Joseph Krist

Publisher

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The municipal bond market, just before its recent pullback has been trading at near 70 year lows in yield. Issuers of all credit stripes are coming forward and with a couple of exceptions are finding a warm welcome for their offerings. So we’re all good, right?

This is an environment where every technique available to help municipal issuers should be utilized to deal with the lack of revenues. Instead things like advance refunding capabilities remain unavailable to issuers, This, while at the same time a real federal fiscal response to the policy of essentially downloading the operational with the pandemic responsibilities of dealing with the pandemic were devolved to the states. It is as if the decision was made to outsource services while being unwilling to pay the entities providing them.

So now we move into the fall with fiscal pressures remaining effectively unabated for government. Yet now is when some of the most significant expenses will be incurred. The preparation work to adapt classroom and other spaces for in person learning is substantial, costly, and likely to be required through at least year end. The recent experiences with college campus openings have been clearly fraught and the sort of on again off again process which some schools seem to be attempting is likely to be more costly than other responses.

The nation’s largest transit system has confirmed how much trouble it is in. The current level of ridership (est. at 25%) has generated significant operating losses which are not sustainable. The agency finds itself in the midst of a hurricane the effects of which are only partially attributable to its own decisions. MTA has requested $12 billion in aid to cover its operating losses through 2021. But that funding is at risk without a substantial federal stimulus bill. Without it MTA projects fares and tolls would be raised by one percent and one dollar, respectively, above already scheduled increases in 2021 and 2023.

The situation with the MTA is simply the largest and most glaring example of the problems. Across the country, state revenues from and for transportation are getting crushed. The situation is being replicated at various scales whether it be less funding for public transit or delayed or scaled back road maintenance and/or construction. The ability of toll roads to facilitate commercial and freight usage may position them better relative to public transit issuers but the demand issue remains in either case. The result for now is diminished infrastructure and a diminished ability to achieve full economic recovery.

So to answer our question, no it’s not alright.

TECH AND GOVERNMENT

The pandemic reinforced the importance of technology as a credit factor. Technology enabled the economy to a least limp along without utter collapse thanks to the technological innovations of the last two decades. The central role of technology in facilitating electronic transactions and video capability that allowed many to continue to work were economic lifesavers. At the same time, the reliance on technology raises several troubling aspects from a societal point of view. These include issues of equal access to education, work, and even medical care. The solutions to those issues will be decided outside of the market.

For municipal bond investors, the issue of government and technology will be a continuing source of risk and cost. You can still go to local municipal governments where the screens are black and the type is either glowing white or green. Think the movie War Games. Then you understand why you can’t complete basic tasks expeditiously or cost effectively. And it’s not a partisan thing. But it is reality and that’s the sort of thing which will throttle adaptation of technology to cover the range of potential applications government provides.

The challenge of updating and replacing information and operating technology will be its cost. Many issuers are not in a position to fund significant tech infrastructure. Yet information technology and infrastructure will be key to the adoption and implementation of technology in support of transportation. One of the ongoing debates in infrastructure world is the issue of technology based transit modalities.

Many of those at the front of the movement to make individual autonomous mobility the cornerstone of 21st century transit are finding out just how much of a chasm exists between the capabilities of government systems and corporate systems. One of the issues which contributed to the huge  level of operating problems for the California was the age of some of the software the system was based on. Some of the system was still on code written for COBOL (Look it up). They’re going to need some serious upgrades to the local tech infrastructure if the future is electric AV powered by renewable energy.

Which leads us to the issue of the effect of making decisions under duress. One of the risks for policymakers going forward as the pandemic follows its course until a vaccine intervenes, is that current conditions can generate impacts which in the longer term are not viable. It has been interesting to see how different interest groups have been actively spinning current conditions in big cities. Whether it’s the end of on street parking, punitive congestion fees, or the permanent expansion of outdoor dining, proponents do not seem to have given much thought to the long term impact of those decisions.

Take dining. The extension of dining into what were formerly parking spaces in NYC stands out. The concept works well in a time of seriously diminished traffic but is there a viable economic model for operating that way? Will it be enough to replace the 10,000 restaurants estimated to have closed in NYC since March? Are current levels of business enough to support rents long term? What tradeoffs in terms of transit and traffic must be made as the level of economic activity is on a sustained path to recovery?

We take the view that the path may be longer than one would hope but, that in a couple of years people will be happy to sit in restaurants and bars, that they will go to movies in theatres, and that once again sports stadia and arenas will be full again. The economic havoc on capital finance will serve to reinforce previously existing preferences in terms of public versus private vehicles. 

We do not subscribe to the theory that it’s the end of the world as we know it and I feel fine. It is important that decisions be made soberly rather than in the heat of battle.

PRIVATIZATION ADVOCATES TRY AGAIN

Under the heading of never letting a good crisis go to waste, the pandemic is providing opportunities for advocates of privatization of existing public assets to take another shot at public opinion. Once again, we see the private sector attempt to use the pandemic and its economic impacts to advance the cause of privatization. The latest comes from the Koch-financed Reason Foundation. It released a study which purports to offer a solution to pension underfunding through the sale of toll roads.

That study concludes that Illinois could generate the largest net toll road lease proceeds but its unfunded pension liability is so large that the lease proceeds would cover just 14 percent of its pension debt. Florida and Oklahoma could pay down half of their unfunded liabilities. Unfortunately, the study rests on some questionable calculations to arrive at its conclusions.

It also ignores the politics of privatization in states like New Jersey and Florida where toll increases generate big oppositions. It also has the bad luck to cite the Chicago Skyway and Indiana Toll Road as US examples. Neither of those deals measured up to the claims of proponents. The study draws on data from a number of overseas toll road P3 transactions in recent years to estimate what each toll road system might be worth to infrastructure investors. Unfortunately, the gross valuation is what would apply globally but that ignores the realities of municipal bonds in the United States, a change of control (such as a long-term lease) requires that existing tax-exempt bonds be paid off.

PUERTO RICO ELECTRIC

The Puerto Rico Energy Bureau is the governmental overseer of the Puerto Rico Electric Authority (PREPA). While PREPA undertakes to restructure and refinance its debt, it also is seeking to rebuild the Commonwealth’s electric system after three years of hurricanes and earthquakes. After Hurricane Maria, we made the case that the rebuilding effort had created a huge opportunity to develop a much more resilient and climate friendly electric grid. With abundant sunshine and wind available year round, the opportunity to shift from a fossil fueled to a renewable generation base was at hand.

Since Maria destroyed the system, PREPA has undertaken a plan of recovery which in many ways seeks to maintain the status quo. So we were glad to see that recent reviews undertaken by the Bureau have led to the Bureau recommending an increased reliance on renewables. It effectively rejected PREPA’s plans to increase reliance on natural gas. The regulators proposed at least 3,500 megawatts of solar and more than 1,300 megawatts of battery storage by 2025. It also sought to have PREPA reconsider its plan to spend $5.9 billion on a rebuild of the heavily damaged transmission system.

The bureau’s proposal would cost PREPA an estimated $13.8 billion compared to around $14.4 billion projected under the utility’s plan. That would represent a 4% reduction in overall costs. Not huge but still meaningful. The disagreement will likely complicate the debt restructuring process. We do not see that as a reason to plunge ahead without real debate over the future of the electric system.

We were interested by comments we saw regarding concerns over reliability of a renewable versus a fossil fuel based system. Those concerns are rooted in the fact that the utility serves a truly closed system with the added complication of reliance on 100% externally generated fuel sources. It is not obvious why concerns about redundancy for a renewable based system are any different than those which existed for the original system. Because there is no access to outside sources of power, the legacy oil and gas based system had the same issues. The risk of energy shortages (such as we see in California) has always been present in Puerto Rico. We do not think that those concerns are sufficient to discourage the development of significant renewable generation resources for PR.

WHY RUNNING GOVERNMENT LIKE A BUSINESS USUALLY FAILS

The current stimulus standoff is generating different responses from different organizations as they operate their businesses. Some of them think that their experiences provide answers to the issues government face. Most of those who think that way reveal their inability to distinguish between a business and a service. While it is not a municipal credit, the Postal Service is a good example.

The current debate effectively revolves around the issue of profitability. The President does not understand the concept of public goods. The Postal Service was never designed to be a business it was designed to be a subsidized service. The current shenanigans at the USPS are based in the belief that it must be profitable in the sense that any business must be profitable. The role of the USPS in facilitating commerce and therefore the economy has economic value. That is why only the USPS has to serve every address and is the only entity required to facilitate things like animal delivery and transport.

It is also why basic infrastructure like water, sewer, and roads have largely been developed under the framework of a public good. Public goods are not supposed to “make money”. The profit they generate is reflected in the role they play in providing a necessary service base in support of economic activity. In those situations where services provide excess revenues those are usually applied to the funding of public goods. service related surpluses fund other facilities or fund items which would otherwise be funded by taxes.

No matter how you slice it, these proposed asset sales take money from public goods and divert it to private interests. Projects which do not generate distributable returns to their investors are generally not undertaken. So at least some portion of the economic return generated by formerly public goods represents a transfer of income and/or wealth from the public to the private sector.

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