Joseph Krist

Publisher

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ISSUE OF THE WEEK

California Health Facilities Financing Authority

$684,475,000*

SUTTER HEALTH

TAXABLE BONDS

$606 million

Tax-exempt Revenue Bonds

In the current environment, this large Northern California hospital system has determined that a taxable refunding generates sufficient savings to justify refinancing tax exempt debt with proceeds of the issue. The bonds come to market with Aa3/AA- ratings. Concurrently, the system will issue tax exempt debt to fund its significant ongoing capital program. The system plans some 44.9 billion of capital spending over the next five years.

Bonds are secured by a gross revenue pledge pursuant to Sutter’s 1985 Master Trust Indenture (MTI), with payments made by Sutter’s Obligated Group (approximately 99% of the System’s total revenues). All members of the Obligated Group are jointly and severally liable with respect to the payment of each obligation secured under the MTI. Financial covenants include a debt to capitalization requirement of less than 60%, a debt service coverage requirement of over 1.1 times, and a days cash on hand requirement of over 70 days.

Sutter  operates 29 acute care facilities, operates a small health plan, manages a large number of out-patient facilities, and manages five medical foundations that contract with medical groups organized as professional corporations that account for the services of 2395 physicians. In fiscal 2017, Sutter Health produced over $12 billion in revenues, and generated over 193,000 admissions.

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FEDERAL TAX CUT WILL BOOST STATE CORPORATE TAX REVENUES

The Council On State Taxation has released a study “The Impact of Federal Tax Reform on State Corporate Income Taxes”, produced through the efforts of Ernst and Young (EY) researchers. The report estimates the impact of federal tax changes on the tax position of companies.  The EY study assesses the impact that the corporate tax provisions of the TCJA will have on respective states’ corporate income taxes. Its overall conclusion is that conformity with federal tax reform will result in an estimated state corporate tax base increase averaging 12% for the first ten years, with a range generally between 7% and 14% in individual states.

According to the report, the average expansion in the state corporate tax base is estimated to be 8% from 2018 through 2022, which increases to 13.5% for the period 2022 through 2027. This increase in the later years is primarily attributable to research and experimentation (R&E) expense amortization beginning in 2022 and the change in the calculation of the interest limitation in the same year. The federal tax base expansions due to interest limitation, research and expenditure amortization, limitation of like kind exchange for personal property, and fringe benefit limitations total approximately 10%. Since virtually all of the states conform to these provisions, these changes represent a large portion of the overall expansion of the tax base in most states.

According to the report, the largest expansions in federal corporate tax base arise in the manufacturing and capital-intensive service industry sectors due primarily to the transition tax. The finance and holding company sector will be impacted mostly by the impact of the federal NOL limitations and the transition tax and GILTI. The labor intensive service sector will see the smallest overall increase in federal taxable income. While it is somewhat affected by the transition tax and the business expense interest limitation, it benefits almost equally from the expansion of bonus depreciation and the move to a territorial tax system.

What all of this implies is that, in the first year, there is a positive potential impact on state revenues as the result of the federal tax cuts. Whether this is a long run positive depends on how corporate taxpayers react. We would expect pressure to be brought to bear on state legislatures to make adjustments to their own tax codes to account for this non-legislative increase. We do have concern that as this process sorts itself out, the resulting increases in tax liability may mute the positive intended economic impact of the federal tax cut. In particular, the larger share of base expansion assigned to the manufacturing sector may help to dampen the employment impact intended by the proponents of the tax cut.

We note that states traditionally associated with manufacturing – Pennsylvania, New Jersey, New York, Iowa, Massachusetts, and Missouri – to name a few have the highest percentage rates of expansion in their corporate tax base as the result of the federal changes.

CENSUS DATA SHOWS IMPACT OF HOUSING COSTS

The US Census Bureau released data this past week revealing population trends for the country’s major metropolitan areas. Among these was Wayne County, MI which is substantially comprised of the City of Detroit. The good news for the city is that the area is now ranked ninth on the list of declining county populations rather than third as was the case in 2017. This is attributable to, among other things the availability of housing in the City of Detroit.

One criticism of the City’s efforts on renewal in the post-bankruptcy era is that it has mainly attracted higher income workers back into the city. The availability of lower cost affordable housing has not been as readily addressed. Now the State of Michigan and the City have announced a program to begin to address that demand. To the surprise of no one, it will rely in a substantial way on tax exempt financing.

Detroit is creating a $250 million affordable housing fund that would preserve 10,000 affordable housing units with expiring low-income housing tax credits and create 2,000 new ones on vacant land or in existing vacant buildings by 2023. The fund would be made up of $50 million in grant funding; $150 million in low-interest borrowing; and another $50 million in city and federal funds over the next five years.

The fund will comprise monies from bank financing, low-income housing tax credits, tax-exempt bonds, brownfield financing and historic tax credits. The first project funding commitments are expected early next year. Last year, the City Council approved an ordinance requires housing developers who receive a certain threshold of public subsidies or discounted city-owned land in Detroit to set aside at least 20% of their units for lower-income residents.

NEW JERSEY TOBACCO REFUNDING HIGHLIGHTS RECENT USE TRENDS

The State of New Jersey is undertaking a current refunding of outstanding tobacco securitization debt. The issue gives us a chance to look at historic sales data and the accompanying projections of future sales trends supplied in the prospectus. This issue will have a final maturity of 2046 and features the well established “turbo” maturity schedule which, if met, would retire approximately one-third of the bonds within 14 years.

The O.S. shows that sales of cigarettes have been declining in this century at an average of 3% per year. The rate of decline has not been consistent with large drops attributable to the Great Recession and price and taxation events. Sales actually increased twice (albeit less than 2%) on a year over year basis. The forecast of cigarette consumption which is included in the prospectus calls for annual declines in sales of 2.9% annually through 2046 (the final maturity of the bonds).

The State receives 3.8669963% of the annual $9 billion of payments made by the original and subsequent participating manufacturers under the terms of the Master Settlement Agreement. These payments are pledged to the repayment of the bonds on a subordinate basis. There is also a $52 million reserve to be maintained for the bonds.

These bonds will refund debt with a final maturity of 2041 so there is some extension of the maturity risk associated with this issue.

We have always taken the view that tobacco bonds are primarily a professional institutional investor trading vehicle. We believe that the historic price volatility that the sector has experienced due to the typically extended duration of the bonds is more than the typical individual investor should be expected to handle on their own. Nothing about the structure or security position of this issue causes us to change our view.

CONNECTICUT TO SELL BONDS IN THE FACE OF A DEFICIT

The State of Connecticut will try to sell some $600 million of general obligation bonds in the wake of the latest current deficit assessment. The State Comptroller last week announced that the State faces a General Fund deficit from operations of $192.7 million, an improvement of $2.1 million from the level reported in February. Projected revenues remain unchanged from the level reported last month. The figure does not include the impact of a deposit which is required to be made to the State’s Budget Reserve Fund if General Fund revenues exceed $3.5 billion as is expected to be the case.

Without action to mitigate the projected deficit, the balance in the BRF, after transfers to extinguish the FY 2018 deficit, is projected to be $685.1 million, equivalent to 3.6% of FY 2019 General Fund appropriations. If the projected deficit is resolved without utilizing resources from the BRF, the balance in the reserve will reach $877.8 million, or 4.7% of FY 2019 General Fund appropriations. Expenditures are estimated to be $16.2 million above the budget plan. The expenditure and revenue estimates assume that the budgeted level of rate increases and supplemental payments to hospitals will be made, and that the budgeted amount of the hospital user fee and federal revenue will be collected.

Statutory provisions require the state to process certain hospital rate and supplemental payments in advance of full federal approval. The state’s submissions are currently under federal review, but it is unclear whether and when federal approvals will be obtained. If approvals are delayed beyond the end of the fiscal year, there could be a budgetary impact of approximately $150 million.

All of this is reflected in S&P’s latest statement on Connecticut’s credit. It affirmed its ‘A+’ rating on the state’s approximately $18.5 billion of GO debt outstanding, its ‘A’ rating on state appropriation-secured debt, and its ‘BBB+’ rating on state moral obligation debt. The outlook on all long-term debt is negative. S&P cited revenue weakness because of slow economic growth and recent population decline and reduced revenue-raising flexibility after the state instituted substantial tax increases in the past two biennium budgets. Less expenditure flexibility following implementation of new constitutional spending caps; reductions in state aid to localities; implementation of a recent labor agreement that reduced costs, but also created fixed pay schedules and prohibits layoffs over the next four years; and rising fixed-debt service, pension, and OPEB expenditures all contribute to the outlook.

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.

 

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$251,000,000

Philadelphia School District

General Obligation Bonds

The District’s debt carries an underlying Ba2 rating and an A2 enhanced rating. The underlying rating is based on strained financial position and narrow reserves, exacerbated by substantial charter enrollment pressures. As students leave the system for charter schools the District loses state revenues which are linked by formula to average daily attendance. This has been a long standing problem for the District. The trend of shift in enrollment from the public system to charter schools has slowed but is still an issue for the District and its finances.

The A2 enhanced rating reflects the credit support of the Pennsylvania School District Intercept Program, which provides that state aid will be allocated to bondholders in the event that the school district cannot meet its scheduled debt service payments. The rating reflects that Philadelphia School District has engaged a fiscal agent, and there is language in the bond documents that will trigger the state aid intercept prior to default.

The positive outlook assumes that finances will be maintained within the range of what is considered structural balance on a forward basis. Governance of the system was returned to local control in 2018. The mayor’s recent budget proposals have allocated permanent tax increases to the district.

These are general obligation bonds of the Philadelphia School District, to which the district has pledged its full faith, credit, and taxing power. The district’s GO debt is supported by a lock-box structure, whereby four dedicated tax streams (including property tax) are allocated on a daily, pro-rata basis to bondholders. The Pennsylvania School District Intercept Program is not a general obligation guarantee of the Commonwealth, and in fact, there have been times when the state has not distributed any aid to school districts, as was the case during the 2016 state budget impasse. However, with implementation of Act 85 in 2016, the state has ensured that intercept payments, for the benefit of bond debt service, will be made even in the absence of an appropriation budget.

The enhanced rating is ultimately tied to the general obligation rating of the Commonwealth. The current outlook for the Commonwealth’s rating is stable despite a difficult annual budgeting process and an excessively political environment due to the upcoming gubernatorial election in November.

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CYBERSECURITY BACK IN THE NEWS

Analysis by DHS and FBI was revealed this week that showed that since at least March 2016, Russian government cyber actors—hereafter referred to as “threat actors”—targeted government entities and multiple U.S. critical infrastructure sectors, including the energy, nuclear, commercial facilities, water, aviation, and critical manufacturing sectors. In multiple instances, the threat actors accessed workstations and servers on a corporate network that contained data output from control systems within energy generation facilities.

Russian state hackers had the foothold they would have needed to manipulate or shut down power plants. made their way to machines with access to critical control systems at power plants that were not identified. The hackers never went so far as to sabotage or shut down the computer systems that guide the operations of the plants. The report made it clear that efforts to actually shut down operations did not occur, not because of technical inability but because a conscious decision was made not to.

The groups that conducted the energy attacks are linked to Russian intelligence agencies. Affected facilities included that of the Wolf Creek Nuclear Operating Corporation, which runs a nuclear plant near Burlington, Kan. At the time of that attack in summer 2016, the corporation said that no “operations systems” had been affected and that their corporate network and the internet were separate from the network that runs the plant.

The level of disclosure available from municipal utilities as to the cyber threats they face and their response to them has varied. They range from none to very broad and inexact statements of actions usually unaccompanied by any cost estimate assigned to these efforts. This report makes clear that the potential risk from cyber attack is significant. Investors would not tolerate minimal to no discussion of various natural, legal, or regulatory risk. There is no reason for investors to tolerate a lack of disclosure in this critical area.

GUAM REVENUE ISSUERS UNDER PRESSURE

In the aftermath of Puerto Rico’s ongoing fiscal crisis, investors seeking triple tax exempt debt may have looked to Guam. After some steps were taken to improve the central government’s fiscal position, the credit became somewhat more attractive for investment. Now it appears that this may no longer be a viable strategy. The island’s GO is on negative outlook and now the revenue issuers on Guam are under pressure as well.

Moody’s announced this week that the Baa2 rating on the A.B. Won Guam International Airport Authority’s senior General Revenue Bonds was affirmed  but that it had changed the rating outlook to negative from stable. The change in rating outlook to negative reflects Moody’s assessment of the linkage between Guam International Airport Authority and local economic conditions in Guam.  Moody’s is concerned that a deterioration of local economic conditions could put negative pressure on travel demand to and from the island, and would likely have an impact on enplanements and routes offered by airline carriers. In that regard, Delta Airlines has recently decided to no longer serve the Guam Airport and United Airlines also reduced some of its weekly Japan flights as result of lower demand from Japan. Japan is the major source of tourism to Guam.

Moody’s affirmed the Baa2 ratings on the Guam Power Authority (GPA)’s senior revenue bonds but also changed the outlook to negative from stable. According to Moody’s, GPA operates fairly independently from the government. It expects that the authority would not be able to disconnect itself from the local economic conditions or material financial stress at the government level. Until now, the government has remained current on paying its bills and there has been no pressure to receive transfers 2017 electric revenue. A deterioration of government finances or local economic conditions could put pressure on outstanding receivables and customers’ ability to pay their bills. In addition, the Public Utility Commission’s willingness to support rate increases could weaken during time of economic stress.

WATER IN THE WEST – CALIFORNIA DRINKING WATER TAX

A new study from the University of California at Davis identifies those San Joaquin Valley residents without access to drinking water. The report names some 300 areas, many in unconsolidated communities which do not have their own water systems supplied by any of the major California water distributors. In many cases, these connections are not the result of a lack of proximity to these suppliers. Rather they are the product of a lack of funding to finance such projects.

Many of these communities rely on water supplies which are vulnerable to runoff which allows any number of dangerous chemicals to taint the supplies for these systems.  This is especially common in unincorporated communities categorized as disadvantaged, which are also overwhelmingly Hispanic. Some of the systems have treatment facilities attached to them but the economics of operating these plants has led to their shutdown or abandonment. The result is the presence of substances like arsenic and nitrate. Some 300 public water systems in California are believed to be contaminated.

Now legislation has been introduced in the California legislature to provide funding for the creation of a fund to finance the cost of connecting these individual systems to larger systems which can treat the water over a larger base to reduce the per user cost of cleaning the drinking water. Senate Bill 623 would establish a fund to help those communities pay for water treatment projects.

It would seem to be an idea which would lend itself to broad based support and there is such support in the legislature. But enactment is not a sure thing due to the source of funding for the proposed fund. That source is a proposed tax on the bills of other water users. The bill would impose, until July 1, 2020, a safe and affordable drinking water fee in specified amounts on each customer of a public water system in the State. The bill, until January 1, 2033, would require a every person who manufactures or distributes fertilizing materials to be licensed by the Secretary of Food and Agriculture and to pay to the secretary a fertilizer safe drinking water fee of $0.005 per dollar of sale for all sales of fertilizing materials. The bill, on and after January 1, 2033, would reduce the fee to $0.002 per dollar of sale.

A number of large municipal water systems have registered opposition. Many systems in California have used water charges to help further water conservation during times of drought. These increased rates have led to pressure on local water boards to minimize rate increases whenever possible. In addition, the bill would impose a specific fee on milk producers. These producers are a powerful lobby in the nation’s largest milk producing state. This political pressure serves to generate opposition to the proposed tax.

The Association of California Water Agencies has come out against the bill in its current form.  ACWA and more than 135 public water agencies are advancing what they present as a more appropriate alternative – a package of existing and proposed funding sources that do not include a tax on drinking water. This package includes ongoing federal safe drinking water funds, state general obligation bonds and an augmentation from the state general fund, in addition to agricultural assessments proposed in the bill.

Arguably, any increase for an individual water system which is not related to the coverage of its own operating costs and debt service could be considered credit negative.

DOJ SIDES WITH STATES IN INTERNET TAX CASE

In 1992, the US Supreme Court ruled in Quill v. North Dakota, that states could not tax mail-order products delivered from other states through common carrier or the U.S. Postal Service. Internet retailers such as Amazon have used the ruling to avoid collecting state sales taxes. Because Congress has refused to pass legislation allowing states to collect sales taxes from internet retailers, many U.S. jurisdictions have been unable to collect sales taxes they are owed from online sales.

South Dakota vs. Wayfair Inc., which will be orally argued before the Supreme Court in April, was filed after that state passed a law seeking to collect the sales tax from online retailers. The U.S. Department of Justice (DOJ) has filed a brief in the U.S. Supreme Court supporting state efforts to collect internet sales taxes. The DOJ argues that “In light of internet retailers’ pervasive and continuous virtual presence in the states where their websites are accessible, the states have ample authority to require those retailers to collect state sales taxes owed by their customers. Quill Corp. v. North Dakota should not be read to bar that result, both because the Quill Court did not and could not anticipate the development of modern e-commerce, and because Quill’s analysis was deeply flawed.”

Quill allows states to collect sales taxes only from businesses that have a physical presence in their jurisdictions. DOJ argues further that  “the nature of an internet retailer’s presence in the states where its website is accessible is different in kind from any type of ‘presence’ that the court could have anticipated…. And given the proliferation of such retailers, imposition of a physical-presence requirement would substantially impede state tax collection and…distort retailers’ choices of appropriate business models.

DOJ now joins 35 states which have filed friend of the court briefs in the case supporting South Dakota’s effort.

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.

 

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$1,000,920,000

New York City Transitional Finance Authority (TFA)

Building Aid Revenue Bonds

Educational projects in New York City’s education capital plan, including new construction, building additions, and rehabilitations, are eligible for state building aid.  The State Education Department (SED) determines the amount of confirmed building aid payable annually by applying a building aid ratio to the amount of aidable debt service for the year. These funds are pledged to the payment of debt service on the bonds. The state aid intercept provision of Section 99-B of the School Finance Law is available to these bonds.

Each year the state annually appropriates money to New York City to pay for educational needs of the city’s students. A portion of this aid constitutes the state building aid. The state does not distinguish between the payment of education aid and building aid, making lump sum payments to the city. To secure the bonds and separate building aid from the rest of the education aid, the city, TFA, SED and the state comptroller entered into an MOU specifying procedures to determine the amount included in each general education aid payment that is attributable to state building aid. Prior to each general education aid payment, the TFA is required to calculate and certify to the SED, the comptroller and the state budget director the amount of the building aid payment payable to the TFA..

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THE JANUS CASE WON’T INSURE LABOR PIECE – MAYBE THE OPPOSITE

For years, vocal observers have blamed public employee salary and pension costs on unions and the collective bargaining process. Those who hold that view have placed their hopes on a decision in favor of the plaintiff in the recently argued Janus case in the US Supreme Court. Such a decision would be seen by proponents as the last nail in the coffin of public sector employee unions and their ability to bargain effectively on behalf of their employees. It is viewed as potentially ushering in a more “rational” environment for the setting of public employee salaries and benefits.

Recent events in West Virginia may reveal a serious weakness in that view. The strike being conducted by the state’s school teachers is not being conducted in support of a standard collective borrowing process. After all, West Virginia is not a collective bargaining state for its public employees. The current job action is not being led or sponsored by the teachers’ union. Costs to striking teachers are being funded through The WV Teachers Strike Support Fund, an independently created and funded organization. As of early last week, the Fund had a GoFundMe page for the striking workers which had garnered more than $218,000 by midday Monday.

The Fund had reviewed 174 requests and approved more than $71,000 — to teachers and school service personnel to cover strike costs, child care, medical bills, lost pay for aides and substitutes, re-stocking food pantries, and other efforts to support children and families during the strike. Those teachers were apparently having some success. The WV House approved a 5% raise suggested by the Governor and the Senate approved a 4% raise. The $13 million difference between the two levels of raise is the gap to be bridged in order to end the strike.

The ability of the teachers to achieve a raise outside of the typical collective borrowing process could be seen as a template for future job actions by public employees in other jurisdictions which have or hope to curtail union bargaining rights. The ability of employees to use technology and the internet to raise funds could ultimately mitigate the restrictions on union abilities to raise funds through the mandatory “dues check off”.

COAL CONTINUES LONG TERM DECLINE

For states like West Virginia and Wyoming, the handwriting is on the wall for their major commodity industry – coal. The U.S. Energy Information Administration (EIA) expects the share of U.S. total utility-scale electricity generation from natural gas-fired power plants to rise from 32% in 2017 to 33% in 2018 and to 34% in 2019. The forecast generation share from coal in 2018 averages 30%, about the same as in 2017, but then falls to 29% in 2019. The nuclear share of generation was 20% in 2017 and is forecast to average 20% in 2018 and 19% in 2019. Nonhydropower renewables provided slightly less than 10% of electricity generation in 2017 and is expected to provide about 10% in both 2018 and 2019. The generation share of hydropower was almost 8% in 2017 and is forecast to be about 7% in both 2018 and 2019.

Wind generated an estimated 691,000 megawatthours per day (MWh/d) of electricity in 2017. EIA projects that generation from wind will rise to an average of 705,000 MWh/d in 2018 and 765,000 MWh/d in 2019. If project conditions hold, generation from conventional hydropower is projected to average 730,000 MWh/d in 2019, which would make it the first year that wind generation exceeds hydropower generation. EIA projects that total solar electricity generation will increase from an estimated average of 209,000 MWh/d in 2017 to 240,000 MWh/d in 2018 and to 287,000 MWh/d in 2019.

It is clear that the forces working against employment in the coal industry continue. Much of Wyoming’s supply is mechanically surface stripped while underground mines continue to increase the use of automation to extract the mineral. Combined with steadily decreasing demand from the power generation industry, the outlook for mining employment remains grim.  It is anticipated that energy firms will retire coal-fired power plants that account for 20 gigawatts of power, about 10 percent of the total amount of U.S. coal capacity.

This will continue pressure on West Virginia’s economy and fiscal outlook.

GUAM UNDER THE GUN

S&P Global Ratings has placed its ‘BB-‘ rating on the Government of Guam’s general obligation (GO) debt and its ‘B+’ rating on the government’s various certificates of participation (COPs) on CreditWatch with negative implications. S&P cited the government’s disclosure that its cash flow will be extremely constrained over the next several months, and perhaps even longer, and also reflects its view that the government’s ability to meet its ongoing obligations could be impaired. The fiscal stress is due to an estimated $67 million decrease in general fund revenue for fiscal 2018 due to the effect of The Tax Cuts and Jobs Act of 2017, signed into law by President Trump on Dec. 22, 2017.

The government’s total general fund balance was negative $106 million as of audited fiscal 2016 (ended Sept. 30), equal to negative 14% of expenditures, with the unreserved or unassigned portion growing for a third-consecutive year to negative $215

million. Audited financial statements for fiscal year-end (Sept. 30) 2017 are not yet available. S&P is looking for evidence from Guam officials addressing a history of structural imbalance in its general fund, including recurring deficits, a very large negative general fund balance, and massive long-term liabilities.

NYC IBO REVIEWS NYC BUDGET PROPOSAL 

Based on the Independent Budget Office’s (IBO) reestimates of city spending and revenues, the budget for 2018 is projected to be $88.3 billion rising to $89.3 billion in 2019 (all years are fiscal years unless otherwise noted). Based on its analysis, the budgets for both years are not only balanced, but are projected to end with surpluses. IBO’s estimates yield smaller budget gaps in 2020 and 2021 than those estimated by the Mayor, while in 2022 it estimates a surplus.

What are the risks?  The Governor’s current budget assumes millions of dollars less for the city than the Mayor estimates in his current financial plan. If these changes were to be adopted, the city would have to find ways to make up for these lost funds, either through reduced services or by finding other funding sources, most likely from the city itself. IBO, following the Office of Management and Budget (OMB), has assumed that the city will drop some links to the federal tax system so as to avoid impacts on the city’s own revenues, but these steps would still leave many high-income city residents facing major changes in their federal taxes.

IBO has raised its forecast of near-term U.S. economic growth. It projects an acceleration of real growth to 2.9 percent in 2018, and somewhat slower growth of 2.6 percent in 2019. New York City’s economy added 67,000 jobs in 2017—an impressive ninth consecutive year of employment growth. But the pace of employment growth—1.5 percent— was slowest since the recession. IBO forecasts continuing but diminishing employment gains in the city, from 62,400 in 2018 and 50,000 in 2019 declining to 36,900 by 2022. The bright spots for city employment growth in 2017 were health care services (+22,700), accommodation and food services (+12,800), construction (+10,000), and finance and insurance (+9,500). The latter includes an increase of 7,500 jobs in the securities sector.

Tax revenues, which are projected to grow by 6.8 percent from 2017 to 2018 account for much of the growth in total revenue. The city’s total own source revenue—excluding state, federal, and other grants—is projected to grow by 5.1 percent. For 2019, IBO anticipates a smaller gain of 1.2 percent in total revenue to $89.3 billion, pulled down by declines in city revenue from miscellaneous sources and federal grants. Tax revenue growth is expected to outpace total revenue growth with $60.2 billion in tax revenues projected for 2019, a $2.2 billion (3.8 percent) increase over the forecast for the current year. The city’s own non-tax revenues (primarily fees, fines, and sales) are projected to fall by 3.7 percent from 2018 to 2019, to $6.7 billion.

Noncity revenues in 2019 are expected to be 4.7 percent lower than in 2018, largely the result of an anticipated decrease in federal grants, which are expected to shrink by 13.8 percent. Much of the drop is due to the winding down of Sandy-related recovery aid. Annual growth of total revenue will average 3.2 percent over the last three years of the financial plan period, driven by city tax revenues growing at an average annual rate of 4.1 percent over that period, with other city revenues nearly flat (0.2 percent). Growth in noncity revenue sources is projected to average 1.1 percent annually in 2020 through 2022.

The real question for investors relates to the City’s ability to service its debt. Over the last five years the city has paid an average of $5.8 billion annually through its operating budget to service its outstanding debt, which as of June 30, 2017 totaled $86.3 billion. The preliminary budget assumes that over the next five years debt service will rise from $7.1 billion in 2019 to $8.8 billion in 2022 and cost the city an average of $7.6 billion annually. New debt the city expects to issue from 2018 through 2022 is the main driver of increases in debt service over the plan period. While higher interest rate assumptions also account for some of the increase, most of the growth is primarily the product of the city’s aggressive plan to sharply increase capital expenditures over the next few years.

IS LOUISIANA THE NEXT KANSAS?

The Louisiana Legislature gave up on addressing the state’s budget crisis on March 5 and adjourned two days before their special session was scheduled to end. The legislators left Baton Rouge without any solution to an expected budget of $994 million. The regular session of the legislature, when lawmakers write the budget that goes into effect July 1, starts next week. It’s not yet clear what services will be prioritized for funding.

Many fear that targets will leave college students, people with disabilities, hospitals, district attorneys and local sheriffs with more uncertainty about the future of their state funding. The focus is on cuts because tax bills cannot be taken up during the regular session, which opens March 12 and is supposed to end by June 4. To get around that restriction, the Governor, House Speaker, and Senate president favor adjourning the regular session 10 to 20 days early to hold another special session to raise taxes before June.

The current stalemate is about politics. The House rejected a sales tax hike for a second time in one week. Both parties  appeared to be in agreement that a sales tax hike and change in state income tax deductions should be approved. But House members could not agree on the order in which those two bills should be voted upon Sunday night. The parties were concerned that if the other side got their preferred tax bill approved and out of the House, that the other group would then block the second tax bill from moving forward.

The situation is also complicated by the compromise struck in 2016 when over $1 billion worth of temporary taxes in 2016 were passed. Those taxes expire June 30, creating the current looming financial problems. At the root of all of it is the failed supply side experiment undertaken by prior Governor Bobby Jindal. In an effort to raise his national profile he convinced the state that massive tax cuts, primarily for corporations in the state would stimulate so much economic activity that the lost tax revenues would be replaced. Like so many other state supply side experiments, these results failed to come to pass.

The result is a negative rating outlook for the State and a high degree of uncertainty for bond holders.

TaaS AND HEALTHCARE

Much has been made about the potential impacts of the ride share industry on public transit and the perception of the industry to positively impact transit and related outcomes. the implication is that the benefits are so clear that existing transit models are doomed with associated negative impacts on transit related municipal bond credits. The idea has gained currency with the latest announcement that Uber is teaming up with health care organizations to provide transportation for patients going to and from medical appointments. The rides can be scheduled for patients through doctor’s offices, by receptionists or other staffers. And they can be booked for immediate pickup or up to 30 days in advance.

Uber Health will send its passengers’ ride information through an SMS text message. The company also plans to introduce the option for passengers to receive a call with trip details to their landline instead.  Sounds like a no brainer, especially in addressing the needs of older, lower income patients who might not have current access to current technology communication devices.

Reality, may be different. JAMA Intern Medicine earlier this month published the results of a study conducted in Philadelphia as to the relative efficacy of ride sharing services relative to reliance on existing forms of transit to get patients to doctor appointments. The study asked what is the association between offering rideshare-based transportation services and missed appointment rates for primary care patients? The finding was that the missed appointment rate was not significantly different between patients offered rideshare-based transportation services compared with controls.

Transportation barriers contribute to missed primary care appointments for patients with Medicaid. Rideshare services have been proposed as alternatives to nonemergency medical transportation programs because of convenience and lower costs. 786 Medicaid beneficiaries who resided in West Philadelphia and were established primary care patients at 1 of 2 academic internal medicine practices located within the same building were included.

Patients assigned to both arms received up to 3 additional appointment reminder phone calls from research staff 2 days before their scheduled appointment. During these calls, patients in the intervention arm were offered a complimentary ridesharing service. Research staff prescheduled rides for those interested in the service. After their appointment, patients phoned research staff to initiate a return trip home.

The uptake of ridesharing was low and did not decrease missed primary care appointments. This does not mean that the idea is without merit. Rather it means that further study is warranted before the death of mass transit is prematurely declared. It also means that TaaS may not be as meaningful an impact on the healthcare delivery model as may be thought. We believe that current trends towards consolidation, scale, and diversity of entrance points will continue to be the drivers of healthcare credits. Technology will have much to offer the industry but transportation will not have the short term impact on credit that some advocates believe.

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.

Joseph Krist

Publisher

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ISSUE OF THE WEEK

$1,208,855,000

THE OKLAHOMA DEVELOPMENT

FINANCE AUTHORITY

Health System Revenue Bonds

(OU Medicine Project)

Moody’s: Baa3   S&P: BB+

OU Medicine, Inc. is the owner and operator of the health system previously known as OU Medical System. OU Medicine is a system of three acute care hospitals, an ambulatory surgery center and operates 22 other related clinics and other access points, composed of: OU Medical Center in Oklahoma City, Oklahoma, OU Medical Center Edmond in Edmond, Oklahoma and the Children’s Hospital in Oklahoma City. The hospitals serve as teaching and training facilities for students enrolled at the University of Oklahoma Health Sciences Center.

OU Medicine has a strong market position as a high acuity provider in Oklahoma. It’s close affiliations with and ties to University of Oklahoma entities and unique ties to the State through The University Hospitals Authority and Trust facilitates steady supplemental reimbursement payments. This helps to generate very good cashflow margins. The recent acquisition of for-profit HCA’s joint venture interest has created a more leveraged credit contributing to the split investment noninvestment grade ratings. Management of the transition to an independent not-for-profit health system is an important ratings consideration.. The rating is constrained by high pro forma leverage following the buyout of for-profit HCA’s joint venture interest, a very competitive market, modest initial liquidity, and high Medicaid and self-pay.

Children’s facilities tend to have very high Medicaid exposure and cash positions are often reflective of this factor offset by their unique abilities to raise funds through donations. Security for the bonds includes unrestricted receivables and a mortgage on certain property (including OU Medical Center and OU Medical Center Edmond). The MTI allows for a replacement master indenture if certain financial tests are met.

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KENTUCKY PENSION PROPOSAL

If the Kentucky legislature and the Governor get there way, future employees of the commonwealth will no longer have guaranteed pension benefits. A proposed bill filed by four legislators would Amend KRS 6.505 to provide that the “inviolable contract” provisions shall not apply to legislative changes to the Commonwealth’s employee  Retirement Plans that become effective on or after July 1, 2018. The bill reflects the view that historic underfunding of the Commonwealth’s pension funds can only be addressed by cutting benefits and not through the increase of any taxes to generate revenues to fund Kentucky’s substantial unfunded pension liabilities.

The bill would also create a new section of KRS 61.510 to 61.705 to establish an optional 401(a) money purchase plan for new nonhazardous members who begin participating in the Kentucky Employees Retirement System (KERS) and County Employees Retirement System (CERS) on or after January 1, 2019, who elect to participate in the plan; provide that the optional money plan that will operate as another benefit tier in KERS/CERS and will include a 4% employer contribution.

The bill was introduced after significant outside pressure was brought to bear. That campaign included a one-page letter, apparently emailed to all members of the General Assembly, which said any pension changes made during the 2018 legislative session must include “moving all future employees from a defined-benefits system to a defined-contribution system.” The letter was driven by conservative think tanks and the notorious tax agitator Grover Norquist. Norquist is behind the “starve the beast” movement which seeks to significantly eliminate public sector spending.

Kentucky’s pension systems have lost more than $7 billion in value over the past 10 years through below average investment performance. The legislation would reduce cost of living adjustments (COLAs), adjust the minimum retirement age, and shift some of the costs of pensions to localities and school districts. The plan would shift more financial pressure to localities while only slowly addressing the state pension burden.

At the same time, the bill would seemingly reduce transparency regarding the pension funds’ funding and investment results. Specifically, it would provide that the Public Pension Oversight Board’s hiring of an actuary to perform a review of state-retirement system rates is voluntary.

Employees and their supporters have opposed the bill on the basis of the ideological stance of the organizations from outside the Commonwealth who are advising the Governor. The primary group – Save Our Pensions – operates outside the jurisdiction of both the Kentucky Registry of Election Finance and the Legislative Branch Ethics Commission. Since it is not advertising on behalf of a candidate, it doesn’t have to register with the state’s election finance branch. And since it isn’t lobbying legislators directly on the pension issue, it doesn’t have to register with the legislative ethics commission.

Registered as a 501(c)(4) tax-exempt social welfare group with the IRS, the group also doesn’t have to publicly disclose its donors.

The approach to pensions extends the Governor’s well established ideological approach to the Commonwealth’s overall finances including his stance on taxes, Medicaid and now, pensions.

EMPLOYEES IN WEST VIRGINIA WIN TENTATIVE RAISE

Early in the week, the US Supreme Court heard oral arguments in what is known as the Janus Case. The case was brought by an individual state employee in Illinois, backed by anti-union groups, who seeks to strip unions of their right to collect dues from all employees on whose behalf it negotiates with employers. It is widely expected that the court will rule against unions.

Ironically, in nearby West Virginia, unionized teachers in the state’s public school systems won the Governor’s support for a 5% raise for themselves after a four day strike. At the same time, all other state employees would receive a 3% raise. The proposal must now be approved by the state legislature. West Virginia law does not recognize a right for public school employees to collectively bargain. Rather, the legislature regulates public school labor by statute.

For the teachers, the legislature has been much less supportive. As we go to press, teachers will have been on strike for seven days and they appear to be dug in. The state’s teacher’s salaries were ranked 48th in the nation in 2016. The dispute comes amidst calls for teachers to become security guards, rising health costs, and a diminished state economy that makes West Virginia a more difficult place to attract teachers to.

KENTUCKY CONSIDERS GAS TAX INCREASE

While Washington dithers over whether to pass an infrastructure plan, how to fund the Highway Trust Fund, and the question of raising taxes to do it, the states continue to move forward with consideration of revenue raising proposals. The latest is in the Kentucky legislature. Like many states, transportation needs are pressing and underfunded and the feeling is that states cannot wait for the federal government to get its act together.

A bipartisan proposal in the Kentucky legislature would raise the gas tax and impose annual fees on hybrid and electric vehicles in an attempt to replenish the state’s stagnant road fund. Kentucky faces a backlog of over $1 billion in road paving projects. This does not include some 1,000 bridges that require repair or replacement. At the same time, the Commonwealth’s road fund to finance repair and replacement projects has not increased since 2014.

A study committee was formed in the summer of 2017 by the then Speaker of the Kentucky House. The results of that study led to House Bill 609 . The bill would add an extra $391 million a year to the state’s road fund. It would do so by setting the average wholesale floor price at $2.90; increase the supplemental tax on gasoline and special fuels by increasing the existing rate from five cents per gallon (cpg) on gasoline and two cpg on special fuels to eight and a half cpg for both and setting that as the minimum rate. It would establish a base fee for hybrid vehicles, hybrid electric plug-in vehicles, and nonhybrid electric vehicles and require the fee to be adjusted with any increase or decrease in the gasoline tax established. It would also increase a variety of motor vehicle fees as part of the overall program.

WHAT TARIFFS WOULD MEAN FOR CREDIT

Trade wars usually do not end well. So we greet the news that the President appears to have been convinced that steel and aluminum tariffs will be good for workers in those industries is dismaying. We see no evidence that employment will be increased in those industries as the result of higher cost US steel and aluminum. The fact is that direct employment in the steel industry is 140,000. While those workers may benefit, workers in manufacturing industries like autos and appliances will be hurt. Construction may become more expensive so employment will be hurt there.

On the other side of the trade, export businesses like agriculture, commodities, energy and technology will all potentially face reduced demand. If you are a wheat farmer in Kansas, you are now facing a wheat farmer in Canada whose country is in the TPP. Airplane manufacturers will lose to Canadian and European producers. So take the strip roughly between Idaho and Minnesota in the north right on down the front range of the Rockies and along the Mississippi and ask where will they sell their commodities?

Now if you are a manufacturer what do you do? Three years ago, Ford Motor gambled when it started selling a new version of its F-150 pickup truck made mainly of aluminum rather than steel. With lower gas prices, fuel economy is no longer a persuasive factor for many truck buyers. While sales are brisk, F-Series trucks — including the F-150 and the brawnier Super Duty — have only slightly increased their share of the full-size pickup truck segment since the aluminum models arrived and share is actually lower than it was in 2013.

In 2017, the company’s income in North America fell 17 percent, in part because of rising steel and aluminum prices. Aluminum prices have risen more than 20 percent in the last three years. New-vehicle sales in the United States are expected to decline this year and next anyway. Now they will be more expensive. And competitors are introducing different materials. For example, G.M. unveiled a GMC Sierra available with a bed of carbon-fiber composite.

The point is about more than the auto industry. The development in materials choices, costs of fuel, introduction of artificial intelligence are all factors impacting employment way beyond the cost of Chinese steel and aluminum. The inflationary aspects of tariffs are more wide ranging and negative for municipal credits than the cost of any one commodity. Lower corporate profits from higher costs and lower sales impact all states. They impact local employment and tax revenues.

It also has not taken long for there to be impacts. Electrolux, a foreign appliance manufacturer which sources all of its materials from US producers for use at plants in the US, announced that anticipated higher steel and aluminum prices would lead them to delay construction of a $250 million production facility in Tennessee. Sales, income, and property tax revenues plus jobs will be delayed as well.

WHERE ARE THE STEEL MILLS AND ALUMINUM SMELTERS IN THE US?

Michigan, Indiana, Ohio, Pennsylvania, Alabama, Colorado, Delaware, Mississippi, South Carolina. These include huge integrated mills as well as specialty mini-mills. In addition to jobs and sales of raw materials, many of these facilities are huge consumers of electric power. Primary aluminum smelters – huge consumers of electricity – are located in New York, Washington, South Carolina, Kentucky. So for the short term these facilities will get some breathing room.

WHICH STATES EXPORT?

Should there be widespread retaliation for the imposition of tariffs, it is useful to know which states have the most to lose in terms of their exporting volume. The five largest exporting states in terms of dollar value of the goods they ship are Texas, California, Washington, New York, and Illinois. This reflects significant manufacturing bases in these states as well as substantial agricultural sectors. Ohio, Louisiana, Michigan, and Florida are also major exporters.

 

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.