Joseph Krist

Publisher

________________________________________________________________

RATING IMPACT BECOMES CLEARER

We noticed in a variety of ratings reports that a common theme is emerging. The impact of the pandemic and the containment and mitigation restrictions imposed by states and cities on sales taxes is unsurprising. In all of those situations – whether they be direct sales tax revenue bonds or general obligations supported by a significant reliance on sales activities – when they have led to negative outlooks for ratings they come accompanied by estimates of the probability of downgrade.

It looks like the most commonly cited probability of a downgrade is one in three. That probability has been assigned to a diverse range of credits and include those with historically strong credit profiles to those who have had more difficult histories. They are diverse geographically and diverse in terms of the way they generate revenues. This week alone the credits receiving negative outlooks with that 33% probability of downgrade ranged from AAA credits backed by heretofore solid economies to BB distressed city credits.

It is hard to tell exactly why some credits have not been providing timely information to the rating agencies but we took note of several credits this week which saw ratings withdrawn due to inadequate financial reporting. They tend to be smaller credits where information systems may not be up to date which makes revenue collection and accounting and reporting more difficult.

Other rating actions confirm trends we have identified early in the pandemic. Moody’s downgraded the Washington State Convention Center Public Facilities District’s senior lien lodging tax bonds to A1 from Aa3 and downgraded the subordinate lien lodging tax bonds to A3 from A1, respectively. The outlook has also been revised to negative from stable. The downgrades and negative outlook affect $1.3 billion in debt outstanding. “The downgrade of the PFD’s senior and subordinate lien lodging tax bonds to A1 and A3, respectively, is driven by the substantial declines in lodging tax revenue following the outbreak of the corona virus pandemic. Previously healthy and growing pledged revenue driven by the strength of the underlying Puget Sound economy have dropped to nearly zero as business and leisure travel to the Seattle metro area has largely ceased.” Moody’s expects debt service coverage from pledged revenue to be sufficient for the July 2020 debt service payment but, coverage from regular lodging tax revenue is likely to be less than sum sufficient in 2021. 

PUERTO RICO

The U.S. Supreme Court unanimously ruled that members of Puerto Rico’s Financial Oversight and Management Board do not require U.S. senate approval because the board’s handling of the island’s $125 billion bankruptcy is limited to Puerto Rico’s fiscal issues and it only exercises local, territorial authority. The decision will likely give the Board more confidence to exercise its oversight powers. That is positive for the long run viability of the Commonwealth credit as there are many hurdles to overcome for the Commonwealth to achieve any level of fiscal stability.

The case was brought by Aurelius Investment and a public employees union. They had hoped that they would have their claims receive better treatment without the Board. The decision comes as the creation of the Board is about to mark its fourth anniversary. It says that ““Congress has long legislated for entities that are not states — the District of Columbia and the Territories,” he wrote, both making law for those places and creating structures for allowing local officials to make and enforce local laws. This structure suggests that when Congress creates local offices using these two unique powers, the officers exercise power of the local government, not the Federal Government.” 

Now it will be interesting to see how the Board uses its newly reinforced powers to manage the recovery of the Commonwealth’s finances. The issue of its legality now much more settled, the Board will have a stronger position from which to negotiate. That does not mean that legal pressure is off the board. Representatives of the utility workers union continue to challenge the Board’s role and existence. And there will be continued resistance to any outside oversight.

PANDEMIC CASUALTIES – MEDICAID EXPANSION

The last couple of years have seen growing electoral support for the expansion of Medicaid eligibility under the Affordable Care Act. It had even begun to occur in some of the “reddest” states. Two of those states are recently in the news however, for announcing delays in the implementation of expansion. The pandemic and its resulting pressure on state budgets is driving these decisions.

A deal in deep-red Kansas to expand Medicaid to about 150,000 poor people has been tabled for this year.  The Governor and legislative leadership had reached agreement but there was resistance among some conservative lawmakers over issues related to abortion. With the impact of the pandemic added to the equation, there was not enough support at present to move forward with expansion. This despite the fact that expansion was a significant issue in the 2019 election for Governor.

Oklahoma has the nation’s second-highest uninsured rate but that was not enough to keep the Governor from vetoing legislation to expand Medicaid. The expansion was slated to commence on July 1 but political issues have now combined with the pandemic to stop that.  Voters will still have a chance to authorize the state would not take effect this year.

While not a direct expansion of Medicaid, some states had been attempting to enact legislation creating a “public option” for health insurance. The most prominent were Colorado and Washington. In Colorado, legislation was pending that would offer an insurance plan at an estimated 7 to 20% cheaper than private options by paying doctors and hospitals less. The state projected about 18,000 people newly able to afford coverage would sign up for the plan.

Washington will still attempt such a plan but expectations are being tempered. In both states, the hospital sector has been opposed to proposed lower reimbursement levels especially as these institutions try to recover from the impact of limits on many services as the result of the pandemic.

P3 CHANGES

I’ve written on the issue of public/private partnerships and their role in the development of large scale infrastructure projects for some time now in a variety of publications. In some situations, such partnerships (P3) have generated positive results for their sponsors and municipalities in terms of both cost and efficient execution of the projects. Those successes encouraged others to consider and adopt the concept for several large scale transportation projects. Now, however, a couple of high visibility P3 projects have seen those partnerships lose partners or see their projects returned to traditional providers to complete projects.

The market has already had time to digest and analyze the decision by Denver International Airport (DIA) to terminate the P3 created to renovate and expand its Great Hall terminal complex. Now, we see that the P3 created for the expansion in Maryland of the Purple Line Rail Project is losing a partner. The design/build entity for the project – Purple Line Transit Constructors (PLTC), a joint venture between Fluor, The Lane Construction Corp. and Traylor Bros. Inc. – announced “that it has not been able to successfully negotiate time extensions for schedule delays and for the extra costs it has incurred during the last three years on the project.

The move follows announcements last year that certain major construction entities were withdrawing from the P3 space. The impacts on project costs, schedules, and ultimately the rate of return earned by the P3 participant have made those returns less attractive to these companies. Because of the size and visibility of projects like DIA and the Purple Line, many see these moves as signs of the demise of the concept.

We disagree. Each project should include a review of all available funding, financing, and execution modalities when they are being considered. There is clearly a role for the private sector in the development of public infrastructure. That role however, does change from project to project. That is a risk which potential private participants should consider further when they negotiate the terms of their participation in these projects.

SOUTH CAROLINA PUBLIC SERVICE AUTHORITY

The South Carolina legislature has decided to delay its process for determining the future for the troubled utility until next year. The budget difficulties associated with the corona virus pandemic have taken precedent. The legislature passed legislation providing for enabling the overall government to continue operations. Part of that legislation includes restrictions and oversight provisions governing Santee Cooper which are expected to remain in effect until May 31, 2021.

Governance will be provide through the Santee Cooper Oversight Committee. The Committee will be comprised of the governor, president of the Senate, speaker of the House, and the chairmen of the Senate Finance Committee and House Ways and Means Committee. The Committee will review for approval many of the contracting activities of the Authority as well as providing for review of many of the Authority’s functions.

Santee Cooper wanted to negotiate coal and rail contracts, refinance existing debt and conduct a request for a proposal process for including solar projects. The legislation provides for the Authority to be able to issue debt, and to resolve outstanding claims and lawsuits. The legislation specifically limits the authority from entering employment contracts with terms longer than six months.

The ability to manage and negotiate litigation is important as the Authority hopes to execute a settlement of a class action suit against it. A proposed settlement is scheduled for a court hearing on July 20. That proposal would require Santee Cooper to pay $200 million in cash over three years and to freeze rates for four years. That suit was filed within weeks of the cessation of construction at the Sumner nuclear facility.

Now the utility’s stakeholders including its bondholders are facing another year of risk and uncertainty. The decision as to whether to maintain or sell the utility can now be evaluated in the light of all of the impacts of the pandemic and economic realities.

MUNICIPAL LIQUIDITY BORROWING

Last week we noted the adoption of a budget for FY 2021 by the State of Illinois. With that process out of the way, the state has announced its next step in financing itself as it deals with the fiscal impact of the pandemic. It has executed an agreement to sell $1.2 billion of one-year, general obligation backed notes to the Federal Reserve. The issue will be the first to close under the Municipal Liquidity Facility program. The one year notes will come at a rate of 3.82% based on the Fed’s formula for determining rates. The move comes after the State decided that a public debt sale would not have yielded the most favorable results.

The rate of 3.82% is based on MLF pricing guidance that includes a base tied to the overnight swap index and a spread based on an issuer’s ratings. The New York Fed put out a pricing guidance as of June 1 that put a borrower rated at the lowest investment grade level— BBB-minus across the board — at 3.83%. The State had been able to gauge the market’s appetite for the State’s notes through a prior recent bond sale which made the 3.82% note rate the more favorable alternative. The Illinois legislature had to amend legislation governing short-term borrowing by the State to forgo a competitive sale requirement. This allowed the State to sell directly to the MLF for fiscal 2020 and 2021.

The State has not used its full authorization for short-term borrowing. The Legislature has authorized up to $5 billion of notes to fund tax shortfalls resulting from the pandemic. The State qualifies to borrow up to $9.7 billion under the terms of the Liquidity Facility program. It is anticipated that Illinois will sell additional notes especially if expected federal legislation provides inadequate resources to fund state and local tax shortfalls. This issue represents just over 20% of the State’s expected short term borrowings.

As Illinois takes advantage of this facility for state governments, the program is being expanded. The Federal Reserve said on Wednesday it will allow governors of U.S. states to designate transit agencies, airports, utilities and other institutions to borrow under its municipal liquidity program. Governors will be able to designate two issuers in their states whose revenues are generally derived from operating government activities. The program is being expanded to allow all U.S. states to be able to have at least two cities or counties eligible to directly issue notes to the municipal liquidity facility regardless of population. Until that change, only U.S. states and cities with a population of at least 250,000 residents or counties with a population of at least 500,000 residents have been able to make use of the program.

PENNSYLVANIA INTERIM BUDGET

Many states are likely to enact FY 2021 budgets in the full knowledge that those plans will have to be revisited as the impacts of the pandemic can be more fully determined. One state has gone so far as to enact an interim budget. The Commonwealth of Pennsylvania has adopted what is effectively a five month budget. The temporary, no-new-taxes budget plan maintains current spending levels while the Legislature watches to see how badly corona virus-related shutdowns damage tax collections and whether the federal government sends another aid package to states.

The action comes in the face of estimates of a $5 billion hit to revenues due to the pandemic. As adopted, the budget includes full-year money for many public school budget lines, as well as for state-supported universities, debt service and school pension obligations. But much of the rest of the state’s operating budget lines would be funded through Nov. 30. The plan takes pressure off local school district credits. It does leave counties in a state of limbo, even though they are the main expense point for many social services. Those credits remain under significant pressure.  

PANDEMIC CASUALTIES – HOSPITALS

No matter where you look in the flow of information out about the costs of the pandemic continues to run negative. A recent story on the problems with smaller and rural hospitals getting federal aid reflective of their costs and reimbursements provides some data. Around Chicago, The University of Chicago Medical Center got the state’s largest share in the high-impact funding round, with a total of $72 million—or 10 percent of the $694 million spread across 33 Illinois facilities. Nonetheless, monthly revenue declines of $70 million in March and April and negative cash flow of $35 million for each month occurred. Rush University Medical Center was losing about $40 million a month prior to resuming elective surgeries in early May. 

The smaller community safety net hospitals have fared poorly, an issue we recently highlighted. St. Anthony Hospital was the only independent safety net in Chicago to qualify for a high-impact payment, getting $21.5 million for admitting 264 COVID patients.

As for rural hospitals, over a six year-period, median overall profit margins declined for all rural hospital types except for critical access hospitals (CAH), according to aHealth Affairs study released last week. The study  analyzed data from the Centers for Medicare & Medicaid Services (CMS).  Nonprofit CAHs saw median overall profit margins rise between 2.5% to 3.2% from 2011 to 2017, while all other rural hospitals experienced declines ranging from 0.4% to 5.7% over the same period. The study concluded that rural and 2010, noting the amplified struggle by provider organizations in states that did not expand Medicaid as part of the Affordable Care Act.

NEW JERSEY TURNPIKE

The pandemic may have crushed utilization rates on the New Jersey Turnpike – they were down 61% in April. The pandemic has not stopped the need for planning for capital investment for its roads and establishing ways to fund it. So in the midst of all the disruption, the New Jersey Turnpike Authority (NJTA) approved a resolution passing a $24 billion Long Range Capital Plan and associated toll rate increases to fund it. The NJTA operates the New Jersey Turnpike (Turnpike) and the Garden State Parkway.

The vote comes at a perilous time for all transportation credits. In this case, the Authority has not been a frequent toll increase entity. It can take advantage of the fact that the last toll rate increase in  January 2012 was 53% on the Turnpike and 50% on the Parkway. There have only been eight toll increases in the 69 year history of the Turnpike. The 2020 toll rate increase is smaller than three of the last five since 1991. The plan incorporates smaller annual increases as it includes the initial approval for toll rates to be increased according to a still undetermined index, with a 3% annual cap, starting on January 1, 2022.

It is hoped that the use of an index based formula for determining tolls will reduce politization of the issue which has historically pressured the Authority’s ratings. It has been nine years since the last effort to legislate roll backs of increases. In the near future, the concern is likely more due to pressure for the Authority to deliver annual “surpluses” to the State. The current agreement governing those transfers between the Authority and the State runs out after FY 2021.

PANDEMIC CASUALTIES – CULTURAL FACILITIES AND TOURISM

The outlook for bonds backed by revenues from cultural facilities are in for a longer road than they had hoped to recovery. While sports can resume some level of operation through money from television rights contracts, by definition things like museums cannot. This puts them in a unique orbit in the universe of cultural facility debt.

The Metropolitan Opera announced that it has canceled the first few months of its 2020-season, and will now open its doors next season with a special gala performance on December 31st. The company’s performances will then continue through June 5, 2021. Those with tickets to canceled performances with have the value of their tickets credited to their Met account, the company said, with that value transferable to another performance through the end of the 2021-22 season. Tickets to canceled performances can also be refunded or have their value donated to the Met. 

The risk of extraneous events -natural, terrorism to name two – to the financial position of any of the established cultural institutions nationwide.  The pandemic presents challenges so unique that it is difficult to imagine a return to status quo for many of these institutions. The New York market reflects trends seen in many places. Half a century ago, the majority of attendees at major cultural facilities in New York came from New York. Broadway shows had an 80/20 ratio of natives to tourists. A near thirty year effort has reversed those ratios for almost every major cultural activity.

The pandemic however, highlights the risks of a tourism based economy. Until the economy is restored to support good levels of disposable incomes, economies which rely on those incomes will be hurt. Another issue is whether new workplace realities reduce the number of people and business entertainment to a serious degree.  In cities like San Francisco and New York, these two forces converge.  We expect that many other facilities will face similar decisions and challenges.

SCHOOL DISTRICTS

We will find out what the taxpayers think at least those in New York State when they vote on school budgets next week. Districts can get approval on only one budget resolution, voters are not offered a menu of options. NYS districts will all suffer reduced state aid. Many will show what a contingency budget looks like and in many cases it will not be pretty. Given economic realities, tax increases would seem to be off the table. We do not expect to see many approvals for exceeding the 2% tax cap.

The state’s largest district is funded through NYC. New York State’s enacted budget for state fiscal year 2021 eliminated a proposed 3.0 percent increase in school aid that had been included in the Governor’s Executive Budget, presented in January, before the Covid-19 pandemic emerged. The state’s enacted budget only provided a $96 million (0.4 percent) increase statewide for the upcoming school year, with state aid to New York City falling by $18 million (0.2 percent) compared with the prior year. Under the enacted state budget, the city’s Department of Education (DOE) shortfall in state education aid, relative to the aid the city expected in January, grew to $360 million.

For New York City, the $717 million pandemic adjustment reduced total state school aid by 6.3 percent compared with a 2.6 percent cut for the rest of the state. This expected to be offset in the end by CARES Act funds. The updated state financial plan incorporating the state’s enacted budget projects that over $8.0 billion of the anticipated $8.2 billion reduction in aid to-localities funding for fiscal year 2021 will remain in place through 2024. Alas, the CARES Act provides only one-time relief, restoring funds lost through the pandemic adjustment after 2021 would require additional federal funding.

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.