Joseph Krist

Publisher

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THE COSTS MOUNT WHILE THE MAYOR WAVERS

The effort to reopen the NYC public school system is becoming a guide book as to how not to get something done. At least the system is not financed and funded with its own source of revenues as is the case in most other big cities. So far the funding of the system directly through the city has not negatively impacted the City’s credit rating. But it is costing the City some serious money while it attempts to execute the Mayor’s hybrid vision.

The City’s Independent Budget Office (IBO)  estimated the additional weekly cost of operating New York City’s public schools while complying with state public health guidance prompted by the Covid-19 pandemic. Although considerable uncertainty remains, it projects that the cost will be roughly $32 million a week across multiple city agencies. It  projects that the cost of hiring additional teachers will account for over 60 % of the additional costs for operating New York City public schools—more than $19 million a week.

Schools across the city would require a 20 % increase in the number of general and special education teachers on their rosters compared with last year (2019-2020), when there were more than 78,000 school-based general education and special education teachers in the system. An additional 11,900 teachers or substitutes would be needed to meet the demands of schools’ hybrid schedules of in-person and remote instruction.

That is just for teaching staff. Custodial costs—including spending for PPE, custodial supplies, and labor costs associated with the extra cleaning—will total nearly $6 million a week and account for more than 17 percent of the additional costs. The weekly cost for testing almost 103,000 students and school-based staff each month (15 percent of each group that has opted into in-person instruction) is estimated at $1.6 million a week. Additional transportation costs would be $1.7 million a week. IBO noted additional capital costs that will be incurred, such as costs for upgrading HVAC systems, purchasing air filters for classrooms, and purchasing additional tablets and hotspots to meet students’ technology needs. It did not estimate those costs.

In the end, it all comes back to the City budget.

HOSPITAL REIMBURSEMENTS

Some of the nation’s largest and best known medical centers are coming in for scrutiny after the results of a RAND Corporation study was released showing that there are significant discrepancies between private insurance payments and Medicare pay for services.

In 2018, across all hospital inpatient and outpatient services, employers and private insurers included in this study paid 247 % of what Medicare would have paid for the same services at the same facilities, including both professional and facility fees. This difference increased from 224 % of Medicare in 2016 and 230 % in 2017. In 2018, relative prices for hospital inpatient services averaged 231 % of Medicare and 267 % of Medicare for hospital outpatient services. Florida, Tennessee, Alaska, West Virginia, and South Carolina) had relative prices that were above 325 % of Medicare.

The RAND researchers collected claims data, including provider identifiers and

allowed amounts, for enrollees in employer-sponsored health benefits from three types of data sources: self-insured employers who chose to participate in the report and provided claims data for their enrollees,  state-based all-payer claims databases from Delaware, Colorado, Connecticut, Maine, New Hampshire, and Rhode Island and health plans that chose to participate.

It puts into stark relief the great fear that many providers have as public sentiment steadily shifts towards at least access to some form of public health insurance. As more work like this is done and data like this becomes more widely available and disseminated, public sentiment is likely to continue to move in the direction of single payer. That was already likely in the aftermath of the pandemic.  

HOSPITALS EMERGE AS PRIME CYBER THREAT TARGETS

In 2017, the National Health Service in Great Britain was hacked by ransom seekers. Shortly thereafter, hospitals in west Virginia and Pennsylvania were attacked. These incidents led to emergency room shutdowns and transfers of patients whose care depended on computerized records. In 2019, 764 American health care providers were hit by ransomware.  At least those cases did not result in deaths. Now however, news out of Germany puts a halt to that streak.

The first death attributed to a ransomware attack was reported this week.  A young patient died after the hospital in which she was treated was attacked forcing her transfer to another facility where the delay in treatment of her emergency condition contributed to her death.  The hospital failed to update its software after a security patch for software it used had been made available. The cybercriminals were able to use the flaw to break in and encrypt data.

F.B.I. advisories warn victims not to pay their extortionists.  Infrascale, a security company, surveyed some 500 corporate executives about their plans or practices for dealing with cyber attacks. Nearly 75% of those surveyed said that they would pay the ransom. This reflects the fact that insurers for these risks have decided that it is cheaper to pay the ransom than the cost to clean up and recover data.

American health centers hit with ransomware this year were Boston’s Children’s Hospital, which saw more than 500 affiliate pediatric offices hit last February and, in June, Arkansas Children’s Hospital in Little Rock, among the largest children’s hospitals in the United States.  The University Hospital in New Jersey was hit with ransomware, and subsequently saw patient medical records published on the internet. The need to access health records and computer systems creates vulnerabilities that increases the likelihood that medical victims will pay their extortionists. The trend comes as hospitals increasing turn to electronic records as their main data source for patient care.

The German experience highlights why analysts are asking more and more questions about how borrowers are dealing with cybersecurity issues. It is understood that information on prevention and mitigation tactics which is provided cannot be too detailed but it is not unreasonable for borrowers to offer some evidence or affirmation of their efforts to mitigate the risk. Asking about what procedures are in place to address issues like the one at the German hospital is not asking borrowers to give up the store. The failure to insure that patches and the like are addressed is no different than asking if adequate audit and accounting procedures are in place. It is a management issue, even if it involves technical issues.

DOWNGRADES ACCELERATE AS THE PANDEMIC LINGERS

It was only a matter of time but the pace of downgrades is beginning to pick up. They are in sectors we have previously noted as vulnerable due to the restrictions on activity related to the pandemic. S&P lowered its long-term rating to ‘BBB+’ from ‘A’ on Rhode Island Commerce Corp.’s first-lien special facility revenue bonds outstanding, issued for Rhode Island Airport Corp. (RIAC). The outlook is negative. The credit in question is backed by the consolidated rental car facility (CONRAC) primarily at the Providence airport. The material negative impact of the COVID-19 pandemic on traffic levels and rental car transaction days, expected financial performance metrics were cited to support the move.

S&P lowered its ratings on Fresno, Calif.’s airport revenue bonds outstanding, issued for Fresno Yosemite International Airport (FAT). The outlook is negative. “The rating action and negative outlook reflect our expectation that activity levels at FAT will be depressed, unpredictable, or demonstrate anemic growth due to the COVID-19 pandemic and associated effects outside of management’s control.”  Essentially the same issues were cited in downgrades of smaller airports including Augusta, GA and Portland, ME.

The largest airport revenue credit to be downgraded was Philadelphia International which saw its rating moved one notch lower to A-. We focus on what S&P said about the airport sector in connection with the Philadelphia action. “We view this precipitous decline not as a temporary disruption with a relative rapid recovery, but as a backdrop for what we believe will be a period of sluggish air travel demand that could extend beyond our rating outlook horizon.

The big name to be downgraded was the City of Milwaukee which saw S&P lower its general obligation rating two notches to A. The city has long had significant pension funding issues which actually were beginning to be addressed. A revision to the City’s discount rate  lowering it to 7.50% from 8.24% is forcing the city to more than double its budget requirements to maintain funding levels. The City has been using reserves to meet rising obligations but home rule limitations on the city’s taxing power restrict its ability to raise taxes to meet the higher obligations. The impact of the pandemic has magnified all of these pressures.

NY SCHOOL DISTRICTS

School districts in New York State approached September and the opening of schools with trepidation as the State explored various options including reductions or withholdings of state aid to deal with its own budget issues. September is the third-highest month of the year for school aid distributed by the state on a dollar basis. It also is generally a period of low liquidity as summer only brings limited cost reductions for districts. So the fact that the state has come through with anticipated funding at a critical time can only be viewed positively.

The districts are not out of the woods yet. It will be halfway through the State’s fiscal year as of September 30. So far the impact of the pandemic on revenues has been shared between fiscal years. The vulnerability is if there is a return of significant pandemic impacts that the bulk of that impact would occur in the remainder of the State’s April1-March 31 fiscal year. With that in mind it is not surprising that uncertainty remains about future payments. there are real concerns around  how any further withholding would impact more economically disadvantaged districts.

The complex structure of payment schedules for each district render generalizations about the district’s credit to be specific to each issuer. New York’s complex school aid formulas and schedules are legislated. They use a number of factors especially wealth to determine the amount and timing of aid payments a given district receives. in some cases – because state aid is a small % of their total revenues (usually wealthy in terms of property values) those districts actually have gotten a larger share of their aid revenues than have less wealthy districts. This means that districts more reliant on state aid for the bulk of their operating revenues are extremely vulnerable to the fiscal problems of the State as the pandemic unfolds.

PANDEMIC REFINANCING

The Harris County-Houston Sports Authority financed Minute Maid Park for Major League Baseball’s Houston Astros, NRG Stadium, formerly Reliant Stadium, for the National Football League’s Houston Texans, Toyota Center for the National Basketball Association’s Houston Rockets, and BBVA Stadium for professional soccer’s Houston Dynamo in its 23 years of existence. Throughout its history it has weathered stormy relations with a bond insurer and even stormier relations with a credit support provider. It has been a credit popular with retail bondholders.

In the middle of the decade, the Authority was forced to effectively accelerate the amortization schedule on some of its debt which led to a cash crunch  that resulted in the Authority’s ratings on its outstanding debt dipping into non-investment grade territory. The Authority used reserves to pay debt service and ultimately was able to resolve litigation with the bond insurer which enabled it to refinance its debt and regain investment grade ratings.

The latest effort to restructure and refinance debt comes as the result of the pandemic. None of its venues generate fan related revenue. Tax revenues pledged to the Authority’s debt – taxes on hotel rooms and rental cars- have been crushed by the pandemic. The planned refinancing will include taxable as well as tax exempt debt reflecting interest rate realities as well as limits on advance refunding. It’s another example of how limits on advance refunding are not a red or blue issue.

CLIMATE AND POWER

Broadly stated, there have been two approaches to climate change and the production and emission of carbon dioxide into the atmosphere. One approach is to limit the emission of carbon dioxide through things like renewable energy and electric vehicles. More radical efforts would seek to limit agricultural production especially the consumption of meat. The other approach is to find ways to manage the carbon dioxide emissions that modern industrial, transportation, agricultural activities which result.

The most prominent of the latter is carbon sequestration or carbon capture. Carbon Capture and Storage (CCS) is a technology that can capture up to 90% of the carbon dioxide (CO2) emissions produced from the use of fossil fuels in electricity generation and industrial processes, preventing the carbon dioxide from entering the atmosphere.

The only coal carbon capture project in the U.S. and the largest post-combustion carbon capture project in the world is the Petra Nova plant at a Texas electric generating facility. It was expected that the plant would remove carbon dioxide from the emissions process and develop stores of C02 which could then be sold to oil drilling operations.

As is often the case with new technologies like this, economics have a way of creating hurdles which manage to trump the science behind them. So, given the crashing economics of the oil and gas industries in 2020 it is not surprising that economics have conspired to sink (for now) the Petra Nova project. NRG, the company that operates the W.A. Parish Generating Station from which Petra Nova captured emissions, the carbon capture project has not operated since May 1, 2020.

It’s easy to cite the economics but filings with the US Department of Energy and the SEC tell a different story. A technical report submitted by Petra Nova to the Department of Energy shows that the project actually experienced so many outages that it did not operate for one of out every three days over the last three years. Overall, the project yielded very disappointing results both technically and financially. The project, fueled by a gas fired generation system, captured carbon dioxide from one of the four coal units at NRG’s W.A. Parish Generating Station near Houston, Texas. Emissions from the gas generator were not captured. The CO2 was then piped 81 miles to an oil field using “enhanced oil recovery”.

Emissions data from the Environmental Protection Agency and a report submitted to the Department of Energy, showed that the carbon capture project actually captured just 7% of the power plant’s total carbon dioxide emissions. The inability of the plant to operate reliably and the fact that oil prices remained well below the break even threshold for the plant of between $75 and $100 per barrel spelled economic doom for the facility. It is now “mothballed”.

While efforts to date have been undertaken by investor owned utilities, the technology offered hope to large coal fired generators both IOUs and municipal systems. The failure of the Texas plant has led the Institute for Energy Economics and Financial Analysis to say ‘that the mothballing of Petra Nova highlights the deep financial risks facing other proposed U.S. coal-fired carbon capture projects, including Enchant Energy’s plan for the San Juan Generating Station in New Mexico and Minnkota Power Cooperative’s Tundra Project at the Milton R. Young Station in North Dakota.”

For municipals which operate coal fired generation, the failure does nothing to decrease the environmental pressure on these facilities. It could likely lead to closures or repurposing (like at the municipal bond financed Intermountain Power facility in Utah) of municipally owned generation facilities.

GAS TAXES RISE UNDER THE RADAR

Alabama and New Jersey have raised their gas taxes effective October 1. Local gas taxes are being implemented as well. Missoula County, MT is beginning to impose a 2 cent/gallon local gas tax increase. The City of Normal, IL voted to double the motor fuel tax from four cents per gallon to eight. The local increases will generate some $1 million which does not sound like much until you consider that this represents some one third of local road budgets for these jurisdictions.

With the demand for gasoline and prices low, gas tax increase are seen as a viable source right now. It helps that gasoline prices vary throughout the year, so differences in price are not always met with consumer resistance. Taxes usually aren’t broken down at the pump so consumers do not readily realize that the taxes have gone up. Also, U.S. motorists drove 11% fewer miles in July than a year ago as drivers stayed home due to the coronavirus pandemic according to USDOT data for the most recent month available. The biggest declines were seen on the East Coast, where mileage in the North fell 15.4% and in the South by 11.3%. Driving on urban Interstate roads fell by 14.8%, the sharpest decline seen in single road category.

In the case of NJ, the impact on volumes may come as much from the resulting drop in demand from out of state buyers. The Garden State’s historically low gas tax rates always made it worth it for travelers to fill up in NJ versus in NY or PA. This was especially true for commercial truck traffic, a mainstay on New Jersey’s Turnpike. Now we will see what a more competitive price environment looks like.

CLIMATE AND TRANSPORTATION

Gov. Gavin Newsom of California issued an executive order directing California’s regulators to develop a plan that would require automakers to sell steadily more zero-emissions passenger vehicles in the state, such as battery-powered or hydrogen-powered cars and pickup trucks, until they make up 100 percent of new auto sales in 2035.

There may be no better time than in the midst of a hugely climate based disaster to make the move. Transportation is seen as California’s largest source of planet-warming emissions, accounting for roughly 40 percent of the state’s greenhouse gases from human activity. The order would not prevent Californians from owning cars with internal combustion engines past 2035 or selling them on the used-vehicle market.

It is a step which was always expected but it seems clear that the wildfires of the past half decade are driving the effort. In June, the state adopted a major rule requiring more than half of all trucks sold in the state to be zero-emissions by 2035. The industry reacted negatively to the concept of a mandate but that is to be expected. California has long been a leader in efforts to combat auto pollution. The nation’s first tailpipe emissions standards and greenhouse gas emissions standards for cars originated in California. “Check engine” lights were also first mandated by CARB before being required by the EPA. 

Electric transportation is becoming more of a chicken and egg conversation. The industry expresses reluctance to fully embrace the change until they see what in their eyes is a sufficient level of demand. At the same time, the technology remains too expensive for the average consumer  so the demand is not there yet. Here a regulatory incentive or stimulus as the case may be could be key to driving the development of affordable electric vehicles. 

PANDEMIC CASUALTIES

The news that the Metropolitan Opera will not resume performances until the fall of 2021 due to the pandemic is a chilling sign to the cultural space. While this is a story about one credit – the Metropolitan Opera – it is still a story about the issues facing the cultural space. In making its announcement, the Met indicated that the revenue losses to date and those to result from the cancellation going forward will require contract renegotiations with the unions representing the bulk of its employees.

This after revenue hits of $150 million led to roughly 1,000 full-time employees, including its orchestra and chorus to be furloughed without pay since April. Other institutions in the space have already executed significant cost cuts through negotiations. The Boston Symphony Orchestra and its players have agreed to a new three-year contract reducing their pay by an average of 37% in the first year. The San Francisco Opera agreed to a new deal that will cut its orchestra’s salary in half this season. Both have provisions to raise pay as revenues return.

It will be easier for outdoor cultural venues like zoos and botanical gardens to slowly ramp up patronage than will be the case for the enclosed entertainment space. The importance and place of the Metropolitan Opera in the American cultural landscape means that decisions by this one institution will resonate throughout the non-profit cultural sector. We would expect to see more such announcements, especially if the much feared second wave occurs.

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 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 turn of the leaves lets us know that we are about to enter a potentially difficult phase of the pandemic. Lacking a vaccine, the potential for a “second wave” overhangs the economy. In the meantime, there has been much focus on the failing stimulus process. The individual impacts on individual states and cities are already coming into focus. With the close of the fiscal first quarter for many governments, revenue realities will begin to take shape.

The crush on revenues is creating newly favorable environments for policy and fiscal changes. In New Jersey we see the “millionaire’s tax” about to make it into law. In Pennsylvania, the issue of legalized recreational marijuana is up for debate legislatively. It’s an issue we focus on in more detail below. On the revenue side, the news continues to be negative. The NYS Comptroller reports that Local government sales tax revenue declined by 7.8 % in August compared to the same period last year. This drop in revenue is similar to the decline in July of 8.2 %. New York City had a 7.1 % decline, a $43.9 million reduction in revenues, which was comparable to the 7.3 % ($44.6 million) decrease seen in July.

A lack of congressional action and a continuation of trends continue to weaken credit. So risk increases. At the same time, all indications are that rates will be held low for an extended period making getting compensated for risk that much  harder. Stay awake!

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CANNABIS

A petition in Montana to legalize recreational marijuana for adults 21 and older has qualified for the state ballot in November. Initiative 190 and Constitutional Initiative 118 will be eligible for state residents to vote on. It is impressive that the ballot items qualified given the limitations of the pandemic. The initiative reportedly required 25,000 verified signatures to qualify, while the constitutional amendment needed around 50,000.

The initiative would legalize the sale and possession of limited marijuana quantities while adding a 20 percent tax on the sale of non-medicinal pot products in the state. Supporting organizations estimate that sales would generate $48 million in tax revenue for the state by 2025.

In South Dakota, Amendment A would legalize the recreational use of marijuana for individuals 21 years old and older. Individuals would be allowed to possess or distribute up to one ounce of marijuana. The amendment would require the South Dakota State Legislature to pass laws providing for a program for medical marijuana and the sale of hemp by April 1, 2022. Mississippi voters will decide whether to legalize medical marijuana. 

Arizona voters will be able to vote on Prop 207. If it passes, Arizona lawmakers would have to establish regulations for the Arizona recreational marijuana industry by April 5, 2021. The proposition purports to cover the whole range of concerns with legalization. Adults 21 and older would be able to possess 1 ounce of marijuana and the law limits home cultivation to 6 plants at an individual’s primary residence and 12 plants at a residence where two or more individuals who are at least 21 years old reside at one time.

A 16% excise tax (the same as cigarettes and alcohol) would be placed on recreational marijuana products. Money from the excise tax would fund various state agencies and be dispersed between community college districts, police and fire departments, and the Highway User fund. Marijuana use would remain illegal in public places and no marijuana products could be sold that imitate brands marketed to children or look like humans, animals, insects, fruits, toys or cartoons.

The governor of Pennsylvania has proposed legalization as a revenue source. This comes as New Jersey voters will consider Question 1. It would amend the state constitution to legalize the recreational use of  cannabis, for persons age 21 and older and legalizes the cultivation, processing, and sale of retail marijuana. The constitutional amendment would take effect on January 1, 2021. There would still be a significant legislative hurdle to overcome as the amendment would only be enabling the legislature and CRC to enact additional laws and regulations.

Much as was the case when Prohibition was ended in the midst of the Great Depression, initial moral objections to the legalization of alcohol were overcome by the need for state revenues during a time of economic distress. Current state and local government fiscal conditions are creating a similarly based source of support for legalization of marijuana.

APPROPRIATION DEBT

The long running dispute between Platte County, MO and holders of 2007 Platte County Industrial Development Authority bonds issued to finance parking facilities at a shopping mall is destined for the Missouri Supreme Court. In 2018, the County decided not to appropriate some $765,000 to cover shortfalls in revenue available for debt service on the bonds. The County had pledged to make up such shortfalls but the payment of those monies was dependent upon annual appropriations by the County legislature.

Such language is not unusual in financings of this type and while uncommon, other jurisdictions have taken similar actions when revenues which came up shirt were generated from private facilities. Other such non-appropriations have involved hotels and ice skating facilities.

The trustee for the bonds had threatened to pursue litigation from the start of the dispute in 2018 so the County sued to have its agreement validated and has won two prior rounds in the Missouri courts. The trustee unsuccessfully argued the financing agreement supporting the bond issue represented a legally enforceable promise to pay, even in the face of clear language in the bond documents that any payments under the County pledge were subject to appropriation. The Missouri Court of Appeals for the Western District opined that the plain language of the Financing Agreement does not contain a promise by the County to pay for the shortfalls for the Zona Rosa Bonds. 

The continued litigation comes as the new developer for Zona Rosa has announced major changes to the development. Plans include the demolition of retail space and the increase in open green space. It comes as the new developer hopes to develop multi-family housing and hotels at the development. Zona Rosa has been struggling since the Great Recession and more than 50 of its storefronts are closed. The mall hopes to continue to diversify its real estate with more office and residential uses. No details have emerged so it does not appear that there will be any quick fix for the defaulted bonds.

The dispute gives us an opportunity to reinforce our long held belief that investors who rely on legal provisions over and above economic fundamentals are making a serious mistake. If a project is not economically viable on its own, legal provisions can only help so much. They guaranty a place on line at bankruptcy court and not much else. Threats against market access for issuers who do not meet “moral obligation” payment requirements have proven largely empty.

As litigation has increasingly become a favored tactic of investors, the increasing reliance on litigation simply reinforces the details of the legal agreements underlying bond issues. “Moral obligation” security pledges are not legally enforceable payment requirements. The litigation in this case will likely result in affirmation of that concept.

As always, it is up to the investor to do their due diligence and to understand exactly what the legal provisions are and to understand what they do and what they do not do.

GOING TO SCHOOL ON THE MLF

If you have been doing this as long as I have, the continued inability of Congress to get its arms around the municipal bond market is a source of unending frustration. The latest evidence is that Congress is planning to hold hearings on the Municipal Lending Facility. The MLF is a borrowing program which allows the Federal reserve to provide liquidity funding to state and local governments which cannot be addressed through the marketplace.

The MLF provides funding at relatively expensive rates. The Fed initially charged issuers a premium for using the program at a baseline of 150 basis points for triple-A to 590 basis points for below investment-grade-rated issuers. Last month, the Fed reduced those prices by 50 basis points in each credit category. That still does not provide cheap money. As a result, potential borrowers seem to be waiting out the process currently underway in Congress to develop one more stimulus package.

This has caused some consternation among some in Congress who apparently expected strapped municipalities to embrace short term borrowings in a rapid manner. They are shocked that only two borrowers have accessed the funding. That concern reveals a failure to grasp what the facility was intended for – a lender of last resort who could provide financing at a market clearing rate. By that measure, the lack of utilization is almost predictable. In addition, the program was designed with a major flaw in that the minimum population requirements for borrowers – 500,000 – excluded huge swaths of the issuer community to be denied access to the program. There are e tire counties at the forefront of the excess expenditure pressures facing governments who are not able to access the funding.

Those are the obvious places to start. Municipalities have been clamoring for a reduction in the population threshold with numerous bills being offered to do so. That would be a start. A further reduction in borrowing rates would make sense. The problem is that Congress has limited time to act unless one believes that action could be taken during a lame duck session. It is likely that some borrowers are waiting until after the election to see what the expected makeup of Congress is to determine the likelihood of a better deal emerging from a different political atmosphere after January.

MTA DOWNGRADE

The most predictable downgrade of the year finally happened when Moody’s lowered its rating on NY MTA transit revenue bonds from A2 to A3. The Authority’s precarious financial position is well known. The highly uncertain outlook for additional aid from the federal government helps to drive the timing of the downgrade as well as the maintenance of a negative outlook.

This is a very difficult period for the agency. The corporate sector in NYC is working to return its workers to office locations which would hopefully increase utilization of public transit and generate revenues. Some companies are considering rotation plans which would effectively turn many office jobs into a form of shift work. This would enable them to meet pandemic limits on occupancy to enforce social distancing.

A return to the status quo is likely the best long term remedy for the revenue woes of a system which derives a far greater proportion of its total revenues from fares than do most transit systems in the US. More clarity around timelines for an increase in demand would enable the Authority to be more precise in estimating its revenue needs going forward. The problem is that there remains great resistance to the idea of a return to status quo as well as the likelihood of extended economic disruption.  

WATER WARS

When I write about disputes over water, those stories usually come out of the American West. While the extended drought which has plagued the West is rightly now in the spotlight, the first Supreme Court case to resolve a dispute over groundwater that crosses state lines will unfold over the session beginning October 1. That case is a dispute over the use of a fresh water aquifer which provides very clean fresh water to businesses and residents of a three state region.

Mississippi v. Tennessee has been dismissed and rejected  multiple times since Mississippi originally filed the suit against the City of Memphis and its utility company Memphis Light, Gas, and Water in 2005. In 2014 the State of Mississippi revived its suit and added the State of Tennessee to the list of defendants.  The interstate nature of the dispute enabled the Supreme Court to accept the case.

The appeals continued in spite of a significant trail of case law that supports water having a special status as an asset in terms of ownership. Individuals and entities can often have rights to the use of water accessed through their property but ownership of the water itself as part of the real estate has been negatively viewed by courts for nearly 200 years.

It is an argument about where each party gets to place its “straw” into the aquifer in question. Some of the argument ironically around increased use of what has become a  scarce and declining asset – the water. One of the factors driving the search for a final judgment is that the water’s purity makes it a source of inexpensive and non-filtered water. That is a significant cost to avoid. As is the claim by Mississippi for some $615 million. It is also been driven by evidence of subsidence in the area which indicates that the aquifer is effectively running low.

SEC ENFORCEMENT

Yet another municipal bond issuer has run afoul of the securities and exchange commission (SEC). In the latest example, charged Park View School, Inc., a state-funded, nonprofit charter school operator based in Prescott Valley, Arizona, and its former President with misleading investors in an April 2016 municipal bond offering.

The complaint charged that in the years and months leading up to the bond offering, Park View experienced significant operating losses and repeatedly made unauthorized withdrawals from two reserve accounts to cover routine operating expenses, to pay other debts, and to transfer money to affiliated entities. Park View allegedly defaulted one year later by reducing the interest payments that it made on the bonds. Park View allegedly provided investors an offering document that included misleading statements about profit and expense projections and showed that Park View would be profitable in the upcoming fiscal year and able to repay the bondholders.

According to the SEC, a 2016 official statement issued to support an offering of bonds included misleading statements about profit and expense projections and showed that Park View would be profitable in the upcoming fiscal year. In reality, it experienced significant operating losses and repeatedly made unauthorized withdrawals from two reserve accounts to cover routine operating expenses, to pay other debts, and to transfer money to affiliated entities.  

Park View and its President agreed to settle with the SEC and to be enjoined from future violations of the charged securities laws. The school President  further agreed to pay a $30,000 penalty and to be enjoined from participating in future municipal securities offerings. Investors seem to have overestimated the state’s role in chartering the school and assumed a level of veracity to be associated with a state chartered entity that simply was not there.

The irony is that the schools – a middle school and a senior high school-  Prescott, AZ – are not new to the municipal bond market. The sponsor has been chartered for 20 years and has had outstanding debt since at least 2011. So they knew what the rules of the road were when they brought this issue to market leaving them little excuse for misleading investors. The situation also highlights the role of conduit issuers and the lack of control or authority over the conduct of some of the borrowers they help.

THE FUTURE IS ALREADY HAPPENING

I continue to see article after article issuing “the answer” to a whole range of estimates of the ultimate impact of the pandemic in relation to the structure of work. Much is being made of the ongoing debate in cities like New York and other major economic hubs over how to reopen. The most intense debate in terms of public goods has been over education. A consensus formed around online learning except in NY. The issues in the private sector seem to revolve around when office staff can be asked, requested, or required to return. At the same time, the hospitality industry continues to be battered.

In the most  cautiously reopened major city, NY, major employers are quietly establishing schedules and procedures which would enable fairly significant numbers of their employees to return to office settings. It’s what is driving some of the clamor from major businesses in the city. New York office-based employers have been permitted to bring back workers at 50 percent capacity. As the pandemic drags on, the pressure will be there to repopulate existing office space which often exists under long term lease. The asset becomes a drag as the cost of rent is not offset by the existence of any economic activity on site.

Despite the benefits of working from home being apparent to many, there is also a significant share of the workforce that relishes a return to the office. Here is where the maintenance of existing space and the goals of a new workplace actually converge. Office capacity will have to be reduced to meet social distancing requirements so some work from home will likely continue on a rotational basis. Real estate interests are already talking about total workplace ecosystems and other concepts in support of the idea that office space and the demand for it will still be needed.

The timing and scale of the return to offices will be the key factor driving transit, development, and real estate trends longer term. It is hard to see in the midst of the event unfolding whether it be the pandemic, the fires, or the floods and storms that they have an eventual end. That is not the same as saying that it will just go away. We believe that cities are not dead and that ultimately employment will drive migration pretty much as it has always done.

NEW JERSEY MILLIONAIRE TAX

It has always been a policy goal of the Governor to raise marginal income tax rates at the high end off the income scale. Opponents have long believed that such a tax scheme would drive high income residents out of the state (to places like Florida where there is no income tax). It has taken the economic impact of the pandemic to make the concept acceptable politically. To that end, the Governor announced a budget agreement with the legislature whereby lawmakers agreed to raise the tax rate on income over $1 million to 10.75 %, up from 8.97 %. Individuals earning more than $5 million were already taxed at the higher rate.

The deal may not be as beneficial to the state as it also includes a recurring $500 rebate for families with at least one child and an annual income of less than $150,000 a year for couples and $75,000 for single parents. Estimates of the revenue impact of the new tax are $390 million in new revenues but this is offset by the cost of the rebates estimated at $340 million. So it is a tax shift rather than a real revenue producer.

The politics matter. More than 1.5 million NJ residents have filed for unemployment benefits since lockdowns were imposed. The Governor has a 71% approval rating. So the political stars aligned for the tax shift to be agreed to. Now we will see how realistic the threatened exodus from the state will be. An above average hurricane season and the current wildfire disaster are limiting the options for people looking to move. So the jury is out on the impact of the tax plan.

The next step is legislative approval of the full budget.  The pending nine-month, $32.4 billion spending plan will cover the remainder of fiscal 2021 beginning  Oct. 1. (The 2020 fiscal year was extended through September 30.)  The proposed budget Mr. Murphy released last month also includes about $1.2 billion in spending cuts and $4 billion in new bonding debt.

So, if adopted, New Jersey will be the crash test dummy for the raise taxes on the rich movement. If it succeeds, progressives will move onto other states with graduated income tax schemes (New York being the next likely battleground) and try to achieve the goal of taxing the rich there.  The debate will unfold as the home sale market in northern NJ has heated up as NYC residents seek homes with outdoor space within commuting distance. So it will be interesting if that dynamic is altered by the tax if enacted.

 
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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It has become increasingly clear that the poisoned current political environment is claiming meaningful aid to state and local government as its primary scalp. It is clear that state and local government face untenable choices in the absence of significant help. The debate comes even in the face of clear indications that significant layoffs will occur in October and after without another PPP round. Furloughs will shift to layoff. The airlines are only the most visible example but many industries will be impacted as increasing pressure on disposable income holds down spending and delays recalls to all types of businesses.

The implications for municipal bonds are increasingly negative as federal inaction not only chokes off revenue but does it at a time when expenses cannot be similarly adjusted. It makes no sense, especially when states are being left on their own from not just a fiscal standpoint but also a regulatory/legal standpoint. If Congress and the President want to abdicate their responsibilities, they could at least provide some resources to those who are actually managing the pandemic.

Inaction also hamstrings efforts at economic stimulation. Increasingly, states and their agencies are announcing delays and postponements of significant infrastructure projects which could be a good source of virtually immediate economic activity. Longer term, delays in several large projects have significant economic implications which will extend the time of recovery and act as a cap on economic upside. If you can put aside the politics for just a minute, the illogic of the current state of affairs is clear.

There is only one partner in the debate which can print money and legally run a deficit – the federal government. That, along with requirements that every state except Vermont must operate under a balanced budget means that the federal government occupies a unique and pivotal position in the process of recovery. That recovery should not count on the results of the upcoming election. There are clear solutions, it’s the politics holding things up.

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WHY PANDEMIC AID IS COMPLICATED

Congress returns 22 days before the start of the federal fiscal year and there appears to be declining hope for a significant federal bailout package. There remains a significant segment of Senate republicans seemingly dead set against any additional aid to state and local government. While much of the opposition seems to be based in an antipathy towards “blue” states, we look at one “red” state to see why there might be a basis for opposition.

In 2016, the Utah legislature authorized the creation of the Utah Inland Port. The plan was to provide fun ding for infrastructure which would connect Utah industries – energy primary among them – with overseas buyers of exports from the Beehive State. In response, private interests undertook a variety of investments. The most prominent is the development of a cargo facility for exports of Utah coal in the Port of Oakland, CA.

The 2016 legislation was designed to create a $53 million fund to support the development of “throughput infrastructure” out of state. The Oakland port facility is the most prominent example. Efforts to develop such a facility have been the subject of ongoing litigation. That process has stymied development and the developer has subsequently filed for bankruptcy.

Now in the midst of the pandemic and the economic pressure being felt by all levels of government, four Utah counties are looking for $20 million of the $53 million of funds to be transferred to the port developer. Carbon, Emery, Sevier and Sanpete counties have told the bankruptcy court overseeing the developer’s Ch. 11 filing that “this project will not only save high-paying jobs but will promote economic growth in rural Utah and create new and lasting jobs for the state and region.”

It is easy to question how to balance the realities of economic development with the fiscal realities of the pandemic. There have been many references like those targeting pension funding needs and unions. What there has not been is as much criticism of subsidies and tax “incentives” which reduce revenues available to government. Whether it is a subsidy for a dying industry (coal) or for a foreign company like Foxconn, these already controversial programs undermine the case supporting them.

We are seeing numerous efforts across jurisdictions to use the pandemic as either cover for or an excuse for significant regulatory concessions or subsidies for business. The need to rebuild the economy is forcing governments to consider these programs even as they experience significant revenue losses. They come under increasing scrutiny in the wake of the failure to extend programs like the PPP and the failure to enact additional aid to local governments. They allow opponents of more aid to point to programs like the Utah program (which serves an out of state entity) to support their opposition.

CANNABIS IN THE KEYSTONE STATE

Pennsylvania is one of the states which chose to enact what was effectively an interim budget in order to start the fiscal year beginning July 1. The commonwealth passed a $25.8 billion interim fiscal 2021 budget in May that funds the state through the end of November. With the course of the pandemic uncertain and the outlook for federal stimulus uncertain at best, states and cities will have to constantly update and revise their plans for balancing budgets in the current fiscal year. The pandemic and its economic effects have put heretofore unpopular ideas for raising revenues back under consideration.

The Governor of Pennsylvania has proposed legalization of adult-use cannabis to help with the commonwealth’s recovery from COVID-19. The proposal reflects The State Auditor  estimates that regulating and taxing marijuana for adult use could generate nearly $600 million of new revenue annually. The Governor’s plan cites significant revenue generations in states like Washington and Colorado in support of legalization. The proposal would direct a portion of the revenue toward existing small business grants. Half of the grants would go to historically disadvantaged businesses with the remainder going to social justice programs.

The debate comes as the Commonwealth examines the future of its state liquor monopoly. The debate has been contentious and it can be expected that the debate over the Governor’s proposal will be vigorous in the socially conservative state. To reflect this reality, the Governor wants to implement legalization incrementally. His initial ask is for decriminalizing possession of small amounts of marijuana. It comes as New Jersey voters will consider the full legalization of cannabis in November and efforts to do the same in the New York legislature are expected to be renewed as the impact of the pandemic fades.

AIRPORT REVENUES

In 1982, a federal law was enacted that imposed constraints on the use of airport revenue (e.g., concessions, parking fees, and airlines’ landing fees), prohibiting “diversion” for non-airport purposes in order to ensure use on airport investment and improvement. However, the law exempted “grandfathered” airport sponsors— those with state or local laws providing for such diversion—from this prohibition. The FAA Reauthorization Act of 2018 provides for GAO to examine grandfathered airport revenue diversion. The study was designed to provide information for those considering a repeal of those provisions.

A repeal of grandfathered revenue diversion would have complex legal and financial implications for transportation authorities. Transportation authority officials said that a repeal would inherently reduce their flexibility to use revenues across their assets and could lead to a default of their outstanding bonds if airport revenues could no longer be used to service debt; exempting outstanding bonds could alleviate some financial concerns. For city and state government sponsors, a loss in general fund revenue could result in reduced government services, though they said a phased-in repeal could help in planning for lost revenue.

Where would repeal have its primary impact? From fiscal years 1995 through 2018, FAA data show that the nine grandfathered airport sponsors lawfully diverted revenue amounts that varied from as little as no diversion by some sponsors in some years to as much as $840 million by a sponsor in one year. All city- and state-government airport sponsors regularly diverted revenue for each of the 24 years from 1995 through 2018, per their local laws and agreements. In 2018, revenue diversions for the five airport sponsors ranged from almost $7 million (City of St. Louis) to about $47 million (City and County of San Francisco). diverted airport revenue comprised less than 1.5 percent of the airport sponsors’ total annual general fund expenditures in 2018 and less than 4.5 percent of their airport(s) operating revenues for that year.

Who would be hurt by a repeal?  Maryland officials explained that under a repeal, the Maryland state legislature would need to restructure MAA to separate its revenues from the state transportation trust fund. Since MAA does not currently have the legal authority to maintain its own cash reserves to finance its own infrastructure investments, officials said a repeal would necessitate legislation establishing a separate state aviation fund for MAA, with a one-time cost of at least $250 million needed to provide the fund with its own starting balance.

In Massachusetts, if Massport were no longer able to use airport revenue to help support its seaport, costs to seaport users would increase, resulting in negative regional economic effects, including job losses at the port and in the wider community. Officials also said that repeal would prohibit Massport’s payments to three neighboring cities, which would hinder cooperation with those cities on airport infrastructure expansion.

The Port Authority of New York and New Jersey is unique among the impacted agencies in that it is the only one serving more than one state. For the Port, a repeal would include possible non-compliance with its governing statutes and breach of its contractual covenants with its bondholders. The general reserve fund statute requires that surplus revenues from PANYNJ’s assets be pooled and does not indicate how PANYNJ should proceed if it were required to stop consolidating revenue.

All of the transportation agencies indicated that a repeal could result in airport revenues no longer being permissible to secure or pay debt service on consolidated bonds. According to Massport and PANYNJ officials, a repeal would cause their agency’s outstanding bonds to be in default or subject their agency to a legal cause of action for breach of contract. According to Massport and PANYNJ officials, a repeal would cause their agency’s outstanding bonds to be in default or subject their agency to a legal cause of action for breach of contract. These airport sponsors currently have $1.6 billion and $22 billion in outstanding bonds, respectively.

TOBACCO

The 2020 National Youth Tobacco Survey has been released. The annual review gives a good indication of current trends among the tobacco industry’s prime marketing target. In 2020, 19.6% of high school students (3.02 million) and 4.7% of middle school students (550,000) reported current e-cigarette use. Among current e-cigarette users, 38.9% of high school students and 20.0% of middle school students reported using e-cigarettes on 20 or more of the past 30 days; 22.5% of high school users and 9.4% of middle school users reported daily use. Among all current e-cigarette users, 82.9% used flavored e-cigarettes, including 84.7% of high school users (2.53 million) and 73.9% of middle school users (400,000).

The significance for a tobacco investor is that in spite of sustained demand for nicotine among a prime market cohort, the demand is for e cigarettes rather than “sticks”. It’s actual cigarette sales of cigarettes that matter to bondholders. The 20% use rate for e cigarettes makes the case for declining cigarette consumption.  The most recent Federal Trade Commission Cigarette Report was released at year end. It showed that the number of cigarettes that the largest cigarette companies in the United States sold to wholesalers and retailers nationwide declined from 229.1 billion in 2017 to 216.9 billion in 2018. That represents a decline of over 5%.

PANDEMIC CASUALTIES – RATINGS

As the pandemic continues, the expected impact on ratings is finally emerging. This week, S&P offered examples. S&P Global Ratings lowered its long-term rating by two notches to ‘BBB’ from ‘A-‘ on YMCA of Greater New York’s (YMCA) and Build NYC Resource Corp.’s general obligation (GO) bonds, issued for the YMCA. The outlook is negative. Gyms were not allowed to open until mid-August in New York State. The Y is planning on opening nine of its 22 branches in September 2020. Capacity is limited to 33%. The organization is facing a projected general operating deficit of $14 million in calendar year 2020.

S&P Global Ratings lowered its long-term rating and underlying rating (SPUR) on the New Orleans Aviation Board’s (NOAB) general airport revenue bonds (GARBs), issued for Louis Armstrong New Orleans International Airport (MSY), to ‘A-‘ from ‘A’ and the outlook remains negative. The announcement cited “the severe drop in demand has diminished NOAB’s overall credit quality and will likely pressure financial metrics relative to historical levels.

We view this precipitous decline not as a temporary disruption with a relatively rapid recovery, but as a backdrop for what we believe will be a period of sluggish air travel demand that could extend beyond our rating outlook horizon.” S&P also lowered its rating to ‘A-‘ from ‘A’ on St. Louis’ airport revenue bonds issued for St. Louis Lambert International Airport (STL) and kept that rating on negative outlook as well.

Private student housing remains vulnerable especially in light of the initial poor experience with efforts to return students to campus at so many schools. S&P Global Ratings cut by two notches to BB from BBB-minus the 2017 student housing revenue bond issue sold through the Illinois Finance Authority on behalf of the not-for-profit CHF Chicago LLC. The facility opened last Fall  more than 97% occupancy rates in fall 2019 and spring 2020. As of Aug. 24 a 53% occupancy rate set it up for significantly weaker financial performance.

Private universities with pressured finances continue to find themselves in a ratings vice. Enrollment declines are hurting revenues while online learning keeps students away along with the auxiliary revenues they would generate living on campus. The latest example is John Carroll University, a Catholic Jesuit private university located in University Heights, Ohio. Its rating outlook was shifted to negative by Moody’s. The school is showing how smaller private universities are trying to cope. The school plans expense reductions in fiscal 2021 to mitigate losses in net tuition and auxiliary revenue, in addition to utilizing remaining CARES Act funds and has approved a supplemental endowment draw in fiscal 2021 to help manage the revenue losses.

SUPPORT GROWS FOR STRINGS ON NYC BORROWING

We are glad to see support growing among respected outside observers for some controls on being imposed on New York City’s fiscal position be part of any borrowing Authority granted by the State to help the City manage the pandemic. The latest example is the private watchdog,  the Citizens Budget Commission, which has been a serious observer of New York City’s fiscal position for nearly 80 years. The control board position is that the State “should certify borrowing as part of a “comprehensive and feasible” multiyear plan that leads to fiscal stability.

It supports a period during which the control board must approve and condition each borrowing instance, monitor the city’s fiscal management, and approve or reject city actions with major fiscal impacts. A control period would continue until the board determines the city can support recurring spending with recurring revenues or the city meets pre-determined benchmarks.”

It really is not unreasonable to attach extraordinary terms to efforts to deal with this extraordinary situation. The market – investors, traders, raters – are all in a position to support and facilitate well reasoned and structured financing plans to deal with these most extraordinary fiscal times. The message should be clear to the Mayor that he needs to come to the table with a responsible plan that reflects a willingness to accept input from the whole range of sources. The key to resolution of the 1970’s fiscal disaster that was NYC was the involvement of both the private sector and the unions in formulating an overall plan. That sort of engagement seems to be something the Mayor believes he can shun. If he keeps it up, he may wind up having to borrow for one year at a higher cost than from the Fed.

In the meantime, a bit of kabuki theater is taking shape in terms of the government/business relationship. Earlier in the summer, the Partnership for New York made clear its view that the private sector is best suited to solving the city’s multiple economic problems. Then a predictable spate of responses generally rejecting such an approach occurred. The Partnership then undertook a study which unsurprisingly reinforced the private sector bias. Now a group of chief executives from some 150 of the city’s major businesses have issued a letter decrying the current state of affairs in NYC and asking the Mayor to follow the Partnership’s framework. All of this while the Mayor plays chicken with the Legislature over layoffs. Different circumstances have driven us down this road before.

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 PANDEMIC AND THE ECONOMY

There have been many unfavorable aspects to the need to work remotely but there have been some benefits. One of the obvious ones is the positive impact on the environment from reduced transportation. One aspect of this phenomenon has already been manifest in the crash of oil prices due to severely diminished demand. This decreased demand and spending has had however, the beneficial effect of increasing the disposable income of workers who no longer have a daily commute.

It is hard to determine the exact magnitude of the level of decreased spending but we are beginning to see attempts made to measure it. A researcher working on behalf of a company which links freelancers to businesses has released an analysis on the subject. The analysis estimated that cutting daily commutes out of the equation has saved Americans about $758 million a day in time and expense since the pandemic began. The analysis rests on an assumption that commuting by car costs on average $12.50 an hour.

That generates $411 million a day in savings with an additional amount credited to fewer trips to by gas and that fewer accidents also generate economic savings. Combine these factors and one gets to the daily total of $758 million per day.

Like any analysis which relies on them, the numbers rely on the quality of those assumptions. That leads us to focus not on the accuracy of the numbers but what they reflect about what is going on in the economy.  One of the issues facing the economy going forward is whether the office as we know it will survive. Lower spending, less time in commuting might continue to be attractive to many workers. The longer remote work persists (and many companies are staying remote thorough year end) and if people are given the choice, the alterations in commuting patterns could become permanent.

It is an important concern for all sorts of municipal issuers. We look forward to additional analyses on the subject.

The Federal Reserve also has released its latest Beige Book documenting its findings about economic activity. For the broad economy, activity increased among most Districts, but gains were generally modest and activity remained well below levels prior to the COVID-19 pandemic. Manufacturing rose in most Districts, which coincided with increased activity at ports and among transportation and distribution firms. Consumer spending continued to pick up, sparked by strong vehicle sales and some improvements in tourism and retail sectors. But many Districts noted a slowing pace of growth in these areas, and total spending was still far below pre-pandemic levels. Commercial construction was down widely, and commercial real estate remained in contraction.

Other data and comments reflect the crisis in the tourism and hospitality sectors as well as the airline industry. The recent announcements of permanent cuts to airline employment will likely be reflected in other businesses and industries dependent upon air travel. As we checked through the regional summaries in the Book, we were struck by how often terms like – Outlooks were increasingly uncertain; Uncertainty is extremely high; expectations have been scaled back; conditions in the energy and agriculture sectors remained weak –  came up. It paints a picture of slow recovery both economically and fiscally.

Another sign of the pandemic comes with Amtrak’s plan to furlough 2,000 employees. It is a direct result of diminished ridership and can be seen as a sign of the decline in economic activity in its busiest region. like New York’s MTA, it can cut service to a level which can be supported by available revenue. Amtrak  plans to reduce daily service on its long-distance train network to three times per week without funding help. Cuts of that magnitude would be indicative of difficulties in the underlying economies supporting these agencies. In July compared with July 2019, ridership on the relatively shorter routes through more urban areas was down more than 80%.

PANDEMIC FLEXIBILITY

The pandemic has forced issuers to be more flexible in their approaches to the financing of the revenue shortfalls. In some jurisdictions, structures have existed that provide for borrowing by local issuers to finance these shortfalls. These structures have not always been designed to deal with the unique impacts of something like the pandemic on these issuers. One of the best examples of this sort of borrower is school districts.

New York State has been at the center of the pandemic and the impact of its extended lockdowns and limits on economic activity on local government finances has been significant. To deal with the drop in revenues being received by the State of New York, the State has been withholding 20% of state aid typically distributed to local governments. localities and school districts have taken a number of steps in response to their resulting revenue declines. These include the use of short term borrowing in anticipation of either revenues or the proceeds of a future long term debt issues.

In New York, localities operate under debt limitations enacted by legislation. Among the limitations are a requirement that they be financed or retired within five legislation which extends the period over which notes are outstanding to seven from five years. The ability to roll over the notes an extra two years will allow management to better manage the expected long-term interest costs of borrowing. They can either reducing the note’s principal through annual paydowns of principal by cash funding of capital projects. In either case, long-term principal would decline, lowering future overall debt service requirements.

The legislation also addresses other techniques used by local government to manage the revenue interruptions and shortfalls stemming from the pandemic. The period in which governments must replenish restricted funds that they transfer temporarily to their operating budgets has been extended to five years in equal annual installments from the previous requirement to replenish them within the current fiscal year. The legislation also eases local governments’ access to capital reserve funds to pay for capital costs attributable to the pandemic. Governments will no longer need a referendum to move the funds  access. Capital reserve funds would normally be locked up and not available for corona virus-related expenses.

In New Jersey, newly enacted legislation will allow localities in the Garden State to borrow to replace revenues lost to the pandemic. The legislation permits localities to borrow for up to five years. If local governments can show that debt service costs would present a significant financial hardship that includes a need to increase the tax levy by more than 2%, the repayment period on the bonds could be extended to 10 years. Local governments also received new authorization to increase the tax levy to account for increased mid-year budget appropriations needed to fund emergency COVID-19 expenses. The higher taxes would not be subject to approval from the Local Finance Board which is typically required for municipalities when they exceed the state property tax cap.

We would expect to see similar changes made to local finance laws unfold across the country.

YET NYC STANDS ON ITS OWN

In an effort to pressure the state to provide additional financial aid, the mayor of NYC has chosen to frame the debate over how best to address the revenue to press is that the City must be authorized to borrow up to $5 billion to cover the budget gap which resulted. And that borrowing should have a thirty year term. Without that authorization, the Mayor threatens to lay off 22,000 city employees in as little as 30 days. The layoffs are clearly a bargaining chip to be played with a legislature that is increasingly impatient with the Mayor’s stewardship of the city.

We have stood firmly in the camp of those who believe that the City has been poorly managed especially in the Mayor’s second term. It can be argued that the health aspect of the pandemic was managed as best as could be given the magnitude of the pandemic in New York especially in NYC. Issues in the public eye – primarily the schools and public safety – are easy to cite as examples of ideology clouding management competence. The ongoing debacle over the opening of schools just extends and complicates the economic recovery.  

None of that would be causing a crisis if the economy had kept chugging along creating cover for some of the more troubling issues like soaring headcount which many had questioned. The management of the Thrive NY mental health program raised issues of confidence in Albany and now that the City needs help from the legislature, those concerns create hurdles in the City’s effort to generate additional funds.

Our view is that borrowing authority should be based on a more aggressive amortization schedule. The authority should be linked to cost cutting measures. They would include obvious things like negotiated changes in all forms of compensation, work rule changes, better technology, and better physical plant management. everything should be on the table and all parties will see changes in their level of control. The City’s credibility is on the line and the Mayor needs to step up.

PANDEMIC AND TRANSIT

Two very different scenarios are unfolding in the mass transit space in California. In San Francisco, the San Francisco Municipal Transportation Agency said will not open until at least the end of the year. Since March, the system had only three days of operation before mechanical and staffing issues forced a new shutdown. The mechanical issue will rely on parts not expected to be available until the third week of October. The staff issue reflects the positive test for a person and exposure of two others that forced the qualified workers to quarantine. The closed system does not provide an opportunity to train other personnel.

In Los Angeles, the city will study the potential for eliminating fares on the Metro system. Subsidized or free service is an issue being debated in several jurisdictions across the country. Los Angeles benefits from the fact that fares contribute only about 13% of operating revenues. Contrast this with New York where fares have historically contributed over half of operating funds. The revenue gap which would result in L.A. is far more manageable than the gap which would result in N.Y.

VIRGIN ISLANDS

“The refinancing of our existing bond debt in this unprecedented low-interest-rate environment is too great an opportunity to not explore.”  And so the Virgin Island’s has approved a plan to securitize a portion of its matching fund revenue (derived from the sale of rum) through a taxable debt issue. Like Puerto Rico, the Virgin Islands have had a slow recovery from Hurricane Maria. Now the impact of the pandemic on tourism has accelerated the negative impact of the national economic decline on the V.I. future.

Going into the pandemic, the Virgin Islands credit was characterized by excessive debt and poor fiscal practices. High unfunded pension liabilities and the financial difficulties of the power Authority (sound familiar) have been the recent headliners. Concerns about the timeliness and quality of financial reporting add to the mix. It has all contributed to a well earned Caa rating.

Now existing bond holders who are not refinanced out of their holdings have an arguably weaker credit supporting those investments than they did before. And it does little to address the underlying fundamentals which weaken the credit. It does put off a real cash crunch for the government for now and that would seem to be the major objective of the proposed issue.

MEDICAID, HOSPITALS, AND THE PANDEMIC

It is estimated that some 5 million workers have lost their employer provided health insurance as the result of job losses related to the pandemic. In some cases, these workers might be able to replace that coverage under the Affordable Care Act but many of them will wind up qualifying for Medicaid. We already know that pandemic fears have driven hospital utilization down, impacting revenues after periods of higher unanticipated expenses related to the pandemic. This has created liquidity pressures on hospitals, especially in the most hard hit of markets. The NYC market is a good example.

The Mount Sinai Hospital and Mount Sinai Hospitals Group  provide a good example. In the first quarter, Mount Sinai actually made money in spite of the limitations on operations driven by the pandemic. Recent material increases in liquidity and execute initiatives to improve margins had improved the system’s financial position. Nonetheless, the outlook going forward is uncertain. It has resulted in Moody’s assigning a negative outlook to Mount Sinai’s rating. An already high Medicaid share of revenues will likely increase because of the economic downturn. At the same time, state budget stress could drive Medicaid cuts.

The pandemic comes at a quite inconvenient time for the System. Mount Sinai hopes to replace its money losing facility in lower Manhattan (full disclosure I was born there) with a state of the art facility oriented much more towards outpatient care versus the current traditional structure. If the project is delayed because of a prolonged period of modest margins and high operating leverage would extend the period in which money losing divisions must be supported. Part of the strategy envisions the sale of real estate associated with the existing facility which would have improved liquidity. The benefits of such a sale will either be delayed or will yield a less favorable price.

CHICAGO BUDGET

As one of the largest cities in the U.S. to operate on a calendar year budget, the City of Chicago finds itself at a disadvantage. The primary fiscal impact of the pandemic will occur during this calendar year so that will amplify the impact on the City’s budget. The depth of that impact was reflected in the 2021 Budget Forecast released by the Mayor and city budget officials this week.

The forecast shows a $1.2 billion funding gap which must be addressed by year end. The City’s midyear shortfall for the current fiscal year is $799 million. A $783 million gap is projected for fiscal 2021. The Mayor has hinted at a combination of tax increases and layoffs to deal with the budget realities. This while historical pressures remain. In 2021, the city will pay its four pension funds $1.8 billion, approximately $91 million more than in 2020 from its general operating fund.

The City acknowledges the contribution of existing pressures before the pandemic to the City’s budget gap. Of the city’s projected budget shortfall of $1.2 billion in 2021, $783 million is due to the pandemic while the remainder reflects the City’s structural deficit. It comes as the City projects that full economic recovery is not likely until 2022.

The city will use $350 million in federal relief funds and $100 million saved by refinancing debt last year to help close the 2020 deficit. A hoped for debt refinancing is planned to generate $100 million in current year budget savings.  Over the longer term, the City is putting hopes in a casino which is projected to generate revenues to partially fund uniformed service employee pensions.

It is a bleak outlook which should hold back any improvement in the City’s credit for an extended period.

LAS VEGAS MONORAIL

The Las Vegas Convention and Visitors Authority to buy the struggling Las Vegas Monorail. The monorail opened for service in 2004 The monorail opened for service in 2004 after delays and cost overruns. It has never been a financial success and it was an unmitigated disaster for investors and bond insurers who supported the bonds. The purchase would not be a vote of confidence for the monorail’s financial viability.

It does give the Authority control over the monorail’s exclusivity agreement, which stopped other transportation options in the Strip corridor. It is also interesting that the debate over the vote included comments to the effect that the monorail probably has an 8- to 10-year lifespan. This reflects the expected useful life of the monorail’s physical assets and what is considered to be a prohibitive cost of replacing that rolling stock. It likely spells the end of one of the more interesting sagas of the high yield world over the last two decades and it supports the views of those who knew from the start that the project would not succeed.

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.