Joseph Krist

Publisher

________________________________________________________________

PENSION REFORM HURDLES

Over the last decade, the issue of public employee pensions has been a bigger and bigger issue in any discussion of municipal credit. A significant number of state and local credits have seen credit pressures from lower rates of return which were occurring coincident with higher levels of retirements. The increasing role of pension funding in the rating process has also focused attention. In many cases, the pension funding debate has brought to light the various hurdles which exist that pension reform a much more difficult task.

The latest example involves transit agencies in California. The California Public Employees’ Pension Reform Act of 2013 (PEPRA) requires a public retirement system, as defined, to modify its plan or plans to comply with the act and, among other provisions, establishes new retirement formulas that may not be exceeded by a public employer offering a defined benefit pension plan for employees first hired on or after January 1, 2013. Employee unions have challenged the law based on their view that the California law conflicts with federal law resulting in an illegal reduction in pension benefits.

At the time of the bill enactment in to law, the transit unions were the most vociferous opponents. They pressed the federal government to intervene in support of the workers. Section 12(c) of the Urban Mass Transportation Act of 1964 requires that the U.S. Secretary of Labor certify that fair and equitable arrangements are in place to protect provisions that may be necessary for the preservation of rights, privileges, and benefits (including continuation of pension rights and benefits) under existing collective bargaining agreements or otherwise and the continuation of collective bargaining rights, While the dispute between the State and the federal government continued, then Gov. Brown signed a bill which exempted the transit agencies from the California legislation while it negotiated with the feds. Ultimately, the U.S. Labor Department withdrew its objections to the law and certified that California transit agencies were in compliance.

That did not stop the transit worker unions. They challenged the changes once again in 2019 and they were turned down by the Labor Department. Now, in the aftermath of the pandemic and the resulting infrastructure funding, the unions challenged the California pension law again. This time the Labor department is headed by a union member for the first time and now the union viewpoint is prevailing.

The policy change – reversing two previous reviews under administrations of both parties – now threatens the funding from the infrastructure bill for some 15 transit agencies. They are the Alameda-Contra Costa Transit District, Golden Gate Bridge Highway and Transportation District, Los Angeles County Metropolitan Transportation Authority, Riverside Transit Agency, San Francisco Bay Area Rapid Transit District, San Joaquin Regional Transit District, the San Mateo County Transit District and the Santa Clara Valley Transportation Authority. The State’s governor and congressional delegation are all petitioning the Department to review its decision. Without a change, over $11 billion of anticipated funding could be held back.

It is a real credit negative for these agencies. Many are already operating at reduced levels and many are only now beginning to reimpose fares. It is a policy allegedly designed to protect the working man but, in this case if it leads to service cutbacks and job reductions, exactly how is the working man helped by this?

GAS TAX

The State of Wyoming has gotten lots of attention given its role as a primary.  source of coal for the electric generation industry. It also has significant wind “resources” and is seen as a potential wind power center. Given the importance of coal to the state’s economy in recent years, it has been out front in its efforts to slow the efforts to reduce or eliminate fossil fuel use. It has tended to shun efforts to raise the cost of fossil fueled resources whether they are fuel specific taxes or overall carbon taxes.

Nonetheless, the Wyoming Legislature’s Transportation, Highways and Military Affairs committee advanced a bill to the full Legislature that would raise the gas tax by 5 cents a gallon starting July 2022, another 5 cents starting July 2023, and another 5 cents starting July 2024. Currently the gas tax in Wyoming is 24 cents per gallon. Currently, Wyoming’s gas tax is lower than that of all of its immediate neighbors with the exception of Colorado.

The timing of the proposal is interesting. The State expects to receive some $2 billion of federal money as the result of the recently passed infrastructure legislation that is broadly specified as being for roads. The effective injection of $200 million annually for ten years still does not fully address existing shortfalls in fuel tax funding in Wyoming. If nothing else, the legislation forced agencies to update and improve their capital plans which likely found an excess of potential projects relative to existing and new federal resources.

UNION HURDLES TO ELECTRIFICATION

Toyota became the latest auto manufacturer to announce plans for factories to support electric car development and assembly. It will open a factory to make batteries outside of Greensboro, NC in 2025. The investment will be some $1.2 billion and create 1,700 jobs. The decision follows that of other competitors and it shares in common with them a location in a right to work state.

It comes as the Senate debates provisions in the Build Back Better bill which would tie subsidies to purchasers of electric cars to the issue of whether or not those cars are produced by union workers. The issue has become a real sticking point and creates potential conflicts for liberal and/or progressive legislators. The debate puts domestic, traditionally union producers in line with their union employees but the subsidy limit could limit demand for the vehicles. That would make climate goals harder to achieve by making the cars less affordable.

MUNI UTILITIES AND THE ENVIRONMENT

Sea Light is the municipal electric system owned and operate by the City of Seattle. It finds itself in the middle of the conflict between the carbon-free nature of hydroelectric power versus the interests of other environmental concerns. In the Pacific Northwest, the issue of the impact of hydroelectric dams on fish migration has received much recent attention. One proposal would call for the breaching of four dams in eastern Washington.

Sea Light faces a different issue. The utility owns three dams on the Skagit River for which their operating permits expire in 2025.  The facilities generate about 20% of its power needs. Now, the city is seeking to have the facilities relicensed for 30 to 50 years. That process will require studies to be undertaken in 2022 and 2023 to develop the application for a new license. The application is required to be filed two years before the expiration, by law. The Federal Energy Regulatory Commission then will consider the application.

Sea Light has agreed to examine fish passage at the dams and it has agreed to assess decommissioning and removal of the dams — and to repeat the assessment during the life of the new license, to respond to changing environmental conditions, technology and customer demand. That may not be enough to satisfy tribal interests who are suing to have the dams removed and are even challenging the green status of hydroelectric power because of its impact on fish.

The review of the dams in Washington comes as California debates the planned closure of the Diablo Canyon nuclear plant in 2025. The planned closure has resulted in some unexpected advocacy alliances. A recent study out of Stanford and MIT found that if Diablo Canyon was kept operating through 2045, it could reduce the state’s reliance on natural gas, save up to $21 billion in power system costs and save 90,000 acres of land use from energy production.

A Colorado municipal utility is in a position to expand its resources through the use of green energy. The Arkansas River Power Authority serves six municipalities by distributing power generated or purchased at wholesale. For two decades, a private utility has provided the bulk of its power. Now, in a move that the Authority says will result in lower costs and rates, it will obtain its power from a non-legacy provider.

The Authority hopes to reduce its carbon footprint and respond to customer desires for clean energy. It also believes that it can maintain or even lower its retail rates as the result of the new power contract. It currently owns back-up generators as well as some wind generation directly. The power purchase agreement gives the Authority increased access to renewable power than would have been the case with its legacy provider, Xcel Energy.

Burlington, VT voters approved authorization for a $20 million Net Zero Energy Revenue Bond for Burlington Electric Department. 70% of voters supported the ballot item. The Department’s Green Stimulus incentives are designed to encourage residents to switch from fossil fuel-burning cars and furnaces to electric vehicles (EVs) and cold-climate heat pumps. Bond also will fund grid updates for reliability, technology systems to better serve customers, and new EV charging stations. These bonds will be paid from electric revenues.

At the same time, those same voters did not support tax-backed GO debt for traditional infrastructure. A $40 million bond authorization needed a very high 75% supermajority but the results saw approval at an insufficient 57%. The fact that the proposal got a clear majority may not necessarily mean that there is a preference for green improvements versus traditional improvements. The 75% vote requirement was a significant impediment to approval. The user pays aspect of a revenue bond financing may have made that more attractive as well.  

PRE-PAID ENERGY MOVES TO RENEWABLES

The municipal bond market has long dealt with gas prepayment bonds. These complex transactions have found an audience especially with institutional investors. As the practice became more and more accepted, it is not a surprise that the financing technique is being used to facilitate the changes occurring in the retail electric distribution space.

The California Community Choice Financing Authority (CCCFA) recently sold some $2 billion of bonds to finance activities on behalf of community choice aggregators. The two Clean Energy Project Revenue Bonds, issued on the behalf of East Bay Community Energy (EBCE), MCE, and Silicon Valley Clean Energy (SVEC) prepay for the purchase of over 450 megawatts of clean electricity. The power is secured under long-term purchase agreements with generators.

Who are the aggregators and who do they serve?  EBCE operates a Community Choice Energy program for Alameda County and fourteen incorporated cities, serving more than 1.7 million residential and commercial customers. MCE is a load-serving entity supporting a 1,200 MW peak load. MCE provides electricity service and innovative programs to more than 540,000 customer accounts and more than one million residents and businesses in 37 member communities across four Bay Area counties: Contra Costa, Marin, Napa, and Solano. SVEC serves more than 270,000 residential and commercial customers in 13 Santa Clara County jurisdictions. 

Like the gas deals, the ultimate credit rests upon the ability of the energy supplier to perform. Like the gas deals, the energy trading subsidiary of a major investment banking institution (Morgan Stanley in this case). The variety of transactions underlying the credit are similar to gas deals as in commodity swap providers, energy suppliers, e.g. This structure places the bank at the center of the key issues supporting the credit. For this reason, the rating on the bonds reflects Morgan Stanley’s current ratings.  

GOVERNANCE ISSUES FOR MUNI UTILITIES

As the sector of ESG investing continues to expand and evolve, governance issues should likely be getting more attention. While the assessment and valuation of governance factors in the ESG equation continues to evolve, we are surprised that the utility sector may be the one sector in the muni market which is seeing concerning situations regarding governance.

We have seen the aborted effort in Jacksonville to privatize that City’s electric system in a scheme which sought to enrich utility management. Questions about the management of the South Carolina Public Service Authority and its decision to participate in the Plant Votgle expansion still create significant credit uncertainty for that agency. Now, we see that the nation’s largest municipal utility faces governance issues as well.

Former LADWP general manager David Wright admitted to using his influence to persuade officials to award lucrative projects to companies he secretly planned to work for following his retirement. From a pure credit standpoint, the financial impact of these actions on DWP is minimal.

The level of situations like these, combined with the recent events at investor-owned utilities, tells you all you need to know about the current state of the utility industry. With power generation being such a key component of strategies to deal with the changing climate, management and governance are more important than they have ever been.

NORTH DAKOTA’S LEGACY FUND

In the past, we have questioned the approach of some states (in particular, Pennsylvania) took towards generating income and wealth from the oil and gas industries. This is especially true in connection with fracking derived fuels and newer fields in general such as the Bakken Field in North Dakota. Recently, the State of North Dakota saw its lending and credit support activities through the Legacy Fund receive a positive outlook from Moody’s.

In 2009, the Legislative Assembly passed House Concurrent Resolution No. 3054, which placed the question of creating the Legacy Fund on the 2010 general election ballot.  North Dakota voters approved the measure. Thirty percent of total revenue derived from taxes on oil and gas production or extraction must be transferred by the state treasurer to a special fund in the state treasury known as the legacy fund. The legislative assembly may transfer funds from any source into the legacy fund and such transfers become part of the principal of the legacy fund. The principal and earnings of the legacy fund could not be expended until after June 30, 2017. 

The first constitutionally mandated transfer of Legacy Fund earnings to the General Fund occurred in July of 2019.  The total amount transferred for the 2017-2019 Biennium was $455,263,216. The Legacy Fund corpus is currently $8.3 billion and in the 2019-21 biennium, $872 million of earnings were transferred to the General Fund.  

Legacy Fund Infrastructure Program bonds finance various capital programs around the state, including the Fargo) flood diversion project, water-related and energy conservation projects through the Resources Trust Fund, local government loans for infrastructure projects through the Infrastructure Revolving Loan Fund, state bridge and highway projects through the Highway Fund, and a new Agriculture Projects Development Center at North Dakota State University.

Legislation was enacted this year which calls for Legacy Fund earnings to be transferred to the Legacy Earning Fund in the General Fund. The legislation provides for the distribution of amounts transferred to the General Fund and specifies that earnings equivalent to 7% of the 5-year average market value of the Legacy Fund. Of those funds, the first $150 million are allocated to the Legacy Sinking and Interest Fund for debt service payments on bonds issued under the program.

ILLINOIS RECOVERY LIFTS UNIVERSITY CREDITS

Moody’s Investors Service has upgraded the University of Illinois (U of I) issuer rating to Aa3 from A1. The upgrade “reflects continued favorable operating performance, further balance sheet growth, and strong enrollment despite operating volatility caused by the pandemic. These organic improvements were supplemented by significant federal pandemic support and strong investment returns.”

In the end, what seems to have driven the move was Moody’s view of the State of Illinois’ (Baa2/stable) own improved fiscal and financial position, supporting Moody’s expectations of continued steady and on-time operating support to the university, whose dependance upon the state in terms of operating funds is about 30%.

While that is great for the flagship institution, the State’s improved fiscal outlook was cited when Moody’s upgraded the financially troubled North East Illinois University to Ba2. NEIU is a regional comprehensive public university with multiple campuses in the Chicago metropolitan area. It is designated by the US Department of Education as a Hispanic-Serving Institution. Fall 2020 full-time equivalent student enrollment was 4,672 students.

That niche status can cut both ways. If the served population is economically vulnerable, the demand for the school can vary widely. The State’s financial crisis coincided with sustained and persistent full-time equivalent enrollment losses, with enrollment declining by more than 40% over the past decade. Nevertheless, the State’s improved outlook reduced funding uncertainty for the school which gets 50% of its funding from direct state aid.

FUNDING THE POLICE

The question of policing in the City of Oakland seems to have ever changing answers. In 2014, local voters approved Measure Z which enacted a parcel tax on property which was to be dedicated to funding police. Measure Z requires the city to maintain at least 678 sworn officers in order to collect the revenue. The measure allows a grace period for taking steps to hire more officers and lets the council legislate an exemption.

Now, the City finds itself short of that requirement (albeit by 8 positions). The police department is budgeted for 737 sworn positions. So, the City Council has voted to increase funding to support recruitment and training of new officers. This is a trend that is playing out across the country as local government tries to balance the many issues surrounding the subject of policing.

Now that crime rates are rising to levels not seen in a decade, we expect that the movement to “defund” the police will not be one that is popularly supported.

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.