Joseph Krist

Publisher

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RURAL CREDIT AND BROADBAND

We have long been promoting the need for financing intervention to develop rural broadband. The problem of the lack of access to these services in rural areas has received increased attention. It has even received some funding from the federal government. That funding is scant compared to the need. As we ourselves are rural broadband consumers, we admit to an above average concern with the subject.

Recently we came across a story in the Fresno Bee that we think highlights the scope of the issue. The Federal Communications Commission, through its Connect America Fund Phase II auctions, is spending $13.5 million over the next 10 years to provide broadband service to about 5,600 rural homes and businesses in Fresno, Kings, Madera, Merced and Tulare counties. That sounds promising until you see the magnitude of the need. In Fresno County, the FCC’s investment of about $4.1 million will cover about 1,800 homes and businesses. That leaves some 71,800 households without access.

The five counties effectively are poster children for the rural broadband dilemma.  Rural and economically below average they include some of least cost effective areas to serve for a for profit provider.  The report estimates that nationwide, about 17 million households – or 14% of U.S. households – have no internet access. In Fresno County, it’s more than 73,600 households — roughly 25%.

We strongly believe that there is a significant role to be played by state and local government to bridge the internet access divide. The biggest obstacle to implementation currently the difficulty in deriving profits from the service. Municipal bond issuers could be created to finance and provide the sort of backbone infrastructure without the need to run it on other than a lowest cost of service basis. States need to enact authorizing legislation and allow municipalities to pool their resources and address the problem.

NYC BUDGET

Mayor Bill DeBlasio released his preliminary budget proposal for FY 2021. The Fiscal Year 2021 Preliminary Expense Budget is $95.3 billion.  After years of steady increases in spending and record high employee headcount, the mayor seems to have finally accepted the realities of the need to curb some of that growth. Unfortunately for investors, the budget as presented is much more of a political document than it is a plan for fiscal stewardship.

In presenting his budget, the Mayor focused on the state’s financial issues rather than those of the city. The basis for the plan is the expectation that the State’s efforts to balance its FY 2021 budget in the face of a projected $6 billion budget gap will disproportionately impact the city generally and the poor specifically. He is positioning himself as the savior of Medicaid in the city. At the same time, the Mayor complains about the need for additional funding for the MTA while continuing to fund the free fare program.

The commentary accompanying the numbers provides some context. “The New York City economy is still expanding but the pace is slowing. Payrolls continued to grow for a tenth year, but it appears that 2019 will mark the fourth consecutive year of softer job gains. Sectors that have been reporting decelerating job growth include finance, real estate, and leisure and hospitality. This latter sector may be partly reflecting slowing tourism activity. Professional and business services and healthcare have been advancing strongly, although healthcare gains appear to be caused by home-care aides funded by Medicaid.” That last comment reflects a belief on the part of many that one of the issues driving Medicaid costs is the $15 minimum wage. Cuts in those services would damage one of the interest groups the Mayor counts on.

Where is the money going to come from? The City of New York is expected to collect $64.4 billion in tax revenue in fiscal year 2020. This represents growth of 4.6 percent over the prior fiscal year. Property taxes are forecast to increase 7.1 percent, while non property taxes are forecast to increase 2.1 percent. Non-property Tax revenue growth is forecast to grow 2.1 percent in 2020 and remains fl at in 2021. Personal income tax revenue totals $13.7 billion in 2020, an increase of 2.9 percent. The increase reflects strong wage growth and slight bonus growth coupled with a decrease in non-wage income. Business income tax revenues (business corporation and unincorporated business taxes) are forecast at $6.3 billion. This represents an increase of 1.4 percent over the prior fiscal year.

Sales tax revenue is expected to experience a growth of 7.0 percent to $8.4 billion in 2020. This increase is spurred by consumer spending and tourism. Hotel tax revenue is forecast at $638.0 million in 2020, a 2.0 percent increase over the prior fiscal year. The numbers reflect the City’s ever increasing reliance on tourism and services.

So this budget seems to be designed to pick a fight with Albany as much as it seeks to achieve necessary policy goals. At least debt service remains below 10% of the budget. That’s important as the City faces staggering capital demands in the face of massive infrastructure needs.

HEALTHCARE

CMS generally has paid more for clinic visits conducted in off-campus hospital outpatient departments (HOPD) than those conducted in the physician-office setting. However, the agency in 2019 began to shift payments for services provided at HOPDs to match those for clinical visits that it pays under Medicare’s Physician Fee Schedule. Known as “site-neutral payment” policies, CMS had planned to implement the site-neutral payment policy over a two-year period by: reducing the payments for routine clinical visits to off-campus HOPDs by 30% in CY 2019 compared with CY 2018, bringing Medicare payments down to $81 for such visits and beneficiary copays down to $16. It would also reduce the payments by 60% in CY 2020 compared with CY 2018, bringing Medicare payments down to $46 for such visits and beneficiary copays down to $9. CMS estimated the change would save Medicare about $380 million in 2019 and $760 million in 2020.

The American Hospital Association, the Association of American Medical Colleges and several hospital members filed a lawsuit in the U.S. District Court for the District of Columbia. A federal judge ruled in September 2019 that CMS didn’t have the authority to make the 2019 cuts. Nonetheless, CMS decided to go ahead with the second round of cuts that started Jan. 1. Hospitals could face a 60% reduction in Medicare payments to off-campus outpatient departments if the cuts aren’t reversed. A judge had previously ruled that the parties could not sue until the cuts were actually imposed.

CMS has to refund $380 million in cuts for the 2019 year to hospitals as a result of the 2019 ruling. A similar outcome seems likely in 2020.

TRANSIT DEVELOPMENTS CULTURAL REALITIES

I have believed and argued for some time that one of the major hurdles to be overcome in a resolution of the ongoing debate over the future of transit has nothing to do with the usual suspects – fares, reliability, access. The hurdle I refer to is best described as the issue of social equity in the provision of public  transportation facilities. One of the realities which “alternative transportation” advocates continue to refuse to admit to is the reality that the movement towards micromobility is driven by a less than homogeneous base.

Whether it’s the slower rollout of services like bike rentals in poorer neighborhoods, the use of remote regulators to “depower” electric scooters, or other technological approaches applied to access to emerging service modalities, a pattern emerges. In city after city, these services are rolled out without the agreement of or even the opportunity provided for governmental entities to review the implications and impacts. Even with the involvement of government, the results are not always equitable. 

A good example is Mayor de Blasio’s heavily-subsidized NYC Ferry service. This service is back in the spotlight as press reports highlight the apparent inequities of the City’s current scheme to subsidize ferry service to and from Manhattan. The data has been around for some months. For whatever reason, the press seems to have been relying on getting the data through the Freedom of Information Act even though it has been available since the Fall of 2019. So what follows is not news to us.

New York City, through its economic development corporation, operates a fleet of passenger ferry boats which act primarily as an alternative form of transportation for commuters to Manhattan. The ferry service is heavily subsidized and this funding has occurred in parallel with the decline of the New York City bus and subway system. The system is a form of P3 as the city’s Economic Development Corporation runs the ferry network with private cruise company Hornblower.

Over a two week segment in May and June, the operators conducted a survey of more than 5,400 riders. A couple of points of data generated from the surveys have generated a response highlighting the socioeconomic issue raised. The problem is that the agency’s analysts determined that 64% of the boat users are white, and that riders’ median annual income falls in the $75,000 to $99,000 range. A 2017 report from city Comptroller Scott Stringer’s office found that two-thirds of subway riders are people of color, and that straphangers’ median income is roughly $40,000 a year.

The difference in and of itself is not a surprise given the locations of the very stops feeding riders to the boats.  The area demographics around those terminals and stops seems to be reflected in the boat ridership demographics. They do not seem to be generating new net users of mass transit. So they would seem to be siphoning demand and patronage from the city bus and subway system.  It is that concern that focuses attention of the next data points.

Here’s how the data shape a narrative which support some of the stereotypes. 60% identify as millenials. 75% are commuters to work. This produces a system that is richer, whiter, and younger than is the case with the mass transit system. And yet that system receives a subsidy from the City equivalent to $9.82 in addition to the $2.75. This is a glaring difference between the level of subsidy provided per ride to the ferry service and the level of per ride subsidy provided to 

And it screams of economic inefficiency. The EDC has described demand for the ferry service as “booming”.  The “booming” ferry ridership includes 2.5 million trips made this past summer, a record for the service. That’s still less than half of the 5.4 million rides the subway does on an average weekday. At the same time, the subway receives roughly $1.05 worth of subsidies per rider, according to a report released earlier this year by the watchdog Citizens Budget Commission.

The data raises some basic questions as to the logic behind the Mayor’s efforts to expand the City’s role in the provision of ferry service. With the onset of the State’s budget process, transportation will again be in the spotlight with the MTA facing extraordinary capital funding needs. The City has been resistant to the concept of increased city subsidies for mass transit even as it continues to subsidize services which support only a very narrow slice of the population.

CALIFORNIA SCHOOL DISTRICT FRAUD

In the Fall of 2019, the SEC announced that it had fined the Montebello Unified School District Superintendent $10,000 after finding the district had broken federal laws involving the sale of bonds used to raise millions for construction projects at the school district. In September, according to the SEC’s complaint and order, immediately before and concurrently with the District’s sale of $100 million of general obligation bonds in December 2016, Montebello’s independent auditor repeatedly raised concerns about allegations of fraud and internal controls issues to the District’s Board of Education and management. In response, Montebello allegedly refused to authorize the fees needed for the audit firm to complete its audit and instead decided to terminate the audit firm.  The offering documents for Montebello’s December 2016 bonds failed to disclose this information to investors and instead included a copy of the District’s audit report from the prior fiscal year, which included an unmodified or “clean” audit opinion from the firm. 

The SEC alleges that Montebello’s former Chief Business Officer, helped prepare the misleading offering documents and also concealed the audit firm’s concerns by providing deceptive updates about the status of its pending audit to various gatekeepers, including the disclosure lawyers who worked on the bond offering. The SEC’s order found that Anthony Martinez, Montebello’s Superintendent of Schools, signed the final bond offering document and made false certifications in connection with the bonds.

Now the legal difficulties could impact the District’s ratings. S&P Global Ratings placed its ‘A-‘ underlying rating (SPUR) on Montebello Unified School District, Calif.’s outstanding general obligation bonds and its ‘BBB+’ SPUR on Los Angeles County Schools Regional Business Services Corp.’s outstanding certificates of participation issued for the district on CreditWatch with negative implications. S&P has not received responses to requests for information ” regarding the  federal investigation . S&P said “We need the information to maintain our rating on the securities in accordance with our applicable criteria and policies.”

We wonder why S&P doesn’t just pull the rating. Yes that might hurt secondary bond values but it would also be a real signal that misrepresentations large or small will not be tolerated. After all, one could make the argument that these misrepresentations have led to a rating not fully commensurate with the District’s financial realities. It would be nice to see the rating agencies take a stand. The SEC’s complaint, filed in U.S. District Court for the Central District of California, charges the business manager with violating the antifraud provisions of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder as well as Section 17(a) of the Securities Act of 1933, and seeks permanent and conduct-based injunctions as well as a financial penalty.

PENSIONS CLAIM ANOTHER ILLINOIS RATING

S&P Global Ratings lowered its rating to ‘A+’ from ‘AA-‘ rating on Cook County, Ill.’s general obligation (GO) debt, of which roughly $2.8 billion in principal for GO bonds remains outstanding. The outlook is stable. The move comes as the state enters its FY 2021 budget season. Underfunded state and local pension funds are once again front and center in the budget debate.

While much attention is rightly focused on the City of Chicago’s difficult pension situation, Cook County faces substantial issues and relies on the same tax base as does the City.  “The downgrade reflects the county’s large and underfunded pension obligation,” said S&P, “and although the county has made steps to address its pension funding levels–specifically with a new sales tax revenue stream beginning in fiscal 2016 that significantly increased its annual contributions–its ability to meets its planned additional payments over the long term will remain an ongoing challenge, in our view. Further, even with these additional payments, in our view, contributions fall well short of both static funding and minimum funding progress, in part because of poor assumptions and methodologies.”

S&P does note some positive factors. ” Although the county’s poorly funded pension will likely place considerable pressure on its finances, in our view, recent progress toward actuarially based statutory payments through new sales tax revenue has reduced the likelihood of plan insolvency. Over the outlook period, pension contributions are known and are not expected to cause significant budgetary pressure. However, given the plans’ assumptions and methods and very low funded ratio, costs are certain to rise and will be a continuing challenge for the county–particularly given the reduced flexibility caused by overlapping entities, in our view.”  

The bottom line – the Chicagoland region will continue to be negatively impacted. While legally distinct entities, the troubles of one or the other credits (the city or the county) are inextricably linked. Not only is the scope of the problems significant but the politics may be as difficult as there are in any large city. We think that the rating could have easily accommodated one more notch lower to reflect those pressures.

CALIFORNIA SCHOOL DISTRICTS BENEFIT FROM LEGISLATION

Assembly Bill 1505 was enacted in 2019 and it became effective at the beginning of 2020. The legislation was designed to slow the growth of charter schools, especially in poorer areas where charters and public districts directly compete for students and the state aid that follows them. Aid, after all is based on attendance. K-12 school districts gained more authority via legislation to reject new charter school applications. K-12 districts have more flexibility to reject new charter school applications by allowing them to evaluate the fiscal impact of a proposed charter on the district, and whether the school will duplicate or undermine programs already in place. The law also makes districts the primary authorizers of new charter schools, with the state retaining an appeal review function.

Like it or not, charter schools do indeed move resources from one group of schools to another. Often, charters do not have to deal with legacy employee costs or the costs of special education. The number of charter schools increased 60% statewide between the 2009-10 and 2017-18 school years. The largest number of charter students is by far in the Los Angeles Unified School District. Proportionally, the poorer districts of Oakland and Sacramento see significant proportions of its total enrollment base in charters (27% and 13% respectively.

Limits on new charters has to be viewed positively in terms of general credit factors. The new law provides additional powers for financially struggling K-12 districts to limit potential new charter school competitors, a credit positive for those districts. The districts include those the state says “may not” meet financial obligations, which have a “qualified certification;” those the state says “will not” meet them, which have a “negative certification;” and those under state receivership. Of California’s 10 districts with the largest charter school enrollment, three fit these categories: Oakland Unified, Twin Rivers Unified, and Sacramento City Unified.

CLIMATE CHANGE FOLLOW UP

Last week we commented on the subject of climate change and municipal credit. Since then the National Oceanic and Atmospheric Administration released data regarding damage from floods in 2019. The data is interesting.

Precipitation across the contiguous U.S. totaled 34.78 inches (4.48 inches above the long-term average), ranking 2019 as the second-wettest year on record after 1973. Michigan, Minnesota, North Dakota, South Dakota and Wisconsin each had their wettest year ever recorded. Hence, the downstream flooding which impacted the Mississippi Valley. The combined cost of just the Missouri, Arkansas and Mississippi River basin flooding ($20 billion) was almost half of the U.S. cost total in 2019.

The average temperature measured across the contiguous U.S. in 2019 was 52.7 degrees F (0.7 of a degree above the 20th-century average), placing 2019 in the warmest third of the 125-year period. Here’s an anomaly that always complicates the debate. Despite the warmth, it was still the coolest year across the Lower 48 states since 2014.  Last year, the U.S. experienced 14 weather and climate disasters with losses exceeding $1 billion each and totaling approximately $45 billion. Their locations as depicted in the image provided by NOAA reinforces one point we made last week. Simply avoiding “coastal” risk is not a sophisticated enough approach.

NEW  YORK CAPITAL DEMANDS RISE

The numbers were already staggering – $30 billion for the Gateway Tunnel, $50 billion for the MTA, and $32 billion for the New York City Housing Authority (NYCHA). At $112 billion the pressure is enormous. So it was a bit disconcerting to see that the new boss at NYCHA has had to increase NYCHA’s need by 25% in his latest estimate. Some change from the 2018 estimate was expected but this a substantial increase. Apparently, the 2018 estimate didn’t fully capture the costs of lead abatement, elevator replacement and other compliance costs. 

Sometime this year the agency will release an updated proposal to raise additional capital and therein lies the rub. Debt will clearly be part of the plan but there were vague references that it “might be” looking to disposition. Currently, NYCHA hopes to convert 15,000 apartments to private management by the end of the year as part of the federal Rental Assistance Demonstration program (RAD). 

Under RAD, it allows Public Housing Authorities (PHA) to manage a property using one of two types of HUD funding contracts that are tied to a specific building: Section 8 project-based voucher (PBV); or Section 8 project-based rental assistance (PBRA). PBV and PBRA contracts are 15- or 20-years long. The program is “voluntary” but it is important to note that the city is managing NYCHA under the terms of a consent decree with the federal government. There is enormous pressure on the City to use the RAD program. So it is not a purely financial or credit based approach. That raises concerns about the execution of these conversions and the clarity surrounding the potential implications for NYCHA and its investors.

So we look out ahead and see a capital need of some $120 billion just from these three areas. That doesn’t count the normal capital investment requirements of the City. One thing investors won’t have to worry about going forward will be the supply of new bonds.

HIGH SPEED RAIL

After a five year effort, Indian County, FL is expected to let an appeals court ruling stand unchallenged that The U.S. Court of Appeals last month ruled Virgin Trains legally was entitled to finance its private railroad project with government issued, tax-free private-activity bonds. The county has determined that its appeal was unlikely to be heard by the U.S. Supreme Court. It will not pursue such review.

The county will continue to pursue its Circuit Court lawsuit over maintenance of the 21 crossings along the Florida East Coast Railway corridor within Indian River County. The lawsuit, filed last year, claims Indian River County should not be required to pay for crossing improvements that Virgin Trains says are required in order to run 32 higher-speed passenger trains daily. Safety has been a significant issue for Virgin USA as federal data released in December that in terms of deaths by pedestrians on tracks, the Brightliner route is the most dangerous in the US.

These deaths occur at a rate of more than one a month and about one for every 29,000 miles the trains have traveled. That’s the worst per-mile death rate of the nation’s 821 railroads. The company has not been blamed in any of the deaths as suicides and drivers trying to beat or avoid existing gates have been the cause. U.S. trains fatally strike more than 800 people annually, an average of about 2.5 daily. About 500 are suspected suicides. So the issue comes down to who pays for the upgraded crossings – the railroad or the County?

The favorable turn in the legal outlook is clearly credit positive for the bonds.

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.