Joseph Krist

Publisher

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STIMULUS MONEY FOR STATES AND LOCALITIES

As we go to press, the Senate has passed its version of the stimulus bill and it awaits an expected vote in favor in the House. It is important to note that the $350 billion of aid to state and local government does not include additional funding under individual categories like vaccine distribution costs, school reopening costs which alone get an additional $144 billion. Medicaid gets a boost. Under the stimulus bill, states newly expanding Medicaid under the ACA would also receive a 5 percent bump in the federal funding match for their traditional Medicaid programs for two years. Because the traditional Medicaid population is significantly larger than the expansion population, the funding increase  is projected to cover a state’s 10 percent match for expansion enrollees and then some over those two years.

There are finally more specific numbers available to let us see how much of the $350 billion included in the pending stimulus legislation for state and local governments will reach individual governments. The bulk of the money goes to state governments with $216 billion of the $350 billion in the package for state governments. California will receive the largest share at $26.264 billion, followed by Texas at $16.824 billion, New York at $12.6 billion, and Florida at $10.3 billion. So much for the blue state bailout aspect of the debate as the largest shares are split among the colors.

Counties in California will receive $7.6 billion, the largest county share of the $65 billion available for those entities. Notable county shares include Alameda at $324 million; Los Angeles at $1.947 billion. Other major county allotments include Cook County, IL at $999 million; Nassau County, NY gets $398 million and neighboring Suffolk County gets $286 million. City totals include $1.345 billion for the City of Los Angeles, $636 billion for San Francisco; $880 million for Detroit, $435 million for Boston; $1.982 billion for Chicago; $4.3 billion for NYC; $500 million for Cleveland; Philadelphia would see $1.3 billion. Puerto Rico and its municipalities would receive a combined $4.3 billion.

One of the key issues underpinning opposition was doubt about the needed amount of aid to state and governments. Opponents seize on data from states like Minnesota (see our comments below) to support their cause. There also were issues with how initial aid was spent in that some recipient cities were pretty clear that they were using the funds for general budget relief rather than direct pandemic mitigation. It did not help the case but was not enough to stop the bill.

THE PANDEMIC ECONOMY – TWO DISPARATE EXAMPLES

As one of the largest municipal bond issuers in the country, the outlook for the NYC economy is of prime interest to investors. So we saw with interest the latest analysis of the city’s economy from its Independent Budget Office.

Based on Bureau of Labor Statistics data through December, New York City lost 557,000 jobs for the year 2020. During the first two quarters of 2020, with New York State as the epicenter of the pandemic in the U.S., the city lost a total of 889,000 jobs, or 19.0 % of total employment. A relatively strong initial recovery followed, with the city adding 210,000 jobs in the third quarter as the pandemic eased over the summer.

But job growth subsequently slowed through the fall and even turned negative in December; during the entire fourth quarter of 2020, the city had a net increase of just 122,000 jobs. In 2020, the largest losses were concentrated among major sectors closely tied to services and consumer activity, including leisure and hospitality (202,000 jobs), administrative and support services (53,000 jobs), and retail and wholesale trade (49,000 jobs). IBO forecasts employment growth of 152,000 jobs in 2021, 149,000 in 2022, 107,000 in 2023, and an average of 53,000 per year in 2024 and 2025.

That would leave the City just below pre-pandemic employment peaks. That reflects  an outlook which sees leisure and hospitality as having the weakest projected recovery of any sector, with jobs at the end of the forecast period still down from pre-pandemic levels by 23.2% (466,000 jobs in 2019 versus 358,000 jobs in 2025).

Where are the hopeful signs? Health care, information, professional/technical services, and financial services are cited as the sectors which may reach levels of employment above their pre-pandemic levels. The lag will come in sectors tied to tourism and high levels of disposable income.  It should be noted that despite the pandemic, personal income—the total of all sources of income received by city residents—increased by an estimated 2.9 percent in 2020, to $701.8 billion. Yes that reflects a high level of transfer payment from among other things, the federal stimulus payments and unemployment insurance. That is reflected in wage and salary data which shows in 2020, a decline of 3.4 percent from 2019.

The apparent incongruity between employment levels and wage impacts reflects the continuing split in the City’s economy – the so-called tale of two cities. Many of the lower-wage industries that saw the steepest employment losses also suffered large declines in aggregate wages, including leisure and hospitality (41.2%), administrative and support services (19.7%), and trade (13.4%). Meanwhile, certain higher-wage industries saw increases in aggregate wages, including information (10.5%), securities (6.1%), education (3.3%), professional/technical services (3.1%), and health (1.6%).

It is impossible to discuss the NYC economy without mentioning real estate. IBO estimates total taxable real estate sales of $61.3 billion for 2020, down from $99.8 billion in 2019. Going forward, the commercial real estate sector appears poised to be the area of the most risk for declining property valuations and property tax collections. Businesses in consumer-facing sectors have seen the largest losses in employment and earnings, and many existing jobs in professional and technical sectors have shifted toward alternative working arrangements.

The NYC numbers accompany a similar analysis of the economy of Minnesota which accompanied a favorably revised state budget estimate. In March and April 2020, as the pandemic was taking hold and economic activity was being restricted to slow spread of COVID-19, Minnesota lost 388,000 jobs, approximately 13 percent of February 2020 employment. The state began adding jobs in May, and through December 140,000 of the jobs lost in the early spring had been recovered.

As of December, Minnesota had 248,000 (8.0 percent) fewer jobs than in February. Between February and December 2020, Minnesota’s leisure and hospitality sector—made up of accommodation and food services and arts, entertainment, and recreation—lost 123,400 jobs, 44 percent of the sector’s February employment.  Since the onset of the pandemic, Minnesota’s labor force has fallen by 102,000.

TEXAS POWER CRISIS

Texas’s largest and oldest electric power cooperative – Brazos Electric Power Cooperative Inc, which supplies electricity to more than 660,000 consumers – filed for bankruptcy protection, citing a disputed $1.8 billion bill from the state’s grid operator (ERCOT). The move highlights the risk facing many of the Lone Star State’s electric utilities, especially municipal utilities.

One such utility- the City of Denton’s electric system – last week sued ERCOT in a state court to prevent it from charging it for fees unpaid by other users of the grid. The situation highlights the increased risk that local utilities face as the result of the difficulties at ERCOT, the manager of the single state Texas grid. We expect to see more stories like this. What will matter is how these issues are resolved.

One municipal utility – San Antonio – has gone on record as blaming the grid situation and its now clearly attendant financial risk as the basis for delaying renewable energy investments. The initial reaction of state government was to blame renewable resources for the inadequate supplies of power even though the impact of the storm was as great or greater at legacy fossil generating sources. This all reflects the pressure being put on by the state’s natural gas producers.

So now we are not surprised to see that in the wake of the recent power outage, some cities with municipal electric systems are reacting to this pressure by scaling back their plans to move to a fossil free generation environment. San Antonio and Austin are extending the period of time before natural gas in new buildings is banned and they are reducing their reduced emissions goals.

CARBON CAPTURE AND MUNICIPAL BONDS

While the infrastructure debate continues, a variety of proposals are being floated which could allow tax-free municipal bonds to be used to finance the development of carbon capture technologies. Carbon capture is controversial. Many would argue that it is not a proven technology. So we find it somewhat troubling that some in Congress are willing to advantage their favored industry with private activity bond status while not moving forward on items like advance refunding.

The proposal comes shortly after the only operating carbon capture facility in the U.S. was shut down. NRG Energy, which owns the project, announced that it would be shut down indefinitely. This Texas project was the largest in the world and it did not work. Reliability and performance issues doomed the plant. Another effort in Mississippi failed financially and never operated.

The CCS technology at the required so much energy that its owner and operator  (NRG) had to build a natural gas generator—the emissions of which were not offset by the technology employed at the plant—just to power the scrubber. Other economic issues included the fact that NRG actually wanted to use the carbon to extract oil at other properties. The economics of the CCS plant depended on the use of the carbon for oil production. When oil prices tanked, the plant was taken off line as it was uneconomical.

All of this reminds of the many other technologies presented to the municipal bond market – medium density fiber from wood waste, paper deinking just to name two – which took advantage of tax exempt financing to provide at least some portion of project economics.  They did not work either. Those projects left a trail of default wreckage throughout the tax-exempt high yield fund space. Like amusement parks, waste technologies, and other projects which needed tax exempt financing because at market taxable rates the project economics do not work, CCS projects look like they are next to take their place among those failures.

FOSSIL FUEL LIMITS

A move towards local bans on the use of natural gas in new building construction was enough to motivate the gas industry to try to override local rules through state legislation. (See last week’s edition on PREMPTION) In Vermont, the state’s largest city, Burlington has just elected to take a different approach. Rather than restrict through regulation, the city chooses to use taxing power This year’s town meeting vote saw the regulation of thermal energy systems in the city of Burlington pass by 8,931 to 4,910 votes or about 65%-35%. This is the first step in a multi step process.

The result allows the city to ask the state Legislature if it can draft legislation to tax new developments if they choose to use fossil fuels in their heating. This vote will come back to residents if the Legislature approves, and then the City Council will draft another resolution for voters to vote again on a potential carbon fee. The experiment will bear watching as it merges a liberal city like Burlington with an idea most prominently advanced through the University of Chicago. We expect municipal issuers to face similar choices in light of the efforts to stymie a regulatory approach.

PANDEMIC POLICY IMPACTS

The pandemic and its impact on revenues at the state level generated some unexpected results. With all of the emphasis on job losses and high unemployment rates during the first few months of the pandemic, the impact of lockdowns and reduced economic activity on state revenues was not estimated correctly. The budget season and the need to generate revenue estimates to support the budget process have documented the pandemic’s effect.

One of the trends to emerge is that the pandemic’s impact on incomes was wildly unequal. It turns out that the structure of a state’s taxes had real impacts on the effect of the pandemic on revenues. Because the impact of job losses was concentrated to a great degree among lower wage job categories as opposed to white collar workers who could work remotely, the expected pressure on income tax collections just has not materialized to the extent anticipated.

This has led some to look at changes to their state’s tax structure and propose changes. In New Mexico, a bill is being offered that would raise the state’s marginal income tax slightly. Senate Bill 89 would increase the percentage rate on taxable income for people earning the most. The top bracket would tax at a 6.5% rate, up from the current 5.9%. It is estimated to bring in $100 million in incremental revenue. State statistics say only 4% of the state’s households earn more than $200,000 a year.

PUERTO RICO AND MARKET CREDIBILITY

The executive director of the Puerto Rico Fiscal Agency and Financial Advisory Authority spoke at a high yield conference this week. The comments were supposed to reflect positively on the outlook for Puerto Rico’s efforts to regain access to the municipal bond market. Depending on your viewpoint, you may react positively to them. We however, beg to differ.

“Not only were we able to gain credibility through restructuring issuers COFINA [Puerto Rico Sales Tax Financing Authority], Government Development Bank, Puerto Rico Infrastructure Finance Authority Ports  but we were able to gain more credibility when we went back to the market in September and December 2020 with both the Public Housing Administration and the water utility.”  That is indeed questionable.

Neither of the two issuers referenced issued debt backed by governmental as opposed to enterprise revenues. They both refunded more expensive existing debt so the debt service payment on those bonds should be more likely. We see a real distinction in that water debt historically performs very well in bankruptcy and the housing debt is paid from revenues from the federal government.

It is the area of governmental versus enterprise debt with which we have a problem. The government’s opposition to any adjustment in pension payments – even temporary – is a warning sign that the stomach to achieve real reform is not there. The economy still reels from hurricanes, earthquakes, and floods. The tourist economy remains pandemic bound. And many of the structural weaknesses of the local economic environment remain unaddressed. But to date, much political capital is wasted on the quest for statehood in a political environment where that is not soon achievable.

The government has dug in on pensions. It has always been our view that the Commonwealth has to act responsibly on its own before it can have credibility. The pension issue should be viewed as a test. Like the Christmas bonus, it is a sign of an entity which will not accept reality. The Title III process is one quarter away from being four years along and yet it’s clear that there remain significant hurdles to overcome before that process can end. Then the Commonwealth can begin to consistently deliver on its own the necessary financial and economic information investors need in order to rebuild trust.

THE FUTURE OF WORK

Much has been posited about the future of work in the face of technological change. In addition to the obvious impacts of the pandemic on employment from economic activity restrictions, a number of pre-pandemic factors became more real as businesses adapted to pandemic economic realities.

The issue of technology or its older name automation is not new. It has already had profound effects on the nature of work and the hierarchy of employment which has resulted. For those preexisting factors, the pandemic served as an accelerant. Diminished traffic accelerated the full automation of tolls on the Pennsylvania Turnpike. The NYS Thruway completed automated toll equipment on additional segments of the road.

On the corporate side, pandemic restrictions increased reliance on machine based contacts with customers – banks, grocers, restaurants. It has come out that even the kids taking your drive thru order at McDonald’s are being replaced in a trial. There are plenty of other examples. The pandemic exposed structural issues with the economy. A new report from the Future of Work Commission, a 21-member body appointed by Gov. Gavin Newsom in August 2019, notes that Among California’s low-wage workers, 53% are employed in essential occupations, which are most vulnerable to the virus compared with 39% of workers in middle- and high-wage occupations, many of whom are able to work from home.

Combine this with the newfound attractiveness of remote work to many in the workforce. The result is fewer people commuting and occupying offices further pressuring service jobs. That then increases the disconnect between work and residents of lesser means. This comes as there is much focus on the potential for property tax pressures stemming from lower demand for commercial spaces. All of this points to more uncertain environment for general obligation tax supported credits. It is manageable, but uncertain.

NUCLEAR FALLOUT IN OHIO CONTINUES

The Ohio Senate voted unanimously to repeal the nearly $1 billion in subsidies that were to have been sent to two Ohio nuclear plants owned by a former FirstEnergy subsidiary. The bill also would eliminate the fees on Ohioans’ electric bills that pay for the subsidies. A court ruling has stayed the collection of these fees pending appeal.

The Federal Energy Regulatory Commission ruled in 2019 that if power generation companies receive state subsidies like the ones offered by HB6, the commission would make it harder for those companies to sell electricity from the two nuclear plants. That ruling said that new resources receiving subsidies will now be subject to the Minimum Offer Price Rule (MOPR), which raises the price floor for those resources attempting to sell their power into the wholesale market.  The result effectively penalizes nuclear power even though the intended target is wind and solar generation.

The subsidization of nuclear and the efforts of the  nuclear industry to obtain these subsidies are at the core of ongoing scandals in Ohio and Illinois. The Ohio House Speaker was indicted and the Illinois House Speaker retired in reaction to pressure related to efforts by utilities owning  nuclear assets to obtain subsidies. There is irony that legislation designed to support legacy generation actually hurt in this case.

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