Joseph Krist

Publisher

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HEALTHCARE

The healthcare sector remains one of the municipal industry’s most interesting. As it evolves, it presents a variety of models and approaches which provide a variety of investment opportunities. Large systems versus stand alone facilities; urban versus rural; public versus private. They all reflect different approaches and funding models as they cope with the lack of consensus; the ability of patients to pay, and the particular characteristics and demands of individual local markets. It places some systems squarely in the middle of the conflict between the various market forces currently challenging hospital managements.

The latest example is New York’s Montefiore Medical Center, long considered the leading hospital in the Bronx. Montefiore Health System (MHS) is the parent of Montefiore Medical Center (MMC), which is comprised of three inpatient campuses with 1,558 licensed beds located in the Bronx, NY, as well as several other affiliated “member” organizations in Westchester, Rockland and Orange Counties. Member hospitals include 292 bed White Plains Hospital, 121 bed Montefiore Mount Vernon Hospital, 223 bed Montefiore New Rochelle Hospital, 375 bed Nyack Hospital, 242 bed St. Luke’s Cornwall Hospital, and 150 bed Burke Rehabilitation Hospital. MMC’s medical staff (2,800 physicians), is comprised of employed providers including faculty practice physicians as well as non-employed independent physicians. Montefiore Medicine Academic Health System (MMAH) is the parent above MHS that also controls Albert Einstein College of Medicine (AECOM).

Historically, Montefiore has primarily concentrated on its local market but that market has declining demographics in terms of the financial wherewithal of its primary service area. Nonetheless, it has maintained its quality standards and its role as a significant academic medical center. This however, has not been enough to maintain the system’s finances leading to changes  in its approach to the evolving healthcare marketplace.

In recent years, Montefiore has tried to maintain its role in serving underserved populations but has also attempted to expand its presence as a regional health system. This reflects the declining demographics of the Bronx as well as the hospital’s unique role as a “safety net” hospital while maintaining its position as the primary teaching hospital for the Albert Einstein College of Medicine (AECOM). This places Montefiore in a very difficult position. It faces funding pressures to maintain the academic quality of AECOM while it is also exposed to potential revenue constraints as New York State considers changes to state funding for safety net hospitals driven by overall state budget concerns.

Montefiore finds itself in the eye of a political hurricane. It has a heavily unionized workforce and a larger than average Medicaid component to its patient base. In New York, the impacts of policy decisions like raising the minimum wage to $15 an hour produce a higher cost base at the same time funding is under consideration for cuts. These issues have led the system’s management to undertake an effort to reposition it as a regional provider. This may or may not serve to diversify the system’s revenue base but it will not improve the situation facing several of its individual hospital components.

Montefiore also has a highly leveraged balance sheet and the abovementioned factors have limited its profitability and ability to generate excess cash to address those leverage issues. All of these issues and a planned upcoming bond issue contributed to moody’s recent announcement that it was downgrading Montefiore’s rating from Baa2 to Baa3. “The downgrade to Baa3 from Baa2 reflects unanticipated and meaningful additional debt beyond what was already considered, that will further reduce Montefiore’s financial flexibility amid ongoing and increasing constraints to operating performance. Leverage, which is already high relative to operations and cash, will rise beyond levels consistent with the Baa2 rating. In addition, the potential for strategic shifts following a change in senior management, will provide uncertainty.”

STATE BUDGETS ALREADY GENERATING TRENDS

The states are only beginning to face their FY 2021 budget processes but certain trends are already emerging. Transportation , healthcare, and education are the emerging points of emphasis. Education is focusing on the university sector as states like Illinois and California contemplate tuition increases. Rising costs and increasing demands for insurance reform are driving efforts to deal with Medicaid from a variety of perspectives. New York is focusing on Medicaid costs as a source of budget pressures. Concurrently, Kansas is expected to expand access to Medicaid under the Affordable Care Act after a change in administrations.

Even just a cursory look at headlines yields a strong emphasis on transportation. We have made the case for a long time that states and municipalities would have to take the lead as waiting for an infrastructure plan from the White House has become akin to waiting for Godot. The poisonous political environment in Washington has made it clear that federal action on a comprehensive is unlikely. So now we see the infrastructure dependent transportation sector moving front and center in the state budget process.

Massachusetts will consider an $18 billion transportation infrastructure funding package. Connecticut will consider a financing and funding program including tolls. New York’s governor has proposed a long term approach to transportation envisioning some $275 billion of investment. Virginia’s Gov. Ralph Northam announced $3 billion in improvements for rail traffic along I-95 that is expected to provide new opportunities for Virginia Railway Express commuter trains. The state’s gas tax hasn’t gone up since 1986, and in fact was lowered in 2013 by a Republican governor who had proposed getting rid of it altogether. It’s currently one of the lowest in the country. The Governor is proposing a 4 cent a gallon increase.

Maryland is poised to move forward on a $9 billion plan to expand capacity on I-270 through a public private partnership. The Michigan Senate approved a bill that would require the Michigan Department of Transportation to hire an outside consultant to study the feasibility of putting toll booths on Michigan highways. The study would have a cost of up to $150,000, and a contract with a third party would be subject to a separate approval. The bill calls for the study to review the economic impact and feasibility of tolling particular interstate highways; the ability to provide discounts or credits to lessen the impact of tolling on local, commuter and in-state drivers; information related to the number and impact of out-of-state drivers who would be expected to use the toll roads.

DETROIT

The City of Detroit and the regional economy got real good news in terms of corporate manufacturing investment in infrastructure. This won’t be located downtown where much redevelopment has occurred but rather will revive investment at GM’s Detroit-Hamtramck assembly plant. The plant was scheduled for closure but a byproduct of the October UAW strike against the company was an agreement on electric car investment and employment. GM is investing $2.2 billion in the Detroit plant where it will produce all-electric trucks and sport utility vehicles.

The plant will employ more than 2,200 people, the company said. Production is scheduled to begin in late 2021 on an all-electric pickup truck, followed by the Cruise Origin, a six-passenger vehicle that is intended for use as a self-driving taxi. The plan addresses a variety of concerns regarding the City’s recovery, its relationship with the auto industry, and it’s place in the future of transportation technology.

Other former GM sites are being converted or revitalized to serve 21st century technology needs in transportation. G.M. and South Korea’s LG Chem will make the battery cells that will power the electric vehicles made at the Detroit-Hamtramck plant in a separate plant near Lordstown, Ohio. Groundbreaking expected later this year and employment is planned for 1,100. This follows the closure of the plant by GM. The production at the Detroit plant of electric vehicles will replace the Cadillac CT6 and the Chevrolet Impala models which are currently produced at the factory.

PRIVATE COLLEGE RATING PRESSURE

Yet another tuition dependant private college is facing rating pressure as enrollments fall. The latest is New York’s Marymount Manhattan College. Moody’s has placed the College’s Baa2 rating on negative outlook after it reported a substantial enrollment decline. FTE (full time equivalent) enrollment declined by 3% in fall 2018 and an unexpectedly large 10% in fall 2019. This places real pressures on the College’s finances as it relies on tuition for 93% of its operating funds. A one-time influx of substantial cash in fiscal 2020 (a sale of its air rights on one of its buildings, generated a one-time $9.6 million influx in cash, which will be booked as in revenue in fiscal 2020). It has bought the College some time but given its low liquidity and poor fundraising effort, the impact of lower enrollments is real and immediate.

One thing in investors favor is the fact that the college owns valuable real estate on Manhattan’s Upper East Side. So there is an exit strategy in the event the College does not turn things around in terms of enrollment. The College will have to balance the need to increase enrollments through increased financial aid with the requirement to meet financial ratio covenants in support of its outstanding debt. It is required to maintain a debt service coverage ratio equal to or greater than 1.25x and an Available Assets to Debt Ratio greater than 25%. It is expected to be in compliance for fiscal 2020.

In the Midwest, Moody’s has downgraded Augsburg University’s (MN) rating to Ba1 from Baa3 with a negative outlook. Weaker financial performance combined with declining liquidity constraining its flexibility to respond to future challenges in a highly competitive environment were cited. It was noted that in fiscal 2019, pressures on operations, in part due to the opening of new facilities and rising debt service, absent offsetting stronger revenue growth resulted in a 6% operating deficit and a narrow operating cash flow margin of 5%.

This drove debt service coverage to below 1x, and below the covenant required by privately held debt. While the covenant requirement was waived for fiscal 2019, coverage, the university will face narrow coverage in fiscal 2020. This means the University will have ongoing exposure to potential acceleration of debt repayment. Risk is further heightened by very low monthly liquidity, which declined to $13.6 million or 66 days in fiscal 2019 due to financing of capital projects, and is insufficient to cover demand debt should payments be accelerated.

At the core is its heavy dependence on student charges, at 83% of total revenue. This exposes  Augsburg’s financial performance to the revenue uncertainty related to potential volatility in enrollment. Net, net – the University’s rating will face continued pressure. It difficult mix of tuition dependence, demand volatility, and less than optimum mix and structure of debt are difficult to overcome. Private higher ed is quickly becoming a high yield staple.

INFRASTRUCTURE “PLAN” FROM DEMOCRATS

The history of the Trump Administration’s approach to infrastructure consists primarily of a lot of talk supported by absolutely no policy follow through. It has resulted in one of the great missed opportunities to take advantage of historically low borrowing costs and a favorable political environment. Rightfully, Democrats in Congress have criticized the lack of serious proposals. So there has been hope that with at least one house under their control, so serious proposals might be offered.

That makes the release of a House infrastructure plan this week so disappointing. The Democrats’ framework (just some ideas without any proposed implementing and funding legislation) proposes $329 billion for roads and bridges, $55 billion for passenger rail, $30 billion for airport investments, $50.5 billion for wastewater infrastructure, $86 billion for expanding broadband access for rural areas, and $12 billion for a “next generation” 911 system for emergency calls.

The release does not deal with how to pay for it. Once again, states are taking the lead on issues of funding. On January 13, 2020, the Washington State Transportation Commission (WSTC) submitted their final report on a possible transition to a road usage charge (RUC) to the Governor, State Legislature and the Federal Highway Administration. The WSTC recommended that the Legislature should begin a gradual transition to road usage charging in Washington State. The Legislature should begin a gradual transition to road usage charging in Washington. From fiscal year 2018 to 2019, gasoline consumption declined 2.1% despite an expected 1.5% increase in vehicle miles traveled, and representing 3.1% lower consumption than forecasted at the beginning of the year.

The report also deals with the issue of car owner acceptance which is seen by many as the major obstacle to adoption. The ranking member of the U.S. House transportation committee is a big proponent of vehicle mileage taxes. The research in Washington supports that view. After experiencing the WA RUC prototype system, pilot participants became more favorable towards a RUC throughout the year, with 68% of respondents preferring RUC over the gas tax or preferring it equally to the gas tax by the end of the pilot, an increase from 52% at the beginning of the pilot. Only 19% preferred the gas tax, up from 17% at the outset.

The report also highlighted some of the realities of the legal, regulatory, and political hurdles to be faced during any transition. After experiencing the WA RUC prototype system, pilot participants became more favorable towards a RUC throughout the year, with 68% of respondents preferring RUC over the gas tax or preferring it equally to the gas tax by the end of the pilot, an increase from 52% at the beginning of the pilot. Only 19% preferred the gas tax, up from 17% at the outset.

HOTEL TAXES

Hotel taxes are pledged in support of a variety of municipal bond funded projects. They support projects which may bring economic activity but are projects seen as having a primarily private benefit – sports facilities are a favorite example as well as convention centers. These taxes had shown consistent growth over the years so they are seen as a good way for an issuing jurisdiction to fund such facilities without creating a burden on the local taxpayer.

So we were interested to see that in at least one market – San Diego – this ever increasing revenue stream may be flagging. San Diego County’s hotel revenue growth fell by more than 2 percent last year, marking the first yearly decline since 2009.  This despite slightly positive hotel revenue growth nationally. The percentage of filled hotel rooms, while still relatively high for San Diego County, at nearly 77 percent, fell in 2019, as did revenue per available room, a standard metric used in the hospitality industry to measure hotel performance.

The firm STR, which tracks hotel industry performance, has generated data that shows that in San Diego County, where overall supply grew by 2.5 percent but demand for rooms was largely flat. Over the last two years, the county saw nearly 3,000 additional hotel rooms come online. Room rates declined in the six consecutive months starting in June, 2019.

For the nation as a whole, STR is projecting growth in revenue per available room to come in at well below 1 percent for 2020. So it would be a good time to review holdings secured by hotel and other tourism related taxes to see if you are still comfortable with debt service coverage for your convention center and stadium bond holdings.

DEMOGRAPHICS AND CREDIT

Next month, the Municipal Analyst Group of New York will devote their monthly meeting to a discussion of demographics, data, and how this all impacts on the analysis of state and local credits. It is a timely subject given the availability of data for 2019 which has caused concern about some credits. Much attention was paid to population data for Illinois and Chicago that showed Illinois suffering the largest rate of population decline of any state. Declines in population for Chicago have also been raised as an issue by the rating agencies as well as investors.

We have argued previously that focus on the headlines numbers documenting outmigration may lead to the wrong conclusion. Chicago may be the best example of this. Chicago Magazine recently looked at data from a comparison of 2010 Census data with the 2013–2017 American Community Survey. It found that Illinois saw a decline in households earning less than $100,000 a year, while those earning more than $200,000 increased by 50 %. The state’s real per capita income is also on an upward trend, from $43,208 in 2010 to $53,727 in 2019. 

In Chicago, not all of the outmigration is out of Illinois. As the cost of housing has steadily increased, lower income residents often move to suburbs to find lower cost housing while continuing to be employed in the city. It is a phenomenon being repeated around the country. In some metropolitan areas, the most vibrant housing markets are in the suburban markets where housing prices have lagged behind overall averages.

These sorts of phenomenon may generate “negative”  trends in per capita debt calculations but may also support improvement in terms of debt to personal income and debt as a percentage of estimated full value ratios.   

COAL TAKES ANOTHER HIT

On 23 January, Dairyland Power Cooperative in Wisconsin announced that its Sustainable Generation Plan includes the retirement of the 345-megawatt (MW) coal-fired Genoa Station #3 (G3) in 2021. Dairyland is an electric generation and transmission cooperative that supplies wholesale electricity to its members (24 distribution cooperatives and 17 municipal utilities) in Wisconsin, Minnesota, Iowa and Illinois. Dairyland and its cooperative members serve 274,000 connected consumers. It is the process of obtaining permits for the construction, along with Minnesota Power, a new natural-gas fired plant, the 625 MW Nemadji Trail Energy Center, in Wisconsin.

That proposed plant has reached several hurdles. A December decision by the Minnesota Supreme Court overruled the Minnesota Public Utility Commission and required an Environmental Assessment Worksheet, even though the plant is based in Wisconsin. In January, the plant received a key approval from the Wisconsin Public Service Commission. Right now the project is caught between forces opposing any new fossil-fueled capacity and those looking to transition from to goal to gas to renewables. Neither of those views have any room for coal in their discussion and after all, that is the point.

Elsewhere in the coal dependent Midwestern power grid, the announcement came that  Hoosier Energy Rural Electric Cooperative Inc. in Indiana will also retire a coal plant. Hoosier is a Bloomington, Indiana-based generation and transmission cooperative providing wholesale electric power and transmission services under long-term, full requirements contracts with its 18 electric distribution cooperative members. The members, in turn, serve about 650,000 consumers through their distribution infrastructure, which spans southern Indiana and southeastern Illinois. The retirement of the 1,070-megawatt (MW) coal-fired Merom Generating Station in 2023 will mean that the cooperative will have successfully retired all of its owned coal-fired generation after first retiring its Frank E. Ratts coal plant in 2015.

ROCHESTER, NY SCHOOL DISTRICT

The SEC launched an investigation late in 2019 into Rochester City School District finances, and potentially false statements RCSD officials made when seeking short-term financing earlier in the year. It is reported that when obtaining a rating for a short-term borrowing, RCSD officials claimed that finances were trending positively, and they would rely less on reserves than anticipated. In reality, the district was running a current deficit, and would finish the year over budget by $30 million. 

The opening of that investigation was soon followed by Moody’s revisiting its rating on the City of Rochester which issues debt on behalf of the school district. In December, Moody’s downgraded to A2 from Aa3 the City of Rochester, NY’s issuer and General Obligation Limited Tax (GOLT) debt ratings and revised its outlook on the city to negative. The city had approximately $290 million in GOLT debt outstanding as of 2019. Moody’s was clear that ” the downgrade to A2 reflects the significant decline in reserves and liquidity at the City School District, which is a component unit of the City. The decline in reserves, which is well in excess of what management projected during our discussion in July of this year, is the result of poor budgeting of teacher salaries, benefits, transportation costs and costs associated with charter schools.

This has all culminated in the Governor’s budget proposal for legislation to create a state monitor to oversee the School District’s finances. The district has already laid off more than 100 teachers trying to close its budget gap. Local public officials are supportive. The District is hoping for an extraordinary infusion of some $25 million as a part of the state budget and it is likely that the money would be tied to the appointment of a monitor.

Bottom line for bondholders is that this is another example of New York’s historically positive hands on approach to local financial mismanagement.

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.