Joseph Krist

Publisher

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The President has effectively announced game on in the effort to reopen the country. By adopting state by state approach, the reopening process will effectively create 50 state laboratories in terms of how this will work and what the impact on states will be a some try to reopen as fast as they can and others take a more measured approach. What will be most interesting is to see how it all unfolds. If early openers prove to be premature, the potential cost to those states could be significantly higher than it would otherwise be in the event of a second wave of infections. Those states could just as easily find themselves back at square one as they could find themselves able to move forward. In that event, those states would have merely increased the fiscal costs of the pandemic while doing significant additional damage to their state economies.

Whether a state opens or not, the pressure on state and local credits is only increased by the offloading of responsibility of responding to the pandemic to the states. That will exacerbate the high level of fiscal pressure on state and local government we already see. All in all, the Opening Up America plan introduced this week represents a transparent effort to shift cost down to state and local government without funding or financing support. It comes at a time of unprecedented federal hostility to local government which is unfortunately based on political interests rather than any sound public policy goals. It appears that the zombie protesters outside the state capitol in Ohio are running the show now. That is not good for munis.

BIG NAME CREDITS UNDER THE GUN

The ongoing impact of the pandemic on life as we know it continues to take its toll on some of the most widely held and best known credits. The latest example is the Port Authority of New York and New Jersey. The Port Authority generates the majority of operating income with the airports and the tolled bridges and tunnels. The Port Authority estimates it will receive approximately $435 million in federal stimulus funding under the 2020 CARES Act for its airports. It is likely that without additional outside funding that the aid will not be sufficient to cover the operating shortfall resulting from the limits on traffic. It is not clear at all whether there will be federal aid targeted at the toll facilities.

The reduced utilization does not offset the need for ongoing maintenance so that the facilities remain in good repair to accommodate a resumption of utilization. Fortunately, the PANYNJ had around $2.4 billion in the general reserve fund and around $1.6 billion in the consolidated bond reserve fund on hand at year end. Nevertheless, Moody’s has reduced its outlook for its rating on the Port’s consolidated bonds to negative to reflect ” the risk of total DSCR below Moody’s previous expectation of 1.75x and lower liquidity levels over the next 12 to 18 months. It also reflects the uncertainty around the length of governmental restrictions to contain the spread of the corona virus and the length of time before an eventual recovery of its credit metrics.”

The downgrade was followed by the Port’s own statement about current conditions. “Because approximately one third of the Port Authority’s revenues are derived from passenger tolls, fares and user fees, declining utilization has had and will continue to have a negative effect on our revenues for an indeterminate period of time. In addition, some tenants who pay rent to locate and operate at our facilities are also heavily affected by the reduced activity levels and may be unable to meet certain obligations to the Port Authority. Some have requested specific relief from contractual payment obligations.”  As of March 31, 2020, unrestricted cash and investments, including amounts in the General Reserve Fund total approximately $3.34 billion, with investments valued at market.

The other major New York credit to come under pressure is the Triborough Bridge & Tunnel Authority (TBTA). The TBTA’s facilities include: Robert F. Kennedy Bridge (formerly the Triborough Bridge), Verrazzano-Narrows Bridge, Bronx-Whitestone Bridge, Throgs Neck Bridge, Henry Hudson Bridge, Marine Parkway-Gil Hodges Memorial Bridge, Cross Bay Veterans Memorial Bridge, Hugh L. Carey Tunnel (formerly the Brooklyn-Battery Tunnel), and the Queens Midtown Tunnel. The TBTA receives its revenues from all tolls, rates, fees, charges, rents, proceeds of use and occupancy insurance on any portion of its tunnels, bridges and other facilities, including the net revenues of the Battery Parking Garage, and bridges and tunnels’ receipts from those sources. 

Moody’s reduced its outlook to negative from stable to reflect the assumption of materially lower TBTA revenues in 2020 due to the corona virus combined with ongoing credit pressure on the MTA which may materially reduce the organization’s combined liquidity. On the positive side, Moody’s estimates that ” the authority’s credit profile remains strong and could withstand approximately a 40% reduction in operating revenues in FY 2020 while maintaining its ability to pay debt service without liquidity support.”

It’s likely that we will see additional outlook adjustments and downgrades in the transportation sector. The Illinois tollway says passenger volume is down 55% since the stay-at-home order went into effect March 20.

THE PRESS AND MUNICIPAL CREDIT

This week the New York Times ran a story under the headline “Plunge in Convention Hotel Travel Puts Municipal Bonds at Risk”.  The story focused on convention center hotels, a sector which has experienced significant fluctuations in the perception of their credits. The sector emerged coincident with the widespread growth of high yield municipal bond funds. Unfortunately, the article was written from the operator and developer perspective so it was not particularly enlightening about municipal bonds.

Weeks ago, we flagged bonds whose credit relied on taxes and/or revenues to pay off the associated bonds as an area of concern. That was the case regardless of whether or not, there was a pledge of general municipal revenues. The article expressed the correct concern that reduced occupancy and reduced sales tax revenues were bad for these credits. The implication was that cities would be forced to expend general fund monies to support shortfalls in revenues available for debt service. What the story missed was that municipalities support these projects in a variety of ways and that the requirement to pay in the event of shortfalls is often far from a certainty.

Take Baltimore which supported the development of a 750 room hotel adjacent to its Convention Center. In this case, the city support includes the site-specific hotel occupancy tax (HOT) collected at the property and the ability to use up to $7 million of city-wide HOT that must be appropriated from the city’s budget annually, if needed. Yes, that money could have eventually made its way to the City’s general fund but the upfront pledge identifies this as a source of dedicated revenue. That’s a far cry from a city guarantee.

In the case of the Denver Convention Center financing, the City’s obligations are more definitively enumerated including its ability to use any general revenues it chooses. While still subject to annual appropriation, the more explicit language in the security for the bonds makes a better case for the City to be seen as supporting the bonds. In either case, the need for the project to succeed is basic to the security and ratings.

There is of course the issue of whether these concepts have been tested. In one of the better known high yield bond hotel defaults, investors counted on an annual appropriation mechanism to require the Village of Lombard, IL to make up project revenue shortfalls. Unfortunately for investors, the Village declined to make the appropriations when requested and debt service payments were missed. So much for precedent.

My point is that the major media outlets do such a poor job of covering our market. Granted that many of the issues which impact our market are nuanced but the inability of the press to figure it out with some help from people who know has long been disappointing. If you are on the retail distribution side of the business, these headlines just generate a lot of unnecessary angst that you have to deal with.

DATA BEGINS TO EMERGE

We’re seeing the expected press accounts of the fears over the impact of the pandemic on government finances. But it’s all about fear with little information. Now hopefully, the information void will start to fill. A recent report from NYC’s Independent Budget Office (IBO) is one of the first efforts at estimating the impact that we have seen.

IBO has constructed a pared-down economic forecast for NYC, premised on an assumption that the local economy will shed roughly 475,000 jobs over the 12 months spanning the second quarter of calendar year 2020 through the first quarter of 2021. The local economy gradually begins to add jobs starting in the second quarter, with job growth remaining slow through the end of 2022. IBO “constructed a pared-down economic forecast, premised on an assumption that the local economy will shed roughly 475,000 jobs over the 12 months spanning the second quarter of calendar year 2020 through the first quarter of 2021. The local economy gradually begins to add jobs starting in the second quarter, with job growth remaining slow through the end of 2022.

IBO notes that its estimates are based on a forecast of the U.S. economy in recession for the first three quarters of calendar year 2020, with real gross domestic product (GDP) falling by about 4.5 percent for the year as a whole. This compares with our January baseline forecast of 1.8 percent output growth in 2020. The report notes that the city’s economy relies heavily on industries that have been largely shut down in order to limit the spread of the corona virus. These include the retail, transportation, tourism, leisure, and entertainment industries. It estimates retail employment will fall by 100,000 starting in the second quarter of calendar year 2020 (a loss of 60,000 jobs is expected in this quarter alone), with loses continuing through the first quarter of 2021. Over the same period, we project a loss of 86,000 jobs in hotels and restaurants along with a combined loss of 26,000 jobs in the arts, entertainment, and recreation industries.

It is also unsurprising that retail employment will fall by 100,000 starting in the second quarter of calendar year 2020 (a loss of 60,000 jobs is expected in this quarter alone), with loses continuing through the first quarter of 2021. Over the same period, we project a loss of 86,000 jobs in hotels and restaurants along with a combined loss of 26,000 jobs in the arts, entertainment, and recreation industries.

And now for the bad news on taxes. Prior to the shutdowns, leisure and hospitality, which includes sports and entertainment, accommodations, and bars and restaurants, accounted for 21.6 percent of all sales subject to the sales tax, while retail other than food, groceries, and alcohol added another 28.5 percent. The estimate is that sales tax revenue would fall short of IBO’s January baseline forecast by $1.1 billion (-13.1 percent) in 2020 and $3.1 billion (-36.4 percent) in 2021.

Sales tax revenue would fall short of IBO’s January baseline forecast by $1.1 billion (-13.1 percent) in 2020 and $3.1 billion (-36.4 percent) in 2021. The city’s separate tax on hotel occupancy is expected that this revenue would drop by $127 million (-19.8 percent) below IBO’s January baseline forecast for 2020 and $530 million (-82.0 percent) lower in 2021, when the number of nightly room rentals will be less than half the number it projected in January. As for business taxes, revenue from the general corporation tax (GCT) would fall $724 million (-17.9 percent) below IBO’s January baseline forecast for 2021, and $521 million (-12.5 percent) below in 2022. The unincorporated business tax, which is paid by partnerships and proprietorships, would fall short of the baseline by $406 million (-19.6 percent) in 2021 and $292 million (-13.5 percent) in 2022.

Property related tax impacts will occur over time but they will be real. There will of course be delinquencies in the payment of property taxes but the hit on valuations is, by virtue of the city’s property tax rules, an impact that will be phased in over five years. Of more concern is the impact on real estate sales related taxes. transfer tax revenue is expected to fall short of the forecasts in our January baseline by $168 million (-12.2%) in 2020, $344 million (-24.0 %) in 2021, and $122 million (-8.2 %) in 2022. For the mortgage tax, the shortfalls relative to our January baseline would be $69 million (-6.5 %), $112 million (-10.7%), and $87 million (-8.4 %) in 2020, 2021, and 2022, respectively.

The projected shortfalls would leave the city with essentially no growth in tax revenue for 2020 and a 4.2 percent decline in tax revenue for 2021 compared with 2020. Excluding the real property tax with its built-in stability, year-over-year declines in tax revenues would be 6.4 % in 2020 and 12.0 % in 2021. The City has not seen revenue impacts like this since the 1970’s. Excluding the real property tax with its built-in stability, year-over-year declines in tax revenues would be 6.4 % in 2020 and 12.0 % in 2021.

CITY BUDGETS REACT TO VIRUS REALITIES

As the IBO released its estimates, the Mayor released his Executive Budget. The Executive Budget Forecast has reduced tax revenue by 3.5% in FY20, or $2.2 billion, and 8.3% in FY21, or $5.2 billion compared to the Preliminary January Plan Budget. Losses in both years are primarily related to a decline in the Sales and Hotel Tax, Personal Income Tax, and Business Taxes, all due to the COVID-19 pandemic. In order to balance the budget while prioritizing health care, safety, shelter and food needs, the Administration has achieved savings of  $2.7 billion across FY20 and FY21. This includes PEG savings of $2.1 billion ($600 million recurring annually) and $550 million in Citywide savings ($220 million recurring annually). The reductions in the assumptions are substantial but the drops in revenue are less than those projected by IBO.

City of Los Angeles Controller Ron Galperin has revised the current fiscal year’s General Fund revenue estimate downward by $231 million due to fallout from the corona virus. This represents a 3.54 % decrease from the previous March 1 estimate and well below the amount budgeted for the year. For fiscal year 2021, he now estimates a decline in projected General Fund revenues of between $194 million and $598 million, depending on the length of the current shutdown and the speed at which the economy begins to recover.

The largest sources of the decrease this fiscal year are Transient Occupancy Tax (TOT) and Licenses, Permits, Fees and Fines (LPFF), which together are reduced by $110 million, as the travel and tourism industry has fallen by more than 70% and City office operations have been largely closed during the crisis. Revenues reflecting economic activity, such as Business Tax and Sales Tax, also are projected lower, but not to the same degree because both are lagging indicators that will be impacted much more heavily in the coming year.

BUT WILL IT BE ENOUGH?

Even the significant adjustments which will flow from expected revenue trends may not be enough as the outlook for the national economy for the near term is not good, at least as reflected in the April Beige Book from the Fed. A few items summarize what faces tax collectors and budgeters. All Districts reported highly uncertain outlooks among business contacts, with most expecting conditions to worsen in the next several months. No District reported upward wage pressures. Most cited general wage softening and salary cuts except for high-demand sectors such as grocery stores that were awarding temporary “hardship” or “appreciation” pay increases.

Manufacturing activity contracted sharply, and energy and agricultural sectors deteriorated as commodity prices fell sharply. Employment levels fell slightly, but layoffs accelerated late in the month. All of that spells real impacts on taxable income for FY 20 through FY 22. On the current side, estimates of U.S. retail and food services sales for March 2020, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $483.1 billion, a decrease of 8.7% (±0.4%) from the previous month, and 6.2% (±0.7%) below March 2019. And that is only March.

HIGH YIELD’S SPECIAL EXPOSURE TO STAY AT HOME ORDERS

It is likely that the high yield sector will begin to see the impact of the corona virus pandemic on many of the credits at its center. Senior living facilities, niche manufacturing facilities, charter schools, hotels are just a few of the sectors with near and long term vulnerabilities.

It would be a shock if there were not a slew of technical defaults from obligors supporting bonds issued for these facilities. In the short term, senior living will face the specter of patients seeking to leave in response to concerns from patients and their families as these centers have been particularly hit by the pandemic. Many of the outstanding hotel transactions are directly impacted by cancellations thereby hurting cash flows for dent service. It will be more difficult for these credits to meet indenture requirements for annual debt service coverage.

We are starting to see the first notices of actual or potential technical defaults as individual facilities are unable to operate and generate revenues. These also include manufacturing facilities which support bonds from project revenues alone. In some cases, a deep pocketed parent company could choose to step into the breach but this is an international pandemic and those entities have issues of their own in their home countries. In other cases, reserve funds will buy some time but not more than a year. This is the situation many toll and fare based credits find themselves in.

Many stand alone project financings sold to the high yield funds do not have significant excess revenues or reserves, especially those reliant on current economic activity. So it is incumbent on investors to know what they own. Unfortunately, we see this pattern repeated through every down credit cycle. It happened when bond insurers were downgraded as a result of the financial crisis in 2008. Suddenly, the nature of underlying credits mattered. It happened when Puerto Rico defaulted and fund owners suddenly found out how much of their state specific municipal fund was actually in Puerto Rico paper. Now, investors need to find out how the bonds they own (either directly or through a fund) are secured to assess how much risk they face.

COAL GENERATION FACES ANOTHER HIT

The Scherer generation facility in Georgia is a four unit facility which is the nation’s largest coal generation facility. Various shares of the plant are owned by Georgia Power, Florida Power and light, and municipal utilities including Oglethorpe Power Corp., the Municipal Electric Authority of Georgia, the Jacksonville Electric Authority and Dalton Utilities. As the industry shifts in response to the changing and declining economics of coal fired generation, at least one of the major owners is rethinking their ownership in the plant.

Florida Power & Light Co. submitted its ten year resource plan to regulators in Florida and the plan calls for FP&L FPL owns 76% of Unit 4 at Plant Scherer, and Jacksonville, Fla.’s electric company, JEA, owns the remaining share. It also wants to shutter another 330 MW coal plant and two old natural gas fired generators. The plan to divest itself of the plant is consistent with the plans of its parent, NextEra Energy Inc., which owns the world’s largest renewable energy developer, NextEra Energy Resources.

the plan to divest adds to the troubles of Jacksonville Electric Authority which is facing a management and leadership vacuum after a disastrous effort to privatize the utility. The Authority is already under federal investigation over that issue and the plan by FP&L puts further pressure on JEA as it tries to move on from the privatization effort. It highlights the management hole at JEA which could not come at a worse time as the utility deals with lower demand from virus mitigation efforts as well as the pressure all utilities are under from their role as massive carbon producers.

The move by FP&L could cause it to sell its portion of Unit 4 or work with JEA on an agreement to close the unit. The proposed divestiture comes at an awkward time for JEA as it is in the midst of a dispute with MEAG over its participation in the ill-fated nuclear expansion at Plant Votgle in Georgia. With coal on the decline and the effort to develop new carbon neutral generation facing daunting odds of completion, JEA finds itself between a rock and a hard place. None of this is good for the JEA credit.

SANTEE COOPER IN A NEGATIVE SPOTLIGHT

Lots is being said about the need to unite, focus on the economy and on stopping the corona virus. That has not stopped politics from interfering in the resolution of some other big topics at least in South Carolina. Those political disputes have held up a resolution of the process of the state legislature in determining the future ownership and operation of the South Carolina Public Service Authority (Santee Cooper).

The situation with Santee Cooper resulting from its ill-fated decision to participate in the construction of an expansion of the Sumner nuclear generating plant has been documented here. The resulting financial impact on Santee Cooper and its ratepayers from the participation in the Sumner expansion has led to calls for the divestment of the utility by the state or the establishment of new controls and procedures to increase outside oversight of the utility.

Now the debate over the future of Santee Cooper is holding up enactment of a state budget. A bill to allow state government to keep spending included a section to extend the law allowing the state to sell or reform Santee Cooper into 2021. House leaders said Senate leaders agreed to a provision preventing Santee Cooper from entering into any contracts over a year in length. At the last minute, several senators opposed the bill to allow the state to keep spending money if it doesn’t pass a budget by the end of June because of the restrictions on state-owned utility Santee Cooper in it.

Santee Cooper has not helped its cause by managing its messaging to its customers and the political establishment in a less than artful manner. It has been caught misrepresenting the position of its members which has cost the agency the support of the Governor and the House leadership. One of the agency’s long term strengths had been its support over the years from the state’s political establishment. The legislature has one month to figure out what to do with Santee Cooper. The failure of negotiations over Santee Cooper meant the House and Senate also couldn’t reach an agreement to set the parameters of any special session needed after the May 14 deadline in the state constitution for the session to end.

All of this leaves the agency’s bondholders in the air. The lack of consensus in the legislature casts a huge cloud over the agency and its ability to manage and operate. The debate does not seem to be leading to any plan to deal with the approximately $4 billion of stranded costs for Santee Cooper resulting from the Sumner debacle. Now the pandemic is impacting electricity demand especially from the commercial and industrial load customers. We would not be surprised by another downgrade for the once proud utility.

CALIFORNIA POWER AGENCIES

There has been so much focus on the ongoing bankruptcy of Pacific Gas and electric that it is easy to overlook the status of major municipal power providers in the state. They also have exposure to wildfire risk in terms of their role as major distributors and generators of electric power. So we looked with interest at upcoming financings for two of those entities; the L.A. Department of Water and Power (LADWP) and the Southern California Public Power Agency (SCPPA). We especially focused on the issue of wildfires and potential liability.

LADWP is currently in litigation related to the cause of the December 2017, 15,000+ acre Sylmar Creek Fire where LADWP’s investigation concluded that LADWP’s equipment did not cause or contribute to the fire ignition. In October 2019, the 745-acre Getty Fire resulted in 10 residences being destroyed and another 15 damaged. This fire began in LADWP’s service territory from a tree branch from over 30 feet away landing on one of LADWP’s power lines due to high wind conditions. LADWP may be liable for damaged property.

On the other side of the coin, LA exceeds the state’s standards related to the spacing between its transmission lines and has implemented other fire mitigation programs including the replacement of the distribution power lines’ cross bars with composite or steel material, as well as an active vegetation, brush and tree management program. LADWP can raise its rates through its Energy Cost pass through rates within 90 days without City Council approval if LADWP needs emergency recovery of any unexpected high costs or to replenish any depleted liquidity that was used during a potential short-term shock. This rate making structure provides additional and more certain support not available to the investor owned utilities .

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.