Joseph Krist
Publisher
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Now that the stimulus package has been enacted, attention can be focused on an infrastructure bill. We fully expect a package to pass. The stars are certainly aligned more favorably for such a result than has been true for some time. Nonetheless, we do not expect the process to occur in a straightforward manner. It has become quickly apparent that the many disparate issues interest groups are seeking to address through an infrastructure bill may very well result in a less effective package. It will be difficult to satisfactorily address the many issues which could potentially arise.
The infrastructure bill is being hammered out at a time when there is no clear set of initiatives which could satisfy all of these groups. Infrastructure is being linked to “economic justice”, climate change, and a host of social issues. Unfortunately, a consensus around how best to deal with those issues among advocates remains unclear. As identity politics rule the day, interest groups have been unable to find commonality in a way that generates the most benefit for the most people. We see housing advocates complaining that electrification will be too expensive for low income groups. Carbon taxes are seen as an additional economic burden as well.
The lack of consensus will serve as an effective hurdle for many ideas. Transportation is at the center of this debate. Recently, we have seen advocates for mitigating climate change challenge the notion of electric vehicles. They claim that removing internal combustion vehicles and substituting electric vehicles is not enough to help the climate. That only reducing vehicle ownership will suffice. That would make many think that that issue can be solved through renewable energy production. At the same time, others oppose the siting of renewables on environmental grounds.
One of the great failures of “the left” in this country over the second half of the 20th century forward has been dealing with the economic realities of what they want. We are not going to be able to fundamentally reorder the economy without expecting disruption and cost. Disruption and cost lead to resistance. The cost of environmental remediation has always been underestimated. A clean environment is not free. And there has to be another answer to the problem away from taxing the wealthy.
Municipal bonds will wind up being at the center of this. This is the only major financial market in a position to address all of the issues which might ultimately become part of the infrastructure debate. Jobs, housing, healthcare, education, transportation are all right in the muni wheelhouse. And don’t look now but there was actually a serious mention of advance refundings and private activity bonds at a Senate hearing on an infrastructure bill. There’s hope!
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CLIMATE RISKS IN 2021
The National Oceanic and Atmospheric Administration (NOAA) has released its Spring 2021 outlook estimating flooding and other natural disaster risk for the upcoming season. Prior outlooks have predicted flooding and wildfire events which have had credit implications for impacted areas. As environmental issues come to have greater rating significance, these outlooks help investors anticipate and evaluate climate risks in their portfolio.
It has already been a difficult winter in many areas and the impacts have been clear. Now, a different set of climate concerns come with the warmer months. Drier conditions in the Southwest U.S. associated with La Niña and the failed 2020 summer monsoon have been contributing factors to the development and intensification of what represents the most significant U.S. spring drought since 2013, which will impact approximately 74 million people.
The precipitation outlook favors above-normal precipitation for parts of the Midwest, the Great Lakes, the Mid-Atlantic, the Northeast and in Hawaii, while below-normal precipitation is forecast across the southern Plains and much of the West.
One big difference this year is the projection of much less flooding. NOAA hydrologists are forecasting limited moderate flooding this spring and no areas with a greater than a 50% chance of major flooding for the first time since 2018. Widespread minor to moderate flooding is predicted across the Coastal Plain of the Carolinas while minor to isolated moderate flooding is predicted for the Lower Missouri and Lower Ohio River basins. Overall, this flood year is not expected to be severe or as prolonged as the previous two years.
Water supply forecasts through spring are predicted to be below to much-below normal for most of the desert southwest, southern Oregon, and southern Idaho into much of the Rocky Mountains, which will play a major role in drought persistence this spring.
ANOTHER NUCLEAR DELAY
Georgia Power announced another delay in the in-service date for the first of its two new reactors at the Plant Votgle site. After many delays, the first new unit was scheduled to be on line in November of this year. Now the date has been delayed until at least the Spring.
The issue is that the start of hot functional testing for Plant Vogtle Unit 3 will be delayed from the original start date in the second half of this month. Georgia Power’s had already announced in February that productivity had slowed into January 2021, which increased the total project budget by $325-$415 million. A rise in active COVID-19 cases at the site delayed productivity, but these abated in February and March. The schedule on the project has been beset by COVID related issues for some time so the January problem was above “normal”.
For each month the plant is able to ultimately unable to open, an additional $25 million in costs will accrue. Georgia Power attributed the delay to “additional construction remediation work” necessary before the reactor undergoes testing and fuel loading. Originally set to occur this month, the testing has been postponed until April. Just to refresh, MEAG Power owns 22.7% of the project and another municipal issuer Oglethorpe Power Corporation owns 30%.
AND A SMALL UTILITY SHALL LEAD THEM
In 2014, the Holland Michigan and county electric utilities issued debt for the Holland Energy Park (HEP). The facility is a natural gas fueled generating station. It was funded with bonds secured by net electric revenues. It was a bit of a gamble since the plant generated power in excess of the utility’s demand.
The move by utilities to look at generation alternatives to coal and oil made the project’s excess power attractive as a “green” source. So all of the excess is sold into the Michigan grid at prices which have enabled the utility to generate revenues for the City’s general fund. That even after Holland BPW was able to reduce electric rates by an average of 6% for customers and it proposes to cut rates some 10% starting in July.
And yet this all highlights one of the emerging dilemmas facing the climate change movement. In Holland, the utility can show that it has reduced its carbon footprint and point to financial success associated with it. Climate change advocates would say that the plant represents little if any progress in terms of fossil fuel dependence. Trying to convince a ratepayer that 6 and 10% cuts in rates are bad won’t fly.
It is part of the economic realities confronting the climate change movement.
TEXAS POWER CRISIS AND MUNICIPAL UTILITIES
The publicly owned San Antonio, TX electric utility CPS Energy will have a chance to test the market’s reaction to the financial ramifications of the recent power distribution debacle in Texas. The utility and its customers face potentially much higher rate requirements to meet the obligations resulting from the exorbitant bills being delivered to utilities by the state’s grid operator, ERCOT. CPS hopes to issue some $375 million of long term debt to refinance outstanding commercial paper.
The situation with the charges from ERCOT has resulted in Fitch and S&P lowering their CPS bond ratings to AA- and they both joined Moody’s in maintaining negative outlooks. The ultimate magnitude of the ERCOT charges related to February’s difficulties is unclear. ERCOT ran up $20 billion in charges for five days of energy supply to utilities across Texas.
The size of the bills and the limited resources of smaller systems have led to a cumulative shortfall in payments to ERCOT of over $1 billion net dollars. These shortfalls are financed by delivering “short” payments to generating utilities like CPS which sell power through ERCOT. Through 3/22, this has resulted in a revenue reduction from ERCOT of $18 million.
As of now, the potential for increased costs to CPS is unclear. CPS is vulnerable to seeing more of ERCOT shortfalls negatively impacting CPS’ finances. The issue will remain a cloud over the utility as ERCOT’s billing practices are now the subject of multiple legal challenges. In addition, the Texas legislature is considering bills to address the situation. Nonetheless, there are still significant risks to CPS’s financial position. Natural gas costs for CPS related to the storm are estimated at $670 million and purchased power costs assigned to CPS are estimated at $365 million. Some $365 million of the costs of natural gas and purchased power have been paid.
Currently in the absence of legislative or regulatory fixes, CPS is forced to pursue a legal strategy against ERCOT. The goal is to protect CPS from what are generally agreed to be exorbitant rates charged to utilities and their customers during the storm. While the process works its way through the three branches of state government, CPS has had to seek increased credit line capacity and plan for a potential debt program to address the final costs stemming from the storm.
That plan is at the center of the pressure on CPS’ ratings. It would fund the ultimately determined cost resulting from storm-related charges with the proceeds of debt secured by a separate charge on customer bills. It has been shown in the recent past that there is a strong appetite for securitization of costs like this with potential investors. Nonetheless, the overall impact of such a plan would be negative for CPS’ ratings. The official statement may actually summarize the whole situation – “CPS Energy believes that its efforts … to ultimately accommodate the final financial and operating results of the 2021 Weather Event will prove successful, but success has multiple measures.”
That, in a nutshell, summarizes the basis for a negative outlook on the credit.
NASSAU COUNTY OUTLOOK
A locality and its residents may chafe over the limitations imposed by the role of a financial control board but it is hard to argue with their results. Oversight boards have been essential in the fiscal rehabilitation of entities across the country. In the 20 years since the initial legislation creating the Nassau County Interim Finance Authority (NIFA) was enacted, the County has navigated a recovery through several economic cycles and restructuring of its debts. Through the use of control periods, NIFA has had a direct hand in managing the County’s fiscal affairs. That role addresses any governance concerns that negatively impacted the County’s ratings over the years.
NIFA allowed the county’s ratings to slowly but steadily improve to where they stand today at A2 by Moody’s. This rating reflects “expectations that sale tax revenues will increase due to Nassau County’s recent economic recovery, supported by a very large tax base with strong wealth and income.” It looks like the county will achieve a third consecutive year of improved financial results in 2021. Governance is also considered a positive factor now because of NIFA’s role. This cushions the rating against the pressure of the County’s relatively high taxes and debt burden.
All of this moved Moody’s to revise its outlook on the county’s rating to positive. The change is based on the expectation that financial results will continue to be balanced and that an economic recovery will drive revenue growth, especially that of sales taxes.
NYS BUDGET
As this piece went to press, the annual budget process for the State of New York is coming to a head. The new fiscal year begins on April 1 so the pressure is on. The process this year has been complicated by the process of passage of the federal stimulus and the ongoing political drama enveloping the Governor. Now that the stimulus has been passed and the State is receiving more than it expected, the push will come to restore spending cuts in the Governor’s proposed budget. The political pressure is coming from the Legislature to raise taxes and increase spending which it believes that the Governor will be in a much weakened position to stave off.
Cuomo’s proposed budget only included temporary tax increases if the state did not receive Covid-19 assistance from the government in that third stimulus package. The Legislature’s plan would cost more — $208.3 billion, an increase of $15.6 billion, or 8.1%, over the current year’s budget. The proposed spending is $12.2 billion, or 6.3%, higher than Cuomo’s proposal. It all would be funded by what progressives refer to as a millionaires tax.
This would come from increasing the top income tax rate from 8.82% for single filers earning more than $1 million and couples earning more than $2 million to 9.85%. And it would establish two new brackets: 10.85% for taxpayers between $5 million and $25 million and 11.85% for taxpayers over $25 million. The plan would also increase capital gains taxes, create new taxes on businesses and increase the state’s estate tax.
New York State’s budget process has often been the accelerant to the overall legislative process on difficult issues. The negotiations follow a well established process and policy decisions through the “three people in the room” process. This year that dynamic along with national trends and the pandemic have led to a breakthrough for advocates of legalized recreational cannabis in NYS.
That process has resulted in an agreement which would legalize recreational marijuana for adults 21 and older, Personal possession of up to three ounces would be permitted. As expected a significant sales tax of tax on sales would be assessed at 13%. The first 9% would go to the state with the other 4% to local governments.
One twist in the proposal is for distributors to pay an excise tax, which could be as high as three cents per milligram of THC. It would be levied according to a sliding scale, based on the type of product and how strong it is. In a reflection of the division of opinion in the state along geographic lines cities, towns, and villages may also choose not to approve retail and delivery weed within their jurisdiction.
The plan also addresses many of the issues which typically inform debates on the issue. Tax revenue from sales would fund the operations of the newly created Office of Cannabis Management and police officer training to detect impaired driving. Forty percent of the remaining revenue is targeted for school aid. A 40% share would be put into a fund establishing grants for social equity which has been a significant issue in the NY debate. The remaining 20% would fund drug-treatment and public-education programs.
FLORIDA TRANSPORTATION TAX RULING
Hillsborough County voters approved a 1% sales tax in 2018 with nearly 60% of the vote. The charter amendment initially included references to exact percentages allocated to the Hillsborough Area Regional Transit Authority and the three cities within Hillsborough County. It also struck specific references to how much money can be spent on certain types of projects like roads or transit. That wording provided an opening to opponents of the measure.
They cited the removal of that language in subsequent litigation that struck down portions of the amendment and argued that these changes had so fundamentally changed the amendment such that it was no longer consistent with what voters approved in 2018. By a margin of 4-1, the Florida Supreme Court agreed.
Hillsborough residents and visitors have paid the sales tax since the beginning of 2019. To date, the county has collected nearly $500 million in taxes from the sales surtax. The status of those funds is unclear at present. The irony is that the effort to fund the transportation plan could be another pandemic victim. Hillsborough County commissioners originally were moving towards putting an amendment on the ballot to address the legal concerns but like many things in 2020, it was thought that the pandemic and impacts on voting might not result in approval. Now the County will have to attempt what would effectively be a corrective ballot question in 2022 under different circumstances.
PREEMPTION
Legislation to block local governments in Georgia from limiting what fuel sources offices, houses and other buildings can use is poised to clear the Legislature. The State Senator who carried the bill in the Senate, said “its intent is to stave off future efforts in Georgia to abolish the use of fossil fuels like coal and natural gas going forward.” In Georgia this bill received bipartisan sponsorship and support although it is ultimately a move “against” the climate change movement.
This bill joins another under consideration in Indiana which has the same goals in mind. (It’s what happens when outside advocacy groups write legislation.) One local legislature there has taken a very public stance against preemption calling it “an assault on local home rule”. The issue here is limitations on new solar and wind.
Alabama law says revenue from gasoline and other motor fuel taxes levied by the state can only be used for infrastructure and similar uses, but there are no such restrictions on the local gas taxes collected by hundreds of governments. A pending bill would alter that. It says that all taxes on motor fuels, “whether called an excise tax, license tax, or otherwise, levied by a municipality or county or by local law may be used only for road and bridge construction and maintenance.”
USC AND A FINANCIAL RECKONING
USC has had its share of bad press in recent years reflecting its place at the center of a number scandals. Most of the public attention has been on events which while negative, did not present significant financial implications. Now, the university faces a real financial hurdle in the wake of its latest problem.
USC announced that it has resolved outstanding litigation against the University in connection with its employment of a doctor at its student health facilities who was eventually charged with sexual assault. The resolution comes with a cost – USC will pay more than $1.1 billion through a combination of three sets of settlements with more than 700 accusers. The sum dwarfs to prior settlements at Penn State and Michigan State. The U.S.C. claims cover a 2018 federal class action already settled for $215 million, a second group of several dozen cases in which the amount of the settlement was not made public and a third settlement for $852 million.
USC has a strong resource base and Aa1 and AA ratings. Nevertheless, the University’s financial response will result in a weaker credit. The university president said, according to press reports, the university would fund the settlement over two years through a combination of “litigation reserves, insurance proceeds, deferred capital spending, sale of nonessential assets, and careful management of nonessential expenses.” Press reports indicate that no philanthropic gifts, endowment funds or tuition would be redirected to pay the costs.
We’re not saying it’s the end of the world but the ratings need to reflect the fact that the total sum is equal to 25% of FY 2019 net assets and essentially equal to net student revenue for the FY 2019. By any measure it is a serious hit. At least a one notch downgrade seems more than appropriate.
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