Joseph Krist

Publisher

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This week we focus on unemployment as it drives most everything we comment on. There is the direct funding need generated by record initial claims, the uncertainty about the duration of social distancing practices, the potential offloading of laid off employee medical costs to Medicaid, and the costs of highly diminished transportation and its immediate impact on revenues. The lack of coherent federal strategy in response to the pressures generated by the pandemic coupled with continued wishful thinking by the White House has simply added to the difficulty in assessing the pandemics true impacts and potential long term credit effects. Anyone who tries to tell you otherwise is only fooling themselves.

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PANDEMICS, UNEMPLOYMENT, AND BUDGETS

Three weeks ago, initial unemployment claims were at about 200,000. In the week ending March 21, the advance figure for seasonally adjusted initial claims was 3,283,000, an increase of 3,001,000 from the previous week’s revised level. This marks the highest level of seasonally adjusted initial claims in the history of the seasonally adjusted series. The previous high was 695,000 in October of 1982. The previous week’s level was revised up by 1,000 from 281,000 to 282,000. The 4-week moving average was 998,250, an increase of 765,750 from the previous week’s revised average. The previous week’s average was revised up by 250 from 232,250 to 232,500.

The State of New York is not only the epicenter for the virus but is also the first state to have to budget  under the terms of the new economic reality in the US. It is grappling with the fact that we are undoubtedly in a nationwide recession as well as the State’s role as the center of the financial industry. It is feared that the economic consequences of the pandemic will create a $15 billion plus hole in the State’s revenue base. With the declines in the stock market, the capital gains states of NY, NJ, CT. MA, IL, CA will see disproportionate impacts.

We already see requests from the State of California and the City of New York to identify significant potential expense reductions in the face of both an anticipated revenue decline as well as delays in revenue receipt as the result of the delay in the federal tax payment date. NJ State Treasurer Elizabeth Maher announced that she is placing $920 million of appropriations into reserves. We would not be surprised to see a higher volume of cash flow borrowings.

The reality is that state and local budget makers are flying blind as there is no real visibility as to a potential time frame for the renewal of “normal” economic activity. We would anticipate lower general obligation bond ratings to decline essentially across the board. Some states are taking significant steps to marshal resources. NJ State Treasurer Elizabeth Maher announced that she is placing $920 million of appropriations into reserves. 

The Senate stimulus bill would offset some of the impacts on credits especially in the transportation sector. The bill would provide $25 billion to transit agencies, the figure they had been seeking. The money could be used to pay to put personnel on administrative leave as agencies cut service, as well as to buy protective equipment and cover other costs. New York’s Metropolitan Transportation Authority is expected to get almost $4 billion. 

Airports would see a further $10 billion in grants on the condition that they keep 90 percent of their staff employees until the end of the year. It is not clear on whether these monies would benefit contractor employees who make up a significant segment of labor at airport terminal commercial outlets.

We do not see any provisions for toll road revenue losses. This is a concern as roads are virtually empty. Credits backed by high occupancy and demand management lanes will continue to be impacted. One high profile high yield bond is being directly affected. Virgin Trains USA, the parent company of the Brightline express train, suspended all train service in South Florida and laid off 250 employees amid the corona virus concerns. 

The Senate stimulus also provides $117 billion for hospitals and veterans’ health care; $11 billion for vaccines, therapeutics, diagnostics, and other preparedness needs; $4.3 billion for the Centers for Disease Control; $16 billion for the Strategic National Stockpile; and $45 billion for FEMA disaster relief fund, among other things.  More than 80 percent of the total funding provided in the corona virus emergency supplemental appropriations division of the package will go directly to state and local governments. Health care systems would receive $130 billion, including $127 billion for a Public Health and Social Services Emergency Fund.  

NO CENSUS, NO FEELING

One of the things that we would normally be anticipating is the US census for 2020. As our industry and market have become so much more data driven, the importance of the availability of good data whether it be for trading, for analysis, or government has continued to grow. The development of good data regarding the economic, demographic, educational , and other aspects of American’s lives are central to much of the work we all do.

Among all of the issues arising from the corona virus pandemic, interruptions to the process of collecting data from residents for the 2020 Census pale beside things like ventilators and shelter orders. Nonetheless, the hurdle that various actions taken to control the pandemic across multiple states  can create for the timely and complete execution of the Census is substantial. While many can complete

their forms on line, a significant portion of the population does not have or use internet access. Some will fill out and mail a form but up to a quarter of the population may need to be contacted in person.

The US has never failed to execute a timely Census but the possibility of a delay must be considered. If it is delayed, that would raise all sorts of issues with the data. A delay in the data could also impact the state redistricting process. This has practical and political considerations for states and localities especially as they involve issues of federal funding for many projects covering many sectors.

PUERTO RICO

The financial Oversight Board is looking to the courts to postpone proceedings on existing proposals to restructure its defaulted debt. “In light of Puerto Rico’s current reality, the oversight board believes that the government and the oversight board’s sole focus should be on getting Puerto Rico through this unfortunate crisis. The board will present a motion in court to adjourn consideration of the proposed plan of adjustment’s disclosure hearing until further notice.”

There are practical considerations which support such a move. The economic impact of the corona virus pandemic will hit the Commonwealth as hard as anywhere given its weakened economic and fiscal conditions to begin with. As will be the case with the states, Puerto Rico will see significant revenue losses. These will likely be enough to force a reevaluation of many of the economic and revenue assumptions supporting the restructuring plan.

Meanwhile, the US District Court for the First Circuit ruled against holders of debt issued to fund pensions in their request to have the assets of the pension fund taken from the general government and given to bondholders. The Puerto Rico government as part of its restructuring largely abolished the pension system. It then, ordered that the assets be transferred over to the general government funds with the general fund assuming its obligation to pay pensions.

The bondholders’ primary argument on appeal was that the federal court didn’t apply standard commercial bankruptcy principles. The justices said the federal judge could consider that this was a governmental bankruptcy and different interests were involved.  The Court reasoned that “The bankruptcy of a public entity … is very different from that of a private person or concern”. A commercial bankruptcy is designed to “balance the rights of creditors and debtors,” whereas governmental bankruptcies are intended to allow governments “the opportunity to continue operations while adjusting or refinancing their creditor obligations.”

We see it as positive that the Court ruled that the nature of municipal versus corporate bankruptcies is different. The role of investors who traffic in distressed situations in the municipal market has been evolving leading to a debate over the role of distressed institutional investors. I believe that they have a role and often provide a needed source of liquidity for holders without the ability to ride out bankruptcies. At the same time their efforts to jam the round peg of a governmental entity into the square hole of corporate bankruptcy practices often bring unnecessary delay to the process of restructuring a municipal entity.

The bondholders still have a separate case pending in the U.S. Court of Federal Claims in which they are arguing that the asset transfer amounted to a “taking” in violation of the Fifth Amendment. The First Circuit suggested that the plaintiffs “avoid a proliferation of actions seeking essentially the same remedy. Each such proceeding potentially drains assets which could be put to other uses.” We agree.

RATING AGENCIES AGREE WITH US

Fitch placed the ratings of five large U.S. public transit agencies on rating watch negative. They are the Metropolitan Transportation Authority in New York, the San Francisco Bay Area Rapid Transit District, the Washington Metropolitan Area Transit Authority, the Metropolitan Atlanta Rapid Transit Authority, and Colorado’s Regional Transportation District. S&P has lowered its outlook on the Metropolitan Atlanta Rapid Transit Authority’s (MARTA) sales tax revenue bonds to negative from stable. It also lowered its long-term rating and underlying rating to ‘A-‘ from ‘A’ on the Metropolitan Transportation Authority (MTA, or the MTA), N.Y.’s transportation revenue bonds (TRBs) outstanding.

Moody’s revised its outlook  to negative on the Aa3 and A2 ratings of the New York Convention Center Development Center’s (NYCCDC) Senior Lien and Subordinate Lien Revenue Bonds including the Aa3 rating on SONYMA bonds that are subordinated to the Senior Lien Revenue Bonds and the A2 rating on SONYMA bonds that are included in the Subordinated Lien Revenue Bonds. The bonds is secured by a $1.50 per-night unit fee on occupied hotel rooms in New York City; a revenue account minimum balance requirement of 80% of MADS; a debt service reserve funded at maximum annual debt service ($43.4 million for the senior lien and $24.5 million for the subordinate lien); and (iv) a credit support agreement with SONYMA that establishes a dedicated account that may be used to pay up to one-third of debt service each year, after tapping the corporation’s other reserves.

S&P Global Ratings placed Queens Ballpark Co. LLC (Citi Field) and Yankee Stadium LLC — the respective homes of the Mets and Yankees — and Louisville Arena Authority LLC on credit watch with negative implications. S&P rates both New York ballpark bonds BBB. “Stadiums and arenas are already facing canceled events and suspended sports seasons due to the corona virus outbreak,” S&P said. “As a result, cash flows in the related project financings are under pressure.” S&P also revised its outlook on toll roads as well as the airport and parking facilities sectors to negative. Moody’s Investors Service revised its sector outlook for toll roads to negative from stable.

Fitch has downgraded Suffolk County, NY to ‘BBB+’ from ‘A-‘. “Current economic conditions, triggered by the corona virus pandemic, are expected to place significant additional pressure on the county’s revenues and cash position in the near term.” Fitch noted that the county’s financial resilience is limited with no general fund reserves to address fiscal pressures that will arise from the current economic slowdown. The majority of the county’s budgeted operating revenues for 2020, including the general fund and police district fund, come from sales and use tax collections (approximately 47%) and property taxes (approximately 22%).

Fitch highlighted the fact that it does not expect the county to come close to budgeted sales tax assumptions due to the recent declines in oil and gas prices, the temporary closure of the major shopping malls, restaurants and the casino, and other economic pressures associated with the corona virus pandemic. Budget balancing is likely to require drastic spending cuts or increased borrowing.

Port credits began to feel the pressure. Moody’s revised its outlook to negative on port credits in Port Canaveral and Miami-Dade due to unprecedented Corona virus (COVID-19) restrictions globally that led to the halt of cruise operations at PortMiami and other cruise ports in the US for a 30-day period since March 13, 2020.

CA LIFORNIA WILDFIRE AGREEMENT

Pacific Gas & Electric reached an agreement with Gov. Gavin Newsom. It pledged billions of dollars to help wildfire victims, improve safety and make other changes. Half of the company’s $13.5 billion payment to wildfire victims will be in the form of PG&E stock under a previously reached agreement. 

Now, PG&E has agreed to a plea bargain in state court to settle pending criminal charges against the company. The plea agreement requires PG&E to accepted a maximum penalty of $3.5 million. In exchange, “no other or additional sentence will be imposed on the utility in the criminal action in connection with the 2018 Camp Fire.” The company will also pay the district attorney’s office $500,000 to cover the cost of its investigation. The plea  must be approved by a state court, which is scheduled to consider it on April 24, and the bankruptcy court.

The agreement should allow the utility to exit bankruptcy by June 30, a state-mandated deadline for it to take part in the fund designed to help utilities pay claims from future wildfires. PG&E must receive approval of its plan by state regulators and the bankruptcy judge by June 30 and have its financing in place by Sept. 30. Failure to do so will set off the sale of the company.

The agreements will keep PG&E as an investor owned entity after it was threatened with an effective takeover by a state created entity. It will not necessarily be able to maintain itself as a sound entity even after this second bankruptcy is concluded. It will be a heavily leveraged entity as it finances capital needs and will likely face a constricted ratemaking environment.

HOSPITALS AND INSURANCE

California, Colorado, Connecticut, Maryland, Massachusetts, Minnesota, Nevada, New York, Rhode Island, Vermont and Washington run their own health insurance exchanges under the Affordable Care Act. These states have opened up enrollment under the Affordable Care Act to allow laid-off workers to get subsidized health insurance. Under the Affordable Care Act, people who lose insurance coverage when they lose their job are already allowed to buy their own insurance.  The newly announced changes will anyone without comprehensive insurance could simply sign up for a health plan, without having to prove such special conditions. 

The potential for large surges in demand through emergency departments especially by those without health insurance created huge risks for hospitals who could see their uninsured charity caseloads skyrocket without knowing how those costs would be covered. The Kaiser Family Foundation estimates that 17 million people already uninsured are eligible for marketplace coverage. More than a quarter of those people were eligible for a bronze plan that would cost them nothing in premiums after federal subsidies were applied (they would still have a high deductible). 

The question remains what the 32 states which operate through the federal marketplace will be able to do. They cannot expand their programs without federal approval. Whether that approval will come while the Administration is fighting to have the ACA declared unconstitutional is unclear. 36 states expanded their Medicaid programs under the Affordable Care Act, and in those states anyone now earning less than 138% of the federal poverty level — about $17,000 for a single person and $35,500 for a family of four, annually — can qualify for coverage right away. 

There has been some effort to support the states from the federal government. The Centers for Medicare & Medicaid Services (CMS) approved an additional 11 state Medicaid waiver requests under Section 1135 of the Social Security Act (Act), bringing the total number of approved Section 1135 waivers for states to 13. The waivers are designed to facilitate relief from administrative requirements, such as prior authorization and provider enrollment requirements, suspending certain nursing home pre-admission reviews, and facilitating reimbursement to providers for care delivered in alternative settings due to facility evacuations.  This will facilitate funding for the states during this crucial period.

The expansion of coverage would be positive for hospitals in that it would reduce charity care burdens and provide more certainty about how they would be reimbursed. The need for increased coverage is highlighted by the plight of rural hospitals. While many of the financially distressed hospitals in this cohort have been smaller, the pressure on the rural hospital sector is impacting larger rural facilities.

Two 200+ bed facilities saw their ratings downgraded . Southeast Hospital, d/b/a SoutheastHEALTH is a not-for-profit 501(c)(3) health system located in Missouri. The system operates a flagship hospital of 245 licensed beds in Cape Girardeau, a rural community hospital in Dexter, and numerous outpatient clinics. It saw its Moody’s rating lowered to Ba1 from Baa3, affecting approximately $127 million of rated debt. The outlook is revised to negative from stable. Moody’s also downgraded Hutchinson Regional Medical Center, Inc. (HRMC) in Kansas to Ba1 from Baa3, affecting approximately $35 million of rated debt. Both hospitals had underlying credit problems but now are facing increased pressure as the result of the pandemic.

For hospitals whose financial position was marginal going into the pandemic, there will be further ratings pressures. These are just two of the latest examples.

BORDER RESTRICTIONS AND LOCAL CREDITS

On the US Mexican border, several credits will be impacted by the closure of the US-Mexico border to nonessential travel to slow the spread of the corona virus until 20 April closure of the US-Mexico border to nonessential travel to slow the spread of the corona virus until  April.20. The reduced toll revenue is also negative for US-Mexico border cities which rely on transfers from their international bridge funds to support general funds. Lower bridge revenue flowing to border cities’ general funds increases the credit-negative effects of reduced sales tax revenue.

Take Laredo, TX where up to 50% of bridge toll revenue is transferred to the general fund. The Laredo International Toll Bridge System consists of four bridges at the intersection of major rail lines and highways. Bridge transfers provided 17% ($34 million) of general fund revenue in fiscal 2018, which ended 30 September 2018, while sales taxes accounted for 16%.  The impact on retail sales in border cities will be replicated at the many other communities which serve as ports of entry. The free flow of goods and people across the border has supported the emergence of commerce based economies with facilities such as warehouses becoming significant sources of property value growth, taxes, and jobs.

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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Publisher’s Note: The overarching impact of the corona virus pandemic is that we are about to see something unprecedented in our nation’s history – the near total shutdown of industry in the country. This week’s announcement that Ford and GM will halt production at their manufacturing facilities through the end of March at a minimum is unlike anything seen in this country since World War II. The companies and the United Auto Workers will work together on plans to restart production in compliance with social distancing protocols among workers, including at shift change times, and to maximize cleaning times between shifts changes. As demand slackens, we would not be surprised to see additional industrial and manufacturing disruptions.

This is a unique experience in US history certainly after World War II. One would have to go back to the Spanish Flu Pandemic of 1918 and 1919 to find a similar experience. The difference is how intertwined the world is now versus then which raises a whole host of issues creating this unique experience. Unique means that in many ways we are making it up as we go along. With that in mind, view this week’s comments.

CORONA VIRUS

The declaration of a national emergency and the actions increasingly being taken by localities to limit gatherings has made it clearer where the potential sector weak spots are in the municipal credit spectrum. So now the process of picking winning and losing sectors depending upon the individual credit characteristics can begin.

It is estimated that some 14% of total consumption spending – recreation services recreation services; food services and accommodation; transportation services- is effectively shut down for an indefinite period of time. The immediate impact will be on credits backed by taxes related to economic activity. “Wages that aren’t earned aren’t spent.” Sales tax bonds will come under pressure as non-essential spending is curtailed as the result of mandated closings of things like restaurants and bars.

Sales taxes provide current cash flow. They are usually collected and remitted to the taxing jurisdiction monthly. Credits secured by things like admissions taxes (from arena and entertainment facilities), hotel taxes, convention center revenues, toll roads, will all see revenue impacts. Flight cutbacks will reduce throughput at airports which rely on the economic activity from the increasingly important retail sales activity at terminals. That will impact general airport revenue bonds. Stand alone enterprise credits like airport rental car and garage facilities will be under stress.

One sector facing long term implications in addition to the short term pressures is the senior living industry. The vulnerability of their residents to the impact of pandemics is clear. There is no way to determine how the experience of the corona virus will impact long term demand for all of these facilities. For those in the early stages of development and fill up, the potential impact is significant as these projects often rely of fairly delicate timelines for the receipt of those revenues to meet covenant requirements as well as repayment schedules. The potential impact on housing demand and sales will make it more difficult to meet financial targets and schedules.

Project financings for things like shopping malls and casinos will be vulnerable. The Carousel Center in Syracuse, NY was already experiencing operating difficulties when it was downgraded by Moody’s in Late 2019. Carousel Center Company L.P. signed a three year loan extension and modification agreement with the special servicer of its subordinate CMBS loan on May 31, 2019. Now, the extended time period of inactivity faced by a project such as this means that its ability to meet the new Debt Yield covenants in 2020 and 2021 to secure the second and third year of the loan extension remains uncertain. While it is likely that the developer will make every effort to make payments in lieu of taxes which secure the bonds, the secondary financing difficulties make the project vulnerable to a bankruptcy by the developer to deal with the secondary financing needs.

The newly opened American Dream mall and entertainment complex in New Jersey was under significant pressure from its start. $800 million of limited obligation revenue bonds backed by a payment-in-lieu-of-taxes agreement between developer Triple Five Group and East Rutherford, along with $287 million of grant revenue bonds supported by anticipated sales tax revenue were issued to finance the project. Now the facility has closed in response to the virus which will further pressure the reliance on developer support for the bonds while tax cash flows are interrupted.

The impact of the stock market will be felt in multiple ways. States like CA, NY, NJ, IL, and MA all are vulnerable to negative impacts on capital gains revenues. So the immediate impact will be on operations. Longer term, pension funds are at the center of stock market risk so it is likely that funding ratio data and expense requirements to maintain funding will generate negative news.

Overhanging all of this is the need for states to take swift action without the benefit of a coordinated federal response. Maryland Gov. Larry Hogan (R) and New York Gov. Andrew Cuomo (D) ordered state health officials to reopen closed hospitals and to convert other facilities in order to accommodate patients. Retired medical staff is being recruited. These are expenses which must be covered but who and how much is effectively yet to be determined. Cuomo’s order will add an additional 9,000 beds to the 53,000 beds already available around the state. Maryland has about 8,000 hospital beds, and Hogan’s order will boost capacity by an additional 6,000.

Early in the week, The President advised states to seek out their own equipment, a potential sign that the federal government was not prepared or equipped to aid states that are going to need serious help. That will require funding. States will also be at the front lines of providing and funding unemployment insurance.

For smaller communities, orders to effectively shelter in place will reduce short term travel and reduce the opportunity to collect fines. In some rural communities, reduced travel will impact their ability to collect fines which are often an important component of local budgets. Less traffic makes it harder to issue speeding tickets which for many small towns are a significant revenue source. In larger communities, reduced travel will result in lower revenues from parking charges as well as parking related fines. In some localities, ticketing and fines have been suspended which will impact revenues.

On the public transit side, ridership on the NY subway was down 27% in one week and that was before schools and public facilities were closed. Seattle’s Sound Transit has experienced a 25 percent drop in ridership in February compared to the month before. Ferry ridership in Seattle was down 15 percent on Monday, March 9th, compared to the previous Monday. In San Francisco, BART fares account for 60 percent of the agency’s service budget and officials estimate the current drop in ridership will cost BART up to more than $600,000 each weekday. Ridership has fallen some 30%.  

WHO WORKS WHERE

The Airports Council International-North America (ACI-NA) represents local, regional and state governing bodies that own and operate commercial airports in the United States and Canada. They have their own agenda but they have produced data to reflect the potential impact of the economic downturn we are in. The council estimates  that about 1.2 million people work at 485 commercial airports in the United States. O’Hare in Chicago employs 41,000 alone.

Casinos in most places are shut down. Obviously the front line for economic impact would be Las Vegas. Nevada employs 403,000 in the gaming industry segment alone. The top five include New Jersey, Pennsylvania, Mississippi, and Louisiana each with between 30,000 and 40,000 employed.

And then there are the overall leisure/hospitality statistics. Some 16.8 million are employed as of February 2020. Less than three percent of them are unionized so they are not likely to have employment terms favorable to their being laid off. They make an average of $435 per week. So their unemployment will generate pressure on the health and shelter providers.

PRACTICAL FISCAL RESPONSES TO CORONA VIRUS

When one tries to assess the potential fiscal impact of the ongoing pandemic, the implications for ongoing funding things like education must be considered. School aid is often based on formulae which include factors like attendance and the provision of a minimum number of school days. The legislation by which things like ongoing school aid as well as state enhancement programs securing local school bonds does not always include provisions to cover situations such as is occurring right now.

One state’s recent action highlights one such example. In New York, aid is based on attendance as well as minimum day requirements. Should a district choose or be forced to close their facilities for any extended period, it was not clear whether the laws under which school aid is distributed would permit all of the anticipated aid. Districts and their creditors were concerned that cash flow issues related to delayed or lessened anticipated school aid could cause payment interruptions by districts. So it was positive to see that The Governor issued an Executive Order to eliminate the aid penalty for schools directed to close by state or local officials or those closed under a state or local declaration of emergency that do not meet 180-day requirements if they are unable to make up school days. 

For the states generally, the demand for unemployment support and the need to fund it is already apparent. Initial unemployment claims are in the tens of thousands in many states. Twenty three states have unemployment trust fund balances below their recommended funding levels according to the US department of Labor. That is before any Medicaid hit just from that cohort and not inclusive of corona related costs.

After several years of significant headcount increases, the City of New York finds itself with less room to maneuver through the corona virus pandemic. The City does have budgetary reserves but they will be quickly evaporated as it faces a significant revenue hit. This week, City Comptroller Scott Stringer estimated that the City would experience a $3.2 billion loss to the city’s tax revenues over the next six months. The comptroller called for spending at most agencies to be reduced 4% from what the mayor had proposed. For the Department of Homeless Services, the Administration for Children’s Services and the Human Resources Administration, reductions should be 2%. The Health Department and the department overseeing the city’s public hospitals should be exempt, according to the Comptroller. He estimates that over the next six months, restaurant sales will go down 80%, real estate sales, 20% and tourism-related retail, 20%. 

Seattle’s budget director last week estimated the city could collect $110 million less than expected in general-fund tax revenue this year due to an economic breakdown caused by the virus and by efforts to slow its spread. Hawaii’s chief state economist estimates that tax revenue coming into Hawaii state coffers is now expected to be $48 million to $80 million less than previous estimates for the rest of 2020 due to the impact of the corona virus. The drop will be primarily driven by declines in visitors coming to Hawaii and their spending. The latest data indicate that international arrivals are already down by more than 30% compared to the same period last year.

The virus is taking its toll operationally. In Pennsylvania , the Department of Transportation (Penn DOT) is suspending all operations, including construction, except critical and emergency work. Driver licenses, photo ID cards and learner’s permits scheduled to expire from March 16, 2020 through March 31, 2020, the expiration date is now extended until April 30, 2020. Vehicle registrations, safety inspections and emissions inspections scheduled to expire from March 16 through March 31, 2020, the expiration date is now extended until April 30, 2020. Persons with Disabilities Parking Placards scheduled to expire from March 16 through March 31, 2020, the expiration date is now extended until April 30, 2020. Moves like this should be expected across the country. That will impact the timing of fee revenues which along with possible tax payment deferrals could impact cash flows.

SOUTH CAROLINA PUBLIC SERVICE LITIGATION SETTLEMENT

In 2017, concerns were rising about the viability of the project to expand nuclear generating capacity at the Sumner Nuclear plant. A group of consumers filed a class action lawsuit against the plant’s sponsors The suit was brought in an effort to claw back charges customers paid for the unfinished twin nuclear reactor project. It names several electric cooperatives, former and current Santee Cooper directors, South Carolina Electric & Gas and SCANA Corp., and Dominion Energy, which bought SCANA in January 2019.

Now Santee Cooper has announced that it has reached a proposed settlement with the plaintiffs. The utility’s board of directors agreed to pay $200 million in cash over three years and to freeze rates for four years to end the suit. Dominion will pay $320 million in stock that will be sold and converted to cash as part of the settlement. Santee Cooper and Dominion also agreed not to attempt to recover settlement proceeds in base rates or other customer charges.

The settlement, if approved by the court, will remove a major source of uncertainty for Santee Cooper and may enhance its prospects for remaining a public utility. It allows the utility to more accurately estimate its stranded costs and determine a more certain course for its ongoing viability. It reduces the total liability with which creditors and investors would be effectively competing.  

The proposed settlement also helps to solidify some of the math being used to support assumptions being made by potential private suitors involved in efforts to acquire Santee Cooper’s assets. It is likely that the settlement will enhance the position of those who support reforming Santee Cooper’s oversight and management while maintaining its ability to compete. The ability to continue to finance its capital needs in the tax exempt market will continue to provide Santee Cooper with a cost advantage.

Proponents of a sale to private interests still have support in the state legislature and the outcome of deliberations currently underway in the state legislature is unclear. The approval of the proposed settlement is still uncertain. Preliminary approval of the settlement by the judge will begin a process during which all members of the class will be identified, and then they will be given the opportunity to opt into or opt out of the settlement.

Conclusion of the settlement process will be a credit positive event for the Authority and its bondholders.

GREAT LAKES WATER AUTHORITY

During the bankruptcy of the City of Detroit, investors holding debt issued for the Greater Detroit Water and Sewer Systems may have been one of the best positioned creditors. Between existing precedents for special revenue debt like that of the water and sewer systems and its regional revenue base, those credits were the most likely to be successfully restructured. So it was easy to counsel patience to those investors especially retail investors who were significant holders of the debt. Eventually, the Greater Detroit debt was restructured into a new entity, the Great Lakes Water Authority.

Now patient investors who worked through the bankruptcy, restructuring, and exchange process are seeing that patience rewarded. Moody’s Investors Service has upgraded to A1 from A2 and to A2 from A3 the senior and second lien water revenue ratings and the senior and subordinate sewer revenue ratings, respectively, of the Great Lakes Water Authority (GLWA), MI Water Enterprise. It cited ” continuation of strong operating performance that has resulted in healthy annual debt service coverage and liquidity. Additionally factored are the system’s large scale of operations, independent rate setting authority, and sound legal provisions of outstanding revenue debt. At the upgraded rating, these strengths continue to balance the system’s elevated debt burden, as well as their reliance on revenue derived from retail operations within the City of Detroit (Ba3 positive). The upgrade of the second lien revenue bonds to A2 incorporates the same factors while the lower rating reflects a subordinate claim on pledged net revenue.”

The restructuring improved regional oversight of the systems while maintaining their geographically diverse revenue streams. The regional character of the revenue base has only become clearer over time providing a solid foundation on which to rebuild its credit strength. It was always a regional credit and while Detroit had its problems the utilities managed to maintain the city’s suburban communities as customers of the systems.

RATINGS ACTIONS

We cited NY’s Metropolitan Transportation Authority as a vulnerable credit do to its reliance on farebox revenues. The corona virus will impact many credits and sectors but the MTA’s Transportation Revenue Bonds were especially vulnerable in the short term. So we view with interest the announcement this week that the Moody’s outlook for the A1 Transportation Revenue Bond (TRB) rating is negative.

According to Moody’s, MTA’s ridership levels and financial performance will be vulnerable if a widespread coronavirus outbreak occurs in NYC, or if local precautions to control an outbreak are extended. The credit impact will depend on the depth and duration of the economic and service disruption. We note that the MTA has ridden out prior interruptions in ridership – strikes, natural disasters, terror attacks without any real impact on bondholders. Unlike those events, the pandemic is forcing the MTA to fund increased employee education, customer communications and station and fleet sanitization, which will increase expenditures. 

The situation highlights the security structure for the MTA farebox bonds. Unlike most other rated transit systems, there is no debt service reserve fund. Pledged revenues flow to a trustee held account and are set-aside monthly for debt service before being released for operations. Longer term , the basic challenges the MTA faces – flat ridership trends, rapidly escalating leverage that includes growing market access risk, large debt and capital needs and growing public pressure to improve service and limit fare increases – will remain in a damaged economic environment. In the longer term, MTA will also be challenged by growing and relatively inflexible labor costs, and environmental risks (particularly from natural disasters).

PANDEMIC POSTPONES BOND VOTES

After the California primary, transit advocates were concerned that results from those elections might indicate that there was diminishing support for tax funding for transportation projects. Now, with 7 Bay Area counties under shelter in place regulations, there has been concern that a proposed sales tax backed transit funding program in a nine county around the Bay Area might not succeed at the polls this November. The proposal would ask voters in those counties to approve a 1 cent increase in sales taxes with proceeds dedicated to supporting debt issued to fund various transportation projects in the region.

The ballot measure was being proposed to the state Legislature under Senate Bill 278. In order to be placed on the November ballot, the bill would have had to be passed under an urgency clause that would have required at least two-thirds majority support from both the Senate and Assembly. Gov. Gavin Newsom would then have had to sign the law by June 24. Now in light of current events, proponents have announced that they are shifting their emphasis to the post-2020 time frame.

We would not be surprised to see other bond proposals wither in the face of the unprecedented funding demands due to the pandemic. It will be very difficult to garner support for any increases in taxes in the near term as individuals and businesses struggle in the face of extraordinary limits on economic activity. There are practical considerations as well. Many ballot actions in support of proposed bond issuances benefit from efforts to generate support in the community. Efforts in that regard are thwarted by the restrictions (required or voluntary) resulting from the pandemic.

Many scheduled elections in which bond ballot measures would be offered will be difficult to hold. To that end, Texas Governor Greg Abbott announced that local governments could suspend May 2 elections until the general election Nov. 3. The Metropolitan St. Louis Sewer District will go to court in an effort to postpone a $500 million bond referendum scheduled for April 7 because of the COVID-19 outbreak.

NONTRADITIONAL CREDITS UNDER PRESSURE FROM VIRUS LIMITS

Here in New York, there are certain credits which will be under unique pressures due to the limits on public gatherings. While no one is currently predicting defaults, four  prominent cultural or sports functions are exposed to financial pressure as seasons and performances are put on hold.

Bonds issued to finance Yankee Stadium and Citi Field are secured to varying degrees by revenues tied to attendance. The Yankee Stadium bond revenues pledged to debt service are dependent upon attendance or as George Steinbrenner used to put it “fannies in the seats”. A protracted stoppage would be akin to the risk of an extended labor stoppage which has always been cited as a major risk to the bonds. The Citi Field debt is secured by a pledge of certain seat revenues as well as revenues from advertisers at the stadium.  When all is said and done, a downgrade would not be surprising.

The Metropolitan Opera also issued municipal bond debt. It was downgraded in 2018 as the impact of  softening ticket revenue. It also faces labor pressures, pension costs, and disappointing fundraising trends. Weakened operating performance including inability to cover debt service with a 5% endowment spending rate, reduction in unrestricted liquidity, meaningful reduction in total cash and investments, and softened prospects for donor support or inability to meet fundraising targets were all cited as potential drivers of another downgrade. Now, the opera estimates that it will lose $60 million of revenue – a 20% hit after it announced that it would cancel the rest of its season because of the coronavirus pandemic and begin an emergency fund-raising effort aimed at covering the anticipated loss of revenue.

Other NY institutions with debt outstanding include the Museum of Modern Art. It just had its rating of Aa2 affirmed in January by Moody’s which cited excellent visitor demand and programs and strong membership which support revenue prospects. It also noted that the museum remains vulnerable to changes in New York City tourism patterns or art programming preferences. Additionally the museum has some exposure to contractual expenses through pension plans and collective bargaining agreements. Now it has announced that it will stay closed at least until July and expected a nearly $100 million shortfall.

There will be other examples across the country as cultural and educational facilities around the country are closed potentially for extended periods.

IT’S FLOOD SEASON AGAIN

While signs of Spring abound after the 2nd hottest February on record, not all of them are good. This is the time of year when the National Oceanic and Atmospheric Administration released its annual Spring Outlook and its estimates of potential flooding during the winter runoff. Last year saw exceptional levels of flooding across the middle of the country.

This year, NOAA says that major to moderate flooding is likely in 23 states from the Northern Plains south to the Gulf Coast, with the most significant flood potential in parts of North Dakota, South Dakota and Minnesota. It is forecasting above-average temperatures across the country this spring, as well as above-average precipitation in the central and eastern United States. Significant rainfall events could trigger flood conditions on top of already saturated soils. 

The flooding will renew the debate over physical mitigation (flood walls and levees) versus strategies such as managed retreat. The greatest risk for major and moderate flood conditions includes the upper and middle Mississippi River basins, the Missouri River basin and the Red River of the North. Moderate flooding is anticipated in the Ohio, Cumberland, Tennessee, and Missouri River basins, as well as the lower Mississippi River basin and its tributaries. The West seems best positioned going into flood season. Drought conditions are expected to persist and expand throughout California in the months ahead, and drought is likely to persist in the central and southern Rocky Mountains, the southern Plains, southern Texas, and portions of the Pacific Northwest.

Once again, states and localities will be central to any response further straining finances after the impact of the corona virus pandemic. The Army Corps of Engineers and the Federal Emergency Management Agency, are linchpins of the nation’s flood response. They could be stretched thin as the nnation fights the virus.

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

Joseph Krist

Publisher

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This week, the emergence of a full blown pandemic and an anemic federal response to it have clearly shifted the operational and funding burden to the issuers in the municipal bond market. The nature and timing of this event, relative to many current trends and the nation’s political realities, create an unprecedented set of challenges.

The nature of the pandemic such that anyone who pretends to tell you that they know what will happen is, to be charitable, irresponsible. Our comments about the pandemic and its potential impact on credit reflect that view. We hope that these thoughts however, inform your own assessment of the event and its potential impact on the credit security of your portfolios.

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CORONA VIRUS IMPACT EXPANDS

The language is both stark and boilerplate. It soberly outlines the current risks to credit related to the corona virus for any credit reliant on travel or large gatherings. In the case of the following it applies to one credit but it could also be applied to a variety of credits dependent upon people gathering together and generating economic activity. Just substitute the appropriate words for McCormick Place or the Metropolitan Pier and Exhibition Authority for the credit of your choice. It happens that McCormick Place and the Authority are in the front lines of this situation.

“If the COVID-19 persists as a public health emergency or if other health epidemic conditions arise and persist, additional events at McCormick Place or other venues owned or operated by the Authority may be cancelled and related commercial activity and taxable transactions reduced. Such additional cancellations could also occur as a result of event and travel restrictions imposed by federal or local governmental authorities, voluntary decisions to withdraw by event sponsors and planners, and voluntary decisions to forego travel by expected event attendees.

While as of the date hereof, the remainder of events scheduled for the balance of 2020 at McCormick Place or other venues owned and operated by the Metropolitan Pier and Exhibition Authority have not been cancelled due to concerns about COVID-19, the Authority gives no assurance that there will not be future cancellations, nor is it possible for the Authority to predict whether or to what extent COVID-19 or any other pandemic, epidemic or other health-related conditions will affect the Authority’s operations, commercial activity, taxable transactions or the Revenues.”

This is one event which has actually resulted in disclosure. While the factors referenced may be obvious, the reality is that seeing them addressed in a timely manner by a major issuer is a positive development.

We consider certain states to be good indicators of the potential near term impact of the virus. They would be states with a reliance on sales as opposed to income taxes. There the impact in terms of declining travel and economic activity will give a fairly good real time measure of the impact. Florida is our primary target. The travel and economic activity related to MLB spring training, Disney World and other tourist attractions, and spring break are significant drivers. The monthly sales tax data from Florida will give us some basis for comparison and analysis. Texas, another sales tax state, has already seen the cancellation of South by Southwest and California’s Coachella festival has been postponed until the Fall. The center of attention – Washington State – is another state which relies on sales taxes. Nevada is a sales tax state as well as transportation/tourism dependent.

Some 100 major colleges and universities have cancelled classes. Some local school districts are closing schools for at least a week. Now that mass gatherings have been effectively banned, the fallout will quickly spread. The ban on gatherings will, if it lasts include the Easter season, traditionally a strong period for tourism. With events like the NCAA basketball tournament, Broadway, and the major professional sports leagues shut down, the economic impact will quickly emerge.

That brings us to the potential policy impact. As we go to press, the Administration proposals for steps to address the employment issues resulting from these event shutdowns are insufficient. That is not a political opinion – it’s just how it is. So many of those who works in those impacted industries – tourism, sports, cultural events, hospitality, transportation – are not covered by benefits or unemployment insurance. They will experience an immediate cash hit. And the big question is how long will this last? Unfortunately, there is no way to know until widespread testing is available and implemented.

What we do believe is that major governmental issuers – states, counties, and large municipalities will bear the brunt of any fiscal impact. It is a good sign that some major employers – Walmart and Darden Restaurants – are offering two weeks paid sick leave.  Implementation of such policies across the board would substantially relieve pressure on tax revenues.

One of the issues which will arise from an extended duration of social distancing is the potential long term impact on where and how people work. The immediate impacts will be on traffic as it is reflected in different commuting realities and on mass transit.

The photo is of one of New York’s busiest rush hour subway stops, the express platform at 59th Street and Lexington Avenue. This is 9 a.m. on a Thursday. Normally, the 4 and 5 lines are the busiest lines in Manhattan. If the pandemic is not dealt with, this could be the reality for many transit systems. That would result in a significant impact on revenues. One comfort is that many of the bonds sold to finance rapid transit construction and expansion are backed by dedicated sales taxes (Los Angeles and Atlanta are two). In New York however, the primary security for MTA bonds for the buses and subways is a pledge of the gross revenues of the system (the farebox). There doesn’t seem to be a lot of revenue potential in the picture.

HOSPITALS AND CORONA VIRUS

It is impossible to predict the impact on this sector on either a micro or macro level. Each institution will have its own set of circumstances and levels of outside government support as the effects of the pandemic spread. Having said that, here are the things which concern us.

Utilization will increase but it will not be profitable utilization. There are between 28 and 30 million uninsured individuals and many of them will either be treated or tested through hospital facilities. We are still not getting good data about the actual scope of the pandemic and there is not enough data on which conclusions may be reached regarding the potential need for acute care admissions The messaging from the Administration is muddled at best. Supposedly testing will be paid for (how and by whom is not clear) but there are no provisions for covering inpatient care or drugs for this cohort.

The potential for major hospitals to incur substantial unexpected expenses for supplies and personnel is significant. Because of the trends of declining inpatient utilization and the reduction of available beds, there is much less slack in the system than many think is the case. Estimates are that there are approximately 200,000 “excess” beds in hospitals nationwide. These are not likely to be sufficient in the event of a rapid need for care. An Economist article cited a recent study of covid-19 in China which found that 5% of patients needed to be admitted to an intensive care unit, with many needing intensive ventilation or use of a more sophisticated machine that oxygenates blood externally. America has 95,000 ICU beds and 62,000 mechanical ventilators, while only 290 hospitals out of 6,000 offer the most intensive treatment. 

This leads us to the issue of how charity care is funded and/or reimbursed. Charity care has traditionally been funded by states although the levels of funding and resources available to fund such care varies widely across the country. In the interim, utilization and revenues will be negatively impacted as hospitals are being asked to delay and/or curtail elective surgery. This will reduce revenues from sources which tend to have insurance.

Should corona related demand spike, hospitals will face daunting personnel challenges which will likely result in increased costs for more staff and/or overtime costs. Most troublesome is the fact that there is no good guidance as to how long the pandemic will last or how serious its effects could be. Hospital managements will have to rely on the strength of their balance sheets and available cash resources to fund operations as the pandemic unfolds.

That puts systems and large facilities at an advantage once again relative to stand alone institutions and smaller institutions. Rural hospitals will again be at relatively greater risk since they tend to have weaker balance sheets and operating profiles. On sector where size may not be an advantage will be the safety net hospitals. They will be exposed to the greatest potential for demand from uninsured patients who also are more likely to be in those groups considered most vulnerable.

OIL PRICES

The two places likely to see the greatest impact from lower oil prices are Texas and North Dakota as they are in the lead in terms of traditional drilling and fracking, respectively. There has already been employment impacts in oil dependent states but the current situation seems more dire. It’s not just the number of rigs which operate but the jobs in the oil services sector, the heavy equipment sector, as well as jobs in general services including restaurants and residential facilities.

Before this weekend, the impact of oil prices did lead to rig closures but it was the decline in new drilling where it was truly felt. Albeit in Canada, the pre-crisis price of oil made a multi-billion project in the Canadian oil sands uneconomical and was cancelled. Now the impact of the price war between Saudi Arabia and Russia is even more severe so there be even more reduced investment in smaller projects throughout the oil patch.

Generally, the uncertainty around the length and depth of an economic slowdown could not come at a worse time for governmental budgets. With so many of them facing June deadlines, it may be hard to predict with any certainty what the impact on both sides of the government income statement will be. We suspect that Credit volatility – at least in perceptions if not immediately ratings – will happen through the end of 2020 at least. Any significant deviations from projections on the downside will raise real concerns as they appear monthly and quarterly.

Other credits under pressure include those ports which derive significant revenues from oil exports. An example is the Port of Corpus Christi, TX. It handled 40% of total U.S. oil exports in January, or about 1.38 million barrels a day. The short term impact is blunted by the fact that many of the port’s agreements are based on take-or-pay contracts — meaning the port gets paid whether barrels are shipped or not.  The price decline, if it maintains over an extended period, will reduce production and shipments and will impact long term demand for the port.

PUERTO RICO

The Puerto Rico debt restructuring proceedings will extend through Election Day according to a schedule approved by the judge overseeing Puerto Rico’s Title III proceedings. The Puerto Rico Oversight Board and some groups of holders of general obligation bonds supported a schedule advanced by the Chief Mediator leading negotiations and other parties such as the Puerto Rico Fiscal Agency and Financial Advisory Authority, the Unsecured Creditors Committee, bond insurer Assured Guaranty (AGO), bond insurer Ambac Assurance, Invesco (IVZ), and others opposed the proposed timeframe.

The judge said she would set aside weekdays Oct. 21 to 31 and Nov. 1 to 6, excepting days for the omnibus hearing and for Election Day, to be used for the confirmation hearing. The deadline for the filing of objections to the release of a disclosure statement covering the proposed settlement to April 24. A hearing will also be held on the diversion of money from local government instrumentalities and their revenue bonds to the central government-guaranteed bonds, better known as “clawbacks”.

The uncertainty continues.

CALIFORNIA SCHOOL BOND DEFEAT

Supporters of a school bond authorization initiative were surprised when the 2020 Proposition 13 did not pass on March 3. After all, California voters have passed every construction bond for education since 1994, when voters narrowly defeated two small bonds, one for higher education and one for K-12 schools.  Organizations representing teachers, parents, school leaders, higher education groups, unions and business groups like the California Business Roundtable all endorsed Prop. 13.

The ballot summary of the bond made clear  that the principal and the $11 billion in interest on the bond would be repaid through the state’s general fund. Apparently, that was not enough to convince people that this initiative had nothing to do with the tax limiting Prop. 13 initiative which passed in 1978. Every decade, starting the year ending in “8,” the numbering cycle starts again for California ballot initiatives.  There were a dozen initiatives on state ballots in 2018; the state construction bond was the only measure appearing for the March primary, so it became Prop. 13.

Apparently, a large number of people believed that the two propositions were related and that the initiative would require higher property taxes. What did not help was the inclusion of provisions regarding requirements for the use of union construction workers on school projects and  increasing the local school district bonding limit. This allowed opponents to frame the issue as one of likely tax increases and higher costs for capital facilities.

One other provision would have reduced fees that districts can charge multi-unit housing developers and eliminated fees for large residential complexes near transit lines. This concerned some larger district managements who feared a loss of those revenues without some offset. Development around transit facilities is a hot button issue for affordable housing advocates who see the impact of gentrification as outweighing the benefits of new development.  

We do not read anything into these results which could have national implications. The factors contributing to this unexpected defeat we see as California issues.

NYS BUDGET SHIFTS COSTS TO NYC

As a result of the 1996 federal welfare legislation and the 1997 implementing legislation adopted by New York State, the state and city have three distinct cash assistance programs. Those on Family Assistance qualify for federal Temporary Assistance for Needy Families (TANF) grants. Needy single adults or couples without children are not eligible for Family Assistance but can receive benefits from the state’s Safety Net Assistance program. Safety Net Assistance was originally funded jointly by the city and state, each paying 50 percent of the cost, with no federal contribution. Families that reach their 60 months of federal TANF eligibility who are still eligible for benefits can shift to the 60 Month Converted to Safety Net program. Emergency Assistance for Families provides up to four months of grants for families in danger of homelessness.

The state’s funding comes through block grants from the Federal government so the experience is instructive as other programs come under consideration for block grants (block grants for Medicaid are a Republican dream) from the Federal government. In state fiscal year 2011-2012, the state allocated more of its TANF block grant to Family Assistance, increasing the federal share for the program from 50 to 100 %. Changes to the Safety Net and 60 Month Converted programs, which had previously been funded with 50 % state and 50 % city shares, but now were funded with 71 % city and 29 % state shares.

Governor Cuomo’s 2020-2021 Executive Budget proposes to increase the city share of both Family Assistance and Emergency Assistance for Families from 10 to 15 %. Since the city’s 2021 cash assistance budget includes a combined $455.4 million in federal funds for these two programs, a 5 percentage point increase in the city share would cost New York City an additional $25.3 million annually.

TRANSPORTATION AND MOBILITY

The lack of a comprehensive approach to emerging transportation technologies is forcing individual jurisdictions – large, medium, and small – to take their own regulatory approaches. The latest example comes from Spokane, WA where the city is considering a slate of proposed changes to the city’s contract with Lime and city laws that govern the use of scooters and bicycles. The proposals reflect issues around persistent complaints about scooters illegally cruising down sidewalks and being abandoned in places that obstruct pedestrian walkways.

The city official in charge of micro mobility planning summed up where we are. “We’ve done the carrot – we’ve done education, we’ve done Lime Patrol, and we’ve done all these things to encourage people to act right. Now we’re providing the stick, which is a fine through their user account when they park improperly.” Scooters and bicycles are not allowed on downtown sidewalks. Riders must be at least 18 years old, and scooters and bicycles must be parked in a way that leaves sidewalks clear.

The local press reports that an in-person survey of traffic by city staff at one busy intersection last year found more scooters illegally riding on the sidewalk than on the road, where they are meant to be used. City officials propose adding a new regulation that would require the company to tag each scooter with an identification number. City code enforcement officers would document parking violations via a time-stamped photograph and charge Lime $15 for each infraction. The company would pass on the fine to the user. The city will require Lime to suspend the account of any user who violates the rules three times in a year.

NEW MEXICO TAKES ON PENSION FUNDING AND THE BUDGET

The State of New Mexico has enacted legislation which primarily reduces Public Employees Retirement Association (PERA) fund cost-of-living adjustments (COLAs) and mandates increased contributions by employees and participating governments. The legislation primarily reduces Public Employees Retirement Association (PERA) fund cost-of-living adjustments (COLAs) and mandates increased contributions by employees and participating governments. PERA is severely underfunded, with a 71% funded ratio based on a reported 7.25% discount rate. Halve the discount rate and the funding ratio drops below 50%.

Moody’s has developed what it calls its “tread water” indicator to determine pension underfunding exposure. Using that metric, the governments’ collective tread-water indicator was $570 million in fiscal 2019, roughly 25% of payroll. Unfortunately, the state and participating governments contributed roughly $371 million in aggregate to PERA in fiscal 2019 (ended June 30, 2019), which equated to roughly 15% of active employee payroll.  The legislation calls for the state and its participating employees to increase their contributions to PERA by 0.5% of payroll per year for four years, producing a 2% cumulative increase relative to payroll for both the state and the employees, beginning July 1. Local governments that participate in PERA and many of their employees will similarly increase contributions relative to payroll, but not until  July, 2022.

The legislature also approved a fiscal 2021 budget of $7.6 billion. The final budget reflected the realities of the current health problem. When the Governor signed the bill, it was after she had cut $110 million in projects from an accompanying public works package due to concerns over plummeting oil prices and the impact of corona virus.

The action will hopefully not be the start of a trend where operating problems are solved by cutting back on infrastructure. The projects spanned many sectors including proposed school improvements, tribal building repairs, road renovations, and street signs. This as the budget left intact 4% pay raises for New Mexico teachers and state employees that will take effect in July. 

It is telling that the budget was adopted with the cuts despite the fact that as of last month, the state was estimated to have $1.7 billion in reserves when the budget year ends in June. It was not all bad news for infrastructure. The signed budget bill does include $180 million for statewide highway construction and repairs.

FLOOD CONTROL – MANAGED RETREAT VS. EVICTIONS

We have frequently commented on the impacts of climate change and various possible mitigation approaches. Two weeks ago, we discussed the concept of managed retreat as a way to deal with rising water levels and their impact on infrastructure. That is one approach as is the use of eminent domain as a way to relocate vulnerable structures and people. Now the use of eminent domain is back in the news with real implications for local credits.

The Army Corps of Engineers’ mission includes protecting Americans from flooding and coastal storms. It is the primary source of infrastructure development for flood mitigation from the federal government. Building sea walls, levees and other protections, and elevating homes are all elements in the Corps’ set of responsibilities and its projects are generally two thirds funded by the federal government.

Now as flooding becomes more frequent and severe, the Corps is taking a different approach paying local governments to buy and demolish homes at risk of flooding.  It is not a partisan approach as the Corps said that voluntary programs were “not acceptable” and that all future buyout programs “must include the option to use eminent domain, where warranted” in 2015 under the Obama administration.

The Corps estimates how much damage a house is likely to suffer in the next 50 years, then compares that to what it would cost to buy and tear down the house, plus moving expenses for the owner. If the buyout costs less, the homeowner is asked to sell for the assessed value of the home. It is not a universally accepted strategy. Some of the most vulnerable places – New Jersey and Miami-Dade – have refused to use eminent domain.

Now these and other jurisdictions face the loss of the Corps’ share of funding for mitigation. Some initially agreed to the terms of the Corps’ funding plan but have since reversed themselves as political backlash grows. So far the scope of these programs seems fairly limited but the reaction has not been positive from homeowners. 

What is particular to this administration is an unwillingness to advance infrastructure funding at the federal level. The view that too much overdevelopment in vulnerable areas contributes to huge natural disaster losses is not new. But this plan comes at a time when so many things – flood mitigation, public transit, and roads – which have relied on a state/local/federal partnership are facing severe federal funding cutbacks.

Now lower levels of government must choose between draconian actions like eminent domain or significant funding challenges to address the issues themselves. The result of this process is not likely to be positive for local credits under the current regime. It also continues a trend of federal influence on local affairs generally being on the negative side as has been the case for some time in regard to capital financing generally.

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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PUBLIC BANKS

California legalized public banks last October. Now the first steps in establishing local public banks have been taken. The Santa Cruz County Board of Supervisors voted to begin discussions with  jurisdictions proposing a viability study, the first step in the creation of a public bank. A letter was sent to Monterey, Santa Clara, San Luis Obispo, San Benito and Santa Barbara counties and to the cities of Seaside, Monterey, San Luis Obispo, Watsonville, Scotts Valley, Santa Cruz and Capitola.

The move has achieved significant support not only from progressive legislators but a broader slice of the political establishment. The effort to coordinate with a significant number of jurisdictions reflects Santa Cruz County’s view that “the scale of operations for public banks is far too large to be undertaken by anything smaller than the largest cities or counties in California or multi-jurisdictional efforts.”  The idea of a public bank has even received support from the business community. The Monterey Peninsula Chamber of Commerce and the Salinas Taxpayers Association have said “this is a progressive vision that would have some crossover appeal for business.”

RURAL INTERESTS TAKE ANOTHER HIT

The U.S. Department of Education recently dealt another blow to some of the nation’s poorest rural school districts when it informed them of a bookkeeping change which will likely result in a significant reduction in federal aid to local school districts. 800 schools stand to lose thousands of dollars from the Rural and Low-Income School Program because the department has abruptly changed how districts are to report how many of their students live in poverty. 

The department has allowed schools to use the percentage of students who qualify for federally subsidized free and reduced-price meals, a common proxy for school poverty rates, because census data can miss residents in rural areas. This has been the case since the program began in 2002. Now the Department insists that the Districts use data from the Census Bureau’s Small Area Income and Poverty Estimates to determine whether 20% of their area’s school-age children live below the poverty line.

Congress created the Rural Education Achievement Program when it determined that rural schools lacked the resources to compete with their urban and suburban counterparts for competitive grants. The program is the only dedicated federal funding stream for rural school districts. There is some geographic concentration among the impacted school districts. Over half of them are in Oklahoma.

Some 100 of the 149 schools in Maine that qualified last year would lose funding this year under the census criteria. The funding supports increased literacy and is also often applied to fund technology investments in areas which are already plagued by limited or no broadband access. Rural school districts serve nearly one in seven public-school students and the Rural School and Community Trust found that many districts “face nothing less than an emergency.” Nearly one in six students living in rural areas lives below the poverty line, one in seven qualifies for special education services, and one in nine has changed residence in the previous 12 months.

SUMNER NUCLEAR DEBACLE CONTINUES

The South Carolina legislature is in the middle of a debate over the future of the South Carolina Public Service Authority (Santee Cooper). The debate is over whether to maintain the status quo or to sell the utility which finds itself mired in the center of the cancelled  V.C. Sumner nuclear plant quagmire. The V.C. Summer project cost more than $9 billion before it was called off in 2017 by its sponsor, South Carolina Electric and Gas.  Now that the state looks to move forward in its process of deciding what to do, the story has taken yet another turn.

The Securities and Exchange Commission and the U.S. Attorney’s Office for South Carolina have announced that they are suing executives of SCE&G for fraud in their disclosures (or lack thereof) in connection with the failed project. The SEC’s lawsuit was filed against SCANA (the holding company for SCE&G) and Dominion’s (the buyer of SCE&G) electricity business in South Carolina, as well as two of SCANA’s top executives during the project: former CEO Kevin Marsh and former Executive Vice President Steve Byrne.

Bechtel Corp., one of the world’s largest construction and engineering firms was paid $1 million to study the project by SCANA and Santee Cooper, which owned 45% of the reactors. Bechtel informed SCANA’s executives in 2017 that the project likely wouldn’t be completed in time to claim billions of dollars in federal tax credits that were set to expire in 2021. Gov. Henry McMaster forced Santee Cooper to release the study.

While nuclear power is often mentioned as a potential source of source of climate friendly generation, the fact is that the economics of nuclear generation construction remain prohibitive. The financial risks associated with nuclear power have yet to be successfully addressed and the industry finds itself in much the same place as it was in the 70’s and 80’s when it came close to bankrupting numerous investor owned utilities. Many of the joint action agencies around the country were established essentially as bailouts for the investor owned sponsors of nuclear power. The South Carolina Public Service Authority is just another in a long line of such entities.

This is what happens when factors other than economics are allowed to drive decisions. The fact that this project as well as the Votgle projects in Georgia have failed is not a surprise. The decision to participate was driven by politics as much as anything else. When project sponsors as well as potential investors ignore economics and reality, it is at their peril.

JEA RATINGS

Moody’s has decided to weigh in on the City of Jacksonville’s efforts to extricate itself from the aforementioned financial disaster that is the Plant Votgle expansion. The city and its utility were the subject of downgrades this week as Moody’s views the action as ” calling into question its willingness to support an absolute and unconditional obligation of its largest municipal enterprise, which weakens the city’s creditworthiness on all of its debt. The city and JEA sued to invalidate a contract the city-owned utility signed in 2008 with a Georgia utility authority that binds JEA to help pay open-ended construction costs at the Votgle expansion.

Moody’s made it clear that the rating would be restored if the City dropped the suit. A recent estimate for the project’s completed costs was around $27 billion. JEA could pay $2.5 billion or more of the project’s cost. The plant was once priced around $14 billion.

Given the unique nature of nuclear plant construction and its financing, it is hard to make the case that Jacksonville is somehow unwilling to meet its overall debt obligations. The governance issues which the action has raised in conjunction with the botched effort to privatize the Jacksonville Electric Authority are legitimate but there has never been an implication that Jacksonville is seeking to walk away from its debts. We are more troubled by the attempt to privatize the utility because of the governance and oversight issues it raised.

From our standpoint, Moody’s is doing the right thing for the wrong reasons. The privatization effort revealed weak oversight. The legal challenge to the power purchase agreement with MEAG to purchase Votgle capacity is a legitimate process to address the issues arising from the Plant Votgle debacle. We do not agree that this is a sign of an overall policy change impacting the City’s willingness and ability to pay its debts.

HARDER TIMES FOR COAL COUNTRY

The US Federal Trade Commission released a February decision to block a joint venture in the Powder River Basin (PRB) coal-producing region of Wyoming. Peabody and Arch in June 2019 had announced a definitive agreement to combine seven operating coal mines and reserves in the PRB and Colorado into a joint venture. The expected synergies were being undertaken to improve profitability in the face of a coal market under continuing pressure from the decline in demand from utility operators. The US Energy Information Administration forecasts that production in the US Western Region, including the PRB, will fall to 310 million tons in 2020, down from 378 million tons in 2019 and 418 million tons in 2018 – a decline of over 25% in two years.

Much has been made of the potential economic impact of responses to climate change and their dampening impact on coal prices. The decline of demand from utilities especially impacts the PBR as its surface mined low sulfur coal is especially attractive to utilities. Moody’s projects that US coal production will fall by 15%-20% in 2020, based on significant ongoing reductions in the electric utility sector’s coal consumption, down from 24% in 2019 and about 50% in 2008. Like so many other industries where climate and economic realities have led to long term declines in production, the handwriting has been on the wall for some time in communities whose economies have been built around coal. The impact of climate change on demand is yet one more brick on the load of the coal industry.

The region in northeastern Wyoming which comprises the Powder River Basin covers all or part of 8 counties in the state. Coal operations are largely conducted within two – Campbell and Converse counties. There is not a lot of tax backed debt outstanding and the bulk of it is for school districts. The major city in the region – Gillette – is a Aa3 rated issuer but its dependence upon the coal based economy has a dampening impact on the city’s rating potential.

The fact that credits are subject to single industry dependence for economic, demographic, and tax growth is not new even though some seem to believe that climate change related pressures are somehow different in terms of their potential credit impact. The changes coming to credits like those in the powder River Basin are nothing that market participants haven’t seen before.

CHINA SYNDROME HITS U.S.PORTS

First it was tariffs. Then it was the Lunar New Year. The corona virus followed up. It’s a triple threat impacting port operations throughout the country. Now we have data to support those concerns.

On the West Coast, The Port of Los Angeles saw the number of 20-foot equivalent units fall 5.4% in January when compared with 2019. The port processed 806,144 TEUs compared with 852,449 a year ago. Port of Long Beach saw a 4.6% year-over-year drop in January. The port processed 626,829 TEUs compared with 657,286 in 2019. The Port of Oakland experienced a 0.6% in January, processing 211,160 TEUs compared with 212,433 in 2019. The Northwest Seaport Alliance, which operates facilities in Seattle and Tacoma, Wash., saw a 19.1% year-over-year drop in TEUs as it processed 263,816 containers compared with a record 326,228 last January. 

While the largest numbers of ill patients is found along the West Coast, the impact is being felt at East Coast ports as well. The Port of Savannah saw a 12.7% decline in January volume as the port processed 377,672 TEUs compared with 433,079 in 2019. The Port of Virginia saw a 5.3% decline in January, to 227,234 TEUs from 240,111 in 2019. The Port of New York and New Jersey, saw its monthly container volume slip in January by 0.9%, to 617,024 TEUs compared with 622,531 during the year-ago period.

CORONA VIRUS

The concerns which might arise as the result of the corona virus breakout are not hard to guess at. Credits dependant on travel (airports, transit) are obvious candidates. Many convention centers and conference centers will see cancellations. Hotel credits are obviously at risk. These could obviously experience short term credit deterioration. In our view, the issue is not necessarily short term risk of default but the longer term impacts of events like the pandemic.

After 9/11 travel limitations caused many businesses to rethink their conference and meeting practices. Conference lengths were shortened. Many were moved to in house sites. Declines in occupancies and demand were experienced. The underlying assumptions driving feasibility studies no longer were no longer valid. SARS had a similar impact on hotels, travel, and tourism in 2003. The financial crisis of 2008 also had similar impacts. This caused a rethink of the importance of many of the meetings and conferences and increased the utilization of online meetings and presentations.

Now that mass meetings of all sorts are being discouraged and cancelled, the potential for disruption both short and long term grows. It is important for investors in this space to understand the project specific credit drivers supporting the projects you own. Know whether the credits in this space you own are stand alone project financings or whether they rely on supplemental government support. Make sure you understand the nature of the local obligation which you are relying on. The level of government commitment varies widely and often is contingent on future legislative actions.

RAINY DAY FUNDS WHEN IT ISN’T RAINING

A recurring theme in the municipal bond press has been that states are well positioned to deal with any potential recession because they have been able to accumulate reserves to fund initial revenue shortfalls. That is all well and good when times are fairly normal. Unfortunately, that might not remain the case. Huge reserves do position states well but only if they are used for the purposes for which they are intended. We are beginning to see signs that the relative health of state general fund balances or “rainy day funds” may be pressured as legislators look to fund needed infrastructure and now public health needs.

There is no way to assess right now the impact on state budgets which might result from the corona virus. There is such inconsistent information and resources coming from the federal government that states will have to share the initial burden. The potential for serious financial consequences remains. The crisis comes at a time when skepticism is arising about various proposals to increase funding at the state level for  shifted attentions to issues infrastructure. Connecticut legislators have expressed a desire to apply some of the state’s budget reserves to funding transportation in lieu of higher gas taxes or tolls.

In Michigan, Republicans are proposing replacing the six percent sales tax on gas with a per-gallon tax. The goal is try to gain the money without raising net taxes on Michiganders. The plan is estimated to generate $800 million which would then be directed toward local and county-maintained roads. Some 92% of the roads in the state are owned and maintained by cities, villages and county road commissions. This plan is a response to the Governor’s proposal to issue $3.5 billion in debt for transportation. That proposal followed a rejection of a proposed increase in gas taxes.

EARTHQUAKE RISKS

It has been a while since the San Francisco and Northridge earthquakes brought attention to the risks of those sorts of events. Since then, climate change and its attendant impacts on life in the State have shifted attention to events like wildfires and issues with water. The fear has skewed more towards the potential impacts of those events and the potential impact from seismic events have received less attention.

So our radar was awakened by the release of a study by the Earthquake Engineering Research Institute San Diego Chapter. A study, partially funded by FEMA, found that San Diego County is subject to seismic hazards coming from several regionally active faults, including the local Rose Canyon Fault which runs through the heart of downtown San Diego. An earthquake originated on this fault may produce substantial damage and losses for the San Diego community. San Diegans need to be aware of this hazard.

According to the study, The Rose Canyon Fault Zone strikes through the heart of the San Diego metropolitan area, presenting a major seismic hazard to the San Diego region, one of the fastest growing population centers in California and home to over 3.3 million residents. The region’s large population coupled with the poor seismic resistance of its older buildings and infrastructure systems, make San Diego vulnerable to earthquakes. Best models show San Diego County facing an 18 % probability of a magnitude 6.7 or larger earthquake occurring in the next 30-year period on a fault either within the County or just offshore. Primary geologic hazards include surface fault rupture and severe ground shaking from La Jolla, along the I-5 corridor, through Old Town, the Airport, downtown San Diego, and splintering into the San Diego Bay, Coronado, and the Silver Strand.

The scenario earthquake the study observed  is expected to cause widespread damage to buildings, including moderate to severe damage to approximately 120,000 of the nearly 700,000 structures countywide. Economic losses associated with building and infrastructure damage are estimated at more than $38 billion. In part, that reflects the fact that much of the existing infrastructure of the San Diego region was built before recognition of the seismic hazards posed by the Rose Canyon Fault Reason to disinvest? No. But San Diego is usually not associated with earthquake risk to the same extent L.A., S.F. and many inland communities are. It’s just another factor in the credit equation to evaluate. 

NYU LANGONE UNDER FEDERAL INVESTIGATION

NYU Langone Medical Center is a major provider in Manhattan and regionally in the New York metropolitan area. It has revealed that it received a subpoena in January from HHS’ Office of the Inspector General that asked for information related to its Medicare cost reports submitted from 2010 to 2019. The Office of the Inspector General is asking for data and documents used to calculate how much money the health system should receive for indirect medical education expenses. The indirect portion is a welcome source of revenue for teaching hospitals that train physicians and tend to have higher costs.

NYU Langone closed on a $466 million bond issue on January, 2020. There is reference to how much the hospital gets from indirect medical education expenses but the offering document does not reference the subpoena. The time period in question was very difficult for NYU Langone. Over that time, it opened a new facility and suffered significant damage from Superstorm Sandy. The investigation does not appear as a pre-sale rating concern.

It’s not clear as to what amount of money may be at risk or the timing of a finding, if any. It is also fair to note that this process often leads to negotiated resolutions. It is unlikely that the federal government would be seeking to significantly damage the hospital’s financial position. It is however, something to watch.

HARVEY, IL BOND RESTRUCTURING

The Chicagoland suburb of Harvey has been in litigation with a variety of parties as it seeks to regain its financial footing after years of declining property values and revenues. The weak finances have landed the city in hot water with its uniformed services pensioners, the City of Chicago, and its bond insurers. Holders of a 2007 issue of general obligation  bonds have been in litigation since the city defaulted on that debt ($32 million).

After a status hearing last week in a lawsuit filed by holders of Harvey’s $32 million 2007 general obligation bond issue, Harvey’s legal representative hinted that a bond exchange might be the city’s best alternative. Under the terms of a decision rendered by the court in December, 2019, Cook County was ordered to segregate Harvey’s tax revenues needed to cover debt service payments in an escrow before sending tax dollars to the city. Harvey’s interim agreement with the 2007 holders that frees up $301,000 of property tax revenue currently held in escrow was approved in Cook County court.

Chicago sued Harvey after it fell in behind on payments for Chicago-treated water from Lake Michigan. The two cities agreed to a consent decree in 2015, but Harvey violated it and the court stripped Harvey of control over its water operations in 2017. A new administration in Harvey has argued the receivership has failed to accomplish the goal of bringing the city current  on water payments while extracting fees for its services and withholding revenues. The bondholders argue they are entitled to a portion of water rents and rates because about $5 million of the 2007 bonds financed water system improvements. 

Ultimately, a negotiated restructuring is likely the city’s best plan for resolving its debt dilemma. Any such resolution would likely extend the maturity of the debt and reduce debt servicing obligations significantly in the next few fiscal years.   

CALIFORNIA ELECTIONS HAVE NATIONAL IMPLICATIONS

Californians voted on some 289 local ballot measures. While they are local, some reflect policies which are being considered nationwide. Proposition D targets San Francisco’s rampant storefront vacancy problem with a tax on landlords who keep stores empty for more than six months. It would impose a $250 per foot tax on sidewalk frontage the first year, then $500 and $1,000 in subsequent years. As we go to press, it received the required 66% approval pending mail-in ballots. New York’s City Council is considering legislation along the same general lines.

There were mixed results for issues funding public transit and schools. In many places the issue was not whether there was a majority in favor of proposals but whether the required supermajorities (they range from 55 to 66.7%). Housing and development issues were front and center. Prop. E is San Francisco would tie commercial development to residential development. It is a reaction to the current real estate/housing environment and looks like it will pass with the required supermajority.

These are all issues which resonate nationally. Look and learn to see where politics and policies are going. A growing constituency across the country is more willing to embrace government intervention in local housing markets and developments. California is just the leading indicator.

WILDFIRE RATINGS FALLOUT

Recent actions taken to lower ratings in the aftermath of the most recent wildfires in California are impacting some of the state’s largest and best known electric utility issuers. while PG&E has been at the center of most of the attention paid to the role of utilities in the spread of wildfires, municipal utilities are not immune to the impact. recently, S&P downgraded the long-term and underlying ratings on the Los Angeles Department of Water & Power (LADWP) power system revenue bonds to ‘AA-‘ with a negative outlook from ‘AA’.

S&P specifically cited its updated assessment of the department’s overall wildfire risk profile as informed by our review of its revised wildfire mitigation plan taken in conjunction with the department’s specific wildfire exposure and ongoing potential liability claims as measured against power system reserves and insurance coverage. is a The risk posed by the operation of large scale transmission and distribution infrastructure is yet another headwind facing the utility as it navigates an increasingly complex array of issues facing LADWP as it operates in the California legislative and regulatory environment.

The downgrade of one of the major electric utility credits in the state has had knock on effects on the ratings of joint action projects in which LADWP is a significant participant. The latest example is the S&P Global Ratings revision of the outlook to negative from stable and affirmed its ‘AA-‘ long-term rating on the Southern California Public Power Authority’s (SCPPA) series 2012A and 2012B Mead-Adelanto Project revenue bonds and Mead-Phoenix Project revenue bonds.

The action reflected the significant share of project entitlement and debt service represented by participants rated AA-/Negative. LADWP and Glendale together represent a significant share of transmission entitlement and debt service. It comes as LADWP deals with the conversion of the Intermountain generating asset away from coal and the aggressive climate change mitigation targets legislated by the State.

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.