Joseph Krist

Publisher

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As we go to press on this Friday morning, a certified election result will not occur for the presidential election. Nonetheless, elections for state offices have produced some trends. There was the smallest shift in the partisan make up of state legislators in many election cycles. The implications of these results is that in spite of the apparent loss by President Trump, Republicans still dominate statehouses.

This has significant implications for the decennial redistricting process which could further entrench the party at the state level and keep the makeup of the House relatively closely split. This has implications for spending by the federal government and how it will deal with things like healthcare, especially if the Supreme Court rules against the ACA. So the uncertainty that confronts sectors like transportation and healthcare is likely to continue. With that as context, here are what we see as the significant issues from the week.

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MTA

The MTA announced that it is preparing to borrow the final $2.9 billion available to it from the Federal Reserve’s Municipal Liquidity Facility (MLF). The decision comes in  the face of continuing impacts on ridership and pressure on its ratings from the limits imposed by the pandemic. Unsurprisingly, the decision has been received negatively by the rating agencies but that seems to more on the basis of the long term view of the Authority’s finances. In announcing its view that the move to borrow was credit negative, Moody’s noted that their view is rooted in their assumptions about the post-pandemic ridership trends.

Moody’s sees a scenario where even when the economy returns to a more normal performance. It expects MTA ridership to permanently remain 10% below its pre-corona virus level – establishing a “new normal” – largely because of an increase in work-from home flexibility. Restoration of demand to 90%of pre-pandemic levels would be a significant improvement from the currently diminished demand. On  October 28, the MTA’s estimated subway ridership was down 69.7% from the same day in 2019 and Metro-North ridership was down 78%.

It should be noted that the new round of borrowing will be secured by secured by dedicated taxes and paid before the outstanding transportation revenue bonds. Eventually, these borrowings will become a part of the Authority’s long term debt structure as the likely source of the note repayment will be a long term refinancing.

The election has reduced the likelihood that the MTA will get as much as it needs in any future stimulus given the resulting split in the Senate. Should the Republicans retain their majority, another stimulus is likely but the mood against aiding state and local governments directly does not seem to have improved. Broadly generalizing, Republicans have backed roads over mass transit and the Democrats have favored mass transit in previous funding debates.

ELECTIONS

The bid to convert Illinois’ income tax regime from a flat rate to a progressive rate went down to defeat. Revenues would likely have increased under such a plan at a time when the state could certainly use them in its quest for structural balance. The defeat of the proposal is credit negative for the State and Chicago as well. The defeat reflects the continuing resistance to taxes to address the State’s structural budget problems. The results were definitive with 55% against and 45% for in a vote which required 60% approval to meet the constitutional threshold for amendments.

Moody’s outlined some alternative revenue steps which might be taken by the Legislature. They would only require a simple majority and include Alternatives include increasing the 4.95% flat tax that applies to individual income or broadening the state sales tax to more services. Raising the flat income tax by 70 basis points, to 5.65%, would generate about $3 billion of additional revenue, the same as had been projected for the first full year under graduated income tax rates that the state had devised in connection with the proposed constitutional amendment.  

In California, Proposition 22 which would have altered the status of “gig” employees went down to defeat after a $200 million investment in support of the proposition. Uber and Lyft had said that they could not operate in the State if they were forced to treat their drivers as employees. Proposition 22 would have shifted local property tax burdens from the residential sector to the commercial sector by lifting the limits on property taxes imposed by Proposition 13 for commercial property. It was seen as a potential significant revenue generator for localities. Proposition 19, a generous new property tax break for older California homeowners, partly paid for by removing a low-tax guarantee for those who inherit a home from a parent or grandparent was winning as we went to press but the outcome was still in doubt..

Legal recreational marijuana was approved by voters in New Jersey, Montana,  and Arizona. In South Dakota, voters legalized medical use. Mississippi did as well but on a more limited basis. Arizona voters approved a ballot question (Proposition 207 ) to legalize recreational pot for people ages 21 and older with a 16% excise tax on retail sales. Montana approved two measures. One (Initiative 190 ) to legalize recreational marijuana with a 20% tax and let people convicted of marijuana offenses apply for resentencing or records expungement, and the other (Constitutional Initiative 118) to let the Legislature set the age for buying, using, and possessing marijuana at 21.

South Dakota voters passed Constitutional Amendment A and Initiated Measure 26 to legalize recreational and medical cannabis. New Jersey said yes to Public Question No. 1 to legalize recreational cannabis for people ages 21 and older and subject it to state sales tax. Local taxes would have to be approved by the Legislature.  Mississippi voters passed Initiative 65to legalize medical marijuana and rejected an alternative added by legislators to let lawmakers regulate a more restrictive program.

Arizona voters looked likely to approve Proposition 208, a measure that would raise revenue for education by applying a 3.5% surcharge on taxable annual incomes above $250,000, for individuals, or above $500,000 for joint filers.

The wildfires in Colorado should probably get some credit for generating support for a 1/4 cent increase in the local sales tax in Denver. The stated purpose of the tax is to reduce the City’s carbon footprint. The City has goals for reducing C02 emissions by 40% by 2025, by 60% by 2030 and by 100% by 2040. In combination with a similar increase to be dedicated to homelessness issues, the local sales tax in Denver will reach 8.81%.

Austin voters overwhelmingly approved Proposition A, which would raise property taxes in the City of Austin to help pay for the Project Connect transit improvement plan. The plan includes two new light rail lines, a new commuter rail line, and a new bus rapid transit line  that would run in its own right-of-way so it doesn’t mix with traffic. A new downtown transit tunnel would also be built. Proposition B, which would allow the city to borrow $460 million for a host of infrastructure improvements, including new sidewalks, bikeways and street repairs was also approved by two thirds of the voters.

Seattle voters have approved a six-year measure which enacts a tax of 0.15%, or 15 cents on a $100 purchase, to generate $42 million a year. That money, to be collected starting April 1, replaces existing taxes that expire this Dec. 31, of .10% plus a $60 car fee. Total sales tax within Seattle will reach 10.15% including state, county and transit-agency shares. To the south, Portland metropolitan area voters rejected Measure 26-218 which proposed a tax of up to 0.75% on private employers with 25 or more workers. Similar efforts to impose such a tax had been attempted in Seattle unsuccessfully as well.  

PUERTO RICO

First the debt restructuring news. U.S. District Judge Laura Taylor Swain denied a motion asking the court for an independent investigation into trading activity and possible violations of the confidentiality order by several creditors including bond insurer National Public Finance Guarantee Corp. in the mediation process of the Puerto Rico debt’s restructuring. The judge also decided that by Feb. 10, the Commonwealth’s Financial Oversight and Management Board (FOMB) must submit “at a minimum an informative motion comprising of a term sheet disclosing the material economic and structural features of a Commonwealth and PBA [Public Building Administration] plan of adjustment [POA].”

The proposal for an investigation would have an independent investigator look into insider trading claims rather than the New York Attorney General and the SEC. Judge Swain stated that Promesa “does not explicitly authorize the Court to order to initiate an independent investigation” like the one in National’s motion and added that National did not provide a viable option. An additional motion made by the PSA creditors, which comprises the Ad Hoc Group of Constitutional Debtholders, the Ad Hoc Group of General Obligation Bondholders, the  Lawful Constitutional Debt Coalition (LCDC) and the QTCB Noteholder Group was also rejected.

The court actions highlight the divide between the creditor groups. National contends that some creditors have used their participation in the restructuring process to trade certain contested bonds from the Commonwealth and obtain profits for themselves. National was concerned that it would be left “holding the bag” to cover any losses to investors in bonds it insured.

As for the election, the former two-term resident commissioner—from 2009 to 2016 – Pedro Pierluisi was elected Governor by the narrowest of margins. The percentage difference in votes between the two top candidates for governor was less than 1 percent. The election also included a yes-or-no plebiscite on whether Puerto Rico should be admitted as the 51st state of the United States. Statehood prevailed in the political status referendum, with 52.29 percent voting “yes” to statehood, and 47.71 percent voting against, with 88.34 percent of units reporting.

One of the difficulties with the debate over statehood vs. the status quo is the consistent history of a true split in the electorate. There has never been a question on the ballot regarding Puerto Rico’s status that generated a clear and convincing result one way or another. It’s one of the prime hurdles for statehood proponents to overcome. That lack of political consensus continues to hold back efforts to resuscitate the Commonwealth economy.  And low voter participation of just over 50% of eligible voters reduces the value of these status votes.

Proponents of statehood are already making their case in the mainland press. The problem is that while a majority of voters opted for statehood, it was a small majority. In essence, proponents are claiming a mandate on the basis of the expressed view of 25% of eligible voters. Opponents can seize on that to say that new real mandate in support of either the status quo or statehood resulted.

CASINOS ON THE BALLOT

In Virginia, voters in four cities – Bristol, Danville, Norfolk, and Portsmouth  voted to allow for the construction of proposed casino developments in those cities. The casinos are tentatively slated to open in 2023. In the meantime, they are expected to add construction employment and repurpose old industrial and commercial sites in the respective cities. Each city will benefit from the payment by the casinos of all applicable local fees and taxes, including property, sales, hotel occupancy and meal taxes and each city will receive a portion of the gaming tax revenue to be collected by the state.

The Commonwealth will levy a gross receipts tax on casino activities, a portion of which will be allocated to host cities according to a formula. With the exception of Bristol, the cities will keep their full share of local revenues. Bristol is one of the significant stops on the NASCAR circuit. Races can draw some 165,00 spectators who then generate significant local revenue in the City especially in connection with race days. Bristol’s local revenues would be directed to a Regional Improvement Commission which would distribute them evenly among the city and the 12 counties within the Virginia Department of Transportation’s Bristol service district which includes Bland, Buchanan, Dickenson, Grayson, Lee, Russell, Scott, Smyth, Tazewell, Washington, Wise and Wythe counties.

Moody’s views the approvals as credit positive for the localities. They cite the potential to generate increased local tax revenues and create significant numbers of jobs. Norfolk estimates that the development will bring it $25- $45 million in recurring tax revenues when it is open. Bristol projects it will generate about $16 million in new recurring local tax revenue. Danville would be able to transfer ownership of a blighted industrial site and get a $20 million upfront payment. Virginia was one of nine states that prohibited casino gambling. Gaming taxes will be imposed at rates of 18%, 23% and 30% for casinos’ adjusted gross receipts of the first $200 million, between $200 and $400 million, and in excess of $400 million, respectively.

These gaming taxes will be held for appropriation by the General Assembly pursuant to formula host cities will receive 6%, 7%, and 8% of adjusted gross receipts. 0.8%  would go to the Problem Gambling Treatment and Support, 0.2% would go to the Family and Children’s Trust Fund. For the one casino operated by an Indian tribe (the one in Norfolk), 1% will go to the Virginia Indigenous People’s Trust Fund. Any residual would be available for appropriation for programs established to address public school construction, renovations or upgrades throughout the state.

UTAH NUCLEAR

A nuclear generating facility actually planned to be physically located in Idaho but to be paid for by sales to Utah municipal utilities is losing participants. The decision to withdraw follows announced cost increases by the Utah Associated Municipal Power Systems (UAMPS), which was the primary intended buyer for capacity from the proposed plant. Completion of the project would be delayed by 3 years to 2030. It also estimates the cost would climb from $4.2 billion to $6.1 billion.

NuScale is an entity which was spun out of Oregon State University in 2007. It is their plant design that will be used for the plant. It’s efforts to promote nuclear power have benefited from DOE support cost sharing agreements whereby DOE would cover some $1.4 billion of construction and development costs. The attraction of the facility is its small modular design the company says will be safer, cheaper, and more flexible that a conventional gigawatt power reactor. Each of NuScale’s little reactors would produce 60 MW. A plant would contain 12 of the modular reactors, which would be built in a factory and shipped to the plant site. 

This would allow the generator to serve as a peaking facility much in the way a similar sized fossil fueled facility might serve. The proposed project still has many rivers to cross even as it passed a key milestone in the NRC review process, receiving its safety evaluation report. It expects to receive a final “design certification” to come next year. 

UAMPS contends, in an effort to deal with a poor track record for nuclear generating development and construction, that construction will not be commenced until the full output of the plant is sold. That process is a long way from completion. It’s a concern that another municipal utility is being challenged to participate in not just a nuclear facility, but a nuclear facility of a new design. Too often our market is taken advantage of because of our lower cost of financing and need for yield. This could become another example of this phenomenon.

INTERNET SALES TAXES

Once the Supreme Court ruled in favor of states seeking to tax sales of products through the internet, many states began imposing such taxes. Now we are beginning to see data about how much revenue these taxes generate. Recently, Arizona completed its first year of collections and released updated collection information.

Under a state law that took effect on October 1, 2019, out-of-state businesses that do not have a physical presence in Arizona and meet certain economic thresholds must collect and remit transaction privilege tax in Arizona. The Arizona Department of Revenue has seen a steady rise in transaction privilege tax collection. Since October 1, 2019, the Arizona Department of Revenue (ADOR) has brought in more than $467 million in transaction privilege tax from over 4,500 remote sellers and marketplace facilitators. In fiscal year 2020 (September 1, 2019 – June 30, 2020), the department collected over $278.7 million and over $128.6 million towards the General Fund.

Now it’s not clear as to whether these sorts of results will be sustainable. It is likely that collections of sales taxes from internet sales in 2020 may be a bit of an aberration as the impact of the pandemic on local economic activity drove significant demand to purchase on line rather than in person.  So it is difficult to use this past performance under unusual conditions as a basis for predicting future results.

OPOIOD LITIGATION

I have fielded many inquiries about whether ongoing litigation against manufacturers and distributors of opioids would be the next securitization candidate for the municipal bond market. Settlement talks have been ongoing for at least the past year. A proposed settlement was rejected in 2019 due to a variety of factors.

Now it looks like a settlement of the litigation may be at hand. According to press reports, a settlement involving a $26 billion payout is likely to be approved. Three major drug distributors and a large drug manufacturer – McKesson, Cardinal Health, AmerisourceBergen and Johnson & Johnson – have indicated that they would support such a settlement.  The distributors will collectively pay about $21 billion over 18 years, with $8 billion paid by McKesson alone. J&J would contribute $5 billion. The move is being motivated by the existence of two suits – one in New York and one in West Virginia – scheduled to begin in January, 2021. The WV case is being brought by the local governments in the state as prior settlements in WV were only with the State.

Each state would determine how it would distribute settlement money. The amount each state would receive is expected to be determined by four factors: state population, overdose deaths, diagnoses of substance use disorders and volume of pills sold. The distribution formula has been the source of much conflict among the plaintiffs and has been hampered by arguments over attorney compensation.  The settlement would provide $2 billion for the lawyers which is expected to be paid out over seven years.

Significant differences between this and the tobacco settlement. First, there is much less money involved and the payments in this suit will occur under a fixed timeline with a final date certain. The tobacco settlement provided for payments in perpetuity. That allowed for longer amortizations and greater flexibility in terms of managing cash flows in support of any bonds issued. Other differences include the fact that annual payment amounts are not based on ongoing consumption or sales of the product as is the case with tobacco bonds.

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