Joseph Krist

Publisher

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MCCONNELL ADVOCATES FOR STATE BANKRUPTCIES

The pandemic has clearly generated significant pressure on state and local government finances and it has been clear that some level of direct financial aid would be necessary to provide operating assistance to these entities. Such aid would enable governments to confront their responsibilities in response to the pandemic and shoulder the additional responsibilities which the President has made clear he believes are theirs.

It would reduce pressure on them to borrow for operations and it would help to avoid layoffs which would ultimately impact basic government services especially in the area of public safety. It would also reduce the number of people on unemployment. The arguments in favor of aid parallel many of the justifications for the PPP packages passed by Congress. Even President Trump has “promised” that another stimulus (round 4 or 5 but who’s counting) would contain aid to the state and local governments to fight the pandemic.

So it was especially disconcerting to see Senate Majority leader McConnell take the position that states should consider bankruptcy. It was especially disappointing to see the Leader link his opposition to aid to his belief that the states would use the money for pension funding and that aid in this time would be a political bailout. The flaws in his argument should be pretty clear but they should be examined nonetheless.

The Depression was the last time that state and local governments were under the kind of fiscal pressure currently confronting states and municipalities. While Arkansas managed to be the only state to default on its debt, Congress was asked to confront the potential for others to default. As it reexamined the federal bankruptcy laws it made the conscious decision not to provide the states with the ability to declare bankruptcy under Chapter 9. That has served as one of the foundational pillars upon which the municipal bond market has existed. It is at the core of the general obligation pledge by states.

Clearly the pressures of the pandemic and the pressure on Congress to act to offset the poor federal response to the pandemic have clouded the leaders thinking. The potential for damage to municipal bond investors is incalculable. But the real motive may be antipathy to government and its employees, especially those who are unionized. The Leader mentioned unions the source of the problem while ignoring the role of legislators in the historic underfunding of pension obligations. This despite the fact that the negotiated pension benefits granted to employees reflected two sided negotiations (any negotiation requires at least two parities to be involved). It is also pretty rich to hear the Senator from Kentucky – historically one of the worst states in terms of underfunding its pensions- blast irresponsible pension funding decisions. It also reflects a lack of knowledge on the Leader’s part. Pensioners have been treated fairly well in recent bankruptcies (at least in relation to bondholders and other creditors) so there is nothing to indicate that other bankruptcies would yield a different result.

He seems to think that residents of jurisdictions where they have gone through bankruptcy or other significant restructuring processes are somehow better off for having gone through the process. Whether it be bankruptcy or supervised restructuring (Philadelphia, New York, and Washington, DC come to mind – those experiences led to wrenching choices between priorities like public education versus public safety which had long term negative implications for the residents of those entities. It can be argued that the NYC school system never recovered from the cuts made during the City’s road back from its 1975 financial crisis.

Ironically, one of the states which arguably needs the most aid is New York and its pension system is one of the better funded systems in the country. It can be argued that steps taken over the years including the creation of multiple different tiers of pension benefits actually acts as a model for others to follow. Pensions per se are not New York’s problem. Right now, the problem is the fiscal damage ensuing from the shutdown of the economy which accounts for some 10% of national GDP. Bankruptcy will not change that.

RATINGS FOLLOWING THE MONEY

The Atlanta & Fulton County Recreation Authority issues debt secured by a first lien on a 3% rental car tax collected in Atlanta and College Park. Moody’s has assessed the likelihood that car rental tax revenues will suffer an immediate and substantial drop from a coronavirus-induced slowdown. The slowdown has the potential to cause some tax revenue tied to hospitality and travel-related activity to decline by up to 85% through mid-summer, potentially driving debt service coverage down significantly. As a result, it has placed the Authority’s Aa3 and A1 ratings on review for downgrade.

Last week we noted estimates from the City of Los Angeles Controller regarding potential impacts on the city’s major revenue sources. The information was enough for Moody’s to change its view of the city’s likely revenue and reserve trajectory. The prior expectation was for continued revenue growth and increasing reserves over our 18-24 month outlook horizon. Such near-term improvement is no longer probable in the current economic environment, even if the coronavirus downturn proves short and the recovery relatively rapid.

Another sector potentially under pressure is the retail and recreation/entertainment space. Moody’s has downgraded the Syracuse Industrial Development Agency, NY’s (SIDA) Carousel Center Project, PILOT Revenue Bonds to Ba3 from Ba2 and placed the ratings on review for downgrade. The downgrade and review follow the transfer of the subordinate $300 million CMBS loan to special servicing owing to the unprecedented circumstances related to the coronavirus outbreak that resulted in Governor Cuomo issuing a statewide executive order to close all malls on March 18, 2020. Deals like this one which count on outside sources of funding and liquidity from developers find themselves impacted by the nationwide pressure on the mall space as essentially all of these facilities operate under some form of restriction related to the coronavirus.

While actual downgrades await further information in terms of likely schedules for resumption of operations, airport rating outlooks continue to be reduced even if it is from positive to stable. Airport revenue credits have been impacted in that way across the board including Salt Lake City, Denver, San Francisco, and Miami.

PANDEMIC AND CREDIT

We think that when we try to project where the credit environment will be going forward post-pandemic, it is important to distinguish between the current trends as opposed to the actual longer term trends which will follow the pandemic. We are seeing a lot of speculation about the post-pandemic model for cities and what this implies for capital investment and public goods. The current stay at home environment is generating lots of views advocating for controversial approaches to things like healthcare, transportation, housing, and education. Once the pandemic is dealt with – however long it takes – life will begin to reestablish itself. It is important to remember that the current state of affairs is not sustainable long term.

Given that context, we nevertheless believe that some sectors deserve increased scrutiny. The most obvious would be credits dependent upon the retail sector. The role of retail shopping malls as the anchors and main draws at those malls is in the spotlight. The stay at home closings have seriously damaged an industry which was under enormous stress even without the pandemic. The demise of Sears/KMart was a canary in the coal mine for what could happened to poorly structured retail entities in the event of real economic stress. Now, the remaining anchor store players are all facing unprecedented pressure.

Recent press reports highlight the potential bankruptcy of Neiman Marcus and the entry into restructuring talks between J.C. Penney and its lenders. Macy’s said on March 30 that after closing its stores for nearly two weeks, it had lost the majority of its sales. With these entities seeking to cancel orders, refusing acceptance of goods at warehouses,  and extending repayments periods the potential impact on rents and cash flows to mall operators is significant. The negative impact on direct payments as well as taxes generated by retail activity will drive investors to want to know much more detail on the security mechanisms behind each issue.

In the healthcare sector, we see short term impacts on revenues due to the lack of elective surgeries and other services held down by stay at home orders. As always seems to be the case, rural hospitals with weaker and less liquid balance sheets are in the crosshairs of this event. That is not to understate the damage being done to hospital finances as we write. Hospitals will be at the center of the ongoing response to the pandemic going forward as there will still be a need for more than usual acute care (costly and poorly reimbursed by government providers) and the most impacted facilities  serve areas which economically and demographically will remain susceptible to the pandemic especially in a second wave.

Hospitals are not waiting for federal action. The latest example is Henry Ford Health which is serving patients in one of the nation’s hotspots, Detroit. The system has announced that it will furlough 2,800 employees or 9% of its 31,600 workers across its five hospitals to meet hundreds of millions of dollars in incurred and expected budget losses. The hospital system had a $43 million loss in operating income in March due to site closures, increased personal protective equipment costs and the cancellation of elective procedures.  The losses for April and May are expected to be larger. It’s the latest example of a clear trend for healthcare employment. Health care employment declined by 43,000, with job losses in offices of dentists (-17,000), offices of physicians (-12,000), and offices of other health care practitioners (-7,000). Over the prior 12 months, health care employment had grown by 374,000.

The housing sector provides some unique challenges. The pandemic has shined a brighter light on the realities of housing and its relationship to economics. In all of the nation’s largest cities, housing is a contentious issue. The cost of housing drives decisions regarding where one lives, what quality of life it affords, and what sort of employment will allow one to satisfy their needs. The pandemic has served as a vehicle to question so many of the assumptions behind how business are constructed and operated, why they have the office structures that they do and are all of those buildings  necessary? Existing general assumptions have supported greater density especially around transit facilities, the need for huge headquarter spaces and ways to get employees there, and a movement to effectively end single family zoning restrictions on development.

If we move to a model where the majority of “white collar” work is done remotely, that has likely negative implications for local tax bases. It would create much more freedom in terms of where and why people locate. More outdoor space or one’s own space might be more attractive than a Starbucks on every block and a walk to work. It will exacerbate the need for affordable housing. That will force municipalities to rethink development and permitting policies. The pandemic has exposed the need for affordable housing near places of employment and service as many of the currently classified as “essential” workers are also among the lowest paid. They rely on public transport and often on a number of public services.

Transportation has the potential to suffer the most consequences. Already we see the various interest groups advocating for significant changes to the mass transit system in this country. We are seeing discussions about ride sharing replacing public transit which ignore studies showing that such a shift would lead to massive congestion without a significant improvement in commutes. This would exacerbate the existing congestion issues associated with ride sharing. And it ignores the realities which exist in the largest cities.

New York is not going to successfully move some 5 million people daily without a vibrant mass transit system. Streets filled with ride share vehicles and reliance on “personal mobility modalities” (scooters and the like) just are not feasible. The reliance on walking to work would have the effect of limiting distances one could live from work. This would create issues about the cost and location of housing. Those issues won’t be solved expanding sidewalks and banning cars. Other issues like fare subsidies will have to wait as the financial hit being taken by the major mass transit agency are staggering.

PUERTO RICO

In a filing submitted to the bankruptcy judge hearing Puerto Rico’s Title III proceedings, the Puerto Rico Fiscal Agency and Financial Advisory Authority said the Puerto Rico Treasury Department has estimated that in the current fiscal year the commonwealth of Puerto Rico may lose between $1.5 billion and $1.6 billion in tax revenue due to reduced economic activity associated with the island virus lockdown and the delays in tax payments. The filing was made in connection with several motions before the bankruptcy court. It was considering an Unsecured Creditors Committee challenge to the Puerto Rico plan of adjustment. The judge decided to take a two step approach towards resolving the issues before it. One part of the process would include  approving disclosure for the plan. The other step would be part of confirming the plan.

The Unsecured Creditors are challenging the plan’s treatment of pensions and general unsecured claims in two distinct classes, with very different recoveries. The current proposal would provide for retirees to receive between 92.5% and 100% of what had been promised them. As for the challengers, the plan proposes giving the general unsecured claims no more than 3.9%. The challenge is based on the theory that

both classes of creditor have equal legal claim to Puerto Rico government money and that this should result in equal treatment. The dispute highlights the emergent trend of more favorable treatment of pensioners over creditors such as bondholders.

UTILITIES UNDER PRESSURE

The National Rural Electric Cooperative Association released an estimate of the revenue impact of the pandemic on its members. While this component represents a slice of the industry, the findings of the association can be a useful indicator for what the municipal utility sector could be facing as the result of lower demand related to pandemic limits. According to the Association, the nation’s electric cooperatives could lose up to $10 billion in revenue as the economic fallout from the novel coronavirus pandemic continues to linger. The cooperatives are facing a roughly 5% drop in electricity sales, costing them $7.4 billion. They also face a potential amount of money lost from unpaid electricity bills of as much as $2.6 billion.

The study comes as major municipal utilities are coming to market and releasing estimates of the impact of the pandemic on their revenues and operations. The latest is the Sacramento Municipal Utility District (SMUD) in CA. SMUD estimates that it will see a $47 million to $68 million revenue reduction in 2020 and a 2021 revenue reduction of between $67 million and $128 million. It estimates that it may need to reduce operating expenses in 2020 by up to $40 million and by up to $100 million to meet its internal financial planning metrics.

STATES REVISE REVENUE ESTIMATES DOWN

NY State Comptroller Thomas DiNapoli estimates that the amount of overall tax receipts delayed from April to July could be as much as $9 billion to $10 billion, depending largely on how many taxpayers choose to delay their filings. While the state received almost $3.8 billion in Coronavirus Relief Fund resources earlier this month, the total amount of federal assistance available to help address cash-flow and budget-balancing needs remains to be determined. The ability of the state to fully achieve its Medicaid savings target also remains unclear.

Significant losses of State tax revenues are likely to extend into State Fiscal Year (SFY) 2021-22, and there may be further effects in the following years. There will also be upward pressure on State spending for essential services related to the ongoing public health and economic challenges. The State ended SFY 2019-20 with a higher-than-projected General Fund balance of $8.9 billion, but could face a cash crunch starting early in the new fiscal year due to the tax filing delay. On March 17th , the Office of the State Comptroller estimated that SFY 2020-21 tax revenue would be at least $4 billion and possibly more than $7 billion below the Executive Budget projection of $87.9 billion as a result of the economic impacts of the coronavirus pandemic. Economic conditions have worsened further since that date.

The State’s video-lottery terminal (VLT) facilities and commercial casinos have been closed since March 16th. Receipts from these facilities were projected at a combined $1.2 billion in SFY 2020-21. In SFY 2019-20, State revenues from casinos and VLTs averaged $95 million per month.4 In addition, the Native American casinos in the State are closed, reducing receipts from tribal-State compacts which were projected at $219 million in SFY 2020-21, including funding for local host governments. Lottery receipts including Quick Draw rely heavily on sales through retail outlets, as well as restaurants and bars. These receipts, which were projected to generate $2.5 billion for the State this year, are also likely to be affected by diminished consumer traffic in those businesses.

Federal aid has begun to flow to the State, including receipt of nearly $3.8 billion in Coronavirus Relief Fund resources on April 17th. Such funding is to be used for expenses related to the COVID-19 pandemic. in some instances, limitations on use of these resources may hamper the State’s flexibility to use the funds as a budget management tool. The State last encountered severe cash flow issues in the wake of the 2008 financial crisis. Reduced tax revenues and diminishment of the General Fund resulted in delays to required payments for school aid and other purposes, as well as other budget management actions, in 2009 and 2010.

The Delaware Economic and Financial Advisory Council on Monday lowered its revenue estimate for this year by $416 million, or 9%, compared to its March estimate. This year’s revenue total is currently predicted to be almost 6% less than the amount collected last year. The panel also lowered its revenue estimates for the fiscal year starting July 1 by $273 million, or 6%, compared to its March estimate.

HOW ONE TRANSIT AGENCY IS DEALING WITH THE REVENUE HIT

The San Francisco Municipal Transportation Agency (SFMTA) board decided this week to raise fares despite economic downturn and public criticism. Starting in July, monthly fast passes will cost an extra five dollars, bringing the total to $86 for a regular pass or $103 for a pass that allows access to BART stations in SF. Starting in 2021, the price of those passes will rise to $88 and $106 respectively.

Individual rides paid for with a Clipper card will grow more expensive as well, moving up from $2.50 now to $2.80 in July, then $2.90 next year. Cash fares will remain the same at $3. The agency argued that SFMTA must continue paying drivers and other employees a rate commensurate with the cost of living and that the only options other than raising prices would be cutting service or laying off workers. The head of the SFMTA acknowledged public comment about the price increases was overwhelmingly negative but noted that “not a single [person] suggested where we should get additional revenue” otherwise.

The SF situation could be a harbinger of things to come across the country as mass transit providers seek to address the huge loss in demand resulting from the pandemic. It will divide a more wide ranging debate about funding for mass transit. Fare hikes will fall hardest on those least positioned financially to afford them while the alternative mobility industry has yet to resolve its issues over where and who it serves customers. This will stimulate efforts to develop non-fare based funding sources and to subsidize fares for low income riders. All of this will have yet to be determined impacts on transit system backed credits.

CORNHUSKER TUITION PROGRAM

The cost of attending college has been at the forefront of political debate with various  proposals being offered for federal programs to offer low or free tuition. While the debate goes on and a resolution awaits the results of the 2020 elections, states have been moving forward with their own plans. States are uniquely positioned to do so through their roles as funders and operators of institutions of higher education.

The latest state to offer a tuition benefit to lower income students is Nebraska. The University of Nebraska announced that it will offer free tuition to in-state undergraduate students whose families earn less than $60,000 a year. The program will be known as Nebraska Promise. It will begin this coming fall. To be eligible, students must take a minimum of 12 credit hours per semester and maintain a 2.5 GPA. The university will cover up to 30 credits in an academic year. 

The program will include all four of the state’s four year campuses and includes nursing school at the University of Nebraska Medical Center campus. It does not cover room and board but it does at least address tuition. It is impressive in that the announcement of the program follows university officials forecast of a shortfall of at least $50 million this fiscal year because of the coronavirus pandemic. Officials attributed the shortfall to housing refunds, event cancellations, medical costs and other factors.

There are fiscal implications as the University is seeking to fund the program out of its existing budget. That will undoubtedly lead to some level of program cuts. The pressure is limited by the projected limited increased demand. Nebraska Promise would cover about 1,000 additional current and future NU students, officials said. With the announcement, Nebraska becomes the 18th state to offer some form of tuition free college.

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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The President has effectively announced game on in the effort to reopen the country. By adopting state by state approach, the reopening process will effectively create 50 state laboratories in terms of how this will work and what the impact on states will be a some try to reopen as fast as they can and others take a more measured approach. What will be most interesting is to see how it all unfolds. If early openers prove to be premature, the potential cost to those states could be significantly higher than it would otherwise be in the event of a second wave of infections. Those states could just as easily find themselves back at square one as they could find themselves able to move forward. In that event, those states would have merely increased the fiscal costs of the pandemic while doing significant additional damage to their state economies.

Whether a state opens or not, the pressure on state and local credits is only increased by the offloading of responsibility of responding to the pandemic to the states. That will exacerbate the high level of fiscal pressure on state and local government we already see. All in all, the Opening Up America plan introduced this week represents a transparent effort to shift cost down to state and local government without funding or financing support. It comes at a time of unprecedented federal hostility to local government which is unfortunately based on political interests rather than any sound public policy goals. It appears that the zombie protesters outside the state capitol in Ohio are running the show now. That is not good for munis.

BIG NAME CREDITS UNDER THE GUN

The ongoing impact of the pandemic on life as we know it continues to take its toll on some of the most widely held and best known credits. The latest example is the Port Authority of New York and New Jersey. The Port Authority generates the majority of operating income with the airports and the tolled bridges and tunnels. The Port Authority estimates it will receive approximately $435 million in federal stimulus funding under the 2020 CARES Act for its airports. It is likely that without additional outside funding that the aid will not be sufficient to cover the operating shortfall resulting from the limits on traffic. It is not clear at all whether there will be federal aid targeted at the toll facilities.

The reduced utilization does not offset the need for ongoing maintenance so that the facilities remain in good repair to accommodate a resumption of utilization. Fortunately, the PANYNJ had around $2.4 billion in the general reserve fund and around $1.6 billion in the consolidated bond reserve fund on hand at year end. Nevertheless, Moody’s has reduced its outlook for its rating on the Port’s consolidated bonds to negative to reflect ” the risk of total DSCR below Moody’s previous expectation of 1.75x and lower liquidity levels over the next 12 to 18 months. It also reflects the uncertainty around the length of governmental restrictions to contain the spread of the corona virus and the length of time before an eventual recovery of its credit metrics.”

The downgrade was followed by the Port’s own statement about current conditions. “Because approximately one third of the Port Authority’s revenues are derived from passenger tolls, fares and user fees, declining utilization has had and will continue to have a negative effect on our revenues for an indeterminate period of time. In addition, some tenants who pay rent to locate and operate at our facilities are also heavily affected by the reduced activity levels and may be unable to meet certain obligations to the Port Authority. Some have requested specific relief from contractual payment obligations.”  As of March 31, 2020, unrestricted cash and investments, including amounts in the General Reserve Fund total approximately $3.34 billion, with investments valued at market.

The other major New York credit to come under pressure is the Triborough Bridge & Tunnel Authority (TBTA). The TBTA’s facilities include: Robert F. Kennedy Bridge (formerly the Triborough Bridge), Verrazzano-Narrows Bridge, Bronx-Whitestone Bridge, Throgs Neck Bridge, Henry Hudson Bridge, Marine Parkway-Gil Hodges Memorial Bridge, Cross Bay Veterans Memorial Bridge, Hugh L. Carey Tunnel (formerly the Brooklyn-Battery Tunnel), and the Queens Midtown Tunnel. The TBTA receives its revenues from all tolls, rates, fees, charges, rents, proceeds of use and occupancy insurance on any portion of its tunnels, bridges and other facilities, including the net revenues of the Battery Parking Garage, and bridges and tunnels’ receipts from those sources. 

Moody’s reduced its outlook to negative from stable to reflect the assumption of materially lower TBTA revenues in 2020 due to the corona virus combined with ongoing credit pressure on the MTA which may materially reduce the organization’s combined liquidity. On the positive side, Moody’s estimates that ” the authority’s credit profile remains strong and could withstand approximately a 40% reduction in operating revenues in FY 2020 while maintaining its ability to pay debt service without liquidity support.”

It’s likely that we will see additional outlook adjustments and downgrades in the transportation sector. The Illinois tollway says passenger volume is down 55% since the stay-at-home order went into effect March 20.

THE PRESS AND MUNICIPAL CREDIT

This week the New York Times ran a story under the headline “Plunge in Convention Hotel Travel Puts Municipal Bonds at Risk”.  The story focused on convention center hotels, a sector which has experienced significant fluctuations in the perception of their credits. The sector emerged coincident with the widespread growth of high yield municipal bond funds. Unfortunately, the article was written from the operator and developer perspective so it was not particularly enlightening about municipal bonds.

Weeks ago, we flagged bonds whose credit relied on taxes and/or revenues to pay off the associated bonds as an area of concern. That was the case regardless of whether or not, there was a pledge of general municipal revenues. The article expressed the correct concern that reduced occupancy and reduced sales tax revenues were bad for these credits. The implication was that cities would be forced to expend general fund monies to support shortfalls in revenues available for debt service. What the story missed was that municipalities support these projects in a variety of ways and that the requirement to pay in the event of shortfalls is often far from a certainty.

Take Baltimore which supported the development of a 750 room hotel adjacent to its Convention Center. In this case, the city support includes the site-specific hotel occupancy tax (HOT) collected at the property and the ability to use up to $7 million of city-wide HOT that must be appropriated from the city’s budget annually, if needed. Yes, that money could have eventually made its way to the City’s general fund but the upfront pledge identifies this as a source of dedicated revenue. That’s a far cry from a city guarantee.

In the case of the Denver Convention Center financing, the City’s obligations are more definitively enumerated including its ability to use any general revenues it chooses. While still subject to annual appropriation, the more explicit language in the security for the bonds makes a better case for the City to be seen as supporting the bonds. In either case, the need for the project to succeed is basic to the security and ratings.

There is of course the issue of whether these concepts have been tested. In one of the better known high yield bond hotel defaults, investors counted on an annual appropriation mechanism to require the Village of Lombard, IL to make up project revenue shortfalls. Unfortunately for investors, the Village declined to make the appropriations when requested and debt service payments were missed. So much for precedent.

My point is that the major media outlets do such a poor job of covering our market. Granted that many of the issues which impact our market are nuanced but the inability of the press to figure it out with some help from people who know has long been disappointing. If you are on the retail distribution side of the business, these headlines just generate a lot of unnecessary angst that you have to deal with.

DATA BEGINS TO EMERGE

We’re seeing the expected press accounts of the fears over the impact of the pandemic on government finances. But it’s all about fear with little information. Now hopefully, the information void will start to fill. A recent report from NYC’s Independent Budget Office (IBO) is one of the first efforts at estimating the impact that we have seen.

IBO has constructed a pared-down economic forecast for NYC, premised on an assumption that the local economy will shed roughly 475,000 jobs over the 12 months spanning the second quarter of calendar year 2020 through the first quarter of 2021. The local economy gradually begins to add jobs starting in the second quarter, with job growth remaining slow through the end of 2022. IBO “constructed a pared-down economic forecast, premised on an assumption that the local economy will shed roughly 475,000 jobs over the 12 months spanning the second quarter of calendar year 2020 through the first quarter of 2021. The local economy gradually begins to add jobs starting in the second quarter, with job growth remaining slow through the end of 2022.

IBO notes that its estimates are based on a forecast of the U.S. economy in recession for the first three quarters of calendar year 2020, with real gross domestic product (GDP) falling by about 4.5 percent for the year as a whole. This compares with our January baseline forecast of 1.8 percent output growth in 2020. The report notes that the city’s economy relies heavily on industries that have been largely shut down in order to limit the spread of the corona virus. These include the retail, transportation, tourism, leisure, and entertainment industries. It estimates retail employment will fall by 100,000 starting in the second quarter of calendar year 2020 (a loss of 60,000 jobs is expected in this quarter alone), with loses continuing through the first quarter of 2021. Over the same period, we project a loss of 86,000 jobs in hotels and restaurants along with a combined loss of 26,000 jobs in the arts, entertainment, and recreation industries.

It is also unsurprising that retail employment will fall by 100,000 starting in the second quarter of calendar year 2020 (a loss of 60,000 jobs is expected in this quarter alone), with loses continuing through the first quarter of 2021. Over the same period, we project a loss of 86,000 jobs in hotels and restaurants along with a combined loss of 26,000 jobs in the arts, entertainment, and recreation industries.

And now for the bad news on taxes. Prior to the shutdowns, leisure and hospitality, which includes sports and entertainment, accommodations, and bars and restaurants, accounted for 21.6 percent of all sales subject to the sales tax, while retail other than food, groceries, and alcohol added another 28.5 percent. The estimate is that sales tax revenue would fall short of IBO’s January baseline forecast by $1.1 billion (-13.1 percent) in 2020 and $3.1 billion (-36.4 percent) in 2021.

Sales tax revenue would fall short of IBO’s January baseline forecast by $1.1 billion (-13.1 percent) in 2020 and $3.1 billion (-36.4 percent) in 2021. The city’s separate tax on hotel occupancy is expected that this revenue would drop by $127 million (-19.8 percent) below IBO’s January baseline forecast for 2020 and $530 million (-82.0 percent) lower in 2021, when the number of nightly room rentals will be less than half the number it projected in January. As for business taxes, revenue from the general corporation tax (GCT) would fall $724 million (-17.9 percent) below IBO’s January baseline forecast for 2021, and $521 million (-12.5 percent) below in 2022. The unincorporated business tax, which is paid by partnerships and proprietorships, would fall short of the baseline by $406 million (-19.6 percent) in 2021 and $292 million (-13.5 percent) in 2022.

Property related tax impacts will occur over time but they will be real. There will of course be delinquencies in the payment of property taxes but the hit on valuations is, by virtue of the city’s property tax rules, an impact that will be phased in over five years. Of more concern is the impact on real estate sales related taxes. transfer tax revenue is expected to fall short of the forecasts in our January baseline by $168 million (-12.2%) in 2020, $344 million (-24.0 %) in 2021, and $122 million (-8.2 %) in 2022. For the mortgage tax, the shortfalls relative to our January baseline would be $69 million (-6.5 %), $112 million (-10.7%), and $87 million (-8.4 %) in 2020, 2021, and 2022, respectively.

The projected shortfalls would leave the city with essentially no growth in tax revenue for 2020 and a 4.2 percent decline in tax revenue for 2021 compared with 2020. Excluding the real property tax with its built-in stability, year-over-year declines in tax revenues would be 6.4 % in 2020 and 12.0 % in 2021. The City has not seen revenue impacts like this since the 1970’s. Excluding the real property tax with its built-in stability, year-over-year declines in tax revenues would be 6.4 % in 2020 and 12.0 % in 2021.

CITY BUDGETS REACT TO VIRUS REALITIES

As the IBO released its estimates, the Mayor released his Executive Budget. The Executive Budget Forecast has reduced tax revenue by 3.5% in FY20, or $2.2 billion, and 8.3% in FY21, or $5.2 billion compared to the Preliminary January Plan Budget. Losses in both years are primarily related to a decline in the Sales and Hotel Tax, Personal Income Tax, and Business Taxes, all due to the COVID-19 pandemic. In order to balance the budget while prioritizing health care, safety, shelter and food needs, the Administration has achieved savings of  $2.7 billion across FY20 and FY21. This includes PEG savings of $2.1 billion ($600 million recurring annually) and $550 million in Citywide savings ($220 million recurring annually). The reductions in the assumptions are substantial but the drops in revenue are less than those projected by IBO.

City of Los Angeles Controller Ron Galperin has revised the current fiscal year’s General Fund revenue estimate downward by $231 million due to fallout from the corona virus. This represents a 3.54 % decrease from the previous March 1 estimate and well below the amount budgeted for the year. For fiscal year 2021, he now estimates a decline in projected General Fund revenues of between $194 million and $598 million, depending on the length of the current shutdown and the speed at which the economy begins to recover.

The largest sources of the decrease this fiscal year are Transient Occupancy Tax (TOT) and Licenses, Permits, Fees and Fines (LPFF), which together are reduced by $110 million, as the travel and tourism industry has fallen by more than 70% and City office operations have been largely closed during the crisis. Revenues reflecting economic activity, such as Business Tax and Sales Tax, also are projected lower, but not to the same degree because both are lagging indicators that will be impacted much more heavily in the coming year.

BUT WILL IT BE ENOUGH?

Even the significant adjustments which will flow from expected revenue trends may not be enough as the outlook for the national economy for the near term is not good, at least as reflected in the April Beige Book from the Fed. A few items summarize what faces tax collectors and budgeters. All Districts reported highly uncertain outlooks among business contacts, with most expecting conditions to worsen in the next several months. No District reported upward wage pressures. Most cited general wage softening and salary cuts except for high-demand sectors such as grocery stores that were awarding temporary “hardship” or “appreciation” pay increases.

Manufacturing activity contracted sharply, and energy and agricultural sectors deteriorated as commodity prices fell sharply. Employment levels fell slightly, but layoffs accelerated late in the month. All of that spells real impacts on taxable income for FY 20 through FY 22. On the current side, estimates of U.S. retail and food services sales for March 2020, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $483.1 billion, a decrease of 8.7% (±0.4%) from the previous month, and 6.2% (±0.7%) below March 2019. And that is only March.

HIGH YIELD’S SPECIAL EXPOSURE TO STAY AT HOME ORDERS

It is likely that the high yield sector will begin to see the impact of the corona virus pandemic on many of the credits at its center. Senior living facilities, niche manufacturing facilities, charter schools, hotels are just a few of the sectors with near and long term vulnerabilities.

It would be a shock if there were not a slew of technical defaults from obligors supporting bonds issued for these facilities. In the short term, senior living will face the specter of patients seeking to leave in response to concerns from patients and their families as these centers have been particularly hit by the pandemic. Many of the outstanding hotel transactions are directly impacted by cancellations thereby hurting cash flows for dent service. It will be more difficult for these credits to meet indenture requirements for annual debt service coverage.

We are starting to see the first notices of actual or potential technical defaults as individual facilities are unable to operate and generate revenues. These also include manufacturing facilities which support bonds from project revenues alone. In some cases, a deep pocketed parent company could choose to step into the breach but this is an international pandemic and those entities have issues of their own in their home countries. In other cases, reserve funds will buy some time but not more than a year. This is the situation many toll and fare based credits find themselves in.

Many stand alone project financings sold to the high yield funds do not have significant excess revenues or reserves, especially those reliant on current economic activity. So it is incumbent on investors to know what they own. Unfortunately, we see this pattern repeated through every down credit cycle. It happened when bond insurers were downgraded as a result of the financial crisis in 2008. Suddenly, the nature of underlying credits mattered. It happened when Puerto Rico defaulted and fund owners suddenly found out how much of their state specific municipal fund was actually in Puerto Rico paper. Now, investors need to find out how the bonds they own (either directly or through a fund) are secured to assess how much risk they face.

COAL GENERATION FACES ANOTHER HIT

The Scherer generation facility in Georgia is a four unit facility which is the nation’s largest coal generation facility. Various shares of the plant are owned by Georgia Power, Florida Power and light, and municipal utilities including Oglethorpe Power Corp., the Municipal Electric Authority of Georgia, the Jacksonville Electric Authority and Dalton Utilities. As the industry shifts in response to the changing and declining economics of coal fired generation, at least one of the major owners is rethinking their ownership in the plant.

Florida Power & Light Co. submitted its ten year resource plan to regulators in Florida and the plan calls for FP&L FPL owns 76% of Unit 4 at Plant Scherer, and Jacksonville, Fla.’s electric company, JEA, owns the remaining share. It also wants to shutter another 330 MW coal plant and two old natural gas fired generators. The plan to divest itself of the plant is consistent with the plans of its parent, NextEra Energy Inc., which owns the world’s largest renewable energy developer, NextEra Energy Resources.

the plan to divest adds to the troubles of Jacksonville Electric Authority which is facing a management and leadership vacuum after a disastrous effort to privatize the utility. The Authority is already under federal investigation over that issue and the plan by FP&L puts further pressure on JEA as it tries to move on from the privatization effort. It highlights the management hole at JEA which could not come at a worse time as the utility deals with lower demand from virus mitigation efforts as well as the pressure all utilities are under from their role as massive carbon producers.

The move by FP&L could cause it to sell its portion of Unit 4 or work with JEA on an agreement to close the unit. The proposed divestiture comes at an awkward time for JEA as it is in the midst of a dispute with MEAG over its participation in the ill-fated nuclear expansion at Plant Votgle in Georgia. With coal on the decline and the effort to develop new carbon neutral generation facing daunting odds of completion, JEA finds itself between a rock and a hard place. None of this is good for the JEA credit.

SANTEE COOPER IN A NEGATIVE SPOTLIGHT

Lots is being said about the need to unite, focus on the economy and on stopping the corona virus. That has not stopped politics from interfering in the resolution of some other big topics at least in South Carolina. Those political disputes have held up a resolution of the process of the state legislature in determining the future ownership and operation of the South Carolina Public Service Authority (Santee Cooper).

The situation with Santee Cooper resulting from its ill-fated decision to participate in the construction of an expansion of the Sumner nuclear generating plant has been documented here. The resulting financial impact on Santee Cooper and its ratepayers from the participation in the Sumner expansion has led to calls for the divestment of the utility by the state or the establishment of new controls and procedures to increase outside oversight of the utility.

Now the debate over the future of Santee Cooper is holding up enactment of a state budget. A bill to allow state government to keep spending included a section to extend the law allowing the state to sell or reform Santee Cooper into 2021. House leaders said Senate leaders agreed to a provision preventing Santee Cooper from entering into any contracts over a year in length. At the last minute, several senators opposed the bill to allow the state to keep spending money if it doesn’t pass a budget by the end of June because of the restrictions on state-owned utility Santee Cooper in it.

Santee Cooper has not helped its cause by managing its messaging to its customers and the political establishment in a less than artful manner. It has been caught misrepresenting the position of its members which has cost the agency the support of the Governor and the House leadership. One of the agency’s long term strengths had been its support over the years from the state’s political establishment. The legislature has one month to figure out what to do with Santee Cooper. The failure of negotiations over Santee Cooper meant the House and Senate also couldn’t reach an agreement to set the parameters of any special session needed after the May 14 deadline in the state constitution for the session to end.

All of this leaves the agency’s bondholders in the air. The lack of consensus in the legislature casts a huge cloud over the agency and its ability to manage and operate. The debate does not seem to be leading to any plan to deal with the approximately $4 billion of stranded costs for Santee Cooper resulting from the Sumner debacle. Now the pandemic is impacting electricity demand especially from the commercial and industrial load customers. We would not be surprised by another downgrade for the once proud utility.

CALIFORNIA POWER AGENCIES

There has been so much focus on the ongoing bankruptcy of Pacific Gas and electric that it is easy to overlook the status of major municipal power providers in the state. They also have exposure to wildfire risk in terms of their role as major distributors and generators of electric power. So we looked with interest at upcoming financings for two of those entities; the L.A. Department of Water and Power (LADWP) and the Southern California Public Power Agency (SCPPA). We especially focused on the issue of wildfires and potential liability.

LADWP is currently in litigation related to the cause of the December 2017, 15,000+ acre Sylmar Creek Fire where LADWP’s investigation concluded that LADWP’s equipment did not cause or contribute to the fire ignition. In October 2019, the 745-acre Getty Fire resulted in 10 residences being destroyed and another 15 damaged. This fire began in LADWP’s service territory from a tree branch from over 30 feet away landing on one of LADWP’s power lines due to high wind conditions. LADWP may be liable for damaged property.

On the other side of the coin, LA exceeds the state’s standards related to the spacing between its transmission lines and has implemented other fire mitigation programs including the replacement of the distribution power lines’ cross bars with composite or steel material, as well as an active vegetation, brush and tree management program. LADWP can raise its rates through its Energy Cost pass through rates within 90 days without City Council approval if LADWP needs emergency recovery of any unexpected high costs or to replenish any depleted liquidity that was used during a potential short-term shock. This rate making structure provides additional and more certain support not available to the investor owned utilities .

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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Once again, government and its means of funding and financing public services is at the forefront of the response to the corona virus pandemic. Initially, attention will focus on the near term pressure on municipal finances – lower revenues and high immediate expense requirements. Longer term, state and local governments will be at the center of any recovery through their ability to regulate activity and tax and spend. The impacts of the pandemic on economic activity, on service needs and demands will serve as the basis for debate going forward over the role of government and the nature of its responsibilities. This reflects the stark divide which has emerged between haves and have nots.

The experiences resulting from the pandemic and its impact are likely to fundamentally alter the debate over the real role of government. We believe that the trend over the last 40 years shifting the responsibility for the provision of  services from the public to the private sector will be reexamined. Many of the obvious results of the pandemic in terms of its disproportionate impact on the poor can be best dealt with by government. One example is the education system. The reality is that schools are about much more than education – they are the center for programs enabling two parents in a family to working an economy which often requires that to be the case through its early morning and after school programs. The school system is the main vehicle for nutrition supporting poor communities. It is also likely to be the main source of healthcare services to poor children.

The health system will come under scrutiny. Lower income citizens tend to have poorer health and a lack of access to reasonable healthcare. we would not be surprised to see pressure grow for school based primary healthcare for children. The prevalence of serious ongoing health conditions in poor communities explains the disproportionate impact of the virus on those demographic cohorts. Part of the problem is that the increasing emphasis on private rather than public healthcare is not supported by a funding mechanism which supports institutions providing lower profit primary care to economically disadvantaged populations.

These issues would, in a logical world, lead to a reevaluation of the anti tax starve the beast mentality which has driven much of our politics and public policy over the last 40 years. It would examine the increasing reliance on individual taxation versus corporate taxation and it would consider the virtues of graduated rather than flat rate income tax schemes. It would shift away from property taxes as the primary source of school funding.

The pandemic has also highlighted the unpleasant reality that transit policies over the last decade have not reflected the interests of all demographic groups. The micromobility industry simply does not address the needs of all segments of society. The scooter and bike crowd remains primarily white, younger, and male. They live certain places and in certain ways which do not reflect the realities of poorer residents. You need access to the internet to remote learn, to communicate, to access goods and services, to bank. The lack of internet and broadband services has made the divide between rich and poor even greater.

The municipal market will have to deal with much of this. It will require analysts to put some of their own political and philosophical beliefs aside as they evaluate municipal credit in light of new circumstances. Not all private or business based approaches will be appropriate. In sectors like healthcare, student housing, transportation, and education, we are likely to see a new appreciation for the benefits of strong public education, heath, and transportation systems We need to remember the role that government services played in helping people manage the pandemic and its economic impacts.

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MTA BY THE NUMBERS

We are finally getting to see some real data on the impact of the corona virus pandemic on mass transit. The NYC Independent Budget Office has released some telling data.
Subway ridership was 32.2 million for the week ending February 28, 2020, two days before the first confirmed case of the Covid-19 virus in New York City. Ridership fell in every subsequent week, with the week ending March 27 serving only 4.6 million riders, a decrease of 86 percent from ridership levels seen four weeks earlier.

How does that translate to the revenue side of the ledger? Accompanying the drop in ridership is a reduction in fare revenue that IBO estimates will ultimately result in a decline of $970 million (21 percent) in NYC Transit subway and bus revenue in the current calendar year. This compared with fare revenue forecast by the transportation authority only a few weeks before in its February 2020 financial plan. IBO’s estimate assumes that most riders with 7-day and 30-day unlimited passes do not immediately renew when current passes expire, and that ridership remains depressed through early May and then creeps upwards again through mid-June, stabilizing at around 25 million weekly riders.

The wide ranging impact of the revenues generated by the MTA from all of its facilities is evident in the IBO comments. IBO notes that in addition to subway and bus fare revenue, the Metropolitan Transportation Authority uses the surplus toll revenue that remains after covering bridge and tunnel expenses to fund mass transit. That support exceeded $1.1 billion in 2019. The transportation authority has included a toll increase for 2021 in its latest financial plan. That will not help the current situation as toll revenue in 2020 is likely to take a major hit in the wake of the current shutdown.

It’s not just pure “transit” revenues which flow through to the MTA. The economic shutdown will have wide ranging effects as other revenues dedicated to transit, including taxes on real estate transactions and mortgage activity, a portion of the sales tax, and many other taxes and fees, will decline in response to the contraction of economic activity. Anticipating a financial shortfall, the Metropolitan Transportation Authority requested some $4 billion from Washington and is set to receive $3.8 billion from the recent federal aid package. IBO estimates that the $3.8 billion is equivalent to around 22 % of the transportation authority’s total operating budget (including debt service) projected for 2020.

The MTA is representative of many large urban transit systems which face significant declines in ridership. Cutbacks in service have occurred at all of the major systems especially those with subways.

REAL TIMETABLES FOR THE ECONOMY

The Congressional Budget Office (CBO) expects that the economy will contract sharply during the second quarter of 2020 as a result of the continued disruption of commerce stemming from the spread of the novel corona virus. Gross domestic product is expected to decline by more than 7% during the second quarter. If that happened, the decline in the annualized growth rate reported by the Bureau of Economic Analysis would be about four times larger and would exceed 28 percent. Those declines could be much larger, however.

The unemployment rate is expected to exceed 10% during the second quarter, in part reflecting the 3.3 million new unemployment insurance claims reported on March 26 and the 6.6 million new claims reported this morning. (The number of new claims was about 10 times larger this morning than it had been in any single week during the recession from 2007 to 2009). The analysis incorporated an expectation that the current extent of social distancing across the country would continue—on average, and with local variation—for the next three months. 

CITIES TAKE STEPS TO ADJUST TO LOWER REVENUE

One of the cities in the US which is quite dependent on tourism and recreation is San Diego, CA. The City has estimated that the pandemic would cost San Diego about $109 million: $83 million in lost hotel tax revenue and $26 million in lost sales tax revenue. To deal with the decline in tax revenues the City has furloughed some 800 employees in what are deemed nonessential services during this time. Most of the employees had been working at city libraries and recreation centers before those facilities closed. Some others worked for the city’s Transportation and Stormwater Department.

The City is allowing those employees using accrued vacation time to continue to be paid and it is hoping that federal aid would come soon enough to avoid layoffs. The San Diego Union Tribune estimated that using the average salary for city workers of $70,000, one month of furloughs for 800 employees would save the city nearly $5 million. If the furloughs last through June, the city’s savings could approach $15 million.

The news comes as the City of New York announced plans to reduce expenditures by some $1.3 billion. They include education, transportation, social services and benefit programs. They reflect the fact that transit use is down that the schools are closed, and that many programs such as summer job programs may be simply not feasible to operate. Nearly 10% of the reductions will come from a public sector hiring freeze and vacancy reductions.

The City is also likely to need to access the short-term markets to borrow for liquidity. Over recent years, short term borrowing has often been viewed as a negative credit event for both states and localities. The fact is that such efforts are a logical response to exogenous events like a pandemic. The press has been casting such plans in a negative light even though short term borrowing was a regular feature of municipal financial operations for decades.  

Detroit is facing an estimated $100million shortfall in revenues as the result of its dependence on the auto industry and casinos and the shutdown of those two industries in the face of social distancing regulations. The city’s three casinos released their report on March revenue that showed a 59% drop from last year. The city gets about $600,000 daily from the casinos. That doesn’t reflect the impact of employment losses associated with those industries. Even after facilities reopen, the loss of disposable income during the pandemic will have longer lasting effects. Municipal income tax revenue is Detroit’s largest single tax revenue source at $361 million in 2019 with gambling related revenue next at $184 million .

KANSAS BROADBAND FUNDING

The availability of serious rural broadband access has been a regular subject here and in other venues for sharing my thoughts. So we were interested in recent legislation dealing with the issue in the State of Kansas.

The Eisenhower Legacy Transportation Program (Program), as its name implies, is primarily concerned with transportation infrastructure. It authorizes the Secretary of Transportation, working jointly with the Office of Broadband Development within the Department of Commerce, to make grants for construction projects that expand and improve broadband service in Kansas. The law requires grants made by the Secretary to reimburse grant recipients for up to 50% of actual construction costs in expanding and improving broadband service. It establishes the Broadband Infrastructure Construction Grant Fund, to be used to provide grants for the expansion of broadband service in Kansas subject to appropriation. 

There is some concern that the Transportation Department might not be the best place to manage and administer a broadband development plan. While the law requires each county in the state to receive $8 million annually for infrastructure, there is no requirement for allocations to broadband. The law requires the Transportation Secretary to select projects for development every two years, but does not require the Secretary to construct every project selected for development. It  authorizes the Secretary to notify the Director of Accounts and Reports to transfer all remaining and unencumbered funds from the Broadband Infrastructure Construction Grant Fund to the State Highway Fund at the end of each fiscal year.

ENERGY AND THE PANDEMIC

The U.S. Energy Information Administration’s (EIA) publishes its Short-Term Energy Outlook monthly. The latest outlook estimates the impacts of the corona virus on demand for energy from a variety of sources. The data highlights some of the issues facing municipal credits as the result of pandemic driven steep declines in demand.

EIA expects U.S. motor gasoline consumption to fall by 1.7 million b/d from the first quarter of 2020 to an average of 7.1 million b/d in the second quarter, before gradually increasing to 8.9 million b/d in the second half of the year. U.S. jet fuel consumption will fall by 0.4 million b/d from the first quarter of 2020 to average 1.2 million b/d in the second quarter. U.S. distillate fuel oil consumption would see a smaller decline, falling by 0.2 million b/d to average 3.8 million b/d over the same period. In 2020, EIA forecasts that U.S. motor gasoline consumption will average 8.4 million b/d, a decrease of 9% compared with 2019, while jet fuel and distillate fuel oil consumption will fall by 10% and 5%, respectively over the same period.

That has significant implications for tax revenues derived from the sale of fuel for cars and airplanes. Severance taxes will also take a hit as EIA forecasts U.S. crude oil production will average 11.8 million b/d in 2020, down 0.5 million b/d from 2019. In 2021, EIA expects U.S. crude production to decline further by 0.7 million b/d. If realized, the 2020 production decline would mark the first annual decline since 2016. 

EIA expects retail sales of electricity to the industrial sector will fall by 4.2% in 2020 as many factories cut back production. Forecast U.S. sales of electricity to the residential sector fall by 0.8% in 2020. EIA forecasts that total U.S. electric power sector generation will decline by 3% in 2020. The pandemic has not fundamentally altered the move away from fossil fueled generation. U.S. coal production will total 537 million short tons (MMst) in 2020, down 153 MMst (22%) from 2019. EIA forecasts that total coal consumption will decrease by 19% in 2020, driven primarily by electric power sector demand, which will fall by 107 MMst (20%) in 2020. 

TEXAS HIGH SPEED RAIL

A group of some two dozen state lawmakers in Texas have signed a letter urging the U.S. Department of Transportation to end work related to a high-speed rail project projected to connect Houston and Dallas. The line is being undertaken by Texas Central Partners, a private entity. The legislators contend that TCP “simply does not have the financial resources required or expertise employed to continue with this project.”

The project has been mired in disputes with landowners along the project’s planned right of way (ROW) over efforts to acquire land for the project. There has been much opposition from landowners in areas which will not be served by the project to efforts to employ eminent domain if necessary to acquire ROW.  The company has said it has already secured 30% of land needed for the project, including 50% of the property needed in Grimes County.

Last month, Texas Central laid off 28 employees and announced that the project would be delayed because of pandemic-related issues with its partners in Italy, Spain and Japan. It said that it would resume its efforts at land acquisition and financing “when we have our permits and the financial markets have stabilized.”

PRIVATE STUDENT HOUSING AND THE PANDEMIC

Privatized student housing was a discussion topic in the last few months as one private sponsor/operator sought to sue the University of Oklahoma when the University declined to make up shortfalls in revenues from low occupancy at a  student housing facility. A recent Boston Globe story highlighted the nature of private versus university owned housing. It makes it clear that these facilities may be built to serve universities but are not run or owned or financed by universities.

LightView Apartments is a private residential complex built on Northeastern land across from campus to house the university’s undergraduates. Monthly rents start at $1300 per person. Leases at LightView run through August on a calendar, not the academic year, basis. So many students move in planning to be able to sublet their apartments to summer students to offset some of the room costs.The pandemic has thrown those plans out of whack. Northeastern, like nearly all higher education providers has moved to online learning to facilitate closures of campus housing. It also is not clear when for certain, the university will be able to return to its current structure. For those who lived in university owned and operated housing, it offered refunds on room and board payments. They can do that as the owner.

Here is where the unrealistic notions of investors and residents align. The private owners aren’t linked to any of the university’s policies so when Northeastern (or any other school for that matter) closes its facilities, the same policies don’t apply to private facilities. It’s as clear a delineation between private and school owned housing as you can get. So the university’s involvement is to waive its requirement that the operator only let Northeastern students live there.

Yes, the schools and developers of these projects are participants in their development but the whole purpose of these projects is to keep the liabilities off of university balance sheets. So no matter how these projects are marketed to tenants and investors that underlying premise should govern how one assesses the creditworthiness of these projects. They generate better yields than do those for projects which are owned by and part of university housing systems for a reason. The present situation illuminates that reason.

MICROMOBILITY

The Arizona Supreme Court unanimously rejected a challenge by the state’s attorney general who said the $4 pickup and drop-off fee that led Uber and Lyft to threaten to stop serving the Phoenix airport were unconstitutional. Attorney General Mark Brnovich argued that the fee increases violate a 2018 constitutional amendment that banned new fees on services. The city argued the higher fees are not taxes on services, but rather permissible charges for businesses to use the city-owned Sky Harbor International Airport. The city successfully compared the charges to the rental payments made by various concessionaires at the airport.

One non-financial issue that did make it through New York State’s budget process was a provision that would legalize throttle-based bikes and scooters. That legalizes electric scooters and bikes. The legislation would create three classes of e-bikes: Class 1 is pedal-assisted with no throttle; Class 2 is throttle-assisted with a maximum speed of 20 mph; and Class 3 is throttle-powered with a maximum speed of 25 mph. E-scooters would be capped at 15 mph, and riders under 18 years of age would be required to wear a helmet. Helmets would also be required for riders of Class 3 e-bikes.

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’s stunning unemployment claims report makes a strong case in favor of a view that essentially all municipal credits should carry a negative outlook. We do not foresee a cascade of sudden multi notch downgrades but rather a steady negative trend underlying most if not all of the metrics supporting ratings. We do not anticipate significant defaults to result from the pandemic over the near term. We do anticipate that downgrades will increase impacts on trading values and raising investor concern.

For investors who plan to hold their bonds until maturity or redemption,  holding on to what have been to date sound credits makes sense. For those who are concerned with real time valuations and the potential short term trading impact, it is a different story. It is time to lighten up on some sectors (project finance – corporate backed or individual facility backed – in all sectors, private student housing, senior living to name a few) and shift to revenue backed enterprise credits (utilities – water, sewer, electric) which are better able to weather a longer term storm.

We are truly in unchartered waters. The implementation of essentially nationwide lockdown regulations has not occurred in our history. There are no good models for an economy with a 30% unemployment rate over an extended period. Current federal fiscal policies, especially those regarding taxation, have created an environment not conducive to decisive and sizeable enough federal fun ding efforts. Even with additional stimulus actions in Washington, states and municipalities will ultimately bear the financing and funding burden of recovery.

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CORONA VIRUS

“The first line of attack is supposed to be the hospitals and the local government and the states themselves.” That comment from the President highlights the unique role that the issuers in our market face. That raises the issue of why Congress has made it increasingly harder for states and localities to fund and finance their activities. The trend over the last 40 years has been to chip away at the ability of states and localities to access capital. So now the ability to use tax exempt financing to engage the private sector is limited, the ability to refinance to provide maximum flexibility to address situations like the current one is limited. All of this was somewhat acceptable when there was a strong federal structure in place to support responses to national emergencies. That is no longer the case.

The lack of such a structure has done significant current and near future damage to state and local finances. That means that stimulus 4 – and there will be a couple of more bills – will need to be the foundation to support a real federal response to the issue of the impact of the pandemic on state and local finances. So far the enacted legislation has help for the health system, people, small businesses, and big businesses. Yes, some public transit agencies will get to divide $25 billion. It has not addressed revenue and expense impacts on general governmental finances resulting from that first line of attack standpoint. It also does not deal with toll facilities which are experiencing significant lower use and revenue.

So what to do when such a federal response is lacking? One has to find what evidence they can about the efficacy of social management policies which seek to combat the virus. The concern is especially heightened as all signs point to a potentially cataclysmic impact on state and local economies and fiscal positions. Now we have some objective guidance to support state and local interventions.

The Federal Reserve Bank of New York has released a study of the impact of “non-pharmaceutical interventions” (MPI) implemented in response to the Spanish Flu pandemic in 1918-1919. It’s primary findings indicate that areas that were more severely affected by the 1918 Flu Pandemic see a sharp and persistent decline in real economic activity. Second, it found that early and extensive NPIs have no adverse effect on local economic outcomes. On the contrary, cities that intervened earlier and more aggressively experience a relative increase in real economic activity after the pandemic. It was true that the 1918 Flu Pandemic led to an 18% reduction in state manufacturing output for a state at the mean level of exposure. Exposed areas also see a rise in bank charge-offs, reflecting an increase in business and household defaults. It also notes that the effects lasted for up to four years after the pandemic.

On the local level, cities that intervened earlier and more aggressively experience a relative increase in manufacturing employment, manufacturing output, and bank assets in 1919, after the end of the pandemic. The effects are economically sizable. Reacting 10 days earlier to the arrival of the pandemic in a given city increases manufacturing employment by around 5% in the post period. Likewise, implementing NPIs for an additional 50 days increases manufacturing employment by 6.5% after the pandemic.

The 1918 Flu Pandemic lasted from January 1918 to December 1920, and it spread worldwide. It is estimated that about 500 million people, or one-third of the world’s population, became infected with the virus. The number of deaths is estimated to be at least 50 million worldwide, with about 550,000 to 675,000 occurring in the United States. The pandemic thus killed about 0.66 percent of the U.S. population. The pandemic came in three different waves, starting with the first wave in spring 1918, a second wave in fall 1918, and a third wave in the winter of 1918 and spring of 1919. The pandemic peaked in the U.S. during the second wave in the fall of 1918.

What else can the study tell us about the economic and fiscal risks which result on a more specific basis? One thing is that the employment and output declines in high exposure states are persistent, and there is limited evidence of a reversal, even by 1923. Most U.S. cities applied a wide range of NPIs in fall 1918 during the second and most deadly wave of the 1918 Flu Pandemic. The measures applied include social distancing measures such as the closure of schools, theaters, and churches, the banning of mass gatherings, but also other measures such as mandated mask wearing, case isolation, making influenza a notifiable disease, and public disinfection/hygiene measures.

Other research supports the continuation of social and economic measures by state and local governments. A working paper from University of Chicago researches estimates that moderate social distancing would save 1.7 million lives between March 1 and October 1, with 630,000 due to avoided overwhelming of hospital intensive care units. Using the projected age-specific reductions in death and age-varying estimates of the value of a statistical life (VSL), we find that the mortality benefits of social distancing are over $8 trillion or $60,000 per US household.

The bottom line is that there is no quick answer to how best to handle the pandemic but there is clear evidence that a strong and timely approach is the best way in both the long and short run. There is no way for states and cities to avoid a significant fiscal hit at least in the short run. New York State will not have a timely budget and many other states are likely to have the same experience. It is also likely that good and timely information will not be available to legislators trying to enact budgets. At the same time, the closures of many public offices will delay the aggregation and distribution of complete and timely financial disclosures to all municipal finance stakeholders. 

CORONA VIRUS INFECTS RATINGS

This week the impact of the corona virus began to be seen in a variety of ratings actions. These actions all occurred in sectors which we have recently highlighted as being vulnerable to the revenue impacts of the corona virus. In the hospital sector, Moody’s Investors Service has placed under review for possible downgrade the ratings of four Washington hospital districts and one California healthcare district due to anticipated financial stress stemming from the coronavirus outbreak. This action affects approximately $214.7 million of rated outstanding general obligation bonds and $19.9 million of rated outstanding general obligation limited tax bonds.

The state general obligation sector saw Moody’s Investors Service has affirmed the Aa3 on the state of Louisiana’s outstanding general obligation bonds but revised the outlook to stable from positive reflecting the impact of the novel corona virus crisis on the state of Louisiana and its expectation that there will be substantial impacts of the crisis on state finances and the economy which will dampen the positive trajectory the state’s finances have been on for the past several years. Moody’s revised its outlooks on both the State and the City of New York to negative from stable, citing the severe strain from the pandemic. We would expect similar actions on credits in the hard hit states. Likely candidates include the State of Michigan and Detroit, Illinois and Chicago, Louisiana and New Orleans.

On March 25, 2020, Moody’s placed the Government of Guam’s general obligation bonds (Ba1) on review for possible downgrade. It also has placed the Baa2 ratings assigned to the Port Authority of Guam’s port revenue bonds on review for downgrade. has affirmed the Baa2 ratings assigned to Antonio B. Won Pat International Airport Authority, Guam’s (GIAA) senior general revenue bonds. The rating outlook has been changed to negative from stable. The actions reflect  a significant reduction in visitors to the territory from Asia as a result of the Corona virus (COVID-19) pandemic, uncertainty about the timing of and speed of a recovery in visitor arrivals, and the impact of the downturn in visitors on the Port Authority of Guam’s revenues as well as general government revenues.

Now we have evidence of predicted impacts on travel related credits. Moody’s Investors Service has affirmed the Baa2 rating on approximately $50 million of Taxable Revenue Bonds, Series 2005 (Rental Car Facility Project at Ted Stevens Anchorage International Airport) issued as special and limited obligations of the Alaska Industrial Development and Export Authority. The outlook has been revised to negative from stable. Moody’s said that the negative outlook reflects our view that rental car transaction days will decline significantly over the next 12 months, resulting in narrow or less than sum-sufficient net revenue DSCRs along with the potential for draws on project reserves. The negative outlook also incorporates uncertainty regarding the project’s ability to adapt its revenues and capital expenditures in a timely manner and the risk that the path to recovery may not restore coverage or liquidity to satisfactory levels.

STATE REVENUE IMPACT

The Illinois General Assembly’s Commission on Government Forecasting and Accountability (COGFA), has released a report which estimates the potential impact on Illinois’ revenues. It based its projections on declines in tax revenues experienced during recent recessions. The conclusion: Illinois’ general operating revenues could fall between almost $2 billion and more than $8 billion over several years, depending on the severity of the virus-triggered recession. Before the crisis, COGFA had estimated that General Funds revenue would total $40.6 billion in fiscal year 2021, which begins on July 1, 2020.

COGFA’s report said the downturn between FY2001 and FY2003 saw overall General Funds tax revenues fall by a combined $1.3 billion, or 5.5%, from $24.1 billion to $22.8 billion. The three main State-source revenues—individual income taxes, sales taxes and corporate income taxes—declined by a similar 5.7% during the period. A recession of like magnitude would be expected to reduce total General Funds revenue by close to $2 billion over the next several years, according to COGFA.

According to the Commission, the Great Recession that began in December 2007 and officially ended in June 2009 saw overall General Funds revenues fall by $2.6 billion, or 8.7%, from $29.7 billion to $27.1 billion. The major State-source revenues declined by a combined $3.2 billion, or 16.6%, from $19.4 billion to $16.2 billion, but the effect was mitigated by federal stimulus funding through the American Recovery and Reinvestment Act. Due to recent income tax increases beginning in 2011, these revenues have grown from about 60% of the total to nearly 78%, according to COGFA. As a result, a recession similar to the Great Recession is expected to result in a decrease of about 11% in total receipts over several years, or a revenue loss of about $4.5 billion.

Pennsylvania reported that general fund revenue dropped 6.2% in March. Fiscal year-to-date general fund collections total $25.3 billion which is $45.6 million or 0.2% below estimates. Withholding of income tax and sales tax are below estimates in March by $20 million and $24.2 million. Keep in mind that sales tax collections are effectively on a one month lag as 60% of the sales tax remitted in March was for retail sales in February. State officials had expected payments of personal income tax to total about $2.1 billion during April, May and June but that will not happen as the tax payment  date has been moved to July 15.

THE STOCK MARKET AND PUBLIC PENSION FUNDING

One of the concerns to emerge from the current crisis and its impact on the stock market is the potential for serious negative consequences for the nation’s public pension funds. One major pension fund investor is New York City which reports that at the end of 2019, the five plans that compose the retirement system held $153 billion in assets on behalf of city workers. Extraordinarily low interest rates for government bonds in recent years have compelled pension plans to rely more heavily on equities as well as alternative assets—like hedge funds, “high yield” debt, and real estate—to increase returns. The City’s Independent Budget Office (IBO) has provided one of the first estimates of the potential impact of the stock market’s recent gyrations on pension funding.

The analysis only covers the five city funds but it outlines many of the issues which will confront pension fund managers in light of the pandemic’s impact on the economy. Assuming the NYC system met its 7% return on assets benchmark in the current fiscal year, the pensions’ assets would add approximately $10.7 billion in value. The amount owed to the pension system resulting from investment returns that fall short of 7 percent  (the assumed rate of return) is phased-in over the next seven years. Because the start of payments is lagged by one year, the first budgetary impact of losses experienced by the funds’ investments in 2020 would not be felt until 2022.

The dollar impact is potentially substantial. IBO notes that during the Great Recession of 2008, the pension system’s investments saw asset values decline by over 20% in a single year. Scaling to today’s assets, a 20% decline in value for the current year would mean the system would require an additional $41.2 billion to be made whole. The single-year losses realized by the pension system in 2022 would be $5.8 billion, resulting in an additional employer contribution of $386 million for each of the next 15 years. The city now contributes about $10 billion annually to the pension system. 

We would expect that similar data could be generated for any number of other public pension funds. The current investment experience will therefore be a drag on credit performance for some extended period. Thus the need to fund pensions will compete to a higher degree with other capital needs. The price for the lack of a coherent approach to infrastructure funding over the past three years will increase in light of the need to fund pensions and other new costs which will result from the pandemic.

HOSPITALS TRY TO MANAGE THE SURGE

Bon Secours Mercy Health will furlough its employees if their work doesn’t involve treating COVID-19 patients. It operates hospital and nursing care services in the States of New York, Maryland, Virginia, Kentucky, South Carolina, and Florida. The system is projecting it will suffer operating losses of $100 million per month without serious non-patient care reductions in headcount. Furloughed employees will be paid through April 3, and the health system will then pay out any personal time off (PTO) those workers have accrued. They will be eligible for enhanced unemployment.

The move comes at the same time its outstanding debt was upgraded  and assigned an  A1 rating by Moody’s. Moody’s based the change on BSMH’s strong liquidity of over $5 billion, centralized management model and platform, and proven ability to quickly execute complicated integration strategies, which will provide resources to manage through COVID-19 challenges. Governance considerations include the successful execution of system-wide integration initiatives over the last 18 months, consolidated management structure, and a common IT platform, all of which will drive a second year of sizable synergy benefits. Strong liquidity from $1.2 billion asset sale proceeds, upcoming asset sales, and expected bank line availability will provide flexibility during COVID-19 operating stress and for long-term growth strategies.

It is just the latest example as hospitals seek to shift the cost burden of stay at home policies to the government. The implementation of restrictions of non-emergency care has a significant impact on their revenues from non-governmental private insurance payers. There is also far less need for the many administrative personnel usually needed to service the existing insurance scheme in the US. The layoffs and cost reductions are the primary tool at the disposal of hospital managements as they navigate a high cost limited reimbursement environment in their effort to maintain as positive a credit profile as they can.

STATE BUDGETS ADAPT TO VIRUS REALITIES

Gov. Andrew M. Cuomo announced an agreement with the Legislature on a $177 billion budget. The pandemic led to a plan which includes lots of hopeful assumptions, increased borrowing power through the relaxation of statutory debt limits, and gives the Governor unilateral flexibility to make budget cuts through the end of Fiscal year 2021.

As is the case in many states, budget negotiations are intertwined with non fiscal policy issues. The impact of the pandemic created an atmosphere of urgency to get a fiscal framework in place as the state deals with its role as the pandemic epicenter. This meant that several such policy issues which might have led to a different budget outcome on both the revenue and expense side were set aside to facilitate a budget settlement.  

New Jersey will extend the state’s deadline for a new 2021 fiscal year budget to Sept. 30 from June 30. It is the first state to do so. “This will allow the administration and the legislature to focus fully on leading New Jersey out of this crisis, and to allow for a robust, comprehensive, and well-informed budget process later in the year,” according to the Governor and the leaders of the state legislature. It would not be a surprise to see other states follow suit as the national stay at home periods continue over what is typically the quarter when states receive their highest proportion of revenues.

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