Joseph Krist

Publisher

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So we have now passed the 40 million mark for new unemployment claims verifying what one can see with their own eyes. At the same time, the Administration has apparently decided that releasing economic projections as a part of the budget process would contain more bad news than they believe the American public can handle. The claims number is 25% of the labor force even as the reported rate is over 13%. The implications for FY 2021 for states and municipalities are bleak.

Municipal bonds will and should be at the center of the debate over next steps on the road to recovery. There seems to be a growing consensus that infrastructure could be a key generator of jobs going forward. A number of comments and proposals have been floated all involving municipal bonds. Whether they be issued for capital finance purposes or  for operating purposes, municipal borrowing is likely to be a key component of any recovery process. It was true of the Great Depression and it is true during the current depression.

The current Depression has raised worries over government solvency. Moody’s made some comments about bankruptcy which should give investors pause. They raise issues which we have raised previously.” Municipalities will not strive to make bondholders whole when doing so would be too painful for residents and other constituents… municipalities will not strive to make bondholders whole when doing so would be too painful for residents and other constituents.”  The second issue reflects cracks in the legal consensus around the treatment of special revenues .

Moody’s notes that decisions in the ongoing Title III proceedings in Puerto Rico have been negative for special revenue backed bondholders. “If this court determines that the revenues securing Fairfield’s bonds constitute special revenue pledges protecting bondholders against impairment, just as another judge ruled in Jefferson County’s bankruptcy case in this district, it would contrast with the recent 1st US Circuit Court of Appeals decision in the Puerto Rico (Ca negative) bankruptcy-like proceedings and likely provoke further litigation, possibly ending at the appellate-court level.”

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HOSPITALS AND FEDERAL AID

We have for some time been advising that investors should be very wary of the small and/or rural hospital sector. They have always been characterized by narrowly balanced finances at best. In recent years, these hospitals have been asked to deal with an increasing share of uninsured patients and cash positions have narrowed in the face of weakened reimbursements. Obviously, these institutions have been among the worst positioned to withstand a significant economic decline. So one might have hoped that the needs of these institutions would have been addressed through any of the pieces of federal legislation designed to mitigate the impact of the corona virus pandemic.

Unsurprisingly, the Trump Administration has taken a different path. The Department of Health and Human Services (HHS) has now begun distributing a portion of the $175 billion allocated for grants to health care providers in the Coronavirus Aid, Relief, and Economic Security (CARES) Act and the Paycheck Protection Program and Health Care Enhancement Act. Congress stated the money can be used either for costs related to treating COVID patients or to reimburse for lost revenue due to the pandemic. The largest share of the initial tranche of $72.4 billion to be distributed is the $50 billion that the Department of Health and Human Services allocated to providers who participate in Medicare based on their total net patient revenue from all sources.

A recent analysis of the distributions was released by the Kaiser Family Foundation (KFF) and it confirmed the worst fears of the rural hospital sector. These institutions tend to have higher levels of patients either under Medicaid or uninsured. The KFF research showed that the formula used to allocate the $50 billion in funding favored hospitals with the highest share of private insurance revenue as a percent of total net patient revenue. The hospitals in the top 10% based on share of private insurance revenue received $44,321 per hospital bed, more than double the $20,710 per hospital bed for those in the bottom 10% of private insurance revenue.

The disparity reflects the reliance of HSS on input from the larger hospitals and the for profit sector. The formula penalizes smaller and rural hospitals for the fact of the underlying demographics of their patients. KFF found that when compared to the 457 hospitals with the lowest share of private insurance revenue, the 457 hospitals with the highest share of private insurance revenue are less likely to be teaching hospitals (10% vs. 38%) and more likely to be for-profit (33% vs. 23%).  The hospitals with the highest share of private insurance revenue also had higher operating margins (4.2% vs. -9.0%) and provided less uncompensated care as a share of operating expenses (7.0% vs. 9.1%).  Uncompensated care includes bad debt, charity care and unreimbursed Medicaid and children’s health insurance program expenses.

KFF also notes that all things being equal, hospitals with more market power can command higher reimbursement rates from private insurers and therefore received a larger share of the grant funds under the formula HHS used. An alternative methodology for distributing the funds based on patient volume or that increased the size of the grant for providers that are more reliant on public payors such as Medicaid would have distributed the funding more evenly and less skewed by higher revenues from private insurers.

Dignity Health, the Cleveland Clinic, and Stanford Health Care were the only organizations to receive over $100 million in payments from the Relief Fund. Other recipients include Memorial Hermann Health System, $92,422,556, NYU Langone Hospitals, $92,120,455, County Of Los Angeles, $80,867,712, HMH Hospitals Corporation, $76,839,719; Florida Cancer Specialists & Research Institute, $67,343,375; Memorial Hospital For Cancer And Allied Diseases, $64,048,724; Massachusetts General, $58,076,206; Yale New Haven Hospital, $54,994,143; Ohio Health Corporation, $53,810,332, Allina Health System, $53,596,403; Texas Oncology Pa, $52,039,485.

The reimbursement formula is just another brick on the credit load faced by the smaller and rural hospital sector. Only one could be considered a safety net provider. And it is one more reason to avoid the single site and rural hospitals.

VEHICLE MILEAGE TAXES

The pandemic has potentially created opportunities to innovate in the funding of certain services. One of those sectors in the middle of technological change and its impact is transportation. Some states may find that the need to strengthen state finances in the aftermath of the pandemic allows for more creative thought.

We saw this week that the Director of the Wyoming Department of Transportation has suggested a ” a per-mile road usage charge was an option worth considering” as a source of funding for state road projects. Utah and Oregon recently implemented their versions of vehicle mileage taxes (VMT). Other alternatives in Wyoming include a bill to create a master I-80 tolling plan, which would have considered ways to exclude Wyoming drivers. It failed introduction in the Senate, with nearly two-thirds of legislators in opposition. 

Wyoming has assumed for its revenue projections a program with a penny-per-mile rate, which would be half a cent lower than those in Oregon and Utah. It is estimated to bring the state roughly $104 million in annual revenue. That would cover a significant part of the state’s estimated annual road bill.

The discussion is reflective of certain trends regarding the potential for tolls to become a major funding source. In any number of jurisdictions, voters have shown clear opposition to tolls for both new projects as well as maintenance projects. The opposition has been across the country even where there has been a clear need for improvements. That opposition limits the range of funding options available for capital development.

ILLINOIS BUDGET

Illinois was one of the states in similar straits to that of New York with high caseloads and impacts which could potentially result in  difficult budget process. New York moved relatively quickly and enacted its budget essentially on time. Now the Land of Lincoln has moved forward with its budget. The state legislature passed approved a “maintenance level” budget of $40 billion. It depends on federal funds and on companion legislation designed to made another effort to get a casino in Chicago up and running.

The adopted budget keeps spending essentially flat for everything except pandemic related health expenditures. Any budget enacted would be a highly uncertain one given the dispute over state and local aid levels in any future federal legislation. Add the additional uncertainty of the pending November vote on the constitutional amendment restructuring the state’s income tax rates. Asking for more could be a bit unrealistic.

NYC BORROWING REQUEST MEETS OPPOSITION

The state Legislature refused to take up Mayor Bill de Blasio’s request to allow New York City to borrow $7 billion to address a shortfall triggered by the corona virus pandemic pandemic. The Mayor estimates that the pandemic will impact the City’s revenues by some $9 billion. Publicly, the reasons include a desire to wait and see what aid is generated for state and local governments in an expected fifth stimulus bill. There are also issues of oversight cited by both the Legislature and the Governor.

To address those concerns, it has been proposed that should a borrowing be authorized for essentially operating costs, that the borrowing be done under the oversight of the Financial Control Board. The real story is the lack of trust between the Mayor and the State, both the Legislature and the Governor. We have discussed on numerous occasions the concerns that existed about absolute spending levels by the City as well as the number of employees and accountability for spending programs like Thrive NY. While publicly unspoken, these are real drivers of the debate.

The Legislature adjourned for this session leaving a number of topics for later discussion which are normally settled in the session ending in June. In the interim, the City Council President (a 2021 mayoral candidate) has expressed concerns about oversight as well. The City also has to adopt a balanced budget by June 30. The lack of borrowing authority will force a more rigorous approach to expense control as the budget process unfolds.

We expect that that the City will ultimately receive borrowing authority but under much tighter outside oversight and control than the Mayor would like.

EDUCATION, HEALTH, AND THE PANDEMIC

Stanford University is poised to come to market with $750,000,000 of taxable municipal bonds. The issue provides a good opportunity to see how one of the financially strongest private universities talks about how it will operate going forward. This comes as universities large and small, public and private, grapple with the issue of how to approach the fall semester.

The University has announced that a university-wide salary freeze and a moratorium of hiring were in place and that operating budgets were to adopt expense reduction targets of up to 25%. This is driven by, among other things, a projected 15% reduction in revenue available through the university’s endowment. These funds are estimated to account for 26% of the pre-pandemic current budget. That budget projected a $126 million surplus. The most recent estimate issued in May is for a $40 to $45 million operating deficit.

In FY 2019, student income – tuition, room and board, fees – generated 11% ($653 million) of operating revenues. As is the case with the major private research facilities that research is actually a financial keystone for many of them. In the case of Stanford, sponsored support for research comprises 27% ($1.7 billion) of total operating revenue. The medical facilities are integrated into the University’s financial operations. They account for 20% of revenue.

Currently, the University does not estimate a reopening schedule in terms of on-campus teaching and residence. Currently, the entire University operates remotely. It does say that research operations will resume before in-person instruction resumes. In the meantime, Stanford Health Care was one of three organizations to receive over $100 million in payments from the CARES Act Relief Fund.

In Massachusetts, a committee of a dozen Massachusetts college presidents has released an outline of a plan to help universities reintegrate half a million students and some 136,000 employees back into a campus setting. The plan comes with higher education leaders also urging the governor and legislature to change the law so that institutions are held legally harmless if they reopen and people get sick.

That may be a bigger issue than even the extra costs of equipping facilities to provide mitigation. It is a common theme whether it be for businesses (especially those with offices) or for educational institutions. College heads are less certain about being able to test students, faculty, and staff particularly when they come back to campus, according to a survey the advisory group conducted of nearly 90 campus leaders. 

According to the Boston Globe, slightly fewer than 60 percent of state institutions were very or somewhat confident that they could do robust testing of everybody returning to campus. Fewer than three quarters of college leaders felt strongly that they could do the contact tracing to curb the virus’ spread, according to the survey. Boston University recently announced it would open its own testing lab and is buying robots to conduct large-scale testing.

Michigan State will resume in-person classes in the fall along with “enhanced” remote learning opportunities. Students will be able to return for in-person classes on Sept. 2, as previously scheduled. There will be both in-person and online components to instruction in the fall semester. It is planned to end all in-person instruction on Wednesday, Nov. 25, with remaining instruction, study sessions and final examinations moving remotely for the remaining three weeks of the semester. Students will have the option of returning to their permanent residences for the Thanksgiving holiday and not returning to campus, or remaining on campus until the semester ends. 

The question of liability will likely be central to the debate over the next stimulus package. While resistance to state and local aid appears to be softening, there appears to be a linkage between government aid and liability protection.

TOURISM BEGINS TO GEAR UP

With venues large and small being closed for some three months, some bonds backed by tourism related revenues (sales taxes, hotel, car rental) were seen to be at particular risk. Now we see that the relaxation of pandemic related restrictions on public activity is driving the reopening of some of these facilities in some of the most tourist dependant municipalities.

The Orlando area has announced several openings and dates. Disney World is slated begin reopening in July. Magic Kingdom — the most attended park — and Animal Kingdom will reopen for business on July 15. Universal Orlando, is expected to reopen June 5 with Sea World reopening a week later.

Las Vegas will begin to try to create a viable model going forward after the Governor of Nevada announced that casinos will begin reopening next week on June 4.  Nevada had the highest unemployment rate of any state in the country last month, with 28.2% of workers without a job — nearly double the national average of 14.7%.  Guidelines issued this month by the Nevada Gaming Control Board limit capacity to 50% and require new cleaning and social-distancing policies.  This reduces the number of slot machines and regulators have capped capacity at three players a table for blackjack and four for poker.

Both of these areas will provide a good initial test of the dynamic between the desire to reopen, whether there is enough current demand, and whether hospital employees will be willing to return to work under proposed mitigation protocols.

NYC RESTAURANTS AND STREETS

The latest interest group to seek use of the public streets for its businesses is the New York City Hospitality Alliance which represents the City’s restaurant industry. The NYC Council introduced legislation backed by the restaurant industry requiring the mayor to find a way to open streets, sidewalks and public plazas to outdoor dining.  Proponents have couched it as a way to rescue the businesses.

The controversial part comes from comments from the Alliance. ““Our hope is there may be areas where entire streets could be shut down for restaurant service.”  That raises issues which have been heretofore been primarily the provenance of the transportation space namely who owns the streets. Are municipalities expected to turn over use of its streets to certain businesses but not others? How does that reflect in things like property taxes? Do proposed closures raise issues of public safety (access to police and fire) and do they create negative real estate impacts?

The NYC moves come in the wake of the release of guidance for restaurants seeking to reopen in Chicago. That city calls for tables to be placed at least six feet apart, or have a permanent barrier, such as Plexiglas, installed between them, while parties at one table should be capped at six people. Patrons must always wear face coverings — except, of course, when eating — while employees should cover up allowed for the time being.

PG&E UPDATE

The California Public Utilities Commission voted 5 to 0 in favor of PG&E’s plan to exit bankruptcy. The approval was seen as the last significant hurdle for the company to overcome. It preserves the utility’s status as an investor owned entity. Over 200 public officials across the state had supported the idea of creating a public entity to own and operate the PG&E assets. Legislation to allow for such a takeover is working its way through the California Assembly.

The plan includes a statement that its bankruptcy reorganization would not increase customer rates and would lead to about $1 billion in interest savings to customers.  One condition of the approval is guidelines for PG&E and other utilities that cut power to customers during extreme weather events to prevent equipment from causing wildfires. The guidelines require improved communication with local governments and communities while limiting the duration of the power shut-offs.

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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Memorial Day did not become an official Federal holiday until 1971. It sprang from the originally Southern tradition of decorating soldiers graves on the last Monday in May. It recognized service and most importantly sacrifice. While we remember the sacrifices of the past this Monday, it is worth comparing the sacrifice we commemorate to the sacrifices we are being asked to make today. Dying in combat or wearing a mask? Dying in combat or waiting a couple of more weeks to go to the bar? Yes these are difficult and in our lifetimes unprecedented times but they can be overcome with a little sacrifice. Enjoy Memorial Day just do it responsibly.

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MUNICIPAL BONDS IN THE IDEOLOGY CROSSFIRE

Jerome H. Powell, the Federal Reserve chair, testified before the Senate banking Committee and suggested that the central bank might expand its program to buy municipal debt and agreed that state and local governments could slow the economic recovery if they laid off workers amid budget crunches. “We have the evidence of the global financial crisis and the years afterward, where state and local government layoffs and lack of hiring did weigh on economic growth.” 

The Congressional Budget Office (CBO) released its economic outlook through 2021. CBO estimates that real (inflation-adjusted) gross domestic product (GDP) will contract by 11% in the second quarter of this year, which is equivalent to a decline of 38% at an annual rate. In the second quarter, the number of people employed will be almost 26 million lower than the number in the fourth quarter of 2019. The estimates seem to assume that there is not a spike in the fall and early winter into 2021.

Compared with their values two years earlier, by the fourth quarter of 2021 real GDP is projected to be 1.6% lower, the unemployment rate 5.1 percentage points higher, and the employment-to-population ratio 4.8 percentage points lower. Inflation and interest rates on federal borrowing will remain relatively low because of subdued economic activity and weak labor market conditions through 2021.

These estimates and comments reflect one side of the current economic debate over the ultimate scope and scale of stimulus spending. The other side reflects the ongoing efforts of the starve the beast anti-tax movement. It’s latest iteration comes from an Op-Ed in the New York Times from former Wisconsin Governor Scott Walker. He advocated against any direct aid to states and localities because “workers and small businesses need help more than government bureaucracies. ”

Among his other pearls of wisdom are that “one way to help, which will not cost the federal government more money, is to allow people collecting the enhanced unemployment benefit of $600 per week to go back to work and keep the payment until the end of the program. ” And who funds unemployment payments? Those hard pressed states who under Mr. Walker’s proposal would be subsidizing people with jobs, not businesses who could raise pay to incentivize people.

He also goes on to assert that “shortfalls created by the disappearance of federal stimulus funds was a primary reason for the budget crisis that many state governments faced after the last recession.” Too bad it was his political party that fought the stimulus after 2008. What is really rich is that he takes credit for Wisconsin’s pension funding status as the best funded pension funds in the nation. Those funds were the best funded because of a long history of bipartisan cooperation on the issue. All he did was take something that was doing well for years and didn’t screw it up.

As for economic development, here’s where things get dicey. Walker was the governor who pushed for tax incentives to the tune of $3 billon for the Foxconn manufacturing development. That deal is already on track to under deliver in terms of total number of jobs as well as the salaries available for the majority of the jobs.  Should Wisconsin be treated badly for the Foxconn deal?

From our standpoint, the whole red/blue aid discussion misses the point.  At the moment, jobs are jobs. A basic understanding of economics would see the multiplier effect of people being paid no matter the source of that pay.  There will be a time for the ideological issues to be sorted out but right now, the people reopening businesses could not care less how their customer funded his purchase. They’re just thankful for cash flow.  Aid to states and localities would provide much needed cash flow.

PANDEMIC CASUALTIES – SAFETY NET HOSPITALS

While the arguments over when, how, and where to “reopen” the country continue, there are some issues about which there can be little disagreement. Data to date shows the disproportionate impact of the pandemic based on race and/or economics. As with all other major health issues, disproportionate share hospitals (DSH) bear an indeed disproportionate share of the resulting burdens from the pandemic. While always under pressure, the DSH or “safety net” facilities are in a uniquely difficult spot in that their limited financial positions make it difficult to cope with both the revenue losses and the rapidly increased supply expenses associated with the pandemic.

With plenty of existing hurdles to overcome, these facilities now face potential regulatory burdens stemming from their participation in the federal 340 b drug program. Established in 1992 under Section 602 of the Veterans Health Care Act, the 340B Drug Pricing Program allows eligible hospitals, health centers, and clinics (covered entities) to access covered outpatient drugs at reduced prices from manufacturers participating in Medicaid. The program includes a variety of documentation requirements which are more difficult to comply with. If a facility is unable to meet those requirements even under these emergency circumstances, the resulting expense burden occurring as the result of being out of the program could be substantial.

Hospitals, healthcare professionals, and advocacy organizations  have asked the federal Health Resources and Services Administration’s (HRSA) Office of Pharmacy Affairs (OPA) which is responsible for administering the 340B program, to relax program regulations during the pandemic to relieve this burden. Part of the problem is limited technical abilities to generate and transit the required information under current circumstances which rely on electronic data transmissions. These facilities were already behind the curve in many cases technologically going into the pandemic due to limited financial resources. The financial impacts of the pandemic will not help them.

Obviously the risk will be credit specific. So what sort of institutions would we look at? NYC Health and Hospitals, Boston Medical Center, Temple University Medical Center, LA County/USC Medical Center are urban examples. Rural hospitals are also often DSHs.

PG&E MOVES TOWARDS RESOLUTION

It would have been a difficult task to accomplish but the takeover of PG&E by a public entity became less likely with the announcement that thousands of homeowners and businesses had overwhelmingly approved a $13.5 billion settlement for wildfires caused by PG&E’s equipment in 2018. The deal requires the power company to begin compensating, as early as August, some 70,000 wildfire victims who lost homes, businesses and other property.

The announcement means that the most significant remaining hurdle to the resolution of the utility’s bankruptcy proceedings by June 30 to qualify for a $20 billion wildfire fund created by the California legislature. PG&E has agreed to pay half of the $13.5 billion in cash and the other half in the company’s stock. In an all-cash settlement, PG&E has agreed to pay $11 billion in a separate deal with a group of investors and businesses that own insurance claims against the company.

PG&E still has to gain approval for its bankruptcy plan from the California Public Utilities Commission, which is scheduled to vote Thursday on a record penalty of almost $2 billion against the utility for the wildfires it caused.  The actions come after the coalition of government officials who support the creation of a public entity to take over PG&E asked the PUC to reject the proposed settlement.

PANDEMIC CASUALTIES – SENIOR LIVING

Senior living quickly emerged as a prime sector for exposure to the pandemic as the earliest clusters were at nursing homes. While there are great differences in the range of care offered by facilities in this cohort – independent living, assisted living, skilled nursing, some combination of some or all of these – there are common aspects which conflict with best practices in mitigation of the pandemic. An older population, some already old and sick, and all in some form of congregate housing all put these facilities in the crosshairs.

Now there is confirmation of the financial impact of the pandemic on this sector of the municipal market. Moody’s recently cited a variety of specific impacts. They include The Amsterdam House Continuing Care Retirement Community in Nassau County, New York which failed to make a debt service deposit due April 1, and requested debt service waivers through at least July 1 from bondholders. Henry Ford Village in Michigan also missed a monthly debt service deposit, and expects to miss another this month. The project will draw from its debt service reserve fund.

Eagle Senior Living has outstanding bonds secured by revenues from an obligated group operating  17 facilities across eight states. It reported in a Municipal Securities Regulatory Board (MSRB) filing that a reduction of leads and presentations throughout the month of March ranging from 25 to 40% had occurred and there was a reduction of 75% of the same to date in April. has implemented a 14- day quarantine of all new admissions to independent and assisted living as well as strict move-in procedures requiring staff to disinfect and move in furniture. Resident families and guests are not permitted to visit along with all non-essential visitors. No new admissions are being made to memory care due to resident safety and the impracticality of being able to maintain a 14-day quarantine period.

These are more than mere headwinds. The business relies on a steady growth in assets held by potential residents and in particular, a healthy home sales market. The economic impact of the pandemic, especially in a dreaded second wave, would devastate those two markets and limit the available pool of customers needed to maintain occupancy levels.

CHAPTER 9

Fairfield, a city of just under 12,000 residents west of Birmingham, AL filed for bankruptcy under Chapter 9 of the federal bankruptcy code in the U.S. Bankruptcy Court for the Northern District of Alabama in Birmingham. The petition states the city has between 200 and 999 creditors with $1 million to $10 million in liabilities. It’s largest creditor was listed as US Bank with an $18 million unsecured claim. The top 10 creditors for the city are: Fairfield Board of Education $2 million; Jefferson County Finance Department $1.7 million; Alabama Power $994,091; AMBAC $900,000; Alabama Finance Department – Computer $590,532; Birmingham Water Works $550,924; Regions Bank $417,752; Jefferson County Sheriff $349,576; and Retirement Systems of Alabama $305,000.

The city admits that its financial position was precarious before the pandemic. A resolution by the Fairfield City Council states the city has faced “a substantial decline in revenues in recent years due to economic forces beyond its control.” Yes the city has seen some of its businesses succumb to the limits imposed by the pandemic. But the pandemic also gives cover to public officials seeking to take advantage of ” an opportunity to reorganize, reassess our finances.”

Here is where the impacts of recent bondholder unfriendly bankruptcy decisions come back to bite future bondholders. The Fairfield bankruptcy resolution states the city while the bankruptcy process proceeds will honor all pre-petition accrued obligations to current City employees for wages and salaries, including earned vacation, severance and sick leave pay and contributions to employee benefit plans. It also will honor “pre-petition and post-petition continuing obligations to trade vendors that have provided and continue to provide goods and services to the City in the ordinary course of business and according to the credit terms agreed to by such vendors and the City.”

The resolution pointedly omits bondholders from this cohort of pre-petition obligations to be honored. Fairfield says it wants to develop a plan that includes adjusting the terms and conditions of its debts and obligations under Chapter 9. Fairfield brings to an even dozen the number of Alabama municipalities to file for Chapter 9 reorganization since 1991.

STATES BEGIN BUDGET ADJUSTMENTS

South Carolina has decided to enact what is effectively a temporary budget in the face of the fiscal impacts of the pandemic. The Governor has signed a continuing resolution which will allow the State to keep operating until the Legislature can reconvene in September. At that time, the State will have a much better idea of what federal resources will have been provided to the State to offset the budget impact of the pandemic.

To date, South Carolina has received more than $2.7 billion in federal COVID-19 relief. The Legislature is requiring that $1.9 billion of the State’s share into a separate account and treat its spending similar to how the Legislature approaches a budget bill: allow the full General Assembly to first approve it. In the meantime, the agreement allows state agencies and colleges and universities the ability to furlough employees, a step the University of South Carolina has been considering after it moved classes online and returned money back to students.

Waiting would allow South Carolina to see how some of its major industries fare under reopening. The problems facing the hospitality industry hit hard in the state’s coastal region. On the other side, the “autobahn” between Greenville and Spartanburg holds it breath while the auto industry reopens. In Michigan and Illinois, Ford had to stop production at two reopened facilities due to corona virus infections even after a heavy sanitizing and mitigation effort.

WILL MUNIS FINANCE ANOTHER DAM FIX?

Two years ago it was a government built and owned dam in northern California that flooded. That put the State Department of Water resources on the hook for financing needed repairs at the Oroville Dam. The circumstances of the latest example are different and once again highlight the municipal finance industry’s role as a savior of corporate failure.

The Edenville Dam is one of four hydroelectric projects along the Tittabawassee River northwest of Midland, MI. The city is the corporate headquarters location for Dow Chemical and facilities in the city include a nuclear reactor.  Now the dam has failed and 40,000 residents in Midland are at risk. So is Dow Chemical. So who is responsible for fixing the dam?

The Edenville dam and three others were owned by a private interest. That entity failed to invest in the dams over time and the Edenville Dam was constructed in 1924 and was on FERC’s list of “high hazard” dams. Rather than invest, the private owner instead agreed in January of this year (the deal finally closes in 2022) to sell the dams to a municipal authority which planned to finance some $100 million of capital investment in the four dams.

The purchase was apparently the only way to get the needed work done as FERC had repeatedly faulted the previous owner for failing to maintain and improve spillways, which help direct excess water around the dam to relieve pressure on the structure. FERC is reported to have assigned a 5 in 10 chance that the dam would fail under high flood conditions while the private owner put the odds at 5 in 1,000,000. 

SCHOOLS FACE HIGHER COSTS

As the country moves towards reopening, school districts across the country are assessing how to mitigate against the spread of the virus. The possible fixes involve fewer students in each classroom, alternate schedules or even an old favorite (I date myself here) split sessions. Split sessions were originally intended to deal with attendance demands due to population trends. Now, split sessions could address new pandemic based attendance requirements.

The cost of operating schools will of course go up to address enhanced cleaning requirements, increased physical infrastructure requirements, and personnel costs associated with increased cleaning and transit employees. And it is fair to say that teachers will never have a better time to make their case as to their value to the community. It is no surprise that many parents are pressing to get schools open after lockdowns, especially in the case of working parents who rely on the schools as much for day care as they do for education.

This puts school districts in a tough position. Their underlying tax bases will likely be under pressure as businesses close and property values are depressed. If the states which are ultimately the funders of education do not receive federal assistance, it will be that much harder for them to downstream revenues to those districts under the state school aid programs in every state.

LIKE THE VIRUS CLIMATE CHANGE IS NOT GOING AWAY

As the massive flood in Michigan bears witness, significantly increased moisture is becoming an annual feature of each year. Now, the National Oceanic and Atmospheric Administration has issued its predictions for the 2020 hurricane season. Significant incidents in Puerto Rico, Texas, and Florida have become annual events. NOAA’s Climate Prediction Center predicted a 60 % chance of an above-normal 2020 Atlantic hurricane season, with a 30 % chance of a near-normal season. The agency predicted just a 10 % chance of a below-normal season.

NOAA forecast the 2020 Atlantic hurricane season that runs from June through November will include 13 to 19 named storms, with six to 10 possible hurricanes. Three to six of those could become “major” hurricanes of Category 3 or higher. If 2020 does meet that forecast, it would mark a new record of five consecutive above-normal Atlantic hurricane seasons, surpassing a previous record of four seasons during 1998 to 2001. An average hurricane season produces 12 named storms, with 6 becoming hurricanes.

Such a storm season would contribute to issues like flooding again draw attention to the vulnerability of infrastructure to floods and storms. Issues like raising the elevation of streets, rezoning, preventive infrastructure, and managed withdrawal will arise again. This time however, the debate will occur in the context of constrained budgets and revenue generating ability which will in the short term drive that debate. Can local governments fund and finance the investments in resilience under the likely depressed revenue environment?

SHORT TERM BORROWING IN THE SPOTLIGHT

Do this long enough and you see just about every cycle come full circle. That is about to be the case with short term borrowing by state and local government poised to increase. Attention has increased with the development of the Federal Reserve’s Municipal Liquidity Facility. These borrowings – usually in the form of tax and/or revenue anticipation notes have long been an effective cash management and project funding tool. Many issuers, especially states, have used these notes to address timing differences which create temporary cash imbalances.

This year the pandemic has created special pressures on cash flows. This has been exacerbated by extensions of the tax filing date into this summer. This has caused significant cash deficits as these issuers struggle with reduced revenues during their traditionally heaviest quarter of revenue receipts with the unprecedented expense demands related to the pandemic. Because the size and timing of potential issuance is uncertain and the ability of the market to deal with the potential flow due to credit fears, the Federal Reserve’s Municipal Liquidity Facility was authorized and funded at $500 billion.

One of the concerns is that short term debt has at times been not a means to address structural and timing issues but a form of deficit spending. Technically, that concern can be correct. That overlooks the importance of short term borrowing in the process of recovery from extraordinary events. A good example is the experience of the City of New York in the aftermath of 9/11. The City was able to use such borrowings to finance the increased current expenditures driven by the attack and its aftermath. There is no reason to look negatively at borrowers who issue notes in the current circumstances where it can be argued that the economic impact of the pandemic is much greater in comparison.

Right now, the market is focusing on Illinois and its potential borrowing requirements. Yes, Illinois entered this period in a significantly weaker position than most states. Yes, the $4.2 billion of short term borrowing is significant. But it is not an outlier in terms of its decision to use such borrowing to meet disaster induced funding needs. So we do not view the potential for significant short term borrowing by the state to be any sign of a lack of will to address its problems. The real risk pre-pandemic was the failure of a proposed constitutional amendment to move the state income tax to a graduated rate scheme on the November ballot. That has not changed or increased the level of uncertainty which already existed before the pandemic.

TRAVEL WOES HIT LAS VEGAS CREDITS

It’s pretty well established that one of the last sectors to fully rebound from the impacts of the pandemic is the travel/hospitality/leisure industry. For economies where tourism and/or entertainment serve as primary economic pillars, the limitations of attendance and operations have had severe effects. One of the best examples is the greater Las Vegas economy.

Now the impacts of laid off employees and no visitors is being reflected in the ratings of local issuers. This week Moody’s announced that it has downgraded two significant issuers. The Clark County School District had its rating affirmed at A1 but the outlook for the rating was lowered to negative. This reflects Moody’s  expectation that the district’s financial position will be challenged by the coronavirus pandemic which has severely affected the region’s tourism and gaming dependent economy. The State’s ability to support the District will be limited by the impact of the pandemic on state revenues.

The ever growing City of Henderson is feeling the pressure as well. It’s Aa2 rating now carries a negative outlook as the same pressures impacting the Clark County School District are hitting Henderson.

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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Call it what you want but we face depression level employment conditions. The most recent claims number brings unemployment to 23% without accounting for non-participants in the work force. While we realize that precipitous moves in ratings are most likely not in  the cards, that does not mean that the market can’t establish it view of creditworthiness. In the meantime, the debate over the next stimulus package will center around aid to states and municipalities. The argument for stimulus is bolstered by the Fed chairman’s most recently expressed views supporting additional stimulus.

Without it, states and cities will have to take steps to deal with their declining fiscal positions which will have direct economic implications. The traditionally busy summer construction season will look completely different this year. Major capital projects like road repairs are already being slowed, suspended, or reimagined to use different materials and work crews. The contract letting process is on hold in number of states and the economic impact of those decisions has yet to fully take hold.

On the county and local level, those governments cannot wait to decide whether to make cuts. While advertised as temporary, many of these entities have furloughed employees. Many of these cuts are in basic services which support economic activities through functions like business licensing, real estate transactions, inspections, and permitting. These changes will act as a further drag on local economies.

The next obvious concern is the impact on the economies of primarily small businesses for their survival. The multiplier effect stemming from these delays, cancellations, and changes is yet to be felt. That may also be said about the impact of potential delays in the re-openings of institutions like colleges. While the impact of closures and shifts to online learning are clearer, the economies of many localities depend on the presence of colleges to generate demand for all sorts of goods and services. Many of these local economies have long felt essentially immune from the changes in the larger economy.

The reality is that while the present economic realities are daunting, the worst may be yet to come. Empty campuses do not generate pizza deliveries. The potentially longer lasting effects of the downturn will pressure state unemployment trust funds and likely generate borrowing which must be supported by fees from employers. This will serve as an additional drag on the recovery of the economy as well as state fiscal positions.

Given the increasingly negative economic outlook, we would expect to see a series of state downgrades over the summer. States are in the middle of their budget processes and we expect that the rating agencies will wait for the legislative session season to play out before making any moves. Like so many other times of economic challenge, this period has reinforced the role of the rating agencies as lagging indicators of creditworthiness. We discuss the revisions in the fiscal outlook for several states this week. We  ask how these states can be considered worthy of the same ratings they had just eight weeks ago?

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PANDEMIC CASUALTIES – STUDENT FACILITIES REVENUE BONDS

The California State University, the nation’s largest four-year public university system, announced that classes at its 23 campuses would be canceled for the fall semester, with instruction taking place almost exclusively online. More than 480,000 undergraduates are enrolled at the Cal States and they have been taking their classes online since March.

To date, only several smaller institutions have announced similar decisions.  Many schools, public and private, are weighing various courses of action for the fall semester. The decision to open or close has implications for the outstanding debt of these institutions. For bonds secured by student dining and housing revenues to finance those facilities, the plan to stay online has potentially significant implications for the bonds. In the same way, bonds for non-academic facilities backed by student fees also will face financial pressure.

The public institutions are the primary issuers of debt backed by “auxiliary service” revenues. California State is a good example as it issues debt secured by revenue including gross revenue from various auxiliary and mandatory student fees. Total pledged revenue was $5.33 billion for fiscal 2019, including $3.35 billion of Tuition Fees (the basic enrollment charge paid by all CSU students). There is a sum-sufficient rate covenant and no debt service reserve fund.

The university issued system revenue debt in February with a Aa2 rating. The rationale for the rating was “continued excellent demand for The CSU, accompanied by consistently solid cash flow and debt service coverage.” The State of California continues to provide healthy increases in state funding, including capital support. Now, the source of outside support (the State) is under incredible short term stress, 40% of historic revenues are at risk, and demand for the system is under pressure as students attempt to assign a real valuation to the on-campus experience. The rating assigned in January carried a stable outlook but assumed cash flows and demand which may not be realized.

Given the pressures on the revenue sources (the state, economically weaker students, and potentially closed facilities) it’s hard to see how the credit behind the debt could be considered stable.

PANDEMIC CASUALTIES – PORT REVENUES

The National Retail Federation tracks import/export data for its members and produces, among other things, reports on things like port activity. Twenty foot equivalent units (TEU) provide the base metric and input for any analysis of operations and trends. A recent report from NRF documents the actual and potential impact on port operations as the result of the pandemic.

Imports at major U.S. retail container ports are expected to see double-digit year-over-year declines this spring and summer. April was estimated at 1.51 million TEU, down 13.4% year-over-year. May is forecast at 1.47 million TEU, down 20.4% from last year; June at 1.46 million TEU, down 18.6; July at 1.58 million TEU, down 19.3%; August at 1.73 million TEU, down 12%, and September at 1.7 million TEU, down 9.3%.

Before the coronavirus began to have an effect on imports, February through May had been forecast at a total of 6.9 million TEU but is now expected to total 5.87 million TEU, a drop of 14.9%. The first half of 2020 is forecast to total 9.15 million TEU, down 13% from the same period last year. So the current impact of the declines is significant but not unmanageable. At the same time, the importance of getting reopening the country right is highlighted in the report.

The Port of Los Angeles the port handled 689,000 TEUs in April. That’s a 6.5% year-over-year decrease  but better than the March results which showed the port handled 449,568 TEUs in March, a year-over-year volume plunge of 30.9%. According to the Port, “based on the first quarter of this year, the volume at the Port of Los Angeles was down 18.5%, and now if we add in the April stats we’re down about 15.5. On any given day looking at the traffic moving through the Port of Los Angeles we’re doing about 80% of normal volume for this time of year.”

The NRF projections rely on no emergence of a “second wave” of the virus. The report comes with the caveat that “we continue to expect recovery to come in the second half of the year, especially the fourth quarter and into 2021. This is based on the big and somewhat tenuous assumption that there is no second wave of the virus.”

PANDEMIC CASUALTIES – SMART DEVELOPMENT

The Smart Cities movement took a hit recently with the announcement by Google’s parent – Alphabet – that it was no longer going to pursue its experiment in smart cities development under way in Toronto, Canada. Originally dubbed “Sidewalk Toronto” in October 2017, the project was designed to oversee technology based development in a 12 acre area along the Toronto waterfront. The plan called for new housing and smart city technologies including sensor-based traffic signals, dynamic curbs, underground delivery routes for trucks, self-financing light rail transit, heated pavement and pneumatic waste collection.

Quayside is the name of the 12-acre waterfront district on Lake Ontario that was scheduled to be redeveloped by Sidewalk Labs and government-appointed nonprofit Waterfront Toronto. The project was outlined in June 2019 by Sidewalk Labs,  the Alphabet entity created for projects like this. Sidewalk Labs unveiled a three-volume, 1,524-page master plan for the site which estimated the cost at $2.8 billion.  It also helped the public understand some of the issues associated with the anticipated technologies to be used.

The public reaction to the project was mixed. While the effort to produce a fairly walkable, self-contained community was seen as a positive, the reliance on technology based monitoring raised concerns.  Those concerns centered around data privacy and the collection of information from citizens, which are an essential feature of many promised smart-city features.

So here we have one technology company advancing a project which raises data concerns amongst the public while in California we have technology/transportation companies fighting efforts by governments to access data to monitor and manage micromobility providers within their jurisdictions. It places the technology industry writ large on both sides of the privacy/technology debate.

So why care if you are a municipal bond investor? The pandemic is leading proponents of various strategies and technologies to try their best to use the temporary changes in urban living and transportation to advance their agendas. Most of those strategies will involve substantial capital investment on the part of host municipalities. The sort of investment to be required to produce development along the lines of the Toronto project would be substantial and the private sector has not shown the appetite to finance or fund it on its own.

Whenever those conditions arise, the municipal market is looked to as a source of affordable financing. So, municipal investors need to support sound decision making on the part of municipalities so as not to squander resources on a level of risk which really should not be borne by taxpayers and bondholders. It is an important thought to hold as companies like Uber, Lyft, and Airbnb all announced substantial employment cuts. With future funding in some doubt, the transportation networking companies are in a weaker bargaining position going forward as they engage governments while they try to expand. The decision by Uber to dump its Jump e bike subsidiary onto Lime reflects the instability in the mobility space.

 As the executive director of the San Francisco Municipal Transportation Agency (SFMTA) recently pointed out “At a time when all of these private companies should be demonstrating their value, they’re actually fighting for their own financial lives and therefore prioritizing the convenience of the privileged over the needs of cities and their most vulnerable travelers. The private mobility space has got a lot of work to do, to rebuild relationships with cities, and get people to see them as actually a part of a solution, rather than just a mechanism for some potential profit in the future.”All of that is positive for governments and their finances.

PANDEMIC CASUALTIES – HOSPITALS

Strata Decision Technology is an advisory firm in the hospital sector with access to operating information on some 1,000 U.S. hospitals. They have released research on the impact of the pandemic on hospital operations and finances. They found that across all service lines and in every region of the country there was an average decrease in the number of unique patients who sought care in a hospital setting of 54.5%. Clinical service lines that saw the sharp drops in patient encounters included those with life-threatening illnesses such as a 57% decrease in cardiology, and a 55% decrease in breast health with a 37% decline in cancer care overall.

The restrictions on elective surgeries can be seen in the data. The top 10 procedures account for over 50% of the total payments made to hospitals. In this category there were significant declines in the number of hip (-79%) and knee (-99%) replacement surgeries as well as in spinal fusions (-81%) and repair of fractures (-38%). Coronary stents (-44%) and diagnostic catherization (-65%) also saw significant declines. If you’ve had any of those done lately, the potential revenue hit to hospitals is obvious. Access to clinical care for patients with life-threatening conditions declined significantly including congestive heart failure (-55%), heart attacks (-57%) and stroke (-56%).

Those procedures are effectively where the money is for hospitals. Health systems in the study cohort (2 million patient visits and procedures from 51 healthcare delivery systems in 40 states, with varying rates of COVID-19 cases in their 228 hospitals) lost an estimated $1.35 billion in revenue during the 2-week study period compared to the prior year.  Extrapolating the drop in volume from the cohort to a national view would be the equivalent revenue loss of $60.1 billion per month for hospitals nationwide.

According to the study, the number of uninsured or self-pay patients has increased dramatically in the last 90 days, mirroring the rise in the national unemployment rate. In January, 7% of all inpatient and outpatient encounters in the study cohort were with patients who lacked health insurance. By April that figure had risen to 11%, and early results from May indicate 15% of all patients in the cohort are now uninsured, an increase of 114% in just 90 days. 

FEDERAL PANDEMIC ASSISTANCE TO NYC

The New York City Independent Budget Office (IBO) estimates that $5.3 billion in aid from the federal government’s four coronavirus relief packages will flow to the city budget. That does not include federal aid granted to public agencies that provide essential city services but are outside the city budget. That additional aid include $3.8 billion for the Metropolitan Transportation Authority (MTA), at least $818.6 million for NYC Health + Hospitals (H+H, the city’s public hospital system), and $211.9 million for the city’s public housing authority.

The majority of the $5.3 billion in aid that the city is estimated to receive must be used to cover direct costs incurred by the city due to the Covid-19 pandemic or to fund programs that provide aid to city residents impacted by the resulting downturn, such as increased funding for existing food and rental assistance programs. The more than $700 million in federal education aid included in this total will replace state school aid cut by the Governor in the state’s recently enacted budget. The largest impact on the city budget comes from changes to Medicaid funding. The Families First Coronavirus Act increased the share of Medicaid paid by the federal government by 6.2 percentage points (called the enhanced Federal Medical Assistance Percentage, or eFMAP.) In New York the federal, state, and city governments share Medicaid costs, so if the state allows the savings from the eFMAP to flow through to localities across the state there would be savings for the city.

STATES TRY TO COPE

A survey conducted by the Louisiana Oil & Gas Association found that members have been forced to reduce 23% of their Louisiana workforce. This reflects the fact that 77.5% of operators have already begun taking steps to shut-in production. and 51.35% said bankruptcy is likely. 34% applied for Economic Injury Disaster Loans (EIDL) funds, of those only 25% received the funds they expected. Of those who received funds, 46.6% indicted they were not enough to help them stay in business and 72% indicated they were not enough to avoid layoffs. It is not just the number of jobs lost but the fact that jobs in the oil and gas industry are among the state’s best paying. The impact on income tax revenues and sales tax revenues will be substantial.

Georgia has requested that all state departments and agencies submit revised budget plans for fiscal 2021, which ends 30 June 2021, that include a 14% cut from the original fiscal 2020 base of about $27.5 billion. That is positive for the state’s financial position. The across the board nature of the proposed cuts does however, lessen the amounts available for local aid including school districts. Moody’s estimates that the State Department of Education may see its funding cut by $1.5 billion. That would require districts to cut programs or raise taxes. April was the first month to include the full effect of the coronavirus-induced downturn, with Georgia’s revenue falling 35.9% year on year, reducing year-to-date revenue 3.4% versus 2019.

Texas reported $2.58 billion in state sales tax revenue in April — an approximate 8% drop from what the state collected the same month last year. That drop, from $2.8 billion to $2.58 billion, marked the steepest decline since January 2010 and covered sales made in March. Florida’s sales taxes provide for 78 % of the State’s general revenue programs. A May 1 daily revenue report showed that sales and use taxes, plus a few other unrelated revenues, collected during April were about $773 million below the state’s $3.1 billion sales tax estimate.

Other general impacts on projected budget results include Connecticut where the state’s Consensus Revenue Estimates revised general fund revenues and special transportation revenues downward for the current fiscal year, FY 2020 and next three ensuring fiscal years from January estimates. .General fund revenues are now estimated to drop $942.1, or 4.8%. The special transportation fund is expected to decline by $164.4 million, or a 9.5% reduction from January.

In Illinois the current fiscal year general fund revenues were revised to $2.7 billion below February estimates of $36.9 billion by the Governor’s Office of Management and Budget (GOMB). GOMB reports that the revenue shortfall and additional FY 2020 borrowing has created a budgetary gap when compared to the Governor’s original spending plan in February. 

Maryland Comptroller Peter Framchot and the Bureau of Revenue Estimates outlined a shortfall of approximately $2.8 billion during the final quarter of FY 2020. The impact represents a loss of nearly 15% to the state’s general fund.  Maryland’s withholding tax revenues declined by 22% or an average monthly impact of $185 million in losses. The economic shutdown could also result in a loss of 59% of all sales tax revenue in a month, or almost $250 million. 

Pennsylvania’s Independent Fiscal Office (IFO), reported that April revenue collections were down by $2.16 billion, or 49.8% less than projections released in August 2019. Sales and use tax collections fell short of estimates by $357.3, or 35.9%. Personal income tax revenues were below estimates by $1.48 billion and $105 million is estimated to be permanently lost due to reduced economic activity. 

TRANSPORTATION MEASURES THE IMPACT

A University of California-Davis study issued on April 30 found that total vehicle miles traveled or VMT in California is down statewide between 61% and 90% as a result of various stay-at-home orders issued by Governor Gavin Newsom. It estimates that COVID-19-related reduction in travel is slicing an estimated $46 million per week from fuel tax funds for California transportation projects. In Illinois, road travel is down as much as 46% across the state. The Maine Department of Transportation is expecting a roughly $74 million loss in transportation revenue due to COVID-19 over the spring and summer months.

The Minnesota Department of Transportation (MnDOT)  estimates it will take in $440 million less than anticipated over this year and next. MnDOT predicts income from the gas tax will plummet by about 30% compared with what was anticipated for the rest of this fiscal year, which runs through June 30. During the 2021 fiscal year, which starts July 1, the agency said it might drop by 15%.

WHILE YOU WERE SHELTERING IN PLACE…

The Maryland Purple Line, a controversial light rail project, had been the subject of litigation for some time. The litigation – which ultimately did not succeed in stopping the project – only slowed it. The first lawsuit delayed construction by almost a year before a federal appeals court rejected it in 2017. A federal judge dismissed a second lawsuit last year. The slowdown did impact construction and generated costs, however.

Those extra costs are the subject of an ongoing dispute between the state and the contractors on the project. The contractor said May 1 that it would quit in 60 to 90 days because of years-long disagreements with the state over who should pay for cost overruns related to construction delays. Now a third lawsuit is moving through the federal courts alleging that the U.S. Army Corps of Engineers had violated the Clean Water Act by allowing construction crews to discharge dredge and fill into streams.

That suit was dismissed by a U.S. District judge in April. Now, the plaintiffs have decided to appeal the decision to the U.S. Court of Appeals for the 4th Circuit in Richmond. Briefs are scheduled to be filed by lawyers on both sides this summer. The appeal could result in further delays and it will complicate the dispute between the contractor and the state.  

PRESSURE ON UTILITIES

The US Energy Information Administration (EIA) released its latest monthly Short-Term Energy Outlook (STEO) and it validates a number of points we have made in our comments on the sector over time. The outlook says that the effects of social distancing guidelines are likely to continue affecting U.S. electricity consumption during the next few months. EIA expects retail sales of electricity in the commercial sector will fall by 6.5% in 2020 because many businesses have closed and many people are working from home. Similarly, EIA expects industrial retail sales of electricity will fall by 6.5% in 2020 as many factories cut back production. Forecast U.S. sales of electricity to the residential sector fall by 1.3% in 2020 because of lower electricity demand as a result of milder winter and summer weather, which is offset slightly by increased household electricity consumption as much of the population spends relatively more time at home.

Here’s what really caught our eye. EIA forecasts that total U.S. electric power sector generation will decline by 5% in 2020. Most of the expected decline in electricity supply is reflected in lower fossil fuel generation, especially at coal-fired power plants. EIA expects that coal generation will fall by 25% in 2020. EIA forecasts U.S. average coal consumption will decrease by 23% to 453 Million short tons (MMst) in 2020. The decrease is primarily driven by a 24% decline in electric power sector consumption and persistently low natural gas prices. EIA expects renewable energy to be the fastest-growing source of electricity generation in 2020, the effects the economic slowdown related to COVID19 are likely to affect new generating capacity builds during the next few months. EIA expects the electric power sector will add 20.4 gigawatts of new wind capacity and 12.7 gigawatts of utility-scale solar capacity in 2020.

Even the pandemic disaster has not been enough to deter the market forces driving the decline of coal. We expect that municipal utilities will have to become bigger players in the renewable energy space as developers of  renewable generating resources directly and not just as ultimate distributors. They will have to remain nimble as local economies absorb and adapt to changes in job locations, commutes, and work habits which are likely to result from the pandemic.

ONE LESS FOR THE ROAD?

The same energy report projected fuel consumption and those numbers do not look good for transportation infrastructure funding. EIA expects U.S. total liquid fuels consumption will rise from an average of 15.9 million b/d in the second quarter of 2020 to 18.7 million b/d in the third quarter of 2020 and then to average 19.8 million b/d in 2021, up 8% from 2020, but lower than 2019 levels. EIA forecasts jet fuel consumption to decline by 25% year-over-year for all of 2020 and by more than 50% year-over-year in the second quarter. Gasoline and distillate fuel consumption will both see consumption fall about 10% compared with 2019 levels.

This directly impacts gas tax revenues obviously. Where it multiplies is in what it implies about the impact of changes in travel especially commuting. The impending shift to more telecommuting for work we believe is real. The implications for the impact on mobility choices and demands are real and potentially substantial. It will require creative approaches to road funding and the support for the capital it relies on.

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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We keep hearing that the pandemic isn’t everyone’s problem when it comes to federal assistance to states. Data out this week showing that the virus moved from the coasts and gateway cities out to the rest of the country will not help anti- New York bias out there among them. Fortunately, data suggests that the State of New York might have been better positioned to deal with the pandemic if more of the state’s resources had been allowed to remain in state rather than bankrolling the rest of the country.

That data shows that in Federal Fiscal Year (FFY) 2018, New York State generated an estimated $26.6 billion more in federal taxes than it received in federal spending. In total dollars, New York’s deficit was the highest among the 50 states. For every tax dollar paid to Washington, our State received 90 cents in return—well below the national average of $1.21. The State generated nearly $254 billion, 8 % of the $3.2 trillion in federal tax receipts. By contrast, the $227 billion in federal spending the State received represented 6 % of the nationwide total, virtually the same as New York’s share of the U.S. population.

So the State would able to fund the entire revenue loss from the pandemic and have money left over were it not for this imbalance. It could even help NYC if it chose. Connecticut tops the list of donor states. Residents there receive just 74 cents back for every $1 they pay in federal taxes. Kentucky on the other hand pays in only about one half of what New York contributes on a per capita basis. So no matter your political leanings, the data tells the story.

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RATINGS TOLL BEGINS TO TAKE SHAPE

The negative impact of the pandemic on the economy and taxes derived from economic activity is already manifesting itself in negative ratings actions. The latest example is the entity which financed Miller Park and the arena for the Bucks in Milwaukee, The Wisconsin Center District . The district’s Series 1996A, 2003A, 2016A and 2020A bonds are secured by a senior lien on the following special taxes: a 2.5% Basic Room Tax, a 0.5% Local Food and Beverage Tax, and a 3% Local Rental Car Tax, all of which are levied across Milwaukee County (Aa2 stable) and can only be used for debt service. The bonds are additionally secured by a 7% Additional Room Tax levied in the City of Milwaukee (A1 negative), which is pledged first to debt service and then any lawful purpose.

Now, Moody’s Investors Service has downgraded to A3 from A2 the rating on Wisconsin Center District’s senior debt to A3 and its junior lien debt to Baa3. The analysis assumes a gradual recovery beginning in the second half of 2020 with slow improvement over the ensuing months. Now the District is undertaking and advanced refunding of some of its debt. The resulting restructuring of the District’s debt service schedule will reduce near term debt service requirements which will accommodate the limits on the economy resulting from the pandemic.

The uncertainty facing the higher education space is unprecedented. Already, schools are seeing fewer acceptances by the usual May 1 deadline so it is difficult for administrators to estimate enrollments and revenues. So far, the vast majority of institutions indicating that they plan to reopen are the state university systems. Overseen ultimately by politicians, these institutions are getting caught up in pandemic politics as states which are considered to have pro-Trump governors are the most favorably disposed to open.

The real risk is in the private space, especially in the smaller college category. These schools were already under financial stress from existing pressures on enrollments. S&P Global Ratings revised the outlooks to negative from stable and affirmed its ratings on certain U.S. not-for-profit colleges and universities (including all related entities), due to the heightened risks associated with the financial toll caused by the COVID-19 pandemic and related recession. The public and private colleges and universities affected by these actions include primarily those with lower ratings (‘BBB’ rating category and below).

Helpfully, S&P named liquidity, as measured by available resources compared to debt and operating expenses, as the primary metric assessed. Liquidity will be the key as colleges manage the financial impact on institutions from the loss of auxiliary revenue from housing and dining fees, and parking fees; as well as revenues from athletics, theater, and other events, which is material for many.

Another risk is the limitations of travel and the potential impact on historically lucrative foreign student demand. If global travel restrictions are prolonged, or the imminent recession diminishes foreign students’ financial means, then some could opt to study or work in their home countries instead. Growth in this demand was already slowing from pre-pandemic efforts to limit immigration. The pandemic has exponentially increased the negative pressure on foreign demand. This impacts public and private schools.

The impact on investments resulting from the pandemic will hurt as most U.S. colleges and universities depend on endowments and fundraising for a significant portion of revenues. Declines in performance and endowment market values along with weaker fundraising results could negatively affect credit metrics during the outlook period. 

For public institutions all major revenue sources are under pressure. Recent increases in state support may not be sustainable and it is likely most states will make cuts to higher education funding. Funding for higher education still remains below pre-recession levels in certain states and this will continue. Some have already withheld funds from higher education institutions for the remainder of the fiscal year (New Jersey and Missouri, e.g.).

FISCAL CURVE IS NOT FLATTENING

The NYC Independent Budget Office (IBO) is updating its forecasts for the NYC budget for the rest of FY 2020, FY 202, and FY 2022. It notes that even after only two months that its outlook has continued to weaken. Now, IBO projects that  the city has a budget gap of $544 million that must be closed in the two months remaining in the current fiscal year. It also estimates a shortfall in the upcoming fiscal year of $830 million and a budget gap that balloons to nearly $6.0 billion in 2022, just 14 months from now. Tax revenue for 2020 is now projected to fall $2.9 billion (4.6 percent) below what was estimated in the Preliminary Budget report; for 2021 the shortfall is $6.6 billion (9.9 percent). It  expects tax collections will total about $61.5 billion this fiscal year, a gain of only 0.2 percent from 2019 and the picture for 2021 is considerably worse. Tax revenues for 2021 will total about $2 billion less than this year, a year-over-year decline of 3.2 percent.

The State of Minnesota has released a revised budget outlook. Like many states, the economy and a rainy day fund had Minnesota riding high fiscally. The February budget estimate is traditionally the one on which the legislature bases its budget debate. Now that the pandemic is eating away at fiscal strength, the picture is much different. The February estimate included a projected revenue surplus in February, 2020 of $1.5 billion. The revised Projected revenue deficit in May 2020 is $2.42 billion. The $3.9 billion reversal is covered in part by $2 billion the state has received from the federal CARES Act and a rainy day fund balance of $2.36 billion. As no one expects the economy to “snap back” to pre-pandemic levels, the damage has not stopped but available are all spoken for.  Minnesota can dip into the rainy day account once there is an official projection of a deficit to pay for the existing budget and be done without further action by the Legislature.

Ohio is in the middle of its biennial budget process. It has a “rainy day” reserve of some $2.7 billion but the state is so far relying on expenditure cuts.  The state had previously reported revenue estimates were up by $200 million over budgeted projections, but state fiscal results through April now project a $777 million deficit. To cover the deficit, the Governor has opted for $700 million of budget cuts instead. The State reported that in April collections showed a $636 million decline in state income taxes and a $237 million decline in sales taxes. Tax revenue overall declined by $867 million. The cuts will impact primary spending priorities. Medicaid spending is budgeted to decline by $210 million. Kindergarten through 12th grade foundation payments will be cut by $300 million and higher education by $110 million and trim $100 million in other general state agency spending. 

Alaska had already been dealing with the declining reliability of oil as the state’s main source of income. Battles over the Permanent Fund dividend had led to contentious budget processes over several years. Those pressures however, pale in comparison to what the state of Alaska faces now. ConocoPhillips, the third-largest U.S. oil producer, announced it would its production in Alaska by half, roughly 100,000 barrels a day, beginning in June. The decline in throughput accompanies similar moves to maintain temporary production cuts demanded by Alyeska Pipeline Service Co. (owned by ConocoPhillips, BP and Exxon Mobil) for May due to projections of oversupply and lack of tanker transport. Alyeska carries crude from the North Slope to the Valdez Marine Terminal.

The California Department of Finance reports that California began 2020 with a strong bill of financial health—a strong economy, historic reserves, and a structurally balanced budget.  The unemployment rate (3.9%) was one-third of its Great Recession peak (12.3%).  The “Wall of Debt” (past budgetary borrowing) was eliminated, and supplemental payments were made to retirement obligations.  The 2020-21 Governor’s budget reflected a $5.6 billion surplus.  The budget reflected a record level of reserves: $21 billion in FY 2020-21, including $18 billion projected in the state’s Rainy Day Fund.  Revenues through March ran $1.35 billion above January’s projections, as markets outperformed the budget forecast.

Now for the May Revision. In the last one-week reporting period, nearly 478,000 claims were filed in California for state and federal unemployment benefits. Since mid March, more than 4.2 million claims have been filed. Finance projects that the 2020 unemployment rate will be 18%, a much higher rate than during the Great Recession. California personal income is projected to fall by nearly 9% on an annual basis in 2020.

Compared to the January forecast, the state’s three main General Fund revenue sources are projected to drop for the 2020-21 fiscal year as follows:  Personal Income Tax: -25.5 %.  Sales and Use Tax: -27.2 %.  Corporation Tax: -22.7 %. Specifically, Finance projects that General Fund revenues will decline by $41.2 billion below January projections, as follows:  2018-19: +$0.7 billion  2019-20: -$9.7 billion  2020-21: -$32.2 billion. Under Proposition 98’s constitutional calculation, this revenue decline results in a lower required funding level by $18.3 billion General Fund for K-12 schools and community colleges.

The Revenue declines of ($41.2 billion), combined with $7.1 billion in caseload increases supporting health and human services programs, and other expenditures of approximately $6 billion (the majority in response to COVID) will result in an overall budget deficit of approximately $54.3 billion, of which $13.4 billion occurs in the current year and $40.9 billion is in the budget year.  This overall deficit is equal to nearly 37 % of General Fund spending authorized in the 2019 Budget Act.  This is also nearly three and one half times the revised balance in the Rainy Day Fund ($16 billion).

JEA BACK IN THE SPOTLIGHT

The Jacksonville Electric Authority has asked its former CEO, Paul McElroy who retired in April of 2018, to serve as an interim CEO of the troubled utility for six months while a permanent CEO is hired. The outgoing CEO is part of the group under federal investigation over the recent failed attempt to privatize the utility.

The process of investigating exactly what happened at JEA and in the city that allowed the privatization plan to advance as far as it did is ongoing. It includes the Mayor’s office as well. It raises serious concern surrounding the governance of the utility both directly and through oversight by the city. The credit would be expected to suffer a ratings impact if the agencies are serious about their emerging emphasis on environmental, social, and governance issues (ESG).

It has also been pointed out that the new interim CEO approved the contract with the Municipal Electric Authority of Georgia (MEAG) for power from the Votgle nuclear plant. The Authority is now in litigation to void the purchases required under the contract. That contract was among issues contributing to lower ratings for the City’s debt. The contract litigation will effectively cap ratings where they are unless a settlement can be achieved.

CHICAGO PENSIONS

The debate over the next stimulus bill from Congress will center on aid to states and localities. In that debate, Illinois’ name keeps coming up along with pensions. So, however unhelpful that debate is to addressing the incredible burden being shouldered by states and municipalities, it does bring a spotlight back onto pension problems in the state.

The Illinois state legislature’s non-partisan Commission on Government Forecasting and Accountability has released its latest analysis of the state of the pension funds supporting workers from the major public agencies serving Chicago. The Chicago Transit Authority Retirement Fund covers all employees of the Chicago Transit Authority. At the end of FY 2018 (January 1, 2019) there were 8,159 active employees and 8,020 employee annuitants. Total Actuarial Assets of the system at the end of that year were $1.836 billion and Total Actuarial Liabilities were $3.489 billion. That is essentially a one to one ratio of active workers to retirees which is not sustainable. The funding ratio – 53%. The Cook County Employees’ Pension Fund covers all persons employed and paid by the County. At the end of 2018 there were 19,671 active employees and 15,820 employee annuitants. Total Actuarial Assets of the system at the end of that year were $10.513 billion and Total Actuarial Liabilities were $17.304 billion. The worker/retiree ratio is just north of one to one. Funding ratio – 61%.

The Firemen’s Annuity and Benefit Fund of Chicago covers anyone employed by the City of Chicago in its fire services whose duty it is to in any way participate in the work of controlling and extinguishing fires. At the end of 2018 there were 4,487 active employees and 3,422 employee annuitants. Total Actuarial Assets of the system at the end of that year were $1.130 billion and Total Actuarial Liabilities were $6.156 billion. That is a 1.3 to 1 worker/retiree ration. Funding ration – 18%. The Policemen’s Annuity and Benefit Fund of Chicago covers any employee in the Police Department of the City of Chicago sworn and designated by law as a police officer. At the end of 2018 there were 13,438 active employees and 9,930 employee annuitants. Total Actuarial Assets of the system at the end of that year were $3.145 billion and Total Actuarial Liabilities were $13.215 billion. Funding ratio – 24%.

On an overall basis, the eight funds reviewed produced a combined unfunded liability of $44 billion. The funding ratio for the combined funds is a paltry 35.2%. That calls for significant transfers of current revenues into pension funding but that is not going to happen in the current environment. We have doubts about whether voters will approve the amendment to the state constitution allowing for a graduated income tax versus the current flat rate. That is a key component of the plan of the governor for fiscal and pension reform that is currently holding the state’s ratings where they are.

PENSION REFORM IN TEXAS

In 2017, Dallas, TX faced a looming crisis in its police and fire pension funds. Pensioners had historically had the ability to make lump sum withdrawals under the terms of the DROP provisions included in their pension plans. Deferred retirement option plans (DROPs) allow employees to continue to work past their eligible retirement age and in exchange, an employer will set aside annual lump sum payments into an interest-bearing account. Upon retirement, the money that has grown in this account will be paid to you, on top of the rest of your accrued earnings. 

Many large lump-sum withdrawals by participants in the Dallas pension funds from their DROP accounts followed investment losses in real estate and other alternative asset classes in 2014 and 2015. This forced the city to contemplate significant increases in expenditures for payments into the funds in order to keep them solvent. In an effort to reduce the amounts needed from current revenues, the City did not allow lump sum withdrawals beginning in 2017. Unsurprisingly, the police and fire unions sued the city.

The Dallas Police & Fire Pension System’s (DPFP) are one of the city’s two pension systems. They  account for some two-thirds of Dallas’ adjusted net pension liability (ANPL). As of its fiscal 2019  reporting and based on a 4.22% discount rate, Dallas’ ANPL was $6.2 billion. Its reported net pension liability, based on a weighted-average 6.73% discount rate, was $3.8 billion. In fiscal 2019, pension contributions consumed around 12% of the city’s operating revenue. That was not a tenable situation going forward and the ability to limit the lump sum withdrawals was a key component of the City’s effort to manage its pension liabilities.

Under current conditions, it would be expected that another “run” on the fund could be imminent. Coming at a time of exceptional market volatility and economic distress, the City would have been hard put to maintain the solvency of the system in the face of significant withdrawals. In an environment where the pandemic is driving expenses while at the same time revenues are crashing, the City’s credit would come under immediate pressure.

Now that pressure is off with the decision of the Fifth US Circuit Court of Appeals which affirmed the City’s right to halt the lump sum withdrawals in 2017. It ruled that the removal of participants’ lump-sum withdrawal options in 2017 was permissible, eliminating a potential liquidity risk for the system and ultimately the city’s budget. Significant withdrawals would pose a threat to the DPFP’s solvency and exacerbate the pressure on the city’s finances, in part because the system struggles to unwind its heavy asset allocation to real assets and other alternatives.

Before the current environment took hold, the system’s net cash flows were close to zero in 2017, 2018 and 2019. This reflected the halt to DROP withdrawals. This allowed the system to stabilize, relieved pressure on the City’s fiscal position, and helped to stabilize its credit ratings. The court decision is definitely credit positive for the City.

CULTURAL INSTITUTIONS CUT BACK

The American Museum of Natural History cut its full-time staff by about 200 people, amounting to dozens of layoffs, and put about 250 other full-time employees on indefinite furlough. The museum projects a budget deficit of between $80 million and $120 million for the remainder of this fiscal year, which ends on June 30, and the next fiscal year. The Whitney Museum of American Art  laid off 76 of its 420 workers. The Metropolitan Museum of Art, facing a potential shortfall for the next fiscal year that might swell to $150 million, announced last month that it was laying off more than 80 people. And the Solomon R. Guggenheim Museum has said it would furlough more than 90 staff members.

What is interesting is the fact that these institutions are by and large not tapping into their endowment funds to cover keeping employees on the payroll. Given the potential for a significant negative impact on donations, this is probably a rational response to that phenomenon. Some of the institutions are being criticized for taking this approach. While these institutions may be not for profit, they are still businesses. It is prudent to take these steps in the interest of long term solvency given the current economic realities.

CYBERSECURITY

President Donald Trump signed an executive order titled Securing the United States Bulk-Power System. The executive order calls for the development of procurement policies that prioritize the security of the US energy grid, as opposed to current rules that give preference to the lowest-cost bids. The Secretary of Energy is empowered through the order to determine if equipment is insecure or harmful to national security, and with blocking its use in US power plants and their transmission systems. The idea is to incentivize manufacturers to invest in developing and maintaining strong cyber security practices or risk exclusion from the US market.

The order is intended in part to address the widespread presence of critical infrastructure components, including software applications and telecommunications equipment, from equipment manufacturers in China and Russia. These countries are known for active cyber espionage and tampering with the physical operations of utility facilities. Wide variance in cyber security practices between suppliers  exposes utility operations and networks to indirect threats that utilities cannot accurately monitor or prevent. The reliance on foreign made equipment and software has been a concern for officials responsible for cyber security. The order does not detail specific products or countries of origin. It instead charges the Secretary of Energy to determine which particular individuals, companies and countries are “foreign adversaries exclusively for the purposes of this order.”

WHERE THE JOBS ARE BEING LOST

The highlight number of the week was the April unemployment number. The 14.7% rate and the number of unemployed at 22 million are already records for the post-war era. Since the numbers are based on a mid-month survey, we know based on the unemployment claims data that this greatly understates the real situation. The May data is likely bring those numbers up to 20% and 35 million unemployed.

There is new data out on the unemployment situation which reveals that unemployment is primarily concentrated in two sectors – construction and the leisure/hospitality space. The data shows that of the 701,000 nonfarm jobs lost in the United States in March, nearly 60 percent came from food services and drinking places, according to the Bureau of Labor Statistics. The potential long term impact on employment is huge. Recently, we have seen estimates that 40 to 50% of bars and restaurants may not reopen. And those are businesses which were thriving in late 2019.

The potential impact of this would be subject to a multiplier effect as these industries traditionally  have been a great source of jobs for those with no college background or as a first job. These would be the individuals less well positioned to compete for the jobs which do return after the pandemic.  They have less ability to wait out the pandemic and therefore are more likely to turn to government social service programs more quickly. These businesses, many of which are individually owned , are finding that complying with all of the regulations attached to the PPP could actually make participation less practical

A recent NY Times article highlighted one of the weaknesses of the Payroll Protection Program in that the loans are only forgiven if they keep paying workers.  Problems with business interruption insurance are making it harder for businesses to hold on.  The fact that restaurants are consistently found in polling to be the last businesses that people would feel comfortable returning to, the outlook for this sector and the sales tax backed debt which it supports is dire.

Opportunity Insights, a non-profit organization at Harvard University has produced data on the change in consumer spending in different locations in the country. It uses data from credit card processors, payroll firms, job posting aggregators, and financial services firms to develop its estimates. The map below reflects more current real time data as opposed to much of the Federal data which by its nature tends to be time lagged. One example of the phenomenon is the Employment Situation Summary (i.e., jobs report) released by the Bureau of Labor Statistics on May 8. It presents information on employment rates as of the week ending April 12. The OI data is as recent as three days before.

That is an important distinction as the OI numbers allow us to take a look at reopened states. That data shows that recent policies ending shut-downs in certain states such as Georgia and South Carolina have not been associated with significant increases in economic activity. These findings suggest that the primary barrier to economic activity is the threat of COVID-19 itself as opposed to legislated economic shutdowns. In Georgia, consumer spending, employment and hours at small businesses, the number of small businesses that are open, and time spent at work all remain relatively similar to their levels prior to April 24.

 
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 increasingly partisan approach to the fiscal damage done to state and local budgets as the result of the pandemic is at best, disappointing. While politics have always been one of the elements to be evaluated in the successful analysis of municipal credit, partisanship is another story. What we are seeing now is ideology, not practicality. The impact on the economy is clear at 30 million new unemployed. The numbers are bound to increase as even tech based companies like Uber and TripAdvisor are seen to be ready to announce layoffs. That’s in addition to the expected wave of unpaid commercial rent from many of the companies laying off staff. and from retail outlets with few or no customers. These things are happening in a variety of states led by both Democrats and Republicans.

One  good example is the pension funding red herring thrown out there by the Senate Majority Leader. and the White House.  Kentucky has the worst funding ratio among any of the states. At the same time, New York has one of the five best funding ratios. Yes, Illinois, Connecticut, and New Jersey have pension problems but what they have in common is their relative bipartisan history in terms of who held the Governorships. How many downgrades did New Jersey suffer during Chris Christie’s tenure? counting isn’t constructive but the point is that pension funding is a national problem not a partisan problem. It’s also fair to note that a federal entity, the Pension Benefit Guaranty Board exists to bail out pensioners from poorly managed corporations. But not governments?

The discussion during the effort to save the economy from the pandemic is beyond a distraction. It is an impediment to the realization of the goals held on either side of the partisan debate. And it is bad for the process of shoring up state and local credits which have done the majority of the work on the pandemic. It is clear that there is no consensus in support of state bankruptcy.

Now, the President is refusing to extend the federal guidelines regarding things like social distancing .So it’s clear that the attack on state and local government finances is on in earnest. Hit to revenues because you didn’t open as fast as another? That was your fault. More people on unemployment because it’s not safe to return to work? Yup, the states fault. This, as just this week the medical professionals messaged that social distancing must continue for months. The implication is that recovery to the status quo is a few quarters away. Our views are based on the belief that the reality is that a  vaccine will be the answer to the pandemic and a full return to the status quo. That cannot be rushed and it must be safely effective which takes longer. In the interim, a return to 90% of where the economy was might be a good norm to assume as you do your near term forward analysis of the next two to four fiscal years.

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POST PANDEMIC MUNIS.

We are seeing much speculation as to the impact of the pandemic on the US economy and way of life. Much of this commentary is about the future of cities and whether one result will be a paradigm shift in how people locate themselves in relation to where and how they work. Many of the ideas being advanced would require major alterations to the way municipalities are run. There seems to be an assumption that the resulting changes in demand for capital projects would be accommodated easily in spite of the potential changes to how revenues are generated.

One example is the assumption that the responses to the pandemic which have been salutary can be maintained in the context of a restoration of a fully functioning economy. We would remind everyone that there are significant vested interests in returning to something like the ways of life we had going in. The post-pandemic era will not necessarily feature a return to the status quo but it will not be one without large gatherings, mass transit, or private vehicles.  None of the major population centers of the US in 1918-1919 experienced a slowdown in growth. We believe that this will be the case again.

We are seeing much speculation as to the impact of the pandemic on the US economy and way of life. Much of this commentary is about the future of cities and whether one result will be a paradigm shift in how people locate themselves in relation to where and how they work. Many of the ideas being advanced would require major alterations to the way municipalities are run. There seems to be an assumption that the resulting changes in demand for capital projects would be accommodated easily in spite of the potential changes to how revenues are generated.

Mass transit presents a significant issue. Now, the lack of cars and essentially any transportation is being treated as if it is a sustainable long term plan for cities. At the same time, the micro mobility industry is already feeling the pain of pandemic restrictions on movement. Bird, a major e scooter provider has laid off nearly one-third of its direct staff. in a business which has yet to generate profits while relying on regular outside cash infusions, expenses are just not tolerable without operating revenue. Much has been made about the improvements in noise and air pollution underway in the major cities. That improvement, at the expense of a functioning economy and education system, is sparking much thought about cities and transit in the post-pandemic era.

One thing which will not be viable is the approach to urban transit planning taken by the micro mobility industry. ‘We shouldn’t have to pay a city, the city should be paying us” is an attitude attributable to an executive at Bird, the scooter provider. If that is the underpinning of the sector’s business model going forward, it’s not going to work. All of the new modalities will be tested for their full public revenue potential under the economic circumstances of the next couple of years. That will be driven by necessity based on the significant revenue hit municipal credits have faced.

Already the outlook for congestion pricing taking effect as scheduled in Manhattan is waning. The troubles of the MTA (see more later) are likely to become an impediment to a shift away from private vehicles. The capital cost and operating/maintenance cost of new facilities such as protected bike lanes will be more of a burden relative to available resources. It will be in the system’s financial interest to drive as much demand as possible for mass transit services. A sort of policy triage will result that will act to limit the ability of states and cities to fund substantial additional infrastructure. Those facilities which can be produced at the least cost to benefit the most people will be undertaken and others will become delayed or unaffordable luxuries.

There will have been an existing economic infrastructure which will have many interests supporting its rapid restoration. Sports, entertainment, and cultural institutions will not simply disappear. They will still retain their places as significant drivers of economic activity. Look back at the 1918-1919 pandemic and see what followed as the nation moved beyond the limits it imposed. Some of the nation’s most iconic sports venues – Yankee Stadium, the Rose Bowl and the Los Angeles Coliseum, Chicago Stadium, and Madison Square Garden were all constructed and put into operation within the ten years after the pandemic. In New York, active planning and construction of the independent subway system took place throughout the decade of the 20’s.

The point is that mass gatherings not only resumed but thrived and were supported by significant capital investment in facilities to support them. We believe that large events will return and that they will regain their role as drivers of economic activity. We believe that people will want to return to restaurant and drinking venues. They will need to be able to get to them. One of the issues which the economic restrictions has highlighted is the difficult straits in which major public transit agencies find themselves. The MTA in New York is carrying something between 5-10% of its normal load.

The decrease has impacted revenues but has also damaged the non-fare tax and spending base. This creates a serious problem as the same forces impacting the revenue base will also impact the capital finance base on which the maintenance and expansion is reliant. It is ironic that as the MTA was poised to complete the northern portion of the 2nd Avenue Subway, it faced a situation very similar to the one which prevented the construction from 125th Street south in the early 1970’s – the dire fiscal straits of the state and city.  

MTA

New York’s Metropolitan Transportation Authority is in the process of trying to sell some $670 million of its core financing credit, the Transportation Revenue credit backed by fares. The offering gives us a chance to quantify the impact of the pandemic and its socialization restrictions on the Authority’s finances. The official statement for the offering provides us with hard data on ridership and utilization.

As of the beginning of April, ridership on the subways was down 91%. The bus system saw even greater declines at 98%. The commuter railroads have also seen declines of 98%.  The resulting revenue losses will be brutal. Traffic on the bridges and tunnels operated by the MTA and its subsidiaries is down by two thirds. The revenue impact in terms of lost revenues is $142 million a week. Over a full fiscal year, that comes to $7.4 billion. On top of that, MTA relies on state and local subsidies totaling some $6.4 billion.

The impact on the capital program is clear. MTA has for now halted the award of new Capital Plan construction or consulting contracts. It has also suspended the solicitation of bids for contracts. At the same time, the CARES Act is projected by the MTA to generate about $4 billion to the agency. The MTA also expects funding outside of the CARES Act from FEMA to cover costs for things like sanitizing  and safety equipment for MTA workers. While there is no local matching effort required for the receipt of CARES Act funding, the state has nonetheless taken a variety of steps to help the MTA through this period. The budget for the FY beginning April1 includes a significant increase in the borrowing authority of the MTA. It also loosens restrictions on the use of revenues derived from congestion pricing. The budget also obligates the City of New York to increase its share of the cost of paratransit services supplied by the MTA to city residents.

 ECONOMIC OUTLOOK FACING THE STATES

The Congressional Budget Office (CBO) has developed preliminary projections of key economic variables through the end of calendar year 2021. Inflation-adjusted gross domestic product (real GDP) is expected to decline by about 12% during the second quarter, equivalent to a decline at an annual rate of 40% for that quarter. The unemployment rate is expected to average close to 14% during the second quarter. Interest rates on 3-month Treasury bills and 10-year Treasury notes are expected to average 0.1 percent and 0.6 percent, respectively, during that quarter.

In 2021, real GDP is projected to grow by 2.8 percent, on a fourth-quarter-to-fourth-quarter basis. Under that projection, real GDP at the end of 2021 would be 6.7 % below what CBO projected for that quarter in its economic outlook produced in January 2020. The labor force participation rate is projected to decline from 63.2 % in the first quarter of this year to 59.8 % in the third quarter. The unemployment rate at the end of 2021 would be about 6 percentage points higher than the rate in CBO’s economic projection produced in January 2020, and the labor force would have about 6 million fewer people.

LIQUIDITY FOR MUNICIPALS

The Federal Reserve has broadened eligibility for the Municipal Liquidity Facility to let more local governments participate. The central bank has lowered the population requirement to 250,000 from 1 million for cities and to 500,000 from 2 million for counties and plans to buy as much as $500 billion in short-term notes issued by states. The Fed has also expanded the duration of debt it will purchase to three years from two. More than 200 municipalities are eligible to participate. While welcome, the program leaves out a significant portion of the short term municipal borrowing universe.

New Jersey has announced a plan to fill some of the void. The New Jersey Infrastructure Bank (I-Bank) will have available $50 million to provide liquidity for municipalities in New Jersey that experience difficulty rolling over BANs. There will be sector, issue, and credit limits, interest rate guidelines, and a maturity limit of 90 days for any BAN submitted for consideration. While the $50 million looks small in comparison to the levels of federal support, it will  support smaller borrowers where they do not meet the test for federal liquidity assistance.

New Jersey’s I-Bank has amended its investment policy to permit it to invest in local government unit BANs in certain circumstances. The BAN purchase program is a limited and specialized resource made available only to participants in I-Bank associated financing programs to address failed sales occurring during BAN rollovers. This program is designed to ensure solvency and fiscal stability for New Jersey’s local government units, providing protection against potential defaults during the present liquidity crisis.

VIRUS ECONOMIC FOOTPRINTS BEGIN TO EMERGE

The data on urban surface transit ridership has been clearly and sharply lower inflicting significant short term damage on the financers of these systems and credits. Now we begin to see data on the impact of the overwhelming drop in aviation passenger traffic. Las Vegas’ McCarran International Airport serviced 53 % fewer flights in March of this year than it did in March 2019. 2.3 million fewer travelers boarded flights last month. Southwest Airlines, the dominant carrier at the airport, serviced 1.6 million Las Vegas flyers in March 2019. This March, that number dropped to around 600,000 passengers. McCarran International Airport completely shuttered two of its concourses in early April.

State departments of transportation are experiencing significant drops in revenues as the lack of driving has driven down demand for gasoline. The result is that there is significantly less revenue from fuel taxes available to fund projects. The lack of gas revenues has overtaken the impact of social distancing measures on the ability of these departments to execute their projects. The American Association of State Highway and Transportation Officials, or AASHTO, estimates state transportation departments will lose $50 billion in expected revenue over the next 18 months.

States including North Carolina, Ohio, Oklahoma and Pennsylvania are already cutting projects or furloughing workers ahead of revenue shortfalls. Recently, the director of the MO Department (MO DOT)outlined the scope of his state’s dilemma. MoDOT expects to lose 30% of its expected revenue over the next 18 months, about $925 million. According to the MO DOT director, Missouri would lose the ability to draw down $2.1 billion in federal funds for construction projects without those tax revenues or additional federal aid. Added to a loss of $530 million in state funds, the state wouldn’t be able to award $2.6 billion of the $4.9 billion in construction projects it planned through 2025. “To put this into perspective, that would equate to approximately 400 bridges and 20,000 lane miles of Missouri roadways NOT being repaired that are in our current plan.” 

The North Carolina Department of Transportation says that the traffic volume falloff is projected to cause at least a $300 million budget shortfall for the agency in its current fiscal year, which ends June 30. The Washington State Department of Transportation expects a loss of revenue of as much as $100 million per month; approximately 38 % of its average monthly transportation revenue collections.

The City of San Francisco has shown how the pandemic and its demands on resources can and will alter normal operational practices. As a result of the pandemic, SF will present and consider a balanced interim budget before July 1. A full budget will not be presented until August 1 and that budget will be considered over a period not to go beyond October 1. The August plan will cover the two fiscal year period ending June 30, 2021. The City entered the pandemic with reserve of some $740 million but these will quickly be absorbed by the to date impacts on the local economy and tax base for the tourism dependent city. The city estimates that tax revenues will experience a negative imp[act relative to budgeted amounts of between $225 and $575 million depending on the exact timing and magnitude of any economic recovery.

The City’s disclosure – something for which they deserve real credit – highlights another problem facing government at all levels. That is pensions. We have written about the country’s public pension problem and its has been at the center of general obligation analysis for some time. The City points out the problem faced by so many pension funds face. The plan assumes an annual rate of return of 7.4% on its pension investments. Through February, the city’s return was 3%. That was before the equity markets got crushed. Where similar experiences occur and they will,  the low returns will require higher current funding to maintain efforts to more fully fund pensions.

The phenomenon is clear across the country. This is not the fault of the pensioners. It isn’t really the fault of fund managers. It’s a black swan event that nonetheless has done some real damage. The language coming out of the President and the Senate Majority Leader casting the present situation confronting their states as something to assign fault about is not helpful. It only obscures the lack of understanding the Administration and its Congressional allies have of basic tenets of municipal finance and credit. The casting of the current situation in partisan terms only weakens the ability of the federal government to respond constructively.

I would be remiss if I did not reference the news that the Department of Health and Human Services, in its haste to get money out, distributed grants of some $50 billion to closed hospitals. The distribution relied on Medicare reimbursement data for fiscal 2019 which ended on September 30. ” If an institution is closed and their bank account is also closed, the funds are automatically returned,” a HHS spokesperson said. The glass is apparently half full.

TECHNOLOGICAL CHANGE AND THE PANDEMIC

Two items caught our eye this week as the longer term impacts of the pandemic begin to emerge. They have real implications on the process of deciding if and how to develop public infrastructure in an era of technological change. The first was the announcement that Ford Motor Co. was stepping back from its relationship with electric vehicle developer Rivian. Ford had invested $500 million in Rivian which was helping to develop an electric Lincoln model. Ford said it is still making preparations to launch the Mustang Mach-E, a flagship electric vehicle. Nevertheless, the economic decline in the first half of this year has and will damage the environment for new vehicle development.

The second comes in a series of regulatory filings from the state’s major utilities, electric automakers, EV charging providers and New York City’s transit agency. The state’s Department of Public Service in January, released a plan which would put utilities in charge of identifying the best sites for building new chargers and upgrading nearby grid infrastructure. Most of the costs associated with the preparations, meanwhile, would be covered by new incentives. Currently, the state is providing $580 million in incentives for such development. In light of the economy, these entities are looking for more from a state which finds itself in a serious financial crunch of its own. The six New York power utilities in a joint filing said that the charger plan’s incentives should be expanded to cover 100% of the costs associated with preparing the grid to accommodate the new stations. 

The state committed in 2013 to registering 850,000 electric cars by 2025 — up from fewer than 50,000 at present. By midcentury, the state wants to phase out gas car sales entirely. Transit agencies also have new mandates for converting buses and fleet vehicles to electric models. By 2025, five county agencies in upstate and suburban New York must electrify a quarter of their fleet and finish that conversion by 2035, in accordance with an executive order by the governor in January. New York City’s buses are slated to go all-electric five years later.

This just one example of why it might have been good that municipalities  did not run headlong into massive adoption of tech based infrastructure. We are seeing increasing examples of companies pulling back from office based models to integrated models of employment with a heavy emphasis on telecommuting. Some of the recent redundancy announcements have been accompanied by the closing of physical locations. The whole system of transit as a way to deliver workers to businesses is being reexamined. These issues will generate real demand (rather than anticipated) for infrastructure which can then be sized and funded appropriately.

NECESITY AS THE MOTHER OF INVENTION

All across the country, the closure of schools and a shift to online learning highlighted a topic on which we have written much – the availability of rural internet service. The phenomenon has generated a variety of responses. It’s not just about the availability of hardware to students in poorer rural areas but also about the lack of access to a viable internet service provider (ISP). Now we see that the realities of the pandemic are leading some entities – primarily school districts – to take on the role of ISP for their students.

The Visalia Unified School District in Tulare County, CA has announced that over the next three months, it will begin to install antennas at seven Visalia-area schools. The project is expected to provide 91% of the district with WiFi access. Countywide, 45% of households don’t have a broadband internet subscription — among the highest in the entire state — according to a 2019 Public Policy Institute of California report. The District estimates that about a quarter of VUSD students don’t have internet service or don’t have a high-speed connection required by many learning programs. The project has an estimated cost of $700,000, over half of which will be covered through emergency dollars the state has distributed to all California districts. VUSD received $466,000 which will be applied toward the ISP project.

The Tulare County Office of Education has already secured a frequency from the Federal Communications Commission to make high-speed internet a reality for all Tulare County students by this fall.

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