Joseph Krist

Publisher

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THE ECONOMIC BACKDROP

The Federal Reserve has released its latest Beige Book with its view of the economy as the nation neared Thanksgiving. Most Federal Reserve Districts have characterized economic expansion as modest or moderate since the prior Beige Book period. However, four Districts described little or no growth, and five narratives noted that activity remained below pre-pandemic levels for at least some sectors. Moreover, Philadelphia and three of the four Midwestern Districts observed that activity began to slow in early November as COVID-19 cases surged.

Banking contacts in numerous Districts reported some deterioration of loan portfolios, particularly for commercial lending into the retail and leisure and hospitality sectors. An increase in delinquencies in 2021 is more widely anticipated. Providing for childcare and virtual schooling needs was widely cited as a significant and growing issue for the workforce, especially for women – prompting some firms to extend greater accommodations for flexible work schedules.

Contacts are concerned that when unemployment benefits and moratoriums on evictions and foreclosures expire, an avalanche of bankruptcies will emerge among other small and medium-sized businesses, as well as households. hiring plans for the year ahead were generally modest. About a third of contacts expected they will still be below pre-pandemic staff levels 12 months from now.

This creates a backdrop for the upcoming budget season for the states which will be difficult even if there is a stimulus.

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PANDEMIC FUNDING NEEDS

At least when the northeastern states bore the brunt of the first wave of the corona virus pandemic,  Congress stepped up and provided aid to institutions like hospitals and to many state and local entities. While it was not enough, it did allow some of the hospital credits to be shored up against the financial impacts of the pandemic response. Now the atmosphere in Congress is different and the consensus supporting an additional fiscal response is much less apparent. That makes for a far more difficult environment for healthcare credits in the areas of greatest demand. It is not clear as to whether sufficient support will be available to these credits especially in the center of the nation.

Another major sector on the precipice of fiscal disaster are the nation’s major mass transit agencies. While the troubles of New York’s MTA have been most prominent,  transit agencies across the country are facing draconian cuts in service without additional federal fiscal aid. (see article) While current utilization rates are historically low,  these agencies face the dilemma resulting from the fact that service cutbacks could permanently alter demand impacting revenues and debt service coverage. The States are muddling through as best they can. This is being used by some to make an argument that additional aid is not needed.

There is one problem. The current federal “plan” for distribution of a vaccine against the corona virus relies on the States to distribute the vaccine to providers. What it does not provide is any funding for this crucial step in the process. Estimates of the cost to the States have ranged up to $8.5 billion. Given the potential for increased economic pressure from emerging lockdowns, it is unfair to expect the already impacted state budgets to absorb more imposed fiscal demands.

Regardless of one’s individual politics, the failure to fund vaccine distribution through to final consumers makes no sense. It is consistent with the resistance to limits on activities in terms of a national strategy against the virus. But logically, the cost should be borne at the national level even if the actual physical execution of the plan is at the state level. Given where the virus is currently least under control, it makes no sense on a partisan basis.

These three sectors – hospitals, mass transit, and states – should be the primary targets of any additional federal support.

PUERTO RICO

The US Supreme Court declined to hear an appeal from bondholders seeking higher recovery on approximately $3 billion of defaulted C-rated Puerto Rico Employees Retirement System (ERS) bonds, issued in 2008 to fund pension liabilities. The “plan of adjustment” offered a 13% recovery on their claim. ERS bondholders’ debt service payments have been suspended since the Title III proceeding began in May 2017.

The US district court overseeing Puerto Rico’s bankruptcy-like case ruled in June 2019 that employer pension contributions to ERS do not qualify as special revenues under US bankruptcy law, a distinction bondholders sought in hopes of forcing Puerto Rico to resume debt service payments during the Title III proceeding. Special revenue backed debt holders have historically fared well during prior Chapter 9 proceedings.

The court further ruled that ERS bondholders’ lien on employer pension contributions does not “attach” to any contributions made after the system’s May 2017 bankruptcy-like petition, leaving them with an entirely unsecured claim. An appeal of that decision in the US Court of Appeals for the First Circuit upheld the lower court decision. The decision by the Supreme Court not to hear ERS bondholders’ appeal confirms of the First Circuit’s ruling as the final word.

Another shoe to drop was the news that the Puerto Rico Oversight Board approved a proposal that would include cuts in pensions.. Under the proposal, the board would cut by 8.5% pensions above $1,500 a month. This is an increase from $1,200 a month, as had been the case in the February 2020 proposed plan of adjustment. Clearly, asking pension bond investors to take huge haircuts without some impact on pensioners does not make sense. And then there is the Christmas bonus.

Over time one becomes immune to shock when the lack of a realistic outlook of the part of Puerto Rico’s ruling class becomes such an ingrained feature of the political landscape. The latest is the news that the Gov. Wanda Vázquez administration is requesting an authorization from Puerto Rico’s Financial Oversight and Management Board (FOMB) to use “excess” funding that had been earmarked for monthly payments to government retirees to cover a $23 million gap in this year’s allotment for payment of the annual Christmas bonus to public employees. 

It is just so indicative of the blind spot that Puerto Rico’s governments  have had over the years when it comes to the perception of investors. What is one supposed to think about a plan to take money for pensions away from pensioners and give it to current employees at the same time the financiers of the pensions are being asked to take 13 cents on the dollar.

MUNICIPAL LENDING FACILITY

The decision by the Trump administration to end the Federal Reserve’s Municipal Liquidity Facility program at the end of the year has caused some consternation. We believe that the market will survive the loss of the program. Recent months have shown that the market has the ability to finance the needs of even some of its most troubled borrowers.

The issue comes down to that of cost. The market clearing rates charged to borrowers from the facility do represent a significant spread above general rates. What they do not represent is a huge burden for potential borrowers on an absolute basis. Prior crises for municipal borrowers generated double digit interest rates even with credit support. That’s not desirable but the point is that it has been handled before.

The fact of the matter is that utilization of the facility has been much less than was expected. That is not indicative of any policy or programmatic flaw. There still is time for additional borrowing through December 31 but there only seem to be a couple of candidates likely to tap the facility. Illinois announced that it will access the program for a second time for $2 billion. The favorable market reception for some of the most prominently mentioned borrowers supports the more conservative view.

PENNSYLVANIA ELECTRIC CAR FEES

It took a party line vote but the Pennsylvania House has approved legislation enacting a fee on the registration of electric and hybrid vehicles. The fee is ostensibly designed to address the issue of owners being “free riders” on the Commonwealth’s roads by virtue of electric and/or hybrid car ownership. The fee would be $75 per year for a hybrid gas-electric vehicle, $175 a year for an electric vehicle and $275 for an electric vehicle with a weight rating of more than 26,000 pounds, such as a city bus.

The majority of the Legislature is supportive of the energy industry broadly in the Commonwealth. They saw the issue as an opportunity to impose a penalty on owners of greener cars. It’s consistent with the history of undertaxation of the natural gas fracking industry. The situation is one where the issue of equalizing user costs for roads may have taken a step forward (green) while clearly establishing an adversarial stance about non-internal combustion transportation (not green). It is hard to make the case that electric vehicles do not impose costs on the transportation infrastructure.

Mileage fees would address that concern as they would be agnostic as to the sort of motor for vehicles generating the utilization of roads. They are not as far along the political curve as these annual fees are. Twenty-eight states have laws requiring a special registration fee for electric vehicles while 14 states impose a fee specifically on hybrids. Mileage taxes are currently in their beta phase on a limited voluntary basis in other states.

This is not the only transit issue causing debate in the Keystone State. The Pennsylvania Department of Transportation (PennDOT) waited until the end of the budget process to announce a need for some $600 million of debt issuance to cover revenue shortfalls due to reduced driving. Because the issue was not part of the recently concluded state budget process, the state legislature would have to reconvene to approve the funding. Without the funding, PennDOT said construction on hundreds of road projects would stop on Dec. 1st, and those working on the projects could be laid off.

This led to an agreement between the Governor and the Legislature that allowed PennDOT to continue road and bridge work after lawmakers pledged to tackle PennDOT’s funding crisis when they return to session in January.

MORE TRANSIT FUNDING WOES

The operating agency running the Washington, D.C. Metro is proposing a new operating budget with a nearly $500 million deficit. The proposed 2021 budget includes closing Metrorail at 9 p.m., ending weekend service, closing 19 rail stations and reducing the number of trains, which would result in longer wait times. Current data shows the return of 20-25% of the pre-pandemic ridership. The system would look for $500 million in aid from any package enacted by Congress.

Without further federal action and major additional budget relief, MTA management now preliminarily projects total deficits attributable to COVID-19 pandemic impacts for the November Plan period of approximately $15.9 billion. As of November 6th, ridership was down 69% on the subway, 49% combined on bus service provided by MTA New York City Transit and MTA Bus, 73% on the MTA Long Island Rail Road, and 77% on MTA Metro-North Railroad. Traffic. MTA intends to borrow the maximum it is allowed to borrow under the program, $2.9 billion, before the lending window closes at the end of 2020. MTA expects to issue long-term bonds in 2023 to repay the MLF loan.

MARYLAND P3 SURVIVES

Deadlines have passed and in some areas of the project management was offloaded to the State in the face of the apparent breakup of the P3 developing the Purple Line in Maryland. Now, an agreement has been reached which will preserve the P3 nature of the project. Gov. Larry Hogan announced the state will pay $250 million to settle with the private consortium, Purple Line Transit Partners,  to settle “all outstanding financial claims and terminates the current litigation between the parties.”

Meridiam, Star America and Fluor were the corporate partners comprising Purple Line Transit.  The project will continue with Meridiam and Star America remaining as developers and equity partners. The group will then find a design-built contractor to finish the project , substituting for Fluor.  Some work on the project has continued under supervision by the state, including light rail car manufacturing, bridge work, stormwater drainage, paving, utility and pump station construction. That work will continue awaiting the selection of a new design-builder partner.

The project publicly maintains an estimated 2024 completion date. We’ll see as any potential design-build partner will be making its own assessment. It is a positive to see that a resolution has been reached removing a significant hurdle slowing project completion. Now the risk is more focused on ultimate execution of the project.

HARRISBURG PARKING

The debt problems in Pennsylvania’s capital city continue, this time with the city’s parking revenue bonds issued through the Pennsylvania Economic Development Financing Authority. Moody’s Investors Service has downgraded to Ba2 from Baa3 the rating on the Authority’s (PEDFA) (The System) Senior Parking Revenue Bonds (Capitol Region Parking System) The outlook has been changed to negative from stable. Roughly $117.5 million of outstanding par is affected.

The credit generated sum sufficient coverage but was always challenged to generate greater revenues. Operations were characterized by high leverage and total cost obligations, minimal liquidity, limited capital funding, and uncertain willingness and rate-making flexibility to raise rates. A primary source of revenue is a long term lease with the Commonwealth (70% of the system’s spaces) which locks in revenue levels which only generate at best thin coverage. These charges cannot be readily raised.

Under the circumstances of the pandemic, the credit required increasing drawdowns of capital reserve funds. That raises issues regarding good maintenance and upkeep and how they will be funded in the face of current demand trends. For bondholders, the unfavorable economics are backed up by an unfavorable legal structure that enables a covenant default as well as payment default on the subordinate bonds to trigger an acceleration of the senior bonds.

CLIMATE CHANGE, MANAGED RETREAT AND MUNICIPALS

Over time we have commented on a number of issues surrounding responses to climate change and their implications for municipal credits. One of those responses is the concept of managed retreat. In practice to date, much of that discussion has been theoretical. Now we have an example of a real municipal project designed to facilitate a managed retreat.

State Route 1 along the Sonoma County coast in California has been damaged by multiple erosive forces and the existing two-lane roadway continues to be undermined by coastal erosion and is vulnerable to future storms. Caltrans has responded by initiating emergency projects to reinforce the roadway, including constructing a retaining wall in 2004, which was later undermined by coastal erosion. Since 2017 Caltrans has issued emergency work orders to repair and stabilize the worsening roadway, but these are all short-term solutions.

Now Caltrans has announced a plan to relocate a section of State Route 1 in the area of Gleason Beach, north of San Francisco. The Gleason Beach Realignment Project would construct an approximately 3,700-foot, two-lane roadway and 850-foot long bridge span over Scotty Creek. This would move State Route 1 away from areas of erosion, preserve access to the existing homeowners. This allows the State to address one of the obvious risks from climate change, that of rising sea levels.

Continued coastal erosion and other conditions has undermined the existing SR 1 at a rate of 1 foot annually and could increase to approximately 1.5 feet per year by 2050 and 4.6 feet per year by 2100. The project is scheduled to begin in 2021 and be completed in 2023. Its projected cost is $73milion. Whether it is road relocations like this or road raising projects as have been seen Florida, the concept is gaining greater currency and we expect to see more debt issuance for these sorts of mitigation and resiliency projects.

On the East Coast, other projects will be funded on a smaller scale in coastal communities in the Northeast. In Maine, ten such communities will develop the State’s first comprehensive resilience plan. This planning will highlight the sorts of projects which are likely able to be financed in the municipal bond market. A role for municipalities is clear. Physical infrastructure-based projects such as elevating roads and expanding culverts are the market’s bread and butter,  The cities also will seek to highlight policy issues which can be more currently be addressed such as land use decisions, municipal policies, and land conservation efforts. 

MIDWEST NUCLEAR DRAMA UNFOLDING

The idea that private operators of nuclear generating plants could receive subsidies to continue to operate unprofitable nuclear generating facilities is not new. In New York and Illinois, operators have been successful in receiving such subsidies. The operators cite the lack of greenhouse emissions from nuclear generation and the role of these facilities as sources of employment. The efforts to obtain these subsidies have been steeped in politics and the desperation of the operators have led them to push the ethical envelope as they seek support for these subsidies.

In Ohio, these efforts have come under harsh scrutiny. HB 6, a $1 billion bailout for Ohio’s two nuclear power plants was signed into law in July 2019. Shortly thereafter, an investigation by the FBI was announced into an alleged $60 million public corruption scheme led by Republican Speaker Larry Householder. The Speaker and several associates are alleged to have been paid tens of millions of dollars to pass HB 6 and to prevent a referendum against the law from coming before Ohio voters. If proven, it would be the largest corruption and money-laundering scheme ever in Ohio. 

Now legislation is being introduced which would repeal House Bill 6. Without any change, residential customers will be billed an 85-cent fee each month on their electric bills starting Jan. 1.  Those fees, and larger ones assessed on businesses, would raise about $150 million a year for two nuclear plants originally owned by the IOU First Energy. It’s a contentious issue as it pits supporters of the energy/climate status quo and those who wish to move to renewables. The outcome of the ongoing legal and investigative proceedings will influence the ultimate resolution of the issue of legacy generating assets in an era of environmental change.

In Illinois, former Commonwealth Edison officials pleaded not guilty to charges that they engaged in a years-long bribery scheme that federal prosecutors allege was aimed at influencing Illinois House Speaker Michael Madigan. Com Ed is another utility saddled with unprofitable nuclear generating plants. The 2016 Future Energy Jobs Act provided ratepayer-funded subsidies to two nuclear power plants owned by ComEd’s parent company Exelon.

The employees are charged with agreeing to provide no-work jobs and lobbying contracts to close associates of Madigan as part of an effort to maintain his support for legislation helping Com Ed. A deferred prosecution agreement was announced by prosecutors in July in which current ComEd officials admitted to the scheme and agreed for the company to pay a $200 million fine in exchange for cooperating with the investigation and assurances that the company would reform its internal controls.

As climate change responses are proposed many believe that nuclear power will get another serious look as a source of carbon free energy production. These examples of extraordinary political actions taken to overcome the unfavorable economics of nuclear power tell us that the utilities know that nuclear does not make economic sense.

ATLANTIC CITY

Given the impacts of the pandemic and related closures and limitations, one might not readily expect that the locale of a major center of casino gambling would be an improving credit. Nonetheless, Moody’s Investors Service has affirmed the City of Atlantic City, NJ’s long-term issuer rating at Ba3 and revised the outlook to positive from stable. The positive outlook reflects Moody’s expectations that, despite the pandemic, Atlantic City will continue making strides in improving its governance and finances. 

The City has successfully entered into a program for payments in lieu of taxes (PILOT) with the  casinos. The pandemic has not been a total wipe out for the casinos with the growth of online gambling. This has enabled PILOT payments to be made adding certainty to the City’s revenue base. This has occurred as financial practices have improved under the continued, strong oversight by the State of New Jersey. That oversight occurs under legislation dealing specifically with Atlantic City which effectively expires toward year end 2021. 

The rating assumes that oversight will continue. Without any additional legislative action, the State Supervision Act will remain in effect. This act grants the state certain oversight powers over all New Jersey municipalities and additional supervisory powers over distressed municipalities such as Atlantic City.

THE POLITICS OF WATER

Westlands Water District is the largest agricultural water district in the United States, made up of more than 1,000 square miles of prime farmland in western Fresno and Kings Counties. Water is delivered to Westlands through the Central Valley Project (CVP), a federal water project that stores water in large reservoirs in Northern California for use by cities and farms throughout California. Water is delivered to farms through 1,034 miles of underground pipe and more than 2,924 water meters.

It is one of a number of water agencies who secured their water from the federal system under renewable contracts. This created a risk for the agencies in terms of long term planning and operations. So they looked as they have historically to their political connections to attempt to create an opportunity for long term commitments for water.

The 2016 Water Infrastructure Improvements for the Nation Act, known as the WIIN Act, allowed for reclamation contractors across the West to get permanent contracts if they repaid what they still owe U.S. taxpayers for construction of a federal water project. The distribution of water from the federal water project is managed by the US Bureau of Reclamation which is part of the US Department of Interior.

 Interior Secretary David Bernhardt for years represented Westlands as a Washington lawyer and lobbyist before joining the Trump administration. Now his decision to make permanent Westlands Water Districts water allocation is reported to provide a permanent entitlement to annual irrigation deliveries that amount to roughly twice as much water as the nearly 4 million residents of Los Angeles use in a year. The overwhelming bulk is for agricultural use.

The Administration has chosen to fully wade into the California water wars. While granting long term allotments to big agriculture interests it has also proposed raising the height of the Shasta Dam to increase supplies available for allotment under agreements favoring agriculture. It simply insures that the long running water wars in California will continue.

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