Joseph Krist

Publisher

RECENT STATE DEMOGRAPHICS

According to the US Census Bureau, Forty states and the District of Columbia saw population increases between 2018 and 2019. Ten states lost population between 2018 and 2019, four of which had losses over 10,000 people. The 10 states that lost population were New York (-76,790; -0.4%), Illinois (-51,250; -0.4%), West Virginia (-12,144; -0.7%), Louisiana (-10,896; -0.2%), Connecticut (-6,233; -0.2%), Mississippi (-4,871; -0.2%), Hawaii (-4,721; -0.3%), New Jersey (-3,835; 0.0%), Alaska (-3,594; -0.5%), and Vermont (-369  ; -0.1%). 

To be honest, these numbers just tell a story from 50,000 feet up so much detail and nuance is lost. We are more interested in things like the incomes and ages of the people moving. States with decreasing but aged populations present one set of issues while growth can still dictate increased demand for capital facilities (especially schools). Both present challenges.

The point is that much will be made of the data depending on where an individual state falls in the rankings. Critics of fiscal policies in Illinois and New York will make much of the negative data while states which grow will likely take a different view. By the way, here are the eight growing states and the numerical increases – Washington (612), Utah (293), Nevada (232), Arizona (175), Idaho (166), Montana (66), Vermont (44), and Colorado (30).

That is not a large number but he direction is still positive. Four states had more deaths than births, also called natural decrease: West Virginia (-4,679), Maine (-2,262), New Hampshire (-121) and Vermont (-53). The top states with net domestic migration loss were California (-203,414), New York (-180,649), Illinois (-104,986), New Jersey (-48,946), Massachusetts (-30,274) and Louisiana (-26,045). We note that the top 5 all are negatively impacted by the loss of the SALT deduction.

MICROMOBILITY

Micromobility advocates will have to wait before they can legally deploy electric bicycles and scooters on the streets of New York’s cities. Legislation legalizing their use was vetoed by the Governor. One of his primary stated issues is the law’s lack of a helmet requirement for users of the bicycles. The legislation would have allowed cities and towns around the state to set local rules for electric scooters and bicycles. Scooter rental companies like Bird and Lime would not have been allowed to operate in Manhattan.

The deployment of these vehicles raises significant safety issues on both sides of the transportation transaction. In Elizabeth, NJ, a 16-year-old boy became the first person killed while riding a shared electric scooter when he collided with a tow truck in November. Another NJ city – Hoboken – started a pilot program in May and stopped it last month while the City Council is considering whether to renew the program.

Leave it to the micromobility advocates to treat this not as a transit safety issue but in terms of race, inequity, and general social policies. That ignores the reality of the real time use and speeds of the bicycles delivering your food and the danger to the unprotected. Of course, these advocates tend to ignore the use of these vehicles on sidewalks, for example. The point is that this clouds the debate and the lack of common sense does not advance development.

SUTTER HEALTH BURIES SETTLEMENT UNDER CHRISTMAS WRAP

Sutter Health, the dominant haelthcare provider in northern California agreed to pay $575 million to settle claims of anti-competitive behavior brought by the California state attorney general as well as unions and employers. The details were not expected to be made public until the first quarter of 2020. Sutter will also be prohibited from engaging in several practices including “all or nothing” agreements which made insurers choose between servicing all of Sutter’s hospitals or none of them.

Sutter will be required to limit what it can charge patients for out-of-network services. These are a leading cause of “surprise medical bills”. The chain was not helped by the fact that there was lots of data available to document the rise in prices Sutter was able to drive through ownership of an increasing number of facilities.

The news ironically followed the release by the California Health Care Foundation of a report documenting the disparity between health costs within the state. It found that various inpatient and outpatient services cost more in California than in other states, and they cost more in Northern California than in Southern California. A critical factor in the fast growth of prices in California compared with the rest of the country is market concentration. The percentage of physicians in practices owned by a hospital/health system has increased dramatically. For specialists, the increase has been even faster.

In 2016, Northern California wage-adjusted prices were on average 24% higher than in Southern California. In the end, the data spoke for itself and the various explanations offered simply did not carry the day.

P3s

Denver International Airport has paid $128 million to Great Hall Partners as part of its divorce from the consortium, which had been hired to redesign and renovate the airport’s main terminal.  When all is said and done, DIA will pay between $170 million and $210 million. DIA moved to terminate the contract after the revelation that bad concrete is laced throughout the terminal. The termination also followed big cost disagreements with the consortium, which claimed the project would cost $1 billion — not $650 million, the agreed-upon figure.

DIA officials expect to propose a contract with the new builder, Hensel Phelps, in January. Construction should resume in January but the completion date has been pushed back to 2024.

St. Louis has decided not to pursue a P3 arrangement for its airport after taking initial steps towards such a financing. The announcement came as the four member working group was reviewing 18 submissions to a request for qualifications from firms and working to finalize which firms would be invited to participate in a request for proposals. The city was seeking “to structure a transaction that meets the city’s primary objectives: improvement of the airport for all stakeholders, including incremental uses of the airport’s significant excess capacity and net cash proceeds to the city, upfront and/or over time for non-airport purposes.” 

Support for the project was less than universal. The politic s behind the proposed expansion reflect the status of the City as the owner of the airport which actually serves a significant population outside of the city which drives facility demand. The clash between those interests has come to the fore in the form of proposals to reconstruct regional governmental structures. These were defeated at previous elections with concerns about how those changes would shift power and economic benefits throughout the St.Louis metropolitan area. Support for a public vote was growing and in light of the regional politics, such a vote would have been problematic.

In New York, recent successful public/private partnerships has supported an environment for increased use of the concept. Now, Gov. Cuomo approved legislation Tuesday granting New York City the power to issue a single request for proposal and contract for the engineering and construction of capital projects. The bill also forces private contractors to cover any extra costs that come with unexpected changes or delays to a project. Design-build can also be applied to most undertakings of the Department of Design and Construction, Department of Environmental Protection, Department of Transportation, Health and Hospitals Corporation, School Construction Authority that costs more than $10 million. The legislation sets the threshold for the Parks Department or the Housing Authority at $1.2 million.

CYBER ATTACK NETS RANSOM

A December cyber attack on the Hackensack Meridian Health system resulted in the payment of a ransom to the hackers. The attack brought down the system’s computer network for two days, during which facilities were forced to reschedule some non-emergency procedures and revert to using paper—rather than electronic—medical records. Hackensack Meridian said that, “due to the frequency with which healthcare organizations are targeted by cyber criminals,” it had a coverage plan in place to cover the costs associated with the cyber attack, including payment and recovery efforts. 

Hackensack Meridian did not immediately comment on which parts of the system were not operational and for how long. there was no initial information provided regarding how much time the system expects it to take to bring those applications online.

The system ran the risk of paying up and then not seeing their systems back on line. It also, by going against broad recommendations from law enforcement that ransoms not be paid, risks encouraging other attacks on Hackensack Meridian but other providers as well.

CANNABIS

In its annual draft report, the California Cannabis Advisory Committee cited high taxes, overly burdensome regulations and local control issues posing significant obstacles to the legal marijuana market in California. Those pressures are reflected in tax revenue about a third of what was expected and with only about 800 of an anticipated 6,000 licensees open for business.

The report estimates that California is expected to generate $3.1 billion in licensed pot sales in 2019. As is so often the case, that would make the Golden State the largest market for legal cannabis in the world. But nearly three times as much — $8.7 billion — is expected to be spent on unlicensed sales. It was originally estimated the state would take in $1 billion annually in tax revenue from cannabis. In reality, the fiscal year that ended in June saw just $288 million collected. The current state budget projects $359 million in tax collections.

An increase in taxes on cannabis cultivation is scheduled for Jan. 1, including a bump tied to inflation that will raise the levy on cannabis flower from $9.25 per ounce to $9.65. The Legislative Analyst’s Office recommended that lawmakers consider overhauling how cannabis is taxed, including a possible potency-based tax to reduce harmful use and eliminating the cultivation tax. 

Meanwhile, the Massachusetts Cannabis Control Commission marked the end of one year of legal recreational cannabis sales in the Commonwealth. The first two Marijuana Retailers commenced operations in Massachusetts in November, 2018. Since then, 33 total have opened statewide. Another 54 Retailers with provisional or final license approval were in the process of completing the Commission’s inspection and compliance procedures towards that end. In total, the Commission has licensed 227 Marijuana Establishments, including Cultivators and Product Manufacturers.

ANOTHER PRIVATE COLLEGE IN TROUBLE

Just before the new year, another longstanding private college saw its finances result in a downgrade. This time it’s Hartwick College in Oneonta, NY. The institution’s origin is rooted in the founding of Hartwick Seminary in 1797. That history and tradition has noit been enough to balance the College’s finances. Moody’s Investors Service has downgraded Hartwick College’s bond rating to Ba3 from Ba1, affecting $38 million of debt. The outlook continues negative.

In Moody’s view,” The downgrade is driven by Hartwick’s materially increasing and now very deep operating deficits that will persist through at least fiscal 2020 and most likely beyond. The college is relying on supplemental endowment draws to fund operations which will result in further reductions in liquidity. This weak financial performance is largely driven by a challenging revenue environment with a small scale of operations, $49 million expense base, and a high cost education model. While the college has incrementally trimmed expenses over the past five years, reductions have fallen well short of the 20% decline in operating revenue during this period. The college confronts a difficult student market environment reflected in declining net tuition revenue, which accounts for about 81% of total operating revenue, a business condition which is likely to persist for the foreseeable future.

Hartwick College is a small, tuition dependent private liberal arts and sciences college with fall 2019 enrollment of 1,180 students and fiscal 2019 operating revenue of approximately $39 million. That is not nearly enough to cover some $10 million of expenses over and above that revenue stream. For four consecutive years through fiscal 2019, the college’s calculated annual debt service coverage under the covenant was below 1.0x. The negative outlook acknowledges the college’s structurally unbalanced operating performance driving continued liquidity declines. Absent a significant increase in philanthropy, it will be difficult for the college to restore fiscal balance.

Declining net tuition revenue accounts for about 81% of total operating revenue, a business condition which is likely to persist for the foreseeable future. Over the last five years, operating revenue has declined some 20%.

The news on Hartwick comes as government datat continues to reflect demographic trends which bode ill for college credits which are tuition dependant. declining net tuition revenue, which accounts for about 81% of total operating revenue, a business condition which is likely to persist for the foreseeable future.

The news on Hartwick’s worsening credit were accompanied by government datat reinforcing demographic trends which bode ill for tuition dependant private colleges. According to the U.S. Census Bureau’s national and state population estimates released, forty-two states and the District of Columbia had fewer births in 2019 than 2018, while eight states saw a birth increase. With fewer births in recent years and the number of deaths increasing, natural increase (or births minus deaths) has declined steadily over the past decade. The Northeast region, the smallest of the four regions with a population of 55,982,803 in 2019, saw population decrease for the first time this decade, declining by 63,817 or -0.1%. 

NYC BUDGET OUTLOOK

Just before the end of the year, the NYC Independent Budget Office delivered its outlook for the NYC budget as we enter 2020. IBO expects the city to end the current fiscal year with a surplus of $635 million that will be used to prepay expenses for next year, leaving a gap of $2.9 billion for fiscal year 2021, which begins on July 1, 2020. IBO’s outlook for the local economy is for the expansion underway since the end of the Great Recession to continue, although at a slower pace. IBO continues to project relative strength in the growth of city tax collections—thanks largely to the property tax—at rates that exceed planned expenditures. However, as personal income tax revenue grows more slowly and the business income and property transfer taxes see actual declines in revenue, IBO expects tax revenue growth in 2020 to fall sharply from 4.0% in 2019 to 1.9%.

Looking at the economy, the growth of New York City’s economy has also slowed in 2019. IBO projects employment growth of 65,000 for the year (4th quarter to 4th quarter), compared with an average of 98,000 jobs a year from 2010 through 2018. IBO forecasts slower employment growth of 50,100 in 2020, and even smaller job gains in the following years. Slower employment growth coupled with slowing growth in the labor force is expected to increase the unemployment rate but only slightly—from a projected 4.2 percent in 2019 to no more than 4.5 percent during the forecast period. Health care and social service employment is expected to grow more slowly but this sector will continue to provide more new jobs than any other.

QUICK THINGS TO LOOK FOR IN 2020

The year opens with a mediator’s recommendation that settlement talks continue in the Commonwealth’s debt restructuring case of debt including commonwealth general obligation, Highways and Transportation Authority, and Public Buildings Authority bonds. The outcome of this process will raise as many questions as it answers about any comparable action. On Dec. 23 the Mediation Team Leader Houser described the ongoing mediation talks as being “productive.” She said if the parties reached further progress, she would have to add other parties to the discussions and that coming to an agreement would take additional time.

The judge managing the case  extended the deadline for the team to submit a report to Feb. 10 from Jan. 10. She extended the planned hearing on the report and any possible further extension of the stay on litigation to March 4 from Jan. 29. She also extended the stay on litigation to March 11 from Jan. 31.

Annual appropriation debt will have its day in court as the trustee for $29 million of debt sold through Platte County, MO’s industrial development authority for the Zona Rosa Shopping Center project has been granted of an appeal of a decision rendered against the Trustee in May, 2019.

The county argued that the pledge provided on the bonds was not a promise to pay, but a pledge that the auditor could request coverage of a shortfall with the decision resting with the county on an annual basis. Platte County sued the bond trustee UMB Bank NA in November 2018 to secure a legal determination that it was not legally on the hook to make the appropriation.

The Zona Rosa bonds are repaid with a dedicated 1% sales tax in Zona Rosa, but the revenue doesn’t fully cover debt service. It is another reminder of the need to evaluate economic viability along with project documents.

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 advisers prior to making any investment decisions.

This is our last post of 2019. We wish you a hopeful Christmas and a brave New Year. The MCN will return in  the first week of January.

Joseph Krist

Publisher

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CORPORATE AND MUNI CREDIT CONVERGENCE

As much of the analytical work current being done on municipal credit increases its focus on legal provisions after Detroit and Puerto Rico, the differences between our markets emerges. There is extensive case law on Chapter 11 but the number of completed municipal bankruptcy cases is perhaps 1,000. That lack of case law became painfully apparent in the Detroit case when bondholders were pitted against employee pensions. The concerns raised about special revenues in the Puerto Rico bankruptcy reinforce the lack of substantial case law.

Much will ride on the outcomes of the various proceedings involving Puerto Rico and its investors. Decisions which produce results which threaten long established norms in terms of the relative strength and standing of various creditor claims will clearly be a concern. At the same time there is enough about the Puerto Rico bankruptcy relative to that of states given its Commonwealth status to see a bit less concern. The different local governmental structure versus those of the lower 48 states puts a number of key municipal functions under central government rather than state/local control. The applicability of the outcome in Puerto Rico is not clear.

One thing which the Puerto Rico experience has done is to lessen the attractiveness of a Chapter 9 filing by a state from the investor standpoint. It is not clear how much weight legal provisions including constitutional provisions could be given if maximization of creditor recoveries were subjugated to other creditor classes (pensions and benefits versus debt service). We believe that state bankruptcies are not a likely result (no Illinois is not going Chapter 9). If we believe that Puerto Rico will have limited applicability, it still means that one basic credit tenet will remain true. That is the fact that if you make an investment based on sound economics, they will trump legal provisions every time.

What this does however, is make the case that harmonization of ratings between the municipal and corporate sectors will remain difficult. We think that the differences in accounting, reporting, and disclosure standards and scheduling will effectively block full harmonization.

FLORIDA GEORGIA WATER DISPUTE

As drought impacted the southeastern US earlier in the decade, the State of Florida and the State of Georgia found themselves at odds over the State of Georgia retention of water by Georgia which eventually flow to Florida. The dispute was submitted to the federal courts where the State of Florida had suffered defeats in its effort to have Georgia’s water restrictions overturned on environmental grounds. Florida had appealed adverse decisions to the US Supreme Court.

The Supreme Court held, however, that a prior Special Master had applied too strict a redressability standard. In light of that holding, the Court remanded the dispute to a new Special Master with instructions to make findings concerning the following questions on remand: (1) whether Florida suffered harm caused by decreased water flow into the Apalachicola River; (2) whether Florida showed that Georgia’s use of the Flint River is inequitable; (3) whether that potentially inequitable use harmed Florida; (4) whether an equity based cap on Georgia’s use of Flint River waters would materially increase stream flow in the Apalachicola River given the Corps’ operational rules or reasonable modifications that could be made to those rules; and (5) whether such additional stream flow in the Apalachicola River may significantly redress the economic and ecological harm that Florida has suffered.

Now the Special Master has issued his findings to the Court. He did  recommend that the Supreme Court grant Florida’s request for a decree equitably apportioning the waters of the ACF Basin because the evidence has not shown harm to Florida caused by Georgia; the evidence has shown that Georgia’s water use is reasonable; and the evidence has not shown that the benefits of apportionment would substantially outweigh the potential harms. The complaining state must demonstrate by clear and convincing evidence “that it has suffered a threatened invasion of rights that is of serious magnitude.”

Florida was attributing declines in its oyster industry to lower water flows. Florida alleged that lower flows in the Apalachicola River (the “River”) have harmed the ecosystems in both the River and the Apalachicola Bay (the “Bay”). Florida highlights the collapse of the Bay’s oyster fishery, but Florida has not proved that the harm to the oysters resulted from “the action of [Georgia].”

The Special Master said that ” Florida has pointed to harm in the oyster fishery collapse, but I do not find that Georgia caused that harm by clear and convincing evidence. Next, although Georgia’s use of the Flint and Chattahoochee Rivers has increased since the 1970s, Georgia’s use is not unreasonable or inequitable. Last, I have determined that the benefits of an apportionment would not substantially outweigh the harm that might result. This is especially true given that the Army Corps’ reservoir operations on the Chattahoochee River would prevent most stream flow increases from reaching Florida during the times when more stream flow is needed to alleviate Florida’s alleged harms.

As time goes on and climate change impacts water supplies and demands, the use and distribution of water from sources in multiple jurisdictions will continue to be a flashpoint for disputes. Although not the case in this dispute, other water disputes could definitely have credit implications.

PUERTO RICO

The bankruptcy judge overseeing Puerto Rico’s efforts to restructure and eliminate its debt has approved a scheduling plan proposed by a court-appointed mediation team. the mediator has recommended that the case be  litigated after efforts to avoid that did not succeed. The mediation team will submit an amended report by mid-January.

The action follows the mediator’s recommendation last month that litigation should proceed over the rights of owners of revenue bonds against the U.S. commonwealth, as well as the validity of general obligation and Public Buildings Authority bonds and whether bondholders’ claims were secured or unsecured.

The mediator said bond-related issues “have the potential to drive overall restructuring outcomes.” As the litigation unfolds, negotiated settlements of the items in dispute could occur but we see it as more likely that the litigation will determine how the parties pursue their claims. The debt subject to the litigation currently include commonwealth general obligation, Highway and Transportation Authority, and Public Building Authority bonds. 

Litigation will establish creditor classes and hopefully will provide clarity over the status of special revenue  bonds. It is the special revenue bond question which seems to have most perplexed the market. There are significant worries that a resolution of Puerto Rico’s fairly unique credit issues would lead to a significant change in the treatment and application of special revenues could establish a very negative precedent for holders of revenue bonds nationwide. The likelihood that an unfavorable litigation result through efforts by nontraditional investors with much more short term perspectives than are the case for the vast bulk of municipal bond investors is a huge concern which will overhang the market into 2020.

IOWA UTILITY P3 MOVES FORWARD

The demise of the public/private partnership concept when it involves a public university had been predicted by some after a couple of private student housing projects failed financially. The likelihood that this would be the case was lessened by news out of Iowa this week. The Board of Regents for the University of Iowa recently approved the establishment of a $1.165 billion public-private partnership (P3) with the University of Iowa (UI) utility system and ENGIE North America and Meridiam.

Under the agreement, ENGIE and Meridiam will pay $1.165 billion to the University of Iowa for a 50-year operating agreement for its utility system. Most of this upfront payment will be placed into an endowment. Annual proceeds from this endowment are projected at $15 million by the University. The UI retains ownership of the utility system and operation of the utility system will return to the university following the 50-year deal. No university staff positions will be eliminated under this agreement.

The University of Iowa will pay ENGIE and Meridiam a $35 million annual fee in years one-through-five of the deal, with the fee increasing by 1.5% annually thereafter. The UI will use $166 million of the lump sum to pay off existing utility bonds and consulting fees. The deal also addresses environmental issues. ENGIE and Meridiam will adopt the UI’s existing goal of operating coal-free by 2025 or sooner and continue campus-wide sustainability efforts. 

The project has been supported by the Governor as a way to increase university funding from other than state sources.  

WHAT WE’RE LOOKING AT FOR 2020

Here are the topics we think that municipal bond investors concerned about credit should watch.

Chicago – The largest city with the most serious credit problems. A diverse range of issuers rely on a common tax and revenue base and their demands on that base individually and collectively will cause significant strains. The flexibility these issuers have is limited both legally as well as practically and we expect that the City especially will be in the news all year. Strap in.

California – the state is facing a potentially huge disruption to and reconfiguration of its electric supply system. The PG&E bankruptcy and the state’s political environment could easily lead to a resolution which sees PG&E’s physical assets and their operation moved to a public rather than a private entity.  The move towards a public power resolution is gaining momentum and political support. There is also a strong likelihood that Proposition 13 will come under assault from a proposed ballot initiative. If adopted, the local financial picture would be significantly altered.

New York – The state is facing a significant projected budget gap for FY 2021. It is the first state to adopt a budget each year. This year policy issues will complicate the budget process as congestion pricing details have to be adopted for NYC to put its proposed scheme into effect. The budget will also be a mechanism for addressing ongoing capital needs for mass transit and public housing in NYC.

Florida – Just as California considers a public power option for tat state, Jacksonville, Florida is undertaking a proposed sale of its municipal utility to private interests. The proposed sale is controversial and there are already signs of pushback from the City Council which must approve any transaction. A sale would have to address outstanding debt from the Jacksonville Electric Authority.

Transportation and Micro Mobility – The ongoing battles between providers of ride sharing and individual mobility modalities will continue. The continuing practices of service providers which essentially ignore local regulatory concerns will insure that the currently contentious environment in which these issues are dealt with continues.  Mass transit will continue, especially in the Northeast, to face significant capital demands even as utilization slows or even declines. Systems in D.C., Boston, and New York face significant rolling stock and basic infrastructure needs which will require significant debt issuance.

TAX INCENTIVES UNDER SCRUTINY AGAIN

The past year saw a turn in the trend of municipalities and states falling all over themselves to offer tax incentives to businesses to locate within their boundaries. Opponents of a massive tax incentive plan to lure Amazon to build its headquarters 2 facility in the borough of Queens were successful in their opposition to a large tax “giveaway”. The issue continues to be debated as Amazon locates distribution facilities throughout the city while it has just announced an agreement to lease space in Manhattan to house 1500 employees. And they are doing it without direct tax incentives.

Now in Wisconsin, the state and Foxconn are engaged in a new dispute after a heavily incentivized facility has undergone a change of plans. Originally intended as a large screen production facility, the company has shifted its emphasis away from large screen to small screen products. This after it appeared that such a facility would not deliver the number and type of jobs originally promised but at lower average salaries to boot. A Governor took office in January, 2019 after the companies leading ally in the state lost his bid for a third term as Governor. The new administration has taken a dim view of the plans to reconfigure the plant away from its originally conceived form.

This has led the current administration to respond to a recent request from Foxconn to receive tax credits under its agreement for some $150 million of contracts which have been let to commence construction. In response, the state has informed Foxconn that the new project doesn’t qualify for incentives under the existing contract. The scaled-down factory in Wisconsin won’t qualify for tax credits unless the Taiwanese electronics giant renegotiates with the state. The Wisconsin Economic Development Corporation is taking the position that WEDC hasn’t evaluated the Generation 6 project (the downsized version) or properly contracted for it. As such the project is ineligible for tax credits under Wisconsin law.

Past experience with Foxconn in other states, particularly Pennsylvania where Foxconn did not deliver on its promises of new facilities in exchange for tax incentives, made many in Wisconsin cautious. Perhaps the Pennsylvania experience made Foxconn think that they could change the terms of its deal with Wisconsin without any ramifications.

We think that it is perfectly legitimate for states and cities to rethink tax incentives in the event of project changes. The history of tax incentives has yielded such a mixed bag of results versus promises that it is refreshing to see at least one jurisdiction trying to get the phenomenon under control.

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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MASSACHUSETTS CONSIDERS GAS TAX ALTERNATIVES

The Commonwealth of Massachusetts is considering legislation which would allow it to join with states like Oregon in implementing mileage based taxes on automobiles. The impact of alternative vehicles and increased fuel efficiency on gas tax revenues is well established. Now a bill has been offered to create a pilot program to test fees based on the miles people travel rather than the amount of gas used.

The idea is being considered as a part of a package of increased revenues for transportation. One plan would instruct the Department of Transportation to report on the feasibility of implementing all-electronic tolling on state and interstate highways “not currently subject to a toll.”  A second bill would expand tolls to stretches of Interstate 93, Interstate 95 and Route 2 in an attempt to apply equal charges to drivers across the Boston region. That bill also calls for implementation of dynamic “peak pricing” where the toll varies based on road conditions.

Another bill would increase the fees on ride-sharing companies such as Uber and Lyft. The state currently assesses a flat 20-cent fee on each ride through those services, regardless of length. The legislation would change that to a scaled percentage of the overall fare. Under the proposal, the fees would be 4.25 % of the total fare paid for shared rides and 6.25 % of the fare for a single passenger trip.

Reactions to the plan show the split in approaches between and among the ride sharing companies. Uber has come out general in favor of congestion pricing versus limits on the number of vehicles (like in NYC). In this case, Lyft  said in a statement that the company believes higher fees will not significantly reduce congestion. Such a position favors the ride sharing companies as it reduces funding for mass transit which has been the primary competitor targeted by these companies.

The Metropolitan Area Planning Council in July said the MBTA missed out on more than $20 million in foregone fare revenue from passengers who substituted  TNCs for public transit.  It is just another example of the clash of interests between private providers profiting through use of the public streets and providers of public mass transit. It is a battle without an apparent end.

However this saga ends, it highlights the ongoing need to fund public transit in an environment where many of those best positioned to fund or use it pursue alternatives. Until states and cities come up with a regulatory and taxing scheme which reflects the real benefit to the TNCs, transit funding will continue to be a clash with no real winners.

HEALTHCARE SPENDING DATA DRIVES CAUTIOUS CREDIT OUTLOOK

A colleague observed this week that AA and rated hospital credits traded anywhere from 40 to 100 basis points wide to AAA general obligation yields. We think that there is ample reason to ask for additional yield return when holding healthcare credits. Here is some data from the Centers for Medicare and Medicaid about costs which should give one pause.

National health expenditures (NHE) grew 4.6% to $3.6 trillion in 2018, or $11,172 per person, and accounted for 17.7% of Gross Domestic Product GDP).Medicare spending grew 6.4% to $750.2 billion in 2018, or 21 percent of total NHE. Medicaid spending grew 3.0% to $597.4 billion in 2018, or 16 percent of total NHE.

Private health insurance spending grew 5.8% to $1,243.0 billion in 2018, or 34 percent of total NHE. Out of pocket spending grew 2.8% to $375.6 billion in 2018, or 10 percent of total NHE. Hospital expenditures grew 4.5% to $1,191.8 billion in 2018, slower than the 4.7% growth in 2017. Physician and clinical services expenditures grew 4.1% to $725.6 billion in 2018, a slower growth than the 4.7% in 2017. Prescription drug spending increased 2.5% to $335.0 billion in 2018, faster than the 1.4% growth in 2017.

The largest shares of total health spending were sponsored by the federal government (28.3 %) and the households (28.4 %).   The private business share of health spending accounted for 19.9 % of total health care spending, state and local governments accounted for 16.5 %, and other private revenues accounted for 6.9 %. That state and local share poses a real risk to the states.

Under current law, national health spending is projected to grow at an average rate of 5.5 % per year for 2018-27 and to reach nearly $6.0 trillion by 2027. Health spending is projected to grow 0.8 percentage point faster than Gross Domestic Product (GDP) per year over the 2018-27 period; as a result, the health share of GDP is expected to rise from 17.9 %in 2017 to 19.4 % by 2027.

The report also provided a wide look at the geography behind the data although it is noted that the most recent year in the 15 year record was 2014. Nonetheless, in 2014, per capita personal health care spending ranged from $5,982 in Utah to $11,064 in Alaska.   Per capita spending in Alaska was 38 percent higher than the national average ($8,045) while spending in Utah was about 26 percent lower; they have been the lowest and highest, respectively, since 2012.

Health care spending by region continued to exhibit considerable variation. In 2014, the New England and Mideast regions had the highest levels of total per capita personal health care spending ($10,119 and $9,370, respectively), or 26 and 16 % higher than the national average.   In contrast, the Rocky Mountain and Southwest regions had the lowest levels of total personal health care spending per capita ($6,814 and $6,978, respectively) with average spending roughly 15 % lower than the national average.

So now the data provides a map of where higher growth in the expense side of the income statement might occur geographically. Combine that with the demographic trend of a longer lived aged population and the potential for limits on revenues and you have a risk profile which demands compensation. And remember, the elderly were the smallest population group, nearly 15 % of the population, and accounted for approximately 34 % of all spending in 2014. The question is how long will it be politically sustainable for healthcare to account for 1 out of every 5 dollars of economic activity?

PG&E WILDFIRE SETTLEMENT

Pacific Gas & Electric on Friday announced a settlement with insurers and others for several Northern California wildfires including the wine country blazes in 2017 and the fire that nearly destroyed the town of Paradise in 2018. The wine country fires in 2017 impacted more than 200,000 acres mostly in Napa County, destroyed or damaged more than 5,500 homes, displaced 100,000 people and killed at least 41. The Camp fire, which raced through Paradise in 2018, killed 86 people and destroyed more than 13,900 homes. 

PG&E already had agreed to pay $1 billion to cities, counties and other public entities, and $11 billion to insurance companies and other entities that have already paid claims relating to the 2017 and 2018 wildfires. This settlement is intended to help victims with no insurance and victims whose insurance was not enough to cover their losses. People have until Dec. 31 to file initial claims for a share from the trust fund that the settlement will create.

The settlement will largely reimburse insurance companies who have been largely taking the lead in funding recovery from the fires. Some $11 billion of the settlement will cover those costs. This highlights the importance of insurance in the recovery process highlighting the concerns around the willingness of the insurance industry to write business in the state. A one year regulatory halt to non-renewals is only a band aid while the industry and the state seek to craft longer term solutions to the ongoing wildfire risks in California.

Insurers have responded by raising rates, re-underwriting the risk, purchasing additional reinsurance if available and reconsidering risk models. The moratorium applies retroactively to the October 2019 state of emergency declared by current Governor Gavin Newsom, and insurers will need to offer to reinstate or renew the policies that have not been renewed or were canceled since October because of wildfire exposure.

OIL STATES TAKE DIVERGENT REVENUE PATHS

Texas sales tax revenue for November set a record for any month at $3.18 billion, an increase of 6.2% over the same month last year, state Comptroller Glenn Hegar reported. In the same month, neighboring Oklahoma recorded its first drop in monthly receipts in more than two and a half years, Treasurer Randy McDaniel reported.

The drop in revenue in Oklahoma is another sign of the weakness in reliance on one major industry. Oklahoma’s less diverse economy has already seen negative impacts in its agricultural sector due to the ongoing trade wars. Less prominent has been the fact that lower oil prices are impacting the state economy as well.

The news about declining Oklahoma revenues comes in the wake of recent announcements by Halliburton that it was making permanent the loss of some 1500 jobs in the state. These were not layoffs but absolute cuts in headcount. Oil services are an important source of well paying jobs so this does not bode well for Oklahoma’s near term revenue outlook. Recent moves by international producers to prop up prices highlight the weakness in oil pricing.

On the positive side, the Texas economy continues to reflect the increasing diversity of its economy. The Lone Star state benefits from migration and increasing employment away from the oil industry. That accounts for the positive revenue growth trend in Texas versus the negative trends in Oklahoma.

PRIVATE STUDENT HOUSING

Another private student housing deal has come under credit pressure as colleges and universities confront pricing and demand issues. The latest is at Claremont College in California.

A privately operated and financed housing facility saw the rating on outstanding debt (NCCD – Claremont Properties LLC’s (CA) University Housing Revenue Bonds) from 2017 was downgraded by Moody’s to Caa2. The rating change reflects  insufficient project revenues to cover operating expenses and debt service obligations, weak market position and demand that will prolong financial distress, and an imminent tap to the debt service reserve fund (DSRF) to supplement net operating income to pay semi-annual bond debt service.

Moody’s cited the fact that “the project’s 60% occupancy rate generates insufficient revenue to cover budgeted operating expenses and debt service obligations. As a result, the borrower has requested that pledged revenue be disbursed to pay operating expenses prior to required deposits to the bond fund for debt service.” Most importantly, the rating also incorporates that there is no express or implied guaranty from the universities. Though The Claremont Colleges, Inc. (Aa3 stable), Keck Graduate Institute (KGI), and Claremont Graduate University (CGU, Ba1 negative) have entered into cooperation agreements with the project, the institutions do not provide any assurances that it will take any actions to avoid a default of the project’s bonds.

The lack of a guaranty is not unusual nor is it unusual that existence of cooperation agreements does not lead to financial pledges. This has been an item of concern especially for private partners in these transactions who have often operated under the erroneous assumption that promises to direct students or to include privately operated living facilities in the array of choices available to students of a given institution imply an obligation to provide financial support to these projects when they fail to meet occupancy and/or profitability targets established by those operators.

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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NEW YORK UTILITIES DIMMING CREDIT OUTLOOK

Over recent months, National Grid has been engaged in a serious fight over its efforts to secure permits for natural gas pipeline expansion. In an effort to generate pressure on state politicians and regulators, National Grid decided to stop new natural gas connections in and around the New York metropolitan area. This is generating significant pressure from developers and potential business operators.

The state and the Governor in particular have maintained their opposition to the pipeline project. Now in the face of a continued moratorium on hookups, the governor has significantly raised the ante in the dispute. He has suggested that the franchise from the state under which National Grid is permitted to operate its gas facilities could be revoked.

The next step is not clear but at least one rating agency has weighed in on the impact of the Governor’s move. Moody’s has issued a warning that all the utilities operating under state franchises are now at risk of revocation. That is indeed technically true. It is also true that the risk of revocation is significantly higher for National Grid relative to the other utilities. Moody’s referenced a perception by the New York governor that NG did not look at finding alternative (short and medium term) measures to manage the supply constraints, absent the pipeline, such that the moratorium could be lifted; and its poor handling of the moratorium with its customers.

While the method may be different now, the state can arguably be said to be doing something it has done before. In many cases, the regulatory ratemaking process accomplished sufficient pressure as to lead to the eventual dismantling of the Long Island Lighting Company. It was succeeded by the public agency, the Long island Power Authority. We do not believe that the state’s ultimate goal is to revoke the franchise but it is a bold escalation of the conflict. Moody’s views political intervention as a material credit negative, especially when the intervention emanates from a governor’s or attorney general’s office.

AUTONOMOUS VEHICLES

The National Transportation Safety Board called upon federal regulators Tuesday to create a review process before allowing automated test vehicles to operate on public roads, based upon the agency’s investigation of a fatal collision between an Uber automated test vehicle and a pedestrian. The March 18, 2018, nighttime fatal collision between an Uber automated test vehicle and a pedestrian has focused much attention on both the technology but more importantly on the approach taken by the AV industry towards government’s role in managing its streets. The NTSB said an Uber Technologies Inc. division’s “inadequate safety culture” contributed to the crash.

The NTSB determined that the immediate cause of the collision was the failure of the Uber ATG operator to closely monitor the road and the operation of the automated driving system because the operator was visually distracted throughout the trip by a personal cell phone. Contributing to the crash was Uber ATG’s inadequate safety risk assessment procedures, ineffective oversight of the vehicle operators and a lack of adequate mechanisms for addressing operators’ automation complacency – all consequences of the division’s inadequate safety culture. “The collision was the last link of a long chain of actions and decisions made by an organization that unfortunately did not make safety the top priority.”

The really sad/annoying part of this is that the attitude towards safety takes us back over half a century to the days of the rear engine Corvairs and the arguments against seat belts. We are asked time and time again by companies like Uber to trust them or to learn how to think of things in different ways or to think outside of the box. So when you see the NTSB conclusions you can see why these companies whether they be AV producers or ride share companies cannot be trusted.

“The Uber ATG automated driving system detected the pedestrian 5.6 seconds before impact. Although the system continued to track the pedestrian until the crash, it never accurately identified the object crossing the road as a pedestrian — or predicted its path. Had the vehicle operator been attentive, the operator would likely have had enough time to detect and react to the crossing pedestrian to avoid the crash or mitigate the impact. While Uber ATG managers had the ability to retroactively monitor the behavior of vehicle operators, they rarely did so. The company’s ineffective oversight was exacerbated by its decision to remove a second operator from the vehicle during testing of the automated driving system.

SOUND TRANSIT

Sound Transit will continue to collect car-tab taxes Sound Transit will continue to collect car-tab taxes even after the success of Initiative 976, approved by voters statewide this month. Cities and counties, including Seattle, have already sued to challenge I-976, claiming it’s a “poorly drafted hodgepodge that violates multiple provisions of the Constitution,” including a ban on multiple-subject initiatives.

They’ve sought an injunction to block I-976 before Dec. 5, when much of the initiative is expected to go into effect. it would cut state funding  for multimodal projects, ferries and state troopers; revoke city car-tab fees such as the $80 in Seattle for added bus service and roadwork; and remove 11% of Sound Transit’s roughly $2 billion yearly income. Sound Transit has pledged tax proceeds to the repayment of debt issued to finance the capital needs of the regional district which serves the greater Seattle metropolitan area.

Does it mean bondholders are at risk? Previous efforts to cut funding for Sound Transit through initiatives have succeeded at the ballot box but have not been able to stop tax collections related to bonds. The state Supreme Court agreed bond contracts signed in 1999 allowed the agency to collect the taxes until 2028 when those bonds expired.

Without court intervention, drivers whose vehicle registrations renew on or after Dec. 5 will see a tax cut —. They don’t have to pay city transportation-benefit district fees ranging from $20 to $80, such as Seattle’s voter-approved charges for extra bus service. Contrary to the image many have of Seattle as a progressive bastion, support for the car taxes in the metro area is far from unanimous. Unlike King County voters, majorities in both Snohomish and Pierce counties supported the initiative.

PUERTO RICO FACES DAUNTING CHALLENGE

The American Society of Civil Engineers (ASCE) Committee on America’s Infrastructure, made up of expert civil engineers, assigns grades using the following criteria: capacity, condition, funding, future need, operation and maintenance, public safety, resilience and innovation. It has also included Puerto Rico in its assessment and the results of its study show the scale of the capital finance challenges facing the Commonwealth.

The ASCE Puerto Rico Section announced a near failing grade of a ‘D-‘ for the island’s infrastructure. The Report Card graded eight categories of infrastructure: bridges (D+), dams (D+), drinking water (D), energy (F), ports (D), roads (D-), solid waste (D-), and wastewater (D+). None of this is a surprise in the aftermath of Hurricane Maria. Energy received the lowest grade of ‘F,’ meaning the system’s infrastructure is in unacceptable condition and has widespread advanced signs of deterioration.

The Puerto Rico Electric Power Authority (PREPA) proposed a $20 billion plan to renovate the energy grid on the island. How to finance and fund the needs is a different story. According to ASCE, “If the island wants to rebuild and modernize its infrastructure, it must increase received investment by $1.23 billion to $2.3 billion annually—or $13 to $23 billion over 10 years. However, when considering deferred maintenance and hurricane-related recovery projects, the investment gap is even larger. There is a dire need for the island to rebuild smarter by building to adequate codes and standards, acquiring funding from all levels of government, and incorporating resilience into infrastructure plans by using climate-resilient materials.”

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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ASCENSION CAUGHT UP IN TECH DISPUTE

The Department of Health and Human Service’s Office for Civil Rights, the federal agency that enforces HIPAA, would “like to learn more information about this mass collection of individuals’ medical records with respect to the implications for patient privacy under HIPAA,” associated with “Project Nightingale”.

“Project Nightingale” is a project that Google launched last year. It analyses health data from patients who received care at St. Louis-based Ascension, one of the nation’s largest health systems. Ascension is a large issuing presence in the municipal bond space. Data reportedly includes patients’ lab results, medications and diagnoses. Google’s partnership with Ascension also involves a commercial contract to move Ascension’s on-premise data centers to Google’s cloud-computing system.

Here’s the problem, one not unlike many of the tech industry’s disputes with government. Ascension patients were not notified about the partnership with Google so they did not get a chance to opt out. According to Google the intended goal is to use Google’s artificial intelligence tools to recommend changes to a patient’s care, such as different treatment plans, diagnostic tests or additional physicians, as well as to flag unexpected deviations in the patient’s care.

Google has struck similar partnerships with the health systems of Stanford University, the University of Chicago and the University of California at San Francisco. The concern is that a higher level of detail is being analyzed under the arrangement with Ascension. The University of Chicago is being sued by a patient over its sharing thousands of medical records with Google for a research project on predicting patient outcomes, claiming that the health system had not properly de-identified patient information. Google and UChicago Medicine have maintained that they followed regulations, including HIPAA.

It is difficult to deal with the single mindedness of the tech entities in terms of their use of data. It’s the modern equivalent of and ends justifies the means approach whether is the management of public streets and roadways or whether it’s over issues of patient privacy. There just seems to be a lack of common sense manifested in the industry’s inability to see the concerns of the other parties they interact with.

Until the scale of the issues can be determined, it’s not possible to assess the level of risk to the Ascension credit if violations of HIPPA have occurred. Only then can the potential scale of the potential costs of any resulting litigation be determined. There should be some sort of trust penalty associated with Ascension. It seems inconsistent for a religiously based system that deigns to use its beliefs to deny certain medical services should have entered into such an arrangement with Google on what appears to be a secretive basis.

HIGHER EDUCATION REMAINS UNDER PRESURE

For some time we have commented on the potential for credit problems in the higher education sector. There have been several defaults and closures of institutions. So we are interested in comments made this week by Moody’s Investors Service based on its tenth annual tuition survey.

The data is stark. Median net tuition revenue will grow 1.0% and 2.3% for public and private universities, respectively, for fiscal 2020, according to the results. The continued trend of softening net tuition revenue growth for both public and private universities reflects enrollment and pricing challenges. Moody’s also cited factors we have been concerned about including flat numbers of high school graduates, a favorable economy drawing students into the workforce, and some declines in international student enrollment. These factors are not one offs but are rather reflective of trends.

The report highlights issues more specific to the private schools The median growth in net tuition revenue among private universities is likely to soften slightly, partially because of increasing competition reflected in continuously rising discount rates. » The first-year discount rate at private universities rose slightly to 51% for students entering in fall 2019. Overall, nearly one quarter of private university survey respondents reported a first-year tuition discount of 60% or higher, an indicator that private universities will struggle to sustain net tuition revenue growth.

Other more specific points include some focusing on the public universities.  Among public universities, the median annual growth in net tuition revenue in fiscal 2020 is projected at 1%. This represents a decrease from 1.8% in fiscal 2019, due in part to relatively flat enrollment.  Nearly two-thirds of public universities are projected to grow overall net tuition revenue at under 3% for fiscal 2020, our proxy for inflation in the higher education sector. This is almost double the level five years ago.  Continued declines in the number of international students also contribute to more constrained revenue growth. Among our public university survey respondents, the median decline in international students for fall 2019 was 3.7%.

Overall, the public schools offer more safety. They have a larger constituency, the provide much research and support for economic drivers in state economies, they are the low or lower cost alternative for a larger segment of demand. They also have more a more diversified mix of undergraduate, graduate and professional programs. That drives demand as well.

MORE MONEY RAINS ON THE PRAIRIE

We have expressed concerns about the potential impact on state credits in the farm belt resulting from the ongoing trade war, primarily with China. early on the trump Administration disbursed aid to farmers for 50% of their estimated losses resulting from reduced demand for US agricultural products. Now as the trade disputes have dragged on well after previously announced potential settlement dates, the federal Agriculture Department will begin distributing another round of tariff relief payments next week to farmers and ranchers.

The aid payments have been coming across two years. The Administration has already paid farmers at least $6.7 billion for their 2019 production. It paid $8.6 billion for last year’s production and additional trade relief efforts like commodity purchases and marketing assistance. The first set of 2019 payments covered 50% of a farmer’s eligible production; the new funds announced will cover an additional 25%. 

Hog and dairy farmers have been the primary recipients. They are on the front lines of the trade war but coincidentally are in areas key to the president’s reelection hopes so the additional funding is not a surprise. And they do help to mitigate the credit impact on the agricultural states. They are nonetheless a band aid. They also to some extent insult farmers. As one said to the Boston Globe, “I don’t know what socialism is if it’s not receiving a check from the government.” 

TIME TO PAY FOR THE CPS CONTRACT

The news out of Chicago about the city’s ability to fund its recently negotiated labor contracts not good. – especially the one for the CPS teachers – was not good. It puts the already beleaguered tax base supporting both the City and CPS under even more pressure. The situation augers poorly for the ratings of the City and its associated underlying taxing entities. Mayor Lori Lightfoot and Chicago Public Schools leaders have agreed on where the funds to pay for the first year of new union contracts will be found. The problem is that some of those revenues are not recurring leaving a significant hole in future budgets.

The district is relying on the state to keep its pledge to increase school funding, which can change year to year. CPS also is relying on its own ability to significantly raise property taxes. The additional contract costs for the current school year total $137 million: $115 million for the CTU contract and $22 million for the SEIU contract. In addition, the district has to pay $60 million or so in teacher pension contributions formerly paid by the city.

CPS already budgeted $89 million to cover higher personnel costs clearly not enough to cover the full cost increase. By the fifth year of the CTU contract, CPS will need $504 million more a year to cover the added costs. For SEIU, that cost will be at least $54 million. That comes to $558 million in additional costs by the 2024 budget year — about 8% more than the $7 billion that the district spent last year.

PROPOSITION 13 CHALLENGE

When it was passed 40 years ago, there were many doom and gloom predictions about the credit impact of the limitations on property taxes enacted under Proposition 13 in California. As it turns out, Prop. 13 has not become an issue in terms generally of state and local credit in the Golden State. That does not mean that it is universally supported. The law’s reliance of assessed value based on the purchase price of the home has created inequities between the taxes paid by owners on property for which ownership has been extended versus those paid by properties which have recently turned over. Essentially, two very similar properties directly adjacent to each other may have significantly different tax bills. Now, this situation is generating more and more concern.

An effort is underway to address some of the perceived shortcomings of the law. Efforts are underway to place an initiative on the November, 2020 ballot which would allow county assessors to split their tax rolls into two lists. Homeowners and some small businesses would still receive the full Proposition 13 benefits: a 1% tax based on a property’s purchase value and annual tax increases of no more than 2%.

Commercial and industrial property owners would be subject to different rules. While their tax rates wouldn’t change, beginning in 2022 the levy would be based on the current market value of the real estate. Business property values would have to be updated by county assessors at least every three years. Some of California’s most powerful public employee unions — including Service Employees International Union, the California Teachers Assn. and the California Federation of Teachers. They represent those at the forefront of the affordable housing debate in California.

Proponents want to include provisions directing the application of the additional revenue to be derived from the proposed taxing changes. Schools would receive most of the new tax revenue while municipalities also would receive a share of the new property tax revenue. The allocation is not accidental. Initiative supporters see a connection in that public support for the idea of loosening the property tax limits on businesses increases in polls by as much as 10 percentage points if voters are told the money will go to education.

The ballot initiative will be strongly challenged and if on the ballot strongly opposed by the commercial business interests which will be impacted. The California Business Roundtable has promised California Business Roundtable an “aggressive” campaign to kill it. They suggest that the tax will create just another cost to retailers which will be passed onto consumers. The president of the nonpartisan Public Policy Institute of California offers some sage advice for handicapping this one. “Initiative campaigns often focus on the idea of unintended consequences,” he said. “To me, that’s what this is going to be all about. You’re going to hear that from both sides. And the voters will have to decide.”

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

Last week marked the 300th edition of the municreditnews.com. Over the five years of its publication, we have tried to cover the entire range of issues which impact on the creditworthiness of state and local credits. We hope that you find our comments useful and informative. We appreciate your support. Let us know what you want to hear about.

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NORTH CAROLINA BUDGET

It isn’t a state normally in the news for budget trouble but these are not normal times. The North Carolina General Assembly adjourned without passing a biennial budget for fiscal 2019-21. The legislature could not overcome disagreements about teacher pay and Medicaid expansion among other things. The good news is that a full budget is not needed to ensure that things like debt service payments are made. A continuing appropriation and the passage of several standalone measures ensure that those payments will occur.

As a relatively state with historically stable finances, the ongoing budget dispute which played out in the summer did not garner much attention. It does however mark the second time in three bienniums that the state has not managed timely budget adoption. The direct impact on the state actually is most visible in its impact on programmatic implementation. One example is the fact that a planned launch of a  Medicaid managed care plan this month has been   delayed because of the budget impasse

The real losers in the dispute are the counties and localities in the state. Counties with new state funds included in the 2019-21 Appropriations Act may need to delay the start of intended capital projects. Counties could also find themselves under pressure to provide funding to local school districts. Counties routinely supplement the local BOEs’ operating budgets and are required by state law to provide for their capital needs. Local school districts may have to look to the counties to make up funding shortfalls. As a growing state, schools need to expand to keep up with demand. For those counties with already tight finances, school needs dictated by state law could run up against other expense requirements of the counties.

The dispute also comes at a time where the state’s steadily increasing exposure to climate change related capital demands is becoming more evident. The NC Department of Transportation (DOT)  has requested general fund support because of large expenses related to storm damages, including Hurricane Dorian in early September. DOT must also fund  settlements resulting from a state Supreme Court ruling that the DOT cannot reserve land for future roads without paying for the land. Landowners seeking compensation from the DOT have forced the DOT to find some additional funding to cover those costs estimated at up to $360 million.

To fund the settlement and storm related costs, legislation pending in the Legislature recommends transferring $360 million from the state’s general fund to help cover the settlements as well as another $300 million loan from the state’s savings reserve to help with projects delayed by Hurricane Dorian. The transfer of $360 million would equal about 1.5% of general revenue. At the same time, the Legislature passed two bills designed to reduce revenues to the state including a corporate franchise tax cut and increases in the standard deduction for income tax filers. At the same time,  all of the spending bills passed by the legislature to date would result in fiscal 2020 appropriations similar to those in the budget vetoed by the governor, totaling nearly $24 billion.

NEW YORK BUDGET SHORTFALL

A cash report released by NYS Comptroller Tom DiNapoli’s office is a preliminary warning sign that the state budget is under increasing pressure. ​ The source of that pressure is Medicaid spending. New York’s Medicaid program is on track for a $2.9 billion shortfall as the program has already spent more than 60 percent of its state-funded budget by the end of September, about $13.1 billion. That is only five months into the fiscal year.

The problem reflects both budget maneuvering and the realities of higher expenses tied to things like local minimum wage laws which are increasing costs for providers. The budget maneuver which benefitted FY 2019 results came from the Cuomo administration’s decision to delay $1.7 billion in Medicaid payments from the end of the 2018-19 fiscal year to the beginning of 2019-20. The impact was to  effectively double expenditures for April.

Medicaid has been running over budget for at least the past year, which should have triggered across-the-board payment cuts under the state’s “global cap” statute. Pressures from providers (a powerful lobby in the state) drove the maneuver. Now however, it is time to pay the piper. A real answer will not come until the release of the governor’s Executive Budget in January for the FY beginning April 1.

NEVADA HITS RATINGS JACKPOT

Ten years after the Silver State was at the center of the mortgage and financial crisis, the State is finally reaping the benefits of the long economic recovery. Moody’s announced that it has upgraded to Aa1 from Aa2 the rating on the State of Nevada’s approximately $1.2 billion of outstanding general obligation (GO) bonds, which includes all bonds issued by the state described as general obligation (limited tax). Moody’s cited the state’s strong and growing economy as demonstrated by robust employment and population growth and an increase in rainy day reserves. 

By all measures, the state economy has achieved consistently strong growth in both employment and income since the time of the financial crisis. It has a moderate debt and pension burden and favorable demographic trends. The state’s relatively favorable tax burden relative to states like its neighbor California continues to benefit the state and support current economic and employment trends. The significant role of the gaming/tourism industries does continue although the state has managed to attract a more diverse set of businesses attracted by relatively lower costs and the availability of land for distribution facilities for several online retailers. The reliance on the Las Vegas attractions is one potential concern but that would be more based in national trends in the economy rather than any action  by the state.

The only real concerns expressed in support of the rating action revolve around the need to manage the state’s reserves and the potential negative impacts from a prolonged decrease in tourism, reduced visitor spending or severe economic stagnation.

SALES TAXES AS A CREDIT INDICATOR

Historically, sales tax revenue trends have been a great current indicator of overall conditions and likely trends in state revenues. They reflect current activity as they are collected and remitted without much lag time so they can often be the credit equivalent of a canary in a coal mine. So we looked with interest at sales tax revenue trends in Texas.

Texas Comptroller Glenn Hegar has released totals for fiscal 2019 state revenues, in addition to announcing monthly state revenues for August. State sales tax revenue totaled $2.99 billion in August, 4 % more than in August 2018. Total sales tax revenue for the three months ending in August 2019 was up 3.9 percent compared to the same period a year ago. Growth in August state sales tax revenue was led by remittances from the construction, manufacturing and wholesale trade sectors.

The data points to continued positive economic growth even as its energy sector seems to slow a bit. This is reflected in individual category data for August. In August 2019, Texas collected the following revenue from motor vehicle sales and rental taxes — $488.3 million, up 0.3 percent from August 2018; motor fuel taxes — $327.1 million, up 5.7 percent from August 2018; natural gas production taxes — $102.3 million, down 19.2 percent from August 2018; and oil production taxes — $355.5 million, down 6.2 percent from August 2018.

FLOOD FUNDS IN TEXAS

Voters approved a constitutional amendment to provide for a source of funding for flood control projects in the state. Support for such a measure grew out of the state’s experiences after Hurricane Harvey in 2017. The largest city, Houston, saw whole neighborhoods inundated when waters were released onto properties which probably should not have been developed. The much higher number of residential and small community properties which are subject to flooding  from consistently heavier precipitation events created a broad base of support for the plan.

Proposition 8 authorizes the Flood Infrastructure Fund, which seeks to help the state recover from recent flooding while also preparing communities for future storms. It calls for the fund to receive a one-time, $800 million allocation from the state’s rainy day fund as a starting point, and lawmakers could refill it in the future. The author of the measure points to the fact that it creates a lockbox for those funds,” he said. This means future lawmakers can add to the fund, but they cannot drain it for other purposes, even if the money goes unused for multiple years.

The process would provide a source of state funding the use of which would not have to be reauthorized legislatively. This results from the State Legislature meeting only 60 days biennially. This extends the time between an event and the state’s ability to extend funding for projects. It is one of the weaknesses of the state’s legislative structure.

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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STATE OVERSIGHT SUCCESS

On October 24, the Massachusetts Executive Office of Administration and Finance announced that the state will end its financial oversight over the City of Lawrence . After 10 years of oversight, city management projects balanced operations with slight surpluses during fiscal 2020-24. Between 2008and 2011, the city accumulated over $27 million in operating deficits, equal to 10% of annual general fund revenue.  

The City’s financial difficulties led to the appointment of a fiscal overseer in fiscal 2010 as part of special legislation. With a fiscal overseer, Lawrence fell under the second most intense level of state oversight of municipalities in Massachusetts. The fiscal overseer has supervised all financial operations in consultation with the city’s financial management team. The city’s financial challenges before oversight stemmed from weak budget management, including managing financial obligations tied to collective bargaining agreements, combined with limited operating flexibility to absorb state aid cuts.

The special legislation also authorized the issuance of deficit financing notes ($16.4 million outstanding as of 30 June 2019) to cure the accumulated operating deficits from 2008-11. Over the period of supervision, a five-year budget forecast and capital plan were updated annually, as well as formally adopted financial policies

City management’s projected surpluses are modest at less than 1% of the city’s $321 million annual budget. Even with outside supervision, Lawrence faces practical constraints on raising property taxes with a tax base that has a median family income equal to 59% of the US average and a high 24% poverty rate. The city is heavily dependent on state aid, which has grown 3% annually over the past 10 years. Rising costs associated with education, health insurance and pension contributions will continue to exert hard to control pressures on the operating budget. Management projects that annual pension contributions will increase 3.3% annually over the next five years.

State aid represented 70% of fiscal 2018 general fund revenue, with property taxes the second largest revenue source at 20%. Education is the largest expenditure, comprising 62% of fiscal 2018 general fund expenses followed by public safety at 8%.

 Currently, the cities of Lynn (Baa1 stable) and Methuen (A3 negative) are each coordinating with a fiscal stability officer.

HOUSING IN CALIFORNIA

Apple announced a $2.5 billion plan to help address the housing crisis in California. The plan includes $1 billion for an affordable housing investment fund and another $1 billion to help first-time home buyers find mortgages. Facebook said last month that it would give $1 billion in a package of grants, and loans. In June, Google pledged $1 billion for a similar effort in California.

Apple’s plan is not just based on spending. Part of the $2.5 billion figure includes making available land it owns in San Jose, worth $300 million, for new affordable housing; $150 million to support affordable housing in the Bay Area, including long-term forgivable loans and grants; and $50 million to address the causes of homelessness in Silicon Valley.

Will all of this spending really put a dent in the State’s housing shortage? It is hard to say that this will be enough. The issues in California which lead to a housing shortage include issues of land availability relative to jobs, zoning issues which restrict the ability to develop affordable multifamily housing in coordination with transportation policies, and property tax policies which hinder movement. Only by addressing all of these issues in concert will California be able to make meaningful progress in the development of sufficient affordable housing in the state.

SALES TAXES ON THE BALLOT

A good test of the appetite for tax increases occurs in California as a number of localities are asking their voters to approve sales tax increases. In Irwindale, voters will decide on Measure I, a sales tax increase that will push the local rate to 10.25%, the state maximum. The tax increase could translate to an estimated $1.2 million annually and would help fund police protection, 911 emergency response and other public safety initiatives, senior citizen resources, parks, infrastructure and road improvements, transportation, recreation programs, maintaining library services and maintaining programs that create jobs and attract businesses.

In Monrovia, Voters will decide on Measure K, a sales tax increase that will push the local rate to 10.25%, the state maximum. If passed, Monrovia would yield about $4.5 million annually. It would be earmarked for projects that have been on hold. In Sierra Madre, voters will decide on Measure S, a sales tax increase that will push the local rate to 10.25%, the state maximum. Measure S may bring in a $225,000 a year, according to the L.A. County Registrar-Recorder. The potential monies would maintain police patrols, police, fire and paramedic response times, maintain emergency planning and response, maintain for parks, streets, sidewalks and parkway trees, maintain library services, recreation and senior programs and supplement general finances. In South Pasadena, voters will decide on Measure A, a sales tax increase that will push the local rate to 10.25%, the state maximum. The funds, if passed, would be used to maintain 911 emergency response times, focused on home break-ins and thefts, maintain neighborhood, school and park police patrols, fire and paramedic services, fire station operations and emergency preparedness, retain and attract local businesses, maintain streets and infrastructure and maintain general services and city finances.

In terms of property tax increases, in San Marino voters will decide on Measure SM, a parcel tax that is estimated to yield $3.4 million each year until 2025. The money would go for paramedic services, fire protection and prevention and police protection, according to the county registrar. Parcel taxes are a form of property taxes, based on the characteristics of the property — in San Marino’s case, primarily focused on zoning — instead of the value of it.

YONKERS

One of the historically troubled credits in New York State has been the City of Yonkers, located on New York City’s northern border. This proximity to the city has not yielded the benefits one might expect over the last half century. The city’s credit has reflected the decline of its jobs and housing base. It resulted in state oversight and the creation of security mechanisms for the City’s debt. It is this assistance which has maintained the City’s market access.

Now the City hopes to issue just under $100 million of debt. The City is rated A2 with a negative outlook by Moody’s. The credit was assigned a negative outlook. This despite the acknowledgement of a significant number of new multifamily rental and condominium complexes being built around the city’s mass transit centers. Moody’s notes that new high density complexes will bring a significant number of new residents which will increase income tax revenue and likely contribute to growth in sales tax revenue, two major revenue sources for the city. 

Nonetheless, the city’s narrow reserve position, above average long-term liabilities and below average wealth and income profile relative to regional averages weigh on the credit. This is offset to some degree by significant state oversight, including the segregation of funds into a lock box for the payment of debt service. This is a key mechanism which effectively directs first property tax collections to the payment of debt service. Additional security is provided under the New York State Section 99-b Intercept Program. 

The rating on the bonds reflects a quirk in the City’s security provisions. The bonds are secured by a General Obligation pledge as limited by New York State’s legislated Property Tax Cap (Chapter 97 (Part A) of the Laws of the State of New York, 2011) as well as by the city’s pledge of its faith and credit. However, the City’s rating does not get full credit for that pledge as Moody’s considers the current issues and the city’s outstanding debt to be GO Limited Tax because of limitations under New York State law on property tax levy increases. The absence of distinction between the GOLT rating and the Issuer rating reflects the city council’s ability to override the property tax cap and the faith and credit pledge in support of debt service.

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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CITY REVENUE OUTLOOK

The National League of Cities has released the results of its annual survey of City Fiscal Conditions. This year’s City Fiscal Conditions research looked at the fiscal conditions and factors across 500+ U.S. cities. It found that almost two in three finance officers in large cities are predicting a recession as soon as 2020. Cities’ revenue growth stalled in the 2018 fiscal year, but this year’s continued drop indicates mounting pressures on city budgets. The Midwest is bearing the brunt of declining conditions, the report found. Overall general fund revenues in Midwestern cities dipped by 4.4% in fiscal year 2018.

In fiscal year 2018, total constant-dollar general fund revenue growth slowed to 0.6 percent. Income tax and property tax revenues slowed, while sales tax revenue growth was unchanged from the prior year. Property tax revenues grew by 1.8 percent, compared to 2.6 % in FY 2017. Sales tax revenues grew by 1.9 %, compared to 1.8 % in FY 2017. Income tax revenues grew by 0.6 percent, compared to 1.3 percent in FY 2017. expenditures are climbing, increasing by 1.8 percent in fiscal year 2018. While that’s a growth rate is slightly lower than the prior three years, officials also expect it to climb again to 2.3 percent for fiscal year 2019. Infrastructure needs, public safety spending and pension costs are among the most significant expenditures.

The data shows the impact of the continuing decline in manufacturing and the impacts of tax and trade policies and their very detrimental effect on the Midwest. Overall, revenues in Midwestern cities declined 4.4%. Much of that appears to be driven by  large revenue drops   in big cities. Chicago, Illinois, recorded an 11.7 percent revenue decline in fiscal year 2018 while Minneapolis, Minnesota, dropped by 9.6 percent. According to the NLC survey, finance officers from large (63%) and larger mid-sized cities (49%) are more likely than finance officers from smaller mid-sized cities (38%) and small cities (35%) to predict that the next recession will occur in the next one to two years.

The NLC attributes the difference in outlook to a couple of factors. large cities are experiencing a bigger gap between revenue growth and spending growth than their smaller counterparts. Housing market growth is also reaching its peak in large cities and is already slumping in some large West Coast cities such as Seattle, Washington, and San Francisco, California. June home prices for  major West Coast cities fell for the first time since 2012, declining by 1.7 percent. Business investment in 2019 is also on the decline, a metric which tends to hit larger cities first.

The report reiterates the leading pressures on local budgets. Infrastructure needs, public safety needs and pensions were reported as the top three burdens on city budgets in 2019. At the same time, the survey revealed several trends on the revenue side of the credit equation that should give one pause. Sales and income tax growth rates peaked in 2015 and growth rates for property taxes peaked a year later. Another source of concern is the growth of state level preemptions which limit local powers to tax and regulate. For example, this year the Texas state legislature signed into law a bill to cap local property tax revenue growth at 3.5%. In addition to preemptions that have been in place for years in states like Michigan and Colorado, new legislation was passed this year to cap local spending in Iowa, to require elections for tax increases in Texas, and to prevent cities from imposing their own commercial activity taxes in Oregon.

Put all of this together and one begins to ask, at current market conditions do I get paid for the risk I’m taking? It’s not so much a question of whether the market is most effectively pricing municipal debt relative to different asset classes but rather a question of whether current absolute rates generate a sufficient reward for the risk potentially being assumed. It’s clear that the best days for revenue growth have passed while the same pressures  plaguing local budgets have not subsided and in many cases have increased. We don’t propose the end of the world as we know it but we do wonder when the market will wise up and asked to be paid for the risk they take.

NEW YORK MAKES ITS CHOICES

The war on mass transit continues in New York City. The MTA continues to scramble to find funding for projects expanding access in poor neighborhoods (the Second Avenue subway extension to 125th Street), improving accessibility for the disabled and the aging, and maintaining its capital plant in general. The affordable housing crisis continues with the revelation that there are some 110,000 homeless students enrolled in the City’s public schools ( that’s a lot more than the City’s regularly peddled number that there are 60,000 homeless overall in the City). Not to say that the NYCHA is in a bit of a funding pickle for capital themselves.

So what has the City government agreed on for $1.5 billion in spending over a ten year period? 250 miles of protected bike lanes. Lanes by the way which are paid for by some sort of user fee, right? Some form of safety regulation (helmets) or insurance requirement? Some form of revenue generated from the user base (even the farebox covers a much higher % of operating costs than most other US transit systems)? No. None of that. Instead, the City will spend this money which intentionally or not really covers a very specific cohort (white males under say 45) at the expense of other more diverse population cohorts.

In the end, it’s up to the City to do what it wants but it is fair to question the capital priorities especially when there is no connection between use and funding of an asset. It’s one side of the dilemma posed by the advances of various modes of micromobility. Until the issues of funding relative to utilization are more clearly established, issues not directly related to transportation will continue to intrude on the debate over the future of transportation.

CHICAGO BLUES

This is shaping up to be a tough budget season for the City of Chicago. The Mayor’s budget proposal is receiving lukewarm support from a variety of constituencies. Many are expressing concern about the need for the state to take actions in order to allow the City to address its revenue and pension problems. And the teachers strike against the Chicago Public Schools continues. The longer it goes the more vicious the cycle gets as more people will look for permanent alternatives to CPS schools. With each passing day, the district doesn’t get aid based on average daily attendance.

It can be hard to see through the rhetoric of this strike. The union is taking on a variety of issues outside of traditional workplace issues. They are attempting to direct funds from tax increment districts. According to the Chicago Tribune, TIFs now cover about one fourth of the city’s real estate, including some areas downtown. The city can redirect money from TIF districts that isn’t committed to specific projects through a process called declaring a surplus. Mayor Lightfoot has proposed declaring a record $300.2 million TIF surplus in 2020. That’s up from the $175.7 million this year that Emanuel included in his final budget. As the biggest taxing body, CPS stands to collect $163.1 million of the proposed $300.2 million surplus.

We do not take the view that the City is in danger of default. What we do however believe is that investors need to be compensated for the risks they are taking in connection with the direct debt of the City or the schools district. These entities are fortunate that absolute market levels provide reasonable borrowing costs for both new money and refunding purposes. In a market where rates rise and are expected to continue to do so, credits like the City of Chicago and the CPS are in a position to get hammered in terms of spread.

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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MAJOR SYSTEM SETTLES ANTI TRUST CHALLENGES

Sutter Health, a large Northern California nonprofit health care system with 24 hospitals, 34 surgery centers and 5,500 physicians, has announced a preliminary settlement agreement in an antitrust case brought originally by private interests but joined by California’s Office of the Attorney General. Sutter stood accused of violating California’s antitrust laws by using its market power to illegally drive up prices.

The case shone a light on many of the aspects of the issue of healthcare costs – what drives them and how they can be controlled. As systems grow and consolidation continues, many of the same issues raised in this case appear in the evaluation of other mergers. They involve a number of significant interests – the hospitals, insurers, state and federal government – all of whom are positioned to advance their particular interests.

Some aspects of the Northern California marketplace made Sutter a convenient target. The chain of health care facilities had $13 billion in operating revenue in 2018. A University of California, Berkeley study from 2018 found that health care costs in Northern California, where Sutter is dominant, are 20% to 30% higher than in Southern California, even after adjusting for cost of living.

The settlement is expected to address the issue of negotiations between providers and insurers. Sutter is known as an aggressive bargainer but that is true of other large systems across the country. Merger opponents seize on these negotiations as a source of price inflation. In terms of the immediate impact on the Sutter credit, that likely will not be publicly revealed until 1Q 2020. There were estimates that Sutter could have had monetary exposure of up to $2.7 billion according to press reports.

PROVIDENCE SCHOOLS FACE STATE CONTROL

It was recently announced that the State of Rhode Island would take over the operation of the Providence Public School System. The action comes after the release of an outside report produced by Johns Hopkins University (Aa2 stable that highlighted the system’s  significant academic and administrative deficiencies., The state’s takeover, prompted by poor academic outcomes rather than financial difficulty, takes effect November 1 and will continue for at least five years. The school system is a unit of the city, which is responsible for its debt.

Schools are the largest single source of expenditure for the City. It is important to note that this action was not driven by finances. The state education department has sweeping powers to assume budgetary, governance, programmatic and personnel control of chronically underperforming school districts. The state education commissioner is crafting a turnaround plan for the Providence schools and the state is expected  appoint a turnaround superintendent in the coming weeks. PPSD’s board comprises nine members appointed by the Providence mayor and approved by the City Council.

So this is not a credit event for the schools but it could have some benefit for the City’s overall financial position. In fiscal 2018 (ended 30 June 2018), 58% of PPSD revenue was from the state, 31% from local sources and 11% from federal funding. The state presence likely reduces the need for the city to increase its own funding of the school system, including the growing cost of educating English-language learners, which is considerable given the city’s diverse population. The action comes at a time when the City’s finances are still considered to be vulnerable. Moody’s correctly points out that a weak educational system generally has adverse social effects, making a city a less desirable place to live and less attractive to businesses. If the Providence takeover leads to material improvement in school quality, the city’s socioeconomic profile will improve.

The state has controlled the Central Falls School District (CFSD) since 1993, when CFSD was unable to meet financial obligations absent increased state funding.  

PUBLIC POWER IN CALIFORNIA

The role of private utility generation and transmission assets as sources of wildfire risk has focused enormous attention on California’s investor owned utilities. This week, tens of thousands of Californians could be without power again this week as two major utility companies consider shutting off electricity to large swaths of the state amid heightened concerns that hot weather and strong winds could lead to wildfires. PG&E may shut off power in 17 California counties as dangerous winds return. More than 17,000 Southern California Edison customers in five counties — Los Angeles, San Bernardino, Orange, Santa Barbara and Ventura — are also under consideration for power outages in coming days.

One of the city’s without its own integrated public power system is San Jose. In San Jose, somewhere around 60,000 residents went without power for a couple days in the last series of rolling blackouts.  This is motivating support for investigating alternatives to reliance on PG&E in the City. The mayor has announced that he is directing staff to study the feasibility of creating a municipal utility. That would potentially require the city to purchase power lines off of PG&E and to finance construction of microgrids and energy storage systems.

San Jose already buys energy outside of PG&E through its own provider, San Jose Clean Energy. But PG&E controls energy transmission. The mayor is trying to shift the city into increased reliance on solar even though the city also ranks third in the nation for solar power generation per capita. 

The city of Santa Clara has run its own electrical utility for more than a century, offering lower rates and higher ratios of clean energy than PG&E.  San Jose officials plan to poll residents in the fall to gauge public interest in having the city acquire PG&E’s distribution lines and invest in microgrids. If voters say they don’t want San Jose to buy PG&E infrastructure,  the city will push forward on its efforts to develop microgrids.

SF HOUSING BOND

The median home sales price in San Francisco is $1.35 million. The median rent of a one bedroom apartment is $3,700 per month. The City’s affordable housing woes are well documented. The City has previously sought approval for bonding authority to address the crisis as recently as 2015. Now, the City seeks additional authority on the November 5 ballot.

If Proposition A passes, the city would borrow $600 million dollars to construct 2,800 new affordable housing units. Part of the money would go toward repairing existing public housing developments that have become dilapidated. Other parts would finance the building or buying of low income housing. The bonds would be paid from the proceeds of a tax on homeowners in San Francisco at nearly two cents for every hundred dollars in assessed property value. So if your house is worth that median $1.35 million, you’d pay about $256 in additional property taxes a year.

The proceeds would be spent as follows: $150 million for public housing, $220 million for low-income housing, $60 million for middle-income housing and preservation, $150 million for senior housing, and $20 million for educator housing. Another proposition, Prop. E would allow 100 percent affordable and educator housing to be built on public land.

Teacher unions have offered data which shows that 64 percent of its teachers pay more than 30 percent of their income on housing, making them officially rent-burdened, and almost 15 percent spend more than half.  It is a phenomenon which is being replicated in cities across the country, impacting not only but teachers but the vast majority of municipal employees.

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

Publisher’s Note: We took an unanticipated hiatus to deal with some medical issues. We should be back to our weekly publishing schedule. We appreciate your indulgence.

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NEWARK WATER

It did not seem to get as much publicity as one might expect given that it is the state’s largest city but the lead pipe contamination situation facing Newark, NJ is moving towards a resolution. There was rightfully much concern about the potential costs of a remediation for a city which has long faced financial difficulties. It was clear that the cost of remediation would be substantial and that the City would need some outside financial assistance to address the water problem.

So it was very positive to see the news that federal legislation was signed that allows the State of New Jersey  to provide financial assistance to Newark  that would help the city remediate lead in its drinking water, a credit positive. State assistance, combined with $155 million Newark will receive from a settlement with the Port Authority of New York and New Jersey , would be used to service $120 million in debt the city plans to issue for the lead remediation.  The Port Authority settlement will generate $5 million upfront and $5 million per annum for 30 years.

The legislation permits the state to transfer certain federal funds to its drinking water revolving fund to be used for lead remediation. The state has not yet allocated or promised any of these monies to Newark. The $120 million debt issuance will increase Newark’s leverage, though the degree is limited. Debt will increase to 4.8% of fiscal 2019 equalized value or 1.06x 2017 current fund revenue, up from 4% and 0.88x.

The situation has shown that when governments get together to address situations like these, a resolution is possible. The Port Authority’s participation is key. So too is the fact that Essex County, where Newark is located, will be guaranteeing the city’s debt issuance. Because Essex has much stronger credit quality than Newark, the guarantee will help the city cut borrowing costs, which the city and county estimate could save Newark as much as $15 million over the life of the bond.

The situation in Newark has highlighted the significant use of lead piping especially to convey water to individual residences. The Governor has announced a plan to issue $500 million of bonds to pay for some of the costs of removal and replacement of existing lead piping. A proposal for a bond authorization would appear on the November 2020 ballot if such a plan is approved by the Legislature.

JEA PRIVATIZATION

Jacksonville Florida has taken the next step in its effort to divest itself of its integrated utility system. The City received 16 bids from a variety of private utility interests. Information about who the bidders are is not coming from the City which has adopted a somewhat opaque approach to the whole process. The bids were presented in sets of boxes which the City made a show of opening but concealing any details. JEA is using an unusual “invitation to negotiate” process that keeps information under wraps during the evaluation and negotiation stages. After JEA staff announces an intent to award all the records and tape-recordings of the meetings will become public record.

Nonetheless, some of the bidders disclosed their participation in the bidding. NextEra Energy, the parent company of Florida Power & Light, Duke Energy, and Emera, which owns Tampa Electric and Peoples Gas have disclosed that they have bid.  JEA will need to cover costs of eliminating several billion dollars of debt, $400 million in one-time customer rebates, $132 million in pension benefits for employees, $165 million in retention bonuses for JEA workers and a cash payment of at least $3 billion to City Hall. Estimates are that To purchase the entirety of JEA’s electric and water operations, a bidder would need to be able to pay at least in the range of $6.8 billion to $7.3 billion. 

There are arguments on both sides of the issue of the process being used by city officials. The opacity of the process is probably more comfortable for the private entities in the negotiation but it does raise issues of perception. This might raise some unnecessary barriers in the approval process. If the JEA board agrees to do a deal, it would go to the City Council for it to decide if the deal makes sense for city government and the community. The City Council can either approve or reject a deal. Approval would send the terms and conditions to Duval County voters for final say in a voter referendum.

The potential for unnecessary perception issues to arise has not gone unrecognized. The city Inspector General and Ethics Director have expressed their intention to sit in on the negotiations. The city is contacting inspector general offices throughout the country to see what “best practices” they use for such closed-door negotiations.  The Authority intends to decide over the next two weeks which respondents will move to the next stage of entering negotiations with JEA.

CALIFORNIA UPGRADE

Moody’s Investors Service has upgraded to Aa2 from Aa3 the rating on the State of California’s outstanding general obligation (GO) bonds. Here’s their rationale. ” The upgrade of California’s GO bonds to Aa2 incorporates continued expansion of the state’s massive, diverse and dynamic economy and corresponding growth in revenue. The action also recognizes the state government’s disciplined approach to managing revenue growth indicated by its use of surplus funds to build reserves and pay down long-term liabilities. At the upgraded rating, these strengths balance several challenges that will persist. The most significant challenges include high revenue volatility given the state’s heavy reliance on income taxes, lower flexibility to adjust spending and raise revenue compared to other states, and above average leverage and fixed cost burdens. The upgraded rating still reflects certain social challenges relative to other US states. These include a high rate of poverty when accounting for the state’s elevated cost of living, and very expansive public support of the lower income population that would present the state with difficult spending and policy decisions in the event of reduced financial support from the US government.”

Well now we have until the next recession to see if the California credit has become any less exposed to its historic level of volatility, reflecting its income tax dependence on a relatively small percentage of taxpayers at the high end of the income scale. The State still faces awesome capital needs and its increasingly difficult housing market is becoming problematic for the economy. The state also faces issues from federal immigration policies which contribute to reductions in population in certain primarily urban areas. Historically in many cities, immigrants make up for the well documented phenomenon of population movements in search of more affordable housing costs. These, along with pension and climate related costs, weigh on a potentially higher rating.

PR CREDITORS HAVE THEIR DAY AT THE SUPREME COURT

The Supreme Court heard arguments in the challenge to the authority of the PROMESA financial control board. The creditors in this case contend that the board was appointed in violation of the US Constitution. The dispute is over whether the oversight board supervising Puerto Rico’s finances is actually a federal agency whose members must be presidential nominees confirmed by the Senate, or an entity structured by Congress under its authority to administer the U.S. territories. To date, it has operated as a Congressionally structured entity.

Aurelius has a heavyweight counsel representing them before the Court, Ted Olson. That didn’t prevent the justices from challenging the Aurelius arguments. Aurelius has historically taken aggressive stands in other sovereign debt cases. This time, Justice Brett Kavanaugh suggested that if the creditors’ definition of a federal officer requiring Senate confirmation was correct, it could put territorial self-government in jeopardy.

The Board argues that Congress specifically invoked its territorial powers in creating the board, directed it to work in Puerto Rico’s interest and insulated its members from political interference by giving them three-year terms during which they could be removed only for cause. This led to Justice Sotomayor to ask “How you can label this a territorial officer as opposed to a federal officer…when none of the people of Puerto Rico have voted?”

When the federal appeals court in Boston ruled in February that the board’s members were federal officers requiring Senate confirmation. At the same time, it suggested a remedy – the Senate could vote to confirm the members—President Obama’s appointees who, as a backstop, subsequently were nominated by President Trump. That was noted by the Justices who suggested that this could be accomplished quickly, obviating the need to dismantle the board and throw a huge delay into the debt restructuring process.

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.