Joseph Krist

Publisher

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ISSUE OF THE WEEK

$173,500,000

FLORIDA DEVELOPMENT FINANCE CORPORATION

SOLID WASTE

DISPOSAL REVENUE BONDS

(SOUTHEAST RENEWABLE FUELS, LLC PROJECT)

Coming to a high yield portfolio of yours could be a piece of this issue. This meets all of the traits of a muni high yield deal complete with (for many investors) a less familiar technology and product, a bit of speculation, construction risk, commodity price risk, and operating risk.

The project is designed to convert waste fiber from a variety of sources: biomass, sugar cane waste, and sorghum. The plant will take the fiber product and convert it into pulp usable to produce certain forms of paper packaging. Currently, the technology is in operation in Asia and Europe but is still in the construction stage in the US.

Revenue for the project and ultimately payment of debt service will be produced through the sale of the final pulp product. A contract with an entity to distribute the product is in place and that party guarantees to purchase amounts equal to some 38% of the project’s capacity.

As is always the case with these projects, the risk is borne by the investor. It is a true project financing with the only revenue available for debt service derived from the operation of the facility and sale of the product. There some performance guarantees but there are no direct financial guarantees. All of this is reflected in the Limited Distribution to Qualified Investors and $100,000 minimum denominations.

In reality these Qualifies Investors will largely be representing retail investors who may or may not understand what they own.

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AIRPORT BONDING NEEDS

The Airports Council International has released the results of a survey of the capital needs facing airports in the United States. In 2017, 1.7 billion passengers and 31.7 million metric tons of cargo traveled through U.S. airports. The Council estimates that America’s airports are facing more than $128 billion in new infrastructure needs across the system and a debt burden of $91.6 billion from past projects. That’s about a 28 percent bump up from ACI-NA’s last study. The Council uses their data to support increases in PFC’s. The Council cites the fact that the PFC cap – last adjusted in 2000 – has seen its purchasing power eroded by 50% in the past two decades.

The Council takes the position that modernizing the federal government’s PFC cap is the simplest and most free-market option for providing airports with the locally controlled self-help they need to finance vital infrastructure projects. They view PFCs as locally generated revenues used for “local” projects. The airline industry to say the least disagrees. Airlines for America takes the view that “PFCs are nothing more than a tax on travelers — a tax that isn’t needed considering there’s almost $7 billion in the Aviation Trust Fund which airports can access.”

The debate comes in parallel with the debate being played out in the Congress. The House Transportation Committee chair and Aviation Subcommittee co-chair are on the record in favor of an increase in the cap on PFCs. “A number of airports are bonded out, and in order to issue new bonds and do additional capacity or terminal work,” they need the cap raised, Chairman DeFazio said. “And we’re still working on the details of what that might be.” The subcommittee chair mentioned hiking the cap to $8.50. It’s now $4.50 per flight segment.

O’HARE HYPERLOOP DYING ON THE VINE

One immediate result of the Chicago mayoral race is that the future of the O’Hare hyperloop project was a loser along with the fifteen candidates who did not qualify for the runoff. In June, Musk and his Boring Co. were selected to build the underground tunnel system where passengers would be transported between Block 37 in the Loop and O’Hare Airport in just 12 minutes each way. On its website, Musk and The Boring Co. said that passengers would be transported by electric skates that can travel at speeds of up to 155 miles per hour. “It will take 12 minutes to travel from O’Hare to downtown. The Chicago Express Loop is three to four times faster than existing transportation systems between O’Hare Airport and downtown Chicago.” 

Neither of the two candidates remaining in the race is viewed as a supporter of the project. It is true that the project as proposed by Musk would be 100% privately funded. The reality is that the project is competing for political bandwidth along with issues like taxes, schools, public safety, and pension funding.

CANNABIS IN ILLINOIS

One of the sources of potential new revenue for the State of Illinois is the tax revenue which is expected to be generated from the legalization of recreational marijuana. Proponents were heartened by the release of the results of a survey commissioned by the state legislature. A private sector consultant has developed data around the issue of demand and the industry’s ability to meet that demand and enable the legal market to overtake the illicit market.

That study showed that demand could be as high as 550,000 pounds a year, far more than the state’s licensed growers can supply. The 16 licensed growers in the state would take issue with that. The study projects demand based on information generated from a survey of those who were willing to respond and ‘admit” current marijuana use. The survey says current growers could meet only 35 to 54 % of demand if recreational marijuana were legalized.

The study follows one conducted by Illinois NORML which says the state has the most expensive marijuana in the country and is already seeing shortages of some products for medical customers. That study suggested licensing more cultivators and allowing existing dispensaries to begin growing marijuana, since they have already been vetted and authorized by the state to handle the drug.

The findings will be seized upon by those who believe that the issues of incarceration resulting from past drug law enforcement should be addressed through the licensing of many smaller growers and distributors. If the expected market were fully met, the report says, the state could collect at least $440 million annually in tax revenue. Sponsors of a bill to legalize recreational cannabis have said they plan to introduce a proposal in March or April. If it becomes law, recreational sales might not start until 2020.

The issues at play in Illinois are being replicated across the country. The idea of conflating marijuana legalization with the issues of judicial and correctional reform, and the emerging issues of reparations has seriously compromised debate on the issue. These factors are holding up legalization for recreational purposes in New York and New Jersey.

THE CREDIT IMPACT OF THE DECLINE OF COAL

Much of the focus of public opinion on the issue of coal consumption and its role in climate change is on the environmental aspect of the issue. For municipal investors, the decline of coal has other consequences. The immediate impact of declining coal production is the decline in the level of revenues derived from severance taxes. In Kentucky, state government collects the coal severance tax and makes distributions to counties. Supported spending includes  road maintenance and construction of 11 regional industrial parks, education programs, mine safety research and workers’ compensation for injured miners, water and sewer infrastructure, and facilities like senior centers, community centers, and cemeteries. Localities also used a portion of the coal severance tax to pay for law enforcement, and waste management. 

Now the counties and localities are feeling the pinch. In 2012, Kentucky distributed $32.2 million back to 29 coal-producing counties. That amount fell to $12.4 million in 2018 — a 61% decline in six years. In Virginia, where severance taxes are levied on coal and natural gas producers, the Virginia Coalfield Economic Development Authority, funded by a portion of the coal and natural gas severance tax, saw the tax drop 62%  from 2011 to 2017. 

For localities, the cuts have been painful. The decline in production also lowers the value of the property used in coal production. The lower severance revenue represents a double whammy for localities which face both the cuts as well as a diminished tax base against which they can generate replacement revenues. They also generate population declines which diminishes the job base and the overall economic base which generates revenues.

MOODY’S SENDS MIXED SIGNALS ON NEW YORK CITY

When Amazon backed out of its deal with New York City and State, Moody’s was quick to describe the situation as credit negative for the city. They were concerned about what message the City was sending to the tech industry and whether the City was becoming less business friendly. They expressed concern about the City’s ability  to diversify its economy going forward. So now, just a couple of weeks later, Moody’s has taken the opportunity to revisit the credit. In the interim, the Amazon deal may be showing signs of resuscitation and the City is preparing for reduced revenue growth stemming from the late 2017 federal tax law changes.

So we question the basis for this week’s upgrade of the City’s GO credit. The Mayor’s supporters are latching onto this as proof that the Mayor is managing the City responsibly. The City still faces significant capital demands, directly for its public housing stock which is now being operated under a consent decree by a temporary manager. It can expect to be called upon to make significant additional funding actions to support the MTA’s massive capital plan.

The issues cited – strong financial management and steady improvement in its financial position that reflect greater flexibility to react to the next downturn – were questioned this week by the City’s Controller who questions the City’s reserve position in the face of a growing consensus around a recession occurring by 2020.  The report references lower benefit costs but simultaneously expresses concern about rising healthcare expenses.

It is confusing to say the least. Given where the State and City are in their budget processes, the upgrade might make more sense once those processes are completed and a clearer picture of the economic outlook emerges. It might also makes more sense if it did not accompany real questions about recent new spending on education and mental health which clearly did not and is not achieving its goals. The inability to show any tangible results for some $1 billion in new spending should be concerning to all.

EDUCATION: PUBLIC VS. CHARTER

The issue of charter schools versus public schools continues to be debated. Municipal bonds investors have the opportunity to invest in both as well as in one or the other. In determining whether to invest it is best to understand the continuing dynamic between the two school philosophies.

One of the issues which has often hindered the debate is the issue of standards and comparability. Now, California is poised to take the lead in the development of common sets of standards for both types. Last week, A proposal championed by Gov. Gavin Newsom to require new transparency standards for charter schools across California was passed by state legislators. Senate Bill 126 codifies a recent opinion from California Atty. Gen. Xavier Becerra that governing boards of charter schools should be subject to the same open-meetings laws and conflict-of-interest standards as public school districts. 

The California Teachers Assn. endorsed the measure and the charter school groups involved took a neutral position. Charter school supporters spent heavily in the 2018 election cycle in favor of opponents of the new Governor. Their lack of a position on this issue and support for two teacher job actions in large districts created the political dynamic that supported passage.

Now the state and its school systems must find ways to increase the funding needs stemming from settlement of the labor disputes.

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

Joseph Krist

Publisher

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CONNECTICUT BUDGET

With a new administration taking hold in the Nutmeg State, investors hope to see real action on the state’s budget and in particular on pensions. This week the Governor articulated his budget plans. They include revenue expansions and tolling on four of the state’s primary highways.

So how would the Governor raise revenues? The Governor proposed expanding the sales tax to include many new products and services, like tax preparation, haircuts, dry cleaning, veterinary services and newspapers. The 1% tax on digital downloads will be increased to the 6.35% sales tax rate and the sales tax on boats will be increased from 2.99% to the standard 6.35%. All together, Lamont’s budget counts on more than $1 billion in new sales tax revenue over two years.

Other tax increases include raising the hotel occupancy tax from 15% to 17%, with 10% of the total money going into a tourism account and raising the real estate conveyance tax on sales of more than $800,000 from 1.25 % to 1.5 %. To soften the blow of higher taxes, the Governor wants to restoration of the $200 property tax credit to all tax filers (it’s currently limited to the elderly and those with dependents) and the elimination of the $250 business entity tax that companies in Connecticut have to pay every other year. 

The proposal to toll the state’s highways has been a source of contention for some time. To address prior political opposition, the Governor’s plan includes two options. One is a trucks-only proposal. Rhode Island currently has such a scheme in place on its section of I 95. The second proposal would raise about $800 million a year once it was fully implemented in 2025. The Governor estimates that 40% of the revenue raised from the second option would be paid by out of states drivers.

The state’s pension underfunding position would rely on the use of current surplus while relying on the municipalities assuming 25%  of pension costs for their employees. This has always been a heavy political lift in the Legislature. Even harder is the Governor’s hope that state employee unions would voluntarily make changes to the way cost of living adjustments are handled for state retirees, tying them to the stock market rather than guaranteeing a certain percentage increase.

Other revenue adds would include a 10 cent tax on single-use plastic bags, a 75% on e-cigarettes, a 1.5 cent per ounce tax on sugar-sweetened beverages and new bottle deposits on wine bottles, liquor bottles and nips. According to the Governor’s estimates the plastic bag tax would raise $57 million over two years, taxing e-cigarettes would generate $16.4 million over two years and the tax on sugary drinks would raise $163.1 million in its first full year.

ILLINOIS BUDGET

Governor J.B. Pritzker presented his first budget proposal of his tenure. His words make clear the challenges facing the Governor and the Legislature. “Illinois is faced with a $3.2 billion budget deficit and a $15 billion debt from unpaid bills. Last year alone, the state paid out more than $700 million in late payment penalties. That’s enough to cover free four-year university tuition for more than 12,000 students.”  There is a structural deficit today of over $3 billion per year that if left unaddressed will continue to grow. There is a backlog of unpaid bills and debt associated with it that exceeds $15 billion.”

“Out of this year’s $39 billion budget, approximately $20 billion is required payments on our debt, on our pensions, on our court-ordered obligations or federally protected programs.  To balance the budget by simply cutting government, we would have to reduce discretionary spending on all these direct services our jobs, our families and our businesses rely on by approximately 15%.”

The Governor’s proposal includes legalizing and regulating adult-use cannabis in this legislative session. He estimates that it would bring in $170 million in licensing and other fees in fiscal year 2020. The budget also includes the legalization and taxation of sports betting.  He estimates that Illinois can realize more than $200 million from sports betting fees and taxes in FY 2020. 

Other revenue enhancements include a proposal to enact a tax on insurance companies, specifically a managed care organization assessment to help cover the costs of the State’s Medicaid program. It would be structured to generate approximately $390 million in revenue to cover a portion of the state’s Medicaid costs. This would be a way to increase Illinois’ federal match.

The Governor offered proposals to deal with the state’s well documented pension funding problem. His administration is offering a 5-point program. It revolves around the enactment of a graduated income tax versus the current flat rate regime. The Governor says that a portion of the proceeds from the graduated tax would be applied to the pension system, over and above the state’s required pension payments. 

Pension bonds are also part of the plan. in addition, it would make the optional retiree buyout program permanent and smooth the pension ramp by “modestly” extending it. The state’s university system would see an increase of 5% in funding from the state after years of cuts. This would be credit positive for the debt issued by those institutions.

The proposal is the easy part of this process. The state’s political atmosphere remains strained after four years of standoff between the legislature and the Governor.

NYC, AMAZON, AND JOBS

With so much attention focused on the City and State of New York’s failed effort to conclude an agreement with Amazon, it might seem as if NYC was a jobless desert reliant on tax handouts to sustain its economy. A recent report from NYC Controller puts those concerns to rest.

The City’s economy grew 3.9% in Q4 2018, the strongest growth since 4.0% in Q2 2017, driven by a surge in the labor market and modest wage growth (as measured by average hourly earnings). For the year, the gross city product grew 3.0%, the most robust year over year growth rate since 2015. The banking sector, a key driver of the City’s economy, continued to perform strongly as a result of higher interest rates, lower corporate tax rates, and deregulation. Net income after taxes for the top six banks in the U.S. rose to almost $30.0 billion in Q4 2018, compared to a loss of over $6.2 billion in Q4 2017 driven by robust growth (16.9%) in pre-tax income (mostly from higher interest rates) and a steep decline in taxes. (Taxes for the top six U.S. banks fell by 84.1 % in Q4 2018 from the prior year, following enactment of the Tax Cuts and Jobs Act (TCJA), which reduced the federal corporate income tax rate from 35% to 21%).

The City’s private sector added 34,000 jobs or 3.5% (SAAR) in Q4 2018, the highest gain since the 37,000 jobs created in Q3 2014. The public sector added 1,300 jobs in Q4 2018. National private-sector employment grew 2.1% (SAAR) in Q4 2018, the fastest since the 2.1% increase in Q1 2018 (Chart 2). This is amazingly strong growth for so late in a business cycle.

But the next comment reflects why the Amazon tax breaks were controversial. over half of the new private-sector jobs created were in low-wage industries. Low-wage industries added 21,100 jobs and accounted for 62.0 % of total private-sector jobs created in Q4 2018. Medium-wage industries accounted for 29.8 % of the new private-sector jobs as they added 10,100 jobs in Q4 2018 and high-wage sectors accounted for 8.2 % and added 2,800 jobs. In comparison, 63.3% of new private-sector jobs in the U.S. in the fourth quarter were in low-wage industries, while 20.4% were in medium-wage industries, and 16.3% were in high-wage industries.

Moody’s has expressed the view that the failure of the Amazon deal is credit negative for the city. That finding is interesting in light of the Controller’s comments. Moody’s acknowledges that New York City has a younger workforce than the US as a whole — almost 66% of the population is between 25 and 54 years old — and also a more educated one: 36% of New York City residents have a bachelor’s degree or higher, compared with 30% for the US overall. New York City also has one of the lowest crime rates among the big US cities. But interestingly, Moody’s also cites the city’s transportation system and access to the national transportation system. Given the public uproar over the condition and reliability of the city’s transit system, this is a bit puzzling. Especially, since the impact on transit was one of the foundations for local opposition to the deal.

Intentional or otherwise, Moody’s takes a fairly strong position in favor of tax breaks as an economic development tool. Effectively, they pit classes of the city’s population against each other. One of the issues which Amazon ran away from was how it could provide employment  to historically economically limited segments of the population – like the residents of the nation’s largest public housing facility located essentially across the street.

Moody’s undercuts is view by citing the fact that “companies such as Google and Facebook have expanded significantly in New York City without direct state or city support because they want access to its creative workforce. In addition, jobs and wages in New York City’s high-tech sector, while accounting for only 1% of total employment, are growing faster than every other industry, growth we expect will continue. ” One has to wonder why Amazon did not feel that it could compete on a level playing field with Amazon and Google.

BUDGET SEASON IS REGULATION SEASON

For those many states which conduct limited legislative sessions, the budget negotiations are often the site of significant new regulations. This year is no different with a variety of proposals being introduced as part of the budget process across the country.

In Oregon, a proposal for statewide rent control is headed for a vote on the Oregon House floor. Senate Bill 608 , is expected to be approved and sent to a supportive governor for her signature. The bill would limit annual rent increases to 7% plus inflation throughout the state. Annual increases in the Consumer Price Index, a measure of inflation, for Western states has ranged from just under 1% to 3.6% over the past five years. New construction would be exempt for 15 years and vacancy decontrol would apply after existing tenants leave.

Other components of the bill mimic those seen in other jurisdictions like New York. The bill would require most landlords to cite a cause, such as failure to pay rent or other lease violation, when evicting renters after the first year of tenancy. So-called “landlord-based” for-cause evictions would be allowed, including the landlord moving in or a major renovation. In those cases, landlords would have to provide 90 days’ notice and pay one month’s rent to the tenant, though landlords with four or fewer units would be exempt from the payment.

Oregon would become the first state to enact a statewide rent control program. In other states with rent control policies, cities enact and administer local programs. Oregon law provides that rent control is not a power granted to localities.

In addition to New Jersey, New York State is debating the legalization of recreational marijuana. It is likely that the debate will continue beyond the budget cycle. The debate in New York is complicated by the politics of criminal justice reform and economic development. The industry is looked to as a potential source of “reparations” to benefit historically disadvantaged individuals and groups.

In plain English, proponents of reparations want to see recreational licenses issued to formerly incarcerated individuals who were convicted under prior more strict drug enforcement practices. That debate will b complicated by positions of some Presidential candidates in support of reparations. We would not be surprised to see these concerns derail current efforts to establish legal recreational marijuana outlets.

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

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$206,710,000*

NORTH CAROLINA MEDICAL CARE COMMISSION

Health Care Facilities Revenue Bonds

(Wake Forest Baptist Obligated Group)

Moody’s: A2  S&P: A

WFB is the largest academic medical center in its region but that has not relieved pressure on the ratings. The Moody’s rating carries a negative outlook. The concerns driving the outlook include WFB’s the fact that operating cash flow margins, which were already moderate in fiscal 2017, fell lower in fiscal 2018 and will likely remain modest in fiscal 2019. The system is absorbing its acquisition of High Point Regional. That merger is leading to higher expenses associated with HPR and unfavorable payor mix shifts. These expenses are negatively impacting cash balances while the balance sheet was increasingly leveraged due to the acquisition. Another source of uncertainty is the potential financial impact of the State’s plan to convert its Medicaid population to a managed care model.

Wake Forest Baptist (WFB) consists of Wake Forest University Baptist Medical Center (WFBMC), North Carolina Baptist Hospital (NCBH), Wake Forest University Health Sciences (WFUHS), and their respective affiliates. WFBMC was created in 1975 and houses the senior management team and many of the centralized functions of three organizations: WFUHS, NCBH, and WFBMC. WFUHS includes the faculty practice plan, the School of Medicine and Wake Forest Innovations (formerly the Piedmont Triad Research Park). NCBH (885 beds) is WFB’s flagship tertiary and quaternary academic medical center. WFB also owns four smaller hospitals: Lexington Medical Center (94 beds located 26 miles south of NCBH), Davie Medical Center (81 beds located 12 miles southwest of NCBH), Wilkes Medical Center (130 bed located 56 miles west NCBH), and High Point Regional Medical Center (351 beds located 20 miles southeast of NCBH).

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BAD MONTH FOR TAX INCENTIVES

The Amazon debacle will be chewed over for some time and a variety of reasons will be offered. None of them individually will account for the company’s decision to take their project and go home. There are however, a few items which stand out that do not require a lot of analysis.

Amazon showed no ability to navigate anything other extremely calm political waters. The company has faced almost no opposition in any of its other locations whether they be headquarters or warehouses. They have been able to steamroll the political structures in so many locations. They got the City Council to reverse itself on housing finance matters merely by threatening not to expand. So they came into the most political jurisdiction in the nation unprepared to work with it.

They failed to appreciate that an anti-union position in New York will galvanize a critical mass of opposition to any entity espousing such a view. They were apparently unaware of the City’s history of successful skepticism of projects of this scale (Westway anyone?). And they apparently did not have the stomach for any real confrontation. That may have been the real miscalculation.

These sorts of machinations are not the prime concern of individual investors who hold municipal bonds. But they are interesting in that the experience does provide certain clues as to how governments and companies will balance their view of local needs versus the views of the general public. One issue that is becoming clearer is the level of public opposition to “tax incentives” and other funding transfers at a time of underinvestment in infrastructure. It was hard to explain in simple terms why the state and city would give up $3 billion at a time when two major agencies (excluding Gateway tunnel costs) need some $60-70 billion of capital funding.

And there was this view – “Google and Apple just expanded their offices,” he said. “And they did it quietly, without any handouts. It just seems that, also, Amazon wanted a bit more than their fair share when everybody else was still doing it the old-fashioned way.” “There should be a more altruistic concept of these companies like Amazon joining the community and earning loyalty rather than, ‘Punch my meal ticket,’” Both of those tech giants have landed in NY and expanded and Google is a significant employer now and going forward. Apple’s stores are fairly ubiquitous throughout Manhattan. So while not a sophisticated expression, the quote speaks volumes. Those interests which tend to speculate in these situations – real estate and retail – did exactly that and are being reminded of the fact that sometimes speculators lose.

It also bears mention that the Amazon project would have been developed within an Opportunity Zone. Ironically, opportunity zones were championed by tech funded interests. The people who invest in Opportunity Funds are able to minimize their tax burden through preferential treatment of capital gains. The people who invest in Opportunity Funds are able to minimize their tax burden through preferential treatment of capital gains. An investor who retains an investment for seven years will pay only 85 percent of the capital gains taxes that would have been due on the original investment. If the investment is held beyond 10 years, the investor permanently avoids capital gains taxes on any proceeds from the Opportunity Fund investment.

The point of the bill was to stimulate investment especially in smaller (less than 1 million) communities. It was not designed to support projects like Amazon’s in Long Island City (LIC). Gentrification was already a well established fact in the surrounding neighborhoods. Some investment in development was already happening with some developers repurposing projects in development in response to the planned Amazon campus. Would it have accelerated existing developments and attracted some newer ones? Of course. That will still happen at a slower and likely more diverse pace.

The public is catching on to these sorts of major revenue concessions to attract development. This is the second prominent such transaction to unfold somewhat differently than contemplated as it follows the reconfiguration of the Foxconn deal in Wisconsin. In both cases, the deals were likely not going to deliver promised job booms for the non-college manufacturing cohort. The continuing efforts by corporations to tie taxes to development run counter to the current political winds. It will be important to see how government tailors its policies to reflect these trends.

CALIFORNIA JANUARY REVENUE

State Controller Betty T. Yee reported California’s total revenues of $18.79 billion in January were lower than estimates in the governor’s 2019-20 fiscal year budget proposal by $1.81 billion, or 8.8%, but higher than projections in the FY 2018-19 Budget Act by $1.21 billion, or 6.9%. Total revenues of $74.42 billion for the first seven months of FY 2018-19 were lower than expected in the proposed and enacted budgets by $2.87 billion and $1.32 billion, respectively. In the fiscal year to date, state revenues are just 0.2% lower than the same time last year.

Sales tax and corporation tax –– two of the state’s “big three” revenue sources –– came in higher than assumed in last month’s proposed budget. For January, personal income tax (PIT) receipts of $16.36 billion were $2.53 billion, or 13.4%, less than the Department of Finance forecasted last month but $403.6 million, or 2.5%, higher than assumed in the budget enacted last June. PIT revenue was still 4.8% higher than in January 2018. Sales tax receipts of $1.59 billion for January were $602.8 million higher than anticipated in the proposed FY 2019-20 budget and $647.4 million higher than in the FY 2018-19 Budget Act. Last month’s $579.2 million in corporation taxes were 9.0% higher than estimates in the FY 2019-20 budget proposal and 12.0% higher than in the enacted FY 2018-19 budget.

ILLINOIS PENSIONS

The new administration in Illinois is attempting to undertake an overall program of asset sales and the use of pension obligation bonds in an effort to improve the State’s woefully underfunded pension plans. Our view of pension bonds has been and continues to be negative. Away from the obvious risk of investment underperformance, we are philosophically opposed to the bonds in that they are always a mechanism to relieve the current pain associated with a current problem. They are a political answer rather than a sound financial answer.

That view is supported by Deputy Gov. Dan Hynes who suggested the key to the plan is to extend the period of time the state has to reach full funding of its pension plays by seven years, to 2052. “Full funding” currently is defined has having 90% of the assets needed to pay promised benefits. He acknowledges that current budget relief is a goal. Extending the full-payment ramp to 2052 will reduce the amount the state has to contribute next year by about $800 million. In fairness, the administration is also suggesting that it will provide a guaranteed annual share of revenues from the graduated income tax Gov. Pritzker hopes to enact into law after voters consider a constitutional amendment in 2020. 

The Governor also supports a plan to consolidate hundreds of smaller pension funds, mostly downstate plans covering police and fire workers, to allow them to cut resources and get better returns on investment. These funds have been a source of contention leading to court actions seeking to segregate operating funds and requiring them to be applied to pension funding. This has significantly reduced the operating flexibility of the smaller communities often exacerbating already weakening financial positions.

TEXAS DEVELOPMENT FINANCING

One of the tried and true methods of financing infrastructure in unincorporated areas of the Lone Star State is the use of municipal utility districts (MUD). MUDs are created under Texas law and are managed by a board of directors often consisting of developer representatives. The construction of the infrastructure is undertaken to support development against which taxes are levied  for the monies needed to pay off the MUD debt. In reality, the hope for a MUD is that the larger municipality next to which many MUDs are located will annex the land in the MUD. The MUD debt is then refinanced with debt secured by the much larger revenue base of the annexing entity. MUDs are regulated by the state, require a local election to issue bonds, and exist separately and out of the control of a city or county government.

That structure raises issues of control and management for the municipalities which are expected to absorb the debt acquired through annexation. One solution to those control issues is the use of public improvement districts (PID).  PIDs issue debt backed by special assessments which are fixed for the life of the issue. PID are created within existing municipalities. PID bonds are issued by cities or counties but, they are clearly only repaid from assessments and not by the local government’s general obligations. They carry separate ratings from the government’s credit.

PID debt much more closely resemble assessment backed debt issued by jurisdictions in  Florida and California. This will introduce an increased level of risk from exposure to the willingness and ability of developers to pay the assessments through the build out phases of these developments. While a newer risk for Texas investors, the use of PID debt is much more familiar to the high yield municipal investors across the market. With PIDs effectively restricted to larger minimum denominations ($100,000) yields tend to be higher reflecting the developer risk . Significant increases in the issuance of this debt (MUDs outstanding exceed PIDs outstanding by a factor of 10) will provide a new sector for institutional high yield investment.

One characteristic of Texas MUD debt is that it is highly concentrated around the Houston area. Historically, this was seen as a positive. Recent attention focused on the chronic flood problem facing Houston and surrounding Harris County has raised some concerns about the potential for flooding to alter or limit development. The Dallas Fed has raised the issue as it surveys the outlook for economic growth in the Houston region. ” The high concentration of MUDs in the Houston area may expose this financing model to new risks — those associated with more frequent and catastrophic flooding events. While MUDs will likely remain a vital part of the developer’s toolkit, this type of debt could become costlier and raise home prices in residential developments. And rising costs for homeownership might diminish one of the Houston area’s traditional selling points: affordability.”

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

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$900,000,000

District of Columbia

General Obligation Bonds

Moody’s: Aaa  S&P: AA+

Those of us who go back far enough to remember when the District of Columbia could not borrow without outside credit support appreciate how high a hill the District had to climb to get to the level it has achieved. The rating reflects both improved management of the City and the benefits of the District’s development into a much more diverse and dynamic economy since the 1980’s. Its per capita income is higher than that of all 50 states, and its GDP is greater than that of17 states. In addition, the District is seen as having exemplary fiscal governance, and its updated four-year financial plan is its strongest ever. The District already has among the lowest pension liabilities of any large city, and has pre-funded its other postretirement benefits (OPEB) liability, which affords it significant financial flexibility.

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BRIGHTLINE FIGHT TO CONTINUE

The effort to deny the Virgin/Brightline consortium access to private activity bond financing continues. Indian River County, Florida, voted 4-1 Tuesday to spend up to $400,000 to appeal the denial of the county’s motion for summary judgment in a federal lawsuit it filed to challenge the Brightline project’s $1.15 billion of private activity bonds and federal agency environmental approvals. The consortium recently received another extension in the deadline to June 30 to issue private activity bonds to finance its continued expansion.

Indian River County’s action follows a decision on Dec. 24, 2018  by Federal Judge Christopher Cooper to grant motions for summary judgment sought by the USDOT and Brightline. The county’s appeal of Cooper’s ruling will be heard by the U.S. Court of Appeals for the District of Columbia Circuit. Ironically, the appeal comes as Brightline / Virgin Trains USA, is in the equity markets with an initial public offering as another way to finance the continued expansion of the private passenger train system. The IPO launch announced Jan. 30 and calls for the issuance of 28.3 million shares of common stock at $17 and $19 per share. The initial offering is expected to raise between $468 million and $540 million, depending on the price of shares. Fortress Investment Group LLC will retain majority ownership of the train company. The company will transition its consumer facing brand to Virgin Trains USA during this year.

The IPO raises legitimate issues as to the need for the project to rely on PAB financing. If they have access to equity, it undermines the case for the necessity of subsidized PAB financing. The continued effort to obtain the financing in spite of access to other sources of funding lends credence to the view that the project does not stand on its own economic viability without subsidies.

KC AIRPORT P3 MOVES FORWARD

The City of Kansas City, MO announced that it has reached a tentative airline agreement and a new $1.5 billion price tag for the Kansas City International Airport single-terminal modernization project.  The new $1.5 billion total does not include financing. According to the previous estimate, at the $1.64 billion price tag, the total cost with financing would be about $1.9 billion. The city expects six of the eight airlines to sign on  including Southwest, American, Delta, United, Alaska and Spirit. Frontier does not sign lease agreements of this nature, according to the City and Allegiant has indicated it does not plan to sign. Those airlines still can fly out of KCI, but they will pay a different rate than the airlines that sign the agreement.  

The project now awaits an environmental review. The City must now figure out how to fund initial project work such as demolition of an existing terminal. Bonds ultimately would fund much of the project but, the city needs roughly $90 becomes available. It has been publically pledged that “taxpayer monies” would not be used for the airport. Some local legislators take the view that allowing the City’s Aviation Project to use general fund monies, even if it would be repaid from bond proceeds would violate that pledge.

NEW YORK STATE

Local sales tax collections continued to climb in 2018, growing for the third year in a row, according to a report released today by State Comptroller Thomas P. DiNapoli. Collections across the state of $17.5 billion grew by $872 million, or 5.3%. “Local sales tax collections grew at a faster pace in 2018 than in recent years, boosting local revenues,” DiNapoli said. “Despite the good news, a slowdown in collection growth in the fourth quarter shows that sales tax revenue can be unpredictable. Local officials should keep a watchful eye on consumer spending and this revenue source and be prepared to react accordingly.”

Every region in the state has experienced an increased annual growth rate in sales tax collections in each of the last three years, with the exception of the Finger Lakes (which slowed from 4.9% in 2017 to 3.7% in 2018). Year-over-year growth was especially strong in several upstate regions. The Southern Tier saw the highest year-over-year increase at 6.8%, the strongest for the region since 2011. The North Country had the second highest (5.9%), followed by the Mohawk Valley (5.8%). Downstate, the Long Island and Mid-Hudson regions saw collections grow by 4.5% and 5.1% in 2018. Notably, Central New York has seen a significant turnaround in its collections, climbing 5.1% in 2018, having been the only region with a decline in collections (-0.9 %) in 2016.

New York City’s sales tax collections grew by 5.7%. The city’s increases have typically been robust over the past several years. For the 57 counties outside of New York City, collections grew in 55 of them. Sullivan County experienced the largest increase (16.4%), followed by Tioga and Hamilton counties (16.1%). Collections were down in 2018 in Cayuga (-1.3%) and Madison (-0.7%) counties.

All but one of the cities with their own sales tax experienced an increase in year-over-year collections in 2018. Gloversville had the strongest growth (17.8%), along with the cities of Norwich (12.8%) and Salamanca (8.3%). Oneida was the only city that saw its collections decrease (5.2%), mostly due to technical adjustments.

Two proposed changes to the state sales tax, including one related to the taxation of sales through online marketplaces – such as Amazon – have the potential to drive millions of dollars in additional sales tax revenues to local governments.

This will be important as the state is facing a $2.3 billion tax-revenue shortfall. Laying the blame primarily on the impact of federal tax law changes,  the state cited the move of wealthy individuals to other taxing jurisdictions (Florida?) as a cause of the lower revenue estimate. Other states which have historically benefitted from the SALT deduction are also reporting shortfalls in year-end income tax revenues. They include, unsurprisingly, California and New Jersey.

TOBACCO TARGETED AGAIN

An Arizona state lawmaker introduced the proposal that would increase the current $2-a-pack on cigarettes by an additional $1.50. A similar increase on vaping products is also a part of the proposal. The proceeds of the increased tax would generate funding for the state’s Board of Regents to award scholarships to residents who received A or B grades in each academic course required for graduation. The Arizona Legislature would have to agree to place the measure on the 2020 ballot.

In Hawaii, one legislator has introduced a bill which would raise the minimum smoking age incrementally each year to 30 in 2020, 40 in 2021, 50 in 2022, 60 in 2023 and 100 in 2024. The bill only addresses cigarettes while leaving e cigarette and vaping restrictions as is. The Hawaii Island lawmaker said he doesn’t think taxes or regulations are doing enough to stem their use. He wants to see them off store shelves all together.

A state senator introduced SB 887, which would increase the excise tax on cigarettes to 21 cents, instead of 16 cents, in July. It mandates revenue be used for health programs and research.

PG&E IMPACTS BEGIN TO EMERGE

A January 31 ruling from the judge overseeing the PG&E bankruptcy approved motions including an order to maintain existing arrangements between community choice aggregators (CCAs) and PG&E. CCAs are an emerging municipal credit sector especially in the California market. CCAs were established to provide electricity customers choice of generation supplier in the service areas of California’s investor-owned utilities. Once a CCA is formed, it becomes the default provider for generation services in the defined area. CCA customers have the option to opt-out and return to PG&E for their generation service but most customers elect to stay with the CCA. The CCA is unregulated on its cost recovery like municipal electric utilities and has a local governance role in power supply planning, local greenhouse gas reduction policies and customer choice.

In the case of PG&E, it has a contract with Marin Clean Energy (MCE), the first CCA to operate in California . Under that agreement, PG&E includes the charges for generation services provided by MCE on the monthly electricity bill that PG&E sends to customers. The customer pays the bill, and on a daily basis, PG&E transfers collected CCA generation revenues to MCE. So there was concern that revenues due to MCE which would, among other things, get tied up while the bankruptcy proceedings proceeded.

The judge’s order also included an acknowledgment that the revenues are not a part of PG&E’s estate; that PG&E must return to regular banking and billing operations, including remitting bill collections to CCAs; and that CCA revenues cannot have a lien placed against them by the debtor-in-possession lender. The positive effect on CCA finances stems primarily  from the increased stability to CCAs’ cash flow collections, which enables their power suppliers and other vendors to have greater certainty that CCA revenues and cash flow will remain unaffected by the utility’s bankruptcy filing.

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

Joseph Krist

Publisher

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NEGATIVE RURAL HOSPITAL TREND CONTINUES

There continue to be signs that the single facility rural community hospital facility remains under significant pressure. The latest example shows that even a facility that is larger than what is typical still faces the same pressure. Yakima Valley Memorial Hospital does business as Virginia Mason Memorial. It is a 226 staffed bed community hospital located in Yakima, WA. It saw 11,751 admissions in the last year.

The hospital, like so many others in the rural space, makes a significant economic contribution employing 2,800 and generating annual revenues of $433,163,870. But it still operates as a single site rural provider. So while revenue growth was solid, expense growth still exceeded revenues and the operating margin was still negative 0.9%.

It is not a surprise that these numbers impacted the hospital’s rating. The hospital issues debt secured by a receivables pledge and a lien on the primary hospital campus. There is also a debt service reserve fund. Key financial covenants include minimum days cash on hand of 40 days, and debt service coverage of 1.2x. This should all provide for coverage of debt service but it’s the trend which concerns.

So Moody’s downgraded Yakima Valley Memorial Hospital’s  revenue bond rating to Ba1 from Baa3. This reflected expectation of continued weak performance in fiscal 2019 following a miss to budget in fiscal 2018. Importantly, the outlook remains negative for the rating even after this downgrade. The negative outlook reflects an expectation of still modest margins in fiscal 2019, despite expectations of improvement, reflecting continued cost and market challenges.

So in a nutshell, there you have the rural hospital sector.

PUERTO RICO

The latest turn of events in Puerto Rico’s ongoing effort to restructure its debt is the decision by the judge overseeing the Commonwealth’s Title III proceedings to grant an urgent motion establishing procedures to handle a request by the island’s Financial Oversight and Management Board to dismiss $6 billion in general obligation (GO) debt issued by the commonwealth after 2012. This will include a “two-stage procedure” that will ensure disagreements over the proposals are worked out. Judge Swain said the “best thing for me to do” was to ask the objectors and respondents to have a “meet and confer” that would result in a revised procedural order.

If the definition of justice is a result which leaves both parties disappointed, then this fits the bill. Bondholders said the procedures did not provide adequate notice to creditors and potential objectors, and granted the government substantive advantages that were not provided to the holders of the challenged GO bonds. Bondholders say that the proposed procedures force creditors to file joint responses, compromising their ability to present their arguments adequately; treats creditors differently according to the amount of their claim; and prematurely forces creditors to answer discovery requests.

The judge takes the position that case management orders call for all bondholders to receive notices and answers were needed regarding whether anyone was at risk of a default judgment and what would happen to those creditors who do not answer notices of the proposed repeal of $6 billion in debt. The judge asked for improvements to the language of the notices and for assurances that all bondholders, large and small, be informed. She also cited the fact that creditors could seek the committee by petitioning the United States Trustee. The U.S. Trustee is part of the U.S. Department of Justice and is responsible for overseeing the administration of bankruptcy cases.

GO bondholder representatives expressed a view that parties should have 60 days to announce if they will participate in the process. Attorneys for the fiscal board’s Special Claims Committee are not supportive of smaller holders receiving any more protection basing that position on its perception that most of the creditors that purchased the challenged bonds were not retail bondholders, as they were sold in increments of $150,000.

Experienced high yield investors know that initial denominations do not prevent bonds from winding up in “small bondholder” hands, so we take that argument with a grain of salt. Once again, the small bondholder finds themselves in a disadvantaged position. It shouldn’t be that way. As the Special Claims Committee representative said about another aspect of this case – “It does not have to be that complicated.” 

While these events unfolded, the executive director of the Puerto Rico Fiscal Agency and Financial Advisory Authority and the Puerto Rico Sales Tax Financing Corp. (Cofina) announced that the U.S. District Court approved the “Third Amended Title III Plan of Adjustment” between Cofina bondholders and monoline insurers. The Plan of adjustment is the first under Title III of the Puerto Rico Oversight, Management and Economic Stability Act (Promesa) and follows the recent restructuring of the Government Development Bank for Puerto Rico under the law’s Title VI.

SANTEE COOPER IN PLAY?

The State of South Carolina has received four legitimate offers to buy all of Santee Cooper and pay off the state-owned utility’s $8 billion in debt according to Virginia-based ICF, a consultant advising on a possible sale of the municipal utility. ICF was hired by a special committee of lawmakers and the governor. ICF estimates the sale of Santee Cooper would leave its customers paying less for the V.C. Summer debacle than customers of SCE&G, the majority partner in the failed $9 billion project. SCE&G customers collectively must pay an additional $2.3 billion for two unfinished reactors over the next 20 years even though the utility was bought by Virginia-based Dominion Energy earlier this year.

It is estimated that customers that Santee Cooper directly serves will be forced to pay roughly $6,200 more per household in higher rates for the unfinished reactors over the next four decades. Customers of the 20 co-ops who buy power from Santee Cooper contractually are obligated to pay about $4,200 per household for the failed project.

Seventeen parties expressed interest in Santee Cooper at one point but,  only 10 submitted preliminary bids. Companies that privately have shown interest in Santee Cooper include Florida-based NextEra Energy, Charlotte-based Duke Energy, Virginia-based Dominion Energy, Greenville-based Pacolet Milliken Enterprises, Atlanta-based Southern Co., New York-based LS Power and South Carolina’s 20 electric co-ops – who together buy three-fifths of Santee Cooper’s electricity. Dominion said it is interested in managing Santee Cooper – but not buying it.

The report begins a process of evaluation of proposals by the State legislature. The likely timeline for the process would not likely provide for a resolution before the fall. The outcome is far from a slam dunk as there are many perspectives being brought to the debate. They include issues of public versus private ownership, the jobs of current Santee Cooper employees. Skepticism is seen as being a bigger issue in the State Senate where members have been skeptical that a for-profit company can buy Santee Cooper, pay off its more than $8 billion in total debt, and still charge lower electric rates than the not-for-profit state agency.

A more subtle issue would be the long term status of Santee Cooper’s coal fired generation assets. The report acknowledges that any buyer could find cost savings by investing in more natural gas generation and moving away from Santee Cooper’s coal-fired power plants. Those decisions will have real implications for the locations of those facilities.

Ultimately, the coop customers probably hold the hammer in the resolution of the situation. The co-ops could opt out of their long-term contract to buy power from Santee Cooper if they don’t like the buyer, taking 60% of the utility’s business with them. But the co-ops have said they favor a sale or transformation of Santee Cooper that would lower their customers’ power bills.

NEWARK UPGRADE

Moody’s Investors Service has assigned a Baa2 underlying rating  and upgraded the city’s outstanding GOULT, GOLT, GOULT & GOLT-backed non-contingent lease debt, and GOLT-backed custodial receipt debt to Baa2 from Baa3. The upgrade was attributed to “the city’s weak, albeit improved, fund balance and cash position, a sizeable and diverse tax base, and an elevated debt and pension burden. The rating also incorporates the city’s weak resident wealth and income levels, elevated poverty, and recent tax base growth.”

The outlook on the underlying rating remains positive. The outlook relies on the premise that the recent positive trend of financial operations will continue, leading to a strengthened reserve and liquidity position. The outlook also incorporates expectations that ongoing redevelopment will lead to material tax base expansion. It is important to note that Newark is the county seat for Essex County (Aaa) and New Jersey’s most populous city. It has a population of approximately 285,000 and is a major regional economic center and transportation hub.

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

Joseph Krist

Publisher

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NATIVE AMERICAN CASINOS

While the debate over the benefits of casinos operated by Native American tribes will continue, there has been a resolution of one long running dispute between a tribe and the communities which host Native American casinos. Recently, an arbitrator found that the Seneca of Nation of Indians in western New York were required to continue to make revenue sharing payments to host communities. The arbitration panel ruled the Senecas must continue to pay the state a percentage of the nation’s slot machine revenues, as well as nearly two years of back payments. Buffalo, Niagara Falls and Salamanca will all receive funding they have been due but were not receiving while this battle was being waged. The arbitration panel ruled the Senecas must continue to pay the state a percentage of the nation’s slot machine revenues, as well as nearly two years of back payments. Buffalo, Niagara Falls and Salamanca will all receive funding they have been due but were not receiving while this battle was being waged.

The decision has the most meaning for the City of Niagara Falls which relies heavily on these payments. The casino had been hailed as the most significant economic development project in the City for some time. The loss of these revenues put significant pressure on the City’s finances. While it was working from a stronger financial base, the town of Salamanca would also face negative financial impacts from the tribe’s withholding of revenue sharing payments. Moody’s has noted that “had the Seneca Nation won the arbitration and refused to make payments to these cities going forward, both cities would have faced significant financial uncertainty.” 

Moody’s has declared that last week’s resolution in an arbitration between the state and the Seneca of Nation of Indians will have a positive financial impact on three Western New York cities.

COFINA REFINANCING

The Financial Oversight and Management Board has submitted its arguments in support of the pending restructuring agreement designed to refinance the Commonwealth’s outstanding $17.6 billion of Cofina’s debt. The judge overseeing the Commonwealth’s pending Title III proceedings had had asked for legal arguments to support the new Cofina structure amid concerns it would be a de facto rewrite of the commonwealth’s Constitution. 

The concern comes from the provisions of the restructuring plan which effectively commit future legislatures to appropriate for debt service. The plan would also effectively change the definition of available resources, as Cofina will be given ownership of a portion of the sales and use tax revenue. Does that clash with constitutional provisions supporting general obligation debt as the first priority of payment?

The request does reflect the concern about the willingness to interpret the Constitution in opposite ways depending on the situation. If the judge’s concerns stand, the creditors would be seen as asking for some of the very provisions established to support investment in the bonds to now be inoperative in order to “save” the existing creditors.

The Board made some substantial claims in its arguments. The bond legislation is “valid and constitutional,” the board reiterated. In order to confirm a Title III plan, section 314 of Promesa requires that the court find the debtor is not prohibited by law from taking any action necessary to carry out the plan. The board asserted that, under Promesa, the court has jurisdiction over all property of the commonwealth and has held that the determination of the extent or validity of Cofina property is a mixed question of federal and state law.

For those of you who don’t follow the ins and outs of things, the restructuring of Cofina’s debt has two parts. In the first, commonwealth and Cofina bondholders settled their dispute over ownership of the sales and use tax by agreeing to divide the 5.5% portion of the 11.5% sales and use tax. From the 5.5% portion, Cofina will keep 53.6% and the commonwealth receives the rest. According to court documents, the split will result in the commonwealth receiving about $400 million a year from the sales and use tax over the next 40 years. Secondly, under the debt plan, Cofina bondholders will exchange their current bonds for new bonds whose value is being cut. Cofina senior bondholders will recover 93% of the value of their original bonds and junior bondholders 53%.

FOXCONN IN THE INCENTIVE COOP?

It is not often that something said at the World Economic Forum in Davos has direct meaning for municipal credit issues. One thing we saw did catch our attention as it dealt with a favorite topic – the use of tax incentives as a job generator.

Until Amazon held its competition between cities vying for the location of what they thought could be 50,000 jobs, the most significant use of tax incentives to lure jobs was the deal which the State of Wisconsin arrived at with Foxconn. Away from the sheer size of the package, the timeframe for recovery by the State of its “investment” was one of the primary sources of criticism of the plan.

The consensus is that the breakeven date for the return on investment was sometime in the mid 2040s. That assumed that the employment levels advertised to arise from this deal were based on certain assumptions including the types of jobs, the products to be made there, and the availability of workers. There was concern that previous experiences with Foxconn and its failure to follow through after receiving tax incentives put the benefits of the factory at risk.

Now, we have upper management from Foxconn participating in a discussion at Davos regarding automation and production. There Foxconn stated that their goal was to have 80% of its production accomplished through automation and artificial intelligence. The comments came at the same time that the company was fighting off a spotlight on the fact that it appears that Foxconn wants to import Chinese engineers to work in Wisconsin.

The comments have raised concerns that the employment to be generated for Wisconsin residents will be concentrated in lower skilled (and lower value) assembly jobs while the higher paying technical jobs will go to others. If that is indeed the case, the economics of the deal become less favorable. That will lead to lower than expected levels of economic activity, less tax revenue, and the opportunity cost of foregoing those revenues during a time of scarce resources across the country for governmental projects.

Hopefully, Amazon will be a more reliable partner at its new locations. The Virginia legislature is moving bills through which would approve state tax incentives of up to $750 million over the next 15 years for Amazon to build a headquarters facility in Arlington.  The package would provide cash grants to the online retail giant on condition that the company create tens of thousands of jobs with average pay of at least $150,000 a year. The bill would also include giving grants of $22,000 per new full-time job for the first 25,000 jobs, for a maximum of $550 million. After that, grants of $15,564 per new job would be issued for up to 12,850 additional jobs, for a total of $200 million.

GAS TAXES ON THE DOCKET

Many state legislatures are looking at the prospect of raising gas taxes to finance infrastructure projects. The moves come amidst the lack of a federal program to fund infrastructure. States realize that they do not have a reliable federal partner so they are taking matters into their own hands.

The latest example is in Hawaii where measures introduced in both the state House and Senate would increase gas taxes and other vehicle fees to generate additional money for the State Highway Fund. The proposed legislation would increase the state gas tax from 16 cents to 21 cents per gallon on Hawaii Island and other neighbor islands, and to 22 cents on Oahu.

Other fees would be increased. The legislation also would increase annual vehicle registration fees by $5 — from $45 to $50 — and increase tax rates for each gallon of diesel oil, as well as gasoline or other aviation fuel used for airplanes, by 1 cent. The state vehicle weight tax also would increase. The state Department of Transportation estimates that an increase of 5 cents per gallon of gas would raise an extra $27.2 million in revenue. The proposed change to the vehicle weight tax is expected to generate an additional $10.12 million in revenue, while higher registration fees will generate nearly $5.6 million, for a total of $42.9 million in additional funds.

Not every state sees the same level of political support. A recent poll of Wisconsin voters showed that voters are reluctant to raise taxes and fees for roads and highways. The poll shows 52%  prefer to keep gas taxes and fees where they are — while 42% favor increasing both.

TARIFFS BITE

We finally have an estimate of the economic impact of the Administration’s tariff wars. “On net, CBO estimates that the new tariffs on both imports and exports will reduce U.S. real GDP by about 0.1 percent, on average, through 2029.” The tariffs amounted to import taxes of 10-30% $284 billion of imported goods, amounting to 12% of all imported goods. In response, U.S. trade partners put tariffs of their own on $134 billion worth of American exports, equivalent to 9%.

Supporters of the trade policies behind tariffs to the fact that In 2018, the level of revenues collected from both pre-existing and new tariffs amounted to $41 billion, or 0.2 % of GDP. CBO projected that the level of duties would rise to 0.3% in 2019 and hover between 0.3 and 0.4 % of GDP over the next decade. 

Imagine the reaction if a tax was imposed by say, a Democrat, which created a permanent drag on the economy of 0.4%. Economic drag is always the argument against regulation and other policies. So we note this self-inflicted wound which will have uneven impact throughout the economy.

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

Joseph Krist

Publisher

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TARIFFS INFLUENCE BUT DO NOT YET HURT RESULTS

There has been much to consider in terms of the potential impact of the ongoing US trade wars. One of the ready points of worry is whether tariffs against Chinese goods would lead to sufficiently diminished shipping volumes which would hurt port revenue bond coverage. Initially, that concern was not supported by full year results at at least one major west coast port.

The Port of Oakland reported a record-setting 2018 in cargo movement, thanks to an expected spike in imports aimed at beating new tariffs on goods shipped from China. The Port handled 2.5 million 20-foot containers in 2018, up 5% compared to 2017. Imports were up 5 % and exports were down 3.5 % over the same time period. Empty containers returning to Asia, the port’s largest trading partner by region, increased by 19.7 %. 

The bases cited for the strength of the 2018 numbers especially those for the fourth quarter do raise some ominous signs.  A spokesman for the Port did admit that “some of the shippers we talked to did indicate that there was an attempt to move cargo much more quickly, in hopes of beating the tariffs.”  Other data such as the volume of empty containers exiting the port point to support for the surge theory tied to pending tariff increases.

The same pattern is seen at the other major California ports. The Ports of Los Angeles and Long Beach said they set all-time records for moving cargo in 2018, after U.S. retailers and manufacturers pulled forward imports to avoid higher tariffs on Chinese goods. The Port of Los Angeles, North America’s busiest container port, handled 9.46 million 20-foot equivalent units (TEUs) last year, the most in its 111-year history and 1.2 percent more than in 2017.

The neighboring Port of Long Beach processed more than 8 million TEUs for the first time last year, after container cargo totals jumped 7 percent from 2017.

So like so many things, the near term outlook is really out of the control of the port operators. The failure of negotiations on trade would diminish volumes in both directions and would clearly negatively impact port revenues.

PUERTO RICO

Special Claims Committee announced that it and the Official Committee of Unsecured Creditors in Puerto Rico’s debt restructuring filed an objection in U.S. District Court to a portion of the settlement which would “annul” more than $6 billion of Puerto Rico’s bonded debt. The board and the Creditors’ Committee asked the judge overseeing Puerto Rico’s restructuring case to also disallow the claims of that debt under Title III of the Puerto Rico Oversight, Management, and Economic Stability Act (Promesa).

All general obligation bonds, which are backed by the full faith and credit of Puerto Rico, issued by Puerto Rico in 2012 and 2014 are considered invalid debt by the board. The board asserts that the so-called “invalid debt” was issued in “clear violation” of the commonwealth’s Constitution and should be declared null and void. This comes in the wake of a study undertaken for the Board to determine the validity of the Commonwealth’s outstanding debt. The matter, involving bond issuances in 2012 and 2014, will be heard during a Jan. 30 omnibus hearing. 

GO creditors including bond insurers have challenged the determination of invalid issuance. Assured Guaranty articulated the concerns of the impacted GO creditors. “Commonwealth’s Series 2012 A GO Bonds insured by Assured Guaranty Municipal Corp. were issued in full compliance with applicable provisions of the Puerto Rico Constitution and related laws, including the constitutional debt limitation provision, and we believe that they are legal, valid and binding obligations of the Commonwealth. In 2012, AGM insured $369 million of 2012 A GO refunding bonds while at the same time coming off risk on $532 million of GO bonds we had previously insured. The $369 million has been included in the amounts of Puerto Rico exposure we regularly disclose.

L.A. TEACHERS STRIKE

The ongoing strike by the teachers of the Los Angeles Unified School District is garnering much attention. Given the job actions undertaken by teachers in several states during last year’s budget cycle, the focus of much interest and coverage has been on the issue of teacher pay.

From this standpoint, we see much much more going on. The issues included in these negotiations also include things like class size which are under the control of the District but also are on much larger issues which go beyond the District’s boundaries. The dispute is designed to focus on things like housing affordability for teachers, state aid levels, and charter schools.

These issues have arisen in other California school districts but they have not been at the scale of those in the nation’s second largest school district. The teachers, by pressing for more state aid are hoping to blunt opposition from property tax payers to  higher school taxes. Reducing that burden makes it easier to make the case for public education and traditional funding. The union also hopes to – from its perspective – level the playing field between pure public schools and charter schools.

But it is fair to ask why would a bondholder care? The rating agencies have put forth a variety of comments on the strike but they all make the point that the dispute is not seen as a credit issue.

BUT IT WILL BE FELT AT THE STATE LEVEL

The headlines make the case: Texas Lt. Gov. Dan Patrick (R), a staunch conservative, has proposed increasing teacher salaries by $5,000 across the board, an expense that would cost the state $3.7 billion over two years.

 Georgia Gov. Brian Kemp (R) has proposed a $3,000 increase, at a cost of $418 million.

 South Carolina Gov. Henry McMaster (R) wants to give teachers a 5 percent pay raise, totaling about $155 million.

Arkansas legislators will debate increasing teacher salaries over the next three years, under a bill introduced this week. 

In Indiana, Gov. Eric Holcomb (R) this week proposed using billions in state reserve funds to pay down pension liabilities, saving the state $140 million. He proposed giving all of those savings to teachers in the form of pay hikes.

Clearly the politics have moved in favor of the teachers. That will drive a demand for more state level funding to keep property taxes as low as possible.

SHUTDOWN IMPACTS

Metro is losing $400,000 a day as the federal government shutdown drags on, cutting into its ridership and parking revenue, according to a letter the agency sent to the region’s U.S. senators. the agency has suffered daily rail ridership losses averaging 16 percent; average daily ridership for Metrobus is down 8 percent.

Any transit agency which relies on federal grant money an agency is owed is not being disbursed, leaving the agencies with varying levels of capital spending that has not been reimbursed. 

States and municipalities which have large SNAP (food stamps) recipients are facing the potential need to either fund the payments due this month and next month from their own resources or see thousands of their residents unable to get food and not generate the economic activity such purchases generate. Either way the impacts of the shutdown expand daily.

The view here is that even another month of shutdown will not lead to muni defaults. It is a problem nonetheless as these sorts of artificial distortions to economic activity are detrimental to realistic revenue estimation and planning. This at the time of year when the majority of budget plans are considered and adopted. Like it or not, the federal budget has become so intertwined with those of state and local government that disputes like that over the federal budget can easily lead to negative impacts at the state and local budget level.

THREE THINGS TO WATCH FOR

The PG&E bankruptcy could be resolved in a number of ways which could easily involve public utilities. There are numerous transmission and/or generation and/or distribution utilities owned and managed by municipal utilities.  The interest is in whether any of the municipal entities become part of a solution. A federal judge is considering ordering Pacific Gas and Electric Co. to inspect its entire electric grid in the coming months and turn off power during windy weather if it has not determined its equipment is safe for those conditions through pending litigation.

The resolution of disagreements over how best to deal with the development of additional nuclear generating capacity at two southeastern US sites in the face of unfavorable economics. The two sites face different initial fates – the South Carolina plant is suspended while the Georgia plant plunges on. The former is more of a regulatory political situation while the likely decision driver in the Georgia situation is at this point a legal dispute.

The unfolding drama surrounding New York’s MTA will ultimately improve the clarity about all of the competing motives and interest groups make the MTA an interesting credit. The latest plan to repair the subway tunnel to Brooklyn is the subject of much controversy. If it is adopted, the City will have taken a number of steps like closing and reconfigurations of the streets to accommodate the lost subway volume. With the line likely to be usable much more of the time, the resulting traffic changes will reveal much about the alternative transportation space.

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

Joseph Krist

Publisher

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KENTUCKY CONSIDERS MARIJUANA

In the Bluegrass State, a medical marijuana legalization bill will be filed in the 2019 Regular Session. House Bill 136 will look to make medical marijuana available for up to 60,000 Kentuckians. “The intention of this legislation is not the generate tax revenue, but rather to provide relief to the thousands of Kentuckian who suffer from conditions that have not responded to traditional medicine,” according to the bill’s sponsor. The bill does not allow those using medical marijuana to “smoke in public”.  It would be up to the doctor to decide what form of cannabis patient would benefit from.

Requirements include a yearly licensing fee and limits on possession. The bill sponsors say the intention is strictly to give patients additional treatment options. Kentucky is already a producer of hemp used for medical marijuana purposes. It exports hemp for use in the production of the non-intoxicating CBD products sold in other states. Medical marijuana would be regulated by the Department of Public Protection’s Office of Alcoholic Beverage Control. The state-run system will issue licenses for cultivators, dispensaries, safety facilities, processors along with practitioners and patients.

PURPLE LINE BLUES

The long saga of Maryland’s Purple Line continues its twisted route to completion. After legal delays and other issues, Purple Line Transit Partners (PLTP), a team of companies building the 16-mile line and helping to finance its construction, has told the state the line won’t begin carrying passengers until February 2023.  That represents an 11 month delay from the most recent projection.

It comes as some State officials project an October 2022 opening. The problem is that the February 2023 opening date is possible only if work is accelerated  according to the contractor. Also, delays have added at least $215 million to the light-rail line’s cost.  The news comes amidst reporting from the Washington Post that the delays — and the potential for hundreds of millions in cost overruns — have been the subject of intense discussions between the state and PLTP for nearly two years, before construction even started.

Even the effort by the State adds to the confusion. “The Maryland Department of Transportation, Maryland Transit Administration and the Purple Line Transit Partners are still working on developing a recovery schedule to open the Purple Line for revenue service by the end of 2022.”  The delays add to the Line’s already controversial history. It also is not providing support for the P3 movement as the latest delays are attributable to construction issues as opposed to the many legal issues which slowed development.

THE LATEST FROM NYC

The mayor said a millionaire’s tax, a transportation bond act, and congestion pricing could be used to help fund the nation’s biggest subway and bus system. That is a turnaround from the mayor’s prior position against congestion fees. It is a reflection of how difficult the City’s transit situation is.

Millionaire’s taxes are becoming a more established feature of budget suggestions from “progressive” public officials and candidates. We see this proposal to have the least likelihood of success in the state legislature. It also is interesting that while the City fights calls to increase annual operating funding for the MTA, it has found funding for its attempt at universal healthcare.

All of these issues are arising at a point in the cycle where it is hard to argue that we are closer to the beginning than the end. The undertaking of these kind of significant initiatives at that point generate increased fiscal risks going forward.

GUAM – THE OTHER TERRITORY

After the Puerto Rico debt debacle, some investors sought to maintain the tax benefit of territorial debt by looking at credits in Guam. In the face of the continuing fiscal difficulties in Puerto Rico and the US Virgin Islands, it is refreshing to see ratings progress in at least one case. Last week, Moody’s maintained its Ba1 issuer rating but lifted the outlook to stable from negative.

The loss of income tax revenues triggered by federal tax cuts enacted in December 2017 led  Guam’s government to offset the lost revenue in fiscal 2018. It bolstered its liquidity with a temporary increase in the business privilege tax, one-time revenues from a tax amnesty program, and spending cuts. It offset the lost revenue in the fiscal 2019 budget with a permanent extension of the increase in the business privilege tax and a continuation of most of the previously enacted spending cuts.

The credits continue to reflect general fund deficits and debt levels which, while below those of other territories, are significantly above US state medians. Generally positive economic trends and a good economic outlook, and a favorable pension funding situation are also reflected in the rating.

The improved outlook for the general credit of Guam also benefits its other issuers. Guam Power Authority, Guam Waterworks Authority, and the Port Authority of Guam all saw the outlook on their ratings move from negative to stable.

BUDGET SEASON UNDERWAY

California has seen a proposed budget and New York will follow this week. The budget proposals for many other states have begun to emerge. There are a number of common areas of emphasis. Education is the leader with funding being proposed for better compensating teachers as well as universal pre-K. Energy is emerging as a point of emphasis with the expansion of alternative energy capacity is high on the list of many.

Another common theme seems to be transportation. Whether it be the expansion of current capacity, the maintenance of existing but aging infrastructure, or the application of “smart” road technology nearly every state of the state speech references the need to support infrastructure especially for transportation. The need to protect the environment (even if just for tourism development) is another priority given the change in policy in Washington. The current shutdown situation highlights how states view national parks and the vital economic role that some of these facilities play in those jurisdictions.

Overlaying all of this is the uncertainty surrounding the revenue outlook. It is clear that the impact of federal tax changes which led to an increase in state and local revenues has been significant. The concern is that the increases in state revenues seen in 2018 may not be permanent as taxpayers adjust behavior and the impact of changes such as the loss of the SALT deduction on economic behavior finally emerge.

There are also trends which suggest that a bit of caution is appropriate. As states report revenues through year end, there are multiple instances of drops in December’s revenue on a year over year basis. The debate over the tax cut did lead some tax payers to accelerate payments into calendar 2017 and also led to efforts to prepay 2018 taxes so that those payments could be deducted before the SALT deduction change went into effect.

IT ONCE WAS LOST BUT NOW IT’S FOUND

In 2017, a new financial management team in Philadelphia reviewed the City’s finance and accounting practices an records. This process resulted in the discovery of significant discrepancies in the City’s record keeping processes. It was said that the inability to reconcile records had led to the “loss” of $40 million. The solution was the creation of panel of officials to investigate the scope of the problem and seek ad/or implement changes to the City’s accounting practices.

The panel was led by Philadelphia’s Treasurer Rasheia Johnson and former City Controller Jonathan Saidel. It  announced last week it has fully reconciled 76 of 77 city bank accounts with reconciliation of the final account slated for early January. The efforts helped reduce the difference between Philadelphia’s city records and its bank accounts to $900,000 from $40 million identified in 2017.

It was easy to look at the situation as a significant negative. We took the view that the situation while not desirable was not a sign of impending crisis or an inability to service debt. Given the fact the problems reflected issues with a lack of technology and centralized bookkeeping, it was likely that the accounts would eventually be reconciled. And so now, what once was lost has now been found.

SHUTDOWN PAIN CENTERS

In Huntsville, Ala., the National Aeronautics and Space Administration and the U.S. Army are the two largest employers. In Chicago, the Chicago Federal Executive Board is the largest employer with nearly 50,000 employees affected by the shutdown. The Treasury Department is a major employer in both the Philadelphia and Kansas City metro regions.  Once you are outside major metropolitan areas, the story is perhaps more painful.

Rural states are among those with the highest percentage of their workforces employed by federal agencies that have shut down. Montana, Alaska, New Mexico, Wyoming and South Dakota are some of the most exposed. And it is not just the fact that people are forced out of work. These are often some of the best paying jobs in rural areas.

It’s not just rural areas that see this income effect. Metropolitan-area federal workers earn on average 50% more annually than nonfederal workers, according to 2017 data from the Labor Department. In El Paso the average federal wage is twice the local average and in Huntsville the scientists and engineers employed by NASA generate wages some 85% higher than the local average.

Other problems include holdups in home sales, distributions of monthly transit funding, issuance of Section 8 vouchers, payments to contractors. With each day, the negative impacts of lower spending related to the shutdown become greater and clearer. And pretty soon, Americans will learn about the multiplier effect as reduced spending and economic activity impact businesses which are based on their proximity to federal facilities.

PG&E

The announcement that Pacific Gas and Electric plans to enter into Chapter 11 proceedings is of interest to the municipal market. The timing of the move may have been the subject of some debate but the forces leading to the move have been obvious for some time. For owners of pollution control bonds backed by PG&E, the decision could have real ramifications.

The company, which is the largest investor-owned utility in California, said it faced an estimated $30 billion liability for damages from the 2017 and 2018 wildfires that killed scores in Northern California, a sum that would exceed its insurance and assets. The announcement was driven by state requirements that the company was required to give employees 15 days’ notice of such a move.

PG&E cited 50 complaints on behalf of at least 2,000 plaintiffs in connection with the Camp Fire, including six seeking to be litigated as a class action. It also cited 700 complaints on behalf of at least 3,600 plaintiffs related to 2017 wildfires, including five seeking to be certified as class actions.

We’ve been here before as PG&E went bankrupt early this century when a deregulation move by the state in 2000 and 2001 resulted in blackouts and soaring electricity rates.

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

Joseph Krist

Publisher

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This week we start the New Year with commentary on some of our favorite subjects. The latest on Florida’s high speed railroad, healthcare mergers, pensions, New York City, pensions, public education and charter schools, and the latest moves in the perpetual Santa Rosa Bay Bridge default.  We look at California’s changes to its system of oversight of fiscally distressed school districts. Happy New Year!

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BRIGHTLINE

The Office of Program Policy Analysis and Government Accountability is the research arm of the Florida Legislature. In October it issued a report on rail safety. The report got a bit more exposure as the operators of the Brightline sought an extension on the existing December 31 deadline to close on an issue of private activity bonds.  They were successful in obtaining a six month extension of that deadline. The USDOT however,  advised Brightline that “any amount of unused bond allocation following an initial bond issuance will automatically return to U.S. DOT’s remaining aggregate amount of private activity bonds, and thus be available for other eligible applicants.” The bond extension gives Brightline more time to complete a separate application for a Railroad Rehabilitation and Improvement Financing loan to further cover the cost of the Miami-to-Orlando service.

HEALTH MERGER

A proposed merger between San Francisco-based Dignity Health and Catholic Health Initiatives, based in Englewood, Colorado, has been delayed. The two hospital heavyweights have moved the expected closing date for their new combined organization to Jan. 31, 2019 from Dec. 31, 2018, according to a statement from Dignity. Dignity’s statement said the two companies “continue to finalize the last steps to bring our operations together and to combine our ministries, including the completion of licenses, certifications and other administrative items. We are looking forward to completing our alignment.”

The merger, proposed in December 2017, aims to create a new company called CommonSpirit Health that will have operations spanning 16 states and including 136 hospitals, including 30 hospitals in California. Dignity runs five hospitals in Arizona, three in Nevada and 31 in California. In the North State, it has Mercy Medical in Redding, St. Elizabeth Community Hospital in Red Bluff and Mercy Medical Mt. Shasta in Mount Shasta.

SANTA ROSA BRIDGE DEFAULT

It may the Freddy Kruger of bond defaults but the bondholders are taking another whack at the Santa Rosa Bay Bridge credit which has had a troubled financial history over its 20 year life. The trustee bank representing bondholders filed a lawsuit seeking to force the state Department of Transportation to raise tolls on Northwest Florida’s Garcon Point Bridge to pay off construction bonds that are in default. The Trustee is asking a judge to order the Department of Transportation to “upwardly adjust” the tolls. The $3.75 one-way toll has not changed since 2011.

The lawsuit, filed in Leon County circuit court, alleges the failure to increase tolls is a violation of the original bond agreement that stated the Santa Rosa Bay Bridge Authority, which has since disbanded, or the Department of Transportation would maintain tolls that “would always generate sufficient revenue” to pay off the bonds.

Since the bridge authority has no members, the lawsuit said the responsibility to raise the tolls falls on the Florida Department of Transportation, and the agency’s “intentional failure to timely respond to the revenue shortages” has resulted in the loss of toll revenue that should have been collected and paid to the bondholders. The bondholders are caught between the rock of no toll increases and the hard place of insufficient demand for the bridge.

The credit has found itself in a classic death spiral as higher tolls weaken already dampened demand which then drives the need for high tolls. As this story has unfolded, many other factors have changed. The real estate development which was supposed to result from the bridge has been buffeted by a number of events. The latest is the relatively decreased attractiveness of barrier island real estate in an era of climate change. Have the fates conspired against the project? Yes. Does that make it imperative that a speculative investment be bailed out? No.

DIFFERENT PATHS FOR PUBLIC EDUCATION

The City of New Orleans is poised to become the first city in the US to turn over its entire public school system to charter operators. What is interesting about the situation is that one of the pillars of support for the charter school model versus the traditional public school model is the need for choice. Here is the first significant example of a system where there is no choice but that the monopoly which creates this phenomenon is private rather than public. That introduces a totally new twist on the issue whichever side of the charter school issue you find yourself on.

Our interest in the issue is predominantly academic. Over time, the results delivered by the charter school space in a non-competitive environment will go a long way towards shaping the debate over how best to provide K-12 education. Those results will be seized upon by either side in the debate.

As New Orleans goes the charter route, the Los Angeles USD is gearing up for a potential strike by the District’s teachers. The nation’s second largest school district takes up this negotiation in the environment left after numerous teacher job actions across the country highlighted the lack of salary growth for teachers. California has been a less favorable environment for charter schools relative to the rest of the country. The negotiations are expected to be contentious.

PENNSYLVANIA PENSIONS

In 2017, the Commonwealth of Pennsylvania enacted legislation establishing the Public Pension Management and Asset Investment Review Commission (PPMAIRC). The Commission was charged with a comprehensive review of the investment management of the Public School Employees’ Retirement System (PSERS) and State Employees’ Retirement System (SERS). The hope was that the review could generate some $3 billion in savings for the underfunded systems.

Recently, the Commission released the results of its effort. It recommends more indexed investing, better discount rate assumptions, much more reporting transparency.  It’s major recommendation – maintaining full payment of the actuarially required contribution. Obviously, there are many variables contributing to the size of that requirement. But in the end, pensions require funding.

So much effort is expended on the retiree side of the equation – they are lazy, greedy, somehow undeserving, they hoodwinked their negotiating counterparts – that to some degree the issue of chronic underfunding (or political cowardice) has become less of a point of criticism. Where changes in conformance with the law are available should they be exploited? Certainly. But at the core the problem in its current state is underfunding.

One other issue which should be easier to address is the issue of costs of managing the funds. The report concludes that the Commonwealth’s pension funds underperform and incur higher than average expenses. According to the Commission, changes in how much work is “farmed out” to external managers or advisors, negotiation of better fee structures, and more efficient internal procedures could generate between $8.2 billion and $9.9 billion of expense savings over a 30 year period.

NEW YORK CITY BUDGET OUTLOOK

The City’s Independent Budget Office (IBO) has released its outlook for the City’s fiscal position in 2019. IBO’s latest projections of revenues and spending under the contours of the Mayor’s November 2018 Financial Plan show the city ending the current fiscal year with a surplus of nearly $400 million. Assuming this year’s surplus is used to prepay some of next year’s expenses, we project a shortfall of $2.1 billion for fiscal year 2020, just 3.0 percent of city-funded expenditures. With a reserve of nearly $1.3 billion already built into next year’s budget, this gap is very manageable, as has been the case in recent years.

IBO’s latest forecast for the local economy and tax collections does not foresee a steep slide through at least 2022. Nonetheless, there are concerning issues given the huge run up in head count by the current administration. Employment growth has slowed in 2018, and is expected to total 64,000 (fourth quarter to fourth quarter), nearly one-third lower than in 2017. It is expected that  positive employment growth to continue in 2019 through 2022 but to be well below the average of 97,000 in the preceding eight years. Assuming Amazon’s HQ2 project proceeds as scheduled, it will moderate, but not reverse, the trend.

IBO forecasts tax revenue of $60.8 billion in 2019 growing to $67.9 billion in 2022, with much of the increase attributable to the property tax, which is expected to grow at an average rate of 5.5 percent annually over that period. After an extraordinary 2018, growth in personal income tax revenue will fall off to a more typical pace. IBO’s tax forecast exceeds the de Blasio Administration’s by $558 million in 2019, $1.0 billion in both 2020 and 2021, and $1.6 billion in 2022, with much of the difference attributable to the outlook for property and the income taxes. IBO projects that total city spending will grow from $90.6 billion this year to nearly $100.5 billion in 2022, an average annual rate of 3.5 % and just below the 3.7 % rate of growth it projects for tax revenues.

There are areas of spending growth which are worrisome. The cost of health care for city employees will rise from $6.7 billion in 2019 to $8.1 billion in 2022, an increase of nearly 7 %. IBO’s forecast for tax revenue in the current fiscal year is $60.8 billion, a gain of 3.2 % ($1.9 billion) from 2018. This growth would be slower than all but one other year in the current expansion and far slower than in 2018, when tax revenue increased 8.4 %. Total tax revenue growth will be faster in 2020 and subsequent years but will still be modest compared with growth earlier in post 2009 expansion. For 2020, IBO forecasts $63.2 billion in total tax revenue, 3.8 % ($2.3 billion) greater than the 2019 forecast. We project that tax revenue will rise at an average rate of 3.7 % annually over the final two years of the financial plan period and total $67.9 billion in 2022.

MEDICAID WARS

The only state which has been permitted by the federal government to implement work rules for Medicaid eligibility under the ACA has generated data on what the impact on recipients would be. That data would seem to support the efforts of those turning to the courts for relief from those requirements.

Arkansas has seen only 1,428 low-income adults required to report their hours in November logged at least 80 hours. Roughly 8,400 failed to report 80 hours, with 98 percent of them not reporting any work activities. The state has removed more than 16,000 low-income adults for failing to log at least 80 hours of work, job training, volunteering or similar activity — including 4,655 in November.

Arkansas’ conservative governor cites the motivation for the program – it provides the help residents need to become independent as justification for the program. Unfortunately, many of the affected citizens are in areas which because of geography or economics do not have internet access. That makes it difficult to comply with reporting requirements as does the fact that the internet site is only open for a limited period each day.

All of that makes it much easier to declare noncompliance and remove recipients from the rolls. So it does not necessarily generate jobs for people or improve or maintain access to healthcare.  That makes it easier for work rule opponents to voice the view that the goal is not independence but budget savings for the state government.  All of this will be hashed out in the federal courts. Individuals who don’t adhere to the new rules for three months get removed from Medicaid for the rest of the year. Nine Arkansas Medicaid enrollees who sued the Trump administration in August to block the rules. 

CALIFORNIA DISTRESSED SCHOOL DISTRICT OVERSIGHT

The Golden State’s Office of the Legislative Analyst recently offered its views of recently enacted changes to the State’s system for supporting distressed local school systems. First, some history. In 1991, the State enacted a Formal Process for Supporting School Districts in Fiscal Distress. This system was designed a variety of levels of support and intervention to districts based on their fiscal health. All districts, regardless of their fiscal position  are subject to ongoing fiscal oversight from their county office of education (COE). Districts determined to be exhibiting signs of fiscal distress receive special COE assistance. For those districts facing the prospect of being able to meet obligations including operating expenses can request an emergency state loan in exchange for temporarily ceding control to an outside administrator. Prior to 2018, these administrators were appointed and overseen by the state Superintendent of Public Instruction.

The fiscal 2019 budget process led to the enactment of changes to the way that extremely distressed districts would be dealt with. Legislation adopted as part of the 2018-19 budget package made three notable changes to the process for supporting districts in exceptional fiscal distress. First, it authorized special grants to supplement the loans already provided to the Inglewood and Oakland Unified school districts. Second, it shifted takeover responsibilities from the state to county level. Third, it established a new process for appointing outside administrators.

The LAO expresses concerns that the special grants to the two troubled school districts will encourage more districts to seek grants in lieu of making more permanent changes. The LAO view is that the state likely has weakened incentives for all districts to make the tough decisions necessary to balance their budgets. In addition, shifting takeover responsibilities from the state to county level could weaken oversight, as the state is better positioned to provide the independent, external perspective necessary for fiscally distressed districts to recover.

The LAO went farther and made recommendations for how to address the problems they see. They recommend supporting the Inglewood and Oakland Unified school districts within the traditional loan process. If additional support for these districts is deemed necessary, they recommend providing loan payment deferrals in exchange for greater state oversight. Concurrently, the LAO recommend shifting takeover responsibilities back to the state from the county level.

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

Joseph Krist

Publisher

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We take this opportunity for indulging my interests as we go off for the Christmas holidays. We wish you a hopeful Christmas. We wish you a brave new year. All anguish pain and sadness, leave your heart and let your road be clear.

IMMIGRATION POLICY AND HIGHER EDUCATION

Total international student enrollment is level (0.0 percent change) among responding institutions. Similar to data from Open Doors 2018, the number of international students pursuing employment opportunities following their academic studies on Optional Practical Training continued to increase (+7.1 %), while the number of enrolled students declined (-1.7 %). New enrollment numbers continue to vary based on institutional characteristics and geographic regions with Associate’s and Master’s institutions, less selective colleges and universities, and the Midwest reporting steeper declines. Research universities indicate an uptick in new international student enrollment. 49 % of institutions describe a drop in new international student numbers. However, 44 % of institutions report an increase, and another 7 % indicate new enrollment was stable. Overall,responding institutions report a 1.5 % decrease in the number of international students enrolling for the first time at a U.S. institution, which indicates a third consecutive year of falling new enrollment. The drop is not as steep as the new enrollment decline in Fall 2017 (down 6.6 % according to Open Doors 2018).

Compared to Fall 2017, more institutions attribute Fall 2018 declines in new enrollment to problems with visa delays and denials (83 percent), the U.S. social and political climate (60 %), and student decisions to enroll in another country (59 %). The common thread linking these issues: immigration policy and attitudes. The unending focus on the “danger” posed by foreigners generally cannot be expected to have anything other than a negative impact on foreign demand.

HUD WILL CONTINUE ITS PLAN TO PRIVATIZE PUBLIC HOUSING

One of the quietist privatization efforts has been underway at the Department of Housing and Urban Development. There have been so many larger issues/scandals during the Trump Administration that efforts led by more low key cabinet members have been able to move under the radar in terms of low income housing policy.

His image may be based primarily on parodies (Trevor Noah crushes it) but HUD has been far from sleepy under the leadership of Dr. Ben Carson. One of his biggest “accomplishments” to date has been to steadily shepherd efforts to get the federal government out of the business of managing and funding low income housing. The more obvious methods of doing so have focused on some large situations (NYCHA comes to mind)which are characterized by a wide range of issues. These other issues – day today infrastructure; funding; and local politics – have successfully obscured HUD’s continuing efforts to shift public housing residents into private housing with Section 8 vouchers.

Carson has suggested raising tenant rents and has held listening tours to encourage more private landlords to accept vouchers as public housing complexes are sold or demolished. That arguably makes sense but only when there are facilities and landlords willing to accept Section 8 vouchers. Recent news has not been favorable regarding the acceptance of Section 8 vouchers.

One example of the push to privatize is the situation with NYCHA. Here HUD has quietly used the potential for direct federal supervision of NYCHA, the nation’s largest public housing agency. In order to fight off such supervision, the DeBlasio administration has revived a previously panned Bloomberg era idea to build market rate housing on open spaces and parking lots included in those properties’ footprints. The plan faces significant political and popular opposition.

In other places, HUD is planning to take projects under its receivership and determine if there are grounds to close those facilities. HUD has done so once before and is in the process of undertaking another such action presently. The current situation in Missouri would mark the second time that the agency has exited a receivership by abolishing a housing authority (the first was in Orange County, Texas, in 2004), and the first time HUD has proposed demolishing or selling all of the public housing complexes in the process.

We will see more of this as the agency’s inspector general prepares to send teams of agents out to examine dozens of “troubled” housing authorities nationwide, which it has never done before, officials said. It is a rough process involving evictions.

The troubled projects share characteristics including incompetent if not criminal management and crumbling infrastructure. Municipal market participants will have noticed a decline in issuance for repairs to public housing facilities. These financings were backed by payments from the federal government to local housing which levered those revenues to support municipal bond debt. That program has been hampered by consistent pressure to cut appropriations to the program as well as uncertainty in funding levels through their inclusion in the annual circus known as the federal budget process.

ANOTHER EFFORT TO PUBLICLY FUND PRIVATE SCHOOLS

The State of Montana operates a tax program designed to help to support private-school scholarships. Many are used for attendance at religiously operated schools.  The Montana Supreme Court struck down the state-run program that gives tax credits to people who donate to private-school scholarships, saying the program violates a constitutional ban against giving state aid to religious organizations.

The program giving tax credits of up to $150 for donations to organizations that give scholarships to private-school students amounts to indirect aid to schools controlled by churches. There is a ban in the Montana Constitution on any direct or indirect state aid to such schools, regardless of how large or small the amount is.

Initially a local judge issued an order last year siding with parents who argued that the program is constitutional because it doesn’t use state funds, only taxpayer money. The law was enacted in 2015 as an alternative to a school voucher program designed to give students who want to attend private schools the means to do so. Most private schools in Montana have religious affiliations, and more than 90 % of the private schools that have signed up with scholarship organizations under the program are religious.

The case marks a longstanding effort by religiously based and operated schools to obtain funding from states. I can remember being asked as a fourth grader to write a letter to the Legislature asking for money for books. It was only considered educational if it paid direct costs of which books were not one. This was in the mid 1960s so it isn’t like the internet was around to help if we didn’t get the books.Unsurprisingly, the effort failed as the arguments that the books were not part of education turned out to be unpersuasive. The more things change, the more they stay the same.

It is of interest here because it goes to the root of funding education. The effort to find workarounds to shift funding from public to non-public schools is continuing. Regardless of one’s views on the politics of the issue, the fact remains that every student who moves from public to private is one less source of state aid based on average daily attendance to the public and one more to the private. In the current environment, the supporters of state aid for religiously based schools will continue their campaign. Conflicts like this make school funding and overall budget adoption more complicated and therefore not supportive of credit.

HOSPITAL DSH MAY NOT BE PILED SO HIGH

It appears that the Medicaid and CHIP Payment and Access Commission (MACPAC) is willing to recommend that Congress slowly phase in disproportionate-share hospital (DSH) cuts that are slated to start in October. Congress hasn’t revised its DSH statute since 1992 despite all of the changes in the healthcare space over a quarter century.

MACPAC is considering a proposal for Congress to change how HHS should divide up the DSH payment cuts, as the program’s allotments vary widely among states. The draft recommendation suggested HHS would favor states with the highest total population of poor adults who don’t qualify for Medicare. A state that doesn’t spend its full allotment would see that money deducted from its share the following year. We note somewhat cynically that some of those states would do so as the result of refusal to expand Medicaid under the ACA. It would also incentivize actions to permit short-term insurance providing minimal coverage.

DSH payments are supposed to decrease by $4 billion starting Oct. 1. By October 2020 they will decrease by $8 billion. So even under the status quo, change would be coming. The current debate is over timing and absorption of the lower funding into hospitals’ overall financial position.The decline in these payments, like just about every other policy twist, will work against smaller providers and single site DSH providers. That remains a sector full of credit danger.

MTA WILL CATCH UNENDING BAD PRESS – BUT DOES IT MATTER TO THE BONDS?

As we move closer to the start of the longawaited 15-19 month shutdown of the Millenial Express (to we natives the Ltrain) tunnel connecting the flannel clad beards with their jobs in Manhattan. It is becoming clear that even if the Authority surprisingly completed its project on time and on budget. there will be much to antagonize all sides of the long term transit debate as various governmental agencies  as various governmental agencies seek to mitigate the closure. And the Authority received an early lump of ratings coal in the form of a negative outlook from Moody’s.

But the relevant question for investors is does any of this matter? It will be a brutal period filled with sad commute stories,whining about the impact on real estate, and potential economic interruptions for businesses on both sides of the East River. The MTA will have  little to do with that other than to focus on getting the job done right in the least amount of time.

What will actually be interesting is to see how the many interest groups and companies will position themselves to be beneficiaries of the “disaster”. They include bicycle proponents,anti-car activists, congestion pricers, TNCs, and the like.

MARIJUANA WILL GROW

The upcoming year could mark a turning point in the movement to legalize marijuana for recreation at the state level. Now that the election time is over, the potential for changes has become clearer. New Jersey is in the midst of debating a plan to legalize recreational use.  Recently, Governor Cuomo’s office has confirmed that “the goal of this administration is to create a model program for regulated adult-use marijuana. We expect to introduce a formal,comprehensive proposal early in the 2019 legislative session.”

The debate has seemed to be less about whether cannabis will be legalized but where and how. Those issues will be settled in part by how the expected revenue pie is to be divided. The timing reflects the expansion of legal cannabis to Vermont and now Massachusetts in the last year. In a kind of domino effect, as one state legalizes the next adjacent state seems to move towards it.

We anticipate that the move to legalize cannabis will continue. While some doctors argue about how much research has been done, medical marijuana patients success with cannabis is expanding support for the concept. Medical marijuana seems to be a testing ground for implementation of cannabis deregulation before the tide of public opinion drives approval.

TRADE WILL CONTINUE TO THREATEN JOBS AND REVENUES

The moves may be against tariffs but if the apparent replacement is “quotas”, then the impact on municipal revenues will still be negative. Steel quotas will not lower the cost of infrastructure projects. Less than hoped for relief from agricultural tariffs will alter planting plans, possibly be a basis for longer lasting loss of marketshare and income, drive costs higher thereby pressuring income, and add a level of revenue volatility which did not need to occur.

There are already signs that the trade war is dampening US economic performance. Clearly trade war fears are a significant factor in equity market volatility and performance. Weaker equity markets will hit both the revenue side of the income statement and contribute to underperformance versus pension fund benchmarks. this will require increased spending as well as weaken balance sheets.

PRIVATE HIGHER ED WOES WILL CONTINUE

The latest casualty in the battle by small independent colleges to survive financially, Newbury College in New England announced that it would close at the end of the 2018-2019 academic year. Newbury has been on probation with accreditors since the summer because of financial issues. The school has suffered for several years from declining enrollment. The college was founded in 1961 and has an enrollment of 620,according to U.S. News and World Report.

According to the school, it is”still exploring potential partnerships that would allow us to remain open, but the Board of Trustees and I have concluded that it is in the best interests of our students, prospective students, faculty and staff to notify them immediately, so they can make the best decisions for their future. Financial challenges, the product of major changes in demographics and costs, are the driving factors behind our decision to close at the end of this academic year. “

Newbury will not be the last to suffer this fate. The challenging demographic trends pointing towards an increasingly competitive environment in terms of recruitment will not change and the relative scarce resources available to fund that competition will perpetuate the spiral.

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