Joseph Krist

Publisher

________________________________________________________________

P3 IN THE SPOTLIGHT

The troubles which have plagued the long delayed Purple Line P3 rail system in Maryland now appear to be influencing the development of another P3 to expand I-270. Maryland hopes construction would start with the replacement and expansion of  the American Legion Bridge. Work would continue around the Beltway to the I-270 spur, before moving up I-270. It would include tolled express lanes which would be the source of revenue to support the financing of the project. The existing free lanes would also would be rebuilt.

As one of the more favorable states for P3s, it was not unexpected that a P3 would be a likely option for Maryland. However, the impact of the ongoing Purple Line experience shows up in the first proposed contract to deal with “pre-development’ components of the project. In reality, it calls for the winner of the contract to deal with a myriad of issues over design, permitting, and acquisition in association with the needed right of way. Those all have the potential to increase costs and delay the project.

It was due to factors like those that the Purple Line P3 cratered. To address some of those potential liabilities, the State of Maryland is proposing that the state would have to reimburse upfront “predevelopment costs” if the project is delayed for a list of reasons. Among potential delay points are that  land costs more than expected, the federal government withholds environmental approval or the state board that approves major contracts does not do so.

The State would have to compensate the private partner with up to $50 million in the event any of the triggering events occur. The needed environmental permits are not in hand. These are often the most successful vehicles for project opponents to employ to stall or halt projects. There remains significant opposition to the project from a variety of interests.

MORE THAN MEETS THE EYE IN GDP REPORT

The fact that the economy fared so poorly in the fourth quarter relative to the third quarter is not surprising. The reinstatement of lockdown conditions and extensions of existing service limits and suspensions could be anything but positive. What interests us is what the data tells us in terms of what the economy might look like going forward once “normal” life resumes. And that positive spending now could have negative impacts later.

The data reflects current trends. The increase in real GDP reflected increases in exports, nonresidential fixed investment, personal consumption expenditures (PCE), residential fixed investment, and private inventory investment that were partly offset by decreases in state and local government spending and federal government spending. It is the underlying detail that draw attention.

The increase in nonresidential fixed investment reflected increases in all components, led by equipment. That is a nice way of saying that manufacturers were able to take advantage of pandemic induced downtime to rethink their use of labor and automate where they could. The pandemic exacerbated that existing trend and portends that while the economy may resume, manufacturing employment gains may not be as robust.

The increase in Personal Consumption Expenditure was more than accounted for by spending on services (led by health care); spending on goods decreased (led by food and beverages). Disposable personal income decreased $372.5 billion, or 8.1 percent, in the fourth quarter, compared with a decrease of $638.9 billion, or 13.2 percent, in the third quarter. The decrease in PCE in 2020 was more than accounted for by a decrease in services (led by food services and accommodations, health care, and recreation services).

That puts the travel/hospitality/entertainment/culture space at the center of  true recovery. No other sector may have been as impacted and the ability of the sector to reemploy staff let go as these facilities closed will be key to determining the pace and extent of the post-pandemic economic growth. Municipal bond credits supported by entities in this space still provide a source of risk as it is not clear as to the timing of a full recovery. It is the reliance of this space upon disposable income that highlights the risks facing these credits.

NATURAL GAS BANS

One of the more recent fronts in the movement to end dependence for energy and fuel from fossil based sources. Fronts against oil have been opened up with carmakers accelerating efforts to develop electric vehicles. Market realities are driving coal out of the electric generation fuel source menu. Now, efforts are turning towards what has been until know a go to alternative to those fuels – natural gas. While cleaner than oil or coal, natural gas carries with it its own set of environmental baggage.

That environmental baggage has driven several municipalities – primarily in California – to enact laws and/or regulations which would not allow the use of natural gas as a fuel source in new construction. While the number of such bans is few, the industry and its policy allies are moving quickly at the state legislative level to enact laws reserving regulation of the use of natural gas in buildings to state regulators. Indiana is about to vote on one such bill even though there are no known existing or pending natural gas limits in the state.

Kansas and Missouri are set to contemplate similar legislation. There are two broad views of these regulations. Proponents would say “No one is talking about removing existing infrastructure in place, ripping that out and forcing people to go electric. These bans are all about new construction, new development. Furthermore, most of these bans I’ve read about include significant exemptions especially for the manufacturing and industrial sector. This is a one-way bill. This bill is not about choice, it’s about the utility’s right to furnish service regardless of the energy source. … There’s nothing in this bill that protects the rights of private property owners to generate their own energy, or to lease their land to third parties who wish to invest in renewable energy on their property.”

Opponents (energy and development companies) would say builders and manufacturers arguing that it is crucial to ensure competitiveness in Indiana’s manufacturing and construction sectors. Tennessee, Kentucky, and Oklahoma are said to be looking at similar legislation. And similar is the key word as the hand of The American Legislative Exchange Council  (ALEC) is thought to be behind the structure of the legislation as they are so often in conservative state legislatures.

POLICY SHIFTS FROM NEW ADMINISTRATION

One example of the impact of a change in administrations is the clear change in attitude towards infrastructure and its role in resiliency. Federal officials aim to free up as much as $10 billion at the Federal Emergency Management Agency to protect against climate disasters before they strike. The money would be applied to projects like building seawalls, elevating or relocating flood-prone homes and taking other steps as climate change intensifies storms and other natural disasters.

Currently, much preventative work is done through local funding and financing. The FEMA plan would use a budgeting maneuver to repurpose a portion of the agency’s overall disaster spending toward projects designed to protect against damage from climate disasters. Initially, the agency believes that the planned budgetary maneuver could generate as much as $3.7 billion to be available for the program, called Building Resilient Infrastructure and Communities, or BRIC. 

The BRIC program was created in the aftermath of the disaster season of 2017, when the United States was struck in quick succession by Hurricanes Harvey, Irma and Maria, as well as wildfires in California that were then the worst on record. the National Institute of Building Sciences  found mitigation funding can save the nation $6 in future disaster costs, for every $1 spent on hazard mitigation.

The program would not be funded by federal dollars completely. State and local governments must provide 25% of the cost of any projects. The consideration comes in the wake of a bipartisan Congressional request that the monies be used in this manner in 2020. That request was rejected by the Trump Administration OMB. With a different philosophy and personnel in place in a Biden Administration, it is much more likely that this funding could be used.

A second sector to see change is the private prison space. Towards the end of the Obama Administration, the department of Homeland security began moving towards ending contracts with private prison operators to house federal prisoners.  The prisons are a source of jobs to the primarily rural communities where they operate. For many of these facilities, the federal contracts are the difference between financial failure and success.

That policy was reversed by the Trump Administration. Now, in keeping with the policies the Obama/Biden Administration was seeking to impose, the President signed an executive order ending contracts between the Department of Justice and private facilities. The policy does not extend to Immigration and Customs Enforcement contracts. The Bureau of Prisons currently holds approximately 11,000 prisoners in 12 facilities. Three are in Texas and two are in Georgia.

TRANSPORTATION FUNDING ALTERNATIVES

Impact fees are a one-time charge assessed only against those who create additional impacts to the transportation system by virtue of a new development or change of use. Their purpose is mitigate the impacts of development on municipal and county infrastructure systems, and to ensure those who are creating the impact, rather than existing tax payers, foot the bill for the cost of new transportation facilities necessary to serve new development.

The Seminole County FL Road (Transportation) Impact Fee was put in place in 1985. Since its adoption, funds collected under this program have been used to construct roads facilities or provide road improvements to accommodate the demands of new growth. The fee has not been updated for a quarter century. Since its adoption, funds collected under this program have been used to construct roads facilities or provide road improvements. Over that time, what constitutes transportation in the minds of users and providers alike, has undergone significant change. 

Now the County is proposing to levy a mobility fee on new development. Mobility fees were legislated 12 years ago by the State. The mobility fee will replace Seminole County’s current Road (Transportation) Impact Fee and will allow for additional transportation modes, to include roads, sidewalks, and multipurpose trails. Seminole calculates that a new mobility fee could raise as much as $6.5 million annually. The county’s current road impact fee raised about $2.64 million last fiscal year.

The proposal serves to highlight many of the issues emerging in the transportation funding space. Proponents of the fee have structured it in such a way that encourages urban development and adds additional relative cost to rural development. The current fee reflects those same concerns. The new fee does anticipate significantly greater increases in the fee for rural  versus urban development.

SANTEE COOPER

The South Carolina House voted 89 to 26 to continue to receive offers for a sale of the state-owned electric utility Santee Cooper (South Carolina Public Service Authority). The bill, which now goes to the South Carolina Senate provides that lawmakers would vet proposed suitors for the utility, a responsibility previously given to a third-party consultant working with a state agency. A six-person committee comprised of three senators and three representatives would consider offers to purchase all or parts of Santee Cooper directly from potential buyers, rather than having a preferred bidder selected by a state agency.

The House legislation also includes reforms for the Santee Cooper, including shortening the terms of board members, putting in education requirements, and having increased oversight from the Public Service Commission and the Office of Regulatory Staff over the utility’s operations and long term agreements. The legislation also provides for the sale evaluation process to be available for 10 years.

That 10 year time frame is a clue to what is really expected to result if the proposed legislation is enacted. A sale is not anticipated soon reading between the tea leaves. Recent comments point towards a reorganization and restaffing of the management of the utility and the ongoing consideration of the sale is a clear shot across the bow of Santee Cooper management. It has all come down to an issue of control.

The debate comes as Santee Cooper has been identified as one of the nation’s utilities with the largest amount of coal fired generating capacity planned to remain open beyond 2030. Among municipal utilities, Santee Cooper has the largest share and is only one of two municipal utilities to be on the top 20 list. That issue will not go away as the control debate unfolds.

ENERGY TAX INCENTIVES GETTING A NEW LOOK

Louisiana’s severance tax on oil – the amount the state charges on oil extracted in the state – is 12.5%. That rate is higher than any other state except Alaska and triple the rate charged for natural gas. Now, the legislature will consider a proposal under which severance taxes for oil would be lowered to 6%, while the severance tax rate on natural gas would go up from 4% to 6%

The proposal seeks to equalize the rates for oil and natural gas. State tax breaks for drilling certain types of wells would be phased out, including one for horizontal drilling widely used in Louisiana’s highly productive Haynesville Shale natural gas play. Louisiana is the site of the most productive natural gas play in the nation and is the only shale play in the country to add rigs over the past year. Louisiana currently ranks third behind Texas and Pennsylvania for natural gas production. 

The proposal comes as officials are projecting $293 million in excess revenue for the current budget year that ends June 30, which legislators can use to make supplemental appropriations when they are back in session. The state also has a $270 million surplus left over from last year, though the state constitution limits the use of those dollars to one-time expenses such as construction projects, paying down debt and shoring up the “rainy day” fund.

The budget debate will unfold as the damage done by pandemic limits on activities is measured. One example is that Louisiana’s casino revenue was down more than 21 % in December compared to December 2019. Under current restrictions meant to control the spread of the coronavirus that causes the illness, casinos are limited to half of their normal capacity and must end alcohol service at 11 p.m.

Virginia is among the 15 states (out of 23 that produced coal in 2018) that offer tax credits to the coal industry. Virginia offers two major tax credits aimed at boosting coal mining in Virginia. The state has spent $225 million between 2010 and 2018 on the Coalfield Employment Enhancement Tax Credit and the Coal Employment and Production Incentive Tax Credit. A report from the Virginia Joint Legislative Audit and Review Commission (JLARC). That report concluded that the tax credits no longer serve their purpose and should be eliminated.

The coalfield tax credit was adopted in 1995 to encourage coal production and coal employment and provides a tax credit to “any person who has an economic interest in coal” mined in the state, which generally is the mining company that extracted the coal. Coal mining companies and electricity generators saved $291.5 million in income taxes because of the coal tax credits between FY10 and FY18. Both of the coal tax credits are among the state’s 10 largest incentives, with the coalfield tax credit being the second-largest incentive. 

The Credit is no longer warranted to maintain competitiveness because Virginia’s coal mining productivity has met that of other nearby coal-producing states. The Coal Employment and Production Incentive Tax Credit, which is designed to encourage electricity generators to use Virginia coal, no longer serves a purpose because all but one of Virginia’s coal-fired plants will close by 2025, and the remaining plant is already dependent on Virginia coal. Legislation to scrap the tax credits next January is moving through the Virginia legislature.

A 2012 JLARC report that said coal production declined at the same rate or faster even with the state-issued credits designed to slow the demise of Virginia’s coal industry. Even industry groups like the Metallurgical Coal Producers Association and Virginia Coalfield Economic Development Authority did not object to the proposal to end the credits 18 months before their scheduled sunset.

The debate is driving a  number of proposals to offset the economic impact of the decline of coal. One would set up a fund to provide grants to renewable energy companies to clean up previously developed but contaminated land and place renewable energy sources there. There is more than 71,000 acres of land affected by coal mining and brownfields in Southwest Virginia that could be redeveloped.

OIL LEASE SUSPENSIONS

The state which looks to be most affected by decisions like this week’s by the Biden Administration which suspended new oil and gas leasing on federal lands is the Cowboy State. In Wyoming, about 51% of oil is drilled on public land, along with an overwhelming 92% of natural gas. In 2019, , according to the Petroleum Association of Wyoming, the oil and gas industry provided $1.67 billion to state and local governments.

A University of Wyoming study projects that if a full leasing moratorium went into effect, the state could be out $304 million in annual revenue. According to the Wyoming Department of Education, the state relies on roughly $150 million each year in oil and gas federal mineral royalties to fund K-12 schools. 

The U.S. Bureau of Land Management auctions parcels of this land to oil and gas companies for development, typically four times a year. If a company obtains the lease, it still needs to secure a permit to drill. Lease terms vary, but typically range from five to 10 years. Permits to drill last two years. The industry “stockpiled” permits in the end of the Trump Administration in anticipation of the possibility of a Democratic administration. The real policy test will come when the leaseholders apply for drilling permits.

The change in federal leasing policy comes as the state is dealing with the long term decline of coal as a generating fuel and the realities of its natural gas industry. The Wyoming State Geological Survey, which is a state entity, recently released its view of the fossil fuel industry in the state. In reality, rise in natural gas production during the Trump years was an aberration. “Wyoming’s natural gas production has been in a gradual decline since the collapse of the coal bed natural gas industry in 2009. Despite Wyoming’s advantages— some of the nation’s largest natural gas reserves, two of the nation’s 10 largest gas fields (Jonah and Pinedale), demonstrated success using horizontal drilling technology in these large fields, and abundant associated gas production from unconventional oil wells.

From 2010 to 2019, Wyoming’s natural gas production declined an average of 4.4 percent each year, with a 13% decline in the first nine months of 2020. Although some of the 2020 decline is due to short term reactions to the pandemic, the overall drop is a result of longer-term trends, including fewer new gas wells being drilled and the natural production decline of older wells.” So the reality is that economics and not ideology are driving Wyoming’s fossil fuel outlook. It is a reflection of national realities.

HEALTHCARE PRESSURES

Labor shortages and higher wages are leading hospitals to employ various strategies to attract and retain clinical talent. Higher salaries and signing incentives, paying more overtime and/or using contract labor at hourly rates that are at all time highs will all contribute to spending pressures at a time when the consumer is looking for every way to reduce their outlays for healthcare.

The insurers will continue to encourage additional procedures to be performed outside the hospital as ambulatory surgery centers (ASCs), urgent care facilities, and the home become the preferred venues for patients to receive care. Even when these service modalities are provided through hospital owned facilities, they are not as profitable as reimbursements are lower for services outside of the acute care setting.

Policy changes and an aging population could increase governmental insurance coverage at the expense of hospitals’ commercial insurance coverage. As retirees migrate to Medicare from commercial insurance, hospitals will receive lower rates of reimbursement for services. Elevated unemployment will also lead to lower patient volumes, as consumers who lose employer provided insurance defer non-urgent care. The same factors driving seniors to Medicare (cost) will also exist should a public option be legislated and that will create the same pressure on revenues that the shift to Medicare does.

If anything, already existing hospital credit trends will continue. Large hospital systems will be better positioned to deal with changes than will stand alone facilities from a financial standpoint. Rural hospitals will continue to be under pressure and more vulnerable to changes in payer mix towards public rather than commercial insurers. The pandemic has not changed that.

MOODY’S UPDATES SCHOOL DISTRICT RATING CRITERIA

Moody’s has published updated methodologies for how it rates US public school districts that provide public education directly to students, typically from pre-kindergarten or kindergarten through 12th grade (K-12) or a subset of grades within this range. School districts rated under this methodology are operationally independent from a city or county government and have the power to issue debt on their own behalf or through a dedicated financing vehicle.

The methodology is used to create a “scorecard” for each rating.  The factors it uses and weights are the school district’s underlying economy (30%), financial performance (30%), its institutional framework (10%), and leverage (30%). Institutional framework refers to at what level of government funding mechanisms are established. Some states rely on a local basis for funding topping off shortfalls from local sources to meet state requirements versus districts where the state sets the basis.

The change has put some 637 school district rating under review. 304 US K-12 public school districts are now on review for possible upgrade, 236 on review for possible downgrade, and 97 on review direction uncertain . The general obligation unlimited tax (GOULT) ratings of 85 US K-12 public school districts were upgraded.  These actions affect issuers with approximately $65 billion in debt . Final reviews under the new methodologies will occur over a course of several months.

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

________________________________________________________________

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

________________________________________________________________

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.

________________________________________________________________

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

________________________________________________________________

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.

__________________________________________________________________

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

________________________________________________________________

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.

________________________________________________________________

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.

Joseph Krist

Publisher

________________________________________________________________

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.

_____________________________________________________________________

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

________________________________________________________________

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

________________________________________________________________

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.

__________________________________________________________________

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.

Joseph Krist

Publisher

________________________________________________________________

GETTING ON OUR SOAPBOX

I saw an opinion piece this week that suggested that any additional stimulus aid to states and localities be contingent on accepting requirements as to how the state and local governments spend the money. That is fine as states and localities have handled grant, aid, and leveraging programs in the past. These include matching fund and other financial requirements. Those are normal policy decisions are made ostensibly for economy and efficiency. Tying healthcare funding under the ACA to funding by states for healthcare make sense, for example.

In particular, the article suggested that Congress require states to build and maintain rainy days funds of certain sizes and proportions. It is further suggested that the reason that states have needed aid to fight the worst and most mismanaged pandemic in history is not because of that but because of their unfunded pension obligations. We find that view ridiculous.

All of the argument seems to revolve around only two parts of the actual public fiscal management equation. Pension funding is a function of good management, responsible legislation, and a supportive electorate. The arguments seem to revolve around whether one should blame the legislatures or the workers. The fact that the pension funding difficulties currently in the spotlight developed over decades under the administrations of both parties and under a variety of economic and fiscal theories does not seem to matter.

What we are seeing today is a reflection of the starve the beast, cut revenue philosophy which has broadly characterized Republican fiscal policy for four decades. Its anti-revenue stance contributes as much as the allegedly greedy public workers backed by the Democratic side. The body politic has been convinced that the only good spending by government is no spending. In this case, it is reasonably easy to identify pandemic related spending and direct any monies generated by Congress to remedy the extraordinary expenses of the pandemic.

Conflating a long history of bad pension management with the problems caused by the extraordinary conditions of the pandemic is ridiculous. The pension expenses plaguing government at present would be the same with or without the pandemic. What is a variable in the equation is the role of the federal government in managing (or more correctly mismanaging) the pandemic response. States could only take steps within their own states to manage restrictions on activity. I’m sure that people in New York State would have loved to have been able to cancel the annual rally in Sturgis, SD which many believe was a catalyst for the ongoing disaster underway in the Plains.

Taken to its logical conclusion, there is as much a case to be made to deny the states currently under a pandemic siege due to the refusals of their governors to impose preventive restrictions any aid as there is to deny states with underfunded pensions assistance. Connecticut. Illinois. New Jersey – blue states. South Carolina, Kentucky, Kansas – red states. They all have badly managed and underfunded pension systems. Chronically so. Going further down a logical path, are pensions more of a problem than irresponsible development subsidized by federal flood insurance? Would FEMA have to pay less if development was restricted in flood zones and wildfire areas? Would states and cities be penalized for issuing ineffective but expensive tax breaks to subsidize business?

In the end, the conflation of current expense demands generated by extraordinary circumstances with the pension funding problem is ludicrous. It’s the sort of ideologically based argument that we have long cautioned against from either party. It’s not constructive and most importantly doesn’t contribute to solving the problem. The states and local governments are asking for help with the pandemic, not for a pension bailout. Let state and local government get through the pandemic and get the red herrings out of the way.

ACA OUTLOOK IMPROVES

We are always wary of trying to read the tealeaves when it comes to issues before the Supreme Court. Nonetheless, it would be a mistake not to note the overwhelming consensus reaction to the arguments heard this week at the Court in the California v Texas case challenging the ACA. By all accounts, the notion of severability – the idea that one portion of a law may be invalidated without invalidating the whole law – seems to be one that will save the Act.

At least two justices clearly expressed the view that the mandate provisions of the law were severable from other provisions of the act. Now that the political firestorm over the appointment of the most recent justice is receding, it is easier to more objectively prognosticate about the expected final result of the case. If we have to make a prediction, we believe that the mandate may be invalidated but that the basics of the ACA including the expansion of Medicaid will be upheld.

Such a result would be credit positive for the major governmental players. The likelihood that the basic terms of the ACA are upheld is increased lessens a significant source of uncertainty for not just providers but also for providers as well as state and local government funders.

ELECTION TAKEAWAYS

So much of the focus has been rightfully on the implications of the Presidential election in the days after its completion. It is true that certain expected federal policy changes will have implications for state and local government. We take the view that local decisions as expressed through the ballot box will have more of a current impact than changes in federal law or policy will.

In Arizona, Proposition 208, an income tax increase to fund teacher salaries increases income taxes through a surcharge on taxable income for single earners who make more than $250,000 and dual earners who make more than $500,000. The Arizona Joint Legislative Budget Committee estimates the surcharge will raise $827 million in revenue, with approximately $702.95 million to be distributed to schools, another $99.2 million available in grants for schools with career technical education programs and $24.8 million that will go towards teacher education throughout the state. The direct funding to districts represents a funding increase of 12.6% in the state’s $5.6 billion general fund expenditure on K-12 education in 2021.

In Los Angeles, Measure RR authorized the Los Angeles Unified School District to issue up to $7 billion in general obligation (GO) bonds. Voters in the SF USD approved Proposition J, which introduces a $288 per parcel tax starting in fiscal year 2022. The tax will generate around $48.1 million annually (equivalent to around 5% of fiscal 2021 budgeted general fund revenue) and allow the district to maintain 7% salary increases negotiated in 2018. The increased revenue is needed as the district drew $40.0 million and $20.0 million, respectively, from its share of the city’s rainy day reserve to fund the pay raises.

In Maryland, voters in Montgomery County approved a charter amendment on property tax limitations that enables the county to raise property tax rates without revenue constraints. The ballot item replaces the existing limit and enables a unanimous vote by County Council to adopt a tax rate on real property that can exceed the rate from the previous year. The county’s previous charter limit, a self-imposed tax cap that was enacted in 1990, limited property tax revenue growth to the rate of inflation (CPI index) and an amount based on new construction. Reinforcing the support for County operations, second charter amendment on the ballot (Question B) was rejected: it aimed to remove the county’s ability to increase revenue above inflation.

THE REAL IMPACT OF PROPOSITION 22

Much will be written and said about the success of the transportation network companies (TNC) in defeating a ballot initiative aimed at reclassifying gig workers as employees. While so much focus on that aspect of the initiative is driving debate, one troublesome aspect of the initiative should draw much more concern. Other initiatives have attempted to make it hard for a legislature to override a voted change by requiring supermajorities for repeal.

I have trouble with supermajority requirements philosophically but to date the required percentages have not exceeded two thirds. That’s manageable. In the case of Proposition 22, the initiative included language which requires a 7/8 majority in the legislature in order for the initiative to be overridden. That effectively prevents any change in the law going forward. It would be dangerous to see a significant body of voter initiatives include such excessive supermajority requirements.

In this case, an exceedingly well funded campaign supported overwhelmingly by the TNCs was more successful than a more thought out and debated legislative process. From our standpoint it’s yet another example of the TNCs adversary approach towards government which hinders its long term goal of replacing public transportation. It also reinforces the view that their long term profitability relies on fully autonomous vehicles. And when that comes, Proposition 22 will be why the unemployed drivers can’t claim unemployment insurance. 

NEW JERSEY

S&P Global Ratings has lowered its rating on the State of New Jersey’s general obligation (GO) bonds to ‘BBB+’ from ‘A-‘, as well as lowered its long-term and underlying ratings to ‘BBB’ from ‘BBB+’ on various other bonds secured by annual appropriations from the state. “The downgrade reflects our view that New Jersey will continue to have a significant structural deficit that will be difficult to close in the coming years because of decreased revenues as a result of the COVID-19 pandemic, combined with high and increasing debt, pension, and other postemployment benefit liabilities.”

The path back from the credit declines experienced under the Christie administration became longer and more twisted as a result of the pandemic. S&P looks at the history of pension underfunding by the State, the decline in available revenues, and the continued need to increase pension funding and concludes that the state will have a large fiscal 2021 structural deficit of 15.9% of budgeted appropriations. 

MBTA

As the most significant example of the difficulties in which large city public transit agencies, we have rightly devoted significant space to the ongoing troubles at the New York MTA. Nevertheless, other northeastern agencies are beginning to reveal their plans for coping with pandemic related declines in ridership and revenues.

Boston’s public transit agency – the Massachusetts Bay Transit Authority – is the latest to announce plans to cope. The plan would take $130 million from spending on service. The reductions in service would be 15% on buses, 30% on subways and 35% on commuter rail.  The proposal includes the elimination of all weekend commuter rail service, 25 bus routes, ferry service, or any rapid transit after midnight.  The T already exhausted about $827 million from the CARES Act to close gaps in fiscal years 2020 and 2021.

The proposal represents the impacts of eight months of state of emergency restrictions on ridership. Current levels of ridership reflect huge declines compared to pre-pandemic crowds — an average of about 40% on buses, 25% on subways, and 13% on the commuter rail. Those declines significantly reduced fare revenue, which typically makes up about a third of the agency’s budget. Officials now expect they will face a $579 million gap in fiscal year 2022, if you believe the most pessimistic end of earlier estimates.

P3 CHANGES HANDS

In 2012, two major players in the public/private partnership arena, Skanska and Macquarie, partnered with Virginia in 2012 to rebuild and expand the Downtown and Midtown tunnels between Norfolk and Portsmouth. The entities were paid to expand the capacity of the tunnels and an extension of  Martin Luther King Boulevard to Interstate 264. These private partners contributed $1.6 billion of project costs with $550 million paid by the Commonwealth of Virginia. A concession was awarded allowing the operator to collect tolls to an entity owned by the partners known as Elizabeth River Crossings.

Toll collections commenced in 2014 and the private operator immediately ran into criticism over its collection of tolls and financial penalties assessed to non-payers. Within three years, the agreement between the concessionaire and the Commonwealth was renegotiated. Macquarie and Skanska offered to settle for lower amounts and to pay $500,000 annually for 10 years toward a toll-relief program for eligible residents of Norfolk and Portsmouth, among other changes.

Tolling and their collections remain a political sticking point.  Gov. Ralph Northam tasked the Virginia Department of Transportation to “evaluate opportunities to mitigate the financial burden on the commuting public.” Work on the study began in May 2019 and was nearing completion this summer. So the private partners clearly reevaluated their investment.

Now the partners have announced that that the legal entity which operates the facilities, Elizabeth River Crossings, has been sold to a Spanish toll road operator and the John Hancock Life Insurance Co. for more than $2 billion. The sale will generate an annual  5.4% return on asset over the eight year period of ownership to the Macquarie/Skanska partnership. That just doesn’t cut it for these investors relative to their perceived risk.

The new buyer is Abertis, a Spanish toll road company, and Manulife Investment Management, which did so on behalf of John Hancock Life Insurance Company, a division of Manulife Financial Corp. If approved, the project would be Abertis’ first toll road operation in the United States. Under the existing terms governing operation of the facilities, the operator would have the concession for another 50 years. It would be limited to annual increases of 3.5% for tolls.

MORE ON TOLL ROADS

More traditionally financed and operated toll roads are facing issues related to their toll collection practices, especially the use of accumulating additional penalties in the event of non-timely payment of delinquent fees. The Transportation Corridor Agencies, operator of the San Joaquin toll roads, has made a motion in the California courts to settle litigation regarding Transportation Corridor Agencies and its tolling practices.  The Transportation Corridor Agencies and 3M have approved a deal worth nearly $176 million to end a lawsuit filed by a class of millions of motorists who traveled the toll roads. The settlement includes nearly $41 million in cash awards and $135 million in penalty forgiveness.

The lawsuit alleges that Southern California toll companies for tolls on state Routes 73, 133, 241, 261, and the 91 Express Lanes improperly shared personally identifiable information of motorists to third parties. The agencies will provide $135 million worth of penalty forgiveness to members with outstanding penalties. Those eligible will receive the lesser of the total of their outstanding penalties or $57.50. Any remaining funds will go toward those with the oldest outstanding penalties to the newest.

Who gets the money? Class members include anyone whose personally identifiable information was provided by the Transportation Corridor Agencies to any other individual or entity between April 13, 2015, and 30 days after the court issues a preliminary approval order.

In the Bay Area, The Golden Gate Bridge, Highway and Transportation District oversees the bridge, buses and ferries in the Bay Area. It has been relying on federal stimulus assistance to keep paying its employees even in face of significantly reduced traffic. Now those funds are essentially gone and no subsequent stimulus appears on the horizon.

This has led the District to pose a choice to its stakeholders in the absence of any additional stimulus. The District faces a $48 million revenue shortfall. To deal with that gap, the District has proposed either reducing headcount by half or raising tolls. The transit district has experienced about a $2 million a week drop in tolls and fares throughout the pandemic

Golden Gate Bridge traffic is still down 30%, bus ridership dropped 75% and ferry ridership plummeted 96%.  cutting staff would save an ongoing $26.7 million a year until the positions are refilled. One option, which would avert layoffs, is to temporarily raise the toll by $2, from the current range of $7.70 to $8.70 for a car depending on whether a driver pays with FasTrak or by mail. Another option is a hybrid model that would raise the toll by $1.25 and furlough staff one day a week. 

CLIMATE

The powerful derecho that swept through the Midwest in August, focusing its destruction on central Iowa, is officially the most costly thunderstorm event in recorded U.S. history. According to NOAA, an estimated 90% of structures in Cedar Rapids were damaged by the storm, and more than 1,000 homes were destroyed. the U.S. Department of Agriculture estimates that 850,000 crop acres were lost — 50% more than originally estimated.

As of November 2, 2020, more than 200,000 claims have been reported.  Of those claims, nearly 160,000 claims totaling more than $1.6 billion have been paid already.  Insurance companies are holding more than a billion in reserves to be used for the remaining claims. Iowa Gov. Kim Reynolds requested nearly $4 billion in federal aid to help the state’s agricultural industry.

This all comes as the state has come later to the pandemic’s wrath but is now facing its full pressure. The daily case tally has just reached nearly 5,500 and 27 deaths. The total is 162,000 sick and some 1900 dead. It all adds up to additional pressure on the State.

On the positive climate front, green jobs can even spring from the auto industry. One of the fears of local economies is that existing manufacturing locations may not survive the ultimate conversion to electric vehicles. Ford just announced it will add 150 workers at its Kansas City Assembly Plant in Claycomo, Missouri, to build the new E-Transit full-size van that will go on sale late next year. Another 200 workers will be hired at Ford’s Rouge Electric Vehicle Center in Dearborn, Michigan, which will build an all-electric F-150 pickup starting in mid-2022.

Ford will spend about $150 million at a transmission plant in Sterling Heights, Michigan, to make electric motors and transaxles for new electric vehicles. No new jobs will be added but the investment will help keep 225 positions. Automakers sold just over 236,000 fully electric vehicles in 2019, up 36% from 2018. That is a mere 1.4% of all new vehicles sold in the country.

This news comes as the Federal Reserve made its clearest statement to date regarding the potential impact of climate change on the global financial system. “Acute hazards, such as storms, floods, or wildfires, may cause investors to update their perceptions of the value of real or financial assets suddenly…slow increases in mean temperatures or sea levels, or a gradual change in investor sentiment about those risks, introduce the possibility of abrupt tipping points or significant swings in sentiment.” Lost in much of the politics driven debate over climate change is the fact that two of the more objective entities in the federal government – the military and the Federal Reserve – have made clear policy statements in support of a view that climate change is real and is happening. That moves the debate forward.

PUERTO RICO

This week’s news that nearly 200 boxes of uncounted votes have surfaced in Puerto Rico is just the sort of thing that makes statehood a pipedream. Officials acknowledged that the votes could change the results of particularly narrow races that had already been preliminarily certified. Two city mayoral elections are currently decided by margins of under ten votes.

In spite of the hopes of activists and others, the election was already marred by the fact that the winning gubernatorial candidate won with only one-third of the vote.  The president of Puerto Rico’s State Electoral Council, Francisco Rosado Colomer, acknowledged that it could be between 3,000 and 4,000 votes which have been “found”.

The exact circumstances behind the “loss” and “discovery” of the votes are not clear. What is clear is that the perception of the government and politics of Puerto Rico as being incompetent is only enhanced by events like these. It weakens the value of the vote on issues like status. Add this to the narrowing of the partisan breakdown of the U.S. Congress and the outlook for statehood significantly weakens.

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

________________________________________________________________

As we go to press on this Friday morning, a certified election result will not occur for the presidential election. Nonetheless, elections for state offices have produced some trends. There was the smallest shift in the partisan make up of state legislators in many election cycles. The implications of these results is that in spite of the apparent loss by President Trump, Republicans still dominate statehouses.

This has significant implications for the decennial redistricting process which could further entrench the party at the state level and keep the makeup of the House relatively closely split. This has implications for spending by the federal government and how it will deal with things like healthcare, especially if the Supreme Court rules against the ACA. So the uncertainty that confronts sectors like transportation and healthcare is likely to continue. With that as context, here are what we see as the significant issues from the week.

_________________________________________________________________

MTA

The MTA announced that it is preparing to borrow the final $2.9 billion available to it from the Federal Reserve’s Municipal Liquidity Facility (MLF). The decision comes in  the face of continuing impacts on ridership and pressure on its ratings from the limits imposed by the pandemic. Unsurprisingly, the decision has been received negatively by the rating agencies but that seems to more on the basis of the long term view of the Authority’s finances. In announcing its view that the move to borrow was credit negative, Moody’s noted that their view is rooted in their assumptions about the post-pandemic ridership trends.

Moody’s sees a scenario where even when the economy returns to a more normal performance. It expects MTA ridership to permanently remain 10% below its pre-corona virus level – establishing a “new normal” – largely because of an increase in work-from home flexibility. Restoration of demand to 90%of pre-pandemic levels would be a significant improvement from the currently diminished demand. On  October 28, the MTA’s estimated subway ridership was down 69.7% from the same day in 2019 and Metro-North ridership was down 78%.

It should be noted that the new round of borrowing will be secured by secured by dedicated taxes and paid before the outstanding transportation revenue bonds. Eventually, these borrowings will become a part of the Authority’s long term debt structure as the likely source of the note repayment will be a long term refinancing.

The election has reduced the likelihood that the MTA will get as much as it needs in any future stimulus given the resulting split in the Senate. Should the Republicans retain their majority, another stimulus is likely but the mood against aiding state and local governments directly does not seem to have improved. Broadly generalizing, Republicans have backed roads over mass transit and the Democrats have favored mass transit in previous funding debates.

ELECTIONS

The bid to convert Illinois’ income tax regime from a flat rate to a progressive rate went down to defeat. Revenues would likely have increased under such a plan at a time when the state could certainly use them in its quest for structural balance. The defeat of the proposal is credit negative for the State and Chicago as well. The defeat reflects the continuing resistance to taxes to address the State’s structural budget problems. The results were definitive with 55% against and 45% for in a vote which required 60% approval to meet the constitutional threshold for amendments.

Moody’s outlined some alternative revenue steps which might be taken by the Legislature. They would only require a simple majority and include Alternatives include increasing the 4.95% flat tax that applies to individual income or broadening the state sales tax to more services. Raising the flat income tax by 70 basis points, to 5.65%, would generate about $3 billion of additional revenue, the same as had been projected for the first full year under graduated income tax rates that the state had devised in connection with the proposed constitutional amendment.  

In California, Proposition 22 which would have altered the status of “gig” employees went down to defeat after a $200 million investment in support of the proposition. Uber and Lyft had said that they could not operate in the State if they were forced to treat their drivers as employees. Proposition 22 would have shifted local property tax burdens from the residential sector to the commercial sector by lifting the limits on property taxes imposed by Proposition 13 for commercial property. It was seen as a potential significant revenue generator for localities. Proposition 19, a generous new property tax break for older California homeowners, partly paid for by removing a low-tax guarantee for those who inherit a home from a parent or grandparent was winning as we went to press but the outcome was still in doubt..

Legal recreational marijuana was approved by voters in New Jersey, Montana,  and Arizona. In South Dakota, voters legalized medical use. Mississippi did as well but on a more limited basis. Arizona voters approved a ballot question (Proposition 207 ) to legalize recreational pot for people ages 21 and older with a 16% excise tax on retail sales. Montana approved two measures. One (Initiative 190 ) to legalize recreational marijuana with a 20% tax and let people convicted of marijuana offenses apply for resentencing or records expungement, and the other (Constitutional Initiative 118) to let the Legislature set the age for buying, using, and possessing marijuana at 21.

South Dakota voters passed Constitutional Amendment A and Initiated Measure 26 to legalize recreational and medical cannabis. New Jersey said yes to Public Question No. 1 to legalize recreational cannabis for people ages 21 and older and subject it to state sales tax. Local taxes would have to be approved by the Legislature.  Mississippi voters passed Initiative 65to legalize medical marijuana and rejected an alternative added by legislators to let lawmakers regulate a more restrictive program.

Arizona voters looked likely to approve Proposition 208, a measure that would raise revenue for education by applying a 3.5% surcharge on taxable annual incomes above $250,000, for individuals, or above $500,000 for joint filers.

The wildfires in Colorado should probably get some credit for generating support for a 1/4 cent increase in the local sales tax in Denver. The stated purpose of the tax is to reduce the City’s carbon footprint. The City has goals for reducing C02 emissions by 40% by 2025, by 60% by 2030 and by 100% by 2040. In combination with a similar increase to be dedicated to homelessness issues, the local sales tax in Denver will reach 8.81%.

Austin voters overwhelmingly approved Proposition A, which would raise property taxes in the City of Austin to help pay for the Project Connect transit improvement plan. The plan includes two new light rail lines, a new commuter rail line, and a new bus rapid transit line  that would run in its own right-of-way so it doesn’t mix with traffic. A new downtown transit tunnel would also be built. Proposition B, which would allow the city to borrow $460 million for a host of infrastructure improvements, including new sidewalks, bikeways and street repairs was also approved by two thirds of the voters.

Seattle voters have approved a six-year measure which enacts a tax of 0.15%, or 15 cents on a $100 purchase, to generate $42 million a year. That money, to be collected starting April 1, replaces existing taxes that expire this Dec. 31, of .10% plus a $60 car fee. Total sales tax within Seattle will reach 10.15% including state, county and transit-agency shares. To the south, Portland metropolitan area voters rejected Measure 26-218 which proposed a tax of up to 0.75% on private employers with 25 or more workers. Similar efforts to impose such a tax had been attempted in Seattle unsuccessfully as well.  

PUERTO RICO

First the debt restructuring news. U.S. District Judge Laura Taylor Swain denied a motion asking the court for an independent investigation into trading activity and possible violations of the confidentiality order by several creditors including bond insurer National Public Finance Guarantee Corp. in the mediation process of the Puerto Rico debt’s restructuring. The judge also decided that by Feb. 10, the Commonwealth’s Financial Oversight and Management Board (FOMB) must submit “at a minimum an informative motion comprising of a term sheet disclosing the material economic and structural features of a Commonwealth and PBA [Public Building Administration] plan of adjustment [POA].”

The proposal for an investigation would have an independent investigator look into insider trading claims rather than the New York Attorney General and the SEC. Judge Swain stated that Promesa “does not explicitly authorize the Court to order to initiate an independent investigation” like the one in National’s motion and added that National did not provide a viable option. An additional motion made by the PSA creditors, which comprises the Ad Hoc Group of Constitutional Debtholders, the Ad Hoc Group of General Obligation Bondholders, the  Lawful Constitutional Debt Coalition (LCDC) and the QTCB Noteholder Group was also rejected.

The court actions highlight the divide between the creditor groups. National contends that some creditors have used their participation in the restructuring process to trade certain contested bonds from the Commonwealth and obtain profits for themselves. National was concerned that it would be left “holding the bag” to cover any losses to investors in bonds it insured.

As for the election, the former two-term resident commissioner—from 2009 to 2016 – Pedro Pierluisi was elected Governor by the narrowest of margins. The percentage difference in votes between the two top candidates for governor was less than 1 percent. The election also included a yes-or-no plebiscite on whether Puerto Rico should be admitted as the 51st state of the United States. Statehood prevailed in the political status referendum, with 52.29 percent voting “yes” to statehood, and 47.71 percent voting against, with 88.34 percent of units reporting.

One of the difficulties with the debate over statehood vs. the status quo is the consistent history of a true split in the electorate. There has never been a question on the ballot regarding Puerto Rico’s status that generated a clear and convincing result one way or another. It’s one of the prime hurdles for statehood proponents to overcome. That lack of political consensus continues to hold back efforts to resuscitate the Commonwealth economy.  And low voter participation of just over 50% of eligible voters reduces the value of these status votes.

Proponents of statehood are already making their case in the mainland press. The problem is that while a majority of voters opted for statehood, it was a small majority. In essence, proponents are claiming a mandate on the basis of the expressed view of 25% of eligible voters. Opponents can seize on that to say that new real mandate in support of either the status quo or statehood resulted.

CASINOS ON THE BALLOT

In Virginia, voters in four cities – Bristol, Danville, Norfolk, and Portsmouth  voted to allow for the construction of proposed casino developments in those cities. The casinos are tentatively slated to open in 2023. In the meantime, they are expected to add construction employment and repurpose old industrial and commercial sites in the respective cities. Each city will benefit from the payment by the casinos of all applicable local fees and taxes, including property, sales, hotel occupancy and meal taxes and each city will receive a portion of the gaming tax revenue to be collected by the state.

The Commonwealth will levy a gross receipts tax on casino activities, a portion of which will be allocated to host cities according to a formula. With the exception of Bristol, the cities will keep their full share of local revenues. Bristol is one of the significant stops on the NASCAR circuit. Races can draw some 165,00 spectators who then generate significant local revenue in the City especially in connection with race days. Bristol’s local revenues would be directed to a Regional Improvement Commission which would distribute them evenly among the city and the 12 counties within the Virginia Department of Transportation’s Bristol service district which includes Bland, Buchanan, Dickenson, Grayson, Lee, Russell, Scott, Smyth, Tazewell, Washington, Wise and Wythe counties.

Moody’s views the approvals as credit positive for the localities. They cite the potential to generate increased local tax revenues and create significant numbers of jobs. Norfolk estimates that the development will bring it $25- $45 million in recurring tax revenues when it is open. Bristol projects it will generate about $16 million in new recurring local tax revenue. Danville would be able to transfer ownership of a blighted industrial site and get a $20 million upfront payment. Virginia was one of nine states that prohibited casino gambling. Gaming taxes will be imposed at rates of 18%, 23% and 30% for casinos’ adjusted gross receipts of the first $200 million, between $200 and $400 million, and in excess of $400 million, respectively.

These gaming taxes will be held for appropriation by the General Assembly pursuant to formula host cities will receive 6%, 7%, and 8% of adjusted gross receipts. 0.8%  would go to the Problem Gambling Treatment and Support, 0.2% would go to the Family and Children’s Trust Fund. For the one casino operated by an Indian tribe (the one in Norfolk), 1% will go to the Virginia Indigenous People’s Trust Fund. Any residual would be available for appropriation for programs established to address public school construction, renovations or upgrades throughout the state.

UTAH NUCLEAR

A nuclear generating facility actually planned to be physically located in Idaho but to be paid for by sales to Utah municipal utilities is losing participants. The decision to withdraw follows announced cost increases by the Utah Associated Municipal Power Systems (UAMPS), which was the primary intended buyer for capacity from the proposed plant. Completion of the project would be delayed by 3 years to 2030. It also estimates the cost would climb from $4.2 billion to $6.1 billion.

NuScale is an entity which was spun out of Oregon State University in 2007. It is their plant design that will be used for the plant. It’s efforts to promote nuclear power have benefited from DOE support cost sharing agreements whereby DOE would cover some $1.4 billion of construction and development costs. The attraction of the facility is its small modular design the company says will be safer, cheaper, and more flexible that a conventional gigawatt power reactor. Each of NuScale’s little reactors would produce 60 MW. A plant would contain 12 of the modular reactors, which would be built in a factory and shipped to the plant site. 

This would allow the generator to serve as a peaking facility much in the way a similar sized fossil fueled facility might serve. The proposed project still has many rivers to cross even as it passed a key milestone in the NRC review process, receiving its safety evaluation report. It expects to receive a final “design certification” to come next year. 

UAMPS contends, in an effort to deal with a poor track record for nuclear generating development and construction, that construction will not be commenced until the full output of the plant is sold. That process is a long way from completion. It’s a concern that another municipal utility is being challenged to participate in not just a nuclear facility, but a nuclear facility of a new design. Too often our market is taken advantage of because of our lower cost of financing and need for yield. This could become another example of this phenomenon.

INTERNET SALES TAXES

Once the Supreme Court ruled in favor of states seeking to tax sales of products through the internet, many states began imposing such taxes. Now we are beginning to see data about how much revenue these taxes generate. Recently, Arizona completed its first year of collections and released updated collection information.

Under a state law that took effect on October 1, 2019, out-of-state businesses that do not have a physical presence in Arizona and meet certain economic thresholds must collect and remit transaction privilege tax in Arizona. The Arizona Department of Revenue has seen a steady rise in transaction privilege tax collection. Since October 1, 2019, the Arizona Department of Revenue (ADOR) has brought in more than $467 million in transaction privilege tax from over 4,500 remote sellers and marketplace facilitators. In fiscal year 2020 (September 1, 2019 – June 30, 2020), the department collected over $278.7 million and over $128.6 million towards the General Fund.

Now it’s not clear as to whether these sorts of results will be sustainable. It is likely that collections of sales taxes from internet sales in 2020 may be a bit of an aberration as the impact of the pandemic on local economic activity drove significant demand to purchase on line rather than in person.  So it is difficult to use this past performance under unusual conditions as a basis for predicting future results.

OPOIOD LITIGATION

I have fielded many inquiries about whether ongoing litigation against manufacturers and distributors of opioids would be the next securitization candidate for the municipal bond market. Settlement talks have been ongoing for at least the past year. A proposed settlement was rejected in 2019 due to a variety of factors.

Now it looks like a settlement of the litigation may be at hand. According to press reports, a settlement involving a $26 billion payout is likely to be approved. Three major drug distributors and a large drug manufacturer – McKesson, Cardinal Health, AmerisourceBergen and Johnson & Johnson – have indicated that they would support such a settlement.  The distributors will collectively pay about $21 billion over 18 years, with $8 billion paid by McKesson alone. J&J would contribute $5 billion. The move is being motivated by the existence of two suits – one in New York and one in West Virginia – scheduled to begin in January, 2021. The WV case is being brought by the local governments in the state as prior settlements in WV were only with the State.

Each state would determine how it would distribute settlement money. The amount each state would receive is expected to be determined by four factors: state population, overdose deaths, diagnoses of substance use disorders and volume of pills sold. The distribution formula has been the source of much conflict among the plaintiffs and has been hampered by arguments over attorney compensation.  The settlement would provide $2 billion for the lawyers which is expected to be paid out over seven years.

Significant differences between this and the tobacco settlement. First, there is much less money involved and the payments in this suit will occur under a fixed timeline with a final date certain. The tobacco settlement provided for payments in perpetuity. That allowed for longer amortizations and greater flexibility in terms of managing cash flows in support of any bonds issued. Other differences include the fact that annual payment amounts are not based on ongoing consumption or sales of the product as is the case with tobacco bonds.

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.