Joseph Krist

Publisher

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ALL FORMS OF PUBLIC TRANSIT SEE DECLINES

The latest example of the impact upon all forms of mass transit of the pandemic comes out of the Pacific Northwest. Annual ridership aboard Washington State Ferries plunged by nearly 10 million customers in 2020 – a drop of 41% from the previous year – to roughly 14 million. Stay-at-home orders, remote work and decreased tourism because of COVID-19 are the main reasons for the system’s lowest yearly count since 1975.

The impact of empty offices was very clear. For the first time since it began operations in 1951, WSF carried more vehicles (7.6 million) than passengers (6.4 million) last year. This shift in ridership was fueled by a dramatic decline in walk-on customers on routes that serve downtown Seattle and more people choosing to drive on board because of the pandemic.

We find the latter comment to be interesting. The assumption is that the empty streets in big cities will remain the norm. That idea may be misplaced. If the private vehicle is seen as a “safe space” in comparison to traditional public transit or even Lyft and Uber. the constituency for space for private vehicles could be larger than anticipated. In recent months, state ferry ridership has returned to about 60% of pre-pandemic levels. Total vehicles are near 70% of 2019 numbers, while walk-ons are around 20% of last year. 

The increase in remote working continues to impact the ferries. The largest year-to-year dip came on the Seattle/Bremerton run, where ridership was down 64%. The Seattle/Bainbridge Island route had the second biggest decrease at 59%, falling out of the top spot as the system’s busiest for the first time since 1958. The pressure on office space will continue as firms extend remote work options.

In New York, the Metropolitan Transit Authority said it would delay fare increases until the local economy showed signs of a recovery and there was greater clarity about how much federal aid the agency could expect.  MTA is hoping that it could receive additional direct operating aid of up to $8 billion to offset revenue losses stemming from the pandemic.  The Biden Administration is seeking $20 billion for the country’s “hardest hit public transit agencies” in its stimulus proposal. Subway ridership has levelled off at around 30% of pre-pandemic levels, traffic on the M.T.A bridges and tunnels has rebounded to about 84% of normal.

MUNICIPAL BROADBAND

As the Biden Administration takes shape and policy priorities are established, potentially challenged private interests are already challenging those which are seen as challenging their interests. One which amused/annoyed us was an opinion piece in The Hill from an analyst at the Technology Policy Institute. Municipal broadband is a bad idea for cash-strapped towns is the name of the piece. The piece is based on data derived from a research report commissioned from the TPI in 2019.  

The piece comes with it a pile of data and equations and assumptions and a variety of statistical data manipulations seeming to indicate that a serious conclusion will result from the report. At the end of the day, though the really telling conclusions won’t be a shock. They won’t be a shock because the Institute is funded by the Koch family and the telecommunications industry. “The presence of a municipal network did not appear to generate a statistically significant improvement on broadband adoption or in economic conditions. My findings do not show that municipal broadband will necessarily fail. ”

 

In short, a thesis offered and the thesis fails to be proven. That is the amusing part. The annoyance comes from the following comment. “The private sector should continue to support universal broadband, and governments should aid them in doing so.” And “a municipal network might yield benefits on the margin, such as in areas without other coverage.” As the great philosopher Homer Simpson said, “duh”.

What you don’t see is that some of the same entities sponsoring this research are some the worst offenders in terms of providing slow overpriced broadband service. That’s the case even when these providers are granted an effective monopoly in a given service area. (Full disclosure: I am a Spectrum customer in upstate NY. Enough said.) What is also annoying is that these are many of the same arguments advanced against public broadband reflect prejudices leveled against the TVA some 90 years ago. 

We’ve been down this road before. Like the electric distribution industry, both the municipal and private sectors have roles to play in the expansion of rural broadband.

NEW YORK STATE BUDGET 

Governor Cuomo released his formal budget proposal for FY 2022 beginning April 1. The expectation that a Democratic Congress and President would be able to deliver significant additional aid to states and localities underpinned the proposal. The budget statement said that in April, it projected a $63 billion, four-year revenue loss. At the time, 1.8 million New Yorkers had lost their jobs as the virus’s spread was peaking. But in the third quarter of 2020, the economy recovered faster than expectations. While the economic improvement is beneficial, it has not been enough to offset dramatic revenue loss and revenues are estimated to remain down $39 billion over four years, including losses of $11.5 billion in FY 2021 and $9.8 billion in FY 2022.

It came in two forms which depend on two scenarios: one assuming a federal aid package of $6 billion, and another with the full $15 billion that the State is seeking. The latter figure is the estimated shortfall being faced. If the federal government provides a $6 billion aid package the state would be unable to fill its budget gap. This would require, under the Governor’s plan,  cuts of about $2 billion in school funding, $600 million in Medicaid funding and $900 million in general reductions.

On the revenue side of things, a legalization of recreational cannabis could raise about $350 million. Bowing to political realities, some 100 million would be directed to a “social equity fund”. Issues related the reparative economics and justice movements have held up prior legalization which is supported by a majority of residents. The fund is an effort to address those concerns.

Tax receipts have shown sustained strength through December 2020 and into the important first week of collections in January 2021. PIT collections, the largest source of State tax receipts, were $2.25 billion above the estimate in the Enacted Budget Financial Plan through the first three quarters of FY 2021. Sales and use tax collections through the same period were $512 million higher than expected. At the same time, business tax collections, principally related to audits, have been weaker than expected, which party offset the significant improvements in PIT and sales tax collections.

COURT DROPS THE HAMMER ON LONG BEACH, NY

The City of Long Beach last week found itself on the losing end of  a damages decision from a Nassau County Supreme Court in the 31-year-old case of Haberman v. Zoning Board of Appeals of City of Long Beach. Yes, a zoning dispute has managed to survive in the courts  since the 1980’s. The Long Beach City Zoning Board revoked building permits to construct condominium towers  in the oceanside community. The revocation was based upon its determination that the builder had not abided by a previous stipulation of settlement between the parties.

The developer sued to overturn the revocations and won his case. Appeals by the City made their way through to the State’s highest court where they did not succeed in 2017. Over the ensuing years, the parties have litigated the damage claim portions of the case. It is this litigation which resulted in a $131 million judgment from the County Supreme Court.

While the City has consistently argued in court that no monetary damages were appropriate, its financial disclosures have been more realistic. : in Long Beach’s latest official statement from August 2020, the city estimated the judgment would cost it $55 million. At this point the City may appeal although the ever accruing interest on the damage amounts should motivate a settlement as well as a consistent record of ultimate losses on appeal.

The City’s credit was already facing enough pressure. It’s Baa2 rating was assigned a negative outlook in August, 2020. Those pressures include very weak financial position and a history issuing debt for operational expenses. local government has a high level of turnover which complicates a negotiated settlement in the zoning case as well as the City’s efforts to collect recovery monies from Superstorm Sandy damages. The City’s debt was described as above average but manageable in August but a final settlement could create what will effectively become a long term liability.

CLIMATE CHANGE LITIGATION

The U.S. Supreme Court heard arguments this week in a case brought by the City of Baltimore against the major oil companies seeking compensation from oil and gas companies for damages to public lands, buildings, infrastructure like roads and bridges; as well as for the cost of mitigation measures. Baltimore is one of 24 jurisdictions which have filed similar actions.

The argument until now has been over whether the litigation is a state or a federal matter. The energy companies fear that they will not fare as well in state courts as they would in federal court. The question presented is whether federal law permits a court of appeals to review all of the grounds for removal encompassed in a remand order where the removing defendant premised removal in part on the federal-officer or civil-rights removal statutes.

The district court remanded the case to state court, and petitioners appealed. The court of appeals affirmed. Now the energy companies are appealing that decision. What is different now is that the energy companies are asking the Court to rule on issues not previously argued.

The companies want the Court to rule on not just the specific  jurisdiction issues raised in this case but to also rule on the issue of whether or not any of the pending climate change litigation of this sort must be heard in federal rather than state courts. If the Supreme court agrees to decide not just the individual jurisdiction issue in the Baltimore case but also the question of whether any climate change cases like this must be heard in federal rather than state courts, the efficacy of the use of litigation to fight climate change will be lessened.

Not every environmental cause will be lost in the federal courts. A federal appellate court ruled against the Affordable Clean Energy rule. The rule was an effort to relax emissions limits with an eye towards making the economics of coal generation more favorable.  The limits were part of the Obama  administration’s Clean Power Plan which had mandated that power plants make 32% reductions in emissions below 2005 levels by 2030.

AIR TRAVEL AND AIRPORTS

The U.S. Department of Transportation released its January 2020 Air Travel Consumer Report (ATCR) on reporting marketing and operating air carrier data compiled for the month of November 2020. The 10 marketing network carriers reported 389,587 scheduled domestic flights in November 2020 compared to 374,538 flights in October 2020 and 655,072 flights in November 2019. That is a year over year decline of just over 40%.

Of those 389,587 scheduled flights, 0.5%, 2,106 flights, were canceled. Factoring in the cancellations, the carriers reported operating 387,481 flights in November 2020, compared to 372,544 flights in October 2020 and the all-time monthly low of 180,151 flights in May 2020. Airlines operated 649,511 flights in November 2019. That still nets a 40% decline in flights.

This data comes as North America (ACI-NA), the trade association representing commercial service airports in the US and Canada, has reported its financial projections that US airports will lose at least $17bn between April 2021 and March 2022. The $17bn loss was in addition to another $23bn deficit that US airports were expected to incur between March 2020 and March 2021.

None of this is a surprise. The It will take time for airport and related credits to recover. The timing of that recovery is vaccine dependent.

ROAD FUNDING DEBATES

This year it looks like road funding will be at the center of many state budget debates. It may yet be that the negative impact of the pandemic on traffic levels and revenues (tolls and fuel taxes) becomes the mother of invention in state legislatures. And it is happening in all areas of the country.

In Texas, in spring 2020, the Texas Comptroller certified that state motor fuel tax, Proposition 1, and Proposition 7 revenue was a total of $13.9 billion for the 2020-2021 biennium. In July 2020, in the midst of the COVID-19 pandemic, the Comptroller’s certified revenue estimate reduced this figure to $11.96 billion. The $1.9 billion cut in revenue amounts to 14% of the TxDOT budget. Right now, Texans pay 20 cents of state motor fuel tax on every gallon of gasoline or diesel. 15 cents is deposited into the SHF, and 5 cents goes toward education. Texas has the lowest motor fuel tax among the ten most populous states, while Texas also has significantly more lane miles than any other State. The State is responsible for maintaining over 197,000 lane miles.

The state motor fuel tax has not been adjusted since 1991.53 As a result, the tax has lost half of its purchasing power since then. If Texas had indexed the tax to the CPI in 1991, the tax would have grown to approximately 40 cents, and the state would be collecting twice the state motor fuel tax as it currently is today. The state motor fuel tax is the second largest revenue source for transportation, next to FHWA reimbursements. The Texas A&M Transportation Institute has indicated that peak motor fuel revenue will be around 2030.

So the committee explores several alternatives. It offered some surprising commentary on the use of P3s, especially since Texas is one of the larger implementers of P3s to develop road infrastructure. It addresses head on one issue which troubles some namely the transfer of revenues and profits to foreign entities. one of the things holding back widespread P3 use is the issue of the fact that many of these proposals are driven by foreign companies.

Comprehensive development agreements (CDA) are the Texas form of public-private partnership for roadway projects. “While Texas is in the early stages of its currently authorized CDAs, and they have been effective at alleviating traffic in highly congested areas, it should continue to be reviewed if the transfer of locally collected Texas toll or tax dollars to international and often foreign based firms is in the best interest of the public when building future projects. Specific contract clauses embedded within a CDA, such as the duration of the agreements, use of public subsidies, non-compete clauses and termination for convenience provisions, should also continue to be reviewed to ensure these agreements protect the interest of the citizens of Texas.

MUNICIPAL UTILITIES AND NATURAL GAS

With oil no longer a serious source of fuel for power generation and coal on a steady economic decline as well, natural gas is in line to next face the same pressures which are impacting other fossil fuels. While cleaner than oil or coal, the production of natural gas raises its own set of environmental concerns. This is leading to a turn in public opinion regarding natural gas and creating a political environment which supports limits on the use and production of natural gas.

To date, only a small number of communities have enacted legislation to limit and/or ban the use of natural gas. These limits take the form of regulations which no longer allow natural gas to be used in new construction. That raises the issue of what the longer term impact will be on the demand for natural gas going forward. We think that the movement against natural gas raises issues for those utilities which have locked in long term natural gas supply contracts.

Municipal utilities had initially sought to take advantage of the favorable economics of gas in recent years. They did this via the use of prepaid gas contracts. Typically, a municipal gas prepayment bond involves tax-exempt bonds issued by a conduit entity, such as a large financial institution or the commodity subsidiary or a large financial institution. The proceeds from the bonds are channeled through the conduit entity, which buys the gas and immediately resells it to the utility. The conduit entity is set up as a non-profit and is, therefore, able to issue tax-exempt bonds.

The utility or utilities participating in the transaction are offered locked-in gas prices discounted to the market price for terms of up to 20 or 30 years. Utility participants can also benefit from receiving priority treatment in the event of shortages or curtailments. Public power utilities are also able to participate in more than one prepayment transaction simultaneously as a way of diversifying their sources of natural gas supplies. Starting in 2018, some gas prepayment transactions were structured to include a pool of smaller public power utilities.

Typically, gas prepayment transactions are not viewed as debt of the public power utility participants but rather as an operating expense because the utility’s only obligation is to pay for gas received. There is no claim on municipal revenues on behalf of gas prepayment bondholders. Municipal utilities are also permitted to reduce participation in the prepayment transaction by providing notice, usually a few weeks or days. That allows utilities to lessen or eliminate the amount of gas they are required to buy, if their needs fluctuate or they can find better pricing.

So the investor needs to pay close attention to the details of the transaction to understand who their ultimate obligor is in the event that a utility, through economics and/or regulation withdraws from a prepayment agreement. The pressure on natural gas continues. In Connecticut, Gov. Ned Lamont made his opposition to new natural gas generation quite clear this week. He publicly opposed the proposed Killingly Energy Center, a 650-megawatt natural gas power plant.  He implied his intention to slow walk the permitting process.

MICHIGAN

Michigan has been in the news for all kinds of negative reasons over the last year but we have not been able to see the fiscal impact of the pandemic. At the onset of the pandemic, Michigan had nearly completed a full recovery from the Great Recession. Michigan endured more than a decade of job losses during the early 2000s, during which time wage and salary employment in Michigan dropped by almost 18% relative to January 2000. As the labor market began recovering from the Great Recession, steady job growth continued each year through 2019, although by the end of the decade annual gains were slowing. Still, by the end of 2019, total employment was within 5% of the January 2000 level.

The State has released the results of its Consensus Revenue Estimating Conference. The State Department of the Treasury, and the House and Senate Fiscal agencies contributed to the findings. It updates estimates made in May and August 2020. Total FY 2020 General Fund and School Aid Fund revenue was approximately $762 million above the August forecast. The impact of store closings and stay at home orders is reflected in sales tax data. In FY20, sales and use tax collections from online shopping and mail order businesses totaled over $493 million, an increase of over $318 million from the FY19 level of only $175 million.  Since the beginning of the pandemic, collections from online retailers have averaged $65 million per month, up from about $17 million per month in the twelve months prior to the pandemic.

Revenues will be impacted by the income tax rate reduction under MCL 206.51(1), which limits revenue growth to inflation from FY 2021 levels. Michigan had a real stake in the results of the effort to deliver additional federal funds to states. The State estimates that each additional $100 per week in federal unemployment benefits increase withholding and income tax by $4.6 million, assuming current levels of unemployment. Increasing the stimulus payments to $2,000 would increase Michigan personal income by almost $14 billion and may increase sales and use tax by $375 million.

Michigan will remain at the mercy of the overall economy. It will need additional federal help. The pandemic arrived in Michigan just as the auto industry was truly beginning to grapple with the realities of  a future dependent on electric vehicles. This creates an air of uncertainty as well as anticipation as the move to EVs accelerates. It will require adaptability not only by the auto companies but among all the ancillary businesses which support the industry.

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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Ideology moves front and center in many of the issues we explore this week. The Biden stimulus reflects an ideology in favor of government. The Medicaid block grant announcement reflects an opposite ideology. The New York City budget reflects the long term influence of ideology on the part of the Mayor. Proposals to limit the activities of public power entities reflects the ideological battle over green energy. Now that the national election is out of the way, the ideological wars will now move to the state level.

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STIMULUS PROPOSAL – THAT’S MORE LIKE IT

The stimulus proposal from President Biden to provide state, local and territorial governments with $350 billion in emergency aid, along with billions of dollars in assistance for schools and transit was welcome news for budget makers at all levels. In terms of indirect aid, it would provide $1,400 one-time payments to many Americans whose earnings are below a certain amount, while also extending unemployment insurance programs adopted in response to the pandemic and boosting them with a $400 per-week supplemental payment. All of that is positive for municipal credit.

The plan also is calling for $130 billion to help K-12 schools reopen safely and $35 billion for a higher education relief fund directed at public institutions, including community colleges.  It includes$20 billion for public transit agencies.  

From the municipal bond standpoint, there could be more to come. This proposal focuses on operating funding. An infrastructure package is yet to be announced. So the potential for additional resources exists. More important than the actual dollars is the change in philosophy behind the plans. It is hard to see the proposals as anything but positive for municipals.

MEDICAID BLOCK GRANT

The Trump Administration and its legislative allies have spent the last four years trying their best to limit Medicaid through work and reporting requirements. As the courts have consistently ruled against those plans, conservatives have more quietly worked to achieve one long held goal – the conversion of the program to one of block grants to the states.

Now in the death throes of the Administration, one of its medical culture warriors has achieved one of its goals at least temporarily. In a Friday night news drop, the Centers for Medicaid and Medicare services (CMS) approved a waiver for the state of Tennessee to receive its Medicaid funding in the form of a block grant. If Tennessee spends less than the block grant amount, it will be allowed to keep 55%  of the savings to spend on a broad array of services related to “health.” If it spends more, the difference will need to be made up with state funds. 

Tennessee will be allowed to renegotiate prices with drug makers and can decline to cover drugs if it deems the prices too high.  The state also has a troubled history of administering Medicaid under the existing structure which provides less administrative freedom.  States that saw the largest increases in uninsured children — like Tennessee and Texas — were those that created rules to check the eligibility of families more frequently or that reset their lists with new computer systems. 

CMS is run by one of the more ideological members of the Administration who has made the conversion of federal funding programs to block grants a centerpiece of her efforts. The Trump administration has tried to slow the reversal of its Medicaid experiments. Traditionally, such waivers are agreements between H.H.S. and states that can be severed with minimal fuss. But CMS has sent letters to state Medicaid directors, asking them to sign, “as soon as possible,” new contracts that detail more elaborate processes for terminating waivers. Under the contract terms, the federal agency pledges not to end a waiver with less than nine months of notice.

CALIFORNIA BUDGET

California Governor Newsome has released his proposed FY 2022 budget proposal. The budget reflects two basic realities. Revenues have come in much higher than anticipated. The skewing of both the tax structure and the income structure of the state  towards higher income jobs saved the day. In California, this taxpayer cohort was in a much better position to generate income and did so. They tended to be higher paid individuals who could work remotely.

The Budget reflects $34 billion in budget “resiliency” (their term not ours) – budgetary reserves and discretionary surplus – including: $15.6 billion in the Proposition 2 Budget Stabilization Account (Rainy Day Fund) for fiscal emergencies; $3 billion in the Public School System Stabilization Account; an estimated $2.9 billion in the state’s operating reserve; and $450 million in the Safety Net Reserve. The state is operating with a $15 billion surplus.

The budget proposes the use of some of those “resiliency” resources for things like $2.4 billion for the Golden State Stimulus – a $600 state payment to low-income workers who were eligible to receive the Earned Income Tax Credit in 2019, as well as 2020 Individual Taxpayer Identification Number (ITIN) filers; $575 million to more than double this year’s funding for grants to small businesses and small non-profit cultural institutions disproportionately impacted by the pandemic; $70 million to provide immediate and targeted fee relief for small businesses including personal services and restaurants; $2 billion targeted specifically to support and accelerate safe returns to in-person instruction starting in February, with priority for returning the youngest children.

The Budget reflects the state’s highest-ever funding level for K-14 schools – approximately $90 billion total, with $85.8 billion under Proposition 98. Some $2 billion is proposed for immediate action to support and accelerate safe returns to in-person instruction beginning in February. $4.6 billion is proposed for action this spring to expand learning opportunities for students, including summer and after-school programs and $400 million is proposed for school-based mental health. The Budget proposes a General Fund increase of $786 million for the University of California and the California State University systems based on an expectation of flat tuition and fee levels.

FINAL DE BLASIO BUDGET

The process to enact the final budget of the deBlasio Administration has begun with the submission of the Mayor’s FY 22 budget proposal. The proposal reflects the current state of flux in terms of the pandemic, the economy, and national politics. The Mayor’s presentation featured on the fly changes as proposals which would benefit the City were being announced as part of a proposed stimulus. Proposed cuts were literally crossed out and the slides changed as information came in.

This proposal was as much a statement of political philosophy as it was a serious budget document. It depends on a lot of political goodwill from a legislature that looks on the Mayor with skepticism at best. The mayor seems to believe that a new tax on the wealthy will be the answer to the problems of the state and city. The cutbacks included in the Mayor’s plan are a continuation of his use of threatened job cuts to try to generate more state aid.

The mayor continues to tout already existing headcount reductions of 7,000 while threatening an additional 5,000 potential reductions. That still leaves the City’s headcount some 12,000 higher than it was at the start of the deBlasio administration. And it comes as the framework of the upcoming campaign to replace the term limited mayor begins to emerge. That campaign will focus on a lot of spending ideas including the provision of a universal basic income.

The idea of a universal basic income is the centerpiece of the policies behind the newest candidate to enter the mayoral race, Andrew Yang. He would target annual cash payments of about $2,000 to a half million of the poorest New Yorkers, in a city of 8.4 million. Mr. Yang said his proposal would cost the city $1 billion a year. His entrance into the race has led a number of other candidates to embrace the idea.

This is a huge difference from his proposal to fund such a program nationally. That plan called for giving every American citizen over 18 years of age $1,000 a month in guaranteed federal income. It would have been funded by a national value added (sales) tax. In the case of the City, he would only be able to create a universal plan if there was “more funding from public and philanthropic organizations, with the vision of eventually ending poverty in New York City altogether.”

TEXAS REVENUE ESTIMATES

To kick off the budget season, the Texas Comptroller has released his revenue estimates for the State for the upcoming biennium beginning September1. For 2022-23, the state can expect to have $112.5 billion in funds available for general-purpose spending, a 0.4 percent decrease from the corresponding amount of funds available for the 2020-21 biennium. The reports projects $119.6 billion in total collections of general revenue-related (GR-R) funds.

These collections are offset by an expected 2020-21 ending GR-R balance of negative $946 million. In addition, $5.8 billion must be reserved from oil and natural gas taxes for 2022-23 transfers to the Economic Stabilization Fund (ESF) and the State Highway Fund (SHF); another $271 million must be set aside to cover a shortfall in the Texas Guaranteed Tuition Plan, also known as the Texas Tomorrow Fund.

The projected negative ending balance in 2020-21 is a direct result of the COVID-19 pandemic, which caused revenue collections to fall well short of what was expected when the 86th Legislature approved the 2020-21 budget. The projected shortfall does not account for any GR-R expenditure reductions resulting from the state leadership’s instructions for most state agencies to reduce spending by 5 percent of their 2020-21 GR-R appropriations. Nor does it incorporate the effects of substituting federal funds provided as pandemic-related assistance for some GR-R pandemic-related expenditures.

Tax revenues account for approximately  87% of the estimated $119.6 billion in total GR-R revenue for 2022-23. Sixty-two percent of GR-R tax revenue will come from net collections of sales taxes, after $5 billion is allocated to the SHF, as authorized by the Texas Constitution. Other significant sources of general revenue include motor vehicle sales and rental taxes; oil and natural gas production taxes; the franchise tax; insurance taxes; collections from licenses, fees, fines and penalties; interest and investment income; and lottery proceeds.

FLINT WATER

Former Michigan Gov. Rick Snyder has been charged with two counts of willful neglect of duty. The charges are for misdemeanors punishable by imprisonment of up to one year or a maximum fine of $1,000.  It all stems from the implementation of Michigan’s emergency manager statutes in the State’s takeover of the financial affairs of the City of Flint. The Governor was one of nine state officials charged with a total of 41 counts — 34 felonies and seven misdemeanors.

At the core of the issue is the decision by the emergency manager team which switched the city’s water source to the Flint River in 2014 as a cost-saving step while a pipeline was being built to Lake Huron. The problem is that managers and operators did not account for the differences in water from the two different sources.  The water supplied when the switch was made was not treated to reduce corrosion.   State regulators determined that this caused lead to leach from old pipes and spoil the distribution system used by nearly 100,000 residents. That required distribution of bottled water and other non-municipal sources to avoid additional health issues related to elevated levels of lead in the water.

The criminal charges against even Governor will draw renewed attention to the use of the emergency manager statutes in Michigan specifically but also more generally. The environment in which outside overseers might be appointed under statute has changed significantly since these laws were enacted. Anything seen as potentially disenfranchising – which some of these schemes are clearly viewed as already – will operate under an ever more volatile body politic. That makes the outcome of the case even more meaningful and not just in Michigan.

We do not expect that anyone will go to jail in this case. It does however, establish some level of accountability for public officials operating under statutes like those governing Michigan’s emergency managers.

MUSEUMS EXPLORE FINANCIAL ALTERNATIVES

The impact of the pandemic on museums is well documented. We have previously reported on the growing phenomenon of ” deaccessioning” or the sale of art from their existing collections to provide funds to pay off debt or operating expenses.(See the November 2, 2020 issue). Those efforts generated widespread publicity and reactions and it is fair to say that those reactions were not favorable.

Since we covered the topic in the Fall, developments have moved ahead. In Baltimore, the plans to sell at least three major pieces from its collections were withdrawn after local and national blowback. Some institutions continued to investigate the potential for sales of their own. This has led to some cities taking preemptive action to prevent such efforts from moving forward.

The latest example is the move by the City of San Francisco to prevent the San Francisco Art Institute from attempting to sell one its best known works. The Institute has floated the idea of selling a mural painted by Diego Rivera. The works of Rivera and others he influenced produced a raft of murals for public buildings across the country as a part of the economic recovery from the Depression.

Now. after public outcry both locally and nationally, the San Francisco Board of Supervisors voted 11-0 to start the process to designate the mural as a landmark.  Designating the mural as a landmark would severely limit how the 150-year-old institution could leverage it as removing the mural with landmark status would require approval from the city’s Historic Preservation Commission.

The City believes that private donations as well as more creative financing actions could address the concerns of the Institute. It’s not the first time that a sale has been contemplated. In the Fall, a bank sought to sell the mural as collateral for some $19 million of debt.  That plan was halted by the intervention of the University of California Board of Regents stepped in to acquire the Institute’s $19.7 million of debt from that private bank.

A 2016 loan funded the construction of its new Fort Mason campus. Collateral for the loan included the school’s older campus on Chestnut Street and 19 artworks.  The public university system acquired the institute’s deed and became its landlord. Administrators at S.F.A.I. have six years to repurchase the property; if they don’t, the University of California would take possession of the campus. The situation highlights the risks associated with certain kinds of collateral. Many a lender has fooled themselves into thinking that collateral in and of itself provides security. It flows from a fundamental misunderstanding of how fungible an asset that collateral actually can be.

In the end, it is about economic viability. This is yet another example of relying on legal provisions rather than operating sustainability for successful management of a credit. A dose of realism is always a good thing for credits like this.

NEBRASKA PUBLIC POWER DISTRICT

One of the long established public power providers in the nation is at the center of a dispute over transmission lines. As the effort to address climate change moves forward, the need to expand and reinforce the transmission grid nationwide is gaining more attention. Transmission lines are controversial even when they are designed to transmit power from green sources.

Efforts to stop some of these projects takes many forms. In many jurisdictions, litigation has been a primary tool in the effort. Now, the Nebraska Public Power District finds itself the target of proposed legislation in the Nebraska State Legislature. The proposed bill would forbid “a public power district, public irrigation district or public power and irrigation district” from starting or continuing construction on transmission lines at least 200 miles long through Jan. 1, 2023.

The bill targets NPPD’s 225-mile-long R-Project. The project has been slowed by litigation in the federal courts but this bill would block power or irrigation districts from spending “any funds relating to such project during such time period and prior to obtaining any required federal permits.”

The R- project was proposed in 2013. It is believed by opponents to be driven by a desire to facilitate the development of wind generation in the western part of the state.  The proposal highlights the elements that get in the way of the shift to green energy. It is co-sponsored by a legislator from a district that houses a coal generation plant. In a 100% public power state, NPPD is  now at the center of the ideological battle.

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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What a difference a day makes. Now it is possible in the wake of the Georgia Senate runoff to look forward with a lot more visibility about the outlook for municipal credit. One would hope that the Democrats will take the opportunity to take advantage of their electoral hat trick and actually pursue an agenda. It was the squandering of such a majority in the first two years of the departing administration that contributed to the recent electoral outcome.

Clearly, the outlook for additional aid to state and local government has improved  as has the outlook for better funding for mass transit and public housing. The most important change may simply be a change in the atmosphere. The incoming Biden Administration featuring mayors and governors bodes well for an improved attitude towards government.

It did not take the events of Wednesday to convince this observer that his view of the fallacy of an ideological approach to governing is valid. We have now seen on both the state and local level of the dangers of an ideologically based approach to government. It failed on the state level in Kansas where the budget is still recovering from the Brownback era and yesterday showed how such an approach failed on the national level. It is hard to argue that the country’s healthcare system, infrastructure, or education systems are better off than they were four years ago.

Now that the Capitol building has been cleared that does not mean that all of the terrorists are out of those halls. There remain a significant number of legislative terrorists who will do all that they can to obstruct and delay any Biden Administration agenda. Nonetheless, the outlook for municipal credit generally just got a little better.  And the potential for things like the repeal of the limit on the SALT deduction and limits on advance refunding should be easier to accomplish. But the impact of four years of policy and funding neglect leaves many rivers to cross for many municipal issuers.

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MORE LEGAL TROUBLE FOR SUTTER HEALTH

In late 2019, Sutter Health and the California Attorney General settled an antitrust action against Sutter. The State sued Sutter for anticompetitive activity and Sutter eventually settled for $575 million. That litigation was well known. It was widely covered in the press and was specifically cited by rating agencies as one of the factors weakening Sutter Health’s ratings this past fall. It seemed that Sutter was positioned to move forward from the litigation.

Now however, a new case is moving forward in the federal courts.  Sidibe v. Sutter Health was actually filed before the state action. The complaint raises many of the same issues in the state case. The plaintiffs, purchasers of commercial health insurance from certain health plans that contracted with Sutter, claim they paid inflated premiums, co-pays, and other charges as a result of Sutter’s anticompetitive conduct. 

The conduct in question is the use of so-called “all or nothing” contracts with insurers. Sutter included “all-or-nothing” clauses in its contracts that required plans to contract for all of Sutter’s services if it were to buy any of those services.  If an insurer wanted to serve patients at some of Sutter’s hospitals it had to serve patients of all Sutter hospitals. The idea was to force insurers to cover facilities where Sutter had more pricing power.

The complaint also the plaintiffs alleged that Sutter used a second anticompetitive contractual strategy called an “anti-steering” clause, which prevented health plans from encouraging their members to seek care from other lower-cost, in-network providers. Under the contracts, the health plans would be penalized with higher rates for failing to “actively encourage” members to use Sutter services, as opposed to cheaper alternatives. This all works as Sutter dominates the northern California provider market.

The case differs from the state action in that the plaintiffs represent different groups. In this case, the ultimate beneficiaries of a decision in favor of the plaintiffs would be payments to offset higher premium charges to individuals. This sets up a potential class of some 2 million. The affected class includes anyone living in nine specific areas in Northern California who paid premiums to Anthem Blue Cross, Aetna, Blue Shield of California, Health Net or UnitedHealthcare since 2011. 

The complaint was initially dismissed summarily but an appeals court judge overruled and set an October 2021trial date. Sutter will have many motivations to settle the case so we believe that judging the credit impact should be more a matter of how much it will cost rather than a bet on the outcome of a trial.  

JACKSONVILLE – WE HAVE A DISCLOSURE PROBLEM

The Special Investigatory Committee on JEA Matters was convened in February, 2020 in the wake of a spectacularly failed effort to sell the city-owned utility system (JEA). On July 23, 2019, the JEA Board of Directors authorized it’s senior leadership to start a process, the Invitation to Negotiate (the “ITN”), to sell JEA.  At that same meeting, the JEA Board also authorized senior leadership to implement a long-term incentive plan, the Performance Unit Plan, that would compensate participants based, in part, on the amount of proceeds the City received from the sale of JEA (the “PUP”).  

The Committee has now released a report that affirms the worst fears of investors and customers. The public customer base was at best skeptical of the plan to privatize the utility. In the late summer of 2019, JEA imposed what has come to be known as the “Cone of Silence” about the ITN process, purportedly prohibiting members of City Council (and others) from talking about the merits of the ITN.  

In the next month the Mayor got the City Council to approve legislation resulting in the transfer to the City liability for JEA’s unfunded employee pension plan upon the occurrence of a JEA “Recapitalization Event” (a sale). That seems to have been a bridge too far and the Council hired its own counsel to investigate the sale. This culminated in actions in November which led the JEA CEO to “postpone indefinitely” the PUP after the City’s Office of General Counsel (“OGC”) determined the PUP violated Florida law and the Council Auditor’s Office asked JEA probing questions about the PUP. 

Those questions resulted in a report which showed that disclosed the PUP would provide JEA senior executives with grossly excessive compensation.  According to the Council Auditor, the PUP could result in payouts to PUP participants in excess of $600 million dollars. Support for the plan crumbled and by year end the sale process was terminated.

Here is where the disclosure issue arises. The investigation revealed that the Curry administration and JEA engaged in a multi-year effort, from at least 2017 through 2019, to explore selling the City’s municipally-owned utility.  Knowing that public sentiment disfavored transferring JEA to private ownership, the City’s effort to market JEA was conducted with a purposeful lack of transparency. You would never know it from the Authority’s disclosure postings and that is a problem.

Lately we have heard much criticism of borrowers not making payments under the terms of a particular issue that they are not legally obligated to make. Here, the Authority had a real obligations not just to the customers and constituents  but to their investors. It is an obligation they took on at issuance and in this case failed to live up to. JEA should pay a price for the weak governance and oversight structure that allowed it to occur. It should be penalized with the same vigor as when it was penalized when it sued to get out of its power purchase agreement.

Given that this level of nondisclosure was easy to accomplish under the current rules governing the market, we are less optimistic about the potential for things like formal quarterly disclosures from issuers.

MBTA BUDGET CUTS

The impacts of the pandemic and the lack of an effective federal response can’t wait for the regime change in Washington at some agencies. Without a likely source of outside aid, the MBTA in Boston’s Fiscal and Management Control Board approved virtually all of the service cuts that MBTA staff had proposed. The cuts will be phased in over the coming weeks. They include a halt to weekend commuter rail service on all but five lines starting in January, as well as reduced Hingham and Hull ferry service and cuts to all Charlestown and Hingham direct ferry service to Boston.

The lack of service also has employment impacts. The “T” will ask one-sixth of the MBTA’s workforce, including its general manager and other top executives, will be forced to take up to five furlough days in the remaining fiscal year 2021. MBTA drivers and operators will not be required to take furlough days.

If Congress cannot come up with additional funding for agencies like the “T” by March, 20 bus routes will be eliminated; frequency will drop 20% on non-essential bus routes and 5% on essential bus routes; gaps between Red Line, Orange Line and Green Line trains will increase 20 %; Blue Line trains will run up to 5% less frequently.

PANDEMIC LIMITS LINGER

Massachusetts will extend its lockdown provisions and pressure is rising in connection with rising positive test levels in NYC to reimpose limits and closures on schools. Southern California remains fully locked down. Nationwide we see continuation of school closures. This is imposing real constraints on the ability of the economy to recreate jobs. Lower income employment groups who saw gains in the last four years have been the most heavily impacted.

As the economic limits of the pandemic continue, states are beginning the FY 2022 budget process. We have previously opined that this year’s budget cycle will create incentives for expansions of state revenue bases. One of the first signs of that comes from news that the NYS Governor’s proposed budget due this week will include a proposal for state run mobile sports betting. It comes as the handle for New Jersey’s sports betting market has increased to $5 billion.

That provides motivation for New York to consider it. New Jersey estimates that some 20% ($1 Billion) comes from New York bettors. It is that revenue flow that the State of New York would like to capture. In comments to the press the Governor said “At a time when New York faces a historic budget deficit due to the COVID-19 pandemic, the current online sports wagering structure incentivizes a large segment of New York residents to travel out of state to make online sports wagers or continue to patronize black markets.”

We would not be surprised to see a similar dynamic apply to the legalization of cannabis in NY given that New Jersey is now a legal marijuana state. The restricted NY market makes less sense from an economic standpoint as legalization makes its way to surrounding border states.

COAL CONTINUES ITS DOWNWARD TRAJECTORY

You know it’s for real when you see stories about American Electric Power, one of major symbols of coal generation, announcing that its considering retiring one of its coal fired generating plants in West Virginia before the end of its useful life. It comes as the South Carolina Public service Commission has ordered Dominion Energy to conduct a comprehensive coal fleet retirement analysis and assess replacing its South Carolina plants.  

Dominion had submitted a resource plan which failed to include a demand side management resource option or power purchasing options. The plan did not include any renewable energy additions prior to 2026, nor any coal retirements prior to 2028. the same plan proposed raising solar customers’ basic service charge to $19.50 a month, adding a “solar subscription fee” of $5.40/kW a month.

The tie to municipals? Dominion purchased South Carolina Energy & Gas and the partner with the muni utility South Carolina Public Service Authority (Santee Cooper). It is now absorbing the revenue impact of the failed Sumner nuclear expansion that has cast the future of Santee Cooper into great doubt.  

Washington State has established new rules governing the development of power generation resources in the state. They require the state’s electric utilities to eliminate coal-fired electricity by 2026, transition to a carbon-neutral supply by 2030, and source 100% of their electricity from renewable or non-carbon-emitting sources by 2045. These rules, in tandem with those promulgated by the State’s Commerce Department, will cover both investor owned as well as public municipal utilities.

GREEN JOBS BEGIN TO SPROUT

A quick look at a variety of headlines shows that green practices and job growth are not mutually exclusive. One is an announcement that the world’s largest lithium producer, Albemarle plans to invest between $30 million and $50 million to double production at an existing Nevada site by 2025.  The company is the only U.S. lithium producer and it attributes the increased production to the need for electric vehicle batteries.

General Motors Co. reportedly will build two new electric vehicles for Honda at its Spring Hill, TN assembly plant. In Massachusetts, a wind power contractor has announced that its proposed facility will result in cheaper rates than projected as the result of a new federal tax credit included in the recent COVID-19 stimulus package. With the bigger tax credit, Mayflower Wind will cut its price to 7 cents a kilowatt hour, which will save ratepayers roughly $25 million a year. Mayflower expects its 804 megawatt offshore wind farm to be operational by the mid-2020s.

These announcements come as data on declining coal production shows production from the Powder River Basin coal, year on year, declined 15.9%. Central Appalachian production declined from the year-ago week 23.9%. Output in the Illinois Basin was down 15.9% year on year. In Northern Appalachia, production was down 23.9% from the year-ago week.

SEATTLE TRANSIT COST REVISION

While the Purple line in Maryland begins to make progress on its effort to complete its light rail facilities and manage the cost problems which have plagued  other planned projects are having cost problems. These sorts of developments are one of the problems which mass transit advocates need to overcome.

The latest example comes from Seattle’s mass transit system. Sound Transit management has admitted that cost estimates for extending Sound Transit light rail to both Ballard and West Seattle have risen by about $5 billion — more than 50%. For the West Seattle and Ballard light rail lines, more than half of the increase is due to higher prices for land than assumptions made in 2015, before the $54 billion transit ballot measure was approved by voters.

That is the kind of change that erodes support for these projects. Projected costs for those two lines went from a total of $7.1 billion to between $12.1 and $12.6 billion, depending on where stations are located and how they are built. Voters in 2016 approved the $54 billion Sound Transit 3 tax measure to expand regional rail and bus service. The agency had promised West Seattle stations in 2030 and stations in Seattle Center and Ballard by 2035. 

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 year begins with efforts to subvert the November 2020 election. That effort comes after numerous incidents of intimidation and violence against elected officials. I publish this from Sullivan County, NY in a hamlet of 750 people. And yet in neighboring municipalities of similar size in the county we have seen resignations of officials in the face of physical threats. The point is that even the most local political processes have become unable to avoid the vicious display in Washington as we go to press.

Governments at all levels face a populist wave of anger reaching historic levels.  That creates an atmosphere where decisions are made in reflexive response to short term pressures. Those circumstances often lead to decisions with negative long term implications.  An example of this is in our first item this week. Nonetheless, populist anger rules the day at present so we may see more actions taken along  those lines.

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APPROPRIATION DEBT – IT IS WHAT IT IS

In the Show Me State, the trustees for a defaulted issue of bonds ultimately secured by funding from a County which was subject to annual appropriation are not going to be given the opportunity to show their case to the Missouri Supreme Court. To refresh, the case was rooted in a decision in 2018 not to appropriate County funds to cover shortfalls in revenues supporting debt related to a retail development located in Platte County, MO. 

In an effort to preempt legal moves by the trustee for the bonds, the county filed a lawsuit against  the bond trustee in November 2018 seeking court affirmation that it was not obligated to cover shortfalls.  A Platte County Circuit Court judge agreed with the county in a May, 2019 ruling. The trustee appealed and an appellate court panel on Aug. 25, 2020 upheld the lower court decision that the county bears no legal obligation. The trustee in September sought a rehearing that was rejected and it then asked the Missouri Supreme Court to take the case. 

We always were of the view that the effort to force the County to pay would fail. The legal details do not lie. The County was not absolutely obligated to appropriate.   The reality of 21st century municipal finance is that the failure to fund in situations where the requirement to do so is not clearly established in the transaction is no longer the crippling financial stain that it has oft been portrayed as. It helps if you are a smaller and infrequent issuer.

In the case of the bonds in question, interest is being paid but the existing principal amortization is not occurring on a timely basis. The decision by the Court should serve as a basis for more serious negotiations of a restructuring of the debt. It will occur in a changed significantly over time. Zona Rosa is an approximately 500,000 square feet, mixed-use lifestyle center located in Kansas City, Platte County, Missouri. The project opened in 2004 and was expanded by an additional 500,000 square feet starting in 2008. That facilitated a large department store’s relocation.

Ironically, while the litigation played out, the developers announced a plan demolish some storefronts to make way for a new outdoor green space as the first part of a major redevelopment effort. The mall, currently has dozens of vacancies and that is reflected in the financial underperformance of the parking facilities expected to generate revenues for the defaulted bonds. Over time, Zona Rosa hopes to add new multifamily residential development, hotel, office and restaurant space.

We have no quarrel with the idea that an effort to simply walk away from the project and its role as a participant in the financing is troubling. It should be disqualifying as a borrower in the public markets. The reality is that memory fades. If you do this long enough, you see too many examples of defaulting borrowers not only being able to reenter the market but to do so with ratings. But like most any other transactions secured by obligations, there are responsibilities on the investor’s part as well. It reported that this is the ninth transaction involving annual appropriation debt in Missouri to suffer some form of impairment since 2009. So it should not have been a shock.

That goes to reinforce one of our basic tenets of investing and credit risk management. That is the idea that a project should be economically sound and if there is a question about that, then the investors should demand significant financial compensation for that risk. Reliance on legal support as a primary replacement for economic viability simply does not work. Lease rental and other forms of appropriation backed debt are always in a more vulnerable position in bankruptcy. This trend has been reinforced in the restructuring of debt in Detroit and Puerto Rico. Like it or not, the risk of non-appropriation is the new reality.

OHIO NUCLEAR

The Ohio Supreme Court has issued an order stopping utilities from collecting a monthly fee to subsidize two nuclear power plants, part of the state’s scandal-scarred nuclear plant bailout law approved in 2019. A Franklin County judge last week issued a preliminary injunction to stop collection of the subsidies.  The Cities of Columbus and Cincinnati sued to block the law from taking effect January 1st.  That law, and the lobbying process which led to its enactment, were the subject of federal investigations leading to the indictment and resignation of the Speaker of the Ohio House. It is alleged that $60 million changed hands during the legislative process between and among the accused.

The law, HB 6, entitles the plant’s new owner, Energy Harbor, to receive as much as $150 million a year and nearly $1 billion in total. Another $20 million a year from the fees are earmarked for five large solar projects, none of which are operational. Ownership was transferred from First Energy to the Energy Harbor entity as part of its restructuring from bankruptcy. First Energy is at the center of the legal scandal.

The company and its predecessors have been long time guarantors of tax exempt pollution control revenue bonds. So what happens to their successors and the management and operation of the legacy projects can have implications for other investor owned utilities who support municipal bond debt. We also take it as a sign that the utilities know what is economically viable and what is not. As far as we are concerned – message received.

PURPLE LINE MOVES FORWARD

Among the nation’s prominent P3 arrangements, the Purple Line in Maryland has stood out for its delays related to opposition and resistance which led to crippling litigation. Ultimately, the construction member of the partnership pulled out citing unacceptable losses stemming from delays. It is one of the messiest P3 breakups we have seen. It came after the failed P3 renovation project at the Denver Airport. So the P3 concept was under a bit of pressure as we approached year end.

So it was good news to see that the Maryland’s Board of Public Works approved a $250 million legal settlement which requires the State to pay the companies managing the construction to resolve delay-related contract disputes dating to 2017.  The initial ask from the State by the departing partner was $800 million.  So the project has reduced one major cost and source of litigation while providing a basis for moving forward.

Purple Line Transit Partners, now consists of infrastructure investors Meridiam and Star America.  Meridiam and Star America agreed to spend up to an additional $50 million to keep construction moving until a new contractor is on board.  That process has a one year deadline and the hope is that a new contractor will be hired much sooner so that construction can resume. In the interim in the absence of a construction manager,  the Maryland Transit Administration is managing some work, including moving utilities, completing the design and obtaining environmental permits.

NOW THAT THE BALL HAS DROPPED

The New Year will provide some early indicators of the sorts of hurdles and uncertainties states will face as they begin the annual budget cycle. Three large states – New York, California, and Pennsylvania – will each have specific budget issues to deal with. They reflect the general pressures faced by all states but they also reflect issues peculiar to each one.

As the initial epicenter of the pandemic, New York was bound to be in the unenviable position of having to break trail for the others. While a bit of pressure has been taken off the MTA, there remain numerous sources of pressure. The NYC economy is and will remain under extreme duress. The ultimate level of outside funding remains highly uncertain. And the state continues to try to balance the interests on both sides of the landlord/tenant relationship. The current eviction ban will run until the end of February.

California has actually seen substantial revenue growth for the State’s General Fund. For FY 2021 through November, GF revenues were 20% higher than estimated. It was personal income and retail sales taxes driving those gains. Here the State’s income tax structure which had traditionally been a source of volatility actually caused revenues to over perform. Because so much of the State’s income tax revenues come from the highest bracket taxpayers, historic economic slowdowns which impacted that group severely curtailed revenues. In the case of the pandemic, that cohort was least impacted in terms of their ability to generate income by restrictions on the economy resulting from the pandemic.

That does not ensure easy budget sledding for the State. The recent reimposition of lockdowns will serve as an additional pressure on revenues especially as they were imposed through the holidays. The process will be important to watch.

Pennsylvania decided to delay a potentially contentious funding debate which emerged at the end of the last legislative session until this month. Just as a compromise budget for the Commonwealth was about to pass, the state transportation agency (PennDOT) asked for funding to cover a $600 million revenue shortfall related to the pandemic. The debate will come in the wake of the effort to involve the Legislature in the attempt to invalidate the results of the election. And then, they can move on to the FY 2022 budget.

The results of the budget processes in these three states will be good indicators of what the overall budget environment is like.  

TAX CHALLENGE AT THE SUPREME COURT

New Jersey, Connecticut, Hawaii and Iowa have filed an amicus brief in a Supreme Court case that challenges the ability to tax nonresidents’ income while they’ve been working remotely. Arkansas, Connecticut, Delaware, Massachusetts, Nebraska, New York and Pennsylvania rely on the “convenience rule which allows states to tax income earned in the state by non-residents. The case in question was filed by New Hampshire against Massachusetts in October after Massachusetts enacted a temporary tax based on the rule.

Historically, the issues regarding potential double taxation have been resolved through agreements between states. It is a real issue even if an aggressive stand is more a reflection of the fact that 2021 is an election year. It is not a clear cut argument. If one state’s residents are prohibited by a shelter in place order from working in another state, what is the appropriate remedy?

The exact impact of a decision in favor of New Hampshire is unclear as estimates of the ultimate liability range depending upon the states involved. Should it be decided in favor of New Hampshire, it would force the states to attempt to recalibrate their tax relations with other states. We have seen estimates ranging from $1.2 to $3.5 billion in the case of New Jersey taking money back from New York. These are unprecedented times so we are not surprised to see actions taken which reflect the short term conditions imposed by the pandemic.

CHINATOWN REDUX

The Colorado River Compact was drafted in 1922. It allocates the river’s annual flow, dividing the water among seven states. The Colorado provides water to 40 million people and 5.5 million acres of farmland in Colorado, Wyoming, Utah, New Mexico, Nevada, Arizona and California as well as to 29 Native American tribes and the Mexican states of Sonora and Baja California. 

Colorado, Utah, New Mexico and Wyoming must deliver 7.5 million acre-feet a year to Lake Powell for use by the lower-basin states (Arizona, California and Nevada). If the upper basin doesn’t make this delivery, the lower basin can “call” for its water, triggering involuntary cutbacks in water use for the upper basin. The long term drought currently impacting the West has driven flows down 20% over the last 20 years. 

Now the seven states are conducting a new negotiation to manage the Colorado’s flows in the face of that reality. The reduced amount of water has brought renewed attention to one of the most enduring conflicts between agricultural interests and development interests. That conflict has renewed attention to the history of historical water disputes in the region. The easiest example is the dispute over water which pitted interests of farmers in California’s Owens Valley against those of real estate developers in Los Angeles in the 1920’s.

Now the negotiations over the Compact are complicated by the emergence of a significant bloc of private institutional investors. These investors are buying up the rights to water from farmers throughout the region. They won’t use it. Instead, they hope to turn water into a commodity, a basis for speculation tradable on futures markets. They do not seek water for agricultural use but rather as an asset which can be held and manipulated. 

The effort would raise the cost of water especially for users in metropolitan areas. It would not increase supplies. The investors seek to be able to create “accounts” for their water allocations within existing water supplies. Under their plan, an account could be created within one of the region’s federal reservoirs (Lake Powell for example). This would allow the private water owners to hold their water until demand drives the price up. In the case of Colorado, it could theoretically find the State in the position of having to buy back its own Colorado River water. In September, Nasdaq and CME Group, announced a plan to establish a futures market for California water.

Such an arrangement will put some large municipal water systems under pressure. The Metropolitan Water District of Southern California is the largest water utility in the U.S. It has a significant interest in the price of Colorado River water. Should there be a “call” of water, the agricultural water owners would be in a position to profit.

It comes after a year when water utility credits were among the most stable performers. So the introduction of private water markets is a concern and something to watch as the process of renegotiation unfolds over the next five years. It would be a shame to see this sector turned away from its long history of stable financial results and strong credit quality

MORE ANALYTICS FOR THE MUNI MARKET

As is the case with so many other things, in the age of data analytics have become king. Whether its sports, financial management or a variety of other sectors, the available data base and tools to utilize it continue to grow. The rating agencies are developing and acquiring data and using it to implement new ratings criteria. Moody’s explicitly cites environmental, governmental, and social issues when it announces rating changes.

Now there is another data contribution coming from the Federal Emergency Management Agency (FEMA). FEMA has calculated the risk for every county in America for 18 types of natural disasters, such as earthquakes, hurricanes, tornadoes, floods,  volcanoes and even tsunamis.  The risk equation behind the National Risk Index includes three components: a natural hazards component (Expected Annual Loss), a consequence enhancing component (Social Vulnerability), and a consequence reduction component (Community Resilience). 

Expected Annual Loss represents the dollar loss from building value, population and/or agriculture exposure each year due to natural hazards.  Social Vulnerability is the susceptibility of social groups to the adverse impacts of natural hazards, including disproportionate death, injury, loss, or disruption of livelihood.  Community resilience is the ability of a community to prepare for anticipated natural hazards, adapt to changing conditions, and withstand and recover rapidly from disruptions. 

FEMA’s index scores how often disasters strike, how many people and how much property are in harm’s way, how vulnerable the population is socially and how well the area is able to bounce back. That results in a high risk assessment for big cities with high proportions of poor residents and expensive property that are ill-prepared to be hit by once-in-a-generation disasters.

FEMA’s 10 riskiest counties list is led by Los Angeles, followed by the Bronx, New York County (Manhattan) and Kings County (Brooklyn), Miami, Philadelphia, Dallas, St. Louis, Riverside, and San Bernardino counties in California. The bias generated by property values is clearly reinforced in the individual disaster risk indexes.

One example is the fact that Oklahoma City gets a better tornado risk score than does New York City. This reflects the wide disparity in the value of potentially impacted property bases. It does not take into account historic frequencies of events.  It’s flaws are recognized even by FEMA who’s spokesman was quoted in the press as advising “that people shouldn’t move into or out of a county because of the risk rating.”

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.