Joseph Krist

Publisher

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PA TURNPIKE FUNDING UPHELD IN COURT

Over the last decade, Pennsylvania has struggled with meeting the infrastructure needs of the state in the face of difficult overall budget pressures. One way that the Commonwealth chose to address it’s crumbling state road and bridge system was to apply revenues derived from tolls on the Pennsylvania Turnpike. Historically, the Turnpike had only rarely raised tolls and yet still achieved a strong credit position. Now the Turnpike is looked to as a major source of road funding for the state as a whole. This has led to regular annual toll increases.

When enacted, the plan to raise tolls to finance non-toll road facilities was controversial. Users did not like subsidizing other facilities. Bondholders did like seeing their credit security diluted. The Turnpike Commission (PTC) saw its rating lowered. The legislation provided that the funding would be temporary requiring the annual PTC transfer to the state to decline to $50 million from $450 million starting in fiscal 2023.

In the meantime, opponents took their case to the federal Courts. In April, the US District Court for the Middle District of Pennsylvania dismissed their lawsuit against the Pennsylvania Turnpike Commission (PTC, A1 senior and A3 subordinate stable) and the Commonwealth of Pennsylvania (Aa3 stable) brought by the Owner Operator Independent Drivers Association, Inc. (OOIDA). The plaintiffs claimed that the PTC and state (and others) violated the dormant Commerce Clause and the constitutional right to travel by charging higher tolls on the turnpike system to fund other state transportation needs, like capital needs of the state’s transit enterprises.

They appealed the dismissal. Last month, the US Court of Appeals for the Third Circuit affirmed the  April order. The appellate judge reasoned that since Congress expressly authorized the use of tolls for non-tolled purposes under the Intermodal Surface Transportation Efficiency Act of 1991 (ISTEA), the dormant Commerce Clause does not apply. Also upheld was the dismissal of the claim that the plaintiff’s “constitutional right to travel” was violated because not all entry and exit points into and out of the state are “tolled” and thus there are methods to travel across the state that are free, though they may be less convenient. In sum, “the right to travel” does not mean “the most efficient and direct route.”

So the funding scheme remains intact. That is a short run positive for the Commonwealth’s budget. For the Turnpike Commission, the impact is less clear. Now that it has won its litigation challenge, will the Commonwealth amend the legislation and keep the funding scheme in place at its higher current level. The plan has not been positive for the PTC senior lien bond credit. For example, the Commission makes quarterly payments to the Commonwealth for non-PTC projects but recently the state had granted a waiver to the Commission while the litigation unfolded. Once the court handed down the original dismissal order, the waiver from the Commonwealth was not extended and the bill for 2019 and2020 came due. This forced the Commission to issue $712 million of subordinate bonds in June 2019 to pay the state its deferred fiscal 2019 Act 44 payments and the upcoming fiscal 2020 payments.

While the decision may be positive for the Commonwealth’s general credit, the Turnpike Commission remains under pressure. There is concern that the judicial support for the Act 44 funding plan will slow momentum in the effort to establish a more broad based funding plan that takes pressure off the Commissions ratings and bonding capacity.

PUERTO RICO

The Financial Oversight and Management Board for Puerto Rico has released its 2019 annual report. It documents the variety of actions which have occurred in the effort to restructure the Commonwealth’s debt. Our focus however is on the comments regarding the budget for the current 2020 fiscal year. They highlight the inherent conflict between “rightsizing” government relative to its resources with the political reality created by the government’s inordinately large role as a source of employment.

Total government spending of $20.2 billion is focused on the following priority areas: 21% for health, 17% for education, 13% for pensions paid via PayGo, 12% for families and children, and 5% for public safety. The areas prioritized make sense. Here’s where legitimate questions may be raised.  The budget, for example, provides for increased salaries and benefit contributions for police officers and incremental funds to purchase bullet proof vests, radios, and vehicles. Increased salaries during a period when the population at large faces  such huge difficulties?  Social Security is budgeted for all police as of July 2019 to provide them a more secure future retirement. In addition, the Certified Budget raises teachers’ and school principals’ salaries for the second  consecutive  year. This in a school system that faces contracting demand. It also raises the  salaries of firefighters.

The report references, among other places, the experience of New York City under a control board in an effort to prepare citizens for a long recovery period. It’s all well and good to make the reference but to refresh those who forget or do not really know the history, keep these items in mind. New York City made substantial cuts to basic public services in the immediate post-1975 crisis era. Raises? NYC police and firefighters were laid off. That is serious belt tightening.

STORM CLOUDS AHEAD

The outlook for state general obligation credits has been fairly solid up until now throughout the budget process.  We saw many favorable comments about reserves and taxes creating a strong foundation for states to fall back on. Well let’s hope that this do indeed hold up as the economic storm clouds gather at an inopportune point in the budget cycle.

US industrial production decreased 0.2% last month, according to the Federal Reserve, missing economists’ forecast of a 0.2% increase. Meanwhile, 77.5% of capacity was in use at factories, utilities and mines, the lowest figure since October 2017. Continuation of the trend will hurt earnings and tax revenues. Analysts have been cutting S&P 500 profit estimates for the second half of the year. According to FactSet, companies’ earnings will increase 1.5% this year at best, down from a January prediction of growth exceeding 6%.

And that is what could be the problem. Since many of the states budgeted based on best economic data available (which may have included some 1Q data) they weren’t able to account for the current negative impacts of the trade war. The retail industry’s freak out over tariffs is a clue to how fragile things are. Nine major world economies have entered a recession or are on the verge of one.

TECH REDLINING

It is a policy reminiscent of the bad days of urban development. The practice of redlining – the effective refusal of banks to make mortgage loans in certain, usually poorer and less white neighborhoods. The practice has rightly been criticized and has been greatly reduced. One would think that anything that smacked of redlining – no matter what the business – would be a practice which would not be undertaken by our progressive, technology educated brethren. Sadly, this is not the case.

A recent report on scooter use in SF – the epicenter of the micromobility industry – highlights a practice that walks, talks, and squawks of redlining. Despite a promise that it wouldn’t prioritize lucrative wealthy areas of San Francisco over low-income zones, electric scooter company Scoot has blocked drop-offs in two of the city’s poorest neighborhoods. Scoot is a scooter provider which was acquired by Bird – a micromobility provider which has yet to see a regulation it couldn’t ignore.

As a condition for joining the city’s scooter pilot program, Scoot specifically promised it would prioritize serving the Tenderloin and Chinatown as  “communities of concern. ” Scoot claims to only be thinking of the elderly. Communities in Chinatown and the Tenderloin had expressed concerns about potential hazards from scooters to older people and others, as well as possible pitfalls related to narrow sidewalks, so the company decided to exclude areas to address those worries. The no-drop-off zones don’t cover the entirety of either neighborhood, and scooters are available on the peripheries of closed-off areas, so the company believes it is serving those neighborhoods as promised in its permit application.

Bird also maintains red lines around areas of Oakland, its app shows, including Lake Merritt (the home of Barbeque Becky).  Numerous scooters have been deposited in the lake (likely by established neighborhood residents under gentrification pressure from newly arriving tech types). A company spokesperson claims it closed off those areas at the request of city and school district officials.

Lime also operates in Oakland and excludes Lake Merritt and Oakland Technical. A Lime spokesperson said city officials had asked it to close to drop-offs the area surrounding Lake Merritt, and exclude Oakland Technical. Lime also excluded all the other schools in Oakland.

So like Citibikes in New York, the scooter providers just cannot seem to find a way to serve all of a population. They continually reinforce the notion that electric scooters are not a real alternative to today’s public transportation option set but rather a plaything for white hipsters. It simply is not an effective model for developing, financing, and funding public transit.

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 inter, intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Publisher

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MOODY’S AND THE MTA

The transportation space increasingly finds itself at the center of many of the larger debates underway as the nation’s urban landscape develops. One of those issues is the need for significant investment in the nation’s urban mass transit infrastructure. How to pay for it is a question which dominates the discussion on the federal, state, and local levels. So we were intrigued to see Moody’s weigh in on how it thinks transit should be funded at least in the case of New York’s MTA.

First, some context. Funding of the mass transit system in New York has been a constantly evolving process. Initial private investment was ultimately accompanied by public investment and over time the funding responsibility became all public. Each iteration of fun ding policy was accompanied by a variety of funding methods including general obligation debt from the City for the Independent lines. There was always a variety of revenues derived from a variety of sources that matched the diversity of the passenger base.

Over time the realization was achieved that the lifeblood of the economic engine that drove New York State was the City’s mass transit system. It fueled unprecedented levels of development in the City and beyond and the impact was reflected in the source of funding. Fares always generated a higher level of operating revenues than was the case in other cities for years. Those fares, however, were always accompanied by taxes and tolls which effectively accessed much of the income derived from the city economy.

That compact began to fray as the financial recovery of NYC was competing with agencies like MTA for financing. Under those circumstances, a series of dedicated taxes and the authorization of $800 million in fare-backed bonds. The money allowed the agency to buy new cars and fund urgent structural repairs. As time went on bonds became a way to provide political cover to artificially hold down fares and taxes. Taxes are constantly subject to change as the result of one county’s historic intransigence against having to fund the MTA. It is, as they say, no way to run a railroad.

So too it is important to remember that the MTA fare box credit has been remarkably stable given the challenges the system faces daily. This in the face of enormous capital needs, lack of funding consensus, and significant pressures to increase subsidized or even free service. So we find it interesting that after such support of the existing, failing funding model we hear this. “Lagging income growth among the lowest-earning residents of its service area will weaken the MTA’s ability to raise fares and balance its operating budgets,” Moody’s  said in a press release. “However, the essential role of mass transit in the New York economy provides a strong incentive to tap the region’s high and growing overall wealth to subsidize transit operations.”

That’s the sort of leap from rating credit to making policy recommendations that gets the agencies into trouble. Essentially by supporting good ratings for the MTA fare box credit for a long time they unwittingly aided and abetted the effort to postpone funding choices.  When the debate first began essentially in the 80’s, issues of fairness and equity were at the heart of the transit funding debate. That has not changed in the era since but the politics have. This comes off  jumping on the bandwagon. A Brooklyn councilman wants the MTA to offer free service on holidays. He compares is to suspending alternate side of the street parking on holidays. Christmas Day, New Year’s Day, Memorial Day, Independence Day, L​​abor Day and Thanksgiving would be the days. Admittedly, MTA ridership is significantly lower during major holidays. It’s reflective of the political headwinds facing the agency.

If you’re Moody’s is that a train you want to be in front of?

MEDICAID EXPANSION SPEED BUMP

It appears that the Utah state legislature’s effort to have its cake and eat it too as it responds to a voter initiative expanding Medicaid will not fly. At least not from the standpoint of the Centers for Medicaid and Medicare (CMS), the agency with oversight over Medicaid expansion waivers. In November, 2018, Utah voters authorized he expansion of Medicaid eligibility under the terms of the Affordable Are Act. Republicans in the Legislature agreed to expand the program to include people making up to 100% of the federal poverty income line. Under the Affordable Care Act, states can expand Medicaid to people making up to 138% of the federal poverty line. 

And therein lies the rub. Utah was asking for full reimbursement although it was not expanding the program to the same extent. It essentially wanted full coverage even though it was – based on the income limit – only making three fourths of the effort. CMS takes the position that while it remains committed to its goal of allowing states additional flexibility in Medicaid, it would reject plans that would limit expansion enrollment while requesting full Medicaid funding available from the government.

At its core, the action is another in a chain of them coming from the federal government in a continuing effort to gut the Affordable Care Act. CMS approved a version of the plan to serve as a “bridge” ahead of a full expansion, allowing Utah’s Medicaid program to begin enrolling individuals April 1. Those who have enrolled will be able to keep their coverage as the state finds a new solution. It’s worth noting that the program failed to pass even though it contained the current Trump Administration work requirements.

All of this occurs against the backdrop of pending litigation in the Fifth Circuit Court of Appeals which seeks to have the ACA declared unconstitutional.  A District Court determined that the ACA is unconstitutional now that Congress has rolled back the penalty requiring everyone who did not carry health insurance to pay a fine. Other court action generated a third loss for the Administration’s efforts to impose work rules. For a third time the same federal judge who ruled against Arkansas and Kentucky’s work rule schemes ruled that federal health officials were “arbitrary and capricious” when they approved the New Hampshire’s plans, failing to consider the requirements’ effects on low-income residents who rely on Medicaid for health coverage.

Data came out this week in a study by the General Accounting Office (GAO) which shows what might happen if the ACA goes away and the ranks of the uninsured grow again. Medicaid, the joint federal-state program that finances health care coverage for low-income and medically needy individuals, spent an estimated $177.5 billion on hospital care in fiscal year 2017. About a quarter ($46.3 billion) of those hospital payments were supplemental payments—typically lump sum payments made to providers that are not tied to a specific individual’s care. States determine hospital payment amounts within federal limits. In fiscal year 2017, DSH payments totaled about $18.1 billion. 

Medicaid disproportionate share hospital (DSH) payments are one type of supplemental payment and are designed to help offset hospitals’ uncompensated care costs for serving Medicaid beneficiaries and uninsured patients. Under the Medicaid DSH program, uncompensated care costs include two components: (1) costs related to care for the uninsured; and (2) the Medicaid shortfall—the gap between a state’s Medicaid payment rates and hospitals’ costs for serving Medicaid beneficiaries. As we go to press, plans to delay cuts to the DSH program are under negotiation as a part of the federal budget process. Medicaid DSH payments covered 51 % of the uncompensated care costs nationwide. In 19 states, DSH payments covered at least 50% of uncompensated care costs.

MARIJUANA – FACTS OR FEARS?

In the wake of recent efforts to legalize marijuana, it helps to look at the facts behind some of the claims made especially by opponents of legalization. Any debate is always ore useful and illuminating when it is a debate based n facts. Two concerns are almost always cited. One is the potential for increased use by teenagers and the other is the specter of thousands of newly impaired drivers on the roads. No matter one’s position on the matter, it is always useful to look at data to evaluate these claims. In that light, we view the findings of two sets of data from dispassionate sources.

The first issue is that of increased access to marijuana by minors. A recent report from the Journal of the American Medical Association deals with this issue. In the United States, 33 states and the District of Columbia have passed medical marijuana laws (MMLs), while 10 states and the District of Columbia have legalized the recreational use of marijuana. A 2018 meta-analysis concluded that the results from previous studies do not lend support to the hypothesis that MMLs increase marijuana use among youth, while the evidence on the effects of recreational marijuana laws (RMLs) is mixed. 

The estimates generated for the report showed that marijuana use among youth may actually decline after legalization for recreational purposes. This latter result is consistent with findings in prior studies and with the argument that it is more difficult for teenagers to obtain marijuana as drug dealers are replaced by licensed dispensaries that require proof of age. The data is not necessarily consistent.

One study found increased marijuana use among 8th and 10th graders after it was legalized for recreational use in Washington State. However, the same authors found no evidence of an association between legalization and adolescent marijuana use in Colorado. A third study using data from the Washington Healthy Youth Survey, found that marijuana use among 8th and 10th graders fell after legalization for recreational purposes.

On the issue of safety, the Nevada Office of Traffic Safety recently released new data which shows that marijuana related fatalities in Clark County had gone down. The number spiked in 2017 immediately after the legalization of marijuana. However, within a year, those numbers decreased by about 30%. This reflects patterns seen in other jurisdictions.

A study sponsored by the Society for the Study of Addiction, after the legalization of recreational marijuana showed that in the year following implementation of recreational cannabis sales, traffic fatalities temporarily increased by an average of one additional traffic fatality per million residents in both legalizing US states of Colorado, Washington and Oregon and in their neighboring jurisdictions.

LEADING BY EXAMPLE – ELECTRIC BUSES

The Los Angeles County Metropolitan Transportation Authority (Metro) has received its first zero emission electric bus that will be used on the Orange Line later this year. The Orange Line will be the first line to receive these electric buses with a total of 40 buses to be delivered to the agency and deployed on the Orange Line by the fall of 2020.

The buses will be purchased from the US subsidiary of BYD, the Chinese manufacturer of electric buses. China is way ahead of the US in terms of its development and production of electric buses. Bus purchasers are not experiencing the same type of intervention being experienced by rapid transit operators who wish to purchase Chinese made subway cars. The federal government and Congress have acted to intervene in those purchases on national security grounds.

The vehicles are not cheap even from the most competitive vendor. The electric buses cost $1.15 million each in a contract valued at $80,003,282. This contract includes the deployment of the electric buses and associated charging infrastructure. The new buses will be capable of being recharged at various points along the Orange Line to support its 24/7 operation.

Metro hopes to extend its deployment of electric vehicles. In a separate purchase, Metro ordered an additional 65 zero emission electric buses from the manufacturer BYD with five of those buses being 60-foot articulated buses earmarked for the Orange Line and the remainder to be used on the Silver Line that operates between the El Monte Bus Station and the Harbor Gateway Transit Center in Gardena. Metro plans to convert the Silver Line to zero emission buses in 2021.

The electric buses cost $1.15 million each in a contract valued at $80,003,282. This contract includes the deployment of the electric buses and associated charging infrastructure. The new buses will be capable of being recharged at various points along the Orange Line to support its 24/7 operation.

In Atlanta, MARTA has announced that it will replace six diesel buses with zero-emission battery electric models. Funding for the purchase will come from a $2.6 million grant from the U.S. Department of Transportation. The grant is one awarded under the U.S. Department of Transportation the Low- or No-Emission (Lo-No) Grant program run by its Federal Transit Administration (FTA).

Overall, the FTA will award $84.9 million in grants to 38 projects for the deployment of transit buses and infrastructure that use advanced propulsion technologies. These include hydrogen fuel cells, battery electric engines, and related infrastructure investments such as charging stations. The 38 awarded projects are from 38 states. Some other municipal recipients include the Vermont Agency of Transportation and the Prince George’s County, Maryland Department of Transportation.

The use of electric vehicles by transit agencies and governments is a great opportunity for municipal entities to take a leadership position in the transition from internal combustion engines. The involvement of the federal government in funding these projects is a positive development.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Publisher

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WHEN GUTTING HIGHER EDUCATION IS A CREDIT POSITIVE

We understand that certain actions and events can be seen as having a positive effect  in a every discrete way for an individual credit. A revenue source dries up or is withdrawn and an institution takes clear somewhat radical steps to deal with the situation which serve to shore up the ability to pay debt service in the short run. Such a scenario is likely “credit positive”.  While that may be true n the very near term, there are times when it is hard to view such a credit in a positive light when viewed through the lens of its larger economic and policy impact.

The latest example of that dilemma is what is going on at the University of Alaska. The budget adopted by the Legislature at the behest of the new Governor restores the annual payment to each Alaskan resident funded by revenues in the State’s Permanent Fund. The payment had been reduced in response to lower oil production and prices and declining reserves of oil.  The payment had been reduced to balance the budget in the face  lower oil revenues.

In order to restore the payment to its prior level and maintain a balanced budget, significant cuts needed to be made. Among the entities targeted for cuts was the state’s university system. Under the budget adopted (even after a special session to reconsider the cuts) the state legislature acquiesced and allowed the Governor’s cuts to the University to stand. The result is a reduction of 41% in the states funding for the University effective as of July 1.

The university has represented that it has a moderate amount of liquidity but estimates that if it has to maintain spending at fiscal 2019 levels, it will deplete reserves by early 2020. So the only real response is to cut expenses. The overwhelming majority of expenses at most universities is related to personnel. Much of the expense stem from the tenure system governing faculty. That means that short term budget relief in the face of this magnitude of revenue reduction can only be dealt with extraordinarily. So it is the case in Alaska.

On July 22, the University of Alaska’s Board of Regents voted to declare financial exigency. This is a legal strategy to eliminate tenured positions in the face of extraordinary fiscal circumstances. The University has said that administrative positions will  be the first to be reduced but that efforts to implement cut to faculty including  tenured faculty will follow. In September, the Board of Regents will decide on a course of action.

In response to this action we see the Moody’s headline that says “University of Alaska’s financial-exigency declaration is credit positive”.  We understand that from a very narrow University of Alaska revenue bond standpoint it could be seen as positive. Moody’s notes that the action will force the University to deal with declining enrollment, loss of research competitiveness, a material reduction in liquidity and additional accreditor scrutiny as it implements changes over the next one to two years. This leads us to ask what exactly is credit positive about a credit which faces these aforementioned pressures?

Alaska is a state which because of its size and small population does not have a robust private higher education alternative. Significantly cutting back faculty, offerings, and research can only harm the economy of the State at a time when its major industries e under stress (the price of being resource dependent in an environment of climate change). The diminishment of higher education at a time when technology becomes more and more important to economic success seems  represent an unnecessary self-inflicted wound in the interest of short term gain.

Here’s where the rating agencies unwittingly put themselves in the middle of political debates. The headline “University of Alaska’s financial-exigency declaration is credit positive” will be seized upon by supporter of the cuts as some kind of outside endorsement of the action. Better the rating had been put on uncertain status with the potential for a downgrade than to take an action which could be misused for political ends.

At the end of the day, the cuts are bad for Alaska. Major state universities are not just sources of more reasonably priced higher education. The conduct and produce research which supports, government, industry, and small business. The loss of that capability and knowledge base can have only negative longer term consequences for the State. So we respectfully disagree with the idea that in the broader sense that this move is credit positive.

CALIFORNIA AUDIT

The federal government requires California to publish its Single Audit report, which includes the Comprehensive Annual Financial Report (CAFR), within nine months of the end of the fiscal year, or by March 31, 2019; however, the State Controller’s Office (State Controller) did not issue the State’s CAFR until June 2019, more than two months after it was due. One reason for the CAFR’s delay was that the State Controller did not implement a major new accounting and financial reporting standard for postemployment benefits other than pensions (OPEB) in a timely manner. It also chose a methodology for allocating OPEB liabilities to state funds in a manner that is inconsistent with how the State pays for OPEB benefits, which created the risk of a material misstatement to the CAFR.

Currently, the State pays for these benefits as they become due using the pay‑as‑you‑go method. Specifically, the General Fund initially pays health and dental insurance premiums for state retirees and their dependents, and is subsequently reimbursed by other funds for a portion of these costs based on their proportionate share of the healthcare and dental costs of active employees. However, the State Controller’s allocation methodology is based on the State’s recent efforts to prefund its OPEB liability by making financial contributions to OPEB plans based on pensionable compensation (the portion of employee pay used to calculate retirement benefits). However, these contributions cannot be used to pay benefits until the earlier of July 2046, or when an OPEB plan is fully funded. 

The CSA finding asserts that the methodology SCO used to allocate OPEB liabilities to State funds creates a risk that a material misstatement to the State’s CAFR could occur. However, later in the finding, CSA states the allocation did not result in a material misstatement in the FY 2017–18 CAFR. This was the first year of implementation of Governmental Accounting Standards Board Statement Number 75 (GASB 75), and SCO had to work with the most complete and accurate data available at the time. With the constraints on time and data accessibility, SCO moved forward with what it believed was a reasonable and rational approach, that could be supported by source documents, in allocating the State’s OPEB liability. SCO is not opposed to re-evaluating its allocation methodology in future years when additional information becomes available.

Press reports have expressed some surprise that this is not a big issue for investors. Reports like this one from the State Auditor are useful in terms of highlighting details of potential reporting shortcomings but it is not surprising to us that the discussion is effectively a nonevent in terms of its impact on the State’s credit. It has not been implied that the numbers ultimately generated were untrue. The reasons for the delay do not seem to reflect malfeasance so it really is not a big event.

PUERTO RICO

What we know is that Gov. Ricardo Rosselló resigned Friday as promised. We know that he used a recess appointment to name former non-voting representative to the US House of Representatives Pedro Pierluisi Secretary of State. Thus, Pierluisi automatically became Governor Rosello’s successor. He only promised to serve as governor until Wednesday, when the Puerto Rico Senate has called a hearing on his nomination. If the Senate votes no, Pierluisi said, he will step down and hand the governorship to the justice secretary, the next in line under the constitution.

Even if he retains the position, his options are limited by the short 18 month remaining time on his term. While it is heartening to see that he advocates privatization of the power system-a step we have advocated for since the immediate aftermath of Maria, he also is on record opposing several austerity measures demanded by the board, including laying off public employees and eliminating a Christmas bonus.

Until elections take place in November 2020,  it is hard to articulate a positive case for the Commonwealth’s credit. There will be bankruptcy ruling which will almost certainly be appealed, more maneuvering over the next 18 months for political power on the island, and no real end to the uncertain state of affairs. The Puerto Rico Senate ended Monday the special session convened by former Gov. Ricardo Rosselló to consider the nomination of Pedro Pierluisi as secretary of State. This means that Mr. Pierluisi has not been confirmed thus putting his governorship in legal peril. The Governor’s position? “Given that today the Senate did not cast a vote and that the vast majority of the Senators did not have the opportunity to express themselves concerning my governorship, with the utmost deference to the Supreme Court of Puerto Rico, I will wait for its decision, trusting that what is best for Puerto Rico will prevail.” 

On Sunday night, the Senate sued Pierluisi and the government of Puerto Rico, requesting Pierluisi’s swearing-in as governor be declared null. The Supreme Court gave the Senate, Pierluisi and the attorney general until noon Tuesday to present their arguments.

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.

PUERTO RICO

In a week full of events challenging the Commonwealth and creditors alike, the resignation of Governor Rosello effective August 2 was the biggest. His successor at least temporarily was expected to be the secretary of justice, Wanda Vázquez. Ms. Vázquez was next in line under the commonwealth’s Constitution because the secretary of state, who would have succeeded Mr. Rosselló as governor, resigned last week . Mr. Rosselló is the first chief executive to step down during a term since Puerto Ricans started electing their governors in 1947. Now, however, Ms. Vazquez has said that she will not accept appointment to the job.

The line of succession after the position of Secretary of State snakes its way along an unclear path through the remaining Cabinet Secretaries. With this backdrop, some 60 community organizations presented a letter to U.S. District Judge Laura Taylor Swain, requesting that the ongoing bankruptcy proceedings over the island’s debt be stayed until Puerto Rico stabilizes and a comprehensive audit of its debt has begun. Judge Swain is reported in the local press to have granted the petition and halted all adversary cases and claims against the government for 120 days.

After all, it is not clear who will be the governor of the Commonwealth during this later phase of the Title III proceedings. The Governor has resigned. The Fiscal Control Board is in a process of being challenged in court. The designated successor is not in place. The outgoing governor would have to nominate that person to be his secretary of state. It is not at all clear who legitimately represents the island’s citizens.

BURLINGTON BROADBAND

Burlington, VT was one of the first municipalities to finance, own, and operate a combined telecommunications utility.

On March 13, 2019, the city closed on the sale of Burlington Telecom (“BT”), a telecommunications business previously operated by the city, to Champlain Broadband, LLC, an affiliate of Schurz Communications, Inc. (the “Purchaser”). The sale of BT to the Purchaser was approved by the City Council of the Issuer on December 27, 2017, and regulatory approval for the sale was received from the Vermont Public Utility Commission on February 19, 2019. The Issuer received approximately $7 million from the sale.

The sale also resolved outstanding litigation which had threatened the city’s financial position. In late 2009, it became publicly known that BT was unable to make payments on the City’s $33.5 million lease with Citibank or return $17 million of City general fund dollars improperly spent on BT by the prior administration.  These events resulted in a federal lawsuit with Citibank, six steps of downgrades in the City’s credit rating from 2010 to 2012, and a lack of liquidity that put the City’s continued operations of core municipal functions at risk.

The settlement, according to the City brought full and final resolution to the $33.5+ million Burlington Telecom lawsuit with Citibank, as until today’s closing, Citibank retained the ability to re-open its lawsuit;  Citibank’s full release of the City from further BT liability is attached. It recovered at least $6.97 million of the $17 million improperly spent by the City prior to 2010 (an additional recovery of up to $500,000 in the future is possible) In addition, the City retains ownership of the building that houses Burlington Telecom and will begin receiving rental payments of $115,000 a year and tax payments of $18,000 annually.

At the time of closing, the City said that it had ensured that the City’s financial recovery and improved credit rating will continue.  They were quite right about that. Moody’s just announced that it upgraded to Aa3 from A2 the rating on the City of Burlington, Vermont’s outstanding general obligation unlimited tax (GOULT) bonds. It specifically referenced the settlement of the litigation. 

ILLINOIS BOND CHALLENGE

For years, individuals in several states have fought efforts by states to issue debt without some form of direct voter authorization. For a generation of municipal analysts, the name Schultz will forever be associated with numerous legal actions seeking to halt the issuance of various issues of bonds which were not subject to voter approval in New York State. The litigation is strewn across three decades. It should be noted that the suits ultimately were found in favor of the state.

The latest such effort is now occurring in Illinois. A hedge fund and the chief executive officer of a conservative think tank he filed suit in Sangamon County, IL circuit court alleging that bonds issued in 2003 to fund pensions and in 2017 to fund backlogged payments are deficit financing bonds which e plaintiffs assert are illegal. They seek to invalidate up to $14.3 billion of bonds.

One thing that always fascinates is the view of hedge funds versus what their role is in a given transaction. It does not favor investors if debt can be invalidated some 16 years after issuance. It is insistence on respect for the validity of issued debt that has hedge funds portrayed as bad guys in the Puerto Rico restructuring. Now, a hedge fund is essentially taking the other side. So they are not consistent and heir position doesn’t make sense.

In the case of the think tank plaintiff, the political animus of the CEO towards the Democrats in the state legislature is well established. The Illinois Policy Institute backed an Illinois employee named Mark Janus in his challenge to the constitutionality of mandatory union fees.  In 2014, the institute helped defeat a movement to amend the Illinois Constitution and replace the state’s flat income tax with a progressive income tax.  Voters will have a chance to vote on the income tax in 2020. They are expected to vigorously oppose the proposed income tax changes.

The institute faces the reality that it will be very difficult to reduce pension liabilities in the near term. If the state ceases making principal and interest payments on the debt it could contribute an additional $13 billion to its pensions over the next 14 years, according to the complaint. So this is their fallback.

As is the case often, this one relies on the parsing of words. Article nine, section nine of the Illinois Constitution says the state may issue long-term debt only to finance “specific purposes” if approved by three-fifths of the legislature or by popular referendum. Using bond money to cover general expenses, speculate in the market, or pay past-due bills isn’t a “specific purpose” for incurring state debt, but rather another name for deficit financing, the complaint said.

WHO SAYS TECHNOLOGICAL CHANGE ONLY CREATES GREAT JOBS?

We came across a fascinating story this week about the expansion of an industry as the result f disruptive technological change in the transportation space. it’s not what you think. It’s the expansion of the repossession industry into the electric scooter space. There is a real company in San Diego called ScootScoop. They are paid by business owners and landlords who are fed up with the deluge of dockless two-wheelers. It is a two man operation with a yard for scooter storage and a tow truck. ScootScoop charges the scooter companies $30 for pick-up and an additional $2 for each day that the scooter is in storage, capping the daily fees off after a month.

It hasn’t gone all smoothly. A lawsuit was filed in California Superior Court in late March which accused the company of improperly impounding Bird’s scooters and then “ransoming” them back to the $2 billion company. Lime filed a nearly identical suit soon after.

Many observers have wryly noted that the scooter companies are relying on the California Vehicle Code. The scooter companies have fought every attempt to enforce regulation of their industry under the same code. Others respond more strongly. A federal lawsuit has been filed by a disability rights group against Bird, Lime, Razor, and the City of San Diego. It claims that scooters are being left in front of wheelchair ramps, curbs, and crosswalks. 

It is all part of the battle for control over the streets and the revenue which can be derived from them. On July 1st, the City of San Diego – one  the defendants – implemented new regulations to address the scooter complaints. They require scooter companies to obtain insurance policies, free the city from all legal liability, cap speeds on the boardwalk, and obtain permits for every scooter in circulation. 

LONG TIME MUNICIPAL UTILITY UP FOR PRIVATIZATION

The Jacksonville, FL Electric Authority (JEA) board voted to give its CEO the authority to explore methods of privatizing JEA, including becoming a privately held or investor-owned company; evaluating an initial public offering making JEA a publicly traded company; or converting into a customer-owned utility. Privatization is one potential solutions to shrinking energy sales and declining revenue due to increases in energy efficiency and falling costs of home generation of renewable energy. 

The board chose from among a series of alternatives. One  scenario detailed in May would have put in place a 52% electric rate increase, a 15% rise in water rates and a reduction in JEA’s city contribution from a projected $118 million in fiscal year 2020 to nothing by 2023.  Scenario 2, or a “traditional utility response,” would have cut 574 jobs at JEA and raised electric rates 26% by 2030.

The vote also retains a $72.2 million plan between JEA and Ryan Companies US Inc. to build a high-rise headquarters in Downtown Jacksonville for the city-owned utility. JEA would then lease the building from the private builder. City Council approved the on June 25, effectively simultaneously with a  JEA’s board vote to enter into the lease 

The CEO has predicted that researching the options for privatization will take six to nine months. Should the board decide to sell JEA assets in a sale or competitive solicitation, it would require additional board action, approval by council and a voter referendum. The CEO is on record that a privatization would have to provide the city $3 billion as a supplement to future JEA annual contributions, give $400 million to customers as a rebate, guarantee a 3-year contractual rate, fund and provide the city and the Duval County Public Schools with 100% renewable energy by 2030; fund and provide 40 million gallons daily of alternative water capacity for Northeast Florida by 2035.

It would also have to guarantee protection of certain employee retirement benefits; maintain employee compensation and benefits for three years; make retention payments to all full-time employees at 100% of their current base compensation, and maintain the agreement to lease a new headquarters and retain employees in Downtown Jacksonville. The board also approved the introduction of legislation to council to revise employee pensions. The resolution would guarantee that all current employees receive full retirement benefits in the event of privatization. 

It is not clear how much support a privatization has. The mayor said in April 2018 he would not submit a proposal to council to privatize JEA. He said he would not support a decision by the JEA board that would lead to “hundreds of job cuts or failure to meet the retirement needs of career employees.”

“As a publicly owned asset, the value of JEA is built on the investment of taxpayers. Any policy regarding the utility’s future must respect that investment. Jacksonville taxpayers are co-owners of the utility and must have a voice in the future of their investment,” 

A private buyer would have to redeem the JEA’s outstanding debt in the event of a sale.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Publisher

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ISSUE OF THE WEEK

CommonSpirit Health is the entity which resulted from the merger of Dignity Health and Catholic Health Initiatives. It is now coming to market with four bond issues totaling $5.8 billion of combined principal. The new ratings on CommonSpirit are BBB+. This reflects actions by S&P Global Ratings which lowered its long-term rating and underlying rating (SPUR) to ‘BBB+’ from ‘A’ on all debt issued for Dignity Health, Calif. The existing BBB+ rating on debt for CHI was maintained but the positive outlook was removed.

The plan of finance submitted is expected by management to provide $6.3 billion of bond proceeds (including net premium), the majority of which will be used for current refundings and advanced refundings of multiple series of bonds issued on behalf of Dignity Health and CHI. The advance refundings will be financed through the $2.7 billion taxable bond portion of the issuance. A portion of CHI’s CP program will also be refinanced, although the program will remain outstanding for potential future use. Approximately $600 million of net new debt is included in the $6.3 billion, and CommonSpirit intends to use these funds for reimbursement of prior capital expenditures; the funds are available to support future capital investments.

The rating incorporates what we call integration risk. S&P refers to this process as “growing pains”. The outlook assumes that no new net debt will be issued at least through the first year of consolidated operations.  We view the merged entity as symbolic of where health credits will be continually pressured to grow and consolidate. The availability of a large and sound balance sheet has been an effective tool for hospital managements to deal with the vagaries of healthcare funding. It also position these institutions to more effectively manage their reimbursement relationships with private insurers.

Nonetheless, CommonSpirit’s ratings will continue to be weighed down by the substantial debt burden which has historically been a significant negative drag on the CHI credit. it will take time to reduce the burden and provide a base for ratings improvement

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LAS VEGAS MONORAIL

This is one of those credits which keeps rising from the grave. The project went bankrupt in 2010. Now the Monorail Co is pursuing financing for an extension to serve two additional hotels on the Strip. The Monorail Co. has also approached Nevada Gov. Steve Sisolak’s office “regarding a substantial new bond financing proposal,” according to a Monorail spokesman. The Monorail Co. has repeatedly delayed the start of construction on its planned extension to Mandalay Bay. Securing new bonds to finance the project have proven difficult for a system that went bankrupt in 2010 after ticket sales fell well below official projections.

The Monorail Co. is still working to secure an additional $172 to extend its mile track on the Strip’s east side to Mandalay Bay and to the MGM Sphere at the Venetian arena project. Budget documents showed the system was expected to make about $6.5 million less in ticket sales in 2017 and 2018 than was forecast in a Monorail Co.-commissioned ridership study published in April 2016. 

Earlier this year the Monorail Co. president asked the Clark County Commission to guarantee up to $135 million of hotel room tax revenue over 30 years if the monorail needed it to help pay for the extensions. The commission has yet to make a decision on the request. Monorail backers just continue to fail to see the reality that like so any other public transit facilities, fares are never enough to pay the costs including capital costs of these projects.

PHILADELPHIA

Over the last several years, cities like Detroit with its bankruptcy and Chicago with its well documented pension problems have dominated the attention of observers of city finances. That focus has allowed the City of Philadelphia to effectively fly under the radar as it deals with issues of economic development homelessness, its education system, and public transportation. When investors were trying to decide which cities might be candidates for bankruptcy in the middle of the decade, Philadelphia was often mentioned among likely candidates.

Now Philadelphia has begun to distance itself from the likes of Detroit and Chicago. It plans to soon issue $356 million General Obligation bonds. In connection with that sale, Moody’s has announced that it maintains its A2 rating on the City of Philadelphia’s parity General Obligation debt as well as an A2 rating on its outstanding service fee and lease revenue bonds (non-pension related). It also maintained an A3 rating on the city’s pension obligation bonds.

The outlook is stable for all rated securities. The outlook is stable given the city’s materially improved financial position at fiscal year 2018 end, projections that show relative financial stability over the next five years, and permanent funding for Philadelphia schools that largely eliminates its previously projected deficits. The stable outlook also reflects continued positive trends in the city’s economy, contributing to its improved financial health, consistently conservative budgeting and Moody’s expectation of continued positive budget to actual variance going forward.

Moody’s said that the A2 rating reflects the city’s large and diverse tax base and its position as a regional hub for the mid-Atlantic US. It also incorporates other tax base strengths not captured in traditional metrics, such as a significant “eds & meds” presence that serves as a considerable tax base anchor, offset by some persistent weaknesses, like the city’s very high poverty and above average unemployment rate. The city also continues to face a moderately high debt and pension burden.

The comment did reflect some concerns not particular to Philadelphia but reflective of the Detroit and Puerto Rico bankruptcies. “The city’s pension obligation bonds are rated A3, one notch below the city’s GO and other service fee debt, to reflect a higher loss given default risk given relative performance of pension obligation bonds relative to other debt in Chapter 9 bankruptcy scenarios.” So there it is. The relative treatment of pensioners versus creditors now begins to creep into the market. Absent clearer legal guidance, the initial effect will be seen through the ratings process rather than through rush to the courthouse by weaker credits.

ANOTHER NEW HOSPITAL CREDIT

Nuvance Health is an integrated health system based in Eastern New York and Western Connecticut. The system operates seven hospital campuses: Vassar Brothers Hospital, Putnam Hospital, Northern Dutchess, Danbury Hospital, New Milford Hospital, Norwalk Hospital and Sharon Hospital. The system is looking to issue debt for the first time as a combined entity following  the April 1, 2019 merger of Health Quest (HQ) Systems and Western Connecticut Health Network (WCHN). The combined stem includes two tertiary care facilities and further supported by several community hospitals along the Mid-Hudson Valley and Western Connecticut region. 

The new credit comes to market with a Moody’s A3 rating. According to Moody’s, “the rating favorably anticipates realization of modest net synergies and efficiencies from the proposed centralized operating model. That said, execution risk will be high given the new merger, provider fee variability in Connecticut, a large presence of a unionized workforce at both legacy systems and the current and unexpected downturn in performance at HQ due to weaker volumes and physician turnover. It also cited its view that  cash will decline over the next three years as the system funds the equity component of a new patient tower at HQ’s Vassar Brothers Medical Center this year (set to open, as planned, in 2020). Other large capital projects are planned at both the NY and CT hospitals which will require the use of cash and proceeds from the upcoming financing, including construction of a new medical school.

With all of that, a negative outlook was assigned to the rating. The negative outlook reflects Moody’s view that Nuvance Health will face near term challenges to achieve and sustain stronger operating performance to support high leverage while liquidity will decline given a higher capital plan over the near term. Inability to achieve projected improvement or declines in liquidity beyond expectations will pressure the rating.

PUERTO RICO

The situation in Puerto Rico continues to grow and evolve. The move this weekend by Governor Rosello to hold on to his potion smacked of desperation. He will not run for re-election in 2020 and he resigned as president of his New Progressive Party (NPP). The fact that key positions in the succession chain are vacant only adds to the instability and uncertainty. The opposition to the Governor will focus on street protests and the legislature. More than 200,000 people have signed a petition on Change.org demanding that Puerto Rico Gov. Ricardo Rosselló resign for his “incompetence and lack of maturity to govern and for continuous corruption charges at the highest levels of his cabinet.”

Pressure will shift to the Legislature to consider impeachment if the Governor chooses to stand and fight. As for creditors, none of this helps. There was already significant mistrust among the parties and the pending decisions in  the Commonwealth’s Title III proceedings will be harder to implement given the existing executive branch vacancies. The Secretary of State, the executive director of the Fiscal Agency and Financial Advisory Authority as well as interim director of the Office of Management and Budget (OMB) and the government’s chief financial  and investment officers—resigned from their positions.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Publisher

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THE EMERALD CITY

The Muni Credit News took a couple of weeks off (hopefully you noticed) and headed to the Northwest. Part of that trip included a visit to Seattle. The city tries to be on the forefront of progressive governance whether it be transit, the environment, or social policy. It tries to leverage its role as a tech headquarters to create a modern image but it struggles with some longstanding issues. Much has changed yet at the same time much has remained the same.

The first issue is a symptom of the underlying problems. That issue is homelessness. The numbers of homeless mostly mentally ill individuals is clearly higher. They are not hidden away, they are right in the city center. And they are aggressive. It is the sort of situation that easily deters visitors. There is no easy fix. Yet this creates additional costs for the City of Seattle until the underlying problem is addressed. Which brings us to the issue of development.

There was lots of construction and almost all of it residential. So that will increase supply and availability to meet the local housing needs across the board? No. The development was all geared towards market rate buyers. Half to one and a half million market rate. It wasn’t really clear where if any where affordable  housing was being developed.  That means the problem will just continue. The old tools which have been tried and abandoned in other cities – including the installation of various items designed to deter public sleeping in open city spaces – are all on display. And failing in the absence of housing supply.

Then there was transportation. Whatever you want they have – monorail, bus, light rail, subway, traditional electric buses (on overhead lines). And they certainly have lots of micromobility. Scooters and electric bikes strewn all over the sidewalks. When you read about the phenomenon you ask is it really that bad? Unfortunately, the answer is yes. Seattle was the first major city in North America to allow private dockless bike sharing companies to operate within the city beginning in July 2017. At least Manhattan learned something and will not allow the vehicles in Manhattan.

SANCTUARY CITIES

The early successes in federal court on the part of those cities seeking to receive funding for local law enforcement from the federal government suffered a setback this week. A number of so-called “sanctuary cities” sued the federal government after grant requests were turned down when those cities could not certify that the focus of the supported law enforcement efforts would be directed at illegal immigration enforcement. The Department of Justice (DOJ) chose to prioritize agencies that focused on unauthorized immigration and agreed to give Immigration and Customs Enforcement (ICE) access to jail records and immigrants in custody. 

The particular program in question is Community Oriented Policing Services (COPS) grants. The program really doesn’t have anything to do with immigration enforcement. The city of Los Angeles first sued the administration after it was denied a $3 million grant on the grounds that it did not receive the money because it did not focus on immigration for its community policing grant application. A federal district court judge found in favor of the City.

Now, The 9th Circuit Court of Appeals ruled that the Department of Justice (DOJ) was within its rights to withhold Community Oriented Policing Services (COPS) grants from sanctuary cities. “The panel rejected Los Angeles’s argument that DOJ’s practice of giving additional consideration to applicants that choose to further the two specified federal goals violated the Constitution’s Spending Clause.”   

An appeal would be expected in that other California cities have had success in the courts over the issue of grants and new requirements to obtain them. What does not help is how the law works. Congress created the fund in 1994. It was meant to provide federal assistance to state and local law enforcement to get more police on foot patrol and improve police-community interaction. However, the law provided for the Justice Department to administer the funds.

PUERTO RICO

Protesters amassed in Old San Juan for several day to demand the resignation of embattled Gov. Ricardo Rosselló. The position of Secretary of State  was occupied by Luis G. Rivera Marín until he resigned Saturday. The positions of chief financial officer and representative of the governor to the island’s Financial Oversight and Management Board, both held by Christian Sobrino became vacant on Saturday as well.

The Governor is in the midst of a political scandal resulting from a release of e mails sent by staff which disparaged legislative and other political opponents of the Rosello administration. The messages include 889 pages of a messaging app chat group in which Rosselló and his inner circle speak without inhibition about how to manipulate opinion polls, how to mark officials and journalists to affect their reputation, and how to handle operations to give the impression that they are addressing fundamental problems that affect citizens.

So what’s the point? The Rosello administration has been exposed as a sham. It finds itself the subject of federal indictments from the U.S. Department of Justice against former Education Secretary Julia Keleher and Ángela Ávila, the former executive director of the Health Insurance Administration. There have been enough concerns about this administration’s competence. Now it looks like they haven’t even been trying.

Under these circumstances, the implementation of a final plan of emergence from the Title III proceedings is now a longer way off. It is most likely that whatever decision reached by Judge Swain will be appealed. In the meantime creditors face a Promesa board of unclear standing, an extremely weak chief executive, and a poisonous political atmosphere. And regardless of intent, a blank check has been handed to opponents of real aid and reform including the President.

The resolution of Puerto Rico’s effort to escape its debt burden and reinvent its economy will not in and of itself create success for Puerto Rico. The latest political saga is but one in a long line now spanning two generations of political failure. Already a significant opening has been ignored which would have provided much cover for the hard decisions which needed to be made. Regardless of how this all turns out, it will go down as a missed opportunity.

CONNECTICUT PENSION REPORT

The Connecticut Legislature established the Connecticut Pension Sustainability Commission to study the feasibility of placing state capital assets in a trust and maximizing those assets for the sole benefit of the state pension system.

The Commission’s key findings, conclusions and recommendations The Commission’s key findings, conclusions and recommendations include a belief that it may be feasible for the state to establish a mechanism to identify and transfer state assets into a trust for the sole benefit of the state’s pension funds. The Commission recommends that the legislature provide specific policy guidelines before specific assets are considered for potential contribution to a trust mechanism and concludes that the Office of the State Treasurer is the appropriate authority to provide oversight and direction on the management of any kind of asset trust

The Commission believes that the concept of using the proceeds of the Connecticut Lottery for the benefit of the pension funds or the wholesale transfer of the Connecticut Lottery, as an asset to the funds, is technically feasible.  In many cases, a program such as this would be a sign of weak governance but the reality is that traditional approaches to addressing the State’s extreme unfunded liability position are not going t cut it.

The Commission consisted of appointees from all the major legislative and executive agencies. That should in theory provide cover for any legislators needing it. Commissions are a tried and true way to drive consensus on topics with no obvious political upside. Pension funding  is one of those issues. Let’s see if they take advantage of the opportunity.

SEC CONTINES ENFORCEMENT EFFORT

The Securities and Exchange Commission (SEC) has announce another enforcement action in the municipal securities space.

The latest matter involves a registered municipal advisor’s use of unregistered “solicitor” municipal advisors to solicit business from school districts in California. In 2010, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act which amended the Exchange Act to establish a federal regulatory regime applicable to municipal advisors. The Exchange Act and SEC rules and regulations identify two broad categories of municipal advisors: (1) those that provide certain advice to or on behalf of a municipal entity or obligated person; and (2) those that undertake certain solicitations of a municipal entity or obligated person on behalf of an unaffiliated broker-dealer, municipal advisor or investment adviser. The latter category of municipal advisors are known as “solicitor municipal advisors.” Section 15B(a)(1)(B) requires all municipal advisors to register with the Commission. The registration requirement for solicitor municipal advisors is intended to provide protection and transparency to municipal entities and obligated persons as they make decisions on the hiring of financial professionals, including the hiring of municipal advisors.

Dale Scott & Co., Inc. (“DSC”) is a seven employee municipal advisory firm located in San Francisco, California, that provides advisory services to school districts and community college districts in California. DSC is registered as a municipal advisor with both the Commission and the Municipal Securities Rulemaking Board. Between October 2011 and March 2016, DSC engaged three unregistered parties to provide various services to DSC including to solicit municipal advisory business on DSC’s behalf. By soliciting municipal advisory business on behalf of DSC without properly registering with the Commission, those three parties violated the registration requirements of Section 15B(a)(1)(B) of the Exchange Act. DSC was a cause of those violations.

Why should the individual investor care? So often when an issuer finds itself in trouble financially it has often followed the advice of  unscrupulous advisor. It is a natural outgrowth of the knowledge imbalance between issuers and other market participants. The nature of political and elective turnover makes it more difficult for issuers to rely on their own in-house expertise. It is all the more important that issuers receive advice from those advisors who properly register and disclose.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Publisher

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WHAT DOES A RATING REALLY SAY?

One of the characteristics of credit analysis in the municipal space is its willingness to divorce operational from financial issues. In the transportation sector this is especially true. Whether through the use of pledged revenues derived from non-transit sources (like sales taxes) or legal structures creating gross liens on revenues, the linkage between operational issues and credit perceptions remains weak.

We mention this in connection with ratings actions taken this week by Moody’s regarding debt issued by the Washington Metropolitan Transit Authority (WMATA). WMATA has been best known for its service difficulties, declining ridership, and significant capital needs. So it was a little surprising that WMATA revenue bonds had been the subject of an upgrade at this time.

Nonetheless, Moody’s Investors Service has upgraded to Aa3 from A2 the rating on gross transit revenue bonds of the Washington Metropolitan Area Transit Authority, DC (WMATA). The outlook on the rating is revised to stable from positive. Clearly the role of Virginia and Maryland in providing operating subsidies is the overriding factor in this move. “The upgrade to Aa3 incorporates the strong operating environment of the authority, which itself is grounded in continued commitments from the District of Columbia (Aaa stable) and the states of Maryland (Aaa stable) and Virginia (Aaa stable) to financially support the transit enterprise. Subsidies from these governments now cover more than half of WMATA’s annual operating costs.

We have seen though, that support for subsidizing the system has been known to waver. It is hard to see how a system like this with as many management, organizational, and political hurdles to overcome while relying so heavily on outside revenues. As operational issues arise as they did in recent years, they are a source of tension which lead to uncertainties about ongoing subsidy levels.

In making the case for the upgrade, Moody’s cited “improved internal liquidity, continued bank support through lines of credit, and greater certainty with regard to federal grant funding following the FTA’s approval of the Washington Metrorail Safety Commission’s Safety Oversight Program. ” At the same time, the announcement highlights “weak coverage of debt service by net operating revenue, though this is also mitigated by the role played by the state and local government subsidies. A key challenge factored into the rating is WMATA’s heavy post-employment benefits burden. Unfunded pension and OPEB liabilities are high relative to the authority’s revenue and will likely remain a source of rising expenses for years to come.”

It all adds up to quite a mixed bag of factors to evaluate. Our view is that these are enough to hold the rating at its previous level, hence our surprise at this point in time. It’s only been three years since the Authority’s debt was downgraded. It seems like a pretty quick turnaround from here.

LAUSD ELECTIONS HAVE CONSEQUENCES

The recent failure at the ballot box of a proposal to increase property taxes has rightly been seen as a blow to the District’s credit outlook. When the District reach an agreement with its teachers to raise wages and increase resources to the schools, it was widely assumed that support for the teachers goals would translate into support for increased funding from the taxpayers.

That turned out to be a significant miscalculation when voters rejected a proposal for a parcel tax to fund the increased costs of the settlement. The defeat has forced the District to scramble to find ways  keep its budget balanced without the increased revenue to fund a higher cost base. One had to wonder when these events would manifest themselves in the District’s ratings.

It did not take long to see action. Last week, Moody’s Investors Service has downgraded Los Angeles Unified School District, CA’s outstanding general obligation (GO) bonds to Aa3 from Aa2 affecting approximately $10.2 billion in outstanding debt. Specifically it said that “the rating downgrades reflect the district’s structural budgetary challenges and limited financial flexibility stemming from rising fixed costs and recent concessions with the teachers’ union for higher salaries and increased resources. The district faces revenue constraints arising from declining enrollment, increasing dependence on state aid growth that’s slowing and voter rejection of a recent parcel tax measure. As a result, the district is facing a $500 million budget gap.”

The nation’s second largest public school district and the largest one which issues its own debt clearly faces daunting challenges. One thing everyone agreed on at the end of the January teachers’ strike was that the funds to pay for it were not there. So let’s hope that Moody’s note that “management that has a record of outperforming budgeted projections and built up sound reserve levels that buy it time in responding to these challenges before they would cause financial strain” proves out.

PUERTO RICO

It is impossible to comment on events in the municipal space without doing so in regards to the latest efforts by Puerto Rico to evade its legal and moral responsibilities. Previously, I described the efforts to expunge debt while minimizing the pain inflicted on the electorate as being on a par with a drive by shooting. You may get your target but lots of innocent people can get hurt in the process.

Puerto Rico justifies its actions towards debt holders by invoking the specter of the evil hedge fund debt holders. Whatever anyone think of that particular investor class, it can’t be seen as a positive that issuers can decide which group of investors is worthy of fair and legal treatment. And it makes no sense to treat parties like the bond insurers in the same manner just because they are larger corporate entities.

So, it is from that perspective that we view the announcement by the Puerto Rico’s Financial Oversight and Management Board of its plan to restructure $35 billion in debt and non-debt claims of commonwealth and Public Buildings Authority creditors. The plan is to sharply reduce what is available for investors while essentially exempting the Commonwealth’s pensioners from any real pain. The 2012/2014 holders have the option to litigate for equal recovery with pre-2012 bonds, called vintage, or settle at certain levels. The 2012 GOs, which total $2.7 billion, can settle at 45% or be litigated for pari vintage recovery. The 2014 GO bondholders, which have a claim of some $3.6 billion, can settle at 35% or litigate for pari-vintage recovery. Holders of some $700 million in 2012 PBA bonds settle at 23% with net GO claim treated as 2012 GO. Vintage PBA bonds, which total about $3.9 billion can settle at 73% of the recovery.

The government was clear in expressing its position that the government will not support any proposed plan support agreement (PSA) that is based on the recently enacted fiscal plan, which calls for pension cuts. So there it is. All holders must be large holders, all of them were vultures, all of them are an excuse to walk away from responsibility. And all of this represents a corporate mentality whereby the rules of risk taking markets are applied to a risk averse market.

That’s great until one realizes that this is not the corporate market. Now Puerto Rico must face a future where its entree back into the municipal market is not clear. And if it does regain access, will it not need credit support? If it does, will the bond insurance industry be as open to exposure to the credit that treated them so poorly before? The idea that the bond insurer should be treated in the same way as a distressed buyer ignores one little point – the insurers effectively bought at par while many of the current creditors had an effective entry price into the credit of substantially less. So the bond insurers dismay is more than understandable.

It is ironic that for over 40 years potential individual investors would ask what if there’s an insurrection? The fear was of debt repudiation. Now the insurrection against debt repayment  is being generated not as much from below as it is being generated by a political establishment seeking to come out the other side of this debacle with their access to their power and relative privilege intact. They still do not appear to understand that audits and accountability matter. Just this past week, the Financial Oversight and Management Board said the commonwealth government failed to comply with the Puerto Rico Oversight, Management, and Economic Stability Act of 2016 (Promesa) because it has yet to submit certain financial and budget reports. 

The government did not submit, when due April 15, budget-to-actual reports for the University of Puerto Rico (UPR) and the Highway and Transportation Authority (HTA) for the third quarter of fiscal year 2019, as required by Section 203(a) of Promesa. The government did not submit budget-to-actual reports for PREPA, HTA and UPR for fiscal year 2018 and asked these be submitted by the new June 30 deadline. From now on, the board said, the government will also be required to publish public quarterly Section 203(a) reports one month after they are submitted to the board.

The question is will we make them pay a price?

SURPRISE MEDICAL BILLS – SIZE WILL AGAIN MATTER?

With bills under serious consideration in Congress to limit what are known as surprise medical bills, the healthcare industry has reacted with alarm. Clearly, the practice of accepting insurance and hen trying to claw additional revenues from patients usually not in a position to m informed decisions fails many tests of equity and fairness. Surprise bills usually arise from emergency services provided to patients insured patients who inadvertently receive care from providers outside of their insurance networks.

A number of solutions are on offer. Legislative solutions include capping out-of-network charges for emergency medical services at in-network levels; or setting up an arbitration process to resolve out-of-network charges. Other legislation would require a single, “bundled bill” for all care received in an emergency room or have hospitals guarantee that all of their affiliated doctors and service providers are in-network. As usual, change presents challenges and those entities with access to more resources will be best positioned to handle them. Smaller providers are likely to have high out-of-network exposures because they are challenged to negotiate favorable in-network rates from insurers. The largest providers have significant negotiating leverage with insurers, making them likely to already be in-network.

As has been the case for the decade since the enactment of the Affordable Care Act, large providers with diverse sources of reimbursement will be best positioned to withstand changes in insurance reimbursement. The legislation is considered likely to impact hospitals, physician staffing companies, laboratories, radiology and other ancillary provider companies. There are also several proposals that would impact air ambulance providers. Overall, it will be better to be bigger going forward in the healthcare sector.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$315,065,000*

LANSING BOARD OF WATER AND LIGHT

CITY OF LANSING, MICHIGAN

UTILITY SYSTEM REVENUE BONDS

Moody’s : Aa3  SP: AA-

Our interest in the deal is less with the creditworthiness of the issuer but more with the use of proceeds. in this case, the utility is financing the construction of a 250 MW combined cycle natural gas fueled generation plant. The project is designed to achieve the goals of a plan authored in 2015 to, among other things meet environmental goals. The new gas plant will allow Lansing to shut down five coal fired generating units at two sites, one at the end of 2020 and o at the end of 2025.

The city, which is also the state capital, has a goal of generating 30% of its energy from renewables and 40% by 2030. This is another case where economics supported by popular demand for greener power is driving local utility decisions in the face of the federal government abandonment of its environmental responsibilities. As recently as 2010, the utility owned 14 coal fired facilities.

The plan to construct the gas unit comes as the utility is also in the process of acquiring interests in wind and solar projects so that it can be generating 20% of its power needs from renewables by 2020.

The utility is also approaching cybersecurity issues in its disclosure. The electric system was the victim of a ransomware hack in 2016. This event is acknowledged in the documents and includes a broad discussion of its efforts to combat any future attacks. It may not be as robust as one might like but the acknowledgement of the subject is a positive.

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WE’RE NOT IN KANSAS ANYMORE

When former Governor Sam Brownback took office he launched the state on a great experiment with Arthur Laffer-style government finance theories. This in spite of the fact that the State and a group of plaintiffs we involved in litigation over the state’s local school aid formulas. The uproar surrounding the state’s collapsing financial position often stole some attention from the issue of education funding. Well, the results of the supply side experiment are in. The state took downgrades, Governor Brownback retired to be representative to world religious groups, and Mr.Laffer  just was awarded the Medal of freedom by President Trump.

In the meantime, the dispute and debate over school funding in Kansas continued. Now, the Kansas State Supreme Court issued a unanimous decision signing off on a law enacted in April that boosts the state’s education funding by roughly $90 million a year. It was the high court’s seventh ruling in less than six years in a lawsuit over spending, which was filed by four school districts in 2010.

Kansas now spends more than $4 billion a year on its public schools — some $1 billion more than it did during the 2013-14 school year — as the result of the court’s decisions. Increases are promised through the 2022-23 school year, and the April law was designed to raise spending to account for inflation, something the court ruled last year was necessary.

The state will still be subject to review by the Court to insure that the State continues to comply with the Court’s orders. The result keeps pressure n the State to keep up its funding promises. For individual school districts, the resolution of the funding issue removes a source of negative credit pressure.

MANUFACTURING

It’s been difficult to assess whether the economic policies currently ascendant in Washington  truly have achieved their job retention and repatriation goals. That reflects the fact t the signals currently out there to evaluate e quite mixed. So says a report from the Economic Innovation Group. They reviewed data on manufacturing employment

Pennsylvania’s manufacturing base, for example, now employs only two-thirds the number of people it did in 2000. The state would have to keep adding the same number of manufacturing jobs it did over the past two years—5,570 jobs annually—for another 35 years to get back to where it was 18 years ago.

Only five western states—Nevada, Alaska, North Dakota, South Dakota, and Utah—contained more manufacturing jobs at the end of 2018 than they did in 2000.  Those numbers may confirm or undermine some of your suppositions about these places. So we want to look a little deeper at the data.

Those numbers actually highlight some anomalies. Nevada did indeed have the highest rate of gain in that period. Are all the theories about cost, weather, taxes true? It’s hard to tell because the growth is in one place. A Tesla battery factory in Storrey County is the change. So, Nevada’s number isn’t quite so impressive.

In reality, the picture is mixed. Manufacturing has no doubt recorded positive job growth. As the report indicates, the employment surge was broadly felt but still uneven. A majority of counties (57%) saw their manufacturing growth rates improve, with either growth accelerating or decline slowing, over the first two years of the Trump administration relative to the last four years of the Obama administration.

Manufacturing’s expansion was broad-based across regions, but on average counties in western states saw the highest annual growth rates from December 2016 to December 2018. The South created the largest sheer number of new manufacturing jobs over the past two years: 173,900.

Here comes the old water. The jobs are often in sectors like food and beverages which are now considered manufacturing. It added 84,400 jobs to the economy from December 2016 to December 2018. The apparel and print-related industries combined were responsible for a loss of 28,700 jobs. Income data helps to account for why there is so much attention on wealth disparity. Manufacturing’s share of U.S. GDP has grown steadily since 2008, from 12% to 16%—increasing by a quarter. Manufacturing now contributes more to U.S. economic output than it did 10 years ago. However, manufacturing employment has been far surpassed by that of the professional services sector.

It also makes it harder to estimate revenues since service employment has often been harder to account for and tax than has been the case with income earned by employees  from traditional industrial employers. It also increases risk in that the merging tech based economy will by its very nature be much more mobile. The fact that one’s living will likely be less dependent upon being attached to one place or physical facility introduces a complication  the process of estimating, planning, and collecting revenues.

NYC JUST KEEPS SPENDING

The City of New York announced agreement on its budget for fiscal 2020. That’s the good news. It’s all downhill from here.  The budget, including capital spending, comes in at $92.6 billion. That means that NYC spending has increased some 23% above the level included in the Mayor’s first budget only five years ago. It is something t think about when the city complains when it is asked to pay for things like NYCHA and the MTA.

 It reflects a continuing trend of increases in soft spending – things like social workers in schools, quieter fire truck sirens. They reflect the priorities of the mayor who has never seen a program he does not want to spend on. In his view, “the things that we are investing in either, in some cases, are sheer need, things we must address for a variety of reasons or things that we think are the kinds of investments that make sense for this city and are manageable and affordable.”

The Mayor also contends that the city has accumulated reserves in amounts sufficient to support the spending through any downturn. Some might beg to differ. For example, the nonpartisan  Citizens Budget Commission estimates that a recession would reduce revenues by as much as $20 billion over three years, a number that dwarfs the city’s reserves.

The rate of growth in the level of spending by the City has been an issue of concern to us for some time. The Mayor has been extremely fortunate to have been in office during one of the longest periods of economic expansion in US history. The good economy has allowed increases in spending but has also created a sense of security about the City’s finances which we view as unwarranted.

The City’s personal income tax revenues remain concentrated among higher income residents. While the City has seen the economy reduce its dependence of the health of the financial markets, Given the sources of that income, the City remains vulnerable to financial market downturns . The declines in incomes would naturally hit the City’s real estate and service industries which could force the City to have to cut back spending (usually with a meat ax rather than a scalpel) quickly to avoid rapid draw downs of reserves.

One also has to account for the facts that term limits  have resulted in an inexperienced City Council when it comes to managing in a downturn. From a financial standpoint there will be plenty to cut in a downturn but, politically it will be much harder so much of the increased spending is in the area of social service which can be considered as “nice to haves” but not necessities. That lack of experience in a downturn would make managing such a period extremely difficult.

MEASURING THE IMPACT OF EXPANDED MEDICAID

A recent study in the journal of the American Medical Association (JAMA) asked “Has the expansion of Medicaid eligibility under the Affordable Care Act been associated with any differences in cardiovascular mortality rates?” It found that states that expanded eligibility for Medicaid had a significantly smaller increase in rates of cardiovascular mortality for middle-aged adults after expansion than states that did not expand Medicaid.

So amidst all of the debate which occurred in several legislatures around the country at least some facts were established. the study showed that “Medicaid expansion was associated with lower cardiovascular mortality and may be an important consideration for states debating expansion of Medicaid eligibility.” Other studies show that for  patients with end-stage renal disease, Medicaid expansion was associated with lower all-cause mortality.

This is one piece of non-political data which helps to explain the support for Medicaid expansion and the position of healthcare as one of, if not the leading, issue in recent polling. As a leading source of spending for states after education, trends in this area hold important clues as to the ability of states to keep budgets balanced in the face of rising healthcare demands.

As more data like this is developed and made available, pressure will increase to expand Medicaid access. This may be enough to put most of the remaining holdout states to the point where expansion makes sense.

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.

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STATE FINANCIAL TRENDS

The Pew Charitable Trusts recently released t results of its survey of rends in state spending since the Great Recession. What initially caught our eye is the data on spending on education. We can’t help but note the correlation between decreased spending on public higher education and the rise of the cost of a college education and the concern about student loan indebtedness. It helps to explain the political pressure to increase spending to support institutions directly or to do it by providing tuition free access to the public higher education system.

Despite nearly 10 years of national economic growth—in what would be the longest U.S. expansion on record by the end of June 2019—states haven’t fully erased the effects of the recession. States still have not fully restored cuts in funding for infrastructure, public schools and universities, the number of state workers, and support for local governments. Nearly a fifth of states collect less revenue than before the downturn, more than a third have smaller rainy day funds, and almost half spend less from their general fund budgets than a decade earlier. Meanwhile, fixed costs—for Medicaid and underfunded public pension systems—are higher in almost every state.

The recession undercut states’ largest source of revenue: tax dollars. States missed out on an estimated $283 billion when collections fell and remained below 2008’s level until 2013 after adjusting for inflation.  Even though total state tax collections in late 2018 were 13.4 % higher than a decade ago, based on quarterly tax revenue collections adjusted for inflation, nine states still were taking in fewer tax dollars than at their peak before receipts fell in the 2007-09 downturn.

Spending from states’ general funds—the largest source of state expenditures—has surpassed pre-recession levels by 4.3 % after adjusting for inflation. In fiscal year 2018, 23 states still spent less in inflation-adjusted terms than in fiscal 2008. Spending in nine states in fiscal 2018 was more than 10 % below fiscal 2008 levels. Nowhere was spending down more than in Alaska—by nearly a third compared with a decade ago. Still, 14 states were spending at least 10 % more than at the start of the recession, led by North Dakota’s 53 % jump since fiscal 2008.

State financial support for higher education—the third-biggest slice of state budgets—was still 13 percent below its high before the downturn on a per-student basis after adjusting for inflation. States now rely primarily on tuition revenue from students and their families, rather than state support, to fund public higher education. Nationally, tuition dollars collected by public universities jumped 43 % per student from 2008 to 2018 after adjusting for inflation.

State financial support peaked at $9,248 per full-time-equivalent student in fiscal 2008 and fell by about a quarter to its lowest level of $6,888 in fiscal 2012. State support has partially recovered but still remained 13 % below fiscal 2008 levels in 2018, at $8,073 per student. In total dollar terms, this meant states spent $88.2 billion in 2018, 7 % less than in 2008 after adjusting for inflation. Preliminary data show that total nominal state support for higher education increased in 2019 for the seventh year in a row, though support is expected to remain highly sensitive to economic slowdowns.15

Seven years after the recession ended, state funding per pupil for public elementary and secondary schools—the largest area of states’ general fund budgets—stood at $6,745 nationally, below 2008 levels by about 1.7 %, or nearly $120 per pupil, after adjusting for inflation. State support per pupil was lower in a majority of states—29—in academic year 2016 compared with 2008, according to the most recent available data, and was down at least 10 % in nine of those states. Initial data for 2017 and 2018 show that more than 20 states continued to provide less per-pupil funding than at the start of the recession.

Primary and secondary schools receive roughly 45 % of their funding from the state, with a nearly equal share from local governments. The mix varies widely, so both funding streams are important in gauging the recession’s full effect on education. After the downturn, both state and local funding fell on a per-pupil basis when faced with declining tax revenue. Although the 50-state total for this combined funding has surpassed 2008 levels, schools in 20 states still received fewer dollars per pupil from state and local funds in 2016.

Wrapped up in school funding are teacher salaries, which on average were still below pre-recession levels in 2016 in real dollars. But how much teachers earn and who funds their salaries differ significantly by state. Even an increase in per-pupil spending doesn’t necessarily mean more dollars for salaries and classrooms. For example, an increase also could reflect rising pension contributions.

In the wake of the recession, state governments reduced investing in infrastructure. As a share of the economy, state spending on fixed assets—such as highways, sidewalks, airfields, electronics, or software—has been falling since 2009.20

In real dollars, state governments’ investments in infrastructure dropped by 3.2 % from 2007 to 2017, with ups and downs along the way. But infrastructure spending relative to gross domestic product (GDP) dropped almost every year between a 2009 peak and 2017, following more than two decades of stability. In fact, 2017 marked the lowest level of funding as a share of the economy in more than half a century. States’ declining infrastructure investment relative to GDP is a sign that spending on fixed assets has not kept pace with economic growth.

Because state-level data on infrastructure investment by category are unavailable, a look into combined investments by states and localities shows that infrastructure types were affected differently. For example, transportation structures—such as air transportation and mass transit systems—seem to have been prioritized, with a nearly 30 % increase in spending. Funding for highways and streets, which generally receive the most state and local infrastructure investment, dropped 6 % between 2007 and 2017, while spending on the second-largest recipient—educational structures such as schools—fell 14 % after accounting for inflation.

In the recession’s wake, many local governments had to manage with less money from their states. Total state aid to localities was down by 5.3 % at its post-recession low point in fiscal 2013 and was still slightly lower—by just 0.8 %—at the end of fiscal 2016 than before the recession after adjusting for inflation. But local governments in 26 states received less state aid in fiscal 2016 than in fiscal 2008, the last year before tumbling tax revenue led to budget cuts and forced states to cut spending. The decline in state aid to local governments ranged from less than 0.5 % in Pennsylvania to 22.8 % in Arizona compared with fiscal 2008. 

Cutbacks in state aid put a strain on local budgets and exposed cities and other localities to greater risk of financial problems. For local governments together, state aid is the second-largest source of revenue after tax dollars, and significant cuts can lead to difficult decisions about raising other revenue or cutting spending.

One way for states to cut spending during downturns is to reduce their payroll. Whether through early retirements, buyouts, or layoffs, state agencies can cut spending by shrinking their workforce. The 2007-09 recession was no different. Total state employment, excluding teachers and other public school staff, peaked at slightly above 2.8 million public employees in 2008 as states had not yet borne the brunt of the recession. After shedding almost 170,000 jobs and reaching its lowest point in 2013, the state workforce nationwide started to grow slightly. However, in 2018, more than a decade after the recession began, state governments across the U.S. still had fewer employees, having lost 4.7 %, or more than 132,000 jobs, from the peak.

With fewer workers on government payrolls, lawmakers’ options for reducing spending in a future recession are reduced. In addition to pent-up demand to restore spending cuts from the recession, states face the challenge of rebuilding rainy day funds to prepare for the next economic downturn.

At the end of fiscal 2018, these funds held more money than in any year on record. But at least 19 states still had smaller rainy day funds as a share of general fund operating costs than in fiscal 2007—the last full budget year before the recession hit. For many states, though, even pre-recession levels were inadequate to plug huge budget gaps caused by the last recession.

Seven states had less than a week’s worth of operating costs in rainy day funds in fiscal 2018, including Wisconsin (6.8 days), Kentucky (3.0 days), Illinois (0.1 day), and Pennsylvania (less than 0.1 day). Three had nothing: Kansas, Montana, and New Jersey. Although there is no one-size-fits-all rule for how much states should save, the clock is ticking on their chances to use the economic expansion to rebuild reserves.

Medicaid costs borne by the states surged following the recession after the phaseout of a one-time infusion of federal economic recovery dollars. The extra federal aid helped states deal with a spike in enrollment in the health insurance program for low-income Americans after people lost jobs and income during the downturn. Even after the economy improved, Medicaid continued to consume a greater share of state revenue than before the recession.

Nationwide, Medicaid expenses accounted for 17.1 cents of every state-generated dollar in 2016, compared with 14.3 cents in 2007, just before the recession. Although the federal government covers at least half of the total costs of insuring Medicaid recipients, the portion shouldered by states is their second-biggest expense after K-12 education. Higher Medicaid costs can limit what states have left to fund other priorities, such as schools, transportation, and public safety.

Preliminary figures indicate that the dollars states spent on Medicaid also increased in 2017 and 2018, even though a leading cost driver—enrollment growth—began to slow. Some of the increase was due to states for the first time picking up a small share of the costs of insuring newly eligible low-income adults under the Affordable Care Act’s optional expansion of Medicaid coverage. Through 2016, the federal government covered 100 % of the costs of the expansion population. States began picking up 5 % of the costs for this population in 2017 and will gradually increase their share to 10 % by 2020.

The recession didn’t cause states’ pension funding problems, but it did compound them—first, by reducing investment returns on the assets that states had saved to fund their employees’ retirements, and second by squeezing state budgets and making it even more difficult to fully fund their annual pension payments. As a result, the gap grew between how much states had saved and how much they needed to cover the pension benefits promised to public workers. The greater the gap, the more a state would need to set aside annually simply to keep its pension debt from growing.

As of fiscal 2016, states had enough set aside to cover just 66 % of their total pension liabilities, the lowest level since fiscal 2003 (the earliest available data). The shortfall between pension assets and liabilities amounted to a collective debt of $1.35 trillion by fiscal 2016, taking into account new accounting standards that raised the 50-state total by roughly $100 billion.

Greater than expected investment returns on the back of a booming stock market in fiscal years 2017 and 2018 helped shrink the 50-state total unfunded pension liability, though estimates show that it remained near historic highs. However, market losses in the first half of fiscal 2019 threatened to reverse the progress states may have made in whittling down their pension debt.

So no, it’s not your imagination. The recovery of state fiscal positions during the 10 year recovery from the Great Recession has been slow and sporadic. The data shows that states are significantly under investing in forms of capital. The lowest infrastructure spending in half a century and significant declines in higher education spending represent serious disinvestment in those forms of capital most likely to generate the highest returns going forward in a more technologically and knowledge based economy. And it leaves many states badly positioned for the next recession.

Disclaimer:  The opinions and statements expressed in this column are solely those of the author, who is solely responsible for the accuracy and completeness of this column.  The opinions and statements expressed on this website are for informational purposes only, and are not intended to provide investment advice or guidance in any way and do not represent a solicitation to buy, sell or hold any of the securities mentioned.  Opinions and statements expressed reflect only the view or judgment of the author(s) at the time of publication, and are subject to change without notice.  Information has been derived from sources deemed to be reliable, but the reliability of which is not guaranteed.  Readers are encouraged to obtain official statements and other disclosure documents on their own and/or to consult with their own investment professional and advisors prior to making any investment decisions.

Joseph Krist

Publisher

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ALTERNATIVE ENERGY GETS A BOOST

Revolution Wind is projected to be a wind powered energy generation project to be built off the coast of Martha’s Vineyard. Last week, Rhode Island state regulators approved a 20-year power purchase agreement (PPA) for the power delivered by an offshore wind joint venture of Ørsted and Eversource Energy. Ørsted operates America’s only operating offshore wind farm – the 30MW Block Island Wind Farm, developed by Deepwater Wind – in Rhode Island. The five-turbine offshore wind farm has been in operation since 2016.

Revolution Wind would include about 50 turbines located in federal waters between Montauk, New York, and Martha’s Vineyard, Massachusetts. The state of Connecticut has also selected about 300 MW from Revolution Wind in a PPA. The project backers claim that Revolution Wind can deliver a quarter of Rhode Island’s total electric load. Once permits are in-hand, local construction work on Revolution Wind will begin as early as 2020, with offshore installation starting in 2022 and the project in operation by 2023. Offshore oceanographic and geophysical survey work began in 2018.

BALTIMORE HACKING TWIST

During the month that the City of Baltimore has spent recovering from the early May ransomware attack a persistent concern has been the discovery that the software which facilitated attack may have been something originally created by the National Security Agency. A program known as EternalBlue and other N.S.A. tools were stolen and released on the internet in 2017. Those tools have been cited in other attacks on municipalities. The NSA used EternalBlue for such spying for at least five years before the hackers stole the tool.

What’s maddening is that Microsoft issued a patch to combat these programs  2017. Yet, Baltimore never installed the patch. Apologists for the city suggest that

“the reality is that patching can be hard and requires resources that many municipalities don’t have.” To some extent true, but this seems to be more of an execution issue rather than a pure financial issue.

Some have suggested that the federal government should provide funding to protect local government computer stems. It would be a surprise to see that happen. Just the other day, the President said that people can vote twice, once electronically and once on paper ballots as a way to deal with foreign election interference. No one wants to admit that this is not just about money. It is about the relatively weak position that technology managers are in today versus the position of private vendors. The fear is that not only in terms of cybersecurity but also in terms of technology generally, states and municipalities are showing up at the tech gunfight with pea shooters.

IT’S A MORAL RATHER THAN A LEGAL OBLIGATION

The term seems almost quaint now. In an age of hyperlegalization, it is surprising  that the concept of the “moral obligation” has lasted this long. There was always a basic legal fact about all such debt. The obligation to pay was dependent upon an affirmative legislative act each year in order for debt serve to be paid. It was always thought that the failure to pay on appropriation risk debt would be considered to be tantamount to effectively defaulting  all debt. This led to an era of high acceptance of the “moral obligation” concept.

The “moral obligation” concept was born in a time when attitudes towards debts, defaults, and obligations were looked at much differently. In the ensuing 50 years, attitudes towards debt repayment, moral versus legal obligations, bankruptcy, and the like have all significantly changed. Increasingly, municipalities which helped to facilitate debt issuance, especially for private owned and operated projects, by putting their “moral obligation” pledge to make up revenue shortfalls at projects behind these deals. Investors historically looked at the practice as an extra source of security.

Now it is becoming clear that the “moral obligation” is not nearly as of much concern to borrowers as it once was. Penalties are hard to impose in this market as pools of investible cash wait n the sidelines and absolute l rate levels make the rate “penalty” much more manageable. So when faced with a choice between raising taxes, annoying constituents by cutting services, or sticking it to anonymous bondholders, the decision not to subsidize bad bond deals for private projects is not that hard a decision.

There are two ways for investors to react. They can scream and holler about a city’s willingness t meet a contingent liability. The second choice  to install some discipline into the investment process and buy deals that make economic sense. That decision does not need a court imprimatur, investors can do it themselves.

So against that backdrop, we view the announcement that a Missouri Circuit Court Judge issued a decision granting summary judgment in favor of Platte County in its declaratory judgment action against UMB Bank, N.A., the Trustee for bonds issued to finance a parking facility at a retail complex in the County. The bonds were secured by limited sales tax revenues and a “moral obligation” on the part of the County to appropriate funds to cover any debt service shortfalls. In the face of a budget shortfall away from this obligation and lacking political support for paying, the County has declined.

It is easy to lump this situation in with decisions in Detroit and Puerto Rico and see it as part of a trend. I see this as different from PR in that (not that it’s a better result for creditors) if the security requires regular appropriations for annual debt service then the County is likely within its rights to fail to appropriate. The retail facility is constantly offered for sale. There are relatively new current owners. The project defaulted on its mortgage. That’s not enough to trigger the “moral obligation” in the County’s view. Other smaller communities have done this and the predicted financial and market Armageddon hasn’t happened to them  at least from their point of view. The County budget is tight so they’ve decided it is worth this.

It’s not so much that courts are seemingly siding with bondholders. Populism is a real thing west of the Hudson, so the onus is on the investor to understand the legals. A moral obligation, like many other things is for better or worse not what it once was. It is also a trend. A hotel in Illinois, an ice rink in Minnesota, parking facilities all have been the subject of non-appropriation actions. This one won’t be the last.

ILLINOIS

As we post this week’s edition, the Governor was poised to sign several pieces of significant legislation to implement  several provisions of the budget. The Legislature took advantage of the ability to coordinate which resulted from the Governor’s decisive election margin in the Fall. The Governor had been upfront during the campaign about his priorities so the political atmosphere had changed significantly than was the case during the Rauner administration.

Two pieces have a direct credit impact The first is the approval of legislation to lay the groundwork for voters to vote on a constitutional amendment to convert the state’s income tax from a flat tax to a graduated rate schedule. The second piece included a vote to raise vehicle fees, double the gas tax to 38 cents per gallon, expand casino gambling in the state, and legalize recreational marijuana and sports betting.

The casino legislation will allow a casino to be opened in Chicago and established provisions for the distribution of revenues to among others the City of Chicago. The marijuana legislation provided a structure for revenue allocation and distribution of those revenue. Included among the revenue dedications, the law provides for 10% of marijuana derived revenue to be applied specifically to the State’s unpaid bill backlog. The new budget also includes an elimination of the state’s franchise tax, the reinstatement of a tax incentive to help manufacturers and a new tax incentive to support data centers in Illinois.

Clearly, the state is on a different track under the new Governor. At the same time, the State still faces significant problems. The largest of the festering problems is that of pensions. That is the one area that proved most difficult to address. The difference now is that the Legislature and the Governor are no longer locked into a ideological battle that yielded at best a stalemate while the State’s ratings were battered. Pension reform will be a long process given the need to amend the State Constitution to enable real change to occur.