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Muni Credit News Week of June 17, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$315,065,000*

LANSING BOARD OF WATER AND LIGHT

CITY OF LANSING, MICHIGAN

UTILITY SYSTEM REVENUE BONDS

Moody’s : Aa3 SP: AA-

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

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

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

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

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WE’RE NOT IN KANSAS ANYMORE

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

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

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

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

MANUFACTURING

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

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

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

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

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

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

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

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

NYC JUST KEEPS SPENDING

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

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

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

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

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

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

MEASURING THE IMPACT OF EXPANDED MEDICAID

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

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

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

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

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

Muni Credit News Week of June 10, 2019

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STATE FINANCIAL TRENDS

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Muni Credit News Week of June 3, 2019

Joseph Krist

Publisher

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ALTERNATIVE ENERGY GETS A BOOST

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

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

BALTIMORE HACKING TWIST

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

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

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

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

IT’S A MORAL RATHER THAN A LEGAL OBLIGATION

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

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

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

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

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

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

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

ILLINOIS

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

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

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

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

Muni Credit News Week of May 27, 2019

Joseph Krist

Publisher

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Hopefully, you’re reading this after an enjoyable holiday weekend. Before you do, take a minute to remember someone in your family who may have served our nation but was fortunate enough to come home. Take just a minute, and remember what they were willing to do. For you and me, even if they never knew quite who they were ultimately doing it for. And then enjoy the country they left us in to show our appreciation.

It may also surprise you to know that it only became an official federal holiday in 1971. As a part of the process of creating the holiday, in 1966 the federal government declared Waterloo, New York, the official birthplace of Memorial Day. Waterloo—which first celebrated the day on May 5, 1866—was chosen because it hosted an annual, community-wide event, during which businesses closed and residents decorated the graves of soldiers with flowers and flags.

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BETTER HEALTH IS A CREDIT ISSUE

New research shows states that expanding Medicaid improves the health of women of childbearing age: increasing access to preventive care, reducing adverse health outcomes before, during and after pregnancies, and reducing maternal mortality rates. While more must be done, Medicaid expansion is an important means of addressing persistent racial disparities in maternal health and maternal mortality. Better health for women of childbearing age also means better health for their infants. States that have expanded Medicaid under the Affordable Care Act saw a 50% greater reduction in infant mortality than non-expansion states.

The uninsured rate for women of childbearing age is nearly twice as high in states that have not expanded Medicaid compared to those that have expanded Medicaid (16 % v. 9%). States with the highest uninsured rates for women of childbearing age are: Alabama, Alaska, Florida, Georgia, Idaho, Mississippi, Nevada, North Carolina, Oklahoma, South Carolina, Texas and Wyoming. Ten of these twelve states have not expanded Medicaid.

The research, from the Georgetown University Health Policy Institute, highlights the benefit of Medicaid expansion. Yes, expansion does result in some increased cost to the states but those increases are often more than mitigated by the significant reduction in maternal mortality as well as the lower level of expenditure associated with a healthier start in life.

For hospitals, the arguments in favor of Medicaid expansion are clear. The national rates of decline in the number of uninsured women of childbearing age from 2013-2017 were just under 9%. In states which expanded, all of the states with the exception of Florida saw rates of decline in excess of the national average. And what did all of those states have in common? They expanded Medicaid under the ACA.

THE HOSPITAL PAYMENT DEBATE

RAND Corporation researchers used data from three sources — self-insured employers, state-based all-payer claims databases, and health plans — to assess $13 billion in hospital spending in terms of hospital price levels, variation, and trends from 2015 through 2017 in 25 states. The study yielded results which highlight the many differences between individual markets making generalizations difficult. This has complicated the debate over health insurance.

The primary findings: relative prices varied twofold among states. Some states (Michigan, Pennsylvania, New York, and Kentucky) had relative prices in the range of 150 to 200 percent of Medicare rates; other states (Colorado, Montana, Wisconsin, Maine, Wyoming, and Indiana) had relative prices in the range of 250 to 300-plus percent of Medicare rates. However, eight states — Michigan, New York, Tennessee, Massachusetts, Louisiana, New Hampshire, Montana, and Maine — stand out as exceptions to this general finding, with relative prices that are roughly equal for inpatient and outpatient services.

Transparency by itself is likely insufficient to reduce hospital prices, and employers may need state or federal policy interventions to rebalance negotiating leverage between hospitals and employer health plans. Such interventions could include placing limits on payments for out-of-network hospital care or applying insurance benefit design innovations to target high prices paid to providers and allowing employers to buy into Medicare or another public option that pays providers prices based on Medicare rates.

The hospitals have real concerns around the issue of reimbursements. The data shows that a change to a single payer system would have real negative revenue repercussions for providers. The shift from private to public insurance also would produce a significant cut in hospital costs. We have yet to see robust analyses of the likely impact of a single payer system. The math regarding the issue is not straightforward. A single payer system may increase usage of services. That increased usage could replace some revenues through volume while incurring lower costs for care through reduced chronic illness demand and reduced acuity levels.

Hospitals will be central to the acceptance of any significant change in the US health insurance scheme. Hospitals were a crucial ally in the effort to pass the ACA, and they remain key to ongoing efforts to improve the 2010 health law. At present, the interests of the various hospital subgroups – rural, inner city safety net, for profit – do not converge. So a variety of different stances emerge. More government-funded coverage could actually help safety net hospitals. For the profit-based sector, “A public option for us is a complete nonstarter. We are totally opposed and would fight it.”

Whatever the result, the current environment will allow the debate to linger on well after the 2020 elections.

PENSION PROPOSAL IN ILLINOIS

This legislative session in Illinois is one of the more intriguing ones nationally as the Legislature attempts to deal with the impact of a new governor and his effect on policy. Most of the focus has been on his proposal to shift the state from a flat rate income tax to a graduated income tax and on the legalization of recreational cannabis. This has shifted attention away from other issues of import to investors. One of those issues – pensions. So it is meaningful to see what if anything legislators are willing to risk in making proposals to reduce the liability and shore up the state’s credit.

HJRCA0021 was offered earlier this year to deal with real and imagined legal barriers to real pension reform. The bill would amend the General Provisions Article of the Illinois Constitution. In a provision that specifies that membership in any pension or retirement system of the State, any unit of local government or school district, or any agency or instrumentality thereof shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired, limits the benefits that are not subject to diminishment or impairment to accrued and payable benefits. It also provides that nothing in the provision shall be construed to limit the power of the General Assembly to make changes to future benefit accruals or benefits not yet payable, including for existing members of any public pension or public retirement system.

If ultimately adopted, the change would create a real basis for changing the state’s pension benefit outlook. Removing the constitutional impediment to changes (including those regarding future benefit terms for existing employees) would then eliminate a crutch which has been leaned on by both sides in this issue to explain away the failure to act. While the ability to act does not guarantee that action will occur, the change would nonetheless help to focus attention on the core issues at hand.

CARLESS IN SEATTLE

Seattle has ranked among the top four major U.S. cities in growth for five consecutive years. Since 2010, over 100,000 people have moved here– and more are on the way. Seattle–area jobs are projected to grow 28 % by 2035. This rapid growth will present some challenges, particularly when it comes to traffic and congestion. Recent experiences with the impacts (or lack thereof) of the closing of the Alaska Way viaduct have emboldened proponents of congestion pricing to encourage such fee in Seattle.

The City’s transportation department screened 11 tools based on four preliminary areas of focus (equity, climate and health, traffic congestion, and implementation). That process caused the department to identify four tools: cordon pricing, area pricing, fleet pricing, and a road usage charge.

The department’s report on how it plans to conduct its study of congestion pricing alternatives highlights some of the difficulties in developing reliable data to present to support its plans. Data is limited and largely regional in scale, meaning fine-grained results are not yet possible. It also shows how these plans can be complicated by a desire to address not only transportation issues but larger socio economic concerns. Seattle’s program articulates a number of “social justice” goals which it is much harder to develop data on. For example, the report notes that structuring pricing to reduce the impacts on specific communities of concern, such as low-income households, can make a pricing program more equitable.

The issue is complicated and controversial enough as a simple transit issue but becomes almost unmanageable when implemented as a tool of “social justice” implementation. The City believes that 13% of workers who drive in the region would be affected by a downtown pricing program. The report devotes, for a transportation issue, a significant amount of time discussing race. Under the banner of equity issues, the report unwittingly emphasizes issues which could easily derail support for a plan.

In the City’s own words “Implementing a pricing program is challenging: public support can be expected to rise and fall over the course of public conversation leading up to implementation, and to rise again after the public experiences the benefits of the project. Pricing policies often trigger the phenomenon known as “acceptability decreases with detail.”

The Seattle Transportation Benefit District was established in 2010, and the state authorizing legislation for transportation benefit districts provides the authority to charge vehicle tolls within the boundaries of the district. Tolls may not be imposed without the approval of a majority of the votes in the district voting on a proposition at a general or special election. This would seem to give the public an even larger role than is typical in the imposition of such a system.

PUERTO RICO ATTACKS DEBT HOLDERS AGAIN

The latest legal attempt by Puerto Rico’s Financial Oversight & Management Board (FOMB) to claw back debt service payments on debt issued for the Employee retirement System. The actions filed by the FOMB intend to recover interest and principal from bondholders who own at least $2.5 million worth of bonds that the FOMB said the ERS was “never authorized” to issue to the public in 2008 because the issuance was not submitted to the Legislature.

The FOMB hopes to recover some $392 million in aggregate payments made to bondholders. The $2.5 million threshold for being exposed to the suit clearly establishes that the real effort is to target different classes of pari passu bondholders. It is one thing to issue multiple debt securities backed by clearly delineated sources of repayment. It is another to arbitrarily or otherwise change the rules of the game after you realize you are losing.

The Commonwealth is continuing on a path on which it acts like a bankrupt foreign country. Bankrupt not only economically but also politically. A small concentrated political class, supported by a vast employment network of local government, should know better than to play upon post-hurricane sympathy as an excuse to execute one of the most dishonorable restructuring efforts in the history of this market.

Muni Credit News Week of May 20, 2019

Joseph Krist

Publisher

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TAX INCENTIVES

The extent of the effect varied based on the type of incentive being offered. Research and development tax credits were shown to have the largest negative effect, followed by investment tax credits and property tax abatements. Job training grants were shown to increase a state’s dependence on the federal government for additional funding, whereas job-creation credits were found to have no significant effect on the fiscal health of a state.

The role and value of tax incentives in the economic development process has long been a favorite topic. So we are intrigued by the findings of some North Carolina State University researchers who wanted to see if the granting of financial incentives to encourage the creation, expansion, or relocation of businesses within their borders. The study used data from 32 states (accounting for more than 90 percent of all incentives offered by state governments) for the years 1990 to 2015.

Spoiler alert: “After controlling for the governmental, political, economic, and demographic characteristics of a state, we find that incentives draw resources away from the state. Ultimately, the results show that financial incentives negatively affect the overall fiscal health of a state.” The results of the analysis show that financial incentives negatively impact the overall fiscal health of the states offering the incentives.

The question is why? Tax incentives, for example, limit the revenue available for a government to collect, while also requiring additional expenditures to meet the increased demand for public services that come with economic expansion.

The research also generated some findings about state financial health in general. One of the areas of interest was the relationship between tax policies and the state/federal relationship. “States that have a Democratic majority in their legislature are healthier than their Republic majority counterparts… Specifically, legislatures that have a Democratic majority have a lower dependence on the federal government by 3.5% and a 48.0% lower debt ratio.

DISCLOSURE

It was almost amusing to see that the Government Finance Officers Association (GFOA) is upset with the tone of the latest effort by the municipal analyst community to get municipal issuers to accept disclosure requirements. It has been nearly 45 years since the Tower Amendment was passed. This effectively was taken as a thumbs up for issuers to come to market with only the most minimal disclosure requirements. Since then, the need for better, faster, and more detailed disclosure has never been clearer. Just ask those investors burnt by Puerto Rico’s almost comical lack of disclosure and accountability.

It has become a rule of thumb that whenever a GFOA officer or representative appears before an analyst gathering and the subject of disclosure comes up, that the GFOA rep will make an impassioned case against disclosure. Disclosure apparently prevents children from receiving a good education, citizens from receiving proper public safety protection, and will cause grass to grow in the cracks of the unrepaired pavement of city streets. Yes disclosure costs money but there are alternatives for borrowers who can’t or will not disclose. Finance your needs through bank loans. Some of your compatriots do it and they do not apparently have to disclose the existence of what is potentially a parity obligation with that securing holders of an entity’s public debt.

I do not know of another public debt market which permits different classes of borrower to meet widely divergent standards of disclosure. Yes we have many small borrowers in the municipal market and yes compliance and disclosure is a cost but that is true for many small corporate borrowers as well. That is why there is a significant bank lending role in the corporate market. And that is where small corporate borrowers finance their capital needs.

So now the small municipal borrowers are offended. Well, the refusal to act like serious professional entities could be construed as offensive, a tone which lenders might have trouble with. And perhaps the borrower/issuer community could give this some thought. The analysts have rightly called for more and better disclosure. Would the small issuer community rather be shut out of the market altogether? Would it prefer to have a narrower market for its needs rather than a larger, more diverse, and probably cheaper source of financing?

And here is where we get to take some blame. No matter how much we complain, cajole, or beg the buy side always caves in. The pressure to keep fully invested seems to have always outweighed the logic of having the best information possible to support our investment decisions. The litany of municipal defaults which occurred against a backdrop of insufficient disclosure is well known – Cleveland, WPPSS, Detroit, and Puerto Rico. And every time one of these events rocks our market there is lots of righteous indignation but ultimately market access is granted in a relatively short period of time.

All of those defaults were accompanied by shoddy disclosure which supported questionable practices. In the end however, the price to be paid for those defaults was nothing close to the value of the losses incurred. In that sense, the market has failed. None of these examples are small borrowers. They were each substantial entities, each of whom should have been in a position to provide basic and timely information. Yet they were able to borrow because the buyers allowed them to.

The GFOA has always been in a position of obstruction of real serious logical evolution of municipal disclosure. What they have never been able to sufficiently address is the point that they are government officials which means that everything they do is public business. A government entity is a public entity therefore everything that entity does is public. It’s not that the information needed to meet disclosure is unavailable. It’s that the issuers are unwilling to assemble it or provide access to it.

So in the face of long standing intransigence and opposition, where else was the market supposed to turn? It was Congress under the Tower Amendment that set the legal standards contributing to this mess and it is likely Congress that will have to act to undo the damage. Going forward, a broad market based on good consistent and timely information will be key to addressing the nation’s infrastructure needs. Our market will need to expand its base and its horizons if we want it to play a central role in that process.

Clinging to outdated and parochial notions about how borrowers interact with the market will only hurt those communities most in need of the financing capacity and abilities. That will require a change in mindset on the part of borrowers. But it also must be followed by legislative support at the state level.

The existing codified reporting structures and requirements are clearly in need of updates (that’s you New Jersey, e.g.). So long as local finance officers are required to develop and maintain reports conforming to state law requirements, our hopes for disclosure that is meaningful and usable will continue to be seen as simply and extra and unneeded expense.

Absent these changes, the National Federation of Municipal Analysts is more than right to seek SEC involvement. The issuers can complain but when they wind up with much more onerous disclosure requirements than currently exist in order to gain access to the public debt markets, they will have no one to blame but themselves.

AND ANOTHER THING

The SEC has announced a settlement with a municipal bond advisory firm. Clear Scope Advisors Inc. agreed to pay more than $25,000 to settle charges the firm violated the federal securities laws and MSRB Rules G-2 and G-3 by not having its advisors properly qualified. Clear Scope provided municipal advisory services to two issuers without having any municipal advisor professionals who took and passed the Series 50, according to the SEC. The MSRB sent reminders to firms to take the Series 50 exam, which became required on Sept. 12, 2017. All municipal advisors have to pass the test before engaging in municipal advisory activities on behalf of a municipal advisory firm.

Situations like this usually stem from some action by an advisor that hurts an issuer. Interestingly, The MSRB notes that it maintains a list of advisors who have met SEC requirements. The MSRB has been trying to direct issuers to its website to see if their municipal advisor is qualified. As the MSRB Chief Compliance Officer notes, “You can’t stop people who don’t want to follow the rules. They will always be out there, but I’m trying to get issuers to start looking at our website because it’s listed there.” Clear Scope Advisors was not listed on the site because it did not have at least one qualified person.

As for the issuer “victims”? Looking at a website requires no significant expertise, staff, or financial resources. Unlike disclosure, there really is no excuse for not exercising due diligence regarding the people advising you.

INFRASTRUCTURE ANNIVERSARY

Amidst all of the debate and angst over the state of the nation’s transportation infrastructure, an important anniversary passed recently. May 11 was the 150th Anniversary of the Golden Spike Ceremony, marking the completion of the first American Transcontinental Railroad. Within three years of this event, trains could travel from New York City to San Francisco in just one week. Prior to the completion of the railroad, travelers spent up to six arduous months traveling by ship or covered wagon, often enduring great dangers at great cost.

Projects like the Transcontinental Railroad were an early form of public private partnership. The federal government provided land to the railroads who then undertook the financing and funding and construction of the railroad. Now there were many aspects of the process that were highly troubling in the light of history in terms of the sourcing and use of labor. Frankly, those practices were unacceptable. Today, structures exist to better protect workers and outlaw the exploitation of them as was the case with the Transcontinental Railroad.

All of the positive aspects of such a project could easily translate into a workable P3 concept for financing public capital facilities. Land use regulation, a current regulatory framework, and a financing capability are bought to the table by government. The actual physical execution of the project, its management, and operation are easily within the province of the private sector.

Muni Credit News Week of May 13, 2019

Joseph Krist

Publisher

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CALIFORNIA BUDGET REVISION

California Governor Gavin Newsome released his revised budget proposal. The May Revision reflects the following changes: it now includes a portion of the Proposition 98 settle-up that was not reflected in the Budget. This marks the first time in over a decade that all budgetary debts are completely paid off. An additional $1.2 billion deposit into the Rainy Day Fund brings the reserve to $16.5 billion in 2019-20. The Rainy Day Fund is now expected to reach its constitutional cap of 10 percent of General Fund Revenues in 2020-21—two years earlier than predicted in January. By the end of 2022-23, the Rainy Day Fund balance is projected to be $18.7 billion. In addition, for the first time, $389 million in Proposition 98 funding is reserved in the Public School System Stabilization Account. This transfer is required by Proposition 2.

The total budget for the year is proposed at $219 billion of which $150 billion is in the General Fund. Overall, revenues are projected to increase by some 3.1%. The budget remains subject to California’s continued reliance on the income tax, especially at the higher end of the income spectrum. Personal income taxes are estimated at $102 billion. Education remains a high priority. The May Revision includes total funding of $101.8 billion ($58.9 billion General Fund and $42.9 billion other funds) for all K-12 education programs. Some of that is driven by Proposition 98 requirements imposed by the voters. Total K-14 Proposition 98 funding at May Revision is $75.6 billion in 2017-18, $78.1 billion in 2018-19, and $81.1 billion in 2019-20.

On pensions, another area of concern to investors, The Governor’s Budget proposed funding to reduce employer contributions to CalSTRS from 18.13 percent to 17.1 percent in 2019-20, based on current assumptions. The May Revision adds $150 million one-time non-Proposition 98 General Fund to reduce the employer contribution rate to 16.7 percent in 2019-20.

Recent negotiations with teachers in Los Angeles highlighted many issues confronting education funding in the state. Those concerns are reflected in this proposal. In addition to providing money, the budget also reflects the current tide running against charter schools in the state. The budget would require charters to abide by new requirements including prohibiting charter schools from discouraging students from enrolling in a charter school or encouraging students to disenroll from a charter school on the basis of academic performance or student characteristic, such as special education status. It would also prohibit charter schools from requesting a pupil’s academic records or requiring that a pupil’s records be submitted to the charter school prior to enrollment.

FLORIDA TOLL ROAD POLITICAL BACKUP

The Florida Legislature approved a bill which would set up a new organization called the Greater Miami Expressway Agency to replace the Miami-Dade Expressway Authority (MDX) It would freeze toll rates until 2029. Current MDX members would be blocked from serving on the new agency. The law responds to political pressures which stem from a view that too much of the Authority’s toll revenue does not benefit county residents.

The bill would replace the MDX on July 1 with a new toll agency with a similar governing structure and the same toll rates. Provisions call for a 10-year freeze on tolls, but allow the board of the new Greater Miami Expressway Agency to overrule that rule with super-majority votes. Other changes in the bill include a 25% rebate for Miami-Dade County residents who utilize the toll system frequently. Once a Miami-Dade SunPass holder incurs $12.50 in tolls each month, they become eligible for the rebate. MDX officials have already indicated they will file a lawsuit challenging the legislation.

MDX calls the bill an unconstitutional unwinding of a 1996 agreement creating the agency, when it paid $91 million for the five former state expressways that make up its toll system. Along with the 112 and the 836 (the Dolphin), the MDX expressways include the Don Shula, the Gratigny and the Snapper Creek. The Authority became less popular in 2014 when it ended toll-free stretches along its busiest expressway, the 836, and one to the north, the 112.

The mechanics of the bill which allegedly protect the interests of the Authority’s holders of outstanding debt are overwhelmed by the politics behind the move. Simply reconstituting the board without addressing its pressing debt needs more resembles meddling than oversight. The S&P move to downgrade the Authority’s debt reflects real concerns about the willingness of a new board to adjust tolls appropriately given the politics behind the move.

STADIUM GAMES

For their time, the Oakland A’s had the coolest uniforms but the worst stadium in Major League Baseball (MLB). Their finances, along with those of the City of Oakland, have not always been the healthiest. This has hindered any plan for a new stadium. Effectively, the A’s have been searching for a new home for some two decades.

Now the City through the Port of Oakland appears ready to sign a four-year term sheet to lease the Howard Terminal waterfront property to the team for construction of a new waterfront ballpark. The A’s will pay the Port $100,000 for the right to continue negotiations over the purchase of the 50-acre property located west of Jack London Square. The team hopes to build a 35,000-seat ballpark on the site that also includes 3,000 housing units and retail.

Under terms of the agreement, the A’s would pay an additional $150,000 to the Port if a deal is not consummated after one year; $200,000 after two years; and $250,000 after three years. Legislation that would help the City of Oakland finance infrastructure and transportation projects for the ballpark was approved by the State Senate on a 34-0 vote. The bill would allow Oakland to create an infrastructure financing district. Funding of the actual stadium is expected to be privately financed. A portion of any tax increment revenue generated would be allocated to the Oakland School District which helped to blunt opposition to the legislation.

In a reverse of the Oakland situation, the Village of Bridgeview, IL approved a memorandum of understanding with the Chicago Fire of Major League Soccer to end the team’s lease. Ending the lease would free the club to move back to Chicago and most likely Soldier Field. The Fire are expected to pay $60.5 million to leave SeatGeek Stadium. The lease runs through 2036.

The Fire will pay Bridgeview $60.5 million over 15 years — $10 million of it upfront . A team in the women’s professional soccer league will still play at the Bridgeview venue. The funds will be used to pay down the debt service remaining on the venue, and avoid raising property taxes. Bridgeview sold $134.6 million of bonds in 2005 to finance the project. But development in the area — and the projected revenues — failed to materialize creating a financial burden for the Village.

PORTS GETTING INFRASTRUCTURE HELP?

The House Transportation and Infrastructure Committee was scheduled to approve the “Full Utilization of the Harbor Maintenance Trust Fund Act,” H.R. 2396. It is designed to unlock federal money collected in the fund, which currently has a $9.3 billion balance. The fund is backed by a tax of 0.125% on the value of commercial cargo loaded at federally funded ports.

Harbor maintenance funds have previously been used to offset the federal deficit rather than being spent on actual port projects. The bill would enable spending of $34 billion over the next 10 years by making it easier for Congress to appropriate both the trust fund’s current balance and new revenue collected during the next decade. That would enable the Army Corps of Engineers to address a $20.5 billion backlog in harbor dredging projects, as well as other needed navigation work.

THE COST OF NATURAL DISASTER

“At a time of constrained budgets, it is fiscally prudent to understand the amount and the scope of the Federal Government’s involvement in providing disaster-related assistance to communities in need. The Federal Government does not provide a single, publicly available estimate of the amount it is spending on disaster-related assistance. Because recovery is a long-term process, providing disaster-related assistance requires significant Federal resources to support a multi-agency, multi-year restoration of infrastructure and commerce in affected communities.”

“Understanding the expenditures of individual Federal agencies for disaster-related assistance will help better inform the congressional appropriations process, as well as presidential budget requests. (5) Knowledge about disaster-related expenses will illustrate opportunities for reducing these expenses through efforts to reduce vulnerabilities to future natural disasters. Disaster-related assistance encompasses Federal obligations related to disaster response, recovery, and mitigation efforts, as well as administrative costs associated with these activities.”

It is one of the great frustrations of a municipal bond analysts life that there is so little coherent data available against which to test one’s assumptions. Much of it is proprietary and subject to the whims of finance officers. This stuff is public information which in any normal decision making process should be available to all stakeholders. Better information leads to better results.

ANOTHER NUKE BITES THE DUST

Exelon Corp. said it will close Three Mile Island Nuclear Generating Station in September. Efforts to obtain what were effectively government subsidies to support plant economics for the plant are falling short. A pair of bills that would have helped nuclear by allowing facilities to qualify for Pennsylvania’s alternative energy standard. Climate concerns in part drove the NYS legislature to approve operating subsidies for non- carbon emitting nuclear plants.

Following the Sept. 30 end date, the TMI site will begin its decommissioning phase. The utility has already filed a decommissioning plan with the Nuclear Regulatory Commission, which entails a cooling period during which the site will sit mothballed for nearly 50 years as some of the radioactivity wears out. Known as SAFSTOR, the decommissioning strategy will delay teardown of the plant until 2074.

RESILIENCE – A CREDIT ISSUE

One of the leading federal voices calling for resiliency projects and funding has been the Department of defense (DOD). DOD has previously identified 79 bases on its “mission assurance priority installation” list. Congress sought additional and more granular data including the 10 most at risk facilities for each service. Now the Air Force has produced such a list.

Southern California’s Vandenberg Air Force Base takes the top spot while Florida bases take up six spots on the new list. The other three spots went to bases located in Virginia, Delaware and South Carolina. The most endangered Navy base was Naval Air Station at Key West, Florida, and the most endangered Army base is Fort Hood in Texas.

The risks projected to stem from climate change were flooding, drought, desertification and wildfires. Declining permafrost is an issue for maintaining and siting training facilities. The inability to fully utilize facilities diminishes their attractiveness and reduces the resources put into the facilities and their surrounding communities.

HOW PUERTO RICO IMPACTS THE MARKET (THE WRONG WAY)

The uproar over the decision of the Court overseeing Puerto Rico’s financial restructuring is beginning to cast its ripple effect across the revenue bond market. In light of the decision allowing the Commonwealth of Puerto Rico to apply PR Highway Authority revenues to pay direct Commonwealth debt instead of highway bond debt, investors are reevaluating the legal strength of the pledges securing their bonds from other issuers.

The credit agencies have taken notice as well. Moody’s Investors Service has placed the Aa3 rating of the Illinois State Toll Highway Authority (ISTHA) under review for downgrade. ISTHA has approximately $6.1 billion of bonds outstanding. Moody’s specifically cited the decision. “The rating action is driven by the recent US Court of Appeals for the 1st Circuit ruling related to the Puerto Rico Highways and Transportation Authority (PRHTA) bonds, which calls into question the strength of credit separations between a general government and its enterprises and component units. The review will consider economic, governance, and financial interdependencies between ISTHA and the State of Illinois (Baa3 Stable) and the extent that, in light of the afore-mentioned court ruling, and such interdependencies pose risks to ISTHA that could have an impact on its credit quality.”

It makes sense that an entity similar in construct to PRHTA in the weakest state financially should come under this scrutiny. At the same time, we view the Puerto Rico situation to be somewhat unique. The politics of the island are not comparable, there are cultural issues contributing to intransigence, and there are risks associated with being in the hurricane zone which do not necessarily translate when comparing situations and credits.

Nevertheless, Puerto Rico does not exist in a vacuum so what happens in Puerto Rico does not necessarily stay in Puerto Rico. What does translate is that economics always matter. At the end of the day, economically sustainable fiscal and borrowing policies will always be more important than politics or legal protections. Legals do not matter when a project is not economically viable.

Muni Credit News Week of May 6, 2018

Joseph Krist

Publisher

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PENSIONS CLAIM ANOTHER RATING

Birmingham, AL became the latest casualty of the pension wars. Moody’s announced both a downgrade of the City’s GO rating but also continued placement on negative outlook. The downgrade of the issuer rating to Aa3 reflects continued growth of the city’s pension liabilities, primarily the result of the repeated annual underfunding of pensions. The Aa3 rating also takes into consideration a diverse and regionally significant economy located in central Alabama as well as a stable financial position marked by healthy reserve levels. Debt levels are moderately above-average but remain affordable given the lack of near-term debt plans and ongoing tax base growth.

The city of Birmingham is located in Jefferson County (A3 stable) and is the largest city in the state of Alabama with an estimated population of 212,265 (2017 American Community Survey). It faces a continuing and significant pension underfunding situation. The negative outlook reflects the expectation that the city will be challenged over the near-term to adequately fund its pension liability. The negative outlook reflects the expectation that the city will be challenged over the near-term to adequately fund its pension liability. That is a nice way of saying that the City was not able to articulate a plan to fund pensions.

ENERGY NORTHWEST RATING POWER DIMMED

This week Moody’s announced that it had changed the outlook for BPA and for all BPA supported obligations to negative from stable. The explanation was fairly extensive.

“The change in BPA ‘s rating outlook to negative from stable reflects the steady erosion of BPA’s internal and external liquidity since 2015, which we expect will continue through the new FY2020-2021 rate period, and BPA’s intent to further extend the Energy Northwest nuclear debt beyond the scope of the current “Regional Cooperation” program. Over the last three years, BPA’s liquidity has steadily declined to 89 days cash on hand at FY2018 compared to an average of 135 days cash on hand from FY2013-FY2015. Looking forward, we expect continued deterioration of this metric trending towards BPA’s minimum objective of 60 days cash on hand although the extent and timing of the decline will likely be affected by wholesale market prices and hydrology conditions. We further note that BPA’s availability under its US Treasury line has declined by over $1 billion since 2015 on an adjusted net basis (netting out deferred borrowing) and BPA’s FY2020-2021 proposed rates incorporate further availability declines possibly below the $1.5 billion quantitative threshold previously outlined in past research for consideration of a downward rating action.”

The continuing pressure on rates is not surprising. politically, raising rates is difficult in the best of times but many rural ratepayers in Washington have limited capacity to absorb increases. In addition, federal policies are designed to pay off the direct federal investment in BPA faster than the investment provided by investors in bonds like those issued by Entergy. Moody’s cites the fact that “the continued extension of non-federal debt in exchange for the accelerated payment of debt owed to the federal government that effectively undermines the de facto subordination of federal debt to non-federal debt. Since 2013, BPA has accelerated the repayment of a net $2.5 billion of subordinated, federal appropriations debt while extending maturing debt on the ENW’s nuclear projects. On the look forward basis, we expect BPA will continue to extend the ENW debt as part of a broader plan to prevent an even greater depletion of the US Treasury line availability than currently expected.”

CHICAGO HOSPITAL DRAMA (NOT THE ONE ON TV)

It isn’t a rural hospital but it is a facility which shares many characteristics which have led to financial pressures for those providers. Westlake Hospital is a community facility with 230 beds which serves the village of Melrose Park in suburban Chicago. It was sold to an out of state private operator. It now loses $2 million a month and the owners cite the need for some $30 million of capital investment. From that standpoint, the numbers don’t bode well for continued operation.

The owners sought approval from the state to close the hospital. A decision in favor of closing had been the subject of a temporary injunction keeping the hospital open. That injunction was only in effect until the state board made its decision. Now that a decision has been rendered, the injunction is likely to be lifted. The Village of Melrose Park is considering an appeal. It will continue litigation against the owner for fraud but that litigation does not involve keeping the hospital open.

The fact is that community hospitals within reasonable proximity to teaching/research hospitals like the large urban facilities are going to be hard pressed to compete. Westlake has this locational disadvantage with the added burden of a large cohort of government pay patients. The hospital can then only compete on the basis of cost efficiency which a facility with a service area profile like this one (poorer, older, less mobile) has a harder time with. As mobility options develop and expand, the locational disadvantage would only worsen.

TRANSIT FUNDING

The Minnesota House passed a Democratic-backed transportation budget bill Monday night that includes the Governor’s proposal to increase the state’s gasoline tax by 20 cents per gallon to pay for road and bridge projects. The proposal would raise the gas tax by a nickel per year for four years for a 70% total increase from the current tax of 28.5 cents per gallon. The proposal is at the center of the state’s transportation debate.

On the local level, the bill would also raise the sales tax in the Twin Cities metropolitan area by a half-cent to generate more money for public transportation. And it would raise vehicle registration fees. The overall debate is emerging as one based on populism with the impact on the less well off and rural residents at the center of opposition to transportation financing.

In Illinois, there are multiple transit funding bills pending. One would raise the gas tax from 19 cents to 38 cents, along with raising automobile registration fees, including those for electric cars. The state “lock box” amendment for motor fuel tax which permits its use only for safety of roads and bridges is a part of this bill. Another would increase the gas tax even further while phasing out the sales tax on motor fuel among other wide-ranging changes.

THE US TERRITORIAL RELIEF ACT

This legislation would give U.S. territories like Puerto Rico the option to terminate their debt if they meet certain criteria, like being struck by a disaster, suffering major population loss, and staggering under overwhelming debt. In reintroducing the bill, Senator Elizabeth Warren made sure to say that debt held by bond insurers and “Wall Street” would not be paid.

The bill, originally introduced last year, establishes a Puerto Rico Debt Restructuring Compensation Fund. It provides federal funds to compensate eligible unsecured creditors, to be allocated by a special master. It allocates $7.5 billion for Puerto Rican creditors whose debt was terminated, including Puerto Rican residents, banks and credit unions that did business solely in Puerto Rico, the island’s unions and public pension plans, and businesses with a principal place of business in Puerto Rico.

It allocates $7.5 billion for mainland creditors whose debt was terminated, including individual investors, trade unions, pension plans, and open-end mutual funds that pledge to waive the manager’s fee for any compensation received. It also excludes hedge funds and their investors, bond insurers, many financial firms with consolidated assets greater than $2 billion, and repo or swaps investors from the distribution.

The U.S. Territorial Relief Act gives territories the option to terminate their non-pension debt obligations if they meet certain stringent eligibility criteria. If Puerto Rico chooses to terminate its debt load within three years of the bill’s enactment, the bill makes $15 billion in federal funds available to Puerto Rican residents and other creditors whose holdings were terminated. This is the closest we have seen a proposal come to any portion of a “federal put”. The theory that the federal government would never let Puerto Rico debt holders go unpaid was always a selling point of the less scrupulous set of investment advisors and brokers who sold Puerto Rico bonds and funds to retail investors. The aspect of federal reimbursement of losses based on investor class status should be troubling.

PUERTO RICO LITIGATION TURNS AGAINST THE BANKS

It is not clear, other than the voiding of $9 billion of debt, what the strategic goal of Puerto Rico’s latest legal gambit. The Financial Oversight and Management Board for Puerto Rico filed complaints to recover more than $1 billion from holders of bonds issued in excess of Puerto Rico’s constitutional debt limit, and from firms and advisers that helped with the issuance of those bonds. The entities sued include Barclays Capital, BofA Securities, Merrill Lynch Capital Services Inc., Citigroup Inc., Goldman Sachs, J.P. Morgan Chase & Co., Jefferies Group LLC, Mesirow Financial Inc., Morgan Stanley, Ramírez & Co., RBC Capital Markets, Santander Securities, UBS Financial Services Inc. of Puerto Rico, VAB Financial, BMO Capital Markets, Raymond James, Scotia MSD, and TCM Capital.

Claims were also filed against ANB Bank, Jefferies and Bank LLC, Northern Trust Company/OCH-ZIFF Capital Management, Union Bank and Union Bank Trust Co., Bank of New York Mellon, and First Southwest Co. The Board also listed the law firm of Sidley Austin LLP of Chicago as a defendant.

The lawsuit has some aspects of a drive by hit with a spray of legal gunfire being unleashed on just about everyone who helped Puerto Rico issue debt. It begs the question of how suing this group will do anything to help Puerto Rico in the future. If the defendants decide that doing business with the Commonwealth is a bad idea, who will facilitate the financing of the island’s significant capital needs?

The fiscal panel also filed several hundred complaints against entities to recover payments they received on account of “invalid” bonds. The board said it intends to proceed with the clawback litigation against large bondholders who own at least $2.5 million worth of the bonds that are being challenged in the U.S. District Court for the District of Puerto Rico. At the same time it acknowledges that “Bondholders may have relied on information provided by the issuers, underwriters, and other professionals and lenders when they invested in the bonds.”

So the lawsuit is filed on behalf of, among others, the Commonwealth which the suit lists as a potential source of information and assurances as to the legitimacy of the debt. Does that put the Commonwealth in the position of having fraudulently issued the debt? Did it make false and/or misleading representations?

One example cited in the suit are bonds issued by Puerto Rico’s Public Buildings Authority to build and maintain public schools were to be repaid by rental payments on the buildings. So the Board’s position is that any debt funded by a general fund expenditure is actually a general obligation? Most investors knew the difference and so did the Commonwealth. Now some did ultimately look at this debt as a GO but the language in the offering documents was pretty clear.

The precedent which would be established by success would have far reaching effects throughout the market. It would be a real negative for the finance of public capital facilities if the Board succeeds.

IS ANOTHER CALIFORNIA CITY IN TROUBLE?

The city manager of Oxnard, CA has informed nearly 1,900 employees that some of their jobs will be eliminated as the City faces increasing pressure to balance its budget. Pension costs and spikes in health care are some of the reasons for the budget shortfall. Projected expenditures are approximately $10 million more than anticipated revenue.

Last year, the city closed a $7 million shortfall mostly be eliminating vacant positions and other cutbacks. While these costs are undeniably rising, they were not unanticipated. At the same time, the current position of the City reflects a legacy of shortsighted decisions. As the mayor said, “We’re making decisions that should have been made 10, 20 years ago to put the city on a sustainable path. These are very painful cuts, but we have to live within our means. The city historically has not lived within our means.”

In a nutshell, the situation illustrates the realities facing many local credits. The employee beneficiaries are usually a convenient target but the fact of the matter is that pensions and other costs of employees are the product of negotiations between two sides. We expect that the usual debate over the City’s problems will ensue with employees pressured to give up benefits while legislators do everything they can to cover for historical shortsightedness.

The song remains the same.

POLITICS WILL LIKELY SINK INFRASTRUCTURE PLAN

The President and the democratic leadership of the Congress have agreed on a spending goal to support an “infrastructure” package at the federal level. Republicans say they are against raising taxes to pay for an infrastructure initiative. The senate majority whip noted “If we’re going to do infrastructure, I think we ought to pay for it. I don’t think we ought to put it on the debt. I think $2 trillion is really ambitious. If you do a 35-cent increase in the gas tax, for example, indexed for inflation, it gets you only half a trillion.”

Some GOP lawmakers have since raised concerns that funding a wide array of projects ranging from roads to railroads to airports, broadband and power grids, could deplete money available for the upcoming Highway Trust Fund reauthorization, which they want to pass this year. So the issue is, is the problem infrastructure itself or is it a question of the price tag? The Senate leadership is already coalescing around a $1 trillion plan. That would assume that with a gas tax increase (or vehicle mileage tax) only a half a trillion gap would need to be “paid for”.

There were positives and negatives to emerge from the initial discussions. Trump agreed the old 20-80 [federal-private split in funding] was much too low and that he doesn’t like these private-public partnerships. Once again, such a stance places the states and localities at the forefront of innovation in the production of capital projects. It is at that level that we are seeing the most ambitious use of and experimentation with concepts like public-private partnerships.

Muni Credit News Week of April 29, 2019

Joseph Krist

Publisher

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TEXAS HIGH SPEED RAIL UNDER LEGISLATIVE ASSAULT

The Texas Central Railroad would provide high speed rail service on a route covering a 240-mile stretch of mostly rural land sandwiched between the urban hubs of Dallas and Houston. The project is being privately financed. Its owners have gone out of their way to emphasize its private character. Nonetheless, the project is of interest to the municipal bond space. The resolution of its efforts to secure right of way will be a good indicator of whether high speed rail can be produced privately.

Rural landowners and their supporters say the project would unfairly strip land from private property owners for a project that could easily fail. It is primarily legislators from districts in those areas who are leading the legislation against the train. One proposed measure would prevent a company from surveying land for a high-speed rail project until it has all the necessary funding for construction. Another would prevent state agencies from issuing permits or negotiating rights-of-way with a high-speed rail company unless they’ve received what bullet train supporters have called an “alphabet soup” of all necessary federal approvals and permits.

The point of interest is to see how these issues are resolved in terms of whether the politics of high speed rail are effectively prohibitive. If a privately financed venture in a pro-business state like Texas cannot succeed, where can it? If it cannot, then public financing will be the only route for high speed rail. That would likely be its death knell as the support for public subsidies seems lacking.

PUERTO RICO

The U.S. House Committee on Natural Resources has scheduled a hearing for May 2 titled “The Status of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA): Lessons Learned Three Years Later.” It is likely that the hearing will be designed to highlight complaints over the actions taken by the Board reduce government spending, often affecting essential services the government provides to residents. The committee chair has expressed the view that potential amendments to the statute, created to oversee the fiscal policies of the elected government of Puerto Rico, that would allow for a “less oppressive” law be considered.

One of the hallmarks of Congressional involvement in the Puerto Rico debt crisis has been the politicization of the issue of Puerto Rico. This is true regardless of the change in the majority in the House. The unpopular board is being questioned in the midst of the unfolding legal process surrounding a ruling that declared the Financial Oversight and Management Board unconstitutional because its members were not confirmed by the U.S. Senate.

The whole process reflects Puerto Rico’s unfortunate role of being stuck in the middle between the partisan factions in Congress. None of it is helpful to any of the stakeholders involved in the process of dealing with the Commonwealth’s debt and still damaged economic realities.

AV TIDE RECEDES A BIT

The assumption of so many is that the technology wave is an unstoppable tsunami. Then every once in a while we get news that should cause one to step back. One example is the recent announcement that Toyota Motor Corp said it was halting plans to install Dedicated Short-Range Communications technology on U.S. vehicles aimed at letting cars and trucks communicate with one another to avoid collisions. Toyota announced plans in April 2018 to begin the installation of DSRC technology in 2021 “with the goal of adoption across most of its lineup by the mid-2020s.”

The move reflects the fact that “unfortunately we have not seen significant production commitments from other automakers.” One of the recurring issues to hold up momentum for adoption of AV is the lack of regulatory guidance. Without the establishment of standards for AV development and implementation, it will be impossible for infrastructure providers to respond to technological change as it relates to transportation.

Use a DSRC system or use a 4G- or 5G-based system? With questions as basic as this outstanding, how are municipal infrastructure providers supposed to adapt roads and systems to meet the needs of these emerging technology? Given the track record in this space, can the process be market based?

After all, automakers were allocated a section of spectrum for DSRC in the 5.9 GHz band in 1999 but it has essentially gone unused. Some FCC and cable company officials want to reallocate the spectrum for Wi-Fi and other uses. Testing has gone on for years to see if the band can be shared.

DSRC transmissions enable vehicle-to-vehicle and vehicle-to-infrastructure communications and broadcast precise vehicle information up to 10 times per second, including location, speed and acceleration. It is reported that the NHTSA has estimated that connected vehicles technologies could eliminate or reduce the severity of up to 80 percent of crashes not involving impaired drivers.

Not everyone is willing to wait on a federal regulatory effort. In Oklahoma, legislation just passed would establish rules regulating how to safely operate driverless vehicles navigating state highways. One legislative sponsor said that “it is crucial for the state to implement uniform regulations when it comes to automated driving systems, adding that it is also important to encourage development of the emerging industry. We don’t want to have a hodgepodge of rules from city to city and county to county regulating this technology. It makes sense for the state to oversee that with guidance from (the Oklahoma Department of Transportation, Department of Public Safety) and other experts.

IT’S STILL A SUBSIDY

We were caught by a story about The Florida Department of Transportation wanting to construct two new CSX railroad bridges over Interstate 4 that would include plans for high-speed rail. Plans submitted to the Southwest Florida Water Management District show an I-4 configuration that accommodates a multimodal envelope in the median for high-speed rail.

Qui bono? Who benefits? Well surprise, surprise it’s Virgin Trains USA, formerly known as Brightline. Plans for connecting from Orlando International Airport to Tampa would use rights of way along I-4 and two other state roads. “The corridor will then enter the I-4 median and the preserved rail corridor, proceed west through the Lakeland area, where a planned future station is under consideration, and continue until it exits I-4 near downtown Tampa to a terminal station,” according to the railroad.

In fairness, Polk County’s 2040 long range transportation plan that was adopted in 2015 assumed high speed rail. At the time five stations were proposed along the I-4 corridor, with downtown Tampa and Orlando International Airport stations anchoring each end. The additional three stations would be located in Polk County, Disney World, and at the Orange County Convention Center, according to the 2040 plan.

If the state pays the cost of your infrastructure than the state has subsidized your business. It is a legitimate policy tool to support projects in this way. It would just be simpler for everyone if project participants were honest about the role of government and subsidy (by policy, funding, or finance) in their endeavors.

Muni Credit News Week of April 22, 2018

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$250,000,000

Michigan Finance Authority

Henry Ford Health System

The system comes to market supported by a rating upgrade from Moody’s. The upgrade of existing ratings to A2 reflects Moody’s view that Henry Ford Health System will continue generating stronger margins and cash flow over the next year, leading to improved leverage metrics and stronger liquidity, despite the additional debt incurred with the proposed bond transaction. Although it expect favorable performance trends to continue in both the provider and insurance divisions, Moody’s anticipates it will take some time for the insurance division to generate consistently stronger margins.

Henry Ford Health System is a large, fully integrated health system based in the Detroit metropolitan area. The system operates five acute care hospitals, two behavioral health hospitals, more than 60 ambulatory care and outpatient service facilities, a sizable health insurance business, and a large employed group physician practice. The flagship hospital, Henry Ford Hospital, is a tertiary/quaternary referral hospital located near downtown Detroit.

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SANCTUARY CITIES

A three-judge panel in a federal appeals court decided unanimously that most of California’s so-called sanctuary laws can continue to be enforced. The decision came in a case brought by the US DOJ against California’s decision to declare itself a “sanctuary state”. The far reaching law prohibits police and sheriff’s officials from notifying federal immigration authorities of the release dates of immigrant inmates.

That provision is of particular concern to sanctuary city opponents, something acknowledged by the court. According to the decision, the law “may well frustrate the federal government’s immigration enforcement efforts. However, whatever the wisdom of the underlying policy adopted by California, that frustration is permissible.” The law also requires that employers to notify workers of inspections by immigration agents.

“Only those provisions that impose an additional economic burden exclusively on the federal government are invalid,” the court said. The court did say that the state, in inspecting federal detention centers, cannot impose requirements on the federal government that will force it to spend money. It did note however, that the law did “not treat the federal government worse than anyone else; indeed, it does not regulate federal operations at all.”

The Trump administration could request an en banc hearing for its appeal. That would require the whole 9th Circuit to review the ruling or ask the U.S. Supreme Court to overturn the decision. If it ultimately stands, the decision would be a victory for those jurisdictions which do not support the specific tactics of the federal government in its enforcement of immigration laws. It would reduce their financial exposure to the threat of cutoffs of funding from the federal government for a variety of purposes including law enforcement.

WHAT’S GOING ON WITH THE CENSUS?

One of the fears going into the 2020 national census has been that urban populations will be undercounted. It is based on a number of concerns not limited to illegal immigration but also to the millennial aversion to answering questions from the government especially if they are not in an online format. Those issues may be superseded by problems already emerging in terms of urban area counting.

Last week, the Census Bureau released its estimates of population trends. It appears that changes in the Bureau’s methodology may be producing less reliable data. The change in methodology meant to make one of the American Community Survey questions less ambiguous. Instead of asking people born abroad when they arrived in the United States, the bureau based its latest count on a more specific question: It asked where they lived a year ago.

That change is being blamed for an effective undercount. Major cities are clearly being impacted regardless of which region is located in. Chicago, New York, Houston, Dallas, greater Los Angeles, and San Diego are among the losers of population. This would seem to run contrary to the prevailing wisdom regarding the attractiveness of cities and the Sun Belt.

It is an important question which needs to be resolved. With localities facing increasing funding demands for issues including transportation, resilience, and adaptation to climate change, accurate data will be essential to allowing these localities to qualify for and receive federal funding under a plethora of programs.

One data point of interest is the growth in exurban areas. It reflects a growing trend of movement to more outlier locations. It is reflected in increased demand for services like rural broadband which support small business establishment and expansion in many rural areas. The Census data shows that many rural areas are experiencing net in migration as individuals seek a lower cost of living especially in terms of housing costs.

ANOTHER STEP ON THE ROAD TO RECOVERY

Stockton, CA saw its rating upgraded by Moody’s. The upgrade to A3 reflects the continued moderate growth in the city’s assessed value and improved financial position supported by healthy reserves and liquidity. The city’s five year average available operating fund balance is strong at 39.6% of operating revenues. The A3 rating incorporates the city’s sizeable and diverse tax base and weak socioeconomic indicators. The rating also reflects the city’s low debt burden and elevated pension burden. Rising pension costs and funding city infrastructure needs will also continue to be budgetary pressures.

The stable outlook reflects Moody’s expectation that the city’s assessed value will continue to benefit from moderate growth and a sound financial position supported by the city’s formal policy of maintaining a working capital reserve at 17%. The move comes even despite court decisions favoring pensioners over debt holders.

THE UBER REALITY

A recent study released by Georgetown University documents a number of hurdles faced by jurisdictions trying to arrive at a regulatory scheme which satisfy the many competing interests resulting from the growth of the ride sharing industry. The study follows a group of drivers working for Uber in the District of Columbia. D.C. has been a leader in efforts to regulate the industry while accommodating some of its realities.

In 2014 the D.C. Council adopted regulations to govern Transportation Network Companies (TNCs). The Vehicle for Hire Innovation Amendment Act of 2014 (“VHIAA”) required background checks, set general vehicle standards, mandated insurance coverage, and arranged for the collection of 1% of gross receipts for all UberX rides provided in the city. The law has weaknesses however. Under the VHIAA, regulatory authority over TNCs was delegated to the Department of For Hire Vehicles. However, the Department is prohibited from requiring companies to submit a list or inventory of vehicles or operators.

To address some of these issues, in 2018 the D.C. Council approved a 6% tax on TNC services to support Metro, and passed a data-sharing requirement for ride-hailing services. The Private Vehicle-For-Hire Data Sharing Amendment Act of 2018 requires quarterly transmissions of data on: numbers of drivers; trip location pick-ups and drop-offs; dates and times of ride requests, pick-ups and drop-offs; total miles driven by drivers en route to a pick-up and during a ride (but not while waiting for a ride request); and average fares and distances driven.

The point of all of this is that even in a jurisdiction which seems to be proactive or ahead of the curve, regulation is a difficult matter. Many of the hurdles to regulation, operations, are imposed by the legislation enacted ostensibly to better regulate the services. Under the 2014 D.C. law, Reports on safety and consumer protection are prohibited from public release. Finally, journalists, researchers, and policymakers may not use the federal Freedom of Information Act to access basic information about the operation of TNCs in its jurisdiction. The 2018 law also seeks to impede inquiries under the Freedom of Information Act.

These provisions support the tendency of TNCs to observe secrecy as a prime modus operandi. It is difficult to square the position of the industry as a positive force when it is so resistant to simple informational requirements. We believe that the tendency towards opacity and secrecy will only impede the growth of technology especially in the transportation sector and its acceptance. Can you imagine if a public transit system refused to make operating data available or did not take responsibility for the background of the individuals it employs?

TOBACCO REGULATION GETS A NEW ALLY

The new realities of the tobacco industry can be summed up in this week’s news that Senator Mitch McConnell will introduce legislation to raise the legal age to buy tobacco from 18 to 21, calling it a “top priority” when the Senate returns from recess in late April. McConnell said he wants to change the law to discourage vaping and teenage nicotine addiction and improve Kentucky’s public health.

The news is interesting from a public health point of view but does little to change the overall trajectory of cigarette sales. The attraction of vaping to the next generation of nicotine consumers is troubling if this becomes the preferred nicotine conveyance method. As for tobacco credits, the preferred return of principal date should still be sooner than later. If anything, the trend towards vaping bodes poorly for those bonds with the longest maturity.

It’s the fact that McConnell represents the nation’s second largest producer of tobacco as much as his Senate leadership position that makes this move especially relevant. It means that he will probably get the bill passed given the bipartisan nature of current tobacco politics. That will address the variety of age-related sale and marketing restrictions existing under the current state based structure. So one gets a bit of regulatory consistency but also gets a bit of pressure on overall sales.

FITCH ON SPECIAL REVENUE BONDS

In response to the March 26, 2019 ruling by the United States Court of Appeals for the First Circuit regarding the bondholder protections provided by special revenue status under Chapter 9 of the U.S. bankruptcy code, Fitch Ratings has developed rating sensitivities corresponding to the likelihood and severity of potential rating changes resulting from a final court ruling upholding the decision.

Fitch Ratings has placed the seven U.S. Public Finance ratings that are more than six notches higher than the Issuer Default Rating (IDR) for the associated local government on Rating Watch Negative. According to Fitch, The ratings placed on Rating Watch Negative have the highest ratings relative to their associated governments’ IDRs. Ratings on special revenue bonds that are closer to the associated government’s IDR are less likely to be affected by a re-evaluation of special revenue protections. While special revenues offer substantial protections in the event of a bankruptcy filing, the ruling creates uncertainty about full and timely payment of special revenue obligations during the bankruptcy of the associated government.

Going forward, Fitch will offer one of three comments regarding the rating sensitivities corresponding to the likelihood and severity of potential rating changes resulting from a final court ruling upholding the decision. Ratings for which the sensitivities are relevant are utility and tax-supported ratings that are higher than but within six notches of the related government’s Issuer Default Rating (IDR).

For special revenue ratings between one and three notches above the IDR: “The rating is unlikely to be affected by a recent ruling by the United States Court of Appeals for the First Circuit regarding the protections provided to holders of bonds secured by pledged special revenues. Fitch believes those protections warrant a distinction in ratings above the IDR regardless of the outcome of the case.”

For special revenue ratings between four and six notches above the IDR: “The rating may be affected by the recent appeals court ruling regarding the protections provided to holders of bonds secured by pledged special revenues. Fitch believes those protections warrant a distinction in ratings above the IDR regardless of the outcome of the case. However, a final decision consistent with the First Circuit’s ruling may result in security ratings closer to the IDR.”

For California school districts with ratings above the IDR that are not currently on Rating Watch Negative because of the ruling: “The rating may be affected by the recent appeals court ruling regarding the protections provided to holders of bonds secured by pledged special revenues. Fitch believes those protections warrant a distinction in ratings above the IDR regardless of the outcome of the case. However, a final decision consistent with the First Circuit’s ruling may result in security ratings closer to the IDR. Given state constitutional and statutory restrictions, Fitch believes potential rating changes would be modest.”

Muni Credit News Week of April 8, 2019

Joseph Krist

Publisher

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ISSUE OF THE WEEK

The Brightline debt train finally picked up passengers this past week with a $2.7 billion private activity bond issue. The bonds were said to be strongly oversubscribed with ultimate yields above 6.5% on the long dated maturities. In this market, that represents a significant yield premium even for high yield municipal bond debt generally. That reflects the relatively strong market conditions and generally narrow credit spreads which characterized the municipal market throughout the first quarter of 2019.

The market seems a bit entranced with the participation of Richard Branson’s Virgin Group in the Brightline project. As we pointed out to the Associated Press, “Branson is a huge branding success — and that’s not to say he hasn’t been an economic success,” Krist said, calling him a “genius” when it comes to getting Virgin’s name in front of the public. “His brand as an innovative, somewhat thinking out-of-the-box kind of guy has survived regardless of the absolute level of operating success achieved by his various businesses.” I also noted that while Branson has had success in widely divergent fields, from recording to transportation, his British train operation has had a mixed record over 20 years.

The completion of the financing does answer one major credit concern – will project completion to Orlando be funded? The adoption of the Virgin brand does create some more opportunities for ridership but the risk of underperformance continues to be tipped against the bondholder. Only time will answer the overarching question shadowing the enterprise – has the municipal market once again fallen for a technology and a plan which supposedly wiser heads chose to decline participation in?

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HEALTHCARE TECH GETS A GENTLE NUDGE

Those who subscribe to economic nudge theory will be heartened by the news that the Centers for Medicare and Medicaid Services is moving to expand the range of beneficiaries eligible for telemedicine benefits. Telemedicine has been proceeding forward at a less than rapid pace and the move by CMS to nudge hospitals to more widely adopt the services is seen as enhancing the adoption of the technology on a wider scale.

The new rule, scheduled to go into effect in the 2020 plan year, will allow Medicare Advantage to offer telehealth services as part of their basic benefits package, providing patients more options to receive healthcare services from locations like their home. This is a significant change from current policy which historically had been limited to beneficiaries in rural areas with limited access to brick-and-mortar care facilities.

Medicare Advantage plans previously had the flexibility to provide telehealth services under their supplemental benefits banner. The new rule shifts remote visits to a core part of the benefits covered by CMS. Under the current rules MA plans are not permitted to directly allocate federal dollars to telehealth services.

CONGESTION PRICING – CREDIT POSITIVE?

There seems to be a discernable wave of academic/professional support for the congestion pricing proposal adopted by the NYS Legislature. We choose our words carefully as it is important to emphasize was that what was approved was a serious concept but nowhere near a detailed plan. The devil as always will be in the details and significant interests have staked out potentially difficult implementation issues.

Despite the lack of detail – the level of charge and the potential exemptions from the base – are the most prominent issues to be left to an “independent” board. The likelihood is that a plan will be adopted and implemented by the scheduled January 1, 2021 start date. It is likely that there will be substantial exemptions for a variety of transit cohorts so it is difficult to estimate a real sustainable revenue stream the plan will provide.

If it succeeds in reducing congestion in a meaningful and clearly manifest way, than congestion pricing will be credit positive for a variety of New York credits including those of the City and State of New York. Recently, Moody’s indicated that it views a congestion pricing plan as credit positive. We agree with a significant amount of Moody’s comments in support of its view. We differ in that in the absence of real details about who pays how much under whatever final scheme emerges, we are less comfortable estimating future funding realities and their implications for the MTA credit and that of its related credit partners.

ONE SMALL COLLEGE FIGHTS THE TREND

One college in New Rochelle NY is in the news for its announced closing and criminal financial mismanagement. It could be just one more chapter in the recent history of small college financial difficulties. There are always exceptions to trends. In this case one does not have to leave New Rochelle to find another small college with a credit that is on the way up.

Moody’s Investors Service has revised Iona College, NY’s outlook to positive from stable and affirmed the Baa2 rating on roughly $74 million of outstanding revenue bonds. According to Moody’s, ” The revision of the outlook to positive incorporates the combination of continued solid operating cash flow, material growth in flexible reserves fueled by retained surpluses, and modest but steady debt reduction achieved over the past several years. The college’s management has a track record of strong fiscal discipline, consistently generating robust debt service coverage. This is particularly impressive given that the college’s student market position, which accounts for over 80% of revenue, is experiencing strong competition and has limited ability to generate net tuition revenue gains. That competition is reflected in a very high selectivity rate of 88%, a very low matriculation rate of 9.6%, and volatility in enrollment and net tuition revenue. Despite those challenges the college’s liquidity continues to improve and its spendable cash and investments provide a good cushion to debt and expenses.”

COMMUNITY HOPSITAL FIGHTING CHOPPY WATERS

Milford Regional Medical Center is a 145 bed community hospital located approximately 40 miles southwest of Boston and 15 miles southeast of Worcester, Massachusetts. The obligated group also includes Milford Regional Physician Group (MRPG), a multi-specialty physician group practice with 94 employed physicians across multiple sites. It has some $102 million of debt outstanding rated below investment grade at Ba2 after a recent downgrade.

Like so many hospitals of this size, high financial leverage id a significant issue. At the same time, incremental debt borrowings associated with a new IT project hurt the credit but are likely necessary as technology becomes more and more prominent in the provision of direct patient care (see our earlier comments on CMS changes in funding) . It competes with the high level Boston institutions for patients but struggles with its ultimate level of profitability. Ultimately, significant profitability is not likely.

SINKING FERRY SERVICE

The NYC Comptroller has proposed that the city’s Department of Transportation “immediately explore” taking over NYC Ferry. The DOT, he said, already has experience running the 202-year-old Staten Island Ferry and could improve the efficiency of NYC Ferry’s six routes. The service has been controversial due to the high level of subsidy provided by the City to support low fares on the ferries.

The Citizens Budget Commission found the ferry service costs city taxpayers $10.73 per ride, compared to $1.05 for each subway ride. Critics have noticed that the contract with the operator finds the City having committed to buy boats from the operator. Recent press reports indicate that a runner-up bid for the ferry contract could have saved money by providing its own boats. The contract was won with a bid that was about $30 million lower than its competitor’s. But that bid left city taxpayers on the hook for $232 million to purchase 38 vessels, with another $137 million allocated for future ferry purchases.

It is one thing to push for expanded means of public transport. It is another to be open about the full economic implications of any alternative transit program. In this case the continued level of high individual ride subsidy indicates that the economics of public ferry service at its current scale just does not make a lot of sense. It makes less sense when that level of individual ride subsidy applied to the subway would fund lots of capital upgrades.

METRICS MATTER IN A DATA DRIVEN AGE

One of the challenges facing the municipal market is the increasing reliance on data by all participants – underwriters, raters, investors, analysts – to evaluate the creditworthiness of borrowers and to accurately price risk. When municipal bonds come under attack as they did in the tax cut debate in Congress in 2017, it is often hard for proponents of municipal bonds to make the case for the positive impact of municipal bonds on society as a whole.

So in the middle of this kind of debate, it is important that cities and other borrowers employ data to monitor performance and impact of major programmatic initiatives. That is why it is so disappointing to see the lack of such data on two major program initiatives undertaken by NYC mayor Bill DeBlasio and his wife Chirlaine McCray. Recent hearings conducted by the NYC Council shined a spotlight on the difficulties facing those seeking to evaluate the efficacy and impact of large social service programs.

In 2017, The Mayor announced New York Works, a plan to create 100,000 jobs paying an average of $50,000 per year. The $850 million initiative should be subject to normal oversight with metrics established to measure to efficiency and impact of that level of spending. Alas that is not the case. Officials from the Economic Development Corporation, the agency charged with delivering upon the mayor’s plan say it is “impractical for the city to track specific jobs created.”

The second program is Thrive NYC, a program with the very laudable goal of increasing awareness and treatment of mental health issues especially among lower income residents. Led by the Mayor’s wife, that program has received some $250 million in funding. Recently, the NYC Council criticized the management of the program citing a lack of transparency as to spending and programmatic results.

These two programs are in the spotlight in the wake of the ending of a program known as Renewal. Renewal was an effort to turn around failing schools that cost $773 million over three years but improved only a quarter of the schools in the program. That program was also plagued by a lack of good supporting data.

Why do we care? The three programs have in common high levels of spending, poor results relative to promises, and questionable management. “Renewal Schools is failing to renew. ThriveNYC is failing to thrive and New York Works is failing to work,” according to one Councilperson, “because there is a pattern of failing to measure outcomes.” It is not an accident. According to the NY Times, officials from the economic development agency said they had chosen “not to burden” companies “with tracking every single job created by their actions,” since “further actions” are often required by the city’s partners to create the jobs.

In today’s market, a municipal borrower just cannot consume resources without some accountability to those who provide those resources. If you wonder why there is such suspicion about the implementation of things like congestion pricing to fund mass transit, look no farther than the Mayor’s office and its lack of data transparency to understand why.