Joseph Krist

Publisher

________________________________________________________________

The quick reversal of trend in terms of municipal credit is impressive. The much more optimistic outlook for the economy through year end is already showing up in rating activity. Negative outlooks are being revised to stable and upgrades are clearly shoring up the municipal market.

If travel picks up as many expect, there will be a clear impact on airport and airport related credits. The economic activity generated by travel and tourism is already relieving pressure on credits supported by revenues derived from hotel taxes and sales taxes. Multiple states have seen upgrades to outlooks. Connecticut was the most prominent example. After several years as one of the more troubled state credits, the Nutmeg State has seen its ratings upgraded by all four rating agencies. Louisiana, a state whose major industries are under pressure, has been assigned a positive outlook.  

At the same time, we are a bit more restrained in our outlook for state credits. One concern has been the application of what are arguably one-time revenues to fund significant rounds of new spending. NYC is doing it. California’s Governor has proposed a budget which allocates $25 billion to one-time or temporary spending, including nearly $15 billion for capital outlay; $7 billion to revenue-related reductions; $3.4 billion to the Special Fund for Economic Uncertainties (SFEU) balance; and nearly $2 billion to ongoing spending increases, although these costs would grow substantially over time.

Other sectors which stood to benefit from the improving outlook for the pandemic include some hospitals, higher education institutions, cultural and entertainment facilities. As these facilities reopen and demand reestablished, we would expect the perception of these credits to improve fairly dramatically. ports are another sector seeing immediate benefits. After a year of reduced activity, ports are now dealing with capacity issues which are expected to last through the summer.

__________________________________________________________________

CALIFORNIA BUDGET REVIEW

The Legislative Analyst Office (LAO) in California has reviewed the Governor’s May Revision to his fiscal 2022 budget proposal. Much has been made of the huge surplus the state has accumulated through a combination of better than expected revenues and a federal stimulus windfall. The LAO starts off with a disagreement over the actual size of the surplus truly available for new spending.

LAO estimates the state has $38 billion in discretionary state funds to allocate in the 2021‑22 budget process, an estimate that is different than the Governor’s figure—$76 billion. The differences in estimates stem from differing definitions. The Governor counts $27 billion in constitutionally required spending on schools and community colleges, nearly $8 billion in required reserve deposits, and $3 billion in required debt payments in his calculation of the surplus. After excluding these amounts, the two surplus estimates are nearly the same.

The Governor’s estimate includes constitutionally required spending on schools and community colleges, reserves, and debt payments which must be allocated to specified purposes. The constitution requires the state to spend minimum annual amounts on schools and community colleges (under Proposition 98) and budget reserves and debt payments (under Proposition 2). Mainly as a result of higher revenues, relative to January, constitutionally required spending is higher by nearly $16 billion across the budget window.

The May Revision includes roughly 400 new proposals costing $23 billion in new spending. That leaves $16 billion of surplus for other purposes. The revision sends some definitely mixed messages..Under the administration’s estimates and proposals, total reserves would reach $19.8 billion in 2021‑22. Yet some of the new spending uses $12 billion in reserve withdrawals and borrowing to increase spending. Overall, the State’s reserves are pegged to be lower by nearly one-half.

Schools and community colleges would receive the largest spending allocations. The major components of the next largest  category are $5.5 billion for broadband, $1.1 billion to replenish the state Unemployment Insurance Trust Fund, and $305 million for the Employment Development Department to more quickly address workload. Those are three major areas where the pandemic directly impacted life across the board.

The State Appropriations Limit (SAL) limits how the state can use revenues that exceed a specified threshold ($16 billion for FY 2022). Each year, the state compares the appropriations limit to appropriations subject to the limit. If appropriations subject to the limit exceed the limit (on net) over any two-year period, there are excess revenues. The Legislature can use excess revenues in three ways: (1) appropriate more money for purposes excluded from the SAL (under the Governor’s proposal, the common new spending for this purpose is capital outlay), (2) split the excess between additional school and community college district spending and taxpayer rebates, or (3) lower tax revenues.

NYC OUTLOOK UPGRADE

New York City was the beneficiary of an improved outlook from Moody’s. The outlook was moved from negative to stable. The fortunes of the City were greatly enhanced by its designation for significant funding from the federal government. The move comes as the City Council begins its deliberations on the FY 2022 budget.

The Mayor’s Executive Budget plan is the current administration’s last opportunity to present an executive budget, and the last time their budgetary priorities and vision will shape an adopted budget. Those priorities are apparent as the City’s Independent Budget Office (IBO) estimates that about a third ($4.2 billion) of the federal stimulus funding added in the Executive Budget is proposed for baselined initiatives that will continue past current plan years, and the expiration of the stimulus funding.

The stimulus funds, including $5.9 billion of ARPA funding provided directly to the city for general purposes and $7.0 billion of ARPA and CRRSA funds allocated to the Department of Education, along with FEMA moving to full reimbursement of city Covid-related expenses, have filled a large portion of the revenue shortfall brought on by the pandemic.

OREGON FIRE FALLOUT

A lawsuit filed on behalf of 70 landowners in Oregon’s McKenzie River Valley seeks $103 million from two public utilities, Lane Electric Cooperative and Eugene Water & Electric Board, for damages arising from the Holiday Farm fire. The Labor Day fire destroyed 430 homes, killed one person and burned 173,393 acres. The lawsuit alleges that fires were started when tree branches contacted power lines.

The plaintiffs contend that the utilities had been warned about fire conditions but chose to maintain power throughout their systems. In addition to homes, fires such as these have significant impacts on businesses related to logging and lumber activities. The municipal utilities now join several investor owned utilities in Oregon as well as California as defendants in similar lawsuits.

WASHINGTON CLIMATE BILL RAINS ON SUPPORTERS

As the nation and the states move to cope with the realities of climate change, a number of conflicts have arisen between various interest groups. Those conflicts have played out in ways which increasingly are surprising. Issues like carbon pricing and vehicle mileage taxes have been considered. While this has not necessarily resulted in positive legislative action, the debate on the issues sheds light on the viability of many proposed actions and solutions. It also creates some dilemmas.

One of the best examples of the resulting inconsistencies is currently playing out in Washington State. The Legislature passed a broadly backed package to address climate change and the Governor has positioned himself as a national environmental champion. The issue was contentious and a variety of compromises were struck which overcame objections to individual provisions of the proposals (a low carbon fuel standard and a “cap-and-trade” policy). In return, legislators agreed to increase the gas tax by 5 cents. 

So when the legislation passed, the Governor’s signature was seen as a formality. Instead, the Governor vetoed the portion of the legislation raising the gas tax. The state Constitution allows for a governor to veto sections of a bill while signing the rest into law, but Inslee vetoed a specific provision. The Legislature has done this previously when the Governor in 2019 after he vetoed certain sentences in particular areas of the transportation budget. A County Superior Court judge invalidated those vetoes. The Legislature, including members of the Governor’s party, plan to sue on similar grounds again.

How is this all going to work? Under the new laws, fuel companies must start reducing their emissions a little each year in order to hit a statewide goal of emissions 20% below 2017 levels by 2038. Fuel companies can clean up their fuels by producing biofuels or mixed fuels. If they can’t, they would be required to purchase “credits” to make up for emissions that go above the allowed amount. The cap-and-trade plan puts a cap on carbon pollution and greenhouse gas emissions beginning in 2023. The largest polluters in the state would need to either clean up their work to meet the cap or purchase allowances from the state. The state would receive the revenue from those allowances.

ILLINOIS DEBT CHALLENGE FAILS

Billed as an issue of a concerned citizen contesting a bond issue rather than as a front for the effort to create a successful short trading strategy by a private equity investor, the latest challenge to the State of Illinois’ debt issuance powers has failed. The Illinois Supreme Court in a unanimous decision cited the issue of laches. This doctrine deals with how long a plaintiff can wait to take an action. In this case the Court directly referred to the fact that the ” petitioner waited to file his taxpayer action until 16 years had elapsed following enactment of the 2003 bond authorization statute and 2 years had elapsed following enactment of the 2017 bond authorization statute.”

The Court neatly found a way to stop the challenge without ruling directly on the issue of the validity of the debt – $10 billion of 2003 pension bonds and $6 billion of bill backlog borrowing in 2017. A decision of the issue of the validity of the debt would have to wait for another legal challenge.  The use of litigation by motivated political players to halt state borrowing efforts are a fairly regular occurrence as is their general failure to succeed in their efforts to stop or invalidate debt.

The opinion reflected the Court’s understanding of the implications of allowing the case to proceed. It specifically referenced the fat that “enjoining the state from meeting its obligation to make payments on general obligation bonds will, at the very least, have a detrimental effect on the State’s credit rating.” The Court effectively found that the long wait time before the original lawsuit was filed was done to make the State’s position more difficult.

We find this decision to be reinforcing of a general lack of willingness by the courts to invalidate debt. That long established pattern made us confident that the suit and others like it which are a fact of life will continue to be losing efforts.

ROCKY MOUNTAIN WAY

Colorado now relies largely on the 22-cent per gallon gas tax and 20.5-cent diesel rate to fund transportation work.  Newly created fees would be collected from electric vehicle registrations, fuel taxes, retail deliveries, passenger ride services, and short-term vehicle rentals. The fees would be phased in from fiscal year 2022-23 through fiscal year 2031-32 and then indexed to highway construction costs.

Raises in the gas tax would start at 2 cents per gallon and ultimately reach 8 cents per gallon. A fee applied solely to diesel sales initially would be 2 cents per gallon and later increase to 8 cents per gallon. Also included in the bill is a requirement for the $50 existing registration fee charged per electric vehicle to be adjusted annually for inflation. The tax increases are accompanied by transfers from the State’s general Fund.

$507 million in one-time funding would come from the state’s general fund for fiscal year 2021-22. The State Highway Fund would receive $355.2 million. Another $24 million would go to local governments. The remaining $127.8 million would be directed for multimodal uses. Currently, state law requires $50 million to be transferred annually from the General to the Highway Fund. That has been repealed in the face of the significant one time transfer.

MORE NUCLEAR DELAYS

MEAG, Oglethorpe Power, and the Jacksonville Electric Authority got more bad news about the operating schedule for the Plant Vogtle expansion. Georgia Power Co. said that delays in completing testing means the first new unit at its Vogtle plant is now unlikely to start generating electricity before January at the earliest. The additional month will add another $48 million to the cost of the two nuclear units.

The reactors, approved in 2012, were initially estimated to cost a total of $14 billion, with the first new reactor originally planned to start generation in 2016.  Now the plant’s costs are expected to come in at or above $26 billion. The second new reactor is supposed to start operating in November 2022. The company says it is still on schedule.

CLIMATE LITIGATION

By a 7-1 decision, the Supreme Court ruled that suit filed by the City of Baltimore in July 2018 against the major oil companies should be sent back to the U.S. Court of Appeals. The suit, and some 20 others like it from other jurisdictions, argues  that the companies’ “production, promotion and marketing of fossil fuel products, simultaneous concealment of the known hazards of those products, and their championing of anti-science campaigns” harmed the city.

The fossil fuel companies requested an expansive review of issues in the decision to send the case to state court; the city requested that the rules of appeal be interpreted narrowly, in a way that would have allowed the case to proceed in state courts. The court majority ruled that the appeals court should not be overly limited in its review of issues.

There some 20 similar lawsuits to the one filed by Baltimore. They by and large seek to have their claims adjudicated in state courts which are seen as friendlier to the arguments advanced by the cities. So the decision to send this case back to the federal courts for review is being seen as a “loss” for the City of Baltimore and the other cities suing.

But it is important to note that the decision was not about the merits of the cities’ cases. The decision reflected in part a unanimous 2011 Supreme Court ruling which said that, under federal law, the Clean Air Act displaced the common law of nuisance, giving jurisdiction to the Environmental Protection Agency. So the decision at least establishes the proper forum for these cases to be adjudicated in.

PRISONS AND RURAL ECONOMIES

Where I live in upstate NY, the role of prisons as drivers of employment and incomes for local residents could not be clearer. While the drive for criminal justice reform is driven mainly by urban constituencies, the economic impacts of reform of bail and imprisonment policies fall primarily on rural host communities.

It is a pattern which repeats itself across the country. In California, the impact of prison closings is generating concern about host localities and their economies. California’s prison system employs some 50,000 people and consumes about $16 billion in annual state spending. So when a prison is closed, the impact is quickly felt. Taft in Kern County, which had its federal prison close last year, lost 18% of its population in 2020, the highest population loss in the state that year.

Susanville and Tracy are two California communities scheduled to see prisons in their jurisdictions closed. The City of Susanville estimates that the closure of the California Correctional Center scheduled for June 2022 means Susanville could lose an estimated 25% of its employment base — jobs that can pay as much as $90,000. The prison helped to offset job losses from the decline of the regional lumber industry in the late 20th century.

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.