm the lower court’s dismissal of OOIDA and other plaintiffs’ lawsuit against the Pennsylvania Turnpike Commission  and the Commonwealth of Pennsylvania. The denial of OOIDA’s petition is credit positive for the PTC and the state because it provides near final clarification on the legality of the funding laws that use PTC tolls for non-system needs, including other transportation and transit needs in the state.       

After a long period of infrequent toll increases, the Commonwealth decided earlier in the last decade to raise tolls and generate excess revenues to be used to address local capital needs supporting the state’s road system. This funded an annual transfer from the Turnpike Commission of $450 million. That raised the ire of the trucking industry which felt it was being singled out as a source of funding as they believed that the bulk of the increased toll burden fell on them. Hence, the litigation against the PTC and the commonwealth. The plaintiffs alleged the PTC, the state and others violated the dormant commerce clause and the constitutional right to travel by charging higher tolls on the turnpike system to fund other state transportation needs, like capital needs of the state’s transit enterprises.

Existing state statute requires the annual PTC transfer to the state to decline to $50 million from $450 million starting in fiscal 2023. To address the issue of funding for local roads, Act 89 identified the Motor Vehicle Sales and Use Tax as the replacement source of revenue to fill the funding gap that will materialize when the transfers decline.  The funding plan to use turnpike revenue had real negative credit impacts for the PTC. The PTC currently has $6.7 billion of subordinate debt outstanding that was issued to fund these transfers to date and it will rise through fiscal 2022. The pressure to support that debt and maintain the Turnpike led to rating declines. The favorable court decision is credit positive for the PTC.

Nonetheless, the impact of the litigation outcome is uncertain. In the aftermath of the decision, there are concerns that the unsuccessful legal challenge could still encourage the Legislature to abandon plans to use different revenues to fund the state’s local road needs. While this is a legitimate concern, the current atmosphere in the State legislature supports speeding up the shift from turnpike revenues to the fuel revenues. This uncertainty will slow actual rating improvement but the current environment makes for a better trading environment for Turnpike debt.

PUERTO RICO

Holders of municipal bond debt issued on the behalf of the Puerto Rico Employees Retirement System have had a bad run in the federal courts. The latest blow to their case occurred when a U.S. Appeals Court ruled that bondholders’ claim on the assets of Puerto Rico’s public employee pension system ended when the system filed for bankruptcy in May 2017. The First Circuit Court of Appeals affirmed Federal Judge Laura Taylor Swain’s June, 2019 decision that bondholders’ claim on employer contributions to the U.S. commonwealth’s Employees Retirement System (ERS) did not extend into bankruptcy.

ERS’s assets include certain properties and investments that it had before requesting bankruptcy-like protection under Title Three of PROMESA, in May 2017. The First Circuit ruling clearly denies the access of SRE creditors to Public pension contributions. Those contributions include payments from employees so employees were effectively pitted against bondholders. Increasingly in recent bankruptcies, that has been a losing proposition for bondholders.

The financial oversight board took the view after the ruling that ” the commonwealth has no obligation to pay bondholders other than the value of encumbered assets in ERS when it commenced its case under Title III of PROMESA.” As things currently stand, the plan of adjustment the board filed in court in September for Puerto Rico’s core government debt and pension liabilities included an 87% haircut or value reduction for ERS bonds. 

The bondholders continue to face legal adversity. They are appealing the decision of Judge Swain who is overseeing the Title III proceedings from Jan. 7 denying their motion for the appointment of a trustee to pursue ERS claims arising from the oversight board’s role in the system’s bankruptcy.

The PREPA restructuring has hit another roadblock as the Governor and the Legislature’s leadership have come out against any rate increase for retail customers that might be part of a debt restructuring. Disagreements over rate increases have delayed hearings on a proposed restructuring have been delayed on five occasions as the parties attempt to marshal political support necessary to any restructuring agreement implementation. The existing proposal for an agreement with PREPA bondholders begins in the first year with a Settlement Charge of 1 cent per kilowatt hour. Then it increases to 3.46 c / kWh from the 2nd to the 4th year and to 3.7 c / kWh in the 5th year. This includes the basic Transition Charge plus the Subsidy Charge, which reaches up to 25% of the Transition Charge.

OHIO OPEB COST SHIFT

The Trustees of the Ohio Public Employees Retirement System approved changes in the funding of retiree health costs. Beginning January 1, 2022, for retirees who are Medicare-eligible — ages 65 and older — the monthly allowance provided by OPERS to offset health care costs will be reduced. The allowance currently ranges from $225 to $405, depending on age, years of service and retirement date. The lower allowances will range from $178 to $315.

Retirees under the age of 65 will no longer be covered by a group plan, where OPERS picks up between 51 percent to 90 percent of the cost. On average, retirees are paying $354 a month. Those employees will be expected to apply a monthly stipend towards the purchase of insurance on the open market and through the Affordable Care Act.

Clearly the state is shifting its cost base from itself to Medicare. Without the changes, OPERS projected that its $11.3 billion health care fund would run out of money by 2030. OPERS has $94 billion in assets for pension benefits and serves 1.14 million people. OPERS covers most of the city, county and state workers, has provided health care coverage to retirees since 1974.

In addition to the reduced healthcare benefit, OPERS hopes to have legislation enacted which would  eliminate the cost of living allowance given to retirees in 2022 and 2023 and delay the COLA for two years for all new retirees. 

Like many approaches to the “reform” of pension and OPEB funding, this one puts the onus of the recipients. It acknowledges that the political reality is that trustees want to explore the idea of asking lawmakers to increase the employer contribution rate to generate funds for health care coverage. Lawmakers and taxpayers are considered unlikely to embrace such a change.

Moody’s has declared the changes to be credit positive. We agree that reduced funding requirements are good for the state’s finances but the changes do create a couple of areas of risk. One is that the Trump Administration is focusing on supporting litigation to invalidate the Affordable Care Act. Should it succeed, one of the pillars of Ohio’s plan will be destroyed. Along with efforts to eliminate protections for patients with preexisting conditions, the availability of insurance for many individuals would be in question. If that occurs with no replacement, the state’s Medicaid burden could be significantly impacted.

We think that it will take an extended period to see if the overall health insurance structure which emerges over the next few years actually is positive for Ohio. If it is not, the economic impact on the state will be quite negative. Case in point follows below.

PROPOSED FEDERAL MEDICAID CHANGES

Medicaid has been in the news as it is at the center of the Fiscal 2020 budget process in New York State. While the State seeks to adjust and shift cost responsibilities for the program to county and local governments (a large chunk would come from New York City), a major wrench has been thrown into the works with the release of proposed changes from the Centers for Medicare and Medicaid (CMS).

This week, CMS released a proposal to states which would significantly alter federal funding for the program. CMS proposes to effectively cap annual federal spending for Medicaid by converting the funding mechanism to a block grant formula. According to CMS, the changes are intended “to provide states with a menu of maximum up-front flexibilities with which to design their program. It is clear from the letter containing the proposal that the goal is to limit spending, restrict access, and encourage the use of non-hospital facilities to provide services. The language belies the magnitude of the proposed changes.

Here are some examples:  The ability to impose additional conditions of eligibility, such as community engagement requirements for non-elderly, non-pregnant adult Medicaid beneficiaries who are eligible for Medicaid on a basis other than disability. That is bureaucratic speak for work rules. This despite consistent court rulings against the imposition of such requirements. In addition, states are finding that work requirement enforcement has not been successful due to difficulties with verification. Another is the ability to make certain changes in benefits, premiums, and co-payments during the course of the demonstration without the need for state plan or demonstration amendments and further approval by CMS. Providers are going to love that one whether they be individual practitioners or hospitals. Nothing helps financial planning or credit stability like the uncertainty such a system would provide.

Another would provide the ability to change eligibility and enrollment processes, such as eliminating retroactive eligibility. The changes would also provide the ability to make certain administrative changes during the course of a demonstration under the proposed changes, such as certain changes in provider payment rates and application of claims review prior to making payment, without amendments or further approval by CMS. providers would be unable to determine how much they might receive over the course of a year which would likely make it less likely that providers would like to participate.

Bottom line is that while some states see these proposals positively, the expansion of Medicaid has been an unqualified political success. Just about every time voters have had an opportunity to support Medicaid expansion under the ACA, they do. The do it in red states especially (Utah and Idaho, e.g.). Once Kansans got rid of their ideologue governor, Medicaid expansion was supported there as well. So the idea that the federal efforts to restrict healthcare access is not only a political winner but also a financial winner for states and counties just does not stand up to the facts.

The proposed cuts would hurt hospitals by reducing their revenues, reducing incentives to get care outside of a hospital setting (emergency rooms), and forcing them to rely on state funding to cover the increased charity care burden which will result. All of that is credit negative for hospital credits.

RURAL WOES CONTINUE

Now that the Muni Credit News has moved its headquarters to upstate New York, our existing focus on the unique credit and infrastructure needs of rural areas becomes more intense. In the midst of trade wars and commodity price uncertainties, we now have additional evidence of the difficulties facing rural economies. The latest evidence comes from Farm Bureau, an independent, non-governmental, voluntary organization which advocates for farmers. 

According to the Farm Bureau, while well below historical highs, Chapter 12 family farm bankruptcies in 2019 increased by nearly 20% from the previous year, according to recently released data from the U.S. Courts. Compared with figures from over the last decade, the 20% increase trails only 2010, the year following the Great Recession, when Chapter 12 bankruptcies rose 33%.

During the 2019 calendar year there were 595 Chapter 12 family farm bankruptcies, up nearly 100 filings from 2018 and the highest level since 2011’s 637 Chapter 12 filings. Given that there are slightly more than 2 million farms in the U.S., the 2019 bankruptcy data reveals a bankruptcy rate of approximately 2.95 bankruptcies per 10,000 farms, slightly below the rate of 2.99 filings per 10,000 farms in 2011.

During the fourth quarter of 2019, there were 147 Chapter 12 bankruptcy filings, which was up 14% from the prior year but down 8% from the third quarter of 2019. On a year-over-year basis, Chapter 12 filings have increased for five consecutive quarters. The continued increase in Chapter 12 filings was not unanticipated given the multi-year downturn in the farm economy, record farm debt, headwinds on the trade front and recent changes to the bankruptcy rules in 2019’s Family Farmer Relief Act, which raised the debt ceiling to $10 million.

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.