Joseph Krist

Publisher

________________________________________________________________

GATEWAY TUNNEL REVIVAL

The need for major capital investment in the rail infrastructure supporting the New York metropolitan area has been clear for a long time. The Gateway Tunnel project is designed to address issues arising from the age of the existing rail tunnel infrastructure (over 100 years). The damage from Superstorm Sandy accelerated the interest in the project. A funding source had been identified – there had been a general agreement that the federal government would cover half the cost of building the tunnels, with New York and New Jersey sharing the other half. 

Then politics intervened with then Gov. Christie refusing to provide New Jersey’s share and that allowed the Trump Administration to get its hands on it. They used the environmental approval process to stall the project. Another hurdle was the disagreement over whether any funds borrowed – not granted – from the federal government by the states and used to fund their state share counted as part of a state’s share of the overall project. In the meantime, the need continued and the cost remained subject to increase over time to its current price of $11.6 billion.

Now, the proposed infrastructure package could easily provide the federal share of funding.  The Biden Administration will allow the states to borrow from the federal government if they choose and it will count as part of their share of the costs. The U.S. Department of Transportation will no longer sit on the environmental approvals needed for the project. So now it can move forward.

INTERNATIONAL STUDENTS

The Muni Credit News has been talking about the impact of tightened immigration rules under the Trump Administration from its beginning. We have documented the role of international students in the financial welfare of the universities they attend as well as the overall economic benefit these students generate through consumer spending and real estate. As full fare paying customers they have become a reliable source of income to these institutions.

Now that universities are planning for full reopenings in the fall, these institutions are looking to the Biden Administration to dismantle the obstacles raised against international students attendance at U.S. institutions of higher education. It comes as Moody’s has opined that the limits on international students is having long term negative impacts of the finances of colleges with substantial international cohorts. We’re glad to see Moody’s come to that view but it has been apparent for some time that this was a credit concern.

College students and academics from China, Iran, Brazil, South Africa, the Schengen Area of the European Union, the United Kingdom and Ireland have been added to the State Department’s list of national interest exceptions to the Covid-19 travel restrictions, which allows them to come to the United States despite travel restrictions . But there are still issues with the need to obtain visas from consulates around the world which under the best of times have limited ability to process requests.

A couple of data points highlight the problem. At University of California at Berkeley, 13 % of students are from overseas. Carnegie Mellon University, finds 18%  students are from overseas. Nearly 1.1 million students from abroad attended college in the U.S. in the 2019-2020 academic year, according to the Institute of International Education.

At the same time pressure is being placed on the Administration to support immigration, another side of the college enrollment issue emerges. California is the latest state to consider limits on non-resident admissions to the UC system. The UC regents in 2017 capped nonresident enrollment at 18% systemwide under legislative pressure, with a higher share grandfathered in for UCLA, Berkeley, San Diego and Irvine. Now the demand from California residents is skyrocketing.

A bill is under consideration which would reduce the proportion of nonresident incoming freshmen to 10% from the current systemwide average of 19% over the next decade beginning in 2022 and compensate UC for the lost income from higher out-of-state tuition. Ironically, this would highlight the importance of international students as that demand has shown to be price inelastic.

The issue of access to state residents who have in large part financed the UC system through taxes is a long standing one. When the state’s finances were damaged by the Great Recession, reduced aid to UC led to tuition increases. The bill’s sponsors claim that it would ultimately allow nearly 4,600 more California students to secure freshmen seats each year, with the biggest gains expected at UCLA, UC Berkeley and UC San Diego. Those schools see non-resident shares as high as 25%.

MUSIC STOPS ON THE CAROUSEL

One clear victim of the pandemic was brick and mortar retail. It has raised concerns about municipal bonds whose source of repayment is payments made by projects like shopping and entertainment malls. The restrictions on public activities which limited or prevented patronage increased the pressure on a couple of the larger projects as they either started out (the American Dream project in New Jersey) or which were already under some financial strain.

The best example of the latter is the Carousel Center in Syracuse, NY. The project had a rocky financial history before the pandemic. The project originally thought that it would attract the same number of  visitors as Las Vegas does in a year. That was dubious prospect at best given the realities of weather and more geographically limited appeal. The limits of the pandemic exacerbated existing shortfalls in demand and revenues. This left much less available to cover PILOT payments (payments in lieu of taxes) on bonds issued to finance a portion of construction.

The project has undertaken a number of efforts to restructure its obligations which have involved deadline extensions among other steps to prevent foreclosures. The troubled finances of the project have led to steady downgrades to its outstanding ratings. Now it has been announced that Carousel Center Company L.P. has hired a restructuring agent and counsel and is actively engaging its lenders, including some PILOT bondholders and the PILOT bond trustee, with an unknown restructuring proposal. 

This led Moody’s to downgrade the rating on the outstanding debt secured by PILOT payments to Caa1. Moody’s points out that because of lower valuations for shopping malls, including the Carousel Center, there is a higher likelihood that the PILOT bonds could be impaired should a debt restructuring, distressed exchange transaction or a bankruptcy filing. It references the fact that “in extreme cases like a bankruptcy, the PILOT bondholders could be impaired if the PILOT agreement is rejected or if some unforeseen action occurred in that proceeding as there is no legal precedent for what will happen to the PILOT bonds in a bankruptcy. For example, the property tax generation potential of the legacy Carousel Center is arguably lower than the PILOT payments given the below 60% occupancy rates now compared to above 80% before the pandemic.”

The rapid decline in occupancy in the legacy Carousel Center portion of the Destiny USA mall has also reduced the publicly reported asset’s value that is materially lower than the PILOT bonds and the subordinate CMBS loans outstanding. One deadline occurred this week. A major concern for the municipal bond holders is that they have little control over events which could trigger actions detrimental to the bondholders.

The project relies on some old models with its reliance on big box and major retailer anchor tenants. Many of these entities have been under financial pressure even before the pandemic and now are facing significant closures. Best Buy, Michaels, Lord & Taylor, and Abercrombie are all recent departees from the project.

While the pandemic may have been foreseeable, the concept behind the mall was always suspect. The projected patronage numbers provided strained credulity even back in 2007 when the PILOT bonds were issued by the Syracuse Industrial Development Agency. It took a high level of optimism to believe in any project drawing nearly 40 million people to Syracuse for the mall. While I may have been prejudiced from having gone to school in Syracuse, the likelihood that those levels of patronage could be achieved struck me as extremely unlikely.

Now, Moody’s takes the view that “there is significant uncertainty as to whether the Carousel Center can reach previous occupancy levels above 80% given the currently low level and difficult market for new retail tenants. With below 60% occupancy levels, the mall’s market position has also weakened and with the loss of several anchors and large box stores, the overall impact is larger than losing the smaller in-line tenants. 

FREE FARES – TWO APPROACHES

Over recent years a significant movement has emerged to support the subsidy, reduction, or elimination of fares on public transit. It is one of many issues encompassed in the “progressive” movement. Now, two of California’s major cities are about to take clearly different paths on that issue.

In San Francisco, the Board of Supervisors  (City Council) had voted to implement an experiment this summer under which fares on Muni would have been free for all riders between July 1 and Sept. 30. The agency would have still collected voluntary fares for people who still wanted to pay. 

The system hoped to use the experiment to generate data on ridership patterns and demand to determine where such a program would generate the most benefit. $12.5 million in city funds that would have supported the three-month pilot. Now the Mayor has indicated she will veto the plan. The argument against the plan reflects the financial damage done by the pandemic. Ridership on Muni trains and buses is at about 30% of pre-pandemic levels, while services are at about 70% of what they were before shelter-in-place.

Los Angeles County’s Metropolitan Transportation Authority’s board approved a 23-month fareless transit pilot program. The program would begin in August and initially be offered to K-12 and community college students. In January 2022, the pilot will expand to include “qualifying low-income residents” (annual income is less than $35,000). Metro officials estimate rider fares account for 13% of the agency’s operating costs, and roughly one-third of those costs go toward expenses related to fare collection, such as fare enforcement, accounting and fare box maintenance. 

The different plans reflect the complexity around issues like transit funding. These systems are increasingly seen as being at the center of the debate over “economic justice”. There will likely be more debates like this going forward as the recovery from the pandemic emerges in a likely inconsistent manner.

BIDEN TAX PROPOSALS DISAPPOINT MUNIS

Handicapping legislation is often difficult. The proposed changes to the tax code in support of infrastructure financing released this week by the Biden Administration are a good case in point. Whether it was the debate over the 2017 tax cuts or the many times when an infrastructure week actually looked possible, two items were considered to be no brainers. One was an expansion of the ability to issue private activity bonds and the revival of advance refunding capability.

So it has puzzled many that neither of those two changes were included in the Green Book published by the U.S. Treasury which details proposed tax code changes. Advance refunding has broad bipartisan support. It’s value was made clear even in its absence as the low interest rate environment was able to provide significant flexibility to issuers. Imagine the savings which could have been realized through tax exempt refundings.

As for private activity bonds (PABs), they too are favored on a bipartisan basis. The arguments in recent times have been more about purposes and volume caps than they have been about the use of tax exempt financing for private businesses. For certain projects, the most efficient subsidy could very well be PABs. In other cases, there are legitimate arguments to be made against project subsidies.

Some less obvious items were proposed. Qualified School Infrastructure Bonds were part of the American Recovery and Reinvestment Act enacted in February 2009. They would be issued as taxable debt and would receive interest subsidies similar to the Build America Bonds (BABs) which were issued under the ARRA and then subject to annually declining subsidy payments. Bonds could be issued over three years from 2022 through 2024 with annual total issuance limits of $16.7 billion.

PUERTO RICO ELECTRIC

Luma Energy, took over the transmission and distribution operations of the Puerto Rico Electric Power Authority under the 15 year contract awarded in the aftermath of the hurricanes of 2017 and the ongoing financial restructuring. Luma is required to manage the process of upgrading the battered system. The primary source of funding will money coming from the U.S. Federal Emergency Management Agency.

The company has pledged to reduce power interruptions by 30%, the length of outages by 40% and cut workplace accidents by 50%.  It is a significant undertaking complicated by a militant workers union and a hostile political environment which has made ratemaking exceptionally difficult. 20 unions representing thousands of Puerto Rican workers ranging from teachers to truck drivers announced on the start date of the contract that they would go on strike if the Luma contract is not rescinded.

The system needs to be upgraded. PREPA’s power generation units average 45 years old. The latest fiscal plan approved by the federal board foresees Luma spending some $3.85 billion through fiscal year 2024 to revamp the grid’s transmission and distribution system.

The transition of the utility may not be politically popular but the reality is that the existing PREPA structure was  not up to the job of maintaining and operating the system. We have advocated a privatization of PREPA since the hurricanes ravaged the island. We believe that a private operator was better positioned to run the utility given the weakness and politization of PREPA management. A private operator is better positioned to implement alternatives in generation and transmission than would be the case under the existing PREPA structure.

Nonetheless, the Puerto Rico Senate has filed litigation challenging the validity of the contract with Luma Energy. Some things don’t change.

STATE LEGISLATORS TRY TO BLOCK OUT THE SUN

Renewable energy has been at the center of debate in a number of state legislatures as the politics of energy, the environment, and economics collide. A number of legislative actions involved with the electric grid send some very mixed messages. In Indiana, a bill to establish state level zoning standards for renewable power projects was defeated. Sounds like a good thing for local control advocates but not good for solar arrays and windmills. Local zoning boards want to retain their control both for and against these projects.

Ohio over the last year has tried and failed to subsidize nuclear generation. The effort led to a huge corruption scandal. Now, The Ohio Senate passed legislation which would require renewable energy developers — before filing a separate application with the state Power Siting Board that currently exists in law — to hold a public hearing with advance notice to local officials. County commissions could then pass resolutions to ban wind or solar projects outright or limit them to certain “energy development districts” in the county.

So this law merely extends requirements like this which exist for current fossil fuel generation right? Apparently not. The law looks much more like an impediment to solar and wind development. Its sponsor admitted as much in the local press. He believes that fossil fuels like natural gas and coal are more necessary for the reliability of the grid than wind and solar.

CYBER RISK APPEARS AGAIN

It was hospitals in the fall. Over the winter it was a municipal water system. Now a series of transit agencies are the targets. This week’s announcement of the hacking of the MTA in New York brought more light to the subject. The positive is that the MTA was apparently able to contain the impact and that operations were not affected. It was also positive to see the agency was able to hold the cost of recovery to a very manageable number and did not pay a ransom.

What we take away from the situation is that disclosure on the topic remains a very thorny issue. Given the nature of the hack and the relatively low cost associated with the recovery from it, in practical terms it might not be seen as a material event for investor purposes. At the same time it shouldn’t take press inquiries to generate an announcement that had the potential to be material.

It’s another reason for the investor community to come up with and demand clear disclosure standards for an ever changing municipal bond environment.

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.