Joseph Krist

Publisher

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This is our last issue for calendar 2020. We wish you a hopeful Christmas and a brave New Year. The Muni Credit News will  return for the first week in January.

As the year has worn on, it has become increasingly difficult to keep politics from influencing our judgment. We are not concerned about the ultimate ability of the U.S. economy to recover and eventually thrive. That reflects our view of the enormous resources we have as a country and faith that its workforce will continue to be the most innovative and productive in the world.

Having said that, the politics of the country especially on the national level should give one pause. This is far from the first time that the country has been divided. It’s not the first time that a generational clash of values has happened. But it does come at a time, unlike others,  when truth has become subjective. Having dealt with politicians from both parties over the years I can honestly say that I cannot remember a time when the differences were over the interpretation of facts, not the existence or veracity of facts.

We also see troubling trends. When I was in my early years as a sell side analyst, I would get asked regularly about Puerto Rico bonds and the potential for an insurrection that would result in efforts to repudiate debt. I could write that off to ignorance or racism and move on. Now, one has to wonder when we see photos of armed protesters in the halls of legislatures whether an investor could ask the same question about Idaho, Michigan, or Virginia.

As we go to press on Sunday night, it appears that Congress will enact a relief bill providing stimulus checks up to $600 per adult and child, meaning a family of four would receive $2,400 up to a certain income. The size of that benefit would be reduced for people who earned more than $75,000 in 2019, similar to the last round of stimulus checks.  The bill would also extend federal unemployment benefits of up to $300 per week, which could start as early as Dec. 27.

What the package does not include is aid for states and localities. The budget year begins for many on January 1 and many smaller credits will have to budget on what they have. This has potentially significant impacts on employment and economic activity just as many jurisdictions are entering lockdown periods.  It makes for a more uncertain credit outlook if additional funding is not provided especially during the distribution phases of an immunization program. 

That said, the market did very well in meeting the challenges of the pandemic. It was able to finance all of its issuers’ needs in an orderly and economically effective way.

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I’ve been asked a lot what I think will be the important driving factors credit in 2021. The biggest change will be the fact that a Biden administration believes in government while the current administration did not. As we write this, the biggest remaining variable is a huge one – control of the U.S. Senate. It’s clear that the Senate elections in Georgia are even more meaningful than they already were. If the Senate is not under Democratic control, the policy gridlock and ideological drive to stymie any additional aid to states and cities will limit available resources.

It was one thing when Ronald Reagan made his joke about “I’m from the government and I’m here to help.” He then turned around and accepted a tax increase to fund Social Security and ran deficits which were for their time huge. But they did not set out to consciously undermine state and local finances. Now, we see overt efforts to undermine state finances combined with a significant offload of national responsibilities to states.

It makes no logical sense from either side of the partisan divide. Clearly it’s ideology. If you don’t want to give states and cities cash (which would probably be the most useful form of aid to these entities), at least restore the SALT deduction and advance refunding. The Fed chair made it pretty clear that low interest rates will be around for a while.  Yes, advance refunding and the SALT deductions are expenditures but they don’t require Federal cash expenditures. It would be a shame if ideology got in the way of commonsense fiscal management.

The slowing labor market recovery, significantly reduced pandemic-related state and federal government transfers, and a resurging wave of corona virus infections and hospitalizations will slow the pace and challenge the durability of the economic recovery of many U.S. states. Timing matters. New York and California both begin their budget processes in earnest before Inauguration Day.

The budget makers at all levels will be forced to make assumptions as to economies and revenues during the most uncertain period in memory. The level of stimulus provided by Congress will be the biggest source of uncertainty. This is especially true given that moratoriums on evictions, utility payments, and rents are not assured into the new year. Those potential negative pressures on local budgets will come just as FY 2022 budget decisions must be made.

Having set the backdrop, we examine some individual sectors.

Mass transit has arguably been the most visible loser in terms of the impact of the pandemic on credit. The situation in New York is telling. Subway ridership and fare revenue bottomed out in April and recovery has been slow. The share of MetroCard swipes in Manhattan remains depressed, reflecting declines in commuting to work and the collapse of tourism. Similar phenomena are observable in all of the major urban areas. The transit sector is right up there among the most vulnerable if office utilization remains below pre-pandemic levels.

For mass transit, the lifting of ideological opposition to funding can only be good. With three of the largest and oldest subway systems in the country in dire need of repair and expansion, the lack of federal funding has been a major hurdle. At the same time, mass transit is facing another crossroads which will have clear implications for the sector. What is the real expected level of utilization with other factors in the equation like changes in demand for centrally located office and housing space post pandemic? With the inclusion of some $4 billion in the current relief package, the MTA has received time to figure this all out?

It won’t just be about money. The drive by the Trump administration to privatize transportation will not continue. That philosophical basis for the development of policy relied on a model which simply has not worked that well. We think that New York is a good example of P3 projects working out favorably and that other state models are examples where it does not. The difference which leaps out is that models which involve concessions to operate as well as develop seem to have more problems than design build P3 models.

In New York, design build has generated three prominent bridge replacement/expansions and two airport renovations. They have generally received favorable reviews and support for the design/build P3 concept has grown in a strong union state. Where road projects have been leased to developer/operators, public support has been substantially less. Concessionaires have sold out both under duress or for other reasons.

All of this contributes to our view that P3s will continue to have their place but there will be no headlong rush to fully utilize the concept.

Energy Outside of pandemic related issues, the sector underwent significant change in 2020. The year saw unsuccessful efforts to convert investor owned electric generation and distribution assets to public ownership. The Jacksonville Electric Authority abandoned efforts to privatize the JEA which led to criminal investigations. In South Carolina, the legislature punted a decision on the future ownership and structure of the South Carolina Public Service Authority in the wake of the cancellation of the Sumner nuclear plant expansion.

 Many saw the troubles and bankruptcy of Pacific Gas and Electric in the wake of significant forest fires in California in recent years as an opportunity for public entities to take over PG&E’s troubled operations. It became clear that the process would be more difficult and time consuming than many thought and supporters of a public utility could not get a proposal together before PG&E was able to emerge from bankruptcy.

Boulder, CO considered converting the City’s electric distribution system to public ownership in an effort to support environmental goals. A proposal was put on the ballot this past November but residents instead voted to extend the city’s current arrangements for another 20 years with Xcel Energy.

The JEA saga continued as it announced that its new permanent CEO will be someone with utility experience. The announcement follows the firing of the previous CEO who did not have experience running a utility but did have experience privatizing public assets. The new CEO has a long history of operating local public utilities as well as experience with the TVA.

The market realities leading to closure after closure of coal fired generating facilities will continue. The pace of closures may slow as many remaining coal plants are newer and comparatively more economic. Nonetheless, the drive to decarbonize will continue. And plants will have to perform efficiently (environmentally and economically) to continue to operate.  

The change in philosophy alone at the White House will be a significant change catalyst and municipal utilities will be right in the center of them..

Congestion Pricing was held hostage to the ideological leanings of the Trump administration which refused to move forward on required federal approval processes for New York City’s application to levy congestion charges. It is likely that a Biden administration will look more favorably on congestion pricing proposals. This will be offset  by the economic realities of the pandemic and the desire to facilitate as much commerce as possible as the economy recovers.

Infrastructure  Infrastructure Day, Week, Month, Year. We’ll take whatever form it comes in as long as the process moves forward. A lack of federal policy beyond privatization has stymied all sorts of development whether it’s the repair of public housing stock or regional projects like the Gateway Tunnel. That does not even begin to include the significant number of smaller local projects which often are based in federal policies. It is nonetheless impressive that municipal issuers have managed to finance as many projects as they have during the last four years. Imagine what could happen with real support from the federal government.

Housing This was another sector where investment was held back by policy. The effort to shift projects into private hands as a price to be paid for needed renovations did nothing for some of the neediest projects. The best example is the New York City Housing Authority. The well known massive maintenance needs of these projects remained largely unaddressed while the Trump Administration promoted various schemes to convert public assets to private hands.

The looming eviction deadlines take on more relevance at year end given the pending expiration of a pair of temporary aid programs to individuals. The pending relief legislation will provide only short term fix. The Federal Reserve Bank of San Francisco studied what happened when unemployment insurance ended for workers who lost their jobs during the recessions of 2001 or 2007-9. Household income declined $522 a month on average, they found. There are real concerns that renters will be forced out of their homes without additional assistance.

On the other end of the spectrum, the ability of many to work from home has tended to benefit those in professional fields and other office workers. This has driven up prices for single family housing especially in major metropolitan area suburbs. If the prognostications about the likely level of return to the office on the part of workers are correct, than this state of affairs will likely continue.

This will all contribute to a willingness on the part of municipalities to reexamine their zoning laws. While not a direct fiscal issue, rezoning as a method to address affordable housing shortages will be an increasingly utilized tool. It serves to improve housing stock, preserve ownership, and support existing communities. These are often better connected to transportation and employment opportunities. Changes in zoning will have various impacts on assessed values and tax revenues which we believe would be positive.

Senior Living is far from a one size fits all sector. The American Health Care Association and National Center for Assisted Living, which represents more than 14,000 nursing homes and assisted living facilities across the U.S., found 90% of the 953 nursing homes that responded said their profit margins are 3% or less, and 65% said they are currently operating at a loss. The biggest increase in cost was staffing.

Digging deeper we find that the realities for skilled nursing credits are far different than for continuing care senior living credits. The IL and AL segments of integrated senior living projects have been able to generate revenues to support skilled nursing beds as those beds generate increased costs and real concerns about people’s willingness to move to nursing homes. It all combines to improve the outlook for senior living.

Transportation Technology Toyota plans to unveil a prototype electric car with a solid state battery in 2021, a long-sought technological breakthrough that would dramatically increase range and longevity while cutting charging time. Mercedes-Benz announces six new electric vehicles, including two SUVs that will be built at an Alabama plant. The police department in Redding, CA is seeking city approval for a specially equipped Tesla and other electric or vehicles for its fleet. The request follows a successful pilot program in Fremont, CA.

Three simple stories which neatly cover three important legs to the acceptance of electric vehicles story. The Toyota announcement addresses commonly cited concerns with EVs over range and charging time. The Mercedes announcement is about jobs related to EV production at an existing plant. That’s one fewer group of workers “losing” in the process of transition. The police car announcement shows that entities with fairly unique and stringent operating requirements are able to satisfy them with electric power.

We have noticed that as localities go through their budget processes for 2021, the issue of electric vehicles has moved forward in the debate. Even where cities are not moving towards widespread adoption at present we have noted that those debates seem to center around the issues of when and how much. Governmental users are in a unique position to advance technological change in transportation simply through the investment and purchasing decisions they make. Now that the idea of employing electric vehicles is seen as viable for vehicles associated with public safety, the next step to full adoption for municipal vehicle fleets is not far behind.

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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MEDICAID WORK RULES REACH SUPREME COURT

Arkansas was one of the first states to receive permission from the federal government to require Medicaid recipients to meet minimum requirements to work in order to receive Medicaid benefits. More than 18,000 people lost coverage in Arkansas due to work requirements once the requirement was enforced. In February, a federal appeals court had found that the approval of the requirements in Arkansas was “arbitrary and capricious.” The court said the administration did not adequately account for loss of coverage that would stem from the requirements to work or volunteer. The D.C. Circuit reached a similar conclusion in May when New Hampshire’s work requirements were challenged.

The decisions reflected the operating realities of these programs which in large part need recipients to self-report on line their employment or volunteer efforts. Given that the program serves the poorest, access to the internet is far from a given for that cohort making it likely that those individuals would lose coverage. The philosophical legal issue is whether Congress intended for a law designed to increase access to health coverage to be used coercively to motivate work or volunteerism.

To date, the courts have found that that tying the issues of work and health coverage are not consistent with Congressional intent.

PANDEMIC CASUALTIES – CULTURAL FACILITIES

The New York Philharmonic projects that the cancellation of its 2020-21 season will result in $21 million of lost ticket revenue, on top of $10 million lost in the final months of its previous season this spring. Now, in light of these losses as well as the likelihood of a slow return to indoor events, The Philharmonic has reached an agreement with its musicians that includes substantial salary cuts.

The musicians will see 25% cuts to their base pay through August 2023. Pay will then gradually increase until the contract ends in September 2024, though at that point the players will still be paid less than they were before the corona virus pandemic struck.  It’s not clear how much this agreement will set a trend as the pandemic occurred coincident with the expiration of the existing labor contract. It is easier to negotiate these sorts of cuts within the context of an expired agreement versus reopening an existing contract.

It is nonetheless a sign of what may be to come for many of these institutions.  They will be under pressure even in the immediate aftermath of the pandemic. The Metropolitan Opera (the Philharmonic’s next door neighbor, is seeking 30% cuts in pay from several of its major unions until box office reaches pre-pandemic revenue levels, at which point the cuts will be reduced to 15%. 

These maneuverings reflect the larger reality that the economic recovery from the pandemic will be gradual and the magnitude of that recovery highly uncertain at present. The non-profit sector, especially its arts based component, is undergoing an unprecedented set of pressures which will dampen overall creditworthiness.

CONVENTION CENTERS

King County will look to bail out the Washington State Convention Center with a $100 million loan as sufficient private sources of funding have not materialized for the $1.9 billion expansion project in downtown Seattle.  The County had previously indicated the expansion project was $300 million short of its funding target and, without federal aid, could run out of money by the end of the year. The money would come from the county’s $3.4 billion investment pool, which invests funds for county agencies and school, water, sewer and fire districts.

Since the pandemic began, 67 conventions have been canceled, according to the Downtown Seattle Association. Downtown hotels have held only 10% to 20% of their normal guests, according to the Downtown Seattle Association, and revenues have been down more than 90% from last year. This directly impacts the credit supporting municipal bonds issued to finance construction as they are payable from local and county hotel taxes.

It is another way of funding the project without asking the taxpayers (currently) to fund it through increased tax revenues. That does not mean that all of the county’s stakeholders will be happy. Some will question the prioritizing of the convention center over things like transit and affordable housing. It will allow the project to continue so the facility is best positioned for any post-pandemic demand.

CLIMATE CHANGE AND CAR DEALERS

In September of this year, General Motors informed its 880 Cadillac dealers that they would be required to invest some $200,000 in their dealerships to accommodate electric car sales. The dealer network had until Nov. 30 to make the decision if they wanted to take a buyout. Some 150 dealers out of the 880 opted for the buyout. The impact on potential sales is not clear.

The choice comes as GM looks to sell more vehicles powered by electricity than by fossil fuels by the end of the decade.  Cadillac will be its primary outlet for electric vehicles initially. An electric crossover model is expected to be available in the first quarter of 2022. The investment GM is asking for would cover charging stations, training of employees and lifts that can carry the heavy batteries powering the vehicles.

Dealers are important sources of local tax revenue and a source of employment for non-college graduates. This is especially true in more rural areas so the loss of jobs and tax revenues is important. Now that the industry is coalescing behind a move to follow California’s increasingly heavy regulation of internal combustion powered vehicles, it is likely to accelerate acceptance of the Golden State’s pending restrictions on their sales.

It is just the largest most visible example of the trend. If they haven’t already, all of the carmakers will be undertaking similar efforts with their dealer networks. That is the reality of California’s policy ending internal combustion vehicles sales in 2035.

CLIMATE CHANGE AND PUBLIC POWER

Nebraska’s two large public utilities are moving forward on goals to get their operations down to net-zero  carbon emissions. The Lincoln Electric System has voted to achieve net-zero carbon emissions by 2040. Lincoln has been purchasing wind power from three facilities in Nebraska and two neighboring states since 2015. Since 2010, LES has reduced its carbon emissions 42%.

The other major public electric utility in the state – the Omaha Power District – has adopted a goal of net zero generation but by 2050.  The OPPD adopted its goal one year earlier than did Lincoln and it seems to have established a starting point for Lincoln. The 2040 date adopted there is a compromise between a 30 year goal favored by established businesses and a 20 year goal favored by newer energy based businesses.

In both cases, public utility ownership seems to be fostering a more direct public process in decision making that is hindered by the need to generate “profits”. This is in contrast to IOUs owned by a holding company parent dependent upon dividend generation by the local US utility.

FOSSIL FUEL FUTURE

For utilities public and IOU, the potential for having to deal with stranded assets under aggressive plans to move generation to renewables can be a real impediment toward achievement of climate goals. So we saw with interest research making a case that a 2035 electricity decarbonization deadline, as proposed by President-elect Biden and the 2020 Democratic party platform, would strand only about 15% of fossil capacity-years and 20% of job-years.

In 2018, 10,435 fossil fuel–fired generators produced 63% of U.S. electricity with 841 GW of capacity. They also emitted 1.9 billion tonnes of carbon dioxide, 1.3 Mt of nitrogen oxides, and 1.4 Mt of sulfur dioxide, while consuming 3.2 billion m³ of water for plant operations and fuel extraction. These facilities operated in 1248 of 3141 counties, directly employed about 157,000 people at generators and fuel-extraction facilities.

So the basis of the economic fear associated with decarbonization is obvious. The research shows that the end of coal generation may simply be rooted in operating reality as much or more than policy decisions. Look at the current landscape to see why this is the case. Of operable U.S. fossil fuel–fired generation capacity (630 out of 840 GW), 73% reaches the end of its typical life span by 2035 (810 GW, or 96%, by 2050; 100% by 2066). About 13% of U.S. fossil fuel–fired generation capacity (110 GW) operating in 2018 had already exceeded its typical life span. 

Those numbers make the case that blind political resistance to the move away from fossil fuels simply ignores reality. A key finding of this research is that a 2035 deadline for completely retiring fossil-based electricity generators would strand only about 15% (1700 GW-years) of fossil fuel–fired capacity life, alongside about 20% (380,000 job-years) of direct power plant and fuel extraction jobs remaining as of 2018.

Does this mean that there is no disruption associated with decarbonization? No. Requiring fossil generators to close by 2035 would result in limited, although sometimes locally impactful, asset stranding relative to typical life spans. 

PANDEMIC CASUALTIES – G.O. RATINGS

The second wave of the pandemic is underway in New York City. The closure of the schools last week and the threat of renewed restrictions on gatherings and economic activity like indoor dining have renewed pressure on the City’s finances. So, S&P has lowered its outlook on the City’s ratings from stable to negative.

S&P made it clear that this is a move related to the virus rather than a criticism of management. “The negative outlook reflects (S&P’s) opinion of uncertainties, such as a recent uptick in the virus transmission rate that could negatively affect the city’s financial forecast, the trajectory for global tourism trends and additional federal stimulus funding for state and local governments, service reductions at the Metropolitan Transportation Authority that could affect the economic recovery within the region, and weakness in property tax values that will not be evident until fiscal 2023.” 

That last point is important. Regardless of the difficulties currently underway in the City’s real estate sectors, the fact that property values for tax purposes are adjusted over a five year period rather than within the FY that valuation impacts occur has a supportive effect on property tax collections.  

Fitch also downgraded to rating on NYC general obligation debt to AA- from AA. “The downgrade of the city’s IDR to ‘AA-‘ from ‘AA’ and one-notch downgrade on associated securities reflects Fitch’s expectation that the impact of the corona virus and related containment measures will have a longer-lasting impact on New York’s economic growth than most other parts of the country. This view is informed by the weak rebound to date in employment, real estate transactions, tourism and mass transit usage. Very low rates of employees returning to offices and the potential for a longer-term trend of lower office usage could exacerbate current economic pressures on the city’s credit profile.”

Another city to see its rating impacted negatively is Milwaukee. The pandemic was seen as an impediment to the placement of a sales tax initiative on the ballot. Without the additional revenue from a sales tax, higher state aid, or substantial expenditure cuts, the concern is that the city’s currently adequate reserves will deteriorate. This led Moody’s to downgrade the rating to A2 from A1 on the city of Milwaukee, WI’s outstanding general obligation unlimited tax (GOULT) bonds. The lack of additional revenues comes as the City faces pension costs which are scheduled to significantly increase under the city’s current pension funding ramp up period.

SALT RIVER NUCLEAR DEAL

One public utility has found away to increase its nuclear generating capacity without the accompanying construction risk in Arizona. The Salt River Project announced that its board has approved the purchase of part of Public Service Co. of New Mexico’s ownership share of the Palo Verde Nuclear Generating Station in Arizona. SRP was already one of the owners of the plant. Its purchase of 114 megawatts of Palo Verde’s output will increase SRP’s share of the plant from 17.5% to 20%.

The purchase of most of the power is expected to be completed in January 2023, followed by the remainder in 2024. SRP specifically cited the lesser risk of purchasing a share in an existing facility versus the cost and risk of new nuclear generation.  SRP needs to lower its carbon emitting generation capacity to meet its 2035 Sustainability Goals which call for a reduction of CO2 emitted by generation by 65% by 2035 and 90% by 2050. 

For SRP, it achieves several short term goals while approaching  nuclear in a far more cost and risk effective way versus the strategies being followed by MEAG and SCPSA in the southeastern U.S.

MUNICIPALS AND FOSSIL FUEL INVESTMENT

A couple of recent announcements show that the drive to force divestment in the fossil fuel industry which had hit financial and educational institutions is beginning to have its impact on municipal investment activities. The latest examples are Summit County, CO and New York State.

While the scope and timing of the two divestment programs are substantially different, the underlying factors driving the decision are similar. The County formally passed an ESG resolution which provided mechanisms for divestiture. This after the County passed its Climate Action Plan in 2019. The Treasurer’s Office has completed the sale of its last holdings of fossil fuel stocks from the County’s managed portfolio of investments.

In the case of New York State, the continuing pressure on the earnings of fossil fuel entities has made it easier to make a case for divestiture. The State had been loathe to make the decision purely on a policy basis. Now, the State will require companies to meet new standards requiring them to show “future ability to provide investment returns in light of the global consensus on climate change.”  The Fund is committing to sell its investments in any oil, gas, oil-services and pipeline companies that do not have clear plans to abandon the fossil fuel business. 

The fund is committed to selling its stakes in firms – including utilities, manufacturing, transportation  – if they do not eliminate such emissions by 2040. This phase of climate related investments came in  the face of an effort by the legislature to mandate changes in the investment policy. The announcement by the Comptroller comes under a formal agreement with the Legislature under which pending legislation on this issue was withdrawn.

ILLINOIS DEBT CHALLENGE GOES ON

The effort by a hedge fund investor to take advantage of a short strategy using credit default swaps by having some $16 billion of State of Illinois general obligation debt invalidated will have its day in the Illinois Supreme Court. While the fund investor has dropped out of the appeal, a state political activist who was the straw plaintiff is pressing on.

The case has so far been decided on matters of plaintiff standing rather than on the “merits” of the plaintiffs case. The Illinois Supreme Court will now deal with the facts of the case. The complaint alleged that Illinois’s 2003 and 2017 GO Bond issuances violated a provision of the Illinois Constitution that requires long-term debt to be for a “specific purpose” (Il. Const. art. IX, § 9), arguing that “specific purposes” include only “specific projects in the nature of capital improvements, including roads, buildings, and bridges.”

The complaint further alleged that the 2003 issuance of “Pension Funding Bonds” failed to satisfy this “specific purposes” requirement, because it allocated bond proceeds to be used to reimburse the State’s General Fund for past contributions to the State’s retirement systems. The complaint similarly alleged that the 2017 issuance of “Income Tax Proceed Bonds” failed to satisfy this “specific purposes” requirement, because it allocated bond proceeds to be used to pay past due bills related to general operating expenses.

We believe that the bonds validity will be upheld. The real problem with the case is that the standard for granting leave to file taxpayer suits has been reduced , as the court focused specifically on whether the proposed complaint was “frivolous” or “malicious” and on whether the petitioner’s claims were merely “colorable,” rather than placing the burden squarely on the petitioner to establish that reasonable grounds existed for filing the suit. This makes it more likely that suits such as this might be brought primarily for the facilitation of investment strategies which pay off in the case of invalidation.

ROAD TO RECOVERY

California State University (CSU) was the first state university to decide to conduct its full fall 2020 semester on line. Now, CSU announced that it is planning for an anticipated return to delivering courses primarily in-person starting with the fall 2021 term. It cited ” light at the end of the tunnel with the promising progress on vaccines.”  The announcement comes as high school and transfer students have until December 15 to complete their applications for fall admission. 

In as much as the system was an “early adopter” in the pandemic response, we think that it is significant that the move is being announced during the ongoing pandemic surge in California. CSU is, after all, is the largest system of four-year higher education in the country, with 23 campuses, 53,000 faculty and staff and 486,000 students. is the largest system of four-year higher education in the country, with 23 campuses, 53,000 faculty and staff and 486,000 students. It serves as an excellent indicator for how many systems are likely to respond.

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 ECONOMIC BACKDROP

The Federal Reserve has released its latest Beige Book with its view of the economy as the nation neared Thanksgiving. Most Federal Reserve Districts have characterized economic expansion as modest or moderate since the prior Beige Book period. However, four Districts described little or no growth, and five narratives noted that activity remained below pre-pandemic levels for at least some sectors. Moreover, Philadelphia and three of the four Midwestern Districts observed that activity began to slow in early November as COVID-19 cases surged.

Banking contacts in numerous Districts reported some deterioration of loan portfolios, particularly for commercial lending into the retail and leisure and hospitality sectors. An increase in delinquencies in 2021 is more widely anticipated. Providing for childcare and virtual schooling needs was widely cited as a significant and growing issue for the workforce, especially for women – prompting some firms to extend greater accommodations for flexible work schedules.

Contacts are concerned that when unemployment benefits and moratoriums on evictions and foreclosures expire, an avalanche of bankruptcies will emerge among other small and medium-sized businesses, as well as households. hiring plans for the year ahead were generally modest. About a third of contacts expected they will still be below pre-pandemic staff levels 12 months from now.

This creates a backdrop for the upcoming budget season for the states which will be difficult even if there is a stimulus.

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PANDEMIC FUNDING NEEDS

At least when the northeastern states bore the brunt of the first wave of the corona virus pandemic,  Congress stepped up and provided aid to institutions like hospitals and to many state and local entities. While it was not enough, it did allow some of the hospital credits to be shored up against the financial impacts of the pandemic response. Now the atmosphere in Congress is different and the consensus supporting an additional fiscal response is much less apparent. That makes for a far more difficult environment for healthcare credits in the areas of greatest demand. It is not clear as to whether sufficient support will be available to these credits especially in the center of the nation.

Another major sector on the precipice of fiscal disaster are the nation’s major mass transit agencies. While the troubles of New York’s MTA have been most prominent,  transit agencies across the country are facing draconian cuts in service without additional federal fiscal aid. (see article) While current utilization rates are historically low,  these agencies face the dilemma resulting from the fact that service cutbacks could permanently alter demand impacting revenues and debt service coverage. The States are muddling through as best they can. This is being used by some to make an argument that additional aid is not needed.

There is one problem. The current federal “plan” for distribution of a vaccine against the corona virus relies on the States to distribute the vaccine to providers. What it does not provide is any funding for this crucial step in the process. Estimates of the cost to the States have ranged up to $8.5 billion. Given the potential for increased economic pressure from emerging lockdowns, it is unfair to expect the already impacted state budgets to absorb more imposed fiscal demands.

Regardless of one’s individual politics, the failure to fund vaccine distribution through to final consumers makes no sense. It is consistent with the resistance to limits on activities in terms of a national strategy against the virus. But logically, the cost should be borne at the national level even if the actual physical execution of the plan is at the state level. Given where the virus is currently least under control, it makes no sense on a partisan basis.

These three sectors – hospitals, mass transit, and states – should be the primary targets of any additional federal support.

PUERTO RICO

The US Supreme Court declined to hear an appeal from bondholders seeking higher recovery on approximately $3 billion of defaulted C-rated Puerto Rico Employees Retirement System (ERS) bonds, issued in 2008 to fund pension liabilities. The “plan of adjustment” offered a 13% recovery on their claim. ERS bondholders’ debt service payments have been suspended since the Title III proceeding began in May 2017.

The US district court overseeing Puerto Rico’s bankruptcy-like case ruled in June 2019 that employer pension contributions to ERS do not qualify as special revenues under US bankruptcy law, a distinction bondholders sought in hopes of forcing Puerto Rico to resume debt service payments during the Title III proceeding. Special revenue backed debt holders have historically fared well during prior Chapter 9 proceedings.

The court further ruled that ERS bondholders’ lien on employer pension contributions does not “attach” to any contributions made after the system’s May 2017 bankruptcy-like petition, leaving them with an entirely unsecured claim. An appeal of that decision in the US Court of Appeals for the First Circuit upheld the lower court decision. The decision by the Supreme Court not to hear ERS bondholders’ appeal confirms of the First Circuit’s ruling as the final word.

Another shoe to drop was the news that the Puerto Rico Oversight Board approved a proposal that would include cuts in pensions.. Under the proposal, the board would cut by 8.5% pensions above $1,500 a month. This is an increase from $1,200 a month, as had been the case in the February 2020 proposed plan of adjustment. Clearly, asking pension bond investors to take huge haircuts without some impact on pensioners does not make sense. And then there is the Christmas bonus.

Over time one becomes immune to shock when the lack of a realistic outlook of the part of Puerto Rico’s ruling class becomes such an ingrained feature of the political landscape. The latest is the news that the Gov. Wanda Vázquez administration is requesting an authorization from Puerto Rico’s Financial Oversight and Management Board (FOMB) to use “excess” funding that had been earmarked for monthly payments to government retirees to cover a $23 million gap in this year’s allotment for payment of the annual Christmas bonus to public employees. 

It is just so indicative of the blind spot that Puerto Rico’s governments  have had over the years when it comes to the perception of investors. What is one supposed to think about a plan to take money for pensions away from pensioners and give it to current employees at the same time the financiers of the pensions are being asked to take 13 cents on the dollar.

MUNICIPAL LENDING FACILITY

The decision by the Trump administration to end the Federal Reserve’s Municipal Liquidity Facility program at the end of the year has caused some consternation. We believe that the market will survive the loss of the program. Recent months have shown that the market has the ability to finance the needs of even some of its most troubled borrowers.

The issue comes down to that of cost. The market clearing rates charged to borrowers from the facility do represent a significant spread above general rates. What they do not represent is a huge burden for potential borrowers on an absolute basis. Prior crises for municipal borrowers generated double digit interest rates even with credit support. That’s not desirable but the point is that it has been handled before.

The fact of the matter is that utilization of the facility has been much less than was expected. That is not indicative of any policy or programmatic flaw. There still is time for additional borrowing through December 31 but there only seem to be a couple of candidates likely to tap the facility. Illinois announced that it will access the program for a second time for $2 billion. The favorable market reception for some of the most prominently mentioned borrowers supports the more conservative view.

PENNSYLVANIA ELECTRIC CAR FEES

It took a party line vote but the Pennsylvania House has approved legislation enacting a fee on the registration of electric and hybrid vehicles. The fee is ostensibly designed to address the issue of owners being “free riders” on the Commonwealth’s roads by virtue of electric and/or hybrid car ownership. The fee would be $75 per year for a hybrid gas-electric vehicle, $175 a year for an electric vehicle and $275 for an electric vehicle with a weight rating of more than 26,000 pounds, such as a city bus.

The majority of the Legislature is supportive of the energy industry broadly in the Commonwealth. They saw the issue as an opportunity to impose a penalty on owners of greener cars. It’s consistent with the history of undertaxation of the natural gas fracking industry. The situation is one where the issue of equalizing user costs for roads may have taken a step forward (green) while clearly establishing an adversarial stance about non-internal combustion transportation (not green). It is hard to make the case that electric vehicles do not impose costs on the transportation infrastructure.

Mileage fees would address that concern as they would be agnostic as to the sort of motor for vehicles generating the utilization of roads. They are not as far along the political curve as these annual fees are. Twenty-eight states have laws requiring a special registration fee for electric vehicles while 14 states impose a fee specifically on hybrids. Mileage taxes are currently in their beta phase on a limited voluntary basis in other states.

This is not the only transit issue causing debate in the Keystone State. The Pennsylvania Department of Transportation (PennDOT) waited until the end of the budget process to announce a need for some $600 million of debt issuance to cover revenue shortfalls due to reduced driving. Because the issue was not part of the recently concluded state budget process, the state legislature would have to reconvene to approve the funding. Without the funding, PennDOT said construction on hundreds of road projects would stop on Dec. 1st, and those working on the projects could be laid off.

This led to an agreement between the Governor and the Legislature that allowed PennDOT to continue road and bridge work after lawmakers pledged to tackle PennDOT’s funding crisis when they return to session in January.

MORE TRANSIT FUNDING WOES

The operating agency running the Washington, D.C. Metro is proposing a new operating budget with a nearly $500 million deficit. The proposed 2021 budget includes closing Metrorail at 9 p.m., ending weekend service, closing 19 rail stations and reducing the number of trains, which would result in longer wait times. Current data shows the return of 20-25% of the pre-pandemic ridership. The system would look for $500 million in aid from any package enacted by Congress.

Without further federal action and major additional budget relief, MTA management now preliminarily projects total deficits attributable to COVID-19 pandemic impacts for the November Plan period of approximately $15.9 billion. As of November 6th, ridership was down 69% on the subway, 49% combined on bus service provided by MTA New York City Transit and MTA Bus, 73% on the MTA Long Island Rail Road, and 77% on MTA Metro-North Railroad. Traffic. MTA intends to borrow the maximum it is allowed to borrow under the program, $2.9 billion, before the lending window closes at the end of 2020. MTA expects to issue long-term bonds in 2023 to repay the MLF loan.

MARYLAND P3 SURVIVES

Deadlines have passed and in some areas of the project management was offloaded to the State in the face of the apparent breakup of the P3 developing the Purple Line in Maryland. Now, an agreement has been reached which will preserve the P3 nature of the project. Gov. Larry Hogan announced the state will pay $250 million to settle with the private consortium, Purple Line Transit Partners,  to settle “all outstanding financial claims and terminates the current litigation between the parties.”

Meridiam, Star America and Fluor were the corporate partners comprising Purple Line Transit.  The project will continue with Meridiam and Star America remaining as developers and equity partners. The group will then find a design-built contractor to finish the project , substituting for Fluor.  Some work on the project has continued under supervision by the state, including light rail car manufacturing, bridge work, stormwater drainage, paving, utility and pump station construction. That work will continue awaiting the selection of a new design-builder partner.

The project publicly maintains an estimated 2024 completion date. We’ll see as any potential design-build partner will be making its own assessment. It is a positive to see that a resolution has been reached removing a significant hurdle slowing project completion. Now the risk is more focused on ultimate execution of the project.

HARRISBURG PARKING

The debt problems in Pennsylvania’s capital city continue, this time with the city’s parking revenue bonds issued through the Pennsylvania Economic Development Financing Authority. Moody’s Investors Service has downgraded to Ba2 from Baa3 the rating on the Authority’s (PEDFA) (The System) Senior Parking Revenue Bonds (Capitol Region Parking System) The outlook has been changed to negative from stable. Roughly $117.5 million of outstanding par is affected.

The credit generated sum sufficient coverage but was always challenged to generate greater revenues. Operations were characterized by high leverage and total cost obligations, minimal liquidity, limited capital funding, and uncertain willingness and rate-making flexibility to raise rates. A primary source of revenue is a long term lease with the Commonwealth (70% of the system’s spaces) which locks in revenue levels which only generate at best thin coverage. These charges cannot be readily raised.

Under the circumstances of the pandemic, the credit required increasing drawdowns of capital reserve funds. That raises issues regarding good maintenance and upkeep and how they will be funded in the face of current demand trends. For bondholders, the unfavorable economics are backed up by an unfavorable legal structure that enables a covenant default as well as payment default on the subordinate bonds to trigger an acceleration of the senior bonds.

CLIMATE CHANGE, MANAGED RETREAT AND MUNICIPALS

Over time we have commented on a number of issues surrounding responses to climate change and their implications for municipal credits. One of those responses is the concept of managed retreat. In practice to date, much of that discussion has been theoretical. Now we have an example of a real municipal project designed to facilitate a managed retreat.

State Route 1 along the Sonoma County coast in California has been damaged by multiple erosive forces and the existing two-lane roadway continues to be undermined by coastal erosion and is vulnerable to future storms. Caltrans has responded by initiating emergency projects to reinforce the roadway, including constructing a retaining wall in 2004, which was later undermined by coastal erosion. Since 2017 Caltrans has issued emergency work orders to repair and stabilize the worsening roadway, but these are all short-term solutions.

Now Caltrans has announced a plan to relocate a section of State Route 1 in the area of Gleason Beach, north of San Francisco. The Gleason Beach Realignment Project would construct an approximately 3,700-foot, two-lane roadway and 850-foot long bridge span over Scotty Creek. This would move State Route 1 away from areas of erosion, preserve access to the existing homeowners. This allows the State to address one of the obvious risks from climate change, that of rising sea levels.

Continued coastal erosion and other conditions has undermined the existing SR 1 at a rate of 1 foot annually and could increase to approximately 1.5 feet per year by 2050 and 4.6 feet per year by 2100. The project is scheduled to begin in 2021 and be completed in 2023. Its projected cost is $73milion. Whether it is road relocations like this or road raising projects as have been seen Florida, the concept is gaining greater currency and we expect to see more debt issuance for these sorts of mitigation and resiliency projects.

On the East Coast, other projects will be funded on a smaller scale in coastal communities in the Northeast. In Maine, ten such communities will develop the State’s first comprehensive resilience plan. This planning will highlight the sorts of projects which are likely able to be financed in the municipal bond market. A role for municipalities is clear. Physical infrastructure-based projects such as elevating roads and expanding culverts are the market’s bread and butter,  The cities also will seek to highlight policy issues which can be more currently be addressed such as land use decisions, municipal policies, and land conservation efforts. 

MIDWEST NUCLEAR DRAMA UNFOLDING

The idea that private operators of nuclear generating plants could receive subsidies to continue to operate unprofitable nuclear generating facilities is not new. In New York and Illinois, operators have been successful in receiving such subsidies. The operators cite the lack of greenhouse emissions from nuclear generation and the role of these facilities as sources of employment. The efforts to obtain these subsidies have been steeped in politics and the desperation of the operators have led them to push the ethical envelope as they seek support for these subsidies.

In Ohio, these efforts have come under harsh scrutiny. HB 6, a $1 billion bailout for Ohio’s two nuclear power plants was signed into law in July 2019. Shortly thereafter, an investigation by the FBI was announced into an alleged $60 million public corruption scheme led by Republican Speaker Larry Householder. The Speaker and several associates are alleged to have been paid tens of millions of dollars to pass HB 6 and to prevent a referendum against the law from coming before Ohio voters. If proven, it would be the largest corruption and money-laundering scheme ever in Ohio. 

Now legislation is being introduced which would repeal House Bill 6. Without any change, residential customers will be billed an 85-cent fee each month on their electric bills starting Jan. 1.  Those fees, and larger ones assessed on businesses, would raise about $150 million a year for two nuclear plants originally owned by the IOU First Energy. It’s a contentious issue as it pits supporters of the energy/climate status quo and those who wish to move to renewables. The outcome of the ongoing legal and investigative proceedings will influence the ultimate resolution of the issue of legacy generating assets in an era of environmental change.

In Illinois, former Commonwealth Edison officials pleaded not guilty to charges that they engaged in a years-long bribery scheme that federal prosecutors allege was aimed at influencing Illinois House Speaker Michael Madigan. Com Ed is another utility saddled with unprofitable nuclear generating plants. The 2016 Future Energy Jobs Act provided ratepayer-funded subsidies to two nuclear power plants owned by ComEd’s parent company Exelon.

The employees are charged with agreeing to provide no-work jobs and lobbying contracts to close associates of Madigan as part of an effort to maintain his support for legislation helping Com Ed. A deferred prosecution agreement was announced by prosecutors in July in which current ComEd officials admitted to the scheme and agreed for the company to pay a $200 million fine in exchange for cooperating with the investigation and assurances that the company would reform its internal controls.

As climate change responses are proposed many believe that nuclear power will get another serious look as a source of carbon free energy production. These examples of extraordinary political actions taken to overcome the unfavorable economics of nuclear power tell us that the utilities know that nuclear does not make economic sense.

ATLANTIC CITY

Given the impacts of the pandemic and related closures and limitations, one might not readily expect that the locale of a major center of casino gambling would be an improving credit. Nonetheless, Moody’s Investors Service has affirmed the City of Atlantic City, NJ’s long-term issuer rating at Ba3 and revised the outlook to positive from stable. The positive outlook reflects Moody’s expectations that, despite the pandemic, Atlantic City will continue making strides in improving its governance and finances. 

The City has successfully entered into a program for payments in lieu of taxes (PILOT) with the  casinos. The pandemic has not been a total wipe out for the casinos with the growth of online gambling. This has enabled PILOT payments to be made adding certainty to the City’s revenue base. This has occurred as financial practices have improved under the continued, strong oversight by the State of New Jersey. That oversight occurs under legislation dealing specifically with Atlantic City which effectively expires toward year end 2021. 

The rating assumes that oversight will continue. Without any additional legislative action, the State Supervision Act will remain in effect. This act grants the state certain oversight powers over all New Jersey municipalities and additional supervisory powers over distressed municipalities such as Atlantic City.

THE POLITICS OF WATER

Westlands Water District is the largest agricultural water district in the United States, made up of more than 1,000 square miles of prime farmland in western Fresno and Kings Counties. Water is delivered to Westlands through the Central Valley Project (CVP), a federal water project that stores water in large reservoirs in Northern California for use by cities and farms throughout California. Water is delivered to farms through 1,034 miles of underground pipe and more than 2,924 water meters.

It is one of a number of water agencies who secured their water from the federal system under renewable contracts. This created a risk for the agencies in terms of long term planning and operations. So they looked as they have historically to their political connections to attempt to create an opportunity for long term commitments for water.

The 2016 Water Infrastructure Improvements for the Nation Act, known as the WIIN Act, allowed for reclamation contractors across the West to get permanent contracts if they repaid what they still owe U.S. taxpayers for construction of a federal water project. The distribution of water from the federal water project is managed by the US Bureau of Reclamation which is part of the US Department of Interior.

 Interior Secretary David Bernhardt for years represented Westlands as a Washington lawyer and lobbyist before joining the Trump administration. Now his decision to make permanent Westlands Water Districts water allocation is reported to provide a permanent entitlement to annual irrigation deliveries that amount to roughly twice as much water as the nearly 4 million residents of Los Angeles use in a year. The overwhelming bulk is for agricultural use.

The Administration has chosen to fully wade into the California water wars. While granting long term allotments to big agriculture interests it has also proposed raising the height of the Shasta Dam to increase supplies available for allotment under agreements favoring agriculture. It simply insures that the long running water wars in California will continue.

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.