Joseph Krist

Publisher

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Publisher’s Note: The overarching impact of the corona virus pandemic is that we are about to see something unprecedented in our nation’s history – the near total shutdown of industry in the country. This week’s announcement that Ford and GM will halt production at their manufacturing facilities through the end of March at a minimum is unlike anything seen in this country since World War II. The companies and the United Auto Workers will work together on plans to restart production in compliance with social distancing protocols among workers, including at shift change times, and to maximize cleaning times between shifts changes. As demand slackens, we would not be surprised to see additional industrial and manufacturing disruptions.

This is a unique experience in US history certainly after World War II. One would have to go back to the Spanish Flu Pandemic of 1918 and 1919 to find a similar experience. The difference is how intertwined the world is now versus then which raises a whole host of issues creating this unique experience. Unique means that in many ways we are making it up as we go along. With that in mind, view this week’s comments.

CORONA VIRUS

The declaration of a national emergency and the actions increasingly being taken by localities to limit gatherings has made it clearer where the potential sector weak spots are in the municipal credit spectrum. So now the process of picking winning and losing sectors depending upon the individual credit characteristics can begin.

It is estimated that some 14% of total consumption spending – recreation services recreation services; food services and accommodation; transportation services- is effectively shut down for an indefinite period of time. The immediate impact will be on credits backed by taxes related to economic activity. “Wages that aren’t earned aren’t spent.” Sales tax bonds will come under pressure as non-essential spending is curtailed as the result of mandated closings of things like restaurants and bars.

Sales taxes provide current cash flow. They are usually collected and remitted to the taxing jurisdiction monthly. Credits secured by things like admissions taxes (from arena and entertainment facilities), hotel taxes, convention center revenues, toll roads, will all see revenue impacts. Flight cutbacks will reduce throughput at airports which rely on the economic activity from the increasingly important retail sales activity at terminals. That will impact general airport revenue bonds. Stand alone enterprise credits like airport rental car and garage facilities will be under stress.

One sector facing long term implications in addition to the short term pressures is the senior living industry. The vulnerability of their residents to the impact of pandemics is clear. There is no way to determine how the experience of the corona virus will impact long term demand for all of these facilities. For those in the early stages of development and fill up, the potential impact is significant as these projects often rely of fairly delicate timelines for the receipt of those revenues to meet covenant requirements as well as repayment schedules. The potential impact on housing demand and sales will make it more difficult to meet financial targets and schedules.

Project financings for things like shopping malls and casinos will be vulnerable. The Carousel Center in Syracuse, NY was already experiencing operating difficulties when it was downgraded by Moody’s in Late 2019. Carousel Center Company L.P. signed a three year loan extension and modification agreement with the special servicer of its subordinate CMBS loan on May 31, 2019. Now, the extended time period of inactivity faced by a project such as this means that its ability to meet the new Debt Yield covenants in 2020 and 2021 to secure the second and third year of the loan extension remains uncertain. While it is likely that the developer will make every effort to make payments in lieu of taxes which secure the bonds, the secondary financing difficulties make the project vulnerable to a bankruptcy by the developer to deal with the secondary financing needs.

The newly opened American Dream mall and entertainment complex in New Jersey was under significant pressure from its start. $800 million of limited obligation revenue bonds backed by a payment-in-lieu-of-taxes agreement between developer Triple Five Group and East Rutherford, along with $287 million of grant revenue bonds supported by anticipated sales tax revenue were issued to finance the project. Now the facility has closed in response to the virus which will further pressure the reliance on developer support for the bonds while tax cash flows are interrupted.

The impact of the stock market will be felt in multiple ways. States like CA, NY, NJ, IL, and MA all are vulnerable to negative impacts on capital gains revenues. So the immediate impact will be on operations. Longer term, pension funds are at the center of stock market risk so it is likely that funding ratio data and expense requirements to maintain funding will generate negative news.

Overhanging all of this is the need for states to take swift action without the benefit of a coordinated federal response. Maryland Gov. Larry Hogan (R) and New York Gov. Andrew Cuomo (D) ordered state health officials to reopen closed hospitals and to convert other facilities in order to accommodate patients. Retired medical staff is being recruited. These are expenses which must be covered but who and how much is effectively yet to be determined. Cuomo’s order will add an additional 9,000 beds to the 53,000 beds already available around the state. Maryland has about 8,000 hospital beds, and Hogan’s order will boost capacity by an additional 6,000.

Early in the week, The President advised states to seek out their own equipment, a potential sign that the federal government was not prepared or equipped to aid states that are going to need serious help. That will require funding. States will also be at the front lines of providing and funding unemployment insurance.

For smaller communities, orders to effectively shelter in place will reduce short term travel and reduce the opportunity to collect fines. In some rural communities, reduced travel will impact their ability to collect fines which are often an important component of local budgets. Less traffic makes it harder to issue speeding tickets which for many small towns are a significant revenue source. In larger communities, reduced travel will result in lower revenues from parking charges as well as parking related fines. In some localities, ticketing and fines have been suspended which will impact revenues.

On the public transit side, ridership on the NY subway was down 27% in one week and that was before schools and public facilities were closed. Seattle’s Sound Transit has experienced a 25 percent drop in ridership in February compared to the month before. Ferry ridership in Seattle was down 15 percent on Monday, March 9th, compared to the previous Monday. In San Francisco, BART fares account for 60 percent of the agency’s service budget and officials estimate the current drop in ridership will cost BART up to more than $600,000 each weekday. Ridership has fallen some 30%.  

WHO WORKS WHERE

The Airports Council International-North America (ACI-NA) represents local, regional and state governing bodies that own and operate commercial airports in the United States and Canada. They have their own agenda but they have produced data to reflect the potential impact of the economic downturn we are in. The council estimates  that about 1.2 million people work at 485 commercial airports in the United States. O’Hare in Chicago employs 41,000 alone.

Casinos in most places are shut down. Obviously the front line for economic impact would be Las Vegas. Nevada employs 403,000 in the gaming industry segment alone. The top five include New Jersey, Pennsylvania, Mississippi, and Louisiana each with between 30,000 and 40,000 employed.

And then there are the overall leisure/hospitality statistics. Some 16.8 million are employed as of February 2020. Less than three percent of them are unionized so they are not likely to have employment terms favorable to their being laid off. They make an average of $435 per week. So their unemployment will generate pressure on the health and shelter providers.

PRACTICAL FISCAL RESPONSES TO CORONA VIRUS

When one tries to assess the potential fiscal impact of the ongoing pandemic, the implications for ongoing funding things like education must be considered. School aid is often based on formulae which include factors like attendance and the provision of a minimum number of school days. The legislation by which things like ongoing school aid as well as state enhancement programs securing local school bonds does not always include provisions to cover situations such as is occurring right now.

One state’s recent action highlights one such example. In New York, aid is based on attendance as well as minimum day requirements. Should a district choose or be forced to close their facilities for any extended period, it was not clear whether the laws under which school aid is distributed would permit all of the anticipated aid. Districts and their creditors were concerned that cash flow issues related to delayed or lessened anticipated school aid could cause payment interruptions by districts. So it was positive to see that The Governor issued an Executive Order to eliminate the aid penalty for schools directed to close by state or local officials or those closed under a state or local declaration of emergency that do not meet 180-day requirements if they are unable to make up school days. 

For the states generally, the demand for unemployment support and the need to fund it is already apparent. Initial unemployment claims are in the tens of thousands in many states. Twenty three states have unemployment trust fund balances below their recommended funding levels according to the US department of Labor. That is before any Medicaid hit just from that cohort and not inclusive of corona related costs.

After several years of significant headcount increases, the City of New York finds itself with less room to maneuver through the corona virus pandemic. The City does have budgetary reserves but they will be quickly evaporated as it faces a significant revenue hit. This week, City Comptroller Scott Stringer estimated that the City would experience a $3.2 billion loss to the city’s tax revenues over the next six months. The comptroller called for spending at most agencies to be reduced 4% from what the mayor had proposed. For the Department of Homeless Services, the Administration for Children’s Services and the Human Resources Administration, reductions should be 2%. The Health Department and the department overseeing the city’s public hospitals should be exempt, according to the Comptroller. He estimates that over the next six months, restaurant sales will go down 80%, real estate sales, 20% and tourism-related retail, 20%. 

Seattle’s budget director last week estimated the city could collect $110 million less than expected in general-fund tax revenue this year due to an economic breakdown caused by the virus and by efforts to slow its spread. Hawaii’s chief state economist estimates that tax revenue coming into Hawaii state coffers is now expected to be $48 million to $80 million less than previous estimates for the rest of 2020 due to the impact of the corona virus. The drop will be primarily driven by declines in visitors coming to Hawaii and their spending. The latest data indicate that international arrivals are already down by more than 30% compared to the same period last year.

The virus is taking its toll operationally. In Pennsylvania , the Department of Transportation (Penn DOT) is suspending all operations, including construction, except critical and emergency work. Driver licenses, photo ID cards and learner’s permits scheduled to expire from March 16, 2020 through March 31, 2020, the expiration date is now extended until April 30, 2020. Vehicle registrations, safety inspections and emissions inspections scheduled to expire from March 16 through March 31, 2020, the expiration date is now extended until April 30, 2020. Persons with Disabilities Parking Placards scheduled to expire from March 16 through March 31, 2020, the expiration date is now extended until April 30, 2020. Moves like this should be expected across the country. That will impact the timing of fee revenues which along with possible tax payment deferrals could impact cash flows.

SOUTH CAROLINA PUBLIC SERVICE LITIGATION SETTLEMENT

In 2017, concerns were rising about the viability of the project to expand nuclear generating capacity at the Sumner Nuclear plant. A group of consumers filed a class action lawsuit against the plant’s sponsors The suit was brought in an effort to claw back charges customers paid for the unfinished twin nuclear reactor project. It names several electric cooperatives, former and current Santee Cooper directors, South Carolina Electric & Gas and SCANA Corp., and Dominion Energy, which bought SCANA in January 2019.

Now Santee Cooper has announced that it has reached a proposed settlement with the plaintiffs. The utility’s board of directors agreed to pay $200 million in cash over three years and to freeze rates for four years to end the suit. Dominion will pay $320 million in stock that will be sold and converted to cash as part of the settlement. Santee Cooper and Dominion also agreed not to attempt to recover settlement proceeds in base rates or other customer charges.

The settlement, if approved by the court, will remove a major source of uncertainty for Santee Cooper and may enhance its prospects for remaining a public utility. It allows the utility to more accurately estimate its stranded costs and determine a more certain course for its ongoing viability. It reduces the total liability with which creditors and investors would be effectively competing.  

The proposed settlement also helps to solidify some of the math being used to support assumptions being made by potential private suitors involved in efforts to acquire Santee Cooper’s assets. It is likely that the settlement will enhance the position of those who support reforming Santee Cooper’s oversight and management while maintaining its ability to compete. The ability to continue to finance its capital needs in the tax exempt market will continue to provide Santee Cooper with a cost advantage.

Proponents of a sale to private interests still have support in the state legislature and the outcome of deliberations currently underway in the state legislature is unclear. The approval of the proposed settlement is still uncertain. Preliminary approval of the settlement by the judge will begin a process during which all members of the class will be identified, and then they will be given the opportunity to opt into or opt out of the settlement.

Conclusion of the settlement process will be a credit positive event for the Authority and its bondholders.

GREAT LAKES WATER AUTHORITY

During the bankruptcy of the City of Detroit, investors holding debt issued for the Greater Detroit Water and Sewer Systems may have been one of the best positioned creditors. Between existing precedents for special revenue debt like that of the water and sewer systems and its regional revenue base, those credits were the most likely to be successfully restructured. So it was easy to counsel patience to those investors especially retail investors who were significant holders of the debt. Eventually, the Greater Detroit debt was restructured into a new entity, the Great Lakes Water Authority.

Now patient investors who worked through the bankruptcy, restructuring, and exchange process are seeing that patience rewarded. Moody’s Investors Service has upgraded to A1 from A2 and to A2 from A3 the senior and second lien water revenue ratings and the senior and subordinate sewer revenue ratings, respectively, of the Great Lakes Water Authority (GLWA), MI Water Enterprise. It cited ” continuation of strong operating performance that has resulted in healthy annual debt service coverage and liquidity. Additionally factored are the system’s large scale of operations, independent rate setting authority, and sound legal provisions of outstanding revenue debt. At the upgraded rating, these strengths continue to balance the system’s elevated debt burden, as well as their reliance on revenue derived from retail operations within the City of Detroit (Ba3 positive). The upgrade of the second lien revenue bonds to A2 incorporates the same factors while the lower rating reflects a subordinate claim on pledged net revenue.”

The restructuring improved regional oversight of the systems while maintaining their geographically diverse revenue streams. The regional character of the revenue base has only become clearer over time providing a solid foundation on which to rebuild its credit strength. It was always a regional credit and while Detroit had its problems the utilities managed to maintain the city’s suburban communities as customers of the systems.

RATINGS ACTIONS

We cited NY’s Metropolitan Transportation Authority as a vulnerable credit do to its reliance on farebox revenues. The corona virus will impact many credits and sectors but the MTA’s Transportation Revenue Bonds were especially vulnerable in the short term. So we view with interest the announcement this week that the Moody’s outlook for the A1 Transportation Revenue Bond (TRB) rating is negative.

According to Moody’s, MTA’s ridership levels and financial performance will be vulnerable if a widespread coronavirus outbreak occurs in NYC, or if local precautions to control an outbreak are extended. The credit impact will depend on the depth and duration of the economic and service disruption. We note that the MTA has ridden out prior interruptions in ridership – strikes, natural disasters, terror attacks without any real impact on bondholders. Unlike those events, the pandemic is forcing the MTA to fund increased employee education, customer communications and station and fleet sanitization, which will increase expenditures. 

The situation highlights the security structure for the MTA farebox bonds. Unlike most other rated transit systems, there is no debt service reserve fund. Pledged revenues flow to a trustee held account and are set-aside monthly for debt service before being released for operations. Longer term , the basic challenges the MTA faces – flat ridership trends, rapidly escalating leverage that includes growing market access risk, large debt and capital needs and growing public pressure to improve service and limit fare increases – will remain in a damaged economic environment. In the longer term, MTA will also be challenged by growing and relatively inflexible labor costs, and environmental risks (particularly from natural disasters).

PANDEMIC POSTPONES BOND VOTES

After the California primary, transit advocates were concerned that results from those elections might indicate that there was diminishing support for tax funding for transportation projects. Now, with 7 Bay Area counties under shelter in place regulations, there has been concern that a proposed sales tax backed transit funding program in a nine county around the Bay Area might not succeed at the polls this November. The proposal would ask voters in those counties to approve a 1 cent increase in sales taxes with proceeds dedicated to supporting debt issued to fund various transportation projects in the region.

The ballot measure was being proposed to the state Legislature under Senate Bill 278. In order to be placed on the November ballot, the bill would have had to be passed under an urgency clause that would have required at least two-thirds majority support from both the Senate and Assembly. Gov. Gavin Newsom would then have had to sign the law by June 24. Now in light of current events, proponents have announced that they are shifting their emphasis to the post-2020 time frame.

We would not be surprised to see other bond proposals wither in the face of the unprecedented funding demands due to the pandemic. It will be very difficult to garner support for any increases in taxes in the near term as individuals and businesses struggle in the face of extraordinary limits on economic activity. There are practical considerations as well. Many ballot actions in support of proposed bond issuances benefit from efforts to generate support in the community. Efforts in that regard are thwarted by the restrictions (required or voluntary) resulting from the pandemic.

Many scheduled elections in which bond ballot measures would be offered will be difficult to hold. To that end, Texas Governor Greg Abbott announced that local governments could suspend May 2 elections until the general election Nov. 3. The Metropolitan St. Louis Sewer District will go to court in an effort to postpone a $500 million bond referendum scheduled for April 7 because of the COVID-19 outbreak.

NONTRADITIONAL CREDITS UNDER PRESSURE FROM VIRUS LIMITS

Here in New York, there are certain credits which will be under unique pressures due to the limits on public gatherings. While no one is currently predicting defaults, four  prominent cultural or sports functions are exposed to financial pressure as seasons and performances are put on hold.

Bonds issued to finance Yankee Stadium and Citi Field are secured to varying degrees by revenues tied to attendance. The Yankee Stadium bond revenues pledged to debt service are dependent upon attendance or as George Steinbrenner used to put it “fannies in the seats”. A protracted stoppage would be akin to the risk of an extended labor stoppage which has always been cited as a major risk to the bonds. The Citi Field debt is secured by a pledge of certain seat revenues as well as revenues from advertisers at the stadium.  When all is said and done, a downgrade would not be surprising.

The Metropolitan Opera also issued municipal bond debt. It was downgraded in 2018 as the impact of  softening ticket revenue. It also faces labor pressures, pension costs, and disappointing fundraising trends. Weakened operating performance including inability to cover debt service with a 5% endowment spending rate, reduction in unrestricted liquidity, meaningful reduction in total cash and investments, and softened prospects for donor support or inability to meet fundraising targets were all cited as potential drivers of another downgrade. Now, the opera estimates that it will lose $60 million of revenue – a 20% hit after it announced that it would cancel the rest of its season because of the coronavirus pandemic and begin an emergency fund-raising effort aimed at covering the anticipated loss of revenue.

Other NY institutions with debt outstanding include the Museum of Modern Art. It just had its rating of Aa2 affirmed in January by Moody’s which cited excellent visitor demand and programs and strong membership which support revenue prospects. It also noted that the museum remains vulnerable to changes in New York City tourism patterns or art programming preferences. Additionally the museum has some exposure to contractual expenses through pension plans and collective bargaining agreements. Now it has announced that it will stay closed at least until July and expected a nearly $100 million shortfall.

There will be other examples across the country as cultural and educational facilities around the country are closed potentially for extended periods.

IT’S FLOOD SEASON AGAIN

While signs of Spring abound after the 2nd hottest February on record, not all of them are good. This is the time of year when the National Oceanic and Atmospheric Administration released its annual Spring Outlook and its estimates of potential flooding during the winter runoff. Last year saw exceptional levels of flooding across the middle of the country.

This year, NOAA says that major to moderate flooding is likely in 23 states from the Northern Plains south to the Gulf Coast, with the most significant flood potential in parts of North Dakota, South Dakota and Minnesota. It is forecasting above-average temperatures across the country this spring, as well as above-average precipitation in the central and eastern United States. Significant rainfall events could trigger flood conditions on top of already saturated soils. 

The flooding will renew the debate over physical mitigation (flood walls and levees) versus strategies such as managed retreat. The greatest risk for major and moderate flood conditions includes the upper and middle Mississippi River basins, the Missouri River basin and the Red River of the North. Moderate flooding is anticipated in the Ohio, Cumberland, Tennessee, and Missouri River basins, as well as the lower Mississippi River basin and its tributaries. The West seems best positioned going into flood season. Drought conditions are expected to persist and expand throughout California in the months ahead, and drought is likely to persist in the central and southern Rocky Mountains, the southern Plains, southern Texas, and portions of the Pacific Northwest.

Once again, states and localities will be central to any response further straining finances after the impact of the corona virus pandemic. The Army Corps of Engineers and the Federal Emergency Management Agency, are linchpins of the nation’s flood response. They could be stretched thin as the nnation fights the virus.

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.