Joseph Krist

Publisher

As we go to press, the infrastructure and reconciliation legislation is hanging in the balance. The ultimate outcome of the legislative process remains in doubt. The House and Senate did pass — and Mr. Biden signed — legislation to fund the government until Dec. 3, with more than $28 billion in disaster relief and $6.3 billion to help relocate refugees from Afghanistan. The issues are coming down to a question of what is infrastructure and what is social engineering.

The tax changes contemplated seem likely to survive as they appear to have support. They call for raising the corporate tax rate to 25%, up from 21%; setting a top individual income tax rate of 39.6%, up from 37%; and increasing the capital gains tax rate to 28%.

It’s energy policy which becomes a major stumbling block. Senator Manchin’s demands include means-testing any new social programs to keep them targeted at the poor; a major initiative on the treatment of opioid addictions that have ravaged his state; control of shaping a clean energy provision that, by definition, was aimed at coal, a mainstay of West Virginia; and assurances that nothing in the bill would eliminate the production and burning of fossil fuels.

The process as it unfolds, highlights the difficulties which hold back a serious systematic approach to the funding and financing of infrastructure.

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POLICE FUNDING

With just over a month to go before Election Day, we see several items on local or state ballots which will go some way to judging the staying power of certain trends. Minneapolis voters will decide on whether they wish to effectively shut down the City’s police force and replace it with a Department of Public Safety. That department would include a variety of medical and mental health practioners along with some traditional law enforcement who would answer many of the mental health situations which police are currently called on to deal with.  

The initiative would provide for joint oversight of the resulting organization by both the executive (the Mayor) and the legislative (City Council). This has raised concerns over day-to-day management and the split in final executive authority. The proposed plan may actually result in more public safety spending than is currently the case. It would however reallocate funding among services provided resulting in “effective” police defunding.

This vote occurs against a backdrop of generally rising urban crime. Cities which had some of the most violent public actions over the issue of police conduct in 2020 are actually increasing police funding. We recently noted the increase in funding through a very generous labor negotiation in Chicago. Now the outgoing Mayor of Seattle has proposed a budget which increase the number of officers on the city police force on a net of attrition/retirement basis.

This past two years have seen a dramatic reduction in the size of Seattle PD’s uniformed force as resignations and retirements reached unprecedented levels. The 2022 Proposed Budget for SPD includes funding sufficient to add a net of 35 new officers. This increase would increase the average officer count to 1,230 still well short of the 1,343 officers that had been funded for 2021.

THE ELECTRIC ECONOMY

Ford said it would build two battery plants in Kentucky and one in Tennessee, all in a joint venture with its main battery cell supplier, SK Innovation of South Korea. It will also build an assembly factory in Tennessee. In combination, the four facilities are scheduled to create 11,000 jobs.

Half of those jobs will be created at Stanton, about 50 miles northeast of Memphis. The campus is expected to employ 6,000 people and will house suppliers and a battery recycling operation as well as the truck and battery factories. Ford and SK Innovation will invest $5.6 billion at the site. Two plants in Kentucky will be in Glendale, about 50 miles south of Louisville, and are expected to create 5,000 jobs, at a cost of $5.8 billion. 

The plants will be at the center of the debate over the potential impact of electric cars and incentives to be provided by the federal government. It has been proposed by labor interests that government incentives be provided for electric cars produced at unionized facilities. Initially, it seemed to be an effort to target companies like Toyota who are both foreign owned and non-union.

Those provisions might be problematic. “Right to work” laws in Tennessee and Kentucky bar union membership as a condition of employment. Efforts to unionize workforces in the South have historically failed. So, the issue becomes – good green jobs vs. unionized green jobs. The Republican-controlled Legislature has voted to put Tennessee’s right to work law as an amendment to the state Constitution by placing a measure on the next gubernatorial ballot.  That sets up a conflict as the manufacturing facilities to be established have been announced as union shops.

PUERTO RICO PENSIONS

One of the major stumbling blocks on the route to a final Plan of Adjustment for the Commonwealth of Puerto Rico has been that of pensions. The Commonwealth has been very resistant to changes in pension payments for its government retirees. Now, in an effort to move talks forward and increase the likelihood of Plan approval, the Oversight Board has softened its stance. The Board announced it “is willing to agree” to increase the threshold of beneficiaries exempt from any reduction from $1,500 to $2,000 per month.

“The Oversight Board is also willing to support restoring any reduction in pension benefits should Puerto Rico receive federal Medicaid funds in excess of amounts projected in the 2021 Certified Fiscal Plan for Puerto Rico and should such funds generate enough savings in the government’s general fund budget to permit a restoration of the benefit reduction.  The Oversight Board said it could also accept “contingent on the commonwealth obtaining and maintaining adequate Medicaid funding.” The fiscal office said it would accept these proposals “if the Puerto Rico Legislature adopted the necessary legislation for the Plan of Adjustment and the Governor signs that legislation into law.”

One has to question the use of increased Medicaid funding to prevent reductions in pensions. That would seem to complicate the Commonwealth’s historic use of the Medicaid funding imbalance between it and the states. One of the main arguments for statehood is that it would address the historic funding imbalance. It’s not clear how using Medicaid to cover pension costs exactly makes the case for statehood or increased aid.

These strategies which rely on status and the resulting inequalities to address shortcomings in the management of its fiscal affairs become more tired each year. Oversight and financial responsibility will continue to be prerequisites for success in the restructuring process. The resistance encountered throughout this process bodes poorly for the Commonwealth’s fiscal future. The real question is: Has the bankruptcy been truly transformational on will the Commonwealth quickly return to its old ways once the bankruptcy process comes to an end?

CALIFORNIA WATER WAR TRUCE

The Imperial Irrigation District, the largest single recipient of Colorado River water, and the Metropolitan Water District have settled a lawsuit that once threatened to derail a multistate agreement governing the use and apportionment of Colorado River water. Under the agreement, Imperial can store water in Lake Mead on the Arizona-Nevada border under Metropolitan’s account. Imperial will contribute water under a regional drought contingency plan.

The dispute was rooted in negotiations under the Drought Contingency Plan developed in response to the long-term drought in the Colorado River basin. Imperial sued Metropolitan, alleging the water agency that serves Los Angeles violated a state environmental law when it did not negotiate directly with Imperial in the drought contingency talks. The Los Angeles County Superior Court ruled against Imperial, which appealed to the California Court of Appeals earlier this year.

Imperial sued Metropolitan, alleging the water agency that serves Los Angeles violated a state environmental law when it sidestepped Imperial in the drought contingency talks. The Los Angeles County Superior Court ruled against Imperial, which appealed to the California Court of Appeals earlier this year.

The new settlement agreement commits both agencies to seeking additional state and federal funding for restoration projects. At the center of this issue is the Salton Sea. The area around it is a mix of potential (brine deposits filled with lithium) and pollution wreaking havoc on the lives of those who live nearby. The seabed itself is the site of an increasing number of industrial facilities. How they would be impacted by efforts to refill the sea through a restoration program is unclear.

HOTELS BACK IN THE MUNI MARKET

The hospitality business was among the hardest hit by the restrictions and realities of the pandemic. Once again, a major economic disruption has disrupted that industry. While the circumstances of the Great Recession and the pandemic are very different, the net result on the operation and finances of projects within that space is quite similar.  Several hotel projects developed in the first half of the 2000 decade ran into serious problems requiring defaults and restructurings which led to real investment losses.

So, we are intrigued by the latest effort to obtain financing for a startup hotel project which comes out of North Carolina. A hotel/conference center project located adjacent to the UNC-Charlotte campus is the latest example. The project was conceived after the Great Recession and construction started in 2019. Who was to know that the greatest public health disaster in a century was just around the corner?  The positive view points out that the worst of the initial phase of the pandemic coincided with the bulk of the construction period.

The facility began operations at the end of 1Q21, just as vaccines were taking hold. The operations since then have been unsurprising in that occupancy opened in the mid-30% range which is well below the projected average occupancy for fiscal 21-22. Going forward, the hotel assumes an average 75% occupancy rate five years out. Already the facility has seen the impact of a negative turn in the pandemic as occupancies which had risen a bit over the summer took a downward dip as the pandemic resurged especially in the South.

What really got our attention is the use of the issuer, Public Finance Authority. This issuer seems to be the one to turn to when the typical in-state issuer of bonds for what are essentially commercial projects chooses not to associate with the risk. This always raises a red flag for us. Public Finance Authority is a Wisconsin issuer but often issues debt for other jurisdictions. That is the case when local considerations (usually political) interfere with financing, PFA often steps into the breach.

This deal goes to great ends to maintain the tax exemption for the bonds. The facility is owned by the UNC-Charlotte endowment. Neither of the institutions is designed to draw customers from has any ownership interest. The ownership by the endowment of a tax-exempt entity is designed to clear the tax exemption hurdle.

In the end, you won’t see this risk if you are an investor directly in bonds. The retail investor who owns a high yield fund is likely to see that risk. In today’s environment of historically low rates, it will be an opportunity which those funds will be attracted to.

MTA

New York State Comptroller Thomas P. DiNapoli annually reviews the financial outlook for the Metropolitan Transportation Authority, the state agency responsible for the mass transit system in the New York metropolitan area. The MTA may be the most heavily impacted issuer in the market as the result of the pandemic. It has been bailed out financially in the near term by the receipt of some $1o billion in federal pandemic assistance.

In February 2021, the MTA projected cash deficits before gap-closing actions of $5.7 billion in 2021, $4.8 billion in 2022, $4.1 billion in 2023 and $4 billion in 2024. On July 21, 2021, the MTA released a midyear update to its 2021 budget and a four-year financial plan based on the preliminary budget for 2022 (the “July Plan”). Fare and toll revenue is expected to increase by $1.7 billion in 2021, $1.6 billion in 2022, $831 million in 2023 and $395 million in 2024. Dedicated taxes and subsidies also improved by $1.8 billion during the financial plan period.

Despite these improvements, the July Plan still forecasts substantial gaps of $4.8 billion in 2021, $2.9 billion in 2022, $2.5 billion in 2023, $2.8 billion in 2024 and $3.3 billion in 2025. The report clearly highlights the variables facing the Authority as it plans ahead. The Office of the State Comptroller estimates that fare revenue in 2022 could be $300 million higher than planned if workers telecommute an average of 1.5 days per week starting next spring, but could be $500 million lower than planned if workers telecommute an average of 3 to 4 days per week.

The longer-term risks facing the MTA are clear. One is that two potential revenue sources remain uncertain. The first is the potential for more federal money under the pending reconciliation bill. The other is the reliance on congestion pricing in Manhattan which is currently under review. Congestion pricing is expected to generate $15 billion for the MTA’s 2020-2024 capital program. The starting date of the program is still unknown, although the MTA now assumes it to be in 2023.

The report sums up the import of a financially viable MTA. “The greater New York City region cannot achieve a full economic recovery without a financially stable MTA.” No, it cannot.

ZERO EMISSIONS CREDITS

So called Zero Emissions Credits (ZECs) are the primary vehicle which states use to support the operation of existing nuclear generating plants. They are most recently in the news as one of the difficult issues to deal with in the legislation supporting state initiatives to support clean energy. Laws were enacted from 2017 to 2019 to fund zero emissions credits (ZECs) in Connecticut, Illinois, New Jersey, New York and Ohio.  It happens that nuclear is often the primary source of carbon free power. According to Exelon, nuclear provides 85% of the clean energy in Maryland and Illinois, 91% in Pennsylvania, and over 50% in New York.

One item in the pending reconciliation legislation in the U.S. Congress would provide federal funding for ZEC credits. (American Nuclear Infrastructure Act (S. 2373)) As the reconciliation process unfolds, $6 billion to fund ZECs from 2022 to 2026 where they are demonstrated as economically necessary to limit emissions is included in the Senate approved bill. 

COAL SUBSIDIES?

The legacy of the effort to support legacy generating assets in Ohio continues manifest itself. The 2019 legislation which was passed as the result of illegal efforts to influence legislators has been seen as an effort to support nuclear power. Tucked into that legislation were subsidies for two World War II era coal fired plants. Now, the Ohio legislature is considering a bill to repeal those subsidies. The bill is sponsored on a bipartisan basis in one house and by Republicans in the other.

The two plants are owned by investor-owned entities through the Ohio Valley Electric Corporation. Before the bill, only customers from AEP Ohio, Duke Energy Ohio and AES Ohio, formerly Dayton Power & Light, were charged for the plants, paying $176 million from 2016 through 2019. The 2019 legislation enlarged that customer base to pay for the subsidies. The plants were built in the 1950s to provide power to a uranium enrichment facility in Pike County. The contract with the U.S. Department of Energy ended in 2003.

OVEC took over the distribution of power from the plants since that time. The Ohio Manufacturers’ Association, representing commercial and industrial ratepayers has said the plants lost $1.3 billion from 2012 through 2019 and continue to lose money. We are big believers in the idea that the market should be allowed to deal with issues like this. In this case, the market is speaking loudly and clearly.

Unfortunately, the debt issued for the two plants extends to 2040. OVEC does not effectively have other revenue generating assets to support that debt.

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