Joseph Krist

Publisher

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MCCONNELL ADVOCATES FOR STATE BANKRUPTCIES

The pandemic has clearly generated significant pressure on state and local government finances and it has been clear that some level of direct financial aid would be necessary to provide operating assistance to these entities. Such aid would enable governments to confront their responsibilities in response to the pandemic and shoulder the additional responsibilities which the President has made clear he believes are theirs.

It would reduce pressure on them to borrow for operations and it would help to avoid layoffs which would ultimately impact basic government services especially in the area of public safety. It would also reduce the number of people on unemployment. The arguments in favor of aid parallel many of the justifications for the PPP packages passed by Congress. Even President Trump has “promised” that another stimulus (round 4 or 5 but who’s counting) would contain aid to the state and local governments to fight the pandemic.

So it was especially disconcerting to see Senate Majority leader McConnell take the position that states should consider bankruptcy. It was especially disappointing to see the Leader link his opposition to aid to his belief that the states would use the money for pension funding and that aid in this time would be a political bailout. The flaws in his argument should be pretty clear but they should be examined nonetheless.

The Depression was the last time that state and local governments were under the kind of fiscal pressure currently confronting states and municipalities. While Arkansas managed to be the only state to default on its debt, Congress was asked to confront the potential for others to default. As it reexamined the federal bankruptcy laws it made the conscious decision not to provide the states with the ability to declare bankruptcy under Chapter 9. That has served as one of the foundational pillars upon which the municipal bond market has existed. It is at the core of the general obligation pledge by states.

Clearly the pressures of the pandemic and the pressure on Congress to act to offset the poor federal response to the pandemic have clouded the leaders thinking. The potential for damage to municipal bond investors is incalculable. But the real motive may be antipathy to government and its employees, especially those who are unionized. The Leader mentioned unions the source of the problem while ignoring the role of legislators in the historic underfunding of pension obligations. This despite the fact that the negotiated pension benefits granted to employees reflected two sided negotiations (any negotiation requires at least two parities to be involved). It is also pretty rich to hear the Senator from Kentucky – historically one of the worst states in terms of underfunding its pensions- blast irresponsible pension funding decisions. It also reflects a lack of knowledge on the Leader’s part. Pensioners have been treated fairly well in recent bankruptcies (at least in relation to bondholders and other creditors) so there is nothing to indicate that other bankruptcies would yield a different result.

He seems to think that residents of jurisdictions where they have gone through bankruptcy or other significant restructuring processes are somehow better off for having gone through the process. Whether it be bankruptcy or supervised restructuring (Philadelphia, New York, and Washington, DC come to mind – those experiences led to wrenching choices between priorities like public education versus public safety which had long term negative implications for the residents of those entities. It can be argued that the NYC school system never recovered from the cuts made during the City’s road back from its 1975 financial crisis.

Ironically, one of the states which arguably needs the most aid is New York and its pension system is one of the better funded systems in the country. It can be argued that steps taken over the years including the creation of multiple different tiers of pension benefits actually acts as a model for others to follow. Pensions per se are not New York’s problem. Right now, the problem is the fiscal damage ensuing from the shutdown of the economy which accounts for some 10% of national GDP. Bankruptcy will not change that.

RATINGS FOLLOWING THE MONEY

The Atlanta & Fulton County Recreation Authority issues debt secured by a first lien on a 3% rental car tax collected in Atlanta and College Park. Moody’s has assessed the likelihood that car rental tax revenues will suffer an immediate and substantial drop from a coronavirus-induced slowdown. The slowdown has the potential to cause some tax revenue tied to hospitality and travel-related activity to decline by up to 85% through mid-summer, potentially driving debt service coverage down significantly. As a result, it has placed the Authority’s Aa3 and A1 ratings on review for downgrade.

Last week we noted estimates from the City of Los Angeles Controller regarding potential impacts on the city’s major revenue sources. The information was enough for Moody’s to change its view of the city’s likely revenue and reserve trajectory. The prior expectation was for continued revenue growth and increasing reserves over our 18-24 month outlook horizon. Such near-term improvement is no longer probable in the current economic environment, even if the coronavirus downturn proves short and the recovery relatively rapid.

Another sector potentially under pressure is the retail and recreation/entertainment space. Moody’s has downgraded the Syracuse Industrial Development Agency, NY’s (SIDA) Carousel Center Project, PILOT Revenue Bonds to Ba3 from Ba2 and placed the ratings on review for downgrade. The downgrade and review follow the transfer of the subordinate $300 million CMBS loan to special servicing owing to the unprecedented circumstances related to the coronavirus outbreak that resulted in Governor Cuomo issuing a statewide executive order to close all malls on March 18, 2020. Deals like this one which count on outside sources of funding and liquidity from developers find themselves impacted by the nationwide pressure on the mall space as essentially all of these facilities operate under some form of restriction related to the coronavirus.

While actual downgrades await further information in terms of likely schedules for resumption of operations, airport rating outlooks continue to be reduced even if it is from positive to stable. Airport revenue credits have been impacted in that way across the board including Salt Lake City, Denver, San Francisco, and Miami.

PANDEMIC AND CREDIT

We think that when we try to project where the credit environment will be going forward post-pandemic, it is important to distinguish between the current trends as opposed to the actual longer term trends which will follow the pandemic. We are seeing a lot of speculation about the post-pandemic model for cities and what this implies for capital investment and public goods. The current stay at home environment is generating lots of views advocating for controversial approaches to things like healthcare, transportation, housing, and education. Once the pandemic is dealt with – however long it takes – life will begin to reestablish itself. It is important to remember that the current state of affairs is not sustainable long term.

Given that context, we nevertheless believe that some sectors deserve increased scrutiny. The most obvious would be credits dependent upon the retail sector. The role of retail shopping malls as the anchors and main draws at those malls is in the spotlight. The stay at home closings have seriously damaged an industry which was under enormous stress even without the pandemic. The demise of Sears/KMart was a canary in the coal mine for what could happened to poorly structured retail entities in the event of real economic stress. Now, the remaining anchor store players are all facing unprecedented pressure.

Recent press reports highlight the potential bankruptcy of Neiman Marcus and the entry into restructuring talks between J.C. Penney and its lenders. Macy’s said on March 30 that after closing its stores for nearly two weeks, it had lost the majority of its sales. With these entities seeking to cancel orders, refusing acceptance of goods at warehouses,  and extending repayments periods the potential impact on rents and cash flows to mall operators is significant. The negative impact on direct payments as well as taxes generated by retail activity will drive investors to want to know much more detail on the security mechanisms behind each issue.

In the healthcare sector, we see short term impacts on revenues due to the lack of elective surgeries and other services held down by stay at home orders. As always seems to be the case, rural hospitals with weaker and less liquid balance sheets are in the crosshairs of this event. That is not to understate the damage being done to hospital finances as we write. Hospitals will be at the center of the ongoing response to the pandemic going forward as there will still be a need for more than usual acute care (costly and poorly reimbursed by government providers) and the most impacted facilities  serve areas which economically and demographically will remain susceptible to the pandemic especially in a second wave.

Hospitals are not waiting for federal action. The latest example is Henry Ford Health which is serving patients in one of the nation’s hotspots, Detroit. The system has announced that it will furlough 2,800 employees or 9% of its 31,600 workers across its five hospitals to meet hundreds of millions of dollars in incurred and expected budget losses. The hospital system had a $43 million loss in operating income in March due to site closures, increased personal protective equipment costs and the cancellation of elective procedures.  The losses for April and May are expected to be larger. It’s the latest example of a clear trend for healthcare employment. Health care employment declined by 43,000, with job losses in offices of dentists (-17,000), offices of physicians (-12,000), and offices of other health care practitioners (-7,000). Over the prior 12 months, health care employment had grown by 374,000.

The housing sector provides some unique challenges. The pandemic has shined a brighter light on the realities of housing and its relationship to economics. In all of the nation’s largest cities, housing is a contentious issue. The cost of housing drives decisions regarding where one lives, what quality of life it affords, and what sort of employment will allow one to satisfy their needs. The pandemic has served as a vehicle to question so many of the assumptions behind how business are constructed and operated, why they have the office structures that they do and are all of those buildings  necessary? Existing general assumptions have supported greater density especially around transit facilities, the need for huge headquarter spaces and ways to get employees there, and a movement to effectively end single family zoning restrictions on development.

If we move to a model where the majority of “white collar” work is done remotely, that has likely negative implications for local tax bases. It would create much more freedom in terms of where and why people locate. More outdoor space or one’s own space might be more attractive than a Starbucks on every block and a walk to work. It will exacerbate the need for affordable housing. That will force municipalities to rethink development and permitting policies. The pandemic has exposed the need for affordable housing near places of employment and service as many of the currently classified as “essential” workers are also among the lowest paid. They rely on public transport and often on a number of public services.

Transportation has the potential to suffer the most consequences. Already we see the various interest groups advocating for significant changes to the mass transit system in this country. We are seeing discussions about ride sharing replacing public transit which ignore studies showing that such a shift would lead to massive congestion without a significant improvement in commutes. This would exacerbate the existing congestion issues associated with ride sharing. And it ignores the realities which exist in the largest cities.

New York is not going to successfully move some 5 million people daily without a vibrant mass transit system. Streets filled with ride share vehicles and reliance on “personal mobility modalities” (scooters and the like) just are not feasible. The reliance on walking to work would have the effect of limiting distances one could live from work. This would create issues about the cost and location of housing. Those issues won’t be solved expanding sidewalks and banning cars. Other issues like fare subsidies will have to wait as the financial hit being taken by the major mass transit agency are staggering.

PUERTO RICO

In a filing submitted to the bankruptcy judge hearing Puerto Rico’s Title III proceedings, the Puerto Rico Fiscal Agency and Financial Advisory Authority said the Puerto Rico Treasury Department has estimated that in the current fiscal year the commonwealth of Puerto Rico may lose between $1.5 billion and $1.6 billion in tax revenue due to reduced economic activity associated with the island virus lockdown and the delays in tax payments. The filing was made in connection with several motions before the bankruptcy court. It was considering an Unsecured Creditors Committee challenge to the Puerto Rico plan of adjustment. The judge decided to take a two step approach towards resolving the issues before it. One part of the process would include  approving disclosure for the plan. The other step would be part of confirming the plan.

The Unsecured Creditors are challenging the plan’s treatment of pensions and general unsecured claims in two distinct classes, with very different recoveries. The current proposal would provide for retirees to receive between 92.5% and 100% of what had been promised them. As for the challengers, the plan proposes giving the general unsecured claims no more than 3.9%. The challenge is based on the theory that

both classes of creditor have equal legal claim to Puerto Rico government money and that this should result in equal treatment. The dispute highlights the emergent trend of more favorable treatment of pensioners over creditors such as bondholders.

UTILITIES UNDER PRESSURE

The National Rural Electric Cooperative Association released an estimate of the revenue impact of the pandemic on its members. While this component represents a slice of the industry, the findings of the association can be a useful indicator for what the municipal utility sector could be facing as the result of lower demand related to pandemic limits. According to the Association, the nation’s electric cooperatives could lose up to $10 billion in revenue as the economic fallout from the novel coronavirus pandemic continues to linger. The cooperatives are facing a roughly 5% drop in electricity sales, costing them $7.4 billion. They also face a potential amount of money lost from unpaid electricity bills of as much as $2.6 billion.

The study comes as major municipal utilities are coming to market and releasing estimates of the impact of the pandemic on their revenues and operations. The latest is the Sacramento Municipal Utility District (SMUD) in CA. SMUD estimates that it will see a $47 million to $68 million revenue reduction in 2020 and a 2021 revenue reduction of between $67 million and $128 million. It estimates that it may need to reduce operating expenses in 2020 by up to $40 million and by up to $100 million to meet its internal financial planning metrics.

STATES REVISE REVENUE ESTIMATES DOWN

NY State Comptroller Thomas DiNapoli estimates that the amount of overall tax receipts delayed from April to July could be as much as $9 billion to $10 billion, depending largely on how many taxpayers choose to delay their filings. While the state received almost $3.8 billion in Coronavirus Relief Fund resources earlier this month, the total amount of federal assistance available to help address cash-flow and budget-balancing needs remains to be determined. The ability of the state to fully achieve its Medicaid savings target also remains unclear.

Significant losses of State tax revenues are likely to extend into State Fiscal Year (SFY) 2021-22, and there may be further effects in the following years. There will also be upward pressure on State spending for essential services related to the ongoing public health and economic challenges. The State ended SFY 2019-20 with a higher-than-projected General Fund balance of $8.9 billion, but could face a cash crunch starting early in the new fiscal year due to the tax filing delay. On March 17th , the Office of the State Comptroller estimated that SFY 2020-21 tax revenue would be at least $4 billion and possibly more than $7 billion below the Executive Budget projection of $87.9 billion as a result of the economic impacts of the coronavirus pandemic. Economic conditions have worsened further since that date.

The State’s video-lottery terminal (VLT) facilities and commercial casinos have been closed since March 16th. Receipts from these facilities were projected at a combined $1.2 billion in SFY 2020-21. In SFY 2019-20, State revenues from casinos and VLTs averaged $95 million per month.4 In addition, the Native American casinos in the State are closed, reducing receipts from tribal-State compacts which were projected at $219 million in SFY 2020-21, including funding for local host governments. Lottery receipts including Quick Draw rely heavily on sales through retail outlets, as well as restaurants and bars. These receipts, which were projected to generate $2.5 billion for the State this year, are also likely to be affected by diminished consumer traffic in those businesses.

Federal aid has begun to flow to the State, including receipt of nearly $3.8 billion in Coronavirus Relief Fund resources on April 17th. Such funding is to be used for expenses related to the COVID-19 pandemic. in some instances, limitations on use of these resources may hamper the State’s flexibility to use the funds as a budget management tool. The State last encountered severe cash flow issues in the wake of the 2008 financial crisis. Reduced tax revenues and diminishment of the General Fund resulted in delays to required payments for school aid and other purposes, as well as other budget management actions, in 2009 and 2010.

The Delaware Economic and Financial Advisory Council on Monday lowered its revenue estimate for this year by $416 million, or 9%, compared to its March estimate. This year’s revenue total is currently predicted to be almost 6% less than the amount collected last year. The panel also lowered its revenue estimates for the fiscal year starting July 1 by $273 million, or 6%, compared to its March estimate.

HOW ONE TRANSIT AGENCY IS DEALING WITH THE REVENUE HIT

The San Francisco Municipal Transportation Agency (SFMTA) board decided this week to raise fares despite economic downturn and public criticism. Starting in July, monthly fast passes will cost an extra five dollars, bringing the total to $86 for a regular pass or $103 for a pass that allows access to BART stations in SF. Starting in 2021, the price of those passes will rise to $88 and $106 respectively.

Individual rides paid for with a Clipper card will grow more expensive as well, moving up from $2.50 now to $2.80 in July, then $2.90 next year. Cash fares will remain the same at $3. The agency argued that SFMTA must continue paying drivers and other employees a rate commensurate with the cost of living and that the only options other than raising prices would be cutting service or laying off workers. The head of the SFMTA acknowledged public comment about the price increases was overwhelmingly negative but noted that “not a single [person] suggested where we should get additional revenue” otherwise.

The SF situation could be a harbinger of things to come across the country as mass transit providers seek to address the huge loss in demand resulting from the pandemic. It will divide a more wide ranging debate about funding for mass transit. Fare hikes will fall hardest on those least positioned financially to afford them while the alternative mobility industry has yet to resolve its issues over where and who it serves customers. This will stimulate efforts to develop non-fare based funding sources and to subsidize fares for low income riders. All of this will have yet to be determined impacts on transit system backed credits.

CORNHUSKER TUITION PROGRAM

The cost of attending college has been at the forefront of political debate with various  proposals being offered for federal programs to offer low or free tuition. While the debate goes on and a resolution awaits the results of the 2020 elections, states have been moving forward with their own plans. States are uniquely positioned to do so through their roles as funders and operators of institutions of higher education.

The latest state to offer a tuition benefit to lower income students is Nebraska. The University of Nebraska announced that it will offer free tuition to in-state undergraduate students whose families earn less than $60,000 a year. The program will be known as Nebraska Promise. It will begin this coming fall. To be eligible, students must take a minimum of 12 credit hours per semester and maintain a 2.5 GPA. The university will cover up to 30 credits in an academic year. 

The program will include all four of the state’s four year campuses and includes nursing school at the University of Nebraska Medical Center campus. It does not cover room and board but it does at least address tuition. It is impressive in that the announcement of the program follows university officials forecast of a shortfall of at least $50 million this fiscal year because of the coronavirus pandemic. Officials attributed the shortfall to housing refunds, event cancellations, medical costs and other factors.

There are fiscal implications as the University is seeking to fund the program out of its existing budget. That will undoubtedly lead to some level of program cuts. The pressure is limited by the projected limited increased demand. Nebraska Promise would cover about 1,000 additional current and future NU students, officials said. With the announcement, Nebraska becomes the 18th state to offer some form of tuition free college.

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