Joseph Krist

Publisher

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Call it what you want but we face depression level employment conditions. The most recent claims number brings unemployment to 23% without accounting for non-participants in the work force. While we realize that precipitous moves in ratings are most likely not in  the cards, that does not mean that the market can’t establish it view of creditworthiness. In the meantime, the debate over the next stimulus package will center around aid to states and municipalities. The argument for stimulus is bolstered by the Fed chairman’s most recently expressed views supporting additional stimulus.

Without it, states and cities will have to take steps to deal with their declining fiscal positions which will have direct economic implications. The traditionally busy summer construction season will look completely different this year. Major capital projects like road repairs are already being slowed, suspended, or reimagined to use different materials and work crews. The contract letting process is on hold in number of states and the economic impact of those decisions has yet to fully take hold.

On the county and local level, those governments cannot wait to decide whether to make cuts. While advertised as temporary, many of these entities have furloughed employees. Many of these cuts are in basic services which support economic activities through functions like business licensing, real estate transactions, inspections, and permitting. These changes will act as a further drag on local economies.

The next obvious concern is the impact on the economies of primarily small businesses for their survival. The multiplier effect stemming from these delays, cancellations, and changes is yet to be felt. That may also be said about the impact of potential delays in the re-openings of institutions like colleges. While the impact of closures and shifts to online learning are clearer, the economies of many localities depend on the presence of colleges to generate demand for all sorts of goods and services. Many of these local economies have long felt essentially immune from the changes in the larger economy.

The reality is that while the present economic realities are daunting, the worst may be yet to come. Empty campuses do not generate pizza deliveries. The potentially longer lasting effects of the downturn will pressure state unemployment trust funds and likely generate borrowing which must be supported by fees from employers. This will serve as an additional drag on the recovery of the economy as well as state fiscal positions.

Given the increasingly negative economic outlook, we would expect to see a series of state downgrades over the summer. States are in the middle of their budget processes and we expect that the rating agencies will wait for the legislative session season to play out before making any moves. Like so many other times of economic challenge, this period has reinforced the role of the rating agencies as lagging indicators of creditworthiness. We discuss the revisions in the fiscal outlook for several states this week. We  ask how these states can be considered worthy of the same ratings they had just eight weeks ago?

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PANDEMIC CASUALTIES – STUDENT FACILITIES REVENUE BONDS

The California State University, the nation’s largest four-year public university system, announced that classes at its 23 campuses would be canceled for the fall semester, with instruction taking place almost exclusively online. More than 480,000 undergraduates are enrolled at the Cal States and they have been taking their classes online since March.

To date, only several smaller institutions have announced similar decisions.  Many schools, public and private, are weighing various courses of action for the fall semester. The decision to open or close has implications for the outstanding debt of these institutions. For bonds secured by student dining and housing revenues to finance those facilities, the plan to stay online has potentially significant implications for the bonds. In the same way, bonds for non-academic facilities backed by student fees also will face financial pressure.

The public institutions are the primary issuers of debt backed by “auxiliary service” revenues. California State is a good example as it issues debt secured by revenue including gross revenue from various auxiliary and mandatory student fees. Total pledged revenue was $5.33 billion for fiscal 2019, including $3.35 billion of Tuition Fees (the basic enrollment charge paid by all CSU students). There is a sum-sufficient rate covenant and no debt service reserve fund.

The university issued system revenue debt in February with a Aa2 rating. The rationale for the rating was “continued excellent demand for The CSU, accompanied by consistently solid cash flow and debt service coverage.” The State of California continues to provide healthy increases in state funding, including capital support. Now, the source of outside support (the State) is under incredible short term stress, 40% of historic revenues are at risk, and demand for the system is under pressure as students attempt to assign a real valuation to the on-campus experience. The rating assigned in January carried a stable outlook but assumed cash flows and demand which may not be realized.

Given the pressures on the revenue sources (the state, economically weaker students, and potentially closed facilities) it’s hard to see how the credit behind the debt could be considered stable.

PANDEMIC CASUALTIES – PORT REVENUES

The National Retail Federation tracks import/export data for its members and produces, among other things, reports on things like port activity. Twenty foot equivalent units (TEU) provide the base metric and input for any analysis of operations and trends. A recent report from NRF documents the actual and potential impact on port operations as the result of the pandemic.

Imports at major U.S. retail container ports are expected to see double-digit year-over-year declines this spring and summer. April was estimated at 1.51 million TEU, down 13.4% year-over-year. May is forecast at 1.47 million TEU, down 20.4% from last year; June at 1.46 million TEU, down 18.6; July at 1.58 million TEU, down 19.3%; August at 1.73 million TEU, down 12%, and September at 1.7 million TEU, down 9.3%.

Before the coronavirus began to have an effect on imports, February through May had been forecast at a total of 6.9 million TEU but is now expected to total 5.87 million TEU, a drop of 14.9%. The first half of 2020 is forecast to total 9.15 million TEU, down 13% from the same period last year. So the current impact of the declines is significant but not unmanageable. At the same time, the importance of getting reopening the country right is highlighted in the report.

The Port of Los Angeles the port handled 689,000 TEUs in April. That’s a 6.5% year-over-year decrease  but better than the March results which showed the port handled 449,568 TEUs in March, a year-over-year volume plunge of 30.9%. According to the Port, “based on the first quarter of this year, the volume at the Port of Los Angeles was down 18.5%, and now if we add in the April stats we’re down about 15.5. On any given day looking at the traffic moving through the Port of Los Angeles we’re doing about 80% of normal volume for this time of year.”

The NRF projections rely on no emergence of a “second wave” of the virus. The report comes with the caveat that “we continue to expect recovery to come in the second half of the year, especially the fourth quarter and into 2021. This is based on the big and somewhat tenuous assumption that there is no second wave of the virus.”

PANDEMIC CASUALTIES – SMART DEVELOPMENT

The Smart Cities movement took a hit recently with the announcement by Google’s parent – Alphabet – that it was no longer going to pursue its experiment in smart cities development under way in Toronto, Canada. Originally dubbed “Sidewalk Toronto” in October 2017, the project was designed to oversee technology based development in a 12 acre area along the Toronto waterfront. The plan called for new housing and smart city technologies including sensor-based traffic signals, dynamic curbs, underground delivery routes for trucks, self-financing light rail transit, heated pavement and pneumatic waste collection.

Quayside is the name of the 12-acre waterfront district on Lake Ontario that was scheduled to be redeveloped by Sidewalk Labs and government-appointed nonprofit Waterfront Toronto. The project was outlined in June 2019 by Sidewalk Labs,  the Alphabet entity created for projects like this. Sidewalk Labs unveiled a three-volume, 1,524-page master plan for the site which estimated the cost at $2.8 billion.  It also helped the public understand some of the issues associated with the anticipated technologies to be used.

The public reaction to the project was mixed. While the effort to produce a fairly walkable, self-contained community was seen as a positive, the reliance on technology based monitoring raised concerns.  Those concerns centered around data privacy and the collection of information from citizens, which are an essential feature of many promised smart-city features.

So here we have one technology company advancing a project which raises data concerns amongst the public while in California we have technology/transportation companies fighting efforts by governments to access data to monitor and manage micromobility providers within their jurisdictions. It places the technology industry writ large on both sides of the privacy/technology debate.

So why care if you are a municipal bond investor? The pandemic is leading proponents of various strategies and technologies to try their best to use the temporary changes in urban living and transportation to advance their agendas. Most of those strategies will involve substantial capital investment on the part of host municipalities. The sort of investment to be required to produce development along the lines of the Toronto project would be substantial and the private sector has not shown the appetite to finance or fund it on its own.

Whenever those conditions arise, the municipal market is looked to as a source of affordable financing. So, municipal investors need to support sound decision making on the part of municipalities so as not to squander resources on a level of risk which really should not be borne by taxpayers and bondholders. It is an important thought to hold as companies like Uber, Lyft, and Airbnb all announced substantial employment cuts. With future funding in some doubt, the transportation networking companies are in a weaker bargaining position going forward as they engage governments while they try to expand. The decision by Uber to dump its Jump e bike subsidiary onto Lime reflects the instability in the mobility space.

 As the executive director of the San Francisco Municipal Transportation Agency (SFMTA) recently pointed out “At a time when all of these private companies should be demonstrating their value, they’re actually fighting for their own financial lives and therefore prioritizing the convenience of the privileged over the needs of cities and their most vulnerable travelers. The private mobility space has got a lot of work to do, to rebuild relationships with cities, and get people to see them as actually a part of a solution, rather than just a mechanism for some potential profit in the future.”All of that is positive for governments and their finances.

PANDEMIC CASUALTIES – HOSPITALS

Strata Decision Technology is an advisory firm in the hospital sector with access to operating information on some 1,000 U.S. hospitals. They have released research on the impact of the pandemic on hospital operations and finances. They found that across all service lines and in every region of the country there was an average decrease in the number of unique patients who sought care in a hospital setting of 54.5%. Clinical service lines that saw the sharp drops in patient encounters included those with life-threatening illnesses such as a 57% decrease in cardiology, and a 55% decrease in breast health with a 37% decline in cancer care overall.

The restrictions on elective surgeries can be seen in the data. The top 10 procedures account for over 50% of the total payments made to hospitals. In this category there were significant declines in the number of hip (-79%) and knee (-99%) replacement surgeries as well as in spinal fusions (-81%) and repair of fractures (-38%). Coronary stents (-44%) and diagnostic catherization (-65%) also saw significant declines. If you’ve had any of those done lately, the potential revenue hit to hospitals is obvious. Access to clinical care for patients with life-threatening conditions declined significantly including congestive heart failure (-55%), heart attacks (-57%) and stroke (-56%).

Those procedures are effectively where the money is for hospitals. Health systems in the study cohort (2 million patient visits and procedures from 51 healthcare delivery systems in 40 states, with varying rates of COVID-19 cases in their 228 hospitals) lost an estimated $1.35 billion in revenue during the 2-week study period compared to the prior year.  Extrapolating the drop in volume from the cohort to a national view would be the equivalent revenue loss of $60.1 billion per month for hospitals nationwide.

According to the study, the number of uninsured or self-pay patients has increased dramatically in the last 90 days, mirroring the rise in the national unemployment rate. In January, 7% of all inpatient and outpatient encounters in the study cohort were with patients who lacked health insurance. By April that figure had risen to 11%, and early results from May indicate 15% of all patients in the cohort are now uninsured, an increase of 114% in just 90 days. 

FEDERAL PANDEMIC ASSISTANCE TO NYC

The New York City Independent Budget Office (IBO) estimates that $5.3 billion in aid from the federal government’s four coronavirus relief packages will flow to the city budget. That does not include federal aid granted to public agencies that provide essential city services but are outside the city budget. That additional aid include $3.8 billion for the Metropolitan Transportation Authority (MTA), at least $818.6 million for NYC Health + Hospitals (H+H, the city’s public hospital system), and $211.9 million for the city’s public housing authority.

The majority of the $5.3 billion in aid that the city is estimated to receive must be used to cover direct costs incurred by the city due to the Covid-19 pandemic or to fund programs that provide aid to city residents impacted by the resulting downturn, such as increased funding for existing food and rental assistance programs. The more than $700 million in federal education aid included in this total will replace state school aid cut by the Governor in the state’s recently enacted budget. The largest impact on the city budget comes from changes to Medicaid funding. The Families First Coronavirus Act increased the share of Medicaid paid by the federal government by 6.2 percentage points (called the enhanced Federal Medical Assistance Percentage, or eFMAP.) In New York the federal, state, and city governments share Medicaid costs, so if the state allows the savings from the eFMAP to flow through to localities across the state there would be savings for the city.

STATES TRY TO COPE

A survey conducted by the Louisiana Oil & Gas Association found that members have been forced to reduce 23% of their Louisiana workforce. This reflects the fact that 77.5% of operators have already begun taking steps to shut-in production. and 51.35% said bankruptcy is likely. 34% applied for Economic Injury Disaster Loans (EIDL) funds, of those only 25% received the funds they expected. Of those who received funds, 46.6% indicted they were not enough to help them stay in business and 72% indicated they were not enough to avoid layoffs. It is not just the number of jobs lost but the fact that jobs in the oil and gas industry are among the state’s best paying. The impact on income tax revenues and sales tax revenues will be substantial.

Georgia has requested that all state departments and agencies submit revised budget plans for fiscal 2021, which ends 30 June 2021, that include a 14% cut from the original fiscal 2020 base of about $27.5 billion. That is positive for the state’s financial position. The across the board nature of the proposed cuts does however, lessen the amounts available for local aid including school districts. Moody’s estimates that the State Department of Education may see its funding cut by $1.5 billion. That would require districts to cut programs or raise taxes. April was the first month to include the full effect of the coronavirus-induced downturn, with Georgia’s revenue falling 35.9% year on year, reducing year-to-date revenue 3.4% versus 2019.

Texas reported $2.58 billion in state sales tax revenue in April — an approximate 8% drop from what the state collected the same month last year. That drop, from $2.8 billion to $2.58 billion, marked the steepest decline since January 2010 and covered sales made in March. Florida’s sales taxes provide for 78 % of the State’s general revenue programs. A May 1 daily revenue report showed that sales and use taxes, plus a few other unrelated revenues, collected during April were about $773 million below the state’s $3.1 billion sales tax estimate.

Other general impacts on projected budget results include Connecticut where the state’s Consensus Revenue Estimates revised general fund revenues and special transportation revenues downward for the current fiscal year, FY 2020 and next three ensuring fiscal years from January estimates. .General fund revenues are now estimated to drop $942.1, or 4.8%. The special transportation fund is expected to decline by $164.4 million, or a 9.5% reduction from January.

In Illinois the current fiscal year general fund revenues were revised to $2.7 billion below February estimates of $36.9 billion by the Governor’s Office of Management and Budget (GOMB). GOMB reports that the revenue shortfall and additional FY 2020 borrowing has created a budgetary gap when compared to the Governor’s original spending plan in February. 

Maryland Comptroller Peter Framchot and the Bureau of Revenue Estimates outlined a shortfall of approximately $2.8 billion during the final quarter of FY 2020. The impact represents a loss of nearly 15% to the state’s general fund.  Maryland’s withholding tax revenues declined by 22% or an average monthly impact of $185 million in losses. The economic shutdown could also result in a loss of 59% of all sales tax revenue in a month, or almost $250 million. 

Pennsylvania’s Independent Fiscal Office (IFO), reported that April revenue collections were down by $2.16 billion, or 49.8% less than projections released in August 2019. Sales and use tax collections fell short of estimates by $357.3, or 35.9%. Personal income tax revenues were below estimates by $1.48 billion and $105 million is estimated to be permanently lost due to reduced economic activity. 

TRANSPORTATION MEASURES THE IMPACT

A University of California-Davis study issued on April 30 found that total vehicle miles traveled or VMT in California is down statewide between 61% and 90% as a result of various stay-at-home orders issued by Governor Gavin Newsom. It estimates that COVID-19-related reduction in travel is slicing an estimated $46 million per week from fuel tax funds for California transportation projects. In Illinois, road travel is down as much as 46% across the state. The Maine Department of Transportation is expecting a roughly $74 million loss in transportation revenue due to COVID-19 over the spring and summer months.

The Minnesota Department of Transportation (MnDOT)  estimates it will take in $440 million less than anticipated over this year and next. MnDOT predicts income from the gas tax will plummet by about 30% compared with what was anticipated for the rest of this fiscal year, which runs through June 30. During the 2021 fiscal year, which starts July 1, the agency said it might drop by 15%.

WHILE YOU WERE SHELTERING IN PLACE…

The Maryland Purple Line, a controversial light rail project, had been the subject of litigation for some time. The litigation – which ultimately did not succeed in stopping the project – only slowed it. The first lawsuit delayed construction by almost a year before a federal appeals court rejected it in 2017. A federal judge dismissed a second lawsuit last year. The slowdown did impact construction and generated costs, however.

Those extra costs are the subject of an ongoing dispute between the state and the contractors on the project. The contractor said May 1 that it would quit in 60 to 90 days because of years-long disagreements with the state over who should pay for cost overruns related to construction delays. Now a third lawsuit is moving through the federal courts alleging that the U.S. Army Corps of Engineers had violated the Clean Water Act by allowing construction crews to discharge dredge and fill into streams.

That suit was dismissed by a U.S. District judge in April. Now, the plaintiffs have decided to appeal the decision to the U.S. Court of Appeals for the 4th Circuit in Richmond. Briefs are scheduled to be filed by lawyers on both sides this summer. The appeal could result in further delays and it will complicate the dispute between the contractor and the state.  

PRESSURE ON UTILITIES

The US Energy Information Administration (EIA) released its latest monthly Short-Term Energy Outlook (STEO) and it validates a number of points we have made in our comments on the sector over time. The outlook says that the effects of social distancing guidelines are likely to continue affecting U.S. electricity consumption during the next few months. EIA expects retail sales of electricity in the commercial sector will fall by 6.5% in 2020 because many businesses have closed and many people are working from home. Similarly, EIA expects industrial retail sales of electricity will fall by 6.5% in 2020 as many factories cut back production. Forecast U.S. sales of electricity to the residential sector fall by 1.3% in 2020 because of lower electricity demand as a result of milder winter and summer weather, which is offset slightly by increased household electricity consumption as much of the population spends relatively more time at home.

Here’s what really caught our eye. EIA forecasts that total U.S. electric power sector generation will decline by 5% in 2020. Most of the expected decline in electricity supply is reflected in lower fossil fuel generation, especially at coal-fired power plants. EIA expects that coal generation will fall by 25% in 2020. EIA forecasts U.S. average coal consumption will decrease by 23% to 453 Million short tons (MMst) in 2020. The decrease is primarily driven by a 24% decline in electric power sector consumption and persistently low natural gas prices. EIA expects renewable energy to be the fastest-growing source of electricity generation in 2020, the effects the economic slowdown related to COVID19 are likely to affect new generating capacity builds during the next few months. EIA expects the electric power sector will add 20.4 gigawatts of new wind capacity and 12.7 gigawatts of utility-scale solar capacity in 2020.

Even the pandemic disaster has not been enough to deter the market forces driving the decline of coal. We expect that municipal utilities will have to become bigger players in the renewable energy space as developers of  renewable generating resources directly and not just as ultimate distributors. They will have to remain nimble as local economies absorb and adapt to changes in job locations, commutes, and work habits which are likely to result from the pandemic.

ONE LESS FOR THE ROAD?

The same energy report projected fuel consumption and those numbers do not look good for transportation infrastructure funding. EIA expects U.S. total liquid fuels consumption will rise from an average of 15.9 million b/d in the second quarter of 2020 to 18.7 million b/d in the third quarter of 2020 and then to average 19.8 million b/d in 2021, up 8% from 2020, but lower than 2019 levels. EIA forecasts jet fuel consumption to decline by 25% year-over-year for all of 2020 and by more than 50% year-over-year in the second quarter. Gasoline and distillate fuel consumption will both see consumption fall about 10% compared with 2019 levels.

This directly impacts gas tax revenues obviously. Where it multiplies is in what it implies about the impact of changes in travel especially commuting. The impending shift to more telecommuting for work we believe is real. The implications for the impact on mobility choices and demands are real and potentially substantial. It will require creative approaches to road funding and the support for the capital it relies on.

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