Joseph Krist

Publisher

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Memorial Day did not become an official Federal holiday until 1971. It sprang from the originally Southern tradition of decorating soldiers graves on the last Monday in May. It recognized service and most importantly sacrifice. While we remember the sacrifices of the past this Monday, it is worth comparing the sacrifice we commemorate to the sacrifices we are being asked to make today. Dying in combat or wearing a mask? Dying in combat or waiting a couple of more weeks to go to the bar? Yes these are difficult and in our lifetimes unprecedented times but they can be overcome with a little sacrifice. Enjoy Memorial Day just do it responsibly.

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MUNICIPAL BONDS IN THE IDEOLOGY CROSSFIRE

Jerome H. Powell, the Federal Reserve chair, testified before the Senate banking Committee and suggested that the central bank might expand its program to buy municipal debt and agreed that state and local governments could slow the economic recovery if they laid off workers amid budget crunches. “We have the evidence of the global financial crisis and the years afterward, where state and local government layoffs and lack of hiring did weigh on economic growth.” 

The Congressional Budget Office (CBO) released its economic outlook through 2021. CBO estimates that real (inflation-adjusted) gross domestic product (GDP) will contract by 11% in the second quarter of this year, which is equivalent to a decline of 38% at an annual rate. In the second quarter, the number of people employed will be almost 26 million lower than the number in the fourth quarter of 2019. The estimates seem to assume that there is not a spike in the fall and early winter into 2021.

Compared with their values two years earlier, by the fourth quarter of 2021 real GDP is projected to be 1.6% lower, the unemployment rate 5.1 percentage points higher, and the employment-to-population ratio 4.8 percentage points lower. Inflation and interest rates on federal borrowing will remain relatively low because of subdued economic activity and weak labor market conditions through 2021.

These estimates and comments reflect one side of the current economic debate over the ultimate scope and scale of stimulus spending. The other side reflects the ongoing efforts of the starve the beast anti-tax movement. It’s latest iteration comes from an Op-Ed in the New York Times from former Wisconsin Governor Scott Walker. He advocated against any direct aid to states and localities because “workers and small businesses need help more than government bureaucracies. ”

Among his other pearls of wisdom are that “one way to help, which will not cost the federal government more money, is to allow people collecting the enhanced unemployment benefit of $600 per week to go back to work and keep the payment until the end of the program. ” And who funds unemployment payments? Those hard pressed states who under Mr. Walker’s proposal would be subsidizing people with jobs, not businesses who could raise pay to incentivize people.

He also goes on to assert that “shortfalls created by the disappearance of federal stimulus funds was a primary reason for the budget crisis that many state governments faced after the last recession.” Too bad it was his political party that fought the stimulus after 2008. What is really rich is that he takes credit for Wisconsin’s pension funding status as the best funded pension funds in the nation. Those funds were the best funded because of a long history of bipartisan cooperation on the issue. All he did was take something that was doing well for years and didn’t screw it up.

As for economic development, here’s where things get dicey. Walker was the governor who pushed for tax incentives to the tune of $3 billon for the Foxconn manufacturing development. That deal is already on track to under deliver in terms of total number of jobs as well as the salaries available for the majority of the jobs.  Should Wisconsin be treated badly for the Foxconn deal?

From our standpoint, the whole red/blue aid discussion misses the point.  At the moment, jobs are jobs. A basic understanding of economics would see the multiplier effect of people being paid no matter the source of that pay.  There will be a time for the ideological issues to be sorted out but right now, the people reopening businesses could not care less how their customer funded his purchase. They’re just thankful for cash flow.  Aid to states and localities would provide much needed cash flow.

PANDEMIC CASUALTIES – SAFETY NET HOSPITALS

While the arguments over when, how, and where to “reopen” the country continue, there are some issues about which there can be little disagreement. Data to date shows the disproportionate impact of the pandemic based on race and/or economics. As with all other major health issues, disproportionate share hospitals (DSH) bear an indeed disproportionate share of the resulting burdens from the pandemic. While always under pressure, the DSH or “safety net” facilities are in a uniquely difficult spot in that their limited financial positions make it difficult to cope with both the revenue losses and the rapidly increased supply expenses associated with the pandemic.

With plenty of existing hurdles to overcome, these facilities now face potential regulatory burdens stemming from their participation in the federal 340 b drug program. Established in 1992 under Section 602 of the Veterans Health Care Act, the 340B Drug Pricing Program allows eligible hospitals, health centers, and clinics (covered entities) to access covered outpatient drugs at reduced prices from manufacturers participating in Medicaid. The program includes a variety of documentation requirements which are more difficult to comply with. If a facility is unable to meet those requirements even under these emergency circumstances, the resulting expense burden occurring as the result of being out of the program could be substantial.

Hospitals, healthcare professionals, and advocacy organizations  have asked the federal Health Resources and Services Administration’s (HRSA) Office of Pharmacy Affairs (OPA) which is responsible for administering the 340B program, to relax program regulations during the pandemic to relieve this burden. Part of the problem is limited technical abilities to generate and transit the required information under current circumstances which rely on electronic data transmissions. These facilities were already behind the curve in many cases technologically going into the pandemic due to limited financial resources. The financial impacts of the pandemic will not help them.

Obviously the risk will be credit specific. So what sort of institutions would we look at? NYC Health and Hospitals, Boston Medical Center, Temple University Medical Center, LA County/USC Medical Center are urban examples. Rural hospitals are also often DSHs.

PG&E MOVES TOWARDS RESOLUTION

It would have been a difficult task to accomplish but the takeover of PG&E by a public entity became less likely with the announcement that thousands of homeowners and businesses had overwhelmingly approved a $13.5 billion settlement for wildfires caused by PG&E’s equipment in 2018. The deal requires the power company to begin compensating, as early as August, some 70,000 wildfire victims who lost homes, businesses and other property.

The announcement means that the most significant remaining hurdle to the resolution of the utility’s bankruptcy proceedings by June 30 to qualify for a $20 billion wildfire fund created by the California legislature. PG&E has agreed to pay half of the $13.5 billion in cash and the other half in the company’s stock. In an all-cash settlement, PG&E has agreed to pay $11 billion in a separate deal with a group of investors and businesses that own insurance claims against the company.

PG&E still has to gain approval for its bankruptcy plan from the California Public Utilities Commission, which is scheduled to vote Thursday on a record penalty of almost $2 billion against the utility for the wildfires it caused.  The actions come after the coalition of government officials who support the creation of a public entity to take over PG&E asked the PUC to reject the proposed settlement.

PANDEMIC CASUALTIES – SENIOR LIVING

Senior living quickly emerged as a prime sector for exposure to the pandemic as the earliest clusters were at nursing homes. While there are great differences in the range of care offered by facilities in this cohort – independent living, assisted living, skilled nursing, some combination of some or all of these – there are common aspects which conflict with best practices in mitigation of the pandemic. An older population, some already old and sick, and all in some form of congregate housing all put these facilities in the crosshairs.

Now there is confirmation of the financial impact of the pandemic on this sector of the municipal market. Moody’s recently cited a variety of specific impacts. They include The Amsterdam House Continuing Care Retirement Community in Nassau County, New York which failed to make a debt service deposit due April 1, and requested debt service waivers through at least July 1 from bondholders. Henry Ford Village in Michigan also missed a monthly debt service deposit, and expects to miss another this month. The project will draw from its debt service reserve fund.

Eagle Senior Living has outstanding bonds secured by revenues from an obligated group operating  17 facilities across eight states. It reported in a Municipal Securities Regulatory Board (MSRB) filing that a reduction of leads and presentations throughout the month of March ranging from 25 to 40% had occurred and there was a reduction of 75% of the same to date in April. has implemented a 14- day quarantine of all new admissions to independent and assisted living as well as strict move-in procedures requiring staff to disinfect and move in furniture. Resident families and guests are not permitted to visit along with all non-essential visitors. No new admissions are being made to memory care due to resident safety and the impracticality of being able to maintain a 14-day quarantine period.

These are more than mere headwinds. The business relies on a steady growth in assets held by potential residents and in particular, a healthy home sales market. The economic impact of the pandemic, especially in a dreaded second wave, would devastate those two markets and limit the available pool of customers needed to maintain occupancy levels.

CHAPTER 9

Fairfield, a city of just under 12,000 residents west of Birmingham, AL filed for bankruptcy under Chapter 9 of the federal bankruptcy code in the U.S. Bankruptcy Court for the Northern District of Alabama in Birmingham. The petition states the city has between 200 and 999 creditors with $1 million to $10 million in liabilities. It’s largest creditor was listed as US Bank with an $18 million unsecured claim. The top 10 creditors for the city are: Fairfield Board of Education $2 million; Jefferson County Finance Department $1.7 million; Alabama Power $994,091; AMBAC $900,000; Alabama Finance Department – Computer $590,532; Birmingham Water Works $550,924; Regions Bank $417,752; Jefferson County Sheriff $349,576; and Retirement Systems of Alabama $305,000.

The city admits that its financial position was precarious before the pandemic. A resolution by the Fairfield City Council states the city has faced “a substantial decline in revenues in recent years due to economic forces beyond its control.” Yes the city has seen some of its businesses succumb to the limits imposed by the pandemic. But the pandemic also gives cover to public officials seeking to take advantage of ” an opportunity to reorganize, reassess our finances.”

Here is where the impacts of recent bondholder unfriendly bankruptcy decisions come back to bite future bondholders. The Fairfield bankruptcy resolution states the city while the bankruptcy process proceeds will honor all pre-petition accrued obligations to current City employees for wages and salaries, including earned vacation, severance and sick leave pay and contributions to employee benefit plans. It also will honor “pre-petition and post-petition continuing obligations to trade vendors that have provided and continue to provide goods and services to the City in the ordinary course of business and according to the credit terms agreed to by such vendors and the City.”

The resolution pointedly omits bondholders from this cohort of pre-petition obligations to be honored. Fairfield says it wants to develop a plan that includes adjusting the terms and conditions of its debts and obligations under Chapter 9. Fairfield brings to an even dozen the number of Alabama municipalities to file for Chapter 9 reorganization since 1991.

STATES BEGIN BUDGET ADJUSTMENTS

South Carolina has decided to enact what is effectively a temporary budget in the face of the fiscal impacts of the pandemic. The Governor has signed a continuing resolution which will allow the State to keep operating until the Legislature can reconvene in September. At that time, the State will have a much better idea of what federal resources will have been provided to the State to offset the budget impact of the pandemic.

To date, South Carolina has received more than $2.7 billion in federal COVID-19 relief. The Legislature is requiring that $1.9 billion of the State’s share into a separate account and treat its spending similar to how the Legislature approaches a budget bill: allow the full General Assembly to first approve it. In the meantime, the agreement allows state agencies and colleges and universities the ability to furlough employees, a step the University of South Carolina has been considering after it moved classes online and returned money back to students.

Waiting would allow South Carolina to see how some of its major industries fare under reopening. The problems facing the hospitality industry hit hard in the state’s coastal region. On the other side, the “autobahn” between Greenville and Spartanburg holds it breath while the auto industry reopens. In Michigan and Illinois, Ford had to stop production at two reopened facilities due to corona virus infections even after a heavy sanitizing and mitigation effort.

WILL MUNIS FINANCE ANOTHER DAM FIX?

Two years ago it was a government built and owned dam in northern California that flooded. That put the State Department of Water resources on the hook for financing needed repairs at the Oroville Dam. The circumstances of the latest example are different and once again highlight the municipal finance industry’s role as a savior of corporate failure.

The Edenville Dam is one of four hydroelectric projects along the Tittabawassee River northwest of Midland, MI. The city is the corporate headquarters location for Dow Chemical and facilities in the city include a nuclear reactor.  Now the dam has failed and 40,000 residents in Midland are at risk. So is Dow Chemical. So who is responsible for fixing the dam?

The Edenville dam and three others were owned by a private interest. That entity failed to invest in the dams over time and the Edenville Dam was constructed in 1924 and was on FERC’s list of “high hazard” dams. Rather than invest, the private owner instead agreed in January of this year (the deal finally closes in 2022) to sell the dams to a municipal authority which planned to finance some $100 million of capital investment in the four dams.

The purchase was apparently the only way to get the needed work done as FERC had repeatedly faulted the previous owner for failing to maintain and improve spillways, which help direct excess water around the dam to relieve pressure on the structure. FERC is reported to have assigned a 5 in 10 chance that the dam would fail under high flood conditions while the private owner put the odds at 5 in 1,000,000. 

SCHOOLS FACE HIGHER COSTS

As the country moves towards reopening, school districts across the country are assessing how to mitigate against the spread of the virus. The possible fixes involve fewer students in each classroom, alternate schedules or even an old favorite (I date myself here) split sessions. Split sessions were originally intended to deal with attendance demands due to population trends. Now, split sessions could address new pandemic based attendance requirements.

The cost of operating schools will of course go up to address enhanced cleaning requirements, increased physical infrastructure requirements, and personnel costs associated with increased cleaning and transit employees. And it is fair to say that teachers will never have a better time to make their case as to their value to the community. It is no surprise that many parents are pressing to get schools open after lockdowns, especially in the case of working parents who rely on the schools as much for day care as they do for education.

This puts school districts in a tough position. Their underlying tax bases will likely be under pressure as businesses close and property values are depressed. If the states which are ultimately the funders of education do not receive federal assistance, it will be that much harder for them to downstream revenues to those districts under the state school aid programs in every state.

LIKE THE VIRUS CLIMATE CHANGE IS NOT GOING AWAY

As the massive flood in Michigan bears witness, significantly increased moisture is becoming an annual feature of each year. Now, the National Oceanic and Atmospheric Administration has issued its predictions for the 2020 hurricane season. Significant incidents in Puerto Rico, Texas, and Florida have become annual events. NOAA’s Climate Prediction Center predicted a 60 % chance of an above-normal 2020 Atlantic hurricane season, with a 30 % chance of a near-normal season. The agency predicted just a 10 % chance of a below-normal season.

NOAA forecast the 2020 Atlantic hurricane season that runs from June through November will include 13 to 19 named storms, with six to 10 possible hurricanes. Three to six of those could become “major” hurricanes of Category 3 or higher. If 2020 does meet that forecast, it would mark a new record of five consecutive above-normal Atlantic hurricane seasons, surpassing a previous record of four seasons during 1998 to 2001. An average hurricane season produces 12 named storms, with 6 becoming hurricanes.

Such a storm season would contribute to issues like flooding again draw attention to the vulnerability of infrastructure to floods and storms. Issues like raising the elevation of streets, rezoning, preventive infrastructure, and managed withdrawal will arise again. This time however, the debate will occur in the context of constrained budgets and revenue generating ability which will in the short term drive that debate. Can local governments fund and finance the investments in resilience under the likely depressed revenue environment?

SHORT TERM BORROWING IN THE SPOTLIGHT

Do this long enough and you see just about every cycle come full circle. That is about to be the case with short term borrowing by state and local government poised to increase. Attention has increased with the development of the Federal Reserve’s Municipal Liquidity Facility. These borrowings – usually in the form of tax and/or revenue anticipation notes have long been an effective cash management and project funding tool. Many issuers, especially states, have used these notes to address timing differences which create temporary cash imbalances.

This year the pandemic has created special pressures on cash flows. This has been exacerbated by extensions of the tax filing date into this summer. This has caused significant cash deficits as these issuers struggle with reduced revenues during their traditionally heaviest quarter of revenue receipts with the unprecedented expense demands related to the pandemic. Because the size and timing of potential issuance is uncertain and the ability of the market to deal with the potential flow due to credit fears, the Federal Reserve’s Municipal Liquidity Facility was authorized and funded at $500 billion.

One of the concerns is that short term debt has at times been not a means to address structural and timing issues but a form of deficit spending. Technically, that concern can be correct. That overlooks the importance of short term borrowing in the process of recovery from extraordinary events. A good example is the experience of the City of New York in the aftermath of 9/11. The City was able to use such borrowings to finance the increased current expenditures driven by the attack and its aftermath. There is no reason to look negatively at borrowers who issue notes in the current circumstances where it can be argued that the economic impact of the pandemic is much greater in comparison.

Right now, the market is focusing on Illinois and its potential borrowing requirements. Yes, Illinois entered this period in a significantly weaker position than most states. Yes, the $4.2 billion of short term borrowing is significant. But it is not an outlier in terms of its decision to use such borrowing to meet disaster induced funding needs. So we do not view the potential for significant short term borrowing by the state to be any sign of a lack of will to address its problems. The real risk pre-pandemic was the failure of a proposed constitutional amendment to move the state income tax to a graduated rate scheme on the November ballot. That has not changed or increased the level of uncertainty which already existed before the pandemic.

TRAVEL WOES HIT LAS VEGAS CREDITS

It’s pretty well established that one of the last sectors to fully rebound from the impacts of the pandemic is the travel/hospitality/leisure industry. For economies where tourism and/or entertainment serve as primary economic pillars, the limitations of attendance and operations have had severe effects. One of the best examples is the greater Las Vegas economy.

Now the impacts of laid off employees and no visitors is being reflected in the ratings of local issuers. This week Moody’s announced that it has downgraded two significant issuers. The Clark County School District had its rating affirmed at A1 but the outlook for the rating was lowered to negative. This reflects Moody’s  expectation that the district’s financial position will be challenged by the coronavirus pandemic which has severely affected the region’s tourism and gaming dependent economy. The State’s ability to support the District will be limited by the impact of the pandemic on state revenues.

The ever growing City of Henderson is feeling the pressure as well. It’s Aa2 rating now carries a negative outlook as the same pressures impacting the Clark County School District are hitting Henderson.

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.