Joseph Krist

Publisher

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PANDEMIC ECONOMY

The Federal Reserve will leave interest rates near zero for the foreseeable future . It projects the unemployment rate to end 2020 at 9.3% and remain elevated for some time, coming in at 5.5% in 2022.  Officials are expecting output to contract by 6.5% at the end of this year compared to the final quarter of 2019, before rebounding by 5% in 2021.

The last time the Fed released projections was in December, when officials expected 2020 unemployment to close out at 3.5% with 1.9% inflation and 2% growth. Now, the Fed chair, Jerome H. Powell, said at a news conference that the latest unemployment data probably understates the extent of unemployment. 

So will exports pick up as other countries enter various phases of reopening? The Organization for Economic Cooperation and Development predicts that the global economy will contract 6% this year if a second wave of the virus is avoided. If a second wave does occur, world economic output would fall 7.6%, before rebounding by 2.8% in 2021. The two scenarios are viewed as having equal probabilities of occurring. The OECD projections are sobering in that export demand will not be able to drive growth. That demand has driven export growth in the energy, transportation, and agricultural sectors and they remain dependent on them.

PANDEMIC DOES DRIVE SOME BENEFIT

The Pennsylvania Turnpike Commission has announced that the cashless, all-electronic tolling (AET) system instituted in March to minimize the spread of the COVID-19 virus will become permanent. Customers will move through the toll plaza lanes at posted speeds without stopping. Changes like that along with the effort in some states to use the huge reductions in traffic as an opportunity to undertake major projects more efficiently have been unanticipated benefits of the lockdowns.

The drop in driving has also yielded some new revenue patterns leading to some innovation in transportation funding. Beginning July 1st, the statewide gas tax in Virginia will increase by five cents this year and next and there will be a highway use fee implemented. The highway use fee is designed to generate more of a user fee. The Commonwealth says the average fee is expected to be $19 annually for most vehicles, which would represent 85 percent of the difference between the amount of fuel tax on a vehicle that gets an average of 23.7 miles per gallon and the amount of fuel tax on a more fuel-efficient vehicle. To offset these changes, vehicle registration fees will be reduced by $10 or between 20% and 25%.

RATINGS AND WHAT THEY ARE TELLING US

The pandemic continues to pressure a variety of ratings. We are as interested in these actions as much for what they reflect about given sectors as they do about the individual impacted  credits. As the various restrictions on activity are gradually relaxed, the longer term impacts of the pandemic on particular sectors come into clearer focus. Here are a few visible examples of credit downgrades which are reflective as much about sector concerns as they are about individual credit details.

S&P Global Ratings lowered its underlying rating (SPUR) on the Pennsylvania Economic Development Financing Authority’s (PEDFA) $106 million–bonds outstanding and accreted interest–series 2013A senior parking revenue bonds to ‘B+’ from ‘BB+’. The parking system buyout was an important component of the plan to keep Harrisburg out of bankruptcy. Now, “While the system currently has capacity to meet its financial commitments on existing obligations, we believe the lingering weak operational performance and ongoing adverse economic conditions brought on by the current economic recession will impair the obligor’s financial capacity to meet its future commitments on all its obligations.”

S&P Global Ratings lowered its rating on Harris County-Houston Sports Authority, Texas’ senior-lien series 2001A, 2001G, and 2014A bonds to ‘BBB’ from ‘A-‘, and its rating on the authority’s second-lien series 2014C bonds to ‘BBB-‘ from ‘BBB’. At the same time, S&P Global Ratings affirmed its ‘BB+’ rating on the junior-lien series 2001H bonds, and its ‘BB’ rating on the third-lien series 2004A-3 bonds. The outlook for all ratings is negative. The reason: Anticipated decline in pledged revenues in 2020 due to the onset of COVID-19 and weakness in the energy sector; Unaudited fiscal 2019 pledged tax revenue providing 1.51x, 1.35x, 0.67x, and 0.74x maximum annual debt service (MADS) coverage on the senior-, second-, junior-, and third-lien bonds, respectively.

S&P Global Ratings revised the outlook to negative from stable on St. Louis Municipal Finance Corp., Mo.’s series 2014 city parks leasehold improvement dedicated revenue debt, issued for the city of St. Louis. “The projected drop in the city’s key revenues because of economic restrictions imposed as a result of the COVID-19 pandemic will materially limit the city’s ability to maintain structural balance within the current and following fiscal years.”  The downgrade has a one in three chance of happening in as little as six months.

S&P Global Ratings lowered the Port Authority of New York and New Jersey’s senior secured series 6 and 8 special project bonds issued on behalf of JFK International Air Terminal LLC one notch to BBB from BBB-plus. S&P is forecasting that annual passenger volumes for the Terminal 4 project will be 57% lower in 2020 than a year ago and would not recover to 2019 levels until 2024. Passenger volumes are projected to gradually improve throughout the year from a 92% drop in the second quarter, to 70% in the third quarter and 50% in the fourth quarter. The Queens Ballpark Co. LLC bonds issued to build Citi Field, the home of baseball’s New York Mets, received a downgrade to BB-plus from BBB. The status of the 2020 season is still “up in the air” and the team is openly for sale.

So those are the specifics of each story. The broader picture is that there will be many credits which rely directly or indirectly on economic activity to produce revenues to pay back bonds. The particular impact of tourism and travel overall (to include business travel) on many credits is stronger than one might think. Even for more locally driven economic activity, the limits on economic activity have been real and immediate for many credits. If you couldn’t go shopping, you didn’t need to go into town and park, eat. Even if you did want to attend, sports and concerts will not be available due to postponements and cancellations.

MC CORMICK PLACE

The Metropolitan Pier and Exhibition Authority, IL (MPEA) was able to successfully sell some $882 million of sales tax backed revenue bonds to fund the convention facilities at McCormick Place in Chicago. At the time of the sale, the Authority rightly made disclosures about the potential impact of the pandemic on economic activity as well as the number of events cancelled and the potential for more.

Even as the State of Illinois begins to emerge from the restrictions imposed as the result of the pandemic, the impact of the pandemic continues to emerge. The Association of Manufacturing Technology today called off its upcoming International Manufacturing Technology Show scheduled for Sept. 14-19. The event, which is held in Chicago every other year, was slated to bring nearly 130,000 attendees to McCormick Place and account for more than 99,000 nightly stays at Chicago hotels. MPEA estimates IMTS’ local economic impact, including ancillary spending on restaurants and transportation, to be $247 million alone.

This announcement follows the cancellation of the Radiological Society of North America’s (RSNA) 2020 annual meeting. The RSNA event—which was planned for late November and early December—and IMTS would have accounted for more than 200,000 out of 586,000 room nights that were expected from McCormick Place events during the second half of the year, according to MPEA. The convention center had lost 95 events to COVID-related cancellations that would have accounted for 744,000 room nights.

Bondholders can take some solace from the fact that the revenues covering debt service are not directly generated from the convention center. Things like ticket revenues are not pledged. The loss of events however, puts a major damper of one of the major drivers of economic activity and sales taxes for debt service so it matters. Hotel, car rental, and restaurant taxes are the Authority’s prime source of revenue with a dedicated portion of state sales taxes providing the remainder. The Authority’s tax sources have been among those most directly exposed to the economic restrictions of the pandemic.

The State has shown its commitment to the credit when budget disputes over the last five years resulted in an inability by the State to pass a budget. An enacted budget triggers payments for the Authority’s bonds. that means that those monies are subject to appropriation. When a budget has not been adopted, the State Legislature has enacted enabling legislation that facilitated the necessary transfers of revenue to pay debt service.  

RESERVE FUNDS MATTER AGAIN

Over recent years, the covenants which serve as the basis for the security of bond repayments have been steadily weakened. In the municipal bond market, this has shown up most clearly in the continuing move towards reducing the requirement for reserve funds. Historically, a fully funded debt service reserve fund equal to maximum annual debt service was the gold standard. Over time these requirements were gradually reduced for many borrowers with fund sizing reduced to six months debt service and in some cases reserve requirements were eliminated.

When objections were raised to lower levels of reserve protection, investors were told that new realities had replaced old thinking and after all, many issuers has established long records of repayment without resorting to draws on their reserves. Issuers were convinced that reserve funds represented stranded assets that only inflated the amount needed to borrow to fund reserves. The move towards weaker reserve positions was supported when there were effectively no ratings repercussions for issuers lowering or eliminating reserves.

The pandemic has now shown the value of reserves. As the situation unfolds, we are beginning to see issuers disclose that they either have or will likely have to make draws on their debt service reserve funds to cover their next debt service payment.

PRESSURE ON PROPERTY TAXES

The pandemic and its impacts on municipal operations and finances are becoming clearer by the day. While much attention is rightly focused on the impact on sales and income taxes, property taxes are another item which must be considered. In New York, the City Council is considering two proposals which would allow some taxpayers to defer property tax payments. The proposals reflect the fact that many New York homeowners are facing lost or much-diminished incomes and are worried about their ability to pay their property taxes, which are due in a few weeks. Many commercial property owners report that they, too, may have trouble paying their property taxes because some of their tenants—of apartments and/or commercial space—are unable to pay their rent, leaving landlords with insufficient income to pay all of their bills.

The City’s Independent Budget Office recently discussed two proposals which would offer property owners the option of deferring taxes due on July 1. The first would apply to owners whose primary residence has an assessed value below $250,000 (the vast majority of one-, two-, and three-family houses, coops, and condos qualify under this test) and whose household income is below $200,000 (according to census data, only about 10 percent of homeowners in the city would be excluded by the this criterion). Owners who meet these criteria and who faced some health or economic hardship due to Covid-19 can apply for the right to defer their July 1 tax payment until October 1 without incurring penalty or interest.

IBO does not have the access to homeowner income data or information on individual and household impacts of Covid-19 that would allow it to offer a robust estimate of how much revenue would be deferred. IBO did provide a “rough estimate” using property values, census income data, and zip code health statistics. That analysis suggests about $500 million in collections could be shifted from July to October, which is about one-third of what small property owners usually pay on July 1. It is notable that when looking at the zip code level, areas hardest hit by Covid-19 have low homeownership rates. Homeownership and property values are generally higher in zip codes with relatively low Covid-19 infection rates.

The second proposal would also offer owners of commercial properties with assessed value over $250,000 the chance to defer property taxes due July 1, but on different terms. Property owners would have to pay a quarter of their deferred payment by October 1, 2020 and pay the remainder by May 1, 2021 with interest accruing at a rate of 9 percent. Owners with either commercial or residential tenants would be required to offer rent forbearance during the deferral period.

Properties affected by the Covid-19 public health orders or occupied by tenants who were impacted would be eligible. Many properties would be eligible under this proposal and these properties are responsible for a much greater share of baseline property taxes than small property owners. However, the accrual of interest and the requirement to offer rental forbearance during the deferral period will likely discourage many from participating. IBO does not have an estimate of the amount of revenue that would be deferred. Both of these proposals would take effect on July 1.

There will be many similar situations across the country. For many municipalities, property taxes are the primary source of revenues and collections have historically held up pretty well during times of economic difficulty. That has been cited by the rating agencies as a reason why general obligation downgrades may be as numerous as feared. The IBO rightly notes that “this time however, is different.”

VIRGIN ISLANDS

Over time we have commented on the dire fiscal straits in which the US Virgin Islands Power Authority has existed over recent years. Whether it be the impact of Hurricane Maria, the potential for the Authority to be unable to purchase needed fuel, or the national economic disaster, the Authority has faced many challenges often escaping serious default by the thinnest of margins.

It appears that the Authority’s luck is about to run out. Press reports cite multiple sources for the view that the Authority is likely to default on debt maturing July 1. Moody’s said toe the Daily Bond buyer ““Our Caa2 senior electric system revenue bonds rating and Caa3 subordinated electric system revenue bonds rating with a negative outlook continue to reflect a high probability of default for the U.S. Virgin Islands’ Water and Power Authority (WAPA). We expect WAPA will likely be able to make debt service payments on the rated senior and subordinate electric system revenue bonds on July 1. However, WAPA will be challenged to refinance the unrated bond anticipation notes due this July 1, 2020, or extend their maturity. WAPA has very limited cash on its balance sheet, which is likely insufficient to redeem all outstanding bond anticipation notes at maturity.”  Fitch released a statement that “maintenance of the ratings watch reflects risks related to the authority’s debt profile and near-term maturities. WAPA faces debt service obligations on July 1, 2020, that include scheduled bond anticipation note (BAN) maturities totaling approximately $49 million that will require external financing or maturity extension. ”

It can be argued that a debt default by the Authority has been inevitable and that it  would take an event of that magnitude to drive needed changes in the Authority’s operations. The Authority is weighed down by a dependence upon oil as its primary fuel,  a weak economy , and an unsupportive rate environment. The note holders are in a weak position behind the senior debt holders and it is not clear what practical remedies are available to address the Authority’s problems. Some investors who had gotten used to the availability of triple tax exempt income at a spread were tempted to take the plunge on VI debt after the Puerto Rico default, even though it was clear that the Authority’s credit was on a knife edge.

NEW YORK HOSPITALS REPORT THE DAMAGE

With the city serving as the epicenter of the pandemic, it is no surprise that the major not-for-profit health systems experienced significant financial pressure. The results for the first quarter of 2020 bear this out.

Northwell Health, the state’s largest private health system with 19 hospitals, lost $141 million. New York–Presbyterian lost $128.5 million on the operations of its 10 campuses. Montefiore Health System, which runs facilities in the Bronx and the Hudson Valley, lost $96.8 million. The results represented loss margins of 4% to 6% for the systems. Mount Sinai Hospital did manage to make a profit, reporting $33.3 million in operating income in the first quarter. This was however, a drop-off of about one-third from its performance in early 2019.

Northwell received $1 billion from federal Cares Act programs, New York–Presbyterian got $567 million, and Mount Sinai received about $263 million. They also received advance Medicaid payments. Those payments however, are required to be repaid within one year. If that does not happen, outstanding balances would carry a 10.25% interest rate.

Hospitals are hoping that the next stimulus package would convert resulting loans into grants. They are also hoping that additional aid to state and local governments could provide additional resources if it is part of the next bill.

LOST IN THE FOG OF THE PANDEMIC

This time the fog smothering an airport’s operations is from the economic downturn’s impact on travel. In any other time, the completion of a significant major infrastructure would get much well deserved attention. But as is the case with so many other things during the pandemic, the new LaGuardia airport central terminal was officially opened. That marks the completion of the major project component and leaves the overall expansion/rehabilitation about 50% complete.

At a time when some major public/private partnership projects have hit serious snags, this project seems to be poised to represent how a well crafted P3 project can actually realize the promise of the concept. Ironically, it is the fourth P3 project to be successfully completed in New York. The successful implementation of these P3 projects in an area historically resistant to the concept is another example of the idea that if you can make it there, you can make it anywhere. The project only bolsters the case for P3 proponents.

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