Joseph Krist

Publisher

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As the infrastructure funding standoff continues in Washington, it is easy for the gross spending figures to overwhelm some of the sector by sector spending items. This tends to make one think that a fairly sizeable amount of money being spent on a problem should actually fix the problem. Much attention is being paid to how much as opposed to how little of the real size of infrastructure capital needs are actually being met.

A good example is housing. The next attempt at stimulus, the American Jobs Plan would provide $40 billion for rehabilitation of existing public housing stock across the country. The Administration estimates that some 1 million apartments are over 50 years old. Many come close to exceeding the limits of habitability – water and heat are often recurring problems and capital repairs long delayed.

While federal funding for new public housing ended with the budget compromises of the mid 1990’s, spending for capital maintenance continued. As time passed and politics hardened, spending for upkeep like boilers for water and heat and functioning elevators consistently reduced. That left public housing authorities with little to leverage in support of tax exempt bonding for those costs as had historically been the case.

So we see a substantial sum proposed for many of these issues. Here’s the rub. While New York does have by far the largest number of public housing units in the country, most major cities have substantial public housing infrastructure. So if the $40 billion was applied to fill the capital needs of the NYC Housing Authority there would still be a multi-billion dollar shortfall in NY and none for the rest of the country. It is just another example of the challenges faced by municipal bond issuers.

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PANDEMIC PRESSURES LINGER

The economy may be opening up again but that does not mean that some credits are no longer in trouble as the pace of the reopening may not be fast enough for some credits to avoid problems. The latest example comes from San Antonio where the impacts on travel, tourism, and convention activities have not been mitigated sufficiently to generate necessary cash flows to meet debt service.

Moody’s has downgraded to Baa1 from A3 the city of San Antonio Convention Center Hotel Finance Corporation, TX’s bonds and has placed the rating under review for further downgrade. The pandemic so limited business that “the accumulated pledged revenue and reserve in the equity fund for the hotel special tax bonds were depleted and used to meet the July 15, 2020 obligation, reducing the flexibility for future payments. Accumulated pledged revenue was also used to make the January 15, 2021 payment. Following the January payment, the city has continued to receive pledged revenue but collections have remained weak and are projected to be insufficient for the July 15, 2021 payment.” 

It is expected that debt service reserves will be used to fund some $1-1.4 million of debt shortfalls. The downgrade to Baa1 also reflects a much weaker credit profile from a year ago with limited flexibility although the city is exploring various options for the future. None of those alternatives, however, are projected to be available to meet the July 15 debt service payment.

With an end to the harsh limitations of the pandemic clearly in sight, timing of the return to revenue sufficiency for many similar projects will be a key factor in determining whether other similar credits will face similar issues.  

TREASURY REGS FOR STIMULUS SPENDING

The U.S. Treasury Department released much-anticipated guidance for the American Recovery Plan’s (ARP) $350 billion in direct state and local aid, including details on how it will implement the law’s restriction on using ARP funds for state tax cuts. The long awaited guidance allows those governments to properly apply the funds without risks to the state budgets they are right in the middle of enacting.

During the debates over the various stimulus packages since the onset of the pandemic, the specter of a “blue state bailout” was consistently raised. It all stemmed from an ill advised item in the original stimulus bill mentioning funding of Illinois’ pensions  shortfall. At the same time, representatives from “red states” sought to use funding for their pet cause – tax cuts.

Now at least the states have guidance at this important point in their budget processes. The ARP’s legislative language was fairly broad: States “shall not use [ARP] funds … to either directly or indirectly offset a reduction in net tax revenue … or delay the imposition of any tax or tax increase.” The rule applied to any “change in law, regulation, or administrative interpretation.” The law also provided the Treasury to clawback any ARP money used for such tax cuts.

The new guidance addresses some of the issues raised by litigation from a group of red state attorneys general challenging the rules. Several of those states intended to use aid to finance tax cuts regardless of any guidance. Hence, the litigation. Now, Treasury will compare each state’s fiscal year tax revenue during the ARP years (March 2021 to December 2024 or whenever a state exhaust its ARP funds) to its fiscal year 2019 tax revenue—as reported by the Census Bureau and adjusted for inflation.

This formula allows Treasury to work the numbers such that if a state’s tax collections in one of the ARP years are above its real 2019 level, any tax cuts passed that year were paid for with economic growth and not ARP funds. Problem solved! Additional cushion is provided by the fact that each state gets a 1% de minimis exemption to account for “the inherent challenges and uncertainties that recipient governments face.”  It allows for a state to pass a tax cut as part of a revenue neutral budget and then see revenues decline, it will not count as a violation of the rules. 

Conversely, if a state sees revenue cuts directly attributable to tax legislation it would potentially run afoul of the rules. If that state passed significant tax cuts and its next year’s revenue was below its real 2019 baseline, it must document how it financed the tax cuts without ARP funds. It cannot make cuts to a department, agency, or authority that used ARP funds. A state would need to point to offsets – taxes raised, spending cut—but no cuts to a department, agency, or authority that used ARP funds are permissible. 

Pensions even got a bit of help when all was said and done. While pension deposits are prohibited, recipients may use funds for routine payroll contributions for employees whose wages and salaries are an eligible use of funds. Treasury’s Interim Final Rule identifies several other ineligible uses, including funding debt service, legal settlements or judgments, and deposits to rainy day funds or financial reserves.

AUTONOMOUS VEHICLES

It will take some time before all of the ultimate impacts of the pandemic are clear. One of the sectors to have seen much of that impact has been the mass transit sector. Now that systems are reopening – in NY the MTA has resumed 24 hour service – we can begin to see what the true impact will be. One of the fears of the mass transit sector is that people will be unwilling to use those systems and will instead choose to use services from transportation network companies (TNC) instead of public mass transit. The initial signals we’re seeing don’t necessarily spell the beginning of the end for public transit.

It is clear that at present the core transit functions of Uber and Lyft are not moneymakers. The history of the business is that the demand for it has been driven by price considerations. The subsidized prices they charge are what generate the favorable cost/benefit assessment a customer makes. While there will be some acceptance of higher prices, the rate of increase in that cost is likely to exceed the rise in the benefit of the service.

As is well known, the one place that these companies can improve that ratio and drive demand is by lowering the costs. The most obvious cost is that of the driver. It has long been clear that ultimate profitability for the TNC is reliant on autonomous vehicles. That drove much of the TNC investment in autonomous technology and development which did not produce the desired result.

With the reopening expanding over the summer we expect to see lots of noise over transit and vehicle use going forward. There will be a real push and pull between those who wish to maintain services and modalities and those who demand that public infrastructure accommodate large scale autonomous utilization now. I’ve always been skeptical of claims about the speed of new technology. That’s the product of time and experience.

We don’t think that AV adoption will occur nearly as fast as proponents hope. Two recent comments in the press happened to be timely.

“If you look at almost every industry that is trying to solve really, really difficult technical challenges, the folks that tend to be involved are a little bit crazy and little bit optimistic.”  – president of Nuro.

“These cars will be able to operate on a limited set of streets under a limited set of weather conditions at certain speeds. We will very safely be able to deploy these cars, but they won’t be able to go that many places.” – an executive at Lyft.

If that is the state of play for the foreseeable future, it is not realistic to expect public agencies to make capital funding decisions for a truly nascent technology at the expense of current modes of transportation.

CARBON CAPTURE AND MUNIS

Sens. Michael Bennet (D-Colo.) and Rob Portman (R-Ohio) introduced the Carbon Capture Improvement Act to help power plants and industrial facilities to finance carbon capture and storage equipment as well as more unproven direct air capture projects. The bill would permit businesses to use private activity bonds, which local and state governments currently have access to, in order to finance a carbon capture project.

We note that both Senators represent states with significant economic interests tied to the extraction of minerals. So their approach to climate change is not about shifting to renewable fuels and away from the environmental destruction of associated with fossil fuel extraction and production. It is interesting that Senator Portman has discovered the joys of private activity bonds after supporting the 2017 tax legislation.

This is just the latest example of the effort to save the fossil fuel industry through the subsidy of tax exempt financing. At the same time the industry fights the financial claims of municipal issuers in association with pending litigation on the impact of climate change, the industry seeks to use the benefits of issuance by municipal issuers to subsidize their share of the costs of climate change.

ESG

The “social cost of carbon”  is an effort to measure the economic harm of putting one additional ton of carbon dioxide, the prime greenhouse gas, into the air. A 2019 Colorado law regulating utilities includes a minimum of $46 a ton to estimate compliance. The 2019 law directed the Colorado Public Utilities Commission to use a social cost of carbon in evaluating all existing electric generation and in the approval of the plan by Xcel Energy, the state’s largest electricity provider, for closing plants and adding new generation.

Now there are two new bills pending which would extend the use of the concept to cover methane in evaluating energy efficiency and demand management programs for utilities, like Xcel and Atmos Energy, selling natural gas to homes and businesses. The emerging weaknesses of the approach is reflected in the fact that there is no agreement as to how one calculates the social cost of carbon.  And that is a huge problem.

Over the years many efforts have been made to develop consistent replicable calculations to measure a number of factors. These would be used to develop scores and/or rating systems for investors who wished to be able to use them to meet a variety of purposes. The fact is that the process is complicated and not always open, so the results to date have not produced the desired metrics.

Even after you crack open the black box and perfect the math, there is still the issue of what exactly defines green. At one point, issuers were using eight different sets of standards to support their assertion of “green” status. Some of the “standards” were developed internally by the issuers. That is not how one validates the concepts underpinning ESG  investing.

Investors are getting wise. The municipal analyst community through the National Federation of Municipal Analysts is undertaking an effort to reach a consensus on what is green for purposes of the municipal bond market. In the meantime, there are some federal efforts to calculate these costs dating back some 25 years. Nonetheless, no clear consensus has emerged.

That reflects the model based nature of most of the effort to date which can provide widely divergent results and prices. As one researcher put it, ““We think we can describe the range.  “We have to pick a number somewhere in the middle of the range, that is all you can do.” That’s a problem for investors who increasingly rely on a data based analytic approach to portfolio management. An imprecise number lowers its value for trading valuation purposes and can create compliance nightmares for management and marketing purposes.

NUCLEAR SUBSIDIES

Senator Ben Cardin (D-MD) said he would introduce an amendment with fellow Democrats, Senators Sheldon Whitehouse (D-RI)  and Bob Casey (D-PA) which would provide a production tax credit of $15 per megawatt hour for existing nuclear plant owners or operators in states such as New York, Illinois, and Pennsylvania with deregulated power markets. The credit would be reduced by 80% for any market revenues above $25 per megawatt hour. The credit would begin to phase down when greenhouse gas emissions fall by 50% below 2020 levels and ends entirely after 2030. The proposal comes as the Ohio legislature considers the expulsion of its former Speaker and the chief of staff for the former Illinois House Speaker indicted over efforts by power companies to obtain subsidies from state governments.

IOWA CHARTER SCHOOLS

Typically, the supervision and regulation of charter schools has been the province of local school districts. Local control stems from the fact that many charter schools are paid for by the local taxpayers. We have long had concerns about the drainage of funding from local school districts to charter schools especially where it creates funding shortfalls for the public system.

Now in Iowa we see new legislation which takes the authorization for charter schools out of the  hands of the local funding entity. HF 813, which was signed recently allows private charter school operators, known as founding groups, to seek approval to operate directly from the state Board of Education. Charter school founding groups can still be created by a local school board, but the new state-approval option provides an opportunity to pursue approval free of local opposition. The state board will approve and monitor the performance of all charter schools.

In Iowa, funding is based on enrollment using a state cost-per-pupil (SCPP) formula. Under HF 813, the state will fund 100% of the SCPP for the first year of a charter school’s operation because the formula is based on prior-year enrollment. Thereafter, these costs will be funded by the combination of state and local funds. At the same time, the law allows charter schools to avoid some of the costs borne by traditional school districts. Charter schools will be required to operate a brick-and-mortar “attendance center” but they are not required to provide remote options.

Even though it allows charters to be approved by local entities, the law  is another form of preemption. The new state-approval option provides an opportunity to pursue approval free of local opposition. That creates a real problem for districts which are required to fund schools they do not want.

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