Joseph Krist

Publisher

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This week, the emergence of a full blown pandemic and an anemic federal response to it have clearly shifted the operational and funding burden to the issuers in the municipal bond market. The nature and timing of this event, relative to many current trends and the nation’s political realities, create an unprecedented set of challenges.

The nature of the pandemic such that anyone who pretends to tell you that they know what will happen is, to be charitable, irresponsible. Our comments about the pandemic and its potential impact on credit reflect that view. We hope that these thoughts however, inform your own assessment of the event and its potential impact on the credit security of your portfolios.

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CORONA VIRUS IMPACT EXPANDS

The language is both stark and boilerplate. It soberly outlines the current risks to credit related to the corona virus for any credit reliant on travel or large gatherings. In the case of the following it applies to one credit but it could also be applied to a variety of credits dependent upon people gathering together and generating economic activity. Just substitute the appropriate words for McCormick Place or the Metropolitan Pier and Exhibition Authority for the credit of your choice. It happens that McCormick Place and the Authority are in the front lines of this situation.

“If the COVID-19 persists as a public health emergency or if other health epidemic conditions arise and persist, additional events at McCormick Place or other venues owned or operated by the Authority may be cancelled and related commercial activity and taxable transactions reduced. Such additional cancellations could also occur as a result of event and travel restrictions imposed by federal or local governmental authorities, voluntary decisions to withdraw by event sponsors and planners, and voluntary decisions to forego travel by expected event attendees.

While as of the date hereof, the remainder of events scheduled for the balance of 2020 at McCormick Place or other venues owned and operated by the Metropolitan Pier and Exhibition Authority have not been cancelled due to concerns about COVID-19, the Authority gives no assurance that there will not be future cancellations, nor is it possible for the Authority to predict whether or to what extent COVID-19 or any other pandemic, epidemic or other health-related conditions will affect the Authority’s operations, commercial activity, taxable transactions or the Revenues.”

This is one event which has actually resulted in disclosure. While the factors referenced may be obvious, the reality is that seeing them addressed in a timely manner by a major issuer is a positive development.

We consider certain states to be good indicators of the potential near term impact of the virus. They would be states with a reliance on sales as opposed to income taxes. There the impact in terms of declining travel and economic activity will give a fairly good real time measure of the impact. Florida is our primary target. The travel and economic activity related to MLB spring training, Disney World and other tourist attractions, and spring break are significant drivers. The monthly sales tax data from Florida will give us some basis for comparison and analysis. Texas, another sales tax state, has already seen the cancellation of South by Southwest and California’s Coachella festival has been postponed until the Fall. The center of attention – Washington State – is another state which relies on sales taxes. Nevada is a sales tax state as well as transportation/tourism dependent.

Some 100 major colleges and universities have cancelled classes. Some local school districts are closing schools for at least a week. Now that mass gatherings have been effectively banned, the fallout will quickly spread. The ban on gatherings will, if it lasts include the Easter season, traditionally a strong period for tourism. With events like the NCAA basketball tournament, Broadway, and the major professional sports leagues shut down, the economic impact will quickly emerge.

That brings us to the potential policy impact. As we go to press, the Administration proposals for steps to address the employment issues resulting from these event shutdowns are insufficient. That is not a political opinion – it’s just how it is. So many of those who works in those impacted industries – tourism, sports, cultural events, hospitality, transportation – are not covered by benefits or unemployment insurance. They will experience an immediate cash hit. And the big question is how long will this last? Unfortunately, there is no way to know until widespread testing is available and implemented.

What we do believe is that major governmental issuers – states, counties, and large municipalities will bear the brunt of any fiscal impact. It is a good sign that some major employers – Walmart and Darden Restaurants – are offering two weeks paid sick leave.  Implementation of such policies across the board would substantially relieve pressure on tax revenues.

One of the issues which will arise from an extended duration of social distancing is the potential long term impact on where and how people work. The immediate impacts will be on traffic as it is reflected in different commuting realities and on mass transit.

The photo is of one of New York’s busiest rush hour subway stops, the express platform at 59th Street and Lexington Avenue. This is 9 a.m. on a Thursday. Normally, the 4 and 5 lines are the busiest lines in Manhattan. If the pandemic is not dealt with, this could be the reality for many transit systems. That would result in a significant impact on revenues. One comfort is that many of the bonds sold to finance rapid transit construction and expansion are backed by dedicated sales taxes (Los Angeles and Atlanta are two). In New York however, the primary security for MTA bonds for the buses and subways is a pledge of the gross revenues of the system (the farebox). There doesn’t seem to be a lot of revenue potential in the picture.

HOSPITALS AND CORONA VIRUS

It is impossible to predict the impact on this sector on either a micro or macro level. Each institution will have its own set of circumstances and levels of outside government support as the effects of the pandemic spread. Having said that, here are the things which concern us.

Utilization will increase but it will not be profitable utilization. There are between 28 and 30 million uninsured individuals and many of them will either be treated or tested through hospital facilities. We are still not getting good data about the actual scope of the pandemic and there is not enough data on which conclusions may be reached regarding the potential need for acute care admissions The messaging from the Administration is muddled at best. Supposedly testing will be paid for (how and by whom is not clear) but there are no provisions for covering inpatient care or drugs for this cohort.

The potential for major hospitals to incur substantial unexpected expenses for supplies and personnel is significant. Because of the trends of declining inpatient utilization and the reduction of available beds, there is much less slack in the system than many think is the case. Estimates are that there are approximately 200,000 “excess” beds in hospitals nationwide. These are not likely to be sufficient in the event of a rapid need for care. An Economist article cited a recent study of covid-19 in China which found that 5% of patients needed to be admitted to an intensive care unit, with many needing intensive ventilation or use of a more sophisticated machine that oxygenates blood externally. America has 95,000 ICU beds and 62,000 mechanical ventilators, while only 290 hospitals out of 6,000 offer the most intensive treatment. 

This leads us to the issue of how charity care is funded and/or reimbursed. Charity care has traditionally been funded by states although the levels of funding and resources available to fund such care varies widely across the country. In the interim, utilization and revenues will be negatively impacted as hospitals are being asked to delay and/or curtail elective surgery. This will reduce revenues from sources which tend to have insurance.

Should corona related demand spike, hospitals will face daunting personnel challenges which will likely result in increased costs for more staff and/or overtime costs. Most troublesome is the fact that there is no good guidance as to how long the pandemic will last or how serious its effects could be. Hospital managements will have to rely on the strength of their balance sheets and available cash resources to fund operations as the pandemic unfolds.

That puts systems and large facilities at an advantage once again relative to stand alone institutions and smaller institutions. Rural hospitals will again be at relatively greater risk since they tend to have weaker balance sheets and operating profiles. On sector where size may not be an advantage will be the safety net hospitals. They will be exposed to the greatest potential for demand from uninsured patients who also are more likely to be in those groups considered most vulnerable.

OIL PRICES

The two places likely to see the greatest impact from lower oil prices are Texas and North Dakota as they are in the lead in terms of traditional drilling and fracking, respectively. There has already been employment impacts in oil dependent states but the current situation seems more dire. It’s not just the number of rigs which operate but the jobs in the oil services sector, the heavy equipment sector, as well as jobs in general services including restaurants and residential facilities.

Before this weekend, the impact of oil prices did lead to rig closures but it was the decline in new drilling where it was truly felt. Albeit in Canada, the pre-crisis price of oil made a multi-billion project in the Canadian oil sands uneconomical and was cancelled. Now the impact of the price war between Saudi Arabia and Russia is even more severe so there be even more reduced investment in smaller projects throughout the oil patch.

Generally, the uncertainty around the length and depth of an economic slowdown could not come at a worse time for governmental budgets. With so many of them facing June deadlines, it may be hard to predict with any certainty what the impact on both sides of the government income statement will be. We suspect that Credit volatility – at least in perceptions if not immediately ratings – will happen through the end of 2020 at least. Any significant deviations from projections on the downside will raise real concerns as they appear monthly and quarterly.

Other credits under pressure include those ports which derive significant revenues from oil exports. An example is the Port of Corpus Christi, TX. It handled 40% of total U.S. oil exports in January, or about 1.38 million barrels a day. The short term impact is blunted by the fact that many of the port’s agreements are based on take-or-pay contracts — meaning the port gets paid whether barrels are shipped or not.  The price decline, if it maintains over an extended period, will reduce production and shipments and will impact long term demand for the port.

PUERTO RICO

The Puerto Rico debt restructuring proceedings will extend through Election Day according to a schedule approved by the judge overseeing Puerto Rico’s Title III proceedings. The Puerto Rico Oversight Board and some groups of holders of general obligation bonds supported a schedule advanced by the Chief Mediator leading negotiations and other parties such as the Puerto Rico Fiscal Agency and Financial Advisory Authority, the Unsecured Creditors Committee, bond insurer Assured Guaranty (AGO), bond insurer Ambac Assurance, Invesco (IVZ), and others opposed the proposed timeframe.

The judge said she would set aside weekdays Oct. 21 to 31 and Nov. 1 to 6, excepting days for the omnibus hearing and for Election Day, to be used for the confirmation hearing. The deadline for the filing of objections to the release of a disclosure statement covering the proposed settlement to April 24. A hearing will also be held on the diversion of money from local government instrumentalities and their revenue bonds to the central government-guaranteed bonds, better known as “clawbacks”.

The uncertainty continues.

CALIFORNIA SCHOOL BOND DEFEAT

Supporters of a school bond authorization initiative were surprised when the 2020 Proposition 13 did not pass on March 3. After all, California voters have passed every construction bond for education since 1994, when voters narrowly defeated two small bonds, one for higher education and one for K-12 schools.  Organizations representing teachers, parents, school leaders, higher education groups, unions and business groups like the California Business Roundtable all endorsed Prop. 13.

The ballot summary of the bond made clear  that the principal and the $11 billion in interest on the bond would be repaid through the state’s general fund. Apparently, that was not enough to convince people that this initiative had nothing to do with the tax limiting Prop. 13 initiative which passed in 1978. Every decade, starting the year ending in “8,” the numbering cycle starts again for California ballot initiatives.  There were a dozen initiatives on state ballots in 2018; the state construction bond was the only measure appearing for the March primary, so it became Prop. 13.

Apparently, a large number of people believed that the two propositions were related and that the initiative would require higher property taxes. What did not help was the inclusion of provisions regarding requirements for the use of union construction workers on school projects and  increasing the local school district bonding limit. This allowed opponents to frame the issue as one of likely tax increases and higher costs for capital facilities.

One other provision would have reduced fees that districts can charge multi-unit housing developers and eliminated fees for large residential complexes near transit lines. This concerned some larger district managements who feared a loss of those revenues without some offset. Development around transit facilities is a hot button issue for affordable housing advocates who see the impact of gentrification as outweighing the benefits of new development.  

We do not read anything into these results which could have national implications. The factors contributing to this unexpected defeat we see as California issues.

NYS BUDGET SHIFTS COSTS TO NYC

As a result of the 1996 federal welfare legislation and the 1997 implementing legislation adopted by New York State, the state and city have three distinct cash assistance programs. Those on Family Assistance qualify for federal Temporary Assistance for Needy Families (TANF) grants. Needy single adults or couples without children are not eligible for Family Assistance but can receive benefits from the state’s Safety Net Assistance program. Safety Net Assistance was originally funded jointly by the city and state, each paying 50 percent of the cost, with no federal contribution. Families that reach their 60 months of federal TANF eligibility who are still eligible for benefits can shift to the 60 Month Converted to Safety Net program. Emergency Assistance for Families provides up to four months of grants for families in danger of homelessness.

The state’s funding comes through block grants from the Federal government so the experience is instructive as other programs come under consideration for block grants (block grants for Medicaid are a Republican dream) from the Federal government. In state fiscal year 2011-2012, the state allocated more of its TANF block grant to Family Assistance, increasing the federal share for the program from 50 to 100 %. Changes to the Safety Net and 60 Month Converted programs, which had previously been funded with 50 % state and 50 % city shares, but now were funded with 71 % city and 29 % state shares.

Governor Cuomo’s 2020-2021 Executive Budget proposes to increase the city share of both Family Assistance and Emergency Assistance for Families from 10 to 15 %. Since the city’s 2021 cash assistance budget includes a combined $455.4 million in federal funds for these two programs, a 5 percentage point increase in the city share would cost New York City an additional $25.3 million annually.

TRANSPORTATION AND MOBILITY

The lack of a comprehensive approach to emerging transportation technologies is forcing individual jurisdictions – large, medium, and small – to take their own regulatory approaches. The latest example comes from Spokane, WA where the city is considering a slate of proposed changes to the city’s contract with Lime and city laws that govern the use of scooters and bicycles. The proposals reflect issues around persistent complaints about scooters illegally cruising down sidewalks and being abandoned in places that obstruct pedestrian walkways.

The city official in charge of micro mobility planning summed up where we are. “We’ve done the carrot – we’ve done education, we’ve done Lime Patrol, and we’ve done all these things to encourage people to act right. Now we’re providing the stick, which is a fine through their user account when they park improperly.” Scooters and bicycles are not allowed on downtown sidewalks. Riders must be at least 18 years old, and scooters and bicycles must be parked in a way that leaves sidewalks clear.

The local press reports that an in-person survey of traffic by city staff at one busy intersection last year found more scooters illegally riding on the sidewalk than on the road, where they are meant to be used. City officials propose adding a new regulation that would require the company to tag each scooter with an identification number. City code enforcement officers would document parking violations via a time-stamped photograph and charge Lime $15 for each infraction. The company would pass on the fine to the user. The city will require Lime to suspend the account of any user who violates the rules three times in a year.

NEW MEXICO TAKES ON PENSION FUNDING AND THE BUDGET

The State of New Mexico has enacted legislation which primarily reduces Public Employees Retirement Association (PERA) fund cost-of-living adjustments (COLAs) and mandates increased contributions by employees and participating governments. The legislation primarily reduces Public Employees Retirement Association (PERA) fund cost-of-living adjustments (COLAs) and mandates increased contributions by employees and participating governments. PERA is severely underfunded, with a 71% funded ratio based on a reported 7.25% discount rate. Halve the discount rate and the funding ratio drops below 50%.

Moody’s has developed what it calls its “tread water” indicator to determine pension underfunding exposure. Using that metric, the governments’ collective tread-water indicator was $570 million in fiscal 2019, roughly 25% of payroll. Unfortunately, the state and participating governments contributed roughly $371 million in aggregate to PERA in fiscal 2019 (ended June 30, 2019), which equated to roughly 15% of active employee payroll.  The legislation calls for the state and its participating employees to increase their contributions to PERA by 0.5% of payroll per year for four years, producing a 2% cumulative increase relative to payroll for both the state and the employees, beginning July 1. Local governments that participate in PERA and many of their employees will similarly increase contributions relative to payroll, but not until  July, 2022.

The legislature also approved a fiscal 2021 budget of $7.6 billion. The final budget reflected the realities of the current health problem. When the Governor signed the bill, it was after she had cut $110 million in projects from an accompanying public works package due to concerns over plummeting oil prices and the impact of corona virus.

The action will hopefully not be the start of a trend where operating problems are solved by cutting back on infrastructure. The projects spanned many sectors including proposed school improvements, tribal building repairs, road renovations, and street signs. This as the budget left intact 4% pay raises for New Mexico teachers and state employees that will take effect in July. 

It is telling that the budget was adopted with the cuts despite the fact that as of last month, the state was estimated to have $1.7 billion in reserves when the budget year ends in June. It was not all bad news for infrastructure. The signed budget bill does include $180 million for statewide highway construction and repairs.

FLOOD CONTROL – MANAGED RETREAT VS. EVICTIONS

We have frequently commented on the impacts of climate change and various possible mitigation approaches. Two weeks ago, we discussed the concept of managed retreat as a way to deal with rising water levels and their impact on infrastructure. That is one approach as is the use of eminent domain as a way to relocate vulnerable structures and people. Now the use of eminent domain is back in the news with real implications for local credits.

The Army Corps of Engineers’ mission includes protecting Americans from flooding and coastal storms. It is the primary source of infrastructure development for flood mitigation from the federal government. Building sea walls, levees and other protections, and elevating homes are all elements in the Corps’ set of responsibilities and its projects are generally two thirds funded by the federal government.

Now as flooding becomes more frequent and severe, the Corps is taking a different approach paying local governments to buy and demolish homes at risk of flooding.  It is not a partisan approach as the Corps said that voluntary programs were “not acceptable” and that all future buyout programs “must include the option to use eminent domain, where warranted” in 2015 under the Obama administration.

The Corps estimates how much damage a house is likely to suffer in the next 50 years, then compares that to what it would cost to buy and tear down the house, plus moving expenses for the owner. If the buyout costs less, the homeowner is asked to sell for the assessed value of the home. It is not a universally accepted strategy. Some of the most vulnerable places – New Jersey and Miami-Dade – have refused to use eminent domain.

Now these and other jurisdictions face the loss of the Corps’ share of funding for mitigation. Some initially agreed to the terms of the Corps’ funding plan but have since reversed themselves as political backlash grows. So far the scope of these programs seems fairly limited but the reaction has not been positive from homeowners. 

What is particular to this administration is an unwillingness to advance infrastructure funding at the federal level. The view that too much overdevelopment in vulnerable areas contributes to huge natural disaster losses is not new. But this plan comes at a time when so many things – flood mitigation, public transit, and roads – which have relied on a state/local/federal partnership are facing severe federal funding cutbacks.

Now lower levels of government must choose between draconian actions like eminent domain or significant funding challenges to address the issues themselves. The result of this process is not likely to be positive for local credits under the current regime. It also continues a trend of federal influence on local affairs generally being on the negative side as has been the case for some time in regard to capital financing generally.

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.