Joseph Krist

Publisher

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We keep hearing that the pandemic isn’t everyone’s problem when it comes to federal assistance to states. Data out this week showing that the virus moved from the coasts and gateway cities out to the rest of the country will not help anti- New York bias out there among them. Fortunately, data suggests that the State of New York might have been better positioned to deal with the pandemic if more of the state’s resources had been allowed to remain in state rather than bankrolling the rest of the country.

That data shows that in Federal Fiscal Year (FFY) 2018, New York State generated an estimated $26.6 billion more in federal taxes than it received in federal spending. In total dollars, New York’s deficit was the highest among the 50 states. For every tax dollar paid to Washington, our State received 90 cents in return—well below the national average of $1.21. The State generated nearly $254 billion, 8 % of the $3.2 trillion in federal tax receipts. By contrast, the $227 billion in federal spending the State received represented 6 % of the nationwide total, virtually the same as New York’s share of the U.S. population.

So the State would able to fund the entire revenue loss from the pandemic and have money left over were it not for this imbalance. It could even help NYC if it chose. Connecticut tops the list of donor states. Residents there receive just 74 cents back for every $1 they pay in federal taxes. Kentucky on the other hand pays in only about one half of what New York contributes on a per capita basis. So no matter your political leanings, the data tells the story.

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RATINGS TOLL BEGINS TO TAKE SHAPE

The negative impact of the pandemic on the economy and taxes derived from economic activity is already manifesting itself in negative ratings actions. The latest example is the entity which financed Miller Park and the arena for the Bucks in Milwaukee, The Wisconsin Center District . The district’s Series 1996A, 2003A, 2016A and 2020A bonds are secured by a senior lien on the following special taxes: a 2.5% Basic Room Tax, a 0.5% Local Food and Beverage Tax, and a 3% Local Rental Car Tax, all of which are levied across Milwaukee County (Aa2 stable) and can only be used for debt service. The bonds are additionally secured by a 7% Additional Room Tax levied in the City of Milwaukee (A1 negative), which is pledged first to debt service and then any lawful purpose.

Now, Moody’s Investors Service has downgraded to A3 from A2 the rating on Wisconsin Center District’s senior debt to A3 and its junior lien debt to Baa3. The analysis assumes a gradual recovery beginning in the second half of 2020 with slow improvement over the ensuing months. Now the District is undertaking and advanced refunding of some of its debt. The resulting restructuring of the District’s debt service schedule will reduce near term debt service requirements which will accommodate the limits on the economy resulting from the pandemic.

The uncertainty facing the higher education space is unprecedented. Already, schools are seeing fewer acceptances by the usual May 1 deadline so it is difficult for administrators to estimate enrollments and revenues. So far, the vast majority of institutions indicating that they plan to reopen are the state university systems. Overseen ultimately by politicians, these institutions are getting caught up in pandemic politics as states which are considered to have pro-Trump governors are the most favorably disposed to open.

The real risk is in the private space, especially in the smaller college category. These schools were already under financial stress from existing pressures on enrollments. S&P Global Ratings revised the outlooks to negative from stable and affirmed its ratings on certain U.S. not-for-profit colleges and universities (including all related entities), due to the heightened risks associated with the financial toll caused by the COVID-19 pandemic and related recession. The public and private colleges and universities affected by these actions include primarily those with lower ratings (‘BBB’ rating category and below).

Helpfully, S&P named liquidity, as measured by available resources compared to debt and operating expenses, as the primary metric assessed. Liquidity will be the key as colleges manage the financial impact on institutions from the loss of auxiliary revenue from housing and dining fees, and parking fees; as well as revenues from athletics, theater, and other events, which is material for many.

Another risk is the limitations of travel and the potential impact on historically lucrative foreign student demand. If global travel restrictions are prolonged, or the imminent recession diminishes foreign students’ financial means, then some could opt to study or work in their home countries instead. Growth in this demand was already slowing from pre-pandemic efforts to limit immigration. The pandemic has exponentially increased the negative pressure on foreign demand. This impacts public and private schools.

The impact on investments resulting from the pandemic will hurt as most U.S. colleges and universities depend on endowments and fundraising for a significant portion of revenues. Declines in performance and endowment market values along with weaker fundraising results could negatively affect credit metrics during the outlook period. 

For public institutions all major revenue sources are under pressure. Recent increases in state support may not be sustainable and it is likely most states will make cuts to higher education funding. Funding for higher education still remains below pre-recession levels in certain states and this will continue. Some have already withheld funds from higher education institutions for the remainder of the fiscal year (New Jersey and Missouri, e.g.).

FISCAL CURVE IS NOT FLATTENING

The NYC Independent Budget Office (IBO) is updating its forecasts for the NYC budget for the rest of FY 2020, FY 202, and FY 2022. It notes that even after only two months that its outlook has continued to weaken. Now, IBO projects that  the city has a budget gap of $544 million that must be closed in the two months remaining in the current fiscal year. It also estimates a shortfall in the upcoming fiscal year of $830 million and a budget gap that balloons to nearly $6.0 billion in 2022, just 14 months from now. Tax revenue for 2020 is now projected to fall $2.9 billion (4.6 percent) below what was estimated in the Preliminary Budget report; for 2021 the shortfall is $6.6 billion (9.9 percent). It  expects tax collections will total about $61.5 billion this fiscal year, a gain of only 0.2 percent from 2019 and the picture for 2021 is considerably worse. Tax revenues for 2021 will total about $2 billion less than this year, a year-over-year decline of 3.2 percent.

The State of Minnesota has released a revised budget outlook. Like many states, the economy and a rainy day fund had Minnesota riding high fiscally. The February budget estimate is traditionally the one on which the legislature bases its budget debate. Now that the pandemic is eating away at fiscal strength, the picture is much different. The February estimate included a projected revenue surplus in February, 2020 of $1.5 billion. The revised Projected revenue deficit in May 2020 is $2.42 billion. The $3.9 billion reversal is covered in part by $2 billion the state has received from the federal CARES Act and a rainy day fund balance of $2.36 billion. As no one expects the economy to “snap back” to pre-pandemic levels, the damage has not stopped but available are all spoken for.  Minnesota can dip into the rainy day account once there is an official projection of a deficit to pay for the existing budget and be done without further action by the Legislature.

Ohio is in the middle of its biennial budget process. It has a “rainy day” reserve of some $2.7 billion but the state is so far relying on expenditure cuts.  The state had previously reported revenue estimates were up by $200 million over budgeted projections, but state fiscal results through April now project a $777 million deficit. To cover the deficit, the Governor has opted for $700 million of budget cuts instead. The State reported that in April collections showed a $636 million decline in state income taxes and a $237 million decline in sales taxes. Tax revenue overall declined by $867 million. The cuts will impact primary spending priorities. Medicaid spending is budgeted to decline by $210 million. Kindergarten through 12th grade foundation payments will be cut by $300 million and higher education by $110 million and trim $100 million in other general state agency spending. 

Alaska had already been dealing with the declining reliability of oil as the state’s main source of income. Battles over the Permanent Fund dividend had led to contentious budget processes over several years. Those pressures however, pale in comparison to what the state of Alaska faces now. ConocoPhillips, the third-largest U.S. oil producer, announced it would its production in Alaska by half, roughly 100,000 barrels a day, beginning in June. The decline in throughput accompanies similar moves to maintain temporary production cuts demanded by Alyeska Pipeline Service Co. (owned by ConocoPhillips, BP and Exxon Mobil) for May due to projections of oversupply and lack of tanker transport. Alyeska carries crude from the North Slope to the Valdez Marine Terminal.

The California Department of Finance reports that California began 2020 with a strong bill of financial health—a strong economy, historic reserves, and a structurally balanced budget.  The unemployment rate (3.9%) was one-third of its Great Recession peak (12.3%).  The “Wall of Debt” (past budgetary borrowing) was eliminated, and supplemental payments were made to retirement obligations.  The 2020-21 Governor’s budget reflected a $5.6 billion surplus.  The budget reflected a record level of reserves: $21 billion in FY 2020-21, including $18 billion projected in the state’s Rainy Day Fund.  Revenues through March ran $1.35 billion above January’s projections, as markets outperformed the budget forecast.

Now for the May Revision. In the last one-week reporting period, nearly 478,000 claims were filed in California for state and federal unemployment benefits. Since mid March, more than 4.2 million claims have been filed. Finance projects that the 2020 unemployment rate will be 18%, a much higher rate than during the Great Recession. California personal income is projected to fall by nearly 9% on an annual basis in 2020.

Compared to the January forecast, the state’s three main General Fund revenue sources are projected to drop for the 2020-21 fiscal year as follows:  Personal Income Tax: -25.5 %.  Sales and Use Tax: -27.2 %.  Corporation Tax: -22.7 %. Specifically, Finance projects that General Fund revenues will decline by $41.2 billion below January projections, as follows:  2018-19: +$0.7 billion  2019-20: -$9.7 billion  2020-21: -$32.2 billion. Under Proposition 98’s constitutional calculation, this revenue decline results in a lower required funding level by $18.3 billion General Fund for K-12 schools and community colleges.

The Revenue declines of ($41.2 billion), combined with $7.1 billion in caseload increases supporting health and human services programs, and other expenditures of approximately $6 billion (the majority in response to COVID) will result in an overall budget deficit of approximately $54.3 billion, of which $13.4 billion occurs in the current year and $40.9 billion is in the budget year.  This overall deficit is equal to nearly 37 % of General Fund spending authorized in the 2019 Budget Act.  This is also nearly three and one half times the revised balance in the Rainy Day Fund ($16 billion).

JEA BACK IN THE SPOTLIGHT

The Jacksonville Electric Authority has asked its former CEO, Paul McElroy who retired in April of 2018, to serve as an interim CEO of the troubled utility for six months while a permanent CEO is hired. The outgoing CEO is part of the group under federal investigation over the recent failed attempt to privatize the utility.

The process of investigating exactly what happened at JEA and in the city that allowed the privatization plan to advance as far as it did is ongoing. It includes the Mayor’s office as well. It raises serious concern surrounding the governance of the utility both directly and through oversight by the city. The credit would be expected to suffer a ratings impact if the agencies are serious about their emerging emphasis on environmental, social, and governance issues (ESG).

It has also been pointed out that the new interim CEO approved the contract with the Municipal Electric Authority of Georgia (MEAG) for power from the Votgle nuclear plant. The Authority is now in litigation to void the purchases required under the contract. That contract was among issues contributing to lower ratings for the City’s debt. The contract litigation will effectively cap ratings where they are unless a settlement can be achieved.

CHICAGO PENSIONS

The debate over the next stimulus bill from Congress will center on aid to states and localities. In that debate, Illinois’ name keeps coming up along with pensions. So, however unhelpful that debate is to addressing the incredible burden being shouldered by states and municipalities, it does bring a spotlight back onto pension problems in the state.

The Illinois state legislature’s non-partisan Commission on Government Forecasting and Accountability has released its latest analysis of the state of the pension funds supporting workers from the major public agencies serving Chicago. The Chicago Transit Authority Retirement Fund covers all employees of the Chicago Transit Authority. At the end of FY 2018 (January 1, 2019) there were 8,159 active employees and 8,020 employee annuitants. Total Actuarial Assets of the system at the end of that year were $1.836 billion and Total Actuarial Liabilities were $3.489 billion. That is essentially a one to one ratio of active workers to retirees which is not sustainable. The funding ratio – 53%. The Cook County Employees’ Pension Fund covers all persons employed and paid by the County. At the end of 2018 there were 19,671 active employees and 15,820 employee annuitants. Total Actuarial Assets of the system at the end of that year were $10.513 billion and Total Actuarial Liabilities were $17.304 billion. The worker/retiree ratio is just north of one to one. Funding ratio – 61%.

The Firemen’s Annuity and Benefit Fund of Chicago covers anyone employed by the City of Chicago in its fire services whose duty it is to in any way participate in the work of controlling and extinguishing fires. At the end of 2018 there were 4,487 active employees and 3,422 employee annuitants. Total Actuarial Assets of the system at the end of that year were $1.130 billion and Total Actuarial Liabilities were $6.156 billion. That is a 1.3 to 1 worker/retiree ration. Funding ration – 18%. The Policemen’s Annuity and Benefit Fund of Chicago covers any employee in the Police Department of the City of Chicago sworn and designated by law as a police officer. At the end of 2018 there were 13,438 active employees and 9,930 employee annuitants. Total Actuarial Assets of the system at the end of that year were $3.145 billion and Total Actuarial Liabilities were $13.215 billion. Funding ratio – 24%.

On an overall basis, the eight funds reviewed produced a combined unfunded liability of $44 billion. The funding ratio for the combined funds is a paltry 35.2%. That calls for significant transfers of current revenues into pension funding but that is not going to happen in the current environment. We have doubts about whether voters will approve the amendment to the state constitution allowing for a graduated income tax versus the current flat rate. That is a key component of the plan of the governor for fiscal and pension reform that is currently holding the state’s ratings where they are.

PENSION REFORM IN TEXAS

In 2017, Dallas, TX faced a looming crisis in its police and fire pension funds. Pensioners had historically had the ability to make lump sum withdrawals under the terms of the DROP provisions included in their pension plans. Deferred retirement option plans (DROPs) allow employees to continue to work past their eligible retirement age and in exchange, an employer will set aside annual lump sum payments into an interest-bearing account. Upon retirement, the money that has grown in this account will be paid to you, on top of the rest of your accrued earnings. 

Many large lump-sum withdrawals by participants in the Dallas pension funds from their DROP accounts followed investment losses in real estate and other alternative asset classes in 2014 and 2015. This forced the city to contemplate significant increases in expenditures for payments into the funds in order to keep them solvent. In an effort to reduce the amounts needed from current revenues, the City did not allow lump sum withdrawals beginning in 2017. Unsurprisingly, the police and fire unions sued the city.

The Dallas Police & Fire Pension System’s (DPFP) are one of the city’s two pension systems. They  account for some two-thirds of Dallas’ adjusted net pension liability (ANPL). As of its fiscal 2019  reporting and based on a 4.22% discount rate, Dallas’ ANPL was $6.2 billion. Its reported net pension liability, based on a weighted-average 6.73% discount rate, was $3.8 billion. In fiscal 2019, pension contributions consumed around 12% of the city’s operating revenue. That was not a tenable situation going forward and the ability to limit the lump sum withdrawals was a key component of the City’s effort to manage its pension liabilities.

Under current conditions, it would be expected that another “run” on the fund could be imminent. Coming at a time of exceptional market volatility and economic distress, the City would have been hard put to maintain the solvency of the system in the face of significant withdrawals. In an environment where the pandemic is driving expenses while at the same time revenues are crashing, the City’s credit would come under immediate pressure.

Now that pressure is off with the decision of the Fifth US Circuit Court of Appeals which affirmed the City’s right to halt the lump sum withdrawals in 2017. It ruled that the removal of participants’ lump-sum withdrawal options in 2017 was permissible, eliminating a potential liquidity risk for the system and ultimately the city’s budget. Significant withdrawals would pose a threat to the DPFP’s solvency and exacerbate the pressure on the city’s finances, in part because the system struggles to unwind its heavy asset allocation to real assets and other alternatives.

Before the current environment took hold, the system’s net cash flows were close to zero in 2017, 2018 and 2019. This reflected the halt to DROP withdrawals. This allowed the system to stabilize, relieved pressure on the City’s fiscal position, and helped to stabilize its credit ratings. The court decision is definitely credit positive for the City.

CULTURAL INSTITUTIONS CUT BACK

The American Museum of Natural History cut its full-time staff by about 200 people, amounting to dozens of layoffs, and put about 250 other full-time employees on indefinite furlough. The museum projects a budget deficit of between $80 million and $120 million for the remainder of this fiscal year, which ends on June 30, and the next fiscal year. The Whitney Museum of American Art  laid off 76 of its 420 workers. The Metropolitan Museum of Art, facing a potential shortfall for the next fiscal year that might swell to $150 million, announced last month that it was laying off more than 80 people. And the Solomon R. Guggenheim Museum has said it would furlough more than 90 staff members.

What is interesting is the fact that these institutions are by and large not tapping into their endowment funds to cover keeping employees on the payroll. Given the potential for a significant negative impact on donations, this is probably a rational response to that phenomenon. Some of the institutions are being criticized for taking this approach. While these institutions may be not for profit, they are still businesses. It is prudent to take these steps in the interest of long term solvency given the current economic realities.

CYBERSECURITY

President Donald Trump signed an executive order titled Securing the United States Bulk-Power System. The executive order calls for the development of procurement policies that prioritize the security of the US energy grid, as opposed to current rules that give preference to the lowest-cost bids. The Secretary of Energy is empowered through the order to determine if equipment is insecure or harmful to national security, and with blocking its use in US power plants and their transmission systems. The idea is to incentivize manufacturers to invest in developing and maintaining strong cyber security practices or risk exclusion from the US market.

The order is intended in part to address the widespread presence of critical infrastructure components, including software applications and telecommunications equipment, from equipment manufacturers in China and Russia. These countries are known for active cyber espionage and tampering with the physical operations of utility facilities. Wide variance in cyber security practices between suppliers  exposes utility operations and networks to indirect threats that utilities cannot accurately monitor or prevent. The reliance on foreign made equipment and software has been a concern for officials responsible for cyber security. The order does not detail specific products or countries of origin. It instead charges the Secretary of Energy to determine which particular individuals, companies and countries are “foreign adversaries exclusively for the purposes of this order.”

WHERE THE JOBS ARE BEING LOST

The highlight number of the week was the April unemployment number. The 14.7% rate and the number of unemployed at 22 million are already records for the post-war era. Since the numbers are based on a mid-month survey, we know based on the unemployment claims data that this greatly understates the real situation. The May data is likely bring those numbers up to 20% and 35 million unemployed.

There is new data out on the unemployment situation which reveals that unemployment is primarily concentrated in two sectors – construction and the leisure/hospitality space. The data shows that of the 701,000 nonfarm jobs lost in the United States in March, nearly 60 percent came from food services and drinking places, according to the Bureau of Labor Statistics. The potential long term impact on employment is huge. Recently, we have seen estimates that 40 to 50% of bars and restaurants may not reopen. And those are businesses which were thriving in late 2019.

The potential impact of this would be subject to a multiplier effect as these industries traditionally  have been a great source of jobs for those with no college background or as a first job. These would be the individuals less well positioned to compete for the jobs which do return after the pandemic.  They have less ability to wait out the pandemic and therefore are more likely to turn to government social service programs more quickly. These businesses, many of which are individually owned , are finding that complying with all of the regulations attached to the PPP could actually make participation less practical

A recent NY Times article highlighted one of the weaknesses of the Payroll Protection Program in that the loans are only forgiven if they keep paying workers.  Problems with business interruption insurance are making it harder for businesses to hold on.  The fact that restaurants are consistently found in polling to be the last businesses that people would feel comfortable returning to, the outlook for this sector and the sales tax backed debt which it supports is dire.

Opportunity Insights, a non-profit organization at Harvard University has produced data on the change in consumer spending in different locations in the country. It uses data from credit card processors, payroll firms, job posting aggregators, and financial services firms to develop its estimates. The map below reflects more current real time data as opposed to much of the Federal data which by its nature tends to be time lagged. One example of the phenomenon is the Employment Situation Summary (i.e., jobs report) released by the Bureau of Labor Statistics on May 8. It presents information on employment rates as of the week ending April 12. The OI data is as recent as three days before.

That is an important distinction as the OI numbers allow us to take a look at reopened states. That data shows that recent policies ending shut-downs in certain states such as Georgia and South Carolina have not been associated with significant increases in economic activity. These findings suggest that the primary barrier to economic activity is the threat of COVID-19 itself as opposed to legislated economic shutdowns. In Georgia, consumer spending, employment and hours at small businesses, the number of small businesses that are open, and time spent at work all remain relatively similar to their levels prior to April 24.

 
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